UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________

FORM 10-K/A

(Amendment No. 3)

(mark one)

R         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES ACT OF 1934

For the fiscal year ended December 31, 2014

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 000-53673

NetREIT, Inc.

(Exact name of registrant as specified in its charter)

(760) 471-8536

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, Series A, par value $0.01 per share

(Title of class)

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

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

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. R  Yes £  No

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

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 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). R  Yes £  No

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

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

At March 15, 2015, registrant had issued and outstanding 16,877,377 shares of its common stock, par value $0.01 per share.

 DOCUMENTS INCORPORATED BY REFERENCE

Part III, Items 10, 11, 12, 13 and 14 incorporate by reference certain specific portions of the definitive Proxy Statement for NetREIT’s Annual Meeting currently scheduled to be held on June 12, 2015. Only those portions of the proxy statement which are specifically incorporated by reference herein shall constitute a part of this annual report.

EXPLANATORY NOTE

This Amendment on Form 10-K/A to the NetREIT, Inc. (“NetREIT”) Annual Report (“Annual Report”) on Form 10-K for the fiscal year ended December 31, 2014 (the “Original Filing”), Form 10-K/A (Amendment No. 1) as filed on April 21, 2015 and Form 10-K/A (Amendment No. 2) as filed on June 16, 2015, is being filed solely (i) for the purposes of amending Part II, Item 7 Management’s discussion and analysis of financial condition and results of operations, (ii) to provide a signature page omitted in Amendment No. 2 and (iii) to include as exhibits the new certifications required by Rule 13a-14(a) under the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”).

The purpose of this amendment is to correct the table of “Same-property operating results” included in Part II, Item 7 in the Section titled “results of operations for the years ended December 31, 2014 and 2013.” The table in the Original Filing and Amendment No. 1 erroneously included properties that were not held for the full year during each year, in “Rental revenues – Commercial properties,” “Rental revenues – Model Homes,”  and “General and administrative – Model Homes” and a mathematical formula error in the totals for “Net operating income.”

In accordance with Rule 12b-15 under the Exchange Act, Part II, Item 7 of the Original Filing has been amended and restated in its entirety. This Amendment does not amend or otherwise update any other information in the Original Filing. Accordingly, this Amendment should be read in conjunction with the Original Filing and Amendment No. 1.

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

The following discussion relates to our financial statements and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to materially differ from those projected. Some of the information presented is forward-looking in nature, including information concerning projected future occupancy rates, rental rate increases, project development timing and investment amounts. Although the information is based on our current expectations, actual results could vary from expectations stated in this report. Numerous factors will affect our actual results, some of which are beyond our control. These include the timing and strength of national and regional economic growth, the strength of commercial and residential markets, competitive market conditions, fluctuations in availability and cost of construction materials and labor resulting from the effects of worldwide demand, future interest rate levels and capital market conditions. You are cautioned not to place undue reliance on this information, which speaks only as of the date of this report. We assume no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under federal securities laws to disclose material information. For a discussion of important risks related to our business, and an investment in our securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information. See Item 1A for a discussion of material risks.

OVERVIEW

The Company operates as a self-managed and self-administered real estate investment trust, or REIT.  The Company invests in a diverse portfolio of real estate assets including industrial, office, residential, retail, self-storage and model home leased residential properties located primarily in the western United States. As of December 31, 2014, including properties held for sale, the Company owned or had an equity interest in:

·          Fourteen office buildings and one industrial building (“Office Properties”) which total approximately 1,152,000 rentable square feet,

·          Five retail shopping centers (“Retail Properties”) which total approximately 230,000 rentable square feet,

·          Seven self-storage facilities (“Self-Storage Properties”) which total approximately 652,000 rentable square feet, and

·          Fifty-four Model Homes owned by three affiliated limited partnerships (“Residential Properties”).

NetREIT’s office, retail and industrial properties are located primarily in Southern California and Colorado, with two properties located in North Dakota. Our Model Home properties are located in seven states. We do not develop properties but acquire properties that are stabilized or that we anticipate will be stabilized within two or three years of acquisition. We consider a property to be stabilized once it has achieved an 80% occupancy rate for a full year as of January 1 of such year, or has been operating for three years. Our geographical clustering of assets enables us to reduce our operating costs through economies of scale by servicing a number of properties with less staff, but it also makes us more susceptible to changing market conditions in these discrete geographic areas.

Most of our office and retail properties are leased to a variety of tenants ranging from small businesses to large public companies, many of which do not have publicly rated debt. We have in the past entered into, and intend in the future to enter into, purchase agreements for real estate having net leases that require the tenant to pay all of the operating expense (Net, Net, Net Leases) or pay increases in operating expenses over specific base years. Most of our office leases are for terms of 3 to 5 years with annual rental increases built into such leases. In general, we have experienced decreases in rental rates in many of our submarkets due to recessionary conditions and other related factors when leases expire and are extended. During 2013 and 2012, the changes in rental rates have affected our operating results due to the older leases being extended at market rates lower than the old rates. We cannot give any assurance that as the older leases expire or as we add new tenants that rental rates will be equal to or above the current market rates. Also, decreased demand and other negative trends or unforeseeable events that impair our

ability to timely renew or re-lease space could have a negative effect on our future financial condition, results of operations and cash flow.

Our Model Homes are typically leased for 2 to 3 years to the home developer on a triple net lease.  Under a triple net lease, the tenant is required to pay all operating, maintenance and insurance costs and real estate taxes with respect to the leased property.

Our self-storage properties are rented pursuant to rental agreements that are typically for no longer than six months in duration. The self-storage properties are located in markets having other self-storage properties. Competition with these other properties will impact the operating results of these properties, which depends materially on our ability to timely lease vacant self-storage units, to actively manage unit rental rates, and our tenants’ ability to make required rental payments. To be successful, we must be able to continue to respond quickly and effectively to changes in local and regional economic conditions by adjusting rental rates of these properties within their regional market in Southern California. We depend on websites, advertisements, flyers, etc. to secure new tenants to fill any vacancies.

We seek to diversify our portfolio by commercial real estate segments to reduce the adverse effect of a single under-performing segment, geographic market and/or tenant. We further supplement this at the tenant level through our credit review process, which varies by tenant class.  For example, our commercial and industrial tenants tend to be corporations or individual owned businesses.  In these cases, we typically obtain financial records, including financial statements and tax returns (depending on the circumstance), and run credit reports for any prospective tenant to support our decision to enter into a rental arrangement. We also typically obtain security deposits from these commercial entities. Our Model Home business partners are also typically substantial home developers with established credit histories. These tenants are subjected to financial review and analysis prior to us entering into a sales-leaseback transaction. Our ownership of the underlying property provides a further means to avoiding significant credit losses. Our self-storage tenants, on the other hand, are typically individuals or smaller businesses, and the underlying transaction size is much smaller due to the short-term nature of the rental agreements. We do not perform credit reviews for this customer class, instead relying on the small transaction size to avoid significant credit losses. Our agreements also give us the right to auction off the storage locker contents in instances in which payment has not been forthcoming.

SIGNIFICANT TRANSACTIONS IN 2014

Preferred Stock Financing - In August 2014, we closed on an offering of our Series B Preferred Stock. The financing, which will be funded in installments, should be completed no later than the one-year anniversary of the initial investment. We issued 16,600 shares of our Series B Preferred Stock for $16.6 million during 2014. These shares have a $0.01 par value and a $1,000 per share liquidation preference. The Series B Preferred Stock shall be redeemed through a cash payment equal to the face value of the shares outstanding at redemption. The return on these funds is 14% - 10% to be paid on a monthly basis, and the remaining 4% shall accrue and compound monthly and be payable at the redemption date. We expect to receive a total capital contribution of $40.0 million from this financing by the conclusion of the funding period. The proceeds of this financing are to be used for Series B Preferred investor approved property acquisitions. The Series B Preferred Stock is scheduled to be redeemed by the third anniversary of the closing date; however, we can extend the redemption date by up to two additional years.

Acquisitions - we acquired the following properties during 2014:

·          A 93,000 square foot, multi-tenant office building located in Bismarck, ND for $5.4 million dollars in May (through a cash payment of $2.0 million and the assumption of the existing loan on the property of $3.4 million). The property was 85% occupied at acquisition.

·          An 84,000 square foot, multi-tenant office building located in Lakewood, Colorado for $9.4 million in August (through a cash payment of $2.8 million and a promissory note totaling $6.6 million). The property was 82% occupied at acquisition.

·          A 110,000 square foot, multi-tenant office property located in Colorado Springs, Colorado for $15.5 million in December (through a cash payment of $5.2 million and a promissory note of $10.3 million).  The property is comprised of two buildings, and was 97% occupied at acquisition.

·          A 79,000 square foot, multi-tenant office property located in Centennial, Colorado was also acquired in December for $11.8 million (through a cash payment of $3.3 million and a promissory note of $8.5 million).  The property was 100% occupied at acquisition.

·          Also in December, a 44,000 square foot, multi-tenant retail property located in Colorado Springs, Colorado for $11.2 million (through a cash payment of $2.4 million, a promissory note of $8.4 million and $400,000 loan termination fee).  The property was 97% occupied at acquisition.

·          NetREIT Dubose, Dubose Model Home Investors #201 LP and Dubose Model Home Investors #202 LP acquired eighteen (18) Model Home properties in Pennsylvania and Arizona at various times during the year (and leased them back to the home builders). The purchase price for the properties totaled $4.2 million, consisting of cash payments of $1.7 million and promissory notes of $2.5 million.

Dispositions - We review our portfolio of investment properties for value appreciation potential on an on-going basis, and dispose of any properties that no longer satisfy our requirements in this regard. The proceeds from any such property sale, after repayment of any associated mortgage, are available for investing in properties that we believe will have a much greater likelihood of future price appreciation.

During 2014, we sold our Fontana Medical Plaza property for $4.1 million (this was a single tenant property acquired by us in 2009 in a joint venture in which we held a 51% interest), while NetREIT Dubose and our limited partnerships (DMHI #201 and DMHI #202) sold forty-five Model Home properties (upon the maturity of leases) for $20.9 million. 

Debt transactions - During 2014, the Company originated approximately $36.4 million of promissory notes payable and assumed one promissory note of $3.4 million in connection with property acquisitions.  The originated notes bear interest at interest rates ranging from 4.3 to 4.5%. During 2014, the Company also refinanced approximately $10.9 million of existing debt with new debt of approximately $17.1 million, providing additional cash to invest in new acquisitions.  The new debt bears interest at an average rate of 4.7%, compared to 5.7% on the old debt, and, due to a four year interest-only provision, we were able to reduce our debt service costs on the refinanced obligations by approximately $67,000 per year. Although our aggregate debt outstanding increased due to acquisitions of new properties and the refinancing of existing debt, the weighted average interest rate of our non-Model Home property mortgages decreased to 4.9% at December 31, 2014 from 5.4% at December 31, 2013.

ECONOMIC ENVIRONMENT

The United States continues to be the path of a slow recovery from the recession that began in 2008.  The current economic environment has shown decreases in residential housing foreclosures and shadow inventory and a decreasing supply of homes available for purchase resulting in an increase in single-family home prices, housing starts and building permits. In addition, unemployment rates have decreased over the last several years. On the commercial side vacancy rates have decreased but are still higher than pre-recessionary levels.  U.S. corporations, earnings and stock market investments and activity have rebounded. We believe that the pace of the overall recovery will likely continue to be slow and disjointed as many sections of the country have not seen job growth. Full recovery will need increasing job growth, but even then it will not be consistent across industries, geographies or periods of the year causing an uneven tempo of growth.

Increases in the size of the U.S. debt, slow economic recovery concerns, and uncertain surrounding the continue raising of the U.S. Government federal debt ceiling raise the possibility of additional credit-rating downgrades by rating agencies. The possibility of further downgrades to the U.S. government’s sovereign credit rating, or its perceived creditworthiness, and/or the impact of the current crisis in Europe with respect to the ability of certain European Union countries to continue to service their sovereign debt obligations are inherently unpredictable and could adversely affect the U.S. and global financial markets and economic conditions.  Although the United States Federal Reserve Bank has started to scale back the quantitative easing and their intent is to keep interest rates low through 2015, these credit ratings concerns could cause interest rates and borrowing costs to rise, which may have a

negative effect on our ability to access both the debt and equity markets on favorable terms. Continued adverse economic conditions could have a material adverse effect on our business, financial condition and results of operations.

Our ability to make new investments is highly dependent upon our ability to procure external financing. Our principal source of external financing includes the issuance of equity securities and mortgages secured by properties.  The market for mortgages has improved although the interest rates increase during 2014 but are still low compared to pre-recessionary rates. We continue to obtain mortgages from the CMBS market, life insurance companies and regional banks.

MANAGEMENT EVALUATION OF RESULTS OF OPERATIONS

Management’s evaluation of operating results includes an assessment of our ability to generate cash flow necessary to pay operating expenses, general and administrative expenses, debt service and to fund distributions to our stockholders. As a result, Management’s assessment of operating results gives less emphasis to the effects of unrealized gains and losses and other non-cash charges, such as depreciation and amortization and impairment charges, which may cause fluctuations in net income for comparable periods but have no impact on cash flows. Management’s evaluation of our potential for generating cash flow includes assessments of our recently acquired properties, our non-stabilized properties, long-term sustainability of our real estate portfolio, our future operating cash flow from anticipated acquisitions, and the proceeds from the sales of our real estate assets.

In addition, Management evaluates our portfolio and individual properties results of operations with a primary focus on increasing and enhancing the value, quality and quantity of properties in our real estate holdings. Properties that have reached goals in occupancy and rental rates are evaluated for potential added value appreciation and, if lacking such potential, are sold with the equity reinvested in properties that have better potential without foregoing cash flow.  Management focuses its efforts on improving underperforming assets through re-leasing efforts, including negotiation of lease renewals and rental rates.

The ability to increase assets under management is affected by our ability to raise borrowings and/or capital, coupled with our ability to identify appropriate investments.

CRITICAL ACCOUNTING POLICIES

As a company primarily involved in owning income generating real estate assets, management considers the following accounting policies critical as they reflect our more significant judgments and estimates used in the preparation of our financial statements and because they are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses.

Real Estate Assets and Lease Intangibles. Land, buildings and improvements are recorded at cost, including tenant improvements and lease acquisition costs (including leasing commissions, space planning fees, and legal fees). We capitalize any expenditure that replaces, improves, or otherwise extends the economic life of an asset, while ordinary repairs and maintenance are expensed as incurred. We allocate the purchase price of acquired properties between the acquired tangible assets and liabilities (consisting of land, building, tenant improvements, land purchase options, and long-term debt) and identified intangible assets and liabilities (including the value of above-market and below-market leases, the value of in-place leases, unamortized lease origination costs and tenant relationships), based in each case on their respective fair values.

We allocate the purchase price to tangible assets of an acquired property based on the estimated fair values of those tangible assets assuming the building was vacant. Estimates of fair value for land, building and building improvements are based on many factors including, but not limited to, comparisons to other properties sold in the same geographic area and independent third party valuations. We also consider information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair values

of the tangible and intangible assets and liabilities acquired.

The value allocated to acquired lease intangibles is based on management’s evaluation of the specific characteristics of each tenant’s lease. Characteristics considered by management in allocating these values include the nature and extent of the existing business relationships with the tenant, growth prospects for developing new business with the tenant, the remaining term of the lease and the tenant’s credit quality, among other factors.

The value allocable to the above-market or below-market market component of an acquired in-place lease is determined based upon the present value (using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of rents that would be paid using fair market rates over the remaining term of the lease.

The value of in-place leases, unamortized lease origination costs and tenant relationships are amortized to expense over the remaining term of the respective leases, which range from less than a year to ten years. The amount allocated to acquire in-place leases is determined based on management’s assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. The amount allocated to unamortized lease origination costs is determined by what we would have paid to a third party to secure a new tenant reduced by the expired term of the respective lease.

Impairment of Real Estate Assets.  We review the carrying value of each property to determine if circumstances that indicate impairment in the carrying value of the investment exist or that depreciation periods should be modified. If circumstances support the possibility of impairment, we prepare a projection of the undiscounted future cash flows, without interest charges, of the specific property and determine if the investment in such property is recoverable. If impairment is indicated, the carrying value of the property is written down to its estimated fair value based on our best estimate of the property’s discounted future cash flows.

Goodwill and Intangible Assets.  Intangible assets, including goodwill and lease intangibles, are comprised of finite-lived and indefinite-lived assets. Lease intangibles represents the allocation of a portion of the purchase price of a property acquisition representing the estimated value of in-place leases, unamortized lease origination costs, tenant relationships and land purchase options. Intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. Indefinite-lived assets are not amortized.

We test for impairment of goodwill and other definite and indefinite lived assets at least annually, and more frequently as circumstances warrant. Impairment is recognized only if the carrying amount of the intangible asset is considered to be unrecoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the estimated fair value of the asset.

Sales of Real Estate Assets.  Gains from the sale of real estate assets will not be recognized under the full accrual method until certain criteria are met. Gain or loss (the difference between the sales value and the cost of the real estate sold) shall be recognized at the date of sale if a sale has been consummated and the following criteria are met:

a.       The buyer is independent of the seller;

b.       Collection of the sales price is reasonably assured; and

c.        The seller will not be required to support the operations of the property or its related obligations to an extent greater than its proportionate interest.

Gains relating to transactions which do not meet the criteria for full accrual method of accounting are deferred and recognized when the full accrual method of accounting criteria are met or by using the installment or deposit methods of profit recognition, as appropriate in the circumstances.

Revenue Recognition. We recognize revenue from rent, tenant reimbursements, and other revenue once all of the following criteria are met:

a.       Persuasive evidence of an arrangement exists;

b.       Delivery has occurred or services have been rendered;

c.        The amount is fixed or determinable; and

d.       The collectability of the amount is reasonably assured.

Annual rental revenue is recognized in rental revenues on a straight-line basis over the term of the related lease. Estimated recoveries from certain tenants for their pro rata share of real estate taxes, insurance and other operating expenses are recognized as revenues in the period the applicable expenses are incurred or as specified in the leases. Other tenants pay a fixed rate and these tenant recoveries are recognized as revenue on a straight-line basis over the term of the related leases.

Certain of our leases currently contain rental increases at specified intervals. We record as an asset, and include in revenues, deferred rent receivable that will be received if the tenant makes all rent payments required through the expiration of the initial term of the lease. Deferred rent receivable in the accompanying balance sheets includes the cumulative difference between rental revenue recorded on a straight-line basis and rents received from the tenants in accordance with the lease terms. Accordingly, Management determines to what extent the deferred rent receivable applicable to each specific tenant is collectible. We review material deferred rent receivable, as it relates to straight-line rents, and take into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of deferred rent with respect to any given tenant is in doubt, we record an increase in the allowance for uncollectible accounts, and write-off of the specific rent receivable. No such reserves related to deferred rent receivables have been recorded as of December 31, 2014 or 2013.

Income Taxes.  We have elected to be taxed as a REIT under Sections 856 through 860 of the Code, for federal income tax purposes. To qualify as a REIT, we must distribute annually at least 90% of adjusted taxable income, as defined in the Code, to our stockholders and satisfy certain other organizational and operating requirements. As a REIT, no provision will be made for federal income taxes on income resulting from those sales of real estate investments which have or will be distributed to stockholders within the prescribed limits. However, taxes will be provided for those gains which are not anticipated to be distributed to stockholders unless such gains are deferred pursuant to Section 1031. In addition, we will be subject to a federal excise tax which equals 4% of the excess, if any, of 85% of ordinary income plus 95% of any capital gain net income over cash distributions, as defined. We believe that we have met all of the REIT distribution and technical requirements for the years ended December 31, 2014 and 2013, respectively.

Earnings and profits that determine the taxability of distributions to stockholders differ from net income reported for financial reporting purposes due to differences in estimated useful lives and methods used to compute depreciation and the carrying value (basis) on the investments in properties for tax purposes, among other things. During the years ended December 31, 2014 and 2013, all distributions were considered return of capital to the stockholders and therefore non-taxable because of our operating losses.

Fair Value Measurements. Certain assets and liabilities are required to be carried at fair value, or if long-lived assets are deemed to be impaired, to be adjusted to reflect this condition. The guidance requires disclosure of fair values calculated under each level of inputs within the following hierarchy:

Level 1 – Quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2 – Inputs other than quoted process that are observable for the asset or liability, either directly or indirectly.

Level 3 – Unobservable inputs for the asset or liability.

Fair value is defined as the price at which an asset or liability is exchanged between market participants in an orderly transaction at the reporting date. Our cash equivalents, mortgage notes receivable, accounts receivable and payables and accrued liabilities all approximate fair value due to their short term nature. Management believes that the recorded and fair values of notes payable are approximately the same as of December 31, 2014 and 2013.

Depreciation and Amortization. The Company records depreciation and amortization expense using the straight-line method over the useful lives of the respective assets. The cost of buildings are depreciated over estimated useful lives of 39 years, the costs of improvements are amortized over the shorter of the estimated life of the asset or term of the tenant lease (which range from 1 to 10 years), and the cost of furniture, fixtures and equipment are depreciated over 4 to 5 years.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013

Our results of operations for 2014 and 2013 are not indicative of those expected in future periods as we expect that rental income, interest expense, rental operating expense, general and administrative expense and depreciation and amortization will significantly increase in future periods as a result of the assets acquired over the last two years and as a result of anticipated growth through future acquisitions of real estate related investments.

Same-Property Operating Results

The table below presents the 2014 and 2013 operating results for the Company’s rental properties owned as of January 1, 2013 (with the exception noted below), thereby excluding the impact on our results of operations from the real estate properties acquired during 2014. The Company believes that this type of non-GAAP financial measure, when considered with our financial statements prepared in accordance with GAAP, is useful to investors to better understand the Company’s operating results. Properties are included in this analysis if they were owned and operated for the entirety of both periods being compared, except for our Lancaster and Casa Grande properties. These properties were exchanged for one-another in a like-kind exchange in the second quarter of 2013, and so have both been included in the following analysis. Same-property operating results should not be considered as an alternative to net income prepared in accordance with GAAP or as a measure of liquidity, Further, same-property operating results is a measure for which there is no standard definition and, as such, it is not consistently defined or reported on among the Company’s peers, and thus may not provide an adequate basis for comparison between REITs.

The following table summarizes certain components of same-property operating results for the years ended December 31, 2014 and 2013.

Revenues.  Total revenue was $19.9 million for the year ended December 31, 2014, compared to $19.6 for the same period in 2013, an increase of $339,000 or 1.7%. The increase in rental income as reported in 2014 as compared to 2013 reflects:

·          A net increase in industrial and office properties rental income of $1.0 million as a result of the five property acquisitions we made during 2014.  The resulting $1.3 million increase in rental revenues arising from these new properties more than compensated for the decline in rental income owing to a non-recurring lease cancellation fee of $345,000 received in 2013.

·          Revenues from rentals of Model Homes decreased to $2.0 million in 2014 from $2.9 million in the prior year. The 30.0% decrease in rental revenues arose as a result of a reduction in the number of Model Homes that we owned in 2014 compared to the prior year. We owned 54 Model Homes at December 31, 2014 compared to 77 homes at December 31, 2013.

·          Self-storage revenue increased $140,000 during 2014, primarily as a result of additional revenues of approximately $95,000 generated from our Lancaster self-storage facility. This facility was acquired in May 2013; therefore our 2014 results reflect a full year of site revenue compared to eight months of site revenue included in our results of operations in 2013.

Rental Operating Costs.  Rental operating costs were $7.5 million for the year ended December 31, 2014 compared to $6.4 million for the same period in 2013, an increase of $1.1 million or 17.0%. Costs associated with properties acquired during 2014 accounted for $593,000 of this increase. Additionally, we experienced an increase in our costs at properties we owned during all of 2014 and 2013 due to an increase in third party on-site management fees ($171,000), additional repairs and maintenance costs ($95,000), an increase in janitorial expenses ($60,000), additional legal and accounting fees ($68,000) and an increase in the cost of unreimbursed utilities ($66,000).

Rental operating costs as a percentage of rental and fee income was 37.5% and 32.6% for the years ended December 31, 2014 and 2013, respectively, primarily due to the decline in Model Home rental revenues. Model Home rental operating costs as a percentage of rental and fee income was 8.9% and 6.6% for the years ended December 31, 2014 and 2013, respectively. Model Home rental operating costs are typically low as the leasees pay for all of the expenses related to the homes, including taxes and insurance. Although Model Home operating costs remained relatively consistent as a percentage of revenues, the decrease in the scope of Model Home business translated into an increase in our overall rental operating costs as a percentage of rental and fee income.

General and Administrative Expenses. General and administrative (“G&A”) expenses were $5.6 million for the year ended December 31, 2014, compared to $5.4 for the same period in 2013, representing an increase of $112,000 or 2.1%. While our overall G&A costs remained relatively unchanged, our federal income taxes increased by $430,000 at our taxable REIT subsidiaries due to the gains on the sales of model homes, which increase was partially offset by a decrease in compensation costs of $295,000 due to the reassignment of certain of our personnel to NTR Property Management, our in-house property management company (the costs of which are included in rental operating expenses).

Depreciation and Amortization. Depreciation and amortization expenses were $6.0 million for the year ended December 31, 2014, compared to $5.3 million for the same period in 2013, representing an increase of $740,000 or 13.9%. Depreciation costs associated with properties acquired during 2014 accounted for all of this increase.

Asset Impairments. We review the carrying value of each of our real estate properties annually to determine if circumstances indicate an impairment in the carrying value of these investments exists. During fiscal 2013, we recognized asset impairment charges on our Havana Parker and Morena Office Centre properties of $1.5 million and $500,000, respectively. During fiscal 2014, we recognized an additional impairment charge of $950,000 for our Havana Parker property. These impairment charges reflect management’s estimate of the fair market value based on sales comps of like property in the same geographical area.

Interest Expense. Interest expense, including amortization of deferred finance charges, increased by $1.4 million, or 28.0%, to $6.5 million for the year ended December 31, 2014 compared to $5.1 million for the same period in 2013. The increase in interest expense was primarily the result of the preferred return on the Series B Preferred Stock issued in August 2014 of $776,000, and amortization of the deferred offering costs associated with that transaction. Additionally, we incurred interest costs of $269,000 as a result of our 2014 acquisitions of the Bismarck and Union Terrace properties. The interest expense for our other 2014 acquisitions was minimal due to the timing of the closing (they were acquired in late-December 2014). The weighted average interest rate on our outstanding debt was 4.9% as of December 31, 2014 compared to 5.1% as of December 31, 2013.

Gain on Sale of Real Estate Assets and Partnerships, net. For the year ended December 21, 2014, we had a gain on the sale of our Fontana Medical Center of $1.7 million, gains from the sales of Model Homes of $3.5 million and a loss on the sale of a land parcel of $0.1 million. For the year ended December 31, 2013, the Company had a net gain on the sale of the Casa Grande Apartments totaling $322,000 and gains from the sales of Model Homes totaling $1.3 million. In addition, in 2013 the Company also recognized gains from the liquidation of its interests in the two limited partnerships totaling $372,000.

Gain on Extinguishment of Debt. In December 2014, the Company and the lender for the Havana Parker Complex entered into to a loan modification agreement pursuant to which the lender agreed to reduce the outstanding loan balance on the property by $537,000 (from $3,037,000 to $2,500,000) and also agreed to defer a portion of the monthly interest on the loan until loan maturity. Under the modified agreement, interest only payments (at 2.5%) are due through in July 1, 2016, at which time all principal and the deferred interest are due. The Company has the

option to extend the loan maturity date for one additional year in exchange for making a one-time payment of $100,000 (which will be applied to outstanding principal).

LIQUIDITY AND CAPITAL RESOURCES

Overview

As discussed above under Economic Environment, during 2014, there have been signs of economic improvement and stabilization in the equity markets. We expect the market turbulence could continue in the commercial real estate arena due to the uncertainties previously discussed. We believe that as a result of the trends, new mortgage financing will continue remain less favorable in terms of loan amount to value as pre-recession days, which may negatively impact our ability to finance future acquisitions. Long-term interest rates remain relatively low by historical standards but we anticipate that interest rates will increase during the next couple years.  On the other hand, we believe the negative trends in the mortgage markets for smaller properties and in some geographic locations have reduced property prices and may, in certain cases, reduce competition for those properties.

Our future sources of liquidity include existing cash and cash equivalents, cash flows from operations, new mortgages on our unencumbered properties, refinancing of existing mortgages, future sales of our Series B Preferred Stock (as described below) and the possible sale of additional equity/debt securities. Our available liquidity at December 31, 2014 included cash and cash equivalents of $5.6 million, as well as our potential borrowing capacity under potential credit facilities such as a revolving line of credit or from mortgages on unencumbered properties and refinancing of mortgages with low debt to value. We do not have a revolving line of credit at the current time, and we cannot guarantee that we will be able to consummate a line of credit in the near future, but we have been exploring the possibilities of obtaining such a line of credit. We also do not have any commitments or other arrangements with any financial institution to borrow any amounts in the form of mortgages on currently unencumbered properties or through refinancing existing mortgages and we cannot be certain that a financial institution would ultimately provide such financing, but we estimate that such borrowings represent additional borrowing capacity of approximately $12.5 million. During 2014, for example, we refinanced approximately $10.9 million of existing debt with new debt of approximately $17.1 million.  The new debt bears interest at an average rate of 4.7% compared to 5.7% on the old debt and, due to a four year interest-only provision, our annual debt service costs decreased by $67,000 as a result of this transaction. We are currently working with an institution to refinance an existing mortgage with an outstanding principal balance of approximately $3.0 million with interest at 5.6% with a new mortgage of $6.0 million with interest at 4.5%.  We expect this refinancing to close in the next quarter.

Our future capital needs include paying down existing borrowings, maintaining our existing properties, funding tenant improvement, paying lease commissions and the payment of a competitive distribution to our stockholders. We also are actively seeking investments that are likely to produce income in order to pay distributions as well as long-term gains for our stockholders. To ensure that we are able to effectively execute these objectives, we routinely review our liquidity requirements and continually evaluate all potential sources of liquidity.

Our short term liquidity needs include paying our current operating costs, satisfying the debt service requirements of our existing mortgages and funding for our distributions to stockholders. During the year ended December 31, 2014, our principal debt service and the cash portion of the distributions to our shareholders’ was $8.6 million, while the net cash provided by our operating activities totaled $4.0 million. The remainder of the distribution was covered by proceeds from sales of real estate assets. We believe that the cash flow from our existing portfolio, distributions from joint ventures in Model Home partnerships and our anticipated acquisitions (when operational for the full term) will be sufficient to fund our near term operating costs, fund the debt service costs on our existing mortgages, and fund the cash portion of distribution to stockholders at the current rate. However, if our cash flow from operating activities is not sufficient to fund our short term liquidity needs, including the payment of cash dividends at current rates to our stockholders, we will fund a portion of these needs from additional borrowings of secured or unsecured indebtedness or we will reduce the rate of distribution to the stockholders.  

Our long-term liquidity needs include proceeds necessary to grow and maintain our portfolio of investments. We believe that the $23.4 million available from the sale of preferred stock as discussed below along with the potential financing capital available to us in the future is sufficient to fund our long-term liquidity needs.  We are continually

reviewing our existing portfolio for properties that have met maximized short and long term potential with the intent of selling those properties and reinvesting the proceeds in properties that have equivalent or better short term benefits and better long term potential.  We expect to obtain additional cash in connection with refinancing of maturing mortgages and assumption of existing debt collateralized by some or all of our real property in the future to meet our long-term liquidity needs.  If we are unable to arrange a line of credit, borrow on unencumbered properties, or sell securities to the public we may not be able to acquire additional properties to meet our long-term objectives.  

Cash and Cash Equivalents

At December 31, 2014, we had approximately $5.6 million in cash and cash equivalents compared to approximately $10.2 million at December 31, 2013. Our cash and cash equivalents are held in bank accounts at third party institutions and consist of invested cash and cash in our operating accounts.  During 2014 and 2013, we did not experience any loss or lack of access to our cash or cash equivalents. Approximately $3.0 million of our cash balance is intended for capital expenditures on existing Properties. We intend to use the remainder of our existing cash and cash equivalents for acquisitions, general corporate purposes and distributions to our stockholders.

Series B Preferred Stock

In August 2014, the Company closed on an offering of our Series B Preferred Stock.  We expect to receive a total capital contribution of $40.0 million from this financing by the conclusion of the funding period. An initial investment of $16.6 million was made at the close of the transaction, and an additional investment of $23.4 million will be made on or before the one year anniversary of the initial investment. We believe that the remaining proceeds from this offering will allow us to increase the size of our property portfolio by approximately $78.0 million. We will continue to seek acquisitions or properties for equity in a DownREIT structure.  Our ability to access equity markets is dependent on a number of factors including general market conditions for the REIT industry and market perception of our Company.  

Secured Debt

As of December 31, 2014, NetREIT had mortgage notes payable in the aggregate principal amount of $116.2 million, collateralized by a total of 26 properties with loan terms at issuance ranging from 3 to 30 years.  The weighted-average interest rate on the mortgage notes payable as of December 31, 2014 was approximately 5.0%, and our debt to book value on these properties was approximately 63.0%.

As of December 31, 2014, NetREIT Dubose, and related entities, had 54 fixed-rate mortgage notes payable in the aggregate principal amount of $7.7 million, collateralized by a total of 54 Model Home properties. These loans generally have a term at issuance of three to five years.  The average balance outstanding and the weighted-average interest rate on these mortgage loans are $321,000 and 5.2%, respectively, as of December 31, 2014. Our debt to net book value on these properties is approximately 57.0%. The Company has guaranteed these promissory notes.  The balloon principal payments on the notes payable are in 2016 and 2019, and are typically tied to the end of the lease and the sale of the Model Home properties securing the debt.

Despite the disruptions in the debt market discussed in "Overview" above, we have been able to refinance maturing debts before scheduled maturity dates and we have also not experienced any unusual difficulties financing our acquisitions.

Cash Flows for the Years Ended December 31, 2014 and 2013

Operating Activities: Net cash provided by operating activities was essentially unchanged in comparison to the prior year – cash flow from operations of $4.4 million for 2014 compared to cash flow from operations of $4.1 million for 2013. We anticipate that with the recent acquisitions and the future anticipated acquisitions, the cash provided by operating activities will cover the cash portion of our distributions to stockholders in the future.

Investing Activities: Net cash used in investing activities was $42.3 million for the year ended December 31, 2014, compared to net cash used of $0.2 million during the same period in 2013. The increase in net cash used in the current year was primarily due to the acquisitions of the five properties for $53.3 million and the acquisition of 18

Model Homes for an aggregate purchase price of $5.7 million. Results for 2013 include the acquisition of our Lancaster property and five Model Homes for $5.3 million. During 2013, our investment activities were curtailed due to the time we spent on a very large portfolio of office buildings, only to lose out on the opportunity after six months of due diligence and negotiations.  Hence, we only acquired one non-Model Home property for $3.6 million. These uses of funds were offset by the proceeds received on sales of real estate of $22.3 million from the sale of the Fontana Medical Plaza property and 34 Model Homes in 2014, compared to proceeds received on sales of real estate of $11.5 million from the sale of the Casa Grande apartments and 31 Model Homes in 2013. 

We anticipate that the acquisitions of both the non-Model Home properties and of Model Homes will increase during 2015 and thereafter. Future acquisitions by the Company will depend on funds available from cash on hand and the proceeds from the issuance of our Series B Preferred Stock and from the sale of existing properties. Future acquisitions of Model Homes will depend on the availability of Model Homes from developers at acceptable prices.

We currently project that we could spend up to $3.0 million on capital improvements, tenant improvements and leasing costs for properties within our portfolio during 2015. Capital expenditures may fluctuate in any given period subject to the nature, extent, and timing of improvements required to the properties. We may spend more on gross capital expenditures during 2015 as compared to 2014 due to rising construction costs and the anticipated increase in property acquisitions in 2015. Tenant improvements and leasing costs may also fluctuate in any given year depending upon factors such as the property, the term of the lease, the type of lease, the involvement of external leasing agents and overall market conditions.

Financing Activities: Net cash provided by financing activities in 2014 was $33.7 million compared to cash used of $4.5 million for the comparable prior year period. The increase in cash flow in the current year was primarily attributable to net inflow of $36.4 million from new mortgage and debt refinancing activity and the net cash inflow of $13.9 million from the sale of Series B Preferred Stock, offset by the net cash outflow of $1.6 million used to redeem preferred shares. Net cash flows associated with noncontrolling interests also adversely impacted our operations by $11.1 million (a net cash outflow of $7.5 million during 2014 (primarily due to special distributions of stemming from two years of high Model Home sales activity) compared to a net cash inflow of $3.6 million in 2013 (due to capital raising activities of the Model Home entities).

We anticipate mortgaging one unencumbered property and increasing mortgages balances in connection with refinancing debt maturing in 2015 on several other properties (during the next two years) to provide additional funds for financing activities. These properties have an estimated market value of approximately $33.3 million and mortgage obligations of $10.8 million, which we believe will allow us to increase our net borrowings by approximately $12.5 million. In addition, we expect that we will generate approximately $23.4 million from the planned issuance of Series B Preferred Stock. We anticipate using the cash so provided to acquire approximately $120.0 million of new properties. We are also pursuing other sources of capital either through a line of credit facility or the possible sale of additional equity/debt securities to provide resources to pursue future acquisitions.

On February 6, 2015, we entered into an Agreement of Purchase and Sale and Joint Escrow Instructions to sell 100% of our Sparky’s Self-Storage Portfolio, as defined in the Purchase Agreement, for a purchase price of approximately $36.3 million to an unaffiliated third party purchaser. The Self-Storage Portfolio is a portfolio of seven self-storage properties located in San Bernardino County, California. The Buyer is currently conducting due diligence on the Self-Storage Portfolio during an initial 55-day inspection period.  Initially, the Buyer escrowed a deposit in the amount of $500,000.  At the expiration of the due diligence period, an additional $500,000 deposit will be due, and the total deposit will become non-refundable and will be applied to the purchase price at closing. The sale of the Self-Storage Portfolio is subject to the fulfillment of certain closing conditions and other terms and conditions customary for real estate transactions.  There can be no assurance that any or all of the conditions will be satisfied or, if satisfied, that the Self-Storage Portfolio will be sold. Assuming that outstanding contingencies are satisfied, we anticipate that the closing of the Self-Storage Portfolio sale will take place in the second quarter of 2015. We expect that the net proceeds from this transaction will be redeployed into our property portfolio.

Off-Balance Sheet Arrangements

As of December 31, 2014, we do not have any off-balance sheet arrangements or obligations, including contingent obligations.

Non-GAAP Supplemental Financial Measures:

Funds From Operations (“FFO”)  

Management believes that FFO is a useful supplemental measure of our operating performance. We compute FFO using the definition outlined by the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT defines FFO as net income (loss) in accordance with GAAP, plus depreciation and amortization of real estate assets (excluding amortization of deferred financing costs and depreciation of non-real estate assets) reduced by gains and losses from sales of depreciable operating property and extraordinary items, as defined by GAAP. Other REITs may use different methodologies for calculating FFO and, accordingly, our FFO may not be comparable to other REITs. Because FFO excludes depreciation and amortization, gains and losses from property dispositions that are available for distribution to stockholders and extraordinary items, it provides a performance measure that, when compared year over year, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses and interest costs, providing a perspective not immediately apparent from net income. In addition, Management believes that FFO provides useful information to the investment community about our financial performance when compared to other REITs since FFO is generally recognized as the industry standard for reporting the operations of REITs. However, FFO should not be viewed as an alternative measure of our operating performance since it does not reflect either depreciation and amortization costs or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties which are significant economic costs and could materially impact our results from operations.

The following table presents our FFO for the years ended December 31, 2014 and 2013.

No conclusion or comparisons should be made from the presentation of these figures.

Modified Funds From Operations (“MFFO”)

We define MFFO, a non-GAAP measure, consistent with the Investment Program Association’s (“IPA”) Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REIT Modified Funds From Operations, or the Practice Guideline, issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of GAAP net income: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above-market and below-market leases and liabilities (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments); accretion of discounts and amortization of premiums on debt investments; nonrecurring impairments of real estate-related investments (i.e., infrequent or unusual, not reasonably likely to recur in the ordinary course of business); mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, nonrecurring unrealized gains and losses on hedges, foreign exchange, derivatives or securities

holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized.

Our MFFO calculation complies with the IPA’s Practice Guideline described above. In calculating MFFO, we exclude acquisition related expenses, amortization of above-market and below-market leases, deferred rent receivables and the adjustments of such items related to noncontrolling interests. Under GAAP, acquisition fees and expenses are characterized as operating expenses in determining operating net income. These expenses are paid in cash by us. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to such property. The acquisition of properties, and the corresponding acquisition fees and expenses, is the key operational feature of our business plan to generate operational income and cash flow to fund distributions to our stockholders. Further, under GAAP, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income in determining cash flow from operating activities. In addition, we view fair value adjustments of impairment charges and gains and losses from dispositions of assets as non-recurring items or items which are unrealized and may not ultimately be realized, and which are not reflective of on-going operations and are therefore typically adjusted for when assessing operating performance. In particular, we believe it is appropriate to disregard impairment charges, as this is a fair value adjustment that is largely based on market fluctuations and assessments regarding general market conditions which can change over time. An asset will only be evaluated for impairment if certain impairment indications exist and if the carrying, or book value, exceeds the total estimated undiscounted future cash flows (including net rental and lease revenues, net proceeds on the sale of the property, and any other ancillary cash flows at a property or group level under GAAP) from such asset. Investors should note, however, that determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of MFFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and the relatively limited term of our operations, it could be difficult to recover any impairment charges.

The following table presents our MFFO for the years ended December 31, 2014 and 2013.

SIGNATURES

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