KBS REAL ESTATE INVESTMENT TRUST III, INC. The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and the notes thereto. Also see "Forward-Looking Statements" and "Summary Risk Factors" preceding Part I and Part I, Item 1A, "Risk Factors."
Overview
We were formed onDecember 22, 2009 as aMaryland corporation that elected to be taxed as a REIT beginning with the taxable year endedDecember 31, 2011 and we intend to continue to operate in such a manner. We conduct our business primarily through ourOperating Partnership , of which we are the sole general partner. Subject to certain restrictions and limitations, our business is managed by our advisor pursuant to an advisory agreement and our advisor conducts our operations and manages our portfolio of real estate investments. Our advisor owns 20,857 shares of our common stock. We have no paid employees.
We have invested in a diverse portfolio of real estate investments. As of
Section 5.11 of our charter requires that we seek stockholder approval of our liquidation if our shares of common stock are not listed on a national securities exchange bySeptember 30, 2020 , unless a majority of the conflicts committee of our board of directors, composed solely of all of our independent directors, determines that liquidation is not then in the best interest of our stockholders. Pursuant to our charter requirement, the conflicts committee considered the conflicts committee's and the board of directors' assessment of alternatives available to us, market conditions, uncertainty as a result of the COVID-19 pandemic's impact on work-from-home arrangements and the impact of such arrangements on theU.S. office market, the debt capital markets, and the lack of liquidity in the marketplace, and onSeptember 28, 2022 , our conflicts committee unanimously determined to postpone approval of our liquidation. Section 5.11 of our charter requires that the conflicts committee revisit the issue of liquidation at least annually. Also in connection with the conflict committee's and the board of directors' assessment of alternatives available to us, our assessment of our capital raising prospects, market conditions, economic uncertainty and the other factors mentioned above, at this time we do not intend to pursue a conversion to an "NAV REIT."
Market Outlook - Real Estate and Real Estate Finance Markets
Volatility in global financial markets and changing political environments can cause fluctuations in the performance of theU.S. commercial real estate markets. Possible future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to renew tenants early, to retain tenants who are up for renewal or to attract new tenants, may result in decreases in cash flows from investment properties. Further, revenues from our properties could decrease due to a reduction in occupancy (caused by factors including, but not limited to, tenant defaults, tenant insolvency, early termination of tenant leases and non-renewal of existing tenant leases), rent deferrals or abatements, tenants being unable to pay their rent and/or lower rental rates. Increases in the cost of financing due to higher interest rates will prevent us from refinancing debt obligations at terms as favorable as the terms of existing indebtedness. Further, increases in interest rates would increase the amount of our debt payments on our variable rate debt to the extent the interest rates on such debt are not fixed through interest rate swap agreements or limited by interest rate caps. Market conditions can change quickly, potentially negatively impacting the value of real estate investments. Management continuously reviews our investment and debt financing strategies to optimize our portfolio and the cost of our debt exposure. The ongoing challenges affecting theU.S. commercial real estate industry, especially as it pertains to commercial office buildings, continues to be one of the most significant risks and uncertainties we face. The combination of the continued economic slowdown, rapidly rising interest rates and significant inflation (or the perception that any of these events may continue) as well as a lack of lending activity in the debt markets have contributed to considerable weakness in the commercial real estate markets. During 2021 and 2022, the usage of many of our assets remained lower than pre-pandemic levels, and we cannot predict when, if and to what extent economic activity, including the use of and demand for office space, will return to pre-pandemic levels. In addition, we experienced a significant reduction in leasing interest and activity when compared to pre-pandemic levels. Further, potential changes in customer behavior, such as continued work-from-home arrangements, which increased as a result of the COVID-19 pandemic, could materially and negatively impact the future demand for office space, adversely impacting our operations. Both upcoming and recent tenant lease expirations amidst the aforementioned headwinds coupled with slower than expected return-to-office, most notably in theSan Francisco Bay Area where we own several assets, have had direct and material impacts on our ability to access certain credit facilities (see "-Liquidity and Capital Resources" below), which, in large part, provide liquidity to manage redemption requests. 60
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During the year endedDecember 31, 2020 , we recognized an impairment charge of$19.9 million for an office/retail property due to the continued deterioration of retail demand at the property which was further impacted by the COVID-19 pandemic. We have also made a significant investment in the common units of the SREIT. Due to the disruptions in the financial markets discussed above, since earlyMarch 2020 , the trading price of the common units of the SREIT has experienced substantial volatility. As ofMarch 13, 2023 , the aggregate value of our investment in the units of the SREIT was$78.8 million , which was based solely on the closing price of the units on the SGX-ST of$0.365 per unit as ofMarch 13, 2023 , and did not take into account any potential discount for the holding period risk due to the quantity of units we hold. This is a decrease of$0.515 per unit from our initial acquisition of the SREIT units at$0.880 per unit onJuly 19, 2019 . We have concluded that it is critical to preserve capital given the current state of the markets. OnJanuary 17, 2023 , our board of directors determined to suspend Ordinary Redemptions under our share redemption program and reduce the distribution rate from that of prior periods. These actions were a direct result of the factors discussed above. Continued disruptions in the financial markets and economic uncertainty could adversely affect our ability to implement our business strategy and generate returns to stockholders and our ability to sustain our current distribution rate. Overall, there remains significant uncertainty regarding the timing and duration of the economic recovery, which precludes any prediction as to the ultimate adverse impact the current disruptions in the markets may have on our business. However, we believe that our cash flow from operations, cash on hand, current availability under our loan facilities, proceeds from our dividend reinvestment plan, current and anticipated financing activities and anticipated asset sales are sufficient to meet our liquidity needs for the foreseeable future.
Liquidity and Capital Resources
Our principal demands for funds during the short and long-term are and will be for operating expenses, capital expenditures and general and administrative expenses; payments under debt obligations; redemptions of common stock; and payments of distributions to stockholders. Our primary sources of capital for meeting our cash requirements are as follows:
•Cash flow generated by our real estate and real estate-related investments;
•Debt financings (including amounts currently available under existing loan facilities);
•Proceeds from the sale of our real estate properties and real estate-related investments; and
•Proceeds from common stock issued under our dividend reinvestment plan.
Our real estate properties generate cash flow in the form of rental revenues and tenant reimbursements, which are reduced by operating expenditures, capital expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from our real estate properties is primarily dependent upon the occupancy level of our portfolio, the net effective rental rates on our leases, the collectability of rent and operating recoveries from our tenants and how well we manage our expenditures. Due to uncertainties in theU.S. office real estate market, most notably in the greaterSan Francisco Bay Area where we own certain assets, we anticipate that our future cash flows from operations may be impacted due to lease rollover and reduced demand for office space. Our investment in the equity securities of the SREIT generates cash flow in the form of dividend income, and dividends are typically declared and paid on a semi-annual basis, though dividends are not guaranteed. As ofDecember 31, 2022 , we held 215,841,899 units of the SREIT which represented 18.2% of the outstanding units of the SREIT as of that date. As ofDecember 31, 2022 , we had mortgage debt obligations in the aggregate principal amount of$1.7 billion , with a weighted-average remaining term of 0.9 years. As ofDecember 31, 2022 , we had$1.3 billion of notes payable maturing during the 12 months endingDecember 31, 2023 . As ofDecember 31, 2022 , our debt obligations consisted of$123.0 million of fixed rate notes payable and$1.6 billion of variable rate notes payable. As ofDecember 31, 2022 , the interest rates on$1.0 billion of our variable rate notes payable were effectively fixed through interest rate swap agreements. The maturity dates of certain loans may be extended beyond their current maturity dates; however, the extension options are subject to certain terms and conditions contained in the loan documents some of which are more stringent than our current loan compliance tests. As a result, in order to qualify for certain loan extensions, we may be required to reduce the loan commitment amount or make paydowns on certain loans, which would reduce our liquidity. Additionally, continued increases in interest rates, reductions in real estate values and future tenant turnover in the portfolio will have a further impact on our ability to meet such tests and may further reduce our available liquidity under our loan agreements. 61
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We paid cash distributions to our stockholders during the year endedDecember 31, 2022 using cash flow from operations from current and prior periods and proceeds from debt financing. Cash flows from operations are an important factor in our ability to sustain our current distribution rate. We have experienced a reduction in our net cash flows from operations in recent periods primarily due to lease expirations in our portfolio and a resulting decrease in occupancy. InJanuary 2023 , our board of directors reduced our distribution rate from prior periods due to the continued impact of the economic slowdown on our cash flows. See Part I, Item 1A, "Risk Factors," Part II, Item 5, "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities - Distribution Information," "-Market Outlook-Real Estate and Real Estate Finance Markets" above and "-Distributions" below. Our management team and our board of directors will continue to monitor our results of operations and operating cash flows, and based on an analysis of our cash flows and projected cash flows may consider a further reduction to our distribution rate in a future period. We believe that our cash flow from operations, cash on hand, current availability under our loan facilities, proceeds from our dividend reinvestment plan, current and anticipated financing activities and anticipated asset sales are sufficient to meet our liquidity needs for the foreseeable future. Under our charter, we are required to limit our total operating expenses to the greater of 2% of our average invested assets or 25% of our net income for the four most recently completed fiscal quarters, as these terms are defined in our charter, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. Operating expenses for the four fiscal quarters endedDecember 31, 2022 did not exceed the charter-imposed limitation.
Cash Flows from Operating Activities
During the year endedDecember 31, 2022 and 2021, net cash provided by operating activities was$76.0 million and$100.8 million , respectively. Net cash provided by operating activities was lower during the year endedDecember 31, 2022 primarily as a result of an increase in interest costs in 2022, a decrease in dividends received from our investment in the SREIT in 2022 due to our sale of 73,720,000 units in the SREIT inNovember 2021 , the timing of payments of lease commissions and the disposition of Domain Gateway inNovember 2021 .
Cash Flows from Investing Activities
Net cash used in investing activities was
Cash Flows from Financing Activities
During the year ended
•$197.9 million of net cash provided by debt financing as a result of proceeds from notes payable of$282.1 million , partially offset by principal payments on notes payable of$83.0 million and payments of deferred financing costs of$1.2 million ;
•$89.2 million of cash used for redemptions and repurchases of common stock;
•$56.2 million of net cash distributions, after giving effect to distributions
reinvested by stockholders of
•$0.6 million provided by interest rate swap settlements for off-market swap instruments.
We expect that our debt financing and other liabilities will be between 45% and 65% of the cost of our tangible assets (before deducting depreciation and other non-cash reserves). There is no limitation on the amount we may borrow for the purchase of any single asset. We limit our total liabilities to 75% of the cost of our tangible assets (before deducting depreciation and other non-cash reserves), meaning that our borrowings and other liabilities may exceed our maximum target leverage of 65% of the cost of our tangible assets without violating these borrowing restrictions. We may exceed the 75% limit only if a majority of the conflicts committee approves each borrowing in excess of this limitation and we disclose such borrowings to our stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. To the extent financing in excess of this limit is available on attractive terms, our conflicts committee may approve debt in excess of this limit. From time to time, our total liabilities could also be below 45% of the cost of our tangible assets due to the lack of availability of debt financing. As ofDecember 31, 2022 , our borrowings and other liabilities were approximately 58% of the cost (before deducting depreciation and other noncash reserves) and 60% of the book value (before deducting depreciation) of our tangible assets, respectively. 62
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We also expect to use our capital resources to make certain payments to our advisor. We currently make payments to our advisor in connection with the acquisition of investments, the management of our investments and costs incurred by our advisor in providing services to us. We also pay fees to our advisor in connection with the disposition of investments. We reimburse our advisor and dealer manager for certain stockholder services. In addition, our advisor is entitled to an incentive fee upon achieving certain performance goals. Among the fees payable to our advisor is an asset management fee. With respect to investments in real property, the asset management fee is a monthly fee equal to one-twelfth of 0.75% of the amount paid or allocated to acquire the investment, plus the cost of any subsequent development, construction or improvements to the property. This amount includes any portion of the investment that was debt financed and is inclusive of acquisition expenses related thereto (but excludes acquisition fees paid or payable to our advisor). In the case of investments made through joint ventures, the asset management fee is determined based on our proportionate share of the underlying investment (but excluding acquisition fees paid or payable to our advisor). With respect to investments in loans and any investments other than real property, the asset management fee is a monthly fee calculated, each month, as one-twelfth of 0.75% of the lesser of (i) the amount actually paid or allocated to acquire or fund the loan or other investment (which amount includes any portion of the investment that was debt financed and is inclusive of acquisition or origination expenses related thereto but is exclusive of acquisition or origination fees paid or payable to our advisor) and (ii) the outstanding principal amount of such loan or other investment, plus the acquisition or origination expenses related to the acquisition or funding of such investment (excluding acquisition or origination fees paid or payable to our advisor), as of the time of calculation. We currently do not pay asset management fees to our advisor on our investment in units of the SREIT. Notwithstanding the foregoing onNovember 8, 2022 , we and our advisor renewed the advisory agreement and amended certain provisions related to the payment of asset management fees (the "Renewed Advisory Agreement"), among other provisions. Pursuant to the Renewed Advisory Agreement and until theBonus Retention Fund (defined below) is fully funded, commencing with asset management fees accruing fromOctober 1, 2022 , we pay$1.15 million of the monthly asset management fee to our advisor in cash and we deposit the remainder of the monthly asset management fee into an interest bearing account in our name, which amounts will be paid to our advisor from such account solely as reimbursement for payments made by our advisor pursuant to our advisor's employee retention program (such account, the "Bonus Retention Fund "). We will be deemed to have fully funded theBonus Retention Fund once we have deposited$8.5 million in cash into such account, at which time the monthly asset management fee will be payable in full to our advisor. Amounts deposited in theBonus Retention Fund will not be due or paid by us to our advisor unless we have received an invoice from our advisor with a computation of the payments paid or to be paid by our advisor to employees pursuant to our advisor's employee retention program for the applicable period. Our advisor has acknowledged and agreed that payments by our advisor to employees under our advisor's employee retention program that are reimbursed by us from theBonus Retention Fund will be conditioned on (a) our liquidation and dissolution; (b) a transaction involving the acquisition, merger, conversion or consolidation, either directly or indirectly, of us in which (i) we are not the surviving entity and (ii) our advisor is no longer serving as an advisor or asset manager to the surviving entity in such transaction; (c) the sale or other disposition of all or substantially all of our assets; (d) the non-renewal or termination of the Renewed Advisory Agreement without cause; or (e) the termination of the employee without cause. To the extent theBonus Retention Fund is not fully paid out to employees as set forth above, the Renewed Advisory Agreement provides that the residual amount will be deemed additional Deferred Asset Management Fees (defined below) and be treated in accordance with the provisions for payment of Deferred Asset Management Fees. Two of our executive officers,Mr. Waldvogel andMs. Yamane , and one of our directors,Mr. DeLuca , participate in and have been allocated awards under our advisor's employee retention program, which awards would only be paid as set forth above. Prior to entering the Renewed Advisory Agreement, the advisory agreement had provided that with respect to asset management fees accruing fromMarch 1, 2014 , our advisor would defer, without interest, our obligation to pay asset management fees for any month in which our modified funds from operations ("MFFO") for such month, as such term is defined in the practice guideline issued by theInstitute of Portfolio Alternatives ("IPA") inNovember 2010 and interpreted by us, excluding asset management fees, did not exceed the amount of distributions declared by us for record dates of that month. We remained obligated to pay our advisor an asset management fee in any month in which our MFFO, excluding asset management fees, for such month exceeded the amount of distributions declared for the record dates of that month (such excess amount, an "MFFO Surplus"); however, any amount of such asset management fee in excess of the MFFO Surplus was deferred under the advisory agreement. If the MFFO Surplus for any month exceeded the amount of the asset management fee payable for such month, any remaining MFFO Surplus was applied to pay any asset management fee amounts previously deferred in accordance with the advisory agreement. 63
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Pursuant to the Renewed Advisory Agreement, asset management fees accruing fromOctober 1, 2022 are no longer subject to the deferral provision described above. Asset management fees that remained deferred as ofSeptember 30, 2022 are "Deferred Asset Management Fees." As ofSeptember 30, 2022 , Deferred Asset Management Fees totaled$8.5 million . The Renewed Advisory Agreement also provides that we remain obligated to pay our advisor outstanding Deferred Asset Management Fees in any month to the extent that MFFO for such month exceeds the amount of distributions declared for the record dates of that month (such excess amount, a "RMFFO Surplus"); provided however, that any amount of outstanding Deferred Asset Management Fees in excess of the RMFFO Surplus will continue to be deferred. Like the prior advisory agreement, the Renewed Advisory Agreement provides that notwithstanding the foregoing, any and all Deferred Asset Management Fees that are unpaid will become immediately due and payable at such time as our stockholders have received, together as a collective group, aggregate distributions (including distributions that may constitute a return of capital for federal income tax purposes) sufficient to provide (i) an 8.0% per year cumulative, noncompounded return on such net invested capital (the "Stockholders' 8% Return") and (ii) a return of their net invested capital, or the amount calculated by multiplying the total number of shares purchased by stockholders by the issue price, reduced by any amounts to repurchase shares pursuant to our share redemption program. The Stockholders' 8% Return is not based on the return provided to any individual stockholder. Accordingly, it is not necessary for each of our stockholders to have received any minimum return in order for our advisor to receive Deferred Asset Management Fees. In addition, the Renewed Advisory Agreement provides that any and all Deferred Asset Management Fees that are unpaid will also be immediately due and payable upon the earlier of:
(i) a listing of our shares of common stock on a national securities exchange;
(ii) our liquidation and dissolution;
(iii) a transaction involving the acquisition, merger, conversion or consolidation, either directly or indirectly, of us in which (y) we are not the surviving entity and (z) our advisor is no longer serving as an advisor or asset manager to the surviving entity in such transaction; and
(iv) the sale or other disposition of all or substantially all of our assets.
The Renewed Advisory Agreement may be terminated (i) upon 60 days written notice without cause or penalty by either us (acting through the conflicts committee) or our advisor or (ii) immediately by us for cause or upon the bankruptcy of our advisor. If the Renewed Advisory Agreement is terminated without cause, then our advisor will be entitled to receive from us any residual amount of theBonus Retention Fund deemed to be additional Deferred Asset Management Fees, provided that upon such non-renewal or termination we do not retain an advisor in which our advisor or its affiliates have a majority interest. Upon termination of the Renewed Advisory Agreement, all unpaid Deferred Asset Management Fees will automatically be forfeited by our advisor, and if the Renewed Advisory Agreement is terminated for cause, any residual amount of theBonus Retention Fund deemed to be additional Deferred Asset Management Fees will also automatically be forfeited by our advisor. As ofDecember 31, 2022 , we had accrued$10.2 million of asset management fees, of which$8.5 million were Deferred Asset Management Fees. As ofDecember 31, 2022 , we have deposited$1.7 million of restricted cash into theBonus Retention Fund . We had not made any payments to our advisor from theBonus Retention Fund as ofDecember 31, 2022 . For the year endedDecember 31, 2022 , we and our advisor agreed to adjust MFFO for the purpose of the calculation above to add back the following non-operating expenses: a one-time write-off of prepaid offering costs of$2.7 million and a$0.5 million fee to the conflicts committee's financial advisor in connection with the conflicts committee's review of alternatives available to us. 64
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Debt Obligations
The following is a summary of our debt obligations as of
Payments Due During the Years Ended December 31,
Debt Obligations Total 2023 2024-2025 2026-2027
Outstanding debt obligations (1) $ 1,671,395 $ 1,252,185 $ 419,210 $ -
Interest payments on outstanding debt
obligations (2) (3) 89,178 77,390 11,788 -
Interest payments on interest rate swaps
(4) (5) - - - -
_____________________
(1) Amounts include principal payments only based on maturity dates as of
December 31, 2022 . The maturity dates of certain loans may be extended beyond
their current maturity dates; however, the extension options are subject to
certain terms and conditions contained in the loan documents some of which are
more stringent than our current loan compliance tests. As a result, in order to
qualify for certain loan extensions, we may be required to reduce the loan
commitment amount or make paydowns on certain loans, which would reduce our
liquidity. Additionally, continued increases in interest rates, reductions in
real estate values and future tenant turnover in the portfolio will have a
further impact on our ability to meet such tests and may further reduce our
available liquidity under our loan agreements.
(2) Projected interest payments are based on the outstanding principal amounts,
maturity dates and interest rates in effect as of December 31, 2022 (consisting
of the contractual interest rate and using interest rate indices as of
December 31, 2022 , where applicable).
(3) We incurred interest expense related to notes payable of
(4) Projected interest payments on interest rate swaps are calculated based on the notional amount, effective term of the swap contract, and fixed rate net of the swapped floating rate in effect as ofDecember 31, 2022 . In the case where the swapped floating rate (one-month LIBOR or one-month Term SOFR) atDecember 31, 2022 is higher than the fixed rate in the swap agreement, interest payments on interest rate swaps in the above debt obligations table would reflect zero as we would not be obligated to make any interest payments on those swaps and instead expect to receive payments from our swap counter-parties.
(5) We incurred net realized losses related to interest rate swaps of
Capital Expenditures Obligations
As ofDecember 31, 2022 , we have capital expenditure obligations of$69.3 million , the majority of which is expected to be spent in the next twelve months and of which$24.1 million has already been accrued and included in accounts payable and accrued liabilities on our consolidated balance sheet as ofDecember 31, 2022 . This amount includes unpaid contractual obligations for building improvements and unpaid portions of tenant improvement allowances which were granted pursuant to lease agreements executed as ofDecember 31, 2022 , including amounts that may be classified as lease incentives pursuant to GAAP. In certain cases, tenants may have discretion when to utilize their tenant allowances and may delay the start of projects or tenants control the construction of their projects and may not submit timely requests for reimbursement or there are general construction delays, all of which could extend the timing of payment for a portion of these capital expenditure obligations beyond twelve months.
Results of Operations
In this section, we discuss the results of our operations for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 . For a discussion of the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 , please refer to Item 7 of Part II, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 , which was filed with theSEC onMarch 31, 2022 and which specific discussion is incorporated herein by reference. As ofDecember 31, 2022 and 2021, we owned 16 office properties, one mixed-use office/retail property and an investment in the equity securities of the SREIT. The following table provides summary information about our results of operations for the years endedDecember 31, 2022 and 2021 (dollar amounts in thousands): 65
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Comparison of the year endedDecember 31, 2022 versus the year endedDecember 31, 2021 $ Changes Due to Dispositions of For the Years Ended Properties and $ Change Due December 31, Ceasing of to Properties Held Increase Percentage Equity Method of Throughout Both 2022 2021 (Decrease) Change Accounting (1) Periods (2) Rental income$ 275,026 $ 280,144 $ (5,118) (2) %$ (8,262) $ 3,144 Dividend income from real estate equity securities 14,850 - 14,850 100 % - 14,850 Other operating income 18,141 16,617 1,524 9 % (92) 1,616 Operating, maintenance and management 74,783 68,806 5,977 9 % (242) 6,219 Real estate taxes and insurance 51,811 57,687 (5,876) (10) % (137) (5,739) Asset management fees to affiliate 20,102 19,832 270 1 % (412) 682 General and administrative expenses 8,115 6,116 1,999 33 % n/a n/a Depreciation and amortization 111,860 110,984 876 1 % (2,429) 3,305 Interest expense 60,259 34,564 25,695 74 % (681) 26,376 Net gain on derivative instruments (51,932) (5,263) (46,669) 887 % - (46,669) Unrealized (loss) gain on real estate equity securities (92,812) 16,765 (109,577) (654) % - (109,577) Write-off of prepaid offering costs (2,728) - (2,728) (100) % n/a n/a Other interest income 63 52 11 21 % n/a n/a Equity in income of an unconsolidated entity - 8,698 (8,698) (100) % (8,698) - Loss from extinguishment of debt - (214) 214 (100) % 214 - Gain on sale of real estate, net - 114,321 (114,321) (100) % (114,321) - _____________________ (1) Represents the dollar amount increase (decrease) for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 related to dispositions of properties afterJanuary 1, 2021 and ceasing of equity method of accounting related to our investment in the units of the SREIT for periods afterNovember 9, 2021 .
(2) Represents the dollar amount increase (decrease) for the year ended
Rental income from our real estate properties decreased from$280.1 million for the year endedDecember 31, 2021 to$275.0 million for the year endedDecember 31, 2022 . The decrease in rental income was primarily due to the dispositions of real estate properties subsequent toJanuary 1, 2021 , partially offset by a net increase in rental income related to lease commencements subsequent toDecember 31, 2021 with respect to properties held throughout both periods. We expect rental income to vary based on occupancy rates and rental rates of our real estate investments and to the extent of continued uncertainty in the real estate and financial markets and to increase due to tenant reimbursements related to operating expenses to the extent physical occupancy increases as employees return to the office. See "Market Outlook - Real Estate and Real Estate Finance Markets." Dividend income from our real estate equity securities was$14.9 million for the year endedDecember 31, 2022 . OnNovember 9, 2021 , upon our sale of 73,720,000 units in the SREIT, we determined that based on our ownership interest of 18.5% of the outstanding units of the SREIT as of that date, we no longer had significant influence over the operations, financial policies and decision making with respect to the SREIT. Accordingly, effectiveNovember 9, 2021 , our investment in the units of the SREIT represents an investment in marketable securities and is therefore presented at fair value at each reporting date based on the closing price of the SREIT units on the SGX-ST on that date and dividend income is recognized as it is declared based on eligible units as of the ex-dividend date. Prior toNovember 9, 2021 , our investment in the SREIT was accounted for under the equity method of accounting. Other operating income increased from$16.6 million during the year endedDecember 31, 2021 to$18.1 million for the year endedDecember 31, 2022 . The increase in other operating income was primarily due to an increase in parking revenues for properties held throughout both periods, offset by the disposition of Anchor Centre inJanuary 2021 . We expect other operating income to vary in future periods based on occupancy rates and parking rates at our real estate properties and to the extent of continued uncertainty in the real estate and financial markets. 66
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Operating, maintenance and management costs increased from$68.8 million for the year endedDecember 31, 2021 to$74.8 million for the year endedDecember 31, 2022 . The increase in operating, maintenance and management costs was primarily due to an overall increase in operating costs, including utilities, janitorial and security costs, as a result of general inflation, an increase in physical occupancy at properties held throughout both periods and higher legal fees and space planning costs related to leasing activities, offset by the dispositions of real estate properties subsequent toJanuary 1, 2021 . We expect operating, maintenance and management costs to increase in future periods as a result of general inflation and to the extent physical occupancy increases as employees return to the office. Real estate taxes and insurance decreased from$57.7 million for the year endedDecember 31, 2021 to$51.8 million for the year endedDecember 31, 2022 , primarily due to a decrease in real estate taxes as a result of a property tax appeal for a real estate property held throughout both periods during the year endedDecember 31, 2022 , property tax refunds received during the year endedDecember 31, 2022 and the dispositions of real estate properties subsequent toJanuary 1, 2021 . We expect real estate taxes and insurance to increase in future periods as a result of general inflation and general increases due to future property tax reassessments for properties that we continue to own. Asset management fees with respect to our real estate investments increased from$19.8 million for the year endedDecember 31, 2021 to$20.1 million for the year endedDecember 31, 2022 , primarily due to capital improvements at properties held throughout both periods, offset by the dispositions of real estate properties subsequent toJanuary 1, 2021 . We expect asset management fees to increase in future periods as a result of any improvements we make to our properties and to decrease to the extent we dispose of properties. As ofDecember 31, 2022 , there were$10.2 million of accrued asset management fees, of which$8.5 million were Deferred Asset Management Fees. For a discussion of Deferred Asset Management Fees, see "- Liquidity and Capital Resources" herein. General and administrative expenses increased from$6.1 million for the year endedDecember 31, 2021 to$8.1 million for the year endedDecember 31, 2022 , primarily due to professional fees incurred related to our conflicts committee's and board of directors' evaluation of various alternatives available to us. General and administrative costs consisted primarily of portfolio legal fees, board of directors fees, third party transfer agent fees, financial advisor consulting fees and audit costs. We expect general and administrative expenses to vary in future periods. Depreciation and amortization increased slightly from$111.0 million for the year endedDecember 31, 2021 to$111.9 million for the year endedDecember 31, 2022 , primarily due to an increase in capital improvements at a property held throughout both periods, offset by the disposition of Domain Gateway inNovember 2021 . We expect depreciation and amortization to increase in future periods as a result of additional capital improvements, offset by a decrease in amortization related to fully amortized tenant origination and absorption costs. Interest expense increased from$34.6 million for the year endedDecember 31, 2021 to$60.3 million for the year endedDecember 31, 2022 . Included in interest expense was (i)$30.6 million and$56.4 million of interest expense payments for the years endedDecember 31, 2021 and 2022, respectively, and (ii) the amortization of deferred financing costs of$4.0 million and$3.9 million for the years endedDecember 31, 2021 and 2022, respectively. The increase in interest expense was due to additional borrowings to refinance a property held throughout both periods, draws on our revolving debt and higher one-month LIBOR, one-month BSBY and one-month Term SOFR during the year endedDecember 31, 2022 and the related impact on interest expense related to the portion of our variable rate debt. In general, we expect interest expense to vary based on fluctuations in interest rates (for our variable rate debt) and the amount of future borrowings. Net gain on derivative instruments increased from$5.3 million for the year endedDecember 31, 2021 to$51.9 million for the year endedDecember 31, 2022 . Included in net gain on derivative instruments was (i) unrealized gain on interest rate swaps of$23.3 million and$52.2 million for the years endedDecember 31, 2021 and 2022, respectively, (ii) realized gain on interest rate swaps of$6.9 million for the year endedDecember 31, 2022 , offset by (iii)$18.0 million and$7.2 million of realized loss on interest rate swaps for the years endedDecember 31, 2021 and 2022, respectively. The increase in net gain on derivative instruments was primarily due to changes in fair values with respect to our interest rate swaps that are not accounted for as cash flow hedges during the year endedDecember 31, 2022 . In general, we expect net gains or losses on derivative instruments to vary based on fair value changes with respect to our interest rate swaps that are not accounted for as cash flow hedges. During the year endedDecember 31, 2022 , we recorded an unrealized loss on real estate equity securities of$92.8 million as a result of the decrease in the closing price of the units of the SREIT on the SGX-ST. During the period fromNovember 9, 2021 throughDecember 31, 2021 , we recorded an unrealized gain on real estate equity securities of$16.8 million based on the difference in the aggregate carrying value of our 215,841,899 units of the SREIT onNovember 9, 2021 and the aggregate fair value of these units as ofDecember 31, 2021 , based on the closing price of the SREIT units on the SGX-ST on that date. 67
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During the year endedDecember 31, 2022 , we recorded$2.7 million related to the write-off of prepaid offering costs. In connection with the conflict committee's and the board of directors' assessment of alternatives available to us, our assessment of our capital raising prospects, market conditions, economic uncertainty and the other factors mentioned above under "-Overview", at this time we do not intend to pursue a conversion to an "NAV REIT." In order to avoid additional legal, accounting and other offering costs, we withdrew our registration statement on Form S-11 to register a public offering as an NAV REIT, which had been filed with theSEC . During the period fromJanuary 1, 2021 throughNovember 8, 2021 , we recorded equity in income of an unconsolidated entity of$8.7 million , related to our investment in the SREIT. Equity in income of an unconsolidated entity during the period fromJanuary 1, 2021 throughNovember 8, 2021 included a gain of$3.1 million related to our sale of 73,720,000 units in the SREIT onNovember 9, 2021 and a gain of$1.1 million to reflect the net effect to our investment as a result of the net proceeds raised by the SREIT in a private offering inJuly 2021 . As discussed above, effectiveNovember 9, 2021 , based on our 18.5% ownership interest in the SREIT as of that date, we do not exercise significant influence over the operations, financial policies and decision making with respect to the SREIT. Accordingly, our investment in the units of the SREIT represents an investment in marketable securities and therefore is presented at fair value as ofDecember 31, 2022 , based on the closing price of the SREIT units on the SGX-ST on that date. We recognized a gain on sale of real estate of$114.3 million during the year endedDecember 31, 2021 related to the dispositions of Anchor Centre inJanuary 2021 and Domain Gateway inNovember 2021 . We did not dispose of any real estate during the year endedDecember 31, 2022 .
Funds from Operations and Modified Funds from Operations
We believe that funds from operations ("FFO") is a beneficial indicator of the
performance of an equity REIT. We compute FFO in accordance with the current
National Association of Real Estate Investment Trusts ("NAREIT") definition. FFO
represents net income, excluding gains and losses from sales of operating real
estate assets (which can vary among owners of identical assets in similar
conditions based on historical cost accounting and useful-life estimates), gains
and losses from change in control, impairment losses on real estate assets,
depreciation and amortization of real estate assets, and adjustments for
unconsolidated partnerships and joint ventures. In addition, we elected the
option to exclude mark-to-market changes in value recognized on real estate
equity securities in the calculation of FFO. We believe FFO facilitates
comparisons of operating performance between periods and among other REITs.
However, our computation of FFO may not be comparable to other REITs that do not
define FFO in accordance with the NAREIT definition or that interpret the
current NAREIT definition differently than we do. Our management believes that
historical cost accounting for real estate assets in accordance with U.S.
generally accepted accounting principles ("GAAP") implicitly assumes that the
value of real estate assets diminishes predictably over time. Since real estate
values have historically risen or fallen with market conditions, many industry
investors and analysts have considered the presentation of operating results for
real estate companies that use historical cost accounting to be insufficient by
themselves. As a result, we believe that the use of FFO, together with the
required GAAP presentations, provides a more complete understanding of our
performance relative to our competitors and provides a more informed and
appropriate basis on which to make decisions involving operating, financing, and
investing activities.
Changes in accounting rules have resulted in a substantial increase in the
number of non-operating and non-cash items included in the calculation of FFO.
As a result, our management also uses MFFO as an indicator of our ongoing
performance as well as our dividend sustainability. MFFO excludes from FFO:
acquisition fees and expenses (to the extent that such fees and expenses have
been recorded as operating expenses); adjustments related to contingent purchase
price obligations; amounts relating to straight-line rents and amortization of
above and below market intangible lease assets and liabilities; accretion of
discounts and amortization of premiums on debt investments; amortization of
closing costs relating to debt investments; impairments of real estate-related
investments; mark-to-market adjustments included in net income; and gains or
losses included in net income for the extinguishment or sale of debt or hedges.
We compute MFFO in accordance with the definition of MFFO included in the
practice guideline issued by the IPA in November 2010 as interpreted by
management. Our computation of MFFO may not be comparable to other REITs that do
not compute MFFO in accordance with the current IPA definition or that interpret
the current IPA definition differently than we do.
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We believe that MFFO is helpful as a measure of ongoing operating performance because it excludes costs that management considers more reflective of investing activities and other non-operating items included in FFO. Management believes that excluding acquisition fees and expenses (to the extent that such fees and expenses have been recorded as operating expenses) from MFFO provides investors with supplemental performance information that is consistent with management's analysis of the operating performance of the portfolio over time. MFFO also excludes non-cash items such as straight-line rental revenue. Additionally, we believe that MFFO provides investors with supplemental performance information that is consistent with the performance indicators and analysis used by management, in addition to net income and cash flows from operating activities as defined by GAAP, to evaluate the sustainability of our operating performance. MFFO provides comparability in evaluating the operating performance of our portfolio with other non-traded REITs. MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes. FFO and MFFO are non-GAAP financial measures and do not represent net income as defined by GAAP. Net income as defined by GAAP is the most relevant measure in determining our operating performance because FFO and MFFO include adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization and the other items described above. Accordingly, FFO and MFFO should not be considered as alternatives to net income as an indicator of our current and historical operating performance. In addition, FFO and MFFO do not represent cash flows from operating activities determined in accordance with GAAP and should not be considered an indication of our liquidity. We believe FFO and MFFO, in addition to net income and cash flows from operating activities as defined by GAAP, are meaningful supplemental performance measures; however, neither FFO nor MFFO reflects adjustments for the operations of properties sold or under contract to sale during the periods presented. During periods of significant disposition activity, FFO and MFFO are much more limited measures of future performance and dividend sustainability. In connection with our presentation of FFO and MFFO, we are providing information related to the proportion of MFFO related to properties sold during the years endedDecember 31, 2022 , 2021 and 2020, and a real estate loan receivable paid off in full onDecember 11, 2020 . 69
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Although MFFO includes other adjustments, the exclusion of adjustments for straight-line rent, the amortization of above- and below-market leases, amortization of discounts and closing costs, unrealized (gains) losses on derivative instruments and loss from extinguishment of debt are the most significant adjustments for the periods presented. We have excluded these items based on the following economic considerations:
•Adjustments for straight-line rent. These are adjustments to rental revenue as
required by GAAP to recognize contractual lease payments on a straight-line
basis over the life of the respective lease. We have excluded these adjustments
in our calculation of MFFO to more appropriately reflect the current economic
impact of our in-place leases, while also providing investors with a useful
supplemental metric that addresses core operating performance by removing rent
we expect to receive in a future period or rent that was received in a prior
period;
•Amortization of above- and below-market leases. Similar to depreciation and
amortization of real estate assets and lease related costs that are excluded
from FFO, GAAP implicitly assumes that the value of intangible lease assets and
liabilities diminishes predictably over time and requires that these charges be
recognized currently in revenue. Since market lease rates in the aggregate have
historically risen or fallen with local market conditions, management believes
that by excluding these charges, MFFO provides useful supplemental information
on the realized economics of the real estate;
•Amortization of discounts and closing costs. Discounts and closing costs
related to debt investments are amortized over the term of the loan as an
adjustment to interest income. This application results in income recognition
that is different than the underlying contractual terms of the debt investments.
We have excluded the amortization of discounts and closing costs related to our
debt investments in our calculation of MFFO to more appropriately reflect the
economic impact of our debt investments, as discounts will not be economically
recognized until the loan is repaid and closing costs are essentially the same
as acquisition fees and expenses on real estate. We believe excluding these
items provides investors with a useful supplemental metric that directly
addresses core operating performance;
•Unrealized (gains) losses on derivative instruments. These adjustments include
unrealized (gains) losses from mark-to-market adjustments on interest rate
swaps. The change in fair value of interest rate swaps not designated as a hedge
are non-cash adjustments recognized directly in earnings and are included in
interest expense. We have excluded these adjustments in our calculation of MFFO
to more appropriately reflect the economic impact of our interest rate swap
agreements; and
•Loss from extinguishment of debt. A loss from extinguishment of debt, which
includes prepayment fees related to the extinguishment of debt, represents the
difference between the carrying value of any consideration transferred to the
lender in return for the extinguishment of a debt and the net carrying value of
the debt at the time of settlement. We have excluded the loss from
extinguishment of debt in our calculation of MFFO because these losses do not
impact the current operating performance of our investments and do not provide
an indication of future operating performance.
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Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by NAREIT, is presented in the following table, along with our calculation of MFFO, for the years endedDecember 31, 2022 , 2021 and 2020, respectively (in thousands). No conclusions or comparisons should be made from the presentation of these periods. For the
Years Ended
2022 2021 2020
Net (loss) income attributable to common stockholders
$ 143,657 $ (18,497) Depreciation of real estate assets 91,429 86,025 83,323 Amortization of lease-related costs 20,431 24,959 27,483 Impairment charges on real estate - - 19,896
Unrealized loss (gain) on real estate equity securities 92,812
(16,765) -
Gain on sale of real estate, net - (114,321) (49,457)
Adjustments for noncontrolling interests - consolidated entity (1)
- - 6,144
Adjustment for investment in an unconsolidated entity (2)
- 12,046 16,040
FFO attributable to common stockholders (3) (4) (5) 142,214
135,601 84,932
Straight-line rent and amortization of above- and
below-market leases, net (12,176) (5,304) (7,371)
Amortization of discount and closing costs on real estate loan receivable
- - (2,415)
Loss from extinguishment of debt - 214 199
Unrealized (gains) losses on derivative instruments (52,189)
(23,283) 25,165
Adjustment for investment in an unconsolidated entity (2)
- (3,321) 4,426
MFFO attributable to common stockholders (3) (4) (5)
$ 103,907 $ 104,936 _____________________
(1) Reflects adjustments to eliminate the noncontrolling interest holder's share of the adjustments to convert our net income (loss) attributable to common stockholders to FFO.
(2) Reflects our noncontrolling interest share of adjustments to convert our net income (loss) to FFO and MFFO for our equity investment in an unconsolidated entity. (3) FFO and MFFO for the year endedDecember 31, 2021 include a one-time$2.5 million holdover payment from a tenant related to a six-month lease extension which was received inDecember 2021 and was recognized as rental income for GAAP purposes on a straight-line basis for a six-month period throughMay 2022 . (4) FFO and MFFO exclude our share of the SREIT's FFO and MFFO, respectively, for the period fromNovember 9, 2021 throughDecember 31, 2021 and for the year endedDecember 31, 2022 . OnNovember 9, 2021 , upon our sale of 73,720,000 units in the SREIT, we determined that based on our ownership interest of 18.5% of the outstanding units of the SREIT as of that date, we no longer have significant influence over the operations, financial policies and decision making with respect to the SREIT and therefore, ceased accounting for our investment in the SREIT as an equity method investment on that date. Accordingly, effectiveNovember 9, 2021 , our investment in the units of the SREIT represents an investment in marketable securities and is therefore presented at fair value at each reporting date based on the closing price of the SREIT units on the SGX-ST on that date. As a result, FFO and MFFO related to our investment in the SREIT will be recognized based on dividends declared. FFO and MFFO for the year endedDecember 31, 2022 include the aggregate dividends declared and received from the SREIT for the year endedDecember 31, 2022 . (5) FFO and MFFO for the year endedDecember 31, 2022 include a one-time write-off of prepaid offering costs of$2.7 million and a$0.5 million fee to the conflicts committee's financial advisor in connection with the conflicts committee's review of alternatives available to us. In connection with the conflict committee's and the board of directors' assessment of alternatives available to us, our assessment of our capital raising prospects, market conditions, economic uncertainty and the other factors mentioned above under "-Overview", at this time we do not intend to pursue a conversion to an "NAV REIT." In order to avoid additional legal, accounting and other offering costs, we withdrew our registration statement on Form S-11 to register a public offering as an NAV REIT, which had been filed with theSEC . 71
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Our calculation of MFFO above includes amounts related to the operations of two office properties sold onJanuary 19, 2021 andNovember 2, 2021 , respectively, the operations of the multifamily apartment complex held by theHardware Village joint venture that was sold onMay 7, 2020 and interest income from our real estate loan receivable paid off in full onDecember 11, 2020 . Please refer to the table below with respect to the proportion of MFFO related to the real estate properties sold during the years endedDecember 31, 2021 and 2020, and the real estate loan receivable paid off (in thousands). For the Years Ended December 31, 2022 2021 2020 MFFO by component: Assets held for investment$ 77,849 $ 99,320 $ 97,892 Real estate properties sold - 4,587 4,340 Real estate loan receivable paid off - - 2,704 MFFO$ 77,849 $ 103,907 $ 104,936 FFO and MFFO may also be used to fund all or a portion of certain capitalizable items that are excluded from FFO and MFFO, such as tenant improvements, building improvements and deferred leasing costs.
Distributions
Distributions declared, distributions paid and cash flow from operating
activities were as follows during 2022 (in thousands, except per share amounts):
Distributions Distributions Paid (1) (2) Cash Flow
Distributions Declared from Operating
Period Declared Per Share (1) Cash Reinvested Total Activities
First Quarter 2022 $ 22,795 $ 0.149 $ 16,721 $ 6,266 $ 22,987 $ 7,533
Second Quarter 2022 22,336 0.149 13,336 9,139 22,475 15,996
Third Quarter 2022 22,017 0.150 13,093 8,992 22,085 35,234
Fourth Quarter 2022 22,087 0.150 13,055 8,994 22,049 17,202
$ 89,235 $ 0.598 $ 56,205 $ 33,391 $ 89,596 $ 75,965
_____________________
(1) Assumes share was issued and outstanding on each monthly record date for
distributions during the period presented. For each monthly record date for
distributions during the period from January 1, 2022 through December 31, 2022 ,
distributions were calculated at a rate of $0.04983333 per share.
(2) Distributions are generally paid on a monthly basis. Distributions for the
monthly record date of a given month are generally paid on or about the first
business day of the following month.
For the year ended December 31, 2022 , we paid aggregate distributions of $89.6
million , including $56.2 million of distributions paid in cash and $33.4 million
of distributions reinvested through our dividend reinvestment plan. Our net loss
for the year ended December 31, 2022 was $62.5 million . FFO for the year ended
December 31, 2022 was $142.2 million and cash flow from operating activities was
$76.0 million . See the reconciliation of FFO to net income above. We funded our
total distributions paid, which includes net cash distributions and dividends
reinvested by stockholders, with $62.8 million of cash flow from current
operating activities, $22.1 million of cash flow from operating activities in
excess of distributions paid during prior periods and $4.7 million of proceeds
from debt financing. For purposes of determining the source of our distributions
paid, we assume first that we use cash flow from operating activities from the
relevant or prior periods to fund distribution payments.
In January 2023 , we reduced the distribution rate from that of prior periods due
to the continued impact of the economic slowdown on our cash flows. See Part I,
Item 1A, "Risk Factors," Part II, Item 5, "Market for Registrant's Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities -
Distribution Information," and "-Market Outlook-Real Estate and Real Estate
Finance Markets" above. Our management team and our board of directors will
continue to monitor our results of operations and operating cash flows, and
based on an analysis of our cash flows and projected cash flows may consider a
further reduction to our distribution rate in a future period.
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Over the long-term, we generally expect our distributions will be paid from cash flow from operating activities from current periods or prior periods (except with respect to distributions related to sales of our assets and distributions related to the sales or repayment of real estate-related investments). From time to time during our operational stage, we may not pay distributions solely from our cash flow from operating activities, in which case distributions may be paid in whole or in part from debt financing. To the extent that we pay distributions from sources other than our cash flow from operating activities, the overall return to our stockholders may be reduced. Further, our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including those discussed under "Forward-Looking Statements," "Summary Risk Factors," Part I, Item 1A, "Risk Factors" and in this Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." Those factors include: the future operating performance of our real estate investments in the existing real estate and financial environment; the success and economic viability of our tenants; our ability to refinance existing indebtedness at comparable terms; changes in interest rates on any variable rate debt obligations we incur; the level of participation in our dividend reinvestment plan; and continued disruptions in the financial markets, including the current economic slowdown, the rising interest rate environment and inflation (or the public perception that any of these events may continue) as well as potential changes in the demand for office properties resulting from the COVID-19 pandemic and uncertain economic conditions. In the event our FFO and/or cash flow from operating activities decrease in the future, the level of our distributions may also decrease. In addition, future distributions declared and paid may exceed FFO and/or cash flow from operating activities.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with GAAP and in conjunction with the rules and regulations of theSEC . The preparation of our 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 our disclosure of contingent assets and liabilities as of the dates of the 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 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 - Operating Leases
Real Estate
We recognize minimum rent, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related leases when collectibility is probable and record amounts expected to be received in later years as deferred rent receivable. 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 (including amounts that can be taken in the form of cash or a credit against the tenant's rent) that is funded is treated as a lease incentive and amortized as a reduction of rental 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 lessee or lessor supervises the construction and bears the risk of cost overruns;
•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.
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In accordance with ASU 2016-02, Leases (Topic 842) ("Topic 842"), tenant
reimbursements for property taxes and insurance are included in the single lease
component of the lease contract (the right of the lessee to use the leased
space) and therefore are accounted for as variable lease payments and are
recorded as rental income on our statement of operations. In addition, we
adopted the practical expedient available under Topic 842, to not separate
nonlease components from the associated lease component and, instead to account
for those components as a single component if the nonlease components otherwise
would be accounted for under the new revenue recognition standard (Topic 606)
and if certain conditions are met, specifically related to tenant reimbursements
for common area maintenance which would otherwise be accounted for under the
revenue recognition standard. We believe the two conditions have been met for
tenant reimbursements for common area maintenance as (i) the timing and pattern
of transfer of the nonlease components and associated lease components are the
same and (ii) the lease component would be classified as an operating lease.
Accordingly, tenant reimbursements for common area maintenance are also
accounted for as variable lease payments and recorded as rental income on our
statement of operations.
In accordance with Topic 842, we make a determination of whether the
collectibility of the lease payments in an operating lease is probable. If we
determine the lease payments are not probable of collection, we would fully
reserve for any contractual lease payments, deferred rent receivable, and
variable lease payments and would recognize rental income only to the extent
cash has been received. These changes to our collectibility assessment are
reflected as an adjustment to rental income. We make estimates of the
collectability of the lease payments which requires significant judgment by
management. We consider payment history, current credit status, the tenant's
financial condition, security deposits, letters of credit, lease guarantees and
current market conditions that may impact the tenant's ability to make payments
in accordance with its lease agreements, including the impact of the continued
disruptions in the financial markets on the tenant's business, in making the
determination.
We, as a lessor, record costs to negotiate or arrange a lease that would have
been incurred regardless of whether the lease was obtained, such as legal costs
incurred to negotiate an operating lease, as an expense and classify such costs
as operating, maintenance, and management expense on our consolidated statement
of operations, as these costs are no longer capitalizable under the definition
of initial direct costs under Topic 842.
Sales of Real Estate
We follow the guidance of ASC 610-20, Other Income - Gains and Losses from the
Derecognition of Nonfinancial Assets ("ASC 610-20"), which applies to sales or
transfers to noncustomers of nonfinancial assets or in substance nonfinancial
assets that do not meet the definition of a business. Generally, our sales of
real estate would be considered a sale of a nonfinancial asset as defined by ASC
610-20.
ASC 610-20 refers to the revenue recognition principles under ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606). Under ASC 610-20, if we
determine we do not have a controlling financial interest in the entity that
holds the asset and the arrangement meets the criteria to be accounted for as a
contract, we would derecognize the asset and recognize a gain or loss on the
sale of the real estate when control of the underlying asset transfers to the
buyer. The application of these criteria can be complex and incorrect
assumptions on collectability of the transaction price or transfer of control
can result in the improper recognition of the gain or loss from sales of real
estate during the period.
Real Estate Equity Securities Dividend income from real estate equity securities is recognized on an accrual basis based on eligible units as of the ex-dividend date.
Real Estate
Depreciation and Amortization
Real estate costs related to the acquisition and improvement of properties are
capitalized and depreciated over the expected useful life of the asset on a
straight-line basis. Repair and maintenance costs are charged to expense as
incurred and significant replacements and betterments are capitalized. Repair
and maintenance costs include all costs that do not extend the useful life of
the real estate asset. We consider the period of future benefit of an asset to
determine its appropriate useful life. Expenditures for tenant improvements are
capitalized and amortized over the shorter of the tenant's lease term or
expected useful life. We anticipate the estimated useful lives of our assets by
class to be generally as follows:
Land N/A
Buildings 25-40 years
Building improvements 10-25 years
Tenant improvements Shorter of lease term or expected useful life
Tenant origination and absorption costs Remaining term of related leases, including
below-market renewal periods
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Real Estate Acquisition Valuation
We record the acquisition of income-producing real estate or real estate that will be used for the production of income as a business combination or an asset acquisition. If substantially all of the fair value of the gross assets acquired are concentrated in a single identifiable asset or group of similar identifiable assets, then the set is not a business. For purposes of this test, land and buildings can be combined along with the intangible assets for any in-place leases and accordingly, most acquisitions of investment properties would not meet the definition of a business and would be accounted for as an asset acquisition. To be considered a business, a set must include an input and a substantive process that together significantly contributes to the ability to create an output. All assets acquired and liabilities assumed in a business combination are measured at their acquisition-date fair values. For asset acquisitions, the cost of the acquisition is allocated to individual assets and liabilities on a relative fair value basis. Acquisition costs associated with business combinations are expensed as incurred. Acquisition costs associated with asset acquisitions are capitalized. We assess the acquisition date fair values of all tangible assets, identifiable intangibles and assumed liabilities using methods similar to those used by independent appraisers, generally utilizing a discounted cash flow analysis that applies appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors, including historical operating results, known and anticipated trends, and market and economic conditions. The fair value of tangible assets of an acquired property considers the value of the property as if it were vacant. We record above-market and below-market in-place lease values for acquired properties based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management's estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of above-market in-place leases and for the initial term plus any extended term for any leases with below-market renewal options. We amortize any recorded above-market or below-market lease values as a reduction or increase, respectively, to rental income over the remaining non-cancelable terms of the respective lease, including any below-market renewal periods. We estimate the value of tenant origination and absorption costs by considering the estimated carrying costs during hypothetical expected lease-up periods, considering current market conditions. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods.
We amortize the value of tenant origination and absorption costs to depreciation and amortization expense over the remaining non-cancelable term of the leases.
Estimates of the fair values of the tangible assets, identifiable intangibles and assumed liabilities require us to make significant assumptions to estimate market lease rates, property-operating expenses, carrying costs during lease-up periods, discount rates, market absorption periods, and the number of years the property will be held for investment. The use of inappropriate assumptions would result in an incorrect valuation of our acquired tangible assets, identifiable intangibles and assumed liabilities, which would impact the amount of our net income. Subsequent to the acquisition of a property, we may incur and capitalize costs necessary to get the property ready for its intended use. During that time, certain costs such as legal fees, real estate taxes and insurance and financing costs are also capitalized.
Impairment of Real Estate and Related Intangible Assets and Liabilities
We continually monitor events and changes in circumstances that could indicate
that the carrying amounts of our real estate and related intangible assets and
liabilities may not be recoverable or realized. When indicators of potential
impairment suggest that the carrying value of real estate and related intangible
assets and liabilities 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 and liabilities through its undiscounted future cash
flows 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 real estate and related intangible assets and liabilities.
Projecting future cash flows involves estimating expected future operating
income and expenses related to the real estate and its related intangible assets
and liabilities as well as market and other trends. Using inappropriate
assumptions to estimate cash flows or the expected hold period until the
eventual disposition could result in incorrect conclusions on recoverability and
incorrect fair values of the real estate and its related intangible assets and
liabilities and could result in the overstatement of the carrying values of our
real estate and related intangible assets and liabilities and an overstatement
of our net income.
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Real estate equity securities are carried at fair value based on quoted market prices for the security. Unrealized gains and losses on real estate equity securities are recognized in earnings.
Derivative Instruments
We enter into derivative instruments for risk management purposes to hedge our exposure to cash flow variability caused by changing interest rates on our variable rate notes payable. We record these derivative instruments at fair value on the accompanying consolidated balance sheets. The changes in fair value for derivative instruments that are not designated as a hedge or that do not meet the hedge accounting criteria are recorded as gain or loss on derivative instruments and included in interest expense as presented in the accompanying consolidated statements of operations. The calculation of the fair value of derivative instruments is complex and different inputs used in the model can result in significant changes to the fair value of derivative instruments and the related gain or loss on derivative instruments included as interest expense in the accompanying consolidated statements of operations. The valuation of our derivative instruments is based on a proprietary model using the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and volatility. The fair values of interest rate swaps are estimated using the market standard methodology of netting the discounted fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of interest rates (forward curves) derived from observable market interest rate curves. In addition, credit valuation adjustments, which consider the impact of any credit risks to the contracts, are incorporated in the fair values to account for potential nonperformance risk.
Fair Value Election of Hybrid Financial Instruments with Embedded Derivatives
When we enter into interest rate swaps which include off-market terms, we determine if these contracts are hybrid financial instruments with embedded derivatives requiring bifurcation between the host contract and the derivative instrument. We elected to initially and subsequently measure these hybrid financial instruments in their entirety at fair value with concurrent documentation of this election. Changes in the fair value of the hybrid financial instrument under this fair value election are recorded in earnings and are included in interest expense in the accompanying consolidated statements of operations. The cash flows for these off-market swap instruments which contain an other-than-insignificant financing element at inception are included in cash flows provided by or used in financing activities on the accompanying consolidated statements of cash flows.
Income Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code. To continue to qualify as a REIT, we must continue to 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 net income 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.
Subsequent Events
We evaluate subsequent events up until the date the consolidated financial statements are issued.
Distributions Paid
On
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Distributions Authorized
OnMarch 10, 2023 , our board of directors authorized aMarch 2023 distribution in the amount of$0.03833333 per share of common stock to stockholders of record as of the close of business onMarch 20, 2023 , which we expect to pay inApril 2023 , and anApril 2023 distribution in the amount of$0.03833333 per share of common stock to stockholders of record as of the close of business onApril 20, 2023 , which we expect to pay inMay 2023 .
Investors may choose to receive cash distributions or purchase additional shares through our dividend reinvestment plan.
Suspension of Ordinary Redemptions
On
We will continue to evaluate the markets and our overall liquidity profile as we
determine when to potentially remove the suspension on Ordinary Redemptions,
though we can give no assurance in this regard.
All Ordinary Redemption requests that have been received were canceled. Further,
no Ordinary Redemptions will be accepted or collected during the suspension of
the share redemption program. However, any redemptions sought in connection with
and meeting the requirements for Special Redemptions will still be eligible and
will continue to be processed in accordance with the current share redemption
program.
In addition, there are several other limitations on our ability to redeem shares
under the share redemption program. See Part II, Item 5, "Market for
Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities-Amended and Restated Share Redemption Program."
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