Presidio Property Trust, Inc. - Quarter Report: 2008 September (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2008

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

For the period from                      to                     

NetREIT

CALIFORNIA		33-0841255
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification no.)

1282 Pacific Oaks Place, Escondido, California 92029
(Address of principal executive offices)

(760) 471-8536
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No þ.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 o No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller Reporting Company þ
				(Do not check if a 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 o No þ.

At April 30, 2009, registrant had issued and outstanding 7,560,569 shares of its common stock, no par value. The information contained in this Form 10-Q should be read in conjunction with the registrant’s Annual Report on Form 10.

 

 

INDEX TO FINANCIAL STATEMENTS

		Page
Part I FINANCIAL INFORMATION:
Item 1. FINANCIAL STATEMENTS:
Condensed Balance Sheets as of September 30, 2008 (unaudited) and December 31, 2007			3
Condensed Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2007 (unaudited)			4
Condensed Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2008 (unaudited)			5
Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007 (unaudited)			6
Notes to Condensed Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			28
Item 3. Quantitative and Qualitative Disclosures about Market Risk			50
Item 4T. Controls and Procedures			50
Part II OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			51
Item 3. Defaults Upon Senior Securities			52
Item 4. Submission of Matters to a Vote of Security Holders			52
Item 5. Other Information			52
Item 6. Exhibits			52
Signatures			53
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

NetREIT

		September 30, 2008				December 31, 2007
		(Unaudited)				(Note 1)
ASSETS
Real estate assets, net		$	61,925,695			$	41,917,510
Lease intangibles, net			1,087,202				851,615
Land purchase option			1,370,000				1,370,000
Investment in real estate ventures			1,028,086				703,587
Mortgages receivable and interest			2,062,368				1,888,555
Cash and cash equivalents			292,227				4,880,659
Restricted cash			665,076				697,894
Tenant receivables, net			113,191				42,636
Due from related party			38,584				118,447
Deferred rent receivable			168,062				112,268
Deferred stock issuance costs			111,148				179,462
Deposits on potential acquisitions			75,000				—
Other assets, net			837,405				349,608
TOTAL ASSETS		$	69,774,044			$	53,112,241
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Mortgage notes payable		$	24,951,573			$	22,420,316
Accounts payable and accrued liabilities			1,148,327				844,549
Dividends payable			395,755				296,790
Tenant security deposits			262,418				272,681
Total liabilities			26,758,073				23,834,336
Commitments and contingencies
Stockholders’ equity:
Undesignated preferred stock, no par value, shares authorized: 8,995,000, no shares issued and outstanding at September 30, 2008 and December 31, 2007			—				—
Series A preferred stock, no par value, shares authorized: 5,000, no shares issued and outstanding at September 30, 2008 and December 31, 2007			—				—
Convertible Series AA preferred stock, no par value, $25 liquidating preference, shares authorized: 1,000,000; 50,200 shares issued and outstanding at September 30, 2008 and December 31, 2007, liquidating value of $1,255,000			1,028,916				1,028,916
Common stock Series A, no par value, shares authorized: 100,000,000; 5,797,227 and 3,835,958 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively			47,915,505				31,299,331
Common stock Series B, no par value, shares authorized: 1,000, no shares issued and outstanding at September 30, 2008 and December 31, 2007			—				—
Additional paid-in capital			433,204				433,204
Dividends paid in excess of accumulated earnings			(6,361,654	)			(3,483,546	)
Total stockholders’ equity			43,015,971				29,277,905
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	69,774,044			$	53,112,241

See notes to unaudited condensed financial statements.

NetREIT

		Three Months Ended September 30,								Nine Months Ended September 30,
		2008				2007				2008				2007
Rental income		$	1,469,945			$	701,204			$	3,909,656			$	1,776,401
Costs and expenses:
Interest			376,920				229,534				946,772				544,303
Rental operating costs			735,480				359,293				1,953,030				913,780
General and administrative			360,327				151,602				942,196				467,551
Depreciation and amortization			636,252				241,411				1,597,802				569,153
Total costs and expenses			2,108,979				981,840				5,439,800				2,494,787
Other income (expense):
Interest income			84,981				137,815				257,473				277,548
Gain on sale of real estate			—				—				605,539				9,775
Equity in earnings of real estate ventures			10,257				1,366				27,825				1,366
Other income (expense)			776				—				(10,313	)			5,306
Total other income			96,014				139,181				880,524				293,995
Loss from continuing operations			(543,020	)			(141,455	)			(649,620	)			(424,391	)
Discontinued operations:
Income from discontinued operations			—				65,885				—				197,424
Net loss			(543,020	)			(75,570	)			(649,620	)			(226,967	)
Preferred stock dividends			(21,963	)			(23,538	)			(65,888	)			(65,888	)
Net loss attributable to common stockholders		$	(564,983	)		$	(99,108	)		$	(715,508	)		$	(292,855	)
Loss attributable to common stockholders — basic and diluted:
Loss from continuing operations		$	(0.10	)		$	(0.05	)		$	(0.15	)		$	(0.21	)
Income from discontinued operations							0.02								0.08
Loss per common share		$	(0.10	)		$	(0.03	)		$	(0.15	)		$	(0.13	)
Weighted average number of common shares outstanding — basic and diluted			5,411,227				3,021,060				4,728,243				2,315,639

See notes to unaudited condensed financial statements.

NetREIT

		Series AA																Additional				Dividends Paid in Excess of
		Preferred Stock								Common Stock								Paid-in				Accumulated
		Shares				Amount				Shares				Amount				Capital				Earnings				Total
Balance, December 31, 2007			50,200			$	1,028,916				3,835,958			$	31,299,331			$	433,204			$	(3,483,546	)		$	29,277,905
Sale of common stock at $10 per share											1,830,184				18,301,839												18,301,839
Stock issuance costs															(2,876,971	)											(2,876,971	)
Repurchase of common stock											(7,227	)			(61,827	)											(61,827	)
Reinvestment of cash dividends											71,913				683,590												683,590
Exercise of stock options											17,136				101,979												101,979
Exercise of warrants											485				4,530												4,530
Dividends reinvested on restricted stock											1,581				15,052												15,052
Vesting of restricted stock outstanding											200				2,000												2,000
Net loss																							(649,620	)			(649,620	)
Dividends paid																							(1,386,751	)			(1,386,751	)
Dividends (declared)/reinvested											46,997				445,982								(841,737	)			(395,755	)
Balance, September 30, 2008			50,200			$	1,028,916				5,797,227			$	47,915,505			$	433,204			$	(6,361,654	)		$	43,015,971

See notes to unaudited condensed financial statements.

NetREIT

		Nine Months Ended				Nine Months Ended
		September 30, 2008				September 30, 2007
Cash flows from operating activities:
Net loss		$	(649,620	)		$	(226,967	)
Adjustments to reconcile net loss to net cash provided by operating activities (including discontinued operations):
Depreciation and amortization			1,597,802				642,223
Stock compensation			2,000
Gain on sale of real estate			(605,539	)			(9,775	)
Bad debts			34,121
Distributions from real estate ventures in excess of earnings			48,330
Equity in earnings of real estate ventures			(27,825	)			(1,366	)
Changes in operating assets and liabilities:
Deferred rent receivable			(55,794	)			(63,087	)
Tenant receivables			(104,676	)			(39,567	)
Other assets			(549,452	)			470,145
Accounts payable and accrued liabilities			302,440				144,944
Due from related party			79,863				(44,167	)
Tenant security deposits			(10,263	)			179,896
Net cash provided by operating activities			61,387				1,052,279
Cash flows from investing activities:
Real estate investments			(22,570,458	)			(23,284,209	)
Deposits on potential acquisitions			(75,000	)
Net proceeds received from sale of real estate			1,028,083
Issuance of mortgages receivable			(173,813	)			(398,246	)
Restricted cash			32,818				(442,676	)
Proceeds from short-term investments			22,991				20,995
Net cash used in investing activities			(21,735,379	)			(24,104,136	)
Cash flows from financing activities:
Proceeds from mortgage notes payable			10,447,500				14,675,750
Repayment of mortgage notes payable			(7,916,243	)			(117,566	)
Net proceeds from issuance of common stock			15,424,868				11,819,479
Repurchase of common stock			(61,827	)			(38,459	)
Exercise of stock options			101,979				82,558
Exercise of warrants			4,530
Deferred stock issuance costs			68,314				(94,571	)
Dividends paid			(983,561	)			(612,753	)
Net cash provided by financing activities			17,085,560				25,714,438
Net increase (decrease) in cash and cash equivalents			(4,588,432	)			2,662,581
Cash and cash equivalents:
Beginning of period			4,880,659				5,783,283
End of period		$	292,227			$	8,445,864
Supplemental disclosure of cash flow information:
Interest paid		$	899,961			$	462,162
Non cash investing and financing activities:
Reinvestment of cash dividend		$	1,144,624			$	670,068
Reclassification of real estate to investment in real estate ventures		$	345,005			$	699,876
Accrual of dividends		$	395,755

See notes to unaudited condensed financial statements.

NetREIT

1. ORGANIZATION AND BASIS OF PRESENTATION

NetREIT (the “Company”) was incorporated in the State of California on January 28, 1999 for the purpose of investing in real estate properties. The Company qualifies and operates as a self-administered real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended, (the “Code”) commenced operations with capital provided by its private placement offering of its equity securities in 1999.

The Company invests in a diverse portfolio of real estate assets. The primary types of properties the Company invests in include office, retail, self-storage properties and residential properties located in the western United States. The Company also invests in mortgage loans.

As of September 30, 2008, the Company owned or had an equity interest in four office buildings (“Office Properties”) which total approximately 298,000 rentable square feet, three retail shopping centers and a single tenant retail property (“Retail Properties”) which total approximately 85,000 rentable square feet, one 39 unit apartment building (“Residential Properties”), and two self storage facilities (“Self Storage Properties”) which total approximately 210,000 rentable square feet.

Basis of Presentation. The accompanying interim condensed financial statements have been prepared by the Company’s management in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). In the opinion of management, the accompanying interim condensed financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim periods presented. However, the results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. These condensed financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s registration statement on Form 10 for the year ended December 31, 2007 filed with the SEC on May 6, 2008 and subsequently amended. The condensed balance sheet at December 31, 2007 has been derived from the audited financial statements included in the Form 10.

2. SIGNIFICANT ACCOUNTING POLICIES

Property Acquisitions. The Company accounts for its acquisitions of real estate in accordance with Statement of Financial Standards (“SFAS”) No. 141, “Business Combinations” (“SFAS 141”) which requires the purchase price of acquired properties be allocated to the acquired tangible assets and liabilities, consisting of land, building, tenant improvements, a land purchase option, long-term debt and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, the value of in-place leases, unamortized lease origination costs and tenant relationships, based in each case on their fair values.

The Company allocates the purchase price to tangible assets of an acquired property (which includes land, building and tenant improvements) based on the estimated fair values of those tangible assets, assuming the building was vacant. Estimates of fair value for land, building and building improvements are based on many factors including, but not limited to, comparisons to other properties sold in the same geographic area and independent third party valuations. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair values of the tangible and intangible assets and liabilities acquired.

The total value allocable to intangible assets acquired, which consists of unamortized lease origination costs, in-place leases and tenant relationships, are allocated based on management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics considered by management in allocating these values include the nature and extent of the existing business relationships with the tenant, growth prospects for developing new business with the tenant, the remaining term of the lease and the tenant’s credit quality, among other factors.

The value allocable to above or below market component of an acquired in-place lease is determined based upon the present value (using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of rents that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above or below market leases are included in lease intangibles, net in the accompanying condensed balance sheets and are amortized on a straight-line basis as an increase or reduction of rental income over the remaining non-cancelable term of the respective leases. As of September 30, 2008, the unamortized balance of below market leases was $39,291. As of September 30, 2007, the Company did not have any deferred rent for above or below market leases.

The land lease acquired with the World Plaza acquisition in 2007 has a fixed purchase price option cost of $181,710 at the termination of the lease in 2062. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) management valued the land option at its residual value of $1,370,000, based upon comparable land sales adjusted to present value. The difference between the strike price of the option and the recorded cost of the land purchase option is approximately $1.2 million. Accordingly, management has determined that exercise of the option is considered probable. The land purchase option was determined to be a contract based intangible asset associated with the land. As a result, this asset has an indefinite life and is treated as a non-amortizable asset. The amount is included as land purchase option on the accompanying condensed balance sheets.

The value of in-place leases, unamortized lease origination costs and tenant relationships are amortized to expense over the remaining term of the respective leases, which range from less than a year to ten years. The amount allocated to acquire in-place leases is determined based on management’s assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. The amount allocated to unamortized lease origination costs is determined by what the Company would have paid to a third party to recruit a new tenant reduced by the expired term of the respective lease. The amount allocated to tenant relationships is the benefit resulting from the likelihood of a tenant renewing its lease. Amortization expense related to these assets was $151,094 and $24,572 for the three months ended September 30, 2008 and 2007, respectively. Amortization expense related to these assets was $391,179 and $51,835 for the nine months ended September 30, 2008 and 2007, respectively.

Sales of Undivided Interests in Properties.

The Company accounts for profit recognition on sales of real estate in accordance with SFAS No. 66 “Accounting for Sales of Real Estate” (“SFAS 66”). Pursuant to SFAS 66, profits from sales will not be recognized under the full accrual method by the Company until certain criteria are met. Profit (the difference between the sales value and the proportionate cost of the partial interest sold) shall be recognized at the date of sale if a sale has been consummated and the following:

a. The buyer is independent of the seller.

b. Collection of the sales price is reasonably assured.

c. The seller will not be required to support the operations of the property or its related obligations to an extent greater than its proportionate interest.

Gains relating to transactions which do not meet the criteria for full accrual method of accounting are deferred and recognized when the full accrual method of accounting criteria are met or by using the installment or deposit methods of profit recognition, as appropriate in the circumstances.

Depreciation and Amortization of Buildings and Improvements. Land, buildings and improvements are recorded at cost. Major replacements and betterments, which improve or extend the life of the asset, are capitalized and depreciated over their estimated useful lives, while ordinary repairs and maintenance are expensed as incurred. The cost of buildings and improvements are depreciated using the straight-line method over estimated useful lives ranging from 30 to 55 years for buildings, improvements are amortized over the shorter of the estimated life of the asset or term of the tenant lease which range from 1 to 10 years, and 4 to 5 years for furniture, fixtures and equipment. Depreciation expense, including discontinued operations, for buildings and improvements for the three months ended September 30, 2008 and 2007, was $468,015 and $325,972, respectively. Depreciation expense, including discontinued operations, for buildings and improvements for the nine months ended September 30, 2008 and 2007, was $1,167,960 and $562,054, respectively.

Intangible Assets —Lease intangibles represents the allocation of a portion of the purchase price of a property acquisition representing the estimated value of in-place leases, unamortized lease origination costs, tenant relationships and a land purchase option. Intangible assets are comprised of finite-lived and indefinite-lived assets. In accordance with SFAS 142, indefinite-lived assets are not amortized. Finite-lived intangibles are amortized over their expected useful lives. The Company assesses its intangibles and goodwill for impairment at least annually.

In accordance with SFAS 142, the Company is required to perform a test for impairment of goodwill and other definite and indefinite lived assets at least annually, and more frequently as circumstances warrant. The Company tests for impairment as of December 31. Based on the last review, no impairment was deemed necessary at December 31, 2007.

Investments in Real Estate Ventures. The Company analyzes its investments in joint ventures to determine whether the joint venture should be accounted for under the equity method of accounting or consolidated into the financial statements based on standards set forth under SFAS Interpretation No. 46(R), “Consolidation of Variable Interest Entities”, Statement of Position 78-9, “Accounting for Investments in Real Estate Ventures” and Emerging Issues Task Force (“EITF”) Statement No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights. Based on the guidance set forth in SFAS Interpretation No. 46(R)”. The Company has determined that the limited partners and/or tenants in common in its real estate ventures have certain protective and substantive participation rights that limit the Company’s control of the investment. Therefore, the Company’s share of its investment in real estate ventures have been accounted for under the equity method of accounting in the accompanying condensed financial statements.

Under the equity method, the Company’s investment in real estate ventures is stated at cost and adjusted for the Company’s share of net earnings or losses and reduced by distributions. Equity in earnings of real estate ventures is generally recognized based on the Company’s ownership interest in the earnings of each of the unconsolidated real estate ventures. For the purposes of presentation in the statement of cash flows, the Company follows the “look through” approach for classification of distributions from joint ventures. Under this approach, distributions are reported under operating cash flow unless the facts and circumstances of a specific distribution clearly indicate that it is a return of capital (e.g., a liquidating dividend or distribution of the proceeds from the joint venture’s sale of assets) in which case it is reported as an investing activity.

Management assesses whether there are any indicators that the value of the Company’s investments in unconsolidated real estate ventures may be impaired when events or circumstances indicate that there may be an impairment. An investment is impaired if management’s estimate of the fair value of the investment is less than its carrying value. To the extent impairment has occurred, and is considered to be other than temporary, the loss is measured as the excess of the carrying amount of the investment over the fair value of the investment. No impairment charges were recognized for the nine months ended September 30, 2008 or 2007.

Provision for Loan Losses. The accounting policies require the Company to maintain an allowance for estimated credit losses with respect to mortgage loans it has made based upon its evaluation of known and inherent risks associated with its lending activities. Management reflects provisions for loan losses based upon its assessment of general market conditions, its internal risk management policies and credit risk rating system, industry loss experience, its assessment of the likelihood of delinquencies or defaults, and the value of the collateral underlying its investments. Actual losses, if any, could ultimately differ from these estimates. There have been no provisions for loan losses at September 30, 2008 and 2007.

Revenue Recognition. The Company recognizes revenue from rent, tenant reimbursements, and other revenue once all of the following criteria are met in accordance with SEC Staff Accounting Bulletin Topic 13, “Revenue Recognition”:

	•		persuasive evidence of an arrangement exists;
	•		delivery has occurred or services have been rendered;
	•		the amount is fixed or determinable; and
	•		the collectability of the amount is reasonably assured.

In accordance with SFAS No. 13, “Accounting for Leases” (“SFAS 13”), as amended and interpreted, minimum annual rental revenue is recognized in rental revenues on a straight-line basis over the term of the related lease.

Certain of the Company’s leases currently contain rental increases at specified intervals, and generally accepted accounting principles require the Company to record an asset, and include in revenues, deferred rent receivable that will be received if the tenant makes all rent payments required through the expiration of the initial term of the lease. Deferred rent receivable in the accompanying condensed balance sheets includes the cumulative difference between rental revenue recorded on a straight-line basis and rents received from the tenants in accordance with the lease terms. Accordingly, the Company determines, in its judgment, to what extent the deferred rent receivable applicable to each specific tenant is collectible. The Company reviews material deferred rent receivable, as it relates to straight-line rents, on a quarterly basis and takes into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of deferred rent with respect to any given tenant is in doubt, the Company records an increase in the allowance for uncollectible accounts or records a direct write-off of the specific rent receivable. No such reserves have been recorded as of September 30, 2008 or December 31, 2007.

Discontinued Operations and Properties. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets” (“SFAS 144”), the income or loss and net gain or loss on dispositions of operating properties and the income or loss on all properties classified as held for sale are reflected in the statements of operations as discontinued operations for all periods presented. A property is classified as held for sale when certain criteria, set forth under SFAS 144, are met. At such time, the Company presents the respective assets and liabilities separately on the balance sheets and ceases to record depreciation and amortization expense. As of September 30, 2008 and December 31, 2007, the Company did not have any properties classified as held for sale.

The following is a summary of discontinued operations for the nine months ended September 30, 2007:

Discontinued operations:		2007
Rental income		$	390,143
Rental operating expense			124,915
Depreciation and amortization			67,804
Total income from discontinued operations		$	197,424
Earnings per share		$	.08

Impairment. The Company accounts for the impairment of real estate in accordance with SFAS 144 which requires that the Company review the carrying value of each property to determine if circumstances that indicate impairment in the carrying value of the investment exist or that depreciation periods should be modified. If circumstances support the possibility of impairment, the Company prepares a projection of the undiscounted future cash flows, without interest charges, of the specific property and determines if the investment in such property is recoverable. If impairment is indicated, the carrying value of the property would be written down to its estimated fair value based on the Company’s best estimate of the property’s discounted future cash flows. There have been no impairments recognized on the Company’s real estate assets at September 30, 2008 and December 31, 2007.

Federal Income Taxes. The Company has elected to be taxed as a Real Estate Investment Trust (“REIT”) under Sections 856 through 860 of the Code, for federal income tax purposes. To qualify as a REIT, the Company must distribute annually at least 90% of adjusted taxable income, as defined in the Code, to its stockholders and satisfy certain other organizational and operating requirements. As a REIT, no provision will be made for federal income taxes on income resulting from those sales of real estate investments which have or will be distributed to stockholders within the prescribed limits. However, taxes will be provided for those gains which are not anticipated to be distributed to stockholders unless such gains are deferred pursuant to Section 1031. In addition, the Company will be subject to a federal excise tax which equals 4% of the excess, if any, of 85% of the Company’s ordinary income plus 95% of the Company’s capital gain net income over cash distributions, as defined.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 provides guidance for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return, and provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition of tax positions. FIN 48 was effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 effective for the fiscal year beginning January 1, 2007, and the adoption had no impact on the Company’s results of operations.

Earnings and profits that determine the taxability of distributions to stockholders differ from net income reported for financial reporting purposes due to differences in estimated useful lives and methods used to compute depreciation and the carrying value (basis) on the investments in properties for tax purposes, among other things.

The Company believes that it has met all of the REIT distribution and technical requirements for the nine months ended September 30, 2008 and for the year ended December 31, 2007.

Stock Options. In December 2004, the FASB approved the revision of SFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”), and issued the revised SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”). In April 2005, the effective date of adoption was changed from interim periods ending after June 15, 2005 to annual periods beginning after June 15, 2005. SFAS 123(R) effectively replaces SFAS 123, and supersedes Accounting Principles Board Opinion No. 25. SFAS 123(R) was effective for awards that are granted, modified, or settled in cash for annual periods beginning after June 15, 2005. The Company adopted SFAS 123(R) on January 1, 2006 using the modified prospective approach. Under the modified prospective approach, stock-based compensation expense is recorded for the unvested portion of previously issued awards that remained outstanding at January 1, 2006 using the same estimate of the grant date fair value and the same attribution method used to determine the pro forma disclosure under SFAS 123. SFAS 123(R) also requires that all share-based payments to employees after January 1, 2006, including employee stock options, be recognized in the financial statements as stock-based compensation expense based on the fair value on the date of grant.

Earnings (Loss) Per Common Share. Basic earnings (loss) per common share (“Basic EPS”) is computed by dividing net income (loss) available to common stockholders (the “numerator”) by the weighted average number of common shares outstanding (the “denominator”) during the period. Diluted earnings per common share (“Diluted EPS”) is similar to the computation of Basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back the after-tax amount of interest recognized in the period associated with any convertible debt and dividends on convertible preferred stock. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an anti-dilutive effect on net earnings (loss) per share.

The following is a reconciliation of the denominator of the basic earnings per common share computation to the denominator of the diluted earnings per common share computations, for the three and nine months ended September 30, 2008 and 2007:

		Three months ended								Nine months ended
		September 30,								September 30,
		2008				2007				2008				2007
Weighted average shares used for Basic EPS			5,411,227				3,021,060				4,728,243				2,315,639
Incremental shares from share-based compensation			—				—				—				—
Incremental shares from conversion of NetREIT 01 LP Partnership			—				—				—				—
Incremental shares from convertible preferred and warrants			—				—				—				—
Adjusted weighted average shares used for Diluted EPS			5,411,227				3,021,060				4,728,243				2,315,639

Weighted average shares from share based compensation, shares from conversion of NetREIT 01 LP Partnership and shares from convertible preferred and warrants with respect to a total of 958,177 shares of common stock for the three and nine months ended September 30, 2008, were excluded from the computation of diluted earnings per share as their effect was anti-dilutive. Weighted average shares from share based compensation and shares from convertible preferred and warrants with respect to a total of 898,592 shares of common stock for the three and nine months ended September 30, 2007, were excluded from the computation of diluted earnings per share as their effect was anti-dilutive.

Fair Value of Financial Instruments. The Company calculates the fair value of financial instruments using available market information and appropriate present value or other valuation techniques such as discounted cash flow analyses. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The derived fair value estimates cannot always be substantiated by comparison to independent markets and in many cases, could not be realized in immediate settlement of the instruments. Management believes that the carrying values reflected in the accompanying condensed balance sheets reasonably approximate the fair values for financial instruments.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant estimates include the allocation of purchase price paid for property acquisitions between land, building and intangible assets acquired including their useful lives; the allowance for doubtful accounts, which is based on an evaluation of the tenants’ ability to pay and the provision for possible loan losses with respect to mortgages receivable and interest. Actual results may differ from those estimates.

Segments. SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information” (“SFAS 131”), establishes standards for the way that public entities report information about operating segments in their financial statements. The Company acquires and operates income producing properties including office properties, residential properties, retail properties and self storage properties and invests in real estate assets, including real estate loans, and as a result, the Company operates in five business segments. See Note 9 “Segment Information”.

Recent Issued Accounting Standards. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value and establishes a framework for measuring fair value under U. S. generally accepted accounting principles (“GAAP”). The key changes to current practice are (1) the definition of fair value, which focuses on an exit price rather than an entry price; (2) the methods used to measure fair value, such as emphasis that fair value is a market-based measurement, not an entity-specific measurement, as well as the inclusion of an adjustment for risk, restrictions, and credit standing and (3) the expanded disclosures about fair value measurements, SFAS 157 does not require any new fair value measurements. SFAS 157, as amended, was effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company adopted SFAS 157 on January 1, 2008 and, effective for the third quarter 2008, adopted FASB Staff Position SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS 157-3”). The adoption of SFAS 157 and FSP SFAS 157-3 did not have a significant impact on the Company’s financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurements attributes for similar types of assets and liabilities. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. In adopting SFAS 159, the Company did not elect the fair value option for any financial assets or liabilities. Therefore, the adoption of SFAS 159 did not have a significant impact on the Company’s financial position or results of operations.

In November 2007, the FASB issued Emerging Issues Task Force (“EITF”) Issue No. 07-06, “Accounting for Sale of Real Estate Subject to the Requirements of SFAS 66 When the Agreement Includes a Buy-Sell Clause” (“EITF 07-06”). A buy-sell clause is a contractual term that gives both investors of a jointly-owned entity the ability to offer to buy the other investor’s interest. EITF 07-06 applies to sales of real estate to an entity if the entity is both partially owned by the seller of the real estate and subject to an arrangement between the seller and the other investor containing a buy-sell clause. The EITF concluded the existence of a buy-sell clause does not represent a prohibited form of continuing involvement that would preclude partial sale and profit recognition pursuant to SFAS 66. The EITF cautioned the buy-sell clause could represent such a prohibition if the terms of the buy-sell clause and other facts and circumstances of the arrangement suggest:

	•		the buyer cannot act independently of the seller or
	•		the seller is economically compelled or contractually required to reacquire the other investor’s interest in the jointly owned entity.

EITF 07-06 was effective for new arrangements in fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The adoption of EITF 07-06 did not have a significant impact on the Company’s financial position or results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”), which replaces SFAS 141. SFAS 141R expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date. SFAS 141R also requires that all assets, liabilities, contingent considerations, and contingencies of an acquired business be recorded at fair value at the acquisition date. In addition, SFAS 141R requires that acquisition costs generally be expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. SFAS 141R is effective for business combinations beginning January 1, 2009. The Company has evaluated the impact that SFAS 141R will have on its future financial statements and believes that the impact on expenses related to acquisitions will not be material as it is traditional for the property seller to pay significant costs such as broker commissions.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidating Financial Statements—an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. In addition, SFAS 160 provides reporting requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company does not believe the adoption of SFAS 160 will have a significant impact on the Company’s financial position or results of operations.

In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP SFAS 142-3”), which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142. FSP SFAS 142-3 is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R. FSP SFAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, as well as interim periods within those fiscal years, and must be applied prospectively to intangible assets acquired after the effective date. The Company is currently evaluating the impact the adoption of the pronouncement will have on its results of operations.

3. REAL ESTATE ASSETS AND LEASE INTANGIBLES

A summary of the nine properties 100% owned by the Company as of September 30, 2008 is as follows:

Real estate

assets, net

Square

Property

(in

Property Name

Date Acquired

Location

Footage

Description

thousands)

Havana/Parker Complex

June 2006

Aurora, Colorado

114,000

Office

$

6,164.4

Garden Gateway

March 2007

Colorado Springs, Colorado

115,052

Office

13,947.4

World Plaza

September 2007

San Bernardino, California

55,096

Retail

6,059.7

Regatta Square

October 2007

Denver, Colorado

5,983

Retail

2,085.2

Sparky’s Palm Self-Storage

November 2007

Highland, California

60,508

Self Storage

4,596.8

Sparky’s Joshua Self-Storage

December 2007

Hesperia, California

149,650

Self Storage

7,694.8

Executive Office Park

July 2008

Colorado Springs, Colorado

65,084

Office

9,709.9

Waterman Plaza

August 2008

San Bernardino, California

21,285

Retail

6,832.5

Pacific Oaks Plaza

September 2008

Escondido, California

16,037

Office

4,835.0

Total real estate assets, net

$

61,925.7

The following table sets forth the components of the Company’s investments in real estate:

		September 30,				December 31,
		2008				2007
Land		$	11,440,290			$	6,940,554
Buildings and other			49,653,390				34,330,636
Tenant improvements			2,818,002				1,746,852
			63,911,682				43,018,042
Less accumulated depreciation and amortization			(1,985,987	)			(1,100,532	)
Real estate assets, net		$	61,925,695			$	41,917,510

During the nine months ended September 30, 2008, the Company acquired three properties, which are summarized below:

In July 2008, the Company acquired Executive Office Park located in Colorado Springs, Colorado. The purchase price for the property was $10.1 million, including transaction costs. The Company purchased the property for $3.5 million cash and with $6.6 million borrowed under a line of credit the Company established on July 9, 2008. This property is comprised of a condominium development consisting of four separate buildings situated on four legal parcels. The property is developed as an office condominium complex. The property consists of a total of 65,084 rentable square feet situated on a total of 4.65 acres.

In August 2008, the Company acquired Waterman Plaza located in San Bernardino, California. The purchase price for the property was $7.2 million, including transaction costs. The Company purchased the property with $3.3 million cash and a new fixed rate mortgage note in the amount of $3.9 million secured by this property. This property is a newly constructed retail/office building consisting of approximately 21,285 square feet situated on a total of 2.7 acres with approvals to construct an additional 2,500 square foot building.

In September 2008, the Company acquired Pacific Oaks Plaza, an office building located in Escondido, California. The purchase price for the property was $4.9 million, including transaction costs, all paid in cash. This property consists of approximately 16,000 square feet and is being utilized as the Company’s headquarters and, approximately 3,900 square feet of the building is leased to an unrelated entity.

In accordance with SFAS No. 141, “Business Combinations,” the Company allocated the purchase price of the properties acquired during the nine months ended September 30, 2008 as follows:

						Buildings and				Tenant												Total Purchase
		Land				other				Improvements				In-place Leases				Leasing Costs				Price
Executive Office Park		$	1,265,735			$	7,747,826			$	797,219			$	195,518			$	119,583			$	10,125,881
Waterman Plaza			2,350,000				4,319,736				177,030				135,162				182,101				7,164,029
Pacific Oaks Plaza			980,000				3,862,791								23,254				10,438				4,876,483

Property sales

Casa Grande

In March 2008, the Company sold an undivided 54.92% interest in Casa Grande Apartments located in Cheyenne, Wyoming. The purchasers paid $1.0 million, net of transaction costs, in cash. For financial reporting purposes, a gain of $0.6 million is included in the accompanying condensed statement of operations in the line item gain on sale of real estate for the nine months ended September 30, 2008.

The investors in Casa Grande properties are held as tenants in common and have been granted certain protective and substantive participating rights that limit the Company’s control over investment in the property. As a result, the Company’s remaining investment in this property is included on the accompanying condensed balance sheets in investment in real estate ventures and accounted for under the equity method.

Lease Intangibles

The following table summarizes the net value of other intangible assets and the accumulated amortization for each class of intangible asset:

		September 30, 2008												December 31, 2007
		Lease				Accumulated				Lease				Lease				Accumulated				Lease
		Intangibles				Amortization				Intangibles, net				Intangibles				Amortization				Intangibles, net
In-place leases		$	683,898			$	(105,033	)		$	578,865			$	329,963			$	(50,116	)		$	279,847
Leasing costs			586,014				(139,728	)			446,286				273,892				(41,600	)			232,292
Tenant relationships			365,817				(264,475	)			101,342				365,817				(26,341	)			339,476
Below-market lease			(40,298	)			1,007				(39,291	)
		$	1,595,431			$	(508,229	)		$	1,087,202			$	969,672			$	(118,057	)		$	851,615

The estimated aggregate amortization expense for the remainder of the current year and each of the five succeeding years is as follows:

		Estimated Aggregate
		Amortization
		Expense
Three months ending December 31, 2008		$	155,388
Year ending December 31, 2009			294,386
2010			221,460
2011			143,763
2012			89,408
2013 and thereafter			182,797
		$	1,087,202

The weighted average amortization period for the intangible assets, in-place leases, leasing costs, tenant relationships and below-market leases acquired as of September 30, 2008 was 6.2 years.

4. INVESTMENT IN REAL ESTATE VENTURES

The following table sets forth the components of the Company’s investment in real estate ventures:

						Investment balance at:
		Equity				September 30,				December 31,
		Percentage				2008				2007
7-11 Escondido			51.40	%		$	692,116			$	703,587
Casa Grande Apartments			44.6				335,970				—
						$	1,028,086			$	703,587

As of December 31, 2007, the investment in 7-11 Escondido was held as a tenant in common with an unrelated party. On April 21, 2008, the Company and the other tenant in common contributed their respective equity ownership to NetREIT 01 LP, a California limited partnership. At any time on or after September 30, 2008, the partner has an option to exchange its equity interest in the property into shares of NetREIT common stock at a conversion price equal to $9.30 per share up to 77,369 shares. The Company has a put option to convert the partner’s equity interests in NetREIT 01 LP to shares of Company common stock at $9.30 per share for up to 77,369 common shares upon the earlier of April 21, 2013 or the completion of an initial public offering of shares to be registered under the Securities Act of 1933.

The Company’s share of earnings for these equity investments for the nine months ended September 30, 2008 and 2007, was $27,825 and $1,366, respectively.

Condensed balance sheets of all entities included in investment in real estate ventures as of September 30, 2008 and December 31, 2007 are as follows:

		September 30,				December 31,
		2008				2007
Real estate assets		$	1,688,621			$	703,587
Total assets		$	1,688,621			$	703,587
Liabilities		$	660,535			$	—
Owner’s equity			1,028,086				703,587
Total liabilities and owner’s equity		$	1,688,621			$	703,587

Condensed statements of operations of the two entities included in investment in real estate ventures for the nine and three months ended September 30, 2008 and 2007 are as follows:

		Nine months ended								Three months ended
		September 30,								September 30,
		2008				2007				2008				2007
Rental income		$	168,176			$	13,815			$	72,940			$	13,815
Costs and expenses:
Rental operating costs			73,768				414				35,845				414
		$	94,408			$	13,401			$	37,095			$	13,401

5. MORTGAGES RECEIVABLE

In March 2007, the Company originated a mortgage loan in the amount of $500,000 collateralized by a first deed of trust on land under development as a retirement home in Escondido, California. This mortgage loan accrues interest at 15% per year. The mortgage loan unpaid principal and accrued interest was due and payable on March 20, 2008. At September 30, 2008 and December 31, 2007, the principal and accrued interest was $472,641 and $413,368, respectively.

In October 2007, the Company originated a mortgage loan in the amount of $935,000 collateralized by a second deed of trust on the same land under development above. This mortgage loan accrues interest at 11.5% per year. The mortgage loan unpaid principal and accrued interest was due and payable on October 1, 2008. At September 30, 2008 and December 31, 2007, the principal and accrued interest was $1,050,369 and $962,478, respectively.

In November 2007, the Company originated a mortgage loan in the amount of $500,000 collateralized by a third deed of trust on the same land above. This mortgage loan accrues interest at 15% per year. The mortgage loan unpaid principal and accrued interest was due and payable on November 19, 2008. At September 30, 2008 and December 31, 2007, the principal and accrued interest was $539,358 and $512,709, respectively.

On July 29, 2008, all three loans were modified to extend the due dates to be uniformly due and payable on December 31, 2008.

These loans, together with accrued interest, having a balance due of approximately $2.1 million went into default on January 1, 2009. The Company has commenced acquiring title to the property and will seek to sell the property in the near future. The Company does not anticipate incurring any losses with respect to these loans.

6. MORTGAGE NOTES PAYABLE

The following table sets forth the components of mortgage notes payable as of September 30, 2008 and December 31, 2007:

		September 30,				December 31,
		2008				2007
Mortgage note payable in monthly installments of $24,330 through July 1, 2016, including interest at a fixed rate of 6.51%, collateralized by the Havana/Parker Complex property.		$	3,475,263			$	3,520,170
Mortgage note payable in monthly installments of $71,412 through April 5, 2014, including interest at a fixed rate of 6.08%; collateralized by the leases and office buildings of the Garden Gateway Plaza property. Certain obligations under the note are guaranteed by the executive officers.			10,722,379				10,872,323
Mortgage note payable in monthly installments of $27,088 through February 1, 2012, including interest at a fixed rate of 5.31%; collateralized by the World Plaza property.			3,556,431				3,656,363
Revolving line of credit facility to borrow up to $6,597,500, interest only payments at a fixed rate of 6.25%; principal payable December 10, 2009; collateralized by the Executive Office Park and Regatta Square properties.			3,347,500
Mortgage note payable in monthly installments of $25,995 through September 1, 2015, including interest at a fixed rate of 6.5%; collateralized by the Waterman Plaza property.			3,850,000
Assumed mortgage note payable in monthly installments of $39,302 through March 10, 2008, including interest at a fixed rate of 9.506%; collateralized by the Sparky’s Joshua Self-Storage property. The Company paid the loan off in its entirety in January 2008.							4,371,460
		$	24,951,573			$	22,420,316

7. RELATED PARTY TRANSACTIONS

Certain services and facilities are provided to the Company by C.I. Holding Group, Inc. and Subsidiaries (“CI”) a small shareholder in the Company and is approximately 35% owned by the Company’s executive management. A portion of the Company’s general and administrative costs are paid by CI and then reimbursed by the Company.

The Company has entered into a property management agreement with CHG Properties, Inc. (“CHG”), a wholly owned subsidiary of CI, to manage all of its properties at rates of up to 5% of gross income. During the three months ended September 30, 2008 and 2007, the Company paid CHG total management fees of $64,668 and $29,196, respectively, and $175,344 and $68,236 during the nine months ended September 30, 2008 and 2007, respectively.

During the term of the property management agreement, the Company has an option to acquire the business conducted by CHG. The option is exercisable, without any consent of the property manager, its board or its shareholders, with the approval of a majority of the Company’s directors not otherwise interested in the transaction. The option price is shares of the Company to be determined by a predefined formula based on the net income of CHG during the 6-month period immediately preceding the month in which the acquisition notice is delivered. The Company has no intention to exercise the option to acquire CHG.

Prior to the sale of the Rancho Santa Fe Property in October 2007, the Company leased office space in this property to CI under a lease that provided for monthly lease payments of $8,787 per month. The Company received cash from accrued rental income from CI totaling $31,364 and $35,148 during the three months ended September 30, 2008 and 2007, respectively, and received $85,655 and $71,584 during the nine months ended September 30, 2008 and 2007, respectively. At September 30, 2008 and December 31, 2007, CI owed the Company $20,909 and $118,447, respectively, relating to the above lease.

8. STOCKHOLDERS’ EQUITY

Employee Retirement and Share-Based Incentive Plans

Stock Options.

Each of these options was awarded pursuant to the Company’s 1999 Flexible Incentive Plan (the “Plan”). The following table summarizes the stock option activity. The exercise price and number of shares under option have been adjusted to give effect to stock dividends declared by the Company. There have not been any stock options granted since June 2005.

The following table summarizes employee stock option activity for the year ended December 31, 2007 and the nine months ended September 30, 2008:

						Weighted
						Average Exercise
		Shares				Price
Balance, December 31, 2006			55,683			$	7.06
Options Exercised			(13,182	)		$	6.36
Balance, December 31, 2007			42,501			$	7.28
Options Exercised			(17,136	)		$	5.95
Options outstanding and exercisable, September 30, 2008			25,365			$	8.18

At September 30, 2008, the options outstanding and exercisable had exercise prices ranging from $7.20 to $8.64, with a weighted average price of $8.18, and expiration dates ranging from June 2009 to June 2010 with a weighted average remaining term of 1.43 years.

The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. The aggregate intrinsic value of options outstanding, all of which are exercisable, was $46,058 at September 30, 2008.

Share-Based Incentives. The Compensation Committee of the Board of Directors adopted a restricted stock award program under the Plan in December 2006 for the purpose of attracting and retaining officers, key employees and non-employee board members. The Board has granted nonvested shares of restricted common stock on January 1, 2007 and 2008. The nonvested shares have voting rights and are eligible for dividends paid to common shares. The share awards vest in equal annual installments over the three or five year period from date of issuance. The Company recognized compensation cost for these fixed awards over the service vesting period, which represents the requisite service period, using the straight-line attribution expense method.

The value of the nonvested shares was calculated based on the offering price of the shares in the most recent private placement offering of $10 adjusted for a 5% stock dividend since granted. The value of granted nonvested restricted stock issued during the nine months ended September 30, 2008 and 2007 totaled $278,710 and $142,374, respectively. During the nine months ended September 30, 2008, 200 shares were vested. During the three months ended September 30, 2008 and the nine months ended September 30, 2008, dividends of $5,624 and $15,052 were paid on the nonvested shares, respectively. The nonvested restricted shares will vest in equal installments over the next two to four and a quarter years.

Cash Dividends. Cash dividends declared per common share for the nine months ended September 30, 2008 and 2007 were $0.44 and $0.45, respectively. The dividend paid to stockholders of the Series AA Preferred for the three months ended September 30, 2008 was $21,963, and for the nine months ended September 30, 2008 was $65,888 or an annualized portion of the 7% of the liquidation preference of $25 per share.

Sale of Common Stock. During the nine months ended September 30, 2008 the net proceeds from the sale of 1,830,184 shares of common stock was $15,424,868.

9. SEGMENTS

The Company’s five reportable segments consists of mortgage loan activities and the four types of commercial real estate properties for which the Company’s decision-makers internally evaluate operating performance and financial results: Residential Properties, Office Properties, Retail Properties, Self Storage Properties and Real Estate Loans. The Company also has certain corporate level activities including accounting, finance, legal administration and management information systems which are not considered separate operating segments.

The Company’s chief operating decision maker evaluates the performance of its segments based upon net operating income. Net operating income is defined as operating revenues (rental income, tenant reimbursements and other property income) less property and related expenses (property expenses, real estate taxes, ground leases and provisions for bad debts) and excludes other non-property income and expenses, interest expense, depreciation and amortization, and general and administrative expenses. The accounting policies of the reportable segments are the same as those described in the Company’s significant accounting policies (see Note 2). There is no intersegment activity.

The following tables reconcile the Company’s segment activity to its combined results of operations and financial position for the three and nine months ended September 30, 2008 and 2007 and as of September 30, 2008 and December 31, 2007:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Office Properties:
Rental income		$	846,990			$	622,444			$	2,071,834			$	1,563,254
Property and related expenses			425,409				324,711				1,081,513				819,045
Net operating income, as defined			421,581				297,733				990,321				744,209
Residential Properties:
Rental income			—				54,288				49,517				161,645
Property and related expenses			—				28,871				25,456				88,071
Net operating income, as defined			—				25,417				24,061				73,574
Equity in earnings from real estate ventures			3,000				—				11,877				—
Retail Properties:
Rental income			319,693				24,472				871,029				51,502
Property and related expenses			130,515				5,711				324,806				6,664
Net operating income, as defined			189,178				18,761				546,223				44,838
Equity in earnings from real estate ventures			7,257				1,366				15,948				1,366
Self Storage Properties:
Rental income			303,262				—				917,276				—
Property and related expenses			179,556				—				521,255				—
Net operating income, as defined			123,706				—				396,021				—
Mortgage loan activity:
Interest income			67,923				7,062				192,068				14,354
Reconciliation to Net Income Available to Common Stockholders:
Total net operating income, as defined, for reportable segments			812,645				350,339				2,176,519				878,341
Unallocated other income:
Gain on sale of real estate			—				—				605,539				9,775
Total other income			17,834				130,753				55,092				268,500
Unallocated other expenses:
General and administrative expenses			360,327				151,602				942,196				467,551
Interest expense			376,920				229,534				946,772				544,303
Depreciation and amortization			636,252				241,411				1,597,802				569,153
Loss from continuing operations			(543,020	)			(141,455	)			(649,620	)			(424,391	)
Income from discontinued operations							65,885								197,424
Net loss			(543,020	)			(75,570	)			(649,620	)			(226,967	)
Preferred dividends			(21,963	)			(23,538	)			(65,888	)			(65,888	)
Net loss available for common stockholders		$	(564,983	)		$	(99,108	)		$	(715,508	)		$	(292,855	)

		September 30,				December 31,
		2008				2007
						(as restated)
Assets:
Office Properties:
Land, buildings and improvements, net (1)		$	35,183,726			$	20,787,078
Total assets (2)			36,367,757				21,899,523
Residential Property:
Land, buildings and improvements, net (1)			—				777,569
Total assets (2)			—				777,773
Investment in real estate ventures			335,970
Retail Properties:
Land, buildings and improvements, net (1)			16,806,241				9,760,526
Total assets (2)			17,224,503				9,825,269
Investment in real estate ventures			692,116				703,587
Self Storage Properties:
Land, buildings and improvements, net (1)			12,392,930				12,813,952
Total assets (2)			12,437,118				12,829,217
Mortgage loan activity:
Mortgage receivable and accrued interest			2,062,368				1,888,555
Total assets			2,062,368				1,888,555
Reconciliation to Total Assets:
Total assets for reportable segments			69,119,832				47,923,924
Other unallocated assets:
Cash and cash equivalents			292,227				4,880,659
Prepaid expenses and other assets, net			361,985				307,658
Total Assets		$	69,774,044			$	53,112,241

		Nine months ended
		September 30,
		2008				2007
Capital Expenditures: (1)
Office Properties:
Acquisition of operating properties		$	14,963,070			$	15,192,642
Capital expenditures and tenant improvements			262,952				394,684
Residential Property:
Capital expenditures and tenant improvements			—				18,581
Retail Properties:
Acquisition of operating properties			7,164,030				7,641,858
Capital expenditures and tenant improvements			158,377				36,444
Self Storage Properties:
Acquisition of operating properties			—				—
Capital expenditures and tenant improvements			22,029				—
Mortgage Loan Activity:
Loans originated			173,813				398,246
Total Reportable Segments:
Acquisition of operating properties			22,127,100				22,834,500
Capital expenditures and tenant improvements			443,358				449,709
Total real estate expenditures		$	22,570,458			$	23,284,209
Total loan origination		$	173,813			$	398,246

10. SUBSEQUENT EVENTS

Acquisitions

On January 2, 2009, the Company acquired the Morena Office Center, an office building located in San Diego, California. The purchase price for the property was $6.6 million, including transaction costs. The Company purchased the property with $3.4 million cash and a $3.2 million draw on its line of credit facility. This property consists of approximately 26,784 square foot building on approximately 0.62 acres.

On February 5, 2009, Dubose Model Homes USA, L.P., a Texas limited partnership and the Company entered into an agreement (“Agreement”) to form Dubose Acquisition Partners II, Ltd, a limited partnership (the “Partnership”) pursuant to the provisions of the Texas Business Organizations Code. The purpose of the Partnership is to acquire up to twenty-eight model homes from homebuilder subsidiaries of Weyerhaeuser Real Estate Company or its affiliates with a potential for capital appreciation, to rent said model homes, to sell such model homes, and to conduct such other businesses which are incidental or necessary to the foregoing.

Dubose Model Homes USA, L.P. is the original general partner and the Company is a limited partner. The Partnership will admit limited partners accepted by the general partner who purchase “Units”, defined as a limited partnership interest in the partnership resulting from a capital contribution of $19,250. Initially there will be 100 Units sold to the limited partners for aggregate initial capital contributions of $1,925,000. The Company has elected to purchase 51 of the initial 100 Units at the price of $19,250 per Unit, for a total capital contribution of $981,750, and has deposited such funds with the general partner. The 51 Units are currently a majority ownership, and it is the intention of the Company to maintain a majority ownership of the Units at all times during the Agreement.

Larry G. Dubose, a Director at NetREIT since June 2005, currently serves as President of the General Partner, Dubose Model Homes USA, L.P., a company he founded in 1985. Mr. Dubose sold Dubose Model Homes USA, L.P., in 2004 and does not currently maintain any ownership interest.

On February 5, 2009, the Company and Fontana Dialysis Building, LLC formed Fontana Medical Plaza, LLC (“FMP”) which the Company is Managing Member and 51% owner. On February 19, 2009, FMP assumed an agreement to purchase the Fontana Medical Plaza located in Fontana, California. The purchase price for the property is $1,900,000, before transaction costs. The Company purchased the property with $800,000 cash and a $1,100,000 draw on its line of credit facility. The property consists of approximately 10,500 square feet and is currently unoccupied. The FMP has also assumed a lease agreement for a tenant to occupy 100% of the building for ten years with three five year renewal options. The new tenant is expected move in upon the completion of the tenant improvements expected to be complete no later than July 2009. The lease agreement requires annual rent payments during the first five years of $259,973 increasing by 12.5% on the fifth year anniversary and on each five year anniversary thereafter.

On March 23, 2009, the Company acquired The Rangewood Medical Office Building (“Rangewood) located in Colorado Springs, Colorado. The purchase price for the property was $2.7 million, including transaction costs. The Company purchased the property with $230,000 cash and a $2,430,000 draw on its line of credit facility. Rangewood is a 3-story, Class A medical office building of approximately 18,222 rentable square feet. The building was constructed in 1998 and as of the date of the acquisition, was 92% occupied.

Property sales

In October 2008, the Company sold an undivided 25.3% of its interests in Sparky’s Palm Self Storage. The purchaser paid $1.4 million, net of transaction costs, in cash. For financial reporting purposes, the gain of $0.1 million will be included in the statement of operations in the line item gain on sale of real estate for the year ended December 31, 2008. The Company’s remaining investment in this property will be included on the balance sheet in investment in real estate ventures and accounted for under the equity method.

In October 2008, the Company sold an undivided 5.99% of its interests in Garden Gateway. The purchaser paid $1.0 million, of which $0.4 million was paid in cash and $0.6 million paid in the form of a promissory note secured by the interest in the property. For financial reporting purposes, the gain of $0.1 million will be included in the statement of operations in the line item gain on sale of real estate for the year ended December 31, 2008. The Company’s remaining investment in this property will be included on the balance sheet in investment in real estate ventures and accounted for under the equity method. The deed of trust for the loan secured by Garden Gateway Plaza contains the Company’s covenant not to transfer an interest in the property. The Company advised the real estate broker of its intent to transfer an interest in the property at the time it negotiated this sale. The Company contracted to transfer the undivided interest in the property based on its belief that the lender had agreed to its transfer. The Company has not yet received the lender’s written waiver of this restriction and has contacted the lender to resolve this issue. If it does not give its waiver, the lender could claim the Company breached this covenant and pursue one or more remedies, including immediate payment of the entire loan balance. The Company believes it to be in the lender’s best interest not to do so and believes it will resolve this issue in a satisfactory manner.

In December 2008, the Company sold an undivided 9.33% of its interests in its Sparky’s Palm Self Storage. The purchaser paid $0.5 million, net of transactions costs, in cash and $0.6 million paid in the form of a promissory note secured by the interest in the property. For financial reporting purposes, the gain of $0.04 million will be included in the statement of operations in the line item gain on sale of real estate for the year ended December 31, 2008. The Company’s remaining investment in this property will be included on the balance sheet in investment in real estate ventures and accounted for under the equity method.

In December 2008, the Company sold an undivided 25.0% of its interests in its Casa Grande Apartments. The purchaser paid $0.5 million, net of transaction costs, in cash. For financial reporting purposes, the gain of $0.3 million will be included in the statement of operations in the line item gain on sale of real estate for the year ended December 31, 2008. The Company’s remaining investment in this property will be included on the balance sheet in investment in real estate ventures and accounted for under the equity method.

In December 2008, the Company sold an undivided 13.4% of its interests in its Sparky’s Palm Self Storage. The purchaser paid $0.7 million, of which $0.4 million was paid in cash and $0.3 million paid in the form of a promissory note secured by the interest in the property. For financial reporting purposes, the gain of $0.3 million will be included in the statement of operations in the line item gain on sale of real estate for the year ended December 31, 2008. The Company’s remaining investment in this property will be included on the balance sheet in investment in real estate ventures and accounted for under the equity method.

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

The following discussion relates to our condensed financial statements and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this “Management’s Discussion and Analysis and Plan of Operation” that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to materially differ from those projected. Some of the information presented is forward-looking in nature, including information concerning projected future occupancy rates, rental rate increases, project development timing and investment amounts. Although the information is based our current expectations, actual results could vary from expectations stated in this report. Numerous factors will affect our actual results, some of which are beyond our control. These include the timing and strength of national and regional economic growth, the strength of commercial and residential markets, competitive market conditions, and fluctuations in availability and cost of construction materials and labor resulting from the effects of worldwide demand, future interest rate levels and capital market conditions.

You are cautioned not to place undue reliance on this information, which speaks only as of the date of this report. We assume no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under federal securities laws to disclose material information. For a discussion of important risks related to our business, and an investment in our securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information Item 1A and Item 2 included in the Form 10, as amended, filed with the Securities and Exchange Commission.

Economic Outlook

Beginning in the Fall of 2007 and throughout 2008, the U.S. and global economy entered a serious recession. The current economic environment is characterized by a severe residential housing slump, depressed commercial real estate valuations, weak consumer confidence, rising unemployment and concerns regarding stagflation, deflation and inflation. Numerous financial systems around the world have become illiquid and banks have become less willing to lend to other banks and borrowers. Uncertainty remains in terms of the depth and duration of these adverse economic conditions.

The conditions described above have created an environment of limited financing alternatives for acquiring properties as lending institutions have cut back on making loans and tightened credit standards. Continued market volatility could impact our ability to finance future property acquisitions. In addition, this difficult economic environment may make it difficult for our tenants to continue to meet their obligations to the Company.

OVERVIEW AND BACKGROUND

NetREIT (which we sometimes refer to as “we,” “us” or the “Company”) operates as a self-administered real estate investment trust (“REIT”) headquartered in the Pacific Oaks Plaza, in the City of Escondido in San Diego County, California. We have been in a growth stage having increased capital by approximately 83.0% to $43.0 million at September 30, 2008 from $23.5 million at September 30, 2007. Our investment portfolio, consisting of real estate assets, net; investments in real estate ventures; land purchase option; and mortgages receivable and interest, increased by approximately 105.2% to $67.5 million at September 30, 2008 from $32.9 million at September 30, 2007. During the nine months ended September 30, 2008 rental income increased by approximately 116.7% to $3.9 million from $1.8 million for the nine months ended September 30, 2007 primarily due to the increase in the number of properties owned during those periods. The increase in capital and the increase in the real estate investment portfolio was made possible by the increase in net proceeds from the sale of common stock of approximately $19.2 million during the twelve month period ended September 30, 2008.

As of September 30, 2008, the Company’s owned or had an interest in four office buildings (“Office Properties”) which total approximately 298,000 rentable square feet, three retail shopping centers and a 7-Eleven property (“Retail Properties”) which total approximately 85,000 rentable square feet, two self-storage facilities (“Self Storage Properties”) which total approximately 210,000 rentable square feet and one 39 unit apartment building (“Residential Properties”). On a limited basis, the Company also invests in mortgage loans.

Our properties are located primarily in Southern California and Colorado. These areas have above average population growth. The clustering of our assets enables us to reduce our operating costs through economies of scale by servicing a number of properties with less staff. We do not develop properties but acquire properties that are stabilized or that we anticipate will be stabilized in the first year following our acquisition of the property. A property is considered to be stabilized once it has achieved an 80% occupancy rate for a full year as of January 1, or has been open for three years. We are actively communicating with real estate brokers and other third parties to locate properties for potential acquisitions in an effort to build our portfolio.

Most of our office and retail properties we currently own are leased to a variety of tenants ranging from small businesses to large public companies, many of which do not have publicly rated debt. We have in the past entered into, and intend in the future to enter into, purchase agreements for real estate having net leases that require the tenant to pay all of the operating expense (Triple Net Leases) or pay increases in operating expenses over specific base years. Most of our leases are for terms of 3 to 5 years with annual rental increases built into the leases.

Our residential and self storage properties that we currently own are rented under short term agreements of 6 months or less. Our self storage properties are located in markets that have multiple self storage properties from which to choose. Competition will impact our property results. Our operating results of these properties depend materially on our ability to lease available self storage units, to actively manage unit rental rates, and on the ability of our tenants to make required rental payments. We believe that we will continue to respond quickly and effectively to changes in local and regional economic conditions by adjusting rental rates by concentration of these properties in one region of Southern California. We depend on advertisements, flyers, web sites, etc. to secure new tenants to fill any vacancies.

Current Developments and Trends

As mentioned above, real estate financing and sales markets are experiencing severe illiquidity, disruptions and uncertainty. These are trends which we first began experiencing in the Fall of 2007. We expect this trend may continue throughout 2009 and possibly beyond.

We believe uncertainty in the real estate financing market will continue to make mortgage financing more difficult to obtain, which may affect our ability to finance future property acquisitions. Three of our six acquisitions during the 12 month period ended September 2008 were obtained for cash and three were obtained with a financing and cash. Two involved new financing that we obtained with satisfactory terms, however, we have experienced challenges in obtaining financing in the amounts related to purchase price or the rates that were previously available. We acquired the other property subject to the seller’s existing mortgage financing.

Illiquidity in the credit markets and negative trends in many other sectors of the U.S. economy have disrupted and depressed the real estate market, reducing the number of buyers and competition for properties. We believe that these trends will continue to depress the real estate market sales volumes and prices. This may present the Company opportunities to purchase properties at lower prices provided the Company does not need to rely on new mortgage financing. We are currently looking for properties we can acquire for cash or assume existing debt.

Although long-term interest rates remain relatively low by historical standards, there has been a significant increase in the credit spreads across the credit spectrum as banks and other institutional lenders have adopted more conservative lending practices. Increases in credit spreads or deterioration in individual tenant credit may lower the appraised values of properties. We generally enter into three to five leases with our tenants to mitigate the impact that fluctuations in interest rates have on the values of our portfolio.

Inflation rates in the United States have continued to rise. Increases in inflation generally will have a negative impact on our properties to the extent that tenant leases do not provide for rent increases in response to increase in inflation rates. To mitigate this risk, our leases generally have fixed rent increases or increases based on formulas indexed to increases in the Consumer Price Index (“CPI”) or other indices for the jurisdiction in which the property is located. To the extent that the CPI increases, additional rental income streams may be generated from these leases and thereby mitigate the impact of inflation.

Management Evaluation of Results of Operations

Management evaluates our results of operations with a primary focus on increasing and enhancing the value, quality and quantity of its real estate portfolio. Management focuses its efforts on improving underperforming assets through re-leasing efforts, including negotiation of lease renewals, or selectively selling assets in order to increase value in our real estate portfolio. The ability to increase assets under management is affected by our ability to raise capital and our ability to identify appropriate investments.

Management’s evaluation of operating results includes our ability to generate necessary cash flow in order to fund distributions to our shareholders. As a result, management’s assessment of operating results gives less emphasis to the effects of unrealized gains and losses, which may cause fluctuations in net income for comparable periods but have no impact on cash flows, and to other non-cash charges such as depreciation and impairment charges. Management’s evaluation of our potential for generating cash flow includes an assessment of the long-term sustainability of our real estate portfolio. During this growth stage, past funding of distributions to our shareholders exceeded our cash flow from operations. We anticipate that as we acquire additional properties our revenues will increase at a faster rate than our general and administrative expenses due to efficiencies of scale. We therefore believe that distributions to our shareholders will be funded by cash flow from operations.

Management focuses on measures of cash flows from investing activities and cash flows from financing activities in its evaluation of our capital resources. Investing activities typically consist of the acquisition or disposition of investments in real property or, to a limited extent, mortgage receivables and the funding of capital expenditures with respect to real properties. Financing activities primarily consist of the proceeds from sale of stock, borrowings and repayments of mortgage debt and the payment of distributions to our shareholders.

CRITICAL ACCOUNTING POLICIES

The presentation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Certain accounting policies are considered to be critical accounting policies, as they require management to make assumptions about matters that are highly uncertain at the time the estimate is made, and changes in the accounting estimate are reasonably likely to occur from period to period. Management believes the following critical accounting policies reflect our more significant judgments and estimates used in the preparation of our financial statements. For a summary of all of our significant accounting policies, see note 2 to our condensed financial statements included elsewhere in this Form 10-Q.

Property Acquisitions. The Company accounts for its acquisitions of real estate in accordance with Statement of Financial Standards (“SFAS”) No. 141, “Business Combinations” (“SFAS 141”) which requires the purchase price of acquired properties be allocated to the acquired tangible assets and liabilities, consisting of land, building, tenant improvements, a land purchase option, long-term debt and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, the value of in-place leases, unamortized lease origination costs and tenant relationships, based in each case on their fair values.

The Company allocates the purchase price to tangible assets of an acquired property (which includes land, building and tenant improvements) based on the estimated fair values of those tangible assets, assuming the building was vacant. Estimates of fair value for land, building and building improvements are based on many factors including, but not limited to, comparisons to other properties sold in the same geographic area and independent third party valuations. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair values of the tangible and intangible assets and liabilities acquired.

The total value allocable to intangible assets acquired, which consists of unamortized lease origination costs, in-place leases and tenant relationships, are allocated based on management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics considered by management in allocating these values include the nature and extent of the existing business relationships with the tenant, growth prospects for developing new business with the tenant, the remaining term of the lease and the tenant’s credit quality, among other factors.

The value allocable to above or below market component of an acquired in-place lease is determined based upon the present value (using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of rents that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above or below market leases are included in lease intangibles, net in the accompanying condensed balance sheets and are amortized on a straight-line basis as an increase or reduction of rental income over the remaining non-cancelable term of the respective leases. As of September 30, 2008, the unamortized balance of below market leases was $39,291. As of September 30, 2007, the Company did not have any deferred rent for above or below market leases.

The land lease acquired with the World Plaza acquisition in 2007 has a fixed purchase price option cost of $181,710 at the termination of the lease in 2062. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) management valued the land option at its residual value of $1,370,000, based upon comparable land sales adjusted to present value. The amount is included as land purchase option on the accompanying condensed balance sheets. The difference between the strike price of the option and the recorded cost of the land purchase option is approximately $1.2 million. Accordingly, management has determined that exercise of the option is considered probable. The land purchase option was determined to be a contract based intangible associated with the land. As a result, this asset has an indefinite life and is treated as a non-amortizable asset.

The value of in-place leases, unamortized lease origination costs and tenant relationships are amortized to expense over the remaining term of the respective leases, which range from less than a year to ten years. The amount allocated to acquire in-place leases is determined based on management’s assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. The amount allocated to unamortized lease origination costs is determined by what the Company would have paid to a third party to recruit a new tenant reduced by the expired term of the respective lease. The amount allocated to tenant relationships is the benefit resulting from the likelihood of a tenant renewing its lease. Amortization expense related to these assets was $151,094 and $24,572 for the three months ended September 30, 2008 and 2007, respectively. Amortization expense related to these assets was $391,179 and $51,835 for the nine months ended September 30, 2008 and 2007, respectively.