KBS Real Estate Investment Trust II, Inc. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________________

FORM 10-Q

______________________________________________________

(Mark One)


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

For the quarterly period ended September 30, 2019


☐			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 every Interactive Data File required to be submitted 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 such files). Yes x No ¨

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

Large Accelerated Filer

☐

Accelerated Filer

☐

Non-Accelerated Filer

☒

Smaller reporting company

☐

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
None	N/A	N/A

As of November 8, 2019, there were 185,461,792 outstanding shares of common stock of the registrant.

Table of Contents

KBS REAL ESTATE INVESTMENT TRUST II, INC.

FORM 10-Q

September 30, 2019

INDEX

PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018

Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2019 and 2018

Consolidated Statements of Stockholders’ Equity (unaudited) for the Three and Nine Months Ended September 30, 2019 and 2018

Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2019 and 2018

Condensed Notes to Consolidated Financial Statements as of September 30, 2019 (unaudited)

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Item 4.

Controls and Procedures

PART II.

OTHER INFORMATION

Item 1.

Legal Proceedings

Item 1A.

Risk Factors

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.

Defaults upon Senior Securities

Item 4.

Mine Safety Disclosures

Item 5.

Item 6.

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)


	September 30, 2019		December 31, 2018
	(unaudited)
Assets
Real estate:
Land	$	118,955	$	118,955
Buildings and improvements	580,169		550,802
Tenant origination and absorption costs	28,025		30,846
Total real estate held for investment, cost	727,149		700,603
Less accumulated depreciation and amortization	(133,429)		(116,714)
Total real estate held for investment, net	593,720		583,889
Real estate held for sale, net	257,163		370,318
Total real estate, net	850,883		954,207
Cash and cash equivalents	48,133		57,730
Restricted cash	15,681		17,957
Rents and other receivables, net	79,824		67,232
Above-market leases, net	169		224
Assets related to real estate held for sale	38,571		46,817
Prepaid expenses and other assets	23,363		12,850
Total assets	$	1,056,624	$	1,157,017
Liabilities and stockholders’ equity
Notes payable:
Notes payable, net	$	300,900	$	266,296
Notes payable related to real estate held for sale, net	115,693		148,912
Total notes payable, net	416,593		415,208
Accounts payable and accrued liabilities	69,408		48,903
Due to affiliate	102		55
Distributions payable	3,481		3,874
Below-market leases, net	190		308
Liabilities related to real estate held for sale	—		6
Other liabilities	14,504		17,189
Total liabilities	504,278		485,543
Commitments and contingencies (Note 9)
Redeemable common stock	5,655		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, 185,551,436 and 186,464,794 shares issued and outstanding as of September 30, 2019 and December 31, 2018, respectively	1,856		1,865
Additional paid-in capital	1,667,906		1,667,897
Cumulative distributions in excess of net income	(1,123,071)		(1,008,288)
Total stockholders’ equity	546,691		661,474
Total liabilities and stockholders’ equity	$	1,056,624	$	1,157,017

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 September 30,						Nine Months Ended September 30,
	2019		2018		2019		2018
Revenues:
Rental income	$	24,943	$	30,411	$	78,619	$	95,578
Interest income from real estate loans receivable	—		—		—		434
Other operating income	1,480		2,271		5,359		6,968
Total revenues	26,423		32,682		83,978		102,980
Expenses:
Operating, maintenance, and management	7,991		8,773		25,867		25,379
Real estate taxes and insurance	4,294		4,387		13,959		13,634
Asset management fees to affiliate	2,469		2,688		7,707		8,192
General and administrative expenses	1,342		1,416		4,204		4,452
Depreciation and amortization	11,050		12,077		33,053		38,427
Interest expense	4,418		4,175		13,262		13,494
Impairment charges on real estate	14,300		—		14,300		—
Total expenses	45,864		33,516		112,352		103,578
Other income:
Other interest income	114		380		477		867
Loss from extinguishment of debt	(165)		—		(471)		(212)
Gain on sale of real estate, net	—		—		30,754		24,884
Total other (loss) income	(51)		380		30,760		25,539
Net (loss) income	$	(19,492)	$	(454)	$	2,386	$	24,941
Net (loss) income per common share, basic and diluted	$	(0.10)	$	—	$	0.01	$	0.13
Weighted-average number of common shares outstanding, basic and diluted	185,770,646		186,968,315		186,064,468		187,293,455

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 Three Months Ended September 30, 2019 and 2018 (unaudited)

(dollars in thousands)


	Common Stock					Additional Paid-in Capital		Cumulative Distributions and Net Income (Loss)		Total Stockholders’ Equity
	Shares	Amounts
Balance, June 30, 2019	185,871,023	$	1,859	$	1,667,903	$	(1,093,129)	$	576,633
Net loss	—	—		—		(19,492)		(19,492)
Redemptions of common stock	(319,587)	(3)		(1,435)		—		(1,438)
Transfers from redeemable common stock	—	—		1,438		—		1,438
Distributions declared	—	—		—		(10,450)		(10,450)
Balance, September 30, 2019	185,551,436	$	1,856	$	1,667,906	$	(1,123,071)	$	546,691


	Common Stock					Additional Paid-in Capital		Cumulative Distributions and Net Income (Loss)		Total Stockholders’ Equity
	Shares	Amounts
Balance, June 30, 2018	187,162,274	$	1,872	$	1,673,772	$	(988,396)	$	687,248
Net loss	—	—		—		(454)		(454)
Redemptions of common stock	(416,615)	(4)		(2,033)		—		(2,037)
Transfers from redeemable common stock	—	—		2,037		—		2,037
Distributions declared	—	—		—		(11,523)		(11,523)
Balance, September 30, 2018	186,745,659	$	1,868	$	1,673,776	$	(1,000,373)	$	675,271

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 (CONTINUED)

For the Nine Months Ended September 30, 2019 and 2018 (unaudited)

(dollars in thousands)


	Common Stock					Additional Paid-in Capital		Cumulative Distributions and Net Income (Loss)		Total Stockholders’ Equity
	Shares	Amounts
Balance, December 31, 2018	186,464,794	$	1,865	$	1,667,897	$	(1,008,288)	$	661,474
Net income	—	—		—		2,386		2,386
Redemptions of common stock	(913,358)	(9)		(4,336)		—		(4,345)
Transfers from redeemable common stock	—	—		4,345		—		4,345
Distributions declared	—	—		—		(117,169)		(117,169)
Balance, September 30, 2019	185,551,436	$	1,856	$	1,667,906	$	(1,123,071)	$	546,691


	Common Stock					Additional Paid-in Capital		Cumulative Distributions and Net Income (Loss)		Total Stockholders’ Equity
	Shares	Amounts
Balance, December 31, 2017	187,666,302	$	1,877	$	1,673,767	$	(991,062)	$	684,582
Net income	—	—		—		24,941		24,941
Redemptions of common stock	(920,643)	(9)		(4,493)		—		(4,502)
Transfers from redeemable common stock	—	—		4,502		—		4,502
Distributions declared	—	—		—		(34,252)		(34,252)
Balance, September 30, 2018	186,745,659	$	1,868	$	1,673,776	$	(1,000,373)	$	675,271

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)


	Nine Months Ended September 30,
	2019		2018
Cash Flows from Operating Activities:
Net income	$	2,386	$	24,941
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	33,053		38,427
Impairment charges on real estate	14,300		—
Noncash interest income on real estate-related investments	—		3
Deferred rent	2,761		3,096
Bad debt expense	—		213
Amortization of above- and below-market leases, net	(65)		948
Amortization of deferred financing costs	1,169		940
Loss from extinguishment of debt	471		212
Gain on sale of real estate, net	(30,754)		(24,884)
Changes in operating assets and liabilities:
Rents and other receivables	(14,841)		(2,391)
Prepaid expenses and other assets	(13,469)		(2,601)
Accounts payable and accrued liabilities	18,574		3,180
Due to affiliate	47		29
Other liabilities	(2,685)		8,478
Net cash provided by operating activities	10,947		50,591
Cash Flows from Investing Activities:
Proceeds from sale of real estate	130,285		94,015
Improvements to real estate	(30,943)		(24,205)
Principal repayments on real estate loans receivable	—		13,920
Net cash provided by investing activities	99,342		83,730
Cash Flows from Financing Activities:
Proceeds from notes payable	134,350		375,000
Principal payments on notes payable	(133,681)		(460,446)
Payments of deferred financing costs	(924)		(2,810)
Payments to redeem common stock	(4,345)		(4,502)
Distributions paid to common stockholders	(117,562)		(34,874)
Net cash used in financing activities	(122,162)		(127,632)
Net (decrease) increase in cash and cash equivalents and restricted cash	(11,873)		6,689
Cash and cash equivalents and restricted cash, beginning of period	75,687		86,643
Cash and cash equivalents and restricted cash, end of period	$	63,814	$	93,332
Supplemental Disclosure of Cash Flow Information:
Interest paid	$	12,131	$	12,663
Supplemental Disclosure of Noncash Transactions:
Accrued improvements to real estate	$	6,748	$	7,517
Distributions payable	$	3,481	$	3,754

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

September 30, 2019

(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 September 30, 2019, the Company owned six office properties (of which two were held for sale) and an office campus consisting of five office buildings.

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 June 6, 2019 (the “Advisory Agreement”). The Advisory Agreement is effective through May 21, 2020 and 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. 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 September 30, 2019, the Company had redeemed 28,053,701 shares sold in the Offering for $256.1 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, 2018, except for the Company’s adoption of the lease accounting standards issued by the Financial Accounting Standards Board (“FASB”) effective on January 1, 2019. 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, 2018 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 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 and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

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)

September 30, 2019

(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 nine months ended September 30, 2019 and 2018.

Distributions declared per common share were $0.056 and $0.630 in the aggregate for the three and nine months ended September 30, 2019, respectively, and consisted of the following:

•For each month commencing January 2019 through June 2019, the Company’s board of directors declared distributions per common share in the amount of $0.02062500 per share of common stock to stockholders of record based on a monthly record date.

•On June 12, 2019, the Company’s board of directors declared a special distribution in the amount of $0.45 per share of common stock to stockholders of record as of the close of business on June 17, 2019.

•For each month commencing July 2019 through September 2019, the Company’s board of directors declared distributions per common share in the amount of $0.01875000 per share of common stock to stockholders of record based on a monthly record date.

Distributions declared per common share were $0.062 and $0.183 in the aggregate for the three and nine months ended September 30, 2018, 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 periods commencing January 2018 through September 2018.

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 September 30, 2019, the Company aggregated its investments in real estate properties into one reportable business segment.

Reclassifications

Certain amounts in the Company’s prior period consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications have not changed the results of operations of prior periods. Upon adoption of the lease accounting standards of Topic 842 on January 1, 2019 (described below), the Company accounted for tenant reimbursements for property taxes, insurance and common area maintenance as variable lease payments and recorded these amounts as rental income on the statement of operations. For the three and nine months ended September 30, 2018, the Company reclassified $2.0 million and $7.6 million, respectively, of tenant reimbursement revenue for property taxes, insurance, and common area maintenance to rental income for comparability purposes.

In addition, during the nine months ended September 30, 2019, the Company sold two office properties and classified two office properties as held for sale. As a result, certain assets and liabilities were reclassified to held for sale on the consolidated balance sheets for all periods presented.

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)

September 30, 2019

(unaudited)

Revenue Recognition - Operating Leases

Real Estate

On January 1, 2019, the Company adopted the lease accounting standards under Topic 842 including the package of practical expedients for all leases that commenced before the effective date of January 1, 2019. Accordingly, the Company (i) did not reassess whether any expired or existing contracts are or contain leases, (ii) did not reassess the lease classification for any expired or existing lease, and (iii) did not reassess initial direct costs for any existing leases. The Company did not elect the practical expedient related to using hindsight to reevaluate the lease term. In addition, the Company adopted the practical expedient for land easements and did not assess whether existing or expired land easements that were not previously accounted for as leases under the lease accounting standards of Topic 840 are or contain a lease under Topic 842.

In addition, Topic 842 provides an optional transition method to allow entities to apply the new lease accounting standards at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings. The Company adopted this transition method upon its adoption of the lease accounting standards of Topic 842, which did not result in a cumulative effect adjustment to the opening balance of retained earnings on January 1, 2019. The Company’s comparative periods presented in the financial statements will continue to be reported under the lease accounting standards of Topic 840.

In accordance with Topic 842, tenant reimbursements for property taxes and insurance are included in the single lease component of the lease contract (the right of the lessee to use the leased space) and therefore are accounted for as variable lease payments and are recorded as rental income on the Company’s statement of operations beginning January 1, 2019. In addition, the Company adopted the practical expedient available under Topic 842 to not separate nonlease components from the associated lease component and instead to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue recognition standard (Topic 606) and if certain conditions are met, specifically related to tenant reimbursements for common area maintenance which would otherwise be accounted for under the revenue recognition standard. The Company believes the two conditions have been met for tenant reimbursements for common area maintenance as (i) the timing and pattern of transfer of the nonlease components and associated lease components are the same and (ii) the lease component would be classified as an operating lease. Accordingly, tenant reimbursements for common area maintenance are also accounted for as variable lease payments and recorded as rental income on the Company’s statement of operations beginning January 1, 2019.

The Company recognizes minimum rent, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related leases when collectibility is probable and records amounts expected to be received in later years as deferred rent receivable. If the lease provides for tenant improvements, the Company determines whether the tenant improvements, for accounting purposes, are owned by the tenant or the Company. When the Company is the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance (including amounts that can be taken in the form of cash or a credit against the tenant’s rent) that is funded is treated as a lease incentive and amortized as a reduction of rental revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:

•whether the lease stipulates how a tenant improvement allowance may be spent;

•whether the lessee or lessor supervises the construction and bears the risk of cost overruns;

•whether the amount of a tenant improvement allowance is in excess of market rates;

•whether the tenant or landlord retains legal title to the improvements at the end of the lease term;

•whether the tenant improvements are unique to the tenant or general purpose in nature; and

•whether the tenant improvements are expected to have any residual value at the end of the lease.

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)

September 30, 2019

(unaudited)

In accordance with Topic 842, the Company makes a determination of whether the collectibility of the lease payments in an operating lease is probable. If the Company determines the lease payments are not probable of collection, the Company would fully reserve for any contractual lease payments, deferred rent receivable, and variable lease payments and would recognize rental income only if cash is received. Beginning January 1, 2019, these changes to the Company’s collectibility assessment are reflected as an adjustment to rental income. Prior to January 1, 2019, bad debt expense related to uncollectible accounts receivable and deferred rent receivable was included in operating, maintenance, and management expense in the statement of operations. Any subsequent changes to the collectibility of the allowance for doubtful accounts as of December 31, 2018, which was recorded prior to the adoption of Topic 842, are recorded in operating, maintenance, and management expense in the statement of operations.

Beginning January 1, 2019, the Company, as a lessor, records costs to negotiate or arrange a lease that would have been incurred regardless of whether the lease was obtained, such as legal costs incurred to negotiate an operating lease, as an expense and classifies such costs as operating, maintenance, and management expense on the Company’s consolidated statement of operations, as these costs are no longer capitalizable under the definition of initial direct costs under Topic 842.

Square Footage, Occupancy and Other Measures

Square footage, occupancy, number of tenants and other similar measures, including annualized base rent and annualized base rent per square foot, used to describe real estate investments included in these condensed notes to the consolidated financial statements are unaudited and outside the scope of the Company’s independent registered public accounting firm’s review of the Company’s financial statements in accordance with the standards of the United States Public Company Accounting Oversight Board.

Recently Issued Accounting Standards Update

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments (“ASU No. 2016-13”). ASU No. 2016-13 affects entities holding financial assets and net investments in leases that are not accounted for at fair value through net income. The amendments in ASU No. 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. ASU No. 2016-13 also amends the impairment model for available-for-sale securities. An entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. ASU No. 2016-13 also requires new disclosures. For financial assets measured at amortized cost, an entity will be required to disclose information about how it developed its allowance for credit losses, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes. For financing receivables and net investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it currently discloses about the credit quality of these assets by year of the asset’s origination for as many as five annual periods. For available-for-sale securities, an entity will be required to provide a roll-forward of the allowance for credit losses and an aging analysis for securities that are past due. ASU No. 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is still evaluating the impact of adopting ASU No. 2016-13 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)

September 30, 2019

(unaudited)

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework -Changes to the Disclosure Requirements for Fair Value Measurement (“ASU No. 2018-13”). The primary focus of ASU 2018-13 is to improve the effectiveness of the disclosure requirements for fair value measurements. ASU No. 2018-13 removes the requirement to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for the timing of transfers between levels and the valuation processes for Level 3 fair value measurements. It also adds a requirement to disclose changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and to disclose the range and weighted average of significant unobservable inputs used to develop recurring and nonrecurring Level 3 fair value measurements. For certain unobservable inputs, entities may disclose other quantitative information in lieu of the weighted average if the other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop the Level 3 fair value measurements. In addition, public entities are required to provide information about the measurement uncertainty of recurring Level 3 fair value measurements from the use of significant unobservable inputs if those inputs reasonably could have been different at the reporting date. ASU No. 2018-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Entities are permitted to early adopt either the entire standard or only the provisions that eliminate or modify the requirements. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company is still evaluating the impact of adopting ASU No. 2018-13 on its financial statements, but does not expect the adoption of ASU No. 2018-13 to have a material impact on its financial statements.

3. REAL ESTATE HELD FOR INVESTMENT

As of September 30, 2019, the Company’s portfolio of real estate held for investment was composed of four office properties and an office campus consisting of five office buildings, encompassing in the aggregate approximately 2.7 million rentable square feet. As of September 30, 2019, the Company’s real estate portfolio was 74% occupied. The following table summarizes the Company’s real estate portfolio as of September 30, 2019 (in thousands):


Property	Date Acquired	City	State	Property Type	Total Real Estate at Cost		Accumulated Depreciation and Amortization		Total Real Estate, Net
Willow Oaks Corporate Center	08/26/2009	Fairfax	VA	Office	$	118,547	$	(24,520)	$	94,027
Union Bank Plaza	09/15/2010	Los Angeles	CA	Office	195,544		(34,710)		160,834
Granite Tower	12/16/2010	Denver	CO	Office	144,368		(31,588)		112,780
Fountainhead Plaza	09/13/2011	Tempe	AZ	Office	119,384		(27,357)		92,027
Corporate Technology Centre	03/28/2013	San Jose	CA	Office	149,306		(15,254)		134,052
					$	727,149	$	(133,429)	$	593,720

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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)

September 30, 2019

(unaudited)

As of September 30, 2019, 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
Union Bank Plaza	Los Angeles, CA	701,888	$	160,834	15.2	%	$	23,798	$	42.29	80	%
Corporate Technology Centre	San Jose, CA	415,492	134,052		12.7	%	5,774		33.39		42	%
Granite Tower	Denver, CO	591,070	112,780		10.7	%	18,884		34.86		92	%

_____________________

⁽¹⁾Annualized base rent represents annualized contractual base rental income as of September 30, 2019, 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. Annualized base rent excludes leases that have been executed but have not commenced as of September 30, 2019.

Operating Leases

The Company’s real estate properties held for investment are leased to tenants under operating leases for which the terms and expirations vary. As of September 30, 2019, the leases had remaining terms, excluding options to extend, of up to 15.7 years with a weighted-average remaining term of 6.6 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 $3.4 million and $2.5 million as of September 30, 2019 and December 31, 2018, respectively.

During the nine months ended September 30, 2019 and 2018, the Company recognized deferred rent from tenants, net of lease incentive amortization, which reduced rental income by $2.8 million and $3.1 million, respectively. As of September 30, 2019 and December 31, 2018, the cumulative deferred rent balance was $78.8 million and $61.7 million, respectively, and is included in rents and other receivables on the accompanying balance sheets. The cumulative deferred rent balance included $54.8 million and $38.6 million of unamortized lease incentives as of September 30, 2019 and December 31, 2018, respectively. As of September 30, 2019 and December 31, 2018, lease incentive payable was $52.1 million and $35.2 million, respectively, and is included in accounts payable and accrued liabilities on the accompanying balance sheets.

As of September 30, 2019, the future minimum rental income from the Company’s properties held for investment under non-cancelable operating leases was as follows (in thousands):


October 1, 2019 through December 31, 2019	$	14,264
2020	59,820
2021	55,459
2022	59,634
2023	54,929
Thereafter	388,947
	$	633,053

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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)

September 30, 2019

(unaudited)

As of September 30, 2019, the Company had approximately 80 tenants over a diverse range of industries and geographic areas in its portfolio of real estate held for investment. 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	12	$	19,363	28.1	%
Mining, Oil & Gas Extraction	3	13,154		19.1	%
Educational Services	1	11,728		17.0	%
		$	44,245	64.2	%

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of September 30, 2019, 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.

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 September 30, 2019. During the nine months ended September 30, 2019, the Company recorded an adjustment to rental income of $0.9 million for lease payments that were deemed not probable of collection and a net recovery of bad debt of $0.1 million, which was included in operating, maintenance, and management expense in the accompanying consolidated statements of operations. During the nine months ended September 30, 2018, the Company recorded bad debt expense of $0.2 million, which was included in operating, maintenance, and management expense in the accompanying consolidated statements of operations.

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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)

September 30, 2019

(unaudited)

As of September 30, 2019, the Company had a concentration of credit risk related to the following tenant leases 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
Union Bank	Union Bank Plaza	Finance	295,563	14.6%	$	15,730	22.8%	$	53.22	05/31/2020 03/31/2021/ 05/31/2021/ 05/31/2022 05/31/2035 ⁽²⁾⁽³⁾
The University of Phoenix	Fountainhead Plaza	Educational Services	445,957	22.0%	11,728		17.0%	26.30		08/31/2023 ⁽⁴⁾
Anadarko Petroleum Corporation	Granite Tower	Mining, Oil & Gas Extraction	360,584	17.8%	12,256		17.8%	33.99		04/30/2021 / 04/30/2033 ⁽⁵⁾

_____________________

⁽²⁾ Represents the expiration dates of the lease as of September 30, 2019 and does not take into account any tenant renewal options. Pursuant to a lease amendment that the Company entered into with Union Bank on December 31, 2017, Union Bank surrendered 15,829 rentable square feet of its total rentable square footage on March 31, 2018 and 31,320 rentable square feet of its total rentable square footage on June 30, 2018. In addition, Union Bank also surrendered 321 parking area passes on March 31, 2018. During the year ended December 31, 2018, the Company received $11.4 million of lease termination fees from Union Bank, of which $8.5 million was deferred as of December 31, 2018. During the nine months ended September 30, 2018, $1.4 million was recognized as rental income and $0.8 million was recognized as other operating income in the accompanying consolidated statement of operations. During the nine months ended September 30, 2019, $1.4 million was recognized as rental income and $0.7 million was recognized as other operating income in the accompanying consolidated statements of operations, and $6.4 million was deferred as of September 30, 2019 and included in other liabilities on the accompanying consolidated balance sheets.

⁽³⁾ On August 2, 2019, the Company entered into amended and restated lease agreements with Union Bank relating to Union Bank’s office, retail, and storage spaces, which amended the terms of the leases as follows: (i) remeasured the existing rentable square footage from 295,563 rentable square feet to 307,729 rentable square feet effective June 1, 2020, (ii) of the 307,729 rentable square feet, a total of 131,135 rentable square feet of office space and 11,985 rentable square feet of retail space will be surrendered at various dates between May 31, 2020 and May 31, 2022 and the remaining 164,609 rentable square feet will expire on May 31, 2035, and (iii) the addition of 3,152 rentable square feet of retail space for a 15-year lease term expiring on May 31, 2035. Each of Union Bank’s amended and restated office and retail lease agreements has two five-year extension options on all or a portion of the leased space and a one-time option to terminate and cancel the lease in its entirety effective May 31, 2032, by delivering eighteen months’ notice and subject to payment of lease termination fees. Union Bank also has two one-time options to terminate and cancel a portion of its lease.

⁽⁴⁾ The University of Phoenix has two options to extend the term of this lease for five years per option term.

⁽⁵⁾ Per the lease agreement, 64,841 rentable square feet will expire on April 30, 2021 and the remainder will expire on April 30, 2033.Anadarko Petroleum Corporation has an option to terminate all or a portion of its leased space effective April 30, 2028 or April 30, 2030.

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

Geographic Concentration Risk

As of September 30, 2019, the Company’s net investments in real estate in California and Colorado represented 27.9% and 10.7% 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 Colorado 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.

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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)

September 30, 2019

(unaudited)

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

MARKET LEASE LIABILITIES

As of September 30, 2019 and December 31, 2018, 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
	September 30, 2019		December 31, 2018		September 30, 2019		December 31, 2018		September 30, 2019		December 31, 2018
Cost	$	28,025	$	30,846	$	835	$	835	$	(1,154)	$	(2,635)
Accumulated amortization	(16,785)		(16,869)		(666)		(611)		964		2,327
Net amount	$	11,240	$	13,977	$	169	$	224	$	(190)	$	(308)

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 and nine months ended September 30, 2019 and 2018 were as follows (in thousands):


	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	For the Three Months Ended September 30,						For the Three Months Ended September 30,						For the Three Months Ended September 30,
	2019		2018		2019		2018		2019		2018
Amortization	$	(920)	$	(1,410)	$	(18)	$	(555)	$	27	$	144


	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	For the Nine Months Ended September 30,						For the Nine Months Ended September 30,						For the Nine Months Ended September 30,
	2019		2018		2019		2018		2019		2018
Amortization	$	(2,761)	$	(5,815)	$	(55)	$	(1,697)	$	120	$	749

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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)

September 30, 2019

(unaudited)

5. REAL ESTATE HELD FOR SALE

During the nine months ended September 30, 2019, the Company sold two office properties and as of September 30, 2019, the Company had classified two office properties as held for sale. During the year ended December 31, 2018, the Company sold three office buildings that were part of an eight-building office campus. The results of operations for the properties sold during the nine months ended September 30, 2019 and the year ended December 31, 2018 and the two office properties classified as held for sale as of September 30, 2019 are included in continuing operations on the Company’s consolidated statements of operations. The following table summarizes certain revenue and expenses related to the Company’s real estate properties that were sold during the year ended December 31, 2018 and the three and nine months ended September 30, 2019 and the two office properties that were classified as held for sale as of September 30, 2019, which were included in continuing operations (in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2019		2018		2019		2018
Revenues
Rental income	$	7,918	$	12,390	$	30,575	$	40,030
Other operating income	354		959		1,786		2,630
Total revenues	8,272		13,349		32,361		42,660
Expenses
Operating, maintenance, and management	2,393		3,845		9,845		11,859
Real estate taxes and insurance	750		1,525		3,698		5,156
Asset management fees to affiliate	835		1,117		2,653		3,520
General and administrative expenses	41		36		45		63
Depreciation and amortization	3,599		5,132		12,304		15,961
Interest expense	1,233		1,544		4,379		5,573
Impairment charges on real estate	14,300		—		14,300		—
Total expenses	$	23,151	$	13,199	$	47,224	$	42,132

The following summary presents the major components of assets and liabilities related to real estate held for sale as of September 30, 2019 and December 31, 2018 (in thousands).


	September 30, 2019		December 31, 2018
Assets related to real estate held for sale
Total real estate, at cost	$	304,436	$	427,335
Accumulated depreciation and amortization	(47,273)		(57,017)
Real estate held for sale, net	257,163		370,318
Other assets	38,571		46,817
Total assets related to real estate held for sale	$	295,734	$	417,135
Liabilities related to real estate held for sale
Notes payable, net	115,693		148,912
Other liabilities	—		6
Total liabilities related to real estate held for sale	$	115,693	$	148,918

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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)

September 30, 2019

(unaudited)

As of September 30, 2019, the following properties held for sale 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
Campus Drive Buildings ⁽²⁾	Florham Park, NJ	1,168,846	$	257,164	24.3	%	$	32,181	$	32.78	84	%

_____________________

⁽²⁾Subsequent to September 30, 2019, the Company entered into a purchase and sale agreement for the 100 & 200 Campus Driving Buildings and the 300-600 Campus Buildings (together, the “Campus Drive Buildings”) with a buyer unaffiliated with the Company or the Advisor. See Note 10, “Subsequent Events - Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC.”

During the three and nine months ended September 30, 2019, the Company recorded non-cash impairment charges of $14.3 million to write down the carrying value of the Company’s investment in the Campus Drive Buildings to their contractual sales price less estimated costs to sell. The impairment was primarily due to estimated closing costs and disposition fees, which are reflected upon classification of the Campus Drive Buildings to held for sale. Subsequent to September 30, 2019, the Company entered into a purchase and sale agreement for the Campus Drive Buildings with a buyer unaffiliated with the Company or the Advisor. See Note 10, “Subsequent Events - Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC.”

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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)

September 30, 2019

(unaudited)

6. NOTES PAYABLE

As of September 30, 2019 and December 31, 2018, the Company’s notes payable, including notes payable related to real estate held for sale, consisted of the following (dollars in thousands):


	Book Value as of September 30, 2019		Book Value as of December 31, 2018		Contractual Interest Rate as of September 30, 2019 ⁽¹⁾	Effective Interest Rate as of September 30, 2019 ⁽¹⁾	Payment Type	Maturity Date ⁽²⁾
Corporate Technology Centre Mortgage Loan ⁽³⁾	$	40,894	$	41,868	3.50%	3.5%	Principal & Interest	04/01/2020
Portfolio Loan Facility ⁽⁴⁾	281,293		375,000		One-month LIBOR + 1.45%	3.6%	Interest Only	03/29/2020
Granite Tower Mortgage Loan ⁽⁵⁾	95,350		—		One-month LIBOR + 1.65%	3.8%	⁽⁵⁾	09/01/2023
Total notes payable principal outstanding	$	417,537	$	416,868
Deferred financing costs, net	(944)		(1,660)
Total notes payable, net	$	416,593	$	415,208

_____________________

⁽¹⁾ Contractual interest rate represents the interest rate in effect under the loan as of September 30, 2019. Effective interest rate is calculated as the actual interest rate in effect as of September 30, 2019, using interest rate indices as of September 30, 2019, where applicable.

⁽²⁾ Represents the initial maturity date or the maturity date as extended as of September 30, 2019; subject to certain conditions, the maturity dates of certain loans may be extended beyond the maturity date shown.

⁽³⁾ The loan documents require the Company to reserve for the annual charges for real estate taxes by making monthly deposits to an account held by the lender, subject to certain terms and conditions contained in the loan documents.

⁽⁴⁾ On August 30, 2019, the Company repaid $62.0 million due under this loan and Granite Tower was released as security from the Portfolio Loan Facility. See below, “- Recent Financing Transactions - Granite Tower Mortgage Loan.” As of September 30, 2019, the Portfolio Loan Facility is secured by the 100 & 200 Campus Drive Buildings, the 300-600 Campus Drive Buildings, Willow Oaks Corporate Center, Union Bank Plaza and Fountainhead Plaza. As of September 30, 2019, $281.3 million of term debt of the Portfolio Loan Facility was outstanding and $62.4 million of revolving debt remained available for future disbursements, subject to certain terms and conditions set forth in the loan documents.

⁽⁵⁾ See below, “- Recent Financing Transaction - Granite Tower Mortgage Loan.”

During the three and nine months ended September 30, 2019, the Company incurred $4.4 million and $13.3 million of interest expense, respectively. During the three and nine months ended September 30, 2018, the Company incurred $4.2 million and $13.5 million of interest expense, respectively. As of September 30, 2019 and December 31, 2018, $1.3 million of interest expense was payable. Included in interest expense for the three and nine months ended September 30, 2019 were $0.4 million and $1.2 million of amortization of deferred financing costs, respectively. Included in interest expense for the three and nine months ended September 30, 2018 were $0.3 million and $0.9 million of amortization of deferred financing costs, respectively. Also included in interest expense for the nine months ended September 30, 2018 was $0.3 million of debt refinancing costs.

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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)

September 30, 2019

(unaudited)

The following is a schedule of maturities, including principal amortization payments, for all notes payable outstanding as of September 30, 2019 (in thousands):


October 1, 2019 through December 31, 2019	$	330
2020	321,857
2021	—
2022	—
2023	95,350
Thereafter	—
	$	417,537

Certain of the Company’s notes payable contain financial debt covenants. As of September 30, 2019, the Company was in compliance with these debt covenants.

Recent Financing Transaction

Granite Tower Mortgage Loan

On August 30, 2019, in connection with the partial principal repayment of the Portfolio Loan Facility, the Company, through an indirect wholly owned subsidiary (the “Granite Tower Mortgage Loan Borrower”), entered into a four-year mortgage loan with an unaffiliated lender (the “Granite Tower Mortgage Loan Agent”) for borrowings of up to $145.0 million (the “Granite Tower Mortgage Loan”). As of September 30, 2019, $95.4 million had been disbursed to the Company with the remaining loan balance of $49.6 million available for future disbursements, subject to certain conditions set forth in the loan agreement. The Granite Tower Mortgage Loan matures on September 1, 2023. The Granite Tower Mortgage Loan bears interest at a floating rate of 165 basis points over one-month LIBOR during the term of the loan. Monthly payments are initially interest-only. On January 1, 2022, monthly payments for the Granite Tower Mortgage Loan will begin to 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. The Company has the right to repay all or a portion of the Granite Tower Mortgage Loan without fee, premium or penalty, subject to certain conditions contained in the loan agreement.

KBS REIT Properties II, LLC (“REIT Properties II”), the Company’s wholly owned subsidiary, is providing a guaranty of (i) payment of, and agrees to protect, defend, indemnify and hold harmless the Granite Tower Mortgage Loan Agent and each lender for, from and against, any liability, obligation, deficiency, loss, damage, costs and expenses (including reasonable attorney’s fees), and any litigation which may at any time be imposed upon, incurred or suffered by the Granite Tower Mortgage Loan Agent or any lender because of (a) certain intentional actions committed by the Granite Tower Mortgage Loan Borrower, (b) fraud or intentional misrepresentations by the Granite Tower Mortgage Loan Borrower or REIT Properties II in connection with the loan documents as described in the guaranty agreement, and (c) certain bankruptcy or insolvency proceedings involving the Granite Tower Mortgage Loan Borrower, as such acts are described in the guaranty, and (ii) upon and subject to the events and conditions described in the guaranty, payment of certain indemnity obligations of the Granite Tower Mortgage Loan Borrower related to environmental matters.

REIT Properties II also provides a limited completion guaranty of all obligations of the Granite Tower Mortgage Loan Borrower under an amendment of a major tenant’s lease up to a maximum guaranteed amount of $45.7 million.

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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)

September 30, 2019

(unaudited)

7. 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 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.

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

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 notes payable as of September 30, 2019 and December 31, 2018, which carrying amounts do not generally approximate the fair values (in thousands):


	September 30, 2019										December 31, 2018
	Face Value		Carrying Amount		Fair Value		Face Value		Carrying Amount		Fair Value
Financial liabilities:
Notes payable	$	417,537	$	416,593	$	418,212	$	416,868	$	415,208	$	416,163

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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)

September 30, 2019

(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.

Assets Recorded at Fair Value

During the nine months ended September 30, 2019, the Company measured the following assets at fair value on a nonrecurring basis (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)
Nonrecurring Basis:
Impaired real estate held for sale	$	295,803	$	—	$	—	$	295,803

As of September 30, 2019, the Campus Drive Buildings classified as held for sale were measured at estimated fair value as these properties were impaired and the carrying values of these properties were adjusted to estimated fair value. The Company estimated the fair value for these impaired real estate properties held for sale based on the contractual sales price, less estimated costs to sell.

8. 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 or served as the advisor and dealer manager, respectively, for KBS Real Estate Investment Trust, Inc. (“KBS REIT I”) (which liquidated in December 2018), KBS Real Estate Investment Trust III, Inc. (“KBS REIT III”), Pacific Oak Strategic Opportunity REIT, Inc., formerly KBS Strategic Opportunity REIT, Inc., (“Pacific Oak Strategic Opportunity REIT”) (advisory agreement terminated as of October 31, 2019 and the dealer manager agreement will terminate as of December 31, 2019), KBS Legacy Partners Apartment REIT, Inc. (“KBS Legacy Partners Apartment REIT”) (which liquidated in December 2018), Pacific Oak Strategic Opportunity REIT II, Inc., formerly KBS Strategic Opportunity REIT II, Inc., (“Pacific Oak Strategic Opportunity REIT II”) (advisory agreement terminated as of October 31, 2019 and the dealer manager agreement will terminate as of December 31, 2019) and KBS Growth & Income REIT, Inc. (“KBS Growth & Income REIT”).

On November 1, 2019, Pacific Oak Strategic Opportunity REIT and Pacific Oak Strategic Opportunity REIT II each entered into advisory agreements with a new external advisor, Pacific Oak Capital Advisors, LLC. Pacific Oak Capital Advisors, LLC is part of a group of companies formed, owned and managed by Keith D. Hall and Peter McMillan III. Together, through GKP Holding LLC, Messrs. Hall and McMillan, indirectly own a 33 1/3% interest in the Advisor and the Dealer Manager.

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)

September 30, 2019

(unaudited)

As of January 1, 2018, the Company, together with KBS REIT III, KBS Growth & Income REIT, Pacific Oak Strategic Opportunity REIT, KBS Legacy Partners Apartment REIT, Pacific Oak Strategic Opportunity REIT II, the Dealer Manager, the Advisor and other KBS-affiliated entities, had entered into an errors and omissions and directors and officers liability insurance program where the lower tiers of such insurance coverage were 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. At the June 2018 renewal, Pacific Oak Strategic Opportunity REIT, Pacific Oak Strategic Opportunity REIT II and Legacy Partners Apartment REIT elected to cease participation in the program and obtained separate insurance coverage. In June 2019, the Company renewed its participation in the program. The program is effective through June 30, 2020.

During the nine months ended September 30, 2019 and 2018, no other business transactions occurred between the Company and KBS REIT I, KBS REIT III, Pacific Oak Strategic Opportunity REIT, KBS Legacy Partners Apartment REIT, Pacific Oak Strategic Opportunity REIT II, KBS Growth & Income REIT, the Advisor, the Dealer Manager or other KBS-affiliated entities.

Pursuant to the terms of these agreements, summarized below are the related-party costs incurred by the Company for the nine months ended September 30, 2019 and 2018, respectively, and any related amounts payable as of September 30, 2019 and December 31, 2018 (in thousands):


	Incurred													Payable as of
	Three Months Ended September 30,						Nine Months Ended September 30,						September 30,	December 31,
	2019		2018		2019		2018		2019		2018
Expensed
Asset management fees	$	2,469	$	2,688	$	7,707	$	8,192	$	—	$	—
Reimbursement of operating expenses ⁽¹⁾	69		69		222		246		102		55
Disposition fees ⁽²⁾	—		—		1,334		972		—		—
	$	2,538	$	2,757	$	9,263	$	9,410	$	102	$	55

_____________________

⁽¹⁾ Reimbursable operating expenses primarily consists 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 $55,000 and $53,000 for the three months ended September 30, 2019 and 2018, respectively, and $170,000 and $181,000 for the nine months ended September 30, 2019 and 2018, respectively, and were the only type of employee costs reimbursed under the Advisory Agreement for the nine months ended September 30, 2019 and 2018. 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.

During the nine months ended September 30, 2018, the Advisor reimbursed the Company for a $0.1 million property insurance rebate.

9. 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 investments; management of the daily operations of the Company’s real estate 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

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)

September 30, 2019

(unaudited)

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 September 30, 2019.

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.

10. SUBSEQUENT EVENTS

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

Distributions Paid

On October 1, 2019, the Company paid distributions of $3.5 million, which related to distributions declared for September 2019 in the amount of $0.01875000 per share of common stock to stockholders of record as of the close of business on September 20, 2019. On November 1, 2019, the Company paid distributions of $3.5 million, which related to distributions declared for October 2019 in the amount of $0.01875000 per share of common stock to stockholders of record as of the close of business on October 21, 2019.

Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC

On September 9, 2008, the Company, through an indirect wholly owned subsidiary, KBSII 100-200 Campus Drive, LLC, purchased two four-story office buildings located at 100 & 200 Campus Drive in Florham Park, New Jersey containing 590,458 rentable square feet on an approximate 71.1-acre parcel of land (the “100 & 200 Campus Drive Buildings”). On October 10, 2008, the Company, through an indirect wholly owned subsidiary, KBSII 300-600 Campus Drive, LLC, purchased four four-story office buildings containing 578,388 rentable square feet (the “300-600 Campus Drive Buildings”). The 300-600 Campus Drive Buildings are located at 300, 400, 500 and 600 Campus Drive in Florham Park, New Jersey on an approximate 64.80-acre parcel of land.

On October 22, 2019, the Company, through indirect wholly owned subsidiaries, entered into a membership interest purchase and sale agreement and escrow instructions (the “Agreement”) for the sale of all of the membership interests of KBSII 300-600 Campus Drive, LLC (the owner of the 300-600 Campus Drive Buildings) and KBSII 100-200 Campus Drive, LLC (the owner of the 100 & 200 Campus Drive Buildings)(together, the “Property Owners”) to a buyer unaffiliated with the Company or the Advisor (the “Purchaser”). Pursuant to the Agreement, the total purchase price for the Property Owners is $320.0 million.

On October 30, 2019, the Company, through indirect wholly owned subsidiaries, entered into the first amendment to the Agreement (the “First Amendment”) with the Purchaser to extend the ending date of the due diligence period from October 30, 2019 to October 31, 2019, and on October 31, 2019, the Company, through indirect wholly owned subsidiaries, entered into the second amendment to the Agreement (the “Second Amendment”) with the Purchaser to reduce the total purchase price for the Property Owners to $311.0 million.

Per the Agreement, the closing date is expected to be on or before December 16, 2019. Under the Second Amendment, the Purchaser has an option to extend the closing date to January 16, 2020 and a second option to extend the closing date to January 31, 2020, subject to certain conditions set forth in the Second Amendment. There can be no assurance that the Company will complete the sale of the Property Owners. The Purchaser would be obligated to purchase the Property Owners only after satisfaction of agreed upon closing conditions. In some circumstances, if the Purchaser fails to complete the acquisition, it may forfeit up to $4.0 million of earnest money.

Table of Contents

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, one 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, except with respect to distributions paid from the net proceeds from the sale of real estate. 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 reducing our stockholders’ returns.

•Our investments in real estate 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 could decrease. Such events would make it more difficult for us to meet our debt service obligations and could reduce our stockholders’ returns.

•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.

•As of September 30, 2019, we have $376.6 million of variable debt outstanding, and we may incur additional variable rate debt in the future. The interest and related payments on our variable rate debt will vary with the movement of LIBOR or other indexes. Increases in one-month LIBOR or other indexes would increase the amount of our debt payments and could reduce our stockholders’ returns.

•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.

Table of Contents

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 and proceeds from the sales of real estate properties 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 our stockholders’ returns.

•As of September 30, 2019, we had classified two office properties as held for sale, which were under contract to sell as of November 12, 2019. During the year ended December 31, 2018, we sold three office buildings that were part of an eight-building office campus and received the repayment on one real estate loan receivable. During the nine months ended September 30, 2019, we sold two office properties. As a result of our disposition activity, our general and administrative expenses, which are not directly related to the size of our portfolio, have increased as a percentage of our cash flow from operations and will continue to increase to the extent we sell additional assets.

•Although the Special Committee (defined below) engaged a financial advisor 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. While we anticipate that our exploration of strategic alternatives and marketing of some of our remaining assets for sale will result in additional stockholder liquidity, there is no assurance that this will be the case, nor can we give assurance that it will provide a return to stockholders that equals or exceeds our estimated value per share. We do not expect to provide additional updates regarding our review of strategic alternatives until such time, if any, that we are prepared to announce a material transaction or to conclude the strategic review.

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, 2018, as filed with the Securities and Exchange Commission (the “SEC”), and in Part II, Item 1A herein.

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 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 investments. Our advisor owns 20,000 shares of our common stock. We have no paid employees.

We invested in a diverse portfolio of real estate and real estate-related investments. As of September 30, 2019, we owned six office properties (of which two were held for sale) and an office campus consisting of five office buildings.

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 September 30, 2019, we had redeemed 28,053,701 shares sold in our offering for $256.1 million.

On January 27, 2016, our board of directors formed the Special Committee composed of all of our independent directors to explore the availability of strategic alternatives involving us. As part of the process of exploring strategic alternatives, on February 23, 2016, the Special Committee engaged Evercore to act as our financial advisor and to assist us and the Special Committee with this process. Under the terms of the engagement, Evercore provided 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 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.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

The Special Committee determined that it would be in our best interest and the best interest of our stockholders to market some of our assets for sale while it continues to explore strategic alternatives for us. Based on the results of this sales effort, the board of directors may conclude that it would be in our best interest and the best interest of our stockholders to sell additional assets and, depending on the scope of the proposed asset sales, thereafter to adopt a plan of liquidation that would involve the sale of our remaining assets. In the event of such a determination, the proposed plan of liquidation would be presented to our stockholders for approval. While we anticipate that our exploration of strategic alternatives and marketing of some of our remaining assets for sale will result in additional stockholder liquidity, there is no assurance that this will be the case, nor can we give assurance that it will provide a return to stockholders that equals or exceeds our estimated value per share.

Our charter requires that we seek stockholder approval of our liquidation if our shares of common stock are not listed on a national securities exchange by March 31, 2018, unless a majority of our independent directors determines that liquidation is not then in the best interest of our stockholders. On March 12, 2019, the conflicts committee unanimously determined to postpone approval of our liquidation while the Special Committee continues to explore strategic alternatives for us. Our charter requires that the conflicts committee revisit the issue of liquidation at least annually.

Our focus in 2019 is to: continue to strategically sell assets and consider special distributions to stockholders; negotiate lease renewals or new leases that facilitate the sales process and enhance property stability for prospective buyers; complete capital projects, such as renovations or amenity enhancements, to attract quality buyers; and finalize our assessment of strategic alternatives.

Market Outlook – Real Estate and Real Estate Finance Markets

Volatility in global financial markets and changing political environments can cause fluctuations in the performance of the U.S. commercial real estate markets. 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 from investment properties. To the extent there are increases in the cost of financing due to higher interest rates, this may cause difficulty in refinancing debt obligations at terms as favorable as the terms of existing indebtedness. Further, increases in interest rates would increase the amount of our debt payments under our variable rate debt obligations. Market conditions can change quickly, potentially negatively impacting the value of real estate investments. Management continuously reviews our investment and debt financing strategies to optimize our portfolio and the cost of our debt.

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 properties, proceeds from debt financing and proceeds from the sale of real estate properties as our primary sources of immediate and long-term liquidity.

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 3, 2018, our board of directors approved an annual dollar limitation of $10.0 million in the aggregate for the calendar year 2019 for Special Redemptions (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 September 30, 2019, we had $5.7 million available for Special Redemptions for the remainder of 2019.

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 September 30, 2019, our real estate properties were 74% occupied.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

For the nine months ended September 30, 2019, our cash needs for capital expenditures and the payment of debt obligations were met with cash on hand. Operating cash needs during the same period were met with cash flow generated by our real estate. We paid distributions to our stockholders during the nine months ended September 30, 2019 using current period cash flow from operations, cash flow from operations in excess of distributions paid from prior periods, proceeds from debt financing and the net proceeds from the sales of two of our properties. We believe that our cash on hand, cash flow from operations, availability under our portfolio loan facility and mortgage loan and proceeds from the sales of real estate properties will be sufficient to meet our liquidity needs for the foreseeable future.

On June 12, 2019, our board of directors declared a special distribution in the amount of $0.45 per share of common stock to stockholders of record as of the close of business on June 17, 2019 (the “Special Distribution”). The Special Distribution was funded primarily from the net proceeds from the sales of Pierre Laclede Center and Emerald View at Vista Center on May 23, 2019. We paid the Special Distribution on June 21, 2019. Also on June 12, 2019, our board of directors approved an updated estimated value per share of our common stock of $4.50, effective June 17, 2019, to reflect the impact of the payment of the Special Distribution. The June 2019 estimated value per share was based solely on the December 3, 2018 estimated value per share reduced for the impact of the payment of the Special Distribution. This was the sole adjustment to the estimated value per share. For a full description of the methodologies and assumptions used in June 2019 estimated value per share determination, see our Current Report on Form 8-K filed with SEC on December 7, 2018 and our Current Report on Form 8-K filed with the SEC on June 14, 2019.

Our cash flow from operations has decreased and will continue to decrease in future periods 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 additional strategic asset sales as opportunities become available in the market and may further adjust our distribution policy as a result. Any future special distributions we make from the proceeds of 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 2019. As of September 30, 2019, we had classified two office properties as held for sale.

Cash Flows from Operating Activities

As of September 30, 2019, we owned six office properties (of which two were held for sale) and an office campus consisting of five office buildings. During the nine months ended September 30, 2019, net cash provided by operating activities was $10.9 million, compared to $50.6 million during the nine months ended September 30, 2018. The decrease in net cash provided by operating activities was primarily due to lease termination fees received in 2018, the disposition of assets and the lease expiration of a tenant that occupied 100% of Corporate Technology Centre. Cash flows from operating activities will decrease in the future as a result of future asset sales.

Cash Flows from Investing Activities

Net cash provided by investing activities was $99.3 million for the nine months ended September 30, 2019 and consisted of the following:

•$130.3 million of net proceeds from the sale of two office properties; and

•$31.0 million used for improvements to real estate.

Cash Flows from Financing Activities

During the nine months ended September 30, 2019, net cash used in financing activities was $122.2 million and consisted of the following:

•$134.4 million of proceeds from notes payable;

•$133.7 million of principal payments on notes payable;

•$117.6 million of cash used for distributions;

•$4.4 million of cash used for redemptions of common stock; and

•$0.9 million of payments of deferred financing costs.

Table of Contents

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 paid 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 included any portion of the investment that was debt financed and was 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 September 30, 2019, we had $48.1 million of cash and cash equivalents and up to $112.0 million available for future disbursements under our portfolio loan facility and one of our mortgage loans, subject to certain conditions and restrictions set forth in the 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 and 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 September 30, 2019, our borrowings and other liabilities were approximately 37% of both the cost (before deducting depreciation and other noncash reserves) and book value (before deducting depreciation) of our tangible assets.

Contractual Commitments and Contingencies

The following is a summary of our contractual obligations as of September 30, 2019 (in thousands):


			Payments Due During the Years Ending December 31,
Contractual Obligations	Total		Remainder of 2019		2020 - 2021		2022 - 2023		Thereafter
Outstanding debt obligations ⁽¹⁾	$	417,537	$	330	$	321,857	$	95,350	$	—
Interest payments on outstanding debt obligations ⁽²⁾	19,809		3,775		10,068		5,966		—

_____________________

⁽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 September 30, 2019 (consisting of the contractual interest rate). We incurred interest expense of $12.1 million, excluding amortization of deferred financing costs of $1.2 million during the nine months ended September 30, 2019.

Results of Operations

Overview

As of September 30, 2018, we owned eight office properties and an office campus consisting of five office buildings. Subsequent to September 30, 2018, we sold two office properties. As a result, as of September 30, 2019, we owned six office properties (of which two were held for sale) and an office campus consisting of five office buildings. The results of operations presented for the three and nine months ended September 30, 2019 and 2018 are not directly comparable due to disposition activity. In general, we expect income and expenses to decrease in future periods due to disposition activity.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Comparison of the three months ended September 30, 2019 versus the three months ended September 30, 2018

The following table provides summary information about our results of operations for the three months ended September 30, 2019 and 2018 (dollar amounts in thousands):


	Three Months Ended September 30,						Increase (Decrease)		Percentage Change		$ Change Due to Dispositions ⁽¹⁾		$ Change Due to Properties Held Throughout Both Periods ⁽²⁾
	2019		2018
Rental income	$	24,943	$	30,411	$	(5,468)	(18)	%	$	(4,813)	$	(655)
Other operating income	1,480		2,271		(791)		(35)	%	(537)		(254)
Operating, maintenance and management costs	7,991		8,773		(782)		(9)	%	(1,585)		803
Real estate taxes and insurance	4,294		4,387		(93)		(2)	%	(742)		649
Asset management fees to affiliate	2,469		2,688		(219)		(8)	%	(288)		69
General and administrative expenses	1,342		1,416		(74)		(5)	%	n/a		n/a
Depreciation and amortization	11,050		12,077		(1,027)		(9)	%	(1,664)		637
Interest expense	4,418		4,175		243		6	%	(448)		691
Impairment charges on real estate	14,300		—		14,300		100	%	—		14,300
Other interest income	114		380		(266)		(70)	%	n/a		n/a
Loss from extinguishment of debt	(165)		—		(165)		(100)	%	(165)		—

_____________________

⁽¹⁾ Represents the dollar amount increase (decrease) for the three months ended September 30, 2019 compared to the three months ended September 30, 2018 related to real estate disposed of on or after July 1, 2018.

⁽²⁾ Represents the dollar amount increase (decrease) for the three months ended September 30, 2019 compared to the three months ended September 30, 2018 related to real estate investments owned by us throughout both periods presented.

Rental income decreased from $30.4 million for the three months ended September 30, 2018 to $24.9 million for the three months ended September 30, 2019, primarily due to dispositions of real estate properties subsequent to July 1, 2018 and an overall decrease in portfolio occupancy of 2% related to real estate properties held throughout both periods, partially offset by an increase in rental income as a result of the amendment of Union Bank’s lease in August 2019 and higher property tax recoveries at a real estate property held throughout both periods, which was due to a change in the arrangement whereby the tenant reimbursed us for property tax expenses during the three months ended September 30, 2019 instead of the tenant paying the property tax bill directly during the three months ended September 30, 2018. Overall, we expect rental income to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties.

Other operating income decreased from $2.3 million for the three months ended September 30, 2018 to $1.5 million for the three months ended September 30, 2019, primarily due to dispositions of real estate properties subsequent to July 1, 2018 and a decrease in parking revenues from a property held throughout both periods as a result of waiving a tenant’s parking charges in 2019 due to a new lease agreement.

Operating, maintenance and management costs decreased from $8.8 million for the three months ended September 30, 2018 to $8.0 million for the three months ended September 30, 2019, primarily due to dispositions of real estate properties subsequent to July 1, 2018, offset by an increase in operating, maintenance and management costs due to a change in the arrangement whereby the tenant reimbursed us for operating, maintenance and management costs during the three months ended September 30, 2019 instead of the tenant paying these costs directly during the three months ended September 30, 2018 for a property held throughout both periods. Also included in operating, maintenance and management costs for the three months ended September 30, 2019 was $0.1 million of legal fees related to leasing. Upon adoption of the lease accounting standards of Topic 842, beginning January 1, 2019, as a lessor, we record legal costs incurred to negotiate an operating lease as an expense, as these costs are no longer capitalizable under the definition of initial direct costs under Topic 842. Prior to January 1, 2019, these legal costs were capitalized and included in real estate, cost. We expect operating, maintenance and management costs to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties, offset by general increases due to inflation.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Real estate taxes and insurance decreased from $4.4 million for the three months ended September 30, 2018 to $4.3 million for the three months ended September 30, 2019, primarily due to dispositions of real estate properties subsequent to July 1, 2018, offset by an increase in property tax expenses of $0.3 million at a property held throughout both periods due to a change in the arrangement whereby the tenant reimbursed us for property tax expenses during the three months ended September 30, 2019 instead of the tenant paying the property tax bill directly during the three months ended September 30, 2018 and an increase of $0.3 million due to a higher property tax assessed value for one real estate property held throughout both periods. We expect real estate taxes and insurance to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties, partially offset by increases due to higher property tax assessed values.

Asset management fees with respect to our real estate investments decreased from $2.7 million for the three months ended September 30, 2018 to $2.5 million for the three months ended September 30, 2019, primarily due to dispositions of real estate properties. All asset management fees incurred as of September 30, 2019 have been paid. We expect asset management fees to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties, partially offset by increases in capital improvements.

Depreciation and amortization decreased from $12.1 million for the three months ended September 30, 2018 to $11.1 million for the three months ended September 30, 2019 due to dispositions of real estate properties subsequent to July 1, 2018, offset by an increase in depreciation and amortization relating to various building improvements placed in service in 2018 at Union Bank Plaza and Willow Oaks Corporate Center and the acceleration of amortization of tenant improvements costs in connection with Union Bank’s amended and restated lease in August 2019. We expect depreciation and amortization to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties and an overall decrease in amortization of tenant origination costs related to lease expirations.

Interest expense increased from $4.2 million for the three months ended September 30, 2018 to $4.4 million for the three months ended September 30, 2019. Included in interest expense for the three months ended September 30, 2019 and 2018 were $0.4 million and $0.3 million of amortization of deferred financing costs, respectively. The increase in interest expense is primarily due to debt refinancing costs, an increase in one-month LIBOR and its impact on interest expense related to our variable debt and an overall increase in our total debt outstanding. In general, we expect interest expense to decrease in future periods due to debt repayments related to disposition activity and anticipated future 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) and our level of future borrowings, which will depend on the availability and cost of debt financing, loan draws and any debt repayments we make.

During the three months ended September 30, 2019, we recorded non-cash impairment charges of $14.3 million to write down the carrying value of our investment in the Campus Drive Buildings to their contractual sales price less estimated costs to sell. The impairment was primarily due to estimated closing costs and disposition fees, which are reflected upon classification of the Campus Drive Buildings to held for sale. Subsequent to September 30, 2019, we entered into a purchase and sale agreement for the Campus Drive Buildings with a buyer unaffiliated with us or our advisor. See “-Subsequent Events - Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC.” We did not record any impairment charges on our real estate properties during three months ended September 30, 2018.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Comparison of the nine months ended September 30, 2019 versus the nine months ended September 30, 2018

The following table provides summary information about our results of operations for the nine months ended September 30, 2019 and 2018 (dollar amounts in thousands):


	Nine Months Ended September 30,						Increase (Decrease)		Percentage Change		$ Change Due to Dispositions ⁽¹⁾		$ Change Due to Properties Held Throughout Both Periods ⁽²⁾
	2019		2018
Rental income	$	78,619	$	95,578	$	(16,959)	(18)	%	$	(9,601)	$	(7,358)
Interest income from real estate loan receivable	—		434		(434)		(100)	%	(434)		—
Other operating income	5,359		6,968		(1,609)		(23)	%	(742)		(867)
Operating, maintenance and management costs	25,867		25,379		488		2	%	(2,245)		2,733
Real estate taxes and insurance	13,959		13,634		325		2	%	(1,471)		1,796
Asset management fees to affiliate	7,707		8,192		(485)		(6)	%	(675)		190
General and administrative expenses	4,204		4,452		(248)		(6)	%	n/a		n/a
Depreciation and amortization	33,053		38,427		(5,374)		(14)	%	(4,052)		(1,322)
Interest expense	13,262		13,494		(232)		(2)	%	(1,150)		918
Impairment charges on real estate	14,300		—		14,300		100	%	—		14,300
Other interest income	477		867		(390)		(45)	%	n/a		n/a
Loss from extinguishment of debt	(471)		(212)		(259)		122	%	(259)		—
Gain on sale of real estate, net	30,754		24,884		5,870		24	%	5,870		—

_____________________

⁽¹⁾ Represents the dollar amount increase (decrease) for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018 related to real estate and real estate-related investments disposed of or repaid on or after January 1, 2018.

⁽²⁾ Represents the dollar amount increase (decrease) for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018 related to real estate investments owned by us throughout both periods presented.

Rental income decreased from $95.6 million for the nine months ended September 30, 2018 to $78.6 million for the nine months ended September 30, 2019, primarily due to dispositions of real estate properties subsequent to January 1, 2018 and an overall decrease in portfolio occupancy of 2% related to real estate properties held throughout both periods, partially offset by an increase in rental income due to higher property tax recoveries at a real estate property held throughout both periods, which was due to a change in the arrangement whereby the tenant reimbursed us for property tax expenses during the nine months ended September 30, 2019 instead of the tenant paying the property tax bill directly during the nine months ended September 30, 2018. Overall, we expect rental income to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties.

Interest income from our real estate loan receivable, recognized using the interest method, was $0.4 million for the nine months ended September 30, 2018. The borrower under our real estate loan receivable paid off the entire principal balance due to us on June 1, 2018.

Other operating income decreased from $7.0 million for the nine months ended September 30, 2018 to $5.4 million for the nine months ended September 30, 2019, primarily due to dispositions of real estate properties subsequent to January 1, 2018 and a decrease in parking revenues from a property held throughout both periods as a result of waiving a tenant’s parking charges in 2019 due to a new lease agreement.

Table of Contents

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 increased from $25.4 million for the nine months ended September 30, 2018 to $25.9 million for the nine months ended September 30, 2019, primarily due to a change in the arrangement whereby the tenant reimbursed us for operating, maintenance and management costs during the nine months ended September 30, 2019 instead of the tenant paying these costs directly during the nine months ended September 30, 2018 for a property held throughout both periods, and an increase in utility costs and general repair and maintenance costs, offset by dispositions of real estate properties subsequent to January 1, 2018. Also included in operating, maintenance and management costs for the nine months ended September 30, 2019 was $0.4 million of legal fees related to leasing. Upon adoption of the lease accounting standards of Topic 842, beginning January 1, 2019, as a lessor, we record legal costs incurred to negotiate an operating lease as an expense, as these costs are no longer capitalizable under the definition of initial direct costs under Topic 842. Prior to January 1, 2019, these legal costs were capitalized and included in real estate, cost. We expect operating, maintenance and management costs to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties, offset by general increases due to inflation.

Real estate taxes and insurance increased from $13.6 million for the nine months ended September 30, 2018 to $14.0 million for the nine months ended September 30, 2019, primarily due to an increase in property tax expenses of $1.1 million at a property held throughout both periods due to a change in the arrangement whereby the tenant reimbursed us for property tax expenses during the nine months ended September 30, 2019 instead of the tenant paying the property tax bill directly during the nine months ended September 30, 2018 and an increase of $0.5 million due to a higher property tax assessed value for one real estate property held throughout both periods, offset by a decrease in property tax and insurance due to dispositions of real estate properties subsequent to January 1, 2018. We expect real estate taxes and insurance to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties, partially offset by increases due to higher property tax assessed values.

Asset management fees with respect to our real estate investments decreased from $8.2 million for the nine months ended September 30, 2018 to $7.7 million for the nine months ended September 30, 2019, primarily due to dispositions of real estate properties and the payoff of our real estate loan receivable subsequent to January 1, 2018, offset by a net increase in asset management fees for properties held throughout both periods due to an increase in capital improvements. All asset management fees incurred as of September 30, 2019 have been paid. We expect asset management fees to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties, partially offset by increases in capital improvements.

General and administrative expenses decreased from $4.5 million for the nine months ended September 30, 2018 to $4.2 million for the nine months ended September 30, 2019, primarily due to a decrease in professional fees.

Depreciation and amortization decreased from $38.4 million for the nine months ended September 30, 2018 to $33.1 million for the nine months ended September 30, 2019 due to dispositions of real estate properties subsequent to January 1, 2018 and as a result of lease expirations and early lease terminations related to properties held throughout both periods, partially offset by an increase in depreciation and amortization relating to the building improvements placed in service during 2018 at Willow Oaks Corporate Center and the 100 & 200 Campus Drive Buildings. We expect depreciation and amortization to decrease in future periods due to disposition activity and anticipated future dispositions of real estate properties and an overall decrease in amortization of tenant origination costs related to lease expirations.

Interest expense decreased from $13.5 million for the nine months ended September 30, 2018 to $13.3 million for the nine months ended September 30, 2019. Included in interest expense for the nine months ended September 30, 2019 was $1.2 million of amortization of deferred financing costs. Included in interest expense for the nine months ended September 30, 2018 was $0.9 million of amortization of deferred financing costs and $0.3 million of debt refinancing costs. The decrease in interest expense is primarily due to loan repayments in connection with dispositions of real estate properties subsequent to January 1, 2018, offset by an increase in one-month LIBOR and its impact on interest expense related to our variable debt. In general, we expect interest expense to decrease in future periods due to debt repayments related to disposition activity and anticipated future 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) and our level of future borrowings, which will depend on the availability and cost of debt financing, loan draws and any debt repayments we make.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

During the nine months ended September 30, 2019, we recorded non-cash impairment charges of $14.3 million to write down the carrying value of our investment in the Campus Drive Buildings to their contractual sales price less estimated costs to sell. The impairment was primarily due to estimated closing costs and disposition fees, which are reflected upon classification of the Campus Drive Buildings to held for sale. Subsequent to September 30, 2019, we entered into a purchase and sale agreement for the Campus Drive Buildings with a buyer unaffiliated with us or our advisor. See “-Subsequent Events - Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC.” We did not record any impairment charges on our real estate properties during three months ended September 30, 2018.

We recognized a gain on sale of real estate of $30.8 million related to dispositions of two office properties during the nine months ended September 30, 2019. During the nine months ended September 30, 2018, we recognized a gain on sale of real estate of $24.9 million related to dispositions of three office buildings that were part of an eight-building office campus.

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. MFFO excludes from FFO: 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 Institute for Portfolio Alternatives (formerly known as 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.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

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 reflects adjustments for the operations of properties and real estate-related investments sold, held for sale or repaid during the periods presented. During periods of significant disposition activity, FFO and MFFO are much more limited measures of future performance. In connection with our presentation of FFO and MFFO, we are providing information related to the proportion of MFFO related to properties sold, held for sale and real estate-related investments repaid as of September 30, 2019.

Although MFFO includes other adjustments, the exclusion of straight-line rent, the amortization of above- and below-market leases and loss from extinguishment of debt 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, while 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; and

•Loss from extinguishment of debt. A loss from extinguishment of debt, which includes prepayment fees related to the extinguishment of debt, represents the difference between the carrying value of any consideration transferred to the lender in return for the extinguishment of a debt and the net carrying value of the debt at the time of settlement. We have excluded the loss from extinguishment of debt in our calculation of MFFO because these losses do not impact the current operating performance of our investments and do not provide an indication of future operating performance.

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 and nine months ended September 30, 2019 and 2018 (in thousands). No conclusions or comparisons should be made from the presentation of these periods.


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2019		2018		2019		2018
Net (loss) income	$	(19,492)	$	(454)	$	2,386	$	24,941
Depreciation of real estate assets	8,579		8,947		25,822		26,973
Amortization of lease-related costs	2,471		3,130		7,231		11,454
Impairment charges on real estate	14,300		—		14,300		—
Gain on sale of real estate, net	—		—		(30,754)		(24,884)
FFO	5,858		11,623		18,985		38,484
Straight-line rent and amortization of above- and below-market leases	(421)		1,560		2,696		4,147
Amortization of discounts and closing costs	—		—		—		3
Loss from extinguishment of debt	165		—		471		212
MFFO	$	5,602	$	13,183	$	22,152	$	42,846

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 three office buildings that were part of an eight-building office campus and two office properties that were sold, one real estate loan receivable that was paid off between January 1, 2018 and September 30, 2019; and two office properties that were held for sale as of September 30, 2019. Please refer to the table below with respect to the proportion of MFFO related to real estate properties sold or held for sale and the real estate-related investment paid off as of September 30, 2019 (in thousands).


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2019		2018		2019		2018
MFFO by component:
Assets held for investment	$	2,531	$	6,020	$	11,299	$	27,218
Real estate properties held for sale	3,071		4,960		7,762		7,613
Real estate properties sold	—		2,203		3,091		7,630
Real estate loans receivable paid off	—		—		—		385
MFFO	$	5,602	$	13,183	$	22,152	$	42,846

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, second and third quarters of 2019 (in thousands, except per share amounts):


Period	Distributions Declared⁽¹⁾		Distributions Declared Per Share⁽¹⁾		Distributions Paid ⁽²⁾		Cash Flows Provided by (Used in) Operations
First Quarter 2019	$	11,532	$	0.062	$	11,564	$	6,455
Second Quarter 2019	95,187		0.512		95,194		6,024
Third Quarter 2019	10,450		0.056		10,804		(1,532)
	$	117,169	$	0.630	$	117,562	$	10,947

_____________________

⁽¹⁾ “Distributions Declared” and “Distributions Declared Per Share” consist of the following:

•For each month commencing January 2019 through June 2019, our board of directors declared distributions per common share in the amount of $0.02062500 per share of common stock to stockholders of record based on a monthly record date. These distributions totaled approximately $23.1 million.

•On June 12, 2019, our board of directors declared the Special Distribution in the amount of $0.45 per share of common stock to stockholders of record as of the close of business on June 17, 2019. This Special Distribution totaled approximately $83.7 million.

•For each month commencing July 2019 through September 2019, our board of directors declared distributions per common share in the amount of $0.01875000 per share of common stock to stockholders of record based on a monthly record date. These distributions totaled approximately $10.8 million.

⁽²⁾ Other than the Special Distribution, distributions were paid on a monthly basis, on or about the first business day of the following month.

For the nine months ended September 30, 2019, we paid aggregate distributions of $117.6 million, all of which were paid in cash. FFO and cash flow from operations for the nine months ended September 30, 2019 were $19.0 million and $10.9 million, respectively. We funded our total distributions paid with $12.5 million of current period cash flow from operations, $11.7 million of cash flow from operations in excess of distributions paid from prior periods, $83.7 million of net proceeds from the sale of real estate and $9.7 million of proceeds from debt financing. For purposes of determining the source of our distributions paid and other than for special distributions, 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, FFO from current or prior periods and proceeds from sales of our assets.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

As of September 30, 2019, we had classified two office properties as held for sale, which were under contract to sell as of November 12, 2019. During the nine months ended September 30, 2019, we sold two office properties. During the year ended December 31, 2018, we sold three office buildings that were part of an eight-building office campus and received the repayment on one real estate loan 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 additional strategic asset sales as opportunities become available in the market and may further adjust our distribution policy as a result.

On June 12, 2019, our board of directors approved an updated estimated value per share of our common stock of $4.50, effective June 17, 2019, to reflect the impact of the payment of the Special Distribution. The June estimated value per share was based solely on the December 3, 2018 estimated value per share reduced for the impact of the payment of the Special Distribution. For a full description of the methodologies and assumptions used in our estimated value per share determination, see our Current Report on Form 8-K filed with SEC on December 7, 2018 and our Current Report on Form 8-K filed with the SEC on June 14, 2019. Any future special distributions we make from the proceeds of 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 2019.

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, 2018, as filed with the SEC, and the risks discussed in Part II, Item 1A herein. 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; our ability to refinance existing indebtedness at comparable terms; changes in interest rates on our variable rate debt obligation; our ability to successfully dispose of additional 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, 2018 filed with the SEC. There have been no significant changes to our accounting policies during 2019, except for our adoption of the lease accounting standards issued by the Financial Accounting Standards Board effective on January 1, 2019.

Revenue Recognition - Operating Leases

Real Estate

On January 1, 2019, we adopted the lease accounting standards under Topic 842 including the package of practical expedients for all leases that commenced before the effective date of January 1, 2019. Accordingly, we (i) did not reassess whether any expired or existing contracts are or contain leases, (ii) did not reassess the lease classification for any expired or existing lease, and (iii) did not reassess initial direct costs for any existing leases. We did not elect the practical expedient related to using hindsight to reevaluate the lease term. In addition, we adopted the practical expedient for land easements and did not assess whether existing or expired land easements that were not previously accounted for as leases under the lease accounting standards of Topic 840 are or contain a lease under Topic 842.

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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, Topic 842 provides an optional transition method to allow entities to apply the new lease accounting standards at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings. We adopted this transition method upon our adoption of the lease accounting standards of Topic 842, which did not result in a cumulative effect adjustment to the opening balance of retained earnings on January 1, 2019. Our comparative periods presented in the financial statements will continue to be reported under the lease accounting standards of Topic 840.

In accordance with Topic 842, tenant reimbursements for property taxes and insurance are included in the single lease component of the lease contract (the right of the lessee to use the leased space) and therefore are accounted for as variable lease payments and are recorded as rental income on our statement of operations beginning January 1, 2019. In addition, we adopted the practical expedient available under Topic 842 to not separate nonlease components from the associated lease component and instead to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue recognition standard (Topic 606) and if certain conditions are met, specifically related to tenant reimbursements for common area maintenance which would otherwise be accounted for under the revenue recognition standard. We believe the two conditions have been met for tenant reimbursements for common area maintenance as (i) the timing and pattern of transfer of the nonlease components and associated lease components are the same and (ii) the lease component would be classified as an operating lease. Accordingly, tenant reimbursements for common area maintenance are also accounted for as variable lease payments and recorded as rental income on our statement of operations beginning January 1, 2019.

We recognize minimum rent, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related leases when collectibility is probable and record amounts expected to be received in later years as deferred rent receivable. If the lease provides for tenant improvements, we determine whether the tenant improvements, for accounting purposes, are owned by the tenant or us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance (including amounts that can be taken in the form of cash or a credit against the tenant’s rent) that is funded is treated as a lease incentive and amortized as a reduction of rental revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:

•whether the lease stipulates how a tenant improvement allowance may be spent;

•whether the lessee or lessor supervises the construction and bears the risk of cost overruns;

•whether the amount of a tenant improvement allowance is in excess of market rates;

•whether the tenant or landlord retains legal title to the improvements at the end of the lease term;

•whether the tenant improvements are unique to the tenant or general purpose in nature; and

•whether the tenant improvements are expected to have any residual value at the end of the lease.

In accordance with Topic 842, we make a determination of whether the collectibility of the lease payments in an operating lease is probable. If we determine the lease payments are not probable of collection, we would fully reserve for any contractual lease payments, deferred rent receivable, and variable lease payments and would recognize rental income only if cash is received. Beginning January 1, 2019, these changes to our collectibility assessment are reflected as an adjustment to rental income. Prior to January 1, 2019, bad debt expense related to uncollectible accounts receivable and deferred rent receivable was included in operating, maintenance, and management expense in the statement of operations. Any subsequent changes to the collectibility of the allowance for doubtful accounts as of December 31, 2018, which was recorded prior to the adoption of Topic 842, are recorded in operating, maintenance, and management expense in the statement of operations.

Beginning January 1, 2019, we, as a lessor, record costs to negotiate or arrange a lease that would have been incurred regardless of whether the lease was obtained, such as legal costs incurred to negotiate an operating lease, as an expense and classify such costs as operating, maintenance, and management expense on our consolidated statement of operations, as these costs are no longer capitalizable under the definition of initial direct costs under Topic 842.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Subsequent Events

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

Distributions Paid

On October 1, 2019, we paid distributions of $3.5 million, which related to distributions declared for September 2019 in the amount of $0.01875000 per share of common stock to stockholders of record as of the close of business on September 20, 2019. On November 1, 2019, we paid distributions of $3.5 million, which related to distributions declared for October 2019 in the amount of $0.01875000 per share of common stock to stockholders of record as of the close of business on October 21, 2019.

Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC

On September 9, 2008, we, through an indirect wholly owned subsidiary, KBSII 100-200 Campus Drive, LLC, purchased two four-story office buildings located at 100 & 200 Campus Drive in Florham Park, New Jersey containing 590,458 rentable square feet on an approximate 71.1-acre parcel of land (the “100 & 200 Campus Drive Buildings”). On October 10, 2008, we, through an indirect wholly owned subsidiary, KBSII 300-600 Campus Drive, LLC, purchased four four-story office buildings containing 578,388 rentable square feet (the “300-600 Campus Drive Buildings”). The 300-600 Campus Drive Buildings are located at 300, 400, 500 and 600 Campus Drive in Florham Park, New Jersey on an approximate 64.80-acre parcel of land.

On October 22, 2019, we, through indirect wholly owned subsidiaries, entered into a membership interest purchase and sale agreement and escrow instructions (the “Agreement”) for the sale of all of the membership interests of KBSII 300-600 Campus Drive, LLC (the owner of the 300-600 Campus Drive Buildings) and KBSII 100-200 Campus Drive, LLC (the owner of the 100 & 200 Campus Drive Buildings)(together, the “Property Owners”) to a buyer unaffiliated with us or our advisor (the “Purchaser”). Pursuant to the Agreement, the total purchase price for the Property Owners is $320.0 million.

On October 30, 2019, we, through indirect wholly owned subsidiaries, entered into the first amendment to the Agreement (the “First Amendment”) with the Purchaser to extend the ending date of the due diligence period from October 30, 2019 to October 31, 2019, and on October 31, 2019, we, through indirect wholly owned subsidiaries, entered into the second amendment to the Agreement (the “Second Amendment”) with the Purchaser to reduce the total purchase price for the Property Owners to $311.0 million.

Per the Agreement, the closing date is expected to be on or before December 16, 2019. Under the Second Amendment, the Purchaser has an option to extend the closing date to January 16, 2020 and a second option to extend the closing date to January 31, 2020, subject to certain conditions set forth in the Second Amendment. There can be no assurance that we will complete the sale of the Property Owners. The Purchaser would be obligated to purchase the Property Owners only after satisfaction of agreed upon closing conditions. In some circumstances, if the Purchaser fails to complete the acquisition, it may forfeit up to $4.0 million of earnest money.

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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 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 borrow funds at a combination of fixed and variable rates. Interest rate fluctuations will generally not affect our future payments on our fixed rate debt unless such instruments mature or are otherwise terminated. However, interest rate changes will affect the fair value of our fixed rate instruments. As of September 30, 2019, the fair value of our fixed rate debt was $40.9 million and the outstanding principal balance of our fixed rate debt was $40.9 million. The fair value estimate of our fixed rate debt is 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 September 30, 2019. 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 September 30, 2019, we were exposed to market risks related to fluctuations in interest rates on $376.6 million of variable rate debt outstanding. Based on interest rates as of September 30, 2019, if interest rates were 100 basis points higher or lower during the 12 months ending September 30, 2020, interest expense on our variable rate debt would increase or decrease by $3.8 million.

The interest rates of our fixed rate debt and variable rate debt as of September 30, 2019 were 3.5% and 3.6%, respectively. The interest rates represent the actual interest rate in effect as of September 30, 2019, using interest rate indices as of September 30, 2019, where applicable.

For a discussion of the interest rate risks related to the current capital and credit markets, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Outlook — Real Estate and Real Estate Finance Markets” herein and the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC.

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 September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

In addition to the risks discussed below, please see the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC.

A significant percentage of our assets is invested in the 100 & 200 Campus Drive Buildings and the 300-600 Campus Drive Buildings (together, the “Campus Drive Buildings”), Union Bank Plaza, Corporate Technology Centre and Granite Tower and the value of our stockholders’ investment in us will fluctuate with the performance of these investments.

The Campus Drive Buildings represented 24.3% of our total assets and represented approximately 31.8% of our total annualized base rent as of September 30, 2019. On October 22, 2019, we, through wholly owned subsidiaries, entered into an agreement to sell the Campus Drive Buildings. We can give no assurance that we will complete the sale of these properties. Union Bank Plaza represented approximately 15.2% of our total assets and represented approximately 23.5% of our total annualized base rent as of September 30, 2019. Corporate Technology Centre represented approximately 12.7% of our total assets and represented approximately 5.7% of our total annualized base rent as of September 30, 2019. The lease for the single tenant that occupied Corporate Technology Centre expired on October 31, 2018. As a result of renovating, rebranding and leasing-up this property, occupancy is currently at 42%. We can give no assurance that we will be successful in our strategy to renovate and re-lease Corporate Technology Centre. If we are not successful in our strategy to renovate and re-lease the remaining three vacant buildings, our operating results will suffer and the resale value of the property will be diminished. Granite Tower represented 10.7% of our total assets and represented approximately 18.7% of our total annualized base rent as of September 30, 2019.

The geographic concentration of our portfolio makes us particularly susceptible to adverse economic developments in the Florham Park, New Jersey, Los Angeles, San Jose and Denver real estate markets, respectively. 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 our operating results and our ability to pay distributions to our stockholders.

Because of the concentration of a significant portion of our assets in three geographic areas, any adverse economic, real estate or business conditions in these areas could affect our operating results and our ability to make distributions to our stockholders.

As of September 30, 2019, our real estate properties in California, New Jersey and Colorado represented 27.9%, 24.3% and 10.7% of our total assets, respectively. As a result, the geographic concentration of our portfolio makes it particularly susceptible to adverse economic developments in the California, New Jersey and Colorado 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 our operating results and our ability to pay distributions to stockholders.

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PART II. OTHER INFORMATION (CONTINUED)

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

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.

c.)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 and, together with redemptions sought in connection with a stockholder’s death, “Special Redemptions”). Such redemptions are subject to the limitations described in the share redemption program document, including:

•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 3, 2018, our board of directors approved the dollar amount limitation for Special Redemptions for calendar year 2019 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.

Upon a transfer of shares, any pending redemption requests with respect to such transferred shares will be canceled as of the date the transfer is accepted by us. Stockholders wishing to continue to have a redemption request related to any transferred shares considered by us must resubmit their redemption request.

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.

On December 3, 2018, our board of directors approved an estimated value per share of our common stock of $4.95 (unaudited) (the “December EVPS”) 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, 2018. The change in the redemption price became effective for the December 2018 redemption date, which was December 31, 2018, and was effective through the May 2019 redemption date, which was May 31, 2019. For a full description of the methodologies used to value our assets and liabilities in connection with the calculation of the December EVPS, see Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Market Information” of our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on March 13, 2019.

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PART II. OTHER INFORMATION (CONTINUED)

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

In connection with the declaration of the Special Distribution, on June 12, 2019, our board of directors approved an updated estimated value per share of our common stock of $4.50 (unaudited), effective June 17, 2019, which was the record date for the Special Distribution, based solely on subtracting the Special Distribution declared by our board of directors in the amount of $0.45 per share of common stock from the December EVPS of $4.95. This was the sole adjustment to the estimated value per share. The change in the redemption price became effective for the June 2019 redemption date, which was June 28, 2019, 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 2019. For a full description of the methodologies used to determine the estimated value per share, see our Current Report on Form 8-K filed with the SEC on June 14, 2019.

We may amend, suspend or terminate our share redemption program for any reason upon ten business days’ notice to our stockholders, and 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 (a) in a Current Report on Form 8-K or in our annual or quarterly reports, all publicly filed with the SEC or (b) in a separate mailing to our stockholders.

The only redemptions we made under our share redemption program during the nine months ended September 30, 2019 were those that qualified as, and met the requirements for, Special Redemptions under our share redemption program and we fulfilled all redemption requests that qualified as Special Redemptions under our share redemption program. We funded redemptions during the nine months ended September 30, 2019 with existing cash on hand.

During the nine months ended September 30, 2019, 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 2019	87,190	$	4.95	⁽³⁾
February 2019	80,441	$	4.95	⁽³⁾
March 2019	108,367	$	4.95	⁽³⁾
April 2019	150,957	$	4.95	⁽³⁾
May 2019	94,897	$	4.95	⁽³⁾
June 2019	71,919	$	4.50	⁽³⁾
July 2019	74,700	$	4.50	⁽³⁾
August 2019	140,594	$	4.50	⁽³⁾
September 2019	104,293	$	4.50	⁽³⁾
Total	913,358

_____________________

⁽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), on May 19, 2014 (which amendment became effective on June 18, 2014) and on December 7, 2018 (which amendment became effective on January 6, 2019).

⁽²⁾ We describe the determination of the redemption price above.

⁽³⁾ We limit the dollar value of shares that may be redeemed under the share redemption program as described above. For the nine months ended September 30, 2019, we redeemed $4.3 million of shares of common stock, which represented all redemption requests received in good order and eligible for redemption through the September 2019 redemption date. Based on the redemption limitations described above and redemptions through September 30, 2019, we may redeem up to $5.7 million of shares in connection with Special Redemptions for the remainder of 2019.

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PART II. OTHER INFORMATION (CONTINUED)

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

Financing of Granite Tower Mortgage Loan

On August 30, 2019, we repaid $62.0 million due under the Portfolio Loan Facility and Granite Tower was released as security from the loan. In connection with the partial principal repayment of the Portfolio Loan Facility, on August 30, 2019, we, through an indirect wholly owned subsidiary (the “Granite Tower Mortgage Loan Borrower”), entered into a four-year mortgage loan with Bank of America, N.A., as administrative agent, sole arranger and bookrunner (the “Granite Tower Mortgage Loan Agent”), for borrowings of up to $145.0 million (the “Granite Tower Mortgage Loan”). At closing, $95.4 million was funded and the remaining $49.6 million was available for future disbursements, subject to certain conditions set forth in the loan agreement. The Granite Tower Mortgage Loan matures on September 1, 2023. The Granite Tower Mortgage Loan bears interest at a floating rate of 165 basis points over one-month LIBOR during the term of the loan. Monthly payments are initially interest-only. On January 1, 2022, monthly payments for the Granite Tower Mortgage Loan will begin to 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. We have the right to repay all or a portion of the Granite Tower Mortgage Loan without fee, premium or penalty, subject to certain conditions contained in the loan agreement.

KBS REIT Properties II, LLC (“REIT Properties II”), our wholly owned subsidiary, is providing a guaranty of (i) payment of, and agrees to protect, defend, indemnify and hold harmless the Granite Tower Mortgage Loan Agent and each lender for, from and against, any liability, obligation, deficiency, loss, damage, costs and expenses (including reasonable attorney’s fees), and any litigation which may at any time be imposed upon, incurred or suffered by the Granite Tower Mortgage Loan Agent or any lender because of (a) certain intentional actions committed by the Granite Tower Mortgage Loan Borrower, (b) fraud or intentional misrepresentations by the Granite Tower Mortgage Loan Borrower or REIT Properties II in connection with the loan documents as described in the guaranty agreement, and (c) certain bankruptcy or insolvency proceedings involving the Granite Tower Mortgage Loan Borrower, as such acts are described in the guaranty, and (ii) upon and subject to the events and conditions described in the guaranty, payment of certain indemnity obligations of the Granite Tower Mortgage Loan Borrower related to environmental matters.

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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						Fourth Amended and Restated Bylaws of the Company, incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed September 22, 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

10.1						Retail Lease (relating to Union Bank Plaza), by and between KBSII 445 South Figueroa, LLC. and MUFG Union Bank, N.A., dated as of August 2, 2019

10.2						Amended and Restated Office Lease (relating to Union Bank Plaza), by and between KBSII 445 South Figueroa, LLC. and MUFG Union Bank, N.A., dated as of August 2, 2019

10.3						Loan Agreement related to the Granite Tower Loan Facility, by and between KBSII Granite Tower, LLC, and Bank of America, N.A., dated as of August 30, 2019

10.4						Promissory Note related to the Granite Tower Loan Facility, by and between KBSII Granite Tower, LLC, and Bank of America, N.A., dated as of August 30, 2019

10.5						Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing related to the Granite Tower Loan Facility, by and between KBSII Granite Tower, LLC and Bank of America, N.A., dated as of August 8, 2019

10.6						Limited Payment Guaranty Agreement related to the Granite Tower Loan Facility, by KBS REIT Properties II, LLC, in favor of Bank of America, N.A., dated as of August 30, 2019

10.7						Limited Completion Guaranty Agreement related to the Granite Tower Loan Facility, by and between KBS REIT Properties II, LLC, in favor of Bank of America, N.A., dated as of August 30, 2019

10.8						Environmental Indemnification and Release Agreement related to the Granite Tower Loan Facility, by KBSII Granite Tower, LLC, for the benefit of Bank of America, N.A., dated as of August 30, 2019

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 adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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

99.1						Ninth Amended and Restated Share Redemption Program, incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K, filed December 7, 2018

101.INS						Inline XBRL Instance Document

101.SCH						Inline XBRL Taxonomy Extension Schema

101.CAL						Inline XBRL Taxonomy Extension Calculation Linkbase

101.DEF						Inline XBRL Taxonomy Extension Definition Linkbase

101.LAB						Inline XBRL Taxonomy Extension Label Linkbase

101.PRE						Inline XBRL Taxonomy Extension Presentation Linkbase

104						Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

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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:

November 12, 2019

By:

/S/ CHARLES J. SCHREIBER, JR.

Charles J. Schreiber, Jr.

Chairman of the Board,
Chief Executive Officer and Director

(principal executive officer)

Date:

November 12, 2019

By:

/S/ JEFFREY K. WALDVOGEL

Jeffrey K. Waldvogel

Chief Financial Officer, Treasurer and Secretary

(principal financial officer)