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EX-31.1 - SECTION 302 CERTIFICATION OF CEO - Griffin Capital Essential Asset REIT, Inc.dex311.htm
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EX-32.2 - SECTION 906 CERTIFICATION OF CFO - Griffin Capital Essential Asset REIT, Inc.dex322.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CEO - Griffin Capital Essential Asset REIT, Inc.dex321.htm
Table of Contents
Index to Financial Statements

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, 2010   OR   

 

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

  For the transition period from              to             

Commission File Number:            333-159167

The GC Net Lease REIT, Inc.

(Exact name of Registrant as specified in its charter)

 

Maryland   26-3335705
(State or other jurisdiction of   (IRS Employer Identification No.)
incorporation or organization)  

2121 Rosecrans Avenue, Suite 3321, El Segundo, California 90245

(Address of principal executive offices)

(310) 606-5900

(Registrant’s telephone number)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class   Name of Each Exchange on Which Registered
None   None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 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 ¨ 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 ¨ No x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment of this Form 10-K.  ¨

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

 

Large Accelerated Filer ¨      Accelerated Filer ¨
Non-Accelerated Filer x (Do not check if a smaller reporting company)    Smaller reporting company ¨

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

The aggregate market value of voting common stock held by non-affiliates was approximately $9,068,300 assuming a market value of $10 per share, as of June 30, 2010.

As of March 22, 2011, there were 2,500,297 outstanding shares of common stock of the registrant.

Documents Incorporated by Reference:

The Registrant incorporates by reference in Part III (Items 10, 11, 12, 13 and 14) of this Form 10-K portions of its Definitive Proxy Statement for the 2011 Annual Meeting of Stockholders.


Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

         Page No.  

PART I

       4   

    ITEM 1.

 

BUSINESS

     4   

    ITEM 1A.

 

RISK FACTORS

     15   

    ITEM 1B.

 

UNRESOLVED STAFF COMMENTS

     36   

    ITEM 2.

 

PROPERTIES

     37   

    ITEM 3.

 

LEGAL PROCEEDINGS

     40   

    ITEM 4.

 

REMOVED AND RESERVED

     40   

PART II

       41   

    ITEM 5.

 

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

     41   

    ITEM 6.

 

SELECTED FINANCIAL DATA

     45   

    ITEM 7.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     45   

    ITEM 7A.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     55   

    ITEM 8.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     56   

    ITEM 9.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     56   

    ITEM 9A.

 

CONTROLS AND PROCEDURES

     56   

    ITEM 9B.

 

OTHER INFORMATION

     57   

PART III

       57   

    ITEM 10.

 

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     57   

    ITEM 11.

 

EXECUTIVE COMPENSATION

     57   

    ITEM 12.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     57   

    ITEM 13.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

     58   

    ITEM 14.

 

PRINCIPAL ACCOUNTING FEES AND SERVICES

     58   

PART IV

       58   

    ITEM 15.

 

EXHIBITS, FINANCIAL STATEMENT SCHEDULES

     58   

SIGNATURES

     62   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Form 10-K of The GC Net Lease REIT, Inc., other than historical facts, may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend for all such forward-looking statements to be covered by the applicable safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act, as applicable. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, including known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this report is filed with the Securities and Exchange Commission. We cannot guarantee the accuracy of any such forward-looking statements contained in this Form 10-K, and we do not intend to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Any such forward-looking statements are subject to risks, uncertainties, and other factors and are based on a number of assumptions involving judgments with respect to, among other things, future economic, competitive, and market conditions, all of which are difficult or impossible to predict accurately. To the extent that our assumptions differ from actual results, our ability to meet such forward-looking statements, including our ability to generate positive cash flow from operations and provide distributions to stockholders, and our ability to find suitable investment properties, may be significantly hindered.

All forward-looking statements should be read in light of the risks identified in Part I, Item 1A of this Form 10-K.

 

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PART I

 

ITEM 1. BUSINESS

Overview

We were formed on August 28, 2008 under the Maryland General Corporation Law (“MGCL”) primarily with the purpose of acquiring single tenant net lease properties. We expect to use a substantial amount of the net proceeds from the Public Offering (as defined below) to invest in these properties. We began operations on May 6, 2009 and are subject to the general risks associated with a start-up enterprise, including the risk of business failure. Our year end is December 31. We deferred the election to be taxed as a REIT until December 31, 2010 to ensure that certain non-financial requirements were satisfied, which we did not satisfy as of December 31, 2009. As of December 31, 2010, we satisfied these non-financial requirements, and will proceed with the election to be taxed as a REIT.

We have no paid employees and are externally advised and managed by an affiliate of ours, The GC Net Lease REIT Advisor, LLC (our advisor). Griffin Capital Corporation, our sponsor, is the sole member of our advisor and an affiliate of the sole owner of The GC Net Lease REIT Property Management, LLC, our property manager. Our operating partnership is The GC Net Lease REIT Operating Partnership, L.P. We expect to own all of our properties directly or indirectly through our operating partnership or similar entities.

On February 20, 2009, we commenced a private offering to accredited investors only pursuant to a confidential private placement memorandum. On May 6, 2009 we satisfied our minimum offering requirement and commenced operations. We declared our first distribution to stockholders in the second quarter of 2009, which was initially paid on June 15, 2009.

We terminated our private offering on November 6, 2009, having raised approximately $2.36 million through the issuance of approximately 247,978 shares, and began our offering to the public upon the SEC declaring our registration statement effective. We are currently offering a maximum of 82,500,000 shares of common stock to the public, consisting of 75,000,000 shares for sale to the public (our “Primary Public Offering”) and 7,500,000 shares for sale pursuant to our distribution reinvestment plan (collectively, our “Public Offering”). As of December 31, 2010, we had issued 1,597,359 shares of our common stock for gross proceeds of approximately $15.94 million in our Public Offering.

Investment Objectives

Overview

If we sell the maximum in our Public Offering, we estimate that approximately 88.25% of the gross offering proceeds will be available for investment. Such net offering proceeds will be used to primarily invest in single tenant net lease properties in accordance with our investment objectives. We may also use net offering proceeds to pay down debt or make distributions if our cash flows from operations are insufficient. The remaining 11.75% will be used to pay sales commissions, dealer manager fees and reimburse organization and offering expenses. We expect our acquisition fees and actual acquisition expenses to constitute approximately 2.57% of our gross offering proceeds, which will allow us to invest approximately 85.68% in real estate investments. Our investment objectives and policies may be amended or changed at any time by our board of directors. Although we have no plans at this time to change any of our investment objectives, our board of directors may change any and all such investment objectives, including our focus on single tenant net lease properties, if they believe such changes are in the best interests of our stockholders. In addition, we may invest in real estate properties other than single tenant net lease properties if our board deems such investments to be in the best interests of our stockholders. We cannot assure our stockholders that our policies or investment objectives will be attained or that the value of our common stock will not decrease.

 

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Primary Investment Objectives

Our primary investment objectives are to:

 

   

invest in income-producing real property in a manner that allows us to qualify as a REIT for federal income tax purposes;

 

   

provide regular cash distributions to our stockholders;

 

   

preserve and protect stockholders’ invested capital; and

 

   

achieve appreciation in the value of our properties over the long term.

We cannot assure our stockholders that we will attain these primary investment objectives.

Exchange Listing and Other Liquidity Events

Our board will determine when, and if, to apply to have our shares of common stock listed for trading on a national securities exchange, subject to satisfying then-existing applicable listing requirements. Subject to then-existing market conditions and the sole discretion of our board of directors, we intend to seek one or more of the following liquidity events within eight to 11 years after completion of our Public Offering:

 

   

list our shares on a national securities exchange;

 

   

merge, reorganize or otherwise transfer our company or its assets to another entity with listed securities;

 

   

commence the sale of all of our properties and liquidate our company; or

 

   

otherwise create a liquidity event for our stockholders.

However, we cannot assure our stockholders that we will achieve one or more of the above-described liquidity events within the timeframe contemplated or at all. This time frame represents our best faith estimate of the time necessary to build a portfolio sufficient enough to effectuate one of the liquidity events listed above. Our board of directors has the sole discretion to continue operations beyond 11 years after completion of our Public Offering if it deems such continuation to be in the best interests of our stockholders. Even if we do accomplish one or more of these liquidity events, we cannot guarantee that a public market will develop for the securities listed or that such securities will trade at a price higher than what our stockholders paid for their shares in our Public Offering. At the time it becomes necessary for our board of directors to determine which liquidity event, if any, is in the best interests of us and our stockholders, we expect that the board will take all relevant factors at that time into consideration when making a liquidity event decision. We expect that the board will consider various factors including, but not limited to, costs and expenses related to each possible liquidity event and the potential subordinated fees paid to our advisor.

Investment Strategy

We will seek to acquire a portfolio of single tenant net lease properties throughout the United States diversified by corporate credit, physical geography, product type and lease duration. Although we have no current intention to do so, we may also invest a portion of the net proceeds in single tenant net lease properties outside the United States. We intend to acquire assets consistent with our single tenant acquisition philosophy by focusing primarily on properties:

 

   

mission critical to the business operations of the tenant;

 

   

located in primary, secondary and certain select tertiary markets;

 

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leased to tenants with stable and/or improving credit quality; and

 

   

subject to long-term leases with defined rental rate increases or with short-term leases with high-probability of renewal and potential for increasing rent.

Our sponsor has been acquiring single tenant net lease properties for well over a decade. Our sponsor’s positive acquisition and ownership experience with single tenant net lease properties of the type we intend to acquire stems from the following:

 

   

the credit quality of the lease payment is determinable and equivalent to the senior unsecured credit rating of the tenant;

 

   

the critical nature of the asset to the tenant’s business provides greater default protection relative to the tenant’s balance sheet debt;

 

   

the percentage recovery in the event of a tenant default is empirically greater than an unsecured lender; and

 

   

long-term leases provide a consistent and predictable income stream across market cycles while short-term leases offer income appreciation upon renewal and reset.

We will seek to provide stockholders the following benefits:

 

   

a cohesive management team experienced in all aspects of real estate investment with a track record of acquiring single tenant net lease assets;

 

   

a clear alignment of interests between management and investors, as the affiliates of our sponsor invested over $26 million in our portfolio by contributing certain of our properties;

 

   

stable cash flow backed by a portfolio of single tenant net lease real estate assets;

 

   

minimal exposure to operating and maintenance expense increases given our focus on single tenant net lease properties;

 

   

contractual lease rate increases enabling distribution growth;

 

   

insulation from short-term economic cycles resulting from the long-term nature of underlying asset leases;

 

   

enhanced stability resulting from diversified credit characteristics of corporate credits; and

 

   

portfolio stability promoted through geographic and product type investment diversification.

General Acquisition and Investment Policies

We will seek to make investments that satisfy the primary investment objective of providing regular cash distributions to our stockholders. However, because a significant factor in the valuation of income-producing real property is its potential for future appreciation, we anticipate that some properties we acquire may have both the potential for growth in value and for providing regular cash distributions to our stockholders.

Our advisor has substantial discretion with respect to the selection of specific properties. However, each acquisition will be approved by our board of directors. In selecting a potential property for acquisition, we and our advisor consider a number of factors, including but not limited to the following:

 

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tenant creditworthiness;

 

   

lease terms, including length of lease term, scope of landlord responsibilities, presence and frequency of contractual rental increases, renewal option provisions, exclusive and permitted use provisions, co-tenancy requirements and termination options;

 

   

projected demand in the area;

 

   

a property’s geographic location and type;

 

   

proposed purchase price, terms and conditions;

 

   

historical financial performance;

 

   

projected net cash flow yield and internal rates of return;

 

   

a property’s physical location, visibility, curb appeal and access;

 

   

construction quality and condition;

 

   

potential for capital appreciation;

 

   

demographics of the area, neighborhood growth patterns, economic conditions, and local market conditions;

 

   

potential capital and tenant improvements and reserves required to maintain the property;

 

   

prospects for liquidity through sale, financing or refinancing of the property;

 

   

the potential for the construction of new properties in the area;

 

   

treatment under applicable federal, state and local tax and other laws and regulations;

 

   

evaluation of title and obtaining of satisfactory title insurance; and

 

   

evaluation of any reasonable ascertainable risks such as environmental contamination.

There is no limitation on the number, size or type of properties that we may acquire or on the percentage of net offering proceeds that may be invested in any particular property type or single property. The number and mix of properties will depend upon real estate market conditions and other circumstances existing at the time of acquisition and the amount of proceeds raised in our Public Offering. In determining whether to purchase a particular property, we may obtain an option on such property. The amount paid for an option, if any, is normally surrendered if the property is not purchased and may or may not be credited against the purchase price if the property is ultimately purchased.

Description of Leases

We expect, in most instances, to acquire single tenant properties with existing net leases. When spaces in a property become vacant, existing leases expire, or we acquire properties under development or requiring substantial refurbishment or renovation, we anticipate entering into “net” leases. “Net” leases means leases that typically require tenants to pay all or a majority of the operating expenses, including real estate taxes, special assessments and sales and use taxes, utilities, insurance, common area maintenance charges, and building repairs related to the property, in addition to the lease payments. There are various forms of net leases, typically classified as triple-net or double-net. Under most commercial

 

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leases, tenants are obligated to pay a predetermined annual base rent. Some of the leases also will contain provisions that increase the amount of base rent payable at points during the lease term and/or that require the tenant to pay rent based upon a percentage of the tenant’s revenues. Percentage rent can be calculated based upon a number of factors. Triple-net leases typically require the tenant to pay all costs associated with a property in addition to the base rent and percentage rent, if any. Double-net leases typically hold the landlord responsible for the roof and structure, or other aspects of the property, while the tenant is responsible for all remaining expenses associated with the property. To the extent we acquire multi-tenant properties, we expect to have a variety of lease arrangements with the tenants of these properties. Since each lease is an individually negotiated contract between two or more parties, each lease will have different obligations of both the landlord and tenant and we cannot predict at this time the exact terms of any future leases into which we will enter. We will weigh many factors when negotiating specific lease terms, including, but not limited to, the rental rate, creditworthiness of the tenant, location of the property and type of property. Many large national tenants have standard lease forms that generally do not vary from property to property. We will have limited ability to revise the terms of leases to those tenants.

We anticipate that many of our acquisitions will have lease terms of seven to 15 years at the time of the property acquisition. We may acquire properties under which the lease term has partially expired. We also may acquire properties with shorter lease terms if the property is located in a desirable location, is difficult to replace, or has other significant favorable real estate attributes. Generally, the leases require each tenant to procure, at its own expense, commercial general liability insurance, as well as property insurance covering the building for the full replacement value and naming the ownership entity and the lender, if applicable, as the additional insured on the policy. As a precautionary measure, we may obtain, to the extent available, secondary liability or property insurance, as well as loss of rents insurance that covers one or more years of annual rent in the event of a rental loss.

Tenants will be required to provide proof of insurance by furnishing a certificate of insurance to our advisor on an annual basis. The insurance certificates will be tracked and reviewed for compliance by our property manager.

Our Borrowing Strategy and Policies

We may incur our indebtedness in the form of bank borrowings, purchase money obligations to the sellers of properties and publicly or privately-placed debt instruments or financing from institutional investors or other lenders. We may obtain a credit facility or separate loans for each acquisition. Our indebtedness may be unsecured or may be secured by mortgages or other interests in our properties. We may use borrowing proceeds to finance acquisitions of new properties, to pay for capital improvements, repairs or buildouts, to refinance existing indebtedness, to pay distributions, to fund redemptions of our shares or to provide working capital.

There is no limitation on the amount we can borrow for the purchase of any property. Our aggregate borrowings, secured and unsecured, must be reasonable in relation to our net assets and must be reviewed by our board of directors at least quarterly. We anticipate that we will utilize approximately 60% leverage in connection with our acquisition strategy. However, our charter limits our borrowing to 300% of our net assets (equivalent to 75% of the cost of 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, along with the justification for such excess. As of December 31, 2010, our leverage was approximately 66%.

We may borrow amounts from our advisor or its affiliates only if such loan is approved by a majority of our directors, including a majority of our independent directors not otherwise interested in the transaction, as fair, competitive, commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties under the circumstances.

 

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Except as set forth in our charter regarding debt limits, we may re-evaluate and change our debt strategy and policies in the future without a stockholder vote. Factors that we could consider when re-evaluating or changing our debt strategy and policies include then-current economic and market conditions, the relative cost of debt and equity capital, any acquisition opportunities, the ability of our properties to generate sufficient cash flow to cover debt service requirements and other similar factors. Further, we may increase or decrease our ratio of debt to book value in connection with any change of our borrowing policies.

Acquisition Structure

Although we are not limited as to the form our investments may take, our investments in real estate will generally constitute acquiring fee title or interests in joint ventures or similar entities that own and operate real estate.

We will make acquisitions of our real estate investments directly or indirectly through our operating partnership. We will acquire interests in real estate either directly through our operating partnership or indirectly through limited liability companies or limited partnerships, or through investments in joint ventures, partnerships, co-tenancies or other co-ownership arrangements with other owners of properties, affiliates of our advisor or other persons.

Real Property Investments

Our advisor will be continually evaluating various potential property investments and engaging in discussions and negotiations with sellers, developers and potential tenants regarding the purchase and development of properties for us and other programs sponsored by our sponsor. At such time while our Public Offering is being conducted, if we believe that a reasonable probability exists that we will acquire a specific property, we will supplement our prospectus to disclose the negotiations and pending acquisition of such property. We expect that this will normally occur upon the signing of a purchase agreement for the acquisition of a specific property, but may occur before or after such signing or upon the satisfaction or expiration of major contingencies in any such purchase agreement, depending on the particular circumstances surrounding each potential investment. A supplement to our prospectus will also describe any improvements proposed to be constructed thereon and other information that we consider appropriate for an understanding of the transaction. Further data will be made available after any pending acquisition is consummated, also by means of a supplement to our prospectus, if appropriate. STOCKHOLDERS SHOULD UNDERSTAND THAT THE DISCLOSURE OF ANY PROPOSED ACQUISITION CANNOT BE RELIED UPON AS AN ASSURANCE THAT WE WILL ULTIMATELY CONSUMMATE SUCH ACQUISITION OR THAT THE INFORMATION PROVIDED CONCERNING THE PROPOSED ACQUISITION WILL NOT CHANGE BETWEEN THE DATE OF THE SUPPLEMENT AND ANY ACTUAL PURCHASE. We intend to obtain what we believe will be adequate insurance coverage for all properties in which we invest. Some of our leases may require that we procure insurance for both commercial general liability and property damage; however, we expect that those leases will provide that the premiums will be fully reimbursable from the tenant. In such instances, the policy will list us as the named insured and the tenant as the additional insured. However, we may decide not to obtain any or adequate earthquake or similar catastrophic insurance coverage because the premiums are too high, even in instances where it may otherwise be available.

Conditions to Closing Acquisitions

We will not purchase any property unless and until we obtain at least a Phase I environmental assessment and history for each property purchased and we are sufficiently satisfied with the property’s environmental status. In addition, we will generally condition our obligation to close the purchase of any investment on the delivery and verification of certain documents from the seller or other independent professionals, including but not limited to, where appropriate:

 

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property surveys and site audits;

 

   

building plans and specifications, if available;

 

   

soil reports, seismic studies, flood zone studies, if available;

 

   

licenses, permits, maps and governmental approvals;

 

   

tenant estoppel certificates;

 

   

historical financial statements and tax statement summaries of the properties;

 

   

proof of marketable title, subject to such liens and encumbrances as are acceptable to us; and

 

   

liability and title insurance policies.

Joint Venture Investments

As of December 31, 2010, we had not entered into any joint venture 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 joint ventures, 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 or property type. 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, our advisor will evaluate the real property which such joint venture owns or is being formed to own under the same criteria that the advisor uses to evaluate other real estate investments.

We may enter into joint ventures with affiliates of our advisor for the acquisition of properties, but only provided that:

 

   

a majority of our directors, including a majority of our independent directors, not otherwise interested in the transaction, approve the transaction as being fair and reasonable to us; and

 

   

the investment by us and such affiliate are on substantially the same terms and conditions.

To the extent possible and if approved by our board of directors, including a majority of our independent directors, we will attempt to obtain a right of first refusal or option to buy if such venture partner elects to sell its interest in the property held by the joint venture. In the event that the venture partner were to elect to sell property held in any such joint venture, however, we may not have sufficient funds to exercise our right of first refusal to buy the venture partner’s interest in the property held by the joint venture. Entering into joint ventures with affiliates of our advisor will result in certain conflicts of interest.

Construction and Development Activities

As of December 31, 2010, we had not undertaken any construction or development activities. From time to time, we may construct and develop real estate assets or render services in connection with these activities. We may be able to reduce overall purchase costs by constructing and developing a property versus purchasing a completed property. Developing and constructing properties would, however, expose us to risks such as cost overruns, carrying costs of projects under construction or development, availability and costs of materials and labor, weather conditions and government regulation.

 

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To comply with the applicable requirements under federal income tax law, we intend to limit our construction and development activities to performing oversight and review functions, including reviewing the construction design proposals, negotiating and contracting for feasibility studies and supervising compliance with local, state or federal laws and regulations, negotiating contracts, overseeing construction, and obtaining financing. In addition, we may use “taxable REIT subsidiaries” or certain independent contractors to carry out these oversight and review functions. We will retain independent contractors to perform the actual construction work.

Government Regulations

Our business will be subject to many laws and governmental regulations. Changes in these laws and regulations, or their interpretation by agencies and courts, occur frequently.

Americans with Disabilities Act

Under the Americans with Disabilities Act of 1990, or ADA, all public accommodations and commercial facilities are required to meet certain federal requirements related to access and use by disabled persons. These requirements became effective in 1992. Complying with the ADA requirements could require us to remove access barriers. Failing to comply could result in the imposition of fines by the federal government or an award of damages to private litigants. Although we intend to acquire properties that substantially comply with these requirements, we may incur additional costs to comply with the ADA. In addition, a number of additional federal, state and local laws may require us to modify any properties we purchase, or may restrict further renovations thereof, with respect to access by disabled persons. Additional legislation could impose financial obligations or restrictions with respect to access by disabled persons. Although we believe that these costs will not have a material adverse effect on us, if required changes involve a greater amount of expenditures than we currently anticipate, our ability to make expected distributions could be adversely affected.

Environmental Matters

Under various federal, state and local laws, ordinances and regulations, a current or previous owner or operator of real property may be held liable for the costs of removing or remediating hazardous or toxic substances. These laws often impose clean-up responsibility and liability without regard to whether the owner or operator was responsible for, or even knew of, the presence of the hazardous or toxic substances. The costs of investigating, removing or remediating these substances may be substantial, and the presence of these substances may adversely affect our ability to rent units or sell the property or to borrow using the property as collateral and may expose us to liability resulting from any release of or exposure to these substances. If we arrange for the disposal or treatment of hazardous or toxic substances at another location, we may be liable for the costs of removing or remediating these substances at the disposal or treatment facility, whether or not the facility is owned or operated by us. We may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site that we own or operate. Certain environmental laws also impose liability in connection with the handling of or exposure to asbestos-containing materials, pursuant to which third parties may seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials and other hazardous or toxic substances.

Other Regulations

The properties we acquire likely will be subject to various federal, state and local regulatory requirements, such as zoning and state and local fire and life safety requirements. Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. We intend to acquire properties that are in material compliance with all such regulatory requirements. However, we cannot assure stockholders that these requirements will not be changed or that new requirements will not be imposed which would require significant unanticipated expenditures by us and could have an adverse effect on our financial condition and results of operations.

 

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Disposition Policies

As of December 31, 2010, we had not disposed of any investments. We generally intend to hold each property we acquire for an extended period. However, we may sell a property at any time if, in our judgment, the sale of the property is in the best interests of our stockholders.

The determination of whether a particular property should be sold or otherwise disposed of will generally be made after consideration of relevant factors, including prevailing economic conditions, other investment opportunities and considerations specific to the condition, value and financial performance of the property. In connection with our sales of properties, we may lend the purchaser all or a portion of the purchase price. In these instances, our taxable income may exceed the cash received in the sale.

We may sell assets to third parties or to affiliates of our advisor. Our nominating and corporate governance committee of our board of directors, which is comprised solely of independent directors, must review and approve all transactions between us and our advisor and its affiliates.

Investment Limitations in our Charter

Our charter places numerous limitations on us with respect to the manner in which we may invest our funds, most of which are those typically required by various provisions of the Statement of Policy Regarding Real Estate Investment Trusts published by the North American Securities Administrators Association (“NASAA REIT Guidelines”). So long as our shares are not listed on a national securities exchange, the NASAA REIT Guidelines apply to us, and we will not:

 

   

Invest in equity securities unless a majority of our directors, including a majority of our independent directors, not otherwise interested in the transaction approve such investment as being fair, competitive and commercially reasonable.

 

   

Invest in commodities or commodity futures contracts, except for future contracts when used solely for the purpose of hedging in connection with our ordinary business of investing in real estate assets and mortgages.

 

   

Invest in real estate contracts of sale, otherwise known as land sale contracts, unless the contract is in recordable form and is appropriately recorded in the chain of title.

 

   

Make or invest in mortgage loans unless an appraisal is obtained concerning the underlying property, except for those mortgage loans insured or guaranteed by a government or government agency. In cases where our independent directors determine, and in all cases in which the transaction is with any of our directors or our advisor and its affiliates, we will obtain an appraisal from an independent appraiser. We will maintain such appraisal in our records for at least five years and it will be available to our stockholders for inspection and duplication. We will also obtain a mortgagee’s or owner’s title insurance policy as to the priority of the mortgage or condition of the title.

 

   

Make or invest in mortgage loans, including construction loans, on any one property if the aggregate amount of all mortgage loans on such property would exceed an amount equal to 85% of the appraised value of such property, as determined by an appraisal, unless substantial justification exists for exceeding such limit because of the presence of other loan underwriting criteria.

 

   

Make or invest in mortgage loans that are subordinate to any mortgage or equity interest of any of our directors, our advisor or their respective affiliates.

 

   

Make investments in unimproved property or indebtedness secured by a deed of trust or mortgage loans on unimproved property in excess of 10% of our total assets.

 

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Issue equity securities on a deferred payment basis or other similar arrangement.

 

   

Issue debt securities in the absence of adequate cash flow to cover debt service.

 

   

Issue equity securities that are assessable after we have received the consideration for which our board of directors authorized their issuance.

 

   

Issue “redeemable securities” redeemable solely at the option of the holder, which restriction has no effect on our ability to implement our share redemption program.

 

   

When applicable, grant warrants or options to purchase shares to our advisor or its affiliates or to officers or directors affiliated with our advisor except on the same terms as options or warrants that are sold to the general public. Further, the amount of the options or warrants cannot exceed an amount equal to 10% of outstanding shares on the date of grant of the warrants and options.

 

   

Lend money to our directors, or to our advisor or its affiliates, except for certain mortgage loans described above.

Changes in Investment Policies and Limitations

Our charter requires that our independent directors review our investment policies at least annually to determine that the policies we are following are in the best interests of our stockholders. Each determination and the basis therefor is required to be set forth in the applicable meeting minutes. The methods of implementing our investment policies may also vary as new investment techniques are developed. The methods of implementing our investment objectives and policies, except as otherwise provided in our charter, may be altered by a majority of our directors, including a majority of our independent directors, without the approval of our stockholders. The determination by our board of directors that it is no longer in our best interests to continue to be qualified as a REIT shall require the concurrence of two-thirds of the board of directors. Investment policies and limitations specifically set forth in our charter, however, may only be amended by a vote of the stockholders holding a majority of our outstanding shares.

Investments in Mortgages

As of December 31, 2010, we had not invested in any mortgages. While we intend to emphasize equity real estate investments and, hence, operate as what is generally referred to as an “equity REIT,” as opposed to a “mortgage REIT,” we may invest in first or second mortgage loans, mezzanine loans secured by an interest in the entity owning the real estate or other similar real estate loans consistent with our REIT status. We may make such loans to developers in connection with construction and redevelopment of real estate properties. Such mortgages may or may not be insured or guaranteed by the Federal Housing Administration, the Veterans Administration or another third party. We may also invest in participating or convertible mortgages if our directors conclude that we and our stockholders may benefit from the cash flow or any appreciation in the value of the subject property. Such mortgages are similar to equity participation.

Affiliate Transaction Policy

Our board of directors has established a nominating and corporate governance committee, which will review and approve all matters the board believes may involve a conflict of interest. This committee is composed solely of independent directors. This committee of our board of directors will approve all transactions between us and our advisor and its affiliates.

 

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Investment Company Act and Certain Other Policies

We intend to operate in such a manner that we will not be subject to regulation under the Investment Company Act of 1940 (“1940 Act”). Our advisor will continually review our investment activity to attempt to ensure that we do not come within the application of the 1940 Act. Among other things, our advisor will attempt to monitor the proportion of our portfolio that is placed in various investments so that we do not come within the definition of an “investment company” under the 1940 Act. If at any time the character of our investments could cause us to be deemed as an investment company for purposes of the 1940 Act, we will take all necessary actions to attempt to ensure that we are not deemed to be an investment company.

In addition, we do not intend to:

 

   

underwrite securities of other issuers; or

 

   

actively trade in loans or other investments.

Subject to the restrictions we must follow in order to qualify to be taxed as a REIT, we may make investments other than as previously described, although we do not currently intend to do so. We have authority to purchase or otherwise reacquire our common shares or any of our other securities. We have no present intention of repurchasing any of our common shares except pursuant to our share redemption program, and we would only take such action in conformity with applicable federal and state laws and the requirements for qualifying as a REIT under the Internal Revenue Code (the “Code”).

Employees

We have no paid employees. The employees of our advisor provide management, acquisition, advisory and certain administrative services for us.

Competition

As we purchase properties for our portfolio, we are in competition with other potential buyers for the same properties, and may have to pay more to purchase the property than if there were no other potential acquirers or we may have to locate another property that meets our investment criteria. Although we intend to acquire properties subject to existing leases, the leasing of real estate is highly competitive in the current market, and we may experience competition for tenants from owners and managers of competing projects. As a result, we may have to provide free rent, incur charges for tenant improvements, or offer other inducements, or we might not be able to timely lease the space, all of which may have an adverse impact on our results of operations. At the time we elect to dispose of our properties, we will also be in competition with sellers of similar properties to locate suitable purchasers for its properties.

Industry Segments

We internally evaluate all of our properties and interests therein as one industry segment and, accordingly, we do not report segment information.

 

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ITEM 1A. RISK FACTORS

Below are risks and uncertainties that could adversely affect our operations that we believe are material to stockholders. Other risks and uncertainties may exist that we do not consider material based on the information currently available to us at this time.

Risks Related to an Investment in The GC Net Lease REIT, Inc.

We have limited prior operating history or established financing sources, this is the first REIT sponsored by affiliates of our advisor, and the prior performance of real estate investment programs sponsored by affiliates of our advisor may not be an indication of our future results.

We have a limited operating history, and stockholders should not rely upon the past performance of other real estate investment programs sponsored by affiliates of our advisor to predict our future results. We were incorporated in August 2008. As of December 31, 2010, we own six properties. Although members of our advisor’s management team have significant experience in the acquisition, finance, management and development of commercial real estate, this is the first REIT sponsored by affiliates of our advisor. Accordingly, the prior performance of real estate investment programs sponsored by our advisor and its affiliates may not be indicative of our future results.

To be successful in this market, we, through our advisor and its affiliates, must, among other things:

 

   

identify and acquire investments that further our investment objectives;

 

   

increase awareness of the “The GC Net Lease REIT, Inc.” name within the investment products market;

 

   

expand and maintain our network of participating broker-dealers;

 

   

attract, integrate, motivate and retain qualified personnel to manage our day-to-day operations;

 

   

respond to competition for our targeted real estate properties and other investments as well as for potential investors; and

 

   

continue to build and expand our operational structure to support our business.

We cannot guarantee that we will succeed in achieving these goals, and our failure to do so could cause stockholders to lose all or a portion of their investment.

Stockholders will not have the opportunity to evaluate our future investments before we make them, which makes an investment in us more speculative.

As of December 31, 2010, we own six properties. We will not provide stockholders with information to evaluate our future investments prior to our acquisition of properties, other than through our disclosures required by the rules of the SEC. We will seek to make a substantial portion of our investments in single tenant net lease properties. We may also, in the discretion of our advisor, invest in other types of real estate or in entities that invest in real estate.

 

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If we are unable to raise substantial funds, we will be limited in the number, type, and diversification of investments we may make, and the value of stockholders’ investments will fluctuate with the performance of the specific properties we acquire.

Our Public Offering is being made on a best efforts basis, whereby the participating broker-dealers are only required to use their best efforts to sell our shares and have no firm commitment or obligation to purchase any of the shares. As a result, the amount of proceeds we raise in our Public Offering may be substantially less than the amount we would need to achieve a broadly diversified property portfolio. If we are unable to raise a substantial amount of funds, we will make fewer investments resulting in less diversification in terms of the number of investments owned, the types of investments that we make, and the geographic regions in which our investments are located. In such event, the likelihood of our profitability being affected by the performance of any one of our investments will increase. Stockholders’ investment in our shares will be subject to greater risk to the extent that we lack a diversified portfolio of investments. In addition, our inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, and our financial condition and ability to pay distributions could be adversely affected.

If we, through our advisor, are unable to find suitable investments and related financing, then we may not be able to achieve our investment objectives or pay distributions.

Our ability to achieve our investment objectives and to pay distributions is dependent upon the performance of our advisor in selecting our investments and arranging financing. As of December 31, 2010, we own six properties. Stockholders will have no opportunity to evaluate the terms of transactions or other economic or financial data concerning our investments, other than through our disclosures required by the rules of the SEC. Therefore, stockholders will have to rely entirely on the management ability of our advisor and the oversight of our board of directors. We cannot be sure that our advisor will be successful in obtaining suitable investments on financially attractive terms or that, if it makes investments on our behalf, our objectives will be achieved. If we are unable to find suitable investments, we will hold the proceeds of our Public Offering in an interest-bearing account or invest the proceeds in short-term, investment-grade investments. In such an event, our ability to pay distributions to our stockholders would be adversely affected.

We may suffer from delays in locating suitable investments, which could adversely affect our ability to make distributions and the value of our stockholders’ investments.

We could suffer from delays in locating suitable investments, particularly as a result of our reliance on our advisor at times when management of our advisor is simultaneously seeking to locate suitable investments for other affiliated programs. Delays we encounter in the selection, acquisition and development of income-producing properties likely would adversely affect our ability to make distributions and the value of our stockholders’ investments. In such event, we may pay all or a substantial portion of our distributions from the proceeds of our Public Offering or from borrowings in anticipation of future cash flow, which may constitute a return of our stockholders’ capital. We are not prohibited from undertaking such activities by our charter, bylaws or investment policies, and there are no current limits on the amount of distributions to be paid from such funds. Distributions from the proceeds of our Public Offering or from borrowings also could reduce the amount of capital we ultimately invest in properties. This, in turn, would reduce the value of our stockholders’ investments. In particular, if we acquire properties prior to the start of construction or during the early stages of construction, it will typically take several months to complete construction and rent available space. Therefore, our stockholders could suffer delays in the receipt of cash distributions attributable to those particular properties.

 

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If we pay distributions from sources other than our cash flow from operations, we will have less funds available for the acquisition of properties, and our stockholders’ overall returns may be reduced.

In the event we do not have enough cash from operations to fund our distributions, we may borrow, issue additional securities or sell assets in order to fund the distributions or make the distributions out of net proceeds from our Public Offering. We are not prohibited from undertaking such activities by our charter, bylaws or investment policies, and there are no current limits on the amount of distributions to be paid from such funds. If we pay distributions from sources other than cash flow from operations, we will have less funds available for acquiring properties, which may reduce our stockholders’ overall returns. Additionally, to the extent distributions exceed cash flow from operations, a stockholder’s basis in our stock will be reduced and, to the extent distributions exceed a stockholder’s basis, the stockholder may recognize a capital gain.

If our advisor loses or is unable to obtain key personnel, our ability to implement our investment objectives could be delayed or hindered, which could adversely affect our ability to make distributions and the value of our stockholders’ investments.

Our success depends to a significant degree upon the contributions of certain of our executive officers and other key personnel of our advisor and sponsor, including Kevin A. Shields, David Rupert, Michael J. Escalante, Joseph E. Miller, Mary P. Higgins, Don Pescara, Julie A. Treinen and David Thailing, each of whom would be difficult to replace. Our advisor does not have an employment agreement with any of these key personnel and we cannot guarantee that all, or any particular one, will remain affiliated with us and/or our advisor. If any of our key personnel were to cease their affiliation with our advisor, our operating results could suffer. Further, we do not intend to separately maintain key person life insurance on any of these individuals. We believe that our future success depends, in large part, upon our advisor’s ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition for such personnel is intense, and we cannot assure our stockholders that our advisor will be successful in attracting and retaining such skilled personnel. If our advisor loses or is unable to obtain the services of key personnel or does not establish or maintain appropriate strategic relationships, our ability to implement our investment strategies could be delayed or hindered, and the value of our stockholders’ investments may decline.

Our ability to operate profitably will depend upon the ability of our advisor to efficiently manage our day-to-day operations.

We will rely on our advisor to manage our business and assets. Our advisor will make all decisions with respect to our day-to-day operations. Thus, the success of our business will depend in large part on the ability of our advisor to manage our operations. Any adversity experienced by our advisor or problems in our relationship with our advisor could adversely impact the operation of our properties and, consequently, our cash flow and ability to make distributions to our stockholders.

Our rights and the rights of our stockholders to recover claims against our officers, directors and our advisor are limited, which could reduce our stockholders’ and our recovery against them if they cause us to incur losses.

Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in the corporation’s best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter, in the case of our directors, officers, employees and agents, and the advisory agreement, in the case of our advisor, require us to indemnify our directors, officers, employees and agents and our advisor and its affiliates for actions taken by them in good faith. Additionally, our charter limits the liability of our directors and officers for monetary damages to the maximum extent permitted under Maryland law. As a result, we and our stockholders may have more limited rights against our

 

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directors, officers, employees and agents, and our advisor and its affiliates, than might otherwise exist under common law, which could reduce our stockholders’ and our recovery against them. In addition, we may be obligated to fund the defense costs incurred by our directors, officers, employees and agents of our advisor in some cases which would decrease the cash otherwise available for distribution to our stockholders.

Risks Related to Conflicts of Interest

Our advisor and its officers and certain of our key personnel will face competing demands relating to their time, and this may cause our operating results to suffer.

Our advisor and its officers and certain of our key personnel and their respective affiliates serve as key personnel, advisors, managers and sponsors of 16 other real estate programs, including seven programs having investment objectives and legal and financial obligations similar to ours, and may have other business interests as well. Because these persons have competing demands 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 is necessary or appropriate, which may constitute a breach of their fiduciary duties to us. If this occurs, the returns on our stockholders’ investments may suffer.

Our officers and one of our directors face conflicts of interest related to the positions they hold with some of our affiliated entities, which could hinder our ability to successfully implement our investment objectives and to generate returns to our stockholders.

Our executive officers and one of our directors are also officers of some of our affiliates, including our sponsor, our advisor, our property manager, our dealer manager and other affiliated entities. As a result, these individuals owe fiduciary duties to these other entities and their owners, which fiduciary duties may conflict with the duties that they owe to our stockholders and us. 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 investment objectives. Conflicts with our business and interests are most likely to arise from involvement in activities related to (1) allocation of new investments and management time and services between us and the other entities, (2) our purchase of properties from, or sale of properties to, affiliated entities, (3) the timing and terms of the investment in or sale of an asset, (4) development of our properties by affiliates, (5) investments with affiliates of our advisor, (6) compensation to our advisor, and (7) our relationship with our dealer manager and property manager. If we do not successfully implement our investment objectives, 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 advisor will face conflicts of interest relating to the purchase of properties, and such conflicts may not be resolved in our favor, which could adversely affect our investment opportunities.

We may be buying properties at the same time as one or more of the other programs managed by officers and key personnel of our advisor. Our advisor and its affiliates are actively involved in 16 other real estate programs and four other properties, including tenant in common programs and other real estate programs that may compete with us or otherwise have similar business interests. Our advisor and our property manager will have conflicts of interest in allocating potential properties, acquisition expenses, management time, services and other functions between various existing enterprises or future enterprises with which they may be or become involved. There is a risk that our advisor will choose a property that provides lower returns to us than a property purchased by another program sponsored by our sponsor. We cannot be sure that officers and key personnel acting on behalf of our advisor and on behalf of these other programs will act in our best interests when deciding whether to allocate any particular property to us. Such conflicts that are not resolved in our favor could result in a reduced level of distributions we may be able to pay to our stockholders and the value of their investments. If our advisor or its affiliates breach

 

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their legal or other obligations or duties to us, or do not resolve conflicts of interest, we may not meet our investment objectives, which could reduce our expected cash available for distribution to our stockholders and the value of their investment.

We may face a conflict of interest when purchasing properties from affiliates of our advisor.

As of December 31, 2010, we have acquired four of our properties from certain affiliates of our sponsor, including our Chairman and President, Kevin A. Shields, and our Vice President – Acquisitions, Don Pescara, and the President of our Sponsor, David C. Rupert. We may purchase properties from one or more affiliates of our advisor in the future. A conflict of interest may exist in such an acquisition and affiliates of our advisor may be entitled to fees on both sides of such a related party transaction. The business interests of our advisor and its affiliates may be adverse to, or to the detriment of, our interests. Additionally, the prices we pay to affiliates of our advisor for our properties may be equal to, or in excess of, the prices paid by them, plus the costs incurred by them relating to the acquisition and financing of the properties. 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. Furthermore, because any agreement that we enter into with affiliates of our advisor will not be negotiated in an arm’s-length transaction, and as a result of the affiliation between our advisor and its affiliates, our advisor may be reluctant to enforce the agreements against such entities. Our nominating and corporate governance committee of our board of directors will approve all transactions between us and our advisor and its affiliates.

Our advisor will face conflicts of interest relating to the incentive fee structure under our advisory agreement, which could result in actions that are not necessarily in the long-term best interests of our stockholders.

Our advisor and its affiliates will perform services for us in connection with the offer and sale of our shares and the selection, acquisition and management of our properties pursuant to our advisory agreement. In addition, our advisor will be entitled to fees that are structured in a manner intended to provide incentives to our advisor to perform in our best interests and in the best interests of our stockholders. The amount of such compensation has not been determined as a result of arm’s-length negotiations, and such amounts may be greater than otherwise would be payable to independent third parties. While affiliates of our sponsor, including our President, will have a significant equity interest in our operating partnership through the contribution of certain of our properties, our advisor is entitled to receive substantial minimum compensation regardless of performance. Therefore, our advisor’s interests may not be wholly aligned with those of our stockholders. In that regard, our advisor could be motivated to recommend riskier or more speculative investments in order for us to generate the specified levels of performance or sales proceeds that would entitle our advisor to fees. In addition, our advisor’s entitlement to fees upon the sale of our assets and to participate in sale proceeds could result in our advisor recommending sales of our investments at the earliest possible time at which sales of investments would produce the level of return that would entitle our advisor to compensation relating to such sales, even if continued ownership of those investments might be in our best long-term interest.

Our advisory agreement will require us to pay a performance-based termination fee to our advisor in the event that we terminate our advisor prior to the listing of our shares for trading on an exchange or, absent such listing, in respect of its participation in net sale proceeds. To avoid paying this fee, our independent directors may decide against terminating the advisory agreement prior to our listing of our shares or disposition of our investments even if, but for the termination fee, termination of the advisory agreement would be in our best interest. In addition, the requirement to pay the fee to our advisor at termination could cause us to make different investment or disposition decisions than we would otherwise make in order to satisfy our obligation to pay the fee to the terminated advisor.

 

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At the time it becomes necessary for our board of directors to determine which liquidity event, if any, is in the best interests of us and our stockholders, our advisor may not agree with the decision of our board as to which liquidity event, if any, we should pursue if there is a substantial difference in the amount of subordinated fees the advisor may receive for each liquidity event. Our advisor may prefer a liquidity event with higher subordinated fees. If our board of directors decides to list our shares for trading on an exchange, our board may also decide to merge us with our advisor in anticipation of the listing process. Such merger may result in substantial compensation to the advisor which may create certain conflicts of interest.

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 other joint venture partners at our expense.

We may enter into joint ventures with other programs sponsored by our sponsor, including other REITs, for the acquisition, development or improvement of properties. Our advisor may have conflicts of interest in determining which program sponsored by our sponsor 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, which may result in the co-venturer receiving benefits greater than the benefits that we receive. In addition, we may assume liabilities related to the joint venture that exceed the percentage of our investment in the joint venture, and this could reduce the returns on our stockholders’ investments.

There is no separate counsel for us and our affiliates, which could result in conflicts of interest.

Baker, Donelson, Bearman, Caldwell & Berkowitz, PC acts as legal counsel to us and also represents our sponsor, advisor, our dealer manager and some of their affiliates. There is a possibility in the future that the interests of the various parties may become adverse and, under the code of professional responsibility of the legal profession, Baker, Donelson, Bearman, Caldwell & Berkowitz, PC may be precluded from representing any one or all of such parties. If any situation arises in which our interests appear to be in conflict with those of our advisor or its affiliates, additional counsel may be retained by one or more of the parties to assure that their interests are adequately protected. Moreover, should a conflict of interest not be readily apparent, Baker, Donelson, Bearman, Caldwell & Berkowitz, PC may inadvertently act in derogation of the interest of the parties which could affect our ability to meet our investment objectives.

Risks Related to the Offering and Our Corporate Structure

The limit on the number of shares a person may own may discourage a takeover that could otherwise result in a premium price to our stockholders.

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 ensure that we do not fail to qualify as a REIT under this test, our charter restricts ownership by one person or entity to no more than 9.8% in value or number, whichever is more restrictive, of any class of our outstanding stock. 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 for holders of our common stock.

 

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

Our charter permits our board of directors to issue up to 900,000,000 shares of capital stock. In addition, our board of directors, without any action by our stockholders, may amend our charter from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series of stock that we have authority to issue. Our board of directors may 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. Thus, our board of directors could authorize the issuance of preferred stock with terms and conditions that could have a priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock. 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 for holders of our common stock.

We are not afforded the protection of Maryland law relating to business combinations.

Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder 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. An interested stockholder is defined as:

 

   

any person who beneficially owns 10% or more of the voting power of the corporation’s shares; or

 

   

an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding voting stock of the corporation.

These prohibitions are intended to prevent a change of control by interested stockholders who do not have the support of our board of directors. Since our charter contains limitations on ownership of 9.8% or more of our common stock, we opted out of the business combinations statute in our charter. Therefore, we will not be afforded the protections of this statute and, accordingly, there is no guarantee that the ownership limitations in our charter would provide the same measure of protection as the business combinations statute and prevent an undesired change of control by an interested stockholder.

A stockholder’s investment returns may be reduced if we are required to register as an investment company under the Investment Company Act of 1940; if we become an unregistered investment company, we will not be able to continue our business.

We do not intend to register as an investment company under the 1940 Act. As of December 31, 2010, we own six properties, and our intended investments in real estate will represent the substantial majority of our total asset mix, which would not subject us to the 1940 Act. In order to maintain an exemption from regulation under the 1940 Act, we must engage primarily in the business of buying real estate, and these investments must be made within a year after our Public Offering ends. If we are unable to invest a significant portion of the proceeds of our Public Offering in properties within one year of the termination of our Public Offering, we may avoid being required to register as an investment company by temporarily investing any unused proceeds in government securities with low returns, which would reduce the cash available for distribution to investors and possibly lower our stockholders’ returns.

 

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To maintain compliance with our 1940 Act exemption, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may be required to acquire additional income- or loss-generating assets that we might not otherwise acquire or forego opportunities to acquire interests in companies that we would otherwise want to acquire. If we are required to register as an investment company but fail 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.

Stockholders are bound by the majority vote on matters on which our stockholders are entitled to vote and, therefore, a stockholder’s vote on a particular matter may be superseded by the vote of other stockholders.

Stockholders may vote on certain matters at any annual or special meeting of stockholders, including the election of directors. However, stockholders will be bound by the majority vote on matters requiring approval of a majority of the stockholders even if they do not vote with the majority on any such matter.

If stockholders do not agree with the decisions of our board of directors, they only have limited control over changes in our policies and operations and may not be able to change such policies and operations, except as provided for in our charter and under applicable law.

Our board of directors determines our major policies, including our policies regarding investments, operations, capitalization, financing, growth, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of our stockholders. Under the MGCL and our charter, our stockholders have a right to vote only on the following:

 

   

the election or removal of directors;

 

   

any amendment of our charter, except that our board of directors may amend our charter without stockholder approval to increase or decrease the aggregate number of our shares, to increase or decrease the number of our shares of any class or series that we have the authority to issue, or to classify or reclassify any unissued shares by setting or changing the preferences, conversion or other rights, restrictions, limitations as to distributions, qualifications or terms and conditions of redemption of such shares, provided however, that any such amendment does not adversely affect the rights, preferences and privileges of the stockholders;

 

   

our liquidation or dissolution; and

 

   

any merger, consolidation or sale or other disposition of substantially all of our assets.

All other matters are subject to the discretion of our board of directors. Therefore, stockholders are limited in their ability to change our policies and operations.

We will not calculate the net asset value per share for our shares until 18 months after completion of our last offering, therefore, stockholders will not be able to determine the net asset value of their shares on an ongoing basis during our Public Offering and for a substantial period of time thereafter.

We do not intend to calculate the net asset value per share for our shares until 18 months after the completion of our last offering. Beginning 18 months after the completion of the last offering of our shares (excluding offerings under our distribution reinvestment plan), our board of directors will determine the value of our properties and our other assets based on such information as our board

 

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determines appropriate, which may or may not include independent valuations of our properties or of our enterprise as a whole. We will disclose this net asset value to stockholders in our filings with the SEC. Therefore, stockholders will not be able to determine the net asset value of their shares on an ongoing basis during our Public Offering.

Stockholders’ interests in us will be diluted as we issue additional shares.

Our stockholders will not have preemptive rights to any shares issued by us in the future. Subject to any limitations set forth under Maryland law, our board of directors may increase the number of authorized shares of stock (currently 900,000,000 shares), increase or decrease the number of shares of any class or series of stock designated, or reclassify any unissued shares without the necessity of obtaining stockholder approval. All of such shares may be issued in the discretion of our board of directors. Therefore, as we (1) sell shares in our Public Offering or sell additional shares in the future, including those issued pursuant to our distribution reinvestment plan, (2) sell securities that are convertible into shares of our common stock, (3) issue shares of our common stock in a private offering of securities to institutional investors, (4) issue shares of restricted common stock or stock options to our independent directors, (5) issue shares to our advisor, its successors or assigns, in payment of an outstanding fee obligation as set forth under our advisory agreement, or (6) issue shares of our common stock to sellers of properties acquired by us in connection with an exchange of limited partnership interests of our operating partnership, existing stockholders and investors purchasing shares in our Public Offering will experience dilution of their equity investment in us. Because the limited partnership interests of our operating partnership may, in the discretion of our board of directors, be exchanged for shares of our common stock, any merger, exchange or conversion between our operating partnership and another entity ultimately could result in the issuance of a substantial number of shares of our common stock, thereby diluting the percentage ownership interest of other stockholders. As of December 31, 2010, we had 1,845,339 shares of common stock issued and outstanding and we own approximately 37% of the operating partnership units; the contributors own approximately 52% of the operating partnership units; and the remaining 11% is owned by third parties. Because of these and other reasons, stockholders should not expect to be able to own a significant percentage of our shares.

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 shares, the selection and acquisition of our investments, and the management of our properties. They will be paid substantial fees for these services, which will reduce the amount of cash available for investment in properties or distribution to stockholders.

We may be unable to pay or maintain cash distributions or increase distributions over time.

There are many factors that can affect the availability and timing of cash distributions to stockholders. Distributions will be based principally on cash available from our operations. The amount of cash available for distribution will be affected by many factors, such as our ability to buy properties as offering proceeds become available, and our operating expense levels, as well as many other variables. Actual cash available for distribution may vary substantially from estimates. We cannot assure our stockholders that we will be able to pay or maintain distributions or that distributions will increase over time. Nor can we give any assurance that rents from the properties will increase, or that future acquisitions of real properties will increase our cash available for distribution to stockholders. Our actual results may differ significantly from the assumptions used by our board of directors in establishing the distribution rate to stockholders.

 

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We are uncertain of our sources of debt or equity for funding our future capital needs. If we cannot obtain funding on acceptable terms, our ability to make necessary capital improvements to our properties may be impaired or delayed.

The gross proceeds of the Public Offering will be used to purchase real estate investments and to pay various fees and expenses. In addition, to qualify as a REIT, we generally must distribute to our stockholders at least 90% of our taxable income each year, excluding capital gains. Because of this distribution requirement, it is not likely that we will be able to fund a significant portion of our future capital needs from retained earnings. We have not identified all sources of debt or equity for future funding, and such sources of funding may not be available to us on favorable terms or at all. If, however, we do not have access to sufficient funding in the future, we may not be able to make necessary capital improvements to our properties, pay other expenses or expand our business.

Risks Related to Investments in Single Tenant Net Lease Real Estate

Many of our properties will depend upon a single tenant for all or a majority of their rental income, and our financial condition and ability to make distributions may be adversely affected by the bankruptcy or insolvency, a downturn in the business, or a lease termination of a single tenant, including those caused by the current economic downturn.

We expect that many of our properties will be occupied by only one tenant or will derive a majority of their rental income from one tenant and, therefore, the success of those properties will be materially dependent on the financial stability of such tenants. The nation as a whole and our local economies are currently experiencing a severe economic slowdown affecting companies of all sizes and industries. A tenant at one or more of our properties may be negatively affected by the current economic slowdown. Lease payment defaults by tenants, including those caused by the current economic downturn, could cause us to reduce the amount of distributions we pay. A default of a tenant on its lease payments to us and the potential resulting vacancy would cause us to lose the revenue from the property and force us to find an alternative source of revenue to meet any mortgage payment and prevent a foreclosure if the property is subject to a mortgage. In the event of a default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-letting the property. If a lease is terminated or an existing tenant elects not to renew a lease upon its expiration, there is no assurance that we will be able to lease the property for the rent previously received or sell the property without incurring a loss. A default by a tenant, the failure of a guarantor to fulfill its obligations or other premature termination of a lease, or a tenant’s election not to extend a lease upon its expiration, could have an adverse effect on our financial condition, operating results and our ability to pay distributions.

We rely on certain tenants and adverse effects to their business could affect our performance.

As of December 31, 2010, our six tenants, based on rental income, were Chicago Bridge & Iron Company (Delaware) (approximately 24.3%), World Kitchen, LLC (approximately 23.3%), Renfro Corporation (approximately 18.8%), Hopkins Enterprises, Inc. (approximately 13.7%), World Color (USA), LLC (approximately 12.2%), and ITT Educational Services, Inc. (approximately 7.7%). The revenues generated by the properties these tenants occupy are substantially reliant upon the financial condition of these tenants and, accordingly, any event of bankruptcy, insolvency, or a general downturn in the business of any of these tenants may result in the failure or delay of such tenant’s rental payments which may have a substantial adverse effect on our financial performance.

If a tenant declares bankruptcy, we may be unable to collect balances due under relevant leases.

Any of our tenants, or any guarantor of a tenant’s lease obligations, could be subject to a bankruptcy proceeding pursuant to Title 11 of the bankruptcy laws of the United States. Such a bankruptcy filing would bar all efforts by us to collect pre-bankruptcy debts from these entities or their

 

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properties, unless we receive an enabling order from the bankruptcy court. Post-bankruptcy debts would be paid currently. If a lease is assumed, all pre-bankruptcy balances owing under it must be paid in full. If a lease is rejected by a tenant in bankruptcy, we would have a general unsecured claim for damages. If a lease is rejected, it is unlikely we would receive any payments from the tenant because our claim is capped at the rent reserved under the lease, without acceleration, for the greater of one year or 15% of the remaining term of the lease, but not greater than three years, plus rent already due but unpaid. This claim could be paid only in the event funds were available, and then only in the same percentage as that realized on other unsecured claims.

A tenant or lease guarantor bankruptcy could delay efforts to collect past due balances under the relevant leases, and could ultimately preclude full collection of these sums. Such an event could cause a decrease or cessation of rental payments that would mean a reduction in our cash flow and the amount available for distributions to stockholders. In the event of a bankruptcy, we cannot assure our stockholders that the tenant or its trustee will assume our lease. If a given lease, or guaranty of a lease, is not assumed, our cash flow and the amounts available for distributions to stockholders may be adversely affected.

Net leases may not result in fair market lease rates over time.

We expect a large portion of our rental income to come from net leases, and net leases frequently provide the tenant greater discretion in using the leased property than ordinary property leases, such as the right to freely sublease the property, to make alterations in the leased premises and to terminate the lease prior to its expiration under specified circumstances. Further, net leases are typically for longer lease terms and, thus, there is an increased risk that contractual rental increases in future years will fail to result in fair market rental rates during those years. As a result, our income and distributions to our stockholders could be lower than they would otherwise be if we did not engage in net leases.

Our real estate investments may include special use single tenant properties that may be difficult to sell or re-lease upon tenant defaults or early lease terminations.

We focus our investments on commercial and industrial properties, a number of which may include manufacturing facilities and special use single tenant properties. These types of properties are relatively illiquid compared to other types of real estate and financial assets. This illiquidity will limit our ability to quickly change our portfolio in response to changes in economic or other conditions. With these properties, if the current lease is terminated or not renewed or, in the case of a mortgage loan, if we take such property in foreclosure, we may be required to renovate the property or to make rent concessions in order to lease the property to another tenant or sell the property. In addition, in the event we are forced to sell the property, we may have difficulty selling it to a party other than the tenant or borrower due to the special purpose for which the property may have been designed. These and other limitations may affect our ability to sell or re-lease properties and adversely affect returns to stockholders.

A high concentration of our properties in a particular geographic area, or that have tenants in a similar industry, would magnify the effects of downturns in that geographic area or industry.

We expect that our properties will be diverse according to geographic area and industry of our tenants. However, in the event that we have a concentration of properties in any particular geographic area, any adverse situation that disproportionately affects that geographic area would have a magnified adverse effect on our portfolio. Similarly, if our tenants are concentrated in a certain industry or industries, any adverse effect to that industry generally would have a disproportionately adverse effect on our portfolio. As of December 31, 2010, we did not have significant industry concentration in our portfolio; however approximately 48% of our total rental income is concentrated in the State of Illinois.

 

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If a sale-leaseback transaction is recharacterized in a tenant’s bankruptcy proceeding, our financial condition could be adversely affected.

We may enter into sale-leaseback transactions, whereby we would purchase a property and then lease the same property back to the person from whom we purchased it. In the event of the bankruptcy of a tenant, a transaction structured as a sale-leaseback may be recharacterized as either a financing or a joint venture, either of which outcomes could adversely affect our business. If the sale-leaseback were recharacterized as a financing, we might not be considered the owner of the property, and as a result would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. The tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding balance. If confirmed by the bankruptcy court, we could be bound by the new terms, and prevented from foreclosing our lien on the property. If the sale-leaseback were recharacterized as a joint venture, our lessee and we could be treated as co-venturers with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the lessee relating to the property. Either of these outcomes could adversely affect our cash flow and the amount available for distributions to stockholders.

General Risks Related to Investments in Real Estate

Adverse economic conditions may negatively affect our property values, returns and profitability.

Recent geopolitical events have exacerbated the general economic slowdown that has affected the nation as a whole and the local economies where our properties may be located. Economic weakness and higher unemployment, combined with higher costs, especially for energy, food and commodities, has put considerable pressure on consumer spending, which, along with limited debt financing, has resulted in many U.S. companies experiencing poorer financial and operating performance over the past few years than in prior periods. As a result, this slowdown has reduced demand for space and removed support for rents and property values. The following market and economic challenges may adversely affect our property values or operating results:

 

   

poor economic times may result in a tenant’s failure to meet its obligations under a lease or bankruptcy;

 

   

re-leasing may require reduced rental rates and increased costs involved in re-leasing, under the new leases; and

 

   

increased insurance premiums, resulting in part from the increased risk of terrorism, may reduce funds available for distribution, or, to the extent we are able to pass such increased insurance premiums on to our tenants, may increase tenant defaults.

A continuing environment of declining prices could further weaken real estate markets. We do not know how long the slowdown will last, or when, or even if, real estate markets will return to more normal conditions. Since we cannot predict when real estate markets may recover, the value of our properties may decline if market conditions persist or worsen. Further, the results of operations for a property in any one period may not be indicative of results in future periods, and the long-term performance of such property generally may not be comparable to, and cash flows may not be as predictable as, other properties owned by third parties in the same or similar industry. The already weak conditions in the real estate markets could be further exacerbated by a deterioration of national or regional economic conditions. Our property values and operations could be negatively affected to the extent that the current economic downturn is prolonged or becomes more severe.

 

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Disruptions in the credit markets and real estate markets could have a material adverse effect on our results of operations, financial condition and ability to pay distributions to stockholders.

Domestic and international financial markets currently are experiencing significant disruptions which have been brought about in large part by failures in the U.S. banking system. These disruptions have severely impacted the availability of credit and have contributed to rising costs associated with obtaining credit. If debt financing is not available on terms and conditions we find acceptable, we may not be able to obtain financing for investments. If these disruptions in the credit markets persist, our ability to borrow monies to finance the purchase of, or other activities related to, real estate assets will be negatively impacted. If we are unable to borrow monies on terms and conditions that we find acceptable, we likely will have to reduce the number of properties we can purchase, and the return on the properties we do purchase may be lower. In addition, we may find it difficult, costly or impossible to refinance indebtedness which is maturing. If interest rates are higher when the properties are refinanced, our income could be reduced. In addition, if we pay fees to lock in a favorable interest rate, falling interest rates or other factors could require us to forfeit these fees. All of these events would have a material adverse effect on our results of operations, financial condition and ability to pay distributions.

In addition to volatility in the credit markets, the real estate market is subject to fluctuation and can be impacted by factors such as general economic conditions, supply and demand, availability of financing and interest rates. To the extent we purchase real estate in an unstable market, we are subject to the risk that if the real estate market ceases to attract the same level of capital investment in the future that it attracts at the time of our purchases, or the number of companies seeking to acquire properties decreases, the value of our investments may not appreciate or may decrease significantly below the amount we pay for these investments.

Our operating results will be affected by economic and regulatory changes that have an adverse impact on the real estate market in general, and we cannot assure stockholders that we will be profitable or that we will realize growth in the value of our real estate properties.

Our operating results will be subject to risks generally incident to the ownership of real estate, including:

 

   

changes in general economic or local conditions;

 

   

changes in supply of or demand for similar or competing properties in an area;

 

   

changes in interest rates and availability of permanent mortgage funds that may render the sale of a property difficult or unattractive;

 

   

changes in tax, accounting, real estate, environmental and zoning laws;

 

   

changes in property tax assessments and insurance costs; and

 

   

increases in interest rates and tight money supply.

These and other reasons may prevent us from being profitable or from realizing growth or maintaining the value of our real estate properties.

We may obtain only limited warranties when we purchase a property.

The seller of a property will often sell such property in its “as is” condition on a “where is” basis and “with all faults,” without any warranties of merchantability or fitness for a particular use or purpose. In addition, purchase agreements may contain only limited warranties, representations and indemnifications that will only survive for a limited period after the closing. Also, many sellers of real

 

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estate are single purpose entities without significant other assets. The purchase of properties with limited warranties or from undercapitalized sellers increases the risk that we may lose some or all of our invested capital in the property as well as the loss of rental income from that property.

Our inability to sell a property when we desire to do so could adversely impact our ability to pay cash distributions to stockholders.

The real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. We cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. Real estate generally cannot be sold quickly. Also, the tax laws applicable to REITs require that we hold our properties for investment, rather than for sale in the ordinary course of business, which may cause us to forego or defer sales of properties that otherwise would be in our best interest. Therefore, we may not be able to dispose of properties promptly, or on favorable terms, in response to economic or other market conditions, and this may adversely impact our ability to make distributions to stockholders.

In addition, we may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure our stockholders that we will have funds available to correct such defects or to make such improvements.

In acquiring a property, we may agree to restrictions that prohibit the sale of that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These provisions would also restrict our ability to sell a property.

We may not be able to sell our properties at a price equal to, or greater than, the price for which we purchased such properties, which may lead to a decrease in the value of our assets.

We may be purchasing our properties at a time when capitalization rates are at historically low levels and purchase prices are high. Therefore, the value of our properties may not increase over time, which may restrict our ability to sell our properties, or in the event we are able to sell such property, may lead to a sale price less than the price that we paid to purchase the properties.

We may acquire or finance properties with lock-out provisions, which may prohibit us from selling a property, or may require us to maintain specified debt levels for a period of years on some properties.

Lock-out provisions are provisions that generally prohibit repayment of a loan balance for a certain number of years following the origination date of a loan. Such provisions are typically provided for by the Code or the terms of the agreement underlying a loan. Lock-out 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 distribution to stockholders. Lock-out provisions may prohibit us from reducing the outstanding indebtedness with respect to any properties, refinancing such indebtedness on a non-recourse basis at maturity, or increasing the amount of indebtedness with respect to such properties.

Lock-out provisions could impair our ability to take actions during the lock-out period that would otherwise be in our stockholders’ best interests and, therefore, may have an adverse impact on the value of the shares, relative to the value that would result if the lock-out provisions did not exist. In particular, lock-out 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 our stockholders’ best interests.

 

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If we suffer losses that are not covered by insurance or that are in excess of insurance coverage, we could lose invested capital and anticipated profits.

Material losses may occur in excess of insurance proceeds with respect to any property, as insurance may not be sufficient to fund the losses. However, there are types of losses, generally of a catastrophic nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, which are either uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. In addition, we may decide not to obtain any or adequate earthquake or similar catastrophic insurance coverage because the premiums are too high even in instances where it may otherwise be available. Insurance risks associated with potential terrorism acts could sharply increase the premiums we pay for coverage against property and casualty claims. Additionally, mortgage lenders in some cases have begun to insist that commercial property owners purchase specific coverage against terrorism as a condition for providing mortgage loans. It is uncertain whether such insurance policies will be available, or available at reasonable cost, which could inhibit our ability to finance or refinance our potential properties. In these instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We cannot assure our stockholders that we will have adequate coverage for such losses. The Terrorism Risk Insurance Act of 2002 is designed for a sharing of terrorism losses between insurance companies and the federal government. We cannot be certain how this act will impact us or what additional cost to us, if any, could result. If such an event damaged or destroyed one or more of our properties, we could lose both our invested capital and anticipated profits from such property.

Delays in the acquisition, development and construction of properties may have adverse effects on our results of operations and returns to stockholders.

Delays we encounter in the selection, acquisition and development of real properties could adversely affect our stockholders’ returns. Although we expect that we will invest primarily in properties that have operating histories or whose construction is complete, from time to time we may acquire unimproved real property, properties that are in need of redevelopment, or properties that are under development or construction. Investments in such properties will be subject to the uncertainties associated with the development and construction of real property, including those related to re-zoning land for development, environmental concerns of governmental entities and/or community groups and our builders’ ability to build in conformity with plans, specifications, budgets and timetables. If a builder fails to perform, we may resort to legal action to rescind the purchase or the construction contract or to compel performance. A builder’s performance may also be affected or delayed by conditions beyond the builder’s control.

Where properties are acquired prior to the start of construction or during the early stages of construction, it will typically take several months to complete construction and lease available space. Therefore, operating cash flows from these properties will be delayed and can affect how distributions will be funded. We may incur additional risks when we make periodic progress payments or other advances to builders before they complete construction. These and other factors can result in increased costs of a project or loss of our investment. We also must rely on rental income and expense projections and estimates of the fair market value of a property upon completion of construction when agreeing upon a purchase price at the time we acquire the property. If our projections are inaccurate, we may pay too much for a property, and the return on our investment could suffer.

Costs of complying with governmental laws and regulations, including those relating to environmental matters, may adversely affect our income and the cash available for distribution.

All real property we acquire, and the operations conducted on real property are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges, air emissions, the operation and

 

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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 may 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. This liability could be substantial. In addition, the presence of hazardous substances, or the failure to properly remediate these substances, may adversely affect our ability to sell, rent or pledge such property as collateral for future borrowings.

Some of these laws and regulations have been amended so as to require compliance with new or more stringent standards as of future dates. Compliance with new or more stringent laws or regulations or stricter interpretation of existing laws may require us to incur material expenditures. Future laws, ordinances or regulations may impose material environmental liability. Additionally, our tenants’ operations, the existing condition of land when we buy it, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties may affect our properties. In addition, there are various local, state and federal fire, health, life-safety and similar regulations with which we may be required to comply, and that may subject us to liability in the form of capital costs to comply, fines or damages for noncompliance. Any material expenditures, fines, or damages we must pay will reduce our ability to make distributions to stockholders and may reduce the value of stockholders’ investments.

Further, we may not obtain an independent third-party environmental assessment for every property we acquire. In addition, we cannot assure stockholders that any such assessment that we do obtain will reveal all environmental liabilities or that a prior owner of a property did not create a material environmental condition not known to us. We cannot predict what other environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted, or what environmental conditions may be found to exist in the future. We cannot assure our stockholders that our business, assets, results of operations, liquidity or financial condition will not be adversely affected by these laws, which may adversely affect cash available for distribution, and the amount of distributions to our stockholders.

Our costs associated with complying with the Americans with Disabilities Act may affect cash available for distribution.

Our properties will be subject to the Americans with Disabilities Act of 1990, or ADA. Under the ADA, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. The ADA has separate compliance requirements for “public accommodations” and “commercial facilities” that generally require that buildings and services, including restaurants and retail stores, be made accessible and available to people with disabilities. The ADA’s requirements could require removal of access barriers and could result in the imposition of injunctive relief, monetary penalties, or, in some cases, an award of damages. We will attempt to acquire properties that comply with the ADA or place the burden on the seller or other third party to ensure compliance with the ADA. However, we cannot assure our stockholders that we will be able to acquire properties or allocate responsibilities in this manner. If we cannot, our funds used for ADA compliance may affect cash available for distribution and the amount of distributions to our stockholders.

If we sell properties by providing financing to purchasers, defaults by the purchasers would adversely affect our cash flows.

If we decide to sell any of our properties, we intend to use our best efforts to sell them for cash. However, in some instances we may sell our properties by providing financing to purchasers. When we provide financing to purchasers, we will bear the risk that the purchaser may default, which could negatively impact our cash distributions to 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

 

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delayed until the promissory notes or other property we may accept upon the sale are actually paid, sold, refinanced or otherwise disposed of. In some cases, we may receive initial down payments in cash and other property in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years. If any purchaser defaults under a financing arrangement with us, it could negatively impact our ability to make distributions to stockholders.

Increases in interest rates may adversely affect the demand for our shares.

One of the factors that influences the demand for purchase of our shares is the annual rate of distributions that we pay on our shares, as compared with interest rates. An increase in interest rates may lead potential purchasers of our shares to demand higher annual distribution rates, which could adversely affect our ability to sell our shares and raise proceeds in our Public Offering, which could result in higher leverage or a less diversified portfolio of real estate.

We will be subject to risks associated with the co-owners in our co-ownership arrangements that otherwise may not be present in other real estate investments.

We may enter into joint ventures or other co-ownership arrangements with respect to a portion of the properties we acquire. Ownership of co-ownership interests involves risks generally not otherwise present with an investment in real estate such as the following:

 

   

the risk that a co-owner may at any time have economic or business interests or goals that are or become inconsistent with our business interests or goals;

 

   

the risk that a co-owner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives;

 

   

the possibility that an individual co-owner might become insolvent or bankrupt, or otherwise default under the applicable mortgage loan financing documents, which may constitute an event of default under all of the applicable mortgage loan financing documents or allow the bankruptcy court to reject the tenants-in-common agreement or management agreement entered into by the co-owner owning interests in the property;

 

   

the possibility that a co-owner might not have adequate liquid assets to make cash advances that may be required in order to fund operations, maintenance and other expenses related to the property, which could result in the loss of current or prospective tenants and may otherwise adversely affect the operation and maintenance of the property, and could cause a default under the mortgage loan financing documents applicable to the property and may result in late charges, penalties and interest, and may lead to the exercise of foreclosure and other remedies by the lender;

 

   

the risk that a co-owner could breach agreements related to the property, which may cause a default under, or result in personal liability for, the applicable mortgage loan financing documents, violate applicable securities laws and otherwise adversely affect the property and the co-ownership arrangement; or

 

   

the risk that a default by any co-owner would constitute a default under the applicable mortgage loan financing documents that could result in a foreclosure and the loss of all or a substantial portion of the investment made by the co-owner.

Any of the above might subject a property to liabilities in excess of those contemplated and thus reduce the amount available for distribution to our stockholders.

 

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In the event that our interests become adverse to those of the other co-owners, we may not have the contractual right to purchase the co-ownership interests from the other co-owners. Even if we are given the opportunity to purchase such co-ownership interests in the future, we cannot guarantee that we will have sufficient funds available at the time to purchase co-ownership interests from the co-owners.

We might want to sell our co-ownership interests in a given property at a time when the other co-owners in such property do not desire to sell their interests. Therefore, we may not be able to sell our interest in a property at the time we would like to sell. In addition, we anticipate that it will be much more difficult to find a willing buyer for our co-ownership interests in a property than it would be to find a buyer for a property we owned outright.

Risks Associated with Debt Financing

If we are unable to make our debt payments when required, a lender could foreclose on the property or properties securing such debt, which could reduce the amount of distributions we pay to stockholders and decrease the value of stockholders’ investments.

We may have a significant amount of acquisition indebtedness secured by first priority mortgages on our properties. In addition, all of our properties contain, and any future acquisitions we make will likely contain, mortgage financing. If we are unable to make our debt payments when required, a lender could foreclose on the property or properties securing such debt. In any such event, we could lose some or all of our investment in these properties, which would reduce the amount of funds available for distributions we pay to our stockholders and decrease the value of our stockholders’ investments.

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

When providing financing, a lender could impose restrictions on us that affect our distribution and operating policies and our ability to incur additional debt. Loan documents we enter into may contain covenants that limit our ability to further mortgage the property, discontinue insurance coverage or replace our advisor. These or other limitations may adversely affect our flexibility and limit our ability to make distributions to stockholders.

Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to make distributions to stockholders.

We expect that we will incur additional indebtedness in the future. Interest we pay will reduce cash available for distribution. Additionally, if we incur variable rate debt, increases in interest rates would increase our interest costs, which could reduce our cash flows and our ability to make distributions to 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 that may not permit realization of the maximum return on such investments.

We have broad authority to incur debt, and high debt levels could hinder our ability to make distributions and could decrease the value of our stockholders’ investments.

Although, technically, our board may approve unlimited levels of debt, our charter generally limits us to incurring debt no greater than 300% of our net assets before deducting depreciation or other non-cash reserves (equivalent to 75% leverage), unless any excess borrowing is approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report, along with a justification for such excess borrowing. 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. These factors could limit the amount of cash we have available to distribute and could result in a decline in the value of our stockholders’ investments.

 

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Federal Income Tax Risks

Failure to qualify as a REIT would adversely affect our operations and our ability to make distributions as we will incur additional tax liabilities.

If we fail to qualify as a REIT for any taxable year, we will be subject to federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT status. Losing our REIT status would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the distributions paid deduction, and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.

To qualify as a REIT, and to avoid the payment of federal income and excise taxes and maintain our REIT status, we may be forced to borrow funds, use proceeds from the issuance of securities, or sell assets to pay distributions, which may result in our distributing amounts that may otherwise be used for our operations.

To obtain the favorable tax treatment accorded to REITs, we normally will be required each year to distribute to our stockholders at least 90% of our real estate investment trust taxable income, determined without regard to the deduction for distributions paid and by excluding net capital gains. We will be subject to federal income tax on our undistributed taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which distributions we pay with respect to any calendar year are less than the sum of (1) 85% of our ordinary income, (2) 95% of our capital gain net income, and (3) 100% of our undistributed income from prior years. These requirements could cause us to distribute amounts that otherwise would be spent on acquisitions of properties and it is possible that we might be required to borrow funds, use proceeds from the issuance of securities or sell assets in order to distribute enough of our taxable income to maintain our REIT status and to avoid the payment of federal income and excise taxes. These methods of obtaining funding could affect future distributions by increasing operating costs and decreasing available cash. In addition, such distributions may constitute a return of capital.

If our operating partnership fails to maintain its status as a partnership for federal income tax purposes, its income would be subject to taxation and our REIT status would be terminated.

We intend to maintain the status of our operating partnership as a partnership for federal income tax purposes. However, if the IRS were to successfully challenge the status of our operating partnership as a partnership, it would be taxable as a corporation. In such event, this would reduce the amount of distributions that our operating partnership could make to us. This would also result in losing our REIT status and becoming subject to a corporate level tax on our own income. This would substantially reduce our cash available to pay distributions and the return on our stockholders’ investments. In addition, if any of the entities through which our operating partnership owns its properties, in whole or in part, loses its characterization as a partnership for federal income tax purposes, it would be subject to taxation as a corporation, thereby reducing distributions to our operating partnership. Such a recharacterization of our operating partnership or an underlying property owner could also threaten our ability to maintain REIT status.

Stockholders may have tax liability on distributions they elect to reinvest in our common stock.

If stockholders participate in our distribution reinvestment plan, they will be deemed to have received, and for income tax purposes will be taxed on, the amount reinvested in common stock to the extent the amount reinvested was not a tax-free return of capital. As a result, unless stockholders are a tax-exempt entity, they may have to use funds from other sources to pay their tax liability on the value of the common stock received.

 

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In certain circumstances, we may be subject to federal and state income taxes as a REIT, which would reduce our cash available for distribution to our stockholders.

Even if we qualify and maintain our status as a REIT, we may be subject to federal income taxes or state taxes. For example, net income from a “prohibited transaction” will be subject to a 100% tax. We may not be able to make 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 the 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 our cash available for distribution to our stockholders.

We may be required to pay some taxes due to actions of our taxable REIT subsidiary which would reduce our cash available for distribution to stockholders.

Any net taxable income earned directly by our taxable REIT subsidiaries, or through entities that are disregarded for federal income tax purposes, which are wholly-owned by our taxable REIT subsidiaries, will be subject to federal and possibly state corporate income tax. We filed an election to treat The GC Net Lease REIT TRS, Inc. as a taxable REIT subsidiary, and we may elect to treat other subsidiaries as taxable REIT subsidiaries in the future. In this regard, several provisions of the laws applicable to REITs and their subsidiaries ensure that a taxable REIT subsidiary will be subject to an appropriate level of federal income taxation. For example, a taxable REIT subsidiary is limited in its ability to deduct certain interest payments made to an affiliated REIT. In addition, the REIT has to pay a 100% penalty tax on some payments that it receives or on some deductions taken by a taxable REIT subsidiary if the economic arrangements between the REIT, the REIT’s customers, and the taxable REIT subsidiary are not comparable to similar arrangements between unrelated parties. Finally, some state and local jurisdictions may tax some of our income even though as a REIT we are not subject to federal income tax on that income because not all states and localities follow the federal income tax treatment of REITs. To the extent that we and our affiliates are required to pay federal, state and local taxes, we will have less cash available for distributions to stockholders.

Distributions to tax-exempt investors may be classified as unrelated business taxable income.

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

 

   

part of the income and gain recognized by certain qualified employee pension trusts with respect to our common stock may be treated as UBTI if shares of our common stock are predominately held by qualified employee pension trusts, and we are required to rely on a special look-through rule for purposes of meeting one of the REIT share ownership tests, and we are not operated in a manner to avoid treatment of such income or gain as UBTI;

 

   

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

 

   

part or all of the income or gain recognized with respect to our common stock 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), (c)(9), (c)(17) or (c)(20) of the Code may be treated as UBTI.

 

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Complying with the REIT requirements may cause us to forego otherwise attractive opportunities.

To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of shares of our common stock. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution, or we may be required to liquidate otherwise attractive investments in order to comply with the REIT tests. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.

Legislative or regulatory action could adversely affect investors.

The tax rate applicable to qualifying corporate distributions received by individuals prior to 2013 has been reduced to a maximum rate of 15% for federal income tax purposes. This special tax rate is generally not applicable to distributions paid by a REIT, unless such distributions represent earnings on which the REIT itself has been taxed or in the case where the REIT has received a taxable dividend from a regular “C” corporation such as from our taxable REIT subsidiary. As a result, distributions (other than capital gain distributions) we pay to individual investors generally will be subject to the tax rates that are otherwise applicable to ordinary income, which currently are as high as 35%. This change in law may make an investment in our shares comparatively less attractive to individual investors than an investment in the shares of non-REIT corporations, and could have an adverse effect on the value of our common stock. Stockholders are urged to consult with their own tax advisor with respect to the impact of recent legislation on their investment in our common stock and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our common stock.

Foreign purchasers of our common stock may be subject to FIRPTA tax upon the sale of their shares.

A foreign person disposing of a U.S. real property interest, including shares of a U.S. corporation whose assets consist principally of U.S. real property interests, is generally subject to a tax, known as FIRPTA tax, on the gain recognized on the disposition. Such FIRPTA tax does not apply, however, to the disposition of stock in a REIT if the REIT is “domestically controlled.” A REIT is “domestically controlled” if less than 50% of the REIT’s stock, by value, has been owned directly or indirectly by persons who are not qualifying U.S. persons during a continuous five-year period ending on the date of disposition or, if shorter, during the entire period of the REIT’s existence.

We cannot assure stockholders that we will qualify as a “domestically controlled” REIT. If we were to fail to so qualify, gain realized by foreign investors on a sale of our shares would be subject to FIRPTA tax, unless our shares were traded on an established securities market and the foreign investor did not at any time during a specified testing period directly or indirectly own more than 5% of the value of our outstanding common stock.

ERISA and Related Risks for Employee Benefit Plans, IRAs, and Other Tax-Favored Benefit Accounts

ERISA and the Code impose certain restrictions on (i) employee benefit plans (as defined in Section 3(3) of ERISA), (ii) plans described in Code Section 4975(e)(1), including IRAs and Keogh plans, (iii) any entities whose underlying assets include plan assets by reason of a plan’s investment in such entities, and (iv) persons who have certain specified relationships to such plans, i.e., parties-in-interest under ERISA and disqualified persons under the Code. If stockholders are investing the assets of such a plan or account in our common stock, they should satisfy themselves that, among other things:

 

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their investment is consistent with their fiduciary obligations under ERISA, the Code, or other applicable law;

 

   

their investment is made in accordance with the documents and instruments governing their IRA, plan or other account, including any applicable investment policy;

 

   

their investment satisfies the prudence and diversification requirements of ERISA or other applicable law;

 

   

their investment will not impair the liquidity of the IRA, plan or other account;

 

   

their investment will not produce UBTI for the IRA, plan or other account;

 

   

they will be able to value the assets of the plan annually in accordance with the requirements of ERISA or other applicable law, to the extent applicable; and

 

   

their investment will not constitute a prohibited transaction under Section 406 of ERISA or Section 4975 of the Code or constitute a violation of analogous provisions under other applicable law, to the extent applicable.

Persons investing the assets of employee benefit plans, IRAs, and other tax-favored benefit accounts should consider ERISA and related risks of investing in our shares.

ERISA and Code Section 4975 prohibit certain transactions that involve a “party-in-interest” (under ERISA) or a “disqualified person” (under the Code) and any of the following: (i) employee benefit plans (as defined in Section 3(3) of ERISA), (ii) plans described in Code Section 4975(e)(1), including individual retirement accounts and Keogh plans, (iii) any entities whose underlying assets include plan assets by reason of a plan’s investment in such entities, and (iv) persons who have certain specified relationships to such plans, i.e., parties-in-interest under ERISA and disqualified persons under the Code. For example, based on the reasoning of the U.S. Supreme Court in John Hancock Life Ins. Co. v. Harris Trust and Savings Bank, 510 U.S. 86 (1993), an insurance company’s general account may be deemed to include assets of plans investing in the general account (e.g., through the purchase of an annuity contract), and the insurance company might be treated as a party-in-interest or disqualified person with respect to a plan by virtue of such investment. Consequently, the fiduciary of a plan or trustee or custodian of an account contemplating an investment in our shares should consider whether we, any other person associated with the issuance of the shares, or any of their affiliates is or might become a “party-in-interest” or “disqualified person” with respect to the IRA, plan or other account and, if so, whether an exception from such prohibited transaction rules is applicable.

In addition, the Department of Labor (“DOL”) plan asset regulations as modified by ERISA Section 3(42) provide that, subject to certain exceptions, the assets of an entity in which an IRA, plan or other account holds an equity interest may be treated as assets of an investing IRA, plan or other account, in which event the underlying assets of such entity (and transactions involving such assets) would be subject to the prohibited transaction provisions. Furthermore, if an employee benefit plan invests in our shares and we have significant participation by benefit plan investors (as defined in the DOL plan asset regulations), the standards of prudence and other provisions of ERISA could extend to us with respect to our investments and the trustee or other fiduciary of such plan may be deemed to have improperly delegated fiduciary responsibilities to us in violation of ERISA. We intend to take such steps as may be necessary to qualify us for one or more of the exceptions available, and thereby prevent our assets from being treated as assets of any investing IRA, plan or other account.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not Applicable.

 

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ITEM 2. PROPERTIES

As of December 31, 2010, we owned six properties, encompassing approximately 2.0 million rentable square feet as shown in the table below:

 

Property  

Acquisition

Date

 

Purchase

Price

 

Property

Type

 

Year Built/

Renovated

 

Square

Feet

 

Approximate

Acres

 

Implied

Initial

Capitalization

Rate (1)

               

Renfro

Clinton, SC

  06/18/09   $21,700,000  

Manufacturing/

Distribution

  1986   565,000   42.2   8.58%

Plainfield

Plainfield, IL

  06/18/09   $32,660,000  

Office/

Laboratory

  1958-1991   176,000   29.1   7.96%

Will Partners

Monee, IL

  06/04/10   $26,305,000  

Manufacturing/

Distribution

  2000   700,200   34.3   8.79%

Emporia Partners

Emporia, KS

  08/27/10   $  8,360,000  

Manufacturing/

Distribution

  1954/2000   320,800   16.6   9.86%

ITT

Los Angeles, CA

  09/23/10   $  7,800,000   Office   1996/2010   35,800   3.5   9.76%

Quad/Graphics

Loveland, CO

  12/30/10   $11,850,000  

Printing

Facility/

Office

  1986/1996/2009   169,800   15.0   10.26%
Total       $108,675,000           1,967,600   140.7    

(1) The estimated going-in capitalization rate is determined by dividing the projected net rental payment for the first fiscal year we own the property by the acquisition price (exclusive of closing and offering costs). Generally, pursuant to each lease, if the tenant is directly responsible for the payment of all property operating expenses, insurance and taxes, the net rental payment by the tenant to the landlord is equivalent to the base rental payment. The projected net rental payment includes assumptions that may not be indicative of the actual future performance of a property, including the assumption that the tenant will perform its obligations under its lease agreement during the next 12 months.

As of December 31, 2010, annualized gross base rent for our six tenants mentioned above, totaled $9.93 million as shown in the table below:

 

           
Property   Tenant   Industry  

2010 Annualized

Gross Base Rent

 

% of Annualized

Gross Base Rent

  Year of Lease
Expiration
           

Renfro

Clinton, SC

  Renfro Corp  

Manufacturing

(Hosiery

Products)

  $    1,863,000   18.8%   2021

Plainfield

Plainfield, IL

 

Chicago Bridge

& Iron Company

(Delaware)

 

Construction

Engineering Services

  $    2,415,000   24.3%   2022

Will Partners

Monee, IL

 

World

Kitchen, LLC

 

Distribution

(Kitchen

Accessories)

  $    2,311,000   23.3%   2020

Emporia

Partners

Emporia, KS

 

Hopkins

Enterprises, Inc.

 

Manufacturing

(Automotive

Parts)

  $    1,363,000   13.7%   2020

ITT

Los Angeles,

CA

  ITT Educational Services, Inc.   Educational   $       762,000   7.7%   2016

Quad/Graphics

Loveland, CO

 

World Color

(USA), LLC

  Printing   $    1,216,000   12.2%   2022

Total

          $    9,930,000   100.0%    

 

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The market and demographic data contained in the following descriptions of our properties was primarily obtained from the appraisals of each property. Although we believe these independent sources are reliable as of their dates of issuance, the market and demographic information contained therein has not been independently verified and we cannot ensure the accuracy or completeness of this information. As a result, stockholders should be aware that the market and demographic data contained in the following descriptions, and beliefs and estimates based on such data, may not be reliable.

Quad/Graphics

The Quad/Graphics property is an industrial printing facility with a two-story office component located at 380 West 37th Street, Loveland, Colorado. The property is located approximately 45 miles north of Denver and 20 miles north of Boulder. Loveland, Colorado is located just west of Interstate 25, northern Colorado’s primary north-south freeway, which connects Loveland to Denver and other major cities in the region.

The Quad/Graphics lease commenced in 1995 and the property is leased in its entirety to World Color (USA), LLC under a triple-net lease, which lease is guaranteed by both World Color Press, Inc. and its parent company Quad/Graphics, Inc. Quad/Graphics, Inc. is a publicly-traded printing company which acquired World Color Press, Inc. in July 2010, thereby creating one of the world’s largest printing companies. Quad/Graphics, Inc. has operations throughout the United States, Latin America and Europe. Construction on the Quad/Graphics property was originally completed in 1986 and the facility was expanded in 1996 and again in 2009 for a combined total of approximately 45,000 square feet in expansions.

ITT

The ITT property is a single-story office facility located at 12669 Encinitas Blvd., Los Angeles (Sylmar), California. The ITT property is located approximately 20 miles northwest of Downtown Los Angeles at the border of the San Fernando and Santa Clarita Valleys.

The ITT lease commenced in 1996. The ITT Property is leased in its entirety to ITT Educational Services, Inc. (“ITT”) under a triple-net lease. ITT is a publicly-traded, private college system focused on technology-oriented programs of study and operates over 121 educational campuses and four learning centers in 37 states. The ITT property was originally constructed as a build-to-suit for ITT. Since 1996, ITT has utilized the ITT property as its principal educational campus serving the San Fernando and Santa Clarita Valleys. The ITT property was recently expanded and renovated in 2010, including the addition of 5,785 square feet for construction of additional classrooms, a library and expansion of the student lounge, and renovation of existing classroom and computer lab space.

Emporia Partners

The Emporia Partners property is a single-story production and distribution facility located at 428 Peyton Street, Emporia, Kansas, approximately 50 miles southwest of Topeka and 100 miles southwest of Kansas City. The property was originally constructed in 1954 with the last major addition of approximately 164,200 rentable square feet completed in 2000. The Emporia Partners property is located in Lyon County and can accommodate additional improvements of up to 107,000 square feet. The property is located in a strategic location at the intersection of Interstate 35, Interstate 335 and U.S. Highway 50 in east central Kansas, which affords the subtenant, Hopkins Manufacturing Corporation (“Hopkins Manufacturing”) fast, convenient transportation of their products, with no U.S. city located more than two days away by motor freight.

The Emporia Partners property is leased in its entirety to Hopkins Enterprises, Inc. (“Hopkins) under a triple-net lease and Hopkins subleases the property to Hopkins Manufacturing. Since 1954, Hopkins Manufacturing has utilized the property under the sublease as its headquarters and regional

 

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production and distribution point, completing 13 separate additions to the space to accommodate their expanding business and product lines, including construction in 2000 which doubled the size of the property’s facilities. Hopkins Manufacturing is a manufacturer and marketer of specialized towing products and functional accessories for the automotive and recreational vehicle aftermarkets, with notable brand names including Hoppy®, TAP™, LiteMate®, BrakeBuddy®, Spillmaster®, and FloTool.

Will Partners

The Will Partners property is a single-story warehouse/distribution facility located at 5800 Industrial Drive, Monee, Illinois, part of the South Suburban Chicago submarket. The property is located in Will County, approximately 38 miles southwest of Chicago. Approximately 20% of the Will Partners property consists of undeveloped land.

The Will Partners property is leased in its entirety to World Kitchen, LLC (“World Kitchen”) under a triple-net lease. The Will Partners property was a build-to-suit for World Kitchen, which has occupied the property since its completion. World Kitchen utilizes the property as its principal regional distribution center, one of two such centers for the company in the U.S. World Kitchen, LLC is a manufacturer, designer, developer and/or marketer of consumer bakeware, dinnerware, kitchen and household tools, rangetop cookware and cutlery products. The Will Partners property has instant access to Interstate 57, which connects to other major interstates in the area, including I-80, I-90, I-94 and I-294.

Renfro

The Renfro property is a single-story warehouse/distribution property located at 1702 Springdale Drive, Clinton, South Carolina, part of the Greenville, South Carolina regional market. The property is located in Laurens County, approximately 45 miles southeast of Greenville. The Renfro property consists of a warehouse/distribution building, a small office building, a surface parking lot and a truck maintenance facility. The Renfro property is adjacent to U.S. Highway 76, which provides access to Interstate 26.

The Renfro property is leased in its entirety to Renfro Corporation (“Renfro”) under a triple-net lease. Renfro utilizes the property as its principal regional distribution center, which serves Renfro’s largest domestic manufacturing facility, located in nearby Whitmire, South Carolina. Renfro is a privately-held corporation, founded and headquartered in North Carolina since 1921. Renfro is the largest manufacturer of socks in the U.S. and the second largest manufacturer of all hosiery products in the world, with total disclosed annual revenues of approximately $350 million. Renfro manufactures socks under the Fruit of the Loom, Nike, Ralph Lauren, Dr. Scholl’s and Starter brands, among others, and is the largest supplier of hosiery products to Wal-Mart. Renfro employs over 4,500 people worldwide and operates manufacturing facilities in North Carolina, South Carolina, Alabama, India, Turkey, Pakistan and Mexico.

Plainfield

The Plainfield property is an office/laboratory property located at 1501 North Division Street, Plainfield, Illinois, part of the Chicago, Illinois regional market. The property was constructed between 1958 and 1991, consisting of two office buildings and a laboratory, and has a weighted average age of 27 years as of the acquisition date. The property is located in Will County, approximately 35 miles southwest of Chicago. The property is located approximately three miles from Interstate 55 and is 10 miles and 12 miles from Interstates 80 and 88, respectively.

The Plainfield property is leased in its entirety to Chicago Bridge & Iron Company (Delaware) (“Chicago Bridge & Iron”), under a triple-net lease. Chicago Bridge & Iron utilizes the property as the home office for its intellectual personnel, with the bulk of its engineers located at the property. Chicago Bridge & Iron N.V., the parent company of Chicago Bridge & Iron, is the guarantor of the Chicago

 

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Bridge & Iron lease. Chicago Bridge & Iron N.V. is a publicly-traded corporation listed on the New York Stock Exchange, and is one of the world’s largest engineering, procurement and construction companies, with approximately 18,000 employees worldwide. Chicago Bridge & Iron N.V. has over 80 locations around the world, over 70 proprietary licensed technologies and over 1,500 patents and patent applications.

Acquisition Indebtedness

In conjunction with the acquisition of our properties, we have assumed and engaged in various types and amounts of debt. For a more detailed description of our debt, see Note 4, Debt, in the notes to the financial statements contained in this report. A summary of our secured promissory notes as of December 31, 2010 is as follows:

 

     Carrying value as of:              
Encumbered Property    December 31,
2010
     December 31,
2009
    Stated Interest
Rate (1)
    Maturity
Date
 

Renfro Property

   $ 13,030,000       $ 13,000,000  (2)      5.75%        June 2013     

Plainfield Property

     20,796,437         21,041,558        6.65%        November 2017   

Will Partners Property

     16,900,000         -        5.75%        June 2013     

Emporia Partners Property

     5,332,794         -        5.88%        September 2023   

ITT Property

     5,070,000         -        5.75%        June 2013     

Quad/Graphics Property

     7,871,500         -        6.50%        June 2011     
                     

Total

   $ 69,000,731       $ 34,041,558       
                     

(1) Represents the stated interest rate in place as of December 31, 2010.

(2) The debt associated with the Renfro Property was refinanced on November 22, 2010 in connection with an amendment to our credit agreement with KeyBank National Association. (See Note 4, Debt, to the consolidated financial statements.)

The following table presents the future principal payment requirements on outstanding secured promissory notes at December 31, 2010:

 

2011

   $ 8,413,369   

2012

     572,403   

2013

     35,614,600   

2014

     654,737   

2015 and thereafter

     23,745,622   
        

Total payments

   $ 69,000,731   
        

The weighted average interest rate of our fixed rate debt as of December 31, 2010 was approximately 6.50%.

 

ITEM 3. LEGAL PROCEEDINGS

 

(a) From time to time, we are party to legal proceedings that arise in the ordinary course of our business. We are not aware of any legal proceedings of which the outcome is reasonably likely to have a material adverse effect on our results of operations or financial condition. Nor are we aware of any such legal proceedings contemplated by governmental authorities.

 

(b) None.

 

ITEM 4. (REMOVED AND RESERVED )

 

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PART II

 

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

Market Information

As of March 22, 2011, we had approximately $24.83 million in shares of common stock outstanding, including $0.25 million in shares issued pursuant to our distribution reinvestment plan, held by a total of 676 stockholders of record. There is no established trading market for our common stock. Therefore, there is a risk that a stockholder may not be able to sell our stock at a time or price acceptable to the stockholder, or at all. We are currently selling shares of our common stock to the public at a price of $10.00 per share and at a price of $9.50 per share pursuant to our distribution reinvestment plan. Additionally, we provide discounts in our Public Offering for certain categories of purchasers, including based on volume discounts. Pursuant to the terms of our charter, certain restrictions are imposed on the ownership and transfer of shares.

Unless and until our shares are listed on a national securities exchange, it is not expected that a public market for our shares will develop. To assist fiduciaries of Plans (as defined below) subject to the annual reporting requirements of ERISA and Account (as defined below) trustees or custodians to prepare reports relating to an investment in our shares, we intend to provide reports of our quarterly and annual determinations of the current value of our net assets per outstanding share to those fiduciaries (including Account trustees and custodians) who identify themselves to us and request the reports. Until 18 months after the completion of any subsequent offerings of our shares (excluding offerings under our distribution reinvestment plan), we intend to use the offering price of shares in our most recent offering as the per share net asset value (unless we have made a special distribution to stockholders of net sales proceeds from the sale of one or more properties prior to the date of determination of net asset value, in which case we will use the offering price less the per share amount of the special distribution). Beginning 18 months after the completion of the last offering of our shares, our board of directors will determine the value of the properties and our other assets based on such information as our board determines appropriate, which may or may not include independent valuations of our properties or of our enterprise as a whole.

We anticipate that we will provide annual reports of our determination of value (1) to Account trustees and custodians not later than January 15 of each year, and (2) to other Plan fiduciaries within 75 days after the end of each calendar year. Each determination may be based upon valuation information available as of October 31 of the preceding year, updated, however, for any material changes occurring between October 31 and December 31.

There can be no assurance, however, with respect to any estimate of value that we prepare, that:

 

   

the estimated value per share would actually be realized by our stockholders upon liquidation, because these estimates do not necessarily indicate the price at which properties can be sold;

 

   

our stockholders would be able to realize estimated net asset values if they were to attempt to sell their shares, because no public market for our shares exists or is likely to develop; or

 

   

that the value, or method used to establish value, would comply with ERISA or Code requirements described above.

For purposes of the preceding paragraphs, “Plans” include tax-qualified pension, stock bonus or profit-sharing plans, employee benefit plans described in Section 3(3) of ERISA, and annuities described in Section 403(a) or (b) of the Code, and “Accounts” include an individual retirement account or annuity described in Sections 408 or 408A of the Code (also known as IRAs), an Archer MSA described in Section 220(d) of the Code, a health savings account described in Section 223(d) of the Code, and a Coverdell education savings account described in Section 530 of the Code.

 

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Distributions

We intend to elect to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, for the year ended December 31, 2010. 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 we distribute to our 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 IRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to stockholders. However, as of December 31, 2010, we satisfied the REIT requirements and distributed all of our taxable income.

Distributions to stockholders are characterized for federal income tax purposes as ordinary income, capital gains, non-taxable return of capital or a combination of the three. Distributions that exceed our current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital for tax purposes rather than a distribution and reduce the stockholders’ basis in our common shares. To the extent that a distribution exceeds both current and accumulated earnings and profits and the stockholders’ basis in the common shares, it will generally be treated as a capital gain. We will annually notify stockholders of the taxability of distributions paid during the preceding year.

Distributions for a given month are paid approximately 15 days after month-end and are paid from proceeds raised from our private offering of our shares and from our Public Offering and operating cash flow generated from our properties. The following table shows the distributions we have declared and paid through December 31, 2010:

 

Quarter

   Total
Distributions
Declared and
Paid to Limited
Partners
    Total
Distributions
Declared  and

Paid to
Stockholders (1)
    Distributions
Declared per
Common
Share (2)
     Annualized
Percentage
Return

2nd Quarter 2009

   $ 44,827      $ 17,120 (3)    $ 0.10       6.75%

3rd Quarter 2009

   $ 343,677      $ 34,961      $ 0.17       6.75%

4th Quarter 2009

   $ 343,677      $ 40,752      $ 0.17       6.75%

1st Quarter 2010

   $ 336,205      $ 54,021      $ 0.17       6.75%

2nd Quarter 2010

   $ 380,538      $ 122,559      $ 0.17       6.75%

3rd Quarter 2010

   $ 519,755 (4)    $ 184,428      $ 0.17       6.75%

4th Quarter 2010

   $ 539,038      $ 259,482      $ 0.17       6.75%

1st Quarter 2011

     N/A        N/A      $ 0.17       6.75%

 

  (1) Declared distributions are paid monthly in arrears.

 

  (2) Distributions declared per common share amounts are rounded to the nearest $0.01.

 

  (3) Distributions began on June 15, 2009, for the period from May 6, 2009, the date we satisfied the minimum offering requirements, through May 31, 2009.

 

  (4) Amount includes $0.02 million paid to our advisor for 2009 and 2010 distributions.

Securities Authorized for Issuance under Equity Compensation Plans

On February 12, 2009, our board of directors adopted our Employee and Director Long-Term Incentive Plan (the “Plan”) in order to (1) provide incentives to individuals who are granted awards because of their ability to improve our operations and increase profits; (2) encourage selected persons to accept or continue employment with us or with our advisor or its affiliates that we deem important to our

 

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long-term success; and (3) increase the interest of our independent directors in our success through their participation in the growth in value of our stock. Pursuant to the Plan, we may issue stock-based awards to our directors and full-time employees (should we ever have employees), executive officers and full-time employees of our advisor and its affiliate entities that provide services to us and certain consultants who provide significant services to us.

The total number of shares of our common stock (or common stock equivalents) reserved for issuance under the Plan is equal to 10% of our outstanding shares of stock at any time, but not to exceed 10,000,000 shares. The term of the Plan is ten years. Awards granted under the Plan may consist of stock options, restricted stock, stock appreciation rights and other equity-based awards. The stock-based payment will be measured at fair value and recognized as compensation expense over the vesting period. No awards have been granted under the Plan as of December 31, 2010.

Upon our earlier dissolution or liquidation, upon our reorganization, merger or consolidation with one or more corporations as a result of which we are not the surviving corporation, or upon sale of all or substantially all of our properties, the Plan will terminate, and provisions will be made for the assumption by the successor corporation of the awards granted or the replacement of the awards with similar awards with respect to the stock of the successor corporation, with appropriate adjustments as to the number and kind of shares and exercise prices. Alternatively, rather than providing for the assumption of awards, the compensation committee, when formed, may either (1) shorten the period during which awards are exercisable, or (2) cancel an award upon payment to the participant of an amount in cash that the compensation committee determines is equivalent to the amount of the fair market value of the consideration that the participant would have received if the participant exercised the award immediately prior to the effective time of the transaction.

In the event that the compensation committee, when formed, determines that any distribution, recapitalization, stock split, reorganization, merger, liquidation, dissolution or sale, transfer, exchange or other disposition of all or substantially all of our assets, or other similar corporate transaction or event, affects the stock such that an adjustment is appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan or with respect to an award, then the compensation committee shall, in such manner as it may deem equitable, adjust the number and kind of shares or the exercise price with respect to any award.

The following table provides information about the common stock that may be issued under the Plan as of December 31, 2010:

 

Plan Category

  Number of Securities to
be Issued Upon Exercise

of Outstanding Options,
Warrants and Rights
    Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights
    Number of Securities
Remaining for Future
Issuance Under Equity
Compensation Plans
 
Equity Compensation Plans Approved by Security Holders                   184,534   
Equity Compensation Plans Not Approved by Security Holders                     
                       

Total

                  184,534   
                       

 

* The total number of shares of our common stock (or common stock equivalents) reserved for issuance under the Plan is equal to 10% of our outstanding shares of stock at any time, but not to exceed 10,000,000 shares. As of December 31, 2010, we had 1,845,339 outstanding shares of common stock, including shares issued pursuant to the distribution investment plan.

 

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Use of Proceeds from Registered Securities

We registered 82,500,000 shares of our common stock in our Public Offering (SEC File No. 333-159167, effective November 6, 2009), of which we registered 75,000,000 shares to be offered to the public in our primary offering at an aggregate offering price of up to $750,000,000, or $10.00 per share, and 7,500,000 shares to be offered to investors pursuant to our distribution reinvestment plan at an aggregate offering price of $71,250,000, or $9.50 per share. During the year ended December 31, 2010, we did not sell any equity securities that were not registered under the Securities Act of 1933. Our equity raise as of December 31, 2010 resulted in the following:

 

Common shares issued in our Public Offering

     1,580,039   

Common shares issued in our Public Offering pursuant to the distribution reinvestment plan

     17,320   

Gross Public Offering proceeds

   $             15,771,208   

Gross Public Offering proceeds from shares issued pursuant to the distribution reinvestment plan

   $ 164,549   

Selling commissions and dealer manager fees paid

   $ 1,550,875   

Reimbursement to our advisor of O&O costs paid

   $ 190,694   

Reimbursement to our advisor of O&O costs deferred

   $ 85,812   

Net Public Offering proceeds

   $ 14,108,376   

The remainder of the net proceeds was used to fund property acquisitions of approximately $54.32 million, general operating expenses and shareholder distributions. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for detailed information on the use of proceeds.)

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Share Redemption Program

As noted in Note 8, Commitments and Contingencies – Share Redemption Program, in the notes to the financial statements contained in this report, and more fully described in our prospectus dated November 6, 2009, as supplemented from time to time, our board of directors adopted a share redemption program on February 20, 2009, which enables our stockholders to have their shares redeemed by us, subject to the significant conditions and limitations described in our prospectus. Our share redemption program has no set termination date, but our ability to redeem shares under the program is limited as described in the prospectus. As of December 31, 2010, the maximum amount that may yet be redeemed under our publicly announced program was $0.17 million. As of December 31, 2010, there were no share redemption requests. Our board of directors may choose to amend, suspend or terminate our share redemption program upon 30 days’ written notice at any time.

During the year ended December 31, 2010, we redeemed shares as follows:

 

    For the Quarter    

Ended

   Total Number of
Shares Redeemed
as Part of Publicly
Announced Plans
   Average
Price
Paid per
Share
   Cumulative Number
of Shares  Redeemed
as Part of Publicly
Announced Plans

March 31, 2010

   -    N/A    -

June 30, 2010

   0    N/A    0

September 30, 2010

   0    N/A    0

December 31, 2010

   0    N/A    0

 

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ITEM 6. SELECTED FINANCIAL DATA

The following selected financial and operating information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the financial statements and related notes thereto included elsewhere in this annual report on Form 10-K:

 

     For the Year Ended December 31,  
     2010     2009     2008  

Operating Data

      

Total revenue

   $ 7,269,741      $ 2,732,577      $   

Net loss

     (3,809,088     (2,235,586       

Net loss per share, basic and diluted

     (1.08     (1.79       

Distributions declared per common share

     0.68        0.44          

Balance Sheet Data

      

Total real estate, net

   $ 103,033,549      $ 53,486,605      $   

Total assets

     110,141,076        55,294,930        201,000   

Total debt

     69,000,731        34,041,558          

Total liabilities

     72,996,263        37,016,005          

Redeemable noncontrolling interests

     4,886,686                 

Redeemable common stock

     170,810        8,994          

Stockholders’ equity

     13,509,517        591,183        1,000   

Total equity

     32,087,317        18,269,931        201,000   

Other Data

      

Net cash (used in) provided by operating activities

   $ (824,774   $ 58,498      $   

Net cash used in investing activities

     (38,754,607              

Net cash provided by financing activities

     40,828,181        127,774          

 

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

The following “Management’s Discussion and Analysis of Financial Condition and Result of Operations” should be read in conjunction with the financial statements and the notes thereto contained in this report.

Overview

We were formed on August 28, 2008 under the Maryland General Corporation Law for the purpose of engaging in the business of investing in single tenant net lease properties. We began operations on May 6, 2009 and are subject to the general risks associated with a start-up enterprise, including the risk of business failure. Our year end is December 31. As used in this report, “we,” “us” and “our” refer to The GC Net Lease REIT, Inc. We deferred the election to be taxed as a REIT until December 31, 2010 to ensure that certain non-financial requirements were satisfied, which we did not satisfy as of December 31, 2009. As of December 31, 2010, we satisfied these non-financial requirements.

We have no paid employees and are externally advised and managed by an affiliate, The GC Net Lease REIT Advisor, LLC, who is our advisor. Griffin Capital Corporation, our sponsor, is the sole member of our advisor and an affiliate of the sole owner of The GC Net Lease REIT Property

 

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Management, LLC, our property manager. Our operating partnership is The GC Net Lease REIT Operating Partnership, L.P. We expect to own all of our properties directly or indirectly through our operating partnership or similar entities.

On February 20, 2009, we commenced a private offering to accredited investors only pursuant to a confidential private placement memorandum. On May 6, 2009 we satisfied our minimum offering requirement and commenced operations. We declared our first distribution to stockholders in the second quarter of 2009, which was initially paid on June 15, 2009.

We terminated our private offering on November 6, 2009, having raised approximately $2.36 million through the issuance of 247,978 shares, and began our offering to the public upon the SEC declaring our registration statement effective. We are currently offering a maximum of 82,500,000 shares of common stock to the public, consisting of 75,000,000 shares for sale to the public (our “Primary Public Offering”) and 7,500,000 shares for sale pursuant to our distribution reinvestment plan (collectively, our “Public Offering”). As of December 31, 2010, we had issued 1,597,359 total shares of our common stock for gross proceeds of approximately $15.94 million in our Public Offering, of which 17,320 shares, or $0.17 million, was issued pursuant to the distribution reinvestment plan.

Significant Accounting Policies and Estimates

We have established accounting policies which conform to generally accepted accounting principles (“GAAP”). The preparation of our consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different estimates would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may use different estimates and assumptions that may impact the comparability of our financial condition and results of operations to those companies.

We believe the accounting policies listed below are the most critical in the preparation of our consolidated financial statements. These policies are described in greater detail in Note 2, Basis of Presentation and Summary of Significant Accounting Policies, to the consolidated financial statements:

 

   

Real Estate - Valuation and purchase price allocation, depreciation;

 

   

Impairment of Real Estate and Related Intangible Assets and Liabilities;

 

   

Revenue Recognition;

 

   

Noncontrolling Interests in Consolidated Subsidiaries;

 

   

Common Stock and Noncontrolling Interests Subject to Redemption;

 

   

Fair Value Measurements;

 

   

Income Taxes-deferred tax assets and related valuation allowance, REIT qualification; and Loss Contingencies

Recently Issued Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash (“ASU No. 2010-01”). This ASU clarifies that when the stock portion of a distribution allows stockholders to elect to receive cash or stock with a potential limitation on the total amount of cash that all stockholders can elect to receive in the aggregate, the distribution would be considered a share issuance as opposed to a stock dividend and the share issuance would be reflected in earnings per share prospectively. ASU No. 2010-01 is effective for interim and

 

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annual periods ending on or after December 15, 2009 and should be applied on a retrospective basis. The adoption of ASU No. 2010-01 did not have an impact on our consolidated financial statements.

In June 2009, new accounting provisions, ASC 810-10, “Variable Interests and Special Purpose Entities in Consolidated Financial Statements,” were released that eliminate the primarily quantitative model to determine the primary beneficiary of a variable interest entity (“VIE”) and replace it with a qualitative model that focuses on which entities have the power to direct the activities of the VIE as well as the obligation or rights to absorb the VIE’s losses or receive its benefits. The reconsideration of the initial determination of VIE status is still based on the occurrence of certain events. These new accounting provisions became effective for fiscal years and interim periods beginning after November 15, 2009. The adoption of ASC 810-10 did not have an impact on our consolidated financial statements.

In February 2010, the FASB issued updated guidance in ASC 810, “Consolidation,” which defers the effective date of the consolidation guidance of FASB Statement No. 167 for certain investment funds and money market funds. The update also modifies the requirements for evaluating whether a decision maker’s or service provider’s fee is a variable interest and clarifies that a quantitative calculation in the evaluation thereof should not be the sole basis for determining the above. As of December 31, 2010, we did not have any investments, or other variable interests, in entities that were determined to be VIEs.

Results of Operations

Overview

Prior to January 1, 2009, we did not own any properties and there were no operations. As of December 31, 2009, we owned two properties, which were contributed on June 18, 2009. During 2010 we acquired four additional properties, which resulted in a portfolio of six properties at December 31, 2010. Therefore, our results of operations for the year ended December 31, 2010 are not directly comparable to those for the year ended December 31, 2009 and are not indicative of those expected in the future periods. We expect that rental income, operating expenses, depreciation, and amortization expenses will each increase in future periods as a result of acquisitions made during the year ended December 31, 2010 being owned for an entire period and anticipated future acquisitions of real estate assets.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

The following table provides summary information about our results of operations for the year ended December 31, 2010 and 2009:

 

     Year Ended December 31,      Increase
(Decrease)
     Percentage
Change
     2010      2009        

Rental income

   $ 6,509,724       $ 2,507,487       $ 4,002,237       160%

Property tax recovery

   $ 755,370       $ 213,878       $ 541,492       253%

Asset management fees

   $ 560,141       $ 219,674       $ 340,467       155%

Property management fees

   $ 188,793       $ 68,442       $ 120,351       176%

Property tax expense

   $ 755,370       $ 213,878       $ 541,492       253%

Acquisition fees and expenses

   $ 2,103,134       $ 1,637,592       $ 465,542       28%

General and administrative expenses

   $ 1,359,686       $ 683,769       $ 675,917       99%

Depreciation and amortization

   $ 2,941,676       $ 920,919       $ 2,020,757       219%

Interest expense

   $ 3,170,029       $ 1,223,889       $ 1,946,140       159%

 

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Rental Income

Rental income for the year ended December 31, 2010 is comprised of rental income of $6.10 million and adjustments to straight-line contractual rent of $0.47 million, less in-place lease valuation amortization of $0.06 million. In the current period, rental income increased by $4.0 million compared to the year ended December 31, 2009 as a result of (1) $1.81 million in rental income related to the additional real estate acquired during the year ended December 31, 2010, and (2) a $2.19 million increase in rental income related to the Plainfield and Renfro properties resulting from 12 months of revenue recognition in 2010 compared to six months in 2009. Also included as a component of revenue is the recovery of property taxes, which increased by $0.54 million compared to the year ended December 31, 2009 as a result of the acquisition of additional real estate. We expect rental income to increase in future periods as a result of our acquisitions during the year ended December 31, 2010 and as we acquire additional properties.

Property Operating Expenses

Property operating expenses for the year ended December 31, 2010 and 2009 totaled $1.50 million and $0.50 million, respectively, consisting of asset management fees, property management fees, and property taxes. The total increase from the year ended December 31, 2009 of $1.0 million is a result of (1) $0.21 million in property and asset management fees and $0.37 million in property taxes for the real estate acquired during the year ended December 31, 2010, and (2) a $0.25 million increase in property and asset management fees and a $0.17 million increase in property tax expense as a full year of activity was captured for Plainfield and Renfro compared to the six months of activity in 2009. We expect property operating expenses to increase in future periods as a result of our acquisitions during the year ended December 31, 2010, and as we acquire additional properties.

Acquisition Fees and Expenses

Real estate acquisition fees and expenses due to our advisor for the year ended December 31, 2010 increased by $0.47 million compared to the year ended December 31, 2009 and consisted of the following:

 

Property

   Date
Acquired
     Acquisition
fees/expenses
due Advisor
     Acquisition expenses
incurred by REIT
     Total  

Will Partners

     6/4/2010       $ 789,158       $ 167,030       $ 956,188   

Emporia Partners

     8/27/2010         250,686         116,306         366,992   

ITT

     9/23/2010         234,000         37,288         271,288   

Quad/Graphics

     12/30/2010         355,500         153,166         508,666   
                             

Total

      $ 1,629,344       $ 473,790       $ 2,103,134   

We expect to continue to incur acquisition fees and expenses in the future as we acquire additional properties.

General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2010 increased by $0.68 million compared to the same period in the prior year due to (1) increased operating activity in the current year and (2) the year ended December 31, 2009 contained activity from the date we broke escrow, or May 6, 2009, compared to 12 months in the current period. General and administrative expenses for the year ended December 31, 2010 consisted mostly of professional fees, including accounting and legal costs of $0.78 million, directors’ and officers’ insurance of $0.26 million, board of directors fees of $0.09 million,

 

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as well as other expenses totaling $0.24 million, consisting mostly of office expenses such as allocated personnel costs and rent incurred by our advisor ($0.09 million in total), transfer agent fees (approximately $0.05 million), and non-financing closing costs related to the refinancing of the Renfro property debt ($0.03 million). Further, organizational costs were reduced (a reduction of $0.08 million) to the extent the amount of organizational costs incurred exceeded 15% of the total equity raised in our Public Offering, as discussed in our amended and restated advisory agreement and in the Organizational and Offering Costs section of Note 2 to the financial statements. The reduction in organizational costs is reflected as a reduction of the “Due to Affiliates” balance in the consolidated balance sheets. We expect general and administrative expenses to increase in future periods as we make additional investments, but to decrease as a percentage of total revenues.

Depreciation and Amortization Expense

Depreciation and amortization expense for the year ended December 31, 2010 consisted of depreciation of building and building improvements of our properties of $1.88 million and amortization of the contributed and acquired values allocated to tenant origination and absorption costs of $1.06 million. The increase of $2.02 million as compared to the year ended December 31, 2009 is a result of (1) $0.74 million in depreciation and amortization for the real estate acquired during the year ended December 31, 2010, and (2) a $1.28 million increase related to the Renfro and Plainfield properties for 12 months of activity in the current period compared to six months of activity in 2009. We expect depreciation and amortization expense to increase in future periods as a result of our acquisitions during the year ended December 31, 2010, and as we acquire additional properties.

Interest Expense

Interest expense for the year ended December 31, 2010 increased by $1.95 million compared to the year ended December 31, 2009. The increase is due primarily to: (1) a $0.92 million increase related to the Renfro and Plainfield properties for the 12 months of activity in the current period compared to six months of interest expense for the year ended December 31, 2009; (2) $0.11 million in interest expense related to the assumption of the Emporia Partners property debt in conjunction with the contribution on August 27, 2010; and (3) $0.74 million in interest expense related to the origination of the Credit Facility and the short-term bridge facility, as discussed in Note 4, Debt, to the consolidated financial statements. Interest expense for the year ended December 31, 2010 also includes the amortization of deferred financing costs of $0.16 million whereas during the year ended December 31, 2009, there were no deferred financing costs, and $0.02 million related to an interest rate cap pursuant to debt covenant requirements of the Credit Facility. We expect interest expense to increase in future periods as a result of the acquisitions made during the year ended December 31, 2010 and as we acquire additional real estate and assume any related debt.

Liquidity and Capital Resources

Long-Term Liquidity and Capital Resources

On a long-term basis, our principal demands for funds will be for property acquisitions, either directly or through entity interests, for the payment of operating expenses and distributions, and for the payment of interest on our outstanding indebtedness and other investments. Generally, cash needs for items, other than property acquisitions, will be met from operations and proceeds received from offerings. However, there may be a delay between the sale of our shares and our purchase of properties that could result in a delay in the benefits to our stockholders, if any, of returns generated from our investments. Our advisor will evaluate potential additional property acquisitions and engage in negotiations with sellers on our behalf. After a purchase contract is executed that contains specific terms, the property will not be purchased until the successful completion of due diligence, which includes review of the title insurance commitment, an appraisal and an environmental analysis. In some instances, the proposed

 

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acquisition will require the negotiation of final binding agreements, which may include financing documents. During this period, we may decide to temporarily invest any unused proceeds from offerings in certain investments that could yield lower returns than the properties. These lower returns may affect our ability to make distributions.

On June 4, 2010, we, through our operating partnership, entered into a credit agreement with KeyBank National Association, which provided our operating partnership with an initial $25 million credit facility (the “Credit Facility”) to finance the acquisition of properties. Our operating partnership made an initial draw of $16.9 million to facilitate the acquisition of the Will Partners property and a subsequent draw of $5.07 million to finance the ITT property acquisition.

On November 22, 2010, we, through our operating partnership, entered into an amendment to the credit agreement with KeyBank, thereby increasing the total amount of the Credit Facility, upon which we drew an additional $13.03 million from the facility to refinance the debt encumbering the Renfro property. The total amount of funds drawn under the Credit Facility is now $35 million.

On December 30, 2010, we, through our operating partnership, entered into a Bridge Loan with KeyBank (the “Bridge Loan”) and thereby obtained approximately $7.87 million used as a source to fund the acquisition of the Quad/Graphics property. The terms of the Bridge Loan require payments made throughout the month equal to the net equity raised in our Public Offering, subject to a monthly minimum amount of approximately $1.33 million.

Other potential future sources of capital include proceeds from our Public Offering, proceeds from secured or unsecured financings from banks or other lenders, proceeds from the sale of properties and undistributed funds from operations. If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures. To the extent we are not able to secure additional financing in the form of a credit facility (other than the current Credit Facility) or other third party source of liquidity, we will be heavily dependent upon the proceeds of our Public Offering and income from operations in order to meet our long-term liquidity requirements and to fund our distributions.

Short-Term Liquidity and Capital Resources

We expect we will meet our short-term operating liquidity requirements from advances from our advisor and its affiliates, proceeds received in our Public Offering and operating cash flows generated from our properties and other properties we acquire in the future. Any advances from our advisor will be repaid, without interest, as funds are available after meeting our current liquidity requirements, subject to the limitations on reimbursement set forth in the “Management Compensation” section of our prospectus. Our amended and restated advisory agreement provides that expenses advanced to us by our advisor shall be reimbursed no less frequently than monthly. The offering and organizational costs associated with our Public Offering (excluding sales commissions and dealer manager fees) were initially paid by our advisor and will be reimbursed by us, up to 3.5% of the gross offering proceeds raised by us in the terminated or completed offering for the issuer’s organizational and offering costs. The offering and organizational costs (including sales commissions and dealer manager fees) may not exceed 15% of gross offering proceeds of the Primary Public Offering. If the organization and offering expenses exceed such limits, within 60 days after the end of the month in which our Public Offering terminates or is completed, the advisor must reimburse us for any excess amounts. As of December 31, 2010, we incurred organizational and offering costs, in excess of the 15% limitation. Therefore, if we terminated our Public Offering on December 31, 2010, the probability that we would be liable to our advisor for advanced organizational and offering costs, based on the gross proceeds raised to date and organizational and offering costs incurred in excess of the limitation discussed above, is remote. As a result we generated a receivable due from our advisor of $0.28 million (after deducting $0.64 million in unreimbursed amounts previously advanced by our advisor), which was recorded as a reduction in the “Due to Affiliates” balance in the

 

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consolidated balance sheets. No payment is required until 60 days following the completion or termination of our Public Offering in accordance with the amended and restated advisory agreement. We will continue to monitor both the 3.5% and 15% limitations and expect the receivable to decrease as we raise additional offering proceeds and, as a result, become liable once again for organizational and offering costs advanced by our advisor. Operating cash flows are expected to increase as properties are added to our portfolio.

The line of credit associated with the Renfro property had an initial term of one year but was extended until July 29, 2010 with an automatic option to extend it further to January 29, 2011. On July 29, 2010, we exercised the automatic second extension and extended the term to January 29, 2011. On November 22, 2010, we, through our operating partnership, entered into an amendment to the credit agreement with KeyBank, thereby increasing the total amount of the Credit Facility, upon which we drew an additional $13.03 million from the facility to refinance the debt encumbering the Renfro property. The total amount of funds drawn under the Credit Facility is now $35 million.

Our cash and cash equivalent balances increased $1.25 million during the year ended December 31, 2010 and were used in or provided by the following:

Operating Activities. During the year ended December 31, 2010, we used $0.82 million of cash from operating activities, compared to $0.06 million generated during the year ended December 31, 2009. The use of cash in operations increased in 2010 primarily due to the increase in the net loss from $2.24 million for the year ended December 31, 2009 to $3.81 million for the year ended December 31, 2010. The net loss in the current period is offset by non-cash adjustments of $2.69 million (consisting of depreciation and amortization of $3.16 million less deferred rent of $0.47 million) and cash provided by working capital of $0.29 million. Cash from working capital during the prior year was $1.31 million higher as a result of the timing of payables.

Investing Activities. During the year ended December 31, 2010, we used $38.75 million in cash for investing activities, specifically for the acquisition of the Will Partners, Emporia Partners, ITT and Quad/Graphics properties. This resulted in an increase from the year ended December 31, 2009 when no cash was used in the Renfro and Plainfield contributions. Additionally, we funded $0.45 million for tenant improvements mainly from reserve proceeds held by lenders, which were assumed by us in conjunction with the contribution of the Plainfield and Renfro properties, compared to $3.16 million funded during the year ended December 31, 2009.

Financing Activities. During the year ended December 31, 2010, we generated $40.83 million from financing activities as compared to $0.13 million during the year ended December 31, 2009. The net increase is a result of (1) $42.87 million in combined proceeds from the Credit Facility and the Bridge Loan and an increase of $13.60 million in the issuance of common stock (which includes an increase in gross offering proceeds of $13.22 million, a decrease in the discount on common stock of $0.1 million and a decrease in incurred offering costs of $0.28 million compared to the year ended December 31, 2009); and (2) a $12.91 million payoff of the Renfro property debt; a $0.31 million increase in loan amortization compared to the year ended December 31, 2009 due to an increase in debt and due to a full year of amortization of the Renfro and Plainfield loans and the amortization of the Emporia Partners mortgage from the contribution date; a $1.12 million increase in amortization of deferred financing costs compared to the year ended December 31, 2009 when there were no deferred financing costs; and a $1.43 million increase in distribution payments.

Distributions and Our Distribution Policy

Distributions will be paid to our stockholders as of the record date selected by our board of directors. We expect to continue to pay distributions monthly based on daily declaration and record dates

 

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so that investors may be entitled to distributions immediately upon purchasing our shares. We expect to regularly pay distributions unless our results of operations, our general financial condition, general economic conditions, or other factors inhibit us from doing so. Distributions will be authorized at the discretion of our board of directors, which will be directed, in substantial part, by its obligation to cause us to comply with the REIT requirements of the Code. The funds we receive from operations that are available for distribution may be affected by a number of factors, including the following:

 

   

the amount of time required for us to invest the funds received in our Public Offering;

 

   

our operating and interest expenses;

 

   

the amount of distributions or dividends received by us from our indirect real estate investments;

 

   

our ability to keep our properties occupied;

 

   

our ability to maintain or increase rental rates;

 

   

tenant improvements, capital expenditures and reserves for such expenditures;

 

   

the issuance of additional shares; and

 

   

financings and refinancings.

We made our first distribution on June 15, 2009 to investors of record on May 31, 2009. We achieved our minimum escrow requirement on May 6, 2009; therefore, our first monthly distribution was for a partial month. Since June 15, 2009, we funded distributions with operating cash flow from our properties and offering proceeds raised in our private offering and our Public Offering. To the extent that we do not have taxable income, distributions paid will be considered a return of capital to stockholders.

The following table shows total distributions paid for the four quarters of 2010:

 

     December 31,
2010
           September 30,
2010
          June 30,
2010
          March 31,
2010
       

Distributions paid in cash- noncontrolling interests

   $ 533,179         $ 496,645        $ 343,676        $ 336,205     

Distributions paid in cash- common stockholders

     162,080           123,391          80,337          39,433     

Distributions reinvested (shares issued)

     79,788           48,124          26,890          7,014     
                                         

Total distributions

   $ 775,047         (1 )    $ 668,160        $ 450,903        $ 382,652     
                                         

Source of distributions:

                 

Cash flows provided by (used in) operations

   $ 276,853        

 

(2

36

) 

  $ (96,454    

 

(2

(14

) 

%) 

  $ (517,377    

 

(2

(115

) 

%) 

  $ (487,796    

 

(2

(128

) 

%) 

Proceeds from issuance of common stock

     418,406         54     716,490        107     941,390        209     863,434        226

Distributions reinvested (shares purchased)

     79,788         10     48,124        7     26,890        6     7,014        2
                                         

Total sources

   $ 775,047         100   $ 668,160        100   $ 450,903        100   $ 382,652        100
                                         

 

(1)

Total distributions declared but not paid as of December 31, 2010 for noncontrolling interests (including our advisor), and common stockholders were $0.18 million and $0.07 million, respectively.

 

(2)

Percentages were calculated by dividing the respective source amount by the total sources of distributions. Sources appearing as negative amounts represent instances in which cash flows were used in, rather than provided by, operations. Accordingly, percentages calculated on these amounts also appear as negative numbers.

 

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Funds from Operations

We believe that funds from operations (“FFO”) is a beneficial indicator of the performance of an equity REIT. Because FFO calculations exclude such items as depreciation and amortization of real estate assets and gains and losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), they facilitate comparisons of operating performance between periods and between other REITs. Our management believes that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities. The National Association of Real Estate Investment Trusts (“NAREIT”) defines FFO as net income or loss computed in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships and joint ventures. Other REITs may not define FFO in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently than we do.

The Investment Program Association, (“IPA”), issued Practice Guideline 2010-01 (the IPA MFFO Guideline) on November 2, 2010, which extended financial measures to include Modified Funds from Operations (“MFFO”). We adopted the IPA MFFO Guideline commencing with this annual report. Management believes that MFFO is a beneficial indicator of on-going portfolio performance and our ability to sustain our current distribution level. More specifically, MFFO isolates the financial results of the REIT’s operations. MFFO, however, is not considered an appropriate measure of historical earnings as it excludes certain significant costs that are otherwise included in reported earnings. Further, since the measure is based on historical financial information, MFFO for the period presented may not be indicative of future results or our future ability to pay our dividends. In computing MFFO, FFO is adjusted for certain non-cash items such as straight-line rent, the amortization of in-place lease valuations and the amortization of financing costs. FFO is further adjusted for certain non-operating cash items such as acquisitions fees and expenses.

By providing FFO and MFFO, we present information that assists investors in aligning their analysis with management’s analysis of long-term operating activities. MFFO also allows for a comparison of the performance of our portfolio with other REITs that are not currently engaging in acquisitions, as well as a comparison of our performance with that of other non-traded REITs, as MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes. As explained below, management’s evaluation of our operating performance excludes items considered in the calculation of MFFO based on the following economic considerations:

 

   

Straight line rent, amortization of in-place lease valuation and amortization of financing costs. These items are GAAP non-cash adjustments and are included in historical earnings. These items are added back to FFO as a means of determining operating results of our portfolio.

 

   

Acquisition-related costs. In evaluating the performance of our portfolio over time, management employs business models and analyses that differentiate the costs to acquire investments from the investments’ revenues and expenses. Management believes that excluding acquisition costs from MFFO provides investors with supplemental performance

 

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information that is consistent with the performance models and analysis used by management, and provides investors a view of the performance of our portfolio over time, including after we cease to acquire properties on a frequent and regular basis. In accordance with GAAP, as of January 1, 2009, acquisition related transaction costs are required to be expensed as incurred compared to the prior practice of capitalizing such costs and amortizing them over the estimated useful lives of the assets acquired. These costs have been and will continue to be funded with cash proceeds from our primary offering.

For all of these reasons, we believe the non-GAAP measures of FFO and MFFO, in addition to net income and cash flows from operating activities, as defined by GAAP, are helpful supplemental performance measures and useful in understanding the various ways in which our management evaluates the performance of our real estate portfolio. However, FFO and MFFO should not be considered as alternatives to net income or to cash flows from operating activities. The material limitation associated with FFO and MFFO is that they are not indicative of our cash available to fund distributions since other uses of cash, such as capital expenditures at our properties and principal payments of debt, are not deducted when calculating FFO and MFFO. FFO or MFFO should not be considered as an alternative to net income (loss), or an indication of our liquidity, and each should be reviewed in connection with GAAP measurements.

Neither the SEC, NAREIT, nor any other applicable regulatory body has evaluated the acceptability of the exclusions contemplated to adjust FFO in order to calculate MFFO and its use as a non-GAAP performance measure. In the future, the SEC or NAREIT may decide to standardize the allowable exclusions across the REIT industry, and we may have to adjust the calculation and characterization of this non-GAAP measure.

Our calculation of FFO and MFFO is presented in the following table for the years ended December 31, 2010 and 2009.

 

     Year Ended December 31,  
     2010     2009  

Net Loss

   $ (3,809,088   $ (2,235,586

Adjustments:

    

Depreciation of building and improvements

     1,884,394        569,346   

Amortization of intangible assets

     1,057,282        351,573   
                

Funds from Operations (FFO)

   $ (867,412   $ (1,314,667
                

Reconciliation of FFO to Modified Funds From Operations (MFFO)

    

Funds From Operations

   $ (867,412   $ (1,314,667

Adjustments:

    

Acquisition Fees and Expenses

     2,103,134        1,637,592   

Revenues in excess of cash received (straight-line rents)

     (465,225     (206,770

Revenues in excess of cash received (amortization of above/below market rent)

     61,604        (19,313

Amortization of financing costs

     156,099        -   
                

MFFO

   $ 988,200      $ 96,842   
                

 

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Contractual Commitments and Contingencies

The following is a summary of our contractual obligations as of December 31, 2010:

 

     Payments Due During the Years Ending December 31,  
   Total      2011      2012-2013     2014-2015      Thereafter  

Outstanding debt obligations (1)

             

Plainfield

   $ 20,796,437       $ 262,170       $ 576,048      $ 663,217       $ 19,295,002   

Credit Facility

     35,000,000         -         35,000,000  (4)      -         -   

Emporia Partners

     5,332,794         279,699         610,955        689,026         3,753,114   

Bridge Loan (2)

     7,871,500         7,871,500         -        -         -   
                                           

Total outstanding debt

     69,000,731         8,413,369         36,187,003        1,352,243         23,048,116   
                                           

Interest on outstanding debt obligations (3)

             

Plainfield

   $ 9,115,748       $ 1,392,598       $ 2,733,192      $ 2,645,524       $ 2,344,434   

Credit Facility

     5,098,333         2,040,451         3,057,882        -         -   

Emporia Partners

     2,321,857         308,926         566,035        487,568         959,328   

Bridge Loan

     145,666         145,666         -        -         -   
                                           

Total interest

     16,681,604         3,887,641         6,357,109        3,133,092         3,303,762   
                                           

Total

   $ 85,682,335       $ 12,301,010       $ 42,544,112      $ 4,485,335       $ 26,351,878   
                                           

 

(1) Amounts include principal payments only.
(2) The Bridge Loan was used to finance the Quad/Graphics property acquisition and is due on June 30, 2011.
(3) Projected interest payments are based on the outstanding principal amounts and interest rates in effect at December 31, 2010.
(4) $16.9 million of the Credit Facility was used to finance the Will Partners property acquisition; an additional $5.07 million of the Credit Facility was used to finance the ITT property acquisition; and an additional $13.03 million of the Credit Facility was used to refinance the Renfro property debt. The total Credit Facility is $35 million.

Subsequent Events

See Note 10, Subsequent Events, to the consolidated financial statements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risks include 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 expect that the primary market risk to which we will be exposed is interest rate risk, including the risk of changes in the underlying rates on our variable rate debt.

As of December 31, 2009, our debt consisted of two mortgage loans and a line of credit totaling $34.04 million (the Renfro and Plainfield combined debt). As of December 31, 2010, our debt consisted of the Plainfield mortgage loan, along with an additional mortgage loan of $5.33 million that we assumed in connection with the Emporia Partners property, a $35.0 million draw from the Credit Facility, and $7.87 million from the Bridge Loan.

Emporia Partners Debt

In conjunction with the contribution of the Emporia Partners property, we assumed $5.42 million in debt. See Note 4, Debt, to the consolidated financial statements for a detailed description of the

 

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assumed debt. As this is fixed-rate debt, an increase in current interest rates of 1.00% would have no impact on our future earnings or cash flows.

Credit Facility

On June 4, 2010, we obtained approximately $16.9 million in debt to finance our acquisition of the Will Partners property pursuant to the Credit Facility. On September 23, 2010, we further obtained $5.07 million in debt from the Credit Facility to finance our acquisition of the ITT property. On November 22, 2010, we increased the total amount of the Credit Facility, upon which we drew an additional $13.03 million from the facility to refinance the debt encumbering the Renfro property. See Note 4, Debt, to the consolidated financial statements, for a detailed description of the Credit Facility, which is subject to certain debt covenant requirements. An increase in current interest rates of 1.00% would have no impact on our future earnings or cash flows as the minimum interest rate on the Credit Facility would still apply.

Bridge Loan

On December 30, 2010, we obtained approximately $7.87 million in debt to help fund the acquisition of the Quad/Graphics property pursuant to the Bridge Loan. In connection with the Bridge Loan, we also executed another amendment to the credit agreement with KeyBank (the “Second Amendment to Credit Facility”). Pursuant to the Second Amendment to Credit Facility, the debt obtained from the Bridge Loan is secured under the Credit Facility. When the Bridge Loan is paid in full, the Quad/Graphics property will serve as additional security for the Credit Facility, the guarantees issued in connection with the Bridge Loan will be released, and the Quad/Graphics property may be refinanced pursuant to the terms of the Credit Facility. An increase in current interest rates of 1.00% would have no impact on our future earnings or cash flows as the minimum interest rate on Bridge Loan would still apply.

Renfro and Plainfield Debt

In conjunction with the contribution of the properties on June 18, 2009 we assumed certain debt. See Note 4, Debt, to the consolidated financial statements, for a detailed description of the Renfro and Plainfield debt that was assumed in the prior period and the payoff of the Renfro debt in the current period. As the Plainfield debt is fixed rate debt, an increase in current interest rates of 1.00% would have no impact on our future earnings or cash flows.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary data filed as part of this annual report are set forth beginning on page F-1 of this annual report.

 

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

There were no changes in or disagreements with our independent registered public accountant during the years ended December 31, 2010 and 2009.

 

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As of the end of the period covered by this report, management, including our president and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our president and chief financial officer

 

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concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our president and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for us. Our management, including our president and chief financial officer, evaluated, as of December 31, 2010, the effectiveness of our internal control over financial reporting using the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2010. This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to an exemption provided by the SEC that permits non-accelerated filers to provide only management’s report in this annual report.

There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

During the fourth quarter of 2010, there was no information required to be disclosed in a report on Form 8-K which was not disclosed in a report on Form 8-K.

PART III

We expect to file a definitive Proxy Statement for our 2011 Annual Meeting of Stockholders (the “2011 Proxy Statement”) with the SEC, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K and is incorporated by reference to the 2011 Proxy Statement. Only those sections of the 2011 Proxy Statement that specifically address the items required to be set forth herein are incorporated by reference.

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item is incorporated by reference to the 2011 Proxy Statement to be filed with the SEC.

 

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference to the 2011 Proxy Statement to be filed with the SEC.

 

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

The information required by this Item is incorporated by reference to the 2011 Proxy Statement to be filed with the SEC.

 

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information required by this Item is incorporated by reference to the 2011 Proxy Statement to be filed with the SEC.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this Item is incorporated by reference to the 2011 Proxy Statement to be filed with the SEC.

PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

(a) List of Documents Filed.

1. The list of the financial statements contained herein is set forth on page F-1 hereof.

2. Schedule III — Real Estate and Accumulated Depreciation is set forth beginning on page S-1 hereof. All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are not applicable and therefore have been omitted.

3. The Exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index below.

 

(b) See (a) 3 above.

 

(c) See (a) 2 above.

 

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EXHIBIT INDEX

The following exhibits are included in this Annual Report on Form 10-K for the year ended December 31, 2010 (and are numbered in accordance with Item 601 of Regulation S-K).

 

Exhibit

No.

 

Description

3.1

  Third Articles of Amendment and Restatement of The GC Net Lease REIT, Inc., incorporated by reference to Exhibit 3.1 to Pre-Effective Amendment No. 3 to the Registrant’s Registration Statement on Form S-11, filed on October 29, 2009, Commission File No. 333-159167

3.2

  Bylaws of The GC Net Lease REIT, Inc., incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-11, filed on May 12, 2009, Commission File No. 333-159167

4.1

  Form of Subscription Agreement and Subscription Agreement Signature Page (included as Appendix B to prospectus, incorporated by reference to the Registrant’s final prospectus filed pursuant to Rule 424(b)(3), filed on November 6, 2009, Commission File No. 333-159167)

10.1

  First Amended and Restated Limited Partnership Agreement of The GC Net Lease REIT Operating Partnership, L.P., incorporated by reference to Exhibit 10.1 to Pre-Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-11, filed on August 19, 2009, Commission File No. 333-159167

10.2

  The GC Net Lease REIT, Inc. 2009 Long Term Incentive Plan, incorporated by reference to Exhibit 10.3 to the Registrant’s Registration Statement on Form S-11, filed on May 12, 2009, Commission File No. 333-159167

10.3

  The GC Net Lease REIT, Inc. Distribution Reinvestment Plan (included as Appendix C to prospectus, incorporated by reference to the Registrant’s final prospectus filed pursuant to Rule 424(b)(3), filed on November 6, 2009, Commission File No. 333-159167)

10.4

  Tax Protection Agreement by and among The GC Net Lease REIT, Inc., The GC Net Lease REIT Operating Partnership, L.P., Kevin A. Shields, Don G. Pescara and David C. Rupert, incorporated by reference to Exhibit 10.5 to the Registrant’s Registration Statement on Form S-11, filed on May 12, 2009, Commission File No. 333-159167

10.5

  Form of Master Property Management, Leasing and Construction Management Agreement, incorporated by reference to Exhibit 10.6 to the Registrant’s Quarterly Report on Form 10-Q, filed on December 10, 2009, Commission File No. 333-159167

10.6

  Lease Agreement for Renfro Property, incorporated by reference to Exhibit 10.7 to Pre-Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-11, filed on August 19, 2009, Commission File No. 333-159167

10.7

  Amendment to Lease Agreement for Renfro Property, incorporated by reference to Exhibit 10.8 to Pre-Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-11, filed on August 19, 2009, Commission File No. 333-159167

10.8

  Lease Agreement for Plainfield Property, incorporated by reference to Exhibit 10.9 to Pre-Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-11, filed on August 19, 2009, Commission File No. 333-159167

10.9

  Amendment to Lease Agreement for Plainfield Property, incorporated by reference to Exhibit 10.10 to Pre-Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-11, filed on August 19, 2009, Commission File No. 333-159167

10.10

  Contribution Agreement for Renfro Property, incorporated by reference to Exhibit 10.11 to Pre- Effective Amendment No. 2 to the Registrant’s Registration Statement on Form S-11, filed on September 25, 2009, Commission File No. 333-159167

 

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Exhibit

No.

 

Description

10.11

  Contribution Agreement for Plainfield Property, incorporated by reference to Exhibit 10.12 to Pre-Effective Amendment No. 2 to the Registrant’s Registration Statement on Form S-11, filed on September 25, 2009, Commission File No. 333-159167

10.12

  Fixed Rate Note for Plainfield Property, incorporated by reference to Exhibit 10.17 to the Registrant’s Annual Report on Form 10-K, filed on March 30, 2010, Commission File No. 333-159167

10.13

  Contribution Agreement for Will Partners Property dated June 4, 2010, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on June 9, 2010, Commission File No. 333-159167

10.14

  Amended and Restated Lease for Will Partners Property dated April 26, 2000, incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed on June 9, 2010, Commission File No. 333-159167

10.15

  First Amendment to Amended and Restated Lease for Will Partners Property dated June 4, 2010, incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed on June 9, 2010, Commission File No. 333-159167

10.16

  Tax Protection Agreement for Will Partners Property dated June 4, 2010, incorporated by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed on June 9, 2010, Commission File No. 333-159167

10.17

  Credit Agreement for KeyBank Revolver dated June 4, 2010, incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed on June 9, 2010, Commission File No. 333-159167

10.18

  Guaranty for KeyBank Revolver dated June 4, 2010, incorporated by reference to Exhibit 10.6 to the Registrant’s Current Report on Form 8-K, filed on June 9, 2010, Commission File No. 333-159167

10.19

  Contribution Agreement for Emporia Partners Property dated August 27, 2010, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on August 30, 2010, Commission File No. 333-159167

10.20

  Tax Protection Agreement for Emporia Partners Property dated August 27, 2010, incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed on August 30, 2010, Commission File No. 333-159167

10.21

  Lease for Emporia Partners Property dated January 3, 2001, incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed on August 30, 2010, Commission File No. 333-159167

10.22

  Amended and Restated Limited Liability Company Agreement for Emporia Partners dated August 11, 2003, incorporated by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed on August 30, 2010, Commission File No. 333-159167

10.23

  First Amendment to Amended and Restated Limited Liability Company Agreement for Emporia Partners dated August 27, 2010, incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed on August 30, 2010, Commission File No. 333-159167

10.24

  Fixed Rate Note for Emporia Partners Property dated August 8, 2003, incorporated by reference to Exhibit 10.6 to the Registrant’s Current Report on Form 8-K, filed on August 30, 2010, Commission File No. 333-159167

10.25

  Guaranty Agreement for Emporia Partners Property dated August 27, 2010, incorporated by reference to Exhibit 10.7 to the Registrant’s Current Report on Form 8-K, filed on August 30, 2010, Commission File No. 333-159167

10.26

  Purchase and Sale Agreement for ITT Property, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on September 24, 2010, Commission File No. 333-159167

 

60


Table of Contents
Index to Financial Statements
Exhibit
No.
 

Description

10.27

  Net Commercial Lease between Panattoni/Phelan-Roxford and ITT Educational Services, Inc. dated August 3, 1995, incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed on September 24, 2010, Commission File No. 333-159167

10.28

  Second Amendment to Lease between Panattoni/Phelan-Sylmar Joint Venture and ITT Educational Services, Inc. dated August 27, 2007, incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed on September 24, 2010, Commission File No. 333-159167

10.29

  Second Amended and Restated Advisory Agreement, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on November 16, 2010, Commission File No. 333-159167

10.30

  First Amendment to Credit Agreement for KeyBank Revolver, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on November 29, 2010, Commission File No. 333-159167

10.31

  Purchase and Sale Agreement by and between One Directory Place LLC and The GC Net Lease (Loveland) Investors, LLC, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed on January 6, 2011, Commission File No. 333-159167

10.32

  Lease between One Directory Place LLC and Directory Printing Company, incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed on January 6, 2011, Commission File No. 333-159167

10.33

  First Amendment to Lease between One Directory Place LLC and Quebecor Printing Loveland, Inc., incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed on January 6, 2011, Commission File No. 333-159167

10.34

  Second Amendment to Lease between One Directory Place LLC and Quebecor World Loveland, Inc., incorporated by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed on January 6, 2011, Commission File No. 333-159167

10.35

  Third Amendment to Lease between One Directory Place LLC and World Color (USA), LLC, incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed on January 6, 2011, Commission File No. 333-159167

10.36

  Lease Memorandum, incorporated by reference to Exhibit 10.6 to the Registrant’s Current Report on Form 8-K, filed on January 6, 2011, Commission File No. 333-159167

21.1

  Subsidiaries of The GC Net Lease REIT, Inc., incorporated by reference to Exhibit 21.1 to Post- Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-11, filed on April 8, 2010, Commission File No. 333-159167

31.1*

  Certification of Principal Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*

  Certification of Principal Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*

  Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002

32.2*

  Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002

 

 

* Filed herewith.

 

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Index to Financial Statements

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of El Segundo, State of California, on March 24, 2011.

 

THE GC NET LEASE REIT, INC.
By:  

/s/ Kevin A. Shields

 

 

Kevin A. Shields

  President and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

 

Signature

  

Title

 

Date

/s/ Kevin A. Shields

  

President and Director

  March 24, 2011

 

Kevin A. Shields

   (Principal Executive Officer)  

/s/ Joseph E. Miller

   Chief Financial Officer and Treasurer   March 24, 2011

 

Joseph E. Miller

   (Principal Financial and Accounting Officer)  

/s/ Gregory M. Cazel

   Independent Director  

March 24, 2011

 

Gregory M. Cazel

    

/s/ Timothy J. Rohner

   Independent Director   March 24, 2011

 

Timothy J. Rohner

    

 

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Table of Contents
Index to Financial Statements

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Consolidated Financial Statements

  

Report of Independent Registered Public Accounting Firm

     F-2   

Consolidated Balance Sheets as of December 31, 2010 and 2009

     F-3   

Consolidated Statements of Operations for the Years Ended December 31, 2010 and 2009

     F-4   

Consolidated Statements of Equity for the Years Ended December 31, 2010 and 2009

     F-5   

Consolidated Statements of Cash Flows for the Years Ended December 31, 2010 and 2009

     F-6   

Notes to Consolidated Financial Statements

     F-7   
Financial Statement Schedule   

Schedule III- Real Estate Assets and Accumulated Depreciation and Amortization

     S-1   

All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.

 

F-1


Table of Contents
Index to Financial Statements

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of

The GC Net Lease REIT, Inc.:

We have audited the accompanying consolidated balance sheets of The GC Net Lease REIT, Inc. (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, equity, and cash flows for each of the two years in the period ended December 31, 2010. Our audits also included the financial statement schedule listed in the index at Item 15. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The GC Net Lease REIT, Inc. at December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

Los Angeles, California

March 24, 2011

 

F-2


Table of Contents
Index to Financial Statements

CONSOLIDATED FINANCIAL STATEMENTS

THE GC NET LEASE REIT, INC.

CONSOLIDATED BALANCE SHEETS

 

     December 31, 2010     December 31, 2009  
ASSETS     

Cash and cash equivalents

   $ 1,636,072      $ 387,272   

Restricted cash

     1,658,070        655,670   

Real estate:

    

Land

     11,703,796        5,108,916   

Building and improvements

     77,096,442        41,009,335   

Tenant origination and absorption cost

     18,095,906        8,289,273   
                

Total real estate

     106,896,144        54,407,524   

Less: accumulated depreciation and amortization

     (3,862,595     (920,919
                

Total real estate, net

     103,033,549        53,486,605   

Above market leases, net

     1,725,856        101,591   

Deferred rent

     671,995        206,770   

Deferred financing costs, net

     967,051        -   

Other assets

     448,483        457,022   
                

Total assets

   $ 110,141,076      $ 55,294,930   
                
LIABILITIES AND EQUITY     

Mortgage payable

     26,129,231        34,041,558   

Credit Facility

     35,000,000        -   

Bridge Loan

     7,871,500        -   

Restricted reserves

     538,741        208,333   

Accounts payable and other liabilities

     857,322        1,033,745   

Distributions payable

     248,092        128,824   

Due to affiliates, net

     1,480,570        1,022,526   

Below market leases, net

     870,807        581,019   
                

Total liabilities

     72,996,263        37,016,005   

Commitments and contingencies (Note 8)

    

Noncontrolling interests subject to redemption, 531,000 and no units eligible towards redemption as of December 31, 2010 and December 31, 2009, respectively

     4,886,686        -   

Common stock subject to redemption

     170,810        8,994   

Stockholders’ equity:

    

Preferred Stock, $0.001 par value; 200,000,000 shares authorized; no shares outstanding, as of December 31, 2010 and December 31, 2009

     -        -   

Common Stock, $0.001 par value; 700,000,000 shares authorized; 1,845,339 and 252,319 shares outstanding, as of December 31, 2010 and December 31, 2009, respectively

     18,438        2,523   

Additional paid-in capital

     15,441,289        928,009   

Cumulative distributions

     (713,332     (92,834

Accumulated deficit

     (1,236,878     (246,515
                

Total stockholders’ equity

     13,509,517        591,183   

Noncontrolling interests

     18,577,800        17,678,748   
                

Total equity

     32,087,317        18,269,931   
                

Total liabilities and equity

   $ 110,141,076      $ 55,294,930   
                

See accompanying notes.

 

F-3


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended December 31,  
     2010     2009  

Revenues:

    

Rental income

   $ 6,509,724      $ 2,507,487   

Property tax recovery

     755,370        213,878   

Interest income

     4,647        11,212   
                

Total revenue

     7,269,741        2,732,577   
                

Expenses:

    

Asset management fees to affiliates

     560,141        219,674   

Property management fees to affiliates

     188,793        68,442   

Property tax expense

     755,370        213,878   

Acquisition fees and expenses

     2,103,134        1,637,592   

General and administrative expenses

     1,359,686        683,769   

Depreciation and amortization

     2,941,676        920,919   

Interest expense

     3,170,029        1,223,889   
                

Total expenses

     11,078,829        4,968,163   
                

Net loss

     (3,809,088     (2,235,586

Net loss attributable to noncontrolling interests

     (2,818,725     (1,989,071
                

Net loss attributable to The GC Net Lease REIT, Inc. common stockholders

   $ (990,363   $ (246,515
                

Net loss per share, basic and diluted

   $ (1.08   $ (1.79
                

Weighted average number of common shares outstanding, basic and diluted

     919,833        137,598   
                

Distributions declared per common share

   $ 0.68      $ 0.44   
                

See accompanying notes.

 

F-4


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

CONSOLIDATED STATEMENTS OF EQUITY

 

     Common Stock     Additional
Paid-In
    Cumulative     Accumulated     Total
Stockholders’
    Non-controlling     Total  
     Shares     Amount     Capital     Distributions     Deficit     Equity     Interests     Equity  

Balance, December 31, 2008

     100      $ 1      $ 999      $ -      $ -      $ 1,000      $ 200,000      $ 201,000   

Gross proceeds from issuance of common stock

     252,219        2,522        2,519,665        -        -        2,522,187        -        2,522,187   

Discount on issuance of common stock

     -        -        (121,987     -        -        (121,987     -        (121,987

Offering costs

     -        -        (1,470,668     -        -        (1,470,668     -        (1,470,668

Distributions

     -        -        -        (83,840     -        (83,840     -        (83,840

Issuance of shares for distribution reinvestment plan

     947        9        8,985        (8,994     -        -        -        -   

Additions to common stock subject to redemption

     (947     (9     (8,985     -        -        (8,994     -        (8,994

Contribution of noncontrolling interests

     -        -        -        -        -        -        20,200,000        20,200,000   

Distributions for noncontrolling interests

     -        -        -        -        -        -        (732,181     (732,181

Net loss

     -        -        -        -        (246,515     (246,515     (1,989,071     (2,235,586
                                                                

Balance, December 31, 2009

     252,319        2,523        928,009        (92,834     (246,515     591,183        17,678,748        18,269,931   

Gross proceeds from issuance of common stock

     1,575,040        15,736        15,727,108        -        -        15,742,844        -        15,742,844   

Discount on issuance of common stock

     -        -        (21,635     -        -        (21,635     -        (21,635

Offering costs

     -        -        (1,192,014     -        -        (1,192,014     -        (1,192,014

Distributions

     -        -        -        (458,682     -        (458,682     -        (458,682

Issuance of shares for distribution reinvestment plan

     17,033        170        161,646        (161,816     -        -        -        -   

Additions to common stock subject to redemption

     947        9        (161,825     -        -        (161,816     -        (161,816

Contribution of noncontrolling interests

     -        -        -        -        -        -        10,380,000        10,380,000   

Additions to noncontrolling interests subject to redemption

     -        -        -        -        -        -        (4,886,686     (4,886,686

Distributions for noncontrolling interests

     -        -        -        -        -        -        (1,568,275     (1,568,275

Distributions for noncontrolling interests subject to redemption

     -        -        -        -        -        -        (207,262     (207,262

Net loss

     -        -        -        -        (990,363     (990,363     (2,818,725     (3,809,088
                                                                

Balance, December 31, 2010

     1,845,339      $ 18,438      $ 15,441,289      $ (713,332   $ (1,236,878   $ 13,509,517      $ 18,577,800      $ 32,087,317   
                                                                

See accompanying notes.

 

F-5


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year Ended December 31,  
     2010     2009  

Operating Activities:

    

Net loss

   $ (3,809,088   $ (2,235,586

Adjustments to reconcile net loss to net cash (used in) provided by operations:

    

Depreciation of building and building improvements

     1,884,394        569,346   

Amortization of intangible assets

     1,057,282        351,573   

Amortization of above and below market leases

     61,604        (19,314

Amortization of deferring financing costs

     156,099        -   

Deferred rent

     (465,225     (206,770

Change in operating assets and liabilities:

    

Other assets

     8,539        (457,022

Accounts payable and other liabilities

     (176,423     1,033,745   

Due to affiliates

     458,044        1,022,526   
                

Net cash (used in) provided by operating activities

     (824,774     58,498   
                

Investing Activities:

    

Acquisition of properties, including reserves

     (38,754,607     -   

Tenant improvements

     (452,615     3,159,445   

Tenant improvements funded from restricted cash reserves

     452,615        (3,159,445
                

Net cash used in investing activities

     (38,754,607     -   
                

Financing Activities:

    

Proceeds from borrowings

     42,871,500        -   

Principal payoff of secured indebtedness

     (12,911,990     -   

Principal amortization payments on secured indebtedness

     (422,423     (114,561

Deferred financing costs

     (1,123,150     -   

Issuance of common stock, net

     14,529,195        929,532   

Distributions to noncontrolling interests

     (1,709,708     (616,377

Distributions to common stockholders

     (405,243     (70,820
                

Net cash provided by financing activities

     40,828,181        127,774   
                

Net increase in cash and cash equivalents

     1,248,800        186,272   

Cash and cash equivalents at the beginning of the period

     387,272        201,000   
                

Cash and cash equivalents at the end of the period

   $ 1,636,072      $ 387,272   
                

Supplemental Disclosures of Cash Flow Information:

    

Cash paid for interest

   $ 2,847,765      $ 1,030,521   

Contribution of real estate assets by affiliates

   $ 10,380,000      $ 50,749,336   

Supplemental Disclosures of Significant Non-cash Transactions:

    

Restricted cash- assumed upon contribution of real estate assets by affiliates

   $ 646,096      $ 3,606,782   

Restricted cash- ongoing improvement reserve paid by tenant

   $ 152,515      $ 208,333   

Mortgage debt assumed in conjunction with the contribution of real estate assets by affiliates

   $ 5,422,086      $ 34,156,119   

Limited partnership units of the operating partnership issued in conjunction with the contribution of real estate assets by affiliates, net of discount

   $ 10,380,000      $ 20,200,000   

Distributions payable to noncontrolling interests

   $ 181,633      $ 115,804   

Distributions payable to common stockholders

   $ 66,459      $ 13,020   

Common stock issued pursuant to the distribution reinvestment plan

   $ 161,816      $ 8,994   

See accompanying notes.

 

F-6


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

1. Organization

The GC Net Lease REIT, Inc., a Maryland corporation (the “Company”), was formed on August 28, 2008 under the Maryland General Corporation Law. The Company was organized primarily with the purpose of acquiring single tenant net lease properties, and expects to use a substantial amount of the net proceeds from the Public Offering (as defined below) to invest in these properties. The Company deferred the election to be taxed as a REIT until December 31, 2010 to ensure that certain non-financial requirements were satisfied, which the Company did not satisfy as of December 31, 2009. As of December 31, 2010, the Company satisfied these non-financial requirements. The Company’s year end is December 31.

Griffin Capital Corporation, a California corporation (the “Sponsor”), is the sponsor of the Company’s Public Offering (as defined below). The Company’s Sponsor was formed in 1995 to principally engage in acquiring and developing office and industrial properties.

The GC Net Lease REIT Advisor, LLC, a Delaware limited liability company (the “Advisor”) was formed on August 27, 2008. The Sponsor is the sole member of the Advisor. On November 6, 2009, the Company entered into its amended and restated advisory agreement for the Public Offering, as amended. On November 9, 2010, the Company entered into its second amended and restated advisory agreement for the Public Offering (the “Second Amended and Restated Advisory Agreement”). The Advisor is responsible for managing the Company’s affairs on a day-to-day basis and identifying and making acquisitions and investments on behalf of the Company under the terms of the advisory agreement. The officers of the Advisor are also officers of the Sponsor. The advisory agreement has a one-year term and it may be renewed for an unlimited number of successive one-year periods.

On August 28, 2008, the Advisor purchased 100 shares of common stock for $1,000 and became the Company’s initial stockholder. The Company’s Third Articles of Amendment and Restatement authorize 700,000,000 shares of common stock with a par value of $0.001 and 200,000,000 shares of preferred stock with a par value of $0.001. On February 20, 2009, the Company began to offer a maximum of 10,000,000 shares of common stock, which included shares for sale pursuant to the distribution reinvestment plan, pursuant to a private placement offering to accredited investors (collectively, the “Private Offering”). Simultaneously with the Private Offering, the Company undertook the process of registering an offering of a maximum of 82,500,000 shares of common stock, consisting of 75,000,000 shares for sale to the public (the “Primary Public Offering”) and 7,500,000 shares for sale pursuant to the distribution reinvestment plan at $9.50 per share (collectively, the “Public Offering”). On November 6, 2009, the Securities and Exchange Commission (the “SEC”) declared the Public Offering effective, and the Company terminated the Private Offering with the commencement of the Public Offering. As of December 31, 2010 and December 31, 2009, the Company had 1,845,339 and 252,319 shares outstanding, respectively. As of December 31, 2010 and December 31, 2009, the Company had $170,810 and $8,994 in shares classified as common stock subject to redemption. (See Note 7, Share Redemption Program).

Griffin Capital Securities, Inc. (the “Dealer Manager”) is one of the Company’s affiliates. The Dealer Manager is responsible for marketing the Company’s shares being offered pursuant to the Public Offering. On October 27, 2009, the Company and the Dealer Manager entered into a dealer manager agreement for the Public Offering. The dealer manager agreement may be terminated by either party upon prior written notice.

The GC Net Lease REIT Operating Partnership, L.P., a Delaware limited partnership (the “Operating Partnership”), was formed on August 29, 2008. On December 26, 2008, the Advisor

 

F-7


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

purchased a 99% limited partnership interest in the Operating Partnership for $200,000 and on December 26, 2008, the Company contributed the initial $1,000 capital contribution, received by the Advisor, to the Operating Partnership in exchange for a 1% general partner interest. As of December 31, 2010, the Company owns approximately 37% of the limited partnership units of the Operating Partnership, and, as a result of the contribution of four properties to the Company, certain affiliates of the Sponsor, including the Company’s President and Chairman, Kevin A. Shields, the Company’s Vice President — Acquisitions, Don Pescara and David C. Rupert, the President of the Sponsor, own approximately 52% of the limited partnership units of the Operating Partnership. The remaining approximately 11% of the limited partnership units are owned by third parties. Prior to January 1, 2009 the Company did not own any properties and, therefore, during the year ended December 31, 2008 there were no operations. The Operating Partnership will own, directly or indirectly, all of the properties acquired. The Operating Partnership will conduct certain activities through the Company’s taxable REIT subsidiary, The GC Net Lease REIT TRS, Inc., a Delaware corporation (the “TRS”) formed on September 2, 2008, which is a wholly-owned subsidiary of the Operating Partnership.

The Company’s property manager is The GC Net Lease REIT Property Management, LLC, a Delaware limited liability company (the “Property Manager”), which was formed on August 28, 2008 to manage the Company’s properties. The Property Manager will derive substantially all of its income from the property management services it will perform for the Company.

 

2. Basis of Presentation and Summary of Significant Accounting Policies

The accompanying consolidated financial statements of the Company are prepared by management on the accrual basis of accounting and in accordance with principles generally accepted in the United States (“GAAP”) as contained in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification” or “ASC”), and in conjunction with rules and regulations of the SEC. The consolidated financial statements include accounts of the Company and the Operating Partnership. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statement and accompanying notes. Actual results could materially differ from those estimates.

Cash and Cash Equivalents

The Company considers all short-term, highly liquid investments that are readily convertible to cash with a maturity of three months or less at the time of purchase to be cash equivalents. Cash equivalents may include cash and short-term investments. Short-term investments are stated at cost, which approximates fair value. There were no restrictions on the use of the Company’s operating cash balance as of December 31, 2010 and December 31, 2009.

The Company maintains cash accounts with major financial institutions. The cash balances consist of business checking accounts and money market accounts. These accounts are insured by the Federal Deposit Insurance Corporation up to $250,000 at each institution. At times, the balances in these accounts may exceed the insured amounts. The Company has not experienced any losses with respect to cash balances in excess of government-provided insurance. Management believes there was no significant concentration of credit risk with respect to these cash balances as of December 31, 2010 and December 31, 2009.

 

F-8


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

Restricted Cash

In conjunction with the acquisition and contribution of certain real estate assets (see Note 3, Real Estate), the Company assumed certain reserves to be used for specific property improvements. As of December 31, 2010 and December 31, 2009, the balance of these reserves, included in the consolidated balance sheets as restricted cash, was $1.66 million and $0.66 million, respectively.

Real Estate

Purchase Price Allocation

The Company applies the provisions ASC 805-10, “Business Combinations,” to account for business combinations. In accordance with the provisions, the Company recognizes the assets acquired, the liabilities assumed and any noncontrolling interest in the acquired entity at their fair values as of the acquisition date, on an “as if vacant” basis. Further, the Company recognizes the fair value of assets acquired, liabilities assumed and any noncontrolling interest in acquisitions of less than a 100% interest when the acquisition constitutes a change in control of the acquired entity. The accounting provisions have also established that acquisition-related costs and restructuring costs are considered separate and not a component of a business combination, and therefore, are expensed as incurred.

Acquired in-place leases are valued as above-market or below-market as of the date of acquisition. The valuation is measured based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (a) the contractual amounts to be paid pursuant to the in-place leases and (b) management’s estimate of fair market lease rates for the corresponding in-place leases over a period equal to the remaining non-cancelable term of the lease for above-market leases, taking into consideration extension options for below-market leases. In addition, renewal options are considered and will be included in the valuation of in-place leases if (1) it is likely that the tenant will exercise the option, and (2) the renewal rent is considered to be sufficiently below a fair market rental rate at the time of renewal. The above-market and below-market lease values are capitalized as intangible lease assets or liabilities and amortized as an adjustment to rental income over the remaining terms of the respective leases.

The aggregate fair value of in-place leases includes direct costs associated with obtaining a new tenant, opportunity costs associated with lost rentals which are avoided by acquiring an in-place lease, and tenant relationships. Direct costs associated with obtaining a new tenant include commissions, tenant improvements, and other direct costs and are estimated using methods similar to those used by independent appraisals and management’s consideration of current market costs to execute a similar lease. These direct costs are included as intangible lease assets in the consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases. The value of opportunity costs is calculated using the contractual amounts to be paid, including real estate taxes, insurance, and other operating expenses, pursuant to the in-place leases over a market lease-up period for a similar lease. Customer relationships are valued based on management’s evaluation of certain characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics management will consider in allocating these values include the nature and extent of the Company’s existing business relationships with tenants, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors. These intangibles will be included in intangible lease assets in the consolidated balance sheets and are amortized to expense over the remaining term of the respective leases.

 

F-9


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

The determination of the fair values of the assets and liabilities acquired requires the use of significant assumptions with regard to the current market rental rates, rental growth rates, discount rates and other variables. The use of inappropriate estimates would result in an incorrect assessment of the purchase price allocations, which could impact the amount of the Company’s reported net income.

Depreciation

The purchase price of real estate acquired and costs related to development, construction, and property improvements will be capitalized. Repairs and maintenance costs include all costs that do not extend the useful life of the real estate asset and will be charged to expense as incurred. The Company considers the period of future benefit of an asset to determine the appropriate useful life. The Company anticipates the estimated useful lives of its assets by class to be generally as follows:

 

Buildings

  25-40 years

Building Improvements

  5-20 years

Land Improvements

  15-25 years

Tenant Improvements

  Shorter of estimated useful life or remaining contractual lease term

Tenant origination and absorption cost

  Remaining contractual lease term

In-place lease valuation

  Remaining contractual lease term with consideration as to extension options for below-market leases

Impairment of Real Estate and Related Intangible Assets and Liabilities

The Company will continually monitor events and changes in circumstances that could indicate that the carrying amounts of real estate and related intangible assets may not be recoverable. When indicators of potential impairment are present that indicate that the carrying amounts of real estate and related intangible assets may not be recoverable, management assesses the recoverability of the assets by determining whether the carrying value of the assets will be recovered through the undiscounted future operating cash flows expected from the use of the assets and the eventual disposition. If, based on this analysis, the Company does not believe that it will be able to recover the carrying value of the asset, the Company will record an impairment loss to the extent the carrying value exceeds the estimated fair value of the asset.

Projections of expected future undiscounted cash flows require management to estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, discount rates, the number of months it takes to re-lease the property and the number of years the property is held for investment. There were no impairment indicators present at December 31, 2010 that would have required the Company to record an impairment loss related to the real estate assets or intangible assets and liabilities.

Revenue Recognition

With the acquisition and contribution of certain real estate assets (see Note 3, Real Estate), the associated leases have net minimum rent payment increases during the term of the lease, and are recorded to rental revenue on a straight-line basis, commencing as of the contribution or acquisition date. If a lease provides for contingent rental income, the Company will defer the recognition of contingent rental income, such as percentage rents, until the specific target that triggers the contingent rental income is achieved. Currently, there are no leases that provide for contingent rental income.

 

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Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

During the years ended December 31, 2010 and 2009, the Company recognized deferred rent from tenants of $0.47 million and $0.21 million, respectively. As of December 31, 2010 and 2009, the cumulative deferred rent balance was $0.67 million and $0.21 million, respectively, and is included in deferred rent on the consolidated balance sheets.

The Company records an estimate for real estate tax reimbursement each month. At the end of the calendar year the Company reconciles the estimated real estate tax reimbursement to the actual amount incurred and adjusts the property tax recovery to reflect the actual amount incurred.

Organizational and Offering Costs

Organizational and offering costs of the Private Offering and the Public Offering were paid by the Sponsor, on behalf of the Advisor, for the Company and will be reimbursed from the proceeds of the Private Offering and the Public Offering. Organizational and offering costs consist of all expenses (other than sales commissions and the dealer manager fee) to be paid by the Company in connection with the Public Offering, including legal, accounting, printing, mailing and filing fees, charges from the escrow holder and other accountable offering expenses, including, but not limited to, (i) amounts to reimburse the Advisor for all marketing related costs and expenses, such as salaries and direct expenses of employees of the Advisor and its affiliates in connection with registering and marketing the Company’s shares; (ii) technology costs associated with the offering of the Company’s shares; (iii) costs of conducting training and education meetings; (iv) costs of attending seminars conducted by participating broker-dealers; and (v) payment or reimbursement of bona fide due diligence expenses.

The initial advisory agreement required the Company to pay directly or reimburse the Advisor for all organizational and offering expenses related to the Private Offering. Pursuant to the Second Amended and Restated Advisory Agreement, the Company will reimburse the Advisor for organizational and offering expenses incurred in connection with the Primary Public Offering in an amount not to exceed 3.5% of gross offering proceeds of the terminated or completed Primary Public Offering for issuer costs (excluding sales commissions and dealer manager fees). In addition, pursuant to the Second Amended and Restated Advisory Agreement, organization and offering expenses (including sales commissions and dealer manager fees and non-accountable due diligence expense allowance, but excluding acquisition fees and expenses) may not exceed 15% of gross offering proceeds of the terminated or completed Public Offering. If the organization and offering expenses exceed such limits discussed above, within 60 days after the end of the month in which the Public Offering terminates or is completed, the Advisor must reimburse the Company for any excess amounts. As long as the Company is subject to the Statement of Policy Regarding Real Estate Investment Trusts published by the North American Securities Administrators Association (“NASAA REIT Guidelines”), such limitations discussed above will also apply to any future public offerings.

On May 6, 2009, the Company sold the minimum amount of shares and thereby became obligated to the Advisor for offering and organizational costs incurred as follows:

 

     Year Ended December 31,  
     2010     2009  

Cumulative offering costs- Private and Public Offerings

   $ 3,507,244      $ 1,470,668   

Cumulative organizational costs- Private and Public Offerings

   $ 341,455      $ 322,146   

Due to/(from) Advisor (included in “Due to Affiliates”)- see discussion below

   $ (276,632   $ 812,802   

 

F-11


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

As of December 31, 2010, the Company incurred organizational and offering costs related to its Public Offering of approximately $3.29 million, which exceeds the 15% of gross proceeds limitation pursuant to the Second Amended and Restated Advisory Agreement. Therefore, if the Company terminated its Public Offering on December 31, 2010, the probability that the Company would be liable to the Advisor for advanced organizational and offering costs, based on the gross proceeds raised to date and organizational and offering costs incurred in excess of the limitation discussed above, is remote. As a result, the Company generated a receivable due from the Advisor of $0.28 million (after deducting $0.64 million in unreimbursed amounts previously advanced by the Advisor), which is reflected as a reduction in the “Due to Affiliates” balance in the consolidated balance sheets. No payment is required until 60 days following the completion or termination of the offering in accordance with the Second Amended and Restated Advisory Agreement. The Company continues to monitor both the 3.5% and 15% limitations and expects the receivable to decrease as the Company raises additional offering proceeds. (See Note 6, Related Party Transactions.)

Deferred Financing Costs

Deferred financing costs represent commitment fees, loan fees, legal fees and other third-party costs associated with obtaining financing. These costs are amortized as interest expense over the terms of the respective financing agreements. As of December 31, 2010, the Company’s deferred financing costs, net of amortization, were $0.97 million. There were no deferred financing costs as of December 31, 2009.

Noncontrolling Interests

Due to the Company’s control through the general partner interest in the Operating Partnership and the limited rights of the limited partners, the Operating Partnership, including its wholly-owned subsidiary, is consolidated with the Company and the limited partners’ interests are reflected as noncontrolling interests in the accompanying consolidated balance sheets.

The Company reports noncontrolling interests in subsidiaries within equity in the consolidated financial statements, but separate from total stockholders’ equity. Also, any acquisitions or dispositions of noncontrolling interests that do not result in a change of control are accounted for as equity transactions. Further, the Company recognizes a gain or loss in net income when a subsidiary is deconsolidated upon a change in control. Net income allocated to noncontrolling interests is shown as a reduction to net income in calculating net income available to common stockholders. Any future purchase or sale of an interest in an entity that results in a change of control may have a material impact on the financial statements, as the interest in the entity will be recognized at fair value with gains and losses included in net income (loss).

If noncontrolling interests are determined to be redeemable, they are classified as temporary equity and reported at their redemption value as of the balance sheet date. Thus, noncontrolling interests determined to be redeemable were classified as temporary equity.

Share-Based Compensation

On February 12, 2009, the Company adopted an Employee and Director Long-Term Incentive Plan (the “Plan”) pursuant to which the Company may issue stock-based awards to its directors and full-time employees (should the Company ever have employees), executive officers and full-time employees of the Advisor and its affiliate entities that provide services to the Company, and certain consultants who provide significant services to the Company. The term of the Plan is 10 years. The total number of shares of common stock reserved for issuance under the Plan is 10% of the outstanding shares of stock at

 

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Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

any time. Awards granted under the Plan may consist of stock options, restricted stock, stock appreciation rights and other equity-based awards. The stock-based payment will be measured at fair value and recognized as compensation expense over the vesting period. No awards have been granted under the Plan as of December 31, 2010.

Fair Value Measurements

In April 2009, the FASB issued updated guidance related to the interim and annual disclosures about the fair value of financial instruments in ASC 825-10, “Disclosure about Fair Value of Financial Instruments” and ASC 820-10, “Fair Value Measurements and Disclosures” (“ASC 820”). The provisions require interim and annual disclosures of the fair value of all financial instruments (recognized or unrecognized) and include the following:

 

   

Effective April 1, 2009: new provisions providing additional guidance in determining fair values when there is no active market or where the price inputs being used represent distressed sales; and

 

   

Effective January 1, 2009: new framework for fair value measurements and disclosure for all nonfinancial assets and nonfinancial liabilities, including those reported at fair value on a nonrecurring basis; and new provisions pertaining to the fair value for assets or liabilities arising from contingencies in business combinations and property acquisitions.

The updated guidance in ASC 820 is effective for interim and annual periods ending after June 15, 2009 and provides guidance on how to determine the fair value of assets and liabilities in the current economic environment and reemphasizes that the objective of a fair value measurement remains an exit price. If the Company were to conclude that there has been a significant decrease in the volume and level of activity of the asset or liability in relation to normal market activities, quoted market values may not be representative of fair value and the Company may conclude that a change in valuation technique or the use of multiple valuation techniques may be appropriate. The updated guidance modifies the requirements for recognizing other-than-temporarily impaired debt securities and revises the existing impairment model for such securities by modifying the current intent and ability indicator in determining whether a debt security is other-than-temporarily impaired.

The framework established by the FASB for measuring fair value in generally accepted accounting principles for both financial and nonfinancial assets and liabilities provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described as follows:

 

   

Level 1. Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets;

 

   

Level 2. Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

 

   

Level 3. Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

F-13


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

In January 2010, the FASB issued updated guidance in ASC 820, which is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years beginning after December 15, 2010.

In August 2009, the FASB issued updated guidance in ASC 820 to provide clarification for the fair value measurement of liabilities in circumstances where quoted prices for an identical liability in an active market are not available. The guidance is effective for the first reporting period beginning after issuance.

Financial instruments as of December 31, 2009, consisted of cash and cash equivalents, restricted cash, accounts receivable, accounts payable and other accrued expenses, and mortgage payable. Financial instruments as of December 31, 2010 consisted of the same accounts as well as the Credit Facility and the Bridge Loan, as defined in Note 4, Debt. Pursuant to the terms of the Credit Facility, the Operating Partnership, in consolidation with the Company, is subject to certain loan compliance covenants, one of which is a varying interest rate covenant that would require the Operating Partnership to effect an interest rate hedge if the minimum varying debt to total debt requirement is not satisfied. As of December 31, 2010, the Company had two interest rate cap agreements in effect for a combined notional amount of $22.20 million. (See Note 4, Debt.) Other than the Plainfield mortgage debt, as discussed in Note 4, Debt, to the consolidated financial statements, the amounts of the financial instruments presented in the consolidated financial statements substantially approximate their fair value. The fair value of the Plainfield mortgage debt is estimated using borrowing rates available to the Company for debt instruments with similar terms and maturities. As of December 31, 2010 and 2009, the fair value of the Plainfield mortgage debt was $21.8 million and $22.17 million, respectively, compared to the carrying value of $20.8 million and $21.04 million, respectively. As such, the adoption of these provisions, each of which were applied on a prospective basis, did not have a material effect to the Company’s financial statements.

Income Taxes

The Company intends to elect to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”) for the year ended December 31, 2010. To qualify as a REIT, the Company must meet certain organizational and operational requirements. The Company intends to adhere to these requirements and maintain its REIT status for the current and subsequent years. As a REIT, the Company generally will not be subject to federal income tax on taxable income that is distributed to stockholders. However, the Company may be subject to certain state and local taxes on its income and property, and federal income and excise taxes on its undistributed taxable income, if any. If the Company fails to qualify as a REIT in any taxable year, the Company will then be subject to federal income taxes on the 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 IRS grants the Company relief under certain statutory provisions. Such an event could materially adversely affect net income and net cash available for distribution to stockholders. As of December 31, 2010, the Company satisfied the REIT requirements and distributed all of its taxable income.

Pursuant to the Code, the Company has elected to treat its corporate subsidiary as a taxable REIT subsidiary (“TRS”). In general, the TRS may perform non-customary services for the Company’s tenants and may engage in any real estate or non real estate-related business. The TRS will be subject to corporate federal and state income tax. As of December 31, 2010, the Company’s TRS had not commenced operations.

 

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Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

The Company provides for income taxes on all transactions that have been recognized in accordance with ASC 740, “Income Taxes” (“ASC 740”). ASC 740 requires that the Company record a valuation allowance against the net deferred income tax assets associated with the Company’s net operating loss (“NOL”) carryforwards if it is “more likely than not” that the Company will not be able to utilize them to offset future taxable income. For the year ended December 31, 2009, due to the uncertainty surrounding the Company’s ability to generate sufficient future taxable income to realize the NOL, the Company recorded a valuation allowance for the entire amount of the net deferred tax asset. For the year ended December 31, 2010, due to the fact that the Company will elect to be taxed as a REIT, the Company has written off its net deferred tax assets and valuation allowance.

Per Share Data

The Company reports earnings per share attributable for the period as (1) basic earnings per share computed by dividing net income (loss) by the weighted average number of shares outstanding during the period, and (2) diluted earnings per share computed by dividing net income by the weighted average number of shares outstanding, including common stock equivalents. As of December 31, 2010, common stock equivalents are anti-dilutive and therefore have no impact on dilutive earnings per share.

The Company made its first distribution on June 15, 2009 to investors of record on May 31, 2009. Distributions declared per common share assumes each share was issued and outstanding each day during the year ended December 31, 2010 and the period from May 31, 2009 through December 31, 2009. Distributions declared per common share was based on daily declaration and record dates selected by the board of directors of $0.00184932 per day per share on the outstanding shares of common stock.

Recently Issued Accounting Pronouncements

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash (“ASU No. 2010-01”). This ASU clarifies that when the stock portion of a distribution allows stockholders to elect to receive cash or stock with a potential limitation on the total amount of cash that all stockholders can elect to receive in the aggregate, the distribution would be considered a share issuance as opposed to a stock dividend and the share issuance would be reflected in earnings per share prospectively. ASU No. 2010-01 is effective for interim and annual periods ending on or after December 15, 2009 and should be applied on a retrospective basis. The adoption of ASU No. 2010-01 did not have an impact on the Company’s consolidated financial statements.

In June 2009, new accounting provisions, ASC 810-10, “Variable Interests and Special Purpose Entities in Consolidated Financial Statements,” were released that eliminate the primarily quantitative model to determine the primary beneficiary of a variable interest entity (“VIE”) and replace it with a qualitative model that focuses on which entities have the power to direct the activities of the VIE as well as the obligation or rights to absorb the VIE’s losses or receive its benefits. The reconsideration of the initial determination of VIE status is still based on the occurrence of certain events. In February 2010, the FASB issued updated guidance in ASC 810, “Consolidation,” which defers the effective date of the consolidation guidance of FASB Statement No. 167 for certain investment funds and money market funds. The update also modifies the requirements for evaluating whether a decision maker’s or service provider’s fee is a variable interest and clarifies that a quantitative calculation in the evaluation thereof should not be the sole basis for determining the above. As of December 31, 2010, the Company did not have any investments, or other variable interests, in entities that were determined to be VIEs.

 

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Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

3. Real Estate

Quad/Graphics

On December 30, 2010, the Company, through the Operating Partnership, acquired an industrial printing facility with a two-story office component located in Loveland, Colorado (“Quad/Graphics property”) from an unaffiliated third party. The Quad/Graphics property is 100% leased to a single tenant, World Color (USA), LLC (“World Color”), on a net lease basis, obligating World Color to all costs and expenses to operate and maintain the property. The lease on the Quad/Graphics property is guaranteed by both World Color Press, Inc. and its parent company Quad/Graphics, Inc. On the acquisition date, the Quad/Graphics lease had a remaining term of approximately 12 years.

The purchase price of the Quad/Graphics property was $11.85 million, which includes the Company’s January rent payment and the prorated share of the December rent payment totaling $0.11 million, respectively, which were paid at closing and recorded as prepaid rent. In addition, the Company funded a deferred maintenance reserve of $0.26 million. The purchase price and related closing fees and expenses were partially financed with $7.87 million in debt from a bridge loan obtained from KeyBank (the “Bridge Loan”), discussed in Note 4, Debt, $4.04 million in cash raised in the Public Offering, and $0.20 million in good faith deposits and was allocated as follows:

 

Land

   $  1,949,600   

 

Building and improvements

   $ 8,210,166   

 

Tenant origination and absorption cost

   $ 2,025,570   

 

In-place lease valuation (below market)

   $ (335,336

ITT

On September 23, 2010, the Company, through the Operating Partnership, acquired a single-story, office facility located in Los Angeles (Sylmar), California (“ITT property”) from an unaffiliated third party. The ITT property is 100% leased to a single tenant, ITT Educational Services, Inc. (“ITT”), on a net lease basis, obligating ITT to all costs and expenses to operate and maintain the property. The landlord is responsible for certain capital expenditures such as roof, parking lot, mechanical and structural costs. On the acquisition date, the ITT lease had a remaining term of approximately six years.

The purchase price of the ITT property was $7.8 million, which includes a $0.35 million reserve for maintenance, $0.03 million in a transferred security deposit obligation and the Company’s prorated share of the September rent payment, $0.02 million, that was paid at closing and recorded as prepaid rent. The purchase price and related closing fees and expenses were partially financed with $5.07 million of the Credit Facility discussed in Note 4, Debt, $2.53 million in cash raised in the Public Offering, and $0.20 million in good faith deposits and was allocated as shown in the table below:

 

Land

   $  2,877,062   

 

Building and improvements

   $ 3,076,738   

 

Tenant origination and absorption cost

   $ 1,145,162   

 

In-place lease valuation (above market)

   $ 336,263   

 

Deferred maintenance reserve assumed

   $ 350,000   

 

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Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

ITT, at their discretion, has the option to renew the in-place lease for an additional five-year term at a specified rate. The increase in rental rate between the current in-place rate and the renewal rate was concluded to approximate market and, as a result, was not factored into the in-place lease valuation.

Emporia Partners

On August 27, 2010, various affiliates of the Sponsor and an entity owned by an affiliate of the Sponsor contributed all of the ownership interests in an entity (“Emporia Partners”) that owns a fully-leased office headquarters and industrial production and distribution facility located in Emporia Kansas (“Emporia Partners property”) to the Company, through the Operating Partnership. The Emporia Partners property is 100% leased to a single tenant, Hopkins Enterprises, Inc. (“Hopkins”), which subleases the property to Hopkins Manufacturing Corporation (“Hopkins Manufacturing”) on a net lease basis, obligating Hopkins to all costs and expenses to operate and maintain the property, including capital expenditures. Pursuant to the Amended and Restated Limited Liability Company Agreement for Emporia Partners, Hopkins, as a member of Emporia Partners, is due priority returns from the rental income received from Hopkins Manufacturing as sub-tenant under the lease. Additionally, Hopkins has the option to extend the lease term for an additional ten-year term at fair market rent and the option to purchase the property pursuant to the terms of the lease. After considering the term of the lease, the lease was classified as an operating lease. On the acquisition date, the Emporia Partners lease had a remaining lease term of approximately 10 years.

The contribution value of the Emporia Partners property was approximately $8.36 million and was allocated as shown below. The Company caused the Operating Partnership to issue $2.9 million in limited partnership units with the remainder of the contribution value and the acquisition fees and expenses paid in connection with the contribution using proceeds from the Public Offering and assumption of the related debt as shown in the following table:

 

Land

   $ 274,110   

 

Building and improvements

   $ 5,693,414   

 

Tenant origination and absorption cost

   $ 1,874,059   

 

Restricted improvement reserve assumed

   $ 514,607   

 

Property tax and insurance reserves assumed

   $ 261,496   

 

Mortgage payable assumed

   $ 5,422,086   

 

Accrued interest

   $ 23,026   

 

Prepaid rent

   $ 11,078   

 

Limited partnership units issued (units)

     315,200   

 

Price per share of units issued

   $ 9.20   

 

Limited partnership units issued (dollars)

   $ 2,900,000   

Will Partners

On June 4, 2010, three unaffiliated third parties and an entity owned by an affiliate of the Sponsor contributed all of the ownership interests in a single-story, warehouse/distribution facility located in Monee, Illinois (“Will Partners property”) to the Company, through the Operating Partnership. The Will Partners property is 100% leased to a single tenant, World Kitchen, LLC (“World Kitchen”), on a net lease basis, obligating World Kitchen to all costs and expenses to operate and maintain the property, including capital expenditures. In conjunction with the acquisition, the World Kitchen lease was

 

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Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

amended, which extended the original termination date five years to February 29, 2020. On the acquisition date the remaining term was approximately 10 years.

The contribution value of the Will Partners property was approximately $26.31 million and was allocated as shown in the table below. The Company caused the Operating Partnership to issue $7.48 million in limited partnership units with the remainder of the contribution value financed with $16.9 million of the Credit Facility discussed in Note 4, Debt approximately $1.75 million in cash raised in the Public Offering, and the Company’s prorated share of the June rent payment, $0.17 million, that was paid at closing and recorded as prepaid rent.

 

Land

   $ 1,494,108   

 

Building and improvements

   $ 18,654,174   

 

Tenant origination and absorption cost

   $ 4,761,842   

 

In-place lease valuation (above market)

   $ 1,395,154   

 

Restricted improvement reserve assumed

   $ 742,366   

 

Prepaid rent

   $ 173,325   

 

Limited partnership units issued (units)

     813,000   

 

Price per share of units issued

   $ 9.20   

 

Limited partnership units issued (dollars)

   $ 7,480,000   

Renfro and Plainfield

On June 18, 2009, affiliates of the Sponsor contributed membership interests in two entities, Plainfield Partners, LLC, a single member limited liability company which owns an office/laboratory property located in Plainfield, Illinois (“Plainfield”) and Renfro Properties, LLC, a single member limited liability company which owns a single-story warehouse/distribution property located in Clinton, South Carolina (“Renfro”), to the Operating Partnership. The properties are occupied by Chicago Bridge & Iron Company (“CB&I”) and Renfro Corporation (“Renfro Corp”), respectively, and are full net leases, obligating the tenant for all expenses and costs of operating and maintaining the property, including capital expenditures. As of the contribution date, the CB&I lease had a remaining lease term of 13 years, and the Renfro Corp lease had a remaining lease term of 12 years.

The combined fair market value of the assets contributed for Renfro and Plainfield was approximately $54.36 million and was allocated as shown in the table below:

 

Land

   $ 5,108,916   

 

Building and improvements

   $ 37,849,890   

 

Tenant origination and absorption cost

   $ 8,289,273   

 

In-place lease valuation (above market)

   $ 106,487   

 

In-place lease valuation (below market)

   $ (605,228

Restricted improvement reserve assumed

   $ 3,606,782   

 

Mortgage payable assumed

   $ 34,156,119   

 

Limited partnership units issued (units)

     2,020,000   

 

Price per share of units issued

   $ 10.00   

 

Limited partnership units issued (dollars)

   $ 20,200,000   

 

F-18


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

The properties acquired through the contributions of the entity interests of Plainfield Partners, LLC, Renfro Properties, LLC, Will Partners, and Emporia Partners, along with the acquisitions of the ITT and Quad/Graphics properties are heretofore referred to as the “Properties.”

Intangibles

The Company allocated a portion of the acquired and contributed real estate asset value to in-place lease valuation and tenant origination and absorption cost, as discussed above and as shown below. The leases were measured against comparable leasing information and the present value of the difference between the contractual, in-place rent and the fair market rent was calculated using a 9.50% discount rate for the Renfro Corp and CB&I leases, a 9.00% discount rate for the Will Partners lease, a 9.76% discount rate for the ITT lease, and a 10.26% discount for the Quad/Graphics lease. The Emporia Partners property in-place lease was considered to be at market, therefore none of the purchase price was allocated to an in-place lease valuation.

 

     In-place Lease
Valuation
     Tenant Origination
and

Absorption Cost
 

Annual amortization

   $ 135,577       $ 1,700,130   

5-year amortization

   $ 677,885       $ 8,500,650   

Weighted-average remaining amortization period

     9.62 years         10.21 years   

Reserves

As part of the real estate asset acquisitions and contributions, the Company assumed certain building and tenant improvement reserves. Additionally, an ongoing replacement reserve is funded by certain tenants pursuant to each tenant’s respective lease as follows:

 

     December 31,
2009
    Balance upon
acquisition/
contribution during
the year ended
December 31, 2010
    Additions      Utilizations     December 31,
2010
 

Renfro

   $ 447,337  (1)    $ -      $ -       $ (447,337   $ -   

Plainfield

     208,333  (1)      -        100,000         -        308,333   

Will Partners

     -        742,366  (1)      52,515         (694,958     99,923   

Emporia Partners

     -        776,103  (2)      97,355         (228,366     645,092   

ITT

     -        350,000  (3)      -         (5,278     344,722   

Quad/Graphics

     -        260,000  (3)      -         -        260,000   
                                         

Total

   $ 655,670      $ 2,128,469      $ 249,870       $ (1,375,939   $ 1,658,070   
                                         

 

  (1) Represents reserves funded by the tenant.

 

  (2) Balance at December 31, 2010 consists of a replacement reserve of $0.51 million which was funded by the contributing entity and tax and insurance reserves totaling $0.13 million, which were funded by the tenant.

 

  (3) Represents reserves funded by the Company.

 

F-19


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

The following summarizes the future minimum net rent payments pursuant to the lease terms discussed above as of December 31, 2010:

 

     2011

   $ 9,476,147   

     2012

     9,561,938   

     2013

     9,619,892   

     2014

     9,822,242   

Thereafter

     63,403,335   
        

     Total

   $ 101,883,554   
        

As of December 31, 2010, our six properties, based on rental income, were Plainfield in Plainfield, IL (approximately 24.3%), Will Partners in Monee, IL (approximately 23.3%), Renfro in Clinton, SC (approximately 18.8%), Emporia in Emporia, KS (approximately 13.7%), Quad/Graphics in Loveland, CO (approximately 12.2%), and ITT in Los Angeles, CA (approximately 7.7%). Approximately 47.6% of the Company’s rental income was concentrated in the State of Illinois as of December 31, 2010.

Pro Forma Financial Information (unaudited)

The following condensed unaudited pro forma operating information is presented as if the Properties had been included in operations at the beginning of the prior period:

 

     For the Year Ended
December 31,
 
     2010      2009  

Revenue

   $ 11,107,104       $ 10,870,437   
                 

Net Loss

   $ (3,465,238)       $ (3,813,259)   
                 

Net loss attributable to common stockholders

   $ (900,962)       $ (803,454)   
                 

Loss per share

   $ (0.98)       $ (1.85)   
                 

 

4. Debt

In conjunction with the contribution of the Emporia Partners property, the Company assumed the mortgage debt as follows:

 

Original loan balance

   $6.93 million

Assumed loan balance

   $5.42 million

Interest rate

   5.88% (fixed)

Initial loan term

   20 years

Loan Maturity

   September 2023

The terms of the loan require monthly principal and interest payments. The loan is secured by a first mortgage and security agreement on the Company’s interest in the underlying Emporia Partners property, a fixture filing, and an assignment of leases, rents, income and profits. As of December 31, 2010 the balance of the loan was $5.33 million.

 

F-20


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

On June 4, 2010, the Company, through the Operating Partnership, entered into a credit agreement with KeyBank National Association (“KeyBank”), which provided the Company with an initial $25 million credit facility (the “Credit Facility”) to finance the acquisition of properties. The terms of the Credit Facility provide for monthly, interest-only payments with the balance due on June 4, 2013. The Credit Facility is guaranteed by the Company and is secured by a security agreement on the Operating Partnership’s underlying interest in the Will Partners and ITT properties, a fixture filing, and an assignment of leases, rents, income and profits.

Under the terms of the Credit Facility, the Operating Partnership has the option of selecting the applicable variable rate for each revolving loan, or portion thereof, of either (a) LIBOR multiplied by the Statutory Reserve Rate (as defined in the agreement relating to the Credit Facility) to which the administrative agent is subject, with respect to this rate, for Eurocurrency funding (the “LIBOR-based rate”), plus 3.75%, or (b) an alternate base rate, which is the greater of the (i) Prime Rate, (ii) Federal Funds Rate plus 0.50%, or (iii) the adjusted LIBOR-based rate set forth in subsection (a) plus 3.75%. These rates are subject to a minimum LIBOR of 2.00%. Prior to November 28, 2011, the Operating Partnership may request an increase in the total commitments under the Credit Facility up to $150 million, subject to certain conditions. The Operating Partnership made an initial draw of $16.9 million to acquire the Will Partners property and a subsequent draw of $5.07 million to acquire the ITT property. The Operating Partnership elected to have the LIBOR-based rate apply to such loans, which amounted to an initial interest rate of 5.75%. As of December 31, 2010 the LIBOR-based rate was 0.26%. The Operating Partnership may change this election from time to time, as provided by the Credit Facility terms.

Pursuant to the terms of the Credit Facility, the Operating Partnership, in consolidation with the Company, is subject to certain loan compliance covenants. Compliance with these covenants was required beginning with the quarter ended September 30, 2010. With the acquisition and financing of the ITT property, the Company was required to effect an interest rate hedge instrument on September 28, 2010. The Company executed an interest rate cap for a notional amount of $3.6 million, fixing the index at 2.0%. The hedge is in place for six months, expiring on April 17, 2011. The Company paid $7,000 for the interest rate cap. On December 28, 2010, the Company executed an additional interest rate cap in connection with the refinancing of the Renfro property debt, for a notional amount of $18.6 million, fixing the index at 2.0%. The second hedge is also in place for six months, expiring on June 30, 2011. The Company paid $10,000 for the second interest rate cap.

On November 22, 2010, the Company, through the Operating Partnership, entered into an amendment to the credit agreement with KeyBank, thereby increasing the total amount of the Credit Facility, upon which the Company drew an additional $13.03 million from the facility to refinance the debt encumbering the Renfro property. The additional debt is subject to the same terms described above. The total amount of funds drawn under the credit facility is now $35 million. As part of the amendment, KeyBank temporarily amended the interest coverage ratio covenant requirement from 1.85 times adjusted earning before interest, taxes, depreciation, and amortization (EBITDA) to 1.80 times for the third and fourth quarters ending September 30, 2010 and December 31, 2010, respectively, and clarified the definition of fixed charge coverage ratio.

On December 30, 2010, the Company, through the Operating Partnership, entered into a bridge loan with KeyBank (the “Bridge Loan”) and thereby obtained approximately $7.87 million from KeyBank to help fund the acquisition of the Quad/Graphics property. The Bridge Loan has a term of six months, and it bears interest at a rate of daily LIBOR plus 450 basis points, with an initial rate of 6.5%. These rates are subject to a minimum LIBOR of 2%. The terms of the Bridge Loan require payments made periodically throughout the month equal to the net equity raised in the Company’s Public Offering,

 

F-21


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

subject to a monthly minimum amount of approximately $1.33 million. The Bridge Loan is guaranteed by various wholly-owned subsidiaries of the Company’s Operating Partnership, as well as by Kevin A. Shields, the Company’s President and Chairman. In connection with the Bridge Loan, the Company also executed another amendment to the credit agreement with KeyBank (the “Second Amendment to Credit Facility”). Pursuant to the Second Amendment to Credit Facility, the debt obtained from the Bridge Loan is secured under the Credit Facility. When the Bridge Loan is paid in full, the Quad/Graphics property will serve as additional security for the Credit Facility, the guarantees issued in connection with the Bridge Loan will be released, and the Quad/Graphics property may be refinanced pursuant to the terms of the Credit Facility. In addition, as part of the Second Amendment to Credit Facility, KeyBank further amended the tangible net worth definition (as defined in the Second Amendment to Credit Facility) and liquidity covenant requirements from $2.0 million to $1.0 million through June 30, 2011.

In conjunction with the contribution of the Renfro and Plainfield properties on June 18, 2009 the Company assumed the following debt:

 

    

Renfro
Line of Credit

  

Renfro
Term Debt

  

Plainfield
Mortgage Debt

Original loan balance

   $5.0 million  (1)    $8.0 million  (2)    $21.50 million

Assumed loan balance

   $5.0 million    $8.0 million    $21.16 million

Interest rate

   6.5% (fixed)    6.5% (fixed)    6.65% (fixed)

Initial term

   One year    Three years    10 years

Maturity

   January 2011    January 2012    November 2017

Unamortized loan balance at
December 31, 2009

   $5.0 million    $8.0 million    $21.04 million

Unamortized loan balance at
December 31, 2010

   (3)    (3)    $20.79 million

 

  (1) The Renfro Line of Credit provided for monthly, interest only payments with an initial term of one year, or an expiration of January 29, 2010. In January 2010, the Line of Credit was extended for six months to July 29, 2010 with an automatic six-month extension should the Line of Credit not be paid in full by that date. The Company exercised the automatic extension on July 29, 2010, extending the term an additional six months to January 29, 2011. All other terms were unchanged. Both loans were guaranteed by an affiliate, and were secured by a first mortgage and assignment of rents and leases on the Renfro property.

 

  (2) The Renfro property debt was refinanced in January 2009. The Term Debt was used to partially pay off the prior loan and the Line of Credit was used to pay off the remaining balance of the prior loan and to fund $2.0 million of the tenant improvement allowance. The Renfro Term Debt called for monthly, interest only payments during the tenant improvement period, then monthly payments of principal and interest, based on a 25-year amortization schedule, for the remainder of the term. The tenant improvement period ended in January 2010 with the completion of the improvement projects, and release of all remaining tenant improvement reserve funds, therefore amortization of the Term Debt commenced on March 1, 2010.

 

  (3) The Renfro Line of Credit and Term Debt were paid off on November 22, 2010 with a draw of $13.03 million from the Credit Facility (as amended) as discussed above.

The terms of the Plainfield mortgage debt require monthly principal and interest payments. The Plainfield mortgage debt is secured by a first mortgage and security agreement on the Operating Partnership’s interest in the underlying property, a fixture filing, and an assignment of leases, rents, income and profits.

 

F-22


Table of Contents
Index to Financial Statements

THE GC NET LEASE REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

 

The following summarizes the future principal repayments per the loan terms discussed above:

 

     2011      2012      2013      2014      2015 and
after
     Total  
     (1)             (2)                       

Plainfield

   $ 262,170       $ 276,421       $ 299,627       $ 320,465       $ 19,637,754       $ 20,796,437   

Credit Facility

     -           -           35,000,000         -         -         35,000,000   

Emporia

     279,699         295,982         314,973         334,272         4,107,868         5,332,794   

Bridge Loan

     7,871,500         -           -           -         -         7,871,500   
                                                     

Total

   $ 8,413,369       $ 572,403       $ 35,614,600       $ 654,737       $ 23,745,622       $ 69,000,731   
                                                     

 

  (1) Amount includes payment of the remaining balance on the Bridge Loan upon expiration on June 30, 2011.