Sila Realty Trust, Inc. - Quarter Report: 2016 June (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________
FORM 10-Q
___________________________________________
(Mark One)
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2016
OR
¨ | 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: 000-55435
___________________________________________
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
(Exact name of registrant as specified in its charter)
___________________________________________
Maryland | 46-1854011 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
4890 West Kennedy Blvd., Suite 650 Tampa, FL 33609 | (813) 287-0101 | |
(Address of Principal Executive Offices; Zip Code) | (Registrant’s Telephone Number) | |
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)
___________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
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 | ý (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 ý
As of August 11, 2016, there were approximately 71,479,000 shares of Class A and Class T common stock of Carter Validus Mission Critical REIT II, Inc. outstanding.
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
(A Maryland Corporation)
TABLE OF CONTENTS
Page | ||
PART I. | ||
Item 1. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II. | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
2
PART 1. FINANCIAL STATEMENTS
Item 1. Financial Statements.
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(Unaudited) June 30, 2016 | December 31, 2015 | ||||||
ASSETS | |||||||
Real estate: | |||||||
Land | $ | 73,796 | $ | 48,882 | |||
Buildings and improvements, less accumulated depreciation of $10,947 and $5,262, respectively | 476,686 | 361,632 | |||||
Construction in progress | 10,058 | — | |||||
Total real estate, net | 560,540 | 410,514 | |||||
Cash and cash equivalents | 35,648 | 31,262 | |||||
Acquired intangible assets, less accumulated amortization of $4,507 and $2,007, respectively | 60,623 | 54,633 | |||||
Other assets | 16,150 | 10,218 | |||||
Total assets | $ | 672,961 | $ | 506,627 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Liabilities: | |||||||
Credit facility, net of deferred financing costs of $99 and $103, respectively | $ | 94,901 | $ | 89,897 | |||
Accounts payable due to affiliates | 3,997 | 741 | |||||
Accounts payable and other liabilities | 11,153 | 8,244 | |||||
Intangible lease liabilities, less accumulated amortization of $366 and $98, respectively | 7,141 | 7,409 | |||||
Total liabilities | 117,192 | 106,291 | |||||
Stockholders’ equity: | |||||||
Preferred stock, $0.01 par value per share, 100,000,000 shares authorized; none issued and outstanding | — | — | |||||
Common stock, $0.01 par value per share, 500,000,000 shares authorized; 68,170,536 and 48,488,734 shares issued, respectively; 68,020,354 and 48,457,191 shares outstanding, respectively | 680 | 485 | |||||
Additional paid-in capital | 596,292 | 425,910 | |||||
Accumulated distributions in excess of earnings | (41,104 | ) | (26,061 | ) | |||
Accumulated other comprehensive loss | (101 | ) | — | ||||
Total stockholders’ equity | 555,767 | 400,334 | |||||
Noncontrolling interests | 2 | 2 | |||||
Total equity | 555,769 | 400,336 | |||||
Total liabilities and stockholders’ equity | $ | 672,961 | $ | 506,627 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands, except share data and per share amounts)
(Unaudited)
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2016 | 2015 | 2016 | 2015 | ||||||||||||
Revenue: | |||||||||||||||
Rental revenue | $ | 10,888 | $ | 2,966 | $ | 20,909 | $ | 5,189 | |||||||
Tenant reimbursement revenue | 1,315 | 101 | 2,718 | 188 | |||||||||||
Total revenue | 12,203 | 3,067 | 23,627 | 5,377 | |||||||||||
Expenses: | |||||||||||||||
Rental expenses | 1,577 | 187 | 3,261 | 322 | |||||||||||
General and administrative expenses | 757 | 448 | 1,522 | 927 | |||||||||||
Acquisition related expenses | 1,946 | 2,811 | 3,611 | 3,527 | |||||||||||
Asset management fees | 1,058 | 289 | 2,013 | 494 | |||||||||||
Depreciation and amortization | 4,300 | 926 | 8,166 | 1,610 | |||||||||||
Total expenses | 9,638 | 4,661 | 18,573 | 6,880 | |||||||||||
Income (loss) from operations | 2,565 | (1,594 | ) | 5,054 | (1,503 | ) | |||||||||
Interest expense, net | 732 | 291 | 1,611 | 661 | |||||||||||
Net income (loss) attributable to common stockholders | $ | 1,833 | $ | (1,885 | ) | $ | 3,443 | $ | (2,164 | ) | |||||
Other comprehensive loss: | |||||||||||||||
Unrealized loss on interest rate swaps, net | $ | (101 | ) | $ | — | $ | (101 | ) | $ | — | |||||
Other comprehensive loss attributable to common stockholders | (101 | ) | — | (101 | ) | — | |||||||||
Comprehensive income (loss) attributable to common stockholders | $ | 1,732 | $ | (1,885 | ) | $ | 3,342 | $ | (2,164 | ) | |||||
Weighted average number of common shares outstanding: | |||||||||||||||
Basic | 63,514,780 | 24,058,949 | 58,591,709 | 17,869,872 | |||||||||||
Diluted | 63,530,999 | 24,058,949 | 58,608,490 | 17,869,872 | |||||||||||
Net income (loss) per common share attributable to common stockholders: | |||||||||||||||
Basic | $ | 0.03 | $ | (0.08 | ) | $ | 0.06 | $ | (0.12 | ) | |||||
Diluted | $ | 0.03 | $ | (0.08 | ) | $ | 0.06 | $ | (0.12 | ) | |||||
Distributions declared per common share | $ | 0.16 | $ | 0.16 | $ | 0.32 | $ | 0.31 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except for share data)
(Unaudited)
Common Stock | Additional Paid in Capital | Accumulated Distributions in Excess of Earnings | Accumulated Other Comprehensive Loss | Total Stockholders’ Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||
No. of Shares | Par Value | |||||||||||||||||||||||||||||
Balance, December 31, 2015 | 48,457,191 | $ | 485 | $ | 425,910 | $ | (26,061 | ) | $ | — | $ | 400,334 | $ | 2 | $ | 400,336 | ||||||||||||||
Issuance of common stock | 18,617,580 | 186 | 182,318 | — | — | 182,504 | — | 182,504 | ||||||||||||||||||||||
Issuance of common stock under the distribution reinvestment plan | 1,064,224 | 10 | 10,086 | — | — | 10,096 | — | 10,096 | ||||||||||||||||||||||
Commissions on sale of common stock and related dealer manager fees | — | — | (14,944 | ) | — | — | (14,944 | ) | — | (14,944 | ) | |||||||||||||||||||
Distribution and servicing fees | — | — | (3,042 | ) | — | — | (3,042 | ) | — | (3,042 | ) | |||||||||||||||||||
Other offering costs | — | — | (2,926 | ) | — | — | (2,926 | ) | — | (2,926 | ) | |||||||||||||||||||
Repurchase of common stock | (118,641 | ) | (1 | ) | (1,134 | ) | — | — | (1,135 | ) | — | (1,135 | ) | |||||||||||||||||
Stock-based compensation | — | — | 24 | — | — | 24 | — | 24 | ||||||||||||||||||||||
Distributions declared to common stockholders | — | — | — | (18,486 | ) | — | (18,486 | ) | — | (18,486 | ) | |||||||||||||||||||
Other comprehensive loss | — | — | — | — | (101 | ) | (101 | ) | — | (101 | ) | |||||||||||||||||||
Net income | — | — | — | 3,443 | — | 3,443 | — | 3,443 | ||||||||||||||||||||||
Balance, June 30, 2016 | 68,020,354 | $ | 680 | $ | 596,292 | $ | (41,104 | ) | $ | (101 | ) | $ | 555,767 | $ | 2 | $ | 555,769 | |||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months Ended June 30, | |||||||
2016 | 2015 | ||||||
Cash flows from operating activities: | |||||||
Net income (loss) | $ | 3,443 | $ | (2,164 | ) | ||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |||||||
Depreciation and amortization | 8,166 | 1,610 | |||||
Amortization of deferred financing costs | 447 | 291 | |||||
Amortization of above-market leases | 19 | 13 | |||||
Amortization of intangible lease liabilities | (268 | ) | (7 | ) | |||
Straight-line rent | (2,699 | ) | (747 | ) | |||
Stock-based compensation | 24 | 11 | |||||
Changes in operating assets and liabilities: | |||||||
Accounts payable and other liabilities | 1,184 | 2,659 | |||||
Accounts payable due to affiliates | 111 | 183 | |||||
Other assets | (1,366 | ) | (825 | ) | |||
Net cash provided by operating activities | 9,061 | 1,024 | |||||
Cash flows from investing activities: | |||||||
Investment in real estate | (161,462 | ) | (123,806 | ) | |||
Capital expenditures | (2,087 | ) | (157 | ) | |||
Escrow funds, net | (2,515 | ) | (2 | ) | |||
Real estate deposits, net | 443 | (1,133 | ) | ||||
Net cash used in investing activities | (165,621 | ) | (125,098 | ) | |||
Cash flows from financing activities: | |||||||
Proceeds from issuance of common stock | 182,504 | 223,988 | |||||
Proceeds from credit facility | 45,000 | 2,000 | |||||
Payments on credit facility | (40,000 | ) | (39,500 | ) | |||
Payments of deferred financing costs | (281 | ) | (288 | ) | |||
Repurchases of common stock | (1,135 | ) | — | ||||
Offering costs on issuance of common stock | (17,649 | ) | (26,810 | ) | |||
Distributions to stockholders | (7,493 | ) | (1,740 | ) | |||
Net cash provided by financing activities | 160,946 | 157,650 | |||||
Net change in cash and cash equivalents | 4,386 | 33,576 | |||||
Cash and cash equivalents - Beginning of period | 31,262 | 3,694 | |||||
Cash and cash equivalents - End of period | $ | 35,648 | $ | 37,270 | |||
Supplemental cash flow disclosure: | |||||||
Interest paid, net of interest capitalized of $101 and $0, respectively | $ | 1,242 | $ | 272 | |||
Supplemental disclosure of non-cash transactions: | |||||||
Common stock issued through distribution reinvestment plan | $ | 10,096 | $ | 2,731 | |||
Distribution and servicing fees accrued | $ | 2,963 | $ | — | |||
Net unrealized loss on interest rate swap | $ | (101 | ) | $ | — | ||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2016
Note 1—Organization and Business Operations
Carter Validus Mission Critical REIT II, Inc., or the Company, is a Maryland corporation that was formed on January 11, 2013, which elected to be taxed as a real estate investment trust, or a REIT, under the Internal Revenue Code of 1986, as amended, for federal income tax purposes commencing with its taxable year ended December 31, 2014. The Company commenced principal operations on July 3, 2014 when it satisfied the minimum offering requirement and issued approximately 213,333 shares of Class A common stock for gross proceeds of $2,000,000. Substantially all of the Company’s business is conducted through Carter Validus Operating Partnership II, LP, a Delaware limited partnership, or the Operating Partnership, formed on January 10, 2013. The Company is the sole general partner of the Operating Partnership and Carter Validus Advisors II, LLC, or the Advisor, is the initial limited partner of the Operating Partnership.
The Company is offering for sale a maximum of $2,350,000,000 in shares of common stock, consisting of up to $2,250,000,000 in shares in its primary offering and up to $100,000,000 in shares of common stock to be made available pursuant to the Company’s distribution reinvestment plan, or the DRIP, on a “best efforts” basis, or the Offering, pursuant to a registration statement on Form S-11, or the Registration Statement, filed with the Securities and Exchange Commission, or the SEC, under the Securities Act of 1933, as amended, or the Securities Act, which was declared effective on May 29, 2014. The Company has registered for offering shares of Class A common stock and shares of Class T common stock, in any combination with a dollar value up to the maximum primary offering amount. The initial offering price for the shares in the primary offering is $10.00 per Class A share and $9.574 per Class T share.
As of June 30, 2016, the Company had accepted investors’ subscriptions for and issued approximately 68,168,000 shares of Class A and Class T common stock (including shares of common stock issued pursuant to the DRIP) in the Offering, resulting in receipt of gross proceeds of approximately $674,158,000, before selling commissions and dealer manager fees of approximately $59,583,000, distribution and servicing fees of approximately $3,042,000 and other offering costs of approximately $13,184,000. As of June 30, 2016, the Company had approximately $1,675,842,000 in Class A shares and Class T shares of common stock remaining in the Offering.
Substantially all of the Company’s business is managed by the Advisor. Carter Validus Real Estate Management Services II, LLC, or the Property Manager, an affiliate of the Advisor, serves as the Company’s property manager. The Advisor and the Property Manager have received, and will continue to receive, fees for services related to the acquisition and operational stages. The Advisor will also be eligible to receive fees during the liquidation stage. SC Distributors, LLC, an affiliate of the Advisor, or the Dealer Manager, serves as the dealer manager of the Offering. The Dealer Manager has received, and will continue to receive, fees for services related to the Offering.
The Company was formed to invest primarily in quality income-producing commercial real estate, with a focus on data centers and healthcare properties, preferably with long-term net leases to investment grade and other creditworthy tenants, as well as to make other real estate-related investments that relate to such property types. Real estate-related investments may include equity or debt interests, including securities, in other real estate entities. The Company also may originate or invest in real estate-related notes receivable. The Company expects real estate-related notes receivable originations and investments to be focused on first mortgage loans, but also may include real estate-related bridge loans, mezzanine loans and securitized notes receivable. As of June 30, 2016, the Company owned 29 real estate investments, consisting of 42 properties, located in 23 metropolitan statistical areas, or MSAs, and one micropolitan statistical area, or µSA.
Except as the context otherwise requires, “we,” “our,” “us,” and the “Company” refer to Carter Validus Mission Critical REIT II, Inc., the Operating Partnership and all wholly-owned subsidiaries.
7
Note 2—Summary of Significant Accounting Policies
The summary of significant accounting policies presented below is designed to assist in understanding the Company’s condensed consolidated financial statements. Such condensed consolidated financial statements and the accompanying notes thereto are the representation of management. These accounting policies conform to accounting principles generally accepted in the United States of America, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal and recurring nature considered for a fair presentation have been included. Operating results for the three and six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.
The condensed consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements at that date but does not include all the information and notes required by GAAP for complete financial statements. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's audited consolidated financial statements as of and for the year ended December 31, 2015 and related notes thereto set forth in the Company's Annual Report on Form 10-K, filed with the SEC on March 28, 2016.
Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, and all wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
On January 1, 2016, the Company adopted Accounting Standards Update, or ASU, ASU 2015-02, Amendments to the Consolidation Analysis, which amends the current consolidation guidance affecting both the variable interest entity, or VIE, and voting interest entity, or VOE, consolidation models. The standard does not add or remove any of the characteristics in determining if an entity is a VIE or VOE, but rather enhances the way the Company assesses some of these characteristics. The Operating Partnership meets the criteria as a VIE, the Company is the primary beneficiary and, accordingly, the Company continues to consolidate the Operating Partnership. The Company’s sole asset is its investment in the Operating Partnership, and consequently, all of the Company’s assets and liabilities represent those assets and liabilities of the Operating Partnership. All of the Company’s debt is an obligation of the Operating Partnership.
Use of Estimates
The preparation of the condensed consolidated financial statements and accompanying notes in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates are made and evaluated on an ongoing basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates.
Concentration of Credit Risk and Significant Leases
As of June 30, 2016, the Company had cash on deposit, including restricted cash, in certain financial institutions that had deposits in excess of current federally insured levels; however, the Company has not experienced any losses in such accounts. The Company limits its cash investments to financial institutions with high credit standings; therefore, the Company believes it is not exposed to any significant credit risk on its cash deposits. To date, the Company has experienced no loss of or lack of access to cash in its accounts. Concentration of credit risk with respect to accounts receivable from tenants is limited.
As of June 30, 2016, the Company owned real estate investments in 23 MSAs and one µSA, four MSAs of which accounted for 10.0% or more of rental revenue. Real estate investments located in the Houston-The Woodlands-Sugar Land, Texas MSA, the Oklahoma City, Oklahoma MSA, the Dallas-Fort Worth-Arlington, Texas MSA, and the Cincinnati, Ohio-Kentucky-Indiana MSA accounted for 15.3%, 12.8%, 12.5%, and 10.1%, respectively, of rental revenue for the six months ended June 30, 2016.
As of June 30, 2016, the Company had one tenant's exposure concentration that accounted for 10.0% or more of rental revenue. The leases with tenants under common control of the guarantor Post Acute Medical, LLC accounted for 13.2% of rental revenue for the six months ended June 30, 2016.
Deferred Financing Costs
Deferred financing costs are loan fees, legal fees and other third-party costs associated with obtaining financing. These costs are amortized over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing costs are generally expensed when the associated debt is refinanced or repaid before maturity unless specific rules are met that would allow for the carryover of such costs to the refinanced debt. Costs incurred in seeking financing transactions that do not close are expensed in the period in which it is determined that the financing will not close.
8
On January 1, 2016, the Company adopted ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, and ASU 2015-15, Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated With Line-of-Credit Arrangements, or ASUs 2015-03 and 2015-15. According to ASUs 2015-03 and 2015-15, deferred financing costs related to a recognized debt liability in connection with term loans, including the term loan portion of the Company's credit facility, are presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. Deferred financing costs related to the revolving line of credit portion of the Company's secured credit facility are presented in the balance sheet as an asset, which is included in other assets on the condensed consolidated balance sheet. As required, the Company retrospectively applied the guidance in ASUs 2015-03 and 2015-15 to the prior period presented, which resulted in a decrease of $103,000 in other assets and credit facility on the condensed consolidated balance sheet as of December 31, 2015.
Share Repurchase Program
The Company’s share repurchase program allows for repurchases of shares of the Company’s common stock when certain criteria are met. The share repurchase program provides that all repurchases during any calendar year, including those redeemable upon death or a qualifying disability of a stockholder, are limited to those that can be funded with equivalent proceeds raised from the DRIP Offering during the prior calendar year and other operating funds, if any, as the board of directors, in its sole discretion, may reserve for this purpose.
Repurchases of shares of the Company’s common stock are at the sole discretion of the Company’s board of directors. In addition, the Company’s board of directors, in its sole discretion, may amend, suspend, reduce, terminate or otherwise change the share repurchase program upon 30 days' prior notice to the Company’s stockholders for any reason it deems appropriate. The share repurchase program provides that the Company will limit the number of shares repurchased during any calendar year to 5.0% of the number of shares of common stock outstanding on December 31st of the previous calendar year. In addition, the share repurchase program provides that all redemptions during any calendar year, including those upon death or a qualifying disability of a stockholder, are limited to those that can be funded with equivalent proceeds raised from the DRIP Offering during the prior calendar year and other operating funds, if any, as the board of directors, in its sole discretion, may reserve for this purpose. During the six months ended June 30, 2016, the Company received valid repurchase requests related to 118,641 Class A shares of common stock, all of which were redeemed in full for an aggregate purchase price of approximately $1,135,000 (an average of $9.57 per share). During the six months ended June 30, 2016 and 2015, the Company did not receive repurchase requests related to Class T shares. During the six months ended June 30, 2015, the Company did not receive repurchase requests related to Class A shares.
Fair Value
Accounting Standards Codification, or ASC, 820, Fair Value Measurements and Disclosures, or ASC 820, defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. ASC 820 emphasizes that fair value is intended to be a market-based measurement, as opposed to a transaction-specific measurement.
Fair value is defined by ASC 820 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, various techniques and assumptions can be used to estimate the fair value. Assets and liabilities are measured using inputs from three levels of the fair value hierarchy, as follows:
Level 1—Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2—Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).
Level 3—Unobservable inputs, only used to the extent that observable inputs are not available, reflect the Company’s assumptions about the pricing of an asset or liability.
The following describes the methods the Company used to estimate the fair value of the Company’s financial assets and liabilities:
Cash and cash equivalents, other assets, accounts payable due to affiliates and accounts payable and other liabilities—The Company considers the carrying values of these financial instruments, assets and liabilities to approximate fair value because of the short period of time between origination of the instruments and their expected realization.
9
Secured credit facility—The outstanding principal of the secured credit facility – variable was $70,000,000 and $90,000,000, which approximated its fair value as of June 30, 2016 and December 31, 2015, respectively. The interest on the secured credit facility – variable is calculated at the London Interbank Offered Rate, or LIBOR, plus an applicable margin. The interest rate resets to market on a monthly basis. The fair value of the Company's secured credit facility – variable is estimated based on the interest rates currently offered to the Company by financial institutions. The estimated fair value of the secured credit facility – variable rate fixed through an interest rate swap agreement (Level 2) was approximately $23,498,000 as of June 30, 2016 as compared to the outstanding principal of $25,000,000 as of June 30, 2016.
Derivative instruments—Considerable judgment is necessary to develop estimated fair values of financial instruments. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize, or be liable for, on disposition of the financial instruments. The Company has determined that the majority of the inputs used to value its interest rate swaps fall within Level 2 of the fair value hierarchy. The credit valuation adjustments associated with these instruments utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and the respective counterparty. However, as of June 30, 2016, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions, and has determined that the credit valuation adjustments are not significant to the overall valuation of its interest rate swaps. As a result, the Company determined that its interest rate swaps valuation in its entirety is classified in Level 2 of the fair value hierarchy.
In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis as of June 30, 2016 (amounts in thousands):
June 30, 2016 | |||||||||||||||
Fair Value Hierarchy | |||||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | ||||||||||||
Assets: | |||||||||||||||
Derivative assets | $ | — | $ | — | $ | — | $ | — | |||||||
Total assets at fair value | $ | — | $ | — | $ | — | $ | — | |||||||
Liabilities: | |||||||||||||||
Derivative liabilities | $ | — | $ | (123 | ) | $ | — | $ | (123 | ) | |||||
Total liabilities at fair value | $ | — | $ | (123 | ) | $ | — | $ | (123 | ) | |||||
The Company did not have financial assets and liabilities required to be measured at fair value as of December 31, 2015.
Derivative Instruments and Hedging Activities
As required by ASC 815, Derivatives and Hedging, or ASC 815, the Company records all derivative instruments as assets and liabilities in the statement of financial position at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in the condensed consolidated statements of comprehensive income (loss) during the current period.
The Company is exposed to variability in expected future cash flows that are attributable to interest rate changes in the normal course of business. The Company’s primary strategy in entering into derivative contracts is to add stability to future cash flows by managing its exposure to interest rate movements. The Company utilizes derivative instruments, including interest rate swaps, to effectively convert some its variable rate debt to fixed rate debt. The Company does not enter into derivative instruments for speculative purposes.
In accordance with ASC 815, the Company designates interest rate swap contracts as cash flow hedges of floating-rate borrowings. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) in the condensed consolidated statements of comprehensive income (loss) and reclassified into earnings in the same line item associated with the forecasted transaction and the same period during which the hedged transaction affects earnings. The ineffective portion of the gain or loss on the derivative instrument is recognized in the condensed consolidated statements of comprehensive income (loss) during the current period.
10
In accordance with the fair value measurement guidance ASU 2011-04, Fair Value Measurement, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.
Earnings Per Share
The Company calculates basic earnings per share by dividing net income (loss) attributable to common stockholders for the period by the weighted average shares of its common stock outstanding for that period. Diluted earnings per share are computed based on the weighted average number of shares outstanding and all potentially dilutive securities. Shares of non-vested restricted common stock give rise to potentially dilutive shares of common stock. For the three and six months ended June 30, 2016, diluted earnings per share reflected the effect of approximately 16,000 and 17,000, respectively, of non-vested shares of restricted common stock that were outstanding as of such period. For the three and six months ended June 30, 2015, there were 9,000 shares of non-vested restricted common stock outstanding, but such shares were excluded from the computation of diluted earnings per share because such shares were anti-dilutive during this period.
Recently Issued Accounting Pronouncements
On May 28, 2014, the Financial Accounting Standards Board, or the FASB, issued ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. The objective of ASU 2014-09 is to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle, which may require more judgment and estimates within the revenue recognition process than are required under existing GAAP. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date, or ASU 2015-14. ASU 2015-14 defers the effective date of ASU 2014-09 by one year to fiscal years and interim periods beginning after December 15, 2017. Early adoption is permitted as of the original effective date, which was annual reporting periods beginning after December 15, 2016, and the interim periods within that year. On March 17, 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Principal versus Agent Considerations), or ASU 2016-08, which improves the implementation guidance on principal versus agent considerations. ASU 2016-08 clarifies that an entity is a principal when it controls the specified good or service before that good or service is transferred to the customer, and is an agent when it does not control the specified good or service before it is transferred to the customer. The effective date of this update is the same as the effective date of ASU 2015-14. The Company is in the process of evaluating the impact ASUs 2014-09 and 2016-08 will have on the Company’s condensed consolidated financial statements.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the Company’s condensed consolidated financial position or results of operations.
Note 3—Real Estate Investments
During the six months ended June 30, 2016, the Company purchased 14 real estate properties, of which 11 were determined to be business combinations and three were determined to be asset acquisitions. See Note 4—"Business Combinations" for further discussion of business combinations. The following table summarizes the consideration transferred for all real estate properties acquired during the six months ended June 30, 2016 (amounts in thousands):
Six Months Ended June 30, 2016 | |||
Investments in real estate: | |||
Purchase price of business combinations | $ | 127,947 | |
Purchase price of asset acquisitions | 33,515 | ||
Total purchase price of real estate investments acquired | $ | 161,462 | |
11
Acquisition fees and expenses in connection with the acquisition of properties determined to be business combinations are expensed as incurred, including investment transactions that are no longer under consideration, and are included in acquisition related expenses in the accompanying condensed consolidated statements of comprehensive income (loss). Acquisition fees and expenses associated with transactions determined to be asset acquisitions are capitalized. The Company expensed acquisition fees and expenses of approximately $1,839,000 and $2,653,000 for the three months ended June 30, 2016 and 2015, respectively, and $3,368,000 and $3,275,000 for the six months ended June 30, 2016 and 2015, respectively. The Company capitalized acquisition fees and expenses of approximately $648,000 and $234,000 for the three months ended June 30, 2016 and 2015, respectively, and $2,035,000 and $234,000 for the six months ended June 30, 2016 and 2015, respectively. The total amount of all acquisition fees and costs is limited to 6.0% of the contract purchase price of a property. The contract purchase price is the amount actually paid or allocated in respect of the purchase, development, construction or improvement of a property exclusive of acquisition fees and costs. For the six months ended June 30, 2016 and 2015, acquisition fees and costs did not exceed 6.0% of the contract purchase price of the Company's acquisitions during such periods.
Note 4—Business Combinations
During the six months ended June 30, 2016, the Company completed the acquisition of 100% of the interests in 11 real estate properties (three data centers and eight healthcare properties) that were determined to be business combinations. The aggregate purchase price of the acquisitions determined to be business combinations was $127,947,000, plus closing costs.
The following table summarizes the acquisitions determined to be business combinations during the six months ended June 30, 2016:
Property Description | Date Acquired | Ownership Percentage | |
HPI — Edmond | 01/20/2016 | 100% | |
HPI — Oklahoma City III | 01/27/2016 | 100% | |
HPI — Oklahoma City IV | 01/27/2016 | 100% | |
Alpharetta Data Center III | 02/02/2016 | 100% | |
Flint Data Center | 02/02/2016 | 100% | |
HPI — Newcastle | 02/03/2016 | 100% | |
HPI — Oklahoma City V | 02/11/2016 | 100% | |
HPI — Oklahoma City VI | 03/07/2016 | 100% | |
HPI — Oklahoma City VII | 06/22/2016 | 100% | |
Somerset Data Center | 06/29/2016 | 100% | |
Integris Lakeside Women's Hospital | 06/30/2016 | 100% | |
Results of operations for the acquisitions determined to be business combinations are reflected in the accompanying condensed consolidated statement of income for three and six months ended June 30, 2016 for the period subsequent to the acquisition date of each property. For the period from the first acquisition date through June 30, 2016, the Company recorded $1,973,000 in revenues and a net loss of $2,636,000 for its business combination acquisitions.
The following table summarizes management’s preliminary allocation of the fair value of the acquisitions determined to be business combinations during the six months ended June 30, 2016 (amounts in thousands):
Total | |||
Land | $ | 12,950 | |
Buildings and improvements | 107,501 | ||
In-place leases | 6,170 | ||
Tenant improvements | 1,326 | ||
Total assets acquired | $ | 127,947 | |
12
Assuming the business combinations described above had occurred on January 1, 2015, pro forma revenues and net income attributable to common stockholders would have been as follows for the periods listed below (amounts in thousands, except per share amounts, unaudited):
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2016 | 2015 | 2016 | 2015 | ||||||||||||
Pro forma basis: | |||||||||||||||
Revenues | $ | 13,065 | $ | 10,964 | $ | 25,551 | $ | 21,062 | |||||||
Net income attributable to common stockholders | $ | 4,446 | $ | 1,265 | $ | 8,504 | $ | 850 | |||||||
Net income per common share attributable to common stockholders: | |||||||||||||||
Basic | $ | 0.07 | $ | 0.02 | $ | 0.14 | $ | 0.01 | |||||||
Diluted | $ | 0.07 | $ | 0.02 | $ | 0.14 | $ | 0.01 | |||||||
The condensed pro forma consolidated financial statements for the three and six months ended June 30, 2016 and 2015 include pro forma adjustments related to the acquisitions during 2016 and 2015. The pro forma information for the three and six months ended June 30, 2016 was adjusted to exclude approximately $1,839,000 and $3,368,000, respectively, of acquisition fees and costs recorded related to the Company's real estate investments. The pro forma information may not be indicative of what actual results of operations would have been had the transactions occurred at the beginning of 2015, nor is it necessarily indicative of future operating results.
Note 5—Acquired Intangible Assets, Net
Acquired intangible assets, net, consisted of the following as of June 30, 2016 and December 31, 2015 (amounts in thousands, except weighted average life amounts):
June 30, 2016 | December 31, 2015 | ||||||
In-place leases, net of accumulated amortization of $4,447 and $1,967, respectively (with a weighted average remaining life of 13.7 years and 14.5 years, respectively) | $ | 59,785 | $ | 53,776 | |||
Above-market leases, net of accumulated amortization of $46 and $32, respectively (with a weighted average remaining life of 7.9 years and 8.4 years, respectively) | 208 | 222 | |||||
Ground lease interest, net of accumulated amortization of $14 and $9, respectively (with a weighted average remaining life of 67.3 years and 67.8 years, respectively) | 630 | 635 | |||||
$ | 60,623 | $ | 54,633 | ||||
The aggregate weighted average remaining life of the acquired intangible assets was 14.3 years and 15.1 years as of June 30, 2016 and December 31, 2015, respectively.
Note 6—Other Assets
Other assets consisted of the following as of June 30, 2016 and December 31, 2015 (amounts in thousands):
June 30, 2016 | December 31, 2015 | ||||||
Deferred financing costs, related to the revolver portion of the secured credit facility, net of accumulated amortization of $1,237 and $802, respectively | $ | 2,555 | $ | 2,717 | |||
Real estate escrow deposits | — | 443 | |||||
Restricted cash held in escrow | 4,442 | 1,927 | |||||
Tenant receivables | 2,883 | 2,065 | |||||
Straight-line rent receivable | 5,161 | 2,462 | |||||
Prepaid and other assets | 1,109 | 604 | |||||
$ | 16,150 | $ | 10,218 | ||||
13
Note 7—Future Minimum Rent
The Company’s real estate assets are leased to tenants under operating leases with varying terms. The leases frequently have provisions to extend the terms of the lease agreements. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants.
The future minimum rent to be received from the Company’s investments in real estate assets under non-cancelable operating leases for the six months ending December 31, 2016 and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):
Year | Amount | |||
Six months ending December 31, 2016 | $ | 21,389 | ||
2017 | 43,491 | |||
2018 | 44,203 | |||
2019 | 44,665 | |||
2020 | 43,645 | |||
Thereafter | 461,263 | |||
$ | 658,656 | |||
Note 8—Credit Facility
Significant activities regarding the secured credit facility since December 31, 2015 include:
• | During the six months ended June 30, 2016, the Company drew $45,000,000 and repaid $40,000,000 on the secured credit facility. |
• | During the six months ended June 30, 2016, the Company increased the borrowing base availability under the secured credit facility by $69,165,000 by adding 12 properties to the aggregate pool availability. |
• | The Company entered into an interest rate swap agreement to effectively fix LIBOR on $25,000,000 of the term loan of the secured credit facility. |
• | As of June 30, 2016, the Company had a total pool availability under the secured credit facility of $233,778,000 and an aggregate outstanding principal balance of $95,000,000. As of June 30, 2016, $138,778,000 remained to be drawn on the secured credit facility. |
• | As of June 30, 2016, unamortized deferred financing costs related to the secured credit facility were $99,000. |
The principal payments due on the secured credit facility for the six months ending December 31, 2016 and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):
Year | Amount | |||
Six months ending December 31, 2016 | $ | — | ||
2017 | — | |||
2018 | 70,000 | |||
2019 | 25,000 | |||
2020 | — | |||
Thereafter | — | |||
$ | 95,000 | |||
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Note 9—Intangible Lease Liabilities, Net
Intangible lease liabilities, net, consisted of the following as of June 30, 2016 and December 31, 2015 (amounts in thousands, except weighted average life amounts):
June 30, 2016 | December 31, 2015 | ||||||
Below-market leases, net of accumulated amortization of $366 and $98, respectively (with a weighted average remaining life of 14.0 years and 14.5 years, respectively) | $ | 7,141 | $ | 7,409 | |||
$ | 7,141 | $ | 7,409 | ||||
Note 10—Commitments and Contingencies
Litigation
In the ordinary course of business, the Company may become subject to litigation or claims. As of June 30, 2016, there were, and currently there are, no material pending legal proceedings to which the Company is a party.
Note 11—Related-Party Transactions and Arrangements
The Company reimburses the Advisor and its affiliates for organization and offering expenses it incurs on the Company’s behalf, but only to the extent the reimbursement would not cause the selling commissions, dealer manager fees, distribution and servicing fees and other organization and offering expenses to exceed 15% of the gross proceeds of the Offering. The Company expects that organization and offering expenses (other than selling commissions, dealer manager fees and distribution and servicing fees) will be approximately 1.25% of the gross proceeds. As of June 30, 2016, the Advisor and its affiliates incurred approximately $10,458,000 on the Company’s behalf in offering costs. The Company accrued approximately $3,396,000 of other organization and offering expenses as of June 30, 2016, including the total estimated liability of future distribution and servicing fees in the amount of $2,963,000, which the Company may pay in the future on the Class T primary shares issued in the Offering. The total represents the maximum liability for other organization and offering costs as of June 30, 2016. Other organization expenses are expensed as incurred and offering expenses are charged to stockholders’ equity as incurred or as such amounts are reimbursed to the Advisor.
The Company pays to the Advisor 2.0% of the contract purchase price of each property or asset acquired and 2.0% of the amount advanced with respect to a mortgage loan. For the three months ended June 30, 2016 and 2015, the Company incurred approximately $1,937,000 and $1,904,000, respectively, and for the six months ended June 30, 2016 and 2015, the Company incurred approximately $4,170,000 and $2,471,000, respectively, in acquisition fees to the Advisor or its affiliates. In addition, the Company reimburses the Advisor for acquisition expenses incurred in connection with the selection and acquisition of properties or other real estate-related investments (including expenses relating to potential investments that the Company does not close), such as legal fees and expenses, costs of real estate due diligence, appraisals, non-refundable option payments on properties not acquired, travel and communications expenses, accounting fees and expenses and title insurance premiums, whether or not the property was acquired. The Company expects these expenses will be approximately 0.75% of the purchase price of each property or real estate-related investment.
The Company pays to the Advisor an asset management fee calculated on a monthly basis in an amount equal to 1/12th of 0.75% of gross assets (including amounts borrowed), which is payable monthly in arrears. The Advisor may, in its sole discretion, choose to take any monthly asset management fee in the form of subordinated restricted Class B Units of the Operating Partnership. In the event the Advisor chooses to be compensated in Class B Units, then the Operating Partnership will, within 30 days after the end of the applicable month (subject to the approval of the board of directors), issue a number of restricted Class B Units to the Advisor equal to: (i) the cost of assets multiplied by 0.0625% (or the lower of the cost of assets and the applicable net asset value, or NAV, multiplied by 0.0625%, once the Company begins calculating NAV) divided by (ii) the value of one share of common stock as of the last day of such calendar month, which will be the offering price, less selling commissions and dealer manager fees, until such time as the Company calculates NAV, when it will then be the per share NAV for common shares. The Advisor will be entitled to receive certain distributions of net sales proceeds on the vested and unvested Class B Units it receives in connection with its assets management services at the same rate as distributions received on the Company’s common stock. Such distributions will be in addition to the incentive fees the Advisor and its affiliates may receive from the Company, including, without limitation the subordinated participation in net sales proceeds, the subordinated incentive listing distribution or the subordinated distribution upon termination of the advisory agreement, as applicable.
15
Class B Units are subject to forfeiture until such time as: (a) the value of the Operating Partnership’s assets plus all distributions made equals or exceeds the total amount of capital contributed by investors plus a 6.0% cumulative, pretax, non-compounded annual return thereon, or the economic hurdle; (b) any one of the following events occurs concurrently with or subsequently to the achievement of the economic hurdle described above: (i) a listing of the Company’s common stock on a national securities exchange; (ii) a transaction to which the Company or the Operating Partnership shall be a party, as a result of which operating partnership units or common stock shall be exchanged for or converted into the right, or the holders of such securities shall otherwise be entitled, to receive cash, securities or other property or any combination thereof; or (iii) the termination of the advisory agreement without cause; and (c) the Advisor pursuant to the advisory agreement is providing services to the Company immediately prior to the occurrence of an event of the type described in clause (b) above, unless the failure to provide such services is attributable to the termination without cause of the advisory agreement by an affirmative vote of a majority of the Company’s independent directors after the economic hurdle described above has been met. Any outstanding Class B Units will be forfeited immediately if the advisory agreement is terminated for any reason other than a termination without cause. Any outstanding Class B Units will be forfeited immediately if the advisory agreement is terminated without cause by an affirmative vote of a majority of the Company’s board of directors before the economic hurdle described above has been met. For the three months ended June 30, 2016 and 2015, the Company incurred approximately $1,058,000 and $289,000, respectively, and for the six months ended June 30, 2016 and 2015, the Company incurred approximately $2,013,000 and $494,000, respectively, in asset management fees. As of June 30, 2016, the Company did not issue any Class B Units.
In connection with the rental, leasing, operation and management of the Company’s properties, the Company pays the Property Manager and its affiliates aggregate fees equal to 3.0% of monthly gross revenues from the properties managed, or property management fees. The Company will reimburse the Property Manager and its affiliates for property-level expenses that any of them pay or incur on the Company’s behalf, including salaries, bonuses and benefits of persons employed by the Property Manager and its affiliates except for the salaries, bonuses and benefits of persons who also serve as one of its executive officers. The Property Manager and its affiliates may subcontract the performance of their duties to third parties and pay all or a portion of the property management fee to the third parties with whom they contract for these services. If the Company contracts directly with third parties for such services, it will pay them customary market fees and may pay the Property Manager an oversight fee equal to 1.0% of the gross revenues of the properties managed. In no event will the Company pay the Property Manager or any affiliate both a property management fee and an oversight fee with respect to any particular property. The Company also will pay the Property Manager a separate fee for the one-time initial rent-up, leasing-up of newly constructed properties or re-leasing to existing tenants. For the three months ended June 30, 2016 and 2015, the Company incurred approximately $312,000 and $80,000, respectively, and for the six months ended June 30, 2016 and 2015, the Company incurred approximately $611,000 and $140,000, respectively, in property management fees to the Property Manager, which are recorded in rental expenses in the accompanying condensed consolidated statements of comprehensive income (loss). As of June 30, 2016, the Company has not incurred any leasing commissions to the Property Manager.
The Company reimburses the Advisor for all expenses it paid or incurred in connection with the services provided to the Company, subject to certain limitations. Expenses in excess of the operating expenses in the four immediately preceding quarters that exceeds the greater of (a) 2.0% of average invested assets or (b) 25% of net income, subject to certain adjustments, will not be reimbursed unless the independent directors determine such excess expenses are justified. The Company will not reimburse the Advisor for personnel costs in connection with services for which the Advisor receives an acquisition fee or a disposition fee. For the three months ended June 30, 2016 and 2015, the Advisor allocated approximately $321,000 and $200,000, respectively, and for the six months ended June 30, 2016 and 2015, the Advisor allocated approximately $598,000 and $362,000, respectively, in operating expenses to the Company, which are included as part of general and administrative expenses in the accompanying condensed consolidated statements of comprehensive income (loss).
The Company will pay its Advisor, or its affiliates, if it provides a substantial amount of services (as determined by a majority of the Company’s independent directors) in connection with the sale of properties, a disposition fee, up to the lesser of 1.0% of the contract sales price and one-half of the total brokerage commission paid if a third party broker is also involved, without exceeding the lesser of 6.0% of the contract sales price or a reasonable, customary and competitive real estate commission. As of June 30, 2016, the Company has not incurred any disposition fees to the Advisor or its affiliates.
The Advisor will receive 15% of the remaining net sale proceeds after return of capital contributions plus payment to investors of a 6.0% annual cumulative, non-compounded return on the capital contributed by investors. As of June 30, 2016, the Company has not incurred any subordinated participation in net sale proceeds to the Advisor or its affiliates.
Upon the listing of the Company’s shares on a national securities exchange, which the Company has no intention to do at this time, the Advisor will receive 15.0% of the amount by which the sum of the Company’s adjusted market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to a 6.0% annual cumulative, non-compounded return to investors, or the subordinated incentive listing fee. As of June 30, 2016, the Company has not incurred any subordinated incentive listing fees to the Advisor or its affiliates.
16
Upon termination or non-renewal of the advisory agreement, with or without cause, the Advisor will be entitled to receive distributions from the Operating Partnership equal to 15% of the amount by which the sum of the Company’s adjusted market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to an annual 6.0% cumulative, non-compounded return to investors. In addition, the Advisor may elect to defer its right to receive a subordinated distribution upon termination until either shares of the Company’s common stock are listed and traded on a national securities exchange or another liquidity event occurs. As of June 30, 2016, the Company has not incurred any subordinated termination fees to the Advisor or its affiliates.
Certain affiliates of the Company receive fees in connection with the Offering and will continue to receive fees during the acquisition, management and sale of assets of the Company.
The Company pays the Dealer Manager selling commissions of up to 7.0% of the gross offering proceeds per Class A share and up to 3.0% of gross offering proceeds per Class T share. All selling commissions are expected to be re-allowed to participating broker-dealers. The Company will not pay selling commissions with respect to shares of any class sold pursuant to the DRIP. In addition, the Company pays the Dealer Manager a dealer manager fee of up to 3.0% of gross offering proceeds from the sale of Class A and Class T shares.The dealer manager fee may be partially re-allowed to participating broker-dealers. No dealer manager fees will be paid in connection with purchases of shares made pursuant to the DRIP. For the three months ended June 30, 2016 and 2015, the Company incurred approximately $6,940,000 and $11,431,000, respectively, and for the six months ended June 30, 2016 and 2015, the Company incurred approximately $14,944,000 and $21,321,000, respectively, for selling commissions and dealer manager fees in connection with the Offering to the Dealer Manager.
The Company pays the Dealer Manager a distribution and servicing fee with respect to its Class T shares that are sold in the primary offering that accrues daily in an amount equal to 1/365th of 1.0% of the amount of the purchase price per share (or, once reported, the NAV per share for such day) on a continuous basis from year to year. Termination of such payment will commence on the earliest to occur of the following: (i) a listing of the Class T shares on a national securities exchange, (ii) following the completion of the Offering, total underwriting compensation in the Offering equaling 10% of the gross proceeds from the primary portion of the Offering, (iii) there are no longer any Class T shares outstanding, or (iv) the fourth anniversary of the last day of the fiscal quarter in which the primary offering terminates. The Dealer Manager may re-allow the distribution and servicing fee to participating broker-dealers and servicing broker-dealers. The distribution and servicing fee will be paid monthly in arrears. The distribution and servicing fee will not be payable with respect to Class T shares issued under the DRIP. The Company will not pay a distribution and servicing fee with respect to Class A shares. For the three and six months ended June 30, 2016, the Company incurred approximately $3,020,000 and $3,042,000, respectively, for distribution and servicing fees to the Dealer Manager. For the three and six months ended June 30, 2015, the Company did not incur distribution and servicing fees to the Dealer Manager because it had not sold any Class T shares.
In the Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, filed with the SEC on May 12, 2016, the Company did not record the estimated liability for distribution and servicing fees the Company may pay in the future on Class T shares in the amount of $1,162,000 due to the adoption of an accounting policy based on an industry practice guideline. The Company subsequently determined that the amount should have been accrued in equity. This amount was inconsequential to total shareholders’ equity and total liabilities as of March 31, 2016; therefore, this amount has been adjusted prospectively and recorded in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.
Accounts Payable Due to Affiliates
The following amounts were outstanding due to affiliates as of June 30, 2016 and December 31, 2015 (amounts in thousands):
Entity | Fee | June 30, 2016 | December 31, 2015 | |||||||
Carter Validus Advisors II, LLC and its affiliates | Asset management fees | $ | 389 | $ | 290 | |||||
Carter Validus Real Estate Management Services II, LLC | Property management fees | 108 | 101 | |||||||
Carter Validus Advisors II, LLC and its affiliates | General and administrative costs | 98 | 96 | |||||||
Carter Validus Advisors II, LLC and its affiliates | Offering costs | 3,396 | 250 | |||||||
Carter Validus Advisors II, LLC and its affiliates | Acquisition expenses and fees | 6 | 4 | |||||||
$ | 3,997 | $ | 741 | |||||||
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Note 12—Segment Reporting
Management reviews the performance of individual properties and aggregates individual properties based on operating criteria into two reportable segments—commercial real estate investments in data centers and healthcare, and makes operating decisions based on these two reportable segments. The Company’s commercial real estate investments in data centers and healthcare are based on certain underwriting assumptions and operating criteria, which are different for data centers and healthcare. There were no intersegment sales or transfers during the six months ended June 30, 2016 and 2015.
The Company evaluates performance based on net operating income of the individual properties in each segment. Net operating income, a non-GAAP financial measure, is defined as total revenues, less rental expenses, which excludes depreciation and amortization, general and administrative expenses, acquisition related expenses, asset management fees and interest expense, net. The Company believes that segment net operating income serves as a useful supplement to net income (loss) because it allows investors and management to measure unlevered property-level operating results and to compare operating results to the operating results of other real estate companies between periods on a consistent basis. Segment net operating income should not be considered as an alternative to net income (loss) determined in accordance with GAAP as an indicator of financial performance, and accordingly, the Company believes that in order to facilitate a clear understanding of the consolidated historical operating results, segment net operating income should be examined in conjunction with net income (loss) as presented in the accompanying condensed consolidated financial statements and data included elsewhere in this Quarterly Report on Form 10-Q.
General and administrative expenses, acquisition related expenses, asset management fees, depreciation and amortization and interest expense, net are not allocated to individual segments for purposes of assessing segment performance.
Non-segment assets primarily consist of corporate assets, including cash and cash equivalents, real estate and escrow deposits, deferred financing costs attributable to the revolving line of credit portion of the Company's secured credit facility and other assets not attributable to individual properties.
Summary information for the reportable segments during the three and six months ended June 30, 2016 and 2015, is as follows (amounts in thousands):
Data Centers | Healthcare | Three Months Ended June 30, 2016 | |||||||||
Revenue: | |||||||||||
Rental and tenant reimbursement revenue | $ | 2,177 | $ | 10,026 | $ | 12,203 | |||||
Expenses: | |||||||||||
Rental expenses | (317 | ) | (1,260 | ) | (1,577 | ) | |||||
Segment net operating income | $ | 1,860 | $ | 8,766 | 10,626 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (757 | ) | |||||||||
Acquisition related expenses | (1,946 | ) | |||||||||
Asset management fees | (1,058 | ) | |||||||||
Depreciation and amortization | (4,300 | ) | |||||||||
Income from operations | 2,565 | ||||||||||
Interest expense, net | (732 | ) | |||||||||
Net income attributable to common stockholders | $ | 1,833 | |||||||||
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Data Centers | Healthcare | Three Months Ended June 30, 2015 | |||||||||
Revenue: | |||||||||||
Rental and tenant reimbursement revenue | $ | 181 | $ | 2,886 | $ | 3,067 | |||||
Expenses: | |||||||||||
Rental expenses | (8 | ) | (179 | ) | (187 | ) | |||||
Segment net operating income | $ | 173 | $ | 2,707 | 2,880 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (448 | ) | |||||||||
Acquisition related expenses | (2,811 | ) | |||||||||
Asset management fees | (289 | ) | |||||||||
Depreciation and amortization | (926 | ) | |||||||||
Loss from operations | (1,594 | ) | |||||||||
Interest expense, net | (291 | ) | |||||||||
Net loss attributable to common stockholders | $ | (1,885 | ) | ||||||||
Data Centers | Healthcare | Six Months Ended June 30, 2016 | |||||||||
Revenue: | |||||||||||
Rental and tenant reimbursement revenue | $ | 3,714 | $ | 19,913 | $ | 23,627 | |||||
Expenses: | |||||||||||
Rental expenses | (571 | ) | (2,690 | ) | (3,261 | ) | |||||
Segment net operating income | $ | 3,143 | $ | 17,223 | 20,366 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (1,522 | ) | |||||||||
Acquisition related expenses | (3,611 | ) | |||||||||
Asset management fees | (2,013 | ) | |||||||||
Depreciation and amortization | (8,166 | ) | |||||||||
Income from operations | 5,054 | ||||||||||
Interest expense, net | (1,611 | ) | |||||||||
Net income attributable to common stockholders | $ | 3,443 | |||||||||
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Data Centers | Healthcare | Six Months Ended June 30, 2015 | |||||||||
Revenue: | |||||||||||
Rental and tenant reimbursement revenue | $ | 181 | $ | 5,196 | $ | 5,377 | |||||
Expenses: | |||||||||||
Rental expenses | (8 | ) | (314 | ) | (322 | ) | |||||
Segment net operating income | $ | 173 | $ | 4,882 | 5,055 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (927 | ) | |||||||||
Acquisition related expenses | (3,527 | ) | |||||||||
Asset management fees | (494 | ) | |||||||||
Depreciation and amortization | (1,610 | ) | |||||||||
Loss from operations | (1,503 | ) | |||||||||
Interest expense, net | (661 | ) | |||||||||
Net loss attributable to common stockholders | $ | (2,164 | ) | ||||||||
Assets by each reportable segment as of June 30, 2016 and December 31, 2015 are as follows (amounts in thousands):
June 30, 2016 | December 31, 2015 | ||||||
Assets by segment: | |||||||
Data centers | $ | 100,470 | $ | 44,207 | |||
Healthcare | 534,270 | 427,878 | |||||
All other | 38,221 | 34,542 | |||||
Total assets | $ | 672,961 | $ | 506,627 | |||
Capital additions and acquisitions by reportable segments for the six months ended June 30, 2016 and 2015 are as follows (amounts in thousands):
Six Months Ended June 30, | |||||||
2016 | 2015 | ||||||
Capital additions and acquisitions by segment: | |||||||
Data centers | $ | 56,544 | $ | 13,534 | |||
Healthcare | 107,005 | 110,429 | |||||
Total capital additions and acquisitions | $ | 163,549 | $ | 123,963 | |||
Note 13—Accounts Payable and Other Liabilities
Accounts payable and other liabilities, as of June 30, 2016 and December 31, 2015, were comprised of the following (amounts in thousands):
June 30, 2016 | December 31, 2015 | ||||||
Accounts payable and accrued expenses | $ | 2,936 | $ | 2,283 | |||
Accrued interest expense | 274 | 221 | |||||
Accrued property taxes | 1,113 | 505 | |||||
Distributions payable to stockholders | 3,444 | 2,548 | |||||
Tenant deposits | 1,975 | 1,848 | |||||
Deferred rental income | 1,288 | 839 | |||||
Derivative liabilities | 123 | — | |||||
$ | 11,153 | $ | 8,244 | ||||
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Note 14—Derivative Instruments and Hedging Activities
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed rate payments over the life of the agreements without exchange of the underlying notional amount.
The effective portion of changes in the fair value of derivatives designated, and that qualify, as cash flow hedges is recorded in accumulated other comprehensive loss in the accompanying condensed consolidated statement of stockholders' equity and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.
During the six months ended June 30, 2016, the Company's derivative instrument was used to hedge the variable cash flows associated with variable rate debt. The ineffective portion of changes in fair value of the derivative is recognized directly in earnings. During the three and six months ended June 30, 2016, the Company recognized a loss of $22,000 due to ineffectiveness of its hedge of interest rate risk, which was recorded in interest expense, net in the accompanying condensed consolidated statements of comprehensive income (loss).
Amounts reported in accumulated other comprehensive loss related to the derivative will be reclassified to interest expense as interest payments are made on the Company’s variable rate debt. During the next twelve months, the Company estimates that an additional $104,000 will be reclassified from accumulated other comprehensive loss as an increase to interest expense.
See Note 2—"Summary of Significant Accounting Policies" for a further discussion of the fair value of the Company’s derivative instruments.
The following table summarizes the notional amount and fair value of the Company’s derivative instrument (amounts in thousands):
Derivative Designated as Hedging Instrument | Balance Sheet Location | Effective Dates | Maturity Dates | June 30, 2016 | December 31, 2015 | |||||||||||||||||||||||||
Outstanding Notional Amount | Fair Value of | Outstanding Notional Amount | Fair Value of | |||||||||||||||||||||||||||
Asset | (Liability) | Asset | (Liability) | |||||||||||||||||||||||||||
Interest rate swap | Accounts payable and other liabilities | 07/01/2016 | 12/22/2020 | $ | — | (1) | $ | — | $ | (123 | ) | $ | — | $ | — | $ | — | |||||||||||||
(1) | The trade date of the swap was June 24, 2016 with an effective date of July 1, 2016. |
The notional amount under the agreement is an indication of the extent of the Company’s involvement in the instrument at the time, but does not represent exposure to credit, interest rate or market risks.
Accounting for changes in the fair value of a derivative instrument depends on the intended use and designation of the derivative instrument. The Company designated the interest rate swap as a cash flow hedge to hedge the variability of the anticipated cash flows on its variable rate secured credit facility. The change in fair value of the effective portion of the derivative instrument that is designated as a hedge is recorded in other comprehensive income (loss), or OCI, in the accompanying condensed consolidated statements of comprehensive income (loss).
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The table below summarizes the amount of loss recognized on the interest rate derivative designated as a cash flow hedge for the three and six months ended June 30, 2016 and 2015 (amounts in thousands):
Derivative in Cash Flow Hedging Relationship | Amount of (Loss) Recognized in OCI on Derivative (Effective Portion) | Location of (Loss) Reclassified From Accumulated Other Comprehensive Loss to Net Income (Effective Portion) | Amount of Loss Reclassified From Accumulated Other Comprehensive Loss to Net Income (Effective Portion) | |||||||
Three Months Ended June 30, 2016 | ||||||||||
Interest rate swap | $ | (101 | ) | Interest expense, net | $ | — | ||||
Total | $ | (101 | ) | $ | — | |||||
Three Months Ended June 30, 2015 | ||||||||||
Interest rate swap | $ | — | Interest expense, net | $ | — | |||||
Total | $ | — | $ | — | ||||||
Six Months Ended June 30, 2016 | ||||||||||
Interest rate swap | $ | (101 | ) | Interest expense, net | $ | — | ||||
Total | $ | (101 | ) | $ | — | |||||
Six Months Ended June 30, 2015 | ||||||||||
Interest rate swap | $ | — | Interest expense, net | $ | — | |||||
Total | $ | — | $ | — | ||||||
Credit Risk-Related Contingent Features
The Company has an agreement with its derivative counterparty that contain cross-default provisions, whereby if the Company defaults on certain of its indebtedness, then the Company could also be declared in default on its derivative obligation, resulting in an acceleration of payment thereunder.
In addition, the Company is exposed to credit risk in the event of non-performance by its derivative counterparty. The Company believes it mitigates its credit risk by entering into agreements with creditworthy counterparties. The Company records credit risk valuation adjustments on its interest rate swaps based on the respective credit quality of the Company and the counterparty. As of June 30, 2016, the fair value of the derivative in a net liability position, including accrued interest but excluding any adjustment for nonperformance risk related to the agreement, was $123,000. As of June 30, 2016, there were no termination events or events of default related to the interest rate swap.
Tabular Disclosure Offsetting Derivatives
The Company has elected not to offset its derivative liability position in its condensed consolidated financial statements. The following table presents the effect on the Company’s financial position had the Company made the election to offset its derivative liability position as of June 30, 2016 (amounts in thousands):
Offsetting of Derivative Liabilities | ||||||||||||||||||||||||
Gross Amounts Not Offset in the Balance Sheet | ||||||||||||||||||||||||
Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Balance Sheet | Net Amounts of Liabilities Presented in the Balance Sheet | Financial Instruments Collateral | Cash Collateral | Net Amount | |||||||||||||||||||
June 30, 2016 | $ | 123 | $ | — | $ | 123 | $ | — | $ | — | $ | 123 | ||||||||||||
The Company did not have any financial instruments hedged through interest rate swaps as of December 31, 2015.
The Company reports the derivative in the accompanying condensed consolidated balance sheets as accounts payable and other liabilities.
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Note 15—Accumulated Other Comprehensive Loss
The following table presents a rollforward of amounts recognized in accumulated other comprehensive loss, net of noncontrolling interests, by component for the six months ended June 30, 2016 and 2015 (amounts in thousands):
Unrealized Loss on Derivative Instruments | Accumulated Other Comprehensive Loss | ||||||
Balance as of December 31, 2015 | $ | — | $ | — | |||
Other comprehensive loss before reclassification | (101 | ) | (101 | ) | |||
Amount of loss reclassified from accumulated other comprehensive loss to net income (effective portion) | — | — | |||||
Other comprehensive loss | (101 | ) | (101 | ) | |||
Balance as of June 30, 2016 | $ | (101 | ) | $ | (101 | ) | |
During the six months ended June 30, 2016 and 2015, there were no reclassifications out of accumulated other comprehensive loss.
Note 16—Economic Dependency
The Company is dependent on the Advisor and its affiliates for certain services that are essential to the Company, including the sale of the Company’s shares of common and preferred stock available for issuance; the identification, evaluation, negotiation, purchase and disposition of real estate investments and other investments; the management of the daily operations of the Company’s real estate portfolio; and other general and administrative responsibilities. In the event that the Advisor and its affiliates are unable to provide the respective services, the Company will be required to obtain such services from other sources.
Note 17—Subsequent Events
Distributions to Stockholders Paid
On July 1, 2016, the Company paid aggregate distributions of approximately $3,203,000 to Class A stockholders ($1,410,000 in cash and $1,793,000 in shares of the Company’s Class A common stock pursuant to the DRIP), which related to distributions declared for each day in the period from June 1, 2016 through June 30, 2016. On August 1, 2016, the Company paid aggregate distributions of approximately $3,398,000 to Class A stockholders ($1,508,000 in cash and $1,890,000 in shares of the Company’s Class A common stock issued pursuant to the DRIP), which related to distributions declared for each day in the period from July 1, 2016 through July 31, 2016.
On July 1, 2016, the Company paid aggregate distributions of approximately $241,000 to Class T stockholders ($80,000 in cash and $161,000 in shares of the Company's Class T common stock pursuant to the DRIP), which related to distributions declared for each day in the period from June 1, 2016 through June 30, 2016. On August 1, 2016, the Company paid aggregate distributions of approximately $303,000 to Class T stockholders ($105,000 in cash and $198,000 in shares of the Company’s Class T common stock issued pursuant to the DRIP), which related to distributions declared for each day in the period from July 1, 2016 through July 31, 2016.
Distributions Declared
Class A Shares
On August 12, 2016, the board of directors of the Company approved and declared a distribution to the Company’s Class A stockholders of record as of the close of business on each day of the period commencing on September 1, 2016 and ending on November 30, 2016. The distributions will be calculated based on 366 days in the calendar year and will be equal to $0.001748634 per share of Class A common stock, which will be equal to an annualized distribution rate of 6.4%, assuming a purchase price of $10.00 per share of Class A common stock. The distributions declared for each record date in September 2016, October 2016 and November 2016 will be paid in October 2016, November 2016 and December 2016, respectively. The distributions will be payable to stockholders from legally available funds therefor.
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Class T Shares
On August 12, 2016, the board of directors of the Company approved and declared a daily distribution to the Company’s Class T stockholders of record as of the close of business on each day of the period commencing on September 1, 2016 and ending November 30, 2016. The distributions will be calculated based on 366 days in the calendar year and will be equal to $0.001488487 per share of Class T common stock, which will be equal to an annualized distribution rate of 5.69%, assuming a purchase price of $9.574 per share. The distributions declared for each record date in September 2016, October 2016 and November 2016 will be paid in October 2016, November 2016 and December 2016, respectively. The distributions will be payable to stockholders from legally available funds therefor.
Status of the Offering
As of August 11, 2016, the Company had accepted investors’ subscriptions for and issued approximately 71,673,000 shares of Class A and Class T common stock in the Offering, resulting in receipt of gross proceeds of approximately $708,229,000 including shares of its common stock issued pursuant to the DRIP. As of August 11, 2016, the Company had approximately $1,641,771,000 in Class A shares and Class T shares of common stock remaining in the Offering.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes thereto, and the other unaudited financial information appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with our audited consolidated financial statements, and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission, or the SEC, on March 28, 2016, or the 2015 Annual Report on Form 10-K.
The terms “we,” “our,” and the “Company” refer to Carter Validus Mission Critical REIT II, Inc., Carter Validus Operating Partnership II, LP, or our Operating Partnership, and all wholly-owned subsidiaries.
Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q, other than historical facts, include forward-looking statements that reflect our expectations and projections about our future results, performance, prospects and opportunities. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, as well as known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. 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,” “would,” “could,” “should,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management’s view only as of the date this Quarterly Report on Form 10-Q is filed with the SEC. We make no representation or warranty (express or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q, and we do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. See Item 1A. “Risk Factors” of our 2015 Annual Report on Form 10-K for a discussion of some, although not all, of the risks and uncertainties that could cause actual results to differ materially from those presented in our forward-looking statements.
Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.
Overview
We were formed on January 11, 2013 under the laws of Maryland to acquire and operate a diversified portfolio of income-producing commercial real estate with a focus on data centers and healthcare properties, preferably with long-term net leases to investment grade and other creditworthy tenants, as well as to make other real estate-related investments that relate to such property types. We are offering shares of Class A common stock and shares of Class T common stock, in any combination, with a dollar value up to the maximum offering amount, or the Offering. The initial offering price for the shares in our primary offering is $10.00 per Class A share and $9.574 per Class T share.
As of June 30, 2016, we had accepted investors’ subscriptions for and issued approximately 68,168,000 shares of Class A and Class T common stock (including shares of common stock issued pursuant to the DRIP) in our Offering, resulting in receipt of gross proceeds of approximately $674,158,000, before selling commissions and dealer manager fees of approximately $59,583,000, distribution and servicing fees of approximately $3,042,000 and other offering costs of approximately $13,184,000. As of June 30, 2016, we had approximately $1,675,842,000 in Class A shares and Class T shares of common stock remaining in our Offering. We will not pay distribution and servicing fees with respect to shares of Class A common stock or shares of Class T common stock issued pursuant to the DRIP.
Substantially all of our operations are conducted through Carter Validus Operating Partnership II, LP, or our Operating Partnership. We are externally advised by Carter Validus Advisors II, LLC, which is our affiliate, or our Advisor, pursuant to an advisory agreement between us and our Advisor. Our Advisor supervises and manages our day-to-day operations and selects the properties and real estate-related investments we acquire, subject to the oversight and approval of our board of directors. Our Advisor also provides marketing, sales and client services on our behalf. Our Advisor engages affiliated entities to provide various services to us. Our Advisor is managed by, and is a subsidiary of, our sponsor, Carter Validus REIT Management Company II, LLC, or our Sponsor. We have no paid employees and we rely on our Advisor to provide substantially all of our services.
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Carter Validus Real Estate Management Services II, LLC, or our Property Manager, a wholly-owned subsidiary of our Sponsor, serves as our property manager. Our Advisor and our Property Manager received, and will continue to receive, fees during the acquisition and operational stages and our Advisor may be eligible to receive fees during the liquidation stage of the Company. SC Distributors, LLC, an affiliate of the Advisor, or the Dealer Manager, serves as the dealer manager of the Offering. The Dealer Manager has received, and will continue to receive, fees for services related to our Offering.
We currently operate through two reportable segments – commercial real estate investments in data centers and healthcare. As of June 30, 2016, we had purchased 29 real estate investments, consisting of 42 properties, comprising approximately 2,004,000 of gross rentable square feet for an aggregate purchase price of approximately $624,861,000.
Critical Accounting Policies
Our critical accounting policies were disclosed in our 2015 Annual Report on Form 10-K. There have been no material changes to our critical accounting policies as disclosed therein.
Interim Unaudited Financial Data
Our accompanying condensed consolidated financial statements have been prepared by us in accordance with GAAP in conjunction with the rules and regulations of the SEC. Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, our accompanying condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. Our accompanying condensed consolidated financial statements reflect all adjustments, which are, in our view, of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim period. Interim results of operations are not necessarily indicative of the results to be expected for the full year; such full year results may be less favorable. Our accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our 2015 Annual Report on Form 10-K.
Qualification as a REIT
We qualified and elected to be taxed as a REIT for federal income tax purposes and we intend to continue to be taxed as a REIT. To maintain our qualification as a REIT, we must continue to meet certain organizational and operational requirements, including a requirement to currently distribute at least 90.0% of our REIT taxable income to our 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 maintain our qualification as a REIT in any taxable year, we would then be subject to federal income taxes on our taxable income at regular corporate rates and would 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 us relief under certain statutory provisions. Such an event could have a material adverse effect on our net income and net cash available for distribution to our stockholders.
Recently Issued Accounting Pronouncements
For a discussion of recently issued accounting pronouncements, see Note 2—“Summary of Significant Accounting Policies—Recently Issued Accounting Pronouncements” to our condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q.
Segment Reporting
We report our financial performance based on two reporting segments—commercial real estate investments in data centers and healthcare. See Note 12—"Segment Reporting," to our condensed consolidated financial statements that are part of this Quarterly Report on Form 10-Q for additional information on our two reporting segments.
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Results of Operations
Our results of operations are influenced by the timing of acquisitions and the operating performance of our real estate properties. The following table shows the property statistics of our real estate properties as of June 30, 2016 and 2015:
June 30, | |||||
2016 | 2015 | ||||
Number of commercial operating real estate properties (1) | 40 | 13 | |||
Leased rentable square feet | 2,003,000 | 704,000 | |||
Weighted average percentage of rentable square feet leased | 99.9 | % | 99.9 | % | |
(1) | As of June 30, 2016, we owned 42 real estate properties, two of which were under construction. |
The following table summarizes our real estate properties' activity for the three and six months ended June 30, 2016 and 2015:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2016 | 2015 | 2016 | 2015 | ||||||||||||
Commercial operating real estate properties acquired(1) | 3 | 5 | 12 | 7 | |||||||||||
Approximate aggregate purchase price of acquired real estate properties (1) | $ | 76,046,000 | $ | 95,424,000 | $ | 161,462,000 | $ | 123,807,000 | |||||||
Leased rentable square feet | 202,000 | 320,000 | 481,000 | 382,000 | |||||||||||
(1) | During the three months ended June 30, 2016, we acquired four real estate properties, one of which was under construction. During the six months ended June 30, 2016, we acquired 14 real estate properties, two of which were under construction. |
The following discussion is based on our condensed consolidated financial statements for the three and six months ended June 30, 2016 and 2015.
This section describes and compares our results of operations for the three and six months ended June 30, 2016 and 2015. We generate almost all of our net operating income from property operations. In order to evaluate our overall portfolio, management analyzes the net operating income of same store properties. We define "same store properties" as operating properties that were owned and operated for the entirety of both calendar periods being compared and exclude properties under development.
By evaluating the property net operating income of our same store properties, management is able to monitor the operations of our existing properties for comparable periods to measure the performance of our current portfolio and determine the effects of our new acquisitions on net income (loss).
We are not aware of any material trends and uncertainties, other than national economic conditions affecting real estate generally, that may be reasonably expected to have a material impact, favorable or unfavorable, on revenues or incomes from the acquisition, management and operation of properties other than those set forth in our Annual Report on Form 10-K for the year ended December 31, 2015 and in Part II, Item 1A. "Risk Factors" of this Quarterly Report on Form 10-Q.
Three Months Ended June 30, 2016 Compared to the Three Months Ended June 30, 2015
Changes in our revenues are summarized in the following table (amounts in thousands):
Three Months Ended June 30, | |||||||||||
2016 | 2015 | Change | |||||||||
Same store rental revenue | $ | 2,554 | $ | 2,554 | $ | — | |||||
Non-same store rental revenue | 8,333 | 408 | 7,925 | ||||||||
Same store tenant reimbursement revenue | 83 | 94 | (11 | ) | |||||||
Non-same store tenant reimbursement revenue | 1,232 | 7 | 1,225 | ||||||||
Other operating income | 1 | 4 | (3 | ) | |||||||
Total revenue | $ | 12,203 | $ | 3,067 | $ | 9,136 | |||||
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• | Same store rental revenue was unchanged. Adjustments to straight-line rental revenue offset the increase in contractual rental revenue resulting from average annual rent escalations of 2.38% at our same store properties. |
• | Non-same store rental revenue increased $7.9 million due to the acquisition of 32 operating properties, with annual rent escalations, since April 1, 2015. |
• | Non-same store tenant reimbursement revenue increased $1.2 million due to the acquisition of 32 operating properties since April 1, 2015. |
Changes in our expenses are summarized in the following table (amounts in thousands):
Three Months Ended June 30, | |||||||||||
2016 | 2015 | Change | |||||||||
Same store rental expenses | $ | 142 | $ | 166 | $ | (24 | ) | ||||
Non-same store rental expenses | 1,435 | 21 | 1,414 | ||||||||
General and administrative expenses | 757 | 448 | 309 | ||||||||
Acquisition related expenses | 1,946 | 2,811 | (865 | ) | |||||||
Asset management fees | 1,058 | 289 | 769 | ||||||||
Depreciation and amortization | 4,300 | 926 | 3,374 | ||||||||
Total expenses | $ | 9,638 | $ | 4,661 | $ | 4,977 | |||||
• | Non-same store rental expenses, certain of which are subject to reimbursement by our tenants, increased primarily due to the acquisition of 32 operating properties since April 1, 2015. |
• | General and administrative expenses increased primarily due to an increase in professional and legal fees of $0.2 million and an increase in personnel costs of $0.1 million, in connection with our Company's growth. |
• | Acquisition related expenses decreased due to a decrease in real estate properties determined to be business combinations. Acquisition fees and expenses associated with transactions determined to be business combinations are expensed as incurred. During the three months ended June 30, 2016, we acquired three real estate properties for an aggregate purchase price of $72.8 million as compared to four real estate properties for an aggregate purchase price of $87.7 million during the three months ended June 30, 2015. |
• | Asset management fees increased due to an increase in the weighted average operating assets held to $430.3 million as of June 30, 2016, as compared to $62.3 million as of June 30, 2015. |
• | Depreciation and amortization increased due to an increase in the weighted average depreciable basis of operating real estate investments to $382.3 million as of June 30, 2016, as compared to $53.8 million as of June 30, 2015. |
Changes in interest expense, net are summarized in the following table (amounts in thousands):
Three Months Ended June 30, | |||||||||||
2016 | 2015 | Change | |||||||||
Interest expense, net: | |||||||||||
Interest on secured credit facility | $ | (616 | ) | $ | (149 | ) | $ | (467 | ) | ||
Amortization of deferred financing costs | (246 | ) | (159 | ) | (87 | ) | |||||
Cash deposits interest | 29 | 17 | 12 | ||||||||
Capitalized interest | 101 | — | 101 | ||||||||
Total interest expense, net | (732 | ) | (291 | ) | (441 | ) | |||||
Net income (loss) attributable to common stockholders | $ | 1,833 | $ | (1,885 | ) | $ | 3,718 | ||||
• | Interest on secured credit facility increased due to an increase in the average outstanding principal balance on our secured credit facility. The outstanding principal balance of our secured credit facility was $95.0 million as of June 30, 2016, and $0 as of June 30, 2015. |
• | Capitalized interest increased due to an increase in the average accumulated expenditures on development properties to $9.3 million as of June 30, 2016, as compared to $0 as of June 30, 2015. |
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Six Months Ended June 30, 2016 Compared to the Six Months Ended June 30, 2015
Changes in our revenues are summarized in the following table (amounts in thousands):
Six Months Ended June 30, | |||||||||||
2016 | 2015 | Change | |||||||||
Same store rental revenue | $ | 3,766 | $ | 3,763 | $ | 3 | |||||
Non-same store rental revenue | 17,141 | 1,420 | 15,721 | ||||||||
Same store tenant reimbursement revenue | 157 | 169 | (12 | ) | |||||||
Non-same store tenant reimbursement revenue | 2,561 | 19 | 2,542 | ||||||||
Other operating income | 2 | 6 | (4 | ) | |||||||
Total revenue | $ | 23,627 | $ | 5,377 | $ | 18,250 | |||||
• | Same store rental revenue was unchanged. Adjustments to straight-line rental revenue offset the increase in contractual rental revenue resulting from average annual rent escalations of 2.17% at our same store properties. |
• | Non-same store rental revenue increased $15.7 million due to the acquisition of 34 operating properties, with annual rent escalations, since January 1, 2015. |
• | Non-same store tenant reimbursement revenue increased $2.5 million due to the acquisition of 34 operating properties since January 1, 2015. |
Changes in our expenses are summarized in the following table (amounts in thousands):
Six Months Ended June 30, | |||||||||||
2016 | 2015 | Change | |||||||||
Same store rental expenses | $ | 238 | $ | 264 | $ | (26 | ) | ||||
Non-same store rental expenses | 3,023 | 58 | 2,965 | ||||||||
General and administrative expenses | 1,522 | 927 | 595 | ||||||||
Acquisition related expenses | 3,611 | 3,527 | 84 | ||||||||
Asset management fees | 2,013 | 494 | 1,519 | ||||||||
Depreciation and amortization | 8,166 | 1,610 | 6,556 | ||||||||
Total expenses | $ | 18,573 | $ | 6,880 | $ | 11,693 | |||||
• | Non-same store rental expenses, certain of which are subject to reimbursement by our tenants, increased primarily due to the acquisition of 34 operating properties since January 1, 2015. |
• | General and administrative expenses increased primarily due to an increase in professional and legal fees of $0.4 million, an increase in personnel costs of $0.1 million and an increase in other administrative costs of $0.1 million in connection with our Company's growth. |
• | Acquisition related expenses increased due to an increase in real estate properties determined to be business combinations. Acquisition fees and expenses associated with transactions determined to be business combinations are expensed as incurred. During the six months ended June 30, 2016, we acquired 11 real estate properties for an aggregate purchase price of $127.9 million as compared to six real estate properties for an aggregate purchase price of $116.1 million during the six months ended June 30, 2015. |
• | Asset management fees increased due to an increase in the weighted average assets held to $430.3 million as of June 30, 2016, as compared to $62.3 million as of June 30, 2015. |
• | Depreciation and amortization increased due to an increase in the weighted average depreciable basis of real estate investments to $382.3 million as of June 30, 2016, as compared to $53.8 million as of June 30, 2015. |
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Changes in interest expense, net are summarized in the following table (amounts in thousands):
Six Months Ended June 30, | |||||||||||
2016 | 2015 | Change | |||||||||
Interest expense, net: | |||||||||||
Interest on secured credit facility | $ | (1,317 | ) | $ | (387 | ) | $ | (930 | ) | ||
Amortization of deferred financing costs | (447 | ) | (291 | ) | (156 | ) | |||||
Cash deposits interest | 52 | 17 | 35 | ||||||||
Capitalized interest | 101 | — | 101 | ||||||||
Total interest expense, net | (1,611 | ) | (661 | ) | (950 | ) | |||||
Net income (loss) attributable to common stockholders | $ | 3,443 | $ | (2,164 | ) | $ | 5,607 | ||||
• | Interest on secured credit facility increased due to an increase in the average outstanding principal balance on our secured credit facility. The outstanding principal balance of our secured credit facility was $95.0 million as of June 30, 2016, and $0 as of June 30, 2015. |
• | Capitalized interest increased due to an increase in the average accumulated expenditures on development properties to $9.3 million as of June 30, 2016, as compared to $0 as of June 30, 2015. |
Organization and Offering Costs
We reimburse our Advisor or its affiliates for organization and offering costs it incurs on our behalf, but only to the extent the reimbursement would not cause the selling commissions, dealer manager fees, distribution and servicing fees and other organization and offering costs incurred by us to exceed 15% of gross offering proceeds as of the date of the reimbursement. We expect that other organization and offering costs (other than selling commissions, dealer manager fees and distribution and servicing fees) will be approximately 1.25% of the gross offering proceeds. Our Advisor and its affiliates incurred other organization and offering costs on our behalf of approximately $10,458,000 as of June 30, 2016. As of June 30, 2016, we reimbursed our Advisor or its affiliates approximately $10,041,000 in offering expenses and accrued approximately $3,396,000 of other organization and offering expenses, the total of which represents our maximum liability for other organization and offering costs as of June 30, 2016. As of June 30, 2016, we incurred approximately $62,625,000 in selling commissions, dealer manager fees and distribution and servicing fees to our Dealer Manager. Other offering costs (other than selling commissions, dealer manager fees and distribution and servicing fees) were approximately $13,184,000 as of June 30, 2016.
When incurred, organization costs are expensed and offering costs, including selling commissions, dealer manager fees, distribution and servicing fees and other offering costs are charged to stockholders’ equity. For a further discussion of other organization and offering costs, see Note 11—"Related-Party Transactions and Arrangements" to the condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q.
Inflation
We are exposed to inflation risk as income from long-term leases is the primary source of our cash flows from operations. There are provisions in certain of our leases, with tenants, that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include reimbursement billings for operating expenses, pass-through charges and real estate tax and insurance reimbursements. However, due to the long-term nature of our leases, among other factors, the leases may not reset frequently enough to adequately offset the effects of inflation.
Liquidity and Capital Resources
Our principal demands for funds are for acquisitions of real estate and real estate-related investments, to pay operating expenses and interest on our current and future indebtedness and to pay distributions to our stockholders. Our sources of funds are primarily the net proceeds of our Offering, funds equal to amounts reinvested in the DRIP, operating cash flows, our secured credit facility and other borrowings. In addition, we require resources to make certain payments to our Advisor and our Dealer Manager, which, during our Offering, include payments to our Advisor and its affiliates for reimbursement of other organization and offering expenses and other costs incurred on our behalf, and payments to our Dealer Manager and its affiliates for selling commissions, dealer manager fees, distribution and servicing fees, and offering expenses.
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Generally, cash needs for items other than acquisitions of real estate and real estate-related investments are met from operations, borrowings, and the net proceeds of our Offering. However, there may be a delay between the sale of shares of our common stock and our investments in real estate, which could result in a delay in the benefits to our stockholders, if any, of returns generated from our investment operations.
Our Advisor evaluates potential additional investments and engages in negotiations with real estate sellers, developers, brokers, investment managers, lenders and others on our behalf. Until we invest all of the proceeds of our Offering in properties and real estate-related investments, we may invest in short-term, highly liquid or other authorized investments. Such short-term investments will not earn significant returns, and we cannot predict how long it will take to fully invest the proceeds in properties and real estate-related investments. The number of properties we acquire and other investments we make will depend upon the number of shares sold in our Offering and the resulting amount of net proceeds available for investment.
When we acquire a property, our Advisor prepares a capital plan that contemplates the estimated capital needs of that investment. In addition to operating expenses, capital needs may also include costs of refurbishment, tenant improvements or other major capital expenditures. The capital plan also sets forth the anticipated sources of the necessary capital, which may include a line of credit or other loans established with respect to the investment, operating cash generated by the investment, additional equity investments from us or joint venture partners or, when necessary, capital reserves. Any capital reserves would be established from the net proceeds of our Offering, proceeds from sales of other investments, operating cash generated by other investments or other cash on hand. In some cases, a lender may require us to establish capital reserves for a particular investment. The capital plan for each investment will be adjusted through ongoing, regular reviews of our portfolio or as necessary to respond to unanticipated additional capital needs.
Short-term Liquidity and Capital Resources
On a short-term basis, our principal demands for funds will be for the acquisition of real estate and real estate-related notes and investments and payments of tenant improvements, acquisition related costs, operating expenses, distributions, and interest and principal payments on current and future debt financings. We expect to meet our short-term liquidity requirements through net cash flows provided by operations, net proceeds from our Offering, borrowings on our secured credit facility, as well as secured and unsecured borrowings from banks and other lenders to finance our expected future acquisitions.
Long-term Liquidity and Capital Resources
On a long-term basis, our principal demands for funds will be for the acquisition of real estate and real estate-related investments and payments of tenant improvements, acquisition related costs, operating expenses, distributions and repurchases to stockholders, and interest and principal payments on current and future indebtedness. We expect to meet our long-term liquidity requirements through proceeds from cash flow from operations, borrowings on our secured credit facility, proceeds from secured or unsecured borrowings from banks or other lenders, proceeds from our Offering and funds equal to amounts reinvested in the DRIP.
We expect that substantially all cash flows from operations will be used to pay distributions to our stockholders after certain capital expenditures; however, we have used, and may continue to use other sources to fund distributions, as necessary, such as proceeds from our Offering, borrowings on our secured credit facility and/or future borrowings on unencumbered assets. To the extent cash flows from operations are lower due to fewer properties being acquired or lower-than-expected returns on the properties held, distributions paid to stockholders may be lower. We expect that substantially all net cash flows from our Offering or debt financings will be used to fund acquisitions, certain capital expenditures identified at acquisition, repayments of outstanding debt or distributions to our stockholders in excess of cash flows from operations.
Capital Expenditures
We estimate that we will require approximately $42.4 million in expenditures for capital improvements over the next 12 months. We cannot provide assurances, however, that actual expenditures will not exceed these estimated expenditure levels. As of June 30, 2016, we had $4.4 million of restricted cash in escrow reserve accounts for such capital expenditures. In addition, as of June 30, 2016, we had approximately $35.6 million in cash and cash equivalents. For the six months ended June 30, 2016, we had capital expenditures of $2.1 million that primarily related to four healthcare real estate investments.
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Credit Facility
On December 22, 2015, we amended certain agreements related to our secured credit facility to add certain lenders and to increase the maximum commitments available under the secured credit facility from $180,000,000 to an aggregate of up to $265,000,000, consisting of a $240,000,000 revolving line of credit, with a maturity date of December 22, 2018, subject to our Operating Partnership's right to two, 12-month extension periods, and a $25,000,000 term loan, with a maturity date of December 22, 2019, subject to our Operating Partnership's right to one, 12-month extension. The proceeds of loans made under the secured credit facility may be used to finance the acquisition of real estate investments, for tenant improvements and leasing commissions with respect to real estate, for repayment of indebtedness, for capital expenditures with respect to real estate and for general corporate and working capital purposes. The secured credit facility can be increased to $550,000,000, subject to certain conditions. See Note 8—"Credit Facility" to the condensed consolidated financial statements that are part of this Quarterly Report on Form 10-Q.
As of June 30, 2016, we had a total pool availability under the secured credit facility of $233,778,000 and an aggregate outstanding principal balance of $95,000,000. As of June 30, 2016, $138,778,000 remained available to be drawn on the secured credit facility.
Cash Flows
Six Months Ended June 30, | ||||||||||||
(in thousands) | 2016 | 2015 | Change | |||||||||
Net cash provided by operating activities | $ | 9,061 | $ | 1,024 | $ | 8,037 | ||||||
Net cash used in investing activities | $ | (165,621 | ) | $ | (125,098 | ) | $ | (40,523 | ) | |||
Net cash provided by financing activities | $ | 160,946 | $ | 157,650 | $ | 3,296 | ||||||
Operating Activities
• | Net cash provided by operating activities increased due to annual rental increases at our same store properties and the acquisition of our new operating properties, partially offset by increased operating expenses. |
Investing Activities
• | Net cash used in investing activities increased primarily due to an increase in investments in real estate of $37.7 million, and increase in escrow funds of $2.5 million and an increase in capital expenditures of $1.9 million, offset by a decrease in real estate deposits of $1.6 million. |
Financing Activities
• | Net cash provided by financing activities increased primarily due to an increase in proceeds from our secured credit facility of $43.0 million and a decrease in offering costs related to the issuance of common stock of $9.2 million, offset by a decrease in proceeds from the issuance of common stock of $41.5 million, an increase in distributions to our stockholders of $5.8 million, an increase in repurchases of our common stock of $1.1 million and an increase in payments on our secured credit facility of $0.5 million. |
Distributions
The amount of distributions payable to our stockholders is determined by our board of directors and is dependent on a number of factors, including our funds available for distribution, financial condition, capital expenditure requirements and the annual distribution requirements needed to maintain our status as a REIT under the Code. Our board of directors must authorize each distribution and may, in the future, authorize lower amounts of distributions or not authorize additional distributions and, therefore, distribution payments are not guaranteed. Our Advisor may also defer, suspend and/or waive fees and expense reimbursements if we have not generated sufficient cash flow from our operations and other sources to fund distributions. Additionally, our organizational documents permit us to pay distributions from unlimited amounts of any source, and we may use sources other than operating cash flows to fund distributions, including proceeds from our Offering, which may reduce the amount of capital we ultimately invest in properties or other permitted investments.
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We have funded distributions with operating cash flows from our properties, proceeds raised in our Offering and reinvestments pursuant to the DRIP. 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 paid during the six months ended June 30, 2016 and 2015 (amounts in thousands):
Six Months Ended June 30, | |||||||||||
2016 | 2015 | ||||||||||
Distributions paid in cash - common stockholders | $ | 7,493 | $ | 1,740 | |||||||
Distributions reinvested (shares issued) | 10,096 | 2,731 | |||||||||
Total distributions | $ | 17,589 | $ | 4,471 | |||||||
Source of distributions: | |||||||||||
Cash flows provided by operations (1) | $ | 7,493 | 43% | $ | 1,024 | 23% | |||||
Offering proceeds from issuance of common stock (1) | — | —% | 716 | 16% | |||||||
Offering proceeds from issuance of common stock pursuant to the DRIP (1) | 10,096 | 57% | 2,731 | 61% | |||||||
Total sources | $ | 17,589 | 100% | $ | 4,471 | 100% | |||||
(1) | Percentages were calculated by dividing the respective source amount by the total sources of distributions. |
Total distributions declared but not paid on Class A shares and Class T shares as of June 30, 2016 were approximately $3,444,000 for common stockholders. These distributions were paid on July 1, 2016.
For the six months ended June 30, 2016, we declared and paid distributions of approximately $17,589,000 to Class A stockholders and Class T stockholders, including shares issued pursuant to the DRIP, as compared to FFO (as defined below) for the six months ended June 30, 2016 of approximately $11,609,000. The payment of distributions from sources other than FFO may reduce the amount of proceeds available for investment and operations or cause us to incur additional interest expense as a result of borrowed funds.
For a discussion of distributions paid subsequent to June 30, 2016, see Note 17—"Subsequent Events" to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Contractual Obligations
Our contractual obligations as of June 30, 2016 were as follows (amounts in thousands):
Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | Total | |||||||||||||||
Principal payments—variable rate debt fixed through interest rate swap (1) | $ | — | $ | — | $ | 25,000 | $ | — | $ | 25,000 | |||||||||
Interest payments—variable rate debt fixed through interest rate swap (2) | 608 | 1,383 | 332 | — | 2,323 | ||||||||||||||
Principal payments—variable rate debt | — | 70,000 | — | — | 70,000 | ||||||||||||||
Interest payments—variable rate debt | 1,414 | 2,443 | — | — | 3,857 | ||||||||||||||
Capital expenditures | 42,357 | 7,589 | — | — | 49,946 | ||||||||||||||
Total | $ | 44,379 | $ | 81,415 | $ | 25,332 | $ | — | $ | 151,126 | |||||||||
(1) | As of June 30, 2016, we had $25.0 million outstanding principal under the secured credit facility that was fixed through the use of an interest rate swap agreement. |
(2) | We used the fixed rate under our interest rate swap agreement as of June 30, 2016 to calculate the debt payment obligations in future periods. |
Off-Balance Sheet Arrangements
As of June 30, 2016, we had no off-balance sheet arrangements.
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Related-Party Transactions and Arrangements
We have entered into agreements with our Advisor and its affiliates, whereby we agree to pay certain fees to, or reimburse certain expenses of, our Advisor or its affiliates for acquisition fees and expenses, organization and offering expenses, asset and property management fees and reimbursement of operating costs. Refer to Note 11—"Related-Party Transactions and Arrangements" to our condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q for a detailed discussion of the various related-party transactions and agreements.
Funds from Operations and Modified Funds from Operations
One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. The purchase of real estate assets and real estate-related investments, and the corresponding expenses associated with that process, is a key operational feature of our business plan in order to generate cash from operations. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group, has promulgated a measure known as funds from operations, or FFO, which we believe is an appropriate supplemental measure to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental performance measure. FFO is not equivalent to our net income (loss) as determined under GAAP.
We define FFO, consistent with NAREIT’s definition, as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales of property and asset impairment write-downs, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnership and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect FFO on the same basis.
We, along with others in the real estate industry, consider FFO to be an appropriate supplemental measure of a REIT’s operating performance because it is based on a net income (loss) analysis of property portfolio performance that excludes non-cash items such as depreciation and amortization and asset impairment write-downs, which we believe provides a more complete understanding of our performance to investors and to our management, and when compared year over year, reflects the impact on our operations from trends in occupancy.
Historical accounting convention (in accordance with GAAP) for real estate assets requires companies to report its investment in real estate at its carrying value, which consists of capitalizing the cost of acquisitions, development, construction, improvements and significant replacements, less depreciation and amortization and asset impairment write-downs, if any, which is not necessarily equivalent to the fair market value of its investment in real estate assets.
The historical accounting convention requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, which could be the case if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or as requested or required by lessees for operational purposes in order to maintain the value disclosed. We believe that, since the fair value of real estate assets historically rises and falls with market conditions including, but not limited to, inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using historical accounting for depreciation could be less informative.
In addition, we believe it is appropriate to disregard asset impairment write-downs as they are a non-cash adjustment to recognize losses on prospective sales of real estate assets. Since losses from sales of real estate assets are excluded from FFO, we believe it is appropriate that asset impairment write-downs in advancement of realization of losses should be excluded. Impairment write-downs are based on negative market fluctuations and underlying assessments of general market conditions, which are independent of our operating performance, including, but not limited to, a significant adverse change in the financial condition of our tenants, changes in supply and demand for similar or competing properties, changes in tax, real estate, environmental and zoning law, which can change over time. When indicators of potential impairment suggest that the carrying value of real estate and related assets may not be recoverable, we assess the recoverability by estimating whether we will recover the carrying value of the asset through undiscounted future cash flows and eventual disposition (including, but not limited to, net rental and lease revenues, net proceeds on the sale of property and any other ancillary cash flows at a property or group level under GAAP). If based on this analysis, we do not believe that we will be able to recover the carrying value of the real estate asset, we will record an impairment write-down to the extent that the carrying value exceeds the estimated fair value of the real estate asset. Testing for indicators of impairment is a continuous process and is analyzed on a quarterly basis. 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 FFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and that we intend to have a relatively limited term of our operations, it could be difficult to recover any impairment charges through the eventual sale of the property. No impairment losses have been recorded to date.
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In developing estimates of expected future cash flow, we make certain assumptions regarding future market rental income amounts subsequent to the expiration of current lease arrangements, property operating expenses, terminal capitalization and discount rates, the expected number of months it takes to re-lease the property, required tenant improvements and the number of years the property will be held for investment. The use of alternative assumptions in the future cash flow analysis could result in a different determination of the property’s future cash flows and a different conclusion regarding the existence of an asset impairment, the extent of such loss, if any, as well as the carrying value of the real estate asset.
Publicly registered, non-listed REITs, such as us, typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operations. While other start up entities may also experience significant acquisition activity during their initial years, we believe that publicly registered, 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. We will use the proceeds raised in our offering to acquire real estate assets and real estate-related investments, and we intend to begin the process of achieving a liquidity event (i.e., listing of our shares of common stock on a national securities exchange, a merger or sale, the sale of all or substantially all of our assets, or another similar transaction) within five to seven years after the completion of our offering stage, which is generally comparable to other publicly registered, non-listed REITs. Thus, we do not intend to continuously purchase real estate assets and intend to have a limited life. Due to these factors and other unique features of publicly registered, non-listed REITS, the Investment Program Association, or the IPA, an industry trade group, has standardized a measure known as modified funds from operations, or MFFO, which we believe to be another appropriate supplemental measure to reflect the operating performance of a publicly registered, non-listed REIT. MFFO is a metric used by management to evaluate sustainable performance and dividend policy. MFFO is not equivalent to our net income (loss) as determined under GAAP.
We define MFFO, a non-GAAP measure, consistent with the IPA’s definition: FFO further adjusted for the following items included in the determination of GAAP net income (loss); acquisition fees and expenses; amounts related to straight-line rental income and amortization of above and below intangible lease assets and liabilities; accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income (loss); 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, adjustments related to contingent purchase price obligations where such adjustments have been included in the derivation of GAAP net income (loss), and after adjustments for a consolidated and unconsolidated partnership and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. Our MFFO calculation complies with the IPA’s Practice Guideline, described above. In calculating MFFO, we exclude paid and accrued acquisition fees and expenses that are reported in our condensed consolidated statements of comprehensive income (loss), amortization of above and below-market leases, amounts related to straight-line rents (which are adjusted in order to reflect such payments from a GAAP accrual basis to closer to an expected to be received cash basis of disclosing the rent and lease payments), ineffectiveness of interest rate swap; and the adjustments of such items related to noncontrolling interests in our Operating Partnership. The other adjustments included in the IPA’s guidelines are not applicable to us.
Since MFFO excludes acquisition fees and expenses, it should not be construed as a historic performance measure. Acquisition fees and expenses are paid in cash by us, and we have not set aside or put into escrow any specific amount of proceeds from our offerings to be used to fund acquisition fees and expenses. Acquisition fees and expenses include payments to our Advisor or its affiliates and third parties. Such fees and expenses will not be reimbursed by our Advisor or its affiliates and third parties, and therefore if there are no further proceeds from the sale of shares of our common stock to fund future acquisition fees and expenses, such fees and expenses will need to be paid from either additional debt, operational earnings or cash flows, net proceeds from the sale of properties, or from ancillary cash flows. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds. Nevertheless, our Advisor or its affiliates will not accrue any claim on our assets if acquisition fees and expenses are not paid from the proceeds of our offerings. Under GAAP, acquisition fees and expenses related to the acquisition of properties determined to be business combinations are expensed as incurred, including investment transactions that are no longer under consideration, and are included in acquisition related expenses in the accompanying condensed consolidated statements of comprehensive income (loss) and acquisition fees and expenses associated with transactions determined to be an asset purchase are capitalized.
All paid and accrued acquisition fees and expenses have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the real estate asset, these fees and expenses and other costs related to such property. In addition, MFFO may not be an indicator of our operating performance, especially during periods in which properties are being acquired.
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In addition, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income (loss) in determining cash flows from operations in accordance with GAAP.
We use MFFO and the adjustments used to calculate it in order to evaluate our performance against other publicly registered, non-listed REITs, which intend to have limited lives with short and defined acquisition periods and targeted exit strategies shortly thereafter. As noted above, MFFO may not be a useful measure of the impact of long-term operating performance if we do not continue to operate in this manner. We believe that our use of MFFO and the adjustments used to calculate it allow us to present our performance in a manner that reflects certain characteristics that are unique to publicly registered, non-listed REITs, such as their limited life, limited and defined acquisition period and targeted exit strategy, and hence the use of such measures may be useful to investors. For example, acquisition fees and expenses are intended to be funded from the proceeds of our offering and other financing sources and not from operations. By excluding acquisition fees and expenses, the use of MFFO provides information consistent with management’s analysis of the operating performance of its real estate assets. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such charges that may reflect anticipated and unrealized gains or losses, we believe MFFO provides useful supplemental information.
Presentation of this information is intended to assist management and investors in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) as an indication of our performance, as an indication of our liquidity, or indicative of funds available for our cash needs, including our ability to make distributions to our stockholders. FFO and MFFO should be reviewed in conjunction with other measurements as an indication of our performance. MFFO has limitations as a performance measure in an offering such as ours where the price of a share of common stock is stated value and there is no asset value determination during the offering stage and for a period thereafter. MFFO may be useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete and net asset value is disclosed. MFFO is not a useful measure in evaluating net asset value since impairment write-downs are taken into account in determining net asset value but not in determining MFFO.
FFO and MFFO, as described above, should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income (loss) or in its applicability in evaluating our operational performance. The method used to evaluate the value and performance of real estate under GAAP should be construed as a more relevant measure of operation performance and considered more prominently than the non-GAAP FFO and MFFO measures and the adjustments to GAAP in calculating FFO and MFFO. MFFO has not been scrutinized to the level of other similar non-GAAP performance measures by the SEC or any other regulatory body.
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The following is a reconciliation of net income (loss) attributable to common stockholders, which is the most directly comparable GAAP financial measure, to FFO and MFFO for the three and six months ended June 30, 2016 and 2015 (amounts in thousands, except share data and per share amounts):
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2016 | 2015 | 2016 | 2015 | ||||||||||||
Net income (loss) attributable to common stockholders | $ | 1,833 | $ | (1,885 | ) | $ | 3,443 | $ | (2,164 | ) | |||||
Adjustments: | |||||||||||||||
Depreciation and amortization | 4,300 | 926 | 8,166 | 1,610 | |||||||||||
FFO attributable to common stockholders | $ | 6,133 | $ | (959 | ) | $ | 11,609 | $ | (554 | ) | |||||
Adjustments: | |||||||||||||||
Acquisition related expenses (1) | $ | 1,946 | $ | 2,811 | $ | 3,611 | $ | 3,527 | |||||||
Amortization of intangible assets and liabilities (2) | (124 | ) | — | (249 | ) | 6 | |||||||||
Straight-line rents (3) | (1,533 | ) | (432 | ) | (2,699 | ) | (747 | ) | |||||||
Ineffectiveness of interest rate swap | 22 | — | 22 | — | |||||||||||
MFFO attributable to common stockholders | $ | 6,444 | $ | 1,420 | $ | 12,294 | $ | 2,232 | |||||||
Weighted average common shares outstanding - basic | 63,514,780 | 24,058,949 | 58,591,709 | 17,869,872 | |||||||||||
Weighted average common shares outstanding - diluted | 63,530,999 | 24,058,949 | 58,608,490 | 17,869,872 | |||||||||||
Net income (loss) per common share - basic | $ | 0.03 | $ | (0.08 | ) | $ | 0.06 | $ | (0.12 | ) | |||||
Net income (loss) per common share - diluted | $ | 0.03 | $ | (0.08 | ) | $ | 0.06 | $ | (0.12 | ) | |||||
FFO per common share - basic | $ | 0.10 | $ | (0.04 | ) | $ | 0.20 | $ | (0.03 | ) | |||||
FFO per common share - diluted | $ | 0.10 | $ | (0.04 | ) | $ | 0.20 | $ | (0.03 | ) | |||||
(1) | In evaluating investments in real estate assets, management differentiates the costs to acquire the investment from the operations derived from the investment. Such information would be comparable only for publicly registered, non-listed REITs that have completed their acquisitions activities and have other similar operating characteristics. By excluding expensed acquisition related expenses, management believes MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management’s analysis of the investing and operating performance of our properties. Acquisition fees and expenses include payments in cash to our Advisor and third parties. Acquisition fees and expenses incurred in a business combination, under GAAP, are considered operating expenses and as expenses are included in the determination of net income (loss), which is a performance measure under GAAP. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to the property. |
(2) | Under GAAP, certain intangibles are accounted for at cost and reviewed at least annually for impairment, and certain intangibles are assumed to diminish predictably in value over time and are amortized, similar to depreciation and amortization of real estate-related assets that are excluded from FFO. However, because real estate values and market lease rates historically rise or fall with market conditions, management believes that by excluding charges related to amortization of these intangibles, MFFO provides useful supplemental information on the performance of the real estate. |
(3) | Under GAAP, rental revenue is recognized on a straight-line basis over the terms of the related lease (including rent holidays if applicable). This may result in income recognition that is significantly different than the underlying contract terms. By adjusting for the change in deferred rent receivables, MFFO may provide useful supplemental information on the realized economic impact of lease terms, providing insight on the expected contractual cash flows of such lease terms, and aligns with our analysis of operating performance. |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market risk includes 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, the primary market risk to which we are exposed is interest rate changes, primarily as a result of long-term debt used to acquire properties and make loans and other permitted investments. We manage our interest rate risk by limiting the impact of interest rate changes on earnings, prepayment penalties and cash flows, and by lowering overall borrowing costs while taking into account variable interest rate risk. To achieve our objectives, we may borrow at fixed or variable rates.
We have entered, and may continue to enter, into derivative financial instruments, such as interest rate swaps, in order to mitigate our interest rate risk on a given variable rate financial instrument. To the extent we do, we are exposed to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative contract is negative, we owe the counterparty and, therefore, it does not possess credit risk. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We manage the market risk associated with interest rate contracts by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. We have not entered, and do not intend to enter, into derivative or interest rate transactions for speculative purposes. We may also enter into rate-lock arrangements to lock interest rates on future borrowings.
In addition to changes in interest rates, the value of our future investments will be 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.
As of June 30, 2016, $70,000,000 of the $95,000,000 total principal debt outstanding related to the secured credit facility was subject to variable interest rates. As of June 30, 2016, the weighted average interest rate on such debt was 2.20%. As of June 30, 2016, an increase of 50 basis points in the market rates of interest would have resulted in a change in interest expense of approximately $350,000 per year.
As of June 30, 2016, we had one interest rate swap agreement outstanding, which matures on December 22, 2020. On June 24, 2016, we entered into the interest rate swap agreement in the amount of $25,000,000. As of June 30, 2016, the aggregate settlement liability value was $134,000. The settlement value of this interest rate swap agreement is dependent upon existing market interest rates and swap spreads. As of June 30, 2016, an increase of 50 basis points in the market rates of interest would have resulted in a settlement asset value of the interest rate swap of $401,000. This interest rate swap was designated as a hedging instrument.
We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.
Item 4. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs.
As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, we conducted an evaluation as of June 30, 2016 under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of June 30, 2016, were effective at a reasonable assurance level.
(b) Changes in internal control over financial reporting. There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the three months ended June 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are not aware of any material pending legal proceedings to which we are a party or to which our properties are the subject.
Item 1A. Risk Factors.
There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC on March 28, 2016, except as noted below.
Distributions paid from sources other than our cash flows from operations, including from the proceeds of this Offering, will result in us having fewer funds available for the acquisition of properties and other real estate-related investments, which may adversely affect our ability to fund future distributions with cash flow from operations and may adversely affect your overall return.
We have paid, and may continue to pay, distributions from sources other than from our cash flows from operations. For the six months ended June 30, 2016, our cash flows provided by operations of approximately $9.1 million was a shortfall of approximately $8.5 million, or 48.3%, of our distributions (total distributions were approximately $17.6 million, of which $7.5 million was cash and $10.1 million was reinvested in shares of our common stock pursuant to our DRIP) during such period and such shortfall was paid from proceeds from our DRIP Offering. For the year ended December 31, 2015, our cash flows provided by operations of approximately $3.3 million was a shortfall of approximately $12.7 million, or 79.5%, of our distributions (total distributions were approximately $16.0 million, of which $6.4 million was cash and $9.6 million was reinvested in shares of our common stock pursuant to our DRIP) during such period and such shortfall was paid from proceeds from our Offering. Until we acquire additional properties or other real estate-related investments, we may not generate sufficient cash flows from operations to pay distributions. Our inability to acquire additional properties or other real estate-related investments may result in a lower return on your investment than you expect.
We may pay, and have no limits on the amounts we may pay, distributions from any source, such as from borrowings, the sale of assets, the sale of additional securities, advances from our Advisor, our Advisor’s deferral, suspension and/or waiver of its fees and expense reimbursements and Offering proceeds. Funding distributions from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding distributions with the sale of assets may affect our ability to generate cash flows. Funding distributions from the sale of additional securities could dilute your interest in us if we sell shares of our common stock to third party investors. Funding distributions from the proceeds of our Offering will result in us having less funds available for acquiring properties or real estate-related investments. Our inability to acquire additional properties or real estate-related investments may have a negative effect on our ability to generate sufficient cash flow from operations from which to pay distributions. As a result, the return investors may realize on their investment may be reduced and investors who invest in us before we generate significant cash flow may realize a lower rate of return than later investors. Payment of distributions from any of the aforementioned sources could restrict our ability to generate sufficient cash flow from operations, affect our profitability and/or affect the distributions payable upon a liquidity event, any or all of which may have an adverse effect on an investment in us.
A high concentration of our properties in a particular geographic area, or of tenants in a similar industry, would magnify the effects of downturns in that geographic area or industry.
As of June 30, 2016, we owned 29 real estate investments, located in 23 metropolitan statistical areas, or MSAs, and one micropolitan statistical area, of which four MSAs accounted for 10.0% or more of our contractual rental revenue. Real estate investments located in the Houston-The Woodlands-Sugar Land, Texas MSA, the Oklahoma City, Oklahoma MSA, the Dallas-Fort Worth-Arlington, Texas MSA, and the Cincinnati, Ohio-Kentucky-Indiana MSA accounted for 15.3%, 12.8%, 12.5%, and 10.1%, respectively, of our contractual rental revenue for the six months ended June 30, 2016. In the event that we have a concentration of properties in any particular geographic area, any adverse situation that disproportionately effects that geographic area would have a magnified adverse effect on our portfolio. Similarly, if tenants of our properties become 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 June 30, 2016, the Company had one tenant's exposure concentration that accounted for 10.0% or more of rental revenue. The leases with tenants under common control of the guarantor Post Acute Medical, LLC accounted for 13.2% of rental revenue for the six months ended June 30, 2016.
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Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to pay distributions to our stockholders.
As of June 30, 2016, we had $25.0 million of fixed interest rate principal outstanding fixed through interest rate swap and $70.0 million of variable rate principal outstanding. As of June 30, 2016, our weighted average interest rate was 2.32%. Increases in interest rates would increase our interest costs, if we obtain additional variable rate debt, which could reduce our cash flows and our ability to pay distributions to you. 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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Unregistered Sales of Equity Securities
On June 24, 2016, we granted an aggregate of 9,000 shares of restricted Class A common stock under our 2014 Restricted Share Plan to our three independent directors in connection with such independent directors’ re-election to our board of directors. Each independent director received 3,000 shares of restricted Class A common stock. The shares were not registered under the Securities Act and were issued in reliance on Section 4(2) of the Securities Act. There were no other sales of unregistered securities during the three months ended June 30, 2016.
Use of Public Offering Proceeds
On May 29, 2014, our Registration Statement on Form S-11 (File No. 333-191706), covering a public offering of up to $2,350,000,000 in shares of our common stock, was declared effective under the Securities Act. We are offering for sale a maximum of $2,250,000,000 in shares of common stock (exclusive of $100,000,000 in shares of common stock to be made available pursuant to our DRIP) in our primary offering on a “best efforts” basis. We are offering shares of Class A common stock and shares of Class T common stock, in any combination with a dollar value up to the maximum offering amount. The initial offering price for the shares in the primary offering is $10.00 per Class A share and $9.574 per Class T share. The purchase price for shares in our DRIP is $9.50 per Class A share and $9.095 per Class T share.
As of June 30, 2016, we had received subscriptions for and issued approximately 68,168,000 shares of our Class A and Class T common stock (including shares of common stock issued pursuant to the DRIP) for gross proceeds of approximately $674,158,000 (before selling commissions, dealer manager fees and distribution and servicing fees of approximately $62,625,000 and other offering costs of approximately $13,184,000). As of June 30, 2016, from the net offering proceeds, we had paid approximately $13,489,000 in acquisition fees to our Advisor, approximately $4,457,000 in acquisition costs and approximately $14,032,000 in cash distributions to our stockholders. With the remaining net offering proceeds and proceeds from our secured credit facility, we had acquired $624,861,000 in total real estate investments as of June 30, 2016.
As of June 30, 2016, approximately $3,396,000 remained payable to our Dealer Manager and our Advisor or its affiliates for costs related to our Offering.
Share Repurchase Program
Our share repurchase program permits stockholders to sell their shares back to us after they have held them for at least one year, subject to certain conditions and limitations. We will limit the number of shares repurchased during any calendar year to 5.0% of the number of shares of our common stock outstanding on December 31st of the previous calendar year. In addition, the share repurchase program provides that all redemptions during any calendar year, including those upon death or a qualifying disability of a stockholder, are limited to those that can be funded with proceeds raised from the DRIP Offering during the prior calendar year and other operating funds, if any, as the board of directors, in its sole discretion, may reserve for this purpose. Our board of directors has the right, in its sole discretion, to waive such holding requirement in the event of the death or qualifying disability of a stockholder, or other involuntary exigent circumstances, such as bankruptcy, or a mandatory requirement under a stockholder’s IRA.
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During the three months ended June 30, 2016, we fulfilled the following repurchase requests pursuant to our share repurchase program:
Period | Total Number of Shares Repurchased | Average Price Paid per Share | Total Numbers of Shares Purchased as Part of Publicly Announced Plans and Programs | Approximate Dollar Value of Shares Available that may yet be Repurchased under the Program | ||||||||||
04/01/2016 - 04/30/2016 | 42,484 | $ | 9.84 | 42,484 | $ | — | ||||||||
05/01/2016 - 05/31/2016 | 17,719 | $ | 9.43 | 17,719 | $ | — | ||||||||
06/01/2016 - 06/30/2016 | 22,468 | $ | 9.40 | 22,468 | $ | — | ||||||||
Total | 82,671 | 82,671 | ||||||||||||
During the three months ended June 30, 2016, we repurchased approximately $797,000 of Class A shares of common stock, which represented all repurchase requests received in good order and eligible for repurchase through the June 30, 2016 repurchase date. No shares of Class T common stock were repurchased during the three months ended June 30, 2016 and 2015. During the three months ended June 30, 2015, no Class A shares were repurchased under the share repurchase program.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits.
The exhibits listed on the Exhibit Index (following the signatures section of this Quarterly Report on Form 10-Q) are filed herewith, or incorporated by reference.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CARTER VALIDUS MISSION CRITICAL REIT II, INC. | |||
(Registrant) | |||
Date: August 15, 2016 | By: | /s/ JOHN E. CARTER | |
John E. Carter | |||
Chief Executive Officer | |||
(Principal Executive Officer) | |||
Date: August 15, 2016 | By: | /s/ TODD M. SAKOW | |
Todd M. Sakow | |||
Chief Financial Officer | |||
(Principal Financial Officer and Principal Accounting Officer) | |||
EXHIBIT INDEX
Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index immediately precedes the exhibits.
The following exhibits are included, or incorporated by reference, in this Quarterly Report on Form 10-Q for the six months ended June 30, 2016 (and are numbered in accordance with Item 601 of Regulation S-K).
Exhibit No: | ||
3.1 | Second Articles of Amendment and Restatement of Carter Validus Mission Critical REIT II, Inc. (included as Exhibit 3.1 to Post-Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-11 (File No. 333-191706) filed June 12, 2014, and incorporated herein by reference). | |
3.2 | Amended and Restated Bylaws of Carter Validus Mission Critical REIT II, Inc. (included as Exhibit 3.2 to Pre-Effective Amendment No. 3 to the Registrant’s Registration Statement on Form S-11 (File No. 333-191706) filed May 9, 2014, and incorporated herein by reference). | |
4.1 | Subscription Agreement (included as Appendix B to the Registrant's final prospectus filed pursuant to Rule 424(b)(3), filed on April 28, 2016 (File No. 333-191706), and incorporated herein by reference). | |
4.2 | Additional Subscription Agreement (included as Appendix C to the Registrant's final prospectus filed pursuant to Rule 424(b)(3), filed on April 28, 2016 (File No. 333-191706), and incorporated herein by reference). | |
4.3 | Automatic Purchase Program Enrollment Form (included as Appendix D to the the Registrant's final prospectus filed pursuant to Rule 424(b)(3), filed on April 28, 2016 (File No. 333-191706), and incorporated herein by reference). | |
4.4 | Amended and Restated Distribution Reinvestment Plan (included as Appendix E to the Registrant's final prospectus filed pursuant to Rule 424(b)(3), filed on April 28, 2016 (File No. 333-191706), and incorporated herein by reference). | |
4.5 | Form of Multi-Product Subscription Agreement (included as Appendix F to the Registrant's final prospectus filed pursuant to Rule 424(b)(3), filed on April 28, 2016 (File No. 333-191706), and incorporated herein by reference). | |
10.1 | Joinder Agreement, dated June 1, 2016, by HCII HPI-3115 SW 89TH STREET, LLC, DCII-5225 EXCHANGE DRIVE, LLC, and DCII-3255 NEIL ARMSTRONG BOULEVARD, LLC to KeyBank National Association, as Agent (included as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 000-55435), filed on June 3, 2016, and incorporated herein by reference). | |
31.1* | Certification of Chief Executive Officer of the Company pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2* | Certification of Chief Financial Officer of the Company pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1** | Certification of Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2** | Certification of Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document | |
* | Filed herewith. |
** | Furnished herewith in accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act, except to the extent that the registrant specifically incorporates it by reference. |