Lightstone Value Plus REIT V, Inc. - Quarter Report: 2011 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2011

 

Commission File Number: 000-53650

 

Behringer Harvard Opportunity REIT II, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

15601 Dallas Parkway, Suite 600, Addison, Texas 75001

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (866) 655-3600

 

None

(Former name, former address and former fiscal year, if changed since last report)

 

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 o

 

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

 

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

 

 

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

 

As of October 28, 2011, Behringer Harvard Opportunity REIT II, Inc. had 24,774,823 shares of common stock outstanding.

 

 

Table of Contents

 

BEHRINGER HARVARD OPPORTUNITY REIT II, INC.

FORM 10-Q

Quarter Ended September 30, 2011

 

		Page
PART I
FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited).
	Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010	3
	Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2011 and 2010	4
	Consolidated Statements of Equity for the Nine Months Ended September 30, 2011 and 2010	5
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	40
Item 4.	Controls and Procedures.	41
PART II
OTHER INFORMATION
Item 1.	Legal Proceedings.	42
Item 1A.	Risk Factors.	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	42
Item 3.	Defaults Upon Senior Securities.	44
Item 4.	Removed and Reserved
Item 5.	Other Information.	44
Item 6.	Exhibits.	44
Signature		45

 

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PART I

FINANCIAL INFORMATION

Item 1.                   Financial Statements.

Behringer Harvard Opportunity REIT II, Inc.

Consolidated Balance Sheets

(in thousands, except shares)

(unaudited)

 

		September 30,			December 31,
		2011			2010
Assets
Real estate
Land and improvements, net		$	82,432		$	75,032
Buildings and improvements, net		205,930			175,302
Real estate under development		86			314
Total real estate		288,448			250,648
Real estate loan receivable, net		—			25,202
Total real estate and real estate-related investments, net		288,448			275,850
Cash and cash equivalents		81,320			49,375
Restricted cash		7,522			10,891
Accounts receivable, net		8,610			1,202
Receivable from related party		1,864			—
Interest receivable-real estate loan receivable		—			2,227
Prepaid expenses and other assets		1,680			1,283
Investment in unconsolidated joint venture		—			4,428
Furniture, fixtures and equipment, net		7,266			6,812
Acquisition deposits		477			—
Deferred financing fees, net		4,199			4,273
Lease intangibles, net		7,812			11,138
Total assets		$	409,198		$	367,479
Liabilities and Equity
Notes payable		$	205,148		$	175,378
Accounts payable		2,495			1,605
Payables to related parties		—			526
Acquired below-market leases, net		1,417			2,090
Distributions payable		1,009			940
Accrued and other liabilities		6,937			4,729
Total liabilities		217,006			185,268
Commitments and contingencies
Equity
Preferred stock, $.0001 par value per share; 50,000,000 shares authorized, none outstanding		—			—
Convertible stock, $.0001 par value per share; 1,000 shares authorized, 1,000 outstanding		—			—
Common stock, $.0001 par value per share; 350,000,000 shares authorized, 24,576,034 and 22,329,502 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively		2			2
Additional paid-in capital		218,012			195,149
Accumulated distributions and net loss		(38,306		)	(23,883		)
Accumulated other comprehensive income		220			410
Total Behringer Harvard Opportunity REIT II, Inc. equity		179,928			171,678
Noncontrolling interest		12,264			10,533
Total equity		192,192			182,211
Total liabilities and equity		$	409,198		$	367,479

 

See Notes to Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Consolidated Statements of Operations and Comprehensive Income (Loss)

(in thousands, except per share amounts)

(unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2011			2010			2011			2010
Revenues
Rental revenue		$	9,320		$	3,007		$	26,089		$	6,204
Hotel revenue		1,865			—			4,856			—
Interest income from real estate loan receivable		444			1,169			2,926			3,753
Total revenues		11,629			4,176			33,871			9,957
Expenses:
Property operating expenses		5,417			1,097			14,967			2,016
Interest expense		2,554			702			7,217			1,399
Real estate taxes		1,246			303			3,683			663
Property management fees		319			86			1,049			196
Asset management fees		801			292			2,205			683
General and administrative		613			706			1,667			1,562
Acquisition expense		331			3,135			1,786			4,581
Depreciation and amortization		3,902			1,577			11,803			3,235
Total expenses		15,183			7,898			44,377			14,335
Interest income, net		24			180			111			437
Gain on sale of investment		—			152			—			152
Bargain purchase gain		—			—			—			5,492
Other income (expense)		821			5			821			(133		)
Income (loss) before equity in earnings (losses) of unconsolidated joint ventures and noncontrolling interest		(2,709		)	(3,385		)	(9,574		)	1,570
Equity in earnings (losses) of unconsolidated joint ventures		2,989			(144		)	2,681			(151		)
Net income (loss)		280			(3,529		)	(6,893		)	1,419
Net (income) loss attributable to the noncontrolling interest		416			231			1,351			(388		)
Net income (loss) attributable to common shareholders		$	696		$	(3,298	)	$	(5,542	)	$	1,031
Weighted average shares outstanding:
Basic and diluted		24,508			20,509			23,739			18,369
Net income (loss) per share attributable to common shareholders
Basic and diluted		$	0.03		$	(0.16	)	$	(0.23	)	$	0.06
Comprehensive income (loss):
Net income (loss)		$	280		$	(3,529	)	$	(6,893	)	$	1,419
Other comprehensive income (loss):
Unrealized losses on interest rate derivatives		(104		)	—			(346		)	—
Foreign currency translation gain		(169		)	373			87			373
Total other comprehensive income (loss)		(273		)	373			(259		)	373
Comprehensive income (loss)		7			(3,156		)	(7,152		)	1,792
Comprehensive loss attributable to noncontrolling interest		437			—			1,420			—
Comprehensive income (loss) attributable to common shareholders		$	444		$	(3,156	)	$	(5,732	)	$	1,792

 

See Notes to Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Consolidated Statements of  Equity

(in thousands)

(unaudited)

 

																		Accumulated
		Convertible Stock					Common Stock					Additional			Accumulated			Other
		Number		Par			Number		Par			Paid-in			Distributions and			Comprehensive			Noncontrolling			Total
		of Shares		Value			of Shares		Value			Capital			Net (Loss)			Income (loss)			Interest			Equity
Balance at January 1, 2010		1		$	—		14,649		$	1		$	126,815		$	(6,839	)	$	—		$	2,622		$	122,599
Issuance of common stock, net							6,596		1			58,452												58,453
Redemption of common stock							(130	)				(1,189		)										(1,189		)
Distributions declared on common stock															(6,877		)							(6,877		)
Contributions from noncontrolling interest																					3,404			3,404
Distributions to noncontrolling interest																					(2,057		)	(2,057		)
Foreign currency translation gain																		373						373
Net income															1,031						388			1,419
Balance at September 30, 2010		1		$	—		21,115		$	2		$	184,078		$	(12,685	)	$	373		$	4,357		$	176,125
Balance at January 1, 2011		1		$	—		22,330		$	2		$	195,149		$	(23,883	)	$	410		$	10,533		$	182,211
Issuance of common stock, net							2,420		—			24,436												24,436
Redemption of common stock							(174	)				(1,573		)										(1,573		)
Distributions declared on common stock															(8,881		)							(8,881		)
Contributions from noncontrolling interest																					3,648			3,648
Distributions to noncontrolling interest																					(497		)	(497		)
Other comprehensive income (loss):
Unrealized losses on interest rate derivatives																		(277		)	(69		)	(346		)
Foreign currency translation gain																		87						87
Net loss															(5,542		)				(1,351		)	(6,893		)
Balance at September 30, 2011		1		$	—		24,576		$	2		$	218,012		$	(38,306	)	$	220		$	12,264		$	192,192

 

See Notes to Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

		Nine months ended September 30,
		2011			2010
Cash flows from operating activities:
Net income (loss)		$	(6,893	)	$	1,419
Adjustments to reconcile net income (loss) to net cash flows provided by (used in) operating activities:
Depreciation and amortization		11,484			2,536
Amortization of deferred financing fees		1,008			143
Equity in (earnings)/losses of unconsolidated joint venture		(2,681		)	151
Bargain purchase gain		—			(5,492		)
Gain on sale of interest in unconsolidated joint venture		—			(152		)
Change in operating assets and liabilities:
Accounts receivable		(301		)	(285		)
Interest receivable-real estate loan receivable		2,227			(1,246		)
Prepaid expenses and other assets		(1,182		)	(9		)
Accounts payable		(250		)	338
Accrued and other liabilities		2,007			789
Net payables to related parties		(152		)	182
Addition of lease intangibles		(556		)	(267		)
Cash provided by (used in) operating activities		4,711			(1,893		)
Cash flows from investing activities:
Acquisition deposits		—			(2,222		)
Purchases of real estate		(37,381		)	(64,186		)
Investment in unconsolidated joint venture		—			(4,630		)
Proceeds from sale of interest in unconsolidated joint venture		—			616
Investment in real estate loans receivable		—			(12,594		)
Additions of property and equipment		(8,975		)	(893		)
Repayment of notes receivable		25,000			—
Change in restricted cash		4,861			(583		)
Cash used in investing activities		(16,495		)	(84,492		)
Cash flows from financing activities:
Financing costs		(728		)	(1,401		)
Proceeds from notes payable		30,626			59,479
Payments on notes payable		(1,212		)	—
Issuance of common stock		17,934			61,031
Redemptions of common stock		(1,573		)	(624		)
Offering costs		(1,647		)	(6,785		)
Distributions		(2,899		)	(2,002		)
Contributions from noncontrolling interest holders		3,648			3,404
Distributions to noncontrolling interest holders		(497		)	(2,057		)
Cash provided by financing activities		43,652			111,045
Effect of exchange rate changes on cash and cash equivalents		77			4
Net change in cash and cash equivalents		31,945			24,664
Cash and cash equivalents at beginning of period		49,375			67,509
Cash and cash equivalents at end of period		$	81,320		$	92,173

 

See Notes to Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

1.                                      Business and Organization

 

Organization

 

Behringer Harvard Opportunity REIT II, Inc. (which may be referred to as the “Company,” “we,” “us,” or “our”) was organized as a Maryland corporation on January 9, 2007 and has elected to be taxed, and currently qualifies, as a real estate investment trust (“REIT”) for federal income tax purposes.

 

We acquire and operate commercial real estate and real estate-related assets.  In particular, we focus generally on acquiring commercial properties with significant possibilities for short-term capital appreciation, such as those requiring development, redevelopment, or repositioning, those located in markets and submarkets with high growth potential, and those available from sellers who are distressed or face time-sensitive deadlines.  In addition, given economic conditions as of September 30, 2011, our opportunistic investment strategy also includes investments in real estate-related assets that present opportunities for higher current income.  Such investments may have capital gain characteristics, whether as a result of a discounted purchase or related equity participations.  We may acquire a wide variety of commercial properties, including office, industrial, retail, hospitality, recreation and leisure, single-tenant, multifamily and other real properties.  These properties may be existing, income-producing properties, newly constructed properties, or properties under development or construction.  They may include multifamily properties purchased for conversion into condominiums or single-tenant properties that may be converted for multi-tenant use.  We may invest in real estate-related securities, including securities issued by other real estate companies, either for investment or in change of control transactions completed on a negotiated basis or otherwise.  Further, we may also originate or invest in collateralized mortgage-backed securities, mortgage, bridge or mezzanine loans, and Section 1031 tenant-in-common interests (including those issued by affiliates of our Advisor, as defined below), or in entities that make investments similar to the foregoing.  We expect to make our investments in or in respect of real estate assets located in the United States and other countries based on our view of existing market conditions.  We completed our first property acquisition, an office building located in Denver, Colorado, on October 28, 2008.  As of September 30, 2011, we consolidated ten real estate assets.

 

Substantially all of our business is conducted through Behringer Harvard Opportunity OP II LP, a limited partnership organized in Delaware on January 12, 2007 (“Behringer Harvard Opportunity OP II”).  As of September 30, 2011, our wholly-owned subsidiary, BHO II, Inc., a Delaware corporation, was the sole general partner of Behringer Harvard Opportunity OP II and owned a 0.1% partnership interest in Behringer Harvard Opportunity OP II.  As of September 30, 2011, our wholly-owned subsidiary, BHO Business Trust II, a Maryland business trust, was the sole limited partner of Behringer Harvard Opportunity OP II and owned the remaining 99.9% interest in Behringer Harvard Opportunity OP II.

 

We are externally managed and advised by Behringer Harvard Opportunity Advisors II, LLC, a Texas limited liability company that was formed on March 16, 2010 (the “Advisor”) when Behringer Harvard Opportunity Advisors II LP, a Texas limited partnership formed in January 2007, was converted to a limited liability company.  The Advisor is responsible for managing our day-to-day affairs and for identifying and making acquisitions and investments on our behalf.

 

Our office is located at 15601 Dallas Parkway, Suite 600, Addison, Texas 75001, and our toll-free telephone number is (866) 655-3600.  The name Behringer Harvard is the property of Behringer Harvard Holdings, LLC (“Behringer Harvard Holdings”) and is used by permission.

 

Public Offerings of Common Stock

 

On February 26, 2007, we filed an initial Registration Statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to offer up to 125,000,000 shares of common stock for sale to the public (the “Initial Offering”), of which 25,000,000 shares were being offered pursuant to our distribution reinvestment plan (the “DRP”).  The SEC declared our Registration Statement effective on January 4, 2008, and we commenced the Initial Offering on January 21, 2008.  On July 3, 2011, we ceased offering shares of common stock in the Initial Offering.  On September 29, 2011, we filed a post-effective amendment to the initial Offering registration statement to deregister 25,166,864 shares of unsold common stock in the Initial Offering.

 

Prior to termination of the Initial Offering, on September 13, 2010, we filed a second Registration Statement on Form S-11 with the SEC to register a follow-on public offering of up to 75,000,000 shares of our common stock for sale to the public (the “Follow-On Offering” and, together with the Initial Offering, the “Offerings”), of which 25,000,000 shares are being offered pursuant to the DRP.  We reserve the right to reallocate the shares we are offering between our primary offering and the DRP.  On July 5, 2011, the Follow-On Offering registration statement was declared effective by the SEC, and we commenced offering shares under the Follow-On Offering.  Through September 30, 2011, we raised gross offering

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

proceeds of approximately $248.9 million from the sale of approximately 25 million shares under the Initial Offering and the Follow-On Offering (collectively, the “Offerings”), including shares sold under the DRP.

 

In connection with our initial capitalization, on January 19, 2007, we issued 22,471 shares of our common stock and 1,000 shares of our convertible stock to Behringer Harvard Holdings.  As of September 30, 2011, we had 24,576,034 shares of common stock outstanding, which includes the 22,471 shares issued to Behringer Harvard Holdings.  As of September 30, 2011, we had 1,000 shares of convertible stock issued and outstanding to Behringer Harvard Holdings.

 

We commenced operations on April 1, 2008 upon satisfaction of the conditions of our escrow agreement and our acceptance of initial subscriptions of common stock in the Initial Offering.  Upon admission of new stockholders, subscription proceeds are used for payment of dealer manager fees and selling commissions and may be utilized as consideration for investments and the payment or reimbursement of offering expenses and operating expenses.  Until required for such purposes, net offering proceeds are held in short-term, liquid investments.  We are currently using the net proceeds from the Offerings primarily to acquire real estate and real estate-related assets consistent with our opportunistic investment strategy.  As of September 30, 2011, we had issued 25,037,007 shares of our common stock, including 22,471 shares owned by Behringer Harvard Holdings, and 1,677,217 shares issued through the DRP.  As of September 30, 2011, we had redeemed 460,973 shares of our common stock.

 

Our common stock is not currently listed on a national securities exchange.  Depending upon the prevailing market conditions, it is our intention to consider beginning the process of liquidating our assets and distributing the net proceeds to our stockholders within three to six years after the termination of the Initial Offering.  If we do not begin an orderly liquidation within that period, we may seek to have our shares listed on a national securities exchange.

 

2.                                      Interim Unaudited Financial Information

 

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010, which was filed with the SEC on March 30, 2011.

 

The results for the interim periods shown in this report are not necessarily indicative of future financial results.  The accompanying consolidated balance sheet as of September 30, 2011, the consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2011 and 2010 and consolidated statements of equity and cash flows for the nine months ended September 30, 2011 and 2010 have not been audited by our independent registered public accounting firm.  In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments necessary to fairly present our consolidated financial position as of September 30, 2011 and December 31, 2010 and our consolidated results of operations and cash flows for the periods ended September 30, 2011 and 2010.  Such adjustments are of a normal recurring nature.

 

3.                                      Summary of Significant Accounting Policies

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  These estimates include such items as purchase price allocation for real estate acquisitions, impairment of long-lived assets, depreciation and amortization, and allowance for doubtful accounts.  Actual results could differ from those estimates.

 

Principles of Consolidation and Basis of Presentation

 

Our consolidated financial statements include our accounts and the accounts of other subsidiaries over which we have control.  All inter-company transactions, balances, and profits have been eliminated in consolidation.  Interests in entities acquired will be evaluated based on applicable GAAP, which includes the requirement to consolidate entities deemed to be variable interest entities (“VIE”) in which we are the primary beneficiary.  If the interest in the entity is determined not to be a VIE, then the entity will be evaluated for consolidation based on legal form, economic substance, and the extent to which we have control and/or substantive participating rights under the respective ownership agreement.  In the Notes to Consolidated Financial Statements, all dollar and share amounts in tabulation are in thousands of dollars and shares, respectively, unless otherwise noted.

 

There are judgments and estimates involved in determining if an entity in which we have made an investment is a VIE and, if so, whether we are the primary beneficiary.  The entity is evaluated to determine if it is a VIE by, among other

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

things, calculating the percentage of equity being risked compared to the total equity of the entity.  Determining expected future losses involves assumptions of various possibilities of the results of future operations of the entity, assigning a probability to each possibility and using a discount rate to determine the net present value of those future losses.  A change in the judgments, assumptions, and estimates outlined above could result in consolidating an entity that should not be consolidated or accounting for an investment using the equity method that should in fact be consolidated, the effects of which could be material to our financial statements.

 

We have evaluated subsequent events for recognition or disclosure in our consolidated financial statements.

 

Real Estate

 

Upon the acquisition of real estate properties, we recognize the assets acquired, the liabilities assumed, and any noncontrolling interest as of the acquisition date, measured at their respective fair values.  The acquisition date is the date on which we obtain control of the real estate property.  The assets acquired and liabilities assumed may consist of buildings, any assumed debt, identified intangible assets and asset retirement obligations.  Identified intangible assets generally consist of the above-market and below-market leases, in-place leases, in-place tenant improvements and tenant relationships.  Goodwill is recognized as of the acquisition date and measured as the aggregate fair value of the consideration transferred and any noncontrolling interests in the acquiree over the fair value of identifiable net assets acquired.  Likewise, a bargain purchase gain is recognized in current earnings when the aggregate fair value of the consideration transferred and any noncontrolling interests in the acquiree is less than the fair value of the identifiable net assets acquired.  Acquisition-related costs are expensed in the period incurred.  Initial valuations are subject to change until our information is finalized, which is no later than twelve months from the acquisition date.

 

We determine the value of above-market and below-market in-place leases for acquired properties based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of current market lease rates for the corresponding in-place leases, measured over a period equal to (a) the remaining non-cancelable lease term for above-market leases, or (b) the remaining non-cancelable lease term plus any below-market fixed rate renewal option for below-market leases.  We record the fair value of above-market and below-market leases as intangible assets or intangible liabilities, respectively, and amortize them as an adjustment to rental income over the above determined lease term.

 

The total value of identified real estate intangible assets acquired is further allocated between in-place lease values and tenant relationships based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant.  The aggregate value of in-place leases acquired and tenant relationships is determined by applying a fair value model.  The estimates of fair value of in-place leases include an estimate of carrying costs during the expected lease-up periods for the respective spaces, considering current market conditions.  In estimating fair value of in-place leases, we consider items such as real estate taxes, insurance and other operating expenses, as well as lost rental revenue during the expected lease-up period and carrying costs that would have otherwise been incurred had the leases not been in place, including tenant improvements and commissions.  The estimates of the fair value of tenant relationships also include costs to execute similar leases, including leasing commissions, legal costs and tenant improvements, as well as an estimate of the likelihood of renewal as determined by management on a tenant-by-tenant basis.

 

We amortize the value of in-place leases to expense over the term of the respective leases.  The value of tenant relationship intangibles is amortized to expense over the initial term and any anticipated renewal periods, but in no event does the amortization period for intangible assets exceed the remaining depreciable life of the building.  Should a tenant terminate its lease, the unamortized portion of the in-place lease value and tenant relationship intangibles is charged to expense.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

Anticipated amortization expense associated with the acquired lease intangibles for each of the following five years as of September 30, 2011 is as follows:

 

		Lease / Other
		Intangibles
October 1, 2011 - December 31, 2011		$	635
2012		1,719
2013		1,251
2014		725
2015		370

 

Accumulated depreciation and amortization related to our consolidated investments in real estate assets and intangibles were as follows:

 

											Acquired
		Buildings and			Land and			Lease			Below-Market
September 30, 2011		Improvements			Improvements			Intangibles			Leases
Cost		$	215,724		$	83,474		$	15,355		$	(2,352	)
Less: depreciation and amortization		(9,794		)	(1,042		)	(7,543		)	935
Net		$	205,930		$	82,432		$	7,812		$	(1,417	)

 

											Acquired
		Buildings and			Land and			Lease			Below-Market
December 31, 2010		Improvements			Improvements			Intangibles			Leases
Cost		$	179,319		$	75,187		$	15,043		$	(3,138	)
Less: depreciation and amortization		(4,017		)	(155		)	(3,905		)	1,048
Net		$	175,302		$	75,032		$	11,138		$	(2,090	)

 

Cash and Cash Equivalents

 

We consider investments in highly liquid money market funds or investments with original maturities of three months or less to be cash equivalents.  The carrying amount of cash and cash equivalents reported on the balance sheet approximates fair value.

 

Restricted Cash

 

As required by our lenders, restricted cash is held in escrow accounts for anticipated capital expenditures, real estate taxes and other reserves for our consolidated properties.  Capital reserves are typically utilized for non-operating expenses such as tenant improvements, leasing commissions and major capital expenditures.  Alternatively, a lender may require its own formula for an escrow of capital reserves.

 

Investment Impairment

 

For all of our real estate and real estate related investments, we monitor events and changes in circumstances indicating that the carrying amounts of the real estate assets may not be recoverable.  Examples of the types of events and circumstances that would cause management to assess our assets for potential impairment include, but are not limited to:  a significant decrease in the market price of an asset; a significant adverse change in the manner in which the asset is being used; an accumulation of costs in excess of the acquisition basis plus construction of the property; major vacancies and the resulting loss of revenues; natural disasters; a change in the projected holding period; legitimate purchase offers and changes in the global and local markets or economic conditions.  Our assets may at times be concentrated in limited geographic locations and, to the extent that our portfolio is concentrated in limited geographic locations, downturns specifically related to such regions may result in tenants defaulting on their lease obligations at a portion of our properties within a short time period, which may result in asset impairments.  When such events or changes in circumstances are present, we assess potential impairment by comparing estimated future undiscounted operating cash flows expected to be generated over the life of the asset and from its eventual disposition to the carrying amount of the asset.  In the event that the carrying amount exceeds the estimated future undiscounted operating cash flows, we recognize an impairment loss to adjust the carrying amount of the asset to estimated fair value.  We consider projected future undiscounted cash flows, trends, strategic decisions

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

regarding future development plans, and other factors in our assessment of whether impairment conditions exist.  While we believe our estimates of future cash flows are reasonable, different assumptions regarding factors such as market rents, economic conditions, and occupancy rates could significantly affect these estimates.

 

In evaluating our investments for impairment, management may use appraisals and make estimates and assumptions, including, but not limited to, the projected date of disposition of the properties, the estimated future cash flows of the properties during our ownership, and the projected sales price of each of the properties.  A future change in these estimates and assumptions could result in understating or overstating the carrying value of our investments, which could be material to our financial statements.

 

We believe the carrying value of our operating real estate is currently recoverable.  Accordingly, there were no impairment charges for the nine months ended September 30, 2011 or 2010.  However, if market conditions worsen beyond our current expectations, or if changes in our strategy significantly affect any key assumptions used in our fair value calculations, we may need to take charges in future periods for impairments related to our existing investments.  Any such non-cash charges would have an adverse effect on our consolidated financial position and results of operations.

 

Revenue Recognition

 

We recognize rental income generated from leases on real estate assets on a straight-line basis over the terms of the respective leases, including the effect of rent holidays, if any.  Straight-line rental revenue of $0.1 million and $0.3 million was recognized in rental revenues for the three and nine months ended September 30, 2011, respectively.  Straight-line rental revenue of $0.1 million was recognized in rental revenues for both the three and nine months ended September 30, 2010.  Net below market lease amortization of less than $0.1 million and $0.3 million was recognized in rental revenues for the three and nine months ended September 30, 2011, respectively.  Net below market lease amortization of $0.2 million and $0.7 million was recognized in rental revenues for the three and nine months ended September 30, 2010, respectively.

 

Hotel revenue is derived from the operations of the Courtyard Kauai at Coconut Beach Hotel, consisting of guest room, food and beverage, and other revenue, and is recognized as the services are rendered.

 

We recognize interest income from real estate loans receivable on an accrual basis over the life of the loan using the interest method.  Direct loan origination fees and origination or acquisition costs, as well as acquisition premiums or discounts, are amortized over the life of the loan as an adjustment to interest income.  We will cease accruing interest on loans when there is concern as to the ultimate collection of principal or interest of the loan.

 

Accounts Receivable

 

Accounts receivable primarily consisted of a receivable of $7.1 million for the proceeds from the sale of Inland Empire Distribution Center due to us from the unconsolidated joint venture, receivables from our tenants related to our consolidated properties of $0.8 million and straight-line rental revenue receivables of $0.8 million as of September 30, 2011.  The proceeds from the sale of Inland Empire Distribution Center were received subsequent to September 30, 2011.  As of December 31, 2010, accounts receivable primarily consisted of receivables from our tenants related to our consolidated properties of $0.8 million and straight-line rental revenue receivables of $0.4 million.

 

Furniture, Fixtures, and Equipment

 

Furniture, fixtures, and equipment are recorded at cost and are depreciated using the straight-line method over their estimated useful lives of five to seven years.  Maintenance and repairs are charged to operations as incurred while improvements to such assets are capitalized.  Accumulated depreciation associated with our furniture, fixtures, and equipment was $1.2 million and $0.3 million as of September 30, 2011 and December 31, 2010, respectively.

 

Deferred Financing Fees

 

Deferred financing fees are recorded at cost and are amortized to interest expense of our notes payable using a straight-line method that approximates the effective interest method over the life of the related debt.  Accumulated amortization of deferred financing fees was $1.2 million and $0.4 million as of September 30, 2011 and December 31, 2010, respectively.

 

Derivative Financial Instruments

 

Our objective in using derivatives is to add stability to interest expense and to manage our exposure to interest rate movements or other identified risks and to minimize the variability caused by foreign currency translation risk related to our net investment in foreign real estate.  To accomplish these objectives, we use various types of derivative instruments to manage fluctuations in cash flows resulting from interest rate risk attributable to changes in the benchmark interest rate of

 

11

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

LIBOR.  These instruments include LIBOR-based interest rate swaps and caps.  For our net investments in foreign real estate, we may use foreign exchange put/call options to eliminate the impact of foreign currency exchange movements on our financial position.

 

We measure our derivative instruments and hedging activities at fair value and record them as an asset or liability, depending on our rights or obligations under the applicable derivative contract.  For derivatives designated as fair value hedges, the changes in the fair value of both the derivative instrument and the hedged items are recorded in earnings.  Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.  For derivatives designated as cash flow hedges, the effective portions of changes in fair value of the derivatives are reported in other comprehensive income (loss) and are subsequently reclassified into earnings when the hedged item affects earnings.  We assess the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction.

 

As of September 30, 2011, we do not have any derivatives designated as net investment hedges or fair value hedges.  No derivatives were being used for trading or speculative purposes.  See Notes 5 and 13 for further information regarding our derivative financial instruments.

 

Organization and Offering Expenses

 

We reimburse the Advisor or its affiliates for any organization and offering expenses (other than selling commissions and the dealer manager fee) incurred on our behalf in connection with the primary offering component of the Offerings.  In connection with the Initial Offering, we reimbursed the Advisor for $7.5 million of organization and offering expenses (other than selling commissions and the dealer manager fee) that it had incurred on our behalf.  On October 9, 2009, the Advisor waived $3.5 million of organization and offering expenses (other than selling commissions and the dealer manager fee) it had incurred on our behalf through December 31, 2008.  On July 5, 2011, in connection with the Follow-On Offering, we entered into the Third Amended and Restated Advisory Management Agreement with the Advisor.  Pursuant to the Third Amended and Restated Advisory Agreement, we will not reimburse the Advisor for any additional organization and offering expenses (other than selling commissions and the dealer manager fee) incurred on our behalf in connection with the primary offering until the completion of our Follow-On Offering.

 

Upon completion of the Follow-On Offering, the Advisor will reimburse us to the extent that the total amount spent on organization and offering expenses in the Offerings (other than selling commissions and the dealer manager fee) exceeds 1.5% of the gross proceeds raised in the primary component of the Offerings; however, if we have reimbursed the Advisor less than 1.5% of the gross proceeds raised in the primary component of the Offerings, we will reimburse the Advisor for any additional organization and offering expenses it incurs up to the 1.5% limit.  We have limited the amount of organization and offering reimbursement accruals to amounts we currently expect to have to dispense.  Based on our current review of projected gross proceeds from our Offerings, we have booked a receivable from the Advisor for $2.3 million of organization and offering expenses that were previously reimbursed to the Advisor.

 

Organization and offering expenses are defined generally as any and all costs and expenses incurred by us in connection with our formation, preparing for the Offerings, the qualification and registration of the Offerings, and the marketing and distribution of our shares.  Organization and offering expenses include, but are not limited to, accounting and legal fees; costs to amend the registration statement and supplement the prospectus; printing, mailing and distribution costs; filing fees; amounts to reimburse our Advisor or its affiliates for the salaries of employees; and other costs in connection with preparing supplemental sales literature; telecommunication costs; fees of the transfer agent, registrars, trustees, escrow holders, depositories and experts; and fees and costs for employees of our Advisor or its affiliates to attend industry conferences.

 

All offering costs are recorded as an offset to additional paid-in capital, and all organization costs are recorded as an expense at the time we become liable for the payment of these amounts.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

Income Taxes

 

We have elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”), and have qualified as a REIT since the year ended December 31, 2008.  To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we distribute at least 90% of our REIT taxable income to our stockholders.  As a REIT, we generally will not be subject to federal income tax at the corporate level.  We are organized and operate in such a manner as to qualify for taxation as a REIT under the Code and intend to continue to operate in such a manner, but no assurance can be given that we will operate in a manner so as to qualify or remain qualified as a REIT.

 

We have reviewed our tax positions under GAAP guidance that clarifies the relevant criteria and approach for the recognition and measurement of uncertain tax positions.  The guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition of a tax position taken, or expected to be taken, in a tax return.  A tax position may only be recognized in the financial statements if it is more likely than not that the tax position will be sustained upon examination.  We believe it is more likely than not that the tax positions taken relative to our status as a REIT will be sustained in any tax examination.

 

Foreign Currency Translation

 

For our international investment where the functional currency is other than the U.S. dollar, assets and liabilities are translated using period-end exchange rates, while the statement of operations amounts are translated using the average exchange rates for the respective period.  Differences arising from the translation of assets and liabilities in comparison with the translation of the previous periods or from initial recognition during the period are included as a separate component of accumulated other comprehensive income (loss) (“AOCI”).

 

The Euro is the functional currency for the operations of Holstenplatz.  We also maintain a Euro-denominated bank account that is translated into U.S. dollars at the current exchange rate at the last day of each reporting period.  The resulting translation adjustments are recorded as a separate component of AOCI in our consolidated statement of equity.  For the nine months ended September 30, 2011, the foreign currency translation adjustment was a gain of $0.1 million.  For the nine months ended September 30, 2010, the foreign currency translation adjustment was a gain of $0.4 million.

 

Accumulated Other Comprehensive Income (Loss)

 

AOCI, which is reported in the accompanying consolidated statement of equity, consists of gains and losses affecting equity that are excluded from net income (loss) under GAAP.  The components of AOCI consist of cumulative foreign currency translation gains and losses and the unrealized gain on derivative instruments.

 

Stock-Based Compensation

 

We have adopted a stock-based incentive award plan for our directors and consultants and for employees, directors and consultants of our affiliates.  We have not issued any stock-based awards under the plan as of September 30, 2011.

 

Concentration of Credit Risk

 

At September 30, 2011 and December 31, 2010, we had cash and cash equivalents deposited in certain financial institutions in excess of federally insured levels.  We have diversified our cash and cash equivalents among several banking institutions in an attempt to minimize exposure to any one of these entities.  We regularly monitor the financial stability of these financial institutions and believe that we are not exposed to any significant credit risk in cash and cash equivalents or restricted cash.

 

Noncontrolling Interest

 

Noncontrolling interest represents the noncontrolling ownership interest’s proportionate share of the equity in our consolidated real estate investments.  Income and losses are allocated to noncontrolling interest holders based on their ownership percentage.

 

Earnings per Share

 

Net income (loss) per share is calculated based on the weighted average number of common shares outstanding during each period.  The weighted average shares outstanding used to calculate both basic and diluted income (loss) per share were the same for the three and nine months ended September 30, 2011 and 2010, as there were no potentially dilutive securities outstanding.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

Reportable Segments

 

GAAP establishes standards for reporting financial and descriptive information about an enterprise’s reportable segments.  We have determined that we have one reportable segment, with activities related to the ownership, development and management of real estate assets.  Our chief operating decision maker evaluates operating performance on an individual property level.  Therefore, our properties are aggregated into one reportable segment.

 

4.                                      New Accounting Pronouncements

 

In April 2011, the FASB issued further clarification on when a loan modification or restructuring is considered a troubled debt restructuring. In determining whether a loan modification represents a troubled debt restructuring, an entity should consider whether the debtor is experiencing financial difficulty and the lender has granted a concession to the borrower. This guidance is to be applied retrospectively, with early application permitted.  This guidance was effective for the first interim or annual period beginning on or after June 15, 2011. The adoption of this guidance did not have a material impact on our financial statements or disclosures.

 

In May 2011, the FASB issued updated guidance for fair value measurements.  The guidance amends existing guidance to provide common fair value measurements and related disclosure requirements between GAAP and International Financial Reporting Standards.  This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We are currently evaluating this guidance to determine if it will have a material impact on our financial statements or disclosures.

 

In June 2011, the FASB issued updated guidance related to comprehensive income.  The guidance requires registrants to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, registrants will be required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statements where the components of net income and the components of other comprehensive income are presented. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Early adoption is permitted.  Our current presentation complies with the guidance of this new standard.

 

5.                                      Assets and Liabilities Measured at Fair Value

 

Fair value measurements are determined based on the assumptions that market participants would use in pricing the asset or liability.  As a basis for considering market participant assumptions in fair value measurements, a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy) has been established.

 

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets and liabilities that we have the ability to access.  Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals.  Level 3 inputs are unobservable inputs for the asset or liability that are typically based on an entity’s own assumptions, as there is little, if any, related market activity.  In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.  Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

Recurring Fair Value Measurements

 

Currently, we use interest rate swaps and caps to manage our interest rate risk.  The valuation of these instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative.  This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, implied volatilities, and foreign currency exchange rates.

 

We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.  Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by itself and its counterparties.  However, as of September 30, 2011, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives.  As a result, we have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

 

The following fair value hierarchy table presents information about our assets measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010.

 

September 30, 2011		Level 1			Level 2			Level 3			Total
Assets
Derivative financial instruments		$	—		$	24		$	—		$	24

 

December 31, 2010		Level 1			Level 2			Level 3			Total
Assets
Derivative financial instruments		$	—		$	372		$	—		$	372

 

6.                                      Fair Value Disclosure of Financial Instruments

 

We determined the following disclosure of estimated fair values using available market information and appropriate valuation methodologies.  However, considerable judgment is necessary to interpret market data and develop the related estimates of fair value.  The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

 

As of September 30, 2011 and December 31, 2010, management estimated that the carrying value of cash and cash equivalents, restricted cash, accounts receivable, prepaid expenses and other assets, accounts payable, accrued expenses, other liabilities, payables/receivables from related parties, and distributions payable were at amounts that reasonably approximated their fair value based on their highly-liquid nature and/or short-term maturities and the carrying value of real estate loans receivable reasonably approximated fair value based on expected interest rates for notes to similar borrowers with similar terms and remaining maturities.  We had no real estate loans receivable as of September 30, 2011.

 

The notes payable of $205.1 million and $175.4 million as of September 30, 2011 and December 31, 2010, respectively, have a fair value of approximately $209.4 million and $178.5 million as of September 30, 2011 and December 31, 2010, respectively, based upon interest rates for debt with similar terms and remaining maturities that management believes we could obtain.

 

7.                                      Real Estate and Real Estate-Related Investments

 

As of September 30, 2011, we consolidated ten real estate assets.  The following table presents certain information about our consolidated investments as of September 30, 2011:

 

Property Name

Location

Date Acquired

Approximate Rentable Square Footage or Number of Units and Total Square Feet of Units

Description

Encumbrances

Ownership Interest

1875 Lawrence

Denver, CO

October 28, 2008

185,000

15-story office building

$ 20.8 million

100

%

Palms of Monterey

Fort Myers, FL

May 10, 2010

408 units / 518,000 square feet

Multifamily

19.7 million

90

%

Holstenplatz

Hamburg, Germany

June 30, 2010

80,000

8-story office

10.6 million

100

%

Archibald Business Center

Ontario, California

August 27, 2010

231,000

Office and industrial warehouse

6.3 million

80

%

Parrot’s Landing

North Lauderdale, Florida

September 17, 2010

560 units / 519,000 square feet

Multifamily

29.1 million

90

%

Florida MOB Portfolio (1)

South Florida

October 8, 2010/October 20, 2010 (2)

694,000

Medical office

33.7 million

90

%(2)

Courtyard Kauai Coconut Beach Hotel

Kauai, Hawaii

October 20, 2010

311 Rooms (3)

Hotel

38 million

80

%

Interchange Business Center

San Bernardino, California

November 23, 2010

802,000

Industrial

19.4 million

80

%

River Club apartments and the Townhomes at River Club (formerly referred to as the UGA Portfolio)

Athens, Georiga

April 25, 2011

1,128 beds (4)

Student housing

25.2 million

85

%

Babcock Self Storage

San Antonio, Texas

August 30, 2011

537 units

self storage

2.3 million

85

%

 

(1) We acquired a portfolio of eight medial office buildings, known as the Original Florida MOB Portfolio on October 8, 2010. We acquired a medical office building known as Gardens Medical Pavilion on October 20, 2010. Collectively, the Original Florida MOB Portfolio and Gardens Medical Pavilion are referred to as the Florida MOB Portfolio.

(2) The Florida MOB Portfolio consists of nine Medical Office Buildings. We own 90% of each of eight of the buildings. We own 90% of a 90% JV interest in the ninth building, Gardens Medical Pavilion.

(3) The Courtyard Kauai Coconut Beach Hotel has 311 rooms and approximately 6,200 square feet (unaudited) of meeting space.

(4) The River Club apartments and the Townhomes at River Club consists of two student housing complexes located in Athens, Georgia with a total of 1,128 beds.

 

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