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EX-32.2 - EXHIBIT 32.2 - Sila Realty Trust, Inc.a2016q310qexhibit322reitii.htm
EX-32.1 - EXHIBIT 32.1 - Sila Realty Trust, Inc.a2016q310qexhibit321reitii.htm
EX-31.2 - EXHIBIT 31.2 - Sila Realty Trust, Inc.a2016q310qexhibit312reitii.htm
EX-31.1 - EXHIBIT 31.1 - Sila Realty Trust, Inc.a2016q310qexhibit311reitii.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________
FORM 10-Q
___________________________________________
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
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: 000-55435
___________________________________________
cvmcriilogoa07.jpg
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
(Exact name of registrant as specified in its charter)
___________________________________________

Maryland
 
46-1854011
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
4890 West Kennedy Blvd., Suite 650
Tampa, FL 33609
 
(813) 287-0101
(Address of Principal Executive Offices; Zip Code)
 
(Registrant’s Telephone Number)
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)
___________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      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. (Check one):
Large accelerated filer
 
  
Accelerated filer
 
 
 
 
 
 
 
 
Non-accelerated filer
 
☒ (Do not check if a smaller reporting company)
  
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  
As of November 10, 2016, there were approximately 78,134,000 shares of Class A and Class T common stock of Carter Validus Mission Critical REIT II, Inc. outstanding.
 



CARTER VALIDUS MISSION CRITICAL REIT II, INC.
(A Maryland Corporation)
TABLE OF CONTENTS
 
 
Page
 
PART I.
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


2


PART 1. FINANCIAL STATEMENTS
Item 1. Financial Statements. 
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
(Unaudited)
September 30, 2016
 
December 31, 2015
ASSETS
Real estate:
 
 
 
Land
$
89,857

 
$
48,882

Buildings and improvements, less accumulated depreciation of $14,240 and $5,262, respectively
527,802

 
361,632

Construction in progress
13,701

 

Total real estate, net
631,360

 
410,514

Cash and cash equivalents
49,090

 
31,262

Acquired intangible assets, less accumulated amortization of $6,003 and $2,007, respectively
67,621

 
54,633

Other assets
22,815

 
10,218

Total assets
$
770,886

 
$
506,627

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
 
 
 
Credit facility, net of deferred financing costs of $294 and $103, respectively
$
134,706

 
$
89,897

Accounts payable due to affiliates
5,760

 
741

Accounts payable and other liabilities
12,979

 
8,244

Intangible lease liabilities, less accumulated amortization of $500 and $98, respectively
7,007

 
7,409

Total liabilities
160,452

 
106,291

Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value per share, 100,000,000 shares authorized; none issued and outstanding

 

Common stock, $0.01 par value per share, 500,000,000 shares authorized; 75,580,055 and 48,488,734 shares issued, respectively; 75,333,847 and 48,457,191 shares outstanding, respectively
753

 
485

Additional paid-in capital
659,651

 
425,910

Accumulated distributions in excess of earnings
(49,959
)
 
(26,061
)
Accumulated other comprehensive loss
(13
)
 

Total stockholders’ equity
610,432

 
400,334

Noncontrolling interests
2

 
2

Total equity
610,434

 
400,336

Total liabilities and stockholders’ equity
$
770,886

 
$
506,627

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands, except share data and per share amounts)
(Unaudited)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Revenue:
 
 
 
 
 
 
 
Rental revenue
$
12,183

 
$
6,230

 
$
33,092

 
$
11,419

Tenant reimbursement revenue
1,411

 
654

 
4,129

 
842

Total revenue
13,594

 
6,884

 
37,221

 
12,261

Expenses:
 
 
 
 
 
 
 
Rental expenses
1,794

 
827

 
5,055

 
1,149

General and administrative expenses
836

 
439

 
2,358

 
1,366

Acquisition related expenses
1,821

 
3,760

 
5,432

 
7,287

Asset management fees
1,227

 
639

 
3,240

 
1,133

Depreciation and amortization
4,782

 
2,438

 
12,948

 
4,048

Total expenses
10,460

 
8,103

 
29,033

 
14,983

Income (loss) from operations
3,134

 
(1,219
)
 
8,188

 
(2,722
)
Interest expense, net
626

 
542

 
2,237

 
1,203

Net income (loss) attributable to common stockholders
$
2,508

 
$
(1,761
)
 
$
5,951

 
$
(3,925
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized income (loss) on interest rate swaps, net
$
88

 
$

 
$
(13
)
 
$

Other comprehensive income (loss) attributable to common stockholders
88

 

 
(13
)
 

Comprehensive income (loss) attributable to common stockholders
$
2,596

 
$
(1,761
)
 
$
5,938

 
$
(3,925
)
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
71,852,230

 
34,794,832

 
63,044,148

 
23,573,522

Diluted
71,866,949

 
34,794,832

 
63,060,086

 
23,573,522

Net income (loss) per common share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
$
0.03

 
$
(0.05
)
 
$
0.09

 
$
(0.17
)
Diluted
$
0.03

 
$
(0.05
)
 
$
0.09

 
$
(0.17
)
Distributions declared per common share
$
0.16

 
$
0.16

 
$
0.47

 
$
0.48

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except for share data)
(Unaudited)
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Distributions in Excess of Earnings
 
Accumulated Other Comprehensive Loss
 
Total
Stockholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
 
 
 
 
 
 
 
 
No. of
Shares
 
Par
Value
 
 
 
 
 
 
Balance, December 31, 2015
48,457,191

 
$
485

 
$
425,910

 
$
(26,061
)
 
$

 
$
400,334

 
$
2

 
$
400,336

Issuance of common stock
25,368,284

 
253

 
247,998

 

 

 
248,251

 

 
248,251

Issuance of common stock under the distribution reinvestment plan
1,718,538

 
17

 
16,268

 

 

 
16,285

 

 
16,285

Vesting of restricted common stock
4,500

 

 
41

 

 

 
41

 

 
41

Commissions on sale of common stock and related dealer manager fees

 

 
(19,938
)
 

 

 
(19,938
)
 

 
(19,938
)
Distribution and servicing fees

 

 
(4,462
)
 

 

 
(4,462
)
 

 
(4,462
)
Other offering costs

 

 
(4,125
)
 

 

 
(4,125
)
 

 
(4,125
)
Repurchase of common stock
(214,666
)
 
(2
)
 
(2,041
)
 

 

 
(2,043
)
 

 
(2,043
)
Distributions declared to common stockholders

 

 

 
(29,849
)
 

 
(29,849
)
 

 
(29,849
)
Other comprehensive loss

 

 

 

 
(13
)
 
(13
)
 

 
(13
)
Net income

 

 

 
5,951

 

 
5,951

 

 
5,951

Balance, September 30, 2016
75,333,847

 
$
753

 
$
659,651

 
$
(49,959
)
 
$
(13
)
 
$
610,432

 
$
2

 
$
610,434

The accompanying notes are an integral part of these condensed consolidated financial statements.

5


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
Nine Months Ended
September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income (loss)
$
5,951

 
$
(3,925
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
12,948

 
4,048

Amortization of deferred financing costs
703

 
481

Amortization of above-market leases
27

 
20

Amortization of intangible lease liabilities
(402
)
 
(44
)
Straight-line rent
(4,344
)
 
(1,549
)
Stock-based compensation
41

 
23

Ineffectiveness of interest rate swap
(49
)
 

Changes in operating assets and liabilities:
 
 
 
Accounts payable and other liabilities
1,042

 
3,380

Accounts payable due to affiliates
230

 
266

Other assets
(610
)
 
(1,800
)
Net cash provided by operating activities
15,537

 
900

Cash flows from investing activities:
 
 
 
Investment in real estate
(239,729
)
 
(257,138
)
Capital expenditures
(4,380
)
 
(640
)
Escrow funds, net
(2,490
)
 
478

Real estate deposits, net
(5,287
)
 
(281
)
Net cash used in investing activities
(251,886
)
 
(257,581
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock
248,251

 
311,955

Proceeds from credit facility
115,000

 
72,000

Payments on credit facility
(70,000
)
 
(39,500
)
Payments of deferred financing costs
(767
)
 
(581
)
Repurchases of common stock
(2,043
)
 
(155
)
Offering costs on issuance of common stock
(23,979
)
 
(36,618
)
Distributions to stockholders
(12,285
)
 
(3,759
)
Net cash provided by financing activities
254,177

 
303,342

Net change in cash and cash equivalents
17,828

 
46,661

Cash and cash equivalents - Beginning of period
31,262

 
3,694

Cash and cash equivalents - End of period
$
49,090

 
$
50,355

Supplemental cash flow disclosure:
 
 
 
Interest paid, net of interest capitalized of $293 and $0, respectively
$
1,887

 
$
600

Supplemental disclosure of non-cash transactions:
 
 
 
Common stock issued through distribution reinvestment plan
$
16,285

 
$
5,795

Distribution and servicing fees accrued
$
4,226

 
$

Liability assumed at acquisition
$
1,236

 
$

Accrued capital expenditures
$
1,469

 
$

Net unrealized loss on interest rate swap
$
(13
)
 
$

The accompanying notes are an integral part of these condensed consolidated financial statements.

6


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2016
Note 1—Organization and Business Operations
Carter Validus Mission Critical REIT II, Inc., or the Company, is a Maryland corporation that was formed on January 11, 2013, which elected to be taxed as a real estate investment trust, or a REIT, under the Internal Revenue Code of 1986, as amended, for federal income tax purposes commencing with its taxable year ended December 31, 2014. The Company commenced principal operations on July 3, 2014 when it satisfied the minimum offering requirement and issued approximately 213,333 shares of Class A common stock for gross proceeds of $2,000,000. Substantially all of the Company’s business is conducted through Carter Validus Operating Partnership II, LP, a Delaware limited partnership, or the Operating Partnership, formed on January 10, 2013. The Company is the sole general partner of the Operating Partnership and Carter Validus Advisors II, LLC, or the Advisor, is the initial limited partner of the Operating Partnership.
The Company is offering for sale a maximum of $2,350,000,000 in shares of common stock, consisting of up to $2,250,000,000 in shares in its primary offering and up to $100,000,000 in shares of common stock to be made available pursuant to the Company’s distribution reinvestment plan, or the DRIP, on a “best efforts” basis, or the Offering, pursuant to a registration statement on Form S-11, or the Registration Statement, filed with the Securities and Exchange Commission, or the SEC, under the Securities Act of 1933, as amended, or the Securities Act, which was declared effective on May 29, 2014. The Company has registered for offering shares of Class A common stock and shares of Class T common stock, in any combination with a dollar value up to the maximum primary offering amount.
As of September 30, 2016, the Company had issued approximately 75,573,000 shares of Class A and Class T common stock (including shares of common stock issued pursuant to the DRIP) in the Offering, resulting in receipt of gross proceeds of approximately $746,094,000, before selling commissions and dealer manager fees of approximately $64,577,000, distribution and servicing fees of approximately $4,462,000 and other offering costs of approximately $14,383,000. As of September 30, 2016, the Company had approximately $1,603,906,000 in Class A shares and Class T shares of common stock remaining in the Offering.
Substantially all of the Company’s business is managed by the Advisor. Carter Validus Real Estate Management Services II, LLC, or the Property Manager, an affiliate of the Advisor, serves as the Company’s property manager. The Advisor and the Property Manager have received, and will continue to receive, fees for services related to the acquisition and operational stages. The Advisor will also be eligible to receive fees during the liquidation stage. SC Distributors, LLC, an affiliate of the Advisor, or the Dealer Manager, serves as the dealer manager of the Offering. The Dealer Manager has received, and will continue to receive, fees for services related to the Offering.
The Company was formed to invest primarily in quality income-producing commercial real estate, with a focus on data centers and healthcare properties, preferably with long-term net leases to investment grade and other creditworthy tenants, as well as to make other real estate-related investments that relate to such property types. Real estate-related investments may include equity or debt interests, including securities, in other real estate entities. The Company also may originate or invest in real estate-related notes receivable. The Company expects real estate-related notes receivable originations and investments to be focused on first mortgage loans, but also may include real estate-related bridge loans, mezzanine loans and securitized notes receivable. As of September 30, 2016, the Company owned 30 real estate investments, consisting of 43 properties, located in 24 metropolitan statistical areas, or MSAs, and one micropolitan statistical area, or µSA.
Except as the context otherwise requires, “we,” “our,” “us,” and the “Company” refer to Carter Validus Mission Critical REIT II, Inc., the Operating Partnership and all wholly-owned subsidiaries.

7


Note 2—Summary of Significant Accounting Policies
The summary of significant accounting policies presented below is designed to assist in understanding the Company’s condensed consolidated financial statements. Such condensed consolidated financial statements and the accompanying notes thereto are the representation of management. These accounting policies conform to accounting principles generally accepted in the United States of America, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal and recurring nature considered for a fair presentation, have been included. Operating results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.
The condensed consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements at that date but does not include all the information and notes required by GAAP for complete financial statements. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's audited consolidated financial statements as of and for the year ended December 31, 2015 and related notes thereto set forth in the Company's Annual Report on Form 10-K, filed with the SEC on March 28, 2016.
Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, and all wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
On January 1, 2016, the Company adopted Accounting Standards Update, or ASU, ASU 2015-02, Amendments to the Consolidation Analysis, which amends the current consolidation guidance affecting both the variable interest entity, or VIE, and voting interest entity, or VOE, consolidation models. The standard does not add or remove any of the characteristics in determining if an entity is a VIE or VOE, but rather enhances the way the Company assesses some of these characteristics. The Operating Partnership meets the criteria as a VIE, the Company is the primary beneficiary and, accordingly, the Company continues to consolidate the Operating Partnership. The Company’s sole asset is its investment in the Operating Partnership, and consequently, all of the Company’s assets and liabilities represent those assets and liabilities of the Operating Partnership. All of the Company’s debt is an obligation of the Operating Partnership.
Use of Estimates
The preparation of the condensed consolidated financial statements and accompanying notes in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates are made and evaluated on an ongoing basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates.
Concentration of Credit Risk and Significant Leases
As of September 30, 2016, the Company had cash on deposit, including restricted cash, in certain financial institutions that had deposits in excess of current federally insured levels; however, the Company has not experienced any losses in such accounts. The Company limits its cash investments to financial institutions with high credit standings; therefore, the Company believes it is not exposed to any significant credit risk on its cash deposits. To date, the Company has experienced no loss of or lack of access to cash in its accounts. Concentration of credit risk with respect to accounts receivable from tenants is limited.
As of September 30, 2016, the Company owned real estate investments in 24 MSAs and one µSA, three MSAs of which accounted for 10.0% or more of contractual rental revenue. Real estate investments located in the Oklahoma City, Oklahoma MSA, the Houston-The Woodlands-Sugar Land, Texas MSA, and the Dallas-Fort Worth-Arlington, Texas MSA accounted for 15.9%, 14.5%, and 11.9%, respectively, of contractual rental revenue for the nine months ended September 30, 2016.
As of September 30, 2016, the Company had two exposures to tenant concentration that accounted for 10.0% or more of contractual rental revenue. The leases with tenants under common control of the guarantor Post Acute Medical, LLC and the leases with Healthcare Partners Investments, LLC accounted for 12.6% and 11.4%, respectively, of contractual rental revenue for the nine months ended September 30, 2016.
Deferred Financing Costs
Deferred financing costs are loan fees, legal fees and other third-party costs associated with obtaining financing. These costs are amortized over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing costs are generally expensed when the associated debt is refinanced or repaid before maturity unless specific rules are met that would allow for the carryover of such costs to the refinanced debt. Costs incurred in seeking financing transactions that do not close are expensed in the period in which it is determined that the financing will not close.

8


On January 1, 2016, the Company adopted ASU 2015-03, InterestImputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, and ASU 2015-15, Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated With Line-of-Credit Arrangements, or ASUs 2015-03 and 2015-15. According to ASUs 2015-03 and 2015-15, deferred financing costs related to a recognized debt liability in connection with term loans, including the term loan portion of the Company's credit facility, are presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. Deferred financing costs related to the revolving line of credit portion of the Company's secured credit facility are presented in the balance sheet as an asset, which is included in other assets on the condensed consolidated balance sheet. As required, the Company retrospectively applied the guidance in ASUs 2015-03 and 2015-15 to the prior period presented, which resulted in a decrease of $103,000 in other assets and credit facility on the condensed consolidated balance sheet as of December 31, 2015.
Share Repurchase Program
The Company’s share repurchase program allows for repurchases of shares of the Company’s common stock when certain criteria are met. Repurchases of shares of the Company’s common stock are at the sole discretion of the Company’s board of directors. In addition, the Company’s board of directors, in its sole discretion, may amend, suspend, reduce, terminate or otherwise change the share repurchase program upon 30 days' prior notice to the Company’s stockholders for any reason it deems appropriate. The share repurchase program provides that the Company will limit the number of shares repurchased during any calendar year to 5.0% of the number of shares of common stock outstanding on December 31st of the previous calendar year. In addition, the share repurchase program provides that all repurchases of shares of common stock during any calendar year, including those upon death or a qualifying disability of a stockholder, are limited to those that can be funded with equivalent proceeds raised from the DRIP Offering during the prior calendar year and other operating funds, if any, as the board of directors, in its sole discretion, may reserve for this purpose. During the nine months ended September 30, 2016, the Company received valid repurchase requests related to 214,666 Class A shares of common stock, all of which were repurchased in full for an aggregate purchase price of approximately $2,043,000 (an average of $9.52 per share). During the nine months ended September 30, 2015, the Company received valid repurchase requests related to 15,511 Class A shares of common stock, all of which were repurchased in full for an aggregate purchase price of approximately $155,000 (an average of $9.99 per share). During the nine months ended September 30, 2016 and 2015, the Company did not receive repurchase requests related to Class T shares.
Fair Value
Accounting Standards Codification, or ASC, 820, Fair Value Measurements and Disclosures, or ASC 820, defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. ASC 820 emphasizes that fair value is intended to be a market-based measurement, as opposed to a transaction-specific measurement.
Fair value is defined by ASC 820 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, various techniques and assumptions can be used to estimate the fair value. Assets and liabilities are measured using inputs from three levels of the fair value hierarchy, as follows:
Level 1—Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2—Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).
Level 3—Unobservable inputs, only used to the extent that observable inputs are not available, reflect the Company’s assumptions about the pricing of an asset or liability.
The following describes the methods the Company used to estimate the fair value of the Company’s financial assets and liabilities:
Cash and cash equivalents, other assets, accounts payable due to affiliates and accounts payable and other liabilities—The Company considers the carrying values of these financial instruments, assets and liabilities to approximate fair value because of the short period of time between origination of the instruments and their expected realization.
Secured credit facility—The outstanding principal of the secured credit facility – variable was $110,000,000 and $90,000,000, which approximated its fair value as of September 30, 2016 and December 31, 2015, respectively. The interest on the secured credit facility – variable is calculated at the London Interbank Offered Rate, or LIBOR, plus an applicable margin.

9


The interest rate resets to market on a monthly basis. The fair value of the Company's secured credit facility – variable is estimated based on the interest rates currently offered to the Company by financial institutions. The estimated fair value of the secured credit facility – variable rate fixed through an interest rate swap agreement (Level 2) was approximately $24,777,000 as of September 30, 2016 as compared to the outstanding principal of $25,000,000 as of September 30, 2016.
Derivative instruments—Considerable judgment is necessary to develop estimated fair values of financial instruments. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize, or be liable for, on disposition of the financial instruments. The Company has determined that the majority of the inputs used to value its interest rate swaps fall within Level 2 of the fair value hierarchy. The credit valuation adjustments associated with these instruments utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and the respective counterparty. However, as of September 30, 2016, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions, and has determined that the credit valuation adjustments are not significant to the overall valuation of its interest rate swaps. As a result, the Company determined that its interest rate swaps valuation in its entirety is classified in Level 2 of the fair value hierarchy.
In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis as of September 30, 2016 (amounts in thousands):
 
September 30, 2016
 
Fair Value Hierarchy
 
 
 
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs (Level 3)
 
Total Fair
Value
Assets:
 
 
 
 
 
 
 
Derivative assets
$

 
$
36

 
$

 
$
36

Total assets at fair value
$

 
$
36

 
$

 
$
36

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$

 
$

 
$

 
$

Total liabilities at fair value
$

 
$

 
$

 
$

The Company did not have financial assets and liabilities required to be measured at fair value as of December 31, 2015.
Derivative Instruments and Hedging Activities
As required by ASC 815, Derivatives and Hedging, or ASC 815, the Company records all derivative instruments as assets and liabilities in the statement of financial position at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. For derivative instruments not designated as hedging instruments, the income or loss is recognized in the condensed consolidated statements of comprehensive income (loss) during the current period.
The Company is exposed to variability in expected future cash flows that are attributable to interest rate changes in the normal course of business. The Company’s primary strategy in entering into derivative contracts is to add stability to future cash flows by managing its exposure to interest rate movements. The Company utilizes derivative instruments, including interest rate swaps, to effectively convert some its variable rate debt to fixed rate debt. The Company does not enter into derivative instruments for speculative purposes.
In accordance with ASC 815, the Company designates interest rate swap contracts as cash flow hedges of floating-rate borrowings. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the income or loss on the derivative instrument is reported as a component of other comprehensive income (loss) in the condensed consolidated statements of comprehensive income (loss) and reclassified into earnings in the same line item associated with the forecasted transaction and the same period during which the hedged transaction affects earnings. The ineffective portion of the income or loss on the derivative instrument is recognized in the condensed consolidated statements of comprehensive income (loss) during the current period.
In accordance with the fair value measurement guidance ASU 2011-04, Fair Value Measurement, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

10


Earnings Per Share
The Company calculates basic earnings per share by dividing net income (loss) attributable to common stockholders for the period by the weighted average shares of its common stock outstanding for that period. Diluted earnings per share are computed based on the weighted average number of shares outstanding and all potentially dilutive securities. Shares of non-vested restricted common stock give rise to potentially dilutive shares of common stock. For the three and nine months ended September 30, 2016, diluted earnings per share reflected the effect of approximately 15,000 and 16,000, respectively, of non-vested shares of restricted Class A common stock that were outstanding as of such period. For the three and nine months ended September 30, 2015, there were 15,750 shares of non-vested restricted Class A common stock outstanding, but such shares were excluded from the computation of diluted earnings per share because such shares were anti-dilutive during this period.
Recently Issued Accounting Pronouncements
On May 28, 2014, the Financial Accounting Standards Board, or the FASB, issued ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. The objective of ASU 2014-09 is to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle, which may require more judgment and estimates within the revenue recognition process than are required under existing GAAP. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date, or ASU 2015-14. ASU 2015-14 defers the effective date of ASU 2014-09 by one year to fiscal years and interim periods beginning after December 15, 2017. Early adoption is permitted as of the original effective date, which was annual reporting periods beginning after December 15, 2016, and the interim periods within that year. On March 17, 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Principal versus Agent Considerations), or ASU 2016-08, which improves the implementation guidance on principal versus agent considerations. ASU 2016-08 clarifies that an entity is a principal when it controls the specified good or service before that good or service is transferred to the customer, and is an agent when it does not control the specified good or service before it is transferred to the customer. The effective date of this update is the same as the effective date of ASU 2015-14. The Company is in the process of evaluating the impact ASUs 2014-09 and 2016-08 will have on the Company’s condensed consolidated financial statements.
On June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses, or ASU 2016-13. ASU 2016-13 requires more timely recording of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. ASU 2016-13 requires that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The amendments in ASU 2016-13 require the Company to measure all expected credit losses based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets and eliminates the “incurred loss” methodology in current GAAP. ASU 2016-13 is effective for fiscal years beginning after, and interim periods within, December 15, 2019. Early adoption is permitted for fiscal years beginning after, and interim periods within, December 15, 2018.  The Company is in the process of evaluating the impact ASU 2016-13 will have on the Company’s condensed consolidated financial statements.
On August 26, 2016, the FASB issued ASU 2016-15, Statement of Cash Flows, or ASU 2016-15. ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 addresses eight classification issues related to the statement of cash flows: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon bonds; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7) beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Entities should apply this ASU using a retrospective transition method to each period presented. The Company is in the process of evaluating the impact ASU 2016-15 will have on the Company’s condensed consolidated financial statements.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the Company’s condensed consolidated financial position or results of operations.

11



Note 3—Real Estate Investments
During the nine months ended September 30, 2016, the Company purchased 15 real estate properties, of which 12 were determined to be business combinations and three were determined to be asset acquisitions. See Note 4—"Business Combinations" for further discussion of business combinations. The following table summarizes the consideration transferred for all real estate properties acquired during the nine months ended September 30, 2016 (amounts in thousands):
 
Nine Months Ended
September 30, 2016
Investments in real estate:
 
Purchase price of business combinations (1)
$
207,447

Purchase price of asset acquisitions
33,518

Total purchase price of real estate investments acquired
$
240,965

(1)
In connection with one business combination, the Company assumed a $1,236,000 contractual liability during the nine months ended September 30, 2016.
Acquisition fees and expenses in connection with the acquisition of properties determined to be business combinations are expensed as incurred, including investment transactions that are no longer under consideration, and are included in acquisition related expenses in the accompanying condensed consolidated statements of comprehensive income (loss). Acquisition fees and expenses associated with transactions determined to be asset acquisitions are capitalized. The Company expensed acquisition fees and expenses of approximately $1,684,000 and $3,760,000 for the three months ended September 30, 2016 and 2015, respectively, and $5,052,000 and $7,287,000 for the nine months ended September 30, 2016 and 2015, respectively. The Company capitalized acquisition fees and expenses of approximately $2,037,000 and $234,000 for the nine months ended September 30, 2016 and 2015, respectively. The Company did not capitalize any acquisition fees and expenses for the three months ended September 30, 2016 and 2015. The total amount of all acquisition fees and costs is limited to 6.0% of the contract purchase price of a property. The contract purchase price is the amount actually paid or allocated in respect of the purchase, development, construction or improvement of a property exclusive of acquisition fees and costs. For the nine months ended September 30, 2016 and 2015, acquisition fees and costs did not exceed 6.0% of the contract purchase price of the Company's acquisitions during such periods.
Note 4—Business Combinations
During the nine months ended September 30, 2016, the Company completed the acquisition of 100% of the interests in 12 real estate properties (four data centers and eight healthcare properties) that were determined to be business combinations. The aggregate purchase price of the acquisitions determined to be business combinations was $207,447,000, plus closing costs.
The following table summarizes the acquisitions determined to be business combinations during the nine months ended September 30, 2016:
Property Description
Date
Acquired
 
Ownership
Percentage
HPI — Edmond
01/20/2016
 
100%
HPI — Oklahoma City III
01/27/2016
 
100%
HPI — Oklahoma City IV
01/27/2016
 
100%
Alpharetta Data Center III
02/02/2016
 
100%
Flint Data Center
02/02/2016
 
100%
HPI — Newcastle
02/03/2016
 
100%
HPI — Oklahoma City V
02/11/2016
 
100%
HPI — Oklahoma City VI
03/07/2016
 
100%
HPI — Oklahoma City VII
06/22/2016
 
100%
Somerset Data Center
06/29/2016
 
100%
Integris Lakeside Women's Hospital
06/30/2016
 
100%
AT&T Hawthorne Data Center
09/27/2016
 
100%

12


Results of operations for the acquisitions determined to be business combinations are reflected in the accompanying condensed consolidated statements of comprehensive income (loss) for three and nine months ended September 30, 2016 for the period subsequent to the acquisition date of each property. For the period from the first acquisition date through September 30, 2016, the Company recorded $4,588,000 in revenues and a net loss of $3,286,000 for its business combination acquisitions.
The following table summarizes management’s preliminary allocation of the fair value of the acquisitions determined to be business combinations during the nine months ended September 30, 2016 (amounts in thousands):
 
Total
Land
$
29,012

Buildings and improvements
162,340

In-place leases
14,664

Tenant improvements
1,431

Total assets acquired
$
207,447

Assuming the business combinations described above had occurred on January 1, 2015, pro forma revenues and net income attributable to common stockholders would have been as follows for the periods listed below (amounts in thousands, except per share amounts, unaudited):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Pro forma basis:
 
 
 
 
 
 
 
Revenues
$
15,017

 
$
13,050

 
$
43,538

 
$
37,081

Net income attributable to common stockholders
$
4,471

 
$
4,929

 
$
13,383

 
$
1,792

Net income per common share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
$
0.06

 
$
0.07

 
$
0.18

 
$
0.03

Diluted
$
0.06

 
$
0.07

 
$
0.18

 
$
0.03

The condensed pro forma consolidated financial statements for the three and nine months ended September 30, 2016 and 2015 include pro forma adjustments related to the acquisitions during 2016 and 2015. The pro forma information for the three and nine months ended September 30, 2016 was adjusted to exclude approximately $1,684,000 and $5,052,000, respectively, of acquisition fees and costs recorded related to the Company's real estate investments. The pro forma information may not be indicative of what actual results of operations would have been had the transactions occurred at the beginning of 2015, nor is it necessarily indicative of future operating results.
Note 5—Acquired Intangible Assets, Net
Acquired intangible assets, net, consisted of the following as of September 30, 2016 and December 31, 2015 (amounts in thousands, except weighted average life amounts):
 
September 30, 2016
 
December 31, 2015
In-place leases, net of accumulated amortization of $5,935 and $1,967, respectively (with a weighted average remaining life of 13.1 years and 14.5 years, respectively)
$
66,791

 
$
53,776

Above-market leases, net of accumulated amortization of $52 and $32, respectively (with a weighted average remaining life of 7.7 years and 8.4 years, respectively)
202

 
222

Ground lease interest, net of accumulated amortization of $16 and $9, respectively (with a weighted average remaining life of 67.0 years and 67.8 years, respectively)
628

 
635

 
$
67,621

 
$
54,633

The aggregate weighted average remaining life of the acquired intangible assets was 13.6 years and 15.1 years as of September 30, 2016 and December 31, 2015, respectively.

13


Note 6—Other Assets
Other assets consisted of the following as of September 30, 2016 and December 31, 2015 (amounts in thousands):
 
September 30, 2016
 
December 31, 2015
Deferred financing costs, related to the revolver portion of the secured credit facility, net of accumulated amortization of $1,488 and $802, respectively
$
2,590

 
$
2,717

Real estate escrow deposits
5,730

 
443

Restricted cash held in escrow
4,417

 
1,927

Tenant receivables
2,107

 
2,065

Straight-line rent receivable
6,806

 
2,462

Prepaid and other assets
1,129

 
604

Derivative assets
36

 

 
$
22,815

 
$
10,218

Note 7—Future Minimum Rent
The Company’s real estate assets are leased to tenants under operating leases with varying terms. The leases frequently have provisions to extend the terms of the lease agreements. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants.
The future minimum rent to be received from the Company’s investments in real estate assets under non-cancelable operating leases for the three months ending December 31, 2016 and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):
Year
 
Amount
Three months ending December 31, 2016
 
$
12,009

2017
 
48,533

2018
 
49,396

2019
 
50,013

2020
 
49,153

Thereafter
 
494,425

 
 
$
703,529


14


Note 8—Credit Facility
The Company's debt outstanding as of September 30, 2016 and December 31, 2015 consisted of the following (amounts in thousands):

 
September 30, 2016
 
December 31, 2015
Secured credit facility:
 
 
 
 
Revolving line of credit
 
$
85,000

 
$
65,000

Term loan
 
50,000

 
25,000

Total secured credit facility, principal amount outstanding
 
135,000

 
90,000

Unamortized deferred financing costs related to the term loan secured credit facility
 
(294
)
 
(103
)
Total secured credit facility, net of deferred financing costs
 
$
134,706

 
$
89,897

Significant activities regarding the secured credit facility since December 31, 2015 include:
During the nine months ended September 30, 2016, the Company drew $115,000,000 and repaid $70,000,000 on the secured credit facility.
During the nine months ended September 30, 2016, the Company increased the borrowing base availability under the secured credit facility by $81,120,000 by adding 14 properties to the aggregate pool availability.
During the nine months ended September 30, 2016, the Company entered into an interest rate swap agreement to effectively fix LIBOR on $25,000,000 of the term loan of the secured credit facility.
On September 30, 2016, the Operating Partnership and certain of the Company's subsidiaries amended certain agreements related to the secured credit facility to increase the maximum commitments available under the secured credit facility from $265,000,000 to an aggregate of up to $315,000,000, consisting of a $265,000,000 revolving line of credit, with a maturity date of December 22, 2018, subject to the Operating Partnership’s right for two 12-month extension periods, and a $50,000,000 term loan, with a maturity date of December 22, 2019, subject to the Operating Partnership’s right for one 12-month extension period. Subject to certain conditions, the secured credit facility can be increased to $550,000,000.
As of September 30, 2016, the Company had a total pool availability under the secured credit facility of $252,479,000 and an aggregate outstanding principal balance of $135,000,000. As of September 30, 2016, $117,479,000 remained to be drawn on the secured credit facility.
The principal payments due on the secured credit facility for the three months ending December 31, 2016 and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):
Year
 
Amount
Three months ending December 31, 2016
 
$

2017
 

2018
 
85,000

2019
 
50,000

2020
 

Thereafter
 

 
 
$
135,000

Note 9—Intangible Lease Liabilities, Net
Intangible lease liabilities, net, consisted of the following as of September 30, 2016 and December 31, 2015 (amounts in thousands, except weighted average life amounts):
 
September 30, 2016
 
December 31, 2015
Below-market leases, net of accumulated amortization of $500 and $98, respectively (with a weighted average remaining life of 13.8 years and 14.5 years, respectively)
$
7,007

 
$
7,409


$
7,007

 
$
7,409


15


Note 10—Commitments and Contingencies
Litigation
In the ordinary course of business, the Company may become subject to litigation or claims. As of September 30, 2016, there were, and currently there are, no material pending legal proceedings to which the Company is a party.
Note 11—Related-Party Transactions and Arrangements
The Company reimburses the Advisor and its affiliates for organization and offering expenses it incurs on the Company’s behalf, but only to the extent the reimbursement would not cause the selling commissions, dealer manager fees, distribution and servicing fees and other organization and offering expenses to exceed 15% of the gross proceeds of the Offering. The Company expects that organization and offering expenses (other than selling commissions, dealer manager fees and distribution and servicing fees) will be approximately 1.25% of the gross proceeds. As of September 30, 2016, the Advisor and its affiliates incurred approximately $11,732,000 on the Company’s behalf in offering costs. The Company accrued approximately $549,000 of other organization and offering expenses as of September 30, 2016. Other organization expenses are expensed as incurred and offering expenses are charged to stockholders’ equity as incurred or as such amounts are reimbursed to the Advisor.
The Company pays to the Advisor 2.0% of the contract purchase price of each property or asset acquired and 2.0% of the amount advanced with respect to a mortgage loan. For the three months ended September 30, 2016 and 2015, the Company incurred approximately $1,590,000 and $2,673,000, respectively, and for the nine months ended September 30, 2016 and 2015, the Company incurred approximately $5,760,000 and $5,144,000, respectively, in acquisition fees to the Advisor or its affiliates. In addition, the Company reimburses the Advisor for acquisition expenses incurred in connection with the selection and acquisition of properties or other real estate-related investments (including expenses relating to potential investments that the Company does not close), such as legal fees and expenses, costs of real estate due diligence, appraisals, non-refundable option payments on properties not acquired, travel and communications expenses, accounting fees and expenses and title insurance premiums, whether or not the property was acquired. The Company expects these expenses will be approximately 0.75% of the purchase price of each property or real estate-related investment.
The Company pays to the Advisor an asset management fee calculated on a monthly basis in an amount equal to 1/12th of 0.75% of gross assets (including amounts borrowed), which is payable monthly in arrears. The Advisor may, in its sole discretion, choose to take any monthly asset management fee in the form of subordinated restricted Class B Units of the Operating Partnership. In the event the Advisor chooses to be compensated in Class B Units, then the Operating Partnership will, within 30 days after the end of the applicable month (subject to the approval of the board of directors), issue a number of restricted Class B Units to the Advisor equal to: (i) the cost of assets multiplied by 0.0625% (or the lower of the cost of assets and the applicable net asset value, or NAV, multiplied by 0.0625%, once the Company begins calculating NAV) divided by (ii) the value of one share of common stock as of the last day of such calendar month, which will be the offering price, less selling commissions and dealer manager fees, until such time as the Company calculates NAV, when it will then be the per share NAV for common shares. The Advisor will be entitled to receive certain distributions of net sales proceeds on the vested and unvested Class B Units it receives in connection with its assets management services at the same rate as distributions received on the Company’s common stock. Such distributions will be in addition to the incentive fees the Advisor and its affiliates may receive from the Company, including, without limitation the subordinated participation in net sales proceeds, the subordinated incentive listing distribution or the subordinated distribution upon termination of the advisory agreement, as applicable.
Class B Units are subject to forfeiture until such time as: (a) the value of the Operating Partnership’s assets plus all distributions made equals or exceeds the total amount of capital contributed by investors plus a 6.0% cumulative, pretax, non-compounded annual return thereon, or the economic hurdle; (b) any one of the following events occurs concurrently with or subsequently to the achievement of the economic hurdle described above: (i) a listing of the Company’s common stock on a national securities exchange; (ii) a transaction to which the Company or the Operating Partnership shall be a party, as a result of which operating partnership units or common stock shall be exchanged for or converted into the right, or the holders of such securities shall otherwise be entitled, to receive cash, securities or other property or any combination thereof; or (iii) the termination of the advisory agreement without cause; and (c) the Advisor pursuant to the advisory agreement is providing services to the Company immediately prior to the occurrence of an event of the type described in clause (b) above, unless the failure to provide such services is attributable to the termination without cause of the advisory agreement by an affirmative vote of a majority of the Company’s independent directors after the economic hurdle described above has been met. Any outstanding Class B Units will be forfeited immediately if the advisory agreement is terminated for any reason other than a termination without cause. Any outstanding Class B Units will be forfeited immediately if the advisory agreement is terminated without cause by an affirmative vote of a majority of the Company’s board of directors before the economic hurdle described above has been met. For the three months ended September 30, 2016 and 2015, the Company incurred approximately $1,227,000 and $639,000, respectively, and for the nine months ended September 30, 2016 and 2015, the Company incurred approximately

16


$3,240,000 and $1,133,000, respectively, in asset management fees. As of September 30, 2016, the Company did not issue any Class B Units.
In connection with the rental, leasing, operation and management of the Company’s properties, the Company pays the Property Manager and its affiliates aggregate fees equal to 3.0% of monthly gross revenues from the properties managed, or property management fees. The Company will reimburse the Property Manager and its affiliates for property-level expenses that any of them pay or incur on the Company’s behalf, including salaries, bonuses and benefits of persons employed by the Property Manager and its affiliates except for the salaries, bonuses and benefits of persons who also serve as one of its executive officers. The Property Manager and its affiliates may subcontract the performance of their duties to third parties and pay all or a portion of the property management fee to the third parties with whom they contract for these services. If the Company contracts directly with third parties for such services, it will pay them customary market fees and may pay the Property Manager an oversight fee equal to 1.0% of the gross revenues of the properties managed. In no event will the Company pay the Property Manager or any affiliate both a property management fee and an oversight fee with respect to any particular property. For the three months ended September 30, 2016 and 2015, the Company incurred approximately $353,000 and $174,000, respectively, and for the nine months ended September 30, 2016 and 2015, the Company incurred approximately $964,000 and $314,000, respectively, in property management fees to the Property Manager, which are recorded in rental expenses in the accompanying condensed consolidated statements of comprehensive income (loss). The Company also will pay the Property Manager a separate fee for the one-time initial rent-up, leasing-up of newly constructed properties or re-leasing to existing tenants. As of September 30, 2016, the Company has not incurred any leasing commissions to the Property Manager.
For acting as general contractor and/or construction manager to supervise or coordinate projects or to provide major repairs or rehabilitation on our properties, the Company may pay the Property Manager up to 5.0% of the cost of the projects, repairs and/or rehabilitation, as applicable, or construction management fees. For the three and nine months ended September 30, 2016, the Company incurred $265,000 in construction management fees to the Property Manager. For the three and nine months ended September 30, 2015, the Company did not incur construction management fees to the Property Manager. Construction management fees are capitalized in real estate, net in the accompanying condensed consolidated balance sheets.
The Company reimburses the Advisor for all expenses it paid or incurred in connection with the services provided to the Company, subject to certain limitations. Expenses in excess of the operating expenses in the four immediately preceding quarters that exceeds the greater of (a) 2.0% of average invested assets or (b) 25% of net income, subject to certain adjustments, will not be reimbursed unless the independent directors determine such excess expenses are justified. The Company will not reimburse the Advisor for personnel costs in connection with services for which the Advisor receives an acquisition fee or a disposition fee. For the three months ended September 30, 2016 and 2015, the Advisor allocated approximately $337,000 and $223,000, respectively, and for the nine months ended September 30, 2016 and 2015, the Advisor allocated approximately $935,000 and $586,000, respectively, in operating expenses to the Company, which are included as part of general and administrative expenses in the accompanying condensed consolidated statements of comprehensive income (loss).
The Company will pay its Advisor, or its affiliates, if it provides a substantial amount of services (as determined by a majority of the Company’s independent directors) in connection with the sale of properties, a disposition fee, up to the lesser of 1.0% of the contract sales price and one-half of the total brokerage commission paid if a third party broker is also involved, without exceeding the lesser of 6.0% of the contract sales price or a reasonable, customary and competitive real estate commission. As of September 30, 2016, the Company has not incurred any disposition fees to the Advisor or its affiliates.
The Advisor will receive 15% of the remaining net sale proceeds after return of capital contributions plus payment to investors of a 6.0% annual cumulative, non-compounded return on the capital contributed by investors. As of September 30, 2016, the Company has not incurred any subordinated participation in net sale proceeds to the Advisor or its affiliates.
Upon the listing of the Company’s shares on a national securities exchange, the Advisor will receive 15.0% of the amount by which the sum of the Company’s adjusted market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to a 6.0% annual cumulative, non-compounded return to investors, or the subordinated incentive listing fee. As of September 30, 2016, the Company has not incurred any subordinated incentive listing fees to the Advisor or its affiliates.

17


Upon termination or non-renewal of the advisory agreement, with or without cause, the Advisor will be entitled to receive distributions from the Operating Partnership equal to 15% of the amount by which the sum of the Company’s adjusted market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to an annual 6.0% cumulative, non-compounded return to investors. In addition, the Advisor may elect to defer its right to receive a subordinated distribution upon termination until either shares of the Company’s common stock are listed and traded on a national securities exchange or another liquidity event occurs. As of September 30, 2016, the Company has not incurred any subordinated termination fees to the Advisor or its affiliates.
Certain affiliates of the Company receive fees in connection with the Offering and will continue to receive fees during the acquisition, management and sale of assets of the Company.
The Company pays the Dealer Manager selling commissions of up to 7.0% of the gross offering proceeds per Class A share and up to 3.0% of gross offering proceeds per Class T share. All selling commissions are expected to be re-allowed to participating broker-dealers. The Company will not pay selling commissions with respect to shares of any class sold pursuant to the DRIP. In addition, the Company pays the Dealer Manager a dealer manager fee of up to 3.0% of gross offering proceeds from the sale of Class A and Class T shares.The dealer manager fee may be partially re-allowed to participating broker-dealers. No dealer manager fees will be paid in connection with purchases of shares made pursuant to the DRIP. For the three months ended September 30, 2016 and 2015, the Company incurred approximately $4,994,000 and $8,285,000, respectively, and for the nine months ended September 30, 2016 and 2015, the Company incurred approximately $19,938,000 and $29,606,000, respectively, in selling commissions and dealer manager fees in connection with the Offering to the Dealer Manager.
The Company pays the Dealer Manager a distribution and servicing fee with respect to its Class T shares that are sold in the primary offering that accrues daily in an amount equal to 1/365th of 1.0% of the most recent offering price per Class T share sold in the primary offering on a continuous basis from year to year; provided, however, that upon the termination of the primary offering, the distribution and servicing fee will accrue daily in an amount equal to 1/365th of 1.0% of the most recent estimated NAV per Class T share on a continuous basis from year to year. Termination of such payment will commence on the earliest to occur of the following: (i) a listing of the Class T shares on a national securities exchange, (ii) following the completion of the Offering, total underwriting compensation in the Offering equaling 10% of the gross proceeds from the primary portion of the Offering, (iii) there are no longer any Class T shares outstanding, or (iv) the fourth anniversary of the last day of the fiscal quarter in which the primary offering terminates. The Dealer Manager may re-allow the distribution and servicing fee to participating broker-dealers and servicing broker-dealers. The distribution and servicing fee will be paid monthly in arrears. The distribution and servicing fee will not be payable with respect to Class T shares issued under the DRIP. The Company will not pay a distribution and servicing fee with respect to Class A shares. For the three and nine months ended September 30, 2016, the Company incurred approximately $1,420,000 and $4,462,000, respectively, in distribution and servicing fees to the Dealer Manager. For the three and nine months ended September 30, 2015, the Company did not incur distribution and servicing fees to the Dealer Manager because it had not sold any Class T shares.
Accounts Payable Due to Affiliates
The following amounts were outstanding due to affiliates as of September 30, 2016 and December 31, 2015 (amounts in thousands):
Entity
 
Fee
 
September 30, 2016
 
December 31, 2015
Carter Validus Advisors II, LLC and its affiliates
 
Asset management fees
 
$
443

 
$
290

Carter Validus Real Estate Management Services II, LLC
 
Property management fees
 
140

 
101

Carter Validus Real Estate Management Services II, LLC
 
Construction management fees
 
265

 

Carter Validus Advisors II, LLC and its affiliates
 
General and administrative costs
 
134

 
96

Carter Validus Advisors II, LLC and its affiliates
 
Offering costs
 
549

 
250

SC Distributors, LLC
 
Distribution and servicing fees
 
4,226

 

Carter Validus Advisors II, LLC and its affiliates
 
Acquisition expenses and fees
 
3

 
4


 
 
 
$
5,760

 
$
741


18


Note 12—Segment Reporting
Management reviews the performance of individual properties and aggregates individual properties based on operating criteria into two reportable segments—commercial real estate investments in data centers and healthcare, and makes operating decisions based on these two reportable segments. The Company’s commercial real estate investments in data centers and healthcare are based on certain underwriting assumptions and operating criteria, which are different for data centers and healthcare. There were no intersegment sales or transfers during the nine months ended September 30, 2016 and 2015.
The Company evaluates performance based on net operating income of the individual properties in each segment. Net operating income, a non-GAAP financial measure, is defined as total revenues, less rental expenses, which excludes depreciation and amortization, general and administrative expenses, acquisition related expenses, asset management fees and interest expense, net. The Company believes that segment net operating income serves as a useful supplement to net income (loss) because it allows investors and management to measure unlevered property-level operating results and to compare operating results to the operating results of other real estate companies between periods on a consistent basis. Segment net operating income should not be considered as an alternative to net income (loss) determined in accordance with GAAP as an indicator of financial performance, and accordingly, the Company believes that in order to facilitate a clear understanding of the consolidated historical operating results, segment net operating income should be examined in conjunction with net income (loss) as presented in the accompanying condensed consolidated financial statements and data included elsewhere in this Quarterly Report on Form 10-Q.
General and administrative expenses, acquisition related expenses, asset management fees, depreciation and amortization and interest expense, net are not allocated to individual segments for purposes of assessing segment performance.
Non-segment assets primarily consist of corporate assets, including cash and cash equivalents, real estate and escrow deposits, deferred financing costs attributable to the revolving line of credit portion of the Company's secured credit facility and other assets not attributable to individual properties.
Summary information for the reportable segments during the three and nine months ended September 30, 2016 and 2015, is as follows (amounts in thousands):
 
Data Centers
 
Healthcare
 
Three Months Ended
September 30, 2016
Revenue:
 
 
 
 
 
Rental and tenant reimbursement revenue
$
2,497

 
$
11,097

 
$
13,594

Expenses:
 
 
 
 
 
Rental expenses
(440
)
 
(1,354
)
 
(1,794
)
Segment net operating income
$
2,057

 
$
9,743

 
11,800

 
 
 
 
 
 
Expenses:
 
 
 
 
 
General and administrative expenses
 
 
 
 
(836
)
Acquisition related expenses
 
 
 
 
(1,821
)
Asset management fees
 
 
 
 
(1,227
)
Depreciation and amortization
 
 
 
 
(4,782
)
Income from operations
 
 
 
 
3,134

Interest expense, net
 
 
 
 
(626
)
Net income attributable to common stockholders
 
 
 
 
$
2,508


19


 
Data Centers
 
Healthcare
 
Three Months Ended
September 30, 2015
Revenue:
 
 
 
 
 
Rental and tenant reimbursement revenue
$
543

 
$
6,341

 
$
6,884

Expenses:
 
 
 
 
 
Rental expenses
(90
)
 
(737
)
 
(827
)
Segment net operating income
$
453

 
$
5,604

 
6,057


 
 
 
 
 
Expenses:
 
 
 
 
 
General and administrative expenses
 
 
 
 
(439
)
Acquisition related expenses
 
 
 
 
(3,760
)
Asset management fees
 
 
 
 
(639
)
Depreciation and amortization
 
 
 
 
(2,438
)
Loss from operations
 
 
 
 
(1,219
)
Interest expense, net
 
 
 
 
(542
)
Net loss attributable to common stockholders
 
 
 
 
$
(1,761
)
 
Data Centers
 
Healthcare
 
Nine Months Ended
September 30, 2016
Revenue:
 
 
 
 
 
Rental and tenant reimbursement revenue
$
6,211

 
$
31,010

 
$
37,221

Expenses:
 
 
 
 
 
Rental expenses
(1,011
)
 
(4,044
)
 
(5,055
)
Segment net operating income
$
5,200

 
$
26,966

 
32,166

 
 
 
 
 
 
Expenses:
 
 
 
 
 
General and administrative expenses
 
 
 
 
(2,358
)
Acquisition related expenses
 
 
 
 
(5,432
)
Asset management fees
 
 
 
 
(3,240
)
Depreciation and amortization
 
 
 
 
(12,948
)
Income from operations
 
 
 
 
8,188

Interest expense, net
 
 
 
 
(2,237
)
Net income attributable to common stockholders
 
 
 
 
$
5,951


20


 
Data Centers
 
Healthcare
 
Nine Months Ended
September 30, 2015
Revenue:
 
 
 
 
 
Rental and tenant reimbursement revenue
$
724

 
$
11,537

 
$
12,261

Expenses:
 
 
 
 
 
Rental expenses
(98
)
 
(1,051
)
 
(1,149
)
Segment net operating income
$
626

 
$
10,486

 
11,112

 
 
 
 
 
 
Expenses:
 
 
 
 
 
General and administrative expenses
 
 
 
 
(1,366
)
Acquisition related expenses
 
 
 
 
(7,287
)
Asset management fees
 
 
 
 
(1,133
)
Depreciation and amortization
 
 
 
 
(4,048
)
Loss from operations
 
 
 
 
(2,722
)
Interest expense, net
 
 
 
 
(1,203
)
Net loss attributable to common stockholders
 
 
 
 
$
(3,925
)
Assets by each reportable segment as of September 30, 2016 and December 31, 2015 are as follows (amounts in thousands):
 
September 30, 2016
 
December 31, 2015
Assets by segment:
 
 
 
Data centers
$
179,629

 
$
44,207

Healthcare
533,786

 
427,878

All other
57,471

 
34,542

Total assets
$
770,886

 
$
506,627

Capital additions and acquisitions by reportable segments for the nine months ended September 30, 2016 and 2015 are as follows (amounts in thousands):
 
Nine Months Ended
September 30,
 
2016
 
2015
Capital additions and acquisitions by segment:
 
 
 
Data centers
$
134,831

 
$
33,114

Healthcare
109,278

 
224,664

Total capital additions and acquisitions
$
244,109

 
$
257,778

Note 13—Accounts Payable and Other Liabilities
Accounts payable and other liabilities, as of September 30, 2016 and December 31, 2015, were comprised of the following (amounts in thousands):
 
September 30, 2016
 
December 31, 2015
Accounts payable and accrued expenses
$
4,245

 
$
2,283

Accrued interest expense
290

 
221

Accrued property taxes
1,456

 
505

Distributions payable to stockholders
3,826

 
2,548

Tenant deposits
1,765

 
1,848

Deferred rental income
1,397

 
839

 
$
12,979

 
$
8,244


21


Note 14—Derivative Instruments and Hedging Activities
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed rate payments over the life of the agreements without exchange of the underlying notional amount.
The effective portion of changes in the fair value of derivatives designated, and that qualify, as cash flow hedges is recorded in accumulated other comprehensive loss in the accompanying condensed consolidated statement of stockholders' equity and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.
During the nine months ended September 30, 2016, the Company's derivative instrument was used to hedge the variable cash flows associated with variable rate debt. The ineffective portion of changes in fair value of the derivative is recognized directly in earnings. During the three and nine months ended September 30, 2016, the Company recognized income of $71,000 and $49,000, respectively, due to ineffectiveness of its hedge of interest rate risk, which was recorded in interest expense, net in the accompanying condensed consolidated statements of comprehensive income (loss).
Amounts reported in accumulated other comprehensive loss related to the derivative will be reclassified to interest expense as interest payments are made on the Company’s variable rate debt. During the next twelve months, the Company estimates that an additional $56,000 will be reclassified from accumulated other comprehensive loss as an increase to interest expense.
See Note 2—"Summary of Significant Accounting Policies" for a further discussion of the fair value of the Company’s derivative instruments.
The following table summarizes the notional amount and fair value of the Company’s derivative instrument (amounts in thousands):
Derivative
Designated as
Hedging
Instrument
 
Balance
Sheet
Location
 
Effective
Dates
 
Maturity
Dates
 
September 30, 2016
 
December 31, 2015
Outstanding
Notional
Amount
 
Fair Value of
 
Outstanding
Notional
Amount
 
Fair Value of
Asset
 
(Liability)
 
Asset
 
(Liability)
 
Interest rate swap
 
Other assets
 
07/01/2016
 
12/22/2020
 
$
25,000

 
$
36

 
$

 
$

 
$

 
$

The notional amount under the agreement is an indication of the extent of the Company’s involvement in the instrument at the time, but does not represent exposure to credit, interest rate or market risks.
Accounting for changes in the fair value of a derivative instrument depends on the intended use and designation of the derivative instrument. The Company designated the interest rate swap as a cash flow hedge to hedge the variability of the anticipated cash flows on its variable rate secured credit facility. The change in fair value of the effective portion of the derivative instrument that is designated as a hedge is recorded in other comprehensive income (loss), or OCI, in the accompanying condensed consolidated statements of comprehensive income (loss).

22


The table below summarizes the amount of income and loss recognized on the interest rate derivative designated as a cash flow hedge for the three and nine months ended September 30, 2016 and 2015 (amounts in thousands):
Derivative in Cash Flow Hedging Relationship
 
Amount of (Loss) Income Recognized
in OCI on Derivative
(Effective Portion)
 
Location of (Loss) Income
Reclassified From
Accumulated Other
Comprehensive Loss to
Net Income
(Effective Portion)
 
Amount of (Loss) Income
Reclassified From
Accumulated Other
Comprehensive Loss to
Net Income
(Effective Portion)
Three Months Ended September 30, 2016
 
 
 
 
 
 
Interest rate swap
 
$
62

 
Interest expense, net
 
$
(26
)
Total
 
$
62

 
 
 
$
(26
)
Three Months Ended September 30, 2015
 
 
 
 
 
 
Interest rate swap
 
$

 
Interest expense, net
 
$

Total
 
$

 
 
 
$

Nine Months Ended September 30, 2016
 
 
 
 
 
 
Interest rate swap
 
$
(39
)
 
Interest expense, net
 
$
(26
)
Total
 
$
(39
)
 
 
 
$
(26
)
Nine Months Ended September 30, 2015
 
 
 
 
 
 
Interest rate swap
 
$

 
Interest expense, net
 
$

Total
 
$

 
 
 
$

Credit Risk-Related Contingent Features
The Company has an agreement with its derivative counterparty that contains cross-default provisions, whereby if the Company defaults on certain of its indebtedness, then the Company could also be declared in default on its derivative obligation, resulting in an acceleration of payment thereunder.
In addition, the Company is exposed to credit risk in the event of non-performance by its derivative counterparty. The Company believes it mitigates its credit risk by entering into agreements with creditworthy counterparties. The Company records credit risk valuation adjustments on its interest rate swaps based on the respective credit quality of the Company and the counterparty. As of September 30, 2016, the fair value of the derivative in a net asset position, including accrued interest but excluding any adjustment for nonperformance risk related to the agreement, was $23,000. As of September 30, 2016, there were no termination events or events of default related to the interest rate swap.
Tabular Disclosure Offsetting Derivatives
The Company has elected not to offset its derivative asset position in its condensed consolidated financial statements. The following table presents the effect on the Company’s financial position had the Company made the election to offset its derivative asset position as of September 30, 2016 (amounts in thousands):
Offsetting of Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
 
 
 
Gross
Amounts of
Recognized
Assets
 
Gross Amounts
Offset in the
Balance Sheet
 
Net Amounts of
Assets Presented in
the Balance Sheet
 
Financial Instruments
Collateral
 
Cash Collateral
 
Net
Amount
September 30, 2016
 
$
36

 
$

 
$
36

 
$

 
$

 
$
36

The Company did not have any financial instruments hedged through interest rate swaps as of December 31, 2015.
The Company reports the derivative in the accompanying condensed consolidated balance sheets as other assets.

23


Note 15—Accumulated Other Comprehensive Loss
The following table presents a rollforward of amounts recognized in accumulated other comprehensive loss by component for the nine months ended September 30, 2016 (amounts in thousands):
 
Unrealized Loss on Derivative
Instruments
 
Accumulated Other
Comprehensive Loss
Balance as of December 31, 2015
$

 
$

Other comprehensive loss before reclassification
(39
)
 
(39
)
Amount of loss reclassified from accumulated other comprehensive loss to net income (effective portion)
26

 
26

Other comprehensive loss
(13
)
 
(13
)
Balance as of September 30, 2016
$
(13
)
 
$
(13
)
The following table presents reclassifications out of accumulated other comprehensive loss for the nine months ended September 30, 2016 and 2015 (amounts in thousands):
Details about Accumulated Other
Comprehensive Loss Components
 
Amounts Reclassified from
Accumulated Other Comprehensive Loss to Net
Income
 
Affected Line Items in the Consolidated Statements of Comprehensive Income (Loss)
 
 
Nine Months Ended
September 30,
 
 
 
 
2016
 
2015
 
 
Interest rate swap contracts
 
$
26

 

 
Interest expense, net
Note 16—Economic Dependency
The Company is dependent on the Advisor and its affiliates for certain services that are essential to the Company, including the sale of the Company’s shares of common and preferred stock available for issuance; the identification, evaluation, negotiation, purchase and disposition of real estate investments and other investments; the management of the daily operations of the Company’s real estate portfolio; and other general and administrative responsibilities. In the event that the Advisor and its affiliates are unable to provide the respective services, the Company will be required to obtain such services from other sources.
Note 17—Subsequent Events
Distributions to Stockholders Paid
On October 3, 2016, the Company paid aggregate distributions of approximately $3,441,000 to Class A stockholders ($1,569,000 in cash and $1,872,000 in shares of the Company’s Class A common stock pursuant to the DRIP), which related to distributions declared for each day in the period from September 1, 2016 through September 30, 2016. On November 1, 2016, the Company paid aggregate distributions of approximately $3,646,000 to Class A stockholders ($1,676,000 in cash and $1,970,000 in shares of the Company’s Class A common stock issued pursuant to the DRIP), which related to distributions declared for each day in the period from October 1, 2016 through October 31, 2016.
On October 3, 2016, the Company paid aggregate distributions of approximately $385,000 to Class T stockholders ($136,000 in cash and $249,000 in shares of the Company's Class T common stock pursuant to the DRIP), which related to distributions declared for each day in the period from September 1, 2016 through September 30, 2016. On November 1, 2016, the Company paid aggregate distributions of approximately $444,000 to Class T stockholders ($159,000 in cash and $285,000 in shares of the Company’s Class T common stock issued pursuant to the DRIP), which related to distributions declared for each day in the period from October 1, 2016 through October 31, 2016.

24


Distributions Declared
Class A Shares
On November 3, 2016, the board of directors of the Company approved and declared a distribution to the Company’s Class A stockholders of record as of the close of business on each day of the period commencing on December 1, 2016 and ending on February 28, 2017. The distributions for December 2016 will be calculated based on 366 days in the calendar year and will be equal to $0.001762273 per share of Class A common stock, which will be equal to an annualized distribution rate of 6.4%, assuming a purchase price of $10.078 per share of Class A common stock. The distributions for January 2017 and February 2017 will be calculated based on 365 days in the calendar year and will be equal to $0.001767101 per share of Class A common stock, which will be equal to an annualized distribution rate of 6.4%, assuming a purchase price of $10.078. The distributions declared for each record date in December 2016, January 2017 and February 2017 will be paid in January 2017, February 2017 and March 2017, respectively. The distributions will be payable to stockholders from legally available funds therefor.
Class T Shares
On November 3, 2016, the board of directors of the Company approved and declared a daily distribution to the Company’s Class T stockholders of record as of the close of business on each day of the period commencing on December 1, 2016 and ending February 28, 2017. The distributions for December 2016 will be calculated based on 366 days in the calendar year and will be equal to $0.001497440 per share of Class T common stock, which will be equal to an annualized distribution rate of 5.68%, assuming a purchase price of $9.649 per share. The distributions for January 2017 and February 2017 will be calculated based on 365 days in the calendar year and will be equal to $0.001501543, which will be equal to an annualized distribution rate of 5.68%, assuming a purchase price of $9.649 per share. The distributions declared for each record date in December 2016, January 2017 and February 2017 will be paid in January 2017, February 2017 and March 2017, respectively. The distributions will be payable to stockholders from legally available funds therefor.
Status of the Offering
As of November 10, 2016, the Company had accepted investors’ subscriptions for and issued approximately 78,401,000 shares of Class A and Class T common stock in the Offering, resulting in receipt of gross proceeds of approximately $773,692,000 including shares of its common stock issued pursuant to the DRIP. As of November 10, 2016, the Company had approximately $1,576,308,000 in Class A shares and Class T shares of common stock remaining in the Offering.
Acquisition of the McLean Data Center Portfolio
On October 17, 2016, the Company acquired 100% of the interest in a data center portfolio consisting of two properties, or the McLean Data Center Portfolio, for an aggregate purchase price of $85,000,000, plus closing costs. The Company financed the purchase of the McLean Data Center using net proceeds from the Offering and proceeds from the secured credit facility. The McLean Data Center Portfolio is leased to multiple tenants.
Acquisition of the Select Medical Rehabilitation Facility
On November 1, 2016, the Company acquired 100% of the interest in a healthcare facility, or the Select Medical Rehabilitation Facility, for an aggregate purchase price of $63,580,000, plus closing costs. The Company financed the purchase of the Select Medical Rehabilitation Facility using net proceeds from the Offering and proceeds from the secured credit facility. The Select Medical Rehabilitation Facility is leased to a single tenant.
Acquisition of the Andover Data Center II
On November 8, 2016, the Company acquired 100% of the interest in a data center property, or the Andover Data Center II, for an aggregate purchase price of $37,000,000, plus closing costs. The Company financed the purchase of the Andover Data Center II using net proceeds from the Offering and proceeds from the secured credit facility. The Andover Data Center II is leased to multiple tenants.


25


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes thereto, and the other unaudited financial information appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with our audited consolidated financial statements, and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission, or the SEC, on March 28, 2016, or the 2015 Annual Report on Form 10-K.
The terms “we,” “our,” and the “Company” refer to Carter Validus Mission Critical REIT II, Inc., Carter Validus Operating Partnership II, LP, or our Operating Partnership, and all wholly-owned subsidiaries.
Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q, other than historical facts, include forward-looking statements that reflect our expectations and projections about our future results, performance, prospects and opportunities. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, as well as known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “would,” “could,” “should,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management’s view only as of the date this Quarterly Report on Form 10-Q is filed with the SEC. We make no representation or warranty (express or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q, and we do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. See Item 1A. “Risk Factors” of our 2015 Annual Report on Form 10-K for a discussion of some, although not all, of the risks and uncertainties that could cause actual results to differ materially from those presented in our forward-looking statements.
Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.
Overview
We were formed on January 11, 2013 under the laws of Maryland to acquire and operate a diversified portfolio of income-producing commercial real estate with a focus on data centers and healthcare properties, preferably with long-term net leases to investment grade and other creditworthy tenants, as well as to make other real estate-related investments that relate to such property types. We are offering shares of Class A common stock and shares of Class T common stock, in any combination, with a dollar value up to $2,350,000,000 in shares of common stock, consisting of up to $2,250,000,000 in the primary offering and $100,000,000 in shares of common stock pursuant to our distribution reinvestment plan, or the DRIP, on a "best efforts" basis, or the Offering. Through September 30, 2016, the initial offering price for the shares in our primary offering was $10.00 per Class A share and $9.574 per Class T share.
On September 29, 2016, our board of directors, at the recommendation of the audit committee, which is comprised solely of independent directors, unanimously approved and established an estimated per share net asset value, or NAV, of $9.07 of each of our Class A common stock and Class T common stock, or the Estimated Per Share NAV, as of June 30, 2016, for purposes of assisting broker-dealers participating in the Offering in meeting their customer account statement reporting obligations under National Association of Securities Dealers Conduct Rule 2340. In connection with the Estimated Per Share NAV, our board of directors unanimously approved the increased primary offering price of $10.078 per Class A share, which reflects the $9.07 Estimated Per Share NAV, a 7.0% selling commission and a 3.0% dealer manager fee, and the increased primary offering price of $9.649 per Class T share, which reflects the $9.07 Estimated Per Share NAV, a 3.0% selling commission and a 3.0% dealer manager fee, effective October 1, 2016. Further, the Board approved $9.574 as the per share purchase price of Class A shares pursuant to the DRIP and $9.167 as the per share purchase price of Class T shares pursuant to the DRIP, effective October 1, 2016. The Estimated Per Share NAV is not subject to audit by our independent registered public accounting firm. Going forward, we intend to publish an updated estimated NAV per share on at least an annual basis.


26


As of September 30, 2016, we had accepted investors’ subscriptions for and issued approximately 75,573,000 shares of Class A and Class T common stock (including shares of common stock issued pursuant to the DRIP) in our Offering, resulting in receipt of gross proceeds of approximately $746,094,000, before selling commissions and dealer manager fees of approximately $64,577,000, distribution and servicing fees of approximately $4,462,000 and other offering costs of approximately $14,383,000. As of September 30, 2016, we had approximately $1,603,906,000 in Class A shares and Class T shares of common stock remaining in our Offering. We will not pay distribution and servicing fees with respect to shares of Class A common stock or shares of Class T common stock issued pursuant to the DRIP.
Substantially all of our operations are conducted through Carter Validus Operating Partnership II, LP, or our Operating Partnership. We are externally advised by Carter Validus Advisors II, LLC, which is our affiliate, or our Advisor, pursuant to an advisory agreement between us and our Advisor. Our Advisor supervises and manages our day-to-day operations and selects the properties and real estate-related investments we acquire, subject to the oversight and approval of our board of directors. Our Advisor also provides marketing, sales and client services on our behalf. Our Advisor engages affiliated entities to provide various services to us. Our Advisor is managed by, and is a subsidiary of, our sponsor, Carter Validus REIT Management Company II, LLC, or our Sponsor. We have no paid employees and we rely on our Advisor to provide substantially all of our services.
Carter Validus Real Estate Management Services II, LLC, or our Property Manager, a wholly-owned subsidiary of our Sponsor, serves as our property manager. Our Advisor and our Property Manager received, and will continue to receive, fees during the acquisition and operational stages and our Advisor may be eligible to receive fees during the liquidation stage of the Company. SC Distributors, LLC, an affiliate of the Advisor, or the Dealer Manager, serves as the dealer manager of the Offering. The Dealer Manager has received, and will continue to receive, fees for services related to our Offering.
We currently operate through two reportable segments – commercial real estate investments in data centers and healthcare. As of September 30, 2016, we had purchased 30 real estate investments, consisting of 43 properties, comprising approximately 2,299,000 of gross rentable square feet for an aggregate purchase price of approximately $704,364,000.
Critical Accounting Policies
Our critical accounting policies were disclosed in our 2015 Annual Report on Form 10-K. There have been no material changes to our critical accounting policies as disclosed therein.
Interim Unaudited Financial Data
Our accompanying condensed consolidated financial statements have been prepared by us in accordance with GAAP in conjunction with the rules and regulations of the SEC. Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, our accompanying condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. Our accompanying condensed consolidated financial statements reflect all adjustments, which are, in our view, of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim period. Interim results of operations are not necessarily indicative of the results to be expected for the full year; such full year results may be less favorable. Our accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our 2015 Annual Report on Form 10-K.
Qualification as a REIT
We qualified and elected to be taxed as a REIT for federal income tax purposes and we intend to continue to be taxed as a REIT. To maintain our qualification as a REIT, we must continue to meet certain organizational and operational requirements, including a requirement to currently distribute at least 90.0% of our REIT taxable income to our stockholders. As a REIT, we generally will not be subject to federal income tax on taxable income that we distribute to our stockholders.
If we fail to maintain our qualification as a REIT in any taxable year, we would then be subject to federal income taxes on our taxable income at regular corporate rates and would not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could have a material adverse effect on our net income and net cash available for distribution to our stockholders.

27


Recently Issued Accounting Pronouncements
For a discussion of recently issued accounting pronouncements, see Note 2—“Summary of Significant Accounting Policies—Recently Issued Accounting Pronouncements” to our condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q.
Segment Reporting
We report our financial performance based on two reporting segments—commercial real estate investments in data centers and healthcare. See Note 12—"Segment Reporting," to our condensed consolidated financial statements that are part of this Quarterly Report on Form 10-Q for additional information on our two reporting segments.
Results of Operations
Our results of operations are influenced by the timing of acquisitions and the operating performance of our real estate properties. The following table shows the property statistics of our real estate properties as of September 30, 2016 and 2015:
 
September 30,
 
2016
 
2015
Number of commercial operating real estate properties
41

(1) 
21

Leased rentable square feet
2,298,000

 
1,207,000

Weighted average percentage of rentable square feet leased
99.9
%
 
100.0
%
(1)
As of September 30, 2016, we owned 43 real estate properties, two of which were under construction.
The following table summarizes our real estate properties' activity for the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Commercial operating real estate properties acquired
1


8

 
13

(1) 
15

Approximate aggregate purchase price of acquired real estate properties
$
79,500,000


$
133,331,000

 
$
227,364,000

(1) 
$
257,138,000

Leased rentable square feet
288,000

 
503,000

 
769,000

 
885,000

(1)
During the nine months ended September 30, 2016, we acquired 15 real estate properties, two of which were under construction. The properties under construction were purchased for $13,601,000.
The following discussion is based on our condensed consolidated financial statements for the three and nine months ended September 30, 2016 and 2015.
This section describes and compares our results of operations for the three and nine months ended September 30, 2016 and 2015. We generate almost all of our net operating income from property operations. In order to evaluate our overall portfolio, management analyzes the net operating income of same store properties. We define "same store properties" as operating properties that were owned and operated for the entirety of both calendar periods being compared and exclude properties under development.
By evaluating the property net operating income of our same store properties, management is able to monitor the operations of our existing properties for comparable periods to measure the performance of our current portfolio and determine the effects of our new acquisitions on net income (loss).
We are not aware of any material trends and uncertainties, other than national economic conditions affecting real estate generally, that may be reasonably expected to have a material impact, favorable or unfavorable, on revenues or incomes from the acquisition, management and operation of properties other than those set forth in our Annual Report on Form 10-K for the year ended December 31, 2015 and in Part II, Item 1A. "Risk Factors" of this Quarterly Report on Form 10-Q.

28


Three Months Ended September 30, 2016 Compared to the Three Months Ended September 30, 2015
Changes in our revenues are summarized in the following table (amounts in thousands):
 
Three Months Ended
September 30,
 
 
 
2016
 
2015
 
Change
 
 
 
 
 
 
Same store rental revenue
$
4,489

 
$
4,489

 
$

Non-same store rental revenue
7,693

 
1,740

 
5,953

Same store tenant reimbursement revenue
586

 
496

 
90

Non-same store tenant reimbursement revenue
825

 
158

 
667

Other operating income
1

 
1

 

Total revenue
$
13,594

 
$
6,884

 
$
6,710

Same store rental revenue was unchanged. Adjustments to straight-line rental revenue offset the increase in contractual rental revenue resulting from average annual rent escalations of 1.94% at our same store properties.
Non-same store rental revenue increased $6.0 million due to the acquisition of 28 operating properties since July 1, 2015.
Non-same store tenant reimbursement revenue increased $0.7 million due to the acquisition of 28 operating properties since July 1, 2015.
Changes in our expenses are summarized in the following table (amounts in thousands):
 
Three Months Ended
September 30,
 
 
 
2016
 
2015
 
Change
 
 
 
 
 
 
Same store rental expenses
$
717

 
$
621

 
$
96

Non-same store rental expenses
1,077

 
206

 
871

General and administrative expenses
836

 
439

 
397

Acquisition related expenses
1,821

 
3,760

 
(1,939
)
Asset management fees
1,227

 
639

 
588

Depreciation and amortization
4,782

 
2,438

 
2,344

Total expenses
$
10,460

 
$
8,103

 
$
2,357

Non-same store rental expenses, certain of which are subject to reimbursement by our tenants, increased primarily due to the acquisition of 28 operating properties since July 1, 2015.
General and administrative expenses increased primarily due to an increase in professional and legal fees of $0.2 million, an increase in personnel costs of $0.1 million and an increase in other administrative costs of $0.1 million, in connection with our Company's growth.
Acquisition related expenses decreased due to a decrease in real estate properties determined to be business combinations. Acquisition fees and expenses associated with transactions determined to be business combinations are expensed as incurred. During the three months ended September 30, 2016, we acquired one real estate property for an aggregate purchase price of $79.5 million as compared to eight real estate properties for an aggregate purchase price of $133.3 million during the three months ended September 30, 2015.
Asset management fees increased due to an increase in the weighted average operating assets held to $516.2 million as of September 30, 2016, as compared to $138.6 million as of September 30, 2015.
Depreciation and amortization increased due to an increase in the weighted average depreciable basis of operating real estate investments to $450.8 million as of September 30, 2016, as compared to $121.8 million as of September 30, 2015.

29


Changes in interest expense, net are summarized in the following table (amounts in thousands):
 
Three Months Ended
September 30,
 
 
 
2016
 
2015
 
Change
Interest expense, net:
 
 
 
 
 
Interest on secured credit facility
$
(590
)
 
$
(378
)
 
$
(212
)
Amortization of deferred financing costs
(256
)
 
(190
)
 
(66
)
Cash deposits interest
28

 
26

 
2

Capitalized interest
192

 

 
192

Total interest expense, net
(626
)
 
(542
)
 
(84
)
Net income (loss) attributable to common stockholders
$
2,508

 
$
(1,761
)
 
$
4,269

Interest on secured credit facility increased due to an increase in the average outstanding principal balance on the secured credit facility. The outstanding principal balance of the secured credit facility was $135.0 million as of September 30, 2016, and $70.0 million as of September 30, 2015.
Capitalized interest increased due to an increase in the average accumulated expenditures on development properties to $15.2 million for the three months ended September 30, 2016, as compared to having no development properties during the three months ended September 30, 2015.
Nine Months Ended September 30, 2016 Compared to the Nine Months Ended September 30, 2015
Changes in our revenues are summarized in the following table (amounts in thousands):
 
Nine Months Ended
September 30,
 
 
 
2016
 
2015
 
Change

 
 
 
 
 
Same store rental revenue
$
5,649

 
$
5,647

 
$
2

Non-same store rental revenue
27,440

 
5,765

 
21,675

Same store tenant reimbursement revenue
232

 
230

 
2

Non-same store tenant reimbursement revenue
3,897

 
612

 
3,285

Other operating income
3

 
7

 
(4
)
Total revenue
$
37,221

 
$
12,261

 
$
24,960

An insignificant increase in same store rental revenue relates to the consumer price index base rent escalation at certain same store properties. In addition, adjustments to straight-line rental revenue were offset by the increase in contractual rental revenue resulting from average annual rent escalations of 2.17% at our same store properties.
Non-same store rental revenue increased $21.7 million due to the acquisition of 35 operating properties since January 1, 2015.
Non-same store tenant reimbursement revenue increased $3.3 million due to the acquisition of 35 operating properties since January 1, 2015.

30


Changes in our expenses are summarized in the following table (amounts in thousands):
 
Nine Months Ended
September 30,
 
 
 
2016
 
2015
 
Change

 
 
 
 
 
Same store rental expenses
$
351

 
$
367

 
$
(16
)
Non-same store rental expenses
4,704

 
782

 
3,922

General and administrative expenses
2,358

 
1,366

 
992

Acquisition related expenses
5,432

 
7,287

 
(1,855
)
Asset management fees
3,240

 
1,133

 
2,107

Depreciation and amortization
12,948

 
4,048

 
8,900

Total expenses
$
29,033

 
$
14,983

 
$
14,050

Non-same store rental expenses, certain of which are subject to reimbursement by our tenants, increased primarily due to the acquisition of 35 operating properties since January 1, 2015.
General and administrative expenses increased primarily due to an increase in professional and legal fees of $0.4 million, an increase in other administrative costs of $0.4 million and an increase in personnel costs of $0.2 million, in connection with our Company's growth.
Acquisition related expenses decreased due to a decrease in real estate properties determined to be business combinations. Acquisition fees and expenses associated with transactions determined to be business combinations are expensed as incurred. During the nine months ended September 30, 2016, we acquired 12 real estate properties for an aggregate purchase price of $207.4 million as compared to ten real estate properties for an aggregate purchase price of $249.4 million during the nine months ended September 30, 2015.
Asset management fees increased due to an increase in the weighted average assets held to $516.2 million as of September 30, 2016, as compared to $138.6 million as of September 30, 2015.
Depreciation and amortization increased due to an increase in the weighted average depreciable basis of real estate investments to $450.8 million as of September 30, 2016, as compared to $121.8 million as of September 30, 2015.
Changes in interest expense, net are summarized in the following table (amounts in thousands):
 
Nine Months Ended
September 30,
 
 
 
2016
 
2015
 
Change
Interest expense, net:
 
 
 
 
 
Interest on secured credit facility
$
(1,907
)
 
$
(765