Lightstone Value Plus REIT V, Inc. - Quarter Report: 2012 June (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 June 30, 2012

 

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 July 31, 2012, Behringer Harvard Opportunity REIT II, Inc. had 26,074,407 shares of common stock outstanding.

 

 

Table of Contents

 

BEHRINGER HARVARD OPPORTUNITY REIT II, INC.

FORM 10-Q

Quarter Ended June 30, 2012

 

	PART I
	FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011	3
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2012 and 2011	4
	Condensed Consolidated Statements of Equity for the Six Months Ended June 30, 2012 and 2011	5
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	37
	PART II
	OTHER INFORMATION
Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3.	Defaults Upon Senior Securities	40
Item 4.	Mine Safety Disclosure	40
Item 5.	Other Information	40
Item 6.	Exhibits	40
Signature		41

 

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PART I

FINANCIAL INFORMATION

 

Item 1.              Financial Statements.

 

Behringer Harvard Opportunity REIT II, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except shares)

(unaudited)

 

		June 30,			December 31,
		2012			2011
Assets
Real estate
Land and improvements, net		$	88,494		$	86,962
Buildings and improvements, net		227,572			218,839
Real estate under development		724			105
Total real estate		316,790			305,906
Assets associated with real estate held for sale		—			29,420
Cash and cash equivalents		69,254			80,130
Restricted cash		6,155			5,616
Accounts receivable, net		2,612			1,704
Receivable from related party		3,180			3,485
Prepaid expenses and other assets		2,217			1,596
Furniture, fixtures and equipment, net		6,930			7,219
Deferred financing fees, net		3,781			4,533
Lease intangibles, net		6,340			8,387
Total assets		$	417,259		$	447,996
Liabilities and Equity
Notes payable		$	223,198		$	239,757
Accounts payable		2,953			3,718
Acquired below-market leases, net		1,192			1,271
Distributions payable		—			1,069
Accrued and other liabilities		8,290			5,140
Obligations associated with real estate held for sale		—			37
Total liabilities		235,633			250,992
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, 26,074,407 and 25,267,048 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively		3			3
Additional paid-in capital		233,400			225,968
Accumulated distributions and net loss		(60,581		)	(43,657		)
Accumulated other comprehensive income		(272		)	83
Total Behringer Harvard Opportunity REIT II, Inc. equity		172,550			182,397
Noncontrolling interest		9,076			14,607
Total equity		181,626			197,004
Total liabilities and equity		$	417,259		$	447,996

 

See Notes to Condensed Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

(in thousands, except per share amounts)

(unaudited)

 

		Three months ended June 30,						Six months ended June 30,
		2012			2011			2012			2011
Revenues
Rental revenue		$	10,102		$	7,504		$	19,934		$	13,886
Hotel revenue		2,432			1,353			4,907			2,991
Interest income from real estate loan receivable		—			1,257			—			2,482
Total revenues		12,534			10,114			24,841			19,359
Expenses:
Property operating expenses		6,191			4,475			12,089			8,706
Interest expense		2,769			2,039			5,405			3,849
Real estate taxes		1,473			1,152			2,917			2,226
Property management fees		479			367			928			662
Asset management fees		852			776			1,670			1,394
General and administrative		767			576			1,391			1,054
Acquisition expense		729			1,109			729			1,454
Depreciation and amortization		4,096			3,277			8,492			6,988
Total expenses		17,356			13,771			33,621			26,333
Interest income, net		44			25			75			87
Other income		50			—			80			—
Loss from continuing operations before income taxes and equity in losses’of unconsolidated joint ventures		(4,728		)	(3,632		)	(8,625		)	(6,887		)
Equity in losses of unconsolidated joint ventures		—			(157		)	—			(309		)
Loss from continuing operations		(4,728		)	(3,789		)	(8,625		)	(7,196		)
Income (loss) from discontinued operations		(18		)	52			8,001			23
Net loss		(4,746		)	(3,737		)	(624		)	(7,173		)
Noncontrolling interest in continuing operations		382			459			757			905
Noncontrolling interest in discontinued operations		4			7			(800		)	30
Net (income) loss attributable to the noncontrolling interest		386			466			(43		)	935
Net loss attributable to the Company		$	(4,360	)	$	(3,271	)	$	(667	)	$	(6,238	)
Amounts attributable to the Company
Continuing operations		$	(4,346	)	$	(3,330	)	$	(7,868	)	$	(6,291	)
Discontinued operations		(14		)	59			7,201			53
Net loss attributable to the Company		$	(4,360	)	$	(3,271	)	$	(667	)	$	(6,238	)
Weighted average shares outstanding:
Basic and diluted		26,089			23,868			25,908			23,349
Net income (loss) per share
Continuing operations		$	(0.17	)	$	(0.14	)	$	(0.30	)	$	(0.27	)
Discontinued operations		—			—			0.28			—
Basic and diluted loss per share		$	(0.17	)	$	(0.14	)	$	(0.02	)	$	(0.27	)
Comprehensive income (loss):
Net loss		$	(4,746	)	$	(3,737	)	$	(624	)	$	(7,173	)
Other comprehensive income (loss):
Unrealized losses on interest rate derivatives		—			(238		)	(1		)	(242		)
Foreign currency translation gain (loss)		(451		)	67			(354		)	256
Total other comprehensive income (loss)		(451		)	(171		)	(355		)	14
Comprehensive loss		(5,197		)	(3,908		)	(979		)	(7,159		)
Comprehensive income (loss) attributable to noncontrolling interest		386			514			(43		)	983
Comprehensive loss attributable to the Company		$	(4,811	)	$	(3,394	)	$	(1,022	)	$	(6,176	)

 

See Notes to Condensed Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Condensed Consolidated Statements of Equity

(unaudited)

(in thousands)

 

																		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 Janauary 1, 2011		1		$	—		22,330		$	2		$	195,149		$	(23,883	)	$	410		$	10,533		$	182,211
Issuance of common stock, net							2,097		—			19,172												19,172
Redemption of common stock							(80	)				(735		)										(735		)
Distributions declared on common stock															(5,791		)							(5,791		)
Contributions from noncontrolling interest																					2,812			2,812
Distributions to noncontrolling interest																					(303		)	(303		)
Other comprehensive income (loss):
Unrealized losses on interest rate derivatives																		(194		)	(48		)	(242		)
Foreign currency translation gain																		256						256
Net loss															(6,238		)				(935		)	(7,173		)
Balance at June 30, 2011		1		$	—		24,347		$	2		$	213,586		$	(35,912	)	$	472		$	12,059		$	190,207
Balance at January 1, 2012		1		$	—		25,267		$	3		$	225,968		$	(43,657	)	$	83		$	14,607		$	197,004
Issuance of common stock, net							910		—			8,346												8,346
Redemption of common stock							(103	)				(914		)										(914		)
Distributions declared on common stock															(16,257		)							(16,257		)
Contributions from noncontrolling interest																					1,492			1,492
Distributions to noncontrolling interest																					(7,066		)	(7,066		)
Other comprehensive income (loss):
Unrealized losses on interest rate derivatives																		(1		)	—			(1		)
Foreign currency translation loss																		(354		)				(354		)
Net income (loss)															(667		)				43			(624		)
Balance at June 30, 2012		1		$	—		26,074		$	3		$	233,400		$	(60,581	)	$	(272	)	$	9,076		$	181,626

 

See Notes to Condensed Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

		Six months ended June 30,
		2012			2011
Cash flows from operating activities:
Net loss		$	(624	)	$	(7,173	)
Adjustments to reconcile net income (loss) to net cash flows used in operating activities:
Depreciation and amortization		8,451			7,630
Amortization of deferred financing fees		525			544
Equity in losses of unconsolidated joint venture		—			309
Gain on sale of discontinued operations		(9,264		)	—
Loss on early extinguishment of debt		1,236			—
Change in operating assets and liabilities:
Accounts receivable		(908		)	(231		)
Interest receivable-real estate loan receivable		—			(1,247		)
Prepaid expenses and other assets		(625		)	(342		)
Accounts payable		(918		)	(655		)
Accrued and other liabilities		2,583			695
Net receivables to related parties		274			(177		)
Addition of lease intangibles		(236		)	(358		)
Cash provided by (used in) operating activities		494			(1,005		)
Cash flows from investing activities:
Purchases of real estate		(11,039		)	(33,881		)
Proceeds from sale of discontinued operations		38,684			—
Additions to property and equipment		(5,982		)	(4,583		)
Change in restricted cash		(540		)	3,311
Cash provided by (used in) investing activities		21,123			(35,153		)
Cash flows from financing activities:
Financing costs		(1,013		)	(716		)
Proceeds from notes payable		7,311			27,549
Payments on notes payable		(23,369		)	(788		)
Issuance of common stock		6,142			16,874
Redemptions of common stock		(914		)	(735		)
Offering costs		(553		)	(1,540		)
Distributions		(14,536		)	(1,873		)
Contributions from noncontrolling interest holders		1,492			2,813
Distributions to noncontrolling interest holders		(7,066		)	(303		)
Cash provided by (used in) financing activities		(32,506		)	41,281
Effect of exchange rate changes on cash and cash equivalents		13			110
Net change in cash and cash equivalents		(10,876		)	5,233
Cash and cash equivalents at beginning of period		80,130			49,375
Cash and cash equivalents at end of period		$	69,254		$	54,608

 

See Notes to Condensed Consolidated Financial Statements.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.                                      Business and Organization

 

Business

 

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, 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 discount 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 and 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 also may originate or invest in collateralized mortgage-backed securities and mortgage, bridge or mezzanine loans, 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 June 30, 2012, we had eleven real estate investments, all of which were consolidated into our condensed consolidated financial statements.

 

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 June 30, 2012, 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 June 30, 2012, 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.

 

Organization

 

On February 26, 2007, we filed a 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, the Initial Offering terminated in accordance with its terms.

 

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 were being offered pursuant to the DRP.  On July 5, 2011, the Follow-On Offering was declared effective by the SEC, and we commenced offering shares under the Follow-On Offering.  We terminated the primary portion of the follow-on offering effective March 15, 2012 and discontinued offering shares of our common stock under the DRP effective April 2, 2012. Through June 30, 2012, we raised gross offering proceeds of approximately $265.3 million from the sale of approximately 26.7 million shares under 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. Behringer Harvard Holdings transferred its shares of convertible stock to the Advisor on April 2, 2010.  As of June 30, 2012, we had 26.1 million shares of common stock outstanding, including the 22,471 shares issued to Behringer Harvard Holdings. As of June 30, 2012, we had 1,000 shares of convertible stock issued and outstanding to the Advisor.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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 for the primary offerings were used for payment of dealer manager fees and selling commissions and could be utilized in the Offerings 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 June 30, 2012, we had issued 26.7 million shares of our common stock, including 22,471 shares owned by Behringer Harvard Holdings and 2.2 million shares issued through the DRP.  As of June 30, 2012, we had redeemed 0.6 million shares of our common stock.

 

Our common stock is not currently listed on a national securities exchange.  Depending upon then 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 condensed 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, 2011, which was filed with the SEC on March 28, 2012.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted in this report on Form 10-Q pursuant to the rules and regulations of the SEC.

 

The results for the interim periods shown in this report are not necessarily indicative of future financial results.  The accompanying condensed consolidated balance sheet as of June 30, 2012, the condensed consolidated statements of operations and comprehensive income (loss) for the three and six months ended June 30, 2012 and 2011 and condensed consolidated statements of equity and cash flows for the six months ended June 30, 2012 and 2011 have not been audited by our independent registered public accounting firm.  In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments necessary to fairly present our condensed consolidated financial position as of June 30, 2012 and December 31, 2011 and our condensed consolidated results of operations and cash flows for the periods ended June 30, 2012 and 2011.  Such adjustments are of a normal recurring nature.

 

3.                                      Summary of Significant Accounting Policies

 

Described below are certain of our significant accounting policies.  The disclosures regarding several of the policies have been condensed or omitted in accordance with interim reporting regulations specified by Form 10-Q.  Please see our Annual Report on Form 10-K for a complete listing of all of our significant accounting policies.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of financial statements in conformity with 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 Condensed 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 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

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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 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 land, inclusive of associated rights, buildings, assumed debt, identified intangible assets and liabilities and asset retirement obligations. Identified intangible assets generally consist of above-market leases, in-place leases, in-place tenant improvements, in-place leasing commissions and tenant relationships.  Identified intangible liabilities generally consist of below-market leases. 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 the 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.

 

The fair value of the tangible assets acquired, consisting of land and buildings, is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land and buildings.  Land values are derived from appraisals, and building values are calculated as replacement cost less depreciation or management’s estimates of the fair value of these assets using discounted cash flow analyses or similar methods believed to be used by market participants.  The value of buildings is depreciated over the estimated useful life of 25 years using the straight-line method.

 

We determine the fair value of assumed debt by calculating the net present value of the scheduled mortgage payments using interest rates for debt with similar terms and remaining maturities that management believes we could obtain at the date of the debt assumption.  Any difference between the fair value and stated value of the assumed debt is recorded as a discount or premium and amortized over the remaining life of the loan using the effective interest method.

 

We determine the value of above-market and below-market 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 (1) the contractual amounts to be paid pursuant to the in-place leases and (2) 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 options that, based on a qualitative assessment of several factors, including the financial condition of the lessee, the business conditions in the industry in which the lessee operates, the economic conditions in the area in which the property is located, and the ability of the lessee to sublease the property during the renewal term, are reasonably assured to be exercised by the lessee 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 determined lease term.

 

The total value of identified real estate intangible assets acquired is further allocated to in-place leases, in-place tenant improvements, in-place leasing commissions 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 for tenant improvements and leasing commissions is based on estimates of these costs incurred at inception of the acquired leases, amortized through the date of acquisition.  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 the carrying costs that would have otherwise been incurred had the leases not been in place, we include such items as real estate taxes, insurance and other operating expenses as well as lost rental revenue during the expected lease-up period based on current market conditions.  The estimates of the fair value of tenant relationships also include costs to execute similar leases including leasing commissions, legal fees 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, in-place tenant improvements and in-place leasing commissions to expense over the initial term of the respective leases.  The tenant relationship values are amortized to expense over the initial term and any anticipated renewal periods, but in no event does the amortization period for intangible assets or liabilities

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

exceed the remaining depreciable life of the building.  Should a tenant terminate its lease, the unamortized portion of the acquired lease intangibles related to that tenant would be charged to expense.

 

Anticipated amortization expense associated with the acquired lease intangibles for each of the following five years as of June 30, 2012 is as follows:

 

Year		Lease / Other Intangibles
July 1, 2012 - December 31, 2012		$	793
2013		1,267
2014		758
2015		386
2016		248

 

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
June 30, 2012		Improvements			Improvements			Intangibles			Leases
Cost		$	242,412		$	90,550		$	15,666		$	(2,394	)
Less: depreciation and amortization		(14,840		)	(2,056		)	(9,326		)	1,202
Net		$	227,572		$	88,494		$	6,340		$	(1,192	)

 

											Acquired
		Buildings and			Land and			Lease			Below-Market
December 31, 2011		Improvements			Improvements			Intangibles			Leases
Cost		$	228,999		$	88,292		$	16,210		$	(2,232	)
Less: depreciation and amortization		(10,160		)	(1,330		)	(7,823		)	961
Net (1)		$	218,839		$	86,962		$	8,387		$	(1,271	)

 

(1)          Excludes Palms of Monterrey, which was sold on January 5, 2012 (classified as held for sale at December 31, 2011)

 

Real Estate Held for Sale

 

We classify properties as held for sale when certain criteria are met, in accordance with GAAP.  At that time we present the assets and obligations of the property held for sale separately in our consolidated balance sheet and we cease recording depreciation and amortization expense related to that property.  Properties held for sale are reported at the lower of their carrying amount or their estimated fair value, less estimated costs to sell.  As of December 31, 2011, our Palms of Monterrey property was classified as held for sale and a sale of the property was completed on January 5, 2012.  We had no property classified as held for sale at June 30, 2012.

 

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

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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 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 six months ended June 30, 2012 or 2011.  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 $0.2 million was recognized in rental revenues for the three and six months ended June 30, 2012, respectively.  Straight-line rental revenue of $0.1 million and $0.2 million was recognized in rental revenues for the three and six months ended June 30, 2011, respectively.  Net below market lease amortization of less than $0.1 million and $0.1 million was recognized in rental revenues for the three and six months ended June 30, 2012, respectively.  Net below market lease amortization of $0.2 million and $0.3 million was recognized in rental revenues for the three and six months ended June 30, 2011, 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.

 

Accounts Receivable

 

Accounts receivable primarily consist of receivables from our tenants related to our consolidated properties of $1.2 million and straight-line rental revenue receivables of $1 million as of June 30, 2012.  Accounts receivable primarily consist of receivables from our tenants related to our consolidated properties of $0.4 million and straight-line rental revenue receivables of $0.9 million as of December 31, 2011.

 

Prepaid Expenses and Other Assets

 

Prepaid expenses and other assets include prepaid directors’ and officers’ insurance, as well as prepaid insurance of our consolidated properties.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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 $1.9 million and $1.2 million as of June 30, 2012 and December 31, 2011, 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 $1.8 million and $1.2 million as of June 30, 2012 and December 31, 2011, 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 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 June 30, 2012, 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 11 for further information regarding our derivative financial instruments.

 

Organization and Offering Expenses

 

We reimbursed the Advisor and its affiliates for 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 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 Management Agreement, we did 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 Follow-On Offering.  We terminated the primary portion of the Follow-On Offering effective March 15, 2012 and discontinued offering of shares of our common stock under the DRP effective April 2, 2012.

 

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.  Based on our current review of gross proceeds from our Offerings, we have recorded a receivable from the Advisor for approximately $3.8 million for organization and offering expenses that were previously reimbursed to the Advisor.  The receivable of $3.8 million is presented net of other payables of $0.6 million to the Advisor on our consolidated balance sheet.  We expect to receive payment from the Advisor for this receivable during the first quarter of 2013.

 

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

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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.

 

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.  Gains and losses resulting from the change in exchange rates from period to period are reported separately as a component of accumulated other comprehensive income (loss) (“AOCI”).  Gains and losses resulting from foreign currency transactions are included in the condensed consolidated statements of operations and comprehensive income (loss).

 

The Euro is the functional currency for the operations of Holstenplatz and Alte Jakobstraße.  We also maintain a Euro-denominated bank account that is translated into U.S. dollars at the current exchange rate at each reporting period.  For the six months ended June 30, 2012, the foreign currency translation adjustment was a loss of $0.4 million.  For the six months ended June 30, 2011, the foreign currency translation adjustment was a gain of $0.3 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 June 30, 2012.

 

Concentration of Credit Risk

 

At June 30, 2012 and December 31, 2011, 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.

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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 six months ended June 30, 2012 and 2011, as there were no potentially dilutive securities outstanding.

 

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 May 2011, the Financial Accounting Standards Board (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.  The adoption of this guidance did not have an impact on our financial statements except for 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.  Due to our early adoption, this guidance did not have a material impact on our financial statements.

 

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

 

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Behringer Harvard Opportunity REIT II, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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 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 June 30, 2012, 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 June 30, 2012 and December 31, 2011.

 

June 30, 2012		Level 1			Level 2			Level 3			Total
Assets
Derivative financial instruments		$	—		$	3		$	—		$	3

 

December 31, 2011		Level 1			Level 2			Level 3			Total
Assets
Derivative financial instruments		$	—		$	19		$	—		$	19

 

Derivative financial instruments classified as assets are included in prepaid expenses and other assets on the balance sheet.

 

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 June 30, 2012 and December 31, 2011, 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.  The notes payable of $223.2 million and $239.8 million as of June 30, 2012 and December 31, 2011, respectively, have a fair value of approximately $225.7 million and $242.2 million as of June 30, 2012 and December 31, 2011, respectively, based upon interest rates for debt with similar terms and remaining maturities that management believes we could obtain.  The fair value of the notes payable is categorized as a Level 2 basis.  The fair value is estimated using a discounted cash flow analysis valuation on the borrowing rates currently available for loans with similar terms and maturities.  The fair value of the notes payable was determined by discounting the future contractual interest and principal payments by a market rate.  Disclosure about fair value of financial instruments is based on pertinent information available to management as of June 30, 2012 and December 31, 2011.

 

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