UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016

FOR THE TRANSITION PERIOD FROM                 TO                

COMMISSION FILE NUMBER: 333-199129

 

Inland Residential Properties Trust, Inc.

(Exact name of registrant as specified in its charter)

 

 

630-218-8000

(Registrant’s telephone number, including area code)

 

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 the filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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).    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.

 

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

As of November 3, 2016, there were 965,995 shares of the registrant’s Class A common stock and 231,692 shares of Class T common stock outstanding.

 

 

 

 

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

TABLE OF CONTENTS

 

 

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes to consolidated financial statements.

 

 

3

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

 

See accompanying notes to consolidated financial statements.

 

 

4

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

CONSOLIDATED STATEMENT OF EQUITY (DEFICIT)

(unaudited)

 

 

See accompanying notes to consolidated financial statements.

 

 

5

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

 

 

See accompanying notes to consolidated financial statements.

 

6

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(unaudited)

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Readers of this Quarterly Report should refer to the audited consolidated financial statements of Inland Residential Properties Trust, Inc. (which may be referred to herein as the “Company,” “we,” “us,” or “our”) for the year ended December 31, 2015, which are included in the Company’s 2015 Annual Report as certain footnote disclosures contained in such audited consolidated financial statements have been omitted from this Quarterly Report. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for the fair presentation have been included in this Quarterly Report.

NOTE 1 - ORGANIZATION

The Company was formed on December 19, 2013 to acquire and manage a portfolio of multi-family properties located primarily in the top 100 United States metropolitan statistical areas, which generally contain populations greater than 500,000 people. The Company entered into a business management agreement (the “Business Management Agreement”) with Inland Residential Business Manager & Advisor, Inc. (the “Business Manager”), an indirect wholly owned subsidiary of Inland Real Estate Investment Corporation (the “Sponsor”), to be the Business Manager to the Company. Substantially all of the Company’s business is conducted through Inland Residential Operating Partnership, L.P. (the “operating partnership”), of which the Company is the sole general partner.

The Company has elected to be taxed as a real estate investment trust for U.S. federal income tax purposes (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, beginning with the tax year ended December 31, 2015. Because the Company qualifies for taxation as a REIT, it generally will not be subject to U.S. federal income tax on its REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, to the extent that it annually distributes all of its REIT taxable income to stockholders and complies with other requirements as a REIT. 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 U.S. federal (including any applicable alternative minimum tax) and state income tax on its taxable income at regular corporate rates. Even if the Company qualifies for taxation as a REIT, it may be subject to certain state and local taxes on its income, property or net worth, respectively, and to U.S. federal income and excise taxes on its undistributed income.

At September 30, 2016, the Company owned one 194,732 square foot 206 unit multi-family community. During the nine months ended September 30, 2016, the property’s daily average occupancy was 93.7% and at September 30, 2016, 198, or 96.1% residential units were leased.

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Disclosures discussing all significant accounting policies are set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission on March 29, 2016, under the heading “Note 2 - Summary of Significant Accounting Policies.” There has been no change to the Company’s significant accounting policies during the nine months ended September 30, 2016, except as noted below.

 

Distribution and Stockholder Servicing Fee

The Company pays a distribution and stockholder servicing fee equal to 1.0% per annum of the purchase price per share (or, once reported, the amount of the Company’s estimated value per share) for each Class T Share sold in its Offering (as defined below). The aggregate amount of underwriting compensation for the Class A Shares and Class T Shares, including the distribution and stockholder servicing fee for the Class T Shares, cannot exceed the Financial Industry Regulatory Authority’s 10% cap on underwriting compensation. The fee is not paid at the time of purchase. The Company accounts for the fee as a charge to equity at the time each Class T Share is sold in its Offering and records a corresponding payable in due to related parties. The distribution and stockholder servicing fee is payable monthly in arrears, as it becomes contractually due. At September 30, 2016, the unpaid fee equals $171,444.

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

General

The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Certain amounts in the prior period consolidated financial statements have been reclassified to conform with the current year presentation.

In April 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Company adopted ASU No. 2015-03 for the nine months ended September 30, 2016. As of September 30, 2016 and December 31, 2015, the unamortized debt issuance costs were $677 and $103,046, respectively. These unamortized debt issuance costs are now classified within mortgages payable, net on the Company’s consolidated balance sheets. The Company applied ASU No. 2015-03 retrospectively to all prior periods presented.

 

Recent Accounting Pronouncements

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The issues addressed in the new guidance include the cash flow classification of: debt prepayment and debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investments, beneficial interests in securitization transactions and separately identifiable cash flows and application of the predominance principle. The standard will be effective for fiscal years beginning after December 15, 2017. The Company does not believe that ASU No. 2016-15 will have a material impact on its consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. ASU No. 2016-02 supersedes the previous leases standard, Leases (Topic 840). The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact of its pending adoption of the new standard on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This standard provides a single comprehensive model to use in accounting for revenue arising from contracts with customers and gains and losses arising from transfers of non-financial assets including sales of property, plant, and equipment, real estate, and intangible assets. ASU No. 2014-09 supersedes most current revenue recognition guidance, including industry-specific guidance. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date of ASU No. 2014-09 one year to annual reporting periods beginning after December 15, 2017 for public entities. ASU No. 2015-14 permits public entities to adopt ASU No. 2014-09 early, but not before the original effective date of annual periods beginning after December 15, 2016. ASU No. 2014-09 may be applied either retrospectively or as a cumulative effect adjustment as of the date of adoption. The Company has begun to evaluate each of the revenue streams under the new model. The Company is currently evaluating the application of this ASU and its effect on its financial position and results of operations.

 

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 3 – EQUITY

 

The Company is authorized to sell up to $1,000,000,000 of shares of common stock which consist of Class A common stock, $.001 par value per share (“Class A Shares”), at a price of $25.00 per share and Class T common stock, $.001 par value per share (“Class T Shares”), at a price of $23.95 per share, in any combination, in an initial “reasonable best efforts” offering (the “Offering”) which commenced on February 17, 2015. The Company is also authorized to issue up to $190,000,000 of Class A and Class T Shares at a per share price of $23.75 and $22.81, respectively, pursuant to the Company’s distribution reinvestment plan (as amended, “DRP”).  Excluding DRP proceeds, the Company generated gross proceeds of $15,689,685 from sales of its Class A Shares and $3,052,216 from sales of its Class T Shares during the nine months ended September 30, 2016. As of September 30, 2016, the Company had 925,055 Class A Shares outstanding and 144,005 Class T Shares outstanding.

 

For the nine months ended September 30, 2016, the Company declared cash distributions of $633,357, paid cash distributions of $297,691 and issued stock dividends of 4,812 shares to stockholders.

    

The Company provides the following programs to facilitate additional investment in the Company’s shares and to provide limited liquidity for stockholders.

 

Distribution Reinvestment Plan

 

The Company provides stockholders with the option to purchase additional shares from the Company by automatically reinvesting cash distributions through the DRP, subject to certain share ownership restrictions. For participants in the DRP, cash distributions paid on Class A Shares and Class T Shares, as applicable, are used to purchase Class A Shares and Class T Shares, respectively. Such purchases under the DRP are not subject to selling commissions, dealer manager fees, distribution and stockholder servicing fees or reimbursement of issuer costs in connection with shares of common stock issued through the DRP and are made initially at a price of $23.75 and $22.81 per Class A Share and Class T Share, respectively. The price is subject to change after the earlier of (1) the change of the public offering price in a public “reasonable best efforts” offering of the Company’s Class A Shares from $25.00 per Class A Share or Class T Shares from $23.95 per Class T Share, as applicable, if there is a change, and (2) termination of all “reasonable best efforts” public offerings of the Company’s Class A Shares or Class T Shares, as applicable.

 

Distributions reinvested through the DRP were $256,050 for the nine months ended September 30, 2016. There were no distributions paid during the nine months ended September 30, 2015.

 

Share Repurchase Program

 

Under the share repurchase program (as amended, the “SRP”), the Company is authorized, in its discretion, to purchase shares from stockholders who have held their shares for at least one year, if requested. Subject to funds being available, the Company will limit the number of shares repurchased during any calendar year to 5% of the number of shares of common stock outstanding on December 31st of the previous calendar year. Funding for the SRP comes from proceeds that the Company receives from the DRP. In the case of repurchases made upon the death of a stockholder or qualifying disability, as defined in the SRP, neither the one year holding period, the limit regarding funds available from the DRP nor the 5% limit applies. The SRP will immediately terminate if the Company’s shares become listed for trading on a national securities exchange. In addition, the Company’s board of directors, in its sole direction, may, at any time, amend, suspend or terminate the SRP.

 

There were no repurchases through the SRP for the nine months ended September 30, 2016 and 2015.

 

 

NOTE 4 - ACQUISITIONS

2016 Acquisitions

 

During the nine months ended September 30, 2016, the Company did not acquire any real estate properties.

 

Pro Forma Disclosures

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

The following condensed pro forma consolidated financial statements for the three and nine months ended September 30, 2015 include pro forma adjustments related to the acquisition and financing during 2015. The 2015 acquisition is presented assuming the acquisition occurred on January 1, 2014.

    

 

 

 

 

NOTE 5 – MORTGAGES PAYABLE

 

As of September 30, 2016, the Company’s mortgage loan is secured by a first mortgage on the property. For the nine months ended September 30, 2016, the Company paid down $18,300,000, and achieved a 60% loan to value, as defined in the mortgage loan agreement. Effective September 30, 2016, the Company exercised its option to extend the maturity date for an additional seven year period to September 30, 2023.  The loan extension requires monthly payments of interest only for the next five years and thereafter, requires monthly payments of principal and interest based upon a 30-year amortization until maturity. The interest rate on the loan was modified which lowered the fixed interest rate from 3.95% to 3.64% per annum. The loan modification releases the Sponsor, and substitutes the Company as the guarantor.  As the substitute guarantor, the Company agreed to guarantee the payment of (a) all real estate taxes on the property which accrue or become due during the term of the loan, (b) all costs and expenses (as defined in the guaranty agreement) and (c) any and all losses, damages, costs or expenses of the lender, which arise in consequence of certain events specified in the guaranty agreement.

 

The Company is in compliance with all financial covenants related to its mortgage payable.

The mortgage payable, unamortized debt issuance costs and the interest rates were as follows:

 

 

 

 

 

 

NOTE 6 – EQUITY-BASED COMPENSATION

The Company grants non-vested restricted shares that entitle the holder to receive one Class A Share for each restricted share when it vests. Restricted shares were issued to non-employee directors as compensation in accordance with the Company’s Employee and Director Incentive Restricted Share Plan (the “RSP”).

Under the RSP, restricted shares generally vest over a one to three year vesting period from the date of the grant based on the specific terms of the grant.  The grant-date value of the restricted shares is amortized over the vesting period representing the requisite service period.  At vesting, any restrictions on the shares lapse.  Compensation expense associated with the director restricted shares was $4,844 and $10,920 for the three and nine months ended September 30, 2016, respectively, and is included in general and

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

administrative expenses in the accompanying consolidated financial statements. As of September 30, 2016, the Company had $19,392 of unrecognized compensation cost related to the unvested restricted share awards. The weighted average remaining period that compensation expense related to non-vested restricted shares will be recognized is 1.66 years. A summary of the status of the restricted shares is presented below:

 

 

 

    

 

NOTE 7 – SEGMENT REPORTING

The Company has one reportable segment as defined by U.S. GAAP, multi-family real estate, for the three and nine months ended September 30, 2016.

 

 

NOTE 8 – TRANSACTIONS WITH RELATED PARTIES

The Sponsor invested $200,000 by purchasing 8,000 shares of common stock which were subsequently converted into 8,000 Class A Shares. On September 9, 2015, the Company sold 87,680.842 Class A Shares to the Sponsor for an aggregate purchase price of $2,000,000, or $22.81 per share.

Since inception, the Sponsor has advanced $2,950,000 in cash to the Company, which is included in due to related parties on the accompanying consolidated balance sheets, to partially fund formation, offering and organization costs.

 

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

The following table summarizes the Company’s related party transactions for the three and nine months ended September 30, 2016 and 2015. Certain compensation and fees payable to the Business Manager for services provided to the Company are limited to maximum amounts.

 

 

 

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

 

 

 

 

NOTE 9 – SUBSEQUENT EVENTS

On October 27, 2016, the Company entered into an amendment to the Business Management Agreement with the Business Manager to remove the provision of subordinated management performance interests to the Business Manager via Class M Units in the Company’s operating partnership based on the annual “additional total return” generated each year on the Class A Shares and Class T Shares. In addition, the limited partnership agreement of the Company’s operating partnership was amended and restated to completely eliminate Class M Units. As of October 27, 2016, no class M units had been issued to the Business Manager by the Company’s operating partnership.

On November 7, 2016, the Company entered into an amendment to the dealer manager agreement with Inland Securities Corporation, the Company’s dealer manager, to allow Inland Securities Corporation to reallow a portion of the dealer manager fee to participating soliciting dealers.

On November 7, 2016, the Company’s board of directors approved an extension of the termination date of the Company’s “reasonable best efforts” offering from February 17, 2017 to February 16, 2018.

Cash distributions

 

The Company’s board of directors declared cash distributions payable to stockholders of record each day beginning on the close of business October 1, 2016 through March 31, 2017.  Distributions declared for 2016 are in an amount equal to $0.003415301 per day

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INLAND RESIDENTIAL PROPERTIES TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

per Class A Share and $0.002760929 per day per Class T Share, based on a 366-day period.  Distributions declared for 2017 will be in an amount equal to $0.003424658 per day per Class A Share and $0.002768493 per day per Class T Share, based on a 365-day period. Distributions were paid monthly in arrears as follows:

 

 

Stock dividends

The Company’s board of directors declared a monthly stock dividend of 0.000833333 Class A Shares and 0.000833333 Class T Shares per Class A Share and Class T Share owned, respectively, payable to stockholders of record at the close of business on October 31, 2016, November 30, 2016, December 31, 2016, January 31, 2017, February 28, 2017 and March 31, 2017. In general, these stock dividends are non-taxable distributions to stockholders and are not considered dividends for purposes of meeting our annual distribution requirements. Stock dividends were issued as follows:

 

 

 

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Certain statements in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Words such as “may,” “could,” “should,” “expect,” “intend,” “plan,” “goal,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “variables,” “potential,” “continue,” “expand,” “maintain,” “create,” “strategies,” “likely,” “will,” “would” and variations of these terms and similar expressions, or the negative of these terms or similar expressions, are intended to identify forward-looking statements.

These forward-looking statements are not historical facts but reflect the intent, belief or current expectations of the management of Inland Residential Properties Trust, Inc. (which we refer to herein as the “Company,” “we,” “our” or “us”) based on their knowledge and understanding of the business and industry, the economy and other future conditions. These statements are not guarantees of future performance, and we caution stockholders not to place undue reliance on forward-looking statements. Actual results may differ materially from those expressed or forecasted in the forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to the factors listed and described under “Risk Factors” in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission on March 29, 2016, and factors described below:

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Forward-looking statements in this Quarterly Report on Form 10-Q reflect our management’s view only as of the date of this Quarterly Report, and may ultimately prove to be incorrect or false. 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. We intend for these forward-looking statements to be covered by the applicable safe harbor provisions created by Section 27A of the Securities Act and Section 21E of the Exchange Act.

The following discussion and analysis relates to the three and nine months ended September 30, 2016 and 2015, respectively and as of September 30, 2016 and December 31, 2015, respectively. You should read the following discussion and analysis along with our consolidated financial statements and the related notes included in this report.

Overview

We are an externally managed Maryland corporation formed in December 2013 to acquire and manage a portfolio of multi-family properties located primarily in the top 100 United States metropolitan statistical areas, which generally contain populations greater than 500,000 people. We expect that our real estate portfolio will consist primarily of “stabilized” Class A and Class B multi-family properties. We are managed by our Business Manager. Substantially all of our business is conducted through Inland Residential Operating Partnership, L.P. (our “operating partnership”), of which we are the sole general partner.

On February 17, 2015, we commenced our initial public offering, referred to herein as the “Offering.” We are authorized to sell up to $1,000,000,000 of shares of common stock which consist of Class A common stock, $.001 par value per share (“Class A Shares”), at a price of $25.00 per share and Class T common stock, $.001 par value per share (“Class T Shares”), at a price of $23.95 per share, in any combination, on a “reasonable best efforts” basis. We are also authorized to issue up to $190,000,000 of Class A and Class T Shares at a per share price of $23.75 and $22.81, respectively, pursuant to our distribution reinvestment plan (as amended, “DRP”).

We have elected to be taxed as a real estate investment trust for U.S. federal income tax purposes (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, beginning with our taxable year ended December 31, 2015. Because we qualify for taxation as a REIT, we generally will not be subject to U.S. federal income tax on our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, to the extent that we annually distribute all of our REIT taxable income to stockholders and comply with other requirements as a REIT. If we fail to qualify as a REIT in any taxable year, without the benefit of certain relief provisions, we will be subject to U.S. federal (including any applicable alternative minimum tax) and state income tax on our taxable income at regular corporate rates. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income, property or net worth, respectively, and to U.S. federal income and excise taxes on our undistributed income.

Company Highlights - Nine Months Ended September 30, 2016

Property Performance

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During the nine months ended September 30, 2016, the average rental rate per unit increased 0.8% and the number of units leased increased from 186 to 198 or 6.5% from December 31, 2015. 

Financings

We paid approximately $18.3 million on our mortgage payable with proceeds from our Offering and achieved a 60% loan to value, as defined in the mortgage loan agreement. Effective September 30, 2016, we exercised our option to extend the maturity date for an additional seven year period to September 30, 2023.  The loan extension requires monthly payments of interest only for the next five years and thereafter, requires monthly payments of principal and interest based upon a 30-year amortization until maturity. The interest rate on the loan was modified which lowered the fixed interest rate from 3.95% to 3.64% per annum. The loan modification releases our Sponsor, and substitutes us as the guarantor.  As the substitute guarantor, we agreed to guarantee the payment of (a) all real estate taxes on the property which accrue or become due during the term of the loan, (b) all costs and expenses (as defined in the guaranty agreement) and (c) any and all losses, damages, costs or expenses of the lender, which arise in consequence of certain events specified in the guaranty agreement.

Capital

Excluding DRP proceeds, we generated gross proceeds of approximately $15.7 million from sales of our Class A Shares and approximately $3.1 million from sales of our Class T Shares during the nine months ended September 30, 2016.

Liquidity and Capital Resources

General

Our principal demand for funds is to acquire real estate assets, to pay operating and offering expenses, to pay principal and interest on our outstanding indebtedness, to pay distributions to our stockholders and to fund our SRP. We generally seek to fund our cash needs for items other than asset acquisitions and offering costs from operations. Our cash needs for acquisitions will be funded primarily from the sale of our shares, including those offered for sale through our DRP, as well as financing obtained concurrent with an acquisition or in the future.  There may be a delay between the sale of our shares and our purchase of assets, which could result in a delay in generating returns, if any, from our investment operations.  Our Business Manager and Inland Real Estate Acquisitions, Inc. evaluate potential acquisitions and engage in negotiations with sellers and lenders on our behalf.  Pending investment in real estate assets, we may decide to invest proceeds from the Offering in certain investments that could yield lower returns than those earned on real estate assets.

For the nine months ended September 30, 2016, we received net offering proceeds of $16.3 million from the sale of our stock. Our ability to fund operations is subject to some uncertainties. If we have not generated sufficient cash flow from operations or raised additional offering proceeds, we may fund our cash needs from advances or contributions from our Business Manager or Sponsor or from cash retained by us in the case that our Business Manager defers, accrues or waives all, or a portion, of its business management fees or its right to be reimbursed for certain expenses. We have not limited the amount of monies from any of these sources that may be used to fund cash needs. Neither our Business Manager nor our Sponsor has any obligation to provide us with advances or contributions, and our Business Manager is not obligated to defer, accrue or waive any portion of its business management fee or reimbursements. Further, there is no assurance that these other sources will be available to fund our cash needs.

Potential future sources of capital include proceeds from secured or unsecured financings from banks or other lenders, proceeds from the sale of assets and undistributed funds from operations. If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures. We have not identified any sources for these types of financings.

Our cash needs, as of September 30, 2016 and 2015, have been primarily to pay down our mortgage payable and pay administrative, organizational, property operating and offering costs. During the nine months ended September 30, 2016, we had no real estate acquisitions. At September 30, 2016 and December 31, 2015, we owed $5.6 million and $5.0 million, respectively, to our Sponsor and its affiliates for advances or unpaid service fees. These amounts include non-interest bearing advances by the Sponsor and its affiliates, which we intend to repay.

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Cash Flow Analysis

 

 

Cash provided by operating activities, for the nine months ended September 30, 2016, was $7,459, which was generated from rental and other property income offset by property operating, interest and general and administrative expenses. Cash used in operating activities of $999,968 for the nine months ended September 30, 2015, consisted primarily of general and administrative expenses.

Cash used in investing activities decreased $45,885,592 for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015, as there was one acquisition in September 2015 but no acquisitions during the same period of 2016.

Cash used in financing activities decreased $50,782,282 to $2,338,328 from cash provided by financing activities of $48,443,954 for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. The decrease is primarily due to:

partially offset by:

A summary of the cash distributions declared and paid, and cash flows provided by (used in) operations for the nine months ended September 30, 2016 and 2015 is as follows:

 

Results of operations

The following discussion is based on our consolidated financial statements for the three and nine months ended September 30, 2016 and 2015.  We did not meet our minimum offering requirement until September 9, 2015 and subsequently purchased our first real estate property on September 30, 2015.  As a result, variances are primarily due to the purchase of our first real estate property in 2015 and our on-going capital raising efforts.

Our net loss was $367,912 and $1,364,824 for the three months ended September 30, 2016 and 2015, respectively, and $1,816,775 and $1,630,022 for the nine months ended September 30, 2016 and 2015, respectively.

Total income.  Total income of $992,668 and $2,929,687 for the three and nine months ended September 30, 2016, respectively, consists of tenant rental and other income which are impacted by market rental rates and occupancy levels. Our property’s average occupancy was 93.7% for 2016 and 198 or 96.1% units were leased as of September 30, 2016.

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Operating loss.  Operating loss for the three and nine months ended September 30, 2016 was $45,434 and $695,233, respectively, which consisted of total income, property operating expenses, general and administrative expenses and depreciation and amortization.

Property operating expenses.  Property operating expenses totaled $299,274 and $900,845 for the three and nine months ended September 30, 2016, respectively, and consisted of property management fees and other operating expenses related to owning and maintaining our real estate property.  Real estate tax expense was $90,283 and $264,836 for the three and nine months ended September 30, 2016, respectively.

General and administrative expenses.  For the three and nine months ended September 30, 2016, general and administrative expenses totaled $201,349 and $802,033, respectively, of which $61,837 and $334,175, respectively, was paid or accrued to related parties.  For the three months ended September 30, 2016, general and administrative expenses consisted primarily of related party stock discounts of $4,814, professional fees of $107,672 and administrative expenses of $88,863. For the nine months ended September 30, 2016, general and administrative expenses consisted primarily of related party stock discounts of $19,356, professional fees of $499,093 and administrative expenses of $283,584. For the three and nine months ended September 30, 2015, general and administrative expenses of $143,703 and $408,901, respectively, primarily consisted of organization costs.

Depreciation and amortization expense.  For the three and nine months ended September 30, 2016, depreciation and amortization expense totaled $378,531 and $1,451,356, respectively, due to depreciation on the real estate property purchased during the third quarter of 2015.

Interest expense.  Interest expense for the three and nine months ended September 30, 2016, totaled $322,478 and $1,121,542, respectively, and is due to financing associated with the real estate property purchased during the third quarter of 2015.

Critical Accounting Policies

 

Disclosures discussing all significant accounting policies are set forth in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission on March 29, 2016, under the heading “Critical Accounting Policies,” except as noted below.

Our accounting policies have been established to conform with U.S. generally accepted accounting principles or “U.S. GAAP.” The preparation of financial statements in conformity with U.S. GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. We consider the policies below to be critical, because they require our management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If management’s judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses.

 

Distribution and Stockholder Servicing Fee

We pay a distribution and stockholder servicing fee equal to 1.0% per annum of the purchase price per share (or, once reported, the amount of our estimated value per share) for each Class T Share sold in our Offering. The aggregate amount of underwriting compensation for the Class A Shares and Class T Shares, including the distribution and stockholder servicing fee for the Class T Shares, cannot exceed the Financial Industry Regulatory Authority’s 10% cap on underwriting compensation. The fee is not paid at the time of purchase. We account for the total fee as a charge to equity at the time each Class T Share is sold in our Offering and record a corresponding payable in due to related parties. The distribution and stockholder servicing fee is payable monthly in arrears as it becomes contractually due. At September 30, 2016, the unpaid fee equals $171,444.

 

Recent Accounting Pronouncements

 

In August 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, Statement of Cash Flows (Topic 230). The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The issues addressed in the new guidance include the cash flow classification of: debt prepayment and debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investments, beneficial interests in securitization transactions and

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separately identifiable cash flows and application of the predominance principle. The standard will be effective for fiscal years beginning after December 15, 2017. We do not believe that ASU No. 2016-15 will have a material impact on our consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. ASU No. 2016-02 supersedes the previous leases standard, Leases (Topic 840). The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of our pending adoption of the new standard on our consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This standard provides a single comprehensive model to use in accounting for revenue arising from contracts with customers and gains and losses arising from transfers of non-financial assets including sales of property, plant, and equipment, real estate, and intangible assets. ASU No. 2014-09 supersedes most current revenue recognition guidance, including industry-specific guidance. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date of ASU No. 2014-09 one year to annual reporting periods beginning after December 15, 2017 for public entities. ASU No. 2015-14 permits public entities to adopt ASU No. 2014-09 early, but not before the original effective date of annual periods beginning after December 15, 2016. ASU No. 2014-09 may be applied either retrospectively or as a cumulative effect adjustment as of the date of adoption. We have begun to evaluate each of the revenue streams under the new model. We are currently evaluating the application of this ASU and its effect on our financial position and results of operations.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Subsequent Events

On October 27, 2016, we entered into an amendment to the Business Management Agreement with the Business Manager to remove the provision of subordinated management performance interests to the Business Manager via Class M Units in our operating partnership based on the annual “additional total return” generated each year on the Class A Shares and Class T Shares. In addition, the limited partnership agreement of our operating partnership was amended and restated to completely eliminate Class M Units. As of October 27, 2016, no Class M Units had been issued to the Business Manager by our operating partnership.

On November 7, 2016, we entered into an amendment to the dealer manager agreement with Inland Securities Corporation, our dealer manager, to allow Inland Securities Corporation to reallow a portion of the dealer manager fee to participating soliciting dealers.

On November 7, 2016, our board of directors approved an extension of the termination date of our “reasonable best efforts” offering from February 17, 2017 to February 16, 2018.

Cash distributions

 

Our board of directors declared cash distributions payable to stockholders of record each day beginning on the close of business October 1, 2016 through March 31, 2017.  Distributions declared for 2016 are in an amount equal to $0.003415301 per day per Class A Share and $0.002760929 per day per Class T Share, based on a 366-day period.  Distributions declared for 2017 will be in an amount equal to $0.003424658 per day per Class A Share and $0.002768493 per day per Class T Share, based on a 365-day period. Distributions were paid monthly in arrears as follows:

 

 

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Stock dividends

Our board of directors declared a monthly stock dividend of 0.000833333 Class A Shares and 0.000833333 Class T Shares per Class A Share and Class T Share owned, respectively, payable to stockholders of record at the close of business on October 31, 2016, November 30, 2016, December 31, 2016, January 31, 2017, February 28, 2017 and March 31, 2017. In general, these stock dividends are non-taxable distributions to stockholders and are not considered dividends for purposes of meeting our annual distribution requirement. Stock dividends were issued as follows:

 

 

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

We may be exposed to interest rate changes primarily as a result of long-term debt used to purchase properties or other real estate assets, maintain liquidity and fund capital expenditures or operations. We will seek to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs.

We may use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets. Derivative instruments may include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions will be determined in light of the facts and circumstances existing at the time of the hedge and may differ from our currently anticipated hedging strategy. If we use derivative financial instruments to hedge against interest rate fluctuations, we will be exposed to both credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty will owe us, which creates credit risk for us because the counterparty may not perform. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We will seek to manage the market risk associated with interest-rate contracts by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. There is no assurance we will be successful.

With regard to variable rate financing, our Business Manager will assess our interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. Our Business Manager will maintain risk management control systems to monitor interest rate cash flow risk attributable to both of our outstanding or forecasted debt obligations as well as our potential offsetting hedge positions. While this hedging strategy will be designed to minimize the impact on our net income and funds from operations from changes in interest rates, the overall returns on stockholder investments may be reduced. Presently, we do not have any variable rate debt. 

 

 

Item 4.  Controls and Procedures

Controls and Procedures

Our management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the principal executive and principal financial officers have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) or Rule 15d-15(f)) during the three months ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

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Part II - Other Information

Item 1.  Legal Proceedings

We are not a party to, and our real estate property is not subject to, any material pending legal proceedings.

Item 1A.  Risk Factors

The following risk factors supplement the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2015.

We have incurred net losses on a U.S. GAAP basis for the three months and nine months ended September 30, 2016.

We incurred a net loss on a U.S. GAAP basis for the three and nine months ended September 30, 2016 of $0.4 million and $1.8 million, respectively. Our loss can be attributed, in part, to property operating, interest and general and administrative expenses. We may incur net losses in the future, which could have a material adverse impact on our financial condition, operations, cash flow, and our ability to service our indebtedness and pay distributions to our stockholders. We are subject to all of the business risks and uncertainties associated with any business, including the risk that the value of a stockholder’s investment could decline substantially. We were formed in December 2013 and, as of September 30, 2016, acquired one multi-family community. We cannot assure you that, in the future, we will be profitable or that we will realize growth in the value of our assets.

To date, we have not generated sufficient cash flow from operations to pay distributions, and, therefore, we have paid, and may continue to pay, distributions from the net proceeds of our Offering and DRP, which reduces the amount of cash we ultimately have to invest in assets, negatively impacting the value of our stockholders’ investment, and is dilutive to our stockholders.

We have not yet generated sufficient cash flow from operations to fund distribution payments and may not do so unless our asset base grows significantly. Our organizational documents permit us to pay distributions from sources other than cash flow from operations. Specifically, some or all of our distributions may be paid from retained cash flow, from borrowings and from cash flow from investing activities, including the net proceeds from the sale of our assets, or from the net proceeds of our Offering and DRP. Accordingly, until such time as we are generating cash flow from operations sufficient to cover distributions we have paid and will likely continue to pay distributions from the net proceeds of our Offering or other sources. We have not established any limit on the extent to which we may use alternate sources, including borrowings or proceeds of the Offering and DRP, to pay distributions. There is no assurance we will generate sufficient cash flow from operations to cover distributions. We began declaring distributions to stockholders of record during November 2015. Of the cash distributions paid to stockholders through September 30, 2016, 85% ($0.5 million) have been paid from the net proceeds of our Offering. To the extent we pay cash distributions, or a portion thereof, from sources other than cash flow from operations, we will have less capital available to invest in properties and other real estate-related assets, the book value per share may decline, and there will be no assurance that we will be able to sustain distributions at that level.

 

A potential change in current U.S. GAAP accounting standards or SEC and FINRA regulations, regarding the accounting for the distribution and stockholder servicing fees, may impact how this fee is currently accounted for by us, which may require us to restate previously issued financial statements.

 

We pay a distribution and stockholder servicing fee equal to 1.0% per annum of the purchase price per share (or, once reported, the amount of our estimated value per share) for each Class T Share sold in our Offering. The fee is on-going and is not paid at the time of purchase and is paid monthly in arrears. We originally adopted industry accounting guidance in the application of accounting for the Class T Shares which has been subsequently amended.  The new guidance currently requires the total amount of the distribution and stockholder serving fee to be accounted for at the time of sale. Based on our quantitative and qualitative analysis associated with the previous non-accrual of the distribution and stockholder servicing fee, we concluded the impact was immaterial to the Company’s reported results at December 31, 2015 and March 31, 2016.

 

Prior to March 31, 2016, the distribution and stockholder servicing fee accrued daily and we accounted for this fee as a charge to equity on a periodic basis as it became contractually due and payable.  Therefore, no accrual for an estimate of the full amount of distribution and stockholder servicing fees was established at the time a Class T Share was sold. At December 31, 2015 and March 31, 2016 the non-accrual of the distribution and stockholder servicing fee resulted in an under-accrual of $14,329 and $33,067, respectively, in liabilities and equity.

 

The Company currently accounts for the fee as a charge to equity at the time each Class T Share is sold in its Offering and records a corresponding payable in due to related parties. The distribution and stockholder servicing fee is payable monthly in arrears, as it becomes contractually due. At September 30, 2016, the unpaid fee equals $171,444.

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Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

On February 17, 2015, our Registration Statement on Form S-11 (File No. 333-199129), covering a public offering of up to $1,190,000,000 of shares of Class A and Class T common stock was declared effective under the Securities Act. The Offering commenced on February 17, 2015 and is ongoing.

We are offering up to $1,000,000,000 of Class A and Class T Shares, in any combination. We are also offering up to $190,000,000 of Class A and Class T Shares in the DRP. We reserve the right to reallocate the shares between share classes in our reasonable best efforts offering and between our reasonable best efforts offering and the DRP.

From the effective date of the Offering through September 30, 2016, we had sold the following securities in the Offering for the following aggregate offering prices:

From the effective date of the Offering through September 30, 2016, we have paid the following costs in connection with the issuance and distribution of the registered securities:

 

 

From the effective date of the Offering through September 30, 2016, the net offering proceeds to us from the Offering, after deducting the total expenses incurred described above, were $21,547,728. As of September 30, 2016, we used $18,300,000 of these net proceeds to repay our debt, approximately $712,000 in related costs associated with our purchase of real estate, of which $54,609 was paid to related parties and approximately $481,000 to pay distributions. The remaining proceeds were held as cash at September 30, 2016.

Recent Sale of Unregistered Equity Securities

During the period covered by this quarterly report, we did not sell any equity securities that were not registered under the Securities Act.

Share Repurchase Program

The SRP is designed to provide eligible stockholders with limited, interim liquidity by enabling them to sell shares back to us. Under the SRP, we are authorized to purchase shares from stockholders who have held their shares for at least one year, if requested, if we choose to repurchase them. The terms under which we may repurchase shares may differ between repurchases upon the death or “qualifying disability” of a stockholder or “Exceptional Repurchases” and all other repurchases or “Ordinary Repurchases.” The repurchase price for Ordinary Repurchases is equal to $21.60 per Class A Share and $21.61 per Class T Share until the valuation date, and thereafter the repurchase price is equal to 96.0% of the most recent applicable estimated value per share reported by us.  Subject to funds being available, in the case of Ordinary Repurchases, we will limit the number of shares repurchased during any calendar year to 5% of the number of Class A Shares and Class T Shares outstanding on December 31st of the previous calendar year. Funding for the SRP comes from proceeds we receive from the DRP. In the event that we determine not to repurchase all of the shares presented during any month, including as a result of having insufficient funds or satisfying the 5% limit, to the extent we decide to repurchase shares, shares will be repurchased on a pro rata basis up to the limits described above. In the case of Exceptional Repurchases, we may repurchase shares at a repurchase price equal to $22.50 per Class A Share and $22.51 per Class T Share until the initial valuation date, and thereafter the repurchase price is equal to 100.0% of the most recent applicable estimated value per share reported by us. Exceptional Repurchases are not subject to a one-year holding period, or the 5% repurchase limit discussed above, and may be repurchased with funds from any source. During the period covered by this quarterly report, we did not repurchase any of our securities.

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Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not Applicable.

Item 5.  Other Information

Not Applicable.

Item 6.  Exhibits

The representations, warranties and covenants made by us in any agreement filed as an exhibit to this Form 10-Q are made solely for the benefit of the parties to the agreement, including, in some cases, for the purpose of allocating risk among the parties to the agreement, and should not be deemed to be representations, warranties or covenants to, or with, you. Moreover, these representations, warranties and covenants should not be relied upon as accurately describing or reflecting the current state of our affairs.

The exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index attached hereto and are incorporated herein by reference.

 

 

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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.

 

 

 

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Exhibit Index

 

 

 

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