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Lightstone Value Plus REIT V, Inc. - Quarter Report: 2013 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, 2013
 
Commission File Number: 000-53650
 
Behringer Harvard Opportunity REIT II, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 
Maryland
 
20-8198863
(State or other jurisdiction of incorporation or
organization)
 
(I.R.S. Employer
Identification No.)
 
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 ý 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 ý 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:
 
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer o 
(Do not check if a smaller reporting company)
 
Smaller reporting company x
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No ý
 
As of October 31, 2013, Behringer Harvard Opportunity REIT II, Inc. had 26,019,075 shares of common stock outstanding.

 

Table of Contents

BEHRINGER HARVARD OPPORTUNITY REIT II, INC.
FORM 10-Q
Quarter Ended September 30, 2013
 
 
 
Page
 
 
 
PART I
FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2
Table of Contents

PART I
FINANCIAL INFORMATION
Item 1.                   Financial Statements (Unaudited). 

Behringer Harvard Opportunity REIT II, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except shares)
(unaudited)
 
 
September 30, 2013
 
December 31, 2012
Assets
 
 

 
 

Real estate
 
 

 
 

Land and improvements, net
 
$
65,448

 
$
73,380

Buildings and improvements, net
 
220,157

 
199,915

Real estate under development
 
102

 
838

Total real estate
 
285,707

 
274,133

 
 
 
 
 
Cash and cash equivalents
 
101,845

 
77,752

Restricted cash
 
7,501

 
3,491

Accounts receivable, net
 
2,505

 
3,008

Receivable from related party
 
—

 
3,269

Prepaid expenses and other assets
 
1,438

 
1,781

Investment in unconsolidated joint venture
 
11,858

 
—

Furniture, fixtures and equipment, net
 
8,177

 
6,864

Deferred financing fees, net
 
3,408

 
3,398

Lease intangibles, net
 
2,280

 
5,370

Total assets
 
$
424,719

 
$
379,066

Liabilities and Equity
 
 

 
 

Notes payable
 
$
212,117

 
$
183,308

Accounts payable
 
1,374

 
1,777

Payables to related parties
 
659

 
—

Acquired below-market leases, net
 
355

 
904

Distributions payable to noncontrolling interest
 
4,353

 
—

Accrued and other liabilities
 
8,771

 
6,544

Total liabilities
 
227,629

 
192,533

 
 
 
 
 
Commitments and contingencies
 
0

 
0

 
 
 
 
 
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, 26,019,075 and 26,060,612 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively
 
3

 
3

Additional paid-in capital
 
232,929

 
233,283

Accumulated distributions and net loss
 
(45,727
)
 
(58,249
)
Accumulated other comprehensive income
 
357

 
126

Total Behringer Harvard Opportunity REIT II, Inc. equity
 
187,562

 
175,163

Noncontrolling interest
 
9,528

 
11,370

Total equity
 
197,090

 
186,533

Total liabilities and equity
 
$
424,719

 
$
379,066

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

3
Table of Contents

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 September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Revenues
 
 

 
 

 
 

 
 

Rental revenue
 
$
7,615

 
$
5,538

 
$
20,564

 
$
16,221

Hotel revenue
 
3,982

 
3,073

 
10,994

 
7,980

Total revenues
 
11,597

 
8,611

 
31,558

 
24,201

 
 
 
 
 
 
 
 
 
Expenses
 
 

 
 

 
 

 
 

Property operating expenses
 
2,857

 
1,772

 
6,975

 
5,076

Hotel operating expenses
 
3,008

 
2,544

 
8,496

 
7,389

Interest expense, net
 
2,053

 
1,737

 
5,776

 
5,152

Real estate taxes
 
1,278

 
781

 
3,418

 
2,258

Property management fees
 
399

 
301

 
1,090

 
855

Asset management fees
 
990

 
776

 
2,535

 
2,350

General and administrative
 
1,225

 
850

 
2,858

 
2,241

Acquisition expense
 
996

 
10

 
4,053

 
739

Depreciation and amortization
 
3,447

 
2,413

 
10,202

 
8,062

Total expenses
 
16,253

 
11,184

 
45,403

 
34,122

 
 
 
 
 
 
 
 
 
Interest income, net
 
25

 
29

 
83

 
93

Other income
 
28

 
17

 
37

 
96

 
 
 
 
 
 
 
 
 
Loss from continuing operations
 
(4,603
)
 
(2,527
)
 
(13,725
)
 
(9,732
)
 
 
 
 
 
 
 
 
 
Income (loss) from discontinued operations, including gains on disposition
 
16,952

 
(866
)
 
31,134

 
5,715

 
 
 
 
 
 
 
 
 
Net income (loss)
 
12,349

 
(3,393
)
 
17,409

 
(4,017
)
 
 
 
 
 
 
 
 
 
Noncontrolling interest in continuing operations
 
182

 
136

 
560

 
606

Noncontrolling interest in discontinued operations
 
(1,691
)
 
156

 
(5,447
)
 
(357
)
Net (income) loss attributable to the noncontrolling interest
 
(1,509
)
 
292

 
(4,887
)
 
249

Net income (loss) attributable to the Company
 
$
10,840

 
$
(3,101
)
 
$
12,522

 
$
(3,768
)
 
 
 
 
 
 
 
 
 
Amounts attributable to the Company
 
 

 
 

 
 

 
 

Continuing operations
 
$
(4,421
)
 
$
(2,391
)
 
$
(13,165
)
 
$
(9,126
)
Discontinued operations
 
15,261

 
(710
)
 
25,687

 
5,358

Net income (loss) attributable to the Company
 
$
10,840

 
$
(3,101
)
 
$
12,522

 
$
(3,768
)
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 

 
 

 
 

 
 

Basic and diluted
 
26,032

 
26,069

 
26,041

 
25,962

 
 
 
 
 
 
 
 
 
Net income (loss) per share
 
 

 
 

 
 

 
 

Continuing operations
 
$
(0.17
)
 
$
(0.09
)
 
$
(0.51
)
 
$
(0.35
)
Discontinued operations
 
0.59

 
(0.03
)
 
0.99

 
0.20

Basic and diluted income (loss) per share
 
$
0.42

 
$
(0.12
)
 
$
0.48

 
$
(0.15
)
 
 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 

 
 

 
 

 
 

Net income (loss)
 
$
12,349

 
$
(3,393
)
 
$
17,409

 
$
(4,017
)
Other comprehensive income (loss):
 
 

 
 

 
 

 
 

Reclassification of unrealized loss on interest rate derivatives to net income
 
18

 
—

 
106

 
—

Unrealized loss on interest rate derivatives
 
—

 
9

 
—

 
8

Foreign currency translation gain (loss)
 
262

 
161

 
135

 
(193
)
Total other comprehensive income (loss)
 
280

 
170

 
241

 
(185
)
Comprehensive income (loss)
 
12,629

 
(3,223
)
 
17,650

 
(4,202
)
Comprehensive (income) loss attributable to noncontrolling interest
 
(1,513
)
 
292

 
(4,897
)
 
248

Comprehensive income (loss) attributable to the Company
 
$
11,116

 
$
(2,931
)
 
$
12,753

 
$
(3,954
)
 

See Notes to Unaudited Condensed Consolidated Financial Statements.

4
Table of Contents

Behringer Harvard Opportunity REIT II, Inc.
Condensed 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, 2012
1

$
—

 
25,267

$
3

$
225,968

 
$
(43,657
)
 
$
83

 
$
14,607

 
$
197,004

Net income (loss)
 

 

 
 

 

 

 
(3,768
)
 
 

 
(249
)
 
(4,017
)
Issuance of common stock, net
 

 

 
910

—

8,346

 
 

 
 

 
 

 
8,346

Redemption of common stock
 

 

 
(111
)
 

(990
)
 
 

 
 

 
 

 
(990
)
Distributions declared on common stock
 

 

 
 

 

 

 
(16,257
)
 
 

 
 

 
(16,257
)
Contributions from noncontrolling interest
 

 

 
 

 

 

 
 

 
 

 
1,543

 
1,543

Distributions to noncontrolling interest
 

 

 
 

 

 

 
 

 
 

 
(7,157
)
 
(7,157
)
Other comprehensive loss:
 

 

 
 

 

 

 
 

 
 

 
 

 
 

Unrealized losses on interest rate derivatives
 

 

 
 

 

 

 
 

 
7

 
1

 
8

Foreign currency translation loss
 

 

 
 

 

 

 
 

 
(193
)
 
 

 
(193
)
Balance at September 30, 2012
1

—

 
26,066

3

233,324

 
(63,682
)
 
(103
)
 
8,745

 
$
178,287

Balance at January 1, 2013
1

$
—

 
26,060

$
3

$
233,283

 
$
(58,249
)
 
$
126

 
$
11,370

 
$
186,533

Net income
 

 

 
 

 

 

 
12,522

 
 

 
4,887

 
17,409

Redemption of common stock
 

 

 
(41
)
 

(354
)
 
 

 
 

 
 

 
(354
)
Contributions from noncontrolling interest
 

 

 
 

 

 

 
 

 
 

 
4,655

 
4,655

Distributions to noncontrolling interest
 

 

 
 

 

 

 
 

 
 

 
(11,394
)
 
(11,394
)
Other comprehensive income (loss):
 

 

 
 

 

 

 
 

 
 

 
 

 
 

Reclassification of unrealized loss on interest rate derivatives to net income
 

 

 
 

 

 

 
 

 
96

 
10

 
106

Foreign currency translation loss
 

 

 
 

 

 

 
 

 
135

 
 

 
135

Balance at September 30, 2013
1

$
—

 
26,019

$
3

$
232,929

 
$
(45,727
)
 
$
357

 
$
9,528

 
$
197,090

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

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Table of Contents

Behringer Harvard Opportunity REIT II, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
 
Nine Months Ended September 30,
 
 
2013
 
2012
Cash flows from operating activities:
 
 

 
 

Net income (loss)
 
$
17,409

 
$
(4,017
)
Adjustments to reconcile net income (loss) to net cash flows provided by (used in) operating activities:
 
 

 
 

Depreciation and amortization
 
12,828

 
12,262

Amortization of deferred financing fees
 
725

 
800

Gain on sale of discontinued operations
 
(31,520
)
 
(9,264
)
Loss on early extinguishment of debt
 
260

 
1,236

Loss on derivatives
 
76

 
—

Change in operating assets and liabilities:
 
 

 
 

Accounts receivable
 
(361
)
 
(932
)
Prepaid expenses and other assets
 
214

 
(261
)
Accounts payable
 
(364
)
 
1,024

Accrued and other liabilities
 
1,533

 
3,428

Payables to related parties
 
96

 
104

Addition of lease intangibles
 
(602
)
 
(336
)
Cash provided by operating activities
 
294

 
4,044

 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Acquisition deposits
 
250

 
—

Purchases of real estate
 
(74,685
)
 
(11,039
)
Investment in unconsolidated joint venture
 
(14,302
)
 
—

Return of investment in unconsolidated joint ventures
 
2,444

 
—

Proceeds from sale of discontinued operations
 
83,470

 
38,684

Additions of property and equipment
 
(6,159
)
 
(11,701
)
Change in restricted cash
 
(2,026
)
 
(332
)
Cash provided by (used in) investing activities
 
(11,008
)
 
15,612

 
 
 
 
 
Cash flows from financing activities:
 
 

 
 

Financing costs
 
(1,228
)
 
(1,015
)
Proceeds from notes payable
 
47,653

 
7,401

Payments on notes payable
 
(12,611
)
 
(29,761
)
Purchase of interest rate derivatives
 
(133
)
 
—

Issuance of common stock
 
—

 
6,142

Redemptions of common stock
 
(354
)
 
(990
)
Offering costs receivable from (payable to) related party
 
3,832

 
(553
)
Distributions
 
—

 
(14,536
)
Contributions from noncontrolling interest holders
 
4,655

 
1,543

Distributions to noncontrolling interest holders
 
(7,041
)
 
(7,157
)
Cash provided by (used in) financing activities
 
34,773

 
(38,926
)
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
34

 
56

Net change in cash and cash equivalents
 
24,093

 
(19,214
)
Cash and cash equivalents at beginning of period
 
77,752

 
80,130

Cash and cash equivalents at end of period
 
$
101,845

 
$
60,916

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

6
Table of Contents

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 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.  As of September 30, 2013, we had 13 real estate investments, 12 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 (“Behringer Harvard Opportunity OP II”).  As of September 30, 2013, 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, 2013, 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 (the "Advisor").  The Advisor is responsible for managing our day-to-day affairs and for identifying and making acquisitions and investments on our behalf.
 
Organization
 
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 September 30, 2013, 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 distribution reinvestment plan (the “DRP”).  As of September 30, 2013, we had redeemed 0.7 million shares of our common stock and had 26.0 million shares of common stock outstanding.  As of September 30, 2013, we had 1,000 shares of convertible stock issued and outstanding to the Advisor.
 
Our common stock is not currently listed on a national securities exchange.  The timing of a liquidity event will depend upon then prevailing market conditions. We currently intend to consider the process of disposing assets, liquidating, and distributing the net proceeds to our stockholders no later than three to six years after the termination of our initial public offering of common stock which occurred on July 3, 2011.  Economic or market conditions may, however, result in different holding periods for different assets. If we do not begin an orderly liquidation, we may seek to have our shares listed on a national securities exchange or seek alternative liquidation opportunities.
 



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Table of Contents
Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


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, 2012, which was filed with the SEC on March 28, 2013.  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 September 30, 2013, the condensed consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2013 and 2012 and condensed consolidated statements of equity and cash flows for the nine months ended September 30, 2013 and 2012 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 September 30, 2013 and December 31, 2012 and our condensed consolidated results of operations and cash flows for the periods ended September 30, 2013 and 2012.  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.  For entities in which we have less than a controlling interest or entities which we are not deemed to be the primary beneficiary, we account for the investment using the equity method of accounting.
 
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 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.
 
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.
 



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Table of Contents
Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)


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 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.
 

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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)


Anticipated amortization expense associated with the acquired lease intangibles for each of the following five years as of September 30, 2013 is as follows:
 
Year
Lease / Other
Intangibles
October 1, 2013 - December 31, 2013
$
544

2014
552

2015
194

2016
157

2017
86

 
Accumulated depreciation and amortization related to our consolidated investments in real estate assets and intangibles were as follows: 
 
 
Buildings and
 
Land and
 
Lease
 
Acquired
Below-Market
September 30, 2013
 
Improvements
 
Improvements
 
Intangibles
 
Leases
Cost
 
$
239,831

 
$
66,705

 
$
8,089

 
$
(805
)
Less: depreciation and amortization
 
(19,674
)
 
(1,257
)
 
(5,809
)
 
450

Net
 
$
220,157

 
$
65,448

 
$
2,280

 
$
(355
)
 
 
 
Buildings and
 
Land and
 
Lease
 
Acquired
Below-Market
December 31, 2012
 
Improvements
 
Improvements
 
Intangibles
 
Leases
Cost
 
$
217,343

 
$
75,873

 
$
14,041

 
$
(2,196
)
Less: depreciation and amortization
 
(17,428
)
 
(2,493
)
 
(8,671
)
 
1,292

Net
 
$
199,915

 
$
73,380

 
$
5,370

 
$
(904
)

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.  We had no property classified as held for sale at September 30, 2013 and December 31, 2012.
 
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 regarding future development plans, and other factors in our assessment of whether impairment conditions exist.  While we believe our estimates of future cash

10
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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)


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 also evaluate our investments in unconsolidated joint ventures at each reporting date.  If we believe there is an other than temporary decline in market value, we will record an impairment charge based on these evaluations.  We assess potential impairment by comparing our portion of estimated future undiscounted operating cash flows expected to be generated by the joint venture over the life of the joint venture’s assets to the carrying amount of the joint venture.  In the event that the carrying amount exceeds our portion of estimated future undiscounted operating cash flows, we recognize an impairment loss to adjust the carrying amount of the joint venture to its estimated fair value.
 
We believe the carrying value of our operating real estate is currently recoverable.  Accordingly, there were no impairment charges for the three and nine months ended September 30, 2013 or 2012.  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.
 
Investment in Unconsolidated Joint Venture
 
We provide funding to third party developers for the acquisition, development and construction of real estate (“ADC Arrangement”).  Under the ADC Arrangement, we may participate in the residual profits of the project through the sale or refinancing of the property.  We evaluate this arrangement to determine if they have characteristics similar to a loan or if the characteristics are more similar to a joint venture or partnership such as participating in the risks and rewards of the project as an owner or an investment partner.  When we determine that the characteristics are more similar to a jointly-owned investment or partnership, we account for the arrangement as an investment in an unconsolidated joint venture under the equity method of accounting (Note 8) or a direct investment (consolidated basis of accounting) instead of applying loan accounting.  The ADC Arrangement is periodically reassessed.
 
Revenue Recognition
 
We recognize rental income generated from leases of 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 $0.4 million was recognized in rental revenues for the three and nine months ended September 30, 2013, respectively, and includes amounts recognized in discontinued operations.  Straight-line rental revenue of $0.1 million and $0.2 million was recognized in rental revenues for the three and nine months ended September 30, 2012, respectively, and includes amounts recognized in discontinued operations.   Net below market lease amortization of less than $0.1 million was recognized in rental revenues for the three and nine months ended September 30, 2013.  Net below market lease amortization of less than $0.1 million and $0.1 million was recognized in rental revenues for the three and nine months ended September 30, 2012, respectively, and includes amounts recognized in discontinued operations.
 
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 related to our consolidated properties of $2.5 million which includes straight-line rental revenue receivables of $1.0 million as of September 30, 2013.  Accounts receivable primarily consisted of receivables related to our consolidated properties of $2.8 million which includes straight-line rental revenue receivables of $1.2 million as of December 31, 2012.
 


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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 according to the Company’s capitalization policy which uses the straight-line method over their estimated useful lives of five to seven years.  Maintenance and repairs are charged to operations as incurred.  Accumulated depreciation associated with our furniture, fixtures, and equipment was $3.6 million and $2.3 million as of September 30, 2013 and December 31, 2012, 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 $1.5 million and $1.4 million as of September 30, 2013 and December 31, 2012, respectively.
 
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. Taxable income from non-REIT activities managed through a taxable REIT subsidiary ("TRS") is subject to applicable federal, state, and local income and margin taxes. We have no taxable income associated with a TRS. Our operating partnerships are flow-through entities and are not subject to federal income taxes at the entity level.

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 other comprehensive income (loss) (“OCI”).  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 three and nine months ended September 30, 2013, the foreign currency translation adjustment was a gain of $0.3 million and $0.1 million, respectively.  For the three and nine months ended September 30, 2012, the foreign currency translation adjustment was a gain of $0.2 million and a loss $0.2 million, respectively.
 
Concentration of Credit Risk
 
At September 30, 2013 and December 31, 2012, 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.
 



12
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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 generally on their ownership percentage.  In certain instances, our joint venture agreement provides for liquidating distributions based on achieving certain return metrics (“promoted interest”).  If a property reaches a defined return threshold, then it will result in distributions to noncontrolling interest which is different from the standard pro-rata allocation 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 each of the three and nine months ended September 30, 2013 and 2012, as there were no potentially dilutive securities outstanding.
 
Reclassification
 
To conform to the current year presentation, which presents hotel operating expense as a separate component of property operating expense on our condensed consolidated statements of operations and comprehensive income, we reclassified $2.5 million and $7.4 million from property operating expense to hotel operating expense for the three and nine months ended September 30, 2012, respectively.
 
Subsequent Events
 
We have evaluated subsequent events for recognition or disclosure in our condensed consolidated financial statements and noted no subsequent events that would require adjustment to the condensed consolidated financial statements or additional disclosure other than the one disclosed herein.
 
4.                                  New Accounting Pronouncements
 
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-02 (“ASU 2013-02”), Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  The update clarifies how to report the effect of significant reclassifications out of accumulated other comprehensive income.  ASU 2013-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012 and is to be applied prospectively.  Our adoption of this ASU did not materially change the presentation of our consolidated condensed financial statements.

In February 2013, the FASB issued updated guidance for the measurement and disclosure of obligations. The guidance requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in the update also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. This guidance is effective for the first interim or annual period beginning on or after December 15, 2013. The adoption of this guidance is not expected to have a material impact on our financial statements or disclosures. 
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.
 

13
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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


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 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, 2013, 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, 2013 and December 31, 2012.
 
September 30, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 

 
 

 
 

 
 

Derivative financial instruments
 
$
—

 
$
175

 
$
—

 
$
175

 
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 

 
 

 
 

 
 

Derivative financial instruments
 
$
—

 
$
13

 
$
—

 
$
13

 
Derivative financial instruments classified as assets are included in prepaid expenses and other assets on the balance sheet.
 
6.                                      Financial Instruments not Reported at Fair Value
 
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, 2013 and December 31, 2012, 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 and payables/receivables from related parties were at amounts that reasonably approximated their fair value based on their highly-liquid nature and/or short-term maturities.  The notes payable of $212.1 million and $183.3 million as of September 30, 2013 and December 31, 2012, respectively, have a fair value of approximately $207.5 million and $179.4 million as of September 30, 2013 and December 31, 2012, respectively, based upon interest rates for debt with similar terms

14
Table of Contents

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 September 30, 2013 and December 31, 2012.
 
7.                                      Real Estate and Real Estate-Related Investments
 
As of September 30, 2013, we consolidated 12 real estate investments on our condensed consolidated balance sheet.  The following table presents certain information about our consolidated investments as of September 30, 2013:
 
Property Name
Location
Date Acquired
Ownership
Interest
1875 Lawrence
Denver, CO
October 28, 2008
100
%
Holstenplatz
Hamburg, Germany
June 30, 2010
100
%
Gardens Medical Pavilion (1)
South Florida
October 20, 2010
79.8
%
Courtyard Kauai Coconut Beach Hotel
Kauai, Hawaii
October 20, 2010
80
%
River Club and the Townhomes at River Club
Athens, Georiga
April 25, 2011
85
%
Babcock Self Storage
San Antonio, Texas
August 30, 2011
85
%
Lakes of Margate
Margate, Florida
October 19, 2011
92.5
%
Arbors Harbor Town
Memphis, Tennessee
December 20, 2011
94
%
Alte Jakobstraße
Berlin, Germany
April 5, 2012
99.7
%
Wimberly at Deerwood ("Wimberly")
Jacksonville, Florida
February 19, 2013
95
%
22 Exchange
Akron, Ohio
April 16, 2013
90
%
Parkside Apartments ("Parkside")
Sugarland, Texas
August 8, 2013
90
%
 
________________________________
(1)         We acquired a portfolio of eight medical 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 were referred to as the Florida MOB Portfolio.  The Florida MOB Portfolio consisted of nine medical office buildings.  On September 20, 2013, we sold the Original Florida MOB Portfolio (see Real Estate Asset Dispositions for more details). As of September 30, 2013, we still own approximately 79.8% of the ninth building, Gardens Medical Pavilion.
 
Real Estate Asset Acquisitions
 
During the nine months ending September 30, 2013, we made three separate real estate acquisitions: a 95% interest in Wimberly; a 90% interest in 22 Exchange and a 90% interest in Parkside for an aggregate purchase price, excluding closing costs, of approximately $85.2 million.  The purchases were partially funded with proceeds of new financings of approximately $46.2 million and an assumed loan of approximately $10.5 million.
 
The following table summarizes the amounts of identified assets acquired and liabilities assumed at the acquisition date :
 
 
Total 
Acquisitions
Buildings
$
71,023

Land
9,182

Land improvements
1,166

Lease intangibles, net
1,772

Furniture, fixtures and equipment
2,168

Signage, landscaping and misc. site improvements
648

Acquired below-market leases, net
(121
)
Total identifiable net assets
$
85,838

 

15
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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


The following table summarizes the amounts recognized for revenues, acquisition expenses and net loss from the acquisition dates to September 30, 2013 (in millions):
 
 
 
Wimberly
 
22 Exchange
 
Parkside
Revenue
 
$
2.3

 
$
1.6

 
$
0.4

Acquisition expenses with unaffiliated third party
 
$
0.8

 
$
0.5

 
$
0.5

Net loss
 
$
(1.8
)
 
$
(1.2
)
 
$
(0.5
)
 
The following unaudited pro forma summary presents our consolidated information for the three acquisitions as if the business combinations had occurred on January 1, 2012:  
 
 
Pro Forma for the Three Months Ended September 30,
 
Pro Forma for the Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Revenue
 
$
11,905

 
$
11,156

 
$
34,784

 
$
31,783

Depreciation and amortization
 
$
(3,942
)
 
$
(3,262
)
 
$
(11,924
)
 
$
(11,853
)
Net income (loss)
 
$
12,920

 
$
(4,353
)
 
$
21,002

 
$
(10,124
)
Net income (loss) per share
 
$
0.50

 
$
(0.17
)
 
$
0.81

 
$
(0.39
)
 
These pro forma amounts have been calculated after applying our accounting policies and adjusting the results to reflect additional depreciation and amortization that would have been charged assuming the fair value adjustments to the tangible and intangible assets had been applied from January 1, 2012.
Wimberly at Deerwood
     On February 19, 2013, we acquired Wimberly, a 322-unit multifamily community in Jacksonville, Florida, from an unaffiliated third party.  The purchase price for Wimberly, excluding closing costs, was approximately $35.6 million.  In connection with the acquisition of Wimberly, on February 19, 2013, we entered into a loan for approximately $26.7 million with an unaffiliated third party.   The loan bears interest at a variable annual rate of approximately 2.28% plus 30-day LIBOR and requires interest-only payments for the first 24 months.  The loan may not be prepaid in whole or in part during the first year.  After the first year, the loan may be prepaid in whole (but not in part) with payment of prepayment fees.  The loan must be repaid in its entirety by March 2023.
22 Exchange
     We acquired a 90% interest in 22 Exchange, a student housing complex in Akron, Ohio on April 16, 2013 from an unaffiliated third party.  The contract purchase price for the property, excluding closing costs, was approximately $28.1 million.  In connection with the purchase, we entered into a loan for approximately $19.5 million with an unaffiliated third party.  The loan bears interest at a fixed rate of 3.93% and requires interest-only payments for the first 36 months.  The loan must be repaid in its entirety by May 2023.
Parkside Apartments
On August 8, 2013, we acquired a 90% interest in Parkside, a 240-unit multifamily community in Sugarland, Texas, from an unaffiliated third party. The contract purchase price for the property was $21.5 million. In connection with the purchase, we assumed a loan of approximately $10.5 million. The loan bears interest at a fixed rate of 5% and requires interest and principal payments. After May 2014, the loan may be prepaid in whole (but not in part) with payment of prepayment fees. The loan must be repaid in its entirety by June 2018 and includes a five-year extension option.
We are in the process of finalizing our acquisition allocations, which are subject to change until the information is finalized, which will be no later than twelve months from the acquisition date.
 




16
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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


Real Estate Asset Dispositions
 
Interchange Business Center
 
On October 18, 2012, we sold one of the four industrial buildings at Interchange Business Center for a contract sales price of approximately $7.5 million, excluding transaction costs.  On April 12, 2013, we sold the remaining three buildings for a contract sales price of approximately $40.4 million, excluding transaction costs. We recorded a gain on sale of real estate property of $14.5 million and loss on early extinguishment of debt of $0.3 million, which is reflected in discontinued operations for the nine months ended September 30, 2013.  A portion of the proceeds from the sale of the asset were used to pay off in full the existing indebtedness of approximately $11.3 million secured by the property.

Original Florida MOB Portfolio
We own a 90% interest in BH-AW Florida MOB Venture, LLC (the “Florida MOB Joint Venture”). The remaining 10% interest in the Florida MOB Joint Venture is owned by AW SFMOB Investor, LLC (“AW Investor”) and AW SFMOB Managing Member, LLC (“AW Managing Member” and collectively with AW Investor, “AW”). Florida MOB Joint Venture indirectly owned ground leasehold interests in the Original Florida MOB Portfolio.
On September 20, 2013, the special purpose entities that owned the Original Florida MOB Portfolio properties sold the properties to entities affiliated with AW and an unaffiliated third party for an aggregate contract sales price of approximately $63 million, which was paid in cash and through the assumption by the buyer of existing indebtedness of approximately $18 million. We recorded a gain on sale of real estate property of $17.1 million.
8.                                      Investment in Unconsolidated Joint Venture
 
On May 24, 2013, we provided mezzanine financing totaling $13.7 million to an unaffiliated third-party entity that owns and will develop an apartment complex in Denver, Colorado (“Prospect Park”).  The developer also had a senior construction loan with a third-party lender, in an aggregate principal amount of $35.6 million.  The senior construction loan is guaranteed by the owners of the developer.  Our mezzanine loan to the developer is subordinate to the senior construction loan.  The loan is collateralized by the property and has an annual interest rate of 10% for the first three years of the term, followed by two one-year extension options at which point, the annual interest rate would increase to 14%.  We have evaluated this ADC arrangement and determined that the characteristics are similar to a jointly-owned investment or partnership, and accordingly, the investment is accounted for as an unconsolidated joint venture under the equity method of accounting instead of loan accounting since we will participate in the residual interests through the sale or refinancing of the property.
 
As of September 30, 2013, the outstanding principal balance under our mezzanine loan was $13.7 million.  In connection with this investment, we capitalized acquisition-related costs and fees totaling $0.4 million.  Interest capitalized for the three and nine months ending September 30, 2013 was $0.1 million and $0.2 million, respectively.  For the three and nine months ended September 30, 2013, we recorded no equity in earnings (losses) of unconsolidated joint venture related to our investment in Prospect Park.
 
The following table sets forth our ownership interest in Prospect Park:
 
 
 
Ownership Interest
 
Carrying Amount at
 
 
Property Name
 
at September 30, 2013
 
September 30, 2013
 
 
Prospect Park
 
N/A
 
$11,858
 
(1
)
 
______________________________
(1)         During the nine months ended September 30, 2013, we received distributions (return of capital) of approximately $2.4 million and capitalized $0.4 million of acquisition expense.  Approximately $2 million of the $2.4 million distributions was an interest reserve funded at closing (classified as restricted cash on the condensed consolidated balance sheet until earned).
 






17
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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


9.                                      Notes Payable
 
The following table sets forth information on our notes payable as of September 30, 2013 and December 31, 2012:
 
 
 
Notes Payable as of
 
Interest
 
Maturity
Description
 
September 30, 2013
 
December 31, 2012
 
Rate
 
Date
1875 Lawrence
 
$
15,621

 
$
15,500

 
30-day LIBOR + 5.35% (1) (2)
 
1/1/2016
Interchange Business Center (4)
 
—

 
9,882

 
30-day LIBOR + 5% (1)(3)
 
12/1/2013
Holstenplatz
 
10,429

 
10,375

 
3.887%
 
4/30/2015
Courtyard Kauai at Coconut Beach Hotel
 
38,000

 
38,000

 
30-day LIBOR + .95% (1)
 
11/9/2015
Florida MOB Portfolio - Palmetto Building (5)
 
—

 
6,077

 
4.55%
 
1/1/2016
Florida MOB Portfolio - Victor Farris Building (5)
 
—

 
12,249

 
4.55%
 
1/1/2016
Florida MOB Portfolio - Gardens Medical Pavilion
 
14,128

 
14,385

 
4.9%
 
1/1/2018
River Club and the Townhomes at River Club
 
25,095

 
25,200

 
5.26%
 
5/1/2018
Babcock Self Storage
 
2,193

 
2,225

 
5.80%
 
8/30/2018
Lakes of Margate
 
15,021

 
15,182

 
5.49% and 5.92%
 
1/1/2020
Arbors Harbor Town
 
26,000

 
26,000

 
3.985%
 
1/1/2019
Alte Jakobstraße
 
8,182

 
8,233

 
2.3%
 
12/30/2015
Wimberly
 
26,685

 
—

 
30-day LIBOR + 2.28% (1)
 
3/1/2023
22 Exchange
 
19,500

 
—

 
3.93%
 
5/5/2023
Parkside (6)
 
11,263

 
—

 
5%
 
6/1/2018
 
 
$
212,117

 
$
183,308

 
 
 
 
 
_________________________________
(1) 30-day LIBOR was 0.19% at September 30, 2013.
(2) Maximum borrowing up to $20.1 million.
(3) The 30-day LIBOR rate was set at a minimum value of 2.5%.
(4) On October 18, 2012, we sold one of the four industrial buildings at Interchange Business Center to an unaffiliated third party.  On April 12, 2013, we sold the remaining three buildings to an unaffiliated third party.  A portion of the proceeds from the sale of the remaining three buildings were used to pay off in full the existing indebtedness associated with the property.
(5) On September 20, 2013, we sold the Original Florida MOB Portfolio properties for an aggregate contract sales price of approximately $63 million, which was paid in cash and through the assumption by the buyer of existing indebtedness of approximately $18 million.
(6) Includes approximately $0.8 million of unamortized premium related to debt we assumed at acquisition.
 
At September 30, 2013, our notes payable balance was $212.1 million and consisted of the notes payable related to our consolidated properties.  We have guaranteed payment of certain recourse liabilities with respect to certain customary nonrecourse carveouts as set forth in the guaranties in favor of the unaffiliated lenders with respect to the Courtyard Kauai at Coconut Beach Hotel, Wimberly, 22 Exchange and Parkside notes payable.  For the nine months ended September 30, 2013, in connection with the acquisition of Wimberly, 22 Exchange and Parkside, we entered into loans with unaffiliated third parties for approximately $26.7 million, $19.5 million and $10.5 million (assumed loan), respectively.  On April 12, 2013, we sold the remaining three industrial buildings at Interchange Business Center to an unaffiliated third party and used a portion of the proceeds from the sale to pay off in full the existing indebtedness of $11.3 million.  On September 20, 2013, we sold the Original Florida MOB Portfolio, which was paid in cash and through the assumption by the buyer of approximately $18 million of existing indebtedness. See footnote 16, Discontinued Operations for further details.  Interest capitalized for the three and nine months ending September 30, 2013 was $0.1 million and $0.2 million, respectively.
 

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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


We are subject to customary affirmative, negative, and financial covenants and representations, warranties and borrowing conditions, all as set forth in our loan agreements.  As of September 30, 2013, we believe we were in compliance with the covenants under our loan agreements.
 
The following table summarizes our contractual obligations for principal payments as of September 30, 2013:
 
Year
Amount Due
October 1, 2013 - December 31, 2013
$
630

2014
2,070

2015
57,847

2016
18,112

2017
2,716

Thereafter
129,957

Unamortized premium
785

 
$
212,117

 
10.                               Leasing Activity
 
Future minimum base rental payments of our office and industrial properties due to us under non-cancelable leases in effect as of September 30, 2013 for our consolidated properties are as follows:
 
October 1, 2013 - December 31, 2013
$
4,626

2014
5,118

2015
3,742

2016
3,165

2017
1,287

Thereafter
1,732

Total
$
19,670

 
 
The schedule above does not include rental payments due to us from our multifamily, hotel, student housing, and self-storage properties, as leases associated with these properties typically are for periods of one year or less.  As of September 30, 2013, none of our tenants accounted for 10% or more of our aggregate annual rental revenues from our consolidated properties.
 
11.                               Derivative Instruments and Hedging Activities
 
We may be exposed to the risk associated with variability of interest rates that might impact our cash flows and the results of operations.  The hedging strategy of entering into interest rate caps and swaps, therefore, is to eliminate or reduce, to the extent possible, the volatility of cash flows.  As of September 30, 2013, none of our derivative instruments were designated as hedging instruments.
 
Derivative instruments classified as assets were reported at their combined fair values of $0.2 million and less than $0.1 million in prepaid expenses and other assets at September 30, 2013 and December 31, 2012, respectively.  During the three months ended September 30, 2013 and 2012, we recorded a reclassification of unrealized loss to interest expense of less than $0.1 million and unrealized gain of less than $0.1 million to other comprehensive income (loss) (“OCI”) in our statement of equity to adjust the carrying amount of the interest rate caps at September 30, 2013 and 2012, respectively. During the nine months ended September 30, 2013 and 2012, we recorded a reclassification of unrealized loss to interest expense of $0.1 million and unrealized gain of less than $0.1 million to OCI in our statement of equity to adjust the carrying amount of the interest rate caps at September 30, 2013 and 2012, respectively. The reclassification out of OCI for the nine months ended September 30, 2013 was due to all derivatives being designated as non-hedging instruments as of January 1, 2013 compared to being designated as hedging instruments as of December 31, 2012.
 

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Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)


The following table summarizes the notional values of our derivative financial instruments.  The notional values provide an indication of the extent of our involvement in these instruments, but do not represent exposure to credit, interest rate, or market risks:
 
Type / Description
 
Notional
Value
 
Interest Rate /
Strike Rate
 
Index
 
Maturity
Not Designated as Hedging Instruments
 
 

 
 
 
 
 
 
Interest rate cap - Courtyard Kauai Coconut Beach Hotel
 
$
38,000

 
3.00% - 6.00%
 
30-day LIBOR
 
October 15, 2014
Interest rate cap - 1875 Lawrence
 
$
20,100

 
2.75%
 
30-day LIBOR
 
January 1, 2016
Interest rate cap - Wimberly
 
$
26,685

 
4.56%
 
30-day LIBOR
 
March 1, 2018
 
The table below presents the fair value of our derivative financial instruments, as well as their classification on the consolidated balance sheets as of September 30, 2013 and December 31, 2012: 
 
Derivatives designated as 
 
Balance Sheet
 
Asset Derivatives
hedging instruments:
 
Location
 
September 30, 2013
 
December 31, 2012
 
 
 
 
 
 
 
Interest rate derivative contracts
 
Prepaid expenses and other assets
 
$
—

 
$
13

 
Derivatives not designated as 
 
Balance Sheet
 
Asset Derivatives
hedging instruments:
 
Location
 
September 30, 2013
 
December 31, 2012
 
 
 
 
 
 
 
Interest rate derivative contracts
 
Prepaid expenses and other assets
 
$
175

 
$
—

 
The table below presents the effect of our derivative financial instruments on the consolidated statements of operations for the three and nine months ended September 30, 2013 and 2012:
 
Derivatives in Cash Flow Hedging Relationships
Amount of Loss Reclassified from OCI into Income (Effective Portion)
Three Months ended September 30, 2012
Nine Months ended September 30, 2012
$
(12
)
$
(26
)
 
Derivatives Not Designated as Hedging Instruments
Amount of Gain or (Loss) (1)
Three months ended September 30, 2013
Nine months ended September 30, 2013
$
(46
)
$
(76
)
 _______________________________
(1) Amounts included in interest expense.  For the three and nine months ending September 30, 2013, reclassification out of OCI for $18 thousand and $106 thousand, respectively, was due to all derivatives being designated as non-hedging instruments as of January 1, 2013 compared to being designated as hedging instruments as of December 31, 2012.
 
12.                               Commitments and Contingencies
 
Our operating leases consisted of ground leases on each of the original eight buildings acquired in connection with the purchase of the Original Florida MOB Portfolio.  Each ground lease was for a term of 50 years, with a 25-year extension option.  The annual payment for each ground lease increased by 10% every 5 years.  On September 20, 2013, we sold the Original Florida MOB Portfolio. As of September 30, 2013, we do not have operating leases. For each of the nine months ended September 30, 2013 and 2012, we incurred $0.2 million in lease expense related to our ground leases. 
 




20
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13.                               Distributions
 
Distributions are authorized at the discretion of our board of directors based on its analysis of our performance over the previous period and expectations of performance for future periods.  These analyses may include actual and anticipated operating cash flow, changes in market capitalization rates for investments suitable for our portfolio, capital expenditure needs, general financial and market conditions and other factors that our board deems relevant.  The board’s decision will be influenced, in substantial part, by its obligation to ensure that we maintain our status as a REIT.  In light of the continued uncertainty in the global financial and real estate markets, we cannot provide assurance that we will be able to achieve expected cash flows necessary to pay distributions at any particular level, or at all.
 
On March 20, 2012, our board of directors declared a special distribution of $0.50 per share of common stock payable to our stockholders of record as of April 3, 2012 and determined to cease regular, monthly distributions in favor of payment of periodic distributions from excess proceeds from asset dispositions or from other sources as necessary to maintain our REIT tax status.  The special distribution was paid on May 10, 2012.
 
We have paid and may in the future pay some or all of our distributions from sources other than operating cash flow.  We have, for example, generated cash to pay distributions from financing activities, components of which may include proceeds from our public offerings of shares of our common stock and borrowings (including borrowings secured by our assets) in anticipation of future operating cash flow.  We have also utilized cash from refinancings and dispositions, the components of which may represent a return of capital and/or the gains on sale.  In addition, from time to time, our Advisor may agree to waive or defer all or a portion of the acquisition, asset management or other fees or incentives due to it, pay general administrative expenses, or otherwise supplement investor returns in order to increase the amount of cash that we have available to pay distributions to our stockholders.
 
We did not pay any distributions to stockholders during the three and nine months ended September 30, 2013. The special cash distribution of $13 million declared during the first quarter of 2012 was paid in the second quarter of 2012 and was based upon the number of stockholders as of April 3, 2012.  Total distributions paid to stockholders during the nine months ended September 30, 2012 were $17.3 million consisting of the special cash distribution of $13 million and regular distributions of $4.3 million including DRP of $2.8 million.  A portion of the $4.3 million regular distributions to stockholders were funded from cash flow provided by operations.  The special cash distribution was funded from proceeds from asset dispositions.  Previous regular cash distributions were funded from proceeds from our public offerings of shares of our common stock, borrowings and cash flow from operations.  Future distributions, if any, declared and paid may exceed cash flow from operating activities until such time as we invest in additional real estate or real estate-related assets at favorable yields and our investments reach stabilization.
 
Distributions declared per share assume the share was issued and outstanding each day during the period.  Beginning January 2012 through March 2012, the declared daily regular distribution rate was $0.0013699 per share of common stock, which was equivalent to an annualized distribution rate of 5.0% assuming the share was purchased for $10.00.
 
14.                               Related Party Transactions
 
The Advisor and certain of its affiliates receive fees and compensation in connection with the acquisition, management, and sale of our assets.
 
Pursuant to a Dealer Manager Agreement, we engaged Behringer Securities LP (“Behringer Securities”) to act as our dealer manager in connection with our public offerings.  Behringer Securities received commissions of up to 7% of gross primary offering proceeds.  Behringer Securities reallowed 100% of selling commissions earned to participating broker-dealers.  In addition, we paid Behringer Securities a dealer manager fee of up to 2.5% of gross offering proceeds.  Pursuant to separately negotiated agreements, Behringer Securities reallowed a portion of its dealer manager fee in an aggregate amount up to 2% of gross offering proceeds to broker-dealers participating in our public offerings; provided, however, that Behringer Securities reallowed, in the aggregate, no more than 1.5% of gross offering proceeds for marketing fees and expenses, conference fees and non-itemized, non-invoiced due diligence efforts and no more than 0.5% of gross offering proceeds for out-of-pocket and bona fide, separately invoiced due diligence expenses incurred as fees, costs or other expenses from third parties.  Further, in special cases pursuant to separately negotiated agreements and subject to applicable limitations imposed by the Financial Industry Regulatory Authority, Behringer Securities used a portion of its dealer manager fee to reimburse certain broker-dealers participating in our public offerings for technology costs and expenses associated with our public offerings and costs and expenses associated with the facilitation of the marketing and ownership of our shares by such broker-dealers’ customers.  No selling commissions, dealer manager fees or organization and offering expenses were paid for sales under the DRP.  We terminated the primary portion of the follow-on public offering effective March 15, 2012 and the DRP portion of the follow-on

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Table of Contents
Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


offering effective April 3, 2012.  For the nine months ended September 30, 2012, Behringer Securities earned selling commissions and dealer manager fees of $0.4 million and $0.2 million, respectively, which were recorded as a reduction to additional paid-in capital.
 
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 our public offerings of our common stock.  The total we were required to remit to the Advisor for organization and offering expenses (other than selling commissions and the dealer manager fee) was limited to 1.5% of the gross proceeds raised in the completed primary offering components of the public offerings as determined upon completion of the public offerings.  The Advisor or its affiliates determined the amount of organization and offering expenses owed based on specific invoice identification, as well as an allocation of costs to us and other Behringer Harvard programs, based on respective equity offering results of those entities in offering.
 
The Advisor was required to reimburse us to the extent that the total amount spent on organization and offering expenses (other than selling commissions and the dealer manager fee) in the public offerings exceeded 1.5% of the gross proceeds raised in the primary component of the public offerings.  Based on the gross proceeds from our public offerings, we recorded a receivable from the Advisor for approximately $3.8 million of organization and offering expenses that were previously reimbursed to the Advisor.  The receivable of $3.8 million is presented net of other payables of $0.5 million to the Advisor on our consolidated balance sheet as of December 31, 2012.  We received payment of $3.8 million from the Advisor for this receivable in March 2013.
 
The Advisor or its affiliates will also receive acquisition and advisory fees of 2.5% of the amount paid and/or in respect of the purchase, development, construction, or improvement of each asset we acquire, including any debt attributable to those assets.  The Advisor and its affiliates will also receive acquisition and advisory fees of 2.5% of the funds advanced in respect of a loan investment.  We incurred acquisition and advisory fees payable to the Advisor of $0.4 million and none for the three months ended September 30, 2013 and 2012, respectively. We incurred acquisition and advisory fees payable to the Advisor of $2.4 million and $0.5 million for the nine months ended September 30, 2013 and 2012, respectively.
 
The Advisor or its affiliates also receive an acquisition expense reimbursement in the amount of 0.25% of (i) the funds paid for purchasing an asset, including any debt attributable to the asset, (ii) the funds budgeted for development, construction, or improvement in the case of assets that we acquire and intend to develop, construct, or improve, and (iii) the funds advanced in respect of a loan investment.  In addition, to the extent the Advisor or its affiliates directly provide services formerly provided or usually provided by third parties, including, without limitation, accounting services related to the preparation of audits required by the SEC, property condition reports, title services, title insurance, insurance brokerage or environmental services related to the preparation of environmental assessments in connection with a completed investment, the direct employee costs and burden to the Advisor of providing these services will be acquisition expenses for which we will reimburse the Advisor.  We also pay third parties, or reimburse the Advisor or its affiliates, for any investment-related expenses due to third parties in the case of a completed investment, including, but not limited to, legal fees and expenses, travel and communication expenses, costs of appraisals, accounting fees and expenses, third-party brokerage or finder’s fees, title insurance, premium expenses, and other closing costs.  In addition, acquisition expenses for which we will reimburse the Advisor, include any payments made to (i) a prospective seller of an asset, (ii) an agent of a prospective seller of an asset, or (iii) a party that has the right to control the sale of an asset intended for investment by us that are not refundable and that are not ultimately applied against the purchase price for such asset.  Except as described above with respect to services customarily or previously provided by third parties, the Advisor is responsible for paying all of the expenses it incurs associated with persons employed by the Advisor to the extent that they are dedicated to making investments for us, such as wages and benefits of the investment personnel.  The Advisor and its affiliates are also responsible for paying all of the investment-related expenses that we or the Advisor or its affiliates incur that are due to third parties or related to the additional services provided by the Advisor as described above with respect to investments we do not make, other than certain non-refundable payments made in connection with any acquisition.  For the three and nine months ended September 30, 2013, we incurred acquisition expense reimbursements of less than $0.1 million and $0.2 million, respectively.  We incurred acquisition expense reimbursements of less than $0.1 million for the nine months ended September 30, 2012.
 
We pay the Advisor or its affiliates a debt financing fee of 1% of the amount available under any loan or line of credit made available to us.  It is anticipated that the Advisor will pay some or all of these fees to third parties with whom it subcontracts to coordinate financing for us.  We incurred debt financing fees of $0.1 million and none for the three months

22
Table of Contents
Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


ended September 30, 2013 and 2012, respectively. We incurred debt financing fees of $0.5 million and $0.1 million for the nine months ended September 30, 2013 and 2012, respectively.
 
We pay the Advisor or its affiliates a development fee in an amount that is usual and customary for comparable services rendered to similar projects in the geographic market of the project if such affiliate provides the development services and if a majority of our independent directors determines that such development fee is fair and reasonable and on terms and conditions not less favorable than those available from unaffiliated third parties.  We incurred no such fees for the three and nine months ended September 30, 2013 and 2012.
 
We will pay the Advisor or its affiliates a construction management fee in an amount not to exceed 5% of all hard construction costs incurred in connection with, but not limited to capital repairs and improvements, major building reconstruction and tenant improvements, if such affiliate supervises construction performed by or on behalf of us or our affiliates. We incurred construction management fees of less than $0.1 million and $0.1 million for the three and nine months ended September 30, 2013. We incurred no construction management fees for the three and nine months ended September 30, 2012.

We pay our property manager and affiliate of the Advisor, Behringer Harvard Opportunity II Management Services, LLC (“BHO II Management”), or its affiliates, fees for the management, leasing, and construction supervision of our properties.  Property management fees are 4.5% of the gross revenues of the properties managed by BHO II Management or its affiliates, plus leasing commissions based upon the customary leasing commission applicable to the same geographic location of the respective property.  In the event that we contract directly with a third-party property manager in respect of a property, BHO II Management or its affiliates receives an oversight fee equal to 0.5% of the gross revenues of the property managed.  In no event will BHO II Management or its affiliates receive both a property management fee and an oversight fee with respect to any particular property.  In the event we own a property through a joint venture that does not pay BHO II Management directly for its services, we will pay BHO II Management a management fee or oversight fee, as applicable, based only on our economic interest in the property.  We incurred and expensed property management fees or oversight fees to BHO II Management of approximately $0.2 million and $0.3 million for the three months ended September 30, 2013 and 2012, respectively. We incurred and expensed property management fees or oversight fees to BHO II Management of approximately $0.7 million and $0.9 million for the nine months ended September 30, 2013 and 2012, respectively.
 
We pay the Advisor or its affiliates a monthly asset management fee of one-twelfth of 1.0% of the sum of the higher of the cost or value of each asset.  For the three months ended September 30, 2013 and 2012, we expensed $0.9 million and $0.8 million, respectively, of asset management fees.  For the nine months ended September 30, 2013 and 2012, we expensed $2.4 million and $2.3 million, respectively, of asset management fees.  Amounts include asset management fees which were classified to discontinued operations and our disposed properties.
 
We reimburse the Advisor or its affiliates for all expenses paid or incurred by the Advisor in connection with the services provided to us, subject to the limitation that we will not reimburse the Advisor for any amount by which our operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceeds the greater of:  (A) 2% of our average invested assets, or (B) 25% of our net income determined without reduction for any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of our assets for that period.  Notwithstanding the above, we may reimburse the Advisor for expenses in excess of this limitation if a majority of our independent directors determines that such excess expenses are justified based on unusual and non-recurring factors. For the three months ended September 30, 2013 and 2012, we incurred and expensed such costs for administrative services of $0.4 million. For the nine months ended September 30, 2013 and 2012, we incurred and expensed such costs for administrative services of $1.2 million and $1.1 million, respectively.
 
We are dependent on the Advisor and BHO II Management for certain services that are essential to us, including asset acquisition and disposition decisions, property management and leasing services, and other general administrative responsibilities.  In the event that these companies were unable to provide us with their respective services, we would be required to obtain such services from other sources.
 





23
Table of Contents
Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


15.                               Supplemental Cash Flow Information
 
Supplemental cash flow information is summarized below:
 
 
 
Nine months ended September 30,
 
 
2013
 
2012
Interest paid, net of amounts capitalized
 
$
5,944

 
$
7,400

Non-cash investing and financing activities:
 
 

 
 

Capital expenditures for real estate in accounts payable
 
$
—

 
$
72

Capital expenditures for real estate in accrued liabilities
 
$
478

 
$
439

Common stock issued in distribution reinvestment plan
 
$
—

 
$
2,790

Offering costs payable to related parties
 
$
—

 
$
8

Assumed debt on acquisition of real estate investment
 
$
11,306

 
$
—

Assumed debt on disposition of real estate investment
 
$
17,983

 
$
—

Accrued distributions to noncontrolling interest holder
 
$
4,353

 
$
—

 
16.                           Discontinued Operations
 
During the nine months ended September 30, 2012, we sold the Palms of Monterrey.  On April 12, 2013, we sold the remaining three buildings at Interchange Business Center for a contract sales price of approximately $40.4 million, excluding transaction costs.  A portion of the proceeds from the sale were used to pay off in full the existing indebtedness associated with the buildings. On September 20, 2013, we sold the Original Florida MOB Portfolio for an aggregate contract sales price of approximately $63 million, which was paid in cash and through the assumption by the buyer of approximately $18 million of existing indebtedness.
 
The following table summarizes the disposition of our properties during 2012 and 2013.
 
Property Name
Date of Disposition
Contract Sales Price
Palms of Monterrey
January 5, 2012
$
39,300

Parrot’s Landing
October 31, 2012
$
56,300

Interchange Business Center (1)
October 18, 2012
$
7,500

Interchange Business Center (1)
April 12, 2013
$
40,400

Original Florida MOB Portfolio (2)
September 20, 2013
$
63,000

_________________________________
(1) On October 18, 2012, we sold one of the four industrial buildings at Interchange Business Center to an unaffiliated third party.  On April 12, 2013, we sold the remaining three buildings to an unaffiliated third party.
(2) On September 20, 2013, we sold the original 8 medical office buildings. We continue to own approximately 79.8% of the ninth building, Gardens Medical Pavilion.
 
We have classified the results of operations for the properties above into discontinued operations in the accompanying condensed consolidated statements of operations.
 

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Table of Contents
Behringer Harvard Opportunity REIT II, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited) 


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Rental revenue
 
$
2,525

 
$
4,560

 
$
8,635

 
$
13,903

Expenses
 
 
 
 
 
 
 
 
Property operating expenses
 
1,535

 
2,065

 
4,130

 
6,076

Interest expense
 
202

 
963

 
983

 
2,980

Real estate taxes
 
64

 
730

 
609

 
2,182

Property management fees
 
126

 
190

 
385

 
577

Asset management fees
 
—

 
48

 
50

 
144

Depreciation and amortization
 
712

 
1,431

 
2,606

 
4,269

Total expenses
 
2,639

 
5,427

 
8,763

 
16,228

Interest income, net
 
1

 
1

 
2

 
12

Loss on early extinguishment of debt (1)
 
—

 
—

 
(260
)
 
(1,236
)
Gain on sale of real estate property
 
17,065

 
—

 
31,520

 
9,264

Income (loss) from discontinued operations, including gains on disposition
 
$
16,952

 
$
(866
)
 
$
31,134

 
$
5,715

________________________________
(1) Loss on early extinguishment of debt for the nine months ended September 30, 2013 was approximately $0.3 million and was comprised of the write-off of deferred financing fees of $0.1 million and an early termination fee of $0.2 million.  Loss on early extinguishment of debt for the nine months ended September 30, 2012 was approximately $1.2 million and was comprised of the write-off of deferred financing fees of $0.4 million and an early termination fee of $0.8 million. 

Item 2.          Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The following discussion and analysis should be read in conjunction with our accompanying financial statements and the notes thereto.
 
Forward-Looking Statements
 
Certain statements in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  These forward-looking statements include discussion and analysis of the financial condition of Behringer Harvard Opportunity REIT II, Inc. and our subsidiaries (which may be referred to herein as the “Company,” “we,” “us” or “our”), including our ability to rent space on favorable terms, to address our debt maturities and to fund our liquidity requirements, the value of our assets, our anticipated capital expenditures, the amount and timing of anticipated future cash distributions to our stockholders, and other matters.  Words such as “may,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “would,” “could,” “should” and variations of these words and similar expressions are intended to identify forward-looking statements.
 
These forward-looking statements are not historical facts but reflect the intent, belief or current expectations of our management based on their knowledge and understanding of the business and industry, the economy and other future conditions.  These statements are not guarantees of future performance, and we caution stockholders not to place undue reliance on forward-looking statements.  Actual results may differ materially from those expressed or forecasted in the forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to the factors listed and described herein and under Item 1A, “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 28, 2013 and the factors described below:
 
•
market and economic challenges experienced by the U.S. economy or real estate industry as a whole and the local economic conditions in the markets in which our properties are located;

•
our ability to make accretive investments in a diversified portfolio of assets;
 

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•
future changes in market factors that could affect the ultimate performance of our development or redevelopment projects, including but not limited to construction costs, plan or design changes, schedule delays, availability of construction financing, performance of developers, contractors and consultants and growth in rental rates and operating costs;

•
the availability of cash flow from operating activities for distributions, if any;

•
our level of debt and the terms and limitations imposed on us by our debt agreements;

•
the availability of credit generally, and any failure to obtain debt financing at favorable terms or a failure to satisfy the conditions and requirements of that debt;

•
our ability to secure resident leases at favorable rental rates;

•
our ability to retain our executive officers and other key personnel of our advisor, our property manager and their affiliates;

•
conflicts of interest arising out of our relationships with our Advisor and its affiliates;

•
unfavorable changes in laws or regulations impacting our business, our assets or our key relationships; and

•
factors that could affect our ability to qualify as a real estate investment trust.
 
Forward-looking statements in this Quarterly Report on Form 10-Q reflect our management’s view only as of the date of this Report, and may ultimately prove to be incorrect.  We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results, except as required by applicable law.  We intend for these forward-looking statements to be covered by the applicable safe harbor provisions created by Section 27A of the Securities Act and Section 21E of the Exchange Act.

Cautionary Note
 
The representations, warranties, and covenants made by us in any agreement filed as an exhibit to this Quarterly Report on Form 10-Q are made solely for the benefit of the parties to the agreement, including, in some cases, for the purpose of allocating risk among the parties to the agreement, and should not be deemed to be representations, warranties, or covenants to or with any other parties.  Moreover, these representations, warranties or covenants should not be relied upon as accurately describing or reflecting the current state of our affairs.
 
Executive Overview
 
We were formed primarily to acquire and operate commercial real estate and real estate-related assets on an opportunistic basis.  In particular, we focus generally on acquiring commercial properties with significant possibilities for 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 loans secured by or related to real estate.  These loan 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 and may include multifamily properties purchased for conversion into condominiums or single-tenant properties that may be converted for multi-tenant use.  Further, 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.  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 current market conditions.
 
We commenced an initial public offering of up to 125,000,000 shares of our common stock on January 21, 2008 of which 25,000,000 shares were offered pursuant to DRP.  On July 3, 2011, our initial public offering terminated in accordance with its terms.  On July 5, 2011, we commenced a follow-on public offering of up to 75,000,000 shares of our common stock of which 25,000,000 shares were offered pursuant to the DRP.  We terminated the primary component of the follow-on public

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offering effective March 15, 2012 and the DRP component effective April 3, 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.
 
Market Outlook
 
During the third quarter of 2013, market analysis was dominated by political deadlock, first over the shutdown of the government and then over a potential government default and their respective potential consequences to the U.S. economy. The temporary resolution in early fourth quarter to reopen the government and extend the debt ceiling seemed to assuage the broader markets. However, the same cannot be said for the economy. The economic reports for the third quarter, which were technically before the shutdown, reflected that employers added 148,000 new jobs during September 2013, down from the average of about 200,000 for the first half of the year. Potentially more important, consumer confidence continued to slip, down almost a third following the shutdown and in decline for the last five weekly surveys. Consumer and business confidence could be critical as the economy heads into the holiday shopping season. It appears that the general consensus is that political uncertainty will continue to hold back what could otherwise be a stronger recovery, particularly in job growth. These assumptions are likely based on a continued level of “normal” political gridlock and that the Federal Reserve’s stimulus programs will continue to be in effect. Should these assumptions vary from expectation, there could be material positive or negative effects on the economy.

As of September 30, 2013, a portion of our portfolio is invested in four multifamily properties.  While the U.S. economy continues on a modest recovery, the multifamily sector continues to have positive rent growth while maintaining good occupancy levels. From a demand perspective, the demographics for the targeted multifamily tenant, the age group from 20 to 34 years old, are still positive in the sector. This group is growing in size and while the other age segments have experienced employment declines, the 20 to 34 year old segment’s aggregate employment has increased. Further, while this age group in previous economic cycles experienced increasing single family home ownership, higher credit standards for single family mortgages and more reluctance to commit to home ownership are currently leading to more rental demand.

On the supply side, after a substantial decline in new developments of multifamily communities from 2008, supply trends are increasing. For the third quarter of 2013, permitting and construction starts, the earliest indications of potential supply, are now slightly above historical averages and up about 19% and 33%, respectively, from 2012. However, completions, while increasing and up about 15% from the prior year, are still well below historical averages. Annual completions have been averaging an annualized pace of about 250,000 units and current trends are just now reaching 200,000 units. Since multifamily developments can take 18 to 36 months or more to entitle, permit and construct, we believe there will continue to be increased supply, if there is adequate capital willing to invest in multifamily projects, and so there continues to be a window for accretive investments. We also believe that the new supply will affect certain markets, and sub markets, to a greater or lesser extent, where factors such as the strength of the local economy, population and job growth and absolute inventory level of units will allow certain markets to better absorb certain levels of supply.

As a result of these factors, many analysts are still projecting continued multifamily rental growth, albeit at a slower pace due in part to the high correlation with job and income growth. Some analysts’ reports are already starting to indicate for certain markets that renting is starting to lose its cost advantage over home ownership and that rental increases will eventually hit limits in relation to disposable income. While the overall factors noted above should still position the multifamily sector to perform better in a slow growth environment, eventually the multifamily sector will need stronger employment, disposable consumer income and household formation to maintain rental growth.
 
As of the end of October 2013, five and ten-year treasury rates, key benchmarks for multifamily financings, are approximately 1.3% and 2.5%, respectively. While these are up about 0.50% to 1.0% from their recession lows, they are still over 1% below the average over the last 10 years. In addition to favorable general interest rates, government sponsored entities (“GSEs”) like Fannie Mae and Freddie Mac, have been a core source for multifamily financing, providing a favorable base level of support for the sector. Further, the positive multifamily fundamentals have brought in other lending sources. In addition to GSEs, insurance companies and commercial banks have been aggressive lenders in our sector. Recently, the Federal Housing Finance Administration, which oversees the operations of Fannie Mae and Freddie Mac, set a target to reduce the multifamily mortgage market by 10% from the 2012 levels.  It expects this reduction to be achieved through a combination of increased pricing, more limited product offerings, and tighter overall underwriting standards.

We own an interest in one hotel property.  Smith Travel Research indicates that during the third quarter of 2013 national overall occupancy rate for hospitality properties in the United States increased 1.4% in year-over-year measurement to 67.9% and the national overall Average Daily Rate (“ADR”) increased 4% to $111.88. The hotel industry is expected to see

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continued modest growth in the near future.  If the economy continues to improve, we expect room rates for hotels to increase since increased demand for hotel rooms generally correlates with growth in the U.S. gross domestic product (GDP).  Compared to the prior year, Courtyard Kauai at Coconut Beach Hotel experienced a double digit increase in occupancy rate and an approximately 20% increase in ADR in year-over-year measurement. Additionally, the property outperformed its competitive set in occupancy, ADR and revenue per available ("RevPar") during the three and nine months ended September 30, 2013.
 
In student housing, unlike traditional multifamily housing, most leases typically commence and terminate on the same dates.  In the case of our typical student housing leases, this date coincides with the commencement of the fall academic term with the leases typically terminating at the completion of the last summer school session of the academic year.  As such, we must re-lease each property in its entirety each year during a highly compressed time period, resulting in significant turnover in our tenant population from year to year.  As a result, we are highly dependent upon the effectiveness of our marketing and leasing efforts during the short annual leasing season that typically begins in January and ends in August of each year.  Our properties’ occupancy rates are therefore typically relatively stable during the August to July academic year, but are susceptible to fluctuation at the commencement of each new academic year, which may be greater than the fluctuation in occupancy rates experienced by traditional multifamily properties.  Most state universities currently face many challenges, including reduced support from constrained state budgets, demands on institutional funds for academic and support services, increased tuition costs and flat to lower student enrollment. These challenges may lead to a decrease in occupancy and lower than anticipated revenues. As of September 30, 2013, a portion of our portfolio is invested in three public university student housing complexes, including two complexes located in Georgia and one complex located in Ohio.
 
Although the current outlook on financing trends appears relatively stable, there are risks.  Potential changes in the U.S. Federal Reserve’s monetary policy could further affect interest rates, while the U.S. political deadlock over the debt ceiling, tax policy and government spending levels can affect the overall level of domestic economic growth.  Although the European debt crisis has moderated, there is a risk that the higher-risk European countries could face new pressures over proposed austerity measures or levels of sovereign borrowings or that new problem countries could surface.  Any of these domestic or global issues could slow growth or push the U.S. into a recession, which could affect the amount of capital available or the costs charged for financings.  Specifically related to the multifamily sector, changes related to GSE’s and other regulatory restrictions could result in less multifamily debt capital and potentially higher borrowing costs.
 
We are continuing to evaluate an active pipeline of prospective acquisitions.  We generally intend to further stabilize our existing portfolio of assets and prudently invest cash and the proceeds from asset sales into additional value-added opportunities.  We will continue to target income-producing acquisitions including multifamily opportunities in states with strong economies, well-located office properties, value-added investments in real estate with in-place cash flow, and selected mezzanine-financing opportunities with an attractive risk/reward profile.
 
We expect the activities above to bring us closer to our ultimate goal of maximizing returns to our investors.  Any significant improvement in the currently slow pace of economic recovery should also bode well for our future success in achieving our strategic objectives.

Liquidity and Capital Resources
 
Our principal demands for funds will be for the (a) acquisition of real estate and real estate-related assets, (b) payment of operating expenses and (c) payment of interest and principal on our outstanding indebtedness.  Generally, we expect to meet cash needs for the payment of operating expenses and interest on our outstanding indebtedness from our cash flow from operations.  To the extent that our cash flow from operations is not sufficient to cover our operating expenses, interest on our outstanding indebtedness, redemptions or distributions, we expect to use borrowings and asset sales to fund such needs.
 
We continually evaluate our liquidity and ability to fund future operations and debt obligations.  As part of those analyses, we consider lease expirations and other factors.  Leases at our consolidated office and industrial properties representing 3.4% of our annualized base rent and 5.3% of our rentable square footage (effective monthly rent per square foot of $1.07) will expire by the end of 2013.  As a normal course of business, we are pursuing renewals, extensions and new leases.  If we are unable to renew or extend the expiring leases under similar terms or are unable to negotiate new leases, it would negatively impact our liquidity and adversely affect our ability to fund our ongoing operations.
 
We expect to fund our short-term liquidity requirements by using cash on hand, cash flow from the operations of our investments and asset sales.  Operating cash flows are expected to increase as additional real estate assets are added to the portfolio and our existing portfolio stabilizes.  Although we intend to diversify our real estate portfolio, to the extent our portfolio is concentrated in certain geographic regions, types of assets, industries or business sectors, downturns relating generally to such regions, assets, industry or business sectors may result in tenants defaulting on their lease obligations at a

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number of our properties within a short time period.  Such defaults could negatively affect our liquidity and adversely affect our ability to fund our ongoing operations.

We may, but are not required to, establish capital reserves from cash flow generated by operating properties and other investments, or net sale proceeds from the sale of our properties and other investments.  Capital reserves are typically utilized for non-operating expenses such as tenant improvements, leasing commissions and major capital expenditures.  Alternatively, a lender may establish its own criteria for escrow of capital reserves.
 
We intend to borrow money to acquire properties and make other investments.  There is no limitation on the amount we may invest in any single property or other asset or on the amount we can borrow for the purchase of any individual property or other investment.  Under our charter, the maximum amount of our indebtedness is limited to 300% of our “net assets” (as defined by our charter) as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent directors.  In addition to our charter limitation, our board of directors has adopted a policy to generally limit our aggregate borrowings to approximately 75% of the aggregate value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests.  Our policy limitation, however, does not apply to individual real estate assets.
 
Commercial real estate debt markets have experienced volatility and uncertainty as a result of certain related factors, including the tightening of underwriting standards by lenders and credit rating agencies, macro-economic issues related to fiscal, tax and regulatory policies and global financial issues arising from the European debt crisis and recessionary implications.  Should the overall cost of borrowings increase, either by increases in the index rates or by increases in lender spreads, we will need to factor such increases into the economics of our acquisitions, developments and investments.  This may result in our investment operations generating lower overall economic returns and a reduced level of cash flow, which could potentially impact our ability to make distributions to our stockholders.  In addition, the dislocations in the debt markets have reduced the amount of capital that is available to finance real estate, which in turn: (a) leads to a decline in real estate values generally; (b) slows real estate transaction activity; (c) reduces the loan to value ratio upon which lenders are willing to extend debt; and (d) results in difficulty in refinancing debt as it becomes due, all of which may reasonably be expected to have a material adverse impact on the value of real estate investments and the revenues, income or cash flow from the operations of real properties and mortgage loans.
 
Debt Financings
 
We may, from time to time, obtain mortgage, bridge or mezzanine loans for acquisitions and investments, as well as property development.  We may obtain financing at the time an asset is acquired or an investment is made or at such later time as determined to be necessary, depending on multiple factors.
 
At September 30, 2013, our notes payable balance was $212.1 million and has a weighted average interest rate of 3.7%.  We have guaranteed payment of certain recourse liabilities with respect to certain customary nonrecourse carveouts as set forth in the guaranties in favor of the unaffiliated lenders with respect to the Courtyard Kauai at Coconut Beach Hotel, Wimberly, 22 Exchange and Parkside notes payable.  For the nine months ended September 30, 2013, in connection with the acquisition of Wimberly, 22 Exchange and Parkside, we entered into loans with unaffiliated third parties for approximately $26.7 million, $19.5 million and $10.5 million (assumed loan), respectively. On April 12, 2013, we sold the remaining three industrial buildings at Interchange Business Center to an unaffiliated third party and used a portion of the proceeds from the sale to pay off in full the existing indebtedness of $11.3 million associated with the property, which was scheduled to mature on December 1, 2013.  On September 20, 2013, we sold the Original Florida MOB Portfolio; the sales price was paid in cash and through the assumption by the buyer of approximately $18 million of existing indebtedness. As of December 31, 2012, our outstanding note payable balance was $183.3 million.
 
Our loan agreements stipulate that we comply with certain reporting and financial covenants.  These covenants include, among other things, maintaining minimum debt service coverage ratios and liquidity.  As of September 30, 2013, we believe we were in compliance with the debt covenants under our loan agreements.
 
One of our principal long-term liquidity requirements includes the repayment of maturing debt.  The following table provides information with respect to the maturities and scheduled principal repayments of our indebtedness as of September 30, 2013.  The table does not represent any available extension options ($ in thousands).  

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Payments Due by Period (1)
 
 
October 1, 2013 -December 31, 2013
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
Principal payments - variable rate debt
 
$
42

 
$
174

 
$
38,629

 
$
16,347

 
$
738

 
$
34,854

 
$
90,784

Principal payments - fixed rate debt
 
588

 
1,896

 
19,218

 
1,765

 
1,978

 
95,103

 
120,548

Interest payments - variable rate debt (based on rates in effect as of September 30, 2013)
 
629

 
2,502

 
2,462

 
1,232

 
1,132

 
3,315

 
11,272

Interest payments - fixed rate debt
 
1,359

 
5,382

 
5,062

 
4,658

 
4,556

 
7,510

 
28,527

Total
 
$
2,618

 
$
9,954

 
$
65,371

 
$
24,002

 
$
8,404

 
$
140,782

 
$
251,131

(1)         Does not include approximately $0.8 million of unamortized premium related to debt we assumed on our acquisition of Parkside.

Results of Operations
 
As of September 30, 2013, we had 13 real estate investments, 12 of which were consolidated in our condensed consolidated financial statements.  During 2013, we completed three investments including an investment in an unconsolidated joint venture during the first six months and one acquisition in the third quarter.  During the nine months ended September 30, 2013, we sold the original eight medical office buildings known as the Original Florida MOB Portfolio on September 20, 2013 and the remaining three buildings at Interchange Business Center in April 2013.
 
As of September 30, 2012, we had 11 real estate investments of which Parrot's Landing and one of the four buildings at Interchange Business Center were classified as held for sale.  During the nine months ended September 30, 2012, we sold one property in January 2012.
 
Three months ended September 30, 2013 as compared to the three months ended September 30, 2012.
 
Continuing Operations
 
Our results of operations for the respective periods presented primarily reflect increases in most categories due to the growth of our portfolio in each period presented.  Management expects increases in most categories in the near future as we purchase additional real estate and real estate-related assets, begin to realize the full year impact of our acquisitions and continue to improve the performance of our investments.
 
Revenues.  Revenues for the three months ended September 30, 2013 were $11.6 million, an increase of $3 million from the three months ended September 30, 2012.  The change in revenue is primarily due to:
 
•
an increase in rental revenue of $2.1 million as a result of our 2013 acquisitions of Wimberly, 22 Exchange and Parkside; and

•
an increase of hotel revenue of $0.9 million at the Courtyard Kauai at Coconut Beach Hotel due to double digit increases in occupancy rate and ADR as a result of improved operating performance.
 
Property Operating Expenses.  Property operating expenses for the three months ended September 30, 2013 and 2012 were $2.9 million and $1.8 million, respectively.  The increase in property operating expenses was primarily due to our acquisitions of Wimberly, 22 Exchange, and Parkside.
 
Hotel Operating Expenses.  Hotel operating expenses for the three months ended September 30, 2013 and 2012 were $3 million and $2.5 million, respectively.  The increase in hotel operating expenses was due to the increased activity at Courtyard Kauai at Coconut Beach Hotel.
 
Interest Expense.  Interest expense, net of amounts capitalized for the three months ended September 30, 2013 and 2012 was $2.1 million and $1.7 million, respectively.  The increase was primarily due to the acquisitions of Wimberly, 22 Exchange and Parkside.  Interest capitalized for the three months ended September 30, 2013 was $0.1 million.
 
Real Estate Taxes.  Real estate taxes were $1.3 million and $0.8 million for the three months ended September 30, 2013 and 2012, respectively.  The increase for the three months ended September 30, 2013 was primarily due to the acquisitions of Wimberly, 22 Exchange, and Parkside.
 

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Property Management Fees.  Property management fees for each of the three months ended September 30, 2013 and 2012 were $0.4 million and $0.3 million, respectively, and were comprised of property management fees paid to unaffiliated third parties and BHO II Management or its affiliates.
 
Asset Management Fees.  Asset management fees for the three months ended September 30, 2013 and 2012 were $1 million and $0.8 million, respectively and were comprised of asset management fees paid to our Advisor with respect to our investments.
 
Acquisition Expense.  Acquisition expense for the three months ended September 30, 2013 of $1 million was primarily due to expenses incurred as a result of our acquisition of Parkside.  Acquisition expense for the three months ended September 30, 2012 was less than $0.1 million.
 
General and Administrative Expenses.  General and administrative expenses for the three months ended September 30, 2013 and 2012 were $1.2 million and $0.9 million, respectively, and were comprised of auditing fees, legal fees, board of directors fees, and other administrative expenses. The increase was primarily due to legal expenses associated with changes in our joint ventures.

Depreciation and amortization.  Depreciation and amortization for the three months ended September 30, 2013 and 2012 was $3.4 million and $2.4 million, respectively.  The increase is primarily a result of our acquisition of Wimberly, 22 Exchange, and Parkside.
 
Nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012.
 
Continuing Operations
 
Our results of operations for the respective periods presented primarily reflect increases in most categories due to the growth of our portfolio in each period presented.  Management expects increases in most categories in the near future as we purchase additional real estate and real estate-related assets, begin to realize the full year impact of our acquisitions and continue to improve the performance of our investments.
 
Revenues.  Revenues for the nine months ended September 30, 2013 were $31.6 million, an increase of $7.4 million from the nine months ended September 30, 2012.  The change in revenue is primarily due to:
 
•
an increase in rental revenue of $4.3 million as a result of our 2013 acquisitions of Wimberly, 22 Exchange, and Parkside and our 2012 acquisition of Alte Jakobstraße in the second quarter; and
 
•
an increase of hotel revenue of $3 million at the Courtyard Kauai at Coconut Beach Hotel due to double digit increases in occupancy rate and ADR as a result of improved operating performance after the completion of renovations in the first quarter of 2012.
 
Property Operating Expenses.  Property operating expenses for the nine months ended September 30, 2013 and 2012 were $7 million and $5.1 million, respectively.  The acquisitions of Wimberly, 22 Exchange, Parkside, and Alte Jakobstraße accounted for $1.5 million of the increase.
 
Hotel Operating Expenses.  Hotel operating expenses for the nine months ended September 30, 2013 and 2012 were $8.5 million and $7.4 million, respectively.  The increase in hotel operating expenses was due to the increased activity at Courtyard Kauai at Coconut Beach Hotel.
 
Interest Expense.  Interest expense, net of amounts capitalized, for the nine months ended September 30, 2013 and 2012 was $5.8 million and $5.2 million, respectively.  The increase was primarily due to interest expense for acquisitions of $0.8 million, partially offset by a $0.2 million decrease at 1875 Lawrence as a result of a lower outstanding loan balance during the period.  Interest capitalized for the nine months ended September 30, 2013 was $0.2 million.
 
Real Estate Taxes.  Real estate taxes were $3.4 million and $2.3 million for the nine months ended September 30, 2013 and 2012, respectively.  The increase for the nine months ended September 30, 2013 was primarily due to the acquisitions of Wimberly, 22 Exchange, and Parkside.
 

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Property Management Fees.  Property management fees for the nine months ended September 30, 2013 and 2012 were $1.1 million and $0.9 million, respectively, and were comprised of property management fees paid to unaffiliated third parties and BHO II Management or its affiliates.
 
Asset Management Fees.  Asset management fees for the nine months ended September 30, 2013 and 2012 were $2.5 million and $2.4 million and were comprised of asset management fees paid to our Advisor with respect to our investments.
 
Acquisition Expense.  Acquisition expense, net of amounts capitalized for the nine months ended September 30, 2013 of $4.1 million was primarily due to expenses incurred as a result of our acquisition of Wimberly, 22 Exchange, and Parkside.  Acquisition costs capitalized related to our equity method investment in Prospect Park for the nine months ended September 30, 2013 was $0.4 million.  Acquisition expense for the nine months ended September 30, 2012 of $0.7 million was primarily due to expenses incurred as a result of our acquisition of Alte Jakobstraße.
 
General and Administrative Expenses.  General and administrative expenses for the nine months ended September 30, 2013 were $2.9 million, as compared to $2.2 million for the nine months ended September 30, 2012, and were comprised of auditing fees, legal fees, board of directors fees, and other administrative expenses.  The increase was primarily due to legal expenses associated with changes in our joint ventures and certain costs capitalized during the Offerings that are now expensed.
 
Depreciation and amortization.  Depreciation and amortization for the nine months ended September 30, 2013 and 2012 was $10.2 million and $8.1 million, respectively.  The increase is primarily a result of our acquisition of Wimberly, 22 Exchange and Parkside.
 
See Note 16 to Condensed Consolidated Financial Statements for further information regarding discontinued operations.

Cash Flow Analysis
 
Cash provided by operating activities for the nine months ended September 30, 2013 was $0.3 million and was primarily comprised of the net income of $17.4 million, adjusted for depreciation and amortization, including amortization of deferred financing fees of $13.6 million, loss on early extinguishment of debt of $0.3 million, and cash used for working capital and other operating activities of approximately $0.5 million, offset by a gain on the sale of the remaining three buildings at Interchange Business Center and the Original Florida MOB Portfolio of $31.5 million.  Cash provided by operating activities for the nine months ended September 30, 2012 was $4 million and was primarily comprised of the net loss of $4 million, adjusted for depreciation and amortization, including amortization of deferred financing fees of $13.1 million, cash used for working capital and other operating activities of approximately $4.2 million and offset by a gain on sale of the Palms of Monterrey of $9.3 million. 

Cash used by investing activities for the nine months ended September 30, 2013 was $11 million, and was comprised of purchases of Wimberly, 22 Exchange and Parkside of $74.7 million, an investment in Prospect Park of $14.3 million, additions of property and equipment of $6.2 million, and a change in restricted cash of $2 million, offset by proceeds from the sale of the remaining three buildings at Interchange Business Center and the Original Florida MOB Portfolio of $83.5 million, a return of investment in Prospect Park of $2.4 million, and acquisition deposits of $0.3 million.  Cash provided by investing activities for the nine months ended September 30, 2012 was $15.6 million, and was comprised of net proceeds from sale of the Palms of Monterrey of $38.7 million, offset by purchase of Alte Jakobstraße of $11 million, additions of property and equipment of $11.7 million and an increase in restricted cash of approximately $0.4 million. 

Cash provided by financing activities for the nine months ended September 30, 2013 was $34.8 million, and was comprised of net proceeds and financing costs of $33.9 million and offering costs receivable from related party of $3.8 million, offset by net distributions to non-controlling interest holders of $2.4 million, redemptions of common stock of $0.4 million and purchases of interest rate derivatives of $0.1 million.  Cash used in financing activities for the nine months ended September 30, 2012 was $38.9 million, and was comprised of payments on notes payable, net of proceeds and financing costs, of $23.4 million, cash distributions to our stockholders of $14.5 million, net distributions to non-controlling interest holders of $5.6 million, redemptions of common stock of $1 million, offset by the issuance of common stock, net of offering costs, of $5.6 million.
 



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Funds from Operations
 
Funds from operations (“FFO”) is a non-GAAP financial measure that is widely recognized as a measure of REIT operating performance.  We use FFO as defined by the National Association of Real Estate Investment Trusts (“NAREIT”) in the April 2002 “White Paper of Funds From Operations” which is net income (loss), computed in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains (or losses) from sales of property and impairments of depreciable real estate (including impairments of investments in unconsolidated joint ventures and partnerships which resulted from measurable decreases in the fair value of the depreciable real estate held by the joint venture or partnership), plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships, joint ventures, subsidiaries, and noncontrolling interests as one measure to evaluate our operating performance.
 
Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate diminishes predictably over time.  Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting alone to be insufficient.  As a result, our management believes that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance.
 
We believe that FFO is helpful to investors and our management as a measure of operating performance because it excludes depreciation and amortization, gains and losses from property dispositions, impairments of depreciable assets, and extraordinary items, and as a result, when compared year to year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, which is not immediately apparent from net income.
 
FFO should not be considered as an alternative to net income (loss), as an indication of our liquidity, nor as an indication of funds available to fund our cash needs, including our ability to make distributions and should be reviewed in connection with other GAAP measurements.  Additionally, the exclusion of impairments limits the usefulness of FFO as a historical operating performance measure since an impairment charge indicates that operating performance has been permanently affected.  FFO is not a useful measure in evaluating net asset value because impairments are taken into account in determining net asset value but not in determining FFO.  Our FFO as presented may not be comparable to amounts calculated by other REITs that do not define these terms in accordance with the current NAREIT definition or that interpret the definition differently.

Our calculation of FFO for the three and nine months ended September 30, 2013 and 2012 is presented below ($ in thousands except per share amounts):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Net income (loss) attributable to the Company
 
$
10,840

 
$
(3,101
)
 
$
12,522

 
$
(3,768
)
Adjustments for (1):
 
 

 
 

 
 

 
 

Real estate depreciation and amortization(2)
 
3,585

 
3,461

 
11,603

 
10,933

Gain on sale of real estate (3)
 
(15,387
)
 
—

 
(25,956
)
 
(8,338
)
Funds from operations (FFO)
 
$
(962
)
 
$
360

 
$
(1,831
)
 
$
(1,173
)
 
 
 
 
 
 
 
 
 
GAAP weighted average shares:
 
 

 
 

 
 

 
 

Basic and diluted
 
26,032

 
26,069

 
26,041

 
25,962

 
 
 
 
 
 
 
 
 
FFO per share
 
$
(0.04
)
 
$
0.01

 
$
(0.07
)
 
$
(0.05
)
 
 
 
 
 
 
 
 
 
Net income (loss) per share
 
$
0.42

 
$
(0.12
)
 
$
0.48

 
$
(0.15
)
_________________________________
(1)         Reflects continuing operations, as well as discontinued operations.
(2)         Includes our consolidated amount and the noncontrolling interest adjustment for the third-party partners’ share.
(3)
For the three months ended September 30, 2013, includes our proportionate share of the gain on the sale of the Original Florida MOB Portfolio.  For the nine months ended September 30, 2013, includes our proportionate share of the gain on the sale of real estate related to the remaining three buildings at Interchange Business Center and the Original Florida MOB Portfolio.  For the nine months ended September 30, 2012, includes our proportionate share of the gain on the sale of real estate related to Palms of Monterrey.
 

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Provided below is additional information related to selected items included in net gain (loss) above, which may be helpful in assessing our operating results.
 
•
Straight-line rental revenue of $0.1 million and $0.4 million was recognized for the three and nine months ended September 30, 2013, respectively.  Straight-line rental revenue of $0.1 million and $0.2 million was recognized for the three and nine months ended September 30, 2012, respectively.  The noncontrolling interest portion of straight-line rental revenue for the three and nine months ended September 30, 2013 and 2012 was less than $0.1 million.

•
Net above/below market lease amortization of less than $0.1 million was recognized as a decrease and an increase to rental revenue for the nine months ended September 30, 2013 and 2012, respectively.  The noncontrolling interest portion of net above/below market lease amortization for the three and nine months ended September 30, 2013 and 2012 was less than $0.1 million.

•
Amortization of deferred financing costs of $0.2 million and $0.7 million was recognized as interest expense for our notes payable for the three and nine months ended September 30, 2013, respectively.  Amortization of deferred financing costs of $0.3 million and $0.8 million was recognized as interest expense for our notes payable for the three and nine months ended September 30, 2012, respectively.

•
During the nine months ended September 30, 2013, we recognized loss on early extinguishment of debt of $0.3 million comprised of the write-off of deferred financing fees of $0.1 million and an early termination fee of $0.2 million.  During the nine months ended September 30, 2012, we recognized loss on early extinguishment of debt of $1.2 million comprised of the write-off of deferred financing fees of $0.4 million and an early termination fee of $0.8 million.
 
In addition, cash flows generated from FFO may be used to fund all or a portion of certain capitalizable items that are excluded from FFO, such as capital expenditures and payments of principal on debt, each of which may impact the amount of cash available for distribution to our stockholders.
 
Distributions
 
Distributions are authorized at the discretion of our board of directors based on its analysis of our performance over the previous periods and expectations of performance for future periods.  These analyses may include actual and anticipated operating cash flow, changes in market capitalization rates for investments suitable for our portfolio, capital expenditure needs, general financial and market conditions and other factors that our board deems relevant.  The board’s decision will be substantially influenced by its obligation to ensure that we maintain our status as a REIT.  In light of the continued uncertainty in the global financial and real estate markets, we cannot provide assurance that we will be able to achieve expected cash flows necessary to pay distributions at any particular level, or at all.
 
On March 20, 2012, our board of directors declared a special distribution of $0.50 per share of common stock payable to our stockholders of record as of April 3, 2012 and determined to cease regular, monthly distributions in favor of payment of periodic distributions from excess proceeds from asset dispositions or from other sources as necessary to maintain our REIT tax status.  The special distribution was paid on May 10, 2012.
 
We have paid and may in the future pay some or all of our distributions from sources other than operating cash flow.  We have, for example, generated cash to pay distributions from financing activities, components of which include proceeds from the Offerings and borrowings (including borrowings secured by our assets) in anticipation of future operating cash flow.  We have also utilized cash from refinancing and dispositions, the components of which may represent a return of capital and/or the gains on sale.  In addition, from time to time, our Advisor may agree to waive or defer all or a portion of the acquisition, asset management or other fees or incentives due to it, pay general administrative expenses or otherwise supplement investor returns in order to increase the amount of cash that we have available to pay distributions to our stockholders.
 
The following summarizes certain information related to the sources of distributions ($ in thousands):
 

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Nine months ending
 
September 30,
 
2012
Total Distributions Paid (1)
$
17,326

 
 

Principal Sources of Funding:
 

Distribution Reinvestment Plan
$
2,790

Cash flow provided by operating activities
$
4,044

Cash available at the beginning of the period (2)
$
80,130

 
_______________________________
(1) Includes special cash distribution of $13 million.
 
(2) Represents the cash available at the beginning of the reporting period (January 1, 2012) primarily attributable to excess funds raised from the issuance of common stock and borrowings, after the impact of historical operating activities, other investing and financing activities.
 
We did not pay any distributions to stockholders during the three and nine months ended September 30, 2013 and the three months ended September 30, 2012.  Total distributions paid to stockholders during the nine months ending September 30, 2012 were $17.3 million consisting of the special cash distribution of $13 million and the regular distributions of $4.3 million.  The special cash distribution was funded from proceeds from asset dispositions.  A portion of the $4.3 million regular distributions to stockholders was funded from cash flow provided by operations.  Future distributions declared and paid may exceed cash flow from operating activities or funds from operations until such time as we invest in additional real estate or real estate-related assets at favorable yields and our investments reach stabilization.
 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements that are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
 
Critical Accounting Policies and Estimates
 
Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with GAAP.  The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On a regular basis, we evaluate these estimates, including investment impairment.  These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates.
 
Below is a discussion of the accounting policies that we consider to be critical in that they may require complex judgment in their application or require estimates about matters that are inherently uncertain.
 
Principles of Consolidation and Basis of Presentation
 
Our condensed 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 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.
 
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 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

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for an investment using the equity method that should in fact be consolidated, the effects of which could be material to our 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 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.
 

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Investment in Unconsolidated Joint Venture
 
We provide funding to third party developers for the acquisition, development and construction of real estate.  Under the ADC Arrangement, we may participate in the residual profits of the project through the sale or refinancing of the property.  We evaluate these arrangements to determine if they have characteristics similar to a loan or if the characteristics are more similar to a joint venture or partnership such as participating in the risks and rewards of the project as an owner or an investment partner.  When we determine that the characteristics are more similar to a jointly-owned investment or partnership, we account for the arrangements as an investment in an unconsolidated joint venture under the equity method of accounting (Note 8) or a direct investment (consolidated basis of accounting) instead of applying loan accounting.  The ADC Arrangement is periodically reassessed.
 
Investment Impairments
 
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 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 also evaluate our investments in unconsolidated joint ventures at each reporting date.  If we believe there is an other than temporary decline in market value, we will record an impairment charge based on these evaluations.  We assess potential impairment by comparing our portion of estimated future undiscounted operating cash flows expected to be generated by the joint venture over the life of the joint venture’s assets to the carrying amount of the joint venture.  In the event that the carrying amount exceeds our portion of estimated future undiscounted operating cash flows, we recognize an impairment loss to adjust the carrying amount of the joint venture to its estimated fair value.
 
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, 2013 and 2012.  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.

Item 3.                   Quantitative and Qualitative Disclosures About Market Risk.
 
Foreign Currency Exchange Risk
 
As of September 30, 2013, we maintained approximately $2 million in Euro-denominated accounts at European financial institutions.  We currently have two investments in Europe.  As the cash is held in the same currency as the real estate assets and related loans, we believe that we are not materially exposed to any significant foreign currency fluctuations related to these accounts as it relates to ongoing property operations.  Material movements in the exchange rate of Euros could materially impact distributions from our foreign investments.

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Interest Rate Risk
 
We may be exposed to interest rate changes primarily as a result of long-term debt used to acquire properties and make loans and other permitted investments.  Our management’s objectives, with regard to interest rate risks, are to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs.  To achieve these objectives, we will borrow primarily at fixed rates or variable rates with the lowest margins available and in some cases, with the ability to convert variable rates to fixed rates.  With regard to variable rate financing, we will assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities.  We may enter into derivative financial instruments such as options, forwards, interest rate swaps, caps, or floors to mitigate our interest rate risk on a related financial instrument or to effectively lock the interest rate portion of our variable rate debt.  Of our $212.1 million in notes payable at September 30, 2013, $80.3 million represented debt subject to variable interest rates, of which $15.6 million is subject to minimum interest rates.  If our variable interest rates increased 100 basis points, we estimate that total annual interest cost, including interest expensed and interest capitalized, would increase by $0.8 million.
 
Interest rate caps classified as assets were reported at their combined fair value of $0.2 million within prepaid expenses and other assets at September 30, 2013.  A 100 basis point decrease in interest rates would result in a $0.2 million net decrease in the fair value of our interest rate caps.  A 100 basis point increase in interest rates would result in a $0.4 million net increase in the fair value of our interest rate caps.
 
Item 4.   Controls and Procedures.
 
Evaluation of Disclosure Controls and Procedures
 
As required by Rule 13a-15(b) and Rule 15d-15(b) under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated, as of September 30, 2013, the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) and Rule 15d-15(e).  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective, as of September 30, 2013, to provide reasonable assurance that information required to be disclosed by us in this report is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
 
We believe, however, that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls systems are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, within a company have been detected.
 
Changes in Internal Control over Financial Reporting
 
There has been no change in internal control over financial reporting that occurred during the quarter ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
PART II
 
OTHER INFORMATION
 
Item 1.                   Legal Proceedings.
 
We are not a party to, and none of our properties are subject to, any material pending legal proceedings.

Item 1A.                Risk Factors.
 
There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2012.
 
Item 2.                   Unregistered Sales of Equity Securities and Use of Proceeds.
 

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Recent Sales of Unregistered Securities
 
During the period covered by this quarterly report, we did not sell any equity securities that were not registered under the Securities Act of 1933.
 
Share Redemption Program
 
Our board of directors has adopted a share redemption program that permits stockholders to sell their shares back to us, subject to the significant conditions and limitations of the program.  Our board of directors can amend the provisions of our share redemption program at any time without the approval of our stockholders.
 
The terms on which we redeem shares may differ between redemptions upon a stockholder’s death, “qualifying disability” (as defined in the share redemption program) or confinement to a long-term care facility (collectively, “Exceptional Redemptions”) and all other redemptions (“Ordinary Redemptions”).  Our board of directors determined to suspend until further notice accepting Ordinary Redemptions effective April 1, 2012.  Under our share redemption program, the purchase price for shares redeemed under the program pursuant to an Exceptional Redemption request is set forth below.
 
Prior to the first valuation conducted by the board of directors, or a committee thereof, the purchase price per share for the redeemed shares equaled 90% of the difference of (a) average price per share the original purchaser or purchasers of shares paid to us for all of his or her shares (as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to our common stock) less (b) the aggregate distributions per share of any net sale proceeds from the sale of one or more of our assets, or other special distributions so designated by the board of directors (the “Special Distributions”), distributed to stockholders prior to the redemption date and declared from the date of first issue of such redeemed Shares.
 
On August 7, 2013, in accordance with the terms of the share redemption program , the per share redemption price for redemptions automatically adjusted as a result of the initial determination by our board of directors of the estimated per share value of $10.09. Beginning August 7, 2013, the per share redemption price for Exceptional Redemptions will equal the lesser of 90% of (a) $10.09 and (b) the average price per share that investor paid for all of his shares (as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to our common stock) less the Special Distributions. Exceptional Redemptions made on or after August 7, 2013 will be made pursuant to the immediately preceding pricing description.

Notwithstanding the redemption prices set forth above, our board of directors may determine, whether pursuant to formulas or processes approved or set by our board of directors, the redemption price of the shares, which may differ between Ordinary Redemptions and Exceptional Redemptions; provided, however, that we must provide at least 30 days’ notice to stockholders before applying this new price determined by our board of directors.
 
Any shares approved for redemption will be redeemed on a periodic basis as determined from time to time by our board of directors, and no less frequently than annually.  We will not redeem, during any twelve-month period, more than 5% of the weighted average number of shares outstanding during the twelve-month period immediately prior to the date of redemption.  In addition, the cash available for redemption in any quarterly period will generally be limited to no more than $250,000, and in no event more than $1,000,000 in any twelve-month period.  The redemption limitations apply to all redemptions, whether Ordinary or Exceptional Redemptions.
 
During the three months ended September 30, 2013 our board of directors redeemed all six Exceptional Redemption requests received that complied with the applicable requirements and guidelines of the share redemption program for an aggregate of 19,478 shares redeemed for $0.2 million (approximately $8.51 per share).  All redemptions were funded with cash on hand.
 
We have not presented information regarding submitted and unfulfilled Ordinary Redemption requests for the nine months ended September 30, 2013 as our board of directors suspended Ordinary Redemptions effective April 1, 2012 and we believe many stockholders who may otherwise desire to have their shares redeemed have not submitted a request due to the suspension of Ordinary Redemptions.
 
Any Ordinary Redemption requests submitted while Ordinary Redemptions are suspended will be returned to investors and must be resubmitted upon resumption of Ordinary Redemptions. If Ordinary Redemptions are resumed, we will give all stockholders notice that we are resuming Ordinary Redemptions, so that all stockholders will have an equal opportunity to submit shares for redemption.  Upon resumption of Ordinary Redemptions, any redemption requests will be honored pro rata among all requests received based on funds available.  Requests will not be honored on a first come, first served basis.

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During the quarter ended September 30, 2013, we redeemed shares as follows:
 
2013
 
Total Number of
Shares Redeemed
 
Average Price
Paid Per Share
 
Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans
or Programs
 
Maximum
Number of Shares
That May Be
Purchased Under
the Plans or
Programs
July
 
—

 
$
—

 
—

 
 

August
 
19,478

 
$
8.51

 
19,478

 
(1
)
September
 
—

 
$
—

 
—

 
 

 
 
19,478

 
$
8.51

 
19,478

 
(1
)
 
_________________________________
(1) A description of the maximum number of shares that may be purchased under our redemption program is included in the narrative preceding this table.


Item 3.                                                         Defaults Upon Senior Securities.
 
None.
 
Item 4.                                                         Mine Safety Disclosures.
 
None.
 
Item 5.             Other Information.
 
None.
 
Item 6.                                                         Exhibits.
 
The exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index attached hereto.

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

 
BEHRINGER HARVARD OPPORTUNITY REIT II, INC.
 
 
 
 
Dated: November 13, 2013
By:
/s/ Andrew J. Bruce
 
 
Andrew J. Bruce
 
 
Chief Financial Officer
 
 
Principal Financial Officer

 

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Index to Exhibits
 
Exhibit Number
 
Description
 
 
 
3.1
 
Third Articles of Amendment and Restatement, incorporated by reference to Exhibit 3.1 to Form 10-Q filed on November 14, 2012
 
 
 
3.2*
 
Second Amended and Restated Bylaws, as amended by Amendment No. 1.
 
 
 
4.1
 
Statement regarding restrictions on transferability of shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates), incorporated by reference to Exhibit 4.1 to Form 10-K filed on March 28, 2013
 
 
 
10.1*
 
The Purchase and Sale Agreement, dated July 8, 2013, between Behringer Harvard Florida MOB Member, LLC, BH-AW Florida MOB Venture, LLC, AW SFMOB Investor, LLC and AW SFMOB Managing Member, LLC.
 
 
 
10.2*
 
First Amendment to the Purchase and Sale Agreement, dated July 8, 2013, between Behringer Harvard Florida MOB Member, LLC, BH-AW Florida MOB Venture, LLC, AW SFMOB Investor, LLC and AW SFMOB Managing Member, LLC.
 
 
 
31.1*
 
Rule 13a-14(a)/15d-14(a) Certification
 
 
 
31.2*
 
Rule 13a-14(a)/15d-14(a) Certification
 
 
 
32.1*
 
Section 1350 Certification**
 
 
 
32.2*
 
Section 1350 Certification**
 
 
 
99.1
 
Second Amended and Restated Share Redemption Program (incorporated by reference to Exhibit 4.4 to Form 10-K filed on March 28, 2012)
 
 
 
101*
 
The following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, filed on November 13, 2013, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Equity, (iv) Condensed Consolidated Statements of Cash Flows and (v) the Notes to Condensed Consolidated Financial Statements.
 
* Filed herewith

** In accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section.  Such certifications will not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.



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