Peakstone Realty Trust - Annual Report: 2016 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________________________________________
FORM 10-K
____________________________________________________
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2016
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 000-55605
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Griffin Capital Essential Asset REIT II, Inc.
(Exact name of Registrant as specified in its charter)
________________________________________________
Maryland | 46-4654479 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
Griffin Capital Plaza
1520 E. Grand Ave
El Segundo, California 90245
(Address of principal executive offices)
(310) 469-6100
(Registrant’s telephone number)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered |
None | None |
Securities registered pursuant to Section 12(g) of the Act: |
Common Stock, $0.001 par value per share |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment of this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
Non-accelerated filer | x (Do not check if a smaller reporting company) | Smaller reporting company | ¨ | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of voting common stock held by non-affiliates was $508,334,447 assuming a market value of $10.00 per share, as of June 30, 2016, the last business day of the registrant's most recently completed second fiscal quarter.
As of March 9, 2017, there were 75,178,530 shares of Class A, Class T and Class I common stock of Griffin Capital Essential Asset REIT II, Inc. outstanding.
Documents Incorporated by Reference:
The Registrant incorporates by reference in Part III (Items 10, 11, 12, 13 and 14) of this Form 10-K portions of its Definitive Proxy Statement for the 2017 Annual Meeting of Stockholders.
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-K of Griffin Capital Essential Asset REIT II, Inc., other than historical facts, may be considered 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”). We intend for all such forward-looking statements to be covered by the applicable safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act. Such forward-looking statements may discuss, among other things, our future capital expenditures, distributions and acquisitions (including the amount and nature thereof), business strategies, the expansion and growth of our operations, our net sales, gross margin, operating expenses, operating income, net income, cash flow, financial condition, impairments, expenditures, capital structure, organizational structure, and other developments and trends of the real estate industry. Such statements are based on a number of assumptions involving judgments with respect to, among other things, future economic, competitive, and market conditions, all of which are difficult or impossible to predict accurately. To the extent that our assumptions differ from actual results, our ability to meet such forward-looking statements, including our ability to generate positive cash flow from operations and provide distributions to stockholders, our ability to find suitable investment properties, and our ability to be in compliance with certain debt covenants, may be significantly hindered. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this report is filed with the Securities and Exchange Commission ("SEC"). We cannot guarantee the accuracy of any such forward-looking statements contained in this Form 10-K, and we do not intend to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by applicable securities laws and regulations.
As used herein, “we,” “us,” and “our” refer to Griffin Capital Essential Asset REIT II, Inc. All forward-looking statements should be read in light of the risks identified in, "Item 1A. Risk Factors "of this Form 10-K.
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PART I
ITEM 1. BUSINESS
Overview
Griffin Capital Essential Asset REIT II, Inc., a Maryland corporation (the "Company," "we," "us,", and "our"), was formed on November 20, 2013 under the Maryland General Corporation Law and qualified as a real estate investment trust ("REIT") commencing with the year ended December 31, 2015. We were organized primarily with the purpose of acquiring single tenant net lease properties that are considered essential to the occupying tenant, and expect to use a substantial amount of the net proceeds from our initial public offering to invest in these properties. We are a newly formed company and are subject to the general risks associated with a start-up enterprise, including the risk of business failure. We have no employees and are externally advised and managed by an affiliate, Griffin Capital Essential Asset Advisor II, LLC, (the "Advisor"). Our year end is December 31.
Our Articles of Incorporation initially authorized 30,000 shares of common stock. On February 11, 2014, our Advisor purchased 100 shares of common stock for $1,000 and became the initial stockholder. Upon the Securities and Exchange Commission ("SEC") declaring our initial public offering effective on July 31, 2014, our Articles of Amendment and Restatement were filed with the State of Maryland and authorized 700,000,000 shares of common stock with a par value of $0.001 and 200,000,000 shares of preferred stock with a par value of $0.001. We currently have our common stock allocated as follows: (i) 250,000,000 Class A shares, (ii) 300,000,000 Class T shares and (iii) 150,000,000 Class I shares. We registered $2.2 billion in common shares in our initial public offering (“Offering”), consisting of $2.0 billion in common shares to be offered to the public in the primary public offering (“Primary Offering”) and $200.0 million in common shares for sale pursuant to our distribution reinvestment plan (“DRP”). We issue shares of our common stock pursuant to our DRP at a purchase price of $9.37 per share for all share classes. In September 2016, our board of directors approved the close of our Primary Offering effective January 20, 2017. We intend to continue to sell shares of our common stock in the offering pursuant to our DRP following the termination of our Primary Offering.
As of March 9, 2017, we had outstanding 75,178,530 shares of our Class A shares, Class T shares, and Class I shares.
On February 13, 2017, our board of directors, including all our independent directors, approved an estimated value per share of our Class A shares, Class T shares, and Class I shares of $9.37 based on the estimated value of our assets less the estimated value of our liabilities, or net asset value, divided by the approximate number of shares outstanding, calculated as of December 31, 2016. We are providing this estimated value per share to assist broker dealers in connection with their obligations under applicable Financial Industry Regulatory Authority ("FINRA") rules with respect to customer account statements. This valuation was performed in accordance with the methodology provided in Practice Guideline 2013-01, Valuations of Publicly Registered Non-Listed REITs, issued by the Investment Program Association ("IPA") in April 2013 ("IPA Valuation Guidelines"), in addition to guidance from the SEC. (Please see "Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities" of this Form 10-K for more information regarding the determination of our NAV.)
Investment Objectives
Overview
We invest in a portfolio consisting primarily of single tenant business essential properties. Our investment objectives and policies may be amended or changed at any time by our board of directors. Although we have no plans at this time to change any of our investment objectives, our board of directors may change any and all such investment objectives, including our focus on single tenant business essential properties, if they believe such changes are in the best interests of our stockholders. In addition, we may invest in real estate properties other than single tenant business essential properties if our board deems such investments to be in the best interests of our stockholders. We cannot assure our stockholders that our policies or investment objectives will be attained or that the value of our common stock will not decrease.
Primary Investment Objectives
Our primary investment objectives are to:
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• | invest in income-producing real property in a manner that allows us to qualify as a REIT for federal income tax purposes; |
• | provide regular cash distributions to our stockholders; |
• | preserve and protect our stockholders' invested capital; and |
• | achieve appreciation in the value of our properties over the long term from proactive investment management and asset management. |
We cannot assure our stockholders that we will attain these primary investment objectives.
Exchange Listing and Other Liquidity Events
Our board maintains sole discretion to change our current strategy as circumstances change if it believes such a change is in the best interest of our stockholders. Subject to existing market conditions, our board of directors may decide that certain significant transactions such as listing our shares on a national securities exchange, dissolution, merger into another entity, consolidation or the sale or other disposition of all or substantially all of our assets, are in the best interests of our stockholders. If our board of directors determines that a liquidity event is in the best interests of us and our stockholders, we expect that the board will take all relevant factors at that time into consideration when making a liquidity event decision.
Investment Strategy
We seek to acquire a portfolio consisting primarily of single tenant business essential properties throughout the United States diversified by corporate credit, physical geography, product type and lease duration. Although we have no current intention to do so, we may also invest a portion of the net proceeds in single tenant business essential properties outside the United States. We acquire assets consistent with our single tenant acquisition philosophy by focusing primarily on properties:
• | essential to the business operations of the tenant; |
• | located in primary, secondary and certain select tertiary markets; |
• | leased to tenants with stable and/or improving credit quality; and |
• | subject to long-term leases with defined rental rate increases or with short-term leases with high-probability renewal prospects and potential for increasing rent. |
General Acquisition and Investment Policies
We seek to make investments that satisfy the primary investment objective of providing regular cash distributions to our stockholders. However, because a significant factor in the valuation of income-producing real property is its potential for future appreciation, some properties we acquire may have the potential both for growth in value and for providing regular cash distributions to our stockholders.
Our Advisor has substantial discretion with respect to the selection of specific properties. However, each acquisition will be approved by our board of directors. In selecting a potential property for acquisition, we and our Advisor consider a number of factors, including, but not limited to, tenant creditworthiness; essential nature of property to tenant; lease terms; geographic location and property type; proposed purchase price and terms and conditions; historical financial performance; projected net cash flow yield and internal rates of return; and potential for capital appreciation.
There is no limitation on the number, size or type of properties that we may acquire or on the percentage of net offering proceeds that may be invested in any particular property type or single property. The number and mix of properties will depend upon real estate market conditions and other circumstances existing at the time of acquisition.
Description of Leases
We primarily acquire single tenant properties with existing net leases. When spaces in a property become vacant, existing leases expire, or we acquire properties under development or requiring substantial refurbishment or renovation, we anticipate entering into “net” leases. “Net” leases means leases that typically require tenants to pay all or a majority of the
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operating expenses, including real estate taxes, special assessments and sales and use taxes, utilities, insurance, common area maintenance charges, property services and building repairs related to the property, in addition to the lease payments. Under most commercial leases, tenants are obligated to pay a predetermined annual base rent. Some of the leases also will contain provisions that increase the amount of base rent payable at points during the lease term and/or that require the tenant to pay rent based upon a percentage of the tenant’s revenues. Percentage rent can be calculated based upon a number of factors. There are various forms of net leases, typically classified as triple-net or absolute triple-net. Triple-net leases typically require the tenant to pay all costs associated with a property in addition to the base rent and percentage rent, if any. However, often times in triple-net leases certain of the capital expenditure costs are not paid for by the tenants (such as roof and structure costs). Absolute triple-net leases are those that require tenants to pay for all the costs in a triple-net lease as well as all the capital costs associated with a property.
Typically, our tenants have lease terms of five to 15 years at the time of the property acquisition. We may acquire properties under which the lease term has partially expired. We also may acquire properties with shorter lease terms if the property is located in a desirable location, is difficult to replace, or has other significant favorable real estate attributes.
Our Borrowing Strategy and Policies
We may incur our indebtedness in the form of bank borrowings, purchase money obligations to the sellers of properties and publicly-or privately-placed debt instruments or financing from institutional investors or other lenders. We may obtain a credit facility or separate loans for each acquisition. Our indebtedness may be unsecured or may be secured by mortgages or other interests in our properties, and by guarantees or pledges of membership interests. We may use borrowing proceeds to finance acquisitions of new properties, to pay for capital improvements, repairs or buildouts, to refinance existing indebtedness, to pay distributions, to fund redemptions of our shares or to provide working capital.
There is no limitation on the amount we can borrow for the purchase of any property. Our aggregate borrowings, secured and unsecured, must be reasonable in relation to our net assets and must be reviewed by our board of directors at least quarterly. We anticipate that we will utilize approximately between 40% and 50% leverage in connection with our acquisition strategy. However, our charter limits our borrowing to 300% of our net assets (equivalent to 75% of the cost of our assets) unless any excess borrowing is approved by a majority of our independent directors and is disclosed to our stockholders in our next quarterly report, along with the justification for such excess. Except as set forth in our charter regarding debt limits, we may re-evaluate and change our debt strategy and policies in the future without a stockholder vote. As of December 31, 2016, our leverage ratio (which we define as our debt as a percentage of the net book value of our real estate) was 44.2%.
Acquisition Structure
Although we are not limited as to the form our investments may take, our investments in real estate will generally constitute acquiring fee title or interests in joint ventures or similar entities that own and operate real estate.
We will make acquisitions of our real estate investments directly through Griffin Capital Essential Asset Operating Partnership II, L.P., our operating partnership, or indirectly through limited liability companies or limited partnerships, or through investments in joint ventures, partnerships, co-tenancies or other co-ownership arrangements with other owners of properties, affiliates of our Advisor or other persons.
Insurance on Properties
Generally, our leases require each tenant to procure, at its own expense, commercial general liability insurance, as well as property insurance covering the building for the full replacement value and naming the ownership entity and the lender, if applicable, as the additional insured on the policy. As a precautionary measure, we obtain, to the extent available, contingent liability and property insurance and flood insurance, as well as loss of rents insurance that covers one or more years of annual rent in the event of a rental loss. In addition, we maintain a pollution insurance policy for all of our properties to insure against the risk of environmental contaminants; however, the coverage and amounts of our environmental and flood insurance policies may not be sufficient to cover our entire risk.
Tenants are required to provide proof of insurance by furnishing a certificate of insurance to our Advisor on an annual basis. The insurance certificates are tracked and reviewed for compliance by our property manager.
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Competition
As we purchase properties for our portfolio, we are in competition with other potential buyers for the same properties, and may have to pay more to purchase the property than if there were no other potential acquirers or we may have to locate another property that meets our investment criteria. Although we intend to acquire properties subject to existing leases, the leasing of real estate is highly competitive in the current market, and we may experience competition for tenants from owners and managers of competing projects. As a result, we may have to provide free rent, incur charges for tenant improvements, or offer other inducements, or we might not be able to timely lease the space, all of which may have an adverse impact on our results of operations. At the time we elect to dispose of our properties, we will also be in competition with sellers of similar properties to locate suitable purchasers for our properties.
Conditions to Closing Acquisitions
We obtain at least a Phase I environmental assessment and history for each property we acquire. In addition, we generally condition our obligation to close the purchase of any investment on the delivery and verification of certain documents from the seller or other independent professionals, including, but not limited to, where appropriate:
• | property surveys and site audits; |
• | appraisal reports; |
• | lease agreements; |
• | building plans and specifications, if available; |
• | soil reports, seismic studies, flood zone studies, if available; |
• | licenses, permits, maps and governmental approvals; |
• | tenant estoppel certificates; |
• | tenant financial statements and information, as permitted; |
• | historical financial statements and tax statement summaries of the properties; |
• | proof of marketable title, subject to such liens and encumbrances as are acceptable to us; and |
• | liability and title insurance policies. |
Joint Venture Investments
We may acquire properties in joint ventures, some of which may be entered into with affiliates of our Advisor. We may also enter into joint ventures, general partnerships, co-tenancies and other participations, such as Delaware Statutory Trusts (DSTs) with real estate developers, owners and others for the purpose of owning and leasing real properties. Among other reasons, we may want to acquire properties through a joint venture with third parties or affiliates in order to diversify our portfolio of properties in terms of geographic region or property type. Joint ventures may also allow us to acquire an interest in a property without requiring that we fund the entire purchase price. In addition, certain properties may be available to us only through joint ventures. In determining whether to recommend a particular joint venture, our Advisor will evaluate the real property which such joint venture owns or is being formed to own under the same criteria that the Advisor uses to evaluate other real estate investments.
We may enter into joint ventures with affiliates of our Advisor for the acquisition of properties, but only provided that:
• | a majority of our directors, including a majority of our independent directors, not otherwise interested in the transaction, approve the transaction as being fair and reasonable to us; and |
• | the investment by us and such affiliate are on substantially the same terms and conditions. |
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To the extent possible and if approved by our board of directors, including a majority of our independent directors, we will attempt to obtain a right of first refusal or option to buy the property held by the joint venture and allow such venture partners to exchange their interest for our operating partnership’s units or to sell their interest to us in its entirety. In the event that the venture partner were to elect to sell property held in any such joint venture, however, we may not have sufficient funds to exercise our right of first refusal to buy the venture partner’s interest in the property held by the joint venture. Entering into joint ventures with affiliates of our Advisor will result in certain conflicts of interest.
Construction and Development Activities
From time to time, we may construct and develop real estate assets or render services in connection with these activities. We may be able to reduce overall purchase costs by constructing and developing a property versus purchasing a completed property. Developing and constructing properties would, however, expose us to risks such as cost overruns, carrying costs of projects under construction or development, completion guarantees, availability and costs of materials and labor, weather conditions and government regulation. To comply with the applicable requirements under federal income tax law, we intend to limit our construction and development activities to performing oversight and review functions, including reviewing the construction design proposals, negotiating and contracting for feasibility studies and supervising compliance with local, state or federal laws and regulations, negotiating contracts, overseeing construction, and obtaining financing. In addition, we may use taxable REIT subsidiaries or certain independent contractors to carry out these oversight and review functions. We will retain independent contractors to perform the actual construction work.
Government Regulations
Our business is subject to many laws and governmental regulations. Changes in these laws and regulations, or their interpretation by agencies and courts, occur frequently.
We and any operating subsidiaries that we may form may be subject to state and local tax in states and localities in which they or we do business or own property. The tax treatment of us, our operating partnership, any operating subsidiaries we may form and the holders of our shares in local jurisdictions may differ from our federal income tax treatment.
Americans with Disabilities Act
Under the Americans with Disabilities Act of 1990, or ADA, all public accommodations and commercial facilities are required to meet certain federal requirements related to access and use by disabled persons. These requirements became effective in 1992. Complying with the ADA requirements could require us to remove access barriers. Failing to comply could result in the imposition of fines by the federal government or an award of damages to private litigants. Although we acquire properties that substantially comply with these requirements, we may incur additional costs to comply with the ADA. In addition, a number of additional federal, state and local laws may require us to modify any properties we purchase, or may restrict further renovations thereof, with respect to access by disabled persons. Additional legislation could impose financial obligations or restrictions with respect to access by disabled persons. Although we believe that these costs will not have a material adverse effect on us, if required changes involve a greater amount of expenditures than we currently anticipate, our ability to make expected distributions could be adversely affected.
Environmental Matters
Under various federal, state and local laws, ordinances and regulations, a current or previous owner or operator of real property may be held liable for the costs of removing or remediating hazardous or toxic substances. These laws often impose clean-up responsibility and liability without regard to whether the owner or operator was responsible for, or even knew of, the presence of the hazardous or toxic substances. The costs of investigating, removing or remediating these substances may be substantial, and the presence of these substances may adversely affect our ability to rent properties or sell the property or to borrow using the property as collateral and may expose us to liability resulting from any release of or exposure to these substances. If we arrange for the disposal or treatment of hazardous or toxic substances at another location, we may be liable for the costs of removing or remediating these substances at the disposal or treatment facility, whether or not the facility is owned or operated by us. We may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site that we own or operate. Certain environmental laws also impose liability in connection with the handling of or exposure to asbestos-containing materials, pursuant to which third parties may seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials and other hazardous or toxic substances. We maintain a pollution insurance policy for all of our properties to insure against the potential liability of remediation and exposure risk.
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Other Regulations
The properties we acquire likely will be subject to various federal, state and local regulatory requirements, such as zoning and state and local fire and life safety requirements. Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. We acquire properties that are in material compliance with all such regulatory requirements. However, we cannot assure you that these requirements will not be changed or that new requirements will not be imposed which would require significant unanticipated expenditures by us and could have an adverse effect on our financial condition and results of operations.
Disposition Policies
We generally intend to hold each property we acquire for an extended period. However, we may sell a property at any time if, in our judgment, the sale of the property is in the best interests of our stockholders. The determination of whether a particular property should be sold or otherwise disposed of will generally be made after consideration of relevant factors, including prevailing economic conditions, other investment opportunities and considerations specific to the condition, value and financial performance of the property.
Investment Limitations in Our Charter
Our charter places numerous limitations on us with respect to the manner in which we may invest our funds, most of which are those typically required by various provisions of the Statement of Policy Regarding Real Estate Investment Trusts published by the North American Securities Administrators Association ("NASAA REIT Guidelines").
Changes in Investment Policies and Limitations
Our charter requires that our independent directors review our investment policies at least annually to determine that the policies we are following are in the best interests of our stockholders. Each determination and the basis therefor is required to be set forth in the applicable meeting minutes. The methods of implementing our investment policies may also vary as new investment techniques are developed. The methods of implementing our investment objectives and policies, except as otherwise provided in our charter, may be altered by a majority of our directors, including a majority of our independent directors, without the approval of our stockholders. The determination by our board of directors that it is no longer in our best interests to continue to be qualified as a REIT shall require the concurrence of two-thirds of the board of directors. Investment policies and limitations specifically set forth in our charter, however, may only be amended by a vote of the stockholders holding a majority of our outstanding shares.
Investments in Mortgages
While we intend to emphasize equity real estate investments and, hence, operate as what is generally referred to as an “equity REIT,” as opposed to a “mortgage REIT,” we may invest in first or second mortgage loans, mezzanine loans secured by an interest in the entity owning the real estate or other similar real estate loans consistent with our REIT status so long as our charter allows. We may make such loans to developers in connection with construction and redevelopment of real estate properties. Such mortgages may or may not be insured or guaranteed by the Federal Housing Administration, the Veterans Benefits Administration or another third party. We may also invest in participating or convertible mortgages if our directors conclude that we and our stockholders may benefit from the cash flow or any appreciation in the value of the subject property. Such mortgages are similar to equity participation.
Affiliate Transaction Policy
Our board of directors has established a nominating and corporate governance committee, which reviews and approves all matters the board believes may involve a conflict of interest. This committee is composed solely of independent directors. This committee of our board of directors approves all transactions between us and our Advisor and its affiliates. We will not acquire any properties in which our sponsor, or its affiliates, owns an economic interest.
Investment Company Act and Certain Other Policies
We intend to operate in such a manner that we will not be subject to regulation under the Investment Company Act of 1940 (the "1940 Act"). Our Advisor will continually review our investment activity to attempt to ensure that we do not come within the application of the 1940 Act. Among other things, our Advisor will attempt to monitor the proportion of our portfolio that is placed in various investments so that we do not come within the definition of an “investment company” under the 1940
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Act. If at any time the character of our investments could cause us to be deemed as an investment company for purposes of the 1940 Act, we will take all necessary actions to attempt to ensure that we are not deemed to be an “investment company.” In addition, we do not intend to underwrite securities of other issuers or actively trade in loans or other investments.
Subject to the restrictions we must follow in order to qualify to be taxed as a REIT, we may make investments other than as previously described in this report, although we do not currently intend to do so. We have authority to purchase or otherwise reacquire our shares of common stock or any of our other securities. We have no present intention of repurchasing any of our shares of common stock except pursuant to our share redemption program, and we would only take such action in conformity with applicable federal and state laws and the requirements for qualifying as a REIT under the Internal Revenue Code of 1986, as amended (the "Code").
Employees
We have no employees. The employees of our Advisor and its affliliates provide management, acquisition, advisory and certain administrative services for us.
Industry Segments
We internally evaluate all of our properties and interests therein as one reportable segment.
ITEM 1A. RISK FACTORS
Below are risks and uncertainties that could adversely affect our operations that we believe are material to stockholders. Other risks and uncertainties may exist that we do not consider material based on the information currently available to us at this time.
Risks Related to an Investment in Griffin Capital Essential Asset REIT II, Inc.
We have a limited operating history and limited established financing sources.
We have a limited operating history, and stockholders should not rely upon the past performance of other real estate investment programs sponsored by our sponsor to predict our future results. We were incorporated in November 2013. As of December 31, 2016, we owned 33 buildings located on 25 properties in 15 states.
Stockholders should consider our prospects in light of the risks, uncertainties and difficulties frequently encountered by companies that are, like us, in their early stage of development. To be successful in this market, we must, among other things:
•identify and acquire investments that further our investment objectives;
•increase awareness of the "Griffin Capital Essential Asset REIT II, Inc." name within the investment products market;
•expand and maintain our network of participating broker-dealers;
•attract, integrate, motivate and retain qualified personnel to manage our day-to-day operations;
• | respond to competition for our targeted real estate properties and other investments as well as for potential investors; and |
•continue to build and expand our operational structure to support our business.
We cannot guarantee that we will succeed in achieving these goals, and our failure to do so could cause our stockholders to lose all or a portion of their investments.
There is currently no public trading market for our shares and there may never be one; therefore, it will be difficult for stockholders to sell their shares.
There is currently no public market for our shares and there may never be one. Stockholders may not sell their shares unless the buyer meets applicable suitability and minimum purchase standards. Our charter also prohibits the ownership by any one individual of more than 9.8% of our stock, unless waived by our board of directors, which may inhibit large investors from desiring to purchase a stockholder's shares. Moreover, our share redemption program includes numerous restrictions that would limit a stockholder's ability to sell their shares to us. Our board of directors could choose to amend, suspend or terminate our share redemption program upon 30 days' notice. Therefore, it may be difficult for stockholders to sell their shares promptly or at all. If stockholders are able to sell their shares, they will likely have to sell them at a substantial discount to the price they paid for the shares. It also is likely that a stockholder's shares would not be accepted as the primary collateral for a loan. Stockholders should purchase the shares only as a long-term investment because of the illiquid nature of the shares.
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Stockholders may be unable to sell their shares because their ability to have their shares redeemed pursuant to our share redemption program is subject to significant restrictions and limitations and if stockholders are able to sell their shares under the program, they may not be able to recover the amount of their investment in our shares.
Even though our share redemption program may provide stockholders with a limited opportunity to sell their shares to us after they have held them for a period of one year, stockholders should be fully aware that our share redemption program contains significant restrictions and limitations. Further, our board may limit, suspend, terminate or amend any provision of the share redemption program upon 30 days' notice. Redemption of shares, when requested, will generally be made on the last business day of the calendar month following the end of the calendar quarter. During any calendar year, we will not redeem in excess of 5% of the weighted average number of shares outstanding during the prior calendar year and redemptions will be funded solely from proceeds from our distribution reinvestment plan. Therefore, in making a decision to purchase our shares, stockholders should not assume that they will be able to sell any of their shares back to us pursuant to our share redemption program at any particular time or at all.
The actual value of shares that we redeem under our share redemption program may be substantially less than what we pay.
Under our share redemption program, shares may be repurchased at a redemption price based on the current estimated net asset value, or NAV, applicable to the class of shares being redeemed. However, if the redemptions are sought upon a stockholder's death or qualifying disability, shares will be redeemed at a price equal to the price paid to acquire such shares from us. The estimated NAV per share and the price paid to acquire shares from us may not accurately represent the current value of our assets per share of our common stock at any particular time and may be higher or lower than the actual value of our assets per share at such time. Accordingly, we may redeem shares at prices that are higher than the actual value of our shares, which would be dilutive to our remaining stockholders.
A portion of the funds raised in our DRP offering is expected to be used to redeem shares, which will reduce the net proceeds available to acquire additional properties.
We currently expect to use a portion of the proceeds from the DRP to redeem shares under our share redemption program. If the demand for redemptions is significant, such portion of the proceeds used to redeem the shares may be substantial. As a result, we may have fewer proceeds available to retire debt or acquire additional properties, which may result in reduced liquidity and profitability or restrict our ability to grow our NAV.
In determining our NAV per share, we relied upon a valuation of our properties as of December 31, 2016. Valuations and appraisals of our properties, real estate-related assets and real estate-related liabilities are estimates of value and may not necessarily correspond to realizable value.
For the purposes of calculating our NAV per share, an independent third-party appraiser valued our properties as of December 31, 2016. The valuation methodologies used to value our properties and certain real estate-related assets involve subjective judgments regarding such factors as comparable sales, rental revenue and operating expense data, the capitalization or discount rate, and projections of future rent and expenses based on appropriate analysis. In addition, we generally do not undertake to mark to market our real estate-related liabilities, but rather these liabilities are usually included in our determination of NAV at an amount determined in accordance with generally accepted accounting principles ("GAAP"). As a result, valuations and appraisals of our properties, real estate-related assets and real estate-related liabilities are only estimates of current market value. Ultimate realization of the value of an asset or liability depends to a great extent on economic and other conditions beyond our control and the control of our Advisor, the independent appraiser, and other parties involved in the valuation of our assets and liabilities. Further, these valuations may not necessarily represent the price at which an asset or liability would sell, because market prices of assets and liabilities can only be determined by negotiation between a willing buyer and seller. Valuations used for determining our NAV also are generally made without consideration of the expenses that would be incurred in connection with disposing of assets and liabilities. Therefore, the valuations of our properties, our investments in real estate-related assets and our liabilities may not correspond to the timely realizable value upon a sale of those assets and liabilities. Our NAV does not reflect fees that may become payable after the date of determination, which fees may not ultimately be paid in certain circumstances, including if we are liquidated or if there is a listing of our common stock. Our NAV does not currently represent enterprise value and may not accurately reflect the actual prices at which our assets could be liquidated on any given day, the value a third party would pay for all or substantially all of our shares, or the price that our shares would trade at on a national securities exchange.
Our NAV is not subject to GAAP, will not be independently audited and will involve subjective judgments by the independent appraiser and other parties involved in valuing our assets and liabilities.
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Our valuation procedures and our NAV are not subject to GAAP and will not be subject to independent audit. Our NAV may differ from equity (net assets) reflected on our audited financial statements, even if we are required to adopt a fair value basis of accounting for GAAP financial statement purposes. In addition, the implementation and coordination of our valuation procedures include certain subjective judgments of our Advisor, as well as of the independent appraiser and other parties we engage, as to whether adjustments to asset and liability valuations are appropriate. Accordingly, you must rely entirely on our board of directors to adopt appropriate valuation procedures and on the independent appraiser and other parties we engage in order to arrive at our NAV, which may not correspond to realizable value upon a sale of our assets.
We have paid, and may continue to pay distributions from sources other than cash flow from operations; therefore, we will have fewer funds available for the acquisition of properties, and our stockholders' overall return may be reduced.
In the event we do not have enough cash from operations to fund our distributions, we may borrow, issue additional securities, or sell assets in order to fund the distributions or make the distributions out of net proceeds from our public offering. We are not prohibited from undertaking such activities by our charter, bylaws, or investment policies, and we may use an unlimited amount from any source to pay our distributions. From inception and through December 31, 2016, we funded 17% of our distributions using offering proceeds and 83% of our distributions using cash flows from operations as shown on the statement of cash flows. If we continue to pay distributions from sources other than cash flow from operations, we will have fewer funds available for acquiring properties, which may reduce our stockholders' overall returns. Additionally, to the extent distributions exceed cash flow from operations, a stockholder's basis in our stock may be reduced and, to the extent distributions exceed a stockholder's basis, the stockholder may recognize a capital gain.
We may be unable to pay or maintain cash distributions or increase distributions over time.
There are many factors that can affect the availability and timing of cash distributions to stockholders. Distributions will be based principally on distribution expectations of our potential investors and cash available from our operations. The amount of cash available for distribution will be affected by many factors, such as our ability to buy properties as offering proceeds become available and our operating expense levels, as well as many other variables. Actual cash available for distribution may vary substantially from estimates. We cannot assure our stockholders that we will be able to pay or maintain distributions or that distributions will increase over time, nor can we give any assurance that rents from the properties will increase, or that future acquisitions of real properties will increase our cash available for distribution to stockholders. Our actual results may differ significantly from the assumptions used by our board of directors in establishing the distribution rate to stockholders.
If we, through our Advisor, are unable to find suitable investments, then we may not be able to achieve our investment objectives or continue to pay distributions.
Our ability to achieve our investment objectives and continue to pay distributions is dependent upon the performance of our Advisor in selecting our investments and arranging financing. As of December 31, 2016, we owned 33 buildings located on 25 properties in 15 states. We cannot be sure that our Advisor will be successful in obtaining suitable investments on financially attractive terms or that, if it makes investments on our behalf, our objectives will be achieved. If we are unable to find suitable investments, we will hold the proceeds of our public offering in an interest-bearing account or invest the proceeds in short-term, investment-grade investments. In such an event, our ability to continue to pay distributions at our current level to our stockholders would be adversely affected.
We may suffer from delays in locating suitable investments, which could adversely affect our ability to make distributions at our current level and the value of a stockholder's investment.
We could suffer from delays in locating suitable investments, particularly as a result of our reliance on our Advisor at times when management of our Advisor is simultaneously seeking to locate suitable investments for other affiliated programs, including Griffin Capital Essential Asset REIT, Inc. ("GCEAR"). Delays we encounter in the selection, acquisition and development of income-producing properties likely would adversely affect our ability to make distributions at our current level and the value of a stockholder's investment. In particular, if we acquire properties prior to the start of construction or during the early stages of construction, it will typically take several months to complete construction and rent available space. Therefore, stockholders could suffer delays in the receipt of cash distributions attributable to those particular properties. In such event, we may pay all or a substantial portion of our distributions from the proceeds of our public offering or from borrowings in anticipation of future cash flow, which may constitute a return of a stockholder's capital. We are not prohibited from undertaking such activities by our charter, bylaws or investment policies, and there are no current limits on the amount of distributions to be paid from such funds. Distributions from the proceeds of our public offering or from borrowings also could reduce the amount of capital we ultimately invest in properties. This, in turn, would reduce the value of a stockholder's investment. In particular, if we acquire properties prior to the start of construction or during the early stages of construction, it will typically take several months to complete construction and rent available space. Therefore, stockholders could suffer delays in the receipt of cash distributions attributable to those particular properties.
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If our Advisor loses or is unable to obtain key personnel, our ability to implement our investment objectives could be delayed or hindered, which could adversely affect our ability to make distributions at our current level and the value of a stockholder's investment.
Our success depends to a significant degree upon the contributions of certain of our executive officers and other key personnel of our Advisor and sponsor, including Kevin A. Shields, Michael J. Escalante, Javier F. Bitar, Joseph E. Miller, David C. Rupert, Randy I. Anderson, Mary P. Higgins, and Howard S. Hirsch, each of whom would be difficult to replace. Our Advisor does not have an employment agreement with any of these key personnel and we cannot guarantee that all, or any particular one, will remain affiliated with us and/or our Advisor. If any of our key personnel were to cease their affiliation with our Advisor, our operating results could suffer. Further, although our sponsor has obtained key person life insurance on some of these individuals, we do not intend to separately maintain key person life insurance on any of these individuals. We believe that our future success depends, in large part, upon our Advisor's ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition for such personnel is intense, and we cannot assure stockholders that our Advisor will be successful in attracting and retaining such skilled personnel. If our Advisor loses or is unable to obtain the services of key personnel or does not establish or maintain appropriate strategic relationships, our ability to implement our investment strategies could be delayed or hindered, and the value of a stockholder's investment may decline.
Our ability to operate profitably will depend upon the ability of our Advisor to efficiently manage our day-to-day operations.
We will rely on our Advisor to manage our business and assets. Our Advisor will make all decisions with respect to our day-to-day operations. Thus, the success of our business will depend in large part on the ability of our Advisor to manage our operations. Any adversity experienced by our Advisor or problems in our relationship with our Advisor could adversely impact the operation of our properties and, consequently, our cash flow and ability to make distributions at our current level to our stockholders.
We are an “emerging growth company” under the federal securities laws and are subject to reduced public company reporting requirements.
In April 2012, President Obama signed into law the Jumpstart Our Business Startups Act, or the JOBS Act. We are an "emerging growth company," as defined in the JOBS Act, and are eligible to take advantage of certain exemptions from, or reduced disclosure obligations relating to, various reporting requirements that are normally applicable to public companies.
We may retain our status as an "emerging growth company" for a maximum of five years, or until the earliest of (1) the last day of the first fiscal year in which we have total annual gross revenue of $1 billion or more, (2) December 31 of the fiscal year that we become a "large accelerated filer" as defined in Rule 12b-2 under the Exchange Act (which would occur if the market value of our common stock held by non-affiliates exceeds $700 million, measured as of the last business day of our most recently completed second fiscal quarter, and we have been publicly reporting for at least 12 months) or (3) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period. Under the JOBS Act, emerging growth companies are not required to (1) provide an auditor's attestation report on management's assessment of the effectiveness of internal control over financial reporting, pursuant to Section 404 of the Sarbanes-Oxley Act, (2) comply with new audit rules adopted by the PCAOB after April 5, 2012 (unless the SEC determines otherwise), (3) provide certain disclosures relating to executive compensation generally required for larger public companies or (4) hold shareholder advisory votes on executive compensation. If we take advantage of any of these exemptions, we do not know if some investors will find our common stock less attractive as a result.
Additionally, the JOBS Act provides that an "emerging growth company" may take advantage of an extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies. This means an "emerging growth company" can delay adopting certain accounting standards until such standards are otherwise applicable to private companies. However, we are electing to "opt out" of such extended transition period, and will therefore comply with new or revised accounting standards on the applicable dates on which the adoption of such standards are required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of such extended transition period for compliance with new or revised accounting standards is irrevocable.
Increases in interest rates may adversely affect the demand for our shares.
One of the factors that influences the demand for purchase of our shares is the annual rate of distributions that we pay on our shares, as compared with interest rates. An increase in interest rates may lead potential purchasers of our shares to demand higher annual distribution rates, which could adversely affect our ability to sell our shares and raise proceeds in our offering, which could result in higher leverage or a less diversified portfolio of real estate.
We rely upon our Advisor and our sponsor to carry out our operations, and some of our sponsor's prior private real estate programs have suffered material adverse business developments.
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In recent years, some of our sponsor's private real estate programs have experienced adverse business developments due to tenant vacancy or bankruptcy, as well as lender foreclosure and litigation involving our sponsor. These adverse developments have resulted in losses or potential losses for investors. We cannot guarantee that we will achieve our investment objectives.
Cybersecurity risks and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information, and/or damage to our business relationships, all of which could negatively impact our financial results.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations, misstated or unreliable financial data, financial loss, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our tenant and investor relationships. As our reliance on technology increases, so will the risks posed to our information systems, both internal and those we outsource. There is no guarantee that any processes, procedures and internal controls we have implemented or will implement will prevent cyber intrusions, which could have a negative impact on our financial results, operations, business relationships or confidential information.
Risks Related to Conflicts of Interest
Our sponsor, Advisor, property manager and their officers and certain of their key personnel will face competing demands relating to their time, which may cause our operating results to suffer.
Our sponsor, Advisor, property manager and their officers and certain of their key personnel and their respective affiliates serve as key personnel, advisors, managers, sponsors, and co-sponsors to some or all of 14 other programs and partnerships affiliated with our sponsor, including GCEAR, Griffin-American Healthcare REIT III, Inc. ("GAHR III"), and Griffin-American Healthcare REIT IV, Inc. ("GAHR IV"), each of which are publicly-registered, non-traded real estate investment trusts, Griffin-Benefit Street Partners BDC Corp. ("GB-BDC"), a non-diversified, closed-end management investment company that has elected to be regulated as a business development company under the 1940 Act, and Griffin Institutional Access Real Estate Fund (“GIA Real Estate Fund”) and Griffin Institutional Access Credit Fund ("GIA Credit Fund"), both of which are non-diversified, closed-end management investment companies that are operated as interval funds under the 1940 Act. Because these persons have competing demands on their time and resources, they may have conflicts of interest in allocating their time between our business and these other activities. During times of intense activity in other programs and ventures, they may devote less time and fewer resources to our business than is necessary or appropriate. If this occurs, the returns on a stockholder's investment may suffer.
In addition, our dealer manager has entered into a dealer manager agreement to serve as dealer manager for GAHR IV and a private REIT offering, and serves as the exclusive wholesale marketing agent for GIA Real Estate Fund and GIA Credit Fund, and may potentially enter into dealer manager agreements to serve as dealer manager for other issuers affiliated with our sponsor. As a result, our dealer manager will have contractual duties to these issuers, which contractual duties may conflict with the duties owed to us. The duties owed to these issuers could result in actions or inactions that are detrimental to our business, which could harm the implementation of our investment objectives. Conflicts with our business and interests are most likely to arise from involvement in activities related to allocation of management time and services between us and these issuers. If our dealer manager is unable to devote sufficient time and effort to the distribution of shares of our common stock, we may not be able to raise significant additional proceeds for investment in real estate. Accordingly, competing demands of our dealer manager's personnel may cause us to be unable to successfully implement our investment objectives, or generate cash needed to make distributions to stockholders, and to maintain or increase the value of our assets.
Our officers and two of our directors face conflicts of interest related to the positions they hold with affiliated entities, which could hinder our ability to successfully implement our investment objectives and to generate returns to our stockholders.
Our executive officers and two of our directors are also officers of our sponsor, our Advisor, our property manager, our dealer manager and other affiliated entities, including GCEAR. As a result, these individuals owe fiduciary duties to these other entities and their owners, which fiduciary duties may conflict with the duties that they owe to our stockholders and us. Their loyalties to these other entities could result in actions or inactions that are detrimental to our business, which could harm the implementation of our investment objectives. Conflicts with our business and interests are most likely to arise from involvement in activities related to (1) allocation of new investments and management time and services between us and the other entities, (2) our purchase of properties from, or sale of properties to, affiliated entities, (3) the timing and terms of the investment in or sale of an asset, (4) development of our properties by affiliates, (5) investments with affiliates of our Advisor, (6) compensation to our Advisor, and (7) our relationship with our dealer manager and property manager. If we do not
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successfully implement our investment objectives, we may be unable to generate cash needed to make distributions to our stockholders and to maintain or increase the value of our assets.
Our Advisor will face conflicts of interest relating to the purchase of properties, including conflicts with GCEAR, and such conflicts may not be resolved in our favor, which could adversely affect our investment opportunities.
We may be buying properties at the same time as one or more of the other programs managed by officers and key personnel of our Advisor, including GCEAR, a public non-traded REIT with a real estate portfolio in excess of $3.0 billion as of December 31, 2016. In addition, GCEAR may have access to significantly greater capital than us. Our sponsor, Advisor and their affiliates are actively involved in 10 other affiliated real estate programs, including four tenant-in-common programs that may compete with us or otherwise have similar business interests, and including GCEAR, GAHR III, GAHR IV, and two private programs. Our Advisor and our property manager will have conflicts of interest in allocating potential properties, acquisition expenses, management time, services and other functions between various existing enterprises or future enterprises with which they may be or become involved. There is a risk that our Advisor will choose a property that provides lower returns to us than a property purchased by another program sponsored by our sponsor. We cannot be sure that officers and key personnel acting on behalf of our Advisor and on behalf of these other programs will act in our best interests when deciding whether to allocate any particular property to us. Such conflicts that are not resolved in our favor could result in a reduced level of distributions we may be able to pay to stockholders and a reduction in the value of our stockholders' investments. If our Advisor or its affiliates breach their legal or other obligations or duties to us, or do not resolve conflicts of interest in the manner described in our prospectus, we may not meet our investment objectives, which could reduce our expected cash available for distribution to stockholders and the value of our stockholders' investments.
Our Advisor will face conflicts of interest relating to the incentive fee structure under our operating partnership agreement, which could result in actions that are not necessarily in the long-term best interests of our stockholders.
Pursuant to our operating partnership agreement, our Advisor and its affiliates will be entitled to distributions that are structured in a manner intended to provide incentives to our Advisor to perform in our best interests and in the best interests of our stockholders. The amount of such compensation has not been determined as a result of arm's-length negotiations, and such amounts may be greater than otherwise would be payable to independent third parties. However, because our Advisor does not maintain a significant equity interest in us and is entitled to receive substantial minimum compensation regardless of performance, our Advisor's interests will not be wholly aligned with those of our stockholders. In that regard, our Advisor could be motivated to recommend riskier or more speculative investments in order for us to generate the specified levels of performance or sales proceeds that would entitle our Advisor to distributions. In addition, our Advisor's entitlement to distributions upon the sale of our assets and to participate in sale proceeds could result in our Advisor recommending sales of our investments at the earliest possible time at which sales of investments would produce the level of return that would entitle our Advisor to compensation relating to such sales, even if continued ownership of those investments might be in our best long-term interest.
Our operating partnership agreement will require us to pay a performance-based termination distribution to our Advisor in the event that we terminate our Advisor prior to the listing of our shares for trading on an exchange or, absent such listing, in respect of its participation in net sale proceeds. The subordinated distribution will provide a 15% subordinated return to the Advisor only in the event that stockholders receive a return of their invested capital plus a 6% cumulative, non-compounded annual return from inception through the termination date. To avoid paying this distribution, our board of directors may decide against terminating the advisory agreement prior to any listing of our shares or disposition of our investments even if, but for the termination distribution, termination of the advisory agreement would be in our best interest. In addition, the requirement to pay the distribution to our Advisor at termination could cause us to make different investment or disposition decisions than we would otherwise make in order to satisfy our obligation to pay the distribution to the terminated Advisor.
Our Advisor will face conflicts of interest relating to joint ventures that we may form with affiliates of our Advisor, which conflicts could result in a disproportionate benefit to other joint venture partners at our expense.
We may enter into joint ventures with other programs sponsored by our sponsor, including other REITs, for the acquisition, development or improvement of properties. Our Advisor may have conflicts of interest in determining which program sponsored by our sponsor should enter into any particular joint venture agreement. The co-venturer may have economic or business interests or goals that are or may become inconsistent with our business interests or goals. In addition, our Advisor may face a conflict in structuring the terms of the relationship between our interests and the interest of the affiliated co-venturer and in managing the joint venture. Since our Advisor and its affiliates will control both the affiliated co-venturer and, to a certain extent, us, agreements and transactions between the co-venturers with respect to any such joint venture will not have the benefit of arm's-length negotiation of the type normally conducted between unrelated co-venturers, which may result in the coventurer receiving benefits greater than the benefits that we receive. In addition, we may assume liabilities related to the joint venture that exceed the percentage of our investment in the joint venture, and this could reduce the returns on our stockholders' investments.
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There is no separate counsel for us and our affiliates, which could result in conflicts of interest.
Nelson Mullins Riley & Scarborough LLP ("Nelson Mullins") acts as legal counsel to us and also represents our sponsor, Advisor, our dealer manager and some of their affiliates. There is a possibility in the future that the interests of the various parties may become adverse and, under the code of professional responsibility of the legal profession, Nelson Mullins may be precluded from representing any one or all of such parties. If any situation arises in which our interests appear to be in conflict with those of our Advisor or its affiliates, additional counsel may be retained by one or more of the parties to assure that their interests are adequately protected. Moreover, should a conflict of interest not be readily apparent, Nelson Mullins may inadvertently act in derogation of the interest of the parties which could affect our ability to meet our investment objectives.
Our Chief Executive Officer and Chairman of our Board of Directors is a controlling person of an entity that has purchased, and may continue to purchase, common stock of the Company and preferred units of limited partnership interest in our operating partnership, and therefore may face conflicts with regard to his fiduciary duties to us and that entity related to that entity making investments in or redeeming our common stock or the preferred units.
Our Chief Executive Officer is a controlling person of an entity that has purchased shares of our common stock. Our Chief Executive Officer owes fiduciary duties to that entity and its security holders that may conflict with the fiduciary duties he owes to us and our stockholders. Our Chief Executive Officer may also make decisions on behalf of that entity related to investments in and redemptions of our common stock, which may result in that entity making an investment in or disposition of our common stock which may be to the detriment of our stockholders.
Further, because such entity holds investments in other entities sponsored by our sponsor, the interests of such entity and its security holders may not be aligned with our interests or those of our stockholders.
In addition, our ability to redeem shares pursuant to our share redemption program is subject to certain limitations, including a limitation on the number of shares we may redeem during each quarter. If that entity should elect to redeem shares in a given quarter, or if any single stockholder who owns a significant number of shares of our common stock elects to redeem shares in a given quarter, the limitations on redemption contained in our share redemption program may be met or exceeded.
Risks Related to Our Corporate Structure
The limit on the number of shares a person may own may discourage a takeover that could otherwise result in a premium price to our stockholders.
In order for us to continue to qualify as a REIT, no more than 50% of our outstanding stock may be beneficially owned, directly or indirectly, by five or fewer individuals (including certain types of entities) at any time during the last half of each taxable year. To ensure that we do not fail to qualify as a REIT under this test, our charter restricts ownership by one person or entity to no more than 9.8% in value or number, whichever is more restrictive, of any class of our outstanding stock. This restriction may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our common stock.
Our charter permits our board of directors to issue stock with terms that may subordinate the rights of common stockholders or discourage a third party from acquiring us in a manner that might result in a premium price to our stockholders.
Our charter permits our board of directors to issue up to 900,000,000 shares of capital stock. In addition, our board of directors, without any action by our stockholders, may amend our charter from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series of stock that we have authority to issue. Our board of directors may classify or reclassify any unissued common stock or preferred stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of redemption of any such stock. Thus, our board of directors could authorize the issuance of preferred stock with terms and conditions that could have a priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock. Preferred stock could also have the effect of delaying, deferring or preventing a change in control of our company, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our common stock.
We are not afforded the protection of Maryland law relating to business combinations.
Under Maryland law, "business combinations" between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as:
•any person who beneficially owns 10% or more of the voting power of the corporation's shares; or
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• | an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding voting stock of the corporation. |
These prohibitions are intended to prevent a change of control by interested stockholders who do not have the support of our board of directors. Since our charter contains limitations on ownership of 9.8% or more of our common stock, we opted out of the business combinations statute in our charter. Therefore, we will not be afforded the protections of this statute and, accordingly, there is no guarantee that the ownership limitations in our charter would provide the same measure of protection as the business combinations statute and prevent an undesired change of control by an interested stockholder.
Our stockholders' investment return may be reduced if we are required to register as an investment company under the Investment Company Act of 1940. If we lose our exemption from registration under the 1940 Act, we will not be able to continue our business.
We do not intend to register as an investment company under the Investment Company Act of 1940 ("1940 Act"). As of December 31, 2016, we owned 33 buildings located on 25 properties, and our intended investments in real estate will represent the substantial majority of our total asset mix, which would not subject us to the 1940 Act. In order to maintain an exemption from regulation under the 1940 Act, we must engage primarily in the business of buying real estate, and these investments must be made within a year after our public offering ends. If we are unable to invest a significant portion of the proceeds of our public offering in properties within one year of the termination of the offering, we may avoid being required to register as an investment company by temporarily investing any unused proceeds in government securities with low returns, which would reduce the cash available for distribution to investors and possibly lower our stockholders' returns.
To maintain compliance with our 1940 Act exemption, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may be required to acquire additional income- or loss-generating assets that we might not otherwise acquire or forego opportunities to acquire interests in companies that we would otherwise want to acquire. If we are required to register as an investment company but fail to do so, we would be prohibited from engaging in our business, and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business.
Our stockholders are bound by the majority vote on matters on which our stockholders are entitled to vote and, therefore, a stockholder's vote on a particular matter may be superseded by the vote of other stockholders.
Our stockholders may vote on certain matters at any annual or special meeting of stockholders, including the election of directors. However, our stockholders will be bound by the majority vote on matters requiring approval of a majority of the stockholders even if they do not vote with the majority on any such matter.
If stockholders do not agree with the decisions of our board of directors, they only have limited control over changes in our policies and operations and may not be able to change such policies and operations, except as provided for in our charter and under applicable law.
Our board of directors determines our major policies, including our policies regarding investments, operations, capitalization, financing, growth, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of our stockholders. Under the Maryland General Corporation Law and our charter, our stockholders have a right to vote only on the following:
•the election or removal of directors;
• | any amendment of our charter, except that our board of directors may amend our charter without stockholder approval to increase or decrease the aggregate number of our shares, to increase or decrease the number of our shares of any class or series that we have the authority to issue, or to classify or reclassify any unissued shares by setting or changing the preferences, conversion or other rights, restrictions, limitations as to distributions, qualifications or terms and conditions of redemption of such shares, provided however, that any such amendment does not adversely affect the rights, preferences and privileges of the stockholders; |
•our liquidation or dissolution; and
•any merger, consolidation or sale or other disposition of substantially all of our assets.
All other matters are subject to the discretion of our board of directors. Therefore, our stockholders are limited in their ability to change our policies and operations.
Our rights and the rights of our stockholders to recover claims against our officers, directors and our Advisor are limited, which could reduce our stockholders' and our recovery against them if they cause us to incur losses.
Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in the corporation's best interests and with the care that an ordinarily prudent
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person in a like position would use under similar circumstances. Our charter, in the case of our directors, officers, employees and agents, and the advisory agreement, in the case of our Advisor, requires us to indemnify our directors, officers, employees and agents and our Advisor and its affiliates for actions taken by them in good faith and without negligence or misconduct. Additionally, our charter limits the liability of our directors and officers for monetary damages to the maximum extent permitted under Maryland law. As a result, we and our stockholders may have more limited rights against our directors, officers, employees and agents, and our Advisor and its affiliates, than might otherwise exist under common law, which could reduce our stockholders' and our recovery against them. In addition, we may be obligated to fund the defense costs incurred by our directors, officers, employees and agents or our Advisor in some cases which would decrease the cash otherwise available for distribution to stockholders.
Our board of directors may change any of our investment objectives, including our focus on single tenant business essential properties.
Our board of directors may change any of our investment objectives, including our focus on single tenant business essential properties. If stockholders do not agree with a decision of our board to change any of our investment objectives, they only have limited control over such changes. Additionally, we cannot assure stockholders that we would be successful in attaining any of these investment objectives, which may adversely impact our financial performance and ability to make distributions at our current level to stockholders.
Our stockholders' interests in us will be diluted as we issue additional shares.
Our stockholders will not have preemptive rights to any shares issued by us in the future. Subject to any limitations set forth under Maryland law, our board of directors may increase the number of authorized shares of stock (currently 900,000,000 shares), increase or decrease the number of shares of any class or series of stock designated, or reclassify any unissued shares without the necessity of obtaining stockholder approval. All of such shares may be issued in the discretion of our board of directors. Therefore, as we (1) sell additional shares in the future, including those issued pursuant to our distribution reinvestment plan, (2) sell securities that are convertible into shares of our common stock, (3) issue shares of our common stock in a private offering of securities to institutional investors, (4) issue shares of restricted common stock or stock options to our independent directors, (5) issue shares to our Advisor, its successors or assigns, in payment of an outstanding fee obligation as set forth under our advisory agreement, or (6) issue shares of our common stock to sellers of properties acquired by us in connection with an exchange of limited partnership interests of our operating partnership, existing stockholders and investors purchasing shares in our public offering will experience dilution of their equity investment in us. Because the limited partnership interests of our operating partnership may, in the discretion of our board of directors, be exchanged for shares of our common stock, any merger, exchange or conversion between our operating partnership and another entity ultimately could result in the issuance of a substantial number of shares of our common stock, thereby diluting the percentage ownership interest of other stockholders. Because of these and other reasons described in this "Risk Factors" section, stockholders should not expect to be able to own a significant percentage of our shares.
Payment of substantial fees and expenses to our Advisor and its affiliates will reduce cash available for investment and distribution.
Our Advisor and its affiliates will perform services for us in connection with the offer and sale of our shares, the selection and acquisition of our investments, and the management of our properties. They will be paid substantial fees and expense reimbursements for these services, which will reduce the amount of cash available for investment in properties or distribution to stockholders.
We are uncertain of our sources of debt or equity for funding our future capital needs. If we cannot obtain funding on acceptable terms, our ability to make necessary capital improvements to our properties may be impaired or delayed.
The gross proceeds of our public offering will be used to purchase real estate investments and to pay various fees and expenses. In addition, to continue to qualify as a REIT, we generally must distribute to our stockholders at least 90% of our taxable income each year, excluding capital gains. Because of this distribution requirement, it is not likely that we will be able to fund a significant portion of our future capital needs from retained earnings. Sources of debt or equity for future funding may not be available to us on favorable terms or at all. If, however, we do not have access to sufficient funding in the future, we may not be able to make necessary capital improvements to our properties, pay other expenses or expand our business.
Our Advisor may receive economic benefits from its status as a special limited partner without bearing any of the risk associated with owning properties.
Our Advisor is a special limited partner in our operating partnership. As the special limited partner, our Advisor may be entitled to receive certain distributions, including an incentive distribution of net proceeds from the sale of properties after we have received and paid to our stockholders the threshold return. We will bear all of the risk associated with the properties but, as a result of the incentive distributions to our Advisor, we may not be entitled to all of the operating partnership's proceeds from a property sale and certain other events.
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Risks Related to Investments in Single Tenant Real Estate
Many of our properties depend upon a single tenant for all or a majority of their rental income, and our financial condition and ability to make distributions at our current level may be adversely affected by the bankruptcy or insolvency, a downturn in the business, or a lease termination of a single tenant, including those caused by the current economic climate.
Most of our properties will be occupied by only one tenant or will derive a majority of their rental income from one tenant and, therefore, the success of those properties is materially dependent on the financial stability of such tenants. The nation as a whole and our local economies are currently experiencing economic uncertainty affecting companies of all sizes and industries. A tenant at one or more of our properties may be negatively affected by the current economic climate. Lease payment defaults by tenants, including those caused by the current economic climate, could cause us to reduce the amount of distributions we pay. A default of a tenant on its lease payments to us and the potential resulting vacancy would cause us to lose the revenue from the property and force us to find an alternative source of revenue to meet any mortgage payment and prevent a foreclosure if the property is subject to a mortgage. In the event of a default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-letting the property. If a lease is terminated or an existing tenant elects not to renew a lease upon its expiration, there is no assurance that we will be able to lease the property for the rent previously received or sell the property without incurring a loss. A default by a tenant, the failure of a guarantor to fulfill its obligations or other premature termination of a lease, or a tenant's election not to extend a lease upon its expiration, could have an adverse effect on our financial condition and our ability to pay distributions.
As of December 31, 2016, our five largest tenants based on annualized net rental income were, Southern Company Services, American Express Travel Related Services, Inc., Amazon.com.dedc, LLC, Bank of America, N.A., and Wyndham Worldwide Operations, therefore we currently rely on these five tenants for a substantial amount of revenue and adverse effects to their business could affect our performance.
As of December 31, 2016, our five largest tenants, based on annualized net rental income, were Southern Company Services, located in Alabama (approximately 11.5%), American Express Travel Related Services, Inc., located in Arizona (approximately 8.1%), Amazon.com.dedc, LLC, located in Ohio (approximately 7.7%), Bank of America, N.A., located in California (approximately 7.3%), and Wyndham Worldwide Operations, located in New Jersey (approximately 7.2%). The revenues generated by the properties these tenants occupy are substantially reliant upon the financial condition of these tenants and, accordingly, any event of bankruptcy, insolvency, or a general downturn in the business of any of these tenants may result in the failure or delay of such tenant's rental payments which may have a substantial adverse effect on our financial performance.
A high concentration of our properties in a particular geographic area, or that have tenants in a similar industry, would magnify the effects of downturns in that geographic area or industry.
We expect that our properties will be diverse according to geographic area and industry of our tenants. However, in the event that we have a concentration of properties in any particular geographic area, any adverse situation that disproportionately affects that geographic area would have a magnified adverse effect on our portfolio. Similarly, if our tenants are concentrated in a certain industry or industries, any adverse effect to that industry generally would have a disproportionately adverse effect on our portfolio. As of December 31, 2016, approximately 16.3%, 13.8%, 13.0%, and 11.5% of our annualized net rent for the 12-month period subsequent to December 31, 2016 was concentrated in the Consumer Services, Capital Goods, Technology Hardware & Equipment, and Utilities industries, respectively. Additionally, as of December 31, 2016, approximately 13.3%, 11.9%, 11.5%, 11.4%, 11.0%, and 10.3% of our annualized net rent for the 12-month period subsequent to December 31, 2016 was concentrated in the states of Ohio, Illinois, Alabama, California, New Jersey, and Arizona, respectively.
A significant portion of our leases are due to expire around the same period of time, which may (i) cause a loss in the value of our stockholders’ investment until the affected properties are re-leased, (ii) increase our exposure to downturns in the real estate market during the time that we are trying to re-lease such space and (iii) increase our capital expenditure requirements during the releasing period.
Our tenant leases are set to expire as shown below:
Year of Lease Expiration | Annualized Net Rent (unaudited) | Number of Lessees | Square Feet | Percentage of Annualized Net Rent | |||||||||
2020 | 8,193,660 | 3 | 746,900 | 11.3 | % | ||||||||
2022 | 1,157,589 | 1 | 312,000 | 1.6 | % | ||||||||
2023 | 6,872,363 | 2 | 658,600 | 9.5 | % | ||||||||
2024 | 8,992,624 | 5 | 632,800 | 12.4 | % | ||||||||
2025 and beyond | 47,256,779 | (1) | 14 | 4,785,400 | 65.2 | % | |||||||
Total | $ | 72,473,015 | 25 | 7,135,700 | 100.0 | % | |||||||
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(1) | Includes escrow proceeds of approximately $7.0 million to be received during the year related to the Southern Company property. |
We may experience similar concentrations of lease expiration dates in the future. As the expiration date of a lease for a single-tenant building approaches, the value of the property generally declines because of the risk that the building may not be re-leased upon expiration of the existing lease or may not be re-leased on terms as favorable as those of the current leases. Therefore, if we were to list or liquidate our portfolio prior to the favorable re-leasing of the space, our stockholders may suffer a loss on their investment. Our stockholders may also suffer a loss (and a reduction in distributions) after the expiration of the lease terms if we are not able to re-lease such space on favorable terms. These expiring leases, therefore, increase our risk to real estate downturns during and approaching these periods of concentrated lease expirations. In addition, we may have to spend significant capital in order to ready the space for new tenants. To meet our need for cash at this time, we may have to increase borrowings or reduce our distributions, or both.
If a tenant declares bankruptcy, we may be unable to collect balances due under relevant leases.
Any of our tenants, or any guarantor of a tenant's lease obligations, could be subject to a bankruptcy proceeding pursuant to Title 11 of the bankruptcy laws of the United States. Such a bankruptcy filing would bar all efforts by us to collect pre-bankruptcy debts from these entities or their properties, unless we receive an enabling order from the bankruptcy court. Post-bankruptcy debts would be paid currently. If a lease is assumed, all pre-bankruptcy balances owing under it must be paid in full. If a lease is rejected by a tenant in bankruptcy, we would have a general unsecured claim for damages. If a lease is rejected, it is unlikely we would receive any payments from the tenant because our claim is capped at the rent reserved under the lease, without acceleration, for the greater of one year or 15% of the remaining term of the lease, but not greater than three years, plus rent already due but unpaid. This claim could be paid only in the event funds were available, and then only in the same percentage as that realized on other unsecured claims.
A tenant or lease guarantor bankruptcy could delay efforts to collect past due balances under the relevant leases, and could ultimately preclude full collection of these sums. Such an event could cause a decrease or cessation of rental payments that would mean a reduction in our cash flow and the amount available for distributions to stockholders. In the event of a bankruptcy, we cannot assure stockholders that the tenant or its trustee will assume our lease. If a given lease, or guaranty of a lease, is not assumed, our cash flow and the amounts available for distributions to stockholders may be adversely affected. Further, our lenders may have a first priority claim to any recovery under the leases, any guarantees and any credit support, such as security deposits and letters of credit.
If a sale-leaseback transaction is recharacterized in a tenant's bankruptcy proceeding, our financial condition could be adversely affected.
We may enter into sale-leaseback transactions, whereby we would purchase a property and then lease the same property back to the person from whom we purchased it. In the event of the bankruptcy of a tenant, a transaction structured as a sale-leaseback may be recharacterized as either a financing or a joint venture, either of which outcomes could adversely affect our business. If the sale-leaseback were recharacterized as a financing, we might not be considered the owner of the property, and as a result would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. The tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding balance. If confirmed by the bankruptcy court, we could be bound by the new terms, and prevented from foreclosing our lien on the property. If the sale-leaseback were recharacterized as a joint venture, our lessee and we could be treated as co-venturers with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the lessee relating to the property. Either of these outcomes could adversely affect our cash flow and the amount available for distributions to stockholders.
Net leases may not result in fair market lease rates over time.
A large portion of our rental income is from net leases. Net leases are typically (1) longer lease terms; and (2) fixed rental rate increases during the primary term of the lease and, thus, there is an increased risk that these contractual lease terms will fail to result in fair market rental rates. As a result, our income and distributions to our stockholders could be lower than they would otherwise be if we did not engage in net leases.
Our real estate investments may include special use single tenant properties that may be difficult to sell or re-lease upon tenant defaults or early lease terminations.
We focus our investments on commercial and industrial properties, a number of which may include manufacturing facilities and special use single tenant properties. These types of properties are relatively illiquid compared to other types of real estate and financial assets. This illiquidity will limit our ability to quickly change our portfolio in response to changes in economic or other conditions. With these properties, if the current lease is terminated or not renewed or, in the case of a mortgage loan, if we take such property in foreclosure, we may be required to renovate the property or to make rent concessions in order to lease the property to another tenant or sell the property. In addition, in the event we are forced to sell the property, we may have difficulty selling it to a party other than the tenant or borrower due to the special purpose for which the
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property may have been designed. These and other limitations may affect our ability to sell or re-lease properties and adversely affect returns to stockholders.
General Risks Related to Investments in Real Estate
Our operating results will be affected by economic and regulatory changes that have an adverse impact on the real estate market in general, and we cannot assure stockholders that we will be profitable or that we will realize growth in the value of our real estate properties.
Our operating results will be subject to risks generally incident to the ownership of real estate, including, and without limitation:
•changes in general economic or local conditions;
•changes in supply of or demand for similar or competing properties in an area;
• | changes in interest rates and availability of permanent mortgage funds that may render the sale of a property difficult or unattractive; |
•changes in tax, real estate, environmental and zoning laws;
•changes in property tax assessments and insurance costs;
•increases in interest rates and tight money supply; and
•loss of entitlements.
These and other reasons may prevent us from being profitable or from realizing growth or maintaining the value of our real estate properties.
We may obtain only limited warranties when we purchase a property.
The seller of a property will often sell such property in its "as is" condition on a "where is" basis and "with all faults," without any warranties of merchantability or fitness for a particular use or purpose. In addition, purchase agreements may contain only limited warranties, representations and indemnifications that will only survive for a limited period after the closing. Also, most sellers of large commercial properties are special purpose entities without significant assets other than the property itself. The purchase of properties with limited warranties or from undercapitalized sellers increases the risk that we may lose some or all of our invested capital in the property as well as the loss of rental income from that property.
Our inability to sell a property when we desire to do so could adversely impact our ability to pay cash distributions to stockholders.
The real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. We cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. Real estate generally cannot be sold quickly. Also, the tax laws applicable to REITs require that we hold our properties for investment, rather than for sale in the ordinary course of business, which may cause us to forego or defer sales of properties that otherwise would be in our best interest. Therefore, we may not be able to dispose of properties promptly, or on favorable terms, in response to economic or other market conditions, and this may adversely impact our ability to make distributions at our current level to stockholders.
In addition, we may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure stockholders that we will have funds available to correct such defects or to make such improvements.
In acquiring a property, we may agree to restrictions that prohibit the sale of that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These provisions would also restrict our ability to sell a property.
We may not be able to sell our properties at a price equal to, or greater than, the price for which we purchased such properties, which may lead to a decrease in the value of our assets.
We may be purchasing our properties at a time when capitalization rates are at historically low levels and purchase prices are high. Therefore, the value of our properties may not increase over time, which may restrict our ability to sell our properties, or in the event we are able to sell such property, may lead to a sale price less than the price that we paid to purchase the properties.
We may acquire or finance properties with lock-out provisions, which may prohibit us from selling a property, or may require us to maintain specified debt levels for a period of years on some properties.
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Lock-out provisions are provisions that generally prohibit repayment of a loan balance for a certain number of years following the origination date of a loan. Such provisions are typically provided for by the Code or the terms of the agreement underlying a loan. Lock-out provisions could materially restrict us from selling or otherwise disposing of or refinancing properties. These provisions would affect our ability to turn our investments into cash and thus affect cash available for distribution to stockholders. Lock-out provisions may prohibit us from reducing the outstanding indebtedness with respect to any properties, refinancing such indebtedness on a non-recourse basis at maturity, or increasing the amount of indebtedness with respect to such properties. Any mortgage debt that we place on our properties may also impose prepayment penalties upon the sale of the mortgaged property. If a lender invokes these penalties upon the sale of a property or prepayment of a mortgage on a property, the cost to us to sell the property could increase substantially.
Lock-out provisions could impair our ability to take actions during the lock-out period that would otherwise be in our stockholders' best interests and, therefore, may have an adverse impact on the value of the shares, relative to the value that would result if the lock-out provisions did not exist. In particular, lock-out provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or change in control might be in our stockholders' best interests.
Adverse economic conditions may negatively affect our property values, returns and profitability.
The following market and economic challenges may adversely affect our property values or operating results:
•poor economic times may result in a tenant's failure to meet its obligations under a lease or bankruptcy;
•re-leasing may require reduced rental rates under the new leases;
•increase in the cost of supplies and labor that impact operating expenses; and
• | increased insurance premiums, resulting in part from the increased risk of terrorism, may reduce funds available for distribution, or, to the extent we are able to pass such increased insurance premiums on to our tenants, may increase tenant defaults. |
We are susceptible to the effects of macroeconomic factors that can result in unemployment, shrinking demand for products, large-scale business failures, and tight credit markets. Our property values and operations could be negatively affected by such adverse economic conditions.
If we suffer losses that are not covered by insurance or that are in excess of insurance coverage, we could lose invested capital and anticipated profits.
Material losses may occur in excess of insurance proceeds with respect to any property, as insurance may not be sufficient to fund the losses. However, there are types of losses, generally of a catastrophic nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, which are either uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. In addition, we may decide not to obtain any or adequate earthquake or similar catastrophic insurance coverage because the premiums are too high even in instances where it may otherwise be available. Insurance risks associated with potential terrorism acts could sharply increase the premiums we pay for coverage against property and casualty claims. Additionally, mortgage lenders in some cases have begun to insist that commercial property owners purchase specific coverage against terrorism as a condition for providing mortgage loans. It is uncertain whether such insurance policies will be available, or available at reasonable cost, which could inhibit our ability to finance or refinance our potential properties. In these instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We cannot assure stockholders that will have adequate coverage for such losses. The Terrorism Risk Insurance Act of 2002 is designed for a sharing of terrorism losses between insurance companies and the federal government. We cannot be certain how this act will impact us or what additional cost to us, if any, could result. If such an event damaged or destroyed one or more of our properties, we could lose both our invested capital and anticipated profits from such property.
Delays in the acquisition, development and construction of properties may have adverse effects on our results of operations and returns to stockholders.
Delays we encounter in the selection, acquisition and development of real properties could adversely affect our stockholders' returns. Investments in unimproved real property, properties that are in need of redevelopment, or properties that are under development or construction will be subject to the uncertainties associated with the development and construction of real property, including those related to re-zoning land for development, environmental concerns of governmental entities and/or community groups and our builders' ability to build in conformity with plans, specifications, budgets and timetables. If a builder fails to perform, we may resort to legal action to rescind the purchase or the construction contract or to compel performance. A builder's performance may also be affected or delayed by conditions beyond the builder's control.
Where properties are acquired prior to the start of construction or during the early stages of construction, it will typically take up to one year or more to complete construction and lease available space. Therefore, stockholders could suffer delays in
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the receipt of cash distributions attributable to those particular real properties. We may incur additional risks when we make periodic progress payments or other advances to builders before they complete construction. These and other factors can result in increased costs of a project or loss of our investment. We also must rely on rental income and expense projections and estimates of the fair market value of a property upon completion of construction when agreeing upon a purchase price at the time we acquire the property. If our projections are inaccurate, we may pay too much for a property, and the return on our investment could suffer.
Costs of complying with governmental laws and regulations, including those relating to environmental matters, may adversely affect our income and the cash available for distribution.
All real property we acquire, and the operations conducted on real property are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials, and the remediation of contamination associated with disposals. Some of these laws and regulations may impose joint and several liability on tenants, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal. This liability could be substantial. In addition, the presence of hazardous substances, or the failure to properly remediate these substances, may adversely affect our ability to sell, rent or pledge such property as collateral for future borrowings.
Some of these laws and regulations have been amended so as to require compliance with new or more stringent standards as of future dates. Compliance with new or more stringent laws or regulations or stricter interpretation of existing laws may require us to incur material expenditures. Future laws, ordinances or regulations may impose material environmental liability. Additionally, our tenants' operations, the existing condition of land when we buy it, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties may affect our properties. In addition, there are various local, state and federal fire, health, life-safety and similar regulations with which we may be required to comply, and that may subject us to liability in the form of fines or damages for noncompliance. Any material expenditures, fines, or damages we must pay will reduce our ability to make distributions to stockholders and may reduce the value of our stockholders' investments.
We cannot assure stockholders that the independent third-party environmental assessments we obtain prior to acquiring any properties we purchase will reveal all environmental liabilities or that a prior owner of a property did not create a material environmental condition not known to us. We cannot predict what other environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted, or what environmental conditions may be found to exist in the future. We cannot assure stockholders that our business, assets, results of operations, liquidity or financial condition will not be adversely affected by these laws, which may adversely affect cash available for distribution, and the amount of distributions to stockholders.
Our costs associated with complying with the Americans with Disabilities Act may affect cash available for distribution.
Our properties will be subject to the Americans with Disabilities Act of 1990, or ADA. Under the ADA, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. The ADA has separate compliance requirements for "public accommodations" and "commercial facilities" that generally require that buildings and services, including restaurants and retail stores, be made accessible and available to people with disabilities. The ADA's requirements could require removal of access barriers and could result in the imposition of injunctive relief, monetary penalties, or, in some cases, an award of damages. We will attempt to acquire properties that comply with the ADA or place the burden on the seller or other third party to ensure compliance with the ADA. However, we cannot assure stockholders that we will be able to acquire properties or allocate responsibilities in this manner. If we cannot, our funds used for ADA compliance may affect cash available for distribution and the amount of distributions to stockholders.
If we sell properties by providing financing to purchasers, defaults by the purchasers would adversely affect our cash flows.
In some instances we may sell our properties by providing financing to purchasers. When we provide financing to purchasers, we will bear the risk that the purchaser may default, which could negatively impact our cash distributions to stockholders. Even in the absence of a purchaser default, the distribution of the proceeds of sales to our stockholders, or their reinvestment in other assets, will be delayed until the promissory notes or other property we may accept upon the sale are actually paid, sold, refinanced or otherwise disposed of. In some cases, we may receive initial down payments in cash and other property in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years. If any purchaser defaults under a financing arrangement with us, it could negatively impact our ability to make distributions at our current level to stockholders.
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We will be subject to risks associated with the co-owners in our co-ownership arrangements that otherwise may not be present in other real estate investments.
We may enter into joint ventures or other co-ownership arrangements with respect to a portion of the properties we acquire. Ownership of co-ownership interests involves risks generally not otherwise present with an investment in real estate such as the following:
• | the risk that a co-owner may at any time have economic or business interests or goals that are or become inconsistent with our business interests or goals; |
• | the risk that a co-owner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives; |
• | the risk that disputes with co-owners may result in litigation, which may cause us to incur substantial costs and/or prevent our management from focusing on our business objectives; |
• | the possibility that an individual co-owner might become insolvent or bankrupt, or otherwise default under the applicable mortgage loan financing documents, which may constitute an event of default under all of the applicable mortgage loan financing documents or allow the bankruptcy court to reject the tenants-in-common agreement or management agreement entered into by the co-owner owning interests in the property; |
• | the possibility that a co-owner might not have adequate liquid assets to make cash advances that may be required in order to fund operations, maintenance and other expenses related to the property, which could result in the loss of current or prospective tenants and may otherwise adversely affect the operation and maintenance of the property, and could cause a default under the mortgage loan financing documents applicable to the property and may result in late charges, penalties and interest, and may lead to the exercise of foreclosure and other remedies by the lender; |
• | the risk that a co-owner could breach agreements related to the property, which may cause a default under, or result in personal liability for, the applicable mortgage loan financing documents, violate applicable securities laws and otherwise adversely affect the property and the co-ownership arrangement; or |
• | the risk that a default by any co-owner would constitute a default under the applicable mortgage loan financing documents that could result in a foreclosure and the loss of all or a substantial portion of the investment made by the co-owner. |
Any of the above might subject a property to liabilities in excess of those contemplated and thus reduce the amount available for distribution to our stockholders.
In the event that our interests become adverse to those of the other co-owners, we may not have the contractual right to purchase the co-ownership interests from the other co-owners. Even if we are given the opportunity to purchase such co-ownership interests in the future, we cannot guarantee that we will have sufficient funds available at the time to purchase co-ownership interests from the co-owners.
We might want to sell our co-ownership interests in a given property at a time when the other co-owners in such property do not desire to sell their interests. Therefore, we may not be able to sell our interest in a property at the time we would like to sell. In addition, we anticipate that it will be much more difficult to find a willing buyer for our co-ownership interests in a property than it would be to find a buyer for a property we owned outright.
Risks Associated with Debt Financing
If we breach covenants under our revolving credit facility with KeyBank and other syndication partners, we could be held in default under such loan, which could accelerate our repayment date and materially adversely affect the value of our stockholders' investment in us.
We entered into a secured credit facility with KeyBank and other syndication partners under which we, through our operating partnership, as the Borrower, were provided with an initial commitment of $250.0 million, which commitment was increased to $410.0 million on August 11, 2015 and further increased to $550.0 million on November 22, 2016, and which may be further increased under certain circumstances up to a maximum total commitment of $1.25 billion.
In addition to customary representations, warranties, covenants, and indemnities, the Revolving Credit Facility (as defined and described further below) contains a number of financial covenants and requires us and the Borrower to comply with the following at all times, which will be tested on a quarterly basis: (i) a maximum consolidated leverage ratio of 60%, or, once the collateral pledges are released, the ratio may increase to 65% for up to four consecutive quarters after a material acquisition only after the facility is deemed unsecured; (ii) a minimum consolidated tangible net worth of approximately $4.7 million, plus 75% of net future equity issuances (including units of operating partnership interests in the Borrower); (iii) a minimum consolidated fixed charge coverage ratio of not less than 1.50:1.00, commencing as of the quarter ended March 31, 2016; (iv) a maximum total secured debt ratio of not greater than 40%, which ratio will increase by five percentage points for four quarters after closing of a material acquisition that is financed with secured debt; (v) a maximum total secured recourse debt ratio,
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excluding recourse obligations associated with interest rate hedges, of 10% of our total asset value (as defined), at the time our tangible net worth equals or exceeds $250 million (secured debt is not permitted prior to the time our tangible net worth exceeds $250 million); (vi) aggregate maximum unhedged variable rate debt of not greater than 30% of our total asset value; and (vii) a maximum payout ratio (as defined) of not greater than 95% of our core funds from operations (as defined), commencing as of the quarter ending March 31, 2018.
The Revolving Credit Facility was initially secured by a pledge of 100% of the ownership interests in each special purpose entity which owns a pool property. On November 1, 2016, all pledged membership interests were released from the lien of the pledge agreements and subsequently terminated. Adjustments to the applicable rate were effective as of January 1, 2017. If we were to default under the Revolving Credit Facility, the lenders could accelerate the date for our repayment of the loan, and could sue to enforce the terms of the loan.
We have broad authority to incur debt, and high debt levels could hinder our ability to make distributions at our current level and could decrease the value of our stockholders' investments.
Although, technically, our board may approve unlimited levels of debt, our charter generally limits us to incurring debt no greater than 300% of our net assets before deducting depreciation or other non-cash reserves (equivalent to 75% leverage), unless any excess borrowing is approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report, along with a justification for such excess borrowing. High debt levels would cause us to incur higher interest charges, would result in higher debt service payments, and could be accompanied by restrictive covenants. These factors could limit the amount of cash we have available to distribute and could result in a decline in the value of our stockholders' investments.
We have incurred, and intend to continue to incur, mortgage indebtedness and other borrowings, which may increase our business risks.
We have placed, and intend to continue to place, permanent financing on our properties or obtain a credit facility or other similar financing arrangement in order to acquire properties as funds are being raised in our public offering. We may also decide to later further leverage our properties. We may incur mortgage debt and pledge all or some of our real properties as security for that debt to obtain funds to acquire real properties. We may borrow if we need funds to pay a desired distribution rate to our stockholders. We may also borrow if we deem it necessary or advisable to assure that we qualify and maintain our qualification as a REIT for federal income tax purposes. If there is a shortfall between the cash flow from our properties and the cash flow needed to service mortgage debt, then the amount available for distribution to our stockholders may be reduced.
We have incurred, and intend to continue to incur, indebtedness secured by our properties, which may result in foreclosure.
Most of our borrowings to acquire properties will be secured by mortgages on our properties. If we default on our secured indebtedness, the lender may foreclose and we could lose our entire investment in the properties securing such loan, which could adversely affect distributions to our stockholders. To the extent lenders require us to cross-collateralize our properties, or our loan agreements contain cross-default provisions, a default under a single loan agreement could subject multiple properties to foreclosure.
High interest rates may make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire and the amount of cash distributions we can make.
If we place mortgage debt on properties, we run the risk of being unable to refinance the properties when the loans come due, or of being unable to refinance at cost effective rates. If interest rates are higher when the properties are refinanced, we may not be able to finance the properties and our income could be reduced. If any of these events occur, our cash flow would be reduced. This, in turn, would reduce cash available for distribution to our stockholders and may hinder our ability to raise more capital by issuing more stock or by borrowing more money.
If we are unable to make our debt payments when required, a lender could foreclose on the property or properties securing such debt, which could reduce the amount of distributions we pay to stockholders and decrease the value of our stockholders' investments.
We may have a significant amount of acquisition indebtedness secured by first priority mortgages on our properties. In addition, all of our properties contain, and any future acquisitions we make will likely contain, mortgage financing. If we are unable to make our debt payments when required, a lender could foreclose on the property or properties securing such debt. In any such event, we could lose some or all of our investment in these properties, which would reduce the amount of distributions we pay to stockholders and decrease the value of our stockholders' investments.
Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions at our current level to stockholders.
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When providing financing, a lender could impose restrictions on us that affect our distribution and operating policies and our ability to incur additional debt. Loan documents we enter into may contain covenants that limit our ability to further mortgage the property, discontinue insurance coverage or replace our Advisor. These or other limitations may adversely affect our flexibility and limit our ability to make distributions at our current level to stockholders.
Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to make distributions at our current level to stockholders.
We expect that we will incur indebtedness in the future. Interest we pay will reduce cash available for distribution. Additionally, if we incur variable rate debt, increases in interest rates would increase our interest costs, which could reduce our cash flows and our ability to make distributions at our current level to stockholders. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments in properties at times that may not permit realization of the maximum return on such investments.
Disruptions in the credit markets could have a material adverse effect on our results of operations, financial condition and ability to pay distributions to stockholders.
Domestic and international financial markets recently experienced significant disruptions which were brought about in large part by failures in the U.S. banking system. These disruptions severely impacted the availability of credit and contributed to rising costs associated with obtaining credit. If debt financing is not available on terms and conditions we find acceptable, we may not be able to obtain financing for investments. If these disruptions in the credit markets resurface, our ability to borrow monies to finance the purchase of, or other activities related to, real estate assets will be negatively impacted. If we are unable to borrow monies on terms and conditions that we find acceptable, we may be forced to use a greater proportion of our offering proceeds to finance our acquisitions, reduce the number of properties we can purchase, and/or dispose of some of our assets. These disruptions could also adversely affect the return on the properties we do purchase. In addition, if we pay fees to lock in a favorable interest rate, falling interest rates or other factors could require us to forfeit these fees. All of these events could have a material adverse effect on our results of operations, financial condition and ability to pay distributions.
Federal Income Tax Risks
Failure to continue to qualify as a REIT would adversely affect our operations and our ability to make distributions at our current level as we will incur additional tax liabilities.
We believe we operate in a manner that allows us to qualify as a REIT for U.S. federal income tax purposes under the Code. Qualification as a REIT involves highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. Our qualification as a REIT will depend upon our ability to meet, through investments, actual operating results, distributions and satisfaction of specific stockholder rules, the various tests imposed by the Code.
If we fail to qualify as a REIT for any taxable year, we will be subject to federal income tax and any applicable alternative minimum tax on our taxable income at regular corporate rates. If our REIT status is terminated for any reason, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of such termination. Losing our REIT status would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax. In addition, distributions to stockholders would no longer qualify for the distributions paid deduction, and we would no longer be required to make distributions.
Foreign purchasers of our common stock may be subject to FIRPTA tax upon the sale of their shares.
A foreign person disposing of a U.S. real property interest, including shares of a U.S. corporation whose assets consist principally of U.S. real property interests, is generally subject to a tax, known as FIRPTA tax, on the gain recognized on the disposition. Such FIRPTA tax does not apply, however, to the disposition of stock in a REIT if the REIT is "domestically controlled." A REIT is "domestically controlled" if less than 50% of the REIT's stock, by value, has been owned directly or indirectly by persons who are not qualifying U.S. persons during a continuous five-year period ending on the date of disposition or, if shorter, during the entire period of the REIT's existence.
We cannot assure stockholders that we will qualify as a "domestically controlled" REIT. If we were to fail to so qualify, gain realized by foreign investors on a sale of our shares would be subject to FIRPTA tax, unless our shares were traded on an established securities market and the foreign investor did not at any time during a specified testing period directly or indirectly own more than 10% of the value of our outstanding common stock.
If our operating partnership fails to maintain its status as a partnership for federal income tax purposes, its income would be subject to taxation and our REIT status would be terminated.
We intend to maintain the status of our operating partnership as a partnership for federal income tax purposes. However, if the IRS were to successfully challenge the status of our operating partnership as a partnership, it would be taxable as a corporation. In such event, this would reduce the amount of distributions that our operating partnership could make to us. This
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would also result in our losing REIT status and becoming subject to a corporate level tax on our own income. This would substantially reduce our cash available to pay distributions and the return on our stockholders' investments. In addition, if any of the entities through which our operating partnership owns its properties, in whole or in part, loses its characterization as a partnership for federal income tax purposes, the underlying entity would become subject to taxation as a corporation, thereby reducing distributions to our operating partnership and jeopardizing our ability to maintain REIT status.
Stockholders may have tax liability on distributions they elect to reinvest in our common stock.
If stockholders participate in our distribution reinvestment plan, they will be deemed to have received, and for income tax purposes will be taxed on, the amount reinvested in common stock to the extent the amount reinvested was not a tax-free return of capital. As a result, unless a stockholder is a tax-exempt entity, a stockholder may have to use funds from other sources to pay its tax liability on the value of the common stock received.
In certain circumstances, we may be subject to federal and state income taxes as a REIT, which would reduce our cash available for distribution to stockholders.
Even if we qualify and maintain our status as a REIT, we may be subject to federal income taxes or state taxes. For example, net income from a "prohibited transaction" will be subject to a 100% tax. We may not be able to make sufficient distributions to avoid excise taxes applicable to REITs. We may also decide to retain income we earn from the sale or other disposition of our property and pay income tax directly on such income. In that event, our stockholders would be treated as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability. We may also be subject to state and local taxes on our income or property, either directly or at the level of the operating partnership or at the level of the other companies through which we indirectly own our assets. Any federal or state taxes we pay will reduce our cash available for distribution to stockholders.
We may be required to pay some taxes due to actions of our taxable REIT subsidiary which would reduce our cash available for distribution to stockholders.
Any net taxable income earned directly by our taxable REIT subsidiary, or through entities that are disregarded for federal income tax purposes as entities separate from our taxable REIT subsidiaries, will be subject to federal and possibly state corporate income tax. We elected to treat Griffin Capital Essential Asset TRS II, Inc. as a taxable REIT subsidiary, and we may elect to treat other subsidiaries as taxable REIT subsidiaries in the future. In this regard, several provisions of the laws applicable to REITs and their subsidiaries ensure that a taxable REIT subsidiary will be subject to an appropriate level of federal income taxation. For example, a taxable REIT subsidiary is limited in its ability to deduct certain interest payments made to an affiliated REIT. In addition, the REIT has to pay a 100% penalty tax on some payments that it receives or on some deductions taken by a taxable REIT subsidiary if the economic arrangements between the REIT, the REIT's customers, and the taxable REIT subsidiary are not comparable to similar arrangements between unrelated parties. Finally, some state and local jurisdictions may tax some of our income even though as a REIT we are not subject to federal income tax on that income because not all states and localities follow the federal income tax treatment of REITs. To the extent that we and our affiliates are required to pay federal, state and local taxes, we will have less cash available for distributions to stockholders.
Distributions to tax-exempt investors may be classified as unrelated business taxable income.
Neither ordinary nor capital gain distributions with respect to our common stock, nor gain from the sale of common stock, should generally constitute unrelated business taxable income (UBTI) to a tax-exempt investor. However, there are certain exceptions to this rule. In particular:
• | part of the income and gain recognized by certain qualified employee pension trusts with respect to our common stock may be treated as UBTI if shares of our common stock are predominately held by qualified employee pension trusts, and we are required to rely on a special look-through rule for purposes of meeting one of the REIT share ownership tests, and we are not operated in a manner to avoid treatment of such income or gain as UBTI; |
• | part of the income and gain recognized by a tax exempt investor with respect to our common stock would constitute UBTI if the investor incurs debt in order to acquire the common stock; and |
• | part or all of the income or gain recognized with respect to our common stock by social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans which are exempt from federal income taxation under Sections 501(c)(7), (c)(9), (c)(17) or (c)(20) of the Code may be treated as UBTI. |
Complying with the REIT requirements may cause us to forego otherwise attractive opportunities.
To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of shares of our common stock. We may be required to make distributions to stockholders at disadvantageous times
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or when we do not have funds readily available for distribution, or we may be required to liquidate otherwise attractive investments in order to comply with the REIT tests. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
Legislative or regulatory action could adversely affect investors.
Individuals with incomes below certain thresholds are subject to taxation at a 15% qualified dividend rate. For those with income above such thresholds, the qualified dividend rate is 20%. These tax rates are generally not applicable to distributions paid by a REIT, unless such distributions represent earnings on which the REIT itself has been taxed. As a result, distributions (other than capital gain distributions) we pay to individual investors generally will be subject to the tax rates that are otherwise applicable to ordinary income for federal income tax purposes, which currently are as high as 39.6%. This disparity in tax treatment may make an investment in our shares comparatively less attractive to individual investors than an investment in the shares of non-REIT corporations, and could have an adverse effect on the value of our common stock. Stockholders are urged to consult with their own tax advisors with respect to the impact of recent legislation on their investment in our common stock and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our common stock.
ERISA Risks
There are special considerations that apply to employee benefit plans, IRAs or other tax-favored benefit accounts investing in our shares which could cause an investment in our shares to be a prohibited transaction which could result in additional tax consequences.
If stockholders are investing the assets of a pension, profit-sharing, 401(k), Keogh or other qualified retirement plan or the assets of an IRA in our common stock, they should satisfy themselves that, among other things:
•their investment is consistent with their fiduciary obligations under ERISA and the Code;
• | their investment is made in accordance with the documents and instruments governing their plan or IRA, including their plan's investment policy; |
•their investment satisfies the prudence and diversification requirements of ERISA;
•their investment will not impair the liquidity of the plan or IRA;
•their investment will not produce UBTI for the plan or IRA;
•they will be able to value the assets of the plan annually in accordance with ERISA requirements; and
•their investment will not constitute a prohibited transaction under Section 406 of ERISA or Section 4975 of the Code.
Persons investing the assets of employee benefit plans should consider ERISA risks of investing in the shares.
ERISA and Code Section 4975 prohibit certain transactions that involve (1) certain pension, profit-sharing, employee benefit, or retirement plans or individual retirement accounts and Keogh plans, and (2) any person who is a "party-in-interest" or "disqualified person" with respect to such a plan. Consequently, the fiduciary of a plan contemplating an investment in the shares should consider whether we, any other person associated with the issuance of the shares, or any of their affiliates is or might become a "party-in-interest" or "disqualified person" with respect to the plan and, if so, whether an exception from such prohibited transaction rules is applicable. In addition, the Department of Labor plan asset regulations provide that, subject to certain exceptions, the assets of an entity in which a plan holds an equity interest may be treated as assets of an investing plan, in which event the underlying assets of such entity (and transactions involving such assets) would be subject to the prohibited transaction provisions. We intend to take such steps as may be necessary to qualify us for one or more of the exceptions available, and thereby prevent our assets as being treated as assets of any investing plan.
A recent rule issued by the U.S. Department of Labor regarding the definitional scope of "investment advice" under ERISA and the Internal Revenue Code could have a negative impact on our ability to raise capital.
In April 2016, the U.S. Department of Labor issued a final rule that substantially expands the range of activities that would be considered to be fiduciary investment advice under ERISA and the Internal Revenue Code, which may make it more difficult to qualify for a prohibited transaction exemption. This final rule could have negative implications on our ability to raise capital from potential investors, including those investing through individual retirement accounts. While the President has signed an Executive Order giving the Secretary of Labor the power to rescind or revise this final rule and the Department of Labor is currently considering its legal options in delaying the applicability date of this final rule, there can be no assurance that this final rule will not be implemented.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
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ITEM 2. PROPERTIES
As of December 31, 2016, we owned a fee simple interest in 25 properties, encompassing approximately 7.1 million rentable square feet. Our rentable square feet under lease as of December 31, 2016 was 100%, with a weighted average remaining lease term of 11.4 years with average annual rent increases of approximately 2.2%. See Part IV, Item 15. “Exhibits, Financial Statement Schedules—Schedule III—Real Estate and Accumulated Depreciation and Amortization,” of this Annual Report on Form 10-K for a detailed listing of all our properties.
Purchase price and other information of the properties acquired during the year ended December 31, 2016 are shown below:
Property | Location | Tenant/Major Lessee | Acquisition Date | Purchase Price | Approx. Square Feet | % Leased | Property Type | Year of Lease Expiration | Annualized Net Rent (1) | ||||||||||||||||
Toshiba TEC | Durham, NC | Toshiba TEC Corporation | 1/21/2016 | $ | 35,800,748 | 200,800 | 100 | % | Office | 2028 | $ | 2,241,776 | |||||||||||||
NETGEAR | San Jose, CA | NETGEAR, Inc. | 5/17/2016 | 44,000,000 | 142,700 | 100 | % | Office | 2025 | 2,953,877 | (2) | ||||||||||||||
Nike | Hillsboro, OR | Nike, Inc. | 6/16/2016 | 45,500,000 | 266,800 | 100 | % | Office | 2020 | 2,871,757 | |||||||||||||||
Zebra Technologies | Lincolnshire, IL | Hewitt Associates LLC | (3) | 8/1/2016 | 60,150,000 | 283,300 | 100 | % | Office | 2017/2026 | 4,253,054 | ||||||||||||||
WABCO | North Charleston, SC | WABCO Air Compressor Holdings Inc. | 9/14/2016 | 13,834,500 | 145,200 | 100 | % | Industrial | 2023 | 1,009,687 | |||||||||||||||
IGT | Las Vegas, NV | IGT | 9/27/2016 | 66,500,000 | 222,300 | 100 | % | Office | 2030 | 4,614,284 | |||||||||||||||
3M | DeKalb, IL | 3M Company | 10/25/2016 | 69,356,000 | 978,100 | 100 | % | Industrial | 2026 | 4,367,238 | |||||||||||||||
Amazon | Etna, OH | Amazon.com.dedc LLC | 11/18/2016 | 88,896,060 | 855,000 | 100 | % | Industrial | 2031 | 5,583,784 | |||||||||||||||
Zoetis | Parsippany, NJ | Zoetis Services LLC | 12/16/2016 | 44,000,000 | 125,700 | 100 | % | Office | 2028 | 2,769,293 | |||||||||||||||
Southern Company | Birmingham, AL | Southern Company Services, Inc. | 12/22/2016 | 131,590,000 | 669,400 | 100 | % | Office | 2044 | 8,352,000 | (4) | ||||||||||||||
(1) | Net rent is based on (a) the contractual base rental payments assuming the lease requires the tenant to reimburse us for certain operating expenses or the property is self managed by the tenant and the tenant is responsible for all, or substantially all, of the operating expenses; or (b) contractual rent payments less certain operating expenses that are our responsibility for the 12-month period subsequent to December 31, 2016 and includes assumptions that may not be indicative of the actual future performance of a property, including the assumption that the tenant will perform its obligations under its lease agreement during the next 12 months. |
(2) | Includes a $700,000 credit for free rent provided by the seller at the date of acquisition. |
(3) | The property was leased to Hewitt Associates LLC ("Hewitt"), a wholly owned subsidiary of Aon PLC, through February 28, 2017, and Zebra Technologies Corporation ("Zebra Technologies") occupied the property under a sublease agreement. On March 1, 2017, immediately following Hewitt's lease expiration, Zebra Technologies' 117-month lease with the Company commenced. |
(4) | Includes escrow proceeds of approximately $7.0 million to be received during the year. |
Revenue Concentration
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The percentage of annualized net rent for the 12-month period subsequent to December 31, 2016, by state, based on the respective in-place leases, is as follows:
State | Annualized Net Rent (unaudited) | Number of Properties | Percentage of Annualized Net Rent | |||||||
Ohio | $ | 9,658,579 | 4 | 13.3 | % | |||||
Illinois | 8,620,292 | 2 | 11.9 | % | ||||||
Alabama | 8,352,000 | (1) | 1 | 11.5 | % | |||||
California | 8,275,780 | 3 | 11.4 | % | ||||||
New Jersey | 7,982,438 | 2 | 11.0 | % | ||||||
Arizona | 7,431,113 | 2 | 10.3 | % | ||||||
Nevada | 6,620,680 | 2 | 9.1 | % | ||||||
Texas | 3,974,765 | 1 | 5.5 | % | ||||||
Oregon | 2,871,757 | 1 | 4.0 | % | ||||||
North Carolina | 2,607,893 | 2 | 3.6 | % | ||||||
All Others | 6,077,718 | (2) | 5 | 8.4 | % | |||||
Total | $ | 72,473,015 | 25 | 100.0 | % | |||||
(1) | Includes escrow proceeds of approximately $7.0 million to be received during the year. |
(2) | All others account for less than approximately 3% of total annualized net rent on an individual basis. |
The percentage of annualized net rent for the 12-month period subsequent to December 31, 2016, by industry, based on the respective in-place leases, is as follows:
Industry (1) | Annualized Net Rent (unaudited) | Number of Lessees | Percentage of Annualized Net Rent | |||||||
Consumer Services | $ | 11,833,825 | 3 | 16.3 | % | |||||
Capital Goods | 10,026,641 | 6 | 13.8 | % | ||||||
Technology Hardware & Equipment | 9,448,707 | 3 | 13.0 | % | ||||||
Utilities | 8,352,000 | (2) | 1 | 11.5 | % | |||||
Diversified Financials | 5,862,676 | 1 | 8.1 | % | ||||||
Retailing | 5,583,784 | 1 | 7.7 | % | ||||||
Banks | 5,321,903 | 2 | 7.3 | % | ||||||
Energy | 3,974,765 | 1 | 5.5 | % | ||||||
Transportation | 3,018,503 | 2 | 4.2 | % | ||||||
Consumer Durables and Apparel | 2,871,757 | 1 | 4.0 | % | ||||||
Pharmaceuticals, Biotechnology & Life Sciences | 2,769,293 | 1 | 3.8 | % | ||||||
All Others | 3,409,161 | (3) | 3 | 4.8 | % | |||||
Total | $ | 72,473,015 | 25 | 100.0 | % | |||||
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(1) | Industry classification based on the Global Industry Classification Standards. |
(2) | Includes escrow proceeds of approximately $7.0 million to be received during the year. |
(3) | All others account for less than 3% of total annualized net rent on an individual basis. |
The percentage of annualized net rent for the 12-month period subsequent to December 31, 2016, by tenant, based on the respective in-place leases, is as follows:
Tenant | Annualized Net Rent (unaudited) | Percentage of Annualized Net Rent | |||||
Southern Company Services, Inc. | $ | 8,352,000 | (1) | 11.5 | % | ||
American Express Travel Related Services Company, Inc. | 5,862,676 | 8.1 | % | ||||
Amazon.com.dedc, LLC | 5,583,784 | 7.7 | % | ||||
Bank of America, N.A. | 5,321,903 | 7.3 | % | ||||
Wyndham Worldwide Operations | 5,213,145 | 7.2 | % | ||||
IGT | 4,614,284 | 6.4 | % | ||||
3M Company | 4,367,238 | 6.0 | % | ||||
Zebra Technologies Corporation | 4,253,054 | 5.9 | % | ||||
Wood Group Mustang, Inc. | 3,974,765 | 5.5 | % | ||||
NETGEAR, Inc. | 2,953,877 | 4.1 | % | ||||
Other | 21,976,289 | (2) | 30.3 | % | |||
Total | $ | 72,473,015 | 100 | % | |||
(1) | Includes escrow proceeds of approximately $7.0 million to be received during the year. |
(2) | All others account for less than 4% of total annualized net rent on an individual basis. |
The tenant lease expirations by year based on annualized net rent for the 12-month period subsequent to December 31, 2016 are as follows:
Year of Lease Expiration | Annualized Net Rent (unaudited) | Number of Lessees | Square Feet | Percentage of Annualized Net Rent | |||||||||
2020 | 8,193,660 | 3 | 746,900 | 11.3 | % | ||||||||
2022 | 1,157,589 | 1 | 312,000 | 1.6 | % | ||||||||
2023 | 6,872,363 | 2 | 658,600 | 9.5 | % | ||||||||
2024 | 8,992,624 | 5 | 632,800 | 12.4 | % | ||||||||
2025 and beyond | 47,256,779 | (1) | 14 | 4,785,400 | 65.2 | % | |||||||
Total | $ | 72,473,015 | 25 | 7,135,700 | 100.0 | % | |||||||
(1) | Includes escrow proceeds of approximately $7.0 million to be received during the year. |
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Acquisition Indebtedness
For a discussion of our acquisitions and indebtedness, see Note 3, Real Estate, and Note 4, Debt, to the consolidated financial statements.
ITEM 3. LEGAL PROCEEDINGS
(a) From time to time, we may become subject to legal proceedings, claims and litigation arising in the ordinary course of our business. We are not a party to any material legal proceedings, nor are we aware of any pending or threatened litigation that would have a material adverse effect on our business, operating results, cash flows or financial condition should such litigation be resolved unfavorably.
(b) None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
As of March 9, 2017, we had approximately 25,581,644, 48,667,260, and 929,626 of Class A, Class T and Class I shares of common stock outstanding, including common stock issued pursuant to our distribution reinvestment plan and our stock distributions held by a total of approximately 16,000 stockholders of record. There is no established trading market for our common stock. Therefore, there is a risk that a stockholder may not be able to sell our stock at a time or price acceptable to the stockholder, or at all. In September 2016, our board of directors approved the close of our Primary Offering effective January 20, 2017. However, we continue to sell shares of our common stock in the offering pursuant to our DRP. We issue shares of our common stock pursuant to our DRP at a purchase price of $9.37 per share for all share classes.
Additionally, we provide discounts in our Offering for certain categories of purchasers, including based on volume discounts. Pursuant to the terms of our charter, certain restrictions are imposed on the ownership and transfer of shares.
Unless and until our shares are listed for trading on a national securities exchange, it is not expected that a public market for our shares will develop. To assist fiduciaries of Plans (as defined below) subject to the annual reporting requirements of ERISA and Account (as defined below) trustees or custodians to prepare reports relating to an investment in our shares, we expect to disclose an estimated value annually, but this estimated value is subject to significant limitations. We approved the first estimated valuation of our shares on February 13, 2017, which was prior to 150 days following the second anniversary of the date we reached the minimum offering amount and broke escrow in this offering. Prior to our estimated valuation, we generally determined the estimated value per share based on the “Net Investment Proceeds” and “Estimated Use of Proceeds” sections of our prospectus, which deducts from gross offering proceeds the selling commissions, dealer manager fees, and organization and offering expenses, which amounts are offset by the dealer manager fees and organization and offering expenses funded by our advisor. We will repeat the process of estimating share value of the common stock periodically, no less than annually.
For purposes of the preceding paragraphs, “Plans” include tax-qualified pension, stock bonus or profit-sharing plans, employee benefit plans described in Section 3(3) of ERISA, and annuities described in Section 403(a) or (b) of the Code, and “Accounts” include an individual retirement account or annuity described in Sections 408 or 408A of the Code (also known as IRAs), an Archer MSA described in Section 220(d) of the Code, a health savings account described in Section 223(d) of the Code, and a Coverdell education savings account described in Section 530 of the Code.
Determination of Estimated Value Per Share
On February 13, 2017, our board of directors, including all our independent directors, approved an estimated value per share of our Class A shares, Class T shares, and Class I shares of $9.37 based on the estimated value of our assets less the estimated value of our liabilities, or net asset value, divided by the approximate number of shares outstanding, calculated as of December 31, 2016. We are providing this estimated value per share to assist broker dealers in connection with their obligations under applicable FINRA rules with respect to customer account statements. This valuation was performed in accordance with the methodology provided in the IPA Valuation Guidelines, in addition to guidance from the SEC.
The estimated value per share was determined after consultation with our Advisor, and Duff & Phelps, LLC ("Duff & Phelps"), an independent third-party valuation firm not affiliated with our Advisor. Duff & Phelps was selected by our nominating and corporate governance committee to appraise the properties in our portfolio as of December 31, 2016. Duff & Phelps is actively engaged in the business of appraising commercial real estate properties similar to those owned by us in connection with public securities offerings, private placements, business combinations, and similar transactions. Duff & Phelps collected reasonably available material information that it deemed relevant in appraising our real estate properties and relied in part on property-level information provided by our Advisor, including (i) property historical and projected operating revenues and expenses; (ii) property lease agreements and/or lease abstracts; and (iii) information regarding recent or planned capital expenditures. In determining an estimated value per share, our board of directors considered the reports provided by Duff & Phelps and information provided by our Advisor. Our goal in calculating an estimated value per share is to arrive at a value that is reasonable and supportable using what our board of directors deems to be appropriate valuation methodologies and assumptions.
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After considering all information provided, and based on the nominating and corporate governance committee's extensive knowledge of our assets and liabilities, our nominating and corporate governance committee concluded that the range of estimated value per share of its Class A shares, Class T shares, and Class I shares of $8.74 to $10.05, with an approximate mid-range value per share of $9.37, as indicated in the reports provided by Duff & Phelps was reasonable and recommended to our board of directors that it adopt $9.37 as the estimated value per share for our Class A shares, Class T shares, and Class I shares. The board of directors unanimously agreed upon the estimated value per share for our Class A shares, Class T shares, and Class I shares of $9.37 recommended by our nominating and corporate governance committee, which determination is ultimately and solely the responsibility of our board of directors.
In conducting their investigation and analyses, Duff & Phelps took into account customary and accepted financial and commercial procedures and considerations as they deemed relevant; made numerous other assumptions as of various points in time with respect to industry performance, general business, economic, and regulatory conditions, and other matters, many of which are beyond their control and our control; and made assumptions with respect to certain factual matters. Furthermore, Duff & Phelps's analyses, opinions, and conclusions were necessarily based upon market, economic, financial, and other circumstances and conditions existing as of or prior to December 31, 2016, and any material change in such circumstances and conditions may affect Duff & Phelps's analyses and conclusions. Duff & Phelps's report contains other assumptions, qualifications, and limitations that qualify the analyses, opinions, and conclusions set forth therein.
Further, the value of our shares will fluctuate over time in response to developments related to individual assets in our portfolio and the management of those assets and in response to the real estate and finance markets. The estimated value per share does not reflect a discount for the fact that we are externally managed, nor does it reflect a real estate portfolio premium/discount versus the sum of the individual property values. The estimated value per share also does not take into account estimated disposition costs and fees for real estate properties that are not held for sale. As a result, our estimated value per share may not reflect the precise amount that might be paid to stockholders for their shares in a market transaction.
For additional information on the methodology used in calculating our estimated value per share, please refer to our Current Report on Form 8-K filed with the SEC on February 16, 2017.
Distributions
We elected to be taxed as a REIT under Sections 856 through 860 of the Code for the year ended December 31, 2015 and for each year thereafter. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to currently distribute at least 90% of the REIT’s ordinary taxable income to stockholders. As a REIT, we generally will not be subject to federal income tax on taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the IRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to stockholders. However, we believe that we will be organized and operate in such a manner as to qualify for treatment as a REIT and intend to operate in the foreseeable future in such a manner that we will remain qualified as a REIT for federal income tax purposes.
Distributions to stockholders, including stock distributions, are characterized for federal income tax purposes as ordinary income, capital gains, non-taxable return of capital or a combination of the three. Distributions that exceed our current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital for tax purposes rather than a distribution and reduce the stockholders’ basis in our common shares. To the extent that a distribution exceeds both current and accumulated earnings and profits and the stockholders’ basis in the common shares, it will generally be treated as a capital gain. We will notify stockholders of the taxability of distributions in January of the subsequent year for distributions paid during the preceding year, whether in cash or shares issued pursuant to the DRP. (See Note 8, Equity, for tax status of distributions per unit.)
Distributions were paid from proceeds raised in our Offering and operating cash flow from our properties. The following table shows the distributions we have declared and paid through December 31, 2016, excluding stock distributions:
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Quarter | Total Distributions Declared and Paid to Preferred Equity Holders (1) | Total Distributions Declared and Paid to Limited Partners (1) | Total Distributions Declared and Paid to Stockholders (1) | Distributions Declared per Common Share (2) | |||||||||||
1st Quarter 2015 | $ | — | $ | 2,712 | $ | 408,118 | $ | 0.13 | |||||||
2nd Quarter 2015 | $ | 21,193 | $ | 2,742 | $ | 1,480,131 | $ | 0.14 | |||||||
3rd Quarter 2015 | $ | 345,009 | $ | 2,773 | $ | 2,409,323 | $ | 0.14 | |||||||
4th Quarter 2015 | $ | 31,601 | $ | 2,773 | $ | 3,412,822 | $ | 0.14 | |||||||
1st Quarter 2016 | $ | — | $ | 2,735 | $ | 4,476,572 | $ | 0.14 | |||||||
2nd Quarter 2016 | $ | — | $ | 2,735 | $ | 6,164,353 | $ | 0.14 | |||||||
3rd Quarter 2016 | $ | — | $ | 2,765 | $ | 7,831,394 | $ | 0.14 | |||||||
4th Quarter 2016 | $ | — | $ | 2,765 | $ | 9,164,499 | $ | 0.14 | |||||||
(1) | Declared distributions are paid monthly in arrears. |
(2) | Distributions declared per common share amounts are rounded to the nearest $0.01. |
Securities Authorized for Issuance under Equity Compensation Plans
On April 22, 2014, our board of directors adopted our Employee and Director Long-Term Incentive Plan (the “Plan”) in order to (1) provide incentives to individuals who are granted awards because of their ability to improve our operations and increase profits; (2) encourage selected persons to accept or continue employment with us or with our Advisor or its affiliates that we deem important to our long-term success; and (3) increase the interest of our independent directors in our success through their participation in the growth in value of our stock. Pursuant to the Plan, we may issue stock-based awards to our directors and full-time employees (should we ever have employees), executive officers and full-time employees of our Advisor and its affiliates that provide services to us and who do not have any beneficial ownership of our Advisor and its affiliates, entities and full-time employees of entities that provide services to us, and certain consultants to us, our Advisor and its affiliates that provide services to us.
The term of the Plan is 10 years and the total number of shares of common stock reserved for issuance under the Plan is 10% of the outstanding shares of stock at any time, not to exceed 10,000,000 shares in the aggregate. Awards granted under the Plan may consist of stock options, restricted stock, stock appreciation rights and other equity-based awards. The stock-based payment will be measured at fair value and recognized as compensation expense over the vesting period. No awards were granted under the Plan as of December 31, 2016. On January 18, 2017, we issued 5,000 restricted stock shares to each of our independent directors.
In the event of an “equity restructuring” (meaning a nonreciprocal transaction between us and our stockholders that causes the per-share fair market value of the shares of stock underlying an award to change, such as a stock dividend, stock split, spinoff, rights offering, or recapitalization through a large, nonrecurring cash dividend), then the number of shares of stock and the class(es) of stock subject to the plan and each outstanding award and the exercise price (if applicable) of each outstanding award shall be proportionately adjusted. Upon our reorganization, merger or consolidation with one or more corporations as a result of which we are not the surviving corporation, or upon sale of all or substantially all of our assets, that, in each case, is not an equity restructuring, appropriate adjustments as to the number and kind of shares and exercise prices will be made either by our compensation committee or by such surviving entity. Such adjustment may provide for the substitution of such awards with new awards of the successor entity or the assumption of such awards by such successor entity. Alternatively, rather than providing for the adjustment, substitution or assumption of awards, the compensation committee may either (1) shorten the period during which awards are exercisable, or (2) cancel an award upon payment to the participant of an amount in cash that the compensation committee determines is equivalent to the amount of the fair market value of the consideration that the participant would have received if the participant exercised the award immediately prior to the effective time of the transaction.
In the event that the compensation committee determines that any distribution, recapitalization, stock split, reorganization, merger, liquidation, dissolution or sale, transfer, exchange or other disposition of all or substantially all of our assets, or other similar corporate transaction or event, affects the stock such that an adjustment is appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan or with respect to an award, then the compensation committee shall, in such manner as it may deem equitable, adjust the number and kind of shares or the exercise price with respect to any award. The following table provides information about the common stock that may be issued
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under the Plan as of December 31, 2016:
Plan Category | Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights | Weighted Average Exercise Price of Outstanding Options, Warrants and Rights | Number of Securities Remaining for Future Issuance Under Equity Compensation Plans (1) | |||||
Equity Compensation Plans Approved by Security Holders | — | — | 7,093,965 | |||||
Equity Compensation Plans Not Approved by Security Holders | — | — | — | |||||
Total | — | — | 7,093,965 | |||||
(1) | The total number of shares of our common stock (or common stock equivalents) reserved for issuance under the Plan is equal to 10% of our outstanding shares of stock at any time, but not to exceed 10,000,000 shares in the aggregate. As of December 31, 2016, we had 70,939,647 outstanding shares of common stock, including shares issued pursuant to the DRP and our stock distributions. |
Recent Sales of Unregistered Securities
During the year ended December 31, 2016, there were no sales of unregistered securities.
Use of Proceeds from Registered Securities
In September 2016, our board of directors approved the close of our Primary Offering effective January 20, 2017. In connection with the closing, our policy was to accept subscription agreements only if they were received by our transfer agent on or before the close of business on January 20, 2017. The accounts had to be fully funded and in good order no later than the close of business on January 31, 2017 for non-qualified account investments and March 3, 2017 for qualified account investments. We continue to sell shares of our common stock in the Offering pursuant to our DRP.
As of December 31, 2016, we had received aggregate gross proceeds from our offering of $684.7 million from the sale of 68,726,054 shares of our Class A, Class T and Class I common stock and approximately $19.7 million from the issuance of 2,082,326 shares of our Class A , Class T and Class I common stock pursuant to the DRP. Our equity raise as of December 31, 2016 resulted in the following:
Common shares issued in our Offering | 68,726,054 | ||
Common shares issued in our Offering pursuant to the DRP | 2,082,326 | ||
Total common shares | 70,808,380 | ||
Gross proceeds from our Offering | $ | 684,747,161 | |
Gross proceeds from our Offering from shares issued pursuant to our DRP | 19,746,488 | ||
Total gross proceeds from our Offering | 704,493,649 | ||
Selling Commissions and Dealer Manager fees incurred | (48,634,098 | ) | |
Reimbursement of O&O costs paid to our Advisor | (4,073,651 | ) | |
Net proceeds from our Offering | 651,785,900 | ||
Reimbursement of O&O costs owed to our Advisor | (2,477,391 | ) | |
Net proceeds from our Offering, adjusted for O&O costs owed to our Advisor | $ | 649,308,509 | |
The net offering proceeds raised in our offering were used primarily to fund:
• | Acquisitions of real property of approximately $414.0 million; |
• | Repayment of debt and redemptions of preferred units of approximately $150.3 million; |
• | Acquisition fees paid and expenses reimbursed to the Advisor of approximately $31.3 million; and |
• | Other business obligations, including, but not limited to, the payment of a portion of cash distributions to the stockholders of approximately $14.6 million and deferred financing cost of approximately $5.7 million. |
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Share Redemption Program
As noted in Note 8, Equity – Share Redemption Program, in the notes to the consolidated financial statements contained in this report, our board of directors has adopted a share redemption program ("SRP") that enables our stockholders to sell their shares to us in limited circumstances. Our SRP permits our stockholders to sell their shares back to us after they have held them
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for at least one year, subject to certain significant conditions and limitations. Our share redemption program has no set termination date, but our ability to redeem shares under the program is limited.
As of December 31, 2016, approximately $16.9 million in shares of common stock were eligible for redemption. As of December 31, 2016, there were 126,482 shares totaling approximately $1.2 million subject to redemption requests. On January 31, 2017, we satisfied all of the eligible redemption requests at a weighted average price per share of $9.40 pursuant to the terms of the SRP. Our board of directors may choose to amend, suspend or terminate our SRP upon 30 days’ written notice at any time.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial and operating information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the financial statements and related notes thereto included elsewhere in this annual report on Form 10-K:
Year Ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
Operating Data | ||||||||||||
Total Revenue | $ | 62,812,454 | $ | 25,149,023 | $ | — | ||||||
Income (Loss) from operations | $ | 4,264,754 | $ | (11,654,866 | ) | $ | (438,806 | ) | ||||
Net loss | $ | (6,106,350 | ) | $ | (16,505,653 | ) | $ | (494,592 | ) | |||
Net loss attributable to common stockholders | $ | (6,103,635 | ) | $ | (17,247,604 | ) | $ | (436,616 | ) | |||
Net loss attributable to common stockholders per Class A, Class T and Class I shares, basic and diluted (1) | $ | (0.12 | ) | $ | (1.19 | ) | $ | (0.86 | ) | |||
Distributions declared per common share | $ | 0.55 | $ | 0.55 | $ | 0.26 | ||||||
Balance Sheet Data | ||||||||||||
Total assets | $ | 1,184,476,275 | $ | 536,719,973 | (2) | $ | 10,588,267 | |||||
Total liabilities | $ | 613,090,704 | $ | 307,212,642 | (2) | $ | 1,057,440 | |||||
Redeemable common stock | $ | 16,929,838 | $ | 4,566,044 | $ | 50,666 | ||||||
Total stockholders’ equity | $ | 554,372,041 | $ | 224,844,098 | $ | 9,341,120 | ||||||
Total equity | $ | 554,455,733 | $ | 224,941,287 | $ | 9,480,161 | ||||||
Other Data | ||||||||||||
Net cash (used in) provided by operating activities | $ | 16,444,781 | $ | (2,935,708 | ) | $ | 53,765 | |||||
Net cash used in investing activities | $ | (548,028,139 | ) | $ | (486,147,536 | ) | $ | (2,000,000 | ) | |||
Net cash provided by financing activities | $ | 563,313,562 | $ | 500,521,908 | $ | 7,916,552 | ||||||
(1) | Amounts were retroactively adjusted to reflect stock dividends. (See note 2, Basis of Presentation and Summary of Significant Accounting Policies, for additional detail). |
(2) | Effective December 31, 2015, the Company adopted new guidance on the presentation of debt issuance costs. This guidance was adopted retrospectively and all prior periods have been adjusted to reflect this change in accounting principle. (See note 2, Basis of Presentation and Summary of Significant Accounting Policies, for additional detail). |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following “Management’s Discussion and Analysis of Financial Condition and Result of Operations” should be read in conjunction with the financial statements and the notes thereto contained in this report.
Overview
Griffin Capital Essential Asset REIT II, Inc., a Maryland corporation (the "Company," "we," "us," "our"), was formed on November 20, 2013 under the Maryland General Corporation Law and qualified as a real estate investment trust ("REIT") commencing with the year ended December 31, 2015. We were organized primarily with the purpose of acquiring single tenant net lease properties that are considered essential to the occupying tenant, and expect to use a substantial amount of the net proceeds from our initial public offering to invest in these properties. We are a newly formed company and are subject to the general risks associated with a start-up enterprise, including the risk of business failure.
As of December 31, 2016, our real estate portfolio consisted of 25 properties consisting substantially of office, industrial, distribution, and data center facilities with a combined acquisition value of $1.1 billion, including the allocation of the purchase price to above and below-market lease valuation, encompassing approximately 7.1 million square feet. Our annualized net rent for the 12-month period subsequent to December 31, 2016 was approximately $72.5 million with approximately 87.7% generated by properties leased to tenants and/or guarantors or whose non-guarantor parent companies have investment grade or equivalent ratings. Our rentable square feet under lease as of December 31, 2016 was 100%, with a weighted average remaining lease term of 11.4 years with average annual rent increases of approximately 2.2% and a leverage ratio of 44.2% as of December 31, 2016.
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Acquisition Indebtedness
For a discussion of our acquisition indebtedness, see Note 3, Real Estate, and Note 4, Debt, to the consolidated financial statements.
Inflation
The real estate market has not been affected significantly by inflation in the past several years due to the relatively low inflation rate. However, in the event inflation does become a factor, we expect that our leases typically will not include provisions that would protect us from the impact of inflation. We will attempt to acquire properties with leases that require the tenants to pay, directly or indirectly, all operating expenses and certain capital expenditures, which will protect us from increases in certain expenses, including, but not limited to, material and labor costs. In addition, we will attempt to acquire properties with leases that include rental rate increases, which will act as a potential hedge against inflation.
Summary of Significant Accounting Policies
We have established accounting policies which conform to GAAP as contained in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification. The preparation of our consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different estimates would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may use different estimates and assumptions that may impact the comparability of our financial condition and results of operations to those companies.
The following critical accounting policies discussion reflects what we believe are the most significant estimates, assumptions, and judgments used in the preparation of our consolidated financial statements. This discussion of our critical accounting policies is intended to supplement the description of our accounting policies in the footnotes to our consolidated financial statements and to provide additional insight into the information used by management when evaluating significant estimates, assumptions, and judgments. For further discussion of our significant accounting policies, see Note 2, “Basis of Presentation and Summary of Significant Accounting Policies” to our consolidated financial statements included in this report.
Real Estate- Valuation and Purchase Price Allocation
In January 2017, the FASB issued Accounting Standards Update ("ASU") 2017-01, Business Combinations, that clarifies the framework for determining whether an integrated set of assets and activities meets the definition of a business. The revised framework establishes a screen for determining whether an integrated set of assets and activities is a business and narrows the definition of a business, which is expected to result in fewer transactions being accounted for as business combinations. Acquisitions of integrated sets of assets and activities that do not meet the definition of a business are accounted for as asset acquisitions. This update is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted for transactions that have not been reported in previously issued (or available to be issued) financial statements.
We adopted this accounting standard early effective October 1, 2016. As a result of this adoption, we evaluated our real estate acquisitions completed during the fourth quarter of 2016 under the new framework and determined that the assets acquired did not meet the definition of a business. Accordingly, we accounted for these transactions as asset acquisitions (see Note 3, Real Estate).
When we acquire operating properties, we allocate the purchase price to the various components of the acquisition based upon the fair value of each component. The components typically include land, building and improvements, tenant improvements, intangible assets related to above and below market leases, intangible assets related to in-place leases, debt and other assumed assets and liabilities. Because of the timing or complexity of completing certain fair value adjustments, the initial purchase price allocation may be incomplete at the end of a reporting period, in which case we may record provisional purchase price allocation amounts based on information available at the acquisition date. Subsequent adjustments to provisional amounts are recognized during the measurement period, which cannot exceed one year from the date of acquisition.
We allocate the purchase price to the fair value of the tangible assets of a property by valuing the property as if it were vacant. This “as-if vacant” value is estimated using an income, or discounted cash flow, approach that relies upon Level 3 inputs, which are unobservable inputs based on our assumptions about the assumptions a market participant would use. These Level 3 inputs include discount rates, capitalization rates, market rents and comparable sales data for similar properties. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. In calculating the “as-if vacant” value for acquisitions completed during the year ended December 31, 2016 we used discount rates ranging from 6.25% to 8.50%.
In determining the fair value of intangible lease assets or liabilities, we also consider Level 3 inputs. Acquired above- and below-market leases are valued based on the present value of the difference between prevailing market rates and the in-place rates measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases, if applicable. The estimated fair value of acquired in-place at-market tenant leases are the costs that would have been incurred to lease the property to the occupancy level of the property at the date of acquisition. Such estimates include the value associated with leasing commissions, legal and other costs, as well as the estimated period necessary to lease such property that would be incurred to lease the property to its occupancy level at the time of its acquisition. Acquisition costs associated with the business combination are expensed in the period they are incurred.
The difference between the fair value and the face value of debt assumed in connection with an acquisition is recorded as a premium or discount and amortized to “interest expense” over the life of the debt assumed. The valuation of assumed liabilities is based on our estimate of the current market rates for similar liabilities in effect at the acquisition date.
For acquisitions that do not meet the accounting criteria to be accounted for as a business combination, we allocate the cost of the acquisition, which includes any associated acquisition costs, to the individual assets (typically land and building) and liabilities assumed on a relative fair value basis.
Impairment of Real Estate and Related Intangible Assets and Liabilities
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of real estate and related intangible assets may not be recoverable. When indicators of potential impairment are present that indicate that the carrying amounts of real estate and related intangible assets may not be recoverable, management will assess the recoverability of the assets by determining whether the carrying value of the assets will be recovered through the undiscounted future operating cash flows expected from the use of the assets and the eventual disposition. If based on this analysis we do not believe that we will be able to recover the carrying value of the asset, we will record an impairment loss to the extent the carrying value exceeds the estimated fair value of the asset.
Projections of expected future undiscounted cash flows require management to estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, discount rates, the number of months it takes to re-lease the property and the number of years the property is held for investment. As of December 31, 2016, we did not record any impairment charges related to our real estate assets or intangible assets.
Revenue Recognition
Leases associated with the acquisition and contribution of certain real estate assets have net minimum rent payment increases during the term of the lease and are recorded to rental revenue on a straight-line basis, commencing as of the
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contribution or acquisition date. If a lease provides for contingent rental income, we will defer the recognition of contingent rental income, such as percentage rents, until the specific target that triggers the contingent rental income is achieved.
Tenant reimbursement revenue, which is comprised of additional amounts collected from tenants for the recovery of certain operating expenses, including repair and maintenance, property taxes and insurance, and capital expenditures, to the extent allowed pursuant to the lease (collectively "Recoverable Expenses"), is recognized as revenue when the additional rent is due. Recoverable Expenses to be reimbursed by a tenant are determined based on our estimate of the property's operating expenses for the year, pro rated based on leased square footage of the property, and are collected in equal installments as additional rent from the tenant, pursuant to the terms of the lease. At the end of the calendar year, we reconcile the amount of additional rent paid by the tenant during the year to the actual amount of Recoverable Expenses incurred by us for the same period. The difference, if any, is either charged or credited to the tenant pursuant to the provisions of the lease. In certain instances the lease may restrict the amount we can recover from the tenant such as a cap on certain or all property operating expenses.
Recently Issued Accounting Pronouncements
See Note 2, Basis of Presentation and Summary of Significant Accounting Policies, to the consolidated financial statements.
Results of Operations
Overview
Same Store Analysis
We acquired our first property in March 2015, as a result, we have no same store comparison for the years ended December 31, 2016 and 2015.
Portfolio Analysis
As of December 31, 2015, we owned 15 properties and as of December 31, 2016, we owned 25 properties. As of December 31, 2016, we were a “blind pool” offering and in the acquisition stage of our life cycle, with the objective and concentration of continually growing our portfolio with assets that adhere to our investment criteria. Therefore, our results of operations for our entire portfolio for the year ended December 31, 2016 are not directly comparable to those for the same period in the prior year as the variances are substantially the result of portfolio growth, specifically in rental income, operating expenses, property and asset management expenses, reimbursable expenses and depreciation and amortization expenses. We expect that rental income, operating expenses, depreciation, and amortization expenses will each increase in future periods as we acquire additional properties.
Comparison of the Years Ended December 31, 2016 and 2015
We own 25 properties as of December 31, 2016. The variances from our results of operations for the year ended December 31, 2016 compared to the same period in the prior year, is primarily a result of current year activity including a full year of revenues and expenses for prior year acquisitions and activity for acquisitions subsequent to December 31, 2015.
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The following tables provide summary information about our results of operations for the years ended December 31, 2016 and 2015:
Year Ended December 31, | Increase/(Decrease) | Percentage Change | ||||||||||||
2016 | 2015 | |||||||||||||
Rental income | $ | 51,402,994 | $ | 21,215,843 | $ | 30,187,151 | 142 | % | ||||||
Property expense recoveries | 11,409,460 | 3,933,180 | 7,476,280 | 190 | % | |||||||||
Asset management fees to affiliates | 6,412,577 | 2,623,770 | 3,788,807 | 144 | % | |||||||||
Property management fees to affiliates | 1,052,461 | 333,016 | 719,445 | 216 | % | |||||||||
Property operating expense | 4,427,715 | 1,316,891 | 3,110,824 | 236 | % | |||||||||
Property tax expense | 7,045,713 | 2,713,373 | 4,332,340 | 160 | % | |||||||||
Acquisition fees and expenses to non-affiliates | 1,112,872 | 3,058,497 | (1,945,625 | ) | 64 | % | ||||||||
Acquisition fees and expenses to affiliates | 6,175,812 | 10,876,098 | (4,700,286 | ) | 43 | % | ||||||||
General and administrative expenses | 2,804,249 | 1,884,983 | 919,266 | 49 | % | |||||||||
Corporate operating expenses to affiliates | 1,622,165 | 1,936,626 | (314,461 | ) | 16 | % | ||||||||
Depreciation and amortization | 27,894,136 | 12,060,635 | 15,833,501 | 131 | % | |||||||||
Interest expense | 10,384,119 | 4,851,048 | 5,533,071 | 114 | % | |||||||||
Acquisition Fees and Expenses to Non-Affiliates and Affiliates
The decrease in acquisition fees and expenses to non-affiliates and affiliates for the year ended December 31, 2016 compared to the same period a year ago was approximately $6.6 million. The decrease was a result of an update to an accounting standard, which clarified the definition of a business combination. Under the clarified definition, our four acquisitions in the fourth quarter of 2016 did not qualify as business combinations; consequently, we accounted for each one as an asset acquisition. Thus, approximately $8.7 million of acquisition expenses were capitalized as part of the asset acquisitions and allocated on a relative fair value basis.
General and Administrative Expenses
The increase in general and administrative expenses for the year ended December 31, 2016 compared to the same period a year ago was approximately $0.9 million. The majority of the increase was related to increases in transfer agent fees and dead deal costs.
Corporate Operating Expenses to Affiliates
The decrease in corporate operating expenses to affiliates for the year ended December 31, 2016 compared to the same period a year ago was approximately $0.3 million. The decrease was primarily due to decreases in Advisor overhead allocation expenses.
Interest Expense
The increase of interest expense for the year ended December 31, 2016 primarily related to the AIG Loan, which was entered into on October 22, 2015 and an increase in the average outstanding borrowings related to the Revolving Credit Facility and interest rate.
Funds from Operations and Modified Funds from Operations
Our management believes that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient. Additionally, publicly registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation. While other start-up entities may also experience significant acquisition activity during their initial
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years, we believe that non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after the acquisition activity ceases.
In order to provide a more complete understanding of the operating performance of a REIT, the National Association of Real Estate Investment Trusts (“NAREIT”) promulgated a measure known as funds from operations (“FFO”). FFO is defined as net income or loss computed in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, adding back asset impairment write-downs, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships, joint ventures and preferred distributions. Because FFO calculations exclude such items as depreciation and amortization of real estate assets and gains and losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), they facilitate comparisons of operating performance between periods and between other REITs. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities. It should be noted, however, that other REITs may not define FFO in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently than we do, making comparisons less meaningful.
The Investment Program Association (“IPA”) issued Practice Guideline 2010-01 (the “IPA MFFO Guideline”) on November 2, 2010, which extended financial measures to include modified funds from operations (“MFFO”). In computing MFFO, FFO is adjusted for certain non-operating cash items such as acquisition fees and expenses and certain non-cash items such as straight-line rent, amortization of in-place lease valuations, amortization of discounts and premiums on debt investments, nonrecurring impairments of real estate-related investments, mark-to-market adjustments included in net income (loss), and nonrecurring gains or losses included in net income (loss) from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis.
Management is responsible for managing interest rate, hedge and foreign exchange risk. To achieve our objectives, we may borrow at fixed rates or variable rates. In order to mitigate our interest rate risk on certain financial instruments, if any, we may enter into interest rate cap agreements or other hedge instruments and in order to mitigate our risk to foreign currency exposure, if any, we may enter into foreign currency hedges. We view fair value adjustments of derivatives, impairment charges and gains and losses from dispositions of assets as non-recurring items or items which are unrealized and may not ultimately be realized, and which are not reflective of on-going operations and are therefore typically adjusted for when assessing operating performance.
Additionally, we believe it is appropriate to disregard impairment charges, as this is a fair value adjustment that is largely based on market fluctuations, assessments regarding general market conditions, and the specific performance of properties owned, which can change over time. No less frequently than annually, we evaluate events and changes in circumstances that could indicate that the carrying amounts of real estate and related intangible assets may not be recoverable. When indicators of potential impairment are present, we assess whether the carrying value of the assets will be recovered through the future undiscounted operating cash flows (including net rental and lease revenues, net proceeds on the sale of the property, and any other ancillary cash flows at a property or group level under GAAP) expected from the use of the assets and the eventual disposition. Investors should note, however, that determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of MFFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and the relatively limited term of our operations, it could be difficult to recover any impairment charges through operational net revenues or cash flows prior to any liquidity event.
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We adopted the IPA MFFO Guideline as management believes that MFFO is a beneficial indicator of our on-going portfolio performance and ability to sustain our current distribution level. More specifically, MFFO isolates the financial results of the REIT’s operations. MFFO, however, is not considered an appropriate measure of historical earnings as it excludes certain significant costs that are otherwise included in reported earnings. Further, since the measure is based on historical financial information, MFFO for the period presented may not be indicative of future results or our future ability to pay our dividends. By providing FFO and MFFO, we present information that assists investors in aligning their analysis with management’s analysis of long-term operating activities. MFFO also allows for a comparison of the performance of our portfolio with other REITs that are not currently engaging in acquisitions, as well as a comparison of our performance with that of other non-traded REITs, as MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes. As explained below, management’s evaluation of our operating performance excludes items considered in the calculation of MFFO based on the following economic considerations:
• | Revenues in excess of cash received, net. Most of our leases provide for periodic minimum rent payment increases throughout the term of the lease. In accordance with GAAP, these contractual periodic minimum rent payment increases during the term of a lease are recorded to rental revenue on a straight-line basis in order to reconcile the difference between accrual and cash basis accounting. As straight-line rent is a GAAP non-cash adjustment and is included in historical earnings, FFO is adjusted for the effect of straight-line rent to arrive at MFFO as a means of determining operating results of our portfolio. In addition, when applicable, in conjunction with certain acquisitions, we may enter into a master escrow or lease agreement with a seller, whereby the seller is obligated to pay us rent pertaining to certain spaces impacted by existing rental abatements. In accordance with GAAP, these proceeds are recorded as an adjustment to the allocation of real estate assets at the time of acquisition, and, accordingly, are not included in revenues, net income, or FFO. This application results in income recognition that can differ significantly from current contract terms. By adjusting for this item, we believe MFFO is reflective of the realized economic impact of our leases (including master agreements) that is useful in assessing the sustainability of our operating performance. |
• | Amortization of in-place lease valuation. Acquired in-place leases are valued as above-market or below-market as of the date of acquisition based on the present value of the difference between (a) the contractual amounts to be paid pursuant to the in-place leases and (b) management's estimate of fair market lease rates for the corresponding in-place leases over a period equal to the remaining non-cancelable term of the lease for above-market leases. The above-market and below-market lease values are capitalized as intangible lease assets or liabilities and amortized as an adjustment to rental income over the remaining terms of the respective leases. As amortization of in-place lease valuation is a non-cash adjustment and is included in historical earnings, FFO is adjusted for the effect of the amortization to arrive at MFFO as a means of determining operating results of our portfolio. |
• | Acquisition-related costs. We were organized primarily with the purpose of acquiring or investing in income-producing real property in order to generate operational income and cash flow that will allow us to provide regular cash distributions to our stockholders. In the process, we incur non-reimbursable affiliated and non-affiliated acquisition-related costs, which in accordance with GAAP, are expensed as incurred and are included in the determination of income (loss) from operations and net income (loss), for property acquisitions accounted for as a business combination. These costs have been and will continue to be funded with cash proceeds from our Primary Offering or included as a component of the amount borrowed to acquire such real estate. If we acquire a property after all offering proceeds from our Primary Offering have been invested, there will not be any offering proceeds to pay the corresponding acquisition-related costs. Accordingly, unless our Advisor determines to waive the payment of any then-outstanding acquisition-related costs otherwise payable to our Advisor, such costs will be paid from additional debt, operational earnings or cash flow, net proceeds from the sale of properties, or ancillary cash flows. In evaluating the performance of our portfolio over time, management employs business models and analyses that differentiate the costs to acquire investments from the investments’ revenues and expenses. Acquisition-related costs may negatively affect our operating results, cash flows from operating activities and cash available to fund distributions during periods in which properties are acquired, as the proceeds to fund these costs would otherwise be invested in other real estate related assets. By excluding acquisition-related costs, MFFO may not provide an accurate indicator of our operating performance during periods in which acquisitions are made. However, it can provide an indication of our on-going ability to generate cash flow from operations and continue as a going concern after we cease to acquire properties on a frequent and regular basis, which can be compared to the MFFO of other non-listed REITs that have completed their acquisition activity and |
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have similar operating characteristics to ours. Management believes that excluding these costs from MFFO provides investors with supplemental performance information that is consistent with the performance models and analysis used by management.
• | Gain or loss from the extinguishment of debt. We use debt as a partial source of capital to acquire properties in our portfolio. As a term of obtaining this debt, we will pay financing costs to the respective lender. Financing costs are presented on the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts and amortized into interest expense on a straight-line basis over the term of the debt. We consider the amortization expense to be a component of operations if the debt was used to acquire properties. From time to time, we may cancel certain debt obligations and replace these canceled debt obligations with new debt at more favorable terms to us. In doing so, we are required to write off the remaining capitalized financing costs associated with the canceled debt, which we consider to be a cost, or loss, on extinguishing such debt. Management believes that this loss is considered an event not associated with our operations, and therefore, deems this write off to be an exclusion from MFFO. |
• | Unrealized gains (losses) on derivative instruments. These adjustments include unrealized gains (losses) from mark-to-market adjustments on interest rate swaps and losses due to hedge ineffectiveness. The change in fair value of interest rate swaps not designated as a hedge and the change in fair value of the ineffective portion of interest rate swaps are non-cash adjustments recognized directly in earnings and are included in interest expense. We have excluded these adjustments in our calculation of MFFO to more appropriately reflect the economic impact of our interest rate swap agreements. |
For all of these reasons, we believe the non-GAAP measures of FFO and MFFO, in addition to income (loss) from operations, net income (loss) and cash flows from operating activities, as defined by GAAP, are helpful supplemental performance measures and useful to investors in evaluating the performance of our real estate portfolio. However, a material limitation associated with FFO and MFFO is that they are not indicative of our cash available to fund distributions since other uses of cash, such as capital expenditures at our properties and principal payments of debt, are not deducted when calculating FFO and MFFO. Additionally, MFFO has limitations as a performance measure in an offering such as ours where the price of a share of common stock is a stated value. The use of MFFO as a measure of long-term operating performance on value is also limited if we do not continue to operate under our current business plan as noted above. MFFO is useful in assisting management and investors in assessing our on-going ability to generate cash flow from operations and continue as a going concern in future operating periods, and in particular, after the offering and acquisition stages are complete and NAV is disclosed. However, FFO and MFFO are not useful measures in evaluating NAV because impairments are taken into account in determining NAV but not in determining FFO and MFFO. Therefore, FFO and MFFO should not be viewed as a more prominent measure of performance than income (loss) from operations, net income (loss) or to cash flows from operating activities and each should be reviewed in connection with GAAP measurements.
Neither the SEC, NAREIT, nor any other applicable regulatory body has opined on the acceptability of the adjustments contemplated to adjust FFO in order to calculate MFFO and its use as a non-GAAP performance measure. In the future, the SEC or NAREIT may decide to standardize the allowable exclusions across the REIT industry, and we may have to adjust the calculation and characterization of this non-GAAP measure.
Our calculation of FFO and MFFO is presented in the following table for the years ended December 31, 2016 and 2015:
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Year Ended December 31, | |||||||
2016 | 2015 | ||||||
Net loss | $ | (6,106,350 | ) | $ | (16,505,653 | ) | |
Adjustments: | |||||||
Depreciation of building and improvements | 11,630,453 | 4,915,542 | |||||
Amortization of leasing costs and intangibles | 16,263,683 | 7,145,093 | |||||
FFO/(FFO deficit) | $ | 21,787,786 | $ | (4,445,018 | ) | ||
Distributions to redeemable preferred unit holders | — | (397,803 | ) | ||||
Distributions to noncontrolling interests | (11,000 | ) | (11,000 | ) | |||
Preferred units redemption premium | — | (375,000 | ) | ||||
FFO/(FFO deficit), adjusted for noncontrolling interest distributions | $ | 21,776,786 | $ | (5,228,821 | ) | ||
Reconciliation of FFO to MFFO: | |||||||
Adjusted FFO/(FFO deficit) | $ | 21,776,786 | $ | (5,228,821 | ) | ||
Adjustments: | |||||||
Acquisition fees and expenses to non-affiliates | 1,112,872 | 3,058,497 | |||||
Acquisition fees and expenses to affiliates | 6,175,812 | 10,876,098 | |||||
Revenues in excess of cash received, net | (3,699,430 | ) | (1,500,085 | ) | |||
Amortization of above/(below) market rent | (3,591,640 | ) | (1,858,029 | ) | |||
Unrealized gain on derivatives | (154,647 | ) | — | ||||
Preferred units redemption premium | — | 375,000 | |||||
Loss on extinguishment of debt - write-off of deferred financing costs | 377,097 | — | |||||
MFFO | $ | 21,996,850 | $ | 5,722,660 | |||
Liquidity and Capital Resources
Long-Term Liquidity and Capital Resources
On a long-term basis, our principal demands for funds will be for property acquisitions, either directly or through entity interests, for the payment of operating expenses and distributions, and for the payment of interest on our outstanding indebtedness and other investments. Generally, cash needs for items, other than property acquisitions, will be met from operations and proceeds received from offerings. However, there may be a delay between the sale of our shares and our purchase of properties that could result in a delay in the benefits to our stockholders, if any, of returns generated from our investment operations. Our Advisor will evaluate potential property acquisitions and engage in negotiations with sellers on our behalf. After a purchase contract is executed that contains specific terms, the property will not be purchased until the successful completion of due diligence, which includes review of the title insurance commitment, an appraisal and an environmental analysis. In some instances, the proposed acquisition will require the negotiation of final binding agreements, which may include financing documents. During this period, we may decide to temporarily invest any unused proceeds from the offering in certain investments that could yield lower returns than the properties. These lower returns may affect our ability to make distributions.
Offering
Our registration statement was declared effective on July 31, 2014, pursuant to which we registered $2.2 billion in shares of common stock in our Offering, consisting of $2.0 billion in shares to be offered to the public in the Primary Offering and $200.0 million in shares for sale pursuant to our DRP. On April 25, 2016, we filed with the State Department of Assessments and Taxation of Maryland (the "Department") Articles Supplementary to our First Articles of Amendment and Restatement, (i) reclassifying 100,000,000 authorized but unissued shares of our Class A common stock, and (ii) 50,000,000 authorized but unissued shares of our Class T common stock, as 150,000,000 shares of Class I common stock. The Articles Supplementary were effective upon filing with the Department.
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The following table summarizes shares issued and gross proceeds for each share class as of December 31, 2016:
Class A | Class T | Class I | |||||||||
Gross proceeds from Primary Offering | $ | 240,779,591 | $ | 436,785,597 | $ | 7,181,972 | |||||
Gross proceeds from DRP | $ | 12,192,042 | $ | 7,484,285 | $ | 70,161 | |||||
Shares issued in Primary Offering | 24,199,760 | 43,754,033 | 772,261 | ||||||||
DRP shares issued | 1,284,804 | 790,101 | 7,421 | ||||||||
Stock distribution shares issued | 171,765 | 125,592 | 1,352 | ||||||||
Total shares issued prior to redemptions | 25,656,329 | 44,669,726 | 781,034 | ||||||||
On March 2, 2016, our board of directors extended the termination date of our Offering from July 31, 2016 until July 31, 2017, which is three years after the effective date of our Offering. In September 2016, our board of directors approved the close of our Primary Offering effective January 20, 2017. In connection with the closing, our policy was to accept subscription agreements only if they were received by our transfer agent on or before the close of business on January 20, 2017. The accounts had to be fully funded and in good order no later than the close of business on January 31, 2017 for non-qualified account investments and March 3, 2017 for qualified account investments. We continue to sell shares of our common stock in the Offering pursuant to our DRP.
Revolving Credit Facility
On December 12, 2014, we, through our operating partnership, entered into the Revolving Credit Facility co-led by KeyBank, N.A. ("Keybank") as administrative agent, and JPMorgan Chase Bank, N.A., as syndication agent, along with a syndicate of lenders. Pursuant to the Revolving Credit Facility, we were provided with an initial commitment of $250.0 million, which commitment may be increased under certain circumstances up to a maximum total commitment of $1.25 billion. On August 11, 2015, we exercised our right under the credit agreement to increase the total commitments from $250.0 million to $410.0 million.
On November 22, 2016, we, through our Operating Partnership, entered into an amendment (the "Increase Agreement") to the Revolving Credit Facility with KeyBank as administrative agent; Bank of America, N.A., SunTrust Bank, Capital One, National Association ("Capital One"), and Wells Fargo Bank, National Association, as co-syndication agents; and KeyBanc Capital Markets, Merrill Lynch, Pierce, Fenner and Smith Incorporated, SunTrust Robinson Humphrey, Inc., Capital One, and Wells Fargo Securities, LLC as joint lead arrangers and joint bookrunners to exercise our right under the Revolving Credit Facility to increase the total commitments from $410 million to $550 million. In connection with the Increase Agreement, we, through our Operating Partnership, also entered into a Joinder Agreement with KeyBank and U.S. Bank National Association ("U.S. Bank"), for the admission of U.S. Bank as a lender with a commitment of $50 million under the Revolving Credit Facility (the "Joinder Agreement"). With the admission of U.S. Bank, JPMorgan Chase terminated its commitment under the Revolving Credit Facility and no longer serves as a lender, syndication agent, joint bookrunner, or joint lead arranger under the Revolving Credit Facility.
The Revolving Credit Facility has an interest rate based on the consolidated leverage ratio reported with the quarterly compliance certificate and is calculated based on the LIBO Rate plus the applicable LIBO Rate margin, as provided in the credit agreement related to the Revolving Credit Facility, or Base Rate plus the applicable base rate margin, as provided in the credit agreement related to the Revolving Credit Facility. The Base Rate is calculated as the greater of (i) the KeyBank Prime rate or (ii) the Federal Funds rate plus 0.50%. Payments under the Revolving Credit Facility are interest only and are due on the first day of each quarter.
The Revolving Credit Facility was initially secured by a pledge of 100% of the ownership interests in each special purpose entity which owns a pool property. On November 1, 2016, all pledged membership interests were released from the lien of the pledge agreements and subsequently terminated. Adjustments to the applicable rate were effective as of January 1, 2017.
As of December 31, 2016, there was approximately $333.5 million outstanding pursuant to the Revolving Credit Facility.
AIG Loan
On October 22, 2015, six special purpose entities that are wholly-owned by our operating partnership, entered into promissory notes with The Variable Annuity Life Insurance Company, American General Life Insurance Company, and the
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United States Life Insurance Company (collectively, the "Lenders"), pursuant to which the Lenders provided such special purpose entities with a loan in the aggregate amount of approximately $127.0 million (the "AIG Loan").
The AIG Loan has a term of 10 years, maturing on November 1, 2025. The AIG Loan bears interest at a rate of 4.15%. The AIG Loan requires monthly payments of interest only for the first five years and fixed monthly payments of principal and interest thereafter. The AIG Loan is secured by cross-collateralized and cross-defaulted first lien deeds of trust and second lien deeds of trust on certain properties. Commencing October 31, 2017, each of the individual promissory notes comprising the AIG Loan may be prepaid but only if such prepayment is made in full, subject to 30 days' prior notice to the holder and payment of a prepayment premium in addition to all unpaid principal and accrued interest to the date of such prepayment.
As of December 31, 2016, there was approximately $127.0 million outstanding pursuant to the AIG Loan.
Derivative Instruments
As discussed in Note 5, Interest Rate Contracts, to the consolidated financial statements, on February 25, 2016, we entered into an interest rate swap agreement to hedge the variable cash flows associated with the existing LIBO Rate-based variable-rate debt on our Revolving Credit Facility. The interest rate swap is effective for the period from April 1, 2016 to December 12, 2018 with a notional amount of $100.0 million.
The effective portion of the change in fair value of derivatives designated and qualifying as cash flow hedges is initially recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments and accruals are made on our variable-rate debt.
The following table sets forth a summary of the interest rate swap at December 31, 2016 and December 31, 2015:
Fair value (1) | Current Effective Notional Amount (2) | |||||||||||||||||||||
Derivative Instrument | Effective Date | Maturity Date | Interest Strike Rate | December 31, 2016 | December 31, 2015 | December 31, 2016 | December 31, 2015 | |||||||||||||||
Assets/(Liabilities): | ||||||||||||||||||||||
Interest Rate Swap | 4/1/2016 | 12/12/2018 | 0.74% | $ | 996,099 | $ | — | $ | 100,000,000 | $ | — | |||||||||||
Contractual Commitments and Contingencies
The following is a summary of our contractual obligations as of December 31, 2016 :
Payments Due During the Years Ending December 31, | |||||||||||||||||||
Total | 2017 | 2018-2019 | 2020-2021 | Thereafter | |||||||||||||||
Outstanding debt obligations (1) (4) | $ | 460,427,720 | $ | — | $ | 333,457,720 | $ | 2,363,968 | $ | 124,606,032 | |||||||||
Interest on outstanding debt obligations (2) | 69,938,321 | 12,066,939 | 27,422,679 | 10,497,386 | 19,951,317 | ||||||||||||||
Interest rate swaps (3) | 277,142 | 134,184 | 142,958 | — | — | ||||||||||||||
Total | $ | 530,643,183 | $ | 12,201,123 | $ | 361,023,357 | $ | 12,861,354 | $ | 144,557,349 | |||||||||
(1) | Amount relates to principal payments for the outstanding balance on the Revolving Credit Facility and AIG Loan at December 31, 2016. The AIG Loan requires monthly payments of interest only for the first five years and fixed monthly payments of principal and interest thereafter. The Revolving Credit Facility is due on December 12, 2019, assuming the one-year extension is exercised and the AIG Loan is due on November 1, 2025. |
(2) | Projected interest payments are based on the outstanding principal amounts under the Revolving Credit Facility and AIG Loan at December 31, 2016. Projected interest payments are based on the interest rate in effect at December 31, 2016. |
(3) | The interest rate swaps contractual commitment was calculated based on the swap rate less the LIBO rate as of December 31, 2016. |
(4) | Deferred financing costs are excluded from total contractual obligations above. |
Other Potential Future Sources of Capital
Potential future sources of capital include proceeds from any public or private offering of our equity, proceeds from secured or unsecured financings from banks or other lenders, proceeds from the sale of properties and undistributed funds from operations. If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital
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expenditures. To the extent we are not able to secure additional financing in the form of a credit facility or other third party source of liquidity, we will be heavily dependent upon the proceeds of our public offering and income from operations in order to meet our long-term liquidity requirements and to fund our distributions.
Short-Term Liquidity and Capital Resources
We expect to meet our short-term operating liquidity requirements from advances from our Advisor and its affiliates, proceeds received in the Offering, and operating cash flows generated from our properties and other properties we acquire in the future. Any advances from our Advisor will be repaid, without interest, as funds are available after meeting our current liquidity requirements, subject to the limitations on reimbursement set forth in the “Management Compensation” section of our prospectus.
Our cash and cash equivalent balances increased by approximately $31.7 million during the year ended December 31, 2016 and were used in or provided by the following:
Operating Activities. Cash flows provided by operating activities are primarily dependent on the occupancy level, the rental rates of our leases, the collectability of rent and recovery of operating expenses from our tenants, and the timing of acquisitions. Net cash provided by operating activities for the year ended December 31, 2016 increased to $16.4 million compared to cash used in operating activities of approximately $(2.9) million for the year ended December 31, 2015. Net cash provided by/(used in) operating activities before changes in operating assets and liabilities for the year ended December 31, 2016 increased by $22.6 million to $15.3 million compared to approximately $(7.3) million for the year ended December 31, 2015. The increase primarily is due to the operating results of properties acquired during the current year.
Investing Activities. During the year ended December 31, 2016, we used $548.0 million in cash for investing activities compared to $486.1 million used during the same period in 2015. The $61.9 million increase in cash utilization in investing activities is primarily related to the following:
• | $73.9 million additional cash used to acquire properties for the year ended December 31, 2016 compared to the same period in 2015; offset by |
• | $15.7 million decrease in real estate acquisition deposits. |
Financing Activities. During the the year ended December 31, 2016, we generated $563.3 million in financing activities compared to $500.5 million generated during the same period in 2015, an increase in cash provided by financing activities of $62.8 million which is comprised primarily of the following:
• | $142.6 million increase in cash provided by the issuance of common stock, net of discounts and offering costs; and |
• | $92.5 million decrease in principal repayments of the Revolving Credit Facility; offset by |
• | $163.1 million decrease in cash provided from borrowings from the Revolving Credit Facility and AIG Loan; and |
• | $8.9 million increase in cash used for payment of distributions of common stockholders. |
Distributions
Distributions will be paid to our stockholders as of the record date selected by our board of directors. We expect to continue to pay distributions monthly based on daily declaration and record dates so that investors may be entitled to distributions immediately upon purchasing our shares. We expect to regularly pay distributions unless our results of operations, our general financial condition, general economic conditions, or other factors inhibit us from doing so. Distributions will be authorized at the discretion of our board of directors, which will be directed, in substantial part, by its obligation to cause us to comply with the REIT requirements of the Code. The funds we receive from operations that are available for distribution may be affected by a number of factors, including the following:
• | the amount of time required for us to invest the funds received in the Offering; |
• | our operating and interest expenses; |
• | the amount of distributions or dividends received by us from our indirect real estate investments; |
• | our ability to keep our properties occupied; |
• | our ability to maintain or increase rental rates; |
• | tenant improvements, capital expenditures and reserves for such expenditures; |
• | the issuance of additional shares; and |
• | financings and refinancings. |
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Distributions may be funded with operating cash flow, offering proceeds raised in our public offering, or a combination thereof. From inception and through December 31, 2016, we funded 83% of our cash distributions from cash flow provided by operating activities and 17% from offering proceeds. To the extent that we do not have taxable income, distributions paid will be considered a return of capital to stockholders. The following table shows distributions declared, distributions paid, and cash flow (used in) or provided by operating activities during the years ended December 31, 2016 and 2015, excluding stock distributions:
Year Ended December 31, 2016 | Year Ended December 31, 2015 | ||||||||||||
Distributions paid in cash — noncontrolling interests | $ | 11,003 | $ | 11,000 | |||||||||
Distributions paid in cash — common stockholders | 11,540,683 | 2,631,865 | |||||||||||
Distributions paid in cash — preferred equity | — | 397,803 | |||||||||||
Distributions of DRP | 15,158,260 | 4,537,562 | |||||||||||
Total distributions | $ | 26,709,946 | (1) | $ | 7,578,230 | ||||||||
Source of distributions (2) | |||||||||||||
Cash flows provided by operations | $ | 11,300,763 | 42 | % | $ | 861,262 | 11 | % | |||||
Offering proceeds from issuance of common stock | 250,923 | 1 | % | 2,179,406 | 29 | % | |||||||
Offering proceeds from issuance of common stock pursuant to the DRP | 15,158,260 | 57 | % | 4,537,562 | 60 | % | |||||||
Total sources | $ | 26,709,946 | (3) | 100 | % | $ | 7,578,230 | 100 | % | ||||
(1) | Distributions are paid on a monthly basis in arrears. Distributions for all record dates of a given month are paid on or about the first business day of the following month. Total distributions declared but not paid as of December 31, 2016 were approximately $1.5 million for common stockholders and noncontrolling interests. |
(2) | Percentages were calculated by dividing the respective source amount by the total sources of distributions. |
(3) | Allocation of total sources are calculated on a quarterly basis. |
Off-Balance Sheet Arrangements
As of December 31, 2016, we had no off-balance sheet transactions, nor do we currently have any such arrangements or obligations.
Subsequent Events
See Note 14, Subsequent Events, to the consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market risks include risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market-sensitive instruments. In pursuing our business plan, we expect that the primary market risk to which we will be exposed is interest rate risk.
In order to modify and manage the interest rate characteristics of our outstanding debt and to limit the effects of interest rate risks on our operations, we may utilize a variety of financial instruments, including interest rate swap agreements, caps, floors, and other interest rate exchange contracts. The use of these types of instruments to hedge a portion of our exposure to changes in interest rates carries additional risks, such as counterparty credit risk and the legal enforceability of hedging contracts.
On February 25, 2016, the Company executed one interest rate swap agreement to hedge the variable cash flows associated with certain existing LIBO Rate-based variable-rate debt, including the Company's Revolving Credit Facility. The interest rate swap is effective for the period from April 1, 2016 to December 12, 2018 with a notional amount of $100.0 million.
Our future earnings and fair values relating to financial instruments are primarily dependent upon prevalent market rates of interest, such as LIBO Rate. However, our interest rate swap agreements are intended to reduce the effects of interest rate changes. The effect of a 1% increase in interest rates, assuming a LIBO Rate floor of 0%, on our variable-rate debt, including our unsecured credit facility and our mortgage loan, after considering the effect of our interest rate swap agreement would decrease our future earnings and cash flows by approximately $2.4 million annually.
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In addition to changes in interest rates, the value of our future investments is subject to fluctuations based on changes in local and regional economic conditions and changes in the creditworthiness of tenants, which may affect our ability to refinance our debt if necessary, when such debt is incurred.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data filed as part of this annual report are set forth beginning on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this report, management, with the participation of our principal executive and principal financial officers, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our chief executive officer and chief financial officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for us. Our management, including our chief executive officer and chief financial officer, evaluated, as of December 31, 2016, the effectiveness of our internal control over financial reporting using the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2016.
There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
(a) During the quarter ended December 31, 2016, there was no information required to be disclosed in a report on Form 8-K which was not disclosed in a report on Form 8-K.
(b) During the quarter ended December 31, 2016, there were no material changes to the procedures by which security holders may recommend nominees to our board of directors.
51
PART III
We expect to file a definitive proxy statement for our 2017 Annual Meeting of Stockholders (the “2017 Proxy Statement”) with the SEC, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K and is incorporated by reference to the 2017 Proxy Statement. Only those sections of the 2017 Proxy Statement that specifically address the items required to be set forth herein are incorporated by reference.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is incorporated by reference to the 2017 Proxy Statement to be filed with the SEC.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the 2017 Proxy Statement to be filed with the SEC.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference to the 2017 Proxy Statement to be filed with the SEC.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference to the 2017 Proxy Statement to be filed with the SEC.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is incorporated by reference to the 2017 Proxy Statement to be filed with the SEC.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) List of Documents Filed.
1.The list of the financial statements contained herein is set forth on page F-1 hereof.
2.Schedule III — Real Estate and Accumulated Depreciation is set forth beginning on page S-1 hereof. All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are not applicable and therefore have been omitted.
3.The Exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index below.
(b) See (a) 3 above.
(c) See (a) 2 above.
EXHIBIT INDEX
The following exhibits are included in this Annual Report on Form 10-K for the year ended December 31, 2016 (and are numbered in accordance with Item 601 of Regulation S-K).
Exhibit No. | Description | |
1.1 | Dealer Manager Agreement and Participating Dealer Agreement dated June 20, 2014, incorporated by reference to Exhibit 1.1 to Pre-Effective Amendment No. 3 to the Registrant's Registration Statement on Form S-11, filed on July 8, 2014, SEC File No. 333-194280 | |
1.2 | Amendment No. 1 to Dealer Manager Agreement and Participating Dealer Agreement dated November 25, 2014, incorporated by reference to Exhibit 1.1 to the Registrant's Current Report on Form 8-K filed on December 1, 2014, SEC File No. 000-55605 | |
1.3 | Amendment No. 2 to Dealer Manager Agreement and Participating Dealer Agreement dated October 9, 2015, incorporated by reference to Exhibit 1.1 to the Registrant's Current Report on Form 8-K, filed on October 9, 2015, SEC File No. 333-194280 | |
1.4 | Amendment No. 3 to Dealer Manager Agreement and Participating Dealer Agreement dated April 25, 2016, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on April 29, 2016, SEC File No. 000-55605 | |
3.1 | First Articles of Amendment and Restatement of Griffin Capital Essential Asset REIT II, Inc., incorporated by reference to Exhibit 3.1 to Pre-Effective Amendment No. 4 to the Registrant's Registration Statement on Form S-11, filed on July 30, 2014, SEC File No. 333-194280 | |
3.2 | Bylaws of Griffin Capital Essential Asset REIT II, Inc., incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-11, filed on March 3, 2014, SEC File No. 333-194280 | |
3.3 | Articles Supplementary of Griffin Capital Essential Asset REIT II, Inc., incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K, filed on April 29, 2016, SEC File No. 000-55605 | |
4.1 | Form of Subscription Agreement and Subscription Agreement Signature Page, incorporated by reference to Exhibit 4.1 to Post-Effective Amendment No. 8 to the Registrant's Registration Statement on Form S-11, filed on November 18, 2016, SEC File No. 333-194280 | |
4.2 | Form of Additional Investment Subscription Agreement, incorporated by reference to Exhibit 4.2 to Post-Effective Amendment No. 8 to the Registrant's Registration Statement on Form S-11, filed on November 18, 2016, SEC File No. 333-194280 | |
4.3 | Amended and Restated Distribution Reinvestment Plan of Griffin Capital Essential Asset REIT II, Inc., incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K, filed on November 18, 2016, SEC File No. 000-55605 | |
10.1 | Advisory Agreement dated July 31, 2014, incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q, filed on August 21, 2014, SEC File No. 333-194280 | |
10.2+ | Employee and Director Long-Term Incentive Plan, incorporated by reference to Exhibit 10.6 to the Registrant's Quarterly Report on Form 10-Q, filed on August 21, 2014, SEC File No. 333-194280 | |
10.3+* | Griffin Capital Essential Asset REIT II, Inc.'s Employee and Director Long-Term Incentive Plan Form of Restricted Stock Agreement for Directors | |
10.4+* | Director Compensation Plan | |
10.5 | KeyBank Revolving Credit Facility dated December 12, 2014, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on December 18, 2014, SEC File No. 333-194280 | |
52
Exhibit No. | Description | |
10.6 | Note payable to KeyBank dated December 12, 2014, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on December 18, 2014, SEC File No. 333-194280 | |
10.7 | Guaranty dated December 12, 2014, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on December 18, 2014, SEC File No. 333-194280 | |
10.8 | Owens Corning Purchase Agreement dated February 2, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on March 12, 2015, SEC File No. 333-194280 | |
10.9 | Owens Corning Lease dated September 2, 1999, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on March 12, 2015, SEC File No. 333-194280 | |
10.10 | Second Amendment to Owens Corning Lease dated April 18, 2014, incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed on March 12, 2015, SEC File No. 333-194280 | |
10.11 | AOPC Purchase Agreement dated March 9, 2015, incorporated by reference to Exhibit 10.4 to the Registrant's Current Report on Form 8-K, filed on March 12, 2015, SEC File No. 333-194280 | |
10.12 | Master Property Management, Leasing, and Construction Management Agreement, dated March 17, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on March 23, 2015, SEC File No. 333-194280 | |
10.13 | Westgate II Purchase Agreement dated March 19, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on April 7, 2015, SEC File No. 333-194280 | |
10.14 | Westgate II Lease dated September 10, 2012, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on April 7, 2015, SEC File No. 333-194280 | |
10.15 | Amendment No. 1 to Westgate II Lease dated February 28, 2013, incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed on April 7, 2015, SEC File No. 333-194280 | |
10.16 | Amendment No. 2 to Westgate II Lease dated May 9, 2014, incorporated by reference to Exhibit 10.4 to the Registrant's Current Report on Form 8-K, filed on April 7, 2015, SEC File No. 333-194280 | |
10.17 | Amendment No. 3 to Westgate II Lease dated June 16, 2014, incorporated by reference to Exhibit 10.5 to the Registrant's Current Report on Form 8-K, filed on April 7, 2015, SEC File No. 333-194280 | |
10.18 | Amendment No. 1 to Advisory Agreement dated March 18, 2015, incorporated by reference to Exhibit 10.14 to Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-11, filed on April 8, 2015, SEC File No. 333-194280 | |
10.19 | AOPC Lease dated May 9, 2011, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on April 28, 2015, SEC File No. 333-194280 | |
10.20 | First Amendment to AOPC Lease dated July 16, 2014, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on April 28, 2015, SEC File No. 333-194280 | |
10.21 | Second Amendment to AOPC Lease dated March 27, 2015, incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed on April 28, 2015, SEC File No. 333-194280 | |
10.22 | Selected Dealer Agreement with Ameriprise dated as of May 5, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on May 11, 2015, SEC File No. 333-194280 | |
10.23 | American Express Center Purchase Agreement dated April 16, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on May 15, 2015, SEC File No. 333-194280 | |
10.24 | Data Center Lease dated August 23, 2005, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on May 15, 2015, SEC File No. 333-194280 | |
10.25 | First Amendment to Data Center Lease dated July 22, 2014, incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed on May 15, 2015, SEC File No. 333-194280 | |
10.26 | Technical Resource Center Lease dated July 27, 2005, incorporated by reference to Exhibit 10.4 to the Registrant's Current Report on Form 8-K, filed on May 15, 2015, SEC File No. 333-194280 | |
10.27 | First Amendment to Technical Resource Center Lease dated July 22, 2014, incorporated by reference to Exhibit 10.5 to the Registrant's Current Report on Form 8-K, filed on May 15, 2015, SEC File No. 333-194280 | |
10.28 | 840 Grier Building Lease dated November 25, 2013, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on June 2, 2015, SEC File No. 333-194280 | |
10.29 | First Amendment to 840 Grier Building Lease dated March 9, 2015, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on June 2, 2015, SEC File No. 333-194280 | |
10.30 | 880 Grier Building Lease dated November 25, 2013, incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed on June 2, 2015, SEC File No. 333-194280 | |
10.31 | 950 Grier Building Lease dated November 25, 2013, incorporated by reference to Exhibit 10.4 to the Registrant's Current Report on Form 8-K, filed on June 2, 2015, SEC File No. 333-194280 | |
53
Exhibit No. | Description | |
10.32 | Wyndham Purchase Agreement dated June 26, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on June 29, 2015, SEC File No. 333-194280 | |
10.33 | Second Amended and Restated Limited Partnership Agreement of Griffin Capital Essential Asset Operating Partnership II, L.P. dated June 24, 2015, incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed on June 29, 2015, SEC File No. 333-194280 | |
10.34 | Amendment No. 1 to the Second Amended and Restated Limited Partnership Agreement of Griffin Capital Essential Asset Operating Partnership II, L.P. dated June 24, 2015, incorporated by reference to Exhibit 10.4 to the Registrant's Current Report on Form 8-K, filed on June 29, 2015, SEC File No. 333-194280 | |
10.35 | Wyndham Lease dated August 5, 2011, incorporated by reference to Exhibit 10.5 to the Registrant's Current Report on Form 8-K, filed on June 29, 2015, SEC File No. 333-194280 | |
10.36 | Commencement Date Agreement dated March 26, 2013, incorporated by reference to Exhibit 10.6 to the Registrant's Current Report on Form 8-K, filed on June 29, 2015, SEC File No. 333-194280 | |
10.37 | 300 West Park Building Lease dated February 13, 2015, incorporated by reference to Exhibit 10.7 to the Registrant's Current Report on Form 8-K, filed on June 29, 2015, SEC File No. 333-194280 | |
10.38 | 500 West Park Building Lease dated February 13, 2015, incorporated by reference to Exhibit 10.8 to the Registrant's Current Report on Form 8-K, filed on June 29, 2015, SEC File No. 333-194280 | |
10.39 | Increase Agreement between Griffin Capital Essential Asset Operating Partnership II, L.P., KeyBank, JPMorgan Chase Bank, Bank of America, Fifth Third Bank, and Suntrust Bank, incorporated by reference to Exhibit 10.28 to the Registrant's Quarterly Report on Form 10-Q, filed on August 13, 2015, SEC File No. 333-194280 | |
10.40 | Joinder Agreement between Griffin Capital Essential Asset Operating Partnership II, L.P., KeyBank, and Associated Bank, National Association, incorporated by reference to Exhibit 10.29 to the Registrant's Quarterly Report on Form 10-Q, filed on August 13, 2015, SEC File No. 333-194280 | |
10.41 | 1800 Tapo Building Lease for the Bank of America property dated November 2013, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on August 19, 2015, SEC File No. 333-194280 | |
10.42 | 450 American Building Lease for the Bank of America property dated November 2013, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on August 19, 2015, SEC File No. 333-194280 | |
10.43 | VALIC Note for Owens Corning Sales, LLC Property, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on October 28, 2015, SEC File No. 333-194280 | |
10.44 | AGL Note for Owens Corning Sales, LLC Property, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on October 28, 2015, SEC File No. 333-194280 | |
10.45 | USL Note for Owens Corning Sales, LLC Property, incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed on October 28, 2015, SEC File No. 333-194280 | |
10.46 | First Deed of Trust for Owens Corning Sales, LLC Property, incorporated by reference to Exhibit 10.4 to the Registrant's Current Report on Form 8-K, filed on October 28, 2015, SEC File No. 333-194280 | |
10.47 | Second Deed of Trust for Owens Corning Sales, LLC Property, incorporated by reference to Exhibit 10.5 to the Registrant's Current Report on Form 8-K, filed on October 28, 2015, SEC File No. 333-194280 | |
10.48 | Recourse Carve-Out Guaranty Agreement, incorporated by reference to Exhibit 10.6 to the Registrant's Current Report on Form 8-K, filed on October 28, 2015, SEC File No. 333-194280 | |
10.49 | Schedule of Omitted Documents, incorporated by reference to Exhibit 10.7 to the Registrant's Current Report on Form 8-K, filed on October 28, 2015, SEC File No. 333-194280 | |
10.50 | Amendment No. 2 to Advisory Agreement dated November 2, 2015, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on November 6, 2015, SEC File No. 333-194280 | |
10.51 | Purchase and Sale Agreement for the Amazon Property, dated September 25, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on November 9, 2015, SEC File No. 333-194280 | |
10.52 | Amendment No. 3 to Advisory Agreement dated December 16, 2015, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on December 18, 2015, SEC File No. 333-194280 | |
10.53 | Amended and Restated Amendment to Selected Dealer Agreement dated December 22, 2015, incorporated by reference to Exhibit 1.1 to the Registrant’s Current Report on Form 8-K, filed on December 23, 2015, SEC File No. 333-194280 | |
54
Exhibit No. | Description | |
10.54 | Amendment No. 4 to Advisory Agreement dated February 9, 2016, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on February 10, 2016, SEC File No. 333-194280 | |
10.55 | Amendment No. 2 to Selected Dealer Agreement with Ameriprise dated April 11, 2016, incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q, filed on May 13, 2016, SEC File No. 000-55605 | |
10.56 | Amendment No. 2 to the Second Amended and Restated Limited Partnership Agreement of Griffin Capital Essential Asset Operating Partnership II, LP, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on April 29, 2016, SEC File No. 000-55605 | |
10.57 | Amendment No. 3 to Selected Dealer Agreement with Ameriprise dated May 31, 2016, incorporated by reference to Exhibit 10.55 to the Registrant's Post-Effective Amendment No. 6 to Form S-11, filed on June 22, 2016, SEC File No. 333-194280 | |
10.58 | Increase Agreement between Griffin Capital Essential Asset Operating Partnership II, L.P., KeyBank, National Association, Bank of America, N.A., SunTrust Bank, Capital One, National Association, JPMorgan Chase Bank, N.A., and Wells Fargo Bank, National Association, incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on November 29, 2016, SEC File No. 000-55605 | |
10.59 | Joinder Agreement between Griffin Capital Essential Asset Operating Partnership II, L.P., KeyBank, National Association, and U.S. Bank National Association, incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on November 29, 2016, SEC File No. 000-55605 | |
10.60 | Amendment No. 4 to Selected Dealer Agreement, dated as of December 19, 2016, by and among Griffin Capital Essential Asset REIT II, Inc., Griffin Capital Corporation, Griffin Capital Securities, LLC, Griffin Capital Essential Asset Advisor II, LLC, and Ameriprise Financial Services, Inc., incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on December 22, 2016, SEC File No. 000-55605 | |
10.61 | Cost Reimbursement Agreement, dated as of December 19, 2016 and effective as of January 1, 2017, by and among Griffin Capital Essential Asset REIT II, Inc., Griffin Capital Corporation, Griffin Capital Securities, LLC, Griffin Capital Essential Asset Advisor II, LLC and American Enterprise Investment Services Inc., incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed on December 22, 2016, SEC File No. 000-55605 | |
10.62 | Purchase and Sale Agreement for 3535 Colonnade Parkway, Birmingham, Alabama dated December 22, 2016, incorporated by reference to Exhibit 99.1 to the Registrant's Current Report on Form 8-K, filed on December 29, 2016, SEC File No. 000-55605 | |
21.1 | Subsidiaries of Griffin Capital Essential Asset REIT II, Inc., incorporated by reference to Exhibit 21.1 to the Registrant's Registration Statement on Form S-11, filed on March 3, 2014, SEC File No. 333-194280 | |
31.1* | Certification of Principal Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2* | Certification of Principal Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1** | Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2** | Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002 | |
101* | The following Griffin Capital Essential Asset REIT II, Inc. financial information for the period ended December 31, 2016 formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Equity, (iv) Consolidated Statements of Cash Flows and (v) Notes to Consolidated Financial Statements. | |
* | Filed herewith. | |
** | Furnished herewith. | |
+ | Management contract, compensatory plan or arrangement filed in response to Item 15(a)(3) of Instructions to Form 10-K. | |
55
ITEM 16. FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of El Segundo, State of California, on March 14, 2017.
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC. | |||
By: | /s/ Kevin A. Shields | ||
Kevin A. Shields | |||
Chief Executive Officer and Chairman | |||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature | Title | Date | ||
/s/ Kevin A. Shields | Chief Executive Officer and Chairman (Principal Executive Officer) | March 14, 2017 | ||
Kevin A. Shields | ||||
/s/ Javier F. Bitar | Chief Financial Officer and Treasurer (Principal Financial Officer) | March 14, 2017 | ||
Javier F. Bitar | ||||
/s/ Michael J. Escalante | Director and President | March 14, 2017 | ||
Michael J. Escalante | ||||
/s/ J. Grayson Sanders | Independent Director | March 14, 2017 | ||
J. Grayson Sanders | ||||
/s/ Kathleen S. Briscoe | Independent Director | March 14, 2017 | ||
Kathleen S. Briscoe | ||||
/s/ Samuel Tang | Independent Director | March 14, 2017 | ||
Samuel Tang | ||||
56
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements | |
Financial Statement Schedule | |
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
F-1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Griffin Capital Essential Asset REIT II, Inc.:
We have audited the accompanying consolidated balance sheets of Griffin Capital Essential Asset REIT II, Inc. (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive loss, equity, and cash flows for the years ended December 31, 2016 and 2015, and for the period from February 11, 2014 (date of initial capitalization) through December 31, 2014. Our audits included the financial statement schedule listed in the Index at Item 15. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Griffin Capital Essential Asset REIT II, Inc. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for the years ended December 31, 2016 and 2015 and for the period from February 11, 2014 (date of initial capitalization) through December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the Company changed (a) its presentation of debt issuance costs as a result of the adoption of the amendment to the FASB Accounting Standards Codification resulting from Accounting Standards Update 2015-03 “Interest - Imputation of Interest - Simplifying the Presentation of Debt Issuance Costs” effective January 1, 2016; and (b) its evaluation of whether an acquisition qualifies as a business combination or asset acquisition as a result of the adoption of the FASB Accounting Standards Codification Update 2017-01 “Business Combination: Clarifying the Definition of a Business,” effective October 1, 2016.
/s/ Ernst & Young LLP
Los Angeles, California
March 14, 2017
F-2
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2016 | December 31, 2015 | ||||||
ASSETS | |||||||
Cash and cash equivalents | $ | 49,340,185 | $ | 17,609,981 | |||
Restricted Cash | 14,221,311 | — | |||||
Real estate: | |||||||
Land | 117,569,491 | 53,229,574 | |||||
Building | 787,998,830 | 353,083,087 | |||||
Tenant origination and absorption cost | 227,407,041 | 110,652,188 | |||||
Construction in progress | 79,993 | — | |||||
Total real estate | 1,133,055,355 | 516,964,849 | |||||
Less: accumulated depreciation and amortization | (39,954,771 | ) | (12,060,635 | ) | |||
Total real estate, net | 1,093,100,584 | 504,904,214 | |||||
Above market leases, net | 3,527,854 | — | |||||
Real estate acquisition deposits | 250,000 | 8,950,000 | |||||
Deferred rent | 5,424,033 | 1,500,086 | |||||
Other assets, net | 18,612,308 | 3,755,692 | |||||
Total assets | $ | 1,184,476,275 | $ | 536,719,973 | |||
LIABILITIES AND EQUITY | |||||||
Debt: | |||||||
Revolving Credit Facility | $ | 330,271,808 | $ | 135,940,517 | |||
AIG Loan | 126,199,639 | 126,013,457 | |||||
Total debt | 456,471,447 | 261,953,974 | |||||
Restricted reserves | 55,797,648 | 104,951 | |||||
Accrued expenses and other liabilities | 21,527,126 | 7,011,243 | |||||
Distributions payable | 1,494,119 | 556,246 | |||||
Due to affiliates | 22,481,213 | 2,323,696 | |||||
Below market leases, net | 55,319,151 | 35,262,532 | |||||
Total liabilities | 613,090,704 | 307,212,642 | |||||
Commitments and contingencies (Note 11) | |||||||
Common stock subject to redemption | 16,929,838 | 4,566,044 | |||||
Stockholders' equity: | |||||||
Preferred Stock, $0.001 par value, 200,000,000 shares authorized; no shares outstanding, as of December 31, 2016 and 2015 | — | — | |||||
Common Stock, $0.001 par value, 700,000,000 shares authorized; 70,939,647 and 28,556,170 Class A, Class T and Class I shares outstanding, as of December 31, 2016 and December 31, 2015, respectively. | 70,939 | 28,556 | |||||
Additional paid-in capital | 615,652,878 | 250,757,479 | |||||
Cumulative distributions | (38,405,155 | ) | (8,257,717 | ) | |||
Accumulated deficit | (23,787,855 | ) | (17,684,220 | ) | |||
Accumulated other comprehensive income | 841,234 | — | |||||
Total stockholders' equity | 554,372,041 | 224,844,098 | |||||
Noncontrolling interests | 83,692 | 97,189 | |||||
Total equity | 554,455,733 | 224,941,287 | |||||
Total liabilities and equity | $ | 1,184,476,275 | $ | 536,719,973 | |||
See accompanying notes.
F-3
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, | |||||||||||
2016 | 2015 | For the Period from February 11, 2014 (Date of Initial Capitalization) through December 31, 2014 | |||||||||
Revenue: | |||||||||||
Rental income | $ | 51,402,994 | $ | 21,215,843 | $ | — | |||||
Property expense recovery | 11,409,460 | 3,933,180 | — | ||||||||
Total revenue | 62,812,454 | 25,149,023 | — | ||||||||
Expenses: | |||||||||||
Asset management fees to affiliates | 6,412,577 | 2,623,770 | — | ||||||||
Property management fees to affiliates | 1,052,461 | 333,016 | — | ||||||||
Property operating | 4,427,715 | 1,316,891 | — | ||||||||
Property tax | 7,045,713 | 2,713,373 | — | ||||||||
Acquisition fees and expenses to non-affiliates | 1,112,872 | 3,058,497 | — | ||||||||
Acquisition fees and expenses to affiliates | 6,175,812 | 10,876,098 | — | ||||||||
General and administrative | 2,804,249 | 1,884,983 | 438,806 | ||||||||
Corporate operating expenses to affiliates | 1,622,165 | 1,936,626 | — | ||||||||
Depreciation and amortization | 27,894,136 | 12,060,635 | — | ||||||||
Total expenses | 58,547,700 | 36,803,889 | 438,806 | ||||||||
Income (Loss) from operations | 4,264,754 | (11,654,866 | ) | (438,806 | ) | ||||||
Interest expense | (10,384,119 | ) | (4,851,048 | ) | (55,786 | ) | |||||
Other income | 13,015 | 261 | — | ||||||||
Net loss | (6,106,350 | ) | (16,505,653 | ) | (494,592 | ) | |||||
Distributions to redeemable preferred unit holders | — | (397,803 | ) | — | |||||||
Preferred units redemption premium | — | (375,000 | ) | — | |||||||
Less: Net loss attributable to noncontrolling interests | 2,715 | 30,852 | 57,976 | ||||||||
Net loss attributable to common stockholders | $ | (6,103,635 | ) | $ | (17,247,604 | ) | $ | (436,616 | ) | ||
Net loss per share, basic and diluted | $ | (0.12 | ) | $ | (1.19 | ) | $ | (0.86 | ) | ||
Weighted average number of common shares | 50,712,589 | 14,479,960 | 508,797 | ||||||||
See accompanying notes.
F-4
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
Year Ended December 31, | |||||||||||
2016 | 2015 | For the Period from February 11, 2014 (Date of Initial Capitalization) through December 31, 2014 | |||||||||
Net loss | $ | (6,106,350 | ) | $ | (16,505,653 | ) | $ | (494,592 | ) | ||
Other comprehensive income: | |||||||||||
Change in fair value of swap agreement | 841,452 | — | — | ||||||||
Total comprehensive loss | (5,264,898 | ) | (16,505,653 | ) | (494,592 | ) | |||||
Distributions to redeemable preferred unit holders | — | (397,803 | ) | — | |||||||
Preferred units redemption premium | — | (375,000 | ) | — | |||||||
Less: comprehensive loss attributable to noncontrolling interests | 2,497 | 30,852 | 57,976 | ||||||||
Comprehensive loss attributable to common stockholders | $ | (5,262,401 | ) | $ | (17,247,604 | ) | $ | (436,616 | ) | ||
F-5
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
CONSOLIDATED STATEMENTS OF EQUITY
Common Stock | Additional Paid-In Capital | Cumulative Distributions | Accumulated Deficit | Accumulated Other Comprehensive Income | Total Stockholders’ Equity | Non- controlling Interests | Total Equity | |||||||||||||||||||||||||||
Shares | Amount | |||||||||||||||||||||||||||||||||
BALANCE February 11, 2014 (Date of Initial Capitalization) | 100 | $ | 1 | $ | 999 | $ | — | $ | — | $ | — | $ | 1,000 | $ | 200,000 | $ | 201,000 | |||||||||||||||||
Gross proceeds from issuance of common stock | 1,128,340 | 11,283 | 11,272,116 | — | — | — | 11,283,399 | — | 11,283,399 | |||||||||||||||||||||||||
Discount on issuance of common stock | — | — | (279,960 | ) | — | — | — | (279,960 | ) | — | (279,960 | ) | ||||||||||||||||||||||
Offering costs including dealer manager fees to affiliates | — | — | (1,154,894 | ) | — | — | — | (1,154,894 | ) | — | (1,154,894 | ) | ||||||||||||||||||||||
Distributions to common stockholders | — | — | — | (21,143 | ) | — | — | (21,143 | ) | — | (21,143 | ) | ||||||||||||||||||||||
Issuance of shares for distribution reinvestment plan | 5,333 | 51 | 50,615 | (50,666 | ) | — | — | — | — | — | ||||||||||||||||||||||||
Additions to common stock subject to redemption | — | — | (50,666 | ) | — | — | — | (50,666 | ) | — | (50,666 | ) | ||||||||||||||||||||||
Distributions for noncontrolling interest | — | — | — | — | — | — | — | (2,983 | ) | (2,983 | ) | |||||||||||||||||||||||
Net loss | — | — | — | — | (436,616 | ) | — | (436,616 | ) | (57,976 | ) | (494,592 | ) | |||||||||||||||||||||
BALANCE December 31, 2014 | 1,133,773 | $ | 11,335 | $ | 9,838,210 | $ | (71,809 | ) | $ | (436,616 | ) | $ | — | $ | 9,341,120 | $ | 139,041 | $ | 9,480,161 | |||||||||||||||
Gross proceeds from issuance of common stock | 26,897,208 | 167,766 | 268,804,318 | — | — | — | 268,972,084 | — | 268,972,084 | |||||||||||||||||||||||||
Adjustment to par value - common stock | — | (152,530 | ) | 152,530 | — | — | — | — | — | — | ||||||||||||||||||||||||
Discount on issuance of common stock | — | — | (997,020 | ) | — | — | — | (997,020 | ) | — | (997,020 | ) | ||||||||||||||||||||||
Offering costs including dealer manager fees to affiliates | — | — | (27,514,088 | ) | — | — | — | (27,514,088 | ) | — | (27,514,088 | ) | ||||||||||||||||||||||
Distributions to common stockholders | — | — | — | (3,172,832 | ) | — | — | (3,172,832 | ) | — | (3,172,832 | ) | ||||||||||||||||||||||
Issuance of shares for distribution reinvestment plan | 477,638 | 1,509 | 4,536,053 | (4,537,562 | ) | — | — | — | — | — | ||||||||||||||||||||||||
Additions to common stock subject to redemption | — | — | (4,537,562 | ) | — | — | — | (4,537,562 | ) | — | (4,537,562 | ) | ||||||||||||||||||||||
Issuance of stock dividends | 47,551 | 476 | 475,038 | (475,514 | ) | — | — | — | — | — | ||||||||||||||||||||||||
Distributions to noncontrolling interest | — | — | — | — | — | — | — | (11,000 | ) | (11,000 | ) | |||||||||||||||||||||||
Preferred units offering cost | — | — | (375,000 | ) | — | — | — | (375,000 | ) | — | (375,000 | ) | ||||||||||||||||||||||
Write-off of offering cost on redemption of preferred units | — | — | 375,000 | — | — | — | 375,000 | — | 375,000 | |||||||||||||||||||||||||
Net loss | — | — | — | — | (17,247,604 | ) | — | (17,247,604 | ) | (30,852 | ) | (17,278,456 | ) | |||||||||||||||||||||
BALANCE December 31, 2015 | 28,556,170 | $ | 28,556 | $ | 250,757,479 | $ | (8,257,717 | ) | $ | (17,684,220 | ) | $ | — | $ | 224,844,098 | $ | 97,189 | $ | 224,941,287 | |||||||||||||||
Gross proceeds from issuance of common stock | 40,700,406 | 40,700 | 406,422,776 | — | — | — | 406,463,476 | — | 406,463,476 | |||||||||||||||||||||||||
F-6
Discount on issuance of common stock | — | — | (695,819 | ) | — | — | — | (695,819 | ) | — | (695,819 | ) | ||||||||||||||||||||||
Offering costs including dealer manager fees and stockholder servicing fees to affiliates | — | — | (43,340,495 | ) | — | — | — | (43,340,495 | ) | — | (43,340,495 | ) | ||||||||||||||||||||||
Distributions to common stockholders | — | — | — | (12,478,558 | ) | — | — | (12,478,558 | ) | — | (12,478,558 | ) | ||||||||||||||||||||||
Issuance of shares for distribution reinvestment plan | 1,599,355 | 1,599 | 15,156,661 | (15,158,260 | ) | — | — | — | — | — | ||||||||||||||||||||||||
Repurchase of common stock | (167,442 | ) | (167 | ) | (1,626,606 | ) | — | — | — | (1,626,773 | ) | — | (1,626,773 | ) | ||||||||||||||||||||
Additions to common stock subject to redemption | — | — | (13,531,487 | ) | — | — | — | (13,531,487 | ) | — | (13,531,487 | ) | ||||||||||||||||||||||
Issuance of stock dividends | 251,158 | 251 | 2,510,369 | (2,510,620 | ) | — | — | — | — | — | ||||||||||||||||||||||||
Distributions to noncontrolling interest | — | — | — | — | — | — | — | (11,000 | ) | (11,000 | ) | |||||||||||||||||||||||
Net loss | — | — | — | — | (6,103,635 | ) | — | (6,103,635 | ) | (2,715 | ) | (6,106,350 | ) | |||||||||||||||||||||
Other comprehensive income | — | — | — | — | — | 841,234 | 841,234 | 218 | 841,452 | |||||||||||||||||||||||||
BALANCE December 31, 2016 | 70,939,647 | $ | 70,939 | $ | 615,652,878 | $ | (38,405,155 | ) | $ | (23,787,855 | ) | $ | 841,234 | $ | 554,372,041 | $ | 83,692 | $ | 554,455,733 | |||||||||||||||
See accompanying notes.
F-7
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, | |||||||||||
2016 | 2015 | For the Period from February 11, 2014 (Date of Initial Capitalization) through December 31, 2014 | |||||||||
Net loss | $ | (6,106,350 | ) | $ | (16,505,653 | ) | $ | (494,592 | ) | ||
Adjustments to reconcile net loss to net cash used in operations: | |||||||||||
Depreciation of building | 11,630,453 | 4,915,541 | — | ||||||||
Amortization of intangibles | 16,263,683 | 7,145,094 | — | ||||||||
Amortization of above and below market leases | (3,591,640 | ) | (1,858,029 | ) | — | ||||||
Amortization of deferred financing costs | 1,195,902 | 514,024 | 21,064 | ||||||||
Deferred rent | (3,923,946 | ) | (1,500,086 | ) | — | ||||||
Unrealized gain on interest rate swaps | (154,647 | ) | — | — | |||||||
Change in operating assets and liabilities: | — | ||||||||||
Other assets, net | (1,040,888 | ) | (2,064,302 | ) | (514,868 | ) | |||||
Accrued expenses and other liabilities | 3,093,852 | 6,271,274 | 175,985 | ||||||||
Due to affiliates, net | (921,638 | ) | 146,429 | 866,176 | |||||||
Net cash provided by (used in) operating activities | 16,444,781 | (2,935,708 | ) | 53,765 | |||||||
Investing Activities: | |||||||||||
Acquisition of properties, net | (553,066,798 | ) | (479,197,536 | ) | — | ||||||
Restricted reserves | (3,541,348 | ) | — | — | |||||||
Improvements to real estate | (40,000 | ) | — | — | |||||||
Payments for construction in progress | (79,993 | ) | — | — | |||||||
Real estate acquisition deposits | 8,700,000 | (6,950,000 | ) | (2,000,000 | ) | ||||||
Net cash used in investing activities | (548,028,139 | ) | (486,147,536 | ) | (2,000,000 | ) | |||||
Financing Activities: | |||||||||||
Proceeds from borrowings - Credit Facility | 249,900,000 | 286,050,000 | — | ||||||||
Proceeds from borrowings - AIG Loan | — | 126,970,000 | — | ||||||||
Principal payoff of indebtedness - Credit Facility | (55,000,000 | ) | (147,492,280 | ) | — | ||||||
Deferred financing costs | (1,578,429 | ) | (2,185,692 | ) | (1,923,146 | ) | |||||
Issuance of common stock, net of offering costs | 383,170,450 | 240,595,548 | 9,848,545 | ||||||||
Issuance of preferred equity subject to redemption | — | 73,260,000 | — | ||||||||
Redemption of preferred units | — | (73,260,000 | ) | — | |||||||
Repurchase of common stock | (1,626,773 | ) | — | — | |||||||
Distributions paid to common stockholders | (11,540,683 | ) | (2,631,865 | ) | (6,798 | ) | |||||
Distributions paid to noncontrolling interests | (11,003 | ) | (11,000 | ) | (2,049 | ) | |||||
Distributions paid to preferred units subject to redemption | — | (397,803 | ) | — | |||||||
Preferred offering cost | — | (375,000 | ) | — | |||||||
Net cash provided by financing activities | 563,313,562 | 500,521,908 | 7,916,552 | ||||||||
Net increase in cash and cash equivalents | 31,730,204 | 11,438,664 | 5,970,317 | ||||||||
Cash and cash equivalents at the beginning of the period | 17,609,981 | 6,171,317 | 201,000 | ||||||||
Cash and cash equivalents at the end of the period | $ | 49,340,185 | $ | 17,609,981 | $ | 6,171,317 | |||||
Supplemental disclosure of cash flow information: | |||||||||||
Cash paid for interest | $ | 9,227,547 | 2,616,311 | $ | — | ||||||
Supplemental disclosures of non-cash investing and financing transactions: | |||||||||||
Increase in Stock Servicing Fee Payable | $ | 17,449,299 | $ | 24,968 | $ | — | |||||
Increase in distributions payable to common stockholders | $ | 937,876 | $ | 540,967 | $ | 14,345 | |||||
Common stock issued pursuant to the distribution reinvestment plan | $ | 15,158,260 | $ | 4,515,378 | $ | 50,666 | |||||
See accompanying notes.
F-8
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
1. Organization
Griffin Capital Essential Asset REIT II, Inc., a Maryland corporation (the “Company”), was formed on November 20, 2013 under the Maryland General Corporation Law and qualified as a real estate investment trust (“REIT”) commencing with the year ended December 31, 2015. The Company was organized primarily with the purpose of acquiring single tenant net lease properties that are considered essential to the occupying tenant, and expects to use a substantial amount of the net proceeds from its initial public offering to invest in these properties. The Company’s year end is December 31.
Griffin Capital Company, LLC, a Delaware limited liability company (the “Sponsor”), is the sponsor of the Company. The Sponsor began operations in 1995, and was incorporated in 1996, to principally engage in acquiring and developing office and industrial properties. Kevin A. Shields, the Company's Chief Executive Officer and Chairman of the Company's board of directors, controls the Sponsor as the trustee of the trust entity that is the sole shareholder of the Sponsor.
Griffin Capital Essential Asset Advisor II, LLC, a Delaware limited liability company (the “Advisor”) was formed on November 19, 2013. Griffin Capital Asset Management Company, LLC, a Delaware limited liability company ("GAMCO") is the sole member of the Advisor and Griffin Capital, LLC, a Delaware limited liability company ("GC") is the sole member of GAMCO. The Sponsor is the sole member of GC. The Advisor is responsible for managing the Company’s affairs on a day-to-day basis and identifying and making acquisitions and investments on behalf of the Company under the terms of the Advisory Agreement (as defined in Note 10, Related Party Transactions.) The Company's officers are also officers of the Advisor and officers of the Sponsor.
Griffin Capital Securities, LLC (the “Dealer Manager”) is a Delaware limited liability company and is a wholly-owned subsidiary of GC. The Dealer Manager was responsible for marketing the Company’s shares offered pursuant to the Offering.
The Company’s property manager is Griffin Capital Essential Asset Property Management II, LLC, a Delaware limited liability company (the “Property Manager”), which was formed on November 19, 2013 to manage the Company’s properties, or provide oversight of other property managers engaged by the Company or an affiliate of the Company. The Property Manager will derive substantially all of its income from the property management services it will perform for the Company.
The Company’s Articles of Incorporation initially authorized 30,000 shares of common stock. On February 11, 2014, the Advisor purchased 100 shares of common stock for $1,000 and became the initial stockholder. Upon the Securities and Exchange Commission, ("SEC"), declaring the offering effective on July 31, 2014, the Company’s Articles of Amendment and Restatement were filed with the State of Maryland and authorized 700,000,000 shares of common stock allocated as 350,000,000 Class A shares and 350,000,000 Class T shares with a par value of $0.001 and 200,000,000 shares of preferred stock with a par value of $0.001. On April 25, 2016, the Company reclassified (i)100,000,000 authorized but unissued shares of the Company's Class A common stock, and (ii) 50,000,000 authorized but unissued shares of the Company's Class T common stock, as 150,000,000 shares of Class I common stock.
The Company registered $2.2 billion in common shares in its initial public offering (“Offering”), consisting of $2.0 billion in common shares to be offered to the public in the primary public offering (“Primary Offering”) and $200.0 million in common shares for sale pursuant to the distribution reinvestment plan (“DRP”). (See Note 8, Equity, for additional details.)
In September 2016, the Company's board of directors approved the close of the Company’s Primary Offering effective January 20, 2017. The Company intends to continue to sell shares of its common stock in the offering pursuant to its DRP following the termination of its Primary Offering.
Griffin Capital Essential Asset Operating Partnership II, L.P., a Delaware limited partnership (the “Operating Partnership”), was formed on November 21, 2013. On February 11, 2014, the Advisor purchased a 99% limited partnership interest and special limited partnership interest in the Operating Partnership for $200,000 and on February 11, 2014, the Company contributed the initial $1,000 capital contribution it received to the Operating Partnership in exchange for a 1% general partner interest.
The Operating Partnership owns, and will own, directly or indirectly, all of the properties acquired by the Company. The Operating Partnership will conduct certain activities through the Company’s taxable REIT subsidiary, Griffin Capital Essential
F-9
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Asset TRS II, Inc., a Delaware corporation (the “TRS”) formed on November 22, 2013, which is a wholly-owned subsidiary of the Operating Partnership. The TRS had no activity as of December 31, 2016.
2. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying consolidated financial statements of the Company are prepared by management on the accrual basis of accounting and in accordance with principles generally accepted in the United States (“GAAP”) as contained in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification” or “ASC”), and in conjunction with rules and regulations of the SEC. The consolidated financial statements include accounts of the Company, the Operating Partnership and the TRS, if applicable. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could materially differ from those estimates.
Principles of Consolidation
The Company's financial statements, and the financial statements of the Company's operating partnership, including its wholly-owned subsidiaries, are consolidated in the accompanying consolidated financial statements. The portion of these entities not wholly-owned by the Company is presented as noncontrolling interests. All significant intercompany accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all short-term, highly liquid investments that are readily convertible to cash with a maturity of three months or less at the time of purchase to be cash equivalents. Cash and cash equivalents may include cash and short-term investments. Short-term investments are stated at cost, which approximates fair value. There were no cash equivalents, nor were there restrictions on the use of the Company’s cash balance as of December 31, 2016 and 2015.
The Company maintains its cash accounts with major financial institutions. The cash balances consist of business checking accounts. These accounts are insured by the Federal Deposit Insurance Corporation up to $250,000 at each institution. The Company has not experienced any losses with respect to cash balances in excess of government provided insurance. Management believes there was no significant concentration of credit risk with respect to these cash balances at December 31, 2016.
Restricted Cash
In conjunction with acquisitions of certain assets, as required by certain lease provisions or certain lenders in conjunction with an acquisition or debt financing, or credits received by the seller of certain assets, the Company assumed or funded reserves for specific property improvements and deferred maintenance, re-leasing costs, and taxes and insurance, which are included on the consolidated balance sheets as restricted cash. As of December 31, 2016, the Company had approximately $14.2 million in restricted cash, which includes tenant improvement funds.
Change in Consolidated Financial Statements Presentation
Certain amounts in the Company's prior period consolidated financial statements have been reclassified to conform to the current period presentation. Corporate operating expenses to affiliates are presented separately from general and administrative expenses on the statement of operations for all periods presented. See Note 10, Related Party Transactions.
The Company decided to discontinue marketing the One Century Place property located in Nashville, Tennessee for sale. The One Century Place property, which was previously classified as held for sale and carried at the lower of its (i) carrying
F-10
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
amount or (ii) fair value less costs to sell, was reclassified as held and used. As a result, assets and liabilities are presented as held and used on the consolidated balance sheets for all periods presented.
Real Estate Purchase Price Allocation
In January 2017, the FASB issued Accounting Standards Update ("ASU") 2017-01, Business Combinations, (see “Recently Issued Accounting Pronouncements” below) that clarifies the framework for determining whether an integrated set of assets and activities meets the definition of a business. The revised framework establishes a screen for determining whether an integrated set of assets and activities is a business and narrows the definition of a business, which is expected to result in fewer transactions being accounted for as business combinations. Acquisitions of integrated sets of assets and activities that do not meet the definition of a business are accounted for as asset acquisitions. This update is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted for transactions that have not been reported in previously issued (or available to be issued) financial statements.
The Company adopted this accounting standard early effective October 1, 2016. As a result of this adoption, the Company evaluated four real estate acquisitions completed during the fourth quarter of 2016 under the new framework and determined that the assets acquired did not meet the definition of a business. Accordingly, the Company accounted for these transactions as asset acquisitions (see Note 3, Real Estate).
The Company applies the provisions in ASC 805-10, Business Combinations, to account for the acquisition of real estate, or real estate related assets, in which a lease, or other contract, is in place representing an active revenue stream, as a business combination. In accordance with the provisions of ASC 805-10, the Company recognizes the assets acquired, the liabilities assumed and any noncontrolling interest in the acquired entity at their fair values as of the acquisition date, on an “as if vacant” basis. Further, the Company recognizes the fair value of assets acquired, liabilities assumed and any noncontrolling interest in acquisitions of less than a 100% interest when the acquisition constitutes a change in control of the acquired entity. The accounting provisions have also established that acquisition-related costs and restructuring costs are considered separate and not a component of a business combination and, therefore, are expensed as incurred. For properties acquired in a sale-leaseback transaction or properties that do not meet the definition of a business combination, acquisition fees and acquisition expenses are included as part of the acquisition price.
Acquired in-place leases are valued as above-market or below-market as of the date of acquisition. The in-place lease valuation is measured based on the present value (using an interest rate, which reflects the risks associated with the leases acquired) of the difference between (a) the contractual amounts to be paid pursuant to the in-place leases and (b) management’s estimate of fair market lease rates for the corresponding in-place leases over a period equal to the remaining non-cancelable term of the lease for above-market leases, taking into consideration below-market extension options for below-market leases. In addition, any renewal options are considered and will be included in the valuation of in-place leases if (1) it is likely that the tenant will exercise the option, and (2) the renewal rent is considered to be sufficiently below a fair market rental rate at the time of renewal. The above-market and below-market lease values are capitalized as intangible lease assets or liabilities and amortized as an adjustment to rental income over the remaining terms of the respective leases, including below market renewal options.
The aggregate fair value of in-place leases includes direct costs associated with obtaining a new tenant, opportunity costs associated with lost rentals, which are avoided by acquiring an in-place lease, and tenant relationships. Direct costs associated with obtaining a new tenant include commissions, tenant improvements, and other direct costs and are estimated using methods similar to those used in independent appraisals and management’s consideration of current market costs to execute a similar lease. These direct costs are considered intangible lease assets and will be included with real estate assets on the consolidated balance sheets. The intangible lease assets will be amortized to expense over the remaining terms of the respective leases. The value of opportunity costs is calculated using the contractual amounts to be paid, including real estate taxes, insurance, and other operating expenses, pursuant to the in-place leases over a market lease-up period for a similar lease. Customer relationships are valued based on management’s evaluation of certain characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics management will consider in allocating these values include the nature and extent of the Company’s existing business relationships with tenants, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors. These intangibles will be included in intangible lease assets on the consolidated balance sheets and will be amortized to expense over the remaining term of the respective leases.
F-11
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
The determination of the fair values of the assets and liabilities acquired requires the use of significant assumptions about current market rental rates, rental growth rates, discount rates and other variables.
Depreciation and Amortization
The purchase price of real estate to be acquired and the costs related to the development, construction, and property improvements are capitalized. Repairs and maintenance costs include all costs that do not extend the useful life of the real estate asset and are expensed as incurred. The Company considers the period of future benefit of an asset to determine the appropriate useful life. The Company anticipates the estimated useful lives of its assets by class to be generally as follows:
Buildings | 40 years | |
Building Improvements | 5-20 years | |
Land Improvements | 15-25 years | |
Tenant Improvements | Shorter of estimated useful life or remaining contractual lease term | |
Tenant Origination and Absorption Cost | Remaining contractual lease term | |
In-place Lease Valuation | Remaining contractual lease term with consideration as to below-market extension options for below-market leases | |
Impairment of Real Estate and Related Intangible Assets
The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of real estate and related intangible assets may not be recoverable, including credit ratings of all tenants to stay abreast of any material changes in credit quality. The Company monitors tenant credit by (1) reviewing the credit ratings of tenants (or their parent companies or lease guarantors) that are rated by nationally recognized rating agencies; (2) reviewing financial statements and related metrics and information that are publicly available or that are required to be provided pursuant to the lease; (3) monitoring news reports and press releases regarding the tenants (or their parent companies or lease guarantors), and their underlying business and industry; and (4) monitoring the timeliness of rent collections.
When indicators of potential impairment are present that indicate that the carrying amounts of real estate and related intangible assets may not be recoverable, management assesses whether the carrying value of the assets will be recovered through the future undiscounted operating cash flows expected from the use of the assets and the eventual disposition. If, based on this analysis, the Company does not believe that it will be able to recover the carrying value of the asset, the Company will record an impairment charge to the extent the carrying value exceeds the net present value of the estimated future cash flows of the asset.
Projections of expected future undiscounted cash flows require management to estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, discount rates, the number of months it takes to re-lease the property and the number of years the property is held for investment. As of December 31, 2016, the Company did not record any impairment charges related to its real estate assets or intangible assets.
Restricted Reserves
Restricted reserves includes amounts payable to tenants for the reimbursement of improvements made to the properties in accordance with the tenant's leases. Amounts are paid as reimbursement requests are received from the tenant.
Revenue Recognition
Leases associated with the acquisition and contribution of certain real estate assets (see Note 3, Real Estate) have net minimum rent payment increases during the term of the lease and are recorded to rental revenue on a straight-line basis, commencing as of the contribution or acquisition date. If a lease provides for contingent rental income, the Company will defer the recognition of contingent rental income, such as percentage rents, until the specific target that triggers the contingent rental income is achieved.
F-12
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Tenant reimbursement revenue, which is comprised of additional amounts collected from tenants for the recovery of certain operating expenses, including repair and maintenance, property taxes and insurance, and capital expenditures, to the extent allowed pursuant to the lease (collectively "Recoverable Expenses"), is recognized as revenue when the additional rent is due. Recoverable Expenses to be reimbursed by a tenant are determined based on the Company's estimate of the property's operating expenses for the year, pro rated based on leased square footage of the property, and are collected in equal installments as additional rent from the tenant, pursuant to the terms of the lease. At the end of the calendar year, the Company reconciles the amount of additional rent paid by the tenant during the year to the actual amount of Recoverable Expenses incurred by the Company for the same period. The difference, if any, is either charged or credited to the tenant pursuant to the provisions of the lease. In certain instances the lease may restrict the amount the Company can recover from the tenant such as a cap on certain or all property operating expenses. As of December 31, 2016, the Company estimated that approximately $0.5 million, net, was over collected from tenants throughout the year, and as a result, the Company recorded a liability to accrued expenses and other liabilities on the accompanying balance sheet.
Derivative Instruments and Hedging Activities
Accounting Standards Codification ("ASC") Topic 815: Derivatives and Hedging ("ASC 815"), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Company’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
As required by ASC 815, the Company recorded all derivatives on the consolidated balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, and whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting. (See Note 5, Interest Rate Contracts).
Income Taxes
The Company elected to be taxed as a REIT under Sections 856 through 860 of the Code for the year ended December 31, 2015 and for each year thereafter. To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to currently distribute at least 90% of the REIT’s ordinary taxable income to stockholders. As a REIT, the Company generally will not be subject to federal income tax on taxable income that is distributed to stockholders. If the Company fails to qualify as a REIT in any taxable year, after the Company initially qualifies to be taxed as a REIT, the Company will then be subject to federal income taxes on the taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect net income and net cash available for distribution to stockholders. However, the Company believes that it is organized and will operate in such a manner as to qualify for treatment as a REIT and intends to operate in the foreseeable future in such a manner that it will remain qualified as a REIT for federal income tax purposes.
The Company could engage in certain business activities that could have an adverse effect on its REIT qualification. The Company has elected to isolate these business activities in the books and records of the TRS. In general, the TRS may perform additional services for the Company’s tenants and generally may engage in any real estate or non-real estate related business. The TRS will be subject to corporate federal and state income tax. As of December 31, 2016, the TRS has not commenced operations.
F-13
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Per Share Data
The Company reports earnings per share for the period as (1) basic earnings per share computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period, and (2) diluted earnings per share computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding, including common stock equivalents. As of December 31, 2016 and 2015, there were no common stock equivalents that would have a dilutive effect on earnings (loss) per share for common stockholders.
The Company retroactively adjusted the number of common shares outstanding in accordance with ASC 260-10, Earnings per Share. ASC 260-10 requires the computations of basic and diluted earnings per share shall be adjusted retroactively for all periods presented to reflect the change in capital structure, if the number of common shares outstanding increases as a result of a stock dividend or stock split or decreases as a result of a reverse stock split. If changes in common stock resulting from stock dividends, stock splits, or reverse stock splits occur after the close of the period but before the consolidated financial statements are issued or are available to be issued, the per-share computations for those and any prior-period consolidated financial statements presented shall be based on the new number of shares.
Segment Information
ASC Topic 280, Segment Reporting, establishes standards for reporting financial and descriptive information about a public entity’s reportable segments. The Company internally evaluates all of the properties and interests therein as one reportable segment.
Unaudited Data
Any references to the number of buildings, square footage, number of leases, occupancy, and any amounts derived from these values in the notes to the consolidated financial statements are unaudited and outside the scope of the Company's independent registered public accounting firm's audit of its consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board.
Recently Issued Accounting Pronouncements
In January 2017, the FASB issued ASU 2017-01, Business Combinations, that clarified the definition of a business. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company adopted this update on October 1, 2016. Refer to “Real Estate Purchase Price Allocation” above for a discussion of this new accounting pronouncement.
In November 2016, the FASB issued an ASU 2016-18, Restricted Cash, that will require companies to include restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The ASU will require a disclosure of a reconciliation between the statement of financial position and the statement of cash flows when the statement of financial position includes more than one line item for cash, cash equivalents, restricted cash, and restricted cash equivalents. Entities with material restricted cash and restricted cash equivalents balances will be required to disclose the nature of the restrictions. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted, and will be applied retrospectively to all periods presented.The Company does not expect the adoption of ASU No. 2016-18 to have a significant impact on its financial statements.
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing diversity in practice. The cash flow issues include debt prepayment or debt extinguishment costs and proceeds from the settlement of insurance claims. The ASU is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017. The Company is currently evaluating the impact the new standard may have on our consolidated financial statements. The Company does not expect the adoption of ASU No. 2016-15 to have a significant impact on its financial statements.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, that changes the impairment model for most financial instruments by requiring companies to recognize an allowance for expected losses, rather
F-14
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
than incurred losses as required currently by the other-than-temporary impairment model. The ASU will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases, and off-balance-sheet credit exposures (e.g., loan commitments). The ASU is effective for reporting periods beginning after December 15, 2019, with early adoption permitted, and will be applied as a cumulative adjustment to retained earnings as of the effective date. The Company is currently evaluating the potential impact of the pending adoption of this new guidance on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 will be effective beginning in the first quarter of 2019. Early adoption of ASU 2016-02 as of its issuance is permitted. The new leases standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. The Company is currently evaluating the impact of adopting the standard on the consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30) (“ASU 2015-03”) to amend the accounting guidance for the presentation of debt issuance costs. The standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for public business entities for fiscal years beginning after December 15, 2015 and retrospective application is required. The Company adopted ASU 2015-03, beginning with the quarter ended March 31, 2016. As a result of the adoption of ASU 2015-03, the Company reclassified approximately $3.6 million of net debt issuance costs from an asset (previously recorded in the line item “Deferred financing costs, net” in the consolidated balance sheet) to a reduction in the carrying amount of the Company's debt as of December 31, 2015. ASU 2015-03 also expands disclosure requirements to include the face amount of the debt liability and the effective interest rate in the notes to the consolidated financial statements. (See Note 4, Debt.)
In February 2015, the FASB issued ASU No. 2015-02, Consolidation: Amendments to the Consolidation Analysis ("ASU No. 2015-02"), which amended the existing accounting standards for consolidation under both the variable interest model and the voting model. Under ASU No. 2015-02, companies will need to re-evaluate whether an entity meets the criteria to be considered a VIE, whether companies still meet the definition of primary beneficiaries, and whether an entity needs to be consolidated under the voting model. ASU No. 2015-02 may be applied using a modified retrospective approach or retrospectively, and is effective for reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company adopted ASU No. 2015-02, beginning with the quarter ended March 31, 2016. There was no change to the Company's consolidated financial statements as a result of adoption.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU No. 2014-15”). The amendments in ASU No. 2014-15 require management to evaluate, for each annual and interim reporting period, whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or are available to be issued when applicable) and, if so, provide related disclosures. ASU No. 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early adoption is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. There was no change to the Company's consolidated financial statements or notes as a result of adoption.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU No. 2014-09”). ASU No. 2014-09 replaces substantially all industry-specific revenue recognition requirements and converges areas under this topic with International Financial Reporting Standards. ASU No. 2014-09 implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. ASU No. 2014-09 also requires enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenues and cash flows from contracts with customers. Other major provisions in ASU No. 2014-09 include capitalizing and amortizing certain contract costs, ensuring the time value of money is considered in the applicable transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. ASU No. 2014-09 was originally effective for reporting periods beginning after December 31, 2016 (for public entities). On April 1, 2015, the FASB voted to defer the effective date of ASU No. 2014-09 by one year, to annual reporting periods beginning after December 15, 2017. On July 9, 2015, the FASB affirmed its proposal to defer the effective date to annual reporting periods beginning after December
F-15
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
15, 2017, although entities may elect to adopt the standard as of the original effective date. The Company is currently evaluating the impact of adopting the standard on the consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments clarify how an entity should identify the unit of accounting (i.e., the specified good or service) for the principal versus agent evaluation, and how it should apply the control principle to certain types of arrangements, such as service transactions, by explaining what a principal controls before the specified good or service is transferred to the customer. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements of ASU No. 2014-09. ASU No. 2014-09 was originally effective for reporting periods beginning after December 15, 2016 (for public entities). On April 1, 2015, the FASB voted to defer the effective date of ASU No. 2014-09 by one year, to annual reporting periods beginning after December 15, 2017. On July 9, 2015, the FASB affirmed its proposal to defer the effective date to annual reporting periods beginning after December 15, 2017, although entities may elect to adopt the standard as of the original effective date. The Company is currently evaluating the impact of adopting the standard on the consolidated financial statements.
F-16
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
3. Real Estate
As of December 31, 2016, the Company's real estate portfolio consisted of 25 properties consisting of office, industrial, distribution, and data center facilities with a combined acquisition value of $1.1 billion, including the allocation of the purchase price to above and below-market lease valuation, encompassing approximately 7.1 million square feet.
Depreciation expense for buildings and improvements for the year ended December 31, 2016 was $11.6 million. Amortization expense for intangibles, including but not limited to, tenant origination and absorption costs for the year ended December 31, 2016 was $16.3 million.
Total rental income included in the Company's statement of operations from acquisitions in 2016 was approximately $12.5 million for the year ended December 31, 2016.
F-17
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
The purchase price and other acquisition items for properties acquired during the year ended December 31, 2016 are shown below.
Paid to Advisor | |||||||||||||||||||||||
Property | Location | Tenant/Major Lessee | Acquisition Date | Purchase Price | Approx. Square Feet | Acquisition Fees and Reimbursable Expenses (1) | Contingent Advisor Payment (2) | Year of Lease Expiration | |||||||||||||||
Toshiba TEC | Durham, NC | Toshiba TEC Corporation | 1/21/2016 | $ | 35,800,748 | 200,800 | $ | 851,835 | $ | — | 2028 | ||||||||||||
NETGEAR | San Jose, CA | NETGEAR, Inc. | 5/17/2016 | 44,000,000 | 142,700 | 987,286 | 197,780 | 2025 | |||||||||||||||
Nike | Hillsboro, OR | Nike, Inc. | 6/16/2016 | 45,500,000 | 266,800 | 1,011,061 | 841,750 | 2020 | |||||||||||||||
Zebra Technologies | Lincolnshire, IL | Hewitt Associates LLC | (3) | 8/1/2016 | 60,150,000 | 283,300 | 1,346,068 | 1,112,775 | 2017/2026 | ||||||||||||||
WABCO | North Charleston, SC | WABCO Air Compressor Holdings Inc. | 9/14/2016 | 13,834,500 | 145,200 | 458,010 | 255,938 | 2023 | |||||||||||||||
IGT | Las Vegas, NV | IGT | 9/27/2016 | 66,500,000 | 222,300 | 1,521,553 | 1,230,250 | 2030 | |||||||||||||||
3M | DeKalb, IL | 3M Company | 10/25/2016 | 69,356,000 | 978,100 | 1,580,988 | 933,511 | 2026 | |||||||||||||||
Amazon | Etna, OH | Amazon.com.dedc LLC | 11/18/2016 | 88,896,060 | 855,000 | 2,052,820 | 541,299 | 2031 | |||||||||||||||
Zoetis | Parsippany, NJ | Zoetis Services LLC | 12/16/2016 | 44,000,000 | 125,700 | 1,063,673 | 698,565 | 2028 | |||||||||||||||
Southern Company | Birmingham, AL | Southern Company Services, Inc. | 12/22/2016 | 131,590,000 | 669,400 | 3,056,530 | 89,803 | 2044 | |||||||||||||||
(1) | The fee consists of a 2.0% base acquisition fee and acquisition expense reimbursement for actual acquisition expenses incurred, estimated to be approximately 1% of acquisition value. (See Note 10, Related Party Transactions, for additional discussion.) |
(2) | Pursuant to the Advisory Agreement, the Advisor is entitled to receive an acquisition fee in an amount up to 3.85% of the contract purchase price (as such term is defined in the Advisory Agreement) for each property the Company acquires. The acquisition fee consists of a 2.0% base acquisition fee and up to an additional 1.85% contingent advisor payment (the "Contingent Advisor Payment"); provided, however, that $5.0 million of amounts advanced by the Advisor for dealer manager fees and organizational and offering expenses (the "Contingent Advisor Payment Holdback") will be retained by the Company until the later of (a) the termination of the Offering, including any follow-on offerings, or (b) July 31, 2017, at which time such amount shall be paid to the Advisor. In connection with a follow-on offering, the Contingent Advisor Payment Holdback may increase, based upon the maximum offering amount in such follow-on offering and the amount sold in prior offerings. |
(3) | The property is currently leased to Hewitt Associates LLC ("Hewitt"), a wholly owned subsidiary of Aon PLC, through February 28, 2017, and Zebra Technologies Corporation ("Zebra Technologies") occupies the property under a sublease agreement. On March 1, 2017, immediately following Hewitt's lease expiration, Zebra Technologies' 117-month lease with the Company will commence. |
F-18
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Real Estate - Valuation and Purchase Price Allocation
The Company allocates the purchase price to the fair value of the tangible assets of a property by valuing the property as if it were vacant. This “as-if vacant” value is estimated using an income, or discounted cash flow, approach that relies upon Level 3 inputs, which are unobservable inputs based on the Company's review of the assumptions a market participant would use. These Level 3 inputs include discount rates, capitalization rates, market rents and comparable sales data for similar properties. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. In calculating the “as-if vacant” value for acquisitions completed during the year ended December 31, 2016, the Company used discount rates ranging from 6.25% to 8.50%.
In determining the fair value of intangible lease assets or liabilities, the Company also considers Level 3 inputs. Acquired above- and below-market leases are valued based on the present value of the difference between prevailing market rates and the in-place rates measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases, if applicable. The estimated fair value of acquired in-place at-market tenant leases are the costs that would have been incurred to lease the property to the occupancy level of the property at the date of acquisition. Such estimates include the value associated with leasing commissions, legal and other costs, as well as the estimated period necessary to lease such property that would be incurred to lease the property to its occupancy level at the time of its acquisition. Acquisition costs associated with the business combination are expensed in the period they are incurred.
F-19
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
The following summarizes the purchase price allocation for the properties acquired during the year ended December 31, 2016:
Properties | Land | Building and Improvements | Tenant Origination and Absorption Cost | In-Place Lease Valuation Above Market | In-Place Lease Valuation (Below) Market | Other Assets | Other assumed liabilities (2) | Total | ||||||||||||||||||||||||
Toshiba TEC | $ | 4,130,000 | $ | 28,640,000 | $ | 8,180,748 | $ | — | $ | (5,150,000 | ) | $ | — | $ | (600,748 | ) | $ | 35,200,000 | ||||||||||||||
NETGEAR | 20,725,500 | 17,656,000 | 8,230,500 | — | (2,612,000 | ) | — | (1,663,500 | ) | 42,336,500 | ||||||||||||||||||||||
Nike | 5,988,000 | 32,535,000 | 9,862,000 | — | (2,885,000 | ) | — | — | 45,500,000 | |||||||||||||||||||||||
Zebra Technologies | 5,238,441 | 35,939,000 | 20,586,559 | 326,000 | (1,940,000 | ) | — | (5,170,557 | ) | 54,979,443 | ||||||||||||||||||||||
WABCO | 1,301,500 | 10,823,000 | 1,775,000 | — | (65,000 | ) | — | — | 13,834,500 | |||||||||||||||||||||||
IGT | 6,324,766 | 52,818,000 | 11,623,234 | — | (4,266,000 | ) | — | (4,049,234 | ) | 62,450,766 | ||||||||||||||||||||||
3M | (1) | 5,320,224 | 55,144,873 | 7,102,162 | 3,419,559 | — | — | — | 70,986,818 | |||||||||||||||||||||||
Amazon | (1) | 5,331,439 | 75,263,912 | 10,505,829 | 75,899 | — | — | — | 91,177,079 | |||||||||||||||||||||||
Zoetis | (1) | 3,374,660 | 31,568,059 | 10,696,623 | 6,224 | — | — | — | 45,645,566 | |||||||||||||||||||||||
Southern Company | (1) | 6,605,387 | 94,487,898 | 28,192,198 | — | (7,030,087 | ) | 12,483,760 | (43,783,030 | ) | 90,956,126 | |||||||||||||||||||||
Total | $ | 64,339,917 | $ | 434,875,742 | $ | 116,754,853 | $ | 3,827,682 | $ | (23,948,087 | ) | $ | 12,483,760 | $ | (55,267,069 | ) | $ | 553,066,798 | ||||||||||||||
(1) | The Company evaluated each fourth quarter transaction above, under the clarified framework for determining whether an integrated set of assets and activities meets the definition of a business, pursuant to the ASU issued in January 2017, which the Company early-adopted effective October 1, 2016. Acquisitions that do not meet the definition of a business are accounted for as asset acquisitions. Since the four transactions lacked a substantive process, these transactions did not meet the definition of a business and consequently were accounted for as asset acquisitions. In each of these transactions, the Company allocated the total consideration (including acquisition costs) for each acquisition to the individual assets and liabilities acquired on a relative fair value basis. |
(2) | Includes liabilities assumed (prepaid rents, tenant improvements and other payables) at the time of acquisition. |
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GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Pro Forma Financial Information (unaudited)
The following condensed pro forma operating information is presented as if the Company’s properties acquired in 2016 had been included in operations as of January 1, 2015. The pro forma operating information excludes certain nonrecurring adjustments, such as acquisition fees and expenses incurred, to reflect the pro forma impact the acquisition would have on earnings on a continuous basis:
Year Ended December 31, | |||||||
2016 | 2015 | ||||||
Revenue | $ | 100,986,064 | $ | 77,653,287 | |||
Net income | $ | 11,634,011 | $ | 9,752,213 | |||
Net income attributable to noncontrolling interests | $ | 5,147 | $ | 18,453 | |||
Net income attributable to common stockholders (1) | $ | 11,628,865 | $ | 8,960,957 | |||
Net income to common stockholders per share, basic and diluted | $ | 0.23 | $ | 0.63 | |||
(1) | Amount is net of net income (loss) attributable to noncontrolling interests and distributions to redeemable noncontrolling interests attributable to common stockholders. |
Future Minimum Contractual Rent Payments
The future minimum contractual rent payments pursuant to the lease terms, with lease expirations ranging from 2017 to 2044, are shown in the table below:
2017 | $ | 62,133,294 | |
2018 | 68,567,983 | ||
2019 | 75,822,030 | ||
2020 | 77,375,910 | ||
2021 | 69,507,122 | ||
Thereafter | 583,028,439 | ||
Total | $ | 936,434,778 | |
Intangibles
The Company allocated a portion of the acquired real estate asset value to in-place lease valuation and tenant origination and absorption cost, as discussed above and as shown below. The in-place lease was measured against comparable leasing information and the present value of the difference between the contractual, in-place rent and the fair market rent was calculated using, as the discount rate, the capitalization rate utilized to compute the value of the real estate at acquisition.
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GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
December 31, 2016 | December 31, 2015 | ||||||
In-place lease valuation (above market) | $ | 3,827,682 | $ | — | |||
In-place lease valuation (above market), accumulated amortization | (299,828 | ) | — | ||||
In-place lease valuation (above market), net | $ | 3,527,854 | $ | — | |||
In-place lease valuation (below market) | $ | (61,068,648 | ) | $ | (37,120,561 | ) | |
In-place lease valuation (below market) - accumulated amortization | 5,749,497 | 1,858,029 | |||||
In-place lease valuation (below market), net | $ | (55,319,151 | ) | $ | (35,262,532 | ) | |
Tenant origination and absorption cost | $ | 227,407,041 | $ | 110,652,188 | |||
Tenant origination and absorption cost - accumulated amortization | (23,408,777 | ) | (7,145,094 | ) | |||
Tenant origination and absorption cost, net | $ | 203,998,264 | $ | 103,507,094 | |||
The intangible assets are amortized over the remaining lease terms of the respective properties, which on a weighted-average basis, was approximately 11.4 years as of December 31, 2016. The amortization of the intangible assets and other leasing costs for the years ended December 31, 2016 and 2015 are as follows:
Amortization (income) expense for the year ended December 31, | |||||||
2016 | 2015 | ||||||
In-place lease valuation | $ | (3,591,640 | ) | $ | (1,858,029 | ) | |
Tenant origination and absorption cost | $ | 16,263,683 | $ | 7,145,094 | |||
The following table sets forth the estimated annual amortization (income) expense for in-place lease valuation, and tenant origination and absorption costs as of December 31, 2016 for the next five years:
Year | In-Place Lease Valuation | Tenant Origination and Absorption Costs | ||||||
2017 | $ | (4,491,000 | ) | $ | 22,721,000 | |||
2018 | $ | (4,617,000 | ) | $ | 22,806,000 | |||
2019 | $ | (4,617,000 | ) | $ | 22,806,000 | |||
2020 | $ | (4,617,000 | ) | $ | 22,806,000 | |||
2021 | $ | (3,722,000 | ) | $ | 22,806,000 | |||
4. Debt
As of December 31, 2016, the Company’s debt consisted of the following:
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GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Book Value as of December 31, 2016 | Book Value as of December 31, 2015 | Contractual Interest Rate (1) | Payment Type | Loan Maturity | Effective Interest Rate (4) | ||||||||||
Revolving Credit Facility | $ | 333,457,720 | $ | 138,557,720 | 2.27% | Interest Only | December 2019 (2) | 2.58% | |||||||
AIG Loan | 126,970,000 | 126,970,000 | 4.15% | Interest Only (3) | November 2025 | 4.22% | |||||||||
Total Debt | 460,427,720 | 265,527,720 | |||||||||||||
Unamortized deferred financing costs | (3,956,273 | ) | (3,573,746 | ) | |||||||||||
Total Debt, net | $ | 456,471,447 | $ | 261,953,974 | |||||||||||
(1) | The 2.27% contractual interest rate is based on a 360-day year, pursuant to the Revolving Credit Facility, whereas the 2.30% weighted-average interest rate is based on a 365-day year. As discussed below, the interest rate on the Revolving Credit Facility (as defined below) is a one-month LIBO Rate + 1.65%. As of December 31, 2016, the LIBO Rate was 0.62%. Including the effect of an interest rate swap agreement with a notional amount of $100.0 million, the weighted average interest rate as of December 31, 2016 was approximately 2.84% for the Company's fixed-rate and variable-rate debt combined. |
(2) | The Revolving Credit Facility has an initial term of four years, maturing on December 12, 2018, and may be extended for a one-year period if certain conditions are met and upon payment of an extension fee. See discussion below. |
(3) | The AIG Loan (as defined below) requires monthly payments of interest only, at a fixed rate, for the first five years and fixed monthly payments of principal and interest thereafter. |
(4) | Reflects the effective interest rate at December 31, 2016 and includes the effect of amortization of deferred financing costs. |
Revolving Credit Facility
On December 12, 2014, the Company, through the Operating Partnership, entered into a revolving credit agreement (the “Revolving Credit Facility”), co-led by KeyBank, N.A. ("KeyBank") and JPMorgan Chase Bank, N.A. ("JPMorgan Chase Bank") with KeyBank as administrative agent, JPMorgan Chase Bank as syndication agent, and a syndicate of lenders. Pursuant to the Revolving Credit Facility, the Company was provided with an initial commitment of $250.0 million, which commitment may be increased under certain circumstances up to a maximum total commitment of $1.25 billion. On August 11, 2015, the Company exercised its right under the credit agreement to increase the total commitments from $250.0 million to $410.0 million.
On November 22, 2016, the Company, through the Operating Partnership, entered into an amendment (the "Increase Agreement") to the Revolving Credit Facility with KeyBank as administrative agent; Bank of America, N.A., SunTrust Bank, Capital One, National Association ("Capital One"), and Wells Fargo Bank, National Association, as co-syndication agents; and KeyBanc Capital Markets, Merrill Lynch, Pierce, Fenner and Smith Incorporated, SunTrust Robinson Humphrey, Inc., Capital One, and Wells Fargo Securities, LLC as joint lead arrangers and joint bookrunners to exercise its right under the Revolving Credit Facility to increase the total commitments from $410 million to $550 million. In connection with the Increase Agreement, the Company, through the Operating Partnership, also entered into a Joinder Agreement with KeyBank and U.S. Bank National Association ("U.S. Bank"), for the admission of U.S. Bank as a lender with a commitment of $50 million under the Revolving Credit Facility (the "Joinder Agreement"). With the admission of U.S. Bank, JPMorgan Chase terminated its commitment under the Revolving Credit Facility and no longer serves as a lender, syndication agent, joint bookrunner, or joint lead arranger under the Revolving Credit Facility.
The Revolving Credit Facility has an interest rate based on the consolidated leverage ratio reported with the quarterly compliance certificate and is calculated based on the LIBO Rate plus the applicable LIBO Rate margin, as provided in the credit agreement related to the Revolving Credit Facility, or Base Rate plus the applicable base rate margin, as provided in the credit agreement related to the Revolving Credit Facility. The Base Rate is calculated as the greater of (i) the KeyBank Prime rate or (ii) the Federal Funds rate plus 0.50%. Payments under the Revolving Credit Facility are interest only and are due on the first day of each quarter.
The Revolving Credit Facility was initially secured by a pledge of 100% of the ownership interests in each special purpose entity which owns a pool property. On November 1, 2016, all pledged membership interests were released from the lien of the pledge agreements and subsequently terminated. Adjustments to the applicable rate were effective as of January 1, 2017.
AIG Loan
F-23
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
On October 22, 2015, six special purpose entities that are wholly-owned by the Operating Partnership entered into promissory notes with The Variable Annuity Life Insurance Company, American General Life Insurance Company, and the United States Life Insurance Company (collectively, the "Lenders"), pursuant to which the Lenders provided such special purpose entities with a loan in the aggregate amount of approximately $127 million (the "AIG Loan").
The AIG Loan has a term of 10 years, maturing on November 1, 2025 and has a fixed rate of interest of 4.15%. The AIG Loan requires monthly payments of interest only for the first five years and fixed monthly payments of principal and interest thereafter. The AIG Loan is secured by cross-collateralized and cross-defaulted first lien deeds of trust and second lien deeds of trust on certain properties. Commencing October 31, 2017, each of the individual promissory notes comprising the AIG Loan may be prepaid but only if such prepayment is made in full, subject to 30 days' prior notice to the holder and payment of a prepayment premium in addition to all unpaid principal and accrued interest to the date of such prepayment.
Pursuant to the terms of the Revolving Credit Facility and AIG Loan, the Company is subject to certain loan compliance covenants. The Company was in compliance with all applicable covenants as of December 31, 2016.
The following summarizes the future principal repayments of all loans as of December 31, 2016 per the loan terms discussed above:
December 31, 2016 | ||||
2017 | $ | — | ||
2018 | — | |||
2019 | 333,457,720 | (1) | ||
2020 | 178,101 | (2) | ||
2021 | 2,185,867 | (2) | ||
Thereafter | 124,606,032 | (2) | ||
Total principal | 460,427,720 | |||
Unamortized deferred loan costs | (3,956,273 | ) | ||
Total | $ | 456,471,447 | ||
(1) | Amount includes payment of the balance of the Revolving Credit Facility, which is due in December 2019. |
(2) | Amount includes payments of the balance of the AIG Loan. |
5. Interest Rate Contracts
Risk Management Objective of Using Derivatives
The Company is exposed to certain risks arising from both business operations and economic conditions. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of debt funding and the use of derivative financial instruments. Specifically, the Company entered into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by expected cash payments principally related to borrowings and interest rates. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The Company does not use derivatives for trading or speculative purposes.
Derivative Instruments
On February 25, 2016, the Company entered into an interest rate swap agreement to hedge the variable cash flows associated with the LIBO Rate-based variable-rate debt, on the Company's Revolving Credit Facility. The interest rate swap is effective for the period from April 1, 2016 to December 12, 2018 with a notional amount of $100.0 million.
The effective portion of the change in fair value of derivatives designated and qualifying as cash flow hedges is initially recorded in accumulated other comprehensive income ("AOCI") and is subsequently reclassified into earnings in the period
F-24
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
that the hedged forecasted transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt.
The following table sets forth a summary of the interest rate swap at December 31, 2016 and December 31, 2015:
Fair value (1) | Current Effective Notional Amount (2) | |||||||||||||||||||||
Derivative Instrument | Effective Date | Maturity Date | Interest Strike Rate | December 31, 2016 | December 31, 2015 | December 31, 2016 | December 31, 2015 | |||||||||||||||
Assets/(Liabilities): | ||||||||||||||||||||||
Interest Rate Swap | 4/1/2016 | 12/12/2018 | 0.74% | $ | 996,099 | $ | — | $ | 100,000,000 | $ | — | |||||||||||
(1) | The Company records all derivative instruments on a gross basis on the consolidated balance sheets, and accordingly, there are no offsetting amounts that net assets against liabilities. As of December 31, 2016, the Company's derivative was in an asset position, and as such, the fair value is included in the line item "Other Assets, net" on the consolidated balance sheet. |
(2) | Represents the notional amount of swap that was effective as of the balance sheet date of December 31, 2016 and December 31, 2015. |
The following table sets forth the impact of the interest rate swap on the consolidated financial statements for the periods presented:
Year Ended December 31, | ||||||||
2016 | 2015 | |||||||
Interest Rate Swap in Cash Flow Hedging Relationship: | ||||||||
Amount of (loss) gain recognized in AOCL on derivatives (effective portion) | $ | 662,695 | $ | — | ||||
Amount of (loss) gain reclassified from AOCL into earnings under “Interest expense” (effective portion) | $ | 178,757 | $ | — | ||||
Amount of (loss) gain recognized in earnings under “Interest expense” (ineffective portion and amount excluded from effectiveness testing) | $ | 154,647 | $ | — | ||||
During the next twelve months, the Company estimates that an additional $0.2 million will be recognized from AOCI into earnings.
Certain agreements with the derivative counterparties contain a provision where if the Company defaults on any of the Company's indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender within a specified time period, then the Company could also be declared in default on its derivative obligations.
As of December 31, 2016, the fair value of interest rate swap was in an asset position excluding any adjustment for nonperformance risk related to these agreements of approximately $1.0 million. As of December 31, 2016, the Company had not posted any collateral related to these agreements.
6. Fair Value Measurements
The Company is required to disclose fair value information about all financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate fair value. The Company measures and discloses the estimated fair value of financial assets and liabilities utilizing a fair value hierarchy that distinguishes between data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. This hierarchy consists of three broad levels, as follows: (i) quoted prices in active markets for identical assets or liabilities, (ii) "significant other observable inputs," and (iii) "significant unobservable inputs." "Significant other observable inputs" can include quoted prices for similar assets or liabilities in active markets, as well as inputs that are observable for the asset or liability, such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. "Significant unobservable inputs" are typically based on an entity’s own assumptions, since there is little, if any, related market activity. In instances in which the determination of the fair value measurement is based on
F-25
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level of input that is significant to the fair value measurement in its entirety. The Company's 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. There were no transfers between the levels in the fair value hierarchy during the year ended December 31, 2016.
The following tables set forth the assets/(liabilities) that the Company measures at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2016:
Total Fair Value | Quoted Prices in Active Markets for Identical Assets and Liabilities | Significant Other Observable Inputs | Significant Unobservable Inputs | |||||||||
Interest Rate Swaps at: | ||||||||||||
December 31, 2016 | $ | 996,099 | $ | — | $ | 996,099 | $ | — | ||||
Financial instruments as of December 31, 2016 consisted of cash and cash equivalents, accounts receivable, accounts payable, other accrued expenses, and borrowings. With the exception of the mortgage loan in the table below, the amounts of the financial instruments presented in the consolidated financial statements substantially approximate their fair value as of December 31, 2016. The fair value of the mortgage loan is estimated by discounting the loan’s principal balance over the remaining term of the mortgage using current borrowing rates available to the Company for debt instruments with similar terms and maturities. The Company determined that the mortgage loan valuation in its entirety is classified in Level 2 of the fair value hierarchy, as the fair value is based on current pricing for debt with similar terms as the in-place debt, and there were no transfers into and out of fair value measurement levels during the years ended December 31, 2016 and 2015.
December 31, 2016 | December 31, 2015 | ||||||||||||||
Fair Value | Carrying Value (1) | Fair Value | Carrying Value (1) | ||||||||||||
AIG Loan | $ | 120,321,701 | $ | 126,970,000 | $ | 126,970,000 | $ | 126,970,000 | |||||||
(1) | The carrying value of the AIG loan does not include deferred financing costs as of December 31, 2016 and 2015. See Note 4, Debt, for details. |
7. Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consisted of the following as of December 31, 2016 and 2015:
Year Ended December 31, | ||||||||
2016 | 2015 | |||||||
Prepaid rent | $ | 9,483,963 | $ | 2,382,913 | ||||
Leasing commission payable | 3,783,030 | — | ||||||
Other liabilities | 8,260,133 | 4,628,330 | ||||||
Total | $ | 21,527,126 | $ | 7,011,243 | ||||
8. Equity
Reallocation of Shares in Public Offering
The Company initially registered $2.2 billion in shares for sale, consisting of Class A common stock and Class T common stock. On December 5, 2014, the Company ceased offering Class T common stock, having sold no shares of Class T common stock at such date. On October 30, 2015, the Company ceased offering Class A common stock, having sold approximately $$240.8 million in shares of Class A common stock, and reallocated the remaining shares, such that, effective November 2, 2015, the Company is offering up to approximately $1.8 billion in shares of Class T common stock in the Primary Offering.
On March 2, 2016, the Company's board of directors extended the termination date of the Offering from July 31, 2016 until July 31, 2017, which is three years after the effective date of the Offering.
F-26
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
On March 29, 2016, the Company's board of directors approved a reallocation of shares being offered in the Primary Offering and the commencement of offering a new class of common stock, Class I shares. Effective April 25, 2016, the Company offered up to $1.56 billion in shares of Class T common stock and up to $0.2 billion in shares of Class I common stock in the Primary Offering. Class I shares were sold at a price of $9.30 per share, reflecting the fact that no selling commissions or stockholder servicing fees are payable on such shares. Class I shares are only available to investors who: (1) purchase shares through fee-based programs, also known as wrap accounts, (2) purchase shares through participating broker dealers that have alternative fee arrangements with their clients, (3) purchase shares through certain registered investment advisers, (4) purchase shares through bank trust departments or any other organization or person authorized to act in a fiduciary capacity for its clients or customers, or (5) are an endowment, foundation, pension fund or other institutional investor.
Class A shares, Class T shares and Class I shares vote together as a single class, and each share is entitled to one vote on each matter submitted to a vote at meetings of the Company's stockholders; provided that with respect to any matter that would only have a material adverse effect on the rights of a particular class of common stock, only the holders of such affected class are entitled to vote. Each class of common stock is entitled to the same distributions as other classes, and the net asset value, or NAV, per share is the same across share classes.
The following table summarizes shares issued and gross proceeds for each share class as of December 31, 2016:
Class A | Class T | Class I | |||||||||
Gross proceeds from Primary Offering | $ | 240,779,591 | $ | 436,785,597 | $ | 7,181,972 | |||||
Gross proceeds from DRP | $ | 12,192,042 | $ | 7,484,285 | $ | 70,161 | |||||
Shares issued in Primary Offering | 24,199,760 | 43,754,033 | 772,261 | ||||||||
DRP shares issued | 1,284,804 | 790,101 | 7,421 | ||||||||
Stock distribution shares issued | 171,765 | 125,592 | 1,352 | ||||||||
Total shares issued prior to redemptions | 25,656,329 | 44,669,726 | 781,034 | ||||||||
Offering and Organizational Costs
Pursuant to the Advisory Agreement, in no event will the Company be obligated to reimburse the Advisor for organizational and offering costs (effective November 2, 2015, only to the extent such costs exceed 1.0% of gross offering proceeds from the Company's public offering) incurred in connection with the Offering totaling in excess of (i) 3.5% (excluding sales commissions, dealer manager fees and stockholder servicing fees) of the gross proceeds raised in the Offering (excluding gross proceeds from the distribution reinvestment plan), and (ii) 15% (including selling commissions, dealer manager fees, stockholder servicing fees and non-accountable due diligence expense allowance but excluding acquisition fees and expenses) of the gross proceeds raised in the Offering (excluding gross proceeds from the distribution reinvestment plan). If the organization and offering costs exceeded such limits discussed above, within 60 days after the end of the month in which the Offering terminated or was completed, the Advisor would have been obligated to reimburse the Company for any excess amounts. As long as the Company is subject to the Statement of Policy Regarding Real Estate Investment Trusts published by the North American Securities Administrators Association (“NASAA REIT Guidelines”), such limitations discussed above will also apply to any future public offerings. As of December 31, 2016, and 2015, organizational and offering costs were 0.8% and 1.4% of gross offering proceeds, respectively, excluding selling commissions, dealer manager fees and stockholder servicing fees, and 10.6% and 10.5% of gross offering proceeds, respectively, including selling commissions, dealer manager fees and stockholder servicing fees. As of December 31, 2016, organizational and offering costs did not exceed the limitations. (See Note 10, Related Party Transactions).
Organizational and offering costs incurred as of December 31, 2016 and 2015, including those incurred by the Company and due to the Advisor, for the Offering are as follows:
F-27
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
December 31, 2016 | December 31, 2015 | ||||||
Cumulative offering costs | $ | 72,009,476 | $ | 28,668,982 | |||
Cumulative organizational costs | $ | 716,724 | $ | 517,841 | |||
Organizational and offering costs advanced by the Advisor, excluding Contingent Advisor Payment Holdback | $ | 4,073,651 | $ | 3,534,806 | |||
Less payments | (4,073,651 | ) | (3,073,206 | ) | |||
Net organizational and offering costs advanced by the Advisor, excluding Contingent Advisor Payment Holdback (1) | $ | — | $ | 461,600 | |||
Advisor Advances: | |||||||
Organizational and offering costs advanced by the Advisor | $ | 2,477,391 | $ | 382,314 | |||
Dealer Manager fees advanced by the Advisor | 2,931,542 | 764,628 | |||||
Net Organizational and Offering costs and Dealer Manager fees advanced by the Advisor | $ | 5,408,933 | $ | 1,608,542 | |||
(1) See Note 10, Related Party Transactions, for discussion on Contingent Advisor Payment Holdback.
Distribution Reinvestment Plan
The Company adopted a DRP that allows stockholders to have distributions otherwise distributable to them invested in additional shares of common stock. The plan became effective on July 31, 2014, and was amended and restated effective as of May 9, 2016. No selling commission, dealer manager fee or stockholder servicing fee are paid on shares sold through the DRP.
Amendment and Restatement of Distribution Reinvestment Plan
On November 15, 2016, the Company's board of directors amended and restated the Company's DRP to state that, effective as of November 28, 2016, until the Company announces an estimated net asset value ("NAV") per share, the purchase price per share under the DRP will be $9.40 per share. The Company announced the estimated NAV per share on February 16, 2017; consequently, the purchase price per share under the DRP equals the published NAV per share, which is $9.37 per share.
Share Redemption Program
The Company adopted a share redemption program that will enable stockholders to sell their stock to the Company in limited circumstances. As long as the common stock is not listed on a national securities exchange or over-the-counter market, stockholders who have held their stock for at least one year may be able to have all or a portion consisting of at least 25% of their shares of stock redeemed by the Company. During any calendar year, the Company will not redeem more than 5.0% of the weighted average number of shares outstanding during the prior calendar year. The cash available for redemption will be limited to the proceeds from the sale of shares pursuant to the Company’s DRP. Share redemption requests must be received by the Company no later than the last business day of the calendar quarter, and shares will be redeemed on the last business day of the month following such calendar quarter. The redemption price per share is expected to be the redemption rate set forth in the following table which is based upon the number of years the stock is held:
Number Years Held | Redemption Price per Share | |
Less than 1 year | No Redemption Allowed | |
After one year from the purchase date | 90.0% of the Redemption Amount (as defined below) | |
After two years from the purchase date | 95.0% of the Redemption Amount | |
After three years from the purchase date | 97.5% of the Redemption Amount | |
After four years from the purchase date | 100.0% of the Redemption Amount | |
The Redemption Amount for shares purchased under the Company's share redemption program shall be the lesser of (i) the amount the stockholder paid for their shares or (ii) the NAV of the shares. The redemption price per share will be reduced by the aggregate amount of net proceeds per share, if any, distributed to the stockholders prior to the repurchase date as a result of a “special distribution.” While the board of directors does not have specific criteria for determining a special distribution, the Company expects that a special distribution will only occur upon the sale of a property and the subsequent distribution of the net sale proceeds. The redemption price per share is subject to adjustment as determined from time to time by the board of directors.
F-28
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
As the use of the proceeds from the DRP for redemptions is outside the Company’s control, the net proceeds from the DRP are considered to be temporary equity and are presented as common stock subject to redemption on the accompanying consolidated balance sheets. The cumulative proceeds from the DRP, net of any redemptions, will be computed at each reporting date and will be classified as temporary equity on the Company’s consolidated balance sheets. As noted above, the redemption is limited to proceeds from new permanent equity from the sale of shares pursuant to the Company’s DRP. As of December 31, 2016, $16.9 million of common stock were available for redemption and $1.2 million of common stock were tendered for redemption and redeemed subsequent to December 31, 2016.
Distributions
Earnings and profits, which determine the taxability of distributions to stockholders, may differ from income reported for financial reporting purposes due to the differences for federal income tax purposes in the treatment of loss on debt, revenue recognition and compensation expense and in the basis of depreciable assets and estimated useful lives used to compute depreciation expense.
The following unaudited table summarizes the federal income tax treatment for all distributions for the years ended December 31, 2016, 2015 and for the period from February 11, 2014 (Date of Initial Capitalization) through December 31, 2014 reported for federal tax purposes and serves as a designation of capital gain distributions, if applicable, pursuant to Internal Revenue Code Section 857(b)(3)(C) and Treasury Regulation § 1.857-6(e).
Years Ended December 31, | ||||||||||||||||||
2016 | 2015 | For the Period from February 11, 2014 (Date of Initial Capitalization) through December 31, 2014 | ||||||||||||||||
Ordinary income | $ | 0.31 | 57.10 | % | $ | 0.21 | 38.60 | % | $ | — | — | % | ||||||
Return of capital | 0.24 | 42.90 | % | 0.34 | 61.40 | % | 0.26 | 100.00 | % | |||||||||
Total distributions paid | $ | 0.55 | 100 | % | $ | 0.55 | 100 | % | $ | 0.26 | 100 | % | ||||||
F-29
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
9. Noncontrolling Interests
Noncontrolling interests represent limited partnership interests in the Operating Partnership. The Operating Partnership issued 20,000 limited partnership units for $10.00 per unit on February 11, 2014, to the Advisor in exchange for the initial capitalization of the Operating Partnership. As of December 31, 2016, noncontrolling interest was approximately 0.03% of total shares outstanding, and approximately 0.04% of weighted average shares outstanding (both measures assuming limited partnership units were converted to common stock).
The Company evaluates individual noncontrolling interests for the ability to recognize the noncontrolling interest as permanent equity on the consolidated balance sheets at the time such interests are issued and on a continual basis. Any noncontrolling interest that fails to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (a) the carrying amount, or (b) its redemption value as of the end of the period in which the determination is made.
The limited partners of the Operating Partnership will have the right to cause the Operating Partnership to redeem their limited partnership units for cash equal to the value of an equivalent number of shares, or, at the Company’s option, the Company may purchase such limited partners' limited partnership units by issuing one share of common stock for each limited partnership unit redeemed. These rights may not be exercised under certain circumstances which could cause the Company to lose its REIT election. Furthermore, limited partners may exercise their redemption rights only after their limited partnership units have been outstanding for one year. The limited partnership units are reported on the consolidated balance sheets as noncontrolling interests.
The following summarizes the activity for noncontrolling interests for the years ended December 31, 2016, 2015 and for the period from February 11, 2014 (Date of Initial Capitalization) through December 31, 2014:
Year Ended December 31, | ||||||||||||
2016 | 2015 | For the Period from February 11, 2014 (Date of Initial Capitalization) through December 31, 2014 | ||||||||||
Beginning balance | $ | 97,189 | $ | 139,041 | $ | 200,000 | ||||||
Distributions to noncontrolling interests | (11,000 | ) | (11,000 | ) | (2,983 | ) | ||||||
Net loss | (2,715 | ) | (30,852 | ) | (57,976 | ) | ||||||
Other comprehensive income | 218 | — | — | |||||||||
Ending balance | $ | 83,692 | $ | 97,189 | $ | 139,041 | ||||||
10. Related Party Transactions
The following table summarizes the related party costs and fees incurred, paid and due to affiliates as of December 31, 2016:
F-30
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
As of December 31, 2015 | Year Ended December 31, 2016 | ||||||||||||||
Payable | Incurred | Paid | Payable | ||||||||||||
Advisor and Property Manager fees | |||||||||||||||
Acquisition fees and expenses | $ | 8,675 | $ | 13,929,823 | $ | 13,938,498 | $ | — | |||||||
Operating expenses | 108,538 | 1,622,165 | 1,712,913 | 17,790 | |||||||||||
Asset management fees | 400,120 | 6,412,577 | 6,005,165 | 807,532 | |||||||||||
Property management fees | 94,528 | 1,052,461 | 1,004,051 | 142,938 | |||||||||||
Other costs advanced by the Advisor | 23,029 | 304,416 | 315,369 | 12,076 | |||||||||||
Selling commissions | |||||||||||||||
Class T shares | 40,421 | 11,396,735 | 11,383,439 | 53,717 | |||||||||||
Dealer Manager fees | |||||||||||||||
Class T and I shares | 14,876 | 3,949,476 | 3,946,246 | 18,106 | |||||||||||
Stockholder servicing fee(1) | 24,968 | 17,449,299 | 1,454,146 | 16,020,121 | |||||||||||
Advisor Advances:(2) | |||||||||||||||
Organization and offering expenses | 843,913 | 2,633,923 | 1,000,445 | 2,477,391 | |||||||||||
Dealer Manager fees (3) | 764,628 | 8,068,585 | 5,901,671 | 2,931,542 | |||||||||||
Total | $ | 2,323,696 | $ | 66,819,460 | $ | 46,661,943 | $ | 22,481,213 | |||||||
(1) | The Dealer Manager is entitled to receive a stockholder servicing fee with respect to Class T shares that will be payable quarterly and will accrue daily in an amount equal to 1/365th of 1.0% of the purchase price per share (or, once reported, the amount of the estimated NAV) of Class T shares sold in the Primary Offering up to a maximum of 4% in the aggregate. |
(2) | Pursuant to the Advisory Agreement, commencing November 2, 2015, the Company remains obligated to reimburse the Advisor for organizational and offering costs incurred after such date, but only to the extent that such costs exceed 1.0% of the gross offering proceeds of the Company’s Offering (subject to the limits discussed in Note 8, Equity). In addition, the Advisor is entitled to receive an acquisition fee in an amount up to 3.85% of the contract purchase price (as such term is defined in the Advisory Agreement) for each property the Company acquires. The acquisition fee consists of a 2.0% base acquisition fee and up to an additional 1.85% Contingent Advisor Payment; provided, however, the Contingent Advisor Payment Holdback will be retained by the Company until the later of (a) the termination of the Offering, including any follow-on offerings, or (b) July 31, 2017, at which time such amount shall be paid to the Advisor. In connection with a follow-on offering, the Contingent Advisor Payment Holdback may increase, based upon the maximum offering amount in such follow-on offering and the amount sold in prior offerings. |
(3) | The Dealer Manager Agreement (as defined below and commencing on April 25, 2016 to incorporate Class I shares) provides that the Dealer Manager is entitled to receive a selling commission up to 3.0% of gross proceeds from Class T shares sold in the Primary Offering and a dealer manager fee equal to 3.0% of gross proceeds from Class T shares or Class I shares sold in the Primary Offering. Pursuant to the Dealer Manager Agreement, of the 3.0% dealer manager fee for Class T and Class I shares, 1.0% will be funded by the Company and 2.0% will be funded by the Advisor. |
Stockholder Servicing Fee
The Company pays the Dealer Manager a stockholder servicing fee with respect to the Class T shares sold as additional compensation to the Dealer Manager, which will be reallocated to the participating broker-dealers. Participating broker-dealers are expected to provide ongoing or regular account or portfolio maintenance for the stockholder, which may include one or more of the following: assisting with recordkeeping, assisting and processing distribution payments, assisting with share repurchase requests, offering to contact the stockholder periodically to provide information about the stockholder’s investment in the Company or to answer questions about the account statement or valuations, or providing other similar services as the stockholder may reasonably require in connection with such stockholder’s investment in Class T shares. The stockholder servicing fee accrues daily equal to 1/365th of 1% of the purchase price per share of the Class T shares sold in the Company's Primary Offering up to a maximum of 4% in the aggregate and is paid quarterly. The Company will cease paying the stockholder servicing fee with respect to the Class T shares sold in this Offering upon the occurrence of certain defined events. The Dealer Manager will generally re-allow 100% of the stockholder servicing fee to participating broker-dealers; provided, however, that with respect to any individual investment, the Dealer Manager will not re-allow the related stockholder servicing fee to any participating broker-dealer if such participating broker-dealer ceases to hold the account related to such investment. In addition, the Dealer Manager will not re-allow the stockholder servicing fee to any participating broker-dealer if such participating broker-dealer does not have a current executed selling agreement with the Dealer Manager. In any instance in which the Dealer Manager does not re-allow the stockholder servicing fee to a participating broker-dealer, the Dealer Manager will return such fee to the Company. The Company records the stockholder servicing fee as a reduction to paid in capital at the time of sale of the Class T share with a corresponding liability, on an undiscounted basis. From inception through March 31, 2016, the Company recorded the stockholder servicing fee as a general and administrative expense when the fee was paid.
F-31
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
The Company’s accounting of stockholder servicing fees of Class T shares sold to the public was determined to not be in compliance with GAAP in prior periods. The Company assessed the cumulative impact of the correction between total equity and total expenses for the year-ended December 31, 2015 and the three months ended March 31, 2016, and as a result, recorded a reduction to equity of approximately $5.6 million and a corresponding increase to Due to Affiliates (as stockholder servicing fee due to the Dealer Manager) of approximately $5.3 million and a decrease of approximately $0.2 million to Corporate Operating Expenses to Affiliates to correct the balances as of June 30, 2016. The effect of the three months ended March 31, 2016 adjustment on income from operations and net loss recorded in the three months ended June 30, 2016 period was $0.2 million and had no impact on earnings per share. In accordance with SEC Staff Accounting Bulletin (“SAB”) No. 99, Materiality and SAB No. 108 (“SAB 108”), Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, the Company assessed the materiality of this correction on its financial statements for the year ended December 31, 2015 and the three months ended March 31, 2016, using both the roll-over method and iron-curtain methods as defined in SAB 108. The Company concluded the effect was not material to its financial statements for any prior period and, as such, those financial statements are not materially misstated. The Company also concluded that providing for the correction in 2016 did not have a material effect on its financial statements for the quarter ended June 30, 2016 and year ended December 31, 2016.
Advisory Agreement
The Company entered into the advisory agreement with the Advisor and the Operating Partnership on July 31, 2014, as amended by Amendment No. 1 to the Advisory Agreement dated March 18, 2015, Amendment No. 2 to the Advisory Agreement dated November 2, 2015, Amendment No. 3 to the Advisory Agreement dated December 16, 2015 and Amendment No. 4 to the Advisory Agreement dated February 9, 2016 (together with such amendments, the “Advisory Agreement”). The Advisor manages the Company’s day-to-day activities pursuant to the Advisory Agreement. Pursuant to the Advisory Agreement, the Company is obligated to reimburse the Advisor for certain services and payments, including payments made by the Advisor to third parties, including in connection with potential acquisitions.
The Advisory Agreement requires, upon termination of the Offering, that any organizational and offering costs, including selling commissions, dealer manager fees, and stockholder servicing fees, incurred above 15% of gross equity raised in the Company’s Offering and that any organizational and offering costs not including selling commissions, dealer manager fees, and stockholder servicing fees, incurred above 3.5% of gross equity raised in the Company’s Offering shall be reimbursed to the Company.
The Advisory Agreement provides that the Company shall reimburse the Advisor for organizational and offering costs, subject to the limitations described above. In conjunction with subsequent amendments to the Advisory Agreement, commencing November 2, 2015, the Company remains obligated to reimburse the Advisor for organizational and offering costs incurred after such date, but only to the extent that such costs exceed 1.0% of the gross offering proceeds of the Company’s Offering.
Acquisition Fees
Commencing November 2, 2015, the Advisor is entitled to receive a fee in an amount up to 3.85% of the contract purchase price (as such term is defined in the Advisory Agreement) of each property the Company acquires. The fee consists of a 2.0% base acquisition fee and up to an additional 1.85% Contingent Advisor Payment; provided, however, that $5.0 million Contingent Advisor Payment Holdback will be retained by the Company until the later of (a) the termination of the Offering, including any follow-on offerings, or (b) July 31, 2017, at which time such amount shall be paid to the Advisor. In connection with a follow-on offering, the Contingent Advisor Payment Holdback may increase, based upon the maximum offering amount in such follow-on offering and the amount sold in prior offerings. The amount of the Contingent Advisor Payment paid upon the closing of an acquisition will be reviewed on an acquisition by acquisition basis and such payment shall not exceed the then outstanding amounts paid by the Advisor for dealer manager fees and organizational and offering expenses at the time of such closing after taking into account the amount of the Contingent Advisor Payment Holdback described above. For these purposes, the amounts paid by the Advisor and considered as "outstanding" will be reduced by the amount of the Contingent Advisor Payment previously paid. The Advisor may waive or defer all or a portion of the acquisition fee or the Contingent Advisor Payment at any time and from time to time, in the Advisor's sole discretion.
Asset Management Fee
F-32
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
The Advisor receives an annual asset management fee for managing the Company’s assets equal to 1.0% of the Average Invested Assets, defined as the aggregate carrying value of the assets invested before reserves for depreciation. The fee will be computed based on the average of these values at the end of each month. The asset management fees are earned monthly.
Operating Expenses
The Advisor and its affiliates are entitled to reimbursement, for certain expenses incurred on behalf of the Company in connection with providing administrative services, including related personnel costs; provided, however, the Advisor must reimburse the Company for the amount, if any, by which total operating expenses (as defined), including advisory fees, paid during the previous 12 months then ended exceeded the greater of: (i) 2% of the Company’s average invested assets for that 12 months then ended; or (ii) 25% of the Company’s net income, before any additions to reserves for depreciation, bad debts or other expenses connected with the acquisition and disposition of real estate interests and before any gain from the sale of the Company’s assets, for that fiscal year, unless the Company’s board of directors has determined that such excess expenses were justified based on unusual and non-recurring factors.
The Company reimbursed the Advisor and its affiliates a portion of the compensation paid by the Advisor and its affiliates for the Company's principal financial officer, Javier F. Bitar, former principal financial officer, Joseph E. Miller, executive vice president, David C. Rupert, and vice president and general counsel, Mary P. Higgins of approximately $0.4 million of which $0.2 million is included in operating expenses for the year ended December 31, 2016 and the remaining in offering costs as of December 31, 2016, for services provided to the Company, for which the Company does not pay the Advisor a fee.
In addition, the Company incurred approximately $0.2 million and $0.4 million for reimbursable expenses to the Advisor for services provided to the Company by certain of its other executive officers during the years ended December 31, 2016 and 2015. The reimbursable expenses include components of salaries, bonuses, benefits and other overhead charges and are based on the percentage of time each executive officer spends on the Company's affairs.
Dealer Manager Agreement
The Company entered into a dealer manager agreement with the Dealer Manager on June 20, 2014, as amended by Amendment No. 1 to the Dealer Manager Agreement dated November 25, 2014, as amended by Amendment No. 2 to the Dealer Manager Agreement dated October 9, 2015, and Amendment No. 3 to the Dealer Manager Agreement dated April 25, 2016 and has entered and intends to continue to enter into participating dealer agreements with various broker-dealers authorizing them to sell shares of the Company’s stock in the Primary Offering (together with the dealer manager agreement and all amendments, the “Dealer Manager Agreement”).
Through October 30, 2015, the Dealer Manager Agreement provided that the Dealer Manager was entitled to receive a selling commission and dealer manager fee equal to 7.0% and 3.0%, respectively, of gross proceeds from Class A shares sold in the Primary Offering. Commencing November 2, 2015, the Dealer Manager Agreement provided that the Dealer Manager was entitled to receive a selling commission equal to up to 3.0% of gross proceeds from Class T shares sold in the Primary Offering and a dealer manager fee equal to 3.0% of gross proceeds from Class T shares sold in the Primary Offering. Commencing April 25, 2016, the Dealer Manager Agreement provides that the Dealer Manager is entitled to receive a selling commission equal to up to 3.0% of gross proceeds from Class T shares sold in the Primary Offering and an aggregate dealer manager fee equal to 3.0% of gross proceeds from Class T shares and Class I shares sold in the Primary Offering. Pursuant to the Dealer Manager Agreement, of the 3.0% dealer manager fee, 1.0% will be funded by the Company and 2.0% will be funded by the Advisor. In addition, the Dealer Manager is entitled to receive an ongoing stockholder servicing fee with respect to Class T shares that will be payable quarterly and will accrue daily in an amount equal to 1/365th of 1.0% of the purchase price per share (or, once reported, the amount of the estimated NAV) of Class T shares sold in the Primary Offering up to a maximum of 4% in the aggregate. The Company will cease paying the stockholder servicing fee with respect to the Class T shares sold in the Offering at the earlier of (i) the date at which the aggregate underwriting compensation from all sources equals 10% of the gross proceeds from the sale of shares in the Primary Offering (i.e., excluding proceeds from sales pursuant to the DRP); (ii) the fourth anniversary of the last day of the fiscal quarter in which the Offering (excluding the DRP offering) terminates; (iii) the date that such Class T share is redeemed or is no longer outstanding; and (iv) the occurrence of a merger, listing on a national securities exchange, or an extraordinary transaction.
F-33
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Upon the sale of shares by participating broker-dealers, the Dealer Manager will re-allow all of the selling commissions paid in connection with sales made by these participating broker-dealers and may, in the Dealer Manager’s discretion, re-allow all of the stockholder servicing fees paid in connection with sales of Class T shares made by these participating broker-dealers for providing ongoing or regular account or portfolio maintenance for the stockholder, assisting with recordkeeping, assisting and processing distribution payments, assisting with share repurchase requests, offering to meet with the stockholder periodically to provide overall guidance on the stockholder’s investment in the Company or to answer questions about the account statement or valuations, or providing other similar services as the stockholder may reasonably require in connection with such stockholder’s investment in Class T Shares; provided, however, that with respect to any individual investment, the Dealer Manager will not re-allow the related stockholder servicing fee to any broker-dealer if such broker-dealer ceases to hold the account related to such investment or fails to provide the aforementioned services. In any instance in which the Dealer Manager does not re-allow the stockholder servicing fee to a participating broker-dealer, the Dealer Manager will return such fee to the Company. The Dealer Manager will also generally re-allow to participating broker-dealers a portion of the 3.0% dealer manager fee earned on the proceeds raised by the participating broker-dealers as marketing fees, reimbursement of the costs and expenses of attending training and education meetings sponsored by the Dealer Manager, payment of attendance fees required for employees of the Dealer Manager or other affiliates to attend retail seminars sponsored by participating broker-dealers, or to defray other distribution-related expenses.
Property Management Agreement
In the event that the Company contracts directly with non-affiliated third party property managers with respect to its individual properties, the Company pays the Property Manager an oversight fee equal to 1.0% of the gross revenues of the property managed, plus reimbursable costs as applicable. Reimbursable costs and expenses include wages and salaries and other expenses of employees engaged in operating, managing and maintaining the Company's properties, as well as certain allocations of office, administrative, and supply costs. In the event that the Company contracts directly with the Property Manager with respect to a particular property, the Company pays the Property Manager aggregate property management fees of up to 3.0%, or greater if the lease so allows, of gross revenues received for management of the Company's properties, plus reimbursable costs as applicable. These property management fees may be paid or re-allowed to third party property managers if the Property Manager contracts with a third party. In no event will the Company pay both a property management fee to the Property Manager and an oversight fee to the Property Manager with respect to a particular property.
In addition, the Company may pay the Property Manager or its designees a leasing fee in an amount equal to the fee customarily charged by others rendering similar services in the same geographic area. The Company may also pay the Property Manager or its designees a construction management fee for planning and coordinating the construction of any tenant directed improvements for which the Company is responsible to perform pursuant to lease concessions, including tenant-paid finish-out or improvements. The Property Manager shall also be entitled to a construction management fee of 5.0% of the cost of improvements. In the event that the Property Manager assists with the development or redevelopment of a property, the Company may pay a separate market-based fee for such services.
Employee and Director Long-Term Incentive Plan
The Company’s board of directors adopted a long term incentive plan (“Plan”), which provides for the grant of awards to the Company's directors and full-time employees (should the Company ever have employees), directors and full-time employees of the Advisor and affiliate entities that provide services to the Company, and certain consultants that provide services to the Company, the Advisor, or affiliate entities. Awards granted under the Plan may consist of stock options, restricted stock, stock appreciation rights, distribution equivalent rights and other equity-based awards. The stock-based payment will be measured at fair value and recognized as compensation expense over the vesting period. The term of the Plan is ten years and the total number of shares of common stock reserved for issuance under the Plan will be equal to 10% of the outstanding shares of stock at any time, not to exceed 10,000,000 shares in the aggregate. As of December 31, 2016, there were 7,093,965 shares reserved for issuance under the Plan, however, no awards had been granted under the Plan.
Conflicts of Interest
The Sponsor, Advisor, Property Manager and their officers and certain of their key personnel and their respective affiliates currently serve as key personnel, advisors, managers and sponsors or co-sponsors to some or all of 14 other programs affiliated with the Sponsor, including Griffin Capital Essential Asset REIT, Inc. ("GCEAR"), Griffin-American Healthcare REIT III, Inc.
F-34
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
("GAHR III"), and Griffin-American Healthcare REIT IV, Inc. ("GAHR IV"), all of which are publicly-registered, non-traded real estate investment trusts, Griffin-Benefit Street Partners BDC Corp. ("GB-BDC"), a non-traded business development company regulated under the Investment Company Act of 1940 (the "1940 Act"), and Griffin Institutional Access Real Estate Fund ("GIA Real Estate Fund"), and Griffin Institutional Access Credit Fund ("GIA Credit Fund"), a non-diversified, closed-end management investment company that is operated as an interval fund under the 1940 Act. Because these persons have competing demands on their time and resources, they may have conflicts of interest in allocating their time between the Company’s business and these other activities.
Some of the material conflicts that the Advisor, the Dealer Manager or its affiliates will face are (1) competing demand for time of the Advisor’s executive officers and other key personnel from the Sponsor and other affiliated entities; (2) determining if certain investment opportunities should be recommended to the Company or another program sponsored or co-sponsored by the Sponsor; and (3) influence of the fee structure under the advisory agreement and distribution structure of the operating partnership agreement that could result in actions not necessarily in the long-term best interest of the stockholders. The board of directors has adopted the Sponsor’s acquisition allocation policy as to the allocation of acquisition opportunities among the Company and GCEAR, which is as follows:
The Sponsor will allocate potential investment opportunities to GCEAR and the Company based on the following factors:
•the investment objectives of each program;
•the amount of funds available to each program;
•the financial impact of the acquisition on each program, including each program’s earnings and distribution ratios;
•various strategic considerations that may impact the value of the investment to each program;
•the effect of the acquisition on diversification of each program’s investments; and
•the income tax effects of the purchase to each program.
In the event all acquisition allocation factors have been exhausted and an investment opportunity remains equally suitable for GCEAR and the Company, the Sponsor will offer the investment opportunity to the REIT that has had the longest period of time elapse since it was offered an investment opportunity.
If the Sponsor no longer sponsors GCEAR, then, in the event that an investment opportunity becomes available that is suitable, under all of the factors considered by the Advisor, for both the Company and one or more other entities affiliated with the Sponsor, the Sponsor has agreed to present such investment opportunities to the Company first, prior to presenting such opportunities to any other programs sponsored by or affiliated with the Sponsor. In determining whether or not an investment opportunity is suitable for more than one program, the Advisor, subject to approval by the board of directors, shall examine, among others, the following factors:
•anticipated cash flow of the property to be acquired and the cash requirements of each program;
•effect of the acquisition on diversification of each program’s investments;
•policy of each program relating to leverage of properties;
•income tax effects of the purchase to each program;
•size of the investment; and
•amount of funds available to each program and the length of time such funds have been available for investment.
Economic Dependency
F-35
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
The Company will be dependent on the Advisor and the Dealer Manager for certain services that are essential to the Company, including the sale of the Company’s shares of common stock available for issue, the identification, evaluation, negotiation, purchase and disposition of properties and other investments, management of the daily operations of the Company’s real estate portfolio, and other general and administrative responsibilities. In the event that these companies are unable to provide the respective services, the Company will be required to obtain such services from other resources.
11. Commitments and Contingencies
Litigation
From time to time, the Company may become subject to legal proceedings, claims and litigation arising in the ordinary course of business. The Company is not a party to any material legal proceedings, nor is the Company aware of any pending or threatened litigation that would have a material adverse effect on the Company’s business, operating results, cash flows or financial condition should such litigation be resolved unfavorably.
12. Declaration of Distributions
During the quarter ended December 31, 2016, the Company paid cash distributions in the amount of $0.00150273220 per day per share on the outstanding shares of common stock payable to stockholders of record at the close of business on each day during the period from October 1, 2016 through December 31, 2016. Such distributions were paid on a monthly basis, on or about the first day of the month, for the month then-ended.
During the quarter ended December 31, 2016, the Company paid stock distributions in the amount of 0.000013661 Class A shares, Class T shares or Class I shares per day per share payable to stockholders of record at the close of business on each day during the period from October 1, 2016 through December 31, 2016. Such distributions were paid on a monthly basis, on or about the first day of the month, for the month then-ended.
On December 20, 2016, the Company’s board of directors declared cash distributions in the amount of $0.00150684932 per day per share on the outstanding shares of common stock payable to stockholders of record at the close of business on each day during the period from January 1, 2017 through March 31, 2017. Such distributions payable to each stockholder of record during a month will be paid on such date of the following month as the Company’s Chief Executive Officer may determine.
On December 20, 2016, the Company's board of directors declared a stock distribution in the amount of 0.000013699 shares of stock per day on the outstanding shares of common stock payable to stockholders of record at the close of business each day of the period commencing on January 1, 2017 through March 31, 2017.
13. Selected Quarterly Financial Data (Unaudited)
Presented below is a summary of the unaudited quarterly financial information for the years ended December 31, 2016 and 2015:
F-36
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
2016 | ||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | |||||||||||||
Total revenue | $ | 12,502,425 | $ | 13,330,196 | $ | 16,333,422 | $ | 20,646,411 | ||||||||
Net (loss)/income | $ | (1,140,542 | ) | $ | (2,825,782 | ) | $ | (2,736,725 | ) | $ | 596,699 | |||||
Net (loss)/income attributable to common stockholders | $ | (1,139,852 | ) | $ | (2,824,537 | ) | $ | (2,735,766 | ) | $ | 596,520 | |||||
Net (loss)/income per share (1) | $ | (0.03 | ) | $ | (0.06 | ) | $ | (0.05 | ) | $ | 0.01 | |||||
2015 | ||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | |||||||||||||
Total revenue | $ | 30,179 | $ | 3,570,455 | $ | 9,682,928 | $ | 11,865,461 | ||||||||
Net (loss) | $ | (1,026,391 | ) | $ | (9,797,905 | ) | $ | (2,638,219 | ) | $ | (3,043,138 | ) | ||||
Net (loss) attributable to common stockholders | $ | (1,019,804 | ) | $ | (9,801,118 | ) | $ | (3,259,242 | ) | $ | (3,167,440 | ) | ||||
Net (loss) per share (1) | $ | (0.30 | ) | $ | (0.87 | ) | $ | (0.18 | ) | $ | (0.13 | ) | ||||
(1) | Amounts were retroactively adjusted to reflect stock dividends. (See note 2, Basis of Presentation and Summary of Significant Accounting Policies, for additional detail). |
14. Subsequent Events
Status of the Offering
As of March 9, 2017, the Company has received and accepted subscriptions in the Offering for 24,199,760, 47,563,146 and 901,225 Class A, Class T and Class I shares of common stock, or $240.8 million, $474.9 million and $8.4 million respectively, excluding Class A ,Class T and Class I shares of common stock issued pursuant to the DRP. To date, a total of $13.4 million, $9.7 million and $0.1 million in distributions of Class A, Class T and Class I common stock were reinvested pursuant to the DRP, respectively, and 1,415,264 and 1,030,750 and 11,344 Class A and Class T and Class I shares of common stock were issued pursuant to the DRP, respectively.
Declaration of Distributions
On March 7, 2017, the Company’s board of directors declared cash distributions in the amount of $0.00150684932 per day per share on the outstanding shares of common stock payable to stockholders of record at the close of business on each day during the period from April 1, 2017 through June 30, 2017. Such distributions payable to each stockholder of record during a month will be paid on such date of the following month as the Company’s Chief Executive Officer may determine.
On March 7, 2017, the Company’s board of directors declared stock distributions in the amount of 0.000013699 per day per share on the outstanding shares of common stock payable to stockholders of record at the close of business on each day during the period from April 1, 2017 through June 30, 2017. Such distributions payable to each stockholder of record during a month will be paid on such date of the following month as the Company’s Chief Executive Officer may determine.
Acquisition of Allstate Property
On January 31, 2017, the Company, through the Operating Partnership, acquired a three-story, Class "A" office property consisting of 70,273 net rentable square feet located in Lone Tree, Colorado (the "Allstate property"). The Allstate property is currently leased in its entirety to Allstate Insurance Company. The purchase price for the Allstate property was $14.75 million, plus closing costs, less a credit in the amount of $350,000 applied at closing.
F-37
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION AND AMORTIZATION
Initial Cost to Company | Cost Capitalized Subsequent to Acquisition | Gross Carrying Amount at December 31, 2016 | Life on which depreciation in latest income statement is computed | |||||||||||||||||||||||||||||||||||||||
Property | Property Type | ST | Encumbrances | Land | Building and Improvements (1) | Land | Building and Improvements | Total | Accumulated Depreciation and Amortization | Date of Construction | Date of Acquisition | |||||||||||||||||||||||||||||||
Owens Corning | Industrial | NC | $ | 3,300,000 | $ | 575,000 | $ | 5,166,626 | $ | — | $ | 575,000 | $ | 5,166,626 | $ | 5,741,626 | $ | 313,103 | N/A | 3/9/2015 | 5-40 years | |||||||||||||||||||||
Westgate II | Office | TX | 34,200,000 | 3,732,053 | 55,101,476 | — | 3,732,053 | 55,101,476 | 58,833,529 | 4,134,011 | N/A | 4/1/2015 | 5-40 years | |||||||||||||||||||||||||||||
Administrative Office of Pennsylvania Courts | Office | PA | 6,070,000 | 1,207,000 | 8,936,000 | — | 1,207,000 | 8,936,000 | 10,143,000 | 625,641 | N/A | 4/22/2015 | 5-40 years | |||||||||||||||||||||||||||||
American Express Center | Data Center/Office | AZ | 54,900,000 | 5,750,000 | 113,670,000 | — | 5,750,000 | 113,670,000 | 119,420,000 | 11,016,228 | N/A | 5/11/2015 | 5-40 years | |||||||||||||||||||||||||||||
MGM Corporate Center | Office | NV | 18,180,000 | 4,260,342 | 28,704,658 | — | 4,260,342 | 28,704,658 | 32,965,000 | 2,084,317 | N/A | 5/27/2015 | 5-40 years | |||||||||||||||||||||||||||||
American Showa | Industrial | OH | 10,320,000 | 1,452,649 | 15,747,351 | — | 1,452,649 | 15,747,351 | 17,200,000 | 907,536 | N/A | 5/28/2015 | 5-40 years | |||||||||||||||||||||||||||||
Huntington Ingalls | Industrial | VA | (2) | 5,415,000 | 29,836,000 | — | 5,415,000 | 29,836,000 | 35,251,000 | 1,675,105 | N/A | 6/26/2015 | 5-40 years | |||||||||||||||||||||||||||||
Wyndham | Office | NJ | (2) | 5,695,816 | 76,531,589 | — | 5,695,816 | 76,531,589 | 82,227,405 | 3,981,852 | N/A | 6/26/2015 | 5-40 years | |||||||||||||||||||||||||||||
Exel | Distribution Center | OH | (2) | 1,988,200 | 13,958,000 | — | 1,988,200 | 13,958,000 | 15,946,200 | 878,556 | N/A | 6/30/2015 | 5-40 years | |||||||||||||||||||||||||||||
Morpho Detection | Office | MA | (2) | 2,350,000 | 9,482,000 | — | 2,350,000 | 9,482,000 | 11,832,000 | 680,636 | N/A | 7/1/2015 | 5-40 years | |||||||||||||||||||||||||||||
FedEx Freight | Industrial | OH | (2) | 2,774,000 | 25,913,000 | — | 2,774,000 | 25,913,000 | 28,687,000 | 1,379,537 | N/A | 7/22/2015 | 5-40 years | |||||||||||||||||||||||||||||
Aetna | Office | AZ | (2) | 1,852,514 | 20,480,575 | — | 1,852,514 | 20,480,575 | 22,333,089 | 731,750 | N/A | 7/29/2015 | 5-40 years | |||||||||||||||||||||||||||||
Bank of America I | Office | CA | (2) | 5,491,000 | 23,514,000 | 70,926 | 5,491,000 | 23,584,926 | 29,075,926 | 2,159,816 | N/A | 8/14/2015 | 5-40 years | |||||||||||||||||||||||||||||
Bank of America II | Office | CA | (2) | 9,206,000 | 20,204,000 | — | 9,206,000 | 20,204,000 | 29,410,000 | 2,134,340 | N/A | 8/14/2015 | 5-40 years | |||||||||||||||||||||||||||||
Atlas Copco | Office | MI | (2) | 1,480,000 | 16,490,000 | — | 1,480,000 | 16,490,000 | 17,970,000 | 904,846 | N/A | 10/1/2015 | 5-40 years | |||||||||||||||||||||||||||||
Toshiba TEC | Office | NC | (2) | 4,130,000 | 36,820,748 | — | 4,130,000 | 36,820,748 | 40,950,748 | 1,309,377 | N/A | 1/21/2016 | 5-40 years | |||||||||||||||||||||||||||||
S-1
GRIFFIN CAPITAL ESSENTIAL ASSET REIT II, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION AND AMORTIZATION
NETGEAR | Office | CA | (2) | 20,725,500 | 25,886,500 | — | 20,725,500 | 25,886,500 | 46,612,000 | 827,046 | N/A | 5/17/2016 | 5-40 years | |||||||||||||||||||||||||||||
Nike | Office | OR | (2) | 5,988,000 | 42,397,000 | 9,067 | 5,988,000 | 42,406,067 | 48,394,067 | 1,623,982 | N/A | 6/16/2016 | 5-40 years | |||||||||||||||||||||||||||||
Zebra Technologies | Office | IL | (2) | 5,238,441 | 56,525,559 | — | 5,238,441 | 56,525,559 | 61,764,000 | 1,001,005 | N/A | 8/1/2016 | 5-40 years | |||||||||||||||||||||||||||||
WABCO | Industrial | SC | (2) | 1,301,500 | 12,598,000 | — | 1,301,500 | 12,598,000 | 13,899,500 | 156,888 | N/A | 9/14/2016 | 5-40 years | |||||||||||||||||||||||||||||
IGT | Office | NV | (2) | 6,324,766 | 64,441,234 | 40,000 | 6,324,766 | 64,481,234 | 70,806,000 | 561,289 | N/A | 9/27/2016 | 5-40 years | |||||||||||||||||||||||||||||
3M | Industrial | IL | (2) | 5,320,224 | 62,247,035 | — | 5,320,224 | 62,247,035 | 67,567,259 | 388,889 | N/A | 10/25/2016 | 5-40 years | |||||||||||||||||||||||||||||
Amazon | Industrial | OH | (2) | 5,331,439 | 85,769,741 | — | 5,331,439 | 85,769,741 | 91,101,180 | 312,452 | N/A | 11/18/2016 | 5-40 years | |||||||||||||||||||||||||||||
Zoetis | Office | NJ | (2) | 3,374,660 | 42,264,682 | — | 3,374,660 | 42,264,682 | 45,639,342 | 73,507 | N/A | 12/16/2016 | 5-40 years | |||||||||||||||||||||||||||||
Southern Company | Office | AL | (2) | 6,605,387 | 122,680,097 | — | 6,605,387 | 122,680,097 | 129,285,484 | 93,062 | N/A | 12/21/2016 | 5-40 years | |||||||||||||||||||||||||||||
Total | $ | 126,970,000 | $ | 117,569,491 | $ | 1,015,365,871 | $ | 119,993 | $ | 117,569,491 | $ | 1,015,485,864 | $ | 1,133,055,355 | $ | 39,954,771 | ||||||||||||||||||||||||||
(1) | Amounts include intangibles. |
(2) | The acquisitions were funded by the credit facility. |
(3) | As of December 31, 2016, the aggregate cost of real estate the Company and consolidated subsidiaries own for federal income tax purposes was approximately $1.1 billion (unaudited). |
Activity for the year ended December 31, | |||||||
2016 | 2015 | ||||||
Real estate facilities | |||||||
Balance at beginning of year | $ | 516,964,849 | $ | — | |||
Acquisitions | 615,970,513 | 516,964,849 | |||||
Improvements | 40,000 | — | |||||
Construction-in-progress | 79,993 | — | |||||
Balance at end of year | $ | 1,133,055,355 | $ | 516,964,849 | |||
Accumulated depreciation | |||||||
Balance at beginning of year | $ | 12,060,635 | $ | — | |||
Depreciation and amortization expense | 27,894,136 | 12,060,635 | |||||
Balance at end of year | $ | 39,954,771 | $ | 12,060,635 | |||
Real estate facilities, net | $ | 1,093,100,584 | $ | 504,904,214 | |||
S-2