Approximate date of commencement of proposed sale to the public:
As soon as practicable after this registration statement becomes effective.
If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act check the following box: x
If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this form is a post-effective amendment filed
pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering. o
If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering. o
If delivery of this prospectus is expected to be made pursuant to Rule 434, check the following box. o
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. (Check one):
Large accelerated filer o
Accelerated filer o
Non-accelerated
filer o
Smaller reporting company x
(Do not check if a
smaller reporting company)
The
Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.
This
Post-Effective Amendment No. 6 consists of the following:
Supplement No. 11 dated October 24, 2014, to the Registrant’s final prospectus, which supersedes and replaces all prior supplements to the prospectus and which will be delivered as an unattached document along with the prospectus;
3.
Part II, included herewith; and
4.
Signature
page, included herewith.
NORTHSTAR REAL ESTATE INCOME II, INC.
Sponsored by
NorthStar Realty Finance Corp.
$1,650,000,000 Maximum Offering
NorthStar Real Estate Income II, Inc. is a Maryland corporation formed to originate, acquire and asset manage a diversified portfolio of commercial real estate, or CRE, debt, select equity and securities investments. We are sponsored by NorthStar Realty Finance Corp. (NYSE: NRF), a publicly traded, diversified commercial real
estate investment and asset management company that is organized as a real estate investment trust, or REIT, with $10.6 billion of assets, as of December 31, 2013. We refer to NorthStar Realty Finance Corp. as our sponsor. We believe that we have qualified as a REIT commencing with our taxable year that ended December 31, 2013 and we intend to operate in a manner so that we continue to qualify as a REIT. As of April 16, 2014, our portfolio consists of three CRE debt investments with a combined principal amount of $139.7 million.
We are offering up to $1,500,000,000 in shares of our common stock to the public at $10.00 per share. We are also offering up to $150,000,000 in shares of our common stock pursuant to our distribution reinvestment plan, or DRP, at a purchase price of
$9.50 per share. We expect to offer shares of common stock in our primary offering until May 6, 2015, unless extended by our board of directors.
Investing in our common stock is speculative and involves substantial risks. You should purchase these securities only if you can afford a complete loss of your investment. See “Risk Factors” beginning on page 19 to read about the more significant risks you should consider before buying shares of our common stock. These risks include the following:
•
We have limited prior operating history and the prior performance of our sponsor and its affiliated entities may not predict our future results.
Therefore, there is no assurance that we will achieve our investment objectives.
•
This is a “blind pool” offering. You will not have the opportunity to evaluate a significant portion of our investments we make subsequent to the date you subscribe for shares.
•
We have paid cash distributions declared through December 31, 2013 using offering proceeds and may continue to pay distributions from sources other than our cash flow from operations, and as a result, we
will have less cash available for investments and your overall return may be reduced. Our organizational documents permit us to pay distributions from any source, including from borrowings, sale of assets and offering proceeds or we may make distributions in the form of taxable stock dividends. We have not established a limit on the amount of proceeds we may use to fund distributions.
•
No public trading market currently exists for our shares; therefore, it will be difficult for you to sell your shares. Any buyer must meet applicable suitability standards. If you are able to sell your shares, you would likely have to sell them at a substantial loss. Our charter does not require our board of directors to list our shares for trading on a national
securities exchange by a specified date or otherwise pursue a transaction to provide liquidity to our stockholders.
•
You will experience dilution in the net tangible book value of your shares of our common stock equal to the offering costs associated with your shares.
•
The amount of distributions we may pay in the future, if any, is uncertain. Due to the risks involved in the ownership of real estate-related investments, there is no guarantee of any return and you may lose a part or all of your investment.
•
Our
investments may decrease in value or lose all value over time.
•
Our executive officers and other key professionals of NS Real Estate Income Advisor II, LLC, our advisor and a subsidiary of our sponsor, are also officers, directors and managers of our sponsor and two other public, non-traded REITs affiliated with our sponsor and their respective advisors. As a result, they face conflicts of interest, including time constraints, allocation of investment opportunities and significant conflicts created by our advisor’s compensation arrangements with us and such other affiliates of our sponsor.
•
The
fees we pay to affiliates in connection with our offering and in connection with the origination, acquisition and asset management of our investments, including to our advisor, were not determined on an arm’s length basis; therefore, we do not have the benefit of arm’s length negotiations of the type normally conducted between unrelated parties. These fees increase your risk of loss.
•
If we raise substantially less than the maximum offering, we may not be able to acquire a diverse portfolio of investments and the value of your shares may vary more widely with the performance of specific assets.
•
We
may change our investment policies without stockholder notice or consent, which could result in investments that are different than, or in different proportion than, those described in this prospectus.
•
Our intended investments in commercial mortgage-backed securities and other structured debt securities will be subject to risks relating to the volatility in the value of underlying collateral, default on underlying income streams, fluctuations in interest rates, and other risks associated with such securities which may be unknown and unaccounted for by issuers of the securities and by rating agencies.
•
If
we terminate our agreement with our advisor, we may be required to pay significant fees to an affiliate of our sponsor, which will reduce the cash available for distribution to you.
Neither the Securities and Exchange Commission, the Attorney General of the State of New York nor any other state securities regulator has approved or disapproved of our common stock, determined if this prospectus is truthful or complete or passed on or endorsed the merits of our offering. Any representation to the contrary is a criminal offense.
The use of projections or forecasts in our offering is prohibited. Any representation to the contrary and any predictions, written or oral, as to the amount or certainty of any present or future cash benefit or tax consequence which may flow from an investment in our common stock is not permitted.
Price to Public (1)
Selling Commissions (2)
Dealer
Manager Fee (2)
Net Proceeds (Before Expenses) (3)
Primary Offering
$
10.00
$
0.70
$
0.30
$
9.00
Total
Maximum
$
1,500,000,000.00
$
105,000,000.00
$
45,000,000.00
$
1,350,000,000.00
Distribution
Investment Plan Per Share
$
9.50
$
—
$
—
$
9.50
Total
Distribution Reinvestment Plan
$
150,000,000.00
$
—
$
—
$
150,000,000.00
(1)
We
reserve the right to reallocate shares of common stock being offered between the primary offering and our distribution reinvestment plan.
(2)
Discounts are available to investors who purchase more than $500,000 in shares of our common stock and to other categories of investors.
(3)
Proceeds are calculated before deducting issuer costs other than selling commissions and dealer manager fees. These issuer costs are expected to consist of, among others, expenses of our organization, actual legal, bona fide out-of-pocket
itemized due diligence expenses, accounting, printing, filing fees, transfer agent costs, postage, escrow fees, data processing fees, advertising and sales literature and other offering-related expenses.
Our dealer manager for our offering, NorthStar Realty Securities, LLC, or NorthStar Realty Securities, is an affiliate of our advisor and our sponsor. The dealer manager is not required to sell any specific number or dollar amount of shares but will use its best efforts to sell the shares offered. We are an “emerging growth company” under the federal securities laws and will be subject to reduced public company reporting requirements.
The shares of common stock we are offering are suitable only as a long-term investment for persons of adequate financial means and who have no need for liquidity in this investment. Because there is no public market for our shares, you will have difficulty selling any shares that you purchase. You should not buy shares of our common stock if you need to sell them immediately or if you will need to sell them quickly in the future.
In consideration of these factors, we have established suitability standards for investors in our offering and subsequent purchasers of our shares. These suitability standards require that a purchaser of shares have either:
•a net worth of at least
$250,000; or
•gross annual income of at least $70,000 and a net worth of at least $70,000.
The following states have established suitability standards that are in addition to those we have established. Shares will be sold only to investors in these states who also meet the special suitability standards set forth below.
Alabama—Alabama investors must represent that, in addition to meeting our suitability standards listed above, they have a liquid net worth of at least ten times their investment in us and other similar programs.
California—A California investor must have a net worth of at least $350,000 or, in the alternative, an annual gross income of at least $70,000 and a net worth of $150,000, and the total investment
in our offering may not exceed 10% of the investor’s net worth.
Iowa—In addition to our suitability requirements, an Iowa investor must have either: (i) a minimum net worth of $350,000 (exclusive of home, auto and furnishings); or (ii) a minimum annual gross income of $70,000 and a net worth of $100,000 (exclusive of home, auto and furnishings). In addition, an investor’s total investment in our shares or any of our affiliates, and the shares of any other non-exchange-traded REIT, cannot exceed 10% of the Iowa resident’s liquid net worth. “Liquid net worth” for purposes of this investment shall consist of cash, cash equivalents and readily marketable securities.
Kansas—It is recommended by the Office of the Kansas Securities Commissioner that Kansas investors not invest, in the aggregate, more than 10% of their liquid net worth
in this and similar direct participation investments. Liquid net worth is defined as that portion of net worth which consists of cash, cash equivalents and readily marketable securities.
Kentucky—A Kentucky investor’s aggregate investment in our offering may not exceed 10% of the investor’s net worth.
Maine—The Maine Office of Securities recommends that a Maine investor’s aggregate investment in our offering and other similar offerings not exceed 10% of the investor’s liquid net worth.
Massachusetts—It is recommended by the Massachusetts Securities Division that Massachusetts investors not invest, in the aggregate, more than 10% of their liquid net worth in this and similar direct participation investments.
Nevada—A
Nevada investor’s aggregate investment in us must not exceed 10% of the investor’s net worth (exclusive of home, furnishings and automobiles).
New Jersey—A New Jersey investor must have a net worth of at least $350,000 or, in the alternative, an annual gross income of at least $70,000 and a net worth of $150,000, and the aggregate investment in us, shares of our affiliates and other direct participation investments may not exceed 10% of the investor’s liquid net worth.
New Mexico—A New Mexico investor’s aggregate investment in our offering, the offerings of our affiliates and the offerings of other non-traded REITs may not exceed 10% of the investor’s liquid net worth.
North Dakota—North Dakota residents must represent that, in addition to the suitability standards listed above, they have a net worth of at least ten times their investment in us.
Oregon—An Oregon investor’s aggregate investment in us and our affiliates may not exceed 10% of the investor’s net worth.
For purposes of determining the suitability of an investor, net worth (total assets minus total liabilities) in all cases should be calculated excluding the value of an investor’s home, home furnishings and automobiles. “Liquid net worth” is defined as that portion of net worth that consists of cash, cash equivalents and readily marketable securities.
In the case of sales
to fiduciary accounts (such as individual retirement accounts, or IRAs, Keogh Plans or pension or profit-sharing plans), these suitability standards must be met by the fiduciary account, by the person who directly or indirectly supplied the funds for the purchase of the shares if such person is the fiduciary or by the beneficiary of the account.
Our sponsor, those selling shares on our behalf and participating broker-dealers and registered investment advisers recommending the purchase of shares in our offering must make every reasonable effort to determine that the purchase of shares in our offering is a suitable and appropriate investment for each stockholder based on information provided by the stockholder regarding the stockholder’s financial situation and investment objectives.
In determining suitability, participating broker dealers who sell shares on our behalf may rely on,
among other things, relevant information provided by the prospective investors. Each prospective investor should be aware that participating broker dealers are responsible for determining suitability and will be relying on the information provided by prospective investors in making this determination. In making this determination, participating broker dealers have a responsibility to ascertain that each prospective investor:
•meets the minimum income and net worth standards set forth above;
•
can reasonably benefit from an investment in our shares based on the prospective investor’s investment objectives and overall portfolio structure;
•
is
able to bear the economic risk of the investment based on the prospective investor’s net worth and overall financial situation; and
•has apparent understanding of:
•the fundamental risks of an investment in the shares;
•the risk that the prospective investor may lose his or her entire investment;
•the lack of liquidity of the shares;
•the restrictions on transferability of the shares; and
•the tax consequences of an investment in the shares.
Participating broker dealers are responsible for making the
determinations set forth above based upon information relating to each prospective investor concerning his or her age, investment objectives, investment experience, income, net worth, financial situation and other investments of the prospective investor, as well as other pertinent factors. Each participating broker dealer is required to maintain records of the information used to determine that an investment in shares is suitable and appropriate for an investor. These records are required to be maintained for a period of at least six years.
Investors seeking to purchase shares of our common stock who meet the suitability standards described herein should proceed as follows:
•Read this entire prospectus and any supplements accompanying this prospectus.
•
Complete the execution copy of the subscription agreement. A specimen copy of the subscription agreement, including instructions for completing it, is included in this prospectus as Appendix B.
•
Deliver
a check for the full purchase price of the shares of our common stock being subscribed for along with the completed subscription agreement to your soliciting broker-dealer. Your check should be made payable to “NorthStar Real Estate Income II, Inc.” or “NorthStar Income II.”
By executing the subscription agreement and paying the total purchase price for the shares of our common stock subscribed for, each investor agrees to accept the terms of the subscription agreement and attests that the investor meets the minimum income and net worth standards as described in this prospectus. Subscriptions will be effective only upon our acceptance and we reserve the right to reject any subscription in whole or in part. Subscriptions will be accepted or rejected within 30 days of receipt by us, and if rejected, all funds will be returned to subscribers with interest and without deduction for any expenses
within ten business days from the date the subscription is rejected. We are not permitted to accept a subscription for shares of our common stock until at least five business days after the date you receive the final prospectus. If we accept your subscription, our transfer agent will mail you a confirmation.
An approved trustee must process and forward to us subscriptions made through IRAs, Keogh plans and 401(k) plans. In the case of investments through IRAs, Keogh plans and 401(k) plans, we will send the confirmation and notice of our acceptance to the trustee.
Minimum Purchase Requirements
You must initially invest at least $4,000 in our shares of common stock to be eligible to participate in our offering. In order to satisfy this minimum purchase requirement, unless otherwise prohibited by state law, a husband and wife may jointly
contribute funds from their separate IRAs, provided that each such contribution is made in increments of $100. You should note that an investment in our shares of common stock will not, in itself, create a retirement plan and that, in order to create a retirement plan, you must comply with all applicable provisions of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code. If you have satisfied the applicable minimum purchase requirement, any additional purchase must be in amounts of at least $100, except for shares purchased pursuant to our DRP.
Investments by Qualified Accounts
Funds from qualified accounts will be accepted if received in installments that together meet the minimum or subsequent investment amount, as applicable, so long as the total subscription amount was indicated on the subscription agreement and all funds are received within a 90-day period.
Investments through IRA Accounts
DST Systems Inc., our transfer agent, has appointed a custodian that has agreed to act as an IRA custodian for purchasers of our common stock who would like to purchase shares through an IRA account and desire to establish a new IRA account for that purpose. Our advisor will pay the fees related to the establishment of new investor accounts of $25,000 or more in us with the appointed IRA custodian. We will not reimburse our advisor for such fees. Thereafter, investors will be responsible for the annual IRA maintenance fees. Prospective investors should consult their tax advisors regarding our advisor’s payment of the establishment fees. Further information about custodial services is available through your broker-dealer or through our dealer manager at 877-940-8777.
Please carefully read the information in this prospectus and any accompanying prospectus supplements, which we refer to collectively as this prospectus. You should rely only on the information contained in this prospectus and the registration statement of which it is a part. We have not authorized anyone to provide you with different information. This prospectus may only be used where it is legal to sell these securities. You should not
assume that the information contained in this prospectus is accurate as of any date later than the date hereof or such other dates as are stated herein or as of the respective dates of any documents or other information incorporated herein by reference.
This prospectus is part of a registration statement that we filed with the Securities and Exchange Commission, or the SEC, using a continuous offering process. Periodically, as we make material investments or have other material developments, we will provide a prospectus supplement that may add, update or change information contained in this prospectus. Any statement that we make in this prospectus will be modified or superseded by any inconsistent statement made by us in a subsequent prospectus supplement. The registration statement we filed with the SEC includes exhibits that provide more detailed descriptions of the matters
discussed in this prospectus. You should read this prospectus and the related exhibits filed with the SEC and any prospectus supplement, together with additional information described herein under “Additional Information.”
The registration statement containing this prospectus, including exhibits to the registration statement, provides additional information about us and the securities offered under this prospectus. The registration statement can be read at the SEC website, www.sec.gov, or at the SEC public reference room mentioned under the heading “Additional Information.”
The following questions and answers about our offering highlight material information regarding us and our offering that may not otherwise be addressed in the “Prospectus Summary” section of this prospectus. You should read this entire prospectus, including the section entitled “Risk Factors,” before deciding to purchase shares of our common stock.
Q:
What is NorthStar Real Estate Income II, Inc.?
A:
We
are a Maryland corporation formed to originate, acquire and asset manage a diversified portfolio of commercial real estate, or CRE, debt, select equity and securities investments. As of April 16, 2014, our portfolio consists of three CRE debt investments with a combined principal balance of $139.7 million.
The use of the terms “NorthStar Income II,” our “company,”“we,”“us” or “our” in this prospectus refer to NorthStar Real Estate Income II, Inc. and its consolidated subsidiaries, unless the context indicates otherwise.
Q:
Who
might benefit from an investment in our shares of common stock?
A:
An investment in our shares may be beneficial for you if you: (i) meet the minimum suitability standards described in this prospectus; (ii) seek to diversify your personal portfolio with a REIT investment focused on CRE debt, select equity and securities investments; (iii) seek to receive current income; (iv) seek to preserve capital; and (v) are able to hold your investment for at least five years following the completion of our offering stage or for longer, consistent with our liquidity strategy. See “Description of Capital Stock—Liquidity Events.” On the other hand, we caution persons who require liquidity, guaranteed income or who seek a short-term investment, that
an investment in our shares will not meet those needs.
Q:
What are the major risks of investing in CRE debt, select equity and securities investments and in us?
A:
We were formed in December 2012 and have limited operating history and our advisor on whom we will depend to select our investments and conduct our operations is also recently-formed. As of April 16, 2014, our portfolio consists of three CRE debt investments; however, we have not yet acquired or identified
a significant portion of the investments that we may make and you will not have an opportunity to evaluate our future investments before we make them. Collateral securing CRE debt and securities may lose its value and we may lose some or all of the principal we invest in CRE debt and securities and our borrowers and tenants may not be able to make debt service or lease payments. In addition, our organizational documents permit us to pay distributions from any source, including from borrowings, sale of assets and offering proceeds or we may make distributions in the form of taxable stock dividends. We have not established a limit on the amount of proceeds we may use to fund distributions. We have paid cash distributions declared through December 31, 2013 using offering proceeds and may continue to pay distributions from sources other than our cash flow from operations. Until the proceeds from our offering are fully invested
and otherwise during the course of our existence, we may not generate sufficient cash flow from operations to fund distributions. If we pay distributions from sources other than our cash flow from operations, we will have less cash available for investments and your overall return may be reduced. You should carefully review the “Risk Factors” section of this prospectus which contains a detailed discussion of the material risks that you should consider before you invest in shares of our common stock.
Q:
What is a real estate investment trust, or REIT?
A:
In
general, a REIT is an entity that:
•
combines the capital of many investors to acquire or provide financing for a diversified portfolio of real estate investments under professional management, some of which may focus on a particular property type or geographic location;
is
able to qualify as a “real estate investment trust” for U.S. federal income tax purposes and is therefore generally not subject to federal corporate income taxes on its net income that is distributed, which substantially eliminates the “double taxation” treatment (i.e., taxation at both the corporate and stockholder levels) that generally results from investments in a corporation; and
•
pays distributions to investors of at least 90% of its annual ordinary taxable income.
In this prospectus, we refer to an entity that qualifies and elects to be taxed as a REIT for U.S. federal income tax purposes as a REIT. We believe that we have qualified as a REIT for U.S. federal
income tax purposes commencing with our taxable year that ended on December 31, 2013 and intend to operate in a manner so that we continue to qualify as a REIT.
Q:
What is an “UPREIT”?
A:
We currently own and plan to continue to own substantially all of our assets and conduct our operations, directly or indirectly, through a limited partnership called NorthStar Real Estate Income Operating Partnership II, LP, or our operating partnership. We refer to partnership interests and special
partnership interests in our operating partnership, respectively, as common units and special units. We are the sole general partner of our operating partnership. Because we conduct substantially all of our operations through an operating partnership, we are organized as an umbrella partnership real estate investment trust, or “UPREIT.”
Q:
Why should I invest in CRE investments?
A:
Allocating some portion of your investment portfolio to CRE may provide you with portfolio diversification, reduction of overall
risk, a hedge against inflation and attractive risk-adjusted returns. For these reasons, institutional investors like pension funds and endowments have embraced CRE as a significant asset class for purposes of asset allocations within their investment portfolios. According to survey data published by Preqin in 2013, private pension plans in the United States had an average real estate allocation of 9.0%, compared with 4.6% in 2012, while public pension plans had an average real estate allocation of 8.3%, compared with 5.1% in 2012. In addition, 91.0% of the institutional investors surveyed in the Preqin report planned to maintain or increase their allocation to real estate investments in the future. Individual investors can also benefit by adding a real estate component to their investment portfolios. You and your financial advisor should determine whether investing in real estate would benefit your investment portfolio.
Q:
Why
should I invest specifically in a company that is focused on CRE debt, select equity and securities investments?
A:
We believe that the market for investment in CRE debt, select equity and securities investments continues to be very compelling from a risk/return perspective. We favor a strategy weighted toward targeting debt or securities investments which maximize current income, with significant subordinate capital and downside structural protections. We believe that our investment strategy, combined with the experience and expertise of our advisor’s management team, will provide opportunities to: (i) originate loans with attractive current returns and strong structural features directly with borrowers, thereby taking advantage of market conditions
in order to seek the best risk-return dynamic for our stockholders; (ii) make other select CRE equity investments to participate in potential market and property upside; and (iii) purchase CRE debt and securities from third parties, in some instances at discounts to their face amounts (or par value). We believe the combination of these strategies and the application of prudent leverage to our CRE investments may also allow us to: (i) realize appreciation opportunities in the portfolio; and (ii) diversify our capital and enhance returns.
How
do we differ from the other public, non-traded REITs sponsored by our sponsor?
A:
Our sponsor currently sponsors two other public, non-traded REITs, NorthStar Real Estate Income Trust, Inc., or NorthStar Income, and NorthStar Healthcare Income, Inc., or NorthStar Healthcare, and may also sponsor additional investment vehicles in the future. We differ from NorthStar Healthcare in several respects. NorthStar Healthcare’s investment strategy is focused on healthcare real estate and, accordingly, may be considered a specialty REIT. In contrast, we were formed to originate, acquire and asset manage a diversified portfolio of CRE debt, select equity and securities investments. In addition, NorthStar/RXR New York Metro Income, Inc., or NorthStar/RXR
Income, a public, non-traded REIT co-sponsored by our sponsor that confidentially submitted a registration statement with the SEC on March 31, 2014, was formed to make commercial real estate investments located in the New York metropolitan area. As a result, our investment strategy is more broadly diversified than that of NorthStar Healthcare and NorthStar/RXR Income and does not specifically target investments in healthcare real estate or real estate investments in the New York metropolitan area. In addition, we expect that substantially all of our investment portfolio will be comprised of debt investments. NorthStar Healthcare, on the other hand, expects that a majority of its investment portfolio will be comprised of healthcare real estate equity investments, with the balance primarily comprised of healthcare real estate debt investments. Our investment strategy is substantially similar to that of NorthStar Income.
However, NorthStar Income successfully completed its offering in July 2013 and has invested substantially all of the related proceeds.
Q:
What is the impact of being an “emerging growth company”?
A:
We do not believe that being an “emerging growth company,” as defined by the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, will have a significant impact on our business or this offering. We have elected to opt out of the extended transition period for complying with new or revised accounting
standards pursuant to Section 107(b) of the JOBS Act. This election is irrevocable. Also, because we are not a large accelerated filer or an accelerated filer under Section 12b-2 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and will not be for so long as our shares of common stock are not traded on a securities exchange, we are not subject to the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. In addition, so long as we are externally managed by our advisor and we do not reimburse our advisor or our sponsor for the compensation it pays our executive officers, we do not expect to include disclosures relating to executive compensation in our periodic reports or proxy statements and as a result do not expect to be required to seek stockholder approval of executive compensation and “golden parachute” compensation arrangements pursuant to Section 14A(a) and (b) of the Exchange
Act. We will remain an “emerging growth company” for up to five years, although we will lose that status sooner if our revenues exceed $1 billion, if we issue more than $1 billion in non-convertible debt in a three year period or if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30.
Q:
What kind of offering is this?
A:
Through our dealer manager, we are offering a maximum of $1,650,000,000 in shares of common stock in a continuous, public offering, of which
$1,500,000,000 in shares are being offered pursuant to our primary offering, or our primary offering, and $150,000,000 in shares are being offered pursuant to our DRP, which are herein collectively referred to as our offering. We are offering shares in our primary offering on a “best efforts” basis at $10.00 per share and shares in our DRP at $9.50 per share. Discounts are also available to investors who purchase more than $500,000 in shares of our common stock and to other categories of investors. We reserve the right to reallocate shares of our common stock being offered between our primary offering and our DRP.
Q:
How does a “best efforts” offering work?
A:
When
shares of common stock are offered to the public on a “best efforts” basis, the broker-dealers participating in our offering are only required to use their best efforts to sell the shares of our common stock. Broker-dealers do not have a firm commitment or obligation to purchase any of the shares of our common stock.
Generally,
you may purchase shares if you have either:
•
a minimum net worth (excluding the value of your home, furnishings and personal automobiles) of at least $70,000 and a minimum annual gross income of at least $70,000; or
•
a minimum net worth (not including home, furnishings and personal automobiles) of at least $250,000.
However, these minimum levels may vary from state to state, so you should carefully read the suitability requirements explained in the “Suitability
Standards” section of this prospectus.
Q:
How do I subscribe for shares?
A:
If you choose to purchase shares of our common stock in our offering, you will need to contact your broker-dealer or financial advisor and fill out a subscription agreement like the one attached to this prospectus as Appendix B for a certain investment amount and pay for the shares at the time you subscribe.
Q:
Is
there any minimum initial investment required?
A:
Yes. You must initially invest at least $4,000 in shares. After you have satisfied the minimum investment requirement, any additional purchases must be in increments of at least $100. The investment minimum for subsequent purchases does not apply to shares purchased pursuant to our DRP.
Q:
How long will our offering last?
A:
We
currently expect that our offering will terminate on May 6, 2015 (two years after the commencement of our offering). However, we could in some circumstances continue our offering under rules promulgated by the SEC until as late as November 2, 2016. If we decide to continue our offering beyond May 6, 2015, we will provide that information in a prospectus supplement. In addition, we reserve the right to terminate our offering for any other reason at any time.
Q:
What is the liquidity event history of programs sponsored by our sponsor?
A:
The
prospectuses of each of NorthStar Income and NorthStar Healthcare disclose that, subject to then-existing market conditions, each of NorthStar Income and NorthStar Healthcare expects to consider alternatives for providing liquidity to their stockholders beginning five years from the completion of their respective offering stages. Only NorthStar Income has completed its offering stage as of the date of this prospectus. While each of NorthStar Income and NorthStar Healthcare expects to seek a liquidity transaction in this time frame, there can be no assurance that a suitable transaction will be available or that market conditions for a transaction will be favorable during that time frame. The board of directors of each of NorthStar Income and NorthStar Healthcare has the discretion to consider a liquidity transaction at any time if it determines such event to be in its best interests. A liquidity transaction could consist of a sale or partial sale or roll-off to scheduled
maturity of their assets, a sale or merger of NorthStar Income or NorthStar Healthcare, a listing of NorthStar Income’s or NorthStar Healthcare’s shares on a national securities exchange or a similar transaction. Some types of liquidity transactions require, after approval by their board of directors, approval of each company’s stockholders.
Q:
Will I be notified of how my investment is doing?
A:
Yes, we will provide you with periodic updates on the performance of your investment in us, including:
•
an
annual report;
•
supplements to this prospectus, generally provided quarterly during our offering; and
In
addition, unless the rules and regulations governing valuations change, within 18 months after the completion of our offering stage, our advisor or another firm we choose for that purpose will establish an estimated value per share of our common stock based on an appraisal of our assets and operations and other factors deemed relevant. The estimated value per share of our common stock will be based upon the fair value of our assets less the fair value of our liabilities under market conditions existing at the time of the valuation. We will obtain independent third party appraisals for the properties underlying our debt investments and will value our other assets in a manner we deem most suitable under the circumstances, including in a manner similar to how our sponsor values its assets, which, in some circumstances, may include an independent appraisal or valuation. A committee comprised of independent directors will be responsible for the oversight of the valuation
process, including approval of engagement of any third parties to assist in the valuation of assets, liabilities and unconsolidated investments and approval of all valuations not performed by an independent third party. We anticipate that any property appraiser we engage will be a member of the Appraisal Institute with the MAI designation or such other professional valuation designation appropriate for the type and geographic locations of the assets being valued and will provide a written opinion, which will include a description of the reviews undertaken and the basis for such opinion. Any such appraisal will be provided to a soliciting participating dealer upon request. After the initial appraisal, appraisals will be done annually and may be done on a quarterly rolling basis. The valuations are estimates and consequently should not necessarily be viewed as an accurate reflection of the fair value of our investments nor will they necessarily represent the amount of
net proceeds that would result from an immediate sale of our assets. We will provide the estimated value per share to you in our annual report. We will consider our offering stage complete when we are no longer publicly offering equity securities in a continuous offering, whether through our current offering or follow on public offerings. For this purpose, we do not consider a “public offering of securities” to include offerings on behalf of selling stockholders or offerings related to our DRP, employee benefit plan or the redemption of interests in our operating partnership.
We will provide the periodic updates and the estimated value per share, once required, to you via one or more of the following methods, in our discretion and with your consent, if necessary:
Information on our website is not incorporated into this prospectus.
Q:
When will I get my detailed tax information?
A:
Your Form 1099-DIV tax information, if required, will be mailed by January 31 of each year, unless extended.
Q:
Who
can help answer my questions about our offering?
A:
If you have more questions about our offering, or if you would like additional copies of this prospectus, you should contact your registered representative or contact:
This prospectus summary highlights material information regarding our business and our offering that is not otherwise addressed in the “Questions and Answers About Our Offering” section of this prospectus. Because it is a summary,
it may not contain all of the information that is important to you. To understand our offering fully, you should read the entire prospectus carefully, including the “Risk Factors” section, before making a decision to invest in our common stock.
NorthStar Real Estate Income II, Inc.
NorthStar Real Estate Income II, Inc. is a Maryland corporation formed to originate, acquire and asset manage a diversified portfolio of CRE debt, select equity and securities investments. As of April 16, 2014, our portfolio consists of three CRE debt investments with a combined principal amount of $139.7 million.
We believe that we have qualified as a REIT commencing with our taxable year that ended December 31, 2013 and we intend to operate in a manner
so that we continue to qualify as a REIT. Among other requirements, REITs are required to distribute to stockholders at least 90% of their annual REIT taxable income (computed without regard to the dividends paid deduction and excluding net capital gain).
•to pay attractive and consistent current income through cash distributions; and
•to preserve, protect and return your capital contribution.
We will also seek to realize growth in the value of our investments and may optimize the timing of their sale.
Summary
of Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully review the “Risk Factors” section of this prospectus which contains a detailed discussion of the material risks that you should consider before you invest in shares of our common stock. Some of the more significant risks relating to an investment in our shares include:
•
We have limited prior operating history. The prior performance of our sponsor and its affiliated entities may not predict our future results. Therefore, there is no assurance that we will achieve our investment objectives.
•
This
is a “blind pool” offering. Because we have not yet acquired or identified a significant portion of the investments that we may make, you will not have an opportunity to evaluate our investments before we make them, making an investment in us more speculative.
•
The amount of distributions we may pay in the future, if any, is uncertain. Our distributions may exceed our earnings, which would represent a return of capital for tax purposes. A return of capital is a return of your investment rather than a return of earnings or gains and will be made after deductions of fees and expenses payable in connection with our offering. Due to the risks involved in the ownership of real estate-related investments, there is no guarantee of any return
and you may lose a part or all of your investment.
•
We have paid cash distributions declared through December 31, 2013 using offering proceeds and may continue to pay distributions from sources other than our cash flow from operations, and as a result, we will have less cash available for investments and your overall return may be reduced. Our
organizational documents permit us to pay distributions from any source, including from borrowings, sale of assets and offering proceeds or we may make distributions in the form of taxable stock dividends. We have not established a limit on the amount of proceeds we may use to fund distributions. Until the proceeds from our offering are fully invested and otherwise during the course of our existence, we may not generate sufficient cash flow from operations to fund distributions. Pursuant to a distribution support agreement, in certain circumstances where our cash distributions exceed our modified funds from operations, or MFFO, our sponsor agreed to purchase up to $10.0 million of shares of our common stock (which includes the $2.0 million of shares purchased by an affiliate of our sponsor to satisfy the minimum offering amount) at $9.00
per share to provide additional cash to support distributions to our stockholders at an annualized rate of 7% on stockholders’ invested capital on shares purchased in our primary offering. Such sales of shares would cause dilution of the ownership interests of our stockholders. After our distribution support agreement with our sponsor has terminated, we may not have sufficient cash available to pay distributions at the rate we had paid during preceding periods or at all.
•
No public trading market currently exists for our shares. Until our shares are listed, if ever, you may not sell your shares unless the buyer meets applicable suitability standards. If you are able to sell your shares, you would likely have to sell them at a substantial loss. Our charter does
not require our board of directors to list our shares for trading on a national securities exchange by a specified date or otherwise pursue a transaction to provide liquidity to our stockholders.
•
You will experience dilution in the net tangible book value of your shares of our common stock equal to the offering costs associated with your shares.
•
We depend on our advisor to select our investments and conduct our operations. Our advisor is a recently-formed entity with limited operating history. Therefore, there is
no assurance our advisor will be successful. In addition, we will pay substantial fees and expenses to our advisor and its affiliates, which were not negotiated at arm’s length. These payments increase the risk that you will not earn a profit on your investment.
•
We intend to invest a substantial portion of the proceeds from our offering in a portfolio of CRE debt, select equity investments and securities. The collateral securing our CRE debt and securities, as well as our select equity investments, may decrease in value or lose all value over time, which may lead to a loss of some or all of the principal in the debt and securities investments we make. Any unsecured debt and securities may involve a heightened level of risk, including a loss
of principal or the loss of the entire investment.
•
We have used and we expect to continue to use leverage in connection with our investments, which increases the risk of loss associated with our investments. We may be unable to obtain financing on favorable terms, if at all. In addition, any such financing may be recourse to us, which may increase the risk of your investment. We may not be able to leverage our assets as fully or in the manner we would choose, which could reduce our return on investment.
•
Our investment
strategy is substantially similar to that of our sponsor and of NorthStar Income and, accordingly, we may compete with our sponsor and NorthStar Income for investments. We may also compete with NorthStar Healthcare and our sponsor may choose to direct investment opportunities in the healthcare industry to NorthStar Healthcare rather than to us. In addition, our sponsor may sponsor or manage other investment vehicles in the future that may have investment strategies similar to our investment strategy and that will rely on our sponsor to source their investment opportunities. Accordingly, our sponsor’s investment professionals may face conflicts of interest in sourcing investment opportunities to us, NorthStar Income and future investment vehicles of our sponsor.
•
Our
borrowers and tenants may not be able to make debt service or lease payments owed to us due to changes in economic conditions, regulatory requirements and other factors.
•
Our executive officers and our advisor’s other key professionals are also officers, directors and managers of our sponsor and their affiliates. As a result, they will face conflicts of interest, including significant conflicts created by our advisor’s compensation arrangements with us and
such affiliates and conflicts in allocating investment opportunities and their time among us and these other entities affiliated with our sponsor.
•
The fees we pay to affiliates in connection with our offering and in connection with the origination, acquisition and asset management of our investments, including to our advisor, were not determined on an arm’s length basis; therefore, we do not have the benefit of arm’s length negotiations of the type normally conducted between unrelated parties.
•
If
we raise substantially less than the maximum offering, we may not be able to acquire a diversified portfolio of investments and the value of your shares may vary more widely with the performance of specific assets.
•
We met the minimum offering requirements for our offering with funds from our sponsor, which is not an indication of broader demand for our stock. As such, the satisfaction of the minimum offering amount should not be viewed as an indication of success of our offering and it may not result in our raising sufficient funds to have a diversified portfolio.
•
We
may change our investment policies without stockholder notice or consent, which could result in investments that are different than, or in different proportion than, those described in this prospectus.
•
We established the offering price of our shares on an arbitrary basis. This price may not be indicative of the price at which our shares would trade if they were listed on an exchange or actively traded, and this price bears no relationship to the book or net value of our assets or to our expected operating income.
•
Our
charter precludes us from borrowing in excess of an amount that is generally expected to approximate 75% of the aggregate cost of our investments, plus cash, before deducting loan loss reserves, other non-cash reserves and depreciation. High financing levels could limit the amount of cash we have available to distribute and could result in a decline in the value of your investment.
•
Our charter does not require our board of directors to seek stockholder approval to liquidate our assets by a specified date, nor does our charter require our board of directors to list our shares for trading by a specified date.
•
Our
charter prohibits the ownership of more than 9.8% in the value of the aggregate of our outstanding shares of stock or more than 9.8% in value or number of shares, whichever is more restrictive, of the aggregate of our outstanding shares of common stock, unless exempted by our board of directors, which may inhibit large investors from purchasing your shares. Our shares cannot be readily sold and, if you are able to sell your shares, you would likely have to sell them at a substantial discount from their offering price.
•
If we fail to qualify as a REIT for federal income tax purposes, it would adversely affect our operations, the value of our shares and our ability to make distributions to our stockholders because we would be subject to U.S.
federal income tax at regular corporate rates with no ability to deduct distributions made to our stockholders.
•
Our intended investments in CMBS and collateralized debt obligation, or CDO, notes and other structured securities will be subject to risks relating to the volatility in the value of our assets and underlying collateral, default on underlying income streams, fluctuations in interests rates, decreased value and liquidity of the investments and other risks associated with such securities which may be unknown and unaccounted for by issuers of the securities and by the rating agencies (Moody’s Investor Services, Standard & Poor’s, Fitch Ratings, Morningstar, DBRS and/or Kroll, generally referred to as rating agencies). These investments
are only appropriate for investors who can sustain a high degree of risk.
•
If we terminate our agreement with our advisor, we may be required to pay significant fees to an affiliate of our sponsor, which will reduce the cash available for distribution to you.
We believe that the near and intermediate-term market for investment in CRE debt, select equity and securities investments continues to be very compelling from a risk-return perspective. We favor a strategy weighted toward targeting CRE debt investments which maximize current income, with significant subordinate capital and downside structural protections. We believe that our investment strategy, combined with the experience and expertise of our advisor’s management team, will provide opportunities to: (i) originate loans with attractive current returns and strong structural features directly with borrowers, thereby taking advantage of market conditions in order to seek the best risk-return dynamic for our stockholders; (ii) make select CRE equity investments
to participate in potential market and property upside; and (iii) purchase CRE debt and securities from third parties, in some instances at discounts to their face amounts (or par value). We believe the combination of these strategies and the application of prudent leverage to our CRE investments may also allow us to: (i) realize appreciation opportunities in the portfolio; and (ii) diversify our capital and enhance returns.
Investment Strategy
Our strategy is to use substantially all of the net proceeds of our offering to originate, acquire and asset manage a diversified portfolio of: (i) CRE debt, including first mortgage loans, subordinate mortgage and mezzanine loans, participations in such loans and preferred equity interests; (ii) select equity investments; and (iii) CRE securities, such as CMBS, unsecured debt of publicly traded REITs and CDO notes. We seek to create and
maintain a portfolio of investments that generate a low volatility income stream of attractive and consistent cash distributions. Our focus on investing in debt instruments emphasizes the payment of current returns to investors and preservation of invested capital as our primary investment objectives. We place a lesser emphasis on, but still may target, capital appreciation from our investments, compared to more opportunistic or equity-oriented strategies.
We expect that a majority of our portfolio will consist of CRE debt and less than a majority of our portfolio will consist of select equity investments and CRE securities. However, we may invest in any of these asset classes, including those that present greater risk, and we have not established any limits on the percentage of our portfolio that may be comprised of these various categories of assets which present differing levels of risk. We cannot predict our actual allocation
of assets under management at this time because such allocation will also be dependent, in part, upon the then current CRE market, the investment opportunities it presents and available financing, if any, as well as other micro and macro market conditions.
We have employed and we expect to continue to selectively employ leverage to enhance total returns to our stockholders through a combination of financing strategies including (i) secured or unsecured borrowings or facilities; (ii) syndications; (iii) securitization financing transactions or other structures; and (iv) seller financing. We will seek to secure conservatively structured leverage that is long-term, non-recourse and non-mark-to-market to the extent obtainable on a cost effective basis.
The period that we will hold our investments will vary depending on the type of asset, interest rates, investment performance, micro
and macro real estate environment, capital markets and credit availability, among other factors. Our advisor expects to hold debt investments until the stated maturity. We may sell all or a partial ownership interest in an asset before the end of the expected holding period if we believe that market conditions have maximized its value to us or the sale of the asset would otherwise be in the best interests of our stockholders.
As of April 16, 2014, our portfolio consists of three CRE debt investments with a combined principal amount of $139.7 million.
The following table presents a summary of our investment portfolio as of April 16, 2014:
Collateral Type
Location
Initial
Maturity
Date
Principal
Amount
Spread over
LIBOR(2)
Current Yield
First Mortgage Loans
Hotel
Dallas, TX
Apr-16
$
75,000
5.1
%
10.0
%
Multifamily
Savannah, GA
Sep-16
25,500
6.3
%
10.4
%
Multifamily/Retail
Norfolk, VA
Jun-17
39,200
5.4
%
8.4
Total/Weighted Average
$
139,700
5.4
%
9.5
_____________________
(1)
All
loans are based on a spread over the one-month London Interbank Offered Rate, or LIBOR. Certain loans are subject to a LIBOR floor. The weighted average LIBOR floor is 0.12%.
Status of Our Initial Public Offering
We are offering up to $1.65 billion in shares of common stock, including $150.0 million in shares that are being offered pursuant to our DRP.
As of April 16, 2014, we received and accepted subscriptions in our offering for 8.5 million shares, or $84.8 million, including 0.2 million shares, or $2.0 million, sold to an affiliate of our sponsor. As of April 16, 2014, 157.3 million shares remained available for sale pursuant to our offering. Our primary offering is expected to terminate on May
6, 2015, unless extended by our board of directors as permitted under applicable law and regulations.
Our Board of Directors
We operate under the direction of our board of directors, the members of which are accountable to us and our stockholders as fiduciaries. Our board of directors has ultimate responsibility for our operations, corporate governance, compliance and disclosure. Our charter requires that a majority of our directors be independent. We have four members of our board of directors, three of whom are independent of us, our advisor and its affiliates. Two of our independent directors serve as directors of NorthStar Income. A majority of our independent directors are required to review and approve all matters our board believes may involve a conflict of interest between us and our sponsor or its affiliates. Our board of directors are elected annually by the stockholders.
Our Sponsor
NorthStar Realty Finance Corp. (NYSE:NRF), or our sponsor, is a publicly traded, diversified commercial real estate investment and asset management company that was formed in October 2003 and completed its initial public offering in October 2004. As of December 31, 2013, our sponsor employed 155 persons. As of the date of this prospectus, our sponsor manages three public non-traded REITs: our company, NorthStar Income and NorthStar Healthcare, which we refer to collectively in this prospectus as the NorthStar Non-Traded REITs. In addition, our sponsor co-sponsors NorthStar/RXR Income, a public, non-traded REIT currently seeking registration with the SEC. On December 10, 2013, our sponsor
announced that its board of directors unanimously approved a plan to spin-off its asset management business into an independent publicly traded company, NorthStar Asset Management Group Inc., or NSAM. On February 5, 2014, NSAM filed an initial registration statement on Form 10 with the SEC to register shares of NSAM’s common stock. The spin-off is expected to be completed in the second quarter of 2014 and our sponsor expects shares of NSAM common stock to be listed on the New York Stock Exchange, or NYSE. Following the completion of the spin-off of NSAM, one or more subsidiaries of NSAM will manage our sponsor, the NorthStar Non-Traded REITs and any other companies our sponsor
and its affiliates may manage or sponsor in the future. We refer in this prospectus to our sponsor and the NorthStar Non-Traded REITs, collectively, as the Managed Companies. We expect this transaction to have no impact on our operations. Our sponsor’s headquarters are located at 399 Park Avenue, 18th Floor, New York, New York10022.
The assets of the Managed Companies grew significantly over the past several years driven by the ability of our sponsor and the NorthStar Non-Traded REITs to raise capital and, in turn, effectively
deploy such capital. The following table presents the assets of the Managed Companies as of December 31, 2013 and 2012 (dollars in thousands):
Based
on principal amount of loans and securities, cost basis of real estate and fair value for investments in private equity funds and equity interests in our sponsor’s collateralized debt obligations.
(2)
Based on consolidated total assets.
In 2013, our sponsor issued aggregate net capital of $1.9 billion, including $1.6 billion from the issuance of common and preferred equity. As of December 31, 2013, our sponsor’s market capitalization was $4.2 billion.
Our sponsor’s management team, which is led by David T. Hamamoto, Daniel
R. Gilbert and Albert Tylis and includes, among others, Debra A. Hess and Ronald J. Lieberman, has broad and extensive experience in real estate investment and finance with some of the nation’s leading CRE and lending institutions. Please see “Management—Directors and Executive Officers” for biographical information regarding the executive officers and key professionals of our company and our advisor. We believe that our sponsor’s active and substantial ongoing participation in the real estate markets and the depth of experience and disciplined investment approach of our sponsor’s management team allows our advisor to successfully execute our investment strategy.
Our Advisor
Our advisor manages our day-to-day operations. Our advisor is indirectly owned by our sponsor, whose team of investment professionals, acting through our advisor, makes most of the decisions regarding the selection, negotiation, financing and disposition of our investments, subject to the limitations in our charter and the direction and oversight of our board of directors. Following the spin-off of NSAM, our advisor will be an affiliate of NSAM. Our advisor also provides portfolio management, marketing, investor relations and other administrative services on our behalf with the goal of maximizing our operating cash flow and preserving our invested capital. Our advisor does not have employees. The members of our advisor’s management team and other personnel performing services for us on behalf of our advisor are employees of our sponsor and its affiliates. Our advisor’s headquarters are located at 399 Park Avenue, 18th Floor,
New York, New York10022.
We believe we have a combination of strengths that will contribute
to our performance. Our advisor utilizes the personnel and resources of our sponsor to select our investments and manage our day-to-day operations. Our sponsor’s corporate, investment and operating platforms are well established, allowing us to realize economies of scale and other strengths, including the following:
•
Experienced Management Team—Our sponsor has a highly-experienced management team of investment professionals who have demonstrated track records of operating REITs and delivering strong returns. The senior management team of our sponsor includes executives who acquired and manage the historical and existing portfolio of its investments and who possess significant operational and management experience in the real estate industry.
We believe our business benefits from the knowledge and industry contacts these seasoned executives have gained through their accomplished careers while investing in numerous real estate cycles. We believe that the accumulated experience of our sponsor’s senior management team will allow us to deploy capital throughout the CRE capital structure fluidly in response to changes in the investment environment. Please see “Management—Directors and Executive Officers” for biographical information regarding these individuals.
•
Real Estate Lending Experience—Our sponsor has developed a reputation as a leading diversified CRE investment and asset management company because of its strong performance record in underwriting
and managing $10.6 billion in real estate investments. We believe that we can leverage our sponsor’s extensive real estate experience, deep and thorough underwriting process, and portfolio management skills to structure and manage our investments prudently and efficiently.
•
Public Company and REIT Experience—The common stock of our sponsor has traded on the NYSE under the symbol “NRF” since October 2004. Our sponsor’s management team is skilled in operating public CRE companies including reporting and compliance with the requirements of the Sarbanes-Oxley Act, including internal control certifications, stock exchange regulations and investor relations. In addition, our sponsor, through advisor entities, currently
manages the NorthStar Non-Traded REITs, including us (with the first being declared effective by the SEC in 2010), which will be advised and managed by NSAM following the completion of its spin-off from our sponsor. Our sponsor’s management team is also skilled in compliance with the requirements under the Internal Revenue Code to obtain REIT status and to maintain the ability to be taxed as a REIT for U.S. federal income tax purposes. Our sponsor’s management team also has experience listing a REIT on the NYSE.
•
Distribution Support Commitment—In order to provide additional cash to pay distributions to our stockholders at a rate of at least 7% per annum on stockholders’ invested capital, our sponsor has agreed to purchase
up to an aggregate of $10.0 million in shares of our common stock (which includes the $2.0 million of shares purchased by an affiliate of our sponsor to satisfy the minimum offering amount) at $9.00 per share until May 6, 2015. If the cash distributions we pay for any calendar quarter exceed MFFO for such quarter, our sponsor will purchase shares following the end of each quarter for a purchase price equal to the amount by which the distributions paid to stockholders exceed MFFO for such quarter, up to an amount equal to a 7% cumulative, non-compounded annual return on stockholders’ invested capital prorated for such quarter. Notwithstanding our sponsor’s obligations pursuant to the distribution support agreement, we are not required to pay distributions to our stockholders at a rate of 7% per annum or at all. After our distribution support agreement with our sponsor has terminated, we may not have sufficient cash available
to pay distributions at the rate we had paid during preceding periods or at all. For more information regarding our sponsor’s share purchase commitment, the purchase of shares thereunder as of the date of this prospectus and our distribution policy, please see “Description of Capital Stock—Distributions.”
The chart below shows the
relationship among various affiliates of our sponsor and our company as of the date of this prospectus. We refer to affiliates of our sponsor as NorthStar affiliates or NorthStar entities.
____________________________
(1)
For a description of our sponsor, please see “—Our Sponsor.”
(2)
The
Public REIT OP, of which our sponsor is the sole general partner, is the entity through which our sponsor makes its investments and conducts, directly and indirectly, substantially all of its operations.
(3)
The Private REIT is a wholly owned subsidiary of the Public REIT OP.
(4)
For a description of our advisor, please see “—Our Advisor.”
(5)
For
a description of our operating partnership, please see “Questions and Answers About our Offering—What is an UPREIT?” and “The Operating Partnership Agreement.”
(6)
We granted special units in the operating partnership to the special unit holder. For a description of these special units, please see “Management Compensation—Special Units—NorthStar OP Holdings II.”
(7)
For a description of our dealer manager, please see “Management—Affiliated Dealer Manager” and “Plan of Distribution—General.”
(8)
Our sponsor may grant equity interests in our advisor and the special unit holder to certain management personnel performing services for our advisor and our dealer manager.
Includes
shares purchased to satisfy our minimum offering requirement, as well as shares purchased pursuant to our distribution support agreement with our sponsor. See “Description of Capital Stock—Distributions.”
Management Compensation
Our dealer manager, our advisor and its affiliates receive fees and expense reimbursements for services relating to our offering and the investment and management of our assets. The most significant items of compensation are included in the following table. Selling commissions and dealer manager fees may vary for different categories of purchasers. This table assumes that we sell all shares of common stock in our offering at the highest possible selling commissions and dealer manager fees (with no discounts to any categories of purchasers). No selling commissions or dealer manager fees are payable on shares sold through our DRP.
See “Management Compensation” for a more detailed explanation of the fees and expenses payable to our dealer manager, our advisor and its affiliates and for a more detailed description of the special units.
Form of Compensation
and Recipient
Determination of Amount
Estimated Amount
for Maximum Offering
Organization and Offering Stage
Selling Commissions—
Dealer Manager
Up to 7% of gross offering proceeds, except no selling commissions are payable on shares sold under our DRP. Our dealer manager will reallow selling commissions to participating broker-dealers.
$105,000,000
Dealer
Manager Fee—
Dealer Manager
Up to 3% of gross offering proceeds, except no dealer manager fee is payable on shares sold under our DRP. Our dealer manager may reallow a portion of the dealer manager fees to any participating broker-dealer, based upon factors such as the number of shares sold by the participating broker-dealer and the assistance of such broker-dealer in marketing our primary offering.
$45,000,000
Other
Organization and
Offering Costs—
Advisor or its Affiliates
We reimburse our advisor or its affiliates for the unreimbursed portion and future organization and offering costs it may incur on our behalf, but only to the extent that the reimbursement would not cause the total amount of selling commissions, dealer manager fees and other organization and offering costs borne by us to exceed 15% of gross proceeds from our offering. If we raise the maximum offering amount, we expect organization and offering costs (other than selling commissions and dealer manager fees) to be approximately $24,750,000 or approximately 1.5% of gross offering proceeds.
$24,750,000
Acquisition and Development Stage
Acquisition Fee—
Advisor or its Affiliates
An amount equal to up to
1% of the amount funded or allocated by us to originate or acquire CRE investments, including acquisition expenses and financing attributable to such investments.
We reimburse our advisor or its affiliates for actual costs incurred in connection with the selection, origination or acquisition of an investment, whether or not originated or acquired.
No financing: $6,637,500
No financing and DRP:
$7,376,250
Leverage
of 50% of cost of investments:
$13,275,000
Leverage of 75% of cost of investment:
$26,550,000
Operational Stage
Asset
Management
Fee—Advisor or its
Affiliates
A monthly asset management fee equal to one-twelfth of 1.25% of the sum of the amount funded or allocated by us for CRE investments, including expenses and any financing attributable to such investments, less any principal received on our debt and securities investments.
Maximum Offering and leverage of 75% of cost of investment: $66,375,000
Other
Operating
Costs—Advisor or its
Affiliates
We reimburse the costs incurred by our advisor or its affiliates in connection with its providing services to us, including our allocable share of our advisor’s overhead, such as rent, employee costs, utilities and technology costs. Employee costs may include our allocable portion of salaries of personnel engaged in managing our operations, including public reporting and investor relations. We do not reimburse our advisor for employee costs in connection with services for which our advisor earns acquisition fees or disposition fees or for the salaries and benefits paid to our executive officers.
Actual
amounts are dependent upon actual expenses incurred; we cannot determine these amounts at the present time.
Liquidation/Listing Stage
Disposition
Fees—
Advisor or its Affiliates
For substantial assistance in connection with the sale of investments and based on the services provided, as determined by our independent directors, an amount equal to up to 1% of the contract sales price of each CRE investment sold. We will not pay a disposition fee upon the maturity, prepayment, workout, modification or extension of a CRE debt investment unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of: (i) 1% of the principal amount of the CRE debt prior to such transaction; or (ii) the amount of the fee paid by the borrower in connection with such transaction. If we take ownership of a property as a result
of a workout or foreclosure of CRE debt, we will pay a disposition fee upon the sale of such property.
Actual amounts are dependent upon the results of our operations; we cannot determine these amounts at the present time.
NorthStar OP Holdings II, LLC, or NorthStar OP Holdings II, an affiliate of our advisor, was issued special units upon its initial investment of $1,000 in our operating partnership
and in consideration of services to be provided by our advisor and as the holder of special units will be entitled to receive distributions equal to 15% of our net cash flows, whether from continuing operations, the repayment of loans, the disposition of assets or otherwise, but only after our stockholders have received, in the aggregate, cumulative distributions equal to their invested capital plus a 7% cumulative, non-compounded annual pre-tax return on such invested capital. In addition, NorthStar OP Holdings II will be entitled to a separate payment if it redeems its special units. The special units may be redeemed upon: (i) the listing of our common stock on a national securities exchange; or (ii) the occurrence of certain events that result in the termination or non-renewal of our advisory agreement, in each case for an amount that NorthStar OP Holdings II would have been entitled to receive had our operating partnership disposed of all of its assets at the enterprise
valuation as of the date of the event triggering the redemption. Please see “Management Compensation—Special Units—NorthStar OP Holdings II” for a description of the calculation of the enterprise valuation.
Actual amounts are dependent upon future liquidity events; we cannot determine these amounts at the present time.
Compensation Paid to Our Advisor and Our Dealer Manager
The following table presents the fees and reimbursements incurred to our advisor and our dealer manager for the year ended December 31, 2013 and the amounts due to related party as of December 31, 2013:
Acquisition/disposition
fees incurred to our advisor related to CRE debt investments are generally offset by origination/exit fees paid to us by borrowers if such fees are required from the borrower. Our advisor may determine to defer fees or seek reimbursement. As of December 31, 2013, all acquisition fees paid were offset by a corresponding origination fee paid to us.
(2)
As of December 31, 2013, our advisor incurred unreimbursed operating costs on our behalf and $1.6 million is still allocable.
(3)
As
of December 31, 2013, our advisor incurred unreimbursed organization and offering costs on our behalf and $2.6 million is still allocable.
(4)
Cost of capital is included in net proceeds from issuance of common stock in our consolidated statements of equity.
Conflicts of Interest
Our advisor and its affiliates experience conflicts of interest in connection with the management of our business. Some of the material conflicts that our advisor and its affiliates face include the following:
•
Our
sponsor’s investment professionals acting on behalf of our advisor and our advisor’s investment committee must determine which investment opportunities to recommend to us and other NorthStar entities, including our sponsor, NorthStar Income, NorthStar Healthcare and any future investment vehicles sponsored by our sponsor, which could reduce the number of potential investments presented to us. If fewer investments are presented to us, we may have less invested offering proceeds and fewer desirable investments.
•
Our sponsor’s investment professionals acting on behalf of our advisor must allocate their time among us, our sponsor’s business and other programs and activities in which they are involved, which could cause them to devote less of their
time to our business than they otherwise would.
•
Our advisor and its affiliates receive fees in connection with transactions involving the origination, acquisition, management and sale of our assets regardless of the quality or performance of the asset acquired or the services provided. This fee structure may cause our advisor to fail to negotiate the best price for the assets we acquire.
Because our advisory agreement and our dealer manager agreement (including the substantial fees our advisor and its affiliates will receive thereunder) were not negotiated at arm’s length, their terms may not be as advantageous to us as those available from unrelated third parties.
•
Upon the occurrence of certain events that result in the termination or non-renewal of our advisory agreement, or in connection with a listing of our shares or a
merger or sale of all our assets, NorthStar OP Holdings II may be entitled to have the special units redeemed as of the termination date if our stockholders have received, or are deemed to receive, in the aggregate, cumulative distributions equal to their invested capital plus a 7% cumulative non-compounded annual pre-tax return on such invested capital. This potential obligation would reduce the overall return to stockholders to the extent such return exceeds 7%.
•
Our dealer manager also acts as the dealer manager for the continuous public offering of NorthStar Income and NorthStar Healthcare. In addition, future NorthStar sponsored programs may seek to raise capital through public offerings conducted concurrently with our offering. As a result,
our dealer manager may face conflicts of interest arising from potential competition with these other programs for investors and investment capital.
Estimated Use of Proceeds
Depending primarily upon the number of shares we sell in our offering, we estimate that between approximately 85.7% (assuming no shares available under our DRP are sold) and approximately 88.1% (assuming all shares available under our DRP are sold) of our gross offering proceeds will be available for investments. We will use the remainder of the offering proceeds to pay offering costs, including selling commissions and dealer manager fees, and, upon investment in our targeted assets, to pay an acquisition fee to our advisor for its services in connection with the selection, origination or acquisition, as applicable, of our CRE debt, select equity and securities investments.
Distributions
We generally intend to pay cash distributions on a monthly basis based on daily record dates. You generally begin to qualify for distributions on the date we mail a confirmation of your subscription for shares of our common stock. Since we commenced operations on September 18, 2013, we have authorized and declared distributions based on daily record dates for each period from September 18, 2013 through June 30, 2014 at a rate of $0.001917808 per share per day, which we will pay on a monthly basis, but we are not required to continue to approve and pay distributions at that rate or at all.
We declared distributions for the period from September 18, 2013 through December
31, 2013 of $199,183, of which $74,814 was reinvested in our DRP. For such period, we paid distributions at an annualized distribution rate of 7.00% based on a purchase price of $10.00 per share of our common stock. Distributions are generally paid to stockholders on the first day of the month following the month for which the distribution has accrued.
100%
distributions declared for the period from September 18, 2013 through December 31, 2013 were paid using proceeds from our offering, including from the purchase of additional shares by our sponsor.
(2)
Represents distributions declared for such period, even though such distributions are actually paid to stockholders the month following such period.
Generally, our policy is to pay distributions from cash flow from operations. However, our organizational documents permit us to pay distributions from any source, including from borrowings, sales of assets and offering proceeds or we may make distributions in the form of taxable stock dividends. We have not established a cap on the use of proceeds to fund distributions. Over the long-term, we expect that our distributions will be paid entirely from cash flow provided by operations. However, our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including our ability to raise and invest capital at favorable yields, the financial performance of our investments in the current real estate and financial environment, the type and mix of our investments and accounting of our investments
in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. As a result, future distributions declared and paid may continue to exceed cash flow provided by operations.
Our sponsor has agreed to purchase up to an aggregate of $10.0 million in shares of our common stock (which includes shares our sponsor purchased in order to satisfy the minimum offering amount) at $9.00 per share until May 6, 2015 to the extent cash distributions to our stockholders at a rate of at least 7% per annum for any calendar quarter exceed MFFO for such quarter. Pursuant to the terms of a distribution support agreement, if the cash distributions we pay for any calendar quarter exceed our MFFO, following the end of such quarter our sponsor will purchase shares for a purchase price equal to the amount by which the distributions paid to stockholders exceed our MFFO for such quarter,
up to an amount equal to a 7% cumulative, non-compounded annual return on stockholders’ invested capital prorated for such quarter. In such instance, we may be paying distributions from proceeds of the shares purchased by our sponsor, not from cash flow from our operations.
The purchase price for shares issued to our sponsor pursuant to this commitment will be equal to the per share price in our primary offering as of the purchase date, reduced by the selling commissions and dealer manager fees which are not payable in connection with sales to our affiliates. As a result, the net proceeds to us from the sale of shares to our sponsor will be the same as the net proceeds we receive from the sales of shares to the public in our offering. For more information regarding our sponsor’s share purchase commitment and our distribution policy, please see “Description of Capital Stock—Distributions.”
For
so long as we qualify as a REIT, we generally will not be subject to federal income tax on the income that we distribute to our stockholders each year. To maintain our qualification as a REIT, we must make aggregate annual distributions to our stockholders each year equal to at least 90% of our REIT taxable income (which is computed without regard to the dividends-paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with U.S. GAAP). See “U.S. Federal Income Tax Considerations—Taxation of NorthStar Real Estate Income II, Inc.—Requirements for Qualification.” Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant.
Our Performance-Funds from Operations and Modified Funds from Operations
We believe that funds from operations, or FFO, and modified funds from operations, or MFFO, both of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and of us in particular. Management believes MFFO is a useful performance measure to evaluate our business and further believes it is important to disclose MFFO in order to be consistent with the Investment Program Association, or the IPA, recommendation and other non-traded REITs. MFFO that adjusts for items such as acquisition fees would only be comparable to non-traded REITs that have completed the majority of their acquisition activity and have other similar operating
characteristics as us. The following table presents a reconciliation of FFO and MFFO to net income (loss) attributable to our common stockholders for the year ended December 31, 2013:
Net
income (loss) attributable to NorthStar Real Estate Income II, Inc. common
stockholders
$
12,455
Funds from Operations
12,455
Modified Funds from Operations:
Funds
from Operations
12,455
Adjustments:
Amortization of premiums, discounts and fees on investments and borrowings, net
42,036
Modified Funds from Operations
54,491
Distribution
Reinvestment Plan
You may reinvest distributions you receive from us in shares of our common stock by participating in our DRP. You may enroll in our DRP by checking the appropriate box on the subscription agreement. You may also withdraw at any time, without penalty, by delivering written notice to us. Shares of our common stock issued pursuant to our DRP are being offered at $9.50 per share. Unless the rules and regulations governing valuations change, within 18 months after the completion of our offering stage, our advisor or another firm we choose for that purpose will establish an estimated value per share of our common stock that we will disclose in our annual report that we publicly file with the SEC. At that time, shares issued pursuant to our DRP will be priced at 95% of such estimated per share value of our common stock. We will consider our offering stage complete when we are no longer publicly offering securities
in a continuous offering, whether through our offering or follow-on public offerings. For this purpose, we do not consider a “public offering of securities” to include offerings on behalf of selling stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests in our operating partnership. No selling commissions or dealer manager fees are payable on shares sold under our DRP. We may amend or terminate our DRP for any reason, except that we may not amend our DRP to eliminate a participant’s ability to withdraw from our DRP, upon ten-days prior written notice to participants. Please see Appendix C: Distribution Reinvestment Plan for all of the terms of our DRP.
As of April 16, 2014, we issued a total of 49,347 shares, raising gross proceeds of approximately $468,796 million, pursuant to our DRP. We may issue up to 15.7 million additional
shares of our common stock pursuant to our DRP.
Share Repurchase Program
Our share repurchase program may provide an opportunity for you to have your shares of common stock repurchased by us, without fees and subject to certain restrictions and limitations. Only stockholders who have purchased shares from us or received their shares through a non-cash transaction, not in the secondary market, will be eligible to participate in the share repurchase program. The purchase price for your shares repurchased under our share repurchase program will be as set forth below until we establish an
estimated per share value of our common stock. Unless the rules and regulations governing valuations change, within 18 months after completion of our offering stage, our advisor or another firm we choose for that purpose will establish an estimated value per share of our common stock that we will disclose in the annual report that we publicly file with the SEC.
Prior to the date that we establish an estimated value per share of our common stock, we will initially repurchase shares at a price equal to, or at a discount from, the purchase price you paid for the shares being repurchased as follows:
Share
Purchase Anniversary
Repurchase Price
as a Percentage of
Purchase Price
Less than 1 year
No Repurchase Allowed
1 year
92.5%
2 years
95.0%
3
years
97.5%
4 years and longer
100.0%
After we establish an estimated value per share of our common stock, we will repurchase shares at a price equal to the lesser of: (i) the purchase price you paid for the shares being repurchased; and (ii) 95% of the estimated value per share.
Unless the shares are being repurchased in connection with a stockholder’s death or qualifying disability, we will not repurchase shares unless you have held the shares for at least one year. Repurchase requests made within two years of the death
or qualifying disability of a stockholder will be repurchased at the higher of the price paid for the shares or our estimated per share value.
We are not obligated to repurchase shares of our common stock under our share repurchase program. The number of shares to be repurchased during the calendar year is limited to: (i) 5% of the weighted average number of shares of our common stock outstanding during the prior calendar year; and (ii) those that could be funded from the net proceeds of the sale of shares under our DRP in the prior calendar year plus such additional cash as may be reserved for that purpose by our board of directors; provided, however, that the above volume limitations shall not apply to repurchases requested within two years after the death or disability of a stockholder.
Our share repurchase program only provides stockholders a limited ability to have shares repurchased
for cash until a secondary market develops for our shares or until our shares are listed on a national securities exchange, at which time our share repurchase program would terminate. No secondary market presently exists nor are the shares currently listed on an exchange and we cannot assure you that any market for our shares will ever develop or that we will list the shares on a national securities exchange. Shares repurchased under our share repurchase program will become unissued shares and will not be resold unless such sales are made pursuant to transactions that are registered or exempt from registration under applicable securities laws.
We may amend or terminate our share repurchase program at our discretion at any time, provided that any amendment that adversely affects the rights or obligations of a participant (as determined in the sole discretion of our board of directors) will only take effect upon ten-days prior
written notice to stockholders except that changes in the number of shares that can be repurchased during any calendar year will only take effect upon ten-business days prior written notice.
As of December 31, 2013, we had not received any requests to repurchase shares of common stock pursuant to our share repurchase program.
Borrowing Policy
We have financed and may continue to finance our investments to provide more cash available for investment and to generate improved returns. We believe that careful use of leverage will help us to achieve our diversification goals and potentially enhance the returns on our investments. Our charter precludes us
from borrowing in excess of an amount that is generally expected to approximate 75% of the aggregate cost of our investments, plus cash, before deducting loan loss reserves, other non-cash reserves and depreciation. However, we may borrow in excess of these amounts if such action is approved by a majority of our board of directors, including a majority of our independent directors and disclosed to stockholders in our next quarterly report along with justification for the excess. Our board of directors reviews our aggregate borrowings, including secured and unsecured financing, at least quarterly to ensure they remain reasonable in relation to our net assets and may from time-to-time modify our leverage policy in light of then-current economic conditions, relative costs of debt and equity
capital, fair value of our assets, growth and acquisition opportunities or other factors they deem appropriate.
Liquidity
Subject to then-existing market conditions, we expect to consider alternatives for providing liquidity to our stockholders beginning five years from the completion of our offering stage; however, there is no definitive date by which we must do so. We will consider our offering stage complete when we are no longer publicly offering equity securities in a continuous offering, whether through our offering or follow-on public offerings. For this purpose, we do not consider a “public offering of equity securities” to include offerings on behalf of selling stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests in our operating partnership. While we expect to seek a liquidity transaction in this time frame, there can
be no assurance that a suitable transaction will be available or that market conditions for a transaction will be favorable during that time frame. Our board of directors has the discretion to consider a liquidity transaction at any time if it determines such event to be in our best interests. A liquidity transaction could consist of a sale or partial sale or roll-off to scheduled maturity of our assets, a sale or merger of our company, a listing of our shares on a national securities exchange or a similar transaction. Some types of liquidity transactions require, after approval by our board of directors, approval of our stockholders. We do not have a stated term, as we believe setting a finite date for a possible, but uncertain future liquidity transaction may result in actions that are not necessarily in the best interest of our
company or within the expectations of our stockholders. In the event that we determine not to pursue a liquidity transaction, you may need to retain your shares for an indefinite period of time.
Investment Company Act Considerations
We intend to conduct our operations so that neither we, nor our operating partnership nor the subsidiaries of our operating partnership, are required to register as investment companies under the Investment Company Act of 1940, as amended, or the Investment Company Act.
Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the Investment
Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exclusion from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.
Our
company is organized as a holding company that conducts its businesses primarily through our operating partnership. Both our company and our operating partnership intend to conduct their operations so that they comply with the 40% test. The securities issued to our operating partnership by any wholly owned or majority-owned subsidiaries that we may form in the future that are excluded from the definition of “investment company” based on Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities our operating partnership may own, may not have a value in excess of 40% of the value of our operating partnership’s total assets on an unconsolidated basis. We will monitor our holdings to ensure continuing and ongoing compliance with this test.
In addition, we believe neither we nor our operating partnership is considered an investment company under Section 3(a)(1)(A) of the Investment Company Act because neither we nor our operating partnership will engage primarily or hold ourselves out
as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through our operating partnership’s wholly owned or majority-owned
subsidiaries, we and our operating partnership will be primarily engaged in the non-investment company businesses of these subsidiaries, namely the business of purchasing or otherwise acquiring mortgages and other interests in real estate.
We expect that most of our investments will be held by wholly owned or majority-owned subsidiaries of our operating partnership and that most of these subsidiaries will rely on the exclusion from the definition of an investment company under Section 3(c)(5)(C) of the Investment Company Act, which is available for entities “primarily
engaged in [the business of]... purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exclusion generally requires that at least 55% of a subsidiary’s portfolio must be comprised of qualifying real estate assets and at least 80% of its portfolio must be comprised of qualifying real estate assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). For purposes of the exclusion provided by Sections 3(c)(5)(C), we classify our investments based in large measure on no-action letters issued by the SEC staff and other SEC interpretive guidance and, in the absence of SEC guidance, on our view of what constitutes a qualifying real estate asset and a real estate related asset. Although we intend to monitor our portfolio on a regular basis and prior to each investment acquisition and disposition, there can be no assurance that we will be able to maintain this exclusion from registration for each
of these subsidiaries.
We may in the future organize special purpose subsidiaries of our operating partnership that will borrow under or participate in government sponsored incentive programs to the extent they exist. We expect that some of these subsidiaries will rely on Section 3(c)(7) for their Investment Company Act exclusion and, therefore, our operating partnership’s interest in each of these subsidiaries would constitute an “investment security” for purposes of determining whether our operating partnership passes the 40% test. Also, we may in the future
organize one or more subsidiaries that seek to rely on the Investment Company Act exclusion provided to certain structured financing vehicles by Rule 3a-7. Any such subsidiary would need to be structured to comply with any guidance that may be issued by the SEC staff on the restrictions contained in Rule 3a-7. In certain circumstances, compliance with Rule 3a-7 may require, among other things, that the indenture governing the subsidiary include limitations on the types of assets the subsidiary may sell or acquire out of the proceeds of assets that mature, are refinanced or otherwise sold, on the period of time during which such transactions may occur, and on the amount of transactions that may occur. We expect that the aggregate value of our operating partnership’s interests in subsidiaries
that seek to rely on Rule 3a-7 will comprise less than 20% of our operating partnership’s (and, therefore, our company’s) total assets on an unconsolidated basis.
In the event that we, or our operating partnership, were to acquire assets that could make either entity fall within the definition of investment company under Section 3(a)(1)(A) or Section 3(a)(1)(C) of the Investment Company Act, we believe that we would still qualify for an exclusion from registration pursuant to Section 3(c)(5)(C).
Qualification for exclusion from registration under the Investment Company Act will limit our ability to acquire or sell certain assets and also could restrict the time at which we can acquire or sell assets. To the extent that the SEC or its staff provides more specific guidance regarding any of the matters
bearing upon such exclusions, we may be required to adjust our strategy accordingly. Any additional guidance from the SEC or its staff could provide additional flexibility to us, or it could further inhibit our ability to pursue the strategies we have chosen.
In August 2011, the SEC solicited public comment on a wide range of issues relating to Section 3(c)(5)(C) of the Investment Company Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage REITs should be regulated in a manner similar to investment companies. There can be no assurance that the laws and regulations governing the Investment Company Act status of REITs, including the more specific or different guidance regarding these exemptions that may be published by the SEC or its staff will not change in a manner that adversely affects our operations. We cannot assure you that the SEC or its staff will not take action that
results in our or our subsidiary’s failure to maintain an exclusion or exemption from the Investment Company Act.
An investment in shares of our common stock involves substantial risks. You should carefully consider all of the material risks described below in conjunction with the other information contained in this prospectus
before purchasing shares. The risks discussed in this prospectus could materially adversely affect our business, operating results, prospects and financial condition. The occurrence of any of the following risks could cause the value of our common stock to decline and could cause you to lose all or part of your investment.
We have limited prior operating history and the prior performance of our sponsor or other real estate investment vehicles sponsored by our sponsor may not predict our future results.
We are a recently formed company and have limited operating history. Since we have limited operating history, you will have no basis upon which to evaluate our ability to achieve our investment objectives
and you should not assume that our performance will be similar to the past performance of our sponsor or other real estate investment vehicles sponsored by our sponsor. Our lack of an operating history significantly increases the risk and uncertainty you face in making an investment in our shares.
Because our offering is a “blind pool” offering, you do not have the opportunity to evaluate a significant portion of our investments before we make them, which is subsequent to the date stockholders subscribe for shares, which makes an investment in our shares more speculative.
We have not yet acquired or identified a significant portion of the investments that we may make. We have not established any limits on the percentage of our portfolio that may be comprised of these various categories of assets. We also cannot predict our actual allocation of asset at this time because
such allocation will also be dependent, in part, upon the amount of financing we are able to obtain, if any, with respect to each asset class in which we invest. However, because you are unable to evaluate the economic merit of assets before we invest in them, you have to rely entirely on the ability of our advisor to select suitable and successful investment opportunities. Furthermore, our board of directors has broad discretion in implementing policies regarding borrower creditworthiness and you do not have the opportunity to evaluate potential borrowers. These factors increase the speculative nature of an investment in our shares.
We have paid and may continue to pay distributions from sources other than our cash flow from operations, and as a result we will have less cash available for investments and your overall return may be reduced.
Our organizational documents permit us
to pay distributions from any source, including offering proceeds, borrowings, our advisor’s agreement to defer, reduce or waive fees (or accept, in lieu of cash, shares of our common stock) or sales of assets or we may make distributions in the form of taxable stock dividends. We have not established a limit on the amount of proceeds we may use to fund distributions. We have funded our cash distributions paid to date using net proceeds from our offering and we may do so in the future. Until the proceeds from our offering are fully invested and otherwise during the course of our existence, we may not generate sufficient cash flow from operations to fund distributions. We began generating cash flow from operations on September 18, 2013, the date of our first investment. For the period from September 18, 2013 through December
31, 2013, we declared distributions of $199,183 compared to cash used by operations of $183,678. All distributions declared during this period were paid using proceeds from our offering, including the purchase of additional shares by our sponsor.
Pursuant to a distribution support agreement, in certain circumstances where our cash distributions exceed MFFO, our sponsor agreed to purchase up to $10.0 million of shares of our common stock at $9.00 per share (which includes the $2.0 million of shares purchased by an affiliate of our sponsor to satisfy the minimum offering amount) to provide additional cash to support distributions to you and has, in fact, purchased 222,886 shares of our common stock as of December 31, 2013. The sale of these shares resulted in the dilution of the ownership interests of our public stockholders. Upon termination or expiration of the distribution
support agreement, we may not have sufficient cash available to pay distributions at the rate we had paid during preceding periods or at all. If we pay distributions from sources other than our cash flow from operations, we will have less cash available for investments, we may have to reduce our distribution rate, our net asset value may be negatively impacted and your overall return may be reduced.
No public trading market for our
shares currently exists, and as a result, it will be difficult for you to sell your shares and, if you are able to sell your shares, you will likely sell them at a substantial discount to the public offering price.
Our charter does not require our board of directors to seek stockholder approval to liquidate our assets by a specified date, nor does our charter require us to list our shares for trading on a national securities exchange by a specified date or otherwise pursue a transaction to provide liquidity to our stockholders. There is no public market for our shares and we currently have no plans to list our shares on a national securities exchange. Until our shares are listed, if ever, you may not sell your shares unless the buyer meets the applicable suitability and minimum purchase standards. In addition, our charter prohibits the ownership of more than 9.8% in value of the aggregate of the outstanding shares of our stock
of any class or series or more than 9.8% in value or number of shares, whichever is more restrictive, of the aggregate of the outstanding shares of our common stock, unless exempted by our board of directors, which may inhibit large investors from purchasing your shares. We have adopted our share repurchase program that may enable you to sell your shares to us in limited circumstances. Share repurchases will be made at the sole discretion of our board of directors. In its sole discretion, our board of directors could amend, suspend or terminate our share repurchase program upon ten-days prior written notice to stockholders except that changes in the number of shares that can be repurchased during any calendar year will only take effect upon ten-business days prior written notice. Further, our share repurchase program includes numerous restrictions that would limit your ability to sell your shares. Therefore, it will be difficult for you to sell your shares promptly or
at all. If you are able to sell your shares, you would likely have to sell them at a substantial discount to the public offering price paid for those shares. It is also likely that your shares would not be accepted as the primary collateral for a loan. Because of the illiquid nature of our shares, you should purchase our shares only as a long-term investment and be prepared to hold them for an indefinite period of time.
Our stockholders may experience dilution.
If you purchase shares of our common stock in our offering, you will incur immediate dilution equal to the costs of the offering we incur in selling such shares. This means that investors who purchase our shares of common stock will pay a price per share that exceeds the amount available to us to invest in assets.
In addition, our stockholders do not have preemptive rights. If
we engage in a subsequent offering of common shares or securities convertible into common shares, issue additional shares pursuant to our DRP or otherwise issue additional shares, investors who purchase shares in our offering who do not participate in those other stock issuances will experience dilution in their percentage ownership of our outstanding shares. Furthermore, you may experience a dilution in the value of your shares depending on the terms and pricing of any share issuances (including the shares being sold in our offering) and the value of our assets at the time of issuance.
We met the minimum offering requirements for our offering with funds from our sponsor, which is not an indication of broader demand for our stock.
Our sponsor or one of its affiliates purchased shares of our common stock in order to satisfy our $2.0 million minimum offering amount. As such, the
satisfaction of the minimum offering amount should not be viewed as an indication of success of our offering and it may not result in our raising sufficient funds to have a diversified portfolio.
The price of our shares in our offering was not established on an independent basis and the actual value of your investments may be substantially less than what you pay. We expect to use the price paid to acquire a share in our offering as the estimated value of our shares for up to 18 months after we completed our offering stage. Even when determining the estimated value of our shares from and after this period, the value of our shares will be based upon a number of assumptions that may not be accurate or complete.
We established the offering price of our shares on an arbitrary basis. The selling price of our shares bears no relationship to our book or asset values or to any other established
criteria for valuing shares. Because the offering price is not based upon any independent valuation, the offering price may not be indicative of the proceeds that stockholders would receive upon liquidation. Further, the offering price may be significantly more than the price at which the shares would trade if they were to be listed on an exchange or actively traded by broker-dealers.
To assist members of the Financial Industry Regulatory
Authority, Inc., or FINRA, and their associated persons that participate in our offering, pursuant to FINRA Conduct Rule 5110, we intend to have our advisor prepare an annual report of the estimated value of our shares, the method by which it was developed and the date of the data used to develop the estimated value; we intend to include this information in our Annual Reports on Form 10-K. Our advisor has indicated that it intends to use the price paid to acquire a share in our offering (ignoring purchase price discounts for certain categories of purchasers) as its estimated per share value of our shares until 18 months after we have completed our offering stage (or for a shorter period if required by applicable rules and regulations). This approach to valuing our shares may bear little relationship and will likely exceed what you might receive for your shares if you tried to sell them or if we liquidated our portfolio. We will consider our offering stage complete when
we are no longer publicly offering equity securities in a continuous offering, whether through our current offering or follow-on public offerings. For this purpose, we do not consider a “public offering of equity securities” to include offerings on behalf of selling stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests in our offering partnership. If our board of directors determines that it is in our best interest, we may conduct follow-on offerings upon the termination of our current offering. Our charter does not restrict our ability to conduct offerings in the future.
Our initial price per share of $10.00 represents the price at which most stockholders will purchase shares in our primary offering; however, this price and any subsequent estimated value is likely to differ from the price at which a stockholder could resell the shares because: (i) there is no public trading
market for the shares at this time; (ii) the price does not reflect, and will not reflect, the fair value of our assets as we acquire them, nor does it represent the amount of net proceeds that would result from an immediate liquidation of those assets, because the amount of proceeds available for investment from our offering is net of selling commissions, dealer manager fees, other organization and offering costs and acquisition and origination fees and expenses; (iii) the estimated value does not take into account how market fluctuations affect the value of our investments; including how the current conditions in the finance and real estate markets may affect the values of our investments; and (iv) the estimated value does not take into account how developments related to individual assets may increase or decrease the value of our portfolio.
When determining the estimated value of our shares from and after 18 months after
completion of our offering stage (or for whatever period may be required by applicable rules and regulations), our advisor, or another firm we choose for that purpose, will estimate the value of our shares based upon a number of assumptions that may not be accurate or complete. The estimates should not be viewed as an accurate reflection of the fair value of our investments nor will they represent the amount of net proceeds that would result from an immediate sale of our assets.
Risks Related to Our Business
The CRE industry has been and may continue to be adversely affected by economic conditions in the U.S. and global financial markets generally.
Our business and operations are dependent on the CRE industry generally, which in turn is dependent upon broad economic conditions in the United States and abroad. The U.S. economy improved
in 2013 but at a slower than expected pace. Challenges still remain due to the uncertainty of the political climate, including federal budget deficits, debt ceiling, gridlock, Federal Reserve policy, concern with emerging market economies and other matters and their impact to the U.S. economy. We would expect this dynamic along with global market instability and the risk of maturing CRE debt that may have difficulties being refinanced, to continue to cause periodic volatility in the market for some time which in turn could impact the CRE industry generally and our business and operations specifically. Adverse conditions in the CRE industry could harm our business and financial condition by, among other factors, reducing the value of our existing assets, limiting our access to debt and equity capital, harming our ability to originate new CRE debt and acquire other CRE investments and otherwise negatively impacting our operations.
A prolonged economic slowdown, a lengthy or severe recession or declining real estate values could harm our investments.
Many of our investments may be susceptible to economic slowdowns or recessions, which could lead to financial losses and a decrease in revenues, earnings and assets. An economic slowdown or recession, in addition to other non-economic factors such as an excess supply of properties, could have a material negative impact on the values of our investments. Declining real estate values will likely reduce our level of new loan originations, since borrowers often use increases in the value of their existing properties to support the purchase or investment in additional properties. Borrowers may also be less able to pay
principal and interest on our CRE debt investments if the economy weakens and property values decline. Further, declining real estate values significantly increase the likelihood that we will incur losses on our investments in the event of a default because the value of our collateral may be insufficient to cover our cost. Any sustained period of increased payment delinquencies, taking title to collateral or losses could adversely affect both our CRE investments as well as our ability to originate, sell and securitize loans, which would significantly harm our revenues, results of operations, financial condition, business prospects and our ability to make distributions to you.
We are subject to significant competition and we may not be able to compete successfully for investments.
We are subject to significant competition for attractive investment opportunities from other real estate
investors, some of which have greater financial resources than us, including publicly traded REITs, non-traded REITs, insurance companies, commercial and investment banking firms, private institutional funds, hedge funds, private equity funds and other investors. We have observed increased competition in 2013 and expect that to continue into 2014. We may not be able to compete successfully for investments. In addition, the number of entities and the amount of funds competing for suitable investments may increase. If we pay higher prices for investments or originate loans on less advantageous terms to us, our returns may be lower and the value of our assets may not increase or may decrease significantly below the amount we paid for such assets. If such events occur, we may experience lower returns on our investments.
We have no established investment criteria limiting the geographic concentration of our investments. If our
investments are concentrated in an area that experiences adverse economic conditions, our investments may lose value and we may experience losses.
Certain of our investments may be secured by a single property or properties in one geographic location. Additionally, properties that we may acquire may also be concentrated in a geographic location. These investments carry the risks associated with significant geographical concentration. The likelihood of our investments being secured by a single or multiple properties in one geographic location is greater towards the earlier periods of our offering until we have raised significant proceeds and made a number of investments. We have not established and do not plan to establish any investment criteria to limit our exposure to these risks for future investments. As a result, properties underlying our investments may be overly concentrated in certain geographic areas and we may experience
losses as a result. A worsening of economic conditions, a natural disaster or civil disruptions in a geographic area in which our investments may be concentrated could have an adverse effect on our business, including reducing the demand for new financings, limiting the ability of borrowers to pay financed amounts and impairing the value of our collateral.
We have no established investment criteria limiting the industry concentration of our investments in CRE debt, select equity and securities investments. If our investments are concentrated in an industry that experiences adverse economic conditions, our investments may lose value and we may experience losses.
Certain CRE debt, select equity and securities investments in which we may invest may be secured by a single property or properties serving a particular industry, such as hotel, office or otherwise. These investments may
carry the risks associated with significant industry concentration. This risk is heightened during the early stage of our offering before we have raised significant capital. We have not established and do not plan to establish any investment criteria to limit our exposure to these risks for future investments. As a result, properties underlying our investments may be overly concentrated in certain industries and we
may experience
losses as a result. A worsening of economic conditions in an industry in which we are concentrated could have an adverse effect on our business, including reducing the demand for new financings, limiting the ability of borrowers to pay financed amounts and impairing the value of our collateral. For the year ended December 31, 2013, one CRE debt investment generated all of our interest income.
We have no established investment criteria limiting the size of each investment we make in CRE debt, select equity and securities investments. If we have an investment that represents a material percentage of our assets and that investment experiences a loss, the value of your investment in us could be significantly diminished.
We are not limited in the size of any single investment we may make and certain of our CRE debt, select equity and
securities investments may represent a significant percentage of our assets. This concentration risk will always exist, however, it is particularly heightened during the early stages of our offering, before we have raised significant capital and invested across a diverse portfolio of assets. We may be unable to raise significant capital and invest in a diverse portfolio of assets which would increase our asset concentration risk. Any such investment may carry the risk associated with a significant asset concentration. For example, in April 2014, we originated a senior loan with a principal amount of $75.0 million. Should this investment, or any other investment representing a material percentage of our assets, experience a loss on all or a portion of the investment, we could experience a material adverse effect, which would result in the value of your investment in us being diminished. For the year ended December 31, 2013,
one of our CRE debt investments generated all of our interest income.
We may change our investment strategy without stockholder consent and make riskier investments.
We may change our investment strategy at any time without the consent of our stockholders, which could result in our making investments that are different from and possibly riskier than the investments described in this prospectus. A change in our investment strategy may increase our exposure to interest rate and commercial real estate market fluctuations.
We may not be effective in originating and managing our investments.
We originate and generally manage our investments. Our origination capabilities depend on our ability to leverage our relationships in the market and deploy capital to borrowers and tenants that hold properties
meeting our underwriting standards. Managing these investments requires significant resources, adherence to internal policies and attention to detail. Managing investments may also require significant judgment and, despite our expectations, we may make decisions that result in losses. If we are unable to successfully originate investments on favorable terms, or at all, and if we are ineffective in managing those investments, our business, financial condition and results of operations could be materially adversely affected.
The CRE debt we originate and invest in and mortgage loans underlying the CRE securities we invest in are subject to risks of delinquency, taking title to collateral, loss and bankruptcy of the borrower under the loan. If the borrower defaults, it may result in losses to us.
Our CRE debt investments are secured by commercial real estate and are subject to risks
of delinquency, loss, taking title to collateral and bankruptcy of the borrower. The ability of a borrower to repay a loan secured by commercial real estate is typically dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced or is not increased, depending on the borrower’s business plan, the borrower’s ability to repay the loan may be impaired. Net operating income of a property can be affected by, each of the following factors, among other things:
•
macroeconomic, regional or local economic conditions;
property operating costs, including insurance premiums, real estate taxes and maintenance costs;
•
competition from comparable types of properties;
•
changes in governmental rules, regulations and fiscal policies, including environmental
legislation;
•
changes in laws that increase operating expenses or limit rents that may be charged;
•
any need to address environmental contamination at the property;
•
the occurrence of any uninsured casualty at the property;
•
changes
in local, regional, national or international economic conditions and/or specific industry segments;
•
declines in local or regional real estate values;
•
branding, marketing and operational strategies;
•
declines in local or regional rental or occupancy rates;
•
increases
in interest rates;
•
natural disasters;
•
social unrest and civil disturbances;
•
terrorism; and
•
increases
in costs associated with leasing, renovation and/or construction.
Any one or a combination of these factors may cause a borrower to default on a loan or to declare bankruptcy. If a default or bankruptcy occurs and the underlying asset value is less than the loan amount, we will suffer a loss.
Additionally, we may suffer losses for a number of reasons, including the following, which could have a material adverse effect on our financial performance:
If the value of real property or other assets securing our CRE debt deteriorates. We expect that our CRE debt and securities investments will generally be directly or indirectly secured by a lien on real property. The occurrence of a default on a CRE debt investment could result in our taking title to collateral. We will not know whether the value
of the properties ultimately securing our CRE debt and ultimately securing the mortgage loans underlying our CRE securities will remain at the levels existing on the dates of origination of the underlying CRE debt and the dates of origination of the mortgage loans ultimately securing our CRE securities, as applicable. If the value of the properties drop, our risk will increase because of the lower value of the collateral and reduction in borrower equity associated with the related CRE debt. In this manner, real estate values could impact the value of our CRE debt and securities investments. Our CRE equity investments (investments in real property) may be similarly affected by real estate property values. Therefore, our CRE debt, select equity and securities investments will be subject to the risks typically associated with real estate. We expect that our CRE debt investments will be fully or substantially non-recourse. In the event of a default by a borrower on a non-recourse
loan, we will only have recourse to the real estate-related assets (including escrowed funds and reserves, if any) collateralizing the debt. For this purpose, we consider CRE debt made to special purpose entities formed solely for the purpose of holding and financing particular assets to be non-recourse. We may sometimes also originate CRE debt that is secured by equity interests in the borrowing entities or by investing directly in the owner of the property. There can be no assurance that the value of the assets securing our CRE debt investments will not deteriorate over time due to factors beyond our control, as was the case during the credit crisis and as a result of the recent economic recession. Mezzanine loans are subject to the additional risk that senior lenders may be directly secured by the real estate assets of the borrowing entity, whereas the mezzanine loans may be secured by ownership interests in the borrower.
If a borrower or guarantor defaults on recourse obligations under a CRE debt investment. We may sometimes obtain personal or corporate guarantees, which will not be secured, from borrowers or their affiliates. These guarantees are often triggered only upon the occurrence of certain trigger, or “bad boy,” events. In cases where guarantees are not fully or partially secured, we will typically rely on financial covenants from borrowers and guarantors which are designed to require the borrower or guarantor to maintain certain levels of creditworthiness. As a result of challenging economic and market conditions, many borrowers and guarantors faced, and continue to face, financial difficulties and were unable, and may continue to be unable, to comply with their financial covenants. If the economy does not strengthen, our borrowers
could experience additional financial stress. Where we do not have recourse to specific collateral pledged to satisfy such guarantees or recourse loans, we will only have recourse as an unsecured creditor to the general assets of the borrower or guarantor, some or all of which may be pledged to satisfy other lenders. There can be no assurance that a borrower or guarantor will comply with its financial covenants or that sufficient assets will be available to pay amounts owed to us under our CRE debt and related guarantees.
Our due diligence may not reveal all material issues relating to our origination or acquisition of a particular investment. In making an assessment of the strength and skills of the management of the borrower or the tenant of a property and other factors that we believe are material to the performance of the investment and otherwise conducting customary due diligence, we will rely
on the resources available to us and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly organized or private entities because there may be little or no information publicly available about the entity. This due diligence may not uncover all material issues relating to such investment and factors outside of our control may later arise. If our due diligence fails to identify issues specific to certain investments, we may be forced to write-down or write-off assets, restructure our operations or incur impairment or other charges that could result in our reporting losses.
In the event of a default or bankruptcy of a borrower, particularly in cases where the borrower has incurred debt that is senior to our CRE debt. If a borrower defaults on our CRE debt and the mortgaged real estate or other borrower assets collateralizing our
CRE debt are insufficient to satisfy the loan, we may suffer a loss of principal or interest. In the event of a borrower bankruptcy, we may not have full recourse to the assets of the borrower or the assets of the borrower may not be sufficient to satisfy our CRE debt. In addition, certain of our CRE debt investments may be subordinate to other debt of the borrower. If a borrower defaults on our CRE debt or on debt senior to our CRE debt or in the event of a borrower bankruptcy, our CRE debt will be satisfied only after the senior debt, if any. Bankruptcy and borrower litigation can significantly increase the time needed for us to acquire underlying collateral in the event of a default, during which time the collateral may decline in value. In addition, there are significant monetary costs and delays associated with the process of taking title to collateral.
In the event provisions of our CRE debt agreements are adjudicated
to be unenforceable. Our rights and obligations with respect to our CRE debt investments are governed by loan agreements and related documentation. It is possible that a court could determine that one or more provisions of a loan agreement or related documentation are unenforceable, such as a loan prepayment provision or the provisions protecting our security interest in the underlying collateral.
Delays in liquidating defaulted CRE debt investments could reduce our investment returns.
If there are defaults under the agreements securing the collateral of our CRE debt investments, we may not be able to take title to and sell the collateral securing the loan quickly. Taking title to collateral can be an expensive and lengthy process that could have a negative effect on the return on our investment. Borrowers often resist when lenders, such as us, seek to
take title to collateral by asserting numerous claims, counterclaims and defenses, including but not limited to, lender liability claims, in an effort to prolong the foreclosure action. In some states, taking title to collateral can take several years or more to resolve. At any time during a foreclosure proceeding, for example, the borrower may file for bankruptcy, which would have the effect of staying the foreclosure action and further delaying the foreclosure process. The resulting time delay could reduce the value of our investment in the defaulted loans. Furthermore, an action to take title to
collateral securing a loan is regulated by state statutes and regulations and is subject to the delays and expenses associated with lawsuits if the borrower raises defenses or counterclaims. In the event of default by a borrower, these restrictions, among other things, may impede our ability to take title to and sell the collateral securing the loan or to obtain proceeds sufficient to repay all amounts due to us on the loan. In addition, we may be forced to operate any collateral for which we take title for a substantial period of time, which could be a distraction for our management team and may require us to pay significant costs associated with such collateral. We may not recover any of our investment even if we take title to collateral.
Jurisdictions with one action or security first rules or anti-deficiency
legislation may limit the ability to take title to collateral or to realize the obligation secured by the property by obtaining a deficiency judgment.
In the event of any default under our CRE debt investments and in the mortgage loans underlying our CRE securities, we bear the risk of loss of principal and nonpayment of interest and fees to the extent of any deficiency between the value of the collateral and the principal amount of the loan. Certain states in which the collateral securing our CRE debt and securities investments may be located may have laws that prohibit more than one judicial action to enforce a mortgage obligation, requiring the lender to exhaust the remedies on such collateral to satisfy the obligation first or limiting the ability of the lender to recover a deficiency judgment from the obligor following the lender’s realization upon the collateral, in particular if a non-judicial foreclosure is pursued.
These statutes may limit the right to take title to collateral or to realize the obligation secured by the property by obtaining a deficiency judgment.
Our borrowers may be unable to achieve their business plans due to the challenging U.S. and global economic conditions, which could cause incremental stress to our CRE debt investments.
Our CRE debt investments may be made to borrowers who have business plans to improve occupancy and cash flow that may not be accomplished. Slower than expected economic growth pressured by a strained labor market, along with overall financial uncertainty, could result in lower occupancy rates and lower lease rates across many property types and may create obstacles for our borrowers attempting to achieve their business plans. If our borrowers are unable to achieve their business plans, our related CRE debt investments could default and severely impact
our liquidity and operating results.
We may be subject to risks associated with future advance or capital expenditure obligations, such as declining real estate values and operating performance.
Our CRE debt investments may require us to advance future funds. We may also need to fund capital expenditures and other significant expenses if we make real estate property investments. Future funding obligations subject us to significant risks such as that the property may have declined in value, projects to be completed with the additional funds may have cost overruns and the borrower and tenant may be unable to generate enough cash flow and execute its business plan, or sell or refinance the property, in order to repay our CRE debt due to us. We could determine that we need to fund more money than we originally anticipated in order to maximize the value of our investment even though
there is no assurance additional funding would be the best course of action. Further, future funding obligations require us to maintain higher liquidity than we might otherwise maintain and this could reduce the overall return on our investments.
We may be unable to restructure our investments in a manner that we believe maximizes value, particularly if we are one of multiple creditors in a large capital structure.
In order to maximize value we may be more likely to extend and work out an investment, rather than pursue other remedies such as taking title to collateral. However, in situations where there are multiple creditors in large capital structures, it can be particularly difficult to assess the most likely course of action that a lender group or the borrower may take and it may also be difficult to achieve consensus among the lender group as to major decisions. Consequently,
there could be a wide range of potential principal recovery outcomes, the timing of which can be unpredictable, based on the strategy pursued by a lender group or other applicable parties. These multiple creditor situations tend to be associated with larger loans. If we are one of a group of lenders, we may be a lender on a subordinated basis and may not independently control the decision making. Consequently, we may be unable to restructure an investment in a manner that we believe would maximize value. Restructuring an investment may ultimately result in us receiving less than had we not restructured the investment.
CRE debt restructurings may reduce our net interest income.
Although our CRE debt investments are relatively new and the CRE market has improved, the U.S. economy and financial markets continue to be challenged. As a result, our borrowers may be at increased risk of default and we or a third party may need to restructure loans if our borrowers are unable to meet their obligations to us and we believe restructuring is the best way to maximize value. In order to preserve long-term value, we may determine to lower the interest rate on loans in connection with a restructuring, which will have an adverse impact on our net interest income. We may also determine to extend the maturity and make other concessions with the goal of increasing overall value, however, there is no assurance that the results of our restructurings
will be favorable to us. We may lose some or all of our investment even if we restructure in an effort to increase value.
Our CRE debt investments may be funded with interest reserves and our borrowers may be unable to replenish those interest reserves once they run out.
Given the transitional nature of our CRE debt investments, we generally expect to require borrowers to pre-fund reserves to cover interest and operating expenses until the property cash flow increases sufficiently to cover debt service costs. We would also generally require the borrower to refill these reserves if they became deficient due to underperformance and if the borrower wanted to exercise extension options under the loan. Despite low interest rates and improving real estate fundamentals, we expect that in the future our borrowers may still have difficulty servicing our CRE debt investments. Many of our
borrowers may only be able to meet their obligations to us because of the reserves we expect to set up at the origination of the loans. We expect that in the future, many of the reserves will run out and some of our borrowers will have difficulty servicing our debt and will not have sufficient capital to replenish reserves, which could have a significant impact on our operating results and cash flow.
The properties underlying certain of our CRE debt investments may not currently be generating sufficient operating cash flow to support debt service payments which may pose a heightened risk of loss.
We may originate CRE debt investments in which the operating cash flow generated from the underlying property is insufficient to support current debt service payments. In such cases, the borrower will typically plan to re-position, re-develop or otherwise lease-up the property in accordance
with an established business plan that we will evaluate during our underwriting of the investment. We expect to generally require the borrower to fund interest or other reserves, whether through proceeds from our loan or otherwise, to support debt service payments and capital expenditures during the period that the borrower is implementing the approved business plan. Despite our expectations, the applicable borrowers may not effectively implement their business plans because of cost over-runs, slower than anticipated leasing and other factors that negatively affect commercial real estate generally as described more specifically elsewhere in these risk factors. As a result, the subject properties may never generate sufficient cash flow to support debt service payments. The interest and other reserves established at origination of the CRE debt investment may be insufficient to support debt service payments and/or capital expenditures while the borrower is implementing
the business plan. Investments in these assets generally entail more significant risk than investments in assets that are currently generating sufficient cash flow to support debt service. We may suffer significant losses with respect to these investments which would negatively impact our operating performance and our ability to make distributions to you.
Our CRE debt and securities investments may be adversely affected by changes in credit spreads.
Our CRE debt we originate or acquire and securities investments we may invest in are subject to changes in credit spreads. When credit spreads widen, the economic value of our investments decrease even if such investment is performing in accordance with its terms and the underlying collateral has not changed.
Higher provision for loan losses and asset impairment charges may occur if economic
conditions do not continue to improve.
We could experience defaults resulting in provision for loan losses and asset impairment charges in the future. Borrowers, for a variety of reasons, may be unable to remain current with principal and interest on loans. Declines in real property values also increase loan-to-value ratios on our loans and, therefore, weaken
our collateral coverage and
increase the likelihood of higher provision for loan losses. Even if our cash flow remains relatively stable, we could suffer losses in accordance with U.S. GAAP, which could adversely affect our access to credit and ability to satisfy financing covenants.
Provision for loan losses is difficult to estimate, particularly in a challenging economic environment.
Our provision for loan losses is evaluated on a quarterly basis. Our determination of provision for loan losses requires us to make certain estimates and judgments, which may be difficult to determine, particularly in a challenging economic environment. While CRE fundamentals have improved, the U.S. economy and financial markets remain challenged. Our estimates and judgments are based on a number of factors, including projected cash flow from the collateral securing our CRE debt structure, including the availability of reserves
and recourse guarantees, likelihood of repayment in full at the maturity of a loan, potential for refinancing and expected market discount rates for varying property types, all of which remain uncertain and are subjective. Our estimates and judgments may not be correct, particularly during challenging economic environments, and, therefore, our results of operations and financial condition could be severely impacted.
With respect to commercial properties, options and other purchase rights may affect value or hinder recovery in the event of taking title to collateral.
A borrower under certain of our CRE debt investments may give its tenants or another person a right of first refusal or an option to purchase all or a portion of the related collateral. These rights may impede our ability to sell the related collateral if we take title or may adversely affect the value or marketability
of the collateral. We may also determine to give our tenants a right of first refusal or similar option, which could negatively affect the residual value of the property.
Both our borrowers’ and tenants’ forms of entities may cause special risks.
Most of the borrowers for our CRE debt investments and our tenants in the real estate that we may own, as well as borrowers underlying our CRE securities, will most likely be legal entities rather than individuals. The obligations these entities will owe us are typically non-recourse so we can only look to our collateral, and at times, the assets of the entity may not be sufficient to recover our investment. Unlike individuals involved in bankruptcies, these legal entities will generally not have personal assets and creditworthiness at stake. As a result, the default or bankruptcy of one of our borrowers or tenants, or a general partner
or managing member of that borrower or tenant, may impair our ability to enforce our rights and remedies under the related mortgage or the terms of the lease agreement, respectively.
The subordinate CRE debt we may originate and invest in may be subject to risks relating to the structure and terms of the related transactions, as well as subordination in bankruptcy, and there may not be sufficient funds or assets remaining to satisfy our investments, which may result in losses to us.
We intend to originate, structure and acquire subordinate CRE debt investments secured primarily by commercial properties, which may include subordinate mortgage loans, mezzanine loans and participations in such loans and preferred equity interests in borrowers who own such properties. We have not placed any limits on the percentage of our portfolio that may be comprised of these types of investments,
which may involve a higher degree of risk than the type of assets that we expect will constitute the majority of our debt investments, namely first mortgage loans secured by real property. These investments may be subordinate to other debt on commercial property and are secured by subordinate rights to the commercial property or by equity interests in the borrower. In addition, real properties with subordinate debt may have higher loan-to-value ratios than conventional debt, resulting in less equity in the real property and increasing the risk of loss of principal and interest. If a borrower defaults or declares bankruptcy, after senior obligations are met, there may not be sufficient funds or assets remaining to satisfy our subordinate interests. Because each transaction is privately negotiated, subordinate investments can vary in their structural characteristics and lender rights. Our rights to control the default or bankruptcy process following a default will vary
from transaction to transaction. The subordinate investments that we originate and invest in may not give us the right to demand taking title to collateral as a subordinate real estate debt holder. Furthermore, the presence of intercreditor agreements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies and control decisions made in bankruptcy proceedings relating to
borrowers.
Similarly, a majority of the participating lenders may be able to take actions to which we object, but by which we will be bound. Even if we have control, we may be unable to prevent a default or bankruptcy and we could suffer substantial losses. Certain transactions that we may originate and invest in could be particularly difficult, time consuming and costly to work out because of their complicated structure and the diverging interests of all the various classes of debt in the capital structure of a given asset.
Many of our investments may be illiquid and we may not be able to vary our portfolio in response to further changes in economic and other conditions, which may result in losses to us.
Many of our investments may be illiquid. As a result, our ability to sell investments in response to changes in economic and other conditions could be limited, even at distressed prices.
The Internal Revenue Code also places limits on our ability to sell certain properties held for fewer than two years. These considerations could make it difficult for us to dispose of any of our assets even if a disposition is in the best interests of stockholders. As a result, our ability to vary our portfolio in response to further changes in economic and other conditions may be relatively limited, which may result in losses to us.
We may make investments in assets with lower credit quality, which will increase our risk of losses.
Our CRE securities in which we may invest may have explicit ratings assigned by at least one of the major rating agencies (Moody’s Investor Services, Standard & Poor’s, Fitch Ratings, Morningstar, DBRS and/or Kroll). However, we may invest in unrated CRE securities, enter into leases with unrated tenants or participate in subordinate, unrated or
distressed mortgage loans. Because the ability of obligors of properties and mortgages, including mortgage loans underlying CMBS, to make rent or principal and interest payments may be impaired during an economic downtown, prices of lower credit quality investments and CRE securities may decline. The existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these investments.
Investments in non-conforming or non-investment grade rated CRE debt or securities involve greater risk of loss.
Some of our investments may not be rated or will be rated as non-investment grade by the rating agencies. The non-investment grade ratings for these assets typically result from the overall leverage of the loans, the lack of a strong operating history for the properties underlying the loans or securities, the borrowers’ credit history,
the properties’ underlying cash flow or other factors. As a result, these investments may have a higher risk of default and loss than investment grade rated assets. Any loss we incur may be significant and may reduce distributions to you and may adversely affect the value of our common stock.
Investments in non-performing real estate assets involve greater risks than investments in stabilized, performing assets and make our future performance more difficult to predict, however, we may still incur losses on performing real estate assets.
Traditional performance metrics of real estate assets are generally not as reliable for non-performing real estate assets as they are for performing real estate assets. Non-performing properties, for example, do not have stabilized occupancy rates and may require significant capital for repositioning. Similarly, non-performing loans do not have
a consistent stream of cash flow to support normalized debt service. In addition, for non-performing loans, often there is greater uncertainty as to the amount or timeliness of principal repayment.
In addition, we may pursue more than one strategy to create value in a non-performing real estate investment. With respect to a property, these strategies may include development, redevelopment or lease-up of such property. With respect to certain of our CRE debt investments, these strategies may include negotiating with the borrower for a reduced payoff, restructuring the terms of the loan or enforcing our rights as lender under the loan and taking title to collateral securing the loan.
The factors described above make it challenging to evaluate non-performing investments. We may further incur losses even on our performing investments.
Floating-rate CRE debt, which is often associated with transitional assets, may entail greater risks of default to us than fixed-rate CRE debt.
Floating-rate loans are often, but not always, associated with transitional properties as opposed to those with highly stabilized cash flow. Floating-rate CRE debt may have higher delinquency rates than fixed-rate loans. Borrowers with floating-rate loans may be exposed to increased monthly payments if the related interest rate adjusts upward from the initial fixed rate in effect during the initial period of the loan to the rate calculated in accordance with the applicable index and margin. Increases in a borrower’s monthly payment, as a result of an increase in prevailing market interest rates may make it more difficult for the borrowers with floating-rate loans
to repay the loan and could increase the risk of default of their obligations under the loan.
We may be subject to risks associated with construction lending, such as declining real estate values, cost overruns and delays in completion.
Our CRE debt investments may include loans made to developers to construct prospective projects, which may include ground-up construction or repositioning an existing asset. The primary risks to us of construction loans are the potential for cost overruns, the developer’s failing to meet a project delivery schedule and the inability of a developer to sell or refinance the project at completion in accordance with its business plan and repay our CRE debt. These risks could cause us to have to fund more money than we originally anticipated in order to complete the project. We may also suffer losses on our CRE debt if the developer is unable to sell
the project or refinance our CRE debt investment.
Investments that are not insured involve greater risk of loss than insured investments.
We will originate and acquire loans and assets as part of our investment strategy. Unlike agency residential mortgages, the CRE debt we invest in will not be insured by any quasi-governmental body or similar third party. Our CRE debt investments may include first mortgage loans, subordinate mortgage and mezzanine loans, preferred equity interests and participations in such loans as well as equity and CRE securities investments. While holding such interests, we will be subject to risks of borrower defaults, bankruptcies, fraud, losses and special hazard losses. To the extent we suffer such losses with respect to our investments, the value of our company and
the value of our common stock may be adversely affected.
Insurance may not cover all potential losses on CRE debt investments which may impair the value of our assets.
We will generally require that each of the borrowers under our CRE debt investments obtain comprehensive insurance covering the collateral, including liability, fire and extended coverage. We also will generally obtain insurance directly on any property we acquire. However, there are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods and hurricanes that may be uninsurable or not economically insurable. We may not require borrowers to obtain certain types of insurance if it is deemed commercially unreasonable. Inflation, changes in building codes and ordinances, environmental considerations and other factors also might make it infeasible to use insurance proceeds to replace a
property if it is damaged or destroyed. Under such circumstances, the insurance proceeds, if any, might not be adequate to restore the economic value of the mortgaged property, which might decrease the value of the property and in turn impair our investment.
Our CRE debt, select equity and mortgage loans underlying our CRE securities investments are subject to the risks typically associated with real estate.
Our CRE debt and securities investments will generally be directly or indirectly secured by a lien on real property. The occurrence of a default on a CRE debt investment could result in our acquiring ownership of the property. We will not know whether the values of the properties ultimately securing our CRE debt and ultimately securing the mortgage loans underlying our CRE securities will remain at the levels existing on the dates of origination of these underlying mortgage
loans and the dates of origination of the loans ultimately securing our CRE securities, as applicable. If the values of the properties drop, our risk will increase because of the lower value of the collateral and reduction in borrower equity associated
with the related loans. In this manner, real estate values could impact the values of our CRE debt and securities investments. Our CRE equity investments may be similarly affected by
real estate property values. Therefore, our CRE debt, select equity and securities investments are subject to the risks typically associated with real estate, including:
•
local, state, national or international economic conditions;
•
real estate conditions, such as an oversupply of or a reduction in demand for real estate space in an area;
•
the
perceptions of the quality, convenience, attractiveness and safety of the properties;
•
competition from comparable properties;
•
the occupancy rate of, and the rental rates charged at, the properties;
•
the ability to collect on a timely basis all rent;
•
the
effects of any bankruptcies or insolvencies;
•
the expense of re-leasing space;
•
changes in interest rates and in the availability, cost and terms of mortgage financing;
•
unknown liens being placed on the properties;
•
bad
acts of third parties;
•
the ability to refinance mortgage notes payable related to the real estate on favorable terms, if at all;
•
the impact of present or future environmental legislation and compliance with environmental laws, including costs of remediation and liabilities associated with environmental conditions affecting properties;
•
cost
of compliance with the Americans with Disabilities Act of 1990, or ADA;
•
adverse changes in governmental rules and fiscal policies;
•
civil unrest;
•
acts of nature, including earthquakes, hurricanes and other natural disasters (which may result in uninsured losses);
•
the
potential for uninsured or underinsured property losses;
•
adverse changes in state and local laws, including zoning laws; and
•
other factors which are beyond our control.
The value of each property is affected significantly by its ability to generate cash flow and net income, which in turn depends on the amount of rental or other income that can be generated net of expenses required to be incurred with respect to the property. Many expenses associated
with properties (such as operating expenses and capital expenses) cannot be reduced when there is a reduction in income from the properties.
These factors may have a material adverse effect on the ability of our borrowers to pay their loans and the ability of the borrowers on the underlying loans securing our securities to pay their loans, as well as on the value and the return that we can realize from assets we originate and acquire.
We depend on borrowers and tenants for a substantial portion of our revenue and, accordingly, our revenue and our ability to make distributions to you will be dependent upon the success and economic viability of such borrowers and tenants.
The success of our origination or acquisition of CRE debt investments significantly depends on the financial stability of the borrowers and tenants underlying such investments.
The inability of a single major borrower or tenant, or a number of smaller borrowers or tenants, to meet their payment obligations could result in reduced revenue or losses.
If we overestimate the value or income-producing ability or incorrectly price the risks of our investments, we may experience losses.
Analysis of the value or income-producing ability of a commercial property is highly
subjective and may be subject to error. We will value our potential investments based on yields and risks, taking into account estimated future losses on the CRE loans and the property included in the securitization’s pools or select CRE equity investments and the estimated impact of these losses on expected future cash flow and returns. In the event that we underestimate the risks relative to the price we pay for a particular investment, we may experience losses with respect to such investment.
We are exposed to environmental liabilities with respect to properties to which we may take title.
In the course of our business, we may take title to real estate and, if we do take title, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third parties for property damage, personal
injury and investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.
If we enter into joint ventures, our joint venture partners could take actions that decrease the value of an investment to us and lower our overall return.
We may in the future enter into joint ventures with third parties to make investments. We may also make investments in partnerships or other co-ownership arrangements or participations. Such investments may involve risks not otherwise
present with other methods of investment, including, for example, the following risks:
•
that our co-venturer or partner in an investment could become insolvent or bankrupt;
•
that such co-venturer or partner may at any time have economic or business interests or goals that are or that become in conflict with our business interests or goals; or
•
that
such co-venturer or partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives.
Any of the above might subject us to liabilities and thus reduce our returns on our investment with that co-venturer or partner. In addition, disagreements or disputes between us and our co-venturer or partner could result in litigation, which could increase our expenses and potentially limit the time and effort our officers and directors are able to devote to our business.
We may make opportunistic investments that may involve asset classes and structures with which we have less familiarity, thereby increasing our risk of loss.
We may make opportunistic investments that may involve asset classes and structures with which we have less familiarity. We may in the future also
determine to invest in other asset classes with which we have limited or no prior experience. When investing in asset classes with which we have limited or no prior experience, we may not be successful in our diligence and underwriting efforts. We may also be unsuccessful in preserving value if conditions deteriorate and we may expose ourselves to unknown substantial risks. Furthermore, these assets could require additional management time and attention relative to assets with which we are more familiar. All of these factors increase our risk of loss.
We will be subject to additional risks if we make investments internationally.
We may acquire real estate assets located outside of the United States and we may originate or acquire senior or subordinate loans made to borrowers located outside of the United States or secured by properties located outside of the United States. Our
expertise to date is in the United States and neither we nor our sponsor has expertise in international markets. Any international investments we make may be affected by
factors peculiar to the laws of the jurisdiction in which the borrower or the property is located and these laws may expose us to risks that are different from and/or in addition to those commonly found in the United States. We may not be as familiar with the potential
risks to our investments outside of the United States and we may incur losses as a result.
Any international investments we make could be subject to the following risks: governmental laws, rules and policies including laws relating to the foreign ownership of real property or mortgages and laws relating to the ability of foreign persons or corporations to remove profits earned from activities within the country to the person’s or corporation’s country of origin; variations in currency exchange rates; adverse market conditions caused by inflation or other changes in national or local economic conditions; changes in relative interest rates; changes in the availability, cost and terms of borrowings resulting from varying national economic policies; changes in real estate and other tax rates, the tax treatment of transaction structures and other changes in operating expenses in a particular country where we have an investment;
imposition of adverse or confiscatory taxes; our REIT tax status not being respected under foreign laws, in which case any income or gains from foreign sources would likely be subject to foreign taxes, withholding taxes, transfer taxes, and value added taxes; lack of uniform accounting standards (including availability of information in accordance with U.S. GAAP); the potential for expropriation; changes in land use and zoning laws; more stringent environmental laws or changes in such laws; changes in the social or political stability or other political, economic or diplomatic developments in or affecting a country where we have an investment; legal and logistical barriers to enforcing our contractual rights in other countries; and possible liability under the United States Foreign Corrupt Practices Act of certain people acting on our behalf or at our request, contrary to our instructions, engaging in practices in violation of such act. Certain of these risks may be
greater in emerging markets and less developed countries. Each of these risks might adversely affect our performance and impair our ability to make distributions to you required to maintain our REIT qualification. In addition, there is less publicly available information about foreign companies and a lack of uniform financial accounting standards and practices (including the availability of information in accordance with U.S. GAAP) which could impair our ability to analyze transactions and receive timely and accurate financial information from tenants or borrowers necessary to meet our reporting obligations to financial institutions or governmental or regulatory agencies.
We may invest in a variety of CRE securities, including CMBS and other subordinate securities, which entail certain heightened risks.
We may invest in a variety of CRE securities, including CMBS and other subordinate
securities, subject to the first risk of loss if any losses are realized on the underlying mortgage loans. CMBS entitle the holders thereof to receive payments that depend primarily on the cash flow from a specified pool of commercial or multifamily mortgage loans. Consequently, CMBS and other CRE securities will be adversely affected by payment defaults, delinquencies and losses on the underlying mortgage loans, which increase during times of economic stress and uncertainty. Furthermore, if the rental and leasing markets deteriorate, including by decreasing occupancy rates and decreasing market rental rates, it could reduce cash flow from the mortgage loan pools underlying our CMBS investments that we may make. The market for CRE securities is dependent upon liquidity for refinancing and may be negatively impacted by a slowdown in new issuance.
Additionally, CRE securities such as CMBS may be subject to particular risks,
including lack of standardized terms and payment of all or substantially all of the principal only at maturity rather than regular amortization of principal. Additional risks may be presented by the type and use of a particular commercial property. Commercial property values and net operating income are subject to volatility, which may result in net operating income becoming insufficient to cover debt service on the related loan. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of the related real estate project rather than upon the liquidation value of the underlying collateral. Furthermore, the net operating income from and value of any commercial property are subject to various risks. The exercise of remedies and successful realization of liquidation proceeds relating to CRE securities may be highly dependent upon the performance of the servicer or special servicer. Expenses of enforcing the underlying
mortgage loan (including litigation expenses) and expenses of protecting the properties securing the loan may be substantial. Consequently, in the event of a default or loss on one or more loans contained in a securitization, we may not recover a portion or all of our investment.
The CRE securities, including CMBS, in which we may invest, are subject to the risks of the CRE debt capital markets as a whole and risks of the securitization
process.
The value of CRE securities may change due to shifts in the market’s perception of issuers and regulatory or tax changes adversely affecting the CRE debt market as a whole. Investments in subordinate CRE securities are also subject to several risks created through the securitization financing transaction process. Subordinate CMBS, for example, are paid only to the extent that there are funds available to make payments. To the extent the collateral pool includes delinquent loans, there is a risk that the payment on our subordinate CMBS will not be fully paid, if paid at all. Subordinate CRE securities are also subject to greater credit risk than those CRE securities that are senior and more highly rated.
Any credit ratings assigned to our securities will be subject to ongoing surveillance and revisions and we cannot assure that those ratings will not be downgraded.
Some
of our securities may be rated by at least one of the major rating agencies. Any credit ratings on our securities, or tenants occupying the properties underlying our securities, will be subject to ongoing surveillance by credit rating agencies. We cannot assure you that any such ratings will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. If rating agencies assign a lower-than-expected rating or reduce or withdraw or indicate that they may reduce or withdraw, their ratings of our investments in the future, the value of these investments could significantly decline, which could adversely affect the value of our investment portfolio and could result in losses upon disposition or the failure of third parties to satisfy their debt service obligations to us.
We may not control the special servicing of the mortgage loans or other debt underlying the CRE securities in which
we may invest and, in such cases, the special servicer may take actions that could adversely affect our interest.
Overall control over the special servicing of the mortgage loans or other debt underlying the CRE securities in which we may invest may be held by a directing certificate holder which is typically appointed by the holders of the most subordinate class of such CRE securities then outstanding. We ordinarily do not have the right to appoint the directing certificate holder. In connection with the servicing of the specially serviced loans, the related special servicer may, at the direction of the directing certificate holder, take actions that could adversely affect our interest.
With respect to certain mortgage loans and other debt included in the CRE securities in which we may invest, the collateral that secures the mortgage loan or other debt underlying the CRE securities
may also secure one or more related mortgage loans or other debt that are not in the securitization pool, which may conflict with our interest.
Certain mortgage loans or other debt included in the CRE securities in which we may invest may be part of a loan combination or split loan structure that includes one or more additional cross-collateralized mortgage loans (senior, subordinate or pari passu and not included in the securitization pool) that are secured by the same mortgage instrument(s) encumbering the same mortgaged property or properties, as applicable, as is the subject mortgage loan. Pursuant to one or more co-lender or similar agreements, a holder, or a group of holders, of a mortgage loan in a subject loan combination or split loan structure may be granted various rights and powers that affect the mortgage loan in that loan combination or split loan structure, including: (i) cure rights; (ii) a purchase option;
(iii) the right to advise, direct or consult with the applicable servicer regarding various servicing matters affecting that loan combination; or (iv) the right to replace the directing certificate holder (without cause). These rights could adversely affect our position.
Market conditions may cause uncertainty in valuing our securities.
Periods of market volatility and lack of liquidity may make the valuation process pertaining to certain of our assets difficult, particularly any CMBS assets for which there was limited market activity. Our estimate of the value of these investments will be primarily based on active issuances and the secondary trading market of such securities as compiled and reported by independent pricing agencies. Our estimate of fair value, which will be based on the notion of orderly market transactions, requires significant judgment and consideration of other
indicators of value such as current interest rates, relevant market
indices, broker quotes, expected cash flow and other relevant market data as appropriate. Our estimates could be wrong and there is a heightened risk of this during challenging and volatile market environments. The amount that we could obtain if we were forced to liquidate our CRE securities investments into the current market could be materially different than management’s
best estimate of fair value.
Our investments in CRE securities, which may include preferred and common equity, will be subject to the specific risks relating to the particular issuer of the securities and may involve greater risk of loss than secured debt financings.
Our investments in CRE securities, which may include preferred and common equity, will involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Issuers that are REITs and other real estate companies are subject to the inherent risks associated with real estate and real estate-related investments discussed in this prospectus. Issuers that are finance companies are subject to the inherent risks associated with structured financing investments also discussed in this prospectus. Furthermore, securities, including preferred and common
equity, may involve greater risk of loss than secured financings due to a variety of factors, including that such investments are generally unsecured and may also be subordinated to other obligations of the issuer. As a result, investments in CRE securities, including preferred and common equity, are subject to risks of: (i) limited liquidity in the secondary trading market; (ii) substantial market price volatility resulting from changes in prevailing interest rates; (iii) subordination to the prior claims of banks and other senior lenders to the issuer; (iv) the operation of mandatory sinking fund or call or redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower yielding assets; (v) the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations; and (vi) the declining creditworthiness and potential for insolvency of the issuer during
periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding securities, including preferred and common equity, and the ability of the issuers thereof to make principal, interest and distribution payments to us.
We may change our targeted investments and investment guidelines without stockholder consent.
Our board of directors may change our targeted investments and investment guidelines at any time without the consent of stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this prospectus. A change in our targeted investments or investment guidelines may increase our exposure to interest rate risk, default risk and real estate market fluctuations, all of which could adversely affect the value of our common stock and our ability to make distributions
to you.
Declines in the fair value of our investments may adversely affect our periodically reported results of operations and credit availability, which may reduce earnings and, in turn, cash available for distribution to you.
Our securities investments will be classified for accounting purposes as “available-for-sale.” These securities will be carried at estimated fair value and temporary changes in the fair value of those assets will generally be directly charged or credited to equity with no impact in our statements of operations. If we determine that a decline in the estimated fair value of an available-for-sale security falls below its amortized value and is not temporary, we will recognize the appropriate loss on that security in our statements of operations, which will reduce our earnings in the period.
A decline in the
fair value of our assets may adversely affect us particularly in instances where we have borrowed money based on the fair value of those assets. If the fair value of those assets declines, the lender may require us to post additional collateral to support the asset. If we were unable to post the additional collateral, our lenders may refuse to continue to lend to us or reduce the amounts they are willing to lend to us. Additionally, we may have to sell assets at a time when we might not otherwise choose to do so. A reduction in credit available may reduce our earnings and, in turn, cash available for distribution to you.
Further, lenders may require us to maintain a certain amount of cash reserves or to set aside unlevered assets sufficient to maintain a specified liquidity position, which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose,
which could reduce our return on equity. In the event that we are unable to meet these contractual obligations, our financial condition could deteriorate rapidly.
The fair value of our investments may decline for a number of reasons, such as changes in prevailing market rates, increases in defaults, increases in voluntary prepayments for those investments that we have that are subject to prepayment risk, widening of credit spreads
and downgrades of ratings of the securities by ratings agencies.
We may invest in CDO notes, which may involve significant risks.
We may invest in CDO notes which are multiple class securities secured by pools of assets, such as CMBS, mortgage loans, subordinate mortgage and mezzanine loans and REIT debt. Like typical securitization structures, in a CDO, the assets are pledged to a trustee for the benefit of the holders of the CDO bonds. Like CMBS, CDO notes are affected by payments, defaults, delinquencies and losses on the underlying loans or securities. CDOs often have reinvestment periods that typically last for five years during which proceeds from the sale of a collateral asset may be invested in substitute collateral. Upon termination of the reinvestment period, the static pool functions very similarly to a CMBS where repayment of principal allows for redemption of bonds
sequentially. To the extent we may invest in the equity interest of a CDO, we will be entitled to all of the income generated by the CDO after the CDO pays all of the interest due on the senior securities and its expenses. However, there may be little or no income or principal available to the holders of CDO equity interests if defaults or losses on the underlying collateral exceed a certain amount. In that event, the value of our investment in any equity interest of a CDO could decrease substantially. In addition, the equity interests of CDOs are illiquid and often must be held by a REIT and because they represent a leveraged investment in the CDO’s assets, the value of the equity interests will generally have greater fluctuations than the value of the underlying collateral.
Some of our investments will be carried at estimated fair value as determined by us and, as a result, there may be uncertainty as to the value of these
investments.
Some of our investments will be recorded at fair value but will have limited liquidity or will not be publicly traded. The fair value of these investments that have limited liquidity or are not publicly traded may not be readily determinable. We will estimate the fair value of these investments on a quarterly basis. Because such valuations are inherently uncertain, may fluctuate over short periods of time and may be based on numerous estimates and assumptions, our determinations of fair value may differ materially from the values that would have been used if a readily available market for these securities existed. If our determinations regarding the fair value of these investments are materially different than the values that we ultimately realize upon their disposal, this could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to
you.
Risks Related to Our Financing Strategy
We may not be able to access financing sources on attractive terms, if at all, which could adversely affect our ability to execute our business plan.
We require outside capital to fund and grow our business. Our business may be adversely affected by disruptions in the debt and equity capital markets and institutional lending market, including the lack of access to capital or prohibitively high costs of obtaining or replacing capital. A primary source of liquidity for us has been the debt and equity capital markets. Access to the capital markets and other sources of liquidity was severely disrupted during the credit crisis and, despite recent improvements, the markets could suffer another severe downturn and another liquidity crisis could emerge. Based on the current conditions, we do not know
whether any sources of capital will be available to us in the future on terms that are acceptable to us, if at all. If we cannot obtain sufficient debt and equity capital on acceptable terms, our business and our ability to operate could be severely impacted.
We may not successfully align the maturities of our liabilities with the maturities on our assets, which could harm our operating results and financial condition.
Our general financing strategy is focused on the use of “match-funded” structures. This means that we seek to align the maturities of our liabilities with the maturities on our assets in order to manage the risks of being forced to refinance our liabilities prior to the maturities of our assets. In addition, we plan to match interest rates on our assets with like-kind borrowings, so fixed-rate investments are financed with fixed-rate
borrowings and floating-rate assets are financed with floating-rate borrowings, directly or indirectly through the use of interest rate swaps, caps and other financial instruments or through a combination of these strategies. We may fail to appropriately employ match-funded structures on favorable terms, or at all. We may also determine not to pursue a match-funded strategy with respect to a portion of our financings for a variety of reasons. If we fail to appropriately employ match-funded strategies or determine not to pursue such a strategy, our exposure to interest rate volatility and exposure to matching liabilities prior to the maturity of the corresponding asset may increase substantially which could harm our operating results, liquidity and financial condition.
Our performance can be negatively affected
by fluctuations in interest rates and shifts in the yield curve may cause losses.
Our financial performance is influenced by changes in interest rates, in particular, such changes may affect our CRE securities, floating-rate borrowings and CRE debt to the extent such debt does not float as a result of floors or otherwise. Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our business in a number of ways. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense incurred in connection with our interest-bearing borrowings and hedges. Changes in the level of interest rates also can affect, among other things, our ability to acquire CRE securities, originate or acquire CRE debt at attractive prices and enter into hedging transactions.
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond our control.
Interest rate changes may also impact our net book value as CRE securities and hedge derivatives, if any, are marked to market each quarter. Generally, as interest rates increase, the value of our fixed rate securities decreases, which decreases the book value of our equity.
Furthermore, shifts in the U.S. Treasury yield curve reflecting an increase in interest rates would also affect the yield required on our CRE securities and therefore their value. For example, increasing interest rates would reduce the value of the fixed rate assets we hold at the time because the higher yields required by increased interest rates result in lower market prices on existing fixed rate assets in
order to adjust the yield upward to meet the market and vice versa. This would have similar effects on our CRE securities portfolio and our financial position and operations to a change in interest rates generally.
Our interest rate risk sensitive assets, liabilities and related derivatives, if any, are generally held for non-trading purposes. As of December 31, 2013, our floating-rate investment had a LIBOR floor so a hypothetical 100 basis point increase in interest rates would have no material impact on our earnings.
In a period of rising interest rates, our interest expense could increase while the interest we earn on our fixed-rate assets or LIBOR capped floating rate assets would not change, which would adversely affect our profitability.
Our operating results depend in large part
on differences between the income from our assets, reduced by any credit losses and financing costs. Income from our assets may respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income. Increases in these rates may decrease our net income and fair value of our assets. Interest rate fluctuations resulting in our interest expense exceeding the income from our assets would result in operating losses for us and may limit our ability to make distributions to you. In addition, if we need to repay existing borrowings during periods of rising interest rates, we could be required to liquidate one or more of our investments at times that may not permit realization of the maximum return on those investments, which would adversely affect our profitability.
Hedging against interest rate exposure may adversely affect our earnings, limit our gains or result in losses, which could adversely affect cash available for distribution to you.
We may enter into interest rate swap, cap or floor agreements or pursue other interest rate hedging strategies. Our hedging activity will vary in scope based on interest rate levels, the type of investments held and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us because, among other things:
•
interest rate hedging can be expensive, particularly during periods of rising
and volatile interest rates;
•
available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;
•
the duration of the hedge may not match the duration of the related liability or asset;
•
our hedging opportunities may be limited by the
treatment of income from hedging transactions under the rules determining REIT qualification;
•
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction;
•
the counterparties with which we trade may cease making markets and quoting prices in such instruments, which may render us unable to enter into an offsetting transaction with respect to an open position;
•
the
party owing money in the hedging transaction may default on its obligation to pay; and
•
we may purchase a hedge that turns out not to be necessary, i.e., a hedge that is out of the money.
Any hedging activity we engage in may adversely affect our earnings, which could adversely affect cash available for distribution to you. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price
movements in the portfolio positions being hedged or liabilities being hedged may vary materially. Moreover, for a variety of reasons, we may not be able to establish a perfect correlation between hedging instruments and the investments being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss.
Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearinghouse or regulated by any U.S. or foreign governmental authorities and involve risks and costs.
The cost of using hedging instruments increases as the period covered by the instrument lengthens and during periods of rising and volatile interest rates. We may increase our hedging activity and thus increase our hedging costs during periods when interest rates are volatile or rising and hedging costs have increased. In addition,
hedging instruments involve risk since they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities. Consequently, there are no regulatory or statutory requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then current market price. It may not always
be possible to dispose of or close out a hedging position without the consent of the hedging counterparty and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot assure you that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.
We
may use short-term borrowings to finance our investments and we may need to use such borrowings for extended periods of time to the extent we are unable to access long-term financing. This may expose us to increased risks associated with decreases in the fair value of the underlying collateral which could cause an adverse impact on our results of operations.
While we expect to seek non-recourse, non-mark-to-market, long-term financing through securitization financing transactions or other structures, such financing may be unavailable to us on favorable terms or at all. Consequently, we may be dependent on short-term financing arrangements that are not matched in duration to our financial assets. Short-term borrowing through repurchase arrangements, credit facilities and other types of borrowings may put our assets and financial condition at risk. Any such short-term financing may also be recourse to us, which will increase
the risk of our investments. We currently have one credit facility that provides for an aggregate of up to $100.0 million to finance investments. We may obtain additional facilities and increase our lines of credit on existing facilities in the future. Our financing structures may economically resemble short-term, floating-rate financing and usually require the maintenance of specific loan-to-collateral value ratios and other covenants. In addition, the value of assets underlying any such short-term financing may be marked-to-market periodically by the lender, including on a daily basis. If the fair value of the assets subject to such financing arrangements decline, we may be required to provide additional collateral or make cash payments to maintain the loan-to-collateral value ratio. If we are unable to provide such collateral or cash repayments, we may lose our economic interest in the underlying assets. Further, such borrowings may require us to maintain a certain
amount of cash reserves or to set aside unleveraged assets sufficient to maintain a specified liquidity position that would allow us to satisfy our collateral obligations. These facilities may be restricted to financing certain types of assets, such as first mortgage loans, which could impact our asset allocation. Our repurchase credit facility provides for an unrestricted cash covenant of at least $3.75 million and maximum of $15.0 million and this amount may increase in the future. In addition, such short-term borrowing facilities may limit the length of time that any given asset may be used as eligible collateral. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our income generated on such assets. In the event that we are unable to meet the collateral obligations for our short-term financing arrangements, our financial condition could deteriorate rapidly.
We use leverage
in connection with our investments, which increases the risk of loss associated with our investments.
We may finance the origination and acquisition of a portion of our investments with credit facilities, securitization financing transactions and other term borrowings, which may include repurchase agreements. Although the use of leverage may enhance returns and increase the number of investments that we can make, it may also substantially increase the risk of loss. Our ability to execute this strategy depends on various conditions in the financing markets that are beyond our control, including liquidity and credit spreads. We may be unable to obtain additional financing on favorable terms or, with respect to our investments, on terms that parallel the maturities of the debt originated or acquired, if we are able to obtain additional financing at all. If our strategy is not viable, we will have to find alternative forms of
long-term financing for our assets, as secured revolving credit facilities and repurchase agreements may not accommodate long-term financing. This could subject us to more restrictive recourse borrowings and the risk that debt service on less efficient forms of financing would require a larger portion of our cash flow, thereby reducing cash available for distribution to you, for our operations and for future business opportunities.
We may also seek securitization financing transactions with respect to some of our investments but we may be unable to do so on favorable terms, if at all. If alternative financing is not available on favorable terms, or at all, we may have to liquidate assets at unfavorable prices to pay off such financing. Our return on our investments and cash available for distribution to you may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to
the earnings that we can derive from the assets we originate or acquire.
Short-term borrowing through repurchase agreements, credit facilities and other borrowings may put our assets and financial condition at risk. Repurchase agreements economically resemble short-term, floating-rate financing and usually require the maintenance of specific loan-to-collateral value ratios. If the
fair value
of the assets subject to a repurchase agreement decline, we may be required to provide additional collateral or make cash payments to maintain the loan-to-collateral value ratio. If we are unable to provide such collateral or cash repayments, we may lose our economic interest in the underlying assets. Further, such borrowings may require us to maintain a certain amount of cash reserves or to set aside unleveraged assets sufficient to maintain a specified liquidity position that would allow us to satisfy our collateral obligations. In addition, such short-term borrowing facilities may limit the length of time that any given asset may be used as eligible collateral. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.
Credit facilities
may contain recourse obligations and any default could materially adversely affect our business, liquidity and financial condition.
We finance certain of our CRE investments through the use of repurchase agreements with one or more financial institutions. Obligations under certain repurchase agreements could be recourse obligations to us and any default thereunder could result in margin calls and further force a liquidation of assets at times when the pricing may be unfavorable to us. Our default under such repurchase agreements could negatively impact our business, liquidity and financial condition.
We enter into a variety of arrangements to finance our investments, which may require us to provide additional collateral and significantly impact our liquidity position.
We use a variety of structures to finance our investments. To the
extent these financing arrangements contain mark-to-market provisions, if the market value of the investments pledged by us declines due to credit quality deterioration, we may be required by our lenders to provide additional collateral or pay down a portion of our borrowings. In a weakening economic environment, we would generally expect credit quality and the value of the investment that serves as collateral for our financing arrangements to decline, and in such a scenario, it is likely that the terms of our financing arrangements would require partial repayment from us, which could be substantial. Posting additional collateral to support our financing arrangements could significantly reduce our liquidity and limit our ability to leverage our assets. In the event we do not have sufficient liquidity to meet such requirements, our lenders can accelerate our borrowings, which could have a material adverse effect on our business and operations.
Lenders
may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions to you.
When providing financing, a lender may impose restrictions on us that affect our distribution and operating policies and our ability to incur additional borrowings. Financing arrangements that we may enter into may contain covenants that limit our ability to further incur borrowings and restrict distributions to you or that prohibit us from discontinuing insurance coverage or replacing our advisor. Credit facilities we enter into contain financial covenants, including a minimum unrestricted cash covenant. These or other limitations would decrease our operating flexibility and our ability to achieve our operating objectives, including making distributions to you.
We have broad authority to use leverage and high levels of leverage could hinder
our ability to make distributions and decrease the value of your investment.
Our charter does not limit us from utilizing financing until our borrowings exceed 300% of our net assets, which is generally expected to approximate 75% of the aggregate cost of our investments, including cash, before deducting loan loss reserves, other non-cash reserves and depreciation. Further, we can incur financings in excess of this limitation with the approval of a majority of our independent directors. High leverage levels would cause us to incur higher interest charges and higher debt service payments and the agreements governing our borrowings may also include restrictive covenants. These factors could limit the amount of cash we have available to distribute to you and could result in a decline in the value of your investment.
We may be unable to obtain financing required to originate or acquire investments as contemplated in our business plan, which could compel us to restructure or abandon a particular origination or acquisition and harm our ability to make distributions to you.
We expect to fund a portion of our investments with financing. We cannot assure you that financing will be available on acceptable terms, if at all, or that we will be able to satisfy the conditions precedent required to use our credit facilities, which could reduce the number, or alter the type, of investments that we would make otherwise. This may reduce our income. Challenges in the credit and financial markets have reduced the availability of financing. To the extent that financing proves to be unavailable when needed, we may be compelled to modify
our investment strategy to optimize the performance of our portfolio. Any failure to obtain financing could have a material adverse effect on the continued development or growth of the target business and harm our ability to make distributions to you.
The loss of or the inability to obtain key investment professionals at our sponsor could delay or hinder implementation of our investment strategies, which could limit our ability to make distributions and decrease the value of your investment.
Our success depends to a significant degree upon the contributions of key personnel at our sponsor, such as Messrs. Hamamoto, Gilbert and Tylis, among others, each of whom would be difficult to replace. Neither we nor our advisor have
employment agreements with these individuals, and we cannot assure you that Messrs. Hamamoto, Gilbert and Tylis will continue to be associated with our sponsor in the future. If any of these persons were to cease their association with us or our sponsor, our operating results could suffer. We do not intend to maintain key person life insurance on any person. We believe that our future success depends, in large part, upon our sponsor and its affiliates’ ability to retain highly-skilled managerial, operational and marketing professionals. Competition for such professionals is intense, and our sponsor and its affiliates may be unsuccessful in attracting and retaining such skilled individuals. If our sponsor loses or is unable to obtain the services of highly-skilled professionals, our ability to implement our investment strategies could be delayed or hindered and the value of your investment may decline.
Any adverse changes
in our sponsor’s financial health, the public perception of our sponsor, or our relationship with our sponsor or its affiliates could hinder our operating performance and the return on your investment.
We have engaged our advisor to manage our operations and our investments. Our advisor has no employees and uses our sponsor’s personnel to perform services on its behalf for us. Our ability to achieve our investment objectives and to pay distributions is dependent upon the performance of our sponsor and its affiliates as well as our sponsor’s investment professionals in the identification and origination or acquisition of investments, the determination of any financing arrangement, the management of our assets and operation of our day-to-day activities.
Because our sponsor is publicly traded, any negative reaction by the stock market reflected in its stock price or deterioration in
the public perception of our sponsor could result in an adverse effect on fundraising in our offering and our ability to acquire assets and obtain financing from third parties on favorable terms. In addition, our sponsor committed to purchase up to an aggregate of $10.0 million of shares of our common stock (which includes the $2.0 million of shares purchased by an affiliate of our sponsor to satisfy the minimum offering amount) at $9.00 per share during the two-year period following commencement of our offering under certain circumstances in which our cash distributions exceed our MFFO, in order to provide additional cash to support distributions to you. Our sponsor has no obligation to extend the distribution support agreement and may determine not to do so. If our sponsor cannot satisfy this commitment to us, or in the event that a NorthStar affiliate no longer serves as our advisor, which would result in the termination of our sponsor’s share purchase commitment,
we would not have this source of capital available to us and our ability to pay distributions to you would be adversely impacted. Any adverse changes in our sponsor’s financial condition or our relationship with our sponsor or advisor and related affiliates could hinder our ability to successfully manage our operations and our portfolio of investments.
Our sponsor may determine not to provide assistance, personnel support or other
resources to our advisor or us, which could impact our ability to achieve our investment objectives and pay distributions.
Our advisor uses our sponsor’s personnel to perform services on its behalf for us and we rely on such personnel and other support for the purposes of originating, acquiring and managing our investment portfolio. Our sponsor, however, may determine not to provide assistance to our advisor or us. Consequently, if our sponsor and its professionals determine not to provide our advisor or us with any assistance or other resources, we may not achieve the same success that we would expect to achieve with such assistance, personnel support and resources.
We do not own the NorthStar name, but were granted a license by our sponsor to use the NorthStar name. Use of the name by other parties or the termination of our license may materially adversely affect our business,
financial condition and results of operations and our ability to make distributions to you.
Pursuant to our advisory agreement, we were granted a non-exclusive, royalty-free license to use the name “NorthStar.” Under this license, we have a right to use the “NorthStar” name as long as our advisor continues to advise us. Our sponsor will retain the right to continue using the “NorthStar” name. We are unable to preclude our sponsor from licensing or transferring the ownership of the “NorthStar” name to third parties, some of whom may compete against us. Consequently, we will be unable to prevent any damage to the goodwill associated with our name that may occur as a result of the activities of our sponsor or others related to the use of our name. Furthermore, in the event the license is terminated, we will be required to change our name and cease using the “NorthStar” name. Any of these events
could disrupt our recognition in the market place, damage any goodwill we may have generated and may materially adversely affect our business, financial condition and results of operations and our ability to make distributions to you.
You may be more likely to sustain a loss on your investment because our sponsor does not have as strong an economic incentive to avoid losses as do sponsors who have made significant equity investments in their companies.
While our sponsor has incurred substantial costs and devoted significant resources to support our business, as of December 31, 2013, our sponsor has only invested $2.2 million in us through the purchase by its subsidiary of 245,109 shares of our common stock including amounts related to its obligation under the distribution support agreement. Therefore, if we are successful in raising
enough proceeds and generating sufficient operating income to be able to reimburse our sponsor for our organization and offering and other costs, our sponsor will have limited exposure to loss in the value of our shares. Without this exposure, you may be at a greater risk of loss because our sponsor does not have as much to lose from a decrease in the value of our shares as do those sponsors who make more significant equity investments in their companies.
Our advisor’s platform may not be as scalable as we anticipate and we could face difficulties growing our business without significant new investment in personnel and infrastructure.
While we believe our advisor’s platform for operating our business is highly scalable and can support significant growth without substantial new investment in personnel and infrastructure, it is possible that if our business grows substantially, our
advisor will need to make significant new investments in personnel and infrastructure to support that growth. Our advisor may be unable to make significant investments on a timely basis or at reasonable costs and its failure in this regard could disrupt our business and operations.
If our advisor’s portfolio management systems are ineffective, we may be exposed to material unanticipated losses.
Our advisor refines its portfolio management techniques, strategies and assessment methods. However, our advisor’s portfolio management techniques and strategies may not fully mitigate the risk exposure of our operations in all economic or market environments, or against all types of risk, including risks that we might fail to identify or anticipate. Any failures in our advisor’s portfolio management techniques and strategies to accurately quantify such risk exposure could limit our ability
to manage risks in our operations or to seek adequate risk adjusted returns and could result in losses.
We are highly dependent on information systems and systems failures could significantly disrupt our business.
As a diversified CRE finance and investment company, our business is highly dependent on communications and information systems, including systems provided by third parties for
which we have no control. Any failure or interruption of our systems, whether as a result of human error or otherwise, could cause delays or other problems in our activities, which could have a material adverse effect on our financial performance.
The use of estimates and valuations may be different from actual results, which could have a material effect on our consolidated financial statements.
We make various estimates that affect reported amounts and disclosures. Broadly, those estimates are used in measuring the fair value of certain financial instruments, establishing provision for loan losses and potential litigation liability. Market volatility may make it difficult to determine the fair value for certain of our assets. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these financial instruments in future periods.
In addition, at the time of any sales and settlements of these assets, the price we ultimately realize will depend on the demand and liquidity in the market at that time for that particular type of asset and may be materially lower than our estimate of their current fair value. Estimates are based on available information and judgment. Therefore, actual values and results could differ from our estimates and that difference could have a material adverse effect on our consolidated financial statements.
We provide you and investors with information using FFO and MFFO, which are non-GAAP financial measures that may not be meaningful for comparing the performances of different REITs and that have certain other limitations.
We provide you and investors with information using FFO and MFFO which are non-GAAP measures, as additional measures of our operating performance. We compute FFO
in accordance with the standards established by National Association of Real Estate Investment Trusts, or NAREIT. We compute MFFO in accordance with the definition established by the IPA. However, our computation of FFO and MFFO may not be comparable to other REITs that do not calculate FFO or MFFO using these definitions without further adjustments.
Neither FFO nor MFFO is equivalent to net income or cash generated from operating activities determined in accordance with U.S. GAAP and should not be considered as an alternative to net income, as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.
Our distribution policy is subject to change.
Our board of directors determines an appropriate common stock distribution based upon numerous factors, including our
targeted distribution rate, REIT qualification requirements, the amount of cash flow generated from operations, availability of existing cash balances, borrowing capacity under existing credit agreements, access to cash in the capital markets and other financing sources, our view of our ability to realize gains in the future through appreciation in the value of our assets, general economic conditions and economic conditions that more specifically impact our business or prospects. Future distribution levels are subject to adjustment based upon any one or more of the risk factors set forth in this prospectus, as well as other factors that our board of directors may, from time-to-time, deem relevant to consider when determining an appropriate common stock distribution.
We may not be able to make distributions in the future.
Our ability to generate income and to make distributions
may be adversely affected by the risks described in this prospectus and any document we file with the SEC under the Exchange Act. All distributions are made at the discretion of our board of directors, subject to applicable law, and depend on our earnings, our financial condition, maintenance of our REIT qualification and such other factors as our board of directors may deem relevant from time-to-time. We may not be able to make distributions in the future.
Our
ability to pay distributions is limited by the requirements of Maryland law.
Our ability to pay distributions on our common stock is limited by the laws of Maryland. Under applicable Maryland law, a Maryland corporation may not make a distribution if, after giving effect to the distribution, the corporation would not be able to pay its liabilities as the liabilities become due in the usual course of business, or generally if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed if the corporation were dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of the stockholders whose preferential rights are superior to those receiving the distribution. Accordingly, we may not make a distribution on our common stock if, after giving effect to the distribution, we would not be able to pay our liabilities as they become due
in the usual course of business or generally if our total assets would be less than the sum of our total liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of the holders of shares of any series of preferred stock then outstanding, if any, with preferences senior to those of our common stock.
You have limited control over changes in our policies and operations, which increases the uncertainty and risks you face as a stockholder.
Our board of directors determines our major policies, including our policies regarding growth, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of our stockholders. We may change our investment policies without stockholder notice or consent, which could result in investments that are different than, or in different proportion than, those
described in this prospectus. Under the Maryland General Corporation Law, or MGCL, and our charter, you have a right to vote only on:
•
the election or removal of directors;
•
amendment of our charter, except that our board of directors may amend our charter without stockholder approval to (i) increase or decrease the aggregate number of our shares of stock of any class or series that we have the authority to issue; (ii) effect certain reverse stock splits; and (iii) change our name or the name or other designation or the par value of
any class or series of our stock and the aggregate par value of our stock.
•
our liquidation or dissolution;
•
certain reorganizations of our company, as provided in our charter; and
•
certain mergers, consolidations
or sales or other dispositions of all or substantially all our assets, as provided in our charter.
Pursuant to Maryland law, all matters other than the election or removal of a director must be declared advisable by our board of directors prior to a stockholder vote. Our board of directors’ broad discretion in setting policies and your inability to exert control over those policies increases the uncertainty and risks you face.
Our board of directors’ broad discretion in setting policies and your inability to exert control over those policies increases the uncertainty and risks you face.
If you fail to meet the fiduciary and other standards under the Employment Retirement Income Security Act, or ERISA, or the Internal Revenue Code as a result of an investment in our stock, you could be subject to criminal and civil penalties.
Special considerations apply to the purchase of shares by employee benefit plans subject to the fiduciary rules of Title I of the ERISA, including pension or profit sharing plans and entities that hold assets of such plans, or ERISA Plans, and plans and accounts that are not subject to ERISA, but are subject to the prohibited transaction rules of Section 4975 of the Internal Revenue Code, including IRAs, Keogh Plans, and medical savings accounts (collectively, we refer to ERISA Plans and plans subject to Section 4975 of the Internal Revenue Code as “Benefit Plans”). If you are investing the assets of any Benefit Plan, you should satisfy themselves that:
•
your investment is consistent with the fiduciary obligations
under ERISA and the Internal Revenue Code or any other applicable governing authority in the case of a government plan;
your investment is made in accordance with the documents and instruments governing the Benefit Plan, including the Benefit Plan’s
investment policy;
•
your investment satisfies the prudence and diversification requirements of Sections 404(a)(1)(B) and 404(a)(1)(C) of ERISA, if applicable and other applicable provisions of ERISA and the Internal Revenue Code;
•
your investment will not impair the liquidity of the Benefit Plan;
•
your
investment will not produce unrelated business taxable income for the Benefit Plan;
•
you will be able to value the assets of the Benefit Plan annually in accordance with the applicable provisions of ERISA and the Internal Revenue Code; and
•
your investment will not constitute a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Internal Revenue Code.
Fiduciaries may be held personally liable under ERISA for losses as a
result of failure to satisfy the fiduciary standards of conduct and other applicable requirements of ERISA. In addition, if an investment in our shares constitutes a non-exempt prohibited transaction under ERISA or the Internal Revenue Code, the fiduciary of the Benefit Plan who authorized or directed the investment may be subject to imposition of excise taxes with respect to the amount invested and an IRA investment in our shares may lose its tax-exempt status.
Governmental plans, church plans and foreign plans that are not subject to ERISA or the prohibited transaction rules of the Internal Revenue Code, may be subject to similar restrictions under other laws. A plan fiduciary making an investment in our shares on behalf of such a plan should satisfy themselves that an investment in our shares satisfies both applicable law and is permitted by the governing plan documents.
Your
interest in us will be diluted if we issue additional shares, which could reduce the overall value of your investment.
Stockholders in our offering do not have preemptive rights to any shares we issue in the future. Our charter authorizes us to issue a total of 450,000,000 shares of capital stock, of which 400,000,000 shares are classified as common stock and 50,000,000 shares are classified as preferred stock. Our board of directors may amend our charter from time to time to increase or decrease the number of authorized shares of capital stock or the number of shares of stock of any class or series that we have authority to issue without stockholder approval. After your purchase in our offering, our board of directors may elect to: (i) sell additional shares in our offering or future public offerings; (ii) issue equity interests in private offerings; (iii) issue shares to our advisor, or its successors or assigns, in payment
of an outstanding fee obligation; (iv) require our sponsor to purchase shares pursuant to the distribution support agreement; (v) issue shares of our common stock to sellers of assets we acquire in connection with an exchange of limited partnership interests of our operating partnership; or (vi) issue shares of our common stock to pay distributions to existing stockholders. To the extent we issue additional equity interests after your purchase in our offering, your percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our investments, you may also experience dilution in the book value and fair value of your shares.
Our charter limits the number of shares a person may own, which may discourage a takeover that could otherwise result in a premium price to you.
Our charter, with certain exceptions,
authorizes our board of directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. To help us comply with the REIT ownership requirements of the Internal Revenue Code, among other purposes, our charter prohibits a person from directly or constructively owning more than 9.8% in value of the aggregate of our outstanding shares of common stock or more than 9.8% in value or number, whichever is more restrictive, of the aggregate of our outstanding shares of common stock, unless exempted by our board of directors. This restriction may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our shares of common stock.
Our charter permits our board of directors to issue stock with terms that may subordinate the rights of our common stockholders or discourage a third party from acquiring us in a manner that could result in a premium price to you.
Our board of directors may classify or reclassify any unissued common stock or preferred stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption of any such stock. Thus, our board of directors could authorize the issuance of preferred stock with priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock. Such preferred stock could also
have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price to holders of our common stock. Our board of directors may determine to issue different classes of stock that have different fees and commissions from those being paid with respect to the shares being sold in our offering. Additionally, our board of directors may amend our charter from time to time to increase or decrease the aggregate number of authorized shares of stock or the number of authorized shares of any class or series of stock without stockholder approval.
Our UPREIT structure may result in potential conflicts of interest with limited partners in our operating partnership whose interests may not be aligned with yours.
Limited partners
in our operating partnership have the right to vote on certain amendments to the partnership agreement, as well as on certain other matters. Persons holding such voting rights may exercise them in a manner that conflicts with the interests of stockholders. As general partner of our operating partnership, we are obligated to act in a manner that is in the best interest of our operating partnership. Circumstances may arise in the future when the interests of limited partners in our operating partnership may conflict with the interests of our stockholders. These conflicts may be resolved in a manner you do not believe are in your best interests.
In addition, NorthStar OP Holdings II, LLC, as the holder of special units, or the special unit holder, in our operating partnership may be entitled to: (i) certain cash distributions, as described in “Management Compensation—Special Units—NorthStar OP Holdings II,” upon the disposition
of certain of our operating partnership’s assets; or (ii) a one time payment in the form of cash or shares in connection with the redemption of the special units upon the occurrence of a listing of our shares on a national stock exchange or certain events that result in the termination or non-renewal of our advisory agreement. The special unit holder will only become entitled to the compensation after our stockholders have received, in the aggregate, cumulative distributions equal to their invested capital plus a 7.0% cumulative, non-compounded annual pre-tax return on such invested capital. This potential obligation to make substantial payments to the special unit holder would reduce the overall return to stockholders to the extent such return exceeds 7.0%.
We may not be able to realize the benefits of any guarantees we may receive which could harm our ability to preserve our capital upon a default.
We
may sometimes obtain personal or corporate guarantees, which will not be secured, from borrowers or their affiliates. These guarantees are often triggered only upon the occurrence of certain triggers and “bad boy” events. In cases where guarantees are not fully or partially secured, we will typically rely on financial covenants from borrowers and guarantors which are designed to require the borrower or guarantor to maintain certain levels of creditworthiness. Borrowers and guarantors may face financial difficulties and may be unable to comply with their financial covenants. During challenging economic conditions, our borrowers could experience additional financial stress. Where we do not have recourse to specific collateral pledged to satisfy such guarantees or recourse loans, we will only have recourse as an unsecured creditor to the general assets of the borrower or guarantor, some or all of which may be pledged to satisfy other lenders. There can be no assurance
that a borrower or guarantor will comply with its financial covenants or that sufficient assets will be available to pay amounts owed to us under our investments and related guarantees.
You are limited in your ability to sell your shares of common stock pursuant to our share repurchase program. You may not be able to sell any of your shares of common stock back to us, and if you do sell your shares, you may not receive the price
you paid upon subscription.
Our share repurchase program may provide you with an opportunity to have your shares of common stock repurchased by us after you have held them for one year. We anticipate that shares of our common stock may be repurchased on a quarterly basis. However, our share repurchase program contains certain restrictions and limitations, including those relating to the number of shares of our common stock that we can repurchase at any given time and limiting the repurchase price. Specifically, we presently intend to limit the number of shares to be repurchased during any calendar year to no more than: (i) 5% of the weighted average of the number of shares of our common stock outstanding during the prior calendar year; and (ii) those that could be funded from the net proceeds from the sale of shares under our DRP in the prior calendar year plus such additional cash as may be borrowed or reserved for that purpose
by our board of directors. In addition, our board of directors reserves the right to reject any repurchase request for any reason or no reason or to amend or terminate our share repurchase program at any time upon ten-days’ notice except that changes in the number of shares that can be repurchased during any calendar year will only take effect upon ten business days prior written notice. Therefore, you may not have the opportunity to make a repurchase request prior to a potential termination of our share repurchase program and you may not be able to sell any of your shares of common stock back to us pursuant to our share repurchase program. Moreover, if you do sell your shares of common stock back to us pursuant to our share repurchase program, you may not receive the same price you paid for any shares of our common stock being repurchased.
The terms of our share repurchase program require us to repurchase shares at a price
ranging from 92.5% to 100.0% of our offering price until we establish an estimated value per share. If the actual net asset value, or NAV, of our shares is less than the price paid for the shares to be repurchased, any repurchases made would be immediately dilutive to our remaining stockholders.
The terms of our share repurchase program require us to repurchase shares at a price ranging from 92.5% to 100.0% of our offering price, until we establish an estimated value per share. Because the offering price of our shares was established on an arbitrary basis and bears no relationship to the book or NAV per share, the offering price per share may reflect a significant premium to the actual NAV per share. In that event, the price at which we repurchase our shares might also reflect a premium to NAV. If the actual NAV of our shares is less than the price paid for the shares to be repurchased, any repurchases made would be immediately
dilutive to our remaining stockholders.
Because our dealer manager is one of our affiliates, you will not have the benefit of an independent due diligence review of us, which is customarily performed in underwritten offerings. The absence of an independent due diligence review increases the risks and uncertainty you face as a stockholder.
Our dealer manager is one of our affiliates. Because our dealer manager is an affiliate, its due diligence review and investigation of us for our offering cannot be considered to be an independent review. Therefore, you do not have the benefit of an independent review and investigation of our offering of the type normally performed by an unaffiliated, independent underwriter in a public securities offering.
Non-traded REITs have been the subject of increased scrutiny by regulators and media outlets
resulting from inquiries and investigations initiated by FINRA and the SEC. We could also become the subject of scrutiny and may face difficulties in raising capital should negative perceptions develop regarding non-traded REITs. As a result, we may be unable to raise substantial funds which will limit the number and type of investments we may make and our ability to diversify our assets.
Our securities, like other non-traded REITs, are sold through the independent broker-dealer channel (i.e., U.S. broker-dealers that are not affiliated with money center banks or similar financial institutions). Governmental and self-regulatory organizations like the SEC and FINRA impose and enforce regulations on broker-dealers, investment banking firms, investment advisers and similar financial services companies. Self-regulatory organizations, such as FINRA, adopt rules, subject to approval by the SEC, that govern aspects of the financial
services industry and conduct periodic examinations of the operations of registered investment dealers and broker-dealers.
In March 2009, the Enforcement Division of FINRA commenced a review of broker-dealer sale and promotion activities of non-traded REITs and in connection with the review, requested information from broker-dealers with respect to sales practices. Subsequent to that review, FINRA has announced that it had filed a
complaint against a broker-dealer firm, charging it with soliciting investors to purchase shares in a non-traded REIT without conducting a reasonable investigation to determine whether it was suitable for those investors, and with providing misleading information on its website regarding distributions to investors. The disciplinary proceedings were settled in October 2012. Although the broker-dealer firm neither admitted nor denied the charges, the terms of the settlement required the broker-dealer firm to, among other things, pay approximately $12.0 million in restitution to certain investors and, in consultation with an independent consultant, make changes to its supervisory systems and training programs relating to the marketing of non-traded REITs. A principal of the broker-dealer firm was also fined and suspended from the securities industry for practices related
to marketing non-traded REITs.
In February 2014, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., and Apple REIT Nine, Inc., each of their external advisors and the chief executive officer and the chief financial officer of each of the REITs entered into a cease and desist order with the SEC and agreed to pay approximately $1.5 million in civil fines in the aggregate. Although the respondents did not admit or deny any wrongdoing, the cease and desist order stated that the REITs made material misrepresentations regarding the valuation of the securities sold through their dividend reinvestment plans, had failed to maintain sufficient disclosure controls and procedures to meaningfully evaluate whether the value of the securities had changed, failed to disclose numerous related party transactions and failed to disclose significant compensation paid by the advisors to the REITs and by the founder to the executive
officers of the REITs.
The above-referenced proceedings and related matters have resulted in increased regulatory scrutiny from the SEC, FINRA and state regulators regarding non-traded REITs. Furthermore, in January 2014 FINRA filed with the SEC proposed amendments to FINRA rules regarding customer account statements, which, if adopted by the SEC without modification, may significantly affect the manner in which non-traded REITs, such as our company, raise capital. The proposed amendments may cause a significant reduction in capital raised by non-traded REITs, which may cause a material negative impact on our ability to achieve our business plan and to successfully complete our offering.
As a result of this increased scrutiny and accompanying negative publicity and coverage by media outlets, FINRA
may impose additional restrictions on sales practices in the independent broker-dealer channel for non-traded REITs, and accordingly we may face increased difficulties in raising capital in our offering. Should we be unable to raise substantial funds in our offering, the number and type of investments we may make will be curtailed, and we may be unable to achieve the desired diversification of our investments. This could result in a reduction in the returns achieved on those investments as a result of a smaller capital base limiting our future investments. It also subjects us to the risks of any one investment, and as a result our returns may be more volatile and your capital could be at increased risk. If we become the subject of scrutiny, even if we have complied with all applicable laws and regulations, responding to such scrutiny could be expensive, harmful to our reputation and be distracting to our management.
Payment
of fees to our advisor and its affiliates reduces cash available for investment and distribution and increases the risk that you will not be able to recover the amount of your investment in our shares.
Our advisor and its affiliates perform services for us in connection with the selection, acquisition, origination, management and administration of our investments. We pay them substantial fees for these services, which results in immediate dilution to the value of your investment and reduces the value of cash available for investment or distribution to stockholders. We may increase the compensation we pay to our advisor subject to approval by our board of directors and other limitations in our charter, which would further dilute your investment and the amount of cash available for investment or distribution to stockholders. Depending primarily upon the number of shares we sell in our offering and assuming a $10.00 purchase
price for shares sold in our primary offering and a $9.50 purchase price for shares sold under our DRP, we estimate that we will use only 85.7% to 88.1% of our gross offering proceeds, and possibly less, for investments and the repurchase of shares of our common stock under our share repurchase program.
Affiliates of our advisor could also receive significant payments even without our reaching the investment-return thresholds should we seek to become self-managed. Due to the apparent preference of
the
public markets for self-managed companies, a decision to list our shares on a national securities exchange might well be preceded by a decision to become self-managed. Given our advisor’s familiarity with our assets and operations, we might prefer to become self-managed by acquiring entities affiliated with our advisor. Such an internalization transaction could result in significant payments to affiliates of our advisor irrespective of whether stockholders received the returns on which we have conditioned incentive compensation.
Therefore, these fees increase the risk that the amount available for distribution to common stockholders upon a liquidation of our portfolio would be less than the purchase price of the shares in our offering. These substantial fees and other payments also increase the risk that you will not be able to resell your shares at a profit, even if our shares are listed on a national securities exchange.
If we terminate our advisory agreement with our advisor, we may be required to pay significant fees to an affiliate of our sponsor, which will reduce cash available for distribution to you.
Upon termination of our advisory agreement for any reason, including for cause, our advisor will be paid all accrued and unpaid fees and expense reimbursements earned prior to the date of termination and the special unit holder may be entitled to a one time payment upon redemption of the special units (based on an appraisal or valuation of our portfolio) in the event that the special unit holder would have been entitled to a subordinated distribution had the portfolio been liquidated on the termination date. If special units are redeemed pursuant to the termination of our advisory agreement, there may not be cash from the disposition of assets to make a redemption payment; therefore, we may
need to use cash from operations, borrowings or other sources to make the payment, which will reduce cash available for distribution to you.
Our advisor may not be successful, or there may be delays, in locating suitable investments, which could limit our ability to make distributions and lower the overall return on your investment.
We rely upon our advisor, which uses our sponsor’s investment professionals, including Messrs. Hamamoto, Gilbert and Tylis to identify suitable investments. Our sponsor and other NorthStar entities also rely on Messrs. Hamamoto, Gilbert and Tylis for investment opportunities. Our advisor may not be successful in locating suitable investments on financially attractive terms, and we may not achieve our objectives. If we, through our advisor, are unable to find suitable investments promptly, we may hold the proceeds from our offering in an interest-bearing
account or invest the proceeds in short-term assets. We expect that the income we earn on these temporary investments will not be substantial. Further, we may use the principal amount of these investments, and any returns generated on these investments, to pay for fees and expenses in connection with our offering and distributions. Therefore, delays in investing proceeds we raise from our offering could negatively impact our ability to generate cash flow for distributions or to achieve our investment objectives.
Our advisor’s management team may acquire assets where the returns are substantially below expectations or which result in net losses. In the event we are unable to timely locate suitable investments, we may be unable or limited in our ability to pay distributions and we may not be able to meet our investment objectives. Our sponsor’s investment professionals, who perform services for us on behalf of our advisor, face
competing demands upon their time, including in instances when we have capital ready for investment, consequently, and we may face delays in execution. Further, the more money we raise in our offering, the more difficult it is to invest our net offering proceeds promptly and on attractive terms. Therefore, the large size of our offering increases the risk of delays in investing our net offering proceeds. Delays we encounter in the selection and origination or acquisition of investments would likely limit our ability to pay distributions to you and lower your overall returns.
Our ability to achieve our investment objectives and to pay distributions depends in substantial part upon the performance of our advisor and third-party servicers.
Our ability to achieve our investment objectives and to pay distributions depends in substantial part upon the performance of our advisor in the
origination and acquisition of our investments, including the determination of any financing arrangements, as well as the performance of the third-party servicers of our real estate debt investments. You must rely entirely on the management abilities of our advisor and the oversight of our board of directors, along with those of our third-party servicers. Additionally, we and our
sponsor have adopted an investment allocation policy
with the intent of eliminating the impact of any conflict that our sponsor’s investment professionals, who are used by our advisor, might encounter in allocating investment opportunities among us, our sponsor and any affiliates of our sponsor, however, there is no assurance that the investment allocation policy will successfully eliminate the impact of any such conflicts. If our advisor performs poorly and as a result is unable to originate and acquire our investments successfully, we may be unable to achieve our investment objectives or to pay distributions to you at presently contemplated levels, if at all. Similarly, if our third-party servicers perform poorly, we may be unable to realize all cash flow associated with our real estate debt investments.
If we raise substantial offering proceeds in a short period of time, we may not be able to invest all of our offering proceeds promptly, which may cause our distributions
and your investment returns to be lower than they otherwise would be.
The more shares we sell in our offering, the greater our challenge is to invest all of our net offering proceeds. The large size of our offering increases the risk of delays in investing our net proceeds promptly and on attractive terms. Pending investment, the net proceeds of our offering may be invested in permitted temporary investments, which include short-term U.S. government securities, bank certificates of deposit and other short-term liquid investments. The rate of return on these investments, which affects the amount of cash available to make distributions to you, has fluctuated in recent years and most likely will be less than the return obtainable from the type of investments in the real estate industry we seek to originate or acquire. Therefore, delays we encounter in the selection, due diligence and origination or acquisition of investments
would likely limit our ability to pay distributions to you and lower your overall returns.
If we are unable to raise substantial funds, we will be limited in the number and type of investments we make and the value of your investment in us will fluctuate with the performance of the specific assets we acquire.
Our offering is being made on a “best efforts” basis, meaning that our dealer manager is only required to use its best efforts to sell our shares and has no firm commitment or obligation to purchase any shares of our common stock in our offering. As a result, the amount of proceeds we raise in our offering may be substantially less than the amount we would need to create a diversified portfolio of investments. If we are unable to raise substantially more than the minimum offering amount, we will make fewer investments resulting in less diversification in terms of the
type, number and size of investments that we make. Moreover, the potential impact of any single asset’s performance on the overall performance of our portfolio increases. Further, we have certain fixed operating expenses, including certain expenses as a public reporting company, regardless of whether we are able to raise substantial funds in our offering. Our inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, reducing our net income and limiting our ability to make distributions to you.
Because we are dependent upon our advisor and its affiliates to conduct our operations and we are also dependent upon our dealer manager and its affiliates to raise capital, any adverse changes in the financial health of these entities or our relationship with them could hinder our operating performance and the return on your investment.
We
are dependent on our advisor and its affiliates to manage our operations and our portfolio and we are also dependent upon our dealer manager and its affiliates to raise capital. Our advisor depends upon the fees and other compensation or reimbursement of costs that it receives from us in connection with the origination, acquisition, management and sale of assets to conduct its operations. Our dealer manager also depends upon the fees that it receives from us in connection with our offering. Any adverse changes in the financial condition of our advisor or its affiliates or our relationship with our dealer manager or its affiliates could hinder their ability to successfully support our business and growth, which could have a material adverse effect on our financial condition and results of operations.
Our dealer manager has a limited operating history and our ability to implement our investment strategy is dependent, in part,
upon the ability of our dealer manager to successfully conduct our offering, which makes an investment in us more speculative.
We have retained our dealer manager to conduct our offering and this is the third offering for which it has served as a dealer manager. The success of our offering, and our ability to implement our business strategy, is dependent upon the ability of our dealer manager to build and maintain a network of
broker-dealers
to sell our shares to their clients. The network of broker-dealers that our dealer manager develops to sell our shares may sell shares of competing REIT products, including some products with areas of focus nearly identical to ours, which they may choose to emphasize to their clients. If our dealer manager is not successful in establishing, operating and managing an active, broad network of broker-dealers, our ability to raise proceeds through our offering will be limited and we may not have adequate capital to implement our investment strategy. If we are unsuccessful in implementing our investment strategy, you could lose all or a part of your investment.
Our rights and the rights of you to recover claims against our independent directors are limited, which could reduce your and our recovery against them if they negligently cause us to incur losses.
Maryland law provides that
a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter generally provides that: (i) no director shall be liable to us or you for monetary damages (provided that such director satisfies certain applicable criteria); (ii) we will generally indemnify non-independent directors for losses unless they are negligent or engage in misconduct; and (iii) we will generally indemnify independent directors for losses unless they are grossly negligent or engage in willful misconduct. As a result, you and we may have more limited rights against our independent directors than might otherwise exist under common law, which could reduce your and our recovery from these persons if they act in a negligent manner. In addition, we may be obligated to fund the
defense costs incurred by our independent directors (as well as by our other directors, officers, employees (if we ever have employees) and agents) in some cases, which would decrease the cash otherwise available for distribution to you. Please see “Management—Limited Liability and Indemnification of Directors, Officers and Others.”
If we do not successfully implement a liquidity transaction, you may have to hold your investment for an indefinite period.
Our charter does not require our board of directors to pursue a transaction providing liquidity to you. If our board of directors determines to pursue a liquidity transaction, we would be under no obligation to conclude the process within a set time. If we adopt a plan of liquidation, the timing of the sale of assets will depend on
real estate and financial markets, economic conditions in areas in which our investments are located and federal income tax effects on you that may prevail in the future. We cannot guarantee that we will be able to liquidate all of our assets on favorable terms, if at all. After we adopt a plan of liquidation, we would likely remain in existence until all our investments are liquidated. If we do not pursue a liquidity transaction or delay such a transaction due to market conditions, our common stock may continue to be illiquid and you may, for an indefinite period of time, be unable to convert your shares to cash easily, if at all, and could suffer losses on your investment in our shares.
If we internalize our management functions, your interests in us could be diluted and we could incur other significant costs associated with being
self-managed.
Our board of directors may decide in the future to internalize our management functions. If we do so, we may elect to negotiate to acquire our advisor’s assets and/or to directly employ the personnel of our sponsor that our advisor uses to perform services on its behalf for us.
Additionally, while we would no longer bear the costs of the various fees and expenses we expect to pay to our advisor under our advisory agreement, our additional direct expenses would include general and administrative costs, including certain legal, accounting and other expenses related to corporate governance, SEC reporting and compliance matters that are borne by our advisor. We would also be required to employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims, potential labor disputes and other employee-related
liabilities and grievances, as well as incur the compensation and benefits costs of our officers and other employees and consultants that are paid by our advisor or its affiliates. We may issue equity awards to officers, employees and consultants, which awards would decrease net income and MFFO and may further dilute your investment. We cannot reasonably estimate the amount of fees to our advisor we would save or the costs we would incur if we became self-managed. If the expenses we assume as a result of an internalization are
higher
than the expenses we avoid paying to our advisor, our net income and MFFO would be lower as a result of the internalization than it otherwise would have been, potentially decreasing the amount of cash available to distribute to stockholders and the value of our shares.
Internalization transactions involving the acquisition of advisors affiliated with entity sponsors have also, in some cases, been the subject of litigation. Even if these claims are without merit, we could be forced to spend significant amounts of money defending claims which would reduce the amount of funds available for us to invest and cash available to pay distributions.
If we internalize our management functions, we could have difficulty integrating these functions as a stand-alone entity. Currently, our advisor and its affiliates perform asset management and general and administrative functions, including accounting
and financial reporting, for multiple entities. These personnel have substantial know-how and experience which provides us with economies of scale. We may fail to properly identify the appropriate mix of personnel and capital needs to operate as a stand-alone entity. Certain key employees may not become employees of our advisor but may instead remain employees of our sponsor or its affiliates. An inability to manage an internalization transaction effectively could thus result in our incurring excess costs and suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. Such deficiencies could cause us to incur additional costs and our management’s attention could be diverted from most effectively managing our investments.
We depend on third-party contractors and vendors and our results of operations and the success of our offering could suffer if our third-party contractors
and vendors fail to perform or if we fail to manage them properly.
We use third-party contractors and vendors including, but not limited to, our external legal counsel, auditors, research firms, property managers, appraisers, insurance brokers, environmental engineering consultants, construction consultants, financial printers, proxy solicitation firms and transfer agent. If our third-party contractors and vendors fail to successfully perform the tasks for which they have been engaged to complete, either as a result of their own negligence or fault, or due to our failure to properly supervise any such contractors or vendors, we could incur liabilities as a result and our results of operations and financial condition could be negatively impacted.
Risks Related to Conflicts of Interest
The fees we pay to affiliates in connection with our
offering and in connection with the origination, acquisition and management of our investments, including to our advisor, were not determined on an arm’s length basis; therefore, we do not have the benefit of arm’s length negotiations of the type normally conducted between unrelated parties.
The fees to be paid to our advisor, our dealer manager and other affiliates for services they provide for us were not determined on an arm’s length basis. As a result, the fees have been determined without the benefit of arm’s length negotiations of the type normally conducted between unrelated parties and may be in excess of amounts that we would otherwise pay to third parties for such services.
Our organizational documents do not prevent us from selling assets to affiliates or from paying our advisor a disposition fee related to such a sale.
If
we sell an asset to an affiliate, our organizational documents would not prohibit us from paying our advisor a disposition fee. As a result, our advisor may not have an incentive to pursue an independent third-party buyer, rather than an affiliate. Our charter only requires that a majority of our board of directors, including a majority of our independent directors, not otherwise interested in the transaction, determine that an affiliated party transaction is fair and reasonable and on terms and conditions no less favorable than those available from unaffiliated third parties. It does not require that such transaction be the most favorable transaction available or provide any other restrictions on our advisor recommending a sale of our assets to an affiliate. As a result, our advisor may earn a disposition fee despite the transaction not being the most favorable to us or stockholders.
Our executive officers and our sponsor’s
key professionals face conflicts of interest caused by their compensation arrangements with us, which could result in actions that are not in the long-term best interests of our company.
Certain of our executive officers and our sponsor’s key professionals, who are used by our advisor to perform services on our behalf, are also officers, directors, managers and key professionals of our sponsor,
our
dealer manager and other affiliated NorthStar entities. Our advisor and its affiliates receive substantial fees from us. These fees could influence the advice given to us by the key personnel of our sponsor, including its investment committee, who performs services for our advisor. Among other matters, these compensation arrangements could affect their judgment with respect to:
•
the continuation, renewal or enforcement of our agreements with our advisor and its affiliates, including our advisory agreement and our dealer manager agreement;
•
public
offerings of equity by us, which entitle our dealer manager to dealer manager fees and will likely entitle our advisor to increased acquisition fees and asset management fees;
•
originations and acquisitions of investments, which entitle our advisor to acquisition fees and asset management fees and, in the case of acquisitions of investments from other NorthStar entities, might entitle affiliates of our advisor to disposition fees in connection with services for the seller;
•
sales of investments, which entitle our
advisor to disposition fees;
•
borrowings to originate or acquire CRE debt or securities investments, which borrowings will increase the acquisition fees and asset management fees payable to our advisor;
•
whether and when we seek to list our common stock on a national securities exchange, which listing could entitle the special unit holder to have its interest in our operating partnership redeemed;
•
whether
we seek approval to internalize our management, which may entail acquiring assets from our sponsor (such as office space, furnishings and technology costs) and employing our sponsor’s professionals performing services for us on behalf of our advisor for consideration that would be negotiated at that time and may result in these investment professionals receiving more compensation from us than they currently receive from our sponsor; and
•
whether and when we seek to sell our company or its assets, which would entitle the special unit holder to a subordinated distribution.
The fees our advisor receives
in connection with transactions involving the origination or acquisition of an asset are based on the cost of the investment, and not based on the quality of the investment or the quality of the services rendered to us. In addition, the special unit holder, an affiliate of our advisor, may be entitled to certain distributions subject to our stockholders receiving a 7.00% cumulative, non-compounded annual pre-tax return. This may influence our sponsor’s key professionals performing services on behalf of our advisor to recommend riskier transactions to us. Additionally, after the termination of our primary offering, our advisor has agreed to reimburse us to the extent total organization and offering costs borne by us exceed 15% of the gross proceeds raised in our offering. As a result, our advisor may decide to extend our offering to avoid or delay the reimbursement of these expenses.
Our sponsor’s professionals acting on behalf
of our advisor face competing demands relating to their time and this may cause our operations and your investment to suffer.
Our advisor has no employees and relies on, among others, our sponsor’s executive officers to perform services for us on behalf of our advisor, including Messrs. Hamamoto, Gilbert, Tylis and Lieberman and Ms. Hess for the day-to-day operation of our business. Messrs. Hamamoto, Gilbert, Tylis and Lieberman and Ms. Hess are also executive officers of our sponsor and other NorthStar entities. As a result of their interests in other NorthStar entities and the fact that they engage in and they continue to engage in other business activities on behalf of themselves and others, these individuals face conflicts of interest in allocating their time among us, our sponsor and other NorthStar entities and other business activities in which they are involved. These conflicts of interest could result in less effective
execution of our business plan as well as declines in the returns on our investments and the value of your investment.
Our executive officers and our sponsor’s key investment professionals who perform services for us on behalf of our advisor face conflicts of interest related to their positions and interests in our advisor and its affiliates, including our dealer manager, which could hinder our ability to implement our business strategy and to generate returns to stockholders.
Our executive officers and our sponsor’s key investment professionals, including members of its investment committee, who perform services for us on behalf of our advisor are also executive officers,
directors, managers and key investment professionals of our sponsor, our dealer manager and other affiliated NorthStar entities. As a result, they owe duties to each of these entities, their members and limited partners and these investors, which duties may from time-to-time conflict with the fiduciary duties that they owe to us and stockholders. In addition, our sponsor may grant equity interests in our advisor and the special unit holder, to certain management personnel performing services for our advisor. The loyalties of these individuals to other entities and investors could result in action or inaction that is detrimental to our business, which could harm the implementation of our business strategy and our investment opportunities. If we do not successfully implement our business strategy, we may be unable to generate the cash needed to make distributions
to stockholders and to maintain or increase the value of our assets.
Our sponsor faces conflicts of interest relating to performing services on our behalf and such conflicts may not be resolved in our favor, meaning that we could invest in less attractive assets, which could limit our ability to make distributions and reduce stockholders’ overall investment.
Our investment strategy is very similar to that of our sponsor and other investment vehicles sponsored by our sponsor, including NorthStar Income and NorthStar Healthcare, and therefore many investment opportunities that are suitable for us may also be suitable for our sponsor and other NorthStar entities. When our sponsor’s investment professionals direct an investment opportunity to our sponsor, its affiliates or the investment vehicles it sponsors and us, they, in their sole discretion, will offer the opportunity to the
entity for which the investment opportunity is most suitable in accordance with the investment allocation policy adopted by our board of directors. When determining the entity for which an investment opportunity would be the most suitable, the factors that our sponsor’s investment professionals may consider include, among other factors, the following:
•
investment objectives, strategy and criteria;
•
cash requirements;
•
effect
of the investment on the diversification of the portfolio, including by geography, size of investment, type of investment and risk of investment;
•
leverage policy and the availability of financing for the investment by each entity;
•
anticipated cash flow of the asset to be acquired;
•
income
tax effects of the purchase;
•
the size of the investment;
•
the amount of funds available;
•
cost of capital;
•
risk
return profiles;
•
targeted distribution rates;
•
anticipated future pipeline of suitable investments;
•
the expected holding period of the investment and the remaining term of the NorthStar entity, if applicable; and
•
affiliate
and/or related party considerations.
If, after consideration of the relevant factors, our sponsor determines that an investment is equally suitable for itself or another NorthStar entity, including us, the investment will be allocated among each of the applicable NorthStar entities, including us, on a rotating basis. If, after an investment has been allocated to us or another NorthStar entity, a subsequent event or development, such as delays in structuring or closing on the investment, makes it, in the opinion of our sponsor’s investment professionals, more appropriate for another NorthStar entity to fund the investment, our sponsor may determine to place the investment with the more appropriate entity while still giving credit to the original allocation. In certain situations, our sponsor may determine to allow more than one investment vehicle, including us, to co-invest in a particular investment.
There is no assurance this policy will remain in place during the entire period we are seeking investment opportunities. In addition, our sponsor may sponsor additional investment vehicles in the future and, in connection with the creation of such investment vehicles, may revise these allocation procedures. The result of a revision to the allocation procedures may, among other things, be to increase the number of parties who have the right to participate in investment opportunities sourced by our sponsor, thereby reducing the number of investment opportunities available to us.
In addition, under this policy, our sponsor’s investment professionals may consider the investment objectives and anticipated future pipeline of future investments of the investment vehicles that it sponsors. Because investing directly
in senior housing facilities is not a focus of our strategy as it is for NorthStar Healthcare (although we have the ability to and may make such investments), our sponsor may choose, for a variety of reasons, to source investment opportunities in the healthcare industry to NorthStar Healthcare rather than to us.
The decision of how any potential investment should be allocated among us, our sponsor and other NorthStar entities for which such investment may be suitable may, in many cases, be a matter of subjective judgment which will be made by our sponsor. Stockholders may not agree with the determination. Our right to participate in the investment allocation process described above will terminate once we have fully invested the proceeds of our offering or if we are no longer advised by an affiliate of our sponsor.
Our dealer manager may distribute future NorthStar-sponsored programs
during our offering, our dealer manager may face potential conflicts of interest arising from competition among us and these other programs for investors and investment capital and such conflicts may not be resolved in our favor.
Our dealer manager does and may in the future act as the dealer manager for other NorthStar entities, such as NorthStar Healthcare, which is currently in the process of offering shares. In addition, future NorthStar-sponsored programs may seek to raise capital through public offerings conducted concurrently with our offering. Our dealer manager could also act as the dealer manager of offerings not sponsored by our sponsor. As a result, our dealer manager may face conflicts of interest arising from potential competition with these other programs for investors and investment capital. Such conflicts may not be resolved in our favor and you will not have the opportunity to evaluate the manner in which
these conflicts of interest are resolved before or after making your investment.
Risks Related to Regulatory Matters and Our REIT Tax Status
We are subject to substantial regulation, numerous contractual obligations and extensive internal policies and failure to comply with these matters could have a material adverse effect on our business, financial condition and results of operations.
We and our subsidiaries are subject to substantial regulation, numerous contractual obligations and extensive internal policies. Given our organizational structure, we are subject to regulation by the SEC, FINRA, the Internal Revenue Service, or the IRS, and other federal, state and local governmental bodies and agencies and state blue sky laws. These regulations
are extensive, complex and require substantial management time and attention. If we fail to comply with any of the regulations that apply to our business, we could be subjected to extensive investigations as well as substantial penalties and our business and operations could be materially adversely affected. Our lack of compliance with applicable law could result in among other penalties, our ineligibility to contract with and receive revenue from the federal government or other governmental authorities and agencies. We also expect to have numerous contractual obligations that we must adhere to on a continuous basis to operate our business, the default of which could have a material adverse effect on our business and financial condition. In addition, any internal policies we establish to manage our business in accordance with applicable law and regulation and in accordance with
our contractual obligations may not be effective in all regards and, further, if we fail to comply with our internal policies, we could be subjected to additional risk and liability.
The direct or indirect effects of the Dodd-Frank Wall Street Reform Act, or the Dodd-Frank Act, enacted in July 2010 for the purpose of stabilizing or reforming the financial markets, may have an adverse effect on our interest rate hedging activities.
In July 2010, the Dodd-Frank Act became law in the United States. Title VII of the Dodd-Frank Act provides for significantly increased regulation of and restrictions on derivatives markets and transactions
that could affect our interest rate hedging or other risk management activities, including: (i) regulatory reporting for swaps; (ii) mandated clearing through central counterparties and execution through regulated exchanges or electronic facilities for certain swaps; and (iii) margin and collateral requirements. Although the U.S. Commodity Futures Trading Commission has not yet finalized certain requirements, many other requirements have taken effect, such as swap reporting, the mandatory clearing of certain interest rate swaps and credit default swaps and the mandatory trading of certain swaps on swap execution facilities or exchanges starting in February 2014. While the full impact of the Dodd-Frank Act on our interest rate hedging activities cannot be assessed until implementing rules and regulations are adopted, the requirements of Title VII may
affect our ability to enter into hedging or other risk management transactions, may increase our costs of entering into such transactions, and may result in us entering into such transactions on less favorable terms than prior to effectiveness of the Dodd-Frank Act and the rules promulgated thereunder. The occurrence of any of the foregoing events may have an adverse effect on our business.
Maintenance of our Investment Company Act exemption imposes limits on our operations.
Neither we, nor our operating partnership, nor any of the subsidiaries of our operating partnership intend to register as an investment company under the Investment Company Act. We intend to make investments and conduct our operations so that we are not required to register as an investment company. If we were obligated
to register as an investment company, we would have to comply with a variety of substantive requirements under the Investment Company Act that impose, among other things:
•
limitations on capital structure;
•
restrictions on specified investments;
•
prohibitions on transactions with affiliates; and
•
compliance
with reporting, recordkeeping, voting, proxy disclosure and other rules and regulations that would significantly increase our operating expenses.
Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash) on an unconsolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are securities issued by majority-owned
subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.
Because we are a holding company that conducts its businesses through subsidiaries, the securities issued by our subsidiaries that rely on the exception from the definition of “investment company” in Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own directly, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis. This requirement
limits the types of businesses in which we may engage through these subsidiaries.
We must monitor our holdings and those of our operating partnership to ensure that the value of their investment securities does not exceed 40% of their respective total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Through our operating partnership’s wholly owned or majority-owned subsidiaries, we and our operating partnership will be primarily engaged in the non-investment company businesses of these subsidiaries, namely the business of purchasing or otherwise acquiring mortgages and other interests in real estate.
Most
of these subsidiaries will rely on the exception from the definition of an investment company under Section 3(c)(5)(C) of the Investment Company Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exemption generally requires that at least 55% of a subsidiary’s portfolio must be comprised of
qualifying
real estate assets and at least 80% of its portfolio must be comprised of qualifying real estate assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). Qualification for exclusion from registration under the Investment Company Act will limit our ability to acquire or sell certain assets and also could restrict the time at which we may acquire or sell assets. For purposes of the exclusions provided by Sections 3(c)(5)(C), we will classify our investments based in large measure on no-action letters issued by the SEC staff and other SEC interpretive guidance and, in the absence of SEC Guidance, on our view of what constitutes a qualifying real estate asset and a real estate related asset. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations we may face, and a number of these no-action positions were issued more than twenty years ago. In August
2011, the SEC issued a concept release in which it asked for comments on various aspects of Section 3(c)(5)(C), and, accordingly, the SEC or its staff may issue further guidance in the future. Future revisions to the Investment Company Act or further guidance from the SEC or its staff may force us to re-evaluate our portfolio and our investment strategy.
We may in the future organize special purpose subsidiaries of the operating partnership that will borrow under or participate in government sponsored incentive programs. We expect that some of these subsidiaries will rely on Section 3(c)(7) for their Investment Company Act exemption and, therefore, our operating partnership’s interest in each of these subsidiaries
would constitute an “investment security” for purposes of determining whether the operating partnership passes the 40% test. Also, we may in the future organize one or more subsidiaries that seek to rely on the Investment Company Act exemption provided to certain structured financing vehicles by Rule 3a-7. Any such subsidiary would need to be structured to comply with any guidance that may be issued by the SEC staff on the restrictions contained in Rule 3a-7. In certain circumstances, compliance with Rule 3a-7 may require, among other things, that the indenture governing the subsidiary include limitations on the types of assets the subsidiary may sell or acquire out of the proceeds of assets that mature, are refinanced or otherwise sold, on the period of time during which such transactions
may occur, and on the amount of transactions that may occur.
The loss of our Investment Company Act exemption could require us to register as an investment company or substantially change the way we conduct our business, either of which may have an adverse effect on us.
On August 31, 2011, the SEC published a concept release (Release No. 29778, File No. S7-34-11, Companies Engaged in the Business of Acquiring Mortgages and Mortgage Related Instruments), pursuant to which it is reviewing whether certain companies that invest in mortgage-backed securities and rely on the exemption from registration under Section 3(c)(5)(C) of the Investment Company Act, such as us, should continue to be allowed to rely on such an exemption from registration. If the SEC takes action with respect to this
exemption, these changes could mean that certain of our subsidiaries could no longer rely on the Section 3(c)(5)(C) exemption, and would have to rely on Section 3(c)(1) or 3(c)(7), which would mean that our investment in those subsidiaries would be investment securities. This could result in our failure to maintain our exemption from registration as an investment company.
If we fail to maintain an exemption, exception or other exclusion from registration as an investment company, either because of SEC interpretational changes or otherwise, we could, among other things, be required either: (i) to substantially change the manner in which we conduct our operations to avoid being required to register as an investment company; or (ii) to register
as an investment company, either of which could have an adverse effect on us and the market price of our common stock. If we are required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration and other matters.
Our advisor is not registered and intends not to register as an investment adviser under the Investment Advisers Act, which could impact the types of investments that it recommends we make and cause us not to invest in opportunities that meet our investment criteria. If our advisor is required to register, it could also hinder our operating performance and negatively
impact the return on your investment.
Our advisor is not currently required to register as an investment adviser under the Investment Advisers Act. Furthermore, we believe if our advisor manages our business consistent with the strategy
adopted by our board of directors, our advisor will not be required to register under the Investment Advisers Act even as a result of changes to the Investment
Advisers Act implemented by the Dodd-Frank Act, which became effective in July 2011. Given the changes instituted by the Dodd-Frank Act, an investment adviser can be required to register with the SEC as an investment adviser if it has regulatory assets under management in excess of relevant statutory thresholds (or meets other statutory requirements), even if it manages only a single client. Whether an adviser has sufficient regulatory assets under management to require registration depends on the nature of the assets it manages. In calculating regulatory assets under management, our advisor must include the value of each “securities portfolio” it manages. If our investments were to constitute a “securities portfolio” under the Investment Advisers Act, then our advisor would be required to register. Specifically, our advisor believes that our assets will not constitute a securities portfolio so long as a majority of our assets consist of loans we originate,
real estate and cash and that our assets do not currently constitute a securities portfolio. Since we do not believe our assets will constitute a securities portfolio, we do not believe we have any regulatory assets under management, and therefore do not need to register. Our advisor intends to manage our investments, consistent with our strategy, so that they will continue to not constitute a securities portfolio in the future. In so doing, it is possible that our advisor could determine not to seek and recommend certain real estate debt and real estate securities available on the secondary market that we might otherwise consider. In such a scenario, we may not invest in opportunities that could improve our operating performance and positively impact your return on your investment. If our board of directors determines to modify our strategy in such a way as to make it likely that our advisor would be required to register under the Investment Advisers Act and our advisor
were required to register, it could also negatively impact our business because our advisor would have to devote significant additional management time to such effort and would incur substantially greater costs to manage its business. This additional management time could distract our advisor from managing our business and our advisor may also seek reimbursement of such additional costs from us, which could decrease your return on your investment in us.
Certain provisions of Maryland law may limit the ability of a third party to acquire control of us.
Certain provisions of the MGCL may have the effect of inhibiting a third-party from acquiring us or of impeding a change of control under circumstances that otherwise could provide our common stockholders with the opportunity to realize a premium over the then-prevailing market price of such shares, including:
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“business
combination” provisions that, subject to limitations, prohibit certain business combinations between an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our outstanding shares of voting stock or an affiliate or associate of the corporation who, at any time within the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of the corporation) or an affiliate of any interested stockholder and us for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes two super-majority stockholder voting requirements on these combinations; and
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“control
share” provisions that provide that holders of “control shares” of our company (defined as voting shares of stock that, if aggregated with all other shares of stock owned or controlled by the acquirer, would entitle the acquirer to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of issued and outstanding “control shares”) have no voting rights except to the extent approved by stockholders by the affirmative vote of at least two-thirds of all of the votes entitled to be cast on the matter, excluding all interested shares.
Pursuant to the Maryland Business Combination Act, our board of directors has by resolution opted out of these provisions. Our bylaws
contain a provision exempting from the Maryland Control Share Acquisition Act any and all acquisitions by any person of shares of our stock. There can be no assurance that these resolutions or exemptions will not be amended or eliminated at any time in the future.
Our charter includes an anti-takeover provision that may discourage a person from launching a mini-tender offer for our shares.
Our
charter provides that any tender offer made by a person, including any “mini-tender” offer, must comply with most provisions of Regulation 14D of the Exchange Act. A “mini-tender offer” is a public, open offer to all stockholders to buy their stock during a specified period of time that will result in the bidder owning less than 5% of the class of securities upon completion of the mini-tender offer process. Absent such a provision in our charter, mini-tender offers for shares of our common stock would not be subject to Regulation 14D of the Exchange Act. Tender offers, by contrast, result in the bidder owning more than 5% of the class of securities and are automatically subject to Regulation 14D of the Exchange Act. Pursuant to our charter, the offeror must provide our company notice of such tender offer at least ten business days before initiating the tender offer. If
the offeror does not comply with these requirements, our company will have the right to redeem the offeror’s shares, including any shares acquired in the tender offer. In addition, the noncomplying offeror shall be responsible for all of our company’s expenses in connection with that offeror’s noncompliance and no stockholder may transfer any shares to such noncomplying offeror without first offering the shares to us at the tender offer price offered by such noncomplying offeror. This provision of our charter may discourage a person from initiating a mini-tender offer for our shares and prevent you from receiving a premium price for your shares in such a transaction.
Our failure to qualify as a REIT would subject us to federal income tax and reduce cash
available for distribution to you.
We intend to elect to be taxed as a REIT commencing with our taxable year ended December 31, 2013, upon the filing of our federal income tax return for that year. We intend to operate in a manner so as to qualify as a REIT for federal income tax purposes. Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only a limited number of judicial and administrative interpretations exist. Even an inadvertent or technical mistake could jeopardize our REIT status. Our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. Moreover, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect,
could make it more difficult or impossible for us to qualify as a REIT. If we fail to qualify as a REIT in any taxable year, we would be subject to federal and applicable state and local income tax on our taxable income at corporate rates, in which case we might be required to borrow or liquidate some investments in order to pay the applicable tax. Losing our REIT status would reduce our net income available for investment or distribution to you because of the additional tax liability. In addition, distributions to you would no longer qualify for the dividends-paid deduction and we would no longer be required to make distributions. Furthermore, if we fail to qualify as a REIT in any taxable year after we elect REIT status, we would generally be unable to elect REIT status for the four taxable years following the year in which our REIT status is lost. For a discussion of the REIT qualifications tests and other considerations relating to our election to be taxed as a REIT,
see “U.S. Federal Income Tax Considerations.”
Complying with REIT requirements may force us to borrow funds to make distributions to you or otherwise depend on external sources of capital to fund such distributions.
To qualify as a REIT, we are required to distribute annually at least 90% of our taxable income, subject to certain adjustments, to our stockholders. To the extent that we satisfy the distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we may elect to retain and pay income tax on our net long-term capital gain. In that case, a stockholder would be taxed on its proportionate share of our undistributed long-term gain and would receive a credit or refund for its proportionate share of the tax we paid. A stockholder, including a tax-exempt
or foreign stockholder, would have to file a federal income tax return to claim that credit or refund. Furthermore, we will be subject to a 4% nondeductible excise tax if the actual amount that we distribute to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws.
From time-to-time, we may generate taxable income greater than our net income (loss) for U.S. GAAP, due to among other things, amortization of capitalized purchase premiums, fair value adjustments and reserves. In addition, our taxable income may be greater than our cash flow available for distribution to you
as a result of, among other things, investments in assets that generate taxable income in advance of the corresponding cash flow from the assets (for example, if a borrower defers the payment of interest in cash pursuant to a contractual right or otherwise).
If we do not have other funds available in the situations described in the preceding paragraphs, we could be required to borrow funds on unfavorable terms, sell investments at disadvantageous prices or find another alternative source of funds to make distributions sufficient to enable us to distribute enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity.
Because
of the distribution requirement, it is unlikely that we will be able to fund all future capital needs, including capital needs in connection with investments, from cash retained from operations. As a result, to fund future capital needs, we likely will have to rely on third-party sources of capital, including both debt and equity financing, which may or may not be available on favorable terms or at all. Our access to third-party sources of capital will depend upon a number of factors, including our current and potential future earnings and cash distributions.
We could fail to qualify as a REIT if the IRS successfully challenges our treatment of our mezzanine loans and repurchase agreements.
We intend to operate in a manner so as to qualify as a REIT for federal income tax purposes. However, qualification as a REIT involves the application of highly technical and complex Internal
Revenue Code provisions for which only a limited number of judicial and administrative interpretations exist. If the IRS disagrees with the application of these provisions to our assets or transactions, our REIT qualification could be jeopardized. For example, IRS Revenue Procedure 2003-65 provides a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in Revenue Procedure 2003-65, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests and interest derived from it will be treated as qualifying mortgage interest for purposes of the 75% income test. Although Revenue Procedure 2003-65 provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. While we expect that any mezzanine loans in which we may invest will typically not meet all of the requirements for reliance on this safe harbor, we expect to invest in mezzanine loans in a manner that we believe will
enable us to satisfy the REIT gross income and asset tests.
In addition, we may enter into sale and repurchase agreements under which we may nominally sell certain of our mortgage assets to a counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that we will be treated for federal income tax purposes as the owner of the mortgage assets that are the subject of any such sale and repurchase agreement notwithstanding that we transferred record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the mortgage assets during the term of the sale and repurchase agreement, in which case our ability to qualify as a REIT could be adversely affected.
Even if the IRS were to disagree with one or more of our interpretations and we were treated as having failed
to satisfy one of the REIT qualification requirements, we could maintain our REIT qualification if our failure was excused under certain statutory savings provisions. However, there can be no guarantee that we would be entitled to benefit from those statutory savings provisions if we failed to satisfy one of the REIT qualification requirements, and even if we were entitled to benefit from those statutory savings provisions, we could be required to pay a penalty tax.
You may have current tax liability on distributions you elect to reinvest in our common stock.
If you participate in our DRP, you will be deemed to have received, and for income tax purposes will be taxed on, the amount reinvested in shares of our common stock to the extent the amount reinvested was not a tax-free return of capital. In addition, you will be treated for tax purposes as having received an additional distribution
to the extent the shares are purchased at a discount to fair market value. As a result, unless you are a tax-exempt entity, you may have to use cash from other sources to pay your tax liability on the value of the shares of common stock received (see “Description of Capital Stock—Distribution Reinvestment Plan”).
Even if we qualify as a REIT for federal income tax purposes, we may be subject to other tax liabilities that reduce
our cash flow and our ability to make distributions to you.
Even if we qualify for taxation as a REIT for federal income tax purposes, we may be subject to certain federal, state and local taxes. Any of these taxes would decrease cash available for distribution to you. For example:
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In order to qualify as a REIT, we must distribute annually at least 90% of our REIT taxable income (which is determined without regard to the dividends paid deduction or net capital gain for this purpose) to you.
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To
the extent that we satisfy the distribution requirement but distribute less than 100% of our REIT taxable income, we will be subject to federal corporate income tax on the undistributed income.
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We will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions we pay in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years.
•
If we have net income from the sale of foreclosure property
that we hold primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, we must pay a tax on that income at the highest corporate income tax rate.
•
If we sell an asset, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of business, our gain would be subject to the 100% “prohibited transaction” tax.
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Any domestic taxable REIT subsidiary, or TRS, of ours will be subject to federal corporate income
tax on its income, and on any non-arm’s-length transactions between us and any TRS, for example, excessive rents charged to a TRS could be subject to a 100% tax.
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We may be subject to tax on income from certain activities conducted as a result of taking title to collateral.
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We may be subject to state or local income, property and transfer taxes, such as mortgage recording taxes.
We may fail to qualify as a REIT if the IRS successfully challenges the
valuation of our common stock used for purposes of our DRP.
In order to satisfy the REIT distribution requirements, the dividends we pay must not be “preferential.” A dividend determined to be preferential will not qualify for the dividends paid deduction. To avoid paying preferential dividends, we must treat every stockholder of a class of stock with respect to which we make a distribution the same as every other stockholder of that class, and we must not treat any class of stock other than according to its dividend rights as a class. For example, if certain stockholders receive a distribution that is more or less than the distributions received by other stockholders of the same class, the distribution will be preferential. If any part of a distribution is preferential, none of that distribution will be applied towards satisfying our REIT distribution requirements.
Stockholders
participating in our DRP receive distributions in the form of shares of our common stock rather than in cash. Currently, the purchase price per share under our DRP is $9.50 per share. From and after 18 months from the completion of our offering stage, the purchase price per share under our DRP will be 95% of the estimated value per share of our common stock, as determined by our advisor or another firm chosen for that purpose. Pursuant to an IRS ruling, the prohibition on preferential dividends does not prohibit a REIT from offering shares under a distribution reinvestment plan at discounts of up to 5% of fair market value, but a discount in excess of 5% of the fair market value of the shares would be considered a preferential dividend. Any discount we offer is intended to fall within the safe harbor for such discounts set forth in the ruling published by the IRS. However, the fair market value of our common stock will not be susceptible to a definitive determination.
If the purchase price under our DRP is deemed to have been at more than a 5% discount at any time, we would be treated as having paid one or more preferential dividends. Similarly, we would be treated as having paid one or more preferential dividends if the IRS
successfully asserted that the value of the common stock distributions paid to stockholders participating in our DRP exceeded on a per-share basis the cash distribution paid
to our other stockholders, which could occur if the IRS successfully asserted that the fair market value of our common stock exceeded the estimated value per share used for purposes of calculating the distributions under our DRP. If we are determined to have paid preferential dividends as a result of our DRP, we would likely fail to qualify as a REIT unless the IRS were to provide relief.
Complying with REIT requirements may cause us to forego otherwise attractive opportunities or liquidate otherwise attractive investments.
To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to stockholders and the ownership of our stock. As discussed above, we may be required to make distributions to you at disadvantageous times
or when we do not have funds readily available for distribution. Additionally, we may be unable to pursue investments that would be otherwise attractive to us in order to satisfy the requirements for qualifying as a REIT.
We must also ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets, including certain mortgage loans and mortgage-backed securities. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities of any one issuer (other than government securities and qualified real
estate assets) and no more than 25% of the value of our total securities can be represented by securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences, unless certain relief provisions apply. As a result, compliance with the REIT requirements may hinder our ability to operate solely on the basis of profit maximization and may require us to liquidate investments from our portfolio, or refrain from making, otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to you.
Modification of the terms of our CRE debt investments and mortgage loans underlying our CMBS in conjunction with reductions in the value of the real property securing such loans
could cause us to fail to qualify as a REIT.
Our CRE debt and securities investments may be materially affected by a weak real estate market and economy in general. As a result, many of the terms of our CRE debt and the mortgage loans underlying our CRE securities may be modified to avoid taking title to a property. Under the Internal Revenue Code, if the terms of a loan are modified in a manner constituting a “significant modification,” such modification triggers a deemed exchange of the original loan for the modified loan. In general, under applicable Treasury Regulations, or the Loan-to-Value Regulation, if a loan is secured by real property and other property and the highest principal amount of the loan outstanding during a taxable year exceeds the fair market value of the real property securing the loan determined as of the date we agreed to acquire the loan or the date we significantly modified the loan, a portion
of the interest income from such loan will not be qualifying income for purposes of the 75% gross income test, but will be qualifying income for purposes of the 95% gross income test. Although the law is not entirely clear, a portion of the loan will likely be a non-qualifying asset for purposes of the 75% asset test. The non-qualifying portion of such a loan would be subject to, among other requirements, the requirement that a REIT not hold securities representing more than 10% of the total value of the outstanding securities of any one issuer, or the 10% Value Test.
IRS Revenue Procedure 2011-16 provides a safe harbor pursuant to which we will not be required to redetermine the fair market value of the real property securing a loan for purposes of the gross income and asset tests discussed above in connection with a loan modification that is: (i) occasioned by a borrower default; or (ii) made at a time when we reasonably
believe that the modification to the loan will substantially reduce a significant risk of default on the original loan. No assurance can be provided that all of our loan modifications will qualify for the safe harbor in Revenue Procedure 2011-16. To the extent we significantly
modify loans in a manner that does not qualify for that safe harbor, we will be required to redetermine the value of the real property securing the loan at
the time it was significantly modified. In determining the value of the real property securing such a loan, we will generally not obtain third-party appraisals, but rather will rely on internal valuations. No assurance can be provided that the IRS will not successfully challenge our internal valuations. If the terms of our debt investments and mortgage loans underlying our CMBS are “significantly modified” in a manner that does not qualify for the safe harbor in Revenue Procedure 2011-16 and the fair market value of the real property securing such loans has decreased significantly, we could fail the 75% gross income test, the 75% asset test and/or the 10% Value Test. Unless we qualified for relief under certain Internal Revenue Code cure provisions, such failures could cause us to fail to qualify as a REIT.
Our acquisition of debt or securities investments may cause us to recognize income for federal income tax purposes
even though no cash payments have been received on the debt investments.
We may acquire debt or securities investments in the secondary market for less than their face amount. The amount of such discount will generally be treated as a “market discount” for federal income tax purposes. If these debt or securities investments provide for “payment-in-kind” interest, we may recognize “original issue discount,” or OID, for federal income tax purposes. Moreover, we may acquire distressed debt investments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding debt constitute “significant modifications” under the applicable Treasury Regulations, the modified debt may be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, if the debt is considered to be “publicly traded” for federal income tax purposes, the
modified debt in our hands may be considered to have been issued with OID to the extent the fair market value of the modified debt is less than the principal amount of the outstanding debt. In the event the debt is not considered to be “publicly traded” for federal income tax purposes, we may be required to recognize taxable income to the extent that the principal amount of the modified debt exceeds our cost of purchasing it. Also, certain loans that we originate and certain previously modified debt we acquire in the secondary market may be considered to have been issued with the OID at the time it was modified.
In general, we will be required to accrue OID on a debt instrument as taxable income in accordance with applicable federal income tax rules even though no cash payments may be received on such debt instrument.
In the event a borrower with respect to a particular debt
instrument encounters financial difficulty rendering it unable to pay stated interest as due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income. Similarly, we may be required to accrue interest income with respect to subordinate mortgage-backed securities at the stated rate regardless of when their corresponding cash payments are received.
In order to meet the REIT distribution requirements, it might be necessary for us to arrange for short-term, or possibly long-term borrowings, or to pay distributions in the form of our shares or other taxable in-kind distributions of property. We may need to borrow funds at times when the market conditions are unfavorable. Such borrowings could increase our costs and reduce the value of your investment. In the event in-kind distributions are made, your tax liabilities associated with an investment in our common stock for a given year may exceed
the amount of cash we distribute to you during such year.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code may limit our ability to hedge our operations effectively. Our aggregate gross income from non-qualifying hedges, fees and certain other non-qualifying sources cannot exceed 5% of our annual gross income. As a result, we might have to limit our use of advantageous hedging techniques or implement those hedges through a TRS. Any hedging income earned by a TRS would be subject to federal, state and local income tax at regular corporate rates. This could increase the cost of our hedging activities or expose us to greater risks associated with interest rate or other changes than we would otherwise incur.
Liquidation of assets may jeopardize our REIT qualification.
To
qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our investments to satisfy our obligations to our lenders, we may
be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% prohibited transaction tax on any resulting gain if we sell assets that are treated as dealer property or
inventory.
Legislative or regulatory tax changes could adversely affect us or you.
At any time, the federal income tax laws can change. Laws and rules governing REITs or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations may take effect retroactively and could adversely affect us or you.
The prohibited transactions tax may limit our ability to engage in transactions, including disposition of assets and certain methods of securitizing loans, which would be treated as sales for federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than property that we took title to as a result of a default on a debt investment
or lease and for which we make a foreclosure property election, but include loans held primarily for sale to customers in the ordinary course of business. We might be subject to the prohibited transaction tax if we were to dispose of or securitize loans in a manner that is treated as a sale of the loans, for federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans and may limit the structures we use for any securitization financing transactions, even though such sales or structures might otherwise be beneficial to us. Additionally, we may be subject to the prohibited transaction tax upon a disposition of real property. Although a safe-harbor exception to prohibited transaction treatment is available, we cannot assure you that we can comply with such safe harbor or that we will avoid owning property that may be characterized as held primarily for sale to customers in the ordinary course
of our trade or business. Consequently, we may choose not to engage in certain sales of real property or may conduct such sales through a TRS.
It may be possible to reduce the impact of the prohibited transaction tax by conducting certain activities through a TRS. However, to the extent that we engage in such activities through a TRS, the income associated with such activities may be subject to a corporate income tax.
We also will not be able to use secured financing structures that would create taxable mortgage pools, other than in a TRS.
We may recognize substantial amounts of REIT taxable income, which we would be required to distribute to you, in a year in which we are not profitable under U.S. GAAP principles or other economic measures.
We may recognize substantial amounts of REIT taxable
income in years in which we are not profitable under U.S. GAAP or other economic measures as a result of the differences between U.S. GAAP and tax accounting methods. For example, certain of our assets will be marked-to-market for U.S. GAAP purposes but not for tax purposes, which could result in losses for U.S. GAAP purposes that are not recognized in computing our REIT taxable income. Additionally, we may deduct our capital losses only to the extent of our capital gains in computing our REIT taxable income for a given taxable year. Consequently, we could recognize substantial amounts of REIT taxable income and would be required to distribute such income to you, in a year in which we are not profitable under U.S. GAAP or other economic measures.
We may distribute our common stock in a taxable distribution, in which case you may sell shares of our common stock to pay tax on such distributions, and you may receive less in
cash than the amount of the dividend that is taxable.
We may make taxable distributions that are payable in cash and common stock. The IRS has issued private letter rulings to other REITs treating certain distributions that are paid partly in cash and partly in stock as taxable distributions that would satisfy the REIT annual distribution requirement and qualify for the dividends paid deduction for federal income tax purposes. Those rulings may be relied upon only by taxpayers to whom they were issued, but we could request a similar ruling from the IRS. Accordingly, it is unclear whether and to what extent we will be able to make taxable distributions payable in cash and common stock. If we made a taxable dividend payable in cash and common stock, taxable stockholders receiving such distributions will be required to include the full fair market value of the stock as dividend, which is generally treated as ordinary income and
is taxable to the extent of our current and accumulated
earnings and profits, as determined for federal income tax purposes. As a result, you may be required to pay income tax with respect to such distributions in excess of the cash distributions received. There is no public market for our shares of common stock and therefore it may be difficult for a stockholder to sell the shares received as a dividend in order to pay this tax.
If a U.S. stockholder does sell these shares, the sales proceeds may be less than the amount taxable as a dividend, depending on the price the stockholder receives for the shares. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. federal income tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in common stock.
REIT distribution requirements could adversely affect our ability to execute our business plan.
We generally must distribute annually at least 90% of our REIT taxable income (which is determined without regard to the dividends paid deduction or net capital gain for this purpose) in order to qualify as a REIT. We intend to make distributions to our stockholders to comply with the REIT requirements of the Internal Revenue Code and to avoid corporate income tax and the 4%
excise tax. We may be required to make distributions to stockholders at times when it would be more advantageous to reinvest cash in our business or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
Our qualification as a REIT could be jeopardized as a result of an interest in joint ventures or investment funds.
We may in the future acquire, limited partner or non-managing member interests in partnerships and limited liability companies that are joint ventures or investment funds. If a partnership or limited liability company in which we own an interest takes or expects to take actions that could jeopardize our qualification as a REIT or require us to pay tax, we may be forced to dispose of our interest in such entity. In addition, it is possible
that a partnership or limited liability company could take an action which could cause us to fail a REIT gross income or asset test, and that we would not become aware of such action in time to dispose of our interest in the partnership or limited liability company or take other corrective action on a timely basis. In that case, we could fail to qualify as a REIT unless we are able to qualify for a statutory REIT “savings” provision, which may require us to pay a significant penalty tax to maintain our REIT qualification.
To qualify and maintain our REIT status, we may be forced to forgo otherwise attractive opportunities, which may delay or hinder our ability to meet our investment objectives and may reduce your overall return.
To qualify as a REIT, we must satisfy certain tests on an ongoing basis concerning, among other things, the sources of our income, nature of our
assets and the amounts we distribute to you. Compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of your investment.
Distributions paid by REITs do not qualify for the reduced tax rates that apply to other corporate distributions.
The maximum tax rate for “qualified dividends” paid by corporations to individuals is generally 20%. Distributions paid by REITs, however, generally are taxed at the normal ordinary income rate applicable to the individual recipient (subject to a maximum rate of 39.6%), rather than the preferential rate applicable to qualified dividends. The more favorable rates applicable to regular corporate distributions could cause potential investors who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations
that pay qualified dividends, which could adversely affect the value of the stock of REITs, including our common stock.
Our charter limits the number of shares a person may own, which may discourage a takeover that could otherwise result in a premium price paid to you.
Our charter, with certain exceptions, authorizes our board of directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. To help us comply with the REIT ownership requirements of the Internal Revenue Code, among other purposes, our charter prohibits a
person from directly or constructively owning more than 9.8% in value of the aggregate of the outstanding shares of our stock of any class or series or more than 9.8% in value or number of shares, whichever is more restrictive, of the aggregate of the outstanding shares of our common stock, unless exempted by our board of directors. This restriction may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might otherwise provide a premium price for holders of our shares of common stock.
This prospectus contains certain “forward-looking statements.” Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,”“will,”“should,”“potential,”“intend,”“expect,”“seek,”“anticipate,”“estimate,”“believe,”“could,”“project,”“predict,”“continue” or other similar words or expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe plans and strategies or state other forward-looking information. Such statements include, but are not limited to, those relating to our ability to successfully complete our offering,
our ability to deploy effectively and timely the net proceeds of our offering, use of proceeds from our offering, our reliance on our advisor and our sponsor, our understanding of our competition and our ability to compete effectively, market and industry trends, estimates relating to our future distributions, our financing needs, our expected leverage and the effects of our current strategies. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain, particularly given the economic environment. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from those forward looking statements. These factors
include, but are not limited to:
•our ability to successfully raise capital in our offering;
•
our dependence on the resources and personnel of our advisor and our sponsor, including our advisor’s ability to source and close on attractive investment opportunities on our behalf;
•the performance of our advisor and our sponsor;
•
our ability to deploy capital quickly and successfully and achieve a diversified
portfolio consistent with our target asset classes;
•
our ability to access financing for our investments at rates that will allow us to meet our target returns, including our ability to complete securitization financing transactions;
•our liquidity;
•
our ability to make distributions to our stockholders, including from sources other than cash flow from operations;
•
the
effect of paying distributions to our stockholders from sources other than cash flow provided by operations;
•the lack of a public trading market for our shares;
•
the impact of economic conditions on our valuations and on our borrowers and others who we depend on to make payments to us;
•
the impact of our sponsor’s planned spin-off of its asset management business, which will include our advisor;
•
our
advisor’s ability to attract and retain sufficient personnel to support our growth and operations;
•
our limited operating history;
•
changes in our business or investment strategy;
•
changes in the value of our portfolio;
•
environmental
compliance costs and liabilities;
•
any failure in our advisor’s due diligence to identify all relevant facts in our underwriting process or otherwise;
•
the impact of market and other conditions influencing the availability of debt versus equity investments and performance of our investments relative to our expectations and the impact on our actual return on invested equity, as well as the cash provided by these investments;
rates of default or decreased recovery rates on our target investments;
•
borrower, tenant and other third party defaults and bankruptcy;
•
the degree and nature of our competition;
•
illiquidity
of properties in our portfolio;
•
our ability to finance our transactions;
•
the effectiveness of our risk management systems;
•
availability of opportunities, including our advisor’s ability to source and close on debt, select equity and securities investments;
•
our
ability to realize current and expected returns over the life of our investments;
•
failure to maintain effective internal controls;
•
regulatory requirements with respect to our business, as well as the related cost of compliance;
•
our ability to qualify and maintain our qualification as
a REIT for federal income tax purposes and limitations imposed on our business by our status as a REIT;
•
changes in laws or regulations governing various aspects of our business and non-traded REITs generally, including, but not limited to, changes implemented by FINRA and changes to laws governing the taxation of REITs;
•
the loss of our exemption from registration under the Investment Company Act;
•
general
volatility in domestic and international capital markets and economies;
•
effect of regulatory actions, litigation and contractual claims against us and our affiliates, including the potential settlement and litigation of such claims;
•
the impact of any conflicts arising among us and our sponsor and its affiliates;
•
the
adequacy of our cash reserves and working capital;
•
the timing of cash flows, if any, from our investments; and
•
other risks associated with investing in our targeted investments, including changes in interest rates, the securities markets, the general economy or the finance and real estate markets specifically.
The foregoing list of factors is not exhaustive. All forward-looking statements included in this prospectus are based upon information available
to us on the date hereof and we are under no duty to update any of the forward-looking statements after the date of this prospectus to conform these statements to actual results.
Factors that could have a material adverse effect on our operations and future prospects are set forth in “Risk Factors” in this prospectus beginning on page 19. The factors set forth in the Risk Factors section and described elsewhere in this prospectus could cause our actual results to differ significantly from those contained in any forward-looking statement contained in this prospectus.
The table below sets forth our estimated use of proceeds from our offering, assuming we sell: (i) $1,500,000,000 in shares, the maximum offering amount, in our primary offering and no shares pursuant to our DRP; and (ii) $1,500,000,000 in shares, the maximum offering amount, in our primary offering and $150,000,000 in shares pursuant to our DRP. Shares of our common stock will be offered in our primary offering at $10.00 per share. Discounts are also available for certain categories of investors. We are also offering up to $150,000,000 in shares pursuant to our DRP at $9.50 per share.
Many of the amounts set forth below represent management’s best estimate since they cannot be precisely calculated at this time. Depending primarily upon
the number of shares we sell in our offering, we estimate that between approximately 85.7% (assuming no shares available under our DRP are sold) and approximately 88.1% (assuming all shares available under our DRP are sold) of our gross offering proceeds will be available for investments. We will use the remainder of the offering proceeds to pay offering costs, including selling commissions and dealer manager fees, and, upon investment in our targeted assets, to pay an acquisition fee to our advisor for its services in connection with the selection, origination or acquisition, as applicable, of our real estate investments.
Generally, our policy is to pay distributions from cash flow from operations. However, our organizational documents permit us to pay distributions from any source, including from borrowings, sale of assets and offering proceeds or we may make distributions in the form of taxable stock dividends. We have
not established a limit on the use of proceeds to fund distributions. We expect to use substantially all of the net proceeds from the sale of shares under our DRP to repurchase shares under our share repurchase program.
We expect that a majority of our portfolio will consist of CRE debt and less than a majority of our portfolio will consist of CRE select equity and securities investments. However, we may invest in any of these asset classes, including those that present greater risk, and we have not established any limits on the percentage of our portfolio that may be comprised of these various categories of assets which present differing levels of risk. We cannot predict our actual allocation of assets under management at this time because such allocation will also be dependent, in part, upon the then current CRE market, the investment opportunities it presents and available financing, if any, as well as other micro and macro
market conditions.
Maximum
Primary Offering
Maximum Primary
Offering and Distribution
Reinvestment
Plan
Amount
%
Amount
%
Gross Offering Proceeds
$
1,500,000,000
100.0
%
$
1,650,000,000
100.0
%
Less
Offering Costs:
Selling Commissions
105,000,000
7.0
%
105,000,000
6.4
%
Dealer
Manager Fee
45,000,000
3.0
%
45,000,000
2.7
%
Organization and Offering Costs (1)
22,500,000
1.5
%
24,750,000
1.5
%
Net
Proceeds
$
1,327,500,000
88.5
%
1,475,250,000
89.4
%
Less:
Acquisition
Fee (2)
13,275,000
0.9
%
$
14,752,500
0.9
%
Acquisition
Expenses (3)
6,637,500
0.4
%
7,376,250
0.4
%
Initial Working
Capital Reserve (4)
—
—
%
—
—
%
Estimated Amount Available for Investments
(5)
$
1,307,587,500
87.2
%
$
1,453,121,250
88.1
%
_________________
(1)
Amount
reflected is an estimate. Includes all expenses (other than selling commissions and dealer manager fees) to be paid by us in connection with the formation of our company and the qualification and registration of our offering and the marketing and distribution of shares, including, without limitation, expenses for printing, preparing and amending registration statements or supplementing
prospectuses,
mailing and distributing costs, telephones and other telecommunications costs, all advertising and marketing expenses, charges of transfer agents, registrars, trustees, escrow holders, depositories and experts and fees, expenses and taxes related to the filing, registration and qualification of the sale of shares under federal and state laws, including taxes and fees and accountants’ and attorneys’ fees for services provided to us in connection with our offering. Our advisor has agreed to reimburse us to the extent selling commissions, the dealer manager fee and other organization and offering costs incurred by us exceed 15% of aggregate gross proceeds from our offering. See “Plan of Distribution.”
(2)
We will pay our advisor or one of its affiliates an
acquisition fee in an amount equal to up to 1% of the amount funded or allocated by us to originate or acquire CRE investments, including acquisition expenses and financing attributable to such investments. We may also incur customary acquisition expenses in connection with the origination or acquisition (or attempted origination or acquisition) of an asset. See note 3 below. This table excludes financing proceeds. To the extent we utilize borrowings to finance our investments, as we expect to do, the amount available for investment and the amount of investment fees will be proportionately greater. If we raise the maximum offering amount, excluding DRP shares, and our financing is equal to 50% of the cost of our investments, then acquisition fees would be approximately $26,550,000. The amount of the acquisition fees payable to our advisor will increase if we sell our assets and reinvest the proceeds.
(3)
Acquisition
expenses may include customary third-party acquisition costs which are typically included in the gross purchase price of the real estate investments we acquire or are paid by us in connection with such acquisitions. These third-party acquisition costs include legal, accounting, consulting, travel, appraisals, engineering, due diligence, option payments, title insurance and other costs and expenses relating to potential acquisitions regardless of whether the property is actually acquired. The actual amount of acquisition expenses cannot be determined at the present time and will depend on numerous factors, including the type and jurisdiction of the real estate investment acquired, the legal structure of the transaction in which the real estate investment is acquired, the aggregate purchase price paid to acquire the real estate investment and the number of real estate investments acquired. For purposes of this table, we have assumed acquisition expenses will constitute
0.5% of net proceeds.
(4)
We may incur capital expenses relating to our investments, such as purchasing a loan senior to ours to protect our junior position in the event of a default by the borrower on the senior loan, making protective advances to preserve collateral securing a loan or making capital improvements on a real property obtained through foreclosure or otherwise. At the time we make an investment, we will establish estimates of the capital needs of such investments through the anticipated holding period of the investments. We do not anticipate that we will establish a permanent reserve for expenses relating to our investment through the anticipated holding period of the investment. However, to the extent that we have insufficient
cash for such purposes, we may establish reserves from gross offering proceeds, out of cash flow generated by our investments or out of the net cash proceeds received by us from any sale or payoff of our investments.
(5)
Until required in connection with investment in a portfolio of CRE debt, select equity and securities investments, substantially all of the net proceeds of our offering and, thereafter, our working capital reserves, may be invested in short-term, highly liquid investments, including government obligations, bank certificates of deposit, short-term debt obligations and interest-bearing accounts or other authorized investments as determined by our board of directors.
We operate under the direction of our board of directors, the members of which are accountable to us and our stockholders as fiduciaries. Our board of directors is responsible for directing the management of our business and affairs. Our board of directors has retained our advisor to manage our day-to-day affairs and to implement our investment strategy, subject to our board of directors’ direction, oversight and approval.
Our charter and bylaws provide that the number of our directors may be established by a majority of our board of directors but may not be fewer than three nor more than 15. Our charter
also provides that a majority of our directors must be independent of us, our advisor and our respective affiliates. We currently have four directors, three of whom are independent. Two of our independent directors serve as directors of NorthStar Income. An independent director is a director who is not and has not for the last two years been associated, directly or indirectly, with our advisor or our sponsor. A director is deemed to be associated with our advisor or sponsor if he or she owns any interest in, is employed by, is an officer or director of, or has any material business or professional relationship with our advisor, our sponsor or any of their affiliates (other than any ownership interest that constitutes a less than one percent interest in any public company), performs services (other than as a director) for us, or serves as a director or trustee for more than three REITs organized by our sponsor or advised by our advisor. As of the date of this prospectus,
none of our independent directors owns any interest in our sponsor, our advisor or any of their affiliates (as such term is defined in the North American Securities Administrators Association’s Statement of Policy Regarding Real Estate Investment Trusts, as revised and adopted on May 7, 2007, or the NASAA REIT Guidelines). We will provide on an annual basis information about any independent director’s ownership in our sponsor, our advisor or any of their affiliates. A business or professional relationship will be deemed material per se if the gross revenue derived by the director from our sponsor, our advisor and any of their affiliates exceeds five percent of: (i) the director’s annual gross revenue derived from all sources during either of the last two years; or (ii) the director’s net worth on a fair market value basis. Pursuant to the NASAA REIT Guidelines, our charter defines an indirect relationship to include circumstances
in which the director’s spouse, parents, children, siblings, mothers- or fathers-in-law, sons- or daughters-in-law or brothers- or sisters-in-law is or has been associated with us, our advisor, our sponsor or any of their affiliates. Our charter requires that at all times at least one of our independent directors must have at least three years of relevant real estate experience. We refer to any director who is not independent as an “affiliated director.” At the first meeting of our board of directors consisting of a majority of independent directors, our charter was reviewed and unanimously approved by a vote of our board of directors as required by the NASAA REIT Guidelines.
Each director will be elected by the stockholders and will serve for a term of one year and until his or her successor is duly elected and qualifies. Although the number of directors may be increased or decreased, a decrease will not have the effect
of shortening the term of any incumbent director.
Any director may resign at any time and may be removed with or without cause by the stockholders upon the affirmative vote of stockholders entitled to cast at least a majority of all the votes entitled to be cast generally in the election of directors. The notice of any special meeting called to remove a director will indicate that the purpose, or one of the purposes, of the meeting is to determine if the director will be removed.
A vacancy created by an increase in the number of directors or the death, resignation, adjudicated incompetence or other incapacity of a director or a vacancy following the removal of a director may be filled only by a vote of a majority of the remaining directors and, in the case of an independent director, the director must also be nominated by the remaining independent directors.
If
there are no remaining independent directors, then a majority vote of the remaining directors will be sufficient to fill a vacancy among our independent directors’ positions. If at any time there are no independent or affiliated directors in office, successor directors will be elected by the stockholders. Each director will be bound by our charter.
The responsibilities
of the members of our board of directors include:
•
approving and overseeing our overall investment strategy, which consists of elements such as investment selection criteria, diversification strategies and asset disposition strategies;
•
approving all investments other than investments in CRE debt and securities;
•
approving
and reviewing the investment guidelines that our advisor must follow when acquiring CRE debt or securities on our behalf without the approval of our board of directors;
•
approving and overseeing our financing strategies;
•
approving and monitoring the relationship among us, our operating partnership and our advisor;
•
approving
a potential liquidity transaction;
•
determining our distribution policy and authorizing distributions from time-to-time; and
•
approving amounts available for repurchases of shares of our common stock.
Members of our board of directors are not required to devote all of their time to our business and are only required to devote such time to our affairs as their duties require. Our board of directors meets quarterly or more frequently as necessary.
We
follow investment guidelines adopted by our board of directors and the investment and borrowing policies set forth in this prospectus unless they are modified by our directors. Our board of directors may establish further written policies on investments and borrowings and shall monitor our administrative procedures, investment operations and performance to ensure that the policies are fulfilled and are in the best interests of our stockholders.
Committees of our Board of Directors
Our board of directors may establish committees it deems appropriate to address specific areas in more depth than may be possible at a full board of directors meeting, provided that the majority of the members of each committee are independent directors. Our board of directors established an audit committee.
Audit Committee
Our
audit committee meets on a regular basis, at least quarterly and more frequently as necessary. Our audit committee’s primary function is to assist our board of directors in fulfilling its oversight responsibilities by reviewing the financial information to be provided to the stockholders and others, the system of internal controls which management has established and the audit and financial reporting process. Our audit committee is comprised of Jonathan T. Albro, Charles W. Schoenherr and Winston W. Wilson, all of whom are independent directors. Mr. Wilson serves as the chairman of our audit committee and has been designated as our audit committee financial expert.
Executive Vice President, General Counsel and Secretary
Jonathan T. Albro
51
Independent
Director
Charles W. Schoenherr
54
Independent Director
Winston W. Wilson
46
Independent Director
David T. Hamamoto. David T. Hamamoto has served as our Chairman of the board of directors and Chairman of our advisor since
December 2012. Mr. Hamamoto has served as Chairman of the board of directors of our sponsor, NorthStar Realty Finance Corp., since October 2007 and Chief Executive Officer of our sponsor since October 2004 and as President of our Sponsor from October 2004 to April 2011. Mr. Hamamoto also serves as Chairman of the board of directors of NorthStar Income since February 2009 and served as its Chief Executive Officer from February 2009 until January 2013. Mr. Hamamoto served as Chairman of the board of directors of NorthStar Healthcare from January 2013 until January 2014. Mr. Hamamoto also serves as Chairman and Chief Executive Officer of NSAM. In July 1997, Mr. Hamamoto co-founded NorthStar Capital Investment Corp., or NorthStar Capital, the predecessor to our sponsor, for which he served as Co-Chief Executive Officer until October 2004. From 1983 to 1997, Mr. Hamamoto worked for Goldman, Sachs & Co. where he was co-head of the Real Estate Principal Investment Area
and general partner of the firm between 1994 and 1997. During Mr. Hamamoto’s tenure at Goldman, Sachs & Co., he initiated the firm’s effort to build a real estate principal investment business under the auspices of the Whitehall Funds. Additionally, Mr. Hamamoto has served as a member of the advisory committee of RXR Realty LLC, or RXR Realty, a leading real estate operating and investment management company focused on high-quality real estate investments in the New York Tri-State area, since December 2013. Mr. Hamamoto served as Executive Chairman from March 2011 until November 2012 (having previously served as Chairman from February 2006 until March 2011) of the board of directors of Morgans Hotel Group Co. (NASDAQ: MHGC), a public global hotel management and ownership company focused on the boutique sector. Mr. Hamamoto holds a Bachelor of Science from Stanford University in Palo Alto, California and a Master of Business Administration from the Wharton School
of Business at the University of Pennsylvania in Philadelphia, Pennsylvania.
We believe that Mr. Hamamoto’s broad and extensive experience in the real estate investment and finance industries and his service as Chairman and Chief Executive Officer of our sponsor supports his appointment to our board of directors.
Daniel R. Gilbert. Daniel R. Gilbert is our Chief Executive Officer and President and Chief Executive Officer and President of our advisor. Mr. Gilbert also serves as Chief Investment and Operating Officer of our sponsor and as the Chief Executive Officer of NorthStar Realty Asset Management, LLC, the holding company for our sponsor’s asset management business. Mr. Gilbert also serves
as the Chief Executive Officer and President of NorthStar Income since January 2013 and March 2011, respectively (having previously served as NorthStar Income’s Chief Investment Officer from its inception in January 2009 through January 2013), as well as the Executive Chairman of NorthStar Healthcare since January 2014 (having previously served as NorthStar Healthcare’s Chief Executive Officer and President from August 2012 to January 2014 and as Chief Investment Officer from NorthStar Healthcare’s inception in October 2010 through February 2012). Mr. Gilbert also serves as Chief Investment and Operating Officer of NSAM. Mr. Gilbert served as Co-President of our sponsor from April 2011 until January 2013 and in various other senior management positions since our sponsor’s initial public offering in October 2004. Mr. Gilbert served as an Executive Vice President and Managing Director of Mezzanine Lending of NorthStar Capital. Prior to that role, Mr. Gilbert was with Merrill
Lynch & Co. in its Global Principal
Investments and Commercial Real Estate Department and prior to joining Merrill Lynch, held accounting and legal-related positions at Prudential Securities Incorporated. Mr. Gilbert holds a Bachelor of Arts degree from Union College in Schenectady, New York.
Debra A. Hess. Debra
A. Hess has been our Chief Financial Officer and Treasurer and Chief Financial Officer and Treasurer of our advisor since December 2012. Ms. Hess currently serves as our sponsor’s Chief Financial Officer, a position she has held since July 2011. Ms. Hess has also served as Chief Financial Officer and Treasurer of NorthStar Income since October 2011 and of NorthStar Healthcare since March 2012. Ms. Hess also serves as Chief Financial Officer of NSAM. Ms. Hess has significant financial, accounting and compliance experience at public companies. Ms. Hess most recently served as Chief Financial Officer and Compliance Officer of H/2 Capital Partners, where she was employed from August 2008 to June 2011. From March 2003 to July 2008, Ms. Hess was a managing director at Fortress Investment Group, where she also served as Chief Financial Officer of Newcastle Investment Corp., a Fortress portfolio company and an NYSE-listed alternative investment manager. From 1993 to 2003,
Ms. Hess served in various positions at Goldman, Sachs & Co., including as Vice President in its Principal Finance Group and as a Manager of Financial Reporting in its Finance Division. Prior to 1993, Ms. Hess was employed by Chemical Banking Corporation in the corporate credit policy group and by Arthur Andersen & Company as a supervisory senior auditor. Ms. Hess holds a Bachelor of Science in Accounting from the University of Connecticut in Storrs, Connecticut and a Master of Business Administration in Finance from New York University’s Stern School of Business in New York, New York.
Ronald J. Lieberman. Ronald J. Lieberman has been our General Counsel and Secretary since December 2012 and has served as our Executive Vice President
since March 2013. Mr. Lieberman is also Executive Vice President, General Counsel and Secretary of our advisor. Mr. Lieberman currently serves as our sponsor’s Executive Vice President, General Counsel and Secretary. Mr. Lieberman has served as our sponsor’s General Counsel since April 2011, as Executive Vice President since April 2012 and Secretary since January 2013, having previously served as Assistant Secretary from April 2011 until January 2013. Mr. Lieberman has also served as General Counsel and Secretary of NorthStar Income and NorthStar Healthcare since October 2011 and April 2011, respectively, and as an Executive Vice President of each of those companies since January 2013. Mr. Lieberman also serves as Executive Vice President, General Counsel and Secretary of NSAM. Prior to joining our sponsor, Mr. Lieberman was a partner in the Real Estate Capital Markets practice at the law firm of Hunton & Williams LLP. Mr. Lieberman practiced at Hunton & Williams
from September 2000 until March 2011 where he advised numerous REITs, including mortgage REITs and specialized in capital markets transactions, mergers and acquisitions, securities law compliance, corporate governance and other board advisory matters. Prior to joining Hunton & Williams, Mr. Lieberman was the associate general counsel at Entrade, Inc., during which time Entrade was a public company listed on the NYSE. Mr. Lieberman began his legal career at Skadden, Arps, Slate, Meagher and Flom LLP. Mr. Lieberman holds a Bachelor of Arts, Master of Business Administration and Juris Doctor, each from the University of Michigan in Ann Arbor, Michigan.
Independent Directors
Jonathan T. Albro is one of our independent directors and a member of our audit committee. Mr. Albro also serves as a director of NorthStar Income and as a member of its audit committee
, a position he has held since January 2010. He is Chief Executive Officer and Managing Partner of Penn Square Real Estate Group, LLC, which he founded in September 2006. At Penn Square Real Estate Group, LLC, he is responsible for strategy, operations, marketing, finance and fundraising. From April 2005 to August 2006, Mr. Albro served as Executive Vice President, National Sales Manager of Cole Capital Markets, Inc., or CCM, and Senior Vice President of Cole Capital Corporation, or CCC. He was responsible for the growth and management of CCM, a distribution company focused on Cole’s suite of real estate offerings in addition to serving on CCC’s executive committee. From September 2001 to April 2005, Mr. Albro served as Executive Vice President and National Sales Manager of MetLife Investors, Inc., a wholly owned subsidiary of MetLife, Inc., where was responsible for sales and distribution of MLI Retirement products through financial intermediaries. In all, Mr. Albro
has over 24 years of experience in the broker-dealer industry. Mr. Albro holds a Bachelor of Science from State University of New York in Fredonia, New York.
We believe that Mr. Albro’s knowledge of and more than 24 years of experience in the broker-dealer industry supports his appointment to our board of directors.
Charles W. Schoenherr is one of our independent
directors and a member of our audit committee. Mr. Schoenherr also serves as a director of NorthStar Income and as a member of its audit committee , a position he has held since January 2010. Mr. Schoenherr serves as Chief Investment Officer of Waypoint Residential which invests in multifamily properties in the Sunbelt. He has served in this capacity since October 2011. Mr. Schoenherr is responsible for sourcing acquisition opportunities and raising capital. From January 2011 through December 2013, Mr. Schoenherr served as Chief Investment Officer of Broadway Partners Fund Manager, LLC, a private real estate investment and management firm that invests in office buildings across the United States. From June 2009 until January 2011, Mr. Schoenherr served as President of Scout Real Estate Capital, LLC, a full service real estate firm that focuses on acquiring, developing and operating hospitality assets, where he was responsible for managing the
company’s properties and originating new acquisition and asset management opportunities. Prior to joining Scout Real Estate Capital, LLC, Mr. Schoenherr was the managing partner of Elevation Capital, LLC, where he advised real estate clients on debt and equity restructuring and performed due diligence and valuation analysis on new acquisitions between November 2008 and June 2009. Between September 1997 and October 2008, Mr. Schoenherr served as Senior Vice President and Managing Director of Lehman Brothers’ Global Real Estate Group, where he was responsible for originating debt, mezzanine and equity transactions on all major property types throughout the United States. During his career he has also held senior management positions with GE Capital Corporation, GE Investments, Inc. and KPMG LLP, where he also practiced as a certified public accountant. Mr. Schoenherr also serves on the Board of Trustees of Iona College and is on its Real Estate Committee and its Investment
Committee. Mr. Schoenherr holds a Bachelor of Business Administration in Accounting from Iona College in New Rochelle, New York and a Master of Business Administration in Finance from the University of Connecticut in Stamford, Connecticut.
We believe that Mr. Schoenherr’s knowledge of the real estate investment and finance industries, including extensive experience originating debt, mezzanine and equity transactions, supports his appointment to our board of directors.
Winston W. Wilson is one of our independent directors and the chairman and financial expert of our audit committee. Mr. Wilson most recently worked for Grant Thornton LLP’s New York office, from August 2008 until December 2012 as Partner in Charge and Financial Services Industry Leader and from August 2011 until December 2012 as National Asset Management Sector Leader. Mr. Wilson joined Grant
Thornton LLP in October 2000 and left in December 2012 to pursue personal interests. Mr. Wilson has over 23 years of experience with financial services companies including, among others, mortgage and equity REITs, broker-dealers, mutual funds and registered investment advisors. Prior to joining Grant Thornton, Mr. Wilson worked for PricewaterhouseCoopers LLP, Credit Suisse First Boston and Brown Brothers Harriman & Co. Mr. Wilson is a certified public accountant in the states of New York, New Jersey and Pennsylvania. He is a member of the American Institute of Certified Public Accountants and New York State Society of CPAs. Mr. Wilson was also recently a member of the American Institute of Certified Public Accountants (AICPA) Investment Company Expert Panel as well as a member of the Strategic Partners Advisory Committee for Managed Funds Associations (MFA). Mr. Wilson has a Master of Business Administration in Finance and Marketing from New York University’s Stern
School of Business in New York, New York and a Master of Science in Economics and a Bachelor of Science in Accounting from Brooklyn College in Brooklyn, New York.
We believe that Mr. Wilson’s extensive public accounting and financial services expertise, including as it relates to REITs and broker-dealers, supports his appointment to our board of directors.
Compensation of Executive Officers and Directors
We do not currently have any employees nor do we currently intend to hire any employees who will be compensated directly by us. Each of our executive officers, including any executive officer who serves as a director, is employed by our sponsor and also serves as an executive officer of our advisor. Our executive officers will serve until their successors are elected and qualify. Each of these individuals receives compensation for his
or her services, including services performed for us on behalf of our advisor, from our sponsor. As executive officers of our advisor, these individuals will serve to manage our day-to-day affairs
and carry out the directives of our board of directors in the review, selection and recommendation of investment opportunities, operating acquired investments and monitoring the performance of these investments to ensure that they are consistent
with our investment objectives. Although we indirectly bear some of the costs of the compensation paid to our executive officers, through fees we pay to our advisor, we do not intend to pay any compensation directly to our executive officers. Our executive officers, as key professionals of our advisor, are entitled to receive awards in the future under our long-term incentive plan as a result of their status as key professionals of our advisor, although we do not currently intend to grant any such awards.
We pay each of our independent directors an annual retainer of $65,000 (to be prorated for a partial term), plus our audit committee chairperson receives an additional $10,000 annual retainer (to be prorated for a partial term). We may give our independent directors the right to receive their annual retainer in an equivalent value of shares of our common stock.
We have adopted
an independent director compensation plan, which operates as a sub-plan of our long-term incentive plan, as described below. Pursuant to the independent director compensation plan , we automatically granted to each of our independent directors 5,000 shares of restricted common stock in connection with satisfying the minimum offering requirement of our continuous public offering. Each independent director who subsequently joins our board of directors will receive 5,000 shares of restricted stock upon election or appointment to our board of directors. In addition, on the date following an independent director’s re-election to our board of directors, he or she will receive 2,500 shares of restricted stock. Restricted stock will generally vest over four years following the grant date; provided, however, that restricted stock will become fully vested on the earlier occurrence of: (i) the termination of the independent director’s service as a director due to his or her death
or disability; or (ii) a change in our control. We reserve the right to modify the nature of the equity grant to our directors from restricted common stock to other forms of stock-based incentive awards (such as units in our operating partnership structured as profit interests) as well as the vesting schedule.
All directors receive reimbursement of reasonable out-of-pocket expenses incurred in connection with attending meetings of our board of directors. If a director is also one of our officers, we will not pay any compensation to such person for services rendered as a director.
Long-Term Incentive Plan
We have adopted a long-term incentive plan, which we use to attract and retain qualified directors, officers, employees, if any, and consultants. Our long-term incentive plan offers these individuals an opportunity to participate in our
growth through awards in the form of, or based on, our common stock. We currently intend to issue awards only to our independent directors under our long-term incentive plan (which awards will be granted under the sub-plan as discussed above under “—Compensation of Executive Officers and Directors”).
Our long-term incentive plan authorizes the granting of restricted stock, stock options, stock appreciation rights, restricted or deferred stock units, performance awards, dividend equivalents, limited partnership interests in our operating partnership, other equity-based awards and cash-based awards to directors, employees and consultants of ours, including to employees of our advisor and of our sponsor, selected by our board of directors for participation in our long-term incentive plan. As required by the NASAA REIT Guidelines, stock options granted under our long-term incentive plan will not exceed an amount equal to
10% of the outstanding shares of our common stock on the date of grant of any such stock options. Any stock options or stock appreciation rights granted under our long-term incentive plan will have an exercise price or base price that is not less than the fair market value of our common stock on the date of grant.
Our board of directors, or a committee of our board of directors, will administer our long-term incentive plan with sole authority to determine all of the terms and conditions of the awards, including whether the grant, vesting or settlement of awards may be subject to the attainment of one or more performance goals. As described above under “—Compensation of Executive Officers and Directors,” our board of directors has adopted a sub-plan to provide for regular grants of restricted stock to our independent directors.
No awards may be granted under either plan if the grant or vesting of the awards would jeopardize our status as a REIT under the Internal Revenue Code or otherwise violate the ownership and transfer restrictions imposed under our charter. Unless otherwise determined by our board of directors, no unexercised or restricted award granted under our long-term incentive plan is transferable except through the laws of descent and distribution.
We have authorized and reserved an aggregate maximum of 2,000,000 shares of our common stock for issuance under our long-term incentive plan. In the event of a transaction between our company and our stockholders that causes the per share value of our common stock to change (including, without
limitation, any stock dividend, stock split, spin-off, rights offering or large nonrecurring cash dividend), the share authorization limits under our long-term incentive plan will be adjusted proportionately and our board of directors must make such adjustments to our long-term incentive plan and awards as it deems necessary, in its sole discretion, to prevent dilution or enlargement of rights immediately resulting from such transaction. In the event of a stock split, a stock dividend or a combination or consolidation of the outstanding shares of common stock into a lesser number of shares, the authorization limits under our long-term incentive plan will automatically be adjusted proportionately and the shares then subject to each award will automatically be adjusted proportionately without any change in the aggregate purchase price.
Unless otherwise provided in an award certificate or any special plan document governing an
award, upon the termination of a participant’s service due to death or disability or upon the occurrence of a change in our control, all outstanding options and stock appreciation rights will become fully exercisable and all time-based vesting restrictions on outstanding awards will lapse as of the date of termination or change in control. Unless otherwise provided in an award certificate or any special plan document governing an award, with respect to outstanding performance-based awards: (i) upon the termination of a participant’s service due to death or disability, the payout opportunities attainable under such awards will vest based on targeted or actual performance (depending on the time during the performance period in which the date of termination occurs); (ii) upon the occurrence of a change in our control, the payout opportunities under such awards will vest based on target performance; and (iii) in either case, the awards will payout on a pro rata basis, based
on the length of time within the performance period elapsed prior to the termination or change in control, as the case may be. In addition, our board of directors may in its sole discretion at any time determine that all or a portion of a participant’s awards will become fully vested. Our board of directors may discriminate among participants or among awards in exercising such discretion.
Our long-term incentive plan will automatically expire on the tenth anniversary of the date on which it was approved by our board of directors and stockholders, unless extended or earlier terminated by our board of directors. Our board of directors may terminate our long-term incentive plan at any time. The expiration or other termination of our long-term incentive plan will have no adverse impact on any award previously granted under our long-term incentive plan. Our board of directors may amend our long-term incentive plan at any time,
but no amendment will adversely affect any award previously granted and no amendment to our long-term incentive plan will be effective without the approval of our stockholders if such approval is required by any law, regulation or rule applicable to our long-term incentive plan.
Limited Liability and Indemnification of Directors, Officers and Others
Subject to certain limitations, our charter limits the personal liability of our stockholders, directors and officers for monetary damages and provides that we will generally indemnify and pay or reimburse reasonable expenses in advance of final disposition of a proceeding to our directors, officers and advisor and our advisor’s affiliates. In addition, we maintain a directors and officers liability insurance policy.
The MGCL permits a Maryland corporation to include in its charter a provision
limiting the liability of its directors and officers to the corporation and its stockholders for money damages, except for liability resulting from: (i) actual receipt of an improper benefit or profit in money, property or services; or (ii) active and deliberate dishonesty established by a final judgment and which is material to the cause of action.
The MGCL requires a Maryland corporation (unless its charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made or threatened to be made a party by reason of his or her service in that capacity. The MGCL allows directors and officers to be indemnified against judgments,
penalties, fines, settlements and reasonable expenses actually incurred in connection with a proceeding unless the following can be established:
•
an act or omission of the director or officer was material to the matter giving rise to the proceeding and was committed in bad faith or was the result of active and deliberate dishonesty;
•
the director or officer actually received an improper personal benefit in money, property
or services; or
•
with respect to any criminal proceeding, the director or officer had reasonable cause to believe his act or omission was unlawful.
A court may order indemnification if it determines that the director or officer is fairly and reasonably entitled to indemnification, even though the director or officer did not meet the prescribed standard of conduct or was adjudged liable on the basis that personal benefit was improperly received. However, indemnification for an adverse judgment in a suit by the corporation or in its right, or for a judgment of liability on the basis that personal benefit was improperly received, is limited to expenses.
The
MGCL permits a corporation to advance reasonable expenses to a director or officer upon receipt of: (i) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification; and (ii) a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed if it is ultimately determined that the standard of conduct was not met.
However, our charter provides that we may only indemnify our directors and our advisor and its affiliates for loss or liability suffered by them or hold them harmless for loss or liability suffered by us if all of the following conditions are met:
•
the party seeking indemnification
has determined, in good faith, that the course of conduct that caused the loss or liability was in our best interests;
•
the party seeking indemnification was acting on our behalf or performing services for us;
•
in the case of affiliated directors and our advisor or its affiliates, the liability or loss was not the result of negligence or misconduct;
•
in
the case of our independent directors, the liability or loss was not the result of gross negligence or willful misconduct; and
•
the indemnification or agreement to hold harmless is recoverable only out of our net assets and not from our stockholders.
We have also agreed to indemnify and hold harmless our advisor and its affiliates performing services for us from specific claims and liabilities arising out of the performance of their obligations under our advisory agreement subject to the limitations set forth immediately above. As a result, we and our stockholders may be entitled to a more limited right of action than we would otherwise have if these indemnification rights were
not included in our advisory agreement.
The general effect to investors of any arrangement under which any of our controlling persons, directors or officers are insured or indemnified against liability is a potential reduction in distributions resulting from our payment of premiums associated with insurance or any indemnification for which we do not have adequate insurance.
The SEC takes the position that indemnification against liabilities arising under the Securities Act of 1933, as amended, or the Securities Act, is against public policy and unenforceable. Indemnification of our directors and our advisor or its affiliates will not be allowed for liabilities arising from or out of an alleged violation of state or federal securities laws, unless one or more of the following conditions are met:
•
there
has been a successful adjudication on the merits of each count involving alleged securities law violations;
•
such claims have been dismissed with prejudice on the merits by a court of competent jurisdiction; or
a
court of competent jurisdiction approves a settlement of the claims against the indemnitee and finds that indemnification of the settlement and the related costs should be made and the court considering the request for indemnification has been advised of the position of the SEC and of the published position of any state securities regulatory authority in which the securities were offered as to indemnification for violations of securities laws.
We may advance funds to our directors, our advisor and its affiliates for reasonable legal expenses and other costs incurred as a result of legal action for which indemnification is being sought only if all of the following conditions are met:
•
the legal action
relates to acts or omissions with respect to the performance of duties or services on behalf of us;
•
the party seeking indemnification has provided us with written affirmation of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification;
•
the legal action is initiated by a third-party who is not a stockholder, or the legal action is initiated by a stockholder acting in his or her capacity as such and a court of competent jurisdiction approves such advancement; and
•
the
party seeking indemnification provides us with a written agreement to repay the amount paid or reimbursed by us, together with the applicable legal rate of interest thereon, in cases in which he or she is ultimately found not to be entitled to indemnification.
Indemnification may reduce the legal remedies available to us and our stockholders against the indemnified individuals. The aforementioned charter provisions do not reduce the exposure of directors and officers to liability under federal or state securities laws, nor do they limit a stockholder’s ability to obtain injunctive relief or other equitable remedies for a violation of a director’s or an officer’s duties to us or our stockholders, although the equitable remedies may not be an effective remedy in some circumstances.
We have entered into indemnification agreements with each of our executive officers
and directors and Albert Tylis, an executive officer of our advisor. The indemnification agreements require, among other things, that we indemnify our executive officers and directors and Mr. Tylis and advance to our executive officers and directors and Mr. Tylis all related expenses, subject to reimbursement if it is subsequently determined that indemnification is not permitted. In accordance with these agreements, we will be required to indemnify and advance all expenses incurred by executive officers and directors and Mr. Tylis seeking to enforce their rights under the indemnification agreements.
Our Advisor
We rely on our advisor to manage our day-to-day activities and to implement our investment strategy, subject to the supervision of our board of directors. Our advisor performs its duties and responsibilities as our fiduciary pursuant to an advisory agreement.
To
the extent permitted by law and regulations, the services for which our advisor receives fees and reimbursements include, but are not limited to, the following:
Offering Services
•
the development of our offering, including the determination of its specific terms;
•
along with our dealer manager, the approval of the participating broker-dealers and negotiation of the related selling agreements;
•
coordination
of the due diligence process relating to participating broker-dealers and their review of any prospectus and other offering and company documents;
•
preparation and approval of all marketing materials to be used by our dealer manager and the participating broker-dealers relating to our offering;
along
with our dealer manager, the negotiation and coordination with our transfer agent of the receipt, collection, processing and acceptance of subscription agreements, commissions and other administrative support functions;
•
creation and implementation of various technology and electronic communications related to our offering; and
•
all other services related to our offering, other than services that: (i) relate to the underwriting, marketing, distribution or sale of our offering; (ii) are to be performed by our dealer
manager; (iii) we elect to perform directly; or (iv) would require our advisor to register as a broker-dealer with the SEC, FINRA or any state.
Acquisition Services
•
serve as our investment and financial advisor and obtain certain market research and economic and statistical data in connection with our investments and investment objectives and policies;
•
subject to the investment objectives and limitations set forth in our charter and the investment guidelines approved
by our board of directors: (i) locate, analyze and select potential investments; (ii) structure and negotiate the terms and conditions of approved investments; and (iii) acquire approved investments on our behalf;
•
oversee the due diligence process related to prospective investments;
•
prepare reports regarding prospective investments which include recommendations and supporting documentation necessary for our board of directors to evaluate the proposed investments;
•
obtain
reports (which may be prepared by our advisor or its affiliates), where appropriate, concerning the value of proposed investments; and
•
negotiate and execute approved investments and other transactions.
Asset Management Services
•
investigate, select and, on our behalf, engage and conduct business with such persons as our advisor deems necessary to the proper performance of its obligations under our advisory agreement, including but not limited to consultants, accountants,
lenders, technical advisors, attorneys, brokers, underwriters, corporate fiduciaries, escrow agents, depositaries, custodians, agents for collection, insurers, insurance agents, developers, construction companies and any and all persons acting in any other capacity deemed by our advisor necessary or desirable for the performance of any of the services under our advisory agreement;
•
monitor applicable markets and obtain reports (which may be prepared by our advisor or its affiliates) where appropriate, concerning the value of our investments;
•
monitor
and evaluate the performance of our investments, provide daily management services and perform and supervise the various management and operational functions related to our investments;
•
formulate and oversee the implementation of strategies for the administration, promotion, management, operation, maintenance, improvement, financing and refinancing, marketing, leasing and disposition of investments on an overall portfolio basis;
•
coordinate and manage relationships between us and any joint venture partners; and
•
provide
financial and operational planning services and investment portfolio management functions.
Accounting and Other Administrative Services
•
manage and perform the various administrative functions necessary for our day-to-day operations;
from
time-to-time, or at any time reasonably requested by our board of directors, make reports to our members of the board of directors on our advisor’s performance of services to us under our advisory agreement;
•
coordinate with our accountants and independent auditors to prepare and deliver to our audit committee an annual report covering our advisor’s compliance with certain aspects of our advisory agreement;
•
provide or arrange for administrative services, legal services, office space, office furnishings, personnel
and other overhead items necessary and incidental to our business and operations;
•
provide financial and operational planning services and portfolio management functions;
•
maintain accounting data and any other information concerning our activities as shall be required to prepare and to file all periodic financial reports and returns required to be filed with the SEC and any other regulatory agency, including annual financial statements;
•
maintain
all appropriate books and records of our company;
•
oversee tax and compliance services and risk management services and coordinate with appropriate third parties, including independent accountants and other consultants, on related tax matters;
•
supervise the performance of such ministerial and administrative functions as may be necessary in connection with our daily operations;
•
provide
our company with all necessary cash management services;
•
manage and coordinate with the transfer agent the process of making distributions and payments to stockholders;
•
consult with our officers and board of directors and assist in evaluating and obtaining adequate insurance coverage based upon risk management determinations;
•
provide
our officers and members of the board of directors with timely updates related to the overall regulatory environment affecting our business, as well as managing compliance with regulatory matters;
•
consult with our officers and board of directors relating to the corporate governance structure and appropriate policies and procedures related thereto; and
•
oversee all reporting, recordkeeping, internal controls and similar matters in a manner to allow us to comply with applicable law.
Stockholder
Services
•
manage communications with our stockholders, including answering phone calls, preparing and sending written and electronic reports and other communications; and
•
establish technology infrastructure to assist in providing stockholder support and services.
Financing Services
•
identify
and evaluate potential financing and refinancing sources, engaging a third-party broker if necessary;
•
negotiate terms of, arrange and execute financing agreements;
•
manage relationships between our company and our lenders; and
•
monitor
and oversee the service of our borrowings.
consult with our board of directors and provide assistance with the evaluation and approval of potential asset dispositions, sales, syndications
or liquidity transactions; and
•
structure and negotiate the terms and conditions of transactions pursuant to which our assets may be sold.
Our advisor is managed by the following individuals:
Executive Vice President, General Counsel and Secretary
Brett S. Klein
36
Managing Director
For biographical information on the management of our advisor, other than for Messrs. Tylis and Klein, see “—Directors and Executive Officers.”
Albert Tylis has been an Executive Vice President of our advisor since January 2013. Mr. Tylis also serves as President of our sponsor and served as our sponsor’s Co-President from April 2011 until January 2013, its Chief Operating Officer from January 2010 until January 2013, its Secretary from April 2006 until January 2013, its Executive Vice President from April 2006 until April 2011 and its General Counsel from April 2006 to April 2011. Mr. Tylis also serves as President of NSAM. Mr. Tylis also served as Chief Operating Officer of
NorthStar Income from October 2010 until January 2013 and as General Counsel and Secretary of NorthStar Income from October 2010 until April 2011. In addition, Mr. Tylis served as Chairman of the board of directors of NorthStar Healthcare from April 2011 until January 2013 and as the General Counsel and Secretary from October 2010 until April 2011. Prior to joining our sponsor in August 2005, Mr. Tylis was the Director of Corporate Finance and General Counsel of ASA Institute and from September 1999 through February 2005, Mr. Tylis was a senior attorney at the law firm of Bryan Cave LLP, where he was a member of the Corporate Finance and Securities Group, the Transactions Group, the Banking, Business and Public Finance Group and supported the firm’s Real Estate Group. Additionally, Mr. Tylis has served as a member of the advisory committee of RXR Realty since December 2013. Mr. Tylis holds a Bachelor of Science from the University of Massachusetts at Amherst and a Juris
Doctor from Suffolk University Law School.
Brett S. Klein has been a Managing Director of our advisor since April 2014. Mr. Klein has been a Managing Director of our sponsor since January 2011 and heads its Alternative and Structured Products Group. Mr. Klein’s responsibilities include capital markets execution including credit facility sourcing/structuring and securitization, operational elements of our sponsor’s non-traded REITs and coordination of sponsor-related activities of our broker dealer. Mr. Klein joined our sponsor in August of 2004, prior to its initial public offering, and works closely with the accounting and legal departments and remains involved in both the investment and portfolio management and servicing businesses. From 2000 to 2004, Mr. Klein worked in the CMBS group at Fitch Ratings, Inc., as Associate Director, where he focused on commercial real estate related securitization
transactions. Mr. Klein holds a Bachelor of Science in Finance, Investment and Banking in addition to Risk Management and Insurance from the University of Wisconsin in Madison, Wisconsin.
The term of our advisory agreement is one year from the commencement of our offering, subject to renewals upon mutual consent of the parties for an unlimited number of successive
one-year periods. On April 17, 2014, our board approved a one-year renewal of our advisory agreement, effective May 6, 2014, upon terms identical to those of the agreement in effect through May 6, 2014. It is the duty of our board of directors to evaluate the performance of our advisor before renewing our advisory agreement. The criteria used in these evaluations will be reflected in the minutes of the meetings of our board of directors in which the evaluations occur. Our advisory agreement may be terminated:
•
immediately by us for “cause,” or upon the bankruptcy of our advisor;
•
without
cause or penalty by us or our advisor upon 60-days’ written notice; or
•
with “good reason” by our advisor upon 60-days’ written notice.
“Good reason” is defined in our advisory agreement to mean either any failure by us to obtain a satisfactory agreement from any successor to assume and agree to perform our obligations under our advisory agreement or any material breach of our advisory agreement of any nature whatsoever by us or our operating partnership. “Cause” is defined in our advisory agreement to mean fraud, criminal conduct, misconduct, negligence or breach of fiduciary duty by our advisor or a material breach of our advisory agreement by our advisor.
In the event of the termination of our advisory agreement, our advisor will cooperate with us and take all reasonable steps to assist in making an orderly transition of the advisory function. Our board of directors shall determine whether any succeeding advisor possesses sufficient qualifications to perform the advisory function and to justify the compensation it would receive from us.
Upon termination of our advisory agreement for any reason, including for cause, our advisor will be paid all accrued and unpaid fees and expense reimbursements earned prior to the date of termination and NorthStar OP Holdings II, as the holder of the special units, may be entitled to a one-time payment upon redemption of the special units (based on an appraisal or valuation of our portfolio) in the event that NorthStar OP Holdings II would have been entitled to a subordinated distribution had the
portfolio been liquidated on the termination date. See “Management Compensation” for a detailed discussion of the compensation payable to our advisor under our advisory agreement and the payments that NorthStar OP Holdings II may be entitled to receive with respect to the special units.
License to Use the Name “NorthStar”
Pursuant to our advisory agreement, our sponsor granted us a non-transferable, non-assignable, non-exclusive royalty-free license to use the name “NorthStar” and all related trade names, trademarks, service marks, brands, logos, marketing materials and other related intellectual property it has the rights to use during the term of our advisory agreement. If we cease to retain our advisor or one of its affiliates to perform advisory services for us, we will, promptly after receipt of written request from our sponsor, cease to conduct business
under or use the name “NorthStar” and all related trade names, trademarks, service marks, brands, logos, marketing materials and other related intellectual property or any derivative thereof. We would also be required to change our name and the names of any of our subsidiaries to a name that does not contain the name “NorthStar” or any other word or words that might, in the reasonable discretion of our sponsor, be susceptible of indication of some form of relationship between us and our manager or any its affiliates.
Holdings of Shares of Common Stock, Common Units and Special Units
An affiliate of our sponsor invested approximately $2.2 million in us through the purchase of 22,223 shares of our common stock at $9.00 per share as part of our initial capitalization and an additional
222,223 shares at $9.00 per share to satisfy our minimum offering amount. Our sponsor or its affiliates must maintain this investment for as long as NorthStar Realty Finance Corp. is our sponsor. Pursuant to a distribution support agreement, our sponsor committed to purchase up to an aggregate of $10.0 million in shares of our common stock (which includes the $2.0 million of shares purchased by an affiliate of our sponsor to satisfy the minimum offering amount) at $9.00 per share in certain circumstances in order to
provide,
among other matters, additional cash to pay distributions, if necessary. See “Description of Capital Stock— Distributions.” In addition to the sponsor’s purchase of our shares to satisfy our initial capitalization and minimum offering requirement, as of December 31, 2013, our sponsor purchased 663 shares of our common stock under the distribution support agreement for $5,971.
Our sponsor and the subsidiary of our sponsor which currently owns shares of our common stock may not vote, and have agreed to abstain from voting their shares, including any additional shares our sponsor acquires or controls through any of its affiliates, in any vote for the removal of directors or any vote regarding the approval or termination of any contract with our sponsor or any of its affiliates. In
determining the requisite percentage in interest of shares necessary to approve a matter on which our sponsor or any of its affiliates may not vote, any shares owned by them will not be included.
Our advisor currently owns 100 common units of our operating partnership, for which it contributed $1,000. We are the sole general partner of our operating partnership. NorthStar OP Holdings II, an affiliate of our advisor, owns all of the special units of our operating partnership, for which it contributed $1,000. The resale of any of our shares of common stock by our affiliates is subject to the provisions of Rule 144 promulgated under the Securities Act, which rule limits the number of shares that may be sold at any one time.
Affiliated Dealer Manager
Our dealer manager is an affiliate of our advisor and provides certain sales, promotional
and marketing services to us in connection with the distribution of the shares of common stock offered pursuant to this prospectus. We pay our dealer manager a selling commission of up to 7% of the gross proceeds from the sale of shares of our common stock sold in our primary offering, all of which will be reallowed to third-party broker-dealers participating in our offering and a dealer manager fee of up to 3% of the gross proceeds from the sale of shares of our common stock sold in our primary offering, a portion of which may be reallowed to any third-party broker-dealer participating in our offering based upon factors such as the number of shares sold by such broker-dealer and the assistance of such broker-dealer in marketing our offering.
The following table summarizes all of the fees and expense reimbursements that we pay to our advisor and its affiliates, including amounts to reimburse their costs in providing services to us. Selling commissions and dealer manager fees may vary for different categories of purchasers as described under “Plan of Distribution.” This table assumes that we sell all shares at the highest possible selling commissions and dealer manager fees (with no discounts to any category of purchasers). No selling commissions or dealer manager fees will be payable on shares sold through our DRP.
Form
of Compensation
and Recipient
Determination of Amount
Estimated Amount for
Maximum Offering(1)
Organization and Offering Stage
Selling
Commissions—
Dealer Manager(2)
Up to 7% of gross offering proceeds, except no selling commissions will be payable on shares sold under our DRP. Our dealer manager will reallow selling commissions to participating broker-dealers.
$105,000,000
Dealer
Manager Fee—
Dealer Manager(2)
Up to 3% of gross offering proceeds, except no dealer manager fee will be payable on shares sold under our DRP. Our dealer manager may reallow a portion of the dealer manager fees to any participating broker-dealer, based upon factors such as the number of shares sold by the participating broker-dealer and the assistance of such broker-dealer in marketing our offering.
$45,000,000
Other
Organization and
Offering Costs—
Advisor or its
Affiliates(3)(4)
We reimburse our advisor or its affiliates for the unreimbursed portion and future organization and offering costs it may incur on our behalf, but only to the extent that the reimbursement would not cause the total amount of selling commissions, dealer manager fees and other organization and offering costs borne by us to exceed 15% of gross proceeds from our offering. If we raise the maximum offering amount, we expect organization and offering costs (other than selling commissions and dealer manager fees) to be approximately $24,750,000 or approximately 1.5% of gross
offering proceeds.
These organization and offering costs include all costs (other than selling commissions and dealer manager fees) to be paid by us in connection with our formation and the qualification and registration of our offering and the marketing and distribution of shares, including, without limitation, costs for printing, preparing and amending registration statements or supplementing prospectuses, mailing and distributing costs, telephones and other telecommunications costs, all advertising and marketing costs, charges of transfer agents, registrars, trustees, escrow holders, depositories and experts and fees, costs and taxes related to the filing, registration and qualification of the sale of shares under federal and state laws, including taxes and fees and accountants’ and attorneys’ fees for services provided to us in connection with our offering. Our estimated organization and offering costs, as a percentage
of our gross offering proceeds, will be greater if we raise the minimum offering amount than if we raise the maximum offering amount because a portion of these costs are fixed in amount and, therefore, will be incurred regardless of the amount of gross offering proceeds raised.
An amount equal to up to 1% of the amount funded or allocated by us to originate or acquire CRE investments, including acquisition expenses and financing attributable to such investments.
No financing:
$13,275,000
No financing and DRP:
$14,752,500
Leverage of 50% of cost of investments:
$26,550,000
Leverage
of 75% of cost of investment:
$53,100,000
Reimbursement of
Acquisition Costs—
Advisor or its
Affiliates(5)
We reimburse our advisor or its affiliates for actual costs incurred in connection with the selection, origination or acquisition of an investment, whether or not originated or acquired.
No financing:
$6,637,500
No
financing and DRP:
$7,376,250
Leverage of 50% of cost of investments:
$13,275,000
Leverage of 75% of cost of investment:
$26,550,000
Operational Stage
Asset
Management
Fee—Advisor or its
Affiliates(4)(6)
A monthly asset management fee equal to one-twelfth of 1.25% of the sum of the amount funded or allocated by us for CRE investments, including expenses and any financing attributable to such investments, less any principal received on our debt and securities investments.
Maximum Offering and
leverage of 75% of cost of
investment:
$66,375,000
Other
Operating Costs—
Advisor or its
Affiliates(6)
We reimburse the costs incurred by our advisor or its affiliates in connection with its providing services to us, including our allocable share of our advisor’s overhead, such as rent, employee costs, utilities and technology costs. Employee costs may include our allocable portion of salaries of personnel engaged in managing our operations, including public reporting and investor relations. We will not reimburse our advisor for employee costs in connection with services for which our advisor earns acquisition fees or disposition fees or for the salaries and benefits paid to our executive officers.
Actual
amounts are dependent upon actual expenses incurred; we cannot determine these amounts at the present time.
Disposition Fees— Advisor or its Affiliate(4)(7)(8)
For substantial assistance in connection with the sale of investments and based on the services provided, as determined by our independent directors, an amount equal to up to 1% of the contract
sales price of each CRE investment sold. We will not pay a disposition fee upon the maturity, prepayment, workout, modification or extension of a CRE debt investment unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of: (i) 1% of the principal amount of the CRE debt prior to such transaction; or (ii) the amount of the fee paid by the borrower in connection with such transaction. If we
Actual amounts are dependent upon results of our operations; we cannot determine these amounts at the present time.
take
ownership of a property as a result of a workout or foreclosure of CRE debt, we will pay a disposition fee upon the sale of such property.
Special Units—NorthStar OP Holdings II(8)
NorthStar OP Holdings II was issued special units upon its initial
investment of $1,000 in our operating partnership and in consideration of services to be provided by our advisor, and as the holder of special units will be entitled to receive distributions equal to 15% of our net cash flows, whether from continuing operations, the repayment of loans, the disposition of assets or otherwise, but only after our stockholders have received, in the aggregate, cumulative distributions equal to their invested capital plus a 7% cumulative, non-compounded annual pre-tax return on such invested capital. In addition, NorthStar OP Holdings II will be entitled to a separate payment if it redeems its special units. The special units may be redeemed upon: (i) the listing of our common stock on a national securities exchange; or (ii) the occurrence of certain events that result in the termination or non-renewal of our advisory agreement, in each case for an amount that NorthStar OP Holdings II would have been entitled to receive had our operating partnership
disposed of all of its assets at the enterprise valuation as of the date of the event triggering the redemption. If the event triggering the redemption is: (i) a listing of our shares on a national securities exchange, the enterprise valuation will be calculated based on the average share price of our shares for a specified period; or (ii) an underwritten public offering, the enterprise value will be based on the valuation of the shares as determined by the initial public offering price in such offering. If the triggering event is the termination or non-renewal of our advisory agreement other than for cause, the enterprise valuation will be calculated based on an appraisal or valuation of our assets.
Actual amounts are dependent upon future liquidity events; we cannot determine these amounts at the present time.
______________________
(1)
The
estimated maximum dollar amounts are based on the sale of the maximum of $1,500,000,000 in shares to the public in our primary offering.
(2)
All or a portion of the selling commissions will not be charged with regard to shares sold to certain categories of purchasers. A reduced dealer manager fee is payable with respect to certain volume discount sales. See “Plan of Distribution.”
(3)
After the termination of our primary offering, our advisor has agreed to reimburse us to the extent total organization and offering
costs borne by us exceed 15% of the gross proceeds raised in our offering.
(4)
Our advisor in its sole discretion may defer or waive any fee payable to it under our advisory agreement or accept, in lieu of cash, shares of our common stock. All or any portion of such fees not taken may be deferred without interest and paid when our advisor determines. Our independent directors will determine, from time-to-time but at least annually, that our total fees and expenses are reasonable in light of our investment performance, net assets, net income and the fees and expenses of other comparable unaffiliated REITs. Each such determination shall be reflected in the minutes of the meeting of our board of directors.
Because the acquisition fee we pay our advisor is a percentage of the amount funded or allocated by us to originate or acquire CRE investments, this fee will be greater to the extent we fund originations and acquisitions through: (i) the incurrence of borrowings; (ii) retained cash flow from operations; (iii) issuances of equity in exchange for assets; and (iv) proceeds from the sale of shares under our DRP.
We reimburse our advisor for amounts it pays in connection with the selection, origination or acquisition of an investment, whether or not we ultimately originate or acquire the investment. Our charter limits our ability
to make investments if the total of all acquisition fees and expenses relating to the investment exceeds 6% of the contract purchase price or 6% of the total funds advanced. This limit may only be exceeded if our board of directors (including a majority of our independent directors) approves the fees and expenses and finds the transaction to be commercially competitive, fair and reasonable to us.
(6)
We reimburse our advisor quarterly for total operating expenses, based upon a calculation for the four preceding fiscal quarters, not to exceed the greater of 2% of our average invested assets or 25% of our net income, unless our independent directors authorized such reimbursement
based on a determination that such excess expenses were justified based on unusual and non-recurring factors. In each case in which such a determination is made, our stockholders will receive written disclosure of the determination, together with an explanation of the factors considered in making the determination, within 60 days after the quarter in which the excess occurred. “Average invested assets” means the average monthly book value of our assets during a specified period before deducting depreciation, loan loss reserves or other similar non-cash reserves. “Total operating expenses” means all costs and expenses paid or incurred by us, as determined under U.S. GAAP, that are in any way related to our operation, including asset management fees, but excluding: (i) the costs of raising capital such as organization and offering costs, legal, audit, accounting, underwriting, brokerage, listing, registration and other fees, printing and other such costs
and taxes incurred in connection with the issuance, distribution, transfer, registration and stock exchange listing of our stock; (ii) interest payments; (iii) taxes; (iv) non-cash expenses such as depreciation, amortization and loan loss reserves; (v) incentive fees paid in compliance with the NASAA REIT Guidelines; (vi) acquisition and origination fees and acquisition expenses; (vii) real estate commissions on the sale of real property; and (viii) other fees and expenses connected with the acquisition, financing, disposition, management and ownership of real estate interests, loans or other property (such as the costs of foreclosure, insurance premiums, legal services, maintenance, repair and improvement of property).
(7)
In addition to the
disposition fee paid to our advisor for substantial assistance in connection with the sale of an investment, including partial sales and syndications, we may also pay disposition fees to unaffiliated third parties. No disposition fee will be paid for securities traded on a national securities exchange. To the extent the disposition fee is paid upon the sale of any assets other than real property, it will count against the limit on “total operating expenses” described in note 6 above.
Our charter limits the maximum amount of the disposition fees payable to our advisor and its affiliates to 3% of the contract sales price. In no event will disposition fees exceed an amount which, when added to the fees paid to unaffiliated parties in connection with a qualifying sale of assets, equals the lesser of a competitive
real estate commission or 6% of the sales price of the assets.
(8)
Upon the termination of our advisory agreement for “cause,” we will redeem the special units in exchange for a one-time cash payment of $1.00. Except for this potential payment and as described in “Management Compensation,” NorthStar OP Holdings II shall not be entitled to receive any redemption or other repayment from us or our operating partnership, including any participation in the monthly distributions we intend to make to our stockholders.
The following table sets forth the beneficial ownership of our common stock as of April 16, 2014 for each person or group that holds more than 5% of our common stock, for each director and executive officer and for our directors and executive officers as a group. As of April 16, 2014, there were no beneficial owners of more than 5% of our outstanding common stock. To our knowledge, each person that beneficially owns our shares has sole voting and disposition power with regard to such shares.
Represents
beneficial ownership of less than 1% of the outstanding shares of our common stock.
(1)
Under SEC rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or direct the voting of the security, or “investment power,” which includes the power to dispose of or to direct the disposition of such security. A person also is deemed to be a beneficial owner of securities if that person has a right to acquire beneficial ownership of the securities within 60 days. Under these rules, more than one person may be deemed to be a beneficial owner of the same securities, and a person may be deemed to be a beneficial owner of securities as to which he
or she has no economic or pecuniary interest.
Unless otherwise indicated, each person or entity has an address in care of our principal executive offices at 399 Park Avenue, 18th Floor, New York, New York10022.
(2)
Each of our independent directors holds 625 vested shares and 4,375 unvested shares of restricted stock.
We are subject to various conflicts of interest arising out of our relationship with our advisor and its affiliates, some of whom serve as our executive officers and directors. We discuss these conflicts below and conclude this section with a discussion of the corporate governance measures we have adopted to mitigate some of the risks posed by these conflicts.
Our Affiliates’ Interests in Other NorthStar Entities
General
Our sponsor has sponsored three other real estate programs that have liquidated, as discussed in “Prior Performance Summary—Our Sponsor’s Prior Investment Programs.” Our sponsor currently sponsors two other public non-traded REIT
programs, NorthStar Income and NorthStar Healthcare. NorthStar Income successfully completed its continuous public offering in July 2013 and has invested substantially all its offering proceeds; however, NorthStar Income may make investments in the future with proceeds from the sale or repayment of existing investments. On August 7, 2012, NorthStar Healthcare commenced its initial public offering of up to $1,000,000,000 in shares of common stock to the public at $10.00 per share and $100,000,000 in shares of common stock pursuant to its DRP at $9.50 per share. In April 2014, the board of directors of NorthStar Healthcare extended its public offering until August 7, 2015. In addition, on March 31, 2014, NorthStar/RXR Income, a program co-sponsored by our sponsor, confidentially submitted a Registration Statement on Form
S-11 to the SEC for a proposed initial public offering of up to $2.0 billion of common stock. As a result, we expect that NorthStar Healthcare and NorthStar/RXR Income will be engaged in their respective public offerings for some period of time during which our offering is also ongoing.
Our executive officers and certain of our directors are also officers, directors and managers of our sponsor, our dealer manager and other affiliates of our sponsor, including NorthStar Income and NorthStar Healthcare. These persons have legal obligations with respect to those entities that are similar to their obligations to us. In the future, these persons and other affiliates of our sponsor may organize other debt-related programs and acquire for their own account debt-related investments that may be suitable for us. Our directors are not restricted from engaging for their own account in business activities of the type conducted by us. In
addition, our sponsor may grant equity interests in our advisor and the special unit holder to certain personnel performing services for our advisor and our dealer manager.
Allocation of Our Affiliates’ Time
We rely on our sponsor’s key executive officers and employees who act on behalf of our advisor, including Messrs. Hamamoto, Gilbert, Tylis and Lieberman and Ms. Hess, for the day-to-day operation of our business. Messrs. Hamamoto, Gilbert, Tylis and Lieberman and Ms. Hess are also executive officers of our sponsor or other affiliates of our sponsor. As a result of their interests in other affiliates of our sponsor, their obligations to other investors and the fact that they engage in and they will continue to engage in other business activities on behalf of themselves and others, Messrs. Hamamoto, Gilbert, Tylis and Lieberman and Ms. Hess face conflicts of interest in allocating
their time among us, our advisor and other affiliates of our sponsor and other business activities in which they are involved. However, we believe that our advisor and its affiliates have sufficient resources and personnel to fully discharge their responsibilities to us and the other affiliates of our sponsor that they advise and manage.
Receipt of Fees and Other Compensation by our Advisor and its Affiliates
Our advisor and its affiliates receive substantial fees from us, which fees were not negotiated at arm’s length. These fees could influence our advisor’s advice to us as well as the judgment of the investment committee and management personnel of our sponsor who perform services on behalf of our advisor, some of whom also serve as executive officers, directors and other key professionals of our sponsor. Among other matters, these compensation arrangements could affect their
judgment with respect to:
•
the continuation, renewal or enforcement of our agreements with our advisor and its affiliates, including our advisory agreement and the dealer manager agreement;
public
offerings of equity by us, which entitle our dealer manager to dealer manager fees and will likely entitle our advisor to increased acquisition fees and asset management fees;
•
originations of loans and acquisitions of investments at higher purchase prices, which entitle our advisor to higher acquisition fees and asset management fees regardless of the quality or performance of the investment or loan and, in the case of acquisitions of investments from other NorthStar entities, might entitle affiliates of our advisor to disposition fees in connection with services for the seller;
•
sales
of investments, which entitle our advisor to disposition fees;
•
borrowings up to or in excess of our stated borrowing policy to originate and acquire investments, which borrowings will increase the acquisition fees and asset management fees payable to our advisor;
•
whether and when we seek to list our common stock on a national securities exchange, which listing could entitle NorthStar OP Holdings II to receive a one-time payment in connection with the redemption of its special units;
•
whether
we seek to internalize our management, which may entail acquiring assets (such as office space, furnishings and technology costs) and other key professionals of our sponsor who are performing services for us on behalf of our advisor for consideration that would be negotiated at that time and may result in these professionals receiving more compensation from us than they currently receive from our sponsor; and
•
whether and when we seek to sell our company or its assets, which would entitle NorthStar OP Holdings II, as holder of the special units, to a subordinated distribution.
The fees our advisor
receives in connection with transactions involving the origination or acquisition of an asset are based on the cost of the investment and not based on the quality of the investment or the quality of the services rendered to us. In addition, as holder of the special units, NorthStar OP Holdings II, an affiliate of our advisor, may be entitled to certain distributions subject to our stockholders receiving a 7.00% cumulative, non-compounded annual pre-tax return. This may influence our sponsor’s key professionals performing services on behalf of our advisor, including its investment committee, to recommend riskier transactions to us. Additionally, after the termination of our primary offering, our advisor has agreed to reimburse us to the extent total organization and offering costs borne by us exceed 15% of the gross proceeds raised in our offering. As a result, our advisor may decide to extend our offering to avoid or delay the reimbursement of these expenses.
Duties
Owed by Some of Our Affiliates to Our Advisor and Our Advisor’s Affiliates
Our executive officers, directors and other key professionals of our sponsor performing services on behalf of our advisor may also be officers, directors, managers and other key professionals of:
•
NorthStar Realty Finance Corp., our sponsor;
•
NS Real Estate Income Advisor II, LLC, our advisor;
NorthStar Real Estate Income Trust, Inc. and its advisor;
•
NorthStar Healthcare Income, Inc. and its advisor; and
•
Other NorthStar affiliates (see the “Prior Performance Summary” section of this prospectus).
As
a result, they may owe duties to these entities, their stockholders, members and limited partners. These duties may from time-to-time conflict with the fiduciary duties that they owe to us.
Affiliated Dealer Manager
Since our dealer manager is an affiliate of our advisor, you will not have the benefit of an independent due diligence review and investigation of the type normally performed by an independent underwriter in connection with our offering of securities. See “Plan of Distribution.”
Our dealer manager also acts as the dealer manager for the continuous public offering of NorthStar Healthcare. In addition, future NorthStar-sponsored programs, including NorthStar/RXR Income, which has submitted a confidential registration statement with the SEC, may seek to raise capital through public offerings conducted concurrently with our offering. As a result, our dealer manager may face conflicts of interest arising from potential competition with these other programs for investors and investment capital.
Certain Conflict Resolution Measures
In order to reduce or eliminate certain potential conflicts of interest, our charter contains restrictions and conflict resolution procedures relating to transactions we enter into with our sponsor, our advisor, our
directors or their respective affiliates. In addition to these charter provisions, our board of directors has also adopted a conflicts of interest policy, which provides additional limitations, consistent with our charter, on our ability to enter these types of transactions in order to further reduce the potential for conflicts inherent in transactions with affiliates. The following describes these restrictions and conflict resolution procedures in our charter and in our conflicts of interest policy.
Charter Provisions Relating to Conflicts of Interest
Advisor Compensation. Our independent directors will determine from time-to-time, but at least annually, that our total fees and expenses are reasonable in light of our investment performance, net assets, net income and the fees and expenses of other comparable REITs. In addition, our independent directors
will evaluate at least annually whether the compensation that we contract to pay to our advisor and its affiliates is reasonable in relation to the nature and quality of services performed and whether such compensation is within the limits prescribed by the charter. Our independent directors will supervise the performance of our advisor and its affiliates and the compensation we pay to them to determine whether the provisions of our advisory agreement are being carried out. This evaluation will be based on the following factors as well as any other factors they deem relevant:
•
the amount of the fees and any other compensation, including equity-based compensation, paid
to our advisor and its affiliates in relation to the size, composition and performance of the assets;
•
the success of our advisor in generating appropriate investment opportunities;
•
the rates charged to other companies, including other REITs, by advisors performing similar services;
•
additional
revenues realized by our advisor and its affiliates through their relationship with us, including whether we pay them or they are paid by others with whom we do business;
•
the quality and extent of service and advice furnished by our advisor and its affiliates;
•
the performance of our investment portfolio; and
•
the
quality of our portfolio relative to the investments generated by our advisor and its affiliates for their own account and for their other clients.
The findings of our board of directors with respect to these evaluations will be recorded in the minutes of the meetings of our board of directors.
Under our charter, we can only pay our advisor or one of its affiliates a disposition fee in connection with the sale of an investment, including partial sales and syndications, if it provides a substantial amount of the services in the effort to sell the investment, as determined by a majority of our independent directors and the commission does not exceed up to 3% of the contract sales price of the property. Moreover, our charter also provides that the commission, when added to
all other disposition fees paid to unaffiliated parties in connection with the sale, may not exceed the lesser of a competitive real estate commission or 6% of the sales price of the property. We do not intend to sell or lease assets to our sponsor, our advisor, any of our directors or any of their affiliates. However, if we do sell an asset to an affiliate, our organizational documents would not prohibit us from paying our advisor a disposition fee. Before we sold or leased an asset to our sponsor, our advisor, any of our directors or any of their affiliates, our charter would require
that a majority of our board of directors, including a majority of our independent directors, not otherwise interested in the transaction, conclude that the transaction is fair and reasonable to us and on terms and conditions no less favorable to us than those available from unaffiliated third parties.
Our charter also requires that any gain from the sale of assets that we may pay our advisor or an entity affiliated with our advisor be reasonable. Such an interest in gain from the sale of assets is presumed reasonable if it does not exceed 15% of the balance of the net sale proceeds remaining after payment to common stockholders, in the aggregate, of an amount equal to 100% of the original issue price of the common stock, plus an amount equal to 7% of the original
issue price of the common stock per year on a cumulative basis. Under our operating partnership’s partnership agreement, NorthStar OP Holdings II is entitled to receive distributions equal to 15% of net cash flow and to have the special units redeemed for the amount it would have been entitled to receive had the operating partnership disposed of all of its assets at the enterprise valuation as of the date of the events triggering the redemption upon: (i) the listing of our common stock on a national securities exchange; or (ii) the occurrence of certain events that result in the termination or non-renewal of our advisory agreement, only if the stockholders first receive a 7% per year cumulative, non-compounded return.
Our charter also limits the amount of acquisition and origination fees and expenses we can incur to a total of 6% of the contract
purchase price for the asset or, in the case of debt that we originate, 6% of the funds advanced. This limit may only be exceeded if a majority of our board of directors (including a majority of our independent directors) not otherwise interested in the transaction approves the fees and expenses and finds the transaction to be commercially competitive, fair and reasonable to us. Although our charter permits combined acquisition and origination fees and expenses to equal 6% of the purchase price or funds advanced, our advisory agreement limits the acquisition fee to an amount equal to up to 1% of the amount funded or allocated by us to originate or acquire CRE investments, including acquisition expenses and financing attributable to such investments. Any increase in the acquisition fee stipulated in our advisory agreement would require the approval of a majority of the members of our board of directors.
Term of Advisory Agreement. Each
contract for the services of our advisor may not exceed one year, although there is no limit on the number of times that we may retain a particular advisor. Our charter provides that a majority of our independent directors may terminate our advisory agreement with NS Real Estate Income Advisor II, LLC without cause or penalty on 60-days’ written notice. NS Real Estate Income Advisor II, LLC may terminate our advisory agreement with good reason on 60-days’ written notice. Upon termination of our advisory agreement by our advisor, NorthStar OP Holdings II, an affiliate of our advisor, will be entitled to receive a one-time payment in connection with the redemption of its special units. For a more detailed discussion of the special units, see the sections entitled “Management—The Advisory Agreement” and “Management Compensation—Special Units—NorthStar OP Holdings II”
of this prospectus.
Our Acquisitions. We will not purchase or lease assets in which our sponsor, our advisor, any of our directors or any of their affiliates has an interest without a determination by a majority of our board of directors (including a majority of our independent directors) not otherwise interested in the transaction that such transaction is fair and reasonable to us and at a price to us no greater than the cost of the asset to our sponsor, our advisor, our director or the affiliated seller or lessor, unless there is substantial justification for the excess amount and such excess is reasonable. In no event may we acquire any such asset at an amount in excess of its current appraised value.
Our charter provides that the consideration we pay for real property will ordinarily be based on the fair value of the property. In cases in which a majority
of our independent directors so determine, and in all cases in which real property is acquired from our sponsor, our advisor, any of our directors or any of their affiliates, the fair value shall be determined by an independent expert selected by our independent directors not otherwise interested in the transaction.
Mortgage Loans Involving Affiliates. Our charter prohibits us from investing in or making loans in which the transaction is with our sponsor, our advisor, our directors or any of their affiliates, except for loans to wholly owned subsidiaries and mortgage loans for which an independent expert appraises the underlying property. We must keep the appraisal for at least five years and make it available for inspection and duplication by any of our stockholders. In addition, a mortgagee’s or owner’s title
insurance policy or
commitment as to the priority of the mortgage or the condition of the title must be obtained. Our charter prohibits us from making or investing in any mortgage loans that are subordinate to any mortgage or equity interest of our sponsor, our advisor, our directors or any of their affiliates.
Joint Ventures or Participations with Affiliates of the Advisor. Subject
to approval by our board of directors and the separate approval of our independent directors, we may enter into joint ventures, participations or other arrangements with affiliates of our advisor to acquire debt and other investments. In conjunction with such prospective agreements, our advisor and its affiliates may have conflicts of interest in determining which of such entities should enter into any particular agreements. Our affiliated partners may have economic or business interests or goals which are or that may become inconsistent with our business interests or goals. In addition, should any such arrangements be consummated, our advisor may face a conflict in structuring the terms of the relationship between our interests and the interest of the affiliated partner, in managing the arrangement and in resolving any conflicts or exercising any rights in connection with the arrangements. Since our advisor will make various decisions on our behalf, agreements and transactions
between our advisor’s affiliates and us as partners with respect to any such venture will not have the benefit of arm’s length negotiations of the type normally conducted between unrelated parties. Our advisor or its affiliates may receive various fees for providing services to the joint venture, including but not limited to an asset management fee, with respect to the proportionate interest in the properties held by our joint venture partners. In evaluating investments and other management strategies, the opportunity to earn these fees may lead our advisor to place undue emphasis on criteria relating to its compensation at the expense of other criteria, such as preservation of capital, in order to achieve higher short-term compensation. We may enter into ventures with our sponsor, our advisor, our directors or affiliates of our advisor for the acquisition of investments or co-investments, but only if: (i) a majority of our directors, including a majority of the independent
directors, not otherwise interested in the transaction approve the transaction as being fair and reasonable to us; and (ii) the investment by us and our sponsor, our advisor, such directors or such affiliate are on terms and conditions that are no less favorable than those that would be available to unaffiliated parties. If we enter into a joint venture with any of our affiliates, the fees payable to our advisor by us would be based on our share of the investment.
Other Transactions Involving Affiliates. A majority of our board of directors, including a majority of our independent directors, not otherwise interested in the transaction must conclude that all other transactions between us and our sponsor, our advisor, any of our directors or any of their affiliates are fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
Lack of Separate Representation. Greenberg Traurig, LLP has acted as special U.S. federal income tax counsel to us in connection with our offering and is counsel to us, our operating partnership, our dealer manager and our advisor in connection with our offering and may in the future act as counsel for each such company. Greenberg Traurig, LLP also may in the future serve as counsel to certain affiliates of our advisor in matters unrelated to our offering. There is a possibility that in the future the interests of the various parties may become adverse. In the event that a dispute were to arise between us, our operating partnership, our dealer manager, our advisor, or any of their affiliates, separate counsel for such parties would be retained as and when appropriate.
Limitation on Operating Expenses. We reimburse our advisor quarterly
for total operating expenses, based upon a calculation for the four preceding fiscal quarters, not to exceed the greater of 2% of our average invested assets or 25% of our net income, unless our independent directors have determined that such excess expenses were justified based on unusual and non-recurring factors. In each case in which such a determination is made, our stockholders will receive written disclosure of the determination, together with an explanation of the factors considered in making the determination, within 60 days after the quarter in which the excess is approved. “Average invested assets” means the average monthly book value of our assets during a specified period before deducting depreciation, loan loss reserves or other similar non-cash reserves. “Total operating expenses” means all costs and expenses paid or incurred by us, as determined under U.S. GAAP, that are in any way related to our operation, including asset management fees,
but excluding: (i) the expenses of raising capital such as organization and offering costs, legal, audit, accounting, underwriting, brokerage, listing, registration and other fees, printing and other such expenses and taxes incurred in connection with the issuance, distribution, transfer, registration and stock exchange
listing of our stock; (ii) interest payments; (iii) taxes; (iv) non-cash expenses such as depreciation, amortization
and bad debt reserves; (v) incentive fees paid in compliance with the NASAA REIT Guidelines; (vi) acquisition and origination fees and acquisition expenses; (vii) real estate commission on the sale of real property; and (viii) other fees and expenses connected with the acquisition, financing, disposition, management and ownership of real estate interests, loans or other property (such as the costs of foreclosure, insurance premiums, legal services, maintenance, repair and improvement of property).
Issuance of Options and Warrants to Certain Affiliates. Until our shares of common stock are listed on a national securities exchange, we will not issue options or warrants to purchase our common stock to our advisor, our directors, our sponsor or any of their affiliates, except on the same terms as such options or warrants, if any, are sold to the general public. We may issue options or warrants to persons
other than our advisor, our directors, our sponsor and their affiliates prior to listing our common stock on a national securities exchange, but not at an exercise price less than the fair market value of the underlying securities on the date of grant and not for consideration (which may include services) that in the judgment of our board of directors has a market value less than the value of such option or warrant on the date of grant. Any options or warrants we issue to our advisor, our directors, our sponsor or any of their affiliates shall not exceed an amount equal to 10% of the outstanding shares of our common stock on the date of grant.
Repurchase of Our Shares. Our charter prohibits us from paying a fee to our sponsor, our advisor or our directors or any of their affiliates in connection with our repurchase of our common stock.
Loans. We
will not make any loans to our sponsor, our advisor, any of our directors or any of their affiliates unless the loans are mortgage loans and an appraisal is obtained from an independent appraiser concerning the underlying property or unless the loans are to one of our wholly owned subsidiaries. In addition, we will not borrow from our sponsor, our advisor, any of our directors or any of their affiliates unless a majority of our board of directors (including a majority of independent directors) not otherwise interested in such transaction approves the transaction as being fair, competitive and commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties. These restrictions on loans only apply to advances of cash that are commonly viewed as loans, as determined by our board of directors. By way of example only, the prohibition on loans would
not restrict advances of cash for legal expenses or other costs incurred as a result of any legal action for which indemnification is being sought nor would the prohibition limit our ability to advance reimbursable expenses incurred by directors or officers or our advisor or its affiliates.
Reports to Stockholders. Our charter requires that we prepare an annual report and deliver it to our common stockholders within 120 days after the end of each fiscal year. Our board of directors are required to take reasonable steps to ensure that the annual report complies with our charter provisions. Among the matters that must be included in the annual report or included in a proxy statement delivered with the annual report are:
•
financial
statements prepared in accordance with U.S. GAAP that are audited and reported on by independent certified public accountants;
•
the ratio of the costs of raising capital during the year to the capital raised;
•
the aggregate amount of advisory fees and the aggregate amount of other fees paid to our advisor and any affiliates of our advisor by us or third parties doing business with us during the year;
•
our
total operating expenses for the year stated as a percentage of our average invested assets and as a percentage of our net income;
•
a report from our independent directors that our policies are in the best interests of our common stockholders and the basis for such determination; and
•
a separately stated, full disclosure of all material terms, factors and circumstances surrounding any and all transactions involving us and our advisor, a director or any affiliate thereof during the year, which disclosure has been examined
and commented upon in the report by our independent directors with regard to the fairness of such transactions.
Voting of Shares Owned by Affiliates. Our advisor, our directors and their affiliates may not vote their shares of common stock regarding: (i) the removal of any of them; or (ii) any transaction between them and us. In determining the requisite percentage in interest of shares
necessary to approve a matter on which our advisor, our directors and their affiliates may not vote, any shares owned by them will not be included.
Allocation of Investment Opportunities. We rely on our sponsor’s investment professionals to identify suitable investment opportunities for our company as well as the other Managed Companies. Our investment strategy may be similar to that of our sponsor and substantially similar to NorthStar Income and may further overlap with the investment strategy of NorthStar Healthcare. Our sponsor has an indefinite life and neither NorthStar Income nor NorthStar Healthcare have a stated term, although they expect to consider liquidity alternatives beginning five years after they complete their offering stages. Although investing directly in senior housing facilities is not a focus
of our strategy as it is for our sponsor and NorthStar Healthcare, we have the ability to and may make such investments. In addition, our sponsor may sponsor or manage other investment vehicles in the future that may have investment strategies similar to our investment strategy and that will rely on our sponsor to source their investment opportunities. Therefore, many investment opportunities that are suitable for us may also be suitable for other NorthStar entities, including our sponsor, its affiliates, and the investment vehicles that it sponsors or manages, including NorthStar Income and NorthStar Healthcare.
When our sponsor’s investment professionals direct an investment opportunity to our sponsor, an affiliate or the investment vehicles it sponsors, including NorthStar Income, NorthStar Healthcare and us, they, in their sole discretion, will offer the opportunity to the entity for which the investment opportunity is
most suitable. When determining the entity for which an investment opportunity would be the most suitable, the factors that our sponsor’s investment professionals may consider include, without limitation, the following:
•
investment objectives, strategy and criteria;
•
cash requirements;
•
effect of the investment
on the diversification of the portfolio, including by geography, size of investment, type of investment and risk of investment;
•
leverage policy and the availability of financing for the investment by each entity;
•
anticipated cash flow of the asset to be acquired;
•
income tax effects of
the purchase;
•
the size of the investment;
•
the amount of funds available;
•
cost of capital;
•
risk
return profiles;
•
targeted distribution rates;
•
anticipated future pipeline of suitable investments;
•
the expected holding period of the investment and the remaining term of the NorthStar entity, if applicable; and
•
affiliate
and/or related party considerations.
If, after consideration of the relevant factors, our sponsor determines that an investment is equally suitable for itself or another NorthStar entity, including us, the investment will be allocated among each of the applicable NorthStar entities, including us, on a rotating basis. If, after an investment has been allocated to us or another NorthStar entity, a subsequent event or development, such as delays in structuring or closing on the investment, makes it, in the opinion of our sponsor’s investment professionals, more
appropriate for a different NorthStar entity to fund the investment, our sponsor may determine to place the investment with the more appropriate NorthStar entity while still giving credit to the original allocation. In certain situations, our sponsor may determine to allow more than one investment vehicle, including us, to co-invest in a particular investment.
While these are the current procedures for allocating our sponsor’s investment opportunities, our sponsor may sponsor additional investment vehicles in the future and, in connection with the creation of such investment vehicles or as our board of directors may otherwise determine, we may revise this allocation policy. The result of such a revision to the allocation procedure may, among other things, be to increase the number of parties who have the right
to participate in investment opportunities sourced by our sponsor, thereby reducing the number of investment opportunities available to us. In the event that our sponsor adopts a revised allocation policy that materially impacts our business, we will disclose this information in a supplement to this prospectus or in the reports we file publicly with the SEC, as appropriate.
The decision of how any potential investment should be allocated among us, our sponsor and other NorthStar entities for which such investment may be most suitable may, in many cases, be a matter of highly subjective judgment which will be made by our sponsor’s investment committee in its sole discretion. This committee currently consists of the following individuals: David T. Hamamoto, Daniel R. Gilbert and Albert Tylis. Certain types of investment opportunities may not enter
the allocation process because of special or unique circumstances related to the asset or the seller of the asset that in the judgment of the investment committee do not fall within the investment objectives of our sponsor or any particular NorthStar entity, including us. In these cases, the investment may be made by another NorthStar entity without us having an opportunity to make such investment.
Our right to participate in the investment allocation process described in this section will terminate once we have fully invested the proceeds of our offering or if we are no longer advised by an affiliate of our sponsor. Please see “Risk Factors—Risks Related to Conflicts of Interest—Our sponsor will face conflicts of interest relating to performing services on our behalf and such conflicts may not be resolved in our favor, meaning that we could acquire less attractive assets, which could limit our ability to make distributions
and reduce your overall investment return.” Our advisor is required to inform our board of directors at least annually of the investments that have been allocated to us and other NorthStar entities so that our board of directors can evaluate whether we are receiving our fair share of opportunities. Based on the information provided, our board of directors (including our independent directors) has a duty to determine that the investment allocation policy is being applied fairly. Our advisor’s success in generating investment opportunities for us and the fair allocation of opportunities among us and the other NorthStar entities are important factors in the board of director’s determination to continue or renew our arrangements with our advisor and its affiliates.
Our Conflicts of Interest Policy
In addition to the provisions in our charter restricting related party transactions,
our board of directors has adopted the following conflicts of interest policy prohibiting us from entering into certain types of transactions with our directors, our advisor, our sponsor or any of their affiliates in order to further reduce the potential for conflicts inherent in transactions with affiliates. As required by our charter, we will not purchase investments from our sponsor or its affiliates without a determination by a majority of our board of directors (including a majority of our independent directors) not otherwise interested in the transaction that such transaction is fair and reasonable to us and at a price to us no greater than the cost of the investment to our sponsor or its affiliate or, if the price to us is in excess of such cost, that substantial justification for such excess exists and such excess is reasonable; provided that in no event shall the cost of such investment to us exceed its current appraised value. In addition, pursuant to this
conflicts of interest policy, we will not borrow money from our directors, our sponsor, our advisor or any of their affiliates unless a majority of the board of directors (including a majority of independent directors) not otherwise interested in the transaction approve the transaction as being fair, competitive and commercially reasonable and no less favorable to us than loans between unaffiliated parties under the same circumstances. We will not amend these policies unless a majority of our board of directors (including a majority of our independent directors) approves the amendment following a determination that the amendment is in the best interests of our stockholders.
to pay attractive and consistent current income through cash distributions; and
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to preserve, protect and return your capital contribution.
We will also seek to realize growth in
the value of our investments and may optimize the timing of their sale. However, we cannot assure you that we will attain these objectives or that the value of our assets will not decrease. Furthermore, within our investment objectives and policies, our advisor will have substantial discretion with respect to the selection, purchase and sale of our assets, subject to the approval of our board of directors through the adoption of our investment guidelines or otherwise. Our independent directors will review our investment policies at least annually to determine whether such policies continue to be in the best interests of our stockholders. Each determination and the basis therefore are required to be set forth in the applicable meeting minutes.
Investment Strategy
Our strategy is to use substantially all of the net proceeds of our offering to originate, acquire and asset manage a
diversified portfolio of: (i) CRE debt, including first mortgage loans, subordinate mortgage and mezzanine loans, participations in such loans and preferred equity interests; (ii) select equity investments; and (iii) CRE securities, such as CMBS, unsecured debt of publicly traded REITs and CDO notes. We seek to create and maintain a portfolio of investments that generate a low volatility income stream of attractive and consistent cash distributions. Our focus on investing in debt instruments emphasizes the payment of current returns to investors and preservation of invested capital as our primary investment objectives. We place a lesser emphasis on, but still may target, capital appreciation from our investments, compared to more opportunistic or equity-oriented strategies.
We expect that a majority of our portfolio will consist of CRE debt and less than a majority of our portfolio will consist of select equity investments
and CRE securities. However, we may invest in any of these asset classes, including those that present greater risk, and we have not established any limits on the percentage of our portfolio that may be comprised of these various categories of assets which present differing levels of risk. We cannot predict our actual allocation of assets under management at this time because such allocation will also be dependent, in part, upon the then current CRE market, the investment opportunities it presents and available financing, if any, as well as other micro and macro market conditions.
We have employed and we expect to selectively employ leverage to enhance total returns to our stockholders through a combination of financing strategies including: (i) secured or unsecured borrowings or facilities; (ii) syndications; (iii) securitization financing transactions or other structures; and (iv) seller financing. We will seek to secure
conservatively structured leverage that is long-term, non-recourse and non-mark to market to the extent obtainable on a cost effective basis.
The period that we will hold our investments will vary depending on the type of asset, interest rates, investment performance, micro and macro real estate environment, capital markets and credit availability, among other factors. Our advisor expects to hold debt investments until the stated maturity. We may sell all or a partial ownership interest in an asset before the end of the expected holding period if we believe that market conditions have maximized its value to us or the sale of the asset would otherwise be in the best interests of our stockholders.
Our Strengths
We believe we have a combination of strengths that will contribute to our performance. In executing on our business strategy, we
will benefit from our advisor’s affiliation with our sponsor given our sponsor’s strong track record and extensive experience and capabilities as a publicly traded, diversified commercial real estate investment and asset management company. These strengths include:
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Experienced Management Team—Our sponsor has a highly experienced management team of
investment professionals who have demonstrated track records of operating REITs and delivering strong returns. The senior management team of our sponsor includes executives who acquired and manage the historical and existing portfolio of investments of our sponsor and affiliates, and who possess significant operational and management experience in the real estate industry. We believe our business benefits from the knowledge and industry contacts these seasoned executives have gained through their accomplished careers while investing in numerous real estate cycles. We believe that the accumulated experience of our sponsor’s senior management team will allow us to deploy capital throughout the CRE capital structure fluidly in response to changes in the investment environment. Please see “Management—Directors and Executive Officers” for biographical
information regarding these individuals.
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Real Estate and Lending Experience—Our sponsor has developed a reputation as a leading diversified CRE investment and asset management company because of its strong performance record in underwriting and managing $10.6 billion in real estate investments. From the inception of investing activities through December 31, 2013, the Managed Companies originated or purchased $8.4 billion of CRE debt representing 457 total positions, of which 60% were directly originated. The Managed Companies have realized 153 loan positions totaling $2.4 billion. We believe that we can leverage our sponsor’s extensive real estate and lending experience, deep and thorough
underwriting process, and portfolio management skills to structure and manage our investments prudently and efficiently.
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Public Company and REIT Experience—The common stock of our sponsor has traded on the NYSE under the symbol “NRF” since October 2004. Our sponsor’s management team is skilled in operating public CRE companies, including reporting and compliance with the requirements of the Sarbanes-Oxley Act, including internal control certifications, stock exchange regulations and investor relations. In addition, our sponsor, through advisor entities, currently manages the NorthStar Non-Traded REITs, including us (with the first becoming effective in 2010), which will be advised and managed by NSAM following
the completion of its spin-off from our sponsor. Our sponsor’s management team is also skilled in compliance with the requirements under the Internal Revenue Code to obtain REIT status and to maintain the ability to be taxed as a REIT for U.S. federal income tax purposes. Our sponsor’s management team also has experience listing a REIT on the NYSE.
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Commitment of Sponsor—Our sponsor has agreed to purchase up to an aggregate of $10.0 million in shares of our common stock (which includes the $2.0 million of shares purchased by an affiliate of our sponsor to satisfy the minimum offering amount) at $9.00 per share until May 6, 2015 to the extent cash distributions to our
stockholders at a rate of at least 7% per annum for any calendar quarter exceed MFFO for such quarter. Our sponsor will purchase shares following the end of each quarter for a purchase price equal to the amount by which the cash distributions paid to stockholders exceed MFFO for such quarter, up to an amount equal to a 7% cumulative, non-compounded annual return on stockholders’ invested capital, prorated for such quarter. Notwithstanding our sponsor’s obligations pursuant to the distribution support agreement, we are not required to pay distributions to our stockholders at a rate of 7% per annum or at all. After our distribution support agreement with our sponsor has terminated, we may not have sufficient cash available to pay distributions at the rate we had paid during preceding periods or at all. For more information regarding our sponsor’s share purchase commitment, the purchases of shares thereunder as of the date of this prospectus and our distribution policy,
please see “Description of Capital Stock—Distributions.”
Market Overview and Opportunity
We believe that the market for investment in CRE debt, select equity and securities investments continues to be very compelling from a risk/return perspective. We favor a strategy weighted toward targeting CRE debt investments which maximize current income, with significant subordinate capital and downside structural protections. We believe that our investment strategy, combined with the experience and expertise of our advisor’s management team, will provide opportunities to: (i) originate loans with attractive current returns and strong structural features directly with borrowers, thereby taking advantage of market
conditions in order to seek the best risk-return dynamic for our stockholders; (ii) make select CRE equity investments to participate in potential market and property upside; and (iii) purchase CRE debt and securities from third parties, in some instances at discounts to their face amounts (or par value). We believe the combination of these strategies and the application of prudent leverage to our CRE investments may also allow us to (i) realize appreciation opportunities in the portfolio and (ii) diversify our capital and enhance returns.
We believe that the following market conditions, some of which are byproducts of the recent liquidity crisis and recession, create a favorable investment environment for us.
Investing in our targeted investments provides the
opportunity to participate in a CRE market where values have shown positive trends and are expected to remain positive, while maintaining downside protection. Property capitalization rates and real estate valuations are directly related. By the fourth quarter of 2009, capitalization rates increased 150 basis points for both core and non-core properties from their lowest levels in the second quarter of 2008 and second quarter of 2007, according to data from BofA Merrill Lynch Global Research/NCREIF and Real Capital Analytics, respectively, which resulted in decreasing property values. Since 2009, core and non-core capitalization rates have not fully recovered from peak levels, implying further potential upside in CRE values. Given certain dynamics in the current market including (i) the continuing steady recovery of the economy (as evidenced by the decrease in unemployment shown below); (ii) prevailing low interest rates and (iii) limited new
CRE supply, we expect real estate values to trend positively due to further capitalization rate compression, increased property level net operating income or a combination of both. We believe our portfolio provides an opportunity to benefit in the growth of CRE values while maintaining downside protection in the event the CRE markets do not improve or have future declines, while investing in select CRE equity transactions provides the opportunity to participate directly in this CRE growth.
Commercial Property Price Index and U.S. Unemployment Rate
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Source:
GreenStreet Advisors and Bureau of Labor Statistics, February 2014
Potential benefits exist in our investments in a rising interest rate environment. With an improving economy tend to come rising interest rates; given our intention to focus on floating rate debt investments, we should benefit from such an environment. Quantitative easing by the Federal Reserve and maintenance of historically low interest
rates have contributed to economic recovery, corporate stability and decreased unemployment. The gradual end of those practices should coincide with increased corporate strength and rental growth, which supports a rising interest rate environment, as shown below. We intend to predominantly make CRE debt investments with a coupon consisting of a credit spread over a floating rate index, usually LIBOR. As interest rates rise, the interest income produced by our floating rate investments will also increase, producing more revenue to us. We also intend to finance or match our floating rate assets with floating rate borrowings. Given we only intend to finance a portion of any given investment, the benefit to our investments if LIBOR increases will outpace the increasing cost of our borrowings, resulting in corresponding improved returns on our invested equity. As a result of an improving economy that supports a rising interest rate environment, we believe our emphasis on
floating rate investments may benefit our stockholders.
Continued growth in the CRE markets should result in increased investment opportunities. According to research from Wells Fargo Securities, the third quarter of 2013 represented the first time in five years that the total amount of commercial mortgages outstanding increased on a year-over-year basis. Access to CRE debt is a key element of a healthy CRE market in which increased CRE transaction volume may occur. At the same time, according to a January 2014 report by J.P. Morgan, it is expected that we are toward the early end of an improving CRE cycle due to limited new supply outside specific sectors and markets. According to information from Real Capital Analytics in the chart below, CRE transaction volume has increased steadily since its nadir in 2009 at $67 billion to over $360 billion in 2013. The improving economy may
continue to provide for greater CRE property transaction volume by sellers looking to realize profits and buyers looking to build additional value. In turn, we are well-positioned to take advantage of increased transaction volume due to our ability to provide flexible capital solutions that are soundly structured, while targeting specific portions of the CRE capital stack to maximize our risk-adjusted returns.
Based on independent reports of properties and portfolios $5 million and greater. Data believed to be accurate but not guaranteed.
Our sponsor’s experience, reputation and successful track record provide investment opportunities through existing relationships. The growth and achievements of our sponsor’s existing platform and reputation as a leading diversified CRE investment and asset management company managing $10.6 billion in real estate investments may provide attractive sources of new investments for us. Through the aggregation of its portfolio and the experiences of its management team, our sponsor has accumulated significant relationships with borrowers and operators. Transactions often must close with hard deadlines and capital deposits at risk. Comfort with
our diligence process and the certainty of execution provided on past transactions with our sponsor may provide us with an advantage when competing for new lending opportunities with successful borrowers with established track records. Our sponsor maintains a robust CRE pipeline from which we will source our investment opportunities. To date, our sponsor and its affiliates have originated approximately $3 billion of investments with repeat business relationships. Additionally, our sponsor’s reputation for an efficient investment process and the ability to provide “one-stop shopping” for solutions across the CRE capital structure may provide us with an advantage when competing for business opportunities. We believe these benefits stemming from affiliation with our sponsor will lead to significant investment opportunities.
The increasing number of maturing CRE loans over the next five years is expected to provide an opportunity for refinancing capital. As shown in the chart below, the large volume of scheduled loan maturities over the next several years will provide significant investment opportunities for providers of capital such as our company. On average, approximately $316 billion of CRE debt matures annually from 2014 through 2016 (or approximately $865 million per day), with approximately $1.6 trillion scheduled to mature through 2018. From 2010 through 2013 (as depicted below), average origination volume was $226 billion, indicating that while a significant portion of loans scheduled to mature from 2014 through 2018 may be refinanced through the CRE
debt origination market, many loans will require other sources of capital in order to be refinanced. These loan maturities would be in addition to the volume of loans required to finance the CRE property and sale activity discussed above. The expected wave of maturities may provide us with various investment opportunities throughout the CRE capital structure due to our flexible platform and sponsor’s strong origination capabilities.
Project CRE Loan Maturities
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Source: Barclays Capital,
Barclays Capital U.S. Securitization Research: CMBS - Scaling the maturity wall, 8/16/13. Mortgage Bankers Association Annual Origination Volume Summation 2013.
Capital available from traditional sources of CRE debt cannot satisfy demand. CMBS issuance peaked at approximately $231 billion in 2007 and subsequently plummeted in 2008 and 2009, falling 95% and 99%, respectively. As shown in the chart below,
from 2009 until 2013, the securitization market for CRE debt has seen a gradual increase in activity from $3 billion to $88 billion (including $2 billion of CDO-like securitizations).
According to the Mortgage Bankers Association, the pre-crisis peak lending year for life companies & pension funds was in 2005 when they accounted
for 19% of total CRE lending. Shortly after this peak and unlike CMBS issuers, life companies & pension funds began to decrease their commercial lending volume, demonstrating an early recognition of deteriorating credit fundamentals. Unlike CMBS programs and commercial banks, which both were slow to re-enter the market, life companies & pension funds increased their allocations and finished 2012 19% above their 2005 pre-crisis peak, and went on to set a new record in 2013 originating $60 billion, or 49% more than 2005.
Consistent with the goal of other government-initiated programs to encourage investing in the lending and capital markets, FNM/FRE significantly increased market share during the recession and credit crisis in the multifamily lending markets. As shown in the following graph, FNM/FRE lending volume increased in 2012 by 27% from the previous high of 2008 to become the highest lending year for FNM/FRE. 2013 continued to show strong volume of $47.5 billion, though down 18% from the 2012 high as other lenders competed for greater market share.
CRE Origination Volume
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Source:
Mortgage Bankers Association, 2001 Quarterly Index Average = 100
CMBS, life companies & pension funds and FNM/FRE traditionally focus on a finite subset of the CRE market and operate under restrictive lending standards. The combined production levels for CMBS, life companies & pension funds and FNM/FRE in 2013 totaled $196 billion. This combined total only accounts for approximately 73% of 2014 scheduled loan maturities, implying excess demand from CRE debt borrowers.
Finally, the sum of 2013 total CRE transaction volume of $360 billion plus 2014 expected maturities of $268 billion results in a potential $600 billion market opportunity. Therefore, we believe there is significant demand from borrowers relative to the CRE debt capital available from traditional sources which may provide opportunities for flexible investors with CRE investment capital.
The current market offers opportunities in legacy CRE securities (issued prior to 2008) and the expanding new issue CRE securitization markets. We believe the current CRE securities market presents opportunities for investors with a proven track record, investment process and a focus on investing in the underlying CRE credit (and not just credit ratings) to purchase investment grade or non-investment grade legacy and new issue CMBS. The opportunity to purchase both senior new issue bonds, which have a high level of liquidity and subordinate new issue bonds or “B-pieces” at discounts, may provide attractive current returns while also generating gains through either the increase of market valuations as credit spreads tighten due to improving fundamentals or repayment at par. As shown below, CMBS investments also generate
attractive returns relative to the credit risk of similarly rated bonds backed by alternative collateral types (while direct lending still provides a more significant premium).
Relative Value of CRE Investing
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Source: Barclays Capital Live, April 3, 2014. Cushman & Wakefield Capital Markets Updates 2007 - 2014.
The health and continued development of the CMBS market has trended positively
alongside the improvement of the broader CRE market. According to a January 2014 report by J.P. Morgan, the balance of loans in special servicing has dropped by 18% from $61 billion to $50 billion. Estimates of $86 to $100 billion of new issue CMBS are anticipated in 2014. We also believe the securitization financing transaction market for value add CRE loans will continue to gain acceptance with investors. We expect to participate in the CMBS market in a variety of ways including: (i) the potential to invest in CMBS as a cash alternative in order to increase returns to our shareholders; (ii) the opportunity to purchase B-pieces and legacy bonds at discounts; (iii) the ability of our company to selectively use leverage to increase returns on legacy and new issue senior CMBS bonds; and (iv) the potential for a rising interest rate environment to provide certain opportunities to purchase
CMBS and achieve our targeted returns for our stockholders.
The current CRE secured lending and securitization markets offer us the opportunity to obtain attractive, long-term, non-mark-to-market financing for our debt investments. As liquidity improves in the CRE market (as described above) we anticipate pricing for CRE debt to become more competitive, but we believe the terms to finance our targeted investments will become more favorable, allowing us to generate attractive returns and maintain our competitiveness. We intend to continue to enter into credit facilities and participate in the securitization financing transaction market as an issuer where we can finance our assets with long-term, non-recourse, non-mark-to-market and match-term leverage (i.e., matching the maturity of our investments with the maturity of our borrowings). This financing strategy has been successfully employed by our
sponsor, which has entered into approximately $3.6 billion of term credit facilities and over $2.6 billion of securitization financing transactions combined through the Managed Companies. These
figures include the success achieved by our prior debt-focused sponsored company, NorthStar Income, which has entered into $490 million of secured financing facilities and financed $730 million of its CRE debt investments through securitization
financing transactions. We believe the availability of financing should allow us to source attractive investments and prudently lever certain assets within our portfolio to achieve our targeted risk-adjusted returns (while maintaining downside protection), although there can be no guarantee that this will be the case.
In summary, after the virtual shutdown of the real estate credit markets in 2007 a gradual recovery has taken place. Despite competition from recent increases in lending by banking institutions, specialty finance companies, CMBS lenders, government agencies, REITs, and life companies & pension funds the availability of CRE capital has not yet returned to historical levels and has not done so evenly across the spectrum of CRE investments. We believe certain markets, borrowers and property types remain underserved by these sources of capital. We expect to capitalize on this by providing borrowers with a single
access point for well-structured debt and equity capital throughout the CRE capital stack on quality assets. We further believe that this CRE environment will allow us to favorably finance our investments. We similarly expect the CRE securities market to offer attractive investment opportunities in both legacy and new issue securities given our focus on underlying credit and that it may also provide opportunities to achieve upside through discounted purchases. We believe the combination of (i) the preceding factors and (ii) the expertise, experience and track record of our sponsor in various market environments and in a broad array of CRE investment disciplines provides us an opportunity to generate attractive risk-adjusted returns for our stockholders, although we cannot assure you that this will be the case.
Targeted Investments
We plan to originate, acquire and asset manage a
diversified portfolio of CRE investments consisting of: (i) CRE debt, including first mortgage loans, subordinate mortgage and mezzanine loans and participations in such loans and preferred equity interests; (ii) select CRE equity investments; and (iii) CRE securities, such as CMBS, unsecured debt of publicly traded REITs and CDO notes. We target assets that generally offer predictable current cash flow and attractive risk-adjusted returns based on the underwriting criteria established and employed by our advisor. Our ability to execute our investment strategy is enhanced through access to our sponsor’s direct origination capabilities, as opposed to a strategy that relies solely on buying assets in the open market from third-party originators. We seek to acquire a portfolio that includes some or all of the following investment characteristics: (i) provides current income; (ii) is secured by high-quality CRE; (iii) includes subordinate capital investments by strong sponsors
that support our investments and provide downside protection; and (iv) possesses strong structural features that maximize repayment potential.
Commercial Real Estate Debt
We intend to invest in CRE debt both by directly originating loans and by purchasing them from third-party sellers. Although we generally prefer the benefits of direct origination, situations may arise to purchase CRE debt, possibly at discounts to par, which will compensate the buyer for the lack of control or structural enhancements typically associated with directly structured investments. The experience of our advisor’s management team in both disciplines will provide us flexibility in a variety of market conditions.
Our primary focus will be to originate, acquire and asset manage the following types of CRE debt.
First
Mortgage Loans. First mortgage loans are loans that have the highest priority to claims on the collateral securing the loans in foreclosure. First mortgage loans provide for a higher recovery rate and lower defaults than other debt positions due to the lender’s favorable control features which at times means control of the entire capital structure. Because of these attributes, this type of investment receives favorable treatment from third-party rating agencies and financing sources, which should increase the liquidity of these investments.
Subordinate Mortgage Loans. Subordinate mortgage loans are loans that have a lower priority to collateral claims. Investors in subordinate mortgages are compensated for the increased risk from a pricing perspective as compared to first mortgage loans but still benefit from a direct lien on the related property or a security interest in
the entity that owns the real estate. Investors typically receive principal and interest
payments at the same time as senior debt unless a default occurs, in which case these payments are made only after any senior debt is paid in full. Rights of holders of subordinate mortgages are usually governed by participation and other agreements that, subject to certain limitations, typically provide the holders with the ability to cure certain
defaults and control certain decisions of holders of senior debt secured by the same properties (or otherwise exercise the right to purchase the senior debt), which provides for additional downside protection and higher recoveries.
Mezzanine Loans. Mezzanine loans are a type of subordinate loan in which the loan is secured by one or more direct or indirect ownership interests in an entity that directly or indirectly owns real estate. Investors in mezzanine loans are compensated for the increased credit risk from a pricing perspective and still benefit from the right to foreclose on its security, in many instances more efficiently than first mortgage loans. Upon a default by the borrower under a mezzanine loan, the mezzanine lender generally can take control of the property owning entity on an expedited basis, subject to the rights of the holders of debt senior in priority on the property. Rights of
holders of mezzanine loans are usually governed by intercreditor or interlender agreements that provide the mezzanine lender with the right to cure defaults and limit certain decisions of holders of any senior debt secured by the same properties, which provides for additional downside protection and higher recoveries.
Preferred Equity. Preferred equity is a type of loan secured by the general or limited partner interest in an entity that owns real estate or real estate related investments. Preferred equity interests are generally senior with respect to the payments of dividends and other distributions, redemption rights and rights upon liquidation to such entity’s common equity. Investors in preferred equity are typically compensated for their increased credit risk from a pricing perspective with fixed payments but may also participate in capital appreciation. Upon a default by a general partner of
a preferred equity investor, there is a change of control event and the limited partner assumes control of the entity. Upon an event of default by a limited partner, a limited partner may lose its rights with regard to operational input and become a passive investor. Rights of holders of preferred equity holders are usually governed by partnership agreements that govern who has control over a property and its decision making, when those rights may be revoked and typically have a cash flow waterfall that allocates any distributions of income or principal into and out of the entity.
Equity Participations or “Kickers.” In connection with our debt origination activities, we intend to pursue select equity participation opportunities, in instances when we believe that the risk-reward characteristics of the loan merit additional upside participation because of the possibility of appreciation in value
of the underlying assets securing the loan. Equity participations can be paid in the form of additional interest, exit fees, percentage of sharing in refinance or resale proceeds or warrants in the borrower. Equity participation can also take the form of a conversion feature, permitting the lender to convert a loan or preferred equity investment into equity in the borrower at a negotiated premium to the current net asset value of the borrower. We expect that we may be able to obtain equity participations in certain instances where the loan collateral consists of an asset that is being repositioned, expanded or improved in some fashion which is anticipated to improve future cash flow. In such case, the borrower may wish to defer some portion of the debt service or obtain higher leverage than might be merited by the pricing and leverage level based on historical performance of the underlying asset. We expect to generate additional revenues from these equity participations
as a result of excess cash flows being distributed or as appreciated properties are sold or refinanced.
Commercial Real Estate and Select Commercial Real Estate Equity Investments
CRE. In limited circumstances, the CRE debt investments described above, in particular investments in distressed debt, may result in us owning commercial real property as a result of a loan workout, taking title or similar circumstances. In addition, although making direct investments in commercial real property at this time will not be a significant focus of our investment strategy, we may make investments in commercial real property to take advantage of attractive investment opportunities as described above, which may result in improved economics. We would expect that if we do make direct property acquisitions (as opposed to acquisitions which result from a loan workout, taking
title or similar circumstances), the properties would have occupancy levels consistent with the performance of the local market and would generate accretive and immediate cash flow. Although we may acquire properties with little or no leverage, given the stabilized nature of the targeted properties, we may apply modest levels of leverage to enhance our
returns. In particular, our sponsor and its investment professionals who will
be performing services for us on behalf of our advisor have extensive experience in acquiring, managing and disposing of net leased properties. Net lease properties generally have a small number of tenants with longer leases and few or no landlord responsibilities. We manage and dispose of any real property assets we acquire in the manner that our advisor determines is most advantageous to us.
Select CRE Equity Investments. We may also choose to selectively acquire: (i) equity interests in an entity (including, without limitation, a partnership or a limited liability company) that is an owner of commercial real property (or in an entity operating or controlling commercial real property, directly or through affiliates), which may be structured to receive a priority return or is senior to the owner’s equity (in the case of preferred equity, as discussed above); (ii) certain strategic joint venture opportunities
where the risk-return and potential upside through sharing in asset or platform appreciation is compelling; (iii) private issuances of equity or securities of public companies; and (iv) investments in a loan, security or other obligations for which the business of the related obligor is significantly related to real estate.
These investments may or may not have a scheduled maturity and are expected to be of longer duration (five to ten year terms) than our typical portfolio investment. Such investments are expected to be fixed rate (if they have a stated investment rate) and may have accrual structures and provide other distributions or equity participations in overall returns above negotiated levels. These investments are also expected to be collateralized or otherwise backed primarily by U.S. real estate collateral.
We do not anticipate allocating a large amount of our capital
or time to these investments initially, but as market conditions begin to improve we believe that compelling “equity” opportunities will arise that should generate significant returns. We have not established the specific terms we will require in our joint venture agreements for select CRE equity investments. Instead, we will establish the terms with respect to any particular joint venture agreement on a case-by-case basis after our board of directors considers all of the facts that are relevant, such as the nature and attributes of our other potential joint venture partners, the proposed structure of the joint venture, the nature of the operations, the liabilities and assets associated with the proposed joint venture and the size of our interest when compared to the interests owned by other partners in the venture. We will not, however, invest in a joint venture in which our sponsor, our advisor, any of our directors or officers or any of their affiliates has
an interest without a determination by a majority of our board of directors (including a majority of our independent directors) not otherwise interested in the transaction that such transaction is fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
Although CRE equity investments have not constituted a relatively large portion of our sponsor’s historical investments, we intend to leverage our sponsor’s management team’s extensive prior experience in this specialized sector, as well as our sponsor’s origination capabilities and extensive financial institution relationships to identify a select number of these investment opportunities that are appropriate for our investment portfolio at the appropriate time in the real estate cycle.
Commercial Real Estate Securities
In
addition to our focus on origination of and investments in CRE debt, we may also acquire CRE securities such as CMBS, unsecured REIT debt and interests in other securitization financing transactions that own real estate-related debt, historically referred to as CDO notes. While we may acquire a variety of CRE securities, we expect that the majority of these investments would be CMBS.
CMBS. CMBS are commercial mortgages pooled in a trust and are principally secured by real property or interests. Accordingly, these securities are subject to all of the risks of the underlying loans. CMBS are structured with credit enhancement, as dictated by the major rating agencies and their proprietary rating methodology, to protect against potential cash flow delays and shortfalls. This credit enhancement usually takes the form of allocation of loan losses to investors in reverse sequential order (equity to AAA classes),
whereas interest distributions and loan prepayments are usually applied sequentially (AAA classes to equity).
The typical commercial mortgage is a five or ten-year loan, with a 30-year amortization schedule and a balloon principal payment due on the maturity date. Most fixed-rate commercial loans have strong prepayment protection and require prepayment penalty fees or defeasance. The loans are structured in this manner to maintain the collateral pool’s cash flow or to compensate the investors for foregone interest collections.
Unsecured REIT Debt. We may also choose to acquire senior unsecured debt of publicly traded REITs that acquire and hold real estate. Publicly traded REITs may own large, diversified pools of CRE properties or they may focus on a specific type of property, such as regional malls, office properties, apartment properties and industrial warehouses. Publicly traded REITs typically employ moderate leverage. Corporate bonds issued by these types of REITs are usually rated investment grade and benefit from strong covenant protection.
CDO Notes. CDOs are multiple class debt notes, secured by pools of assets, such as CMBS, CRE first mortgage or mezzanine loans and unsecured REIT debt. Accordingly, these securities are subject to all of the risks of the underlying loans.
CDOs are structured with credit enhancement levels, as dictated by the rating agencies and their proprietary rating methodology, which involves an underwriting of the underlying assets and contemplated CDO structure. The most constraining rating agency determines the thickness of each tranche of debt (or bond class) and its subordination levels (ability to withstand losses to the underlying assets). CDOs typically require the allocation of loan losses to bond investors in reverse sequential order (equity to AAA classes), whereas interest distributions and loan prepayments are usually applied sequentially (AAA classes to equity). CDOs often include principal and interest coverage tests ratios to protect against principal and interest cash flow delays or to re-direct cash flows to the then-most senior outstanding class of debt. Breaches of principal or interest coverage tests may result in an acceleration of payment of principal and/or interest to senior classes, which
may result in loss to junior bond classes. Like typical securitization structures, in a CDO, the assets are pledged to a trustee for the benefit of the holders of the bonds. CDOs often have reinvestment periods, during which time, proceeds from the sale of a collateral asset may be invested in substitute collateral. Upon termination of the reinvestment period, the static pool functions very similarly to a CMBS securitization where repayment of principal allows for redemption of bonds sequentially.
Other Investments
Although we expect that most of our investments will be of the types described above, we may make other investments, such as international investments. In fact, we may invest in whatever types of interests in real estate or debt-related assets that we believe are in our best interests. Although we can purchase any type of interest in real estate or debt-related assets,
our charter does limit certain types of investments. See “—Investment Limitations.”
Investment Process
Our advisor has the authority to make all the decisions regarding our investments consistent with the investment guidelines and borrowing policies approved by our board of directors and subject to the limitations in our charter and the direction and oversight of our board of directors. Our board of directors must approve all investments other than investments in CRE debt and securities. With respect to investments in CRE debt and securities, our board of directors has adopted investment guidelines that our advisor must follow when acquiring such assets on our behalf without the approval of our board of directors. We will not, however, purchase or lease assets in which our advisor, any of our directors or officers or any of their affiliates has an interest without a determination
by a majority of our board of directors (including a majority of our independent directors) not otherwise interested in the transaction that such transaction is fair and reasonable to us and at a price to us no greater than the cost of the asset to the affiliated seller or lessor, unless there is substantial justification for the excess amount and such excess is reasonable. Our board of directors formally reviews at a duly-called meeting our investment guidelines on an annual basis and our investment portfolio on a quarterly basis or, in each case, more often as they deem appropriate. Changes to our investment guidelines must be approved by our board of directors.
Our advisor will focus on the origination and acquisition of CRE investments. It sources our investments from new or existing customers, former and current financing and investment partners, third-party intermediaries, competitors looking to share risk and securitization
or lending departments of major financial institutions.
In selecting investments for us, our advisor will utilize our sponsor’s established investment and underwriting process, which focuses on ensuring that each prospective investment is being evaluated appropriately. The criteria that our advisor will consider when evaluating prospective investment opportunities include:
•
stringent
evaluation of the market in which a property is located, such as local supply constraints, the quality and nature of the local workforce and prevailing local real estate values;
•
fundamental analysis of the property and its operating performance, including tenant rosters, lease terms, zoning, operating costs and the asset’s overall competitive position in its market;
•
the operating expertise and financial strength of the sponsor, borrower or tenant;
•
real
estate and leasing market conditions affecting the underlying real estate collateral;
•
the cash flow in place and projected to be in place over the term of the CRE investments;
•
the appropriateness of estimated costs and timing associated with capital improvements of the property;
•
a valuation
of the investment, investment basis relative to its value and the ability to liquidate an investment through a sale or refinancing of the underlying asset;
•
review of third-party reports, including appraisals, engineering reports and environmental reports;
•
physical inspections of the property; and
•
the
overall structure of the investment and rights in the collateral documentation.
If a potential investment meets our advisor’s underwriting criteria, our advisor will review the proposed transaction structure, including security, reserve requirements, cash flow sweeps, call protection and recourse provisions. Our advisor will evaluate the asset’s position within the overall capital structure and its rights in relation to other capital providers. In addition, our advisor will analyze each potential investment’s risk-return profile and review financing sources, if applicable, to ensure that the investment fits within the parameters of financing strategies and to maximize performance of the underlying real estate collateral. We will generally not complete any investment until the successful completion of due diligence, which includes the satisfaction of all applicable elements of our investment and underwriting
process and a Phase I assessment of any property underlying CRE debt and of our select equity investments. In addition, we may also conduct additional environmental site assessments to the extent our management team believes such assessments are necessary or advisable.
Borrowing Policy
We have financed and may continue to finance our investments to provide more cash available for investment and to generate improved returns. We believe that careful use of leverage will help us to achieve our diversification goals and potentially enhance the returns on our investments. Our charter precludes us from borrowing in excess of an amount that is generally expected to approximate 75% of the aggregate cost of our investments, plus cash, before deducting loan loss reserves, other non-cash reserves and depreciation. However, we may enter into financing arrangements that further limit our borrowing
capacity. Alternatively, we may borrow in excess of these amounts if such excess is approved by our board of directors, including a majority of our independent directors, and disclosed to stockholders in our next quarterly report along with justification for the excess. Our board of directors reviews our aggregate borrowings, including secured and unsecured liabilities, at least quarterly to ensure the amount remains reasonable in relation to our net assets and may from time-to-time modify our leverage policy in light of then-current economic conditions, relative costs of debt and equity capital, fair value of our assets, growth and acquisition opportunities or other factors they deem appropriate.
Credit Risk Management. We may be exposed to various levels of credit and special hazard risk depending on the nature of our investments and the nature and level of credit enhancements supporting our CRE investments. Our advisor and our executive officers review and monitor credit risk and other risks of loss associated with each investment. In addition, we will seek to diversify our portfolio of assets to avoid undue geographic or borrower concentrations. Our board of directors monitors the overall portfolio risk and levels of provision for loss.
Interest Rate Risk Management. We follow an interest rate risk management policy intended to manage refinancing and interest rate risk. We will generally
seek to match-fund our assets and liabilities by having similar maturities and like-kind interest rate benchmarks (fixed or floating) to manage refinancing and interest rate risk. As part of this strategy, we may engage in hedging transactions, which will primarily include interest rate swaps and may include other hedging instruments. These instruments may be used to hedge as much of the interest rate risk as we determine is in the best interest of our stockholders, given the cost of such hedges and the need to maintain our qualification as a REIT. We may elect to bear a level of interest rate risk that could otherwise be hedged when we believe, based on all relevant facts, that bearing such risk is advisable or economically unavoidable.
Equity Capital Policies. Our board of directors may amend our charter to increase the number of authorized shares of capital stock or the number of shares of stock
of any class or series that we have authority to issue without stockholder approval. After your purchase in our offering, our board may elect to: (i) sell additional shares in this or future public offerings; (ii) issue equity interests in private offerings; (iii) issue shares to our advisor, or its successors or assigns, in payment of an outstanding fee obligation or to our sponsor pursuant to its commitment to purchase shares at our request as needed to fund distributions until May 6, 2015 in the amount by which cash distributions paid for any calendar quarter exceeds MFFO for such quarter; or (iv) issue shares of our common stock to sellers of assets we acquire in connection with an exchange of limited partnership interest of our operating partnership. Our board of directors may also determine to issue different classes of stock which have different fees and commissions from those being paid with respect to the shares
being sold in our offering. To the extent we issue additional equity interests after your purchase in our offering, your percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our investments, you may also experience dilution in the book value and fair value of your shares.
Disposition Policies
Although we generally expect to hold our CRE debt until the stated maturity of such debt, the period that we will hold our investments will vary depending on the type of asset, interest rates, micro- and macro- economic conditions and credit environments, among other factors. Our advisor will continually perform a hold-sell analysis on each investment we own in order to determine the optimal time to hold the asset and generate a strong return to our stockholders. Economic and market conditions may
influence us to hold our investments for different periods of time. We may sell an asset before the end of the expected holding period if we believe that market conditions have maximized its value to us or the sale of the asset would otherwise be in the best interests of our company.
Investment Limitations
Our charter places numerous limitations on us with respect to the manner in which we may invest our capital prior to a listing of common stock. Pursuant to our charter, we may not:
•
invest in commodities or commodity futures contracts,
except for futures contracts when used solely for the purpose of hedging in connection with our ordinary business of investing in CRE investments;
•
invest in real estate contracts of sale, otherwise known as land sale contracts, unless the contract is in recordable form and is appropriately recorded in the chain of title;
•
make
or invest in individual mortgage loans unless an appraisal is obtained concerning the underlying property, except for those loans insured or guaranteed by a government or government
agency. In cases where a majority of our independent directors determine and in all cases in which the transaction is with any of our directors, our advisor, our sponsor or any affiliate thereof, we will obtain an appraisal from an independent
appraiser. We will maintain such appraisal in our records for at least five years and it will be available for your inspection and duplication. We will also obtain a mortgagee’s or owner’s title insurance policy or commitment as to the priority of the mortgage or condition of the title;
•
make or invest in mortgage loans that are subordinate to any loan or equity interest of any of our directors, our advisor, our sponsor or any of our affiliates;
•
invest in equity securities, unless a majority of our directors (including a majority
of independent directors) not otherwise interested in the transaction approves such investment as being fair, competitive and commercially reasonable;
•
make or invest in mortgage loans, including construction loans, on any one real property if the aggregate amount of all loans on such real property would exceed an amount equal to 85% of the appraised value of such real property as determined by appraisal, unless substantial justification exists because of the presence of other underwriting criteria;
•
make investments
in unimproved real property or loans on unimproved real property in excess of 10% of our total assets;
•
issue “redeemable securities,” as defined in Section 2(a)(32) of the Investment Company Act (this limitation, however does not limit or prohibit the operation of our share repurchase program);
•
issue debt securities unless the historical debt service coverage (in the most recently completed fiscal year) as adjusted for known changes is anticipated to be sufficient to properly service that higher level of
debt;
•
grant options or warrants to purchase shares to our advisor, our directors, our sponsor or any affiliate thereof except on the same terms as the options or warrants, if any, are sold to the general public. Further, the amount of the options or warrants issued to such persons cannot exceed an amount equal to 10% of our outstanding shares on the date of grant of the warrants and options;
•
issue shares on a deferred payment basis or under similar arrangement;
•
engage
in trading, except for the purpose of short-term investments;
•
engage in underwriting or the agency distribution of securities issued by others;
•
invest in the securities of any entity holding investments or engaging in activities prohibited by our charter; and
•
make any investment that
our board of directors believes will be inconsistent with our objectives of qualifying and remaining qualified as a REIT unless and until our board of directors determines, in its sole discretion, that REIT qualification is not in our best interests.
Investment Company Act Considerations
Neither we nor our operating partnership nor any of the subsidiaries of our operating partnership intend to register as an investment company under the Investment Company Act. Under Section 3(a)(1) of the Investment Company Act, an issuer is deemed to be an “investment company” if:
•
it
is, or holds itself out as being, engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities, or the holding-out test; and
•
it is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire “investment securities” having a value exceeding 40% of the value of its total assets on an unconsolidated basis, or the 40% test. “Investment securities” excludes U.S. government securities and securities of majority-owned subsidiaries that are not themselves investment companies and are not relying on the
exclusion from the definition of investment company under Section 3(c)(1) or Section 3(c)(7) (relating to private investment companies).
We are organized as a holding company that conducts its businesses primarily through our operating partnership. Both we and our operating partnership intend to conduct each of our operations so that we comply with the 40% test. The securities issued to our operating partnership
by any wholly owned or majority-owned subsidiaries that we may form in the future that are excluded from the definition of “investment company” based on Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities our operating partnership may own, may not have a value in excess of 40% of the value of our operating partnership’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. We monitor our holdings to ensure continuing and ongoing compliance with this test. In addition, we believe neither we nor our operating partnership will be considered an investment company under Section 3(a)(1)(A) of the Investment Company Act because neither we nor our operating partnership will engage primarily or hold ourselves out as being engaged primarily in the business of investing, reinvesting or
trading in securities. Rather, through our operating partnership’s wholly owned or majority-owned subsidiaries, we and our operating partnership will be primarily engaged in the noninvestment company businesses of these subsidiaries.
We expect that most of our assets will be held, directly or indirectly, through wholly owned or majority-owned subsidiaries of our operating partnership. We further expect that most of these subsidiaries will be able to rely on Section 3(c)(5)(C) of the Investment Company Act for an exclusion from the definition of an investment company.
The other subsidiaries of our operating partnership should be able to rely on the exclusions for private investment companies pursuant to Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act. Additionally, we may in the future organize special purpose subsidiaries of our operating partnership that will borrow under or participate in government-sponsored incentive programs that seek to rely on the Investment Company Act exclusion provided to certain structured financing vehicles by Rule 3a-7.
We expect that most of our investments will be held by wholly owned or majority-owned subsidiaries of our operating partnership and that most of these
subsidiaries will rely on the exclusion from the definition of an investment company under Section 3(c)(5)(C) of the Investment Company Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on, and interests in, real estate.” This exclusion generally requires that at least 55% of a subsidiary’s portfolio must be comprised of qualifying real estate assets and at least 80% of its portfolio must be comprised of qualifying real estate assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets).
For the purposes of the exclusion provided by Sections 3(c)(5)(C), we will classify the investments made by our subsidiaries based in
large measure on no-action letters issued by the SEC staff and other SEC interpretive guidance and, in the absence of SEC guidance, on our view of what constitutes a qualifying real estate asset and a real estate related asset. Qualification for exclusion from registration under the Investment Company Act will limit our ability to acquire or sell certain assets and also could restrict the time at which we may acquire or sell assets.
In August 2011, the SEC solicited public comment on a wide range of issues relating to Section 3(c)(5)(C) of the Investment Company Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage REITs should be regulated in a manner similar to investment companies. There can be no assurance that the laws and regulations governing the Investment Company Act status of REITs, including the more specific or different guidance regarding this exclusion that may
be published by the SEC or its staff will not change in a manner that adversely affects our operations. We cannot assure you that the SEC or its staff will not take action that results in our or our subsidiary’s failure to maintain an exemption or exclusion from the Investment Company Act.
Subject to then existing market conditions, we expect to consider alternatives for providing
liquidity to our stockholders beginning five years from the completion of our offering stage; however, there is no definitive date by which we must do so. While we expect to seek a liquidity transaction in this time frame, a suitable transaction may not become available and market conditions for a transaction may not be favorable during that time frame. Our board of directors has the discretion to consider a liquidity transaction at any time if it determines such event to be in our best interests. A liquidity transaction could consist of a sale or partial sale or roll-off to scheduled maturity of our assets, a sale or merger of our company, a listing of our shares on a national securities exchange or a similar transaction. Some types of liquidity transactions require, after approval by our board of directors, approval of our stockholders. We do not have a stated term, as we believe
setting a finite date for a possible, but uncertain future liquidity transaction may result in actions that are not necessarily in the best interest or within the expectations of our stockholders. In the event that we determine not to pursue a liquidity transaction, you may need to retain your shares for an indefinite period of time.
Prior to our completion of a liquidity transaction, our share repurchase program may provide an opportunity for you to have your shares of common stock repurchased, subject to certain restrictions and limitations. See “Description of Capital Stock—Share Repurchase Program.”
The following table presents our CRE debt investments as of April 16, 2014:
Collateral
Type
Location
Initial Maturity Date
Principal Amount
Spread Over LIBOR (1)
Current Yield
Loan-to-value (2)
Origination
Fee
Exit Fee
First Mortgage Loans
Hotel
Dallas,
TX
Apr-16
$
75,000
75,000
5.1
%
10.0
%
82.0
%
—
%
0.75
%
Multifamily
Savannah,
GA
Sep-16
25,500
25,500
6.3
%
10.4
%
84.0
%
1.0
%
1.0
%
Multifamily
/ Retail
Norfolk, VA
Jun-17
39,200
5.4
%
8.4
%
85.0
%
0.75
%
1.0
%
Total
/ Weighted Average
$
139,700
5.4
%
9.5
%
____________________
(1) Certain
loans are subject to a LIBOR floor. The weighted average LIBOR floor is 0.12%.
(2)
The loan-to-value ratio is the amount loaned by us, net of reserves funded and controlled by us and our affiliates, if any, over the appraised value of the property securing the loan at the time of origination.
Trellis Apartments Loan
On January 9, 2014, we, through a subsidiary of our operating partnership, completed the purchase of a $25.5 million senior loan, or the Trellis senior loan, secured by a multifamily property located in Savannah, Georgia. The Trellis senior loan was originated on August 22,
2013 by an affiliate of our sponsor. We acquired the Trellis senior loan at our sponsor’s cost basis through multiple purchases, which were approved by our board of directors, including all of our independent directors, in accordance with our conflicts of interest policy.
The Trellis senior loan is secured by a 264-unit, class-A multifamily property located in Savannah, Georgia. The property was constructed in 2009 and is located approximately 10 miles from downtown Savannah, in close proximity to major transportation routes and regional employers. The property consists of 11 buildings containing 285,000 square feet. The borrower and its affiliates have extensive commercial real estate experience and currently own and manage over 11,000 multifamily units throughout the southeastern United States.
The Trellis senior loan bears interest at a floating rate of 6.30% over one-month
LIBOR, but at no point shall LIBOR be less than 0.25%, resulting in a minimum interest rate of 6.55% per annum. We will earn a fee equal to 1.0% of the outstanding principal amount at the time of repayment. The Trellis senior loan is currently financed on our secured term credit facility with Citibank, N.A., or Citibank.
The initial term of the Trellis senior loan is 36 months, with two one-year extension options available to the borrower, subject to the satisfaction of certain performance tests and the borrower paying a fee equal to (i) 0.25% of the amount being extended for the first extension option and (ii) 0.50% of the amount being extended for the second extension option. The Trellis senior loan may be prepaid at any time during the first 18 months, provided the borrower pay an additional amount equal to the greater of: (i) the remaining interest due on the amount prepaid through month 18; and (ii) 1.0% of the amount
prepaid. Thereafter, the Trellis senior loan may be prepaid in whole or in part without penalty.
201 W 21st Street Multifamily Loan
On February 20, 2014, we, through a subsidiary of our operating partnership, directly originated a $39.2 million senior loan, or the 201 senior loan, secured by a multifamily property located in Norfolk, Virginia. We funded the 201 senior loan with a combination of proceeds from our offering and an advance under our secured term credit facility with Citibank.
The property consists of a 225-unit, Class A multifamily property containing 14,900 square feet of ground-floor retail space and a 437-space covered parking garage. In total, the multifamily and retail components of the property contain
237,000 square feet. The property is managed by an affiliate of the borrower, an experienced real estate owner and operator that manages over 8,000 multifamily units located throughout the eastern United States.
The 201 senior loan bears interest at a floating rate of 5.35% over one-month LIBOR, but at no point shall LIBOR be less than 0.25%, resulting in a minimum interest rate of 5.60%. We earned an upfront fee equal to 0.75% of
the 201 senior loan amount at closing and will earn a fee equal to 1.0% of the outstanding principal amount of the 201 senior loan at the time of repayment.
The initial term of the 201 senior loan is 39 months, with two one-year extension options available to the borrower, subject to the satisfaction of certain performance tests and the payment of a fee equal to 0.25% of the amount being extended for the second one-year extension. The 201 senior loan may be prepaid during the first 24 months, provided the borrower pays an additional amount equal to the greater of: (i) the remaining interest due on the amount prepaid through month 24; and (ii) 1.0% of the amount prepaid. Thereafter, the 201 senior loan may be prepaid in whole or in part without penalty.
Hilton Dallas Loan
On March 28, 2014,
we, through a subsidiary of our operating partnership, together with an affiliate of our sponsor, co-originated a $75.0 million senior loan, or the Hilton Dallas loan, secured by a Hilton hotel located in Dallas, Texas. We initially originated a $70.0 million pari passu participation interest in the Hilton Dallas loan, and on April 8, 2014, purchased, at cost, the remaining $5.0 million pari passu participation from an affiliate of our sponsor. The related-party aspects of the transaction were approved by our board of directors, including all of our independent directors, in accordance with our conflicts of interest policy. We funded the Hilton Dallas loan with a combination of proceeds from our offering and an advance under our secured credit facility with Citibank.
The 500-room property also contains 34,800 square feet of meeting space and is located within the mixed-use
office complex known as Lincoln Centre, which contains over 1.6 million square feet of rentable office space. In total, the property contains 452,000 square feet and is managed by an affiliate of Hilton Hotels & Resorts, a leading global hospitality brand.
The Hilton Dallas loan bears interest at a floating rate of 5.05% over one-month LIBOR. We will earn a fee equal to 0.75% of the outstanding principal balance of the Hilton Dallas loan at the time of repayment.
The initial term of the Hilton Dallas loan is 24 months, with three one-year extension options available to the borrower, subject to the satisfaction of certain performance tests and the payment of a fee equal to 0.25% of the amount being extended for the second and third one-year extensions. The Hilton Dallas loan may be prepaid during the first 20 months, provided the borrower pays an additional amount equal to the
greater of: (i) the remaining interest due on the amount prepaid through month 20; and (ii) 1.0% of the amount prepaid. Thereafter, the Hilton Dallas loan may be prepaid in whole or in part without penalty.
Information Regarding our Debt Investments
In general, the underlying loan documentation for our debt investments requires our borrowers to comply with various financial and other covenants. In addition, these agreements contains customary events of default (subject to certain materiality thresholds and grace and cure periods). The events of default are standard for agreements of this type and include, for example, payment and covenant breaches, insolvency of the borrower, the occurrence of an event of default relating to the collateral or a change in control of the borrower.
Our Borrowings
Citi
Credit Facility
On October 15, 2013, we, through a subsidiary of our operating partnership, entered into a Master Repurchase Agreement, or the Citi credit facility, with Citibank, which provides up to $100.0 million to finance first mortgage loans and senior loan participations secured by commercial real estate, as described in more detail in the Citi credit facility documentation.
Advances under the Citi credit facility accrue interest at per annum rates of one-month LIBOR plus a spread ranging from 2.50% to 3.00%. The Citi credit facility provides for advance rates up to 75%, depending on asset type, subject to adjustment. The initial maturity date of the Citi credit facility is October
15, 2016, or the initial term, with a one-year extension at our option, which may be exercised upon the satisfaction of certain conditions set forth in the Citi credit facility. During the initial term, the Citi credit facility acts as a revolving credit facility that can be paid down and subsequently re-drawn.
In connection with the Citi credit facility, we entered into a limited guaranty, or the guaranty, under which we agreed to guaranty certain obligations under the Citi credit facility. We also agreed to guaranty the obligations under the Citi credit facility if we engage in customary bad acts.
The Citi credit facility and guaranty contain representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary
for agreements of these types. The Citi credit facility contains a financial covenant that requires us to maintain at least $3.75 million and a maximum of $15.0 million in unrestricted cash, depending on the amount drawn, during the term of the Citi credit facility. In addition, the guaranty contains financial covenants that require us to maintain: (i) a tangible net worth, as defined in the guaranty, equal to the lesser of (a) total equity equal to $162,000, subject to increases equal to 80% of aggregate net proceeds raised from our offering and (b) $250.0 million; (ii) a ratio of EBITDA, as defined in the guaranty, to fixed charges of not less than 1.4x; and (iii) a ratio of total borrowings to total equity not greater than 300%.
As of April 16, 2014, we had $81.1 million of borrowings outstanding under the Citi credit facility.
The information below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes, each included in our Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated by reference into this prospectus.
The information presented in this section represents the historical operating results for our sponsor and the experience of real estate programs sponsored by our sponsor, which we refer to as the “prior real estate programs.” Investors in our shares of common stock should not assume that they will experience returns, if any, comparable to those experienced by investors in our sponsor or its prior real estate programs. Investors who purchase our shares of common stock will not thereby acquire any ownership interest in any of the entities to which the following information relates.
The returns to our stockholders will depend in part on the mix of assets in which we invest, the stage of investment and the place
in the capital structure for our investments. As our portfolio is unlikely to mirror in any of these respects the portfolios of our sponsor or its prior real estate programs, the returns to our stockholders will vary from those generated by our sponsor or its prior real estate programs. Other than NorthStar Income and NorthStar Healthcare, the prior real estate programs were conducted through privately-held entities that were not subject to either the up-front commissions, fees and expenses associated with our offering or many of the laws and regulations to which we will be subject. In addition, our sponsor is an internally managed, publicly traded company with an indefinite duration. As a result, you should not assume the past performance of our sponsor or the prior real estate programs described below will be indicative of our future performance.
Overview of Our Sponsor
Our
sponsor is a publicly traded company that is internally managed and operates as a REIT. Our sponsor is a diversified commercial real estate investment and asset management company that was formed in October 2003. In October 2004, our sponsor commenced its operations upon the closing of its initial public offering. In addition to its own assets, our sponsor currently manages assets on behalf of the NorthStar Non-Traded REITs including us, NorthStar Income and NorthStar Healthcare.
Since our sponsor’s initial public offering through December 31, 2013, our sponsor has raised $4.2 billion of capital including common equity, preferred equity, trust preferred securities and exchangeable senior notes.
The following table presents distributions paid and distribution yield for shares of our sponsor’s common stock for the years ended December 31,
2013, 2012 and 2011:
Distributions
paid during a quarter are generally based on the prior quarter’s income. As a result, such distributions paid may not agree to distributions declared for the same period.
(2)
Distributions paid represented a 100% return of capital for 2013 and 2011.
(3)
Because the distribution yield is based on the average stock price, increases in yield could be attributable to decreases in stock price, rather than increases in distribution amounts.
The following table presents the sources of distributions paid on our sponsor’s common and preferred stock for the years ended December 31, 2013, 2012 and 2011. During the periods presented below, operating cash flow have been less than total dividends and distributions paid for seven of the 12 fiscal quarters (dollars in thousands):
Preferred dividends to healthcare venture partner(1)
—
(5,658
)
Common
dividends
(179,258
)
(85,663
)
(40,803
)
Total dividends and distributions paid
$
(234,774
)
$
(112,688
)
$
(67,386
)
___________________
(1)
On
July 14, 2011, our sponsor repaid a $100 million preferred membership interest.
Our sponsor’s primary business objectives are similar to ours. Our sponsor seeks to produce attractive risk-adjusted returns and to generate predictable cash flow for distribution to its stockholders derived from a portfolio of real estate-related investments. The profitability and performance of our sponsor’s business is a function of several metrics: (i) growth in cash available for distribution, or CAD, which is a non-GAAP measure of operating performance; (ii) credit losses or impairment; and (iii) growth in assets of the Managed Companies. The diversification of our sponsor’s portfolio and the underwriting and portfolio management capabilities of the members of our sponsor’s management team, who also serve our advisor’s management team, are additional important factors in
the performance of our sponsor’s business. Since the completion of its initial public offering through December 31, 2013, our sponsor has grown its assets by more than 500% and demonstrated a total return to shareholders of 161% (based on price performance, including reinvestment of dividends, calculated based on data provided by Bloomberg Finance, LP).
On December 10, 2013, our sponsor announced that its board of directors unanimously approved a plan to spin-off its asset management business into a separate publicly traded company. In connection with the proposed spin-off, our sponsor formed NSAM. Our sponsor will be externally managed by NSAM through a management contract with an initial term of 20 years. An affiliate of NSAM will also
manage us, NorthStar Income, NorthStar Healthcare and any other companies our sponsor and its affiliates may manage or sponsor in the future. We refer to our sponsor, us, NorthStar Income and NorthStar Healthcare collectively as the Managed Companies.
In addition, NSAM will own NorthStar Realty Securities, our dealer manager, and perform other asset management-related services. NSAM will be led by our sponsor’s current management team, which has a proven track record of managing and growing both our sponsor and its managed companies. The spin-off is expected to be completed in the second quarter of 2014 and we expect shares of NSAM common stock to be listed on the NYSE.
As of December 31, 2013, the Managed Companies have approximately $10.6 billion of assets, including $8.6 billion at our sponsor, $1.8 billion at NorthStar Income,
$115.8 million at NorthStar Healthcare and $25.3 million at our company.
A number of publicly traded companies, or affiliates of publicly traded companies, are sponsors, advisors or sub-advisors to non-traded REITs and business
development companies, or BDCs. Investors often look to these entities’ experience and prior performance track record as representative of their ability to raise and manage similar pools of capital. Total return information may be influenced by many factors that are not related to a sponsor’s ability to raise and manage similar pools of capital as the programs it sponsors. Although total return of a sponsor is not necessarily indicative of the prior or future performance of the programs it sponsors, a comparison of these companies since September 6, 2011 (the first day all were publicly traded) demonstrates that our sponsor has significantly outperformed the companies included in the competitive set as shown below.
Source:
Bloomberg Finance, LP. Total Returns based on closing stock price at the beginning date of the period and closing stock price at end date of period using a daily ending convention. Assumes dividends are not reinvested and, if applicable, split adjusted. 1) The peers included in this chart, or their affiliates, have all sponsored and advised a non-traded REIT or business development company. 2) Based on the most recent initial public offering date of the companies in the competitive set. 3) You should not assume that the past performance of NorthStar Realty Finance Corp. (NYSE: NRF) will be indicative of our future performance. There is no public trading market for our shares. Our sponsor’s business and operations is dependent on the CRE finance industry generally, which in turn is dependent upon broad economic conditions in the U.S. and abroad. Adverse conditions in the CRE finance industry could harm our sponsor’s business and financial condition by, among other factors,
reducing the value of its existing assets, limiting its access to debt and equity capital, harming its ability to originate new CRE debt and otherwise negatively impacting its operations.
Investment Track-Record
Commercial Real Estate Debt
As of December 31, 2013, $2.2 billion, or 21%, of the Managed Companies’ assets were invested in CRE debt across a portfolio of 68 loan positions with an average investment size of $28.8 million secured by liens on CRE investments of varying security and property types and includes $45 million principal amount of loans related to certain investments accounted for as joint ventures. The Managed Companies’ CRE debt portfolio was comprised of first mortgage loans (63%), mezzanine loans (13%), subordinate mortgage interests (13%) and term loans (11%).
The
following presents the portfolio’s diversity across property type and geographic location as of December 31, 2013, based on principal amount.
From the inception of investing activities through December 31, 2013, the Managed Companies originated or purchased $8.4 billion of CRE debt representing 457 total positions, of which 60% were directly originated, 24% were purchased from third parties and 16% were bought as part of CDO portfolio acquisitions including a total of $297.8 million of healthcare-related CRE debt representing 26 positions. Excluding CDO portfolio acquisitions, the Managed Companies have been repaid on 153 of these loan positions totaling $2.4 billion at a weighted average return on equity of 18% while experiencing limited losses on these repaid loans. Furthermore and including CDO portfolio acquisitions, 17 healthcare-related CRE debt positions, totaling $244.0 million, have
been repaid.
The Managed Companies, excluding CDO portfolio acquisitions, have realized a 17% weighted average return on equity on 73 first mortgage positions of $1.2 billion, a 19% weighted average return on equity on 29 subordinate mortgage positions of $486.0 million, an 18% weighted average return on equity on 49 mezzanine positions of $763.0 million and a 34% weighted average return on equity on two preferred equity positions of $28.0 million.
In funding its various portfolios of CRE debt, the Managed Companies have endeavored to supplement its equity with available financing that matches the term or maturity of its assets. As of December 31, 2013, the Managed Companies have successfully obtained long-term, non-mark to market, match-funded financing for 85% of its CRE debt portfolio.
Commercial
Real Estate
Our sponsor’s real estate business involves investing in healthcare and net lease properties and other real estate investments such as acquiring manufactured housing communities and investments in joint ventures owning indirect investments in real estate through private equity real estate funds.
Healthcare Properties
As of December 31, 2013, the Managed Companies’ healthcare property portfolio comprised $632.4 million, or 6% of assets in 93 healthcare properties, which are comprised of 55 assisted living facilities, or ALF, 29 skilled nursing facilities, or SNF, six independent living facilities, or ILF, two memory care facilities, or MCF, and one medical office building, or MOB. All of the healthcare property portfolio was leased to or managed by third-party operators with
weighted average lease coverage of 1.1x and a 6.8 year weighted average remaining lease term, generating a current return on equity of 13%. According to the American Senior Housing Association, our sponsor was the 22nd largest owner of senior housing properties in the United States.
From inception through December 31, 2013, the Managed Companies purchased a total of $890.9 million of investments in healthcare-related investments in 139 separate properties. The Managed Companies have invested $233.4 million of equity in healthcare properties since 2006. A majority of the healthcare properties in the portfolio have been financed with mortgages provided by various financial institutions totaling $657.5 million. The Managed Companies sold 39 healthcare properties in four separate transactions for $207.0 million and generated an annualized return on equity of 13% and total return
on equity of 19%.
The following presents the Managed Companies’ healthcare property portfolio by property type and geographic location as of December 31, 2013:
Healthcare
by Property Type(1)
Healthcare by Geographic Location(2)
___________________
(1)
Based
on purchase price, or cost.
(2)
Based on number of beds.
Net Lease Properties
As of December 31, 2013, $401.4 million, or 4%, of the Managed Companies’ assets were invested in 26 net lease properties, including one property with three buildings owned through an unconsolidated joint venture, consisting of a portfolio of office, retail and industrial properties totaling 3.2 million square feet with a weighted average remaining lease term of 4.8 years. As of December 31, 2013, these net lease properties were 97% leased generating a current
return on equity of 9%.
From inception through December 31, 2013, the Managed Companies sold four net lease properties totaling 85,455 square feet for a total gain on sale of $44 million. The Managed Companies have invested $121.2 million of equity in net lease properties since 2006. 90% of the properties in the portfolio have been financed with mortgages provided by various financial institutions and/or portfolio level corporate financing totaling $426.7 million. The following presents the Managed Companies’ net lease portfolio across property type and geographic location as of December 31, 2013, based on purchase price, or cost.
Net
Lease by Property Type
Net Lease by Geographic Location
Multifamily Properties
As of December 31, 2013, $504.6 million, or 5%, of the Managed Companies’ assets were invested in 15 multifamily properties representing 6,200 units throughout the United States generating a current
return on equity of 11%. The Managed Companies have invested $135.5 million of equity in multifamily properties since 2013. All of the properties in the portfolio have been financed with mortgages provided by various financial institutions.
The following presents the Managed Companies’ multifamily portfolio across geographic location as of December 31, 2013, based on cost:
Manufactured
Housing Properties
As of December 31, 2013, $1.5 billion, or 14%, of the Managed Companies’ assets were invested in a joint venture with a private investor that owns 119 manufactured housing communities comprised of 27,722 pad rental sites located predominantly in Colorado, Florida, Utah, Texas, New York and Kansas.
The Managed Companies have invested $387.2 million of equity in manufactured housing properties since 2013. All of the properties in the manufactured housing portfolio have been financed with mortgages provided by various financial institutions totaling $1.1 billion, generating a current return on equity of 13%.
The following presents the Managed Companies’ manufactured housing portfolio across geographic location as of December 31,
2013, based on net cash flow(1):
Manufactured Housing by Geographic Location
___________________
(1)
Based on trailing twelve month actual rent less operating expenses for communities owned for the full year 2013 and annualized actual from acquisition date through
December 31, 2013 for communities owned for less than twelve months. Also includes rent from pad sites and homes and interest from seller financing.
Private Equity Investments
As of December 31, 2013, $ 1.1 billion or 11% of the Managed Companies’ assets were invested in real estate private equity funds. The Managed Companies’ private equity investments, or PE Investments, own limited partnership interests in 81 real estate private equity funds managed by institutional-quality sponsors and these investments have generated a current return on equity of 21%. The Managed Companies have invested $912.7 million of equity in PE Investments since 2013.
The following presents the underlying fund interests in the Managed Companies’ PE Investments by investment type and geographic location based on net asset value as of September 30, 2013:
PE Investments by Underlying Investment Type(1)
PE Investments by Underlying Geographic Location(1)
___________________
(1)
Based
on individual fund financial statements.
Our Sponsor’s Prior Real Estate Programs
Since our sponsor commenced operations, in addition to managing its own portfolio as described above, it has managed third-party capital in four other real estate programs: NorthStar Real Estate Securities Opportunity Fund LP, a multi-investor institutional fund organized to invest in real estate-related securities, which we refer to as the Securities Opportunity Fund, NorthStar Income Opportunity REIT I, Inc., which we refer to as NSIO REIT, NorthStar Income and NorthStar Healthcare. In addition, our sponsor previously managed NorthStar Funding, LLC, a joint venture between NorthStar Funding Management LLC, an indirect subsidiary of our sponsor, and a single institutional investor organized for the purpose of making investments in subordinate real estate debt, which we refer to as
the NSF Venture. We do not consider the NSF Venture to be a prior real estate program of our sponsor because NorthStar Funding Management LLC and the institutional fund jointly approved the investments the NSF Venture made. Nonetheless, we have included a description of the history of the NSF Venture because we believe it is relevant to an evaluation of our sponsor’s management team’s performance.
The Securities Opportunity Fund
The Securities Opportunity Fund was a hedge fund formed by our sponsor on June 25, 2007 to invest primarily in real estate securities, a majority of which were intended to be financed using the CDO market. In July 2007, the Securities Opportunity Fund raised $81 million of equity capital from five unaffiliated, non-U.S. investors who agreed to defer redemption rights for between one to three years, and our
sponsor contributed $28 million of its own equity capital to the fund. The Securities Opportunity Fund raised a total of $109 million during its initial offering period. Subsequently, our sponsor contributed an additional $25 million to fund margin calls. A wholly owned affiliate of our sponsor was the manager and general partner of the Securities Opportunity Fund. The Securities Opportunity Fund invested in 12 CRE securities consisting of two CDO bonds ($88.5 million), nine CDO equity positions ($52.2 million) and one CRE bank loan ($20.0 million). The Securities Opportunity Fund was liquidated in 2011.
NSIO REIT
On June 10, 2009, NSIO REIT commenced a private placement sponsored by our sponsor, pursuant to which it offered up to $100.0 million in shares of common stock to accredited investors. NSIO REIT was formed to originate,
invest in and manage a diversified portfolio of commercial real estate investments consisting of: (i) CRE debt, including senior mortgage loans, subordinate mortgages, mezzanine loans and participations in such loans; (ii) CRE-related securities, such as CMBS, unsecured REIT debt, preferred stock of publicly traded REITs and CDO notes; and (iii) other select CRE equity investments.
NSIO REIT invested in three CMBS totaling $30.6
million. NSIO REIT sold one of the CMBS and realized an 80.5% return on equity and NorthStar Income sold the remaining two CMBS and realized a 31% weighted average return on equity. On September 8, 2010, the NSIO REIT board of directors terminated its private placement in contemplation of a proposed merger of NSIO REIT with and into NorthStar Income, which closed on October 18, 2010, as described below. Through September 8, 2010, NSIO REIT had raised gross offering proceeds of $35.0 million from the sale of 3.7 million shares to 499 investors in its private placement.
NorthStar Income
On July 19, 2010, NorthStar Income commenced its initial public offering sponsored by our sponsor,
pursuant to which it was offering up to $1.1 billion in shares of common stock in its continuous initial public offering, on a best efforts basis. NorthStar Income was formed to originate, acquire and manage a portfolio of CRE debt, securities and other select equity investments consisting of: (i) CRE debt, including senior mortgage loans, subordinate mortgages, mezzanine loans and participations in such loans; (ii) CRE related securities, such as CMBS, unsecured REIT debt, and CDO notes; and (iii) other select CRE equity investments.
On October 18, 2010, the merger of NSIO REIT with and into NorthStar Income closed, with NorthStar Income as the surviving entity. Each share of NSIO REIT issued and outstanding immediately prior to the merger was converted into the right to receive, at the election of the holder of such NSIO REIT share: (1) cash, without interest, in an amount
of $9.22 per share; or (2) 1.024 shares of NorthStar Income’s common stock for every one share of NSIO REIT stock. NSIO REIT stockholders paid between $9.25 and $10.00 per share and received distributions (once distributions were declared) equal to 8% on an annualized basis. NSIO REIT stockholders owning multiple shares were entitled to elect to receive a combination of cash and shares of common stock. As a result of the merger, NorthStar Income issued 2.9 million unregistered shares of common stock to 411 NSIO REIT stockholders.
From inception through December 31, 2013, NorthStar Income raised total gross proceeds of $ 1.1 billion; including capital raised in connection with its merger with NSIO REIT and has made the following CRE investments (dollars in thousands):
Represents
principal amount for real estate debt and securities and cost for real estate equity, which includes net purchase price allocation for intangibles and other assets acquired, if any.
(2)
Excludes contributions related to future funding commitments.
In addition, as of December 31, 2013, NorthStar Income had four term loan facilities outstanding totaling $490.0 million, $473.4 million of which was available. As of March 15, 2014, NorthStar Income had three term loan facilities outstanding totaling $390.0 million, $373.4 million of which was available. NorthStar Income contributed $199.2
million of CRE debt collateral to the NorthStar 2012 -1 securitization financing transaction, or 2012-1, and also completed a $532 million securitization financing transaction for NorthStar 2013-1, or 2013-1. The 2012-1 securitization financing transaction was the first of its kind since 2007 for which NorthStar Income expects to earn a yield of approximately 15% on its invested equity in the transaction, inclusive of fees and estimated transaction expenses, assuming all of the underlying loans are repaid at their initial maturity. The 2013-1 securitization financing transaction was also a market leading transaction with structural features and execution yet to be replicated by other issuers for which NorthStar Income expects to earn a yield of approximately 12% on its invested equity in the
transaction, inclusive of fees and estimated transaction expenses, assuming all of the underlying loans are repaid at their initial maturity. Both securitization financing transactions provide NorthStar Income with permanent, non-recourse, non-mark to market financing for its contributed CRE debt investments, which strategy is consistent with its business
NorthStar Income’s primary offering was completed on July 1, 2013 having successfully raised $1.1 billion.
NorthStar Healthcare
On August 7, 2012 NorthStar Healthcare commenced its initial public offering sponsored by our sponsor, pursuant to which it is offering up to
$1.1 billion in shares of common stock in its continuous initial public offering, on a best efforts basis. NorthStar Healthcare was formed to acquire, originate and asset manage a diversified portfolio of equity and debt investments in healthcare real estate, with a focus on the mid-acuity senior housing sector.
From inception through December 31, 2013, NorthStar Healthcare raised total gross proceeds of $109.2 million and has made the following healthcare-related CRE equity and debt investments (dollars in thousands):
Based
on principal amount for real estate debt and cost for real estate equity investments which includes net purchase price allocation related to net intangibles and other assets, if any.
In addition, as of December 31, 2013, NorthStar Healthcare entered into one credit facility totaling $100 million, $100 million of which was available. On February 28, 2014, NorthStar Healthcare amended the credit facility to increase the initial capacity to $100.0 million, subject to increases to up to $200.0 million in accordance with the governing documents.
NorthStar Funding
The initial businesses and assets contributed to our sponsor at the inception of its operations included a 5% equity interest in the NSF Venture and a 50% equity
interest in NorthStar Funding Management LLC, the managing member of the NSF Venture. As managing member, NorthStar Funding Management LLC was responsible for the origination, underwriting, structuring, closing and asset management of investments made by the NSF Venture, all of which were selected by our sponsor.
The NSF Venture originated or acquired a total of $136 million of subordinate real estate debt investments in eight loan positions, comprised of commercial office buildings (95%) and multifamily properties (5%). The NSF Venture did not utilize leverage to acquire its investments or enhance returns. The NSF Venture realized a weighted average return of 15% on $90.1 million of invested equity.
In February 2006, our sponsor sold its outstanding interests in the NSF Venture to the institutional pension fund which owned the remaining equity interest in the NSF Venture and terminated
the associated agreements.
Factors Differentiating Us from Prior Real Estate Programs
While our investment objectives are similar to those of each of these prior real estate programs and the NSF Venture, the risk profile and investment strategy of each of these prior real estate programs and the NSF Venture differ from ours. The Securities Opportunity Fund was a traditional hedge fund that focused on structured and synthetic products, allowed for more aggressive levels of leverage and employed higher risk, long and short investment strategies. The investment strategy of NSIO REIT was a broad investment strategy in CRE debt focused on: (i) directly originating loans with improved structures and enhanced
returns relative to legacy portfolios; (ii) purchasing discounted loans from distressed sellers; and (iii) purchasing CRE securities at discounts to historical pricing. NorthStar Income’s investment strategy is very similar to that of NSIO REIT. The NSF Venture (which is no longer operational) invested exclusively in subordinate debt, without the use of leverage, and had no origination capabilities. In contrast, we are specifically focused on healthcare assets and also expect that a significant portion of our investment portfolio will be comprised of equity real estate.
Adverse Business Developments
As a result of adverse changes in financial market conditions beginning July 2007, the market value of the Securities Opportunity Fund’s securities investments declined
significantly and investors in the Securities Opportunity Fund had experienced significant losses on their original investment. As a result of mark-to-market adjustments reflecting an overall decline in values of real estate securities generally, and a decline in value of the Securities Opportunity Fund’s portfolio securing a $250 million warehouse agreement with a major commercial bank, the Securities Opportunity Fund was required to satisfy a series of contractually required margin calls. During the fourth quarter of 2007 and continuing in the first quarter of 2008, the Securities Opportunity Fund pledged a total of $59 million of cash collateral to the Security Opportunity Fund’s warehouse lender, in addition to the $16 million pledged prior to the margin calls, as security for the obligation to purchase the securities from the lender at the maturity of the warehouse agreement. Our sponsor contributed additional amounts to the Securities Opportunity Fund to fund a
significant portion of these margin calls. Ultimately, our sponsor, as the managing member of the Securities Opportunity Fund, determined that it was no longer in the best interests of the Securities Opportunity Fund to meet additional margin calls beyond its contractual requirements in the face of continuing declines in overall asset values. As a result, the lender exercised its right to take control of the collateral, resulting in a $28 million loss to our sponsor. During the first half of 2008, the Securities Opportunity Fund also monetized investment positions which were established to hedge its exposure to declining values of securities financed under the warehouse agreement, thereby offsetting a portion of the recognized loss from the warehouse agreement.
During the second quarter 2010, our sponsor notified the Securities Opportunity Fund’s administrator and limited partners of its decision to liquidate and dissolve
the Securities Opportunity Fund. Accordingly, during the second quarter of 2010, the Securities Opportunity Fund began to liquidate its assets in an orderly manner. On July 7, 2010, the Securities Opportunity Fund completed the sale of its remaining investments. Our sponsor determined the Securities Opportunity Fund’s final net asset value and liquidated the Securities Opportunity Fund during 2011.
Because the investments of the Securities Opportunity Fund were sold for less than their original purchase price, the investors in the Securities Opportunity Fund have realized negative rates of return. The internal rate of return for the investors on a weighted average basis was (47)% upon final liquidation.
Additional Information
Please see Tables I, III, IV and V under “Prior Performance
Tables” in Appendix A of this prospectus for more information regarding the prior real estate programs and operating results of the prior real estate programs, information regarding the results of the prior real estate programs and information regarding the sale or disposition of assets by the prior real estate programs.
Upon request, prospective investors may also obtain from us without charge copies of our offering materials and any public reports prepared in connection with each of our sponsor, NorthStar Income and NorthStar Healthcare including a copy of their respective most recent Annual Reports on Form 10-K filed with the SEC within the last 24 months. We will also furnish upon request copies of the exhibits to the Form 10-K for which we may charge a reasonable fee. Many of our offering materials and reports prepared in connection with our sponsor, NorthStar Income and NorthStar Healthcare are also available at
www.nrfc.com, www.northstarreit.com/income and www.northstarreit.com/healthcare, respectively. Neither the contents of these websites nor any of the materials or reports relating to our sponsor, NorthStar Income and NorthStar Healthcare are incorporated by reference in or otherwise a part of this prospectus. In addition, the SEC maintains a website
at www.sec.gov that contains reports, proxy and other information that our sponsor, NorthStar Income and NorthStar Healthcare file electronically as NorthStar Realty Finance Corp., NorthStar Real Estate Income Trust, Inc. and NorthStar Healthcare Income, Inc., respectively, with the SEC.
The following is a summary of certain material federal income tax consequences relating to our qualification and taxation as a REIT and the acquisition, ownership and disposition of our common stock that you, as a potential stockholder, may consider relevant. Because this section is a general summary, it does not address all of the potential tax issues that may be relevant to you in light of your particular circumstances. This summary is based on the Internal Revenue Code; current, temporary and proposed Treasury Regulations promulgated thereunder; current administrative interpretations and practices of the IRS; and judicial decisions now in effect, all of which are subject to change (possibly with retroactive effect) or to different interpretations.
We have not requested, and do not plan to request,
any rulings from the IRS concerning the tax treatment with respect to matters contained in this discussion and the statements in this prospectus are not binding on the IRS or any court. Thus, we can provide no assurance that the tax treatment described in this summary will not be challenged by the IRS or will be sustained by a court if challenged by the IRS.
This summary of certain federal income tax consequences applies to you only if you acquire and hold our common stock as a “capital asset” (generally, property held for investment within the meaning of Section 1221 of the Internal Revenue Code). This summary is also based upon the assumption that our operation and the operation of our subsidiaries and other lower-tier and affiliated entities will in each case be in accordance with the applicable organizational documents or
partnership agreements. This summary does not consider all of the rules which may affect the U.S. tax treatment of your investment in our common stock in light of your particular circumstances. For example, except to the extent discussed under the headings “—Taxation of Holders of Our Common Stock—Taxation of Tax-Exempt Stockholders” and “—Taxation of Holders of Our Common Stock—Taxation of Non-U.S. Stockholders,” special rules not discussed here may apply to you if you are:
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a broker-dealer or a dealer in securities or currencies;
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an
S corporation;
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a partnership or other pass-through entity;
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a bank, thrift or other financial institution;
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a regulated investment company or a REIT;
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an
insurance company;
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a tax-exempt organization;
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subject to the alternative minimum tax provisions of the Internal Revenue Code;
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holding our common stock as part of a hedge, straddle, conversion, integrated or other risk reduction or constructive sale transaction;
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holding
our common stock through a partnership or other pass-through entity;
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holding our common stock through the exercise of employee stock options or otherwise received our common stock as compensation;
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a non-U.S. corporation, non-U.S. trust, non-U.S. estate, or an individual who is not a resident or citizen of the United States;
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a
U.S. person whose “functional currency” is not the U.S. dollar; or
If a partnership, including any entity that is treated as a partnership for federal income
tax purposes, holds our common stock, the federal income tax treatment of the partner in the partnership will generally depend on the status of the partner and the activities of the partnership. If you are a partner in a partnership that will hold our common stock, you should consult your tax advisor regarding the federal income tax consequences of acquiring, holding and disposing of our common stock by the partnership.
The rules dealing with U.S. federal income taxation are constantly under review. No assurance can be given as to whether, when or in what form the U.S. federal income tax laws applicable to us and our stockholders may be changed, possibly with retroactive effect. Changes to the federal tax laws and interpretations of federal tax laws could adversely affect an investment in shares of our common stock.
This summary generally does not discuss any alternative minimum
tax considerations or any state, local or non-U.S. tax considerations.
THE FEDERAL INCOME TAX TREATMENT OF HOLDERS OF OUR COMMON STOCK DEPENDS IN SOME INSTANCES ON DETERMINATIONS OF FACT AND INTERPRETATIONS OF COMPLEX PROVISIONS OF FEDERAL INCOME TAX LAW FOR WHICH NO CLEAR PRECEDENT OR AUTHORITY MAY BE AVAILABLE. THIS SUMMARY OF CERTAIN MATERIAL FEDERAL INCOME TAX CONSIDERATIONS IS FOR GENERAL INFORMATION PURPOSES ONLY AND IS NOT TAX ADVICE. YOU ARE ADVISED TO CONSULT YOUR TAX ADVISOR REGARDING THE FEDERAL, STATE, LOCAL AND FOREIGN INCOME AND OTHER TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF OUR COMMON STOCK.
Taxation of NorthStar Real Estate Income II, Inc.
We intend to elect to be taxed as a REIT commencing with our taxable year ended December 31, 2013. We believe
that we have been organized and operated, and intend to continue to operate, in such a manner as to qualify for taxation as a REIT.
REIT Qualification
This section of the prospectus discusses the laws governing the tax treatment of a REIT and its stockholders. These laws are highly technical and complex.
In connection with our offering, Greenberg Traurig, LLP has delivered an opinion to the effect that, commencing with our taxable year which ended on December 31, 2013, assuming the elections and other procedural steps discussed herein are completed in a timely fashion, we have been organized and operated in conformity with the requirements for qualification as a REIT under the Internal Revenue Code, and our proposed method of operation will enable us to continue to meet the requirements
for qualification and taxation as a REIT.
Investors should be aware that the opinion of Greenberg Traurig, LLP is based on various assumptions relating to our organization and operation and is conditioned upon representations and covenants made by us regarding our organization, assets and the conduct of our business operations. While we intend to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations and the possibility of future changes in our circumstances, no assurance can be given by Greenberg Traurig, LLP or by us that we will so qualify for any particular year. Greenberg Traurig, LLP will have no obligation to advise us or the holders of our common stock of any subsequent change in the matters stated, represented or assumed in the opinion, or of any subsequent change in the applicable law. You should be aware that opinions
of counsel are not binding on the IRS or any court, and no assurance can be given that the IRS will not challenge the conclusions set forth in such opinions.
Qualification and taxation as a REIT depends on our ability to meet on a continuing basis, through actual operating results, distribution levels and diversity of share ownership, various qualification requirements imposed upon REITs by the Internal Revenue Code, the compliance with which will not be reviewed by Greenberg Traurig, LLP. Our ability to qualify as a REIT also requires that we satisfy certain asset tests, some of which depend upon the fair market values of assets directly or indirectly owned by us.
Such values may not be susceptible to a precise determination. While we intend to operate in a manner that will allow us to qualify as a REIT, no assurance can be given that the actual results of our operations for any taxable year will satisfy such requirements for qualification and taxation as a REIT.
Taxation of REITs in General
As indicated above, qualification and taxation as a REIT depends upon our ability to meet, on a continuing basis, various qualification requirements imposed upon REITs by the Internal Revenue Code. The material qualification requirements are summarized below under “—Requirements for Qualification— General.” While we intend to operate so that we qualify as a REIT, no assurance can be given that the IRS will not challenge our qualification
or that we will be able to operate in accordance with the REIT requirements in the future. See “—Failure to Qualify” below.
We may own an equity interest in one or more entities that will elect to be treated as REITs, which we refer to as a Subsidiary REIT. Each Subsidiary REIT will be subject to, and must satisfy, the same requirements that we must satisfy in order to qualify as a REIT. Discussions of our qualification under the REIT rules, the anticipated satisfaction of the REIT requirements, and the consequences of a failure to so qualify, also apply to any Subsidiary REITs.
Provided that we qualify as a REIT, we generally will not be subject to federal income tax on our REIT taxable income that is distributed to our stockholders. This treatment substantially eliminates the “double taxation” at the corporate and stockholder levels that have historically resulted
from investment in a corporation. Rather, income generated by a REIT generally is taxed only at the stockholder level upon a distribution of dividends by the REIT.
Most U.S. stockholders that are individuals, trusts or estates are taxed on corporate dividends at a maximum U.S. federal income tax rate of 20% (the same as long-term capital gains). With limited exceptions, however, dividends from us or from other entities that are taxed as REITs are generally not eligible for this rate and will continue to be taxed at rates applicable to ordinary income. The highest marginal non-corporate U.S. federal income tax rate applicable to ordinary income is currently 39.6%. See “—Taxation of U.S. Stockholders on Distributions on Our Common Stock.”
Net operating losses, foreign tax credits and other tax attributes of a REIT generally do not pass through to the stockholders of the REIT,
subject to special rules for certain items such as capital gains recognized by REITs.
As a REIT, we will generally not be subject to income tax. However, we are subject to federal tax in the following circumstances:
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We will be taxed at regular corporate rates on any taxable income, including undistributed net capital gains, that we do not distribute to stockholders during, or within a specified time period after, the calendar year in which the income is earned;
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We may be subject to the
“alternative minimum tax” on our items of tax preference, including any deductions of net operating losses;
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If we have net income from prohibited transactions, which are, in general, sales or other dispositions of property held primarily for sale to customers in the ordinary course of business, other than foreclosure property, such income will be subject to a 100% tax. See “—Prohibited Transactions” and “—Foreclosure Property” below;
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If we elect to treat property that we acquire in connection
with a foreclosure of a mortgage loan or certain leasehold terminations as “foreclosure property,” we may thereby avoid the 100% tax on gain from a sale of that property (if the sale would otherwise constitute a prohibited transaction), but the income from the sale or operation of the property may be subject to corporate income tax at the highest applicable federal corporate income tax rate (currently 35%);
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If we fail to satisfy the 75% gross income test or the 95% gross income test, as discussed below, but nonetheless maintain our qualification as a REIT because other requirements are met, we will be subject to a 100% tax on an amount based upon the magnitude of the failure, adjusted to reflect our profitability;
In the event of a failure of the asset tests (other than certain de minimis failures), as described below under “—Asset Tests,” as long as the failure was due to reasonable cause and not to willful neglect, we dispose of the assets or otherwise comply with such asset tests within six months after the last day of the quarter in which we identify such failure and we file a schedule with the IRS describing the assets that caused such failure, we may nevertheless be able to maintain our qualification as a REIT but would be required to pay a tax equal to the greater of $50,000 or 35% of the net income from the non-qualifying assets during the period in which we failed to satisfy such
asset tests;
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In the event of a failure to satisfy one or more requirements for REIT qualification, other than the gross income tests and the asset tests, where the violation is due to reasonable cause and not willful neglect, we will be required to pay a penalty of $50,000 for each such failure;
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If we fail to distribute during each calendar year at least the sum of: (i) 85% of our REIT ordinary income for such year; (ii) 95% of our REIT capital gain net income for such year; and (iii) any undistributed taxable income
from prior periods, we will be subject to a 4% excise tax on the excess of the required distribution over the sum of (a) the amounts actually distributed, plus (b) retained amounts on which income tax is paid at the corporate level;
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We may be required to pay monetary penalties to the IRS in certain circumstances, including if we fail to meet recordkeeping requirements intended to monitor our compliance with rules relating to the composition of our stockholders, as described below in “—Requirements for Qualification— General”;
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A
100% tax may be imposed on certain items of income and expense that are directly or constructively paid between a REIT and a TRS if and to the extent that the IRS successfully adjusts the reported amounts of these items to conform to an arm’s length pricing standard;
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If we acquire appreciated assets from a corporation that is not a REIT (i.e., a corporation taxable under subchapter C of the Internal Revenue Code) in a transaction in which the adjusted tax basis of the assets in our hands is determined by reference to the adjusted tax basis of the assets in the hands of the subchapter C corporation, we will be subject to tax at the highest corporate income tax rate then applicable if we subsequently recognize the built-in gain on a disposition
of any such assets during the ten-year period following the acquisition from the subchapter C corporation, unless the subchapter C corporation elects to treat the original transfer of the assets to us as a taxable sale;
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The earnings of our lower-tier entities that are subchapter C corporations, if any, including domestic TRSs, are subject to federal corporate income tax; and
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If we own a residual interest in a real estate mortgage investment conduit, or REMIC, we will be taxable at the highest corporate rate on the
portion of any excess inclusion income that we derive from the REMIC residual interests equal to the percentage of our stock that is held in record name by “disqualified organizations.” Similar rules apply to a REIT that owns an equity interest in a taxable mortgage pool. To the extent that we own a REMIC residual interest or a taxable mortgage pool through a TRS, we will not be subject to this tax. For a discussion of “excess inclusion income,” see “—Taxable Mortgage Pools.” A “disqualified organization” includes:
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the United States;
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any
state or political subdivision of the United States;
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any foreign government;
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any international organization;
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any agency or instrumentality of any of the foregoing;
•
any
other tax-exempt organization, other than a farmer’s cooperative described in section 521 of the Internal Revenue Code, that is exempt both from income taxation and from taxation under the unrelated business taxable income provisions of the Internal Revenue Code; and
We do not currently intend to hold REMIC residual interests or interests in taxable mortgage pools.
In addition, we and our subsidiaries may be subject to a variety of taxes, including payroll taxes and state and local income, property and other taxes on assets and operations. We could also be subject to tax in situations and on transactions not presently contemplated.
Requirements for Qualification—General
The Internal Revenue Code defines a REIT as a corporation, trust or association:
(1)
that
is managed by one or more trustees or directors;
(2)
the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest;
(3)
that would be taxable as a domestic corporation but for the special Internal Revenue Code provisions applicable to REITs;
(4)
that
is neither a financial institution nor an insurance company subject to specific provisions of the Internal Revenue Code;
(5)
the beneficial ownership of which is held by 100 or more persons;
(6)
in which, during the last half of each taxable year, not more than 50% in value of the outstanding stock is owned, directly or indirectly, by five or fewer “individuals” (as defined in the Internal Revenue Code to include specified tax-exempt entities);
(7)
that
properly elects to be taxed as a REIT and such election has not been terminated or revoked; and
(8)
which meets other tests described below regarding the nature of its income and assets, its distributions, and certain other matters.
The Internal Revenue Code provides that conditions (1) through (4) must be met during the entire taxable year, and that condition (5) must be met during at least 335 days of a taxable year of 12 months, or during a proportionate part of a shorter taxable year. Our charter provides restrictions regarding the ownership and transfer of our shares, which are intended to assist us in satisfying the share ownership requirements described in conditions (5) and
(6) above. For purposes of condition (6), an “individual” generally includes a supplemental unemployment compensation benefit plan, a private foundation, or a portion of a trust permanently set aside or used exclusively for charitable purposes, but does not include a qualified pension plan or profit sharing trust. We are not required to satisfy conditions (5) and (6) for the first taxable year in which we elect to be taxed as a REIT.
To monitor compliance with the share ownership requirements, we generally are required to maintain records regarding the actual ownership of our shares. To do so, we must demand written statements each year from the record holders of significant percentages of our stock in which the record holders are to disclose the actual owners of the shares (i.e., the persons required to include in gross income the dividends paid by us). A list of those persons failing or refusing to comply with this
demand must be maintained as part of our records. Failure to comply with these recordkeeping requirements could subject us to monetary penalties. If we satisfy these requirements and have no reason to know that condition (6) is not satisfied, we will be deemed to have satisfied such condition. A stockholder that fails or refuses to comply with the demand is required by Treasury Regulations to submit a statement with its tax return disclosing the actual ownership of the shares and other information.
In addition, a corporation generally may not elect to become a REIT unless its taxable year is the calendar year. We satisfy this requirement.
Finally, at the end of any year, a REIT cannot have any earnings and profits accumulated by it or a predecessor during a taxable year in which it was not a REIT. We do not have any earnings and profits accumulated by a C corporation.
The Internal Revenue Code provides relief from violations of the REIT gross income requirements, as described below under “—Income Tests,” in cases where a violation is due to reasonable cause and not willful neglect, and other requirements are met, including the payment of a penalty tax that is based upon the magnitude of the violation. In addition, similar relief is available in the case of certain violations of the REIT asset requirements (see “—Asset Tests” below) and other REIT requirements (see “—Failure to Qualify” below), again provided that the violation is due to reasonable cause and not willful neglect, and other conditions are met, including the payment of a penalty tax. If we were to fail to satisfy any of the various REIT requirements, there can be no assurance that these relief provisions would be available to enable
us to maintain our qualification as a REIT. Even if such relief provisions were available, the amount of any resultant penalty tax could be substantial.
Effect of Subsidiary Entities
Ownership of Partnership Interests. In the case of a REIT that is a partner in a partnership, the REIT is deemed to own its proportionate share of the partnership’s assets, and to earn its proportionate share of the partnership’s income, for purposes of the asset and gross income tests applicable to REITs, as described below. In addition, the assets and gross income of the partnership are deemed to retain the same character in the hands of the REIT. Thus, our proportionate share of the assets and items of income of partnerships in which we own an equity interest (including our interest in our operating partnership) are treated as our assets and items of income for purposes
of applying the REIT requirements. Our proportionate share is generally determined, for these purposes, based upon our percentage interest in the partnership’s equity capital; however, for purposes of the 10% value-based asset test described below, the percentage interest also takes into account certain debt securities issued by the partnership and held by us. Consequently, to the extent that we directly or indirectly hold a preferred or other equity interest in a partnership, the partnership’s assets and operations may affect our ability to qualify as a REIT, even if we have no control, or only limited influence, over the partnership. A summary of certain rules governing the federal income taxation of partnerships and their partners is provided below in “—Tax Aspects of Investments in Partnerships.”
Disregarded Subsidiaries. If
a REIT owns a corporate subsidiary that is a “qualified REIT subsidiary,” that subsidiary is disregarded for federal income tax purposes, and all assets, liabilities and items of income, deduction and credit of the subsidiary are treated as assets, liabilities and items of income, deduction and credit of the REIT itself, including for purposes of the gross income and asset tests applicable to REITs, as described below. A qualified REIT subsidiary is any corporation, other than a TRS as described below, that is wholly owned by a REIT, or by other disregarded subsidiaries owned by the REIT, or by a combination of the two. Other entities that are wholly owned by us, including single member limited liability companies, are also generally disregarded as separate entities for federal income tax purposes, including for purposes of the REIT income and asset tests. Disregarded subsidiaries,
along with partnerships in which we hold an equity interest, are sometimes referred to as “pass-through subsidiaries.”
In the event that one of our disregarded subsidiaries ceases to be wholly owned—for example, if any equity interest in the subsidiary is acquired by a person other than us or another of our disregarded subsidiaries-the subsidiary’s separate existence would no longer be disregarded for federal income tax purposes. Instead, it would have multiple owners and would be treated as either a partnership or a taxable corporation. Such an event could, depending on the circumstances, adversely affect our ability to satisfy the various asset
and gross income requirements applicable to REITs, including the requirement that REITs generally may not own, directly or indirectly, more than 10% of the securities of another corporation. See “—Asset Tests” and “—Income Tests.”
Taxable Subsidiaries. A REIT may jointly elect with a subsidiary corporation, whether or not wholly owned, to treat the subsidiary corporation as a TRS. A corporation in which a TRS directly or indirectly owns more than 35% of its stock, by voting power or value, will automatically be treated as a TRS. The separate existence of a TRS or other taxable corporation, unlike a disregarded subsidiary as discussed above, is not ignored for federal income tax purposes. A TRS is subject to corporate income tax on its earnings, which may reduce the cash flow generated by us and
our subsidiaries in the aggregate and our ability to make distributions to our stockholders.
A REIT is not treated as holding the assets of a taxable subsidiary corporation or as receiving any income that the taxable subsidiary earns. Rather, the stock issued by the taxable subsidiary is an asset in the
hands
of the parent REIT, and the REIT recognizes as income the dividends, if any, that it receives from the taxable subsidiary. The value of the TRS securities held by the REIT will be used to compute the REIT’s compliance with the asset tests, as discussed in more detail below. Because we will not include the assets and income of TRSs in determining our compliance with the REIT income and asset requirements described below, such entities may be used by the parent REIT to indirectly undertake certain activities that the REIT rules might otherwise preclude it from doing directly (or through pass-through subsidiaries), such as providing certain services to tenants or conducting activities that give rise to certain categories of non-qualifying income, such as management fees. Not more than 25% of the value of a REIT’s gross assets may consist of stock or securities of one or more TRSs.
In general, a TRS may not directly or indirectly operate or manage any lodging facilities or health care facilities, or provide rights to any brand name under which any lodging facility or health care facility is operated. A TRS may, however, provide rights to a brand name under which a lodging facility or health care facility is operated if: (i) such rights are provided to an “eligible independent contractor” (as described below) to operate or manage a lodging facility or health care facility; (ii) such rights are held by the TRS as a franchisee, licensee, or in a similar capacity; and (iii) such lodging facility or health care facility is either owned by the TRS or leased to the TRS by its parent REIT. A TRS is not considered to operate or manage a lodging facility” or health care facility solely because the TRS directly or indirectly possesses a license, permit, or similar instrument enabling it to do so.
Subsidiary
REITs. As discussed above, we may indirectly or directly own interests in one or more Subsidiary REITs. We intend that any such Subsidiary REIT will be organized and will operate in a manner to permit it to qualify for taxation as a REIT for federal income tax purposes from and after the effective date of its REIT election. Provided that a Subsidiary REIT meets the requirements for qualification as a REIT, for purposes of determining our qualification as a REIT, stock of the subsidiary that we own will be treated as a qualifying asset, and dividends that we receive will be qualifying income for purposes of the REIT gross asset and income tests that apply to us as described below. See “—Income Tests” and “—Asset Tests”, below. However, if any of these Subsidiary REITs were to fail to qualify as a REIT, then (i) the Subsidiary REIT would become subject corporate income tax as a regular C corporation, as described herein, see “—Failure
to Qualify” below, and (ii) our interest in such Subsidiary REIT, and any income derived from it, could be treated as non-qualifying items for purposes of the REIT asset and income tests, which could adversely affect our ability to qualify as a REIT.
Income Tests
In order to maintain qualification as a REIT, we must satisfy two gross income requirements annually. First, at least 75% of our gross income for each taxable year, excluding gross income from sales of inventory or dealer property in “prohibited transactions,” must be derived from investments relating to real property or mortgages on real property, including “rents from real property”; dividends received from other REITs; interest income derived from mortgage loans secured by real property; income derived from a REMIC in proportion to the real estate assets held by the REMIC, unless at least 95% of the
REMIC’s assets are real estate assets, in which case all of the income derived from the REMIC; certain income from qualified temporary investments; and gains from the sale of real estate assets. Second, at least 95% of our gross income in each taxable year, excluding gross income from prohibited transactions, must be derived from some combination of income that qualifies under the 75% income test described above, as well as other dividends, interest, and gain from the sale or disposition of stock or securities, which need not have any relation to real property. Income and gain from “hedging transactions,” as defined in “—Hedging Transactions,” that we enter into to hedge indebtedness incurred or to be incurred to acquire or carry real estate assets, including certain CRE equity and debt investments or to hedge certain foreign currency risks and that are clearly and timely identified as hedges will be excluded from both the numerator and the denominator
for purposes of the 75% and 95% gross income tests.
Generally, rents received by us will qualify as “rents from real property” and for purposes of the gross income requirements described above, provided that certain requirements are met. If rent is partly attributable to personal property leased in connection with a lease of real property, the portion of the total rent that is attributable to the personal property will not qualify as “rents from real property” unless it constitutes 15% or less of the total rent received under the lease. Also, in order to be treated as qualifying
income for purposes of the REIT gross income requirements, the rent must not be based, in whole or in part, on the income or profits of any person, but may be based on a fixed percentage or percentages of receipts or sales. Moreover, for rents received to qualify as “rents from real property,” the REIT generally must not furnish or render services to the tenants of such property, other than through an “independent contractor” from which the REIT derives no revenue or through a TRS. We and our affiliates are permitted, however, to perform services that are “usually or customarily rendered” in connection with the rental of space for occupancy only and are not otherwise considered rendered to the occupant of the property. In addition, we and our affiliates may directly or indirectly provide non-customary services to tenants of properties
without disqualifying all of the rent from the property if the payment for such services does not exceed 1% of the total gross income from the property. For this purpose, the amount received by the REIT for such service, which is treated as non-qualifying income, is deemed to be at least 150% of the REIT’s direct cost of providing the service. Also, rental income will not qualify as rents from real property to the extent that we directly or constructively hold a 10% or greater interest, as measured by vote or value, in the equity of a lessee.
In order for the rent that we receive to constitute “rents from real property,” the leases must be respected as true leases for U.S. federal income tax purposes and not treated as service contracts, joint ventures or some other type of arrangement. The determination of whether leases are
true leases depends on an analysis of all the surrounding facts and circumstances. We intend that any leases into which we enter will be treated as true leases. If our leases are characterized as service contracts or partnership agreements, rather than as true leases, part or all of the payments that we receive from leases may not be considered rent or may not otherwise satisfy the various requirements for qualification as “rents from real property.” In that case, we might not be able to satisfy either the 75% or 95% gross income test and, as a result, could lose our REIT status unless we qualify for relief, as described above.
Interest income constitutes qualifying mortgage interest for purposes of the 75% gross income test (as described above) to the extent that the obligation is secured by a mortgage on real property. If we
receive interest income with respect to a mortgage loan that is secured by both real property and other property, and the highest principal amount of the loan outstanding during a taxable year exceeds the fair market value of the real property on the date that we have a binding commitment to acquire or originate the mortgage loan, the interest income will be apportioned between the real property and the other collateral, and our income from the arrangement will qualify for purposes of the 75% gross income test only to the extent that the interest is allocable to the real property. Even if a loan is not secured by real property or is undersecured, the income that it generates may nonetheless qualify for purposes of the 95% gross income test.
To the extent that the terms of a loan provide for contingent interest that is based on the cash proceeds realized upon the sale of the property securing the loan, or a shared appreciation
provision, income attributable to the participation feature will be treated as gain from sale of the underlying property, which generally will be qualifying income for purposes of both the 75% and 95% gross income tests provided that the property is not inventory or dealer property in the hands of the borrower or the REIT.
To the extent that a REIT derives interest income from a mortgage loan or income from the rental of real property where all or a portion of the amount of interest or rental income payable is contingent, such income generally will qualify for purposes of the gross income tests only if it is based upon the gross receipts or sales, and not the net income or profits, of the borrower or lessee. This limitation does not apply, however, where the borrower or lessee leases substantially all of its interest in the property to tenants or subtenants, to the extent that the rental income derived by the borrower or lessee,
as the case may be, would qualify as rents from real property had it been earned directly by a REIT.
We may originate and acquire mezzanine loans, which are loans secured by equity interests in an entity that directly or indirectly owns real property, rather than by a direct mortgage of the real property. IRS Revenue Procedure 2003-65 provides a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in the revenue procedure, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests described below, and interest derived from it will be treated as qualifying mortgage interest for purposes of the 75% gross income test. Although the revenue procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. Our mezzanine loans might not meet all of the requirements for reliance on this safe harbor. We intend to make
and acquire mezzanine loans in a manner that will enable us to satisfy the REIT gross income and asset tests.
We may hold certain participation interests in mortgage loans and mezzanine loans originated by other lenders. A participation interest is an interest created in an underlying loan by virtue of a participation or similar agreement, to which the originator of the loan is a party, along with one or more participants. The borrower
on the underlying loan is typically not a party to the participation agreement. The performance of a participant’s investment depends upon the performance of the underlying loan, and if the underlying borrower defaults, the participant typically has no recourse against the originator of the loan. The originator often retains a senior position in the underlying loan, and grants junior participations, which will be a first loss position in the event of a default by the borrower. We may acquire participations in CRE debt which we believe qualify for purposes of the REIT asset tests described below, and that interest derived from such investments will be treated as qualifying mortgage interest for purposes of the 75% gross income test. The appropriate treatment of participation interests for federal income tax purposes is not entirely certain, however, and no assurance can be given that the IRS will not challenge our treatment of participation interests.
We
may acquire CMBS, and expect that the CMBS will be treated either as interests in a grantor trust or as regular interests in REMICs for U.S. federal income tax purposes and that all interest income, original issue discount and market discount from our CMBS will be qualifying income for the 95% gross income test. In the case of mortgage-backed securities treated as interests in grantor trusts, we would be treated as owning an undivided beneficial ownership interest in the mortgage loans held by the grantor trust. The interest, original issue discount and market discount on such mortgage loans would be qualifying income for purposes of the 75% gross income test to the extent that the obligation is secured by real property. In the case of CMBS treated as interests in a REMIC, income derived from REMIC interests will generally be treated as qualifying income for purposes of the 75% and 95% gross income tests. If less than 95% of the assets of the REMIC are real estate assets,
however, then only a proportionate part of our interest in the REMIC and income derived from the interest will qualify for purposes of the 75% gross income test. In addition, some REMIC securitizations include embedded interest swap or cap contracts or other derivative instruments that potentially could produce non-qualifying income for the holder of the related REMIC securities.
We believe that substantially all of our income from our mortgage related securities generally will be qualifying income for purposes of the REIT gross income tests. However, to the extent that we own non-REMIC collateralized mortgage obligations or other debt instruments secured by mortgage loans (rather than by real property), or secured by non-real estate assets, or debt securities that are not secured by mortgages on real property or interests in real property,
the interest income received with respect to such securities generally will be qualifying income for purposes of the 95% gross income test, but not the 75% gross income test. In addition, the loan amount of a mortgage loan that we own may exceed the value of the real property securing the loan. In that case, income from the loan will be qualifying income for purposes of the 95% gross income test, but the interest attributable to the amount of the loan that exceeds the value of the real property securing the loan will not be qualifying income for purposes of the 75% gross income test.
Revenue Procedure 2011-16 discusses a modification of a mortgage loan which (or an interest in which) is held by a REIT if the modification was occasioned by a default on the loan or the modification satisfies both of the following conditions: (a) based on all the facts and circumstances, the REIT or servicer of the loan (the “pre-modified
loan”) reasonably believes that there is a significant risk of default of the pre-modified loan upon maturity of the loan or at an earlier date, and (b) based on all the facts and circumstances, the REIT or servicer reasonably believes that the modified loan presents a substantially reduced risk of default, as compared with the pre-modified loan. Revenue Procedure 2011-16 provides that a REIT may generally treat a modification of a mortgage loan described therein as not being a new commitment to make or purchase a loan for purposes of apportioning interest on that loan between interest with respect to real property or other interest, where the REIT’s acquisition of the loan pre-dated the loan becoming distressed. The modification will also not be treated as a prohibited transaction. Further, with respect to the REIT asset test, the IRS will not challenge the REIT’s treatment of a loan as being in part a “real estate asset” if the REIT treats the loan as being
a real estate asset in an amount equal to the lesser of (a) the value of the loan as determined under Treasury Regulations Section 1.856-3(a), or (b) the loan value
of the real property securing the loan as determined under Treasury Regulations Section 1.856-5(c) and Revenue Procedure 2011-16. We will consider IRS Revenue Procedure 2011-16 and its potential impact on our REIT qualification when acquiring mortgage loans at a discount
on the secondary market.
We may receive distributions from TRSs or other corporations that are not REITs. These distributions will be classified as dividend income to the extent of the earnings and profits of the distributing corporation. Such distributions will generally constitute qualifying income for purposes of the 95% gross income test but not the 75% gross income test. Any dividends we received from a REIT will be qualifying income for purposes of both the 75% and 95% gross income tests.
We may receive various fees in connection with our operations. The fees will be qualifying income for purposes of both the 75% and 95% gross income tests if they are received in consideration for entering into an agreement to make a loan secured by real property and the fees are not determined by the borrower’s income and profits. Other fees generally are not qualifying income for purposes
of either gross income test.
Any income or gain we derive from instruments that hedge certain risks, such as the risk of changes in interest rates with respect to debt incurred to acquire or carry real estate assets or certain foreign currency risks, will not be treated as income for purposes of calculating the 75% or 95% gross income test, provided that specified requirements are met. Such requirements include the instrument is properly identified as a hedge, along with the risk that it hedges, within prescribed time periods. See “—Hedging Transactions” below.
If we fail to satisfy one or both of the 75% or 95% gross income tests for any taxable year, we may still qualify as a REIT for the year if we are entitled to relief under applicable provisions of the Internal Revenue Code. These relief provisions will be generally available if our failure to meet these tests was due
to reasonable cause and not due to willful neglect, we attach to our tax return a schedule of the sources of our income, and any incorrect information on the schedule was not due to fraud with intent to evade tax. It is not possible to state whether we would be entitled to the benefit of these relief provisions in all circumstances. If these relief provisions are inapplicable, we will not qualify as a REIT. As discussed above under “—Taxation of REITs in General,” even where these relief provisions apply, a tax would be imposed upon the amount by which we fail to satisfy the particular gross income test, adjusted to reflect the profitability of such gross income.
Pursuant to The Housing and Economic Recovery Tax Act of 2008, the Secretary of the Treasury has been granted broad authority to determine whether particular items of gain or income qualify or not under the 75% and 95% gross income tests or are to be excluded
altogether from the measure of gross income for such purposes.
Asset Tests
At the close of each calendar quarter, we must satisfy five tests relating to the nature of our assets. First, at least 75% of the value of our total assets must be represented by some combination of “real estate assets,” cash, cash items and U.S. government securities. For this purpose, real estate assets include interests in real property, such as land, buildings, leasehold interests in real property, stock of other corporations that qualify as REITs, certain kinds of mortgage-backed securities and mortgage loans and, under some circumstances, stock or debt instruments purchased with new capital. Assets that do not qualify for purposes of the 75% asset test are subject to the additional asset tests described below.
Second, the value of any one issuer’s
securities owned by us may not exceed 5% of the value of our total assets.
Third, we may not own more than 10% of any one issuer’s outstanding securities, as measured by either voting power or value. The 5% and 10% asset tests do not apply to securities of TRSs, and the 10% value test does not apply to “straight debt” and certain other securities, as described below.
Fourth, the aggregate value of all securities of TRSs held by a REIT may not exceed 25% of the value of the REIT’s total assets.
Fifth, no more than 25% of the value of our total assets may consist of securities, including securities of TRSs that are not qualifying assets for purposes of the 75% test.
Notwithstanding the general rule that a REIT is treated as owning its share of the underlying assets of a subsidiary partnership for purposes of the REIT income and asset tests, if a REIT holds indebtedness issued by a partnership, the indebtedness will be subject to, and may cause a violation of, the asset tests, unless it is a qualifying mortgage asset or otherwise satisfies the rules for “straight debt” or one of the other exceptions to the 10% value test.
Certain securities will not cause a violation of the 10% value test described above. Such securities include instruments that constitute “straight debt.” A security does not qualify as “straight debt” where a REIT (or a controlled TRS of the REIT) owns other securities of the issuer of that security which do not qualify as straight
debt, unless the value of those other securities constitute, in the aggregate, 1% or less of the total value of that issuer’s outstanding securities. In addition to straight debt, the following securities will not violate the 10% value test: (i) any loan made to an individual or an estate; (ii) certain rental agreements in which one or more payments are to be made in subsequent years (other than agreements between a REIT and certain persons related to the REIT); (iii) any obligation to pay rents from real property; (iv) securities issued by governmental entities that are not dependent in whole or in part on the profits of (or payments made by) a non-governmental entity; (v) any security issued by another REIT; and (vi) any debt instrument issued by a partnership if the partnership’s income is such that the partnership would satisfy the 75% gross income test described above under “—Income Tests.” In applying the 10% value test, a debt security issued by a partnership
is not taken into account to the extent, if any, of the REIT’s proportionate interest in that partnership.
Any interests we hold in a REMIC are generally treated as qualifying real estate assets and income we derive from interests in REMICs is generally treated as qualifying income for purposes of the REIT income tests described above. If less than 95% of the assets of a REMIC are real estate assets, however, then only a proportionate part of our interest in the REMIC, and of our income derived from the interest, qualifies for purposes of the REIT asset and income tests. Where a REIT holds a “residual interest” in a REMIC from which it derives “excess inclusion income,” the REIT will be required to either distribute the excess inclusion income or pay a tax on it (or a combination of the two), even though the income may not be received in cash by the REIT. To the extent that distributed excess inclusion income
is allocable to a particular stockholder, the income: (i) would not be allowed to be offset by any net operating losses otherwise available to the stockholder; (ii) would be subject to tax as unrelated business taxable income in the hands of most types of stockholders that are otherwise generally exempt from federal income tax; and (iii) would result in the application of federal income tax withholding at the maximum rate of 30% (and any otherwise available rate reductions under income tax treaties would not apply), to the extent allocable to most types of foreign stockholders.
We may hold certain mezzanine loans that do not qualify for the safe harbor in Revenue Procedure 2003-65 discussed above pursuant to which certain loans secured by a first priority security interest in equity interests in a pass-through entity that directly or indirectly owns real property will be treated as qualifying real estate assets for purposes
of the 75% asset test, in which case such loans may be subject to the 10% vote or value test. In addition such mezzanine loans may not qualify as “straight debt” securities or for one of the other exclusions from the definition of “securities” for purposes of the 10% value test. We intend to make any such investments in such a manner as not to fail the asset tests described above, but there can be no assurance we will be successful in this regard.
We may hold certain participation interests in mortgage loans and mezzanine loans originated by other lenders. Participation interests are interests in underlying loans created by virtue of participations or similar agreements to which the originators of the loans are parties, along with one or more participants. The borrower on the underlying loan is typically not a party to the participation agreement. The performance of this investment depends upon the performance
of the underlying loan and, if the underlying borrower defaults, the participant typically has no recourse against the originator of the loan. The originator often retains a senior position in the underlying loan and grants junior participations which absorb losses first in the event of a default by the borrower. We generally expect to treat our participation interests in mortgage loans and mezzanine loans that qualify for safe harbor under Revenue Procedure 2003-65 as qualifying real estate assets for purposes of the REIT asset tests and interest that we derive from such investments as qualifying mortgage interest for purposes of the 75% gross income test discussed above. The appropriate treatment of participation interests for U.S. federal income tax purposes is not entirely certain, however,
and no assurance can be given that the IRS will not challenge our treatment of our participation interests. In the event of a determination that such participation interests do not qualify as real estate assets, or that the income that we derive from such participation interests does not qualify as mortgage interest for purposes of the REIT asset and income tests, we could be subject to a penalty tax, or could fail to qualify as a REIT.
After initially meeting the asset tests at the close of any quarter, we will not lose our qualification as a REIT for failure to satisfy the asset tests at the end of a later quarter solely by reason of changes in asset values. If we fail to satisfy the asset tests because we acquire assets during a quarter, we can cure this failure by disposing of sufficient non-qualifying
assets within 30 days after the close of that quarter. If we fail the 5% asset test, or the 10% vote or value asset tests at the end of any quarter and such failure is not cured within 30 days thereafter, we may dispose of sufficient assets (generally within six months after the last day of the quarter in which our identification of the failure to satisfy these asset tests occurred) to cure such a violation that does not exceed the lesser of 1% of our assets at the end of the relevant quarter or $10 million. If we fail any of the other asset tests or our failure of the 5% and 10% asset tests is in excess of the de minimis amount described above, as long as such failure was due to reasonable cause and not willful neglect, we are permitted to avoid disqualification as a REIT, after the 30 day cure period, by taking prescribed steps including the disposition of sufficient assets to meet the asset test (generally within six months after the last day of the quarter in which
our identification of the failure to satisfy the REIT asset test occurred) and paying a tax equal to the greater of: (i) $50,000; or (ii) the highest corporate income tax rate (currently 35%) multiplied by the net income generated by the non-qualifying assets during the period in which we failed to satisfy the asset test.
We generally expect to acquire CRE securities that will be qualifying assets for purposes of the 75% asset test. However, to the extent that we own non-REMIC collateralized mortgage obligations or other securities which do not qualify as “real estate” for REIT purposes, those securities will not be qualifying assets for purposes of the 75% asset test.
We intend to monitor compliance on an ongoing basis. Independent appraisals will not be obtained, however, to support our conclusions as to the value of our assets or the value of any particular security or
securities. Moreover, values of some assets, including instruments issued in securitization transactions, may not be susceptible to a precise determination, and values are subject to change in the future. Furthermore, the proper classification of an instrument as debt or equity for federal income tax purposes may be uncertain in some circumstances, which could affect the application of the REIT asset requirements. Accordingly, there can be no assurance that the IRS will not contend that we do not comply with one or more of the asset tests.
Annual Distribution Requirements
In order to qualify as a REIT, we are required to distribute dividends, other than capital gain dividends, to our stockholders in an amount at least equal to:
(a)
the
sum of:
(1)
90% of our “REIT taxable income” (computed without regard to its deduction for dividends paid and net capital gains), and
(2)
90% of our net income, if any, (after tax) from foreclosure property (as described below), minus
(b)
the sum of specified items of non-cash income.
These distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for the year and if paid on or before the first regular dividend payment after such declaration. Distributions that we declare in October, November or December of any year payable to a stockholder of record on a specified date in any of these months will be treated as both paid by us and received by the stockholder on December 31 of the year, provided that we actually pay the distribution during January of the following calendar year.
In order for distributions to be counted for this purpose and to give rise to a tax deduction by us, they must not be “preferential dividends.” A dividend is not a preferential dividend if it is pro rata among all outstanding shares of stock within a particular class, and is in accordance with the preferences among different classes of stock as set forth in our organizational documents.
To the extent that we distribute at least 90%, but less than 100%, of our “REIT taxable income,” as adjusted, we will be subject to tax at the regular corporate tax rates on the retained portion. We may elect to retain, rather than distribute, our net long-term capital gains and pay tax on such gains. In this case, we could elect to have our stockholders include their proportionate share of such undistributed
long-term capital gains in income and receive a corresponding credit for their share of the tax paid by us. Our stockholders would then increase the adjusted basis of their stock by the difference between the designated amounts included in their long-term capital gains and the tax deemed paid with respect to their shares.
To the extent that a REIT has available net operating losses carried forward from prior tax years, such losses may reduce the amount of distributions that it must make in order to comply with the REIT distribution requirements. Such losses, however, will generally not affect the character, in the hands of stockholders, of any distributions that are actually made by the REIT, which are generally taxable to stockholders to the extent that the REIT has current or accumulated earnings and profits.
If we fail to distribute during each calendar year at least the sum
of: (i) 85% of our REIT ordinary income for such year; (ii) 95% of our REIT capital gain net income for such year; and (iii) any undistributed taxable income from prior periods, we would be subject to a 4% excise tax on the excess of such required distribution over the sum of (a) the amounts actually distributed and (b) the amounts of income retained on which we have paid corporate income tax. We intend to make timely distributions so that we are not subject to the 4% excise tax.
It is possible that, from time-to-time, we may not have sufficient cash to meet the distribution requirements due to timing differences between the actual receipt of cash and our inclusion of items in income for federal income tax purposes. Potential sources of non-cash taxable income include real estate and securities that have been financed pursuant to arrangements which require some or all of available cash flows to be used to service borrowings,
loans or mortgage-backed securities we hold that have been issued at a discount and require the accrual of taxable economic interest in advance of its receipt in cash, and distressed loans on which we may be required to accrue taxable interest income even though the borrower is unable to make current payments in cash. Certain modifications of the terms of distressed indebtedness that we hold could also give rise to non-cash taxable income. In the event that such timing differences occur, it might be necessary to arrange for short-term, or possibly long-term, borrowings to meet the distribution requirements or to pay dividends in the form of taxable in-kind distributions of property. See “—Cash/Income Differences” below.
We may be able to cure a failure to meet the distribution requirements for a year by paying “deficiency dividends” to stockholders in a later year, which may be included in our deduction for dividends
paid for the earlier year. In this case, we may be able to avoid losing our REIT status or being taxed on amounts distributed as deficiency dividends. However, we will be required to pay interest and possibly a penalty based on the amount of any deduction taken for deficiency dividends.
Sale-Leaseback Transactions
Some of our investments may utilize sale-leaseback structures. We normally intend to treat these transactions as true leases for U.S. federal income tax purposes. However, depending on the terms of any specific transaction, the IRS might take the position that the transaction is not a true lease but is more properly treated in some other manner. If such recharacterization were successful, we would not be entitled to claim the depreciation deductions available to an owner of the property. In addition, the recharacterization of one or more of these transactions might cause
us to fail to satisfy the Asset Tests or the Income Tests described above based upon the asset we would be treated as holding or the income we would be treated as having earned, and such failure could result in our failing to qualify as a REIT. Alternatively, the amount or timing of income inclusion or the loss of depreciation deductions resulting from the recharacterization might cause us to fail to meet the distribution requirement described above for one or more taxable years absent the availability of the deficiency dividend procedure, or might result in a larger portion of our dividends being treated as taxable income to our stockholders.
We must maintain certain records in order to qualify as a REIT. In addition, to avoid a monetary penalty, we must request, on an annual basis, information from our stockholders that is designed to disclose the actual ownership of our outstanding stock. We intend to comply with these requirements.
Failure to Qualify
If we fail to satisfy one or more requirements for REIT qualification, other than the gross income tests and the asset tests, we could avoid disqualification if our failure is due to reasonable cause and not to willful neglect and we pay a penalty of $50,000 for each such failure. In addition, there are relief provisions for a failure of the gross income tests and asset tests, as
described in “—Income Tests” and “—Asset Tests.”
If we fail to qualify for taxation as a REIT in any taxable year, and the relief provisions do not apply, we will be subject to tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. Distributions to stockholders in any year in which we are not a REIT would not be deductible by us, nor would they be required to be made. In this situation, to the extent of current and accumulated earnings and profits, all distributions to stockholders taxed as individuals may be eligible for a reduced rate applicable to “qualified dividends” and, subject to limitations of the Internal Revenue Code, corporate stockholders may be eligible for the dividends received deduction. Unless we are entitled to relief under specific statutory provisions, we would be disqualified from re-electing to be taxed as a REIT for the four taxable
years following the year during which qualification was lost. It is not possible to state whether, in all circumstances, we would be entitled to this statutory relief.
Prohibited Transactions
Net income derived from a prohibited transaction is subject to a 100% tax. The term “prohibited transaction” generally includes a sale or other disposition of property (other than foreclosure property) that is held primarily for sale to customers in the ordinary course of a trade or business, by a REIT, by a lower-tier partnership in which the REIT holds an equity interest or by a borrower that has issued a shared appreciation mortgage or similar debt instrument to the REIT. We intend to conduct our operations so that no asset owned by us or our pass-through subsidiaries will be held for sale
to customers, and that a sale of any such asset will not be in the ordinary course of business. Whether property is held “primarily for sale to customers in the ordinary course of a trade or business” depends, however, on the particular facts and circumstances. No assurance can be given that any particular property in which we hold a direct or indirect interest will not be treated as property held for sale to customers, or that we can comply with certain safe-harbor provisions of the Internal Revenue Code that would prevent such treatment. The 100% tax will not apply to gains from the sale of property that is held through a TRS or other taxable corporation, although such income will be taxed to the corporation at regular corporate income tax rates.
Foreclosure Property
Foreclosure property is real property (including interests in real property as described below) and any
personal property incident to such real property: (i) that is acquired by a REIT as the result of the REIT having bid in the property at foreclosure, or having otherwise reduced the property to ownership or possession by agreement or process of law, after there was a default (or default was imminent) on a lease of the property or on a mortgage loan held by the REIT and secured by the property; (ii) for which the related loan or lease was acquired by the REIT at a time when default was not imminent or anticipated; and (iii) for which such REIT makes a proper election to treat the property as foreclosure property. REITs generally are subject to tax at the maximum corporate rate (currently 35%) on any net income from foreclosure property, including any gain from the disposition of the foreclosure property, other than income that would otherwise be qualifying income for purposes of the 75% gross income test. Any gain from the sale of property for which a foreclosure property
election has been made will not be subject to the 100% tax on gains from prohibited transactions described above, even if the property would otherwise constitute inventory or dealer property in the hands of the selling REIT. We do not anticipate that we will receive any income from foreclosure property that is not qualifying income for purposes of the 75% gross income test, but, if we do receive any such income, we intend to make an election to treat the related property as foreclosure property or to otherwise determine that the receipt of such non-qualifying income will not adversely affect our status as a REIT.
To the extent that we directly or indirectly hold or acquire any investments and, accordingly, pay taxes, in foreign countries, such foreign taxes may not be passed through to, or used by, our stockholders, as a foreign tax credit or otherwise. Any foreign investments may also generate foreign currency gains and losses. Certain foreign currency gains may be excluded from gross income for purposes of one or both of the gross income tests described above.
Hedging Transactions
We expect to enter into hedging transactions, from time-to-time, with respect to our assets or liabilities. Our hedging activities may include entering into interest rate swaps, caps, and floors, options to purchase these items,
and futures and forward contracts. To the extent that we enter into an interest rate swap or cap contract, option, futures contract, forward rate agreement, or any similar financial instrument to hedge our indebtedness incurred or to be incurred to acquire or carry “real estate assets,” including mortgage loans, or to hedge certain foreign currency risks, any periodic income or gain from the disposition of that contract are disregarded for purposes of the 75% and 95% gross income tests, provided that we meet certain requirements as described below. We are required to identify clearly any such hedging
transaction before the close of the day on which it was acquired, originated, or entered into and satisfy other identification requirements. To the extent that we hedge for other purposes, or to the extent that a portion of our loans are not secured by “real estate assets” (as described under “—Asset Tests”) or in other situations, the income from those transactions will likely be treated as non-qualifying income for purposes of both gross income tests. Moreover, our position in a hedging contract or other derivative instrument, to the extent that it has positive value, may not be treated favorably for purposes of the REIT asset tests.
We intend to structure any hedging transactions in a manner that does not jeopardize our status as a REIT. We may conduct some or all of our hedging activities through a TRS or other corporate
entity, the income from which may be subject to federal income tax, rather than by participating in the arrangements directly or through pass-through subsidiaries. No assurance can be given, however, that our hedging activities will not give rise to income that does not qualify for purposes of either or both of the REIT gross income tests, or that our hedging activities will not adversely affect our ability to satisfy the REIT qualification requirements.
Taxable Mortgage Pools
An entity, or a portion of an entity, may be classified as a taxable mortgage pool, or TMP, under the Internal Revenue Code if: (i) substantially all of its assets consist of debt obligations or interests in debt obligations; (ii) more than 50% of those debt obligations are real estate mortgages or interests in real
estate mortgages as of specified testing dates; (iii) the entity has issued debt obligations (liabilities) that have two or more maturities; and (iv) the payments required to be made by the entity on its debt obligations (liabilities) “bear a relationship” to the payments to be received by the entity on the debt obligations that it holds as assets. Under regulations issued by the U.S. Treasury Department, if less than 80% of the assets of an entity (or a portion of an entity) consist of debt obligations, these debt obligations are considered not to comprise “substantially all” of its assets, and therefore the entity would not be treated as a TMP.
Where an entity, or a portion of an entity, is classified as a TMP, it is generally treated as a taxable corporation for federal income tax purposes. Special rules apply, however, in the case of a TMP that is a REIT, a portion of a REIT or a disregarded subsidiary of
a REIT. In that event, the TMP is not treated as a corporation that is subject to corporate income tax, and the TMP classification does not directly affect the tax status of the REIT. These special rules will not apply to us to the extent we hold all of our assets through our operating partnership.
A portion of the REIT’s income from the TMP arrangement, which might be non-cash accrued income, could be treated as “excess inclusion income.” Pursuant to guidance issued by the IRS, the REIT’s excess inclusion income, including any excess inclusion income from a residual interest in a REMIC, must be allocated among its stockholders in proportion to dividends paid. The REIT is required to notify stockholders of the amount of ’’excess inclusion income" allocated to them. A stockholder’s share of excess inclusion income cannot be offset by any losses or deductions otherwise available to the stockholder, is
subject to tax as unrelated business taxable income in the hands of most types of stockholders that are otherwise generally exempt from federal income tax and results in the application of U.S. federal income tax withholding at the maximum rate (30%), without reduction for any otherwise applicable income tax treaty or other exemption, to the extent allocable to most types of foreign stockholders.
Under the IRS guidance, to the extent that excess inclusion income is allocated to a tax-exempt stockholder of a REIT that is not subject to unrelated business income tax (such as a government entity or charitable remainder trust), the REIT will be subject to tax on this income at the highest applicable corporate tax rate (currently 35%). In that case, the REIT could reduce distributions to such stockholders by the
amount of such tax paid by it that is attributable to such stockholder’s ownership. Treasury Regulations provide that such a reduction in distributions does not give rise to a preferential dividend that could adversely affect the REIT’s compliance with its distribution requirements. See “—Annual Distribution Requirements.” The manner in which excess inclusion income is calculated, or would be allocated to stockholders, including allocations among shares of different classes of stock, is not clear under current law. As required by the IRS guidance, we intend to make such determinations using a reasonable method. Tax-exempt investors, foreign investors and taxpayers with net operating losses should carefully consider the tax consequences described above, and are urged to consult their tax advisors.
If a subsidiary partnership of ours (not wholly owned by us directly or indirectly through one or more disregarded entities),
such as our operating partnership, were a TMP or owned a TMP, the foregoing rules would not apply. Rather, the TMP would be treated as a corporation for federal income tax purposes and would potentially be subject to corporate income tax. In addition, this characterization would alter our REIT income and asset test calculations and could adversely affect our compliance with those requirements, e.g., by causing us to be treated as owning more than 10% of the securities of a C corporation. Because we intend to hold substantially all of our assets, directly or indirectly, through our operating partnership, we will not acquire interests in taxable mortgage pools and will attempt to avoid securitization structures that may be treated as taxable mortgage pools.
Cash/Income Differences
Our operating partnership may acquire debt instruments in the secondary market for less than their principal
amount. The amount of such discount will generally be treated as a “market discount” for federal income tax purposes. It is also possible that certain debt instruments may provide for PIK Interest which could give rise to OID for federal income tax purposes. Moreover, we may acquire distressed debt investments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding debt are “significant modifications” under the applicable Treasury Regulations, the modified debt may be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, if the debt is considered to be “publicly traded” for federal income tax purposes, the modified debt in our hands may be considered to have been issued with original issue discount to the extent the fair market value of the modified debt is less than the principal amount of the outstanding debt. In the event that the debt is not considered
to be “publicly traded” for federal income tax purposes, we may be required to recognize taxable income to the extent that the principal amount of the modified debt exceeds our cost of purchasing it. Also, certain loans that we originate and certain previously modified debt that we acquire may be considered to have been issued with the original issue discount of the time it was modified.
In general, our operating partnership will be required to accrue OID on a debt instrument as taxable income in accordance with applicable federal income tax rules even though no cash payments may be received on such debt instrument. With respect to market discount, although generally our operating partnership is not required to accrue the discount annually as taxable income (absent an election to do so), interest payments with respect to any debt incurred to purchase the investment may not be deductible and a portion of any gain realized
on our operating partnership’s disposition of the debt instrument may be treated as ordinary income rather than capital gain.
Finally, in the event that any debt instruments acquired by our operating partnership are delinquent as to mandatory principal and interest payments, or in the event a borrower with respect to a particular debt instrument acquired by our operating partnership encounters financial difficulty rendering it unable to pay stated interest as due, our operating partnership may nonetheless be required to continue to recognize the unpaid interest as taxable income.
Due to each of these potential timing differences between income recognition or expense deduction and cash receipts or disbursements, there is a significant risk that our operating partnership may recognize and allocate to us substantial taxable income in excess of cash available for distribution. In that event, we may need to borrow funds or take other action to satisfy the REIT distribution requirements for the taxable year in which this “phantom income” is recognized. See “—Annual Distribution Requirements.”
Tax Aspects of Investments in Partnerships
We will hold investments through entities, including our operating partnership, that are classified as partnerships for federal income tax purposes. In general, partnerships are “pass-through”
entities that are not subject to federal income tax. Rather, partners are allocated their proportionate shares of the items of income, gain, loss, deduction and credit of a partnership, and are potentially subject to tax on these items, without regard to whether the partners receive a distribution from the partnership. We will include in our income our proportionate share of these partnership items from subsidiary partnerships for purposes of the various REIT income tests and in the computation of our REIT taxable income. Moreover, for purposes of the REIT asset tests, we will include our proportionate share of assets held by subsidiary partnerships. See “—Effect of Subsidiary Entities—Ownership of Partnership Interests.” Consequently, to the extent that we hold an equity interest in a partnership, the partnership’s assets and operations may affect our ability to qualify as a REIT, even if we may have no control, or only limited influence, over the partnership.
Entity Classification
Investments in partnerships involve special tax considerations, including the possibility of a challenge by the IRS of the status of any partnerships as a partnership, as opposed to an association taxable as a corporation, for federal income tax purposes (for example, if the IRS were to assert that a subsidiary partnership is a TMP). See “—Taxable Mortgage Pools.” If any of these entities were treated as an association for federal income tax purposes, it would be taxable as a corporation and therefore could be subject to an entity-level tax on its income. In such a situation, the character of our assets and items of gross income would change and could preclude us from satisfying the REIT asset tests or the gross income tests as discussed in “—Asset Tests” and “—Income Tests,” and in turn could prevent us from qualifying as a REIT. See
“—Failure to Qualify” above for a discussion of the effect of our failure to meet these tests for a taxable year. In addition, any change in the status of any of these partnerships for tax purposes might be treated as a taxable event, in which case we could have taxable income that is subject to the REIT distribution requirements without receiving any cash.
Tax Allocations with Respect to Partnership Properties
Under the Internal Revenue Code and the Treasury Regulations, income, gain, loss and deduction attributable to appreciated or depreciated property that is contributed to a partnership in exchange for an interest in the partnership must be allocated for tax purposes in a manner such that the contributing partner is charged with, or benefits from, the unrealized gain or unrealized loss associated with the property at the time of the contribution. The amount of the unrealized
gain or unrealized loss is generally equal to the difference between the fair market value of the contributed property at the time of contribution and the adjusted tax basis of such property at the time of contribution (a “book-tax difference”). Such allocations are solely for federal income tax purposes and do not affect the book capital accounts or other economic or legal arrangements among the partners.
To the extent that any of our partnerships acquire appreciated (or depreciated) properties by way of capital contributions from its partners, allocations of income, gain loss and deduction would need to be made in a manner consistent with these requirements. Where a partner contributes cash to a partnership at a time that the partnership holds appreciated (or depreciated) property, the Treasury Regulations provide for a similar allocation of any existing book-tax difference to the other (i.e., non-contributing) partners.
These rules may apply to the contribution by us to our operating partnerships of the cash proceeds received in offerings of our stock. As a result, we could be allocated greater or lesser amounts of depreciation and taxable income in respect of a partnership’s properties than would be the case if all of the partnership’s assets (including any contributed assets) had a tax basis equal to their fair market values at the time of any contributions to that partnership. This could cause us to recognize, over a period of time, taxable income in excess of cash flow from the partnership, which might adversely affect our ability to comply with the REIT distribution requirements discussed above.
We may be subject to state, local or foreign taxation in various jurisdictions, including those in which we and our subsidiaries transact business, own property or reside. The state, local or foreign tax treatment of us may not conform to the federal income tax treatment discussed above. Any foreign taxes incurred by us would not pass through to stockholders to be credited against their United States federal income tax liability. Prospective investors should consult their tax advisors regarding the application and effect of state, local and foreign income and other tax laws on an investment in our common stock.
Taxation of Holders of Our Common
Stock
The following is a summary of certain additional federal income tax considerations with respect to the ownership of our common stock.
Taxation of Taxable U.S. Stockholders
As used herein, the term “U.S. stockholder” means a holder of our common stock that for federal income tax purposes is:
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an individual who is a citizen or resident of the U.S.;
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a corporation (including an entity treated
as a corporation for federal income tax purposes) created or organized in or under the laws of the U.S., any of its states or the District of Columbia;
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an estate whose income is subject to federal income taxation regardless of its source; or
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a trust if: (i) a U.S. court is able to exercise primary supervision over the administration of such trust and one or more U.S. persons have the authority to control all substantial decisions of the trust; or (ii) it has a valid election in place to be treated as a U.S. person.
If a partnership, entity or arrangement treated as a partnership for federal income tax purposes holds our common stock, the federal income tax treatment of a partner in the partnership will generally depend on the status of the partner and the activities of the partnership. If you are a partner in a partnership that will hold our common stock, you should consult your tax advisor regarding the consequences of the purchase, ownership and disposition of our common stock by the partnership.
Taxation of U.S. Stockholders on Distributions on Our Common Stock. As long as we qualify as a REIT, a taxable U.S. stockholder generally must take into account as ordinary income distributions made out of our current or accumulated earnings and profits that we do not designate as capital gain dividends or retained long-term capital gain.
Dividends
paid to corporate U.S. stockholders will not qualify for the dividends received deduction generally available to corporations. In addition, dividends paid to a U.S. stockholder generally will not qualify for the reduced tax rate (which is currently a maximum of 20%) for “qualified dividend income.” Our ordinary dividends generally will be taxed at the higher tax rate applicable to ordinary income, which currently is a maximum marginal rate of 39.6% for shareholders taxed at individual rates. However, the reduced tax rate for qualified dividend income will apply to our ordinary dividends to the extent attributable: (i) to dividends received by us from non-REIT corporations, such as TRSs; and (ii) to income upon which we have paid corporate income tax (e.g., to the extent that we distributed less than 100% of our taxable income in a prior tax year).
A U.S. stockholder generally will take into account as long-term capital
gain any distributions that we designate as capital gain dividends without regard to the period for which the U.S. stockholder has held its common stock. See “—Capital Gains and Losses.” A corporate U.S. stockholder, however, may be required to treat up to 20% of certain capital gain dividends as ordinary income.
We may elect to retain and pay income tax on the net long-term capital gain that we receive in a taxable year. In that case, to the extent that we designate such amount in a timely notice to stockholders, a U.S. stockholder would be taxed on its proportionate share of its undistributed long-term capital gain. The U.S.
stockholder would receive a credit for its proportionate share of the tax we paid. The U.S. stockholder would increase the basis in its stock by the amount of its proportionate share of our undistributed long-term capital gain, minus its share of the tax we paid.
To the extent that we make a distribution in excess of our current and accumulated earnings and profits, such distribution will not be taxable to a U.S. stockholder to the extent that it does not exceed the adjusted tax basis of the U.S. stockholder’s common stock. Instead, such distribution will reduce the adjusted tax basis of such stock. To the extent that we make a distribution in excess of both our current and accumulated earnings and profits and the U.S. stockholder’s adjusted tax basis in its common stock, such stockholder will recognize long-term
capital gain, or short-term capital gain if the common stock has been held for one year or less, assuming the common stock is a capital asset in the hands of the U.S. stockholder. In addition, if we declare a distribution in October, November, or December of any year that is payable to a U.S. stockholder of record on a specified date in any such month, such distribution shall be treated as both paid by us and received by the U.S. stockholder on December 31 of such year, provided that we actually pay the distribution during January of the following calendar year.
Stockholders may not include in their individual income tax returns any of a REIT’s net operating losses or capital losses. Instead, the REIT would carry over such losses for potential offset against its future income. Taxable distributions from us and gain from the disposition of our common stock will not be treated as passive activity income, and, therefore, stockholders
generally will not be able to apply any “passive activity losses,” such as losses from certain types of limited partnerships in which the stockholder is a limited partner to offset income they derive from our common stock. In addition, taxable distributions from us and gain from the disposition of our common stock generally may be treated as investment income for purposes of the investment interest limitations (although any capital gains so treated will not qualify for the lower 20% tax rate applicable to capital gains of U.S. stockholders who are taxed at individual rates). We will notify stockholders after the close of our taxable year as to the portions of our distributions attributable to that year that constitute ordinary income, return of capital, and capital gain.
Participants in our DRP will be treated for tax purposes as having received a distribution equal to the amount of cash that they would have otherwise
been entitled to receive, even though they will not receive cash distributions to pay any resultant tax liability.
Taxation of U.S. Stockholders on the Disposition of Our Common Stock. In general, a U.S. stockholder who is not a dealer in securities must treat any gain or loss realized upon a taxable disposition of our common stock as long-term capital gain or loss if the U.S. stockholder has held the common stock for more than one year and otherwise as short-term capital gain or loss. However, a U.S. stockholder must treat any loss upon a sale or exchange of common stock held by such stockholder for six months or less as a long-term capital loss to the extent of any actual or deemed distributions from us that such U.S. stockholder previously has characterized as long-term capital gain. All or a portion of any loss that a U.S. stockholder realizes upon a taxable disposition of the common stock may
be disallowed if the U.S. stockholder purchases other common stock within 30 days before or after the disposition.
If an investor recognizes a loss upon a disposition of our stock in an amount that exceeds a prescribed threshold, it is possible that the provisions of Treasury Regulations involving “reportable transactions” could apply, with a resulting requirement to separately disclose the loss-generating transaction to the IRS. These regulations, though directed towards “tax shelters,” are written quite broadly, and apply to transactions that would not typically be considered tax shelters. The Code imposes significant penalties for failure to comply with these requirements. You should consult your tax advisors concerning any possible disclosure obligation with respect to the receipt or disposition of our stock, or transactions that we might undertake directly or indirectly. Moreover, we and other participants
in the transactions in which we are involved (including their advisors) might be subject to disclosure or other requirements pursuant to these regulations.
Taxation of U.S. Stockholders on a Redemption of Common Stock. A redemption of our common stock will be treated under Section 302 of the Internal Revenue Code as a distribution that is taxable as dividend income (to the extent of our current or accumulated earnings and profits), unless the redemption satisfies certain tests set forth in Section 302(b) of the Internal Revenue Code enabling the redemption to be treated as sale of our common stock (in which case the redemption will be treated in the same manner as a
sale described above in “—Taxation of U.S. Stockholders on the Disposition of Our Common Stock”). The redemption will satisfy such tests if it: (i) is “substantially disproportionate” with respect to the holder’s interest in our stock; (ii) results in a “complete termination” of the holder’s interest in all our classes of stock; or (iii) is “not essentially equivalent to a dividend” with respect to the holder, all within the meaning of Section 302(b) of the Internal Revenue Code. In determining whether any of these tests have been met, stock considered to be owned by the holder by reason of certain constructive ownership rules set forth in the Internal Revenue Code, as well as stock actually owned, generally must be taken into account. Because the determination as to whether any of the three alternative tests of Section 302(b)
of the Internal Revenue Code described above will be satisfied with respect to any particular holder of our common stock depends upon the facts and circumstances at the time that the determination must be made, prospective investors are urged to consult their tax advisors to determine such tax treatment. If a redemption of our common stock does not meet any of the three tests described above, the redemption proceeds will be treated as a dividend, as described above “—Taxation of U.S. Stockholders on Distributions on Our Common Stock.” Stockholders should consult with their tax advisors regarding the taxation of any particular redemption of our shares.
Capital Gains and Losses. A taxpayer generally must hold a capital asset for more than one year for gain or loss derived from its sale or exchange to be treated as long-term capital gain or loss. The highest marginal individual income tax rate
currently is 39.6%. However, the maximum tax rate on long-term capital gain applicable to U.S. stockholders taxed at individual rates is 20%. The maximum tax rate on long-term capital gain from the sale or exchange of “Section 1250 property,” or depreciable real property, is 25% computed on the lesser of the total amount of the gain or the accumulated Section 1250 depreciation. With respect to distributions that we designate as capital gain dividends and any retained capital gain that we are deemed to distribute, we generally may designate whether such a distribution is taxable to our non-corporate stockholders at a 20% or 25% rate. Thus, the tax rate differential between capital gain and ordinary income for non-corporate taxpayers may be significant. In addition, the characterization of income as capital gain or ordinary income may affect the deductibility of capital losses. A non-corporate taxpayer may deduct capital losses not offset by capital gains against
its ordinary income only up to a maximum annual amount of $3,000. A non-corporate taxpayer may carry forward unused capital losses indefinitely. A corporate taxpayer must pay tax on its net capital gain at ordinary corporate rates. A corporate taxpayer may deduct capital losses only to the extent of capital gains, with unused losses being carried back three years and forward five years.
Medicare Tax. Certain U.S. stockholders who are individuals, estates or trusts and whose income exceeds certain thresholds will be required to pay a 3.8% Medicare tax on dividends, interest and certain other investment income, including capital gains from the sale or other disposition of our common stock.
Information Reporting Requirements and Backup Withholding. We will report to our stockholders and to the IRS the amount of distributions we pay
during each calendar year, and the amount of tax we withhold, if any. Under the backup withholding rules, a stockholder may be subject to backup withholding at the rate of 28% with respect to distributions unless such holder:
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is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact; or
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provides a taxpayer identification number, certifies as to no loss of exemption from backup withholding, and otherwise complies with the applicable requirements of the backup withholding rules.
A
stockholder who does not provide us with its correct taxpayer identification number also may be subject to penalties imposed by the IRS. Any amount paid as backup withholding will be creditable against the stockholder’s income tax liability.
Brokers that are required to report the gross proceeds from a sale of shares on Form 1099-B will also be required to report the customer’s adjusted basis in the shares and whether any gain or loss with respect to the shares is long-term or short-term. In some cases, there may be alternative methods of determining the basis in shares that are disposed of, in which case your broker will apply a default method of its choosing if you do not indicate which method you choose to have applied. You should consult with your own tax advisor regarding the new reporting requirements and your election options.
Tax-exempt entities, including qualified employee pension and profit sharing trusts and IRAs, generally are exempt from federal income taxation. However, they are subject to taxation on their unrelated business taxable income. Dividend distributions from a REIT to a tax-exempt stockholder generally do not constitute unrelated business taxable income, provided that the entity does not otherwise use the shares of the REIT in an unrelated trade or business of the pension trust. However, if a tax-exempt stockholder were to finance its investment in our common stock with debt, a portion of the income that it receives from us would constitute unrelated business taxable income pursuant to the “debt-financed property” rules. In addition, dividends that are attributable to
excess inclusion income, with respect to the REMIC residual interests or taxable mortgage pools, will constitute unrelated business taxable income in the hands of most tax-exempt stockholders. See “—Taxable Mortgage Pools.” Furthermore, social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts, and qualified group legal services plans that are exempt from taxation under special provisions of the federal income tax laws are subject to different unrelated business taxable income rules, which generally will require them to characterize distributions that they receive from us as unrelated business taxable income. Finally, in certain circumstances, a qualified employee pension or profit sharing trust that owns more than 10% of our stock could be required to treat a percentage of the dividends that it receives from us as unrelated business taxable income. Such percentage is equal to the gross income that we derive from an unrelated
trade or business, determined as if we were a pension trust, divided by our total gross income for the year in which we pay the dividends. That rule applies to a pension trust holding more than 10% of our stock only if:
•
the percentage of our dividends that the tax-exempt trust would be required to treat as unrelated business taxable income is at least 5%;
•
we qualify as a REIT by reason of the modification of the rule requiring that no more than 50% of our stock be owned by five or fewer individuals, which modification allows the
beneficiaries of the pension trust to be treated as holding our stock in proportion to their actuarial interests in the pension trust in lieu of treating the pension trust as an individual for this purpose (see “—Taxation of NorthStar Real Estate Income II, Inc.—Requirements for Qualification— General”); and
•
either: (i) one pension trust owns more than 25% of the value of our stock; or (ii) a group of pension trusts individually holding more than 10% of the value of our stock collectively owns more than 50% of the value of our stock.
Taxation of Non-U.S. Stockholders
The term “non-U.S. stockholder” means a holder of our
common stock that is neither a U.S. stockholder nor an entity treated as a partnership for federal income tax purposes. The rules governing federal income taxation of non-U.S. stockholders are complex. This section is only a summary of such rules. Non-U.S. stockholders are urged to consult their tax advisors to determine the impact of federal, state, local and non U.S. income tax laws on the ownership of our common stock, including any reporting requirements.
Ordinary Dividends. A non-U.S. stockholder that receives a distribution that is not attributable to gain from our sale or exchange of a “United States real property interest”, or a USRPI, and that we do not designate as a capital gain dividend or retained capital gain will recognize ordinary income to the extent that we pay such distribution out of our current or accumulated earnings and profits. A withholding tax equal to 30% of the gross
amount of the distribution ordinarily will apply to such distribution unless an applicable tax treaty or other exemption reduces or eliminates the tax. Any dividends that are attributable to excess inclusion income will be subject to the 30% withholding tax, without reduction for any otherwise applicable income tax treaty. See above under “Taxation of NorthStar Real Estate Income II, Inc.—Taxable Mortgage Pools.” If a distribution is treated as effectively connected with the non-U.S. stockholder’s conduct of a U.S. trade or business, the non-U.S. stockholder generally will be subject to federal income tax on the distribution at graduated rates, in the same manner as U.S. stockholders are taxed with respect to
such distribution, and a non-U.S. stockholder that is a corporation also may be subject to the 30% branch profits tax with respect to the distribution. We plan to withhold U.S. income tax at the rate of 30% on the gross amount of any such distribution paid to a non-U.S. stockholder unless either:
•
a lower treaty rate or other exemption applies and the non-U.S. stockholder furnishes to us an IRS Form W-8BEN evidencing eligibility for that reduced rate; or
•
the
non-U.S. stockholder furnishes to us an IRS Form W-8ECI claiming that the distribution is effectively connected income.
Capital Gain Dividends. For any year in which we qualify as a REIT, a non-U.S. stockholder will incur tax on distributions that are attributable to gain from our sale or exchange of a USRPI under the Foreign Investment in Real Property Tax Act of 1980, or FIRPTA. A USRPI includes certain interests in real property and stock in “United States real property holding corporations” but does not include interests solely as a creditor and, accordingly, does not include a debt instrument that does not provide for contingent payments based on the value of or income from real property interests. Under FIRPTA, a non-U.S. stockholder is taxed on distributions attributable to gain from sales of USRPIs as if such gain were effectively connected with a U.S. business of
the non-U.S. stockholder. A non-U.S. stockholder thus would be taxed on such a distribution at the normal capital gains rates applicable to U.S. stockholders, subject to applicable alternative minimum tax and a special alternative minimum tax in the case of a nonresident alien individual. A non-U.S. corporate stockholder not entitled to treaty relief or exemption also may be subject to the 30% branch profits tax on such a distribution. There is a special 35% withholding rate for distributions to non-US stockholders attributable to the REIT’s gains from dispositions of USRPIs. A non-U.S. stockholder may receive a credit against its tax liability for the amount we withhold.
Capital gain dividends that are attributable to our sale of USRPIs would be treated as ordinary dividends rather than as gain from the sale of a USRPI, if: (i) our common stock is “regularly traded” on an established securities market in the United
States; and (ii) the non-U.S. stockholder did not own more than 5% of our common stock at any time during the one-year period prior to the distribution. Such distributions would be subject to withholding tax on such capital gain distributions in the same manner as they are subject to withholding tax on ordinary dividends. Our stock is not regularly traded on an established securities market in the United States and there is no assurance that it ever will be.
Capital gain dividends that are not attributable to our sale of USRPIs (e.g., distributions of gains from sales of debt instruments that are not USRPIs), generally will not be taxable to non-U.S. stockholders or subject to withholding tax.
Non-Dividend Distributions. A non-U.S. stockholder will not incur tax on a distribution in excess of our current and accumulated earnings and profits if the excess
portion of such distribution does not exceed the adjusted basis of its common stock. Instead, the excess portion of such distribution will reduce the adjusted basis of such shares. A non-U.S. stockholder will be subject to tax on a distribution that exceeds both our current and accumulated earnings and profits and the adjusted basis of its common stock, if the non-U.S. stockholder otherwise would be subject to tax on gain from the sale or disposition of its common stock, as described below. Because we generally cannot determine at the time we make a distribution whether the distribution will exceed our current and accumulated earnings and profits, we normally will withhold tax on the entire amount of any distribution at the same rate as we would withhold on an ordinary dividend. However, a non-U.S. stockholder may claim a refund of amounts that we withhold if we later determine that a distribution in fact exceeded our current and accumulated earnings and profits.
We
may be required to withhold 10% of any distribution that exceeds our current and accumulated earnings and profits if our stock is a USRPI. Consequently, although we intend to withhold at a rate of 30% on the entire amount of any distribution, to the extent that we do not do so, we may withhold at a rate of 10% on any portion of a distribution not subject to withholding at a rate of 30%.
Dispositions of Our Common Stock. A non-U.S. stockholder generally will not incur tax under FIRPTA with respect to gain realized upon a disposition of our common stock as long as we: (i) are not a “United States real property holding corporation” during a specified testing period and certain procedural requirements are satisfied; or (ii) are a domestically controlled qualified investment entity. A “United States real property holding corporation” is a U.S. corporation that at any time during the applicable
testing
period owned USRPIs that exceed in value 50% of the value of the corporation’s USRPIs, interests in real property located outside the United States and other assets used in the corporation’s trade or business. No assurance can be provided that we will not become a “United States real property holding corporation.” In addition, we believe that we will be a domestically controlled qualified investment entity, but we
cannot assure you that we will be a domestically controlled qualified investment entity in the future. Even if we were a “United States real property holding corporation” and we were not a domestically controlled qualified investment entity, a non-U.S. stockholder that owned, actually or constructively, 5% or less of our common stock at all times during a specified testing period would not incur tax under FIRPTA if our common stock is “regularly traded” on an established securities market. Our stock is not regularly traded on an established securities market in the United States and there is no assurance that it ever will be.
If the gain on the sale of our common stock were taxed under FIRPTA, a non-U.S. stockholder would be taxed in the same manner as U.S. stockholders with respect to such gain, subject to applicable alternative minimum tax or, a special alternative minimum tax in the case of nonresident alien
individuals. Furthermore, a non-U.S. stockholder will incur tax on gain not subject to FIRPTA if: (i) the gain is effectively connected with the non-U.S. stockholder’s U.S. trade or business, in which case the non-U.S. stockholder will be subject to the same treatment as U.S. stockholders with respect to such gain; or (ii) the non-U.S. stockholder is a nonresident alien individual who was present in the United States for 183 days or more during the taxable year and has a “tax home” in the United States, in which case the non-U.S. stockholder will incur a 30% tax on his capital gains.
FATCA
U.S. tax legislation enacted in 2010, the Foreign Account Tax Compliance Act, or FATCA, and subsequent IRS guidance regarding the implementation of FATCA, provides that 30% withholding tax will be imposed on distributions (for payments made after June 30,
2014) and the gross proceeds from a sale of shares (for payments made after December 31, 2016) to a foreign entity if such entity fails to satisfy certain due diligence, disclosure and reporting rules. In the event of noncompliance with the FATCA requirements, as set forth in Treasury Regulations, withholding at a rate of 30% on distributions in respect of our stock and gross proceeds from the sale of our stock held by or through such foreign entities would be imposed. Non-U.S. persons that are otherwise eligible for an exemption from, or a reduction of, U.S. withholding tax with respect to such distributions and sale proceeds would be required to seek a refund from the IRS to obtain the benefit of such exemption or reduction. We will not pay any additional amounts in respect of any amounts withheld (under FATCA or otherwise). Additional requirements and conditions may be imposed pursuant to an intergovernmental agreement
(if and when entered into) between the United States and the foreign entity’s home jurisdiction. Prospective investors are urged to consult with their tax advisors regarding the application of these rules to an investment in our stock.
Legislative or Other Actions Affecting REITs
The rules dealing with U.S. federal income taxation are constantly under review. No assurance can be given as to whether, when or in what form the U.S. federal income tax laws applicable to us and our stockholders may be changed, possibly with retroactive effect. Changes to the federal tax laws and interpretations of federal tax laws could adversely affect an investment in shares of our common stock.
INVESTMENT BY TAX EXEMPT ENTITIES AND ERISA AND OTHER BENEFIT PLAN CONSIDERATIONS
The following is a summary of some considerations associated with an investment in our shares by a Benefit Plan (as defined below). This summary is based on the provisions of ERISA and the Internal Revenue Code, each as amended through the date of this prospectus, and the relevant regulations, opinions and other authority issued by the Department of Labor and the IRS. We cannot assure you that there will not be adverse tax or labor decisions or legislative, regulatory or administrative changes that would significantly modify the statements expressed herein. Any such changes may apply to transactions entered into prior to the date of their enactment. This summary does not address
issues relating to government plans, church plans, and foreign plans that are not subject to ERISA or the prohibited transaction provisions of Section 4975 of the Internal Revenue Code but that may be subject to similar requirements under other applicable laws. Such plans must determine whether an investment in our shares is in accordance with applicable law and the plan documents.
We collectively refer to employee pension benefit plans subject to ERISA (such as profit sharing, section 401(k) and pension plans), entities that hold assets of such plans, other retirement plans and accounts subject to Section 4975 of the Internal Revenue Code but not subject to ERISA (such as IRAs, Keoghs and medical savings accounts), and health and welfare plans subject to ERISA as Benefit Plans. Each fiduciary or other person responsible for the investment of the assets of a Benefit Plan seeking to invest plan assets in our shares must consider,
among other matters:
•
whether the investment is consistent with the applicable provisions of ERISA and the Internal Revenue Code;
•
whether, under the facts and circumstances pertaining to the Benefit Plan in question, the fiduciary’s responsibility to the plan has been satisfied;
•
in the case of a Benefit
Plan subject to ERISA, whether the investment is in accordance with ERISA’s fiduciary requirements, including the duty to act solely in the interest of plan participants and beneficiaries and for the exclusive purpose of providing benefits to them, as well as defraying reasonable expenses of plan administration, to invest plan assets prudently, and to diversify the investments of the plan, unless it is clearly prudent not to do so;
•
the need to value the assets of the Benefit Plan annually or more frequently;
•
whether
the investment will ensure sufficient liquidity for the Benefit Plan;
•
whether the investment is made in accordance with Benefit Plan documents;
•
whether the investment would constitute or give rise to a prohibited transaction under ERISA or the Internal Revenue Code; and
•
whether the investment
will produce an unacceptable amount of unrelated business taxable income to the Benefit Plan (see “U.S. Federal Income Tax Considerations—Taxation of Holders of Our Common Stock—Taxation of Tax-Exempt Stockholders”).
ERISA also requires that, with certain exceptions, the assets of an employee benefit plan be held in trust and that the trustee, or a duly authorized named fiduciary or investment manager, have exclusive authority and discretion to manage and control the assets of the plan.
Prohibited Transactions
Generally, both ERISA and the Internal Revenue Code prohibit Benefit Plans from engaging in certain transactions involving plan assets with specified parties, such as sales or exchanges or leasing of property, loans or other extensions of credit, furnishing goods or services, or transfers to, or use of,
plan assets. The specified parties are referred to as “parties-in-interest” under ERISA and as “disqualified persons” under the Internal Revenue Code. These definitions generally include both parties owning threshold percentage interests in an investment entity and “persons providing services” to the Benefit Plan, as well as employer sponsors of the Benefit Plan, fiduciaries and other individuals or entities affiliated with the foregoing. For this purpose, a person generally is a fiduciary with respect to a Benefit Plan if, among other things, the
person has discretionary authority or control with respect to plan assets or provides investment advice for a fee with respect to plan assets. Under Department of Labor regulations, a person is deemed to be providing investment advice if that person renders advice as to the advisability of investing in our shares, and that person regularly provides investment advice to the Benefit Plan pursuant to a mutual agreement or understanding that such advice will serve as the primary basis for investment decisions, and that the advice will be individualized for the Benefit Plan based on its particular needs. The prohibited transaction rules under ERISA and the Internal Revenue Code also prohibit fiduciary self-dealing such as the use of Benefit Plan assets to increase his or her own compensation. Thus, if we are deemed to hold plan assets, our management could
be characterized as fiduciaries with respect to such assets, and each would be deemed to be a party-in-interest under ERISA and a disqualified person under the Internal Revenue Code with respect to investing Benefit Plans. Whether or not we are deemed to hold plan assets, if we or our affiliates are affiliated with a Benefit Plan investor, we might be a disqualified person or party-in-interest with respect to such Benefit Plan investor, resulting in a prohibited transaction merely upon investment by such Benefit Plan in our shares.
Plan Asset Considerations
In order to determine how ERISA and the Internal Revenue Code apply to an investment in our shares by a Benefit Plan, a Benefit Plan fiduciary must consider whether an investment in our shares will cause our assets to be treated as assets of the investing Benefit Plan. ERISA provides generally that the term “plan assets”
has the meaning as set forth in Department of Labor regulations as modified or deemed to be modified by Section 3(42) of ERISA. The Department of Labor has issued regulations that provide guidelines as to whether and under what circumstances, the underlying assets of an entity will be deemed to constitute assets of a Benefit Plan under ERISA or the Internal Revenue Code when the plan invests in that entity, which we refer to as the Plan Asset Regulation. Under the Plan Asset Regulation, as modified or deemed to be modified by the express exceptions noticed in Section 3(42) of ERISA, the assets of an entity in which a Benefit Plan makes an equity investment will generally be deemed to be assets of the Benefit Plan, unless one of the exceptions to this general rule applies.
In the event that our underlying assets were treated as the assets of investing Benefit Plans, our management would be treated as fiduciaries with respect
to each Benefit Plan stockholder and an investment in our shares might constitute an ineffective delegation of fiduciary responsibility to our advisor, and expose the fiduciary of the Benefit Plan to co-fiduciary liability under ERISA for any breach by our advisor of the fiduciary duties mandated under ERISA.
If our advisor or its affiliates were treated as fiduciaries with respect to Benefit Plan stockholders, the prohibited transaction restrictions of ERISA and the Internal Revenue Code would apply to any transaction involving our assets. These restrictions could, for example, require that we avoid transactions with persons that are affiliated with or related to us or our affiliates or require that we restructure our activities in order to comply with certain existing statutory or administrative class exemptions from the prohibited transaction restrictions or obtain an individual administrative exemption from the prohibited
transaction restrictions. Alternatively, we might have to provide Benefit Plan stockholders with the opportunity to sell their shares to us or we might dissolve.
If a prohibited transaction were to occur, the Internal Revenue Code imposes an excise tax equal to 15% of the amount involved and authorizes the IRS to impose an additional 100% excise tax if the prohibited transaction is not “corrected” in a timely manner. These taxes would be imposed on any disqualified person who participates in the prohibited transaction. In addition, our advisor and possibly other fiduciaries of Benefit Plan stockholders subject to ERISA who permitted the prohibited transaction to occur or who otherwise breached their fiduciary responsibilities (or a non-fiduciary participating in a prohibited transaction) could be required to restore to the Benefit Plan any profits they realized as a result of the transaction or breach and make good
to the Benefit Plan any losses incurred by the Benefit Plan as a result of the transaction or breach. With respect to an IRA that invests in our shares, the occurrence of a prohibited transaction involving the individual who established the IRA, or his or her beneficiary, would cause the IRA to lose its tax-exempt status under Section 408(e)(2) of the Internal Revenue Code.
The Plan Assets Regulation provides that the underlying
assets of REITs will not be treated as assets of a Benefit Plan investing therein if the interest the Benefit Plan acquires is a “publicly offered security.” A publicly offered security must be:
•
Sold as part of a public offering registered under the Securities Act and be part of a class of securities registered under the Exchange Act within a specified time period;
•
“Widely held,” such as part of a class of securities that is owned by 100 or more persons who are independent of the issuer and one another; and
•
“Freely
transferable.”
Shares of common stock are being sold as part of an offering of securities to the public pursuant to an effective registration statement under the Securities Act, and are part of a class registered under the Exchange Act within the specified time period. In addition, we have over 100 independent stockholders, such that shares of common stock are “widely held.” Whether a security is “freely transferable” depends upon the particular facts and circumstances. Shares of common stock are subject to certain restrictions on transfer intended to ensure that we continue to qualify for federal income tax treatment as a REIT. The Plan Asset Regulation provides, however, that where the minimum investment in a public offering of securities is $10,000 or less, the presence of a restriction on transferability intended to prohibit transfers which would result in a termination or reclassification
of the entity for state or federal tax purposes will not ordinarily affect a determination that such securities are freely transferable. The minimum investment in shares of our common stock is less than $10,000; thus, we believe that the restrictions imposed in order to maintain our status as a REIT should not cause the shares of common stock to be deemed not freely transferable. Nonetheless, we cannot assure you that the Department of Labor and/or the U.S. Treasury Department could not reach a contrary conclusion.
Assuming that shares of common stock will be “widely held,” that no other facts and circumstances other than those referred to in the preceding paragraph exist that restrict transfer of shares of common stock and the offering takes place as described in this prospectus, we believe that shares of our common stock should constitute “publicly offered securities” and, accordingly, our underlying assets
should not be considered “plan assets” under the Plan Assets Regulation. If our underlying assets are not deemed to be “plan assets,” the issues discussed in the second and third paragraphs of this “Plan Assets Considerations” section are not expected to arise.
Other Prohibited Transactions
A prohibited transaction could occur if we, our advisor, any selected broker-dealer or any of their affiliates is a fiduciary (within the meaning of Section 3(21) of ERISA or Section 4975 of the Internal Revenue Code) with respect to any Benefit Plan purchasing our shares. Accordingly, unless an administrative or statutory exemption applies, shares should not be purchased by a Benefit Plan with respect to which any of the above persons is a fiduciary.
Annual Valuation
A fiduciary of
an employee benefit plan subject to ERISA is required to determine annually the fair market value of each asset of the plan as of the end of the plan’s fiscal year and to file a report reflecting that value with the Department of Labor. When the fair market value of any particular asset is not available, the fiduciary is required to make a good faith determination of that asset’s fair market value, assuming an orderly liquidation at the time the determination is made. In addition, a trustee or custodian of an IRA or similar account must provide an IRA (or other account) participant with a statement of the value of the IRA (or other account) each year. In discharging its obligation to value assets of a plan, a fiduciary subject to ERISA must act consistently with the relevant provisions of the plan and the general fiduciary standards of ERISA.
Unless and until our shares are listed on a national securities exchange, we do not
expect that a public market for our shares will develop. To date, neither the IRS nor the Department of Labor has promulgated regulations specifying how a plan fiduciary should determine the fair market value of shares when the fair market value of such shares is not determined in the marketplace.
Until 18 months after we have completed our offering stage (or for whatever period may be required by applicable rules and regulations),
our advisor has indicated that it intends to use the most recent price paid to acquire a share in our primary offering (ignoring purchase price discounts for certain categories of purchasers) as its estimated per share value of our shares; provided that if we have sold a material amount of assets and distributed the net sales proceeds to our stockholders, we will determine the estimated per share value by reducing the most recent per share offering price by the per share amount of such net proceeds which constituted a return of capital. Although this approach to valuing our shares has the advantage of avoiding the cost of paying for appraisals or other valuation services, the estimated value may bear little relationship and will likely exceed what you might receive for your shares if you tried to sell them or if we liquidated our portfolio. We will consider our offering stage complete when we are no longer publicly offering equity securities in a continuous offering,
whether through our current offering or follow-on public offerings. For this purpose, we do not consider a “public offering of securities” to include offerings on behalf of selling stockholders or offerings related to our DRP, employee benefit plan or the redemption of interests in our operating partnership.
In addition, unless the rules and regulations governing valuations change, within 18 months after the completion of our offering stage, our advisor or another firm we choose for that purpose will establish an estimated value per share of our common stock based on an appraisal of our assets and operations and other factors deemed relevant. The estimated value per share of our common stock will be based upon the fair value of our assets less the fair value of our liabilities under market conditions existing at the time of the valuation. We will obtain independent third-party appraisals for the properties underlying
our debt investments and will value our other assets in a manner we deem most suitable under the circumstances, including in a manner similar to how our sponsor values its assets, which, in some circumstances, may include an independent appraisal or valuation. A committee comprised of independent directors will be responsible for the oversight of the valuation process, including approval of engagement of any third-parties to assist in the valuation of assets, liabilities and unconsolidated investments and approval of all valuations not performed by an independent third-party. We anticipate that any property appraiser we engage will be a member of the Appraisal Institute with the MAI designation or such other professional valuation designation appropriate for the type and geographic locations of the assets being valued and will provide a written opinion, which will include a description of the reviews undertaken and the basis for such opinion. Any such appraisal will
be provided to a soliciting participating dealer upon request. After the initial appraisal, appraisals will be done annually and may be done on a quarterly rolling basis. The valuations are estimates and consequently should not necessarily be viewed as an accurate reflection of the fair value of our investments nor will they necessarily represent the amount of net proceeds that would result from an immediate sale of our assets. The estimated valuations should not be utilized for any purpose other than to assist plan fiduciaries in fulfilling their annual valuation and reporting responsibilities.
The following is a summary of the material terms of shares of our common stock as set forth in our charter and is qualified in its entirety by reference to our charter. Under our charter, we have authority to issue a total of 450,000,000 shares of capital stock. Of the total number of shares of capital stock authorized, 400,000,000 shares are classified as common stock with a par value of $0.01 per share and 50,000,000 shares are classified as preferred stock with a par value of $0.01 per share. Our board of directors, with the approval of a majority of the entire board of directors and without any action by our stockholders, may amend our charter from time-to-time to increase or decrease the aggregate number of shares of capital stock or the number of shares of capital stock of
any class or series that we have authority to issue. Our board of directors may classify or reclassify any unissued shares of our common stock from time-to-time into one or more classes or series; provided, however, that the voting rights per share (other than any publicly held share) sold in a private offering shall not exceed the voting rights which bear the same relationship to the voting rights of publicly held shares as the consideration paid to us for each privately offered share bears to the book value of each outstanding publicly held share.
Common Stock
Subject to the restrictions on transfer and ownership of our stock and except as otherwise provided in the charter, the holders of shares of our common stock are entitled to one vote per share on all matters voted on by stockholders, including election of our directors. Our charter does not provide for cumulative voting
in the election of directors. Therefore, the holders of a majority of the outstanding shares of our common stock can elect our entire board of directors. Subject to any preferential rights of any outstanding series of preferred stock, the holders of shares of our common stock are entitled to such distributions as may be authorized from time-to-time by our board of directors out of legally available funds and declared by us and, upon liquidation, are entitled to receive all assets available for distribution to stockholders. All shares of our common stock issued in our offering will be fully paid and nonassessable shares of common stock. Holders of shares of our common stock will not have preemptive rights, which means that you will not have an automatic option to purchase any new shares of common stock that we issue, including any new classes of common stock that we may offer with reduced fees or commissions. Holders of shares of our common stock will not have appraisal
rights, unless our board of directors determines that appraisal rights apply, with respect to all or any classes or series of our common stock, to one or more transactions occurring after the date of such determination in connection with which stockholders would otherwise be entitled to exercise such rights. Stockholders are not liable for our acts or obligations.
We do not issue certificates for shares of our common stock. Shares of our common stock are held in “uncertificated” form which will eliminate the physical handling and safekeeping responsibilities inherent in owning transferable share certificates and eliminate the need to return a duly executed share certificate to effect a transfer. DST Systems Inc. acts as our registrar and as the transfer agent for shares of our common stock. Transfers can be effected simply by mailing a transfer and assignment form, which we will provide to you at no charge, to:
Our charter authorizes our board of directors to classify and reclassify any unissued shares of our common stock and preferred stock into other classes or series of stock.
Prior to issuance of shares of each class or series, our board of directors is required by the MGCL and by our charter to set, subject to our charter restrictions on transfer of our stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption for each class or series. Thus, our board of directors could authorize the issuance of shares of common stock or preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or change in control that might involve a premium price for
holders of our common stock or otherwise be in their best interest. Our board of directors has no present plans to issue preferred stock, but may do so at any time in the future without stockholder approval. The issuance of preferred stock must be approved by a majority of our independent directors not otherwise interested in the transaction, who will have access, at our expense, to our legal counsel or to independent legal counsel.
Meetings, Special Voting Requirements and Access To Records
An annual meeting of the stockholders will be held each year on a specific date which will be at least 30 days after delivery of our annual report. Our board of directors, including the independent directors, will take reasonable steps to insure this requirement is met. Special
meetings of stockholders may be called only upon the request of a majority of our board of directors, a majority of our independent directors, the chairman of our board, our chief executive officer, our president and must be called by our secretary to act on any matter that may properly be considered at a meeting of the stockholders upon the written request of stockholders entitled to cast on such matter at least 10% of all the votes entitled to be cast at the meeting. Upon receipt of a written request of eligible stockholders, either in person or by mail, stating the purpose of the meeting and the matters proposed to be acted on at such meeting, we will provide all stockholders, within ten days after receipt of such request, with written notice either in person or by mail, of such meeting and the purpose thereof. The meeting must be held on a date not less than 15 nor more than 60 days after the distribution of such notice, at a time and place specified in the request,
or if none is specified, at a time and place convenient to stockholders. The presence either in person or by proxy of stockholders entitled to cast 50% of all the votes entitled to be cast at the meeting on any matter will constitute a quorum. Generally, the affirmative vote of a majority of all votes cast is necessary to take stockholder action, except that a majority of the votes represented in person or by proxy at a meeting at which a quorum is present is required to elect a director and except as set forth in the next two paragraphs.
Under the MGCL and our charter, stockholders are generally entitled to vote at a duly held meeting at which a quorum is present on: (i) the amendment of our charter; (ii) our dissolution; or (iii) our merger or consolidation, a statutory share exchange or the sale or other disposition of all or substantially all of our assets. These matters require the affirmative vote of stockholders entitled
to cast at least a majority of the votes entitled to be cast on the matter. With respect to stock owned by our advisor, directors, or any of their affiliates, neither our advisor nor such directors, nor any of their affiliates may vote or consent on matters submitted to stockholders regarding the removal of the advisor, such directors or any of their affiliates or any transaction between us and any of them. In terms of determining the requisite percentage in interest of shares necessary to approve a matter on which our advisor, directors or their affiliates may not vote or consent, any shares owned by any of them shall not be included.
Our advisory agreement, including the selection of our advisor, is approved annually by our board of directors including a majority of our independent directors. While the stockholders do not have the ability to vote to replace our advisor or to select a new advisor, stockholders do have the
ability, by the affirmative vote of stockholders entitled to cast at least a majority of the votes entitled to be cast generally in the election of our board of directors, to remove a director from our board of directors. Any stockholder will be permitted access to all of our records to which they are entitled under applicable law at all reasonable times and may inspect and copy any of them for a reasonable copying charge.
Under the MGCL, our stockholders are entitled to inspect and copy, upon written request during usual business hours, the following corporate documents: (i) our charter; (ii) our bylaws; (iii) minutes of the proceedings of our stockholders; (iv) annual statements of affairs; and (v) any voting trust agreements. A stockholder may
also request access to any other corporate records, which may be evaluated solely in the discretion of our board of directors. Inspection of our records by the office or agency administering the securities laws of a jurisdiction will be provided upon reasonable notice and during normal business hours. An alphabetical list of the names, addresses and telephone numbers of our stockholders, along with the number of shares of our common stock held by each of them, will be maintained as part of our books and records and will be available for inspection by any stockholder or the stockholder’s designated agent at our office upon the request of the stockholders. The stockholder list will be updated at least quarterly to reflect changes in the information contained therein. A copy of the list will be mailed to any stockholder who requests the list within ten days of our receipt of the request. A stockholder may request a copy of the
stockholder list in connection with matters relating, without limitation, to voting rights and the exercise of stockholder rights under federal proxy laws. A stockholder requesting a list will be required to pay reasonable costs of postage and duplication. In addition to the foregoing, stockholders have rights under Rule 14a-7 under the Exchange Act, which provides that, upon the request of investors and the payment of the expenses of the distribution, we are required to distribute specific materials to stockholders in the context of the solicitation of proxies for voting on matters presented to stockholders or, at our option, provide requesting stockholders with a copy of the list of stockholders so that the requesting stockholders may make the distribution of proxies themselves. If a proper request for
the stockholder list is not honored, then the requesting stockholder will be entitled to recover certain costs incurred in compelling the production of the list as well as actual damages suffered by reason of the refusal or failure to produce the list. However, a stockholder will not have the right to, and we may require a requesting stockholder to represent that it will not, secure the stockholder list or other information for the purpose of selling or using the list for a commercial purpose not related to the requesting stockholder’s interest in our affairs. We may also require such stockholder sign a confidentiality agreement in connection with the request.
Exclusive Forum
Our bylaws provide that the Circuit Court for Baltimore City, Maryland is the exclusive forum for derivative lawsuits
brought on our behalf, actions for breach of fiduciary duty, actions pursuant to the MGCL and actions asserting claims governed by the internal affairs doctrine, unless we consent to the selection of an alternative forum.
Restriction on Transfer and Ownership of Shares of Capital Stock
For us to continue to qualify as a REIT, no more than 50% in value of the outstanding shares of our stock may be owned, directly or indirectly through the application of certain attribution rules under the Internal Revenue Code, by any five or fewer individuals, as defined in the Internal Revenue Code to include specified entities, during the last half of any taxable year other than our first taxable year. In addition, the outstanding shares of our stock must be owned by 100 or more persons independent of us and each other during at least 335 days of a 12-month taxable year or during a proportionate
part of a shorter taxable year, excluding our first taxable year for which we elect to be taxed as a REIT. In addition, we must meet requirements regarding the nature of our gross income to qualify as a REIT. One of these requirements is that at least 75% of our gross income for each calendar year must consist of rents from real property and income from other real property investments. The rents received by our operating partnership from any tenant will not qualify as rents from real property, which could result in our loss of REIT status, if we own, actually or constructively within the meaning of certain provisions of the Internal Revenue Code, 10% or more of the ownership interests in that tenant. To assist us in preserving our status as a REIT, among other purposes, our charter contains limitations on the transfer and ownership of shares of our stock which prohibit: (i) any person or entity from owning or acquiring, directly or indirectly, more than 9.8% in value
of the aggregate of our then outstanding shares of capital stock or more than 9.8% in value or number of shares, whichever is more restrictive, of the aggregate of our then outstanding shares of common stock; (ii) any person or entity from owning or acquiring, directly or indirectly shares of our stock to the extent such ownership would result in our being “closely held” within the meaning of Section 856(h) of the Internal Revenue Code (without regard to whether the ownership interest is held during the last half of a taxable year) or otherwise failing to qualify as a REIT; and (iii) any transfer of or other event or transaction with respect to shares of capital stock that would result in the beneficial ownership of our outstanding shares of capital stock by fewer than 100 persons (determined under the principles of Section 856(a)(5) of the Internal Revenue Code).
Our charter provides that the shares of our capital
stock that, if transferred, would: (i) result in a violation of the 9.8% ownership limits; (ii) result in us being “closely held” within the meaning of Section 856(h) of the Internal Revenue Code; (iii) cause us to own 9.9% or more of the ownership interests in a tenant of our real property or the real property of our operating partnership or any direct or indirect subsidiary of our operating partnership; or (iv) otherwise cause us to fail to qualify as a REIT, will be transferred automatically to a trust effective as of the close of business on the business day before the purported transfer of such shares of our capital stock. We will designate a trustee of the trust that will not be affiliated with us or the purported transferee or record holder. We will also name a charitable
organization as beneficiary of the trust. The trustee will receive all dividends and other distributions on the shares of our capital stock held by the trust and will hold such dividends or distributions in trust for the benefit of the beneficiary. The trustee also will be entitled to exercise all voting rights of the shares of capital stock held by the trust. Subject to Maryland law, effective as of the date that shares have been transferred to the trustee, the trustee will have the authority (at the trustee’s sole discretion) to rescind as void any vote cast by the intended transferee prior to our discovery that shares have been transferred to the trustee and to recast such vote in accordance with the desires of the trustee acting for the benefit of the charitable beneficiary; provided, however, that if we have already taken irreversible corporate
action, then the trustee will not have the authority to rescind and recast such vote. The intended transferee will acquire no rights in such shares of capital stock, unless, in the case of a transfer that would cause a violation of the 9.8% ownership limits, the transfer is exempted (prospectively or retroactively) by our board of directors from the ownership limits based upon receipt of information (including certain representations and undertakings from the intended transferee) that such transfer would not violate the provisions of the Internal Revenue Code for our qualification as a REIT. In addition, our charter provides that any transfer of shares of our capital stock that would result in shares of our capital stock being beneficially owned by fewer than 100 persons will be null and void and the intended transferee will acquire no rights in such shares of our capital stock.
The trustee will transfer the shares of our
capital stock to a person whose ownership of shares of our capital stock will not violate the ownership limits. The transfer will be made no later than 20 days after the later of our receipt of notice that shares of our capital stock have been transferred to the trust or the date we determine that a purported transfer of shares of stock has occurred. Upon any such transfer, the interest of the charitable beneficiary in the shares sold will terminate and the trustee will distribute the net proceeds of the sale to the purported transferee or holder. The purported transferee or holder will receive a per share price equal to the lesser of (i) the price per share in the transaction that resulted in the transfer of such shares to the trust (or, in the case of a gift or devise, the market price per share on the date of the event causing the shares to be held in trust); and (ii) the price received by the trustee net of any selling commission and expenses. The trustee may reduce
the amount payable to the purported transferee or holder by the amount of dividends and other distributions which have been paid to the purported transferee or holder and are owed by the purported transferee or holder to the trustee. The charitable beneficiary will receive any excess amounts. If, prior to our discovery that shares have been transferred to the trustee, such shares are sold by a purported transferee or holder, then such shares shall be deemed to have been sold on behalf of the trust and, to the extent that the purported transferee or holder received an amount for such shares that exceeds the amount that such purported transferee or holder was entitled to receive, such excess must be paid and aggregated to the trustee upon demand.
In addition, until the trustee has sold the shares held in the trust, we or our designees have the right to purchase any shares held by the trust at a market price equal to the lesser
of (i) the price per share in the transaction that resulted in the transfer of such shares to the trust (or, in the case of a gift or devise, the market price per share at the time of the gift or devise) and (ii) the market price on the date we, or our designee, exercise such right. Upon a sale to us, the interest of the charitable beneficiary in the shares sold will terminate and the trustee will distribute the net proceeds of the sale to the purported transferee or holder. We may reduce the amount payable to the purported transferee or holder by the amount of dividends and other distributions which have been paid to the purported transferee or holder and are owed by the purported transferee or holder to the trustee. We may pay the amount of such reduction to the trustee for the benefit of the charitable beneficiary.
Any person who (i) acquires or attempts to acquire shares of our capital stock in violation of the foregoing
restrictions or (ii) owns shares of our capital stock that were transferred to any such trust, is required to give immediate written notice to us of such event, and any person who purports to transfer or receive shares of our capital stock subject to such limitations is required to give us 15 days written notice prior to such purported transaction. In both cases, such persons must provide to us such other information as we may request to determine the effect, if any, of such event on our status as a REIT. The foregoing restrictions will continue to apply until our board of directors determines it is no longer in our best interest to attempt to, or to continue to, qualify as a REIT or that compliance with the restrictions is no longer required for us to qualify as a REIT.
The ownership limits do not apply to a person or persons that our board of directors exempts from the ownership limit upon appropriate assurances (including certain representations and undertakings from the intended transferee) that our qualification as a REIT is not jeopardized. Any person who owns 5% or more (or such lower percentage applicable under Treasury Regulations) of the outstanding shares of our capital stock during any taxable year is required, within 30 days after the end of each year, to deliver a statement or affidavit setting forth the number of shares of our capital stock beneficially owned and a description of the manner in which such stock is held.
Distributions
We have authorized and declared distributions based on daily record dates for each
day since September 18, 2013 through June 30, 2014 and have paid distributions on a monthly basis. Each of our distributions to date has been paid at a rate equal to 7% per annum, assuming a $10.00 per share purchase price, but we are not required to continue to approve and pay distributions at that rate or at all.
100%
distributions declared for the period from September 18, 2013 through December 31, 2013 were paid using proceeds from our offering, including from the purchase of additional shares by our sponsor.
(2)
Represents distributions declared for such period, even though such distributions are actually paid to stockholders the month following such period.
We are required to make distributions sufficient to satisfy the requirements for qualification as a REIT for federal income tax purposes. Generally, income distributed will not be taxable to us under the Internal Revenue Code if we distribute
at least 90% of our taxable income each year (computed without regard to the distributions paid deduction and our net capital gain). Distributions will be authorized at the discretion of our board of directors and declared by us, in accordance with our income, cash flow and general financial condition. Our board of directors’ discretion will be directed, in substantial part, by its obligation to cause us to comply with the REIT requirements. Because we may receive income from interest or rents at various times during our fiscal year and because we may need cash flow from operations during a particular period to repurchase shares of our common stock or fund performance-based fees or expenses, our ability to make distributions may be negatively impacted and, distributions may not reflect our income earned in that particular distribution period and may be made in advance of actual receipt of funds in an attempt to make distributions relatively uniform. We are authorized
to borrow money, issue new securities or sell assets to make distributions. There are no restrictions on the ability of our operating partnership to transfer funds to us.
We are not prohibited from distributing our own securities in lieu of making cash distributions to stockholders provided that the securities distributed to stockholders are readily marketable. The receipt of marketable securities in lieu of cash distributions may cause stockholders to incur transaction expenses in liquidating the securities. We do not have any current intention to list the shares of our common stock on a national securities exchange, nor is it expected that a public market for the shares of common stock will develop.
Generally, our policy is to pay distributions from cash flow from operations. However, we can give no assurance that we will pay distributions solely from our cash flow from operations
in the future, especially during the period when we are raising capital and have not yet acquired a substantial portfolio of investments. Our organizational documents permit us to pay distributions from any source, including from borrowings, sale of assets and offering proceeds or we may make distributions in the form of taxable stock dividends. We have not established a cap on the use of proceeds to fund distributions. Over the long-term,
we
expect that our distributions will be paid entirely from cash flow provided by operations. However, our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including our ability to raise and invest capital at favorable yields, the financial performance of our investments in the current real estate and financial environment, the type and mix of our investments and accounting of our investments in accordance with U.S. GAAP. As a result, future distributions declared and paid may continue to exceed cash flow provided by operations.
We have paid, and may continue to pay distributions from sources other than our cash flow from operations, and therefore, we will have less cash available for investments and your overall return may be reduced. In order to provide additional funds to pay distributions on shares purchased in our primary offering at a rate of at least 7% per
annum on stockholders’ invested capital, our sponsor has agreed to purchase up to an aggregate of $10.0 million in shares of our common stock (which includes shares an affiliate of our sponsor purchased in order to satisfy the minimum offering amount) at $9.00 per share until May 6, 2015, as described in more detail below. However, we are not obligated by our governing documents nor can there be any assurance that we will pay any certain amount of distributions on stockholders’ invested capital, even prior to May 6, 2015. Moreover, if our sponsor’s financial condition suffers and it has insufficient cash from operations to meet its obligations, it may need to borrow money or use unrestricted cash in order to satisfy this commitment to us. If our sponsor is unable to obtain financing and cannot satisfy this commitment to us, or in the event that a NorthStar affiliate no
longer serves as our advisor, which would result in the termination of our sponsor’s share purchase commitment, we would not have this source of capital available to us and our ability to pay distributions to stockholders would be adversely impacted. After our distribution support agreement with our sponsor has terminated, we may not have sufficient cash available to pay distributions at the rate we had paid during preceding periods or at all.
Under the terms of our distribution support agreement, if the cash distributions we pay for any calendar quarter exceed our MFFO for such quarter, our sponsor will purchase shares following the end of such calendar quarter for a purchase price equal to the amount by which the distributions paid on such shares exceed our MFFO for such quarter, up to an amount equal to a 7% cumulative, non-compounded annual return on stockholders’ invested capital prorated for such quarter. In such instance,
we may be paying distributions from proceeds of the shares purchased by our sponsor, not from cash flow from our operations.
The purchase price for shares issued to our sponsor pursuant to this commitment will be equal to the per share price in our primary offering as of the purchase date, reduced by the selling commissions and dealer manager fees which are not payable in connection with such sales. As a result, the net proceeds to us from the sale of shares to our sponsor will be the same as the net proceeds we receive from other sales of shares in our offering. However, our sponsor’s purchase of shares will increase our sponsor’s ownership percentage of our common stock, thereby causing dilution of the ownership percentage of our public stockholders. As of December 31, 2013, our sponsor has purchased an aggregate of 222,886 shares of our common stock at a price of $9.00 per
share pursuant to the distribution support agreement.
In connection with the distribution support agreement, summarized financial information of our sponsor follows. Our sponsor is subject to the periodic reporting obligations of the Exchange Act.
The selected historical consolidated information presented for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 relates to our sponsor’s operations and has been derived from our sponsor’s quarterly reviewed and year end audited consolidated financial statements. Our sponsor’s consolidated financial statements include variable interest entities, where our sponsor is the primary beneficiary
and voting interest entities which are generally majority or wholly owned and controlled by our sponsor. Certain prior period amounts have been reclassified in the consolidated financial statements to conform to current period presentation.
Selected Historical Consolidated Information for NorthStar Realty Finance Corp.
Years
Ended December 31,
Operating Data
2013
2012
2011
2010
2009
(Dollars
in thousands except per share and dividends declared data)
Net interest income on debt and securities
$
265,837
$
335,496
$
355,921
$
273,727
$
126,342
Total
other revenues
330,785
165,069
122,457
118,576
92,247
Total
expenses
460,588
308,159
328,624
409,314
289,809
Income
(loss) from operations
136,034
192,406
149,754
(17,011
)
(71,220
)
Income
(loss) from continuing operations
(79,554
)
(275,040
)
(259,855
)
(391,948
)
(154,259
)
Net
income (loss)
(87,910
)
(273,089
)
(242,526
)
(389,560
)
(136,576
)
Net
income (loss) attributable to NorthStar Realty Finance Corp. common stockholders
(137,453
)
(288,587
)
(263,014
)
(395,466
)
(151,208
)
Earnings
Per Share:
Basis
$
(0.65
)
$
(2.31
)
$
(2.94
)
$
(5.17
)
$
(2.16
)
Diluted
$
(0.65
)
$
(2.31
)
$
(2.94
)
$
(5.17
)
$
(2.16
)
Dividends
declared per share of common stock
$
0.85
$
0.66
$
0.46
$
0.40
$
0.40
December
31,
Balance Sheet Data:
2013
2012
2011
2010
2009
(Dollars
in thousands except per share and dividends declared data)
Cash and cash equivalents
$
635,990
$
444,927
$
144,508
$
125,439
$
138,928
Operating
real estate, net
2,369,505
1,390,546
1,089,449
938,062
978,902
Real
estate debt investments, net
1,031,078
1,832,231
1,710,582
1,821,764
1,936,482
Investments
in private equity funds, at fair value
586,018
—
—
—
—
Investments
in and advances to unconsolidated ventures
142,340
111,025
96,143
99,992
38,299
Real
estate securities, available for sale
1,052,320
1,124,668
1,473,305
1,691,054
336,220
Total
assets
6,360,050
5,513,778
5,006,437
5,151,991
3,669,564
Total
borrowings
3,342,071
3,790,072
3,509,126
3,416,939
2,042,422
Total
liabilities
3,662,587
4,182,914
3,966,823
3,779,478
2,210,924
Preferred
stock
697,352
504,018
241,372
241,372
241,372
Total
equity
2,697,463
1,330,864
1,039,614
1,277,691
1,363,818
Years
Ended December 31,
Other Data:
2013
2012
2011
2010
2009
(Dollars
in thousands)
Cash flow from (used in):
Operating activities
$
240,674
$
76,911
$
59,066
$
35,558
$
54,518
Investing
activities
(2,285,153
)
51,901
383,323
403,325
123,319
Financing
activities
2,235,542
171,607
(423,320
)
(452,372
)
(172,948
)
Funds
from Operations and Modified Funds from Operations
We believe that FFO and MFFO, both of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and of us in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT,
as
net income (loss) (computed in accordance with U.S. GAAP), excluding gains (losses) from sales of depreciable property, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, impairment on depreciable property owned directly or indirectly and after adjustments for unconsolidated ventures.
Changes in the accounting and reporting rules under U.S. GAAP that have been put into effect since the establishment of NAREIT’s definition of FFO have prompted an increase in the non-cash and non-operating items included in FFO. For instance, the accounting treatment for acquisition fees related to business combinations has changed from being capitalized to being expensed. Additionally, publicly registered, non-traded REITs are typically different from traded REITs because they generally have a limited life followed by a liquidity event or other targeted exit strategy. Non-traded REITs
typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation as compared to later years when the proceeds from their initial public offering have been fully invested and when they may seek to implement a liquidity event or other exit strategy. However, it is likely that we will make investments past the acquisition and development stage, albeit at a substantially lower pace.
Acquisition fees paid to our advisor in connection with the origination and acquisition of debt investments are amortized over the life of the investment as an adjustment to interest income under U.S. GAAP and are therefore, included in the computation of net income (loss) and income (loss) from operations, both of which are performance measures under U.S. GAAP. Such acquisition fees are paid in cash that would otherwise be available to distribute to our stockholders.
In the event that proceeds from our offering are not sufficient to fund the payment or reimbursement of acquisition fees and expenses to our advisor, such fees would be paid from other sources, including new financing, operating cash flow, net proceeds from the sale of investments or from other cash flow. We believe that acquisition fees incurred by us negatively impact our operating performance during the period in which such investments are originated or acquired by reducing cash flow and therefore the potential distributions to our stockholders. However, almost always, we earn origination fees for debt investments from our borrowers in an amount equal to the acquisition fees paid to our advisor, and as a result, the impact of acquisition fees to our operating performance and cash flow would be minimal.
The origination and acquisition of debt investments and the corresponding acquisition fees paid to our advisor (and any
offsetting origination fees received from our borrowers) associated with such activity is a key operating feature of our business plan that results in generating income and cash flow in order to make distributions to our stockholders. Therefore, the exclusion for acquisition fees may be of limited value in calculating operating performance because acquisition fees affect our overall long-term operating performance and may be recurring in nature as part of net income (loss) and income (loss) from operations over our life.
Due to certain of the unique features of publicly-registered, non-traded REITs, the IPA, an industry trade group, standardized a performance measure known as MFFO and recommends the use of MFFO for such REITs. Management believes MFFO is a useful performance measure to evaluate our business and further believes it is important to disclose MFFO in order to be consistent with the IPA recommendation and other
non-traded REITs. MFFO that adjusts for items such as acquisition fees would only be comparable to non-traded REITs that have completed the majority of their acquisition activity and have other similar operating characteristics as us.
MFFO is a metric used by management to evaluate our future operating performance once our organization and offering and acquisition and development stages are complete and is not intended to be used as a liquidity measure. Although management uses the MFFO metric to evaluate future operating performance, this metric excludes certain key operating items and other adjustments that may affect our overall operating performance. MFFO is not equivalent to net income (loss) as determined under U.S. GAAP.
We define MFFO in accordance with the concepts established by the IPA. Our computation of MFFO may not be comparable to other REITs that do not calculate
MFFO using the same method. MFFO is calculated using FFO. We compute FFO in accordance with the standards established by NAREIT, as net income or loss (computed in accordance with U.S. GAAP), excluding gains or losses from sales of
depreciable properties, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, impairment charges on depreciable property owned directly or indirectly
and after adjustments for unconsolidated/uncombined partnerships and joint ventures. FFO, as defined by NAREIT, is a computation made by analysts and investors to measure a real estate company’s cash flow generated by operations. MFFO excludes from FFO the following items:
•
acquisition fees and expenses; non-cash amounts related to straight-line rent and the amortization of above or below market and in-place intangible lease assets and liabilities (which are adjusted in order to reflect such payments from an accrual basis of accounting under U.S. GAAP to a cash basis of accounting);
•
amortization
of a premium and accretion of a discount on debt investments;
•
non-recurring impairment of real estate-related investments;
•
realized gains (losses) from the early extinguishment of debt; realized gains (losses) on the extinguishment or sales of hedges, foreign exchange, securities and other derivative holdings except where the trading of such instruments is a fundamental attribute of our business;
•
unrealized
gains (losses) from fair value adjustments on real estate securities, including CMBS and other securities, interest rate swaps and other derivatives not deemed hedges and foreign exchange holdings;
•
unrealized gains (losses) from the consolidation from, or deconsolidation to, equity accounting;
•
adjustments related to contingent purchase price obligations; and
•
adjustments
for consolidated and unconsolidated partnerships and joint ventures calculated to reflect MFFO on the same basis as above.
Certain of the above adjustments are also made to reconcile net income (loss) to net cash provided by (used in) operating activities, such as for the amortization of a premium and accretion of a discount on debt and securities investments, amortization of fees, any unrealized gains (losses) on derivatives, securities or other investments, as well as other adjustments.
MFFO excludes non-recurring impairment of real estate-related investments. We assess the credit quality of our investments and adequacy of reserves on a quarterly basis, or more frequently as necessary. Significant judgment is required in this analysis. We consider the estimated net recoverable value of the loan as well as other factors, including but not limited to the fair value
of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive situation of the region where the borrower does business.
We believe that MFFO is a useful non-GAAP measure for non-traded REITs. It is helpful to management and stockholders in assessing our future operating performance once our organization and offering, and acquisition and development stages are complete, because it eliminates from net income non-cash fair value adjustments on our real estate securities and acquisition fees and expenses that are incurred as part of our investment activities. However, MFFO may not be a useful measure of our operating performance or as a comparable measure to other typical non-traded REITs if we do not continue to operate in a similar manner to other non-traded REITs, including if we were to extend our acquisition and development stage or if we determined not to pursue an exit
strategy.
However, MFFO does have certain limitations. For instance, the effect of any amortization or accretion on investments originated or acquired at a premium or discount, respectively, is not reported in MFFO. In addition, realized gains (losses) from acquisitions and dispositions are not reported in MFFO, even though such realized gains (losses) could affect our operating performance and cash available for distribution. Stockholders should note that any cash gains generated from the sale of investments would generally be used to fund new investments.
Neither FFO nor MFFO is equivalent to net income (loss) or cash flow provided by operating activities determined in accordance with U.S. GAAP and should not be construed to be more relevant or accurate than the U.S. GAAP methodology in evaluating our operating performance. Neither FFO nor
MFFO is necessarily indicative of cash flow available to fund our cash needs including our ability to make distributions to our stockholders. FFO and MFFO do not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Furthermore, neither FFO nor MFFO should be considered as an alternative to net income (loss) as an indicator of our operating performance.
The following table presents a reconciliation of FFO and MFFO to net income (loss) attributable to our common stockholders for the year ended December 31, 2013:
Net income (loss) attributable to NorthStar Real Estate Income II, Inc. common stockholders
$
12,455
Funds from Operations
12,455
Modified
Funds from Operations:
Funds from Operations
12,455
Adjustments:
Amortization of premiums, discounts and fees on investments and borrowings, net
42,036
Modified
Funds from Operations
$
54,491
Net Tangible Book Value Per Share
The offering price in our offering is higher than the net tangible book value per share of our common stock as of December 31, 2013. Net tangible book value per share is calculated including tangible assets but excluding intangible assets such as deferred costs or goodwill and any other asset that cannot be sold separately from all other assets of the business as well as intangible assets for which recovery of book value is subject
to significant uncertainty or illiquidity, less liabilities and is a non-GAAP measure. There are no rules or authoritative guidelines that define net tangible book value; however, it is generally used as a conservative measure of net worth, approximating liquidation value. Our net tangible book value reflects dilution in value of our common stock from the issue price as a result of: (i) the substantial fees paid in connection with our initial public offering, including selling commissions and dealer manager fees paid to our dealer manager; and (ii) the fees and expenses paid to our advisor in connection with the selection, origination, acquisition and sale of our investments and the management of our company.
As of December 31, 2013, our net tangible book value per share was $8.75, compared
with our primary offering price per share of $10.00 (ignoring purchase price discounts for certain categories of purchasers) and our DRP price per share of $9.50. Our offering price was not established on an independent basis and bears no relationship to the net value of our assets. Although we do not believe net tangible book value is an indication of the value of our shares, if we were to liquidate our assets at this time, you would likely receive less than the purchase price for your shares due to the factors described above with respect to the dilution in value of our common stock.
Distribution Reinvestment Plan
Our DRP allows you to have cash otherwise distributable to you invested in additional shares of our common stock. Shares issued pursuant to our DRP are being offered at a 5% discount from the price of shares offered in our primary offering at $9.50 per share. Unless
the rules and regulations governing valuations change, from and after 18 months after the completion of our offering stage, our advisor, or another firm we choose for that purpose, will establish an estimated value per share of our common stock that we will disclose in our annual report that we publicly file with the SEC. At that time, shares issued pursuant to our DRP will be priced at 95% of such estimated per share value of our common stock. We will consider our offering stage complete when we are no longer publicly offering equity securities in a continuous offering, whether through our offering or follow-on public offerings. For this purpose, we do
not consider a “public offering of equity securities” to include offerings on behalf of stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests in our operating partnership. A copy of our DRP is included as Appendix C to this prospectus.
You may elect to participate in our DRP by completing the subscription agreement or by other written notice to the plan administrator. Participation in the plan will begin with the next distribution made after acceptance of your written notice. You may also withdraw at any time, without penalty, by delivering written notice to us. We may amend, suspend or terminate our DRP for any reason, except that we may not amend our DRP to eliminate a participant’s ability to withdraw from our DRP, at any time upon ten days prior written
notice to participants. Participation in the plan may also be terminated with respect to any person to the extent that a reinvestment of distributions in shares of our common stock would cause the ownership limits contained in our charter to be violated. Following any termination of our DRP, all subsequent distributions to stockholders would be made in cash.
Participants may acquire shares of our common stock pursuant to our DRP until the earliest date upon which: (i) all the common stock registered in this or future offerings to be offered under our DRP is issued; (ii) our offering and any future offering pursuant to our DRP terminate, and we elect to deregister with the SEC the unsold amount of our common stock registered to be offered under our DRP; or (iii) there is more than a de minimis amount of trading in shares of our common stock, at which time any registered shares
of our common stock then available under our DRP will be sold at a price equal to the fair market value of the shares of our common stock, as determined by our board of directors by reference to the applicable sales price with respect to the most recent trades occurring on or prior to the relevant distribution date. In any case, the price per share will be equal to the then-prevailing market price, which will equal the price on the national securities exchange on which such shares of common stock are listed at the date of purchase.
Holders of common units in our operating partnership may also participate in our DRP and have cash otherwise distributable to them by our operating partnership invested in our common stock at the current price for which shares are being offered pursuant to our DRP.
Stockholders who elect to participate in our DRP, and who are subject to U.S. federal income
taxation laws, will be treated for tax purposes as having received a dividend in an amount equal to the fair value on the relevant distribution date of the shares of our common stock purchased with reinvested distributions, even though such stockholders have elected not to receive the distributions used to purchase those shares of common stock in cash. Under present law, the U.S. federal income tax treatment of that amount will be as described with respect to distributions under “U.S. Federal Income Tax Considerations—Taxation of Holders of Our Common Stock—Taxation of Taxable U.S. Stockholders” in the case of a taxable U.S. stockholder (as defined therein) and as described under “U.S. Federal Income Tax Considerations—Taxation of Holders of Our Common Stock—Taxation of Non-U.S. Stockholders” in the case of a non-U.S. stockholder (as defined therein). However, the tax consequences of participating in our DRP will vary depending upon each participant’s particular
circumstances, and you are urged to consult your own tax advisor regarding the specific tax consequences to you of participation in our DRP.
All material information regarding the distributions to stockholders and the effect of reinvesting the distributions, including tax consequences, will be provided to the stockholders at least annually. Each stockholder participating in our DRP will have an opportunity to withdraw from the plan at least annually after receiving this information.
Share Repurchase Program
Our share repurchase program provides an opportunity for you to have your shares of common stock repurchased by us, without fees and subject to certain restrictions and limitations. Only stockholders who have purchased shares from us or received their shares through a non-cash transaction, not in the secondary market, will be eligible
to participate in the share repurchase program. The purchase price for shares repurchased under the share repurchase program will be as set forth below until we establish an estimated per share value of our common stock. From and after 18 months after completion of our offering stage (or for whatever period may be required by applicable rules and regulations), our advisor or another firm we choose for that purpose, will establish an estimated value per share of our common stock that we will disclose in our annual report that we publicly file with the SEC.
Prior to the date that we establish an estimated value per share of our common stock, we will initially repurchase shares at a price equal to or at a discount from the purchase price you paid for the shares being repurchased as follows:
Share Purchase Anniversary
Repurchase Price as a
Percentage of Purchase Price
Less
than 1 year
No Repurchase Allowed
1 year
92.5%
2 years
95.0%
3 years
97.5%
4 years and longer
100.0%
Unless
the shares are being repurchased in connection with a stockholder’s death or qualifying disability, we may not repurchase shares unless you have held the shares for at least one year. We will repurchase shares within two years of death or “qualifying disability” of a stockholder at the higher of the price paid for the shares or our estimated per share value. A qualifying disability is a disability as such term is defined in Section 72(m)(7) of the Internal Revenue Code. We must receive written notice within 180 days after such stockholder’s qualifying disability.
After we establish an estimated value per share of our common stock, we will repurchase shares at a price equal to the lesser of (i) the purchase price you paid for the shares being repurchased and (ii) 95% of the estimated value per share.
Repurchase of shares of our common stock will be made quarterly upon written
request to us at least 15 days prior to the end of the applicable quarter. Repurchase requests will be honored approximately 30 days following the end of the applicable quarter, which last date of the quarter we refer to as the repurchase date. Stockholders may withdraw their repurchase request at any time up to three business days prior to the repurchase date. In the event that you seek the repurchase of all of your shares of our common stock, shares of our common stock purchased pursuant to our DRP may be excluded from the foregoing one-year holding period requirement. If you have made more than one purchase of our common stock (other than through our DRP), the one-year holding period will be calculated separately with respect to each such purchase. In addition, for purposes of the one-year holding period, holders of units of our operating partnership who exchange their operating partnership units for shares of our common stock shall be deemed to have owned their shares
as of the date they were issued their operating partnership units.
We cannot guarantee that the funds set aside for our share repurchase program will be sufficient to accommodate all requests made in any quarter. In the event that we do not have sufficient cash available to repurchase all of the shares of our common stock for which repurchase requests have been submitted in any quarter, we plan to repurchase the shares of our common stock on a pro rata basis on the repurchase date. In addition, if we repurchase less than all of the shares subject to a repurchase request in any quarter, with respect to any unredeemed shares, you can: (i) withdraw your request for repurchase; or (ii) ask that we honor your request in a future quarter, if any, when such repurchases can be made pursuant to the limitations of the share repurchase when sufficient funds are available. Such pending requests will be honored on a pro rata basis.
We
are not obligated to repurchase shares of our common stock under our share repurchase program. We presently intend to limit the number of shares to be repurchased to: (i) 5% of the weighted average number of shares of our common stock outstanding during the prior calendar year; and (ii) those that could be funded from the net proceeds of the sale of shares under our DRP in the prior calendar year plus such additional funds as may be reserved for that purpose by our board of directors; provided, however, that the above volume limitations shall not apply to repurchases requested within two years after the death or disability of a stockholder. There is no fee in connection with a repurchase of shares of our common stock.
The aggregate amount of repurchases under our share repurchase program is not expected to exceed the aggregate proceeds received from the sale of shares pursuant to our DRP. However, to the extent that the
aggregate proceeds received from the sale of shares pursuant to our DRP are not sufficient to fund
repurchase requests pursuant to the limitations outlined above, our board of directors may, in its sole discretion, choose to use other sources of funds to repurchase shares of our common stock. Such sources of funds could include cash on hand, cash available from borrowings and cash from liquidations of investments as of the end of
the applicable month, to the extent that such funds are not otherwise dedicated to a particular use, such as working capital, cash distributions to stockholders or purchases of real estate assets.
Our share repurchase program only provides stockholders a limited ability to have shares repurchased for cash until a secondary market develops for our shares or until our shares are listed on a national securities exchange or included for quotation in a national securities market, at which time our share repurchase program would terminate. No such market presently exists nor are the shares currently listed on an exchange, and we cannot assure you that any market for our shares will ever develop or that we will list the shares on a national securities exchange. Shares repurchased under our share repurchase program will become unissued shares and will not be resold unless such sales are made pursuant to transactions that are registered
or exempt from registration under applicable securities laws.
In addition, our board of directors may, in its sole discretion, amend, suspend, or terminate our share repurchase program at any time upon ten-day’s notice except that changes in the number of shares that can be repurchased during any calendar year will take effect only upon ten-business days prior written notice. Therefore, you may not have the opportunity to make a repurchase request prior to any potential termination of our share repurchase program.
As of December 31, 2013, we had not received any requests to repurchase shares of common stock pursuant to our share repurchase program.
Liquidity Events
Subject to then existing market conditions, we expect to consider alternatives
for providing liquidity to our stockholders beginning five years from the completion of our offering stage; however, there is no definitive date by which we must do so. We will consider our offering stage complete when we are no longer publicly offering equity securities in a continuous offering, whether through our offering or follow-on public offerings. For this purpose, we do not consider a “public offering of equity securities” to include offerings on behalf of selling stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests in our operating partnership. While we expect to seek a liquidity transaction in this time frame, there can be no assurance that a suitable transaction will be available or that market conditions for a transaction will be favorable during that time frame. Our board of directors has the discretion to consider a liquidity transaction at any time. A liquidity transaction could consist of a sale or partial
sale or roll-off to scheduled maturity of our assets, a sale or merger of our company, a listing of our shares on a national securities exchange or a similar transaction. Some types of liquidity transactions require, after approval by our board of directors, approval of our stockholders. We do not have a stated term, as we believe setting a finite date for a possible, but uncertain future liquidity transaction may result in actions that are not necessarily in the best interest or within the expectations of our stockholders.
Business Combinations
Under the MGCL, certain business combinations between a Maryland corporation and an interested stockholder or the interested stockholder’s affiliate are prohibited for five years after the most recent date on which the stockholder becomes an interested
stockholder. For this purpose, the term “business combinations” includes mergers, consolidations, share exchanges or, in circumstances specified in the MGCL, asset transfers and issuances or reclassifications of equity securities. An “interested stockholder” is defined for this purpose as: (i) any person who beneficially owns, directly or indirectly, 10% or more of the voting power of the corporation’s outstanding voting stock; or (ii) an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of the corporation. A person is not an interested stockholder under the MGCL if our board of directors approved in advance the transaction by which the person otherwise would become an interested stockholder. However, in approving the transaction, our board of directors may provide that its approval is subject to compliance,
at or after the time of the approval, with any terms and conditions determined by our board of directors.
After the five-year prohibition, any such business combination between the corporation and an interested stockholder generally must be recommended by our board of directors of the corporation and approved by the affirmative vote of at least: (i) 80% of the votes entitled to be cast by holders of outstanding voting stock of the
corporation and (ii) two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares of stock held by the interested stockholder or its affiliate with whom the business combination is to be effected, or held by an affiliate or associate of the interested stockholder, voting together as a single voting group.
These super majority vote requirements do not apply if the corporation’s common stockholders receive a minimum price, as defined under the MGCL, for their shares of common stock in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares of common stock.
None of these provisions of the MGCL will apply, however, to business combinations that are approved or exempted by our board of directors of the corporation prior to the time that the interested stockholder becomes an
interested stockholder. Pursuant to the business combination statute, our board of directors has exempted any business combination involving us and any person. Consequently, the five-year prohibition and the super majority vote requirements will not apply to business combinations between us and any person. As a result, any person may be able to enter into business combinations with us that may not be in the best interest of our stockholders, without compliance with the super majority vote requirements and other provisions of the statute.
Our board of directors has adopted a resolution opting out of these provisions. Should our board of directors opt into the business combination statute in the future, it may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.
Control Share Acquisitions
The
MGCL provides that control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by the affirmative vote of stockholders entitled to cast at least two-thirds of the votes entitled to be cast on the matter. Shares of common stock owned by the acquirer, by officers or by employees who are directors of the corporation are not entitled to vote on the matter. “Control shares” are voting shares of stock which, if aggregated with all other shares of stock previously acquired by the acquirer or with respect to which the acquirer has the right to vote or to direct the voting of, other than solely by virtue of a revocable proxy, would entitle the acquirer to exercise voting power in electing directors within one of the following ranges of voting powers:
•
one-tenth
or more but less than one-third;
•
one-third or more but less than a majority; or
•
a majority or more of all voting power.
Control shares do not include shares of stock the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval or shares acquired directly from the corporation. Except as otherwise specified in the statute, a “control share acquisition” means the acquisition of issued and outstanding
control shares. Once a person who has made or proposes to make a control share acquisition has undertaken to pay expenses and has satisfied other required conditions, the person may compel our board of directors to call a special meeting of stockholders to be held within 50 days of demand to consider the voting rights of the shares of stock. If no request for a meeting is made, the corporation may itself present the question at any stockholders meeting. If voting rights are not approved for the control shares at the meeting or if the acquiring person does not deliver an “acquiring person statement” for the control shares as required by the statute, the corporation may redeem any or all of the control shares for their fair value, except for control shares for which voting rights have previously been approved. Fair value is to be determined for this purpose without regard to the absence of voting rights for the control shares, and is to be determined as of the date
of the last control share acquisition or of any meeting of stockholders at which the voting rights for control shares are considered and not approved.
If voting rights for control shares are approved at a stockholders’ meeting and the acquirer becomes entitled to vote a majority of the shares of stock entitled to vote, all other stockholders may exercise appraisal rights. The fair value of the shares of stock as determined for purposes
of these appraisal rights may not be less than the highest price per share paid in the control share acquisition. Some of the limitations and restrictions otherwise applicable to the exercise of dissenters’ rights do not apply in the context of a control share acquisition.
The control share acquisition statute does not apply to shares of stock acquired in a merger or consolidation or on a stock exchange if the corporation is a party to the transaction or to acquisitions approved or exempted by the charter or bylaws of the corporation. As permitted by the MGCL, we have provided in our bylaws that the control share provisions of the MGCL will not apply to any acquisition by any person of shares of our stock, but our board of directors retains the discretion
to opt into these provisions in the future.
Advance Notice of Director Nominations and New Business
Our bylaws provide that with respect to an annual meeting of the stockholders, nomination of individuals for election to our board of directors and the proposal of business to be considered by the stockholders may be made only: (i) pursuant to our notice of the meeting; (ii) by or at the direction of our board of directors; or (iii) by any stockholder who is a stockholder of record both at the time of giving the notice required by our bylaws and at the time of the meeting, who is entitled to vote at the meeting in the election of each individual so nominated or on such other business and who has complied
with the advance notice procedures of the bylaws. With respect to special meetings of stockholders, only the business specified in our notice of the meeting may be brought before the meeting. Nominations of individuals for election to our board of directors at a special meeting may be made only: (i) by or at the direction of our board of directors; or (ii) provided that the special meeting has been called in accordance with our bylaws for the purpose of electing directors, by a stockholder who is a stockholder of record both at the time of giving the notice required by our bylaws and at the time of the meeting, who is entitled to vote at the meeting in the election of each individual so nominated and who
has complied with the advance notice provisions of the bylaws.
Subtitle 8
Subtitle 8 of Title 3 of the MGCL, or Subtitle 8, permits a Maryland corporation with a class of equity securities registered under the Exchange Act and at least three independent directors to elect to be subject, by provision in its charter or bylaws or a resolution of its board of directors and notwithstanding any contrary provision in its charter or bylaws, to any or all of five provisions:
•
a
classified board of directors;
•
a two-thirds vote requirement for removing a director;
•
a requirement that the number of directors be fixed only by vote of our directors;
•
a requirement that vacancies on our board of directors be filled only by the remaining directors and for the remainder
of the full term of the class of directors in which the vacancy occurred; and
•
a majority requirement for the calling of a special meeting of stockholders.
We have elected to provide that, at such time as we are subject to Subtitle 8, vacancies on our board of directors be filled only by the remaining directors and for the remainder of the full term of the directorship in which the vacancy occurred. Through provisions in our charter and bylaws unrelated to Subtitle 8, we vest in our board of directors the exclusive power to fix the number of directorships provided that the number is not fewer
than three. We have not elected to be subject to the other provisions of Subtitle 8.
Tender Offers
Our charter provides that any tender offer made by a person, including, without limitation, any “mini-tender” offer, must comply with certain notice and disclosure requirements. A tender offer is any widespread solicitation for shares of our stock at firm prices for a limited time period.
In
order for a person to conduct a tender offer to one of our stockholders, our charter requires that the person comply with all of the provisions set forth in Regulation 14D of the Exchange Act, and provide our company notice of such tender offer at least ten business days before initiating the tender offer. Regulation 14D requires any person initiating a tender offer to provide:
•
specific disclosure to stockholders focusing on the terms of the offer and information about the bidder;
•
the
ability to allow stockholders to withdraw tendered shares while the offer remains open;
•
the right to have tendered shares accepted on a pro rata basis throughout the term of the offer if the offer is for less than all of our shares; and
•
that all stockholders of the subject class of shares be treated equally.
In addition to the foregoing, there are certain ramifications to any person who attempts to conduct a noncompliant tender offer. If any person initiates
a tender offer without complying with the provisions set forth above, the noncomplying offeror shall also be responsible for all of our expenses in connection with that person’s noncompliance and no stockholder may transfer any shares to such noncomplying offeror without first offering the shares to us at the tender offer price offered by such noncomplying offeror.
Restrictions on Roll-up Transactions
Until our shares are listed on a national securities exchange, our charter requires that we follow the policy set forth below with respect to any “roll-up transaction.” In connection with any proposed transaction considered a “roll-up transaction” involving us and the issuance of securities of an entity, or a roll-up entity, that would be created or would survive after the successful completion of the roll-up transaction, an appraisal of all assets must be obtained from
a competent independent appraiser. The assets must be appraised on a consistent basis, and the appraisal shall be based on the evaluation of all relevant information and shall indicate the value of the assets as of the date immediately prior to the announcement of the proposed roll-up transaction. The appraisal shall assume an orderly liquidation of the assets over a 12-month period. The terms of the engagement of the independent appraiser must clearly state that the engagement is for our benefit and our stockholders’ benefit. A summary of the appraisal, indicating all material assumptions underlying the appraisal, shall be included in a report to our stockholders in connection with any proposed roll-up transaction. If the appraisal will be included in a prospectus used to offer the securities of a roll-up entity, the appraisal shall be filed with the SEC and the states as an exhibit to the registration statement for our offering.
A
“roll-up transaction” is a transaction involving the acquisition, merger, conversion or consolidation, directly or indirectly, of us and the issuance of securities of a roll-up entity. This term does not include:
•
a transaction involving securities of the roll-up entity that have been listed on a national securities exchange for at least 12 months; or
•
a transaction involving our conversion into corporate, trust or association form if, as a consequence of the transaction, there will be no significant adverse change in any of
the following: our stockholder voting rights; the term of our existence; compensation to our sponsor or our advisor; or our investment objectives.
In connection with a proposed roll-up transaction, the person sponsoring the roll-up transaction must offer to our common stockholders who vote “no” on the proposal a choice of:
•
accepting the securities of the roll-up entity offered in the proposed roll-up transaction; or
•
one of the following:
•
remaining
as stockholders and preserving their interests on the same terms and conditions as existed previously; or
•
receiving cash in an amount equal to the stockholders’ pro rata share of the appraised value of our net assets.
We
are prohibited from participating in any proposed roll-up transaction:
•
that would result in our common stockholders having voting rights in a roll-up entity that are less than those provided in our charter and described elsewhere in this prospectus, including rights with respect to the election and removal of directors, annual and special meetings, amendment of our charter and our dissolution;
•
that includes provisions that would operate to materially impede or frustrate the accumulation of shares by any purchaser of the securities
of the roll-up entity, except to the minimum extent necessary to preserve the tax status of the roll-up entity, or which would limit the ability of an investor to exercise voting rights of its securities of the roll-up entity on the basis of the number of shares held by that investor;
•
in which investors’ right to access of records of the roll-up entity will be less than those provided in the section of this prospectus entitled “Description of Capital Stock;” or
•
in which any of the costs of the roll-up transaction
would be borne by us if the roll-up transaction is rejected by our common stockholders.
Reports to Stockholders
Our charter requires that we prepare an annual report and deliver it to our stockholders within 120 days after the end of each fiscal year. Among the matters that must be included in the annual report are:
•
financial statements that are prepared in accordance with U.S. GAAP and are audited by our independent registered public accounting firm;
•
the
ratio of the costs of raising capital during the year to the capital raised;
•
the aggregate amount of asset management fees and the aggregate amount of other fees paid to our advisor and any affiliate of our advisor by us or third parties doing business with us during the year;
•
our total operating expenses for the year, stated as a percentage of our average invested assets and as a percentage of our net income;
•
a
report from our independent directors that our policies are in the best interests of our stockholders and the basis for such determination; and
•
separately stated, full disclosure of all material terms, factors and circumstances surrounding any and all transactions involving us and our advisor, a director, our sponsor or any affiliate thereof during the year; and our independent directors are specifically charged with a duty to examine and comment in the report on the fairness of the transactions.
Under the Securities Act, we must update this prospectus upon the occurrence of certain events, such as property acquisitions. We will file updated prospectuses and prospectus supplements
with the SEC. We are also subject to the informational reporting requirements of the Exchange Act, and accordingly, we will file annual reports, quarterly reports, proxy statements and other information with the SEC. In addition, we will provide you directly with periodic updates, including prospectuses, prospectus supplements, quarterly reports and other information.
Subject to availability, you may authorize us to provide such periodic updates electronically by so indicating on your subscription agreement, or by sending us instructions in writing in a form acceptable to us to receive such periodic updates electronically. Unless you elect in writing to receive such periodic updates electronically, all documents will be provided in paper form by mail. You must have internet access to use electronic delivery. While we impose no additional charge for this service, there may be potential costs associated with electronic delivery,
such as on-line charges. The periodic updates will be available on our website. You may access and print all periodic updates provided through this service. As periodic updates become available, we will notify you of this by sending you an e-mail message that will include instructions on how to retrieve the periodic updates. If our e-mail notification is returned to us as “undeliverable,” we will contact you to obtain your updated e-mail address. If we are unable to obtain a valid e-mail address for you, we will resume sending a paper copy by regular U.S. mail to your address of record. You may revoke
your consent for electronic delivery at any time and we will resume sending you a paper copy of all periodic updates. However, in order for us to be properly notified, your revocation must be given to us a reasonable time before electronic delivery has commenced. We will provide you with paper copies at any time upon request. Such request will not constitute revocation of your consent to receive periodic updates electronically.
Our operating partnership is a Delaware limited partnership. We hold substantially all of our assets in our operating partnership or in subsidiary entities in which our operating partnership owns an interest. We are the sole general partner and a limited partner of our operating partnership. Our advisor has contributed $1,000 to our operating partnership in exchange for common units and NorthStar OP Holdings II has invested $1,000 in exchange for special units. We, our advisor and NorthStar OP Holdings II are currently the only limited partners. The following is a summary of the material terms and provisions of the partnership agreement of NorthStar Real Estate Income Operating Partnership II, LP. This summary is not complete. For more detail, you should refer to the partnership
agreement itself, which is filed as an exhibit to the registration statement of which this prospectus is a part.
Management of the Operating Partnership
As the sole general partner of our operating partnership, we have the exclusive power to manage and conduct the business of our operating partnership. We may not be removed as general partner by the limited partners. Our board of directors has at all times ultimate oversight and policy-making authority, including responsibility for governance, financial controls, compliance and disclosure with respect to our operating partnership. Neither NorthStar OP Holdings II nor any other limited partner of our operating partnership may transact business for our operating partnership or participate in management activities or decisions, except as provided in the partnership agreement and as required by applicable law. Pursuant to an advisory
agreement with our advisor, we have delegated to our advisor authority to make decisions related to our and our operating partnership’s day-to-day business, the origination, acquisition, management and disposition of assets and the selection of property managers and other service providers, in accordance with our investment objectives, strategy, guidelines, policies and limitations.
A general partner is accountable to a limited partnership as a fiduciary and consequently must exercise good faith and integrity in handling partnership affairs.
NorthStar OP Holdings II and our advisor have expressly acknowledged and any future limited partners of our operating partnership will expressly acknowledge that we, as general partner, are acting for our benefit, and the benefit of the limited partners of our operating partnership and our stockholders collectively. Neither we nor our board
of directors is under any obligation to give priority to the separate interests of the limited partners of our operating partnership or our stockholders in deciding whether to cause our operating partnership to take or decline to take any actions. If there is a conflict between the interests of our stockholders on one hand and our operating partnership’s limited partners on the other, we will endeavor in good faith to resolve the conflict in a manner not adverse to either our stockholders or our operating partnership’s limited partners; provided, however, that for so long as we own a controlling interest in our operating partnership, any conflict that cannot be resolved in a manner not adverse to either our stockholders or our operating partnership’s limited partners will be resolved in favor of our stockholders. We are not liable under the partnership agreement to our operating partnership or to any of its limited partners for monetary damages for losses sustained,
liabilities incurred, or benefits not derived by such limited partners in connection with such decisions, provided that we have acted in good faith.
Additional Capital Contributions
In connection with any and all issuances of our shares of common stock, we will make capital contributions to the operating partnership of the proceeds therefrom, provided that if the proceeds actually received and contributed by us are less than the gross proceeds of such issuance as a result of any underwriter’s discount, commissions, placement fees or other expenses paid or incurred in connection with such issuance, then we shall make a capital contribution of such net proceeds to the operating partnership but will receive additional common units with a value equal to the aggregate amount of the gross proceeds of such issuance. Upon any such capital contribution by us, our capital account will be
increased by the actual amount of our capital contribution.
We are authorized to cause our operating partnership to issue additional common units for less than fair market value if we conclude in good faith that such issuance is in the best interests of us and our operating partnership. Our operating partnership may issue preferred partnership units to us if we issue
shares of preferred
stock and contribute the net proceeds from the issuance thereof to our operating partnership or in connection with acquisitions of property or otherwise, which could have priority over the common units with respect to distributions from our operating partnership, including the common units owned by us.
As sole general partner of our operating partnership, we have the ability to cause our operating partnership to issue additional limited partnership interests. These additional interests may be issued to institutional and other large investors that may prefer to make an investment directly in our operating partnership and may include preferred limited partnership interests or other interests subject to different distribution and allocation arrangements, fees and redemption arrangements.
If our operating partnership requires additional funds at any time in excess of capital contributions
made by us, or from borrowings, we may: (i) cause the operating partnership to obtain such funds from outside borrowings; or (ii) elect for us or for any of our affiliates to provide such additional funds to the operating partnership through loans or otherwise.
Operations
The partnership agreement requires that our operating partnership be operated in a manner that will enable us to: (i) satisfy the requirements for being classified as a REIT for federal income tax purposes, unless we otherwise cease to qualify as a REIT; (ii) avoid any federal income or excise tax liability (other than any federal income tax liability associated with our retained capital gains); and (iii) ensure that our operating partnership will not be classified as a “publicly traded partnership” for purposes of Section 7704 of the Internal Revenue Code, which classification could result in our operating
partnership being taxed as a corporation, rather than as a partnership.
Distributions
The partnership agreement generally provides that, except as provided below with respect to the special units and except upon liquidation of our operating partnership, our operating partnership will distribute cash to the partners of our operating partnership in accordance with their relative partnership units, on a quarterly basis (or, at our election, more or less frequently), in amounts determined by us as general partner. Upon the liquidation of our operating partnership, after payment of debts and obligations and any redemption of special units, any remaining assets of our operating partnership will be distributed in accordance with each partner’s positive capital account balance.
The holder of the special units will be entitled to distributions
from our operating partnership equal to 15% of distributions after the other partners, including us, have received in the aggregate, cumulative distributions equal to their capital contributions plus a 7% cumulative non-compounded annual pre-tax return thereon. Depending on various factors, including the date on which shares of our common stock are purchased and the price paid for such shares of common stock, a stockholder may receive more or less than the 7% cumulative non-compounded annual pre-tax return on their net contributions described above prior to the commencement of distributions to the owner of the special units.
LTIP Units
As of the date of this prospectus, our operating partnership has not issued any LTIP units, which are limited partnership interests in our operating partnership more specifically defined in the partnership agreement, but we may cause our operating
partnership to issue LTIP units to members of our board of directors and our management team in accordance with our long-term incentive plan. LTIP units may be issued subject to vesting, forfeiture and additional restrictions on transfer pursuant to the terms of a vesting agreement. In general, LTIP units, a class of partnership units in our operating partnership, will receive the same quarterly per unit non-liquidating distributions as the common units. Initially, each LTIP unit will have a capital account balance of zero and, therefore, will not have full parity with common units with respect to liquidating distributions. However, our partnership agreement provides that “book gain,” or economic appreciation, in our assets realized by our operating partnership as a result of the actual sale of all or substantially all of our operating partnership’s assets or the revaluation of our operating partnership’s assets as provided by applicable Treasury Regulations,
will be allocated first to the LTIP unit holders until
the capital account per LTIP unit is equal to the average capital account per unit of the general partner’s common units in our operating partnership. Until and unless parity is reached, the value for a given number of vested LTIP units will be less than the fair value of an equal number of our operating partnership’s common units. This valuation is unrelated to our annual valuation
provided to ERISA fiduciaries or any valuation required to be provided to our investors following the 18 month period following the completion of our offering (or for whatever period may be required by applicable rules and regulations).
Our partnership agreement provides that our operating partnership’s assets will be revalued upon the occurrence of certain events, specifically additional capital contributions by us or other partners, the redemption of a partnership interest, a liquidation (as defined in the Treasury Regulations) of our operating partnership or the issuance of a partnership interest (including LTIP units) to a new or existing partner as consideration for the provision of services to, or for the benefit of, our operating partnership.
Partnership Expenses
In addition to the administrative and operating costs and expenses
incurred by our operating partnership in originating and acquiring our investments, to the extent not paid by us, our operating partnership will pay all of our administrative costs and expenses, and such expenses will be treated as expenses of our operating partnership. Such expenses will include:
•
all expenses relating to the formation and continuity of our existence;
•
all expenses relating to our offering and registration of securities by us;
•
all
expenses associated with the preparation and filing of any periodic reports by us under federal, state or local laws or regulations;
•
all expenses associated with compliance by us with applicable laws, rules and regulations;
•
all costs and expenses relating to any issuance or redemption of partnership interests or shares of our common stock; and
•
all
our other operating or administrative costs incurred in the ordinary course of our business on behalf of our operating partnership.
Redemption Rights
The holders of common units (other than us and any of our subsidiaries) generally have the right to cause our operating partnership to redeem all or a portion of their common units for, at our sole discretion, shares of our common stock, cash or a combination of both. If we elect to redeem common units for shares of our common stock, we will generally deliver one share of our common stock for each common unit redeemed. The conversion ratio will be adjusted to account for share splits, mergers, consolidations or similar pro rata share transactions. Notwithstanding the foregoing, a limited partner shall not be entitled to exercise
its redemption rights to the extent that the issuance of shares of our common stock to the redeeming limited partner would:
•
result in any person owning, directly or indirectly, shares of our common stock in excess of the stock ownership limit in our charter;
•
result in shares of our capital stock being owned by fewer than 100 persons (determined without reference to any rules of attribution);
•
result
in our being “closely held” within the meaning of Section 856(h) of the Internal Revenue Code; or
•
cause us to own, actually or constructively, 10% or more of the ownership interests in a tenant (other than a TRS) of ours, the operating partnership’s or a subsidiary partnership’s real property, within the meaning of Section 856(d)(2)(B) of the Internal Revenue Code.
The special units will be redeemed for a specified amount upon the earliest of: (i) the occurrence of certain events that result in the termination or non-renewal of our advisory agreement; or (ii) a listing of our shares. If the triggering event is a listing of our shares, the amount of the payment will be: (i)
in the
event of a listing on a national securities exchange only, based on the market value of the listed shares based upon the average closing price or, if the average closing price is not available, the average of bid and ask prices, for the 30 day period beginning 120 days after such listing event; or (ii) in the event of an underwritten public offering, the value of the shares based upon the initial public offering price in
such offering. If the triggering event is the termination of our advisory agreement other than for cause, the amount of the payment will be based on the net asset value of our assets as determined by an independent valuation. According to the terms of the partnership agreement, internalization of our advisor would result in the redemption of the special units because our advisory agreement would be terminated upon internalization of our advisory agreement. However, as part of the negotiated consideration for the internalization, the special unit holder might agree to amend or waive the redemption feature.
Subject to the foregoing, holders of common units (other than us and the holders of the special units) may exercise their redemption rights at any time after one year following the date of issuance of their common units; provided, however, that a holder of common units may not deliver more than two redemption notices in a
single calendar year and may not exercise a redemption right for less than 1,000 common units, unless such holder holds less than 1,000 common units, in which case, it must exercise its redemption right for all of its common units.
Transferability of Operating Partnership Interests
We may not: (i) voluntarily withdraw as the general partner of our operating partnership; (ii) engage in any merger, consolidation or other business combination; or (iii) transfer our general partnership interest in our operating partnership (except to a wholly owned subsidiary), unless the transaction in which such withdrawal, business combination or transfer occurs results in the holders of common units receiving or having the right to receive an amount of cash, securities or other property equal in value to the amount they would have received if they had exercised their redemption rights immediately
prior to such transaction (or in the case of the holder of the special units, the amount of cash, securities or other property equal to the fair value of the special units) or unless, in the case of a merger or other business combination, the successor entity contributes substantially all of its assets to our operating partnership in return for an interest in our operating partnership and agrees to assume all obligations of the general partner of our operating partnership. We may also enter into a business combination or we may transfer our general partnership interest upon the receipt of the consent of a majority-in-interest of the holders of common units, other than our advisor and its affiliates.
With certain exceptions limited partners may not transfer their interests in our operating partnership, in whole or in part, without our written consent, as general partner.
Exculpation
We, as general partner, will not be liable to our operating partnership or limited partners for errors in judgment or other acts or omissions not amounting to willful misconduct or gross negligence since provision has been made in the partnership agreement for exculpation of the general partner. Therefore, purchasers of interests in our operating partnership have a more limited right of action than they would have absent the limitation in the partnership agreement.
Indemnification
The partnership agreement provides for the indemnification of us, as general partner, by our operating partnership for liabilities we incur in dealings with third parties on behalf of our operating partnership. To the extent that the indemnification provisions purport to include indemnification of liabilities arising under the Securities Act, in the opinion
of the SEC, such indemnification is contrary to public policy and therefore unenforceable.
Tax Matters
We are our operating partnership’s tax matters partner and have the authority to make tax elections under the Internal Revenue Code on our operating partnership’s behalf.
The term of the operating
partnership will continue in full force and effect until dissolved upon the first to occur of any of the following events:
•
the bankruptcy, dissolution, death, removal or withdrawal of the general partner (unless the limited partners elect to continue our operating partnership);
•
the passage of ninety (90) days after the sale or other disposition of all or substantially all the assets of our operating partnership; or
•
the
election by the general partner that our operating partnership should be dissolved.
Amendments
In general, we may amend the partnership agreement without the consent of the limited partners. However, any amendment to the partnership agreement that would adversely affect the redemption rights or certain other rights of the limited partners requires the consent of limited partners holding a majority in interest of the limited partnership interests in our partnership (other than us or any of our affiliates).
We are publicly offering a maximum of $1,500,000,000 in shares of our common stock on a “best efforts” basis through our dealer manager. Because this is a “best efforts” offering, our dealer manager must use only its best efforts to sell the shares in our primary offering and has no firm commitment or obligation to purchase any of our shares. Shares of our common stock sold in our primary offering are being offered at $10.00 per share. All shares offered in our primary offering are subject to discounts available for certain categories of purchasers as described below. We are also offering up to $150,000,000 in shares issuable pursuant to our DRP. Any shares purchased pursuant to our DRP will be sold at $9.50 per share. We
reserve the right to reallocate shares of our common stock being offered between our primary offering and our DRP. Unless the rules and regulations governing valuations change, within 18 months after the completion of our offering stage, our advisor, or another firm we choose for that purpose will establish an estimated value per share of our common stock that we will disclose in the annual and quarterly reports that we publicly file with the SEC. At that time, shares issued pursuant to our DRP will be priced at 95% of such estimated per share value of our common stock. We will consider our offering stage complete when we are no longer publicly offering equity securities in a continuous offering, whether through our offering or follow-on public offerings. For this purpose, we do not consider a “public offering of equity securities” to include offerings on behalf of selling stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests
in our operating partnership. If our board of directors determines that it is in our best interests, we may conduct one or more follow-on public offerings upon termination of our offering. Our charter does not restrict our ability to conduct offerings in the future.
We expect to sell the $1,500,000,000 in shares offered in our primary offering over a two-year period. If we have not sold all of our primary offering shares within two years, we may, under rules promulgated by the SEC, in some circumstances continue our primary offering until as late as November 2, 2016. If we decide to continue our primary offering beyond two years from the date of this prospectus, we will provide that information in a prospectus supplement. We may continue to offer shares under our DRP beyond these dates until we have sold $150,000,000 in shares through the reinvestment of distributions. In many
states, we will need to renew the registration statement or file a new registration statement to continue our offering beyond one year from the date of this prospectus. We may terminate our offering at any time.
Our dealer manager is a securities broker-dealer registered with the SEC and a member firm of FINRA that was formed in 2009. The principal business of our dealer manager is to sell the securities offered by programs sponsored by our sponsor. Our dealer manager is indirectly owned and controlled by our sponsor. This is the third offering for which our dealer manager has served as a dealer manager, but its employees average over 15 years’ experience in the broker-dealer industry.
Compensation of Dealer Manager and Participating Broker-Dealers
Except as provided below, our dealer manager receives selling commissions of 7% of the
gross offering proceeds from shares sold in our primary offering. Our dealer manager also receives 3% of our gross offering proceeds as compensation for acting as our dealer manager. We do not pay any selling commissions or dealer manager fees for shares sold under our DRP.
Our dealer manager has authorized other broker-dealers that are members of FINRA, which we refer to as participating broker-dealers, to sell our shares. Our dealer manager reallows all of its selling commissions attributable to a participating broker-dealer. Our dealer manager may also reallow a portion of its dealer manager fee to any participating broker-dealer as a marketing fee. The amount of the reallowance to any participating broker-dealer will be based upon prior or projected volume of sales and the amount of marketing assistance anticipated to be provided in our offering. In addition, to the extent our dealer manager does not reallow the full dealer
manager fee for shares sold in our primary offering to participating broker-dealers as a marketing fee, our dealer manager may use the portion of its dealer manager fee that it retains to reimburse costs of bona fide training and education meetings held by us (primarily the travel, meal and lodging costs of registered representatives of broker-dealers), attendance and sponsorship fees and cost reimbursement of employees of our affiliates to attend seminars conducted by broker-dealers and, in special cases, reimbursement to participating broker-dealers for technology costs associated with our
offering and costs and expenses associated with the facilitation of the marketing of our shares and the ownership of our shares by such broker-dealers’ customers; provided, however, that our dealer manager will not pay any of the foregoing costs to the extent that such payment would cause total underwriting compensation to exceed 10% of the gross proceeds of our primary offering, as required by the rules of FINRA.
We may also sell shares at a discount to our primary offering price through the following distribution channels in the event that the investor:
•
pays a broker a periodic fee, e.g., a percentage
of assets under management, for investment advisory and broker services, which is frequently referred to as a “wrap fee;”
•
has engaged the services of a registered investment adviser with whom the investor has agreed to pay compensation for investment advisory services or other financial or investment advice (other than a registered investment adviser that is also registered as a broker-dealer who does not have a fixed or “wrap fee” feature or other asset fee arrangement with the investor); or
•
is investing
through a bank acting as trustee or fiduciary.
If an investor purchases shares through one of these channels in our primary offering, we will sell the shares at a 7% discount, or at $9.30 per share, reflecting that selling commissions will not be paid in connection with such purchases. We will receive substantially the same net proceeds for sales of shares through these channels. Neither our dealer manager nor its affiliates will compensate any person engaged as a financial advisor by a potential investor as an inducement for such financial advisor to advise favorably for an investment in us.
If an investor purchases shares in our offering net of commissions through a registered investment adviser with whom the investor has agreed to pay compensation for investment advisory services or other financial or investment advice and if in connection with such purchase
the investor must also pay a broker-dealer for custodial or other services relating to holding the shares in the investor’s account, our dealer manager will reduce their dealer manager fee by the amount of the annual custodial or other fees paid to the broker-dealer in an amount up to $250. Each investor will receive only one reduction in purchase price for such fees and this reduction in the purchase price of our shares is only available for the investor’s initial investment in our common stock. The investor must include the “Request for Broker Dealer Custodial Fee Reimbursement Form” with his or her subscription agreement to have the purchase price of the investor’s initial investment in shares reduced by the amount of his or her annual custodial fee and the investor must include support for the amount of his or her annual custodial fee with the subscription agreement.
Certain institutional investors and our affiliates
may also agree with a participating broker-dealer selling shares of our common stock (or with our dealer manager) to reduce or eliminate the selling commission and the dealer manager fee. The amount of net proceeds to us will not be affected by reducing or eliminating selling commissions and dealer manager fees payable in connection with sales to such institutional investors and affiliates.
The table below sets forth the nature and estimated amount of all items viewed as “underwriting compensation” by FINRA, assuming we sell all of the shares offered hereby. To show the maximum amount of dealer manager and participating broker-dealer compensation that we may pay in our primary offering, this table assumes that all shares are sold through distribution channels associated with the highest possible selling commissions and dealer manager fees.
Subject to the cap on organization and offering costs described below, we also reimburse our dealer manager for reimbursements it may make to broker-dealers for bona fide due diligence expenses presented on detailed and itemized invoices.
In accordance with the rules of FINRA, the total amount of all items of underwriting compensation, from whatever source, payable to underwriters, participating broker-dealers or affiliates thereof will not exceed an amount equal to 10% of our gross proceeds from our primary offering. In addition to the limits on underwriting compensation, FINRA and many states also limit our total organization and offering costs, including the seller commissions and dealer manager fee, to 15% of gross offering proceeds. We expect our organization and offering costs (other than the selling
commissions and dealer manager fees) to be approximately 1.5% of our gross proceeds from our offering, assuming we raise the maximum offering amount. Our advisor has agreed to reimburse us to the extent selling commissions, the dealer manager fee and other organization and offering costs incurred by us exceed 15% of aggregate gross proceeds from our offering.
To the extent permitted by law and our charter, we will indemnify the participating broker-dealers and our dealer manager against some civil liabilities, including certain liabilities under the Securities Act and liabilities arising from breaches of our representations and warranties contained in our dealer manager agreement.
Special Discounts
Our dealer manager has agreed to sell up to 5% of the shares offered hereby in our primary offering to persons to be identified by us at a
discount from the offering price. We intend to use this “friends and family” program to sell shares to certain investors identified by us, including investors who have a prior business relationship with our sponsor, such as real estate brokers, joint venture partners and their employees, company executives, surveyors, attorneys and similar individuals, and others to the extent consistent with applicable laws and regulations. We will sell such shares at a 10% discount, or at $9.00 per share, reflecting that selling commissions and dealer manager fees will not be paid in connection with such sales. The net proceeds to us from such sales made net of commissions and dealer manager fees will be substantially the same as the net proceeds we receive from other sales of shares.
Our executive officers and directors, as well as officers and employees of our advisor and our advisor’s affiliates, at their option, also may purchase
the shares offered hereby in our primary offering at a discount from the offering price, in which case they have advised us that they would expect to hold such shares as stockholders for investment and not for distribution. We will sell such shares at a 10% discount, or at $9.00 per share, reflecting that selling commissions and dealer manager fees will not be paid in connection with such sales. The net proceeds to us from such sales made net of commissions and dealer manager fees will be substantially the same as the net proceeds we receive from other sales of shares.
We may sell shares to participating broker-dealers, their retirement plans, their representatives and the family members, IRAs and qualified plans of their representatives at a purchase price of $9.30 per share, reflecting that selling commissions in the amount of $0.70 per share will not be payable. For purposes of this discount, we consider a family member
to be a spouse, parent, child, sibling, mother- or father-in-law, son- or daughter-in-law or brother- or sister-in-law. The net proceeds to us from the sales of these shares will be substantially the same as the net proceeds we receive from other sales of shares.
We are offering volume discounts to investors who purchase more than $500,000 of shares through the same participating broker-dealer in our primary offering. The net proceeds to us from a sale eligible for a volume discount will be the same, but the selling commissions we will pay will be reduced. Because our dealer manager reallows all selling commissions, the amount of commissions participating broker-dealers receive for such sales will be reduced.
Assuming an offering price of $10.00 per share, the following table shows the discounted price per share for volume sales of our primary shares for the shares sold in our primary offering:
Dollar Volume Purchased
Purchase
Price per Share to Investor
Percentage Based on $10.00 per share
Commission Amount per Share
Dealer Manager Fee per Share
Net Proceeds per Share
$500,000 or less
$
10.00
7
%
7
$
0.70
$
0.30
$
9.00
$500,001
– $1,000,000
9.90
6
%
6
0.60
0.30
9.00
$1,000,001
–$2,000,000
9.80
5
%
5
0.50
0.30
9.00
$2,000,001
– $3,000,000
9.70
4
%
4
0.40
0.30
9.00
$3,000,001
– $5,000,000
9.60
3
%
3
0.30
0.30
9.00
Over
$5,000,000
9.50
2
%
2
0.20
0.30
9.00
We
will apply the reduced selling price and selling commission to the entire purchase made at one time. All commission rates and dealer manager fees are calculated assuming a price per share of $10.00. For example, a purchase of 250,000 shares in a single transaction would result in a purchase price of $2,425,000 ($9.70 per share), selling commissions of $100,000 and dealer manager fees of $75,000.
To qualify for a volume discount as a result of multiple purchases of our shares you must use the same participating broker-dealer and you must mark the “Additional Purchase” space on the subscription agreement. We are not responsible for failing to combine purchases if you fail to mark the “Additional Purchase” space. Once you qualify for a volume discount, you will be eligible to receive the benefit of such discount for subsequent purchases of shares in our primary offering through the same participating broker-dealer.
If a subsequent purchase entitles an investor to an increased reduction in selling commissions and dealer manager fees, the volume discount will apply only to the current and future investments.
To the extent purchased through the same participating broker-dealer, the following persons may combine their purchases as a “single purchaser” for the purpose of qualifying for a volume discount:
•
an individual, his or her spouse, their children under the age of 21 and all pension or trust funds established by each such individual;
•
a
corporation, partnership, association, joint-stock company, trust fund or any organized group of persons, whether incorporated or not;
•
an employees’ trust, pension, profit-sharing or other employee benefit plan qualified under Section 491(a) of the Internal Revenue Code; and
•
all commingled trust funds maintained by a given bank.
In the event a person wishes to have his or her order combined with others as a “single purchaser,” that person must
request such treatment in writing at the time of subscription setting forth the basis for the discount and identifying the orders to be combined. Any request will be subject to our verification that the orders to be combined are made by a single purchaser. If the subscription agreements for the combined orders of a single purchaser are submitted at the same time, then the commissions payable and discounted share price will be allocated pro rata among the combined orders on the basis of the respective amounts being combined. Otherwise, the volume discount provisions will apply only to the order that qualifies the single purchaser for the volume discount and the subsequent orders of that single purchaser.
Only shares purchased in our primary offering are eligible for volume discounts. Shares purchased through our DRP will not be eligible for a volume discount nor will such shares count toward the threshold limits listed above
that qualify you for the different discount levels.
Volume discounts for California residents will be available in accordance with the foregoing table of uniform discount levels. However, with respect to California residents, no discounts will be allowed to any group of purchasers and no subscriptions may be aggregated as part of a combined order for purposes of determining the dollar amount of shares purchased.
Regardless
of any reduction in commissions for any reason, any other fees based upon gross proceeds of our offering will be calculated as though the purchaser paid $10.00 per share. An investor qualifying for a discount will receive a higher percentage return on his or her investment than investors who do not qualify for such discount. Please note that although you are permitted to participate in our DRP, if you qualify for the discounts and fee waivers described above, you may be able to receive a lower price on subsequent purchases in our offering than you would receive if you participate in our DRP and have your distributions reinvested at the price offered thereunder.
Term and Termination of the Dealer Manager Agreement
Our agreement with our dealer manager provides that our dealer manager is our exclusive agent and managing dealer until the termination of our offering. Either party may
terminate the dealer manager agreement upon 60 calendar days written notice to the other party.
Subscriptions will be effective only upon our acceptance, and we reserve the right to reject any subscription in whole or in part. Subscriptions will be accepted or rejected within 30 days of receipt by us, and if rejected, all funds will be returned to subscribers without interest and without deduction within ten business days from the date the subscription is rejected. We are not permitted to accept a subscription for shares of our common stock until at least five business days after the date you receive the final prospectus. Subject to certain exceptions described in this prospectus, you must initially invest at least $4,000 in shares of our common stock. After investors have satisfied the minimum purchase requirement, minimum additional purchases must be in increments of $100, except for purchases made pursuant to our DRP, which
are not subject to any minimum purchase requirement.
SUPPLEMENTAL SALES MATERIAL
In addition to this prospectus, we may utilize certain sales material in connection with our offering of shares of our common stock, although only when accompanied by or preceded by the delivery of this prospectus. In certain jurisdictions, some or all of such sales material may not be available. This material may include information relating to our offering, the past performance of our sponsor and its affiliates, property brochures and articles and publications concerning real estate. In addition, the sales material may contain certain quotes from various publications without obtaining the consent of the author or the publication for use of the quoted material in the sales material.
Our
offering of shares of our common stock is made only by means of this prospectus. Although the information contained in such sales material will not conflict with any of the information contained in this prospectus, such material does not purport to be complete, and should not be considered a part of this prospectus or the registration statement of which this prospectus is a part, or as incorporated by reference in this prospectus or said registration statement or as forming the basis of our offering of the shares of our common stock.
LEGAL MATTERS
The legality of the shares of our common stock being offered hereby has been passed upon for us by Venable LLP. The statements relating to certain federal income tax matters
under the caption “U.S. Federal Income Tax Considerations” have been reviewed by and our qualifications as a REIT for federal income tax purposes has been passed upon by Greenberg Traurig, LLP.
EXPERTS
The consolidated financial statements and schedule incorporated by reference in this prospectus and elsewhere in the registration statement have been so incorporated by reference in reliance upon the report of Grant Thornton LLP, independent registered public accountants upon the authority of said firm as experts in accounting and auditing.
The following documents filed with the SEC are incorporated by reference in this prospectus, except for
any document or portion thereof deemed to be “furnished” and not filed in accordance with SEC rules:
We will provide to each person to whom this prospectus is delivered, upon request, a copy of any or all of the information that we have incorporated by reference into this prospectus but have not delivered with this prospectus. To receive a free copy of any of the documents incorporated by reference in this prospectus, other than exhibits, unless they are specifically incorporated by reference in those documents, call or write us at:
The information relating to us contained in this prospectus does not purport to be comprehensive and should be read together with the information contained in the documents incorporated or deemed to be incorporated by reference in this prospectus.
We have filed with the SEC a registration statement under the Securities Act on Form S-11 regarding our offering. This prospectus, which is part of the registration statement, does not contain all the information set forth in the registration statement and the exhibits related thereto filed with the SEC, reference to which is hereby made. We are subject to the informational reporting requirements of the Exchange Act and under the Exchange Act and will file reports, proxy statements and other information with the SEC. You may read and copy the registration statement, the related exhibits and the reports, proxy statements and other information we file with the SEC at the SEC’s public reference facilities maintained by the SEC at 100 F Street, N.E., Washington, DC 20549. You can also request
copies of those documents, upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information regarding the operation of the public reference rooms. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file with the SEC.
You may also request a copy of these filings at no cost, by writing or telephoning us at:
Within 120 days after the end of each fiscal year we will provide to our stockholders of record an annual report. The annual report will contain audited financial statements and certain other financial and narrative information that we are required to provide to stockholders.
The following prior performance tables
provide information relating to the real estate programs sponsored by NorthStar Realty Finance Corp., or our sponsor, and its affiliates, collectively referred to herein as the prior real estate programs. These programs of our sponsor and its affiliates focus on investments in commercial real estate, or CRE, debt, CRE securities and real estate properties. Each individual prior real estate program has its own specific investment objectives; however, the general investment objectives common to all prior real estate programs include providing investors with: (i) exposure to CRE debt investments; and (ii) current income. Other than NorthStar Real Estate Income Trust, Inc. and NorthStar Healthcare Income, Inc., the prior real estate programs were conducted by privately-held entities that were not subject to either the up-front commissions, fees and expenses associated with our offering or many of the laws and regulations to which we will be subject. In addition, our sponsor
is a publicly traded company with an indefinite duration.
This information should be read together with the summary information included in the “Prior Performance Summary” section of this prospectus.
Investors should not construe inclusion of the following tables as implying, in any manner, that we will have results comparable to those reflected in such tables. Distributable cash flow, federal income tax deductions or other factors could be substantially different. Investors should note that by acquiring our shares, they will not be acquiring any interest in any prior program.
Description of the Tables
All information contained in the Tables in this Appendix A is as of December 31, 2013. The following tables are
included herein:
Table I
—
Experience in Raising and Investing Funds (As a Percentage of Investment)
Table III
—
Annual Operating Results of Prior Real Estate Programs
Prior Performance Is Not Indicative of Future Results
Table I presents information showing the experience of our sponsor and affiliates in raising and investing funds for prior real estate programs. Information is included for offerings with similar investment objectives that have closed for the three years ended December 31, 2013. Also set forth is the timing and length of these offerings and information pertaining to the time period over which the proceeds have been invested. All figures are as of December 31, 2013 (dollars in thousands).
Months
to invest 90 percent of amount available for investment (5)
—
—
—
__________________
(1)
On
October 18, 2010, NorthStar Income Opportunity REIT I, Inc. completed a merger with NorthStar Real Estate Income Trust, Inc.
(2)
The data includes information with respect to our sponsor’s initial public offering in October 2004 and additional offerings through December 31, 2013. All of our sponsor’s offerings have been conducted on a firm commitment underwritten basis.
(3)
The amount represents the number of days from
the date the offering began on June 10, 2009 through the date of the merger with NorthStar Real Estate Income Trust, Inc. on October 18, 2010.
(4)
The amount represents the number of days from the date the offering began on July 19, 2010 through the offering completion date of July 1, 2013.
Prior Performance Is Not Indicative of Future Results
Table III presents balance sheet information and the operating results of prior
real estate programs with similar investment objectives that have closed for the five years ended December 31, 2013. Please see the “Prior Performance Summary-Adverse Business Developments” section for a description of major adverse business developments experienced by the prior real estate programs.
Prior Performance Is Not Indicative of Future
Results
Table IV presents summary information on the results of prior real estate programs having similar investment objectives that have completed operations since December 31, 2004. All figures are through December 31, 2013.
NorthStar Income Opportunity REIT I, Inc.
(Dollars in thousands)
Dollar amount raised
$
36,069
Aggregate
compensation paid to sponsor
$
40
Duration
16 months (1)
Date of final sale of security(2)
N/A
Annualized
return on investment
8.5
%
(3)
Median annual leverage
83.7
%
__________________
(1)
The
amount represents the number of months from the date the offering began on June 10, 2009 through the date of the merger with NorthStar Real Estate Income Trust, Inc. on October 18, 2010.
(2)
On October 18, 2010, NorthStar Income Opportunity REIT I, Inc. completed a merger with NorthStar Real Estate Income Trust, Inc.
(3)
Internal rate of return from inception of the program
through liquidation, including all dividends.
The amount represents the number of months from the date the offering began on June 27, 2007 through the date of the fund’s liquidation on June 28, 2011.
(2)
Internal
rate of return from inception of the program through liquidation, including all dividends.
Prior Performance Is Not
Indicative of Future Results
This table presents summary information on the results of the aggregate sale or disposition of commercial real estate securities by NorthStar Real Estate Income Trust, Inc. for the three years ended December 31, 2013.
NorthStar Real Estate Income Trust, Inc.(1)
(Dollars in thousands)
Number
Total
Dollar Amount Invested
Total Sales Proceeds
2013
1
$
41,383
$
41,383
2012
2
29,616
32,379
2011
—
—
—
______________
(1)
On
October 18, 2010, NorthStar Real Estate Income Trust, Inc. completed a merger with NorthStar Income Opportunity REIT I, Inc.
This DISTRIBUTION REINVESTMENT PLAN (“Plan”) is adopted by NorthStar Real Estate Income II, Inc., a Maryland corporation (the “Company”), pursuant to its charter (the “Charter”).
Unless otherwise defined herein, capitalized terms shall have the same meaning as set forth in the Charter.
1. Distribution Reinvestment. As agent for the stockholders (“Stockholders”) of the Company who: (i) purchase shares of the Company’s common stock (“Shares”) pursuant to the Company’s initial public offering (the “Initial Offering”) or (ii) purchase Shares pursuant to any future offering of the Company (“Future Offering”), and who elect to participate in the Plan (the “Participants”), the
Company will apply all distributions declared and paid in respect of the Shares held by each Participant (the “Distributions”), including Distributions paid with respect to any full or fractional Shares acquired under the Plan, to the purchase of Shares for such Participants directly, if permitted under state securities laws and, if not, through our Dealer Manager or Soliciting Dealers registered in the Participant’s state of residence.
2. Effective Date. The effective date of this Plan shall be the date that the minimum offering requirements (as defined in the Prospectus relating to the Initial Offering) are met in connection with the Initial Offering.
3. Procedure for Participation. Any Stockholder who has received a Prospectus, as contained in the
Company’s registration statement filed with the Securities and Exchange Commission (the “SEC”), may elect to become a Participant by completing and executing the subscription agreement, an enrollment form or any other appropriate authorization form as may be available from the Company, our Dealer Manager or a Soliciting Dealer. Participation in the Plan will begin with the next Distribution payable after acceptance of a Participant’s subscription, enrollment or authorization. Shares will be purchased under the Plan on the date that Distributions are paid by the Company. The Company intends to make Distributions on a monthly basis. Each Participant agrees that if, at any time prior to the listing of the
Shares on a national stock exchange, such Participant does not meet the minimum income and net worth standards for making an investment in the Company or cannot make the other representations or warranties set forth in the subscription agreement, such Participant will promptly so notify the Company in writing.
4. Purchase of Shares. Participants will acquire Shares from the Company under the Plan (the “Plan Shares”) at a price equal to $9.50 per Share. From and after 18 months after the completion of the Company’s offering
stage, the Company’s advisor, or another firm it chooses for that purpose, will establish an estimated value per share of the Company’s Shares. At that time, Plan Shares will be priced at 95% of such estimated per Share value. The Company will consider the offering stage complete when it is no longer publicly offering equity securities in a continuous offering, whether through the Initial Offering or Future Offerings. For this purpose, the Company does not consider a “public offering of equity securities” to include offerings on behalf of selling stockholders or offerings related to a distribution reinvestment plan, employee
benefit plan or the redemption of interests in the Company’s operating partnership. Participants in the Plan may also purchase fractional Shares so that 100% of the Distributions will be used to acquire Shares. However, a Participant will not be able to acquire Plan Shares to the extent that any such purchase would cause such Participant to exceed the Aggregate Share Ownership Limit or the Common Share Ownership Limit as set forth in the Charter or otherwise would cause a violation of the Share ownership restrictions set forth in the Charter.
Shares to be distributed by the Company in connection with the Plan may (but are not required to) be supplied from: (i) the Plan Shares which will be registered with the SEC in connection with the
Company’s Initial Offering; (ii) Shares to be registered with the SEC in a Future Offering for use in the Plan (a “Future Registration”); or (iii) Shares purchased by the Company for the Plan in a secondary market (if available) or on a stock exchange (if listed) (collectively, the “Secondary Market”).
Shares purchased in any Secondary Market will be purchased at the then-prevailing market price, which price will be utilized for purposes of issuing Shares in the Plan. Shares acquired by the Company in any Secondary Market or registered in a Future Registration for use in the Plan may be at prices lower or higher than the Share price which will be paid for the Plan Shares pursuant to the Initial Offering.
If the Company acquires Shares in any Secondary Market for use in the Plan, the Company shall use its reasonable efforts to acquire Shares at the lowest price then reasonably available. However, the Company does not in any respect guarantee or warrant that the Shares so acquired and purchased by the Participant in the Plan will be at the lowest possible price. Further, irrespective of the Company’s ability to acquire Shares in any Secondary Market or to make a Future Offering for Shares to be used in the Plan,
the Company is in no way obligated to do either, in its sole discretion.
5. Taxes. REINVESTMENT OF DISTRIBUTIONS DOES NOT RELIEVE A PARTICIPANT OF ANY INCOME TAX LIABILITY WHICH MAY BE PAYABLE ON THE DISTRIBUTIONS.
6. Share Certificates. The ownership of the Shares purchased through the Plan will be in book-entry form unless and until the Company issues certificates for its outstanding common stock.
7. Reports. Within 90 days after the end of the
Company’s fiscal year, the Company shall provide each Stockholder with an individualized report on such Stockholder’s investment, including the purchase date(s), purchase price and number of Shares owned, as well as the dates of Distributions and amounts of Distributions paid during the prior fiscal year. In addition, the Company shall provide to each Participant an individualized quarterly report at the time of each Distribution payment showing the number of Shares owned prior to the current Distribution, the amount of the current Distribution and the number of Shares owned after the current Distribution.
8. Termination by Participant. A Participant may terminate participation in the Plan at any
time, without penalty, by delivering to the Company a written notice. Prior to the listing of the Shares on a national stock exchange, any transfer of Shares by a Participant to a non-Participant will terminate participation in the Plan with respect to the transferred Shares. If a Participant terminates Plan participation, the Company will ensure that the terminating Participant’s account will reflect the whole number of shares in such Participant’s account and provide a check for the cash value of any fractional share in such account. Upon termination of Plan participation for any reason, Distributions will be distributed to the Stockholder in cash.
9. Amendment, Suspension or Termination of Plan by the
Company. The Board of Directors of the Company may by majority vote (including a majority of the Independent Directors) amend, suspend or terminate the Plan for any reason, except to eliminate a Participant’s ability to withdraw from the Plan, upon ten days written notice to the Participants.
10. Liability of the Company. The Company shall not be liable for any act done in good faith, or for any good faith omission to act, including, without limitation, any claims or liability (i) arising out of failure to terminate a Participant’s account upon such Participant’s death prior to receipt of
notice in writing of such death; or (ii) with respect to the time and the prices at which Shares are purchased or sold for a Participant’s account. To the extent that indemnification may apply to liabilities arising under the Securities Act of 1933, as amended, or the securities laws of a particular state, the Company has been advised that, in the opinion of the SEC and certain state securities commissioners, such indemnification is contrary to public policy and, therefore, unenforceable.
You should rely only on the information contained in this prospectus. No dealer, salesperson or other individual has been authorized to give any information or to make any representations that are not contained in this prospectus. If any such information or statements are given or made, you should not rely upon such information or representation. This prospectus does not constitute an offer to sell any securities other than those to which this prospectus relates, or an offer to sell, or a solicitation of an offer to buy, to
any person in any jurisdiction where such an offer or solicitation would be unlawful. This prospectus speaks as of the date set forth above. You should not assume that the delivery of this prospectus or that any sale made pursuant to this prospectus implies that the information contained in this prospectus will remain fully accurate and correct as of any time subsequent to the date of this prospectus.
This Supplement No. 11 supplements, and should be read in conjunction with, our prospectus dated April 30, 2014 and the additional information incorporated by reference herein and described under the heading “Incorporation of Certain Documents by Reference” in this Supplement No. 11. This
Supplement No. 11 supersedes and replaces all prior supplements to the prospectus. Defined terms used herein shall have the meaning ascribed to them in the prospectus, unless the context otherwise requires. The purpose of this Supplement No. 11 is to disclose:
•
the status of our initial public offering;
•
an update to the “Suitability Standards” section of our prospectus;
•
a
description of our investments;
•
information regarding our borrowings;
•
selected financial data;
•
our performance-funds from operations and modified funds from operations;
•
distributions
declared and paid;
•
compensation paid to our advisor and our dealer manager;
•
information regarding our share repurchase program;
•
information regarding our net tangible book value per share;
•
matters
relating to our advisory agreement;
•
an update to the "Conflicts of Interest" section of our prospectus;
•
an update to our risk factors;
•
an update to the biographical information of certain members of our board of directors;
We commenced our initial public offering of $1.65 billion in shares of common stock on May 6, 2013, of which
up to $1.5 billion in shares are being offered pursuant to our primary offering and up to $150 million in shares are being offered pursuant to our distribution reinvestment plan, or DRP. We refer to our primary offering and our DRP collectively as our offering.
As of October 23, 2014, we received and accepted subscriptions in our offering for 23.0 million shares, or $229.7 million, including 0.3 million shares, or $2.6 million, sold to an affiliate of NorthStar Realty Finance Corp., or NorthStar Realty. As of October 23, 2014, 142.7 million shares remained available for sale pursuant to our offering. Our primary offering is expected to terminate on May 6, 2015, unless extended by our board of directors as permitted under applicable law and regulations.
The following suitability standard is hereby added to the “Suitability Standards” section of our prospectus:
Pennsylvania—A Pennsylvania investor’s aggregate investment in our offering may not exceed 10% of the investor’s net worth.
Description of Our Investments
As of the date of this prospectus supplement, our portfolio consists of seven investments, including six senior mortgage loans with a combined principal amount of $347.0 million and one subordinate interest totaling $24.9 million.
The following table presents our investments
as of June 30, 2014, as adjusted for investment activity through October 23, 2014 (dollars in thousands):
Real estate debt investments:
Number
Principal Amount(1)
%
of Total
First mortgage loans
6
$
346,950,000
93.3
%
Subordinate interests
1
24,863,049
6.7
%
Total
real estate debt
7
$
371,813,049
100.0
%
___________________
(1) Includes future funding commitments of $12.0 million for first mortgage loans and $5.8 million for subordinate interests.
Debt
Investments Summary
The following table presents our debt investments as of June 30, 2014 (dollars in thousands):
Collateral Type
Location
Initial
Maturity Date
Principal
Amount
Spread over LIBOR(1)
Leveraged Current Yield
Loan- to- value(2)
Origination
Fee
Exit
Fee
First
Mortgage Loans
Hotel
Dallas, TX
Apr-16
$
75,000
5.1%
10.0%
82%
—
0.75%
Multifamily
Savannah,
GA
Sep-16
25,500
6.3%
10.4%
84%
1.0%
1.0%
Multifamily/Retail
Norfolk,
VA
Jun-17
39,200
5.4%
8.4%
85%
0.75%
1.0%
Multifamily
Atlanta,
GA
May-17
17,500
6.2%
18.4%
56%
1.0%
1.0%
Total/Weighted
Average
$
157,200
5.5%
10.1%
___________________
(1) Certain
loans are subject to a LIBOR floor. The weighted average LIBOR floor is 0.25%.
(2)
The loan-to-value ratio is the amount loaned by us, net of reserves funded and controlled by us and our affiliates, if any, over the appraised value of the property securing the loan at the time of origination.
The
following table presents our debt investments that we completed subsequent to June 30, 2014 through October 23, 2014 (dollars in thousands):
Collateral Type
Location
Initial
Maturity Date
Principal Amount
Spread over LIBOR(1)
Fixed Rate(2)
Leveraged Current Yield(3)
Loan- to- value/cost(4)
Origination Fee
Exit Fee
First
Mortgage Loans
Hotel
FL & PA
Aug-17
$
45,750
5.0%
NA
13.6%
62%
1.0%
0.75%
Office(5)
Woodbury,
NY
Oct-16
144,000
5.0%
NA
9.0%
84%
0.5%
1.0%
Subordinate
Interest
Multifamily(2)(6)
Nashville, TN
Jul-17
24,863
—%
14.0%
14.2%
85%
1.0%
1.0%
Total/Weighted
Average
$
214,613
5.0%
14.0%
10.8%
___________________
(1)
Certain
loans are subject to a LIBOR floor. The weighted average LIBOR floor is 0.21%.
(2)
Represents the interest rate for our subordinate interest investment, which includes a 13.0% current pay rate and a 1.0% interest accrual rate.
(3) Represents the unleveraged yield, if applicable.
(4)
The loan-to-value ratio is the amount loaned by us, net of reserves funded and controlled by us and our affiliates, if any, over the appraised value of the property securing the loan at the time
of origination. For development properties, we calculate loan-to-cost as the amount loaned by us, including any senior debt, over the total cost expected to complete the property.
(5)
Includes future funding commitments of $12.0 million.
(6)
Includes future funding commitments of $5.8 million.
Recent Investments
Hotel Portfolio Loan
On
August 7, 2014, we, through a subsidiary of our operating partnership, originated a $45.75 million senior loan, or the senior loan, secured by a portfolio of three full-service hotel properties located in Pennsylvania and Florida, or the properties. We funded the senior loan with proceeds from our offering.
The properties contain a total of 680 rooms and over 26,000 square feet of combined meeting space. The borrower is an experienced owner of hotel assets and has invested a total of $17.3 million in the properties over the past 18 months. The borrower plans to make additional capital improvements using proceeds from the senior loan held in an upfront reserve controlled by us.
The senior loan bears interest at a floating rate of 5.00% over the one-month London Interbank Offered Rate, or LIBOR, but at no point shall LIBOR be less than
0.25%, resulting in a minimum interest rate of 5.25% per year. The senior loan was originated at a 1.00% discount and we will earn an exit fee equal to 0.75% of the outstanding amount of the senior loan at the time of repayment. Subsequent to closing, we financed the senior loan on one of our secured credit facilities.
The initial term of the senior loan is 36 months, with two one-year extension options available to the borrower, subject to the satisfaction of certain performance tests and the payment of a fee equal to 0.25% of the amount being extended for the first one-year extension and 0.50% of the amount being extended for the second one-year extension. The senior loan may be prepaid during the first 18 months, provided the borrower pays an additional amount equal to the remaining interest due on the amount prepaid through month 18. Thereafter, the senior loan may be prepaid in whole or in part without penalty.
The
loan-to-value ratio, or LTV ratio, of the senior loan is approximately 62%. The LTV ratio is the amount loaned to the borrower net of reserves funded and controlled by us and our affiliates, if any, over the appraised value of the properties at the time of origination.
Long Island Portfolio Loan
On September 30, 2014, we, through a subsidiary of our operating partnership, originated a $144.0 million senior loan, or the Woodbury senior loan, secured by a portfolio of 28 commercial properties located in Woodbury, New York, or the portfolio. We initially funded $132.0 million of the Woodbury senior loan with a combination of proceeds from our offering and an
advance under one of our secured credit facilities. We intend to fund the remaining $12.0 million over the next 24 months, which additional amounts may be financed on our credit facility in the lender’s discretion.
The borrower is an affiliate of an institutional real estate fund managed by RXR Realty LLC, a leading real estate owner, manager and developer in the New York metropolitan area with approximately $7.5 billion of assets under management encompassing approximately 18.3 million square feet as of June 30, 2014. The portfolio contains over 1.4 million square feet, consisting predominantly of Class A and B office space, which is currently leased to more than 150 tenants. The borrower plans to fund tenant improvements, leasing commissions and capital investments
to the portfolio using proceeds from the Woodbury senior loan, cash flow after the payment of debt service on the Woodbury senior loan and any excess sales proceeds in connection with property sale releases as further described below.
The Woodbury senior loan bears interest at a floating rate of 5.0% over one-month LIBOR, but at no point shall LIBOR be less than 0.20%, resulting in a minimum interest rate of 5.20% per year. The Woodbury senior loan was originated at a 0.50% discount and we will earn an exit fee equal to 1.00% of the outstanding amount of the loan at the time of repayment.
The initial term of the Woodbury senior loan is 24 months, or the initial term, with a two-year extension option and a subsequent one-year extension option available to the borrower, subject to the satisfaction of certain performance tests and the payment of a fee equal to 0.25% of the amount being
extended for the second extension option. During the initial term, the borrower may prepay up to 30.0% of the Woodbury senior loan without penalty in connection with the partial sale or other release of underlying collateral based on predetermined release pricing. Additional prepayments are permitted provided the borrower pays an additional amount equal to the remaining interest margin due on the amount prepaid through month 36. The LTV ratio of the senior loan is approximately 84% on a portfolio basis.
Information Regarding our Debt Investments
In general, the underlying loan documentation for our debt investments requires our borrowers to comply with various financial and other covenants. In addition, these agreements contain customary events of default (subject to certain materiality thresholds and grace and cure periods). The events of default are standard
for agreements of this type and include, for example, payment and covenant breaches, insolvency of the borrower, the occurrence of an event of default relating to the collateral or a change in control of the borrower.
Information Regarding Our Borrowings
Summary
As of June 30, 2014, we had $94.2 million of borrowings outstanding under our credit facility with Citibank, N.A., or the Citibank facility. As of October 23, 2014, we had $207.7 million of borrowings outstanding, including borrowings under both the Citibank facility and the DB facility (defined below).
Credit Facilities
Citibank
Facility
On October 15, 2013, we, through a subsidiary of our operating partnership, entered into the Citibank facility, which provides up to $100.0 million to finance first mortgage loans and senior loan participations secured by commercial real estate, as described in more detail in the Citibank facility documentation.
As of June 30, 2014, we had $94.2 million of borrowings outstanding under the Citibank facility. Through October 23, 2014, there had been no changes to the borrowings outstanding under the Citibank facility.
Deutsche Bank Facility
On
July 2, 2014, we, through a subsidiary of our operating partnership, entered into a master repurchase agreement, or the DB facility, with Deutsche Bank, AG, or Deutsche Bank, to provide up to $100.0 million to finance first mortgage loans and senior loan participations secured by commercial real estate, as described in more detail in the DB facility documentation. On September 25, 2014, we amended the terms of the DB facility, increasing the total potential borrowing capacity under the DB facility from $100.0 million to up to $200.0 million. All other terms governing the DB facility remain substantially the same.
As of October 23, 2014, we had $113.5 million borrowings outstanding under the DB facility.
The information below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes, each included in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2014 and our Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated by reference into this prospectus supplement.
The historical operating and balance sheet data as of and for the six months ended June
30, 2014 was derived from the unaudited consolidated financial statements included in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2014, which is incorporated herein by reference. The historical operating and balance sheet data as of December 31, 2013 and 2012 and for the year ended December 31, 2013 was derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013, which is incorporated herein by reference.
Our Performance-Funds from Operations
and Modified Funds from Operations
The following disclosure supersedes the prior disclosure under the heading “Description of Capital Stock—Funds from Operations and Modified Funds from Operations.” For additional information regarding our advisor, see the section entitled “Matters Relating to Our Advisory Agreement” in this prospectus supplement.
We believe that funds from operations, or FFO, and modified funds from operations, or MFFO, both of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and of us in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income (loss) (computed in accordance with U.S. generally accepted accounting principles, or U.S. GAAP), excluding
gains (losses) from sales of depreciable property, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, impairment on depreciable property owned directly or indirectly and after adjustments for unconsolidated ventures.
Changes in the accounting and reporting rules under U.S. GAAP that have been put into effect since the establishment of
NAREIT’s
definition of FFO have prompted an increase in the non-cash and non-operating items included in FFO. For instance, the accounting treatment for acquisition fees related to business combinations has changed from being capitalized to being expensed. Additionally, publicly registered, non-traded REITs are typically different from traded REITs because they generally have a limited life followed by a liquidity event or other targeted exit strategy. Non-traded REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation as compared to later years when the proceeds from their initial public offering have been fully invested and when they may seek to implement a liquidity event or other exit strategy. However, it is likely that we will make investments past the acquisition and development stage, albeit at a substantially lower pace.
Acquisition
fees paid to our advisor in connection with the origination and acquisition of debt investments are amortized over the life of the investment as an adjustment to interest income under U.S. GAAP and are therefore, included in the computation of net income (loss) and income (loss) from operations, both of which are performance measures under U.S. GAAP. Such acquisition fees are paid in cash that would otherwise be available to distribute to our stockholders. In the event that proceeds from our offering are not sufficient to fund the payment or reimbursement of acquisition fees and expenses to our advisor, such fees would be paid from other sources, including new financing, operating cash flow, net proceeds from the sale of investments or from other cash flow. We believe that acquisition fees incurred by us negatively impact our operating performance during the period in which such investments are originated or acquired by reducing cash flow and
therefore the potential distributions to our stockholders. However, in general, we earn origination fees for debt investments from our borrowers in an amount equal to the acquisition fees paid to our advisor, and as a result, the impact of acquisition fees to our operating performance and cash flow would be minimal.
The origination and acquisition of debt investments and the corresponding acquisition fees paid to our advisor (and any offsetting origination fees received from our borrowers) associated with such activity is a key operating feature of our business plan that results in generating income and cash flow in order to make distributions to our stockholders. Therefore, the exclusion for acquisition fees may be of limited value in calculating operating performance because acquisition fees affect our overall long-term operating performance and may be recurring in nature as part of net income (loss)
and income (loss) from operations over our life.
Due to certain of the unique features of publicly-registered, non-traded REITs, the Investment Program Association, or the IPA, an industry trade group, standardized a performance measure known as MFFO and recommends the use of MFFO for such REITs. Management believes MFFO is a useful performance measure to evaluate our business and further believes it is important to disclose MFFO in order to be consistent with the IPA recommendation and other non-traded REITs. MFFO that adjusts for items such as acquisition fees would only be comparable to non-traded REITs that have completed the majority of their acquisition activity and have other similar operating characteristics as us. Neither the Securities and Exchange Commission, or the SEC, nor any other regulatory body has approved the acceptability of the adjustments that we use to
calculate MFFO. In the future, the SEC or another regulatory body may decide to standardize permitted adjustments across the non-listed REIT industry and we may need to adjust our calculation and characterization of MFFO.
MFFO is a metric used by management to evaluate our future operating performance once our organization and offering and acquisition and development stages are complete and is not intended to be used as a liquidity measure. Although management uses the MFFO metric to evaluate future operating performance, this metric excludes certain key operating items and other adjustments that may affect our overall operating performance. MFFO is not equivalent to net income (loss) as determined under U.S. GAAP. In addition, MFFO is not a useful measure in evaluating net asset value, since an impairment is taken into account in determining net asset value but not in determining MFFO.
We
define MFFO in accordance with the concepts established by the IPA and adjust for certain items, such as accretion of a discount and amortization of a premium on borrowings and related deferred financing costs, as such adjustments are comparable to adjustments for debt investments and will be helpful in assessing our operating performance. Our computation of MFFO may not be comparable to other REITs that do not calculate MFFO using the same method. MFFO is calculated using FFO. We compute FFO in accordance with the standards established by NAREIT, as net income or loss (computed in accordance with U.S. GAAP), excluding gains or losses from sales of depreciable properties, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, impairment charges on depreciable property owned directly or indirectly and after adjustments for unconsolidated/ uncombined partnerships and joint ventures. FFO, as defined by NAREIT, is
a computation made by analysts and investors to measure a real estate company’s cash flow generated by operations. MFFO excludes from FFO the following items:
•
acquisition fees and expenses; non-cash amounts related to straight-line rent and the amortization of above or below market and in-place intangible lease assets and liabilities (which are adjusted in order to reflect such payments from an accrual basis of accounting under U.S. GAAP to a cash
•amortization of a premium and accretion of a discount on debt investments;
•non-recurring impairment of real estate-related investments;
•
realized gains (losses) from the early extinguishment of debt; realized gains (losses) on the extinguishment or sales of hedges, foreign exchange, securities and other derivative holdings except where the trading of such instruments is a fundamental attribute of our business;
•
unrealized
gains (losses) from fair value adjustments on real estate securities, including CMBS and other securities, interest rate swaps and other derivatives not deemed hedges and foreign exchange holdings;
•
unrealized gains (losses) from the consolidation from, or deconsolidation to, equity accounting;
•
adjustments related to contingent purchase price obligations; and
•
adjustments
for consolidated and unconsolidated partnerships and joint ventures calculated to reflect MFFO on the same basis as above.
Certain of the above adjustments are also made to reconcile net income (loss) to net cash provided by (used in) operating activities, such as for the amortization of a premium and accretion of a discount on debt and securities investments, amortization of fees, any unrealized gains (losses) on derivatives, securities or other investments, as well as other adjustments.
MFFO excludes non-recurring impairment of real estate-related investments. We assess the credit quality of our investments and adequacy of reserves/impairment on a quarterly basis, or more frequently as necessary. Significant judgment is required in this analysis. With respect to debt investments, we consider the estimated net recoverable value of the loan as well as other factors,
including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive situation of the region where the borrower does business. Fair value is typically estimated based on discounting the expected future cash flow of the underlying collateral taking into consideration the discount rate, capitalization rate, occupancy, creditworthiness of major tenants and many other factors. This requires significant judgment and because it is based on projections of future economic events, which are inherently subjective, the amount ultimately realized may differ materially from the carrying value as of the balance sheet date. A property’s value is considered impaired if our estimate of the aggregate future undiscounted cash flow to be generated by the property is less than the carrying value of the property. If the estimated fair value of the underlying collateral for the
debt investment is less than its net carrying value, a loan loss reserve is recorded with a corresponding charge to provision for loan losses. With respect to a real estate investment, a property’s value is considered impaired if our estimate of the aggregate future undiscounted cash flow to be generated by the property is less than the carrying value of the property. The value of our investments may be impaired and their carrying values may not be recoverable due to our limited life. Investors should note that while impairment charges are excluded from the calculation of MFFO, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flow and the relatively limited term of a non-traded REIT’s anticipated operations, it could be difficult to recover any impairment charges through operational net revenues or cash flow prior to any liquidity event.
We believe that MFFO is
a useful non-GAAP measure for non-traded REITs. It is helpful to management and stockholders in assessing our future operating performance once our organization and offering, and acquisition and development stages are complete, because it eliminates from net income non-cash fair value adjustments on our real estate securities and acquisition fees and expenses that are incurred as part of our investment activities. However, MFFO may not be a useful measure of our operating performance or as a comparable measure to other typical non-traded REITs if we do not continue to operate in a similar manner to other non-traded REITs, including if we were to extend our acquisition and development stage or if we determined not to pursue an exit strategy.
However, MFFO does have certain limitations. For instance, the effect of any amortization or accretion on investments originated or acquired at a premium or discount,
respectively, is not reported in MFFO. In addition, realized gains (losses) from acquisitions and dispositions and other adjustments listed above are not reported in MFFO, even though such realized gains (losses) and other adjustments could affect our operating performance and cash available for distribution. Stockholders should note that any cash gains generated from the sale of investments would generally be used to fund new investments. Any mark-to-market or fair value adjustments may be based on many factors, including current operational or individual property issues or general market or overall industry conditions.
Neither FFO nor MFFO is equivalent to net income (loss) or cash flow provided by operating activities determined in accordance with U.S. GAAP and should not be construed to be more relevant or accurate than the U.S. GAAP methodology in evaluating our operating performance. Neither FFO nor MFFO is necessarily indicative of cash flow available to fund our cash needs including our ability to make distributions to our stockholders. FFO and MFFO do not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Furthermore, neither FFO nor MFFO should be considered as an alternative to net income (loss) as an indicator of our operating performance.
The following table presents a reconciliation of
FFO and MFFO to net income (loss) attributable to common stockholders for the six months ended June 30, 2014:
Net
income (loss) attributable to NorthStar Real Estate Income II, Inc. common stockholders
$
435,351
Funds from operations
435,351
Modified Funds from operations:
Funds
from operations
$
435,351
Adjustments:
Amortization of premiums, discounts and fees on investments and borrowings, net
138,935
Modified funds from operations
$
574,286
Distributions
Declared and Paid
We generally pay distributions on a monthly basis based on daily record dates. We declared distributions for the period from September 18, 2013 (the date of our first investment) through June 30, 2014 of $2.9 million, of which $1.3 million was reinvested in our DRP. For such period, we paid distributions at an annualized distribution rate of 7.0% based on a purchase price of $10.00 per share of our common stock. Distributions are generally paid to stockholders on the first day of the month following the month for which the distribution has accrued.
Represents
distributions declared for such period, even though such distributions are actually paid to stockholders the month following such period.
The distributions paid in excess of our cash flow from operations for the period from September 18, 2013 through June 30, 2014 were paid using offering proceeds, including the purchase of additional shares by NorthStar Realty under our distribution support agreement. Over the long-term, we expect that our distributions will be paid entirely from cash flow provided by operations. However, our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including our ability to raise and invest capital at favorable yields, the financial performance of our
investments in the current real estate and financial environment, the type and mix of our investments and accounting of our investments in accordance with U.S. GAAP. As a result, future distributions declared and paid may exceed cash flow provided
by operations. To the extent distributions are paid from sources other than FFO, the ownership interests of our stockholders will be diluted.
Pursuant
to our distribution support agreement, in certain circumstances where our cash distributions exceed our MFFO, NorthStar Realty committed to purchase up to an aggregate of $10.0 million in shares of our common stock at a price of $9.00 per share to provide additional funds to support distributions to stockholders. On September 18, 2013, NorthStar Realty purchased 222,223 shares of our common stock for $2.0 million under the distribution support agreement to satisfy the minimum offering requirement, which reduced the total commitment.
The following table summarizes shares purchased by NorthStar Realty pursuant to our distribution support agreement:
Under the distribution support agreement, shares of our common stock are purchased at a price of $9.00 per share.
(2)
Subsequent
to June 30 2014, on August 5, 2014, NorthStar Realty purchased 37,797 shares under our distribution support agreement related to the second quarter 2014.
Compensation Paid to Our Advisor and Our Dealer Manager
In connection with the completion of NorthStar Realty’s spin-off of its asset management business into NSAM (as defined in this prospectus supplement), on June 30, 2014, we entered into a new advisory agreement with an affiliate of NSAM and terminated our advisory agreement with our prior advisor, NS Real Estate Income Advisor II, LLC. The information below regarding fees and reimbursements incurred and accrued but not yet paid to our advisor reflect such fees
and reimbursements incurred and accrued but not yet paid to our prior advisor for the periods presented. For additional information regarding our advisor, see the section entitled “Matters Relating to Our Advisory Agreement” in this prospectus supplement.
The following table presents the fees and reimbursements incurred to our advisor and NorthStar Realty Securities, LLC, or our dealer manager, for the six months ended June 30, 2014 and year ended December 31, 2013:
Acquisition/disposition
fees incurred to our advisor related to debt investments are generally offset by origination/exit fees paid to us by borrowers if such fees are required from the borrower. Our advisor may determine to defer fees or seek reimbursement.
As of June 30, 2014, the aggregate amount of fees and reimbursements accrued but not yet paid to our advisor was $3.7 million, representing primarily operating expenses.
Information Regarding Our Share Repurchase Program
We adopted a share repurchase program that may enable stockholders to sell their shares to us in limited circumstances. We are not obligated to repurchase shares pursuant to this program. No stockholder is eligible to participate in the share repurchase program (other than with respect to requests made as a result of death or qualifying disability) until the stockholder has held our shares for at least one year. Our board of directors may amend, suspend or terminate our share repurchase program at any time, subject to certain notice requirements. For the six months ended June 30, 2014 and the year ended December 31, 2013, we did not repurchase
any shares pursuant to the Share Repurchase Program. As of June 30, 2014, there were no unfulfilled repurchase requests.
Information Regarding Our Net Tangible Book Value Per Share
The offering price in our offering is higher than the net tangible book value per share of our common stock as of June 30, 2014. Net tangible book value per share is calculated including tangible assets but excluding intangible assets such as deferred costs or goodwill and any other asset that cannot be sold separately from all other assets of the business as well as intangible assets for which recovery of book value is subject to significant uncertainty or illiquidity, less liabilities and is a non-GAAP measure. There are no rules or
authoritative guidelines that define net tangible book value; however, it is generally used as a conservative measure of net worth, approximating liquidation value. Our net tangible book value reflects dilution in value of our common stock from the issue price as a result of: (i) the substantial fees paid in connection with our initial public offering, including selling commissions and dealer manager fees paid to our dealer manager; and (ii) the fees and expenses paid to our advisor in connection with the selection, origination, acquisition and sale of our investments and the management of our company.
As of June 30, 2014, our net tangible book value per share was $8.53, compared with our primary offering price per share of $10.00 (excluding purchase price discounts for certain categories
of purchasers) and our DRP price per share of $9.50. Our offering price was not established on an independent basis and bears no relationship to the net value of our assets. Although we do not believe net tangible book value is an indication of the value of our shares, if we were to liquidate our assets at this time, you would likely receive less than the purchase price for your shares due to the factors described above with respect to the dilution in value of our common stock.
Further, investors who purchase shares in our offering may experience further dilution of their equity investment in the event that we sell additional common shares in the future, if we sell securities that are convertible into common shares or if we issue shares upon the exercise of options, warrants or other rights.
Matters Relating to Our Advisory Agreement
On
June 30, 2014, NorthStar Realty completed the previously announced spin-off, or the spin-off, of its asset management business into NSAM, a separate public company with its shares of common stock listed on the New York Stock Exchange under the ticker symbol “NSAM”.
Following the completion of the spin-off and the related events described below, NSAM now owns and operates NorthStar Realty’s asset management business and NSAM and its affiliates sponsor and manage the public, non-traded REITs previously sponsored and managed by NorthStar Realty, including us, NorthStar Real Estate Income Trust, Inc., NorthStar Healthcare Income, Inc., which we collectively refer to as the Managed Companies, and any other companies that NSAM may sponsor in the future.
In connection with the spin-off, on June
30, 2014, we, our operating partnership, NSAM and NSAM J-NSII Ltd, a subsidiary of NSAM, or our new advisor, entered into a new advisory agreement, or our new advisory agreement, pursuant to which our new advisor manages our day-to-day activities and implements our investment strategy. The appointment of our new advisor and the entry into the new advisory agreement were approved by our board of directors, including our independent directors.
Upon completion of the spin-off, the existing employees of NorthStar Realty became employees of NSAM, certain of which, including executive officers, employees engaged in NorthStar Realty’s existing loan origination business and certain other employees, became co-employees of NSAM and NorthStar Realty. As a result, we have access to the same personnel and resources that we had prior to the spin-off.
The terms of the new advisory agreement
are substantially the same as those that were in effect prior to the spin-off under our prior advisory agreement, a description of which is included in the section entitled “Management—The Advisory Agreement” in our prospectus.
In connection with the spin-off, on June 30, 2014, we provided notice to our prior advisor and NorthStar Realty of the termination without cause of our
prior advisory agreement. Our prior advisor and NorthStar Realty waived the notice period provided for in our prior advisory agreement and consequently, our prior advisor ceased all activities under our prior advisory agreement effective upon completion of the spin-off.
In connection with the termination of our prior advisory agreement, we, our prior advisor and NorthStar OP Holdings II, LLC, all of which are parties to the limited partnership agreement of our operating partnership, or our operating partnership agreement, agreed that such termination did not constitute a termination event (as defined in our operating partnership agreement) and did not trigger the redemption of the special limited partnership units (as defined in our operating partnership agreement) pursuant to our operating partnership agreement. In addition, the parties to our operating partnership agreement agreed that the term “Advisory Agreement”
in our operating partnership agreement shall mean our new advisory agreement. On June 30, 2014, the parties to our operating partnership agreement entered into an amendment to our operating partnership agreement reflecting the foregoing.
Update to Conflicts of Interest
The “Conflicts of Interest—Certain Conflict Resolution Measures—Allocation of Investment Opportunities” section of our prospectus is hereby superseded and replaced in its entirety by the following:
Allocation of Investment Opportunities. We rely on our sponsor’s investment professionals to identify suitable investment opportunities for our company as well as
the other Managed Companies. Our investment strategy may be similar to that of, and may overlap with, the investment strategies of the other Managed Companies. Therefore, many investment opportunities that are suitable for us may also be suitable for other Managed Companies.
Our advisor and its affiliated advisers and sub-advisers, which we refer to collectively as the NSAM Group, will allocate, in its sole discretion, all investment opportunities to one or more of the Managed Companies, including us, or our sponsor, for which the investment opportunity is most suitable. When determining the entity for which an investment opportunity would be the most suitable, the factors that the NSAM Group may consider include, without limitation, the following:
•
investment
objectives, strategy and criteria;
•
cash requirements;
•
effect of the investment on the diversification of the portfolio, including by geography, size of investment, type of investment and risk of investment;
•
leverage policy and the availability of financing for the investment by each entity;
•
anticipated
cash flow of the asset to be acquired;
•
income tax effects of the purchase;
•
the size of the investment;
•
the amount of funds available;
•
cost
of capital;
•
risk-return profiles;
•
targeted distribution rates;
•
anticipated future pipeline of suitable investments;
•
the
expected holding period of the investment and the remaining term of the Managed Company, if applicable; and
•
affiliate and/or related party considerations.
If, after consideration of the relevant factors, the NSAM Group determines that an investment is equally suitable for more than one company, the investment will be allocated on a rotating basis. If, after an investment has been allocated to a particular company, including us, a subsequent event or development, such as delays in structuring or closing on the investment, makes it,
in the opinion of the NSAM Group, more appropriate for a different entity to fund the investment, the NSAM Group may determine to place the investment with the more appropriate entity while still giving credit to the original allocation. In certain situations, the NSAM Group may determine to allow more than one Managed Company, including us, and our sponsor to co-invest in a particular investment. In discharging its duties under this allocation policy, the NSAM Group endeavors to allocate investment opportunities among the Managed Companies and our sponsor in a manner that is fair and equitable over time.
While these are the current procedures for allocating investment opportunities, the NSAM Group may sponsor additional investment vehicles in the future and, in connection with the creation of such investment
vehicles or otherwise, the NSAM Group may revise this allocation policy. The result of such a revision to the allocation policy may, among other things, be to increase the number of parties who have the right to participate in investment opportunities sourced by the NSAM Group, thereby reducing the number of investment opportunities available to us. Changes to the allocation policy that could adversely impact the allocation of investment opportunities to us in any material respect may be proposed by the NSAM Group and must be approved by our board of directors. In the event that the NSAM Group adopts a revised allocation policy that materially impacts our business, we will disclose this information in the reports we file publicly with the SEC, as appropriate.
The decision of how any potential investment should be allocated among us and other Managed Companies for which such investment may be most suitable may, in many cases,
be a matter of highly subjective judgment which will be made by the NSAM Group in its sole discretion.
Our right to participate in the investment allocation process described herein will terminate once we are no longer advised by our advisor or an affiliate of the NSAM Group. Our advisor is required to inform our board of directors at least annually of the investments that have been allocated to us and other Managed Companies so that our board of directors can evaluate whether we are receiving our fair share of opportunities. Based on the information provided, our board of directors (including our independent directors) has a duty to determine that the investment allocation policy is being applied fairly to us. The NSAM Group’s success in generating investment opportunities for us and the fair allocation of opportunities among us and other Managed Companies are important factors in our board of directors’ determination to
continue our arrangements with our advisor.
Update to Our Risk Factors
The paragraph under the heading “Risk Factors—Risks Related to Our Company—If we pay distributions from sources other than our cash flow from operations, we will have less cash available for investments and your overall return may be reduced.” is superseded in its entirety as follows:
Our organizational documents permit us to pay distributions from any source, including offering proceeds, borrowings or sales of assets. We have not established a limit on the amount of proceeds we may use to fund distributions. We have funded our cash distributions paid to date using net proceeds from our offering and we may do so in the future.
Until the proceeds from our offering are fully invested and otherwise during the course of our existence, we may not generate sufficient cash flow from operations to fund distributions. We began generating cash flow from operations on September 18, 2013, the date of our first investment. For the period from September 18, 2013 through June 30, 2014, we declared distributions of $2.9 million, compared to cash flow used in operations of $1.0 million. The distributions were paid using proceeds from our offering, including the purchase of additional shares by NorthStar Realty under our distribution support agreement.
Pursuant to a distribution support agreement, in certain circumstances where our cash distributions exceed our MFFO, NorthStar Realty agreed to
purchase up to $10.0 million of shares of our common stock at $9.00 per share (which includes the $2.0 million of shares purchased by NorthStar Realty to satisfy the minimum offering amount) to provide additional cash to support distributions to stockholders and has, in fact, purchased 247,714 shares of our common stock as of June 30, 2014. The sale of these shares resulted in the dilution of the ownership interests of our stockholders. Upon termination or expiration of the distribution support agreement, we may not have sufficient cash available to pay distributions at the rate we had paid during preceding periods or at all. If we pay distributions from sources other than our cash flow from operations, we will have less cash available for investments, we may have to reduce our distribution rate, our net asset value may be negatively impacted and stockholders’ overall return may be reduced.
An
Update to the Biographical Information of Certain Members of Our Board of Directors
The biographical information regarding Charles W. Schoenherr included under the heading “Management-Directors and Executive Officers-Independent Directors” is superseded in its entirety as follows:
Charles W. Schoenherr is one of our independent directors and a member of our audit committee. Mr. Schoenherr also serves as a director of NorthStar Income and as a member of its audit committee, a position he has held since January 2010.
Mr. Schoenherr has also served as a member of the board of directors of NorthStar Realty, chairman of its compensation committee and as a member of each of its audit committee and nominating and corporate governance committee since June 2014. Mr. Schoenherr serves as Managing Director of Waypoint Residential which invests in multifamily properties in the Sunbelt. He has served in this capacity since October 2011 and is responsible for sourcing acquisition opportunities and raising capital. From January 2011 through December 2013, Mr. Schoenherr served as Chief Investment Officer of Broadway Partners Fund Manager, LLC, a private real estate investment and management firm that invests in office buildings across the United States. From June 2009 until January 2011, Mr. Schoenherr served as President of Scout
Real Estate Capital, LLC, a full service real estate firm that focuses on acquiring, developing and operating hospitality assets, where he was responsible for managing the company’s properties and originating new acquisition and asset management opportunities. Prior to joining Scout Real Estate Capital, LLC, Mr. Schoenherr was the managing partner of Elevation Capital, LLC, where he advised real estate clients on debt and equity restructuring and performed due diligence and valuation analysis on new acquisitions between November 2008 and June 2009. Between September 1997 and October 2008, Mr. Schoenherr served as Senior Vice President and Managing Director of Lehman Brothers’ Global Real Estate Group, where he was responsible for originating debt, mezzanine and equity transactions on all major property types throughout the United States. During his career he has also held senior management
positions with GE Capital Corporation, GE Investments, Inc. and KPMG LLP, where he also practiced as a certified public accountant. Mr. Schoenherr currently serves on the Board of Trustees of Iona College and is on its Real Estate and Investment Committees. Mr. Schoenherr holds a Bachelor of Business Administration in Accounting from Iona College in New Rochelle, New York and a Master of Business Administration in Finance from the University of Connecticut in Stamford, Connecticut.
We believe that Mr. Schoenherr’s knowledge of the real estate investment and finance industries, including extensive experience originating debt, mezzanine and equity transactions, supports his appointment to our board of directors.
Experts
The audited consolidated financial statements and schedule incorporated by
reference in this prospectus supplement have been so incorporated by reference in reliance upon the report of Grant Thornton LLP, independent registered public accountants upon the authority of said firm as experts in accounting and auditing.
Incorporation of Certain Documents by Reference
We have elected to “incorporate by reference” certain information into this prospectus supplement. By incorporating by reference, we are disclosing important information to you by referring you to documents we have filed separately with the SEC. The information incorporated by reference is deemed to be part of this prospectus supplement, except for information incorporated
by reference that is superseded by information contained in this prospectus supplement. You can access documents that are incorporated by reference into this prospectus supplement on our website at www.northstarreit.com/income2. There is additional information about us and our advisor and its affiliates on our website, but unless specifically incorporated by reference herein as described in the paragraphs below, the contents of our website
are not incorporated by reference in or otherwise a part of this prospectus supplement.
The following documents filed with the SEC are incorporated by reference in this prospectus supplement, except for any document or portion thereof deemed to be “furnished” and not filed in accordance with SEC rules:
We will provide to each person to whom this prospectus supplement is delivered, upon request, a copy of any or all of the information that we have incorporated by reference into this prospectus supplement but not delivered with this prospectus supplement. To receive a free copy of any of the documents incorporated by reference in this prospectus supplement, other than exhibits, unless they are specifically incorporated by reference in those documents, call or write us at:
The information relating to us contained in this prospectus supplement does not purport to be
comprehensive and should be read together with the information contained in the documents incorporated or deemed to be incorporated by reference in this prospectus supplement.
Current Form of Subscription Agreement
Our current form of subscription agreement is attached to this prospectus supplement as Exhibit A. This form supersedes and replaces the form included in the prospectus.
Item 31. Other Expenses of Issuance and Distribution.
The following table sets forth the costs and expenses payable by us in connection with the distribution of the securities being registered, other than selling commissions and dealer manager fees. All amounts are estimated except the SEC registration fee and the FINRA filing fee.
Amount
SEC registration fee
$
225,060
FINRA filing fee
$
225,500
Accounting fees and expenses
$
2,249,400
Legal
fees and expenses
$
5,000,000
Sales and advertising expenses
$
4,600,040
Blue Sky fees and expenses
$
500,000
Printing
expenses
$
4,700,000
Bona fide due diligence
$
2,250,000
Transfer agent fees and administrative expenses
$
5,000,000
Total
$
24,750,000
Item 32. Sales to Special Parties.
Not Applicable.
Item 33. Recent Sales of Unregistered Securities.
On September 18, 2013 and June 19, 2014, pursuant to our independent directors’ compensation plan, we granted 5,000 and 2,500 restricted shares of our common stock, respectively, to each of our three
independent directors pursuant to our independent directors’ compensation plan in private placement transactions exempt from registration pursuant to Section 4(a)(2) of the Securities Act. All shares were issued at $9.00 per share and will generally vest over four years; provided, however, that the restricted stock will become fully vested on the earlier occurrence of: (i) the termination of the independent director’s service as a director due to his or her death or disability; or (ii) a change in our control.
On December 18, 2012, we issued 22,223 shares of common stock at $9.00 per share to NorthStar Realty Finance Corp., in exchange for $200,007 in cash, in a private placement transaction exempt from registration pursuant to Section 4(a)(2) of the Securities Act. NorthStar Realty Finance Corp., our sponsor at the time of the transaction, had access to information concerning
our proposed operations and the terms and conditions of this investment.
Item 34. Indemnification of Directors and Officers.
Subject to certain limitations, our charter limits the personal liability of our directors and officers to us and our stockholders for monetary damages. Our charter also provides that we will generally indemnify our directors, our officers, our advisor and its affiliates for losses they may incur by reason of their service in those capacities and pay or reimburse their reasonable expenses in advance of final disposition of a proceeding.
The Maryland General Corporation Law, or the MGCL, permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation
and its stockholders for money damages except for liability resulting from: (i) actual receipt of an improper benefit or profit in money, property or services; or (ii) active and deliberate dishonesty established by a final judgment and which is material to the cause of action. In addition, the MGCL requires a Maryland corporation (unless its charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made or threatened to be made a party by reason of his or her service in that capacity and allows directors and officers to be indemnified against judgments, penalties, fines, settlements and reasonable expenses actually incurred in connection with a proceeding unless the following can be established: (i) an act
or omission of the director or officer was material to the matter giving rise to the proceedings and was committed in bad faith or was the result of active and deliberate dishonesty; (ii) the director or officer actually received an improper personal benefit in money, property or services; or (iii) with respect to any criminal proceeding, the director or officer had reasonable cause to believe his act or omission was unlawful.
Under the MGCL, a court may order indemnification if it determines that the director or officer is fairly and reasonably entitled to indemnification, even though the director or officer did not meet the prescribed standard of conduct or was adjudged liable on the basis that personal benefit was improperly received. However, indemnification for an adverse judgment in a suit by the corporation
or in its right, or for a judgment of liability on the basis that personal benefit was improperly received, is limited to expenses.
The MGCL permits a corporation to advance reasonable expenses to a director or officer upon receipt of a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification and a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed if it is ultimately determined that the standard of conduct was not met.
However, our charter provides that we will not indemnify a director, the advisor or an affiliate of the advisor for any liability or loss suffered by such indemnitee or hold such indemnitee harmless for any liability or loss suffered by us unless all of the following conditions are met: (i) the indemnitee has determined,
in good faith, that the course of conduct that caused the loss or liability was in our best interests; (ii) the indemnitee was acting on our behalf of performing services for us; (iii) the loss or liability was not the result of negligence or misconduct if the indemnitee is an affiliated director, the advisor or an affiliate of the advisor; or if the indemnitee is an independent director, the loss or liability was not the result of gross negligence or willful misconduct; or (iv) the indemnification or agreement to hold harmless is recoverable only out of our net assets and not from our stockholders.
In addition, we will not provide indemnification to a director, the advisor or an affiliate of the advisor for any loss or liability arising from an alleged violation of federal or state securities laws unless one or more of the following conditions are met: (i) there has been a successful adjudication on the merits of each count
involving alleged securities law violation as to the particular indemnitee; (ii) such claims have been dismissed with prejudice on the merits by a court of competent jurisdiction as to the particular indemnitee; or (iii) a court of competent jurisdiction approves a settlement of the claims against a particular indemnitee and finds that indemnification of the settlement and the related costs should be made, and the court considering the request of indemnification has been advised of the position of the SEC and of the published position of any state securities regulatory authority in which our securities were offered or sold as to indemnification for violation of securities laws.
Pursuant to our charter, we may pay or reimburse reasonable expenses incurred by a director, the advisor or an affiliate of the advisor in advance of final disposition of a proceeding only if all of the following are satisfied: (i) the indemnitee was
made a party to the proceeding by reason of the performance of duties or services on our behalf; (ii) the indemnitee provides us with written affirmation of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by us as authorized by the charter; (iii) the indemnitee provides us with a written agreement to repay the amount paid or reimbursed by us, together with the applicable legal rate of interest thereon, if it is ultimately determined that the indemnitee did not comply with the requisite standard of conduct and is not entitled to indemnification; and (iv) the legal proceeding was initiated by a third-party who is not a stockholder or, if by a stockholder acting in his or her capacity as such, a court of competent jurisdiction approves such advancement.
It is the position of the SEC that indemnification of directors and officers for liabilities arising under the Securities
Act is against public policy and is unenforceable pursuant to Section 14 of the Securities Act.
We have entered into indemnification agreements with each of our executive officers and directors and Albert Tylis, an executive officer of our sponsor. The indemnification agreements require, among other things, that we indemnify our executive officers and directors and Mr. Tylis and advance to the executive officers and directors and Mr. Tylis all related expenses, subject to reimbursement if it is subsequently
determined
that indemnification is not permitted. In accordance with these agreements, we must indemnify and advance all expenses incurred by executive officers and directors and Mr. Tylis seeking to enforce their rights under the indemnification agreements. We also cover officers and directors and Mr. Tylis under our directors’ and officers’ liability insurance.
Item 35. Treatment of Proceeds from Securities Being Registered.
Not Applicable.
Item 36. Financial Statements and Exhibits.
(a)
Financial Statements:
The
following financial statements are incorporated into this registration statement by reference:
to file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement:
(i)
to include any prospectuses required by Section 10(a)(3) of the Securities Act;
(ii)
to
reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement; notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20% change in the maximum aggregate offering price set forth in the “Calculation of Registration Fee” table in the effective registration statement; and
(iii)
to
include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement;
(2)
that, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and our offering of such securities at that time shall be deemed to be the initial bona fide offering thereof;
(3)
that
for the purpose of determining any liability under the Securities Act to any purchaser, each prospectus filed pursuant to Rule 424(b) as part of this registration statement shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness; provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration
statement
will, as to a purchaser with a time of contract of sale prior to such first use, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use;
(4)
to remove from registration by means of a post-effective amendment any of the securities being registered that remain unsold at the termination of our offering;
(5)
that
all post-effective amendments will comply with the applicable forms, rules and regulations of the SEC in effect at the time such post-effective amendments are filed;
(6)
that, for the purpose of determining liability under the Securities Act to any purchaser in the initial distribution of the securities, in a primary offering of securities of the registrant pursuant to this registration statement, regardless of the underwriting method used to sell the securities to the purchaser, if the securities are offered or sold to such purchaser by means of any of the following communications, the undersigned will be a seller to the purchaser and will be considered to
offer or sell such securities to such purchaser:
(i)
any preliminary prospectus or prospectus of the registrant relating to our offering required to be filed pursuant to Rule 424;
(ii)
any free writing prospectus relating to our offering prepared by or on behalf of the registrant or used or referred to by the
registrant;
(iii)
the portion of any other free writing prospectus relating to our offering containing material information about the registrant or its securities provided by or on behalf of the registrant; and
(iv)
any other communication that is an offer in our offering made by the
registrant to the purchaser;
(7)
to send to each stockholder, at least on an annual basis, a detailed statement of any transactions with the registrant’s advisor or its affiliates, and of fees, commissions, compensations and other benefits paid or accrued to the advisor or its affiliates, for the fiscal year completed, showing the amount paid or accrued to each recipient and the services performed;
(8)
to provide to the stockholders
the financial statements required by Form 10-K for the first full fiscal year of operations;
(9)
to file a sticker supplement pursuant to Rule 424(c) under the Securities Act describing each significant property that has not been identified in the prospectus whenever a reasonable probability exists that a property will be acquired and to consolidate all such stickers into a post-effective amendment filed at least once every three months during the distribution period, with the information contained in such amendment provided simultaneously to existing stockholders. Each sticker supplement shall disclose all compensation and fees received by the advisor and its affiliates in connection with any such acquisition. The post-effective amendment shall
include or incorporate by reference audited financial statements in the format described in Rule 3-14 of Regulation S-X that have been filed or are required to be filed on Form 8-K for all significant property acquisitions that have been consummated during the distribution period;
(10)
to file, after the end of the distribution period, a current report on Form 8-K containing the financial statements and any additional information required by Rule 3-14 of Regulation S-X, as appropriate based on the type of property acquired and the type of lease to which such property will be subject, to reflect each commitment (such as the signing of a binding purchase agreement) made after the end of the distribution
period involving the use of 10% or more (on a cumulative basis) of the net proceeds of our offering and to provide the information contained in such report to the stockholders at least once per quarter after the distribution period of our offering has ended; and
(11)
insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any such action, suit, or proceeding) is asserted by such director, officer or
controlling
person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.
Pursuant to the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-11 and has duly caused this Post-Effective Amendment No. 6 to the registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, State of New York, on October 24, 2014.
Pursuant to the requirements of the Securities Act of 1933, as amended, this Post-Effective Amendment No. 6 to the registration statement has been
signed by the following persons in the capacities indicated on October 24, 2014.
Form of Participating Dealer Agreement (included as Appendix A to Exhibit 1.1)
3.1
Articles of Amendment and Restatement of NorthStar Real Estate Income II, Inc. (filed as Exhibit 3.1 to Amendment No. 3 to the
Company’s Registration Statement on Form S-11 (File No. 333-185640) filed with the SEC on May 2, 2013, and incorporated herein by reference)
Opinion
of Venable LLP as to the legality of the securities being registered (filed as Exhibit 5.1 to Amendment No. 3 to the Company’s Registration Statement on Form S-11 (File No. 333-185640) filed with the SEC on May 2, 2013, and incorporated herein by reference)
8.1
Opinion of Greenberg Traurig, LLP regarding certain federal income tax considerations (filed as Exhibit 8.1 to Amendment No. 3 to the Company’s Registration
Statement on Form S-11 (File No. 333-185640) filed with the SEC on May 2, 2013, and incorporated herein by reference)
Limited Partnership Agreement of NorthStar Real Estate Income Operating Partnership II, LP (filed as Exhibit 10.3 to Amendment No. 3 to the
Company’s Registration Statement on Form S-11 (File No. 333-185640) filed with the SEC on May 2, 2013, and incorporated herein by reference)
10.4
First Amendment to Limited Partnership Agreement of NorthStar Real Estate Income Operating
NorthStar
Real Estate Income II, Inc. Independent Directors Compensation Plan (filed as Exhibit 10.5 to Amendment No. 3 to the Company’s Registration Statement on Form S-11 (File No. 333-185640) filed with the SEC on May 2, 2013, and incorporated herein by reference)
Mortgage Participation Agreement, dated as of September 18, 2013, by and between Trellis Apartments-T, LLC, as Noteholder, Trellis Apartments-T, LLC, as the Participation A-1 Holder, and Trellis Apartments NT-II, LLC, the Participation A-2 Holder (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, and
incorporated herein by reference)
Limited Guaranty, made as of July 2, 2014, by NorthStar Real Estate Income II, Inc. and NorthStar Real Estate Income Operating Partnership II, LP, for the benefit of Deutsche Bank AG, Cayman Islands Branch (filed as Exhibit 10.2 to the Company’s Current Report on
Limited Liability Company Agreement of 205 Demonbreun Realty Holding Company LLC, dated as of July 18, 2014, by and between WMG Realty Holding Company LLC and Qarth Holdings NT-II, LLC (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 24, 2014 and incorporated herein by reference)
