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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

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FORM 10-Q

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(Mark One)

 

x

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

For the quarterly period ended September 30, 2013

OR

 

¨

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

For the transition period from                            to                             

 

Commission file number 000-51860

 

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PALADIN REALTY INCOME PROPERTIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

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Maryland	20-0378980
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
10880 Wilshire Blvd., Suite 1400 Los Angeles, California	90024
(Address of Principal Executive Offices)	(Zip Code)

 

(310) 996-8704 

(Registrant’s Telephone Number, Including Area Code)  

 

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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 website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 and 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  x    No  ¨

 

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

 

Large Accelerated filer ¨ Accelerated filer ¨

 

Non-Accelerated filer ¨ Smaller reporting company x

 

(Do not check if a 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

 

As of November 14, 2013, there were 7,720,859 outstanding shares of common stock of Paladin Realty Income Properties, Inc.

 

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PALADIN REALTY INCOME PROPERTIES, INC.

 

INDEX

 

PART I FINANCIAL INFORMATION		Page
Item 1.	Financial Statements
	Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012 (unaudited)	4
	Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2013 and 2012 (unaudited)	5
	Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Statement of Equity for the nine months ended September 30, 2013 (unaudited)	6
	Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012 (unaudited)	7
	Notes to Condensed Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	31
PART II OTHER INFORMATION
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
Item 3.	Defaults Upon Senior Securities	31
Item 4.	Mine Safety Disclosures	31
Item 5.	Other Information	31
Item 6.	Exhibits	32

PART I — FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS.

 

The information furnished in the condensed consolidated balance sheets and related condensed consolidated statements of operations, equity, and cash flows included in this Quarterly Report on Form 10-Q reflects all normal and recurring adjustments that are, in management’s opinion, necessary for a fair and consistent presentation of the aforementioned financial statements. The condensed consolidated financial statements herein should be read in conjunction with the notes to the condensed consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and with the Annual Report on Form 10-K of Paladin Realty Income Properties, Inc. and subsidiaries for the year ended December 31, 2012. Results of operations reported in this Quarterly Report on Form 10-Q for the nine months ended September 30, 2013, are not necessarily indicative of the operating results expected for the full year.

 

 

PALADIN REALTY INCOME PROPERTIES, INC. AND SUBSIDIARIES

 CONDENSED CONSOLIDATED BALANCE SHEETS

 (Unaudited)

 

		September 30, 2013				December 31, 2012
ASSETS
Real Estate:
Building and improvements		$	162,737,584			$	173,902,628
Land			39,986,077				43,586,077
Furniture, fixtures and equipment			5,819,028				7,421,005
Tenant improvements			1,248,936				1,220,958
Total real estate, gross			209,791,625				226,130,668
Less: Accumulated depreciation and amortization			(24,218,867	)			(22,817,144	)
Total real estate, net			185,572,758				203,313,524
Cash and cash equivalents			10,281,295				9,014,937
Restricted cash			2,897,913				1,790,244
Prepaid expenses and other assets, net			1,938,845				2,391,902
TOTAL ASSETS		$	200,690,811			$	216,510,607
LIABILITIES AND EQUITY
Mortgages payable		$	154,230,798			$	166,940,695
Accrued expenses and other liabilities			3,948,870				3,563,165
Distributions payable			774,245				785,862
Total Liabilities			158,953,913				171,289,722
Equity:
Preferred shares, $0.01 par value, 100,000,000 shares authorized; none issued or outstanding			—				—
Common shares, $0.01 par value, 750,000,000 shares authorized; 7,720,859 shares and 7,720,859 shares issued and outstanding, respectively			77,207				77,207
Additional paid-in-capital			67,553,217				67,553,217
Accumulated deficit and distributions			(35,632,374	)			(34,404,801	)
Total Company Equity			31,998,050				33,225,623
Noncontrolling interests			9,738,848				11,995,262
Total Equity			41,736,898				45,220,885
TOTAL LIABILITIES AND EQUITY		$	200,690,811			$	216,510,607

See notes to unaudited condensed consolidated financial statements.

 

 

PALADIN REALTY INCOME PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 (Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Revenues
Rental income		$	5,990,550			$	5,822,852			$	17,894,274			$	17,129,693
Other income			784,973				1,045,793				2,233,376				2,180,257
Interest income			1,181				2,105				2,932				6,734
Total Revenues			6,776,704				6,870,750				20,130,582				19,316,684
Expenses
Property operating			2,558,259				2,461,082				7,466,666				7,104,775
Real property taxes			474,127				472,879				1,422,380				1,419,159
General and administrative			689,417				531,378				1,681,278				1,413,633
Interest expense, including amortization of deferred loan costs			2,101,567				2,143,111				6,245,285				6,689,990
Depreciation and amortization			1,382,276				1,516,448				4,169,237				4,535,604
Property damage			—				—				368,111				—
Total Expenses			7,205,646				7,124,898				21,352,957				21,163,161
Loss from continuing operations			(428,942	)			(254,148	)			(1,222,375	)			(1,846,477	)
Income from discontinued operations			49,478				4,637				189,992				407,258
Gain from sale of real estate			—				—				10,158,857				—
Loan defeasance and related costs			—				—				(3,297,101	)			—
Income from discontinued operations			49,478				4,637				7,051,748				407,258
Net Income (Loss)			(379,464	)			(249,511	)			5,829,373				(1,439,219	)
Noncontrolling interests			(22,549	)			185,470				(3,592,074	)			390,240
Net Income (Loss) Attributable to Company		$	(402,013	)		$	(64,041	)		$	2,237,299			$	(1,048,979	)
Net Income (Loss) per common share – Basic & Diluted
Loss from continuing operations		$	(0.06	)		$	(0.03	)		$	(0.14	)		$	(0.19	)
Income from discontinued operations			0.01				0.02				0.43				0.05
Net income (loss) attributable to Company		$	(0.05	)		$	(0.01	)		$	0.29			$	(0.14	)
Weighted average common shares outstanding - Basic & Diluted			7,720,859				7,717,253				7,720,859				7,530,745

See notes to unaudited condensed consolidated financial statements.

 

PALADIN REALTY INCOME PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF EQUITY

 For the nine months ended September 30, 2013

(Unaudited)

 

		Common Shares								Additional				Accumulated
		Common shares				Amount				Paid-in Capital				Deficit and Dividends				Noncontrolling Interests				Total Equity
BALANCE, December 31, 2012			7,720,859			$	77,207			$	67,553,217			$	(34,404,801	)		$	11,995,262			$	45,220,885
Contributions			—				—				—				—				154,333				154,333
Distributions to noncontrolling interests			—				—				—				—				(6,002,821	)			(6,002,821	)
Distributions declared ($0.60)			—				—				—				(3,464,872	)			—				(3,464,872	)
Net income			—				—				—				2,237,299				3,592,074				5,829,373
BALANCE, September 30, 2013			7,720,859			$	77,207			$	67,553,217			$	(35,632,374	)		$	9,738,848			$	41,736,898

 

See notes to unaudited condensed consolidated financial statements.

 

 

PALADIN REALTY INCOME PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine Months Ended September 30,
		2013				2012
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	5,829,373			$	(1,439,219	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities
Depreciation and amortization expense			4,169,237				5,166,682
Amortization of deferred loan costs			279,818				352,094
Gain on sale of real estate, net of loan defeasance and related costs			(6,861,756	)			—
Changes in operating assets and liabilities:
Increase in restricted cash			(1,440,459	)			(1,126,908	)
Decrease (increase) in prepaid expenses and other assets			104,809				(52,836	)
Decrease in due from affiliates			—				(344,569	)
Increase in accrued expenses and other liabilities			385,705				943,272
Net cash provided by operating activities			2,466,727				3,498,516
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for real estate and improvements			(1,705,248	)			(1,856,722	)
Net proceeds from sale of real estate			22,206,963				—
Decrease in restricted cash			332,790				210,690
Net cash provided by (used in) investing activities			20,834,505				(1,646,032	)
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from mortgages payable			—				13,000,000
Payments on mortgages payable			(12,709,897	)			(14,711,100	)
Deferred loan costs			—				(188,578	)
Decrease in restricted cash			—				277,911
Proceeds from issuance of common shares			—				5,974,294
Shares Redeemed			—				(1,177,149	)
Decrease in unaccepted subscriptions for common stock			—				(277,911	)
Selling commissions and dealer manager fees			—				(571,486	)
Offering costs			—				(211,721	)
Decrease in due from affiliates			—				442,943
Distributions paid			(3,476,489	)			(2,188,959	)
Contributions from noncontrolling interests			154,333				—
Distributions to noncontrolling interests			(6,002,821	)			(690,580	)
Net cash used in financing activities			(22,034,874	)			(322,336	)
Net increase in cash and cash equivalents			1,266,358				1,530,148
Cash and cash equivalents – beginning of period			9,014,937				8,000,503
Cash and cash equivalents – end of period		$	10,281,295			$	9,530,651
Supplemental disclosure of non-cash investing and financing activities
Distributions payable		$	774,245			$	772,129
Common stockholder distributions reinvested in accordance with Distribution Reinvestment Plan		$	—			$	1,171,819
Supplemental disclosure of cash flow information
Cash paid during the period for interest		$	6,051,672			$	7,273,525

 

See notes to unaudited condensed consolidated financial statements.

 

 

Paladin Realty Income Properties, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 September 30, 2013 and 2012 (unaudited)

 

1. Organization

 

Paladin Realty Income Properties, Inc., a Maryland corporation (“Paladin REIT”), was formed on October 31, 2003, to invest in a diversified portfolio of high quality investments, including real property investments and real estate related investments, focusing primarily on investments that produce current income. As of September 30, 2013, Paladin REIT owned interests in 12 joint ventures that own 13 income-producing properties.

 

		Location		Year Built		Number of   Units/Rentable Square Feet
Multifamily Communities
Champion Farms Apartments		Louisville, Kentucky		2000		264 Units
Fieldstone Apartments		Woodlawn, Ohio		2001		266 Units
Pinehurst Apartment Homes		Kansas City, Missouri		1986 and 1988;   renovated in   2006		146 Units
Pheasant Run Apartments		Lee’s Summit, Missouri		1985; renovated in 2003 and 2004		160 Units
The Retreat Apartments		Shawnee, Kansas		1984; renovated in 2004 and 2005		342 Units
Hilltop Apartments		Kansas City, Missouri		1986		124 Units
Conifer Crossing		Norcross, Georgia		1981		420 Units
Beechwood Gardens Apartments1		Philadelphia, Pennsylvania		1967; renovated in 2003 and 2004		160 Units
Stone Ridge Apartments		Columbia, South Carolina		1975		191 Units2
Coursey Place Apartments		Baton Rouge, Louisiana		2003		352 Units
Pines of York Apartments		Yorktown, Virginia		1976		248 Units
Office
Two and Five Governor Park (two properties)		San Diego, California		1985 and 1989		22,470 Sq. Ft. and 53,048 Sq. Ft.

________________

1		On October 4, 2013, Paladin REIT completed the sale of the Beechwood Gardens Apartments.
2		On March 6, 2013, a fire significantly damaged 12 units at Stone Ridge Apartments (“Stone Ridge”), or approximately 6% of the units, and accordingly, Paladin REIT wrote-off approximately $226,000 of building and improvements and has received insurance proceeds of approximately $428,000 and is included in restricted cash in the accompanying condensed consolidated balance sheet. This includes $202,000 of proceeds in excess of costs of building and improvements and such amount is included in other income in the accompanying condensed consolidated statements of operations.  Paladin REIT’s loss related to the fire is expected to be limited to the $10,000 deductible under its property insurance policy.  We have also received approximately $35,000 of insurance proceeds for business interruption and such amount is included in other income in the accompanying condensed consolidated statements of operations. In addition, the damaged units contained asbestos-containing materials (“ACMs”) and such ACMs have been removed pursuant to special guidelines and procedures. The property’s insurance policy contains a limit of $25,000 for the cost of removing ACMs and the cost for the removal of such ACMs was approximately $157,000. The damage to the building and improvements and the estimated cost of removal of the ACMs are reflected in property damage in the accompanying condensed consolidated statements of operations.  In addition, on July 23, 2013, the City of Columbia notified the joint venture that owns the property that three of the fire damaged units are now located in a flood plain and cannot be rebuilt for occupants to inhabit.   It is now expected that the three units will be rebuilt as nine garages, which should allow for rent increases for the nine units that will have dedicated garages.

 

 

 

Paladin REIT’s investment policy includes a variety of real estate product types, including apartments, office buildings, industrial buildings, shopping centers and hotels. Paladin REIT may also make real estate related investments, which include loans on real property such as first mortgage loans and mezzanine loans. Paladin REIT elected to be taxed as a REIT for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2006. Subject to certain restrictions and limitations, the business of Paladin REIT is managed by Paladin Realty Advisors, LLC (“Paladin Advisors”), an affiliate of Paladin REIT, pursuant to an amended and restated advisory agreement, dated July 24, 2013 (the “Advisory Agreement”). Paladin Advisors supervises and manages the day-to-day operations of Paladin REIT and selects the real property investments and real estate related investments it makes, subject to oversight by the board of directors of Paladin REIT. Paladin Advisors also provides marketing, sales, and client services on behalf of Paladin REIT.

 

On February 23, 2005, Paladin REIT’s initial public offering (the “Initial Offering”) was declared effective and Paladin REIT commenced its offering efforts. The Initial Offering terminated on July 28, 2008, in connection with the commencement of Paladin REIT’s follow-on offering (the “First Follow-On Offering”). On January 24, 2012, Paladin REIT terminated the First Follow-On Offering and commenced the second follow-on offering (the “Second Follow-On Offering,” and collectively with the Initial Offering and First Follow-On Offering, the “Offerings”). On July 16, 2012, Paladin REIT terminated the Second Follow-On Offering. As of September 30, 2013, Paladin REIT had received proceeds of $82,622,988 for 8,339,047 shares in the Offerings.

 

On July 18, 2013, Paladin REIT and Paladin Realty Income Properties, L.P. (“Paladin OP”), whose sole general partner is Paladin REIT, entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) with Resource Real Estate Opportunity OP, LP (“Resource OP”), the operating partnership of Resource Real Estate Opportunity REIT, Inc., a Maryland corporation (“Resource”), and RRE Charlemagne Holdings, LLC, a Delaware limited liability company and a wholly owned subsidiary of Resource OP (“Merger Sub”). The Merger Agreement provides for the merger of Paladin OP with and into Merger Sub (the “Merger”), with Merger Sub surviving as a wholly owned subsidiary of Resource OP. Resource will pay $51.2 million in cash, excluding certain transaction costs and subject to certain adjustments, including an adjustment for distributions to Paladin OP differing from specified amounts made prior to the closing of the Merger from the joint venture that owns two office properties (the “Merger Consideration”). The Merger Consideration, together with the existing cash of Paladin OP at the closing date, net of fees and expenses (the “Distribution”) will be distributed to Paladin REIT and Paladin Advisors, as owners of the interests in Paladin OP. Paladin REIT, which owns 99.8% of the interests in Paladin OP, will distribute its portion of the Distribution, together with the existing cash of Paladin REIT at the closing date, to its stockholders and liquidate and dissolve. The remaining 0.2% of the Distribution will be paid to Paladin Advisors, Paladin REIT’s advisor. No fees, other than its proportional share of the Distribution, will be paid to Paladin Advisors in connection with the Merger. The Merger is subject to customary closing conditions, including, among other things, the approval of Paladin REIT’s stockholders.

 

Paladin REIT owns its assets and conducts its operations through Paladin OP. As of September 30, 2013 and December 31, 2012, Paladin Advisors held a 0.2% limited partnership interest and Paladin REIT held a 99.8% general partnership interest in Paladin OP.

 

 

2. Summary of Significant Accounting Policies

 

The accompanying condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Revenues are recognized as earned, and expenses are recognized as incurred.

 

Principles of Reporting

 

Variable Interest Entities

 

The condensed consolidated financial statements include the accounts of Paladin REIT and its wholly owned and controlled entities (collectively, the “Company”). The Company consolidates any variable interest entities (“VIEs”) of which it has control (a) through voting rights or similar rights or (b) by means other than voting rights if the Company is the primary beneficiary, as defined below. When the Company does not have a controlling interest in an entity, but exerts significant influence over the entity, the Company applies the equity method of accounting. All intercompany balances and transactions have been eliminated in consolidation.

 

If an investment was determined to be a VIE, the Company then performed an analysis to determine if the Company is the primary beneficiary of the VIE. A VIE is consolidated by its primary beneficiary. The primary beneficiary is the party that has a controlling financial interest in an entity. In order for a party to have a controlling financial interest in an entity it must have (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (2) the obligation to absorb losses of an entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.

 

Derivative Instruments

 

The Company enters into derivative contracts from time to time to manage interest rate risk and may do so in the future to facilitate asset/liability strategies. The Company has elected to not treat the derivative financial instruments as a hedge because this investment does not meet the strict hedge accounting requirements of Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging. ASC 815 requires that all derivative investments be carried at fair value. Changes in fair value are recorded in earnings for each period. No derivatives were held at quarter end.

 

Risks and Uncertainties

 

The Company is operating in a challenging and uncertain economic environment. Financial and real estate companies continue to be affected by the lack of liquidity in financial markets, declines in real estate values and the reduction in the willingness of financial institutions to make new loans and refinance or extend existing loans on similar terms and conditions.

 

 Noncontrolling Interests

 

Background

 

Noncontrolling interests are presented and disclosed as a separate component of equity (not as a liability or other item outside of permanent equity). Condensed consolidated net income includes the noncontrolling interests’ share of income. The calculation of earnings per share continues to be based on income amounts attributable to the Company. All changes in the Company’s ownership interest in a subsidiary are accounted for as equity transactions if the Company retains its controlling financial interest in the subsidiary.

 

Presentation

 

As of September 30, 2013 and December 31, 2012, the Company’s noncontrolling interests represent noncontrolling ownership interests in joint ventures controlled by the Company through ownership or contractual arrangements. These noncontrolling interests reported in equity are not subject to any mandatory redemption requirements or other redemption features outside of the Company’s control that would result in presentation outside of permanent equity.

 

Use of Estimates

 

The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Management makes significant estimates regarding impairments. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. The current economic environment has increased the degree of uncertainty inherent in these estimates and assumptions. Management adjusts such estimates when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ from those estimates and assumptions.

 

 

 

Real Estate and Depreciation

 

Land is carried at cost. Building and improvements, furniture, fixtures, and equipment, in-place leases, and tenant improvements are stated at cost, less accumulated depreciation and amortization. The Company allocates the purchase price of newly acquired properties between net tangible and identifiable intangible assets. The primary intangible asset associated with an apartment or office building property acquisition is the value of the existing lease agreements. When allocating the purchase price to an acquired property, the Company allocates the purchase price to the estimated value of the land, building, and fixtures assuming the property is vacant and to the estimated intangible value of the existing lease agreements. In some circumstances, the Company engages real estate appraisal firms to provide market information and evaluations that are relevant to its purchase price allocations; however, the Company is ultimately responsible for the purchase price allocation. The Company estimates the intangible value of the lease agreements by determining the lost revenue associated with a hypothetical lease-up. The Company depreciates the buildings and fixtures based on the expected useful life of the asset, which ranges from 27 to 45 years for the buildings and improvements and from 5 to 7 years for furniture, fixtures and equipment, using the straight line basis. The intangible value of the lease agreements is amortized over the average remaining life of the existing leases, which ranges from 3 to 24 months, using the straight line basis. This amortization is included in depreciation and amortization expense on the accompanying condensed consolidated statements of operations. Improvements and betterments are capitalized when they extend the useful life of the asset. Expenditures for repairs and maintenance are expensed as incurred.

 

The Company reviews long-lived assets and related identifiable intangibles for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. When such events or changes in circumstances occur, recoverability of the asset to be held and used is measured by a comparison of the carrying amount of the asset to future cash flows, undiscounted and without interest, expected to be generated by the asset. In order to review the Company’s investment properties for recoverability, the Company considers current market conditions, as well as its intent with respect to holding or disposing of the asset. Fair value is determined through various valuation techniques; including discounted cash flow models, quoted market values and third party appraisals, where considered necessary. If the Company’s analysis indicates that the carrying value of the investment property is not recoverable on an undiscounted cash flow basis, the Company recognizes an impairment charge for the amount by which the carrying value exceeds the current estimated fair value of the real estate property. If the sum of the expected future cash flows (undiscounted and without interest) is less than the Company’s carrying amount for the asset, an impairment loss is recognized based upon the asset’s fair value. Other than property damage recorded for Stone Ridge, there were no other impairment charges taken for the nine months ended September 30, 2013 and 2012.

 

Acquisition of Real Estate

 

The fair value of real estate acquired, and the fair value adjustments for assumed mortgage debt related to property acquisitions, is allocated to the acquired tangible assets, consisting of land, building and improvements and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases and other value of in-place leases based in each case on their fair values. The Company aggregates all identified intangible assets and liabilities and presents them net as a separate line item on the condensed consolidated balance sheets. Acquisition costs are expensed as incurred and are included in property operating expense in the accompanying condensed consolidated statement of operations. Noncontrolling interests acquired are also recorded at estimated fair market value.

 

The fair value of the tangible assets of an acquired property (which includes land, building and improvements and furniture, fixtures and equipment) is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land and building and improvements based on management’s determination of relative fair values of these assets. In allocating the fair value of the identified intangible assets and liabilities of an acquired property, above-market and below-market lease values are recorded based on the difference between the current in-place lease rent and management’s estimate of current market rents. Below-market lease intangibles are recorded as part of deferred revenue and amortized into rental revenue over the non-cancelable periods and bargain renewal periods of the respective leases. Above-market leases are recorded as part of intangible assets and amortized as a direct charge against rental revenue over the non-cancelable portion of the respective leases.

 

 

Deferred Loan Costs

 

Loan costs are capitalized and amortized using the effective interest method over the life of the related loan. The amortization is recorded as a component of interest expense.

 

Revenue Recognition

 

The Company primarily leases residential apartments to tenants under non-cancellable operating leases with terms ranging from 3 to 12 months. The Company also leases commercial space to tenants with lease terms extending to 2017. Rental income related to leases is recognized in the period earned over the lease term.

 

Other income consists of various tenant-related charges and is recognized as revenue in the period in which the applicable charge is incurred.

 

Accounts Receivable

 

Accounts receivable is included in prepaid expenses and other assets, net in the condensed consolidated balance sheets. Bad debts are recorded under the specific identification method, whereby, uncollectible receivables are directly written off when identified.

 

Cash Equivalents

 

Cash equivalents represent highly liquid investments with maturities at the date of purchase of three months or less.

 

Restricted Cash

 

At September 30, 2013 and December 31, 2012, restricted cash included $2,897,913 and $1,790,244, respectively, held in restricted accounts for building and tenant improvements, repairs, property taxes and insurance as required by lenders.

 

Income Taxes

 

The Company elected to be taxed as a REIT for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2006, under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. The Company believes it operates in such a manner as to qualify for treatment as a REIT for federal income tax purposes. Accordingly, the Company generally will not be subject to federal income tax, provided that distributions to its stockholders equal at least the amount of its taxable income. A REIT is subject to a number of organizational and operational requirements, including a requirement that it currently distributes at least 90% of its taxable income to stockholders, subject to certain adjustments. If the Company fails to qualify as a REIT in any taxable year without the benefit of certain relief provisions, it will be subject to federal and state income taxes on its taxable income at regular corporate income tax rates. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state or local taxes on its income, property or net worth and federal income and excise taxes on its undistributed income. No provision has been made for federal income taxes for the nine months ended September 30, 2013 and 2012, in the accompanying condensed consolidated financial statements.

 

The Company uses a more-likely-than-not threshold for recognition and derecognition of tax positions taken or to be taken in a tax return. The Company has assessed its tax positions for all open tax years since January 1, 2009, and concluded that there were no material uncertainties to be recognized. The Company’s accounting policy with respect to interest and penalties related to tax uncertainties is to classify these amounts as provision for income taxes. The Company has not recognized any interest and penalties related to tax uncertainties for the three and nine months ended September 30, 2013 and 2012.

 

Organization and Offering Costs

 

Organization costs are expensed as incurred and offering costs are charged to stockholders’ equity. These costs are subject to a 3.0% limitation of the gross proceeds from the Offerings pursuant to the Company’s Advisory Agreement with Paladin Advisors, as described in Note 5.

 

Discontinued Operations

 

On May 1, 2013, the Lofton Place Apartments were sold for gross proceeds of $26,000,000 in which the Company received approximately $5.6 million in net proceeds. The gain on sale and results of operations are classified as discontinued operations as of September 30, 2013 and 2012.

 

On May 1, 2013, the mortgage loan for Lofton Place Apartments was defeased by payment of $15,005,668 in accordance with the terms of the mortgage loan agreement (which exceeded the balance then due by $3,242,601) plus $54,500 of legal and related costs. The excess of the defeasance payment over the balance then due plus the legal and related costs aggregate $3,297,101, which is presented as “loan defeasance and related costs” in the accompanying consolidated statements of operations.

 

 

 

  On October 4, 2013, the Beechwood Gardens Apartments were sold for gross proceeds of $13,000,000 in which the Company received approximately $3.0 million in net proceeds after repayment of the mortgage payable of $8.4 million. The results of operations are classified as discontinued operations as of September 30, 2013 and 2012.

 

The following presents the operating results for Lofton Place Apartments and Beechwood Gardens Apartments as of:

 

		Three months ended September 30,								Nine months ended September 30,
		2013				2012				2013				2012
Total gross revenues		$	472,335			$	1,258,209			$	2,466,563			$	3,736,829
Net income		$	49,478			$	4,637			$	189,992			$	407,258

 

Expense Reimbursement

 

Pursuant to the terms of the Advisory Agreement, Paladin Advisors is entitled to reimbursement of actual expenses incurred for administrative and other services provided to the Company by Paladin Advisors and its affiliates for which they do not otherwise receive a fee. Additionally, Paladin Advisors must repay the Company quarterly any amounts by which the Company’s operating expenses exceed the 2%/25% Rule in the 12 months then ended (the “Expense Period”), unless a majority of the Company’s independent directors approves reimbursement of any excess. The Company will not reimburse Paladin Advisors for operating expenses that in any fiscal year exceed the 2%/25% Rule. The Company’s average invested assets, as defined in the Advisory Agreement, for any period are equal to the average book value of the Company’s assets invested in equity interests in, and loans secured by, real estate before reserves for depreciation or bad debts or other similar non-cash reserves, computed by taking the average of such values at the end of each month during the period. For the year ended September 30, 2013, the average book value of the Company’s invested assets before reserves for depreciation or bad debts or other similar non-cash reserves was approximately $210,000,000. The Company’s net income, as defined in the Advisory Agreement, for any period, for purposes of the 2%/25% Rule, is equal to our total revenue less total expenses other than additions to reserves for depreciation, bad debts or other similar non-cash reserves for such period. Operating expenses include all expenses incurred by the Company under GAAP including the asset management fee, but excluding organization and offering expenses, selling commissions and dealer manager fees, interest payments, taxes, non-cash expenditures such as depreciation, amortization and bad debt reserves, the subordinated disposition fee, acquisition fees and expenses and distributions pursuant to Paladin Advisors’ subordinated participation interest in Paladin OP.

 

On a quarterly basis, in accordance with the Advisory Agreement, the Company recognizes an expense for operating expenses paid on its behalf by Paladin Advisors that do not exceed the 2%/25% Rule. Additionally, Paladin Advisors must repay to the Company within 60 days after the end of each fiscal quarter for the 12 months then ended any expenses in excess of the 2%/25% Rule, unless a majority of the Company’s independent directors determine that the excess expenses were justified based on unusual and nonrecurring factors which they deem sufficient. Such approved excess represents an unrecognized commitment and becomes payable by the Company at such time when the excess amount and amounts of future operating expenses are within the 2%/25% Rule. Within 60 days after the end of any Expense Period for which total operating expenses exceed the 2%/25% Rule, the Company will send its stockholders written disclosure, together with an explanation of the factors the independent directors considered in arriving at the conclusion that the excess expenses were justified. However, at Paladin Advisors’ option, Paladin Advisors or its affiliate, as applicable, may defer the refund of expenses and elect to receive such payments, without interest, in any subsequent fiscal year that Paladin Advisors designates. As of September 30, 2013, there were no unrecognized commitments relating to unreimbursed excess operating expenses pursuant to the 2%/25% Rule.

 

During the Expense Period ended September 30, 2013, the Company’s general and administrative expenses, including expenses incurred on the Company’s behalf by Paladin Advisors and its affiliates, did not exceed the 2%/25% Rule. During the Expense Period ended September 30, 2013, $84,914 was paid by Paladin Advisors.

 

 

 

 

For the nine months ended September 30, 2013, the Company recognized $1,681,278 of general and administrative expenses. In accordance with the Advisory Agreement, the Company recognizes on a quarterly basis amounts not exceeding the 2%/25% Rule.

 

Per Share Data

 

The Company presents both basic and diluted loss per share (“EPS”). Basic EPS excludes potentially dilutive securities and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period. Dilutive EPS reflects the potential dilution that could occur if securities or other contracts to issue common shares were exercised, where such exercise would result in a lower EPS amount.

 

Fair Value of Financial Instruments

 

In evaluating fair value, GAAP outlines a valuation framework and creates a fair value hierarchy that distinguishes between market assumptions based on market data (observable inputs) and a reporting entity’s own assumptions about market data (unobservable inputs). The hierarchy ranks the quality and reliability of inputs used to determine fair value, which are then classified and disclosed in one of the three categories (or levels).  Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs include quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, and model-derived valuations whose inputs are observable. Level 3 includes model-derived valuations with unobservable inputs.

 

The Company’s financial assets and liabilities are not carried at fair value; however, the fair values of cash and cash equivalents, restricted cash, other assets, distributions payable and other liabilities approximate the carrying values due to the short-term nature of these financial instruments. As of September 30, 2013, mortgages payable had an estimated fair value of approximately $163.3 million compared to the carrying value of $154.2 million. As of December 31, 2012, mortgages payable had an estimated fair value of approximately $183.3 million compared to the carrying value of $166.9 million. To determine fair value, the fixed rate debt is discounted at a rate based on an estimate of current lending rates as of September 30, 2013 and December 31, 2012.  The estimated fair values of the Company’s mortgages payable are considered level 2 within the fair value hierarchy.

 

Reclassifications

 

Certain amounts included in the 2012 unaudited condensed consolidated financial statements have been reclassified to conform to the 2013 presentation, related to the presentation of discontinued operations.

 

 

3. Investments in Real Estate

 

As of September 30, 2013, Paladin REIT held the following investments in real estate:

 

Paladin OP Ownership %

Property

Year Built

Number of Units/Rentable Square Feet

Multifamily Communities

Springhurst Housing Partners, LLC

70.0

%

Champion Farms Apartments

2000

264 Units

Glenwood Housing Partners I, LLC

83.0

%

Fieldstone Apartments

2001

266 Units

KC Pinehurst Associates, LLC

97.5

%

Pinehurst Apartment Homes

1986 and 1988;  renovated in 2006

146 Units

KC Pheasant Associates, LLC

97.5

%

Pheasant Run Apartments

1985; renovated in  2003 and 2004

160 Units

KC Retreat Associates, LLC

97.5

%

The Retreat Apartments

1984; renovated in  2004 and 2005

342 Units

Park Hill Partners I, LLC

49.0

%

Hilltop Apartments

1986

124 Units

FPA/PRIP Conifer, LLC

42.5

%

Conifer Crossing

1981

420 Units

Morgan Beechwood, LLC1

82.3

%

Beechwood Gardens Apartments

1967; renovated in 2003 and 2004

160 Units

DT Stone Ridge, LLC

68.5

%

Stone Ridge Apartments

1975

191 Units2

Coursey Place Sole Member, LLC

51.7

%

Coursey  Place Apartments

2003

352Units

FP-1, LLC

90.0

%

Pines of York Apartments

1976

248 Units

Office

FPA/PRIP Governor Park, LLC

47.7

%

Two and Five Governor Park

1985 and 1989

22,470 Sq. Ft. and 53,048 Sq. Ft.

1		On October 4, 2013, Paladin REIT completed the sale of the Beechwood Gardens Apartments.
2		On March 6, 2013, a fire significantly damaged 12 units at Stone Ridge Apartments (“Stone Ridge”), or approximately 6% of the units, and accordingly, Paladin REIT wrote-off approximately $226,000 of building and improvements and has received insurance proceeds of approximately $428,000 and is included in restricted cash in the accompanying condensed consolidated balance sheet. This includes $202,000 of proceeds in excess of costs of building and improvements and such amount is included in other income in the accompanying condensed consolidated statements of operations.  Paladin REIT’s loss related to the fire is expected to be limited to the $10,000 deductible under its property insurance policy.  We have also received approximately $35,000 of insurance proceeds for business interruption and such amount is included in other income in the accompanying condensed consolidated statements of operations. In addition, the damaged units contained asbestos-containing materials (“ACMs”) and such ACMs have been removed pursuant to special guidelines and procedures. The property’s insurance policy contains a limit of $25,000 for the cost of removing ACMs and the cost for the removal of such ACMs was approximately $157,000. The damage to the building and improvements and the estimated cost of removal of the ACMs are reflected in property damage in the accompanying condensed consolidated statements of operations.  In addition, on July 23, 2013, the City of Columbia notified the joint venture that owns the property that three of the fire damaged units are now located in a flood plain and cannot be rebuilt for occupants to inhabit.   It is now expected that the three units will be rebuilt as nine garages, which should allow for rent increases for the nine units that will have dedicated garages.

 

  

4. Mortgages Payable

 

Mortgages payable consist of the following: 

		September 30, 2013				December 31, 2012
Mortgage payable—interest only at a fixed rate of 6.14% payable monthly until the loan matures on July 1, 2016, secured by Champion Farms Apartments property (1)		$	16,350,000			$	16,350,000
Mortgage payable—principal and interest at 6.05% payable monthly until the loan matures on July 1, 2014, secured by the Fieldstone Apartments property (1)			16,087,359				16,237,883
Mortgage payable—principal and interest at 5.58% payable monthly until the loan matures January 1, 2016, secured by the Pinehurst Apartment Homes property (2)			4,330,736				4,397,847
Mortgage payable—interest only at 5.95% payable monthly until the loan matures on October 1, 2017, secured by the Pheasant Run Apartments property (3)			6,250,000				6,250,000
Mortgage payable—interest only at 5.58% payable monthly until February 1, 2013, after which principal and interest are due until the loan matures on February 1, 2018, secured by the Retreat Apartments property (4)			13,500,064				13,600,000
Mortgage payable—interest only at 5.81% payable monthly until December 1, 2012, after which principal and interest are due until the loan matures on December 1, 2017, secured by the Hilltop Apartments property (5)			4,212,514				4,250,000
Mortgage payable—principal and interest at 5.96% payable monthly until the loan matures on September 1, 2015, secured by the Conifer Crossing property (6)			28,022,717				28,286,958
Mortgage payable—principal and interest at 4.78% payable monthly until the loan matures June 1, 2022, secured by the Two and Five Governor Park properties (7)			12,761,389				12,906,645
Mortgage loan payable—interest only at 5.66% payable monthly until November 1, 2011, after which principal and interest are due until the loan matures on October 1, 2019, secured by the Lofton Place Apartments property (8)			-				11,829,555
Mortgage payable—principal and interest at 5.49% payable monthly until the loan matures on January 1, 2020, secured by the Beechwood Gardens Apartments property (9)			8,474,808				8,560,807
Mortgage payable—interest only at a fixed rate of 5.07% payable monthly until the loan matures on August 1, 2021, secured by Coursey Place Apartments property(10)			28,470,211				28,500,000
Mortgage payable—interest only at 4.46% payable monthly until January 1, 2014, after which principal and interest are due until the loan matures on December 1, 2021, secured by the Pines of York Apartments property (11)			15,771,000				15,771,000
Total mortgages payable		$	154,230,798			$	166,940,695

 

 

 

(1)	In general, the mortgage loan may be voluntarily or involuntarily prepaid subject to certain prepayment penalties. The loan agreement obligation is secured by a mortgage on the property and an assignment of rents and personal property.
(2)	The loan is prepayable at any time prior to its maturity, subject to a prepayment penalty equal to the greater of (a) one percent of the outstanding balance or (b) an amount calculated pursuant to a formula based on the remaining life of the loan and then-current interest rates. In addition, the loan is guaranteed by James E. Lippert, an affiliate of JTL Holdings, LLC and JTL Asset Management, Inc., pursuant to a guaranty dated September 13, 2007, but only upon the occurrence of certain limited events.
(3)	Assuming no event of default occurs before the initial maturity date, the loan will automatically be extended until October 1, 2018, with an adjustable interest rate based on the Federal Home Loan Mortgage Corporation Reference Bill Index. The loan is prepayable at any time prior to its maturity, subject to a prepayment penalty equal to the greater of (a) one percent of the outstanding balance or (b) an amount calculated pursuant to a formula based on the remaining life of the loan and then-current interest rates. In the event of default, the entire unpaid principal balance, any accrued interest, any prepayment penalty and all other amounts payable under the promissory note will be due and payable.
(4)	Assuming no event of default occurs before the initial maturity date, the loan will automatically be extended until February 1, 2019, with an adjustable interest rate based on the Freddie Mac Reference Bill Index. The loan is prepayable at any time prior to its maturity, subject to a prepayment penalty equal to the greater of (a) one percent of the outstanding balance or (b) an amount calculated pursuant to a formula based on the remaining life of the loan and then-current interest rates. The loan is secured by a multifamily mortgage on the property pursuant to a Multifamily Deed of Trust, Assignment of Rents and Security Agreement. In addition, the loan is guaranteed by James E. Lippert, but only upon the occurrence of certain limited events.
(5)	Assuming no event of default occurs before the initial maturity date, the loan will automatically be extended until December 1, 2018, with an adjustable interest rate based on the Freddie Mac Reference Bill Index. The loan is prepayable at any time prior to its maturity, subject to a prepayment penalty equal to the greater of (a) one percent of the outstanding balance or (b) an amount calculated pursuant to a formula based on the remaining life of the loan and then-current interest rates. The loan is secured by a multifamily mortgage on the property pursuant to a Multifamily Deed of Trust, Assignment of Rents and Security Agreement. In addition, the loan is guaranteed by James E. Lippert, but only upon the occurrence of certain limited events.
(6)	Assuming no event of default occurs before the initial maturity date, the loan will automatically be extended until September 1, 2016, with an adjustable interest rate based on the Freddie Mac Reference Bill Index. The loan is prepayable at any time prior to its maturity, subject to a prepayment penalty equal to the greater of (a) one percent of the outstanding balance or (b) an amount calculated pursuant to a formula based on the remaining life of the loan and then-current interest rates. The loan is secured by a multifamily mortgage on the property pursuant to a Multifamily Deed of Trust, Assignment of Rents and Security Agreement. In addition, the loan is guaranteed by Gregory A. Fowler, a management committee representative of FPA Conifer Investors, LLC, but only upon the occurrence of certain limited events.
(7)	On June 1, 2012, the previous loan that was due to expire on December 19, 2012, was replaced with a new 10 year loan of $13,000,000 and the new loan will mature on June 1, 2022. In connection with the loan refinancing, the Company paid loan fees and other costs of $188,578. The loan is generally prepayable subject to a prepayment premium based on the remaining amount of the loan and then-current interest rates. The loan is secured by a mortgage on the property pursuant to a Deed of Trust and Assignment of Rents and Leases and Security Agreement. In addition, the loan is guaranteed by Gregory A. Fowler but only upon the occurrence of certain limited events.
(8)	Assuming no event of default, the loan will mature on October 1, 2019. The loan may be prepaid or defeased during the loan term, subject to certain conditions and limitations. The determination as to prepayment or defeasance is based on actions of the lender with regard to securitizing the loan, which actions are beyond our control. The borrower possesses the right to prepay the loan, in total but not in part, only if the Note is (i) not assigned to a REMIC trust; or (ii) if the Note is assigned to a REMIC trust on or after October 1, 2010. If the loan is prepayable, it shall be subject to a yield maintenance penalty equal to the greater of (a) one percent of the outstanding balance, or (b) an amount calculated pursuant to a formula based on the remaining life of the loan and then-current interest rates. The option to prepay will be replaced with an option to defease if the lender has assigned the Note to a Real Estate Mortgage Investment Conduit (REMIC) trust by October 1, 2010; however, if the Note has been securitized, the loan will be subject to a maximum two-year lock-out to defeasance. The loan is secured by a mortgage on the property pursuant to a Multifamily Mortgage, Assignment of Rents and Security Agreement. In addition, the loan is guaranteed by Charles M. Thompson, but only upon the occurrence of certain limited events.

 

 

 

(9)	Assuming no event of default, the loan will mature on January 1, 2020. The loan may be prepaid or defeased during the loan term, subject to certain conditions and limitations. The determination as to prepayment or defeasance is based on actions of the lender with regard to securitizing the loan, which actions are beyond the Company’s control. The borrower possesses the right to prepay the loan, in total but not in part, only if the Note is (i) not assigned to a REMIC trust; or (ii) if the note is assigned to a REMIC trust on or after January 1, 2011. If the loan is prepayable, it shall be subject to a yield maintenance penalty equal to the greater of (a) one percent of the outstanding balance, or (b) an amount calculated pursuant to a formula based on the remaining life of the loan and then-current interest rates. The option to prepay will be replaced with an option to defease if the lender has assigned the note to a REMIC trust by January 1, 2011; however, if the note has been securitized, the loan will be subject to a maximum two-year lock-out to defeasance. The loan is secured by a mortgage on the property pursuant to a Multifamily Mortgage, Assignment of Rents and Security Agreement. In addition, the loan is guaranteed, jointly and severally, by Herbert Morgan, Robert C. Morgan and Robert J. Moser, but only upon the occurrence of certain limited events.
(10)	The loan will mature on August 1, 2021.  Except if the loan is assigned to a REMIC, the loan is generally prepayable subject to a prepayment premium based on the remaining amount of the loan and then-current interest rates.  In addition, the loan is guaranteed by Charles M. Thompson, an affiliate of ERES Coursey not otherwise affiliated with the Company, but only upon the occurrence of certain limited events.
(11)	The loan is interest only for the first two years and then commences amortization of principal and interest on a 30-year schedule thereafter and will mature on December 1, 2021.  Except if the loan is assigned to a REMIC, the loan is generally prepayable subject to a prepayment premium based on the remaining amount of the loan and then-current interest rates.  The loan is secured by a mortgage on the property pursuant to a Multifamily Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing, effective as of November 15, 2011.  In addition, the loan is separately guaranteed by David C. Falk and Wendy C. Drucker, but only upon the occurrence of certain limited events.  David C. Falk and Wendy C. Drucker are principals of Drucker & Falk.  The Multifamily Note and Security Instrument were assigned to Freddie Mac pursuant to an Assignment of Security Instrument, dated November 15, 2011.

 

The loan agreements contain various covenants, which among other things, limit the ability of the borrower to incur indebtedness, engage in certain business activities, enter into material leases on the property and transfer their interest in the property among others. The loan agreements also contain certain customary events of default, including, without limitation, payment defaults, cross-defaults to certain other agreements with respect to the property and bankruptcy-related defaults. In the event of default, the loan may be accelerated and all amounts due under the loan will become immediately due and payable. As of September 30, 2013, the Company is in compliance with its debt covenants.

 

Paladin REIT’s charter provides that its independent directors must approve any borrowing in excess of 300% of the value of its net assets and the justification for such excess borrowing must be disclosed to its stockholders in its next quarterly report. Net assets for purposes of this calculation are defined to be Paladin REIT’s total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts and other non-cash reserves, less total liabilities. The preceding calculation is generally expected to approximate 75% of the aggregate cost of Paladin REIT’s assets before non-cash reserves and depreciation. As of September 30, 2013, Paladin REIT’s borrowings did not exceed 300% of the value of its net assets.

 

5. Related Party Transactions

 

The Advisory Agreement entitles Paladin Advisors to specified fees upon the provision of certain services with regard to the Offerings as well as reimbursement for organization and offering costs, and certain other costs, incurred by Paladin Advisors on behalf of the Company.

 

 

 

Amounts due to Affiliates

 

		September 30, 2013				December 31, 2012
General and administrative expenses due to affiliates (1)		$	—			$	—
Organization and offering costs due from affiliates (2)			—				—
Total due to affiliates		$	—			$	—
Unrecognized organization and offering costs (3)		$	8,354,241			$	8,354,241

_____________

(1)	Pursuant to the Advisory Agreement, the Company will not reimburse Paladin Advisors for operating expenses that exceed the 2%/25% Rule, except as permitted by the 2%/25% Rule, as described in Note 2. During the three months ended September 30, 2013, the Company incurred $689,417 of general and administrative expenses, which is the equivalent of operating expenses under the Advisory Agreement. Due to the application of the 2%/25% Rule, the Company was able to recognize a total of $689,417 of general and administrative expenses in its condensed consolidated statement of operations.  Pursuant to the Advisory Agreement, the Company paid $114,645 in asset management fees due to Paladin Advisors for its 14 properties during the three months ended September 30, 2013.  During the nine months ended September 30, 2013, the Company incurred $1,681,278 of general and administrative expenses, which is the equivalent of operating expenses under the Advisory Agreement. Due to the application of the 2%/25% Rule, the Company was able to recognize a total of $1,681,278 of general and administrative expenses in its condensed consolidated statement of operations.  Pursuant to the Advisory Agreement, the Company paid $356,685 in asset management fees due to Paladin Advisors for its 14 properties during the nine months ended September 30, 2013. For each of these 14 properties, from the respective dates of acquisition through the period that the Company owns the properties, Paladin Advisors has elected to receive a monthly asset management fee equal to one-twelfth of 0.3% of the Company’s allocable cost of the real property acquired. Paladin Advisors acknowledges that it has waived its right to receive any additional amounts due under the Advisory Agreement for such properties.  During the nine months ended September 30, 2013, in accordance with the Advisory Agreement, the Company reimbursed Paladin Advisors $140,234 of general and administrative expenses.  As of September 30, 2012, there were no unrecognized commitments relating to unreimbursed excess operating expenses pursuant to the 2%/25% Rule.
(2)	Organization and offering costs of the Company are paid by Paladin Advisors or its affiliates, including Paladin Realty, on behalf of the Company and directly by the Company. Organization and offering costs consist of actual marketing, legal, accounting, printing and other offering expenses, including amounts to reimburse Paladin Advisors, its affiliates or its dealer manager, for all marketing related costs and expenses, including, but not limited to, expenses relating to registering and marketing the shares and other marketing and organization costs, technology costs and expenses attributable to the Offerings, and payment or reimbursement of bona fide due diligence expenses of the dealer manager and broker-dealers participating in the Offerings. Pursuant to the Advisory Agreement, the Company is obligated to reimburse Paladin Advisors or its affiliates for amounts advanced for organization and offering costs to the extent they do not exceed 3.0% of the gross proceeds of the Offerings. Organization and offering costs due from affiliates represents such costs in excess of the 3% limitation and are due within 60 days after the end of the Second Follow-On Offering.
(3)	Not reflected in the condensed consolidated financial statements at September 30, 2013 and December 31, 2012 as these amounts have exceeded the 3.0% limitation as described above in Note 2 and only become payable to Paladin Advisors or its affiliates in future periods as we receive additional proceeds from the Company’s offerings and the related offering costs do not exceed such 3% limitation.

 

6. Subsequent Events

 

On October 4, 2013, the Beechwood Gardens Apartments were sold for gross proceeds of $13,000,000 in which the Company received approximately $3.0 million in net proceeds.

 

The Company extended its $3,500,000 loan to DT Stone Ridge, the joint venture that owns the Stone Ridge Apartments, which loan was to mature on December 31, 2013, until March 31, 2014.

 

 

 

ITEM 2.

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

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (the “MD&A”) is intended to help the reader understand our operations and our present business environment. The MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes thereto contained in Part I, Item I of this report and the condensed consolidated financial statements and the accompanying notes thereto contained in Part II, Item 8, and the information under “Risk Factors” contained in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012. As used herein, the terms “we,” “our” and “us” refer to Paladin Realty Income Properties, Inc., a Maryland corporation, and its condensed consolidated subsidiaries. Historical results and trends which might appear in the condensed consolidated financial statements should not be interpreted as being indicative of future operations.

 

Forward-Looking Statements

 

Certain information included in this Quarterly Report on Form 10-Q contains, and other materials filed or to be filed by us with the SEC contain or will contain, forward-looking statements. All statements, other than statements of historical facts, including, among others, statements regarding our possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives, are forward-looking statements. Those statements include statements regarding our intent, belief or current expectations and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. You should not place undue reliance on these forward-looking statements. Statements regarding the following subjects are forward-looking by their nature:

 

·

our business strategy;

 

·

our projected operating results;

 

·

our ability to obtain future financing arrangements;

 

·

estimates relating to our future distributions;

 

·

our understanding of our competition;

 

·

market trends; and

 

·

projected capital expenditures.

  

The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our common stock, along with the following factors that could cause actual results to vary from our forward-looking statements:

 

·

the factors referenced in Part I, Item 1A of our annual report on Form 10-K for the year ended December 31, 2012;

 

·

changes in our business strategy;

 

·

availability, terms and deployment of capital;

 

·

availability of qualified personnel;

 

·

changes in our industry, interest rates or the general economy; and

 

·

the degree and nature of our competition.

 

 We believe these forward-looking statements are reasonable; however, undue reliance should not be placed on any forward-looking statements, which are based on current expectations. All written and oral forward-looking statements attributable to us or persons acting on our behalf are qualified in their entirety by these cautionary statements. Further, forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time unless required by law.

 

 

Overview

 

We are a Maryland corporation formed on October 31, 2003, to invest in a diversified portfolio of high quality investments, including real property investments and real estate related investments, focusing primarily on investments that produce current income.

 

On July 18, 2013, Paladin REIT and Paladin Realty Income Properties, L.P. (“Paladin OP”), whose sole general partner is Paladin REIT, entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) with Resource Real Estate Opportunity OP, LP (“Resource OP”), the operating partnership of Resource Real Estate Opportunity REIT, Inc., a Maryland corporation (“Resource”), and RRE Charlemagne Holdings, LLC, a Delaware limited liability company and a wholly owned subsidiary of Resource OP (“Merger Sub”). The Merger Agreement provides for the merger of Paladin OP with and into Merger Sub (the “Merger”), with Merger Sub surviving as a wholly owned subsidiary of Resource OP. Resource will pay $51.2 million in cash, excluding certain transaction costs and subject to certain adjustments, including an adjustment for distributions to Paladin OP differing from specified amounts made prior to the closing of the Merger from the joint venture that owns two office properties (the “Merger Consideration”). The Merger Consideration, together with the existing cash of Paladin OP at the closing date, net of fees and expenses (the “Distribution”) will be distributed to Paladin REIT and Paladin Advisors, as owners of the interests in Paladin OP. Paladin REIT, which owns 99.8% of the interests in Paladin OP, will distribute its portion of the Distribution, together with the existing cash of Paladin REIT at the closing date, to its stockholders and liquidate and dissolve. The remaining 0.2% of the Distribution will be paid to Paladin Advisors, Paladin REIT’s advisor. No fees, other than its proportional share of the Distribution, will be paid to Paladin Advisors in connection with the Merger. The Merger is subject to customary closing conditions, including, among other things, the approval of Paladin REIT’s stockholders.

 

Portfolio Summary

 

As of September 30, 2013, we owned interests in 12 joint ventures that own 13 income-producing properties:

 

		Location			Year Built			Number of Units/Rentable Square Feet
Multifamily Communities
Champion Farms Apartments		Louisville, Kentucky			2000			264 Units
Fieldstone Apartments		Woodlawn, Ohio			2001			266 Units
Pinehurst Apartment Homes		Kansas City, Missouri			1986 and 1988; renovated in 2006			146 Units
Pheasant Run Apartments		Lee’s Summit, Missouri			1985; renovated in 2003 and 2004			160 Units
The Retreat Apartments		Shawnee, Kansas			1984; renovated in 2004 and 2005			342 Units
Hilltop Apartments		Kansas City, Missouri			1986			124 Units
Conifer Crossing		Norcross, Georgia			1981			420 Units
Beechwood Gardens Apartments1		Philadelphia, Pennsylvania			1967; renovated in 2003 and 2004			160 Units
Stone Ridge Apartments		Columbia, South Carolina			1975			191 Units2
Evergreen at Coursey Place Apartments		Baton Rouge, Louisiana			2003			352 Units
Pines of York Apartments		Yorktown, Virginia			1976			248 Units
Office
Two and Five Governor Park (two properties)		San Diego, California			1985 and 1989			22,470 Sq. Ft.;  53,048 Sq. Ft.

 

 

1		On October 4, 2013, Paladin REIT completed the sale of the Beechwood Gardens Apartments.
2		On March 6, 2013, a fire significantly damaged 12 units at Stone Ridge Apartments (“Stone Ridge”), or approximately 6% of the units, and accordingly, Paladin REIT wrote-off approximately $226,000 of building and improvements and has received insurance proceeds of approximately $428,000 and is included in restricted cash in the accompanying condensed consolidated balance sheet. This includes $202,000 of proceeds in excess of costs of building and improvements and such amount is included in other income in the accompanying condensed consolidated statements of operations.  Paladin REIT’s loss related to the fire is expected to be limited to the $10,000 deductible under its property insurance policy.  We have also received approximately $35,000 of insurance proceeds for business interruption and such amount is included in other income in the accompanying condensed consolidated statements of operations. In addition, the damaged units contained asbestos-containing materials (“ACMs”) and such ACMs have been removed pursuant to special guidelines and procedures. The property’s insurance policy contains a limit of $25,000 for the cost of removing ACMs and the cost for the removal of such ACMs was approximately $157,000. The damage to the building and improvements and the estimated cost of removal of the ACMs are reflected in property damage in the accompanying condensed consolidated statements of operations.  In addition, on July 23, 2013, the City of Columbia notified the joint venture that owns the property that three of the fire damaged units are now located in a flood plain and cannot be rebuilt for occupants to inhabit.   It is now expected that the three units will be rebuilt as nine garages, which should allow for rent increases for the nine units that will have dedicated garages.

We are permitted to invest in a variety of real estate property types, either directly or through joint ventures, including apartments, office buildings, industrial buildings, shopping centers and hotels. We also may invest in loans on real property such as mortgage loans and mezzanine loans, which we refer to as real estate related investments.

 

We own our assets and conduct our operations through Paladin OP. As of September 30, 2013 and December 31, 2012, Paladin Advisors held a 0.2% limited partnership interest, respectively, and we held a 99.8% general partnership interest in Paladin OP, respectively.

 

We elected to be taxed as a REIT for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2006, under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. We believe we operate in such a manner as to qualify for treatment as a REIT for federal income tax purposes. Accordingly, we generally will not be subject to federal income tax, provided that distributions to our stockholders equal at least the amount of our taxable income. Even if we qualify for taxation as a REIT, we may be subject to federal income and excise taxes on our undistributed taxable income. We may also be subject to certain state or local taxes.

 

Critical Accounting Policies

 

A comprehensive discussion of our significant accounting policies, which are unchanged, is presented in our condensed consolidated financial statements and notes thereto appearing elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 28, 2013.

 

Results of Operations

 

Three Months Ended September 30, 2013 Compared to the Three Months Ended September 30, 2012

 

Total revenues for the three months ended September 30, 2013, have decreased by approximately $94,000 as compared to the three months ended September 30, 2012. The decrease relates to fire-damaged units at Stone Ridge Apartments.

 

 

Property operating expenses for the three months ended September 30, 2013, have increased by approximately $97,000 compared to the three months ended September 30, 2012. The increase in operating expenses relates to increased occupancy rates.

 

Real property taxes for the three months ended September 30, 2013, have increased by approximately $1,000 compared to the three months ended September 30, 2012.

 

General and administrative expenses have increased by approximately $158,000 for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The change primarily relates to the pending sale of Paladin O.P.

 

Interest expense, including amortization of deferred financing costs, has decreased by approximately $42,000 for the three months ended September 30, 2013 compared to the three months ended September 30, 2012.

 

Depreciation and amortization expense has decreased by approximately $134,000 for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The change primarily relates to the sale of Lofton Place Apartments.

 

Income allocated to noncontrolling interests increased by $208,000 for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012. The change primarily relates to the allocation of profits and losses of each project.

 

Income from discontinued operations has increased by approximately $45,000 for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The change primarily relates to the sale of Lofton Place Apartments.

 

Nine Months Ended September 30, 2013 Compared to the Nine Months Ended September 30, 2012

 

Total revenues for the nine months ended September 30, 2013 have increased by approximately $814,000 as compared to the nine months ended September 30, 2012. The increase relates to higher occupancy and increased rental rates.

 

Property operating expenses for the nine months ended September 30, 2013, have increased by approximately $362,000 compared to the nine months ended September 30, 2012. The increase in operating expenses relates to increased occupancy rates.

 

Real property taxes for the nine months ended September 30, 2013, have increased by approximately $3,000 compared to the nine months ended September 30, 2012.

 

General and administrative expenses have increased by approximately $267,000 for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012.

 

Interest expense, including amortization of deferred financing costs, has decreased by approximately $445,000 for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012.

 

Depreciation and amortization expense has decreased by approximately $366,000 for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012.

 

Income allocated to noncontrolling interests increased by approximately $3,982,000 for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012. The change primarily relates to the allocation of profits and losses of each project and the gain related to the sale of Lofton Place Apartments.

 

Income from discontinued operations has decreased by approximately $217,000 for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The change primarily relates to the sale of Lofton Place Apartments.

 

 

Inflation

 

We have not noticed a significant impact from inflation on our revenues, net sales or net income from continuing operations.

 

Related Party Transactions and Agreements

 

Organization and Offering Costs. Our organization and offering costs are paid by Paladin Advisors or its affiliates, including Paladin Realty, on behalf of us and directly by us. Organization and offering costs consist of actual legal, accounting, printing and other offering expenses, including amounts to reimburse Paladin Advisors, its affiliates or our Dealer Manager, for all marketing related costs and expenses, including, but not limited to, expenses relating to registering and marketing the shares and other marketing and organization costs, technology costs and expenses attributable to the Offerings, and payment or reimbursement of bona fide due diligence expenses of the Dealer Manager and broker-dealers participating in the Offerings. Pursuant to the Advisory Agreement, we are obligated to reimburse Paladin Advisors or its affiliates for amounts advanced for organization and offering costs, provided that Paladin Advisors and its affiliates are responsible for the payment of organization and offering costs to the extent they exceed 3.0% of gross proceeds from the Offerings, excluding proceeds from our distribution reinvestment plan, and will be required to return to us any amount we reimburse them in excess of 3.0% of the gross proceeds from the Offerings, excluding proceeds from our distribution reinvestment plan.

 

We recognized cumulative organization and offering costs of $2,487,241 as of September 30, 2013. Such costs only become our liability when they do not exceed 3.0% of the gross proceeds of the Offerings, excluding proceeds from our distribution reinvestment plan. When recognized by us, organization and offering costs are charged to stockholders’ equity. For the nine months ended September 30, 2013, the Company has not paid any offering costs.

 

Expense Reimbursement. Pursuant to the terms of the Advisory Agreement, Paladin Advisors is entitled to reimbursement of actual expenses incurred for administrative and other services provided to the Company by Paladin Advisors and its affiliates for which they do not otherwise receive a fee. Additionally, Paladin Advisors must repay the Company quarterly any amounts by which the Company’s operating expenses exceed the 2%/25% Rule in the 12 months then ended (the “Expense Period”) and reimbursed by the Company unless a majority of the Company’s independent directors approves reimbursement of any excess. The Company will not reimburse Paladin Advisors for operating expenses that in any fiscal year exceed the 2%/25% Rule. The Company’s average invested assets, as defined in the Advisory Agreement, for any period are equal to the average book value of the Company’s assets invested in equity interests in, and loans secured by, real estate before reserves for depreciation or bad debts or other similar non-cash reserves, computed by taking the average of such values at the end of each month during the period. For the year ended September 30, 2013, the average book value of the Company’s invested assets before reserves for depreciation or bad debts or other similar non-cash reserves was approximately $210,000,000. The Company’s net income, as defined in the Advisory Agreement, for any period, for purposes of the 2%/25% Rule, is equal to our total revenue less total expenses other than additions to reserves for depreciation, bad debts or other similar non-cash reserves for such period. Operating expenses include all expenses incurred by the Company under GAAP including the asset management fee), but excluding organization and offering expenses, selling commissions and dealer manager fees, interest payments, taxes, non-cash expenditures such as depreciation, amortization and bad debt reserves, the subordinated disposition fee, acquisition fees and expenses and distributions pursuant to Paladin Advisors’ subordinated participation interest in Paladin OP.

 

On a quarterly basis, in accordance with the Advisory Agreement, the Company recognizes an expense for operating expenses paid on its behalf by Paladin Advisors when total expenses do not exceed the 2%/25% Rule. Additionally, Paladin Advisors must repay to the Company within 60 days after the end of each fiscal quarter for the 12 months then ended any expenses in excess of the 2%/25% Rule, unless a majority of the Company’s independent directors determine that the excess expenses were justified based on unusual and nonrecurring factors which they deem sufficient. Such approved excess represents an unrecognized commitment and becomes payable by the Company at such time when the excess amount and amounts of future operating expenses are within the 2%/25% Rule. Within 60 days after the end of any Expense Period for which total operating expenses exceed the 2%/25% Rule, the Company will send its stockholders written disclosure, together with an explanation of the factors the independent directors considered in arriving at the conclusion that the excess expenses were justified. However, at Paladin Advisors’ option, Paladin Advisors or its affiliate, as applicable, may defer the refund of expenses and elect to receive such payments, without interest, in any subsequent fiscal year that Paladin Advisors designates. As of September 30, 2013, there were no unrecognized commitments relating to unreimbursed excess operating expenses pursuant to the 2%/25% Rule.

 

 

 

During the Expense Period ended September 30, 2013, the Company’s general and administrative expenses, including expenses incurred on the Company’s behalf by Paladin Advisors and its affiliates, did not exceed the 2%/25% Rule. During the Expense Period ended September 30, 2013, $84,914 was paid by Paladin Advisors.

 

For the nine months ended September 30, 2013, the Company recognized $1,681,278 of general and administrative expenses. In accordance with the Advisory Agreement, the Company recognizes on a quarterly basis amounts not exceeding the 2%/25% Rule.

 

Acquisition Fees. Pursuant to the terms of the Advisory Agreement, we pay Paladin Advisors acquisition fees in an amount equal to 1.5% of (1) the purchase price of a real property investment acquired directly; (2) our allocable cost of a property acquired in a joint venture or (3) with respect to real estate related investments, the funds advanced for such investment. Our allocable cost of a joint venture investment is equal to the product of (i) the amount actually paid or allocated to the purchase, development, construction or improvement of properties by the joint venture, inclusive of expenses related thereto, and the amount of outstanding debt associated with such properties and the joint venture, and (ii) our percentage economic interest in the joint venture.

 

During the nine months ended September 30, 2013, we did not pay Paladin Advisors any acquisitions fees.

 

Asset Management Fees. Pursuant to the terms of the Advisory Agreement, we will pay Paladin Advisors on a monthly basis an asset management fee in an amount equal to one-twelfth of 0.6% of (1) the purchase price of a real property investment acquired directly; (2) our allocable cost of a property acquired in a joint venture or (3) with respect to real estate related investments, the funds advanced for such investment. Our allocable cost of a joint venture investment is calculated as set forth above under “Acquisition Fees.” Paladin Advisors may elect, in its sole discretion, to defer (without interest) payment of the asset management fee in any month by providing us written notice of such deferral.

 

For each of our existing properties from the respective dates of acquisition through the period that we own the properties, Paladin Advisors has elected to receive a monthly asset management fee equal to one-twelfth of 0.3% of our allocable cost of the real property acquired in these joint ventures. Paladin Advisors acknowledges that it has waived its right to receive any additional amounts due under the Advisory Agreement for such properties.

 

During the nine months ended September 30, 2013, we paid Paladin Advisors $356,685 for asset management fees earned.

 

Trends or Uncertainties

 

The commercial real estate debt markets have experienced continued volatility resulting in lenders decreasing the availability of debt financing as well as increasing the cost of debt financing. As our existing debt is fixed rate debt, our current portfolio will not be materially impacted by the current debt market environment. However, should the reduced availability of debt and/or the increased cost of borrowings continue, either by increases in the index rates or by increases in lender spreads, we will need to consider such factors in the evaluation of future acquisitions. This may result in future acquisitions generating lower overall economic returns and potentially reducing future cash flow available for distribution.

 

The state of the debt markets could also have an impact on the overall demand for real estate investments which may result in a decrease in the price or value of real estate assets. Although this may benefit us for future acquisitions, it could negatively impact the current value of our existing assets.

 

The markets for certain classes of commercial property, including multifamily and office properties, saw general improvement in vacancy rates and pricing. However, continuing high unemployment rates present a continued risk of subdued demand. Although we have not thus far been materially adversely affected by the challenges confronting the commercial real estate markets, a muted recovery in the broad economy could continue to limit revenue growth and negatively affect the results of our operations.

 

 

Our management is not aware of any other material trends or uncertainties that may reasonably be expected to have a material impact, favorable or unfavorable, on revenues or income from the acquisition, management and operation of real property and real estate related investments.

 

Liquidity and Capital Resources

 

During the nine months ended September 30, 2013, our source of funds was net operating income of $11,238,604 from our investments in real estate.

 

We consider net operating income to be an appropriate supplemental performance measure because net operating income reflects the operating performance of our properties and excludes certain items that are not considered to be controllable in connection with the management of the property, such as depreciation, interest expense, interest income and general and administrative expenses. Additionally, we believe that net operating income is a widely accepted measure of comparative operating performance in the real estate investment community. However, our use of the term net operating income may not be comparable to that of other real estate companies as they may have different methodologies for computing this amount. We believe that the line on our condensed consolidated statement of operations entitled “Net Income” is the most directly comparable GAAP measure to net operating income. The following table is a reconciliation of net operating income to our reported net loss for the nine months ended September 30, 2013 and 2012:

 

		Nine Months Ended
		September 30, 2013				September 30, 2012
Net operating income		$	11,238,604			$	10,786,016
Interest income			2,932				6,734
Depreciation and amortization expense			(4,169,237	)			(4,535,604	)
Interest expense, including amortization of deferred loan costs			(6,245,285	)			(6,689,990	)
General and administrative expenses			(1,681,278	)			(1,413,633	)
Property damage			(368,111	)			—
Income from discontinued operations			7,051,748				407,258
Net income (loss)		$	5,829,373			$	(1,439,219	)

 

We have been dependent upon the net proceeds received from our Offerings and cash received from sales of assets to conduct our activities. Following the termination of our Second Follow-On Offering as of July 16, 2012, capital required to make any additional real property investments and real estate related investments will be obtained from our operations and from any indebtedness that we may incur in connection with the acquisition of any real properties and real estate related investments thereafter. We anticipate our sources of funds will continue to consist of operating cash flow and indebtedness. We believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future.

 

Net cash provided by operating activities for the nine months ended September 30, 2013 was $2,799,517 compared to net cash provided by operating activities of $3,498,516 for the nine months ended September 30, 2012.

 

Net cash provided by investing activities for the nine months ended September 30, 2013 was $20,501,715 which related to $22,206,963 of net proceeds from the sale of real estate offset by $1,705,248 of expenditures for real estate and improvements. Net cash used in investing activities for the nine months ended September 30, 2012 was $1,646,032, which included $1,856,722 relating to expenditures for real estate and improvements partially offset by a decrease in restricted cash of $210,690.

 

Net cash used in financing activities was $22,034,874 for the nine months ended September 30, 2013 related to $12,709,897 of payments on mortgages payable, $3,476,489 of distributions paid and $6,002,821 of distributions to noncontrolling interests offset by $154,333 of contributions from noncontrolling interests. Net cash used in financing activities was $322,336 for the nine months ended September 30, 2012 primarily related to $5,974,294 in proceeds from the issuance of shares of common stock in our Second Follow-On Offering, $13,000,000 of borrowings on mortgages payable and $442,943 decrease in due to affiliates partially offset by $14,711,100 of payments on mortgages payable, $188,578 of deferred loan costs, $571,486 of selling commissions and dealer manager fees, $211,721 of offering costs, $2,188,959 of distributions paid, and $690,580 of distributions to noncontrolling interests.

 

 

 

Mortgages Payable

 

We have mortgage loans in an aggregate amount of $154,230,798 outstanding, incurred in connection with our acquisitions. These mortgages payable are described in detail in Note 4 to our condensed consolidated financial statements included herein.

 

Leverage Policy

 

Our charter provides that our independent directors must approve any borrowing in excess of 300% of the value of our net assets and the justification for such excess borrowing must be disclosed to our stockholders in our next quarterly report. Net assets for purposes of this calculation are defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts and other non-cash reserves, less total liabilities. The preceding calculation is generally expected to approximate 75% of the aggregate cost of our assets before non-cash reserves and depreciation. As of September 30, 2013, our leverage did not exceed 300% of the value of our net assets.

 

Distributions

 

We paid $3,476,489 in distributions during the nine months ended September 30, 2013. Our board of directors has declared distributions for the periods listed below to stockholders of record as of the close of business each day during the applicable period and made on the dates listed below.

 

All of the $3,476,489 of distributions were paid in cash. On July 16, 2012, our distribution reinvestment plan was terminated.

 

Month		Annualized Rate Declared  (1)		Date Paid		Total Distributions
December 1, 2012 to December 31, 2012		6.0%		January 15, 2013		$	392,372
January 1, 2013 to January 31, 2013		6.0%		February 15, 2013		$	393,447
February 1, 2013 to February 29, 2013		6.0%		March 15, 2013		$	355,371
March 1, 2013 to March 31, 2013		6.0%		April 15, 2013		$	393,447
April 1, 2013 to April 30, 2013		6.0%		May 15, 2013		$	380,755
May 1, 2013 to May 31, 2013		6.0%		June 17, 2013		$	393,447
June 1, 2013 to June 30, 2013		6.0%		July 15, 2013		$	380,756
July1, 2013 to July 31, 2013		6.0%		August 15, 2013		$	393,447
August 1, 2013 to August 31, 2013		6.0%		September 16, 2013		$	393,447

 

(1)	Distributions were declared in the amount of $0.0016438 per share per day, representing an annualized rate of return of 6.0% on an investment of $10.00 per share if paid each day over a 365-day period.

 

 

 

On August 22, 2013, our board of directors declared distributions for the month of September 2013 that totaled approximately $381,000 when paid on October 15, 2013. On September 26, 2013, our board of directors declared distributions for the month of October 2013 that will total approximately $393,000 when paid on November 15, 2013. On October 28, 2013, our board of directors declared distributions for the month of November 2013 that will total approximately $381,000 when paid on December 16, 2013.

 

		Distributions				Distributions Paid												Cash Flow				Funds from
Period		Declared				Cash				DRIP				Total				from Operations				Operations
Nine months ended September 30, 2013		$	3,464,872			$	3,476,489				—			$	3,476,489			$	2,799,517			$	2,247,150
Year ended December 31, 2012		$	4,580,221			$	3,340,759			$	1,171,819			$	4,512,578			$	5,129,365			$	3,150,129
Inception through September 30, 2013		$	20,648,270			$	12,245,302			$	7,628,349			$	19,873,651			$	10,310,417			$	4,884,740

Paladin Advisors has paid expenses on our behalf, and Paladin Advisors has deferred the reimbursement of a portion of these expense payments and has deferred certain other fees owed to it. The repayment of these deferred expenses has impacted, and could continue to impact our ability to pay distributions from cash flow from operations or at all. During the nine months ended September 30, 2013, there were no previously accrued general and administrative expenses to be reimbursed. These reimbursements have reduced our cash flow provided by operating activities and therefore our ability to fund distributions therefrom.

 

For the nine months ended September 30, 2013, Paladin Advisors and its affiliates had incurred on our behalf $140,234 in general and administrative expenses and for which we reimbursed Paladin Advisors all such amounts.

 

We are reliant on Paladin Advisors to support our activities currently because of our small size. While our reliance on Paladin Advisors to finance our operations has been reduced, we have required, and may continue to require, advances from and deferrals of fees otherwise payable to Paladin Advisors. If our dependence on Paladin Advisors continues, we may not be able to finance our operations and/or continue to pay distributions at the rate we currently pay or at all.

 

The amount of distributions to be distributed to our stockholders in the future will be determined by our board of directors and are dependent on a number of factors, including funds available for payment of distributions (including whether Paladin Advisors continues to pay expenses and/or defer reimbursement of expense payments or fees), our financial condition, capital expenditure requirements, annual distribution requirements needed to maintain our status as a REIT under the Internal Revenue Code, and any limitations imposed by the terms of indebtedness we may incur and other factors.

 

Our Performance—Funds from Operations and Modified Funds from Operations

 

One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group, has promulgated a measure known as Funds from Operations, or FFO, which it believes more accurately reflects the operating performance of a REIT such as us. FFO is not equivalent to our net income or loss as defined under GAAP.

 

We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004. On October 31, 2011, NAREIT issued updated guidance with respect to the definition of FFO and reiterated that the exclusion of impairment write-downs of depreciable real estate is consistent with the definition of FFO. NAREIT defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property and impairment write-downs plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO. Prior to the October 31, 2011 issuance of the updated guidance, we included asset impairment write-downs in the definition of FFO.

 

 

The historical accounting convention used for real estate requires a straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time. Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT, using historical accounting for depreciation, could be less informative.

 

Presentation of this information is intended to assist the reader in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO the same way, so comparisons with other REITs may not be meaningful. Factors that impact FFO include non-cash GAAP income and expenses, one-time non-recurring costs, timing of acquisitions, yields on cash held in accounts, income from portfolio properties and other portfolio assets, interest rates on acquisition financing and operating expenses. Furthermore, FFO should not be considered as an alternative to net income, as an indication of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions and should be reviewed in connection with other measures as an indication of our performance. Nonetheless, our FFO reporting complies with NAREIT’s policy described above.

 

Changes in the accounting and reporting rules under GAAP have prompted a significant increase in the amount of non-operating items included in FFO, as defined, such that management, investors and analysts have considered FFO to be insufficient as a singular financial performance measure. Thus, in addition to FFO, we use modified funds from operations, or MFFO, as defined by the Investment Program Association, or IPA. As defined by the IPA, MFFO excludes from FFO the following items:

 

(1)

Acquisition fees and expenses;

 

(2)

Straight-line rent amounts, both income and expense;

 

(3)

Amortization of above or below market intangible lease assets and liabilities;

 

(4)

Amortization of discounts and premiums on debt investments;

 

(5)

Gains or losses from the early extinguishment of debt;

 

(6)

Gains or losses on the extinguishment or sales of hedges, foreign exchange, securities and other derivatives holdings except where the trading of such instruments is a fundamental attribute of our operations (unrealized gains and losses on hedges and foreign currency transactions, as well as any other cash flow adjustments, are adjustments made to net income in calculating cash flows provided by (used in) operating activities);

 

(7)

Gains or losses related to fair value adjustments for derivatives not qualifying for hedge accounting, including interest rate and foreign exchange derivatives;

 

(8)

Gains or losses related to consolidation from, or deconsolidation to, equity accounting;

 

(9)

Gains or losses related to contingent purchase price adjustments; and

 

(10)

Adjustments related to the above items for unconsolidated entities in the application of equity accounting.

 

We believe that MFFO, with these adjustments, is helpful in evaluating how our portfolio might perform after our acquisition stage and, as a result, may provide an indication of the sustainability of our distributions in the future. MFFO should not be considered as an alternative to net income (loss) or to cash flows from operating activities and is not intended to be used as a liquidity measure indicative of cash flow available to fund our cash needs, including our ability to make distributions. MFFO should be reviewed in connection with other GAAP measurements. As explained below, management’s evaluation of our operating performance excludes the items considered in the calculation based on the following economic considerations:

 

Acquisition costs: In evaluating investments in real estate, including both business combinations and investments accounted for under the equity method of accounting, management’s investment models and analysis differentiates costs to acquire the investment from the operations derived from the investment. Prior to 2009, acquisition costs for these types of investments were capitalized; however, beginning in 2009, acquisition costs related to business combinations are expensed. We believe by excluding expensed acquisition costs, MFFO provides useful supplemental information that is comparable for each type of our real estate investments and is consistent with management’s analysis of the investing and operating performance of our properties.

 

In addition, all paid and accrued acquisition fees and expenses are characterized as operating expenses under GAAP and are included in the determination of net income and income from operations, both of which are performance measures under GAAP. Such acquisition fees and expenses are paid in cash and therefore will not be available to distribute to stockholders and may negatively impact our operating performance during the period in which properties are acquired and negatively impact the total return to stockholders, the potential for future distributions to stockholders and cash flows generated by us. Thus, MFFO may not be an accurate indicator of our operating performance, especially during periods in which properties are being acquired.

 

 

 

An MFFO calculation that excludes acquisition costs and expenses would only be comparable to non-listed REITs that have completed their acquisition activities and have operating characteristics to ours. In the event there are no further proceeds from the sale of shares in an offering to fund future acquisition fees and expenses, such fees and expenses paid or reimbursed to our advisor will not be repaid to us and therefore we will need to pay such fees and expenses from either additional debt, earnings from our operations or operating cash flow, net proceeds from the sale of properties, or from ancillary cash flows.

 

The continued acquisition of properties, and the expenses incurred in connection with such acquisitions, is a key operational feature of our business plan to generate income from our operating activities and cash flow in order to make distributions to our stockholders.

 

The following is the calculation of FFO for each of the nine months ended September 30, 2013 and 2012:

 

		For the Nine Months Ended
		September 30, 2013				September  30, 2012
Net income (loss)		$	5,829,373			$	(1,439,219	)
Less:  Noncontrolling interests 11			(3,592,074	)			390,240
Net income (loss) attributable to Company		$	2,237,299			$	(1,048,979	)
Net income (loss)		$	5,829,373			$	(1,439,219	)
Add:
Depreciation and amortization – consolidated entities			4,479,519				5,166,682
Less:
Gain on sale of real estate			(6,861,756	)			—
FFO			3,447,136				3,727,463
Less: Noncontrolling interests			(1,199,986	)			(1,507,871	)
FFO attributable to Company		$	2,247,150			$	2,219,592
Other adjustments:			—				—
MFFO		$	2,247,150			$	2,219,592
Net income (loss) per share-basic		$	0.29			$	(0.14	)
Net income (loss) per share-diluted		$	0.29			$	(0.14	)
FFO per share-basic		$	0.29			$	0.29
FFO per share-diluted		$	0.29			$	0.29
MFFO per share-basic		$	0.29			$	0.29
MFFO per share-diluted		$	0.29			$	0.29
Weighted average number of shares outstanding—basic			7,720,859				7,530,745
Weighted average number of shares outstanding—diluted			7,720,859				7,530,745

 

Off-Balance Sheet Arrangements

 

As of September 30, 2013 and December 31, 2012, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

No material changes to our exposure to market risk have occurred since our Annual Report on Form 10-K for the year ended December 31, 2012.

 

ITEM 4.

CONTROLS AND PROCEDURES.

 

As of September 30, 2013, management carried out, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Our disclosure controls and procedures are designed to provide reasonable assurance that information we are required to disclose in our reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2013, our disclosure controls and procedures were effective.

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS.

 

None.

 

ITEM 1A.

RISK FACTORS.

 

There were no material changes in our Risk Factors as previously disclosed in Item 1A of our Form 10-K for the year ended December 31, 2012.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4.

MINE SAFETY DISCLOSURES.

 

None.

 

ITEM 5.

OTHER INFORMATION.

 

None.

 

 

ITEM 6.

EXHIBITS.

  

3.1		Second Articles of Amendment and Restatement of the Registrant (filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on July 28, 2008 and incorporated herein by reference).
3.2		Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2 to Post-Effective Amendment No. 5 on April 6, 2007 and incorporated herein by reference).
3.3		Amendment No. 1 to Amended and Restated Bylaws (filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K on March 28, 2008 and incorporated herein by reference).
31.1		Section 302 Certification of Principal Executive Officer.
31.2		Section 302 Certification of Principal Financial Officer.
32.1		Section 906 Certification of Principal Executive Officer.
32.2		Section 906 Certification of Principal Financial Officer.
*101.INS		XBRL Instance Document
*101.SCH		XBRL Taxonomy Extension Schema Document
*101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
*101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
*101.LAB		XBRL Taxonomy Extension Labels Linkbase Document
*101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

*

Pursuant to Rule 406T of SEC Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

  

	PALADIN REALTY INCOME PROPERTIES, INC.
November 14, 2013	By:	/s/ James R. Worms
	James R. Worms
	President and Chief Executive Officer
	(Principal Executive Officer)
November 14, 2013	By:	/s/ John A Gerson
	John A. Gerson
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer)