KBS Real Estate Investment Trust III, Inc. - Quarter Report: 2019 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, 2019



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

For the transition period from to

Commission file number 000-54687

______________________________________________________

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

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

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

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

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



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

As of August 5, 2019, there were 175,679,897 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, 2019

INDEX



PART I.	FINANCIAL INFORMATION		2
	Item 1.	Financial Statements	2
		Consolidated Balance Sheets as of June 30, 2019 (unaudited) and December 31, 2018	2
		Consolidated Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2019 and 2018	3
		Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the Three and Six Months Ended June 30, 2019 and 2018	4
		Consolidated Statements of Equity for the Three and Six Months Ended June 30, 2019 and 2018 (unaudited)	5
		Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2019 and 2018	7
		Condensed Notes to Consolidated Financial Statements as of June 30, 2019 (unaudited)	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	49
	Item 4.	Controls and Procedures	49
PART II.	OTHER INFORMATION		50
	Item 1.	Legal Proceedings	50
	Item 1A.	Risk Factors	50
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
	Item 3.	Defaults upon Senior Securities	53
	Item 4.	Mine Safety Disclosures	53
	Item 5.	Other Information	54
	Item 6.	Exhibits	54
SIGNATURES			56

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, 2019			December 31, 2018
	(unaudited)
Assets
Real estate:
Land	$	401,150		$	402,008
Buildings and improvements	2,936,372			2,911,995
Construction in progress	50,595			35,785
Tenant origination and absorption costs	202,342			223,723
Total real estate held for investment, cost	3,590,459			3,573,511
Less accumulated depreciation and amortization	(579,249		)	(536,990		)
Total real estate held for investment, net	3,011,210			3,036,521
Cash and cash equivalents	66,080			75,023
Restricted cash	5,970			1,015
Rents and other receivables, net	104,441			98,411
Above-market leases, net	3,452			4,176
Prepaid expenses and other assets	84,356			85,645
Total assets	$	3,275,509		$	3,300,791
Liabilities and equity
Notes payable, net	$	2,275,768		$	2,184,538
Accounts payable and accrued liabilities	74,588			67,265
Due to affiliate	4,741			4,209
Distributions payable	9,485			9,801
Below-market leases, net	14,729			17,553
Redeemable common stock payable	16,476			31,647
Other liabilities	49,987			30,396
Total liabilities	2,445,774			2,345,409
Commitments and contingencies (Note 9)
Redeemable common stock	15,631			24,487
Equity
KBS Real Estate Investment Trust III, Inc. stockholders’ equity
Preferred stock, $.01 par value per share; 10,000,000 shares authorized, no shares issued and outstanding	—			—
Common stock, $.01 par value per share; 1,000,000,000 shares authorized, 175,001,561 and 177,523,853 shares issued and outstanding as of June 30, 2019 and December 31, 2018, respectively	1,750			1,775
Additional paid-in capital	1,550,351			1,555,380
Cumulative distributions and net losses	(738,263		)	(626,543		)
Total KBS Real Estate Investment Trust III, Inc. stockholders’ equity	813,838			930,612
Noncontrolling interest	266			283
Total equity	814,104			930,895
Total liabilities and equity	$	3,275,509		$	3,300,791

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,
	2019			2018			2019			2018
Revenues:
Rental income	$	105,843		$	98,794		$	208,850		$	195,416
Other operating income	8,666			8,782			17,037			16,339
Total revenues	114,509			107,576			225,887			211,755
Expenses:
Operating, maintenance and management	26,279			24,301			50,013			47,455
Real estate taxes and insurance	18,418			18,487			35,865			35,261
Asset management fees to affiliate	6,999			6,738			13,871			13,358
General and administrative expenses	1,907			2,012			3,942			3,535
Depreciation and amortization	41,632			39,025			83,040			78,006
Interest expense	47,403			12,517			85,350			13,327
Impairment charges on real estate	—			—			8,706			—
Total expenses	142,638			103,080			280,787			190,942
Other income (loss):
Other income	9			1,575			22			1,876
Other interest income	192			84			264			96
Equity in income (loss) of unconsolidated joint venture	—			(348		)	—			(348		)
Loss from extinguishment of debt	(196		)	—			(196		)	—
Gain on sale of real estate, net	—			11,942			—			11,942
Total other income, net	5			13,253			90			13,566
Net (loss) income	(28,124		)	17,749			(54,810		)	34,379
Net loss attributable to noncontrolling interest	9			—			17			—
Net (loss) income attributable to common stockholders	$	(28,115	)	$	17,749		$	(54,793	)	$	34,379
Net (loss) income per common share attributable to common stockholders, basic and diluted	$	(0.16	)	$	0.10		$	(0.31	)	$	0.19
Weighted-average number of common shares outstanding, basic and diluted	174,783,611			177,649,492			175,154,320			178,588,342

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,
	2019			2018			2019			2018
Net (loss) income	$	(28,124	)	$	17,749		$	(54,810	)	$	34,379
Other comprehensive (loss) income:
Unrealized (loss) income on derivative instruments designated as cash flow hedges	—			(1		)	—			83
Reclassification adjustment realized in net income (effective portion)	—			(96		)	—			(108		)
Total other comprehensive loss	—			(97		)	—			(25		)
Total comprehensive (loss) income	(28,124		)	17,652			(54,810		)	34,354
Total comprehensive loss attributable to noncontrolling interest	9			—			17			—
Total comprehensive (loss) income attributable to common stockholders	$	(28,115	)	$	17,652		$	(54,793	)	$	34,354

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 EQUITY

For the Three Months Ended June 30, 2019 and 2018 (unaudited)

(dollars in thousands)



	Common Stock					Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)		Total Stockholders’ Equity			Noncontrolling Interest			Total Equity
	Shares		Amounts			Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)		Total Stockholders’ Equity			Noncontrolling Interest			Total Equity
Balance, March 31, 2019	174,110,694		$	1,741		$	1,550,411		$	(681,744	)	$	—	$	870,408		$	275		$	870,683
Net loss	—		—			—			(28,115		)	—		(28,115		)	(9		)	(28,124		)
Issuance of common stock	1,136,045		11			12,963			—			—		12,974			—			12,974
Transfers to redeemable common stock	—		—			(10,080		)	—			—		(10,080		)	—			(10,080		)
Redemptions of common stock	(245,178	)	(2		)	(2,942		)	—			—		(2,944		)	—			(2,944		)
Distributions declared	—		—			—			(28,404		)	—		(28,404		)	—			(28,404		)
Other offering costs	—		—			(1		)	—			—		(1		)	—			(1		)
Balance, June 30, 2019	175,001,561		$	1,750		$	1,550,351		$	(738,263	)	$	—	$	813,838		$	266		$	814,104



	Common Stock					Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity			Noncontrolling Interest		Total Equity
	Shares		Amounts			Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity			Noncontrolling Interest		Total Equity
Balance, March 31, 2018	176,993,282		$	1,770		$	1,591,679		$	(526,594	)	$	182		$	1,067,037		$	300	$	1,067,337
Net income	—		—			—			17,749			—			17,749			—		17,749
Other comprehensive loss	—		—			—			—			(97		)	(97		)	—		(97		)
Issuance of common stock	1,276,061		12			14,216			—			—			14,228			—		14,228
Transfers to redeemable common stock	—		—			(23,954		)	—			—			(23,954		)	—		(23,954		)
Redemptions of common stock	(2,995,169	)	(29		)	(33,558		)	—			—			(33,587		)	—		(33,587		)
Distributions declared	—		—			—			(28,778		)	—			(28,778		)	—		(28,778		)
Balance, June 30, 2018	175,274,174		$	1,753		$	1,548,383		$	(537,623	)	$	85		$	1,012,598		$	300	$	1,012,898

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONSOLIDATED STATEMENTS OF EQUITY (CONTINUED)

For the Six Months Ended June 30, 2019 and 2018 (unaudited)

(dollars in thousands)



	Common Stock					Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)		Total Stockholders’ Equity			Noncontrolling Interest			Total Equity
	Shares		Amounts			Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)		Total Stockholders’ Equity			Noncontrolling Interest			Total Equity
Balance, December 31, 2018	177,523,853		$	1,775		$	1,555,380		$	(626,543	)	$	—	$	930,612		$	283		$	930,895
Net loss	—		—			—			(54,793		)	—		(54,793		)	(17		)	(54,810		)
Issuance of common stock	2,317,868		23			26,448			—			—		26,471			—			26,471
Transfers from redeemable common stock	—		—			24,028			—			—		24,028			—			24,028
Redemptions of common stock	(4,840,160	)	(48		)	(55,502		)	—			—		(55,550		)	—			(55,550		)
Distributions declared	—		—			—			(56,927		)	—		(56,927		)	—			(56,927		)
Other offering costs	—		—			(3		)	—			—		(3		)	—			(3		)
Balance, June 30, 2019	175,001,561		$	1,750		$	1,550,351		$	(738,263	)	$	—	$	813,838		$	266		$	814,104



	Common Stock					Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity			Noncontrolling Interest		Total Equity
	Shares		Amounts			Additional Paid-in Capital			Cumulative Distributions in Excess of Net Income (Loss)			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity			Noncontrolling Interest		Total Equity
Balance, December 31, 2017	180,864,707		$	1,809		$	1,591,640		$	(514,451	)	$	110		$	1,079,108		$	300	$	1,079,408
Net income	—		—			—			34,379			—			34,379			—		34,379
Other comprehensive loss	—		—			—			—			(25		)	(25		)	—		(25		)
Issuance of common stock	2,556,146		25			28,476			—			—			28,501			—		28,501
Transfers from redeemable common stock	—		—			21,557			—			—			21,557			—		21,557
Redemptions of common stock	(8,146,679	)	(81		)	(93,290		)	—			—			(93,371		)	—		(93,371		)
Distributions declared	—		—			—			(57,551		)	—			(57,551		)	—		(57,551		)
Balance, June 30, 2018	175,274,174		$	1,753		$	1,548,383		$	(537,623	)	$	85		$	1,012,598		$	300	$	1,012,898

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,
	2019			2018
Cash Flows from Operating Activities:
Net (loss) income	$	(54,810	)	$	34,379
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization	83,040			78,006
Impairment charges on real estate	8,706			—
Equity in loss of unconsolidated joint venture	—			348
Deferred rents	(3,026		)	(4,947		)
Loss due to property damage	90			—
Bad debt expense	—			110
Amortization of above- and below-market leases, net	(2,100		)	(2,587		)
Amortization of deferred financing costs	3,185			3,091
Loss from extinguishment of debt	196			—
Unrealized losses (gains) on derivative instruments	37,899			(25,326		)
Gain on sale of real estate	—			(11,942		)
Changes in operating assets and liabilities:
Rents and other receivables	(3,149		)	(3,067		)
Prepaid expenses and other assets	(19,213		)	(7,918		)
Accounts payable and accrued liabilities	(3,438		)	(5,113		)
Other liabilities	(2,853		)	(2,586		)
Due to affiliates	399			695
Net cash provided by operating activities	44,926			53,143
Cash Flows from Investing Activities:
Improvements to real estate	(35,199		)	(45,931		)
Proceeds from sale of real estate, net	—			41,649
Payments for construction in progress	(14,017		)	(19,092		)
Investment in unconsolidated joint venture	—			(428		)
Payments of post-closing acquisition costs	(338		)	—
Escrow deposits for tenant improvements	972			1,111
Insurance proceeds received for property damage	519			3,928
Net cash used in investing activities	(48,063		)	(18,763		)
Cash Flows from Financing Activities:
Proceeds from notes payable	283,830			126,168
Principal payments on notes payable	(193,664		)	(39,266		)
Payments of deferred financing costs	(4,692		)	(108		)
Payments to redeem common stock	(55,550		)	(93,296		)
Payments of other offering costs	(3		)	—
Distributions paid to common stockholders	(30,772		)	(29,533		)
Net cash used in financing activities	(851		)	(36,035		)
Net decrease in cash, cash equivalents and restricted cash	(3,988		)	(1,655		)
Cash, cash equivalents and restricted cash, beginning of period	76,038			65,486
Cash, cash equivalents and restricted cash, end of period	$	72,050		$	63,831
Supplemental Disclosure of Cash Flow Information:
Interest paid, net of capitalized interest of $1,067 and $2,150 for the six months ended June 30, 2019 and 2018, respectively	$	43,659		$	35,001
Supplemental Disclosure of Noncash Investing and Financing Activities:
Distributions payable	$	9,485		$	9,499
Redeemable common stock payable	$	16,476		$	6,257
Accrued improvements to real estate	$	27,061		$	20,730
Construction in progress payable	$	6,616		$	8,158
Acquisition fee related to construction in progress due to affiliate	$	1,049		$	745
Acquisition fee on unconsolidated joint venture due to affiliate	$	—		$	451
Distributions paid to common stockholders through common stock issuances pursuant to the dividend reinvestment plan	$	26,471		$	28,501

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, 2019

(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 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, 2019, 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, 2019, the Company owned 28 office properties and one mixed-use office/retail property and had entered into a consolidated joint venture to develop and subsequently operate a multifamily apartment project, which is currently under construction.

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, 2019, the Company had also sold 30,244,405 shares of common stock under its dividend reinvestment plan for gross offering proceeds of $307.3 million. Also as of June 30, 2019, the Company had redeemed or repurchased 24,527,469 shares sold in the Offering for $266.0 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(a)(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 its 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, 2018, except for the Company’s adoption of the lease accounting standards issued by the Financial Accounting Standards Board (“FASB”) effective on January 1, 2019. For further information about the Company’s accounting policies, refer to the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”).

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, 2019

(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 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 months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

The consolidated financial statements include the accounts of the Company, REIT Holdings III, the Operating Partnership, their direct and indirect wholly owned subsidiaries, and a joint venture in which the Company has a controlling interest. 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.

Reclassifications

Certain amounts in the Company’s prior period consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications have not changed the results of operations of prior periods. Upon adoption of the lease accounting standards of Topic 842 on January 1, 2019 (described below), the Company accounted for tenant reimbursements for property taxes, insurance and common area maintenance as variable lease payments and recorded these amounts as rental income on the statement of operations. For the three and six months ended June 30, 2018, the Company reclassified $19.4 million and $37.1 million, respectively, of tenant reimbursement revenue for property taxes, insurance, and common area maintenance to rental income for comparability purposes.

Revenue Recognition - Operating Leases

Real Estate

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

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

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, 2019

(unaudited)

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

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


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


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


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


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


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


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

The Company leases apartment units under operating leases with terms generally of one year or less. Generally, credit investigations will be performed for prospective residents and security deposits will be obtained. The Company recognizes rental revenue, net of concessions, on a straight-line basis over the term of the lease, when collectibility is determined to be probable.

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

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, 2019

(unaudited)

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

Per Share Data

Basic net income (loss) per share of common stock is calculated by dividing net income (loss) attributable to common stockholders 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, 2019 and 2018, respectively.

Distributions declared per common share were $0.164 and $0.322 for the three and six months ended June 30, 2018, respectively. Distributions declared per common share assumes each share was issued and outstanding each day from January 1, 2018 through June 30, 2018. For each day that was a record date for distributions during the period from January 1, 2018 through June 30, 2018, distributions were calculated at a rate of $0.00178082 per share per day. Distributions declared per common share were $0.1625 and $0.3250 in the aggregate for the three and six months ended June 30, 2019. Distributions declared per common share assumes each share was issued and outstanding each day that was a record date for distributions and were based on a monthly record date for each month during the periods commencing January 2019 through June 2019. For each monthly record date for distributions during the period from January 1, 2019 through June 30, 2019, distributions were calculated at a rate of $0.0541667 per share.

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

Square Footage, Occupancy and Other Measures

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

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, 2019

(unaudited)

Recently Issued Accounting Standards Update

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

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework -Changes to the Disclosure Requirements for Fair Value Measurement (“ASU No. 2018-13”). The primary focus of ASU 2018-13 is to improve the effectiveness of the disclosure requirements for fair value measurements. ASU No. 2018-13 removes the requirement to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for the timing of transfers between levels and the valuation processes for Level 3 fair value measurements. It also adds a requirement to disclose changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and to disclose the range and weighted average of significant unobservable inputs used to develop recurring and nonrecurring Level 3 fair value measurements. For certain unobservable inputs, entities may disclose other quantitative information in lieu of the weighted average if the other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop the Level 3 fair value measurement. In addition, public entities are required to provide information about the measurement uncertainty of recurring Level 3 fair value measurements from the use of significant unobservable inputs if those inputs reasonably could have been different at the reporting date. ASU No. 2018-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Entities are permitted to early adopt either the entire standard or only the provisions that eliminate or modify the requirements. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company is still evaluating the impact of adopting ASU No. 2018-13 on its financial statements.

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, 2019

(unaudited)


3.	REAL ESTATE

Real Estate Held for Investment

As of June 30, 2019, the Company’s real estate portfolio held for investment was composed of 28 office properties and one mixed-use office/retail property encompassing in the aggregate approximately 11.2 million rentable square feet. In addition, the Company had entered into a consolidated joint venture to develop and subsequently operate a multifamily apartment project, which is currently under construction. As of June 30, 2019, the Company’s real estate portfolio was collectively 90% occupied. The following table summarizes the Company’s investments in real estate as of June 30, 2019 (in thousands):



Property	Date Acquired	City	State	Property Type	Total Real Estate, at Cost⁽¹⁾		Accumulated Depreciation and Amortization⁽¹⁾			Total Real Estate, Net⁽¹⁾
Domain Gateway	09/29/2011	Austin	TX	Office	$	49,574	$	(15,014	)	$	34,560
Town Center	03/27/2012	Plano	TX	Office	114,355		(28,443		)	85,912
McEwen Building	04/30/2012	Franklin	TN	Office	36,316		(8,213		)	28,103
Gateway Tech Center	05/09/2012	Salt Lake City	UT	Office	27,466		(7,281		)	20,185
Tower on Lake Carolyn ⁽²⁾	12/21/2012	Irving	TX	Office	53,253		(13,509		)	39,744
RBC Plaza	01/31/2013	Minneapolis	MN	Office	153,078		(41,459		)	111,619
One Washingtonian Center ⁽²⁾	06/19/2013	Gaithersburg	MD	Office	93,273		(20,763		)	72,510
Preston Commons	06/19/2013	Dallas	TX	Office	119,772		(25,623		)	94,149
Sterling Plaza	06/19/2013	Dallas	TX	Office	79,452		(15,099		)	64,353
201 Spear Street	12/03/2013	San Francisco	CA	Office	145,279		(17,364		)	127,915
Accenture Tower ⁽³⁾	12/16/2013	Chicago	IL	Office	444,835		(78,048		)	366,787
222 Main ⁽²⁾	02/27/2014	Salt Lake City	UT	Office	165,839		(33,968		)	131,871
Anchor Centre	05/22/2014	Phoenix	AZ	Office	96,005		(16,874		)	79,131
171 17th Street ⁽²⁾	08/25/2014	Atlanta	GA	Office	135,156		(30,975		)	104,181
Reston Square ⁽²⁾	12/03/2014	Reston	VA	Office	46,785		(9,781		)	37,004
Ten Almaden	12/05/2014	San Jose	CA	Office	126,187		(20,658		)	105,529
Towers at Emeryville ⁽⁴⁾	12/23/2014	Emeryville	CA	Office	285,882		(37,940		)	247,942
101 South Hanley ⁽²⁾	12/24/2014	St. Louis	MO	Office	72,730		(13,460		)	59,270
3003 Washington Boulevard	12/30/2014	Arlington	VA	Office	151,059		(22,884		)	128,175
Village Center Station ⁽²⁾	05/20/2015	Greenwood Village	CO	Office	76,240		(11,756		)	64,484
Park Place Village	06/18/2015	Leawood	KS	Office/Retail	100,493		(1,182		)	99,311
201 17th Street	06/23/2015	Atlanta	GA	Office	102,090		(16,597		)	85,493
Promenade I & II at Eilan ⁽²⁾	07/14/2015	San Antonio	TX	Office	62,720		(11,051		)	51,669
CrossPoint at Valley Forge ⁽²⁾	08/18/2015	Wayne	PA	Office	90,412		(13,739		)	76,673
515 Congress	08/31/2015	Austin	TX	Office	120,875		(14,889		)	105,986
The Almaden	09/23/2015	San Jose	CA	Office	174,118		(19,587		)	154,531
3001 Washington Boulevard	11/06/2015	Arlington	VA	Office	60,717		(5,994		)	54,723
Carillon	01/15/2016	Charlotte	NC	Office	152,949		(19,875		)	133,074
Hardware Village ⁽⁵⁾	08/26/2016	Salt Lake City	UT	Development/Apartment	121,437		(3,014		)	118,423
Village Center Station II ⁽²⁾	10/11/2018	Greenwood Village	CO	Office	132,112		(4,209		)	127,903
					$	3,590,459	$	(579,249	)	$	3,011,210

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, 2019

(unaudited)

___________________

⁽¹⁾Amounts presented are net of impairment charges.

⁽²⁾On July 18, 2019, the Company sold this property. See Note 8, “Related Party Transactions - Purchase and Sale Agreement for Portfolio Sale” and Note 10, “Subsequent Events - Portfolio Sale and Related Transactions” for more information.

⁽³⁾This property was formerly known as 500 West Madison and was re-named Accenture Tower in connection with the Company’s re-branding strategy for this property.

⁽⁴⁾On July 18, 2019, the Company sold one of the three buildings at this property. See Note 8, “Related Party Transactions - Purchase and Sale Agreement for Portfolio Sale” and Note 10, “Subsequent Events - Portfolio Sale and Related Transactions” for more information.

⁽⁵⁾On August 26, 2016, the Company, through an indirect wholly-owned subsidiary, entered into a joint venture (the “Hardware Village Joint Venture”) to develop and subsequently operate a multifamily apartment complex, located on the developable land at Gateway Tech Center. The Company owns a 99.24% equity interest in the joint venture. In July 2018, one of the two buildings consisting of 267 units was placed into service. The total real estate, at cost, for the building that was placed into service was $69.9 million as of June 30, 2019.

As of June 30, 2019, 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
Accenture Tower	Chicago, IL	1,457,724	$	366,787	11.2	%	$	30,001	$	27.73	74.2	%

_____________________

⁽¹⁾Annualized base rent represents annualized contractual base rental income as of June 30, 2019, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

Operating Leases

The Company’s office and office/retail properties are leased to tenants under operating leases for which the terms and expirations vary. As of June 30, 2019, the leases had remaining terms, excluding options to extend, of up to 14.9 years with a weighted-average remaining term of 4.5 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, 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 $11.0 million and $11.8 million as of June 30, 2019 and December 31, 2018, respectively. No material tenant credit issues have been identified at this time. During the six months ended June 30, 2019, the Company recorded an adjustment to rental income of $1.4 million for lease payments that were deemed not probable of collection. During the six months ended June 30, 2019 and 2018, the Company recorded bad debt (recovery) expense of $(0.3) million and $0.1 million, respectively, which was included in operating, maintenance and management expense in the accompanying consolidated statements of operations.

During the six months ended June 30, 2019 and 2018, the Company recognized deferred rent from tenants of $3.0 million and $4.9 million, respectively. As of June 30, 2019 and December 31, 2018, the cumulative deferred rent balance was $97.8 million and $92.8 million, respectively, and is included in rents and other receivables on the accompanying balance sheets. The cumulative deferred rent balance included $17.8 million and $17.2 million of unamortized lease incentives as of June 30, 2019 and December 31, 2018, respectively.

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, 2019

(unaudited)

As of June 30, 2019, the future minimum rental income from the Company’s properties, excluding apartment leases, under its non-cancelable operating leases was as follows (in thousands):



July 1, 2019 through December 31, 2019	$	153,750
2020	306,971
2021	286,489
2022	255,234
2023	217,821
Thereafter	725,031
	$	1,945,296

As of June 30, 2019, the Company’s office and office/retail properties were leased to 834 tenants over a diverse range of industries and geographic areas. The Company’s highest tenant industry concentrations (greater than 10% of annualized base rent) were as follows:



Industry	Number of Tenants	Annualized Base Rent ⁽¹⁾(in thousands)		Percentage of Annualized Base Rent
Finance	156	$	60,059	18.8	%
Real Estate	80	33,325		10.4	%

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of June 30, 2019, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

As of June 30, 2019, 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.

Geographic Concentration Risk

As of June 30, 2019, the Company’s net investments in real estate in California, Texas and Illinois represented 19%, 15% and 11% 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 pay distributions to stockholders.

Real Estate Sales

During the six months ended June 30, 2019, the Company did not dispose of any real estate properties. In addition, no real estate properties were held for sale as of June 30, 2019. During the year ended December 31, 2018, the Company disposed of one office property.

On November 6, 2014, the Company, through an indirect wholly owned subsidiary, acquired an office property containing 220,020 rentable square feet located on approximately 13.9 acres of land in Rocklin, California (“Rocklin Corporate Center”). On May 25, 2018, the Company sold Rocklin Corporate Center to a purchaser unaffiliated with the Company or the Advisor for $42.9 million before closing costs and credits. The carrying value of Rocklin Corporate Center as of the disposition date was $29.7 million, which was net of $6.0 million of accumulated depreciation and amortization. The Company recognized a gain on sale of $11.9 million related to the disposition of Rocklin Corporate Center.

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, 2019

(unaudited)

The results of operations for Rocklin Corporate Center during the six months ended June 30, 2018 are included in continuing operations on the Company’s consolidated statements of operations. The following table summarizes certain revenues and expenses related to this property for the three and six months ended June 30, 2018 (in thousands):



	For the Three Months Ended June 30, 2018		For the Six Months Ended June 30, 2018
Revenues
Rental income	$	699	$	1,886
Other operating income	1		26
Total revenues	$	700	$	1,912
Expenses
Operating, maintenance, and management	$	142	$	462
Real estate taxes and insurance	71		213
Asset management fees to affiliate	62		127
Depreciation and amortization	—		—
Interest expense	127		320
Total expenses	$	402	$	1,122

Impairment of Real Estate

During the six months ended June 30, 2019, the Company recorded impairment charges of $8.7 million to write down the carrying value of an office/retail property to its estimated fair value as a result of changes in cash flow estimates, including a change to the anticipated hold period of the property, which triggered the future estimated undiscounted cash flows to be lower than the net carrying value of the property. The decrease in cash flow projections was primarily due to the continued lack of demand for the property’s retail component resulting in longer than estimated lease-up periods and lower projected rental rates.

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, 2019

(unaudited)


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

As of June 30, 2019 and December 31, 2018, the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities (excluding fully amortized assets and liabilities and accumulated amortization) were as follows (in thousands):



	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	June 30, 2019			December 31, 2018			June 30, 2019			December 31, 2018			June 30, 2019			December 31, 2018
Cost	$	202,342		$	223,723		$	9,883		$	11,118		$	(36,682	)	$	(40,601	)
Accumulated Amortization	(111,484		)	(117,955		)	(6,431		)	(6,942		)	21,953			23,048
Net Amount	$	90,858		$	105,768		$	3,452		$	4,176		$	(14,729	)	$	(17,553	)

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, 2019 and 2018 were as follows (in thousands):



	Tenant Origination and Absorption Costs						Above-Market Lease Assets						Below-Market Lease Liabilities
	For the Three Months Ended June 30,						For the Three Months Ended June 30,						For the Three Months Ended June 30,
	2019			2018			2019			2018			2019		2018
Amortization	$	(7,209	)	$	(7,856	)	$	(347	)	$	(439	)	$	1,499	$	1,655



	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,
	2019			2018			2019			2018			2019		2018
Amortization	$	(14,419	)	$	(15,998	)	$	(724	)	$	(895	)	$	2,824	$	3,482

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, 2019

(unaudited)


5.	NOTES PAYABLE

As of June 30, 2019 and December 31, 2018, the Company’s notes payable consisted of the following (dollars in thousands):



	Book Value as of June 30, 2019			Book Value as of December 31, 2018			Contractual Interest Rate as of June 30, 2019 ⁽¹⁾	Effective Interest Rate as of June 30, 2019 ⁽¹⁾	Payment Type	Maturity Date ⁽²⁾
Portfolio Loan ⁽³⁾ ⁽⁴⁾	$	84,484		$	84,484		One-month LIBOR + 1.90%	4.34%	Interest Only	06/01/2020
222 Main Mortgage Loan ⁽³⁾	96,518			97,522			3.97%	3.97%	Principal & Interest	03/01/2021
Anchor Centre Mortgage Loan	49,345			49,647			One-month LIBOR + 1.50%	3.94%	Principal & Interest	06/01/2020
171 17th Street Mortgage Loan ⁽³⁾	84,045			84,460			One-month LIBOR + 1.45%	3.89%	Principal & Interest	09/01/2019
Reston Square Mortgage Loan ⁽³⁾	29,304			29,479			One-month LIBOR + 1.50%	3.87%	Principal & Interest	02/01/2020
101 South Hanley Mortgage Loan ⁽³⁾	43,651			43,090			One-month LIBOR + 1.55%	3.94%	Principal & Interest	01/01/2020
3003 Washington Boulevard Mortgage Loan ⁽⁵⁾	—			90,378			⁽⁵⁾	⁽⁵⁾	⁽⁵⁾	⁽⁵⁾
201 17th Street Mortgage Loan ⁽⁶⁾	64,428			64,428			One-month LIBOR + 1.40%	3.62%	Interest Only	08/01/2019
CrossPoint at Valley Forge Mortgage Loan ^{(3) (7)}	51,000			51,000			One-month LIBOR + 1.50%	3.33%	Interest Only⁽⁷⁾	09/01/2022
The Almaden Mortgage Loan	93,000			93,000			4.20%	4.20%	Interest Only	01/01/2022
Promenade I & II at Eilan Mortgage Loan ⁽³⁾	37,300			37,300			One-month LIBOR + 1.75%	3.57%	Interest Only	10/01/2022
201 Spear Street Mortgage Loan	125,000			125,000			One-month LIBOR + 1.45%	3.88%	Interest Only	01/05/2024
Carillon Mortgage Loan ⁽⁸⁾	111,000			92,197			One-month LIBOR + 1.40%	3.31%	Interest Only	04/11/2024
3001 Washington Boulevard Mortgage Loan⁽⁹⁾	—			32,662			⁽⁹⁾	⁽⁹⁾	⁽⁹⁾	⁽⁹⁾
Hardware Village Loan Facility ⁽¹⁰⁾	63,626			49,664			One-month LIBOR + 3.25%	5.67%	Interest Only	02/23/2020
Portfolio Loan Facility ⁽¹¹⁾	932,500			893,500			One-month LIBOR + 1.80%	3.84%	Interest Only	11/03/2020
Village Center Station II Loan ⁽³⁾	77,875			78,343			One-month LIBOR + 1.70%	4.14%	Principal & Interest	03/01/2022
Portfolio Revolving Loan Facility ⁽¹²⁾	200,000			200,000			One-month LIBOR + 1.50%	3.77%	Interest Only	11/01/2021
3001 & 3003 Washington Mortgage Loan ^{(7) (13)}	143,245			—			One-month LIBOR + 1.45%	3.89%	Interest Only⁽⁷⁾	06/01/2024
Total notes payable principal outstanding	2,286,321			2,196,154
Deferred financing costs, net	(10,553		)	(11,616		)
Total notes payable, net	$	2,275,768		$	2,184,538

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, 2019

(unaudited)

_____________________

⁽¹⁾ Contractual interest rate represents the interest rate in effect under the loan as of June 30, 2019. Effective interest rate is calculated as the actual interest rate in effect as of June 30, 2019 (consisting of the contractual interest rate and the effect of interest rate swaps and caps, if applicable), using interest rate indices as of June 30, 2019, where applicable. For further information regarding the Company's derivative instruments, see Note 6, “Derivative Instruments.”

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

⁽³⁾ In connection with the Portfolio Sale on July 18, 2019, the Company repaid the entire principal balance and all other sums due under this loan. See Note 10, “Subsequent Events - Portfolio Sale and Related Transactions” for more information.

⁽⁴⁾ As of June 30, 2019, the Portfolio Loan was secured by Tower on Lake Carolyn, Park Place Village and Village Center Station. The face amount of the Portfolio Loan is $169.0 million, of which $84.5 million is term debt and $84.5 million is revolving debt. As of June 30, 2019, the outstanding balance under the loan consisted of $84.5 million, all of which was term debt.

⁽⁵⁾ On May 21, 2019, the 3003 Washington Boulevard Mortgage Loan was paid off when the Company entered into the 3001 & 3003 Washington Mortgage Loan. See below, “Recent Financing Transactions - 3001 & 3003 Washington Mortgage Loan.”

⁽⁶⁾ Subsequent to June 30, 2019, the 201 17th Street Mortgage Loan maturity date was extended to August 1, 2020.

⁽⁷⁾ Represents the payment type required as of June 30, 2019. Certain future monthly payments due under the loan also include amortizing principal payments. For more information on the Company’s contractual obligations under its notes payable, see the five-year maturity table below.

⁽⁸⁾ See below, “Recent Financing Transactions - Carillon Mortgage Loan Refinancing.”

⁽⁹⁾ On February 1, 2019, the 3001 Washington Boulevard Mortgage Loan was paid off.

⁽¹⁰⁾As of June 30, 2019, $63.6 million had been disbursed under the Hardware Village Loan Facility and $10.4 million remained available for future disbursements, subject to certain conditions contained in the loan documents.

⁽¹¹⁾ As of June 30, 2019, the Portfolio Loan Facility was secured by RBC Plaza, Preston Commons, Sterling Plaza, One Washingtonian Center, Towers at Emeryville, Ten Almaden, Town Center and Accenture Tower. The face amount of the Portfolio Loan Facility was $1.01 billion, of which $757.5 million was term debt and $252.5 million was revolving debt. As of June 30, 2019, the outstanding balance under the loan consisted of $757.5 million of term debt and $175.0 million of revolving debt. As of June 30, 2019, an additional $77.5 million of revolving debt remained available for immediate future disbursements, subject to certain conditions set forth in the loan agreement. During the remaining term of the Portfolio Loan Facility, the Company has an option to increase the loan amount by up to an additional $400.0 million in increments of $25.0 million, to a maximum of $1.41 billion, of which 75% would be term debt and 25% would be revolving debt, subject to certain conditions contained in the loan documents. In connection with the sale of One Washingtonian Center and a building at Towers at Emeryville on July 18, 2019, the Company repaid a portion of the principal balance under this loan. As a result, the revised face amount of the Portfolio Loan Facility is $912.3 million, of which $684.2 million is term debt and $228.1 million is revolving debt. Subsequent to the repayment, the outstanding balance under the loan consisted of $684.2 million of term debt and the additional $228.1 million of revolving debt remained available for immediate future disbursements, subject to certain conditions set forth in the loan agreement. See Note 10, “Subsequent Events - Portfolio Sale and Related Transactions” for more information.

⁽¹²⁾ As of June 30, 2019, the Portfolio Revolving Loan Facility was secured by 515 Congress, Domain Gateway, the McEwen Building, and Gateway Tech Center. The face amount of the Portfolio Loan Facility is $215.0 million, of which $107.5 million is term debt and $107.5 million is revolving debt. As of June 30, 2019, the outstanding balance under the loan consisted of $107.5 million of term debt and $92.5 million of revolving debt. As of June 30, 2019, the remaining $15.0 million of revolving debt remained available for future disbursements upon the Company meeting certain conditions set forth in the loan agreement. During the remaining term of the Portfolio Revolving Loan Facility, the Company has an option to increase the committed amount of the Portfolio Revolving Loan Facility up to four times with each increase of the committed amount to be at least $15.0 million but no greater than, in the aggregate, an additional $170.0 million so that the committed amount will not exceed $385.0 million, of which 50% would be non-revolving debt and 50% would be revolving debt, with the addition of one or more properties to secure the loan, subject to certain terms and conditions contained in the loan documents.

⁽¹³⁾ See below, “Recent Financing Transactions - 3001 & 3003 Washington Mortgage Loan.”

As of June 30, 2019, the Company’s deferred financing costs were $13.0 million, net of amortization, of which $10.6 million was included in notes payable, net and $2.4 million was included in prepaid expenses and other assets on the accompanying consolidated balance sheets. As of December 31, 2018, the Company’s deferred financing costs were $11.7 million, net of amortization, of which $11.6 million was included in notes payable, net and $0.1 million was included in prepaid expenses and other assets on the accompanying consolidated balance sheets.

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, 2019

(unaudited)

During the three and six months ended June 30, 2019, the Company incurred $47.4 million and $85.4 million of interest expense, respectively. During the three and six months ended June 30, 2018, the Company incurred $12.5 million and $13.3 million of interest expense, respectively. Included in interest expense was: (i) the amortization of deferred financing costs of $1.6 million and $3.2 million for the three and six months ended June 30, 2019, respectively, and $1.6 million and $3.3 million for the three and six months ended June 30, 2018, respectively, and (ii) interest expense (including gains and losses) incurred as a result of the Company’s derivative instruments, which increased interest expense by $22.0 million and $35.3 million for the three and six months ended June 30, 2019, respectively, and reduced interest expense by $7.2 million and $24.1 million for the three and six months ended June 30, 2018, respectively. Additionally, the Company capitalized $0.6 million and $1.1 million of interest related to construction in progress during the three and six months ended June 30, 2019, respectively, and $1.1 million and $2.1 million of interest related to construction in progress during the three and six months ended June 30, 2018, respectively. As of June 30, 2019 and December 31, 2018, $7.4 million and $6.8 million of interest expense were payable, respectively.

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



July 1, 2019 through December 31, 2019	$	150,723
2020	1,205,338
2021	294,894
2022	256,121
2023	—
Thereafter	379,245
	$	2,286,321

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

Recent Financing Transactions

Carillon Mortgage Loan Refinancing

On April 11, 2019, the Company, through an indirect wholly owned subsidiary, entered into an amended and restated term loan agreement with the lender of the Carillon Mortgage Loan to increase the aggregate borrowing commitment amount to up to $111.0 million (the “Carillon Mortgage Loan Refinancing”), of which $88.8 million is term debt and $22.2 million is revolving debt. At closing, $111.0 million was funded. The Carillon Mortgage Loan Refinancing matures on April 11, 2024, with one 24-month extension option, subject to certain terms, conditions and fees as described in the loan documents. The Company will have the right to prepay all or a portion of the Carillon Mortgage Loan Refinancing, subject to certain conditions contained in the loan documents.

3001 & 3003 Washington Mortgage Loan

On May 21, 2019, the Company, through an indirect wholly owned subsidiary (the “3001 & 3003 Washington Borrower”), entered into a five-year mortgage loan with an unaffiliated lender, for a committed amount of up to $145.2 million (the “3001 & 3003 Washington Mortgage Loan”). At closing, $143.2 million was funded under the 3001 & 3003 Washington Mortgage Loan with an additional $2.0 million available through two $1.0 million earn-out advances upon satisfaction of certain conditions set forth in the loan documents.

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, 2019

(unaudited)

The 3001 & 3003 Washington Mortgage Loan matures on June 1, 2024. The 3001 & 3003 Washington Mortgage Loan bears interest at a floating rate of 145 basis points over one-month LIBOR during the term of the loan. Monthly payments are initially interest only, with monthly payments commencing on June 1, 2022 to include principal and interest with principal payments calculated using an amortization schedule of 30 years at an interest rate of 6.00% per annum. The 3001 & 3003 Washington Borrower has the right to repay the loan in part and in whole without fee, premium or penalty subject to certain conditions as described in the loan documents.

Under the guaranty agreement related to 3001 & 3003 Washington Mortgage Loan (the “Guaranty”), KBS REIT Properties III, LLC (“REIT Properties III”) (i) provides a guaranty of, among other sums described in the Guaranty, all principal and interest outstanding under the 3001 & 3003 Washington Mortgage Loan in the event of certain bankruptcy or insolvency proceedings involving REIT Properties III, any 3001 & 3003 Washington Borrower or any of their affiliates and (ii) guarantees payment of, and agrees to protect, defend, indemnify and hold harmless each lender for, from and against, any deficiency, loss or damage suffered by any lender because of (a) certain intentional acts committed by any 3001 & 3003 Washington Borrower or (b) certain bankruptcy or insolvency proceedings involving REIT Properties III, any 3001 & 3003 Washington Borrower or any of their affiliates, as such acts are described in the Guaranty.


6.	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.

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, 2019

(unaudited)

The following table summarizes the notional amount and other information related to the Company’s interest rate swaps and cap as of June 30, 2019 and December 31, 2018. 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, 2019			December 31, 2018				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, 2019	Weighted-Average Fix Pay Rate	Weighted-Average Remaining Term in Years
Derivative instruments not designated as hedging instruments
Interest rate swaps	12	$	1,375,574	14	$	1,208,957	One-month LIBOR/ Fixed at 1.67% - 2.51%	2.14%	3.1
Interest rate cap	—	$	—	1	$	100,000	—	—%	—

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, 2019 and December 31, 2018 (dollars in thousands):



		June 30, 2019				December 31, 2018
Derivative Instruments	Balance Sheet Location	Number of Instruments	Fair Value			Number of Instruments	Fair Value
Derivative instruments not designated as hedging instruments
Interest rate swaps ⁽¹⁾	Prepaid expenses and other assets, at fair value	—	$	—		14	$	15,909
Interest rate swaps ⁽¹⁾	Other liabilities, at fair value	12	$	(22,445	)	—	$	—
Interest rate cap	Prepaid expenses and other assets, at fair value	—	$	—		1	$	—

_____________________

⁽¹⁾ During the six months ended June 30, 2019, the Company terminated two interest rate swaps and realized a gain of $0.5 million, which was recorded as an offset to interest expense.

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, 2019

(unaudited)

The change in fair value of the effective portion of a derivative instrument that is designated as a cash flow hedge is recorded as other comprehensive income (loss) on the accompanying consolidated statements of comprehensive income (loss) and as other comprehensive income on the accompanying consolidated statements of 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 are 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,
	2019			2018			2019			2018
Income statement related
Derivatives designated as hedging instruments
Amount of (income) expense recognized on interest rate swaps (effective portion)	$	—		$	(96	)	$	—		$	(108	)
	—			(96		)	—			(108		)
Derivatives not designated as hedging instruments
Realized (gain) loss recognized on interest rate swaps	(1,238		)	201			(2,627		)	1,309
Unrealized loss (gain) on interest rate swaps	23,280			(7,289		)	37,899			(25,326		)
	22,042			(7,088		)	35,272			(24,017		)
Increase (decrease) in interest expense as a result of derivatives	$	22,042		$	(7,184	)	$	35,272		$	(24,125	)

Other comprehensive income related
Unrealized (losses) income on derivative instruments	$	—		$	(1	)	$	—		$	83

During the three and six months ended June 30, 2019 and 2018, there was no ineffective portion related to the change in fair value of the derivative instruments designated as cash flow hedges.


7.	FAIR VALUE DISCLOSURES

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


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


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


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

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST III, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

June 30, 2019

(unaudited)

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

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

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.

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



	June 30, 2019						December 31, 2018
	Face Value		Carrying Amount		Fair Value		Face Value		Carrying Amount		Fair Value
Financial liabilities:
Notes payable	$	2,286,321	$	2,275,768	$	2,295,347	$	2,196,154	$	2,184,538	$	2,202,587

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.

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, 2019

(unaudited)

As of June 30, 2019, the Company measured the following assets 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	$	22,445	$	—	$	22,445	$	—

As of March 31, 2019, the Company measured the following asset at fair value on a nonrecurring basis (in thousands):



			Fair Value Measurements Using
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Nonrecurring Basis:
Impaired real estate ⁽¹⁾	$	103,000	$	—	$	—	$	103,000

_____________________

⁽¹⁾ Amount represents the fair value for a real estate asset impacted by an impairment charge during the year, as of the date that the fair value measurement was made. The carrying value for the real estate asset may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date. See Note 3, “Real Estate – Impairment of Real Estate” for a further discussion on the impaired real estate property.

During the six months ended June 30, 2019, one of the Company’s real estate properties was measured at its estimated fair value based on a discounted cash flow approach. See Note 3, “Real Estate – Impairment of Real Estate” for a further discussion on the impaired real estate property.


8.	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/or the Dealer Manager to specified fees upon the provision of certain services with regard to the Offering and reimbursement of organization and offering costs incurred by the Advisor and the Dealer Manager on behalf of the Company 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/or the Dealer Manager to reimbursement of offering costs related to the dividend reinvestment plan incurred by the Advisor and the Dealer Manager on behalf of the Company 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 or served as the advisor and dealer manager, respectively, for KBS Real Estate Investment Trust, Inc. (“KBS REIT I”) (which liquidated in December 2018), KBS Real Estate Investment Trust II, Inc. (“KBS REIT II”), KBS Strategic Opportunity REIT, Inc. (“KBS Strategic Opportunity REIT”), KBS Legacy Partners Apartment REIT, Inc. (“KBS Legacy Partners Apartment REIT”) (which liquidated in December 2018), KBS Strategic Opportunity REIT II, Inc. (“KBS Strategic Opportunity REIT II”) and KBS Growth & Income REIT, Inc. (“KBS Growth & Income REIT”).

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, 2019

(unaudited)

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

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, 2019 and 2018, respectively, and any related amounts payable as of June 30, 2019 and December 31, 2018 (in thousands):



	Incurred								Payable as of
	Three Months Ended June 30,				Six Months Ended June 30,				June 30,		December 31,
	2019		2018		2019		2018		2019		2018
Expensed
Asset management fees ⁽¹⁾	$	6,999	$	6,738	$	13,871	$	13,358	$	2,314	$	2,559
Reimbursement of operating expenses ^{(2) (3)}	636		956		1,163		1,102		1,378		734
Disposition fees ⁽⁴⁾	—		429		—		429		—		—
Capitalized
Acquisition fee on development project	88		110		133		179		1,049		916
Acquisition fee on unconsolidated joint venture	—		69		—		162		—		—
	$	7,723	$	8,302	$	15,167	$	15,230	$	4,741	$	4,209

_____________________

⁽¹⁾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 $78,000 and $148,000 for the three and six months ended June 30, 2019, respectively, and $85,000 and $173,000 for the three and six months ended June 30, 2018, respectively, and were the only type of employee costs reimbursed under the Advisory Agreement for the three and six months ended June 30, 2019 and 2018, 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.

⁽³⁾ Reimbursement of operating expenses includes $0.6 million and $1.0 million of costs incurred related to the Portfolio Sale for the three and six months ended June 30, 2019, respectively. The Company and the Advisor had agreed to evenly divide certain costs and expenses related to the Portfolio Sale. These costs include legal, audit, tax, printing and other out of pocket costs that the Company incurred related to the Portfolio Sale, which were reimbursable by the Purchaser upon the closing of the Portfolio Sale on July 18, 2019.

⁽⁴⁾ Disposition fees with respect to real estate sold are included in the gain on sale of real estate, net, in the accompanying consolidated statements of operations.

In connection with the Offering, Messrs. Bren, Hall, McMillan and Schreiber 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 Messrs. Bren, Hall, McMillan and Schreiber’s obligations under this indemnification agreement in exchange for reimbursement by Messrs. Bren, Hall, McMillan and Schreiber to the Company for all costs, expenses and premiums related to this supplemental coverage.

During the six months ended June 30, 2018, the Advisor reimbursed the Company for a $0.2 million property insurance rebate.

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, 2019

(unaudited)

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 Institute for Portfolio Alternatives (formerly known as the Investment Program Association) 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.

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 December 31, 2018, the Company had accrued and deferred payment of $2.6 million of asset management fees under the Advisory Agreement, which were subsequently paid in February 2019. As of June 30, 2019, the Company had $2.3 million of asset management fees payable related to asset management fees incurred for the month of June 2019, which were subsequently paid in July 2019.

Lease to Affiliate

On May 29, 2015, the indirect wholly owned subsidiary (the “Lessor”) of the Company that owns 3003 Washington Boulevard entered into a lease with an affiliate of the Advisor (the “Lessee”) 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, 2019, adjusted to straight-line any contractual tenant concessions (including free rent) and rent increases from the lease’s inception through the balance of the initial lease term, for this lease is approximately $0.2 million, and the average annual rental rate (net of rental abatements) over the lease term is $46.38 per square foot.

On March 14, 2019, the Lessor entered into a First Amendment to Deed of Lease with the Lessee to extend the lease period commencing on September 1, 2019 and terminating on August 31, 2024 (the “Amended Lease”) and set the annual base rent during the extension period. The annualized base rent from the commencement of the Amended Lease is approximately $0.3 million, and the average annual rental rate (net of rental abatements) over the term of the Amended Lease through its termination is $62.55 per square foot.

During the three and six months ended June 30, 2019, the Company recognized $60,000 and $120,000 of revenue related to this lease, respectively. During the three and six months ended June 30, 2018, the Company recognized $60,000 and $120,000 of revenue related to this lease, respectively.

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

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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, 2019

(unaudited)

Purchase and Sale Agreement for Portfolio Sale

On June 27, 2019, the Company, through 12 wholly owned subsidiaries, entered into a Portfolio Purchase and Sale Agreement and Escrow Instructions (the “Purchase Agreement”) pursuant to which the Company agreed to sell the Portfolio (as defined below in Note 10 “Subsequent Events - Portfolio Sale and Related Transactions”) to various subsidiaries of a newly formed real estate investment trust (the “Purchaser”) (the “Portfolio Sale”). The Purchaser is affiliated with Charles J. Schreiber, Jr., the Company’s Chief Executive Officer, Chairman of the Board and one of the Company’s directors.

As part of the Portfolio Sale, on June 27, 2019, REIT Properties III entered into a Subscription Agreement (the “Subscription Agreement”) with the Purchaser’s Manager (defined below) to subscribe for $201.0 million of the units to be issued by the Purchaser. Subsequent to June 30, 2019, an additional $70 million of units was subscribed for by REIT III Properties under the placement tranche of the Purchaser’s offering. Pursuant to a set-off agreement entered on June 27, 2019, the Company agreed that the Purchaser may deduct from the aggregate purchase price due from the Purchaser under the Purchase Agreement the subscription amount to be paid by REIT Properties III for the units under the Subscription Agreement.

The Purchaser is externally managed by a joint venture (the “Manager”) among KBS Asia Partners Pte. Ltd., an entity in which Charles J. Schreiber, Jr. currently holds an indirect 50% ownership interest, and other entities unaffiliated with the Company. The Purchaser is expected to pay the Manager an annual base fee of 10% of annual distributable income and an annual performance fee of 25% of the increase in distributions per unit of the Purchaser from the preceding year; however, there would not be any performance fee for 2019 and in 2020 such fee will be based on an increase over projected distributions per unit. In addition, for future acquisitions, the Purchaser will pay the Manager an acquisition fee of 1% of the acquisition price of any real estate acquired. No acquisition fee will be paid with respect to the Purchaser’s acquisition of the Portfolio. The Purchaser will also pay the Manager a divestment fee of 0.5% of the sale price of any real estate sold or divested and a development management fee of 3% of the total project costs incurred for development projects, to the extent the Purchaser acquires a development project. A small portion of these fees paid to the Manager will be paid to KBS Realty Advisors LLC, an affiliate of the Advisor and an entity controlled by Mr. Schreiber, for sub-advisory services. The Schreiber Trust, a trust whose beneficiaries are Charles J. Schreiber, Jr. and his family members, and the Linda Bren 2017 Trust will subscribe for units to be issued by the Purchaser. In addition, Barbara R. Cambon, one of the Company’s former directors, accepted the positions of Chief Executive Officer and Chief Investment Officer of the Manager and will receive compensation for her services. In connection with her acceptance of these positions, Ms. Cambon resigned from the Company’s board of directors effective June 26, 2019.

See Note 10, “Subsequent Events - Portfolio Sale and Related Transactions”

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

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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, 2019

(unaudited)


9.	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, 2019.


10.	SUBSEQUENT EVENTS

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

Distributions Paid

On July 1, 2019, the Company paid distributions of $9.5 million, which related to distributions in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on June 18, 2019. On August 1, 2019, the Company paid distributions of $9.5 million, which related to distributions in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on July 19, 2019.

Distributions Authorized

On August 8, 2019, the Company’s board of directors authorized an August 2019 distribution in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on August 19, 2019, which the Company expects to pay in September 2019, and a September 2019 distribution in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on September 20, 2019, which the Company expects to pay in October 2019.

Investors may choose to receive cash distributions or purchase additional shares through the Company’s dividend reinvestment plan.

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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, 2019

(unaudited)

Portfolio Sale and Related Transactions

On July 18, 2019, the Company, through 12 wholly owned subsidiaries, sold 11 of its properties (the “Portfolio”) to various subsidiaries of the Purchaser. The sale price of the Portfolio was $1.2 billion, before third-party closing costs and credits of approximately $16.1 million and excluding any disposition fees payable to the Advisor. The Portfolio consists of the following properties: Tower I at Emeryville, Emeryville, California; 222 Main, Salt Lake City, Utah; Village Center Station, Greenwood Village, Colorado; Village Center Station II, Greenwood Village, Colorado; 101 South Hanley, St. Louis, Missouri; Tower on Lake Carolyn, Irving, Texas; Promenade I & II at Eilan, San Antonio, Texas; CrossPoint at Valley Forge, Wayne, Pennsylvania; One Washingtonian Center, Gaithersburg, Maryland; Reston Square, Reston, Virginia; and 171 17th Street, Atlanta, Georgia.

In connection with the Portfolio Sale, the Company repaid $613.1 million of outstanding debt secured by the properties in the Portfolio. Pursuant to a set-off agreement, as amended, $271.0 million of the consideration payable by the Purchaser under the Purchase Agreement was set-off against REIT Properties III’s payment obligations for its two subscriptions for units in the Purchaser: (i) the $201 million of units subscribed for by REIT Properties III pursuant to the Subscription Agreement, as amended, and (ii) $70 million of units subscribed for by REIT Properties III under the placement tranche of the Purchaser’s offering. As such, on July 19, 2019, REIT Properties III acquired 307,953,999 units in the Purchaser at an aggregate price of $271 million representing a 33.3% ownership interest in the Purchaser. Currently, the Purchaser does not own any properties other than the Portfolio.

Also on July 15, 2019, REIT Properties III entered into a placement agreement (the “Placement Agreement”) and unit lending agreement (the “Unit Lending Agreement”) with respect to an offering of units of the Purchaser. REIT Properties III is a party to the Placement Agreement as unit lender, and pursuant to the Placement Agreement, REIT Properties III has granted the underwriters in the offering an over-allotment option (the “Over-Allotment Option”) in which REIT Properties III agreed to sell to the underwriters up to 22,727,000 of REIT Properties III’s units in the Purchaser at the offering price. The Over-Allotment Option is exercisable for up to 30 days after the listing of the units of the Purchaser. Any units purchased pursuant to the Over-Allotment Option would reduce REIT Properties III’s ownership interest in the Purchaser. Pursuant to the Unit Lending Agreement, REIT Properties III agreed to lend the 22,727,000 units subject to the Over-Allotment Option to the stabilizing manager of the offering for the purpose of facilitating the settlement of the over-allotment of units in connection with the Purchaser’s offering. The stabilizing manager will re-deliver to REIT Properties III such number of units that are not purchased pursuant to the exercise of the Over-Allotment Option.

On July 8, 2019, the Company, the Operating Partnership, REIT Holdings III and REIT Properties III (collectively, the “REIT III Entities”) entered into lock-up letter agreements with the underwriters whereby each of the REIT III Entities agreed to hold 100% of REIT Properties III’s units in the Purchaser for six months following the listing of the Purchaser and to hold 50% of REIT Properties III’s units in the Purchaser for 12 months following the listing of the Purchaser. During the respective lock-up periods, without the prior written consent of the underwriters and other than pursuant to the Over-Allotment Option or lending for stabilizing transactions pursuant to the Unit Lending Agreement (described above), the REIT III Entities may not offer, sell, pledge, option, grant any rights or warrants, or enter into any swap, hedge or other similar arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the units held by REIT Properties III.

The units in the Purchaser have not been and will not be registered under the Securities Act of 1933, as amended (the “Securities Act”), and may not be offered or sold in the United States except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act. Accordingly, with the exception of the units sold to REIT Properties III, The Schreiber Trust and the Linda Bren 2017 Trust, the units of the Purchaser are being offered and sold only outside the United States in an offshore transaction pursuant to Regulation S under the Securities Act.

Share Redemption Program

See Part II, Item 5 “Other Information,” for updated information about the Company’s share redemption program.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

The following discussion and analysis should be read in conjunction with the accompanying financial statements of KBS Real Estate Investment Trust 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 are dependent on KBS Capital Advisors LLC (“KBS Capital Advisors”), our advisor, to identify investments, to manage our investments and for the disposition of our investments.

•

All of our executive officers, our affiliated director 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 director, 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.

•

Our advisor and its affiliates receive fees in connection with transactions involving the purchase or origination, management and disposition of our investments. Acquisition and asset management 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. 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. These payments increase the risk that our stockholders will not earn a profit on their investment in us and increase the risk of loss to our stockholders.

•

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. From time to time during our operational stage, we may 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 any real estate-related investments, to the extent we make any such additional investments. If we pay distributions from sources other than our cash flow from operations, the overall return to our stockholders may be reduced.

•

We may incur debt until our total liabilities would exceed 75% of the cost of our tangible assets (before deducting depreciation and 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.

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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 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.

•

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.

•

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. 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.

•

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.

•

During any calendar year, we may redeem (i) 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 unless our board of directors authorizes additional funds for redemption and (ii) no more than 5% of the weighted average number of shares outstanding during the prior calendar year. As of July 31, 2019, we had $5.1 million available for Special Redemptions (defined herein) for the remainder of 2019. As of July 31, 2019, we had a total $40.9 million of outstanding and unfulfilled Ordinary Redemption (defined herein) requests, representing 3,583,572 shares. On August 8, 2019, our board of directors approved an increase of the funding available for Ordinary Redemptions for calendar year 2019 by up to an additional $40.0 million, which including redemptions fulfilled to date and the remaining amount reserved for Special Redemptions, increases the share redemption program to the maximum amount for 2019. Given the volume of redemption requests in 2019, and because of the limitations on the dollar amount of shares that may be redeemed under our share redemption program and the number of shares that may be redeemed during a calendar year, it is not likely that we will be able to redeem shares submitted as Ordinary Redemptions after the August 2019 redemption date and shares submitted as Ordinary Redemptions for the August 2019 redemption date will likely be honored on a pro rata basis pursuant to the terms of the share redemption program.

•

Although our board of directors has approved management’s recommendation to explore strategic alternatives for us, we are not obligated to pursue any particular transaction or any transaction at all. We can provide no assurance that we will be able to provide additional liquidity to stockholders. Stockholders may have to hold their shares for an indefinite period of time. Further, although we are exploring strategic alternatives, there is no assurance that this process will provide a return to stockholders that equals or exceeds our estimated value per share.

All forward-looking statements should be read in light of the risks identified in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission (the “SEC”), and in Part II, Item 1A herein.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

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, 2019, we owned 28 office properties and one mixed-use office/retail property and had entered into a consolidated joint venture to develop and subsequently operate a multifamily apartment project, which is currently under construction.

On June 27, 2019, we, through 12 wholly owned subsidiaries, entered into a Portfolio Purchase and Sale Agreement and Escrow Instructions (the “Purchase Agreement”) pursuant to which we agreed to sell 11 of our properties (the “Portfolio”) to various subsidiaries of a newly formed real estate investment trust (the “Purchaser”) (the “Portfolio Sale”). The Purchaser is affiliated with Charles J. Schreiber, Jr., our Chief Executive Officer, Chairman of the Board and one of our directors. The Portfolio consists of the following properties: Tower I at Emeryville, Emeryville, California; 222 Main, Salt Lake City, Utah; Village Center Station, Greenwood Village, Colorado; Village Center Station II, Greenwood Village, Colorado; 101 South Hanley, St. Louis, Missouri; Tower on Lake Carolyn, Irving, Texas; Promenade I & II at Eilan, San Antonio, Texas; CrossPoint at Valley Forge, Wayne, Pennsylvania; One Washingtonian Center, Gaithersburg, Maryland; Reston Square, Reston, Virginia; and 171 17th Street, Atlanta, Georgia. On July 18, 2019, we, through 12 wholly owned subsidiaries, sold the Portfolio to various subsidiaries of the Purchaser. The sale price of the Portfolio was $1.2 billion, before third-party closing costs and credits of approximately $16.1 million and excluding any disposition fees payable to our advisor. In connection with the Portfolio Sale, we repaid $613.1 million of outstanding debt secured by the properties in the Portfolio. Pursuant to a set-off agreement, as amended, $271.0 million of the consideration payable by the Purchaser under the Purchase Agreement was set-off against KBS REIT Properties III LLC’s, our indirect wholly owned subsidiary (“REIT Properties III”), payment obligations for its two subscriptions for units in the Purchaser: (i) the $201 million of units subscribed for by REIT Properties III pursuant to a subscription agreement, as amended, and (ii) $70 million of units subscribed for by REIT Properties III under the placement tranche of the Purchaser’s offering. As such, on July 19, 2019, REIT Properties III acquired 307,953,999 units in the Purchaser at an aggregate price of $271 million representing a 33.3% ownership interest in the Purchaser. Currently, the Purchaser does not own any properties other than the Portfolio. See “Subsequent Events - Portfolio Sale and Related Transactions.”

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.

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, 2019, we had also sold 30,244,405 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $307.3 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(a)(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.

Also as of June 30, 2019, we had redeemed or repurchased 24,527,469 shares sold in our initial public offering for $266.0 million.

On July 22, 2019, we announced that our board of directors has approved management’s recommendation to explore strategic alternatives in an effort to provide enhanced liquidity to our stockholders. These strategic alternatives include our potential conversion into an “NAV REIT” or strategic asset sales. An NAV REIT is a term generally used to describe a REIT that values its shares as often as daily but at least quarterly on a net asset value (“NAV”) basis and provides increased capacity to repurchase shares through its share redemption program. Although our board of directors has approved management’s recommendation to explore strategic alternatives for us, we are not obligated to pursue any particular transaction or any transaction at all.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Market Outlook – Real Estate and Real Estate Finance Markets

Volatility in global financial markets and changing political environments can cause fluctuations in the performance of the U.S. commercial real estate markets. Possible future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to renew tenants early, to retain tenants who are up for renewal or to attract new tenants, may result in decreases in cash flows from investment properties. To the extent there are increases in the cost of financing due to higher interest rates, this may cause difficulty in refinancing debt obligations at terms as favorable as the terms of existing indebtedness. Further, increases in interest rates would increase the amount of our debt payments on our variable rate debt to the extent the interest rates on such debt are not fixed through interest rate swap agreements or limited by interest rate caps. Market conditions can change quickly, potentially negatively impacting the value of real estate investments. Management continuously reviews our investment and debt financing strategies to optimize our portfolio and the cost of our debt exposure.

Liquidity and Capital Resources

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


•	Cash flow generated by our real estate investments;


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


•	Proceeds from the sale of our real estate properties; and


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

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 collectability of rent and operating recoveries from our tenants and how well we manage our expenditures.

As of June 30, 2019, we had mortgage debt obligations in the aggregate principal amount of $2.3 billion, with a weighted-average remaining term of 2.0 years. The maturity dates of certain loans may be extended beyond their current maturity date, subject to certain terms and conditions contained in the loan documents. Assuming our notes payable are fully extended under the terms of the respective loan agreements and other loan documents, we have $49.3 million of notes payables maturing and amortization payments due during the 12 months ending June 30, 2020. We plan to exercise our extension options available under our loan agreements or pay down or refinance the related notes payable prior to their maturity dates. As of June 30, 2019, our debt obligations consisted of $189.5 million of fixed rate notes payable and $2.1 billion of variable rate notes payable. As of June 30, 2019, the interest rates on $1.4 billion of our variable rate notes payable were effectively fixed through interest rate swap agreements. As discussed above, in connection with the Portfolio Sale on July 18, 2019, we repaid $613.1 million of outstanding debt secured by the properties in the Portfolio and made an additional $259.6 million of voluntary paydowns in July 2019 on four loans. As a result, as of July 31, 2019, we had $349.0 million of revolving debt available for immediate future disbursement under various loans, subject to certain conditions set forth in the loan agreements.

We paid distributions to our stockholders during the six months ended June 30, 2019 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, 2019 did not exceed the charter-imposed limitation.

Cash Flows from Operating Activities

During the six months ended June 30, 2019, net cash provided by operating activities was $44.9 million, compared to net cash provided by operating activities of $53.1 million during the six months ended June 30, 2018. Net cash provided by operating activities was higher in 2018 primarily as a result of the timing of payments of operating expenses and leasing commissions.

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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 Investing Activities

Net cash used in investing activities was $48.1 million for the six months ended June 30, 2019 and primarily consisted of the following:


•	$35.2 million used for improvements to real estate;


•	$14.0 million used for construction in progress related to Hardware Village;


•	$0.5 million of insurance proceeds received for property damage;


•	$0.9 million of escrow proceeds received for tenant improvements; and


•	$0.3 million used for post-closing acquisition costs related to the purchase of a joint venture partner’s equity interest in 2018.

Cash Flows from Financing Activities

During the six months ended June 30, 2019, net cash used in financing activities was $0.9 million and primarily consisted of the following:


•	$85.5 million of net cash provided by debt financing as a result of proceeds from notes payable of $283.8 million, partially offset by principal payments on notes payable of $193.6 million and payments of deferred financing costs of $4.7 million;


•	$55.6 million of cash used for redemptions and repurchases of common stock; and


•	$30.8 million of net cash distributions, after giving effect to distributions reinvested by stockholders of $26.5 million.

We expect that our debt financing and other liabilities will be between 45% and 65% of the cost of our tangible assets (before deducting depreciation and other non-cash reserves). There is no limitation on the amount we may borrow for the purchase of any single asset. We limit our total liabilities to 75% of the cost of our tangible assets (before deducting depreciation and other non-cash reserves), meaning that our borrowings and other liabilities may exceed our maximum target leverage of 65% of the cost of our tangible assets without violating these borrowing restrictions. We may exceed the 75% limit only if a majority of the conflicts committee approves each borrowing in excess of this limitation and we disclose such borrowings to our stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. 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. From time to time, our total liabilities could also be below 45% of the cost of our tangible assets due to the lack of availability of debt financing. As of June 30, 2019, our borrowings and other liabilities were approximately 63% of both the cost (before deducting depreciation and other noncash reserves) and book value (before deducting depreciation) of our tangible assets.

We also expect to use our capital resources to make certain payments to our advisor. During our operational stage, we expect to make payments to our advisor in connection with the acquisition 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. We reimburse our advisor and dealer manager for certain stockholder services.

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 is 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.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

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 Institute for Portfolio Alternatives (“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.

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% 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.

As of June 30, 2019, we had reimbursed our advisor for all accrued and deferred asset management fees in accordance with the terms noted above. The amount of asset management fees deferred, if any, 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 our real estate investments and other factors. In addition, deferrals and repayments may occur in the same period, and it is possible that there could be additional deferrals in the future. As of June 30, 2019, we had $2.3 million of asset management fees payable related to asset management fees incurred for the month of June 2019, which was subsequently paid in July 2019.

On September 27, 2018, 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, 2019 (in thousands):



			Payments Due During the Years Ended December 31,
Contractual Obligations	Total		Remainder of 2019		2020-2021		2022-2023		Thereafter
Outstanding debt obligations ⁽¹⁾	$	2,286,321	$	150,723	$	1,500,232	$	256,121	$	379,245
Interest payments on outstanding debt obligations ⁽²⁾	176,893		42,822		99,793		30,859		3,419
Development obligations ⁽³⁾	5,668		5,668		—		—		—

_____________________

⁽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, 2019 (consisting of the contractual interest rate and the effect of interest rate swaps, if applicable). We incurred interest expense of $45.3 million, excluding amortization of deferred financing costs totaling $3.2 million and unrealized losses on derivative instruments of $37.9 million and including interest capitalized of $1.1 million during the six months ended June 30, 2019.

⁽³⁾ We have entered into the Hardware Village joint venture to develop a two-building multifamily apartment complex consisting of 453 units and expect to incur approximately $5.7 million in additional development obligations through 2019. In July 2018, one of the two buildings consisting of 267 units was substantially completed. As of June 30, 2019, $63.6 million had been disbursed under the Hardware Village Loan Facility and $10.4 million remained available for future disbursements, subject to certain conditions contained in the Hardware Village Loan Facility documents.

As discussed above, in connection with the Portfolio Sale, we repaid $613.1 million of outstanding debt secured by the properties in the Portfolio on July 18, 2019.

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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, 2018, we owned 27 office properties and one mixed-use office/retail property and had made an investment in an unconsolidated joint venture to develop and operate an office/retail property (“Village Center Station II”). In addition, we had entered into a consolidated joint venture to develop and subsequently operate a multifamily apartment project (“Hardware Village”). The construction of Village Center Station II was substantially completed in May 2018, and in October 2018, we purchased the unaffiliated developer's 25% equity interest and consolidated Village Center Station II. In addition, one of the two apartment buildings consisting of 267 units at Hardware Village was completed and placed in service in July 2018. As a result, as of June 30, 2019, we owned 28 office properties and one mixed-use office/retail property and had entered into the Hardware Village joint venture. As a result, the results of operations presented for the six months ended June 30, 2019 and 2018 are not directly comparable.

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

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



	Three Months Ended June 30,						Increase (Decrease)			Percentage Change		$ Changes Due to Properties Completed and Disposed ⁽¹⁾			$ Change Due to Properties Held Throughout Both Periods ⁽²⁾
	2019			2018			Increase (Decrease)			Percentage Change		$ Changes Due to Properties Completed and Disposed ⁽¹⁾			$ Change Due to Properties Held Throughout Both Periods ⁽²⁾
Rental income	$	105,843		$	98,794		$	7,049		7	%	$	1,793		$	5,256
Other operating income	8,666			8,782			(116		)	(1	)%	204			(320		)
Operating, maintenance and management costs	26,279			24,301			1,978			8	%	347			1,631
Real estate taxes and insurance	18,418			18,487			(69		)	—	%	145			(214		)
Asset management fees to affiliate	6,999			6,738			261			4	%	189			72
General and administrative expenses	1,907			2,012			(105		)	(5	)%	n/a			n/a
Depreciation and amortization	41,632			39,025			2,607			7	%	2,269			338
Interest expense	47,403			12,517			34,886			279	%	n/a			n/a
Other income	9			1,575			(1,566		)	(100	)%	—			(1,566		)
Other interest income	192			84			108			129	%	n/a			n/a
Loss from extinguishment of debt	(196		)	—			(196		)	(100	)%	—			(196		)
Equity in income of unconsolidated joint venture	—			(348		)	348			(100	)%	348			—
Gain on sale of real estate, net	—			11,942			(11,942		)	(100	)%	(11,942		)	—

_____________________

⁽¹⁾ Represents the dollar amount increase (decrease) for the three months ended June 30, 2019 compared to the three months ended June 30, 2018 related to real estate developments completed and real estate investments disposed of on or after April 1, 2018.

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

Rental income from our real estate properties increased from $98.8 million for the three months ended June 30, 2018 to $105.8 million for the three months ended June 30, 2019. The increase in rental income was primarily due to an increase in rental rates, lease termination fees, property tax recoveries as a result of property tax reassessments and operating expense recoveries in properties held throughout both periods, as well as the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II and Hardware Village West, partially offset by the sale of Rocklin Corporate Center in May 2018. We expect rental income to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, rental income would vary in future periods based on occupancy rates and rental rates of our real estate investments and increase based on the completion of development and the subsequent full operation of Hardware Village.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Other operating income decreased from $8.8 million during the three months ended June 30, 2018 to $8.7 million for the three months ended June 30, 2019. The decrease in other operating income was primarily due to a decrease in parking revenues for properties held throughout both periods, partially offset by the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II. We expect other operating income to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, other operating income would vary in future periods based on occupancy rates and parking rates at our real estate properties.

Operating, maintenance and management costs increased from $24.3 million for the three months ended June 30, 2018 to $26.3 million for the three months ended June 30, 2019. The increase in operating, maintenance and management costs was primarily a result of the operation of Hardware Village West, which was completed in July 2018, and an increase in repair and maintenance costs, an increase in property management fees and an increase in legal fees related to leasing for properties held throughout both periods, partially offset by the sale of Rocklin Corporate Center in May 2018. Upon adoption of the lease accounting standards of Topic 842, beginning January 1, 2019, as a lessor, we record legal costs incurred to negotiate an operating lease as an expense, as these costs are no longer capitalizable under the definition of initial direct costs under Topic 842. Prior to January 1, 2019, these legal costs were capitalized and included in real estate, cost. We expect operating, maintenance and management costs to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, operating, maintenance and management costs would increase in future periods as a result of the completion of development and the subsequent full operation of Hardware Village and general inflation.

Real estate taxes and insurance decreased from $18.5 million for the three months ended June 30, 2018 to $18.4 million for the three months ended June 30, 2019. The decrease in real estate taxes and insurance was primarily due to lower property taxes as a result of property tax reassessments for properties held throughout both periods, partially offset by higher real estate taxes for Hardware Village West which was placed into service in July 2018. We expect real estate taxes and insurance to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, real estate taxes and insurance would increase in future periods as a result of the development and subsequent full operation of Hardware Village, general inflation and general increases due to future property tax reassessments.

Asset management fees with respect to our real estate investments increased from $6.7 million for the three months ended June 30, 2018 to $7.0 million for the three months ended June 30, 2019 due to the increase in capital improvements for properties held throughout both periods, the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II and the operation of Hardware Village West, partially offset by the sale of Rocklin Corporate Center in May 2018. We expect asset management fees to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, we expect asset management fees to increase in future periods as a result of the development and subsequent full operation of Hardware Village and as a result of any improvements we make to our properties. As of June 30, 2019, we had $2.3 million of asset management fees payable related to asset management fees incurred for the month of June 2019, which was subsequently paid in July 2019.

General and administrative expenses decreased from $2.0 million for the three months ended June 30, 2018 to $1.9 million for the three months ended June 30, 2019. The decrease in general and administrative expenses was primarily due to professional fees incurred in 2018 related to the Portfolio Sale. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. We have agreed with our advisor to evenly divide certain costs and expenses related to the Portfolio Sale. We expect general and administrative expenses to vary in future periods.

Depreciation and amortization increased from $39.0 million for the three months ended June 30, 2018 to $41.6 million for the three months ended June 30, 2019, primarily due to the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II, the operation of Hardware Village West and accelerated depreciation and amortization due to early lease terminations for properties held throughout both periods. We expect depreciation and amortization to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, depreciation and amortization would vary in future periods as a result of a decrease in amortization related to fully amortized tenant origination and absorption costs, offset by an increase as a result of the development and subsequent full operation of Hardware Village.

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PART I. FINANCIAL INFORMATION (CONTINUED)

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

Interest expense increased from $12.5 million for the three months ended June 30, 2018 to $47.4 million for the three months ended June 30, 2019. Included in interest expense was (i) $19.0 million and $24.1 million of interest expense payments for the three months ended June 30, 2018 and 2019, respectively, (ii) the amortization of deferred financing costs of $1.6 million and $1.6 million for the three months ended June 30, 2018 and 2019, respectively, and (iii) interest expense (including gains and losses) incurred as a result of our derivative instruments, which reduced interest expense by $7.2 million for the three months ended June 30, 2018 and increased interest expense by $22.0 million for the three months ended June 30, 2019. Additionally, during the three months ended June 30, 2018 and 2019, we capitalized $1.1 million and $0.6 million of interest related to construction in progress, respectively. The increase in interest expense was primarily due to changes in fair values with respect to our interest rate swaps that are not accounted for as cash flow hedges, a higher 30-day LIBOR rate and an increased level of borrowing. We expect interest expense to decrease in future periods due to the repayment of debt related to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, interest expense would increase in future periods as a result of additional borrowings for capital expenditures and development activity. Our interest expense in future periods will also vary based on fair value changes with respect to our interest rate swaps that are not accounted for as cash flow hedges and fluctuations in one-month LIBOR (for our variable rate debt).

During the three months ended June 30, 2018, we recognized $1.6 million of other income as a result of a reduction in contingent liability during the second quarter of 2018.

During the three months ended June 30, 2019, we recognized a loss from extinguishment of debt of $0.2 million related to the write-off of unamortized deferred financing costs as a result of the early pay-off of the 3003 Washington Boulevard Mortgage Loan.

During the three months ended June 30, 2018, we recognized $0.3 million in equity in income of unconsolidated joint venture related to operations of Village Center Station II. On October 11, 2018, we purchased the developer’s 25% equity interest and accounted for Village Center Station II on a consolidated basis.

During the three months ended June 30, 2018, we sold one office property that resulted in a gain on sale of $11.9 million. We did not dispose of any properties during the three months ended June 30, 2019.

Comparison of the six months ended June 30, 2019 versus the six months ended June 30, 2018

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



	Six Months Ended June 30,						Increase (Decrease)			Percentage Change		$ Changes Due to Properties Completed and Disposed ⁽¹⁾			$ Change Due to Properties Held Throughout Both Periods ⁽²⁾
	2019			2018			Increase (Decrease)			Percentage Change		$ Changes Due to Properties Completed and Disposed ⁽¹⁾			$ Change Due to Properties Held Throughout Both Periods ⁽²⁾
Rental income	$	208,850		$	195,416		$	13,434		7	%	$	2,920		$	10,514
Other operating income	17,037			16,339			698			4	%	386			312
Operating, maintenance and management costs	50,013			47,455			2,558			5	%	589			1,969
Real estate taxes and insurance	35,865			35,261			604			2	%	69			535
Asset management fees to affiliate	13,871			13,358			513			4	%	363			150
General and administrative expenses	3,942			3,535			407			12	%	n/a			n/a
Depreciation and amortization	83,040			78,006			5,034			6	%	4,579			455
Interest expense	85,350			13,327			72,023			540	%	n/a			n/a
Impairment charges on real estate	8,706			—			8,706			100	%	—			8,706
Other income	22			1,876			(1,854		)	(99	)%	—			(1,854		)
Other interest income	264			96			168			175	%	n/a			n/a
Loss from extinguishment of debt	(196		)	—			(196		)	(100	)%	—			(196		)
Equity in income (loss) of unconsolidated joint venture	—			(348		)	348			(100	)%	348			—
Gain on sale of real estate, net	—			11,942			(11,942		)	(100	)%	(11,942		)	—

_____________________

⁽¹⁾ Represents the dollar amount increase (decrease) for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 related to real estate developments completed and real estate investments disposed of on or after January 1, 2018.

⁽²⁾ Represents the dollar amount increase (decrease) for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 related 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 from our real estate properties increased from $195.4 million for the six months ended June 30, 2018 to $208.9 million for the six months ended June 30, 2019. The increase in rental income was primarily due to an increase in rental rates, lease termination fees, property tax recoveries as a result of property tax reassessments and operating expense recoveries in properties held throughout both periods, as well as the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II, partially offset by the sale of Rocklin Corporate Center in May 2018. We expect rental income to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, rental income would vary in future periods based on occupancy rates and rental rates of our real estate investments and to increase based on the development and subsequent full operation of Hardware Village.

Other operating income increased from $16.3 million during the six months ended June 30, 2018 to $17.0 million for the six months ended June 30, 2019. The increase in other operating income was primarily due to an increase in parking revenues for properties held throughout both periods, as well as the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II, partially offset by the sale of Rocklin Corporate Center in May 2018. We expect other operating income to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, other operating income would vary in future periods based on occupancy rates and parking rates at our real estate properties.

Operating, maintenance and management costs increased from $47.5 million for the six months ended June 30, 2018 to $50.0 million for the six months ended June 30, 2019. The increase in operating, maintenance and management costs was primarily a result of the operation of Hardware Village West, which was completed in July 2018, and an increase in repair and maintenance costs, an increase in property management fees and an increase in legal fees related to leasing for properties held throughout both periods, partially offset by the sale of Rocklin Corporate Center in May 2018. Upon adoption of the lease accounting standards of Topic 842, beginning January 1, 2019, as a lessor, we record legal costs incurred to negotiate an operating lease as an expense, as these costs are no longer capitalizable under the definition of initial direct costs under Topic 842. Prior to January 1, 2019, these legal costs were capitalized and included in real estate, cost. We expect operating, maintenance and management costs to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, operating, maintenance and management costs would increase in future periods as a result of the development and subsequent full operation of Hardware Village and general inflation.

Real estate taxes and insurance increased from $35.3 million for the six months ended June 30, 2018 to $35.9 million for the six months ended June 30, 2019. The increase in real estate taxes and insurance was primarily due to higher property taxes as a result of property tax reassessments for properties held throughout both periods and the operation of Hardware Village West, partially offset by the sale of Rocklin Corporate Center in May 2018. We expect real estate taxes and insurance to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, real estate taxes and insurance would increase in future periods as a result of the development and subsequent full operation of Hardware Village, general inflation and general increases due to future property tax reassessments.

Asset management fees with respect to our real estate investments increased from $13.4 million for the six months ended June 30, 2018 to $13.9 million for the six months ended June 30, 2019 due to the increase in capital improvements for properties held throughout both periods, the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II and the operation of Hardware Village West, partially offset by the sale of Rocklin Corporate Center in May 2018. We expect asset management fees to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, asset management fees would increase in future periods as a result of the development and subsequent full operation of Hardware Village and as a result of any improvements we make to our properties. As of June 30, 2019, we had $2.3 million of asset management fees payable related to asset management fees incurred for the month of June 2019, which was subsequently paid in July 2019.

General and administrative expenses increased from $3.5 million for the six months ended June 30, 2018 to $3.9 million for the six months ended June 30, 2019. The increase in general and administrative expenses was primarily due to professional fees incurred related to the Portfolio Sale. We have agreed with our advisor to evenly divide certain costs and expenses related to the Portfolio Sale. We expect general and administrative expenses to vary in future periods.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Depreciation and amortization increased from $78.0 million for the six months ended June 30, 2018 to $83.0 million for the six months ended June 30, 2019, primarily due to the acquisition of the developer’s 25% equity interest in Village Center Station II in October 2018 and the operation of Village Center Station II, the operation of Hardware Village West, and accelerated depreciation and amortization due to early lease terminations for properties held throughout both periods, partially offset by the sale of Rocklin Corporate Center in May 2018. We expect depreciation and amortization to decrease in future periods due to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, depreciation and amortization would vary in future periods as a result of a decrease in amortization related to fully amortized tenant origination and absorption costs, offset by an increase as a result of the development and subsequent full operation of Hardware Village.

Interest expense increased from $13.3 million for the six months ended June 30, 2018 to $85.4 million for the six months ended June 30, 2019. Included in interest expense was (i) $36.1 million and $47.5 million of interest expense payments for the six months ended June 30, 2018 and 2019, respectively, (ii) the amortization of deferred financing costs of $3.3 million and $3.2 million for the six months ended June 30, 2018 and 2019, respectively, and (iii) interest expense (including gains and losses) incurred as a result of our derivative instruments, which reduced interest expense by $24.1 million for the six months ended June 30, 2018 and increased interest expense by $35.3 million for the six months ended June 30, 2019. Additionally, during the six months ended June 30, 2018 and 2019, we capitalized $2.1 million and $1.1 million of interest related to construction in progress, respectively. The increase in interest expense was primarily due to changes in fair values with respect to our interest rate swaps that are not accounted for as cash flow hedges, a higher 30-day LIBOR rate and an increased level of borrowing. We expect interest expense to decrease in future periods due to the repayment of debt related to the Portfolio Sale in July 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Additionally, interest expense would increase in future periods as a result of additional borrowings for capital expenditures and development activity. Our interest expense in future periods will also vary based on fair value changes with respect to our interest rate swaps that are not accounted for as cash flow hedges and fluctuations in one-month LIBOR (for our variable rate debt).

During the six months ended June 30, 2019, we recorded non-cash impairment charges of $8.7 million to write down the carrying value of an office/retail property to its estimated fair value as a result of changes in cash flow estimates including a change to the anticipated hold period of the property, which triggered the future estimated undiscounted cash flows to be lower than the net carrying value of the property. The decrease in cash flow projections was primarily due to the continued lack of demand for the property’s retail component resulting in longer than estimated lease-up periods and lower projected rental rates.

During the six months ended June 30, 2018, we incurred $1.9 million of other income primarily as a result of a reduction in contingent liability of $1.6 million during the second quarter of 2018.

During the six months ended June 30, 2019, we recognized a loss from extinguishment of debt of $0.2 million related to the write-off of unamortized deferred financing costs as a result of the early pay-off of the 3003 Washington Boulevard Mortgage Loan.

During the six months ended June 30, 2018, we recognized $0.3 million in equity loss of unconsolidated joint venture related to the operations of Village Center Station II.

During the six months ended June 30, 2018, we sold one office property that resulted in a gain on sale of $11.9 million. During the six months ended June 30, 2019, we did not dispose of any properties.

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), gains and losses from change in control, impairment losses on real estate assets, depreciation and amortization of real estate assets, and adjustments for unconsolidated partnerships and joint ventures. We believe FFO facilitates comparisons of operating performance between periods and among other REITs. However, our computation of FFO may not be comparable to other REITs that do not define FFO in accordance with the NAREIT definition or that interpret the current NAREIT definition differently than we do. Our management believes that historical cost accounting for real estate assets in accordance with U.S. generally accepted accounting principles (“GAAP”) implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and provides a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.

Changes in accounting rules have resulted in a substantial increase in the number of non-operating and non-cash items included in the calculation of FFO. As a result, our management also uses MFFO as an indicator of our ongoing performance as well as our dividend sustainability. MFFO excludes from FFO: acquisition fees and expenses (to the extent that such fees and expenses have been recorded as operating 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 fees and expenses (to the extent that such fees and expenses have been recorded as operating expenses) from MFFO provides investors with supplemental performance information that is consistent with management’s analysis of the operating performance of the portfolio over time. 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; however, neither FFO nor MFFO reflects adjustments for the operations of properties sold or under contract to sale during the periods presented. During periods of significant disposition activity, FFO and MFFO are much more limited measures of future performance and dividend sustainability. In connection with our presentation of FFO and MFFO, we are providing information related to the proportion of MFFO related to properties sold or under contract to sale as of June 30, 2019.

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, adjustments related to contingent purchase price obligations and loss from extinguishment of debt are the most significant adjustments for the periods presented. We have excluded these items based on the following economic considerations:

•

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

•

Amortization of above- and below-market leases. Similar to depreciation and amortization of real estate assets and lease related costs that are excluded from FFO, GAAP implicitly assumes that the value of intangible lease assets and liabilities diminishes predictably over time and requires that these charges be recognized currently in revenue. Since 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;

•

Adjustments relating to contingent purchase price obligations. These are adjustments relating to contingent purchase price obligations where such adjustments have been included in the derivation of GAAP net income. We believe that the elimination of the contingent purchase price consideration adjustment, included in other income for GAAP purposes, is appropriate because the adjustment is a non-cash adjustment that is not reflective of our ongoing operating performance; and

•

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

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

Our calculation of 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, 2019 and 2018, 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,
	2019			2018			2019			2018
Net (loss) income attributable to common stockholders	$	(28,115	)	$	17,749		$	(54,793	)	$	34,379
Depreciation of real estate assets	26,109			23,448			52,605			46,603
Amortization of lease-related costs	15,523			15,577			30,435			31,403
Impairment charges on real estate	—			—			8,706			—
Gain on sale of real estate, net	—			(11,942		)	—			(11,942		)
FFO attributable to common stockholders ⁽¹⁾	13,517			44,832			36,953			100,443
Straight-line rent and amortization of above- and below-market leases, net	(2,304		)	(2,539		)	(5,126		)	(7,534		)
Loss from extinguishment of debt	196			—			196			—
Unrealized losses (gains) on derivative instruments	23,280			(7,289		)	37,899			(25,326		)
Adjustment relating to contingent purchase price obligation	—			(1,575		)	—			(1,575		)
MFFO attributable to common stockholders ⁽¹⁾	$	34,689		$	33,429		$	69,922		$	66,008

_____________________

⁽¹⁾ FFO and MFFO includes $4.2 million and $6.8 million of lease termination income for the three and six months ended June 30, 2019, respectively. FFO and MFFO includes $0.4 million and $0.7 million of lease termination income for the three and six months ended June 30, 2018, respectively.

Our calculation of MFFO above includes amounts related to the operations of the Portfolio sold on July 18, 2019. See “Overview” above and “Subsequent Events - Portfolio Sale and Related Transactions” below. Please refer to the table below with respect to the proportion of MFFO related to the real estate property sold and related to the Portfolio which was under contract for sale as of June 30, 2019 (in thousands).



	For the Three Months Ended June 30,				For the Six Months Ended June 30,
	2019		2018		2019		2018
MFFO by component:
Assets held for investment	$	22,996	$	21,591	$	43,733	$	41,951
Real estate properties sold	—		379		—		872
Real estate properties under contract for sale	11,693		11,459		26,189		23,185
MFFO	$	34,689	$	33,429	$	69,922	$	66,008

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

Distributions

Distributions declared, distributions paid and cash flow from operating activities were as follows for the first and second quarters of 2019 (in thousands, except per share amounts):



	Distributions Declared		Distributions Declared Per Share ⁽¹⁾		Distributions Paid⁽²⁾						Cash Flow from Operating Activities
Period	Distributions Declared		Distributions Declared Per Share ⁽¹⁾		Cash		Reinvested		Total		Cash Flow from Operating Activities
First Quarter 2019	$	28,523	$	0.1625	$	15,390	$	13,497	$	28,887	$	15,008
Second Quarter 2019	28,404		0.1625		15,382		12,974		28,356		29,918
	$	56,927	$	0.3250	$	30,772	$	26,471	$	57,243	$	44,926

_____________________


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


⁽²⁾	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.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

For the six months ended June 30, 2019, we paid aggregate distributions of $57.2 million, including $30.8 million of distributions paid in cash and $26.4 million of distributions reinvested through our dividend reinvestment plan. Our net loss attributable to common stockholders for the six months ended June 30, 2019 was $54.8 million. FFO for the six months ended June 30, 2019 was $37.0 million and cash flow from operating activities was $44.9 million. See the reconciliation of FFO to net (loss) income attributable to common stockholders above. We funded our total distributions paid, which includes net cash distributions and dividends reinvested by stockholders, with $43.3 million of cash flow from current operating activities, $11.1 million of cash flow from operating activities in excess of distributions paid during prior periods and $2.8 million from 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 generally expect our distributions will be paid from cash flow from operating activities from current periods or prior periods (except with respect to distributions related to sales of our assets and distributions related to the repayment of principal under any real estate-related investments we make). From time to time during our operational stage, 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. To the extent that we pay distributions from sources other than our cash flow from operating activities, 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”, “-Market Outlook - Real Estate and Real Estate Finance Markets,” “-Liquidity and Capital Resources,” and “-Results of Operations” herein, and the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC, and those discussed in Part II, Item 1A herein. Those factors include: the future operating performance of our 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, 2018 filed with the SEC. There have been no significant changes to our policies during 2019, except for our adoption of the lease accounting standards issued by the Financial Accounting Standards Board effective on January 1, 2019.

Revenue Recognition - Operating Leases

Real Estate

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

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

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

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

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


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


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


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


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


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


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

We lease apartment units under operating leases with terms generally of one year or less. Generally, credit investigations will be performed for prospective residents and security deposits will be obtained. We recognize rental revenue, net of concessions, on a straight-line basis over the term of the lease, when collectibility is determined to be probable.

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

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

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, 2019, we paid distributions of $9.5 million, which related to distributions in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on June 18, 2019. On August 1, 2019, we paid distributions of $9.5 million, which related to distributions in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on July 19, 2019.

Distributions Authorized

On August 8, 2019, our board of directors authorized an August 2019 distribution in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on August 19, 2019, which we expect to pay in September 2019, and a September 2019 distribution in the amount of $0.05416667 per share of common stock to stockholders of record as of the close of business on September 20, 2019, which we expect to pay in October 2019.

Investors may choose to receive cash distributions or purchase additional shares through the our dividend reinvestment plan.

Portfolio Sale and Related Transactions

On July 18, 2019, we, through 12 wholly owned subsidiaries, sold the Portfolio to various subsidiaries of the Purchaser. The sale price of the Portfolio was $1.2 billion, before third-party closing costs and credits of approximately $16.1 million and excluding any disposition fees payable to our advisor. In connection with the Portfolio Sale, we repaid $613.1 million of outstanding debt secured by the properties in the Portfolio. Pursuant to a set-off agreement, as amended, $271.0 million of the consideration payable by the Purchaser under the Purchase Agreement was set-off against REIT Properties III’s payment obligations for its two subscriptions for units in the Purchaser: (i) the $201 million of units subscribed for by REIT Properties III pursuant to a subscription agreement, as amended, and (ii) $70 million of units subscribed for by REIT Properties III under the placement tranche of the Purchaser’s offering. As such, on July 19, 2019, REIT Properties III acquired 307,953,999 units in the Purchaser at an aggregate price of $271 million representing a 33.3% ownership interest in the Purchaser. Currently, the Purchaser does not own any properties other than the Portfolio.

Also, on July 15, 2019, REIT Properties III entered into a placement agreement (the “Placement Agreement”) and unit lending agreement (the “Unit Lending Agreement”) with respect to an offering of units of the Purchaser. REIT Properties III is a party to the Placement Agreement as unit lender, and pursuant to the Placement Agreement, REIT Properties III has granted the underwriters in the offering an over-allotment option (the “Over-Allotment Option”) in which REIT Properties III agreed to sell to the underwriters up to 22,727,000 of REIT Properties III’s units in the Purchaser at the offering price. The Over-Allotment Option is exercisable for up to 30 days after the listing of the units of the Purchaser. Any units purchased pursuant to the Over-Allotment Option would reduce REIT Properties III’s ownership interest in the Purchaser. Pursuant to the Unit Lending Agreement, REIT Properties III agreed to lend the 22,727,000 units subject to the Over-Allotment Option to the stabilizing manager of the offering for the purpose of facilitating the settlement of the over-allotment of units in connection with the Purchaser’s offering. The stabilizing manager will re-deliver to REIT Properties III such number of units that are not purchased pursuant to the exercise of the Over-Allotment Option.

On July 8, 2019, we, our Operating Partnership, KBS REIT Holdings III LLC and REIT Properties III (collectively, the “REIT III Entities”) entered into lock-up letter agreements with the underwriters whereby each of the REIT III Entities agreed to hold 100% of REIT Properties III’s units in the Purchaser for six months following the listing of the Purchaser and to hold 50% of REIT Properties III’s units in the Purchaser for 12 months following the listing of the Purchaser. During the respective lock-up periods, without the prior written consent of the underwriters and other than pursuant to the Over-Allotment Option or lending for stabilizing transactions pursuant to the Unit Lending Agreement (described above), the REIT III Entities may not offer, sell, pledge, option, grant any rights or warrants, or enter into any swap, hedge or other similar arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the units held by REIT Properties III.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

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

The Purchaser is externally managed by a joint venture (the “Manager”) among KBS Asia Partners Pte. Ltd., an entity in which Charles J. Schreiber, Jr. currently holds an indirect 50% ownership interest, and other entities unaffiliated with us. The Purchaser is expected to pay the Manager an annual base fee of 10% of annual distributable income and an annual performance fee of 25% of the increase in distributions per unit of the Purchaser from the preceding year; however, there would not be any performance fee for 2019 and in 2020 such fee will be based on an increase over projected distributions per unit. In addition, for future acquisitions, the Purchaser will pay the Manager an acquisition fee of 1% of the acquisition price of any real estate acquired. No acquisition fee will be paid with respect to the Purchaser’s acquisition of the Portfolio. The Purchaser will also pay the Manager a divestment fee of 0.5% of the sale price of any real estate sold or divested and a development management fee of 3% of the total project costs incurred for development projects, to the extent the Purchaser acquires a development project. A small portion of these fees paid to the Manager will be paid to KBS Realty Advisors LLC, an affiliate of KBS Capital Advisors and an entity controlled by Mr. Schreiber, for sub-advisory services. The Schreiber Trust, a trust whose beneficiaries are Charles J. Schreiber, Jr. and his family members, and the Linda Bren 2017 Trust will subscribe for units to be issued by the Purchaser. In addition, Barbara R. Cambon, one of our former directors, accepted the positions of Chief Executive Officer and Chief Investment Officer of the Manager and will receive compensation for her services. In connection with her acceptance of these positions, Ms. Cambon resigned from the Company’s board of directors effective June 26, 2019.

Share Redemption Program

See Part II, Item 5 “Other Information,” for updated information about our share redemption program.

Table of Contents

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to the effects of interest rate changes as a result of borrowings used to maintain liquidity 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 by utilizing 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 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, 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, 2019, the fair value of our fixed rate debt was $193.1 million and the outstanding principal balance of our fixed rate debt was $189.5 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, 2019. As we expect to hold our fixed rate instruments to maturity (unless the property securing the debt is sold and the loan is repaid) 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 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, 2019, we were exposed to market risks related to fluctuations in interest rates on $721.2 million of variable rate debt outstanding after giving consideration to the impact of interest rate swap agreements on approximately $1.4 billion of our variable rate debt. Based on interest rates as of June 30, 2019, if interest rates were 100 basis points higher or lower during the 12 months ending June 30, 2020, interest expense on our variable rate debt would increase or decrease by $7.2 million.

The weighted-average interest rates of our fixed rate debt and variable rate debt as of June 30, 2019 were 4.1% and 3.9%, respectively. The weighted-average interest rates represent the actual interest rate in effect as of June 30, 2019 (consisting of the contractual interest rate and the effect of interest rate swaps, if applicable), using interest rate indices as of June 30, 2019 where applicable.

For a discussion of the interest rate risks related to the current capital and credit markets, see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Outlook - Real Estate and Real Estate Finance Markets” herein and the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

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

Because of the limitations on the dollar amount of shares that may be redeemed under our share redemption program and the number of shares that may be redeemed during a calendar year, it is not likely that we will be able to redeem shares submitted as Ordinary Redemptions after the August 2019 redemption date and shares submitted as Ordinary Redemptions for the August 2019 redemption date will likely be honored on a pro rata basis pursuant to the terms of the share redemption program.

Based on the amount of net proceeds raised from the sale of shares under our dividend reinvestment plan during 2018, we had an aggregate of $56.1 million available for redemptions in 2019, including the reserve for redemptions sought in connection with a stockholder’s death, “Qualifying Disability” or “Determination of Incompetence” (each as defined in the share redemption program and together with redemptions sought in connection with a stockholder’s death, “Special Redemptions” all redemptions that do not meet the requirements for a Special Redemption are “Ordinary Redemptions”). As a result of the above-referenced limitations on the number of shares we can purchase pursuant to the share redemption program, as of March 1, 2019, we had exhausted all funds available for Ordinary Redemptions in 2019. As of July 31, 2019, we had $5.1 million available for Special Redemptions for the remainder of 2019. As of July 31, 2019, we had a total $40.9 million of outstanding and unfulfilled Ordinary Redemption requests, representing 3,583,572 shares. On August 8, 2019, our board of directors approved an increase of the funding available for Ordinary Redemptions for calendar year 2019 by up to an additional $40.0 million, which including redemptions fulfilled to date and the remaining amount reserved for Special Redemptions, increases the share redemption program to the maximum amount for 2019.

Given the volume of redemption requests in 2019, and because of the limitations on the dollar amount of shares that may be redeemed under our share redemption program and the number of shares that may be redeemed during a calendar year, it is not likely that we will be able to redeem shares submitted as Ordinary Redemptions after the August 2019 redemption date and shares submitted as Ordinary Redemptions for the August 2019 redemption date will likely be honored on a pro rata basis pursuant to the terms of the share redemption program.

Our board of directors may amend, suspend or terminate our share redemption program upon 10 business days’ notice to our stockholders. We describe the restrictions of our share redemption program in detail below under Part II, Item 2(c).

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PART II. OTHER INFORMATION (CONTINUED)

Item 1A. Risk Factors (continued)

Our advisor and its affiliates face conflicts of interest relating to the acquisition of assets due to their relationship with other KBS-sponsored programs and/or KBS-advised investors, which could result in decisions that are not in our best interest or the best interests of our stockholders.

We rely on our sponsor, KBS Holdings LLC, our advisor, KBS Capital Advisors, and other key real estate and debt finance professionals at our advisor, including Mr. Schreiber, to identify suitable investment opportunities for us. KBS Capital Advisors and KBS Realty Advisors advise other KBS-sponsored programs and funds. As such, KBS-sponsored programs that have funds available for investment and KBS-advised investors that have funds available for investment rely on many of the same real estate and debt finance professionals, as will future KBS-sponsored programs and KBS-advised investors. Many investment opportunities that are suitable for us may also be suitable for other KBS-sponsored programs and KBS-advised investors. In connection with the Portfolio Sale, KBS Capital Advisors and KBS Realty Advisors proposed that the Company’s conflicts committee and board of directors adopt an asset allocation policy (the “Allocation Process”) among us, KBS Real Estate Investment Trust II, Inc. and KBS Growth & Income REIT, Inc. (collectively, the “Core Strategy REITs”) and the Purchaser. The board of directors and conflicts committee adopted the Allocation Process as proposed. The Allocation Process provides that, in order to mitigate potential conflicts of interest that may arise among the Core REITs and the Purchaser, upon the listing of the Purchaser (which occurred on July 19, 2019), potential asset acquisitions that meet all of the following criteria would be offered first to the Purchaser:


(i)	Class A office building;


(ii)	Purchase price of at least $125.0 million;


(iii)	Average occupancy of at least 90% for the first two years based on contractual in-place leases; and


(iv)	Stabilized property investment yield that is generally supportive of the distributions per unit of the Purchaser.

To the extent the Purchaser does not have the funds to acquire the asset or to the extent the Manager of the Purchaser decides to forego the acquisition opportunity, such asset may then be offered to the Core Strategy REITs at the discretion of KBS Capital Advisors.

For so long as we are externally advised, our charter provides that it shall not be a proper purpose of the company for us to make any significant investment unless our advisor has recommended the investment to us. Thus, the real estate and debt finance professionals of our advisor could direct attractive investment opportunities to other KBS-sponsored programs or KBS-advised investors. Such events could result in us investing in properties that provide less attractive returns, which would reduce the level of distributions we may be able to pay our stockholders.

A significant percentage of our assets is invested in Accenture Tower (formerly 500 West Madison) and the value of our stockholders’ investment in us will fluctuate with the performance of this investment.

As of July 18, 2019, Accenture Tower (formerly 500 West Madison) represented approximately 17.3% of our total assets and represented approximately 13.7% of our total annualized base rent. Further, as a result of this acquisition, the geographic concentration of our portfolio makes us particularly susceptible to adverse economic developments in the Chicago real estate market. Any adverse economic or real estate developments in this market, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for office space resulting from the local business climate, could adversely affect our operating results and our ability to pay distributions to our stockholders.

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.

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 an amount equal to our estimated value per share. The following is a description of our share redemption program.

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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, and together with redemptions sought in connection with a stockholder’s death, “Special Redemptions;” all redemptions that do not meet the requirements for a Special Redemption are “Ordinary 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, provided that once we have received requests for redemptions, whether in connection with Special Redemptions or otherwise, that if honored, and when combined with all prior redemptions made during the calendar year, would result in the amount of remaining funds available for the redemption of additional shares in such calendar year being $10.0 million or less, the last $10.0 million of available funds shall be reserved exclusively for Special Redemptions. 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.


•	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.

Upon a transfer of shares, any pending redemption requests with respect to such transferred shares will be canceled as of the date we accept the transfer. Stockholders wishing us to continue to consider a redemption request related to any transferred shares must resubmit their redemption request.

Pursuant to our share redemption program, redemptions made in connection with Special Redemptions are made at a price per share equal to the most recent estimated value per share of our common stock as of the applicable redemption date. Ordinary Redemptions are made at a price per share equal to 95% of our most recent estimated value per share as of the applicable redemption date.

On December 3, 2018, our board of directors approved an estimated value per share of our common stock of $12.02 based on the estimated value of our assets less the estimated value of our liabilities divided by the number of shares outstanding, all as of September 30, 2018, with the exception of an adjustment to our net asset value for the acquisition and assumed loan costs related to our buyout of a joint venture partner’s equity interest in a joint venture that closed subsequent to September 30, 2018 and a reduction to our net asset value for deferred financing costs related to a portfolio revolving loan facility that closed subsequent to September 30, 2018. This estimated value per share became effective for the December 2018 redemption date, which was December 31, 2018.

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.

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PART II. OTHER INFORMATION (CONTINUED)

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

We currently expect to utilize an independent valuation firm to update our estimated value per share no later than December 2019. 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, www.kbsreitiii.com (such information may be provided by means of a link to our public filings on the SEC’s website, www.sec.gov).

Our board of directors may amend, suspend or terminate our share redemption program upon 10 business days’ notice to 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 SEC or (b) in a separate mailing to our stockholders.

The complete share redemption program document is filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended March 31, 2018 and is available at the SEC’s website at www.sec.gov.

During the six months ended June 30, 2019, 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 2019	3,863,019	$	11.43	⁽³⁾
February 2019	204,861	$	11.59	⁽³⁾
March 2019	89,190	$	12.02	⁽³⁾
April 2019	72,512	$	12.02	⁽³⁾
May 2019	67,724	$	12.02	⁽³⁾
June 2019	100,579	$	12.02	⁽³⁾
Total	4,397,885

_____________________

⁽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), on March 7, 2014 (which amendment became effective on April 6, 2014) and on May 9, 2018 (which amendment became effective on June 8, 2018).

⁽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. Based on the amount of net proceeds raised from the sale of shares under our dividend reinvestment plan during 2018, we had an aggregate of $56.1 million available for redemptions in 2019, including the reserve for Special Redemptions. Based on this limitation, as of March 1, 2019, we exhausted all funds available for Ordinary Redemptions in 2019. As of July 31, 2019 we had $5.1 million available for Special Redemptions for the remainder of 2019. As of July 31, 2019, we had a total of $40.9 million of outstanding and unfulfilled Ordinary Redemption requests, representing 3,583,572 shares, recorded as redemptions payable in other liabilities on the accompanying consolidated balance sheets. On August 8, 2019, our board of directors approved an increase of the funding available for Ordinary Redemptions for calendar year 2019 by up to an additional $40.0 million, which including redemptions fulfilled to date and the remaining amount reserved for Special Redemptions, increases the share redemption program to the maximum amount for 2019. Given the volume of redemption requests in 2019, and because of the limitations on the dollar amount of shares that may be redeemed under our share redemption program and the number of shares that may be redeemed during a calendar year, it is not likely that we will be able to redeem shares submitted as Ordinary Redemptions after the August 2019 redemption date and shares submitted as Ordinary Redemptions for the August 2019 redemption date will likely be honored on a pro rata basis pursuant to the terms of the share redemption program.

In addition to the redemptions under the share redemption program described above, during the six months ended June 30, 2019, we repurchased an additional 442,275 shares of our common stock at a weighted-average price of $11.42 per share for an aggregate price of $5.1 million.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

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PART II. OTHER INFORMATION (CONTINUED)

Item 5. Other Information

Increase in Funding for Ordinary Redemptions

Based on the amount of net proceeds raised from the sale of shares under our dividend reinvestment plan during 2018, we initially had an aggregate of $56.1 million available for redemptions in 2019, including the $10.0 million reserve for redemptions sought in connection with a Special Redemption. As of March 1, 2019, we had exhausted all funds available for Ordinary Redemptions in 2019. As of July 31, 2019, we had $5.1 million available for Special Redemptions for the remainder of 2019. As of July 31, 2019, we had a total $40.9 million of outstanding and unfulfilled Ordinary Redemption requests, representing 3,583,572 shares. On August 8, 2019, our board of directors approved an increase of the funding available for Ordinary Redemptions for calendar year 2019 by up to an additional $40.0 million, which including redemptions fulfilled to date and the remaining amount reserved for Special Redemptions, increases the share redemption program to the maximum amount for 2019.

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		Second Amended and Restated Bylaws, incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed September 22, 2016

4.1		Statement regarding restrictions on transferability of shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates), incorporated by reference to Exhibit 4.2 to Pre-Effective Amendment No. 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 for the period ended June 30, 2015, filed August 13, 2015

10.1		Portfolio Purchase and Sale Agreement and Escrow Instructions between certain subsidiaries of the Company and certain subsidiaries of the Purchaser in the Portfolio Sale, dated June 27, 2019

10.2		First Amendment to Portfolio Purchase and Sale Agreement and Escrow Instructions between certain subsidiaries of the Company and certain subsidiaries of the Purchaser in the Portfolio Sale, dated July 16, 2019

10.3		Subscription Agreement of KBS REIT Properties III LLC, dated June 27, 2019

10.4		Subscription Agreement Amendment of KBS REIT Properties III LLC, dated July 15, 2019

10.5		Set-Off Agreement among certain subsidiaries of the Company, certain subsidiaries of the Purchaser in the Portfolio Sale and the parties named therein, dated June 27, 2019

10.6		Set-Off Agreement Amendment among certain subsidiaries of the Company, certain subsidiaries of the Purchaser in the Portfolio Sale and the parties named therein, dated July 17, 2019

10.7		Placement Agreement among the parties named therein, dated July 15, 2019

10.8		Unit Lending Agreement among the parties named therein, dated July 15, 2019

10.9		Lock-up Letter Agreement by the Company, dated July 8, 2019

10.10		Lock-up Letter Agreement by KBS Limited Partnership III, dated July 8, 2019

10.11		Lock-up Letter Agreement by KBS REIT Holdings LLC, dated July 8, 2019

10.12		Lock-up Letter Agreement by KBS REIT Properties III, dated July 8, 2019

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PART II. OTHER INFORMATION (CONTINUED)

Item 6. Exhibits (continued)



Ex.		Description

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

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

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

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

99.1		Fourth Amended and Restated Share Redemption Program, incorporated by reference to Exhibit 99.2 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2018, filed May 9, 2018

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		XBRL Taxonomy Extension Definition Linkbase

101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE		XBRL Taxonomy Extension Presentation Linkbase

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.




		KBS REAL ESTATE INVESTMENT TRUST III, INC.

Date:	August 9, 2019	By:	/S/ CHARLES J. SCHREIBER, JR.
			Charles J. Schreiber, Jr.
			Chairman of the Board, Chief Executive Officer and Director
			(principal executive officer)

Date:	August 9, 2019	By:	/S/ JEFFREY K. WALDVOGEL
			Jeffrey K. Waldvogel
			Chief Financial Officer, Treasurer and Secretary
			(principal financial officer)