Strategic Realty Trust, Inc. - Annual Report: 2018 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(Mark One)
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2018
OR
o | 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 000-54376
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STRATEGIC REALTY TRUST, INC.
(Exact name of registrant as specified in its charter)
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Maryland | 90-0413866 |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
66 Bovet Road, Suite 100 San Mateo, California, 94402 | (650) 343-9300 |
(Address of Principal Executive Offices; Zip Code) | (Registrant’s Telephone Number, Including Area Code) |
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Securities registered pursuant to Section 12(b) of the Act: | ||||
Title of Each Class | Name of Each Exchange on Which Registered | |||
None | None | |||
Securities registered pursuant to Section 12(g) of the Act: | ||||
Common Stock, $0.01 par value per share | ||||
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Indicate by check mark whether the registrant is a well-known season issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No ý
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No ý
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment of this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | ¨ |
Non-accelerated filer | ý | Smaller reporting company | ý |
Emerging growth company | ¨ | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
There is no established trading market for the registrant’s common stock. On August 1, 2018, the registrant’s board of directors approved an estimated value per share of the registrant’s common stock of $6.04 per share based on estimated value of the registrant’s real estate assets and the estimated value of the registrant’s tangible other assets less the estimated value of the registrant’s liabilities divided by the number of shares and operating partnership units outstanding, as of April 30, 2018. For a full description of the methodologies used to value the registrant’s assets and liabilities in connection with the calculation of the estimated value per share as of April 30, 2018, see Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Market Information” of this Annual Report on Form 10-K.
As of June 30, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, 10,705,977 shares of its common stock were held by non-affiliates.
As of March 18, 2019, there were 10,863,299 shares of the registrant’s common stock issued and outstanding.
Documents Incorporated by Reference: Registrant incorporates by reference in Part III (Items 10, 11, 12, 13 and 14) of this Form 10-K portions of its Definitive Proxy Statement for its 2019 Annual Meeting of Stockholders.
STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page | ||
PART I | ||
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
PART III | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
PART IV | ||
Item 15. | ||
Special Note Regarding Forward-Looking Statements
Certain statements included in this Annual Report on Form 10-K that are not historical facts (including any statements concerning investment objectives, other plans and objectives of management for future operations or economic performance, or assumptions or forecasts related thereto) are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements are only predictions. We caution that forward-looking statements are not guarantees. Actual events or our investments and results of operations could differ materially from those expressed or implied in any forward-looking statements. Forward-looking statements are typically identified by the use of terms such as “may,” “should,” “expect,” “could,” “intend,” “plan,” “anticipate,” “estimate,” “believe,” “continue,” “predict,” “potential” or the negative of such terms and other comparable terminology.
The forward-looking statements included herein are based upon our current expectations, plans, estimates, assumptions and beliefs, which involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. The following are some of the risks and uncertainties, although not all of the risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:
• | Our executive officers and certain other key real estate professionals are also officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor. As a result, they face conflicts of interest, including conflicts created by our advisor’s compensation arrangements with us and conflicts in allocating time among us and other programs and business activities. |
• | We are uncertain of our sources for funding our future capital needs. If we cannot obtain debt or equity financing on acceptable terms, our ability to continue to acquire real properties or other real estate-related assets, fund or expand our operations and pay distributions to our stockholders will be adversely affected. |
• | We depend on tenants for our revenue and, accordingly, our revenue is dependent upon the success and economic viability of our tenants. Revenues from our properties could decrease due to a reduction in tenants (caused by factors including, but not limited to, tenant defaults, tenant insolvency, early termination of tenant leases and non-renewal of existing tenant leases) and/or lower rental rates, making it more difficult for us to meet our financial obligations, including debt service and our ability to pay distributions to our stockholders. |
• | A significant portion of our assets are concentrated in one geographic area and in urban retail properties, any adverse economic, real estate or business conditions in this geographic area or in the urban retail market could affect our operating results and our ability to pay distributions to our stockholders. |
• | Our current and future investments in real estate and other real estate-related investments may be affected by unfavorable real estate market and general economic conditions, which could decrease the value of those assets and reduce the investment return to our stockholders. Revenues from our properties could decrease. Such events would make it more difficult for us to meet our debt service obligations and limit our ability to pay distributions to our stockholders. |
• | Certain of our debt obligations have variable interest rates with interest and related payments that vary with the movement of LIBOR or other indices. Increases in these indices could increase the amount of our debt payments and limit our ability to pay distributions to our stockholders. |
All forward-looking statements should be read in light of the risks identified in Part I, Item 1A of this Annual Report. Any of the assumptions underlying the forward-looking statements included herein could be inaccurate, and undue reliance should not be placed upon on any forward-looking statements included herein. All forward-looking statements are made as of the date of this Annual Report, and the risk that actual results will differ materially from the expectations expressed herein will increase with the passage of time. Except as otherwise required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements made after the date of this Annual Report, whether as a result of new information, future events, changed circumstances or any other reason. In light of the significant uncertainties inherent in the forward-looking statements included in this Annual Report, and the risks described in Part I, Item 1A, the inclusion of such forward-looking statements should not be regarded as a representation by us or any other person that the objectives and plans set forth in this Annual Report will be achieved.
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PART I
ITEM 1. BUSINESS
Overview
Strategic Realty Trust, Inc., is a Maryland corporation formed on September 18, 2008 to invest in and manage a portfolio of income-producing retail properties, located in the United States, real estate-owning entities and real estate-related assets, including the investment in or origination of mortgage, mezzanine, bridge and other loans related to commercial real estate. We have elected to be taxed as a real estate investment trust, or REIT, for federal income tax purposes, commencing with the taxable year ended December 31, 2009. As used herein, the terms “we” “our” “us” and “Company” refer to Strategic Realty Trust, Inc., and, as required by context, Strategic Realty Operating Partnership, L.P., a Delaware limited partnership, which we refer to as our “operating partnership” or “OP”, and to their respective subsidiaries. References to “shares” and “our common stock” refer to the shares of our common stock. We own substantially all of our assets and conduct our operations through our operating partnership, of which we are the sole general partner. We also own a majority of the outstanding limited partner interests in the operating partnership.
On November 4, 2008, we filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to offer a maximum of 100,000,000 shares of our common stock to the public in our primary offering at $10.00 per share and up to 10,526,316 shares of our common stock to our stockholders at $9.50 per share pursuant to our distribution reinvestment plan (“DRIP”) (collectively, the “Offering”). On August 7, 2009, the SEC declared the registration statement effective and we commenced the Offering. On February 7, 2013, we terminated the Offering and ceased offering shares of common stock in the primary offering and under the DRIP.
As of February 2013 when we terminated the Offering, we had accepted subscriptions for, and issued, 10,688,940 shares of common stock in the Offering for gross offering proceeds of approximately $104.7 million, and 391,182 shares of common stock pursuant to the DRIP for gross offering proceeds of approximately $3.6 million. We have also granted 50,000 shares of restricted stock and we issued 273,729 shares of common stock to pay a portion of a special distribution on November 4, 2015.
On April 1, 2015, our board of directors approved the reinstatement of the share redemption program and adopted the Amended and Restated Share Redemption Program (the “SRP”). The program was previously suspended, effective as of January 15, 2013. Under the SRP, only shares submitted for repurchase in connection with the death or “qualifying disability” (as defined in the SRP) of a stockholder are eligible for repurchase by us. For more information regarding our share redemption program, refer to Part II, Item 5, “Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities - Share Redemption Program.” Cumulatively, through December 31, 2018, pursuant to the Original Share Redemption Program and the SRP, we have redeemed 737,255 shares of common stock sold in the Offering and/or the DRIP for approximately $5.3 million.
Since our inception, our business has been managed by an external advisor. We do not have direct employees and all management and administrative personnel responsible for conducting our business are employed by our advisor. Currently we are externally managed and advised by SRT Advisor, LLC, a Delaware limited liability company (the “Advisor”) pursuant to an advisory agreement with the Advisor (the “Advisory Agreement”) initially executed on August 10, 2013, and subsequently renewed every year through 2018. The current term of the Advisory Agreement terminates on August 10, 2019. The Advisor is an affiliate of Glenborough, LLC (together with its affiliates, “Glenborough”), a privately held full-service real estate investment and management company focused on the acquisition, management and leasing of commercial properties.
Our office is located at 66 Bovet Road, Suite 100, San Mateo, California 94402, and our main telephone number is (650) 343-9300.
Investment Objectives
Our investment objectives are to:
• | preserve, protect and return stockholders’ capital contributions; |
• | pay predictable and sustainable cash distributions to stockholders; and |
• | realize capital appreciation upon the ultimate sale of the real estate assets. |
Business Strategy
On February 7, 2013, as a result of the termination of the Offering, we ceased offering shares of our common stock in our primary offering and under our DRIP. Additionally, in March 2013, we filed an application with the SEC to withdraw our registration statement on Form S-11 for a contemplated follow-on public offering of our common stock. Prior to the termination
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of the Offering, we funded our investments in real properties and other real-estate related assets primarily with the proceeds from the Offering and debt financing. Since the termination of the Offering, we intend to fund our future cash needs, including any future investments, with debt financing, cash from operations, proceeds to us from asset sales, cash flows from investments in joint ventures and the proceeds from any offerings of our securities that we may conduct in the future. As a result of the termination of the Offering and the resulting decrease in our capital resources, we expect our investment activity to be reduced until we are able to engage in an offering of our securities or are able to identify other significant sources of financing.
We intend to continue to focus on investments in income-producing retail properties. Specifically, we are focused on acquiring high quality urban retail properties in major west coast markets and building a joint venture platform with institutional investors to invest in value–add retail properties. Our investments may include urban store front retail buildings, free standing single tenant buildings, neighborhood, community, power and lifestyle shopping centers, and multi-tenant shopping centers. We may also invest in real estate loans or real estate-related assets that we believe meet our investment objectives. Our near term goal continues to be the recycling of the portfolio that was held in 2013 when the Advisor first began providing services to us pursuant to the Advisory Agreement by selling the remaining legacy properties. As of December 31, 2018, Topaz Marketplace and Shops at Turkey Creek remained the only legacy properties in the portfolio. We believe that a fully recycled and focused high-quality west coast urban retail portfolio will allow us the opportunity to look at various strategic options in the future.
Investment Portfolio
As of December 31, 2018, our portfolio included eight properties, which we refer to as “our properties” or “our portfolio,” comprising an aggregate of approximately 86,000 square feet of single and multi-tenant commercial retail space located in two states, which we purchased for an aggregate purchase price of approximately $51.5 million. Refer to Item 2, “Properties” for additional information on our portfolio. In addition to the properties, in 2015 we invested in two joint ventures with an institutional partner. These ventures acquired two portfolios comprising 19 properties and approximately 1,447,000 square feet. As of December 31, 2018, these ventures own in aggregate, five properties, comprising an aggregate of approximately 494,000 square feet and located in three states. During the first quarter of 2016, we invested, through joint ventures, in two significant retail projects under development that are expected to be completed in June 2019 and January 2021, respectively.
Borrowing Policies
We use, and may continue to use in the future, secured and unsecured debt as a means of providing additional funds for the acquisition of real property, real estate-related loans, and other real estate-related assets. Our use of leverage increases the risk of default on loan payments and the resulting foreclosure on a particular asset. In addition, lenders may have recourse to assets other than those specifically securing the repayment of our indebtedness. As of December 31, 2018, our aggregate outstanding indebtedness, including deferred financing costs, net of accumulated amortization, totaled approximately $34.5 million, or 36.5% of the book value of our total assets.
Our aggregate borrowings, secured and unsecured, are reviewed by our board of directors at least quarterly. Under our Articles of Amendment and Restatement, as amended, which we refer to as our “charter,” we are prohibited from borrowing in excess of 300% of the value of our net assets. Net assets for purposes of this calculation is defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts and other non-cash reserves, less total liabilities. The preceding calculation is generally expected to approximate 75% of the aggregate cost of our assets before non-cash reserves and depreciation. However, we may temporarily borrow in excess of these amounts if such excess is approved by a majority of the independent directors and disclosed to stockholders in our next quarterly report, along with an explanation for such excess. As of December 31, 2018 and 2017, our borrowings were approximately 57.5% and 93.0%, respectively, of the book value of our net assets.
Our Advisor uses its best efforts to obtain financing on the most favorable terms available to us and will seek to refinance assets during the term of a loan only in limited circumstances, such as when a decline in interest rates makes it beneficial to prepay an existing loan, when an existing loan matures or if an attractive investment becomes available and the proceeds from the refinancing can be used to purchase such an investment. The benefits of any such refinancing may include increased cash flow resulting from reduced debt service requirements, an increase in distributions from proceeds of the refinancing and an increase in diversification and assets owned if all or a portion of the refinancing proceeds are reinvested.
Economic Dependency
We are dependent on our Advisor and its affiliates for certain services that are essential to us, including the disposition of real estate and real estate-related investments and, to the extent we acquire additional assets, the identification, evaluation, negotiation and purchase of these assets, management of the daily operations of our real estate and real estate-related
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investment portfolio, and other general and administrative responsibilities. In the event that our Advisor is unable to provide such services to us, we will be required to obtain such services from other sources.
Competitive Market Factors
To the extent that we acquire additional real estate investments in the future, we will be subject to significant competition in seeking real estate investments and tenants. We compete with many third-parties engaged in real estate investment activities, including other REITs, other real estate limited partnerships, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, lenders, hedge funds, governmental bodies, and other entities. Some of our competitors may have substantially greater financial and other resources than we have and may have substantially more operating experience than us. The marketplace for real estate equity and financing can be volatile. There is no guarantee that in the future we will be able to obtain financing or additional equity on favorable terms, if at all. Lack of available financing or additional equity could result in a further reduction of suitable investment opportunities and create a competitive advantage for other entities that have greater financial resources than we do.
Tax Status
We elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, beginning with the taxable year ended December 31, 2009. We believe we are organized and operate in such a manner as to qualify for taxation as a REIT under the Internal Revenue Code, and we intend to continue to operate in such a manner, but no assurance can be given that we will operate in a manner so as to qualify or remain qualified as a REIT. As a REIT, we generally are not subject to federal income tax on our taxable income that is currently distributed to our stockholders, provided that distributions to our stockholders equal at least 90% of our taxable income, subject to certain adjustments. If we fail to qualify as a REIT in any taxable year without the benefit of certain relief provisions, we will be subject to federal income taxes on our taxable income at regular corporate income tax rates. We may also be subject to certain state or local income taxes, or franchise taxes.
We have elected to treat one of our subsidiaries as a taxable REIT subsidiary, which we refer to as a TRS. In general, a TRS may engage in any real estate business and certain non-real estate businesses, subject to certain limitations under the Internal Revenue Code. A TRS is subject to federal and state income taxes.
Environmental Matters
All real property investments and the operations conducted in connection with such investments are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. Some of these laws and regulations may impose joint and several liability on customers, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal.
Under various federal, state and local environmental laws, a current or previous owner or operator of real property may be liable for the cost of removing or remediating hazardous or toxic substances on a real property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of hazardous substances, or the failure to properly remediate these substances, may adversely affect our ability to sell, rent or pledge such real property as collateral for future borrowings. Environmental laws also may impose restrictions on the manner in which real property may be used or businesses may be operated. Some of these laws and regulations have been amended so as to require compliance with new or more stringent standards as of future dates. Compliance with new or more stringent laws or regulations or stricter interpretations of existing laws may require us to incur material expenditures or may impose material environmental liability. Additionally, tenants’ operations, the existing condition of land when we buy it, operations in the vicinity of our real properties, such as the presence of underground storage tanks, or activities of unrelated third-parties may affect our real properties. There are also various local, state and federal fire, health, life-safety and similar regulations with which we may be required to comply and which may subject us to liability in the form of fines or damages for noncompliance. In connection with the acquisition and ownership of real properties, we may be exposed to such costs in connection with such regulations. The cost of defending against environmental claims, of any damages or fines we must pay, of compliance with environmental regulatory requirements or of remediating any contaminated real property could materially and adversely affect our business, lower the value of our assets or results of operations and, consequently, lower the amounts available for distribution to our stockholders.
We do not believe that compliance with existing environmental laws will have a material adverse effect on our consolidated financial condition or results of operations. However, we cannot predict the impact of unforeseen environmental contingencies or new or changed laws or regulations on properties in which we hold an interest, or on properties that may be acquired directly or indirectly in the future.
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Employees
We have no paid employees. The employees of our Advisor and its affiliates provide management, acquisition, disposition, advisory and certain administrative services for us.
Available Information
We are subject to the reporting and information requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, as a result, file our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information with the SEC. The SEC maintains a website (http://www.sec.gov) that contains our annual, quarterly and current reports, proxy and information statements and other information we file electronically with the SEC. Access to these filings is free of charge on the SEC’s website as well as on our website (www.srtreit.com).
ITEM 1A. RISK FACTORS
The following are some of the risks and uncertainties that could cause our actual results to differ materially from those presented in our forward-looking statements. The risks and uncertainties described below are not the only ones we face but do represent those risks and uncertainties that we believe are material to us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business.
Risks Related to an Investment in Us
The estimated value per share of our common stock may not reflect the value that stockholders will receive for their investment.
On August 1, 2018, our board of directors approved an estimated value per share of our common stock of $6.04 per share based on the estimated value of the our real estate assets plus the estimated value of our tangible other assets less the estimated value of our liabilities divided by the number of shares and operating partnership units outstanding, as of April 30, 2018. We provided this estimated value per share to assist broker-dealers that participated in the Offering in meeting their customer account statement reporting obligations under the rules of National Association of Securities Dealers Conduct Rule 2340 as required by the Financial Industry Regulatory Authority (“FINRA”).
FINRA rules provide no guidance on the methodology an issuer must use to determine its estimated value per share. As with any valuation methodology, the methodologies used are based upon a number of estimates and assumptions that may not be accurate or complete. Different parties with different assumptions and estimates could derive a different estimated value per share, and these differences could be significant. The estimated value per share is not audited and does not represent the fair value of our assets or liabilities according to generally accepted accounting principles (“GAAP”). Accordingly, with respect to the estimated value per share, we can give no assurance that:
• | a stockholder would be able to resell his or her shares at this estimated value; |
• | a stockholder would ultimately realize distributions per share equal to our estimated value per share upon liquidation of our assets and settlement of our liabilities or a sale of the company; |
• | our shares of common stock would trade at the estimated value per share on a national securities exchange; |
• | an independent third-party appraiser or other third-party valuation firm would agree with our estimated value per share; or |
• | the methodology used to estimate our value per share would or would not be acceptable to FINRA or for compliance with ERISA reporting requirements. |
The value of our shares will fluctuate over time in response to developments related to individual assets in our portfolio and the management of those assets and in response to the real estate and finance markets. As such, the estimated value per share does not take into account estimated disposition costs and fees for real estate properties that are not held for sale, debt prepayment penalties that could apply upon the prepayment of certain of our debt obligations or the impact of restrictions on the assumption of debt. For a description of the methodologies used to value our assets and liabilities in connection with the calculation of the estimated value per share, refer to Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Market Information”.
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Our business could be negatively affected as a result of stockholder activities. Proxy contests threatened or commenced against us could be disruptive and costly and the possibility that stockholders may wage proxy contests or gain representation on or control of our board of directors could cause uncertainty about our strategic direction.
Campaigns by stockholders to effect changes at public companies are sometimes led by investors seeking to increase stockholder value through actions such as financial restructuring, corporate governance changes, special dividends, stock repurchases or sales of assets or the entire company. Proxy contests, if any, could be costly and time-consuming, disrupt our operations and divert the attention of management and our employees from executing our strategic plan. Additionally, perceived uncertainties as to our future direction as a result of stockholder activities or changes to the composition of the board of directors may lead to the perception of a change in the direction of the business, instability or lack of continuity which may be exploited by our competitors, cause concern to our current or potential customers, and make it more difficult to attract and retain qualified personnel. If such perceived uncertainties result in delay, deferral or reduction in transactions with us or transactions with our competitors instead of us because of any such issues, then our revenue, earnings and operating cash flows could be adversely affected.
Failure to maintain effective disclosure controls and procedures and internal controls over financial reporting could have an adverse effect on our operations.
Section 404 of the Sarbanes-Oxley Act of 2002 requires annual management assessments of the effectiveness of the Company’s internal control over financial reporting. If we fail to maintain the adequacy of our internal control over financial reporting, we may not be able to ensure that we can conclude on an ongoing basis that we have an effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and to maintain our qualification as a REIT and are important in helping to prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, REIT qualification could be jeopardized, and investors could lose confidence in our reported financial information.
There is no trading market for shares of our common stock, and we are not required to effectuate a liquidity event by a certain date. As a result, it will be difficult for you to sell your shares of common stock and, if you are able to sell your shares, you are likely to sell them at a substantial discount.
There is no current public market for the shares of our common stock and we have no obligation to list our shares on any public securities market or provide any other type of liquidity to our stockholders. It will therefore be difficult for you to sell your shares of common stock promptly, or at all. Even if you are able to sell your shares of common stock, the absence of a public market may cause the price received for any shares of our common stock sold to be less than what you paid or less than your proportionate value of the assets we own. We have adopted the Amended and Restated Share Redemption Program (the “Amended and Restated SRP”), but only shares submitted for repurchase in connection with the death or “qualifying disability” (as defined in the Amended and Restated SRP) of a stockholder are eligible for repurchase under the Amended and Restated SRP and the number of shares to be redeemed under the Amended and Restated SRP is limited to the lesser of (i) a total of $3.5 million for redemptions sought upon a stockholder’s death and a total of $1.0 million for redemptions sought upon a stockholder’s qualifying disability, and (ii) 5% of the weighted average of the number of shares of our common stock outstanding during the prior calendar year. Additionally, our charter does not require that we consummate a transaction to provide liquidity to stockholders on any date certain or at all. As a result, you should be prepared to hold your shares for an indefinite length of time.
You are limited in your ability to sell your shares of common stock pursuant to the Amended and Restated SRP. You may not be able to sell any of your shares of our common stock back to us, and if you do sell your shares, you may not receive the price you paid upon subscription.
The Amended and Restated SRP may provide you with an opportunity to have your shares of common stock redeemed by us. However, our share redemption program contains certain restrictions and limitations. Only shares submitted for repurchase in connection with the death or “qualifying disability” (as defined in the Amended and Restated SRP) of a stockholder are eligible for repurchase under the Amended and Restated SRP. Further, we limit the number of shares to be redeemed under the Amended and Restated SRP to the lesser of (i) a total of $3.5 million for redemptions sought upon a stockholder’s death and a total of $1.0 million for redemptions sought upon a stockholder’s qualifying disability, and (ii) 5% of the weighted average of the number of shares of our common stock outstanding during the prior calendar year. In addition, our board of directors reserves the right to reject any redemption request for any reason or to amend or terminate the Amended and Restated SRP at any time. Therefore, you may not have the opportunity to make a redemption request prior to a potential termination of the Amended and Restated SRP and you may not be able to sell any of your shares of common stock back to us pursuant to the
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Amended and Restated SRP. Moreover, if you do sell your shares of common stock back to us pursuant to the Amended and Restated SRP, you may not receive the price you paid for any shares of our common stock being redeemed.
Distributions are not guaranteed, may fluctuate, and may constitute a return of capital or taxable gain from the sale or exchange of property.
From August 2009 to December 2012, our board of directors declared monthly cash distributions. Due to short-term liquidity issues and defaults under certain of our loan agreements, effective January 15, 2013, our board of directors determined to pay future distributions on a quarterly basis (as opposed to monthly). However, our board of directors did not declare or pay a distribution for the first three quarters of 2013. On December 9, 2013, our board of directors re-established a quarterly distribution that has continued through 2018. Refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Distributions” for additional information regarding distributions.
The actual amount and timing of any future distributions will be determined by our board of directors and typically will depend upon, among other things, the amount of funds available for distribution, which will depend on items such as current and projected cash requirements and tax considerations. As a result, our distribution rate and payment frequency may vary from time to time.
To the extent that we are unable to consistently fund distributions to our stockholders entirely from our cash flow from operations, the value of your shares upon a listing of our common stock, the sale of our assets or any other liquidity event will likely be reduced. Further, if the aggregate amount of cash distributed in any given year exceeds the amount of our “REIT taxable income” generated during the year, the excess amount will either be (1) a return of capital or (2) gain from the sale or exchange of property to the extent that a stockholder’s basis in our common stock equals or is reduced to zero as the result of our current or prior year distributions. In addition, to the extent we make distributions to stockholders with sources other than cash flow from operations, the amount of cash that is distributed from such sources will limit the amount of investments that we can make, which will in turn negatively impact our ability to achieve our investment objectives and limit our ability to make future distributions.
Because we are dependent upon our Advisor and its affiliates to conduct our operations, any adverse changes in the financial health of our Advisor or its affiliates or our relationship with them could hinder our operating performance and the return on our stockholders’ investment.
We are dependent on our Advisor to manage our operations and our portfolio of real estate and real estate-related assets. Our Advisor depends on fees and other compensation that it receives from us in connection with the purchase, management and sale of assets to conduct its operations. Any adverse changes in the financial condition of our Advisor or our relationship with our Advisor could hinder our Advisor’s ability to successfully manage our operations and our portfolio of investments. If our Advisor is unable to provide services to us, we may spend substantial resources in identifying alternative service providers to provide advisory functions.
If we internalize our management functions, your interest in us could be diluted and we could incur other significant costs associated with being self-managed.
Our board of directors may decide in the future to internalize our management functions. If we do so, we may elect to negotiate the acquisition of our Advisor’s assets and personnel. At this time, we cannot anticipate the form or amount of consideration or other terms relating to any such acquisition. Such consideration could take many forms, including cash payments, promissory notes and shares of our common stock. The payment of such consideration could result in dilution of your interests as a stockholder and could reduce the earnings per share and funds from operations per share attributable to your investment.
Additionally, while we would no longer bear the costs of the various fees and expenses we pay to our Advisor under the Advisory Agreement, our direct expenses would include general and administrative costs, including legal, accounting and other expenses related to corporate governance, SEC reporting and compliance. We would also be required to employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims, potential labor disputes and other employee-related liabilities and grievances as well as incur the compensation and benefits costs of our officers and other employees and consultants that were being paid by our Advisor or its affiliates. We may issue equity awards to officers, employees and consultants, which awards would decrease net income and funds from operations and may further dilute your investment. We cannot reasonably estimate the amount of fees to our Advisor that we would save or the costs that we would incur if we became self-managed. If the expenses we assume as a result of an internalization are higher than the expenses we avoid paying to our Advisor, our earnings per share and funds from operations per share would be lower as a result of the internalization than they otherwise would have been, potentially decreasing the amount of funds available to distribute to our stockholders and the value of our shares.
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Internalization transactions involving the acquisition of advisors or property managers affiliated with entity sponsors have also, in some cases, been the subject of litigation. Even if these claims are without merit, we could be forced to spend significant amounts of money defending claims which would reduce the amount of funds available for us to invest in properties or other investments or to pay distributions.
If we internalize our management functions, we could have difficulty integrating these functions as a stand-alone entity. Currently, our Advisor and its affiliates perform asset management and general and administrative functions, including accounting and financial reporting, for multiple entities. These personnel have substantial know-how and experience which provides us with economies of scale. We may fail to properly identify the appropriate mix of personnel and capital needs to operate as a stand-alone entity. An inability to manage an internalization transaction effectively could thus result in our incurring excess costs and suffering potential deficiencies in our disclosure controls and procedures or our internal control over financial reporting. Such deficiencies could cause us to incur additional costs, and our management’s attention could be diverted from most effectively managing our real properties and other real estate-related assets.
Provisions of the Maryland General Corporation Law may limit the ability of a third party to acquire control of us and may prevent our stockholders from receiving a premium price for their stock in connection with a business combination.
Our board of directors has elected for us to be subject to certain provisions of the Maryland General Corporation Law (the “MGCL”) relating to corporate governance that may have the effect of delaying, deferring or preventing a transaction or a change of control of us that might involve a premium to the market price of our common stock or otherwise be in our stockholders' best interests. Pursuant to Subtitle 8 of Title 3 of the MGCL, our board of directors has implemented (i) a classified board of directors having staggered three year terms and (ii) a requirement that a vacancy on the board be filled only by the remaining directors. Such provisions may have the effect of discouraging offers to acquire us and of increasing the difficulty of consummating any such offers, even if the acquisition would be in our stockholders’ best interests, and may therefore prevent our stockholders from receiving a premium price for their stock in connection with a business combination.
Risks Related To Our Business
We are uncertain of our sources for funding our future capital needs and our cash and cash equivalents on hand is limited. If we cannot obtain debt or equity financing on acceptable terms, our ability to acquire real properties or other real estate-related assets, fund or expand our operations and pay distributions to our stockholders will be adversely affected.
Our cash and cash equivalents on hand are currently limited. In the event that we develop a need for additional capital in the future for investments, the improvement of our real properties or for any other reason, sources of funding may not be available to us. If we cannot establish reserves out of cash flow generated by our investments or out of net sale proceeds in non-liquidating sale transactions, or obtain debt or equity financing on acceptable terms, our ability to acquire real properties and other real estate-related assets, to expand our operations and make distributions to our stockholders will be adversely affected. Furthermore, if our liquidity were to become severely limited it could jeopardize our ability to continue as a going concern or to make the annual distributions required to continue to qualify as a REIT, which would adversely affect the value of our stockholders’ investment in us.
Uninsured losses or premiums for insurance coverage relating to real property may adversely affect your returns.
We attempt to adequately insure all of our real properties against casualty losses. There are types of losses, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters that are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. Additionally, mortgage lenders sometimes require commercial property owners to purchase specific coverage against terrorism as a condition for providing mortgage loans. These policies may not be available at a reasonable cost, if at all, which could inhibit our ability to finance or refinance our real properties. In such instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. Changes in the cost or availability of insurance could expose us to uninsured casualty losses. In the event that any of our real properties incurs a casualty loss which is not fully covered by insurance, the value of our assets will be reduced by any such uninsured loss. In addition, we cannot assure you that funding will be available to us for repair or reconstruction of damaged real property in the future.
Risks Relating to Our Organizational Structure
The limit on the percentage of shares of our common stock that any person may own may discourage a takeover or business combination that may benefit our stockholders.
Our charter restricts the direct or indirect ownership by one person or entity to no more than 9.8% of the value of our then outstanding capital stock (which includes common stock and any preferred stock we may issue) and no more than 9.8% of the
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value or number of shares, whichever is more restrictive, of our then outstanding common stock unless exempted by our board of directors. This restriction may discourage a change of control of us and may deter individuals or entities from making tender offers for shares of our common stock on terms that might be financially attractive to stockholders or which may cause a change in our management. In addition to deterring potential transactions that may be favorable to our stockholders, these provisions may also decrease your ability to sell your shares of our common stock.
We may issue preferred stock or other classes of common stock, which could adversely affect the holders of our common stock.
Our stockholders do not have preemptive rights to any shares issued by us in the future. We may issue, without stockholder approval, preferred stock or other classes of common stock with rights that could dilute the value of your shares of common stock. However, the issuance of preferred stock must also be approved by a majority of our independent directors not otherwise interested in the transaction, who will have access, at our expense, to our legal counsel or to independent legal counsel. In some instances, the issuance of preferred stock or other classes of common stock would increase the number of stockholders entitled to distributions without simultaneously increasing the size of our asset base.
Our charter authorizes us to issue 450,000,000 shares of capital stock, of which 400,000,000 shares of capital stock are designated as common stock and 50,000,000 shares of capital stock are designated as preferred stock. Our board of directors may amend our charter to increase the aggregate number of authorized shares of capital stock or the number of authorized shares of capital stock of any class or series without stockholder approval. If we ever create and issue preferred stock with a distribution preference over common stock, payment of any distribution preferences of outstanding preferred stock would reduce the amount of funds available for the payment of distributions on our common stock. Further, holders of preferred stock are normally entitled to receive a preference payment in the event we liquidate, dissolve or wind up before any payment is made to our common stockholders, likely reducing the amount common stockholders would otherwise receive upon such an occurrence. In addition, under certain circumstances, the issuance of preferred stock or a separate class or series of common stock may render more difficult or tend to discourage:
• | a merger, tender offer or proxy contest; |
• | the assumption of control by a holder of a large block of our securities; and |
• | the removal of incumbent management. |
Actions of joint venture partners could negatively impact our performance.
We have entered into and may enter into joint ventures with third-parties, including with entities that are affiliated with our Advisor. We may also purchase and develop properties in joint ventures or in partnerships, co-tenancies or other co-ownership arrangements with the sellers of the properties, affiliates of the sellers, developers or other persons. Such investments may involve risks not otherwise present with a direct investment in real estate, including, for example:
• | the possibility that our venture partner or co-tenant in an investment might become bankrupt; |
• | that the venture partner or co-tenant may at any time have economic or business interests or goals which are, or which become, inconsistent with our business interests or goals; |
• | that such venture partner or co-tenant may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives; |
• | the possibility that we may incur liabilities as a result of an action taken by such venture partner; |
• | that disputes between us and a venture partner may result in litigation or arbitration that would increase our expenses and prevent our officers and directors from focusing their time and effort on our business; |
• | the possibility that if we have a right of first refusal or buy/sell right to buy out a co-venturer, co-owner or partner, we may be unable to finance such a buy-out if it becomes exercisable or we may be required to purchase such interest at a time when it would not otherwise be in our best interest to do so; or |
• | the possibility that we may not be able to sell our interest in the joint venture if we desire to exit the joint venture. |
Under certain joint venture arrangements, one or all of the venture partners may have limited powers to control the venture and an impasse could be reached, which might have a negative influence on the joint venture and decrease potential returns to you. In addition, to the extent that our venture partner or co-tenant is an affiliate of our Advisor, certain conflicts of interest will exist.
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Risks Related To Conflicts of Interest
We may compete with other affiliates of our Advisor for opportunities to acquire or sell investments, which may have an adverse impact on our operations.
We may compete with other affiliates of our Advisor for opportunities to acquire or sell real properties and other real estate-related assets. We may also buy or sell real properties and other real estate-related assets at the same time as other affiliates are considering buying or selling similar assets. In this regard, there is a risk that our Advisor will select for us investments that provide lower returns to us than investments purchased by another affiliate. Certain of our Advisor’s affiliates may own or manage real properties in geographical areas in which we may expect to own real properties. As a result of our potential competition with other affiliates of our Advisor, certain investment opportunities that would otherwise be available to us may not in fact be available. This competition may also result in conflicts of interest that are not resolved in our favor.
The time and resources that our Advisor and some of its affiliates, including our officers and directors, devote to us may be diverted, and we may face additional competition due to the fact that affiliates of our Advisor are not prohibited from raising money for, or managing, another entity that makes the same types of investments that we target.
Our Advisor and some of its affiliates, including our officers and directors, are not prohibited from raising money for, or managing, another investment entity that makes the same types of investments as those we target. For example, our Advisor’s management currently manages several privately offered real estate programs sponsored by affiliates of our Advisor. As a result, the time and resources they could devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities. We may also co-invest with any such investment entity. Even though all such co-investments will be subject to approval by our independent directors, they could be on terms not as favorable to us as those we could achieve co-investing with a third-party.
Our Advisor and its affiliates, including certain of our officers and directors, face conflicts of interest caused by compensation arrangements with us and other affiliates, which could result in actions that are not in the best interests of our stockholders.
Our Advisor and its affiliates receive substantial fees from us in return for their services and these fees could influence the advice provided to us. Among other matters, the compensation arrangements could affect their judgment with respect to:
• | acquisitions of property and other investments and originations of loans, which entitle our Advisor to acquisition or origination fees and management fees; and, in the case of acquisitions of investments from other programs sponsored by Glenborough, may entitle affiliates of our Advisor to disposition or other fees from the seller; |
• | real property sales, since the asset management fees payable to our Advisor will decrease; |
• | incurring or refinancing debt and originating loans, which would increase the acquisition, financing, origination and management fees payable to our Advisor; and |
• | whether and when we seek to sell the company or its assets or to list our common stock on a national securities exchange, which would entitle the Advisor and/or its affiliates to incentive fees. |
Further, our Advisor may recommend that we invest in a particular asset or pay a higher purchase price for the asset than it would otherwise recommend if it did not receive an acquisition fee. Certain acquisition fees and asset management fees payable to our Advisor and property management fees payable to the property manager are payable irrespective of the quality of the underlying real estate or property management services during the term of the related agreement. These fees may influence our Advisor to recommend transactions with respect to the sale of a property or properties that may not be in our best interest at the time. Investments with higher net operating income growth potential are generally riskier or more speculative. In addition, the premature sale of an asset may add concentration risk to the portfolio or may be at a price lower than if we held on to the asset. Moreover, our Advisor has considerable discretion with respect to the terms and timing of acquisition, disposition, refinancing and leasing transactions. In evaluating investments and other management strategies, the opportunity to earn these fees may lead our Advisor to place undue emphasis on criteria relating to its compensation at the expense of other criteria, such as the preservation of capital, to achieve higher short-term compensation. Considerations relating to our affiliates’ compensation from us and other affiliates of our Advisor could result in decisions that are not in the best interests of our stockholders, which could hurt our ability to pay you distributions or result in a decline in the value of your investment.
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We may purchase real property and other real estate-related assets from third-parties who have existing or previous business relationships with affiliates of our Advisor, and, as a result, in any such transaction, we may not have the benefit of arm’s-length negotiations of the type normally conducted between unrelated parties.
We may purchase real property and other real estate-related assets from third-parties that have existing or previous business relationships with affiliates of our Advisor. The officers, directors or employees of our Advisor and its affiliates and the principals of our Advisor who also perform services for other affiliates of our Advisor may have a conflict in representing our interests in these transactions on the one hand and preserving or furthering their respective relationships on the other hand. In any such transaction, we will not have the benefit of arm’s-length negotiations of the type normally conducted between unrelated parties, and the purchase price or fees paid by us may be in excess of amounts that we would otherwise pay to third-parties.
Risks Associated with Retail Property
Our retail properties are subject to property taxes that may increase in the future, which could adversely affect our cash flow.
Our real properties are subject to real and personal property taxes that may increase as tax rates change and as the real properties are assessed or reassessed by taxing authorities. Certain of our leases provide that the property taxes, or increases therein, are charged to the lessees as an expense related to the real properties that they occupy, while other leases provide that we are responsible for such taxes. In any case, as the owner of the properties, we are ultimately responsible for payment of the taxes to the applicable government authorities. If real property taxes increase, our tenants may be unable to make the required tax payments, ultimately requiring us to pay the taxes even if otherwise stated under the terms of the lease. If we fail to pay any such taxes, the applicable taxing authority may place a lien on the real property and the real property may be subject to a tax sale. In addition, we will generally be responsible for real property taxes related to any vacant space.
An economic downturn in the United States may have an adverse impact on the retail industry generally. Slow or negative growth in the retail industry may result in defaults by retail tenants which could have an adverse impact on our financial operations.
An economic downturn in the United States may have an adverse impact on the retail industry generally. As a result, the retail industry may face reductions in sales revenues and increased bankruptcies. Adverse economic conditions may result in an increase in distressed or bankrupt retail companies, which in turn could result in an increase in defaults by tenants at our commercial properties. Additionally, slow economic growth is likely to hinder new entrants in the retail market which may make it difficult for us to fully lease our properties. Tenant defaults and decreased demand for retail space would have an adverse impact on the value of our retail properties and our results of operations.
Our properties consist of retail properties. Our performance, therefore, is linked to the market for retail space generally.
As of December 31, 2018, we owned eight properties, each of which is a retail property and the majority of which have multiple tenants. The joint ventures in which we have invested also own retail centers. The market for retail space has been and in the future could be adversely affected by weaknesses in the national, regional and local economies, the adverse financial condition of some large retailing companies, consolidation in the retail sector, excess amounts of retail space in a number of markets and competition for tenants with other shopping centers in our markets. Customer traffic to these shopping areas may be adversely affected by the closing of stores in the same shopping center, or by a reduction in traffic to such stores resulting from a regional economic downturn, a general downturn in the local area where our retail center is located, or a decline in the desirability of the shopping environment of a particular shopping center. Such a reduction in customer traffic could have a material adverse effect on our business, financial condition and results of operations.
Our retail tenants face competition from numerous retail channels, which may reduce our profitability and ability to pay distributions.
Retailers at our current retail properties and at any retail property we may acquire in the future face continued competition from discount or value retailers, factory outlet centers, wholesale clubs, mail order catalogs and operators, television shopping networks and shopping via the Internet. Such competition could adversely affect our tenants and, consequently, our revenues and funds available for distribution.
Retail conditions may adversely affect our base rent and subsequently, our income.
Some of our leases may provide for base rent plus contractual base rent increases. A number of our retail leases may also include a percentage rent clause for additional rent above the base amount based upon a specified percentage of the sales our tenants generate. Under those leases that contain percentage rent clauses, our revenue from tenants may increase as the sales of
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our tenants increase. Generally, retailers face declining revenues during downturns in the economy. As a result, the portion of our revenue that we may derive from percentage rent leases could decline upon a general economic downturn.
Our revenue will be impacted by the success and economic viability of our anchor retail tenants. Our reliance on single or significant tenants in certain buildings may decrease our ability to lease vacated space and adversely affect the returns on your investment.
In the retail sector, a tenant occupying all or a large portion of the gross leasable area of a retail center, commonly referred to as an “anchor tenant,” may become insolvent, may suffer a downturn in business, or may decide not to renew its lease. Any of these events at one of our properties or any retail property we may acquire in the future would result in a reduction or cessation in rental payments to us and would adversely affect our financial condition. A lease termination by an anchor tenant at one of our properties or any retail property we may acquire in the future could result in lease terminations or reductions in rent by other tenants whose leases may permit cancellation or rent reduction if another tenant’s lease is terminated. In such event, we may be unable to re-lease the vacated space. Similarly, the leases of some anchor tenants may permit the anchor tenant to transfer its lease to another retailer. The transfer of a lease to a new anchor tenant could cause customer traffic in the retail center to decrease and thereby reduce the income generated by that retail center. A lease transfer to a new anchor tenant could also allow other tenants to make reduced rental payments or to terminate their leases. In the event that we are unable to re-lease vacated space at one of our properties or any retail property we may acquire in the future to a new anchor tenant, we may incur additional expenses in order to re-model the space to be able to re-lease the space to more than one tenant.
Certain of our tenants account for a meaningful portion of the gross leasable area of our portfolio and/or our annual minimum rent, and the inability of these tenants to make contractual rent payments to us could expose us to potential losses in rental revenue, expense recoveries, and percentage rent.
A concentration of credit risk may arise in our business when a nationally or regionally-based tenant is responsible for a substantial amount of rent in multiple properties owned by us. In that event, if the tenant suffers a significant downturn in its business, it may become unable to make its contractual rent payments to us, exposing us to potential losses in rental revenue, expense recoveries, and percentage rent. Further, the impact may be magnified if the tenant is renting space in multiple locations. Generally, we do not obtain security from nationally-based or regionally-based tenants in support of their lease obligations to us. As of December 31, 2018, Clover Juice, Connor Concepts, Inc., and Western Sizzling each accounted for more than 10% of our annual minimum rent.
The bankruptcy or insolvency of a major tenant may adversely impact our operations and our ability to pay distributions.
The bankruptcy or insolvency of a significant tenant or a number of smaller tenants at one of our properties or any retail property we may acquire in the future may have an adverse impact on our income and our ability to pay distributions. Generally, under bankruptcy law, a debtor tenant has 120 days to exercise the option of assuming or rejecting the obligations under any unexpired lease for nonresidential real property, which period may be extended once by the bankruptcy court. If the tenant assumes its lease, the tenant must cure all defaults under the lease and may be required to provide adequate assurance of its future performance under the lease. If the tenant rejects the lease, we will have a claim against the tenant’s bankruptcy estate. Although rent owing for the period between filing for bankruptcy and rejection of the lease may be afforded administrative expense priority and paid in full, pre-bankruptcy arrears and amounts owing under the remaining term of the lease will be afforded general unsecured claim status (absent collateral securing the claim). Moreover, amounts owing under the remaining term of the lease will be capped. Other than equity and subordinated claims, general unsecured claims are the last claims paid in a bankruptcy and therefore funds may not be available to pay such claims in full.
Because of the concentration of a significant portion of our assets in one geographic area and in urban retail properties, any adverse economic, real estate or business conditions in this geographic area or in the urban retail market could affect our operating results and our ability to pay distributions to our stockholders
As of December 31, 2018, 36.1% of our annual minimum rent was derived from properties in San Francisco, California with an additional 52.7% of our annual minimum rent coming from properties located in other California cities. In addition, our two development projects are in California. As such, the geographic concentration of our portfolio makes us particularly susceptible to adverse economic developments in the California real estate markets. In addition, the majority of our real estate properties consists of urban retail properties. Any adverse economic or real estate developments in the San Francisco or broader California geographic markets, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for urban retail space could adversely affect our operating results and our ability to pay distributions to our stockholders.
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The costs of complying with governmental laws and regulations related to environmental protection and human health and safety may be high.
All real property investments and the operations conducted in connection with such investments are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. Some of these laws and regulations may impose joint and several liability on customers, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal. Under various federal, state and local environmental laws, a current or previous owner or operator of real property may be liable for the cost of removing or remediating hazardous or toxic substances on such real property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of hazardous substances, or the failure to properly remediate these substances, may adversely affect our ability to sell, rent or pledge such real property as collateral for future borrowings. Environmental laws also may impose restrictions on the manner in which real property may be used or businesses may be operated. Some of these laws and regulations have been amended so as to require compliance with new or more stringent standards as of future dates. Compliance with new or more stringent laws or regulations or stricter interpretation of existing laws may require us to incur material expenditures. Future laws, ordinances or regulations may impose material environmental liability. Additionally, our tenants’ operations, the existing condition of land when we buy it, operations in the vicinity of our real properties, such as the presence of underground storage tanks, or activities of unrelated third-parties may affect our real properties. There are also various local, state and federal fire, health, life-safety and similar regulations with which we may be required to comply and which may subject us to liability in the form of fines or damages for noncompliance. In connection with the acquisition and ownership of our real properties, we may be exposed to such costs in connection with such regulations. The cost of defending against environmental claims, of any damages or fines we must pay, of compliance with environmental regulatory requirements or of remediating any contaminated real property could materially and adversely affect our business, lower the value of our assets or results of operations and, consequently, lower the amounts available for distribution to you.
The costs associated with complying with the Americans with Disabilities Act may reduce the amount of cash available for distribution to our stockholders.
Investment in real properties may also be subject to the Americans with Disabilities Act of 1990, as amended, or “ADA”. Under the ADA, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. We are committed to complying with the act to the extent to which it applies. The ADA has separate compliance requirements for “public accommodations” and “commercial facilities” that generally require that buildings and services be made accessible and available to people with disabilities. With respect to the properties we acquire, the ADA’s requirements could require us to remove access barriers and could result in the imposition of injunctive relief, monetary penalties or, in some cases, an award of damages. We will attempt to acquire properties that comply with the ADA or place the burden on the seller or other third-party, such as a tenant, to ensure compliance with the ADA. We cannot assure you that we will be able to acquire properties or allocate responsibilities in this manner. Any monies we use to comply with the ADA will reduce the amount of cash available for distribution to our stockholders.
Real properties are illiquid investments, and we may be unable to adjust our portfolio in response to changes in economic or other conditions or sell a property if or when we decide to do so.
Real properties are illiquid investments. We may be unable to adjust our portfolio in response to changes in economic or other conditions. In addition, the real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and supply and demand that are beyond our control. We cannot predict whether we will be able to sell any real property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We cannot predict the length of time needed to find a willing purchaser and to close the sale of a real property. Also, we may acquire real properties that are subject to contractual “lock-out” provisions that could restrict our ability to dispose of the real property for a period of time. We may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure you that we will have funds available to correct such defects or to make such improvements.
In acquiring a real property, we may agree to restrictions that prohibit the sale of that real property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that real property. Our real properties may also be subject to resale restrictions. All these provisions would restrict our ability to sell a property, which could reduce the amount of cash available for distribution to our stockholders.
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Risks Associated With Debt Financing
Restrictions imposed by our loan agreements may limit our ability to execute our business strategy and could limit our ability to make distributions to our stockholders.
We are a party to loan agreements that contain a variety of restrictive covenants. These covenants include requirements to maintain certain financial ratios and requirements to maintain compliance with applicable laws. A lender could impose restrictions on us that affect our ability to incur additional debt and our distribution and operating policies. In general, we expect our loan agreements to restrict our ability to encumber or otherwise transfer our interest in the respective property without the prior consent of the lender. Loan documents we enter may contain other customary negative covenants that may limit our ability to further mortgage the property, discontinue insurance coverage, replace our Advisor or impose other limitations. Any such restriction or limitation may have an adverse effect on our operations and our ability to make distributions to you.
We will incur mortgage indebtedness and other borrowings, which may increase our business risks, could hinder our ability to make distributions and could decrease the value of your investment.
We have, and may in the future, obtain lines of credit and long-term financing that may be secured by our real properties and other assets. Under our charter, we are prohibited from borrowing in excess of 300% of the value of our net assets. Net assets for purposes of this calculation are defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts or other non-cash reserves, less total liabilities. Generally speaking, the preceding calculation is expected to approximate 75% of the aggregate cost of our investments before non-cash reserves and depreciation. Our charter allows us to borrow in excess of these amounts if such excess is approved by a majority of the independent directors and is disclosed to stockholders in our next quarterly report, along with justification for such excess. As of December 31, 2018, our aggregate borrowings did not exceed 300% of the value of our net assets. Also, we may incur mortgage debt and pledge some or all of our investments as security for that debt to obtain funds to acquire additional investments or for working capital. We may also borrow funds as necessary or advisable to ensure we maintain our REIT tax qualification, including the requirement that we distribute at least 90% of our annual REIT taxable income to our stockholders (computed without regard to the distribution paid deduction and excluding net capital gains). Furthermore, we may borrow if we otherwise deem it necessary or advisable to ensure that we maintain our qualification as a REIT for federal income tax purposes.
High debt levels will cause us to incur higher interest charges, which would result in higher debt service payments and could be accompanied by restrictive covenants. If there is a shortfall between the cash flow from a property and the cash flow needed to service mortgage debt on that property, then the amount available for distributions to stockholders may be reduced. In addition, incurring mortgage debt increases the risk of loss since defaults on indebtedness secured by a property may result in lenders initiating foreclosure actions. In that case, we could lose the property securing the loan that is in default, thus reducing the value of your investment. For tax purposes, a foreclosure on any of our properties will be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we will recognize taxable income on foreclosure, but we would not receive any cash proceeds. If any mortgage contains cross collateralization or cross default provisions, a default on a single property could affect multiple properties. If any of our properties are foreclosed upon due to a default, our ability to pay cash distributions to our stockholders will be adversely affected.
Instability in the debt markets may make it more difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire and the amount of cash distributions we can make to our stockholders.
If mortgage debt is unavailable on reasonable terms as a result of increased interest rates or other factors, we may not be able to finance the purchase of additional properties. In addition, if we place mortgage debt on properties, we run the risk of being unable to refinance such debt when the loans come due, or of being unable to refinance on favorable terms. If interest rates are higher when we refinance debt, our income could be reduced. We may be unable to refinance debt at appropriate times, which may require us to sell properties on terms that are not advantageous to us, or could result in the foreclosure of such properties. If any of these events occur, our cash flow would be reduced. This, in turn, would reduce cash available for distribution to you and may hinder our ability to raise more capital by issuing securities or by borrowing more money.
Increases in interest rates could increase the amount of our debt payments and negatively impact our operating results.
Interest we pay on our debt obligations will reduce cash available for distributions. If we incur variable rate debt, increases in interest rates would increase our interest costs, which would reduce our cash flows and our ability to make distributions to you. 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 at times, which may not permit realization of the maximum return on such investments.
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Derivative financial instruments that we may use to hedge against interest rate fluctuations may not be successful in mitigating our risks associated with interest rates and could reduce the overall returns on your investment.
We may use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets, but no hedging strategy can protect us completely. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. In addition, the use of such instruments may reduce the overall return on our investments. These instruments may also generate income that may not be treated as qualifying REIT income for purposes of the 75% or 95% REIT income test.
Federal Income Tax Risks
Our failure to continue to qualify as a REIT would subject us to federal income tax and reduce cash available for distribution to you.
We elected to be taxed as a REIT under the Internal Revenue Code commencing with our taxable year ended December 31, 2009. We intend to continue to operate in a manner so as to continue to qualify as a REIT for federal income tax purposes. Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only a limited number of judicial and administrative interpretations exist. Even an inadvertent or technical mistake could jeopardize our REIT status. Our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. Moreover, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to continue to qualify as a REIT. If we fail to continue to qualify as a REIT in any taxable year, we would be subject to federal and applicable state and local income tax on our taxable income at corporate rates, in which case we might be required to borrow or liquidate some investments in order to pay the applicable tax. Losing our REIT status would reduce our net income available for investment or distribution to you because of the additional tax liability. In addition, distributions to you would no longer qualify for the dividends-paid deduction and we would no longer be required to make distributions. Furthermore, if we fail to qualify as a REIT in any taxable year for which we have elected to be taxed as a REIT, we would generally be unable to elect REIT status for the four taxable years following the year in which our REIT status is lost.
Complying with REIT requirements may force us to borrow funds to make distributions to you or otherwise depend on external sources of capital to fund such distributions.
To continue to qualify as a REIT, we are required to distribute annually at least 90% of our taxable income, subject to certain adjustments, to our stockholders. To the extent that we satisfy the distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we may elect to retain and pay income tax on our net long-term capital gain. In that case, if we so elect, a stockholder would be taxed on its proportionate share of our undistributed long-term gain and would receive a credit or refund for its proportionate share of the tax we paid. A stockholder, including a tax-exempt or foreign stockholder, would have to file a federal income tax return to claim that credit or refund. Furthermore, we will be subject to a 4% nondeductible excise tax if the actual amount that we distribute to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws.
From time-to-time, we may generate taxable income greater than our net income (loss) for GAAP. In addition, our taxable income may be greater than our cash flow available for distribution to you as a result of, among other things, investments in assets that generate taxable income in advance of the corresponding cash flow from the assets (for instance, if a borrower defers the payment of interest in cash pursuant to a contractual right or otherwise).
If we do not have other funds available in the situations described in the preceding paragraphs, we could be required to borrow funds on unfavorable terms, sell investments at disadvantageous prices or find another alternative source of funds to make distributions sufficient to enable us to distribute enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity.
Because of the distribution requirement, it is unlikely that we will be able to fund all future capital needs, including capital needs in connection with investments, from cash retained from operations. As a result, to fund future capital needs, we likely will have to rely on third-party sources of capital, including both debt and equity financing, which may or may not be available on favorable terms or at all. Our access to third-party sources of capital will depend upon a number of factors, including our current and potential future earnings and cash distributions.
Despite our qualification for taxation as a REIT for federal income tax purposes, we may be subject to other tax liabilities that reduce our cash flow and our ability to make distributions to you.
Despite our qualification for taxation as a REIT for federal income tax purposes, we may be subject to certain federal, state
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and local taxes on our income and assets, including taxes on any undistributed income or property. Any of these taxes would decrease cash available for distribution to you. For instance:
• | in order to continue to qualify as a REIT, we must distribute annually at least 90% of our REIT taxable income (which is determined without regard to the dividends paid deduction or net capital gain for this purpose) to you. |
• | to the extent that we satisfy the distribution requirement but distribute less than 100% of our REIT taxable income, we will be subject to federal corporate income tax on the undistributed income. |
• | we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions we pay in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. |
• | if we have net income from the sale of foreclosure property that we hold primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, we must pay a tax on that income at the highest corporate income tax rate. |
• | if we sell an asset, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of business and do not qualify for a safe harbor in the Internal Revenue Code, our gain would be subject to the 100% “prohibited transaction” tax. |
• | any domestic taxable REIT subsidiary, or TRS, of ours will be subject to federal corporate income tax on its income, and on any non-arm’s-length transactions between us and any TRS, for instance, excessive rents charged to a TRS could be subject to a 100% tax. |
• | we may be subject to tax on income from certain activities conducted as a result of taking title to collateral. |
• | we may be subject to state or local income, property and transfer taxes, such as mortgage recording taxes. |
Complying with REIT requirements may cause us to forgo otherwise attractive opportunities or liquidate otherwise attractive investments.
To continue to qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to stockholders and the ownership of our stock. As discussed above, we may be required to make distributions to you at disadvantageous times or when we do not have funds readily available for distribution. Additionally, we may be unable to pursue investments that would be otherwise attractive to us in order to satisfy the requirements for qualifying as a REIT.
We must also ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets, including certain mortgage loans and mortgage-backed securities. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities of any one issuer (other than government securities and qualified real estate assets) and no more than 20% of the value of our gross assets (25% for taxable years before 2018) may be represented by securities of one or more TRSs. Finally, for the taxable years after 2015, no more than 25% of our assets may consist of debt investments that are issued by “publicly offered REITs” and would not otherwise be treated as qualifying real estate assets. If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences, unless certain relief provisions apply. As a result, compliance with the REIT requirements may hinder our ability to operate solely on the basis of profit maximization and may require us to liquidate investments from our portfolio, or refrain from making, otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to stockholders.
Our acquisition of debt or securities investments may cause us to recognize income for federal income tax purposes even though no cash payments have been received on the debt investments.
We may acquire debt or securities investments in the secondary market for less than their face amount. The amount of such discount will generally be treated as a “market discount” for federal income tax purposes. If these debt or securities investments provide for “payment-in-kind” interest, we may recognize “original issue discount,” or OID, for federal income tax purposes. Moreover, we may acquire distressed debt investments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding debt constitute “significant modifications” under the applicable Treasury Regulations, the modified debt may be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, if the debt is considered to be “publicly traded” for federal income tax purposes, the modified debt in our hands may be considered to
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have been issued with OID to the extent the fair market value of the modified debt is less than the principal amount of the outstanding debt. In the event the debt is not considered to be “publicly traded” for federal income tax purposes, we may be required to recognize taxable income to the extent that the principal amount of the modified debt exceeds our cost of purchasing it. Also, certain loans that we originate and later modify and certain previously modified debt we acquire in the secondary market may be considered to have been issued with the OID at the time it was modified.
In general, we will be required to accrue OID on a debt instrument as taxable income in accordance with applicable federal income tax rules even though no cash payments may be received on such debt instrument on a current basis.
In the event a borrower with respect to a particular debt instrument encounters financial difficulty rendering it unable to pay stated interest as due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income. Similarly, we may be required to accrue interest income with respect to subordinate mortgage-backed securities at the stated rate regardless of when their corresponding cash payments are received.
In order to meet the REIT distribution requirements, it might be necessary for us to arrange for short-term, or possibly long-term borrowings, or to pay distributions in the form of our shares or other taxable in-kind distributions of property. We may need to borrow funds at times when the market conditions are unfavorable. Such borrowings could increase our costs and reduce the value of your investment. In the event in-kind distributions are made, your tax liabilities associated with an investment in our common stock for a given year may exceed the amount of cash we distribute to you during such year.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code may limit our ability to hedge our operations effectively. Our aggregate gross income from non-qualifying hedges, fees and certain other non-qualifying sources cannot exceed 5% of our annual gross income. As a result, we might have to limit our use of advantageous hedging techniques or implement those hedges through a TRS. Any hedging income earned by a TRS would be subject to federal, state and local income tax at regular corporate rates. This could increase the cost of our hedging activities or expose us to greater risks associated with interest rate or other changes than we would otherwise incur.
Liquidation of assets may jeopardize our REIT qualification.
To continue to qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our investments to satisfy our obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% prohibited transaction tax on any resulting gain if we sell assets that are treated as dealer property or inventory.
The prohibited transactions tax may limit our ability to engage in transactions, including disposition of assets and certain methods of securitizing loans, which would be treated as sales for federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of dealer property, other than foreclosure property, but including loans held primarily for sale to customers in the ordinary course of business. We might be subject to the prohibited transaction tax if we were to dispose of or securitize loans in a manner that is treated as a sale of the loans, for federal income tax purposes. In order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans and may limit the structures we use for any securitization financing transactions, even though such sales or structures might otherwise be beneficial to us. Additionally, we may be subject to the prohibited transaction tax upon a disposition of real property. Although a safe-harbor exception to prohibited transaction treatment is available, we cannot assure you that we can comply with such safe harbor or that we will avoid owning property that may be characterized as held primarily for sale to customers in the ordinary course of our trade or business. Consequently, we may choose not to engage in certain sales of real property or may conduct such sales through a TRS.
It may be possible to reduce the impact of the prohibited transaction tax by conducting certain activities through a TRS. However, to the extent that we engage in such activities through a TRS, the income associated with such activities will be subject to a corporate income tax. In addition, the IRS may attempt to ignore or otherwise recast such activities in order to impose a prohibited transaction tax on us, and there can be no assurance that such recast will not be successful.
We also may not be able to use secured financing structures that would create taxable mortgage pools, other than in a TRS or through a subsidiary REIT.
We may recognize substantial amounts of REIT taxable income, which we would be required to distribute to you, in a year in which we are not profitable under GAAP principles or other economic measures.
We may recognize substantial amounts of REIT taxable income in years in which we are not profitable under GAAP or
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other economic measures as a result of the differences between GAAP and tax accounting methods. For instance, certain of our assets will be marked-to-market for GAAP purposes but not for tax purposes, which could result in losses for GAAP purposes that are not recognized in computing our REIT taxable income. Additionally, we may deduct our capital losses only to the extent of our capital gains in computing our REIT taxable income for a given taxable year. Consequently, we could recognize substantial amounts of REIT taxable income and would be required to distribute such income to you, in a year in which we are not profitable under GAAP or other economic measures.
We may distribute our common stock in a taxable distribution, in which case you may sell shares of our common stock to pay tax on such distributions, and you may receive less in cash than the amount of the dividend that is taxable.
We may make taxable distributions that are payable in cash and common stock. The IRS has issued private letter rulings to other REITs treating certain distributions that are paid partly in cash and partly in stock as taxable distributions that would satisfy the REIT annual distribution requirement and qualify for the dividends paid deduction for federal income tax purposes. Those rulings may be relied upon only by taxpayers to whom they were issued, but we could request a similar ruling from the IRS. Accordingly, it is unclear whether and to what extent we will be able to make taxable distributions payable in cash and common stock. If we made a taxable dividend payable in cash and common stock, taxable stockholders receiving such distributions will be required to include the dividend as taxable income to the extent of our current and accumulated earnings and profits, as determined for federal income tax purposes. As a result, you may be required to pay income tax with respect to such distributions in excess of the cash distributions received. If a U.S. stockholder sells the common stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount recorded in earnings with respect to the dividend, depending on the market price of our common stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. federal income tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in common stock.
REIT distribution requirements could adversely affect our ability to execute our business plan.
We generally must distribute annually at least 90% of our REIT taxable income (which is determined without regard to the dividends paid deduction or net capital gain for this purpose) in order to continue to qualify as a REIT. We intend to make distributions to our stockholders to comply with the REIT requirements of the Internal Revenue Code and to avoid corporate income tax and the 4% excise tax. We may be required to make distributions to stockholders at times when it would be more advantageous to reinvest cash in our business or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
Our qualification as a REIT could be jeopardized as a result of an interest in joint ventures or investment funds.
We may hold certain limited partner or non-managing member interests in partnerships or limited liability companies that are joint ventures or investment funds. If a partnership or limited liability company in which we own an interest takes or expects to take actions that could jeopardize our qualification as a REIT or require us to pay tax, we may be forced to dispose of our interest in such entity. In addition, it is possible that a partnership or limited liability company could take an action which could cause us to fail a REIT gross income or asset test, and that we would not become aware of such action in time to dispose of our interest in the partnership or limited liability company or take other corrective action on a timely basis. In that case, we could fail to continue to qualify as a REIT unless we are able to qualify for a statutory REIT “savings” provision, which may require us to pay a significant penalty tax to maintain our REIT qualification.
Distributions paid by REITs do not qualify for the reduced tax rates that apply to other corporate distributions.
The maximum tax rate for “qualified dividends” paid by corporations to non-corporate stockholders is currently 20%. Distributions paid by REITs, however, generally are taxed at ordinary income rates (subject to a maximum rate of 29.6% for non-corporate stockholders), rather than the preferential rate applicable to qualified dividends.
Legislative or regulatory tax changes could adversely affect us or stockholders.
At any time, the federal income tax laws can change. Laws and rules governing REITs or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations may take effect retroactively and could adversely affect us or stockholders.
On November 16, 2017, the U.S. House of Representatives passed the Tax Cuts and Jobs Act (H.R. 1). On December 2, 2017, the Senate passed a different version of the Tax Cuts and Jobs Act. On December 15, 2017, the House and Senate released a Conference report reconciling the House and Senate bills and producing a bill, which was subsequently adopted by both the House and the Senate, and signed into law by the President on December 22, 2017.
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The Tax Cuts and Jobs Act made significant changes to the U.S. federal income tax rules for taxation of individuals and corporations. In the case of individuals, the tax brackets were adjusted, the top federal income rate was reduced to 37%, special rules reduce taxation of certain income earned through pass-through entities and reduce the top effective rate applicable to ordinary dividends from REITs to 29.6% (through a 20% deduction for ordinary REIT dividends received that are not “capital gain dividends” or “qualified dividend income,” subject to complex limitations) and various deductions were eliminated or limited, including limiting the deduction for state and local taxes to $10,000 per year. Most of the changes applicable to individuals are temporary and apply only to taxable years beginning after December 31, 2017 and before January 1, 2026. The top corporate income tax rate was reduced to 21%, and the corporate alternative minimum tax was repealed. The deduction of net interest expense is limited for all businesses, other than certain electing businesses, including certain real estate businesses. There are only minor changes to the REIT rules (other than the 20% deduction applicable to individuals for ordinary REIT dividends received). The Tax Cuts and Jobs Act makes numerous other large and small changes to the tax rules that do not affect REITs directly but may affect our stockholders and may indirectly affect us. For example, the Tax Cuts and Jobs Act amended the rules for accrual of income so that income is taken into account no later than when it is taken into account on applicable financial statements, even if financial statements take such income into account before it would accrue under the original issue discount rules, market discount rules or other rules in the Internal Revenue Code. Such rule may cause us to recognize income before receiving any corresponding receipt of cash, which may make it more likely that we could be required to borrow funds or take other action to satisfy the REIT distribution requirements for the taxable year in which such income is recognized, although the precise application of this rule is unclear at this time.
Stockholders are urged to consult with their tax advisors with respect to the Tax Cuts and Jobs Act and any other regulatory or administrative developments and proposals and their potential effect on investment in our common stock.
Retirement Plan Risks
If the fiduciary of an employee benefit plan subject to ERISA (such as a profit sharing, Section 401(k) or pension plan) or an owner of a retirement arrangement subject to Section 4975 of the Internal Revenue Code (such as an IRA) fails to meet the fiduciary and other standards under ERISA or the Internal Revenue Code as a result of an investment in our stock, the fiduciary could be subject to penalties and other sanctions.
There are special considerations that apply to employee benefit plans subject to ERISA (such as profit sharing, Section 401(k) or pension plans) and other retirement plans or accounts subject to Section 4975 of the Internal Revenue Code (such as an IRA) that are investing in our shares. Fiduciaries and IRA owners investing the assets of such a plan or account in our common stock should satisfy themselves that:
• | the investment is consistent with their fiduciary and other obligations under ERISA and the Internal Revenue Code; |
• | the investment is made in accordance with the documents and instruments governing the plan or IRA, including the plan’s or account’s investment policy; |
• | the investment satisfies the prudence and diversification requirements of Sections 404(a)(1)(B) and 404(a)(1)(C) of ERISA and other applicable provisions of ERISA and the Internal Revenue Code; |
• | the investment in our shares, for which no public market currently exists, is consistent with the liquidity needs of the plan or IRA; |
• | the investment will not produce an unacceptable amount of “unrelated business taxable income” for the plan or IRA; |
• | our stockholders will be able to comply with the requirements under ERISA and the Internal Revenue Code to value the assets of the plan or IRA annually; and |
• | the investment will not constitute a prohibited transaction under Section 406 of ERISA or Section 4975 of the Internal Revenue Code. |
Failure to satisfy the fiduciary standards of conduct and other applicable requirements of ERISA and the Internal Revenue Code may result in the imposition of civil and criminal penalties and could subject the fiduciary to claims for damages or for equitable remedies, including liability for investment losses. In addition, if an investment in our shares constitutes a prohibited transaction under ERISA or the Internal Revenue Code, the fiduciary or IRA owner who authorized or directed the investment may be subject to the imposition of excise taxes with respect to the amount invested. In addition, the investment transaction must be undone. In the case of a prohibited transaction involving an IRA owner, the IRA may be disqualified as a tax-exempt account and all of the assets of the IRA may be deemed distributed and subjected to tax. ERISA plan fiduciaries and IRA owners should consult with counsel before making an investment in our common stock.
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If our assets are deemed to be plan assets, the Advisor and we may be exposed to liabilities under Title I of ERISA and the Internal Revenue Code.
In some circumstances where an ERISA plan holds an interest in an entity, the assets of the entity are deemed to be ERISA plan assets unless an exception applies. This is known as the “look-through rule.” Under those circumstances, the obligations and other responsibilities of plan sponsors, plan fiduciaries and plan administrators, and of parties in interest and disqualified persons, under Title I of ERISA or Section 4975 of the Internal Revenue Code, may be applicable, and there may be liability under these and other provisions of ERISA and the Internal Revenue Code. We believe that our assets should not be treated as plan assets because the shares should qualify as “publicly-offered securities” that are exempt from the look-through rules under applicable Treasury Regulations. We note, however, that because certain limitations are imposed upon the transferability of shares so that we may qualify as a REIT, and perhaps for other reasons, it is possible that this exemption may not apply. If that is the case, and if the Advisor or we are exposed to liability under ERISA or the Internal Revenue Code, our performance and results of operations could be adversely affected. Prior to making an investment in us, you should consult with your legal and other advisors concerning the impact of ERISA and the Internal Revenue Code on your investment and our performance.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Property Portfolio
As of December 31, 2018, our property portfolio included eight retail properties, which we refer to as “our properties” or “our portfolio,” comprising an aggregate of approximately 86,000 square feet of multi-tenant, commercial retail space located in two states. We purchased our properties for an aggregate purchase price of approximately $51.5 million. As of December 31, 2018 and December 31, 2017, approximately 90% and 96% of our portfolio was leased (based on rentable square footage), respectively, with a weighted-average remaining lease term of approximately 5.9 years and 7.0 years, respectively.
(dollars in thousands) | Rentable Square Feet (1) | Percent Leased (2) | Effective Rent (3) (per Sq. Foot) | Date Acquired | Original Purchase Price (4) (5) | |||||||||||||
Property Name | Location | |||||||||||||||||
Topaz Marketplace | Hesperia, CA | 43,199 | 100 | % | $ | 21.53 | 9/23/2011 | $ | 11,880 | |||||||||
Shops at Turkey Creek | Knoxville, TN | 16,324 | 61 | % | 29.59 | 3/12/2012 | 4,300 | |||||||||||
400 Grove Street | San Francisco, CA | 2,000 | 100 | % | 60.00 | 6/14/2016 | 2,890 | |||||||||||
8 Octavia Street | San Francisco, CA | 3,640 | 47 | % | 43.95 | 6/14/2016 | 2,740 | |||||||||||
Fulton Shops | San Francisco, CA | 3,758 | 100 | % | 56.78 | 7/27/2016 | 4,595 | |||||||||||
450 Hayes | San Francisco, CA | 3,724 | 100 | % | 93.08 | 12/22/2016 | 7,567 | |||||||||||
388 Fulton | San Francisco, CA | 3,110 | 100 | % | 64.22 | 1/4/2017 | 4,195 | |||||||||||
Silver Lake | Los Angeles, CA | 10,497 | 100 | % | 64.85 | 1/11/2017 | 13,300 | |||||||||||
86,252 | $ | 51,467 | ||||||||||||||||
(1) | Square feet includes improvements made on ground leases at the property. |
(2) | Percentage is based on leased rentable square feet of each property as of December 31, 2018. |
(3) | Effective rent per square foot is calculated by dividing the annualized December 2018 contractual base rent by the total square feet occupied at the property. The contractual base rent does not include other items such as tenant concessions (e.g., free rent), percentage rent, and expense recoveries. |
(4) | The purchase price for Shops at Turkey Creek includes the issuance of common units in our operating partnership to the sellers. |
(5) | The original purchase price for Topaz Marketplace was reduced to reflect a pad sale during the second quarter of 2018. |
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Lease Expirations
The following table reflects the timing of tenant lease expirations at our properties, as of December 31, 2018 (dollar amounts in thousands):
Year of Expiration (1) | Number of Leases Expiring | Annualized Base Rent (2) | Percent of Portfolio Annualized Base Rent Expiring | Square Feet Expiring | |||||||
2019 | — | $ | — | —% | — | ||||||
2020 | 6 | 426 | 16.1 | 11,514 | |||||||
2021 | 4 | 161 | 6.1 | 8,622 | |||||||
2022 | 1 | 18 | 0.7 | 1,012 | |||||||
2023 | 2 | 321 | 12.2 | 11,417 | |||||||
2024 | 5 | 268 | 10.1 | 8,010 | |||||||
2025 | 1 | 413 | 15.6 | 6,549 | |||||||
2026 | 4 | 231 | 8.7 | 10,099 | |||||||
2027 | 2 | 191 | 7.2 | 8,834 | |||||||
Thereafter | 3 | 615 | 23.3 | 11,890 | |||||||
Total | 28 | $ | 2,644 | 100.0% | 77,947 | ||||||
(1) | Represents the expiration date of the lease as of December 31, 2018, and does not take into account any tenant renewal options. |
(2) | Annualized base rent represents annualized contractual base rent as of December 31, 2018. These amounts do not include other items such as tenant concession (e.g. free rent), percentage rent and expense recoveries. |
Based on our forecasts, the estimated market rents in 2020 are expected to be approximately 8% lower than the expiring rents in 2020.
Properties Under Development
As of December 31, 2018, we had two properties under development. The properties are identified in the following table (dollar amounts in thousands):
Properties Under Development | Location | Estimated Completion Date | Estimated Expected Square Feet | Debt | |||||||
Wilshire Property | Santa Monica, CA | August, 2019 | 12,500 | $ | 8,750 | ||||||
Sunset & Gardner Property | Hollywood, CA | January, 2021 | 37,000 | 8,700 | |||||||
Total | 49,500 | $ | 17,450 | ||||||||
Concentration of Credit Risk
A concentration of credit risk arises in our business when a tenant occupies a substantial amount of space in properties owned by us or accounts for a substantial amount of annual revenue. In that event, if the tenant suffers a significant downturn in its business, it may become unable to make its contractual rent payments to us, exposing us to potential losses in rental revenue, expense recoveries, and percentage rent. Further, the impact may be magnified if the tenant is renting space in multiple locations. Generally, we do not obtain security from nationally-based or regionally-based tenants in support of their lease obligations to us. We regularly monitor our tenant base to assess potential concentrations of our credit risk. As of December 31, 2018, Clover Juice, Connor Concepts, Inc., and Western Sizzling each accounted for more than 10% of our annual minimum rent. Clover Juice is a healthy juice company based in Los Angeles, California. Connor Concepts, Inc. is a parent company of The Chop House and Connors Steak & Seafood, a chain of restaurants across the Southeast. Western Sizzling is a chain of retail buffet restaurants and steakhouses based in Roanoke, Virginia. No other tenant accounted for 10% or more of our annual minimum rent.
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2018 Property Dispositions
On December 20, 2018, we consummated the disposition of Florissant Marketplace, located in Florissant, Missouri, for a sales price of approximately $16.0 million in cash. The net proceeds were used to pay down amounts outstanding under our line of credit.
On July 17, 2018, we consummated the disposition of Ensenada Square, located in Arlington, Texas, for a sales price of approximately $5.8 million in cash. The net proceeds were used to pay down amounts outstanding under our line of credit.
On June 21, 2018, we consummated the disposition of a portion of Topaz Marketplace, located in Hesperia, California, for a sales price of approximately $4.2 million in cash. The net proceeds were used to pay down amounts outstanding under our line of credit.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
There is no established public trading market for our common stock. Therefore, there is a risk that a stockholder may not be able to sell our stock at a time or price acceptable to the stockholder. Unless and until our shares are listed on a national securities exchange, it is not expected that a public market for the shares will develop.
On August 1, 2018, our board of directors approved an estimated value per share of our common stock of $6.04 per share based on the estimated value of our real estate assets and the estimated value of our tangible other assets less the estimated value of our liabilities divided by the number of shares and operating partnership units outstanding, as of April 30, 2018. We are providing this estimated value per share to assist broker-dealers that participated in our Offering in meeting their customer account statement reporting obligations under National Association of Securities Dealers Conduct Rule 2340 as required by the Financial Industry Regulatory Authority (“FINRA”). The valuation with an effective date of April 30, 2018 was performed in accordance with the provisions of Practice Guideline 2013-01, Valuations of Publicly Registered Non-Listed REITs , issued by the Investment Program Association (“IPA”) in April 2013.
Our independent directors are responsible for the oversight of the valuation process, including the review and approval of the valuation process and methodology used to determine our estimated value per share, the consistency of the valuation and appraisal methodologies with real estate industry standards and practices and the reasonableness of the assumptions used in the valuations and appraisals. The estimated value per share was determined after consultation with SRT Advisor, LLC (the “Advisor”) and Robert A. Stanger & Co, Inc. (“Stanger”), an independent third-party valuation firm. The engagement of Stanger was approved by the board of directors, including all of its independent members. Stanger prepared individual appraisal reports (individually an “Appraisal Report” collectively the “Appraisal Reports”), summarizing key inputs and assumptions, on 17 of the 19 properties in which we wholly owned or owned an interest in as of April 30, 2018 (the “Appraised Properties”). Stanger also prepared a net asset value report (the “NAV Report”) which estimates the net asset value per share of our stock as of April 30, 2018. The NAV Report relied upon: (i) the Appraisal Reports for the Appraised Properties; (ii) the book value as of April 30, 2018 for the Sunset & Gardner and Wilshire properties (the “Development Properties”); (iii) Stanger's estimated value of our mortgage loans payable and other debt; (iv) Stanger's valuation of our unconsolidated joint venture interests; and (v) the Advisor's estimate of the value of our other assets and liabilities as of April 30, 2018, to calculate an estimated net asset value per share of our common stock.
Upon the board of directors’ receipt and review of Stanger’s Appraisal Reports and NAV Report, and in light of other factors considered, the board of directors, including the independent directors, approved $6.04 per share as the estimated value of our common stock as of April 30, 2018, which determination is ultimately and solely the responsibility of the board of directors.
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The table below sets forth the calculation of our estimated value per share as of April 30, 2018:
Strategic Realty Trust, Inc. and Subsidiaries
Estimated Value Per Share
(in thousands, except shares and per share amounts)
(unaudited)
Assets | ||||
Investments in real estate, net | $ | 79,030 | ||
Properties under development and development costs | 37,548 | |||
Cash, cash equivalents and restricted cash | 1,822 | |||
Prepaid expenses and other assets, net | 354 | |||
Tenants receivables, net | 229 | |||
Investments in unconsolidated joint ventures | 3,440 | |||
Deferred costs and intangibles, net | 169 | |||
Total assets | 122,592 | |||
Liabilities | ||||
Notes payable and line of credit | (53,656 | ) | ||
Accounts payable and accrued expenses | (846 | ) | ||
Other liabilities | (389 | ) | ||
Total liabilities | (54,891 | ) | ||
Stockholders’ equity | $ | 67,701 | ||
Shares and OP units outstanding | 11,213,320 | |||
Estimated value per share | $ | 6.04 | ||
Methodology and Key Assumptions
Our goal in calculating an estimated value per share is to arrive at a value that is reasonable and supportable using what we deem to be appropriate valuation methodologies and assumptions and a process that is in compliance with the valuation guidelines established by the IPA.
FINRA’s current rules provide no guidance on the methodology an issuer must use to determine its estimated value per share. As with any valuation methodology, the methodologies used are based upon a number of estimates and assumptions that may not be accurate or complete. Different parties with different assumptions and estimates could derive a different estimated value per share, and these differences could be significant. The estimated value per share is not audited and does not represent the fair value of our assets less its liabilities according to U.S. generally accepted accounting principles (“GAAP”), nor does it represent a liquidation value of our assets and liabilities or the amount our shares of common stock would trade at on a national securities exchange. The estimated value per share does not reflect a discount for the fact that we are externally managed, nor does it reflect a real estate portfolio premium/discount versus the sum of the individual property values. The estimated value per share also does not take into account estimated disposition costs and fees for real estate properties that are not held for sale, debt prepayment penalties that could apply upon the prepayment of certain of our debt obligations or the impact of restrictions on the assumption of debt.
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The following is a summary of the valuation and appraisal methodologies used to value our assets and liabilities:
Real Estate
Independent Valuation Firm
Stanger was selected by the Advisor and approved by our independent directors and board of directors to appraise the 17 Appraised Properties in which we wholly own or own an interest in with a valuation date of April 30, 2018. Stanger is engaged in the business of appraising commercial real estate properties and is not affiliated with us or the Advisor. The compensation we paid to Stanger was based on the scope of work and not on the appraised values of the Appraised Properties. The Appraisal Reports were performed in accordance with the Code of Ethics and the Uniform Standards of Professional Appraisal Practice, or USPAP, the real estate appraisal industry standards created by The Appraisal Foundation. Each Appraisal Report was reviewed, approved and signed by an individual with the professional designation of MAI licensed in the state where each real property is located. The use of the Appraisal Reports are subject to the requirements of the Appraisal Institute relating to review by its duly authorized representatives. In preparing the Appraisal Reports, Stanger did not, and was not requested to, solicit third-party indications of interest for our common stock in connection with possible purchases thereof or the acquisition of all or any part of us.
Stanger collected reasonably available material information that it deemed relevant in appraising the Appraised Properties. Stanger relied in part on property-level information provided by the Advisor, including (i) property historical and projected operating revenues and expenses; (ii) property lease agreements and/or lease abstracts; and (iii) information regarding recent or planned capital expenditures.
In conducting their investigation and analyses, Stanger took into account customary and accepted financial and commercial procedures and considerations as they deemed relevant. Although Stanger reviewed information supplied or otherwise made available by us or the Advisor for reasonableness, they assumed and relied upon the accuracy and completeness of all such information and of all information supplied or otherwise made available to them by any other party and did not independently verify any such information. Stanger has assumed that any operating or financial forecasts and other information and data provided to or otherwise reviewed by or discussed with Stanger were reasonably prepared in good faith on bases reflecting the best currently available estimates and judgments of our management, board of directors and/or the Advisor. Stanger relied on us to advise them promptly if any information previously provided became inaccurate or was required to be updated during the period of their review.
In performing its analyses, Stanger made numerous other assumptions as of various points in time with respect to industry performance, general business, economic and regulatory conditions and other matters, many of which are beyond their control and our control. Stanger also made assumptions with respect to certain factual matters. For example, unless specifically informed to the contrary, Stanger assumed that we have clear and marketable title to each Appraised Property, that no title defects exist, that any improvements were made in accordance with law, that no hazardous materials are present or were present previously, that no significant deed restrictions exist, and that no changes to zoning ordinances or regulations governing use, density or shape are pending or being considered. Furthermore, Stanger’s analyses, opinions and conclusions were necessarily based upon market, economic, financial and other circumstances and conditions existing as of or prior to the date of the Appraisal Reports, and any material change in such circumstances and conditions may affect Stanger’s analyses and conclusions. The Appraisal Reports contain other assumptions, qualifications and limitations that qualify the analyses, opinions and conclusions set forth therein. Furthermore, the prices at which our real estate properties may actually be sold could differ from Stanger’s analyses.
Stanger is actively engaged in the business of appraising commercial real estate properties similar to those owned by us in connection with public security offerings, private placements, business combinations and similar transactions. We engaged Stanger to deliver the Appraisal Reports and assist in the net asset value calculation and Stanger received compensation for those efforts. In addition, we have agreed to indemnify Stanger against certain liabilities arising out of this engagement. In the two years prior to the date of this filing, Stanger has provided appraisal and valuation services for us and has received usual and customary fees in connection with those services. Stanger may from time to time in the future perform other services for us, so long as such other services do not adversely affect the independence of Stanger as certified in the applicable appraisal report.
Although Stanger considered any comments received from us or the Advisor regarding the Appraisal Reports, the final appraised values of the Appraised Properties were determined by Stanger. The Appraisal Reports are addressed solely to us to assist it in calculating an updated estimated value per share of our common stock. The Appraisal Reports are not addressed to the public and may not be relied upon by any other person to establish an estimated value per share of our common stock and do not constitute a recommendation to any person to purchase or sell any shares of our common stock.
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The foregoing is a summary of the standard assumptions, qualifications and limitations that generally apply to the Appraisal Reports. All of the Appraisal Reports, including the analysis, opinions and conclusions set forth in such reports, are qualified by the assumptions, qualifications and limitations set forth in each respective Appraisal Report.
Real Estate Valuation
As described above, we engaged Stanger to provide an appraisal of the Appraised Properties consisting of 17 of the 19 properties in our portfolio (including properties owned through joint ventures), as of April 30, 2018. In preparing the Appraisal Reports, Stanger, among other things:
• | performed a site visit of each Appraised Property in connection with this assignment and prior assignments; |
• | interviewed our officers or the Advisor's personnel to obtain information relating to the physical condition of each Appraised Property, including known environmental conditions, status of ongoing or planned property additions and reconfigurations, and other factors for such leased properties; |
• | reviewed lease agreements for those properties subject to a long-term lease and discussed with us or Advisor certain lease provisions and factors on each property; and |
• | reviewed the acquisition criteria and parameters used by real estate investors for properties similar to the subject properties, including a search of real estate data sources and publications concerning real estate buyer's criteria, discussions with sources deemed appropriate, and a review of transaction data for similar properties. |
Stanger appraised each of the Appraised Properties, using various methodologies including a direct capitalization analysis, discounted cash flow analyses and sales comparison approach, as appropriate, and relied primarily on the discounted cash flow analyses for the final valuations of each of the Appraised Properties. Stanger calculated the discounted cash flow value of the Appraised Properties using property-level cash flow estimates, terminal capitalization rates and discount rates that fall within ranges they believe would be used by similar investors to value the Appraised Properties based on survey data adjusted for unique property and market-specific factors.
The Development Properties were included in the NAV Report at their respective book values as of April 30, 2018. As for those properties consolidated on our financials, and for which we do not own 100% of the ownership interest, the property value was adjusted to reflect our ownership interest in such property after consideration of the distribution priorities associated with such property.
As of April 30, 2018, we wholly owned 10 real estate assets which were all appraised by Stanger. The total acquisition cost of the 10 wholly owned properties as appraised by Stanger was $71,742,000 excluding acquisition fees and expenses. In addition, as of June 30, 2018, we had invested $1,278,000 in capital and tenant improvements on these 10 real estate assets since inception. As of April 30, 2018, the total appraised value of the 10 wholly owned appraised properties was $79,030,000. The total appraised real estate value of those 10 properties as of April 30, 2018 compared to the total acquisition cost of our 10 real estate properties plus subsequent capital improvements through June 30, 2018, results in an overall increase in the real estate value of those 10 properties of approximately $6,010,000 or approximately 8.23%. The following summarizes the key assumptions that were used in the discounted cash flow models used to arrive at the appraised value of our Appraised Properties:
Range | Weighted Average | |||
Terminal capitalization rate | 4.25% - 9.50% | 7.25% | ||
Discount rate | 5.00% - 10.50% | 8.01% | ||
Income and expense growth rate | 3.00% | 3.00% | ||
Projection period | 10.0 Years - 14.0 Years | 10.3 Years | ||
As of April 30, 2018, we owned an interest in one property through a joint venture (the “Joint Venture Property”) between a wholly owned subsidiary of us, Grocery Retail Grand Avenue Partners, LLC, a subsidiary of Oaktree Real Estate Opportunities Fund VI, L.P., and GLB SGO, LLC, a wholly owned subsidiary of Glenborough Property Partners, LLC (the “Joint Venture”). Stanger valued the Joint Venture using the terms of the joint venture agreement relating to the allocation of the economic interests between us and our joint venture partners, as applied to a 10-year discounted cash flow analysis derived from the Appraisal Report of the Joint Venture Property and the terms of liabilities encumbering the Joint Venture Property and other fees and expenses of the Joint Venture. Our interest in the Joint Venture was included in the NAV Report based on a 15.0%
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discount rate applied to the projected cash flows. For more information regarding the Joint Venture, please see our Current Report on Form 8-K, filed with the SEC on March 17, 2015.
As of April 30, 2018, we owned an interest in six properties (the “MN Joint Venture Properties”) through a joint venture between our wholly owned subsidiary, MN Retail Grand Avenue Partners, LLC, a subsidiary of Oaktree Real Estate Opportunities Fund VI, L.P., and GLB SGO MN, LLC, a wholly owned subsidiary of Glenborough Property Partners, LLC (the “MN Joint Venture”).
The fair market value of our interest in the MN Joint Venture Properties was estimated by using the terms of the MN Joint Venture Agreement relating to the allocation of the economic interests between us and our joint venture partners, as applied to a 10-year discounted cash flow analysis derived from the Appraisal Report for each of the MN Joint Venture Properties and the terms of liabilities encumbering the MN Joint Venture Properties and other fees and expenses of the MN Joint Venture. Our interest in the MN Joint Venture Properties was included in the NAV Report based on a 15.0% discount rate applied to the projected cash flows. For more information regarding the MN Joint Venture, please see our Current Report on Form 8-K, filed with the SEC on October 6, 2015.
While we believe that Stanger’s assumptions and inputs are reasonable, a change in these assumptions and inputs would significantly impact the calculation of the appraised value of the Appraised Properties and thus, the estimated value per share. The table below illustrates the impact on the estimated value per share if the terminal capitalization rates or discount rates were adjusted by 25 basis points, and assuming all other factors remain unchanged, with respect to the real estate properties referenced in the table above. Additionally, the table below illustrates the impact on the estimated value per share if the terminal capitalization rates or discount rates were adjusted by 5% in accordance with the IPA guidance:
Increase (Decrease) on the Estimated Value per Share due to | ||||||||||||||||
Decrease 25 Basis Points | Increase 25 Basis Points | Decrease 5.0% | Increase 5.0% | |||||||||||||
Terminal capitalization rates | $ | 0.17 | $ | (0.15 | ) | $ | 0.26 | $ | (0.18 | ) | ||||||
Discount rates | 0.18 | (0.11 | ) | 0.24 | (0.17 | ) | ||||||||||
Notes Payable
Values for mortgage loans were estimated by Stanger using a discounted cash flow analysis, which used inputs based on the remaining loan terms and estimated current market interest rates for mortgage loans with similar characteristics, including remaining loan term, loan-to-value ratios, debt-service-coverage ratios, prepayment terms, and collateral property attributes (i.e. age, location, etc.). The current market interest rate was generally determined based on market rates for available comparable debt. The estimated current market interest rates for our consolidated mortgage loans ranged from 4.17% to 11.58%.
As of April 30, 2018, Stanger’s estimate of fair value and carrying value of our consolidated notes payable were $53.7 million. The weighted-average discount rate applied to the future estimated debt payments, which have a weighted-average remaining term of 1.3 years, was approximately 6.6%. The table below illustrates the impact on our estimated value per share if the discount rates were adjusted by 25 basis points, and assuming all other factors remain unchanged, with respect to our notes payable. Additionally, the table below illustrates the impact on the estimated value per share if the discount rates were adjusted by 5% in accordance with the IPA guidance:
Adjustment to Discount Rates | ||||||||||||||||
+25 Basis Points | -25 Basis Points | +5% | -5% | |||||||||||||
Estimated fair value | $ | 53,636 | $ | 53,681 | $ | 53,607 | $ | 53,709 | ||||||||
Weighted average discount rate | 6.7 | % | 6.6 | % | 6.8 | % | 6.4 | % | ||||||||
Change in value per share | $ | — | $ | — | $ | — | $ | — | ||||||||
Other Assets and Liabilities
The carrying values of a majority of our other assets and liabilities are considered to equal their fair value due to their short maturities or liquid nature. Certain balances, such as straight-line rent receivables, lease intangible assets and liabilities, deferred financing costs, unamortized lease commissions and unamortized lease incentives, have been eliminated for the purpose of the valuation due to the fact that the value of those balances were already considered in the valuation of the respective investments.
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Different parties using different assumptions and estimates could derive a different estimated value per share, and these differences could be significant. The value of our shares will fluctuate over time in response to developments related to individual assets in our portfolio and the management of those assets and in response to the real estate and finance markets.
Limitations of Estimated Value Per Share
As mentioned above, we are providing this estimated value per share to assist broker-dealers that participated in our Offering in meeting their customer account statement reporting obligations. As with any valuation methodology, the methodologies used are based upon a number of estimates and assumptions that may not be accurate or complete. Different parties with different assumptions and estimates could derive a different estimated value per share. The estimated value per share is not audited and does not represent the fair value of our assets or liabilities according to GAAP.
Accordingly, with respect to the estimated value per share, we can give no assurance that:
• | a shareholder would be able to resell his or her shares at this estimated value; |
• | a shareholder would ultimately realize distributions per share equal to our estimated value per share upon liquidation of our assets and settlement of our liabilities or a sale of us; |
• | our shares of common stock would trade at the estimated value per share on a national securities exchange; |
• | an independent third-party appraiser or other third-party valuation firm would agree with our estimated value per share; or |
• | the methodology used to estimate our value per share would be acceptable to FINRA or for compliance with ERISA reporting requirements. |
Further, the value of our shares will fluctuate over time in response to developments related to individual assets in our portfolio and the management of those assets and in response to the real estate and finance markets. The estimated value per share does not reflect a discount for the fact that we are externally managed, nor does it reflect a real estate portfolio premium/discount versus the sum of the individual property values. The estimated value per share does not take into account estimated disposition costs and fees for real estate properties that are not held for sale, debt prepayment penalties that could apply upon the prepayment of certain of our debt obligations or the impact of restrictions on the assumption of debt. We currently expect to utilize the Advisor and/or an independent valuation firm to update the estimated value per share in 2019, in accordance with the recommended IPA guidelines.
Stockholder Information
As of March 18, 2019, we had 10,863,299 shares of our common stock outstanding held by a total of approximately 2,982 stockholders. The number of stockholders is based on the records of our transfer agent.
Quarterly Distributions
In order to qualify as a REIT, we are required to distribute at least 90% of our annual REIT taxable income, subject to certain adjustments, to our stockholders. Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant. Some or all of our distributions have been paid, and in the future may continue to be paid, from sources other than cash flows from operations.
Under the terms of the our credit facility, we may pay distributions to our stockholders so long as the total amount paid does not exceed certain thresholds specified in our credit facility; provided, however, that we are not restricted from making any distributions necessary in order to maintain our status as a REIT. Our board of directors will continue to evaluate the amount of future quarterly distributions based on our operational cash needs.
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The following tables set forth the quarterly distributions declared to our common stockholders and common unit holders for the years ended December 31, 2018 and December 31, 2017 (amounts in thousands, except per share amounts):
Distribution Record Date | Distribution Payable Date | Distribution Per Share of Common Stock / Common Unit | Total Common Stockholders Distribution | Total Common Unit Holders Distribution | Total Distribution | ||||||||||||||
First Quarter 2018 | 3/31/2018 | 4/30/2018 | $ | 0.06 | $ | 659 | $ | 14 | $ | 673 | |||||||||
Second Quarter 2018 | 6/30/2018 | 7/31/2018 | 0.06 | 658 | 14 | 672 | |||||||||||||
Third Quarter 2018 | 9/30/2018 | 10/31/2018 | 0.06 | 656 | 14 | 670 | |||||||||||||
Fourth Quarter 2018 | 12/31/2018 | 1/31/2019 | 0.06 | 652 | 14 | 666 | |||||||||||||
Total | $ | 2,625 | $ | 56 | $ | 2,681 | |||||||||||||
Distribution Record Date | Distribution Payable Date | Distribution Per Share of Common Stock / Common Unit | Total Common Stockholders Distribution | Total Common Unit Holders Distribution | Total Distribution | ||||||||||||||
First Quarter 2017 | 3/31/2017 | 4/28/2017 | $ | 0.06 | $ | 655 | $ | 25 | $ | 680 | |||||||||
Second Quarter 2017 | 6/30/2017 | 7/31/2017 | 0.06 | 652 | 25 | 677 | |||||||||||||
Third Quarter 2017 | 9/30/2017 | 10/31/2017 | 0.06 | 660 | 16 | 676 | |||||||||||||
Fourth Quarter 2017 | 12/31/2017 | 1/31/2018 | 0.06 | 659 | 14 | 673 | |||||||||||||
Total | $ | 2,626 | $ | 80 | $ | 2,706 | |||||||||||||
Share Redemption Program
On April 1, 2015, our board of directors approved the reinstatement of the share redemption program (which had been suspended since January 15, 2013) and adopted an Amended and Restated Share Redemption Program (the “SRP”). Under the SRP, only shares submitted for repurchase in connection with the death or “qualifying disability” (as defined in the SRP) of a stockholder are eligible for repurchase by us. Under the current SRP, as amended to date, the number of shares to be redeemed is limited to the lesser of (i) a total of $3.5 million for redemptions sought upon a stockholder’s death and a total of $1.0 million for redemptions sought upon a stockholder’s qualifying disability, and (ii) 5% of the number of shares of our common stock outstanding during the prior calendar year. Share repurchases pursuant to the SRP are made at our sole discretion. We reserve the right to reject any redemption request for any reason or no reason or to amend or terminate the share redemption program at any time subject to the notice requirements in the SRP.
The redemption price for shares that are redeemed is 100% of our most recent estimated net asset value per share as of the applicable redemption date. A redemption request must be made within one year after the stockholder’s death or disability.
The SRP provides that any request to redeem less than $5 thousand worth of shares will be treated as a request to redeem all of the stockholder’s shares. If we cannot honor all redemption requests received in a given quarter, all requests, including death and disability redemptions, will be honored on a pro rata basis. If we do not completely satisfy a redemption request in one quarter, we will treat the unsatisfied portion as a request for redemption in the next quarter when funds are available for redemption, unless the request is withdrawn. We may increase or decrease the amount of funding available for redemptions under the SRP on ten business days’ notice to stockholders. Shares submitted for redemption during any quarter will be redeemed on the penultimate business day of such quarter. The record date for quarterly distributions has historically been and is expected to continue to be the last business day of each quarter; therefore, shares that are redeemed during any quarter are expected to be redeemed prior to the record date and thus would not be eligible to receive the distribution declared for such quarter.
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During the year ended December 31, 2018, we redeemed shares as follows:
Period | Total Number of Shares Redeemed (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program | Approximate Dollar Value of Shares That May Yet be Redeemed Under the Program (2) | ||||||||||
January 2018 | — | $ | — | — | $ | 1,050,393 | ||||||||
February 2018 | — | — | — | 1,050,393 | ||||||||||
March 2018 | 10,312 | 6.27 | 10,312 | 985,737 | ||||||||||
April 2018 | — | — | — | 985,737 | ||||||||||
May 2018 | — | — | — | 985,737 | ||||||||||
June 2018 | 14,710 | 6.27 | 14,710 | 893,504 | ||||||||||
July 2018 | — | — | — | 893,504 | ||||||||||
August 2018 | — | — | — | 893,504 | ||||||||||
September 2018 | 36,903 | 6.04 | 36,903 | 670,608 | ||||||||||
October 2018 | — | — | — | 670,608 | ||||||||||
November 2018 | 3,615 | 6.04 | 3,615 | 648,772 | ||||||||||
December 2018 | 59,599 | 6.04 | 59,599 | 288,793 | ||||||||||
Total | 125,139 | 125,139 | ||||||||||||
(1) | All of our purchases of equity securities during the year ended December 31, 2018, were made pursuant to the SRP. |
(2) | We currently limit the dollar value and number of shares that may yet be repurchased under the SRP as described above. |
Cumulatively, through December 31, 2018, we have redeemed 737,255 shares for $5.3 million. The company had no unfulfilled redemption requests during the year ended December 31, 2018.
Unregistered Sales of Equity Securities and Use of Offering Proceeds
During the year ended December 31, 2018, we did not issue any securities that were not registered under the Securities Act.
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data has been omitted as permitted under rules applicable to smaller reporting companies.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our accompanying consolidated financial statements and the notes thereto included in this Annual Report. Also refer to “Forward Looking Statements” preceding Part I.
As used herein, the terms “we,” “our,” “us,” and “Company” refer to Strategic Realty Trust, Inc., and, as required by context, Strategic Realty Operating Partnership, L.P., a Delaware limited partnership, which we refer to as our “operating partnership” or “OP”, and to their respective subsidiaries. References to “shares” and “our common stock” refer to the shares of our common stock.
Overview
We are a Maryland corporation that was formed on September 18, 2008, to invest in and manage a portfolio of income-producing retail properties, located in the United States, real estate-owning entities and real estate-related assets, including the investment in or origination of mortgage, mezzanine, bridge and other loans related to commercial real estate. During the first quarter of 2016, we also invested, through joint ventures, in two significant retail projects under development. We have elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes, commencing with the taxable year ended December 31, 2009, and we have operated and intend to continue to operate in such a manner. We own substantially all of our assets and conduct our operations through our operating partnership, of which we are the sole general partner. We also own a majority of the outstanding limited partner interests in the operating partnership.
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On November 4, 2008, we filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) for our initial public offering of up to 100,000,000 shares of our common stock at $10.00 per share in our primary offering and up to 10,526,316 shares of our common stock to our stockholders at $9.50 per share pursuant to our distribution reinvestment plan (“DRIP”) (collectively, the “Offering”). On August 7, 2009, the SEC declared our registration statement effective and we commenced our Offering. On February 7, 2013, we terminated our Offering and ceased offering shares of our common stock in our primary offering and under our DRIP.
As of February 2013 when we terminated the Offering, we had accepted subscriptions for, and issued, 10,688,940 shares of common stock in the Offering for gross offering proceeds of approximately $104.7 million, and 391,182 shares of common stock pursuant to the DRIP for gross offering proceeds of approximately $3.6 million. We have also granted 50,000 shares of restricted stock and we issued 273,729 shares of common stock to pay a portion of a special distribution on November 4, 2015. Refer to Part II, Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for details regarding the special distribution.
On April 1, 2015, our board of directors approved the reinstatement of the share redemption program and adopted the Amended and Restated Share Redemption Program (the “SRP”). The program was previously suspended, effective as of January 15, 2013. For more information regarding our share redemption program, refer to Part II, Item 5, “Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities – Share Redemption Program.” Cumulatively, through December 31, 2018, we have redeemed 737,255 shares of common stock sold in the Offering for approximately $5.3 million.
Since our inception, our business has been managed by an external advisor. We do not have direct employees and all management and administrative personnel responsible for conducting our business are employed by our advisor. Currently we are externally managed and advised by SRT Advisor, LLC, a Delaware limited liability company (the “Advisor”) pursuant to an advisory agreement with the Advisor (the “Advisory Agreement”) initially executed on August 10, 2013, and subsequently renewed every year through 2018. The current term of the Advisory Agreement terminates on August 10, 2019. The Advisor is an affiliate of Glenborough, LLC (together with its affiliates, “Glenborough”), a privately held full-service real estate investment and management company focused on the acquisition, management and leasing of commercial properties.
Market Outlook - Real Estate and Real Estate Finance Markets
Retail net absorption in 2018 was 73.2 million square feet, according to CoStar, as compared to deliveries of 71.4 million square feet, with 82.3 million square feet still under construction. This lowered CoStar’s reported vacancy rate to 4.3%. CoStar’s average quoted rental rates trended up, ending the year at $17.06 per square foot, an increase of 4.2% from a year earlier. Vacant sublease space increased from 17.0 million square feet to 18.5 million square feet at year end.
Data from the U.S. Department of Commerce showed pressure from online retailers grew as e-commerce sales increased to 9.8% of total sales in Q3 2018, compared to 9.1% a year before. Overall retail sales grew at 4-5% during 2018, with e-commerce sales outpacing traditional in-store sales. However, JLL noted that “Online retailers are opening stores and well-executed physical stores boosts retailers’ revenues”. JLL also reported, buy online, pick up in-store (“BOPIS”) is on the rise; Cyber Monday BOPIS surged 65.0% over 2017, suggesting that omni-channel retailers are winning out.
Publicly traded real estate investment trusts (“REITs”) in the shopping center and mall sectors showed losses for 2018 with shopping REITs posting total return losses of 13.95% and malls posting total return losses of 26.23%, while the overall REIT market saw total return profits of 8.43% according to KeyBanc Capital Markets.
According to CoStar, sales prices for retail properties sold during the first nine months of 2018 were $19.5 billion, down from $20.5 billion during the same period in 2017, and average cap rates rose from 7.09% in 2017 to 7.29% in 2018.
2018 Significant Events
Property Dispositions
On December 20, 2018, we consummated the disposition of Florissant Marketplace, located in Florissant, Missouri, for a sales price of approximately $16.0 million in cash. The net proceeds were used to repay $15.3 million of outstanding balance on our line of credit.
On July 17, 2018, we consummated the disposition of Ensenada Square, located in Arlington, Texas, for a sales price of approximately $5.8 million in cash. The net proceeds were used to repay $5.3 million of the outstanding balance on our line of credit.
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On June 21, 2018, we consummated the disposition of a portion of Topaz Marketplace, located in Hesperia, California, for a sales price of approximately $4.2 million in cash. The net proceeds were used repay $4.0 million of the outstanding balance on our line of credit.
Share Redemption under the Share Redemption Program
During the year ended December 31, 2018, we redeemed 125,139 shares of common stock for $0.8 million under the SRP at an average price of $6.09 per share.
Review of our Policies
Our board of directors, including our independent directors, has reviewed our policies described in this Annual Report and determined that they are in the best interest of our stockholders because: (1) they increase the likelihood that we will be able to successfully maintain and manage our current portfolio of investments and acquire additional income-producing properties and other real estate-related investments in the future; (2) our executive officers, directors and affiliates of our Advisor have expertise with the type of properties in our current portfolio; and (3) to the extent that we acquire additional real properties or other real estate-related investments in the future, the use of leverage should enable us to acquire assets and earn rental income more quickly, thereby increasing the likelihood of generating income for our stockholders.
Critical Accounting Policies
Below is a discussion of the accounting policies and estimates that management considers critical in that they involve significant management judgments and assumptions, require estimates about matters that are inherently uncertain and because they are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our consolidated financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses.
Revenue Recognition
Revenues include minimum rents, expense recoveries and percentage rental payments. Minimum rents are recognized on an accrual basis over the terms of the related leases on a straight-line basis when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the leased property. If the lease provides for tenant improvements, we determine whether the tenant improvements, for accounting purposes, are owned by the tenant or us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:
• | whether the lease stipulates how a tenant improvement allowance may be spent; |
• | whether the amount of a tenant improvement allowance is in excess of market rates; |
• | whether the tenant or landlord retains legal title to the improvements at the end of the lease term; |
• | whether the tenant improvements are unique to the tenant or general-purpose in nature; and |
• | whether the tenant improvements are expected to have any residual value at the end of the lease term. |
For leases with minimum scheduled rent increases, we recognize income on a straight-line basis over the lease term when collectability is reasonably assured. Recognizing rental income on a straight-line basis for leases results in reported revenue amounts which differ from those that are contractually due from tenants. If we determine that collectability of straight-line rents is not reasonably assured, we limit future recognition to amounts contractually owed and paid, and, when appropriate, establish an allowance for estimated losses.
We maintain an allowance for doubtful accounts, including an allowance for straight-line rent receivables, for estimated losses resulting from tenant defaults or the inability of tenants to make contractual rent and tenant recovery payments. We monitor the liquidity and creditworthiness of our tenants on an ongoing basis. For straight-line rent amounts, our assessment is based on amounts estimated to be recoverable over the term of the lease.
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Certain leases contain provisions that require the payment of additional rents based on the respective tenants’ sales volume (contingent or percentage rent) and substantially all contain provisions that require reimbursement of the tenants’ allocable real estate taxes, insurance and common area maintenance costs (“CAM”). Revenue based on percentage of tenants’ sales is recognized only after the tenant exceeds its sales breakpoint. Revenue from tenant reimbursements of taxes, CAM and insurance is recognized in the period that the applicable costs are incurred in accordance with the lease agreement.
In May 2014, the Financial Accounting Standards Board issued ASU 2014-09. ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers. As our revenues are primarily generated through leasing arrangements, our revenues fall out of the scope of this standard. Effective January 1, 2018, we applied the provisions of Accounting Standards Codification 610-20, Gains and Losses From the Derecognition of Nonfinancial Assets (“ASC 610-20”), for gains on sale of real estate, and recognize any gains at the time control of a property is transferred and when it is probable that substantially all of the related consideration will be collected. As a result of adopting ASC 610-20, using the modified retrospective method, the sales criteria in ASC 360, Property, Plant, and Equipment, no longer applied. As such, we recognized $0.7 million of deferred gains relating to sales of properties to the SGO Joint Venture through a cumulative effect adjustment to accumulated deficit. Other than the cumulative effect adjustment relating to such deferred gains, the adoption of Accounting Standards Codification 606, Revenue From Contracts with Customers (“ASC 606”) and ASC 610-20 did not have an impact on our consolidated financial statements.
Investments in Real Estate
In January 2017, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”) that clarifies the framework for determining whether an integrated set of assets and activities meets the definition of a business. The revised framework establishes a screen for determining whether an integrated set of assets and activities is a business and narrows the definition of a business, which is expected to result in fewer transactions being accounted for as business combinations. Acquisitions of integrated sets of assets and activities that do not meet the definition of a business are accounted for as asset acquisitions.
We elected to early adopt ASU 2017-01 for the reporting period beginning January 1, 2017. As a result of adopting ASU 2017-01, our acquisitions of properties beginning January 1, 2017 were evaluated under the new guidance. The acquisitions that occurred during 2017 were determined to be asset acquisitions, as they did not meet the definition of a business.
Evaluation of business combination or asset acquisition:
We evaluate each acquisition of real estate to determine if the integrated set of assets and activities acquired meet the definition of a business and need to be accounted for as a business combination. If either of the following criteria is met, the integrated set of assets and activities acquired would not qualify as a business:
• Substantially all of the fair value of the gross assets acquired is concentrated in either a single identifiable asset or a group of similar identifiable assets; or
• The integrated set of assets and activities is lacking, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs (i.e. revenue generated before and after the transaction).
An acquired process is considered substantive if:
• The process includes an organized workforce (or includes an acquired contract that provides access to an organized workforce), that is skilled, knowledgeable, and experienced in performing the process;
• The process cannot be replaced without significant cost, effort, or delay; or
• The process is considered unique or scarce.
Generally, we expect that acquisitions of real estate will not meet the revised definition of a business because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e. land, buildings, and related intangible assets), or because the acquisition does not include a substantive process in the form of an acquired workforce or an acquired contract that cannot be replaced without significant cost, effort or delay.
In asset acquisitions, the purchase consideration, including acquisition costs, is allocated to the individual assets acquired and liabilities assumed on a relative fair value basis. As a result, asset acquisitions do not result in the recognition of goodwill or a bargain purchase gain.
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Depreciation and amortization is computed using a straight-line method over the estimated useful lives of the assets as follows:
Years | |
Buildings and improvements | 5 - 30 years |
Tenant improvements | 1 - 15 years |
Tenant improvement costs recorded as capital assets are depreciated over the tenant’s remaining lease term, which we determined approximates the useful life of the improvement. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred. Significant renovations and improvements that improve or extend the useful lives of assets are capitalized. Acquisition costs related to asset acquisitions are capitalized in the consolidated balance sheets.
Impairment of Long-lived Assets
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of our investments in real estate and related intangible assets may not be recoverable. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets may not be recoverable, we assess the recoverability by estimating whether we will recover the carrying value of the real estate and related intangible assets through its undiscounted future cash flows (excluding interest) and its eventual disposition. If, based on this analysis, we do not believe that we will be able to recover the carrying value of the real estate and related intangible assets and liabilities, we would record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the investments in real estate and related intangible assets. Key inputs that we estimate in this analysis include projected rental rates, capital expenditures, property sales capitalization rates and expected holding period of the property.
We evaluate our equity investments for impairment in accordance with ASC Topic 320, Investments – Debt and Securities (“ASC 320”). ASC 320 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss.
We did not record any impairment loss on our investments in real estate and related intangible assets during the years ended December 31, 2018 and 2017. Refer to Part II, Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for more information regarding the methodologies used to estimate fair value of the investments in real estate.
Assets Held for Sale and Discontinued Operations
When certain criteria are met, long-lived assets are classified as held for sale and are reported at the lower of their carrying value or their fair value less costs to sell and are no longer depreciated. With the adoption of Accounting Standards Update No. 2014-08, Presentation of Financial Statements and Property, Plant, and Equipment on April 30, 2014, only disposed properties that represent a strategic shift that has (or will have) a major effect on our operations and financial results are reported as discontinued operations.
Fair Value Measurements
Under generally accepted accounting principles (“GAAP”), we are required to measure or disclose certain financial instruments at fair value on a recurring basis. In addition, we are required to measure other financial instruments and balances at fair value on a non-recurring basis (e.g., carrying value of impaired real estate loans receivable and long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:
• | Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities; |
• | Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and |
• | Level 3: prices or valuation techniques where little or no market data is available for inputs that are significant to the fair value measurement. |
When available, we utilize quoted market prices or other observable inputs (Level 2 inputs), such as interest rates or yield curves, from independent third-party sources to determine fair value and classify such items in Level 1 or Level 2. In instances where the market for a financial instrument is not active, regardless of the availability of a non-binding quoted market price,
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observable inputs might not be relevant and could require us to use significant judgment to derive a fair value measurement. Additionally, in an inactive market, a market price quoted from an independent third-party may rely more on models with inputs based on information available only to that independent third-party. When we determine the market for an asset owned by us to be illiquid or when market transactions for similar instruments do not appear orderly, we use several valuation sources (including internal valuations, discounted cash flow analysis and quoted market prices) and establish a fair value by assigning weights to the various valuation sources. Additionally, when determining the fair value of liabilities in circumstances in which a quoted price in an active market for an identical liability is not available, we measure fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets; or (ii) a present value technique that considers the future cash flows based on contractual obligations discounted by an observed or estimated market rates of comparable liabilities. The use of contractual cash flows with regard to amount and timing significantly reduces the judgment applied in arriving at fair value.
Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In this regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in an immediate settlement of the instrument.
We consider the following factors to be indicators of an inactive market (1) there are few recent transactions; (2) price quotations are not based on current information; (3) price quotations vary substantially either over time or among market makers (for example, some brokered markets); (4) indexes that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability; (5) there is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with our estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability; (6) there is a wide bid-ask spread or significant increase in the bid-ask spread; (7) there is a significant decline or absence of a market for new issuances (that is, a primary market) for the asset or liability or similar assets or liabilities; and (8) little information is released publicly (for example, a principal-to-principal market).
We consider the following factors to be indicators of non-orderly transactions (1) there was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions; (2) there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant; (3) the seller is in or near bankruptcy or receivership (that is, distressed), or the seller was required to sell to meet regulatory or legal requirements (that is, forced); and (4) the transaction price is an outlier when compared with other recent transactions for the same or similar assets or liabilities.
Income Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our annual REIT taxable income to stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal results of operations as calculated in accordance with GAAP). As a REIT, we generally will not be subject to federal income tax on income that we distribute as dividends to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable 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 materially and adversely affect our net income and net cash available for distribution to stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT. Even if we qualify as a REIT, we may be subject to certain state or local income taxes and to U.S. Federal income and excise taxes on our undistributed income.
We evaluate tax positions taken in the consolidated financial statements under the interpretation for accounting for uncertainty in income taxes. As a result of this evaluation, we may recognize a tax benefit from an uncertain tax position only if it is “more-likely-than-not” that the tax position will be sustained on examination by taxing authorities.
When necessary, deferred income taxes are recognized in certain taxable entities. Deferred income tax is generally a function of the period’s temporary differences (items that are treated differently for tax purposes than for financial reporting purposes). A valuation allowance for deferred income tax assets is provided if all or some portion of the deferred income tax asset may not be realized. Any increase or decrease in the valuation allowance is generally included in deferred income tax expense.
Our tax returns remain subject to examination and consequently, the taxability of our distributions is subject to change.
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Portfolio Investments
As of December 31, 2018, our portfolio included:
• | Investments in two consolidated joint ventures, which own property under development in the Los Angeles, California area that are expected to comprise 49,500 square feet upon completion. |
• | Investments in two unconsolidated joint ventures, which own, in aggregate, five retail centers, comprising an aggregate of approximately 494,000 square feet and located in four states. |
• | Eight retail properties, comprising an aggregate of approximately 86,000 square feet of single- and multi-tenant, commercial retail space located in two states. |
Results of Operations
As of December 31, 2018 and 2017, approximately 90% and 96% of our portfolio was leased (based on rentable square footage), respectively, with a weighted-average remaining lease term of approximately 5.9 years and 7.0 years, respectively. In 2018, there were three property dispositions. In 2017, there were two property acquisitions and four property dispositions.
Leasing Information
Committed tenant improvement costs and leasing commissions for new leases during the year ended December 31, 2018 were $60.79 per square foot and $7.92 per square foot, respectively. Committed tenant improvement costs and leasing commissions for new leases during the year ended December 31, 2017 were $16.91 per square foot and $7.29 per square foot, respectively. The following table provides information regarding our leasing activity for the year ended December 31, 2018 for properties we held as of December 31, 2018.
Total Vacant Rentable Sq. Feet at | Lease Expirations in 2018 | New Leases in 2018 | Lease Renewals in 2018 | Total Vacant Rentable Sq. Feet at | Tenant Retention Rate in | |||||
December 31, 2017 | (Sq. Feet) | (Sq. Feet) | (Sq. Feet) | December 31, 2018 | 2018 | |||||
11,425 | 7,681 | 730 | — | 18,376 | —% | |||||
Comparison of the year ended December 31, 2018, versus the year ended December 31, 2017.
The following table provides summary information about our results of operations for the years ended December 31, 2018 and 2017 (amounts in thousands):
Year Ended December 31, | ||||||||||||||
2018 | 2017 | $ Change | % Change | |||||||||||
Rental revenue and reimbursements | $ | 6,751 | $ | 9,035 | $ | (2,284 | ) | (25.3 | )% | |||||
Operating and maintenance expenses | 2,426 | 3,257 | (831 | ) | (25.5 | )% | ||||||||
General and administrative expenses | 1,748 | 1,979 | (231 | ) | (11.7 | )% | ||||||||
Depreciation and amortization expenses | 1,560 | 2,848 | (1,288 | ) | (45.2 | )% | ||||||||
Transaction expense | 39 | 85 | (46 | ) | (54.1 | )% | ||||||||
Interest expense | 887 | 1,824 | (937 | ) | (51.4 | )% | ||||||||
Operating income (loss) | 91 | (958 | ) | 1,049 | (109.5 | )% | ||||||||
Other income, net | 8,161 | 9,995 | (1,834 | ) | (18.3 | )% | ||||||||
Income taxes | 75 | (181 | ) | 256 | (141.4 | )% | ||||||||
Net income | $ | 8,327 | $ | 8,856 | $ | (529 | ) | (6.0 | )% | |||||
Our results of operations for the year ended December 31, 2018, are not necessarily indicative of those expected in future periods.
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Revenue
The decrease in revenue during the year ended December 31, 2018, compared to the same period in 2017, was primarily due to the sales of Woodland West Marketplace in April 2017, Cochran Bypass in October 2017, Morningside Marketplace in November 2017, a portion of Topaz Marketplace in June 2018, and Ensenada Square in July 2018.
Operating and maintenance expenses
Operating and maintenance expenses decreased during the year ended December 31, 2018, when compared to the same period in 2017, which corresponds to the decrease in revenue.
General and administrative expenses
General and administrative expenses decreased during the year ended December 31, 2018, compared to the same period in 2017, primarily due to lower asset management fees, lower audit fees, and lower professional tax fees all corresponding to the decrease in portfolio size.
Depreciation and amortization expenses
Depreciation and amortization expenses decreased during the year ended December 31, 2018, compared to the same period in 2017, primarily due to the classification of Florissant Marketplace as held for sale during the fourth quarter of 2017. The sales of Ensenada Square, a portion of Topaz Marketplace, Cochran Bypass and Morningside Marketplace also contributed to the decrease.
Transaction expense
Transaction fees incurred during the year ended December 31, 2018 were primarily due to payment of financing fees related to the extension of a loan held by one of our unconsolidated joint ventures. Transaction fees incurred during the year ended December 31, 2017 related to acquisition fees for properties acquired prior to January 1, 2017, as well as disposition fees related to sales of properties by one of our unconsolidated joint ventures.
Interest expense
Interest expense decreased during the year ended December 31, 2018, compared to the same period in 2017, due to decreases in debt balances as a result of using the proceeds from property dispositions activities to repay debt.
Other income (loss), net
Other income, net for the year ended December 31, 2018, primarily consisted of approximately $7.9 million related to the gains on sales of a portion of Topaz Marketplace in June 2018, Ensenada Square in July 2018, and Florissant Marketplace in December 2018. Other income, net for the year ended December 31, 2017, primarily consisted of approximately $11.6 million related to the gain on sales of Pinehurst Square East in January 2017, Woodland West Marketplace in April 2017, Cochran Bypass in October 2017 and Morningside Marketplace in November 2017, as well as the recognition of deferred gain resulting from the first quarter of 2017 sale by SGO Retail Acquisitions Venture, LLC (“SGO Joint Venture”) of Aurora Commons.
Income taxes
In addition to various state tax payments, we may from time-to-time incur federal tax, due to our election to treat one of our subsidiaries as a taxable REIT subsidiary (“TRS”). In general, a TRS may engage in any real estate business and certain non-real estate businesses, subject to certain limitations under the Internal Revenue Code. A TRS is subject to federal and state income taxes.
In 2017, we estimated that we could owe Alternative Minimum Tax totaling approximately $0.1 million and this amount was accrued and included in expense as of December 31, 2017. During the year ended December 31, 2018, we finalized our calculation of taxes owed for 2017, which was less than the recorded accrual, resulting in a reversal of $47 thousand and a refund of $40 thousand.
Liquidity and Capital Resources
Since our inception, our principal demand for funds has been for the acquisition of real estate, the payment of operating expenses and interest on our outstanding indebtedness, the payment of distributions to our stockholders and investments in unconsolidated joint ventures and development properties. On February 7, 2013, we ceased offering shares of our common stock in our primary offering and under our distribution reinvestment plan. As a result of the termination of our Offering, offering proceeds from the sale of our securities are not currently available to fund our cash needs. We have used and expect to continue to use debt financing, net sales proceeds and cash flow from operations to fund our cash needs.
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As of December 31, 2018, our cash and cash equivalents were approximately $3.3 million and we had no restricted cash (funds held by the lenders for property taxes, insurance, tenant improvements, leasing commissions, capital expenditures, rollover reserves and other financing needs).
Our aggregate borrowings, secured and unsecured, are reviewed by our board of directors at least quarterly. Under our Articles of Amendment and Restatement, as amended, which we refer to as our “charter,” we are prohibited from borrowing in excess of 300% of the value of our net assets. Net assets for purposes of this calculation is defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts and other non-cash reserves, less total liabilities. However, we may temporarily borrow in excess of these amounts if such excess is approved by a majority of the independent directors and disclosed to stockholders in our next quarterly report, along with an explanation for such excess. As of December 31, 2018 and 2017, our borrowings were approximately 57.5% and 93.7%, respectively, of the carrying value of our net assets.
The following table summarizes, for the periods indicated, selected items in our consolidated statements of cash flows (amounts in thousands):
Year Ended December 31, | |||||||||||
2018 | 2017 | $ Change | |||||||||
Net cash provided by (used in): | |||||||||||
Operating activities | $ | 1,849 | $ | 2,138 | $ | (289 | ) | ||||
Investing activities | 20,109 | 24,243 | (4,134 | ) | |||||||
Financing activities | (22,513 | ) | (30,337 | ) | 7,824 | ||||||
Net decrease in cash, cash equivalents and restricted cash | $ | (555 | ) | $ | (3,956 | ) | |||||
Cash Flows from Operating Activities
The decrease in cash flows from operating activities was primarily due to the 2017 cash flows including a significant decrease in deposit balances resulting from the closing of the acquisitions of 388 Fulton and Silver Lake during the first quarter of 2017.
Cash Flows from Investing Activities
Cash flows from investing activities during the year ended December 31, 2018, primarily consisted of proceeds from the disposition of a portion of Topaz Marketplace, Ensenada Square and Florissant Marketplace of approximately $24.7 million, partially offset by our aggregate additional $4.0 million investments in the Wilshire and Sunset & Gardner Joint Ventures. Cash flows from investing activities during the year ended December 31, 2017, primarily consisted of proceeds from the dispositions of Pinehurst Square East and Woodland West Marketplace of approximately $46.6 million, partially offset by our aggregate $17.8 million in acquisitions of 388 Fulton and Silver Lake in January 2017.
Cash Flows from Financing Activities
Cash flows used in financing activities during the year ended December 31, 2018, primarily consisted of repayment of our debt balances and our quarterly dividend payments of approximately $45.8 million and $2.7 million, respectively, partially offset by approximately $27.6 million from loan proceeds and draws on our line of credit. Cash flows used in financing activities during the year ended December 31, 2017, primarily consisted of repayment of our debt balances of approximately $84.1 million, partially offset by proceeds of approximately $60.7 million from draws on our line of credit.
Short-term Liquidity and Capital Resources
Our principal short-term demand for funds is for the payment of operating expenses, the payment of principal and interest on our outstanding indebtedness and distributions. To date, our cash needs for operations have been covered from cash provided by property operations, the sales of properties and the sale of shares of our common stock. We may fund our short-term operating cash needs from operations, from the sales of properties and from debt.
Long-term Liquidity and Capital Resources
On a long-term basis, our principal demand for funds will be for real estate and real estate-related investments and the payment of acquisition-related expenses, operating expenses, distributions to stockholders, future redemptions of shares and interest and principal payments on current and future indebtedness. Generally, we intend to meet cash needs for items other than acquisitions and acquisition-related expenses from our cash flow from operations, debt and sales of properties. On a long-term
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basis, we expect that substantially all cash generated from operations will be used to pay distributions to our stockholders after satisfying our operating expenses including interest and principal payments. We may consider future public offerings or private placements of equity. Refer to Note 8. “Notes Payable, Net” to our consolidated financial statements included in this Annual Report on Form 10-K for additional information on the maturity dates and terms of our outstanding indebtedness.
Mortgage Loans Secured by Properties Under Development
On August 31, 2018, we refinanced and repaid our initial financing with a new loan from Lone Oak Fund LLC (the “Wilshire Loan”). The Wilshire Loan has a principal balance of approximately $8.8 million, and bears an interest rate of 6.9% per annum, payable monthly, commencing on September 1, 2018. The Wilshire Loan is scheduled to mature on September 30, 2019. We intend to explore all available financing options prior to the loan’s maturity date. The Wilshire Loan is secured by a first Deed of Trust on the property.
As of December 31, 2017, we had borrowings of $8.5 million in connection with our investment in the Wilshire Joint Venture.
On October 29, 2018, we refinanced and repaid our initial financing with a new loan from Lone Oak Fund LLC (the “Sunset & Gardner Loan”). The Sunset & Gardner Loan has a principal balance of approximately $8.7 million, and bears an interest rate of 6.9% per annum. The Sunset & Gardner Loan is scheduled to mature on October 31, 2019. We intend to explore all available financing options prior to the loan’s maturity date. The Sunset & Gardner Loan is secured by a first Deed of Trust on the property.
As of December 31, 2017, we had borrowings of $9.7 million in connection with our investment in the Sunset & Garnder Joint Venture.
Guidelines on Total Operating Expenses
We reimburse our Advisor for some expenses paid or incurred by our Advisor in connection with the services provided to us, except that we will not reimburse our Advisor for any amount by which our total operating expenses at the end of the four preceding fiscal quarters exceed the greater of (1) 2% of our average invested assets, as defined in our charter; and (2) 25% of our net income, as defined in our charter, or the “2%/25% Guidelines” unless a majority of our independent directors determines that such excess expenses are justified based on unusual and non-recurring factors. For the years ended December 31, 2018 and 2017, our total operating expenses did not exceed the 2%/25% Guidelines.
On August 2, 2018, we entered into the Sixth Amendment to the Advisory Agreement. The Advisory Agreement Amendment provides that the Advisor shall not be required to reimburse to us any operating expenses incurred during a given period that exceed the applicable limit on “Total Operating Expenses” (as defined in the Advisory Agreement) to the extent that such excess operating expenses are incurred as a result of certain unusual and non-recurring factors approved by our board of directors, including some related to the execution of our investment strategy as directed by our board of directors.
Inflation
The majority of our leases at our properties contain inflation protection provisions applicable to reimbursement billings for common area maintenance charges, real estate tax and insurance reimbursements on a per square foot basis, or in some cases, annual reimbursement of operating expenses above a certain per square foot allowance. We expect to include similar provisions in our future tenant leases designed to protect us from the impact of inflation. Due to the generally long-term nature of these leases, annual rent increases, as well as rents received from acquired leases, may not be sufficient to cover inflation and rent may be below market rates.
REIT Compliance
To qualify as a REIT for tax purposes, we are required to annually distribute at least 90% of our REIT taxable income, subject to certain adjustments, to our stockholders. We must also meet certain asset and income tests, as well as other requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which our REIT qualification is lost unless the IRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.
Quarterly Distributions
As set forth above, in order to qualify as a REIT, we are required to distribute at least 90% of our annual REIT taxable income, subject to certain adjustments, to our stockholders.
41
Under the terms of the credit facility, we may pay distributions to our stockholders so long as the total amount paid does not exceed certain thresholds specified in the credit facility; provided, however, that we are not restricted from making any distributions necessary in order to maintain our status as a REIT. Our board of directors will continue to evaluate the amount of future quarterly distributions based on our operational cash needs.
Some or all of our distributions have been paid, and in the future may continue to be paid, from sources other than cash flows from operations.
For a presentation of our quarterly distributions declared and paid to our common stockholders and holders of our common units, refer to Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”
Funds From Operations
Funds from operations (“FFO”) is a supplemental non-GAAP financial measure of a real estate company’s operating performance. The National Association of Real Estate Investment Trusts, or “NAREIT”, an industry trade group, has promulgated this supplemental performance measure and defines FFO as net income, computed in accordance with GAAP, plus real estate related depreciation and amortization and excluding extraordinary items and gains and losses on the sale of real estate, and after adjustments for unconsolidated joint ventures (adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO.) It is important to note that not only is FFO not equivalent to our net income or loss as determined under GAAP, it also does not represent cash flows from operating activities in accordance with GAAP. FFO should not be considered an alternative to net income as an indication of our performance, nor is FFO necessarily indicative of cash flow as a measure of liquidity or our ability to fund cash needs, including the payment of distributions.
We consider FFO to be a meaningful, additional measure of operating performance and one that is an appropriate supplemental disclosure for an equity REIT due to its widespread acceptance and use within the REIT and analyst communities. Comparison of our presentation of FFO to similarly titled measures for other REITs may not necessarily be meaningful due to possible differences in the application of the NAREIT definition used by such REITs.
Our calculation of FFO attributable to common shares and Common Units and the reconciliation of net income (loss) to FFO is as follows (amounts in thousands, except shares and per share amounts):
Year Ended December 31, | |||||||
FFO | 2018 | 2017 | |||||
Net income | $ | 8,327 | $ | 8,856 | |||
Adjustments: | |||||||
Gain on disposal of assets | (7,932 | ) | (11,608 | ) | |||
Adjustment to reflect FFO of unconsolidated joint ventures | 65 | 408 | |||||
Depreciation of real estate | 1,205 | 2,047 | |||||
Amortization of in-place leases and leasing costs | 355 | 801 | |||||
FFO attributable to common shares and Common Units (1) | $ | 2,020 | $ | 504 | |||
FFO per share and Common Unit (1) | $ | 0.18 | $ | 0.04 | |||
Weighted average common shares and units outstanding (1) | 11,197,910 | 11,312,042 | |||||
(1) | Our common units have the right to convert a unit into common stock for a one-to-one conversion. Therefore, we are including the related non-controlling interest income/loss attributable to common units in the computation of FFO and including the common units together with weighted average shares outstanding for the computation of FFO per share and common unit. |
Related Party Transactions and Agreements
We are currently party to the Advisory Agreement, pursuant to which the Advisor manages our business in exchange for specified fees paid for services related to the investment of funds in real estate and real estate-related investments, management of our investments and for other services. Refer to Note 12. “Related Party Transactions” to our consolidated financial statements included in this Annual Report on Form 10-K for a discussion of the Advisory Agreement and other related party transactions, agreements and fees.
42
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist primarily of our investments in joint ventures and are described in Note 4. “Investments in Unconsolidated Joint Ventures” in the notes to the consolidated financial statements in this Annual Report on Form 10-K. Our joint ventures typically fund their cash needs through secured debt financings obtained by and in the name of the joint venture entity. The joint ventures’ debts are secured by a first mortgage, are without recourse to the joint venture partners, and do not represent a liability of the partners other than carve-out guarantees for certain matters such as environmental conditions, misuse of funds and material misrepresentations. As of December 31, 2018 and 2017, we have provided carve-out guarantees in connection with our two unconsolidated joint ventures; in connection with those carve-out guarantees we have certain rights of recovery from our joint venture partners.
Subsequent Events
Distributions
On November 8, 2018, our board of directors declared a fourth quarter distribution in the amount of $0.06 per share/unit to common stockholders and holders of common units of record as of December 31, 2018. The distribution was paid on January 31, 2019.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Omitted as permitted under rules applicable to smaller reporting companies.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and supplementary data can be found beginning on Page F-1 of this Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this report, management, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon, and as of the date of, the evaluation, our chief executive officer and chief financial officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and our chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act. In connection with the preparation of this Annual Report, our management, including our chief executive officer and chief financial officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2017, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework (2013). Based on its assessment, our management concluded that, as of December 31, 2018, our internal control over financial reporting was effective.
This Annual Report does not include an attestation report, or any other report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to the rules of the SEC applicable to smaller reporting companies.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2018, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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ITEM 9B. OTHER INFORMATION
As of the three months ended December 31, 2018, all items required to be disclosed under Form 8-K were reported under Form 8-K.
44
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We will file a definitive Proxy Statement for our 2019 Annual Meeting of Stockholders (the “2019 Proxy Statement”) with the SEC, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of the 2019 Proxy Statement that specifically address the items required to be set forth herein are incorporated by reference.
Code of Ethics
We have adopted a Code of Business Conduct and Ethics (the “Code of Ethics”) that contains general guidelines for conducting our business and is designed to help directors, employees and independent consultants resolve ethical issues in an increasingly complex business environment. The Code of Ethics applies to all of our officers, including our principal executive officer, principal financial officer, principal accounting officer, controller and persons performing similar functions and all members of our board of directors. The Code of Ethics covers topics including, but not limited to, conflicts of interest, record keeping and reporting, payments to foreign and U.S. government personnel and compliance with laws, rules and regulations. We will provide to any person without charge a copy of our Code of Ethics, including any amendments or waivers, upon written request delivered to our principal executive office at the address listed on the cover page of this Annual Report.
Audit Committee Financial Expert
The information required by this Item is incorporated by reference to the 2019 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the 2019 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference to the 2019 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference to the 2019 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated herein by reference to the 2019 Proxy Statement.
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as a part of this Annual Report on Form 10-K:
1.The list of financial statements contained herein is set forth on page F-1 hereof.
2.Financial Statement Schedules -
a. | Schedule III - Real Estate Operating Properties and Accumulated Depreciation is set forth beginning on page S-1 hereof. |
b. | All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are not applicable and therefore have been omitted. |
3.The Exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index attached hereto.
46
Index to Consolidated Financial Statements
Financial Statements | Page Number | |
47
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Strategic Realty Trust, Inc. and Subsidiaries
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Strategic Realty Trust, Inc. and Subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations, equity, and cash flows for the years then ended, and the related notes and financial statement schedule (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2018 and 2017, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Moss Adams LLP
San Francisco, California
March 19, 2019
We have served as the Company’s auditor since 2013.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share amounts)
December 31, | December 31, | ||||||
2018 | 2017 | ||||||
ASSETS | |||||||
Investments in real estate | |||||||
Land | $ | 15,217 | $ | 14,020 | |||
Building and improvements | 31,697 | 30,825 | |||||
Tenant improvements | 1,479 | 1,188 | |||||
48,393 | 46,033 | ||||||
Accumulated depreciation | (3,917 | ) | (2,579 | ) | |||
Investments in real estate, net | 44,476 | 43,454 | |||||
Properties under development and development costs | |||||||
Land | 25,851 | 25,851 | |||||
Buildings | 570 | 585 | |||||
Development costs | 13,813 | 9,609 | |||||
Properties under development and development costs | 40,234 | 36,045 | |||||
Cash, cash equivalents and restricted cash | 3,347 | 3,902 | |||||
Prepaid expenses and other assets, net | 137 | 200 | |||||
Tenant receivables, net of $40 and $0 bad debt reserve | 1,084 | 1,007 | |||||
Investments in unconsolidated joint ventures | 2,701 | 2,705 | |||||
Lease intangibles, net | 1,890 | 2,061 | |||||
Assets held for sale | — | 20,646 | |||||
Deferred financing costs, net | 736 | 1,258 | |||||
TOTAL ASSETS (1) | $ | 94,605 | $ | 111,278 | |||
LIABILITIES AND EQUITY | |||||||
LIABILITIES | |||||||
Notes payable, net | $ | 34,536 | $ | 42,223 | |||
Accounts payable and accrued expenses | 1,224 | 2,006 | |||||
Amounts due to affiliates | 30 | 21 | |||||
Other liabilities | 375 | 387 | |||||
Liabilities related to assets held for sale | — | 13,017 | |||||
Below-market lease liabilities, net | 370 | 438 | |||||
Deferred gain on sale of properties to unconsolidated joint venture | — | 668 | |||||
TOTAL LIABILITIES (1) | 36,535 | 58,760 | |||||
Commitments and contingencies (Note 13) | |||||||
EQUITY | |||||||
Stockholders’ equity | |||||||
Preferred stock, $0.01 par value; 50,000,000 shares authorized, none issued and outstanding | — | — | |||||
Common stock, $0.01 par value; 400,000,000 shares authorized; 10,863,299 and 10,988,438 shares issued and outstanding at December 31, 2018 and 2017, respectively | 110 | 111 | |||||
Additional paid-in capital | 95,336 | 96,097 | |||||
Accumulated deficit | (38,546 | ) | (44,741 | ) | |||
Total stockholders’ equity | 56,900 | 51,467 | |||||
Non-controlling interests | 1,170 | 1,051 | |||||
TOTAL EQUITY | 58,070 | 52,518 | |||||
TOTAL LIABILITIES AND EQUITY | $ | 94,605 | $ | 111,278 | |||
(1) | As of December 31, 2018 and 2017, includes approximately $40.5 million and $37.2 million, respectively, of assets related to consolidated variable interest entities that can be used only to settle obligations of the consolidated variable interest entities and approximately $17.3 million and $19.6 million, respectively, of liabilities of consolidated variable interest entities for which creditors do not have recourse to the general credit of the Company. Refer to Note 5. “Variable Interest Entities”. |
See accompanying notes to consolidated financial statements.
49
STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except shares and per share amounts)
Year Ended December 31, | |||||||
2018 | 2017 | ||||||
Revenue: | |||||||
Rental and reimbursements | $ | 6,751 | $ | 9,035 | |||
Expense: | |||||||
Operating and maintenance | 2,426 | 3,257 | |||||
General and administrative | 1,748 | 1,979 | |||||
Depreciation and amortization | 1,560 | 2,848 | |||||
Transaction expense | 39 | 85 | |||||
Interest expense | 887 | 1,824 | |||||
6,660 | 9,993 | ||||||
Operating income (loss) | 91 | (958 | ) | ||||
Other income (loss): | |||||||
Equity in income (loss) of unconsolidated joint ventures | 229 | (59 | ) | ||||
Net gain on disposal of real estate | 7,932 | 11,608 | |||||
Other income | — | 91 | |||||
Loss on extinguishment of debt | — | (1,645 | ) | ||||
Income before income taxes | 8,252 | 9,037 | |||||
Income taxes | 75 | (181 | ) | ||||
Net income | 8,327 | 8,856 | |||||
Net income attributable to non-controlling interests | 175 | 295 | |||||
Net income attributable to common stockholders | $ | 8,152 | $ | 8,561 | |||
Earnings per common share - basic and diluted | $ | 0.74 | $ | 0.78 | |||
Weighted average shares outstanding used to calculate earnings per common share - basic and diluted | 10,962,716 | 10,936,361 | |||||
See accompanying notes to consolidated financial statements.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
(in thousands, except shares)
Number of Shares | Par Value | Additional Paid-in Capital | Accumulated Deficit | Total Stockholders’ Equity | Non-controlling Interests | Total Equity | ||||||||||||||||||||
BALANCE — December 31, 2016 | 10,938,245 | $ | 111 | $ | 96,032 | $ | (50,676 | ) | $ | 45,467 | $ | 1,766 | $ | 47,233 | ||||||||||||
Conversion of OP units to common shares | 187,114 | — | 930 | — | 930 | (930 | ) | — | ||||||||||||||||||
Redemption of common shares | (136,921 | ) | — | (865 | ) | — | (865 | ) | — | (865 | ) | |||||||||||||||
Quarterly distributions | — | — | — | (2,626 | ) | (2,626 | ) | (80 | ) | (2,706 | ) | |||||||||||||||
Net income | — | — | — | 8,561 | 8,561 | 295 | 8,856 | |||||||||||||||||||
BALANCE — December 31, 2017 | 10,988,438 | 111 | 96,097 | (44,741 | ) | 51,467 | 1,051 | 52,518 | ||||||||||||||||||
Redemption of common shares | (125,139 | ) | (1 | ) | (761 | ) | — | (762 | ) | — | (762 | ) | ||||||||||||||
Quarterly distributions | — | — | — | (2,625 | ) | (2,625 | ) | (56 | ) | (2,681 | ) | |||||||||||||||
Cumulative effect from change in accounting principle (Note 2) | — | — | — | 668 | 668 | — | 668 | |||||||||||||||||||
Net income | — | — | — | 8,152 | 8,152 | 175 | 8,327 | |||||||||||||||||||
BALANCE — December 31, 2018 | 10,863,299 | $ | 110 | $ | 95,336 | $ | (38,546 | ) | $ | 56,900 | $ | 1,170 | $ | 58,070 | ||||||||||||
See accompanying notes to consolidated financial statements.
51
STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31, | |||||||
2018 | 2017 | ||||||
Cash flows from operating activities: | |||||||
Net income | $ | 8,327 | $ | 8,856 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Net gain on disposal of real estate | (7,932 | ) | (11,608 | ) | |||
Loss on extinguishment of debt | — | 1,645 | |||||
Equity in (income) loss of unconsolidated joint ventures | (229 | ) | 59 | ||||
Straight-line rent | (139 | ) | (238 | ) | |||
Amortization of deferred costs | 600 | 541 | |||||
Depreciation and amortization | 1,560 | 2,848 | |||||
Amortization of above and below-market leases | (21 | ) | (144 | ) | |||
Bad debt expense | 54 | 14 | |||||
Changes in operating assets and liabilities: | |||||||
Prepaid expenses and other assets | 63 | 853 | |||||
Tenant receivables | (3 | ) | 89 | ||||
Accounts payable and accrued expenses | (428 | ) | (613 | ) | |||
Amounts due to affiliates | 9 | (90 | ) | ||||
Other liabilities | (12 | ) | (74 | ) | |||
Net cash provided by operating activities | 1,849 | 2,138 | |||||
Cash flows from investing activities: | |||||||
Net proceeds from the sale of real estate | 24,735 | 46,633 | |||||
Acquisition of real estate | — | (17,812 | ) | ||||
Investment in properties under development and development costs | (3,987 | ) | (5,081 | ) | |||
Improvements, capital expenditures, and leasing costs | (872 | ) | (1,494 | ) | |||
Investments in unconsolidated joint ventures | (248 | ) | — | ||||
Distributions from unconsolidated joint ventures | 481 | 1,997 | |||||
Net cash provided by investing activities | 20,109 | 24,243 | |||||
Cash flows from financing activities: | |||||||
Redemption of common shares | (762 | ) | (865 | ) | |||
Quarterly distributions | (2,688 | ) | (2,714 | ) | |||
Proceeds from notes payable | 27,550 | 60,700 | |||||
Repayment of notes payable | (45,786 | ) | (84,054 | ) | |||
Loan proceeds from an affiliate | — | 2,500 | |||||
Repayment of loan from an affiliate | — | (2,500 | ) | ||||
Payment of penalties associated with early repayment of notes payable | — | (1,410 | ) | ||||
Payment of loan fees from investments in consolidated variable interest entities | (748 | ) | (453 | ) | |||
Payment of loan fees and financing costs | (79 | ) | (1,541 | ) | |||
Net cash used in financing activities | (22,513 | ) | (30,337 | ) | |||
Net decrease in cash, cash equivalents and restricted cash | (555 | ) | (3,956 | ) | |||
Cash, cash equivalents and restricted cash – beginning of period | 3,902 | 7,858 | |||||
Cash, cash equivalents and restricted cash – end of period | $ | 3,347 | $ | 3,902 | |||
Supplemental disclosure of non-cash investing and financing activities and other cash flow information: | |||||||
Distributions declared but not paid | $ | 666 | $ | 673 | |||
Change in accrued liabilities capitalized to investment in development | (269 | ) | (340 | ) | |||
Change to accrued mortgage note payable interest capitalized to investment in development | (77 | ) | 12 | ||||
Amortization of deferred loan fees capitalized to investment in development | 549 | 463 | |||||
Conversion of OP units to common shares | — | 930 | |||||
Cumulative effect from change in accounting principle | 668 | — | |||||
Cash paid for interest, net of amounts capitalized | 366 | 1,351 | |||||
See accompanying notes to consolidated financial statements.
52
STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Strategic Realty Trust, Inc. (the “Company”) was formed on September 18, 2008, as a Maryland corporation. Effective August 22, 2013, the Company changed its name from TNP Strategic Retail Trust, Inc. to Strategic Realty Trust, Inc. The Company believes it qualifies as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), and has elected REIT status beginning with the taxable year ended December 31, 2009, the year in which the Company began material operations.
Since the Company’s inception, its business has been managed by an external advisor. The Company has no direct employees and all management and administrative personnel responsible for conducting the Company’s business are employed by its advisor. Currently, the Company is externally managed and advised by SRT Advisor, LLC, a Delaware limited liability company (the “Advisor”) pursuant to an advisory agreement with the Advisor (the “Advisory Agreement”) initially executed on August 10, 2013, and subsequently renewed every year through 2018. The current term of the Advisory Agreement terminates on August 10, 2019. The Advisor is an affiliate of Glenborough, LLC (together with its affiliates, “Glenborough”), a privately held full-service real estate investment and management company focused on the acquisition, management and leasing of commercial properties.
Substantially all of the Company’s business is conducted through Strategic Realty Operating Partnership, L.P. (the “OP”). During the Company’s initial public offering (“Offering”), as the Company accepted subscriptions for shares of its common stock, it transferred substantially all of the net proceeds of the Offering to the OP as a capital contribution. The Company is the sole general partner of the OP. As of both December 31, 2018 and 2017, the Company owned 97.9% of the limited partnership interests in the OP.
The Company’s principal demand for funds has been for the acquisition of real estate assets, the payment of operating expenses, interest on outstanding indebtedness, the payment of distributions to stockholders, and investments in unconsolidated joint ventures as well as development of properties. Substantially all of the proceeds of the completed Offering have been used to fund investments in real properties and other real estate-related assets, for payment of operating expenses, for payment of interest, for payment of various fees and expenses, such as acquisition fees and management fees, and for payment of distributions to stockholders. The Company’s available capital resources, cash and cash equivalents on hand and sources of liquidity are currently limited. The Company expects its future cash needs will be funded using cash from operations, future asset sales, debt financing and the proceeds to the Company from any sale of equity that it may conduct in the future.
The Company invests in and manages a portfolio of income-producing retail properties, located in the United States, real estate-owning entities and real estate-related assets, including the investment in or origination of mortgage, mezzanine, bridge and other loans related to commercial real estate. The Company has invested directly, and indirectly through joint ventures, in a portfolio of income-producing retail properties located throughout the United States, with a focus on grocery anchored multi-tenant retail centers, including neighborhood, community and lifestyle shopping centers, multi-tenant shopping centers and free standing single-tenant retail properties. During the first quarter of 2016, the Company invested, through joint ventures, in two significant retail projects under development.
As of December 31, 2018, in addition to the development projects, the Company’s portfolio of properties was comprised of 8 properties, with approximately 86,000 rentable square feet of retail space located in two states. As of December 31, 2018, the rentable space at the Company’s retail properties was 90% leased.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) as contained within the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) and the rules and regulations of the Securities and Exchange Commission (the “SEC”), including the instructions to Form 10-K and Regulation S-X.
The consolidated financial statements include the accounts of the Company, the OP, their direct and indirect owned subsidiaries, and the accounts of joint ventures that are determined to be variable interest entities for which the Company is the primary beneficiary. All significant intercompany balances and transactions are eliminated in consolidation. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows have been included.
53
STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Company evaluates the need to consolidate joint ventures and variable interest entities based on standards set forth in ASC Topic 810, Consolidation (“ASC 810”). In determining whether the Company has a controlling interest in a joint venture or a variable interest entity and the requirement to consolidate the accounts of that entity, management considers factors such as ownership interest, authority to make decisions and contractual and substantive participating rights of the partners/members, as well as whether the entity is a variable interest entity for which the Company is the primary beneficiary. As of December 31, 2018 and 2017, the Company held ownership interests in two unconsolidated joint ventures. Refer to Note 4. “Investments in Unconsolidated Joint Ventures” for additional information. As of December 31, 2018 and 2017, the Company held variable interests in two variable interest entities and consolidated those entities. Refer to Note 5. “Variable Interest Entities” for additional information.
Non-Controlling Interests
The Company’s non-controlling interests are comprised of common units in the OP (“Common Units”). The Company accounts for non-controlling interests in accordance with ASC 810. In accordance with ASC 810, the Company reports non-controlling interests in subsidiaries within equity in the consolidated financial statements, but separate from stockholders’ equity. Net income (loss) attributable to non-controlling interests is presented as a reduction from net income (loss) in calculating net income (loss) attributable to common stockholders on the consolidated statement of operations. Acquisitions or dispositions of non-controlling interests that do not result in a change of control are accounted for as equity transactions. In addition, ASC 810 requires that a parent company recognize a gain or loss in the Company’s results of operations when a subsidiary is deconsolidated upon a change in control. In accordance with ASC 480-10, Distinguishing Liabilities from Equity, non-controlling interests that are determined to be redeemable are carried at their fair value or redemption value as of the balance sheet date and reported as liabilities or temporary equity depending on their terms. The Company periodically evaluates individual non-controlling interests for the ability to continue to recognize the non-controlling interest as permanent equity in the consolidated balance sheets. Any non-controlling interest that fails to qualify as permanent equity will be reclassified as liabilities or temporary equity. All non-controlling interests at December 31, 2018 and 2017, qualified as permanent equity.
Use of Estimates
The preparation of the Company’s consolidated financial statements requires significant management judgments, assumptions and estimates about matters that are inherently uncertain. These judgments affect the reported amounts of assets and liabilities and the Company’s disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in the Company’s consolidated financial statements, and actual results could differ from the estimates or assumptions used by management. Additionally, other companies may utilize different estimates that may impact the comparability of the Company’s consolidated results of operations to those of companies in similar businesses. The Company considers significant estimates to include the carrying amounts and recoverability of investments in real estate, impairments, real estate acquisition purchase price allocations, allowance for doubtful accounts, estimated useful lives to determine depreciation and amortization and fair value determinations, among others.
Cash, Cash Equivalents and Restricted Cash
Cash and cash equivalents represent current bank accounts and other bank deposits free of encumbrances and having maturity dates of three months or less from the respective dates of deposit. The Company limits cash investments to financial institutions with high credit standing; therefore, the Company believes it is not exposed to any significant credit risk in cash.
Restricted cash includes escrow accounts for real property taxes, insurance, capital expenditures and tenant improvements, debt service and leasing costs held by lenders.
In November 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-18, Restricted Cash, which amends (Topic 230), Statement of Cash Flows (“ASU 2016-18”). ASU 2016-18 requires that a statement of cash flows explains the change during the reporting period in the total of cash, cash equivalents, and restricted cash or restricted cash equivalents. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. ASU 2016-18 requires adoption using a retrospective transition method. The Company adopted ASU 2016-18 on January 1, 2018. As a result of adopting ASU 2016-18, the Company revised the presentation of cash, cash equivalents and restricted cash on the consolidated balance sheets and consolidated statements of cash flows for all the periods presented. Upon adoption of ASU 2016-18, the Company recorded a decrease of $1.8 million in net cash provided by operating activities and $2.1 million in net cash provided by investing activities for the year ended December 31, 2017, related to reclassifying the changes in the restricted cash balance from operating activities and investing activities to the cash, cash equivalents and restricted cash balances on the consolidated statements of cash flows.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported on the consolidated balance sheets that sum to the total of the same such amounts shown on the consolidated statement of cash flows (amounts in thousands):
December 31, 2018 | December 31, 2017 | ||||||
Cash and cash equivalents | $ | 3,347 | $ | 3,086 | |||
Restricted cash | — | 816 | |||||
Total cash, cash equivalents, and restricted cash | $ | 3,347 | $ | 3,902 | |||
Revenue Recognition
Revenues include minimum rents, expense recoveries and percentage rental payments. Minimum rents are recognized on an accrual basis over the terms of the related leases on a straight-line basis when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the leased property. If the lease provides for tenant improvements, the Company determines whether the tenant improvements, for accounting purposes, are owned by the tenant or the Company. When the Company is the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:
• | whether the lease stipulates how a tenant improvement allowance may be spent; |
• | whether the amount of a tenant improvement allowance is in excess of market rates; |
• | whether the tenant or landlord retains legal title to the improvements at the end of the lease term; |
• | whether the tenant improvements are unique to the tenant or general-purpose in nature; and |
• | whether the tenant improvements are expected to have any residual value at the end of the lease. |
For leases with minimum scheduled rent increases, the Company recognizes income on a straight-line basis over the lease term when collectability is reasonably assured. Recognizing rental income on a straight-line basis for leases results in recognized revenue amounts which differ from those that are contractually due from tenants on a cash basis. If the Company determines the collectability of straight-line rents is not reasonably assured, the Company limits future recognition to amounts contractually owed and paid, and, when appropriate, establishes an allowance for estimated losses.
The Company maintains an allowance for doubtful accounts, including an allowance for straight-line rent receivables, for estimated losses resulting from tenant defaults or the inability of tenants to make contractual rent and tenant recovery payments. The Company monitors the liquidity and creditworthiness of its tenants on an ongoing basis. For straight-line rent amounts, the Company’s assessment is based on amounts estimated to be recoverable over the term of the lease. The Company’s straight-line rent receivable (excluding properties held for sale), which is included in tenant receivables, net, on the consolidated balance sheets, was approximately $0.6 million and 0.5 million, respectively, at December 31, 2018 and 2017.
Certain leases contain provisions that require the payment of additional rents based on the respective tenants’ sales volume (contingent or percentage rent) and substantially all contain provisions that require reimbursement of the tenants’ allocable real estate taxes, insurance and common area maintenance costs (“CAM”). Revenue based on percentage of tenants’ sales is recognized only after the tenant exceeds its sales breakpoint. Revenue from tenant reimbursements of taxes, insurance and CAM is recognized in the period that the applicable costs are incurred in accordance with the lease agreement.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which was added to the ASC under Topic 606 (“ASC 606”). ASC 606 outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers. As the Company’s revenues are primarily generated through leasing arrangements, the Company’s revenues fall outside the scope of this standard. As part of ASU 2014-09, ASC 610-20, Gains and Losses from Derecognition of Nonfinancial Assets, (“ASC 610-20”) was issued. ASC 610-20 provided guidance for recognizing gains and losses from the transfer of nonfinancial assets, which includes the sale of real estate.
In February 2017, the FASB issued ASU No. 2017-05, Other Income-Gains and Losses for the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets (“ASU 2017-05”). ASU 2017-05 amends the guidance on nonfinancial assets in ASC 610-20. The amendments clarify that (i) a financial asset is within the scope of ASC 610-20 if it meets the definition of an in-substance
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nonfinancial asset and may include nonfinancial assets transferred within a legal entity to a counter-party, (ii) an entity should identify each distinct nonfinancial asset or in substance nonfinancial asset promised to a counter-party and de-recognize each asset when a counter-party obtains control of it, and (iii) an entity should allocate consideration to each distinct asset by applying the guidance in ASC 606 on allocating the transaction price to performance obligations. Further, ASU 2017-05 provides guidance on accounting for partial sales of nonfinancial assets.
Effective January 1, 2018, the Company applied the provisions of ASC 610-20, for gains on sale of real estate, and recognizes any gains at the time control of a property is transferred and when it is probable that substantially all of the related consideration will be collected. As a result of adopting ASC 610-20, using the modified retrospective method, the sales criteria in ASC 360, Property, Plant, and Equipment, no longer applied. As such, the Company recognized $0.7 million of deferred gains related to sales of properties to the SGO Retail Acquisitions Venture, LLC, through a cumulative effect adjustment to accumulated deficit. Other than the cumulative effect adjustment relating to such deferred gains, the adoption of ASC 606 and ASC 610-20 did not have an impact on the Company’s consolidated financial statements.
Valuation of Accounts Receivable
The Company makes estimates of the collectability of its tenant receivables related to base rents, including deferred rents receivable, expense reimbursements and other revenue or income.
The Company analyzes tenant receivables, deferred rent receivable, historical bad debts, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, the Company will make estimates of the expected recovery of pre-petition and post-petition claims in assessing the estimated collectability of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. When a tenant is in bankruptcy, the Company will record a bad debt reserve for the tenant’s receivable balance and generally will not recognize subsequent rental revenue until cash is received or until the tenant is no longer in bankruptcy and has the ability to make rental payments.
Concentration of Credit Risk
A concentration of credit risk arises in the Company’s business when a tenant occupies a substantial amount of space in properties owned by the Company or accounts for a substantial amount of annual revenue. In that event, if the tenant suffers a significant downturn in its business, it may become unable to make its contractual rent payments to the Company, exposing the Company to potential losses in rental revenue, expense recoveries, and percentage rent. Generally, the Company does not obtain security deposits from the nationally-based or regionally-based tenants in support of their lease obligations to the Company. The Company regularly monitors its tenant base to assess potential concentrations of credit risk.
As of December 31, 2018, Clover Juice, Connor Concepts, Inc., and Western Sizzling each accounted for more than 10% of the Company’s annual minimum rent. As of December 31, 2018, $46 thousand was outstanding from Clover Juice. There were no amounts outstanding from Connor Concepts, Inc., or Western Sizzling.
As of December 31, 2017, excluding properties classified as held for sale, Clover Juice accounted for more than 10% of the Company’s annual minimum rent. As of December 31, 2017, there were no amounts outstanding from Clover Juice.
Reportable Segments
ASC 280, Segment Reporting, establishes standards for reporting financial and descriptive information about an enterprise’s reportable segments. The Company has one reportable segment, income-producing retail properties, which consists of activities related to investing in real estate. The retail properties are geographically diversified throughout the United States, and the Company evaluates operating performance on an overall portfolio level.
Investments in Real Estate
In January 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”) that clarifies the framework for determining whether an integrated set of assets and activities meets the definition of a business. The revised framework establishes a screen for determining whether an integrated set of assets and activities is a business and narrows the definition of a business, which is expected to result in fewer transactions being accounted for as business combinations. Acquisitions of integrated sets of assets and activities that do not meet the definition of a business are accounted for as asset acquisitions.
The Company elected to early adopt ASU 2017-01 for the reporting period beginning January 1, 2017. As a result of adopting ASU 2017-01, the Company’s acquisitions of properties beginning January 1, 2017, were evaluated under the new guidance. The acquisitions occurring during 2017 were determined to be asset acquisitions, as they did not meet the revised definition of a business.
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Evaluation of business combination or asset acquisition:
The Company evaluates each acquisition of real estate to determine if the integrated set of assets and activities acquired meet the definition of a business and need to be accounted for as a business combination. If either of the following criteria is met, the integrated set of assets and activities acquired would not qualify as a business:
• Substantially all of the fair value of the gross assets acquired is concentrated in either a single identifiable asset or a group of similar identifiable assets; or
• The integrated set of assets and activities is lacking, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs (i.e. revenue generated before and after the transaction).
An acquired process is considered substantive if:
• The process includes an organized workforce (or includes an acquired contract that provides access to an organized workforce), that is skilled, knowledgeable, and experienced in performing the process;
• The process cannot be replaced without significant cost, effort, or delay; or
• The process is considered unique or scarce.
Generally, the Company expects that acquisitions of real estate will not meet the revised definition of a business because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e. land, buildings, and related intangible assets), or because the acquisition does not include a substantive process in the form of an acquired workforce or an acquired contract that cannot be replaced without significant cost, effort or delay.
In asset acquisitions, the purchase consideration, including acquisition costs, is allocated to the individual assets acquired and liabilities assumed on a relative fair value basis. As a result, asset acquisitions do not result in the recognition of goodwill or a bargain purchase gain.
Depreciation and amortization is computed using a straight-line method over the estimated useful lives of the assets as follows:
Years | |
Buildings and improvements | 5 - 30 years |
Tenant improvements | 1 - 15 years |
Tenant improvement costs recorded as capital assets are depreciated over the tenant’s remaining lease term, which the Company has determined approximates the useful life of the improvement. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred. Significant renovations and improvements that improve or extend the useful lives of assets are capitalized. Acquisition costs related to asset acquisitions are capitalized in the consolidated balance sheets.
Properties Under Development
The initial cost of properties under development includes the acquisition cost of the property, direct development costs and borrowing costs directly attributable to the development. Borrowing costs associated with direct expenditures on properties under development are capitalized. The amount of capitalized borrowing costs is determined by reference to borrowings specific to the project, where relevant. Borrowing costs are capitalized from the commencement of the development until the date of practical completion. Practical completion is when the property is capable of operating in the manner intended by management. Capitalization of borrowing costs is suspended if there are prolonged periods when development activity is interrupted. Capitalized costs are reduced by any profits from incidental operations.
Interest on projects is based on interest rates in place during the development period, and is capitalized until the project is ready for its intended use. The amount of interest capitalized during the years ended December 31, 2018 and 2017, was approximately $3.5 million and $3.4 million, respectively.
Impairment of Long-lived Assets
The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of its investments in real estate and related intangible assets may not be recoverable. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets may not be recoverable, the Company assesses the recoverability by estimating whether the Company will recover the carrying value of the real estate and related intangible assets through its undiscounted future cash flows (excluding interest) and its eventual disposition. If, based on this analysis, the Company does not believe that it will be able to recover the carrying value of the real estate and related intangible assets and
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liabilities, the Company would record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the investments in real estate and related intangible assets. Key inputs that the Company estimates in this analysis include projected rental rates, capital expenditures, property sale capitalization rates, and expected holding period of the property.
The Company evaluates its equity investments for impairment in accordance with ASC 320, Investments – Debt and Securities (“ASC 320”). ASC 320 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss.
The Company continually monitors its properties under development for impairment. Estimates of future cash flows used to test the recoverability of properties under development are based on their expected service potential when development is substantially complete. Those estimates include cash flows associated with all future expenditures necessary to develop the properties under development, including interest payments that will be capitalized as part of the cost of the properties under development.
The Company did not record any impairment losses during the years ended December 31, 2018 and 2017.
Assets Held for Sale and Discontinued Operations
When certain criteria are met, long-lived assets are classified as held for sale and are reported at the lower of their carrying value or their fair value, less costs to sell, and are no longer depreciated. For property sales on or after May 1, 2014, a disposal of a component of an entity is required to be reported as discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. Refer to Note 3. “Real Estate Investments” for a discussion of property sales.
Fair Value Measurements
Under GAAP, the Company is required to measure or disclose certain financial instruments at fair value on a recurring basis. In addition, the Company is required to measure other financial instruments and balances at fair value on a non-recurring basis (e.g., carrying value of impaired real estate loans receivable and long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:
• | Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities; |
• | Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and |
• | Level 3: prices or valuation techniques where little or no market data is available for inputs that are significant to the fair value measurement. |
When available, the Company utilizes quoted market prices or other observable inputs (Level 2 inputs), such as interest rates or yield curves, from independent third-party sources to determine fair value and classify such items in Level 1 or Level 2. In instances where the market for a financial instrument is not active, regardless of the availability of a nonbinding quoted market price, observable inputs might not be relevant and could require the Company to use significant judgment to derive a fair value measurement. Additionally, in an inactive market, a market price quoted from an independent third-party may rely more on models with inputs based on information available only to that independent third party. When the Company determines the market for an asset owned by it to be illiquid or when market transactions for similar instruments do not appear orderly, the Company uses several valuation sources (including internal valuations, discounted cash flow analysis and external appraisals) and establishes a fair value by assigning weights to the various valuation sources. Additionally, when determining the fair value of liabilities in circumstances in which a quoted price in an active market for an identical liability is not available, the Company measures fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets; or (ii) a present value technique that considers the future cash flows based on contractual obligations discounted by observed or estimated market rates of comparable liabilities. The use of contractual cash flows with regard to amount and timing significantly reduces the judgment applied in arriving at fair value.
Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In this regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in an immediate settlement of the instrument.
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The Company considers the following factors to be indicators of an inactive market: (1) there are few recent transactions; (2) price quotations are not based on current information; (3) price quotations vary substantially either over time or among market makers (for example, some brokered markets); (4) indexes that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability; (5) there is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the Company’s estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability; (6) there is a wide bid-ask spread or significant increase in the bid-ask spread; (7) there is a significant decline or absence of a market for new issuances (that is, a primary market) for the asset or liability or similar assets or liabilities; and (8) little information is released publicly (for example, a principal-to-principal market).
The Company considers the following factors to be indicators of non-orderly transactions: (1) there was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions; (2) there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant; (3) the seller is in or near bankruptcy or receivership (that is, distressed), or the seller was required to sell to meet regulatory or legal requirements (that is, forced); and (4) the transaction price is an outlier when compared with other recent transactions for the same or similar assets or liabilities.
Deferred Financing Costs
Deferred financing costs represent commitment fees, 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 straight-line method which approximates the effective interest method. Unamortized deferred financing costs are expensed when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financings that do not close are expensed in the period in which it is determined that the financing will not close.
The Company presents deferred financing costs, net of accumulated amortization, as a contra-liability that reduces the carrying amount of the associated note payable, rather than as a deferred asset. Deferred financing costs related to a line-of-credit arrangement are presented on the balance sheet as a deferred asset, regardless of whether there were any outstanding borrowings at period-end.
Accounting for Investments in Unconsolidated Joint Ventures
The Company accounts for its current investments in unconsolidated joint ventures under the equity method of accounting. Under the equity method of accounting, the Company records its initial investment in a joint venture at cost and subsequently adjusts the cost for the Company’s share of the joint venture’s income or loss and cash contributions and distributions each period. Refer to Note 4. “Investments in Unconsolidated Joint Ventures” for a discussion of the Company’s investments in joint ventures.
The Company monitors its investments in unconsolidated joint ventures periodically for impairment. No impairment indicators were identified and no impairment losses were recorded during the years ended December 31, 2018 and 2017.
Income Taxes
The Company has elected to be taxed as a REIT under the Internal Revenue Code. To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company’s annual REIT taxable income to stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Company generally will not be subject to federal income tax on income that it distributes as dividends to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost, unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially and adversely affect the Company’s net income and net cash available for distribution to stockholders. However, the Company believes that it is organized and operates in such a manner as to qualify for treatment as a REIT. Even if the Company qualifies as a REIT, it may be subject to certain state or local income taxes, and to U.S. federal income and excise taxes on its undistributed income.
The Company evaluates tax positions taken in the consolidated financial statements under the interpretation for accounting for uncertainty in income taxes. As a result of this evaluation, the Company may recognize a tax benefit from an uncertain tax position only if it is “more-likely-than-not” that the tax position will be sustained on examination by taxing authorities.
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When necessary, deferred income taxes are recognized in certain taxable entities. Deferred income tax is generally a function of the period’s temporary differences (items that are treated differently for tax purposes than for financial reporting purposes). A valuation allowance for deferred income tax assets is provided if all or some portion of the deferred income tax asset may not be realized. Any increase or decrease in the valuation allowance is generally included in deferred income tax expense.
The Company’s tax returns remain subject to examination and consequently, the taxability of the distributions is subject to change.
In 2017, the Company estimated it could owe Alternative Minimum Tax totaling approximately $0.1 million and this amount was accrued and included in expense as of December 31, 2017. During the year ended December 31, 2018, the Company finalized its calculation of taxes owed for 2017, which was less than the recorded accrual, resulting in a reversal of $47 thousand and a refund of $40 thousand.
Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed after adjusting the basic EPS computation for the effect of potentially dilutive securities outstanding during the period. The effect of non-vested shares, if dilutive, is computed using the treasury stock method. The Company accounts for non-vested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) as participating securities, which are included in the computation of earnings per share pursuant to the two-class method. The Company’s excess of distributions over earnings related to participating securities are shown as a reduction in income (loss) attributable to common stockholders in the Company’s computation of EPS.
Reclassifications
Certain prior period amounts have been reclassified to conform with current period’s presentation as a result of adoption of ASU 2016-18. See Cash, Cash Equivalents and Restricted Cash section above for discussion of the impact of these reclassifications.
Recent Accounting Pronouncements
The FASB issued the following ASUs which could have potential impact to the Company’s consolidated financial statements:
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for any removed or modified disclosures upon issuance of ASU 2018-13 and delayed adoption of the additional disclosures until the effective date. The adoption of ASU 2018-13 will not have an impact on the Company’s consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing diversity in practice. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. ASU 2016-15 will require adoption on a retrospective basis. The Company adopted ASU 2016-15 on January 1, 2018. Adoption of ASU 2016-15 did not have an impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (“ASU 2016-13”). ASU 2016-13 requires a financial asset, measured at amortized cost basis to be presented at the net amount expected to be collected. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, with adoption permitted for fiscal years beginning after December 15, 2018. Adjustments resulting from adopting ASU 2016-13 shall be applied through a cumulative-effect adjustment to retained earnings. The adoption of ASU 2016-13 will not have an impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires entities to recognize lease assets and lease liabilities on the consolidated balance sheet and disclose key information about leasing arrangements. The guidance retains a distinction between finance leases and operating leases. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous guidance. However, the principal difference from previous guidance is that the lease assets and lease liabilities arising
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from operating leases should be recognized in the statement of financial position. The accounting applied by a lessor is largely unchanged from that applied under the previous guidance. Lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. In July 2018, the FASB also issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases (“ASU 2018-10”). ASU 2018-10 provides narrow amendments that clarify how to apply certain aspects of the guidance in ASU 2016-02. Additionally, in July 2018, the FASB issued ASU No. 2018-11, Targeted Improvements to Topic 842, Leases (“ASU 2018-11”) to amend ASU 2016-02, which would provide lessors with a practical expedient, by class of underlying assets, to not separate non-lease components from the related lease components and, instead, to account for those components as a single lease component, if certain criteria are met. Also, in December 2018, the FASB issued ASU No. 2018-20, Narrow-Scope Improvements for Lessors (“ASU 2018-20”). ASU 2018-20 provides lessors amendments for accounting for sales taxes and other similar taxes collected from lessees, as well as accounting for certain lessor costs. The amendments in this guidance as well as ASU 2018-10, ASU 2018-11 and ASU 2018-20 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Earlier application is permitted. The Company believes that the adoption of ASU 2016-02 will not change the accounting for operating leases on its consolidated financial statements. The Company expects to utilize the practical expedients proposed in ASU 2018-11 as part of its adoption of ASU 2016-02.
3. REAL ESTATE INVESTMENTS
2018 Sales of Properties
On December 20, 2018, the Company consummated the disposition of Florissant Marketplace, located in Florissant, Missouri, for a sales price of approximately $16.0 million in cash. The Company used the net proceeds from the sale of Florissant Marketplace to repay $15.3 million of the total outstanding balance on its line of credit. The disposition of Florissant Marketplace resulted in a gain of $4.2 million, which was included on the Company’s consolidated statement of operations.
On July 17, 2018, the Company consummated the disposition of Ensenada Square, located in Arlington, Texas, for a sales price of approximately $5.8 million in cash. The Company used the net proceeds from the sale of Ensenada Square to repay $5.3 million of the total outstanding balance on its line of credit. The disposition of Ensenada Square resulted in a gain of $1.3 million, which was included on the Company’s consolidated statement of operations.
On June 21, 2018, the Company consummated the disposition of a portion of Topaz Marketplace, located in Hesperia, California, for a sales price of approximately $4.2 million in cash. The Company used the net proceeds from the sale of a portion of Topaz Marketplace to repay $4.0 million of the total outstanding balance on its line of credit. The disposition of a portion of Topaz Marketplace resulted in a gain of $2.4 million, which was included on the Company’s consolidated statement of operations.
2017 Sale of Properties
On November 1, 2017, the Company consummated the disposition of Morningside Marketplace, located in Fontana, California for $12.7 million in cash. The proceeds were used to pay down amounts outstanding under the Company’s line of credit. The sale of the property did not represent a strategic shift that will have a major effect on the Company’s operations and financial results and its results of operations were not reported as discontinued operations on the Company’s consolidated financial statements. The disposition of Morningside Marketplace resulted in a gain of $2.4 million, which was included in the Company’s consolidated statement of operations.
On October 31, 2017, the Company consummated the disposition of Cochran Bypass, located in Chester, South Carolina, for a sales price of approximately $2.5 million in cash. The net proceeds from the sale of Cochran Bypass were used to repay a portion of the outstanding balance under the Company’s line of credit. The sale of the property did not represent a strategic shift that will have a major effect on the Company’s operations and financial results and its results of operations were not reported as discontinued operations on the Company’s consolidated financial statements. The disposition of Cochran Bypass resulted in a gain of $44 thousand, which was included in the Company’s consolidated statement of operations.
On April 17, 2017, the Company consummated the disposition of Woodland West Marketplace, located in Arlington, Texas, for a sales price of approximately $14.6 million in cash. The Company used the net proceeds from the sale of Woodland West Marketplace to repay $13.7 million of the outstanding balance on its line of credit. The sale of the property did not represent a strategic shift that will have a major effect on the Company’s operations and financial results and its results of operations were not reported as discontinued operations on the Company’s consolidated financial statements. The disposition of Woodland West Marketplace resulted in a gain of $2.5 million, which was included on the Company’s consolidated statement of operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
On January 6, 2017, the Company consummated the disposition of Pinehurst Square East, located in Bismarck, North Dakota, for a sales price of approximately $19.2 million in cash. The Company used the net proceeds from the sale of Pinehurst Square East to repay $18.4 million of the outstanding balance on its line of credit. The sale of the property did not represent a strategic shift that will have a major effect on the Company’s operations and financial results and its results of operations were not reported as discontinued operations on the Company’s consolidated financial statements. The disposition of Pinehurst Square East resulted in a gain of $6.1 million, which was included on the Company’s consolidated statement of operations.
The sales of the above properties did not represent a strategic shift that will have a major effect on the Company’s operations and financial results and their results of operations were not reported as discontinued operations on the Company’s consolidated financial statements.
The following table summarizes net operating income related to the properties sold in 2018, which is included in the Company’s consolidated statements of operations for the years ended December 31, 2018 and 2017 (amounts in thousands):
Year Ended December 31, | |||||||
2018 | 2017 | ||||||
Operating income (loss) | $ | 1,687 | $ | 613 | |||
2017 Acquisition of Properties
On January 4, 2017, the Company purchased certain property located in the Hayes Valley neighborhood at 388 Fulton Street in San Francisco, California (“388 Fulton”). The seller was not affiliated with the Company or the Advisor. 388 Fulton is comprised of two leased commercial condominiums with an aggregate of 3,110 square feet of retail space. The aggregate purchase price of 388 Fulton was approximately $4.2 million, subject to customary closing costs and proration adjustments. The Company drew down $4.0 million on its line of credit to fund this acquisition.
On January 11, 2017, the Company purchased certain property located in the Silver Lake neighborhood of Los Angeles, California (“Silver Lake”). The seller was not affiliated with the Company or the Advisor. Silver Lake is comprised of two boutique retail buildings totaling approximately 10,497 square feet of retail space. The aggregate purchase price of Silver Lake was approximately $13.3 million subject to customary closing costs and proration adjustments. The Company drew down $11.0 million on its line of credit to fund this acquisition.
The Company evaluated the above transactions under the new framework pursuant to ASU 2017-01, which the Company early-adopted effective January 1, 2017. Acquisitions that do not meet the definition of a business are accounted for as asset acquisitions. Refer to Note 2. “Summary of Significant Accounting Policies” for further details. Accordingly, the Company accounted for the purchases of Silver Lake and 388 Fulton as asset acquisitions and allocated the total cash consideration to the individual assets and liabilities acquired on a relative fair value basis.
For the year ended December 31, 2017, the Company incurred $0.3 million of acquisition-related costs. These costs were capitalized and allocated to land and buildings acquired on a relative fair value basis.
Pro Forma Financial Information
The pro forma financial information below is based upon the Company’s historical consolidated statements of operations for the years ended December 31, 2018 and 2017, adjusted to give effect to the above sale transactions as if they had been completed at the beginning of 2018 and 2017, respectively. The pro forma financial information is presented for information purposes only, and may not be indicative of what actual results of operations would have been had the transaction occurred at the beginning of 2018 and 2017, respectively, nor does it purport to represent results of operations for future periods (amounts in thousands, except per share amounts):
(Pro Forma) | |||||||
Year Ended December 31, | |||||||
2018 | 2017 | ||||||
Rental and reimbursement revenues | $ | 3,813 | $ | 5,753 | |||
Net income | 6,640 | 16,171 | |||||
Net income attributable to common stockholders | 6,500 | 15,634 | |||||
Net income per share, attributable to common shares - basic and diluted | $ | 0.59 | $ | 1.43 | |||
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Assets Held for Sale and Liabilities Related to Assets Held for Sale
As of September 30, 2018, Shops at Turkey Creek, located in Knoxville, Tennessee, no longer met certain criteria to be classified as held for sale. As such, all the related assets, net of depreciation, and liabilities were recorded within the relevant categories in the consolidated balance sheets. Depreciation catch up of approximately $80 thousand was recorded upon the assets being placed back in service.
At December 31, 2017, Florissant Marketplace, Ensenada Square and Shops at Turkey Creek were classified as held for sale in the consolidated balance sheet. The Company’s consolidated statements of operations included net operating income of approximately $0.6 million for the year ended December 31, 2017, related to the assets held for sale.
The major classes of assets and liabilities related to assets held for sale included in the consolidated balance sheets are as follows (amounts in thousands):
December 31, | |||
2017 | |||
ASSETS | |||
Investments in real estate | |||
Land | $ | 5,248 | |
Building and improvements | 17,522 | ||
Tenant improvements | 1,189 | ||
23,959 | |||
Accumulated depreciation | (5,178 | ) | |
Investments in real estate, net | 18,781 | ||
Tenant receivables, net | 248 | ||
Lease intangibles, net | 1,617 | ||
Assets held for sale | $ | 20,646 | |
LIABILITIES | |||
Notes payable | $ | 10,749 | |
Below-market lease intangibles, net | 2,268 | ||
Liabilities related to assets held for sale | $ | 13,017 | |
Amounts above are being presented at their carrying value, which the Company believes to be lower than their estimated fair value less costs to sell.
4. INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES
SGO Joint Venture
Entry into SGO Joint Venture Agreement
On March 11, 2015, the Company, through a wholly-owned subsidiary, entered into the Limited Liability Company Agreement of SGO Retail Acquisition Venture, LLC (the “SGO Agreement”) to form a joint venture with Grocery Retail Grand Avenue Partners, LLC, a subsidiary of Oaktree Real Estate Opportunities Fund VI, L.P. (“Oaktree”), and GLB SGO, LLC, a wholly-owned subsidiary of Glenborough Property Partners, LLC (“GPP” and together with the Company and Oaktree, the “SGO Members”). GPP is an affiliate of the Company’s property manager, Glenborough, and an affiliate of the Advisor. The joint venture obtained a $34.0 million non-recourse mortgage loan from an unaffiliated third-party lender to purchase the properties.
The SGO Agreement provides for the ownership and operation of SGO Retail Acquisition Venture, LLC (the “SGO Joint Venture”), in which the Company owns a 19% interest, GPP owns a 1% interest, and Oaktree owns an 80% interest. In exchange for ownership in the SGO Joint Venture, the Company contributed $4.5 million to the SGO Joint Venture, which amount was credited against the sale of the Initial SGO Properties (as defined below) to the Joint Venture (as described below), GPP contributed $0.2 million to the SGO Joint Venture, and Oaktree contributed $19.1 million to the SGO Joint Venture.
Pursuant to the SGO Agreement, GPP manages and conducts the day-to-day operations and affairs of the SGO Joint Venture, subject to certain major decisions set forth in the SGO Agreement that require the consent of at least two members, one
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
of whom must be Oaktree. Income, losses and distributions will generally be allocated based on the members’ respective ownership interests. Additionally, in certain circumstances described in the SGO Agreement, the SGO Members may be required to make additional capital contributions to the SGO Joint Venture, in proportion to the SGO Members’ respective ownership interests.
Pursuant to the SGO Agreement, the SGO Joint Venture pays GPP a monthly asset management fee equal to a percentage of the aggregate investment value of the property owned by the SGO Joint Venture in the preceding month. In addition, if Oaktree has received a 12% internal rate of return on its capital contribution, then promptly following the sale of the last of the Initial SGO Properties, the SGO Joint Venture will pay GPP a disposition fee equal to 1% of the aggregate net sales proceeds received by the SGO Joint Venture from the sales of the Initial SGO Properties.
The SGO Joint Venture may make distributions of net cash flow to the SGO Members no less than quarterly, if appropriate. Distributions are pro rata to the SGO Members in proportion to their respective ownership interests in the SGO Joint Venture until the SGO Members have received a 12% internal rate of return on their capital contribution. Thereafter distributions will be 5% to the Company, 5% to GPP and the balance to the Company, GPP and Oaktree pro rata in proportion to each SGO Member’s respective ownership interests in the SGO Joint Venture until Oaktree has received aggregate distributions in an amount necessary to provide Oaktree with the greater of a 17% internal rate of return on its capital contribution and a 1.5 equity multiple on its capital contribution. Distributions will then be 12.5% to the Company, 5% to GPP and the balance to the Company, GPP and Oaktree pro rata in proportion to each SGO Member’s respective ownership interests in the SGO Joint Venture until Oaktree has received aggregate distributions in an amount necessary to provide Oaktree with the greater of a 22% internal rate of return on its capital contribution and a 1.75 equity multiple on its capital contribution (the “SGO Promoted Returns”). Distributions will then be 20% to the Company, 5% to GPP and the balance to the Company, GPP and Oaktree pro rata in proportion to each SGO Member’s respective ownership interests in the SGO Joint Venture. The portion of the SGO Promoted Returns payable to GPP are referred to herein as the “GPP SGO Incentive Fee.” The portion of the SGO Promoted Returns payable to the Company are referred to herein as the Company’s “SGO Earn Out.” As a part of the negotiations for the SGO Joint Venture, Glenborough agreed to reduce certain property management and related charges payable by the SGO Joint Venture from levels that were in place for these assets when held by the Company; the GPP SGO Incentive Fee was implemented in order to provide GPP and its affiliates with an opportunity to recoup those reductions should the SGO Joint Venture assets perform well financially.
Sale of Initial Properties to SGO Joint Venture
On March 11, 2015, as part of the formation of the SGO Joint Venture, the Company entered into a Purchase and Sale Agreement to sell Osceola Village, Constitution Trail and Aurora Commons to the SGO Joint Venture.
The closing of the sale was conditioned on the SGO Joint Venture issuing the Company a 19% membership interest and GPP a 1% membership interest in the SGO Joint Venture.
Due to the related party membership interests in the SGO Joint Venture, the sale of the Initial Properties was considered a partial sale in accordance with ASC Subtopic 360-20, Property, Plant, and Equipment – Real Estate Sales. The related party interests consist of the Company’s 19% and GPP’s 1% membership interests in the SGO Joint Venture. As a result, the Company deferred $1.2 million, representing 20%, of the total realized gain from the sale of the Initial Properties to the SGO Joint Venture. During the year ended December 31, 2017, the SGO Joint Venture completed the sales of the Aurora Common property and a portion of Osceola Village. As a result of the sales, during the year ended December 31, 2017, the Company recognized approximately $0.5 million, of the previously deferred gain. Effective January 1, 2018, the Company applied the provisions of ASC 610-20, for gains on sale of real estate, and recognizes any gains at the time control of a property is transferred and when it is probable that substantially all of the related consideration will be collected. As a result of adopting ASC 610-20, using the modified retrospective method, the sales criteria in ASC 360, Property, Plant, and Equipment, no longer applied. As such, the Company recognized $0.7 million of deferred gains related to sales of properties to the SGO Joint Venture, through a cumulative effect adjustment to accumulated deficit.
SGO MN Joint Venture
On September 30, 2015, the Company, through wholly-owned subsidiaries, entered into the Limited Liability Company Agreement of SGO MN Retail Acquisitions Venture, LLC (the “SGO MN Agreement”) to form a joint venture with MN Retail Grand Avenue Partners, LLC, a subsidiary of Oaktree, and GLB SGO MN, LLC, a wholly-owned subsidiary of GPP (together with the Company and Oaktree, the “SGO MN Members”).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The SGO MN Agreement provides for the ownership and operation of SGO MN Retail Acquisition Venture, LLC (the “SGO MN Joint Venture”), in which the Company owns a 10% interest, GPP owns a 10% interest, and Oaktree owns an 80% interest. In exchange for ownership in the SGO MN Joint Venture, the Company contributed cash in the amount of $2.8 million to the SGO MN Joint Venture, GPP contributed $2.8 million to the SGO MN Joint Venture, and Oaktree contributed $22.7 million to the SGO MN Joint Venture.
On September 30, 2015, the SGO MN Joint Venture used the capital contributions of the SGO MN Members, together with the proceeds of a loan from Bank of America, NA in the amount of $50.5 million, to acquire 14 retail properties located in Minnesota, North Dakota and Nebraska (the “SGO MN Properties”) from a subsidiary of IRET Properties, L.P., a subsidiary of Investors Real Estate Trust (“IRET”), for a total purchase price of $79.0 million. Subsequently, the SGO MN Joint Venture purchased an additional two retail properties in Minnesota from IRET for a purchase price of $1.6 million, one transaction closed on December 23, 2015 and the other on January 8, 2016. In 2016, the SGO MN Joint Venture sold six of the properties and distributed the net sales proceeds, after required reduction of debt, to the SGO MN Members. In 2018 and 2017, the SGO MN Joint Venture sold three and two of the SGO MN Properties, respectively, and distributed the net sales proceeds, after required reduction of debt, to the SGO MN Members.
Pursuant to the SGO MN Agreement, GPP manages and conducts the day-to-day operations and affairs of the SGO MN Joint Venture, subject to certain major decisions set forth in the SGO MN Agreement that require the consent of at least two of the SGO MN Members, one of whom must be Oaktree. Income, losses and distributions are generally allocated based on the SGO MN Members’ respective ownership interests. Additionally, in certain circumstances described in the SGO MN Agreement, the SGO MN Members may be required to make additional capital contributions to the SGO MN Joint Venture, in proportion to the Members’ respective ownership interests.
Pursuant to the SGO MN Agreement, the SGO MN Joint Venture pays GPP a monthly asset management fee equal to a percentage of the aggregate investment value of the property owned by the SGO MN Joint Venture in the preceding month. In addition, if Oaktree has received a 12% internal rate of return on its capital contribution, then promptly following the sale of the last of the SGO MN Properties, the SGO MN Joint Venture will pay GPP a disposition fee equal to one percent of the aggregate net sales proceeds received by the SGO MN Joint Venture from the sales of the SGO MN Properties.
The SGO MN Joint Venture makes distributions of net cash flow to the SGO MN Members no less than quarterly, if appropriate. Distributions are pro rata to the SGO MN Members in proportion to their respective ownership interests in the SGO MN Joint Venture until the SGO MN Members have received a 12% internal rate of return on their capital contribution. Thereafter distributions will be 10% to GPP and the balance to the Company, GPP and Oaktree pro rata in proportion to each SGO MN Member’s respective ownership interests in the SGO MN Joint Venture until Oaktree has received aggregate distributions in an amount necessary to provide Oaktree with the greater of a 17% internal rate of return on its capital contribution and a 1.5 equity multiple on its capital contribution. Distributions will then be 17.5% to GPP and the balance to the Company, GPP and Oaktree pro rata in proportion to each SGO MN Member’s respective ownership interests in the SGO MN Joint Venture until Oaktree has received aggregate distributions in an amount necessary to provide Oaktree with the greater of a 22% internal rate of return on its capital contribution and a 1.75 equity multiple on its capital contribution (the “Promoted Returns”). Distributions will then be 25% to GPP and the balance to the Company, GPP and Oaktree pro rata in proportion to each SGO MN Member’s respective ownership interests in the SGO MN Joint Venture. The portion of the Promoted Returns payable to GPP are referred to herein as the “GPP Incentive Fee.” As a part of the negotiations for the SGO MN Joint Venture, Glenborough agreed to certain reduced property management and related charges payable by the SGO MN Joint Venture; the GPP Incentive Fee was implemented in order to provide GPP and its affiliates with an opportunity to recoup those reductions should the SGO MN Joint Venture assets perform well financially.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes the Company’s investments in unconsolidated joint ventures as of December 31, 2018 and 2017 (amounts in thousands):
Ownership Interest | Investment | |||||||||||||||
Joint Venture | Date of Investment | December 31, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2017 | |||||||||||
SGO Retail Acquisitions Venture, LLC | 3/11/2015 | 19 | % | 19 | % | $ | 1,128 | $ | 978 | |||||||
SGO MN Retail Acquisitions Venture, LLC | 9/30/2015 | 10 | % | 10 | % | 1,573 | 1,727 | |||||||||
Total | $ | 2,701 | $ | 2,705 | ||||||||||||
Year Ended | ||||||||||||||||
December 31, 2018 | December 31, 2017 | |||||||||||||||
Equity in income (loss) of unconsolidated joint ventures | $ | 229 | $ | (59 | ) | |||||||||||
A summary of the aggregate balance sheets and results of operations of the SGO Joint Venture and the SGO MN Joint Venture is presented below (amounts in thousands):
December 31, | |||||||
2018 | 2017 | ||||||
ASSETS | |||||||
Investments in real estate, net | $ | 51,944 | $ | 64,541 | |||
Other assets | 3,123 | 5,408 | |||||
Assets held for sale | 9,361 | 1,169 | |||||
Total assets | $ | 64,428 | $ | 71,118 | |||
LIABILITIES AND MEMBERS’ CAPITAL | |||||||
Notes payable | $ | 34,441 | $ | 45,062 | |||
Other liabilities | 2,224 | 2,737 | |||||
Liabilities held for sale | 6,094 | 900 | |||||
Total liabilities | 42,759 | 48,699 | |||||
Members’ capital | 21,669 | 22,419 | |||||
Total liabilities and members’ capital | $ | 64,428 | $ | 71,118 | |||
Year Ended December 31, | |||||||
2018 | 2017 | ||||||
RESULTS OF OPERATIONS | |||||||
Revenue | $ | 8,688 | $ | 9,129 | |||
Expenses | (8,893 | ) | (9,603 | ) | |||
Operating loss | (205 | ) | (474 | ) | |||
Other income | 2,867 | 350 | |||||
Net income (loss) | $ | 2,662 | $ | (124 | ) | ||
The Company’s off-balance sheet arrangements consist primarily of investments in the joint ventures as set forth in the table above. The joint ventures typically fund their cash needs through secured debt financings obtained by and in the name of the joint venture entity. The joint ventures’ debts are secured by a first mortgage, are without recourse to the joint venture members, and do not represent a liability of the members other than carve-out guarantees for certain matters such as environmental conditions, misuse of funds and material misrepresentations. As of December 31, 2018 and 2017, the Company has provided carve-out guarantees in connection with the two aforementioned unconsolidated joint ventures; in connection with those carve-out guarantees, the Company has certain rights of recovery from the joint venture members.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
5. VARIABLE INTEREST ENTITIES
The Company has variable interests in, and is the primary beneficiary of, variable interest entities (“VIEs”) through its investments in (i) the Sunset & Gardner Joint Venture (formerly known as Gelson’s Joint Venture) and (ii) the 3032 Wilshire Joint Venture (both defined below). The Company has consolidated the accounts of these variable interest entities.
Sunset & Gardner Joint Venture
On January 7, 2016, the Company, through wholly-owned subsidiaries, entered into the Limited Liability Company Agreement of Sunset & Gardner Investors, LLC (the “Sunset & Gardner Joint Venture Agreement”) to form a joint venture (the” Sunset & Gardner Joint Venture”) with Sunset & Gardner LA, LLC (“S&G LA” and, together with the Company, the “Sunset & Gardner Members”), a subsidiary of Cadence Capital Investments, LLC (“Cadence”).
The Sunset & Gardner Joint Venture Agreement provides for the ownership and operation of certain real property by the Sunset & Gardner Joint Venture, in which the Company owns a 100% capital interest and a 50% profits interest. In exchange for ownership in the Sunset & Gardner Joint Venture, the Company contributed cash in an amount of $5.3 million in initial capital contributions and has agreed to contribute a minimum of $0.7 million in subsequent capital contributions to the Sunset & Gardner Joint Venture. S&G LA contributed its rights to acquire the real property and agreed to provide certain management and development services.
On January 28, 2016, the Sunset & Gardner Joint Venture used the capital contributions of the Company, together with the proceeds of a loan in the amount of $10.7 million, to purchase property located at the corner of Sunset Boulevard and Gardner in Hollywood, California from a third party seller, for a total purchase price of approximately $13.0 million.
Pursuant to the Sunset & Gardner Joint Venture Agreement, S&G LA manages and conducts the day-to-day operations and affairs of the Sunset & Gardner Joint Venture, subject to certain major decisions set forth in the Sunset & Gardner Joint Venture Agreement that require the consent of all the Sunset & Gardner Members. The Company has the power to direct the activities of the Sunset & Gardner Joint Venture through its approval process of the activities that most significantly impact the economic performance of the Sunset & Gardner Joint Venture. Such activities include the budgeting, leasing, financings, and ultimately, the sale of the property. Income, losses and distributions are generally allocated based on the Sunset & Gardner Members’ respective capital and profits interests. Through the Company’s commitment to contribute 100% of capital to develop and operate the property through the life of the Sunset & Gardner Joint Venture, the Company has an obligation to absorb losses of the Sunset & Gardner Joint Venture. Additionally, in certain circumstances described in the Sunset & Gardner Joint Venture Agreement, the Company may be required to make additional capital contributions to the Joint Venture, in proportion to the Sunset & Gardner Members’ respective ownership interests.
Until the Company has received back its capital contribution and specified preferred returns, all distributions go to the Company; thereafter, the Sunset & Gardner Joint Venture will distribute the profits 50% to the Company and 50% to S&G LA. Additionally, the Company has the ability to buy out S&G LA upon certain conditions per the Operating Agreement.
Through December 31, 2018, the Company made additional capital contributions totaling $5.3 million to the Sunset & Gardner Joint Venture.
3032 Wilshire Joint Venture
On December 21, 2015, the Company, through wholly-owned subsidiaries, entered into the Limited Liability Company Agreement of 3032 Wilshire Investors, LLC (the “Wilshire Joint Venture Agreement”) to form a joint venture (the “Wilshire Joint Venture”) with 3032 Wilshire SM, LLC, a subsidiary of Cadence (together with the Company, the “Wilshire Members”).
On December 14, 2015, and January 5, 2016, the Company paid deposits in the amounts of $0.5 million and $0.1 million, respectively, toward the acquisition of certain property located at 3032 Wilshire Boulevard and 1210 Berkeley Street in Santa Monica, California (the “Wilshire Property”). On March 7, 2016, the Company contributed $5.7 million to the Wilshire Joint Venture. The Wilshire Joint Venture Agreement provides for the ownership and operation of certain real property by the Wilshire Joint Venture, in which the Company owns a 100% capital interest and a 50% profits interest.
On March 8, 2016, the Wilshire Joint Venture used the deposits and capital contribution of the Company, together with the proceeds of a loan in the amount of $8.5 million, to acquire the Wilshire Property from a third-party seller, for a total purchase price of $13.5 million. The Wilshire Joint Venture is repositioning, and intends to re-lease, the existing improvements on the property.
Pursuant to the Wilshire Joint Venture Agreement, 3032 Wilshire SM manages and conducts the day-to-day operations and affairs of the Wilshire Joint Venture, subject to certain major decisions set forth in the Wilshire Joint Venture Agreement that require the consent of all the Wilshire Members. The Company has the power to direct the activities of the Wilshire Joint
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Venture through its approval process of the activities that most significantly impact the economic performance of the Wilshire Joint Venture. Such activities include the budgeting, leasing, financings, and ultimately, the sale of the property. Income, losses and distributions are generally allocated based on the Wilshire Members’ respective capital and profits interests. Through the Company’s commitment to contribute 100% of capital to develop and operate the property through the life of the Wilshire Joint Venture, the Company has an obligation to absorb losses of the Wilshire Joint Venture. Additionally, in certain circumstances described in the Wilshire Joint Venture Agreement, the Company may be required to make additional capital contributions to the Wilshire Joint Venture, in proportion to the Wilshire Members’ respective ownership interests.
Until the Company has received back its capital contribution and specified preferred returns, all distributions go to the Company; thereafter, the Wilshire Joint Venture will distribute the profits 50% to the Company and 50% to 3032 Wilshire SM. Additionally, the Company has the ability to buy out 3032 Wilshire SM upon certain conditions per the Operating Agreement.
Through December 31, 2018, the Company made additional capital contributions totaling $2.8 million to the Wilshire Joint Venture.
The following reflects the aggregate assets and liabilities of the Sunset & Gardner Joint Venture and the Wilshire Joint Venture, which were consolidated by the Company, as of December 31, 2018 and 2017 (amounts in thousands):
December 31, | |||||||
2018 | 2017 | ||||||
ASSETS | |||||||
Properties under development and development costs: | |||||||
Land | $ | 25,851 | $ | 25,851 | |||
Buildings | 570 | 585 | |||||
Development costs | 13,813 | 9,609 | |||||
Properties under development and development costs | 40,234 | 36,045 | |||||
Cash, cash equivalents and restricted cash | 276 | 1,099 | |||||
Prepaid expenses and other assets, net | 9 | 9 | |||||
Lease intangibles, net | 4 | — | |||||
TOTAL ASSETS (1) | $ | 40,523 | $ | 37,153 | |||
LIABILITIES | |||||||
Notes payable, net (2) | $ | 17,166 | $ | 19,116 | |||
Accounts payable and accrued expenses | 132 | 478 | |||||
Amounts due to affiliates | 8 | 9 | |||||
Other liabilities | 9 | 9 | |||||
TOTAL LIABILITIES | $ | 17,315 | $ | 19,612 | |||
(1) | The assets of the Sunset & Gardner Joint Venture and Wilshire Joint Venture can be used only to settle obligations of the respective consolidated joint ventures. |
(2) | As of December 31, 2018 and 2017, includes reclassification of approximately $0.3 million and $0.1 million, respectively, of deferred financing costs, net, as a contra-liability. The creditors of the consolidated joint ventures do not have recourse to the general credit of the Company. The notes payable of the consolidated joint ventures are not guaranteed by the Company. |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. FUTURE MINIMUM RENTAL INCOME
Operating Leases
The Company’s real estate properties are leased to tenants under operating leases for which the terms and expirations vary. As of December 31, 2018, the leases at the Company’s properties have remaining terms (excluding options to extend) of up to 12.9 years with a weighted-average remaining term (excluding options to extend) of approximately 5.9 years. The leases may have provisions to extend the lease agreements, options for early termination after paying a specified penalty, rights of first refusal to purchase the property at competitive market rates, and other terms and conditions as negotiated. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants. Generally, upon the execution of a lease, the Company requires security deposits from tenants in the form of a cash deposit and/or a letter of credit. Amounts required as security deposits vary depending upon the terms of the respective leases and the creditworthiness of the tenant, but generally are not significant amounts. Therefore, exposure to credit risk exists to the extent that a receivable from a tenant exceeds the amount of its security deposit. Security deposits received in cash related to tenant leases are included in other liabilities in the accompanying consolidated balance sheets and totaled approximately $0.2 million as of both December 31, 2018 and 2017.
As of December 31, 2018, the future minimum rental income from the Company’s properties under non-cancelable operating leases was as follows (amounts in thousands):
2019 | $ | 2,757 | |
2020 | 2,625 | ||
2021 | 2,365 | ||
2022 | 2,353 | ||
2023 | 2,316 | ||
Thereafter | 7,750 | ||
Total | $ | 20,166 | |
7. LEASE INTANGIBLES AND BELOW-MARKET LEASE LIABILITIES, NET
As of December 31, 2018 and 2017, the Company’s acquired lease intangibles and below-market lease liabilities were as follows (amounts in thousands):
Lease Intangibles | Below-Market Lease Liabilities | ||||||||||||||
December 31, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2017 | ||||||||||||
Cost | $ | 3,030 | $ | 2,783 | $ | (526 | ) | $ | (571 | ) | |||||
Accumulated amortization | (1,140 | ) | (722 | ) | 156 | 133 | |||||||||
Total | $ | 1,890 | $ | 2,061 | $ | (370 | ) | $ | (438 | ) | |||||
The Company’s amortization of lease intangibles and below-market lease liabilities for the years ended December 31, 2018 and 2017, were as follows (amounts in thousands):
Lease Intangibles | Below-Market Lease Liabilities | ||||||||||||||
Year Ended December 31, | Year Ended December 31, | ||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||
Amortization | $ | (402 | ) | $ | (853 | ) | $ | 67 | $ | 196 | |||||
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The scheduled future amortization of lease intangibles and below-market lease liabilities, as of December 31, 2018, was as follows (amounts in thousands):
Lease Intangibles | Below-Market Lease Intangibles | ||||||
2019 | $ | 356 | $ | (63 | ) | ||
2020 | 276 | (53 | ) | ||||
2021 | 229 | (37 | ) | ||||
2022 | 227 | (37 | ) | ||||
2023 | 219 | (37 | ) | ||||
Thereafter | 583 | (143 | ) | ||||
Total | $ | 1,890 | $ | (370 | ) | ||
8. NOTES PAYABLE, NET
Line of Credit
The Company’s line of credit is a revolving credit facility with an initial maximum aggregate commitment of $30.0 million. Effective February 15, 2017, the Company’s line of credit was refinanced to increase the maximum aggregate commitment under the credit facility from $30.0 million to $60.0 million. The credit facility matures on February 15, 2020. Each loan made pursuant to the credit facility will be either a LIBOR loan or a base rate loan, at the election of the Company, plus an applicable margin, as defined. Monthly payments are interest only with the entire principal balance and all outstanding interest due at maturity. The Company will pay the lender an unused commitment fee, quarterly in arrears, which will accrue at 0.30% per annum, if the usage under the Company’s line of credit is less than or equal to 50% of the line of credit amount, and 0.20% per annum if the usage under the Company’s line of credit is greater than 50% of the line of credit amount. The Company is providing a guaranty of all of its obligations under the Company’s line of credit and all other loan documents.
As of December 31, 2018 and 2017, the Company’s line of credit had an outstanding principal balance of $17.4 million and $23.1 million, respectively. The December 31, 2017, balance excludes $10.7 million, which was classified as held for sale as of December 31, 2017. As of December 31, 2018 and 2017, the Company’s line of credit was secured by Topaz Marketplace, 8 Octavia Street, 400 Grove Street, the Fulton Shops, 450 Hayes, 388 Fulton, Silver Lake, and The Shops at Turkey Creek.
Mortgage Loans Secured by Properties Under Development
On August 31, 2018, the Company refinanced and repaid its initial financing with a new loan from Lone Oak Fund LLC (the “Wilshire Loan”). The Wilshire Loan has a principal balance of approximately $8.8 million, and bears an interest rate of 6.9% per annum, payable monthly, commencing on September 1, 2018. The Wilshire Loan is scheduled to mature on September 30, 2019. The Company intends to explore all available financing options prior to the loan’s maturity date. The Wilshire Loan is secured by, a first Deed of Trust on the property.
As of December 31, 2017, the Company had borrowings of $8.5 million in connection with its investment in the Wilshire Joint Venture.
On October 29, 2018, the Company refinanced and repaid its initial financing with a new loan from Lone Oak Fund LLC (the “Sunset & Gardner Loan”). The Sunset & Gardner Loan has a principal balance of approximately $8.7 million, and bears an interest rate of 6.9% per annum. The Sunset & Gardner Loan is scheduled to mature on October 31, 2019. The Company intends to explore all available financing options prior to the loan’s maturity date. The Sunset & Gardner Loan is secured by, a first Deed of Trust on the property.
As of December 31, 2017, the Company had borrowings of $9.7 million in connection with its investment in the Sunset & Garnder Joint Venture.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following is a schedule of future principal payments for all of the Company’s notes payable outstanding as of December 31, 2018 (amounts in thousands):
2019 | $ | 17,450 | |
2020 | 17,370 | ||
Total (1) | $ | 34,820 | |
(1) | Total future principal payments reflect actual amounts due to creditors, and excludes reclassification of $0.3 million deferred financing costs, net. |
During the years ended December 31, 2018 and 2017, the Company incurred and expensed approximately $0.9 million and $1.8 million, respectively, of interest costs, which included the amortization of deferred financing costs of approximately $0.6 million and $0.5 million, respectively, for each period. Also during the years ended December 31, 2018 and 2017, the Company incurred and capitalized approximately $3.5 million and $3.4 million, respectively, of interest expense related to the variable interest entities, which included amortization of deferred financing costs of approximately $0.3 million and $0.5 million, respectively, for each period.
As of December 31, 2018 and 2017, interest expense payable was approximately $0.2 million and $0.3 million, respectively, including an amount related to the variable interest entities of approximately $0.1 million and $0.2 million, respectively, for each period.
9. FAIR VALUE DISCLOSURES
The Company believes the total carrying values reflected on its consolidated balance sheets for cash, cash equivalents and restricted cash, accounts receivable, accounts payable and accrued expenses, amounts due to affiliates, mortgage loans secured by properties under development, and the Company’s line of credit reasonably approximate their fair values due to their short-term nature.
As part of the Company’s ongoing evaluation of the Company’s real estate portfolio, the Company estimates the fair value of its investments in real estate by obtaining outside independent appraisals on all of the operating properties. The appraised values are compared with the carrying values of its real estate portfolio to determine if there are indications of impairment.
For both the years ended December 31, 2018 and 2017, the Company did not record any impairment losses.
10. EQUITY
Common Stock
Under the Company’s Articles of Amendment and Restatement (the “Charter”), the Company has the authority to issue 400,000,000 shares of common stock. All shares of common stock have a par value of $0.01 per share.
On February 7, 2013, the Company terminated the Offering and ceased offering its securities. The Company sold 10,688,940 shares of common stock in its primary offering for gross operating proceeds of $104.7 million, 391,182 shares of common stock under the distribution reinvestment plan (“DRIP”) for gross offering proceeds of $3.6 million, granted 50,000 shares of restricted stock and issued 273,729 common shares to pay a portion of a special distribution on November 4, 2015. Cumulatively, through December 31, 2018, pursuant to the Original Share Redemption Program and the Amended and Restated Share Redemption Program (the “SRP”), the Company has redeemed 737,255 shares sold in the Offering and/or the DRIP for $5.3 million.
Common Units of the OP
On May 26, 2011, in connection with the acquisition of Pinehurst Square East, a retail property located in Bismarck, North Dakota, the OP issued 287,472 Common Units to certain of the sellers of Pinehurst Square East who elected to receive Common Units for an aggregate value of approximately $2.6 million, or $9.00 per Common Unit. On March 12, 2012, in connection with the acquisition of Turkey Creek, a retail property located in Knoxville, Tennessee, the OP issued 144,324 Common Units to certain of the sellers of Turkey Creek who elected to receive Common Units for an aggregate value of approximately $1.4 million, or $9.50 per Common Unit.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
During the year ended December 31, 2017, in response to anticipated taxable income allocations to OP Unit holders who acquired their OP Units as a part of their contribution of Pinehurst Square East, certain holders of Common Units of the OP elected to convert their common units of the OP into the Company’s common shares on a one-for-one basis. As a result, 187,114 Common Units were converted to common shares for an aggregate basis of approximately $0.9 million.
Pursuant to the Advisory Agreement, in April 2014 the Company caused the OP to issue to the Advisor a separate series of limited partnership interests of the OP in exchange for a capital contribution to the OP of $1 thousand (the “Special Units”). The terms of the Special Units entitle the Advisor to (i) 15% of the Company’s net sale proceeds upon disposition of its assets after the Company’s stockholders receive a return of their investment plus a 7% cumulative, non-compounded rate of return or (ii) an equivalent amount in the event that the Company lists its shares of common stock on a national securities exchange or upon certain terminations of the Advisory Agreement after the Company’s stockholders are deemed to have received a return of their investment plus a 7% cumulative, non-compounded rate of return.
The holders of Common Units, other than the Company and the holder of the Special Units, generally have the right to cause the OP to redeem all or a portion of their Common Units for, at the Company’s sole discretion, shares of the Company’s common stock, cash or a combination of both. If the Company elects to redeem Common Units for shares of common stock, the Company will generally deliver one share of common stock for each Common Unit redeemed. Holders of Common Units, other than the Company and the holders of the Special Units, may exercise their redemption rights at any time after one year following the date of issuance of their Common Units; provided, however, that a holder of Common Units may not deliver more than two redemption notices in a single calendar year and may not exercise a redemption right for less than 1,000 Common Units, unless such holder holds less than 1,000 Common Units, in which case, it must exercise its redemption right for all of its Common Units.
Preferred Stock
The Charter authorizes the Company to issue 50,000,000 shares of $0.01 par value preferred stock. As of December 31, 2018 and 2017, no shares of preferred stock were issued and outstanding.
Share Redemption Program
On April 1, 2015, the Company’s board of directors approved the reinstatement of the share redemption program (which had been suspended since January 15, 2013) and adopted the SRP. Under the SRP, only shares submitted for repurchase in connection with the death or “qualifying disability” (as defined in the SRP) of a stockholder are eligible for repurchase by the Company. Under the current SRP, as amended to date, the number of shares to be redeemed is limited to the lesser of (i) a total of $3.5 million for redemptions sought upon a stockholder’s death and a total of $1.0 million for redemptions sought upon a stockholder’s qualifying disability, and (ii) 5% of the weighted-average number of shares of the Company’s common stock outstanding during the prior calendar year. Share repurchases pursuant to the SRP are made at the sole discretion of the Company. The Company reserves the right to reject any redemption request for any reason or no reason or to amend or terminate the share redemption program at any time subject to the notice requirements in the SRP.
The redemption price for shares that are redeemed is 100% of the Company’s most recent estimated net asset value per share as of the applicable redemption date. A redemption request must be made within one year after the stockholder’s death or disability.
The SRP provides that any request to redeem less than $5 thousand worth of shares will be treated as a request to redeem all of the stockholder’s shares. If the Company cannot honor all redemption requests received in a given quarter, all requests, including death and disability redemptions, will be honored on a pro rata basis. If the Company does not completely satisfy a redemption request in one quarter, it will treat the unsatisfied portion as a request for redemption in the next quarter when funds are available for redemption, unless the request is withdrawn. The Company may increase or decrease the amount of funding available for redemptions under the SRP on ten business days’ notice to stockholders. Shares submitted for redemption during any quarter will be redeemed on the penultimate business day of such quarter. The record date for quarterly distributions has historically been and is expected to continue to be the last business day of each quarter; therefore, shares that are redeemed during any quarter are expected to be redeemed prior to the record date and thus would not be eligible to receive the distribution declared for such quarter.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes share redemption activity during the years ended December 31, 2018 and 2017 (amounts in thousands, except shares):
Year Ended December 31, | |||||||
2018 | 2017 | ||||||
Shares of common stock redeemed | 125,139 | 136,921 | |||||
Purchase price | $ | 762 | $ | 865 | |||
As stated above, cumulatively, through December 31, 2018, pursuant to the Original Share Redemption Program and the SRP, the Company has redeemed 737,255 shares sold in the Offering and/or its dividend reinvestment plan for $5.3 million.
Quarterly Distributions
In order to qualify as a REIT, the Company is required to distribute at least 90% of its annual REIT taxable income, subject to certain adjustments, to its stockholders. Some or all of the Company’s distributions have been paid, and in the future may continue to be paid from sources other than cash flows from operations.
Under the terms of the amended credit facility, the Company may pay distributions to its investors so long as the total amount paid does not exceed 100% of the cumulative Adjusted Funds From Operations plus up to an additional $2.0 million of the Company’s net proceeds from property dispositions, as defined in the amended Company’s line of credit; provided, however, that the Company is not restricted from making any distributions necessary in order to maintain its status as a REIT. The Company’s board of directors evaluates the Company’s ability to make quarterly distributions based on the Company’s operational cash needs.
The following tables set forth the quarterly distributions declared to the Company’s common stockholders and Common Unit holders for the years ended December 31, 2018, and 2017 (amounts in thousands, except per share amounts):
Distribution Record Date | Distribution Payable Date | Distribution Per Share of Common Stock / Common Unit | Total Common Stockholders Distribution | Total Common Unit Holders Distribution | Total Distribution | ||||||||||||||
First Quarter 2018 | 3/31/2018 | 4/30/2018 | $ | 0.06 | $ | 659 | $ | 14 | $ | 673 | |||||||||
Second Quarter 2018 | 6/30/2018 | 7/31/2018 | 0.06 | 658 | 14 | 672 | |||||||||||||
Third Quarter 2018 | 9/30/2018 | 10/31/2018 | 0.06 | 656 | 14 | 670 | |||||||||||||
Fourth Quarter 2018 | 12/31/2018 | 1/31/2019 | 0.06 | 652 | 14 | 666 | |||||||||||||
Total | $ | 2,625 | $ | 56 | $ | 2,681 | |||||||||||||
Distribution Record Date | Distribution Payable Date | Distribution Per Share of Common Stock / Common Unit | Total Common Stockholders Distribution | Total Common Unit Holders Distribution | Total Distribution | ||||||||||||||
First Quarter 2017 | 3/31/2017 | 4/28/2017 | $ | 0.06 | $ | 655 | $ | 25 | $ | 680 | |||||||||
Second Quarter 2017 | 6/30/2017 | 7/31/2017 | 0.06 | 652 | 25 | 677 | |||||||||||||
Third Quarter 2017 | 9/30/2017 | 10/31/2017 | 0.06 | 660 | 16 | 676 | |||||||||||||
Fourth Quarter 2017 | 12/31/2017 | 1/31/2018 | 0.06 | 659 | 14 | 673 | |||||||||||||
Total | $ | 2,626 | $ | 80 | $ | 2,706 | |||||||||||||
11. EARNINGS PER SHARE
EPS is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during each period. Diluted EPS is computed after adjusting the basic EPS computation for the effect of potentially dilutive securities outstanding during the period. The effect of non-vested shares, if dilutive, is computed using the treasury stock method. The Company applies the two-class method for determining EPS as its outstanding shares of
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
non-vested restricted stock are considered participating securities as dividend payments are not forfeited even if the underlying award does not vest. There was no unvested stock as of December 31, 2018. The Company’s excess of distributions over earnings related to participating securities are shown as a reduction in income (loss) attributable to common stockholders in the Company’s computation of EPS.
The following table sets forth the computation of the Company’s basic and diluted earnings (loss) per share for the years ended December 31, 2018 and 2017 (amounts in thousands, except shares and per share amounts):
Year Ended December 31, | |||||||
2018 | 2017 | ||||||
Numerator - basic and diluted | |||||||
Net income | $ | 8,327 | $ | 8,856 | |||
Net income attributable to non-controlling interests | 175 | 295 | |||||
Net income attributable to common shares | $ | 8,152 | $ | 8,561 | |||
Denominator - basic and diluted | |||||||
Basic weighted average common shares | 10,962,716 | 10,936,361 | |||||
Common Units (1) | — | — | |||||
Diluted weighted average common shares | 10,962,716 | 10,936,361 | |||||
Earnings per common share - basic and diluted | |||||||
Net earnings attributable to common shares | $ | 0.74 | $ | 0.78 | |||
(1) | The effect of 235,194 convertible Common Units pursuant to the redemption rights outlined in the Company’s registration statement on Form S-11 have not been included as they would not be dilutive. |
12. RELATED PARTY TRANSACTIONS
On August 7, 2013, the Company entered into the Advisory Agreement with the Advisor, which has been renewed for successive terms with a current expiration date of August 9, 2019. The Advisor manages the Company’s business as the Company’s external advisor pursuant to the Advisory Agreement. Pursuant to the Advisory Agreement, the Company will pay the Advisor specified fees for services related to the investment of funds in real estate and real estate-related investments, management of the Company’s investments and for other services.
On March 11, 2015, the Company, through a wholly-owned subsidiary, entered into the Limited Liability Company Agreement of SGO Retail Acquisitions Venture, LLC to form the SGO Joint Venture. On September 30, 2015, the Company, through wholly-owned subsidiaries, entered into the Limited Liability Company Agreement of SGO MN Retail Acquisitions Venture, LLC to form the SGO MN Joint Venture. For additional information regarding the SGO Joint Venture and the SGO MN Joint Venture, refer to Note 4. “Investments in Unconsolidated Joint Ventures.”
Although paid in full on December 14, 2017, on September 27, 2017, the Company, through the OP, entered into a $2.5 million bridge loan with Glenborough Property Partners, LLC, an affiliate of the Advisor (the “Bridge Loan”). The Bridge Loan was scheduled to mature on March 31, 2018, at which point the outstanding balance of the principal and all accrued and unpaid interest would be due and payable. The Bridge Loan incurred interest at an adjustable rate equal to the credit facility prime rate. Interest was payable monthly in arrears. The Company had the right to prepay the Bridge Loan at any time in whole or in part without premium or penalty. There were no other loan fees or financing coordination fees paid or payable in connection with this loan. During the year ended December 31, 2017, the Company incurred $23 thousand of interest expense related to the Bridge Loan.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Summary of Related Party Fees
The following table sets forth the Advisor related party costs incurred and payable by the Company for the periods presented (amounts in thousands):
Incurred | Payable as of | |||||||||||||||
Year Ended December 31, | December 31, | |||||||||||||||
Expensed | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Financing coordination fees | $ | 30 | $ | — | $ | — | $ | — | ||||||||
Asset management fees | 750 | 868 | — | — | ||||||||||||
Reimbursement of operating expenses | 164 | 231 | — | — | ||||||||||||
Property management fees | 269 | 350 | 30 | 21 | ||||||||||||
Disposition fees | 336 | 589 | — | — | ||||||||||||
Total | $ | 1,549 | $ | 2,038 | $ | 30 | $ | 21 | ||||||||
Capitalized | ||||||||||||||||
Acquisition fees | $ | 60 | $ | 194 | $ | — | $ | — | ||||||||
Leasing fees | 4 | 222 | — | — | ||||||||||||
Legal leasing fees | 39 | 95 | — | — | ||||||||||||
Construction management fees | 39 | 42 | — | — | ||||||||||||
Financing coordination fees | 269 | 814 | — | — | ||||||||||||
Total | $ | 411 | $ | 1,367 | $ | — | $ | — | ||||||||
Acquisition Fees
Under the Advisory Agreement, the Advisor is entitled to receive an acquisition fee equal to 1% of (1) the cost of each investment acquired directly by the Company or (2) the Company’s allocable cost of an investment acquired pursuant to a joint venture, in each case including purchase price, acquisition expenses and any debt attributable to such investments. An acquisition fee is capitalized by the Company when the related transaction does not qualify as a business combination; otherwise an acquisition fee is expensed.
Financing Coordination Fees
Under the Advisory Agreement, the Advisor is entitled to receive a financing coordination fee equal to 1% of the amount made available and/or outstanding under any (1) financing obtained or assumed, directly or indirectly, by the Company or the OP and used to acquire or originate investments, or (2) the refinancing of any financing obtained or assumed, directly or indirectly, by the Company or the OP.
Asset Management Fees
Under the Advisory Agreement, the Advisor is entitled to receive an asset management fee equal to a monthly fee of one-twelfth (1/12th) of 0.6% of the higher of (1) aggregate cost on a GAAP basis (before non-cash reserves and depreciation) of all investments the Company owns, including any debt attributable to such investments, or (2) the fair market value of the Company’s investments (before non-cash reserves and depreciation) if the board of directors has authorized the estimate of a fair market value of the Company’s investments; provided, however, that the asset management fee will not be less than $250,000 in the aggregate during any one calendar year.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Reimbursement of Operating Expenses
The Company reimburses the Advisor for all expenses paid or incurred by the Advisor in connection with the services provided to the Company, subject to the limitation that the Company will not reimburse the Advisor for any amount by which the Company’s total operating expenses (including the asset management fee described below) at the end of the four preceding fiscal quarters exceeded the greater of (1) 2% of its average invested assets (as defined in the Company’s Articles of Amendment and Restatement (the “Charter”)); or (2) 25% of its net income (as defined in the Charter) determined without reduction for any additions to depreciation, bad debts or other similar non-cash expenses and excluding any gain from the sale of the Company’s assets for that period (the “2%/25% Guideline”). The Advisor is required to reimburse the Company quarterly for any amounts by which total operating expenses exceed the 2%/25% Guideline in the previous expense year that the independent directors do not approve. The Company will not reimburse the Advisor for any of its personnel costs or other overhead costs except for customary reimbursements for personnel costs under property management agreements entered into between the OP and the Advisor or its affiliates. Notwithstanding the above, the Company may reimburse the Advisor for expenses in excess of the 2%/25% Guideline if a majority of the independent directors determine that such excess expenses are justified based on unusual and non-recurring factors. Pursuant to an amendment to the Advisory Agreement entered on August 2, 2018, the board of directors, including a majority of the independent directors identified certain unusual and non-recurring factors that would justify reimbursement to the Advisor of amounts in excess of the 2%/25% Guidelines and confirmed that the Advisor would not be obligated to reimburse the Company for these excess amounts to the extent the excess was caused by such factors.
For the years ended December 31, 2018 and 2017, the Company’s total operating expenses (as defined in the Charter) did not exceed the 2%/25% Guideline.
Property Management Fees
Under the property management agreements between the Company and Glenborough, Glenborough is entitled to receive property management fees calculated at a maximum of up to 4% of the properties’ gross revenue. The property management agreements with Glenborough have been renewed for an additional 12 months, beginning on August 10, 2018. Property management agreements with Glenborough automatically renew every year, unless expressly terminated.
Disposition Fees
Under the Advisory Agreement, if the Advisor or its affiliates provide a substantial amount of services, as determined by the Company’s independent directors, in connection with the sale of a real property, the Advisor or its affiliates may be paid disposition fees up to 50% of a customary and competitive real estate commission, but not to exceed 3% of the contract sales price of each property sold.
Leasing Fees
Under the property management agreements, Glenborough is entitled to receive a separate fee for the leases of new tenants, and for expansions, extensions and renewals of existing tenants in an amount not to exceed the fee customarily charged by similarly situated parties rendering similar services in the same geographic area for similar properties.
Legal Leasing Fees
Under the property management agreements, Glenborough is entitled to receive a market-based legal leasing fee for the negotiation and production of new leases, renewals, and amendments.
Construction Management Fees
In connection with the construction or repair in or about a property, the property manager is responsible for coordinating and facilitating the planning and the performance of all construction and is entitled to receive a fee equal to 5% of the hard costs for the project in question.
Related-Party Fees Paid by the Unconsolidated Joint Ventures
The unconsolidated joint ventures are party to certain agreements with Glenborough for services related to the investment of funds and management of the joint ventures’ investments, as well as the day-to-day management, operation and maintenance of the properties owned by the joint ventures. The joint ventures pay fees to Glenborough for these services. For each of the years ended December 31, 2018 and 2017, the SGO Joint Venture recognized related party fees and reimbursements of $0.2 million. For each of the years ended December 31, 2018 and 2017, the SGO MN Joint Venture recognized related party fees and reimbursements of $0.7 million.The related-party amounts consist of property management, asset management, leasing commission, legal leasing, construction management fees and salary reimbursements.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
13. COMMITMENTS AND CONTINGENCIES
Economic Dependency
The Company is dependent on the Advisor and its affiliates for certain services that are essential to the Company, including the identification, evaluation, negotiation, purchase, and disposition of real estate and real estate-related investments, management of the daily operations of the Company’s real estate and real estate-related investment portfolio, and other general and administrative responsibilities. In the event that the Advisor is unable to provide such services to the Company, the Company will be required to obtain such services from other sources.
Environmental
As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. The Company is not aware of any environmental liability that could have a material adverse effect on its consolidated financial condition or results of operations. However, changes in applicable environmental laws and regulations, the uses and conditions of properties in the vicinity of the Company’s properties, the activities of its tenants and other environmental conditions of which the Company is unaware with respect to the properties could result in future environmental liabilities.
14. SUBSEQUENT EVENTS
Distributions
On November 8, 2018, the Company’s board of directors declared a fourth quarter distribution in the amount of $0.06 per share/unit to common stockholders and holders of common units of record as of December 31, 2018. The distribution was paid on January 31, 2019.
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STRATEGIC REALTY TRUST, INC. AND SUBSIDIARIES
SCHEDULE III — REAL ESTATE OPERATING PROPERTIES AND ACCUMULATED DEPRECIATION
December 31, 2018
(amounts in thousands) | Initial Cost to Company | Cost Capitalized Subsequent to Acquisition(1) | Gross Amount of Which Carried at Close of Period | Life on which Depreciation in Latest Statement of Operations is Computed(3) | ||||||||||||||||||||||||||||
Land | Building & Improvements | Land | Building & Improvements | Total (2) | Accumulated Depreciation | Acquisition Date | ||||||||||||||||||||||||||
Topaz Marketplace | $ | 2,120 | $ | 10,724 | $ | (2,982 | ) | $ | 1,681 | $ | 8,181 | $ | 9,862 | $ | (1,575 | ) | 9/23/2011 | 5-30 | ||||||||||||||
Shops at Turkey Creek | 1,416 | 2,398 | (33 | ) | 1,416 | 2,365 | 3,781 | (515 | ) | 3/12/2012 | 5-30 | |||||||||||||||||||||
400 Grove Street | 1,009 | 1,813 | — | 1,009 | 1,813 | 2,822 | (151 | ) | 6/14/2016 | 5-30 | ||||||||||||||||||||||
8 Octavia Street | 728 | 1,847 | 84 | 728 | 1,931 | 2,659 | (166 | ) | 6/14/2016 | 5-30 | ||||||||||||||||||||||
Fulton Shops | 1,187 | 3,254 | — | 1,187 | 3,254 | 4,441 | (292 | ) | 7/27/2016 | 5-30 | ||||||||||||||||||||||
450 Hayes | 2,324 | 5,009 | 367 | 2,324 | 5,376 | 7,700 | (382 | ) | 12/22/2016 | 5-30 | ||||||||||||||||||||||
388 Fulton | 1,109 | 2,943 | 319 | 1,112 | 3,259 | 4,371 | (247 | ) | 1/4/2017 | 5-30 | ||||||||||||||||||||||
Silver Lake | 5,747 | 6,646 | 364 | 5,760 | 6,997 | 12,757 | (589 | ) | 1/11/2017 | 5-30 | ||||||||||||||||||||||
Total | $ | 15,640 | $ | 34,634 | $ | (1,881 | ) | $ | 15,217 | $ | 33,176 | $ | 48,393 | $ | (3,917 | ) | ||||||||||||||||
(1) | The cost capitalized subsequent to acquisition may include negative balances resulting from the write-off and impairment of real estate assets, and parcel sales. |
(2) | The aggregate net tax basis of land and buildings for federal income tax purposes is $47.4 million. |
(3) | Buildings and building improvements are depreciated over their useful lives as shown. Tenant improvements are amortized over the life of the related lease, which with our current portfolio can vary from 1 year to over 15 years. |
(in thousands) | Year Ended December 31, | |||||||
2018 | 2017 | |||||||
Real Estate: | ||||||||
Balance at the beginning of the year | $ | 46,033 | $ | 65,627 | ||||
Acquisitions | — | 17,128 | ||||||
Improvements | 769 | 746 | ||||||
Dispositions | (22,366 | ) | (13,511 | ) | ||||
Balances associated with changes in reporting presentation (1) | 23,957 | (23,957 | ) | |||||
Balance at the end of the year | $ | 48,393 | $ | 46,033 | ||||
Accumulated Depreciation: | ||||||||
Balance at the beginning of the year | $ | 2,579 | $ | 8,163 | ||||
Depreciation expense | 1,205 | 2,047 | ||||||
Dispositions | (5,045 | ) | (2,453 | ) | ||||
Balances associated with changes in reporting presentation (1) | 5,178 | (5,178 | ) | |||||
Balance at the end of the year | $ | 3,917 | $ | 2,579 | ||||
(1) | The balances associated with changes in reporting presentation represent real estate and accumulated depreciation reclassified as assets held for sale. |
See accompanying report of independent registered public accounting firm.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on March 19, 2019.
Strategic Realty Trust, Inc. | ||
By: | /s/ Andrew Batinovich | |
Andrew Batinovich | ||
Chief Executive Officer, Corporate Secretary and Director (Principal Executive Officer) | ||
By: | /s/ Terri Garnick | |
Terri Garnick | ||
Chief Financial Officer (Principal Financial and Accounting Officer) | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title(s) | Date | ||
/s/ Todd A. Spitzer | Chairman of the Board | March 19, 2019 | ||
Todd A. Spitzer | ||||
/s/ Andrew Batinovich | Chief Executive Officer, Corporate Secretary and Director (Principal Executive Officer) | March 19, 2019 | ||
Andrew Batinovich | ||||
/s/ Terri Garnick | Chief Financial Officer (Principal Financial and Accounting Officer) | March 19, 2019 | ||
Terri Garnick | ||||
/s/ Phillip I. Levin | Director | March 19, 2019 | ||
Phillip I. Levin | ||||
/s/ Jeffrey S. Rogers | Director | March 19, 2019 | ||
Jeffrey S. Rogers | ||||
EXHIBIT INDEX
The following exhibits are included, or incorporated by reference, in this Annual Report on Form 10-K for the year ended December 31, 2018 (and are numbered in accordance with Item 601 of Regulation S-K).
Incorporated by Reference | ||||||||
Exhibit No. | Description | Filed Herewith | Form/File No. | Filing Date | ||||
Articles of Amendment and Restatement of TNP Strategic Retail Trust, Inc. | S-11/ No. 333-154975 | 7/10/2009 | ||||||
Articles of Amendment, dated August 22, 2013 | 8-K | 8/26/2013 | ||||||
Articles Supplementary, dated November 1, 2013 | 8-K | 11/4/2013 | ||||||
Articles Supplementary, dated January 22, 2014 | 8-K | 1/28/2014 | ||||||
Third Amended and Restated Bylaws of Strategic Realty Trust, Inc. | 8-K | 1/28/2014 | ||||||
Promissory Note with Lone Oak Fund, LLC, dated August 31, 2018 | 10-Q | 11/9/2018 | ||||||
The Purchase and Sale Agreement by and between TNP SRT Portfolio II, LLC and ORDA CORP, dated May 3, 2018 | 10-Q | 11/9/2018 | ||||||
The Purchase and Sale Agreement by and between TNP SRT Portfolio II, LLC, and Polimeni International LLC, dated September 20, 2018 | 10-Q | 11/9/2018 | ||||||
The Purchase and Sale Agreement by and between TNP SRT Portfolio II, LLC and Baseline Property, LLC, dated September 14, 2017 | 10-K | 3/23/2018 | ||||||
The Purchase and Sale Agreement by and between Kamin Realty LLC and TNP SRT Portfolio II, LLC, dated September 20, 2017 | 10-K | 3/23/2018 | ||||||
First Amendment to Purchase and Sale Agreement between Kamin Realty LLC and TNP SRT Portfolio II, LLC, dated October 27, 2017 | 10-K | 3/23/2018 | ||||||
Second Amendment to Purchase and Sale Agreement between Kamin Realty LLC and TNP SRT Portfolio II, LLC, dated October 30, 2017 | 10-K | 3/23/2018 | ||||||
Promissory Note between Strategic Realty Operating Partnership, L.P., and Glenborough Property Partners, LLC, dated September 27, 2017 | 10-K | 3/23/2018 | ||||||
Fifth Amendment to the Second Amended and Restated Revolving Credit Agreement among Strategic Realty Operating Partnership, L.P., SRT Secured Holdings, LLC, KeyBank National Association, as administrative agent, and KeyBanc Capital Markets, LLC, as sole lead bookrunner and sole lead arranger, dated September 30, 2018 | 10-Q | 11/9/2018 | ||||||
Fifth Amendment to the Advisory Agreement, dated July 19, 2018 | 8-K | 7/20/2018 | ||||||
Sixth Amendment to the Advisory Agreement, dated August 2, 2018 | 8-K | 8/3/2018 | ||||||
Loan Agreement between Buchanan Mortgage Holdings, LLC and 3032 Wilshire Investors, LLC, dated March 7, 2016 | 10-Q | 5/11/2018 | ||||||
First Amendment to Loan Agreement between Buchanan Mortgage Holdings, LLC and 3032 Wilshire Investors, LLC, dated March 20, 2018 | 10-Q | 5/11/2018 | ||||||
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First Amendment to Loan Agreement between Buchanan Mortgage Holdings, LLC and Sunset & Gardner Investors, LLC, dated January 27, 2017 | 10-Q | 5/11/2018 | ||||||
Second Amendment to Loan Agreement between Buchanan Mortgage Holdings, LLC and Sunset & Gardner Investors, LLC, dated July 20, 2017 | 10-Q | 5/11/2018 | ||||||
Third Amendment to Loan Agreement between Buchanan Mortgage Holdings, LLC and Sunset & Gardner Investors, LLC, dated April 26, 2018 | 10-Q | 5/11/2018 | ||||||
Letter Agreement with Buchanan Mortgage, dated April 20, 2018 | 10-Q | 8/10/2018 | ||||||
The Purchase and Sale Agreement by and between Ginger Investors, LLC and SRT Secured Topaz, LLC, dated May 18, 2018 | 10-Q | 8/10/2018 | ||||||
Promissory Note with Lone Oak Fund, LLC, dated October 24, 2018 | X | |||||||
Lease Agreement with Clover Juice | X | |||||||
Lease Agreement with Western Sizzling | X | |||||||
Lease Agreement with Conner Concepts | X | |||||||
Subsidiaries of the Company | X | |||||||
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | |||||||
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | |||||||
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | X | |||||||
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | X | |||||||
Strategic Realty Trust, Inc. Amended and Restated Share Redemption Program Adopted August 26, 2016 | 8-K | 8/30/2016 | ||||||
101.INS | XBRL Instance Document | X | ||||||
101.SCH | XBRL Taxonomy Extension Schema Document | X | ||||||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | X | ||||||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | X | ||||||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | X | ||||||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | X | ||||||
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