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

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________________

FORM 10-Q

______________________________________________________

(Mark One)



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

For the quarterly period ended June 30, 2016



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

For the transition period from to

Commission file number 000-54687

______________________________________________________

KBS REAL ESTATE INVESTMENT TRUST III, INC.

(Exact Name of Registrant as Specified in Its Charter)

______________________________________________________



Maryland		27-1627696
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
800 Newport Center Drive, Suite 700 Newport Beach, California		92660
(Address of Principal Executive Offices)		(Zip Code)

(949) 417-6500

(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

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

Yes ¨ No x

As of August 8, 2016, there were 180,492,393 outstanding shares of common stock of KBS Real Estate Investment Trust III, Inc.

Table of Contents

KBS REAL ESTATE INVESTMENT TRUST III, INC.

FORM 10-Q

June 30, 2016

INDEX



PART I.	FINANCIAL INFORMATION		2
	Item 1.	Financial Statements	2
		Consolidated Balance Sheets as of June 30, 2016 (unaudited) and December 31, 2015	2
		Consolidated Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2016 and 2015	3
		Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the Three and Six Months Ended June 30, 2016 and 2015	4
		Consolidated Statements of Stockholders’ Equity for the Year Ended December 31, 2015 and the Six Months Ended June 30, 2016 (unaudited)	5
		Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2016 and 2015	6
		Condensed Notes to Consolidated Financial Statements as of June 30, 2016 (unaudited)	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40
	Item 4.	Controls and Procedures	41
PART II.	OTHER INFORMATION		42
	Item 1.	Legal Proceedings	42
	Item 1A.	Risk Factors	42
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
	Item 3.	Defaults upon Senior Securities	44
	Item 4.	Mine Safety Disclosures	44
	Item 5.	Other Information	44
	Item 6.	Exhibits	45
SIGNATURES			46

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)



	June 30, 2016			December 31, 2015
	(unaudited)
Assets
Real estate:
Land	$	399,316		$	380,216
Buildings and improvements	2,631,636			2,480,181
Tenant origination and absorption costs	276,741			273,758
Total real estate, cost	3,307,693			3,134,155
Less accumulated depreciation and amortization	(287,831		)	(222,431		)
Total real estate, net	3,019,862			2,911,724
Real estate loan receivable, net	22,440			21,997
Cash and cash equivalents	44,366			108,242
Rents and other receivables, net	55,347			43,035
Above-market leases, net	9,517			10,977
Prepaid expenses and other assets	39,196			37,899
Total assets	$	3,190,728		$	3,133,874
Liabilities and stockholders’ equity
Notes payable, net	$	1,744,758		$	1,640,654
Accounts payable and accrued liabilities	51,279			48,335
Due to affiliate	3,927			10,219
Distributions payable	9,631			9,832
Below-market leases, net	38,792			41,700
Other liabilities	63,667			40,935
Total liabilities	1,912,054			1,791,675
Commitments and contingencies (Note 10)
Redeemable common stock	74,002			55,367
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, 179,919,389 and 177,943,238 shares issued and outstanding as of June 30, 2016 and December 31, 2015, respectively	1,799			1,779
Additional paid-in capital	1,571,075			1,571,107
Cumulative distributions and net losses	(358,383		)	(281,825		)
Accumulated other comprehensive loss	(9,819		)	(4,229		)
Total stockholders’ equity	1,204,672			1,286,832
Total liabilities and stockholders’ equity	$	3,190,728		$	3,133,874

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 III, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except share and per share amounts)



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Revenues:
Rental income	$	76,800		$	55,945		$	151,785		$	109,445
Tenant reimbursements	18,089			12,485			35,592			24,020
Interest income from real estate loan receivable	417			402			826			783
Other operating income	4,949			3,335			9,954			6,169
Total revenues	100,255			72,167			198,157			140,417
Expenses:
Operating, maintenance and management	22,724			16,531			44,619			31,751
Real estate taxes and insurance	15,699			11,885			31,316			23,047
Asset management fees to affiliate	6,217			4,497			12,360			8,814
Real estate acquisition fees to affiliate	—			3,019			1,473			3,019
Real estate acquisition fees and expenses	12			1,048			301			1,164
General and administrative expenses	1,569			1,286			2,826			2,284
Depreciation and amortization	40,645			32,279			80,109			61,947
Interest expense	18,550			7,636			43,906			20,050
Total expenses	105,416			78,181			216,910			152,076
Other income:
Other interest income	10			71			22			141
Total other income	10			71			22			141
Net loss	$	(5,151	)	$	(5,943	)	$	(18,731	)	$	(11,518	)
Net loss per common share, basic and diluted	$	(0.03	)	$	(0.04	)	$	(0.10	)	$	(0.08	)
Weighted-average number of common shares outstanding, basic and diluted	179,955,247			164,166,681			179,417,799			149,484,191

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 III, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited)

(in thousands)



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Net loss	$	(5,151	)	$	(5,943	)	$	(18,731	)	$	(11,518	)
Other comprehensive (loss) income:
Unrealized losses on derivative instruments	(2,173		)	(44		)	(8,479		)	(6,353		)
Reclassification adjustment realized in net income (effective portion)	1,430			1,716			2,889			3,367
Total other comprehensive (loss) income	(743		)	1,672			(5,590		)	(2,986		)
Total comprehensive loss	$	(5,894	)	$	(4,271	)	$	(24,321	)	$	(14,504	)

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 III, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Year Ended December 31, 2015 and the Six Months Ended June 30, 2016 (unaudited)

(dollars in thousands)



						Additional Paid-in Capital			Cumulative Distributions and Net Losses			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
	Common Stock
	Shares		Amounts
Balance, December 31, 2014	123,426,546		$	1,234		$	1,080,673		$	(146,621	)	$	(2,190	)	$	933,096
Net loss	—		—			—			(29,015		)	—			(29,015		)
Other comprehensive loss	—		—			—			—			(2,039		)	(2,039		)
Issuance of common stock	55,602,428		556			579,653			—			—			580,209
Transfers to redeemable common stock	—		—			(26,038		)	—			—			(26,038		)
Redemptions of common stock	(1,085,736	)	(11		)	(10,579		)	—			—			(10,590		)
Distributions declared	—		—			—			(106,189		)	—			(106,189		)
Commissions on stock sales and related dealer manager fees to affiliate	—		—			(48,947		)	—			—			(48,947		)
Other offering costs	—		—			(3,655		)	—			—			(3,655		)
Balance, December 31, 2015	177,943,238		$	1,779		$	1,571,107		$	(281,825	)	$	(4,229	)	$	1,286,832
Net loss	—		—			—			(18,731		)	—			(18,731		)
Other comprehensive loss	—		—			—			—			(5,590		)	(5,590		)
Issuance of common stock	3,246,214		32			30,937			—			—			30,969
Transfers to redeemable common stock	—		—			(18,635		)	—			—			(18,635		)
Redemptions of common stock	(1,270,063	)	(12		)	(12,322		)	—			—			(12,334		)
Distributions declared	—		—			—			(57,827		)	—			(57,827		)
Other offering costs	—		—			(12		)	—			—			(12		)
Balance, June 30, 2016	179,919,389		$	1,799		$	1,571,075		$	(358,383	)	$	(9,819	)	$	1,204,672

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 III, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)



	Six Months Ended June 30,
	2016			2015
Cash Flows from Operating Activities:
Net loss	$	(18,731	)	$	(11,518	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	80,109			61,947
Noncash interest income on real estate-related investment	15			13
Deferred rents	(10,044		)	(8,998		)
Allowance for doubtful accounts	540			338
Amortization of above- and below-market leases, net	(5,113		)	(2,915		)
Amortization of deferred financing costs	2,548			1,675
Unrealized losses on derivative instruments	18,558			1,996
Changes in operating assets and liabilities:
Rents and other receivables	(2,321		)	(2,427		)
Prepaid expenses and other assets	(7,511		)	(5,371		)
Accounts payable and accrued liabilities	(4,799		)	824
Other liabilities	(1,338		)	1,563
Due to affiliates	(6,351		)	5,956
Net cash provided by operating activities	45,562			43,083
Cash Flows from Investing Activities:
Acquisitions of real estate	(141,760		)	(290,678		)
Improvements to real estate	(29,599		)	(29,347		)
Advances on real estate loan receivable	(544		)	(1,738		)
Purchase of interest rate cap	—			(175		)
Principal repayments on real estate loan receivable	86			80
Escrow deposits for future real estate purchase	—			(1,350		)
Net cash used in investing activities	(171,817		)	(323,208		)
Cash Flows from Financing Activities:
Proceeds from notes payable	134,394			19,052
Principal payments on notes payable	(31,448		)	(105,960		)
Payments of deferred financing costs	(1,333		)	(981		)
Proceeds from issuance of common stock	—			511,920
Payments to redeem common stock	(12,334		)	(3,588		)
Return of contingent consideration related to acquisition of real estate	171			—
Payments of commissions on stock sales and related dealer manager fees	—			(47,772		)
Payments of other offering costs	(12		)	(2,857		)
Distributions paid to common stockholders	(27,059		)	(21,236		)
Reimbursement of other offering costs from affiliate	—			1,173
Net cash provided by financing activities	62,379			349,751
Net (decrease) increase in cash and cash equivalents	(63,876		)	69,626
Cash and cash equivalents, beginning of period	108,242			99,135
Cash and cash equivalents, end of period	$	44,366		$	168,761
Supplemental Disclosure of Cash Flow Information:
Interest paid	$	22,459		$	16,109
Supplemental Disclosure of Noncash Investing and Financing Activities:
Distributions paid to common stockholders through common stock issuances pursuant to the dividend reinvestment plan	$	30,969		$	24,318
Increase in other offering costs due to affiliates	$	—		$	189
Increase in distributions payable	$	—		$	2,636
Increase in accrued improvements to real estate	$	6,789		$	8,030
Liabilities assumed in connection with real estate acquisition	$	10		$	124
Increase in due to affiliate related to acquisition fee on development project	$	59		$	—
Application of escrow deposits to acquisition of real estate	$	4,350		$	—

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 III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2016

(unaudited)


1.	ORGANIZATION

KBS Real Estate Investment Trust III, Inc. (the “Company”) was formed on December 22, 2009 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2011 and it intends to continue to operate in such manner. Substantially all of the Company’s business is expected to be conducted through KBS Limited Partnership III (the “Operating Partnership”), a Delaware limited partnership. The Company is the sole general partner of and owns a 0.1% partnership interest in the Operating Partnership. KBS REIT Holdings III LLC (“REIT Holdings III”), the limited partner of the Operating Partnership, owns the remaining 99.9% interest in the Operating Partnership and is its sole limited partner. The Company is the sole member and manager of REIT Holdings III.

Subject to certain restrictions and limitations, the business of the Company is externally managed by KBS Capital Advisors LLC (the “Advisor”), an affiliate of the Company, pursuant to an advisory agreement the Company entered into with the Advisor (the “Advisory Agreement”). On January 26, 2010, the Company issued 20,000 shares of its common stock to the Advisor at a purchase price of $10.00 per share. As of June 30, 2016, the Advisor owned 20,000 shares of the Company’s common stock.

The Company owns a diverse portfolio of real estate investments. As of June 30, 2016, the Company owned 28 office properties, one mixed-use office/retail property and one first mortgage loan secured by a deed of trust.

The Company commenced its initial public offering (the “Offering”) on October 26, 2010. Upon commencing the Offering, the Company retained KBS Capital Markets Group LLC (the “Dealer Manager”), an affiliate of the Company, to serve as the dealer manager of the Offering pursuant to a dealer manager agreement, as amended and restated (the “Dealer Manager Agreement”). The Company ceased offering shares of common stock in the primary Offering on May 29, 2015 and terminated the primary Offering on July 28, 2015.

The Company sold 169,006,162 shares of common stock in the primary Offering for gross proceeds of $1.7 billion. As of June 30, 2016, the Company had also sold 13,734,060 shares of common stock under its dividend reinvestment plan for gross offering proceeds of $134.1 million. Also as of June 30, 2016, the Company had redeemed 3,099,295 shares sold in the Offering for $30.1 million.

Additionally, on October 3, 2014, the Company issued 258,462 shares of common stock for $2.4 million in private transactions exempt from the registration requirements pursuant to Section 4(2) of the Securities Act of 1933.

The Company continues to offer shares of common stock under its dividend reinvestment plan. In some states, the Company will need to renew the registration statement annually or file a new registration statement to continue the dividend reinvestment plan offering. The Company may terminate its dividend reinvestment plan offering at any time.


2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements and condensed notes thereto have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information as contained within the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) and the rules and regulations of the SEC, including the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for audited financial statements. In the opinion of management, the financial statements for the unaudited interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair and consistent presentation of the results for such periods. Operating results for the three and six and months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

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

Use of Estimates

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

Per Share Data

Basic net income (loss) per share of common stock is calculated by dividing net income (loss) by the weighted-average number of shares of common stock issued and outstanding during such period. Diluted net income (loss) per share of common stock equals basic net income (loss) per share of common stock as there were no potentially dilutive securities outstanding during the three and six months ended June 30, 2016 and 2015, respectively.

Distributions declared per common share were $0.162 and $0.322 for the three and six months ended June 30, 2016, respectively. Distributions declared per common share were $0.162 and $0.322 for the three and six months ended June 30, 2015, respectively. Distributions declared per common share assumes each share was issued and outstanding each day during the three and six months ended June 30, 2016 and 2015, respectively. For each day that was a record date for distributions during the three and six months ended June 30, 2016 and 2015, distributions were calculated at a rate of $0.00178082 per share per day. Each day during the periods from January 1, 2015 through June 30, 2015, January 1, 2016 through February 28, 2016 and March 1, 2016 through June 30, 2016 was a record date for distributions.

Segments

The Company has 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 June 30, 2016, the Company aggregated its investments in real estate properties into one reportable business segment. The Company considered both quantitative and qualitative thresholds and determined that its investment in a real estate loan receivable does not constitute a reportable segment.

Square Footage, Occupancy and Other Measures

Any references to square footage, occupancy or annualized base rent 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.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

Recently Issued Accounting Standards Update

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

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

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

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

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) (“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, but does not expect the adoption of ASU No. 2016-13 to have a material impact on its financial statements.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


3.	REAL ESTATE

As of June 30, 2016, the Company’s real estate portfolio was composed of 28 office properties and one mixed-use office/retail property encompassing in the aggregate approximately 11.0 million rentable square feet. As of June 30, 2016, the Company’s real estate portfolio was collectively 93% occupied. The following table summarizes the Company’s investments in real estate as of June 30, 2016 (in thousands):



Property	Date Acquired	City	State	Property Type	Total Real Estate at Cost		Accumulated Depreciation and Amortization			Total Real Estate, Net
Domain Gateway	09/29/2011	Austin	TX	Office	$	47,373	$	(10,309	)	$	37,064
Town Center	03/27/2012	Plano	TX	Office	118,000		(21,073		)	96,927
McEwen Building	04/30/2012	Franklin	TN	Office	40,365		(8,523		)	31,842
Gateway Tech Center	05/09/2012	Salt Lake City	UT	Office	35,380		(5,001		)	30,379
Tower on Lake Carolyn	12/21/2012	Irving	TX	Office	51,589		(9,809		)	41,780
RBC Plaza	01/31/2013	Minneapolis	MN	Office	149,858		(22,376		)	127,482
One Washingtonian Center	06/19/2013	Gaithersburg	MD	Office	90,072		(10,654		)	79,418
Preston Commons	06/19/2013	Dallas	TX	Office	116,612		(15,403		)	101,209
Sterling Plaza	06/19/2013	Dallas	TX	Office	77,844		(8,842		)	69,002
201 Spear Street	12/03/2013	San Francisco	CA	Office	135,714		(10,308		)	125,406
500 West Madison	12/16/2013	Chicago	IL	Office	443,657		(51,944		)	391,713
222 Main	02/27/2014	Salt Lake City	UT	Office	166,102		(15,553		)	150,549
Anchor Centre	05/22/2014	Phoenix	AZ	Office	92,414		(8,235		)	84,179
171 17th Street	08/25/2014	Atlanta	GA	Office	131,109		(11,653		)	119,456
Rocklin Corporate Center	11/06/2014	Rocklin	CA	Office	33,048		(3,460		)	29,588
Reston Square	12/03/2014	Reston	VA	Office	46,527		(3,629		)	42,898
Ten Almaden	12/05/2014	San Jose	CA	Office	121,998		(8,575		)	113,423
Towers at Emeryville	12/23/2014	Emeryville	CA	Office	257,140		(16,769		)	240,371
101 South Hanley	12/24/2014	St. Louis	MO	Office	65,616		(4,419		)	61,197
3003 Washington Boulevard	12/30/2014	Arlington	VA	Office	150,977		(7,419		)	143,558
Village Center Station	05/20/2015	Greenwood Village	CO	Office	77,993		(4,070		)	73,923
Park Place Village	06/18/2015	Leawood	KS	Office/Retail	128,839		(6,275		)	122,564
201 17th Street	06/23/2015	Atlanta	GA	Office	97,745		(4,128		)	93,617
Promenade I & II at Eilan	07/14/2015	San Antonio	TX	Office	62,650		(2,905		)	59,745
CrossPoint at Valley Forge	08/18/2015	Wayne	PA	Office	89,902		(3,042		)	86,860
515 Congress	08/31/2015	Austin	TX	Office	115,301		(4,556		)	110,745
The Almaden	09/23/2015	San Jose	CA	Office	158,976		(4,975		)	154,001
3001 Washington Boulevard	11/06/2015	Arlington	VA	Office	54,276		(803		)	53,473
Carillon	01/15/2016	Charlotte	NC	Office	150,616		(3,123		)	147,493
					$	3,307,693	$	(287,831	)	$	3,019,862

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

As of June 30, 2016, the following property 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
500 West Madison	Chicago, IL	1,457,724	$	391,713	12.3	%	$	36,002	$	25.81	95.7	%

_____________________

⁽¹⁾Annualized base rent represents annualized contractual base rental income as of June 30, 2016, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

Operating Leases

The Company’s real estate properties are leased to tenants under operating leases for which the terms and expirations vary. As of June 30, 2016, the leases had remaining terms, excluding options to extend, of up to 14.3 years with a weighted-average remaining term of 5.0 years. Some of the leases have provisions to extend the term of the leases, options for early termination for all or a 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 $12.6 million and $12.2 million as of June 30, 2016 and December 31, 2015, respectively.

During the six months ended June 30, 2016 and 2015, the Company recognized deferred rent from tenants of $10.0 million and $9.0 million, respectively. As of June 30, 2016 and December 31, 2015, the cumulative deferred rent balance was $50.2 million and $38.7 million, respectively, and is included in rents and other receivables on the accompanying balance sheets. The cumulative deferred rent balance included $4.4 million and $3.3 million of unamortized lease incentives as of June 30, 2016 and December 31, 2015, respectively.

As of June 30, 2016, the future minimum rental income from the Company’s properties under its non-cancelable operating leases was as follows (in thousands):



July 1, 2016 through December 31, 2016	$	139,471
2017	268,045
2018	249,589
2019	222,332
2020	187,279
Thereafter	568,680
	$	1,635,396

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

As of June 30, 2016, the Company’s real estate properties were leased to approximately 900 tenants over a diverse range of industries and geographic areas. The Company’s highest tenant industry concentration (greater than 10% of annualized base rent) was as follows:



Industry	Number of Tenants	Annualized Base Rent (1) (in thousands)		Percentage of Annualized Base Rent
Finance	168	$	62,663	21.5	%

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of June 30, 2016, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

As of June 30, 2016, no other tenant industries accounted for more than 10% of annualized base rent and no tenant accounted for more than 10% of annualized base rent. No material tenant credit issues have been identified at this time.

Geographic Concentration Risk

As of June 30, 2016, the Company’s net investments in real estate in California, Texas and Illinois represented 21%, 16% and 12% 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, Texas and Illinois 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.

Recent Acquisition

Carillon

On January 15, 2016, the Company, through an indirect wholly owned subsidiary (the “Carillon Buyer”), acquired an office property containing 476,308 rentable square feet located on approximately 1.8 acres of land in Charlotte, North Carolina (“Carillon”). The purchase price (net of closing credits) of Carillon was $146.1 million plus closing costs. The seller was not affiliated with the Company or the Advisor. The Company allocated the purchase price of this property to the fair value of the assets acquired and liabilities assumed. The Company allocated $19.1 million to land, $120.7 million to building and improvements, $10.0 million to tenant origination and absorption costs and $3.7 million to below-market lease liabilities during the six months ended June 30, 2016. The intangible assets and liabilities acquired in connection with this acquisition have weighted-average amortization periods as of the date of acquisition of 6.3 years for tenant origination and absorption costs and 7.6 years for below-market lease liabilities.

The Company recorded the acquisition as a business combination and expensed $1.8 million of acquisition costs related to this property for the six months ended June 30, 2016. During the six months ended June 30, 2016, the Company recognized $6.8 million of total revenues and $2.9 million of operating expenses from this property.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


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

As of June 30, 2016 and December 31, 2015, the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities (excluding fully amortized assets and liabilities and accumulated amortization) were as follows (in thousands):



	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	June 30, 2016			December 31, 2015			June 30, 2016			December 31, 2015			June 30, 2016			December 31, 2015
Cost	$	276,741		$	273,758		$	15,486		$	15,573		$	(57,501	)	$	(56,996	)
Accumulated Amortization	(88,770		)	(71,836		)	(5,969		)	(4,596		)	18,709			15,296
Net Amount	$	187,971		$	201,922		$	9,517		$	10,977		$	(38,792	)	$	(41,700	)

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 six months ended June 30, 2016 and 2015 were as follows (in thousands):



	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	For the Three Months Ended June 30,						For the Three Months Ended June 30,						For the Three Months Ended June 30,
	2016			2015			2016			2015			2016		2015
Amortization	$	(12,162	)	$	(10,985	)	$	(788	)	$	(1,049	)	$	3,738	$	2,532



	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	For the Six Months Ended June 30,						For the Six Months Ended June 30,						For the Six Months Ended June 30,
	2016			2015			2016			2015			2016		2015
Amortization	$	(23,892	)	$	(21,095	)	$	(1,468	)	$	(2,112	)	$	6,581	$	5,027

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


5.	REAL ESTATE LOAN RECEIVABLE

As of June 30, 2016 and December 31, 2015, the Company, through an indirect wholly owned subsidiary, had originated one real estate loan receivable as follows (dollars in thousands):

Loan Name

Location of Related Property or Collateral

Date Originated

Property Type

Loan Type

Outstanding Principal Balance as of June 30,

2016 ⁽¹⁾

Book Value

as of

June 30,

2016 ⁽²⁾

Book Value

as of

December 31,

2015 ⁽²⁾

Contractual Interest

Rate ⁽³⁾

Annualized Effective Interest

Rate ⁽³⁾

Maturity Date

Aberdeen First Mortgage Origination

Dallas, Texas

06/24/2011

Office

Mortgage

22,440

21,997

7.5%

07/01/2016

⁽⁴⁾

_____________________

⁽¹⁾Outstanding principal balance as of June 30, 2016 represents original principal balance outstanding under the loan, increased for any subsequent fundings and reduced for any principal paydowns.

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

⁽³⁾Contractual interest rate is the stated interest rate on the face of the loan. Annualized effective interest rate is calculated as the actual interest income recognized in 2016, using the interest method, annualized and divided by the average amortized cost basis of the investment during 2016. The contractual interest rate and annualized effective interest rate presented are as of June 30, 2016.

⁽⁴⁾On July 1, 2016, the borrower under the Aberdeen First Mortgage Origination paid off the entire principal balance outstanding due to the Company. See Note 11, “Subsequent Events — Real Estate Loan Receivable Payoff.”

The following summarizes the activity related to the real estate loan receivable for the six months ended June 30, 2016 (in thousands):



Real estate loan receivable - December 31, 2015	$	21,997
Advances on real estate loan receivable	544
Principal repayments received on real estate loan receivable	(86		)
Amortization of closing costs and origination fees on originated real estate loan receivable	(15		)
Real estate loan receivable - June 30, 2016	$	22,440

For the three and six months ended June 30, 2016 and 2015, interest income from the real estate loan receivable consisted of the following (in thousands):



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Contractual interest income	$	424		$	408		$	841		$	796
Amortization of closing costs and origination fees	(7		)	(6		)	(15		)	(13		)
Interest income from real estate loan receivable	$	417		$	402		$	826		$	783

As of June 30, 2016, the borrower under the Aberdeen First Mortgage Origination was current on its payments.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


6.	NOTES PAYABLE

As of June 30, 2016 and December 31, 2015, the Company’s notes payable consisted of the following (dollars in thousands):



	Book Value as of June 30, 2016			Book Value as of December 31, 2015			Contractual Interest Rate as of June 30, 2016⁽¹⁾	Effective Interest Rate as of June 30, 2016 ⁽¹⁾	Payment Type	Maturity Date ⁽²⁾
Town Center Mortgage Loan	$	75,000		$	75,000		One-month LIBOR + 1.85%	2.87%	Interest Only	03/27/2018
Portfolio Loan ⁽⁴⁾	127,500			127,500			One-month LIBOR + 1.90%	2.36%	Interest Only	06/01/2019
RBC Plaza Mortgage Loan	75,930			75,930			One-month LIBOR + 1.80%	2.56%	Interest Only	02/01/2017
National Office Portfolio Mortgage Loan ⁽⁵⁾	169,191			169,191			One-month LIBOR + 1.50%	2.79%	Interest Only	07/01/2017
500 West Madison Mortgage Loan ⁽⁶⁾	215,000			215,000			One-month LIBOR + 1.65%	3.16%	Interest Only	12/16/2018
222 Main Mortgage Loan	102,252			102,700			3.97%	3.97%	Principal & Interest⁽³⁾	03/01/2021
Anchor Centre Mortgage Loan	50,000			50,000			One-month LIBOR + 1.50%	3.18%	Interest Only	06/01/2017
171 17th Street Mortgage Loan	80,992			80,992			One-month LIBOR + 1.45%	2.71%	Interest Only⁽³⁾	09/01/2018
Reston Square Mortgage Loan	23,840			23,840			One-month LIBOR + 1.50%	1.96%	Interest Only	02/01/2018
Ten Almaden Mortgage Loan	65,059			63,540			One-month LIBOR + 1.65%	2.11%	Interest Only	01/01/2018
Towers at Emeryville Mortgage Loan ⁽⁷⁾	145,379			143,944			One-month LIBOR + 1.75%	2.21%	Interest Only	01/15/2018
101 South Hanley Mortgage Loan	35,025			35,025			One-month LIBOR + 1.55%	2.01%	Interest Only⁽³⁾	01/01/2020
3003 Washington Boulevard Mortgage Loan	90,378			90,378			One-month LIBOR + 1.55%	2.00%	Interest Only	02/01/2020
Rocklin Corporate Center Mortgage Loan	19,889			19,889			One-month LIBOR + 1.50%	1.95%	Interest Only	06/05/2018
201 17th Street Mortgage Loan	48,563			48,563			One-month LIBOR + 1.40%	1.86%	Interest Only	08/01/2018
CrossPoint at Valley Forge Mortgage Loan	51,000			51,000			One-month LIBOR + 1.50%	3.33%	Interest Only⁽³⁾	09/01/2022
The Almaden Mortgage Loan	76,100			76,100			One-month LIBOR + 1.75%	2.21%	Interest Only	10/01/2016
Promenade I & II at Eilan Mortgage Loan	37,300			37,300			One-month LIBOR + 1.75%	2.21%	Interest Only	10/01/2022
515 Congress Mortgage Loan	67,500			67,500			One-month LIBOR + 1.70%	2.16%	Interest Only	11/01/2020
201 Spear Street Mortgage Loan	100,000			100,000			One-month LIBOR + 1.66%	2.12%	Interest Only	01/01/2019
Carillon Mortgage Loan	76,440			—			One-month LIBOR + 1.65%	2.11%	Interest Only	02/01/2020
3001 Washington Boulevard Mortgage Loan	24,000			—			One-month LIBOR + 1.60%	2.06%	Interest Only	02/01/2019
Total notes payable principal outstanding	1,756,338			1,653,392
Deferred financing costs, net	(11,580		)	(12,738		)
Total Notes Payable, net	$	1,744,758		$	1,640,654

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

_____________________

⁽¹⁾ Contractual interest rate represents the interest rate in effect under the loan as of June 30, 2016. Effective interest rate is calculated as the actual interest rate in effect as of June 30, 2016 (consisting of the contractual interest rate and the effect of interest rate swaps, if applicable), using interest rate indices as of June 30, 2016, where applicable. For further information regarding the Company's derivative instruments, see Note 7, “Derivative Instruments.”

⁽²⁾ Represents the maturity date as of June 30, 2016; subject to certain conditions, the maturity dates of certain loans may be extended beyond the dates shown.

⁽³⁾ Represents the payment type required under the loan as of June 30, 2016. Certain future monthly payments due under these loans also include amortizing principal payments. For more information of the Company’s contractual obligations under its notes payable, see five-year maturity table below.

⁽⁴⁾ As of June 30, 2016, the Portfolio Loan was secured by Domain Gateway, the McEwen Building, Gateway Tech Center, the Tower on Lake Carolyn, Park Place Village and Village Center Station. The face amount of the Portfolio Loan is $255.0 million, of which $127.5 million is term debt and $127.5 million is revolving debt. As of June 30, 2016, the outstanding balance under the loan was $127.5 million of term debt. As of June 30, 2016, an additional $126.5 million of revolving debt remained available for immediate future disbursements, subject to certain conditions set forth in the loan agreement. The remaining $1.0 million of revolving debt is available for future disbursements upon the Company meeting certain financial coverage ratios and subject to certain conditions set forth in the loan agreement. During the remaining term of the Portfolio Loan, the Company has an option, which may be exercised up to two times, to increase the loan amount to a maximum of $350.0 million, of which 50% would be term debt and 50% would be revolving debt, with the addition of one or more properties to secure the Portfolio Loan, subject to certain conditions contained in the loan documents.

⁽⁵⁾ The National Office Portfolio Mortgage Loan is secured by One Washingtonian Center, Preston Commons and Sterling Plaza.

⁽⁶⁾As of June 30, 2016, $215.0 million of term debt was outstanding and $40.0 million remained available for future disbursements, subject to certain terms and conditions contained in the loan documents.

⁽⁷⁾As of June 30, 2016, $145.4 million had been disbursed to the Company and $29.6 million remained available for future disbursements, subject to certain conditions set forth in the loan documents.

As of June 30, 2016, the Company’s deferred financing costs were $11.6 million, net of amortization, and were included in notes payable, net on the accompanying consolidated balance sheets. As of December 31, 2015, the Company’s deferred financing costs were $12.8 million, net of amortization, of which $12.7 million is included in notes payable, net and $0.1 million is included in prepaid expenses and other assets on the accompanying consolidated balance sheets.

During the three and six months ended June 30, 2016, the Company incurred $18.6 million and $43.9 million of interest expense, respectively. During the three and six months ended June 30, 2015, the Company incurred $7.6 million and $20.1 million of interest expense, respectively. As of June 30, 2016 and December 31, 2015, $3.8 million and $3.4 million of interest expense were payable, respectively. Included in interest expense for the three and six months ended June 30, 2016 was $1.3 million and $2.5 million of amortization of deferred financing costs, respectively. Included in interest expense for the three and six months ended June 30, 2015 was $0.8 million and $1.7 million of amortization of deferred financing costs, respectively. Interest expense incurred as a result of the Company’s derivative instruments for the three and six months ended June 30, 2016 was $7.4 million and $21.8 million, respectively. Interest expense incurred as a result of the Company’s derivative instruments for the three and six months ended June 30, 2015 was $0.2 million and $5.4 million, respectively.

The following is a schedule of maturities, including principal amortization payments, for all notes payable outstanding as of June 30, 2016 (in thousands):



July 1, 2016 through December 31, 2016	$	77,009
2017	296,994
2018	676,150
2019	254,081
2020	270,509
Thereafter	181,595
	$	1,756,338

The Company’s notes payable contain financial debt covenants. As of June 30, 2016, the Company was in compliance with these debt covenants.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


7.	DERIVATIVE INSTRUMENTS

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

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

The Company enters into interest rate caps to mitigate its exposure to rising interest rates on its variable rate notes payable. The values of interest rate caps are primarily impacted by interest rates, market expectations about interest rates, and the remaining life of the instrument. In general, increases in interest rates, or anticipated increases in interest rates, will increase the value of interest rate caps. As the remaining life of an interest rate cap decreases, the value of the instrument will generally decrease towards zero.

The following table summarizes the notional amount and other information related to the Company’s interest rate swaps and cap as of June 30, 2016 and December 31, 2015. The notional amount is an indication of the extent of the Company’s involvement in each instrument at that time, but does not represent exposure to credit, interest rate or market risks (dollars in thousands):



	June 30, 2016			December 31, 2015				Weighted-Average Fix Pay Rate	Weighted-Average Remaining Term in Years
Derivative Instruments	Number of Instruments	Notional Amount		Number of Instruments	Notional Amount		Reference Rate as of June 30, 2016	Weighted-Average Fix Pay Rate	Weighted-Average Remaining Term in Years
Derivative instruments designated as hedging instruments
Interest Rate Swaps	7	$	625,130	7	$	625,130	One-month LIBOR/ Fixed at 0.79% - 1.68%	1.35%	2.0

Derivative instruments not designated as hedging instruments
Interest Rate Swaps ⁽¹⁾	12	$	658,183	10	$	557,743	One-month LIBOR/ Fixed at 1.39% - 2.37%	1.99%	3.7
Interest Rate Cap ⁽²⁾	1	$	353,380	1	$	353,380	One-month LIBOR at 2.46%	2.46%	0.5

_____________________

⁽¹⁾ Included in these amounts are 11 forward interest rate swaps with an aggregate notional amount of $607.2 million that were not yet in effect as of June 30, 2016. These 11 interest rate swaps will become effective at various times during the remainder of 2016 through 2018.

⁽²⁾On January 7, 2015, the Company entered into an interest rate cap with an unaffiliated LIBOR cap provider, for a notional amount of $353.4 million, effective from January 7, 2015 to June 30, 2016. The notional amount on the interest rate cap is reduced to $147.3 million from July 1, 2016 to January 1, 2017.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

The following table sets forth the fair value of the Company’s derivative instruments as well as their classification on the consolidated balance sheets as of June 30, 2016 and December 31, 2015 (dollars in thousands):



		June 30, 2016				December 31, 2015
Derivative Instruments	Balance Sheet Location	Number of Instruments	Fair Value			Number of Instruments	Fair Value
Derivative instruments designated as hedging instruments
Interest Rate Swaps	Prepaid expenses and other assets, at fair value	—	$	—		1	$	75
Interest Rate Swaps	Other liabilities, at fair value	7	$	(9,819	)	6	$	(4,304	)

Derivative instruments not designated as hedging instruments
Interest Rate Swaps	Other liabilities, at fair value	12	$	(25,955	)	10	$	(7,400	)
Interest Rate Cap	Prepaid expenses and other assets, at fair value	1	$	—		1	$	3

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



	For the Three Months Ended June 30,					For the Six Months Ended June 30,
	2016		2015			2016		2015
Income statement related
Derivatives designated as hedging instruments
Amount of expense recognized on interest rate swaps (effective portion)	$	1,430	$	1,716		$	2,889	$	3,367
	1,430		1,716			2,889		3,367

Derivatives not designated as hedging instruments
Realized loss recognized on interest rate swaps	178		—			358		—
Unrealized loss (gain) on interest rate swaps	5,813		(1,534		)	18,555		1,843
Unrealized loss on interest rate cap	—		29			3		153
	5,991		(1,505		)	18,916		1,996
Increase in interest expense as a result of derivatives	$	7,421	$	211		$	21,805	$	5,363

Other comprehensive income related
Unrealized losses on derivative instruments	$	2,173	$	44		$	8,479	$	6,353

During the three and six months ended June 30, 2016 and 2015, there was no ineffective portion related to the change in fair value of the derivative instruments designated as cash flow hedges. During the next 12 months, the Company expects to recognize additional interest expense related to derivative instruments designated as cash flow hedges. The present value of the additional interest expense expected to be recognized over the next 12 months related to derivative instruments designated as cash flow hedges totaled $5.3 million as of June 30, 2016 and was included in accumulated other comprehensive income (loss).

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


8.	FAIR VALUE DISCLOSURES

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


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


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


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

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

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

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

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

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

Notes payable: The fair values of the Company’s notes payable are 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 a liability in circumstances in which a quoted price in an active market for an identical liability is not available, the Company measures fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach. The Company classifies these inputs as Level 3 inputs.

The following were the face values, carrying amounts and fair values of the Company’s real estate loan receivable and notes payable as of June 30, 2016 and December 31, 2015, which carrying amounts generally do not approximate the fair values (in thousands):



	June 30, 2016						December 31, 2015
	Face Value		Carrying Amount		Fair Value		Face Value		Carrying Amount		Fair Value
Financial assets:
Real estate loan receivable	$	22,440	$	22,440	$	22,440	$	21,982	$	21,997	$	21,884
Financial liabilities:
Notes payable	$	1,756,338	$	1,744,758	$	1,746,858	$	1,653,392	$	1,640,654	$	1,654,788

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.

As of June 30, 2016, the Company measured the following liabilities at fair value (in thousands):



				Fair Value Measurements Using
	Total			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Recurring Basis:
Liability derivatives - interest rate swaps	$	(35,774	)	$	—	$	(35,774	)	$	—

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


9.	RELATED PARTY TRANSACTIONS

The Company has entered into the Advisory Agreement with the Advisor and the Dealer Manager Agreement with the Dealer Manager. These agreements entitled the Advisor and the Dealer Manager to specified fees upon the provision of certain services with regard to the Offering and entitle the Advisor to specified fees upon the provision of certain services with regard to the investment of funds in real estate investments, the management of those investments, among other services, and the disposition of investments, as well as entitle the Advisor and the Dealer Manager to reimbursement of organization and offering costs incurred by the Advisor and the Dealer Manager on behalf of the Company, such as expenses related to the Offering and dividend reinvestment plan, and 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 DTCC Alternative Investment Product Platform with respect to certain accounts of the Company’s investors serviced through the platform. The Advisor and Dealer Manager also serve as the advisor and dealer manager, respectively, for KBS Real Estate Investment Trust, Inc., KBS Real Estate Investment Trust II, Inc., KBS Strategic Opportunity REIT, Inc., KBS Legacy Partners Apartment REIT, Inc., KBS Strategic Opportunity REIT II, Inc. and KBS Growth & Income REIT, Inc.

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

During the three and six months ended June 30, 2016 and 2015, no other business transactions occurred between the Company and KBS Real Estate Investment Trust, Inc., KBS Real Estate Investment Trust II, Inc., KBS Strategic Opportunity REIT, Inc., KBS Legacy Partners Apartment REIT, Inc., KBS Strategic Opportunity REIT II, Inc. and KBS Growth & Income REIT, Inc.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

Pursuant to the terms of these agreements, summarized below are the related-party costs incurred by the Company for the three and six months ended June 30, 2016 and 2015, respectively, and any related amounts payable as of June 30, 2016 and December 31, 2015 (in thousands):



	Incurred				Incurred				Payable as of
	Three Months Ended June 30,				Six Months Ended June 30,				June 30,		December 31,
	2016		2015		2016		2015		2016		2015
Expensed
Asset management fees ⁽¹⁾	$	6,217	$	4,497	$	12,360	$	8,814	$	3,705	$	10,075
Reimbursement of operating expenses ⁽²⁾	142		40		193		79		163		144
Real estate acquisition fees	—		3,019		1,473		3,019		—		—
Additional Paid-in Capital
Selling commissions	—		15,329		—		32,413		—		—
Dealer manager fees	—		7,284		—		15,359		—		—
Reimbursable other offering costs	—		934		—		1,837		—		—
Capitalized
Acquisition fee on development project	34		—		59		—		59		—
	$	6,393	$	31,103	$	14,085	$	61,521	$	3,927	$	10,219

_____________________

⁽¹⁾As of June 30, 2016, the Company had accrued and deferred payment of $3.7 million of asset management fees. See “Deferral of Asset Management Fees” below.

⁽²⁾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 $42,000 and $93,000 for the three and six months ended June 30, 2016, respectively, and $35,000 and $69,000 for the three and six months ended June 30, 2015, respectively, and were the only type of employee costs reimbursed under the Advisory Agreement for the three and six months ended June 30, 2016 and 2015, respectively. The Company will not reimburse for employee costs in connection with services for which the Advisor earns acquisition or origination fees 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.

During the three and six months ended June 30, 2016, the Advisor reimbursed the Company $0.2 million for property insurance rebate and $0.1 million for legal and professional fees.

In connection with the Offering, the Company’s sponsors agreed to provide additional indemnification to one of the participating broker-dealers. The Company agreed to add supplemental coverage to its directors’ and officers’ insurance coverage to insure the sponsors’ obligations under this indemnification agreement in exchange for reimbursement by the sponsors to the Company for all costs, expenses and premiums related to this supplemental coverage. During the six months ended June 30, 2016, the Advisor incurred $0.1 million for the costs of the supplemental coverage obtained by the Company. During the six months ended June 30, 2015, the Advisor incurred $0.1 million for the costs of the supplemental coverage obtained by the Company.

Deferral of Asset Management Fees

Pursuant to the Advisory Agreement, with respect to asset management fees accruing from March 1, 2014, the Advisor has agreed to defer, without interest, the Company’s obligation to pay asset management fees for any month in which the Company’s modified funds from operations (“MFFO”) for such month, as such term is defined in the practice guideline issued by the Investment Program Association (“IPA”) in November 2010 and interpreted by the Company, excluding asset management fees, does not exceed the amount of distributions declared by the Company for record dates of that month. The Company remains obligated to pay the Advisor an asset management fee in any month in which the Company’s MFFO, excluding asset management fees, for such month exceeds the amount of distributions declared for the record dates of that month (such excess amount, an “MFFO Surplus”); however, any amount of such asset management fee in excess of the MFFO Surplus will also be deferred under the Advisory Agreement. If the MFFO Surplus for any month exceeds the amount of the asset management fee payable for such month, any remaining MFFO Surplus will be applied to pay any asset management fee amounts previously deferred in accordance with the Advisory Agreement.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)

However, notwithstanding the foregoing, any and all deferred asset management fees that are unpaid will become immediately due and payable at such time as the Company's stockholders have received, together as a collective group, aggregate distributions (including distributions that may constitute a return of capital for federal income tax purposes) sufficient to provide (i) an 8.0% per year cumulative, noncompounded return on such net invested capital (the “Stockholders’ 8% Return”) and (ii) a return of their net invested capital, or the amount calculated by multiplying the total number of shares purchased by stockholders by the issue price, reduced by any amounts to repurchase shares pursuant to the Company's share redemption program. The Stockholders’ 8% Return is not based on the return provided to any individual stockholder. Accordingly, it is not necessary for each of the Company's stockholders to have received any minimum return in order for the Advisor to receive deferred asset management fees.

As of June 30, 2016, the Company had accrued and deferred payment of $3.7 million of asset management fees under the Advisory Agreement, as the Company believes the payment of this amount to the Advisor is probable. These fees will be reimbursed in accordance with the terms noted above. During the six months ended June 30, 2016, the Company reimbursed $6.4 million of accrued and deferred asset management fees to the Advisor.

Lease to Affiliate

On May 29, 2015, the indirect wholly owned subsidiary of the Company that owns 3003 Washington Boulevard entered into a lease with an affiliate of the Advisor for 5,046 rentable square feet, or approximately 2.4% of the total rentable square feet, at 3003 Washington Boulevard. The lease commenced on October 1, 2015 and terminates on August 31, 2019. The annualized base rent, which represents annualized contractual base rental income as of June 30, 2016, adjusted to straight-line any contractual tenant concessions (including free rent) and rent increases from the lease’s inception through the balance of the lease term, for this lease is approximately $234,000, and the average annual rental rate (net of rental abatements) over the lease term is $46.38 per square foot. During the three and six months ended June 30, 2016, the Company recognized $59,000 and $117,000 of rental income related to this lease, respectively.

Prior to their approval of the lease, the Company’s conflicts committee and board of directors determined the lease to be fair and reasonable to the Company.


10.	COMMITMENTS AND CONTINGENCIES

Economic Dependency

The Company is dependent on the Advisor for certain services that are essential to the Company, including the identification, evaluation, negotiation, origination, acquisition and disposition of investments; management of the daily operations of the Company’s investment portfolio; and other general and administrative responsibilities. In the event that the Advisor is unable to provide the respective services, the Company will be required to obtain such services from other sources.

Legal Matters

From time to time, the Company may be 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.

Environmental

As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. Compliance with existing environmental laws is not expected to have a material adverse effect on the Company’s financial condition and results of operations as of June 30, 2016.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2016

(unaudited)


11.	SUBSEQUENT EVENTS

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

Distributions Paid

On July 1, 2016, the Company paid distributions of $9.6 million, which related to distributions declared for daily record dates for each day in the period from June 1, 2016 through June 30, 2016. On August 1, 2016, the Company paid distributions of $10.0 million, which related to distributions declared for daily record dates for each day in the period from July 1, 2016 through July 31, 2016.

Distributions Declared

On July 7, 2016, the Company’s board of directors declared distributions based on daily record dates for the period from August 1, 2016 through August 31, 2016, which the Company expects to pay in September 2016. On August 9, 2016, the Company’s board of directors declared distributions based on daily record dates for the period from September 1, 2016 through September 30, 2016, which the Company expects to pay in October 2016, and distributions based on daily record dates for the period from October 1, 2016 through October 31, 2016, which the Company expects to pay in November 2016. Investors may choose to receive cash distributions or purchase additional shares through the Company’s dividend reinvestment plan.

Distributions for these periods will be calculated based on stockholders of record each day during these periods at a rate of $0.00178082 per share per day and equal a daily amount that, if paid each day for a 365-day period, would equal a 6.47% annualized rate based on the Company's December 8, 2015 estimated value per share of $10.04.

Real Estate Loan Receivable Payoff

On July 1, 2016, the borrower under the Aberdeen First Mortgage Origination paid off the entire principal balance outstanding of $22.4 million and accrued interest of $0.1 million. The Aberdeen First Mortgage Origination had an original maturity date of July 1, 2016. The Aberdeen First Mortgage bore interest at a fixed rate of 7.5%.

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 III, Inc. and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to KBS Real Estate Investment Trust III, Inc., a Maryland corporation, and, as required by context, KBS Limited Partnership III, 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 III, 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:


•	We commenced investment operations on June 24, 2011 in connection with our first investment and we have a limited operating history. We are dependent on KBS Capital Advisors LLC (“KBS Capital Advisors”), our advisor, to identify suitable investments and to manage our investments.

•

All of our executive officers, our affiliated directors and other key real estate and debt finance professionals are also officers, affiliated directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, our dealer manager and/or other KBS-affiliated entities. As a result, our executive officers, our affiliated directors, some of our key real estate and debt finance professionals, our advisor and its affiliates face conflicts of interest, including significant conflicts created by our advisor’s and its affiliates’ 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. Furthermore, these individuals may become employees of another KBS-sponsored program in an internalization transaction or, if we internalize our advisor, may not become our employees as a result of their relationship with other KBS-sponsored programs. These conflicts could result in action or inaction that is not in the best interests of our stockholders.

•

Because investment opportunities that are suitable for us may also be suitable for other KBS-sponsored programs or KBS-advised investors, our advisor and its affiliates face conflicts of interest relating to the purchase of properties and other investments and such conflicts may not be resolved in our favor, meaning that we could invest in less attractive assets, which could reduce the investment return to our stockholders.

•

Our advisor and its affiliates receive fees in connection with transactions involving the purchase or origination and management of our investments. These fees are based on the cost of the investment, and not based on the quality of the investment or the quality of the services rendered to us. This may influence our advisor to recommend riskier transactions to us and increases our stockholders’ risk of loss. In addition, we have paid substantial fees to and expenses of our advisor, its affiliates and participating broker-dealers in connection with our now-terminated initial public offering, which payments increase the risk that our stockholders will not earn a profit on their investment. We may also pay significant fees during our listing/liquidation stage. Although most of the fees payable during our listing/liquidation stage are contingent on our stockholders first enjoying agreed-upon investment returns, the investment return thresholds may be reduced subject to approval by our conflicts committee and to other limitations in our charter.

•

Our charter permits us to pay distributions from any source, including offering proceeds or borrowings (which may constitute a return of capital), and our charter does not limit the amount of funds we may use from any source to pay such distributions. As of June 30, 2016, we had used a combination of cash flow from operations, proceeds from debt financing and proceeds from an advance from our advisor to fund distributions. From time to time during our operational stage, we expect to use proceeds from third party financings to fund at least a portion of distributions in anticipation of cash flow to be received in later periods. We may also fund such distributions from the sale of assets or from the maturity, payoff or settlement of debt investments. If we pay distributions from sources other than our cash flow from operations, we will have less funds available for investment in properties and other assets and the overall return to our stockholders may be reduced.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

•

We may incur debt until our total liabilities would exceed 75% of the cost of our tangible assets (before deducting depreciation or other non-cash reserves), and we may exceed this limit with the approval of the conflicts committee of our board of directors. To the extent financing in excess of this limit is available on attractive terms, our conflicts committee may approve debt such that our total liabilities would exceed this limit. High debt levels could limit the amount of cash we have available to distribute and could result in a decline in the value of an investment in us.

•

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

•

We cannot predict with any certainty how much, if any, of our dividend reinvestment plan proceeds will be available for general corporate purposes including, but not limited to: the repurchase of shares under our share redemption program; capital expenditures, tenant improvement costs and leasing costs related to our real estate properties; reserves required by any financings of our real estate investments; the acquisition or origination of real estate investments, which include payment of acquisition or origination fees to our advisor; and the repayment of debt. If such funds are not available from our dividend reinvestment plan offering, then we may have to use a greater proportion of our cash flow from operations to meet these cash requirements, which would reduce cash available for distributions and could limit our ability to redeem shares under our share redemption program.


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

•

Our charter does not require us to liquidate our assets and dissolve by a specified date, nor does our charter require our directors to list our shares for trading by a specified date. No public market currently exists for our shares of common stock, and we have no plans at this time to list our shares on a national securities exchange. Until our shares are listed, if ever, our stockholders may not sell their shares unless the buyer meets the applicable suitability and minimum purchase standards. Any sale must comply with applicable state and federal securities laws. In addition, our charter prohibits the ownership of more than 9.8% of our stock, unless exempted by our board of directors, which may inhibit large investors from purchasing our shares. Our shares cannot be readily sold and, if our stockholders are able to sell their shares, they would likely have to sell them at a substantial discount from the price our stockholders paid to acquire the shares and from our estimated value per share.

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

Overview

We were formed on December 22, 2009 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2011 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 pursuant to an advisory agreement and our advisor 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 have invested in a diverse portfolio of real estate investments. As of June 30, 2016, we owned 28 office properties, one mixed-use office/retail property and one first mortgage loan secured by a deed of trust. On July 1, 2016, the Aberdeen First Mortgage Origination was paid off.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

On February 4, 2010, we filed a registration statement on Form S-11 with the SEC to offer a minimum of 250,000 shares and a maximum of up to 280,000,000 shares, or up to $2,760,000,000 of shares, of common stock for sale to the public, of which up to 200,000,000 shares, or up to $2,000,000,000 of shares, were registered in our primary offering and up to 80,000,000 shares, or up to $760,000,000 of shares, were registered under our dividend reinvestment plan. We ceased offering shares of common stock in our primary offering on May 29, 2015 and terminated the primary offering on July 28, 2015 upon the completion of review of subscriptions submitted in accordance with our processing procedures. We sold 169,006,162 shares of common stock in our now-terminated primary initial public offering for gross offering proceeds of $1.7 billion. As of June 30, 2016, we had also sold 13,734,060 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $134.1 million. Also as of June 30, 2016, we had redeemed 3,099,295 shares sold in our initial public offering for $30.1 million.

Additionally, on October 3, 2014, we issued 258,462 shares of common stock, for $2.4 million, in private transactions exempt from the registration requirements pursuant to Section 4(2) of the Securities Act of 1933.

We continue to offer shares under our dividend reinvestment plan. In some states, we will need to renew the registration statement annually or file a new registration statement to continue the dividend reinvestment plan offering. We may terminate our dividend reinvestment plan offering at any time.

Market Outlook – Real Estate and Real Estate Finance Markets

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

Current conditions in the global capital markets remain volatile. Prior to the June 23, 2016 vote in the United Kingdom in favor of leaving the European Union, economic data and financial market developments suggested that the global economy was improving, although at a slow incremental rate. Growth in most advanced economies remained lackluster, with low potential growth and a gradual closing of output gaps. Prospects remained uneven across emerging markets and developing economies, with some improvement for a few large emerging markets, in particular Brazil and Russia, pointing to a modest upward revision to 2017 global growth relative to the International Monetary Fund’s April 2016 forecast.

The outcome of the U.K. vote, which surprised global financial markets, implies downside risk for the world economy. As a result, the International Monetary Fund recently downgraded the global outlook for 2016 and 2017, despite the better-than-expected performance in early 2016. This downgrade in outlook reflects the expected macroeconomic consequences of a sizable increase in uncertainty, including on the political front. This uncertainty is projected to take a toll on both business and consumer confidence and investment. The initial financial market reaction was severe but generally orderly. As of mid-July 2016, the Great Britain Pound was weakened by about 10 percent since the June 23, 2016 vote; despite some rebound, equity prices are lower in some sectors, especially for European banks; and yields on higher quality assets have declined. Historically low interest rates have been reached in many developed nations.

In the United States, economic growth has been relatively steady and modest. In the United States, first-quarter growth was 0.8%, which was weaker than expected, triggering a downward revision of 0.2% to the 2016 growth forecast. The high-frequency indicators point to a pick up in growth in the U.S. economy in the second quarter and for the remainder of the year, consistent with fading headwinds from a strong U.S. dollar and lower energy sector investment. The impact of Brexit is projected to be muted for the United States, as lower long-term interest rates and a more gradual path of monetary policy normalization in the United States are expected to broadly offset larger corporate spreads, a stronger U.S. dollar, and some decline in confidence in the U.S. economy.

The low interest rate policy of the Federal Reserve Board remains in place. While the U.S. Federal Reserve appeared ready to raise interest rates in in the second half of 2016, increased global geopolitical and economic risks seem to have muted those expectations until late 2016 or early 2017.

Europe and Japan continue to engage in unconventional monetary policy. Asset purchases and stimulus programs in both regions have driven interest rates and investment yields to new lows. Both regions now have historically low interest rates, with some government and corporate bonds trading with negative yields. While the intent of these policies is to spur economic growth, the size of these programs is unprecedented, and the ultimate impact on those economies and the broader global financial system remains unknown.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

With the backdrop of increasing levels of global political conflict, and weaker international economic conditions, the U.S. dollar has remained a safe haven currency. Slowing economic growth, poor corporate earnings and increased global geopolitical risks have caused the markets to discount the likelihood of substantial ongoing tightening of monetary policy. This, in turn, has kept the U.S. yield curve near all-time lows.

The U.S. commercial real estate market continues to benefit from inflows of foreign capital. In 2015, commercial real estate transaction volumes increased 23%, making 2015 the second highest level of investment volume, behind only 2007. However, in the first half of 2016, this trend appears to be slowing. Despite international equity capital continuing to flow into the U.S. markets, lenders have cooled to the market. For balance sheet lenders, such as banks and insurance companies, underwriting standards have been tightened. This has resulted in lower loan-to-value and coverage ratios. The lack of CMBS lending has added pressure to the situation as CMBS lenders are trying to adjust to the new securitization rules which require issuers to maintain an ongoing equity stake in pooled transactions. These trends have led to increased uncertainty in the level and cost of debt for commercial properties, and in turn has injected some volatility into commercial real estate markets.

Impact on Our Real Estate Properties

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

Impact on Our Financing Activities

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

As of June 30, 2016, we had debt obligations in the aggregate principal amount of $1.8 billion, with a weighted-average remaining term of 2.5 years. Our debt obligations consisted of $102.3 million of fixed rate notes payable and $1.7 billion of variable rate notes payable. As of June 30, 2016, the interest rates on $676.1 million of our variable rate notes payable are effectively fixed through interest rate swap agreements. In addition, we entered into 11 interest rate swaps with an aggregate notional amount of $607.2 million, which will become effective at various times during the remainder of 2016 through 2018. We also have an interest rate cap for a notional amount of $353.4 million, effective from January 7, 2015 to June 30, 2016. The notional amount on the interest rate cap is reduced to $147.3 million from July 1, 2016 to January 1, 2017.

Liquidity and Capital Resources

We sold 169,006,162 shares of common stock in our now-terminated primary initial public offering for gross offering proceeds of $1.7 billion. As of June 30, 2016, we had also sold 13,734,060 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $134.1 million. Also as of June 30, 2016, we had redeemed 3,099,295 shares sold in our initial public offering for $30.1 million. We ceased offering shares of common stock in our primary offering on May 29, 2015 and terminated our primary offering on July 28, 2015.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

We have invested all of the proceeds from our now-terminated primary initial public offering, net of selling commissions and dealer manager fees and other organization and offering costs, and proceeds from debt financing in a diverse portfolio of real estate investments. To date, proceeds from our dividend reinvestment plan have been used primarily to fund redemptions of shares under our share redemption program and for capital expenditures on our real estate investments.

Our principal demands for funds during the short and long-term are and will be for the acquisition of additional real estate investments; operating expenses, capital expenditures and general and administrative expenses; payments under debt obligations; redemptions of common stock; and payments of distributions to stockholders. Our primary sources of capital for meeting our cash requirements are as follows:


•	Proceeds from common stock issued under our dividend reinvestment plan;


•	Debt financings (including amounts currently available under existing loan facilities); and


•	Cash flow generated by our real estate investments.

Our real estate properties generate cash flow in the form of rental revenues and tenant reimbursements, which are reduced by operating expenditures, capital expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from our real estate properties 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 June 30, 2016, we owned 28 office properties and one mixed-use office/retail property that were collectively 93% occupied.

As of June 30, 2016, we had mortgage debt obligations in the aggregate principal amount of $1.8 billion, with a weighted-average remaining term of 2.5 years. As of June 30, 2016, we had $126.5 million of revolving debt available for immediate future disbursement under a portfolio loan, subject to certain conditions set forth in the loan agreement.

We made distributions to our stockholders during the six months ended June 30, 2016 using cash flow from operations from current and prior periods and debt financing. We believe that our cash flow from operations, cash on hand, proceeds from our dividend reinvestment plan, proceeds from the sale of real estate and current and anticipated financing activities are sufficient to meet our liquidity needs for the foreseeable future.

Under our charter, we are required to limit our total operating expenses to the greater of 2% of our average invested assets or 25% of our net income for the four most recently completed fiscal quarters, as these terms are defined in our charter, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. Operating expenses for the four fiscal quarters ended June 30, 2016 did not exceed the charter-imposed limitation.

Cash Flows from Operating Activities

We commenced operations in connection with our first investment on June 24, 2011. As of June 30, 2016, we owned 28 office properties, one mixed-use office/retail property and one real estate loan receivable. During the six months ended June 30, 2016, net cash provided by operating activities was $45.6 million, compared to net cash provided by operating activities of $43.1 million during the six months ended June 30, 2015. Net cash provided by operating activities increased in 2016 primarily as a result of growth in our real estate portfolio.

Cash Flows from Investing Activities

Net cash used in investing activities was $171.8 million for the six months ended June 30, 2016 and primarily consisted of the following:


•	$141.8 million for the acquisition of one real estate property;


•	$29.6 million of improvements to real estate; and


•	$0.5 million of advances on our real estate loan receivable.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Cash Flows from Financing Activities

Our cash flows from financing activities consist primarily of debt financings and distributions paid to our stockholders. During the six months ended June 30, 2016, net cash provided by financing activities was $62.4 million and primarily consisted of the following:


•	$101.6 million of net cash provided by debt financing as a result of proceeds from notes payable of $134.4 million, partially offset by principal payments on notes payable of $31.5 million and payments of deferred financing costs of $1.3 million;


•	$27.1 million of net cash distributions, after giving effect to distributions reinvested by stockholders of $31.0 million; and


•	$12.3 million of cash used for redemptions of common stock.

We expect that our debt financing and other liabilities will be between 35% and 65% of the cost of our tangible assets (before deducting depreciation or other non-cash reserves). We expect our debt financing related to the acquisition of core real estate properties to be between 45% and 65% of the aggregate cost of all such assets. We expect our debt financing related to the acquisition or origination of real estate-related investments to be between 0% and 65% of the aggregate cost of all such assets, depending upon the availability of such financings in the marketplace. Though this is our target leverage, we do not limit our leverage until our total liabilities would exceed 75% of the cost of our tangible assets (before deducting depreciation or other non-cash reserves), and we may exceed this limit with the approval of the conflicts committee of our board of directors. To the extent financing in excess of this limit is available on attractive terms, our conflicts committee may approve debt in excess of this limit. As of June 30, 2016, our borrowings and other liabilities were approximately 54% of both the cost (before deducting depreciation or other noncash reserves) and book value (before deducting depreciation) of our tangible assets, respectively.

In addition to making investments in accordance with our investment objectives, we expect to use our capital resources to make certain payments to our advisor and we have made certain payments to our dealer manager. During our acquisition and development stage, we expect to make payments to our advisor in connection with the selection and acquisition or origination of investments, the management of our investments and costs incurred by our advisor in providing services to us. We also pay fees to our advisor in connection with the disposition of investments.

Among the fees payable to our advisor is an asset management fee. With respect to investments in real property, the asset management fee is a monthly 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 expenses related thereto (but excludes acquisition fees paid or payable to our advisor). In the case of investments made through joint ventures, the asset management fee will be determined based on our proportionate share of the underlying investment (but excluding acquisition fees paid to our advisor). With respect to investments in loans and any investments other than real property, the asset management fee is a monthly fee calculated, each month, as one-twelfth of 0.75% of the lesser of (i) the amount actually paid or allocated to acquire or fund the loan or other investment (which amount includes any portion of the investment that was debt financed and is inclusive of acquisition or origination expenses related thereto but is exclusive of acquisition or origination fees paid or payable to our advisor) and (ii) the outstanding principal amount of such loan or other investment, plus the acquisition or origination expenses related to the acquisition or funding of such investment (excluding acquisition or origination fees paid or payable to our advisor), as of the time of calculation.

Pursuant to the advisory agreement, with respect to asset management fees accruing from March 1, 2014, our advisor agreed to defer, without interest, our obligation to pay asset management fees for any month in which our modified funds from operations (“MFFO”) for such month, as such term is defined in the practice guideline issued by the Investment Program Association (“IPA”) in November 2010 and interpreted by us, excluding asset management fees, does not exceed the amount of distributions declared by us for record dates of that month. We remain obligated to pay our advisor an asset management fee in any month in which our MFFO, excluding asset management fees, for such month exceeds the amount of distributions declared for the record dates of that month (such excess amount, an “MFFO Surplus”); however, any amount of such asset management fee in excess of the MFFO Surplus will also be deferred under the advisory agreement. If the MFFO Surplus for any month exceeds the amount of the asset management fee payable for such month, any remaining MFFO Surplus will be applied to pay any asset management fee amounts previously deferred in accordance with the advisory agreement.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

As of June 30, 2016, we had accrued and deferred payment of $3.7 million of asset management fees under the advisory agreement, as we believe the payment of this amount to our advisor is probable. These fees will be reimbursed in accordance with the terms noted above. The amount of asset management fees deferred will vary on a month-to-month basis and the total amount of asset management fees deferred as well as the timing of the deferrals and repayments are difficult to predict as they will depend on the amount of and terms of the debt we use to acquire assets, the level of operating cash flow generated by future acquisitions, and the performance of all of the real estate investments in our portfolio and other factors. In addition, deferrals and repayments may occur in the same period, and it is possible that there could be additional deferrals even after the initial deferrals are fully repaid.

However, notwithstanding the foregoing, any and all deferred asset management fees that are unpaid will become immediately due and payable at such time as our stockholders have received, together as a collective group, aggregate distributions (including distributions that may constitute a return of capital for federal income tax purposes) sufficient to provide (i) an 8.0% per year cumulative, noncompounded return on net invested capital (the “Stockholders’ 8% Return”) and (ii) a return of their net invested capital, or the amount calculated by multiplying the total number of shares purchased by stockholders by the issue price, reduced by any amounts to repurchase shares pursuant to our share redemption program. The Stockholders’ 8% Return is not based on the return provided to any individual stockholder. Accordingly, it is not necessary for each of our stockholders to have received any minimum return in order for our advisor to receive deferred asset management fees.

On September 27, 2015, we and our advisor renewed the advisory agreement. The advisory agreement has a one-year term but may be renewed for an unlimited number of successive one-year periods upon the mutual consent of our advisor and our conflicts committee.

Contractual Commitments and Contingencies

The following is a summary of our contractual obligations as of June 30, 2016 (in thousands):



			Payments Due During the Years Ended December 31,
Contractual Obligations	Total		Remainder of 2016		2017-2018		2019-2020		Thereafter
Outstanding debt obligations ⁽¹⁾	$	1,756,338	$	77,009	$	973,144	$	524,590	$	181,595
Interest payments on outstanding debt obligations ⁽²⁾	113,504		22,177		65,391		21,042		4,894

_____________________

⁽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 June 30, 2016 (consisting of the contractual interest rate and the effect of interest rate swaps, if applicable). We incurred interest expense of $22.8 million, excluding amortization of deferred financing costs totaling $2.5 million and unrealized losses on derivatives of $18.6 million, during the six months ended June 30, 2016.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Results of Operations

Overview

As of June 30, 2015, we owned 22 office properties, one mixed-use office/retail property and one real estate loan receivable. As of June 30, 2016, we owned 28 office properties, one mixed-use office/retail property and one real estate loan receivable. Subsequent to June 30, 2016, the Aberdeen First Mortgage Origination was paid off. In general, we expect that our income and expenses related to our portfolio will increase in future periods as a result of owning the real estate investment acquired in 2016 for an entire period. As a result, the results of operations presented for the six months ended June 30, 2016 and 2015 are not directly comparable due to our acquisition activity.

Comparison of the three months ended June 30, 2016 versus the three months ended June 30, 2015

The following table provides summary information about our results of operations for the three months ended June 30, 2016 and 2015 (dollar amounts in thousands):



	Three Months Ended June 30,				Increase (Decrease)			Percentage Change		$ Change Due to Acquisitions⁽¹⁾			$ Change Due to Properties or Loans Held Throughout Both Periods ⁽²⁾
	2016		2015		Increase (Decrease)			Percentage Change		$ Change Due to Acquisitions⁽¹⁾
Rental income	$	76,800	$	55,945	$	20,855		37	%	$	18,449		$	2,406
Tenant reimbursements	18,089		12,485		5,604			45	%	4,036			1,568
Interest income from real estate loan receivable	417		402		15			4	%	—			15
Other operating income	4,949		3,335		1,614			48	%	1,853			(239		)
Operating, maintenance and management costs	22,724		16,531		6,193			37	%	5,944			249
Real estate taxes and insurance	15,699		11,885		3,814			32	%	3,378			436
Asset management fees to affiliate	6,217		4,497		1,720			38	%	1,614			106
Real estate acquisition fees to affiliate	—		3,019		(3,019		)	(100	)%	(3,019		)	n/a
Real estate acquisition fees and expenses	12		1,048		(1,036		)	(99	)%	(1,036		)	n/a
General and administrative expenses	1,569		1,286		283			22	%	n/a			n/a
Depreciation and amortization	40,645		32,279		8,366			26	%	9,845			(1,479		)
Interest expense	18,550		7,636		10,914			143	%	n/a			n/a

_____________________

⁽¹⁾ Represents the dollar amount increase (decrease) for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 related to real estate investments acquired on or after April 1, 2015.

⁽²⁾ Represents the dollar amount increase (decrease) for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 with respect to real estate investments owned by us throughout both periods presented.

Rental income and tenant reimbursements from our real estate properties increased from $68.4 million for the three months ended June 30, 2015 to $94.9 million for the three months ended June 30, 2016 primarily as a result of the growth in our real estate portfolio. The increase of rental income and tenant reimbursements for the properties held throughout both periods was primarily due to an increase in occupancy and expense recoveries. We expect rental income and tenant reimbursements to vary in future periods depending on occupancy rates and rental rates of our real estate investments and acquisition activity.

Interest income from our real estate loan receivable, recognized using the interest method, remained consistent at $0.4 million for the three months ended June 30, 2015 and 2016. On July 1, 2016, the Aberdeen First Mortgage Origination was paid off.

Other operating income increased from $3.3 million during the three months ended June 30, 2015 to $4.9 million for the three months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. Other operating income primarily consisted of parking revenues. We expect other operating income to vary in future periods depending on occupancy rates and parking rates of our real estate investments and acquisition activity.

Operating, maintenance and management costs increased from $16.5 million for the three months ended June 30, 2015 to $22.7 million for the three months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. The increase in operating, maintenance and management costs for the properties held throughout both periods was primarily due to an increase in repairs and maintenance, association fees and management fees. Operating, maintenance and management costs may increase in future periods, as compared to historical periods, as a result of inflation and acquisition activity.

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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 increased from $11.9 million for the three months ended June 30, 2015 to $15.7 million for the three months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. The increase of real estate taxes and insurance for the properties held throughout both periods was primarily due to higher taxes as the assessed values have increased on several of our properties. We expect that real estate taxes and insurance will generally increase in future periods as a result of inflation, but may vary in future periods.

Asset management fees with respect to our real estate investments increased from $4.5 million for the three months ended June 30, 2015 to $6.2 million for the three months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. We expect asset management fees to vary in future periods as a result of acquisitions or dispositions or payoffs of real estate investments. As of June 30, 2016, there were $3.7 million of accrued and deferred asset management fees. For a discussion of accrued and deferred asset management fees, see “- Liquidity and Capital Resources - Cash Flows from Financing Activities” herein.

Real estate acquisition fees and expenses to affiliate and non-affiliates decreased from $4.1 million for the three months ended June 30, 2015 to $12,000 for the three months ended June 30, 2016. During the three months ended June 30, 2016, we did not acquire any real estate properties. During the three months ended June 30, 2015, we acquired three real estate properties for $290.0 million. We expect real estate acquisition fees and expenses to vary in future periods based upon acquisition activity.

Depreciation and amortization increased from $32.3 million for the three months ended June 30, 2015 to $40.6 million for the three months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. We expect depreciation and amortization to vary in future periods as a result of a decrease in amortization related to fully amortized tenant origination costs and acquisition activity.

Interest expense increased from $7.6 million for the three months ended June 30, 2015 to $18.6 million for the three months ended June 30, 2016. Included in interest expense is the amortization of deferred financing costs of $0.8 million and $1.3 million for the three months ended June 30, 2015 and 2016, respectively. Interest expense incurred as a result of our derivative instruments for the three months ended June 30, 2015 and 2016 was $0.2 million and $7.4 million, respectively, which includes $1.5 million of unrealized gains and $5.8 million of unrealized losses on derivative instruments for the three months ended June 30, 2015 and 2016, respectively. The increase in interest expense is primarily due to increased borrowings as a result of our use of additional debt in acquiring real estate properties in 2015 and 2016 and changes in value on interest rate swaps. We expect interest expense to vary in future periods depending on the advances and paydowns of our existing loans and acquisition activity. In addition, our interest expense in future periods will vary based on fair value changes with respect to our interest rate swaps that are not accounted for as cash flow hedges.

Comparison of the six months ended June 30, 2016 versus the six months ended June 30, 2015

The following table provides summary information about our results of operations for the six months ended June 30, 2016 and 2015 (dollar amounts in thousands):



	Six Months Ended June 30,				Increase (Decrease)			Percentage Change		$ Change Due to Acquisitions⁽¹⁾			$ Change Due to Properties or Loans Held Throughout Both Periods ⁽²⁾
	2016		2015		Increase (Decrease)			Percentage Change		$ Change Due to Acquisitions⁽¹⁾
Rental income	$	151,785	$	109,445	$	42,340		39	%	$	36,799		$	5,541
Tenant reimbursements	35,592		24,020		11,572			48	%	8,309			3,263
Interest income from real estate loan receivable	826		783		43			5	%	—			43
Other operating income	9,954		6,169		3,785			61	%	3,520			265
Operating, maintenance and management costs	44,619		31,751		12,868			41	%	11,648			1,220
Real estate taxes and insurance	31,316		23,047		8,269			36	%	6,913			1,356
Asset management fees to affiliate	12,360		8,814		3,546			40	%	3,277			269
Real estate acquisition fees to affiliate	1,473		3,019		(1,546		)	(51	)%	(1,546		)	n/a
Real estate acquisition fees and expenses	301		1,164		(863		)	(74	)%	(863		)	n/a
General and administrative expenses	2,826		2,284		542			24	%	n/a			n/a
Depreciation and amortization	80,109		61,947		18,162			29	%	19,929			(1,767		)
Interest expense	43,906		20,050		23,856			119	%	n/a			n/a

_____________________

⁽¹⁾ Represents the dollar amount increase (decrease) for the six months ended June 30, 2016 compared to the six months ended June 30, 2015 related to real estate investments acquired on or after January 1, 2015.

⁽²⁾ Represents the dollar amount increase (decrease) for the six months ended June 30, 2016 compared to the six months ended June 30, 2015 with respect to real estate investments owned by us throughout both periods presented.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Rental income and tenant reimbursements from our real estate properties increased from $133.5 million for the six months ended June 30, 2015 to $187.4 million for the six months ended June 30, 2016 primarily as a result of the growth in our real estate portfolio. The increase of rental income and tenant reimbursements for the properties held throughout both periods was primarily due to an increase in occupancy and expense recoveries. We expect that our rental income and tenant reimbursements will vary in future periods as a result of owning the real estate property acquired in 2016 for an entire period and acquisition activity.

Interest income from our real estate loan receivable, recognized using the interest method, remained consistent at $0.8 million for the six months ended June 30, 2015 and 2016. On July 1, 2016, the Aberdeen First Mortgage Origination was paid off.

Other operating income increased from $6.2 million during the six months ended June 30, 2015 to $10.0 million for the six months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. Other operating income primarily consisted of parking revenues. We expect other operating income to vary in future periods as a result of owning the real estate property acquired in 2016 for an entire period and acquisition activity.

Operating, maintenance and management costs increased from $31.8 million for the six months ended June 30, 2015 to $44.6 million for the six months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. The increase in operating, maintenance and management costs for the properties held throughout both periods was primarily due to an increase in repairs and maintenance, association fees and management fees. We expect operating, maintenance and management costs to vary in future periods as a result of owning the real estate property acquired in 2016 for an entire period and acquisition activity.

Real estate taxes and insurance increased from $23.0 million for the six months ended June 30, 2015 to $31.3 million for the six months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. The increase of real estate taxes and insurance for the properties held throughout both periods was primarily due to higher taxes as the assessed values have increased on several of our properties. We expect real estate taxes and insurance to increase in future periods as a result of owning the real estate property acquired in 2016 for an entire period and acquisition activity.

Asset management fees with respect to our real estate investments increased from $8.8 million for the six months ended June 30, 2015 to $12.4 million for the six months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. We expect asset management fees to vary in future periods as a result of owning the real estate property acquired in 2016 for an entire period. As of June 30, 2016, there were $3.7 million of accrued and deferred asset management fees. For a discussion of accrued and deferred asset management fees, see “- Liquidity and Capital Resources - Cash Flows from Financing Activities” herein.

Real estate acquisition fees and expenses to affiliate and non-affiliates decreased from $4.2 million for the six months ended June 30, 2015 to $1.8 million for the six months ended June 30, 2016 due to a decrease in acquisition activity. We acquired one real estate property for $146.1 million during the six months ended June 30, 2016. During the six months ended June 30, 2015, we acquired three real estate properties for $290.0 million. We expect real estate acquisition fees and expenses to vary in future periods based upon acquisition activity.

Depreciation and amortization increased from $61.9 million for the six months ended June 30, 2015 to $80.1 million for the six months ended June 30, 2016, primarily as a result of the growth in our real estate portfolio. We expect depreciation and amortization to vary in future periods as a result of owning the real estate property acquired in 2016 for an entire period and acquisition activity.

Interest expense increased from $20.1 million for the six months ended June 30, 2015 to $43.9 million for the six months ended June 30, 2016. Included in interest expense is the amortization of deferred financing costs of $1.7 million and $2.5 million for the six months ended June 30, 2015 and 2016, respectively. Interest expense incurred as a result of our derivative instruments for the six months ended June 30, 2015 and 2016 was $5.4 million and $21.8 million, respectively, which includes $2.0 million and $18.6 million of unrealized losses on derivative instruments for the six months ended June 30, 2015 and 2016, respectively. The increase in interest expense is primarily due to increased borrowings as a result of our use of additional debt in acquiring real estate properties in 2015 and 2016 and changes in value on interest rate swaps. We expect interest expense to vary in future periods as a result of borrowings in 2016 being outstanding for an entire period and acquisition activity. In addition, our interest expense in future periods will vary based on fair value changes with respect to our interest rate swaps that are not accounted for as cash flow hedges.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Funds from Operations and Modified Funds from Operations

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

Changes in accounting rules have resulted in a substantial increase in the number of non-operating and non-cash items included in the calculation of FFO. Items such as acquisition fees and expenses, which had previously been capitalized prior to 2009, are currently expensed and accounted for as operating expenses. As a result, our management also uses MFFO as an indicator of our ongoing performance as well as our dividend sustainability. MFFO excludes from FFO: acquisition fees and expenses; adjustments related to contingent purchase price obligations; amounts relating to straight-line rents and amortization of above and below market intangible lease assets and liabilities; accretion of discounts and amortization of premiums on debt investments; amortization of closing costs relating to debt investments; impairments of real estate-related investments; mark-to-market adjustments included in net income; and gains or losses included in net income for the extinguishment or sale of debt or hedges. We compute MFFO in accordance with the definition of MFFO included in the practice guideline issued by the 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 costs that management considers more reflective of investing activities and other non-operating items included in FFO. Management believes that excluding acquisition costs from MFFO provides investors with supplemental performance information that is consistent with management’s analysis of the operating performance of the portfolio over time, including periods after our acquisition stage. MFFO also excludes non-cash items such as straight-line rental revenue. Additionally, we believe that MFFO provides investors with supplemental performance information that is consistent with the performance indicators and analysis used by management, in addition to net income and cash flows from operating activities as defined by GAAP, to evaluate the sustainability of our operating performance. MFFO provides comparability in evaluating the operating performance of our portfolio with other non-traded REITs which typically have limited lives with short and defined acquisition periods and targeted exit strategies. MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes.

FFO and MFFO are non-GAAP financial measures and do not represent net income as defined by GAAP. Net income as defined by GAAP is the most relevant measure in determining our operating performance because FFO and MFFO include adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization and the other items described above. Accordingly, FFO and MFFO should not be considered as alternatives to net income as an indicator of our current and historical operating performance. In addition, FFO and MFFO do not represent cash flows from operating activities determined in accordance with GAAP and should not be considered an indication of our liquidity. We believe FFO and MFFO, in addition to net income and cash flows from operating activities as defined by GAAP, are meaningful supplemental performance measures.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Although MFFO includes other adjustments, the exclusion of adjustments for straight-line rent, the amortization of above- and below-market leases, unrealized (gains) losses on derivative instruments and acquisition fees and expenses 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 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;

•

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

•

Acquisition fees and expenses. Acquisition fees and expenses related to the acquisition of real estate are generally expensed. Although these amounts reduce net income, we exclude them from MFFO to more appropriately present the ongoing operating performance of our real estate investments on a comparative basis. Additionally, acquisition fees and expenses have been funded from the proceeds from our now-terminated initial public offering and debt financings and not from our operations. We believe this exclusion is useful to investors as it allows investors to more accurately evaluate the sustainability of our 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 six months ended June 30, 2016 and 2015, respectively (in thousands). No conclusions or comparisons should be made from the presentation of these periods.



	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2016			2015			2016			2015
Net loss	$	(5,151	)	$	(5,943	)	$	(18,731	)	$	(11,518	)
Depreciation of real estate assets	19,089			12,778			37,639			24,594
Amortization of lease-related costs	21,556			19,501			42,470			37,353
FFO	35,494			26,336			61,378			50,429
Straight-line rent and amortization of above- and below-market leases	(7,190		)	(5,398		)	(15,157		)	(11,913		)
Amortization of discounts and closing costs	7			6			15			13
Unrealized losses (gains) on derivative instruments	5,815			(1,505		)	18,558			1,996
Real estate acquisition fees to affiliate	—			3,019			1,473			3,019
Real estate acquisition fees and expenses	12			1,048			301			1,164
MFFO	$	34,138		$	23,506		$	66,568		$	44,708

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.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Distributions

From time to time during our operational stage, we may not pay distributions solely from our cash flow from operating activities or FFO, in which case distributions may be paid in whole or in part from debt financing. Distributions declared, distributions paid and cash flow from operating activities were as follows for the first and second quarters of 2016 (in thousands, except per share amounts):



	Distributions Declared ⁽¹⁾		Distributions Declared Per Share ^{(1) (2)}		Distributions Paid⁽³⁾						Cash Flow from Operating Activities
Period	Distributions Declared ⁽¹⁾		Distributions Declared Per Share ^{(1) (2)}		Cash		Reinvested		Total		Cash Flow from Operating Activities
First Quarter 2016	$	28,667	$	0.160	$	13,281	$	15,322	$	28,603	$	6,838
Second Quarter 2016	29,160		0.162		13,778		15,647		29,425		38,724
	$	57,827	$	0.322	$	27,059	$	30,969	$	58,028	$	45,562

_____________________


⁽¹⁾	Distributions for the periods from January 1, 2016 through February 28, 2016 and March 1, 2016 through June 30, 2016 were based on daily record dates and were calculated at a rate of $0.00178082 per share per day.


⁽²⁾	Assumes share was issued and outstanding each day during the period presented.


⁽³⁾	Distributions are paid on a monthly basis. Distributions for all record dates of a given month are paid on or about the first business day of the following month.

For the six months ended June 30, 2016, we paid aggregate distributions of $58.0 million, including $27.0 million of distributions paid in cash and $31.0 million of distributions reinvested through our dividend reinvestment plan. Our net loss for the six months ended June 30, 2016 was $18.7 million. FFO for the six months ended June 30, 2016 was $61.4 million and cash flow from operating activities was $45.6 million. See the reconciliation of FFO to net loss above. We funded our total distributions paid, which includes net cash distributions and dividends reinvested by stockholders, with $36.2 million of cash flow from operating activities, $4.2 million of cash flow from operating activities in excess of distributions paid during 2015 and $17.6 million of debt financing. For purposes of determining the source of our distributions paid, we assume first that we use cash flow from operating activities from the relevant or prior periods to fund distribution payments.

Over the long-term, we expect that a greater percentage of our distributions will be paid from cash flow from operating activities and FFO (except with respect to distributions related to sales of our assets and distributions related to the repayment of principal under real estate-related investments). From time to time during our operational stage, we may not pay distributions solely from our cash flow from operating activities. To the extent that we pay distributions from sources other than our cash flow from operating activities, we will have less funds available for the acquisition of real estate investments and the overall return to our stockholders may be reduced. Further, our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including those discussed under “Forward-Looking Statements” and “Market Outlook - Real Estate and Real Estate Finance Markets” herein, and the risks discussed in Part II, Item 1A, herein and in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC. Those factors include: the future operating performance of our current and future real estate 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 any variable rate debt obligations we incur; and the level of participation in our dividend reinvestment plan. In the event our FFO and/or cash flow from operating activities decrease in the future, the level of our distributions may also decrease. In addition, future distributions declared and paid may exceed FFO and/or cash flow from operating activities.

Critical Accounting Policies

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

Table of Contents

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 July 1, 2016, we paid distributions of $9.6 million, which related to distributions declared for daily record dates for each day in the period from June 1, 2016 through June 30, 2016. On August 1, 2016, we paid distributions of $10.0 million, which related to distributions declared for daily record dates for each day in the period from July 1, 2016 through July 31, 2016.

Distributions Declared

On July 7, 2016, our board of directors declared distributions based on daily record dates for the period from August 1, 2016 through August 31, 2016, which we expect to pay in September 2016. On August 9, 2016, our board of directors declared distributions based on daily record dates for the period from September 1, 2016 through September 30, 2016, which we expect to pay in October 2016, and distributions based on daily record dates for the period from October 1, 2016 through October 31, 2016, which we expect to pay in November 2016. Investors may choose to receive cash distributions or purchase additional shares through our dividend reinvestment plan.

Distributions for these periods will be calculated based on stockholders of record each day during these periods at a rate of $0.00178082 per share per day and equal a daily amount that, if paid each day for a 365-day period, would equal a 6.47% annualized rate based on our December 8, 2015 estimated value per share of $10.04.

Real Estate Loan Receivable Payoff

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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 and to fund the acquisition, expansion and refinancing of our real estate investment portfolio and operations. We may also be exposed to the effects of changes in interest rates as a result of the acquisition and origination of mortgage and other loans. Our profitability and the value of our real estate 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 may manage interest rate risk by maintaining a ratio of fixed rate, long-term debt such that variable rate exposure is kept at an acceptable level or we may utilize a variety of financial instruments, including interest rate caps, floors, and swap agreements, in order to limit the effects of changes in interest rates on our operations. When we use these types of derivatives to hedge the risk of interest-earning assets or interest-bearing liabilities, we may be subject to certain risks, including the risk that losses on a hedge position will reduce the funds available for the payment of distributions to our stockholders and that the losses may exceed the amount we invested in the instruments.

We borrow funds and make investments at a combination of fixed and variable rates. Interest rate fluctuations will generally not affect our future earnings or cash flows on our fixed rate debt or fixed rate real estate loan receivable unless such instruments mature or are otherwise terminated. However, interest rate changes will affect the fair value of our fixed rate instruments. As of June 30, 2016, the fair value and carrying value of our fixed rate real estate loan receivable were $22.4 million and $22.4 million, respectively. The fair value estimate of our real estate loan receivable is calculated using an internal valuation model that considers the expected cash flows for the loan, underlying collateral value and the estimated yield requirements of institutional investors for loans with similar characteristics, including remaining loan term, loan-to-value, type of collateral and other credit enhancements. On July 1, 2016, the Aberdeen First Mortgage Origination was paid off. As of June 30, 2016, the fair value of our fixed rate debt was $105.7 million and the outstanding principal balance of our fixed rate debt was $102.3 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 loan was originated as of June 30, 2016. As we expect to hold our fixed rate instruments to maturity and the amounts due under such instruments would be limited to the outstanding principal balance and any accrued and unpaid interest, we do not expect that fluctuations in interest rates, and the resulting change in fair value of our fixed rate instruments, would have a significant impact on our operations.

Conversely, movements in interest rates on our variable rate debt and loans receivable 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 June 30, 2016, we were exposed to market risks related to fluctuations in interest rates on $978.0 million of variable rate debt outstanding after giving consideration to the impact of interest rate swap agreements on approximately $676.1 million of our variable rate debt. This amount does not take into account the impact of $607.2 million of forward interest rate swap agreements that were not yet effective as of June 30, 2016. We also have an interest rate cap that had a notional amount of $353.4 million effective from January 7, 2015 to June 30, 2016. The notional amount on the interest rate cap is reduced to $147.3 million from July 1, 2016 to January 1, 2017. Based on interest rates as of June 30, 2016, if interest rates were 100 basis points higher during the 12 months ending June 30, 2017, interest expense on our variable rate debt would increase by $9.8 million. As of June 30, 2016, one-month LIBOR was 0.46505% and if this index was reduced to 0% during the 12 months ending June 30, 2017, interest expense on our variable rate debt would decrease by $4.5 million. As of June 30, 2016, we did not own any variable rate loans receivable.

The annual effective interest rate of our fixed rate real estate loan receivable as of June 30, 2016 was 7.5%. The annual effective interest rate represents the effective interest rate as of June 30, 2016, using the interest method, which we use to recognize interest income on our real estate loan receivable. The interest rate and weighted-average interest rate of our fixed rate debt and variable rate debt as of June 30, 2016 were 4.0% and 2.5%, respectively. The interest rate and weighted-average interest rate represent the actual interest rate in effect as of June 30, 2016 (consisting of the contractual interest rate and the effect of interest rate swaps, if applicable), using interest rate indices as of June 30, 2016 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 in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 4. Controls and Procedures

Disclosure Controls and Procedures

As of the end of the period covered by this report, management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our principal executive officer and principal financial officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Table of Contents

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

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, 2015, as filed with the SEC.

We have paid distributions in part from financings and expect that in the future we may not pay distributions solely from our cash flow from operating activities. To the extent that we pay distributions from sources other than our cash flow from operating activities, we will have less funds available for investment in properties and other assets and the overall return to our stockholders may be reduced.

Our organizational documents permit us to pay distributions from any source, including offering proceeds or borrowings (which may constitute a return of capital), and our charter does not limit the amount of funds we may use from any source to pay such distributions. We have paid distributions in part from financings (including with an advance from our advisor that we have repaid with debt financing), and from time to time during our operational stage, we expect that we may not pay distributions solely from our cash flow from operating activities, in which case distributions may be paid in whole or in part from debt financing. We may also fund such distributions with proceeds from the sale of assets or from the maturity, payoff or settlement of debt investments. If we fund distributions from borrowings, our interest expense and other financing costs, as well as the repayment of such borrowings, will reduce our earnings and cash flow from operating activities available for distribution in future periods. If we fund distributions from the sale of assets or the maturity, payoff or settlement of debt investments, this will affect our ability to generate cash flow from operating activities in future periods. To the extent that we pay distributions from sources other than our cash flow from operating activities, we will have fewer funds available with which to make real estate investments and the overall return to our stockholders may be reduced. In addition, to the extent distributions exceed cash flow from operating activities, a stockholder’s basis in our stock will be reduced and, to the extent distributions exceed a stockholder’s basis, the stockholder may recognize capital gain. There is no limit on the amount of distributions we may fund from sources other than from cash flow from operating activities.

For the six months ended June 30, 2016, we paid aggregate distributions of $58.0 million, including $27.0 million of distributions paid in cash and $31.0 million of distributions reinvested through our dividend reinvestment plan. We funded our total distributions paid, which includes net cash distributions and dividends reinvested by stockholders, with $36.2 million (63%) of cash flow from operating activities, $4.2 million (7%) of cash flow from operating activities in excess of distributions paid during 2015 and $17.6 million (30%) of debt financing. For the six months ended June 30, 2016, our cash flow from operating activities to distributions paid coverage ratio was 79% and our funds from operations to distributions paid coverage ratio was 106%.

See Part I, Item II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations and Modified Funds from Operations” and “— Distributions” herein.

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


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


b)	Not applicable.


c)	We have a share redemption program that may enable stockholders to sell their shares to us in limited circumstances. The restrictions of our share redemption program will severely limit our stockholders’ ability to sell their shares should they require liquidity and will limit our stockholders’ ability to recover the value they invested in our common stock.

Table of Contents

PART II. OTHER INFORMATION (CONTINUED)

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

There are several limitations on our ability to redeem shares under our share redemption program:


•	Unless the shares are being redeemed in connection with 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”), we may not redeem shares unless the stockholder has held the shares for one year.

•

During any calendar year, we may redeem only the number of shares that we could purchase with the amount of net proceeds from the sale of shares under our dividend reinvestment plan during the prior calendar year. Notwithstanding anything contained in our share redemption program to the contrary, we may increase or decrease the funding available for the redemption of shares pursuant to the program 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 our stockholders.


•	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.

For a stockholder’s shares to be eligible for redemption in a given month, the administrator must receive a written redemption request from the stockholder or from an authorized representative of the stockholder setting forth the number of shares requested to be redeemed at least five business days before the redemption date. If we cannot redeem 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 the most recently effective, registration statement, as such registration statement has been amended or supplemented, then we would redeem all of such stockholder’s shares.

If we do not completely satisfy a redemption request on a redemption date because the program administrator did not receive the request in time, because of the limitations on redemptions set forth in our share redemption program or because of a suspension of our share redemption program, then we will treat the unsatisfied portion of the redemption request as a request for redemption at the next redemption date funds are available for redemption, unless the redemption request is withdrawn. Any stockholder can withdraw a redemption request by sending written notice to the program administrator, provided such notice is received at least five business days before the redemption date.

Pursuant to our share redemption program, once we established an estimated value per share for a purpose other than to set the offering price to acquire a share in our now-terminated primary public offering, 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. The price at which we will redeem all other shares eligible for redemption is as follows:


•	For those shares held by the redeeming stockholder for at least one year, 92.5% of our most recent estimated value per share as of the applicable redemption date;


•	For those shares held by the redeeming stockholder for at least two years, 95.0% of our most recent estimated value per share as of the applicable redemption date;


•	For those shares held by the redeeming stockholder for at least three years, 97.5% of our most recent estimated value per share as of the applicable redemption date; and


•	For those shares held by the redeeming stockholder for at least four years, 100% of our most recent estimated value per share as of the applicable redemption date.

On December 8, 2015, our board of directors approved an estimated value per share of our common stock of $10.04 based on the estimated value of our assets less the estimated value of our liabilities divided by the number of shares outstanding, all as of September 30, 2015, with the exception of a reduction to our net asset value for acquisition fees and closing costs related to a real estate acquisition that closed subsequent to September 30, 2015 and deferred financing costs related to a mortgage loan that closed subsequent to September 30, 2015. This estimated value per share became effective for the December 2015 redemption date, which was December 31, 2015.

Table of Contents

PART II. OTHER INFORMATION (CONTINUED)

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

For purposes of determining the time period a redeeming stockholder has held each share, the time period begins as of the date the stockholder acquired the share; provided, that shares purchased by the redeeming stockholder pursuant to our dividend reinvestment plan will be deemed to have been acquired on the same date as the initial share to which the dividend reinvestment plan shares relate. The date of the share’s original issuance by us is not determinative. In addition, as described above, the shares owned by a stockholder may be redeemed at different prices depending on how long the stockholder has held each share submitted for redemption.

We currently expect to utilize an independent valuation firm to update our estimated value per share in December 2016 and in December of each year thereafter. We will report the estimated value per share of our common stock in a Current Report on Form 8-K or in our annual or quarterly reports, all publicly filed with the SEC. We will also provide information about our estimated value per share on our website (such information may be provided by means of a link to our public filings on the SEC’s website, http://www.sec.gov).

Our board may amend, suspend or terminate our share redemption program upon 30 days’ notice to stockholders, provided that we may increase or decrease the funding available for the redemption of shares pursuant to our share redemption program upon 10 business days’ notice.

The complete share redemption program document is filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2013 and is available at the SEC’s website at http://www.sec.gov.

During the six months ended June 30, 2016, we fulfilled all redemption requests eligible for redemption under our share redemption program and received in good order. We funded redemptions under our share redemption program with the net proceeds from our dividend reinvestment plan, and 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 2016	151,856	$	9.67	⁽³⁾
February 2016	124,749	$	9.71	⁽³⁾
March 2016	194,195	$	9.74	⁽³⁾
April 2016	176,038	$	9.63	⁽³⁾
May 2016	249,568	$	9.78	⁽³⁾
June 2016	373,657	$	9.69	⁽³⁾
Total	1,270,063

_____________________

⁽¹⁾ We announced the adoption and commencement of the program on October 14, 2010. We announced amendments to the program on March 8, 2013 (which amendment became effective on April 7, 2013) and on March 7, 2014 (which amendment became effective on April 6, 2014).

⁽²⁾ The prices at which we redeem shares under the program are as set forth above.

⁽³⁾ We limit the dollar value of shares that may be redeemed under the program as described above. One of these limitations is that during each calendar year, our share redemption program limits the number of shares we may redeem to those that we could purchase with the amount of the net proceeds from the issuance of shares under our dividend reinvestment plan during the prior calendar year. However, we may increase or decrease the funding available for the redemption of shares upon ten business days’ notice to our stockholders. In 2015, our net proceeds from the dividend reinvestment plan were $55.4 million. During the six months ended June 30, 2016, we redeemed $12.3 million of shares of common stock and $43.1 million was available for redemptions of shares eligible for redemption for the remainder of 2016.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Table of Contents

PART II. OTHER INFORMATION (CONTINUED)

Item 6. Exhibits



Ex.		Description

3.1		Second Articles of Amendment and Restatement, incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed January 25, 2011

3.2		Amended and Restated Bylaws, incorporated by reference to Exhibit 3.2 to Pre-Effective Amendment No. 3 to the Company’s Registration Statement on Form S-11, Commission File No. 333-164703, filed September 30, 2010

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. 2 to the Company’s Registration Statement on Form S-11, Commission File No. 333-164703, filed August 20, 2010

4.2		Fourth Amended and Restated Dividend Reinvestment Plan, incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q, filed August 13, 2015
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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

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

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

99.1		Third Amended and Restated Share Redemption Program, incorporated by reference to Exhibit 99.3 to the Company’s Annual Report on Form 10-K, filed March 7, 2014

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		XBRL Taxonomy Extension Definition Linkbase

101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE		XBRL Taxonomy Extension Presentation Linkbase

Table of Contents

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 III, INC.

Date:	August 10, 2016	By:	/S/ CHARLES J. SCHREIBER, JR.
			Charles J. Schreiber, Jr.
			Chairman of the Board, Chief Executive Officer and Director
			(principal executive officer)

Date:	August 10, 2016	By:	/S/ JEFFREY K. WALDVOGEL
			Jeffrey K. Waldvogel
			Chief Financial Officer
			(principal financial officer)