InPoint Commercial Real Estate Income, Inc. - Quarter Report: 2018 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to           

Commission file number 000-55782

INPOINT COMMERCIAL REAL ESTATE INCOME, INC.

(Exact name of registrant as specified in its charter)

(800) 826-8228

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.

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 ☒

As of May 9, 2018, there were 2,851,844 shares of the Registrant’s Class P Common Stock outstanding.

TABLE OF CONTENTS

INPOINT COMMERCIAL REAL ESTATE INCOME, INC.

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements 

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INPOINT COMMERCIAL REAL ESTATE INCOME, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements  

2

INPOINT COMMERCIAL REAL ESTATE INCOME, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

Three-months ended March 31, 2018

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements

3

INPOINT COMMERCIAL REAL ESTATE INCOME, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

The accompanying notes are an integral part of these consolidated financial statements

4

InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements

March 31, 2018

(unaudited)

Note 1 – Organization and Business Operations

InPoint Commercial Real Estate Income, Inc. (the “Company”) was incorporated in Maryland on September 13, 2016 to originate, acquire and manage a diversified portfolio of commercial real estate (“CRE”) investments primarily comprised of (i) CRE debt, including first mortgage loans, subordinate mortgage and mezzanine loans (“Credit Loans”), and participations in such loans and (ii) CRE securities, such as commercial mortgage-backed securities (“CMBS”), senior unsecured debt of publicly traded real estate investment trusts (“REITs”), and collateralized debt obligation notes. The Company may also invest in select equity investments in single-tenant, net leased properties. Substantially all of the Company’s business is conducted through InPoint REIT Operating Partnership, LP (the “OP”), a Delaware limited partnership. The Company is the sole general partner and directly or indirectly holds all of the limited partner interests in the OP.

The Company is externally managed by Inland InPoint Advisor, LLC (the “Advisor”), a Delaware limited liability company formed in August 2016 that is a wholly-owned indirect subsidiary of Inland Real Estate Investment Corporation, a member of The Inland Real Estate Group of Companies, Inc. The Advisor is responsible for coordinating the management of the day-to-day operations and originating, acquiring and managing the Company’s CRE investment portfolio, subject to the supervision of the Company’s board of directors. The Advisor performs its duties and responsibilities as the Company’s fiduciary pursuant to an advisory agreement dated October 25, 2016 among the Company, the Advisor and the OP (the “Advisory Agreement”).

The Advisor has delegated certain of its duties to SPCRE InPoint Advisors, LLC (the “Sub-Advisor”), a Delaware limited liability company formed in September 2016 that is a wholly-owned subsidiary of Sound Point CRE Management, LP, pursuant to a sub-advisory agreement between the Advisor and the Sub-Advisor. Among other duties, the Sub-Advisor has the authority to identify, negotiate, acquire and originate the Company’s investments and provide portfolio management, disposition, property management and leasing services to the Company. Notwithstanding such delegation to the Sub-Advisor or affiliates of the Sub-Advisor or Advisor, the Advisor retains ultimate responsibility for the performance of all the matters entrusted to it under the Advisory Agreement, including those duties which the Advisor has not delegated to the Sub-Advisor such as (i) valuation of the Company’s assets and calculation of the Company’s net asset value; (ii) management of the Company’s day-to-day operations, including the hiring and supervising of its employees, if any; (iii) preparation of stockholder reports and communications and arrangement of the Company’s annual stockholder meeting; and (iv) advising the Company regarding its qualification as a REIT for U.S. federal income tax purposes and monitoring its ongoing compliance with the REIT qualification requirements thereafter.

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Note 2 – Summary of Significant Accounting Policies

Disclosures discussing all significant accounting policies are set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 (the “Annual Report”), as filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2018, under the heading Note 2-Summary of Significant Accounting Policies. There have been no changes to the Company’s significant accounting policies for the three months ended March 31, 2018, except as noted below.

Equity-Based Compensation

In accordance with the Company’s Independent Director Restricted Share Plan (the “RSP”), restricted shares are issued to independent directors as compensation. The Company recognizes expense related to the fair value of equity-based compensation awards as operating expense in the consolidated statements of operations. The Company recognizes expense based on the fair value at the grant date on a straight-line basis over the vesting period representing the requisite service period. See Note 10 – "Equity-Based Compensation" for further information.

Basis of Accounting

The accompanying consolidated financial statements and related footnotes have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and require management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of income and expenses during the reported periods. Actual results could differ from such estimates.

Commercial Mortgage Loans Held for Investment and Allowance for Loan Losses

Commercial mortgage loans are held for investment purposes and are anticipated to be held until maturity. Accordingly, they are carried at cost, net of unamortized loan fees and origination costs, and premiums or discounts. Commercial mortgage loans that are deemed to be impaired will be carried at amortized cost less a specific allowance for loan losses. Interest income is recorded on the accrual basis and related discounts, premiums and net deferred fees or costs on investments are amortized over the life of the investment using the effective interest method. Amortization is reflected as an adjustment to interest income in the Company’s consolidated statements of operations. Upon measurement of impairment, the Company records an allowance for loan losses to reduce the carrying value of the loan with a corresponding charge through the provision for loan losses on the Company’s consolidated statements of operations.

The allowance for loan losses reflects management's estimate of loan losses inherent in the loan portfolio as of the balance sheet date. The Company uses a uniform process for determining its allowance for loan losses. The allowance for loan losses includes an asset-specific component and may include a general, formula-based component when the portfolio is determined to be of sufficient size to warrant such a reserve.

The asset-specific reserve component relates to reserves for losses on individual impaired loans. The Company considers a loan to be impaired when, based upon current information and events, it believes that it is probable that the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. This assessment is made on an individual loan basis each quarter based on such factors as payment status, lien position, borrower financial resources and investment in collateral, collateral type, project economics and geographic location, as well as national and regional economic factors. A reserve is established for an impaired loan when the present value of payments expected to be received, observable market prices or the estimated fair value of the collateral (for loans that are dependent on the collateral for repayment) is lower than the carrying value of that loan.

For collateral dependent impaired loans, impairment is measured using the estimated fair value of collateral less the estimated cost to sell. Valuations are performed or obtained at the time a loan is determined to be impaired and designated non-performing, and they are updated if circumstances indicate that a significant change in value has occurred. The Advisor generally will use the income approach through internally developed valuation models to estimate the fair value of the collateral for such loans. In more limited cases, the Advisor will obtain external “as is” appraisals for loan collateral, generally when third party participations exist.

General reserves are recorded when (i) available information as of each balance sheet date indicates that it is probable a loss has occurred in the portfolio and (ii) the amount of the loss can be reasonably estimated. The Company’s policy is to estimate loss rates based on actual losses experienced, if any, or based on historical realized losses experienced in the industry if the Company has not

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experienced any losses. Current collateral and economic conditions affecting the probability and severity of losses are taken into account when establishing the allowance for loan losses.

The Company performs a comprehensive analysis of its loan portfolio and assigns risk ratings to loans that incorporate management's current judgments about their credit quality based on all known and relevant internal and external factors that may affect collectability. The Company considers, among other things, payment status, lien position, borrower financial resources and investment in collateral, collateral type, project economics and geographic location, as well as national and regional economic factors. This methodology results in loans being segmented by risk classification into risk rating categories that are associated with estimated probabilities of default and principal loss. Ratings range from “1” to “5” with “1” representing the lowest risk of loss and “5” representing the highest risk of loss.

Loans are generally placed on non-accrual status when principal or interest payments are past due 90 days or more or when there is reasonable doubt that principal or interest will be collected in full. Accrued and unpaid interest is generally reversed against interest income in the period the loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management's judgment regarding the borrower's ability to make pending principal and interest payments. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management's judgment, are likely to remain current. The Company may make exceptions to placing a loan on non-accrual status if the loan has sufficient collateral value and is in the process of collection.

As of March 31, 2018 and December 31, 2017, the Company has not recorded any allowance for loan losses as the Company did not consider a loan loss to be probable.

Income Taxes

The Company qualified as a REIT under the Internal Revenue Code of 1986, as amended, for federal income tax purposes commencing with the tax year ending December 31, 2017. As a REIT, the Company generally will not be subject to federal income tax to the extent it distributes its REIT taxable income, subject to certain adjustments, to its stockholders. Subsequently, if the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income tax on its taxable income at regular corporate tax rates. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income, property or net worth and federal income and excise taxes on its undistributed income.

The Company had no uncertain tax positions as of March 31, 2018 or December 31, 2017. The Company expects no significant increases or decreases in uncertain tax positions due to changes in tax positions within one year of March 31, 2018. The Company had no interest or penalties relating to income taxes recognized in the consolidated statements of operations for the three-month periods ended March 31, 2018 or 2017. As of March 31, 2018, returns for the calendar year 2016 and 2017 remain subject to examination by U.S. and various state and local tax jurisdictions. For the periods ended March 31, 2018 and 2017, the Company incurred no current income tax expense.

Accounting Pronouncements Recently Issued but Not Yet Effective

In June 2016, the Financial Accounting Standards Board issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which changes how entities measure credit losses for financial assets carried at amortized cost. ASU 2016-13 eliminates the requirement that a credit loss must be probable before it can be recognized and instead requires an entity to recognize the current estimate of all expected credit losses. ASU 2016-13 is effective for SEC filers for reporting periods beginning after December 15, 2019. The amendments may be adopted early for reporting periods beginning after December 15, 2018. The Company is currently evaluating the impact ASU 2016-13 will have on its allowance for loan losses estimate.

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

Note 3 – Real Estate Securities

The following is a summary of the Company’s real estate securities as of March 31, 2018:

The Company classified its CMBS as available-for-sale as of March 31, 2018. These investments are reported at fair value in the consolidated balance sheets with changes in fair value recorded in other income or loss in the consolidated statements of operations. The following table shows the amortized cost, unrealized gains/losses and fair value of the Company’s CMBS investments as of March 31, 2018:

The following is a summary of the Company’s real estate securities as of December 31, 2017:

The Company classified its CMBS as available-for-sale as of December 31, 2017. These investments are reported at fair value in the consolidated balance sheets with changes in fair value recorded in other income or loss in the consolidated statements of operations. The following table shows the amortized cost, unrealized gains/losses and fair value of the Company’s CMBS investments as of December 31, 2017:

As of March 31, 2018, the Company held four CMBS with a total carrying value of $30,947,171 with a total unrealized gain of $66,254. As of December 31, 2017, the Company held three CMBS with a carrying value of $25,993,258 with an unrealized gain of $35,935 and an unrealized loss of $508.  No position had an unrealized loss for a period greater than 12 months. The Company did not have any realized gains or losses during the three-month periods ended March 31, 2018 and 2017.

As of March 31, 2018 and December 31, 2017, amortized cost equaled par value since there were no discounts or premiums on

CMBS.

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

Note 4 – Commercial Mortgage Loans Held for Investment

The following is a summary of the Company’s commercial mortgage loans held for investment as of March 31, 2018:  

The following is a summary of the Company’s commercial mortgage loans held for investment as of December 31, 2017:  

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

Credit Characteristics

As part of the Company’s process for monitoring the credit quality of its loans, it performs a quarterly asset review of the loan portfolio and assigns risk ratings to each of its loans. Risk factors include payment status, lien position, borrower financial resources and investment in collateral, collateral type, project economics and geographic location, as well as national and regional economic factors. To determine the likelihood of loss, the loans are rated on a 5-point scale as follows:

All commercial mortgage loans are assigned an initial risk rating of 2 at origination. The Company performed the quarterly asset review and assigned a risk rating of 2 to all loans as of March 31, 2018 and December 31, 2017. The Company has not recorded any allowance for loan losses as the Company did not consider a loan loss to be probable.

Note 5 – Repurchase Agreements

Commercial Mortgage Loans

A wholly owned subsidiary of the Company entered into a Master Repurchase Agreement (the “Repo Facility”) with Column Financial, Inc. as administrative agent for certain of its affiliates.  The Repo Facility provides up to $100.0 million in advances, subject to adjustment up to $250.0 million, which the Company expects to use to finance the acquisition or origination of eligible loans. The Repo Facility acts in the manner of a revolving credit facility that can be repaid as the Company's assets are paid off and re-drawn as advances against new assets.  Advances under the Repo Facility accrue interest at a per annum rate equal to LIBOR plus 2.25%. The initial maturity date of the Repo Facility is February 15, 2019, with extensions which may be exercised upon the satisfaction of certain conditions.

The details of the Repo Facility as of March 31, 2018 are as follows:

The Company had no Repo Facility as of December 31, 2017.

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

Real Estate Securities

As of March 31, 2018 and December 31, 2017, the Company had entered into one master repurchase agreement for real estate securities with one counterparty and had three and two outstanding real estate security repurchase agreements outstanding, respectively, as described in the table below.

Note 6 – Stockholders’ Equity

During the three-month period ended March 31, 2018, pursuant to a private offering (the “Offering”), the Company issued 742,853 shares of Class P common stock (“Class P Shares”) at an average price of $27.12 per share with total net proceeds of $18,573,040 after offering costs of $1,575,382. In addition, the Company incurred $121,943 in reimbursable deferred offering costs that are payable to the Advisor and Sub-Advisor from future stock issuance.

Distributions Declared

The table below sets forth the distributions declared for Class P Shares during the three-month period ended March 31, 2018.

Distributions Paid

The table below sets forth the distributions paid in cash with respect to the Class P Shares during the three-month period ended March 31, 2018.

During the three-month period ended March 31, 2018, the Company declared distributions of $1,007,676 and paid cash distributions of $881,578. As of March 31, 2018, distributions declared but not yet paid amounted to $384,568.

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

Note 7 – Net Income Per Share

The following table is a summary of the basic and diluted net income per share computation for the three-month periods ended March 31, 2018 and 2017:

Note 8 – Commitments and Contingencies

Litigation and Regulatory Matters

In the ordinary course of business, the Company may become subject to litigation, claims and regulatory matters. The Company has no knowledge of material legal or regulatory proceedings pending or known to be contemplated against the Company at this time.

Note 9 – Transactions with Related Parties

As of March 31, 2018, the Advisor had invested $1.0 million in the Company through the purchase of 40,040 Class P Shares. The purchase price per Class P Share for the Advisor’s investment was $25.00 (the “Transaction Price”), with no payment of selling commissions, dealer manager fees or organization and offering expenses. The Advisor has agreed pursuant to its subscription agreement that, for so long as it or its affiliate is serving as the Advisor, (i) it will not sell or transfer at least 8,000 of the Class P Shares that it has purchased, accounting for $200,000 of its investment, to an unaffiliated third party; (ii) it will not be eligible to submit a request for these 40,040 Class P Shares pursuant to the Company’s share repurchase program prior to the fifth anniversary of the date on which such shares were purchased; and (iii) repurchase requests made for these shares will only be accepted (a) on the last business day of a calendar quarter, (b) after all repurchase requests from all other stockholders for such quarter have been accepted and (c) to the extent that such repurchases do not cause total repurchases in the quarter in which they are being repurchased to exceed that quarter’s repurchase cap.

As of March 31, 2018, Sound Point Capital Management, LP (“Sound Point”), an affiliate of the Sub-Advisor, had invested $3.0 million in the Company through the purchase of 120,000 Class P Shares. The purchase price per Class P Share for this investment was the Transaction Price, with no payment of selling commissions, dealer manager fees or organization and offering expenses. Sound Point has agreed pursuant to its subscription agreement that, for so long as the Sub-Advisor or its affiliate is serving as the Sub-Advisor, (i) it will not be eligible to submit a request for the repurchase of these 120,000 shares pursuant to the Company’s share repurchase program prior to the fifth anniversary of the date on which such shares were purchased; and (ii) repurchase requests made for these shares will only be accepted (a) on the last business day of a calendar quarter, (b) after all repurchase requests from all other stockholders for such quarter have been accepted and (c) to the extent that such repurchases do not cause total repurchases in the quarter in which they are being repurchased to exceed that quarter’s repurchase cap.

The following table summarizes the Company’s related party transactions for the three-month periods ended March 31, 2018 and 2017:

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

Note 10 – Equity-Based Compensation

On March 1, 2018, the Company granted each of its three independent directors 400 restricted Class P Shares for a total of 1,200 Class P Shares with a total value of $30,000.  The restricted Class P Shares will vest in equal one-third increments on March 1, 2019, 2020 and 2021.  

Under the RSP, restricted shares generally vest over a three year vesting period from the date of the grant, subject to the specific terms of the grant. Restricted shares are included in common stock outstanding on the date of vesting. The grant-date value of the restricted shares is amortized over the vesting period representing the requisite service period. Compensation expense associated with the restricted shares issued to the independent directors was $833, in the aggregate, for the three months ended March 31, 2018. As of March 31, 2018, the Company had $29,167 of unrecognized compensation expense related to the unvested restricted shares, in the aggregate. The weighted average remaining period that compensation expense related to unvested restricted shares will be recognized is 2.92 years.

Note 11 – Fair Value of Financial Instruments

The following table presents the Company’s financial instruments carried at fair value in the consolidated balance sheets by its level in the fair value hierarchy (see Note 2 – Summary of Significant Accounting Policies included in the Annual Report) as of March 31, 2018 and December 31, 2017:

The Company did not transfer any assets within fair value levels during the three months ended March 31, 2018 or during the year ended December 31, 2017.

As discussed in Note 2 of the Annual Report, GAAP requires the disclosure of fair value information about financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate that value.  The following table details the carrying amount and fair value of the financial instruments described in Note 2 of the Annual Report:

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

The following describes our methods for estimating the fair value for financial instruments:

Note 12 – Subsequent Events

The Company has evaluated subsequent events through May 10, 2018, the date the financial statements were issued, and determined that there have not been any events that have occurred that would require adjustments to disclosures in the consolidated financial statements except for the following transactions:

Sale of Common Stock

As of May 9, 2018, the Company had 2,851,844 shares of common stock outstanding and had raised proceeds from the Offering since March 31, 2018 and since inception as follows:

Distributions Declared

The table below sets forth the distributions declared for Class P Shares.

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InPoint Commercial Real Estate Income, Inc.

Notes to Consolidated Financial Statements (continued)

March 31 2018

(unaudited)

Distributions Paid

The table below sets forth the distributions paid in cash with respect to the Class P Shares.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Certain statements in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Words such as “may,” “could,” “should,” “expect,” “intend,” “plan,” “goal,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “variables,” “potential,” “continue,” “expand,” “maintain,” “create,” “strategies,” “likely,” “will,” “would” and variations of these terms and similar expressions, or the negative of these terms or similar expressions, are intended to identify forward-looking statements.

These forward-looking statements are not historical facts but reflect the intent, belief or current expectations of the management of InPoint Commercial Real Estate Income, Inc. (which we refer to herein as the “Company,” “we,” “our” or “us”) based on their knowledge and understanding of the business and industry, the economy and other future conditions. These statements are not guarantees of future performance, and we caution stockholders not to place undue reliance on forward-looking statements. Actual results may differ materially from those expressed or forecasted in the forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to the factors described below:

Forward-looking statements in this Quarterly Report on Form 10-Q reflect our management’s view only as of the date of this Quarterly Report, and may ultimately prove to be incorrect or false. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results except as required by applicable law. We intend for these forward-looking statements to be covered by the applicable safe harbor provisions created by Section 27A of the Securities Act and Section 21E of the Exchange Act.

The following discussion and analysis relates to the three-months ended March 31, 2018 and 2017 and as of March 31, 2018 and December 31, 2017. You should read the following discussion and analysis along with our consolidated financial statements and the related notes included in this report. 

Overview

We are a Maryland corporation formed on September 13, 2016 to originate, acquire and manage a diversified portfolio of commercial real estate (“CRE”) investments primarily comprised of (i) CRE debt, including first mortgage loans, subordinate mortgage and mezzanine loans (“Credit Loans”), and participations in such loans and (ii) CRE securities, such as commercial mortgage-backed securities (“CMBS”), senior unsecured debt of publicly traded REITs, and collateralized debt obligation notes. We may also invest in select equity investments in single-tenant, net leased properties. Substantially all of our business is conducted through our operating partnership, of which we are the sole general partner.  We are externally managed by Inland InPoint Advisor, LLC, an indirect subsidiary of Inland Real Estate Investment Corporation. Our Advisor has engaged SPCRE InPoint Advisors, LLC, a subsidiary of Sound Point CRE Management, LP, to perform certain services on behalf of the Advisor for us.

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We operate in a manner that will allow us to qualify as a REIT for U.S. federal income tax purposes commencing with the taxable year ending December 31, 2017. Among other requirements, REITs are required to distribute to stockholders at least 90% of their annual REIT taxable income (computed without regard to the dividends-paid deduction and excluding net capital gain).

On October 25, 2016, we commenced a private offering (the “Offering”) of up to $500,000,000 in our Class P Shares, pursuant to a private placement memorandum dated October 25, 2016. The purchase price per Class P Share currently equals $25.00 plus applicable selling commissions, dealer manager fees and organization and offering expenses, resulting in a total purchase price of $27.38 per Class P Share if maximum selling commissions, dealer manager fees and organization and offering expenses are paid. Inland Securities Corporation, an affiliate of our Advisor, is our dealer manager for the Offering. As of May 9, 2018, we had received and accepted investors’ subscriptions for and issued 2,851,844 Class P Shares in the Offering, resulting in gross proceeds of $76,700,800. As of May 9, 2018, $423,299,200 of Class P Shares remained to be sold in the Offering.

Significant Accounting Policies and Use of Estimates

Disclosures discussing all significant accounting policies are set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 (the “Annual Report”), as filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2018, under the heading “Note 2-Summary of Significant Accounting Policies.” There have been no changes to the Company’s significant accounting policies for the three months ended March 31, 2018, except as noted in Note 2 – “Summary of Significant Accounting Policies” which is included in our notes to consolidated financial statements included in this Quarterly Report on Form 10-Q.

Portfolio

We began operations in October 2016 and our objective is to originate, acquire and manage an investment portfolio of CRE debt and CRE securities that is primarily floating rate and diversified based on the type and location of collateral securing the underlying CRE debt and CRE securities.  We anticipate our investment portfolio will be less diversified and have higher concentrations in asset class, collateral type and geographic location until our capital raise reaches levels that will allow for greater diversification.

The charts below summarize our portfolio as a percentage of par value by type of rate, loan type, collateral type and geographical region as of March 31, 2018 and December 31, 2017:

Floating vs. Fixed Rate:

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Investments by Loan Type:

Investments by Property Type:

Investments by Region:

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An investment’s region is defined according to the below map based on the location of underlying property.

The changes in our portfolio as of March 31, 2018 compared to December 31, 2017 were primarily due to the new loans originated during the period.  Due to the small number of investments in our portfolio, the changes in the portfolio composition may be significant.  We anticipate that these changes will become less significant as our portfolio increases in size.

Real Estate Securities

As of March 31, 2018 and December 31, 2017, our portfolio of real estate securities consisted of four and three investments in CMBS, respectively. Our CMBS investments had a fair value of $30,947,171 and $25,993,258 as of March 31, 2018 and December 31, 2017, respectively. The increase in the size of our portfolio of real estate securities is due to investing capital received from the Offering and increased leverage arising from a Master Repurchase Agreement (the “MRA”).

As of March 31, 2018 and December 31, 2017, our CMBS investments had a weighted average coupon of 3.4% and 2.9% and a remaining life of 1.5 and 1.7 years, respectively.  As of March 31, 2018, 67% of our real estate securities portfolio based on fair value was rated AAA and 33% was rated BB- from at least one national rating agency.  As of December 31, 2017, 80% of our portfolio based on fair value had a rating by a national rating agency of AAA and 20% BB-. The change in the ratings was due to the purchase of additional assets as we invested capital received from the Offering.  Our credit process evaluates the underlying quality of the loans securing the CMBS at the time of purchase and we continually review the credit performance while we own the CMBS. Ratings by national rating agencies are subject to change and may not be continuously updated, and therefore we do not place reliance on these ratings.

Commercial Mortgage Loans Held for Investment

As of March 31, 2018 and December 31, 2017, our portfolio of commercial mortgage loans held for investment consisted of five and three loans, respectively, with outstanding principal balance of $52,010,966 and $32,450,941, respectively.  The increase in the size of our portfolio is due to investing capital received from the Offering.  The portfolio had a weighted average interest rate of 6.69% and 6.80% as of March 31, 2018 and December 31, 2017, respectively.  The change in weighted average interest rate was due to change in portfolio composition through the additional loans originated.  Due to the small number of loans in our portfolio, the weighted average interest rate may change significantly as we continue to originate loans in the future.

Allowance for Loan Losses

As of March 31, 2018 and December 31, 2017, we have not recorded any allowance for loan losses as the loans in the portfolio were not impaired and were performing in compliance with the contractual terms and no losses were probable. See Note 2 - “Summary of Significant Accounting Policies” which is included in our notes to consolidated financial statements included in the Annual Report for further description of our allowance for loan loss policy.

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Results of Operations

Comparison of the Three-Months Ended March 31, 2018 to the Three-Months Ended March 31, 2017

Net Interest Income

Net interest income is generated on our interest-earning assets less related interest-bearing liabilities. The following table presents the average balance of interest-earning assets less related interest-bearing liabilities, associated interest income and expense and corresponding yield earned and incurred for the periods indicated.

The increase in our weighted average interest-earning assets and interest-bearing liabilities was due to the investment of proceeds from the Offering and through increased leverage as we executed our business strategy. The change in the weighted average yield and finance cost was due to the change in the portfolio composition as we invested the proceeds from the Offering.

Operating Expenses

Operating expenses for the three-months ended March 31, 2018 and 2017 consisted of the following:

Total operating expenses for the three-months ended March 31, 2018 and 2017 were $262,297 and $92,864, respectively.  The majority of operating expenses related to professional fees which include audit, tax and legal expenses.  The administrative expense

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was for fund administration services provided by a non-affiliated third party that was discontinued in October 2017.  Debt finance costs relate to amortization of costs associated with the repurchase agreement – commercial mortgage loans that was entered into in February 2018.  Items included in other expense were for general expenses primarily related to on-going transfer agent fees and expenses related to filing SEC reports that were paid to a non-affiliated third party.

Other Income

For the three-month periods ended March 31, 2018 and 2017, our real estate securities increased in value by $30,828 and $89,433, respectively. The changes in valuation were unrealized and were the result of the changes in market conditions that affected the price of our securities.

Net Income

For the three-months ended March 31, 2018 and 2017, our net income was $495,791 and $87,892, or $0.23 and $0.31 per share (basic and diluted), respectively. The increase in net income was primarily due to the increase in net interest income as our investment portfolio increased due to investing the proceeds from the Offering and borrowings.

Non-GAAP Financial Measures

Funds from Operations and Modified Funds from Operations

We use Funds from Operations (“FFO”), a widely accepted metric, to evaluate our performance. FFO provides a supplemental measure to compare our performance and operations to other REITs. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts (“NAREIT”) has promulgated a standard known as FFO, which it believes more accurately reflects the operating performance of a REIT. As defined by NAREIT, FFO means net income computed in accordance with generally accepted accounting principles (“GAAP”), excluding gains (or losses) from sales of operating property, plus depreciation and amortization and after adjustments for unconsolidated entities. In addition, NAREIT has further clarified the FFO definition to add-back impairment write-downs of depreciable real estate or of investments in unconsolidated entities that are driven by measurable decreases in the fair value of depreciable real estate and to exclude the earnings impacts of cumulative effects of accounting changes. We have adopted the NAREIT definition for computing FFO.

Our business plan is to operate as a mortgage REIT with our portfolio consisting of CRE debt and CRE securities. We will typically have no FFO adjustments to our net income or loss computed in accordance with GAAP. Although we have the ability to acquire real property, we have not acquired any at this time and as such have not had any FFO adjustments to our net income or loss computed in accordance with GAAP.

Under GAAP, acquisition related costs are treated as operating expenses reducing our income. Publicly registered, non-listed REITs typically engage in a significant amount of acquisition activity in the early years of their operations, and thus incur significant acquisition related costs during these initial years. Although other start up entities may engage in significant acquisition activity during their initial years, REITs such as us that are not listed on an exchange are unique in that they typically have a limited timeframe during which they acquire a significant number of investments and thus incur significant acquisition related costs. Due to the above factors and other unique features of publicly registered, non-listed REITs, the Institute for Portfolio Alternatives (“IPA”), an industry trade group, published a standardized measure known as Modified Funds from Operations (“MFFO”), which the IPA has promulgated as a supplemental measure for publicly registered non-listed REITs and which may be another appropriate supplemental measure to reflect the operating performance of a non-listed REIT.

The IPA defines MFFO as FFO adjusted for acquisition fees and expenses, amounts relating to straight line rents and amortization of premiums on debt investments, non-recurring impairments of real estate-related investments, mark-to-market adjustments included in net income, non-recurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures.

We define MFFO in accordance with the concepts established by the IPA and adjust FFO for certain items, such as amortization of premium and discounts on real estate securities. We purchase real estate securities at a premium or discount to par value, and in accordance with GAAP, record the amortization of premium/accretion of the discount to interest income. We believe that excluding the amortization of premiums and discounts provides better insight to the expected contractual cash flows.  In addition, we adjust FFO for unrealized gains or losses on real estate securities. Any mark-to-market or fair value adjustments are based on general market or overall industry conditions and may be temporary in nature.

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Because MFFO may be a recognized measure of operating performance within the non-listed REIT industry, MFFO and the adjustments used to calculate it may be useful in order to evaluate our performance against other non-listed REITs. Like FFO, MFFO is not equivalent to our net income or loss as determined under GAAP, as detailed in the table below, and MFFO may not be a useful measure of the impact of long-term operating performance on value if we continue to acquire a significant amount of investments.

Our presentation of FFO and MFFO may not be comparable to other similarly titled measures presented by other REITs. We believe that the use of FFO and MFFO provides a more complete understanding of our operating performance to stockholders and to management, and when compared year over year, reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs. Neither FFO nor MFFO is intended to be an alternative to “net income” or to “cash flows from operating activities” as determined by GAAP as a measure of our capacity to pay distributions. Management uses FFO and MFFO to compare our operating performance to that of other REITs and to assess our operating performance.

Neither the SEC, any other regulatory body nor NAREIT has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, the SEC, another regulatory body or NAREIT may decide to standardize the allowable adjustments across the non-listed REIT industry and we would have to adjust our calculation and characterization of FFO or MFFO.

Our FFO and MFFO are calculated as follows:

Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to pay distributions to our stockholders, fund investments, originate loans, repay borrowings, and other general business needs including the payment of our operating and administrative expenses. Our primary sources of funds for liquidity consist of the net proceeds from the Offering, net cash provided by operating activities, proceeds from repurchase agreements and other financing arrangements and future issuances of equity and/or debt securities.

We currently believe that we have sufficient liquidity and capital resources available for all anticipated uses, including the acquisition of additional investments, required debt service and the payment of distributions to stockholders.

Cash Flow Analysis

We held cash and cash equivalents of $5,765,417 and $1,406,331 as of March 31, 2018 and December 31, 2017, respectively. Our cash and cash equivalents increased due to normal fluctuations and were primarily related to the net proceeds from the Offering and from the net proceeds from our repurchase agreements that were not used to purchase investments.

Our operating activities generated net cash of $88,244 and $89,990 for the three-month periods ended March 31, 2018 and 2017, respectively.  

Our investing activities used $24,378,620 and $5,125,000 for the three-month periods ended March 31, 2018 and 2017, respectively, for the origination of commercial mortgage loans and the purchase of CMBS.

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Our financing activities provided net cash of $28,649,462 and $6,076,171 for the three-month periods ended March 31, 2018 and 2017, respectively. The contributions came from $10,958,000 in net proceeds from our repurchase agreement financing and $18,573,040 in net proceeds from the issuance of our common stock for the three-month period ended March 31, 2018.  For the three-month period ended March 31, 2017, the contributions came from $3,578,000 in net proceeds from our repurchase agreement financing and $2,612,634 in net proceeds from the issuance of our common stock.  

Repurchase Agreements

Commercial Mortgage Loans

We entered into a master repurchase agreement (the “Repo Facility”) with Column Financial, Inc. as administrative agent for certain of its affiliates.  The Repo Facility provides up to $100.0 million in advances, subject to adjustment up to $250.0 million, which we expect to use to finance the acquisition or origination of eligible loans. The Repo Facility acts in the manner of a revolving credit facility that can be repaid as our assets are paid off and re-drawn as advances against new assets.  Advances under the Repo Facility accrue interest at a per annum rate equal to LIBOR plus 2.25%. The initial maturity date of the Repo Facility is February 15, 2019, with extensions which may be exercised upon the satisfaction of certain conditions.

The details of our Repo Facility as of March 31, 2018 are as follows:

We had no Repo Facility as of December 31, 3017.

Real Estate Securities

As of March 31, 2018 and December 31, 2017, we had entered into one MRA for real estate securities with one counterparty and had three and two outstanding real estate security repurchase agreements outstanding, respectively, as described in the table below.

Distributions Declared

The table below sets forth the distributions declared for Class P Shares during the three-month period ended March 31, 2018.

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Distributions Paid

The table below sets forth the distributions paid in cash with respect to our Class P Shares during the three-month period ended March 31, 2018.

Contractual Obligations and Commitments

Our contractual obligations, excluding expected interest payments, as of March 31, 2018 and December 31, 2017 are summarized as follows:

Critical Accounting Policies

Disclosures discussing all critical accounting policies are set forth in our Annual Report under the heading “Summary of Critical Accounting Policies.” There have been no changes to our critical accounting policies during the three months ended March 31, 2018.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Subsequent Events

For information related to subsequent events, reference is made to Note 12 – “Subsequent Events” which is included in our notes to consolidated financial statements included in this Quarterly Report on Form 10-Q.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Credit Risk

Our investments are subject to a high degree of credit risk. Credit risk is the exposure to loss from loan defaults. Default rates are subject to a wide variety of factors, including, but not limited to, borrower financial condition, property performance, property management, supply/demand factors, construction trends, consumer behavior, regional economics, interest rates, the strength of the U.S. economy, and other factors beyond our control. All loans are subject to a certain probability of default. We manage credit risk through the underwriting process, acquiring our investments at the appropriate discount to face value, if any, and establishing loss assumptions. We also carefully monitor the performance of the loans, as well as external factors that may affect their value.

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Interest Rate Risk

Our market risk arises primarily from interest rate risk relating to interest rate fluctuations. Many factors including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control contribute to interest rate risk. To meet our short and long-term liquidity requirements, we may borrow funds at fixed and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes in earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in benefits of lower interest rates with respect to our portfolio of investments with fixed interest rates. During the three-month periods ended March 31, 2018 and 2017, we did not engage in interest rate hedging activities. We do not hold or issue derivative contracts for trading or speculative purposes. We do not have any foreign denominated investments, and thus, we are not exposed to foreign currency fluctuations.

As of March 31, 2018, and December 31, 2017, our investment portfolio was 87% variable rate investments based on LIBOR for various terms. Borrowings under our MRA were short-term and at a variable rate. The following table quantifies the potential changes in interest income net of interest expense should interest rates increase by 50 or 100 basis points or decrease by 25 basis points, assuming that our current balance sheet was to remain constant and no actions were taken to alter our existing interest rate sensitivity:

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Item 4.  Controls and Procedures

Controls and Procedures

Our management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the principal executive and principal financial officers have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) or Rule 15d-15(f)) during the three months ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II - Other Information

Item 1.  Legal Proceedings

In the ordinary course of business, we may become subject to litigation. We have no knowledge of material legal proceedings pending or known to be contemplated against us at this time.

Item 1A.  Risk Factors

Not applicable as we are a smaller reporting company.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

Recent Sales of Unregistered Equity Securities

On October 25, 2016, we commenced the Offering of up to $500,000,000 in our Class P Shares. The Class P Shares are being offered and sold pursuant to an exemption from the registration requirements of the Securities Act, in accordance with Rule 506(b) of Regulation D, and in compliance with any applicable state securities laws. During the three-month period ended March 31, 2018, we received and accepted investors’ subscriptions for and issued 742,853 Class P Shares in the Offering resulting in gross offering proceeds of $20,148,422. During the period from March 31, 2018 to May 9, 2018, we received and accepted investors’ subscriptions for and issued 375,599 Class P Shares in the Offering resulting in gross offering proceeds of $10,203,809. As of May 9, 2018, we have issued 2,851,844 Class P Shares resulting in gross offering proceeds of $76,700,800 and had $423,299,200 of Class P Shares remaining to be sold in the Offering.

On March 1, 2018, we granted each of our three independent directors 400 restricted Class P Shares for a total of 1,200 Class P Shares with a total value of $30,000.  The Class P Shares will vest in equal one-third increments on March 1, 2019, 2020 and 2021.  The Class P Shares were issued under our independent director restricted share plan. No sales commissions or other consideration was paid in connection with such issuances, which were made without registration under the Securities Act in reliance upon the exemption from registration set forth in Section 4(a)(2) of the Securities Act as transactions not involving any public offering.

Except as set forth above, we have not sold any securities which were not registered under the Securities Act during the period covered by this report.

Repurchases of Common Stock

As of the date of this Quarterly Report on Form 10-Q, we have not repurchased any shares of our common stock.

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not Applicable.

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Item 5.  Other Information

Not Applicable.

Item 6.  Exhibits

The representations, warranties and covenants made by us in any agreement filed as an exhibit to this Form 10-Q are made solely for the benefit of the parties to the agreement, including, in some cases, for the purpose of allocating risk among the parties to the agreement, and should not be deemed to be representations, warranties or covenants to, or with, you. Moreover, these representations, warranties and covenants should not be relied upon as accurately describing or reflecting the current state of our affairs.

The exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index attached hereto and are incorporated herein by reference.