KBS Real Estate Investment Trust II, Inc. - Quarter Report: 2016 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________________

FORM 10-Q

______________________________________________________

(Mark One)



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

For the quarterly period ended March 31, 2016



¨	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 000-53649

______________________________________________________

KBS REAL ESTATE INVESTMENT TRUST II, INC.

(Exact Name of Registrant as Specified in Its Charter)

______________________________________________________



Maryland		26-0658752
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
800 Newport Center Drive, Suite 700 Newport Beach, California		92660
(Address of Principal Executive Offices)		(Zip Code)

(949) 417-6500

(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 x No ¨

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



Large Accelerated Filer	¨		Accelerated Filer	¨
Non-Accelerated Filer	x	(Do not check if a smaller reporting company)	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

As of May 4, 2016, there were 189,199,238 outstanding shares of common stock of the registrant.

Table of Contents

KBS REAL ESTATE INVESTMENT TRUST II, INC.

FORM 10-Q

March 31, 2016

INDEX



PART I.	FINANCIAL INFORMATION		2
	Item 1.	Financial Statements	2
		Consolidated Balance Sheets as of March 31, 2016 (unaudited) and December 31, 2015	2
		Consolidated Statements of Operations (unaudited) for the Three Months Ended March 31, 2016 and 2015	3
		Consolidated Statements of Comprehensive Income (unaudited) for the Three Months Ended March 31, 2016 and 2015	4
		Consolidated Statements of Stockholders’ Equity for the Year Ended December 31, 2015 and the Three Months Ended March 31, 2016 (unaudited)	5
		Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2016 and 2015	6
		Condensed Notes to Consolidated Financial Statements as of March 31, 2016 (unaudited)	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	35
	Item 4.	Controls and Procedures	36
PART II.	OTHER INFORMATION		37
	Item 1.	Legal Proceedings	37
	Item 1A.	Risk Factors	37
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
	Item 3.	Defaults upon Senior Securities	38
	Item 4.	Mine Safety Disclosures	38
	Item 5.	Other Information	38
	Item 6.	Exhibits	39
SIGNATURES			40

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)



	March 31, 2016			December 31, 2015
	(unaudited)
Assets
Real estate:
Land	$	206,262		$	206,262
Buildings and improvements	1,020,163			1,009,368
Tenant origination and absorption costs	74,433			76,132
Total real estate, cost	1,300,858			1,291,762
Less accumulated depreciation and amortization	(124,641		)	(113,460		)
Total real estate, net	1,176,217			1,178,302
Real estate loan receivable, net	14,174			14,210
Total real estate and real estate-related investments, net	1,190,391			1,192,512
Cash and cash equivalents	59,476			72,687
Rents and other receivables, net	60,960			58,109
Above-market leases, net	6,968			7,596
Due from affiliate	181			—
Prepaid expenses and other assets	36,971			33,626
Total assets	$	1,354,947		$	1,364,530
Liabilities and stockholders’ equity
Notes payable, net	$	546,276		$	546,077
Accounts payable and accrued liabilities	32,638			30,329
Due to affiliate	40			49
Distributions payable	4,507			4,725
Below-market leases, net	4,534			5,570
Other liabilities	10,987			9,850
Total liabilities	598,982			596,600
Commitments and contingencies (Note 11)
Redeemable common stock	8,316			10,000
Stockholders’ equity:
Preferred stock, $.01 par value; 10,000,000 shares authorized, no shares issued and outstanding	—			—
Common stock, $.01 par value; 1,000,000,000 shares authorized, 189,256,628 and 189,556,185 shares issued and outstanding as of March 31, 2016 and December 31, 2015, respectively	1,892			1,895
Additional paid-in capital	1,684,209			1,684,206
Cumulative distributions in excess of net income	(938,426		)	(928,111		)
Accumulated other comprehensive loss	(26		)	(60		)
Total stockholders’ equity	747,649			757,930
Total liabilities and stockholders’ equity	$	1,354,947		$	1,364,530

See accompanying condensed notes to consolidated financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except share and per share amounts)



	Three Months Ended March 31,
	2016		2015
Revenues:
Rental income	$	34,997	$	36,824
Tenant reimbursements	3,999		3,892
Interest income from real estate loans receivable	268		1,362
Other operating income	1,730		1,852
Total revenues	40,994		43,930
Expenses:
Operating, maintenance, and management	8,734		10,151
Real estate taxes and insurance	5,072		5,221
Asset management fees to affiliate	2,956		3,086
General and administrative expenses	1,962		1,123
Depreciation and amortization	14,892		12,939
Interest expense	4,474		6,847
Impairment charge on real estate	—		4,486
Total expenses	38,090		43,853
Other income:
Other interest income	16		48
Gain on sales of real estate, net	—		27,407
Total other income	16		27,455
Net income	$	2,920	$	27,532
Net income per common share, basic and diluted	$	0.02	$	0.14
Weighted-average number of common shares outstanding, basic and diluted	189,437,758		190,529,659

See accompanying condensed notes to consolidated financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(in thousands)



	Three Months Ended March 31,
	2016		2015
Net income	$	2,920	$	27,532
Other comprehensive income:
Reclassification of realized losses recognized on interest rate swaps (effective portion)	34		692
Total other comprehensive income	34		692
Total comprehensive income	$	2,954	$	28,224

See accompanying condensed notes to consolidated financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Year Ended December 31, 2015 and the Three Months Ended March 31, 2016 (unaudited)

(dollars in thousands)



						Additional Paid-in Capital			Cumulative Distributions and Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity
	Common Stock
	Shares		Amounts
Balance, December 31, 2014	190,561,603		$	1,905		$	1,690,010		$	(890,751	)	$	(1,637	)	$	799,527
Net income	—		—			—			18,377			—			18,377
Other comprehensive income	—		—			—			—			1,577			1,577
Redemptions of common stock	(1,005,418	)	(10		)	(5,804		)	—			—			(5,814		)
Distributions declared	—		—			—			(55,737		)	—			(55,737		)
Balance, December 31, 2015	189,556,185		$	1,895		$	1,684,206		$	(928,111	)	$	(60	)	$	757,930
Net income	—		—			—			2,920			—			2,920
Other comprehensive income	—		—			—			—			34			34
Redemptions of common stock	(299,557	)	(3		)	(1,681		)	—			—			(1,684		)
Transfers from redeemable common stock	—		—			1,684			—			—			1,684
Distributions declared	—		—			—			(13,235		)	—			(13,235		)
Balance, March 31, 2016	189,256,628		$	1,892		$	1,684,209		$	(938,426	)	$	(26	)	$	747,649

See accompanying condensed notes to consolidated financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)



	Three Months Ended March 31,
	2016			2015
Cash Flows from Operating Activities:
Net income	$	2,920		$	27,532
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	14,892			12,939
Impairment charge on real estate	—			4,486
Noncash interest income on real estate-related investments	1			3
Deferred rent	(1,325		)	(1,871		)
Bad debt expense	42			210
Amortization of above- and below-market leases, net	(408		)	(391		)
Amortization of deferred financing costs	369			642
Unrealized losses (gains) on derivative instruments	196			(31		)
Gain on sales of real estate, net	—			(27,407		)
Changes in operating assets and liabilities:
Rents and other receivables	(2,927		)	(403		)
Prepaid expenses and other assets	(3,393		)	(10,728		)
Accounts payable and accrued liabilities	1,066			407
Due from affiliates	(181		)	—
Due to affiliates	(9		)	7
Other liabilities	994			496
Net cash provided by operating activities	12,237			5,891
Cash Flows from Investing Activities:
Proceeds from sale of real estate	—			121,923
Improvements to real estate	(10,176		)	(5,245		)
Principal repayments on real estate loans receivable	35			171
Net cash (used in) provided by investing activities	(10,141		)	116,849
Cash Flows from Financing Activities:
Principal payments on notes payable	—			(89,700		)
Payments of deferred financing costs	(170		)	(10		)
Payments to redeem common stock	(1,684		)	(682		)
Distributions paid to common stockholders	(13,453		)	(15,479		)
Net cash used in financing activities	(15,307		)	(105,871		)
Net (decrease) increase in cash and cash equivalents	(13,211		)	16,869
Cash and cash equivalents, beginning of period	72,687			179,021
Cash and cash equivalents, end of period	$	59,476		$	195,890
Supplemental Disclosure of Cash Flow Information:
Interest paid	$	4,044		$	6,299
Supplemental Disclosure of Noncash Transactions:
Increase in accrued improvements to real estate	$	1,706		$	—

See accompanying condensed notes to consolidated financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(unaudited)


1.	ORGANIZATION

KBS Real Estate Investment Trust II, Inc. (the “Company”) was formed on July 12, 2007 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2008. The Company conducts its business primarily through KBS Limited Partnership II, a Delaware limited partnership formed on August 23, 2007 (the “Operating Partnership”), and its subsidiaries. The Company is the sole general partner of and directly owns a 0.1% partnership interest in the Operating Partnership. The Company’s wholly-owned subsidiary, KBS REIT Holdings II LLC, a Delaware limited liability company formed on August 23, 2007 (“KBS REIT Holdings II”), owns the remaining 99.9% partnership interest in the Operating Partnership and is its sole limited partner.

The Company invested in a diverse portfolio of real estate and real estate-related investments. As of March 31, 2016, the Company owned 12 real estate properties (consisting of 10 office properties, one office/flex property and an office campus consisting of eight office buildings) and one real estate loan receivable.

Subject to certain restrictions and limitations, the business of the Company is managed by KBS Capital Advisors LLC (the “Advisor”), an affiliate of the Company, pursuant to an advisory agreement the Company renewed with the Advisor on May 21, 2015 (the “Advisory Agreement”). The Advisory Agreement may be renewed for an unlimited number of one-year periods upon the mutual consent of the Advisor and the Company. Either party may terminate the Advisory Agreement upon 60 days’ written notice. The Advisor owns 20,000 shares of the Company’s common stock.

Upon commencing its initial public offering (the “Offering”), the Company retained KBS Capital Markets Group LLC (the “Dealer Manager”), an affiliate of the Advisor, to serve as the dealer manager of the Offering pursuant to a dealer manager agreement, as amended and restated on April 30, 2010 (the “Dealer Manager Agreement”). The Company ceased offering shares of common stock in its primary offering on December 31, 2010 and terminated its primary offering on March 22, 2011. The Company terminated its dividend reinvestment plan effective May 29, 2014.

The Company sold 182,681,633 shares of common stock in its primary offering for gross offering proceeds of $1.8 billion. The Company sold 30,903,504 shares of common stock under its dividend reinvestment plan for gross offering proceeds of $298.2 million. Also as of March 31, 2016, the Company had redeemed 24,348,509 shares sold in the Offering for $237.0 million.


2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

There have been no significant changes to the Company’s accounting policies since it filed its audited financial statements in its Annual Report on Form 10-K for the year ended December 31, 2015. For further information about the Company’s accounting policies, refer to the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2015 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”).

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements and condensed notes thereto have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information as contained within the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) and the rules and regulations of the SEC, including the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for audited financial statements. In the opinion of management, the financial statements for the unaudited interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair and consistent presentation of the results for such periods. Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

The consolidated financial statements include the accounts of the Company, KBS REIT Holdings II, the Operating Partnership, and their direct and indirect wholly owned subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.

Use of Estimates

The preparation of the consolidated financial statements and condensed notes thereto in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and condensed notes. Actual results could materially differ from those estimates.

Per Share Data

Basic net income (loss) per share of common stock is calculated by dividing net income (loss) by the weighted-average number of shares of common stock issued and outstanding during such period. Diluted net income (loss) per share of common stock equals basic net income (loss) per share of common stock as there were no potentially dilutive securities outstanding during the three months ended March 31, 2016 and 2015, respectively.

Distributions declared per common share were $0.070 and $0.072 in the aggregate for the three months ended March 31, 2016 and 2015, respectively. Distributions declared per common share assumes each share was issued and outstanding each day that was a record date for distributions and were based on a monthly record date for each month during the period commencing January 2016 through March 2016 and January 2015 through March 2015.

Segments

The Company invested in core real estate properties and real estate-related investments with the goal of acquiring a portfolio of income-producing investments. The Company’s real estate properties exhibit similar long-term financial performance and have similar economic characteristics to each other. As of March 31, 2016, the Company aggregated its investments in real estate properties into one reportable business segment. The Company considered both quantitative and qualitative thresholds and determined that its investment in a real estate loan receivable does not constitute a reportable segment. Prior to the reporting period commencing on January 1, 2016, the Company had identified two reportable business segments based on its investment types: real estate and real estate-related. However, based on the Company’s current investment portfolio, the Company does not believe that its investment in a real estate-related investment is a reportable segment.

Recently Issued Accounting Standards Update

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU No. 2014-09”). ASU No. 2014-09 requires an entity to recognize the revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. ASU No. 2014-09 supersedes the revenue requirements in Revenue Recognition (Topic 605) and most industry-specific guidance throughout the Industry Topics of the Codification. ASU No. 2014-09 does not apply to lease contracts within the scope of Leases (Topic 840). ASU No. 2014-09 was to be effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and is to be applied retrospectively, with early application not permitted. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date (“ASU No. 2015-14”), which defers the effective date of ASU No. 2014-09 by one year. Early adoption is permitted but not before the original effective date. The Company is still evaluating the impact of adopting ASU No. 2014-09 on its financial statements, but does not expect the adoption of ASU No. 2014-09 to have a material impact on its financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU No. 2014-15”). The amendments in ASU No. 2014-15 require management to evaluate, for each annual and interim reporting period, whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or are available to be issued when applicable) and, if so, provide related disclosures. ASU No. 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early adoption is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. The Company does not expect the adoption of ASU No. 2014-15 to have a significant impact on its financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU No. 2016-01”). The amendments in ASU No. 2016-01 address certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU No. 2016-01 primarily affects accounting for equity investments and financial liabilities where the fair value option has been elected. ASU No. 2016-01 also requires entities to present financial assets and financial liabilities separately, grouped by measurement category and form of financial asset in the balance sheet or in the accompanying notes to the financial statements. ASU No. 2016-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early application is permitted for financial statements that have not been previously issued. The Company does not expect the adoption of ASU No. 2016-01 to have a significant impact on its financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU No. 2016-02”). The amendments in ASU No. 2016-02 change the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU No. 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of ASU No. 2016-02 as of its issuance is permitted. The new leases standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. The Company is currently evaluating the impact of adopting the new leases standard on its consolidated financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)


3.	REAL ESTATE

As of March 31, 2016, the Company’s portfolio of real estate was composed of ten office properties, one office/flex property and an office campus consisting of eight office buildings, encompassing in the aggregate approximately 5.2 million rentable square feet. As of March 31, 2016, the Company’s real estate portfolio was 89% occupied. The following table summarizes the Company’s real estate portfolio as of March 31, 2016 (in thousands):



Property	Date Acquired	City	State	Property Type	Total Real Estate at Cost ⁽¹⁾		Accumulated Depreciation and Amortization⁽¹⁾			Total Real Estate, Net⁽¹⁾
100 & 200 Campus Drive Buildings	09/09/2008	Florham Park	NJ	Office	$	136,762	$	(2,917	)	$	133,845
300-600 Campus Drive Buildings	10/10/2008	Florham Park	NJ	Office	154,529		(6,184		)	148,345
350 E. Plumeria Building	12/18/2008	San Jose	CA	Office/Flex	36,717		(8,220		)	28,497
Willow Oaks Corporate Center	08/26/2009	Fairfax	VA	Office	103,209		(14,440		)	88,769
Pierre Laclede Center	02/04/2010	Clayton	MO	Office	74,329		(4,288		)	70,041
Horizon Tech Center	06/17/2010	San Diego	CA	Office	29,533		(884		)	28,649
Union Bank Plaza	09/15/2010	Los Angeles	CA	Office	186,631		(8,879		)	177,752
Emerald View at Vista Center	12/09/2010	West Palm Beach	FL	Office	30,713		(5,087		)	25,626
Granite Tower	12/16/2010	Denver	CO	Office	155,317		(33,378		)	121,939
Gateway Corporate Center	01/26/2011	Sacramento	CA	Office	44,439		(8,874		)	35,565
Fountainhead Plaza	09/13/2011	Tempe	AZ	Office	119,384		(8,207		)	111,177
Corporate Technology Centre	03/28/2013	San Jose	CA	Office	229,295		(23,283		)	206,012
					$	1,300,858	$	(124,641	)	$	1,176,217

_____________________

⁽¹⁾Amounts presented are net of impairment charges.

As of March 31, 2016, the following properties represented more than 10% of the Company’s total assets:



Property	Location	Rentable Square Feet	Total Real Estate, Net (in thousands)		Percentage of Total Assets		Annualized Base Rent (in thousands) ⁽¹⁾		Average Annualized Base Rent per Sq. Ft.		Occupancy
Corporate Technology Centre	San Jose, CA	610,083	$	206,012	15.2	%	$	18,537	$	30.38	100	%
Union Bank Plaza	Los Angeles, CA	627,334	177,752		13.1	%	22,947		39.85		92	%
300-600 Campus Drive Buildings	Florham Park, NJ	578,402	148,345		10.9	%	17,480		30.69		98	%

_____________________

⁽¹⁾Annualized base rent represents annualized contractual base rental income as of March 31, 2016, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

Operating Leases

The Company’s real estate properties are leased to tenants under operating leases for which the terms and expirations vary. As of March 31, 2016, the leases had remaining terms, excluding options to extend, of up to 15.6 years with a weighted-average remaining term of 5.6 years. Some of the leases have provisions to extend the term of the leases, options for early termination for all or part of the leased premises after paying a specified penalty, rights of first refusal to purchase the property at competitive market rates, and other terms and conditions as negotiated. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants. Generally, upon the execution of a lease, the Company requires a security deposit from the tenant in the form of a cash deposit and/or a letter of credit. The amount required as a security deposit varies depending upon the terms of the respective lease and the creditworthiness of the tenant, but generally is not a significant amount. Therefore, exposure to credit risk exists to the extent that a receivable from a tenant exceeds the amount of its security deposit. Security deposits received in cash related to tenant leases are included in other liabilities in the accompanying consolidated balance sheets and totaled $2.4 million and $2.4 million as of March 31, 2016 and December 31, 2015, respectively.

During the three months ended March 31, 2016 and 2015, the Company recognized deferred rent from tenants, net of lease incentive amortization, of $1.3 million and $1.9 million, respectively. As of March 31, 2016 and December 31, 2015, the cumulative deferred rent balance was $57.5 million and $54.6 million, respectively, and is included in rents and other receivables on the accompanying balance sheets. The cumulative deferred rent balance included $12.8 million and $11.9 million of unamortized lease incentives as of March 31, 2016 and December 31, 2015, respectively.

As of March 31, 2016, the future minimum rental income from the Company’s properties under non-cancelable operating leases was as follows (in thousands):



April 1, 2016 through December 31, 2016	$	94,313
2017	123,551
2018	116,952
2019	102,850
2020	97,701
Thereafter	357,243
	$	892,610

As of March 31, 2016, the Company had over 250 tenants over a diverse range of industries and geographic areas. The Company’s highest tenant industry concentrations (greater than 10% of annualized base rent) were as follows:



Industry	Number of Tenants	Annualized Base Rent ⁽¹⁾ (in thousands)		Percentage of Annualized Base Rent
Finance	31	$	30,258	21.9	%
Computer System Design & Programming	11	23,003		16.6	%
Mining, Oil & Gas Extraction	5	16,920		12.2	%
Legal Services	36	14,463		10.5	%
		$	84,644	61.2	%

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of March 31, 2016, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

No other tenant industries accounted for more than 10% of annualized base rent. The Company had not identified any material tenant credit issues as of March 31, 2016. During the three months ended March 31, 2016 and 2015, the Company recorded bad debt expense of $42,000 and $0.2 million, respectively. As of March 31, 2016, the Company had a bad debt expense reserve of approximately $0.3 million, which represented less than 1% of its annualized base rent.

As of March 31, 2016, the Company had a concentration of credit risk related to the following tenant lease that represented more than 10% of the Company’s annualized base rent:

Annualized Base Rent Statistics

Tenant

Property

Tenant Industry

Square

Feet

% of Portfolio (Net Rentable Sq. Ft.)

Annualized

Base Rent

(in thousands) ⁽¹⁾

% of Portfolio Annualized Base Rent

Annualized Base Rent per Sq. Ft.

Lease Expiration ^{(2) (3)}

Union Bank

Union Bank Plaza

Finance

408,260

8.8%

16,804

12.1%

41.16

09/30/2016 /

04/30/2017 /

01/31/2022

_____________________

⁽²⁾ Represents the expiration date of the lease as of March 31, 2016 and does not take into account any tenant renewal or termination options.

⁽³⁾ Of the 408,260 rentable square feet occupied by the tenant, a total of 33,602 rentable square feet will expire on September 30, 2016 and 31,946 rentable square feet will expire on April 30, 2017.

No other tenant accounted for more than 10% of annualized base rent.

Geographic Concentration Risk

As of March 31, 2016, the Company’s net investments in real estate in California and New Jersey represented 35.2% and 20.8% of the Company’s total assets, respectively. As a result, the geographic concentration of the Company’s portfolio makes it particularly susceptible to adverse economic developments in the California and New Jersey real estate markets. Any adverse economic or real estate developments in these markets, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for office space resulting from the local business climate, could adversely affect the Company’s operating results and its ability to make distributions to stockholders.

Impairment of Real Estate

During the three months ended March 31, 2015, the Company recorded impairment charges of $4.5 million with respect to two real estate properties that were reclassified from held for sale to held for investment. The impairment charges were recorded to adjust the carrying values of the properties for any depreciation and amortization expense that would have been recognized if the properties had always been classified as held for investment, which otherwise would have been recorded through depreciation and amortization expense.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)


4.	TENANT ORIGINATION AND ABSORPTION COSTS, ABOVE-MARKET LEASE ASSETS AND BELOW-MARKET LEASE LIABILITIES

As of March 31, 2016 and December 31, 2015, the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities (excluding fully amortized assets and liabilities and accumulated amortization) were as follows (in thousands):



	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	March 31, 2016			December 31, 2015			March 31, 2016			December 31, 2015			March 31, 2016			December 31, 2015
Cost	$	74,433		$	76,132		$	15,347		$	15,375		$	(16,143	)	$	(20,436	)
Accumulated amortization	(32,758		)	(31,020		)	(8,379		)	(7,779		)	11,609			14,866
Net amount	$	41,675		$	45,112		$	6,968		$	7,596		$	(4,534	)	$	(5,570	)

Increases (decreases) in net income as a result of amortization of the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities for the three months ended March 31, 2016 and 2015 were as follows (in thousands):



	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	For the Three Months Ended March 31,						For the Three Months Ended March 31,						For the Three Months Ended March 31,
	2016			2015			2016			2015			2016		2015
Amortization	$	(3,437	)	$	(3,633	)	$	(628	)	$	(748	)	$	1,036	$	1,139

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)


5.	REAL ESTATE LOAN RECEIVABLE

As of March 31, 2016 and December 31, 2015, the Company, through an indirect wholly owned subsidiary, had originated the following real estate loan receivable (dollars in thousands):

Loan Name

Location of Related Property or Collateral

Date Acquired/ Originated

Property Type

Loan Type

Outstanding Principal Balance as of March 31,

2016 ⁽¹⁾

Book Value

as of

March 31,

2016 ⁽²⁾

Book Value

as of

December 31,

2015 ⁽²⁾

Contractual Interest Rate ⁽³⁾

Annualized Effective Interest Rate⁽³⁾

Maturity Date

Sheraton Charlotte Airport Hotel First Mortgage

Charlotte, North Carolina

07/11/2011

Hotel

Mortgage

14,166

14,174

14,210

7.5%

7.6%

08/01/2018

_____________________

⁽¹⁾Outstanding principal balance as of March 31, 2016 represents original principal balance outstanding under the loan, increased for any subsequent fundings and reduced for any principal paydowns.

⁽²⁾Book value represents outstanding principal balance, adjusted for unamortized acquisition discounts, origination fees and direct origination and acquisition costs.

⁽³⁾Contractual interest rate is the stated interest rate on the face of the loan. Annualized effective interest rate is calculated as the actual interest income recognized in 2016, using the interest method, annualized and divided by the average amortized cost basis of the investment during 2016. The contractual interest rate and annualized effective interest rate presented are as of March 31, 2016.

The following summarizes the activity related to the real estate loan receivable for the three months ended March 31, 2016 (in thousands):



Real estate loan receivable - December 31, 2015	$	14,210
Principal repayments received on the real estate loan receivable	(35		)
Amortization of closing costs and origination fees on the real estate loan receivable	(1		)
Real estate loan receivable - March 31, 2016	$	14,174

For the three months ended March 31, 2016 and 2015, interest income from real estate loan receivable consisted of the following (in thousands):



	Three Months Ended March 31,
	2016			2015
Contractual interest income	$	269		$	1,365
Amortization of closing costs and origination fees	(1		)	(3		)
Interest income from real estate loans receivable	$	268		$	1,362

As of March 31, 2016 and December 31, 2015, the borrower under the Company’s real estate loan receivable was current on its debt obligations.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)


6.	REAL ESTATE SALES

In accordance with ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU No. 2014-08”), results of operations from properties that are classified as held for sale in the ordinary course of business on or subsequent to January 1, 2014 would generally be included in continuing operations on the Company’s consolidated statements of operations. Results of operations from properties that were classified as held for sale in financial statements issued prior to January 1, 2014 will remain in discontinued operations on the Company’s consolidated statements of operations. Prior to the adoption of ASU No. 2014-08, the results of operations of properties held for sale or to be disposed of and the aggregate net gains recognized upon their disposition were presented as discontinued operations in the accompanying consolidated statements of operations for all periods presented.

During the year ended December 31, 2015, the Company disposed of one office property. The results of operations for the property sold during the year ended December 31, 2015 are included in continuing operations on the Company’s consolidated statements of operations. As of March 31, 2016, the Company did not have any real estate properties held for sale. The following table summarizes certain revenue and expenses related to the Company’s real estate property that was sold during the year ended December 31, 2015, which were included in continuing operations (in thousands):



	Three Months Ended March 31,
	2016		2015
Revenues
Rental income	$	—	$	1,835
Tenant reimbursements	—		160
Other operating income	—		127
Total revenues	—		2,122
Expenses
Operating, maintenance, and management	—		624
Real estate taxes and insurance	—		196
Asset management fees to affiliate	—		108
Interest expense	—		411
Total expenses	$	—	$	1,339

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)


7.	NOTES PAYABLE

As of March 31, 2016 and December 31, 2015, the Company’s notes payable consisted of the following (dollars in thousands):



	Book Value as of March 31, 2016			Book Value as of December 31, 2015			Contractual Interest Rate as of March 31, 2016⁽¹⁾	Effective Interest Rate as of March 31, 2016⁽¹⁾	Payment Type	Maturity Date ⁽²⁾
Amended and Restated Portfolio Revolving Loan Facility ⁽³⁾	$	75,438		$	75,438		One-month LIBOR + 1.80%	3.1%	Interest Only	06/21/2017
Union Bank Plaza Mortgage Loan ⁽⁴⁾	105,000			105,000			One-month LIBOR + 1.65%	2.1%	Interest Only	09/15/2016
Portfolio Mortgage Loan #1 ⁽⁵⁾	95,033			95,033			One-month LIBOR + 2.15%	2.6%	Interest Only	07/27/2016
Portfolio Mortgage Loan #3 ⁽⁶⁾	54,000			54,000			One-month LIBOR + 1.75% - 1.85%	2.5%	Interest Only	03/01/2017
Corporate Technology Centre Mortgage Loan ⁽⁷⁾	140,000			140,000			3.50%	3.5%	⁽⁷⁾	04/01/2020
300-600 Campus Drive Revolving Loan ⁽⁸⁾	78,000			78,000			One-month LIBOR + 2.05%	2.9%	Interest Only	08/01/2016
Total notes payable principal outstanding	$	547,471		$	547,471
Deferred financing costs, net	(1,195		)	(1,394		)
Total notes payable, net	$	546,276		$	546,077

_____________________

⁽¹⁾ Contractual interest rate represents the interest rate in effect under the loan as of March 31, 2016. Effective interest rate is calculated as the actual interest rate in effect as of March 31, 2016 (consisting of the contractual interest rate and the effect of interest rate swaps and contractual floor rates, if applicable), using interest rate indices as of March 31, 2016, where applicable. For further information regarding the Company’s derivative instruments, see Note 8, “Derivative Instruments.”

⁽²⁾ Represents the initial maturity date or the maturity date as extended as of March 31, 2016; subject to certain conditions, the maturity dates of certain loans may be extended beyond the maturity date shown.

⁽³⁾ As of March 31, 2016, the Amended and Restated Portfolio Revolving Loan Facility was secured by the 350 E. Plumeria Building and Pierre Laclede Center.

⁽⁴⁾ As of March 31, 2016, $105.0 million of the Union Bank Plaza Mortgage Loan had been disbursed to the Company with the remaining loan balance of $14.3 million available for future disbursements, subject to certain conditions set forth in the loan agreement.

⁽⁵⁾As of March 31, 2016, Portfolio Mortgage Loan #1 was secured by Horizon Tech Center, Granite Tower and Gateway Corporate Center.

⁽⁶⁾ As of March 31, 2016, the principal balance under Portfolio Mortgage Loan #3 consisted of the $54.0 million non-revolving portion. The revolving portion of $16.0 million remained available for future disbursements, subject to certain terms and conditions contained in the loan documents. As of March 31, 2016, Portfolio Mortgage Loan #3 was secured by the 100 & 200 Campus Drive Buildings and Willow Oaks Corporate Center.

⁽⁷⁾ Monthly payments are initially interest-only. Beginning on May 1, 2017, monthly payments for the Corporate Technology Centre Mortgage Loan will include principal and interest with principal payments calculated using an amortization schedule of 30 years for the balance of the loan term, with the remaining principal balance, all accrued and unpaid interest and any other amounts due at maturity.

⁽⁸⁾ As of March 31, 2016, the principal balance of the 300-600 Campus Drive Revolving Loan consisted of $78.0 million of the non-revolving portion. The remaining non-revolving portion of $17.0 million and the revolving portion of $25.0 million remained available for future disbursements, subject to certain terms and conditions contained in the loan documents.

During the three months ended March 31, 2016 and 2015, the Company incurred $4.5 million and $6.8 million of interest expense, respectively. As of March 31, 2016 and December 31, 2015, $1.3 million and $1.5 million, respectively, of interest expense were payable. Included in interest expense for the three months ended March 31, 2016 and 2015 were $0.4 million and $0.6 million of amortization of deferred financing costs, respectively. Interest expense incurred as a result of the Company’s interest rate swap agreements were $0.5 million and $1.8 million for the three months ended March 31, 2016 and 2015, respectively.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

The following is a schedule of maturities, including principal amortization payments, for all notes payable outstanding as of March 31, 2016 (in thousands):



April 1, 2016 through December 31, 2016	$	278,033
2017	131,218
2018	2,750
2019	2,848
2020	132,622
	$	547,471

Certain of the Company’s notes payable contain financial debt covenants. As of March 31, 2016, the Company was in compliance with these debt covenants.


8.	DERIVATIVE INSTRUMENTS

The Company enters into derivative instruments for risk management purposes to hedge its exposure to cash flow variability caused by changing interest rates. The primary goal of the Company’s risk management practices related to interest rate risk is to prevent changes in interest rates from adversely impacting the Company’s ability to achieve its investment return objectives. The Company does not enter into derivatives for speculative purposes.

The Company enters into interest rate swaps as a fixed rate payer to mitigate its exposure to rising interest rates on its variable rate notes payable. The value of interest rate swaps is primarily impacted by interest rates, market expectations about interest rates, and the remaining life of the instrument. In general, increases in interest rates, or anticipated increases in interest rates, will increase the value of the fixed rate payer position and decrease the value of the variable rate payer position. As the remaining life of the interest rate swap decreases, the value of both positions will generally move towards zero.

The following table summarizes the notional amount and other information related to the Company’s interest rate swaps as of March 31, 2016 and December 31, 2015. The notional amount is an indication of the extent of the Company’s involvement in each instrument at that time, but does not represent exposure to credit, interest rate or market risks (dollars in thousands):

Derivative Instruments

March 31, 2016

December 31, 2015

Reference Rate as of March 31, 2016

Weighted-Average

Fix Pay Rate

Weighted-Average Remaining Term

in Years

Number of Instruments

Notional Amount

Number of Instruments

Notional Amount

Interest Rate Swaps ⁽¹⁾

$207,438

$265,488

One-month LIBOR/
Fixed at 0.71% - 1.30%

0.98%

0.9

_____________________

⁽¹⁾ During the three months ended March 31, 2016, one of the Company’s interest rate swaps expired. As of March 31, 2016 and December 31, 2015, none of the Company’s interest rate swaps were designated as cash flow hedges.

The following table sets forth the fair value of the Company’s derivative instruments as well as their classification on the consolidated balance sheets as of March 31, 2016 and December 31, 2015 (dollars in thousands):



Derivative Instruments	Balance Sheet Location	March 31, 2016				December 31, 2015
Derivative Instruments	Balance Sheet Location	Number of Instruments	Fair Value			Number of Instruments	Fair Value
Interest Rate Swaps	Prepaid expenses and other assets, at fair value	—	$	—		2	$	19
Interest Rate Swaps	Other liabilities, at fair value	4	$	(801	)	3	$	(658	)

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

The change in fair value of the effective portion of a derivative instrument that is designated as a cash flow hedge is recorded as other comprehensive income (loss) in the accompanying consolidated statements of comprehensive income (loss) and as other comprehensive income in the accompanying consolidated statements of stockholders’ equity. Amounts in other comprehensive income (loss) will be reclassified into earnings in the periods in which earnings are affected by the hedged cash flow. The change in fair value of the ineffective portion is recognized directly in earnings. With respect to swap agreements that were terminated for which it remains probable that the original hedged forecasted transactions (i.e., LIBOR-based debt service payments) will occur, the loss related to the termination of these swap agreements is included in accumulated other comprehensive income (loss) and is reclassified into earnings over the period of the original forecasted hedged transaction. The change in fair value of a derivative instrument that is not designated as a cash flow hedge is recorded as interest expense in the accompanying consolidated statements of operations. The following table summarizes the effects of derivative instruments on the Company’s consolidated statements of operations (in thousands):



	For the Three Months Ended March 31,
	2016		2015
Derivatives designated as hedging instruments ⁽¹⁾
Amount of loss recognized on interest rate swaps (effective portion)	$	34	$	692
	34		692
Derivatives not designated as hedging instruments
Realized loss recognized on interest rate swaps	268		989
Unrealized losses (gains) on interest rate swaps	196		(31		)
Losses related to swap terminations	2		170
	466		1,128
Increase in interest expense as a result of derivatives	$	500	$	1,820

_____________________

⁽¹⁾ All of the Company’s interest rate swap agreements were initially designated as cash flow hedges. During 2014, the Company dedesignated all of its interest rate swap instruments due to the anticipated early repayment of debt in connection with asset sales, and therefore, certain hedged forecasted transactions were no longer probable beyond the projected asset sale date.


9.	FAIR VALUE DISCLOSURES

Under GAAP, the Company is required to measure certain financial instruments at fair value on a recurring basis. In addition, the Company is required to measure other non-financial and financial assets at fair value on a non-recurring basis (e.g., carrying value of impaired real estate loans receivable and long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:


•	Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;


•	Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model‑derived valuations in which significant inputs and significant value drivers are observable in active markets; and


•	Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

The fair value for certain financial instruments is derived using a combination of market quotes, pricing models and other valuation techniques that involve significant management judgment. The price transparency of financial instruments is a key determinant of the degree of judgment involved in determining the fair value of the Company’s financial instruments. Financial instruments for which actively quoted prices or pricing parameters are available and for which markets contain orderly transactions will generally have a higher degree of price transparency than financial instruments for which markets are inactive or consist of non-orderly trades. The Company evaluates several factors when determining if a market is inactive or when market transactions are not orderly. The following is a summary of the methods and assumptions used by management in estimating the fair value of each class of assets and liabilities for which it is practicable to estimate the fair value:

Cash and cash equivalents, rent and other receivables, and accounts payable and accrued liabilities: These balances approximate their fair values due to the short maturities of these items.

Real estate loan receivable: The Company’s real estate loan receivable is presented in the accompanying consolidated balance sheets at its amortized cost net of recorded loan loss reserves (if applicable) and not at fair value. The fair value of the real estate loan receivable was estimated using an internal valuation model that considered the expected cash flows for the loan, underlying collateral value (for collateral-dependent loans) and estimated yield requirements of institutional investors for loans with similar characteristics, including remaining loan term, loan-to-value, type of collateral and other credit enhancements. The Company classifies these inputs as Level 3 inputs.

Derivative instruments: The Company’s derivative instruments are presented at fair value on the accompanying consolidated balance sheets. The valuation of these instruments is determined using a proprietary model that utilizes observable inputs. As such, the Company classifies these inputs as Level 2 inputs. The proprietary model uses the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and volatility. The fair values of interest rate swaps are estimated using the market standard methodology of netting the discounted fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of interest rates (forward curves) derived from observable market interest rate curves. In addition, credit valuation adjustments, which consider the impact of any credit risks to the contracts, are incorporated in the fair values to account for potential nonperformance risk.

Notes payable: The fair value of the Company’s notes payable is estimated using a discounted cash flow analysis based on management’s estimates of current market interest rates for instruments with similar characteristics, including remaining loan term, loan-to-value ratio, type of collateral and other credit enhancements. Additionally, when determining the fair value of liabilities in circumstances in which a quoted price in an active market for an identical liability is not available, the Company measures fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach. The Company classifies these inputs as Level 3 inputs.

The following were the face values, carrying amounts and fair values of the Company’s real estate loan receivable and notes payable as of March 31, 2016 and December 31, 2015, which carrying amounts do not generally approximate the fair values (in thousands):



	March 31, 2016						December 31, 2015
	Face Value		Carrying Amount		Fair Value		Face Value		Carrying Amount		Fair Value
Financial assets:
Real estate loan receivable	$	14,166	$	14,174	$	14,587	$	14,201	$	14,210	$	14,574
Financial liabilities:
Notes payable	$	547,471	$	546,276	$	550,341	$	547,471	$	546,077	$	549,129

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

Disclosure of the fair values of financial instruments is based on pertinent information available to the Company as of the period end and requires a significant amount of judgment. Low levels of transaction volume for certain financial instruments have made the estimation of fair values difficult and, therefore, both the actual results and the Company’s estimate of value at a future date could be materially different.

During the three months ended March 31, 2016, the Company measured the following liabilities at fair value (in thousands):



			Fair Value Measurements Using
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring Basis:
Liability derivatives	$	801	$	—	$	801	$	—


10.	RELATED PARTY TRANSACTIONS

The Company has entered into the Advisory Agreement with the Advisor. This agreement entitles the Advisor to specified fees upon the provision of certain services with regard to the management of the Company’s investments, among other services, and the disposition of investments, as well as reimbursement of certain costs incurred by the Advisor in providing services to the Company. In addition, the Advisor is entitled to certain other fees, including an incentive fee upon achieving certain performance goals, as detailed in the Advisory Agreement. The Company has also entered into a fee reimbursement agreement with the Dealer Manager pursuant to which the Company agreed to reimburse the Dealer Manager for certain fees and expenses it incurs for administering the Company’s participation in the Depository Trust & Clearing Corporation Alternative Investment Product Platform with respect to certain accounts of the Company’s investors serviced through the platform. The Advisor and Dealer Manager also serve as the advisor and dealer manager, respectively, for KBS Real Estate Investment Trust, Inc., KBS Real Estate Investment Trust III, Inc., KBS Strategic Opportunity REIT, Inc., KBS Legacy Partners Apartment REIT, Inc., KBS Strategic Opportunity REIT II, Inc. and KBS Growth & Income REIT, Inc.

On January 6, 2014, the Company, together with KBS Real Estate Investment Trust, Inc., KBS Real Estate Investment Trust III, Inc., KBS Strategic Opportunity REIT, Inc., KBS Legacy Partners Apartment REIT, Inc., KBS Strategic Opportunity REIT II, Inc., the Dealer Manager, the Advisor and other KBS-affiliated entities, entered into an errors and omissions and directors and officers liability insurance program where the lower tiers of such insurance coverage are shared. The cost of these lower tiers is allocated by the Advisor and its insurance broker among each of the various entities covered by the program, and is billed directly to each entity. The allocation of these shared coverage costs is proportionate to the pricing by the insurance marketplace for the first tiers of directors and officers liability coverage purchased individually by each REIT. The Advisor’s and the Dealer Manager’s portion of the shared lower tiers’ cost is proportionate to the respective entities’ prior cost for the errors and omissions insurance. In June 2015, KBS Growth & Income REIT, Inc. was added to the insurance program at terms similar to those described above.

During the three months ended March 31, 2016 and 2015, no other business transactions occurred between the Company and KBS Real Estate Investment Trust, Inc., KBS Real Estate Investment Trust III, Inc., KBS Strategic Opportunity REIT, Inc., KBS Legacy Partners Apartment REIT, Inc., KBS Strategic Opportunity REIT II, Inc. and KBS Growth & Income REIT, Inc.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)

Pursuant to the terms of these agreements, summarized below are the related-party costs incurred by the Company for the three months ended March 31, 2016 and 2015, respectively, and any related amounts payable as of March 31, 2016 and December 31, 2015 (in thousands):



	Incurred				Payable as of
	Three Months Ended March 31,				March 31,		December 31,
	2016		2015		2016		2015
Expensed
Asset management fees	$	2,956	$	3,086	$	—	$	—
Reimbursement of operating expenses ⁽¹⁾	69		45		40		49
Disposition fees ⁽²⁾	—		1,239		—		—
	$	3,025	$	4,370	$	40	$	49

_____________________

⁽¹⁾ Reimbursable operating expenses primarily consist of internal audit personnel costs, accounting software and cybersecurity related expenses incurred by the Advisor under the Advisory Agreement. The Company has reimbursed the Advisor for the Company’s allocable portion of the salaries, benefits and overhead of internal audit department personnel providing services to the Company. These amounts totaled $49,000 and $34,000 for the three months ended March 31, 2016 and 2015, respectively, and were the only type of employee costs reimbursed under the Advisory Agreement for the three months ended March 31, 2016 and 2015. The Company will not reimburse for employee costs in connection with services for which the Advisor earns acquisition, origination or disposition fees (other than reimbursement of travel and communication expenses) or for the salaries or benefits the Advisor or its affiliates may pay to the Company’s executive officers. In addition to the amounts above, the Company reimburses the Advisor for certain of the Company’s direct costs incurred from third parties that were initially paid by the Advisor on behalf of the Company.

⁽²⁾ Disposition fees with respect to real estate sold are included in the gain on sale of real estate, net, in the accompanying consolidated statements of operations. Disposition fees with respect to real estate loans receivable sold are included in the gain on payoff or sale of real estate loans receivable in the accompanying consolidated statements of operations.

As of March 31, 2016, the Company had $0.2 million due from the Advisor, which consisted of a $0.1 million property insurance rebate and $0.1 million in legal and professional fees reimbursable to the Company.


11.	COMMITMENTS AND CONTINGENCIES

Economic Dependency

The Company is dependent on the Advisor for certain services that are essential to the Company, including the disposition of real estate and real estate-related investments; management of the daily operations of the Company’s real estate and real estate-related investment portfolio; and other general and administrative responsibilities. In the event the Advisor is unable to provide any of these services, the Company will be required to obtain such services from other sources.

Environmental

As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. Compliance with existing environmental laws is not expected to have a material adverse effect on the Company’s financial condition and results of operations as of March 31, 2016.

Legal Matters

From time to time, the Company is party to legal proceedings that arise in the ordinary course of its business. Management is not aware of any legal proceedings of which the outcome is probable or reasonably possible to have a material adverse effect on the Company’s results of operations or financial condition, which would require accrual or disclosure of the contingency and possible range of loss. Additionally, the Company has not recorded any loss contingencies related to legal proceedings in which the potential loss is deemed to be remote.

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PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

March 31, 2016

(unaudited)


12.	SUBSEQUENT EVENTS

The Company evaluates subsequent events up until the date the consolidated financial statements are issued.

Distributions Paid

On April 1, 2016, the Company paid distributions of $4.5 million, which related to distributions declared for March 2016 in the amount of $0.02380055 per share of common stock to stockholders of record as of the close of business on March 21, 2016. On May 2, 2016, the Company paid distributions of $4.4 million, which related to distributions declared for April 2016 in the amount of $0.02303279 per share of common stock to stockholders of record as of the close of business on April 20, 2016.

Distributions Declared

On May 6, 2016, the Company’s board of directors declared a May 2016 distribution in the amount of $0.02380055 per share of common stock to stockholders of record as of the close of business on May 20, 2016, which the Company expects to pay in June 2016, and a June 2016 distribution in the amount of $0.02303279 per share of common stock to stockholders of record as of the close of business on June 20, 2016, which the Company expects to pay in July 2016.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

The following discussion and analysis should be read in conjunction with the accompanying financial statements of KBS Real Estate Investment Trust II, Inc. and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to KBS Real Estate Investment Trust II, Inc., a Maryland corporation, and, as required by context, KBS Limited Partnership II, a Delaware limited partnership, which we refer to as the “Operating Partnership,” and to their subsidiaries.

Forward-Looking Statements

Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Those statements include statements regarding the intent, belief or current expectations of KBS Real Estate Investment Trust II, Inc. and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. Actual results may differ materially from those contemplated by such forward-looking statements. Further, forward-looking statements speak only as of the date they are made, and 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 over time, unless required by law.

The following are some of the risks and uncertainties, although not all of the risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:

•

All of our executive officers and some of our directors and other key real estate and debt finance professionals are also officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, the entity that acted as our dealer manager and/or other KBS-affiliated entities. As a result, they face conflicts of interest, including significant conflicts created by our advisor’s compensation arrangements with us and other KBS-sponsored programs and KBS-advised investors and conflicts in allocating time among us and these other programs and investors. These conflicts could result in unanticipated actions.


•	We pay substantial fees to and expenses of our advisor and its affiliates. These payments increase the risk that our stockholders will not earn a profit on their investment in us and increase the risk of loss to our stockholders.

•

We have used proceeds from financings, when necessary, to fund a portion of our distributions during our operational stage. We currently expect that our distributions will generally be paid from cash flow from operations and funds from operations from current or prior periods. We also expect to fund other distributions from the net proceeds from the sale of real estate and from the receipt of principal payments from, or the sale of, our real estate-related loan receivable. We can give no assurance regarding the timing, amount or source of future distributions.

•

We depend on tenants for the revenue generated by our real estate investments and, accordingly, the revenue generated by our real estate investments is dependent upon the success and economic viability of our tenants. Revenues from our properties could decrease due to a reduction in occupancy (caused by factors including, but not limited to, tenant defaults, tenant insolvency, early termination of tenant leases and non-renewal of existing tenant leases) and/or lower rental rates, making it more difficult for us to meet our debt service obligations and limiting our ability to pay distributions to our stockholders.

•

Our investments in real estate and our mortgage loan may be affected by unfavorable real estate market and general economic conditions, which could decrease the value of those assets and reduce the investment return to our stockholders. Revenues from our properties and the property and other assets directly securing our loan investment could decrease. Such events would make it more difficult for the borrower under our loan investment to meet its payment obligations to us. It could also make it more difficult for us to meet our debt service obligations and limit our ability to pay distributions to our stockholders.


•	Disruptions in the financial markets and uncertain economic conditions could adversely affect our ability to implement our business strategy and generate returns to our stockholders.


•	Certain of our debt obligations have variable interest rates and related payments that vary with the movement of LIBOR or other indexes. Increases in these indexes could increase the amount of our debt payments and limit our ability to pay distributions to our stockholders.

•

Our share redemption program provides only for redemptions sought upon a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program document, and, together with redemptions sought in connection with a stockholder’s death, “special redemptions”). The dollar amounts available for such redemptions are determined by the board of directors and may be reviewed and adjusted from time to time. Additionally, redemptions are further subject to limitations described in our share redemption program. We currently do not expect to have funds available for ordinary redemptions in the future.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

•

Since we have terminated our dividend reinvestment plan, we may have to use a greater proportion of our cash flow from operations to meet cash requirements for general corporate purposes, including, but not limited to, capital expenditures, tenant improvement costs and leasing costs related to our real estate properties; reserves required by financings of our real estate properties; the repayment of debt; and special redemptions under our share redemption program. This may reduce cash available for distributions.

•


•	Although the Special Committee (defined below) has engaged a financial advisor to assist with the exploration of strategic alternatives for us, we are not obligated to enter into any particular transaction or any transaction at all.

All forward-looking statements should be read in light of the risks identified in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission (the “SEC”).

Overview

We were formed on July 12, 2007 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2008 and we intend to continue to operate in such a manner. We invested in a diverse portfolio of real estate and real estate-related investments. We conduct our business primarily through our Operating Partnership, of which we are the sole general partner. Subject to certain restrictions and limitations, our business is managed by our advisor, KBS Capital Advisors LLC, pursuant to an advisory agreement. KBS Capital Advisors conducts our operations and manages our portfolio of real estate and real estate-related investments. Our advisor owns 20,000 shares of our common stock. We have no paid employees.

On September 27, 2007, we filed a registration statement on Form S-11 with the SEC to offer a maximum of 280,000,000 shares of common stock for sale to the public, of which 200,000,000 shares were registered in our primary offering and 80,000,000 shares were registered under our dividend reinvestment plan. We ceased offering shares of common stock in our primary offering on December 31, 2010. We sold 182,681,633 shares of common stock in our primary offering for gross offering proceeds of $1.8 billion. We terminated the offering under our dividend reinvestment plan effective May 29, 2014. We sold 30,903,504 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $298.2 million. Also as of March 31, 2016, we had redeemed 24,348,509 shares sold in our offering for $237.0 million.

Our focus in 2016 is to: continue to strategically sell assets and make special distributions to stockholders; strategically negotiate lease renewals or new leases that facilitate the sales process and enhance property stability for prospective buyers; and complete major capital improvement projects, such as renovations or amenity enhancements, with the goal of attracting a greater pool of quality buyers.

Market Outlook – Real Estate and Real Estate Finance Markets

The following discussion is based on management’s beliefs, observations and expectations with respect to the real estate and real estate finance markets.

Current conditions in the global capital markets remain volatile. The International Monetary Fund, in its Global Financial Stability Report, states that the economic outlook has deteriorated in advanced economies because of heightened uncertainty and setbacks to growth and confidence. This situation is amplified in emerging economies, where oil and commodity prices, coupled with slower economic growth, have kept risk levels elevated. Dismal financial conditions in Europe and Japan, and continued outflows from emerging markets are some of the crucial risks leading to financial uncertainty and poor investor confidence. China, in particular, has been a source of uncertainty, as the economy is undergoing a complex transition towards a more sustainable growth model; one that is based on consumption and services.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

In the United States, economic growth has been relatively steady and low. The U.S. labor markets have been improving and are adding approximately 200,000 jobs each month. The unemployment rate is hovering around 5%. These positive signs are, however, offset somewhat by a lack of real income growth and a persistently low labor participation rate. The U.S. energy market has been struggling with the oversupply of oil and natural gas, which is a reversal of the trend that played an important role in the U.S. economic recovery following the 2008-2009 recession. Forward-looking economic indicators provided by the Federal Reserve are pointing to a continued slowing in gross domestic product in Q1 2016.

Central bank interventions and the use of monetary policy to combat the lingering effects of the 2008-2009 recession continue to affect the global economy. The Federal Reserve pursued an accommodative monetary policy that included cutting interest rates and implementing a quantitative easing (“QE”) program. In 2015, the U.S. economy continued strengthening, and the Federal Reserve ceased the QE program and raised the Target Funds rate by 25 basis points. Following this move, the U.S. economic indicators started to weaken, and the dollar traded off against most major world currencies.

In Europe and Japan, the central bank interventions into the local economies have continued. Asset purchases and stimulus programs in both regions have driven down interest rates and investment yields. Both regions now have unnaturally low interest rates, with some government and corporate bonds trading with negative yields. While the intent of these policies is to spur economic growth, the size of these programs is unprecedented, and the ultimate impact on the global financial system remains unknown.

With the backdrop of increasing levels of global political conflict, and weaker international economic conditions, the U.S. dollar has remained a safe haven currency. Slowing economic growth and poor corporate earnings have caused the markets to discount talk of further interest rate increases. This, in turn, has kept the U.S. yield curve near all-time lows, and has kept the dollar weak.

The U.S. commercial real estate market continues to benefit from strong inflows of foreign capital. In 2015, commercial real estate transaction volumes increased 23%, making 2015 the second highest level of investment volume, behind only 2007. Low interest rates and aggressive loan underwriting standards have helped drive property values higher. In the first quarter of 2016, lending standards were tightened and transaction volumes have slowed. This phenomenon is best captured in the decline of the commercial mortgage backed securities market, which saw issuance forecasts slashed as of 2016. Highly leveraged investors are temporarily being forced out of the market. Secondary markets and riskier asset classes experienced a drop in prices.

Impact on Our Real Estate Investments

The volatility in the global financial markets continues to cause a level of uncertainty in our outlook for the performance of the U.S. commercial real estate markets. Both the investing and leasing environments are highly competitive. While there has been an increase in the amount of capital flowing into U.S. real estate markets, the uncertainty regarding the economic environment has made businesses reluctant to make long-term commitments, as is evidenced by the lower level of business investment and capital expenditures. Possible future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to renew tenants early, to retain tenants who are up for renewal or to attract new tenants, may result in decreases in cash flows. Historically low interest rates could help offset some of the impact of these potential decreases in operating cash flow for properties financed with variable rate mortgages; however, interest rates likely will not remain at these historically low levels for the remaining life of many of our investments. In fact, the Federal Reserve increased interest rates in Q4 2015, and has left the door open for another increase in at the end of Q2 2016. Currently we expect further increases in interest rates, but are uncertain as to the timing and levels. Interest rates have become more volatile as the global capital markets react to increasing economic and geopolitical risks.

Impact on Our Real Estate-Related Investment

Our real estate loan receivable is directly secured by commercial real estate. As a result, our real estate-related investment, in general, has been and likely will continue to be impacted by the same factors impacting our real estate properties. The higher yields and the improving credit position of many U.S. tenants and borrowers have attracted global capital. However, the real estate and capital markets are fluid, and the positive trends can reverse quickly. Economic conditions remain relatively volatile and can have a negative impact on the performance of collateral securing our loan investment, and therefore may impact the ability of the borrower under our loan to make contractual interest payments to us.

As of March 31, 2016, we had a fixed-rate real estate loan receivable with an outstanding principal balance of $14.2 million and a carrying value (including unamortized origination and closing costs) of $14.2 million that matures in 2018.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Impact on Our Financing Activities

In light of the risks associated with potentially volatile operating cash flows from some of our real estate properties, and the possible increase in the cost of financing due to higher interest rates, we may have difficulty refinancing some of our debt obligations prior to or at maturity or we may not be able to refinance these obligations at terms as favorable as the terms of our existing indebtedness. Financial market conditions have improved from the bottom of the economic cycle, and short-term interest rates in the U.S. have increased. Market conditions can change quickly, potentially negatively impacting the value of our investments.

As of March 31, 2016, we had debt obligations in the aggregate principal amount of $547.5 million with a weighted-average remaining term of 1.5 years. We had a total of $140.0 million of fixed rate notes payable and $407.5 million of variable rate notes payable as of March 31, 2016. The interest rates on $207.4 million of our variable rate notes payable are effectively fixed through interest rate swap agreements. As of March 31, 2016, we had a total of $332.0 million of debt obligations scheduled to mature within 12 months of that date. We plan to exercise our extension options available under our loan agreements or pay down or refinance the related notes payable prior to their maturity dates.

Liquidity and Capital Resources

Our principal demands for funds during the short- and long-term are and will be for: the payment of operating expenses, capital expenditures and general and administrative expenses; payments under debt obligations; special redemptions of common stock pursuant to our share redemption program; and payments of distributions to stockholders.

We intend to use our cash on hand, cash flow generated by our real estate and real estate-related investment, proceeds from debt financing, proceeds from the sale of real estate properties and possibly the principal repayment on or sale of our real estate loan receivable as our primary sources of immediate and long-term liquidity. As of March 31, 2016, we had an aggregate of $41.0 million available for future disbursements under two credit facilities, subject to certain conditions and restrictions set forth in the respective loan agreements.

Our share redemption program provides only for special redemptions. During each calendar year, such special redemptions are limited to an annual dollar amount determined by the board of directors, which may be reviewed during the year and increased or decreased upon ten business days’ notice to our stockholders. Special redemptions are made at a price per share equal to the most recent estimated value per share of our common stock as of the applicable redemption date. We currently do not expect to make ordinary redemptions in the future. On December 8, 2015, our board of directors approved an annual dollar limitation of $10.0 million in the aggregate for the calendar year 2016 (subject to review and adjustment during the year by the board of directors), and further subject to the limitations described in the share redemption program. As of March 31, 2016, we had $8.3 million available for special redemptions for the remainder of 2016.

Our investments in real estate generate cash flow in the form of rental revenues and tenant reimbursements, which are reduced by operating expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from our real estate investments is primarily dependent upon the occupancy level of our portfolio, the net effective rental rates on our leases, the collectibility of rent and operating recoveries from our tenants and how well we manage our expenditures. As of March 31, 2016, our real estate was 89% occupied and our bad debt reserve was less than 1% of annualized base rent.

Our real estate-related investment generates cash flow in the form of interest income, which is reduced by the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from our real estate-related investment is primarily dependent on the operating performance of the underlying collateral and the borrower’s ability to make debt service payments. As of March 31, 2016, the borrower under our real estate loan receivable was current on its debt service payments to us.

For the three months ended March 31, 2016, our cash needs for capital expenditures and the payment of debt obligations were met with the proceeds from the payoff or sale of real estate loans receivable and proceeds from the sales of real estate properties from prior periods. Operating cash needs during the same period were met with cash flow generated by our real estate and real estate-related investments. We made distributions to our stockholders during the three months ended March 31, 2016 using cash flows from operations and cash on hand. We believe that our cash on hand, cash flow from operations, availability under our credit facilities, proceeds from the sales of real estate properties and the repayment of or sale of our real estate loan receivable will be sufficient to meet our liquidity needs for the foreseeable future. As of March 31, 2016, we had a total of $332.0 million of debt obligations scheduled to mature within 12 months of that date. We plan to exercise our extension options available under our loan agreements or pay down or refinance the related notes payable prior to their maturity dates.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

On December 8, 2015, our board of directors approved an estimated value per share of our common stock of $5.62 (unaudited) based on the estimated value of our assets less the estimated value of our liabilities, divided by the number of shares outstanding, all as of September 30, 2015. For a full description of the assumptions, methodologies and limitations used to value our assets and liabilities in connection with the calculation of our estimated value per share, see our Current Report on Form 8-K dated December 8, 2015 and filed with the SEC on December 9, 2015.

Our cash flow from operations has decreased and will continue to decrease as a result of our disposition activity, and we have adjusted our distribution policy with respect to the amount of monthly distribution payments to take into account our disposition activity and current real estate investments. We may continue to make strategic asset sales as opportunities become available in the market. Any future special distributions we make from the proceeds of future dispositions will reduce our estimated value per share and this reduction will be reflected in our updated estimated value per share, which we expect to update no later than December 2016.

On January 27, 2016, our board of directors formed a special committee (the “Special Committee”) composed of all of our independent directors to explore the availability of strategic alternatives involving us. While we conduct this process, we remain 100% focused on managing our properties.

As part of the process of exploring strategic alternatives, on February 23, 2016, the Special Committee engaged Evercore Group L.L.C. (“Evercore”) to act as our financial advisor and to assist the Special Committee with this process. Under the terms of the engagement, Evercore will provide various financial advisory services, as requested by the Special Committee as customary for an engagement in connection with exploring strategic alternatives. Although the Special Committee has engaged Evercore to assist us and the Special Committee with the exploration of strategic alternatives for us, we are not obligated to enter into any particular transaction or any transaction at all. Further, although we have begun the process of exploring strategic alternatives, there is no assurance that the process will result in stockholder liquidity, or provide a return to stockholders that equals or exceeds our estimated value per share.

Cash Flows from Operating Activities

As of March 31, 2016, we owned 12 real estate properties (consisting of 10 office properties, one office/flex property and an office campus consisting of eight office buildings) and one real estate loan receivable. During the three months ended March 31, 2016, net cash provided by operating activities was $12.2 million, compared to $5.9 million during the three months ended March 31, 2015. The increase in net cash provided by operating activities was primarily due to the timing of lease commission payments. We anticipate cash flows from operating activities to decrease to the extent we make additional asset sales.

Cash Flows from Investing Activities

Net cash used in investing activities was $10.1 million for the three months ended March 31, 2016 and primarily related to improvements to real estate.

Cash Flows from Financing Activities

During the three months ended March 31, 2016, net cash used in financing activities was $15.3 million and consisted primarily of the following:


•	$13.5 million of cash distributions; and


•	$1.7 million of cash used for redemptions of common stock.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

In addition to using our capital resources to meet our debt service obligations, for capital expenditures and for operating costs, we use our capital resources to make certain payments to our advisor. We paid our advisor fees in connection with the acquisition and origination of our assets and pay our advisor fees in connection with the management and disposition of our assets and for certain costs incurred by our advisor in providing services to us. Among the fees payable to our advisor is an asset management fee. With respect to investments in real estate, we pay our advisor a monthly asset management fee equal to one-twelfth of 0.75% of the amount paid or allocated to acquire the investment, plus the cost of any subsequent development, construction or improvements to the property. This amount includes any portion of the investment that was debt financed and is inclusive of acquisition fees and expenses related thereto. With respect to investments in loans and any investments other than real estate, we pay our advisor a monthly asset management fee calculated, each month, as one-twelfth of 0.75% of the lesser of (i) the amount paid or allocated to acquire or fund the loan or other investment (which amount includes any portion of the investment that was debt financed and is inclusive of acquisition or origination fees and expenses related thereto) and (ii) the outstanding principal amount of such loan or other investment, plus the acquisition or origination fees and expenses related to the acquisition or funding of such investment, as of the time of calculation. We also continue to reimburse our advisor and our dealer manager for certain stockholder services.

As of March 31, 2016, we had $59.5 million of cash and cash equivalents and up to $41.0 million available for future disbursements under two credit facilities, subject to certain conditions and restrictions set forth in the respective loan agreements, to meet our operational and capital needs.

In order to execute our investment strategy, we primarily utilized secured debt to finance a portion of our investment portfolio. Management remains vigilant in monitoring the risks inherent with the use of debt in our portfolio and is taking actions to ensure that these risks, including refinance and interest rate risks, are properly balanced with the benefit of using leverage. We limit our total liabilities to 75% of the cost (before deducting depreciation or other noncash reserves) of our tangible assets; however, we may exceed that limit if the majority of the conflicts committee approves each borrowing in excess of such limitation and we disclose such borrowings to our stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. As of March 31, 2016, our borrowings and other liabilities were approximately 36% of both the cost (before deducting depreciation or other noncash reserves) and book value (before deducting depreciation) of our tangible assets, respectively.

Contractual Commitments and Contingencies

The following is a summary of our contractual obligations as of March 31, 2016 (in thousands):



			Payments Due During the Years Ending December 31,
Contractual Obligations	Total		Remainder of 2016		2017-2018		2019-2020
Outstanding debt obligations ⁽¹⁾	$	547,471	$	278,033	$	133,968	$	135,470
Interest payments on outstanding debt obligations ⁽²⁾	26,237		9,004		10,994		6,239

_____________________

⁽¹⁾ Amounts include principal payments only.

⁽²⁾ Projected interest payments are based on the outstanding principal amounts, maturity dates and interest rates in effect as of March 31, 2016 (consisting of the contractual interest rate and the effect of interest rate floors and swaps, if applicable). We incurred interest expense of $3.9 million, excluding net unrealized gains on interest rate swap agreements of $0.2 million, swap termination expense of $2,000 and amortization of deferred financing costs totaling $0.4 million during the three months ended March 31, 2016.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Results of Operations

Overview

As of March 31, 2015, we owned 10 office properties, one office/flex property, an office campus consisting of eight office buildings and two real estate loans receivable. Subsequent to March 31, 2015, we received the repayment on one real estate loan receivable. As a result, as of March 31, 2016, we owned 10 office properties, one office/flex property, an office campus consisting of eight office buildings and one real estate loan receivable. The results of operations presented for the three months ended March 31, 2016 and 2015 are not directly comparable due to the disposition of one real estate property and the repayment of one real estate loan receivable subsequent to January 1, 2015. In general, we expect income and expenses to decrease in future periods due to disposition activity.

Comparison of the three months ended March 31, 2016 versus the three months ended March 31, 2015

The following table provides summary information about our results of operations for the three months ended March 31, 2016 and 2015 (dollar amounts in thousands):



	Three Months Ended March 31,				Increase (Decrease)			Percentage Change		$ Change Due to Dispositions ⁽¹⁾			$ Change Due to Properties or Loans Held Throughout Both Periods ⁽²⁾
	2016		2015		Increase (Decrease)			Percentage Change		$ Change Due to Dispositions ⁽¹⁾
Rental income	$	34,997	$	36,824	$	(1,827	)	(5	)%	$	(1,835	)	$	8
Tenant reimbursements	3,999		3,892		107			3	%	(160		)	267
Interest income from real estate loans receivable	268		1,362		(1,094		)	(80	)%	(1,094		)	—
Other operating income	1,730		1,852		(122		)	(7	)%	(127		)	5
Operating, maintenance and management costs	8,734		10,151		(1,417		)	(14	)%	(624		)	(793		)
Real estate taxes and insurance	5,072		5,221		(149		)	(3	)%	(196		)	47
Asset management fees to affiliate	2,956		3,086		(130		)	(4	)%	(217		)	87
General and administrative expenses	1,962		1,123		839			75	%	n/a			n/a
Depreciation and amortization	14,892		12,939		1,953			15	%	—			1,953
Interest expense	4,474		6,847		(2,373		)	(35	)%	(411		)	(1,962		)
Impairment charge on real estate	—		4,486		(4,486		)	(100	)%	—			(4,486		)
Gain on sale of real estate, net	—		27,407		(27,407		)	(100	)%	(27,407		)	—

_____________________

⁽¹⁾ Represents the dollar amount increase (decrease) for the three months ended March 31, 2016 compared to the three months ended March 31, 2015 related to real estate and real estate-related investments disposed of on or after January 1, 2015.

⁽²⁾ Represents the dollar amount increase (decrease) for the three months ended March 31, 2016 compared to the three months ended March 31, 2015 related to real estate and real estate-related investments owned by us throughout both periods presented.

Rental income and tenant reimbursements decreased from $40.7 million for the three months ended March 31, 2015 to $39.0 million for the three months ended March 31, 2016, primarily due to the disposition of a real estate property subsequent to January 1, 2015, offset by an increase in property tax recoveries from properties held throughout both periods. Overall, we expect rental income and tenant reimbursements to decrease in future periods due to the anticipated dispositions of real estate properties. For the three months ended March 31, 2015, rental income and tenant reimbursements from our real estate property sold were $2.0 million.

Interest income from our real estate loans receivable, recognized using the interest method, decreased from $1.4 million for the three months ended March 31, 2015 to $0.3 million for the three months ended March 31, 2016, primarily as a result of the payoff of a real estate loan receivable subsequent to January 1, 2015, which includes $0.9 million of prepayment fees. Interest income from real estate loans receivable in future periods compared to historical periods will decrease as a result of the anticipated payoff or sale of our real estate loan receivable.

Other operating income decreased from $1.9 million for the three months ended March 31, 2015 to $1.7 million for the three months ended March 31, 2016, primarily due to the disposition of a real estate property subsequent to January 1, 2015. Overall, we expect other operating income to decrease in future periods due to anticipated dispositions of real estate properties. For the three months ended March 31, 2015, other operating income from our real estate property sold was $0.1 million.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Operating, maintenance and management costs decreased from $10.2 million for the three months ended March 31, 2015 to $8.7 million for the three months ended March 31, 2016. The decrease was primarily due to a decrease in repairs and maintenance costs, snow removal costs and utility costs for properties held throughout both periods and the disposition of a real estate property subsequent to January 1, 2015. Operating, maintenance and management costs may increase in future periods, as compared to historical periods, as a result of inflation. Overall, we expect operating, maintenance and management costs to decrease in future periods due to the anticipated dispositions of real estate properties. For the three months ended March 31, 2015, operating, maintenance and management costs from our real estate property sold were $0.6 million.

Real estate taxes and insurance decreased from $5.2 million for the three months ended March 31, 2015 to $5.1 million for the three months ended March 31, 2016. This decrease was primarily due to the disposition of a real estate property subsequent to January 1, 2015. We expect real estate taxes and insurance to decrease in future periods due to the anticipated dispositions of real estate properties. For the three months ended March 31, 2015, real estate taxes and insurance from our real estate property sold were $0.2 million.

Asset management fees with respect to our real estate and real estate-related investments decreased from $3.1 million for the three months ended March 31, 2015 to $3.0 million for the three months ended March 31, 2016, due to the disposition of a real estate property and the payoff of a real estate loan receivable subsequent to January 1, 2015. All asset management fees incurred as of March 31, 2016 have been paid. We expect asset management fees to decrease in future periods due to anticipated asset sales. For the three months ended March 31, 2015, asset management fees from our real estate property sold and our real estate loan receivable paid off were $0.1 million and $0.1 million, respectively.

General and administrative expenses increased from $1.1 million for the three months ended March 31, 2015 to $2.0 million for the three months ended March 31, 2016. This increase was primarily due to legal fees and other professional fees related to the Special Committee’s engagement of Evercore to act as our financial advisor. See “—Liquidity and Capital Resources” for our discussion on the engagement of Evercore.

Depreciation and amortization increased from $12.9 million for the three months ended March 31, 2015 to $14.9 million for the three months ended March 31, 2016 due to the reclassification of two real estate properties from held for sale to held for investment, which resulted in a portion of the depreciation and amortization expense being classified as an impairment charge during the three months ended March 31, 2015. We expect depreciation and amortization to decrease in future periods due to the anticipated dispositions of real estate properties and to an overall decrease in amortization of tenant origination costs related to lease expirations.

Interest expense decreased from $6.8 million for the three months ended March 31, 2015 to $4.5 million for the three months ended March 31, 2016. The decrease in interest expense is primarily due to an overall decrease to our total debt outstanding due to a loan repayment in connection with the disposition of a real estate property during the three months ended March 31, 2015 and in part due to a decrease in the average loan balance of our existing notes payable related to properties held throughout both periods. Included in interest expense is the amortization of deferred financing costs of $0.6 million and $0.4 million for the three months ended March 31, 2015 and 2016, respectively. Also included in interest expense during the three months ended March 31, 2015 was $0.2 million of termination fees related to the payoff of a loan secured by the real estate property sold during the three months ended March 31, 2015. During the three months ended March 31, 2016, we recorded $0.2 million of unrealized loss on interest rate swaps. In general, we expect interest expense to decrease in future periods due to debt repayments related to assets sold and anticipated asset sales, which may be offset by certain fees and costs that may be incurred due to the prepayment of certain loans. Our interest expense in future periods will also vary based on fluctuations in one-month LIBOR (for our variable rate debt, to the extent that such variable rate debt is not subject to an interest rate swap agreement) and our level of future borrowings, which will depend on the availability and cost of debt financing, draws on our credit facilities and any debt repayments we make. In addition, our interest expense in future periods will vary based on fair value changes with respect to our interest rate swaps that are not accounted for as cash flow hedges. For the three months ended March 31, 2015, interest expense from the loan secured by our real estate property sold was $0.4 million.

During the three months ended March 31, 2015, we recognized an impairment charge of $4.5 million with respect to two of our real estate properties that were reclassified from held for sale to held for investment. The impairment charge was recorded to adjust the carrying values of the properties for any depreciation and amortization expense that would have been recognized if the properties had always been classified as held for investment, which otherwise would have been recorded through depreciation and amortization expense. We did not recognize any impairment charge during the three months ended March 31, 2016.

We recognized a gain on sale of real estate of $27.4 million related to the disposition of one office property during the three months ended March 31, 2015. We did not sell any real estate properties during the three months ended March 31, 2016.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Funds from Operations and Modified Funds from Operations

We believe that funds from operations (“FFO”) is a beneficial indicator of the performance of an equity REIT. We compute FFO in accordance with the current National Association of Real Estate Investment Trusts (“NAREIT”) definition. FFO represents net income, excluding gains and losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), impairment losses on real estate assets, depreciation and amortization of real estate assets, and adjustments for unconsolidated partnerships and joint ventures. We believe FFO facilitates comparisons of operating performance between periods and among other REITs. However, our computation of FFO may not be comparable to other REITs that do not define FFO in accordance with the NAREIT definition or that interpret the current NAREIT definition differently than we do. Our management believes that historical cost accounting for real estate assets in accordance with U.S. generally accepted accounting principles (“GAAP”) implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and provides a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.

Changes in accounting rules have resulted in a substantial increase in the number of non-operating and non-cash items included in the calculation of FFO. As a result, our management also uses modified funds from operations (“MFFO”) as an indicator of our ongoing performance as well as our dividend sustainability. MFFO excludes from FFO: acquisition fees and expenses; adjustments related to contingent purchase price obligations; amounts relating to straight-line rents and amortization of above and below market intangible lease assets and liabilities; accretion of discounts and amortization of premiums on debt investments; amortization of closing costs relating to debt investments; impairments of real estate-related investments; mark-to-market adjustments included in net income; and gains or losses included in net income for the extinguishment or sale of debt or hedges. We compute MFFO in accordance with the definition of MFFO included in the practice guideline issued by the Investment Program Association (“IPA”) in November 2010 as interpreted by management. Our computation of MFFO may not be comparable to other REITs that do not compute MFFO in accordance with the current IPA definition or that interpret the current IPA definition differently than we do.

We believe that MFFO is helpful as a measure of ongoing operating performance because it excludes non-operating items included in FFO. MFFO excludes non-cash items such as straight-line rental revenue. Additionally, we believe that MFFO provides investors with supplemental performance information that is consistent with the performance indicators and analysis used by management, in addition to net income and cash flows from operating activities as defined by GAAP, to evaluate the sustainability of our operating performance. MFFO provides comparability in evaluating the operating performance of our portfolio with other non-traded REITs which typically have limited lives with short and defined acquisition periods and targeted exit strategies. MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes.

FFO and MFFO are non-GAAP financial measures and do not represent net income as defined by GAAP. Net income as defined by GAAP is the most relevant measure in determining our operating performance because FFO and MFFO include adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization and the other items described above. Accordingly, FFO and MFFO should not be considered as alternatives to net income as an indicator of our current and historical operating performance. In addition, FFO and MFFO do not represent cash flows from operating activities determined in accordance with GAAP and should not be considered an indication of our liquidity. We believe FFO and MFFO, in addition to net income and cash flows from operating activities as defined by GAAP, are meaningful supplemental performance measures; however, neither FFO nor MFFO reflect adjustments for the operations of properties and real estate-related investments sold or held for sale during the periods presented. During periods of significant disposition activity, FFO and MFFO are much more limited measures of future performance and dividend sustainability. In connection with our presentation of FFO and MFFO, we are providing information related to the proportion of MFFO related to properties sold and real estate-related investments sold or repaid as of March 31, 2016.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Although MFFO includes other adjustments, the exclusion of straight-line rent, the amortization of above- and below-market leases, the amortization of discounts and closing costs, termination fees on derivative instruments and unrealized gains (losses) on derivative instruments are the most significant adjustments for the periods presented. We have excluded these items based on the following economic considerations:

•

Adjustments for straight-line rent. These are adjustments to rental revenue as required by GAAP to recognize contractual lease payments on a straight-line basis over the life of the respective lease. We have excluded these adjustments in our calculation of MFFO to more appropriately reflect the current economic impact of our in-place leases, also providing investors with a useful supplemental metric that addresses core operating performance by removing rent we expect to receive in a future period or rent that was received in a prior period;

•

Amortization of above- and below-market leases. Similar to depreciation and amortization of real estate assets and lease related costs that are excluded from FFO, GAAP implicitly assumes that the value of intangible lease assets and liabilities diminishes predictably over time and requires that these charges be recognized currently in revenue. Since real estate values and market lease rates in the aggregate have historically risen or fallen with local market conditions, management believes that by excluding these charges, MFFO provides useful supplemental information on the realized economics of the real estate;

•

Amortization of discounts and closing costs. Discounts and closing costs related to debt investments are amortized over the term of the loan as an adjustment to interest income. This application results in income recognition that is different than the underlying contractual terms of the debt investments. We have excluded the amortization of discounts and closing costs related to our debt investments in our calculation of MFFO to more appropriately reflect the economic impact of our debt investments, as discounts will not be economically recognized until the loan is repaid and closing costs are essentially the same as acquisition fees and expenses on real estate (discussed below). We believe excluding these items provides investors with a useful supplemental metric that directly addresses core operating performance;


•	Termination fees on derivative instruments. Termination fees on derivative instruments are included in interest expense. Although these amounts reduce net income, we exclude them from MFFO to more appropriately reflect the ongoing impact of our interest rate swap agreements; and

•

Unrealized gains (losses) on derivative instruments. These adjustments include unrealized gains (losses) from mark-to-market adjustments on interest rate swaps and losses due to hedge ineffectiveness. The change in fair value of interest rate swaps not designated as a hedge and the change in fair value of the ineffective portion of interest rate swaps are non-cash adjustments recognized directly in earnings and are included in interest expense. We have excluded these adjustments in our calculation of MFFO to more appropriately reflect the economic impact of our interest rate swap agreements.

Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by NAREIT, is presented in the following table, along with our calculation of MFFO, for the three months ended March 31, 2016 and 2015, respectively (in thousands). No conclusions or comparisons should be made from the presentation of these periods.



	For the Three Months Ended March 31,
	2016			2015
Net income	$	2,920		$	27,532
Depreciation of real estate assets	8,868			7,186
Amortization of lease-related costs	6,024			5,753
Impairment charge on real estate	—			4,486
Gain on sale of real estate, net	—			(27,407		)
FFO	17,812			17,550
Straight-line rent and amortization of above- and below-market leases	(1,733		)	(2,262		)
Amortization of discounts and closing costs	1			3
Termination fees on derivative instruments	2			170
Unrealized losses (gains) on derivative instruments	196			(31		)
MFFO	$	16,278		$	15,430

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Our calculation of MFFO above includes amounts related to the operations of one real estate property sold and one real estate loan receivable paid off between January 1, 2015 and March 31, 2016. Please refer to the table below with respect to the proportion of MFFO related to the real estate property sold and real estate-related investment paid off as of March 31, 2016 (in thousands).



	For the Three Months Ended March 31,
	2016		2015
MFFO by component:
Assets held for investment	$	16,278	$	13,654
Real estate properties sold	—		790
Real estate loans receivable sold or paid off	—		986
MFFO	$	16,278	$	15,430

FFO and MFFO may also be used to fund all or a portion of certain capitalizable items that are excluded from FFO and MFFO, such as tenant improvements, building improvements and deferred leasing costs.

Distributions

Distributions declared, distributions paid and cash flow from operations were as follows for the first quarter of 2016 (in thousands, except per share amounts):



Period	Distributions Declared ⁽¹⁾		Distributions Declared Per Share⁽¹⁾		Distributions Paid ⁽²⁾		Cash Flow From Operations
First Quarter 2016	$	13,235	$	0.070	$	13,453	$	12,237

_____________________

⁽¹⁾ Assumes each share was issued and outstanding each day that was a record date for distributions during the period presented.

⁽²⁾ Other than special distributions, distributions generally are paid on a monthly basis, on or about the first business day of the following month.

For the three months ended March 31, 2016, we paid aggregate distributions of $13.5 million, all of which were paid in cash. FFO and cash flow from operations for the three months ended March 31, 2016 were $17.8 million and $12.2 million, respectively. We funded our total distributions paid with $12.2 million of current period cash flow from operations and $1.3 million of cash on hand. For purposes of determining the source of our distributions paid, we assume first that we use cash flow from operations from the relevant periods to fund distribution payments. See the reconciliation of FFO to net income above.

Over the long term, we expect that our distributions will generally be paid from cash flow from operations and FFO from current or prior periods (except with respect to distributions related to sales of our assets and distributions related to the repayment of principal under our mortgage loan investment).

During the year ended December 31, 2015, we sold one office property and received the repayment of one of our real estate loans receivable, and during the year ended December 31, 2014, we sold 15 real estate properties and received repayments of three of our real estate loans receivable. Our cash flow from operations has decreased and will continue to decrease as a result of our disposition activity, and we have adjusted our distribution policy with respect to the amount of monthly distribution payments to take into account our disposition activity and current real estate investments. We may continue to make strategic asset sales as opportunities become available in the market. Any future special distributions we make from the proceeds of future dispositions will reduce our estimated value per share and this reduction will be reflected in our updated estimated value per share, which we expect to update no later than December 2016.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Our operating performance and ability to pay distributions from our cash flow from operations and/or the disposition of our assets cannot be accurately predicted and may deteriorate in the future due to numerous factors, including those discussed under “Forward — Looking Statements,” “Market Outlook — Real Estate and Real Estate Finance Markets,” “Liquidity and Capital Resources” and “Results of Operations” herein and the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC. Those factors include: the future operating performance of our investments in the existing real estate and financial environment; the success and economic viability of our tenants; the ability of our borrower and its sponsor to continue to make debt service payments and/or to repay their loan upon maturity; our ability to refinance existing indebtedness at comparable terms; changes in interest rates on our variable rate debt obligations; our ability to successfully dispose of some of our assets; and the sources and amounts of cash we have available for distributions.

Critical Accounting Policies

Our consolidated interim financial statements and condensed notes thereto have been prepared in accordance with GAAP and in conjunction with the rules and regulations of the SEC. The preparation of our financial statements requires significant management judgments, assumptions and estimates about matters that are inherently uncertain. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses. A discussion of the accounting policies that management considers critical in that they involve significant management judgments, assumptions and estimates is included in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC. There have been no significant changes to our policies during 2016.

Subsequent Events

We evaluate subsequent events up until the date the consolidated financial statements are issued.

Distributions Paid

On April 1, 2016, we paid distributions of $4.5 million, which related to distributions declared for March 2016 in the amount of $0.02380055 per share of common stock to stockholders of record as of the close of business on March 21, 2016. On May 2, 2016, we paid distributions of $4.4 million, which related to distributions declared for April 2016 in the amount of $0.02303279 per share of common stock to stockholders of record as of the close of business on April 20, 2016.

Distributions Declared

On May 6, 2016, our board of directors declared a May 2016 distribution in the amount of $0.02380055 per share of common stock to stockholders of record as of the close of business on May 20, 2016, which we expect to pay in June 2016, and a June 2016 distribution in the amount of $0.02303279 per share of common stock to stockholders of record as of the close of business on June 20, 2016, which we expect to pay in July 2016.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to the effects of interest rate changes as a result of borrowings used to maintain liquidity, to fund the financing and refinancing of our real estate and real estate-related investment portfolio, and to fund our operations. Our profitability and the value of our investment portfolio may be adversely affected during any period as a result of interest rate changes. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs. We have managed and will continue to manage interest rate risk by maintaining a ratio of fixed rate, long-term debt such that variable rate exposure is kept at an acceptable level. In addition, we may utilize a variety of financial instruments, including interest rate caps, floors, and swap agreements, in order to limit the effects of changes in interest rates on our operations. When we use these types of derivatives to hedge the risk of interest-earning assets or interest-bearing liabilities, we may be subject to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments of distributions to our stockholders and that the losses may exceed the amount we invested in the instruments.

We borrow funds and made real estate-related investments at a combination of fixed and variable rates. Interest rate fluctuations will generally not affect our future earnings or cash flows on our fixed rate debt or fixed rate real estate loan receivable unless such instruments mature or are otherwise terminated. However, interest rate changes will affect the fair value of our fixed rate instruments. As of March 31, 2016, the fair value and carrying value of our fixed rate real estate loan receivable were $14.6 million and $14.2 million, respectively. The fair value estimate of our real estate loan receivable is calculated using an internal valuation model that considers the expected cash flows for the loan, underlying collateral values (for collateral-dependent loans) and the estimated yield requirements of institutional investors for loans with similar characteristics, including remaining loan term, loan-to-value, type of collateral and other credit enhancements. As of March 31, 2016, the fair value of our fixed rate debt was $142.6 million and the outstanding principal balance of our fixed rate debt was $140.0 million. The fair value estimate of our fixed rate debt was calculated 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 March 31, 2016. With respect to our fixed rate instruments, we do not expect that fluctuations in interest rates, and the resulting change in fair value of our fixed rate instruments, would have a significant impact on our ongoing operations.

Conversely, movements in interest rates on our variable rate debt would change our future earnings and cash flows, but not significantly affect the fair value of those instruments. However, changes in required risk premiums would result in changes in the fair value of variable rate instruments. As of March 31, 2016, we were exposed to market risks related to fluctuations in interest rates on $200.1 million of variable rate debt outstanding, after giving consideration to the impact of interest rate swap agreements on approximately $207.4 million of our variable rate debt. Based on interest rates as of March 31, 2016, if interest rates were 100 basis points higher during the 12 months ending March 31, 2017, interest expense on our variable rate debt would increase by $2.0 million. As of March 31, 2016, one-month LIBOR was 0.43725% and if this index was reduced to 0% during the 12 months ending March 31, 2017, interest expense on our variable rate debt would decrease by $0.9 million.

The annual effective interest rate of our fixed rate real estate loan receivable as of March 31, 2016 was 7.6%. The annual effective interest rate represents the effective interest rate as of March 31, 2016, using the interest method, which we use to recognize interest income on our real estate loan receivable. The weighted-average interest rates of our fixed rate debt and variable rate debt as of March 31, 2016 were 3.5% and 2.6%, respectively. The weighted-average interest rate represents the actual interest rate in effect as of March 31, 2016 (consisting of the contractual interest rate and the effect of interest rate swaps and floors, if applicable), using interest rate indices as of March 31, 2016, where applicable.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 4. Controls and Procedures

Disclosure Controls and Procedures

As of the end of the period covered by this report, management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our principal executive officer and principal 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 principal executive officer and our principal 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 the quarter ended March 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Table of Contents

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

Please see the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC.

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


a)	During the period covered by this Form 10-Q, we did not sell any equity securities that were not registered under the Securities Act of 1933.


b)	Not applicable.

•

During each calendar year, special redemptions are limited to an annual dollar amount determined by the board of directors, which may be reviewed during the year and increased or decreased upon ten business days’ notice to our stockholders. We may provide notice by including such information (a) in a Current Report on Form 8-K or in our annual or quarterly reports, all publicly filed with the Securities and Exchange Commission or (b) in a separate mailing to the stockholders. On December 8, 2015, the board of directors approved the dollar amount limitation for special redemptions for calendar year 2016 of $10.0 million in the aggregate (subject to review and adjustment during the year by the board of directors), and further subject to the limitations described in the share redemption program.


•	During any calendar year, we may redeem no more than 5% of the weighted-average number of shares outstanding during the prior calendar year.


•	We have no obligation to redeem shares if the redemption would violate the restrictions on distributions under Maryland General Corporation Law, as amended from time to time, which prohibits distributions that would cause a corporation to fail to meet statutory tests of solvency.

If we cannot repurchase all shares presented for redemption in any month because of the limitations on redemptions set forth in our share redemption program, then we will honor redemption requests on a pro rata basis, except that if a pro rata redemption would result in a stockholder owning less than the minimum purchase requirement described in our currently effective, or our most recently effective, registration statement as such registration statement has been amended or supplemented, then we would redeem all of such stockholder’s shares.

Pursuant to the share redemption program, redemptions made in connection with special redemptions are made at a price per share equal to the most recent estimated value per share of our common stock as of the applicable redemption date. We do not currently expect to have funds available for ordinary redemptions in the future.

The only redemptions we made under our share redemption program during the three months ended March 31, 2016 were those that qualified as, and met the requirements for, special redemptions under our share redemption program and we fulfilled all special redemption requests eligible for redemption under our share redemption program. We funded redemptions during the three months ended March 31, 2016 with proceeds from the sale of real estate properties and existing cash on hand.

We may amend, suspend or terminate our share redemption program upon 30 days’ notice to our stockholders, provided that we may increase or decrease the funding available for the redemption of shares under the program upon ten business days’ notice to our stockholders. We may provide this notice by including such information in a Current Report on Form 8-K or in our annual or quarterly reports, all publicly filed with the SEC, or by a separate mailing to our stockholders. We do not currently expect to have funds available for ordinary redemptions in the future.

Table of Contents

PART II. OTHER INFORMATION (CONTINUED)

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds (continued)

During the three months ended March 31, 2016, we redeemed shares pursuant to our share redemption program as follows:



Month	Total Number of Shares Redeemed ⁽¹⁾	Average Price Paid Per Share ⁽²⁾		Approximate Dollar Value of Shares Available That May Yet Be Redeemed Under the Program
January 2015	144,319	$	5.62	⁽³⁾
February 2015	58,650	$	5.62	⁽³⁾
March 2015	96,588	$	5.62	⁽³⁾
Total	299,557

_____________________

⁽¹⁾ We announced the adoption and commencement of the program on April 8, 2008. We announced amendments to the program on May 13, 2009 (which amendment became effective on June 12, 2009), on March 11, 2011 (which amendment became effective on April 10, 2011), on May 18, 2012 (which amendment became effective on June 17, 2012), on June 29, 2012 (which amendment became effective on July 29, 2012), on October 18, 2012 (which amendment became effective on November 17, 2012), on March 8, 2013 (which amendment became effective on April 7, 2013), on October 17, 2013 (which amendment became effective on November 16, 2013) and on May 19, 2014 (which amendment became effective on June 18, 2014).

⁽²⁾ In accordance with our share redemption program, the redemption price for special redemptions is equal to the most recent estimated value per share of our common stock as of the redemption date. On December 8, 2015, our board of directors approved an estimated value per share of our common stock of $5.62 (unaudited) based on the estimated value of our assets less the estimated value of our liabilities divided by the number of shares outstanding, all as of September 30, 2015. The change in the redemption price became effective for the December 31, 2015 redemption date and will be effective until the estimated value per share is updated. We expect to utilize our advisor and/or an independent valuation firm to update the estimated value per share no later than December 2016. For a full description of the methodologies used to value our assets and liabilities in connection with the calculation of the estimated value per share, see our Current Report on Form 8-K dated December 8, 2015 and filed with the SEC on December 9, 2015.

⁽³⁾ We limit the dollar value of shares that may be redeemed under the share redemption program as described above. For the three months ended March 31, 2016, we redeemed $1.7 million of shares, which represented all redemption requests received in good order and eligible for redemption through the March 2016 redemption date. Based on the redemption limitations described above and redemptions through March 31, 2016, we may redeem up to $8.3 million of shares in connection with special redemptions for the remainder of 2016.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Table of Contents

PART II. OTHER INFORMATION (CONTINUED)

Item 6. Exhibits



Ex.		Description

3.1		Second Articles of Amendment and Restatement of the Company, incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2008, filed May 28, 2008

3.2		Second Amended and Restated Bylaws of the Company, incorporated by reference to Exhibit 3.2 to Pre-Effective Amendment No. 2 to the Company’s Registration Statement on Form S-11, Commission File No. 333-146341, filed April 8, 2008

3.3		Third Amended and Restated Bylaws of the Company, incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, filed March 16, 2016

4.1		Statement regarding restrictions on transferability 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 4.2 to Pre-Effective Amendment No. 1 to the Company’s Registration Statement on Form S-11, Commission File No. 333-146341, filed February 19, 2008

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002

99.1		Eighth Amended and Restated Share Redemption Program, incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed May 19, 2014

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		XBRL Taxonomy Extension Definition Linkbase

101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE		XBRL Taxonomy Extension Presentation Linkbase

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SIGNATURES

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.




		KBS REAL ESTATE INVESTMENT TRUST II, INC.

Date:	May 9, 2016	By:	/S/ CHARLES J. SCHREIBER, JR.
			Charles J. Schreiber, Jr.
			Chairman of the Board, Chief Executive Officer and Director
			(principal executive officer)

Date:	May 9, 2016	By:	/S/ JEFFREY K. WALDVOGEL
			Jeffrey K. Waldvogel
			Chief Financial Officer
			(principal financial officer)