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EX-32.2 - EXHIBIT 32.2 - Sila Realty Trust, Inc.a201710-kexhibit322reitii0.htm
EX-32.1 - EXHIBIT 32.1 - Sila Realty Trust, Inc.a201710-kexhibit321reitii0.htm
EX-31.2 - EXHIBIT 31.2 - Sila Realty Trust, Inc.a201710-kexhibit312reitii0.htm
EX-31.1 - EXHIBIT 31.1 - Sila Realty Trust, Inc.a201710-qexhibit311reitii0.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 000-55435
cvmcriilogoa22.jpg
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
(Exact name of registrant as specified in its charter)
Maryland
 
46-1854011
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
4890 West Kennedy Blvd., Suite 650
Tampa, FL 33609
 
(813) 287-0101
(Address of Principal Executive Offices; Zip Code)
 
(Registrant’s Telephone Number)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
None
 
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $0.01 per share
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
 
Accelerated filer
 
Non-accelerated filer
 
☒ (Do not check if a smaller reporting company)
 
Smaller reporting company
 
 
 
 
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 7(a)(2)(B) of the Securities Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒
As of May 9, 2017, there were approximately 74,877,000 shares of Class A common stock, 532,000 shares of Class I common stock and 18,676,000 shares of Class T common stock of Carter Validus Mission Critical REIT II, Inc. outstanding.
 



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




PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
(Unaudited)
March 31, 2017
 
December 31, 2016
ASSETS
Real estate:
 
 
 
Land
$
171,729

 
$
154,385

Buildings and improvements, less accumulated depreciation of $23,781 and $18,521, respectively
842,469

 
722,492

Construction in progress
26,671

 
20,123

Total real estate, net
1,040,869

 
897,000

Cash and cash equivalents
64,414

 
50,446

Acquired intangible assets, less accumulated amortization of $10,353 and $7,995, respectively
110,885

 
98,053

Other assets, net
31,411

 
24,539

Total assets
$
1,247,579

 
$
1,070,038

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
 
 
 
Notes payable, net of deferred financing costs of $2,196 and $1,945, respectively
$
175,794

 
$
151,045

Credit facility, net of deferred financing costs of $803 and $876, respectively
309,197

 
219,124

Accounts payable due to affiliates
8,672

 
7,384

Accounts payable and other liabilities
19,981

 
17,184

Intangible lease liabilities, less accumulated amortization of $768 and $634, respectively
6,739

 
6,873

Total liabilities
520,383

 
401,610

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

 

Common stock, $0.01 par value per share, 500,000,000 shares authorized; 91,032,935 and 83,109,025 shares issued, respectively; 90,427,297 and 82,744,288 shares outstanding, respectively
904

 
827

Additional paid-in capital
790,371

 
723,859

Accumulated distributions in excess of earnings
(65,689
)
 
(57,100
)
Accumulated other comprehensive income
1,608

 
840

Total stockholders’ equity
727,194

 
668,426

Noncontrolling interests
2

 
2

Total equity
727,196

 
668,428

Total liabilities and stockholders’ equity
$
1,247,579

 
$
1,070,038

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

3


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except share data and per share amounts)
(Unaudited)
 
Three Months Ended
March 31,
 
2017
 
2016
Revenue:
 
 
 
Rental revenue
$
19,682

 
$
10,021

Tenant reimbursement revenue
4,340

 
1,403

Total revenue
24,022

 
11,424

Expenses:
 
 
 
Rental expenses
4,926

 
1,684

General and administrative expenses
925

 
765

Acquisition related expenses

 
1,665

Asset management fees
2,006

 
955

Depreciation and amortization
7,610

 
3,866

Total expenses
15,467

 
8,935

Income from operations
8,555

 
2,489

Interest expense, net
3,764

 
879

Net income attributable to common stockholders
$
4,791

 
$
1,610

Other comprehensive income:
 
 
 
Unrealized income on interest rate swaps, net
$
768

 
$

Other comprehensive income attributable to common stockholders
768

 

Comprehensive income attributable to common stockholders
$
5,559

 
$
1,610

Weighted average number of common shares outstanding:
 
 
 
Basic
86,482,927

 
53,666,785

Diluted
86,499,543

 
53,679,723

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

 
$
0.03

Diluted
$
0.06

 
$
0.03

Distributions declared per common share
$
0.16

 
$
0.16

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

4


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands, except for share data)
(Unaudited)
 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
No. of
Shares
 
Par
Value
 
Additional
Paid-in
Capital
 
Accumulated Distributions in Excess of Earnings
 
Accumulated Other Comprehensive Income
 
Total
Stockholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
Balance, December 31, 2016
82,744,288

 
$
827

 
$
723,859

 
$
(57,100
)
 
$
840

 
$
668,426

 
$
2

 
$
668,428

Issuance of common stock
7,164,054

 
72

 
69,851

 

 

 
69,923

 

 
69,923

Issuance of common stock under the distribution reinvestment plan
759,857

 
7

 
6,994

 

 

 
7,001

 

 
7,001

Vesting of restricted common stock

 

 
17

 

 

 
17

 

 
17

Commissions on sale of common stock and related dealer manager fees

 

 
(4,945
)
 

 

 
(4,945
)
 

 
(4,945
)
Distribution and servicing fees

 

 
(1,649
)
 

 

 
(1,649
)
 

 
(1,649
)
Other offering costs

 

 
(1,573
)
 

 

 
(1,573
)
 

 
(1,573
)
Repurchase of common stock
(240,902
)
 
(2
)
 
(2,183
)
 

 

 
(2,185
)
 

 
(2,185
)
Distributions declared to common stockholders

 

 

 
(13,380
)
 

 
(13,380
)
 

 
(13,380
)
Other comprehensive income

 

 

 

 
768

 
768

 

 
768

Net income

 

 

 
4,791

 

 
4,791

 

 
4,791

Balance, March 31, 2017
90,427,297

 
$
904

 
$
790,371

 
$
(65,689
)
 
$
1,608

 
$
727,194

 
$
2

 
$
727,196

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

5


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
Three Months Ended
March 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
4,791

 
$
1,610

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
7,610

 
3,866

Amortization of deferred financing costs
561

 
202

Amortization of above-market leases
9

 
9

Amortization of intangible lease liabilities
(134
)
 
(134
)
Straight-line rent
(2,232
)
 
(1,166
)
Stock-based compensation
17

 
11

Ineffectiveness of interest rate swaps
8

 

Changes in operating assets and liabilities:
 
 
 
Accounts payable and other liabilities
2,970

 
891

Accounts payable due to affiliates
199

 
97

Other assets
(1,028
)
 
(755
)
Net cash provided by operating activities
12,771

 
4,631

Cash flows from investing activities:
 
 
 
Investment in real estate
(156,875
)
 
(85,403
)
Acquisition costs capitalized subsequent
(44
)
 

Capital expenditures
(8,108
)
 
(247
)
Escrow funds, net
193

 
230

Real estate deposits, net
(3,330
)
 
(400
)
Net cash used in investing activities
(168,164
)
 
(85,820
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock
69,923

 
93,868

Proceeds from notes payable
25,000

 

Proceeds from credit facility
120,000

 
20,000

Payments on credit facility
(30,000
)
 

Payments of deferred financing costs
(526
)
 
(206
)
Repurchases of common stock
(2,185
)
 
(338
)
Offering costs on issuance of common stock
(6,661
)
 
(9,074
)
Distributions to stockholders
(5,977
)
 
(3,359
)
Escrow funds, net
(213
)
 

Net cash provided by financing activities
169,361

 
100,891

Net change in cash and cash equivalents
13,968

 
19,702

Cash and cash equivalents - Beginning of period
50,446

 
31,262

Cash and cash equivalents - End of period
$
64,414

 
$
50,964

Supplemental cash flow disclosure:
 
 
 
Interest paid, net of interest capitalized of $365 during 2017
$
3,225

 
$
595

Supplemental disclosure of non-cash transactions:
 
 
 
Common stock issued through distribution reinvestment plan
$
7,001

 
$
4,626

Distribution and servicing fees accrued during the period
$
1,333

 
$

Liability assumed at acquisition
$
815

 
$

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

6


CARTER VALIDUS MISSION CRITICAL REIT II, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2017
Note 1—Organization and Business Operations
Carter Validus Mission Critical REIT II, Inc., or the Company, is a Maryland corporation that was formed on January 11, 2013. The Company elected to be taxed as a real estate investment trust, or a REIT, under the Internal Revenue Code of 1986, as amended, for federal income tax purposes, on September 11, 2015. Substantially all of the Company’s business is conducted through Carter Validus Operating Partnership II, LP, a Delaware limited partnership, or the Operating Partnership, formed on January 10, 2013. The Company is the sole general partner of the Operating Partnership and Carter Validus Advisors II, LLC, or the Advisor, is the initial limited partner of the Operating Partnership.
The Company is offering for sale a maximum of $2,350,000,000 in shares of common stock, consisting of up to $2,250,000,000 in shares in its primary offering and up to $100,000,000 in shares of common stock to be made available pursuant to the Company’s distribution reinvestment plan, or the DRIP, on a “best efforts” basis, or the Offering, pursuant to a registration statement on Form S-11, or the Registration Statement, filed with the Securities and Exchange Commission, or the SEC, under the Securities Act of 1933, as amended, or the Securities Act, which was declared effective on May 29, 2014. As of March 31, 2017, we were offering Class A shares, Class I shares and Class T shares of common stock, in any combination with a dollar value up to the maximum offering amount.
As of March 31, 2017, the Company had issued approximately 91,026,000 shares of Class A, Class I and Class T common stock (including shares of common stock issued pursuant to the DRIP) in the Offering, resulting in receipt of gross proceeds of approximately $896,207,000, before selling commissions and dealer manager fees of approximately $74,130,000 and other offering costs of approximately $17,450,000. As of March 31, 2017, the Company had approximately $1,453,793,000 in Class A shares, Class I shares and Class T shares of common stock remaining in the Offering.
Substantially all of the Company’s business is managed by the Advisor. Carter Validus Real Estate Management Services II, LLC, or the Property Manager, an affiliate of the Advisor, serves as the Company’s property manager. The Advisor and the Property Manager have received, and will continue to receive, fees for services related to the acquisition and operational stages. The Advisor will also be eligible to receive fees during the liquidation stage. SC Distributors, LLC, an affiliate of the Advisor, or the Dealer Manager, serves as the dealer manager of the Offering. The Dealer Manager has received, and will continue to receive, fees for services related to the Offering.
The Company was formed to invest primarily in quality income-producing commercial real estate, with a focus on data centers and healthcare properties, preferably with long-term net leases to creditworthy tenants, as well as to make other real estate-related investments that relate to such property types. Real estate-related investments may include equity or debt interests, including securities, in other real estate entities. The Company also may originate or invest in real estate-related notes receivable. The Company expects real estate-related notes receivable originations and investments to be focused on first mortgage loans, but also may include real estate-related bridge loans, mezzanine loans and securitized notes receivable. As of March 31, 2017, the Company owned 41 real estate investments, consisting of 57 properties, located in 32 metropolitan statistical areas, or MSAs, and one micropolitan statistical area, or µSA.
Except as the context otherwise requires, “we,” “our,” “us,” and the “Company” refer to Carter Validus Mission Critical REIT II, Inc., the Operating Partnership and all wholly-owned subsidiaries.
Note 2—Summary of Significant Accounting Policies
The summary of significant accounting policies presented below is designed to assist in understanding the Company’s condensed consolidated financial statements. Such condensed consolidated financial statements and the accompanying notes thereto are the representation of management. These accounting policies conform to accounting principles generally accepted in the United States of America, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal and recurring nature considered for a fair presentation, have been included. Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.
The condensed consolidated balance sheet at December 31, 2016 has been derived from the audited consolidated financial statements at that date but does not include all the information and notes required by GAAP for complete financial statements. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's audited

7


consolidated financial statements as of and for the year ended December 31, 2016 and related notes thereto set forth in the Company's Annual Report on Form 10-K, filed with the SEC on March 16, 2017.
Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, and all wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the condensed consolidated financial statements and accompanying notes in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates are made and evaluated on an ongoing basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates.
Concentration of Credit Risk and Significant Leases
As of March 31, 2017, the Company had cash on deposit, including restricted cash, in certain financial institutions that had deposits in excess of current federally insured levels; however, the Company has not experienced any losses in such accounts. The Company limits its cash investments to financial institutions with high credit standing; therefore, the Company believes it is not exposed to any significant credit risk on its cash deposits. To date, the Company has experienced no loss or lack of access to cash in its accounts.
As of March 31, 2017, the Company owned real estate investments in 32 MSAs, one of which accounted for 10.0% or more of contractual rental revenue. Real estate investments located in the Oklahoma City, Oklahoma MSA accounted for 12.9% of contractual rental revenue for the three months ended March 31, 2017.
Share Repurchase Program
The Company’s share repurchase program allows for repurchases of shares of the Company’s common stock when certain criteria are met. The share repurchase program provides that all repurchases during any calendar year, including those redeemable upon death or a Qualifying Disability of a stockholder, are limited to those that can be funded with equivalent proceeds raised from the DRIP Offering during the prior calendar year and other operating funds, if any, as the board of directors, in its sole discretion, may reserve for this purpose.
Repurchases of shares of the Company’s common stock are at the sole discretion of the Company’s board of directors. The Company will limit the number of shares repurchased pursuant to the share repurchase program as follows: during any calendar year, the Company will not repurchase in excess of 5.0% of the number of shares of common stock outstanding on December 31st of the previous calendar year. In addition, the Company’s board of directors, in its sole discretion, may amend, suspend, reduce, terminate or otherwise change the share repurchase program upon 30 days' prior notice to the Company’s stockholders for any reason it deems appropriate.
During the three months ended March 31, 2017, the Company received valid repurchase requests related to 240,902 Class A shares of common stock, all of which were repurchased in full for an aggregate purchase price of approximately $2,185,000 (an average of $9.07 per share). During the three months ended March 31, 2016, the Company received valid repurchase requests related to 35,970 Class A shares of common stock, all of which were repurchased in full for an aggregate purchase price of approximately $338,000 (an average of $9.40 per share). No shares of Class I common stock or Class T common stock were requested to be, or were, repurchased during the three months ended March 31, 2017 and 2016.
Earnings Per Share
The Company calculates basic earnings per share by dividing net income attributable to common stockholders for the period by the weighted average shares of its common stock outstanding for that period. Diluted earnings per share are computed based on the weighted average number of shares outstanding and all potentially dilutive securities. Shares of non-vested restricted common stock give rise to potentially dilutive shares of common stock. For the three months ended March 31, 2017 and 2016, diluted earnings per share reflected the effect of approximately 17,000 and 13,000, respectively, of non-vested shares of restricted stock that were outstanding as of such period.
Recently Issued Accounting Pronouncements
On May 28, 2014, the Financial Accounting Standards Board, or the FASB, issued ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. The objective of ASU 2014-09 is to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity

8


expects to be entitled in exchange for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle, which may require more judgment and estimates within the revenue recognition process than are required under existing GAAP. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date, or ASU 2015-14. ASU 2015-14 defers the effective date of ASU 2014-09 by one year to fiscal years and interim periods beginning after December 15, 2017. Early adoption is permitted as of the original effective date, which was annual reporting periods beginning after December 15, 2016, and the interim periods within that year. On March 17, 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers Principal versus Agent Considerations (Reporting Revenue Gross versus Net), or ASU 2016-08, which clarifies the implementation guidance on principal versus agent considerations in the new revenue recognition standard. ASU 2016-08 clarifies that an entity is a principal when it controls the specified good or service before that good or service is transferred to the customer, and is an agent when it does not control the specified good or service before it is transferred to the customer. The effective date and transition of this update is the same as the effective date and transition of ASU 2015-14. The Company believes the adoption of ASUs 2014-09 and 2016-08 will not have a material impact on the Company’s consolidated financial statements, but may result in additional disclosures.
On February 25, 2016, the FASB issued ASU 2016-02, Leases, or ASU 2016-02. ASU 2016-02 establishes the principles to increase the transparency about the assets and liabilities arising from leases. ASU 2016-02 results in a more faithful representation of the rights and obligations arising from leases by requiring lessees to recognize the lease assets and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions and aligns lessor accounting and sale leaseback transactions guidance more closely to comparable guidance in Topic 606, Revenue from Contracts with Customers, and Topic 610, Other Income. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is in process of evaluating the impact ASU 2016-02 will have on the Company’s consolidated financial statements.
On June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses, or ASU 2016-13. ASU 2016-13 requires more timely recording of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. ASU 2016-13 requires that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The amendments in ASU 2016-13 require the Company to measure all expected credit losses based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets and eliminates the “incurred loss” methodology in current GAAP. ASU 2016-13 is effective for fiscal years, and interim periods within, beginning after December 15, 2019. Early adoption is permitted for fiscal years, and interim periods within, beginning after December 15, 2018. The Company is in the process of evaluating the impact ASU 2016-13 will have on the Company’s consolidated financial statements.
On November 17, 2016, the FASB issued ASU 2016-18, Restricted Cash, or ASU 2016-18. ASU 2016-18 requires that a statement of cash flows explain the change during a reporting period in the total of cash, cash equivalents, and amounts generally described as restricted cash and restricted cash equivalents. This ASU states that transfers between cash, cash equivalents, and restricted cash are not part of the entity’s operating, investing, and financing activities. Therefore, restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. This ASU should be applied using a retrospective transition method to each period presented. The Company is in the process of evaluating the impact ASU 2016-18 will have on the Company’s consolidated statements of cash flows.
On January 5, 2017, the FASB issued ASU 2017-01, Business Combinations, or ASU 2017-01. ASU 2017-01 clarifies the definition of a business. The objective of ASU 2017-01 is to add further guidance that assists entities in evaluating whether a transaction will be accounted for as an acquisition of an asset or a business. The guidance requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If so, the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those years. Early adoption is permitted using a prospective transition method. The Company adopted ASU 2017-01 effective October 1, 2016.
On February 23, 2017, the FASB issued ASU 2017-05, Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets, or ASU 2017-05. ASU 2017-05 clarifies the scope of asset derecognition guidance and accounting for partial sales of nonfinancial assets. Partial sales of nonfinancial assets are common in the real estate industry and include transactions in which the seller retains an equity interest in the entity that owns the assets or has an equity interest in the buyer. ASU 2017-05 is effective for fiscal years beginning after December 15, 2017, including interim

9


reporting periods within those fiscal years. Early adoption is permitted. The Company is in process of evaluating the impact ASU 2017-05 will have on the Company’s condensed consolidated financial statements.
Note 3—Real Estate Investments
During the three months ended March 31, 2017, the Company purchased six real estate properties, all of which were determined to be asset acquisitions. Upon the acquisition of the real estate properties determined to be asset acquisitions, the Company allocates the purchase price of such properties to acquired tangible assets, consisting of land and buildings and improvements, and acquired intangible assets, based on a relative fair value method allocating all accumulated costs. The aggregate purchase price of the acquisitions was $157,690,000, inclusive of a liability assumed at acquisition of $815,000.
The following table summarizes the acquisitions during the three months ended March 31, 2017:
Property Description
Date
Acquired
 
Ownership
Percentage
 
Purchase Price
(amounts in thousands)
Tempe Data Center
01/26/2017
 
100%
 
$
16,224

Norwalk Data Center
03/30/2017
 
100%
 
58,885

Aurora Healthcare Facility
03/30/2017
 
100%
 
11,531

Texas Rehab - Austin
03/31/2017
 
100%
 
36,945

Texas Rehab - Allen
03/31/2017
 
100%
 
23,691

Texas Rehab - Beaumont
03/31/2017
 
100%
 
10,414

Total
 
 
 
 
$
157,690

The following table summarizes management's allocation of the acquisitions during the three months ended March 31, 2017, based on a relative fair value method allocating all accumulated costs (amounts in thousands):
 
Total
Land
$
17,267

Buildings and improvements
125,977

In-place leases
14,446

Total assets acquired
$
157,690

Acquisition fees and expenses associated with transactions determined to be asset acquisitions are capitalized. The Company capitalized acquisition fees and costs of approximately $4,093,000 related to the current quarter acquisitions. The Company capitalized $1,387,000 for the three months ended March 31, 2016. The total amount of all acquisition fees and costs is limited to 6.0% of the contract purchase price of a property. The contract purchase price is the amount actually paid or allocated in respect of the purchase, development, construction or improvement of a property exclusive of acquisition fees and costs. For the three months ended March 31, 2017, acquisition fees and costs did not exceed 6.0% of the contract purchase price of the Company's acquisitions during such periods.
Note 4—Acquired Intangible Assets, Net
Acquired intangible assets, net, consisted of the following as of March 31, 2017 and December 31, 2016 (amounts in thousands, except weighted average life amounts):
 
March 31, 2017
 
December 31, 2016
In-place leases, net of accumulated amortization of $10,267 and $7,918, respectively (with a weighted average remaining life of 12.9 years and 12.8 years, respectively)
$
110,073

 
$
97,232

Above-market leases, net of accumulated amortization of $65 and $58, respectively (with a weighted average remaining life of 7.2 years and 7.4 years, respectively)
189

 
196

Ground lease interest, net of accumulated amortization of $21 and $19, respectively (with a weighted average remaining life of 66.6 years and 66.8 years, respectively)
623

 
625

 
$
110,885

 
$
98,053

The aggregate weighted average remaining life of the acquired intangible assets was 13.2 years and 13.1 years as of March 31, 2017 and December 31, 2016, respectively.

10


Amortization of the acquired intangible assets for the three months ended March 31, 2017 and 2016 was $2,358,000 and $1,181,000, respectively. Amortization of the above-market leases is recorded as an adjustment to rental revenue, amortization expense for the in-place leases is included in depreciation and amortization and amortization expense for the ground lease interest is included in rental expenses in the accompanying condensed consolidated statements of comprehensive income.
Note 5—Intangible Lease Liabilities, Net
Intangible lease liabilities, net consisted of the following as of March 31, 2017 and December 31, 2016 (amounts in thousands, except weighted average life amounts):
 
March 31, 2017
 
December 31, 2016
Below-market leases, net of accumulated amortization of $768 and $634, respectively (with a weighted average remaining life of 13.3 years and 13.6 years, respectively)
$
6,739

 
$
6,873


$
6,739

 
$
6,873

Amortization of below-market leases was $134,000 for the three months ended March 31, 2017 and 2016. Amortization of below-market leases is recorded as an adjustment to rental revenue in the accompanying condensed consolidated statements of comprehensive income.
Note 6—Other Assets, Net
Other assets, net consisted of the following as of March 31, 2017 and December 31, 2016 (amounts in thousands):
 
March 31, 2017
 
December 31, 2016
Deferred financing costs, related to the revolver portion of the secured credit facility, net of accumulated amortization of $2,169 and $1,789, respectively
$
2,857

 
$
3,071

Real estate escrow deposits
3,620

 
290

Restricted cash held in escrow
6,481

 
6,458

Tenant receivable
3,724

 
3,126

Straight-line rent receivable
10,957

 
8,725

Prepaid and other assets
1,514

 
1,087

Derivative assets
2,258

 
1,782

 
$
31,411

 
$
24,539

Note 7—Accounts Payable and Other Liabilities
Accounts payable and other liabilities as of March 31, 2017 and December 31, 2016, were comprised of the following (amounts in thousands):
 
March 31, 2017
 
December 31, 2016
Accounts payable and accrued expenses
$
7,533

 
$
7,657

Accrued interest expense
1,320

 
945

Accrued property taxes
1,657

 
1,164

Distributions payable to stockholders
4,737

 
4,336

Tenant deposits
1,380

 
1,551

Deferred rental income
2,840

 
733

Derivative liability
514

 
798

 
$
19,981

 
$
17,184


11


Note 8—Notes Payable and Secured Credit Facility
The Company's debt outstanding as of March 31, 2017 and December 31, 2016 consisted of the following (amounts in thousands):
 
March 31, 2017
 
December 31, 2016
Notes payable:
 
 
 
Fixed rate notes payable
$
76,000

 
$
51,000

Variable rate notes payable fixed through interest rate swaps
101,990

 
71,540

Variable rate notes payable

(1) 
30,450

Total notes payable, principal amount outstanding
177,990

 
152,990

Unamortized deferred financing costs related to notes payable
(2,196
)
 
(1,945
)
Total notes payable, net of deferred financing costs
175,794

 
151,045

Secured credit facility:
 
 
 
Revolving line of credit
210,000

 
120,000

Term loan
100,000

 
100,000

Total secured credit facility, principal amount outstanding
310,000

 
220,000

Unamortized deferred financing costs related to the term loan of the secured credit facility
(803
)
 
(876
)
Total secured credit facility, net of deferred financing costs
309,197

 
219,124

Total debt outstanding
$
484,991

 
$
370,169

(1)
During the three months ended March 31, 2017, the Company converted its $30,450,000 variable note payable into a variable rate note payable fixed through interest rate swap.
Significant debt activity since December 31, 2016, excluding scheduled principal payments, includes:
During the three months ended March 31, 2017, the Company drew $120,000,000 and repaid $30,000,000 on its secured credit facility.
During the three months ended March 31, 2017, the Company increased the borrowing base availability under the secured credit facility by $54,363,000 by adding five properties to the aggregate pool availability.
As of March 31, 2017, the Company had a total pool availability under the secured credit facility of $342,826,000 and an aggregate outstanding principal balance of $310,000,000. As of March 31, 2017, $32,826,000 remained to be drawn on the secured credit facility.
During the three months ended March 31, 2017, the Company entered into one note payable collateralized by a real estate asset in the principal amount of $25,000,000.
During the three months ended March 31, 2017, the Company entered into four interest rate swap agreements to effectively fix the London Interbank Offered Rate, or LIBOR, on $75,000,000 of the term loan of the secured credit facility.
The principal payments due on the notes payable and secured credit facility for the nine months ending December 31, 2017 and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):
Year
 
Total Amount
Nine months ending December 31, 2017
 
$

2018
 
210,050

2019
 
101,369

2020
 
1,911

2021
 
151,203

Thereafter
 
23,457

 
 
$
487,990


12


Note 9—Related-Party Transactions and Arrangements
The Company reimburses the Advisor and its affiliates for organization and offering expenses it incurs on the Company’s behalf, but only to the extent the reimbursement would not cause the selling commissions, dealer manager fees, distribution and servicing fees and other organization and offering expenses to exceed 15% of the gross proceeds of the Offering. The Company expects that organization and offering expenses (other than selling commissions, dealer manager fees and distribution and servicing fees) will be approximately 1.50% of the gross proceeds. As of March 31, 2017, since inception, the Advisor and its affiliates incurred approximately $13,975,000 on the Company’s behalf in offering costs, of which approximately $316,000 of other organization and offering expenses remained accrued as of March 31, 2017. Other organization expenses are expensed as incurred and offering expenses are charged to stockholders’ equity as incurred.
The Company pays to the Advisor 2.0% of the contract purchase price of each property or asset acquired and 2.0% of the amount advanced with respect to a mortgage loan. For the three months ended March 31, 2017 and 2016, the Company incurred approximately $3,083,000 and $2,233,000, respectively, in acquisition fees to the Advisor or its affiliates. In addition, the Company reimburses the Advisor for acquisition expenses incurred in connection with the selection and acquisition of properties or other real estate-related investments (including expenses relating to potential investments that the Company does not close), such as legal fees and expenses, costs of real estate due diligence, appraisals, non-refundable option payments on properties not acquired, travel and communications expenses, accounting fees and expenses and title insurance premiums, whether or not the property was acquired. The Company expects these expenses will be approximately 0.75% of the purchase price of each property or real estate-related investment.
The Company pays to the Advisor an asset management fee calculated on a monthly basis in an amount equal to 1/12th of 0.75% of gross assets (including amounts borrowed), which is payable monthly in arrears. For the three months ended March 31, 2017 and 2016, the Company incurred approximately $2,006,000 and $955,000, respectively, in asset management fees.
In connection with the rental, leasing, operation and management of the Company’s properties, the Company pays the Property Manager and its affiliates aggregate fees equal to 3.0% of gross revenues from the properties managed, or property management fees. The Company will reimburse the Property Manager and its affiliates for property-level expenses that any of them pay or incur on the Company’s behalf, including salaries, bonuses and benefits of persons employed by the Property Manager and its affiliates except for the salaries, bonuses and benefits of persons who also serve as one of its executive officers. The Property Manager and its affiliates may subcontract the performance of their duties to third parties and pay all or a portion of the property management fee to the third parties with whom they contract for these services. If the Company contracts directly with third parties for such services, it will pay them customary market fees and may pay the Property Manager an oversight fee equal to 1.0% of the gross revenues of the properties managed. In no event will the Company pay the Property Manager or any affiliate both a property management fee and an oversight fee with respect to any particular property. The Company also will pay the Property Manager a separate fee for the one-time initial rent-up, leasing-up of newly constructed properties or re-leasing to existing tenants. For the three months ended March 31, 2017 and 2016, the Company incurred approximately $671,000 and $298,000, respectively, in property management fees to the Property Manager, which are recorded in rental expenses in the accompanying condensed consolidated statements of comprehensive income. For the three months ended March 31, 2017, the Company incurred $23,000 in leasing commissions to the Property Manager. Leasing commission fees are capitalized in other assets, net in the accompanying condensed consolidated balance sheets.
For acting as general contractor and/or construction manager to supervise or coordinate projects or to provide major repairs or rehabilitation on our properties, the Company may pay the Property Manager up to 5.0% of the cost of the projects, repairs and/or rehabilitation, as applicable, or construction management fees. For the three months ended March 31, 2017, the Company incurred approximately $159,000 in construction management fees to the Property Manager. Construction management fees are capitalized in real estate, net in the accompanying condensed consolidated balance sheets.
The Company reimburses the Advisor for all expenses it paid or incurred in connection with the services provided to the Company, subject to certain limitations. Expenses in excess of the operating expenses in the four immediately preceding quarters that exceeds the greater of (a) 2.0% of average invested assets or (b) 25% of net income, subject to certain adjustments, will not be reimbursed unless the independent directors determine such excess expenses are justified. The Company will not reimburse the Advisor for personnel costs in connection with services for which the Advisor receives an acquisition fee or a disposition fee. For the three months ended March 31, 2017 and 2016, the Advisor allocated approximately $365,000 and $278,000, respectively, in operating expenses to the Company.
The Company will pay its Advisor, or its affiliates, if it provides a substantial amount of services (as determined by a majority of the Company’s independent directors) in connection with the sale of properties, a disposition fee, up to the lesser of 1.0% of the contract sales price and one-half of the total brokerage commission paid if a third party broker is also involved, without exceeding the lesser of 6.0% of the contract sales price or a reasonable, customary and competitive real estate commission. As of March 31, 2017, the Company has not incurred any disposition fees to the Advisor or its affiliates.

13


The Advisor will receive 15% of the remaining net sale proceeds after return of capital contributions plus payment to investors of a 6.0% annual cumulative, non-compounded return on the capital contributed by investors. As of March 31, 2017, the Company has not incurred any subordinated participation in net sale proceeds to the Advisor or its affiliates.
Upon the listing of the Company’s shares on a national securities exchange, the Advisor will receive 15.0% of the amount by which the sum of the Company’s adjusted market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to a 6.0% annual cumulative, non-compounded return to investors, or the subordinated incentive listing fee. As of March 31, 2017, the Company has not incurred any subordinated incentive listing fees to the Advisor or its affiliates.
Upon termination or non-renewal of the advisory agreement, with or without cause, the Advisor will be entitled to receive subordinated termination fees from the Operating Partnership equal to 15% of the amount by which the sum of the Company’s adjusted market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to an annual 6.0% cumulative, non-compounded return to investors. In addition, the Advisor may elect to defer its right to receive a subordinated termination fee upon termination until either shares of the Company’s common stock are listed and traded on a national securities exchange or another liquidity event occurs. As of March 31, 2017, the Company has not incurred any subordinated termination fees to the Advisor or its affiliates.
The Company pays the Dealer Manager selling commissions of up to 7.0% of the gross offering proceeds per Class A share and up to 3.0% of gross offering proceeds per Class T share. All selling commissions are expected to be re-allowed to participating broker-dealers. The Company does not pay selling commissions with respect to Class I shares and shares of any class sold pursuant to the DRIP. In addition, the Company pays the Dealer Manager a dealer manager fee of up to 3.0% of gross offering proceeds from the sale of Class A and Class T shares. The Dealer Manager may receive up to 2.0% of the gross offering proceeds from the sale of Class I shares as a dealer manager fee, of which 1.0% will be funded by our Advisor without reimbursement from us. The 1.0% of the dealer manager fee paid from offering proceeds will be waived in the event an investor purchases Class I shares through a registered investment advisor that is not affiliated with a broker dealer. The dealer manager fee may be partially re-allowed to participating broker-dealers. No dealer manager fees will be paid in connection with purchases of shares of any class made pursuant to the DRIP. For the three months ended March 31, 2017 and 2016, the Company incurred approximately $4,945,000 and $8,004,000, respectively, for selling commissions and dealer manager fees in connection with the Offering to the Dealer Manager.
The Company pays the Dealer Manager a distribution and servicing fee with respect to its Class T shares that are sold in the primary offering that accrues daily in an amount equal to 1/365th of 1.0% of the most recent offering price per Class T share sold in the primary offering on a continuous basis from year to year; provided, however, that upon the termination of the primary offering, the distribution and servicing fee will accrue daily in an amount equal to 1/365th of 1.0% of the most recent estimated NAV per Class T share on a continuous basis from year to year. Termination of such payment will commence on the earliest to occur of the following: (i) a listing of the Class T shares on a national securities exchange, (ii) following the completion of the Offering, total underwriting compensation in the Offering equaling 10% of the gross proceeds from the primary portion of the Offering, (iii) there are no longer any Class T shares outstanding, or (iv) the fourth anniversary of the last day of the fiscal quarter in which the primary offering terminates. The Dealer Manager may re-allow the distribution and servicing fee to participating broker-dealers and servicing broker-dealers. The distribution and servicing fee is paid monthly in arrears. The distribution and servicing fee will not be payable with respect to Class T shares issued under the DRIP. The Company does not pay a distribution and servicing fee with respect to Class A and Class I shares. For the three months ended March 31, 2017 and 2016, the Company incurred approximately $1,649,000 and $22,000, respectively, in distribution and servicing fees to the Dealer Manager.

14


Accounts Payable Due to Affiliates
The following amounts were due to affiliates as of March 31, 2017 and December 31, 2016 (amounts in thousands):
Entity
 
Fee
 
March 31, 2017
 
December 31, 2016
Carter Validus Advisors II, LLC and its affiliates
 
Asset management fees
 
$
727

 
$
627

Carter Validus Real Estate Management Services II, LLC
 
Property management fees
 
325

 
252

Carter Validus Real Estate Management Services II, LLC
 
Construction management fees
 
52

 
323

Carter Validus Advisors II, LLC and its affiliates
 
General and administrative costs
 
168

 
138

Carter Validus Advisors II, LLC and its affiliates
 
Offering costs
 
316

 
289

SC Distributors, LLC
 
Distribution and servicing fees
 
7,083

 
5,750

Carter Validus Advisors II, LLC and its affiliates
 
Acquisition expenses and fees
 
1

 
5


 
 
 
$
8,672

 
$
7,384

Note 10—Segment Reporting
Management reviews the performance of individual properties and aggregates individual properties based on operating criteria into two reportable segments—commercial real estate investments in data centers and healthcare, and makes operating decisions based on these two reportable segments. The Company’s commercial real estate investments in data centers and healthcare are based on certain underwriting assumptions and operating criteria, which are different for data centers and healthcare. There were no intersegment sales or transfers during the three months ended March 31, 2017 and 2016.
The Company evaluates performance based on net operating income of the individual properties in each segment. Net operating income, a non-GAAP financial measure, is defined as total revenues, less rental expenses, which excludes depreciation and amortization, general and administrative expenses, acquisition related expenses, asset management fees and interest expense, net. The Company believes that segment net operating income serves as a useful supplement to net income because it allows investors and management to measure unlevered property-level operating results and to compare operating results to the operating results of other real estate companies between periods on a consistent basis. Segment net operating income should not be considered as an alternative to net income determined in accordance with GAAP as an indicator of financial performance, and accordingly, the Company believes that in order to facilitate a clear understanding of the consolidated historical operating results, segment net operating income should be examined in conjunction with net income as presented in the accompanying condensed consolidated financial statements and data included elsewhere in this Quarterly Report on Form 10-Q.
General and administrative expenses, acquisition related expenses, asset management fees, depreciation and amortization and interest expense, net are not allocated to individual segments for purposes of assessing segment performance.
Non-segment assets primarily consist of corporate assets, including cash and cash equivalents, real estate and escrow deposits, deferred financing costs attributable to the revolving line of credit portion of the Company's secured credit facility and other assets not attributable to individual properties.

15


Summary information for the reportable segments during the three months ended March 31, 2017 and 2016, is as follows (amounts in thousands):
 
Data Centers
 
Healthcare
 
Three Months Ended
March 31, 2017
Revenue:
 
 
 
 
 
Rental and tenant reimbursement revenue
$
9,704

 
$
14,318

 
$
24,022

Expenses:
 
 
 
 
 
Rental expenses
(2,660
)
 
(2,266
)
 
(4,926
)
Segment net operating income
$
7,044

 
$
12,052

 
19,096

 
 
 
 
 
 
Expenses:
 
 
 
 
 
General and administrative expenses
 
 
 
 
(925
)
Acquisition related expenses
 
 
 
 

Asset management fees
 
 
 
 
(2,006
)
Depreciation and amortization
 
 
 
 
(7,610
)
Income from operations
 
 
 
 
8,555

Interest expense, net
 
 
 
 
(3,764
)
Net income attributable to common stockholders
 
 
 
 
$
4,791

 
Data Centers
 
Healthcare
 
Three Months Ended
March 31, 2016
Revenue:
 
 
 
 
 
Rental and tenant reimbursement revenue
$
1,537

 
$
9,887

 
$
11,424

Expenses:
 
 
 
 
 
Rental expenses
(254
)
 
(1,430
)
 
(1,684
)
Segment net operating income
$
1,283

 
$
8,457

 
9,740


 
 
 
 
 
Expenses:
 
 
 
 
 
General and administrative expenses
 
 
 
 
(765
)
Acquisition related expenses
 
 
 
 
(1,665
)
Asset management fees
 
 
 
 
(955
)
Depreciation and amortization
 
 
 
 
(3,866
)
Income from operations
 
 
 
 
2,489

Interest expense, net
 
 
 
 
(879
)
Net income attributable to common stockholders
 
 
 
 
$
1,610


16


Assets by each reportable segment as of March 31, 2017 and December 31, 2016 are as follows (amounts in thousands):
 
March 31, 2017
 
December 31, 2016
Assets by segment:
 
 
 
Data centers
$
439,523

 
$
362,969

Healthcare
740,544

 
653,416

All other
67,512

 
53,653

Total assets
$
1,247,579

 
$
1,070,038

Capital additions and acquisitions by reportable segments for the three months ended March 31, 2017 and 2016 are as follows (amounts in thousands):
 
Three Months Ended
March 31,
 
2017
 
2016
Capital additions and acquisitions by segment:
 
 
 
Data centers
$
75,088

 
$
44,161

Healthcare
89,939

 
41,489

Total capital additions and acquisitions
$
165,027

 
$
85,650

Note 11—Future Minimum Rent
Rental Income
The Company’s real estate assets are leased to tenants under operating leases with varying terms. The leases frequently have provisions to extend the terms of the lease agreements. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants.
The future minimum rent to be received from the Company’s investment in real estate assets under non-cancelable operating leases for the nine months ending December 31, 2017 and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):
Year
 
Amount
Nine months ending December 31, 2017
 
$
59,889

2018
 
81,199

2019
 
81,147

2020
 
80,727

2021
 
82,181

Thereafter
 
752,018

 
 
$
1,137,161


17


Rental Expense
The Company has ground lease obligations that generally require fixed annual rental payments and may also include escalation clauses and renewal options.
The future minimum rent obligations under non-cancelable ground leases for the nine months ending December 31, 2017 and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):
Year
 
Amount
Nine months ending December 31, 2017
 
$
6

2018
 
8

2019
 
8

2020
 
8

2021
 
8

Thereafter
 
781

 
 
$
819

Note 12—Fair Value
Notes payable—Fixed Rate—The estimated fair value of notes payable—fixed rate measured using quoted prices and observable inputs from similar liabilities (Level 2) was approximately $73,911,000 and $49,930,000 as of March 31, 2017 and December 31, 2016, respectively, as compared to the outstanding principal of $76,000,000 and $51,000,000 as of March 31, 2017 and December 31, 2016, respectively. The estimated fair value of notes payable—variable rate fixed through interest rate swap agreements (Level 2) was approximately $98,747,000 and $69,247,000 as of March 31, 2017 and December 31, 2016, respectively, as compared to the outstanding principal of $101,990,000 and $71,540,000 as of March 31, 2017 and December 31, 2016, respectively.
Secured credit facility—The outstanding principal of the secured credit facility – variable was $210,000,000 and $195,000,000, which approximated its fair value as of March 31, 2017 and December 31, 2016, respectively. The fair value of the Company's variable rate secured credit facility is estimated based on the interest rates currently offered to the Company by financial institutions. The estimated fair value of the secured credit facility – variable rate fixed through an interest rate swap agreement (Level 2) was approximately $98,004,000 and $24,195,000 as of March 31, 2017 and December 31, 2016, respectively, as compared to the outstanding principal of $100,000,000 and $25,000,000 as of March 31, 2017 and December 31, 2016, respectively.
Derivative instruments—Considerable judgment is necessary to develop estimated fair values of financial instruments. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize, or be liable for, on disposition of the financial instruments. The Company has determined that the majority of the inputs used to value its interest rate swaps fall within Level 2 of the fair value hierarchy. The credit valuation adjustments associated with these instruments utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and the respective counterparty. However, as of March 31, 2017, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions, and has determined that the credit valuation adjustments are not significant to the overall valuation of its interest rate swaps. As a result, the Company determined that its interest rate swaps valuation is classified in Level 2 of the fair value hierarchy.

18


The following table shows the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis as of March 31, 2017 and December 31, 2016 (amounts in thousands):
 
March 31, 2017
 
Fair Value Hierarchy
 
 
 
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs (Level 3)
 
Total Fair
Value
Assets:
 
 
 
 
 
 
 
Derivative assets
$

 
$
2,258

 
$

 
$
2,258

Total assets at fair value
$

 
$
2,258

 
$

 
$
2,258

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$

 
$
514

 
$

 
$
514

Total liabilities at fair value
$

 
$
514

 
$

 
$
514

 
December 31, 2016
 
Fair Value Hierarchy
 
 
 
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs (Level 3)
 
Total Fair
Value
Assets:
 
 
 
 
 
 
 
Derivative assets
$

 
$
1,782

 
$

 
$
1,782

Total assets at fair value
$

 
$
1,782

 
$

 
$
1,782

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$

 
$
798

 
$

 
$
798

Total liabilities at fair value
$

 
$
798

 
$

 
$
798

Note 13—Derivative Instruments and Hedging Activities
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed rate payments over the life of the agreements without exchange of the underlying notional amount.
The effective portion of changes in the fair value of derivatives designated, and that qualify, as cash flow hedges is recorded in accumulated other comprehensive income in the accompanying condensed consolidated statement of stockholders' equity and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.
During the three months ended March 31, 2017, the Company's derivative instruments were used to hedge the variable cash flows associated with variable rate debt. The ineffective portion of changes in fair value of the derivatives are recognized directly in earnings. During the three months ended March 31, 2017, the Company recognized a loss of $8,000 due to ineffectiveness of its hedges of interest rate risk, which was recorded in interest expense, net in the accompanying condensed consolidated statements of comprehensive income.
Amounts reported in accumulated other comprehensive income related to the derivative will be reclassified to interest expense, net as interest payments are made on the Company’s variable rate debt. During the next twelve months, the Company estimates that an additional $730,000 will be reclassified from accumulated other comprehensive income as an increase to interest expense, net.
See Note 12—"Fair Value" for a further discussion of the fair value of the Company’s derivative instruments.

19


The following table summarizes the notional amount and fair value of the Company’s derivative instruments (amounts in thousands):
Derivatives
Designated as
Hedging
Instruments
 
Balance
Sheet
Location
 
Effective
Dates
 
Maturity
Dates
 
March 31, 2017
 
December 31, 2016
Outstanding
Notional
Amount
 
Fair Value of
 
Outstanding
Notional
Amount
 
Fair Value of
Asset
 
(Liability)
 
Asset
 
(Liability)
 
Interest rate swaps
 
Other assets, net/Accounts
payable and other
liabilities
 
07/01/2016 to
02/01/2017
 
12/22/2020 to
12/26/2021
 
$
201,990

 
$
2,258

 
$
(514
)
 
$
96,540

 
$
1,782

 
$
(798
)
The notional amount under the agreements is an indication of the extent of the Company’s involvement in the instruments at the time, but does not represent exposure to credit, interest rate or market risks.
Accounting for changes in the fair value of a derivative instrument depends on the intended use and designation of the derivative instrument. The Company designated the interest rate swaps as cash flow hedges to hedge the variability of the anticipated cash flows on its variable rate secured credit facility and notes payable. The change in fair value of the effective portion of the derivative instruments that are designated as hedges is recorded in other comprehensive income, or OCI, in the accompanying condensed consolidated statements of comprehensive income.
The table below summarizes the amount of income recognized on the interest rate derivatives designated as cash flow hedges for the three months ended March 31, 2017 (amounts in thousands):
Derivatives in Cash Flow Hedging Relationships
 
Amount of Income Recognized
in OCI on Derivative
(Effective Portion)
 
Location of Income
Reclassified From
Accumulated Other
Comprehensive Income to
Net Income
(Effective Portion)
 
Amount of (Loss)
Reclassified From
Accumulated Other
Comprehensive Income to
Net Income
(Effective Portion)
Three Months Ended March 31, 2017
 
 
 
 
 
 
Interest rate swap
 
$
413

 
Interest expense, net
 
$
(355
)
Total
 
$
413

 
 
 
$
(355
)
The Company did not have derivative instruments as of March 31, 2016.
Credit Risk-Related Contingent Features
The Company has agreements with each of its derivative counterparties that contain cross-default provisions, whereby if the Company defaults on certain of its indebtedness, then the Company could also be declared in default on its derivative obligation, resulting in an acceleration of payment thereunder.
In addition, the Company has agreements with each of its derivative counterparties that contain a provision where if the Company either defaults or is capable of being declared in default on any of its indebtedness, then the Company could also be declared in default on its derivative obligations. The Company believes it mitigates its credit risk by entering into agreements with creditworthy counterparties. The Company records credit risk valuation adjustments on its interest rate swaps based on the respective credit quality of the Company and the counterparty. As of March 31, 2017, the fair value of the derivative in a net liability position, including accrued interest but excluding any adjustment for nonperformance risk related to the agreement, was $607,000. As of March 31, 2017, there were no termination events or events of default related to the interest rate swaps.

20


Tabular Disclosure Offsetting Derivatives
The Company has elected not to offset derivative positions in its condensed consolidated financial statements. The following tables present the effect on the Company’s financial position had the Company made the election to offset its derivative positions as of March 31, 2017 and December 31, 2016 (amounts in thousands):
Offsetting of Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
 
 
 
Gross
Amounts of
Recognized
Assets
 
Gross Amounts
Offset in the
Balance Sheet
 
Net Amounts of
Assets Presented in
the Balance Sheet
 
Financial Instruments
Collateral
 
Cash Collateral
 
Net
Amount
March 31, 2017
 
$
2,258

 
$

 
$
2,258

 
$

 
$

 
$
2,258

December 31, 2016
 
$
1,782

 
$

 
$
1,782

 
$

 
$

 
$
1,782

Offsetting of Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
 
 
 
Gross
Amounts of
Recognized
Liabilities
 
Gross Amounts
Offset in the
Balance Sheet
 
Net Amounts of
Liabilities
Presented in the
Balance Sheet
 
Financial Instruments
Collateral
 
Cash Collateral
 
Net
Amount
March 31, 2017
 
$
514

 
$

 
$
514

 
$

 
$

 
$
514

December 31, 2016
 
$
798

 
$

 
$
798

 
$

 
$

 
$
798

The Company reports derivatives in the accompanying condensed consolidated balance sheets as other assets, net and accounts payable and other liabilities.
Note 14—Accumulated Other Comprehensive Income
The following table presents a rollforward of amounts recognized in accumulated other comprehensive income by component for the three months ended March 31, 2017 (amounts in thousands):
 
 
Unrealized Income on Derivative
Instruments
 
Accumulated Other
Comprehensive Income
Balance as of December 31, 2016
 
$
840

 
$
840

Other comprehensive income before reclassification
 
413

 
413

Amount of loss reclassified from accumulated other comprehensive income to net income (effective portion)
 
355

 
355

Other comprehensive income
 
768

 
768

Balance as of March 31, 2017
 
$
1,608

 
$
1,608

The following table presents reclassifications out of accumulated other comprehensive income for the three months ended March 31, 2017 (amounts in thousands):
Details about Accumulated Other
Comprehensive Income Components
 
Amounts Reclassified from
Accumulated Other Comprehensive Income to Net
Income
 
Affected Line Items in the Consolidated Statements of Comprehensive Income
 
 
Three Months Ended
March 31,
 
 
 
 
2017
 
 
Interest rate swap contracts
 
$
355

 
Interest expense, net
The Company did not have derivative instruments as of March 31, 2016.

21


Note 15—Commitments and Contingencies
Litigation
In the ordinary course of business, the Company may become subject to litigation or claims. As of March 31, 2017, there were, and currently there are, no material pending legal proceedings to which the Company is a party.
Note 16—Economic Dependency
The Company is dependent on the Advisor and its affiliates for certain services that are essential to the Company, including the sale of the Company’s shares of common and preferred stock available for issuance; the identification, evaluation, negotiation, purchase and disposition of real estate investments and other investments; the management of the daily operations of the Company’s real estate portfolio; and other general and administrative responsibilities. In the event that the Advisor and its affiliates are unable to provide the respective services, the Company will be required to obtain such services from other sources.
Note 17—Subsequent Events
Distributions to Stockholders Paid
On April 3, 2017, the Company paid aggregate distributions of approximately $3,974,000 to Class A stockholders ($1,927,000 in cash and $2,047,000 in shares of the Company’s Class A common stock pursuant to the DRIP), which related to distributions declared for each day in the period from March 1, 2017 through March 31, 2017. On May 1, 2017, the Company paid aggregate distributions of approximately $3,913,000 to Class A stockholders ($1,898,000 in cash and $2,015,000 in shares of the Company’s Class A common stock pursuant to the DRIP), which related to distributions declared for each day in the period from April 1, 2017 through April 30, 2017.
On April 3, 2017, the Company paid aggregate distributions of approximately $1,000 to Class I stockholders ($400 in cash and $600 in shares of the Company's Class I common stock pursuant to the DRIP), which related to distributions declared for each day in the period from March 1, 2017 through March 31, 2017. On May 1, 2017, the Company paid aggregate distributions of approximately $9,000 to Class I stockholders ($3,000 in cash and $6,000 in shares of the Company's Class I common stock pursuant to the DRIP), which related to distributions declared for each day in the period from April 1, 2017 through April 30, 2017.
On April 3, 2017, the Company paid aggregate distributions of approximately $762,000 to Class T stockholders ($308,000 in cash and $454,000 in shares of the Company's Class T common stock pursuant to the DRIP), which related to distributions declared for each day in the period from March 1, 2017 through March 31, 2017. On May 1, 2017, the Company paid aggregate distributions of approximately $797,000 to Class T stockholders ($324,000 in cash and $473,000 in shares of the Company's Class T common stock pursuant to the DRIP), which related to distributions declared for each day in the period from April 1, 2017 through April 30, 2017.
Distributions Declared
Class A Shares
On May 4, 2017, the board of directors of the Company approved and declared a distribution to the Company’s Class A stockholders of record as of the close of business on each day of the period commencing on June 1, 2017 and ending on August 31, 2017. The distributions will be calculated based on 365 days in the calendar year and will be equal to $0.001767101 per share of Class A common stock, which will be equal to an annualized distribution rate of 6.40%, assuming a purchase price of $10.078 per share of Class A common stock. The distributions declared for each record date in June 2017, July 2017 and August 2017 will be paid in July 2017, August 2017 and September 2017, respectively. The distributions will be payable to stockholders from legally available funds therefor.
Class I Shares
On May 4, 2017, the board of directors of the Company approved and declared a daily distribution to the Company’s Class I stockholders of record as of the close of business on each day of the period commencing on June 1, 2017 and ending on August 31, 2017. The distribution will be calculated based on 365 days in the calendar year and will be equal to $0.001767101 per share of Class I common stock, which will be equal to an annualized distribution rate of 7.04%, assuming a purchase price of $9.162 per share. The distributions declared for each record date in June 2017, July 2017 and August 2017 will be paid in July 2017, August 2017 and September 2017, respectively. The distributions will be payable to stockholders from legally available funds therefor.

22


Class T Shares
On May 4, 2017, the board of directors of the Company approved and declared a daily distribution to the Company’s Class T stockholders of record as of the close of business on each day of the period commencing on June 1, 2017 and ending on August 31, 2017. The distribution will be calculated based on 365 days in the calendar year and will be equal to $0.001501543 per share of Class T common stock, which will be equal to an annualized distribution rate of 5.68%, assuming a purchase price of $9.649 per share. The distributions declared for each record date in June 2017, July 2017 and August 2017 will be paid in July 2017, August 2017 and September 2017, respectively. The distributions will be payable to stockholders from legally available funds therefor.
Status of the Offering, the Extension of the Offering and the Filing of a Registration Statement for a Follow-On Offering
As of May 9, 2017, the Company had accepted investors’ subscriptions for and issued approximately 75,526,000 shares of Class A common stock, 532,000 shares of Class I common stock and 18,676,000 shares of Class T common stock in the Offering, resulting in receipt of gross proceeds of approximately $748,305,000, $4,858,000 and $178,771,000, respectively, including shares of its common stock issued pursuant to its DRIP. As of May 9, 2017, the Company had approximately $1,418,066,000 in Class A shares, Class I shares and Class T shares of common stock remaining in the Offering.
On May 1, 2017, the Company filed a registration statement on Form S-11 under the Securities Act to register a maximum of $332,500,000 of shares of common stock in the primary offering pursuant to a proposed follow-on offering, and a maximum of $17,500,000 of additional shares pursuant to the DRIP. Accordingly, as provided pursuant to Rule 415 promulgated under the Securities Act, the Company extended the Offering until the earlier of (i) the effective date of the registration statement for the proposed follow-on public offering, (ii) November 25, 2017, that date that is 180 days after the third anniversary of the effective date of the Offering, or (iii) the date the maximum offering amount under the Offering is sold. The Company may terminate the Offering at any time. The Company has not issued any shares in connection with the proposed follow-on offering as the registration statement on Form S-11 has not been declared effective by the SEC.
Renewal of the Management Agreement
On May 4, 2017, the board of directors, including all independent directors of the Company, after review of the Property Manager’s performance during the last year, authorized the Company to execute a mutual consent to renew the management agreement by and among the Company, the Operating Partnership and the Property Manager, dated May 19, 2014, as amended and renewed. The renewal will be for a one-year term and will be effective as of May 19, 2017.
Renewal of the Advisory Agreement
On May 4, 2017, the board of directors, including all independent directors of the Company, after review of the Advisor’s performance during the last year, authorized the Company to execute a mutual consent to renew the amended and restated advisory agreement, by and among the Company, the Operating Partnership and the Advisor, dated June 10, 2014, as amended and renewed. The renewal will be for a one-year term and will be effective as of June 10, 2017.
Notes Payable
The following table summarizes the notes payable entered into subsequent to March 31, 2017 and through May 12, 2017:
Property
 
Principal Amount
 
Maturity Date
 
Interest Rate
Norwalk Data Center
 
$34,200,000
 
04/19/2022
 
LIBOR plus 2.50%
Texas Rehabilitation Hospital Portfolio
 
$39,900,000
 
04/20/2022
 
LIBOR plus 2.875%


23


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes thereto and the other unaudited financial information appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with our audited consolidated financial statements, and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission, or the SEC, on March 16, 2017, or the 2016 Annual Report on Form 10-K.
The terms “we,” “our,” and the “Company” refer to Carter Validus Mission Critical REIT II, Inc., Carter Validus Operating Partnership II, LP, or our Operating Partnership, and all wholly-owned subsidiaries.
Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q, other than historical facts, include forward-looking statements that reflect our expectations and projections about our future results, performance, prospects and opportunities. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, as well as known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “would,” “could,” “should,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management’s view only as of the date this Quarterly Report on Form 10-Q is filed with the SEC. We make no representation or warranty (express or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q, and we do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. See Item 1A. “Risk Factors” of our 2016 Annual Report on Form 10-K for a discussion of some, although not all, of the risks and uncertainties that could cause actual results to differ materially from those presented in our forward-looking statements.
Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.
Overview
We were formed on January 11, 2013 under the laws of Maryland to acquire and operate a diversified portfolio of income-producing commercial real estate with a focus on data centers and healthcare properties, preferably with long-term net leases to creditworthy tenants, as well as to make other real estate-related investments that relate to such property types. We are offering for sale a maximum of $2,350,000,000 in shares of common stock, or the maximum offering amount, consisting of up to $2,250,000,000 in shares of common stock in our primary offering and up to $100,000,000 in shares of common stock pursuant to our distribution reinvestment plan, or the DRIP, on a “best efforts” basis pursuant to a registration statement on Form S-11, or the Registration Statement, filed with the SEC under the Securities Act, or our Offering. As of March 31, 2017, we were offering Class A shares, Class I and Class T shares of common stock, in any combination with a dollar value up to the maximum offering amount. The offering price for the shares in the primary offering is $10.078 per Class A share, $9.162 per Class I share, and $9.649 per Class T share and the offering price for shares in the DRIP is $9.07 per Class A share, $9.07 per Class I share and $9.07 per Class T share, which is equal to the most recent estimated per share NAV of each of our Class A common stock and Class T common stock as determined by our board of directors on September 29, 2016.
On May 1, 2017, we filed a registration statement on Form S-11 under the Securities Act to register a maximum of $332,500,000 of shares of Class A, Class I and Class T common stock in the primary offering pursuant to a proposed follow-on offering, and a maximum of $17,500,000 of additional shares pursuant to the DRIP. Accordingly, as provided pursuant to Rule 415 promulgated under the Securities Act, we extended the Offering until the earlier of (i) the effective date of the registration statement for the proposed follow-on public offering, (ii) November 25, 2017, that date that is 180 days after the third anniversary of the effective date of the Offering, or (iii) the date the maximum offering amount under the Offering is sold. We may terminate the Offering at any time. We have not issued any shares in connection with the proposed follow-on offering as the registration statement on Form S-11 has not been declared effective by the SEC.

24


As of March 31, 2017, we had accepted investors’ subscriptions for and issued approximately 91,026,000 shares of Class A, Class I and Class T common stock (including shares of common stock issued pursuant to the DRIP) in our Offering, resulting in receipt of gross proceeds of approximately $896,207,000, before selling commissions and dealer manager fees of approximately $74,130,000 and other offering costs of approximately $17,450,000. As of March 31, 2017, we had approximately $1,453,793,000 in Class A shares, Class I shares and Class T shares of common stock remaining in our Offering.
Substantially all of our operations are conducted through Carter Validus Operating Partnership II, LP, or our Operating Partnership. We are externally advised by Carter Validus Advisors II, LLC, which is our affiliate, or our Advisor, pursuant to an advisory agreement between us and our Advisor. Our Advisor supervises and manages our day-to-day operations and selects the properties and real estate-related investments we acquire, subject to the oversight and approval of our board of directors. Our Advisor also provides marketing, sales and client services related to real estate on our behalf. Our Advisor engages affiliated entities to provide various services to us. Our Advisor is managed by, and is a subsidiary of, our sponsor, Carter Validus REIT Management Company II, LLC, or our Sponsor. We have no paid employees and we rely on our Advisor to provide substantially all of our services.
Carter Validus Real Estate Management Services II, LLC, or our Property Manager, a wholly-owned subsidiary of our Sponsor, serves as our property manager. Our Advisor and our Property Manager received, and will continue to receive, fees during the acquisition and operational stages and our Advisor may be eligible to receive fees during the liquidation stage of the Company. SC Distributors, LLC, an affiliate of the Advisor, or the Dealer Manager, serves as the dealer manager of the Offering. The Dealer Manager has received, and will continue to receive, fees for services related to our Offering.
We currently operate through two reportable segments – commercial real estate investments in data centers and healthcare. As of March 31, 2017, we had purchased 41 real estate investments, consisting of 57 properties, comprising approximately 3,391,000 of gross rental square feet for an aggregate purchase price of approximately $1,157,822,000.
Critical Accounting Policies
Our critical accounting policies were disclosed in our 2016 Annual Report on Form 10-K. There have been no material changes to our critical accounting policies as disclosed therein.
Interim Unaudited Financial Data
Our accompanying condensed consolidated financial statements have been prepared by us in accordance with GAAP in conjunction with the rules and regulations of the SEC. Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, our accompanying condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. Our accompanying condensed consolidated financial statements reflect all adjustments, which are, in our view, of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim period. Interim results of operations are not necessarily indicative of the results to be expected for the full year; such full year results may be less favorable. Our accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our 2016 Annual Report on Form 10-K.
Qualification as a REIT
We qualified and elected to be taxed as a REIT for federal income tax purposes and we intend to continue to be taxed as a REIT. To maintain our qualification as a REIT, we must continue to meet certain organizational and operational requirements, including a requirement to currently distribute at least 90.0% of our REIT taxable income to our stockholders. As a REIT, we generally will not be subject to federal income tax on taxable income that we distribute to our stockholders. If we fail to maintain our qualification as a REIT in any taxable year, we would then be subject to federal income taxes on our taxable income at regular corporate rates and would not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could have a material adverse effect on our net income and net cash available for distribution to our stockholders.
Recently Issued Accounting Pronouncements
For a discussion of recently issued accounting pronouncements, see Note 2—“Summary of Significant Accounting Policies—Recently Issued Accounting Pronouncements” to our condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q.
Segment Reporting

25


We report our financial performance based on two reporting segments—commercial real estate investments in data centers and healthcare. See Note 10—"Segment Reporting" to our condensed consolidated financial statements that are part of this Quarterly Report on Form 10-Q for additional information on our two reporting segments.
Factors that May Influence Results of Operations
We are not aware of any material trends and uncertainties, other than national economic conditions affecting real estate generally, that may be reasonably expected to have a material impact, favorable or unfavorable, on revenues or incomes from the acquisition, management and operation of properties other than those set forth in our Annual Report on Form 10-K for the year ended December 31, 2016 and in Part II, Item 1A. "Risk Factors" of this Quarterly Report on Form 10-Q.
Results of Operations
Our results of operations are influenced by the timing of acquisitions and the operating performance of our real estate properties. The following table shows the property statistics of our real estate properties as of March 31, 2017 and 2016:
 
March 31,
 
2017
 
2016
Number of commercial operating real estate properties (1)
55


36

Leased rentable square feet
3,378,000

 
1,726,000

Weighted average percentage of rentable square feet leased
99.6
%
 
99.3
%
(1)
As of March 31, 2017, we owned 57 real estate properties, two of which were under construction. As of March 31, 2016, we owned 38 properties, two of which were under construction.
The following table summarizes our real estate acquisition activity for the three months ended March 31, 2017 and 2016:
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Commercial operating real estate properties acquired
6


8

(1) 
Approximate aggregate purchase price of acquired real estate properties
$
157,690,000


$
55,150,000

 
Leased rentable square feet
406,000

 
207,000

 
(1)
During the three months ended March 31, 2016, we acquired 10 real estate properties, two of which were under construction.
The following discussion is based on our condensed consolidated financial statements for the three months March 31, 2017 and 2016.
This section describes and compares our results of operations for the three months ended March 31, 2017 and 2016. We generate almost all of our net operating income from property operations. In order to evaluate our overall portfolio, management analyzes the net operating income of same store properties. We define "same store properties" as operating properties that were owned and operated for the entirety of both calendar periods being compared and exclude properties under development.
By evaluating the property net operating income of our same store properties, management is able to monitor the operations of our existing properties for comparable periods to measure the performance of our current portfolio and determine the effects of our new acquisitions on net income.

26


Three Months Ended March 31, 2017 Compared to the Three Months Ended March 31, 2016
Changes in our revenues are summarized in the following table (amounts in thousands):
 
Three Months Ended March 31,
 
 
 
2017
 
2016
 
Change
 
 
 
 
 
 
Same store rental revenue
$
9,369

 
$
9,362

 
$
7

Non-same store rental revenue
10,304

 
658

 
9,646

Same store tenant reimbursement revenue
1,639

 
1,349

 
290

Non-same store tenant reimbursement revenue
2,701

 
54

 
2,647

Other operating income
9

 
1

 
8

Total revenue
$
24,022

 
$
11,424

 
$
12,598

An insignificant increase in same store revenue relates to the consumer price index base rent escalation at certain same store properties. In addition, there was an increase in contractual rental revenue resulting from average annual rent escalations of 2.13% at our same store properties, which was offset by straight-line rental revenue.
Non-same store rental revenue increased $9.6 million due to the acquisition of 27 operating properties since January 1, 2016.
Same store tenant reimbursement revenue increased primarily due to an increase in real estate tax reimbursements at certain same store properties.
Non-same store tenant reimbursement revenue increased $2.6 million due to the acquisition of 27 operating properties since January 1, 2016.
Changes in our expenses are summarized in the following table (amounts in thousands):
 
Three Months Ended March 31,
 
 
 
2017
 
2016
 
Change
 
 
 
 
 
 
Same store rental expenses
$
1,930

 
$
1,612

 
$
318

Non-same store rental expenses
2,996

 
72

 
2,924

General and administrative expenses
925

 
765

 
160

Acquisition related expenses

 
1,665

 
(1,665
)
Asset management fees
2,006

 
955

 
1,051

Depreciation and amortization
7,610

 
3,866

 
3,744

Total expenses
$
15,467

 
$
8,935

 
$
6,532

Same store rental expenses, certain of which are subject to reimbursement by our tenants, increased primarily due to an increase in real estate taxes at certain same store properties.
Non-same store rental expenses, certain of which are subject to reimbursement by our tenants, increased primarily due to the acquisition of 27 operating properties since January 1, 2016.
General and administrative expenses increased due to an increase in professional and legal fees, personnel costs and other administrative costs, in connection with our Company's growth.
Acquisition related expenses decreased due to a decrease in real estate properties determined to be business combinations due to the early adoption of ASU 2017-01, Business Combinations. Acquisition fees and expenses associated with transactions determined to be business combinations are expensed as incurred. During the three months ended March 31, 2017, we did not acquire any real estate properties determined to be business combinations as compared to eight real estate properties determined to be business combinations during the three months ended March 31, 2016.
Asset management fees increased due to an increase in the weighted average operating assets held to $1,011.8 million as of March 31, 2017, as compared to $328.6 million as of March 31, 2016.

27


Depreciation and amortization increased due to an increase in the weighted average depreciable basis of operating real estate investments.
Changes in interest expense, net are summarized in the following table (amounts in thousands):
 
Three Months Ended March 31,
 
 
 
2017
 
2016
 
Change
Interest expense, net:
 
 
 
 
 
Interest on notes payable
$
(1,861
)
 
$

 
$
(1,861
)
Interest on secured credit facility
(1,748
)
 
(701
)
 
(1,047
)
Amortization of deferred financing costs
(561
)
 
(202
)
 
(359
)
Cash deposits interest
41

 
24

 
17

Capitalized interest
365

 

 
365

Total interest expense, net
(3,764
)
 
(879
)
 
(2,885
)
Net income attributable to common stockholders
$
4,791

 
$
1,610

 
$
3,181

Interest on notes payable increased due to an increase in the outstanding principal balance on notes payable to $178.0 million as of March 31, 2017, as compared to $0 as of March 31, 2016.
Interest on secured credit facility increased due to an increase in the weighted average outstanding principal balance on the secured credit facility. The weighted average outstanding principal balance of the secured credit facility was $209.3 million as of March 31, 2017, as compared to $102.0 million as of March 31, 2016.
Capitalized interest increased due to an increase in the average accumulated expenditures on development properties to $27.4 million for the three months ended March 31, 2017, as compared to $0 during the three months ended March 31, 2016.
Organization and Offering Costs
We reimburse our Advisor or its affiliates for organization and offering costs it incurs on our behalf, but only to the extent the reimbursement would not cause the selling commissions, dealer manager fees, distribution and servicing fees and other organization and offering costs incurred by us to exceed 15% of gross offering proceeds as of the date of the reimbursement. We expect that other offering costs (other than selling commissions, dealer manager fees and distribution and servicing fees) will be approximately 1.50% of the gross offering proceeds. Since inception, our Advisor and its affiliates incurred other organization and offering costs on our behalf of approximately $13,975,000 as of March 31, 2017. As of March 31, 2017, we reimbursed our Advisor or its affiliates approximately $13,171,000 in other offering costs. In addition, we paid our Advisor or its affiliates $488,000 in other offering costs related to subscription agreements. As of March 31, 2017, we accrued approximately $316,000 of other offering costs to our Advisor and its affiliates. As of March 31, 2017, we incurred approximately $74,130,000 in selling commissions and dealer manager fees and $7,862,000 in distribution and servicing fees to our Dealer Manager. As of March 31, 2017, we incurred other offering costs (other than selling commissions, dealer manager fees and distribution and servicing fees) of approximately $17,450,000.
When incurred, organization costs are expensed and offering costs, including selling commissions, dealer manager fees, distribution and servicing fees and other offering costs are charged to stockholders’ equity. For a further discussion of other organization and offering costs, see Note 9—"Related-Party Transactions and Arrangements" to the condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q.
Inflation
We are exposed to inflation risk as income from long-term leases is the primary source of our cash flows from operations. There are provisions in certain of our leases with tenants that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include scheduled increases in contractual base rent receipts, reimbursement billings for operating expenses, pass-through charges and real estate tax and insurance reimbursements. However, due to the long-term nature of our leases, among other factors, the leases may not reset frequently enough to adequately offset the effects of inflation.
Liquidity and Capital Resources
Our principal demands for funds are for acquisitions of real estate and real estate-related investments, to pay operating expenses and interest on our current and future indebtedness and to pay distributions to our stockholders. Our sources of funds

28


are primarily the net proceeds of our Offering, funds equal to amounts reinvested in the DRIP, operating cash flows, the secured credit facility and other borrowings. In addition, we require resources to make certain payments to our Advisor and our Dealer Manager, which, during our Offering, include payments to our Advisor and its affiliates for reimbursement of other organization and offering expenses and other costs incurred on our behalf, and payments to our Dealer Manager and its affiliates for selling commissions, dealer manager fees, distribution and servicing fees, and offering expenses.
Generally, cash needs for items other than acquisitions of real estate and real estate-related investments are met from operations, borrowings, and the net proceeds of our Offering. However, there may be a delay between the sale of shares of our common stock and our investments in real estate, which could result in a delay in the benefits to our stockholders, if any, of returns generated from our investment operations.
Our Advisor evaluates potential additional investments and engages in negotiations with real estate sellers, developers, brokers, investment managers, lenders and others on our behalf. Until we invest all of the proceeds of our Offering in properties and real estate-related investments, we may invest in short-term, highly liquid or other authorized investments. Such short-term investments will not earn significant returns, and we cannot predict how long it will take to fully invest the proceeds in properties and real estate-related investments. The number of properties we acquire and other investments we make will depend upon the number of shares sold in our Offering and the resulting amount of net proceeds available for investment.
When we acquire a property, our Advisor prepares a capital plan that contemplates the estimated capital needs of that investment. In addition to operating expenses, capital needs may also include costs of refurbishment, tenant improvements or other major capital expenditures. The capital plan also sets forth the anticipated sources of the necessary capital, which may include a line of credit or other loans established with respect to the investment, operating cash generated by the investment, additional equity investments from us or joint venture partners or, when necessary, capital reserves. Any capital reserves would be established from the net proceeds of our Offering, proceeds from sales of other investments, operating cash generated by other investments or other cash on hand. In some cases, a lender may require us to establish capital reserves for a particular investment. The capital plan for each investment will be adjusted through ongoing, regular reviews of our portfolio or as necessary to respond to unanticipated additional capital needs.
Short-term Liquidity and Capital Resources
On a short-term basis, our principal demands for funds will be for the acquisition of real estate and real estate-related notes and investments and payments of tenant improvements, acquisition related costs, operating expenses, distributions, and interest and principal payments on current and future debt financings. We expect to meet our short-term liquidity requirements through net cash flows provided by operations, net proceeds from our Offering, borrowings on the secured credit facility, as well as secured and unsecured borrowings from banks and other lenders to finance our expected future acquisitions.
Long-term Liquidity and Capital Resources
On a long-term basis, our principal demands for funds will be for the acquisition of real estate and real estate-related notes and investments and payments of tenant improvements, acquisition related costs, operating expenses, distributions and repurchases to stockholders, and interest and principal payments on current and future indebtedness. We expect to meet our long-term liquidity requirements through proceeds from cash flow from operations, borrowings on the secured credit facility, proceeds from secured or unsecured borrowings from banks or other lenders, proceeds from our Offering and funds equal to amounts reinvested in the DRIP.
We expect that substantially all cash flows from operations will be used to pay distributions to our stockholders after certain capital expenditures; however, we have used, and may continue to use other sources to fund distributions, as necessary, such as, proceeds from our Offering, borrowings on the secured credit facility and/or future borrowings on unencumbered assets. To the extent cash flows from operations are lower due to fewer properties being acquired or lower-than-expected returns on the properties held, distributions paid to stockholders may be lower. We expect that substantially all net cash flows from our Offering or debt financings will be used to fund acquisitions, certain capital expenditures identified at acquisition, repayments of outstanding debt or distributions to our stockholders in excess of cash flows from operations.
Capital Expenditures
We will require approximately $35.4 million in expenditures for capital improvements over the next 12 months. We cannot provide assurances, however, that actual expenditures will not exceed these estimated expenditure levels. As of March 31, 2017, we had $6.2 million of restricted cash in escrow reserve accounts for such capital expenditures. In addition, as of March 31, 2017, we had approximately $64.4 million in cash and cash equivalents. For the three months ended March 31, 2017, we had capital expenditures of $8.1 million that primarily related to three healthcare real estate investments.
Credit Facility
As of March 31, 2017, the maximum commitments available under the secured credit facility were $425,000,000, consisting of a $325,000,000 revolving line of credit, with a maturity date of December 22, 2018, subject to our Operating

29


Partnership's right to two, 12-month extension periods, and a $100,000,000 term loan, with a maturity date of December 22, 2019, subject to our Operating Partnership's right to one, 12-month extension.
The proceeds of loans made under the secured credit facility may be used to finance the acquisition of real estate investments, for tenant improvements and leasing commissions with respect to real estate, for repayment of indebtedness, for capital expenditures with respect to real estate and for general corporate and working capital purposes. The secured credit facility can be increased to $550,000,000, subject to certain conditions. See Note 8—"Notes Payable and Secured Credit Facility" to the condensed consolidated financial statements that are part of this Quarterly Report on Form 10-Q.
As of March 31, 2017, we had a total pool availability under the secured credit facility of $342,826,000 and an aggregate outstanding principal balance of $310,000,000. As of March 31, 2017, $32,826,000 remained available to be drawn on the secured credit facility.
Cash Flows
Three Months Ended March 31, 2017 Compared to the Three Months Ended March 31, 2016
 
Three Months Ended
March 31,
 
 
(in thousands)
2017
 
2016
 
Change
Net cash provided by operating activities
$
12,771

 
$
4,631

 
$
8,140

Net cash used in investing activities
$
168,164

 
$
85,820

 
$
82,344

Net cash provided by financing activities
$
169,361

 
$
100,891

 
$
68,470

Operating Activities
Net cash provided by operating activities increased due to annual rental increases at our same store properties and the acquisition of our new operating properties, partially offset by increased operating expenses.
Investing Activities
Net cash used in investing activities increased primarily due to an increase in investments in real estate of $71.5 million, an increase in capital expenditures of $7.9 million and an increase in real estate deposits, net of $2.9 million.
Financing Activities
Net cash provided by financing activities increased primarily due to a net increase in proceeds from the secured credit facility of $70.0 million, an increase in proceeds from notes payable of $25.0 million and a decrease in offering costs related to the issuance of common stock of $2.4 million, offset by a decrease in proceeds from the issuance of common stock of $24.0 million, an increase in distributions to our stockholders of $2.6 million, an increase in repurchases of our common stock of $1.8 million, an increase in deferred financing costs of $0.3 million and an increase in escrow funds, net of $0.2 million.
Distributions
The amount of distributions payable to our stockholders is determined by our board of directors and is dependent on a number of factors, including our funds available for distribution, financial condition, capital expenditure requirements and the annual distribution requirements needed to maintain our status as a REIT under the Code. Our board of directors must authorize each distribution and may, in the future, authorize lower amounts of distributions or not authorize additional distributions and, therefore, distribution payments are not guaranteed. Our Advisor may also defer, suspend and/or waive fees and expense reimbursements if we have not generated sufficient cash flow from our operations and other sources to fund distributions. Additionally, our organizational documents permit us to pay distributions from unlimited amounts of any source, and we may use sources other than operating cash flows to fund distributions, including proceeds from our Offering, which may reduce the amount of capital we ultimately invest in properties or other permitted investments.

30


We have funded distributions with operating cash flows from our properties, proceeds raised in our Offering and reinvestments pursuant to the DRIP. To the extent that we do not have taxable income, distributions paid will be considered a return of capital to stockholders. The following table shows distributions paid during the three months ended March 31, 2017 and 2016 (amounts in thousands):
 
Three Months Ended March 31,
 
2017
 
2016
Distributions paid in cash - common stockholders
$
5,977

 
 
 
$
3,359

 
 
Distributions reinvested (shares issued)
7,001

 
 
 
4,626

 
 
Total distributions
$
12,978

 
 
 
$
7,985

 
 
Source of distributions:
 
 
 
 
 
 
 
Cash flows provided by operations (1)
$
5,977

 
46%
 
$
3,359

 
42%
Offering proceeds from issuance of common stock pursuant to the DRIP (1)
7,001

 
54%
 
4,626

 
58%
Total sources
$
12,978

 
100%
 
$
7,985

 
100%
(1)
Percentages were calculated by dividing the respective source amount by the total sources of distributions.
Total distributions declared but not paid on Class A shares, Class I shares and Class T shares as of March 31, 2017 were approximately $4.7 million for common stockholders. These distributions were paid on April 3, 2017.
For the three months ended March 31, 2017, we declared and paid distributions of approximately $13.0 million to Class A stockholders, Class I stockholders and Class T stockholders, including shares issued pursuant to the DRIP, as compared to FFO (as defined below) for the three months ended March 31, 2017 of approximately $12.4 million. The payment of distributions from sources other than FFO may reduce the amount of proceeds available for investment and operations or cause us to incur additional interest expense as a result of borrowed funds.
For a discussion of distributions paid subsequent to March 31, 2017, see Note 17—"Subsequent Events" to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Contractual Obligations
As of March 31, 2017, we had approximately $488.0 million of principal debt outstanding, of which $178.0 million related to notes payable and $310.0 million related to the secured credit facility. See Note 8—"Notes Payable and Secured Credit Facility" to the condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q for certain terms of the debt outstanding.
Our contractual obligations as of March 31, 2017 were as follows (amounts in thousands):
 
Less than
1 Year
 
1-3 Years
 
3-5 Years
 
More than
5 Years
 
Total
Principal payments—fixed rate debt
$

 
$
538

 
$
75,462

 
$

 
$
76,000

Interest payments—fixed rate debt
3,564

 
7,061

 
6,296

 

 
16,921

Principal payments—variable rate debt fixed through interest rate swap (1)

 
101,356

 
100,634

 

 
201,990

Interest payments—variable rate debt fixed through interest rate swap (2)
8,083

 
15,262

 
7,808

 

 
31,153

Principal payments—variable rate debt

 
210,000

 

 

 
210,000

Interest payments—variable rate debt (3)
6,085

 
4,563

 

 

 
10,648

Capital expenditures
35,432

 

 

 

 
35,432

Ground lease payments
103

 
205

 
205

 
1,548

 
2,061

Total
$
53,267

 
$
338,985

 
$
190,405

 
$
1,548

 
$
584,205

(1)
As of March 31, 2017, we had $202.0 million outstanding principal on notes payable and borrowings under the secured credit facility that were fixed through the use of interest rate swap agreements.
(2)
We used the fixed rates under our interest rate swap agreements as of March 31, 2017 to calculate the debt payment obligations in future periods.

31


(3)
We used LIBOR plus the applicable margin under our variable rate debt agreement as of March 31, 2017 to calculate the debt payment obligations in future periods.
Off-Balance Sheet Arrangements
As of March 31, 2017, we had no off-balance sheet arrangements.
Related-Party Transactions and Arrangements
We have entered into agreements with our Advisor and its affiliates whereby we agree to pay certain fees to, or reimburse certain expenses of, our Advisor or its affiliates for acquisition fees and expenses, organization and offering expenses, asset and property management fees and reimbursement of operating costs. Refer to Note 9—"Related-Party Transactions and Arrangements" to our condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q for a detailed discussion of the various related-party transactions and agreements.
Funds from Operations and Modified Funds from Operations
One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. The purchase of real estate assets and real estate-related investments, and the corresponding expenses associated with that process, is a key operational feature of our business plan in order to generate cash from operations. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group, has promulgated a measure known as funds from operations, or FFO, which we believe is an appropriate supplemental measure to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental performance measure. FFO is not equivalent to our net income as determined under GAAP.
We define FFO, consistent with NAREIT’s definition, as net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property and asset impairment write-downs, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnership and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect FFO on the same basis.
We, along with others in the real estate industry, consider FFO to be an appropriate supplemental measure of a REIT’s operating performance because it is based on a net income analysis of property portfolio performance that excludes non-cash items such as depreciation and amortization and asset impairment write-downs, which we believe provides a more complete understanding of our performance to investors and to our management, and when compared year over year, reflects the impact on our operations from trends in occupancy.
Historical accounting convention (in accordance with GAAP) for real estate assets requires companies to report their investment in real estate at its carrying value, which consists of capitalizing the cost of acquisitions, development, construction, improvements and significant replacements, less depreciation and amortization and asset impairment write-downs, if any, which is not necessarily equivalent to the fair market value of its investment in real estate assets.
The historical accounting convention requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, which could be the case if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or as requested or required by lessees for operational purposes in order to maintain the value disclosed. We believe that, since the fair value of real estate assets historically rises and falls 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 historical accounting for depreciation could be less informative.
In addition, we believe it is appropriate to disregard asset impairment write-downs as they are a non-cash adjustment to recognize losses on prospective sales of real estate assets. Since losses from sales of real estate assets are excluded from FFO, we believe it is appropriate that asset impairment write-downs in advancement of realization of losses should be excluded. Impairment write-downs are based on negative market fluctuations and underlying assessments of general market conditions, which are independent of our operating performance, including, but not limited to, a significant adverse change in the financial condition of our tenants, changes in supply and demand for similar or competing properties, changes in tax, real estate, environmental and zoning law, which can change over time. When indicators of potential impairment suggest that the carrying value of real estate and related assets may not be recoverable, we assess the recoverability by estimating whether we will recover the carrying value of the asset through undiscounted future cash flows and eventual disposition (including, but not limited to, net rental and lease revenues, net proceeds on the sale of property and any other ancillary cash flows at a property or group level under GAAP). If based on this analysis, we do not believe that we will be able to recover the carrying value of the real estate asset, we will record an impairment write-down to the extent that the carrying value exceeds the estimated fair value of the real estate asset. Testing for indicators of impairment is a continuous process and is analyzed on a quarterly basis.

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Investors should note, however, that determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of FFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and that we intend to have a relatively limited term of our operations, it could be difficult to recover any impairment charges through the eventual sale of the property. No impairment losses have been recorded to date.
In developing estimates of expected future cash flow, we make certain assumptions regarding future market rental income amounts subsequent to the expiration of current lease arrangements, property operating expenses, terminal capitalization and discount rates, the expected number of months it takes to re-lease the property, required tenant improvements and the number of years the property will be held for investment. The use of alternative assumptions in the future cash flow analysis could result in a different determination of the property’s future cash flows and a different conclusion regarding the existence of an asset impairment, the extent of such loss, if any, as well as the carrying value of the real estate asset.
Publicly registered, non-listed REITs, such as us, typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operations. While other start up entities may also experience significant acquisition activity during their initial years, we believe that publicly registered, non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after the acquisition activity ceases. We will use the proceeds raised in our offering to acquire real estate assets and real estate-related investments, and we intend to begin the process of achieving a liquidity event (i.e., listing of our shares of common stock on a national securities exchange, a merger or sale, the sale of all or substantially all of our assets, or another similar transaction) within five to seven years after the completion of our offering stage, which is generally comparable to other publicly registered, non-listed REITs. Thus, we do not intend to continuously purchase real estate assets and intend to have a limited life. Due to these factors and other unique features of publicly registered, non-listed REITS, the Investment Program Association, or the IPA, an industry trade group, has standardized a measure known as modified funds from operations, or MFFO, which we believe to be another appropriate supplemental measure to reflect the operating performance of a publicly registered, non-listed REIT. MFFO is a metric used by management to evaluate sustainable performance and dividend policy. MFFO is not equivalent to our net income as determined under GAAP.
We define MFFO, a non-GAAP measure, consistent with the IPA’s definition: FFO further adjusted for the following items included in the determination of GAAP net income; acquisition fees and expenses; amounts related to straight-line rental income and amortization of above and below intangible lease assets and liabilities; accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, adjustments related to contingent purchase price obligations where such adjustments have been included in the derivation of GAAP net income, and after adjustments for a consolidated and unconsolidated partnership and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. Our MFFO calculation complies with the IPA’s Practice Guideline, described above. In calculating MFFO, we exclude paid and accrued acquisition fees and expenses that are reported in our condensed consolidated statements of comprehensive income, amortization of above and below-market leases, amounts related to straight-line rents (which are adjusted in order to reflect such payments from a GAAP accrual basis to closer to an expected to be received cash basis of disclosing the rent and lease payments) and ineffectiveness of interest rate swaps. The other adjustments included in the IPA’s guidelines are not applicable to us.
Since MFFO excludes acquisition fees and expenses, it should not be construed as a historic performance measure. Acquisition fees and expenses are paid in cash by us, and we have not set aside or put into escrow any specific amount of proceeds from our offerings to be used to fund acquisition fees and expenses. Acquisition fees and expenses include payments to our Advisor or its affiliates and third parties. Such fees and expenses will not be reimbursed by our Advisor or its affiliates and third parties, and therefore if there are no further proceeds from the sale of shares of our common stock to fund future acquisition fees and expenses, such fees and expenses will need to be paid from either additional debt, operational earnings or cash flows, net proceeds from the sale of properties, or from ancillary cash flows. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds. Nevertheless, our Advisor or its affiliates will not accrue any claim on our assets if acquisition fees and expenses are not paid from the proceeds of our offerings. Under GAAP, acquisition fees and expenses related to the acquisition of properties determined to be business combinations are expensed as incurred, including investment transactions that are no longer under consideration, and are included in acquisition related expenses in the accompanying condensed consolidated statements of comprehensive income and acquisition fees and expenses associated with transactions determined to be an asset purchase are capitalized.

33


All paid and accrued acquisition fees and expenses have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the real estate asset, these fees and expenses and other costs related to such property. In addition, MFFO may not be an indicator of our operating performance, especially during periods in which properties are being acquired.
In addition, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income in determining cash flows from operations in accordance with GAAP.
We use MFFO and the adjustments used to calculate it in order to evaluate our performance against other publicly registered, non-listed REITs, which intend to have limited lives with short and defined acquisition periods and targeted exit strategies shortly thereafter. As noted above, MFFO may not be a useful measure of the impact of long-term operating performance if we do not continue to operate in this manner. We believe that our use of MFFO and the adjustments used to calculate it allow us to present our performance in a manner that reflects certain characteristics that are unique to publicly registered, non-listed REITs, such as their limited life, limited and defined acquisition period and targeted exit strategy, and hence the use of such measures may be useful to investors. For example, acquisition fees and expenses are intended to be funded from the proceeds of our offering and other financing sources and not from operations. By excluding acquisition fees and expenses, the use of MFFO provides information consistent with management’s analysis of the operating performance of its real estate assets. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such charges that may reflect anticipated and unrealized gains or losses, we believe MFFO provides useful supplemental information.
Presentation of this information is intended to assist management and investors in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income as an indication of our performance, as an indication of our liquidity, or indicative of funds available for our cash needs, including our ability to make distributions to our stockholders. FFO and MFFO should be reviewed in conjunction with other measurements as an indication of our performance. MFFO has limitations as a performance measure. However, it may be useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete and net asset value is disclosed. MFFO is not a useful measure in evaluating net asset value since impairment write-downs are taken into account in determining net asset value but not in determining MFFO.
FFO and MFFO, as described above, 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 operational performance. The method used to evaluate the value and performance of real estate under GAAP should be construed as a more relevant measure of operating performance and considered more prominently than the non-GAAP FFO and MFFO measures and the adjustments to GAAP in calculating FFO and MFFO. MFFO has not been scrutinized to the level of other similar non-GAAP performance measures by the SEC or any other regulatory body.

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The following is a reconciliation of net income attributable to common stockholders, which is the most directly comparable GAAP financial measure, to FFO and MFFO for the three months ended March 31, 2017 and 2016 (amounts in thousands, except share data and per share amounts):
 
Three Months Ended
March 31,
 
2017
 
2016
Net income attributable to common stockholders
$
4,791

 
$
1,610

Adjustments:
 
 
 
Depreciation and amortization
7,610

 
3,866

FFO attributable to common stockholders
$
12,401

 
$
5,476

Adjustments:
 
 
 
Acquisition related expenses (1)
$

 
$
1,665

Amortization of intangible assets and liabilities (2)
(125
)
 
(125
)
Straight-line rent (3)
(2,232
)
 
(1,166
)
Ineffectiveness of interest rate swaps
8

 

MFFO attributable to common stockholders
$