Attached files

file filename
EX-32.1 - Summit Healthcare REIT, Incv179108_ex32-1.htm
EX-21.1 - Summit Healthcare REIT, Incv179108_ex21-1.htm
EX-31.2 - Summit Healthcare REIT, Incv179108_ex31-2.htm
EX-31.1 - Summit Healthcare REIT, Incv179108_ex31-1.htm
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K

(Mark One)

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2009
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: 000-52566
 
CORNERSTONE CORE PROPERTIES REIT, INC.
(Exact name of registrant as specified in its charter)
 
Maryland
73-1721791
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
1920 Main Street, Suite 400, Irvine, California 92614
(Address of Principal Executive Offices)
 
949-852-1007
(Registrant’s Telephone Number, Including Area Code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class:
None
 
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class:
Common Stock, $0.001 par value per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No x

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

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 this Form 10-K or any amendment to this Form 10-K. x

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

Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act): Yes o  No x

As of June 30, 2009 (the last business day of the registrant’s second fiscal quarter), there were 22,482,541 shares of common stock held by non-affiliates of the registrant having an aggregate market value of $166,918,796.

As of March 26, 2010, there were approximately 22,733,499 shares of common stock of Cornerstone Core Properties REIT, Inc. outstanding. The Registrant incorporates by reference portions of its Definitive Proxy Statement for the 2010 Annual Meeting of Stockholders, which is expected to be filed no later than April 30, 2010, into Part III of this Form 10-K to the extent stated herein.
 

                       
CORNERSTONE CORE PROPERTIES REIT, INC.
(A Maryland Corporation)

TABLE OF CONTENTS

 
PART I
 
     
Item 1
Business
3
     
Item 1A
Risk Factors
8
     
Item 1B
Unresolved Staff Comments
22
     
Item 2
Properties
23
     
Item 3
Legal Proceedings
24
     
Item 4
Reserved
24
     
 
PART II
 
     
Item 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
25
     
Item 6
Selected Financial Data
29
     
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
     
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
37
     
Item 8
Financial Statements and Supplementary Data
37
     
Item 9
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
38
     
Item 9A(T)
Controls and Procedures
38
     
Item 9B
Other Information
38
     
 
PART III
 
     
Item 10
Directors, Executive Officers and Corporate Governance
39
     
Item 11
Executive Compensation
39
     
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
39
     
Item 13
Certain Relationships and Related Transactions, and Director Independence
39
     
Item 14
Principal Accounting Fees and Services
39
     
 
PART IV
 
     
Item 15
Exhibits and Financial Statement Schedules
40
 
2


PART I

SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled “Risk Factors” in Item 1A of this report. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, there can be no assurance that our expectations will be realized.

As used in this report, “we,” “us” and “our” refer to Cornerstone Core Properties REIT, Inc. and its consolidated subsidiaries except where the context otherwise requires.

ITEM 1.  BUSINESS

Our Company

Cornerstone Core Properties REIT, Inc., a Maryland corporation, was formed on October 22, 2004 for the purpose of engaging in the business of investing in and owning commercial real estate.  We have qualified, and intend to continue to qualify, as a real estate investment trust (REIT) for federal tax purposes.

We are structured as an umbrella partnership REIT, referred to as an “UPREIT,” under which substantially all of our current and future business is, and will be, conducted through a majority owned subsidiary, Cornerstone Operating Partnership, L.P., a Delaware limited partnership, formed on November 30, 2004.  We are the sole general partner of the operating partnership and have control over its affairs.  

Our external advisor is Cornerstone Realty Advisors, LLC, a Delaware limited liability company. One of our directors is also a director of our advisor and all of our officers are also officers of our advisor.  Our advisor has contractual and fiduciary responsibilities to us and our stockholders.  Under the terms of the advisory agreement, our advisor will use commercially reasonable efforts to present to us investment opportunities and to provide a continuing and suitable investment program consistent with the investment policies and objectives adopted by our board of directors.  Our advisor is responsible for managing our affairs on a day-to-day basis and for identifying and making property acquisitions on our behalf.  Currently, there are no employees of Cornerstone Core Properties REIT, Inc. and its subsidiaries.  All management and administrative personnel responsible for conducting our business are currently employed by affiliates of our advisor.

From our formation through the end of the year ended December 31, 2005, our activities consisted solely of organizational activities including preparing for and launching our initial public offering.  On January 6, 2006, we commenced our initial public offering and retained Pacific Cornerstone Capital, Inc. (“PCC”), an affiliate of our advisor, to serve as the dealer manager for the offering. PCC is responsible for marketing our shares being offered pursuant to the offering. PCC and Terry G. Roussel, the majority owner of our dealer manager and one of our officers and directors, have been the subject of a non-public inquiry by Financial Industry Regulatory Authority (“FINRA”) focused on private placements conducted by our dealer manager during the period from January 1, 2004 through May 30, 2009.  We are not the issuer of any of the securities offered in the private placements that are the subject of FINRA’s investigation.  One such issuer is, however, the managing member of our advisor.  Without admitting or denying the findings, our dealer manager and Terry G. Roussel have settled the FINRA inquiry, which alleges that they violated NASD rules relating to communications with the public (Rule 2210); supervision (Rule 3010) and standards of commercial honor and principles of trade (Rule 2110).  FINRA’s allegations, in sum, focus on claimed material misstatements and omissions with respect to certain performance targets.  Our dealer manager has consented to a censure and fine of $700,000.  Mr. Roussel has consented to a fine of $50,000, suspension from association with a FINRA member in all capacities for 20 business days, and suspension from association with a FINRA member firm in a principal capacity for an additional three months.  Terry G. Roussel served as our dealer manager’s president and chief compliance officer until October 1, 2009, when he resigned as president. In January, Terry G. Roussel transferred his chief compliance officer responsibilities to a qualified registered principal. He presently serves as one of our dealer manager’s two directors.  Our dealer manager has provided additional disclosures, satisfactory to FINRA, to investors in the private offerings.

On November 25, 2008, we filed a registration statement on Form S-11 with the SEC to register a follow-on public offering.  We subsequently amended the registration statement on February 17, 2009.  Pursuant to the registration statement, as amended, we registered up to 56,250,000 shares of common stock in a primary offering for $8.00 per share, with discounts available to certain categories of purchasers. We also registered approximately 21,250,000 shares pursuant to our dividend reinvestment plan at a purchase price equal to $7.60 per share.  We stopped making offers under our initial public offering on June 1, 2009 and commenced our follow-on offering on June 10, 2009.  
 
3


As of December 31, 2009, approximately 20.8 million shares of our common stock had been sold in our initial and follow-on public offering for aggregate gross proceeds of approximately $165.9 million.  This excludes shares issued under our distribution reinvestment plan.

Investment Objectives

Our investment objectives are to:

 
·
preserve stockholder capital by owning and operating real estate on an all-cash basis with no permanent financing;

 
·
purchase investment grade properties with the potential for capital appreciation to our stockholders;

 
·
purchase income-producing properties which will allow us to pay cash distributions to our stockholders at least quarterly, if not more frequently; and

 
·
provide liquidity to our stockholders within the shortest reasonable time necessary to accomplish the above objectives.
 
On or before September 21, 2012, our board of directors will take action to provide enhanced liquidity for our stockholders.  The directors will consider various plans to enhance liquidity, including, but not limited to:

 
·
modifying our stock repurchase program to increase the number of shares that we can redeem under the program during any given period, and to expand the sources of funding that we can use to redeem shares under the program;
 
 
·
seeking stockholder approval to begin an orderly liquidation of our assets and distribute the available proceeds of such sales to our stockholders;

 
·
listing our stock for trading on a national securities exchange; or
 
 
·
seeking stockholder approval of another liquidity event such as a sale of our assets or a merger with another entity.
 
The implementation of one or more of these plans will be at the discretion of our board of directors based upon its consideration of the best interests of our stockholders, however, we currently believe that a modification to our share redemption program as described above is the liquidity option most likely to be implemented on or before September 21, 2012.

Investment Strategy

Large institutional investors have proven how to build a successful real estate portfolio.  They generally start with a foundation of “core” holdings. “Core” holdings are existing, high quality properties owned “all-cash” free and clear of debt.  We believe that “core” holdings are necessary to help investors build the base of their investment portfolio. That is why our primary investment focus is to acquire investment real estate “all cash” with no permanent financing.

All cash real estate investments add a layer of safety to conservative real estate investment which we believe would be difficult to match by any other strategy.  By owning and operating properties on an “all-cash” basis, risk of foreclosure of mortgage debt is substantially eliminated.  Following acquisition of “core” real property investments, many large institutional investors then make “core plus,” “valued added” and “opportunistic” real property investments each of which has increasing levels of debt, risk and yield.

Acquisition Policies

Primary Investment Focus

We focus on acquiring investment grade real estate including multi-tenant industrial properties that are:

 
·
owned and operated on an all-cash basis with no permanent financing;

 
·
high-quality, existing, and currently producing income;

 
·
leased to a diversified tenant base; and
 
4

 
 
·
leased with overall shorter term operating type leases, allowing for annual rental increases and greater potential for capital growth.

We seek potential property acquisitions meeting the above criteria that are located in major metropolitan markets throughout the United States. Among the most important criteria we expect to use in evaluating the markets in which we purchase properties are:

 
·
high population;

 
·
historically high levels of tenant demand and lower historic investment volatility for type of property being acquired;

 
·
high historical and projected employment growth;

 
·
stable household income and general economic stability;

 
·
a scarcity of land for new competitive properties; and

 
·
sound real estate fundamentals, such as high occupancy rates and strong rent rate potential.

The markets in which we invest may not meet all of these criteria and the relative importance that we assign to any one or more of these criteria may differ from market to market or change as general economic and real estate market conditions evolve.  We may also consider additional important criteria in the future.

Multi-tenant industrial properties generally offer a combination of both warehouse and office space adaptable to a broad range of tenants and uses and typically cater to local and regional businesses.  Multi-tenant industrial properties comprise one of the major segments of the commercial real estate market and tenants in these properties come from a broad spectrum of industries including light manufacturing, assembly, distribution, import/export, general contractors, telecommunications, general office/ warehouse, wholesale, service, high-tech and other fields.  These properties diversify revenue by generating rental income from multiple businesses in a variety of industries instead of relying on one or two large tenants.

Other Potential Investments

While we intend to invest in multi-tenant industrial properties, we have the ability to invest in any type of real estate investment that we believe to be in the best interests of our stockholders, including other real estate funds or REITs, mortgage funds, mortgage loans and sale lease-backs.  Furthermore, there are no restrictions on the number or size of properties we may purchase or on the amount or proportion of net proceeds of our initial public offering that we may invest in a single property.  Although we can invest in any type of real estate investment, our charter restricts certain types of investments.  We do not intend to underwrite securities of other issuers or to engage in the purchase and sale of any types of investments other than real estate investments.

Investment Policies and Decisions

Our advisor makes recommendations to our board of directors, which approves or rejects all proposed property acquisitions.  Our independent directors will review our investment policies at least annually to determine whether these policies continue to be in the best interests of our stockholders.

We purchase properties based on the decision of our board of directors after an examination and evaluation by our advisor of many factors including but not limited to the functionality of the property, the historical financial performance of the property, current market conditions for leasing space at the property, proposed purchase price, terms and conditions, potential cash flows and potential profitability of the property.  The number of properties that we will purchase will depend on the amount of funds we raise in our offerings and upon the price we pay for the properties we purchase.  To identify properties that best fit our investment criteria, our advisor will study regional demographics and market conditions and work through local commercial real estate brokers.

Leases and Tenant Improvements

The properties we acquire generally have operating type leases.  Operating type leases generally have either gross or modified gross payment terms.  Under gross leases, the landlord pays all operating expenses of the property.  Under modified gross leases, the tenant reimburses the landlord for certain operating expenses.  A “net” lease provides that the tenant pays or reimburses the owner for all or substantially all property operating expenses.  As landlord, we will generally have responsibility for certain capital repairs or replacement of specific structural components of a property such as the roof, heating and air conditioning systems, the interior floor or slab of the building as well as parking areas.

When a tenant at one of our properties vacates its space, it is likely that we will be required to expend funds for tenant improvements and refurbishments to the vacated space in order to attract new tenants.  If we do not have adequate cash on hand to fund tenant improvements and refurbishments, we may use interim debt financing in order to fulfill our obligations under lease agreements with new tenants.
 
5


Joint Ventures and Other Arrangements

We may acquire some of our properties in joint ventures, some of which may be entered into with affiliates of our advisor.  We may also enter into general partnerships, co-tenancies and other participations with real estate developers, owners and others for the purpose of owning and leasing real properties.  Among other reasons, we may want to acquire properties through a joint venture with third parties or affiliates in order to diversify our portfolio of properties in terms of geographic region, property type and tenant industry group.  Joint ventures may also allow us to acquire an interest in a property without requiring that we fund the entire purchase price.  In addition, certain properties may be available to us only through joint ventures.  In determining whether to recommend a particular joint venture, the advisor will evaluate the real property for which such joint venture owns or is being formed to own under the same criteria described elsewhere in this annual report.  These entities may employ debt financing. (See “Borrowing Policies” below.)

Borrowing Policies

We intend to be an all-cash REIT that will own and operate our properties with no permanent indebtedness.  Generally, we will pay the entire purchase price of each property in cash or with equity securities, or a combination of each.  Being an all-cash REIT mitigates the risks associated with mortgage debt, including the risk of default on the mortgage payments and a resulting foreclosure of a particular property.

During our offering period, we have and intend to continue to use temporary financing to facilitate acquisitions of properties in anticipation of receipt of offering proceeds. We will endeavor to repay such debt financing promptly upon receipt of proceeds in our offering.  To the extent sufficient proceeds from our offerings are unavailable to repay such debt financing within a reasonable time as determined by our board of directors, we may sell properties or raise equity capital to repay the debt so that we will own our properties all-cash, with no permanent acquisition financing.

We may incur indebtedness for working capital requirements, tenant improvements, capital improvements, leasing commissions and to make distributions including but not limited to those necessary in order to maintain our qualification as a REIT for federal income tax purposes.  We will endeavor to borrow funds on an unsecured basis but we may secure indebtedness with some or all of our portfolio of properties if a majority of our independent directors determine that it is in the best interests of us and our stockholders.

We may also acquire properties encumbered with existing financing which cannot be immediately repaid.  To the extent we cannot repay the financing that encumbers these properties within a reasonable time as determined by a majority of our independent directors, we intend to sell properties or raise equity capital to pay debt in order to maintain our all-cash status or reserve an amount of cash sufficient to repay the loan to mitigate the risks of foreclosure.

We may invest in joint venture entities that borrow funds or issue senior equity securities to acquire properties, in which case our equity interest in the joint venture would be junior to the rights of the lender or preferred stockholders. In some cases, our advisor may control the joint venture.

If we list our stock on a national stock exchange, we may thereafter change our strategy and begin to use permanent debt in our investment strategy.  Our charter limits our borrowings to the equivalent of 75% of our cost, before deducting depreciation or other non-cash reserves, of all our assets unless any excess borrowing is approved by a majority of our independent directors and is disclosed to our stockholders in our next quarterly report with an explanation from our independent directors of the justification for the excess borrowing.  While there is no limitation on the amount we may borrow for the purchase of any single property, we intend to repay such debt within a reasonable time or raise additional equity capital or sell properties in order to maintain our all-cash status.

Competition

We compete with a considerable number of other real estate companies seeking to acquire and lease industrial space, most of which may have greater marketing and financial resources than we do.  Principal factors of competition in our business are the quality of properties (including the design and condition of improvements), leasing terms (including rent and other charges and allowances for tenant improvements), attractiveness and convenience of location, the quality and breadth of tenant services provided and reputation as an owner and operator of quality office properties in the relevant market.  Our ability to compete also depends on, among other factors, trends in the national and local economies, financial condition and operating results of current and prospective tenants, availability and cost of capital, construction and renovation costs, taxes, governmental regulations, legislation and population trends.

We may hold interests in properties located in the same geographic locations as other entities managed by our advisor or our advisor’s affiliates.  Our properties may face competition in these geographic regions from such other properties owned, operated or managed by other entities managed by our advisor or our advisor’s affiliates.  Our advisor or its affiliates have interests that may vary from those we may have in such geographic markets.
 
6


Government Regulations

Our company and the properties we own are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. Federal laws such as the National Environmental Policy Act, the Comprehensive Environmental Response, Compensation, and Liability Act, the Resource Conservation and Recovery Act, the Federal Water Pollution Control Act, the Federal Clean Air Act, the Toxic Substances Control Act, the Emergency Planning and Community Right to Know Act and the Hazard Communication Act govern such matters as wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials and the remediation of contamination associated with disposals. Some of these laws and regulations impose joint and several liability on tenants, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal.  Compliance with these laws and any new or more stringent laws or regulations may require us to incur material expenditures.  Future laws, ordinances or regulations may impose material environmental liability.  In addition, there are various federal, state and local 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.

Our properties may be affected by our tenants’ operations, the existing condition of land when we buy it, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties.  The presence of hazardous substances, or the failure to properly remediate these substances, may make it difficult or impossible to sell or rent such property.

Under various federal, state and local environmental laws, ordinances and regulations, a current or previous real property owner or operator may be liable for the cost to remove or remediate hazardous or toxic substances on, under or in such property.  These costs could be substantial.  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.  Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures or prevent us from entering into leases with prospective tenants that may be impacted by such laws.  Environmental laws provide for sanctions for noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties.  Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos-containing materials into the air.  Third parties may seek recovery from real property owners or operators for personal injury or property damage associated with exposure to released hazardous substances.  The cost of defending against claims of liability, of complying with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could be substantial.

We obtain satisfactory Phase I environmental assessments on each property we purchase.  A Phase I assessment is an inspection and review of the property, its existing and prior uses, aerial maps and records of government agencies for the purpose of determining the likelihood of environmental contamination.  A Phase I assessment includes only non-invasive testing.  It is possible that all environmental liabilities were not identified in the Phase I assessments we obtained or that a prior owner, operator or current occupant has created an environmental condition which we do not know about.  There can be no assurance that future law, ordinances or regulations will not impose material environmental liability on us or that the current environmental condition of our properties will not be affected by our tenants, or by the condition of land or operations in the vicinity of our properties such as the presence of underground storage tanks or groundwater contamination.

Acquisition Activity

At December 31, 2009, we owned twelve properties.  All of these properties are consolidated into our accompanying consolidated financials statements and included in the properties summary as provided under “Item 2 Properties” referenced below.

We have acquired our properties to date with a combination of the proceeds from our ongoing public offerings and debt incurred upon the acquisition of certain properties.

Employees

We have no employees and our executive officers are all employees of our advisor’s affiliates.  Substantially all of our work is performed by employees of our advisor’s affiliates.  We are dependent on our advisor and PCC for certain services that are essential to us, including the sale of shares in our ongoing public follow-on offering; the identification, evaluation, negotiation, purchase and disposition of properties; the management of the daily operations of our real estate portfolio; and other general and administrative responsibilities. In the event that these companies are unable to provide the respective services, we will be required to obtain such services from other sources.
 
7


Available Information

Information about us is available on our website (http://www.crefunds.com).  We make available, free of charge, on our Internet website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with the SEC.  These materials are also available at no cost in print to any person who requests it by contacting our Investor Services Department at 1920 Main Street, Suite 400, Irvine, California 92614; telephone (877) 805-3333.  Our filings with the SEC are available to the public over the Internet at the SEC’s website at http://www.sec.gov.  You may read and copy any filed document at the SEC’s public reference room in Washington, D.C. at 100 F Street, N.E., Room 1580, Washington D.C.  Please call the SEC at (800) SEC-0330 for further information about the public reference rooms.

ITEM 1A.  RISK FACTORS

The risks and uncertainties described below can adversely affect our business, operating results, prospects and financial condition.  These risks and uncertainties could cause our actual results to differ materially from those presented in our forward-looking statements.

General

Recent disruptions in the financial markets and continuing poor economic conditions could adversely affect the values of our investments and our ongoing results of operations.
 
Disruptions in the capital markets during the past two years have constrained equity and debt capital available for investment in commercial real estate, resulting in fewer buyers seeking to acquire commercial properties and consequent reductions in property values.  Furthermore, the current state of the economy and the implications of future potential weakening may negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values in our portfolio.  The current downturn may impact our tenants’ ability to pay base rent, percentage rent or other charges due to us.

Liquidity in the global credit market has been significantly contracted by market disruptions, making it costly to finance acquisitions, obtain new lines of credit or refinance existing debt, when debt financing is available at all.
 
The occurrence of these events could have the following negative effects on us:
 
 
·
the values of our investments in commercial properties could decrease below the amounts we paid for the investments;
 
 
·
revenues from our properties could decrease due to lower occupancy rates, reduced rental rates and potential increases in uncollectible receivables;

 
·
our capital expenditures may increase due to re-leasing costs and commissions; and
 
 
·
we may not be able to refinance our existing indebtedness or to obtain additional debt financing on attractive terms.
 
These factors could impair our ability to make distributions to stockholders and decrease the value of investments in us.

Financial markets are still recovering from a period of disruption and recession, and we are unable to predict if and when the economy will stabilize or improve.

The financial markets are still recovering from a recession, which created volatile market conditions, resulted in a decrease in availability of business credit and led to the insolvency, closure or acquisition of a number of financial institutions. While the markets showed signs of stabilizing in the end of 2009, it remains unclear when the economy will fully recover to pre-recession levels. Continued economic weakness in the U.S. economy generally or a new recession would likely adversely affect our financial condition and that of our tenants and could impact the ability of our tenants to pay rent to us.

Our limited operating history makes it difficult for you to evaluate us.  In addition, as a company in its early stages of operations we have incurred losses in the past and may continue to incur losses.
 
We have a limited operating history. As a consequence, our past performance and the past performance of other real estate investment programs sponsored by affiliates of our advisor may not be indicative of the performance we will achieve. We were formed on October 22, 2004 in order to invest primarily in investment real estate. We have acquired twelve properties as of the date of this report and generated limited income, cash flow, funds from operations or funds from which to make distributions to our shareholders.  In addition, as a company in its early stages of operations, we have incurred losses since our inception and we may continue to incur losses.
 
8


Because there is no public trading market for our stock it will be difficult for stockholders to sell their stock. If stockholders are able to sell their stock, they will likely sell it at a substantial discount.
 
There is no current public market for our stock and there is no assurance that a public market will ever develop for our stock. Our charter contains restrictions on the ownership and transfer of our stock, and these restrictions may inhibit our stockholders’ ability to sell their stock. Our charter prevents any one person from owning more than 9.8% in number of shares or value, whichever is more restrictive, of the outstanding shares of any class or series of our stock unless exempted by our board of directors. Our charter also limits our stockholders’ ability to transfer their stock to prospective stockholders unless (i) they meet suitability standards regarding income or net worth, and (ii) the transfer complies with minimum purchase requirements. We have adopted a stock repurchase program, but it is limited in terms of the number of shares of stock which may be redeemed annually. Our board of directors may also limit, suspend or terminate our stock repurchase program at any time. We have no obligations to purchase our stockholders’ stock if redemption would violate restrictions on cash distributions under Maryland law.

It may be difficult for our stockholders to sell their stock promptly or at all. If our stockholders are able to sell shares of stock, they may only be able to sell them at a substantial discount from the price they paid. This may be the result, in part, of the fact that the amount of funds available for investment is expected to be reduced by sales commissions, dealer manager fees, organization and offering expenses, and acquisition fees and expenses. If our offering expenses are higher than we anticipate, we will have a smaller amount available for investment. Unless our aggregate investments increase in value to compensate for these up-front fees and expenses, it is unlikely that our stockholders will be able to sell their stock, whether pursuant to our stock repurchase program or otherwise, without incurring a substantial loss. We cannot assure our stockholders that their stock will ever appreciate in value to equal the price they paid for their stock. It is also likely that their stock would not be accepted as the primary collateral for a loan.  Stockholders should consider their stock as an illiquid investment, and they must be prepared to hold their stock for an indefinite period of time.

Competition with third parties for properties and other investments may result in our paying higher prices for properties which could reduce our profitability and the return on your investment.
 
We compete with many other entities engaged in real estate investment activities, including individuals, corporations, banks, insurance companies, other REITs, real estate limited partnerships, and other entities engaged in real estate investment activities, many of which have greater resources than we do. Some of these investors may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. In addition, the number of entities and the amount of funds competing for suitable investments may increase. Any such increase would result in increased demand for these assets and increased prices. If competitive pressures cause us to pay higher prices for properties, our ultimate profitability may be reduced and the value of our properties may not appreciate or may decrease significantly below the amount paid for such properties. At the time we elect to dispose of one or more of our properties, we will be in competition with sellers of similar properties to locate suitable purchasers, which may result in us receiving lower proceeds from the disposal or result in us not being able to dispose of the property due to the lack of an acceptable return. This may cause our stockholders to experience a lower return on their investment.

If we are unable to find or experience delays in finding suitable investments, we may need to reduce or suspend distributions to our stockholders.
 
Our ability to achieve our investment objectives and to make distributions depends upon the performance of our advisor in the acquisition and operation of our investments, and upon the performance of property managers and leasing agents in the management of our properties and the identification of prospective tenants. We may be delayed in making investments in properties due to delays in the sale of our stock, delays in negotiating or obtaining the necessary purchase documentation for properties, delays in locating suitable investments or other factors. We cannot be sure that our advisor will be successful in obtaining suitable investments on financially attractive terms or that our investment objectives will be achieved. We may also make other real estate investments such as investments in publicly traded REITs, mortgage funds and other entities which make real estate investments. Until we make real estate investments, we will hold the proceeds from our public offerings in an interest-bearing account or invest the proceeds in short-term, investment-grade securities. We expect the rates of return on these short-term investments to be substantially less than the returns we make on real estate investments. If we are unable to invest the proceeds from our offerings in properties or other real estate investments for an extended period of time, distributions to our stockholders may be suspended and may be lower and the value of their investment could be reduced.

If we do not raise substantial funds in our public offerings, we will be limited in the number and type of investments we may make, and the value of investments in us will fluctuate with the performance of the specific properties we acquire.

Our offerings are made on a “best efforts” basis and no individual, firm or corporation has agreed to purchase any of our stock.  The amount of proceeds we raise in our public offerings may be substantially less than the amount we would need to achieve a broadly diversified property portfolio.  If we raise substantially less than the maximum offering amount, we will make fewer investments resulting in less diversification in terms of the number of investments owned and the geographic regions in which our investments are located.  In that case, the likelihood that any single property’s performance would materially reduce our overall profitability will increase.  We are not limited in the number or size of our investments or the percentage of net proceeds we may dedicate to a single investment.  In addition, any inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, and our net income and the distributions we make to stockholders would be reduced.
 
9


We may not generate sufficient cash for distributions. The cash distributions our stockholders receive may be less frequent or lower in amount than expected.
 
If the rental revenues from the properties we own do not exceed our operational expenses, we may reduce or cease cash distributions until such time as we sell a property. We currently expect to make distributions to our stockholders monthly, but may make distributions quarterly or not at all. All expenses we incur in our operations, including payment of interest to temporarily finance properties acquisitions, are deducted from cash funds generated by operations prior to computing the amount of cash available to be paid as distributions to our stockholders. Our directors will determine the amount and timing of distributions. Our directors will consider all relevant factors, including the amount of cash available for distribution, capital expenditure and reserve requirements and general operational requirements. We cannot determine with certainty how long it may take to generate sufficient available cash flow to fully support distributions to our stockholders. We may borrow funds, return capital or sell assets to make distributions. With limited prior operations, we cannot predict the amount of distributions our stockholders may receive. We may be unable to maintain cash distributions or increase distributions over time.

We have, and may in the future, pay distributions from sources other than cash provided from operations.
 
Until proceeds from our offering are invested and generating operating cash flow sufficient to make distributions to stockholders, we intend to pay a substantial portion of our distributions from the proceeds of our offerings or from borrowings in anticipation of future cash flow. To the extent that we use offering proceeds to fund distributions to stockholders, the amount of cash available for investment in properties will be reduced. The distributions paid for the four quarters ended December 31, 2009 were approximately $10.5 million.  Of this amount approximately $6.0 million was reinvested through our dividend reinvestment plan and approximately $4.5 million was paid in cash to stockholders. For the four quarters ended December 31, 2009 cash flow from operations and FFO were approximately $2.9 million and a loss of $4.5 million, respectively.  Accordingly, for the four quarters ended December 31, 2009, total distributions exceeded cash flow from operations and FFO for the same period. During the four quarters ended December 31, 2009, total distributions paid in cash exceeded cash flow from operations and FFO for the same period. We used offering proceeds to pay cash distributions in excess of cash flow from operations during the fourth quarters ended December 31, 2009.  

If we borrow money to meet the REIT minimum distribution requirement or for other working capital needs, our expenses will increase, our net income will be reduced by the amount of interest we pay on the money we borrow and we will be obligated to repay the money we borrow from future earnings or by selling assets, which will decrease future distributions to stockholders.

If we fail for any reason to distribute at least 90% of our REIT taxable income, then we would not qualify for the favorable tax treatment accorded to REITs.  It is possible that 90% of our income would exceed the cash we have available for distributions due to, among other things, differences in timing between the actual receipt of income and actual payment of deductible expenses and the inclusion/deduction of such income/expenses when determining our taxable income, nondeductible capital expenditures, the creation of reserves, the use of cash to purchase stock under our stock repurchase program, and required debt amortization payments.  We may decide to borrow funds in order to meet the REIT minimum distribution requirements even if our management believes that the then prevailing market conditions generally are not favorable for such borrowings or that such borrowings would not be advisable in the absence of such tax considerations. Distributions made in excess of our net income will generally constitute a return of capital to stockholders.

The inability of our advisor to retain or obtain key personnel, property managers and leasing agents could delay or hinder implementation of our investment strategies, which could impair our ability to make distributions.

Our success depends to a significant degree upon the contributions of Terry G. Roussel, the President and Chief Executive Officer of our advisor.  Neither we nor our advisor have an employment agreement with Mr. Roussel or with any of our other executive officers.  If Mr. Roussel was to cease his affiliation with our advisor, our advisor may be unable to find a suitable replacement, and our operating results could suffer.  We believe that our future success depends, in large part, upon our advisor’s, property managers’ and leasing agents’ ability to hire and retain highly skilled managerial, operational and marketing personnel.  Competition for highly skilled personnel is intense, and our advisor and any property managers we retain may be unsuccessful in attracting and retaining such skilled personnel.  If we lose or are unable to obtain the services of highly skilled personnel, property managers or leasing agents, our ability to implement our investment strategies could be delayed or hindered and the value of our stockholders’ investments in us may decline.
 
Risks Related to Conflicts of Interest

Our advisor will face conflicts of interest relating to the purchase and leasing of properties, and such conflicts may not be resolved in our favor, which could limit our investment opportunities and impair our ability to make distributions and could reduce the value of our stockholders’ investment in us.

We rely on our advisor to identify suitable investment opportunities.  We may be buying properties at the same time as other entities that are affiliated with or sponsored by our advisor.  Other programs sponsored by our advisor or its affiliates also rely on our advisor for investment opportunities.  Many investment opportunities would be suitable for us as well as other programs.  Our advisor could direct attractive investment opportunities or tenants to other entities.  Such events could result in our investing in properties that provide less attractive returns, thus reducing the level of distributions that we may be able to pay to our stockholders and the value of their investments in us.
 
10


If we acquire properties from affiliates of our advisor, the price may be higher than we would pay if the transaction was the result of arm’s-length negotiations.

The prices we pay to affiliates of our advisor for our properties will be equal to the prices paid by them, plus the costs incurred by them relating to the acquisition and financing of the properties or if the price to us is in excess of such cost, substantial justification for such excess will exist and such excess will be reasonable and consistent with current market conditions as determined by a majority of our independent directors.  Substantial justification for a higher price could result from improvements to a property by the affiliate of our advisor or increases in market value of the property during the period of time the property is owned by the affiliates of our advisor as evidenced by an appraisal of the property.  These prices will not be the subject of arm’s-length negotiations, which could mean that the acquisitions may be on terms less favorable to us than those negotiated in an arm’s-length transaction.  Even though we will use an independent third party appraiser to determine fair market value when acquiring properties from our advisor and its affiliates, we may pay more for particular properties than we would have in an arm’s-length transaction, which would reduce our cash available for investment in other properties or distribution to our stockholders.

We may purchase properties from persons with whom our advisor or its affiliates have prior business relationships and our advisor’s interest in preserving its relationship with these persons could result in us paying a higher price for the properties than we would otherwise pay.

We may have the opportunity to purchase properties from third parties including affiliates of our independent directors who have prior business relationships with our advisor or its affiliates.  If we purchase properties from such third parties, our advisor may experience a conflict between our interests and its interest in preserving any ongoing business relationship with these sellers.

Our advisor will face conflicts of interest relating to joint ventures that we may form with affiliates of our advisor, which conflicts could result in a disproportionate benefit to the other venture partners at our expense.

We may enter into joint venture agreements with third parties (including entities that are affiliated with our advisor or our independent directors) for the acquisition or improvement of properties.  Our advisor may have conflicts of interest in determining which program should enter into any particular joint venture agreement.  The co-venturer may have economic or business interests or goals that are or may become inconsistent with our business interests or goals.  In addition, our advisor may face a conflict in structuring the terms of the relationship between our interests and the interest of the affiliated co-venturer and in managing the joint venture.  Since our advisor and its affiliates will control both the affiliated co-venturer and, to a certain extent, us, agreements and transactions between the co-venturers with respect to any such joint venture will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated co-venturers.  Co-venturers may thus benefit to our and our stockholders’ detriment.

Our advisor and its affiliates receive commissions, fees and other compensation based upon the sale of our stock, our property acquisitions, the property we own and the sale of our properties and therefore our advisor and its affiliates may make recommendations to us that we buy, hold or sell property in order to increase their compensation.  Our advisor will have considerable discretion with respect to the terms and timing of our acquisition, disposition and leasing transactions.

Our advisor and its affiliates receive commissions, fees and other compensation based upon the sale of our stock and based on our investments.  Therefore, our advisor may recommend that we purchase properties that generate fees for our advisor, but are not necessarily the most suitable investment for our portfolio.  In some instances our advisor and its affiliates may benefit by us retaining ownership of our assets, while our stockholders may be better served by sale or disposition. In other instances they may benefit by us selling the properties which may entitle our advisor to disposition fees and possible success-based sales fees.  In addition, our advisor’s ability to receive asset management fees and reimbursements depends on our continued investment in properties and in other assets that generate fees to them.  Therefore, the interest of our advisor and its affiliates in receiving fees may conflict with our interests.

Our advisor and its affiliates, including our officers, one of whom is also a director, will face conflicts of interest caused by compensation arrangements with us and other Cornerstone-sponsored programs, which could result in actions that are not in the long-term best interests of our stockholders.

Our advisor and its affiliates will receive substantial fees from us that are partially tied to the performance of our investments.  These fees could influence our advisor’s advice to us, as well as the judgment of the affiliates of our advisor who serve as our officers or directors.  Among other matters, the compensation arrangements could affect their judgment with respect to:

 
·
property acquisitions from other advisor-sponsored programs, which might entitle our advisor to disposition fees and possible success-based sale fees in connection with its services for the seller;
 
11

 
 
·
whether and when we seek to list our common stock on a national securities exchange or the Nasdaq National Market, which listing could entitle our advisor to a success-based listing fee but could also adversely affect its sales efforts for other programs if the price at which our stock trades is lower than the price at which we offered stock to the public; and

 
·
whether and when we seek to sell the company or its assets, which sale could entitle our advisor to success-based fees but could also adversely affect its sales efforts for other programs if the sales price for the company or its assets resulted in proceeds less than the amount needed to preserve our stockholders’ capital.

Considerations relating to their compensation from other programs could result in decisions that are not in the best interests of our stockholders, which could hurt our ability to make distributions to our stockholders or result in a decline in the value of their investments in us.

If the competing demands for the time of our advisor, its affiliates and our officers result in them spending insufficient time on our business, we may miss investment opportunities or have less efficient operations which could reduce our profitability and result in lower distributions to stockholders.

We do not have any employees.  We rely on the employees of our advisor and its affiliates for the day-to-day operation of our business.  We estimate that over the life of the company, our advisor and its affiliates will dedicate, on average, less than half of their time to our operations.  The amount of time that our advisor and its affiliates spend on our business will vary from time to time and is expected to be more while we are raising money and acquiring properties.  Our advisor and its affiliates, including our officers, have interests in other programs and engage in other business activities.  As a result, they will have conflicts of interest in allocating their time between us and other programs and activities in which they are involved.  Because these persons have competing interests on their time and resources, they may have conflicts of interest in allocating their time between our business and these other activities.  During times of intense activity in other programs and ventures, they may devote less time and fewer resources to our business than are necessary or appropriate to manage our business.  We expect that as our real estate activities expand, our advisor will attempt to hire additional employees who would devote substantially all of their time to our business.  There is no assurance that our advisor will devote adequate time to our business. If our advisor suffers or is distracted by adverse financial or operational problems in connection with its operations unrelated to us, it may allocate less time and resources to our operations.  If any of these things occur, the returns on our investments, our ability to make distributions to stockholders and the value of their investments in us may suffer.

Our officers, one of whom is also a director, face conflicts of interest related to the positions they hold with our advisor and its affiliates which could hinder our ability to successfully implement our business strategy and to generate returns to our stockholders.

Our officers, one of whom is also a director, are also officers of our advisor, our dealer manager and other affiliated entities.  As a result, they owe fiduciary duties to these various entities and their stockholders and members, which fiduciary duties may from time to time conflict with the fiduciary duties that they owe to us and our stockholders.  Their loyalties to these other entities could result in actions or inactions that are detrimental to our business, which could harm the implementation of our business strategy and our investment, property management and leasing opportunities.  If we do not successfully implement our business strategy, we may be unable to generate cash needed to make distributions to our stockholders and to maintain or increase the value of our assets.
 
Our board’s possible loyalties to existing advisor-sponsored programs (and possibly to future advisor-sponsored programs) could result in our board approving transactions that are not in our best interest and that reduce our net income and lower our distributions to stockholders.

One of our directors is also a director of our advisor which is an affiliate of the managing member of another affiliate-sponsored program.  The loyalties of this director to the other affiliate-sponsored program may influence the judgment of our board when considering issues for us that may affect the other affiliate-sponsored program, such as the following:

 
·
We could enter into transactions with the other program, such as property sales or acquisitions, joint ventures or financing arrangements.  Decisions of our board regarding the terms of those transactions may be influenced by our board’s loyalties to the other program.

 
·
A decision of our board regarding the timing of a debt or equity offering could be influenced by concerns that the offering would compete with an offering of the other program.

 
·
A decision of our board regarding the timing of property sales could be influenced by concerns that the sales would compete with those of the other program.

 
·
We could also face similar conflicts and some additional conflicts if our advisor or its affiliates sponsor additional REITs, assuming some of our directors are also directors of the additional REITs.
 
12

 
Our independent directors must evaluate the performance of our advisor with respect to whether our advisor is presenting to us our fair share of investment opportunities.  If our advisor is not presenting a sufficient number of investment opportunities to us because it is presenting many opportunities to other advisor-sponsored entities or if our advisor is giving preferential treatment to other advisor-sponsored entities in this regard, our independent directors may need to enforce our rights under the terms of the advisory agreement or seek a new advisor.

We are dependent upon our advisor and its affiliates to conduct our operations and to fund our organization and offering activities.  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 your investment.  If our advisor became unable to fund our organization and offering expenses, we may sell fewer shares in this offering, we may be unable to acquire a diversified portfolio of properties, our operating expenses may be a larger percentage of our revenue and our net income may be lower.

We are dependent on Cornerstone Realty Advisors to manage our operations and our portfolio of real estate assets.  Our advisor has limited operating history and it will depend upon the fees and other compensation that it will receive from us in connection with the purchase, management and sale of our properties to conduct its operations.  To date, the fees we pay to our advisor have been inadequate to cover its operating expenses.  To cover its operational shortfalls, our advisor has relied on cash raised in private offerings of its sole member as well as private offerings of an affiliate that has made loans to our advisor’s sole member.  Of these private offerings, the only one that is ongoing is the private offering of the affiliate that has made loans to our advisor’s sole member.  A recent FINRA inquiry, which relates to such private offerings, could adversely affect the success of such private offerings or future private capital-raising efforts.  If our advisor is unable to secure additional capital, it may become unable to meet its obligations and we might be required to find alternative service providers, which could result in a significant disruption of our business and may adversely affect the value of our stockholders’ investments in us.  Furthermore, to the extent that our advisor is unable to raise adequate funds to support our organization and offering activities, our ability to raise money in our follow-on offering could be adversely affected.  If we sell fewer shares in our follow-on offering, we may be unable to acquire a diversified portfolio of properties, our operating expenses may be a larger percentage of our revenue and our net income may be lower.
 
We are dependent on our affiliated dealer manager to raise funds in our follow-on public offering.  Events that prevent our dealer manager from serving in that capacity would jeopardize the success of our offering and could reduce the value of our stockholders’ investments in us.
 
The success of our ongoing follow-on public offering depends to a large degree on the capital-raising efforts of our affiliated dealer manager.  If we were unable to raise significant capital in our offering, our general and administrative costs would be likely to continue to represent a larger portion of our revenues than would otherwise be the case, which would likely adversely affect the value of our stockholders’ investments in us.  In addition, lower offering proceeds would limit the diversification of our portfolio, which would cause the value of investments in us to be more dependent on the performance of any one of our properties.  Therefore, the value of our stockholders’ investments in us could depend on the success of our offering.
 
We believe that it could be difficult to secure the services of another dealer manager for a public offering of our shares should our affiliated dealer manager be unable to serve in that capacity. Therefore, any event that hinders the ability of our dealer manager to conduct offerings on our behalf would jeopardize the success of our offering and, as described above, could adversely affect the value of investments in us. A number of outcomes could impair our dealer manager’s ability to successfully serve in that capacity.

Our dealer manager has limited capital. In order to conduct its operations, our dealer manager depends on transaction-based compensation that it earns in connection with offerings in which it participates. If our dealer manager does not earn sufficient revenues from the offerings that it manages, it may not have sufficient resources to retain the personnel necessary to market and sell large amounts of shares on our behalf. In addition, our dealer manager has also relied on our affiliates in order to fund its operations, and our affiliates have relied on private offerings in order to make such equity investments in our dealer manager.  Should our affiliates become unable or unwilling to make further equity investments in our dealer manager, our dealer manager’s operations and its ability to conduct a successful public offering for us could suffer.
 
Our dealer manager operates in a highly regulated area and must comply with a complex scheme of federal and state securities laws and regulations as well as the rules imposed by FINRA. In some cases, there may not be clear authority regarding the interpretation of regulations applicable to our dealer manager. In such an environment, the risk of sanctions by regulatory authorities is heightened. Although these risks are also shared by other dealer managers of public offerings, the risks may be greater for our dealer manager because of the limited financial resources of our dealer manager and its affiliates. Limited financial resources may make it more difficult for our dealer manager to endure regulatory sanctions and to continue to serve effectively as the dealer manager of our offering.

Risks Related to Our Corporate Structure

A limit on the percentage of our securities a person may own may discourage a takeover or business combination, which could prevent our stockholders from realizing a premium price for their stock.
 
13

 
In order for us to qualify as a REIT, no more than 50% of our outstanding stock may be beneficially owned, directly or indirectly, by five or fewer individuals (including certain types of entities) at any time during the last half of each taxable year.  To assure that we do not fail to qualify as a REIT under this test, our charter restricts direct or indirect ownership by one person or entity to no more than 9.8% in number of shares or value, whichever is more restrictive, of the outstanding shares of any class or series of our stock unless exempted by our board of directors.  This restriction may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price to our stockholders.

Our charter permits our board of directors to issue stock with terms that may subordinate the rights of our common stockholders or discourage a third party from acquiring us in a manner that could result in a premium price to our stockholders.

Our board of directors may increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have authority to issue and classify or reclassify any unissued common stock or preferred stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of redemption of any such stock.  Our board of directors could authorize the issuance of preferred stock with terms and conditions that could have priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock.  Such preferred stock could also have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price to holders of our common stock.

The payment of the subordinated performance fee due upon termination, and the purchase of interests in our operating partnership held by our advisor and its affiliates as required in our advisory agreement, may discourage a takeover attempt that could have resulted in a premium price to our stockholders.

In the event of a merger in which we are not the surviving entity, and pursuant to which our advisory agreement is terminated, our advisor and its affiliates may require that we pay the subordinated performance fee due upon termination, and that we purchase all or a portion of the operating partnership units they hold at any time thereafter for cash, or our stock, as determined by the seller.  The subordinated performance fee due upon termination ranges from a low of 5% if the sum of the appraised value of our assets minus our liabilities on the date the advisory agreement is terminated plus total distributions (other than stock distributions) paid prior to termination of the advisory agreement exceeds the amount of invested capital plus annualized returns of 6%, to a high of 15% if the sum of the appraised value of our assets minus our liabilities plus all prior distributions (other than stock distributions) exceeds the amount of invested capital plus annualized returns of 10% or more.  This deterrence may limit the opportunity for stockholders to receive a premium for their stock that might otherwise exist if an investor attempted to acquire us through a merger.

Our stockholders will have limited control over changes in our policies and operations, which increases the uncertainty and risks of an investment in us.

Our board of directors determines our major policies, including our policies regarding financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of the stockholders. Under Maryland General Corporation Law and our charter, our stockholders have a right to vote only on limited matters. Our board’s broad discretion in setting policies and our stockholders’ inability to exert control over those policies increases the uncertainty and risks of an investment on us.

A stockholder’s interest in us may be diluted if we issue additional stock.

Our stockholders do not have preemptive rights to any stock we issue in the future. Therefore, in the event that we (1) sell stock in the future, including stock issued pursuant to our distribution reinvestment plan, (2) sell securities that are convertible into stock, (3) issue stock in a private offering, (4) issue stock upon the exercise of the options granted to our independent directors, employees of our advisor or others, or (5) issue stock to sellers of properties acquired by us in connection with an exchange of limited partnership interests in our operating partnership, investors purchasing stock in our offerings will experience dilution of their percentage ownership in us. Depending on the terms of such transactions, most notably the price per share, which may be less than the price paid per share in our offerings, and the value of our properties, investors in our offerings might also experience a dilution in the book value per share of their stock.

A stockholder’s interest in us may be diluted if we acquire properties for units in our operating partnership.

Holders of units of our operating partnership will receive distributions per unit in the same amount as the distributions we pay per share to our stockholders and will generally have the right to exchange their units of our operating partnership for cash or shares of our stock (at our option). In the event we issue units in our operating partnership in exchange for properties, investors purchasing stock in our offerings will experience potential dilution in their percentage ownership interest in us. Depending on the terms of such transactions, most notably the price per unit, which may be less than the price paid per share in our offerings, the value of our properties and the value of the properties we acquire through the issuance of units of limited partnership interests in our operating partnership, investors in our offerings might also experience a dilution in the book value per share of their stock.
 
14


Although we are not currently afforded the protection of the Maryland General Corporation Law relating to business combinations our board of directors could opt into these provisions of Maryland law in the future, which may discourage others from trying to acquire control of us and may prevent our stockholders from receiving a premium price for their stock in connection with a business combination.

Under Maryland law, “business combinations” between a Maryland corporation and certain interested stockholders or affiliates of interested stockholders are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities.  Also under Maryland law, control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter.  Shares owned by the acquirer, by officers or by directors who are employees of the corporation are not entitled to vote on the matter. Should our board opt into these provisions of Maryland law, it may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer. Similarly, provisions of Title 3, Subtitle 8 of the Maryland General Corporation Law could provide similar anti-takeover protection.

Our stockholder’s and our rights to recover claims against our independent directors are limited, which could reduce our stockholders’ and our recovery against our independent directors if they negligently cause us to incur losses.

Our charter provides that no independent director shall be liable to us or our stockholders for monetary damages and that we will generally indemnify them for losses unless they are grossly negligent or engage in willful misconduct.  As a result, our stockholders and we may have more limited rights against our independent directors than might otherwise exist under common law, which could reduce our stockholders' and our recovery from these persons if they act in a negligent manner. In addition, we may be obligated to fund the defense costs incurred by our independent directors (as well as by our other directors, officers, employees and agents) in some cases, which would decrease the cash otherwise available for distributions to our stockholders.

Stockholders may not be able to sell their stock under our stock repurchase program.

Our board of directors could choose to amend the terms of our stock repurchase program without stockholder approval. Our board is also free to terminate the program at any time upon 30 days written notice to our stockholders.  In addition, the stock repurchase program includes numerous restrictions that would limit our stockholders ability to sell stock.

The offering price was not established on an independent basis and stockholders may be paying more for our stock than its value or the amount our stockholders would receive upon liquidation.

The offering price of our shares of stock bears no relationship to our book or asset value or to any other established criteria for valuing stock.  The board of directors considered the following factors in determining the offering price for our common stock:

 
·
the offering prices of comparable non-traded REITs; and

 
·
the recommendation of the dealer manager.

However, the offering price is likely to be higher than the price at which our stockholders could resell their shares because (1) our public offering involves the payment of underwriting compensation and other directed selling efforts, which payments and efforts are likely to produce a higher sales price than could otherwise be obtained, and (2) there is no public market for our shares. Moreover, the offering price is likely to be higher than the amount our stockholders would receive per share if we were to liquidate at this time because of the up-front fees that we pay in connection with the issuance of our shares as well as the recent reduction in the demand for real estate as a result of the recent credit market disruptions and economic slowdown.

Because the dealer manager is one of our affiliates, investors in our stock will not have the benefit of an independent review of us or our prospectus customarily undertaken in underwritten offerings.

The dealer manager of our offerings, Pacific Cornerstone Capital, Inc., is an affiliate of our advisor and will not make an independent review of us or our offerings.  Accordingly, investors in our stock do not have the benefit of an independent review of the terms of our offerings.  Further, the due diligence investigation of us by the dealer manager cannot be considered to be an independent review and, therefore, may not be as meaningful as a review conducted by an unaffiliated broker-dealer or investment banker.
 
15


Payment of fees to our Advisor and its affiliates will reduce cash available for investment and distribution.

Our advisor and its affiliates will perform services for us in connection with the offer and sale of our stock, the selection and acquisition of our properties, and possibly the management and leasing of our properties.  They will be paid significant fees for these services, which will reduce the amount of cash available for investment in properties and distribution to stockholders.  The fees to be paid to our advisor and its affiliates were not determined on an arm’s-length basis.  We cannot be sure that a third-party unaffiliated with our advisor would not be willing to provide such services to us at a lower price.

We may also pay significant fees during our listing/liquidation stage.  Although most of the fees payable during our listing/liquidation stage are contingent on our investors first enjoying agreed-upon investment returns, affiliates of our advisor could also receive significant payments even without our reaching the investment-return thresholds should we seek to become self-managed.  Due to the apparent preference of the public markets for self-managed companies, a decision to list our shares on a national securities exchange might well be preceded by a decision to become self-managed.  And given our advisor’s familiarity with our assets and operations, we might prefer to become self-managed by acquiring entities affiliated with our advisor.  Such an internalization transaction could result in significant payments to affiliates of our advisor irrespective of whether our stockholders enjoyed the returns on which we have conditioned other performance-based compensation.

These fees increase the risk that the amount available for payment of distributions to our stockholders upon a liquidation of our portfolio would be less than the purchase price of the shares of stock in the offering.  Substantial up-front fees also increase the risk that our stockholders will not be able to resell their shares of stock at a profit, even if our stock is listed on a national securities exchange.

If we are unable to obtain funding for future capital needs, cash distributions to our stockholders could be reduced and the value of our investments could decline.

If we need additional capital in the future to improve or maintain our properties or for any other reason, we will have to obtain financing from other sources, such as cash flow from operations, borrowings, property sales or future equity offerings.  These sources of funding may not be available on attractive terms or at all.  If we cannot procure additional funding for capital improvements, our investments may generate lower cash flows or decline in value, or both.

Our advisor does not have as strong an economic incentive to avoid losses as do sponsors who have made significant equity investments in the companies they sponsor.
 
Terry G. Roussel, our chief executive officer and an affiliate of our advisor, has invested $1,000 in 125 shares of our stock. As of the date of this report, our advisor and its affiliates have only invested $200,000 in Cornerstone Operating Partnership, L.P. Without significant exposure for our advisor, our investors may be at a greater risk of loss because our advisor and its affiliates do not have as much to lose from a decrease in the value of our stock as do those sponsors who make more significant equity investments in the companies they sponsor.

General Risks Related to Investments in Real Estate and Real Estate Related Investments

Economic and regulatory changes that impact the real estate market may reduce our net income and the value of our properties.

We are subject to risks related to the ownership and operation of real estate, including but not limited to:

 
·
worsening general or local economic conditions and financial markets could cause lower demand, tenant defaults, and reduced occupancy and rental rates, some or all of which would cause an overall decrease in revenue from rents;

 
·
increases in competing properties in an area which could require increased concessions to tenants and reduced rental rates;

 
·
increases in interest rates or unavailability of permanent mortgage funds which may render the sale of a property difficult or unattractive; and

 
·
changes in laws and governmental regulations, including those governing real estate usage, zoning and taxes.

Some or all of the foregoing factors may affect our properties, which would reduce our net income, and our ability to make distributions to our stockholders.

Lease terminations could reduce our revenues from rents and our distributions to our stockholders and cause the value of our stockholders’ investment in us to decline.

The success of our investments depends upon the occupancy levels, rental income and operating expenses of our properties and our company.  In the event of a tenant default or bankruptcy, we may experience delays in enforcing our rights as landlord and may incur costs in protecting our investment and re-leasing our property.  We may be unable to re-lease the property for the rent previously received.  We may be unable to sell a property with low occupancy without incurring a loss.  These events and others could cause us to reduce the amount of distributions we make to stockholders and the value of our stockholders’ investment in us to decline.
 
16


Rising expenses at both the property and the company level could reduce our net income and our cash available for distribution to stockholders.

Our properties are subject to operating risks common to real estate in general, any or all of which may reduce our net income.  If any property is not substantially occupied or if rents are being paid in an amount that is insufficient to cover operating expenses, we could be required to expend funds with respect to that property for operating expenses.  The properties are subject to increases in tax rates, utility costs, operating expenses, insurance costs, repairs and maintenance and administrative expenses.  If we are unable to lease properties on a basis requiring the tenants to pay such expenses, we would be required to pay some or all of those costs which would reduce our income and cash available for distribution to stockholders.

Costs incurred in complying with governmental laws and regulations may reduce our net income and the cash available for distributions.

Our company and the properties we own are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety.  Federal laws such as the National Environmental Policy Act, the Comprehensive Environmental Response, Compensation, and Liability Act, the Resource Conservation and Recovery Act, the Federal Water Pollution Control Act, the Federal Clean Air Act, the Toxic Substances Control Act, the Emergency Planning and Community Right to Know Act and the Hazard Communication Act govern such matters as wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials and the remediation of contamination associated with disposals.  The properties we own and those we expect to  acquire are subject to the Americans with Disabilities Act of 1990 which generally requires that certain types of buildings and services be made accessible and available to people with disabilities.  These laws may require us to make modifications to our properties.  Some of these laws and regulations impose joint and several liability on tenants, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal.  Compliance with these laws and any new or more stringent laws or regulations may require us to incur material expenditures.  Future laws, ordinances or regulations may impose material environmental liability.  In addition, there are various federal, state and local 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.  Our properties may be affected by our tenants’ operations, the existing condition of land when we buy it, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties.  The presence of hazardous substances, or the failure to properly remediate these substances, may make it difficult or impossible to sell or rent such property.  Any material expenditures, fines, or damages we must pay will reduce our ability to make distributions and may reduce the value of our stockholders’ investment in us.

Discovery of environmentally hazardous conditions may reduce our cash available for distribution to our stockholders.

Under various federal, state and local environmental laws, ordinances and regulations, a current or previous real property owner or operator may be liable for the cost to remove or remediate hazardous or toxic substances on, under or in such property.  These costs could be substantial.  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.  Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures or prevent us from entering into leases with prospective tenants that may be impacted by such laws.  Environmental laws provide for sanctions for noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties.  Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos-containing materials into the air.  Third parties may seek recovery from real property owners or operators for personal injury or property damage associated with exposure to released hazardous substances.  The cost of defending against claims of liability, of complying with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could be substantial and reduce our ability to make distributions and the value of our stockholders’ investments in us.

Any uninsured losses or high insurance premiums will reduce our net income and the amount of our cash distributions to stockholders.

Our advisor will attempt to obtain adequate insurance to cover significant areas of risk to us as a company and to our properties.  However, there are types of losses at the property level, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, which are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments.  We may not have adequate coverage for such losses.  If any of our properties incurs a casualty loss that is not fully insured, the value of our assets will be reduced by any such uninsured loss.  In addition, other than any working capital reserve or other reserves we may establish, we have no source of funding to repair or reconstruct any uninsured damaged property.  Also, to the extent we must pay unexpectedly large amounts for insurance, we could suffer reduced earnings that would result in lower distributions to stockholders.
 
17


We may have difficulty selling real estate investments, and our ability to distribute all or a portion of the net proceeds from such sale to our stockholders may be limited.

Equity real estate investments are relatively illiquid.  Therefore, we will have a limited ability to vary our portfolio in response to changes in economic or other conditions.  In addition, the liquidity of real estate investments has been further reduced by the recent turmoil in the capital markets, which has constrained equity and debt capital available for investment in commercial real estate, resulting in fewer buyers seeking to acquire commercial properties and consequent reductions in property values.  As a result of these factors, we will also have a limited ability to sell assets in order to fund working capital and similar capital needs.  When we sell any of our properties, we may not realize a gain on such sale.  We may not elect to distribute any proceeds from the sale of properties to our stockholders; for example, we may use such proceeds to:

 
·
purchase additional properties;

 
·
repay debt, if any;

 
·
buy out interests of any co-venturers or other partners in any joint venture in which we are a party;

 
·
create working capital reserves; or

 
·
make repairs, maintenance, tenant improvements or other capital improvements or expenditures to our remaining properties.

Our ability to sell our properties may also be limited by our need to avoid a 100% penalty tax that is imposed on gain recognized by a REIT from the sale of property characterized as dealer property.  In order to ensure that we avoid such characterization, we may be required to hold our properties for a minimum period of time, generally two years, and comply with certain other requirements in the Internal Revenue Code.

Real estate market conditions at the time we decide to dispose of a property may be unfavorable which could reduce the price we receive for a property and lower the return on our stockholders’ investment in us..

We intend to hold the properties in which we invest until we determine that selling or otherwise disposing of properties would help us to achieve our investment objectives.  General economic conditions, availability of financing, interest rates and other factors, including supply and demand, all of which are beyond our control, affect the real estate market.  We may be unable to sell a property for the price, on the terms, or within the time frame we want.  Accordingly, the gain or loss on our stockholders’ investment in us could be affected by fluctuating market conditions.
.

As part of otherwise attractive portfolios of properties, substantially all of which we can own on an all-cash basis, we may acquire some properties with existing lock-out provisions which may inhibit us from selling a property, or may require us to maintain specified debt levels for a period of years on some properties.

Loan provisions could materially restrict us from selling or otherwise disposing of or refinancing properties.  These provisions would affect our ability to turn our investments into cash and thus affect cash available for distributions to our stockholders.  Loan provisions may prohibit us from reducing the outstanding indebtedness with respect to properties, refinancing such indebtedness on a non-recourse basis at maturity, or increasing the amount of indebtedness with respect to such properties.

Loan provisions could impair our ability to take actions that would otherwise be in the best interests of our stockholders and, therefore, may have an adverse impact on the value of our stock, relative to the value that would result if the loan provisions did not exist.  In particular, loan provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or change in control might be in the best interests of our stockholders.

If we sell properties by providing financing to purchasers of our properties, distribution of net sales proceeds to our stockholders would be delayed and defaults by the purchasers could reduce our cash available for distribution to stockholders.

If we provide financing to purchasers, we will bear the risk that the purchaser may default.  Purchaser defaults could reduce our cash distributions to our stockholders.  Even in the absence of a purchaser default, the distribution of the proceeds of sales to our stockholders, or their reinvestment in other assets, will be delayed until the promissory notes or other property we may accept upon a sale are actually paid, sold, refinanced or otherwise disposed of or completion of foreclosure proceedings.

Actions of our joint venture partners could subject us to liabilities in excess of those contemplated or prevent us from taking actions that are in the best interests of our stockholders which could result in lower investment returns to our stockholders.
 
18


We are likely to enter into joint ventures with affiliates and other third parties to acquire or improve properties.  We may also purchase properties in partnerships, co-tenancies or other co-ownership arrangements.  Such investments may involve risks not otherwise present when acquiring real estate directly, including, for example:

 
·
joint venturers may share certain approval rights over major decisions;

 
·
that such co-venturer, co-owner or partner may at any time have economic or business interests or goals which are or which become inconsistent with our business interests or goals, including inconsistent goals relating to the sale of properties held in the joint venture or the timing of termination or liquidation of the joint venture;

 
·
the possibility that our co-venturer, co-owner or partner in an investment might become insolvent or bankrupt;

 
·
the possibility that we may incur liabilities as a result of an action taken by our co-venturer, co-owner or partner;

 
·
that such co-venturer, co-owner or partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives, including our policy with respect to qualifying and maintaining our qualification as a REIT;

 
·
disputes between us and our joint venturers may result in litigation or arbitration that would increase our expenses and prevent its officers and directors from focusing their time and effort on our business and result in subjecting the properties owned by the applicable joint venture to additional risk; or

 
·
that under certain joint venture arrangements, neither venture partner may have the power to control the venture, and an impasse could be reached which might have a negative influence on the joint venture.

These events might subject us to liabilities in excess of those contemplated and thus reduce our stockholders' investment returns. 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. If our interest is subject to a buy/sell right, we may not have sufficient cash, available borrowing capacity or other capital resources to allow us to elect to purchase an interest of a co-venturer subject to the buy/sell right, in which case we may be forced to sell our interest as the result of the exercise of such right when we would otherwise prefer to keep our interest. Finally, we may not be able to sell our interest in a joint venture if we desire to exit the venture.

If we make or invest in mortgage loans, our mortgage loans may be affected by unfavorable real estate market conditions, including interest rate fluctuations, which could decrease the value of those loans and the return on our stockholders’ investments in us.

If we make or invest in mortgage loans, we will be at risk of defaults by the borrowers on those mortgage loans as well as interest rate risks.  To the extent we incur delays in liquidating such defaulted mortgage loans; we may not be able to obtain sufficient proceeds to repay all amounts due to us under the mortgage loan.  Further, we will not know whether the values of the properties securing the mortgage loans will remain at the levels existing on the dates of origination of those mortgage loans.  If the values of the underlying properties fall, our risk will increase because of the lower value of the security associated with such loans.  In addition, interest rate fluctuations could reduce our returns as compared to market interest rates and reduce the value of the mortgage loans in the event we sell them.

Second mortgage loan investments involve a greater risk of loss in the event of default than traditional mortgage loans.

If we decide to invest in second mortgages, our subordinated priority to the senior lender or lenders will place our investment at a greater risk of loss than a traditional mortgage.  In the event of default, any recovery of our second mortgage investment will be subordinate to the senior lender.   Further, it is likely that any investments we make in second mortgages will be placed with private entities and not insured by a government sponsored entity, placing additional credit risk on the borrower which may result in a loss to our portfolio.

Delays in restructuring or liquidating non-performing mortgage loans could reduce the return on our stockholders' investment.

If we invest in mortgage loans, they may become non-performing after origination or acquisition for a wide variety of reasons. Such non-performing loans may require a substantial amount of workout negotiations and/or restructuring, which may entail, among other things, a substantial reduction in the interest rate and a substantial write-down of the loan. However, even if a restructuring is successfully accomplished, upon maturity of such loan, replacement “takeout” financing may not be available. We may find it necessary or desirable to foreclose on some of the collateral securing one or more of our investments. Intercreditor provisions may substantially interfere with our ability to do so. Even if foreclosure is an option, the foreclosure process can be lengthy and expensive. Borrowers often resist foreclosure actions by asserting numerous claims, counterclaims and defenses, including, without limitation, lender liability claims and defenses, in an effort to prolong the foreclosure action. In some states, foreclosure actions can take up to several years or more to litigate. At any time during the foreclosure proceedings, the borrower may file for bankruptcy, which would have the effect of staying the foreclosure action and further delaying the foreclosure process. Foreclosure litigation tends to create a negative public image of the collateral property and may result in disrupting ongoing leasing and management of the property. Foreclosure actions by senior lenders may substantially affect the amount that we may receive from an investment.
 
19


If a significant portion of our assets are deemed “investment securities,” we may become subject to the Investment Company Act of 1940 which would restrict our operations and we could not continue our business.

If we fail to qualify for an exemption or exception from the Investment Company Act of 1940, we would be required to comply with numerous additional regulatory requirements and restrictions which could adversely restrict our operations and force us to discontinue our business. Our investments in real estate represent the substantial majority of our total asset mix, which would not subject us to the Investment Company Act.  If, however, in the future we originate or acquire mortgage loans and make investments in joint ventures (not structured in compliance with the Investment Company Act) and other investment assets that are deemed by the SEC or the courts to be “investment securities” and these assets exceed 40% of the value of our total assets, we could be deemed to be an investment company and subject to these additional regulatory and operational restrictions.

Even if otherwise deemed an investment company, we may qualify for an exception or exemption from the Investment Company Act. For example, under the real estate/mortgage exception, entities that are primarily engaged in the business of purchasing and otherwise acquiring mortgages and interests in real estate are exempt from registration under the Investment Company Act. Under the real estate exception, the SEC Staff has provided guidance that would require us to maintain 55% of our assets in qualifying real estate interests. In order for an asset to constitute a qualifying real estate interest or qualifying asset, the interest must meet various criteria. Fee interests in real estate and whole mortgage loans are generally considered qualifying assets. If we were required to register as an investment company but failed to do so, we would be prohibited from engaging in our business, and criminal and civil actions could be brought against us.  In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business.

Risks Associated with Debt Financing

We expect to continue to use temporary acquisition financing to acquire properties and otherwise incur other indebtedness, which will increase our expenses and could subject us to the risk of losing properties in foreclosure if our cash flow is insufficient to make loan payments.

We used temporary acquisition financing to acquire nine of the twelve properties we own as of December 31, 2009. We may continue to use temporary acquisition financing to acquire additional properties.  This will enable us to acquire properties before we have raised offering proceeds for the entire purchase price.  We plan to use subsequently raised offering proceeds to pay off the temporary acquisition financing.

We may borrow funds for operations, tenant improvements, capital improvements or for other working capital needs.  We may also borrow funds to make distributions including but not limited to funds to satisfy the REIT tax qualification requirement that we distribute at least 90% of our annual REIT taxable income to our stockholders.  We may also borrow if we otherwise deem it necessary or advisable to ensure that we maintain our qualification as a REIT for federal income tax purposes.  To the extent we borrow funds, we may raise additional equity capital or sell properties to pay such debt.

If there is a shortfall between the cash flow from a property and the cash flow needed to service temporary acquisition financing 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.  For tax purposes, a foreclosure of any of our properties would 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 would recognize taxable income on foreclosure, but we would not receive any cash proceeds.  We may give full or partial guarantees to lenders of mortgage debt to the entities that own our properties.  When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of the debt if it is not paid by such entity.  If any mortgages contain cross-collateralization or cross-default provisions, a default on a single property could affect multiple properties.

Liquidity in the global credit markets has been significantly contracted by market disruptions during the past two years, making it costly to obtain new debt financing, when debt financing is available at all. To the extent that market conditions prevent us from obtaining temporary acquisition financing on financially attractive terms, our ability to make suitable investments in commercial real estate could be delayed or limited.  If we are unable to invest the proceeds from this offering in suitable real estate investments for an extended period of time, distributions to our stockholders may be suspended and may be lower and the value of investments in our shares could be reduced.
 
20


Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions to our stockholders.

When providing financing, a lender may impose restrictions on us that affect our distribution and operating policies and our ability to incur additional debt.  Loan documents we have entered into contain covenants that limit our ability to further mortgage the property, discontinue insurance coverage, or replace our advisor.  These or other limitations may limit our flexibility and prevent us from achieving our operating plans.

High levels of debt or increases in interest rates could increase the amount of our loan payments, reduce the cash available for distribution to stockholders and subject us to the risk of losing properties in foreclosure if our cash flow is insufficient to make loan payments.

Our policies do not limit us from incurring debt.  High debt levels would cause us to incur higher interest charges, would result in higher debt service payments, and could be accompanied by restrictive covenants.  Interest we pay could reduce cash available for distribution to stockholders.  Additionally, variable rate debt could result in increases in interest rates which would increase our interest costs, which would reduce our cash flows and our ability to make distributions to our stockholders.  In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments in properties at times which may not permit realization of the maximum return on such investments and could result in a loss.

Federal Income Tax Risks

If we fail to qualify as a REIT, we will be subjected to tax on our income and the amount of distributions we make to our stockholders will be less.

We have elected to be taxed as a REIT under the Internal Revenue Code.  A REIT generally is not taxed at the corporate level on income it currently distributes to its stockholders.  Qualification as a REIT involves the application of highly technical and complex rules for which there are only limited judicial or administrative interpretations.  The determination of various factual matters and circumstances not entirely within our control may affect our ability to continue to qualify as a REIT.  In addition, new legislation, regulations, administrative interpretations or court decisions could significantly change the tax laws with respect to qualification as a REIT or the federal income tax consequences of such qualification.

If we were to fail to qualify as a REIT in any taxable year:

 
·
we would not be allowed to deduct our distributions to our stockholders when computing our taxable income;

 
·
we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates;

 
·
we would be disqualified from being taxed as a REIT for the four taxable years following the year during which qualification was lost, unless entitled to relief under certain statutory provisions;

 
·
we would have less cash to make distributions to our stockholders; and

 
·
we might be required to borrow additional funds or sell some of our assets in order to pay corporate tax obligations we may incur as a result of our disqualification.

Even if we maintain our status as a REIT, we may be subject to federal and state income taxes in certain events, which would reduce our cash available for distribution to our stockholders.

Net income from a “prohibited transaction” will be subject to a 100% tax.  We may not be able to pay sufficient distributions to avoid excise taxes applicable to REITs.  We may also decide to retain income we earn from the sale or other disposition of our property and pay income tax directly on such income.  In that event, our stockholders would be treated as if they earned that income and paid the tax on it directly.  However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability.  We may also be subject to state and local taxes on our income or property, either directly or at the level of our operating partnership or at the level of the other companies through which we indirectly own our assets.  Any federal or state taxes we pay will reduce the cash available to make distributions to our stockholders.

To maintain our REIT status, we may be forced to forego otherwise attractive opportunities, which may delay or hinder our ability to meet our investment objectives and reduce the overall return to our stockholders.

To qualify as a REIT, we must satisfy certain tests on an ongoing basis concerning, among other things, the sources of our income, nature of our assets and the amounts we distribute to our stockholders. 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. Compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of our stockholders’ investments in us.
 
21

 
If our operating partnership is classified as a “publicly-traded partnership” under the Internal Revenue Code, it will be subjected to tax on our income and the amount of distributions we make to our stockholders will be less.
 
We structured our operating partnership so that it would be classified as a partnership for federal income tax purposes.  In this regard, the Internal Revenue Code generally classifies “publicly traded partnerships” (as defined in Section 7704 of the Internal Revenue Code) as associations taxable as corporations (rather than as partnerships), unless substantially all of  their taxable income consists of specified types of passive income.  In order to minimize the risk that the Internal Revenue Code would classify our operating partnership as a “publicly traded partnership” for tax purposes, we placed certain restrictions on the transfer and/or redemption of partnership units in our operating partnership.  If the Internal Revenue Service were to assert successfully that our operating partnership is a “publicly traded partnership,” and substantially all of our operating partnership’s gross income did not consist of the specified types of passive income, the Internal Revenue Code would treat our operating partnership as an association taxable as a corporation.  In such event, the character of our assets and items of gross income would change and would prevent us from qualifying and maintaining our status as a REIT.  In addition, the imposition of a corporate tax on our operating partnership would reduce the amount of cash distributable to us from our operating partnership and therefore would reduce our amount of cash available to make distributions to you.
 
Distributions payable by REITs do not qualify for the reduced tax rates under recently enacted tax legislation.

Recently enacted tax legislation generally reduces the maximum tax rate for dividend distributions payable by corporations to individuals meeting certain requirements to 15% through 2010. Distributions payable by REITs, however, generally continue to be taxed at the normal rate applicable to the individual recipient, rather than the 15% preferential rate. Although this legislation does not adversely affect the taxation of REITs or distributions paid by REITs, the more favorable rates applicable to regular corporate distributions could cause investors who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that make distributions, which could reduce the value of the stock of REITs, including our stock.

Distributions to tax-exempt investors may be classified as unrelated business taxable income and tax-exempt investors would be required to pay tax on the unrelated business taxable income and to file income tax returns.

Neither ordinary nor capital gain distributions with respect to our common stock nor gain from the sale of stock should generally constitute unrelated business taxable income to a tax-exempt investor. However, there are certain exceptions to this rule. In particular:

 
·
under certain circumstances, part of the income and gain recognized by certain qualified employee pension trusts with respect to our stock may be treated as unrelated business taxable income if our stock is predominately held by qualified employee pension trusts, such that we are a “pension-held” REIT (which we do not expect to be the case);

 
·
part of the income and gain recognized by a tax exempt investor with respect to our stock would constitute unrelated business taxable income if such investor incurs debt in order to acquire the common stock; and

 
·
part or all of the income or gain recognized with respect to our stock held by social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans which are exempt from federal income taxation under Sections 501(c)(7), (9), (17), or (20) of the Code may be treated as unrelated business taxable income.


ITEM 1B.  UNRESOLVED STAFF COMMENTS

Not Applicable.
 
22


ITEM 2.  PROPERTIES

As of December 31, 2009, our portfolio consists of twelve properties which were approximately 81.6% leased.  The following table provides summary information regarding our properties.

Property
 
Location
 
Date Purchased
 
Square
Footage
   
Purchase
Price
   
Debt
   
December 31, 2009
% Leased
 
2111 South Industrial Park
 
North Tempe, AZ
 
June 1, 2006
   
26,800
   
$
1,975,000
   
$
     
85.1
%
Shoemaker Industrial Buildings
 
Santa Fe Springs, CA
 
June 30, 2006
   
18,921
     
2,400,000
     
     
75.7
%
15172 Golden West Circle
 
Westminster, CA
 
December 1, 2006
   
102,200
     
11,200,000
     
2,824,000
     
100.0
%
20100 Western Avenue
 
Torrance, CA
 
December 1, 2006
   
116,433
     
19,650,000
     
4,701,000
     
51.5
%
Mack Deer Valley
 
Phoenix, AZ
 
January 21, 2007
   
180,985
     
23,150,000
     
3,868,000
     
100.0
%
Marathon Center
 
Tampa Bay, FL
 
April 2, 2007
   
52,020
     
4,450,000
     
     
67.2
%
Pinnacle Park Business Center
 
Phoenix, AZ
 
October 2, 2007
   
159,661
     
20,050,000
     
4,553,000
     
100.0
%
Orlando Small Bay Portfolio
                                       
Carter
 
Winter Garden, FL
 
November 15, 2007
   
49,125
                     
92.4
%
Goldenrod
 
Orlando, FL
 
November 15, 2007
   
78,646
                     
75.6
%
Hanging Moss
 
Orlando, FL
 
November 15, 2007
   
94,200
                     
89.0
%
Monroe South
 
Sanford, FL
 
November 15, 2007
   
172,500
                     
64.4
%
             
394,471
     
37,128,000
     
15,860,000
     
76.0
%
                                         
Monroe North Commerce Center
 
Sanford, FL
 
April 17, 2008
   
181,348
     
14,275,000
     
7,078,000
     
72.5
%
                                         
             
1,232,839
   
$
134,278,000
   
$
38,884,000
     
81.6
%

Historical Occupancy
 
The following table sets forth annualized occupancy rates for our material properties for the past five years (or such shorter period for which information is available):
 
   
Annualized Percent Leased (%)
 
Property
 
2009
   
2008
   
2007
   
2006
   
2005
 
                               
15172 Goldenwest Circle
   
100
     
100
     
100
     
100
     
100
 
20100 Western Avenue
   
63
     
100
     
95
     
100
     
100
 
Mack Deer Valley
   
80
     
80
     
99
     
44
(2)
   
(3)
Pinnacle Park Business Center
   
100
     
99
     
96
     
53
(2)
   
(3)
Orlando Small Bay Portfolio
   
77
     
94
     
97
     
(1)
   
(1)
Monroe North CommerCenter
   
82
     
100
     
98
     
(1)
   
(1)
             
(1)
Pre-acquisition leasing information not available.
(2)
These projects completed construction and were put in operation during third quarter of 2006.  Accordingly, these numbers represent the leasing-up period for these projects.
(3)
Represents development and construction period.

Historical Annualized Average Rents
 
The following table sets forth average effective annualized rent per square foot for our material properties for the past five years (or such shorter period for which information is available):

23

 
   
Average Effective Annualized Rent per Square Foot (4)
 
Property
 
2009
   
2008
   
2007
   
2006
   
2005
 
                               
15172 Goldenwest Circle
 
$
8.10
   
$
7.29
   
$
7.56
   
$
7.10
   
$
6.68
 
20100 Western Avenue
 
$
10.16
   
$
11.41
   
$
11.35
   
$
11.26
   
$
10.97
 
Mack Deer Valley
 
$
8.87
   
$
8.73
   
$
7.75
   
$
3.74
(2)
 
$
(3)
Pinnacle Park Business Center
 
$
6.78
   
$
7.65
   
$
8.24
   
$
1.43
(2)
 
$
(3)
Orlando Small Bay Portfolio
 
$
7.71
   
$
7.59
   
$
7.35
   
$
(1)
 
$
(1)
Monroe North CommerCenter
 
$
6.83
   
$
5.83
   
$
5.87
   
$
(1)
 
$
(1)
 
(1)
Pre-acquisition leasing information not available.
(2)
These projects completed construction and were put in operation during third quarter of 2006.  Accordingly, these numbers represent the leasing-up period for these projects.
(3)
Represents development and construction period.
(4)  Average effective annualized rent per square foot is calculated by dividing annual rental revenues by sum of quarterly   occupied square footage.

Portfolio Lease Expirations

The following table sets forth lease expiration information for each of the ten years following December 31, 2009:

Year Ending
December 31
 
No. of
Leases
Expiring
   
Approx.
Amount of
Expiring
Leases
(Sq. Feet)
   
Base Rent
of Expiring
Leases
(Annual $)
   
Percent of
Total
Leasable
Area
Expiring
(%)
   
Percent of
Total
Annual Base
Rent Expiring
(%)
 
Month to Month
   
6
     
62,943
     
263,000
     
5.1
%
   
3.5
%
2010
   
46
     
178,764
     
1,232,000
     
14.5
%
   
16.6
%
2011
   
44
     
263,324
     
2,160,000
     
21.4
%
   
29.1
%
2012
   
15
     
185,612
     
1,366,000
     
15.1
%
   
18.4
%
2013
   
10
     
233,948
     
1,758,000
     
19.0
%
   
23.7
%
2014
   
8
     
59,688
     
536,000
     
4.8
%
   
7.2
%
2015
   
1
     
6,200
     
58,000
     
0.5
%
   
0.8
%
2016
   
1
     
5,364
     
48,000
     
0.4
%
   
0.7
%
2017
   
-
     
-
     
-
     
-
%
   
-
%
2018
   
-
     
-
     
-
     
-
%
   
-
%
     
131
     
995,843
   
$
7,421,000
     
80.8
%
   
100.0
%

Real Estate-Related Investment
 
As of December 31, 2009, we had invested in one real estate loan receivable, the Sherburne Commons Mortgage Loan:
 
                                 
Loan Name
Location of Related Property or Collateral
 
Date
  Originated  
   
  Loan Type  
 
  Payment  
Type
   
Book Value
as of
December 31, 2009
 
Rate 
Type
 
Annual
Interest Rate
 
  Maturity   Date
Sherburne Commons Mortgage Loan
Nantucket, Massachusetts
 
12/14/2009
   
1st Mortgage
 
Interest Only
 
  $
6,900,000  
 
Fixed
 
8.0%
 
1/1/2015
 

ITEM 3.  LEGAL PROCEEDINGS

From time to time in the ordinary course of business, we may become subject to legal proceeding, claims, or disputes.  As of the date hereof, we are not a party to any pending legal proceedings.

ITEM 4.  RESERVED
24

 
PART II

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

During the period covered by this report, there was no established public trading market for our shares of common stock.  In order for FINRA members to participate in the offering and sale of shares of common stock pursuant to our ongoing public offering, we are required to disclose in each annual report distributed to stockholders a per share estimated value of the shares, the method by which it was developed and the date of the data used to develop the estimated value.  In addition, we prepare annual statements of estimated share values to assist fiduciaries of retirement plans subject to the annual reporting requirements of ERISA in the preparation of their reports relating to an investment in our shares.  For these purposes, the deemed value of a share of our common stock is $8.00 per share as of December 31, 2009. The basis for this valuation is that the current public offering price of a share of our common stock is $8.00 per share (ignoring purchase price discounts for certain categories of purchasers).  However, this estimated value is likely to be higher than the price at which you could resell your shares because (1) our public offering involves the payment of underwriting compensation and other directed selling efforts, which payments and efforts are likely to produce a higher sales price than could otherwise be obtained, and (2) there is no public market for our shares.  Moreover, this estimated value is likely to be higher than the amount you would receive per share if we were to liquidate at this time because of the up-front fees that we pay in connection with the issuance of our shares as well as the recent reduction in the demand for real estate as a result of the recent credit market disruptions and economic slowdown.  We expect to continue to use the most recent public offering price for a share of our common stock as the estimated per share value reported in our annual reports on Form 10-K until 18 months have passed since the last sale of a share of common stock in a public offering, excluding public offerings conducted on behalf of selling stockholders or offerings related to a dividend reinvestment plan, employee benefit plan, or the redemption of interests in our operating partnership.  After the 18-month period described above, we expect the estimated share values reported in our annual reports will be based on estimates of the values of our assets net of our liabilities.  We do not currently anticipate that our advisor will obtain new or updated appraisals for our properties in connection with such estimates, and accordingly, these estimated share values should not be viewed as estimates of the amount of net proceeds that would result from a sale of our properties at that time.  We expect that any estimates of the value of our properties will be performed by our advisor; however, our board of directors could direct our advisor to engage one or more third-party valuation firms in connection with such estimates.

Stock Repurchase Program

Our board of directors has adopted a stock repurchase program that enables our stockholders to sell their stock to us in limited circumstances.  Our board of directors may amend, suspend or terminate the program at any time upon thirty days prior notice to our stockholders.

As long as our common stock is not listed on a national securities exchange, our stockholders who have held their stock for at least one year may be able to have all or any portion of their shares of stock redeemed.  At that time, we may, subject to the conditions and limitations described below, redeem the shares of stock presented for redemption for cash to the extent that we have sufficient funds available to us to fund such redemption.  Currently, the amount that we may pay to redeem stock will be the redemption price set forth in the following table which is based upon the number of years the stock is held:

Number Years Held
 
Redemption Price
Less than 1
 
No Redemption Allowed
1 or more but less than 2
 
90% of your purchase price
2 or more but less than 3
 
95% of your purchase price
Less than 3 in the event of death
 
100% of your purchase price
3 or more but less than 5
 
100% of your purchase price
5 or more
 
Estimated liquidation value

We have no obligation to repurchase our stockholders’ shares of stock. Our stock repurchase program has limitations and restrictions and may be cancelled. We intend to redeem shares using proceeds from our distribution reinvestment plan but we may use other available cash to repurchase the shares of a deceased shareholder. Our board of directors may modify our stock repurchase program so that we can also redeem stock using the proceeds from the sale of our properties or other sources.

Until September 21, 2012 our stock repurchase program limits the number of shares of stock we can redeem (other than redemptions due to death of a stockholder) to those that we can purchase with net proceeds from the sale of stock under our distribution reinvestment plan in the prior calendar year. Until September 21, 2012 we do not intend to redeem more than the lesser of (i) the number of shares that could be redeemed using the proceeds from our distribution reinvestment plan in the prior calendar year or (ii) 5% of the number of shares outstanding at the end of the prior calendar year.

For the purpose of calculating the stock repurchase price for shares received as part of the special 10% stock distribution declared in July 2008, the purchase price of such shares will be deemed to be equal to the purchase price paid by the stockholder for shares held by the stockholder immediately prior to the special 10% stock distribution.  For example, if, immediately prior to the special 10% stock distribution, you owned 1,010 shares of our common stock, 1,000 of which you had purchased in the primary offering at $8.00 per share and the remaining 10 of which you had purchased under the distribution reinvestment plan at $7.60 per share, then, of the 101 shares you received as part of the special stock distribution, 100 of these shares would be deemed to have a purchase price of $8.00 per share and one share would be deemed to have a purchase price of $7.60.  These deemed purchase prices would be used in conjunction with the holding period thresholds set forth as above to calculate the stock redemption price for the additional shares.  Therefore, if you were to submit a redemption request after holding the 101 additional shares for more than one year, but less than two years, the stock redemption price for 100 of these shares would be 90% of $8.00, or $7.20 per share, and the stock redemption price for the remaining share would be 90% of $7.60, or $6.84. In the event that all of your shares of stock will be repurchased, shares purchased pursuant to our distribution reinvestment plan may be excluded from the foregoing one-year holding period requirement, in the discretion of the board of directors.
 
25

 
The estimated liquidation value for the repurchase of shares of stock held for 5 or more years will be determined by our advisor or another person selected for such purpose and will be approved by our board of directors. The stock repurchase price is subject to adjustment as determined from time to time by our board of directors. At no time will the stock repurchase price exceed the price at which we are offering our common stock for sale at the time of the repurchase.  We do not charge any fees for participating in our stock repurchase program, however the transfer agent we have appointed to administer the program may charge a transaction fee for processing a redemption request.
 
During the twelve months ended December 31, 2009, we redeemed shares pursuant to our stock repurchase program follows (in thousands, except per-share amounts):

Period
 
Total Number of
Shares Redeemed(1)
   
Average Price Paid
per Share
   
Approximate Dollar Value of Shares
Available That May Yet Be
Redeemed Under the Program (1)
 
                   
January
   
40,873
   
$
6.77
   
$
3,805,000
 
February
   
137,395
   
7.51
   
2,773,000
 
March
   
152,984
   
7.61
   
1,608,000
 
April
   
83,284
   
7.55
   
979,000
 
May
   
43,057
   
7.51
   
655,000
 
June
   
65,453
   
7.67
   
$
152,000
 
July
   
23,079
   
7.39
   
 
August
   
8,113
   
7.99
   
 
September
   
8,178
   
7.98
   
 
October
   
   
   
 
November
   
3,560
   
7.96
   
 
December
   
11,566
   
$
7.97
   
$
 
     
577,542
                 

 
(1)
Until September 21, 2012 our stock repurchase program limits the number of shares of stock we can redeem (other than redemptions due to death of a stockholder) to those that we can purchase with net proceeds from the sale of stock under our distribution reinvestment plan in the prior calendar year. Until September 21, 2012 we do not intend to redeem more than the lesser of (i) the number of shares that could be redeemed using the proceeds from our distribution reinvestment plan in the prior calendar year or (ii) 5% of the number of shares outstanding at the end of the prior calendar year. After September 21, 2012, the number of shares that we redeem under the stock repurchase program is not expected to exceed 10% of the number outstanding at the end of the prior year. Our board of directors may modify our stock repurchase program so that we can redeem stock using the proceeds from the sale of our real estate investments or other sources.

Stockholders

As of March 26, 2010, we had approximately 22.7 million shares of common stock outstanding held by approximately 4,846 stockholders of record.

Distributions

In order to meet the requirements for being treated as a REIT under the Internal Revenue Code, we must pay distributions to our shareholders each taxable year equal to at least 90% of our net ordinary taxable income.  Until proceeds from our offerings are invested and generating operating cash flow sufficient to make distributions to stockholders, we intend to pay all or a substantial portion of our distributions from the proceeds of our offering and or from borrowings in anticipation of future cash flow.  Our board generally declares distributions on a quarterly basis and paid on a monthly basis.  Monthly distributions are paid based on daily record and distribution declaration dates so our investor will be entitled to be paid distributions beginning on the day that they purchase shares.
 
26


During the years ended December 31, 2009 and 2008, we paid distributions, including any distributions reinvested, aggregating approximately $10.5 million and $6.8 million, respectively to our stockholders.  The following table shows the distributions paid based on daily record dates for each day during the period from January 1, 2008 through December 31, 2009, aggregated by quarter as follows:

   
Distribution Declared (1)
               
Period
 
Cash
   
Reinvested
   
Total
   
Funds from Operations
     
Cash flows from  operating activities
 
First quarter 2008
 
$
486,000
   
$
719,000
   
$
1,205,000
   
 $
236,000
   
$
253,000
 
Second quarter 2008
   
610,000
     
926,000
     
1,536,000
     
535,000
     
1,041,000
 
Third quarter 2008
   
831,000
     
1,298,000
     
2,129,000
     
882,000
     
1,090,000
 
Fourth quarter 2008
   
957,000
     
1,442,000
     
2,399,000
     
467,000
     
157,000
 
   
$
2,884,000
   
$
4,385,000
   
$
7,269,000
   
$
2,120,000
   
$
2,541,000
 
                                         
First quarter 2009
 
$
1,020,000
   
$
1,464,000
   
$
2,484,000
   
 $
706,000
   
$
1,090,000
 
Second quarter 2009
   
1,125,000
     
1,523,000
     
2,648,000
     
819,000
     
733,000
 
Third quarter 2009 (2)
   
1,181,000
     
1,554,000
     
2,735,000
     
(4,074,000
)
   
1,126,000
 
Fourth quarter 2009 (3)
   
1,231,000
     
1,546,000
     
2,777,000
     
(1,913,000
)
   
(61,000
)
   
$
4,557,000
   
$
6,087,000
   
$
10,644,000
   
$
(4,462,000
)
 
$
2,888,000
 


(1)
100% and 95.07% of the distributions declared during 2008 and 2009 represented a return of capital for federal income tax purposes, respectively.
(2)
Funds from operations includes note receivable impairment reserve charge of approximately $4.6 million.
(3)
Funds from operations includes real estate impairment reserve charge of approximately $2.4 million.

The declaration of distributions is at the discretion of our board of directors and our board will determine the amount of distributions on a regular basis.  The amount of distributions will depend on our funds from operations, financial condition, capital requirements, annual distribution requirements under the REIT provisions of the Internal Revenue Code and other factors our board of directors deem relevant.

Funds from Operations
 
Funds from operations (“FFO”) is a non-GAAP financial measure that is widely recognized as a measure of REIT operating performance.  We compute FFO in accordance with the definition outlined by the National Association of Real Estate Investment Trusts (“NAREIT”).  NAREIT defines FFO as net income (loss), computed in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains (or losses) from sales of property, plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships, joint ventures and subsidiaries.  Our FFO may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than we do.  We believe that FFO is helpful to investors and our management as a measure of operating performance because it excludes depreciation and amortization, gains and losses from property dispositions, and extraordinary items, and as a result, when compared year to year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, which is not immediately apparent from net income.  Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate 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 alone to be insufficient.  As a result, our management believes that the use of FFO, together with the required GAAP presentations, provide a more complete understanding of our performance.  Factors that impact FFO include start-up costs, fixed costs, delay in buying assets, lower yields on cash held in accounts pending investment, income from portfolio properties and other portfolio assets, interest rates on acquisition financing and operating expenses.  FFO should not be considered as an alternative to net income (loss), as an indication of our performance, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions.  FFO may be used to fund all or a portion of certain capitalizable items that are excluded from FFO, such as capital expenditures and payments of principal on debt, each of which may impact the amount of cash available for distribution to our stockholders. Our calculation of FFO for each of the last four quarters is presented below:
 
27



   
Year Ended December 31,
   
2009(1)
   
2008
   
2007
 
                   
Net loss
 
$
(8,111,000
)
 
$
(1,452,000
)
 
$
(2,604,000
)
Adjustments:
                       
Net (loss) income attributable to noncontrolling interest
   
(8,000 
)
   
3,000 
     
(3,000
)
Real estate assets depreciation and amortization
   
3,641,000
     
3,575,000
     
1,529,000
 
Funds from operations (FFO)
 
$
(4,462,000
)
 
$
2,120,000
   
$
(1,072,000
)
                         
Weighted average shares
   
21,806,219
     
14,241,215
     
7,070,155
 
                         
FFO per weighted average shares
 
$
(0.20
)
 
$
0.15
   
$
(0.15
)
 
(1)
During the third quarter of 2009, we recorded a note receivable impairment reserve of approximately $4.6 million and during the fourth quarter of 2009, we recorded an impairment of real estate of approximately $2.4 million.

Recent Sales of Unregistered Securities

On August 6, 2008, we granted our non-employee directors nonqualified stock options to purchase an aggregate of 20,000 shares of our common stock at an exercise price at $8.00 per share under our Employee and Director Incentive Stock Plan pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933.

We did not sell any equity securities that were not registered under the Securities Act of 1933 during the period covered by this Form 10-K.

Use of Proceeds from Registered Securities

Initial Public Offering

Our registration statement (SEC File No.  333-121238) for our initial public offering of up to 44,400,000 shares of our common stock at $8.00 per share and up to 11,000,000 additional shares at $7.60 per share pursuant to our distribution reinvestment plan was declared effective on September 22, 2005.  The aggregate offering amount of the shares registered for sale in our initial public offering, assuming the maximum number of shares is sold, is $438,800,000.  The offering commenced on January 6, 2006 and was terminated June 1, 2009 prior to the sale of all shares registered.

As of the termination of the offering on June 1, 2009, excluding issuance of approximately 1.2 million shares under our distribution reinvestment plan, we had sold approximately 20.5 million shares of common stock in our initial public offering, raising gross offering proceeds of approximately $163.7 million.  From this amount, we incurred approximately $16.2 million in selling commissions and dealer manager fees payable to our dealer manager and approximately $3.3 million in acquisition fees payable to the advisor.  We have used approximately $93 million of the net offering proceeds to acquire properties and reduce notes payable balance as of December 31, 2009.  As of December 31, 2009, the advisor and its affiliates had incurred on our behalf organizational and offering costs totaling approximately $4.5 million, including approximately $0.1 million of organizational costs that have been expensed, approximately $4.4 million related to offering costs which reduce net proceeds of our initial public offering.

Follow-on Public Offering

Our registration statement (SEC File No. 333-155640) for our follow-on public offering of up to 56,250,000 shares of our common stock at $8.00 per share and up to 21,100,000 additional shares at $7.60 per share pursuant to our distribution reinvestment plan was declared effective on June 10, 2009.  We also retained PCC to conduct our follow-on public offering on a best-efforts basis.  The aggregate offering amount of the shares registered for sale in our follow-on public offering is $610,360,000.  The offering commenced on June 10, 2009 and has not terminated.

As of December 31, 2009, excluding issuance of approximately 0.4 million shares under our distribution reinvestment plan, we had sold approximately 0.3 million shares of common stock in our follow-on offering, raising gross offering proceeds of approximately $2.2 million.  From this amount, we incurred approximately $207,000 in selling commissions and dealer manager fees payable to our dealer manager and approximately $44,000 in acquisition fees payable to the advisor.  As of December 31, 2009, the advisor and its affiliates had incurred on our behalf organizational and offering costs totaling approximately $0.7 million which reduce net proceeds of our follow-on public offering provided, however, we will have no obligation to reimburse of advisor for organizational and offering costs totaling in excess of 3.5% of the gross proceeds of our follow-on offering at the conclusion of the offering.
 
28


Equity Compensation Plans

Information about securities authorized for issuance under our equity compensation plans required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2010 annual meeting of stockholders.

ITEM 6.  SELECTED FINANCIAL DATA

The following should be read with the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto.

   
As of December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
Balance Sheet Data:
                             
Total assets
 
$
157,252,000
   
$
165,104,000
   
$
129,922,000
   
$
50,012,000
   
$
224,000
 
Investments in real estate, net
 
$
127,079,000
   
$
132,955,000
   
$
120,994,000
   
$
36,057,000
   
$
-
 
Notes payable
 
$
38,884,000
   
$
45,626,000
   
$
65,699,000
   
$
20,180,000
   
$
-
 
Stockholders’ equity
 
$
115,024,000
   
$
116,333,000
   
$
60,248,000
   
$
26,719,000
   
$
(93,000
)
                                         
   
Year Ended December 31,
       
   
2009
   
2008
   
2007
   
2006
   
2005
 
Operating Data:
                                       
Revenues
 
$
11,130,000
   
$
10,793,000
   
$
5,865,000
   
$
404,000
   
$
-
 
General and administrative expense
 
$
1,911,000
   
$
1,421,000
   
$
2,359,000
   
$
1,294,000
   
$
95,000
 
Impairment of notes receivable
 
$
4,626,000
   
$
-
   
$
-
   
$
-
   
$
-
 
Impairment of real estate
 
$
2,360,000
   
$
-
   
$
-
   
$
-
   
$
-
 
Net loss attributable to common stockholders
 
$
(8,103,000
)
 
$
(1,455,000
)
 
$
(2,601,000
)
 
$
(1,306,000
)
 
$
(94,000
)
Noncontrolling interest
 
$
(8,000
)
 
$
3,000
   
$
(3,000
)
 
$
(11,000
)
 
$
-
 
Basic and diluted net loss per common share attributable to common stockholders (1)
 
$
(0.37
)
 
$
(0.10
)
 
$
(0.37
)
 
$
(1.44
)
 
$
(752.00
)
Distributions declared
 
$
10,644,000
   
$
7,269,000
   
$
3,196,000
   
$
586,000
   
$
-
 
Distributions per common share
 
$
0.48
   
$
0.47
   
$
0.43
   
$
0.40
   
$
-
 
Weighted average number of shares outstanding (1):
                                       
Basic and diluted
   
21,806,219
     
14,241,215
     
7,070,155
     
909,860
     
125
 
                                         
Other Data:
                                       
Cash flows provided by (used in) operating activities
 
$
2,888,000
   
$
2,541,000
   
$
(1,156,000
)
 
$
(139,000
)
 
$
(84,000
)
Cash flows used in investing activities
 
$
(10,708,000
)
 
$
(11,973,000
)
 
$
(84,799,000
)
 
$
(37,447,000
)
 
$
-
 
Cash flows provided by financing activities
 
$
212,000
   
$
29,065,000
   
$
81,562,000
   
$
48,510,000
   
$
200,000
 


(1)
Net loss per share is based upon the weighted average number of shares of common stock outstanding. All per share computations have been adjusted to reflect the common stock dividends for all periods presented.
 
29


ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and notes appearing elsewhere in this Form 10-K. See also the “Special Note about Forward-looking Statements” preceding Item 1 of this report.

Overview

We were incorporated on October 22, 2004 for the purpose of engaging in the business of investing in and owning commercial real estate.  On January 6, 2006, we commenced an initial public offering of up to 55,400,000 shares of our common stock, consisting of 44,400,000 shares for sale pursuant to a primary offering and 11,000,000 shares for sale pursuant to our distribution reinvestment plan.  We stopped making offers under our initial public offering on June 1, 2009 upon raising gross offering proceeds of approximately $172.7 million from the sale of approximately 21.7 million shares, including shares sold under the distribution reinvestment plan.  On June 10, 2009, we commenced a follow-on offering of up 77,350,000 shares of our common stock, consisting of 56,250,000 shares for sale pursuant to a primary offering and 21,100,000 shares for sale pursuant to our dividend reinvestment plan.  We retained Pacific Cornerstone Capital, Inc. (“PCC”), an affiliate of the advisor, to serve as the dealer manager for our offerings.  PCC is responsible for marketing our shares currently being offered pursuant to the follow-on offering.

We used the net proceeds from our initial public offering to invest primarily in investment real estate including multi-tenant industrial real estate located in major metropolitan markets in the United States.  We intend to use the net proceeds from our follow-on offering to acquire additional real estate investments and pay down temporary acquisition financing on our existing asset.

As of December 31, 2009, we had raised approximately $165.9 million of gross proceeds from the sale of approximately 20.8 million shares of our common stock in our initial public offering and follow-on offering and had acquired twelve properties.

Our revenues, which are comprised largely of rental income, include rents reported on a straight-line basis over the initial term of the lease. Our growth depends, in part, on our ability to increase rental income and other earned income from leases by increasing rental rates and occupancy levels and control operating and other expenses. Our operations are impacted by property specific, market specific, general economic and other conditions.

Market Outlook – Real Estate and Real Estate Finance Markets
 
During 2008 and 2009, significant and widespread concerns about credit risk and access to capital have been present in the global capital markets. Both the national and most global economies have experienced substantially increased unemployment and a downturn in economic activity. In addition, recent failure or near failure of several large financial institutions, together with government interventions in the financial system, including interventions in bankruptcy proceedings and restrictions on businesses, have led to increased market uncertainty and volatility. Despite certain recent positive economic indicators and improved stock market performance, the aforementioned conditions, combined with stagnant business activity and low consumer spending, have resulted in an unprecedented global recession and continue to contribute to a challenging macro-economic environment that may interfere with the implementation of our business strategies.
 
As a result of the decline in general economic conditions, the U.S. commercial real estate industry has also been experiencing deteriorating fundamentals across all major property types and most geographic markets. Tenant defaults are on the rise, while demand for commercial real estate space is contracting. It is expected that this will create a highly competitive leasing environment that should result in downward pressure on both occupancy and rental rates, resulting in leasing incentives becoming more common. Mortgage delinquencies and defaults have trended upward, with many industry analysts predicting significant credit defaults, foreclosures and principal losses, in particular for subordinate securitized debt instruments.
 
From a financing perspective, the severe dislocations and liquidity disruptions in the credit markets have impacted both the cost and availability of commercial real estate debt. The commercial mortgage-backed securities market, formerly a significant source of liquidity and debt capital, has become inactive and has left a void in the market for long-term, affordable, fixed rate debt. This void has been partially filled by portfolio lenders such as insurance companies, but at very different terms than were available in the past five years. These remaining lenders have generally increased credit spreads, lowered the amount of available proceeds, required recourse security and credit enhancements, and otherwise tightened underwriting standards considerably, while simultaneously generally limiting lending to existing relationships with borrowers that invest in high quality assets in top tier markets. In addition, lenders have limited the amount of financing available to existing relationships in an effort to manage and mitigate the risk of overconcentration in certain borrowers.
 
Currently, benchmark interest rates, such as LIBOR, are at historic lows, allowing some borrowers with variable rate real estate loans to continue making debt service payments even as the properties securing these loans experience decreased occupancy and lower rental rates. These low rates have benefitted borrowers with floating rate debt who have experienced lower revenues due to decreased occupancy or lower rental rates. Low short-term rates have allowed them to meet their debt obligations but the borrowers would not meet the current underwriting requirements needed to refinance this debt today. As these loans near maturity, borrowers will find it increasingly difficult to refinance these loans in the current underwriting environment.
 
30

 
These market conditions have and will likely continue to have a significant impact on our real estate investments. In addition, these market conditions have impacted our tenants’ businesses, which makes it more difficult for them to meet current lease obligations and places pressure on them to negotiate favorable lease terms upon renewal in order for their businesses to remain viable. Increases in rental concessions given to retain tenants and maintain our occupancy level, which is vital to the continued success of our portfolio, has resulted in lower current cash flow. Projected future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to retain tenants who are up for renewal or to sign new tenants, are expected to result in additional decreases in cash flows. Historically low interest rates have helped offset some of the impact of these decreases in operating cash flow for properties financed with variable rate mortgages; however, interest rates may not remain at these historically low levels for the remaining life of many of our investments.

Based on these market outlooks, we may limit capital expenditures during 2010 compared to prior years by focusing on those capital expenditures that preserve value. However, if we experience an increase in vacancies, we may incur costs to re-lease properties and pay leasing commissions.
 
Our cash position remains strong. Despite the current economic crisis, we expect to have sufficient cash flow from operations to cover a majority of cash distribution and capital improvements in the next twelve months.
 
Results of Operations

Our results of operations are not indicative of those expected in future periods as we expect that rental income, tenant reimbursements, operating expenses, asset management fees, depreciation, amortization, and net income will each increase in future periods as a result of assets acquired since inception and anticipation of future acquisition of real estate assets.

As of December 31, 2009, we owned twelve properties.  These properties were acquired from June of 2006 through April 2008. During 2009, we owned twelve properties for a full year.  During 2008, we owned eleven properties for a full year, and one for eight and one-half months.  During 2007 we owned seven properties for a full year and four properties for one and one-half months.  Accordingly, the results of our operations for the years ended December 31, 2009, 2008 and 2007 are not directly comparable.

In January 2009, we made a $14.0 million mortgage loan to Caruth Haven L.P, a wholly-owned subsidiary of Cornerstone Healthcare Plus REIT, Inc., sponsored by affiliates of our sponsor.  The loan was to mature on January 21, 2010.  On December 16, 2009, Caruth Haven L.P. fully repaid the loan.

On December 14, 2009, we made a participating first mortgage loan commitment of $8.0 million to Nantucket Acquisition LLC, a Delaware limited liability company managed by Cornerstone Ventures Inc., an affiliate of our advisor, in connection with Nantucket Acquisition’s purchase of a 60-unit senior living community known as Sherburne Commons located on the exclusive island of Nantucket, MA.  The loan matures on January 1, 2015, with no option to extend and bears interest at a fixed rate of 8.0% for the term of the loan.  Interest will be paid monthly with principal due at maturity.  In addition, under the terms of the loan, we are entitled to receive additional interest in the form of a 40% participation in the "shared appreciation" of the property, which is calculated based on the net sales proceeds if the property is sold, or the property's appraised value, less ordinary disposition costs, if the Property has not been sold by the time the loan matures. Prepayment of the loan is not permitted without our consent and the loan is not assumable.

We have no paid employees advised and managed by Cornerstone Realty Advisors, LLC.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
 
Rental revenue, tenant reimbursements and other income decreased to approximately $9.8 million for the year ended December 31, 2009 from approximately $10.6 million for the year ended December 31, 2008.  The decrease is primarily due to lower occupancy rates, lower lease rental rates and longer lease up periods for vacant units as a result of the current economic environment partially offset by Monroe North’s additional one and a half months of revenue in 2009.

Interest income from a note receivable increased to approximately $1.3 million for the year ended December 31, 2009 from $0.2 million for the year ended December 31, 2008.  The increase is due to higher notes receivable balances outstanding during 2009.

Property operating and maintenance costs increased to approximately $3.4 million for the year ended December 31, 2009 from approximately $3.1 million for the year ended December 31, 2008.  The increase is primarily due to an increase in property taxes,  bad debt expense and legal collection costs as a result of current economic conditions partially offset by decrease in property management fees.
 
31


Real estate acquisition costs increased to approximately $0.4 million for the year ended December 31, 2009 from $0 for the year ended December 31, 2008. The increase relates to the portion of the acquisition fee paid to advisor on receipt of offering proceeds which the adoption of an accounting provision in 2009 required us to expense.

Depreciation and amortization is comparable for year ended December 31, 2009 and 2008.

General and administrative expenses increased to approximately $1.9 million for the year ended December 31, 2009 from approximately $1.4 million for the year ended December 31, 2008. The increase is primarily due to higher professional fees, reimbursement of operating costs to the advisor related to the services on our behalf, and a one-time abandoned project refund received in 2008.

Asset management fees increased to approximately $1.5 million for the year ended December 31, 2009 from approximately $1.3 million for the year ended December 31, 2008. The increase is due to higher average assets under management in 2009.
 
A note receivable impairment reserve of approximately $4.6 million was recorded for the year ended December 31, 2009.  There was no impairment reserve recorded in the year ended December 31, 2008.  The 2009 impairment was based on our evaluation of collectability that involves judgment, estimates and a review of the borrower’s business models and their future operations. While we remain confident of the borrower’s ability to successfully execute its business plans, changes in the economic environment and market conditions have delayed planned initiatives, and we concluded that the collectability cannot be reasonably assured.

Impairment of real estate increased to approximately $2.4 million for the year ended December 31, 2009 from $0 for the year ended December 31, 2008.  The 2009 impairment is due to adjustments to reflect a decline in the market value of one of our real estate properties, based on current occupancy and rental rates.

Interest income decreased to approximately $8,000 for the year ended December 31, 2009 from approximately $0.3 million for the year ended December 31, 2008. The decrease is primarily due to lower rates paid on short term investments combined with lower average cash balances available for investment.

Interest expense decreased to approximately $1.4 million for the year ended December 31, 2009 from approximately $3.1 million for the year ended December 31, 2008. The decrease is primarily due to lower interest rates on our credit agreements with HSH Nordbank and Wachovia Bank and a lower debt balance as a result of a $25.0 million principal reduction in the third quarter of 2008.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
 
The increase in rental income and tenant reimbursements and other income as well as the increase in operating costs, asset management fees and depreciation and amortization are primarily due to acquisition of properties during 2007 which were owned for a full year in 2008 and from the acquisition of one additional property during 2008.
 
Rental revenue, tenant reimbursements and other income increased to approximately $10.6 million for the year ended December 31, 2008 from approximately $5.9 million for the year ended December 31, 2007.

Interest income from a note receivable increased to approximately $0.2 million for the year ended December 31, 2008 from $0 for the year ended December 31, 2007, due to the origination of a note receivable to a real estate operating company in 2008.

Property operating and maintenance costs, which include bad debt expense, increased to approximately $3.1 million for the year ended December 31, 2008 from approximately $1.3 million for the year ended December 31, 2007.

Depreciation of real estate and amortization of lease costs increased to approximately $3.6 million for the year ended December 31, 2008 from approximately $1.5 million for the year ended December 31, 2007. The increases in depreciation and amortization resulted primarily from the acquisitions of properties in 2007 which were owned for a full year in 2008. In addition, amortization of intangible lease assets increased due to tenant departures before the end of their lease term.

General and administrative expenses decreased to approximately $1.4 million for the year ended December 31, 2008 from approximately $2.4 million for the year ended December 31, 2007. The 2007 expense included a charge of approximately $0.8 million related to an abandoned project.  

Asset management fees increased to approximately $1.3 million for the year ended December 31, 2008 from approximately $0.7 million for the year ended December 31, 2007 as a result of property acquisitions in 2007 and 2008.
 
Interest income decreased to approximately $0.3 million for the year ended December 31, 2008 from approximately $0.6 million for the year ended December 31, 2007 primarily due to lower investment rates on short term investments in 2008 partially offset by higher average cash balances in 2008.
 
32

 
Interest expense is comparable for year ended December 31, 2008 and 2007.

Liquidity and Capital Resources

We expect that primary sources of capital over the long term will include net proceeds from the sale of our common stock and net cash flows from operations.  We expect that our primary uses of capital will be for property acquisitions, for the payment of tenant improvements and leasing commissions, operating expenses, interest expense on any outstanding indebtedness, cash distributions, and for the repayment of notes payable. In addition, we will continue to use temporary debt financing to facilitate our acquisitions of properties in anticipation of receipt of offering proceeds.

On January 6, 2006, we commenced an initial public offering of up to 55,400,000 shares of our common stock, consisting of 44,400,000 shares for sale pursuant to a primary offering and 11,000,000 shares for sale pursuant to our distribution reinvestment plan.  We stopped making offers under our initial public offering on June 1, 2009 upon raising gross offering proceeds of approximately $172.7 million from the sale of approximately 21.7 million shares, including shares sold under the distribution reinvestment plan.  On June 10, 2009, we commenced a follow-on offering of up 77,350,000 shares of our common stock, consisting of 56,250,000 shares for sale pursuant to a primary offering and 21,100,000 shares for sale pursuant to our dividend reinvestment plan.  As of December 31, 2009, a total of approximately 20.8 million shares of our common stock had been sold in our combined offerings for aggregate gross proceeds of approximately $165.9 million.

As of December 31, 2009, we had approximately $18.7 million in cash and cash equivalents on hand and approximately $34.1 million available under our acquisition credit facility with HSH Nordbank.  We may use the available credit to acquire real estate investments and we may use up to 10% of the credit facility for working capital.  We are entitled to prepay the borrowings under the credit facility at any time without penalty.   The repayment of obligations under the credit agreement may be accelerated in the event of a default, as defined in the credit agreement.  The facility contains various covenants including financial covenants with respect to consolidated interest and fixed charge coverage and secured debt to secured asset value.  As of December 31, 2009, we were in compliance with all these financial covenants.  We anticipate paying down the existing debt obligation with proceeds raised from our follow-on offering.

In addition, on August 17, 2009, we notified Wachovia Bank of our intent to exercise the option to extend our outstanding $22.4 million loan for one year to November 13, 2010. On November 10, 2009, we received a letter from Wachovia Bank approving the loan extension which required an approximate principal reduction of $6.5 million and satisfaction of certain conditions expressed per the loan agreement.  On November 12, 2009, we reduced our outstanding debt with Wachovia Bank by paying down $6.5 million.  On November 13, 2009, we satisfied conditions expressed by Wachovia Bank and extended our loan maturity date to November 13, 2010.

For the notes payable that are due within the next twelve months, we are in the process of negotiating with other financial institutions to refinance our debt maturing in 2010. We plan to refinance all or a portion of the debt maturing in 2010 and repay the other portion with proceeds from our follow-on offering.

Our liquidity will increase as additional subscriptions are accepted and decrease as net offering proceeds are expended in connection with the acquisition and operation of properties and distributions in excess of operating cash flow are made.
 
There may be a delay between the sale of our shares and the purchase of properties.  During this period, net offering proceeds will be temporarily invested in short-term, liquid investments that could yield lower returns than investments in real estate.
 
Until proceeds from our offerings are invested and generating operating cash flow sufficient to fully fund distributions to stockholders, we intend to pay a portion of our distributions from the proceeds of our offering or from borrowings in anticipation of future cash flow.  For the twelve months ended December 31, 2009, distributions to stockholders were paid partially from funds from operations and the remainder was paid from proceeds of our offerings and general borrowings in anticipation of future cash flow.

As of December 31, 2009, our advisor had incurred $4.5 million of organization and offering costs on our behalf, including approximately $0.1 million of organizational costs that have been expensed, approximately $4.4 million of offering costs which reduce net proceeds of our Primary Offering. At December 31, 2009, organization and offering costs incurred and reimbursed to our advisor are approximately 2.8% of the gross proceeds of our Primary Offering. In addition, our advisor will pay all of our organization and offering expenses that, when combined with the sales commissions and dealer manager fees that we incur exceed 13.5% of the gross proceeds from our initial public offering.

The advisor and its affiliates had incurred organizational and offering costs on our behalf for our follow-on offering in the amount of approximately $0.7 million and $0.3 million as of December 31, 2009 and December 31, 2008.

In no event will we have any obligation to reimburse the advisor for these costs totaling in excess of 3.5% of the gross proceeds from our initial public offering or our follow-on public offering.  As of December 31, 2009, we had reimbursed to our advisor a total of $4.5 million for our initial public offering and $0.7 million for our follow-on offering.
 
33


We will not rely on advances from our advisor to acquire properties but our advisor and its affiliates may loan funds to special purposes entities that may acquire properties on our behalf pending our raising sufficient proceeds from our initial public offering to purchase the properties from the special purpose entity.

We will endeavor to repay any temporary acquisition debt financing promptly upon receipt of proceeds in our follow-on public offering.  To the extent sufficient proceeds from our follow-on offering is unavailable to repay such debt financing within a reasonable time as determined by our board of directors, we will endeavor to raise additional equity or sell properties to repay such debt so that we will own our properties with no permanent financing.  In the event that our follow-on public offering is not fully sold, our ability to diversify our investments may be diminished.  We are not aware of any material trends or uncertainties, favorable or unfavorable, other than national economic conditions affecting real estate generally, which we anticipate may have a material impact on either capital resources or the revenues or income to be derived from the operation of real estate properties.

Financial markets have recently experienced unusual volatility and uncertainty. Liquidity has tightened in all financial markets, including the debt and equity markets.  Our ability to fund property acquisitions or development projects, as well as our ability to repay or refinance debt maturities could be adversely affected by an inability to secure financing at reasonable terms, if at all.

Election as a REIT

We elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, for the year ended December 31, 2009.  Under the Internal Revenue Code of 1986, we are not subject to federal income tax on income that we distribute to our stockholders.  REITs are subject to numerous organizational and operational requirements in order to avoid taxation as a regular corporation, including a requirement that they generally distribute at least 90% of their annual taxable income to their stockholders.  If we fail to qualify for taxation as a REIT in any year, our income will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify.  Our failure to qualify as a REIT could result in us having a significant liability for taxes.

Other Liquidity Needs

Property Acquisitions

We expect to purchase properties and have expenditures for capital improvements, tenant improvements and lease commissions in the next twelve months, however, those amounts cannot be estimated at this time.  We cannot assure, however, that we will have sufficient funds to make any acquisitions or related capital expenditures at all.

Debt Service Requirements

On June 30, 2006, we entered into a credit agreement with HSH Nordbank AG, New York Branch, for a temporary credit facility that we will use during the offering period to facilitate our acquisitions of properties in anticipation of the receipt of offering proceeds.  The credit agreement permits us to borrow up to $50,000,000 secured by real property at a borrowing rate based on LIBOR plus a margin ranging from 1.15% to 1.35% and requires payment of a usage premium of up to 0.15% and an annual administrative fee.  We may use the entire credit facility to acquire real estate investments and we may use up to 10% of the credit facility for working capital.

We are entitled to prepay the obligations at any time without penalty.  On March 24, 2009, we notified HSH Nordbank of our intent to exercise the second of two one-year options to extend the loan maturity date.  On June 30, 2009, we satisfied conditions expressed by the lender and extended our loan maturity date to June 30, 2010.  The obligations under the credit agreement may be accelerated in the event of a default as defined in the credit agreement.  As of December 31, 2009, the outstanding balance of borrowings under this credit facility was approximately $15.9 million.

On November 13, 2007, we entered into a loan agreement with Wachovia Bank in connection with the acquisition of Orlando Small Bay portfolio.  Pursuant to the terms of the loan agreement, we may borrow $22.4 million at an interest rate of 140 basis points over 30-day LIBOR, secured by specified real estate properties.  The loan agreement has a maturity date of November 13, 2010. As of December 31, 2009, we have an outstanding balance of approximately $15.9 million under this loan agreement. The loan may be prepaid without penalty.

In connection with our acquisition of Monroe North CommerCenter, on April 17, 2008, we entered into an assumption and amendment of note, mortgage and other loan documents (the “Loan Assumption Agreement”) with Transamerica Life Insurance Company (“Transamerica”).  Pursuant to the Loan Assumption Agreement, we assumed the outstanding principal balance of approximately $7.4 million on the Transamerica mortgage loan.  The loan matures on November 1, 2014 and bears interest at a fixed rate of 5.89% per annum.  As of December 31, 2009, we have an outstanding balance of approximately $7.1 million under this loan agreement.  The monthly payment on this loan is approximately $50,369.
 
We expect to use net cash flows from operations and net proceeds from the sale of our common stock to repay our outstanding debts.
 
34

 
Contractual Obligations

The following table reflects our contractual obligations as December 31, 2009, specifically our obligations under long-term debt agreements and purchase obligations:

   
Payment due by period
 
Contractual Obligations
 
Total
 
Less than
1 year
   
1-3 years
   
3-5 years
   
More than
5 years
 
Notes payable (1)
   
$
38,884,000
   
$
31,999,000
   
$
651,000
   
$
6,234,000
   
$
-
 
Interest expense related to long term debt (2)
   
$
2,238,000
   
$
774,000
   
$
1,162,000
   
$
302,000
   
$
-
 
Note receivable (3)
   
$
2,500,000
   
$
2,500,000
   
$
-
   
$
-
   
$
-
 
Note receivable from related party (4)
   
$
1,100,000
   
$
1,100,000
   
$
-
   
$
-
   
$
-
 



(1)  This represents the sum of a credit agreement with HSH Nordbank, AG and loan agreements with Wachovia Bank National Association and Transamerica Life Insurance Company.  

 (2)  Interest expenses related to the credit agreement with HSH Nordbank, AG and loan agreement with Wachovia Bank National Association are calculated based on the loan balances outstanding at December 31, 2009, one month LIBOR at December 31, 2009 plus appropriate margin ranging from 1.15% and 1.40%. Interest expense related to loan agreement with Transamerica Life Insurance Company is based on a fixed rate of 5.89% per annum.

(3)  We have committed to fund $10.0 million to entities that are parties to an alliance with the managing member of our advisor.  As of December 31, 2009, we have funded approximately $7.5 million of this amount.

(4)  On December 14, 2009, we committed to fund $8.0 million to a related party, an affiliate of our advisor.  As of December 31, 2009, we have funded approximately $6.9 million of this amount.
 
Off-Balance Sheet Arrangements

There are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in the financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Inflation

Although the real estate market has not been affected significantly by inflation in the recent past due to the relatively low inflation rate, we expect that the majority of our tenant leases will include provisions that would protect us to some extent from the impact of inflation.  Where possible, our leases will include provisions for rent escalations and partial reimbursement to us of expenses.  Our ability to include provisions in the leases that protect us against inflation is subject to competitive conditions that vary from market to market.

Subsequent Events

Sale of Shares of Common Stock

Subsequent to December 31, 2009, and through the issuance date of this report, we raised approximately $0.7 million through the issuance of approximately 85,955 shares of our common stock under our offering.

Critical Accounting Policies

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, or GAAP, requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  We believe that our critical accounting policies are those that require significant judgments and estimates such as those related to real estate purchase price allocation, evaluation of possible impairment of real property assets, revenue recognition and valuation of receivables, income taxes, notes receivable and uncertain tax positions.  These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances.  Actual results could vary from those estimates, perhaps in material adverse ways, and those estimates could be different under different assumptions or conditions.  Our significant accounting policies are described in more details in Note 3 to the consolidated financial statements.
 
35


Investments in Real Estate

Upon acquisition of a property, we allocate the purchase price of the property based upon the fair value of the assets acquired, which generally consist of land, buildings, site improvements and intangible lease assets or liabilities including in-place leases, above market and below market leases.  We allocated the purchase price to the fair value of the tangible assets of an acquired property by valuing the property as if it were vacant. The value of the building is depreciated over an estimated useful life of 39 years.

In-place lease values are calculated based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the respective tenant.  

Acquired above and below market leases is valued based on the present value of the difference between prevailing market rates and the in-place rates over the remaining lease term. The value of acquired above and below market leases is amortized over the remaining non-cancelable terms of the respective leases as an adjustment to rental revenue on our consolidated statements of operations.

We amortize the value of in-place leases and above and below market leases over the initial term of the respective leases. Should a tenant terminate its lease, the unamortized portion of the above or below market lease value is charged to revenue.  If a lease is terminated prior to its expiration, the unamortized portion of the tenant improvements, and the in-place lease value is immediately charged to expense. 

Should a significant tenant terminate their lease, the unamortized portion of intangible assets or liabilities is charged to revenue.

The estimated useful lives for lease intangibles range from 1 month to 10 years.

Impairment of Real Estate Assets

Rental properties, properties undergoing development and redevelopment, land held for development and intangibles are individually evaluated for impairment when conditions exist which may indicate that it is probable that the sum of expected future undiscounted cash flows is less than the carrying amount.  Impairment indicators for our rental properties, properties undergoing development and redevelopment, and land held for development is assessed by project and include, but is not limited to, significant fluctuations in estimated net operating income, occupancy changes, construction costs, estimated completion dates, rental rates and other market factors.  We assess the expected undiscounted cash flows based upon numerous factors, including, but not limited to, appropriate capitalization rates, construction costs, available market information, historical operating results, known trends and market/economic conditions that may affect the property and our assumptions about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.  Upon determination that impairment has occurred and that the future undiscounted cash flows are less than the carrying amount, a write-down will be recorded to reduce the carrying amount to its estimated fair value.

Revenue Recognition and Valuation of Receivables

Our revenues, which are comprised largely of rental income, include rents reported on a straight-line basis over the initial term of the lease.  Since our leases may provide for free rent, lease incentives or rental increases at specified intervals, we will be required to straight-line the recognition of revenue, which will result in the recording of a receivable for rent not yet due under the lease terms.  Accordingly, our management will be required to determine, in its judgment, to what extent the unbilled rent receivable applicable to each specific tenant is collectible.  Management will review unbilled rent receivable on a quarterly basis and take into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located.  In the event that the collectability of unbilled rent with respect to any given tenant is in doubt, we will record an increase in our allowance for doubtful accounts or record a direct write-off of the specific rent receivable.

Income Taxes

We have elected to be taxed as a REIT for federal income tax purposes beginning with our taxable year ending December 31, 2006.  To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to currently distribute at least 90% of the REIT’s ordinary taxable income to stockholders.  As a REIT, we generally will not be subject to federal income tax on taxable income that it distributes to its stockholders.  If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service granted us relief under certain statutory provisions.  Such an event could materially adversely affect our net income and net cash available for distribution to stockholders.  However, we believe that we will be organized and operate in such a manner as to qualify for treatment as a REIT, beginning with our taxable year ending December 31, 2007, and intend to operate in the foreseeable future in such a manner so that we will remain qualified as a REIT in subsequent tax years for federal income tax purposes.  100% of the distributions declared during 2008 represented a return of capital for federal income tax purposes.  95.07% of the distributions declared during 2009 represented a return of capital for federal income tax purposes.
36


Notes Receivable
 
On a quarterly basis, we evaluate the collectability of our notes receivable.  Our evaluation of collectability involves judgment, estimates and a review of the underlying collateral and borrower's business models and future operations. During the quarter ended September 30, 2009, we concluded that the collectability with regard to one of our notes cannot be reasonably assured and therefore, we recorded a note receivable reserve of approximately $4.6 million against the balance of the note. The amount of this reserve has been included in our consolidated statements of operations under impairment of notes receivable.

Uncertain Tax Positions

In accordance with the requirements of ASC 740-10, Income Taxes, favorable tax positions are included in the calculation of tax liabilities if it is more likely than not that our adopted tax position will prevail if challenged by tax authorities. As a result of our REIT status, we are able to claim a dividends-paid deduction on our tax return to deduct the full amount of common dividends paid to stockholders when computing our annual taxable income, which results in our taxable income being passed through to our stockholders. A REIT is subject to a 100% tax on the net income from prohibited transactions. A “prohibited transaction” is the sale or other disposition of property held primarily for sale to customers in the ordinary course of a trade or business. There is a safe harbor which, if met, expressly prevents the Internal Revenue Service from asserting the prohibited transaction test. We have not had any sales of properties to date. We have no income tax expense, deferred tax assets or deferred tax liabilities associated with any such uncertain tax positions for the operations of any entity included in the consolidated results of operations.

Recently Issued Accounting Pronouncements

Please refer to Note 3 of the Notes to the Financial Statements.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments.  We invest our cash and cash equivalents in government backed securities and FDIC insured savings account which, by its nature, are subject to interest rate fluctuations.  However, we believe that the primary market risk to which we will be exposed is interest rate risk relating to our credit facilities.

Our credit facility with HSH Nordbank AG, permits us to borrow up to $50,000,000 secured by real property at a borrowing rate based on LIBOR plus a margin ranging from 1.15% to 1.35% and requires payment of a usage premium of up to 0.15% and an annual administrative fee.  We may use the entire credit facility to acquire real estate investments and we may use up to 10% of the credit facility for working capital.  We are entitled to prepay the obligations at any time without penalty. On June 30, 2009, we satisfied conditions expressed by the lender and extended our loan maturity date to June 30, 2010. The repayment of obligations under the credit agreement may be accelerated in the event of a default, as defined in the credit agreement.  As of December 31, 2009, we have an outstanding balance of approximately $15.9 million outstanding on this credit facility.

Our loan agreement entered with Wachovia Bank, National Association permits us to $22.4 million at an interest rate 140 basis points over 30-day LIBOR, secured by specified real estate properties.  The loan agreement had a maturity date of November 13, 2009, with a one-year extension at the option of the borrower.  On November 13, 2009, we satisfied conditions expressed by Wachovia Bank and extended our loan maturity date to November 13, 2010. As of December 31, 2009, we have an outstanding balance of approximately $15.9 million under this loan agreement. The loan may be prepaid without penalty.

We may be exposed to the effects of interest rate changes primarily as a result of debt under our credit facilities used to maintain liquidity and fund expansion of our real estate investment portfolio and operations.  Our interest rate risk management objectives will be to monitor and manage the impact of interest rate changes on earnings and cash flows by considering using certain derivative financial instruments such as interest rate swaps and caps in order to mitigate our interest rate risk on variable rate debt.  We will not enter into derivative or interest rate transactions for speculative purposes.

As of December 31, 2009, we had borrowed approximately $31.8 million under our variable rate credit facility and loan agreement.  An increase in the variable interest rate on the facilities constitutes a market risk as a change in rates would increase or decrease interest incurred and therefore cash flows available for distribution to shareholders.  Based on the debt outstanding as of December 31, 2009, a 1% change in interest rates would result in a change in interest expense of approximately $318,000 per year.

In addition to changes in interest rates, the value of our real estate is subject to fluctuations based on changes in the real estate capital markets, market rental rates for office space, local, regional and national economic conditions and changes in the credit worthiness of tenants.  All of these factors may also affect our ability to refinance our debt if necessary.
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the index included at Item 15.  Exhibits, Financial Statement Schedules.
37


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A(T).  CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our senior management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Our Chief Executive Officer and our Chief Financial Officer have reviewed the effectiveness of our disclosure controls and procedures and have concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report.

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) under the Securities and Exchange Act of 1934.  Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  
Based on their evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that we maintained effective internal control over financial reporting as of December 31, 2009.

There have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

ITEM 9B.  OTHER INFORMATION

None.
 
38

 
PART III

ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities and Exchange Commission no later than April 30, 2010.

ITEM 11.   EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities and Exchange Commission no later than April 30, 2010.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities and Exchange Commission no later than April 30, 2010.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

The information required by this Item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities and Exchange Commission no later than April 30, 2010.

ITEM 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this Item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities and Exchange Commission no later than April 30, 2010.

39


PART IV

ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) (1) Financial Statements

The following financial statements are included in a separate section of this Annual Report on Form 10-K commencing on the page numbers specified below:
 
Report of Independent Registered Public Accounting Firm
 
Consolidated Balance Sheets as of December 31, 2009 and 2008
 
Consolidated Statements of Operations for the Years Ended December 31, 2009, 2008 and 2007
 
Consolidated Statements of Equity for the Years Ended December 31, 2009, 2008, and 2007
 
Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2008, and 2007
 
Notes to Financial Statements

(2) Financial Statement Schedule

Schedule II – Valuation and Qualifying Accounts

Schedule III - Real Estate and Accumulated Depreciation

Schedule IV – Mortgage Loan and Real Estate

(3) Exhibits

The exhibits listed on the Exhibit Index (following the signatures section of this report) are included, or incorporated by reference, in this annual report
 
40<