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Registrant’s telephone number, including area code: (303) 228-2200
_______________________________________
Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
☐
Accelerated filer
☐
Non-accelerated
filer
ý (Do not check if a smaller reporting company)
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant
to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ý
As of August 7, 2017, 101,016,479 unclassified shares of common stock (referred to as “Class E” shares), 2,083,881 shares of Class A common stock, 2,508,869 shares of Class W common stock, and 34,351,448 shares of Class I common stock of Dividend Capital Diversified Property
Fund Inc., each with a par value $0.01 per share, were outstanding.
Common stock, $0.01 par value; 1,000,000,000 shares authorized; 139,913,429 and 150,636,393 shares issued and outstanding, as of June 30, 2017 and December 31, 2016, respectively (2)
1,399
1,506
Additional
paid-in capital
1,280,621
1,361,638
Distributions in excess of earnings
(857,792
)
(839,896
)
Accumulated other comprehensive loss
(5,550
)
(6,905
)
Total
stockholders’ equity
418,678
516,343
Noncontrolling interests
86,999
91,748
Total Equity
505,677
608,091
Total
Liabilities and Equity
$
1,725,278
$
1,783,728
(1)
Includes approximately
$2.5 million and $3.6 million that we owed to Dividend Capital Total Advisors LLC (our "Advisor") and affiliates of our Advisor for services and reimbursement of certain expenses as of June 30, 2017 and December 31, 2016, respectively.
(2)
See Note 7 for the number of shares outstanding of each class of common stock as of June 30, 2017 and December 31,
2016.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Gain
on extinguishment of debt and financing commitments
—
—
—
5,136
Gain on sale of real property (3)
10,352
—
10,352
41,400
Net
income
8,415
135
10,242
48,373
Net income attributable to noncontrolling interests
(1,610
)
(18
)
(1,776
)
(4,474
)
NET
INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS
$
6,805
$
117
$
8,466
$
43,899
NET
INCOME PER BASIC AND DILUTED COMMON SHARE
$
0.05
$
0.00
$
0.06
$
0.27
WEIGHTED
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
Basic
145,288
161,209
147,577
162,581
Diluted
157,209
173,669
159,551
175,179
Distributions
declared per common share
$
0.0891
$
0.0893
$
0.1782
$
0.1785
(1)
Includes
approximately $1.4 million and $1.6 million of reimbursable expenses incurred by our Advisor and its affiliates during the three months ended June 30, 2017 and 2016, respectively, and approximately $3.1 million and $3.5 million of reimbursable expenses incurred by our Advisor and its affiliates during the six months ended June 30, 2017 and 2016.
(2)
Includes
approximately $45,000 paid to our Advisor for advisory fees associated with the disposition of real properties during the three and six months ended June 30, 2017, and $79,000 paid to our Advisor for advisory fees associated with the disposition of real properties during the six months ended June 30, 2016.
(3)
Includes approximately $241,000 paid to our Advisor for advisory fees associated with the disposition
of real properties during the three and six months ended June 30, 2017, and $1.8 million paid to our Advisor for advisory fees associated with the disposition of real properties during the six months ended June 30, 2016.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Adjustments to reconcile net income to net cash provided by operating activities:
Real
estate depreciation and amortization expense
36,734
40,034
Gain on disposition of real property
(10,352
)
(41,400
)
Impairment of real
estate property
1,116
587
Gain on extinguishment of debt and financing commitments
—
(5,136
)
Other adjustments to reconcile net
income to net cash provided by operating activities
3,134
3,608
Changes in operating assets and liabilities
(5,283
)
(2,705
)
Net cash
provided by operating activities
35,591
43,361
INVESTING ACTIVITIES:
Acquisition of real property
—
(65,861
)
Capital
expenditures in real property
(9,268
)
(11,531
)
Proceeds from disposition of real property
29,089
175,965
Principal collections on
debt-related investments
246
231
Other investing activities
(881
)
(828
)
Net cash provided by investing activities
19,186
97,976
FINANCING
ACTIVITIES:
Mortgage note proceeds
201,886
32,100
Mortgage note principal repayments
(161,618
)
(140,494
)
Net
proceeds from (repayments of) revolving line of credit borrowings
17,000
44,000
Redemption of common shares
(101,939
)
(94,973
)
Distributions
on common stock
(17,031
)
(19,381
)
Proceeds from sale of common stock
11,172
49,005
Offering costs for issuance of common stock
(2,309
)
(3,819
)
Distributions
to noncontrolling interest holders
(4,780
)
(3,830
)
Redemption of OP Unit holder interests
(1,518
)
(3,573
)
Other financing activities
(4,142
)
947
Net
cash used in financing activities
(63,279
)
(140,018
)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
(8,502
)
1,319
CASH
AND CASH EQUIVALENTS, beginning of period
13,864
15,769
CASH AND CASH EQUIVALENTS, end of period
$
5,362
$
17,088
Supplemental
Disclosure of Cash Flow Information:
Cash paid for interest
$
18,009
$
20,501
Supplemental Disclosure of Noncash Investing and Financing Activities:
Common
stock issued pursuant to the distribution reinvestment plan
$
10,215
$
10,192
Non-cash disposition of real property *
$
—
$
7,830
*
Represents the amount of sales proceeds from the disposition of real property that we did not receive or pay in cash, primarily due to the repayment of related borrowings by the purchaser at closing.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Dividend Capital Diversified Property Fund Inc. is a Maryland corporation formed on April 11, 2005 to invest in a diverse portfolio of real property and real estate related investments. As used herein, “the Company,”“we,”“our” and “us” refer to Dividend Capital Diversified Property Fund Inc. and its consolidated subsidiaries
and partnerships except where the context otherwise requires.
We operate in such a manner so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes, and we utilize an Umbrella Partnership Real Estate Investment Trust (“UPREIT”) organizational structure to hold all or substantially all of our assets through our operating partnership, Dividend Capital Total Realty Operating Partnership, L.P. (our “Operating Partnership”).
We are the sole general partner of our Operating Partnership. In addition, we have contributed 100% of the proceeds received from our offerings of common stock to our Operating Partnership in exchange for partnership units (“OP Units”) representing our interest as a limited partner of our Operating Partnership. Our Operating Partnership qualifies as a variable
interest entity for accounting purposes and substantially all of the assets of the Company are held by our Operating Partnership, which, subject to certain Operating Partnership and subsidiary level financing restrictions, can be used to settle its obligations. Creditors of certain liabilities of our Operating Partnership have recourse to the Company. Under our Operating Partnership, we historically had variable interest entities that were joint ventures in which we had real estate investments. The accompanying condensed consolidated balance sheets included approximately $48.2 million, after accumulated depreciation and amortization, in net investments in real property in these consolidated variable interest entities as of December 31,
2016. As of June 30, 2017, we did not hold any investment in any joint ventures.
As of June 30, 2017 and December 31, 2016, we owned approximately 92.2% and 92.6%, respectively, of the limited partnership interests in our Operating Partnership, and the remaining limited partnership interests in our Operating Partnership were owned by third-party investors. Our Operating Partnership has classes of OP Units that correspond to our four classes of common stock: Class E OP Units, Class A OP Units, Class W OP Units, and Class I OP
Units. As of June 30, 2017 and December 31, 2016, our Operating Partnership had issued and outstanding approximately 11.9 million and 12.0 million Class E OP Units held by third party investors, respectively, which represent limited partnership interests issued in connection with its private placement offerings. As of June 30, 2017 and December 31, 2016, such Class E OP Units had a maximum approximate redemption value of $89.1 million and $91.2
million, respectively, based on the most recent selling price of our common stock pursuant to our primary offering.
Our Advisor, a related party, manages our day-to-day activities under the terms and conditions of an advisory agreement (as amended from time to time, the “Advisory Agreement”). Our Advisor and its affiliates receive various forms of compensation, reimbursements and fees for services relating to the investment and management of our real estate assets.
On July 12, 2012, the Securities and Exchange Commission (the “Commission”) declared effective our Registration Statement on Form S-11 (Registration Number 333-175989) (as amended, the “Prior Registration Statement”). The Prior Registration
Statement applied to the offer and sale (the “Prior Offering”) of up to $3,000,000,000 of our shares of common stock, of which $2,250,000,000 of shares were expected to be offered to the public in a primary offering and $750,000,000 of shares were expected to be offered to our stockholders pursuant to an amended and restated distribution reinvestment plan (subject to our right to reallocate such amounts). In the Prior Offering, we offered to the public three classes of shares: Class A shares, Class W shares and Class I shares with net asset value (“NAV”) based pricing. On September 15, 2015, we terminated the Prior Offering. Through September 15, 2015, the date our Prior Offering terminated, we had raised gross proceeds
of approximately $183.0 million from the sale of approximately 25.8 million shares in the Prior Offering, including approximately $3.4 million through our distribution reinvestment plan.
On September 16, 2015, the Commission declared effective our Registration Statement on Form S-11 (Registration Number 333-197767) (the “Follow-On Registration Statement”). The Follow-On Registration Statement applies to the Company’s follow-on “best efforts” offering of up to $1,000,000,000 of the
Company’s Class A, Class I and Class W shares of common stock, of which $750,000,000 of shares are expected to be offered to the public in a primary offering and $250,000,000 of shares are expected to be offered to stockholders of the Company pursuant to its distribution reinvestment plan (subject to the Company’s right to reallocate such amounts) (the “Follow-On Offering”). As of June 30, 2017, we had raised gross proceeds of approximately $125.3 million from the sale of approximately 16.8 million shares in the
Follow-On Offering.
As of June 30, 2017, we were offering to sell any combination of Class A shares, Class W shares and Class I shares with a dollar value up to the maximum offering amount pursuant to the Follow-On Offering. We also sold shares of our unclassified common stock, which we refer to as “Class E” shares, pursuant to our distribution reinvestment plan offering registered on our Registration Statement on Form S-3 (Registration Number 333-162636). In
the event of a liquidation event, our assets, or the proceeds therefrom, will be distributed ratably in proportion to the respective NAV for each class until the NAV for each class has been paid. Other than differing allocable fees and liquidation rights, Class E shares, Class A shares, Class W shares, and Class I shares have identical rights and privileges.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Statements
The accompanying interim condensed consolidated financial statements (herein referred to as “financial statements,”“balance sheets,”“statements of income,” “statements of comprehensive income (loss),”“statement of equity,” or “statements of cash flows”)
have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the Commission's instructions to Form 10-Q and Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, these financial statements do not include all the information and disclosure required by GAAP for complete financial statements. In the opinion of management, the accompanying financial statements include all adjustments and eliminations, consisting only of normal recurring items necessary for their fair presentation in conformity with GAAP. Interim results are not necessarily indicative of operating results for a full year. The unaudited information included in this Quarterly Report on Form 10-Q should be read in conjunction with our audited financial statements and notes thereto, included in our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the
Commission on March 3, 2017. There have been no significant changes to the Company’s significant accounting policies during the six months ended June 30, 2017 other than the updates described below.
New Accounting Pronouncements
In February 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update 2017-05, Other Income- Gain and Losses from Derecognition of Nonfinancial Assets (Topic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets ("ASU 2017-05"),
which clarifies that a financial asset is within the scope of ASU 2017-05 if it is deemed an "in substance nonfinancial asset." Additionally, ASU 2017-05 adds guidance for partial sales of nonfinancial assets. The guidance will be effective for annual reporting periods beginning after December 15, 2017, and will require full or modified retrospective application. Early adoption is permitted for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. We plan to adopt ASU 2017-05 at the same time we adopt Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606) when the standard becomes effective for us beginning January
1, 2018 and have not determined whether the full or modified retrospective application will be applied. We do not anticipate the adoption will have a significant impact on our financial statements.
Newly Adopted Accounting Pronouncements
In January 2017, the FASB issued Accounting Standards Update 2017-01 ("ASU 2017-01"), which clarifies the definition of a business in order to provide additional guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Earlier adoption is permitted. The guidance in ASU 2017-01 should be adopted on a prospective basis. We adopted ASU 2017-01 as of January
1, 2017 and anticipate that future acquisitions of real property will likely be accounted for as asset acquisitions rather than business combinations. Among other things, accounting for an asset acquisition requires capitalization of acquisition costs as a component of the acquired assets whereas accounting for business combinations requires acquisition costs to be expensed. Additionally, goodwill is not recognized and contingent consideration is recorded when probable and reasonably estimable under accounting for asset acquisitions.
3. INVESTMENTS IN REAL PROPERTY
Currently, our consolidated investments in real property consist of investments in office, industrial and retail properties. The following tables summarize our consolidated investments in real property as of June 30,
2017 and December 31, 2016 (amounts in thousands):
During the three and six months ended June 30, 2017, we recorded a $1.1 million impairment charge related to a consolidated retail property located in the Greater Boston market ("Hanover"), which we acquired in August 2007. We held a 100% ownership interest in Hanover.
We sold Hanover in May 2017. Prior to the disposition, the net book value of Hanover exceeded the contract sales price less the cost to sell by approximately $1.1 million. Accordingly, we recorded an impairment charge to reduce the net book value of Hanover to our estimate of its fair value less the cost to sell.
During the six months ended June 30, 2016, we recorded a $587,000 impairment charge related to a consolidated office property located in the Chicago, IL market ("40 Boulevard"), which we acquired in January
2007 and we held through a joint venture in which we were not the managing partner. We held an 80% ownership interest in 40 Boulevard. We sold 40 Boulevard in March 2016. Prior to the disposition, the net book value of 40 Boulevard exceeded the contract sales price less the cost to sell by approximately $587,000. Accordingly, we recorded an impairment charge to reduce the net book value of 40 Boulevard to our estimate of its fair value less the cost to sell.
The fair value measurement for the impairment charges related to Hanover and 40 Boulevard
was based on the contract sales price less selling costs. We considered the Level 3 inputs used in determining the fair value of these real property investments to be significant. As such, the investments fall under the Level 3 category of the fair value hierarchy as defined in ASC Topic 820, Fair Value Measurements and Disclosures ("ASC Topic 820").
In the calculation of our daily NAV, our real estate assets are carried at fair value using valuation methodologies consistent with ASC Topic 820. As a result, the timing of valuation changes recorded in our NAV will not necessarily be the same as for impairment charges recorded to our consolidated financial statements prepared pursuant to GAAP. Since we determine our NAV daily, impairment charges pursuant to GAAP will likely always be
delayed and potentially significantly delayed compared to the change in fair value of our properties included in the calculation of our daily NAV.
Rental Revenue
The following table summarizes the adjustments to rental revenue related to the amortization of above-market lease assets, below-market lease liabilities, and straight-line rental adjustments for the three and six months ended June 30, 2017 and 2016. In addition, the following table summarizes tenant recovery income received from tenants for real estate taxes, insurance and other property operating expenses and recognized as rental revenue (amounts in thousands):
Tenant
recovery income presented in this table excludes real estate taxes that were paid directly by our tenants that are subject to triple net lease contracts. Such payments totaled approximately $516,000 and $876,000 during the three months ended June 30, 2017 and 2016, respectively, and approximately $1.1 million and $2.3 million during the six months ended June 30, 2017 and 2016,
respectively.
The following is a summary of amounts related to the top five tenants based on annualized base rent, as of June 30, 2017 (dollar amounts and square feet in thousands):
Annualized
base rent represents the annualized monthly base rent of executed leases as of June 30, 2017.
(2)
The amount presented for Charles Schwab & Co., Inc. ("Schwab") reflects the total annualized base rent for our two leases in place with Schwab as of June 30, 2017. One of these leases, which expires in September 2017, entails the lease of all 594,000 square feet of our 3 Second Street office property (defined below in "Management's Discussion and
Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources") and accounts for $23.5 million or 15.5% of our annualized base rent as of June 30, 2017. We do not expect Schwab to renew this lease. Schwab has subleased 100% of 3 Second Street to 25 sub-tenants through September 2017. We have executed leases directly with 11 of these subtenants that comprise 368,000 square feet or 62% of 3 Second Street that effectively extend their leases beyond the Schwab lease expiration. These direct leases will expire between
September 2020 and September 2032.
The top tenant in the table above comprises 15.6% of annualized base rent as of June 30, 2017. However, due to the near-term expiration of the Schwab lease at 3 Second Street, Schwab is no longer in the top 20 tenants based on future minimum rental revenue, comprising less than 1% of our total future minimum rental revenue as of June 30, 2017. Alternatively, based on future minimum rental revenue as of June 30, 2017,
our top five tenants rank as follows: 1) Stop & Shop, 2) Mizuho Bank Ltd., 3) Shaw's Supermarket, 4) WeWork LLC, and 5) Novo Nordisk.
Our properties in New Jersey, Massachusetts, California, and Texas accounted for approximately 21%, 20%, 14%, and 12% respectively, of our total gross investment in real property portfolio as of June 30, 2017. A deterioration of general economic or other relevant conditions, changes in governmental laws and regulations, acts of nature, demographics or other factors in any of those states or the geographical region in which they are located could result in the loss of tenants, a decrease in the demand for our properties
and a decrease in our revenues from those markets, which in turn may have a disproportionate and material adverse effect on our results of operations and financial condition.
“Gross Investment Amount” as used here and throughout this document represents the allocated gross basis of real property after certain adjustments. Gross Investment Amount for real property (i) includes the effect of intangible lease liabilities, (ii) excludes accumulated depreciation and amortization, and (iii) includes the impact of impairments.
(2)
Amount as of June 30, 2017 and December 31,
2016 includes a floating-rate mortgage note that was subject to an interest rate spread of 1.60% over one-month LIBOR, which we have effectively fixed using an interest rate swap at 3.051% for the term of the borrowing.
(3)
As of June 30, 2017, our floating rate mortgage notes were subject to a weighted average interest rate spread of 2.13% over one-month LIBOR. As of December 31, 2016, our floating rate mortgage note was subject to an interest rate spread
of 1.65% over one-month LIBOR.
(4)
As of June 30, 2017 and December 31, 2016, borrowings under our line of credit were subject to interest at a floating rate of 1.70% and 1.55% over one-month LIBOR, respectively. However, as of December 31, 2016, we had effectively fixed the interest rate of approximately $12.1
million of the total of $236.0 million in borrowings using interest rate swaps, resulting in a weighted average interest rate on the total line of credit of 2.28%.
(5)
As of June 30, 2017 and December 31, 2016, borrowings under our term loans were subject to interest at a weighted average floating rate of 1.75% and 1.60% over one-month LIBOR,
respectively. However, we have effectively fixed the interest rate of approximately $350.0 million in borrowings using interest rate swaps, resulting in a weighted average interest rate on the total term loans of 3.44% and 3.17% as of June 30, 2017 and December 31, 2016, respectively.
Mortgage Notes
As of June 30, 2017, five mortgage notes were interest-only and four
mortgage notes were fully amortizing with outstanding principal balances of approximately $357.5 million and $26.4 million, respectively. None of our mortgage notes are currently recourse to us. The assets and credit of our consolidated properties pledged as collateral for our mortgage notes are not available to satisfy our debt and obligations unless we first satisfy the mortgage note payable on the underlying property.
Revolving Credit Facility and Five-Year Term Loan
Through a syndicate of 14 lenders (the "BofA Lenders") led by Bank of America, N.A., as Administrative Agent ("BofA"), we have a $675 million senior unsecured term loan and revolving line of credit (the “Facility”).
The Facility provides us with the ability from time to time to increase the size of the Facility up to a total of $900 million less the amount of any prepayments under the term loan component of the Facility, subject to receipt of lender commitments and other conditions.
The Facility consists of a $400 million revolving credit facility (the “Revolving Credit Facility”) and a $275 million five-year term loan (the “Term Loan”). The Revolving Credit Facility contains a sublimit of $50 million for letters of credit and a sublimit of $50 million for swing line loans. The primary interest rate for the Revolving Credit Facility is based on LIBOR,
plus a margin ranging from 1.40% to 2.30%, depending on our consolidated leverage ratio. The maturity date of the Revolving Credit Facility is January 31, 2019 and contains one one-year extension option that we may exercise upon (i) payment of an extension fee equal to 0.15% of the sum of the amount outstanding under the Revolving Credit Facility and the unused portion of the Revolving Credit Facility at the time of the extension, and (ii) compliance with the other conditions set forth in the credit agreement. The primary interest rate within the Term Loan is based on LIBOR, plus a margin ranging from 1.35% to 2.20%, depending on our consolidated
leverage ratio. The maturity date of the Term Loan is January 31, 2018 and contains two one-year extension options that we may exercise upon (i) payment of an extension fee equal to 0.125% of the sum of the amount outstanding under the Term Loan at the time of each extension, and (ii) compliance with the other conditions set forth in the credit agreement.
Borrowings under the Facility are available for general business purposes including, but not limited to, refinancing of existing indebtedness and financing the acquisition of permitted investments, including commercial properties. As of June 30, 2017 and December 31,
2016, the unused portion of the Facility was approximately $124.7 million and $164.0 million, respectively, and we had full access to the unused portion of the Facility.
Seven-Year Term Loan
Through a syndicate of six lenders led by Wells Fargo Bank, National Association as Administrative Agent and Regions Bank as Syndication Agent, we have a $200 million seven-year term loan credit agreement (the “$200 million Term Loan”). The primary interest rate within the $200 million Term Loan is based on LIBOR, plus a margin ranging from 1.65%
to 2.55%, depending on our consolidated leverage ratio. The maturity date of the $200 million Term Loan is February 27, 2022 with no extension options.
Borrowings under the $200 million Term Loan are available for general business purposes including, but not limited to financing the acquisition of permitted investments, including commercial properties.
As of June 30, 2017, we were in compliance with all our debt covenants, including those under the Facility and the $200 million Term Loan.
During the six months ended June 30, 2017, we entered into two mortgage note borrowings. The following table describes the new borrowings in more detail (dollar amounts in thousands):
Borrowings
Date
Borrowed
Principal Balance
Fixed or Floating Interest Rate
Stated Interest Rate (1)
Contractual Maturity Date
Extension Options
Collateral
Type
Collateral Market
3 Second Street (2)
1/10/2017
$
127,000
Floating
3.38
%
1/10/2020
2
one-year extensions
Office Property
Northern New Jersey
Centerton Square (3)
6/5/2017
75,000
Floating
3.33
%
7/10/2019
2
one-year extensions
Retail Property
Philadelphia, PA
Total/weighted average borrowings
$
202,000
3.36
%
(1)
For
floating-rate mortgage note borrowings, the stated interest rate is as of June 30, 2017.
(2)
On January 10, 2017, we received proceeds of $127.0 million from the $146.6 million 3 Second Street mortgage note, and we can request the remaining proceeds anytime prior to October 10, 2019 as reimbursement for certain approved capital expenditures, tenant improvement costs and leasing commissions. As of June 30,
2017, the term loan was subject to an interest rate spread of 2.25% over one-month LIBOR. As a result of this borrowing, we entered into an interest rate protection agreement ("Interest Rate Cap") with a notional amount of $146.6 million and a LIBOR strike rate of 3.00%. See Note 5 for additional discussion related to the Interest Rate Cap.
(3)
On June 5, 2017, we received proceeds of $75.0 million from the $81.3 million Centerton
Square mortgage note, and we can obtain the remaining proceeds subject to meeting certain financial ratios. As of June 30, 2017, the term loan was subject to an interest rate spread of 2.25% over one-month LIBOR. As a result of this borrowing, we entered into an Interest Rate Cap with a notional amount of $81.3 million and a LIBOR strike rate of 3.00%. See Note 5 for additional discussion related to the Interest Rate Cap.
Repayment of Mortgage Note
During the six months ended June 30, 2017, we repaid four
mortgage note borrowings in full during the respective free-prepayment periods prior to their scheduled maturities using proceeds from our Facility or our 3 Second Street borrowing. The following table describes these repayments in more detail (dollar amounts in thousands):
Debt Obligation
Repayment
Date
Balance Repaid/Extinguished
Interest Rate Fixed or Floating
Stated Interest Rate
Contractual Maturity Date
Collateral Type
Collateral Market
Eastern
Retail Portfolio
1/10/2017
$
110,000
Fixed
5.51
%
6/11/2017
Retail
Property
Various (1)
Wareham
5/8/2017
24,400
Fixed
6.13
%
8/8/2017
Retail
Property
Greater Boston
Kingston
6/1/2017
10,574
Fixed
6.33
%
11/1/2017
Retail
Property
Greater Boston
Sandwich
6/1/2017
15,825
Fixed
6.33
%
11/1/2017
Retail
Property
Greater Boston
Total/weighted average borrowings
$
160,799
5.74
%
(1)
The Eastern Retail Portfolio was collateralized by three retail properties located in Raleigh, NC, Philadelphia, PA and Greater Boston.
The following table reflects our contractual debt maturities as of June 30, 2017, specifically our obligations under our mortgage notes and unsecured borrowings (dollar amounts in thousands):
We maintain risk management control systems to monitor interest rate risk attributable to both our outstanding and forecasted debt obligations. We generally seek to limit the impact of interest rate changes on earnings and cash flows by selectively utilizing derivative instruments to hedge exposures to changes in interest rates on our secured and unsecured floating rate borrowings. While this hedging strategy is designed to minimize the impact on our net income (loss) and cash provided by operating activities from changes in interest rates, the overall returns on our investments may be reduced. Our board of directors has established policies and procedures regarding our use of derivative instruments for hedging or other purposes to achieve these risk management objectives.
Cash
Flow Hedges of Interest Rate Risk
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from counterparties in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amounts. We have entered into and plan to enter into certain interest rate derivatives with the goal of mitigating our exposure to adverse fluctuations in the interest payments on our one-month LIBOR-indexed debt. Certain of our floating rate borrowings are not hedged and therefore, to an extent, we have ongoing exposure to interest rate movements.
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges under ASC Topic 815 is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the next 12 months, we estimate that approximately $1.7 million will be reclassified as an increase to interest expense related to active effective hedges of existing floating-rate debt, and we estimate that approximately $2.0 million will be reclassified as an increase to interest expense related to effective interest rate swaps where the hedging instrument has been terminated. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.
The table below presents a reconciliation of the beginning and ending balances, between December 31, 2016 and June 30, 2017, of our accumulated other comprehensive loss (“AOCI”), net of amounts attributable to noncontrolling interests, related to the effective portion of our cash flow hedges as presented on our condensed consolidated financial statements, as well as amounts related to our available-for-sale securities (amounts in thousands):
(Losses)
and Gains on Cash Flow Hedges
Unrealized (Losses) and Gains on Available-For-Sale Securities
The valuation of interest rate derivatives is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.
To comply with the provisions of ASC 820, we incorporate credit valuation adjustments
to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.
The majority of the inputs used to value our derivative instruments fall within Level 2 of the fair value hierarchy. However, the credit valuation adjustments associated with our derivative instruments utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of potential default by us and our counterparties. As of June 30, 2017, we had assessed the significance of the impact of the credit valuation adjustments and had determined
that it was not significant to the overall valuation of our derivative instruments. As a result, we have determined that our derivative valuations are classified in Level 2 of the fair value hierarchy.
As of June 30, 2017 and December 31, 2016, we had 10 and 11 outstanding interest rate swaps, respectively, that were designated as cash flow hedges of interest rate risk, with a total notional amount of $383.0 million and $395.1 million, respectively. In addition, as of June 30, 2017
and December 31, 2016, we had one interest rate swap with a total notional amount of $52.5 million that will become effective in July 2018 and mature in July 2021, which was designated as a cash flow hedge of interest rate risk.
As of June 30, 2017, we had two outstanding interest rate caps that were not designated as hedges, with a total notional amount of $227.9 million. Derivatives not designated as hedges are not speculative and are used to hedge our exposure to interest rate movements and other identified risks but do not meet the strict requirements
for hedge accounting. In certain instances, including our current derivative not designated for hedge accounting, we elected not to apply hedge accounting.
The table below presents the gross fair value of our designated and non-designated derivative financial instruments as well as their classification on our accompanying condensed consolidated balance sheets as of June 30, 2017 and December 31, 2016 (amounts in thousands, except for footnoted information):
Although our derivative contracts are subject to master netting arrangements which serve as credit mitigants to both us and our counterparties under certain situations, we do not net our derivative fair values or any existing rights or obligations to cash collateral on our accompanying condensed consolidated balance sheets. If we did net our derivative fair values on our accompanying condensed consolidated balance sheets as of June 30, 2017 and December 31, 2016, there would be no impact.
Effect of Derivative Instruments on the Statements of Income and Comprehensive
Income (Loss)
The table below presents the effect of our derivative financial instruments on our accompanying financial statements for the three and six months ended June 30, 2017 and 2016 (amounts in thousands):
Amount
of loss recognized in OCI (effective portion)
$
(1,928
)
$
(4,902
)
$
(1,332
)
$
(15,098
)
Location
of loss reclassified from accumulated OCI into income (effective portion)
Interest expense
Interest expense
Interest expense
Interest expense
Amount of loss reclassified from accumulated OCI into income (effective portion)
$
1,251
$
1,199
$
2,744
$
2,317
Location
of loss recognized in income (ineffective portion and amount excluded from effectiveness testing)
Other income and (expense)
Other income and (expense)
Other income and (expense)
Other income and (expense)
Amount of loss recognized in income (ineffective portion and amount excluded from effectiveness testing)
$
(47
)
$
—
$
—
$
—
Derivatives
Not Designated as Hedging Instruments
Derivative type
Interest rate cap
Interest rate cap
Interest rate cap
Interest
rate cap
Amount of loss recognized in income
$
(21
)
$
—
$
(101
)
$
—
Location
of loss recognized in income
Other income and (expense)
Other income and (expense)
Other income and (expense)
Other income and (expense)
Credit-Risk-Related Contingent Features
We have agreements with certain of our derivative counterparties that contain a provision where we could be declared in default on our derivative obligations if repayment of the underlying indebtedness
is accelerated by the lender due to our default on the indebtedness. We have agreements with certain other derivative counterparties that contain a provision whereby if we default on any of our indebtedness held by our Operating Partnership, including default where repayment of the indebtedness has not been accelerated by the lender, then we could also be declared in default on our derivative obligations.
As of June 30, 2017, the fair value of derivatives in a net liability position, which included accrued interest but excluded any credit valuation adjustments related to these agreements, was approximately $2.2 million. As of June 30, 2017,
we have not posted any collateral related to these agreements. If we had breached any of these provisions at June 30, 2017, we could have been required to settle our obligations under the agreements at their termination value of $2.2 million.
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
We use the framework established in ASC Topic 820, to measure the fair value of our financial instruments as disclosed in the table below. The fair values estimated below are indicative of certain interest rate and other assumptions as of June 30,
2017 and December 31, 2016, and may not take into consideration the effects of subsequent interest rate or other assumption fluctuations, or changes in the values of underlying collateral. The fair values of cash and cash equivalents, restricted cash, accounts receivable, and accounts payable and accrued expenses approximate their carrying values because of the short-term nature of these instruments.
The table below presents the carrying amounts and estimated fair values of our other financial instruments, other than derivatives which are disclosed in Note 5, as of June 30, 2017 and December 31, 2016 (amounts in thousands):
(1) Amount
includes a floating-rate mortgage note of approximately $32.6 million as of June 30, 2017 and $32.5 million as of December 31, 2016 that was subject to an interest rate spread of 1.60% over one-month LIBOR, which we have effectively fixed using an interest rate swap at 3.051% for the term of the borrowing.
The methodologies used and key assumptions made to estimate fair values of the financial instruments, other than derivatives disclosed in Note 5, described in the above table are as follows:
Debt-Related Investments — The
fair value of our performing debt-related investments are estimated using a discounted cash flow methodology. This method discounts estimated future cash flows using rates management determines best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. Credit spreads and market interest rates used to determine the fair value of these instruments are based on unobservable Level 3 inputs which management has determined to be its best estimate of current market values.
Mortgage Notes and Other Borrowings — The fair value of our mortgage notes and other borrowings are estimated using a discounted cash flow analysis, based on our estimate of market interest rates. Credit spreads relating to the underlying instruments are based on unobservable Level 3 inputs, which we have determined to be our best estimate of current market spreads of similar
instruments.
7. STOCKHOLDERS’ EQUITY
Common Stock
During the six months ended June 30, 2017, we completed two self-tender offers pursuant to which we accepted for purchase approximately 11.8 million unclassified shares of common stock, which we refer to as “Class E” shares, at a weighted average purchase price of $7.50 per share for an aggregate cost of approximately $88.2 million.
The following table describes the changes in each class of common shares during the six months ended June 30, 2017 (shares and dollar amounts in thousands):
Dollar amounts presented in this table represent the gross amount of proceeds from the sale of common shares, or the amount paid to stockholders to redeem or repurchase common shares, and do not include other costs and expenses accounted for within additional paid-in capital, such as selling commissions, dealer manager and distribution fees, offering and organizational costs, and other costs associated with our distribution reinvestment plans, share redemption programs, and self-tender offers.
(2)
During the six months ended June 30, 2017, approximately 140,000
shares that we had previously recognized as issued and outstanding were relinquished pursuant to an amendment to the Restricted Stock Unit Agreements (as defined in Note 8). Please see Note 8 for further discussion.
8. RELATED PARTY TRANSACTIONS
Advisory Agreement
Our day-to-day activities are managed by our Advisor, a related party, under the terms and conditions of the Advisory Agreement. Our Advisor is considered to be a related party as certain indirect owners and employees of our Advisor serve as two of our directors and all of our executive officers. The responsibilities of our Advisor cover all facets of our business, and include the selection
and underwriting of our real property and debt-related investments, the negotiations for these investments, the asset management and financing of these investments and the oversight of real property dispositions.
On June 27, 2017, we, our Operating Partnership and our Advisor entered into the Eleventh Amended and Restated Advisory Agreement, effective June 30, 2017, which clarified that all expense reimbursements available to the Advisor under the agreement are also available to affiliates of the Advisor and/or product specialists engaged by the Advisor to perform services under the agreement. The Advisory Agreement may be renewed for an unlimited number of successive one-year terms. The current term of the Advisory Agreement expires on June 30, 2018. Per the Advisory Agreement,
in consideration for asset management services performed, we pay our Advisor an advisory fee comprised of two separate components: (1) a fixed amount that accrues daily in an amount equal to 1/365th of 1.15% of (a) the “Aggregate Fund NAV” (i.e., the aggregate net asset value or “NAV” of our Class E shares, Class A shares, Class W shares and Class I shares, along with the OP Units held by third parties) for such day and (b) the consideration received by us or our affiliate for selling Interests (defined below) in DST Properties (defined below) to third party investors, net of up-front fees and expense reimbursements payable out of gross sale proceeds from the sale of such Interests, including but not limited to sales commissions, dealer manager fees and non-accountable expense allowances, and (2) a performance component that is based on the annual non-compounded investment return provided to holders of “Fund Interests” (defined as our Class E shares,
Class A shares, Class W shares, Class I shares, and OP Units held by third parties) such that our Advisor will receive 25% of the overall return in excess of 6%; provided that in no event may the performance condition exceed 10% of the overall return for such year, and subject to certain other limitations. Additionally, our Advisor will provide us with a waiver of a portion of its fees generally equal to the amount of the performance component that would have been payable with respect to the Class E shares and the Class E OP Units held by third parties until the NAV of such shares or units exceeds $10.00 per share or unit, the benefit of which will be shared among all holders of Fund Interests.
In addition, we will pay our Advisor a fee of 1.0%
of the total consideration we receive upon the sale of real property assets (excluding DST Properties). For these purposes, a “sale” means any transaction or series of transactions whereby we or our Operating Partnership directly or indirectly (including through the sale of any interest in a joint venture or through a sale by a joint venture in which we hold an interest) sells, grants, transfers, conveys, or relinquishes its ownership of any real property or portion thereof, including the lease of any real property consisting of a building only, and including any event with respect to any real property which gives rise to a significant amount of insurance proceeds or condemnation awards.
Further,
for providing a substantial amount of services in connection with the sale of a property (excluding DST Properties), as determined by a majority of our independent directors, we will pay our Advisor up to 50.0% of the reasonable, customary and competitive commission paid for the sale of a comparable real property, provided that such amount shall not exceed 1.0% of the contract price of the property sold and, when added to all other real estate commissions paid to unaffiliated parties in connection with the sale, may not exceed the lesser of a competitive real estate commission or 6.0% of the sales price of the property.
In addition, pursuant to the Advisory Agreement, we will pay directly, or reimburse
our Advisor and our Dealer Manager (defined below) if they pay on our behalf any organizational and offering expenses (other than selling commissions, the dealer manager fee, distribution fees and non-transaction based compensation allocated to sales-related activities of employees of our Dealer Manager in connection with the offering) relating to any public offerings as and when incurred. After the termination of the primary portion of the offering and again after termination of the distribution reinvestment plan portion of the offering, our Advisor has agreed to reimburse us to the extent that total cumulative organization and offering expenses (including selling commissions, the dealer manager fee and distribution fees) that we incur exceed 15% of our gross proceeds from the applicable offering.
The Advisory Agreement also provides that we must reimburse our Advisor for any private
offering organization and offering expenses, such as those of the DST Program (defined below), it incurs on our behalf, including Advisor personnel costs, unless it has agreed to receive a fee in lieu of reimbursement.
Subject to certain limitations, we reimburse our Advisor for all of the costs it incurs in connection with the services it provides to us, including, without limitation, our allocable share of the personnel (and related employment) costs and overhead (including, but not limited to, allocated rent paid to both third parties and an affiliate of the advisor, equipment, utilities, insurance, travel and entertainment, and other costs) incurred by our Advisor or its affiliates, including, but not limited to, total compensation, benefits and other overhead of all employees involved in the performance of such services.
Public Offering Dealer Manager Agreement
Black
Creek Capital Markets, LLC (f/k/a Dividend Capital Securities LLC) (our “Dealer Manager”), a related party, is distributing the shares of our common stock in our public offering on a “best efforts” basis. Our Dealer Manager is a member of the Financial Industry Regulatory Authority, Inc., or FINRA. Our Dealer Manager coordinates our distribution effort and manages our relationships with participating broker-dealers and financial advisors and provides assistance in connection with compliance matters relating to marketing our public offering.
On September 16, 2015, we entered into a Second Amended and Restated Dealer Manager Agreement (the “Second Amended Dealer Manager Agreement”) with our Dealer Manager. The Dealer Manager served as dealer manager for the Prior Offering and will serve as dealer manager for the Follow-On Offering. The purpose of the Second
Amended Dealer Manager Agreement is to engage our Dealer Manager with respect to the Follow-On Offering while still paying dealer manager fees and distribution fees with respect to the Prior Offering. As amended, the Second Amended Dealer Manager Agreement may be made to apply to future offerings by naming them in a schedule to the agreement, with the consent of the Company and our Dealer Manager. Pursuant to the Second Amended Dealer Manager Agreement, we pay (i) selling commissions on Class A shares sold in the primary offering of up to 3.0% of the public offering price per share, (ii) a dealer manager fee which accrues daily in an amount equal to 1/365th of 0.6% of our NAV per share of Class A and Class W shares outstanding and an amount equal to 1/365th of 0.1%
of our NAV per share of Class I shares outstanding on such day on a continuous basis, and (iii) a distribution fee which accrues daily in an amount equal to 1/365th of 0.5% of our NAV per Class A share outstanding on such day on a continuous basis. Subject to FINRA limitations on underwriting compensation, we will continue to pay the dealer manager fee and distribution fee until the earlier to occur of the following: (i) a listing of the class of such shares on a national securities exchange or (ii) such shares no longer being outstanding.
Pursuant to the Second Amended Dealer Manager Agreement, we may pay to our Dealer Manager a primary dealer fee in the amount of up to 5.0% of the gross proceeds raised from the sale of Class I shares in the primary offering, provided that (i) the total gross proceeds raised with respect to which the
primary dealer fee will apply may not exceed $100,000,000, subject to further increase by our board of directors, in its discretion; (ii) the primary dealer fee will only be paid with respect to sales made by participating broker-dealers specifically approved by us as being eligible; and (iii) the primary dealer fee will only be paid with respect to sales made at times approved by us. The Dealer Manager may reallow a portion of the primary dealer fee to the participating broker-dealers involved in selling such Class I shares based on the portion of the gross proceeds raised from their customers. The Dealer Manager will consider the primary dealer fee to be underwriting compensation subject to certain limits. The primary dealer fee will be paid by us and will not be considered to be a class-specific expense.
On June 23, 2016, our
board of directors increased the maximum amount of total gross proceeds raised with respect to which the primary dealer fee will apply to $150 million. Such amount is subject to further increase by our board of directors, in its discretion.
On December 5, 2013, our board of directors approved revised compensation for our independent directors. In connection with the revised compensation plan, at each annual meeting of stockholders the independent directors will
automatically, upon election, each receive an annual $10,000 grant of Restricted Stock Units ("RSUs") with respect to Class I shares of our common stock, with the number of RSUs based on the NAV per Class I share as of the end of the day of the annual meeting.
Restricted Stock Unit Agreements
We have entered into Restricted Stock Unit Agreements (the “Advisor RSU Agreements”) with our Advisor. The purposes of our Advisor RSU Agreements are to promote an alignment of interests among our stockholders, our Advisor and the personnel of our Advisor and its affiliates, and to promote retention of the personnel of our Advisor and its affiliates. Each restricted stock unit that we grant pursuant to our Advisor RSU Agreements (the "Company RSUs") will, upon vesting, be settled in one share of our Class I common stock. The
Company RSUs are subject to specified vesting and settlement provisions and, upon settlement in Class I shares of Company common stock, require offsets of advisory fees and expenses otherwise payable from the Company to our Advisor as described further below based on the NAV per Class I share on the grant date of the applicable Company RSU. Pursuant to the terms of the Advisor RSU Agreements, we have granted our Advisor approximately 842,000 Company RSUs. On April 13, 2017, we entered into an amendment to the Advisor RSU Agreements pursuant to which the Advisor agreed that approximately 208,000 of the RSUs originally granted under the Agreements would not vest (the "Relinquished RSUs"). Because the underlying shares will not vest and
be delivered to the Advisor, no offset of advisory fees and expenses otherwise payable from the Company to the Advisor will occur with respect to the Relinquished RSUs. However, in consideration for the Advisor's agreement, we agreed to reduce future offsets of advisory fees and expenses in connection with vesting and settlement of other RSUs by approximately $33,000, which amount reflects an increase in net asset value per Class I share since the grants of certain of the Relinquished RSUs. As of June 30, 2017, approximately 123,000 Company RSUs remained unvested and unsettled.
As of June 30,
2017, our Advisor did not have any shares of Class I common stock issued upon settlement of Company RSUs that remained subject to fee offset. The Advisor is expected to redistribute a significant portion of the Company RSUs and/or shares to senior level employees of our Advisor and its affiliates that provide services to us, although the terms of such redistributions (including the timing, amount and recipients) remain solely in the discretion of our Advisor. The weighted average grant-date NAV per Class I share with respect to the unsettled Company RSUs is $7.29 as of June 30, 2017.
Vesting and Payment Offset
Following specified
vesting provisions, an equal percentage of the Company RSUs vest on each of the applicable vesting dates. On each vesting date, an offset amount (each, an “Offset Amount”) will be calculated and deducted on a pro rata basis over the next 12 months from the cash payments otherwise due and payable to our Advisor under our then-current Advisory Agreement for any fees or expense reimbursements. Each Offset Amount equals the number of Company RSUs vesting on such date multiplied by the NAV per Class I share publicly disclosed by us (the “Class I NAV”) as of the end of the applicable grant date (the “Grant Date NAV per Class I Share”). Each Offset Amount is always calculated based on the Grant Date NAV per Class I Share, even beyond the initial grant and vesting date. At the end of each 12-month period following each vesting
date, if the Offset Amount has not been fully realized by offsets from the cash payments otherwise due and payable to our Advisor under the Advisory Agreement, our Advisor shall promptly pay any shortfall to us.
The chart below shows the grant dates, vesting dates, number of unvested shares as of June 30, 2017, and Grant Date NAV per Class I Share (share amounts in thousands).
Award
Grant
Date
Vesting Dates
Number of Unvested Shares
Grant Date NAV per Class I Share
Company RSU
2/25/2015
4/13/2018
66
$
7.18
Company
RSU
2/4/2016
4/15/2019
57
7.41
Total/ weighted average
123
$
7.29
Termination
The
Advisor RSU Agreements will automatically terminate upon termination or non-renewal of the Advisory Agreement by any party for any reason. In addition, upon a change in control of us, then either our Advisor or we may immediately terminate the Advisor RSU Agreements. Further, our Advisor may immediately terminate the Advisor RSU Agreements if we exercise certain rights under the Advisor RSU Agreements to replace the Company RSUs with another form of compensation.
Upon termination of the Advisor RSU Agreements, our Advisor will promptly pay any unused offset amounts
to us or, at our Advisor’s election, return Class I shares in equal value based on the Class I NAV as of the date of termination of the Advisor RSU Agreements. In addition, upon termination of the Advisor RSU Agreements, all unvested Company RSUs will be forfeited except that, unless the Advisor RSU Agreements were terminated at the election of our Advisor following a change in control of us or as a result of a premature termination of the Advisory Agreement at our election for cause (as defined in the Advisory Agreement) or upon the bankruptcy of our Advisor, then following such forfeiture of Company RSUs, our Advisor will have the right to acquire from us the number of Class I shares equal to the number of Company RSUs forfeited, in return for a purchase price equal to such number of Class I shares multiplied by the Grant Date NAV per Class I Share. The Advisor must notify us of its election to exercise the foregoing acquisition right within 30
days following the termination of the Advisor RSU Agreements, and the parties will close the transaction within 60 days following the termination of the Advisor RSU Agreements.
Dividend Equivalent Payments
If our board of directors declares and we pay a cash dividend on Class I shares for any period in which the Company RSUs are outstanding (regardless of whether such Company RSUs are then vested), our Advisor will be entitled to dividend equivalents (the “Dividend Equivalents”) with respect to that cash dividend equal to the cash dividends that would have been payable on the same number of Class I shares as the number of Company RSUs subject to the Advisor RSU Agreements had such Class I shares been outstanding during the same portion of such
period as the Company RSUs were outstanding. Any such Dividend Equivalents may be paid in cash or Class I shares, at our Advisor’s election.
Restricted Stock Grant
Effective February 2, 2017, we granted approximately 58,000 restricted shares of Class I common stock to certain employees of our Advisor and its affiliates at a price of $7.56 per share, of which 25% vested on the grant date with the remaining 75% vesting ratably over the next three anniversaries of the grant date. During the six months
ended June 30, 2017, approximately 38,000 shares of restricted stock vested at a weighted average price of $7.55, based on our NAV per share as of the vesting dates. During the six months ended June 30, 2017, we recorded approximately $210,000 within “general and administrative expenses” in the accompanying condensed consolidated statements of income. Our restricted stock generally vests ratably over a period of three to four years.
Private Placements of Delaware Statutory Trust
Interests
Private Placements
In March 2016, we, through our Operating Partnership, initiated a program to raise capital in private placements exempt from registration under the Securities Act of 1933, as amended (“Private Placements”), through the sale of beneficial interests (“Interests”) in specific Delaware statutory trusts holding real properties, including properties currently indirectly owned by our Operating Partnership (the “DST Program”). From 2006 through 2009, we, through our subsidiaries, conducted similar private placement offerings of fractional interests in which it raised a total of $183.1 million in gross proceeds. These fractional interests were all subsequently acquired by our Operating Partnership in exchange
for an aggregate of 17.7 million OP Units. As of June 30, 2017, we had sold approximately $6.1 million in Interests, which we include in "other liabilities" in our accompanying condensed consolidated balance sheets.
Each Private Placement will offer Interests in one or more real properties placed into one or more Delaware statutory trust(s) by our Operating Partnership or its affiliates (“DST Properties”). We anticipate that these Interests may serve as replacement properties for investors seeking to complete like-kind exchange transactions under Section 1031 of the Internal Revenue Code of 1986, as amended. Additionally, properties underlying Interests sold to investors pursuant to such Private Placements will be leased-back
by an indirect wholly owned subsidiary of our Operating Partnership on a long term basis of up to 29 years. The lease agreements are expected to be fully guaranteed by our Operating Partnership. Additionally, our Operating Partnership will retain a fair market value purchase option (“FMV Option”) giving it the right, but not the obligation, to acquire the Interests from the investors at a later time in exchange for OP Units.
In connection with the DST Program, in March 2016, Dividend Capital Exchange LLC (“DCX”),
a wholly owned subsidiary of our taxable REIT subsidiary that is wholly owned by our Operating Partnership, entered into a Dealer Manager Agreement with our Dealer Manager, pursuant to which our Dealer Manager agreed to conduct Private Placements for Interests reflecting an indirect ownership of up to $500 million of Interests. DCX will pay certain up-front fees and reimburse certain related expenses to the Dealer Manager with respect to capital raised through any such Private Placements. DCX is obligated to pay our Dealer Manager a dealer manager fee of up to 1.5% of gross equity proceeds raised and a commission of up to 5% of gross equity proceeds raised through the Private Placements. The Dealer Manager may re-allow such commissions and a portion of such dealer manager fee to participating broker dealers.
In
addition, we, or our subsidiaries, are obligated to pay directly or reimburse our Advisor and our Dealer Manager if they pay on our behalf, any organization and offering expenses (other than selling commissions and the dealer manager fee) as and when incurred. These expenses may include reimbursements for the bona fide due diligence expenses of participating broker-dealers, supported by detailed and itemized invoices, and similar diligence expenses of investment advisers, legal fees of our Dealer Manager, reimbursements for customary travel, lodging, meals and reasonable entertainment expenses of registered persons associated with our Dealer Manager, the cost of educational conferences held by us, including costs reimbursement for registered persons associated with our Dealer Manager and registered representatives of participating broker-dealers to attend educational conferences
sponsored by us, and attendance fees and costs reimbursement for registered persons associated with our Dealer Manager to attend seminars conducted by participating broker-dealers and promotional items.
We intend to recoup the costs of the selling commissions and dealer manager fees described above through a purchase price “mark-up” of the initial estimated fair value of the DST Properties to be sold to investors, thereby placing the economic burden of these up-front fees on the investors purchasing such Interests. In addition, to offset some or all of our organization and offering expenses associated with the Private Placements, we will add a purchase price mark-up of the estimated fair value of the DST Properties to be sold to investors in the amount of 1.5% of the gross equity proceeds. Collectively, these purchase price mark-ups total up to 8%
of the gross equity proceeds raised in the Private Placements. Additionally, we will be paid, by investors purchasing Interests, a non-accountable reimbursement equal to 1.0% of gross equity proceeds for real estate transaction costs that we expect to incur in selling or buying these Interests. Also, investors purchasing Interests will be required to pay their own respective closing costs upon the initial sale of the interests.
Limited Partnership Agreement
In connection with the launch of the DST Program, the Company, on behalf of itself as general partner and on behalf of all the limited partners thereto, entered into the Fifth Amended and Restated Limited Partnership Agreement of our Operating Partnership, dated as of March
2, 2016, which was further amended on August 2, 2016 (the “Amended and Restated Operating Partnership Agreement”). The Amended and Restated Operating Partnership Agreement amends the prior operating partnership agreement by establishing two series of Class E OP Units, with different redemption and registration rights. The currently existing third-party holders of Class E OP Units will now hold Series 1 Class E OP Units, and will continue to have the same redemption and registration rights they had previously, which include the right, in certain circumstances to require our Operating Partnership to redeem the OP Units for Class E shares of the Company or cash. Any purchasers of Interests in the DST Program that ultimately acquire OP Units through the FMV Option will acquire Series 2 Class E OP Units, which will have similar
redemption and registration rights to those of the holders of Series 1 Class E OP Units, except that their redemption rights will in certain circumstances require our Operating Partnership to redeem the OP Units for either Class I shares of the Company or cash (as determined by our Operating Partnership in its sole discretion). In addition, the Amended and Restated Operating Partnership Agreement provides that a redemption fee of 1.5% of the shares otherwise payable to a limited partner upon redemption of Series 2 Class E Units will be paid to an affiliate of the Manager (defined below). Holders of Series 1 or Series 2 Class E OP Units cannot require us to redeem their Series 1 or Series 2 Class E OP Units with cash.
DCX Manager LLC (the “Manager”), an affiliate of our Advisor, will be engaged to act as the manager of each Delaware statutory trust holding a DST Property. Although the intention is to sell 100% of the interests to third parties, DCX may hold an interest for a period of time and therefore could be subject to the following description of fees and reimbursements paid to the Manager. The Manager will have primary responsibility for performing administrative actions in connection with the trust and any DST Property and has the sole power to determine when it is appropriate for a trust to sell a DST Property. The Manager will be entitled to the following payments from the trust: (i) a management fee equal to a stated percentage (e.g., 1.0%) of the gross rents payable
to the trust, with such amount to be set on a deal-by-deal basis, (ii) a disposition fee of 1.0% of the gross sales price of any DST Property sold to a third party, and (iii) reimbursement of certain expenses associated with the establishment, maintenance and operation of the trust and DST Properties. Additionally, the Manager or its affiliate may earn a 1.0% loan fee for any financing arrangement sourced, negotiated and executed in connection with the DST Program. This loan fee is only payable to the Manager by new investors that purchase Interests and therefore is not paid by the Company or its affiliates.
Summary of Fees and Other Amounts
The following table summarizes fees and
other amounts earned by our Advisor and its related parties in connection with services performed for us during the three and six months ended June 30, 2017 and 2016 (amounts in thousands, except footnoted information):
Advisory fees related to the disposition of real properties
286
—
286
1,807
Development
management fee (3)
—
10
—
29
Primary dealer fee (4)
—
1,697
—
1,697
Selling
commissions
5
17
25
67
Dealer manager fees
116
89
228
174
Distribution
fees
19
17
38
34
Total
$
6,058
$
7,625
$
12,160
$
15,631
(1)
Amounts
reported for the three months ended June 30, 2017 and 2016 include approximately $154,000 and $282,000, respectively, that we were not obligated to pay in consideration of the issuance of Company RSUs to our Advisor. Amounts reported for the six months ended June 30, 2017 and 2016 include approximately $443,000 and $565,000, respectively, that we were not obligated to pay in consideration of the issuance of Company RSUs to our Advisor.
(2) Other
reimbursements paid to our Advisor for the three months ended June 30, 2017 and 2016 include approximately $1.7 million and $1.7 million, respectively, and include approximately $3.5 million and $3.6 million for the six months ended June 30, 2017 and 2016, respectively, to reimburse a portion of the salary, bonus and benefits for employees of our Advisor, including our executive officers, for services provided to us for which our Advisor does
not otherwise receive a separate fee. The balance of such reimbursements are made up primarily of other general overhead and administrative expenses, including, but not limited to, allocated rent paid to both third parties and affiliates of our advisor, equipment, utilities, insurance, travel and entertainment, and other costs.
(3)
Pursuant to our amended Advisory Agreement, our Advisor no longer receives a development management fee in exchange for providing development management services.
(4)
Amounts reported represent primary dealer
fees we paid to our Dealer Manager based on the gross proceeds raised by participating broker-dealers pursuant to certain selected dealer agreements. Of the primary dealer fee earned during the six months ended June 30, 2016, our Dealer Manager reallowed approximately $1.5 million to participating third-party broker-dealers and retained approximately $170,000.
See the accompanying condensed consolidated balance sheets for the amounts we owed to our Advisor and affiliates of our Advisor for such services and reimbursement of certain expenses as of June 30, 2017 and December 31,
2016. Pursuant to the Advisory Agreement, we accrue the advisory fee on a daily basis and pay our Advisor amounts due subsequent to each month-end. In addition, we recorded a liability of approximately $3.9 million for dealer manager and distribution fees that we estimate that we may pay to our Dealer Manager in future periods for shares of our common stock sold in our Follow-On Offering as of June 30, 2017. We anticipate that our Dealer Manager will reallow a significant portion of such fees to third-party broker dealers.
9. NET INCOME PER COMMON SHARE
Reconciliations of the numerator and denominator used to calculate basic net
income per common share to the numerator and denominator used to calculate diluted net income per common share for the three and six months ended June 30, 2017 and 2016 are described in the following table (amounts in thousands, except per share information):
For
the Three Months Ended June 30,
For the Six Months Ended June 30,
Numerator
2017
2016
2017
2016
Net income
$
8,415
$
135
$
10,242
$
48,373
Net
income attributable to noncontrolling interests
(1,610
)
(18
)
(1,776
)
(4,474
)
Net income attributable to common stockholders
6,805
117
8,466
43,899
Dilutive
noncontrolling interests share of net income
558
9
691
3,410
Numerator for diluted earnings per share – adjusted net income
$
7,363
$
126
$
9,157
$
47,309
Denominator
Weighted
average shares outstanding-basic
145,288
161,209
147,577
162,581
Incremental weighted average shares effect of conversion of OP units
11,921
12,460
11,974
12,598
Weighted
average shares outstanding-diluted
157,209
173,669
159,551
175,179
INCOME PER COMMON SHARE -BASIC AND DILUTED
$
0.05
$
0.00
$
0.06
$
0.27
10.
SEGMENT INFORMATION
We have three reportable operating segments, which include our three real property operating sectors (office, industrial, and retail), and we measure our profit and loss of our operating segments based on net operating income (“NOI”). We organize and analyze the operations and results of each of these segments independently, due to inherently different considerations for each segment. Such considerations include, but are not limited to, the nature and characteristics of the investment, investment strategies and objectives. Specifically, the physical characteristics of our buildings, the related operating characteristics, the geographic markets, and the type of tenants are inherently different for each of our segments. The following tables set forth revenue and the components of NOI of our segments for the
three and six months ended June 30, 2017 and 2016 (amounts in thousands):
For the Three Months Ended June 30,
Revenues
NOI
2017
2016
2017
2016
Office
$
27,624
$
30,983
$
16,224
$
20,846
Industrial
1,330
1,534
975
1,110
Retail
21,082
20,185
16,276
15,114
Total
$
50,036
$
52,702
$
33,475
$
37,070
For
the Six Months Ended June 30,
Revenues
NOI
2017
2016
2017
2016
Office
$
57,063
$
64,952
$
34,522
$
44,130
Industrial
2,901
3,245
1,978
2,377
Retail
42,580
40,049
32,040
29,789
Total
$
102,544
$
108,246
$
68,540
$
76,296
We
consider NOI to be an appropriate supplemental financial performance measure because NOI reflects the specific operating performance of our real properties, and excludes certain items that are not considered to be controllable in connection with the management of each property, such as depreciation and amortization, general and administrative expenses, advisory fees, acquisition-related expenses, interest and other (expense) income, interest expense, (gain) loss on extinguishment of debt and financing commitments, gain on the sale of real property, and noncontrolling interests. However, NOI should not be viewed as an alternative measure of our financial performance as a whole, since it excludes such items that could materially impact our results of operations. Further, our NOI may not be comparable to that of other real estate companies, as they may use different methodologies for calculating NOI. Therefore, we believe net income, as defined by GAAP, to be the most appropriate
measure to evaluate our overall financial performance.
The following table is a reconciliation of our reported net income attributable to common stockholders to our NOI for the three and six months ended June 30, 2017 and 2016 (amounts in thousands):
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Quarterly Report on Form 10-Q includes certain statements
that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such forward-looking statements may relate to, without limitation, our future capital expenditures, distributions and acquisitions (including the amount and nature thereof), other development trends of the real estate industry, business strategies, and the growth of our operations. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act. Such statements
are subject to a number of assumptions, risks and uncertainties that may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements are generally identifiable by the use of the words “may,”“will,”“should,”“expect,”“anticipate,”“estimate,”“believe,”“intend,”“project,”“continue,” or the negative of these words, or other similar words or terms. Readers are cautioned not to place undue reliance on these forward-looking statements. Among the factors that may cause our results to vary are general economic and business (particularly real estate and capital market) conditions being less favorable than expected, the business opportunities that may be presented to and pursued by us, changes in laws or regulations (including changes to laws governing
the taxation of REITs), risk of acquisitions, availability and creditworthiness of prospective tenants, availability of capital (debt and equity), interest rate fluctuations, competition, supply and demand for properties in our current and any proposed market areas, tenants’ ability to pay rent at current or increased levels, accounting principles, policies and guidelines applicable to REITs, environmental, regulatory and/or safety requirements, tenant bankruptcies and defaults, the availability and cost of comprehensive insurance, including coverage for terrorist acts, and other factors, many of which are beyond our control. For a further discussion of these factors and other risk factors that could lead to actual results materially different from those described in the forward-looking statements, see "Risk Factors" under (i) Item 1A of Part 1 of our Annual Report on Form 10-K, filed with the Securities and Exchange Commission ("the Commission") on March
3, 2017 and available at www.sec.gov and (ii) Part II, Item 1A of this Quarterly Report on Form 10-Q.
We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of future events, new information or otherwise.
This section of our Quarterly Report on Form 10-Q provides an overview of what management believes to be the key elements for understanding (i) our company and how we manage our business, (ii) how we measure our performance and our operating results, (iii) our liquidity and capital resources, and (iv) the financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
Overview
Dividend Capital Diversified Property Fund Inc. is a Maryland corporation formed on April 11, 2005 to invest in a diverse portfolio of real property and real estate related investments. As used herein, “the Company,”“we,”“our” and “us” refer to Dividend Capital Diversified Property Fund Inc. and its consolidated subsidiaries and partnerships except where the context otherwise requires.
We operate in such a manner so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes, and we utilize an Umbrella Partnership Real Estate Investment Trust (“UPREIT”) organizational structure
to hold all or substantially all of our assets through our operating partnership, Dividend Capital Total Realty Operating Partnership, L.P. (our “Operating Partnership”). Furthermore, our Operating Partnership wholly owns a taxable REIT subsidiary, DCTRT Leasing Corp., through which we execute certain business transactions that might otherwise have an adverse impact on our status as a REIT if such business transactions were to occur directly or indirectly through our Operating Partnership. We are an externally managed REIT and have no employees. Our day-to-day activities are managed by Dividend Capital Total Advisors LLC (our “Advisor”), a related party, under the terms and conditions of an advisory agreement (as amended from time to time, the “Advisory Agreement”).
The primary sources of our revenue and earnings include rent received from customers under operating leases at our properties, including reimbursements
from customers for certain operating costs. Our primary expenses include rental expenses, depreciation and amortization expenses, general and administrative expenses, advisory fees and interest expenses.
We currently have three business segments, consisting of investments in (i) office property, (ii) industrial property, and (iii) retail property. We may have additional segments in the future to the extent we enter into additional real property sectors, such as multifamily, hospitality, and other real property types. For a discussion of our business segments and the associated revenue and net operating
income by segment, see Note 10 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q. We also have investments in real estate related-debt investments (which we refer to as “debt-related investments”).
The following table summarizes our investments in real properties, by segment, using our estimated fair value of these investments as of June 30, 2017 (amounts in thousands):
Geographic
Markets
Number of Properties
Net Rentable Square Feet
% Leased (1)
Aggregate Fair Value
Office properties
13
16
3,404
81.3
%
$
1,187,550
Industrial
properties
2
2
1,173
75.3
%
54,850
Retail
properties
9
33
3,738
95.7
%
1,007,600
Real
properties
19 (2)
51
8,315
86.9
%
$
2,250,000
(1)
Percentage
leased is based on executed leases as of June 30, 2017.
(2)
The total number of our geographic markets does not equal the sum of the number of geographic markets by segment, as we have more than one segment in certain geographic markets.
We may target investments in four primary property categories of office, industrial, retail and multifamily. Although we may own properties in each of these categories, we are not tied to specific allocation targets and we may not always have significant holdings, or any holdings at all, in each category. For example, we do not currently own multifamily
investments, although we intend to consider multifamily investment opportunities in the future. Also, through the disposition of assets, our ownership of industrial assets has declined to less than 5% of our portfolio as of June 30, 2017. From 2013 through the first half of 2016, our investment strategy primarily focused on multi-tenant office and necessity-oriented, multi-tenant retail investments located in what we believe are strong markets poised for long-term growth. Our current investment strategy will continue to focus on these multi-tenant office and necessity-oriented, multi-tenant retail investments. We intend to also incorporate industrial properties into our current investment strategy. We are currently working on selling certain non-strategic office and retail assets. If successful, the disposition of these assets will help us to increase our allocation to industrial
real estate assets and our shorter term liquidity. However, there can be no assurance that we will be successful in this investment strategy, including with respect to any particular asset class. To a lesser extent we may invest in other types of real estate including, but not limited to, hospitality, medical offices, student housing and unimproved land. We anticipate that the majority of our real property investments will be made in the United States, although we may also invest in Canada and Mexico, and potentially elsewhere on a limited basis, to the extent that opportunities exist that may help us meet our investment objectives.
Any future and near-term obligations are expected to be funded primarily through the use of cash on hand, cash generated from operations, proceeds from our public offerings and other equity offerings, proceeds from the sale of existing investments, and the issuance and assumption of debt obligations.
•
Cash
on hand — As of June 30, 2017, we had approximately $5.4 million of cash and cash equivalents.
•
Cash available under our credit facility — As of June 30, 2017, the unused portion of our line of credit was approximately $124.7 million, all of which was available to us.
•
Cash
generated from operations — During the six months ended June 30, 2017, we generated approximately $35.6 million from operations of our real properties and income from debt-related investments.
•
Proceeds from offerings of equity securities — We currently maintain a public offering of our shares of common stock. During the six months ended June 30, 2017, we raised approximately $15.3 million in proceeds from the sale of
Class A, W, and I shares in our current follow-on public offering, which commenced on September 16, 2015, including approximately $3.6 million under the distribution reinvestment plan. Additionally, during the six months ended June 30, 2017, we received approximately $6.6 million in proceeds from the distribution reinvestment plan offering of our unclassified shares of common stock, which we refer to as “Class E” shares (the “Class E DRIP Offering”). Additionally, during the six months ended June 30, 2017, we had raised approximately $3.5 million in proceeds from the sale of beneficial
interests in specific Delaware statutory trusts holding real properties, which we include in "other liabilities" in our accompanying condensed consolidated balance sheets.
We believe that our existing cash balance, cash generated from operations, proceeds from our public offerings and our ability to sell investments and to issue debt obligations remains adequate to meet our expected capital obligations for the next twelve months.
Significant Transactions During the Six Months Ended June
30, 2017
Investment Activities
Real Property Dispositions
During the six months ended June 30, 2017, we completed the disposition of four properties aggregating approximately 660,000 net rentable square feet for an aggregate sales price of approximately $31.3 million. For additional discussion of our real property dispositions, see Note 3 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
Please see "Subsequent Events" included in "Item 2. Management's Discussion and Analysis" of this Quarterly Report
on Form 10-Q for additional information regarding investment activities occurring subsequent to June 30, 2017.
Financing Activities
Self-Tender Offer
During the six months ended June 30, 2017, we completed two self-tender offers pursuant to which we accepted for purchase approximately 11.8 million unclassified shares of common stock, which we refer to as “Class E” shares, at a weighted average purchase price of $7.50 per share for an aggregate cost of approximately $88.2 million.
We funded the purchases with draws on our revolving credit facility.
Repayment of Mortgage Borrowing
During the six months ended June 30, 2017, we repaid four mortgage note borrowings in full with an aggregate balance of approximately $160.8 million at the time of the payoffs and a weighted average interest rate of 5.74%. We funded the repayment with proceeds from our revolving credit facility and our mortgage note borrowings discussed below. For additional information on this repayment, see Note 4 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
Mortgage
Note Borrowing
During the six months ended June 30, 2017, we received proceeds of approximately $202.0 million from two mortgage note borrowings both subject to an interest rate spread of 2.25% over one-month LIBOR. For additional information on these borrowings, see Note 4 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
Please see "Subsequent Events" included in "Item 2. Management's Discussion and Analysis" of this Quarterly Report on Form 10-Q for additional information regarding financing activities occurring subsequent to June 30, 2017.
Net
Asset Value Calculation
Our board of directors, including a majority of our independent directors, has adopted valuation procedures that contain a comprehensive set of methodologies to be used in connection with the calculation of our NAV on a daily basis. One fundamental element of the valuation process, the valuation of our real property portfolio, is managed by Altus Group U.S., Inc., an independent valuation firm (“the Independent Valuation Firm”) approved by our board of directors, including a majority of our independent directors. All parties engaged by us in the calculation of our NAV, including the Advisor, are subject to the oversight of our board of directors. As part of this process, our Advisor reviews the estimates of the values of our real property portfolio and real estate-related assets for consistency with our valuation guidelines and the overall reasonableness of the valuation conclusions, and informs
our board of directors of its conclusions (as needed, but at least once per year as part of their annual review, described below). Although our Independent Valuation Firm or other pricing sources may consider any comments received from us or our Advisor to their individual valuations, the final estimated values of our real properties or certain other assets and liabilities are determined by the Independent Valuation Firm or other pricing source. Our Independent Valuation Firm is available to meet with our board of directors to review valuation information, as well as our valuation guidelines and the operation and results of the valuation process generally. Our board of directors has the right to engage additional valuation firms and pricing sources to review the valuation process or valuations, if deemed appropriate. Every month our senior management team and our Independent Valuation Firm hold an NAV committee meeting to review the prior month’s adjustments to NAV and
discuss any possible changes to the NAV policies and procedures which may be recommended to the board of directors. The information reviewed by this committee is summarized for the audit committee. At least once each calendar year our board of directors, including a majority of our independent directors, reviews the
appropriateness of our valuation procedures. With respect to the valuation of our properties, the Independent Valuation Firm provides the board of directors with periodic valuation reports. From time to time our board of directors, including a majority of our independent directors, may adopt changes to the valuation procedures if it (1) determines
that such changes are likely to result in a more accurate reflection of NAV or a more efficient or less costly procedure for the determination of NAV without having a material adverse effect on the accuracy of such determination or (2) otherwise reasonably believes a change is appropriate for the determination of NAV. We will publicly announce material changes to our valuation procedures or the identity or role of the Independent Valuation Firm.
The following table sets forth the components of NAV for the Company as of June 30, 2017 and March 31, 2017 (amounts in thousands except per share information). As used below, “Fund Interests” means our
Class E shares, Class A shares, Class W shares, and Class I shares, along with the OP Units held by third parties, and “Aggregate Fund NAV” means the NAV of all of the Fund Interests.
When
the fair value of our real estate assets is calculated for the purposes of determining our NAV per share, the calculation is done using the fair value methodologies detailed within the Financial Accounting Standards Board ("FASB") Accounting Standards Codification under Topic 820, Fair Value Measurements and Disclosures (“ASC Topic 820”). However, our valuation procedures and our NAV are not subject to accounting principles generally accepted in the United States (“GAAP”) and will not be subject to independent audit. In the determination of our NAV, the value of certain of our assets and liabilities are generally determined based on their carrying amounts under GAAP; however, those principles are generally based upon historic cost and therefore may not be determined in accordance with ASC Topic 820. Readers should refer to our financial statements for our net book value determined in accordance with
GAAP from which one can derive our net book value per share by dividing our stockholders’ equity by shares of our common stock outstanding as of the date of measurement.
Our valuation procedures, which address specifically each category of our assets and liabilities and are applied separately from the preparation of our financial statements in accordance with GAAP, involve adjustments from historical cost. There are certain factors which cause NAV to be different from net book value on a GAAP basis. Most significantly, the valuation of our real estate assets, which is the largest component of our NAV calculation, will be provided to us by the Independent Valuation Firm on a daily basis. For GAAP purposes, these assets are generally recorded at depreciated or amortized cost. We generally do not undertake to mark-to-market our debt-related investments or real estate-related liabilities, but rather these assets and liabilities
are usually included in our determination of NAV at amounts determined in accordance with GAAP, which amounts have been and could in the future be materially different from the amount of these assets and liabilities if we were to undertake to mark-to-market our debt. Also for NAV purposes, we mark-to-market our hedging instruments on a frequency that management determines to be practicable under the circumstances and currently we seek to mark-to-market our hedging instruments on a weekly basis. However, our NAV policies and procedures allow for that frequency to change to be more or less frequent. Other examples that will cause our NAV to differ from our GAAP net book value include the straight-lining of rent, which results in a receivable for GAAP purposes that is not included in the determination of our NAV, and, for purposes of determining our NAV, the assumption of a value of zero in certain instances where the balance of a loan exceeds the value of the underlying
real estate properties, where GAAP net book value would reflect a negative equity value for such real estate properties, even if such loans are non-recourse. Third party appraisers may value our individual real estate assets using appraisal standards that deviate from fair value standards under GAAP. The use of such appraisal standards may cause our NAV to deviate from GAAP fair value principles. We did not develop our valuation procedures with the intention of complying with fair value concepts under GAAP and, therefore, there could be differences
between our fair values and the fair values derived from the principal market or most advantageous market
concepts of establishing fair value under GAAP.
Under GAAP, we record liabilities for dealer manager and distribution fees that we (i) currently owe Black Creek Capital Markets, LLC (f/k/a Dividend Capital Securities LLC) (our “Dealer Manager”) under the terms of our Dealer Manager agreement and (ii) for an estimate that we may pay to our Dealer Manager in future periods for shares of our common stock sold pursuant to the prior offering, which commenced on July 12, 2012 and terminated on September 15, 2015, and the current follow-on offering, which commenced on September 16, 2015. As of June 30, 2017, we recorded a total liability for dealer manager and distribution fees of approximately
$3.9 million, comprised of a $45,000 current payable to our dealer manager and a $3.9 million estimated liability for dealer manager and distributions fees that we may pay to our dealer manager in future periods. We do not deduct the $3.9 million liability for estimated future dealer manager and distribution fees in our calculation of NAV since we intend for our NAV to reflect our estimated value on the date that we determine our NAV. Accordingly, our estimated NAV at any given time should not include consideration of any estimated future dealer manager and distribution fees that may become payable after such date.
We include no discounts to our NAV for the illiquid nature of our shares, including the limitations on your ability to redeem shares
under our share redemption programs or tender pursuant to self-tender offers and our ability to suspend or terminate our share redemption programs or tender pursuant to self-tender offers at any time. Our NAV generally does not consider exit costs (e.g. selling costs and commissions related to the sale of a property) that would likely be incurred if our assets and liabilities were liquidated or sold. While we may use market pricing concepts to value individual components of our NAV, our per share NAV is not derived from the market pricing information of open-end real estate funds listed on stock exchanges.
Please note that our NAV is not a representation, warranty or guarantee that: (1) we would fully realize our NAV upon a sale of our assets; (2) shares of our common stock would trade at our per share NAV on a national securities exchange; and (3) a stockholder would be able to realize the per share NAV if such stockholder
attempted to sell his or her shares to a third party.
The June 30, 2017 valuation for our real properties was provided by the Independent Valuation Firm in accordance with our valuation procedures and determined starting with the appraised value. The aggregate real property valuation of $2.25 billion compares to a GAAP basis of real properties (before accumulated amortization and depreciation and the impact of intangible lease liabilities) of $2.09 billion, representing an increase of approximately $161.9 million or 7.8%. Certain key assumptions that were used by our Independent Valuation Firm in the discounted cash flow analysis are set forth in the
following table based on weighted averages by property type.
Office
Industrial
Retail
Weighted Average Basis
Exit
capitalization rate
6.59
%
8.00
%
6.41
%
6.55
%
Discount rate / internal rate of return ("IRR")
7.31
%
8.44
%
6.96
%
7.18
%
Annual
market rent growth rate
3.17
%
3.00
%
2.81
%
3.00
%
Average holding period (years)
10.2
12.0
10.1
10.2
A
change in the rates used would impact the calculation of the value of our real properties. For example, assuming all other factors remain constant, an increase in the weighted-average annual discount rate/IRR and the exit capitalization rate of 0.25% would reduce the value of our real properties by approximately 1.95% and 2.32%, respectively.
The following table sets forth the quarterly changes to the components of NAV for the Company and the reconciliation of NAV changes for each class of shares (amounts in thousands,
except per share information):
Set forth below is a discussion of our operating results, followed by a discussion of FFO (as defined below), which we consider to be a meaningful supplemental measure of our operating performance. We also use net operating income ("NOI") as a supplemental financial performance measure because NOI reflects the specific operating performance of our real properties and debt-related investments and excludes certain items that are not considered to be controllable in connection with the management of each property, such as other-than-temporary impairment, losses related to provisions for losses on debt-related investments, gains or losses on derivatives, acquisition-related expenses, gains or losses on extinguishment of debt and financing commitments, interest income, depreciation and amortization, general and administrative expenses, advisory fees, interest expense and noncontrolling
interests. However, NOI should not be viewed as an alternative measure of our operating financial performance as a whole, since it does exclude such items that could materially impact our results of operations. Further, our NOI may not be comparable to that of other real estate companies, as they may use different methodologies for calculating NOI. Therefore, we believe net income, as defined by GAAP, to be the most appropriate measure to evaluate our overall financial performance. We present NOI in the tables below, and include a reconciliation to net income, as defined by GAAP, in Note 10 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
Net Income Attributable to Common Stockholders
Our net income attributable to common
stockholders increased to approximately $6.8 million for the three months ended June 30, 2017 from approximately $117,000 for the three months ended June 30, 2016. The increase was primarily a result of a gain on sale of real property, largely driven by the disposition of three industrial properties ("the Industrial Portfolio") during the three months ended June 30, 2017, partially offset by (i) a decrease in real property NOI from continuing operations primarily as a result of the expiration of our
lease with Sybase Inc. ("Sybase") in January 2017 and 2016 real estate property disposition activity and (ii) an impairment of real estate property during the three months ended June 30, 2017.
Our net income attributable to common stockholders decreased to approximately $8.5 million for the six months ended June 30, 2017 from approximately $43.9 million for the six months ended June 30, 2016. The decrease was primarily a result of (i) a decrease in gain
on sale of real property and a decrease in gain on extinguishment of debt and financing, largely driven by the disposition of three office properties during the six months ended June 30, 2016 and (ii) a decrease in real
property NOI from continuing operations primarily as a result of the expiration of our lease with Sybase in January 2017 and 2016 real estate property disposition activity, partially offset by a decrease in interest expense.
The following series of tables and discussions describe in more detail our
results of operations, including those items specifically mentioned above, for the three and six months ended June 30, 2017 compared to the three and six months ended June 30, 2016.
Three and Six-Months Comparison
Our results of rental activities are presented in two groups: (i) all operating properties that we acquired prior to January 1, 2016 and owned through June 30, 2017 (the “Same
Store Portfolio”), providing meaningful comparisons for the three and six months ended June 30, 2017 and the three and six months ended June 30, 2016, and (ii) all other operating properties, which were acquired or disposed during the same period (the “Non-Same Store Portfolio”). The Same Store Portfolio includes 50 properties, comprising approximately 8.2 million square feet or 99.0% of our total portfolio when measured by square feet.
The following table illustrates the changes in rental revenues,
rental expenses, and net operating income for the three and six months ended June 30, 2017 compared to the three and six months ended June 30, 2016 (dollar amounts in thousands, except footnoted information).
Base
rental revenue represents contractual base rental revenue earned by us from our tenants and does not include the impact of certain GAAP adjustments to rental revenue, such as straight-line rent adjustments, amortization of above-market intangible lease assets or the amortization of below-market lease intangible liabilities. Such GAAP adjustments and other rental revenue such as expense recovery revenue are included in the line item referred to as “other rental revenue.”
(2)
Our same store NOI includes certain non-cash GAAP adjustments for rental revenue for straight line rent and amortization of above market lease assets and below market lease liabilities that caused a increase to GAAP NOI of approximately $376,000
and $67,000 for the three months ended June 30, 2017 and 2016, respectively, and approximately $709,000 and $200,000 for the six months ended June 30, 2017 and 2016, respectively.
(3)
For a discussion as to why we view net operating income to be an appropriate supplemental
performance measure, refer to “Our Operating Results” above. See also Note 10 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
The table below presents the factors contributing to the decrease in our same store base rental revenue for the three months ended June
30, 2017 and 2016 (dollar amounts other than annualized base rent per square foot in thousands):
Same
Store Portfolio
Base Rent for the Three Months Ended June 30,
Average % Leased for the Three Months Ended June 30,
Annualized Base Rent per Square Foot for the Three Months Ended June 30 (1),
2017
2016
$
Change
2017
2016
2017
2016
Office
$
20,918
$
25,322
$
(4,404
)
82.0
%
95.8
%
$
29.98
$
31.05
Industrial
860
838
22
75.3
%
75.3
%
3.89
3.79
Retail
14,911
14,765
146
94.8
%
94.9
%
17.21
17.03
Total
base rental revenue - same store
$
36,689
$
40,925
$
(4,236
)
86.7
%
92.5
%
$
20.55
$
21.50
(1)
Represents
contractual base rent and does not include the impact of tenant concessions, such as free rent and tenant reimbursements.
Base rental revenue in our Same Store Portfolio decreased for the three months ended June 30, 2017, compared to the same period in 2016, primarily due to a decrease in our office portfolio as a result of the Sybase lease expiration in January 2017. Excluding the impact of the Sybase lease expiration, base rental revenue in our Same Store Portfolio increased approximately $422,000 to $36.7 million for the three months ended June 30, 2017
from approximately $36.3 million for the same period in 2016 primarily due to an increase in annualized base rent per square foot in our office portfolio for the three months ended June 30, 2017, resulting from scheduled rent escalations for existing leases and improving rental rates for new and renewal leases.
The table below presents the factors contributing to the decrease in our same store base rental revenue for the six months ended June 30, 2017 and 2016 (dollar amounts other than annualized base rent
per square foot in thousands):
Same Store Portfolio
Base Rent For the Six Months Ended June 30,
Average
% Leased For the Six Months Ended June 30,
Annualized Base Rent per Square Foot for the Six Months Ended June 30 (1),
2017
2016
$ Change
2017
2016
2017
2016
Office
$
43,668
$
50,297
$
(6,629
)
85.9
%
95.8
%
$
29.85
$
30.83
Industrial
1,720
1,675
45
75.3
%
75.3
%
3.89
3.79
Retail
29,800
29,556
244
94.6
%
94.6
%
17.23
17.09
Total
base rental revenue - same store
$
75,188
$
81,528
$
(6,340
)
88.3
%
92.4
%
$
20.69
$
21.44
(1)
Represents
contractual base rent and does not include the impact of tenant concessions, such as free rent and tenant reimbursements.
Base rental revenue in our Same Store Portfolio decreased for the six months ended June 30, 2017, compared to the same period in 2016, primarily due to a decrease in our office portfolio as a result of the Sybase lease expiration in January 2017. Excluding the impact of the Sybase lease expiration, base rental revenue in our Same Store Portfolio increased approximately $1.4 million to $73.6 million for the six months ended June
30, 2017, from approximately $72.2 million for the same period in 2016 primarily due to an increase in annualized base rent per square foot in our office portfolio for the six months ended June 30, 2017, resulting from scheduled rent escalations for existing leases and improving rental rates for new and renewal leases.
Other Rental Revenue - Same Store
Same store other rental revenue increased for the three and six months ended June 30, 2017, compared to the same periods in 2016,
primarily due to a decrease in unfavorable straight-line and above-market rent adjustments resulting from the Sybase lease expiration in January 2017. Excluding the impact of the Sybase lease expiration, other rental revenue in our Same Store Portfolio was relatively flat for the three and six months ended June 30, 2017, compared to the same periods in 2016.
The
table below presents the amounts recorded and changes in rental expense of our Same Store Portfolio for the three and six months ended June 30, 2017 and 2016 (dollar amounts in thousands):
The
increase in real estate taxes of the Same Store Portfolio for the three and six months ended June 30, 2017, compared to the same periods in 2016, is primarily attributable to (i) certain real estate taxes are no longer tenant paid as a result of the Sybase lease expiration in January 2017 and (ii) an increase in property values. The increase in repairs and maintenance expenses of the Same Store Portfolio for the three and six months ended June 30, 2017, compared to the same periods in 2016, is primarily attributable
to an increase in the number of painting and parking lot repairs during the three and six months ended June 30, 2017 compared to the same periods in 2016. The decrease in other expenses of the Same Store Portfolio for the three and six months ended June 30, 2017, compared to the same periods in 2016 is primarily attributable to decrease in reserves for bad debt in our retail portfolio.
Real Property – Non-Same Store Portfolio
The increase in rental revenue and NOI
in our Non-Same Store Portfolio for the three months ended June 30, 2017, compared to the same period in 2016 is primarily attributable to the acquisition of a retail property in May 2016 partially offset by the disposition of real properties during 2017 and 2016.
The decrease in rental revenue and NOI in our Non-Same Store Portfolio for the six months ended June 30, 2017, compared to the same period in 2016 is primarily attributable to the disposition of an office property in Washington, DC in February 2016 partially offset by the acquisition of a retail
property in May 2016.
Other Operating Expenses
Real Estate Depreciation and Amortization Expense
Depreciation and amortization expense decreased for three and six months ended June 30, 2017 compared to the same periods in 2016 primarily due to certain intangible lease assets becoming fully amortized partially offset by the write-off of certain intangible lease assets as a result of early lease terminations.
General and Administrative Expenses
General and administrative expenses decreased for
three and six months ended June 30, 2017 compared to the same periods in 2016, primarily due to a decrease in reimbursements paid to our Advisor due to lower acquisition activity during the three and six months ended June 30, 2017.
Advisory Fees
The decrease in advisory fees for three and six months ended June 30, 2017 compared to the same periods in 2016 primarily resulted
from the common stock redemptions pursuant to our self-tender offerings in 2016 and 2017. See Note 8 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q for further discussion of all fees and reimbursements that we paid to our Advisor during the three and six months ended June 30, 2017 and 2016.
We
recorded $1.1 million in impairment charges during the three and six months ended June 30, 2017 due to the net book value of a retail property exceeding the contract sales price less cost prior to disposition. We recorded approximately $587,000 in impairment charges related to our real properties during the six months ended June 30, 2016.
See Note 3 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q for further discussion of impairment charges recorded
during the three and six months ended June 30, 2017 and 2016.
Other Income (Expenses)
Interest Expense
Interest expense decreased for the three and six months ended June 30, 2017, compared to the same periods in 2016, primarily due to a decrease of the weighted average interest rate to 3.3% as of June 30,
2017 from 3.6% as of June 30, 2016. During 2017 and 2016, we repaid $487.0 million of mortgage note borrowings with proceeds from our revolving line of credit and issued $287.5 million of new mortgage note borrowings. The following table further describes our interest expense by debt obligation, and includes amortization of deferred financing costs, amortization related to our derivatives, and amortization of discounts and premiums for the three and six months ended June 30, 2017 and
2016 (amounts in thousands):
For the Three Months Ended June 30,
For the Six Months Ended June 30,
Debt
Obligation
2017
2016
2017
2016
Mortgage notes
$
3,496
$
6,263
$
7,123
$
13,109
Unsecured
borrowings
6,606
4,155
12,627
8,270
Financing obligations
61
4
97
4
Total
interest expense
$
10,163
$
10,422
$
19,847
$
21,383
Gain
on Extinguishment of Debt and Financing Commitments
During the six months ended June 30, 2016, we had a gain of approximately $5.1 million on extinguishment of debt and financing commitments. The gain in 2016 resulted from the extinguishment of a $5.1 million contingently payable mortgage note that was not ultimately required to be repaid. There was no comparable transaction in 2017.
Gain on Sale of Real
Property
During the three months ended June 30, 2017, we had a gain on sale of real property of approximately $10.4 million. During the six months ended June 30, 2017 and 2016, we had a gain on sale of real property of approximately $10.4 million and $41.4 million, respectively. For a detailed discussion of the real properties we disposed of during the three and six months ended June 30,
2017 and 2016, see Note 3 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
How We Measure Our Operating Performance
Funds From Operations
FFO Definition (“FFO”)
We believe that FFO, as defined by the National Association of Real Estate Investment Trusts (“NAREIT”), is a meaningful supplemental measure of our operating performance because historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time, as reflected through
depreciation and amortization expense. However, since real estate values have historically risen or fallen with market and other conditions, many industry investors and analysts have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient. Thus, NAREIT created FFO as a supplemental measure of operating performance for real estate investment trusts that consists of net income (loss), calculated in accordance with GAAP, plus real estate-related depreciation and amortization and impairment of depreciable real estate, less gains (or losses) from dispositions of real estate held for investment purposes.
The
following table presents a reconciliation of FFO to net income for the three and six months ended June 30, 2017 and 2016 (amounts in thousands, except per share information):
FFO is presented herein as a supplemental financial measure and has inherent limitations. We do not use FFO as, nor should it be considered to be, an alternative to net income (loss) computed under GAAP as an indicator of our operating performance, or as an alternative to cash from operating activities computed under GAAP, or as an indicator of liquidity or our ability to fund our short or long-term cash requirements, including distributions to stockholders. Management uses FFO, in addition to net income (loss) computed under GAAP and cash flows from operating activities computed under GAAP, to evaluate our consolidated operating performance and as a guide to making decisions about future investments. Our FFO calculation does not present, nor do we intend it to present, a complete picture of our financial condition and operating performance. We caution investors against
using FFO to determine a price to earnings ratio or yield relative to our NAV. We believe that net income (loss) computed under GAAP remains the primary measure of performance and that FFO is only meaningful when used in conjunction with net income (loss) computed under GAAP. Further, we believe that our consolidated financial statements, prepared in accordance with GAAP, provide the most meaningful picture of our financial condition and operating performance.
Further, FFO is not comparable to the performance measure established by the Investment Program Association (the “IPA”), referred to as “modified funds from operations,” or “MFFO,” as MFFO makes further adjustments including certain mark-to-market items and adjustments for the effects of straight-line rent. As such, FFO may not be comparable to the MFFO of non-listed REITs that
disclose MFFO in accordance with the IPA standard.
We believe our existing cash balance, our available credit under our revolving credit facilities, cash from operations, additional proceeds from our public offerings, proceeds from the sale of existing investments, and prospective debt or equity issuances will be sufficient to meet our liquidity and capital needs for the foreseeable future, including the next 12 months.
Our capital requirements over the next 12 months are anticipated to include, but are not limited to, operating expenses, distribution payments, debt service payments, including debt maturities of approximately $277.2 million, redemption payments, issuer tender offers, and acquisitions of real property and debt-related investments. Borrowings that are subject to extension options are also subject to certain lender covenants and restrictions that we must meet to extend the initial maturity date. We currently believe that we will qualify for these extension options. However, we cannot guarantee that we will meet the requirements to extend the notes upon initial maturity. In the event that we do not qualify to extend the notes, we expect to repay them with proceeds from new borrowings or available proceeds from our revolving credit facility.
In order to maintain a reasonable level of
liquidity for redemptions of Class A, Class W and Class I shares pursuant to our Second Amended and Restated Class A, W and I Share Redemption Program (the “Class AWI SRP”), we intend to generally maintain under normal circumstances the following aggregate allocation to sources of liquidity, which include liquid assets and capacity under our borrowing facilities: (1) 10% of the aggregate NAV of our outstanding Class A, Class W and Class I shares up to $1 billion of collective Class A, Class W and Class I share NAV, and (2) 5% of the aggregate NAV of our outstanding Class A, Class W and Class I shares in excess of $1 billion of collective Class A, Class W and Class I share NAV. However, as set forth in the Class AWI SRP, no assurance can be given that we will maintain this allocation to liquid assets. Our board of directors has the right to modify, suspend or terminate our Class AWI SRP if it deems such action to be in the best interest of our stockholders. As
of June 30, 2017, the aggregate NAV of our outstanding Class A, Class W and Class I shares was approximately $292.2 million.
We calculate our leverage for reporting purposes as the outstanding principal balance of our total borrowings divided by the fair value of our real property and debt-related investments. Based on this methodology, our leverage was 49.1% as of June 30, 2017. There are other methods of calculating our overall leverage ratio that may differ from this methodology, such as the methodology used in determining our compliance with corporate borrowing covenants. Our leverage, as calculated under our corporate borrowing covenants,
was 52.3% as of June 30, 2017.
As of June 30, 2017, we had approximately $5.4 million of cash and cash equivalents compared to $13.9 million as of December 31, 2016. The following discussion summarizes the sources and uses of our cash during the six months ended June 30, 2017.
Operating Activities
Net
cash provided by operating activities decreased by approximately $7.8 million to approximately $35.6 million for the six months ended June 30, 2017 from approximately $43.4 million for the same period in 2016. The decrease is primarily due to (i) a decrease in NOI as discussed previously under "Our Operating Results.
Lease Expirations
Our primary source of funding for our property-level operating expenses and debt service payments is rent collected pursuant to our tenant leases. Our operating portfolio was approximately
86.9% leased as of June 30, 2017, compared to approximately 90.2% as of June 30, 2016. Our properties are generally leased to tenants for terms ranging from three to ten years. As of June 30, 2017, the weighted average remaining term of our leases was approximately 4.4 years, based on annualized base rent, and 4.8 years, based on leased square footage.
The following is a schedule of expiring leases for our consolidated operating properties by annualized base rent and square footage as of June 30, 2017 and assuming no exercise of lease renewal options (dollar amounts and square footage amounts in thousands, except footnoted information):
Lease
Expirations
Year (1)
Number of Leases Expiring
Annualized Base Rent (2)
%
Square Feet
%
2017
(3)
44
$
13,832
9.1
%
442
6.1
%
2018
110
10,538
7.0
%
454
6.3
%
2019
107
24,885
16.4
%
1,122
15.4
%
2020
116
24,412
16.1
%
1,117
15.4
%
2021
63
16,384
10.8
%
1,260
17.3
%
2022
63
12,803
8.5
%
690
9.5
%
2023
43
17,604
11.6
%
690
9.5
%
2024
26
5,364
3.5
%
335
4.6
%
2025
17
4,029
2.7
%
149
2.1
%
2026
17
3,241
2.1
%
182
2.5
%
Thereafter
40
18,374
12.2
%
822
11.3
%
Total
646
$
151,466
100.0
%
7,263
100.0
%
(1)
The lease expiration year does not include the consideration of any renewal or extension options. Also, the lease expiration year is based on noncancellable lease terms and does not extend beyond any early termination rights that the tenant may have under the lease.
(2)
Annualized base rent represents the annualized monthly base rent of leases executed as of June 30, 2017.
(3)
Represents
the number of leases expiring and annualized base rent for the remainder of 2017. Includes 11 leases with annualized base rent of approximately $319,000 that are on a month-to-month basis. In January 2017, our lease with Sybase, our second largest tenant as of December 31, 2016 based upon annualized base rent, was terminated and is no longer included in the above table.
Our most significant lease is Charles Schwab & Co., Inc. ("Schwab") which leases 100% of a 594,000 square foot office property in Northern New Jersey (“3 Second Street", formerly known as Harborside). The Schwab lease will expire September 2017 and we do not expect the lease to be renewed or extended. The Schwab lease comprises $23.5
million, or 15.5%, of our total annualized base rent as of June 30, 2017 and $8.1 million, or 11.8%, of our total NOI for the six months ended June 30, 2017. As of June 30, 2017, the Schwab lease comprises 7.1% of our total portfolio when measured in square feet.
However, 3 Second Street is 100% subleased to 25 tenants through September 2017 and furthermore 11
of these subleases comprising 368,000 square feet or 62% of 3 Second Street, have executed leases directly with us that effectively extend their leases beyond the Schwab lease expiration. These direct leases will expire between September 2020 and September 2032. As a result, the above lease expiration table includes these direct leases in the years in which the leases will expire, as opposed to reflecting the full impact of the lease expiration of the current in-place lease with Schwab in 2017.
When the Schwab lease expires we may be forced to offer concessions in order to attract new tenants. In addition, we may be required to expend substantial funds to construct new tenant improvements in the vacated space and incur leasing costs. As a result, and until this property is released, we would expect the expiration of the Schwab lease
to negatively impact our operating results and cash flows.
During the six months ended June 30, 2017, we signed new leases for approximately 337,000 square feet and renewal leases for approximately 239,000 square feet. Notable new leases during the three months ended June 30, 2017 includes (i) a 53,000 square foot lease with WeWork LLC to replace HotWire, Inc. at an office property in San Fransisco, CA and (ii) a 40,000 square foot lease with Burlington Stores Inc. to replace a vacant space at a retail property in Philadelphia, PA due to Sports Authority's bankruptcy. Subsequent to June 30,
2017, we entered into a 73,000 square foot lease with Trinet Group, Inc. at an office property in East Bay, CA to partially replace Sybase.
Tenant improvements and leasing commissions related to these leases were approximately $9.9 million and $3.0 million, respectively, or $17.19 and $5.27 per square foot, respectively. Of the leases, approximately 168,000 square feet were considered comparable leases, with average straight line rent growth of 54.8%, and tenant improvements and incentives of approximately $89.17 per square foot. Comparable leases comprise leases for which prior
leases were in place for the same suite within twelve months of executing a new lease. Comparable leases must have terms of at least six months and the square footage of the suite occupied by the prior tenant cannot be more or less than 50% different from the size of the new lease's suite.
We had net cash used in investing activities of approximately $19.2 million for the six months ended June 30, 2017,
compared to net cash provided by investing activities of approximately $98.0 million for the same period in 2016. The $78.8 million change is primarily due to a $146.9 million decrease in proceeds from disposition of real properties, partially offset by a (i) a $65.9 million decrease in cash paid to acquire operating properties and (ii) a $2.3 million decrease in capital expenditures.
Financing Activities
Net cash used in financing activities
decreased approximately $76.7 million to approximately $63.3 million for the six months ended June 30, 2017 from $140.0 million for the same period in 2016. The decrease is primarily due to a $121.7 million increase in cash received from net borrowing activities, partially offset by (i) a $7.0 million increase in cash paid for redemption of common shares and (ii) a $37.8 million decrease in proceeds from the sale of our common shares.
During
the six months ended June 30, 2017 and 2016, we raised approximately $15.3 million and $51.4 million in proceeds from the sale of Class A, W, and I shares, respectively, including approximately $3.6 million and $2.6 million under the distribution reinvestment plan, respectively. The decline in proceeds largely resulted from a primary dealer offering during the three months ended June 30, 2016. We have offered and will continue to offer Class E shares of common stock through the Class E DRIP Offering. The
amount raised under the Class E DRIP Offering decreased by approximately $1.0 million to approximately $6.6 million for the six months ended June 30, 2017, from approximately $7.6 million for the same period in 2016.
Debt Maturities
One of our borrowings with an aggregate outstanding balance as of June 30, 2017 of approximately $275.0 million has a maturity before January 1, 2019; however, this
borrowing is subject to two one-year extension options. For additional information on our upcoming debt maturities, see Note 4 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
Distributions
To obtain the favorable tax treatment accorded to REITs, we normally will be required each year to distribute to our stockholders at least 90% of our real estate investment trust taxable income, determined without regard to the deduction for distributions paid and by excluding net capital gains. The payment of distributions is determined by our board of directors and may be adjusted at its discretion at any time. Distribution levels are set by our board of directors at a level it believes to be appropriate and sustainable based upon a review of a variety of factors including the current
and anticipated market conditions, current and anticipated future performance and make-up of our investments, our overall financial projections and expected future cash needs.
The following table sets forth the amounts and sources of distributions declared for the three and six months ended June 30, 2017 and 2016 (dollar amounts in thousands, except footnoted information):
Common
stock distributions reinvested in common shares
4,920
34.5
%
5,120
32.7
%
9,996
34.6
%
10,219
32.3
%
Total
distributions
$
14,247
100.0
%
$
15,671
100.0
%
$
28,862
100.0
%
$
31,640
100.0
%
Sources
of distributions:
Cash
flow from operations (2)
$
18,285
128.3
%
$
28,147
179.6
%
$
35,591
123.3
%
$
43,361
137.0
%
Financial
performance metric:
NAREIT-defined
FFO (3)
$
17,927
125.8
%
$
20,290
129.5
%
$
37,626
130.4
%
$
46,350
146.5
%
(1)
Other
cash distributions include (i) distributions declared for OP Units for the respective period, (ii) regular distributions made during the period to our joint venture partners that are noncontrolling interest holders, which exclude distributions of disposition proceeds related to properties sold by the joint ventures, (iii) dealer manager and distribution fees we pay to our dealer manager with respect to the Class A, Class W and Class I shares, and (iv) dividend equivalents declared during the period to the unvested restricted stock units granted by the Company to our Advisor.
Prior
to January 1, 2017, expenses associated with the acquisition of real property were recorded to earnings and as a deduction to our cash from operations. As of January 1, 2017, we adopted Accounting Standards Update 2017-01 ("ASU 2017-01") and anticipate that our future acquisitions of real property will likely be accounted for as asset acquisitions which requires capitalization of acquisition costs as a component of the acquired assets. See Note 2 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q for additional discussion regarding ASU 2017-01. We did not incur any acquisition-related expenses for the three and six months ended June 30, 2017. We incurred
acquisition-related expenses of approximately $474,000 and $525,000 for the three and six months ended June 30, 2016, respectively.
(3)
NAREIT-defined FFO is an operating metric and should not be used as a liquidity measure. However, management believes the relationship between NAREIT-defined FFO and distributions may be meaningful for investors to better understand the sustainability of our operating performance compared to distributions made. The definition of NAREIT-defined FFO, a reconciliation to GAAP
net income (loss), and a discussion of NAREIT-defined FFO’s inherent limitations are provided in “How We Measure Our Operating Performance” in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Quarterly Report on Form 10-Q.
Redemptions
Below is a summary of (i) Class E common stock repurchases pursuant to our self-tender offers, (ii) repurchases pursuant to our Class E Share Redemption Program (the “Class E SRP”), and (iii) repurchases pursuant to our Second Amended and Restated Class A, W and I Share Redemption Program (the “Class AWI SRP”) for each of the last four quarterly periods (number of shares in thousands).
For the Quarter
Ended:
Number of Shares Requested for Redemption or Purchase
Number of Shares Redeemed or Purchased
Percentage of Shares Requested for Redemption Redeemed or for Purchase Purchased
See “Part II, Item 2. Unregistered Sales of Equity Securities and Use of Proceeds” of this Quarterly Report on Form 10-Q for more information regarding redemptions of shares during the three months ended June 30, 2017.
On July 21, 2017, we acquired an industrial property in Livermore, CA comprising approximately 96,000 net rentable square feet from an unrelated third party, for a gross purchase price of approximately $16.2 million. At acquisition, the property was approximately 100% leased to four tenants. We acquired the
property using proceeds from our revolving credit facility.
On July 26, 2017, we acquired an industrial property in Las Vegas, NV comprising approximately 248,000 net rentable square feet from an unrelated third party, for a gross purchase price of approximately $24.5 million. At acquisition, the property was approximately 100% leased to one tenant. We acquired the property using proceeds from our revolving credit facility.
Dispositions
On July 21, 2017, we disposed of one building of a multi-building industrial property in Dallas, TX comprising approximately 128,000 net rentable square feet to
an unrelated third party. We sold the property, which had a net basis of approximately $7.3 million as of June 30, 2017, for a total sales price of $7.7 million.
New Accounting Pronouncements and Significant Accounting Policies
For information regarding new accounting pronouncements and significant accounting policies, see Note 2 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the adverse effect on the value of assets and liabilities that results from a change in the applicable market resulting from a variety of factors such as perceived risk, interest rate changes, inflation and overall general economic changes. Accordingly, we manage our market risk by matching projected cash inflows from operating, investing and financing activities with projected cash outflows for debt service, acquisitions, capital expenditures, distributions to stockholders and unit holders, and other cash requirements. Our outstanding borrowings are directly impacted by changes in market conditions. This impact is largely mitigated by the fact that the majority of our outstanding borrowings have fixed interest rates, which minimize our exposure to the risk that
fluctuating interest rates may pose to our operating results and liquidity.
As of June 30, 2017, the fair value of our fixed-rate borrowings was $131.6 million and the carrying value of our fixed-rate borrowings was $128.8 million. The fair value estimate of our fixed-rate borrowings was estimated using a discounted cash flow analysis utilizing rates we would expect to pay for debt of a similar type and remaining maturity if the loans were originated as of June 30, 2017. As we expect to hold our fixed-rate borrowings to maturity and the amounts due under such instruments would be limited to the outstanding principal balance and any accrued and unpaid
interest, we do not expect that fluctuations in interest rates, and the resulting change in fair value of our fixed-rate borrowings, would have a significant impact on our operations.
As of June 30, 2017, we had approximately $632.5 million of unhedged floating-rate borrowings outstanding indexed to LIBOR rates. If the LIBOR rates relevant to our remaining variable rate borrowings were to increase 10%, we estimate that our quarterly interest expense would increase by approximately $194,000 based on our outstanding floating-rate debt as of June 30, 2017.
We may seek to limit the impact of interest rate
changes on earnings and cash flows and to lower our overall borrowing costs by selectively utilizing derivative instruments to hedge exposures to changes in interest rates on loans secured by our assets. We maintain risk management control systems to monitor interest rate cash flow risk attributable to both our outstanding and forecasted debt obligations as well as our potential offsetting hedge positions. While this hedging strategy is designed to minimize the impact on our net income (loss) and funds from operations from changes in interest rates, the overall returns on our investments may be reduced. Our board of directors has established policies and procedures regarding our use of derivative instruments for hedging or other purposes. During the six months ended June 30, 2017, we recorded a decrease in our net liability value
of approximately $460,000 as a result of changes in the value of our derivatives. Changes in the interest rate yield curve directly impact the value of our derivatives and, as capital market expectations of future interest rates have declined, so have the value of our derivatives.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this report, management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective
as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act, is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
Please see the risk factors discussed in Item 1A of Part I of our Annual
Report on Form 10-K filed with the Commission on March 3, 2017.
The following new risk factors update these previously disclosed risk factors under the same heading in our Annual Report on Form 10-K.
We are exposed to risks arising from a small number of tenants comprising a significant portion of our income.
As of June 30, 2017, a significant portion of our annualized base rent comes from one tenant, Schwab, which leases 100% of 3 Second Street. As a result, we are particularly exposed to Schwab's ability and willingness to perform according to the contractual terms of the existing lease. The Schwab lease will expire in September 2017, and we
do not expect the Schwab lease to be renewed or extended. When the lease expires, we may be forced to lower the rental rates or offer other concessions in order to retain the current subtenants. Any reduction in the rental rates or other lease terms may have a meaningful impact to our operating results. Further, when the Schwab lease expires, we will likely suffer from periods of receiving no rent while we seek replacement tenants, and incur costs related to finding replacement tenants. The Schwab lease comprises approximately 15.5% of our annualized base rent as of June 30, 2017. This lease includes 11 subleases comprising approximately 8.7% of our annualized base rent as of June 30,
2017, which are scheduled to expire between September 2020 and September 2032. We expect our rental income to be materially reduced during the periods we are seeking replacement tenants for this property. These factors could adversely affect our results of operations, financial condition, NAV and ability to pay distributions to our stockholders. For additional information regarding this lease expiration, see our discussion under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Operating Activities - Lease Expirations” included in this Quarterly Report on Form 10-Q.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Share Redemption
Program and Other Redemptions or Repurchases
As of June 30, 2017, no material changes had occurred to our Class E SRP or our separate Class AWI SRP as discussed in Item 5 of our Annual Report on Form 10-K filed with the Commission on March 3, 2017.
Pursuant to the Class E SRP as of June 30, 2017, on an ongoing basis, redemptions are only available for redemptions in connection with the death or disability of a stockholder. With respect to all other Class E stockholders, our board of directors evaluates each quarter whether to make liquidity available through our Class E SRP or through a tender offer process. Although no assurances can be made,
our board of directors currently intends to make liquidity available to Class E stockholders each quarter (other than liquidity made available in the event of the death or disability of a stockholder through the Class E SRP) in an amount that is at least equal to the greater of (A) (i) funds received from the sale of Class E shares under our distribution reinvestment plan during such calendar quarter, plus (ii) 50% of the difference between (a) the proceeds (net of sales commissions) received by us from the sale of Class A, Class W and Class I shares in any public primary offering and under our distribution reinvestment plan during the most recently completed calendar quarter, and (b) the dollar amount used to redeem Class A, Class W and Class I shares during the most recently completed calendar quarter pursuant to the Class AWI SRP, less (iii) funds used for redemptions of Class E shares in the most recently completed quarter due to qualifying death or disability requests
of a stockholder during such calendar quarter and (B) the amount that would result in repurchases or redemptions, during any consecutive twelve month period, at least equal to five percent of the number of Class E shares outstanding at the beginning of such twelve-month period (the “Class E Liquidity Amount”), regardless of whether such liquidity will be made available through the Class E SRP or a tender offer, and excluding liquidity made available in the event of the death or disability of a stockholder through the Class E SRP. Our board of directors may at any time decide to reduce or eliminate the Class E Liquidity Amount.
Currently, the Class AWI SRP imposes a quarterly cap on the aggregate “net redemptions” of our Class A, Class W and Class I share classes equal to the amount of shares of such classes with a value (based on the redemption price per share on the day the redemption is effected) of up to 5%
of the aggregate NAV of the outstanding shares of such classes as of the last day of the previous calendar quarter (the “Quarterly Cap”). We use the term “net redemptions” to mean, for any quarter, the excess of our share redemptions (capital outflows) of our Class A, Class W and Class I share classes over the share purchases net of sales commissions (capital inflows) of such classes in any ongoing public offering of Class A, Class W or Class I shares,
whether in a primary offering or pursuant to a distribution reinvestment plan. On any business day during a calendar quarter, the maximum amount available for redemptions will be equal to
(1) 5% of the NAV of our outstanding Class A, Class W and Class I shares, calculated as of the last day of the previous calendar quarter, plus (2) proceeds from sales of new Class A, Class W and Class I shares in our public offering (including reinvestment of distributions but net of sales commissions) since the beginning of the current calendar quarter, less (3) proceeds paid to redeem shares of such classes since the beginning of the current calendar quarter through the prior business day. For each future quarter, our board of directors reserves the right to choose whether the Quarterly Cap will be applied to “gross redemptions,” meaning, for any class and any quarter, amounts paid to redeem shares of such class since the beginning of such calendar quarter, or “net redemptions.” In addition, for each future quarter, our board of directors reserves the right to choose whether the Quarterly Cap and the “net redemptions” test will be applied to our
Class A, Class W and Class I shares on a class-specific basis rather than on the aggregate basis described above. If our board of directors chooses to have the Quarterly Cap and the “net redemptions” test apply on a class-specific basis, then “net redemptions” of our Class A, Class W and Class I share classes will mean, for any class and any quarter, the excess of our share redemptions (capital outflows) of such class over the share purchases net of sales commissions (capital inflows) of such class in any ongoing public offering of Class A, Class W or Class I shares, whether in a primary offering or pursuant to a distribution reinvestment plan. Further, the quarterly cap will mean a quarterly cap on the “net redemptions” of each of our Class A, Class W and Class I share classes equal to the amount of shares of such class with an aggregate value (based on the redemption price per share on the day the redemption is effected) of up to 5% of the NAV
of the outstanding shares of such class as of the last day of the previous calendar quarter. Additionally, our board of directors has the right to modify, suspend or terminate our share redemption programs if it deems such action to be in the best interest of our stockholders.
In aggregate, for the three months ended June 30, 2017, we redeemed (i) approximately 6.1 million Class E shares pursuant to a self-tender offer for approximately $45.5 million and (ii) approximately 1.1 million shares of common stock pursuant to the Class E SRP and the Class AWI SRP for approximately $8.3 million, as described further in the table below (number of shares in thousands,
except footnoted information).
Period
Total Number of Shares Redeemed or Repurchased
Average Price Paid per Share
Total Number of Shares
Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that May Yet Be Purchased Pursuant to the Program (1)
Redemptions
and repurchases are limited under the Class E SRP and the Class AWI SRP as described above and pursuant to the terms of self-tender offers announced from time to time. We redeemed all Class A, W, and I shares that were requested to be redeemed during the three months ended June 30, 2017. As of June 30, 2017, we had capacity under the Class AWI SRP to redeem up to an aggregate of $17.0 million of Class A, W, and I shares. Pursuant to the Class AWI SRP, this capacity resets at the beginning of each quarter.
(2)
Number
of shares includes approximately 6.1 million Class E shares repurchased at $7.49 per share for an aggregate cost of approximately $45.5 million pursuant to a self-tender offer.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
Distribution Reinvestment
Plan Suitability Requirements
Pursuant to the terms of our distribution reinvestment plan (“DRP”), participants in the DRP must promptly notify us if at any time they fail to meet the current suitability requirements for making an investment in us.
The current suitability standards require that Class E stockholders participating in the DRP other than investors in Arizona, California, Ohio and Oregon have either:
•
a net worth (exclusive of home, home furnishings and automobiles) of $150,000 or more; or
•
a
net worth (exclusive of home, home furnishings and automobiles) of at least $45,000 and had during the last tax year, or estimate that such investor will have during the current tax year, a minimum of $45,000 annual gross income.
The current suitability standards require that Class E stockholders participating in the DRP in Arizona, California, Ohio and Oregon must have either:
•
a net worth (exclusive of home, home furnishings
and automobiles) of $250,000 or more; or
•
a net worth (exclusive of home, home furnishings and automobiles) of at least $70,000 and had during the last tax year, or estimate that such investor will have during the current tax year, a minimum of $70,000 annual gross income.
In addition, Class E stockholders participating in the DRP in Ohio and Oregon must have a net worth of at least 10 times their investment in us and any of our affiliates (namely, Industrial Property Trust Inc.).
The current suitability standards for Class A, Class W and Class I stockholders participating in the DRP are listed in the section entitled “Suitability Standards”
in our current Class A, Class W and Class I public offering prospectus on file at www.sec.gov and on our website at www.dividendcapitaldiversified.com.
Stockholders can notify us of any changes to their ability to meet the suitability requirements or change their DRP election by contacting us at Dividend Capital Diversified Property Fund Inc., Investor Relations, 518 17th Street, Suite 1700, Denver, Colorado80202, Telephone: (303) 228-2200.
Statement regarding transfer
restrictions, preferences, limitations and rights of holders of shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates), incorporated by reference to Exhibit 4.5 of the Company’s Registration Statement on Form S-11 (File No. 333-175989), filed April 15, 2013
Amendment to Restricted Stock Unit Agreements, by and between the Company, Dividend Capital Total Realty Operating Partnership LP and Dividend Capital Total Advisors LLC, dated April 13, 2017, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed April 19, 2017
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
