Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For The Fiscal Year Ended December 31, 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 000-55619
LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC.
(Exact Name of Registrant as Specified in Its Charter)
| Maryland | 46-1140492 |
| (State or other jurisdiction | (I.R.S. Employer Identification No.) |
| of incorporation or organization) |
| 1985 Cedar Bridge Avenue, Suite 1, Lakewood, NJ | 08701 |
| (Address of principal executive offices) | (Zip code) |
Registrant's telephone number, including area code: 732-367-0129
Securities registered under Section 12(b) of the Exchange Act:
| Title of Each Class | Name of Each Exchange on Which Registered | |
| None | None |
Securities registered under Section 12(g) of the Exchange Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 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 x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
There is no established market for the Registrant’s common shares. As of June 30, 2016, the last business day of the most recently completed second quarter, there were 6.7 million shares of the registrant’s common stock held by non-affiliates of the registrant. On March 27, 2017, the board of directors of the Registrant approved an estimated value per share of the Registrant’s common stock of $10.00 per share derived from the estimated value of the Registrant’s assets less the estimated value of the Registrant’s liabilities divided by the number of shares outstanding, all as of December 31, 2016. For a full description of the methodologies used to value the Registrant's assets and liabilities in connection with the calculation of the estimated value per share, see Part II, Item 5, “Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Market Information.” As of March 15, 2017, there were approximately 12.9 million shares of common stock held by non-affiliates of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
None.
LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC.
Table of Contents
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Special Note Regarding Forward-Looking Statements
This annual report on Form 10-K, together with other statements and information publicly disseminated by Lightstone Value Plus Real Estate Investment Trust III, Inc. (the “Lightstone REIT III”) contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Exchange Act”), and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and which could materially affect actual results, performances or achievements. Factors which may cause actual results to differ materially from current expectations include, but are not limited to, (i) general economic and local real estate conditions, (ii) the availability of suitable acquisition opportunities, (iii) financing risks, such as the inability to obtain equity, debt, or other sources of financing on favorable terms, (iv) the level and volatility of interest rates and foreign currency exchange rates, (v) increases in operating costs, (vi) the inability of major tenants to continue paying their rent obligations due to bankruptcy, insolvency or general downturn in their business and (vii) changes in governmental laws and regulations. Accordingly, there is no assurance that our expectations will be realized.
All forward-looking statements should be read in light of the factors identified herein at Part 1, Item 1A as well as in the “Risk Factors” section of the Registration Statement on Form S-11 (File No. 333-195292) of the Lightstone REIT III filed with the Securities and Exchange Commission (the “SEC”), as the same may be amended and supplemented from time to time.
General Description of Business
The Lightstone REIT III is a Maryland corporation, formed on October 5, 2012, which elected to qualify to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning with the taxable year ending December 31, 2015. Through December 31, 2016, the Company has acquired nine wholly-owned hotels and it will continue to seek to acquire additional hotels and other commercial real estate assets primarily located in the United States. All such properties may be acquired and operated by the Company alone or jointly with another party. The Company may also originate or acquire mortgage loans secured by real estate.
The Lightstone REIT III is structured as an umbrella partnership REIT (“UPREIT”), and substantially all of its current and future business is and will be conducted through Lightstone Value Plus REIT III LP, a Delaware limited partnership (the “Operating Partnership”).
Lightstone REIT III and the Operating Partnership and its subsidiaries are collectively referred to as the “Company” and the use of “we,” “our,” “us” or similar pronouns in this annual report refers to the Lightstone REIT III, its Operating Partnership or the Company as required by the context in which such pronoun is used.
Offering and Structure
Our sponsor, David Lichtenstein (“Lichtenstein”), who does business through The Lightstone Group, LLC (the “Sponsor”) and majority owns the limited liability company of that name, is one of the largest private residential and commercial real estate owners and operators in the United States today, with a diversified portfolio of over 120 properties containing approximately 10,000 multifamily units, 250,000 square feet of office space, 1.5 million square feet of industrial space, 31 hotels and 4.6 million square feet of retail space. The residential, office, industrial, hotel and retail properties are located in 26 states. Based in New York and supported by a regional office in New Jersey our Sponsor employs approximately 397 staff and professionals. Our Sponsor has extensive experience in the areas of investment selection, underwriting, due diligence, portfolio management, asset management, property management, leasing, disposition, finance, accounting and investor relations.
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Our advisor is Lightstone Value Plus REIT III LLC (the “Advisor”), which is majority owned by our Sponsor. Our Advisor, together with our board of directors (the “Board of Directors”), is and will continue to be primarily responsible for making investment decisions and managing our day-to-day operations. Through his ownership and control of The Lightstone Group, Mr. Lichtenstein is the indirect owner of the Advisor and the indirect owner and manager of Lightstone SLP III LLC, which has subordinated participation interests in the Operating Partnership. Mr. Lichtenstein also acts as the Company’s Chairman and Chief Executive Officer. As a result, he exerts influence over but does not control Lightstone REIT III or the Operating Partnership.
We do not have and will not have any employees that are not also employed by our Sponsor or its affiliates. We depend substantially on our Advisor, which generally has responsibility for our day-to-day operations. Under the terms of the advisory agreement, the Advisor also undertakes to use its reasonable best efforts to present to us investment opportunities consistent with our investment policies and objectives as adopted by our Board of Directors.
The Company’s registration statement on Form S-11 (the “Offering”), pursuant to which it is offering to sell up to 30,000,000 shares of its common stock, par value $0.01 per share (which may be referred to herein as ‘‘shares of common stock’’ or as ‘‘Common Shares’’) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10,000,000 shares available pursuant to its distribution reinvestment plan (the “DRIP”) at an initial purchase price of $9.50 per share) was declared effective by the Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933 on July 15, 2014. Since inception, the Company had received gross proceeds of $112.8 million from the sale of 11.5 million shares of its common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein, who also owns a majority interest in the Company’s Sponsor.)
The Company initially expected to offer the Common Shares offered in its Primary Offering over a two-year period, or until July 15, 2016. However, because the Company had not sold all the Common Shares offered in its Primary Offering within two years, the Company will continue the Primary Offering for an additional year, until July 15, 2017, provided that the Offering will be terminated if all 30.0 million shares of our common stock are sold before such date. The Company reserves the right to reallocate the shares of common stock it is offering between the Primary offering and the DRIP. Additionally, the Offering may be terminated at any time.
Orchard Securities, LLC (“Orchard Securities”) is the Dealer Manager of the Company’s Offering. Orchard Securities has a branch office that does business as “Lightstone Capital Markets” and focuses primarily on distributing interests in programs sponsored by our Sponsor.
As of December 31, 2016, the Advisor owned 20,000 shares of common stock which were issued on December 24, 2012 for $200,000, or $10.00 per share.
As of December 11, 2014, the Company had reached the minimum offering under its Offering by receiving subscriptions of its common shares, representing gross offering proceeds of more than $2.0 million, and effective December 11, 2014 investors were admitted as stockholders and the Operating Partnership commenced operations. Through December 31, 2016, cumulative gross offering proceeds of approximately $112.8 million were released to the Company. The Company invested the proceeds received from the Offering and the Advisor in the Operating Partnership, and as a result, held a 99% general partnership interest as of December 31, 2016 in the Operating Partnership’s common units.
The Company’s shares of common stock are not currently listed on a national securities exchange. The Company may seek to list its shares of common stock for trading on a national securities exchange only if a majority of its independent directors believe listing would be in the best interest of its stockholders. The Company does not intend to list its shares of common stock at this time. The Company does not anticipate that there would be any market for its shares of common stock until they are listed for trading. In the event the Company does not begin the process of achieving a liquidity event prior to the eighth anniversary of the termination of our Offering, our charter requires either (a) an amendment to our charter to extend the deadline to begin the process of achieving a liquidity event, or (b) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio.
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Noncontrolling Interest – Partners of Operating Partnership
On July 16, 2014, the Advisor contributed $2,000 to the Operating Partnership in exchange for 200 limited partner units in the Operating Partnership. A limited partner has the right to convert operating partnership units into cash or, at the option of the Company, an equal number of common shares of the Company, as allowed by the limited partnership agreement.
Lightstone SLP III LLC (the ‘‘Special Limited Partner’’), a Delaware limited liability company of which Mr. Lichtenstein is the majority owner, is a special limited partner in the Operating Partnership and has committed to make a significant equity investment in the Company of up to $36.0 million, which is equivalent to 12.0% of the $300.0 million maximum amount of the Offering. Specifically, the Special Limited Partner has committed to purchase subordinated participation interests in the Operating Partnership (the “Subordinated Participation Interests”) quarterly in an amount equal to the product of (i) $10.00 minus our then current estimated Net Asset Value (“NAV”) per Common Share, multiplied by (ii) the number of our Common Shares outstanding. The Operating Partnership will issue one Subordinated Participation Interest for each $50,000 in cash or interests in real property of equivalent value that the Special Limited Partner contributes. The Special Limited Partner’s obligation will continue until the earlier of: (i) the termination of the Offering; (ii) the Special Limited Partner’s purchase of an aggregate of $36.0 million of Subordinated Participation Interests and (iii) the receipt of gross offering proceeds of $300.0 million. The Special Limited Partner may elect to purchase the Subordinated Participation Interests for cash or may contribute interests in real property of equivalent value.
Through December 31, 2016, the Special Limited Partner has purchased an aggregate of approximately 242 Subordinated Participation Interests in consideration of $12.1 million, including approximately 228 Subordinated Participation Interests in consideration of $11.4 million during the year ended December 31, 2016. The Special Limited Partner may elect to purchase the Subordinated Participation Interests for cash or may contribute interests in real property of equivalent value. The Subordinated Participation Interests may be entitled to receive liquidation distributions upon the liquidation of Lightstone REIT III.
Operations - Operating Partnership Activity
Our Operating Partnership commenced its operations on December 11, 2014. Since then we have and will continue to seek to primarily acquire and operate hospitality properties and to lesser extent, commercial and residential properties principally in North America through our Operating Partnership. Our commercial holdings will consist of full-service or select-service hotels, including extended-stay hotels and to a lesser extent, retail (primarily multi-tenanted shopping centers), industrial and office properties. All such properties may be acquired and operated by us alone or jointly with another party. In addition, we may invest up to 20% of our net assets in collateralized debt obligations, commercial mortgage-backed securities (“CMBS”) and mortgage and mezzanine loans secured, directly or indirectly, by the same types of properties which it may acquire directly.
The following summarizes our completed acquisitions through December 31, 2016:
| · | On February 4, 2015 we acquired a 120-room select service Hampton Inn Hotel (the “Hampton Inn – Des Moines”) located in Des Moines, Iowa; |
| · | On May 15, 2015 we acquired a 146-room select service Courtyard by Marriott Hotel (the “Courtyard - Durham”) located in Durham, North Carolina; |
| · | On March 10, 2016 we acquired an 86-room select service Hampton Inn Hotel (the “Hampton Inn – Lansing”) located in Lansing, Michigan; |
| · | On March 23, 2016 we acquired a 92-room select service Courtyard by Marriott Hotel (the “Courtyard - Warwick”) located in Warwick, Rhode Island; |
| · | On May 2, 2016 we acquired a 127-room select service SpringHill Suites by Marriott Hotel (the “SpringHill Suites – Green Bay”) located in Green Bay, Wisconsin; |
| · | On August 2, 2016 we acquired a portfolio of two select service Home2 Suites by Hilton Hotels, a 139-room select service hotel located in Tukwila, Washington (the “Home2 Suites – Tukwila”) and a 125-room select service hotel located in Salt Lake City, Utah (the “Home2 Suites – Salt Lake” and collectively the “Home2 Suites Hotel Portfolio”); |
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| · | On September 13, 2016 we acquired an 84-room select service Fairfield Inn & Suites by Marriott Hotel (the “Fairfield Inn – Austin”) located in Austin, Texas; and |
| · | On October 7, 2016 we acquired an 80-room select service Staybridge Suites Hotel (the “Staybridge Suites – Austin”) located Austin, Texas. |
The Cove Transaction
On January 31, 2017, we, through a subsidiary of our Operating Partnership and REIT IV COVE LLC (“REIT IV Cove”), a wholly owned subsidiary of Lightstone Real Estate Income Trust, Inc. (“Lightstone IV”), a real estate investment trust also sponsored by our Sponsor and a related party, collectively, the “Assignees”, entered into an Assignment and Assumption Agreement (the “Assignment”) with another of the Lightstone IV’s wholly owned subsidiaries, REIT COVE LLC (the “Assignor”). Under the terms of the Assignment, the Assignees were assigned the rights and obligations of the Assignor with respect to that certain Sale and Purchase Agreement (the “Purchase Agreement”), dated September 29, 2016, made between the Assignor, as the purchaser, LSG Cove LLC (“LSG Cove”), an affiliate of our Sponsor and a related party and Maximus Cove Investor LLC (“Maximus”), an unrelated third party (collectively, the “Buyer”) and an unrelated third party, RP Cove, L.L.C (the “Seller”), pursuant to which the Buyer will acquire the Seller’s membership interest in RP Maximus Cove, L.L.C. (the “Joint Venture”) for approximately $255.0 million. The Joint Venture owns and operates The Cove at Tiburon (“The Cove”), a 281-unit, luxury waterfront multifamily rental property located in Tiburon, California. Prior to entering into the Cove Transaction, Maximus previously owned a separate noncontrolling interest in the Joint Venture.
On January 31, 2017, REIT IV Cove, REIT III Cove, LSG Cove, and Maximus (the “Members”) completed the Cove Transaction for aggregate consideration of approximately $255.0 million, which consisted of $80 million of cash and $175 million of proceeds from a loan from a financial institution. We paid approximately $20.0 million for a 22.5% membership interest in the Joint Venture.
Our interest in the Joint Venture is a non-managing interest, because we exert significant influence over but do not control the Joint Venture, we will account for our ownership interest in the Joint Venture in accordance with the equity method of accounting. All distributions of earnings from the Joint Venture will be made on a pro rata basis in proportion to each Members’ equity interest percentage. Any distributions in excess of earnings from the Joint venture will be made to the Members pursuant to the terms of the Joint Venture’s operating agreement. An affiliate of Maximus is the asset manager of The Cove and receives certain fees as defined in the Property Management Agreement for the management of The Cove. We will commence recording our allocated portion of profit and cash distributions beginning as of January 31, 2017 with respect to our membership interest of 22.5% in the Joint Venture.
In connection with the closing of the Cove Transaction, the Joint Venture simultaneously entered into a $175.0 million loan (the “Loan”) initially scheduled to mature on January 31, 2020 with two, one-year extension options, subject to certain conditions. The Loan requires monthly interest payments through its maturity date. The Loan bears interest at Libor plus 3.85% through its initial maturity and Libor plus 4.15% during each of the extension periods. The Loan is collateralized by The Cove and an affiliate of our Sponsor (the “Guarantor”) has guaranteed the Joint Venture‘s obligation to pay the outstanding balance of the Loan up to approximately $43.8 million (the “Loan Guarantee”). The Members have agreed to reimburse the Guarantor for any balance that may become due under the Loan Guarantee, of which our share is up to approximately $10.9 million.
The Cove is a multi-family complex consisting of 281-units, or 289,690 square feet, contained within 32 apartment buildings over 20.1 acres originally constructed in 1967. As of January 31, 2017, The Cove was 81.5% occupied. The average remaining term for existing leases in The Cove is 4 months and the average rental price per square foot is $4.47.
Starting in 2013, approximately $38 million has been invested in an extensive refurbishment of The Cove; of which to date, 97% of the apartment buildings have been completed. The Members intend to use the remaining proceeds from the Loan and to invest additional capital if necessary to complete the refurbishment of The Cove. The Guarantor provided an additional guarantee of up to approximately $13.4 million (the “Refurbishment Guarantee”) to provide the necessary funds to complete the remaining renovations as defined in the Loan. The Members have agreed to reimburse the Guarantor for any balance that may become due under the Refurbishment Guarantee, of which our share is up to approximately $3.3 million.
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Related Parties
Our Advisor and its affiliates and the Special Limited Partner are related parties of the Company. Certain of these entities have or will receive compensation and fees for services related to our offerings and will continue to receive compensation and fees and services for the investment and management of our assets. These entities have received and/or will receive fees during our offering, acquisition, operational and liquidation stages. The compensation levels during our offering, acquisition and operational stages are based on percentages of the offering proceeds sold, the cost of acquired properties and the annual revenue earned from such properties, and other such fees outlined in each of the respective agreements.
Primary Business Objectives and Strategies
Our primary objective is to achieve capital appreciation with a secondary objective of income without subjecting principal to undue risk. We intend to achieve this goal primarily through investments in real estate properties. We intend to use substantially all of the net proceeds from our Offering to acquire and operate a diversified portfolio of real estate investments.
Acquisition and Investment Policies
We primarily intend to acquire full-service or select-service hotels, including extended-stay hotels. Full-service hotels generally provide a full complement of guest amenities including restaurants, concierge and room service, porter service or valet parking. Select-service hotels typically do not include these amenities. Extended-stay hotels offer upscale, high-quality, residential style lodging with a comprehensive package of guest services and amenities for extended-stay business and leisure travelers. We have no limitation as to the brand of franchise or license with which our hotels will be associated.
Even though we intend primarily to acquire hotels, we may use a portion of the offering proceeds to purchase other types of real estate. We believe that at least 75% of the net proceeds raised in the Offering will be used to acquire hotels and the remaining portion of the net proceeds raised in the Offering will be used to acquire properties and real estate-related assets other than hotels. However, we may use more or less than 75% of the net proceeds raised in the Offering to acquire hotels and are not bound to that limit. Assets other than hotels may include, without limitation, office buildings, shopping centers, business and industrial parks, manufacturing facilities, single-tenant properties, multifamily properties, student housing properties, warehouses and distribution facilities and medical office properties. We expect to invest a significant portion of our funds in direct real estate investments and other equity interests, and the remainder of our funds in debt interests, which may include bridge or mezzanine loans, including in furtherance of a loan-to-own strategy. However, we are not prohibited from investing all our funds in debt interests.
We anticipate that our portfolio will provide consistent current income and may also provide capital appreciation resulting from our expectation that in certain circumstances we will be able to acquire properties at a discount to replacement cost or otherwise at less than what we perceive as the market value or to reposition or redevelop a property so as to increase its value over the amount of capital we deployed to acquire and rehabilitate the property. We may acquire properties that we believe would benefit from a change in management strategy, or that have incurred substantial deferred maintenance. We plan to diversify our portfolio by geographic region, investment size and investment risk with the goal of acquiring a portfolio of hotels and other income-producing real estate properties and real estate-related assets that provide attractive returns for our investors.
Our advisor intends to focus on markets that may be depressed or overbuilt and on sellers who are distressed or time-constrained. Our opportunistic real estate strategy involves more risk than real estate programs that have a targeted holding period for investments longer than ours, utilize leverage to a lesser degree or employ more conservative investment strategies, and, based upon these factors and the experience of our sponsor, The Lightstone Group, we believe that we have a potential for a higher rate of return than comparable real estate programs. The exact markets that will ultimately be targeted by our advisor will depend on its evaluation of property prices and other economic considerations impacting the particular markets.
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As part of our opportunistic real estate investment strategy, we may acquire hotels with low occupancy rates and reposition them by seeking to improve the property and occupancy rates and thereby increase average daily rates, revenue per available room and overall property value. Further, we may invest in hotels that we believe present an opportunity for enhanced future value because of delayed renovations or deferred maintenance that we believe we can remedy.
We intend to purchase properties that have been constructed and have operating histories; additionally, we may acquire properties that are newly constructed, under development or construction or not yet developed. Properties may include multifamily properties purchased for conversion into condominiums or cooperatives, ground leases and properties intended to be converted from one use to another use. Additionally, subject to applicable REIT requirements, as a property reaches a market value that would provide what our advisor believes to be an attractive return to our investors given the then prevailing market conditions, we will consider disposing of the property and may do so for the purpose of distributing the net sale proceeds to our stockholders. We anticipate that such dispositions typically would occur during the period from three to six years after the termination of the Offering. However, subject to provisions of the Code relating to “prohibited transactions,” we may consider investing in properties with a different anticipated holding period in the event such properties provide an opportunity for an attractive overall return. For example, we may acquire properties in markets that are depressed or overbuilt with the anticipation that, within our anticipated holding period, the markets will recover and favorably impact the value of these properties. In addition, we may acquire interests in other entities with similar real property investments or investment strategies. We expect to make our investments in real estate assets located in the United States and its territories, with an initial focus on the Northeast, Southeast, Midwest and Southwest regions of the United States.
Subject to the applicable REIT requirements, to the extent that our advisor determines that it is advantageous, we may originate or invest in real estate-related assets such as mortgage, mezzanine, bridge and other loans and debt and equity securities issued by other real estate companies. In each case, these real estate-related assets will have been identified as being opportunistic investments with significant possibilities for near-term capital appreciation or higher current income; however, we intend to limit these types of investments so that neither the Company nor any of its subsidiaries will be required to register as an investment company under the Investment Company Act.
We may enter into one or more joint ventures, tenant-in-common investments or other co-ownership arrangements for the acquisition, development or improvement of properties with third parties or certain affiliates of our advisor, including other present and future REITs and real estate limited partnerships sponsored by affiliates of our advisor.
Financing Strategy and Policies
We expect that once we have fully invested the proceeds of the Offering, assuming we sell the maximum amount, our portfolio-wide loan-to-value ratio (calculated after the close of the Offering) will be approximately 65%. For purposes of calculating our 65% target leverage, we will determine the loan-to-value ratio on our portfolio based on the greater of the aggregate cost and the fair market value of our investments and other assets. There is no limitation on the amount we may borrow for the purchase of any single asset. Our charter allows us to incur leverage up to 300% of our total “net assets” (as defined in Section I.B of the NASAA REIT Guidelines) as of the date of any borrowing, which is generally expected to be approximately 75% of the cost of our investments. We may only exceed this 300% limit if a majority of our independent directors approves each borrowing in excess of this limit and we disclose such borrowing to our stockholders in our next quarterly report along with a justification for the excess borrowing. In all events, we expect that our secured and unsecured borrowings will be reasonable in relation to the net value of our assets and will be reviewed by our board of directors at least quarterly.
We do not intend to exceed the leverage limit in our charter after we have fully invested the proceeds of the Offering, although we anticipate exceeding the leverage limit in the early stages of our development when the costs of our investments are most likely to exceed our net offering proceeds. Careful use of debt will help us to achieve our diversification goals because we will have more funds available for investment. However, high levels of debt could cause us to incur higher interest charges and higher debt service payments, which would decrease the amount of cash available for distribution to our investors.
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Distribution Objectives
U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with generally accepted accounting principles in the United States (“GAAP”)) determined without regard to the deduction for dividends paid and excluding any net capital gain. In order to qualify or continue to qualify for REIT status, we may be required to make distributions in excess of cash available.
Distributions are paid at the discretion of our Board of Directors. We may fund distributions with cash proceeds from the sale of shares of our common stock or borrowings if we do not generate sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the amount of distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.
We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. “Return of capital” refers to distributions to investors in excess of net income. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, but only to the extent of a stockholder’s adjusted tax basis in our shares, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.
On January 14, 2015, our Board of Directors authorized and we declared a distribution which is calculated based on stockholders of record each day during the applicable period at a rate of $0.00164383 per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 6.0% annualized rate based on a share price of $10.00. Our first distribution began to accrue on December 11, 2014 (date of breaking escrow) through February 28, 2015 (the end of the month following our initial property acquisition) and subsequent distributions have been declared on a monthly basis thereafter. The first distribution was paid on March 15, 2015 and subsequent distributions have been paid on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month. Our stockholders may elect to have their distributions reinvested in additional shares of Common Shares under our DRIP.
Total distributions declared during the years ended December 31, 2016 and 2015 were $4.7 million and $1.0 million.
Distribution Reinvestment and Share Repurchase Programs
Our DRIP provides our stockholders with an opportunity to purchase additional shares of our common stock, at an initial purchase price of $9.50 per common share, equal to 95% of our current Offering price of $10.00 per common share, by reinvesting their distributions. In connection with our Offering, 10,000,000 Common Shares were reserved for issuance under our DRIP and as of December 31, 2016, 220,847 shares of common stock had been issued under our DRIP and 9,779,153 shares remain available for issuance.
Our share repurchase program may provide our stockholders with limited, interim liquidity by enabling them to sell their shares of common stock back to us, subject to restrictions. From our date of inception through December 31, 2015, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the year ended December 31, 2016 we repurchased 34,358 shares of common stock, pursuant to our share repurchase program. We repurchased the shares at an average price per share of $9.99 per share. We funded share repurchases for the periods noted above from the cumulative proceeds of the sale of our shares pursuant to our DRIP.
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Our Board of Directors reserves the right to terminate either program for any reason without cause by providing 10 days written notice of termination of the DRIP to all participants or written notice of termination of the share repurchase program to all stockholders.
Tax Status
We elected to qualify and be taxed as a REIT for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2015. As a REIT, we generally will not be subject to U.S. federal income tax on our net taxable income that we distribute currently to our stockholders. To maintain our REIT qualification under the Internal Revenue Code of 1986, as amended, (the “Code”), we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income, which does not equal net income, as calculated in accordance with GAAP, determined without regard to the deduction for dividends paid and excluding any net capital gain. If we fail to remain qualified for taxation as a REIT in any subsequent year and do not qualify for certain statutory relief provisions, our income for that year will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.
We engage in certain activities through taxable REIT subsidiaries ("TRSs"). When we purchase a hotel we establish a TRS which enters into an operating lease agreement for the hotel. As such, we may be subject to U.S. federal and state income taxes and franchise taxes from these activities.
As of December 31, 2016 and 2015, we had no material uncertain income tax positions. Additionally, even as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.
To qualify or maintain our qualification as a REIT, we engage in certain activities through taxable REIT subsidiaries TRSs. As such, we are subject to U.S. federal and state income and franchise taxes from these activities.
Competition
The hotel and other commercial real estate markets are highly competitive. This competition could reduce occupancy levels and rental revenues at our properties, which would adversely affect our operations. We face competition from many sources. We face competition from other hotels both in the immediate vicinity and the geographic market where our hotels will be located. Overbuilding in the hotel industry will increase the number of rooms available and may decrease occupancy and room rates. In addition, increases in operating costs due to inflation may not be offset by increased room rates. We will also face competition from nationally recognized hotel brands with which we will not be associated.
We compete in all of our markets with other owners and operators of retail, office, industrial and residential real estate. The continued development of new retail, office, industrial and residential properties has intensified the competition among owners and operators of these types of real estate in many market areas in which we intend to operate. We compete based on a number of factors that include location, rental rates, security, suitability of the property’s design to prospective tenants’ needs and the manner in which the property is operated and marketed. The number of competing properties in a particular market could have a material effect on our occupancy levels, rental rates and on the operating expenses of certain of our properties.
In addition, we compete with other entities engaged in real estate investment activities to locate suitable properties to acquire and to locate tenants and purchasers for our properties. These competitors include other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, lenders, governmental bodies and other entities. There are also other REITs with asset acquisition objectives similar to ours and others that may be organized in the future. Some of these competitors, including larger REITs, have substantially greater marketing and financial resources than we will have and generally may be able to accept more risk than we can prudently manage, including risks with respect to the creditworthiness of tenants. In addition, these same entities seek financing through similar channels to those sought by us. Therefore, we will compete for institutional investors in a market where funds for real estate investment may decrease.
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Competition from these and other third party real estate investors may limit the number of suitable investment opportunities available to us. It may also result in higher prices, lower yields and a narrower spread of yields over our borrowing costs, making it more difficult for us to acquire new investments on attractive terms. In addition, competition for desirable investments could delay the investment of proceeds from our Offering in desirable assets, which may in turn reduce our earnings per share and negatively affect our ability to commence or maintain distributions to stockholders.
We believe that our senior management’s experience, coupled with our financing, professionalism, diversity of properties and reputation in the industry enables us to compete with the other real estate investment companies.
Because we are organized as an UPREIT, we believe we are well positioned within the hospitality industry and any industries in which we may operate to offer existing property owners the opportunity to contribute their properties to us in tax-deferred transactions using our Operating Partnership units as transactional currency. As a result, we believe we have a competitive advantage over most of our competitors that are structured as traditional REITs and non-REITs in pursuing acquisitions with tax-sensitive sellers.
Environmental
As an owner of real estate, we will be subject to various environmental laws of U.S. federal, state and local governments. Compliance with existing laws has not had a material adverse effect on our financial condition or results of operations, and management does not believe it will have such an impact in the future. However, we cannot predict the impact of unforeseen environmental contingencies or new or changed laws or regulations on properties in which we hold an interest, or on properties that may be acquired directly or indirectly in the future.
Employees
We do not have employees. We entered into an advisory agreement with our advisor pursuant to which our Advisor supervises and manages our day-to-day operations and selects our real estate and real estate-related investments, subject to oversight by our Board of Directors. We have and will continue to pay our Advisor fees for services related to the investment and management of our assets, and we have and will continue to reimburse our Advisor for certain expenses incurred on our behalf.
Economic Dependence
We are dependent upon the net proceeds received from our Offering to conduct our proposed activities. The capital required to acquire real estate and real estate related investments will be obtained from the proceeds from our Offering and from any indebtedness that we may incur in connection with the acquisition of any real estate and real estate related investments thereafter.
Available Information
We electronically file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and proxy statements, with the SEC. Stockholders may obtain copies of our filings with the SEC, free of charge, from the website maintained by the SEC at http://www.sec.gov, or at the SEC's Public Reference Room at 100 F. Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our office is located at 1985 Cedar Bridge Avenue, Lakewood, New Jersey 08701. Our telephone number is (732) 367-0129. Our website is www.lightstonecapitalmarkets.com.
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Set forth below are the risk factors that we believe are material to our investors. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements on page 2. If any of the risk events described below actually occurs, our business, financial condition or results of operations could be adversely affected.
Risks Related to an Investment in Lightstone Value Plus Real Estate Investment Trust III, Inc.
There is no public trading market for our Common Shares, and there may never be one; therefore, it will be difficult for you to sell your Common Shares except pursuant to our share repurchase program. If you sell your Common Shares to us under our share repurchase program, you may receive less than the total price you paid for the Common Shares.
There currently is no public market for our Common Shares, and there may never be one. If you are able to find a buyer for your Common Shares, you may not sell your Common Shares unless the buyer meets applicable suitability and minimum purchase standards and the sale does not violate state securities laws. Our charter also prohibits the ownership of more than 9.8% in value of the aggregate of our outstanding shares of stock or more than 9.8% (in value or in number of shares, whichever is more restrictive) of our outstanding Common Shares, unless exempted by our board of directors (prospectively or retroactively), which may inhibit large investors from desiring to purchase your Common Shares.
Repurchases of Common Shares through our share repurchase program may be the only way to dispose of your Common Shares, but there are a number of limitations placed on such repurchases. Therefore, you may be required to sell your Common Shares at a substantial discount to the price you originally paid. See ‘‘Share Repurchase Program’’ for a description of the initial repurchase price, as determined by our board of directors. Furthermore, our board of directors reserves the right, in its sole discretion, at any time and from time to time, to amend the terms of, suspend or terminate our share repurchase program. Additionally, our board of directors reserves the right, in its sole discretion, to reject an individual stockholder’s request for repurchase for any reason at any time. Therefore, it will be difficult for you to sell your Common Shares promptly or at all.
You are limited in your ability to sell your Common Shares pursuant to our share repurchase program and may have to hold your Common Shares for an indefinite period of time.
Repurchases of Common Shares through our share repurchase program may be the only way to dispose of your Common Shares, but there are a number of limitations placed on such repurchases. Our board of directors may amend the terms of our share repurchase program without stockholder approval. Our board of directors also is free to suspend or terminate the program or to reject any request for repurchase and there is no assurance our board of directors will not suspend or terminate the program or reject requests for repurchases. In addition, our share repurchase program includes numerous restrictions that would limit your ability to sell your Common Shares within the program. Importantly, funding for our share repurchase program will come exclusively from any proceeds we received from the sale of Common Shares under our DRIP that our board of directors may reserve for this purpose. In addition, we will limit the number of Common Shares repurchased pursuant to our share repurchase program as follows: during any 12-month period, we will not repurchase in excess of 5.0% of the weighted average number of Common Shares outstanding during the prior calendar year; provided, however, that Common Shares repurchased in the case of the death of a stockholder will not count against this 5.0% limit.
Our Offering is a partial “blind pool” offering, so you will not have the opportunity to evaluate all of our investments or our tenants before we engage in investment or leasing activity.
Our Offering is a partial “blind pool offering”. Therefore, we are not able to provide you with information to evaluate all of our investments prior to acquisition. Our board of directors will have wide discretion in implementing our policies relating to the creditworthiness of tenants, and you will not have the opportunity to evaluate potential tenants. In light of our investment strategy, we may lease to tenants that do not have strong credit.
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We may suffer from delays in locating suitable investments, which could adversely affect the return on your investment.
Our ability to achieve our investment objectives and to make distributions to our stockholders is dependent upon the performance of our advisor in the acquisition of our investments and the determination of any financing arrangements, as well as the performance of our property managers in the selection of tenants and the negotiation of leases. The current market for properties that meet our investment objectives is highly competitive, as is the leasing market for such properties. The more Common Shares we sell in our offering, the greater our challenge will be to invest all the net offering proceeds on attractive terms. You will have no opportunity to evaluate the terms of transactions or other economic or financial data concerning our investments. You must rely entirely on the oversight of our board of directors, the management ability of our advisor and the performance of our property managers for us to achieve our investment objectives. We cannot be sure that our advisor will be successful in obtaining suitable investments on financially attractive terms.
Additionally, as a public company, we are subject to ongoing reporting requirements under the Exchange Act. Pursuant to the Exchange Act, we may be required to file with the SEC financial statements of properties we acquire or, in certain cases, financial statements of the tenants of the acquired properties. To the extent any required financial statements are not available or cannot be obtained, we will not be able to acquire the property. As a result, we may not be able to acquire certain properties that otherwise would be a suitable investment. We could suffer delays in our property acquisitions due to these reporting requirements.
Furthermore, where we acquire properties prior to the start of construction or during the early stages of construction, it will typically take several months to complete construction and rent available space. Therefore, you could suffer delays in the receipt of distributions attributable to those particular properties.
Delays we encounter in the selection, acquisition and development of properties could adversely affect your returns. In addition, if we are unable to invest our offering proceeds in real properties in a timely manner, we will hold the proceeds of our offering in an interest-bearing account, invest the proceeds in short-term, investment-grade investments or, ultimately, liquidate. In such an event, our ability to pay distributions to our stockholders and the returns to our stockholders would be adversely affected.
Our sponsor has been involved with investments that have faced adverse business developments, including bankruptcies.
Our sponsor has been involved in prior programs and investment activities that faced adverse business developments, including bankruptcy filings. These adverse developments may negatively affect a potential investor’s assessment of our ability to meet our investment objectives, which in turn may hinder our ability to raise substantial funds in our Offering. If we are unable to raise substantial funds, we will be limited in the number and type of investments we may make, which may negatively affect the value of your investment.
Distributions paid from sources other than our cash flows from operations, particularly from proceeds of our Offering, will result in us having fewer funds available for the acquisition of real estate-related investments and may dilute our stockholders' interests in us, which may adversely affect our ability to fund future distributions with cash flows from operations and may adversely affect our stockholders’ overall return.
Our cash flows provided by operations were approximately $3.7 million for the year ended December 31, 2016. During the year ended December 31, 2016, we declared distributions of approximately $4.7 million, of which $2.8 million, or 59%, was funded from cash flows from operations and approximately $1.9 million, or 41%, was funded from proceeds from common stock issued under the DRIP. Our cash flows provided by operations were approximately $0.7 million for the year ended December 31, 2015. During the year ended December 31, 2015, we declared distributions of approximately $1.0 million, of which $0.6 million, or 60%, was funded from cash flows from operations and approximately $0.4 million, or 40%, was funded from proceeds from common stock issued under the DRIP. Additionally, we may in the future pay distributions from sources other than from our cash flows from operations. Our organizational documents permit us to make distributions from any source, including from the proceeds of the Offering or other offerings, cash advances to us by our advisor, cash resulting from a waiver of fees, and borrowings, including borrowings secured by our assets.
We expect that future distributions will be paid from our cash flow from operations following the acquisition of additional real estate-related investments, but there can be no assurance we will be able to generate sufficient cash flow from operations to do so. We may continue in the future to pay distributions from sources other than from our cash flows from operations, including the net proceeds from our Offering. If we are unable to acquire additional real estate-related investments, it may result in a lower return on an investment in our shares. If we have not generated sufficient cash flows from our operations and other sources, such as from borrowings, the sale of additional securities, advances from our Advisor, and our Advisor's deferral, suspension or waiver of its fees and expense reimbursements, to fund distributions, we may use the proceeds from our Offering. Moreover, our board of directors may change our distribution policy, in its sole discretion, at any time. Distributions made from Offering proceeds are a return of capital to stockholders, from which we will have already paid offering expenses in connection with the Offering. We have not established any limit on the amount of proceeds from the Offering that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would: (1) cause us to be unable to pay our debts as they become due in the usual course of business; (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences, if any; or (3) jeopardize our ability to qualify as a REIT.
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Funding distributions from the proceeds of our Offering results in us having less funds available for acquiring properties or other real estate-related investments and may impact the value of an investment in our Common Shares. As a result, the return realized on an investment in our shares may be reduced. Funding distributions from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding distributions with the sale of assets or the proceeds of the Offering may affect our ability to generate cash flows. Funding distributions from the sale of additional securities could dilute our stockholders’ interest in us if we sell shares of our common stock or securities that are convertible or exercisable into shares of our common stock to third-party investors. Payment of distributions from the mentioned sources could restrict our ability to generate sufficient cash flows from operations, affect our profitability or affect the distributions payable to you upon a liquidity event, any or all of which may have an adverse effect on our stockholders’ investment
To the extent offering proceeds are used to pay fees to our advisor or its affiliates or to fund distributions, our investors will realize dilution and later investors also may realize a lower rate of return than investors who invest earlier in our offering.
Our advisor and its affiliates provide services for us in connection with, among other things, the selection, financing and acquisition of our investments, the management and leasing of our properties, the servicing of our mortgage, bridge, mezzanine or other loans and the disposition of our assets. We pay them substantial upfront fees for some of these services, which reduces the amount of cash available for investment in real estate or distribution to you. We may use Offering proceeds to pay a portion of these fees.
In addition, we may use offering proceeds to fund distributions, and later investors who do not receive those distributions will therefore experience additional immediate dilution of their investment. Also, to the extent we incur debt to fund distributions earlier in our public offering, the amount of cash available for distributions in future periods will be decreased by the repayment of such debt.
The use of offering proceeds to pay fees to our advisor and its affiliates or to fund distributions increases the risk that the amount available for distribution to stockholders upon a liquidation of our portfolio would be less than the purchase price of the Common Shares in our offering.
We may have to make decisions on whether to invest in certain properties without detailed information on the property.
To effectively compete for the acquisition of properties and other investments, our advisor and board of directors may be required to make decisions or post substantial non-refundable deposits prior to the completion of our analysis and due diligence on property acquisitions. In such cases, the information available to our advisor and board of directors at the time of making any particular investment decision, including the decision to pay any non-refundable deposit and the decision to consummate any particular acquisition, may be limited, and our advisor and board of directors may not have access to detailed information regarding any particular investment property, such as physical characteristics, environmental matters, zoning regulations or other local conditions affecting the investment property. Therefore, no assurance can be given that our advisor and board of directors will have knowledge of all circumstances that may adversely affect an investment. In addition, our advisor and board of directors expect to rely upon independent consultants in connection with their evaluation of proposed investment properties, and no assurance can be given as to the accuracy or completeness of the information provided by such independent consultants.
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If we are unable to raise substantial funds, we will be limited in the number and type of investments we may make, and the value of your investment in us will fluctuate with the performance of the specific investments we make.
Our Offering is being made on a ‘‘best efforts’’ basis, meaning that our dealer manager is only required to use its best efforts to sell our Common Shares and has no firm commitment or obligation to purchase any of the Common Shares. As a result, we cannot assure you of the amount of proceeds that will be raised in our Offering. We are dependent on funds from our Offering to make additional investments, resulting in greater diversification in terms of the number of investments owned, the geographic regions in which our investments are located and the types of investments that we acquire. If we do not raise significant additional funds in our Offering, the more likely it will be that we will not be able to achieve significant diversification and the likelihood of our profitability being affected by the performance of any one of our investments will increase. We are not limited in the number or size of our investments or the percentage of net proceeds we may dedicate to a single investment. Your investment in our Common Shares will be subject to greater risk to the extent that we lack a diversified portfolio of investments. In addition, to the extent we are not able to raise additional funds, our fixed operating expenses, as a percentage of gross income, would be higher, and our financial condition and ability to pay distributions could be adversely affected.
If we lose or are unable to obtain key personnel, our ability to implement our investment strategies could be delayed or hindered.
Our success depends to a significant degree upon the continued contributions of our chairman, certain executive officers and other key personnel of us, our advisor and its affiliates. We do not have employment agreements with our chairman and executive officers, and we cannot guarantee that they will remain affiliated with us. If any of our key personnel were to cease their affiliation with us, our advisor or its affiliates, our operating results could suffer. We do not intend to maintain key person life insurance on any of our key personnel. We believe that our future success depends, in large part, upon our advisor’s and its affiliates’ ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition for persons with these skills is intense, and we cannot assure you that our advisor will be successful in attracting and retaining such skilled personnel. If we lose or are unable to obtain the services of key personnel, our ability to implement our investment strategies could be delayed or hindered.
If we internalize our management functions, your interest in us could be diluted, and we could incur other significant costs associated with being self-managed.
Our strategy may involve becoming ‘‘self-managed’’ by internalizing our management functions, particularly if we seek to list our Common Shares on an exchange as a way of providing our stockholders with a liquidity event. The method by which we could internalize these functions could take many forms. We may hire our own group of executives and other employees or we may elect to negotiate to acquire our advisor’s and property managers’ assets and personnel. At this time, we cannot be sure of the form or amount of consideration or other terms relating to any such acquisition. Such consideration could take many forms, including cash payments, promissory notes and shares of our stock. An internalization transaction could result in significant payments to affiliates of our advisor irrespective of whether you enjoyed the returns on which we have conditioned our subordinated share of annual cash flows. The payment of such consideration could result in dilution of your interests as a stockholder and could reduce the net income per Common Share and modified funds from operations per Common Share attributable to your investment. We will not be required to seek a stockholder vote to become self-managed.
In addition, our direct expenses would include general and administrative costs, including legal, accounting and other expenses related to corporate governance and SEC reporting and compliance. If stockholders or other interested parties file a lawsuit related to, or challenging, an internalization transaction, we could incur high litigation costs that would adversely affect the value of your Common Shares. We also would incur the compensation and benefits costs of our officers and other employees and consultants that are now paid by our advisor or its affiliates. We cannot reasonably estimate the amount of fees to our advisor and its affiliates we would save and the costs we would incur if we became self-managed. If the expenses we assume as a result of an internalization are higher than the expenses we avoid paying to our advisor and its affiliates, our net income per Common Share and funds from operations per Common Share would be lower as a result of the internalization than it otherwise would have been, potentially decreasing the amount of funds available to distribute to our stockholders and the value of our Common Shares.
As currently organized, we do not directly employ any employees. If we elect to internalize our management functions, we would employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims, potential labor disputes and other employee-related liabilities and grievances. Nothing in our charter prohibits us from entering into the transaction described above.
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Additionally, there is no assurance that internalizing our management functions will prove to be beneficial to us and our stockholders. We could have difficulty integrating our management functions as a stand-alone entity. Certain personnel of our advisor and its affiliates perform property management, asset management and general and administrative functions, including accounting and financial reporting, for multiple entities. We could fail to properly identify the appropriate mix of personnel and capital needs to operate as a stand-alone entity. An inability to manage an internalization transaction effectively could thus result in our incurring excess costs or suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. Such deficiencies could cause us to incur additional costs, and our management’s attention could be diverted from most effectively managing our portfolio of investments.
If we were to internalize our management or if another investment program, whether sponsored by our sponsor or otherwise, hires the employees of our advisor or our property managers in connection with its own internalization transaction or otherwise, our ability to conduct our business may be adversely affected.
We rely on persons employed by our advisor and its affiliates to manage our day-to-day operations. If we were to effectuate an internalization of our advisor or our property managers, we may not be able to retain all the employees of our advisor or property managers or to maintain a relationship with our sponsor. In addition, some of the employees of the advisor or property managers may provide services to one or more other investment programs. These programs or third parties may decide to retain some of or all our advisor’s or property managers’ key employees in the future. If this occurs, these programs could hire certain of the persons currently employed by our advisor or property managers who are most familiar with our business and operations, thereby potentially adversely impacting our business.
Our rights and the rights of our stockholders to recover claims against our independent directors are limited, which could reduce your and our recovery against them if they negligently cause us to incur losses.
Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter provides that no independent director will be liable to us or our stockholders for monetary damages and that we will generally indemnify them for losses unless they are grossly negligent or engage in willful misconduct. As a result, you and we may have more limited rights against our independent directors than might otherwise exist under common law, which could reduce your and our recovery from these persons if they act in a negligent manner. In addition, we may be obligated to fund the defense costs incurred by our independent directors (as well as by our other directors, officers, employees and agents) in some cases, which would decrease the cash otherwise available for distributions to you.
If our advisor or its affiliates waive certain fees due to them, our results of operations and distributions may be artificially high.
From time to time, our advisor or its affiliates may agree to waive all or a portion of the acquisition, asset management or other fees, compensation or incentives due to them, pay general administrative expenses or otherwise supplement stockholder returns in order to increase the amount of cash available to make distributions to stockholders. If our advisor or its affiliates choose to no longer waive such fees and incentives, our results of operations will be lower than in previous periods and your return on your investment could be negatively affected.
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On March 27, 2017, our board of directors established our most current estimated NAV per share as of December 31, 2016. We currently expect that our advisor will estimate our NAV on a quarterly basis, but our advisor will estimate our NAV on at least an annual basis, and such estimated NAV per share may be lower than the purchase price you pay for Common Shares in our Offering. The estimated NAV per share may not be an accurate reflection of the fair value of our assets and liabilities and likely will not represent the amount of net proceeds that would result if we were liquidated or dissolved or completed a merger or other sale of our Company.
Recent amendments to rules promulgated by FINRA required us to disclose an estimated NAV per share of our Common Shares no later than May 10, 2017, which would have been 150 days following the second anniversary of the date on which we broke escrow in this offering. On May 13, 2016, our board of directors established our initial estimated NAV per Common Share as of March 31, 2016 and on March 27, 2017 our board of directors established our most current estimated NAV per Common Share as of December 31, 2016. We currently expect that our advisor will estimate our NAV on a quarterly basis, but our advisor will estimate our NAV on at least an annual basis. Our board of directors may determine to modify the offering price, including the price at which the shares are offered pursuant to the DRIP, to reflect the most current estimated NAV per Common Share.
The price at which you purchase shares and any subsequent estimated values are likely to differ from the price at which a stockholder could resell such shares because: (i) there is no public trading market for our shares at this time; (ii) the purchase price does not reflect, and will not reflect, the fair value of our assets as we acquire them, nor does it represent the amount of net proceeds that would result from an immediate liquidation of our assets or sale of our Company, because the amount of proceeds available for investment from our offering is net of selling commissions, dealer manager fees, other organizational and offering expense reimbursements and acquisition fees and expenses; (iii) the estimated value does not take into account how market fluctuations affect the value of our investments, including how the current conditions in the financial and real estate markets may affect the values of our investments; (iv) the estimated value does not take into account how developments related to individual assets may increase or decrease the value of our portfolio; and (v) the estimated value does not take into account any portfolio premium or premiums to value that may be achieved in a liquidation of our assets or sale of our portfolio or what a third party would pay to acquire our assets.
Risks Related to Conflicts of Interest
We will be subject to conflicts of interest arising out of our relationships with our Advisor and its affiliates, including the material conflicts discussed below.
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Our advisor and its affiliates, including all our executive officers and some of our directors, will face conflicts of interest caused by their compensation arrangements with us, which could result in actions that are not in the long-term best interests of our stockholders.
Our advisor and its affiliates, including the special limited partner, are entitled to substantial fees and liquidation distributions from us. These fees could influence our advisor’s advice to us as well as the judgment of affiliates of our advisor performing services for us. Among other matters, these compensation arrangements could affect their judgment with respect to:
| • | the continuation, renewal or enforcement of our agreements with our advisor and its affiliates, including the advisory agreement and property management agreements, because our advisor and any of its affiliates that serve as property managers have an incentive to continue receiving fees under these agreements; |
| • | public offerings of equity by us, which will likely entitle our advisor to increased asset management subordinated participation and to increased acquisition, financing coordination and asset management fees; |
| • | property sales, which may result in compensation to our advisor in the form of real estate disposition commissions; |
| • | property acquisitions from third parties, which entitle our advisor to acquisition fees, asset management subordinated participation and asset management fees, which are not calculated based on investment quality, and which could encourage our advisor to purchase assets at higher prices; |
| • | whether to construct improvements on our properties, which would entitle our property managers to construction management fees, and whether to maximize the estimated costs of improvements, since construction management fees are initially calculated in part based on budgeted amounts; |
| • | whether to lease to a less creditworthy tenant, since our property managers will receive leasing fees regardless of tenant quality, and a default by a tenant under its lease obligations may give the respective property manager an opportunity to earn an additional leasing fee; |
| • | borrowings to acquire properties, which borrowings may increase the acquisition, asset management and financing coordination fees and the asset management subordinated participation payable to our advisor; |
| • | determining the compensation paid to employees for services provided to us, which could be influenced in part by whether our advisor is reimbursed by us for the related salaries and benefits; |
| • | whether we seek to internalize our management functions, which internalization could result in our retaining some of our advisor’s and its affiliates’ key officers and employees for compensation that is greater than that which they currently earn or which could require additional payments to affiliates |
of our advisor to purchase the assets and operations of our advisor and its affiliates;
| • | whether and when we seek to liquidate or to list our Common Shares on a national securities exchange, which events may entitle the special limited partner to receive liquidation distributions; and |
| • | whether and when to terminate the advisory agreement or to allow the advisory agreement to expire without renewal (even for poor performance by our advisor), in either case with or without cause, either of which may entitle the special limited partner to (a) receive cash in an amount equal to its net investment, or (b) retain the subordinated participation interests, and in the case of (a), to receive liquidation distributions as well. |
The fees our advisor receives in connection with transactions involving the purchase and management of an asset may be based on the contract purchase price or the book value of the investment rather than the quality of the investment or the quality of the services rendered to us. This may influence our advisor to recommend riskier transactions to us.
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Our advisor and the special limited partner face conflicts of interest relating to the incentive fee structure, which could result in actions that are not necessarily in the long-term best interests of our stockholders.
Under our advisory agreement and our operating partnership’s limited partnership agreement, our advisor and the special limited partner will be entitled to fees and distributions that are structured in a manner intended to provide incentives to our advisor to perform in our best interests and in the best interests of our stockholders. However, because our advisor is entitled to receive substantial minimum compensation regardless of performance, our advisor’s interests are not wholly aligned with those of our stockholders. In that regard, our advisor could be motivated to recommend riskier or more speculative investments in order for us to generate the specified levels of performance that would entitle our advisor or the special limited partner to incentive compensation. In addition, our advisor’s entitlement to fees upon the sale, other disposition or refinancing of our assets could result in our advisor recommending sales of our investments at the earliest possible time at which sales of investments would produce the level of return that would entitle our advisor to compensation relating to such sales, even if continued ownership of those investments might be in our best long-term interest. The limited partnership agreement of our operating partnership requires us to pay a performance-based liquidation distribution to the special limited partner if we liquidate, list or terminate our advisor. To avoid paying this distribution, our independent directors may decide against the liquidation, listing or termination of our advisor even if, but for the liquidation distribution, such event would be in our best interest. Additionally, under the limited partnership agreement of our operating partnership, upon termination or non-renewal of the advisory agreement, even for poor performance by our advisor, the special limited partner will be entitled to (a) receive cash in an amount equal to its net investment, or (b) retain the subordinated participation interests, which also may influence our independent directors to decide against terminating our advisor. In addition, our advisor will be entitled to an annual subordinated performance fee for any year in which holders of our Common Shares receive payment of a 6.0% annual cumulative, pre-tax, non-compounded return on their respective net investments. Our advisor will be entitled to 15.0% of the amount in excess of such 6.0% per annum return; provided, that the amount paid to our advisor will not exceed 10.0% of the aggregate return for such year; and provided, further, that the amount paid to our advisor will not be paid unless holders of our Common Shares receive a return of their respective net investments. The potential to earn an annual subordinated performance fee may encourage our advisor to acquire riskier assets or to dispose of investments earlier than they should be disposed of.
Our advisor will receive an annual subordinated performance fee for years in which a specified return to holders of our Common Shares is achieved. However, if the return is not achieved in subsequent years, and even if our company suffers a loss, our advisor will not be obligated to return to our company any portion of the annual subordinated performance fee it has received.
We will pay our advisor an annual subordinated performance fee calculated on the basis of our annual return to stockholders, payable annually in arrears, such that for any year in which holders of our Common Shares receive payment of a 6.0% annual cumulative, pre-tax, non-compounded return on their respective net investments, our advisor will be entitled to 15.0% of the amount in excess of such 6.0% per annum return; provided, that the amount paid to our advisor will not exceed 10.0% of the aggregate return for such year; and provided, further, that the amount paid to our advisor will not be paid unless holders of our Common Shares receive a return of their respective net investments. This fee will be payable only out of realized appreciation in our assets upon their sale, other disposition or refinancing.
However, if such 6.0% per annum return is not achieved in subsequent years, and even if our company suffers a loss, our advisor will not be obligated to return to our company any portion of the annual subordinated performance fee it has received. We cannot assure you that we will provide such 6.0% per annum return, which we have disclosed solely as a measure for our advisor’s incentive compensation.
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Our sponsor’s other public programs, Lightstone I, Lightstone Value Plus Real Estate Investment Trust II, Inc. (“Lightstone II”), Lightstone Real Estate Income Trust Inc. (“Lightstone IV”) and Hamilton National Income Trust, Inc. (“HNIT”and collectively, “Sponsor’s Other Public Programs”), may be engaged in competitive activities, including the ownership of hotels in our target markets. Additionally, on February 10, 2017, an affiliate of our sponsor became the advisor of Behringer Harvard Opportunity REIT I, Inc. and Behringer Harvard Opportunity REIT II, Inc. which may also be engaged in competitive activities, including the ownership of hotels in our target markets.
Our advisor and its affiliates that serve as property managers and their respective affiliates, through activities of our Sponsor’s Other Public Programs, may be engaged in other activities that could result in potential conflicts of interest with the services that they will provide to us. Our Sponsor’s Other Public Programs may compete with us for both the acquisition and refinancing of hotels and other properties of a type suitable for our investment. In addition, we may compete with our Sponsor’s Other Public Programs for franchise or license arrangements with hotel brands in some of or all our target hotel markets.
Our advisor will face conflicts of interest relating to joint ventures, tenant-in-common investments or other co-ownership arrangements that we may enter into with affiliates of our sponsor or advisor or with other programs sponsored by our sponsor or advisor, which could result in a disproportionate benefit to affiliates of our sponsor or advisor or to another program.
We may enter into joint ventures, tenant-in-common investments or other co-ownership arrangements with other programs also sponsored by The Lightstone Group, LLC (“Lightstone”) for the acquisition, development or improvement of properties as well as the acquisition of real estate-related investments. The executive officers of our advisor are also the executive officers of other real estate investment vehicles, and may in the future sponsor or be the executive officers of other REITs and their advisors, the general partners of other Lightstone-sponsored partnerships or the advisors or fiduciaries of other Lightstone-sponsored programs. These executive officers will face conflicts of interest in determining which Lightstone-sponsored program should enter into any particular joint venture, tenant-in-common or co-ownership arrangement. These persons also may have a conflict in structuring the terms of the relationship between our interests and the interests of the Lightstone-sponsored co-venturer, co-tenant or partner as well as conflicts of interest in managing the joint venture. Further, the fiduciary obligations that our advisor or our board of directors may owe to a co-venturer, co-tenant or partner affiliated with our sponsor or advisor may make it more difficult for us to enforce our rights.
If we enter into a joint venture, tenant-in-common investment or other co-ownership arrangements with another program (whether sponsored by our advisor or by our sponsor or its affiliates) or joint venture, our advisor and its affiliates may have a conflict of interest when determining when and whether to buy or sell a particular real estate property, exercise buy/sell rights or make other major decisions, and you may face certain additional risks. For example, if we become listed for trading on a national securities exchange, and any of the other programs sponsored by our advisor or our sponsor or its affiliates are not traded on any exchange, we may develop more divergent goals and objectives from such joint venturer with respect to the sale of properties in the future. In addition, if we enter into a joint venture with another program sponsored by our advisor or our sponsor or their respective affiliates that has a term shorter than ours, the joint venture may be required to sell its properties at the time of the other program’s liquidation. We may not desire to sell the properties at such time. Even if the terms of any joint venture agreement between us and another program sponsored by our advisor or our sponsor or their respective affiliates grant us a right of first refusal to buy such properties, we may not have sufficient funds to exercise our right of first refusal under these circumstances.
Because Lightstone and its affiliates control us and would control any other Lightstone-sponsored programs, agreements and transactions among the parties with respect to any joint venture, tenant-in-common investment or other co-ownership arrangement between or among such parties will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated co-venturers. Under these joint ventures, neither co-venturer may have the power to control the venture, and under certain circumstances, an impasse could be reached regarding matters pertaining to the co-ownership arrangement, which might have a negative influence on the joint venture and decrease potential returns to you. If a co-venturer has a right of first refusal to buy out the other co-venturer, it may be unable to finance such buyout at that time. If our interest is subject to a buy/sell right, we may not have sufficient cash, available borrowing capacity or other capital resources to allow us to elect to purchase an interest of a co-venturer subject to the buy/sell right, in which case we may be forced to sell our interest as the result of the exercise of such right when we would otherwise prefer to keep our interest. Furthermore, we may not be able to sell our interest in a joint venture if we desire to exit the venture for any reason or, if our interest is likewise subject to a right of first refusal of our co-venturer or partner, our ability to sell such interest may be adversely impacted by such right.
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If we use debt to finance the acquisition of investments, we may pay our advisor twice with respect to such debt, which would adversely affect our operating results and may encourage our advisor to maximize its use of debt financing for acquisitions of investments.
We will pay to our advisor or its affiliates 1.0% of the contract purchase price of each property acquired, which amount includes our pro rata share (direct or indirect) of debt attributable to such property, or 1.0% of the amount advanced for a loan or other investment, which amount includes our pro rata share (direct or indirect) of debt attributable to such investment, as applicable. Further, if our advisor provides services in connection with the financing of an asset, assumption of a loan in connection with the acquisition of an asset or origination or refinancing of any loan on an asset, we will pay our advisor or its assignees a financing coordination fee equal to 0.75% of the amount available or outstanding under such financing. There is nothing to prevent our advisor from receiving both acquisition fees and financing coordination fees with respect to the amount of acquisition financing with respect to a property that we acquire. Such double payment would adversely affect our operating results and may encourage our advisor to maximize its use of debt financing for acquisitions of investments.
Our advisor’s executive officers and key personnel and the executive officers and key personnel of Lightstone-affiliated entities that conduct our day-to-day operations and our offering will face competing demands on their time, and this may cause our investment returns to suffer.
We rely upon the executive officers of our advisor and the executive officers and employees of Lightstone-affiliated entities to conduct our day-to-day operations and our offering. These persons also conduct the day-to-day operations of other investment programs and may in the future also conduct the day-to-day operations of other programs we sponsor and may have other business interests as well. Because these persons have competing interests on their time and resources, they may have conflicts of interest in allocating their time between our business and these other activities. During times of intense activity in other programs and ventures, they may devote less time and fewer resources to our business than is necessary or appropriate. If this occurs, the returns on our investments may suffer.
Our officers face conflicts of interest related to the positions they hold with entities affiliated with our advisor, which could diminish the value of the services they provide to us.
Certain of our executive officers are also officers of our advisor, our advisor’s affiliates that may serve as our property managers and other entities affiliated with our advisor, which may include the advisors and fiduciaries to other Lightstone-sponsored programs. As a result, these individuals owe fiduciary duties to these other entities and their investors, which may conflict with the fiduciary duties that they owe to us and our stockholders. Their loyalties to these other entities and investors could result in action or inaction that is detrimental to our business, which could harm the implementation of our business strategy and our investment and leasing opportunities. Conflicts with our business and interests are most likely to arise from involvement in activities related to (a) allocation of new investments and management time and services between us and the other entities, (b) the timing and terms of the investment in or sale of an asset, (c) development of our properties by affiliates of our advisor, (d) investments with affiliates of our advisor, (e) compensation to our advisor and its affiliates, and (f) our relationships with our property managers. If we do not successfully implement our business strategy, we may be unable to generate the cash needed to make distributions to you and to maintain or increase the value of our assets.
Because we rely on affiliates of Lightstone for the provision of advisory and property management services, if Lightstone or its majority owner are unable to meet their obligations, we may be required to find alternative providers of these services, which could result in a significant and costly disruption of our business.
David Lichtenstein, the majority owner of Lightstone, directly or indirectly owns and controls our advisor and its affiliates that may serve as our property managers. The operations of our advisor and its affiliates that serve as our property managers rely substantially on Mr. Lichtenstein and on Lightstone. Lightstone and its majority owner are dependent on fee income from their other sponsored real estate programs. Real estate market disruptions could adversely affect the amount of such fee income. If Lightstone or its majority owner become unable to meet their obligations as they become due, we might be required to find alternative service providers, which could result in a significant disruption of our business and would likely adversely affect the value of your investment in us.
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Because title insurance services may be provided by a related party, our advisor may face a conflict of interest when considering the terms of title insurance policies that it may purchase.
From time to time, we may purchase title insurance from an agent in which our sponsor owns a fifty percent limited partnership interest. Because this title insurance agent will receive significant fees for providing title insurance, our advisor may face a conflict of interest when considering the terms of title insurance policies that it may purchase.
Members of our board of directors are also on the board of directors of our Sponsor’s Other Public Programs.
Certain of our directors are also directors of our Sponsor’s Other Public Programs. Accordingly, each of our directors owes fiduciary duties to our Sponsor’s Other Public Programs and their respective stockholders. The duties of our directors to our Sponsor’s Other Public Programs may influence the judgment of our board of directors when considering issues that may affect us. For example, we are permitted to enter into a joint venture or preferred equity investment with our Sponsor’s Other Public Programs for the acquisition of property or real estate-related investments. Decisions of our board of directors regarding the terms of those transactions may be influenced by our directors’ duties to our Sponsor’s Other Public Programs and their respective stockholders.
Risks Related to Our Business in General
A limit on the number of shares a person may own may discourage a takeover of our company.
Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Our charter prohibits the ownership of more than 9.8% in value of the aggregate of our outstanding shares of stock or more than 9.8% (in value or number of shares, whichever is more restrictive) of our outstanding Common Shares, unless exempted by our board of directors (prospectively or retroactively), which may inhibit large investors from purchasing your Common Shares. This restriction may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might otherwise provide stockholders with the opportunity to receive a control premium for their Common Shares.
Our charter permits our board of directors to issue stock with terms that may subordinate the rights of the holders of our Common Shares or discourage a third party from acquiring us.
Our charter permits our board of directors to issue up to 200.0 million Common Shares and up to 50.0 million shares of preferred stock, $0.01 par value per share. Our board of directors, without any action by our stockholders, may (a) amend our charter from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series we have authority to issue or (b) classify or reclassify any unissued Common Shares or shares of preferred stock into other classes or series of stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications, and terms and conditions of the repurchase of any such stock. Thus, our board of directors could authorize the issuance of such stock with terms and conditions that could subordinate the rights of the holders of our Common Shares, or have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our Common Shares.
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Maryland law prohibits certain business combinations, which may make it more difficult for us to be acquired.
Under Maryland law, ‘‘business combinations’’ between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer, an issuance or reclassification of equity securities, liquidations or dissolutions in which an interested stockholder will receive something other than cash and any loans, advances, pledges, guarantees or similar arrangements in which an interested stockholder receives a benefit. An interested stockholder is defined as:
| • | any person who beneficially owns, directly or indirectly, 10% or more of the voting power of the then outstanding voting stock of the corporation; or |
| • | an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner, directly or indirectly, of 10% or more of the voting power of the then outstanding stock of the corporation. |
A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which he otherwise would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board.
After the expiration of the five-year period described above, any business combination between a Maryland corporation and an interested stockholder must generally be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:
| • | 80% of the votes entitled to be cast by holders of the then outstanding shares of voting stock of the corporation voting together as a single group; and |
| • | two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder voting together as a single group. |
These supermajority vote requirements do not apply if the corporation’s holders of voting stock receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. Maryland law also permits various exemptions from these provisions, including business combinations that are exempted by the board of directors before the time that the interested stockholder becomes an interested stockholder. The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.
Maryland law also limits the ability of a third party to buy a large stake in us and exercise voting power in electing directors.
Maryland law provides that ‘‘control shares’’ of a Maryland corporation acquired in a ‘‘control share acquisition’’ have no voting rights except to the extent approved by the affirmative vote of stockholders entitled to cast two-thirds of the votes entitled to be cast on the matter. Shares of stock owned by interested stockholders, that is, by the acquirer, by officers or by employees who are directors of the corporation, are excluded from the vote on whether to accord voting rights to the control shares. ‘‘Control shares’’ are voting shares of stock that would entitle the acquirer to exercise voting power in electing directors within specified ranges of voting power. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval or shares acquired directly from the corporation. A ‘‘control share acquisition’’ means the acquisition of issued and outstanding control shares. The control share acquisition statute does not apply (a) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (b) to acquisitions approved or exempted by a corporation’s charter or bylaws. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. We can offer no assurance that this provision will not be amended or eliminated at any time in the future. This statute could have the effect of discouraging offers from third parties to acquire us and increasing the difficulty of successfully completing this type of offer by anyone other than our affiliates or any of their affiliates.
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Our charter includes a provision that may discourage a stockholder from launching a tender offer for our Common Shares.
Our charter provides that any tender offer made by a stockholder, including any ‘‘mini-tender’’ offer, must comply with most provisions of Regulation 14D of the Exchange Act. The offering stockholder must provide our company notice of such tender offer at least ten business days before initiating the tender offer. A stockholder may not transfer any shares to an offering stockholder who does not comply with these requirements unless such stockholder first offers such shares to us at a price equal to the greater of the tender offer price offered in such tender offer or the repurchase price under our share repurchase program as it is in effect at such time. In addition, the non-complying stockholder shall be responsible for all our company’s expenses in connection with that stockholder’s noncompliance. This provision of our charter may discourage a stockholder from initiating a tender offer for our Common Shares and prevent you from receiving a premium price for your Common Shares in such a transaction.
Your investment return may be reduced if we are required to register as an investment company under the Investment Company Act.
The company is not registered, and does not intend to register itself or any of its subsidiaries, as an investment company under the Investment Company Act. If we become obligated to register the company or any of its subsidiaries as an investment company, the registered entity would have to comply with a variety of substantive requirements under the Investment Company Act imposing, among other things:
| • | limitations on capital structure; |
| • | restrictions on specified investments; |
| • | prohibitions on transactions with affiliates; and |
| • | compliance with reporting, recordkeeping, voting, proxy disclosure and other rules and regulations that would significantly change our operations. |
The company intends to conduct its operations, directly and through wholly owned or majority-owned subsidiaries, so that the company and each of its subsidiaries is not an investment company under the Investment Company Act. Under Section 3(a)(1)(A) of the Investment Company Act, a company is deemed to be an ‘‘investment company’’ if it is, or holds itself out as being, engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities. Under Section 3(a)(1)(C) of the Investment Company Act, a company is deemed to be an ‘‘investment company’’ if it is engaged, or proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and owns or propose to acquire ‘‘investment securities’’ having a value exceeding 40% of the value of its total assets (exclusive of government securities and cash items) on an unconsolidated basis. Rule 3a-1 under the Investment Company Act, however, generally provides that, notwithstanding Section 3(a)(1)(C) of the Investment Company Act, an issuer will not be deemed to be an ‘‘investment company’’ under the Investment Company Act; provided, that (a) it does not hold itself out as being engaged primarily, or propose to engage primarily, in the business of investing, reinvesting or trading in securities, and (b) on an unconsolidated basis no more than 45% of the value of its total assets, consolidated with the assets of any wholly owned subsidiary (exclusive of U.S. government securities and cash items), consists of, and no more than 45% of its net income after taxes, consolidated with the net income of any wholly owned subsidiary (for the last four fiscal quarters combined), is derived from, securities other than U.S. government securities, securities issued by employees’ securities companies, securities issued by certain majority-owned subsidiaries of such company and securities issued by certain companies that are controlled primarily by such company. We believe that we, our operating partnership and the subsidiaries of our operating partnership will satisfy this exclusion.
A change in the value of any of our assets could cause us or one or more of our wholly or majority-owned subsidiaries to fall within the definition of ‘‘investment company’’ and negatively affect our ability to maintain our exemption from regulation under the Investment Company Act. To avoid being required to register the company or any of its subsidiaries as an investment company under the Investment Company Act, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income- or loss-generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire interests in companies that we would otherwise want to acquire and would be important to our investment strategy. Our advisor will continually review our investment activity to attempt to ensure that we will not be regulated as an investment company.
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If we were required to register the company as an investment company but failed to do so, we would be prohibited from engaging in our business, and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business.
Rapid changes in the values of potential investments in real estate-related investments may make it more difficult for us to maintain our qualification as a REIT or our exception from the Investment Company Act.
If the market value or income potential of our real estate-related investments declines, including as a result of increased interest rates, prepayment rates or other factors, we may need to increase our real estate investments and income or liquidate our non-qualifying assets in order to maintain our REIT qualification or our exception from registration under the Investment Company Act. If the decline in real estate asset values or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of any non-real estate assets that we may own. We may have to make investment decisions that we otherwise would not make absent REIT and Investment Company Act considerations.
Stockholders have limited control over changes in our policies and operations.
Our board of directors determines our major policies, including our policies regarding financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of the stockholders. Under our charter and the Maryland General Corporation Law, our stockholders generally have a right to vote only on the following matters:
| • | the election or removal of directors; |
| • | any amendment of our charter, except that our board of directors may amend our charter without stockholder approval to: |
| • | change our name; |
| • | increase or decrease the aggregate number of shares that we have the authority to issue; |
| • | increase or decrease the number of our shares of any class or series that we have the authority to issue; and |
| • | effect reverse stock splits; |
| • | our liquidation and dissolution; and |
| • | our being a party to any merger, consolidation, sale or other disposition of all or substantially all of our assets or statutory share exchange. |
All other matters are subject to the discretion of our board of directors.
Our board of directors may change our investment policies and objectives generally and at the individual investment level without stockholder approval, which could alter the nature of your investment.
Our charter requires that our independent directors review our investment policies at least annually to determine that the policies we are following are in the best interests of the stockholders. In addition to our investment policies and objectives, we also may change our stated strategy for any investment in an individual property. These policies may change over time. The methods of implementing our investment policies also may vary, as new investment techniques are developed. Our investment policies, the methods for their implementation, and our other objectives, policies and procedures may be altered by our board of directors without the approval of our stockholders. As a result, the nature of your investment could change without your consent.
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We may not successfully implement our exit strategy, in which case you may have to hold your investment for an indefinite period.
Depending upon then-prevailing market conditions, it is our intention to consider beginning the process of liquidating our assets and distributing the net proceeds to our stockholders within six to nine years after the termination of our initial public offering. If we do not begin the process of achieving a liquidity event by the eighth anniversary of the termination of our offering, our charter requires either (a) an amendment to our charter to extend the deadline to begin the process of achieving a liquidity event, or (b) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio.
Market conditions and other factors could cause us to delay the commencement of our liquidation or to delay the listing of our Common Shares on a national securities exchange beyond eight years from the termination of our initial public offering. If so, our board of directors and our independent directors may conclude that it is not in our best interest to hold a stockholders meeting for the purpose of voting on a proposal for our orderly liquidation. Therefore, if we are not successful in implementing our exit strategy, your Common Shares will continue to be illiquid and you may, for an indefinite period of time, be unable to convert your investment into cash easily with minimum loss.
Your interest will be diluted if we issue additional securities.
Stockholders do not have preemptive rights to any shares issued by us in the future. Our charter currently authorizes us to issue 250.0 million shares of capital stock, of which 200.0 million shares are classified as Common Shares and 50.0 million shares are classified as preferred stock. Our board of directors may amend our charter from time to time to increase or decrease the number of authorized shares of capital stock, or the number of authorized shares of any class or series of stock designated, and may classify or reclassify any unissued shares into one or more classes or series without the necessity of obtaining stockholder approval. Shares will be issued at the discretion of our board of directors. Stockholders will likely experience dilution of their equity investment in us if we: (a) sell Common Shares in the Offering or sell additional Common Shares in the future, including those issued pursuant to our DRIP; (b) sell securities that are convertible into Common Shares; or (c) issue Common Shares to sellers of properties acquired by us in connection with an exchange of limited partnership interests of our operating partnership. In addition, the operating partnership agreement for our operating partnership contains provisions that allow, under certain circumstances, other entities, including other Lightstone-sponsored programs, to merge into or cause the exchange or conversion of their interest for interests of our operating partnership. Because the limited partnership interests in our operating partnership may be exchanged for Common Shares, any merger, exchange or conversion of our operating partnership and another entity ultimately could result in the issuance of a substantial number of Common Shares, thereby diluting the percentage ownership interest of other stockholders.
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We are an ‘‘emerging growth company’’ under the federal securities laws and will be subject to reduced public company reporting requirements.
In April 2012, President Obama signed into law the Jumpstart Our Business Startups Act, or the JOBS Act. We are an ‘‘emerging growth company,’’ as defined in the JOBS Act, and are eligible to take advantage of certain exemptions from, or reduced disclosure obligations relating to, various reporting requirements that are normally applicable to public companies.
We could remain an ‘‘emerging growth company’’ for up to five years, or until the earliest to occur of (1) the last day of the first fiscal year in which we have total annual gross revenue of $1 billion or more, (2) December 31 of the fiscal year that we become a ‘‘large accelerated filer’’ as defined in Rule 12b-2 under the Exchange Act (which would occur if the market value of our Common Shares held by non-affiliates exceeds $700 million, measured as of the last business day of our most recently completed second fiscal quarter, and we have been publicly reporting for at least 12 months) and (3) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period. Under the JOBS Act, emerging growth companies are not required to (1) provide an auditor’s attestation report on management’s assessment of the effectiveness of internal control over financial reporting, pursuant to Section 404 of the Sarbanes-Oxley Act, (2) comply with new audit rules adopted by the Public Company Accounting Oversight Board after April 5, 2012 ( unless the SEC determines otherwise), (3) provide certain disclosures relating to executive compensation generally required for larger public companies or (4) hold shareholder advisory votes on executive compensation. We have not yet made a decision as to whether to take advantage of some of the JOBS Act exemptions that are applicable to us. If we do avail ourselves of any of such exemptions, we do not know if some investors will find our common stock less attractive as a result.
Additionally, the JOBS Act provides that an ‘‘emerging growth company’’ may take advantage of an extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies. This means an ‘‘emerging growth company’’ can delay adopting certain accounting standards until such standards are otherwise applicable to private companies. However, we are electing to ‘‘opt out’’ of such extended transition period, and will therefore comply with new or revised accounting standards on the applicable dates on which the adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of such extended transition period for compliance with new or revised accounting standards is irrevocable.
We disclose funds from operations, or FFO, and modified funds from operations, or MFFO, which are non-GAAP financial measures, in communications with investors, including documents filed with the SEC; however, FFO and MFFO are not equivalent to our net income or loss as determined under GAAP, and you should consider GAAP measures to be more relevant to our
operating performance.
We use internally and disclose to investors FFO and MFFO, which are non-GAAP financial measures, as additional measures of our operating performance. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) a trade group. We compute MFFO in accordance with the definition established by the Investment Program Association, another trade group. However, our computation of FFO and MFFO may not be comparable to that of other REITs that do not calculate FFO or MFFO using these definitions without further adjustments.
Neither FFO nor MFFO is equivalent to net income or cash generated from operating activities determined in accordance with GAAP and should not be considered as an alternative to net income, as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.
Payment of fees to our advisor and its affiliates reduces cash available for investment and payment of distributions.
Our advisor and its affiliates perform services for us in connection with, among other things, the selection, financing and acquisition of our investments, the construction, development, management and leasing of our properties, the servicing of our mortgage, bridge, mezzanine or other loans, the administration of our other investments and the disposition of our assets. They will be paid substantial fees for these services. These fees will reduce the amount of cash available for investment or distributions to stockholders.
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Distributions may be paid from capital and there can be no assurance that we will be able to achieve expected cash flows necessary to continue to pay initially established distributions or maintain distributions at any particular level, or that distributions will increase over time.
There are many factors that can affect the availability and timing of cash distributions to stockholders. Distributions generally will be based upon such factors as the amount of cash available or anticipated to be available from real estate investments and real estate-related securities, mortgage, bridge or mezzanine loans and other investments, current and projected cash requirements and tax considerations. Because we may receive income from interest or rents at various times during our fiscal year, distributions paid may not reflect our income earned in that particular distribution period. The amount of cash available for distributions will be affected by many factors, such as our ability to make acquisitions as offering proceeds become available, the income from those investments and yields on securities of other real estate programs that we invest in, and our operating expense levels, as well as many other variables. Actual cash available for distributions may vary substantially from estimates. We can give no assurance that we will be able to achieve our anticipated cash flow or that distributions will increase over time. Nor can we give any assurance that rents from the properties will increase, that the securities we buy will increase in value or provide constant or increased distributions over time, that loans we make will be repaid or paid on time, that loans will generate the interest payments that we expect, or that future acquisitions of real properties, mortgage, bridge or mezzanine loans, other investments or our investments in securities will increase our cash available for distributions to stockholders. Our actual results may differ significantly from the assumptions used by our board of directors in establishing the distribution rates to stockholders.
Many of the factors that can affect the availability and timing of cash distributions to stockholders are beyond our control, and a change in any one factor could adversely affect our ability to pay future distributions. For instance:
| • | If one or more tenants defaults or terminates its lease, there could be a decrease or cessation of rental payments, which would mean less cash available for distributions. |
| • | Any failure by a borrower under our mortgage, bridge or mezzanine loans to repay the loans or interest on the loans will reduce our income and distributions to stockholders. |
| • | Cash available for distributions may be reduced if we are required to spend money to correct defects or to make improvements to properties. |
| • | Cash available to make distributions may decrease if the assets we acquire have lower yields than expected. |
| • | There may be a delay between the sale of the Common Shares and our purchase of real properties. During that time, we may invest in lower-yielding short-term instruments, which could result in a lower yield on your investment. |
| • | If we lend money to others, such funds may not be repaid in accordance with the loan terms or at all, which could reduce cash available for distributions. |
| • | U.S. federal income tax law requires that a REIT distribute annually to its stockholders at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to dividends paid and excluding net capital gain, to maintain REIT status, and 100% of REIT taxable income and net capital gain to avoid U.S. federal income tax. This limits the earnings that we may retain for corporate growth, such as property acquisition, development or expansion and makes us more dependent upon additional debt or equity financing than corporations that are not REITs. If we borrow funds in the future, more of our operating cash will be needed to make debt payments and cash available for distributions may therefore decrease. |
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| • | In connection with future property acquisitions, we may issue additional Common Shares, interests in our operating partnership or interests in other entities that own our properties. We cannot predict the number of Common Shares, units or interests that we may issue, or the effect that these additional Common Shares might have on cash available for distributions to you. If we issue additional Common Shares, they could reduce the cash available for distributions to you. |
| • | In connection with future property acquisitions which are under development, construction or repositioning, we may experience budget overruns; delays in completion; failure of a contractor or sub-contractor, construction risks including damage, vandalism or accidents; a change in market conditions before such project is ready to be placed in use; the placement of liens on our properties as a result of construction disputes, and numerous additional development, construction and repositioning risks, any of which could require expenditure of more cash than anticipated, increase our borrowings and costs of such borrowings, delay the commencement of cash flow or reduce cash available for distribution. |
| • | We make distributions to our stockholders to comply with the distribution requirements of the Code and to eliminate, or at least minimize, exposure to federal income taxes and the nondeductible REIT excise tax. Differences in timing between the receipt of income and the payment of expenses, and the effect of required debt payments, could require us to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. |
In addition, our board of directors, in its discretion, may retain any portion of our cash on hand for working capital. We cannot assure you that sufficient cash will be available to make distributions to you.
Development projects in which we invest may not be completed successfully or on time, and guarantors of the projects may not have the financial resources to perform their obligations under the guaranties
they provide.
We may make equity investments in, acquire options to purchase interests in or make mezzanine loans to the owners of real estate development projects. Our return on these investments is dependent upon the projects being completed successfully, on budget and on time. To help ensure performance by the developers of properties that are under construction, completion of these properties is generally guaranteed either by a completion bond or performance bond. Our advisor may rely upon the substantial net worth of the contractor or developer or a personal guarantee accompanied by financial statements showing a substantial net worth provided by an affiliate of the entity entering into the construction or development contract as an alternative to a completion bond or performance bond. For a particular investment, we may obtain guaranties that the project will be completed on time, on budget and in accordance with the plans and specifications and that the mezzanine loan will be repaid. However, we may not obtain such guaranties and cannot ensure that the guarantors will have the financial resources to perform their obligations under the guaranties they provide. If we are unable to manage these risks effectively, our results of operations, financial condition and ability to make distributions to you will be adversely affected.
We are uncertain of our sources for funding of future capital needs, which could adversely affect the value of our investments.
Substantially all the gross proceeds of our offering will be used to make investments in real estate and real estate-related assets and to pay various fees and expenses related to our offering. We will establish capital reserves on a property-by-property basis, as we deem appropriate. In addition to any reserves we establish, a lender may require escrow of capital reserves in excess of our established reserves. If these reserves are insufficient to meet our cash needs, we may have to obtain financing from either affiliated or unaffiliated sources to fund our cash requirements. Accordingly, if we develop a need for additional capital in the future for the improvement of our properties or for any other reason, we have not identified any sources for such funding, and we cannot assure you that such sources of funding will be available to us for potential capital needs in the future.
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We may suffer adverse consequences due to the financial difficulties, bankruptcy or insolvency of our tenants.
The current economic conditions may cause the tenants in any properties we own to experience financial difficulties, including bankruptcy, insolvency or a general downturn in their business. We cannot assure you that any tenant that files for bankruptcy protection will continue to pay us rent. A bankruptcy filing by, or relating to, one of our tenants or a lease guarantor would bar efforts by us to collect pre-bankruptcy debts from that tenant or lease guarantor, or its property, unless we receive an order permitting us to do so from the bankruptcy court. In addition, we cannot evict a tenant solely because of bankruptcy. The bankruptcy of a tenant or lease guarantor could delay our efforts to collect past due balances under the relevant leases, and could ultimately preclude collection of these sums. If a lease is assumed by the tenant in bankruptcy, all pre-bankruptcy balances due under the lease must be paid to us in full. If, however, a lease is rejected by a tenant in bankruptcy, we would have only a general, unsecured claim for damages. An unsecured claim would only be paid to the extent that funds are available and only in the same percentage as is paid to all other holders of general, unsecured claims. Restrictions under the bankruptcy laws further limit the amount of any other claims that we can make if a lease is rejected. As a result, it is likely that we would recover substantially less than the full value of the remaining rent during the term.
The failure of any bank in which we deposit our funds could reduce the amount of cash we have available to pay distributions and make additional investments.
The Federal Deposit Insurance Corporation, or FDIC, only insures limited amounts per depositor per insured bank. In the future, we may deposit cash, cash equivalents and restricted cash in certain financial institutions in excess of federally insured levels. If any of the banking institutions in which we have deposited funds ultimately fails, we may lose our deposits over the federally insured levels. The loss of our deposits could reduce the amount of cash we have available to distribute or invest and could result in a decline in the value of your investment.
Market disruptions could adversely impact aspects of our operating results and operating condition.
Market disruptions, including recessions, reduced consumer spending, sovereign downgrades and lack of credit, could reduce demand for hotel space and remove support for rents and property values. The value of our properties may decline if any such market conditions were to emerge.
Our business could be affected by future market and economic challenges experienced by the U.S. economy. These conditions could materially affect the value and performance of our properties, and could affect our ability to pay distributions, the availability or the terms of financing that we have or may anticipate utilizing, and our ability to make principal and interest payments on, or refinance, any outstanding debt when due. Any such challenging economic conditions also could impact the ability of certain of our tenants to enter into new leasing transactions or satisfy rental payments under existing leases. Specifically, market disruptions could have any of the following adverse consequences:
| • | the financial condition of tenants occupying the properties we acquire could be adversely affected, which could result in us having to increase concessions, reduce rental rates or make capital improvements beyond those contemplated at the time we acquired the properties in order to maintain occupancy levels or to negotiate for reduced space needs, which could result in a decrease in our occupancy levels; |
| • | significant job losses could occur, which could decrease demand for office space, multifamily communities and hospitality properties and result in lower occupancy levels, which could result in decreased revenues for properties that we acquire, which could diminish the value of such properties that depend, in part, upon the cash flow generated by such properties; |
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| • | there could be an increase in the number of bankruptcies or insolvency proceedings of tenants and lease guarantors, which could delay our efforts to collect rent and any past due balances under the relevant leases and ultimately could preclude collection of these sums; |
| • | credit spreads for major sources of capital could widen if investors demanded higher risk premiums, resulting in lenders increasing the cost for debt financing; |
| • | our ability to borrow on terms and conditions that we found acceptable, or at all, could be limited, which could result in our investment operations generating lower overall economic returns and a reduced level of cash flow, which could potentially impact our ability to make distributions to our stockholders, reduce our ability to pursue acquisition opportunities if any, and increase our interest expense; |
| • | there could be a reduction in the amount of capital available to finance real estate, which, in turn, could lead to a decline in real estate values generally, slow real estate transaction activity, reduce the loan-to-value ratio upon which lenders are willing to lend, and make sourcing or refinancing our debt more difficult; |
| • | the value of certain properties we may acquire could decrease below the amounts we paid for them, which could limit our ability to dispose of assets at attractive prices or to obtain debt financing secured by our properties and could reduce the availability of unsecured loans; |
| • | to the extent that we may use or purchase derivative financial instruments, one or more counterparties to such derivative financial instruments could default on their obligations to us, or could fail, increasing the risk that we may not realize the benefits of those instruments; and |
| • | the value and liquidity of our short-term investments could be reduced as a result of dislocations in the markets for our short-term investments and increased volatility in market rates for such investments or other factors. |
To hedge against exchange rate and interest rate fluctuations, we may use derivative financial instruments that may be costly and ineffective and may reduce the overall returns on your investment and affect cash available for distribution to our stockholders.
We may use derivative financial instruments to hedge exposures to changes in exchange rates and interest rates on loans secured by our assets and investments in real estate-related assets. Derivative instruments may include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions will be determined in light of the facts and circumstances existing at the time of the hedge and may differ from time to time. Our hedging may fail to protect or could adversely affect us because, among other things:
| • | interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates; |
| • | available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought; |
| • | the duration of the hedge may not match the duration of the related liability or asset; |
| • | the amount of income that a REIT may earn from hedging transactions to offset interest rate losses is limited by federal income tax provisions governing REITs; |
| • | the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; |
| • | the party owing money in the hedging transaction may default on its obligation to pay; and |
| • | we may purchase a hedge that turns out not to be necessary, i.e., a hedge that is out of the money. |
Any hedging activity we engage in may adversely affect our earnings, which could adversely affect cash available for distribution to our stockholders. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged or liabilities being hedged may vary materially. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended accounting treatment and may expose us to risk of loss.
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To the extent that we use derivative financial instruments to hedge against exchange rate and interest rate fluctuations, we will be exposed to credit risk, basis risk and legal enforceability risks. In this context, credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. Basis risk occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset or liability is based, thereby making the hedge less effective. Finally, legal enforceability risks encompass general contractual risks, including the risk that the counterparty will breach the terms of, or fail to perform its obligations under, the derivative contract. If we are unable to manage these risks effectively, our results of operations, financial condition and ability to make distributions to you will be adversely affected.
Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities and involve risks and costs.
The cost of using hedging instruments increases as the period covered by the instrument increases and during periods of rising and volatile interest rates. We may increase our hedging activity and thus increase our hedging costs during periods when interest rates are volatile or rising and hedging costs have increased. In addition, hedging instruments involve risk since they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities. Consequently, there are no requirements with respect to recordkeeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then-current market price. It may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot be certain that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.
There can be no assurance that the direct or indirect effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in July 2010 for the purpose of stabilizing or reforming the financial markets, will not have an adverse effect on our interest rate hedging activities.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) became law in the United States. Title VII of the Dodd-Frank Act contains a sweeping overhaul of the regulation of privately negotiated derivatives. The provisions of Title VII became effective on July 16, 2011 or, with respect to particular provisions, on such other date specified in the Dodd-Frank Act or by subsequent rulemaking. While the full impact of the Dodd-Frank Act on our interest rate hedging activities cannot be assessed until implementing rules and regulations are promulgated, the requirements of Title VII may affect our ability to enter into hedging or other risk management transactions, may increase our costs in entering into such transactions, and may result in us entering into such transactions on more unfavorable terms than prior to effectiveness of the Dodd-Frank Act. The occurrence of any of the foregoing events may have an adverse effect on our business.
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The provision of advisory services to us could require our advisor to register with the SEC as an investment adviser under the Investment Advisers Act of 1940, as amended, (the “Advisers Act”) which could impact the types of investments that it recommends to us and cause us not to invest in opportunities that meet our investment criteria. If our advisor were required to register, it also could hinder our operating performance and negatively impact our business and subject our advisor to additional regulatory burdens and costs to which it is not currently subject.
Our advisor is not currently required to register as an investment adviser under the Advisers Act. Furthermore, we believe that if our advisor advises us consistent with the strategy adopted by our board of directors, our advisor will not be required to register under the Advisers Act even as a result of changes to the Advisers Act implemented by the Dodd-Frank Act, which became effective in July 2011. As a result of the Dodd-Frank Act, many investment advisers that previously relied on the private adviser exemption under the Advisers Act, which was repealed by the Dodd-Frank Act, may need to register as an investment adviser with the SEC, or seek an exemption from registration. Given the changes instituted by the Dodd-Frank Act, an investment adviser may be required to register with the SEC as an investment adviser if it has regulatory assets under management in excess of relevant statutory thresholds (or meets other statutory requirements), even if it manages only a single client. Whether an adviser has sufficient regulatory assets under management to require registration depends on the nature of the assets it manages. In calculating regulatory assets under management, we must include the value of each ‘‘securities portfolio’’ we manage. If our investments were to constitute a ‘‘securities portfolio’’ under the Advisers Act, then our advisor would be required to register. Specifically, we believe that our assets will not constitute a securities portfolio so long as a majority of the assets consist of originated loans, real estate and cash and the assets do not currently constitute a securities portfolio. Since we do not believe our assets will constitute a securities portfolio, we do not believe we have any regulatory assets under management, and therefore our advisor does not need to register. Our advisor intends to manage our investments so that they will continue not to constitute a securities portfolio in the future. In so doing, it is possible that we could determine not to seek certain commercial real estate debt and securities available on the secondary market that we might otherwise consider. In such a scenario, we may not invest in opportunities that could improve our operating performance. If our board of directors determines to modify our strategy in such a way as to make it likely that our advisor would be required to register under the Advisers Act, our business may be negatively affected because our advisor may, among other things, have to devote significant additional management time, may incur significant additional costs and may experience a reduction in revenue associated with compliance with the requirements of the Advisers Act.
Hotel Risk Factors
We are and will continue to be dependent on the third-party managers of our lodging facilities.
In order to qualify as a REIT, we are unable to operate any hotel properties that we acquire or participate in the decisions affecting the daily operations of our hotels. We will lease any hotels we acquire to a taxable REIT subsidiary (“TRS”), in which we may own up to a 100% interest. Our TRS will enter into management agreements with eligible independent contractors that are not our subsidiaries or otherwise controlled by us to manage the hotels. Thus, independent hotel operators, under management agreements with our TRS, will control the daily operations of our hotels.
We will depend on these independent management companies to adequately operate our hotels as provided in the management agreements. We will not have the authority to require any hotel to be operated in a particular manner or to govern any particular aspect of the daily operations of any hotel (for instance, setting room rates). Thus, even if we believe our hotels are being operated inefficiently or in a manner that does not result in satisfactory occupancy rates, revenue per available room and average daily rates, we may not be able to force the management company to change its method of operation of our hotels. We can only seek redress if a management company violates the terms of the applicable management agreement with the TRS, and then only to the extent of the remedies provided for under the terms of the management agreement. If we need to replace any of our management companies, we may be required by the terms of the management agreement to pay substantial termination fees and may experience significant disruptions at the affected hotels.
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Our probable lack of diversification in property type increases the risk of investment.
One of our primary areas of investment will be hotels. There is no limit on the number of properties of a particular hotel brand which we may acquire. The board of directors will review our properties and investments in terms of geographic and hotel brand diversification. Our profitability and our ability to diversify our investments, both geographically and by type of properties purchased, will be limited by the amount of further funds at our disposal. If our assets become geographically concentrated, an economic downturn in one or more of the markets in which we have invested could have an adverse effect on our financial condition and our ability to make distributions. A downturn in the hotel industry could have a more pronounced effect on the amount of cash available to us for distribution and on the value of our assets than if we had diversified our investments.
Adverse trends in the hotel industry may impact our properties.
Our hotels will be subject to all the risks and trends common to the hotel industry. Adverse trends in the hotel industry could adversely affect hotel occupancy and the rates that can be charged for hotel rooms. The success of our properties will depend largely on the property operators’ ability to adapt to dominant trends in the hotel industry. These trends include greater competitive pressures, increased consolidation, a supply of hotel rooms that exceeds demand due to industry overbuilding, dependence on consumer spending patterns and changing demographics, the introduction of new concepts and products, availability of labor, price levels and general economic conditions. The success of a particular hotel brand, the ability of a hotel brand to fulfill any obligations to operators of its business, and trends in the hotel industry may affect our income and the funds we have available to distribute to our stockholders.
An economic downturn and concern about terrorist activities could adversely affect the travel and lodging industries and may affect hotel operations for the hotels we acquire.
Due to an economic downturn or an increase in energy costs and other travel-related expenses, the lodging industry could experience a significant decline in business due to a reduction in travel for both business and pleasure. Consistent with the rest of the lodging industry, the hotels we acquire may experience declines in occupancy and average daily rates due to a decline in travel. Any kind of terrorist activity within the United States, including terrorist acts against public institutions or buildings or modes of public transportation (including airlines, trains or buses) could lessen travel by the public, which could have a negative effect on any of our hotel operations. Any terrorist act directly against or affecting any of our properties would also negatively affect our operations. Our property insurance will typically cover losses for property damage to our properties if there are terrorist attacks against our properties. However, we will not be insured for losses arising from terrorist attacks against other properties or against modes of public transportation (such as airlines, trains or buses), even though such terrorist attacks may curtail travel generally and negatively affect our hotel operations.
Aggressive cost containment and a significant slowdown in the construction of new hotels could occur. In addition, continued U.S. military operations abroad or other significant military or possible terrorist activity could have additional adverse effects on the economy, including the travel and lodging industry. It is possible that these factors could have a material adverse effect on the value of the assets we acquire. Any hotels we acquire, and the business of the managers with which we contract, may be affected, including hotel occupancy and revenues, and, as a result, the revenues for the hotels we acquire may be at reduced levels to the extent that rents and other revenues received by us are calculated as a percentage of hotel revenues. Additionally, if the managers with which we contract default in their obligations to us, our revenues and cash flows may decline or be at reduced levels for extended periods. Operating with reduced revenues would have a negative impact on our cash available for distributions to stockholders.
The hotel industry is seasonal.
The hotel industry is seasonal in nature. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. As a result of the seasonality of the hotel industry, there may be quarterly fluctuations in results of operations of properties leased to subsidiaries. Quarterly financial results may be adversely affected by factors outside our control, including weather conditions and poor economic factors. As a result, we may need to enter into short-term borrowings in certain periods in order to offset these fluctuations in revenues and to make distributions to our stockholders.
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There may be operational limitations associated with management and franchise agreements affecting our properties and these limitations may prevent us from using these properties to their best advantage for our stockholders.
One or more TRSs will operate all our hotel properties pursuant to franchise or license agreements with nationally recognized hotel brands. These franchise agreements may contain specific standards for, and restrictions and limitations on, the operation and maintenance of our properties in order to maintain uniformity within the franchise system. We do not know whether those limitations may conflict with our ability to create specific business plans tailored to each property and to each market.
The standards are subject to change over time, in some cases at the direction of the franchisor, and may restrict our TRS’ ability, as franchisee, to make improvements or modifications to a property without the consent of the franchisor. In addition, compliance with the standards could require us or our applicable TRS, as franchisee, to incur significant expenses or capital expenditures. Action or inaction on our part or by our TRS could result in a breach of those standards or other terms and conditions of the franchise agreements and could result in the loss or cancellation of a franchise license.
In connection with terminating or changing the franchise affiliation of a property, we may be required to incur significant expenses or capital expenditures. Moreover, the loss of a franchise license could have a material adverse effect upon the operations or the underlying value of the property covered by the franchise because of the loss of associated name recognition, marketing support and centralized reservation systems provided by the franchisor.
We will face competition in the hotel industry, which may limit our profitability and return to our stockholders.
The hotel industry is highly competitive. This competition could reduce occupancy levels and rental revenues at our properties, which would adversely affect our operations. We expect to face competition from many sources. We will face competition from other hotels both in the immediate vicinity and the geographic market where our hotels will be located. Overbuilding in the hotel industry will increase the number of rooms available and may decrease occupancy and room rates. In addition, increases in operating costs due to inflation may not be offset by increased room rates. We will also face competition from nationally recognized hotel brands with which we will not be associated.
We will also face competition for investment opportunities. Competitors may include other REITs, national hotel chains and other entities that may have substantially greater financial resources than we do. We will also face competition for investors from other REITs and real estate entities.
We may have to make significant capital expenditures to maintain our lodging properties.
Hotels have an ongoing need for renovations and other capital improvements, including replacements of furniture, fixtures and equipment. Generally, we will be responsible for the costs of these capital improvements, which gives rise to the following risks:
| • | the risk of cost overruns and delays; |
| • | the risk that renovations will be disruptive to operations and displace revenue at the hotels, including revenue lost while rooms under renovation are out of service; |
| • | risks regarding the cost of funding renovations and the possibility that financing for these renovations may not be available on attractive terms; and |
| • | the risk that the return on our investment in these capital improvements will not be what we expect. If we have insufficient cash flow from operations to fund needed capital expenditures, then we will need to borrow to fund future capital improvements. |
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Adverse weather conditions may affect operations of certain of the properties we acquire or reduce our operators’ ability to make scheduled rent payments to us, which could reduce our cash flow from such investments.
Adverse weather conditions may influence revenues at certain types of properties we acquire, such as some hotels and resorts. These adverse weather conditions include heavy snowfall (or lack thereof), hurricanes, tropical storms, high winds, heat waves, frosts, drought (or merely reduced rainfall levels), excessive rain and floods. For example, adverse weather could reduce the number of people that visit properties we acquire. Certain properties may be susceptible to damage from weather conditions such as hurricanes, which damage (including but not limited to property damage and loss of revenue) is not generally insurable at commercially reasonable rates. Poor weather conditions also could disrupt operations at properties we acquire and may adversely affect both the value of our investment in a property and the ability of our tenants and operators to make their scheduled rent payments to us.
Security breaches through cyber-attacks, cyber-intrusions, or otherwise, could disrupt our IT networks and related systems.
Risks associated with security breaches, whether through cyber-attacks or cyber-intrusions over the Internet, malware, computer viruses, attachments to e-mails, or otherwise, against persons inside our organization, persons with access to systems inside our organization, the U.S. government, financial markets or institutions, or major businesses, including tenants, could disrupt or disable networks and related systems, other critical infrastructures, and the normal operation of business. The risk of a security breach or disruption, particularly through cyber-attack or cyber-intrusion, including by computer hackers, foreign governments, and cyber-terrorists, has generally increased as the number, intensity, and sophistication of attempted attacks and intrusions from around the world have increased. Even though we may not be specifically targeted, cyber-attacks on the U.S. government, financial markets, financial institutions, or other major businesses, including tenants, could disrupt our normal business operations and networks, which may in turn have a material adverse impact on our financial condition and results of operations.
Our information technology (“IT”) networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations and they are subject to cybersecurity risks and threats. They also may be critical to the operations of certain of our tenants. Further, our Advisor provides our IT services, and there can be no assurance that their security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. It has been reported that unknown entities or groups have mounted cyber-attacks on businesses and other organizations solely to disable or disrupt computer systems, disrupt operations and, in some cases, steal data. Even the most well protected information, networks, systems, and facilities remain potentially vulnerable because the techniques used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Due to the nature of cyber-attacks, breaches to our systems could go unnoticed for a prolonged period of time. These cybersecurity risks could disrupt our operations and result in downtime, loss of revenue, or the loss of critical data as well as result in higher costs to correct and remedy the effects of such incidents. If our systems for protecting against cyber incidents or attacks prove to be insufficient and an incident were to occur, it could have a material adverse effect on our business, financial condition, results of operations or cash flows. While, to date, we have not experienced a cyber-attack or cyber-intrusion, neither our Advisor nor we may be able to anticipate or implement adequate security barriers or other preventive measures. A security breach or other significant disruption involving our IT networks and related systems could:
| • | disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our tenants; |
| • | result in misstated financial reports, violations of loan covenants, missed reporting deadlines and/or missed permitting deadlines; |
| • | result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT; |
| • | result in the unauthorized access to, and destruction, loss, theft, misappropriation, or release of proprietary, confidential, sensitive, or otherwise valuable information of ours or others, which others could use to compete against us or for disruptive, destructive, or otherwise harmful purposes and outcomes; |
| • | result in our inability to maintain the building systems relied upon by our tenants for the efficient use of their leased space; |
| • | require significant management attention and resources to remedy any damages that result; |
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| • | subject us to claims for breach of contract, damages, credits, penalties, or termination of leases or other agreements; or |
| • | damage our reputation among our tenants and stockholders generally. |
Any or all of the foregoing could have a material adverse effect on our results of operations, financial condition, and cash flows.
General Risks Related to Investments in Real Estate
Part of our strategy for building our portfolio may involve acquiring assets opportunistically. This strategy will involve a higher risk of loss than more conservative investment strategies.
In order to meet our investment objectives we intend to embark on a strategy that may involve acquiring opportunistic assets which we can reposition, redevelop or remarket to create value enhancement and capital appreciation. Our strategy for acquiring properties may involve the acquisition of properties in markets that are depressed or overbuilt. As a result of our investment in these types of markets, we will face increased risks relating to changes in local market conditions and increased competition for similar properties in the same market, as well as increased risks that these markets will not recover and the value of our properties in these markets will not increase, or will decrease, over time. For these and other reasons, we cannot assure you that we will be profitable or that we will realize growth in the value of our real estate properties, and as a result, our ability to make distributions to our stockholders could be affected. Our intended approach to acquiring and operating income-producing properties involves more risk than comparable real estate programs that have a targeted holding period for investments that is longer than ours, utilize leverage to a lesser degree or employ more conservative investment strategies.
Our revenue and net income may vary significantly from one period to another due to investments in opportunity-oriented properties and portfolio acquisitions, which could increase the variability of our cash available for distributions.
Our opportunistic property-acquisition strategy may include investments in properties in various phases of development, redevelopment or repositioning and portfolio acquisitions, which may cause our revenues and net income to fluctuate significantly from one period to another. Projects do not produce revenue while in development or redevelopment. During any period when our projects in development or redevelopment or those with significant capital requirements increase without a corresponding increase in stable revenue-producing properties, our revenues and net income will likely decrease. Many factors may have a negative impact on the level of revenues or net income produced by our portfolio of properties and projects, including higher-than-expected construction costs, failure to complete projects on a timely basis, failure of the properties to perform at expected levels upon completion of development or redevelopment, and increased borrowings necessary to fund higher-than-expected construction or other costs related to the project. Further, our net income and stockholders’ equity could be negatively affected during periods with large portfolio acquisitions, which generally require large cash outlays and may require the incurrence of additional financing. Any such reduction in our revenues and net income during such periods could cause a resulting decrease in our cash available for distributions during the same periods.
Our operating results will be affected by economic and regulatory changes that have an adverse impact on the real estate market in general, and we cannot assure you that we will be profitable or that we will realize growth in the value of our real estate properties.
Our operating results will be subject to risks generally incident to the ownership of real estate, including:
| • | changes in general economic or local conditions; |
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| • | changes in supply of or demand for similar or competing properties in an area; |
| • | changes in interest rates and availability of permanent mortgage funds that may render the sale of a property difficult or unattractive; |
| • | the illiquidity of real estate investments generally; |
| • | changes in tax, real estate, environmental and zoning laws; and |
| • | periods of high interest rates and tight money supply. |
For these and other reasons, we cannot assure you that we will be profitable or that we will realize growth in the value of our real estate properties.
Properties that have significant vacancies could be difficult to sell, which could diminish the return on your investment.
A property may incur vacancies either by the continued default of tenants under their leases or the expiration of tenant leases. If vacancies continue for a long period of time, we may suffer reduced revenues resulting in decreased distributions to stockholders. In addition, the value of the property could be diminished because the market value of a particular property will depend principally upon the value of the leases of such property.
Our investments will be dependent on tenants for revenue, and lease expirations and terminations could reduce our ability to make distributions to stockholders.
The success of our real property investments will be materially dependent on the occupancy rates of our properties and the financial stability of our tenants. If we are unable to renew or extend expiring leases under similar terms or are unable to negotiate new leases, it would negatively impact our liquidity and consequently adversely affect our ability to fund our ongoing operations. In addition, lease payment defaults by tenants could cause us to reduce the amount of distributions to stockholders. A default by a significant tenant on its lease payments to us would cause us to lose the revenue associated with such lease and cause us to have to find an alternative source of revenue to meet mortgage payments and prevent a foreclosure if the property is subject to a mortgage. If there is a tenant default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-letting our property. If significant leases are terminated, we cannot assure you that we will be able to lease the property for the rent previously received or sell the property without incurring a loss. Additionally, loans that we make generally will relate to real estate. As a result, the borrower’s ability to repay the loan may be dependent on the financial stability of the tenants leasing the related real estate.
We may be unable to secure funds for future tenant improvements, which could adversely impact our ability to make cash distributions to our stockholders.
When tenants do not renew their leases or otherwise vacate their space, in order to attract replacement tenants, we will be required to expend substantial funds for tenant improvements and tenant refurbishments to the vacated space. If we have insufficient capital reserves, we will have to obtain financing from other sources. We intend to establish capital reserves on a property-by-property basis, as we deem necessary. In addition to any reserves we establish, a lender may require escrow of capital reserves in excess of our established reserves. If these reserves or any reserves otherwise established are designated for other uses or are insufficient to meet our cash needs, we may have to obtain financing from either affiliated or unaffiliated sources to fund our cash requirements. We cannot assure you that sufficient financing will be available or, if available, will be available on economically feasible terms or on terms acceptable to us. Moreover, certain reserves required by lenders may be designated for specific uses and may not be available for capital purposes such as future tenant improvements. Additional borrowings for capital purposes will increase our interest expense, and therefore our financial condition and our ability to make cash distributions to our stockholders may be adversely affected.
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We may be unable to sell a property if or when we decide to do so, which could adversely impact our ability to make cash distributions to our stockholders.
We intend to hold the various real properties in which we invest until such time as our advisor determines that a sale or other disposition appears to be advantageous to achieve our investment objectives or until it appears that such objectives will not be met. Otherwise, our advisor, subject to approval of our board of directors, may exercise its discretion as to whether and when to sell a property, and we will have no obligation to sell properties at any particular time, except upon our liquidation. If we do not begin the process of achieving a liquidity event by the eighth anniversary of the termination of our offering, our charter requires either (a) an amendment to our charter to extend the deadline to begin the process of achieving a liquidity event, or (b) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio. The real estate market is affected, as discussed above, by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. We cannot predict whether we will be able to sell any asset for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We cannot predict the length of time needed to find a willing purchaser and to close the sale of an asset. If we are unable to sell an asset when we determine to do so, it could have a significant adverse effect on our cash flow and results of operations.
Our co-venture partners, co-tenants or other partners in co-ownership arrangements could take actions that decrease the value of an investment to us and lower your overall return.
We may enter into joint ventures, tenant-in-common investments or other co-ownership arrangements with other Lightstone programs or third parties having investment objectives similar to ours for the acquisition, development or improvement of properties, as well as the acquisition of real estate-related investments. We also may purchase and develop properties in joint ventures or in partnerships, co-tenancies or other co-ownership arrangements with the sellers of the properties, affiliates of the sellers, developers or other persons. Such investments may involve risks not otherwise present with other forms of real estate investment, including, for example:
| • | the possibility that our co-venturer, co-tenant or partner in an investment might become bankrupt; |
| • | the possibility that the investment may require additional capital that we or our partner do not have, which lack of capital could affect the performance of the investment or dilute our interest if the partner were to contribute our share of the capital; |
| • | the possibility that a co-venturer, co-tenant or partner in an investment might breach a loan agreement or other agreement or otherwise, by action or inaction, act in a way detrimental to us or the investment; |
| • | that such co-venturer, co-tenant or partner may at any time have economic or business interests or goals that are or that become inconsistent with our business interests or goals; |
| • | the possibility that we may incur liabilities as the result of the action taken by our partner or co-investor; |
| • | that such co-venturer, co-tenant or partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives, including our policy with respect to qualifying and maintaining our qualification as a REIT; or |
| • | that such partner may exercise buy/sell rights that force us to either acquire the entire investment, or dispose of our share, at a time and price that may not be consistent with our investment objectives. |
Any of the above might subject a property to liabilities in excess of those contemplated and thus reduce our returns on that investment. Furthermore, if there are disputes with our co-venturers, co-tenants or partners in an investment, we could incur high litigation costs that would adversely affect the value of your Common Shares or could result in liability.
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Uninsured losses relating to real property or excessively expensive premiums for insurance coverage may adversely affect your returns.
The nature of the activities at certain properties we may acquire will expose us and our operators to potential liability for personal injuries and, in certain instances, property damage claims. For instance, there are types of losses, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, pollution, environmental matters or extreme weather conditions such as hurricanes, floods and snow storms that are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. Insurance risks associated with potential terrorist acts could sharply increase the premiums we pay for coverage against property and casualty claims. Mortgage lenders generally insist that specific coverage against terrorism be purchased by commercial property owners as a condition for providing mortgage, bridge or mezzanine loans. It is uncertain whether such insurance policies will be available, or available at reasonable cost, which could inhibit our ability to finance or refinance our properties. In such instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We cannot assure you that we will have adequate coverage for such losses. If any of our properties incurs a casualty loss that is not fully covered by insurance, the value of our assets will be reduced by the amount of any such uninsured loss. In addition, other than the capital reserve or other reserves we may establish, we have no source of funding to repair or reconstruct any uninsured damaged property, and we cannot assure you that any such sources of funding will be available to us for such purposes in the future. Also, to the extent we must pay unexpectedly large amounts for insurance, we could suffer reduced earnings that would result in decreased distributions to stockholders.
Our operating results may be negatively affected by potential development and construction delays and result in increased costs and risks, which could diminish the return on your investment.
We may invest some of or all the proceeds available for investment in the acquisition, development or redevelopment of properties upon which we will develop and construct improvements. We could incur substantial capital obligations in connection with these types of investments. We will be subject to risks relating to uncertainties associated with rezoning for development and environmental concerns of governmental entities or community groups and our builder’s ability to control construction costs or to build in conformity with plans, specifications and timetables. The builder’s failure to perform may necessitate legal action by us to rescind the purchase or the construction contract or to compel performance. Performance also may be affected or delayed by conditions beyond the builder’s control. Delays in completion of construction also could give tenants the right to terminate preconstruction leases for space at a newly developed project. We may incur additional risks when we make periodic progress payments or other advances to such builders prior to completion of construction. These and other such factors can result in increased costs of a project or loss of our investment. Substantial capital obligations could delay our ability to make distributions. In addition, we will be subject to normal lease-up risks relating to newly constructed projects. Furthermore, we must rely upon projections of rental income and expenses and estimates of the fair market value of property upon completion of construction when agreeing upon a price to be paid for the property at the time of acquisition of the property. If our projections are inaccurate, we may pay too much for a property, and the return on our investment could suffer.
In addition, we may invest up to 10% of our total assets in unimproved real property. Returns from development of unimproved properties are also subject to risks and uncertainties associated with rezoning the land for development and environmental concerns of governmental entities or community groups. Your investment is subject to the risks associated with investments in unimproved real property.
Competition with third parties in acquiring properties and other assets may reduce our profitability and the return on your investment.
We compete with many other entities engaged in real estate investment activities, including individuals, corporations, bank and insurance company investment accounts, other REITs, real estate limited partnerships, and other entities engaged in real estate investment activities, many of which have greater resources than we have. Larger real estate programs may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. In addition, the number of entities and the amount of funds competing for suitable properties may increase. Any such increase would result in increased demand for these assets and therefore increased prices paid for them. If we pay higher prices for properties and other investments, our profitability will be reduced and you may experience a lower return on your investment.
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Failure to succeed in new markets or in new property classes may have adverse consequences on our performance.
We may from time to time commence development activity or make acquisitions outside of our existing market areas or the property classes of our primary focus if appropriate opportunities arise. The experience of our sponsor in our existing markets in developing, owning and operating certain classes of property does not ensure that we will be able to operate successfully in new markets, should we choose to enter them, or that we will be successful in new property classes. We may be exposed to a variety of risks if we choose to enter new markets, including an inability to evaluate accurately local market conditions, to obtain land for development or to identify appropriate acquisition opportunities, or to hire and retain key personnel, and a lack of familiarity with local governmental and permitting procedures. In addition, we may abandon opportunities to enter new markets or acquire new classes of property that we have begun to explore for any reason and may, as a result, fail to recover expenses already incurred.
Acquiring or attempting to acquire multiple properties in a single transaction may adversely affect our operations.
From time to time, we may attempt to acquire multiple properties in a single transaction. Portfolio acquisitions are more complex and expensive than single-property acquisitions, and the risk that a multiple-property acquisition does not close may be greater than in a single-property acquisition. Portfolio acquisitions also may result in us owning investments in geographically dispersed markets, placing additional demands on our ability to manage the properties in the portfolio. In addition, a seller may require that a group of properties be purchased as a package even though we may not want to purchase one or more properties in the portfolio. In these situations, if we are unable to identify another person or entity to acquire the unwanted properties, we may be required to operate or attempt to dispose of these properties. To acquire multiple properties in a single transaction we may be required to accumulate a large amount of cash. We would expect the returns that we earn on such cash to be less than the ultimate returns in real property and therefore, accumulating such cash could reduce the funds available for distributions. Any of the foregoing events may have an adverse effect on our operations.
If we set aside insufficient capital reserves, we may be required to defer necessary capital improvements.
If we do not have enough capital reserves to supply needed funds for capital improvements throughout the life of the investment in a property, and there is insufficient cash available from our operations, we may be required to defer necessary improvements to the property, which may cause the property to suffer from a greater risk of obsolescence or a decline in value, or a greater risk of decreased cash flow as a result of fewer potential tenants being attracted to the property. If this happens, we may not be able to maintain projected rental rates for affected properties, and our results of operations may be negatively impacted.
In connection with the recent and ongoing economic concerns, to the extent we invest in apartment communities, we may face increased competition from single-family homes and condominiums for rent, which could limit our ability to retain residents, lease apartment units or increase or maintain rents.
Any apartment communities we may invest in may compete with numerous housing alternatives in attracting residents, including single-family homes and condominiums available for rent. Such competitive housing alternatives may become more prevalent in a particular area because of the tightening of mortgage lending underwriting criteria, homeowner foreclosures, the decline in single-family home and condominium sales and the lack of available credit. The number of single-family homes and condominiums for rent in a particular area could limit our ability to retain residents, lease apartment units or increase or maintain rents.
Our failure to integrate acquired properties and new personnel could create inefficiencies and reduce the return of your investment.
To grow successfully, we must be able to apply our experience in managing real estate to a larger number of properties. In addition, we must be able to integrate new management and operations personnel as our organization grows in size and complexity. Failures in either area will result in inefficiencies that could adversely affect our expected return on our investments and our overall profitability.
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Our property managers’ failure to integrate their subcontractors into their operations in an efficient manner could reduce the return on your investment.
Our property managers may rely on multiple subcontractors for on-site property management of our properties. If our property managers are unable to integrate these subcontractors into their operations in an efficient manner, our property managers may have to expend substantial time and money coordinating with these subcontractors, which could have a negative impact on the revenues generated from such properties.
The costs of compliance with environmental laws and other laws and regulations may adversely affect our income and the cash available for any distributions.
All real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials, and the remediation of contamination associated with disposals. Some of these laws and regulations may impose joint and several liability on tenants, owners or operators for the costs of investigation or remediation of contaminated properties, regardless of fault or the legality of the original disposal. In addition, the presence of these substances, or the failure to properly remediate these substances, may adversely affect our ability to sell or rent such property or to use the property as collateral for future borrowings.
Compliance with new or more stringent laws or regulations or stricter interpretation of existing laws may require material expenditures by us. For example, various federal, regional and state laws and regulations have been implemented or are under consideration to mitigate the effects of climate change caused by greenhouse gas emissions. Among other things, ‘‘green’’ building codes may seek to reduce emissions through the imposition of standards for design, construction materials, water and energy usage and efficiency, and waste management. Any such requirements could increase the costs of maintaining or improving our properties or developing new properties.
Discovery of previously undetected environmentally hazardous conditions may adversely affect our operating results.
Under various federal, state and local environmental laws, ordinances and regulations (including those of foreign jurisdictions), a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on, under or in such property. The costs of removal or remediation could be substantial. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures. Environmental laws provide for sanctions for noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos-containing materials into the air, and third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances.
In addition, when excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing, as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold at any of our projects could require us to undertake a costly remediation program to contain or remove the mold from the affected property or development project, which would reduce our operating results.
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The cost of defending against claims of liability, of compliance with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could materially adversely affect our business, assets or results of operations and, consequently, amounts available for distribution to you.
Our costs associated with complying with the Americans with Disabilities Act may affect cash available for distributions.
Our properties are generally expected to be subject to the Americans with Disabilities Act of 1990, as amended (the “Disabilities Act”) or similar laws of foreign jurisdictions. Under the Disabilities Act, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. The Disabilities Act has separate compliance requirements for ‘‘public accommodations’’ and ‘‘commercial facilities’’ that generally require that buildings and services be made accessible and available to people with disabilities. The Disabilities Act’s requirements could require removal of access barriers and could result in the imposition of injunctive relief, monetary penalties or, in some cases, an award of damages. Our funds used for compliance with these laws may affect cash available for distributions and the amount of distributions to you.
If we sell properties by providing financing to purchasers, we will bear the risk of default by the purchaser.
In some instances we may sell our properties by providing financing to purchasers. If we provide financing to purchasers, we will bear the risk of default by the purchaser and will be subject to remedies provided by law, which could negatively impact distributions to our stockholders. There are no limitations or restrictions on our ability to take purchase money obligations. We may, therefore, take a purchase money obligation secured by a mortgage as partial payment for the purchase price of a property. The terms of payment to us generally will be affected by custom in the area where the property being sold is located and the then-prevailing economic conditions. If we receive promissory notes or other property in lieu of cash from property sales, the distribution of the proceeds of sales to our stockholders, or their reinvestment in other assets, will be delayed until the promissory notes or other property are actually paid, sold, refinanced or otherwise disposed of. In some cases, we may receive initial down payments in cash and other property in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years. If any purchaser defaults under a financing arrangement with us, it could negatively impact our ability to make distributions to our stockholders.
Risks Associated with Debt Financing
We anticipate that we will incur mortgage indebtedness and other borrowings, which may increase our business risks.
We anticipate that we will acquire real properties and other real estate-related investments by borrowing new funds. In addition, we may incur or increase our mortgage debt by obtaining loans secured by some of or all our real properties to obtain funds to acquire additional properties and other investments and for payment of distributions to stockholders. We also may borrow funds for payment of distributions to stockholders, in particular, if necessary to satisfy the requirement that we distribute annually to stockholders at least 90% of our REIT taxable income, or otherwise as is necessary or advisable to assure that we maintain our qualification as a REIT and U.S. federal income and excise tax.
There is no limitation on the amount we may invest in any single property or other asset or on the amount we can borrow for the purchase of any individual property or other investment. Under our charter, the maximum amount of our indebtedness shall not exceed 300% of our ‘‘net assets’’ (as defined by our charter) as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent directors.
In addition to our charter limitation, our board of directors has adopted a policy to generally limit our aggregate borrowings to approximately 65% of the greater of the aggregate cost and the fair market value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests. Our policy limitation, however, does not apply to individual real estate assets and only will apply once we have ceased raising capital under this or any subsequent offering and invested substantially all of our capital. As a result, we expect to borrow more than 65% of the aggregate cost and the fair market value of each real estate asset we acquire to the extent our board of directors determines that borrowing these amounts is prudent. For these purposes, the value of our assets is based on methodologies and policies determined by our board of directors that may include, but do not require, independent appraisals.
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If there is a shortfall in cash flow available to service our mortgage debt, then the amount available for distributions to stockholders may be affected. In addition, incurring mortgage debt increases the risk of loss because (a) loss in investment value is generally borne entirely by the borrower until such time as the investment value declines below the principal balance of the associated debt, and (b) defaults on indebtedness secured by a property may result in foreclosure actions initiated by lenders and our loss of the property securing the loan that is in default. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds from the foreclosure. We may give full or partial guarantees to lenders of mortgage debt to the entities that own our properties. When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of the debt if it is not paid by such entity. If any mortgages contain cross-collateralization or cross-default provisions, there is a risk that more than one real property may be affected by a default. If any of our properties is foreclosed upon due to a default, our ability to make distributions to our stockholders will be adversely affected. In addition, because our goal is to be in a position to liquidate our assets within six to nine years after the termination of our initial public offering, our approach to investing in properties utilizing leverage in order to accomplish our investment objectives over this period of time may present more risks to investors than comparable real estate programs that have a longer intended duration and that do not utilize borrowing to the same degree.
If mortgage debt is unavailable at reasonable rates, we may not be able to refinance our properties, which could reduce the amount of cash distributions we can make.
When we place mortgage debt on properties, we run the risk of being unable to refinance the properties when the loans come due, or of being unable to refinance on favorable terms. If interest rates are higher when the properties are refinanced, we may not be able to finance the properties at reasonable rates or at rates comparable to those which existed prior to such refinancing, and our income could be reduced. If this occurs, it would reduce cash available for distribution to our stockholders, and it may prevent us from borrowing more money.
Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions to our stockholders.
In connection with obtaining financing, a lender could impose restrictions on us that affect our ability to incur additional debt and our distribution and operating policies. In general, we expect our loan agreements to restrict our ability to encumber or otherwise transfer our interest in the respective property without the prior consent of the lender. Loan documents we enter may contain other customary negative covenants that may limit our ability to further mortgage the property, discontinue insurance coverage, replace Lightstone Value Plus REIT III LLC as our advisor or impose other limitations. Any such restriction or limitation may have an adverse effect on our operations and our ability to make distributions to you.
Interest-only indebtedness may increase our risk of default and ultimately may reduce our funds available for distribution to our stockholders.
We may finance our property acquisitions using interest-only mortgage indebtedness. During the interest-only period, the amount of each scheduled payment will be less than that of a traditional amortizing mortgage loan. The principal balance of the mortgage loan will not be reduced (except in the case of prepayments) because there are no scheduled monthly payments of principal during this period. After the interest-only period, we will be required either to make scheduled payments of amortized principal and interest or to make a lump-sum or ‘‘balloon’’ payment at maturity. These required principal or balloon payments will increase the amount of our scheduled payments and may increase our risk of default under the related mortgage loan. If the mortgage loan has an adjustable interest rate, the amount of our scheduled payments also may increase at a time of rising interest rates. Increased payments and substantial principal or balloon maturity payments will reduce the funds available for distribution to our stockholders because cash otherwise available for distribution will be required to pay principal and interest associated with these mortgage loans.
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Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to make distributions to our stockholders.
We may incur indebtedness that bears interest at a variable rate. In addition, from time to time we may pay mortgage loans or finance and refinance our properties in a rising interest rate environment. Accordingly, increases in interest rates could increase our interest costs, which could have an adverse effect on our operating cash flow and our ability to make distributions to you. In addition, if rising interest rates cause us to need additional capital to repay indebtedness in accordance with its terms or otherwise, we may need to liquidate one or more of our investments at times that may not permit realization of the maximum return on such investments. Prolonged interest rate increases also could negatively impact our ability to make investments with positive economic returns.
We have entered into financing arrangements involving balloon payment obligations, which may adversely affect our ability to make distributions.
We have entered into financing arrangements that require us to make a lump-sum or ‘‘balloon’’ payment at maturity. Our ability to make a balloon payment at maturity is uncertain and may depend upon our ability to obtain additional financing or our ability to sell the property. At the time the balloon payment is due, we may or may not be able to refinance the balloon payment on terms as favorable as the original loan or sell the property at a price sufficient to make the balloon payment. The effect of a refinancing or sale could affect the rate of return to stockholders and the projected time of disposition of our assets. In addition, payments of principal and interest made to service our debts may leave us with insufficient cash to pay the distributions that we are required to pay to maintain our qualification as a REIT and minimize U.S. federal income and excise tax. Any of these results would have a significant, negative impact on your investment.
We have broad authority to incur debt, and high debt levels could hinder our ability to make distributions and could decrease the value of your investment.
Our board of directors has adopted a policy to generally limit our aggregate borrowings to approximately 65% of the greater of the aggregate cost and the fair market value of our assets, but we may exceed this limit under some circumstances. Such debt may be at a level that is higher than REITs with similar investment objectives or criteria. High debt levels could cause us to incur higher interest charges, could result in higher debt service payments, and could be accompanied by restrictive covenants. These factors could limit the amount of cash we have available to distribute and could result in a decline in the value of your investment.
Risks Related to Investments in Real Estate-Related Securities
Investments in real estate-related securities will be subject to specific risks relating to the particular issuer of the securities and may be subject to the general risks of investing in subordinated real estate securities, which may result in losses to us.
We may invest in real estate-related securities of both publicly traded and private real estate companies. Our investments in real estate-related securities will involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Issuers of real estate-related securities generally invest in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed in this filing, including risks relating to rising interest rates.
Real estate-related securities are often unsecured and also may be subordinated to other obligations of the issuer. As a result, investments in real estate-related securities are subject to risks of (a) limited liquidity in the secondary trading market in the case of unlisted or thinly traded securities, (b) substantial market price volatility resulting from changes in prevailing interest rates in the case of traded equity securities, (c) subordination to the prior claims of banks and other senior lenders to the issuer, (d) the operation of mandatory sinking fund or call/repurchase provisions during periods of declining interest rates that could cause the issuer to reinvest repurchase proceeds in lower-yielding assets, (e) the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations and (f) the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic slowdown or downturn. These risks may adversely affect the value of outstanding real estate-related securities and the ability of the issuers thereof to repay principal and interest or make distribution payments.
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Investments in real estate-related preferred equity securities involve a greater risk of loss than traditional debt investments.
We may invest in real estate-related preferred equity securities, which may involve a higher degree of risk than traditional debt investments due to a variety of factors, including that such investments are subordinate to traditional loans and are not secured by property underlying the investment. Furthermore, should the issuer default on our investment, we would be able to proceed only against the entity in which we have an interest, and not the property owned by such entity and underlying our investment. As a result, we may not recover some of or all our investment.
We expect that a portion of any real estate-related securities investments we make will be illiquid, and we may not be able to adjust our portfolio in response to changes in economic and other conditions.
Certain of the real estate-related securities that we may purchase in connection with privately negotiated transactions will not be registered under the applicable securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, those laws. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited. The mezzanine and bridge loans we may purchase will be particularly illiquid investments due to their short life, their unsuitability for securitization and the greater difficulty of recoupment following a borrower’s default.
We are subject to interest rate risk, which means that changing interest rates may reduce the value of our real estate-related securities investments.
Interest rate risk is the risk that prevailing market interest rates will change relative to the current yield on fixed-income securities such as preferred and debt securities, and to a lesser extent dividend-paying common stock. Generally, when interest rates rise, the market value of these securities declines, and vice versa. In addition, when interest rates fall, issuers are more likely to repurchase their existing preferred and debt securities to take advantage of the lower cost of financing. As repurchases occur, principal is returned to the holders of the securities sooner than expected, thereby lowering the effective yield on the investment. On the other hand, when interest rates rise, issuers are more likely to maintain their existing preferred and debt securities. As a result, repurchases decrease, thereby extending the average maturity of the securities. If we are unable to manage interest rate risk effectively, our results of operations, financial condition and ability to pay distributions to you will be adversely affected.
We may acquire real estate-related securities through tender offers, which may require us to spend significant amounts of time and money that otherwise could be allocated to our operations.
We may acquire real estate-related securities through tender offers, negotiated or otherwise, in which we solicit a target company’s stockholders to purchase their securities. The acquisition of these securities could require us to spend significant amounts of money that otherwise could be allocated to our operations. Additionally, in order to acquire the securities, the employees of our advisor likely will need to devote a substantial portion of their time to pursuing the tender offer — time that otherwise could be allocated to managing our business. These consequences could adversely affect our operations and reduce the cash available for distribution to our stockholders.
Our dependence on the management of other entities in which we invest may adversely affect our business.
We may not control the management, investment decisions or operations of the companies in which we may invest. Management of those enterprises may decide to change the nature of their assets, or management may otherwise change in a manner that is not satisfactory to us. We will have no ability to affect these management decisions, and we may have only limited ability to dispose of our investments.
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Our due diligence may not reveal all of a borrower’s liabilities and may not reveal other weaknesses in its business.
Before making a loan to a borrower or acquiring debt or equity securities of a company, we will assess the strength and skills of such entity’s management and other factors that we believe are material to the performance of the investment. In making the assessment and otherwise conducting customary due diligence, we will rely on the resources available to us and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly organized or private entities because there may be little or no information publicly available about the entities. There can be no assurance that our due diligence processes will uncover all relevant facts or that any investment will be successful.
We will depend on debtors for our revenue, and, accordingly, our revenue and our ability to make distributions to you will be dependent upon the success and economic viability of such debtors.
The success of our investments in real estate-related loans, real estate-related debt securities and other real estate-related investments will materially depend on the financial stability of the debtors underlying such investments. The inability of a single major debtor or a number of smaller debtors to meet their payment obligations could result in reduced revenue or losses.
Risks Associated with Investments in Mortgage, Bridge and Mezzanine Loans
We have relatively less experience investing in mortgage, bridge, mezzanine or other loans as compared to investing directly in real property, which could adversely affect our return on loan investments.
The experience of our advisor and its affiliates with respect to investing in mortgage, bridge, mezzanine or other loans is not as extensive as it is with respect to investments directly in real properties. However, we may continue to make such loan investments to the extent our advisor determines that it is advantageous to us due to the state of the real estate market, as a strategic method of acquiring distressed assets, or in order to diversify our investment portfolio. Our less extensive experience with respect to mortgage, bridge, mezzanine or other loans could adversely affect our return on loan investments.
Our mortgage, bridge or mezzanine loans may be impacted by unfavorable real estate market conditions, which could decrease the value of those loans and the return on your investment.
If we make or invest in mortgage, bridge or mezzanine loans, we will be at risk of defaults on those loans caused by many conditions beyond our control, including local and other economic conditions affecting real estate values and interest rate levels. We do not know whether the values of the property securing the loans will remain at the levels existing on the dates of origination of the loans. If the values of the underlying properties drop, our risk will increase because of the lower value of the security associated with such loans.
Our mortgage, bridge or mezzanine loans will be subject to interest rate fluctuations, which could reduce our returns as compared to market interest rates and reduce the value of the loans if we sell them.
If we invest in fixed-rate, long-term mortgage, bridge or mezzanine loans and interest rates rise, the loans could yield a return lower than then-current market rates. If interest rates decrease, we will be adversely affected to the extent that mortgage, bridge or mezzanine loans are prepaid, because we may not be able to make new loans at the previously higher interest rate. If we invest in variable-rate loans and interest rates decrease, our revenues also may decrease. Finally, if we invest in variable-rate loans and interest rates increase, the value of the loans we own at such time would decrease, which would lower the proceeds we would receive if we sell such assets. For these reasons, if we invest in mortgage, bridge or mezzanine loans, our returns on those loans and the value of your investment will be subject to fluctuations in interest rates.
Delays in liquidating defaulted mortgage, mezzanine or bridge loans could reduce our investment returns.
If there are defaults under our loans, we may not be able to repossess and sell quickly any properties securing such loans. The resulting time delay could reduce the value of our investment in the defaulted loans. An action to foreclose on a property securing a loan is regulated by state statutes and regulations and is subject to many of the delays and expenses of any lawsuit brought in connection with the foreclosure if the defendant raises defenses or counterclaims. If there is a default by a mortgagor, these restrictions, among other things, may impede our ability to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due to us on the loan.
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The mezzanine loans in which we may invest would involve greater risks of loss than senior loans secured by income-producing real properties.
We may invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying real property or loans secured by a pledge of the ownership interests of either the entity owning the real property or the entity that owns the interest in the entity owning the real property. These types of investments involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property because the investment may become unsecured as a result of foreclosure by the senior lender. If borrowers of these loans are real estate developers, our investments may involve additional risks, including dependence for repayment on successful completion and operation of the project, difficulties in estimating construction or rehabilitation costs and loan terms that often require little or no amortization. If there is a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of the entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our loan or on debt senior to our loan, or if there is a borrower bankruptcy, our loan will be satisfied only after the senior debt is paid in full. Where debt senior to our loan exists, the presence of intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through ‘‘standstill periods’’), and control decisions made in bankruptcy proceedings relating to borrowers. As a result, we may not recover some of or all our investment.
Returns on our mortgage, bridge or mezzanine loans may be limited by regulations.
The mortgage, bridge or mezzanine loans in which we invest, or that we may make, may be subject to regulation by federal, state and local authorities or regulation by foreign jurisdictions and subject to various laws and judicial and administrative decisions. We may determine not to make mortgage, bridge or mezzanine loans in any jurisdiction in which we believe we have not complied in all material respects with applicable requirements. If we decide not to make mortgage, bridge or mezzanine loans in several jurisdictions, it could reduce the amount of income we would otherwise receive.
Foreclosures create additional ownership risks that could adversely impact our returns on mortgage investments.
If we acquire property by foreclosure following defaults under our mortgage, bridge or mezzanine loans, we will have the economic and liability risks as the owner.
The liquidation of our assets may be delayed as a result of our investment in mortgage, bridge or mezzanine loans, which could delay distributions to our stockholders.
The mezzanine and bridge loans we may purchase will be particularly illiquid investments due to their short life, their unsuitability for securitization and the greater difficulty of recoupment following a borrower’s default. If our advisor determines that it is in our best interests to make or invest in mortgage, bridge or mezzanine loans, any intended liquidation of us may be delayed beyond the time of the sale of all our properties until all mortgage, bridge or mezzanine loans expire or are sold, because we may enter into mortgage, bridge or mezzanine loans with terms that expire after the date we intend to have sold all
our properties.
Investments that are not U.S. government-insured involve risk of loss.
We may originate and acquire uninsured loans and assets as part of our investment strategy. Such loans and assets may include mortgage loans, mezzanine loans and bridge loans. While holding such interests, we are subject to risks of borrower defaults, bankruptcies, fraud, losses and special hazard losses that are not covered by standard hazard insurance. If there is any default under loans, we bear the risk of loss of principal and nonpayment of interest and to the extent of any deficiency between the value of the collateral and the principal amount of the loan. To the extent we suffer such losses with respect to our investments in such loans, the value of our company and the price of our Common Shares may be adversely affected.
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U.S. Federal Income Tax Risks
Our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and potentially state and local tax, and would adversely affect our operations and the market price of our common stock.
We elected to qualify and be taxed as a REIT for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2015 and intend to operate in a manner that would allow us to continue to qualify as a REIT. However, we may terminate our REIT qualification, if our board of directors determines that not qualifying as a REIT is in our best interests, or inadvertently. Our qualification as a REIT depends upon our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. The REIT qualification requirements are extremely complex and interpretation of the U.S. federal income tax laws governing qualification as a REIT is limited. Furthermore, any opinion of our counsel, including tax counsel, as to our eligibility to qualify or remain qualified as a REIT is not binding on the IRS and is not a guarantee that we will qualify, or continue to qualify, as a REIT. Accordingly, we cannot be certain that we will be successful in operating so we can qualify or remain qualified as a REIT. Our ability to satisfy the asset tests depends on our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income or quarterly asset requirements also depends on our ability to successfully manage the composition of our income and assets on an ongoing basis. Accordingly, if certain of our operations were to be recharacterized by the IRS, such recharacterization would jeopardize our ability to satisfy all requirements for qualification as a REIT. Furthermore, future legislative, judicial or administrative changes to the U.S. federal income tax laws could be applied retroactively, which could result in our disqualification as a REIT.
If we fail to qualify as a REIT for any taxable year, and we do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT qualification. Losing our REIT qualification would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the dividends paid deduction, and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.
As a REIT, in certain circumstances, we may incur tax liabilities that would reduce our cash available for distribution to you.
Even if we maintain our status as a REIT, we may be subject to U.S. federal, state and local income taxes. For example, net income from the sale of properties that are ‘‘dealer’’ properties sold by a REIT (a ‘‘prohibited transaction’’ under the Code) will be subject to a 100% tax. We may not make sufficient distributions to avoid excise taxes applicable to REITs. We also may decide to retain net capital gain we earn from the sale or other disposition of our property and pay U.S. federal income tax directly on such income. In that event, our stockholders would be treated as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability unless they file U.S. federal income tax returns and thereon seek a refund of such tax. We also will be subject to corporate tax on any undistributed REIT taxable income. We also may be subject to state and local taxes on our income or property, including franchise, payroll and transfer taxes, either directly or at the level of our operating partnership or at the level of the other companies through which we indirectly own our assets, such as our TRSs, which are subject to full U.S. federal, state, local and foreign corporate-level income taxes. Any taxes we pay directly or indirectly will reduce our cash available for distribution to you.
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To qualify as a REIT we must meet annual distribution requirements, which may force us to forgo otherwise attractive opportunities or borrow funds during unfavorable market conditions. This could delay or hinder our ability to meet our investment objectives and reduce your overall return.
In order to qualify and maintain our status as a REIT, we must distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. We will be subject to U.S. federal income tax on our undistributed REIT taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which distributions we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. These requirements could cause us to distribute amounts that otherwise would be spent on investments in real estate assets and it is possible that we might be required to borrow funds, possibly at unfavorable rates, or sell assets to fund these distributions. It is possible that we might not always be able to make distributions sufficient to meet the annual distribution requirements and to avoid U.S. federal income and excise taxes on our earnings while we qualify as a REIT.
Certain of our business activities are potentially subject to the prohibited transaction tax, which could reduce the return on your investment.
For so long as we qualify as a REIT, our ability to dispose of property during the first few years following acquisition may be restricted to a substantial extent as a result of our REIT qualification. Under applicable provisions of the Code regarding prohibited transactions by REITs, while we qualify as a REIT, we will be subject to a 100% penalty tax on any gain recognized on the sale or other disposition of any property (other than foreclosure property) that we own, directly or indirectly through any subsidiary entity, including our operating partnership, but generally excluding our TRSs, that is deemed to be inventory or property held primarily for sale to customers in the ordinary course of a trade or business. Whether property is inventory or otherwise held primarily for sale to customers in the ordinary course of a trade or business depends on the particular facts and circumstances surrounding each property. We intend to avoid the 100% prohibited transaction tax by (1) conducting activities that may otherwise be considered prohibited transactions through a TRS (but such TRS would incur corporate rate income taxes with respect to any income or gain recognized by it), (2) conducting our operations in such a manner so that no sale or other disposition of an asset we own, directly or indirectly through any subsidiary, will be treated as a prohibited transaction, or (3) structuring certain dispositions of our properties to comply with the requirements of the prohibited transaction safe harbor available under the Code for properties that, among other requirements, have been held for at least two years. Despite our present intention, no assurance can be given that any particular property we own, directly or through any subsidiary entity, including our operating partnership, but generally excluding TRSs, will not be treated as inventory or property held primarily for sale to customers in the ordinary course of a trade or business.
Our TRSs are subject to corporate-level taxes and our dealings with our TRSs may be subject to 100% excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 25% (20% for taxable years beginning after December 31, 2017) of the gross value of a REIT’s assets may consist of stock or securities of one or more TRSs.
A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT, including gross income from operations pursuant to management contracts. We must operate our ‘‘qualified lodging facilities’’ through one or more TRS that leases such properties from us. We may use our TRSs generally for other activities as well, such as to hold properties for sale in the ordinary course of a trade or business or to hold assets or conduct activities that we cannot conduct directly as a REIT. A TRS will be subject to applicable U.S. federal, state, local and foreign income tax on its taxable income. In addition, the rules, which are applicable to us as a REIT, also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.
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If our leases to our TRSs are not respected as true leases for U.S. federal income tax purposes, we would fail to qualify as a REIT.
To qualify as a REIT, we must satisfy two gross income tests under which specified percentages of our gross income must be derived from certain sources, such as ‘‘rents from real property.’’ In order for such rent to qualify as ‘‘rents from real property’’ for purposes of the REIT gross income tests, the leases must be respected as true leases for U.S. federal income tax purposes and not be treated as service contracts, joint ventures or some other type of arrangement. If our leases are not respected as true leases for U.S. federal income tax purposes, we would fail to qualify as a REIT.
If our operating partnership failed to qualify as a partnership or is not otherwise disregarded for U.S. federal income tax purposes, we would cease to qualify as a REIT.
We intend to maintain the status of the operating partnership as a partnership or a disregarded entity for U.S. federal income tax purposes. However, if the IRS were to successfully challenge the status of the operating partnership as a partnership or disregarded entity for such purposes, it would be taxable as a corporation. In such event, this would reduce the amount of distributions that the operating partnership could make to us. This also would result in our failing to qualify as a REIT, and becoming subject to a corporate level tax on our income. This substantially would reduce our cash available to pay distributions and the yield on your investment. In addition, if any of the partnerships or limited liability companies through which the operating partnership owns its properties, in whole or in part, loses its characterization as a partnership and is otherwise not disregarded for U.S. federal income tax purposes, it would be subject to taxation as a corporation, thereby reducing distributions to the operating partnership. Such a recharacterization of an underlying property owner could also threaten our ability to maintain our REIT qualification.
If our ‘‘qualified lodging facilities’’ are not properly leased to a TRS or the managers of such ‘‘qualified lodging facilities’’ do not qualify as ‘‘eligible independent contractors,’’ we could fail to qualify as a REIT.
In general, we cannot operate any lodging facilities and can only indirectly participate in the operation of ‘‘qualified lodging facilities’’ on an after-tax basis through leases of such properties to our TRSs. A ‘‘qualified lodging facility’’ is a hotel, motel, or other establishment in which more than one-half of the dwelling units are used on a transient basis at which or in connection with which wagering activities are not conducted. Rent paid by a lessee that is a ‘‘related party tenant’’ of ours will not be qualifying income for purposes of the two gross income tests applicable to REITs. A TRS that leases lodging facilities from us will not be treated as a ‘‘related party tenant’’ with respect to our lodging facilities that are managed by an independent management company, so long as the independent management company qualifies as an ‘‘eligible independent contractor.’’
Each of the management companies that enters into a management contract with our TRSs must qualify as an ‘‘eligible independent contractor’’ under the REIT rules in order for the rent paid to us by our TRSs to be qualifying income for purposes of the REIT gross income tests. An ‘‘eligible independent contractor’’ is an independent contractor that, at the time such contractor enters into a management or other agreement with a TRS to operate a ‘‘qualified lodging facility,’’ is actively engaged in the trade or business of operating ‘‘qualified lodging facilities’’ for any person not related, as defined in the Code, to us or the TRS. Among other requirements, in order to qualify as an independent contractor a manager must not own, directly or applying attribution provisions of the Code, more than 35% of our outstanding shares of stock (by value), and no person or group of persons can own more than 35% of our outstanding shares and 35% of the ownership interests of the manager (taking into account only owners of more than 5% of our shares and, with respect to ownership interest in such managers that are publicly traded, only holders of more than 5% of such ownership interests). The ownership attribution rules that apply for purposes of the 35% thresholds are complex. There can be no assurance that the levels of ownership of our stock by our managers and their owners will not be exceeded.
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Our investments in certain debt instruments may cause us to recognize income for U.S. federal income tax purposes even though no cash payments have been received on the debt instruments, and certain modifications of such debt by us could cause the modified debt to not qualify as a good REIT asset, thereby jeopardizing our REIT qualification.
Our taxable income may substantially exceed our net income as determined based on GAAP, or differences in timing between the recognition of taxable income and the actual receipt of cash may occur. For example, we may acquire assets, including debt securities requiring us to accrue original issue discount or recognize market discount income, that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets. In addition, if a borrower with respect to a particular debt instrument encounters financial difficulty rendering it unable to pay stated interest as due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income with the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our stockholders.
As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to (a) sell assets in adverse market conditions, (b) borrow on unfavorable terms, (c) distribute amounts that would otherwise be used for future acquisitions or used to repay debt, or (d) make a taxable distribution of our Common Shares as part of a distribution in which stockholders may elect to receive Common Shares or (subject to a limit measured as a percentage of the total distribution) cash, in order to comply with the REIT distribution requirements.
Moreover, we may acquire distressed debt investments that require subsequent modification by agreement with the borrower. If the amendments to the outstanding debt are ‘‘significant modifications’’ under the applicable Treasury Regulations, the modified debt may be considered to have been reissued to us in a debt- for-debt taxable exchange with the borrower. This deemed reissuance may prevent the modified debt from qualifying as a good REIT asset if the underlying security has declined in value and would cause us to recognize income to the extent the principal amount of the modified debt exceeds our adjusted tax basis in the unmodified debt.
The failure of a mezzanine loan to qualify as a real estate asset would adversely affect our ability to qualify as a REIT.
In general, in order for a loan to be treated as a qualifying real estate asset producing qualifying income for purposes of the REIT asset and income tests, the loan must be secured by real property or an interest in real property. We may acquire mezzanine loans that are not directly secured by real property or an interest in real property but instead secured by equity interests in a partnership or limited liability company that directly or indirectly owns real property or an interest in real property. In Revenue Procedure 2003-65, the IRS provided a safe harbor pursuant to which a mezzanine loan that is not secured by real estate would, if it meets each of the requirements contained in the Revenue Procedure, be treated by the IRS as a qualifying real estate asset. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law and in many cases it may not be possible for us to meet all the requirements of the safe harbor. We cannot provide assurance that any mezzanine loan in which we invest would be treated as a qualifying asset producing qualifying income for REIT qualification purposes. If any such loan fails either the gross income tests or asset test we may be disqualified as a REIT.
We may choose to make distributions in our own stock, in which case you may be required to pay U.S. federal income taxes in excess of the cash dividends you receive.
In connection with our qualification as a REIT, we are required to distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. In order to satisfy this requirement, we may make distributions that are payable in cash and/or our Common Shares (which could account for up to 80% of the aggregate amount of such distributions) at the election of each stockholder. Taxable stockholders receiving such distributions will be required to include the full amount of such distributions as ordinary dividend income to the extent of our current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. As a result, U.S. stockholders may be required to pay U.S. federal income taxes with respect to such distributions in excess of the cash portion of the distribution received.
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Accordingly, U.S. Stockholders receiving a distribution of our shares may be required to sell shares received in such distribution or may be required to sell other stock or assets owned by them, at a time that may be disadvantageous, in order to satisfy any tax imposed on such distribution. If a U.S. Stockholder sells the stock that it receives as part of the distribution in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the distribution, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders we may be required to withhold U.S. tax with respect to such distribution, including in respect of all or a portion of such distribution that is payable in stock, by withholding or disposing of part of the shares included in such distribution and using the proceeds of such disposition to satisfy the withholding tax imposed. In addition, if a significant number of our stockholders determine to sell our Common Shares in order to pay taxes owed on dividend income, such sale may put downward pressure on the market price of our Common Shares.
Various tax aspects of such a taxable cash/stock distribution are uncertain and have not yet been addressed by the IRS. No assurance can be given that the IRS will not impose requirements in the future with respect to taxable cash/stock distributions, including on a retroactive basis, or assert that the requirements for such taxable cash/stock distributions have not been met.
The taxation of distributions to our stockholders can be complex; however, distributions that we make to our stockholders generally will be taxable as ordinary income or constitute a return of capital, which may reduce your anticipated return from an investment in us.
Distributions that we make to our taxable stockholders out of current and accumulated earnings and profits (and not designated as capital gain dividends or qualified dividend income) generally will be taxable as ordinary income. However, a portion of our distributions may (1) constitute a return of capital generally to the extent that they exceed our accumulated earnings and profits as determined for U.S. federal income tax purposes, (2) be designated by us as capital gain dividends generally taxable as long-term capital gain to the extent that they are attributable to net capital gain recognized by us, or (3) be designated by us as qualified dividend income generally to the extent they are attributable to dividends we receive from our TRSs. A return of capital is not taxable, but has the effect of reducing the basis of a stockholder’s investment in our Common Shares. Due to our investment in real estate, depreciation deductions and interest expense may reduce our earnings and profits in our early years with the result that a large portion of distributions to our stockholders in early years may constitute a return of capital rather than ordinary income.
Our stockholders may have tax liability on distributions that they elect to reinvest in Common Shares, but they would not receive the cash from such distributions to pay such tax liability.
If our stockholders participate in our DRIP, they will be deemed to have received, and for U.S. federal income tax purposes will be taxed on, the amount reinvested in our Common Shares to the extent the amount reinvested was not a tax-free return of capital. In addition, our stockholders will be treated for tax purposes as having received an additional distribution to the extent the shares are purchased at a discount to fair market value. As a result, unless a stockholder is a tax-exempt entity, it may have to use funds from other sources to pay its tax liability on the value of the Common Shares received.
Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.
The maximum tax rate applicable to qualified dividend income payable to U.S. Stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, generally are not eligible for this reduced rate. Although this does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our Common Shares. Tax rates could be changed in future legislation.
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Complying with REIT requirements may limit our ability to hedge our liabilities effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code may limit our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets, if properly identified under applicable Treasury Regulations, does not constitute ‘‘gross income’’ for purposes of the 75% gross income test or 95% gross income test. To the extent that we enter into other types of hedging transactions, the income from those transactions will likely be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit, except for being carried forward against future taxable income of such TRS.
Complying with REIT requirements may force us to forego and/or liquidate otherwise attractive investment opportunities.
To qualify as a REIT, we must ensure that we meet the REIT gross income tests annually and that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and certain kinds of mortgage-related securities. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities of any one issuer (other than government securities and qualified real estate assets), and no more than 25% (20% for taxable years beginning after December 31, 2017) of the value of our total assets can be represented by securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate assets from our portfolio or not make otherwise attractive investments in order to maintain our qualification as a REIT. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
The ability of our board of directors to revoke our REIT qualification without stockholder approval may subject us to U.S. federal income tax and reduce distributions to our stockholders.
Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. While we elected to be taxed as a REIT and qualify to be taxed as a REIT, we may terminate our REIT election if we determine that qualifying as a REIT is no longer in the best interests of our stockholders. If we cease to be a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders and on the market price of our Common Shares.
We may be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the market price of our Common Shares.
In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of U.S. federal income tax laws applicable to investments similar to an investment in our Common Shares. Additional changes to the tax laws are likely to continue to occur, and we cannot assure you that any such changes will not adversely affect the taxation of a stockholder. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets. You are urged to consult with your tax advisor with respect to the impact of recent legislation on your investment in our shares and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares. You also should note that our counsel’s tax opinion is based upon existing law, applicable as of the date of its opinion, all of which will be subject to change, either prospectively or retroactively.
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Reform proposals have been recently put forth by members of Congress and the President which, if ultimately proposed as legislation and enacted as law, would substantially change the U.S. federal taxation of (among other things) individuals and businesses. Their proposals set forth a variety of principles to guide potential tax reform legislation. As of the date of this annual report, no legislation has been introduced in Congress. If ultimately reduced to legislation enacted by Congress and signed into law by the President in a form that is consistent with those principles, such reform could change dramatically the U.S. federal taxation applicable to us and our stockholders. No reform proposal specifically addresses the taxation of REITs, but because any tax reform is likely to significantly reduce the tax rates applicable to corporations and dividends received by stockholders, the tax benefits applicable to the REIT structure may be diminished in relation to corporations. Furthermore, proposed tax reform would limit the deductibility of net interest expense and would allow for the immediate deduction of any investment in tangible property (other than land) and intangible assets. Finally, the tax reform proposals do not include any principles regarding how to transition from our current system of taxation to a new tax system based on the principles in such proposed reform. Given how dramatic the changes could be, transition rules are crucial. While it is impossible to predict whether and to what extent any tax reform legislation (or other legislative, regulatory or administrative change to the U.S. federal tax laws) will be proposed or enacted, any such change in the U.S. federal tax laws could affect materially the value of any investment in our stock. You are encouraged to consult with your tax advisor regarding possible legislative and regulatory changes and the potential effect of such changes on an investment in our shares.
Although REITs generally receive better tax treatment than entities taxed as regular corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be treated for U.S. federal income tax purposes as a corporation. As a result, our charter provides our board of directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a regular corporation, without the vote of our stockholders. Our board of directors has fiduciary duties to us and our stockholders and could only cause such changes in our tax treatment if it determines in good faith that such changes are in the best interest of our stockholders.
The share ownership restrictions of the Code for REITs and the 9.8% share ownership limit in our charter may inhibit market activity in shares of stock and restrict our business combination opportunities.
In order to qualify as a REIT, five or fewer individuals, as defined in the Code, may not own, actually or constructively, more than 50% in value of our issued and outstanding shares of stock at any time during the last half of each taxable year, other than the first year for which a REIT election is made. Attribution rules in the Code determine if any individual or entity actually or constructively owns our shares of stock under this requirement. Additionally, at least 100 persons must beneficially own our shares of stock during at least 335 days of a taxable year for each taxable year, other than the first year for which a REIT election is made. To help insure that we meet these tests, among other purposes, our charter restricts the acquisition and ownership of our shares of stock.
Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT while we so qualify. Unless exempted, prospectively or retroactively, by our board of directors, for so long as we qualify as a REIT, our charter prohibits, among other limitations on ownership and transfer of shares of our stock, any person from beneficially or constructively owning (applying certain attribution rules under the Code) more than 9.8% in value of the aggregate of our outstanding shares of stock and more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. Our board of directors may not grant an exemption from these restrictions to any proposed transferee whose ownership in excess of the 9.8% ownership limit would result in the termination of our qualification as a REIT. These restrictions on transferability and ownership will not apply, however, if our board of directors determines that it is no longer in our best interest to continue to qualify as a REIT or that compliance with the restrictions is no longer required in order for us to continue to so qualify as a REIT.
These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our Common Shares or otherwise be in the best interest of the stockholders.
Non-U.S. Stockholders will be subject to U.S. federal withholding tax and may be subject to U.S. federal income tax on distributions received from us and upon the disposition of our shares.
Subject to certain exceptions, distributions received from us will be treated as dividends of ordinary income to the extent of our current or accumulated earnings and profits. Such dividends ordinarily will be subject to U.S. withholding tax at a 30% rate, or such lower rate as may be specified by an applicable income tax treaty, unless the distributions are treated as ‘‘effectively connected’’ with the conduct by the Non-U.S. Stockholder of a U.S. trade or business. Pursuant to Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) capital gain distributions attributable to sales or exchanges of ‘‘U.S. real property interests,’’ (“USRPIs”) generally will be taxed to a Non-U.S. Stockholder as if such gain were effectively connected with a U.S. trade or business. However, a capital gain dividend will not be treated as effectively connected income if (a) the distribution is received with respect to a class of stock that is regularly traded on an established securities market located in the United States and (b) the Non-U.S. Stockholder does not own more than 5% of the class of our stock at any time during the one-year period ending on the date the distribution is received. We do not anticipate that our shares will be ‘‘regularly traded’’ on an established securities market for the foreseeable future, and therefore, this exception is not expected to apply.
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Gain recognized by a Non-U.S. Stockholder upon the sale or exchange of our Common Shares generally will not be subject to U.S. federal income taxation unless such stock constitutes a USRPI under FIRPTA. Our Common Shares will not constitute a USRPI so long as we are a ‘‘domestically-controlled qualified investment entity.’’ A domestically-controlled qualified investment entity includes a REIT if at all times during a specified testing period, less than 50% in value of such REIT’s stock is held directly or indirectly by Non-U.S. Stockholders. We believe, but cannot assure you, that we will be a domestically-controlled qualified investment entity.
Even if we do not qualify as a domestically-controlled qualified investment entity at the time a Non-U.S. Stockholder sells or exchanges our Common Shares, gain arising from such a sale or exchange would not be subject to U.S. taxation under FIRPTA as a sale of a USRPI if (a) our Common Shares are ‘‘regularly traded,’’ as defined by applicable Treasury regulations, on an established securities market, and (b) such Non-U.S. Stockholder owned, actually and constructively, 5% or less of our Common Shares at any time during the five-year period ending on the date of the sale. However, it is not anticipated that our Common Shares will be ‘‘regularly traded’’ on an established market. We encourage you to consult your tax advisor to determine the tax consequences applicable to you if you are a Non-U.S. Stockholder.
Potential characterization of distributions or gain on sale may be treated as unrelated business taxable income to tax-exempt investors.
If (a) we are a ‘‘pension-held REIT,’’ (b) a tax-exempt stockholder has incurred (or deemed to have incurred) debt to purchase or hold our Common Shares, or (c) a holder of Common Shares is a certain type of tax-exempt stockholder, dividends on, and gains recognized on the sale of, Common Shares by such tax-exempt stockholder may be subject to U.S. federal income tax as unrelated business taxable income under the Code.
ITEM 1B. UNRESOLVED STAFF COMMENTS:
None.
| Year to Date | Percentage Occupied for the Year Ended | Revenue per Available Room
for the Year | Average Daily Rate For the
Year Ended | |||||||||||||||||||
| Location | Year Built | Date Acquired | Available Rooms | December 31, 2016 | Ended December 31, 2016 | December 31, 2016 | ||||||||||||||||
| Hampton Inn – Des Moines | Des Moines, Iowa | 1987 | 2/4/2015 | 43,920 | 68 | % | $ | 82.77 | $ | 122.53 | ||||||||||||
| Courtyard - Durham | Durham, North Carolina | 1996 | 5/15/2015 | 53,436 | 74 | % | $ | 75.60 | $ | 102.61 | ||||||||||||
| Hampton Inn – Lansing | Lansing, Michigan | 2013 | 3/10/2016 | 25,542 | 75 | % | $ | 96.43 | $ | 129.20 | ||||||||||||
| Courtyard - Warwick | Warwick, Rhode Island | 2003 | 3/23/2016 | 26,128 | 81 | % | $ | 109.06 | $ | 134.95 | ||||||||||||
| SpringHill Suites - Green Bay | Green Bay, Wisconsin | 2007 | 5/2/2016 | 30,988 | 74 | % | $ | 115.80 | $ | 155.97 | ||||||||||||
| Home2 Suites – Salt Lake | Salt Lake City, Utah | 2013 | 8/2/2016 | 19,000 | 73 | % | $ | 82.49 | $ | 115.34 | ||||||||||||
| Home2 Suites – Tukwila | Tukwila, Washington | 2015 | 8/2/2016 | 21,128 | 74 | % | $ | 103.80 | $ | 140.30 | ||||||||||||
| Fairfield Inn – Austin | Austin, Texas | 2014 | 9/13/2016 | 9,240 | 67 | % | $ | 75.84 | $ | 113.49 | ||||||||||||
| Staybridge Suites – Austin | Austin, Texas | 2009 | 10/7/2016 | 6,960 | 77 | % | $ | 81.05 | $ | 105.90 | ||||||||||||
| Total | 236,342 | 73 | % | $ | 91.40 | $ | 124.90 | |||||||||||||||
From time to time in the ordinary course of business, we may become subject to legal proceedings, claims or disputes.
ITEM 4. Mine Safety Disclosures
Not applicable.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES:
As of March 15, 2017, we had approximately 13.2 million shares of common stock outstanding, held by a total of 3,803 stockholders. The number of stockholders is based on the records of DST Systems Inc., which serves as our registrar and transfer agent.
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Estimated Net Asset Value (“NAV”) and NAV per Share of Common Stock (“NAV per Share”)
On March 27, 2017, our board of directors approved our estimated NAV of approximately $116.6 million and resulting estimated NAV per Share of $10.00, both as of December 31, 2016 and both after the special limited partner’s purchase of subordinated participation interests. Through December 31, 2016, the special limited partner made cash purchases of subordinated participation interests totaling $12.1 million. In the calculation of our estimated NAV, an approximately $1.3 million allocation of value was made to the special limited partner’s subordinated participation interests representing the amount by which the estimated NAV per Share would have exceeded an aggregate $10.00 price per share plus a cumulative, pre-tax non-compounded annual return of 6.0% as of December 31, 2016. Accordingly, the net portion of the NAV attributable to the special limited partner’s cash purchases of subordinated participation interests was approximately $10.7 million as of December 31, 2016.
Process and Methodology
Our Advisor, along with any necessary material assistance or confirmation of a third-party valuation expert or service, is responsible for calculating our NAV, which we currently expect will be done on a quarterly basis for as long as the special limited partner’s obligation to purchase subordinated participation interests continues and thereafter, will be done on at least an annual basis unless and until our Common Shares are approved for listing on a national securities exchange. Our board of directors will review each estimate of NAV and approve the resulting NAV per Share.
Our estimated NAV per Share as of December 31, 2016 was calculated with the assistance of both our Advisor and Marshall & Stevens Incorporated (‘‘M&S’’), an independent third-party valuation engaged by us to assist with the valuation of our assets, liabilities and any allocations of value to the special limited partner’s subordinated participation interests. The Advisor recommended and the board of directors established the estimated NAV per Share as of December 31, 2016 based upon the analyses and reports provided by our Advisor and M&S. The process for estimating the value of our assets, liabilities and allocations of value to the special limited partner’s subordinated participation interests is performed in accordance with the provisions of the Investment Program Association Practice Guideline 2013-01, ‘‘Valuation of Publicly Registered Non-Listed REITs.’’ We believe that our valuations were developed in a manner reasonably designed to ensure their reliability.
The engagement of M&S with respect to our NAV per Share as of December 31, 2016 was approved by our board of directors, including all of our independent directors. M&S has extensive experience in conducting asset valuations, including valuations of commercial real estate, debt, properties and real estate- related investments.
With respect to our NAV per Share as of December 31, 2016, M&S prepared appraisal reports (the ‘‘M&S December 2016 Appraisal Reports’’), summarizing key inputs and assumptions, on the nine properties (the ‘‘M&S Appraised Properties’’) in which we held ownership interests as of December 31, 2016. M&S also prepared a NAV report (the ‘‘December 2016 NAV Report’’) which estimated the NAV per Share as of December 31, 2016. The December 2016 NAV Report relied upon the M&S December 2016 Appraisal Reports for the M&S Appraised Properties, M&S’s estimated value of our mortgage notes payable, and the Advisor’s estimate of the value of our cash and cash equivalents, other assets, due to related parties, other liabilities and allocations of value to limited partner’s subordinated participation interests, to calculate estimated NAV per Share, all as of December 31, 2016.
The table below sets forth the calculation of our estimated NAV and resulting estimated NAV per Share as of December 31, 2016 compared to September 30, 2016 and June 30, 2016.
Dollar and share amounts are presented in thousands, except per share data.
| As of December 31, 2016 | As of September 30, 2016 | As of June 30, 2016 | ||||||||||||||||||||||
| Value | Per Share | Value | Per Share | Value | Per Share | |||||||||||||||||||
| Net Assets: | ||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||
| Real Estate Properties | $ | 150,950 | $ | 12.95 | $ | 139,000 | $ | 13.71 | $ | 75,567 | $ | 10.89 | ||||||||||||
| Non-Real Estate Assets: | ||||||||||||||||||||||||
| Cash and cash equivalents | 55,065 | 10,638 | 10,998 | |||||||||||||||||||||
| Due from related parties | - | 4 | - | |||||||||||||||||||||
| Other assets | 2,530 | 2,575 | 3,949 | |||||||||||||||||||||
| Total non-real estate assets | 57,595 | 4.94 | 13,217 | 1.30 | 14,947 | 2.15 | ||||||||||||||||||
| Total Assets | 208,545 | 17.89 | 152,217 | 15.01 | 90,514 | 13.04 | ||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||
| Mortgages payable | (87,252 | ) | (45,370 | ) | - | |||||||||||||||||||
| Revolving promissory notes payable - related party | - | - | (16,200 | ) | ||||||||||||||||||||
| Due to related parties | (110 | ) | - | (198 | ) | |||||||||||||||||||
| Other liabilities | (3,267 | ) | (3,883 | ) | (3,190 | ) | ||||||||||||||||||
| Total liabilities | (90,629 | ) | (7.77 | ) | (49,253 | ) | (4.86 | ) | (19,588 | ) | (2.82 | ) | ||||||||||||
| Allocation of value to Special Limited Partner's Subordinated Participation | ||||||||||||||||||||||||
| Interests | (1,346 | ) | (0.12 | ) | (1,594 | ) | (0.15 | ) | (1,536 | ) | (0.22 | ) | ||||||||||||
| Adjusted NAV after giving effect to Special Limited Partner's Purchases of | ||||||||||||||||||||||||
| Subordinated Participation Interests | $ | 116,570 | $ | 10.00 | $ | 101,370 | $ | 10.00 | $ | 69,390 | $ | 10.00 | ||||||||||||
| Shares of Common Stock Outstanding | 11,657 | 10,137 | 6,939 | |||||||||||||||||||||
| NAV attributable to Special Limited Partner's Cash Purchase of Subordinated | ||||||||||||||||||||||||
| Participation Interests | $ | 10,745 | $ | 0.92 | $ | 10,497 | $ | 1.04 | $ | 9,555 | $ | 1.38 | ||||||||||||
| NAV without Special Limited Partner's Cash Purchases of Subordinated | ||||||||||||||||||||||||
| Participation Interests | $ | 105,825 | $ | 9.08 | $ | 90,873 | $ | 8.96 | $ | 59,835 | $ | 8.62 | ||||||||||||
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Use of Independent Valuation Firm:
As discussed above, our Advisor is responsible for calculating our NAV. In connection with determining our NAV, our Advisor may rely on the material assistance or confirmation of a third-party valuation expert or service. In this regard, M&S was selected by our board of directors to assist our Advisor in the calculation of our estimated NAV and resulting estimated NAV per Share as of December 31, 2016. M&S’s services included appraising the M&S Appraised Properties and preparing the December 2016 NAV Report. M&S is engaged in the business of appraising commercial real estate properties and is not affiliated with us or our Advisor. The compensation we paid to M&S was based on the scope of work and not on the appraised values of our real estate properties. The appraisals were performed in accordance with the Code of Ethics and the Uniform Standards of Professional Appraisal Practice, or USPAP, the real estate appraisal industry standards created by The Appraisal Foundation. The M&S December 2016 Appraisal Reports were reviewed, approved, and signed by an individual with the professional designation of MAI licensed in the state where each real property is located. The use of the reports is subject to the requirements of the Appraisal Institute relating to review by its duly authorized representatives. In preparing its reports, M&S did not, and was not requested to; solicit third-party indications of interest for our common stock in connection with possible purchases thereof or the acquisition of all or any part of us.
M&S collected reasonably available material information that it deemed relevant in appraising these real estate properties. M&S relied in part on property-level information provided by our Advisor, including (i) property historical and projected operating revenues and expenses; and (ii) information regarding recent or planned capital expenditures.
In conducting their investigation and analyses, M&S took into account customary and accepted financial and commercial procedures and considerations as they deemed relevant. Although M&S reviewed information supplied or otherwise made available by us or our Advisor for reasonableness, they assumed and relied upon the accuracy and completeness of all such information and of all information supplied or otherwise made available to them by any other party and did not independently verify any such information. M&S assumed that any operating or financial forecasts and other information and data provided to or otherwise reviewed by or discussed with M&S were reasonably prepared in good faith on bases reflecting the then best currently available estimates and judgments of our management, our board of directors, and/or our Advisor. M&S relied on us to advise them promptly if any information previously provided became inaccurate or was required to be updated during the period of their review.
In performing its analyses, M&S made numerous other assumptions as of various points in time with respect to industry performance, general business, economic, and regulatory conditions, and other matters, many of which are beyond their control and our control. M&S also made assumptions with respect to certain factual matters. For example, unless specifically informed to the contrary, M&S assumed that we have clear and marketable title to each real estate property appraised, that no title defects exist, that any improvements were made in accordance with law, that no hazardous materials are present or were present previously, that no significant deed restrictions exist, and that no changes to zoning ordinances or regulations governing use, density, or shape are pending or being considered. Furthermore, M&S’s analyses, opinions, and conclusions were necessarily based upon market, economic, financial, and other circumstances and conditions existing as of or prior to the date of the M&S December 2016 Appraisal Reports, and any material change in such circumstances and conditions may affect M&S’s analyses and conclusions. The M&S December 2016 Appraisal Reports contain other assumptions, qualifications, and limitations that qualify the analyses, opinions, and conclusions set forth therein. Furthermore, the prices at which our real estate properties may actually be sold could differ from M&S’s analyses.
M&S is actively engaged in the business of appraising commercial real estate properties similar to those owned by us in connection with public security offerings, private placements, business combinations, and similar transactions. We do not believe that there are any material conflicts of interest between M&S, on the one hand, and us, our Sponsor, our Advisor, and our affiliates, on the other hand. Our Advisor engaged M&S on behalf of our board of directors to deliver their reports to assist in the NAV calculation as of December 31, 2016 and M&S received compensation for those efforts. In addition, we agreed to indemnify M&S against certain liabilities arising out of this engagement. M&S has previously assisted in our prior NAV calculations and has also been engaged by us for certain valuation services with respect to our acquisitions. M&S may from time to time in the future perform other services for us and our Sponsor or other affiliates of the Sponsor, so long as such other services do not adversely affect the independence of M&S as certified in the Appraisal Reports. During the past year M&S has also been engaged to provide appraisal services to another non-trade REIT sponsored by our Sponsor for which it was paid usual and customary fees.
Although M&S considered any comments received from us and our Advisor relating to their reports, the final appraised values of the M&S Appraised Properties were determined by M&S. The reports were addressed to our board of directors to assist our board of directors in calculating an estimated value per share of our common stock as of December 31, 2016. The reports were not addressed to the public, may not be relied upon by any other person to establish an estimated value per share of our common stock, and do not constitute a recommendation to any person to purchase or sell any shares of our common stock.
Our goal in calculating our estimated NAV is to arrive at values that are reasonable and supportable using what we deem to be appropriate valuation methodologies and assumptions. The reports, including the analysis, opinions, and conclusions set forth in such reports, are qualified by the assumptions, qualifications, and limitations set forth in the respective reports. The following is a summary of our valuation methodologies used to value our assets and liabilities by key component:
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Real Estate Properties: We have ownership interests in real estate properties (collectively, the ‘‘Real Estate Properties’’). As of December 31, 2016, on a collective basis, we wholly owned and consolidated the operating results and financial condition of nine hospitality properties, or select services hotels, containing a total of 999 rooms.
As described above, we engaged M&S to provide an appraisal of the M&S Appraised Properties, which consisted of the nine hospitality properties in which we held ownership interests as of December 31, 2016. In preparing the appraisal reports, M&S, among other things:
| • | performed a site visit of each property in connection with this assignment or other assignments; |
| • | interviewed our officers or the Advisor’s personnel to obtain information relating to the physical condition of each appraised property, including known environmental conditions, status of ongoing or planned property additions and reconfigurations, and other factors for such leased properties; and |
| • | reviewed the acquisition criteria and parameters used by real estate investors for properties similar to the subject properties, including a search of real estate data sources and publications concerning real estate buyer’s criteria, discussions with sources deemed appropriate, and a review of transaction data for similar properties. |
M&S employed the income approach and the sales comparison approach to estimate the value of the appraised properties. The income approach involves an economic analysis of the property based on its potential to provide future net annual income. As part of the valuation, a discounted cash flow analysis (‘‘DCF Analysis’’) and direct capitalization analysis was used in the income approach to determine the value of our interest in the portfolio. The indicated value by the income approach represents the amount an investor may pay for the expectation of receiving the net cash flow from the property.
The direct capitalization analysis is based upon the net operating income of the property capitalized at an appropriate capitalization rate for the property based upon property characteristics and competitive position and market conditions at the date of the appraisal.
In applying the DCF Analysis, pro forma statements of operations for the property including revenues and expenses are analyzed and projected over a multi-year period. The property is assumed to be sold at the end of the multi-year holding period. The reversion value of the property which can be realized upon sale at the end of the holding period is calculated based on the capitalization of the estimated net operating income of the property in the year of sale, utilizing a capitalization rate deemed appropriate in light of the age, anticipated functional and economic obsolescence and competitive position of the property at the time of sale. Net proceeds to owners are determined by deducting appropriate costs of sale. The discount rate selected for the DCF Analysis is based upon estimated target rates of return for buyers of similar properties.
The sales comparison approach utilizes indices of value derived from actual or proposed sales of comparable properties to estimate the value of the subject property. The appraiser analyzed such comparable sale data as was available to develop a market value conclusion for the subject property.
M&S prepared the M&S December 2016 Appraisal Reports, summarizing key inputs and assumptions, for each of the appraised properties using financial information provided by us and our Advisor. From such review, M&S selected the appropriate cash flow discount rate, residual discount rate, and terminal capitalization rate in the DCF Analysis, the appropriate capitalization rate in the direct capitalization analysis and the appropriate price per unit in the sales comparison analysis.
The following summarizes the key assumptions that were used in the discounted cash flow models to estimate the value of the M&S Appraised Properties included in our Real Estate Properties, as of December 31, 2016:
| Weighted-average: | ||||
| Exit capitalization rate | 9.29 | % | ||
| Discount rate | 10.09 | % | ||
| Annual market rent growth rate | 3.12 | % | ||
| Annual net operating income growth rate | 2.85 | % | ||
| Holding period (in years) | 10.0 |
While we believe that the assumptions made by M&S are reasonable, a change in these assumptions would impact the calculations of the estimated value of M&S Appraised Properties included in our Real Estate Properties. Assuming all other factors remain unchanged, the following table summarizes the estimated change in the values (dollars in thousands) of the M&S Appraised Properties included in our Real Estate Properties which would result from a 25 basis point increase or decrease in exit capitalization rates and discount rates:
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| Increase of 25 basis points: | ||||
| Exit capitalization rate | $ | (1,710 | ) |
| Discount rate | (2,404 | ) | ||
| Decrease of 25 basis points: | ||||
| Exit capitalization rate | $ | 1,798 | ||
| Discount rate | (2,369 | ) |
As of December 31, 2016, the aggregate estimated fair value of our interests in the Real Estate Properties was approximately $151.0 million and the aggregate cost of our Real Estate Properties was approximately $140.6 million, including approximately $3.3 million of capital and tenant improvements invested subsequent to acquisition. The estimated fair value of our Real Estate Properties compared to the original acquisition price plus subsequent capital improvements through December 31, 2016, results in an estimated overall increase in the real estate value of 7.3%.
Cash and Cash Equivalents: The estimated values of our cash and cash equivalents approximate their carrying values due to their short maturities.
Due from/(to) Related Parties: The estimated value of our due from/(to) related parties approximates its carrying value due to its short maturity.
Other Assets: Our other assets consist of tenant accounts receivable, deposits, and prepaid expenses, subscriptions receivable and other assets. The estimated values of these items approximate their carrying values due to their short maturities. Certain other items, primarily intangibles, have been eliminated for the purpose of the valuation because those items are already considered in our valuation of the respective investments in real estate properties or financial instruments.
Mortgages Payable: Our mortgages payable include both variable and fixed interest rate debt facilities. The estimated value of our variable rate facility was assumed to approximate its outstanding principal balance because it bears interest at a variable rate. The estimated values for our fixed rate facility was estimated using a discounted cash flow analysis, which used inputs based on the remaining loan term and estimated current market interest rate for mortgage loans with similar characteristics, including remaining loan term and loan-to-value ratios. The current market interest rate was generally determined based on market rates for available comparable debt. The estimated current market interest rate for our fixed rate facility was 5.40%.
Other Liabilities: Our other liabilities consist of our accounts payable and accrued expenses, deposits payable and distributions payable. The carrying values of these items were considered to equal their fair value due to their short maturities.
Allocations of Value to Special Limited Partner’s Subordinated Participation Interests: The special limited partner’s subordinated participation interests are classified in noncontrolling interests on our consolidated balance sheet. However, for purposes of our NAV, we do not estimate their fair value in accordance with GAAP. Rather, the IPA’s Practice Guideline 2013-01 provides for adjustments to the NAV for preferred securities, special interests and incentive fees based on the aggregate NAV of the company and payable to the sponsor in a hypothetical liquidation of the company as of the valuation date in accordance with the provisions of the partnership or advisory agreements and the terms of the preferred securities. Because our subordinated participation interests are only payable to the special limited partner in a liquidation event, we believe they should be valued for our NAV in accordance with these provisions.
Accordingly, pursuant to the terms of our operating agreement, no allocations of value are made to the special limited partner’s subordinated participation interests unless the estimated NAV per Share would have exceeded $10.00 per share plus a cumulative, pre-tax non-compounded annual return of 6.0% as of the indicated valuation date. Through December 31, 2016, the special limited partner made cash purchases of subordinated participation interests totaling approximately $12.1 million. In the calculation of our estimated NAV, an approximately $1.3 million allocation of value was made to the special limited partner’s subordinated participation interests representing the amount by which the estimated NAV per Share would have exceeded an aggregate $10.00 price per share plus a cumulative, pre-tax non-compounded annual return of 6.0% as of December 31, 2016. Accordingly, the net portion of the NAV attributable to the special limited partner’s cash purchases of subordinated participation interests was approximately $10.7 million as of December 31, 2016.
Limitations and Risks
As with any valuation methodology, the methodology used to determine our estimated NAV and resulting estimated NAV per Share is based upon a number of estimates and assumptions that may prove later not to be accurate or complete. Further, different market participants with different property-specific and general real estate and capital market assumptions, estimates, judgments and standards could derive different estimated NAVs per share, which could be significantly different from the estimated NAV per Share approved by our board of directors. The estimated NAV per Share approved by our board of directors does not represent the fair value of our assets less liabilities in accordance with GAAP, and such estimated NAV per Share is not a representation, warranty or guarantee that:
| • | a stockholder would be able to resell his or her shares of common stock at the estimated NAV per Share; |
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| • | a stockholder would ultimately realize distributions per share of common stock equal to the estimated NAV per Share upon liquidation of our assets and settlement of our liabilities or a sale of the Company; |
| • | our shares of common stock would trade at the estimated NAV per Share on a national securities exchange; |
| • | an independent third-party appraiser or other third-party valuation firm would agree with the estimated NAV per Share; or |
| • | the methodology used to estimate our NAV per Share would be acceptable to FINRA or under the Employee Retirement Income Security Act with respect to their respective requirements. |
The Internal Revenue Service and the Department of Labor do not provide any guidance on the methodology an issuer must use to determine its estimated NAV per Share. FINRA guidance provides that NAV valuations be derived from a methodology that conforms to standard industry practice.
As with any valuation methodology, our methodology is based upon a number of estimates and assumptions that may not be accurate or complete. Different parties with different assumptions and estimates could derive different estimated NAVs per share, and these differences could be significant. The estimated NAV per Share is not audited and does not represent the fair value of our assets less our liabilities in accordance GAAP, nor do they represent an actual liquidation value of our assets and liabilities or the amount shares of our common stock would trade at on a national securities exchange. As of the date of this filing, although we have not sought stockholder approval to adopt a plan of liquidation of the Company, certain distributions may be payable to the special limited partner for its subordinated participation interests in connection with a liquidation event. Accordingly, our estimated NAV reflects any allocations of value to the subordinated participation interests representing the amount that would be payable to the special limited partner in connection with a liquidation event pursuant to the guidelines for estimating NAV contained in IPA Practice Guideline 2013-01, ‘‘Valuation of Publicly Registered Non-Listed REITs.’’ Our estimated NAV per Share is based on the estimated value of our assets less the estimated value of our liabilities less any allocations to the special limited partner’s subordinated participation interests divided by the number of our diluted shares of common stock outstanding, all as of the date indicated. Our estimated NAV per Share does not reflect a discount for the fact we are externally managed, nor does it reflect a real estate portfolio premium/discount versus the sum of the individual property values. Our estimated NAV per Share does not take into account estimated disposition costs or fees or penalties, if any, that may apply upon the prepayment of certain of our debt obligations or the impact of restrictions on the assumption of certain debt. Our NAV per Share will fluctuate over time as a result of, among other things, future acquisitions or dispositions of assets, developments related to individual assets and the management of those assets and changes in the real estate and capital markets. Different parties using different assumptions and estimates could derive different NAVs and resulting estimated NAVs per share, and these differences could be significant. Markets for real estate and real estate-related investments can fluctuate and values are expected to change in the future. We currently expect that our Advisor will estimate our NAV on a quarterly basis for as long as the special limited partner’s obligation to purchase subordinated participation interests continues and thereafter, our Advisor will estimate our NAV on at least an annual basis. Our board of directors will review and approve each estimate of NAV and resulting estimated NAV per Share.
The following factors may cause a stockholder not to ultimately realize distributions per share of common stock equal to the estimated NAV per Share upon liquidation:
| • | The methodology used to determine estimated NAV per Share includes a number of estimates and assumptions that may not prove to be accurate or complete as compared to the actual amounts received in the liquidation; |
| • | In a liquidation, certain assets may not be liquidated at their estimated values because of transfer fees and disposition fees, which are not reflected in the estimated NAV calculation; |
| • | In a liquidation, debt obligations may have to be prepaid and the costs of any prepayment penalties may reduce the liquidation amounts. Prepayment penalties are not included in determining the estimated value of liabilities in determining estimated NAV; |
| • | In a liquidation, the real estate assets may derive a portfolio premium which premium is not considered in determining estimated NAV; |
| • | In a liquidation, the potential buyers of the assets may use different estimates and assumptions than those used in determining estimated NAV; |
| • | If the liquidation occurs through a listing of the common stock on a national securities exchange, the capital markets may value the Company’s net assets at a different amount than the estimated NAV. Such valuation would likely be based upon customary REIT valuation methodology including funds from operation (‘‘FFO’’) multiples of other comparable REITs, FFO coverage of dividends and adjusted FFO payout of the Company’s anticipated dividend; and |
| • | If the liquidation occurs through a merger of the Company with another REIT, the amount realized for the common stock may not equal the estimated NAV per Share because of many factors including the aggregate consideration received, the make-up of the consideration (e.g., cash, stock or both), the performance of any stock received as part of the consideration during the merger process and thereafter, the reception of the merger in the market and whether the market believes the pricing of the merger was fair to both parties. |
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Share Repurchase Program
Our share repurchase program may provide eligible stockholders with limited, interim liquidity by enabling them to sell shares of common stock back to us, subject to restrictions and applicable law. A selling stockholder must be unaffiliated with us, and must have beneficially held the shares of common stock for at least one year prior to offering the shares of common stock for sale to us through the share repurchase program. Subject to certain limitations, we will also redeem shares of common stock upon the request of the estate, heir or beneficiary of a deceased stockholder.
The prices at which stockholders who have held shares of common stock for the required one-year period may sell shares of common stock back to us are as follows:
| • | in the case of the death of a stockholder: (a) before we have first disclosed a NAV per Common Share based on data supported by appraisals of our assets and operations, the price paid to acquire the Common Shares from us; and (b) after we have first disclosed an NAV per Common Share, our NAV per Common Share; |
| • | the below percentages, except for in the case of the death of a stockholder: (a) before we have first disclosed an NAV per Common Share based on data supported by appraisals of our assets and operations, the price paid to acquire the Common Shares from us; and (b) after we have first disclosed an NAV per Common Share, our estimated value per Common Share: |
| • | 92.5% for stockholders who have continuously held their Common Shares for at least one year; |
| • | 95% for stockholders who have continuously held their Common Shares for at least two years; |
| • | 97.5% for stockholders who have continuously held their Common Shares for at least three years; and |
| • | 100% for stockholders who have continuously held their Common Shares for at least four years. |
Pursuant to the terms of our share repurchase program, we will make repurchases, if requested, at least once quarterly provided repurchases do not impair our capital or operations, as discussed further below. Each stockholder whose repurchase request is granted will receive the repurchase amount 30 days after the fiscal quarter in which we grant his, her or its repurchase request. Subject to certain limitations, we will also repurchase Common Shares upon the request of the estate, heir or beneficiary of a deceased stockholder. We will limit the number of Common Shares repurchased pursuant to our share repurchase program as follows: during any 12-month period, we will not repurchase in excess of 5.0% of the weighted average number of Common Shares outstanding during the prior calendar year; provided, however, that Common Shares repurchased in the case of the death of a stockholder will not count against this 5.0% limit.
Our Board of Directors, in its sole discretion, may choose at any time to terminate our share repurchase program, or reduce or increase the number of Common Shares purchased under the program, if it determines that the funds allocated to our share repurchase program are needed for other purposes, such as the acquisition, maintenance or repair of properties, or for use in making a declared distribution. A determination by our board of directors to eliminate, reduce or increase our share repurchase program will require the affirmative vote of our independent directors. From our date of inception through December 31, 2015, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the year ended December 31, 2016 we repurchased 34,358 shares of common stock, pursuant to our share repurchase program. We repurchased the shares at an average price per share of $9.99 per share. We funded share repurchases for the periods noted above from the cumulative proceeds of the sale of our shares pursuant to our DRIP.
Distributions
U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with GAAP) determined without regard to the deduction for dividends paid and excluding any net capital gain. In order to continue to qualify or qualify for REIT status, we may be required to make distributions in excess of cash available.
Distributions are at the discretion of our Board of Directors. We may use cash proceeds from the sale of shares of our common stock to fund distributions. We may continue to fund such distributions with cash proceeds from the sale of shares of our common stock or borrowings if we do not generate sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the size of these distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.
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We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. “Return of capital” refers to distributions to investors in excess of net income. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, but only to the extent of a stockholder’s adjusted tax basis in our shares, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.
Distributions Declared by our Board of Directors and Source of Distributions
On January 14, 2015, our Board of Directors authorized and we declared a distribution rate which is calculated based on stockholders of record each day during the applicable period at a rate of $0.00164383 per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 6.0% annualized rate based on a share price of $10.00. The first distribution began to accrue on December 11, 2014 (date of breaking escrow) through February 28, 2015 (the end of the month following our initial property acquisition) and subsequent distributions have been declared on a monthly basis thereafter. The first distribution was paid on March 15, 2015 and subsequent distributions have been paid on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month. Our stockholders may elect to have their distributions reinvested in additional shares of Common Shares under our DRIP.
Total distributions declared during the years ended December 31, 2016 and 2015 were $4.7 million and $1.0 million.
The following tables provide a summary of the quarterly distributions declared during the periods indicated:
| Year Ended December 31, 2016 | Three Months Ended December 31, 2016 | Three Months Ended September 30, 2016 | Three Months Ended June 30, 2016 | Three Months Ended March 31, 2016 | ||||||||||||||||||||||||||||||||||||
| Distribution period: | 2016 Year | Percentage
of Distributions | Q4 2016 | Percentage of Distributions | Q3 2016 | Percentage of Distributions | Q2 2016 | Percentage
of Distributions | Q1 2016 | Percentage
of Distributions | ||||||||||||||||||||||||||||||
| Date distribution declared | August 4, 2016 | May 12, 2016 | May 12, 2016 | November 13, 2015 & March 14, 2016 | ||||||||||||||||||||||||||||||||||||
| Date distribution paid | November 15, 2016 | August 15, 2016 | May 16, 2016, | February 15, 2016, | ||||||||||||||||||||||||||||||||||||
| December 15, 2016 | September 15, 2016 | June 15, 2016, | March 15, 2016, | |||||||||||||||||||||||||||||||||||||
| January 13, 2017 | October 14, 2016 | July 15, 2016 | April 15, 2016 | |||||||||||||||||||||||||||||||||||||
| Distribution paid | $ | 2,792,996 | $ | 895,497 | $ | 708,655 | $ | 825,940 | $ | 362,904 | ||||||||||||||||||||||||||||||
| Distribution reinvested | 1,939,115 | 758,041 | 647,455 | 174,361 | 359,258 | |||||||||||||||||||||||||||||||||||
| Total Distributions | $ | 4,732,111 | $ | 1,653,538 | $ | 1,356,110 | $ | 1,000,301 | $ | 722,162 | ||||||||||||||||||||||||||||||
| Source of distributions: | ||||||||||||||||||||||||||||||||||||||||
| Cash flows provided by operations | $ | 2,792,996 | 59 | % | $ | 793,928 | 48 | % | $ | 708,655 | 52 | % | $ | 825,940 | 83 | % | $ | 242,327 | 34 | % | ||||||||||||||||||||
| Offering proceeds | - | 0 | % | 101,569 | 6 | % | - | 0 | % | - | 0 | % | 120,577 | 17 | % | |||||||||||||||||||||||||
| Proceeds from issuance of common stock through DRIP | 1,939,115 | 41 | % | 758,041 | 46 | % | 647,455 | 48 | % | 174,361 | 17 | % | 359,258 | 49 | % | |||||||||||||||||||||||||
| Total Sources | $ | 4,732,111 | 100 | % | $ | 1,653,538 | 100 | % | $ | 1,356,110 | 100 | % | $ | 1,000,301 | 100 | % | $ | 722,162 | 100 | % | ||||||||||||||||||||
| Cash flows provided by operations (GAAP basis) | $ | 3,671,011 | $ | 793,928 | $ | 998,979 | $ | 1,635,777 | $ | 242,327 | ||||||||||||||||||||||||||||||
| - | ||||||||||||||||||||||||||||||||||||||||
| Number of shares (in thousands) of common stock issued pursuant to the Company's DRIP | 205,073 | 79,794 | 68,153 | 19,309 | 37,817 | |||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2015 | Three Months Ended December 31, 2015 | Three Months Ended September 30, 2015 | Three Months Ended June 30, 2015 | Three Months Ended March 31, 2015 | ||||||||||||||||||||||||||||||||||||
| Distribution period: | Percentage
of Distributions | Q4 2015 | Percentage
of Distributions | Q3 2015 | Percentage
of Distributions | Q2 2015 | Percentage
of Distributions | Q1 2015 | Percentage
of Distributions | |||||||||||||||||||||||||||||||
| Date distribution declared | November 14, 2015 | August 14, 2015 | May 14, 2015 | January 14, 2015 | ||||||||||||||||||||||||||||||||||||
| Date distribution paid | November 15, 2015, | August 15, 2015, | May 15, 2015, | March 15, 2015 and | ||||||||||||||||||||||||||||||||||||
| December 15, 2015, and | September 15, 2015, and | June 15, 2015, and | April 15, 2015 | |||||||||||||||||||||||||||||||||||||
| January 15, 2016 | October 15, 2015 | July 15, 2015 | ||||||||||||||||||||||||||||||||||||||
| Distributions paid | $ | 598,419 | $ | 249,743 | $ | 167,976 | $ | 112,612 | $ | 68,088 | ||||||||||||||||||||||||||||||
| Distributions reinvested | $ | 416,169 | 219,572 | 117,554 | 59,605 | 19,438 | ||||||||||||||||||||||||||||||||||
| Total Distributions | $ | 1,014,588 | $ | 469,315 | $ | 285,530 | $ | 172,217 | $ | 87,526 | ||||||||||||||||||||||||||||||
| Source of distributions: | ||||||||||||||||||||||||||||||||||||||||
| Cash flows provided by operations | $ | 598,419 | 59 | % | $ | 118,431 | 25 | % | $ | 167,976 | 59 | % | $ | 112,612 | 65 | % | $ | - | 0 | % | ||||||||||||||||||||
| Offering proceeds | $ | - | 0 | % | 131,312 | 28 | % | - | 0 | % | - | 0 | % | 68,088 | 78 | % | ||||||||||||||||||||||||
| Proceeds from issuance of common | ||||||||||||||||||||||||||||||||||||||||
| stock through DRIP | $ | 416,169 | 41 | % | 219,572 | 47 | % | 117,554 | 41 | % | 59,605 | 35 | % | 19,438 | 22 | % | ||||||||||||||||||||||||
| Total Sources | $ | 1,014,588 | 100 | % | $ | 469,315 | 100 | % | $ | 285,530 | 100 | % | $ | 172,217 | 100 | % | $ | 87,526 | 100 | % | ||||||||||||||||||||
| Cash flows provided by/(used in) | ||||||||||||||||||||||||||||||||||||||||
| operations (GAAP basis) | $ | 697,917 | $ | 118,431 | $ | 400,038 | $ | 285,757 | $ | (106,309 | ) | |||||||||||||||||||||||||||||
| Number of shares (in thousands) | ||||||||||||||||||||||||||||||||||||||||
| of common stock issued pursuant | ||||||||||||||||||||||||||||||||||||||||
| to the Company's DRIP | 43,807 | 23,113 | 12,374 | 6,274 | 2,046 | |||||||||||||||||||||||||||||||||||
Recent Sales of Unregistered Securities
The description of the sale of Subordinated Participations Interests set forth under “- Use of Public Offering Proceeds” is incorporated herein by reference. The Subordinated Participation Interests were issued pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended.
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Use of Public Offering Proceeds
Our registration statement on Form S-11 (the “Offering”), pursuant to which we are offering to sell up to 30,000,000 shares of our common stock, par value $0.01 per share (which may be referred to herein as ‘‘shares of common stock’’ or as ‘‘Common Shares’’) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10,000,000 shares available pursuant to our distribution reinvestment plan (the “DRIP”) at an initial purchase price of $9.50 per share) was declared effective by the Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933 on July 15, 2014. Since inception, we had received gross proceeds of $112.8 million from the sale of 11.5 million shares of our common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein, who also owns a majority interest in our Sponsor.)
We initially expected to offer the Common Shares offered in our Primary Offering over a two-year period, or until July 15, 2016. However, because we had not sold all the Common Shares offered in our Primary Offering within two years, we will continue the Primary Offering for an additional year, until July 15, 2017, provided that the Offering will be terminated if all 30.0 million shares of our common stock are sold before such date. We reserve the right to reallocate the shares of common stock we are offering between the Primary Offering and the DRIP. Additionally, the Offering may be terminated at any time.
As of December 31, 2016, our Advisor owned 20,000 shares of common stock which were issued on December 24, 2014 for $200,000 or $10.00 per share.
As of December 11, 2014, we had reached the minimum offering under our Offering by receiving subscriptions of our common shares, representing gross offering proceeds of more than $2.0 million, and effective December 11, 2014 investors were admitted as stockholders and our Operating Partnership commenced operations. Through December 31, 2016, cumulative gross offering proceeds of approximately $112.8 million have been released to us. We invested the proceeds received from the Offering and our Advisor in our Operating Partnership, and as a result, held a 99% general partnership interest as of December 31, 2016 in the Operating Partnership’s common units.
Lightstone SLP III LLC (the ‘‘Special Limited Partner’’), a Delaware limited liability company of which Mr. Lichtenstein is the majority owner, is a special limited partner in the Operating Partnership and has committed to make a significant equity investment in the Company of up to $36.0 million, which is equivalent to 12.0% of the $300.0 million maximum amount of the Offering. Specifically, the Special Limited Partner has committed to purchase subordinated participation interests in the Operating Partnership (the “Subordinated Participation Interests”) quarterly in an amount equal to the product of (i) $10.00 minus our then current estimated NAV per Common Share, multiplied by (ii) the number of our Common Shares outstanding. The Operating Partnership will issue one Subordinated Participation Interest for each $50,000 in cash or interests in real property of equivalent value that the Special Limited Partner contributes. The Special Limited Partner’s obligation will continue until the earlier of: (i) the termination of the Offering; (ii) the Special Limited Partner’s purchase of an aggregate of $36.0 million of Subordinated Participation Interests and (iii) the receipt of gross offering proceeds of $300.0 million. The Special Limited Partner may elect to purchase the Subordinated Participation Interests for cash or may contribute interests in real property of equivalent value.
Through December 31, 2016, the Special Limited Partner has purchased an aggregate of approximately 242 Subordinated Participation Interests in consideration of $12.1 million, including approximately 228 Subordinated Participation Interests in consideration of $11.4 million during the year ended December 31, 2016. The Special Limited Partner may elect to purchase the Subordinated Participation Interests for cash or may contribute interests in real property of equivalent value. The Subordinated Participation Interests may be entitled to receive liquidation distributions upon the liquidation of Lightstone REIT III.
We will utilize a portion of our public offering proceeds towards funding the dealer manager fees, selling commissions and organization and other offering costs of our Primary Offering.
Below is a summary of the expenses we have incurred in connection with the issuance and distribution of the registered securities since inception:
| (Dollars in Thousands) | ||||
| Type of Expense Amount | ||||
| Selling commissions and dealer manager fees | $ | 10,429 | ||
| Other offering costs | 4,781 | |||
| Total offering expenses incurred from inception through December 31, 2016 | $ | 15,210 |
From the Company’s inception date through December 31, 2016, it has used the cumulative net offering proceeds received of approximately $109.7 million (including the purchase of an aggregate of $12.1 million of Subordinated Participation Interests by the Special Limited Partner), after deducting the offering costs incurred of $15.2 million, as follows:
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| (Dollars in thousands) | ||||
| Purchase of investment properties, net of financings | $ | 55,157 | ||
| Cash and cash equivalents | 53,665 | |||
| Cash distributions not funded by operations | 422 | |||
| Funding of restricted escrows | 851 | |||
| Other uses (primarily timing of payables) | (429 | ) | ||
| Total uses | $ | 109,666 | ||
As of March 15, 2016, we have sold 13.2 million shares of common stock at an aggregate of price of $129.7 million, this includes, 306,841 shares of common stock at an aggregate price of $2.9 million under our DRIP.
ITEM 6. SELECTED FINANCIAL DATA:
The following selected consolidated financial data are qualified by reference to and should be read in conjunction with our consolidated financial statements and Notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.
| As of and for the Years Ended December 31, | ||||||||||||||||
| 2016 | 2015 | 2014 | 2013 | |||||||||||||
| Operating Data: | ||||||||||||||||
| Revenues | $ | 22,551,234 | $ | 6,203,341 | $ | - | $ | - | ||||||||
| Net loss | $ | (113,022 | ) | $ | (340,230 | ) | $ | (143,947 | ) | $ | (1,274 | ) | ||||
| Less: net (income)/loss attributable to noncontrolling interests | (7 | ) | 44 | 25 | - | |||||||||||
| Net loss applicable to Company's common shares | $ | (113,029 | ) | $ | (340,186 | ) | $ | (143,922 | ) | $ | (1,274 | ) | ||||
| Basic and diluted loss per Company's common shares | $ | (0.01 | ) | $ | (0.20 | ) | $ | (4.16 | ) | $ | (0.06 | ) | ||||
| Dividends declared on Company's common shares | $ | 4,732,111 | $ | 1,014,588 | $ | - | $ | - | ||||||||
| Weighted average common shares outstanding-basic and diluted | 7,865,348 | 1,675,534 | 34,605 | 20,000 | ||||||||||||
| Balance Sheet Data: | ||||||||||||||||
| Total assets | $ | 195,316,139 | $ | 35,615,560 | $ | 2,420,104 | $ | 198,726 | ||||||||
| Long-term obligations | $ | 86,870,343 | $ | - | $ | - | $ | - | ||||||||
| Revolving promissory notes payable – affiliate | $ | - | $ | 2,003,614 | $ | - | $ | - | ||||||||
| Company's Stockholders' Equity | $ | 92,976,233 | $ | 30,277,404 | $ | 313,551 | $ | 198,726 | ||||||||
| Other financial data: | ||||||||||||||||
| Funds from operations (FFO) attributable to Company's common shares (1) | $ | 3,071,199 | $ | 406,227 | $ | (143,922 | ) | $ | (1,274 | ) | ||||||
| 1. | For more information about FFO and MFFO, including a reconciliation to our GAAP net loss for each period reported, please see Management’s Discussion and Analysis of Financial Condition and Results of Operations - “Funds from Operations and Modified Funds from Operations.” |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
You should read the following discussion and analysis together with our consolidated financial statements and notes thereto included in this Annual Report on Form 10-K. The following information contains forward-looking statements, which are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize, actual results may differ materially from those expressed or implied by the forward-looking statements. Please see “Special Note Regarding Forward-Looking Statements” above for a description of these risks and uncertainties.
Overview
Lightstone Value Plus Real Estate Investment Trust III, Inc. (the “Lightstone REIT III” or “Company”) primarily has and intends to continue to acquire and operate full-service or select-service hotels, including extended-stay hotels and to a lesser extent commercial and residential properties, principally in North America. Principally through the Lightstone Value Plus REIT III, LP, (the “Operating Partnership”), our acquisitions may include both portfolios and individual properties.
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Our registration statement on Form S-11 (the “Offering”), pursuant to which we are offering to sell up to 30,000,000 shares of our common stock, par value $0.01 per share (which may be referred to herein as ‘‘shares of common stock’’ or as ‘‘Common Shares’’) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10,000,000 shares available pursuant to its distribution reinvestment plan (the “DRIP”) at an initial purchase price of $9.50 per share) was declared effective by the Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933 on July 15, 2014. As of December 31, 2016, we had received gross proceeds of $112.8 million from the sale of 11.5 million shares of its common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein (“Lichtenstein”) our sponsor, who does business through The Lightstone Group, LLC (the “Sponsor”) and majority owns the limited liability company of that name.
Capital required for the purchase of real estate and real estate related investments is expected to be obtained from the public offering of shares of our common stock, and from any indebtedness that we may incur in connection with the acquisition of any real estate and real estate related investments.
Even though we intend primarily to acquire hotels, we may use a portion of the offering proceeds to purchase other types of real estate. We believe that at least 75% of the net proceeds raised in the Offering will be used to acquire hotels and the remaining portion of the net proceeds raised in the Offering will be used to acquire properties and real estate-related assets other than hotels. However, we may use more or less than 75% of the net proceeds raised in the Offering to acquire hotels and are not bound to that limit. Assets other than hotels may include, without limitation, office buildings, shopping centers, business and industrial parks, manufacturing facilities, single-tenant properties, multifamily properties, student housing properties, warehouses and distribution facilities and medical office properties. We expect to invest a significant portion of our funds in direct real estate investments and other equity interests, and the remainder of our funds in debt interests, which may include bridge or mezzanine loans, including in furtherance of a loan-to-own strategy. However, we are not prohibited from investing all our funds in debt interests.
We initially expected to offer the Common Shares offered in our Primary Offering over a two-year period, or until July 15, 2016. However, because we had not sold all the Common Shares offered in our Primary Offering within two years, we will continue the Primary Offering for an additional year, until July 15, 2017, provided that the Offering will be terminated if all 30.0 million shares of our common stock are sold before such date. We reserve the right to reallocate the shares of common stock we are offering between the Primary Offering and the DRIP. Additionally, the Offering may be terminated at any time.
We do not have employees. We entered into an advisory agreement with Lightstone Value Plus REIT III LLC, a Delaware limited liability company, which we refer to as the “Advisor,” pursuant to which the Advisor supervises and manages our day-to-day operations and selects our real estate and real estate related investments, subject to oversight by our Board of Directors. We pay the Advisor fees for services related to the investment and management of our assets, and we will reimburse the Advisor for certain expenses incurred on our behalf.
To qualify or maintain our qualification as a REIT, we engage in certain activities through a wholly-owned taxable REIT subsidiary (“TRS”). As such, we are subject to U.S. federal and state income and franchise taxes from these activities.
Acquisitions and Investment Strategy
We have made and intend to make direct or indirect real estate investments that will satisfy our primary investment objectives of preserving capital, paying regular cash distributions and achieving appreciation of our assets over the long term. The ability of our Advisor to identify and execute investment opportunities at a pace consistent with the capital raised through our public offerings will directly impact our financial performance.
We will continue to seek to acquire and operate hotels and other commercial real estate assets primarily located in the United States. We may acquire and operate all such properties alone or jointly with another party.
The following summarizes our completed acquisitions and investments from our inception through December 31, 2016:
| · | On February 4, 2015 we acquired a 120-room select service Hampton Inn Hotel (the “Hampton Inn – Des Moines”) located in Des Moines, Iowa; |
| · | On May 15, 2015 we acquired a 146-room select service Courtyard by Marriott Hotel (the “Courtyard - Durham”) located in Durham, North Carolina; |
| · | On March 10, 2016 we acquired an 86-room select service Hampton Inn Hotel (the “Hampton Inn – Lansing”) located in Lansing, Michigan; |
| · | On March 23, 2016 we acquired a 92-room select service Courtyard by Marriott Hotel (the “Courtyard - Warwick”) located in Warwick, Rhode Island; |
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| · | On May 2, 2016 we acquired a 127-room select service SpringHill Suites by Marriott Hotel (the “SpringHill Suites – Green Bay”) located in Green Bay, Wisconsin; |
| · | On August 2, 2016 we acquired a portfolio of two select service Home2 Suites by Hilton Hotels, a 139-room select service hotel located in Tukwila, Washington (the “Home2 Suites – Tukwila”) and a 125-room select service hotel located in Salt Lake City, Utah (the “Home2 Suites – Salt Lake” and collectively the “Home2 Suites Hotel Portfolio”); |
| · | On September 13, 2016 we acquired an 84-room select service Fairfield Inn & Suites by Marriott Hotel (the “Fairfield Inn – Austin”) located in Austin, Texas; and |
| · | On October 7, 2016 we acquired an 80-room select service Staybridge Suites Hotel (the “Staybridge Suites– Austin”) located Austin, Texas. |
Current Environment
Our operating results as well as our investment opportunities are impacted by the health of the North American economies. Our business and financial performance may be adversely affected by current and future economic conditions, such as availability of credit, financial markets volatility, and recession.
Our business may be affected by market and economic challenges experienced by the U.S. and global economies. These conditions may materially affect the value and performance of our properties, and may affect our ability to pay distributions, the availability or the terms of financing that we have or may anticipate utilizing, and our ability to make principal and interest payments on, or refinance, any outstanding debt when due.
We are not aware of any other material trends or uncertainties, favorable or unfavorable, other than national economic conditions affecting real estate generally, that may be reasonably anticipated to have a material impact on either capital resources or the revenues or income to be derived from the acquisition and operation of real estate and real estate related investments, other than those referred to in this Form 10-K.
Critical Accounting Estimates and Policies
General.
Our consolidated financial statements included in this annual report include our accounts and the Operating Partnership (over which we exercise financial and operating control). All inter-company balances and transactions have been eliminated in consolidation.
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of our financial statements requires us to make estimates and judgments about the effects of matters or future events that are inherently uncertain. These estimates and judgments may affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
On an ongoing basis, we evaluate our estimates, including contingencies and litigation. We base these estimates on historical experience and on various other assumptions that we believe to be reasonable in the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
To assist in understanding our results of operations and financial position, we have identified our critical accounting policies and discussed them below. These accounting policies are most important to the portrayal of our results and financial position, either because of the significance of the financial statement items to which they relate or because they require management's most difficult, subjective or complex judgments.
Investments in Real Estate
We record investments in real estate at cost and capitalize improvements and replacements when they extend the useful life or improve the efficiency of the asset. We expense costs of repairs and maintenance as incurred. We compute depreciation using the straight-line method over the estimated useful lives of our real estate assets, which is approximately 39 years for buildings and improvements, 5 to 10 years for furniture and fixtures.
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We make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments will have a direct impact on our net income because, if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
When circumstances such as adverse market conditions indicate a possible impairment of the value of a property, we review the recoverability of the property’s carrying value. The review of recoverability will be based on our estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. Our forecast of these cash flows will consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, we record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the property.
We make subjective assessments as to whether there are impairments in the values of our investments in real estate. We will evaluate our ability to collect both interest and principal related to any real estate related investments in which we invest. If circumstances indicate that such investment is impaired, we reduce the carrying value of the investment to its net realizable value. Such reduction in value will be reflected as a charge to operations in the period in which the determination is made.
Real Estate Purchase Price Allocation
When we make an investment in real estate, the fair value of the real estate acquired will be allocated to the acquired tangible assets, consisting of land, building and tenant improvements, identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, for acquired in-place leases, and the value of tenant relationships, and certain liabilities such as assumed debt and contingent liabilities, based in each case on their fair values. Purchase accounting will be applied to assets and liabilities related to real estate entities acquired based upon the percentage of interest acquired. Fees incurred related to acquisitions will be expensed as incurred within general and administrative costs within the consolidated statements of operations. Transaction costs such as professional fees, commissions, acquisition fees and closing costs incurred related to our investment in unconsolidated real estate entities, accounted for under the equity method of accounting, will be capitalized as part of the cost of the investment.
Upon acquisition of real estate operating properties, we estimate the fair value of acquired tangible assets and identified intangible assets and liabilities, assumed debt and contingent liabilities at the date of acquisition, based upon an evaluation of information and estimates available at that date, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other relevant market data. Based on these estimates, we evaluate the existence of goodwill or a gain from a bargain purchase and will allocate the initial purchase price to the applicable assets, liabilities and noncontrolling interest, if any. As final information regarding fair value of the assets acquired and liabilities assumed and noncontrolling interest is received and estimates are refined, appropriate adjustments will be made to the purchase price allocation. The allocations will be finalized within twelve months of the acquisition date.
Revenue Recognition and Valuation of Related Receivables
Our revenue is comprised primarily of revenue from the operations of hotels. Hotel revenue will be recognized as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel’s services.
Accounting for Organization and Other Offering Costs
We record selling commissions and dealer manager fees paid to our dealer manager, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs and professional fees as reduction against additional paid-in capital. Any organization costs are expensed to general and administrative costs.
Treatment of Management Compensation, Expense Reimbursements
Management of our operations is outsourced to our Advisor and certain other affiliates of our Sponsor. Fees related to each of these services are accounted for based on the nature of such service and the relevant accounting literature. Fees for services performed that represent our period costs are expensed as incurred. Such fees include acquisition fees associated with the purchase of interests in real estate entities; asset management fees paid to our Advisor and property management fees paid to affiliates of our Advisor. These fees are expensed or capitalized to the basis of acquired assets, as appropriate.
Affiliates of our Advisor may also perform fee-based construction management services for both our development and redevelopment activities and tenant construction projects. These fees will be considered incremental to the construction effort and will be capitalized to the associated real estate project as incurred. Costs incurred for tenant construction will be depreciated over the shorter of their useful life or the term of the related lease. Costs related to development and redevelopment activities will be depreciated over the estimated useful life of the associated project.
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Leasing activity at our properties may be outsourced to affiliates of our Advisor. Any corresponding leasing fees we pay will be capitalized and amortized over the life of the related lease.
Expense reimbursements made to both our Advisor and affiliates of our Advisor will be expensed or capitalized to the basis of acquired assets, as appropriate.
Income Taxes
We elected to qualify and be taxed as a REIT for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2015. As a REIT, we generally will not be subject to U.S. federal income tax on our net taxable income that we distribute currently to our stockholders. To maintain our REIT qualification under the Internal Revenue Code of 1986, as amended (the “Code”) we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. If we fail to remain qualified for taxation as a REIT in any subsequent year and do not qualify for certain statutory relief provisions, our income for that year will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.
We engage in certain activities through taxable REIT subsidiaries TRSs. When we purchase a hotel we establish a TRS and enter into an operating lease agreement for the hotel. As such, we may be subject to U.S. federal and state income taxes and franchise taxes from these activities.
As of December 31, 2016 and 2015, we had no material uncertain income tax positions. Additionally, even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.
To qualify or maintain our qualification as a REIT, we engage in certain activities through TRSs. As such, we are subject to U.S. federal and state income and franchise taxes from these activities.
Results of Operations
During 2015, we acquired our first investment property, the Hampton Inn – Des Moines on February 4, 2015 and subsequently acquired the Courtyard – Durham on May 15, 2015. During 2016, we acquired the Hampton Inn – Lansing on March 10, 2016, the Courtyard – Warwick on March 23, 2016, the SpringHill Suites – Green Bay on May 2, 2016, the Home2 Suites Hotel Portfolio on August 2, 2016, the Fairfield Inn – Austin on September 13, 2016 and the Staybridge Suites – Austin on October 7, 2016. As a result, we have nine investment properties as of December 31, 2016. The operating results of these investment properties are reflected in our consolidated statements of operations commencing from their respective dates of acquisition.
Comparison of the year ended December 31, 2016 vs. December 31, 2015
Consolidated
The rental revenue, property operating expenses, real estate taxes and depreciation and amortization for the year ended December 31, 2016 is attributable to the Hampton Inn – Des Moines and the Courtyard – Durham and the Hampton Inn – Lansing, the Courtyard – Warwick, the SpringHill Suites – Green Bay, the Home2 Suites Hotel Portfolio, the Fairfield Inn – Austin and the Staybridge Suites – Austin from their respective dates of acquisition.
The rental revenue, property operating expenses, real estate taxes and depreciation and amortization for the year ended December 31, 2015 is attributable to the Hampton Inn – Des Moines and the Courtyard – Durham from their respective dates of acquisition.
Rental revenue
Rental revenue increased by $16.4 million to $22.6 million during the year ended December 31, 2016 compared to $6.2 million for the same period in 2015. Approximately $14.5 million of the increase was attributable to the hotels acquired subsequent to the 2015 period and $1.9 million of the increase was attributable to the Hampton Inn – Des Moines and the Courtyard – Durham which did not have a full year of operations in the 2015 period.
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Property operating expenses
Property operating expenses increased by $9.4 million to $13.1 million during the year ended December 31, 2016 compared to $3.7 million for the same period in 2015. Approximately $8.1 million of the increase was attributable to the hotels acquired subsequent to the 2015 period and $1.3 million of the increase was attributable to the Hampton Inn – Des Moines and the Courtyard – Durham which did not have a full year of operations in the 2015 period.
Real estate taxes
Real estate taxes increased by $0.6 million to $0.9 million during the year ended December 31, 2016 compared to $0.3 million for the same period in 2015. Approximately $0.4 million of the increase was attributable to the hotels acquired subsequent to the 2015 period and $0.2 million of the increase was attributable to the Hampton Inn – Des Moines and the Courtyard – Durham which did not have a full year of operations in the 2015 period.
General and administrative expense
General and administrative expense increased by $2.0 million to $2.9 million during the year ended December 31, 2016 compared to $0.9 million for the same period in 2015. The increase reflects (i) higher acquisition fees and acquisition-related costs of $1.7 million in the 2016 period and (ii) an increase in accounting and corporate filing fees.
Depreciation and amortization
Depreciation and amortization expense increased by $2.5 million to $3.2 million during the year ended December 31, 2016 compared to $0.7 million for the same period in 2015. Approximately $2.1 million of the increase was attributable to the hotels acquired subsequent to the 2015 period and $0.4 million of the increase was attributable to the Hampton Inn – Des Moines and the Courtyard – Durham which did not have a full year of operations in the 2015 period.
Interest expense
Interest expense was $2.5 million during the year ended December 31, 2016 compared to $0.9 million for the same period in 2015. Interest expense is attributable to financings associated with our hotels. During the years ended December 31, 2016 and 2015, interest expense of $0.6 million, which included origination fees of $0.3 million, and interest expense of $0.9 million, which included origination fees of $0.2 million, respectively, was paid to the operating partnership of Lightstone Value Plus Real Estate Investment Trust II, Inc. (“Lightstone II”), a REIT also sponsored by the Company’s Sponsor.
Financial Condition, Liquidity and Capital Resources
Overview:
For the year ended December 31, 2016, our primary source of funds were (i) $73.9 million of proceeds from our sale of shares of common stock under our Offering, (ii) $88.1 million in proceeds from our mortgage payable and (iii) $11.4 million received from the Special Limited Partner’s purchase of approximately 228 Subordinated Participation Interests. The primary source of capital required to fund our future purchases of real estate and/or real estate related investments will principally come from the proceeds related to our Offering, any additional proceeds received from the Special Limited Partner’s purchase of Subordinated Participation Interests, and from any indebtedness that we may incur in connection with the acquisition and operations of any real estate investments thereafter.
We have and intend to continue to utilize leverage either in connection with acquiring our properties or subsequent to their acquisition. The number of different properties we acquire will be affected by numerous factors, including, the amount of funds available to us. When interest rates on mortgage loans are high or financing is otherwise unavailable on terms that are satisfactory to us, we may purchase certain properties for cash with the intention of obtaining a mortgage loan for a portion of the purchase price at a later time.
Our future sources of funds are expected to primarily consist of (i) proceeds from our sale of shares of common stock under our Offering, (ii) cash flows from our operations, (iii) proceeds from our borrowings and (iv) proceeds from the potential sale of additional Subordinated Participation Interests to the Special Limited Partner and (v) proceeds from our DRIP. We currently believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.
We intend to limit our aggregate long-term permanent borrowings to 75% of the aggregate fair market value of all properties unless any excess borrowing is approved by a majority of the independent directors and is disclosed to our stockholders. Market conditions will dictate our overall leverage limit; as such our aggregate long-term permanent borrowings may be less than 75% of aggregate fair market value of all properties. We may also incur short-term indebtedness, having a maturity of two years or less.
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Our charter provides that the aggregate amount of our borrowing, both secured and unsecured, may not exceed 300% of net assets in the absence of a satisfactory showing that a higher level is appropriate, the approval of our Board of Directors and disclosure to stockholders. Net assets means our total assets, other than intangibles, at cost before deducting depreciation or other non-cash reserves less our total liabilities, calculated at least quarterly on a basis consistently applied. Any excess in borrowing over such 300% of net assets level must be approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report to stockholders, along with justification for such excess. Market conditions will dictate our overall leverage limit; as such our aggregate borrowings may be less than 300% of net assets. As of December 31, 2016, our total borrowings were $86.9 million which represented 81% of our net assets.
Our future borrowings may consist of single-property mortgages as well as mortgages cross-collateralized by a pool of properties. Such mortgages may be put in place either at the time we acquire a property or subsequent to our purchasing a property for cash. In addition, we may acquire properties that are subject to existing indebtedness where we choose to assume the existing mortgages. Generally, though not exclusively, we intend to seek to encumber our properties with non-recourse debt. This means that a lender’s rights on default will generally be limited to foreclosing on the property. However, we may, at our discretion, secure recourse financing or provide a guarantee to lenders if we believe this may result in more favorable terms. When we give a guaranty for a property owning entity, we will be responsible to the lender for the satisfaction of the indebtedness if it is not paid by the property owning entity.
In general the type of future financing executed by us to a large extent will be dictated by the nature of the investment and current market conditions. For long-term real estate investments, it is our intent to finance future acquisitions using long-term fixed rate debt. However there may be certain types of investments and market circumstances which may result in variable rate debt being the more appropriate choice of financing. To the extent floating rate debt is used to finance the purchase of real estate, management will evaluate a number of protections against significant increases in interest rates, including the purchase of interest rate cap instruments.
We may also obtain lines of credit to be used to acquire properties. If obtained, these lines of credit will be at prevailing market terms and will be repaid from offering proceeds, proceeds from the sale or refinancing of properties, working capital and/or permanent financing. Our Sponsor and/or its affiliates may guarantee our lines of credit although they are not obligated to do so. We may draw upon lines of credit to acquire properties pending our receipt of proceeds from our public offerings. We expect that such properties may be purchased by our Sponsor’s affiliates on our behalf, in our name, in order to minimize the imposition of a transfer tax upon a transfer of such properties to us.
In addition to making investments in accordance with our investment objectives, we have used and expect to continue use our capital resources to make certain payments to our Advisor, our Dealer Manager, and our Property Manager during the various phases of our organization and operation. During our organizational and offering stage, these payments include payments to our Dealer Manager for selling commissions and the dealer manager fee, and payments to our Advisor for the reimbursement of organization and other offering costs.
Selling commissions and dealer manager fees are paid to the Dealer Manager or soliciting dealers, as applicable, pursuant to various agreements, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs, and professional fees are accounted for as a reduction against additional paid-in capital as costs are incurred. Any organizational costs are accounted for as general and administrative costs. The following table represents the selling commissions and dealer manager fees and other offering costs for the periods indicated:
| For the Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Selling commissions and dealer manager fees | $ | 7,008,694 | $ | 3,377,887 | ||||
| Other offering costs | $ | 770,493 | $ | 1,870,078 | ||||
We have agreements with the Advisor to pay certain fees in exchange for services performed by the Advisor and/or its affiliated entities. Additionally, our ability to secure financing and our real estate operations are dependent upon our Advisor and its affiliates to perform such services as provided in these agreements. Furthermore, the Advisor has and is expected to continue to advance certain organization and offering costs on our behalf to the extent we do not have sufficient funds to pay such costs. As of December 31, 2016 and 2015, we owed the Advisor and its affiliated entities an aggregate of $109,532 and $1.2 million, respectively, which was principally for organization and offering costs paid on its behalf, and is classified as due to related parties on the consolidated balance sheets.
For the years ended December 31, 2016 and 2015, we paid the Advisor acquisition fees of approximately $1.1 million and $269,000, respectively.
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We currently expect that organization and offering expenses, other than selling commissions and dealer manager fee, will amount to approximately 2.0% of our gross offering proceeds assuming we sell the maximum amount of the Offering. In no event will organization and offering expenses ultimately exceed 15.0% of our gross offering proceeds. However, during the initial stage of our Offering, our organization and offering expenses may temporarily exceed 15.0% of gross offering proceeds since many of the expenses incurred in relation to the Offering were incurred prior to the sale of shares of our common stock.
During the acquisition and development stage, payments may include asset acquisition fees and financing coordination fees, and the reimbursement of acquisition related expenses to our Advisor. During our operational stage, we will pay affiliates of our Advisor and/or other third party property managers a property management fee and our Advisor an asset management fee or asset management participation or construction management fees. We also reimburse our Advisor and its affiliates for actual expenses it incurs for administrative and other services provided to us. Upon liquidation of assets, we may pay our advisor or its affiliates a real estate disposition commission. Additionally, our Operating Partnership may be required to make distributions to Lightstone SLP III LLC, an affiliate of the Advisor.
Other Related Party Transactions
From time to time, we may purchase title insurance from an agent in which our Sponsor owns a 50% limited partnership interest. Because this title insurance agent receives significant fees for providing title insurance, our Advisor may face a conflict of interest when considering the terms of purchasing title insurance from this agent. However, before we purchase any title insurance, an independent title consultant with more than 25 years of experience in the title insurance industry reviews the transaction, and performs market research and competitive analysis on our behalf. This process results in terms similar to those that would be negotiated at an arm’s length basis. During the years ended December 31, 2016 and 2015, we paid approximately $154,000 and $21,000, respectively, to the title insurance agent.
During the years ended December 31, 2016 and 2015, we paid $36,298 and $403,589, respectively, to an affiliate of the Sponsor for the Sponsor’s marketing expenses related to the offering that were recorded as a reduction to additional paid in capital.
During the year ended December 31, 2016 and 2015, we recorded interest expense of $606,147 (including origination fees of $276,666) and $904,302 (including origination fees of $178,334), respectively, to the operating partnership of Lightstone II in connection with the Des Moines Promissory Note, the Durham Promissory Note, the Lansing Promissory Note and the Green Bay Promissory Note.
Summary of Cash Flows
The following summary discussion of our cash flows is based on the consolidated statements of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below:
| Year Ended December 31, 2016 | Year Ended December 31, 2015 | |||||||
| Cash flows provided by operating activities | $ | 3,671,011 | $ | 697,917 | ||||
| Cash flows used in investing activities | (112,982,860 | ) | (28,211,839 | ) | ||||
| Cash flows provided by financing activities | 157,628,955 | 32,523,297 | ||||||
| Net change in cash and cash equivalents | 48,317,106 | 5,009,375 | ||||||
| Cash and cash equivalents, beginning of the year | 6,747,401 | 1,738,026 | ||||||
| Cash and cash equivalents, end of the year | $ | 55,064,507 | $ | 6,747,401 | ||||
Our principal sources of cash flow were derived from proceeds received from our Offering, proceeds received from our borrowings, proceeds received from the Special Limited Partner’s purchase of Subordinated Participation Interests and operating cash flows provided by our properties. In the future, we expect to acquire additional properties which we expect to provide us with a relatively consistent stream of cash flow to sufficiently fund our operating expenses, any scheduled debt service and any monthly distributions authorized by our Board of Directors.
Our principal demands for liquidity currently are expected to be acquisition and development activities, distribution payments, scheduled debt service and costs associated with our Offering. The principal sources of funding for our operations are currently expected to be proceeds from the issuance of equity securities and financings.
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Operating activities
The net cash provided by operating activities of $3.7 million during the year ended December 31, 2016 consisted of our net loss of $0.1 million adjusted for depreciation and amortization, amortization of deferred financing costs and other non-cash items aggregating $3.7 million and net changes in operating assets and liabilities of $0.1 million.
Investing activities
The cash used in investing activities of $113.0 million during the year ended December 31, 2016 primarily consisted of approximately $112.3 million for the purchase of investment property and refundable escrow deposits of $0.7 million.
Financing activities
The net cash provided by financing activities of $157.6 million during the year ended December 31, 2016 consisted of $73.9 million of offering proceeds, $88.1 million in proceeds from our mortgages payable and $11.4 million received from the Special Limited Partner’s purchase of approximately 228 Subordinated Participation Interests; partially offset by the payment of $9.2 million of commissions and offering costs, $2.1 million in net payments on our Revolving Promissory Notes Payable – Related Party, cash distributions of $2.6 million to our common stockholders, the payment of loan fees and expenses of $1.6 million and the redemptions and cancellations of shares of common stock of $0.3 million.
We believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.
Distribution Reinvestment and Share Repurchase Programs
Our DRIP provides our stockholders with an opportunity to purchase additional shares of our common stock, at an initial purchase price of $9.50 per share, equal to 95% of our Offering price of $10.00 per share, by reinvesting their distributions. In connection with our Offering, 10,000,000 Common Shares were reserved for issuance under our DRIP and as of December 31, 2016, 220,847 shares of common stock had been issued under our DRIP and 9,779,153 shares remain available for issuance.
Our share repurchase program may provide our stockholders with limited, interim liquidity by enabling them to sell their shares of common stock back to us, subject to restrictions. From our date of inception through December 31, 2015, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the year ended December 31, 2016 we repurchased 34,358 shares of common stock, pursuant to our share repurchase program. We repurchased the shares at an average price per share of $9.99 per share. We funded share repurchases for the periods noted above from the cumulative proceeds of the sale of our shares pursuant to our DRIP.
Our Board of Directors reserves the right to terminate either program for any reason without cause by providing 10 days written notice of termination of the distribution reinvestment program to all participants or written notice of termination of the share repurchase program to all stockholders.
Contractual Obligations
The following is a summary of our estimated contractual obligations outstanding over the next five years and thereafter as of December 31, 2016.
| Contractual Obligations | 2017 | 2018 | 2019 | 2020 | 2021 | Thereafter | Total | |||||||||||||||||||||
| Principal maturities | $ | 424,252 | $ | 445,052 | $ | 60,162,871 | $ | 486,092 | $ | 26,509,613 | $ | - | $ | 88,027,880 | ||||||||||||||
| Interest payments | 4,938,482 | 4,928,583 | 3,516,092 | 1,287,576 | 1,051,196 | - | 15,721,929 | |||||||||||||||||||||
| Total | $ | 5,362,734 | $ | 5,373,635 | $ | 63,678,963 | $ | 1,773,668 | $ | 27,560,809 | $ | - | $ | 103,749,809 | ||||||||||||||
Funds from Operations and Modified Funds from Operations
The historical accounting convention used for real estate assets requires straight-line depreciation of buildings, improvements, and straight-line amortization of intangibles, which implies that the value of a real estate asset diminishes predictably over time. We believe that, because real estate values historically rise and fall with market conditions, including, but not limited to, inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using the historical accounting convention for depreciation and certain other items may be less informative.
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Because of these factors, the National Association of Real Estate Investment Trusts ("NAREIT"), an industry trade group, has published a standardized measure of performance known as funds from operations ("FFO"), which is used in the REIT industry as a supplemental performance measure. We believe FFO, which excludes certain items such as real estate-related depreciation and amortization, is an appropriate supplemental measure of a REIT's operating performance. FFO is not equivalent to our net income or loss as determined under GAAP.
We define FFO, a non-GAAP measure, consistent with the standards set forth in the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the "White Paper"). The White Paper defines FFO as net income or loss computed in accordance with GAAP, but excluding gains or losses from sales of property and real estate related impairments, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.
We believe that the use of FFO provides a more complete understanding of our performance to investors and to management, and reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income.
Changes in the accounting and reporting promulgations under GAAP that were put into effect in 2009 subsequent to the establishment of NAREIT's definition of FFO, such as the change to expense as incurred rather than capitalize and depreciate acquisition fees and expenses incurred for business combinations, have prompted an increase in cash-settled expenses, specifically acquisition fees and expenses, as items that are expensed under GAAP across all industries. These changes had a particularly significant impact on publicly registered, non-listed REITs, which typically have a significant amount of acquisition activity in the early part of their existence, particularly during the period when they are raising capital through ongoing initial public offerings.
Because of these factors, the Investment Program Association (the "IPA"), an industry trade group, published a standardized measure of performance known as modified funds from operations ("MFFO"), which the IPA has recommended as a supplemental measure for publicly registered, non-listed REITs. MFFO is designed to be reflective of the ongoing operating performance of publicly registered, non-listed REITs by adjusting for those costs that are more reflective of acquisitions and investment activity, along with other items the IPA believes are not indicative of the ongoing operating performance of a publicly registered, non-listed REIT, such as straight-lining of rents as required by GAAP. We believe it is appropriate to use MFFO as a supplemental measure of operating performance because we believe that both before and after we have deployed all of our offering proceeds and are no longer incurring a significant amount of acquisition fees or other related costs, it reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income. MFFO is not equivalent to our net income or loss as determined under GAAP.
We define MFFO, a non-GAAP measure, consistent with the IPA's Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations (the "Practice Guideline") issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for acquisition and transaction-related fees and expenses and other items. In calculating MFFO, we follow the Practice Guideline and exclude acquisition and transaction-related fees and expenses (which includes costs incurred in connection with strategic alternatives), amounts relating to deferred rent receivables and amortization of market lease and other intangibles, net (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments), accretion of discounts and amortization of premiums on debt investments and borrowings, mark-to-market adjustments included in net income (including gains or losses incurred on assets held for sale), gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. Certain of the above adjustments are also made to reconcile net income (loss) to net cash provided by (used in) operating activities, such as for the amortization of a premium and accretion of a discount on debt and securities investments, amortization of fees, any unrealized gains (losses) on derivatives, securities or other investments, as well as other adjustments.
MFFO excludes non-recurring impairment of real estate-related investments. We assess the credit quality of our investments and adequacy of reserves on a quarterly basis, or more frequently as necessary. Significant judgment is required in this analysis. We consider the estimated net recoverable value of a loan as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive situation of the region where the borrower does business.
We believe that, because MFFO excludes costs that we consider more reflective of acquisition activities and other non-operating items, MFFO can provide, on a going-forward basis, an indication of the sustainability (that is, the capacity to continue to be maintained) of our operating performance after the period in which we are acquiring properties and once our portfolio is stabilized. We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry and allows for an evaluation of our performance against other publicly registered, non-listed REITs.
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Not all REITs, including publicly registered, non-listed REITs, calculate FFO and MFFO the same way. Accordingly, comparisons with other REITs, including publicly registered, non-listed REITs, may not be meaningful. Furthermore, FFO and MFFO are not indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as determined under GAAP as an indication of our performance, as an alternative to cash flows from operations as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders. FFO and MFFO should be reviewed in conjunction with other GAAP measurements as an indication of our performance. FFO and MFFO should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or in its applicability in evaluating our operating performance. The methods utilized to evaluate the performance of a publicly registered, non-listed REIT under GAAP should be construed as more relevant measures of operational performance and considered more prominently than the non-GAAP measures, FFO and MFFO, and the adjustments to GAAP in calculating FFO and MFFO.
Neither the SEC, NAREIT, the IPA nor any other regulatory body or industry trade group has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, NAREIT, the IPA or another industry trade group may publish updates to the White Paper or the Practice Guidelines or the SEC or another regulatory body could standardize the allowable adjustments across the publicly registered, non-listed REIT industry, and we would have to adjust our calculation and characterization of FFO or MFFO accordingly.
The below table illustrates the items deducted from or added to net loss in the calculation of FFO and MFFO during the periods presented. The table discloses MFFO in the IPA recommended format and MFFO without the straight-line rent adjustment which management also uses as a performance measure. Items are presented net of non-controlling interest portions where applicable.
| For the Year Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Net loss | $ | (113,022 | ) | $ | (340,230 | ) | ||
| FFO adjustments: | ||||||||
| Depreciation and amortization of real estate assets | 3,184,298 | 746,492 | ||||||
| FFO | 3,071,276 | 406,262 | ||||||
| MFFO adjustments: | ||||||||
| Acquisition and other transaction related costs expensed | 2,152,938 | 597,327 | ||||||
| MFFO | 5,224,214 | 1,003,589 | ||||||
| Straight-line rent(1) | - | - | ||||||
| MFFO - IPA recommended format | $ | 5,224,214 | $ | 1,003,589 | ||||
| Net loss | $ | (113,022 | ) | $ | (340,230 | ) | ||
| Less: net (income)/loss attributable to noncontrolling interests | (7 | ) | 44 | |||||
| Net loss applicable to Company's common shares | $ | (113,029 | ) | $ | (340,186 | ) | ||
| Net loss per common share, basic and diluted | $ | (0.01 | ) | $ | (0.20 | ) | ||
| FFO | $ | 3,071,276 | $ | 406,262 | ||||
| Less: FFO attributable to noncontrolling interests | (77 | ) | (35 | ) | ||||
| FFO attributable to Company's common shares | $ | 3,071,199 | $ | 406,227 | ||||
| FFO per common share, basic and diluted | $ | 0.39 | $ | 0.24 | ||||
| MFFO - IPA recommended format | $ | 5,224,214 | $ | 1,003,589 | ||||
| Less: MFFO attributable to noncontrolling interests | (132 | ) | (131 | ) | ||||
| MFFO attributable to Company's common shares | $ | 5,224,082 | $ | 1,003,458 | ||||
| Weighted average number of common shares outstanding, basic and diluted | 7,865,348 | 1,675,534 | ||||||
| (1) | Under GAAP, rental receipts are allocated to periods using various methodologies. This may result in income recognition that is significantly different than underlying contract terms. By adjusting for these items (to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments), MFFO provides useful supplemental information on the realized economic impact of lease terms and debt investments, providing insight on the contractual cash flows of such lease terms and debt investments, and aligns results with management’s analysis of operating performance. |
The table below presents our cumulative distributions declared and cumulative FFO:
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| For the period October 5, 2012 | ||||
| (date of inception) through | ||||
| December 31, 2016 | ||||
| FFO attributable to Company's common shares | $ | 3,332,230 | ||
| Cumulative distributions declared | $ | 5,746,699 | ||
New Accounting Pronouncements
See Note 2 to the Notes to Consolidated Financial Statements for further information of certain accounting standards that have been adopted during 2016 and certain accounting standards that we have not yet been required to implement and may be applicable to our future operations.
Subsequent Events
See Note 9 of the Notes to Consolidated Financial Statements for further information related to subsequent events during the period from January 1, 2017 through the date of the financial statements.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:
Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. The primary market risk to which we are currently and expect to continue to be exposed is interest rate risk.
We are currently and expect to continue to be exposed to the effects of interest rate changes primarily as a result of borrowings used to maintain liquidity and fund the expansion and refinancing of our real estate investment portfolio and operations. Our interest rate risk management objectives have been and will continue to be to limit the impact of interest rate changes on our earnings, prepayment penalties and cash flows and to lower overall borrowing costs while taking into account variable interest rate risk. To achieve our objectives, we may borrow at fixed rates or variable rates. We may also enter into derivative financial instruments such as interest rate swaps and caps in order to mitigate our interest rate risk on a related financial instrument. We will not enter into derivative or interest rate transactions for speculative purposes. As of December 31, 2016, we did not have any derivative agreements outstanding. We do not anticipate having any foreign operations and thus we do not expect to be exposed to foreign currency fluctuations.
The carrying amounts reported in the consolidated balance sheets for cash, accounts receivable (included in other assets) and accounts payable and other accrued expenses approximated their fair values as of December 31, 2016 because of the short maturity of these instruments.
The following table shows our estimated principal maturities during the next five years and thereafter as of December 31, 2016:
| 2017 | 2018 | 2019 | 2020 | 2021 | Thereafter | Total | ||||||||||||||||||||||
| Principal maturities | $ | 424,252 | $ | 445,052 | $ | 60,162,871 | $ | 486,092 | $ | 26,509,613 | $ | - | $ | 88,027,880 | ||||||||||||||
As of December 31, 2016, approximately $59.7 million, or 68%, of our debt, is a variable rate instrument (not subject to an interest rate cap or swap) and our interest expense associated with this instrument is, therefore, subject to changes in market interest rates. A 1% adverse movement (increase in Libor or Prime rate) would increase annual interest expense by approximately $0.6 million
The estimated fair value of our mortgages payable is as follows:
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| As of December 31, 2016 | ||||||||
| Carrying Amount | Estimated Fair Value | |||||||
| Mortgages payable | $ | 88,027,880 | $ | 87,252,072 | ||||
The fair value of our mortgages payable was determined by discounting the future contractual interest and principal payments by market interest rates.
As of December 31, 2015, the estimated fair value of our revolving promissory notes payable – related party approximated its carrying value ($2.1 million) because of its floating interest rate.
In addition to changes in interest rates, the value of our real estate and real estate related investments is subject to fluctuations based on changes in local and regional economic conditions and changes in the creditworthiness of tenants, which may affect our ability to obtain or refinance debt in the future. As of December 31, 2016, we had no off-balance sheet arrangements.
We cannot predict the effect of adverse changes in interest rates on our debt and, therefore, our exposure to market risk, nor can we provide any assurance that long-term debt will be available at advantageous pricing. Consequently, future results may differ materially from the estimated adverse changes discussed above.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Lightstone Value Plus Real Estate Investment Trust III, Inc. and Subsidiaries
(a Maryland corporation)
Schedules not filed:
All schedules other than the one listed in the index have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Lightstone Value Plus Real Estate Investment Trust III, Inc.
We have audited the accompanying consolidated balance sheets of Lightstone Value Plus Real Estate Investment Trust III, Inc. and Subsidiaries (the “Company”) as of December 31, 2016 and 2015 and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years then ended. In connection with our audits of the consolidated financial statements, we have also audited financial statement schedule “Schedule III – Real Estate and Accumulated Depreciation” as of December 31, 2016. The financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lightstone Value Plus Real Estate Investment Trust III, Inc. and Subsidiaries as of December 31, 2016 and 2015 and the consolidated results of their operations and their cash flows for each of the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information stated therein.
/s/ EisnerAmper LLP
Iselin, New Jersey
March 27, 2017
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| December 31, 2016 | December 31, 2015 | |||||||
| Assets | ||||||||
| Investment property: | ||||||||
| Land and improvements | $ | 22,283,209 | $ | 2,205,864 | ||||
| Building and improvements | 103,080,704 | 22,258,087 | ||||||
| Furniture and fixtures | 15,133,479 | 2,501,282 | ||||||
| Construction in progress | 130,249 | 1,175,110 | ||||||
| Gross investment property | 140,627,641 | 28,140,343 | ||||||
| Less accumulated depreciation | (3,862,125 | ) | (731,289 | ) | ||||
| Net investment property | 136,765,516 | 27,409,054 | ||||||
| Cash | 55,064,507 | 6,747,401 | ||||||
| Deposits | 851,441 | 1,000,000 | ||||||
| Accounts receivable and other assets | 2,634,675 | 459,105 | ||||||
| Total Assets | $ | 195,316,139 | $ | 35,615,560 | ||||
| Liabilities and Stockholders' Equity | ||||||||
| Accounts payable and other accrued expenses | $ | 2,684,346 | $ | 1,285,160 | ||||
| Mortgages payable | 86,870,343 | - | ||||||
| Revolving promissory notes payable, net - related party | - | 2,003,614 | ||||||
| Due to related parties | 109,532 | 1,159,314 | ||||||
| Distributions payable | 583,113 | 188,253 | ||||||
| Total liabilities | 90,247,334 | 4,636,341 | ||||||
| Commitments and Contingencies | ||||||||
| Stockholders' Equity: | ||||||||
| Company's stockholders' equity: | ||||||||
| Preferred stock, $0.01 par value; 50,000,000 shares authorized, none issued and outstanding | - | - | ||||||
| Common stock, $0.01 par value; 200,000,000 shares authorized, 11,656,877 and 4,009,656 shares issued and outstanding, respectively | 116,569 | 40,097 | ||||||
| Additional paid-in-capital | 99,309,774 | 32,081,648 | ||||||
| Subscription receivable | (105,000 | ) | (344,371 | ) | ||||
| Accumulated deficit | (6,345,110 | ) | (1,499,970 | ) | ||||
| Total Company stockholders' equity | 92,976,233 | 30,277,404 | ||||||
| Noncontrolling interests | 12,092,572 | 701,815 | ||||||
| Total Stockholders' Equity | 105,068,805 | 30,979,219 | ||||||
| Total Liabilities and Stockholders' Equity | $ | 195,316,139 | $ | 35,615,560 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
| For the Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Revenues | $ | 22,551,234 | $ | 6,203,341 | ||||
| Expenses: | ||||||||
| Property operating expenses | 13,111,144 | 3,685,843 | ||||||
| Real estate taxes | 926,424 | 251,400 | ||||||
| General and administrative costs | 2,869,290 | 946,228 | ||||||
| Depreciation and amortization | 3,184,298 | 746,492 | ||||||
| Total operating expenses | 20,091,156 | 5,629,963 | ||||||
| Operating income | 2,460,078 | 573,378 | ||||||
| Interest expense | (2,499,238 | ) | (904,302 | ) | ||||
| Other expense, net | (73,862 | ) | (9,306 | ) | ||||
| Net loss | (113,022 | ) | (340,230 | ) | ||||
| Less: net (income)/loss attributable to noncontrolling interests | (7 | ) | 44 | |||||
| Net loss applicable to Company's common shares | $ | (113,029 | ) | $ | (340,186 | ) | ||
| Net loss per Company's common shares, basic and diluted | $ | (0.01 | ) | $ | (0.20 | ) | ||
| Weighted average number of common shares outstanding, basic and diluted | 7,865,348 | 1,675,534 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| Common Shares | Additional Paid-In | Subscription | Total Noncontrolling | Total | ||||||||||||||||||||||||
| Shares | Amount | Capital | Receivable | Accumulated Deficit | Interests | Equity | ||||||||||||||||||||||
| BALANCE, December 31, 2014 | 286,674 | $ | 2,867 | $ | 455,880 | $ | - | $ | (145,196 | ) | $ | 1,975 | $ | 315,526 | ||||||||||||||
| Net loss | - | - | - | - | (340,186 | ) | (44 | ) | (340,230 | ) | ||||||||||||||||||
| Distributions declared | - | - | - | - | (1,014,588 | ) | - | (1,014,588 | ) | |||||||||||||||||||
| Distributions paid to noncontrolling interests | - | - | - | - | - | (116 | ) | (116 | ) | |||||||||||||||||||
| Contributions from noncontrolling interests | - | - | - | - | - | 700,000 | 700,000 | |||||||||||||||||||||
| Proceeds from offering | 3,688,657 | 36,887 | 36,547,987 | (344,371 | ) | - | - | 36,240,503 | ||||||||||||||||||||
| Selling commissions and dealer manager fees | - | - | (3,377,887 | ) | - | - | - | (3,377,887 | ) | |||||||||||||||||||
| Other offering costs | - | - | (1,870,078 | ) | - | - | - | (1,870,078 | ) | |||||||||||||||||||
| Shares issued from distribution reinvestment program | 34,325 | 343 | 325,746 | - | - | - | 326,089 | |||||||||||||||||||||
| BALANCE, December 31, 2015 | 4,009,656 | $ | 40,097 | $ | 32,081,648 | $ | (344,371 | ) | $ | (1,499,970 | ) | $ | 701,815 | $ | 30,979,219 | |||||||||||||
| Net (loss)/income | - | - | - | - | (113,029 | ) | 7 | (113,022 | ) | |||||||||||||||||||
| Distributions declared | - | - | - | - | (4,732,111 | ) | - | (4,732,111 | ) | |||||||||||||||||||
| Distributions paid to noncontrolling interests | - | - | - | - | - | (120 | ) | (120 | ) | |||||||||||||||||||
| Contributions from noncontrolling interests | - | - | - | - | - | 11,390,870 | 11,390,870 | |||||||||||||||||||||
| Proceeds from offering | 7,495,057 | 74,951 | 73,589,137 | 239,371 | - | - | 73,903,459 | |||||||||||||||||||||
| Selling commissions and dealer manager fees | - | - | (7,008,694 | ) | - | - | - | (7,008,694 | ) | |||||||||||||||||||
| Other offering costs | - | - | (770,493 | ) | - | - | - | (770,493 | ) | |||||||||||||||||||
| Shares issued from distribution reinvestment program | 186,522 | 1,865 | 1,761,016 | - | - | 1,762,881 | ||||||||||||||||||||||
| Redemption and cancellation of shares | (34,358 | ) | (344 | ) | (342,840 | ) | - | - | - | (343,184 | ) | |||||||||||||||||
| BALANCE, December 31, 2016 | 11,656,877 | $ | 116,569 | $ | 99,309,774 | $ | (105,000 | ) | $ | (6,345,110 | ) | $ | 12,092,572 | $ | 105,068,805 | |||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net loss | $ | (113,022 | ) | $ | (340,230 | ) | ||
| Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
| Depreciation and amortization | 3,184,298 | 746,492 | ||||||
| Amortization of deferred financing costs | 463,318 | 178,333 | ||||||
| Other non-cash adjustments | 19,334 | 13,029 | ||||||
| Changes in assets and liabilities: | ||||||||
| Increase in accounts receivable and other assets | (1,350,571 | ) | (175,260 | ) | ||||
| Increase in accounts payable and other accrued expenses | 1,456,349 | 271,992 | ||||||
| Increase in due to related parties | 11,305 | 3,561 | ||||||
| Net cash provided by operating activities | 3,671,011 | 697,917 | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Purchase of investment property | (112,261,759 | ) | (27,211,839 | ) | ||||
| Funding of restricted escrows | (721,101 | ) | (1,000,000 | ) | ||||
| Net cash used in investing activities | (112,982,860 | ) | (28,211,839 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Proceeds from mortgages payable | 88,096,000 | - | ||||||
| Payments on mortgages payable | (68,120 | ) | - | |||||
| Proceeds from revolving promissory notes payable - related party | 24,200,000 | 20,200,000 | ||||||
| Payments on revolving promissory notes payable - related party | (26,255,281 | ) | (18,144,719 | ) | ||||
| Payment of loan fees and expenses | (1,569,187 | ) | (230,000 | ) | ||||
| Proceeds from issuance of common stock | 73,903,459 | 36,240,503 | ||||||
| Payment of commissions and offering costs | (9,151,111 | ) | (5,042,125 | ) | ||||
| Proceeds from noncontrolling interests | 11,390,870 | - | ||||||
| Distributions to noncontrolling interests | (120 | ) | (116 | ) | ||||
| Distributions to common stockholders | (2,574,371 | ) | (500,246 | ) | ||||
| Redemption and cancellation of common shares | (343,184 | ) | - | |||||
| Net cash provided by financing activities | 157,628,955 | 32,523,297 | ||||||
| Net change in cash | 48,317,106 | 5,009,375 | ||||||
| Cash, beginning of year | 6,747,401 | 1,738,026 | ||||||
| Cash, end of year | $ | 55,064,507 | $ | 6,747,401 | ||||
| Supplemental cash flow information for the periods indicated is as follows: | ||||||||
| Cash paid for interest | $ | 1,650,513 | $ | 719,741 | ||||
| Distributions declared, but not paid | $ | 583,113 | $ | 188,253 | ||||
| Commissions and other offering costs accrued but not paid | $ | 109,540 | $ | 420,377 | ||||
| Subscription receivable | $ | 105,000 | $ | 344,371 | ||||
| Value of shares issued from distribution reinvestment program | $ | 1,762,881 | $ | 326,089 | ||||
| Application of deposit to acquisition of investment property | $ | 869,660 | $ | 500,000 | ||||
| Contribution of non-controlling interest received as offset to due to affiliate | $ | - | $ | 700,000 | ||||
| Investment property acquired but not paid | $ | - | $ | 296,040 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2016 and 2015
1. Organization
Lightstone Value Plus Real Estate Investment Trust III, Inc. (‘‘Lightstone REIT III’’), incorporated on October 5, 2012, in Maryland, elected to qualify and be taxed as a real estate investment trust (‘‘REIT’’) for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2015. Through December 31, 2016, the Company has acquired nine wholly-owned hotels and it will continue to seek to acquire additional hotels and other commercial real estate assets primarily located in the United States. All such properties may be acquired and operated by the Company alone or jointly with another party. The Company may also originate or acquire mortgage loans secured by real estate.
The Lightstone REIT III is structured as an umbrella partnership REIT, or UPREIT, and substantially all of its current and future business will be conducted through Lightstone Value Plus REIT III LP, a Delaware limited partnership (the ‘‘Operating Partnership’’).
Lightstone REIT III and the Operating Partnership and its subsidiaries are collectively referred to as the “Company” and the use of “we,” “our,” “us” or similar pronouns refers to Lightstone REIT III, its Operating Partnership or the Company as required by the context in such pronoun used.
Offering and Structure
Our sponsor David Lichtenstein (“Lichtenstein”), who does business as the Lightstone Group (the “Sponsor”) and majority owns the limited liability company of that name with a diversified portfolio of over 120 properties containing approximately 10,000 multifamily units, approximately 250,000 square feet of office space, 1.5 million square feet of industrial space, 31 hotels and 4.6 million square feet of retail space. The residential, office, industrial, hotel and retail properties are located in 26 states. Based in New York and supported by a regional office in New Jersey, our sponsor employs approximately 397 staff and professionals.
Our advisor is Lightstone Value Plus REIT III LLC (the “Advisor”), which is majority owned by our Sponsor. Our Advisor, together with our board of directors (the “Board of Directors”), is and will continue to be primarily responsible for making investment decisions and managing our day-to-day operations. Through his ownership and control of The Lightstone Group, Mr. Lichtenstein is the indirect owner of the Advisor and the indirect owner and manager of Lightstone SLP III LLC, which has subordinated participation interests in the Operating Partnership. Mr. Lichtenstein also acts as the Company’s Chairman and Chief Executive Officer. As a result, he exerts influence over but does not control Lightstone REIT III or the Operating Partnership.
We do not have and will not have any employees that are not also employed by our Sponsor or its affiliates. We depend substantially on our Advisor, which generally has responsibility for our day-to-day operations. Under the terms of the advisory agreement, the Advisor also undertakes to use its reasonable best efforts to present to us investment opportunities consistent with our investment policies and objectives as adopted by our Board of Directors.
Orchard Securities, LLC (the ‘‘Dealer Manager’’), a broker-dealer registered with FINRA, serves as the dealer manager of the Company’s public offering. The Dealer Manager also has opened an OSJ (“Office of Supervisory Jurisdiction”) that does business as “Lightstone Capital Markets” and focuses primarily on distributing interests in programs sponsored by our Sponsor.
Our Sponsor has various majority owned and controlled affiliated property managers, which may manage certain of the properties we acquire. However, we also contract with other unaffiliated third-party property managers, principally for the management of our hospitality properties.
Our registration statement on Form S-11 (the “Offering”), pursuant to which we are offering to sell up to 30.0 million shares of our common stock, par value $0.01 per share (which may be referred to herein as “shares of common stock” or as “Common Shares”) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10.0 million shares of common stock available pursuant to our distribution reinvestment program (the “DRIP”) at an initial purchase price of $9.50 per share) was declared effective by the Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933 on July 15, 2014 and we began offering our shares of our common stock for sale to the public.
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As of December 31, 2016, we had received aggregate gross proceeds of approximately $112.8 million from the sale of 11.5 million shares of our common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein, who also owns a majority interest in our Sponsor) in our Offering.
The Company initially expected to offer the Common Shares offered in its Primary Offering over a two-year period, or until July 15, 2016. However, because the Company had not sold all the Common Shares offered in its Primary Offering within two years, the Company will continue the Primary Offering for an additional year, until July 15, 2017, provided that the Offering will be terminated if all 30.0 million shares of our common stock are sold before such date. The Company reserves the right to reallocate the shares of common stock it is offering between the Primary offering and the DRIP. Additionally, the Offering may be terminated at any time.
As of December 31, 2016, our Advisor owned 20,000 shares of common stock which were issued on December 24, 2012 for $200,000 or $10.00 per share.
As of December 11, 2014, we had reached the minimum offering under our Offering by receiving subscriptions of our Common Shares, representing gross offering proceeds of approximately $2.0 million, and effective December 11, 2014 investors were admitted as stockholders and our Operating Partnership commenced operations. Through December 31, 2016, cumulative gross offering proceeds of approximately $112.8 million were released to us.
Our shares of common stock are not currently listed on a national securities exchange. We may seek to list our shares of common stock for trading on a national securities exchange only if a majority of our independent directors believe listing would be in the best interest of our stockholders. We do not intend to list our shares of common stock at this time. We do not anticipate that there would be any market for our shares of common stock until they are listed for trading. In the event we do not begin the process of achieving a liquidity event prior to the eighth anniversary of the termination of our Offering, our charter requires either (a) an amendment to our charter to extend the deadline to begin the process of achieving a liquidity event, or (b) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio.
Noncontrolling Interests
Partners of Operating Partnership
On July 16, 2014, our Advisor contributed $2,000 to the Operating Partnership in exchange for 200 limited partner units in the Operating Partnership. A limited partner has the right to convert operating partnership units into cash or, at our option, an equal number of our common shares, as allowed by the limited partnership agreement.
Lightstone REIT III invested the proceeds received from the Offering and its Advisor in the Operating Partnership, and as a result, held a 99% general partnership interest as of December 31, 2016 and 2015 in the Operating Partnership’s common units.
Special Limited Partner
Lightstone SLP III LLC (the ‘‘Special Limited Partner’’), a Delaware limited liability company of which Mr. Lichtenstein is the majority owner, is a special limited partner in the Operating Partnership and has committed to make a significant equity investment in the Company of up to $36.0 million, which is equivalent to 12.0% of the $300.0 million maximum amount of the Offering. Specifically, the Special Limited Partner has committed to purchase subordinated participation interests in the Operating Partnership (the “Subordinated Participation Interests”) quarterly in an amount equal to the product of (i) $10.00 minus our then current estimated NAV per Common Share, multiplied by (ii) the number of our Common Shares outstanding. The Operating Partnership will issue one Subordinated Participation Interest for each $50,000 in cash or interests in real property of equivalent value that the Special Limited Partner contributes. The Special Limited Partner’s obligation will continue until the earlier of: (i) the termination of the Offering; (ii) the Special Limited Partner’s purchase of an aggregate of $36.0 million of Subordinated Participation Interests and (iii) the receipt of gross offering proceeds of $300.0 million.
Through December 31, 2016, the Special Limited Partner has purchased an aggregate of approximately 242 Subordinated Participation Interests in consideration of $12.1 million, including approximately 228 Subordinated Participation Interests in consideration of $11.4 million during the year ended December 31, 2016. The Special Limited Partner may elect to purchase the Subordinated Participation Interests for cash or may contribute interests in real property of equivalent value. The Subordinated Participation Interests may be entitled to receive liquidation distributions upon the liquidation of Lightstone REIT III.
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Related Parties
Our Advisor and its affiliates and the Special Limited Partner are related parties of the Company. Certain of these entities have or will receive compensation for services related to the Offering and will continue to receive compensation and services for the investment, management and disposition of our assets. These entities have and/or will receive compensation during the offering, acquisition, operational and liquidation stages. The compensation levels during our offering, acquisition and operational stages are based on percentages of the offering proceeds sold, the cost of acquired properties and the annual revenue earned from such properties, and other such fees outlined in each of the respective agreements. See Note 6 – Related Party Transactions for additional information.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Lightstone REIT III and the Operating Partnership and its subsidiaries (over which Lightstone REIT III exercises financial and operating control). As of December 31, 2016, the Company had a 99% general partnership interest in the Operating Partnership. All inter-company balances and transactions have been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during a reporting period. The most significant assumptions and estimates relate to the valuation of real estate and depreciable lives. Application of these assumptions requires the exercise of judgment as to future uncertainties and, as a result, actual results could differ from these estimates.
Investments in other real estate entities where the Company has the ability to exercise significant influence, but does not exercise financial and operating control, and is not considered to be the primary beneficiary will be accounted for using the equity method. Investments in other real estate entities where the Company has virtually no influence will be accounted for using the cost method.
Revenue
Hotel revenue is recognized as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel’s services.
Investments in Real Estate
Accounting for Acquisitions
When the Company makes an investment in real estate, the fair value of the real estate acquired will be allocated to the acquired tangible assets, consisting of land, building and improvements, furniture and fixtures and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, acquired in-place leases, and the value of tenant relationships, based in each case on their fair values. Purchase accounting will be applied to assets and liabilities related to real estate entities acquired based upon the percentage of interest acquired. Fees incurred related to acquisitions will be expensed as incurred and recorded in general and administrative costs in the consolidated statements of operations. Transaction costs incurred related to the Company’s investments in unconsolidated affiliated entities, accounted for under the equity method of accounting, will be capitalized as part of the cost of the investment.
Upon the acquisition of real estate operating properties, the Company will estimate the fair value of acquired tangible assets and identified intangible assets and liabilities and certain liabilities such as assumed debt and contingent liabilities, at the date of acquisition, based on evaluation of information and estimates available at that date, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other relevant market data. Based on these estimates, the Company will evaluate the existence of goodwill or a gain from a bargain purchase and will allocate the initial purchase price to the applicable assets, liabilities and noncontrolling interests, if any. As final information regarding fair value of the assets acquired, liabilities assumed and noncontrolling interests is received and estimates are refined, appropriate adjustments will be made to the purchase price allocation. The allocations will be finalized as soon as all the information necessary is available and in no case later than within twelve months from the acquisition date.
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Carrying Value of Assets
The amounts to be capitalized as a result of periodic improvements and additions to real estate property, when applicable, and the periods over which the assets will be depreciated or amortized, will be determined based on the application of accounting standards that may require estimates as to fair value and the allocation of various costs to the individual assets. Differences in the amount attributed to the assets may be significant based upon the assumptions made in calculating these estimates.
Impairment Evaluation
Management will evaluate the recoverability of its investments in real estate assets at the lowest identifiable level, the individual property level. Long-lived assets will be tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss will be recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value.
The Company will evaluate the long-lived assets for potential impairment on an annual basis and record an impairment charge when there is an indicator of impairment and the undiscounted projected cash flows are less than the carrying amount for a particular property. The estimated cash flows used for the impairment analysis and the determination of estimated fair value will be based on the Company’s plans for the respective assets and the Company’s views of market and economic conditions. The estimates consider matters such as future operating income, market and other applicable trends and residual value, as well as the effects of demand, competition, and recent sales data for comparable properties. Changes in estimated future cash flows due to changes in the Company’s plans or views of market and economic conditions could result in recognition of impairment losses, which, under the applicable accounting guidance, may be substantial.
Depreciation and Amortization
Depreciation expense is computed based on the straight-line method over the estimated useful life of the applicable real estate asset. We generally use estimated useful lives of up to thirty-nine years for buildings and improvements and five to ten years for furniture and fixtures. Maintenance and repairs will be charged to expense as incurred.
Investments in Unconsolidated Entities
We will evaluate investments in other entities for consolidation. We will consider the percentage interest in the joint venture, evaluation of control and whether a variable interest entity exists when determining if the investment qualifies for consolidation.
Under the equity method, the investment will be recorded initially at cost, and subsequently adjusted for equity in net income (loss) and cash contributions and distributions. The net income or loss of each investor will be allocated in accordance with the provisions of the operating agreement of the entity. The allocation provisions in these agreements may differ from the ownership interest held by each investor. Differences between the carrying amount of our investment in the respective joint venture and our share of the underlying equity of such unconsolidated entity will be amortized over the respective lives of the underlying assets as applicable. These items will be reported as a single line item in the statements of operations as income or loss from investments in unconsolidated affiliated entities.
Under the cost method of accounting, the investment will be recorded initially at cost, and subsequently adjusted for cash contributions and distributions resulting from any capital events. Dividends earned from the underlying entity will be recorded as interest income.
On a quarterly basis, we will assess whether the value of our investments in unconsolidated entities has been impaired. An investment is impaired only if management’s estimate of the fair value of the investment is less than the carrying value of the investment, and such decline in value is deemed to be other than temporary. The ultimate realization of our investment in partially owned entities is dependent on a number of factors including the performance of that entity and market conditions. If we determine that a decline in the value of a partially owned entity is other than temporary, we will record an impairment charge.
Deferred Costs
We will capitalize initial direct costs associated with financing activities. The costs will be capitalized upon the execution of the loan, presented in the consolidated balance sheets as a direct deduction from the carrying value of the corresponding loan and amortized over the initial term of the corresponding loan. Amortization of deferred loan costs will begin in the period during which the loan is originated using the effective interest method over the term of the loan.
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Income Taxes
The Company elected to qualify and be taxed as a REIT for U.S. federal income tax purposes commencing with the taxable year ended December 31, 2015. If the Company qualifies as a REIT, it generally will not be subject to U.S. federal income tax on its net taxable income that it distributes to its stockholders. To maintain its REIT qualification, the Company must meet a number of organizational and operational requirements, including a requirement that it annually distribute to its stockholders at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. If the Company fails to remain qualified for taxation as a REIT in any subsequent year and does not qualify for certain statutory relief provisions, its income for that year will be taxed at regular corporate rates, and it may be precluded from qualifying for treatment as a REIT for the four-year period following its failure to qualify as a REIT. Such an event could materially adversely affect the Company’s net income and net cash available for distribution to stockholders.
The Company engages in certain activities through taxable REIT subsidiaries ("TRSs"). When the Company purchases a hotel it establishes a TRS and enters into an operating lease agreement for the hotel. As such, the Company may be subject to U.S. federal and state income taxes and franchise taxes from these activities.
As of December 31, 2016 and 2015, we had no material uncertain income tax positions. Additionally, even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.
Additionally, even if the Company qualifies as a REIT, it may still be subject to some U.S. federal, state and local taxes on its income and property and to U.S. federal income taxes and excise taxes on its undistributed income.
To maintain our qualification as a REIT, we may engage in certain activities through wholly-owned taxable REIT subsidiaries (“TRS”). As such, we will be subject to U.S. federal and state income and franchise taxes from these activities.
Selling Commission, Dealer Manager Fees and Organization and Offering Costs
Selling commissions and dealer manager fees paid to the Dealer Manager, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs, and professional fees are accounted for as a reduction against additional paid-in capital (“APIC”) as costs are incurred. Any organization costs are expensed as general and administrative costs. Through December 31, 2016, the Company has incurred approximately $10.4 million in selling commissions and dealer manager fees and $4.8 million of other offering costs. From the commencement of the offering through December 31, 2016, the Company has recorded approximately $15.2 million of these costs against APIC.
Concentration of Risk
The Company maintains its cash in bank deposit accounts, which, at times, may exceed U.S. federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash.
Basic and Diluted Net Earnings per Common Share
Net earnings per common share is computed by dividing the net loss by the weighted average number of shares of common stock outstanding. Diluted earnings per share takes into account the effect of any dilutive instruments. The Company had no potentially dilutive securities outstanding during the periods presented.
Financial Instruments
The carrying amounts of cash, accounts receivable (included in other assets) and accounts payable and other accrued expenses approximate their fair values because of the short maturity of these instruments.
The estimated fair value of our mortgages payable is as follows:
| As of December 31, 2016 | ||||||||
| Carrying Amount | Estimated Fair Value | |||||||
| Mortgages payable | $ | 88,027,880 | $ | 87,252,072 | ||||
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The fair value of our mortgages payable was determined by discounting the future contractual interest and principal payments by market interest rates.
As of December 31, 2015, the estimated fair value of our revolving promissory notes payable – related party approximated its carrying value ($2.1 million) because of its floating interest rate.
New Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board (“FASB”) issued guidance that clarifies the definition of a business and assists in the evaluation of whether a transaction will be accounted for as an acquisition of an asset or as a business combination. The guidance provides a test to determine when a set of assets and activities acquired is not a business. When substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. Under the updated guidance, an acquisition of a single property will likely be treated as an asset acquisition as opposed to a business combination and associated transaction costs will be capitalized rather than expensed as incurred. Additionally, assets acquired, liabilities assumed, and any noncontrolling interest will be measured at their relative fair values. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the requirements and impact of this update on its financial statements.
In January 2017, FASB issued guidance that amends the Codification for SEC staff announcements made at recent Emerging Issues Task Force meetings. The SEC guidance that specifically relates to our consolidated financial statements was from the September 2016 meeting, where the SEC staff expressed their expectations about the extent of disclosures registrants should make about the effects of the new FASB guidance as well as any amendments issued prior to adoption, on revenue and leases. Registrants are required to disclose the effect that recently issued accounting standards will have on their financial statements when adopted in a future period. In cases where a registrant cannot reasonably estimate the impact of the adoption, then additional qualitative disclosures should be considered. The adoption this guidance did not have a material effect on the Company's consolidated financial statements.
In August 2016, the issued FASB an accounting standards update which provides guidance on the classification of certain cash receipts and cash payments in the statement of cash flows, including those related to debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance, and distributions received from equity method investees. This guidance is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. The guidance must be adopted on a retrospective basis and must be applied to all periods presented, but may be applied prospectively if retrospective application would be impracticable. This guidance will not have a material impact on the Company’s consolidated financial statements.
In September 2015, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to simplify the accounting for adjustments made to provisional amounts during the measurement period of a business combination. The amendment requires the acquirer to recognize adjustments to provisional amounts identified during the measurement period in the reporting period in which the adjustment amount is determined. The acquirer is required to also record, in the same period’s financial statements, the effect on earnings as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective with earlier application permitted for financial statements that have not been issued. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In April 2015, the FASB issued an accounting standards update to simplify the presentation of debt issuance costs. This update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The SEC staff noted that this update did not address situations where a company has debt issuance costs related to line-of-credit arrangements. As a result, the FASB issued an additional update which states that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company adopted this standard during the quarter ended March 31, 2016. As a result of adopting this standard on a retrospective basis, $51,667 was reclassified out of prepaid expenses and other assets and was reclassified into revolving promissory notes payable, net - related party on the consolidated balance sheet as of December 31, 2015.
In May 2014, the FASB issued an accounting standards update that provides for a single five-step model to be applied to all revenue contracts with customers as well as requires additional financial statement disclosures that will enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect the adoption of this standard to have a material impact on its financial position, results of operations or cash flows.
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The Company has reviewed and determined that other recently issued accounting pronouncements will not have a material impact on its financial position, results of operations and cash flows, or do not apply to its current operations.
| 3. | Acquisitions |
2015 Acquisitions:
Hampton Inn – Des Moines
On February 4, 2015, the Company completed the acquisition of a 120-room select service hotel located in Des Moines, Iowa (the “Hampton Inn – Des Moines”) from an unrelated third party, for an aggregate purchase price of approximately $10.9 million less adjustments, paid in cash, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, approximately $0.1 million. The acquisition was funded with approximately $2.7 million of offering proceeds and approximately $8.2 million of proceeds under a $10.0 million revolving promissory note (the “Des Moines Promissory Note”) from the operating partnership of Lightstone Value Plus Real Estate Investment Trust II, Inc. (“Lightstone II”), a real estate investment trust also sponsored by the Company’s Sponsor.
The acquisition of the Hampton Inn – Des Moines was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Hampton Inn – Des Moines has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $1.2 million was allocated to land and improvements, $9.2 million was allocated to building and improvements, and $0.5 million was allocated to furniture and fixtures and other assets.
Courtyard – Durham
On May 15, 2015, the Company completed the acquisition of a 146-room select service hotel located in Durham, North Carolina (the “Courtyard – Durham”) from an unrelated third party, for an aggregate purchase price of $16.0 million, less adjustments, paid in cash, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, $0.2 million. The acquisition was funded with $4.0 million of offering proceeds and $12.0 million of proceeds under a $13.0 million revolving promissory note (the “Durham Promissory Note”) from the operating partnership of Lightstone II.
The acquisition of the Courtyard – Durham was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Courtyard – Durham has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $1.0 million was allocated to land and improvements, $13.1 million was allocated to building and improvements, and $1.9 million was allocated to furniture and fixtures and other assets.
2016 Acquisitions:
Hampton Inn – Lansing
On March 10, 2016, the Company completed the acquisition of an 86-room select service hotel located in Lansing, Michigan (the “Hampton Inn – Lansing”) from an unrelated third party, for an aggregate purchase price of approximately $10.5 million less adjustments, paid in cash, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, $105,000. The acquisition was funded with offering proceeds.
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The acquisition of the Hampton Inn – Lansing was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Hampton Inn – Lansing has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $0.4 million was allocated to land and improvements, $9.0 million was allocated to building and improvements, and $1.1 million was allocated to furniture and fixtures and other assets.
The capitalization rate for the acquisition of the Hampton Inn — Lansing was approximately 12.0% (“unaudited”). We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was based upon the twelve-month period ended November 30, 2015. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Courtyard – Warwick
On March 23, 2016, the Company completed the acquisition of a 92-room select service hotel located in Warwick, Rhode Island (the “Courtyard – Warwick”) from an unrelated third party, for an aggregate purchase price of $12.4 million, less adjustments, paid in cash, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, $124,000. The acquisition was funded with offering proceeds.
The acquisition of the Courtyard – Warwick was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Courtyard – Warwick has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $0.7 million was allocated to land and improvements, $11.1 million was allocated to building and improvements, and $0.6 million was allocated to furniture and fixtures and other assets.
The capitalization rate for the acquisition of the Courtyard – Warwick was approximately 8.3% (“unaudited”). We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was based upon the twelve-month period ended January 31, 2016. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
SpringHill Suites – Green Bay
On May 2, 2016, the Company completed the acquisition of a 127-room select service hotel located in Green Bay, Wisconsin (the “SpringHill Suites – Green Bay”) from an unrelated third party, for an aggregate purchase price of approximately $18.3 million, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, approximately $183,000. The acquisition was funded with approximately $8.1 million of offering proceeds and approximately $10.2 million of proceeds from a $14.5 million revolving promissory note (the “Green Bay Promissory Note”) from the operating partnership of Lightstone II (see Note 6 – Related Party Transactions for additional information).
The acquisition of the SpringHill Suites – Green Bay was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the SpringHill Suites – Green Bay has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $0.8 million was allocated to land and improvements, $15.2 million was allocated to building and improvements, and $2.3 million was allocated to furniture and fixtures and other assets.
The capitalization rate for the acquisition of the SpringHill Suites – Green Bay was approximately 9.8% (“unaudited”). We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was based upon the twelve-month period ended November 30, 2015. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
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Home2 Suites Hotel Portfolio
On August 2, 2016, the Company completed the portfolio acquisition of a 139-room select service hotel located in Tukwila, Washington (the “Home2 Suites – Tukwila”) and a 125-room select service hotel located in Salt Lake City, Utah (the “Home2 Suites – Salt Lake” and collectively the “Home2 Suites Hotel Portfolio”) from an unrelated third party, for an aggregate purchase price of approximately $47.3 million, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, approximately $473,000. The acquisition was funded with offering proceeds.
The acquisition of the Home2 Suites Hotel Portfolio was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Home2 Suites Hotel Portfolio has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $16.2 million was allocated to land and improvements, $26.4 million was allocated to building and improvements, and $4.7 million was allocated to furniture and fixtures and other assets.
The capitalization rate for the acquisition of the Home2 Suites Hotel Portfolio was approximately 8.4% (“unaudited”). We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was determined using the projected or budgeted net operating income of the property based upon then-current projections. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Fairfield Inn– Austin
On September 13, 2016, the Company completed the acquisition of an 84-room select service hotel located in Austin, Texas (the “Fairfield Inn– Austin”) from an unrelated third party, for an aggregate purchase price of approximately $12.0 million, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, approximately $120,000. The acquisition was funded with offering proceeds.
The acquisition of the Fairfield Inn – Austin was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Fairfield Inn– Austin has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $1.5 million was allocated to land and improvements, $9.0 million was allocated to building and improvements, and $1.5 million was allocated to furniture and fixtures and other assets.
The capitalization rate for the acquisition of the Fairfield Inn – Austin was approximately 8.7% (“unaudited”). We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was based upon the twelve-month period ended April 30, 2016. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Staybridge Suites – Austin
On October 7, 2016, the Company completed the acquisition of an 80-room select service hotel located in Austin, Texas (the “Staybridge Suites – Austin”) from an unrelated third party, for an aggregate purchase price of approximately $10.0 million, excluding closing and other related transaction costs. In connection with the acquisition, the Company’s Advisor received an acquisition fee equal to 1.0% of the contractual purchase price, approximately $100,000. The acquisition was funded with offering proceeds.
The acquisition of the Staybridge Suites – Austin was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Staybridge Suites – Austin has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $1.9 million was allocated to land and improvements, $6.7 million was allocated to building and improvements, and $1.4 million was allocated to furniture and fixtures and other assets.
The capitalization rate for the acquisition of the Staybridge Suites – Austin was approximately 9.4% (“unaudited”). We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was based upon the twelve-month period ended April 30, 2016. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
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Financial Information
The following table provides the total amount of rental revenue and net income included in the Company’s consolidated statements of operations from the Hampton Inn – Des Moines, Courtyard – Durham, Hampton Inn – Lansing, Courtyard – Warwick, SpringHill Suites – Green Bay, Home2 Suites Hotel Portfolio, Fairfield Inn – Austin and Staybridge Suites – Austin since their respective dates of acquisition for the period indicated:
| For the Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Rental revenue | $ | 22,551,234 | $ | 6,203,341 | ||||
| Net income | $ | 618,623 | $ | 4,244 | ||||
The following table provides unaudited pro forma results of operations for the periods indicated, as if the Hampton Inn – Des Moines, Courtyard – Durham, Hampton Inn – Lansing, Courtyard – Warwick, SpringHill Suites – Green Bay, Home2 Suites Hotel Portfolio, Fairfield Inn – Austin and Staybridge Suites – Austin had been acquired at the beginning of each period. Such pro forma results are not necessarily indicative of the results that actually would have occurred had these acquisitions been completed on the date indicated, nor are they indicative of the future operating results of the combined company.
| For the Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Pro forma rental revenue | $ | 34,445,574 | $ | 30,832,283 | ||||
| Pro forma net income (1) | $ | 1,247,195 | $ | 4,686,920 | ||||
| Pro forma net income per Company's common share, basic and diluted (1) | $ | 0.16 | $ | 2.80 | ||||
| (1) | Includes acquisition fees and acquisition-related expenses aggregating $2,152,938 and $597,327 during the years ended December 31, 2016 and 2015. |
4. Mortgages payable, net
Mortgages payable, net consisted of the following:
| Description | Interest Rate | Weighted Average Interest Rate as of December 31, 2016 | Maturity Date | Amount Due at Maturity | As of December 31, 2016 | As of December 31, 2015 | ||||||||||||||||
| Revolving Credit Facility, secured by seven properties | LIBOR + 4.95% | 5.95 | % | July 2019 | $ | 59,696,000 | $ | 59,696,000 | - | |||||||||||||
| Promissory Note, secured by two properties | 4.73% | 4.73 | % | October 2021 | 26,127,572 | $ | 28,331,880 | |||||||||||||||
| Total mortgages payable | 5.56 | % | $ | 85,823,572 | $ | 88,027,880 | $ | - | ||||||||||||||
| Less: Deferred financing costs | (1,157,537 | ) | ||||||||||||||||||||
| Total mortgage payable, net | $ | 86,870,343 | $ | - | ||||||||||||||||||
Principal Maturities
The following table, based on the initial terms of the mortgage, sets forth their aggregate estimated contractual principal maturities, including balloon payments due at maturity, as of December 31, 2016:
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| 2017 | 2018 | 2019 | 2020 | 2021 | Thereafter | Total | ||||||||||||||||||||||
| Principal maturities | $ | 424,252 | $ | 445,052 | $ | 60,162,871 | $ | 486,092 | $ | 26,509,613 | $ | - | $ | 88,027,880 | ||||||||||||||
| Less: Deferred financing costs | (1,157,537 | ) | ||||||||||||||||||||||||||
| Total principal maturiteis, net | $ | 86,870,343 | ||||||||||||||||||||||||||
On July 13, 2016, the Company, through certain subsidiaries, entered into a $60.0 million revolving credit facility (the “Revolving Credit Facility”), with a bank. The Revolving Credit Facility bears interest at Libor plus 4.95% and provides a line of credit over the next three years, with two, one-year options to extend solely at the discretion of the bank. Interest is payable monthly and the entire unpaid principal balance is due upon expiration of the Revolving Credit Facility. Under the terms of the Revolving Credit Facility, the Company may designate properties as collateral that allows it to borrow up to a 65.0% loan-to-value ratio of the properties. On July 13, 2016, we received an initial loan of $45.4 million under the Revolving Credit Facility which was secured by five hotel properties (SpringHill Suites - Green Bay, Hampton Inn – Des Moines, Hampton Inn - Lansing, Courtyard - Durham, and Courtyard – Warwick). On November 2, 2016, we received an additional loan of $14.3 million under the Revolving Credit Facility and added two more hotel properties (Fairfield Inn – Austin and Staybridge Suites – Austin) as additional collateral under the Revolving Credit Facility. As a result, the Revolving Credit Facility had an outstanding balance and remaining availability of $59.7 million and $0.3 million, respectively, as of December 31, 2016.
On October 5, 2016, the Company entered into a promissory note (the “Promissory Note”) for $28.4 million. The Promissory Note has a term of five years, bears interest at 4.73% and requires monthly interest and principal payments of $147,806 through its stated maturity with the entire unpaid balance due upon maturity. The Promissory Note is cross-collateralized by two hotel properties (Home2 Suites – Tukwila and Home2 Suites – Salt Lake City).
Debt Compliance
Pursuant to the Company’s debt agreements, approximately $0.9 million was held in restricted escrow accounts as of December 31, 2016. Such escrows are subject to release in accordance with the applicable debt agreement for the payment of real estate taxes, insurance and capital improvements, as required. Certain of our debt agreements also contain clauses providing for prepayment penalties and require the maintenance of certain ratios including debt service coverage and fixed leverage charge ratio. The Company is currently in compliance with respect to all of its financial debt covenants.
5. Stockholder’s Equity
Preferred Stock
The Company’s charter authorizes its board of directors to designate and issue one or more classes or series of preferred stock without approval of the stockholders of Common Shares. On July 11, 2014, the Company amended and restated its charter to authorize the issuance of 50,000,000 shares of preferred stock. Prior to the issuance of shares of each class or series, the Company’s board of directors is required by Maryland law and by the Company’s charter to set, subject to the Company’s charter restrictions on ownership and transfer of stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption of each class or series of preferred stock so issued, which may be more beneficial than the rights, preferences and privileges attributable to Common Shares. The issuance of preferred stock could have the effect of delaying, deferring or preventing a change in control of the Company. As of December 31, 2016 and December 31, 2015, the Company had no outstanding shares of preferred stock.
Common Shares
All of the common stock being offered by the Company will be duly authorized, fully paid and nonassessable. Subject to the restrictions on ownership and transfer of stock contained in the Company’s charter and except as may otherwise be specified in the charter, the holders of Common Shares are entitled to one vote per Common Share on all matters submitted to a stockholder vote, including the election of the Company’s directors. There is no cumulative voting in the election of directors. Therefore, the holders of a majority of outstanding Common Shares can elect the Company’s entire board of directors. Except as the Company’s charter may provide with respect to any series of preferred stock that the Company may issue in the future, the holders of Common Shares will possess exclusive voting power.
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Holders of the Company’s Common Shares will be entitled to receive such distributions as authorized from time to time by the Company’s board of directors and declared out of legally available funds, subject to any preferential rights of any preferred stock that the Company issues in the future. In any liquidation, each outstanding Common Share entitles its holder to share (based on the percentage of Common Shares held) in the assets that remain after the Company pays its liabilities and any preferential distributions owed to preferred stockholders. Holders of Common Shares do not have preemptive rights, which means that there is no automatic option to purchase any new Common Shares that the Company issues, nor do holders of Common Shares have any preference, conversion, exchange, sinking fund or redemption rights. Holders of Common Shares will not have appraisal rights unless the board of directors determines that appraisal rights apply, with respect to all or any classes or series of stock, to a particular transaction or all transactions occurring after the date of such determination in connection with which holders of such Common Shares would otherwise be entitled to exercise appraisal rights. Common Shares will be nonassessable by the Company upon its receipt of the consideration for which the board of directors authorized its issuance.
On July 11, 2014, the Company amended and restated its charter to authorize the issuance of 200,000,000 Common Shares. Under its charter, the Company cannot make some material changes to its business form or operations without the approval of stockholders holding at least a majority of the shares of our stock entitled to vote on the matter. These include (1) amendment of its charter, (2) its liquidation or dissolution, and (3) its merger, consolidation or the sale or other disposition of its assets. Share exchanges in which the Company is the acquirer, however, do not require stockholder approval.
Distributions
U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with GAAP) determined without regard to the deduction for dividends paid and excluding any net capital gain. In order to continue to qualify for REIT status, we may be required to make distributions in excess of cash available.
Distributions are at the discretion of our Board of Directors. We may pay such distributions from the sale of shares of our common stock or borrowings if we do not generate sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the size of these distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.
We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. “Return of capital” refers to distributions to investors in excess of net income. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, but only to the extent of a stockholder’s adjusted tax basis in our shares, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.
On January 14, 2015, the Board of Directors of the Company authorized and the Company declared a distribution rate calculated based on stockholders of record each day during the applicable period at a rate of $0.00164383 per day, and which equals a daily amount that, if paid each day for a 365-day period, would equal a 6.0% annualized rate based on a share price of $10.00. The Company’s first distribution began to accrue on December 11, 2014 (date of breaking escrow) through February 28, 2015 (the end of the month following the Company’s initial property acquisition) and subsequent distributions have been declared on a monthly basis thereafter. The first distribution was payable on March 15, 2015 and subsequent distributions have been paid on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month. Our stockholders may elect to have their distributions reinvested in additional shares of Common Shares under our DRIP.
Total distributions declared during the years ended December 31, 2016 and 2015 were $4.7 million and $1.0 million.
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Distribution Payments
On November 15, 2016, December 15, 2016 and January 13, 2017, the Company paid distributions for the months ended October 31, 2016, November 30, 2016 and December 31, 2016, respectively, totaling $1.7 million. The distributions were paid in full using a combination of cash and 79,794 shares of the Company’s common stock issued pursuant to the Company’s DRIP, at a price of $9.50 per share, equal to 95% of the Company’s current Offering price of $10.00 per common share. The distributions were paid from a combination of cash flows provided by operations ($793,928 or 48%) offering proceeds ($101,569 or 6%) and excess cash proceeds from the issuance of common stock through the Company’s DRIP ($758,041 or 46%).
Distribution Declaration
On March 27, 2017, the Board of Directors authorized and the Company declared a distribution for each month during the three-month period ending June 30, 2017. The distributions will be calculated based on shareholders of record at a rate of $0.00164383 per day, and will equal a daily amount that, if paid each day for a 365-day period, would equal a 6.0% annualized rate based on a share price of $10.00 payable on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month. The Company’s stockholders have an option to elect the receipt of Common Shares under the Company’s distribution reinvestment program.
The amount of distributions to be paid to our stockholders in the future will be determined by our Board of Directors and are dependent on a number of factors, including funds available for payment of distributions, our financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our status as a REIT under the Code.
6. Related Party and Other Transactions
The Company has agreements with the Dealer Manager, the Advisor and its affiliates and the Special Limited Partner pursuant to which is has and/or will pay certain fees and liquidation distributions in exchange for services performed or consideration given by these entities and other affiliated entities. The following table summarizes all the compensation and fees the Company may pay to the Dealer Manager, the Advisor and its affiliates, including amounts to reimburse their costs in providing services. The Special Limited Partner has committed to contribute to the Operating Partnership cash or interests in real property in exchange for Subordinated Participation Interests in the Operating Partnership that may entitle the Special Limited Partner to subordinated distribution as described in the table below.
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| Organization and Offering Stage | ||
| Fees | Amount | |
| Selling Commissions | The Dealer Manager receives selling commissions in an amount of up to 7% of the gross proceeds in the primary offering. The Dealer Manager reallows all selling commissions to the participating broker-dealer or registered representative of the dealer manager who actually sold the Common Shares. Selling commissions are expected to be approximately $21.0 million if the maximum offering of 30.0 million shares of common stock is sold under the Offering. Alternatively, a participating broker-dealer or registered representative of the Dealer Manager who actually sold the shares of common stock may elect to receive a fee equal to 7.0% of the gross proceeds from the sale thereof, with either (a) 2.0% thereof paid at the time of such sale and 1.0% thereof paid on each anniversary of the closing of such sale up to and including the fifth anniversary of the closing of such sale or (b) 3.0% thereof paid at the time of such sale and 1.0% thereof paid on each anniversary of the closing of such sale up to and including the fourth anniversary of the closing of such sale. The total amount of all items of compensation from any source payable to our dealer manager or the participating broker-dealers will not exceed an amount that equals 10.0% of the gross proceeds of the offering (excluding Common Shares purchased through our DRIP). From the Company’s inception through December 31, 2016, $7.1 million of selling commissions have been incurred. | |
| Fees | Amount | |
| Dealer Manager Fee |
The Dealer Manager receives a dealer manager fee in an amount of up to 3% of gross proceeds in the primary offering. The Dealer Manager, in its sole discretion, may reallow all or any portion of the dealer manager fee to participating broker-dealers as a marketing fee. No dealer manager fee will be paid with respect to sales under the Company’s DRIP. The estimated dealer management fee is expected to be approximately $9.0 million if the maximum offering of 30.0 million shares of common stock are sold under the Offering. From the Company’s inception through December 31, 2016, $3.3 million of dealer manager fees have been incurred.
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Organization and Offering Expenses
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The Company reimburses the Advisor for all organization and offering expenses in connection with our offering, other than the selling commissions and dealer manager fee. The Company expects that such organization and offering expenses, other than selling commissions and dealer manager fee, will amount to approximately 2.0% of gross offering proceeds. In no event will organization and offering expenses exceed 15.0% of gross offering proceeds. From the Company’s inception through December 31, 2016, $4.8 of organization and offering expenses have been incurred. | |
| Operational Stage | ||
| Fees | Amount | |
| Acquisition Fee |
The Company pays to the Advisor or its affiliates 1.0% of the contract purchase price of each property acquired (including its pro rata share (direct or indirect) of debt attributable to such property) or 1.0% of the amount advanced for a loan or other investment (including its pro rata share (direct or indirect) of debt attributable to such investment), as applicable. From the Company’s inception through December 31, 2016, acquisition fees of $1.4 million have been incurred.
‘‘Contract purchase price’’ or the ‘‘amount advanced for a loan or other investment’’ means the amount actually paid or allocated in respect of the purchase, development, construction or improvement of a property, the amount of funds advanced with respect to a mortgage, or the amount actually paid or allocated in respect of the purchase of other real estate-related assets, in each case inclusive of any indebtedness assumed or incurred in respect of such asset but exclusive of acquisition fees and acquisition expenses.
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| Fees | Amount | |
| Acquisition Expenses |
The Company reimburses the Advisor for expenses actually incurred related to selecting or acquiring assets on the Company’s behalf, regardless of whether the Company actually acquires the related assets. In addition, the Company pays third parties, or reimburses the Advisor or its affiliates, for any investment-related expenses due to third parties, including, but not limited to legal fees and expenses, travel and communications expenses, cost of appraisals, nonrefundable option payments on property not acquired, accounting fees and expenses and title insurance premiums, regardless of whether the Company acquires the related assets. The Company estimates that total acquisition expenses (including those paid to third parties, as described above) will be approximately 0.6% of the contract purchase price of each property (including its pro rata share (direct or indirect) of debt attributable to such property) and 0.6% of the amount advanced for a loan or other investment (including its pro rata share (direct or indirect) of debt attributable to attributable to such investment), as applicable. In no event will the total of all acquisition fees, financing coordination fees and acquisition expenses (including those paid to third parties, as described above) payable with respect to a particular investment be unreasonable or exceed 5% of the contract purchase price of each property including its pro rata share (direct or indirect) of debt attributable to such property) or 5% of the amount advanced for a loan or other investment (including its pro rata share (direct or indirect) of debt attributable to attributable to such investment), as applicable.
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Construction Management Fee |
The Company expects to engage affiliates of the Advisor to provide construction management services for some of its properties. The Company will pay a construction management fee in an amount of up to 5% of the cost of any improvements that the affiliates of the Advisor may undertake. The affiliates of the Advisor may subcontract the performance of their duties to third parties. From the Company’s inception through December 31, 2016, no construction management fees have been incurred.
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| Fees | Amount | |
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Asset Management Subordinated Participation
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The following description of the asset management subordinated participation will apply until the date on which the initial public offering has ended and the Company has invested substantially all the net proceeds therefrom.
Within 30 days after the end of each calendar quarter (subject to the approval of the Company’s board of directors), the Company, as the general partner of the Operating Partnership, will pay an asset management subordinated participation by issuing a number of operating partnership units designated as Class B units of the Operating Partnership (‘‘Class B Units’’) to the Advisor equal to: (i) the cost of the Company’s assets multiplied by 0.1875%; divided by (ii) the value of one Common Share as of the last day of such calendar quarter, which is equal initially to $9.00 (the primary offering price minus selling commissions and dealer manager fees). The fair value of issued Class B Units will be determined and expensed when the Company deems the achievement of the performance condition (described below) to be probable.
The Advisor will be entitled to receive distributions on the vested and unvested Class B Units it receives in connection with its asset management subordinated participation at the same rate as distributions received on the Common Shares; such distributions will be in addition to the incentive fees and distributions the Advisor and its affiliates may receive from the Company, which consist of the annual subordinated performance fee payable to the Advisor and the liquidation distributions payable to the Special Limited Partner.
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 Common Shares 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 OP Units or Common Shares 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.
From the Company’s inception through December 31, 2016, there has been no asset management subordinated participation approved by the Company’s board of directors. |
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| Fees | Amount | |
|
Asset Management Fee
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The following description of the asset management fee will apply beginning on the date on which the initial public offering has ended and the Company has invested substantially all the net proceeds therefrom.
The Company will pay the Advisor or its assignees a monthly asset management fee equal to one-twelfth (1⁄12) of 0.75% of the Company’s average invested assets. Average invested assets means, for a specified period, the average of the aggregate book value of our assets invested, directly or indirectly, in equity interests in and loans secured by real estate, before deducting depreciation, bad debts or other non- cash reserves, computed by taking the average of such values at the end of each month during such period. From the Company’s inception through December 31, 2016, no asset management fees have been incurred. | |
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Property Management Fees |
Property management fees with respect to properties managed by affiliates of the Advisor are payable monthly in an amount not to exceed the fee customarily charged in arm’s-length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of property managers in such area. The affiliates of the Advisor may subcontract the performance of their duties to third parties. The Company reimburses the affiliates of the Advisor for costs and expenses, which may include personnel costs for on-site personnel providing direct services for the properties and for roving maintenance personnel to the extent needed at the properties from time to time, and the cost of travel and entertainment, printing and stationery, advertising, marketing, signage, long distance phone calls and other expenses that are directly related to the management of specific properties. Notwithstanding the foregoing, the Company will not reimburse the affiliates of the Advisor for their general overhead costs or, other than as set forth above, for the wages and salaries and other employee-related expenses of their employees.
In addition, the Company will pay the affiliates of the Advisor a separate fee for the one- time initial rent-up or leasing-up of newly constructed properties in an amount not to exceed the fee customarily charged in arm’s-length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of brokers and agents in such area.
From the Company’s inception through December 31, 2016, no property management fees or separate fees have been incurred.
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| Operating Expenses |
Commencing 12 months after the commencement of the Offering, the Company reimburses the Advisor’s costs of providing administrative services at the end of each fiscal quarter, subject to the limitation that the Company will not reimburse the Advisor (except in limited circumstances) for any amount by which the total operating expenses at the end of the four preceding fiscal quarters exceeds the greater of (i) 2% of average invested assets (as defined above under ‘‘— Asset Management Fee’’) for that fiscal year, and (ii) 25% of net income other than any additions to reserves for depreciation, bad debt or other similar non-cash reserves and excluding any gain from the sale of assets for that period.
Additionally, the Company reimburses the Advisor or its affiliates for personnel costs in connection with other services; however, the Company will not reimburse the Advisor for (a) services for which the Advisor or its affiliates are entitled to compensation in the form of a separate fee, or (b) the salaries and benefits of the named executive officers.
From the Company’s inception through December 31, 2016, none of these costs have been reimbursed. |
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| Fees | Amount | |
|
Financing Coordination Fee |
If the Advisor provides services in connection with the financing of an asset, assumption of a loan in connection with the acquisition of an asset or origination or refinancing of any loan on an asset, the Company will pay the Advisor or its assignees a financing coordination fee equal to 0.75% of the amount available or outstanding under such financing. The Advisor may reallow some of or all this financing coordination fee to reimburse third parties with whom it may subcontract to procure such financing. From the Company’s inception through December 31, 2016, no financing coordination fees have been charged. |
| Liquidation/Listing Stage | ||
| Fees | Amount | |
|
Real Estate Disposition Commissions
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For substantial services in connection with the sale of a property, the Company will pay to the Advisor or any of its affiliates a real estate disposition commission in an amount equal to the lesser of (a) one-half of a real estate commission that is reasonable, customary and competitive in light of the size, type and location of the property and (b) 2.0% of the contract sales price of the property; provided, however, that in no event may the real estate commissions paid to the Advisor, its affiliates and unaffiliated third parties exceed the lesser of 6.0% of the contract sales price or a real estate commission that is reasonable, customary and competitive in light of the size, type and location of the property. The Company’s independent directors will determine whether the Advisor or its affiliates have provided a substantial amount of services to the Company in connection with the sale of a property. A substantial amount of services in connection with the sale of a property includes the preparation by the Advisor or its affiliates of an investment package for the property (including an investment analysis, an asset description and other due diligence information) or such other substantial services performed by the Advisor or its affiliates in connection with a sale. From the Company’s inception through December 31, 2016, no real estate disposition commissions have been incurred.
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Annual Subordinated Performance Fee |
The Company will pay the Advisor an annual subordinated performance fee calculated on the basis of the annual return to holders of Common Shares, payable annually in arrears, such that for any year in which holders of Common Shares receive payment of a 6.0% annual cumulative, pre-tax, non-compounded return on their respective net investments, the Advisor will be entitled to 15.0% of the total return in excess of such 6.0% per annum; provided, that the amount paid to the Advisor will not exceed 10.0% of the aggregate return for such year, and provided, further, that the amount paid to the Advisor will not be paid unless holders of Common Shares receive a return of their respective net investments. This fee will be payable only from realized appreciation in the Company’s assets upon their sale, other disposition or refinancing, which results in the return on stockholders’ respective net investments exceeding 6.0% per annum.
For purposes of the annual subordinated performance fee, “net investment” means $10.00 per Common Share, less a pro rata share of any proceeds received from the sale, other disposition or refinancing of assets.
From the Company’s inception through December 31, 2016, no annual subordinated performance fees have been incurred. | |
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| Fees | Amount | |
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Liquidation Distributions to the Special Limited Partner
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Distributions from the Operating Partnership in connection with its liquidation initially will be made to the Company (which the Company will distribute to holders of Common Shares), until holders of Common Shares have received liquidation distributions from the Operating Partnership equal to their respective net investments plus a cumulative, pre-tax, non-compounded annual return of 6.0% on their respective net investments.
Thereafter, the Special Limited Partner will be entitled to receive liquidation distributions from the Operating Partnership until it has received liquidation distributions from the Operating Partnership equal to its net investment plus cumulative, pre-tax, non-compounded annual return of 6.0% on its net investment.
Thereafter, 85.0% of the aggregate amount of any additional liquidation distributions by the Operating Partnership will be payable to the Company (which the Company will distribute to holders of Common Shares), and the remaining 15.0% will be payable to the Special Limited Partner.
With respect to holders of Common Shares, “net investment” means $10.00 per Common Share, less a pro rata share of any proceeds received from the sale, other disposition or refinancing of assets. With respect to the Special Limited Partner, “net investment” means the value of all contributions of cash or property the Special Limited Partner has made to the Operating Partnership in consideration for its subordinated participation interests, measured as of the respective times of contribution, less a pro rata share of any proceeds received from the sale, other disposition or refinancing of assets.
From the Company’s inception through December 31, 2016, no liquidation distributions have been made. |
The following table represents the selling commissions and dealer manager and other offering costs for the periods indicated:
| For the Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Selling commissions and dealer manager fees | $ | 7,008,694 | $ | 3,377,887 | ||||
| Other offering costs | $ | 770,493 | $ | 1,870,078 | ||||
Since commencement of its Offering through December 31, 2016, the Company has incurred $10.4 million in selling commissions and dealer manager fees and $4.8 million of other offering costs in connection with the public offering of shares of its common stock.
No amounts were paid to the affiliates of the Advisor for property management services for the years ended December 31, 2016 and 2015.
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Revolving promissory notes payable, net – related party
With the Company's acquisitions of the Hampton Inn – Des Moines, the Courtyard – Durham, the Hampton Inn – Lansing and the SpringHill Suites – Green Bay, the Company entered into various related party promissory notes payable. See Note 3 for details.
Des Moines Promissory Note
On February 4, 2015, the Company entered into the Des Moines Promissory Note with the operating partnership of Lightstone II. The Des Moines Promissory Note had a term of one year, bore interest at a floating rate of three-month Libor plus 6.0% and required quarterly interest payments through its stated maturity with the entire unpaid balance due upon maturity. The Company paid an origination fee of $100,000 to Lightstone II in connection with the Des Moines Promissory Note and pledged its ownership interest in the Hampton Inn – Des Moines as collateral.
During the year ended December 31, 2015, the Company incurred interest expense of $421,651 (including origination fees of $91,667) on the Des Moines Promissory Note. During the year ended December 31, 2016, the Company incurred interest expense of $8,333 as a result of the amortization of the remaining origination fee. The Des Moines Promissory Note had no outstanding balance as of December 31, 2015 and expired on February 4, 2016.
Durham Promissory Note
On May 15, 2015, the Company entered into the Durham Promissory Note with the operating partnership of Lightstone II. The Durham Promissory Note had a term of one year, bore interest at a floating rate of three-month Libor plus 6.0% and required quarterly interest payments through its stated maturity with the entire unpaid balance due upon maturity. The Company paid an origination fee of $130,000 to Lightstone II in connection with the Durham Promissory Note and pledged its ownership interest in the Courtyard – Durham as collateral.
On March 1, 2016, the Company took additional borrowings on the note of $8 million. On May 2, 2016, the Durham Promissory Note was repaid in full and has now expired. The outstanding principal balance was $2.1 million as of December 31, 2015. The Durham Promissory Note is included in revolving promissory note payable, net – related party on our consolidated balance sheet (net of debt issuance costs of $51,667 as of December 31, 2015).
During the year ended December 31, 2015, the Company incurred interest expense of $482,651 (including origination fees of $86,667) and during the year ended December 31, 2016, the Company incurred interest expense of $151,751 (including origination fees of $43,333) on the Durham Promissory Note.
Lansing Promissory Note
On May 2, 2016, the Company entered into an $8.0 million Revolving Promissory Note (the “Lansing Promissory Note”) with the operating partnership of Lightstone II. The Lansing Promissory Note had a term of one year (with an option for an additional year), bore interest at a floating rate of three-month Libor plus 6.0% and required quarterly interest payments through its stated maturity with the entire unpaid balance due upon maturity. The Company paid an origination fee of $80,000 to Lightstone II in connection with the Lansing Promissory Note and pledged its ownership interest in the Hampton Inn – Lansing as collateral. On July 13, 2016, the Lansing Promissory Note was repaid in full and terminated.
During the year ended December 31, 2016, the Company incurred interest expense of $161,428, including origination fees expensed of $80,000 on the Lansing Promissory Note.
Green Bay Promissory Note
On May 2, 2016, the Company entered into the Green Bay Promissory Note with the operating partnership Lightstone II. The Green Bay Promissory Note had a term of one year (with an option for an additional year), bore interest at a floating rate of three-month Libor plus 6.0% and required quarterly interest payments through its stated maturity with the entire unpaid balance due upon maturity. The Company paid an origination fee of $145,000 to Lightstone II in connection with the Green Bay Promissory Note and pledged its ownership interest in the SpringHill Suites – Green Bay as collateral. On July 13, 2016, the Green Bay Promissory Note was repaid in full and terminated.
During the year ended December 31, 2016, the Company incurred interest expense of $284,635, including origination fees expensed of $145,000 on the Green Bay Promissory Note.
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Due to related parties and other transactions
In addition to certain agreements with the Sponsor (see Note 1) and Dealer Manager, the Company has agreements with the Advisor to pay certain fees in exchange for services performed by the Advisor and/or its affiliated entities. Additionally, the Company’s ability to secure financing and its real estate operations are dependent upon its Advisor and its affiliates to perform such services as provided in these agreements. Furthermore, the Advisor has and is expected to continue to advance certain organization and offering costs on behalf of the Company to the extent the Company does not have sufficient funds to pay such costs. As of December 31, 2016 and 2015, the Company owed the Advisor and its affiliated entities an aggregate of $109,532 and $1.2 million, respectively, which was principally for organization and offering costs paid on its behalf, and is classified as due to related parties on the consolidated balance sheets. During the year ended December 31, 2016 and 2015, the Company paid $36,298 and $403,589, respectively, to an affiliate of the Sponsor for the Sponsor’s marketing expenses related to the offering that were recorded as a reduction to APIC.
During the years ended December 31, 2016 and 2015, the Company paid the Advisor acquisition fees of approximately $1.1 million and $269,000, respectively.
During the years ended December 31, 2016 and 2015, the Company paid the advisor development fees of $19,847 and $0, respectively.
From time to time, the Company may purchase title insurance from an agent in which its Sponsor owns a 50% limited partnership interest. Because this title insurance agent receives significant fees for providing title insurance, our Advisor may face a conflict of interest when considering the terms of purchasing title insurance from this agent. However, before the Company purchases any title insurance, an independent title consultant with more than 25 years of experience in the title insurance industry reviews the transaction, and performs market research and competitive analysis on our behalf. During the years ended December 31, 2016 and 2015, the Company paid approximately $154,000 and $21,000, respectively, to the title insurance agent.
7. Commitments and Contingencies
Management Agreements
The Company’s hotels operate pursuant to management agreements with various third-party management companies. The management companies perform management functions including, but not limited to, hiring and supervising employees, establishing room prices, establishing administrative policies and procedures, managing expenditures and arranging and supervising public relations and advertising. The Management Agreements are for terms ranging from 1 year to 10 years however, the agreements can be cancelled for any reason by the Company after giving sixty days notice after the one year anniversary of the commencement of the agreements.
The Management Agreements provide for the payment of a base management fee equal to 3% to 3.5% of gross revenues, as defined, and an incentive management fee based on the operating results of the hotel, as defined. The base management fee and incentive management fee, if any, are recorded as property operating expenses in the consolidated statements of operations.
Franchise Agreements
As of December 31, 2016, the Company’s hotels operated pursuant to franchise agreements. Under the franchise agreements, the Company generally pays a fee equal to 3% to 5.5% of gross room sales, as defined, and a marketing fund charge from 2.0% to 2.5% of gross room sales. The franchise fee and marketing fund charge are recorded as property operating expenses in the consolidated statements of operations.
The franchise agreements are for terms ranging from 15 years to 20 years, expiring between 2028 and 2034.
Legal Proceedings
From time to time in the ordinary course of business, the Company may become subject to legal proceedings, claims or disputes.
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8. Quarterly Financial Data (Unaudited)
The following table presents selected unaudited quarterly financial data for each quarter during the years ended December 31, 2016 and 2015:
| 2016 | ||||||||||||||||||||
| Year ended December 31, | Quarter ended December 31, | Quarter ended September 30, | Quarter ended June 30, | Quarter ended March 31, | ||||||||||||||||
| Total revenue | $ | 22,551,234 | $ | 8,002,767 | $ | 7,623,494 | $ | 4,953,528 | $ | 1,971,445 | ||||||||||
| Operating income/(loss) | $ | 2,460,078 | $ | 865,200 | $ | 1,479,384 | $ | 425,788 | $ | (310,294 | ) | |||||||||
| Net (loss)/income | $ | (113,022 | ) | $ | (429,371 | ) | $ | 580,516 | $ | 137,444 | $ | (401,611 | ) | |||||||
| Less (income)/loss attributable to noncontrolling interests | $ | (7 | ) | $ | 5 | $ | (14 | ) | $ | (8 | ) | $ | 10 | |||||||
| Net (loss)/income applicable to Company's common shares | $ | (113,029 | ) | $ | (429,366 | ) | $ | 580,502 | $ | 137,436 | $ | (401,601 | ) | |||||||
| Net (loss)/income per common share, basic and diluted | $ | (0.01 | ) | $ | (0.04 | ) | $ | 0.06 | $ | 0.02 | $ | (0.08 | ) | |||||||
| 2015 | ||||||||||||||||||||
| Year ended December 31, | Quarter ended December 31, | Quarter ended September 30, | Quarter ended June 30, | Quarter ended March 31, | ||||||||||||||||
| Total revenue | $ | 6,203,341 | $ | 1,860,740 | $ | 2,168,262 | $ | 1,620,917 | $ | 553,422 | ||||||||||
| Operating income/(loss) | $ | 573,378 | $ | 196,459 | $ | 450,803 | $ | 46,076 | $ | (119,960 | ) | |||||||||
| Net (loss)/income | $ | (340,230 | ) | $ | (31,724 | ) | $ | 122,075 | $ | (213,953 | ) | $ | (216,628 | ) | ||||||
| Less loss/(income) attributable to noncontrolling interests | 44 | (4 | ) | (25 | ) | 39 | 34 | |||||||||||||
| Net (loss)/income applicable to Company's common shares | $ | (340,186 | ) | $ | (31,728 | ) | $ | 122,050 | $ | (213,914 | ) | $ | (216,594 | ) | ||||||
| Net (loss)/income per common share, basic and diluted | $ | (0.20 | ) | $ | (0.01 | ) | $ | 0.06 | $ | (0.19 | ) | $ | (0.41 | ) | ||||||
9. Subsequent Events
The Cove Transaction
On January 31, 2017, the Company, through a subsidiary of the Operating Partnership, REIT III COVE LLC (“REIT III Cove”) and REIT IV COVE LLC (“REIT IV Cove”), a wholly owned subsidiary of Lightstone Real Estate Income Trust, Inc. (“Lightstone IV”), a real estate investment trust also sponsored by the Sponsor and a related party, collectively, the “Assignees”, entered into an Assignment and Assumption Agreement (the “Assignment”) with another of the Lightstone IV’s wholly owned subsidiaries, REIT COVE LLC (the “Assignor”). Under the terms of the Assignment, the Assignees were assigned the rights and obligations of the Assignor with respect to that certain Sale and Purchase Agreement (the “Purchase Agreement”), dated September 29, 2016, made between the Assignor, as the purchaser, LSG Cove LLC (“LSG Cove”), an affiliate of the Sponsor and a related party and Maximus Cove Investor LLC (“Maximus”), an unrelated third party (collectively, the “Buyer”) and an unrelated third party, RP Cove, L.L.C (the “Seller”), pursuant to which the Buyer will acquire the Seller’s membership interest in RP Maximus Cove, L.L.C. (the “Joint Venture”) for approximately $255.0 million. The Joint Venture owns and operates The Cove at Tiburon (“The Cove”), a 281-unit, luxury waterfront multifamily rental property located in Tiburon, California. Prior to entering into the Cove Transaction, Maximus previously owned a separate noncontrolling interest in the Joint Venture.
On January 31, 2017, REIT IV Cove, REIT III Cove, LSG Cove, and Maximus (the “Members”) completed the Cove Transaction for aggregate consideration of approximately $255.0 million, which consisted of $80 million of cash and $175 million of proceeds from a loan from a financial institution. The Company paid approximately $20.0 million for a 22.5% membership interest in the Joint Venture.
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The Company’s interest in the Joint Venture is a non-managing interest, because the Company exerts significant influence over but does not control the Joint Venture, it will account for its ownership interest in the Joint Venture in accordance with the equity method of accounting. All distributions of earnings from the Joint Venture will be made on a pro rata basis in proportion to each Members’ equity interest percentage. Any distributions in excess of earnings from the Joint venture will be made to the Members pursuant to the terms of the Joint Venture’s operating agreement. An affiliate of Maximus is the asset manager of The Cove and receives certain fees as defined in the Property Management Agreement for the management of The Cove. The Company will commence recording its allocated portion of profit and cash distributions beginning as of January 31, 2017 with respect to its membership interest of 22.5% in the Joint Venture.
In connection with the closing of the Cove Transaction, the Joint Venture simultaneously entered into a $175.0 million loan (the “Loan”) initially scheduled to mature on January 31, 2020 with two, one-year extension options, subject to certain conditions. The Loan requires monthly interest payments through its maturity date. The Loan bears interest at Libor plus 3.85% through its initial maturity and Libor plus 4.15% during each of the extension periods. The Loan is collateralized by The Cove and an affiliate of the Sponsor (the “Guarantor”) has guaranteed the Joint Venture‘s obligation to pay the outstanding balance of the Loan up to approximately $43.8 million (the “Loan Guarantee”). The Members have agreed to reimburse the Guarantor for any balance that may become due under the Loan Guarantee, of which the Company’s share is up to approximately $10.9 million.
The Cove is a multi-family complex consisting of 281-units, or 289,690 square feet, contained within 32 apartment buildings over 20.1 acres originally constructed in 1967. As of January 31, 2017, The Cove was 81.5% occupied. The average remaining term for existing leases in The Cove is 4 months and the average rental price per square foot is $4.47.
Starting in 2013, approximately $38 million has been invested in an extensive refurbishment of The Cove; of which to date, 97% of the apartment buildings have been completed. The Members intend to use the remaining proceeds from the Loan and to invest additional capital if necessary to complete the refurbishment of The Cove. The Guarantor provided an additional guarantee of up to approximately $13.4 million (the “Refurbishment Guarantee”) to provide the necessary funds to complete the remaining renovations as defined in the Loan. The Members have agreed to reimburse the Guarantor for any balance that may become due under the Refurbishment Guarantee, of which the Company’s share is up to approximately $3.3 million.
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Real Estate and Accumulated Depreciation
December 31, 2016
| Gross amount at which | ||||||||||||||||||||||||||||||||||||
| Initial Cost (A) | carried at end of period | |||||||||||||||||||||||||||||||||||
| Encumbrance | Land | Buildings
and Improvements Including Furniture and Fixtures and CIP | Net
Costs Capitalized & Impairments Subsequent to Acquisition | Land
and Improvements | Buildings
and Improvements Including Furniture and Fixtures and CIP | Total (B) | Accumulated
Depreciation (C) | Date Acquired | Depreciable Life (D) | |||||||||||||||||||||||||||
| Revolving Credit Facility(1): | ||||||||||||||||||||||||||||||||||||
| Hampton Inn - Des Moines | $ | - | $ | 1,178,845 | $ | 9,721,155 | $ | 2,852,032 | $ | 1,194,896 | $ | 12,557,136 | $ | 13,752,032 | $ | (770,739 | ) | 2/4/2015 | (D) | |||||||||||||||||
| Des Moines, Iowa | ||||||||||||||||||||||||||||||||||||
| Courtyard - Durham | - | 1,027,019 | 14,972,981 | 94,997 | 1,027,019 | 15,067,978 | 16,094,997 | (1,057,464 | ) | 5/15/2015 | (D) | |||||||||||||||||||||||||
| Durham, North Carolina | ||||||||||||||||||||||||||||||||||||
| Hampton Inn - Lansing | - | 417,311 | 10,082,689 | 222,278 | 417,311 | 10,304,967 | 10,722,278 | (345,498 | ) | 3/10/2016 | (D) | |||||||||||||||||||||||||
| Lansing, Michigan | ||||||||||||||||||||||||||||||||||||
| Courtyard - Warwick | - | 693,601 | 11,706,399 | 134,296 | 693,601 | 11,840,695 | 12,534,296 | (288,752 | ) | 3/23/2016 | (D) | |||||||||||||||||||||||||
| Warwick, Rhode Island | ||||||||||||||||||||||||||||||||||||
| SpringHill Suites - Green Bay | - | 844,426 | 17,405,574 | 17,976 | 844,426 | 17,423,550 | 18,267,976 | (497,126 | ) | 5/2/2016 | (D) | |||||||||||||||||||||||||
| Green Bay, Wisconsin | ||||||||||||||||||||||||||||||||||||
| Fairfield Inn - Austin | - | 1,468,636 | 10,531,364 | - | 1,468,636 | 10,531,364 | 12,000,000 | (157,414 | ) | 9/13/2016 | (D) | |||||||||||||||||||||||||
| Austin, Texas | ||||||||||||||||||||||||||||||||||||
| Staybridge Suites - Austin | - | 1,937,591 | 8,062,409 | 6,062 | 1,937,591 | 8,068,471 | 10,006,062 | (100,968 | ) | 10/6/2016 | (D) | |||||||||||||||||||||||||
| Austin, Texas | ||||||||||||||||||||||||||||||||||||
| Unallocated | 58,817,791 | - | - | - | - | - | - | - | ||||||||||||||||||||||||||||
| Total | 58,817,791 | 7,567,429 | 82,482,571 | 3,327,641 | 7,583,480 | 85,794,161 | 93,377,641 | (3,217,961 | ) | |||||||||||||||||||||||||||
| Promissory Note(2): | ||||||||||||||||||||||||||||||||||||
| Home2 Suites - Salt Lake City | 10,973,622 | 5,756,344 | 12,743,656 | - | 5,756,344 | 12,743,656 | 18,500,000 | (280,430 | ) | 8/2/2016 | (D) | |||||||||||||||||||||||||
| Salt Lake City, Utah | ||||||||||||||||||||||||||||||||||||
| Home2 Suites - Seattle | 17,078,930 | 8,943,385 | 19,806,615 | - | 8,943,385 | 19,806,615 | 28,750,000 | (363,734 | ) | 8/2/2016 | (D) | |||||||||||||||||||||||||
| Seattle, Washington | ||||||||||||||||||||||||||||||||||||
| Total | 28,052,552 | 14,699,729 | 32,550,271 | - | 14,699,729 | 32,550,271 | 47,250,000 | (644,164 | ) | |||||||||||||||||||||||||||
| Total | $ | 86,870,343 | $ | 22,267,158 | $ | 115,032,842 | $ | 3,327,641 | $ | 22,283,209 | $ | 118,344,432 | $ | 140,627,641 | $ | (3,862,125 | ) | |||||||||||||||||||
| Check: | - | - | - | - | - | - | ||||||||||||||||||||||||||||||
Notes:
(1) - The Company's Revolving Credit Facility is cross-collateralized by seven hotels.
(2) - The Company's Promissory Note is cross-collateralized by two hotels, each of which has an allocated loan amount.
Notes to Schedule III:
| (A) | The initial cost to the Company represents the original purchase price of the property, including amounts incurred subsequent to acquisition which were contemplated at the time the property was acquired. |
| (B) | Reconciliation of total real estate owned: |
| For the years ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Balance at beginning of year | $ | 28,140,343 | $ | - | ||||
| Acquisitions, at cost | 110,400,000 | 26,900,000 | ||||||
| Improvements | 2,087,298 | 1,240,343 | ||||||
| Balance at end of year | $ | 140,627,641 | $ | 28,140,343 | ||||
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| (C) | Reconciliation of accumulated depreciation: |
| For the years ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Balance at beginning of year | $ | 731,289 | $ | - | ||||
| Depreciation expense | 3,130,836 | 731,289 | ||||||
| Balance at end of year | $ | 3,862,125 | $ | 731,289 | ||||
| (D) | Depreciation is computed based upon the following estimated lives: |
| Buildings and improvements | 39 years | |
| Furniture and fixtures | 5-10 years |
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PART II. CONTINUED:
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:
None.
Item 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. As of December 31, 2016, we conducted an evaluation under the supervision and with the participation of the Advisor’s management, including our Chairman and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chairman and Chief Executive Officer and Chief Financial Officer concluded as of December 31, 2016 that our disclosure controls and procedures were adequate and effective.
Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system is a process designed by, or under the supervision of, our Chairman and Chief Executive Officer and Chief Financial Officer and effected by our Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles.
Our internal control over financial reporting includes policies and procedures that:
| • | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and disposition of assets; |
| • | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with the authorization of our management and directors; and |
| • | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. |
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, they used the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in its report entitled Internal Control—Integrated Framework (2013). Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2016.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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None.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE REGISTRANT
Directors
The following table presents certain information as of March 15, 2017 concerning each of our directors serving in such capacity:
| Principal Occupation and | Year Term of | Served as a | ||||||
| Name | Age | Positions Held | Office Will Expire | Director Since | ||||
| David Lichtenstein | 56 | Chief Executive Officer and Chairman of the Board of Directors | 2017 | 2014 | ||||
| Edwin J. Glickman | 85 | Director | 2017 | 2014 | ||||
| George R. Whittemore | 67 | Director | 2017 | 2014 |
David Lichtenstein is our Chief Executive Officer and Chairman of our board of directors. Mr. Lichtenstein founded both American Shelter Corporation and The Lightstone Group. From 1988 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of The Lightstone Group, directing all aspects of the acquisition, financing and management of a diverse portfolio of multifamily, lodging, retail and industrial properties located in 20 states and Puerto Rico. From June 2004 to the present, Mr. Lichtenstein has served as the Chairman of the Board of Directors and Chief Executive Officer of Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”) and Chief Executive Officer of Lightstone Value Plus REIT LLC, its advisor. From April 2008 to the present, Mr. Lichtenstein has served as the Chairman of the Board of Directors and Chief Executive Offer of Lightstone Value Plus Real Estate Investment Trust II, Inc. (“Lightstone II”) and Lightstone Value Plus REIT II LLC, its advisor. From September 2014 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of Lightstone Real Estate Income Trust Inc., (“Lightstone IV”), and as Chief Executive Officer of Lightstone Real Estate Income LLC, its advisor. From October 2014 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of Lightstone Enterprises Limited. From June 2015 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of Hamilton National Income Trust, Inc. (“HNIT”) and Chief Executive Officer of Hamilton National Income Trust LLC, its advisor. Mr. Lichtenstein was the president and/or director of certain subsidiaries of Extended Stay Hotels, Inc. (“Extended Stay”) that filed for Chapter 11 protection with Extended Stay. Extended Stay and its subsidiaries filed for bankruptcy protection on June 15, 2009 so they could reorganize their debts in the face of looming amortization payments. Extended Stay emerged from bankruptcy on October 8, 2010. Mr. Lichtenstein is no longer affiliated with Extended Stay. From July 2015 to the present, Mr. Lichtenstein has served as a member of the Board of Directors of the New York City Economic Development Corporation. Mr. Lichtenstein is also a member of the International Council of Shopping Centers and the National Association of Real Estate Investment Trusts, Inc., an industry trade group, as well as a member of the Board of Directors of Touro College and New York Medical College. Mr. Lichtenstein has been selected to serve as a director due to his experience and networking relationships in the real estate industry, along with his experience in acquiring and financing real estate properties.
Edwin J. Glickman is one of our independent directors and the chairman of our audit committee. From April 2008 to the present, Mr. Glickman has served as a member of the board of directors of Lightstone II and from September 2014 to the present has served as a member of the board of directors of Lightstone IV. From December 2004 through January 2015, Mr. Glickman previously served as a member of the board of directors of Lightstone I. In January 1995, Mr. Glickman co-founded Capital Lease Funding, a leading mortgage lender for properties net leased to investment grade tenants, where he remained as Executive Vice President until May 2003 when he retired. Mr. Glickman was previously a trustee of publicly traded RPS Realty Trust from October 1980 through May 1996 and Atlantic Realty Trust from May 1996 to March 2006. Mr. Glickman graduated from Dartmouth College. Mr. Glickman has been selected to serve as an independent director due to his experience in mortgage lending and finance.
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George R. Whittemore From July 2006 to the present, Mr. Whittemore has served as a member of the board of directors of Lightstone I, and from April 2008 to the present has served as a member of the board of directors of Lightstone II. Mr. Whittemore also presently serves as a director of Village Bank Financial Corporation in Richmond, Virginia, a publicly traded company. Mr. Whittemore previously served as a director of Condor Hospitality, Inc. in Norfolk, Nebraska, a publicly traded company, from November 1994 to March 2016. Mr. Whittemore previously served as a director and audit committee chairman of Prime Group Realty Trust from July 2005 until December 2012. Mr. Whittemore previously served as President and Chief Executive Officer of Condor Hospitality Trust, Inc. from November 2001 until August 2004 and as Senior Vice President and Director of both Anderson & Strudwick, Incorporated, a brokerage firm based in Richmond, Virginia, and Anderson & Strudwick Investment Corporation, from October 1996 until October 2001. Mr. Whittemore has also served as Director, President and Managing Officer of Pioneer Federal Savings Bank and its parent, Pioneer Financial Corporation, from September 1982 until August 1994, and as President of Mills Value Adviser, Inc., a registered investment advisor. Mr. Whittemore is a graduate of the University of Richmond. Mr. Whittemore has been selected to serve as an independent director due to his experience in accounting, banking, finance and real estate.
Executive Officers:
The following table presents certain information as of March 15, 2017 concerning each of our executive officers serving in such capacities:
| Name | Age | Principal Occupation and Positions Held | ||
| David Lichtenstein | 56 | Chief Executive Officer and Chairman of the Board of Directors | ||
| Mitchell Hochberg | 64 | President and Chief Operating Officer | ||
| Joseph Teichman | 43 | General Counsel and Secretary | ||
| Donna Brandin | 60 | Chief Financial Officer and Treasurer |
David Lichtenstein for biographical information about Mr. Lichtenstein, see ‘‘Management — Directors.”
Mitchell Hochberg is our President and Chief Operating Officer and also serves as President of Lightstone I and its advisor and President and Chief Operating Officer of Lightstone II, Lightstone IV and HNIT and their advisors. Mr. Hochberg also serves as the President of our sponsor and as the President and Chief Operating Officer of our advisor. From October 2014 to the present, Mr. Hochberg has served as President of Lightstone Enterprises Limited. Prior to joining The Lightstone Group in August 2012, Mr. Hochberg served as principal of Madden Real Estate Ventures from 2007 to August 2012 when it combined with our sponsor. Mr. Hochberg held the position of President and Chief Operating Officer of Ian Schrager Company, a developer and manager of innovative luxury hotels and residential projects in the United States from early 2006 to early 2007 and prior to that Mr. Hochberg founded Spectrum Communities, a developer of luxury neighborhoods in the northeast of the United States, in 1985 where for 20 years he served as its President and Chief Executive Officer. Additionally, Mr. Hochberg serves on the board of directors of Orient-Express Hotels Ltd and as Chairman of the board of directors of Orleans Homebuilders, Inc. Mr. Hochberg received his law degree as a Harlan Fiske Stone Scholar from Columbia University School of Law and graduated magna cum laude from New York University College of Business and Public Administration with a Bachelor of Science degree in accounting and finance.
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Joseph E. Teichman is our General Counsel and Secretary and also serves as General Counsel of Lightstone I, Lightstone II, Lightstone IV and HNIT and their respective advisors. Mr. Teichman also serves as Executive Vice President and General Counsel of our sponsor and as General Counsel of our advisor. From October 2014 to the present, Mr. Teichman has served as Secretary and a Director of Lightstone Enterprises Limited. Prior to joining The Lightstone Group in January 2007, Mr. Teichman practiced law at the law firm of Paul, Weiss, Rifkind, Wharton & Garrison LLP in New York, NY from September 2001 to January 2007. Mr. Teichman earned a J.D. from the University of Pennsylvania Law School and a B.A. from Beth Medrash Govoha, Lakewood, New Jersey. Mr. Teichman is licensed to practice law in New York and New Jersey. Mr. Teichman was also a director of certain subsidiaries of Extended Stay that filed for Chapter 11 protection with Extended Stay. Extended Stay and its subsidiaries filed for bankruptcy protection on June 15, 2009 so they could reorganize their debts in the face of looming amortization payments. Extended Stay emerged from bankruptcy on October 8, 2010. Mr. Teichman is no longer affiliated with Extended Stay. Mr. Teichman is also a member of the Board of Directors of Yeshiva Orchos Chaim, Lakewood, New Jersey and was appointed to the Ocean County College Board of Trustees in February 2016.
Donna Brandin is our Chief Financial Officer and Treasurer and also serves as the Chief Financial Officer and Treasurer of Lightstone I, Lightstone II, Lightstone IV and HNIT. Ms. Brandin also serves as the Executive Vice President, Chief Financial Officer and Treasurer of our sponsor and as the Chief Financial Officer and Treasurer of our advisor and the advisors of Lightstone I and Lightstone II. From October 2014 to the present, Ms. Brandin has served as a Director of Lightstone Enterprises Limited. Prior to joining The Lightstone Group in April 2008, Ms. Brandin held the position of Executive Vice President and Chief Financial Officer of US Power Generation from September 2007 through November 2007 and before that was the Executive Vice President and Chief Financial Officer of Equity Residential, the largest publicly traded apartment REIT in the country, from August 2004 through September 2007. Prior to joining Equity Residential, Ms. Brandin held the position of Senior Vice President and Treasurer for Cardinal Health from June 2000 through August 2004. Prior to 2000, Ms. Brandin held various executive-level positions at Campbell Soup, Emerson Electric Company and Peabody Holding Company. Ms. Brandin earned a Bachelor of Science at Kutztown University and a Masters in Finance at St. Louis University and is a certified public accountant.
Section 16 (a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires each director, officer and individual beneficially owning more than 10% of our common stock to file initial statements of beneficial ownership (Form 3) and statements of changes in beneficial ownership (Forms 4 and 5) of our common stock with the Securities Exchange Commission ("SEC"). Officers, directors and greater than 10% beneficial owners are required by Securities and Exchange Commission rules to furnish us with copies of all such forms they file. Based solely on a review of the copies of such forms furnished to us during and with respect to the fiscal year ended December 31, 2016, or written representations that no additional forms were required, we believe that all of our officers and directors and persons that beneficially own more than 10% of the outstanding shares of our common stock complied with these filing requirements in 2016.
Information Regarding Audit Committee
Our Board established an audit committee in June 2014. The charter of audit committee is available at www.lightstonecapitalmarkets.com/sec-filings or in print to any stockholder who requests it c/o Lightstone Value Plus Real Estate Investment Trust III, Inc., 1985 Cedar Bridge Avenue, Lakewood, NJ 08701. Our audit committee consists of Messrs. Edwin J. Glickman and George R. Whittemore each of whom is “independent” within the meaning of the NYSE listing standards. The Board determined that Messrs. Glickman and Whittemore are qualified as audit committee financial experts as defined in Item 401 (h) of Regulation S-K. For more information regarding the relevant professional experience of Messrs. Glickman and Whittemore see “Directors”.
Code of Conduct and Ethics
We have adopted a Code of Conduct and Ethics that applies to all of our executive officers and directors, including but not limited to, our principal executive officer and principal financial officer. Our Code of Conduct and Ethics can be found at www.lightstonecapitalmarkets.com/sec-filings
ITEM 11. EXECUTIVE COMPENSATION
Compensation of Executive Officers
Our officers will not receive any cash compensation from us for their services as our officers. Our board of directors (including a majority of our independent directors) will determine if and when any of our officers will receive restricted shares of our common stock. Additionally, our officers are officers of one or more of our affiliates and are compensated by those entities (including our sponsor), in part, for their services rendered to us. From our inception through December 31, 2016, the Company has not compensated the officers.
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Compensation of Board of Directors
We pay our independent directors an annual fee of $40,000 and are responsible for reimbursement of their out-of-pocket expenses, as incurred.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Executive Officers:
The following table presents certain information as of March 15, 2017 concerning each of our directors and executive officers serving in such capacities:
| Name and Address of Beneficial Owner | Number of Shares of Common Stock of the Lightstone REIT III Beneficially Owned | Percent of All Common Shares of the Lightstone REIT III | ||||||
| David Lichtenstein (1) | 242,222 | 1.8 | % | |||||
| Edwin J. Glickman | - | - | ||||||
| George R. Whittemore | - | - | ||||||
| Mitchell Hochberg | - | - | ||||||
| Donna Brandin | - | - | ||||||
| Joseph Teichman | - | - | ||||||
| Our directors and executive officers as a group (6 persons) | 242,222 | 1.8 | % | |||||
| (1) | Includes 20,000 shares owned by our Advisor and 222,222 shares owned by an entity 100% owned by David Lichtenstein. Our Advisor is majority owned by David Lichtenstein. The beneficial owner’s business address is 1985 Cedar Bridge Avenue, Lakewood, New Jersey 08701. The Special Limited Partner, which is majority owned by Mr. Lichtenstein, will purchase subordinated participation interests in our operating partnership in exchange for cash or interest in real property. |
EQUITY COMPENSATION PLAN INFORMATION
Stock Incentive Plan
On June 9, 2015 our Board of Directors approved the termination of our stock incentive plan. No awards were granted under the plan prior to its termination.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
David Lichtenstein serves as the Chairman of our Board of Directors and our Chief Executive Officer. Our Advisor and its affiliates and the Special Limited Partner are majority owned and controlled by Mr. Lichtenstein. We have or may entered into agreements with our Advisor and its affiliates to pay certain fees, as described below, in exchange for services performed or consideration given by these and other affiliated entities. As a majority owner of those entities, Mr. Lichtenstein benefits from fees and other compensation that they receive pursuant to these agreements.
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Property Managers
Our Advisor has certain affiliates which may manage the properties we acquire. We also use other unaffiliated third-party property managers, principally for the management of our hospitality properties.
We have agreed to pay our property managers a monthly management fee in an amount not to exceed the fee customarily charged in arm’s-length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of property managers in such area. We will reimburse our property managers for certain costs and expenses. We may also pay our property managers a separate fee for the one-time initial rent-up or leasing-up of newly constructed property in an amount not to exceed the fee customarily charged in arm’s length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of brokers and agents in such area.
We may also engage our property managers to provide construction management services for some of our properties. We will pay a construction management fee in an amount of up to 5% of the cost of any improvements that our property managers undertake.
We did not incur any of these fees from our Advisor or its affiliates for these services during the years ended December 31, 2016 and 2015.
Advisor
We reimburse our Advisor for certain organization and offering expenses in connection with the Offering. We currently expect that such organization and offering expenses, will amount to approximately 2.0% of gross offering proceeds assuming we sell the maximum amount of the offering, and in no event will such expenses ultimately exceed 15.0% of gross offering proceeds.
We pay our Advisor an acquisition fee equal to 1.0% of the gross contractual purchase price (including any mortgage assumed) of each property purchased and reimburse our Advisor for expenses that it incurs in connection with the purchase of a property. We anticipate that acquisition expenses will be 0.6% of a property's purchase price, and acquisition fees and expenses are capped at 5% of the gross contract purchase price of a property. Acquisition fees of $1.1 million and $269,000 were incurred during the years ended December 31, 2016 and 2015, respectively.
Until the date on which our initial public offering ends, and subject to the approval of our board of directors, we may pay to our Advisor annually an asset management subordinated participation by issuing a number of restricted Class B Units equal to: (i) the cost of our assets multiplied by 0.1875%; divided by (ii) the value of one Common Share as of the last day of such calendar quarter, which is equal initially to $9.00 (the primary offering price minus selling commissions and dealer manager fees). The value of issued Class B Units will be determined and expensed when we deem the achievement of the performance condition (described below) to be probable. No annual subordinated performance fees were incurred during the years ended December 31, 2016 and 2015.
Beginning on the date on which our initial public offering ends, the Advisor may be paid an advisor asset management fee of one-twelfth (1/12) of 0.75% of our average invested assets and we will reimburse some expenses of the Advisor relating to asset management. No asset management fees were incurred during the years ended December 31, 2016 and 2015.
If our Advisor provides services in connection with the financing of an asset, assumption of a loan in connection with the acquisition of an asset or origination or refinancing of any loan on an asset, we will pay our Advisor a financing coordination fee equal to 0.75% of the amount available or outstanding under such financing. No financing coordination fees were charged during the years ended December 31, 2016 and 2015.
For substantial services in connection with the sale of a property, we will pay to our Advisor a commission in an amount equal to the lesser of (a) one-half of a real estate commission that is reasonable, customary and competitive in light of the size, type and location of the property and (b) 2.0% of the contract sales price of the property. The commission will not exceed the lesser of 6.0% of the contract sales price or commission that is reasonable, customary and competitive in light of the size, type and location of the property. No real estate disposition commissions were incurred during the years ended December 31, 2016 and 2015.
We will pay our Advisor an annual subordinated performance fee calculated on the basis of our annual return to holders of our Common Shares, payable annually in arrears, such that for any year in which holders of our Common Shares receive payment of a 6.0% annual cumulative, pre-tax, non-compounded return on their respective net investments, our Advisor will be entitled to 15.0% of the amount in excess of such 6.0% per annum return, provided, that the amount paid to the Advisor will not exceed 10.0% of the aggregate return for such year, and provided, further, that the annual subordinated performance fee will not be paid unless holders of our Common Shares receive a return of their respective net investments. No annual subordinated performance fees were incurred during the years ended December 31, 2016 and 2015, respectively.
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We have agreements with the Advisor to pay certain fees in exchange for services performed by the Advisor and/or its affiliated entities. Additionally, our ability to secure financing and our real estate operations are dependent upon our Advisor and its affiliates to perform such services as provided in these agreements. Furthermore, the Advisor has and is expected to continue to advance certain organization and offering costs on our behalf to the extent we do not have sufficient funds to pay such costs. As of December 31, 2016 and 2015, we owed the Advisor and its affiliated entities an aggregate of $109,532 and $1.2 million, respectively, which was principally for organization and offering costs paid on its behalf, and is classified as due to related parties on the consolidated balance sheets.
Special Limited Partner
Lightstone SLP III LLC (the ‘‘Special Limited Partner’’), a Delaware limited liability company of which Mr. Lichtenstein is the majority owner, is a special limited partner in the Operating Partnership and has committed to make a significant equity investment in the Company of up to $36.0 million, which is equivalent to 12.0% of the $300.0 million maximum amount of the Offering. Specifically, the Special Limited Partner has committed to purchase subordinated participation interests in the Operating Partnership (the “Subordinated Participation Interests”) quarterly in an amount equal to the product of (i) $10.00 minus our then current estimated NAV per Common Share, multiplied by (ii) the number of our Common Shares outstanding. The Operating Partnership will issue one Subordinated Participation Interest for each $50,000 in cash or interests in real property of equivalent value that the Special Limited Partner contributes. The Special Limited Partner’s obligation will continue until the earlier of: (i) the termination of the Offering; (ii) the Special Limited Partner’s purchase of an aggregate of $36.0 million of Subordinated Participation Interests and (iii) the receipt of gross offering proceeds of $300.0 million. The Special Limited Partner may elect to purchase the Subordinated Participation Interests for cash or may contribute interests in real property of equivalent value.
Through December 31, 2016, the Special Limited Partner has purchased an aggregate of approximately 242 Subordinated Participation Interests in consideration of $12.1 million, including approximately 228 Subordinated Participation Interests in consideration of $11.4 million during the year ended December 31, 2016. The Special Limited Partner may elect to purchase the Subordinated Participation Interests for cash or may contribute interests in real property of equivalent value. The Subordinated Participation Interests may be entitled to receive liquidation distributions upon the liquidation of Lightstone REIT III.
As the majority owner of the Special Limited Partner, Mr. Lichtenstein is the beneficial owner of a 99% interest in such Subordinated Participation Interests and will thus receive an indirect benefit from any distributions made in respect thereof.
These Subordinated Participation Interests will entitle the Special Limited Partner to a portion of any regular and liquidation distributions that we make to stockholders, but only after stockholders have received a stated preferred return. Although the actual amounts are dependent upon results of operations and, therefore, cannot be determined at the present time, distributions to the Special Limited Partner, as holder of the Subordinated Participation Interests, could be substantial.
Other
From time to time, we purchase title insurance from an agent in which our Sponsor owns a 50% limited partnership interest. Because this title insurance agent receives significant fees for providing title insurance, our Advisor may face a conflict of interest when considering the terms of purchasing title insurance from this agent. However, prior to the purchase by Lightstone of any title insurance, an independent title consultant with more than 25 years of experience in the title insurance industry reviews the transaction, and performs market research and competitive analysis on our behalf. This process results in terms similar to those that would be negotiated at an arm’s length basis. During the years ended December 31, 2016 and 2015, we paid approximately $154,000 and $21,000, respectively, to the title insurance agent.
During the years ended December 31, 2016 and 2015, we paid $36,298 and $403,589, respectively, to an affiliate of the Sponsor for the Sponsor’s marketing expenses related to the offering that were recorded as a reduction to additional paid in capital.
During the years ended December 31, 2016 and 2015, we recorded interest expense of $606,147 (including origination fees of $276,666) and $904,302 (including origination fees of $178,334), respectively, to the operating partnership of Lightstone II in connection with the Des Moines Promissory Note, the Durham Promissory Note, the Lansing Promissory Note and the Green Bay Promissory Note.
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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Principal Accounting Firm Fees
The following table presents the aggregate fees billed to us for the years presented by our principal accounting firm:
| Year ended December 31, 2016 | Year ended December 31, 2015 | |||||||
| Audit Fees (a) | $ | 148,475 | $ | 129,350 | ||||
| Audit-Related Fees (b) | 120,750 | 78,750 | ||||||
| Tax Fees (c) | 35,659 | 15,188 | ||||||
| Total Fees | $ | 304,884 | $ | 223,288 | ||||
| (a) | Fees for audit services consisted of the audit of the Lightstone REIT III’s annual financial statements and interim reviews, including services normally provided in connection with statutory and regulatory filings and including registration statements and consents. |
| (b) | Fees for audit-related services related to audits of entities that the Company has acquired. |
| (c) | Fees for tax services. |
In considering the nature of the services provided by the independent auditor, the audit committee determined that such services are compatible with the provision of independent audit services. The audit committee discussed these services with the independent auditor and Lightstone REIT III management to determine that they are permitted under the rules and regulations concerning auditor independence promulgated by the Securities and Exchange Commission to implement the related requirements of the Sarbanes-Oxley Act of 2002, as well as the American Institute of Certified Public Accountants.
AUDIT COMMITTEE REPORT
To the Directors of Lightstone Value Plus Real Estate Investment Trust III, Inc.:
We have reviewed and discussed with management Lightstone Value Plus Real Estate Investment Trust III, Inc.’s audited financial statements as of and for the year ended December 31, 2016.
We have discussed with the independent auditors the matters required to be discussed by Statement on Auditing Standards No. 61, “Communication with Audit Committees,” (Codification of Statements of Auditing Standards, August 2, 2007 AU 380), as amended, as adopted by the Public Company Accounting Oversight Board.
We have received and reviewed the written disclosures and the letter from the independent auditors required by Public Company Accounting Oversight Board Rule 3526, Communication with Audit Committees Concerning Independence and have discussed with the auditors the auditors’ independence.
Based on the reviews and discussions referred to above, we recommend to the board of directors that the financial statements referred to above be included in Lightstone Value Plus Real Estate Investment Trust III, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016.
Audit Committee
George R. Whittemore
Edwin J. Glickman
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INDEPENDENT DIRECTORS’ REPORT
To the Stockholders of Lightstone Value Plus Real Estate Investment Trust III, Inc.:
We have reviewed the Company’s policies and determined that they are in the best interest of the Company’s stockholders. Set forth below is a discussion of the basis for that determination.
General
The Company primarily intends to acquire full-service or select-service hotels, including extended-stay hotels. Even though the Company intends primarily to acquire hotels, it may purchase other types of real estate. The Company believes that at least 75% of the net proceeds raised in its offering will be used to acquire hotels and the remaining portion of the net proceeds raised in our offering will be used to acquire properties and real estate-related assets other than hotels. However, the Company may use more or less than 75% of the net proceeds raised in its offering to acquire hotels and is not bound to that limit.
Assets other than hotels may include, without limitation, office buildings, shopping centers, business and industrial parks, manufacturing facilities, single-tenant properties, multifamily properties, student housing properties, warehouses and distribution facilities and medical office properties. The Company expects to invest a significant portion of its funds in direct real estate investments and other equity interests, and the remainder of its funds in debt interests, which may include bridge or mezzanine loans, including in furtherance of a loan-to-own strategy. However, the Company is not prohibited from investing all its funds in debt interests.
The Company anticipates that its portfolio will provide consistent current income and may also provide capital appreciation resulting from its expectation that in certain circumstances it will be able to acquire properties at a discount to replacement cost or otherwise at less than what we perceive as the market value or to reposition or redevelop a property so as to increase its value over the amount of capital we deployed to acquire and rehabilitate the property. The Company may acquire properties that it believes would benefit from a change in management strategy, or that have incurred substantial deferred maintenance. The Company plans to diversify its portfolio by geographic region, investment size and investment risk with the goal of acquiring a portfolio of hotels and other income-producing real estate properties and real estate-related assets that provide attractive returns for its investors.
Financing Policies
The Company intends to utilize leverage to acquire its properties. The number of different properties the Company will acquire will be affected by numerous factors, including, the amount of funds available to us. When interest rates on mortgage loans are high or financing is otherwise unavailable on terms that are satisfactory to the Company, the Company may purchase certain properties for cash with the intention of obtaining a mortgage loan for a portion of the purchase price at a later time. There is no limitation on the amount the Company may invest in any single property or on the amount the Company can borrow for the purchase of any property.
The Company intends to limit its aggregate long-term permanent borrowings to 75% of the aggregate fair market value of all properties unless any excess borrowing is approved by a majority of the independent directors and is disclosed to the Company’s stockholders. The Company may also incur short-term indebtedness, having a maturity of two years or less. By operating on a leveraged basis, the Company will have more funds available for investment in properties. This will allow the Company to make more investments than would otherwise be possible, resulting in a more diversified portfolio. Although the Company’s liability for the repayment of indebtedness is expected to be limited to the value of the property securing the liability and the rents or profits derived therefrom, the Company’s use of leveraging increases the risk of default on the mortgage payments and a resulting foreclosure of a particular property. To the extent that the Company does not obtain mortgage loans on the Company’s properties, the Company’s ability to acquire additional properties will be restricted. The Company will endeavor to obtain financing on the most favorable terms available.
Policy on Sale or Disposition of Properties
The Company’s Board will determine whether a particular property should be sold or otherwise disposed of after considering the relevant factors, including performance or projected performance of the property and market conditions, with a view toward achieving its principal investment objectives.
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The Company currently intends to hold its properties for a period of three to six years from the termination of the Company’s initial public offering. At a future date, the Company’s Board may decide to liquidate the Company, list its shares on a national stock exchange, sell its properties individually or merge or otherwise consolidate the Company with a publicly-traded REIT. Alternatively, the Company may merge with, or otherwise be acquired by, the Sponsor or its affiliates. The Company may, however, sell properties prior to such time and if so, may invest the proceeds from any sale, financing, refinancing or other disposition of its properties into additional properties. Alternatively, the Company may use these proceeds to fund maintenance or repair of existing properties or to increase reserves for such purposes. The Company may choose to reinvest the proceeds from the sale, financing and refinancing of its properties to increase its real estate assets and its net income. Notwithstanding this policy, the Board, in its discretion, may distribute all or part of the proceeds from the sale, financing, refinancing or other disposition of all or any of the Company’s properties to the Company’s stockholders. In determining whether to distribute these proceeds to stockholders, the Board will consider, among other factors, the desirability of properties available for purchase, real estate market conditions, the likelihood of the listing of the Company’s shares on a national securities exchange and compliance with the applicable requirements under federal income tax laws.
When the Company sells a property, it intends to obtain an all-cash sale price. However, the Company may take a purchase money obligation secured by a mortgage on the property as partial payment, and there are no limitations or restrictions on the Company’s ability to take such purchase money obligations. The terms of payment to the Company will be affected by custom in the area in which the property being sold is located and the then prevailing economic conditions. If the Company receives notes and other property instead of cash from sales, these proceeds, other than any interest payable on these proceeds, will not be available for distributions until and to the extent the notes or other property are actually paid, sold, refinanced or otherwise disposed. Therefore, the distribution of the proceeds of a sale to the stockholders may be delayed until that time. In these cases, the Company will receive payments in cash and other property in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years.
Independent Directors
George R. Whittemore
Edwin J. Glickman
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ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES:
LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC.
Annual Report on Form 10-K
For the fiscal year ended December 31, 2016
EXHIBIT INDEX
The following exhibits are included, or incorporated by reference, as part of this Annual Report on Form 10-K (and are numbered in accordance with Item 601 of Regulation S-K):
| EXHIBIT NO. | DESCRIPTION | |
| 1.1(1) | Amended and Restated Dealer Manager Agreement by and between Lightstone Value Plus Real Estate Investment Trust III, Inc. and Orchard Securities, LLC | |
| 1.2* | Form of Soliciting Dealer Agreement | |
| 3.1(2) | Articles of Amendment and Restatement of Lightstone Value Plus Real Estate Investment Trust III, Inc. | |
| 3.2(3) | Bylaws of Lightstone Value Plus Real Estate Investment Trust III, Inc. | |
| 4.1(4) | Agreement of Limited Partnership of Lightstone Value Plus REIT III LP | |
| 4.2 | Distribution Reinvestment Program, included as Appendix C to prospectus | |
| 4.4(5) | Second Amended and Restated Contribution Agreement between Lightstone Value Plus REIT III LP and Lightstone SLP III LLC | |
| 10.1(4) | Advisory Agreement by and among Lightstone Value Plus Real Estate Investment Trust III, Inc., Lightstone Value Plus REIT III LP and Lightstone Value Plus REIT III LLC | |
| 10.2(4) | Property Management Agreement by and among Lightstone Value Plus Real Estate Investment Trust III, Inc., Lightstone Value Plus REIT III LP and Beacon Property | |
| 10.3(4) | Property Management Agreement by and among Lightstone Value Plus Real Estate Investment Trust III, Inc., Lightstone Value Plus REIT III LP and Paragon Retail Property Management LLC | |
| 10.4* | Assignment and Assumption of Purchase and Sale Agreement, dated February 4, 2015, by and among LVP HMI Des Moines LLC and Lightstone Acquisitions V LLC. | |
| 10.5* | Assignment and Assumption of Purchase and Sale Agreement, dated May 15, 2015, by and among LVP CY Durham LLC and Lightstone Acquisitions V LLC. | |
| 10.6* | Assignment and Assumption of Purchase and Sale Agreement, dated March 10, 2016, by and among LVP HMI Lansing LLC and Lightstone Acquisitions VIII LLC. | |
| 10.7* | Assignment and Assumption of Purchase and Sale Agreement, dated March 23, 2016, by and among LVP CY Warwick LLC and Lightstone Acquisitions LLC. | |
| 10.8* | Assignment and Assumption of Purchase and Sale Agreement, dated May 2, 2016, by and among LVP SHS Green Bay LLC and Lightstone Acquisitions VII LLC. | |
| 10.9* | Assignment and Assumption of Purchase and Sale Agreement, dated August 2, 2016, by and among LVP H2S Seattle LLC and Lightstone Acquisitions VI LLC. | |
| 10.10* | Assignment and Assumption of Purchase and Sale Agreement, dated August 2, 2016, by and among LVP H2S Salt Lake City LLC and Lightstone Acquisitions VI LLC. | |
| 10.11* | Assignment and Assumption of Purchase and Sale Agreement, dated September 13, 2016, by and among LVP FFI Austin LLC and Lightstone Acquisitions LLC. | |
| 10.12* | Assignment and Assumption of Purchase and Sale Agreement, dated October 7, 2016, by and among LVP SBS Austin LLC and Lightstone Acquisitions LLC. | |
| 10.13* | Assignment and Assumption Agreement, dated as of January 31, 2017, by and among REIT Cove LLC, REIT IV Cove LLC and REIT III Cove LLC. | |
| 10.14* | Revolving Credit Facility dated July 13, 2016 with Western Alliance Bank. | |
| 10.15* | Promissory Note dated October 5, 2016 with Citigroup Global Markets Realty Corp. | |
| 21.1* | Subsidiaries of the Registrant | |
| 31.1* | Certification Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2* | Certification Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1* | Certification Pursuant to Rule 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2* | Certification Pursuant to Rule 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 101* | XBRL (eXtensible Business Reporting Language).The following financial information from Lightstone Value Plus Real Estate Investment Trust III, Inc. on Form 10-K for the year ended December 31, 2016, filed with the SEC on March 28, 2017, formatted in XBRL includes: (1) Consolidated Balance Sheets, (2) Consolidated Statements of Operations, (3) Consolidated Statements of Stockholders’ Equity, (4) Consolidated Statements of Cash Flows, and (5) the Notes to the Consolidated Financial Statement. As provided in Rule 406T of Regulation S-T, this information in furnished and not filed for purpose of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934. |
| * | As filed herewith |
| (1) | Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on January 12, 2017. |
| (2) | Included as an exhibit to our Post-Effective Amendment No. 2 to our Registration Statement on Form S-11 (Reg. No. 333-195292) filed with the Securities and Exchange Commission on September 11, 2015. |
| (3) | Included as Exhibit 3.2 to our Registration Statement on Form S-11 (Reg. No. 333-195292) submitted confidentially to the Securities and Exchange Commission on April 24, 2013. |
| (4) | Included as an exhibit to our Post-Effective Amendment No. 2 to our Registration Statement on Form S-11 (Reg. No. 333-195292) filed with the Securities and Exchange Commission on September 11, 2015. |
| (5) | Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on December 29, 2015. |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST III, INC. | ||
| Date: March 28, 2017 | By: | s/ David Lichtenstein |
| David Lichtenstein | ||
| Chief Executive Officer and Chairman of the Board of Directors | ||
| (Principal Executive Officer) | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| NAME | CAPACITY | DATE | ||
| /s/ David Lichtenstein | Chief Executive Officer and Chairman of the Board | March 28, 2017 | ||
| David Lichtenstein | of Directors (Principal Executive Officer) | |||
| /s/ Donna Brandin | Chief Financial Officer and Treasurer | March 28, 2017 | ||
| Donna Brandin | (Principal Financial Officer and Principal | |||
| Accounting Officer) | ||||
| /s/ Edwin J. Glickman | Director | March 28, 2017 | ||
| Edwin J. Glickman | ||||
| /s/ George R. Whittemore | Director | March 28, 2017 | ||
| George R. Whittemore |
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