Attached files
| file | filename |
|---|---|
| EX-32.2 - EXHIBIT 32.2 - Carter Validus Mission Critical REIT, Inc. | a2017q310qexhibit322reiti0.htm |
| EX-32.1 - EXHIBIT 32.1 - Carter Validus Mission Critical REIT, Inc. | a2017q310qexhibit321reiti0.htm |
| EX-31.2 - EXHIBIT 31.2 - Carter Validus Mission Critical REIT, Inc. | a2017q310qexhibit312reiti0.htm |
| EX-31.1 - EXHIBIT 31.1 - Carter Validus Mission Critical REIT, Inc. | a2017q310qexhibit311reiti0.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________
FORM 10-Q
___________________________________________
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 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: 000-54675
___________________________________________
CARTER VALIDUS MISSION CRITICAL REIT, INC.
(Exact name of registrant as specified in its charter)
___________________________________________
Maryland | 27-1550167 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
4890 West Kennedy Blvd., Suite 650 Tampa, FL 33609 | (813) 287-0101 | |
(Address of Principal Executive Offices; Zip Code) | (Registrant’s Telephone Number) | |
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)
___________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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. (Check one):
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 comply with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of 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 November 6, 2017, there were approximately 186,487,000 shares of common stock of Carter Validus Mission Critical REIT, Inc. outstanding.
CARTER VALIDUS MISSION CRITICAL REIT, 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 1. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements.
CARTER VALIDUS MISSION CRITICAL REIT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(Unaudited) September 30, 2017 | December 31, 2016 | ||||||
ASSETS | |||||||
Real estate: | |||||||
Land ($4,280 and $4,280, respectively, related to VIE) | $ | 181,960 | $ | 181,960 | |||
Buildings and improvements, less accumulated depreciation of $194,011 and $152,486, respectively ($82,689 and $84,760, respectively, related to VIE) | 1,806,806 | 1,812,769 | |||||
Construction in process | — | 16,143 | |||||
Total real estate, net ($86,969 and $89,040, respectively, related to VIE) | 1,988,766 | 2,010,872 | |||||
Cash and cash equivalents ($2,503 and $2,308, respectively, related to VIE) | 42,603 | 42,613 | |||||
Acquired intangible assets, less accumulated amortization of $66,078 and $53,372, respectively ($5,915 and $6,465, respectively, related to VIE) | 165,724 | 178,430 | |||||
Other assets, net ($10,966 and $8,525, respectively, related to VIE) | 122,070 | 105,739 | |||||
Total assets | $ | 2,319,163 | $ | 2,337,654 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Liabilities: | |||||||
Notes payable, net of deferred financing costs of $1,675 and $2,542, respectively ($50,677 and $51,283, respectively, related to VIE) | $ | 449,494 | $ | 484,270 | |||
Credit facility, net of deferred financing costs of $1,101 and $1,789, respectively | 431,899 | 356,211 | |||||
Accounts payable due to affiliates ($35 and $54, respectively, related to VIE) | 2,536 | 2,635 | |||||
Accounts payable and other liabilities ($4,585 and $3,825, respectively, related to VIE) | 41,109 | 40,196 | |||||
Intangible lease liabilities, less accumulated amortization of $18,941 and $16,332, respectively ($7,262 and $8,030, respectively, related to VIE) | 46,789 | 49,398 | |||||
Total liabilities | 971,827 | 932,710 | |||||
Stockholders’ equity: | |||||||
Preferred stock, $0.01 par value per share, 50,000,000 shares authorized; none issued and outstanding | — | — | |||||
Common stock, $0.01 par value per share, 300,000,000 shares authorized; 195,153,569 and 189,848,165 shares issued, respectively; 186,241,949 and 184,909,673 shares outstanding, respectively | 1,862 | 1,849 | |||||
Additional paid-in capital | 1,636,603 | 1,625,862 | |||||
Accumulated distributions in excess of earnings | (329,081 | ) | (258,878 | ) | |||
Accumulated other comprehensive income | 3,149 | 1,823 | |||||
Total stockholders’ equity | 1,312,533 | 1,370,656 | |||||
Noncontrolling interests | 34,803 | 34,288 | |||||
Total equity | 1,347,336 | 1,404,944 | |||||
Total liabilities and stockholders’ equity | $ | 2,319,163 | $ | 2,337,654 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
CARTER VALIDUS MISSION CRITICAL REIT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands, except share data and per share amounts)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||
Revenue: | |||||||||||||||
Rental and parking revenue | $ | 49,293 | $ | 38,144 | $ | 147,855 | $ | 144,446 | |||||||
Tenant reimbursement revenue | 4,447 | 4,916 | 13,264 | 14,011 | |||||||||||
Total revenue | 53,740 | 43,060 | 161,119 | 158,457 | |||||||||||
Expenses: | |||||||||||||||
Rental and parking expenses | 8,087 | 7,372 | 23,191 | 21,384 | |||||||||||
General and administrative expenses | 1,594 | 1,465 | 5,274 | 4,633 | |||||||||||
Change in fair value of contingent consideration | (1,880 | ) | 125 | (2,920 | ) | 370 | |||||||||
Acquisition related expenses | — | 5 | — | 1,645 | |||||||||||
Asset management fees | 4,848 | 5,036 | 14,494 | 14,700 | |||||||||||
Depreciation and amortization | 18,336 | 32,110 | 54,491 | 66,458 | |||||||||||
Total expenses | 30,985 | 46,113 | 94,530 | 109,190 | |||||||||||
Income (loss) from operations | 22,755 | (3,053 | ) | 66,589 | 49,267 | ||||||||||
Other income (expense): | |||||||||||||||
Other interest and dividend income | 497 | 2,893 | 1,551 | 8,572 | |||||||||||
Interest expense, net | (8,849 | ) | (9,292 | ) | (26,373 | ) | (29,119 | ) | |||||||
Provision for loan losses | (7,459 | ) | (42 | ) | (11,631 | ) | (1,708 | ) | |||||||
Total other expense | (15,811 | ) | (6,441 | ) | (36,453 | ) | (22,255 | ) | |||||||
Net income (loss) | 6,944 | (9,494 | ) | 30,136 | 27,012 | ||||||||||
Net income attributable to noncontrolling interests in consolidated partnerships | (898 | ) | (1,006 | ) | (3,018 | ) | (2,995 | ) | |||||||
Net income (loss) attributable to common stockholders | $ | 6,046 | $ | (10,500 | ) | $ | 27,118 | $ | 24,017 | ||||||
Other comprehensive income (loss): | |||||||||||||||
Unrealized income (loss) on interest rate swaps, net | $ | 207 | $ | 3,288 | $ | 1,326 | $ | (3,181 | ) | ||||||
Other comprehensive income (loss) | 207 | 3,288 | 1,326 | (3,181 | ) | ||||||||||
Comprehensive income (loss) | 7,151 | (6,206 | ) | 31,462 | 23,831 | ||||||||||
Comprehensive income attributable to noncontrolling interests in consolidated partnerships | (898 | ) | (1,006 | ) | (3,018 | ) | (2,995 | ) | |||||||
Comprehensive income (loss) attributable to common stockholders | $ | 6,253 | $ | (7,212 | ) | $ | 28,444 | $ | 20,836 | ||||||
Weighted average number of common shares outstanding: | |||||||||||||||
Basic | 186,295,970 | 183,726,479 | 185,834,940 | 182,827,193 | |||||||||||
Diluted | 186,312,758 | 183,726,479 | 185,853,976 | 182,846,104 | |||||||||||
Net income (loss) per common share attributable to common stockholders: | |||||||||||||||
Basic | $ | 0.03 | $ | (0.06 | ) | $ | 0.15 | $ | 0.13 | ||||||
Diluted | $ | 0.03 | $ | (0.06 | ) | $ | 0.15 | $ | 0.13 | ||||||
Distributions declared per common share | $ | 0.18 | $ | 0.18 | $ | 0.52 | $ | 0.52 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
CARTER VALIDUS MISSION CRITICAL REIT, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except for share data)
(Unaudited)
Common Stock | Additional Paid-in Capital | Accumulated Distributions in Excess of Earnings | Accumulated Other Comprehensive Income | Total Stockholders’ Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||
No. of Shares | Par Value | |||||||||||||||||||||||||||||
Balance, December 31, 2016 | 184,909,673 | $ | 1,849 | $ | 1,625,862 | $ | (258,878 | ) | $ | 1,823 | $ | 1,370,656 | $ | 34,288 | $ | 1,404,944 | ||||||||||||||
Vesting of restricted stock | 9,000 | — | 66 | — | — | 66 | — | 66 | ||||||||||||||||||||||
Issuance of common stock under the distribution reinvestment plan | 5,296,404 | 53 | 50,382 | — | — | 50,435 | — | 50,435 | ||||||||||||||||||||||
Purchase of noncontrolling interests | — | — | (500 | ) | — | — | (500 | ) | — | (500 | ) | |||||||||||||||||||
Distributions to noncontrolling interests | — | — | — | — | — | — | (2,503 | ) | (2,503 | ) | ||||||||||||||||||||
Distributions declared to common stockholders | — | — | — | (97,321 | ) | — | (97,321 | ) | — | (97,321 | ) | |||||||||||||||||||
Other offering costs | — | — | (49 | ) | — | — | (49 | ) | — | (49 | ) | |||||||||||||||||||
Repurchase of common stock | (3,973,128 | ) | (40 | ) | (39,158 | ) | — | — | (39,198 | ) | — | (39,198 | ) | |||||||||||||||||
Other comprehensive income | — | — | — | — | 1,326 | 1,326 | — | 1,326 | ||||||||||||||||||||||
Net income | — | — | — | 27,118 | — | 27,118 | 3,018 | 30,136 | ||||||||||||||||||||||
Balance, September 30, 2017 | 186,241,949 | $ | 1,862 | $ | 1,636,603 | $ | (329,081 | ) | $ | 3,149 | $ | 1,312,533 | $ | 34,803 | $ | 1,347,336 | ||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
CARTER VALIDUS MISSION CRITICAL REIT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months Ended September 30, | |||||||
2017 | 2016 | ||||||
Cash flows from operating activities: | |||||||
Net income | $ | 30,136 | $ | 27,012 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization | 54,491 | 66,458 | |||||
Amortization of deferred financing costs | 2,893 | 3,425 | |||||
Amortization of above-market leases | 275 | 329 | |||||
Amortization of intangible lease liabilities | (2,609 | ) | (2,847 | ) | |||
Provision for doubtful accounts | 11,043 | 1,799 | |||||
Provision for loan losses | 11,631 | 1,708 | |||||
Loss on debt extinguishment | 15 | 1,133 | |||||
Straight-line rent | (10,111 | ) | (3,717 | ) | |||
Stock-based compensation | 66 | 67 | |||||
Change in fair value of contingent consideration | (2,920 | ) | 370 | ||||
Changes in operating assets and liabilities: | |||||||
Accounts payable and other liabilities | 4,232 | 2,650 | |||||
Accounts payable due to affiliates | (111 | ) | 1,237 | ||||
Other assets | (11,091 | ) | (12,645 | ) | |||
Net cash provided by operating activities | 87,940 | 86,979 | |||||
Cash flows from investing activities: | |||||||
Investment in real estate | — | (71,000 | ) | ||||
Capital expenditures | (19,975 | ) | (55,096 | ) | |||
Real estate deposits, net | — | 450 | |||||
Notes receivable, net | (13,000 | ) | (4,019 | ) | |||
Net cash used in investing activities | (32,975 | ) | (129,665 | ) | |||
Cash flows from financing activities: | |||||||
Payments on notes payable | (35,643 | ) | (53,675 | ) | |||
Proceeds from credit facility | 75,000 | 185,000 | |||||
Payments of deferred financing costs | (1,681 | ) | (457 | ) | |||
Repurchase of common stock | (39,198 | ) | (26,146 | ) | |||
Offering costs | (49 | ) | (8 | ) | |||
Distributions to stockholders | (47,128 | ) | (44,816 | ) | |||
Purchase of noncontrolling interests in consolidated partnerships | (500 | ) | — | ||||
Distributions to noncontrolling interests in consolidated partnerships | (2,503 | ) | (1,948 | ) | |||
Net cash (used in) provided by financing activities | (51,702 | ) | 57,950 | ||||
Net change in cash, cash equivalents and restricted cash | 3,263 | 15,264 | |||||
Cash, cash equivalents and restricted cash - Beginning of period | 57,605 | 43,070 | |||||
Cash, cash equivalents and restricted cash - End of period | $ | 60,868 | $ | 58,334 | |||
Supplemental cash flow disclosure: | |||||||
Interest paid, net of interest capitalized of $2,794 and $1,820, respectively | $ | 26,150 | $ | 26,314 | |||
Supplemental disclosure of non-cash transactions: | |||||||
Common stock issued through distribution reinvestment plan | $ | 50,435 | $ | 51,227 | |||
Net unrealized gain (loss) on interest rate swap | $ | 1,326 | $ | (3,181 | ) | ||
Accrued capital expenditures | $ | 59 | $ | 6,475 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
CARTER VALIDUS MISSION CRITICAL REIT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2017
Note 1—Organization and Business Operations
Carter Validus Mission Critical REIT, Inc., or the Company, a Maryland corporation, was incorporated on December 16, 2009 and elected to be taxed and currently qualifies as a real estate investment trust, or a REIT, under the Internal Revenue Code of 1986, as amended, or the Code, for federal income tax purposes. The Company was organized to acquire and operate a diversified portfolio of income-producing commercial real estate, with a focus on the data center and healthcare property sectors, net leased to creditworthy tenants, as well as to make other real estate-related investments that relate to such property types. The Company operates through two reportable segments—commercial real estate investments in data centers and healthcare. Substantially all of the Company’s business is conducted through Carter/Validus Operating Partnership, LP, a Delaware limited partnership, or the Operating Partnership. The Company is the sole general partner of the Operating Partnership. Carter/Validus Advisors, LLC, or the Advisor, the Company’s affiliated advisor, is the special limited partner of the Operating Partnership.
As of September 30, 2017, the Company owned 49 real estate investments (including one real estate investment owned through a consolidated partnership), consisting of 84 properties located in 46 metropolitan statistical areas, or MSAs.
The Company ceased offering shares of common stock in its initial public offering, or the Offering, on June 6, 2014. At the completion of the Offering, the Company raised gross proceeds of approximately $1,716,046,000 (including shares of common stock issued pursuant to a distribution reinvestment plan, or the DRIP). The Company will continue to issue shares of common stock under the DRIP Offering (as defined below) until such time as the Company sells all of the shares registered for sale under the DRIP Offering, unless the Company files a new registration statement with the Securities and Exchange Commission, or the SEC, or the DRIP Offering is terminated by the Company’s board of directors. We refer to our DRIP Offering and Offering together as the "Offerings."
On May 22, 2017, the Company registered 11,387,512 shares of common stock with a price per share of $9.519, based on the price per share formula set forth in the registration statement on Form S-3 (which price may change upon the Company's calculation of an updated net asset value per share), for a proposed maximum offering price of $108,397,727 in shares of common stock under the DRIP pursuant to a registration statement on Form S-3, or the DRIP Offering.
As of September 30, 2017, the Company had issued approximately 195,087,000 shares of common stock in the Offerings for gross proceeds of $1,930,203,000, before share repurchases of $87,060,000 and offering costs, selling commissions and dealer manager fees of $174,842,000.
Except as the context otherwise requires, “we,” “our,” “us,” and the “Company” refer to Carter Validus Mission Critical REIT, Inc., the Operating Partnership, all majority-owned subsidiaries and controlled subsidiaries.
7
Note 2—Summary of Significant Accounting Policies
The summary of significant accounting policies presented below is designed to assist in understanding the Company’s condensed consolidated financial statements. Such condensed consolidated financial statements and the accompanying notes thereto are the representation of management. The accompanying condensed consolidated unaudited financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States, 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 necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ended 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 of the information and notes required by GAAP for complete financial statements. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2016 and related notes thereto set forth in the Company’s Annual Report on Form 10-K, filed with the SEC on March 30, 2017.
Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, all majority-owned subsidiaries and controlled subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with GAAP necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. 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.
Allowance for Uncollectible Accounts
Tenant receivables and unbilled deferred rent receivables are carried net of the allowances for uncollectible amounts. An allowance will be maintained for estimated losses resulting from the inability of certain tenants to meet the contractual obligations under their lease agreements. The Company also maintains an allowance for deferred rent receivables arising from the straight-lining of rents. The Company’s determination of the adequacy of these allowances is based primarily upon evaluations of historical loss experience, the tenant’s financial condition, security deposits, letters of credit, lease guarantees and current economic conditions and other relevant factors. For the three months ended September 30, 2017 and 2016, the Company recorded $3,806,000 and $16,502,000, respectively, and for the nine months ended September 30, 2017 and 2016, the Company recorded $13,065,000 and $17,311,000, respectively, in provision for doubtful accounts for rental and parking revenue, tenant reimbursement revenue and straight-line rent receivable, which are recognized in the accompanying condensed consolidated statements of comprehensive income (loss) as a deduction from rental and parking revenue and tenant reimbursement revenue.
Notes Receivable
Notes receivable are reported at their outstanding principal balance, net of any unearned income, unamortized deferred fees and costs and allowances for loan losses. The unamortized deferred fees and costs are amortized over the life of the notes receivable, as applicable, and recorded in other interest and dividend income in the accompanying condensed consolidated statements of comprehensive income (loss).
The Company evaluates the collectability of both interest and principal on each note receivable to determine whether it is collectible primarily through the evaluation of credit quality indicators, such as the tenant's financial condition, evaluations of historical loss experience, current economic conditions and other relevant factors. Evaluating a note receivable for potential impairment requires management to exercise significant judgment. As of September 30, 2017 and December 31, 2016, the aggregate balance on the Company's notes receivable, including accrued interest receivable, before allowances for loan losses was $27,898,000 and $19,422,000, respectively. For the three months ended September 30, 2017 and 2016, the Company recorded $7,459,000 and $42,000, respectively, and for the nine months ended September 30, 2017 and 2016, the Company recorded $11,631,000 and $1,708,000, respectively, as an allowance to reduce the carrying value of notes receivable and accrued interest related to two tenants in provision for loan losses in the accompanying condensed consolidated financial statements.
8
Concentration of Credit Risk and Significant Leases
As of September 30, 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 standings; therefore, the Company believes it is not exposed to any significant credit risk on its cash deposits. To date, the Company has experienced no loss of, or lack of access to, cash in its accounts.
As of September 30, 2017, the Company owned real estate investments in 46 MSAs, (including one real estate investment owned through a consolidated partnership), two of which accounted for 10.0% or more of contractual rental revenue. Real estate investments located in the Houston-The Woodlands-Sugar Land, Texas MSA and the Chicago-Naperville-Elgin, Illinois-Indiana-Wisconsin MSA accounted for an aggregate of 10.1% and 12.3%, respectively, of contractual rental revenue for the nine months ended September 30, 2017.
As of September 30, 2017, the Company had two exposures to tenant concentration that accounted for 10.0% or more of rental revenue. The leases with AT&T Services, Inc. and Bay Area Regional Medical Center, LLC accounted for 12.0% and 10.0%, respectively, of contractual rental revenue for the nine months ended September 30, 2017.
Restricted Cash
Restricted cash consists of restricted cash held in escrow and restricted bank deposits. Restricted cash held in escrow includes cash held by lenders in escrow accounts for tenant and capital improvements, repairs and maintenance and other lender reserves for certain properties, in accordance with the respective lender’s loan agreement. Restricted cash is reported in other assets, net in the accompanying condensed consolidated balance sheets. See Note 5—"Other Assets, Net." Restricted bank deposits consist of tenant receipts for certain properties which are required to be deposited into lender controlled accounts in accordance with the respective lender's loan agreement. Restricted bank deposits are reported in other assets, net in the accompanying condensed consolidated balance sheets.
On April 1, 2017, the Company adopted 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. This ASU states that transfers between cash, cash equivalents, and restricted cash are not part of the Company’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. As required, the Company retrospectively applied the guidance in ASU 2016-18 to the prior period presented, which resulted in an increase of $2,289,000 in net cash provided by financing activities and an increase of $92,000 in net cash provided by operating activities on the condensed consolidated statements of cash flows for the nine months ended September 30, 2016.
The following table presents a reconciliation of the beginning of period and end of period cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets to the totals shown in the condensed consolidated statements of cash flows:
Nine Months Ended September 30, | ||||||||
Beginning of period: | 2017 | 2016 | ||||||
Cash and cash equivalents | $ | 42,613 | $ | 28,527 | ||||
Restricted cash | 14,992 | 14,543 | ||||||
Cash, cash equivalents and restricted cash | $ | 57,605 | $ | 43,070 | ||||
End of period: | ||||||||
Cash and cash equivalents | $ | 42,603 | $ | 41,410 | ||||
Restricted cash | 18,265 | 16,924 | ||||||
Cash, cash equivalents and restricted cash | $ | 60,868 | $ | 58,334 | ||||
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 reinvestments pursuant to the DRIP Offerings 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.
9
Repurchases of shares of the Company’s common stock are at the sole discretion of the Company’s board of directors. In addition, the Company’s board of directors, in its sole discretion, may amend, suspend, reduce, terminate or otherwise change the share repurchase program upon 30 days' prior notice to the Company’s stockholders for any reason it deems appropriate. The share repurchase program provides that the Company will limit the number of shares repurchased during any calendar year to 5.0% of the number of shares of common stock outstanding as of December 31st of the previous calendar year.
During the nine months ended September 30, 2017, the Company received valid repurchase requests related to approximately 3,973,000 shares of common stock, all of which were repurchased in full for an aggregate purchase price of approximately $39,198,000 (an average of $9.87 per share). During the nine months ended September 30, 2016, the Company received valid repurchase requests related to approximately 2,696,000 shares of common stock, all of which were repurchased in full for an aggregate purchase price of approximately $26,146,000 (an average of $9.70 per share).
Earnings Per Share
Basic earnings per share for all periods presented is computed by dividing net income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Shares of non-vested restricted common stock give rise to potentially dilutive shares of common stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding and all potentially dilutive securities. For the three months ended September 30, 2017, diluted earnings per share reflected the effect of approximately 17,000 of non-vested shares of restricted common stock that were outstanding as of such period. For the three months ended September 30, 2016, there were approximately 17,000 of non-vested shares of restricted common stock outstanding; however, such shares were excluded from the computation of diluted earnings per share because such shares were anti-dilutive during this period. For the nine months ended September 30, 2017 and 2016, diluted earnings per share reflected the effect of approximately 19,000 of non-vested shares of restricted common 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 Accounting Standards Update, or ASU, 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. The objective of ASU 2014-09 is to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle, which may require more judgment and estimates within the revenue recognition process than are required under existing GAAP. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date, or ASU 2015-14. ASU 2015-14 defers the effective date of ASU 2014-09 by one year to fiscal years and interim periods beginning after December 15, 2017. Early adoption is permitted as of the original effective date, which was annual reporting periods beginning after December 15, 2016, and the interim periods within that year. On March 17, 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers Principal versus Agent Considerations (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.
As the majority of the Company's revenue is derived from real estate lease contracts, as discussed in relation to ASU 2016-02, Leases, the Company does not expect that the adoption of ASU 2014-09 or related amendments and modifications will have a material impact on the condensed consolidated financial statements. The Company has preliminarily determined the revenue stream that could be most significantly impacted by this ASU relates to parking revenue. The Company expects that the revenue recognition from parking revenue will be generally consistent with current recognition methods, and therefore does not expect material changes to the condensed consolidated financial statements as a result of adoption. For the three and nine months ended September 30, 2017, parking revenue was less than 10% of consolidated revenue. Recoveries from tenants to be impacted by ASU 2014-09 will not be addressed until the Company's adoption of ASU 2016-02, Leases, considering its revisions to accounting for common area maintenance described below. The Company also continues to evaluate the scope of revenue-related disclosures it expects to provide pursuant to the new requirements. The Company expects to adopt the standard using the modified retrospective approach, which requires cumulative adjustments as of the date of adoption. The Company will adopt the standard on its effective date beginning with the first quarter of 2018.
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
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guidance in Topic 606, Revenue from Contracts with Customers, and Topic 610, Other Income. Under ASU 2016-02, a lessee is required to record a right of use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. The Company is a lessee on a limited number of ground leases, which will result in the recognition of a right of use asset and lease liability upon the adoption of ASU 2016-02. Lessor accounting remains largely unchanged, apart from the narrower scope of initial direct costs that can be capitalized. The new standard will result in certain costs, such as legal costs related to lease negotiations, being expensed rather than capitalized. In addition, ASU 2016-02 requires lessors to identify the lease and non-lease components, such as the reimbursement of common area maintenance, contained within each lease. 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 condensed consolidated financial statements.
On June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses, or ASU 2016-13. ASU 2016-13 requires more timely recording of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. ASU 2016-13 requires that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The amendments in ASU 2016-13 require the Company to measure all expected credit losses based upon historical experience, current conditions and reasonable and supportable forecasts that affect the collectability of the financial assets and eliminates the “incurred loss” methodology in current GAAP. ASU 2016-13 is effective for fiscal years, 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 condensed consolidated financial statements. The Company believes that certain financial statements' accounts will be impacted by the adoption of ASU 2016-13, including allowances for doubtful accounts with respect to accounts receivable, straight-line rents receivable and notes receivable.
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 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. The Company does not expect that the adoption of ASU 2017-05 will have a material impact on the condensed consolidated financial statements.
On August 28, 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, or ASU 2017-12. The objectives of ASU 2017-12 are to (i) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (ii) reduce the complexity of and simplify the application of hedge accounting by preparers. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018, and interim periods therein. Early adoption is permitted. The Company is in process of evaluating the impact of ASU 2017-12 will have on the Company’s condensed consolidated financial statements.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the Company’s condensed consolidated financial position or results of operations.
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Note 3—Acquired Intangible Assets, Net
Acquired intangible assets, net, consisted of the following as of September 30, 2017 and December 31, 2016 (amounts in thousands, except weighted average life amounts):
September 30, 2017 | December 31, 2016 | ||||||
In-place leases, net of accumulated amortization of $64,268 and $51,837, respectively (with a weighted average remaining life of 12.3 years and 12.9 years, respectively) | $ | 160,360 | $ | 172,791 | |||
Above-market leases, net of accumulated amortization of $1,539 and $1,303, respectively (with a weighted average remaining life of 9.6 years and 10.3 years, respectively) | 2,821 | 3,057 | |||||
Ground lease interest, net of accumulated amortization of $271 and $232, respectively (with a weighted average remaining life of 58.9 years and 59.5 years, respectively) | 2,543 | 2,582 | |||||
$ | 165,724 | $ | 178,430 | ||||
The aggregate weighted average remaining life of the acquired intangible assets was 13.0 years and 13.5 years as of September 30, 2017 and December 31, 2016, respectively.
Amortization of the acquired intangible assets for the three months ended September 30, 2017 and 2016 was $4,226,000 and $19,041,000, respectively, and for the nine months ended September 30, 2017 and 2016 was $12,706,000 and $27,796,000, respectively. Amortization of the above-market leases is recorded as an adjustment to rental and parking 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 and parking expenses in the accompanying condensed consolidated statements of comprehensive income (loss).
Note 4—Intangible Lease Liabilities, Net
Intangible lease liabilities, net, consisted of the following as of September 30, 2017 and December 31, 2016 (amounts in thousands, except weighted average life amounts):
September 30, 2017 | December 31, 2016 | ||||||
Below-market leases, net of accumulated amortization of $18,547 and $16,031, respectively (with a weighted average remaining life of 16.5 years and 17.1 years, respectively) | $ | 41,858 | $ | 44,374 | |||
Ground leasehold liabilities, net of accumulated amortization of $394 and $301, respectively (with a weighted average remaining life of 41.5 years and 42.2 years, respectively) | 4,931 | 5,024 | |||||
$ | 46,789 | $ | 49,398 | ||||
The aggregate weighted average remaining life of intangible lease liabilities was 19.2 years and 19.6 years as of September 30, 2017 and December 31, 2016, respectively.
Amortization of the intangible lease liabilities for the three months ended September 30, 2017 and 2016 was $870,000 and $897,000, respectively, and for the nine months ended September 30, 2017 and 2016 was $2,609,000 and $2,847,000, respectively. Amortization of below-market leases is recorded as an adjustment to rental and parking revenue and amortization expense of ground leasehold liabilities is included in rental and parking expenses in the accompanying condensed consolidated statements of comprehensive income (loss).
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Note 5—Other Assets, Net
Other assets, net consisted of the following as of September 30, 2017 and December 31, 2016 (amounts in thousands):
September 30, 2017 | December 31, 2016 | ||||||
Deferred financing costs related to the revolver portion of the unsecured credit facility, net of accumulated amortization of $6,979 and $5,833, respectively | $ | 1,202 | $ | 877 | |||
Lease commissions, net of accumulated amortization of $966 and $557, respectively | 4,885 | 4,869 | |||||
Investments in unconsolidated partnerships | 125 | 113 | |||||
Tenant receivables, net of allowances for doubtful accounts of $5,023 and $6,007, respectively | 8,700 | 10,475 | |||||
Notes receivable, net of allowances for loan losses of $10,309 and $4,294, respectively | 17,589 | 15,128 | |||||
Real estate-related notes receivable | 514 | 514 | |||||
Straight-line rent receivable | 64,558 | 53,545 | |||||
Restricted cash | 18,265 | 14,992 | |||||
Derivative assets | 3,437 | 3,070 | |||||
Prepaid and other assets | 2,795 | 2,156 | |||||
$ | 122,070 | $ | 105,739 | ||||
Note 6—Accounts Payable and Other Liabilities
Accounts payable and other liabilities, as of September 30, 2017 and December 31, 2016, were comprised of the following (amounts in thousands):
September 30, 2017 | December 31, 2016 | ||||||
Accounts payable and accrued expenses | $ | 6,515 | $ | 7,200 | |||
Accrued interest expense | 2,840 | 2,855 | |||||
Accrued property taxes | 4,990 | 4,277 | |||||
Contingent consideration obligations | 2,720 | 5,640 | |||||
Distributions payable to stockholders | 10,728 | 10,968 | |||||
Tenant deposits | 1,002 | 1,039 | |||||
Deferred rental income | 12,026 | 6,970 | |||||
Derivative liabilities | 288 | 1,247 | |||||
$ | 41,109 | $ | 40,196 | ||||
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Note 7—Notes Payable and Unsecured Credit Facility
The Company's debt outstanding as of September 30, 2017 and December 31, 2016 consisted of the following (amounts in thousands):
September 30, 2017 | December 31, 2016 | ||||||
Notes payable: | |||||||
Fixed rate notes payable | $ | 101,918 | $ | 114,783 | |||
Variable rate notes payable fixed through interest rate swaps | 308,710 | 330,425 | |||||
Variable rate notes payable | 40,541 | 41,604 | |||||
Total notes payable, principal amount outstanding | 451,169 | 486,812 | |||||
Unamortized deferred financing costs related to notes payable | (1,675 | ) | (2,542 | ) | |||
Total notes payable, net of deferred financing costs | 449,494 | 484,270 | |||||
Unsecured credit facility: | |||||||
Revolving line of credit | 223,000 | 148,000 | |||||
Term loan | 210,000 | 210,000 | |||||
Total unsecured credit facility, principal amount outstanding | 433,000 | 358,000 | |||||
Unamortized deferred financing costs related to the term loan of the unsecured credit facility | (1,101 | ) | (1,789 | ) | |||
Total unsecured credit facility, net of deferred financing costs | 431,899 | 356,211 | |||||
Total debt outstanding | $ | 881,393 | $ | 840,481 | |||
Significant debt activity since December 31, 2016, excluding scheduled principal payments, includes:
• | On January 31, 2017, the Operating Partnership and certain of the Company’s subsidiaries entered into an amendment related to the unsecured credit facility to extend the maturity date and modify the extension options of the revolving line of credit portion of the unsecured credit facility. In connection with the amendment to the unsecured credit facility, the maturity date of the revolving line of credit was changed from May 28, 2017 to May 28, 2018, subject to the Operating Partnership's right to two 12-month extension periods (the Operating Partnership previously had a right to one 12-month extension period). |
• | On February 10, 2017, the Company paid off its debt in connection with one of the Company's notes payable with an outstanding principal balance of $5,645,000 at the time of repayment. The property was subsequently added to the unencumbered pool of the unsecured credit facility. |
• | On June 28, 2017, the Company paid off its debt in connection with one of the Company's notes payable with an outstanding principal balance of $5,337,000 at the time of repayment. The property was subsequently added to the unencumbered pool of the unsecured credit facility. |
• | On August 18, 2017, the Company paid off its debt in connection with one of the Company's notes payable with an outstanding principal balance of $15,162,000 at the time of repayment. The property was subsequently added to the unencumbered pool of the unsecured credit facility. |
• | During the nine months ended September 30, 2017, the Company removed a portfolio of certain healthcare properties from the unencumbered pool of the unsecured credit facility due to a tenant undergoing a restructuring of its liabilities, which decreased the Company's total unencumbered pool availability under the unsecured credit facility by approximately $58,608,000. |
• | During the nine months ended September 30, 2017, the Company added three properties to the unencumbered pool of the unsecured credit facility, which increased the Company's total unencumbered pool availability under the unsecured credit facility by approximately $21,906,000. |
• | During the nine months ended September 30, 2017, the Company made a draw of $75,000,000 on its unsecured credit facility related to repayments of matured notes payable and general corporate purposes. |
• | As of September 30, 2017, the Company had a total unencumbered pool availability under the unsecured credit facility of $475,826,000 and an aggregate outstanding principal balance of $433,000,000. As of September 30, 2017, $42,826,000 remained available to be drawn on the unsecured credit facility. |
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The principal payments due on the notes payable and unsecured credit facility for the three 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 | ||||
Three months ending December 31, 2017 | $ | 33,512 | (1) | ||
2018 | 475,269 | ||||
2019 | 170,785 | ||||
2020 | 136,160 | ||||
2021 | 1,239 | ||||
Thereafter | 67,204 | (2) | |||
$ | 884,169 | ||||
(1) | Of this amount, $30,019,000 relates to one loan agreement that was repaid on October 6, 2017 using proceeds from the unsecured credit facility. |
(2) | Of this amount, $18,441,000 relates to one loan agreement with a maturity date of October 11, 2017. On October 11, 2017, the Company extended the maturity date of this loan agreement to October 11, 2022, subject to the Company's right to two one-year extensions. |
Note 8—Related-Party Transactions and Arrangements
The Company pays the Advisor an annual asset management fee of 0.85% of the aggregate asset value plus costs and expenses incurred by the Advisor in providing asset management services. The fee is payable monthly in an amount equal to 0.07083% of the aggregate asset value as of the last day of the immediately preceding month. For the three months ended September 30, 2017 and 2016, the Company incurred $4,848,000 and $5,036,000, respectively, and for the nine months ended September 30, 2017 and 2016, the Company incurred $14,494,000 and $14,700,000, respectively, in asset management fees to the Advisor.
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. The Company will not reimburse the Advisor for personnel costs in connection with services for which the Advisor receives an acquisition and advisory fee or a disposition fee. For the three months ended September 30, 2017 and 2016, the Advisor allocated $341,000 and $511,000, respectively, and for the nine months ended September 30, 2017 and 2016, the Advisor allocated $1,294,000 and $1,368,000, respectively, in operating expenses incurred on the Company’s behalf, which are recorded in general and administrative expenses in the accompanying condensed consolidated statements of comprehensive income (loss).
The Company has no direct employees. The employees of the Advisor and other affiliates provide services to the Company related to acquisitions, property management, asset management, accounting, investor relations, and all other administrative services. If the Advisor or its affiliates provides a substantial amount of services, as determined by a majority of the Company’s independent directors, in connection with the sale of one or more assets, the Company will pay the Advisor a disposition fee equal to an amount of up to the lesser of 0.5% of the transaction price and one-half of the fees paid in the aggregate to third party investment bankers for such transaction. In no event will the combined real estate commission paid to the Advisor, its affiliates and unaffiliated third parties exceed 6.0% of the contract sales price. In addition, after investors have received a return on their net capital contributions and an 8.0% cumulative non-compounded annual return, then the Advisor is entitled to receive 15.0% of the remaining net sale proceeds, or a subordinated participation in net sale proceeds. As of September 30, 2017, the Company has not incurred a disposition fee or a subordinated participation in net sale proceeds to the Advisor or its affiliates.
Upon the listing of the Company’s common stock on a national securities exchange, the Company will pay the Advisor a subordinated incentive listing fee equal to 15.0% of the amount by which the market value of the Company’s outstanding stock plus all distributions paid by the Company prior to listing exceeds the sum of the total amount of capital raised from investors and the amount of cash flow necessary to generate an 8.0% cumulative, non-compounded annual return to investors, or a subordinated incentive listing fee. As of September 30, 2017, the Company has not incurred a subordinated incentive listing fee.
Upon termination or non-renewal of the Advisory Agreement, with or without cause, the Advisor will be entitled to receive distributions from the Operating Partnership equal to 15.0% 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 an annual 8.0% cumulative, non-compounded return to investors. In addition, the Advisor may elect to defer its right to receive a subordinated distribution upon termination until either shares of the Company’s common stock are listed and traded
15
on a national securities exchange or another liquidity event occurs. As of September 30, 2017, the Company has not incurred any subordinated distribution upon termination fees to the Advisor or its affiliates.
The Company pays Carter Validus Real Estate Management Services, LLC, or the Property Manager, leasing and property management fees for the Company’s properties. Such fees equal 3.0% of monthly gross revenues from single-tenant properties and 4.0% of monthly gross revenues from multi-tenant properties. 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 the Company’s 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 at customary market fees, the Company may pay the Property Manager an oversight fee equal to 1.0% of the gross revenues of the property managed. In no event will the Company pay the Property Manager, the Advisor or its affiliates both a property management fee and an oversight fee with respect to any particular property. The Company will pay the Property Manager a separate fee for the one-time initial rent-up, lease renewals or leasing-up of newly constructed properties. For the three months ended September 30, 2017 and 2016, the Company incurred $1,353,000 and $1,405,000, respectively, and for the nine months ended September 30, 2017 and 2016, the Company incurred $3,797,000 and $4,016,000, respectively, in property management fees to the Property Manager, which are recorded in rental and parking expenses in the accompanying condensed consolidated statements of comprehensive income (loss). For the three months ended September 30, 2017 and 2016, the Company incurred $4,000 and $861,000, respectively, and for the nine months ended September 30, 2017 and 2016, the Company incurred $281,000 and $1,138,000, respectively, in leasing commissions to the Property Manager. Leasing commissions 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 September 30, 2017 and 2016, the Company incurred $190,000 and $933,000, respectively, and for the nine months ended September 30, 2017 and 2016, the Company incurred $419,000 and $933,000, respectively, in construction management fees to the Property Manager. Construction management fees are capitalized in buildings and improvements in the accompanying condensed consolidated balance sheets.
Accounts Payable Due to Affiliates
The following amounts were due to affiliates as of September 30, 2017 and December 31, 2016 (amounts in thousands):
Entity | Fee | September 30, 2017 | December 31, 2016 | |||||||
Carter/Validus Advisors, LLC and its affiliates | Asset management fees | $ | 1,628 | $ | 1,604 | |||||
Carter Validus Real Estate Management Services, LLC | Property management fees | 665 | 791 | |||||||
Carter/Validus Advisors, LLC and its affiliates | General, administrative and other costs | 161 | 174 | |||||||
Carter Validus Real Estate Management Services, LLC | Construction management fees | 78 | 66 | |||||||
Carter Validus Real Estate Management Services, LLC | Leasing commissions | 4 | — | |||||||
$ | 2,536 | $ | 2,635 | |||||||
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Note 9—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 and nine months ended September 30, 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 and parking expenses, which excludes depreciation and amortization, general and administrative expenses, asset management fees, acquisition related expenses, change in fair value of contingent consideration, interest expense, net, provision for loan losses and other interest and dividend income. 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.
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 unsecured credit facility, real estate-related notes receivable, notes receivable and other assets not attributable to individual properties.
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Summary information for the reportable segments during the three and nine months ended September 30, 2017 and 2016, is as follows (amounts in thousands):
Data Centers | Healthcare | Three Months Ended September 30, 2017 | |||||||||
Revenue: | |||||||||||
Rental, parking and tenant reimbursement revenue | $ | 29,883 | $ | 23,857 | $ | 53,740 | |||||
Expenses: | |||||||||||
Rental and parking expenses | (5,288 | ) | (2,799 | ) | (8,087 | ) | |||||
Segment net operating income | $ | 24,595 | $ | 21,058 | 45,653 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (1,594 | ) | |||||||||
Change in fair value of contingent consideration | 1,880 | ||||||||||
Asset management fees | (4,848 | ) | |||||||||
Depreciation and amortization | (18,336 | ) | |||||||||
Income from operations | 22,755 | ||||||||||
Other income (expense): | |||||||||||
Other interest and dividend income | 497 | ||||||||||
Interest expense, net | (8,849 | ) | |||||||||
Provision for loan losses | (7,459 | ) | |||||||||
Net income | $ | 6,944 | |||||||||
Data Centers | Healthcare | Three Months Ended September 30, 2016 | |||||||||
Revenue: | |||||||||||
Rental, parking and tenant reimbursement revenue | $ | 29,487 | $ | 13,573 | $ | 43,060 | |||||
Expenses: | |||||||||||
Rental and parking expenses | (5,284 | ) | (2,088 | ) | (7,372 | ) | |||||
Segment net operating income | $ | 24,203 | $ | 11,485 | 35,688 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (1,465 | ) | |||||||||
Change in fair value of contingent consideration | (125 | ) | |||||||||
Acquisition related expenses | (5 | ) | |||||||||
Asset management fees | (5,036 | ) | |||||||||
Depreciation and amortization | (32,110 | ) | |||||||||
Loss from operations | (3,053 | ) | |||||||||
Other income (expense): | |||||||||||
Other interest and dividend income | 2,893 | ||||||||||
Interest expense, net | (9,292 | ) | |||||||||
Provision for loan losses | (42 | ) | |||||||||
Net loss | $ | (9,494 | ) | ||||||||
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Data Centers | Healthcare | Nine Months Ended September 30, 2017 | |||||||||
Revenue: | |||||||||||
Rental, parking and tenant reimbursement revenue | $ | 89,689 | $ | 71,430 | $ | 161,119 | |||||
Expenses: | |||||||||||
Rental and parking expenses | (15,301 | ) | (7,890 | ) | (23,191 | ) | |||||
Segment net operating income | $ | 74,388 | $ | 63,540 | 137,928 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (5,274 | ) | |||||||||
Change in fair value of contingent consideration | 2,920 | ||||||||||
Asset management fees | (14,494 | ) | |||||||||
Depreciation and amortization | (54,491 | ) | |||||||||
Income from operations | 66,589 | ||||||||||
Other income (expense): | |||||||||||
Other interest and dividend income | 1,551 | ||||||||||
Interest expense, net | (26,373 | ) | |||||||||
Provision for loan losses | (11,631 | ) | |||||||||
Net income | $ | 30,136 | |||||||||
Data Centers | Healthcare | Nine Months Ended September 30, 2016 | |||||||||
Revenue: | |||||||||||
Rental, parking and tenant reimbursement revenue | $ | 87,120 | $ | 71,337 | $ | 158,457 | |||||
Expenses: | |||||||||||
Rental and parking expenses | (15,043 | ) | (6,341 | ) | (21,384 | ) | |||||
Segment net operating income | $ | 72,077 | $ | 64,996 | 137,073 | ||||||
Expenses: | |||||||||||
General and administrative expenses | (4,633 | ) | |||||||||
Change in fair value of contingent consideration | (370 | ) | |||||||||
Acquisition related expenses | (1,645 | ) | |||||||||
Asset management fees | (14,700 | ) | |||||||||
Depreciation and amortization | (66,458 | ) | |||||||||
Income from operations | 49,267 | ||||||||||
Other income (expense): | |||||||||||
Other interest and dividend income | 8,572 | ||||||||||
Interest expense, net | (29,119 | ) | |||||||||
Provision for loan losses | (1,708 | ) | |||||||||
Net income | $ | 27,012 | |||||||||
Assets by each reportable segment as of September 30, 2017 and December 31, 2016 are as follows (amounts in thousands):
September 30, 2017 | December 31, 2016 | ||||||
Assets by segment: | |||||||
Data centers | $ | 1,078,368 | $ | 1,102,550 | |||
Healthcare | 1,196,143 | 1,190,087 | |||||
All other | 44,652 | 45,017 | |||||
Total assets | $ | 2,319,163 | $ | 2,337,654 | |||
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Capital additions and acquisitions by reportable segments for the nine months ended September 30, 2017 and 2016 are as follows (amounts in thousands):
Nine Months Ended September 30, | |||||||
2017 | 2016 | ||||||
Capital additions and acquisitions by segment: | |||||||
Data centers | $ | 672 | $ | 21,867 | |||
Healthcare | 19,303 | 104,229 | |||||
Total capital additions and acquisitions | $ | 19,975 | $ | 126,096 | |||
Note 10—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 lease agreements. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants.
The future minimum rent to be received from the Company’s investments in real estate assets under non-cancelable operating leases, including optional renewal periods for which exercise is reasonably assured, for the three 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 | |||
Three months ending December 31, 2017 | $ | 47,961 | ||
2018 | 194,085 | |||
2019 | 197,420 | |||
2020 | 198,447 | |||
2021 | 193,710 | |||
Thereafter | 1,482,579 | |||
$ | 2,314,202 | |||
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 three months ending December 31, 2017 and for each of the next four years ended December 31 and thereafter, are as follows (amounts in thousands):
Year | Amount | |||
Three months ending December 31, 2017 | $ | 175 | ||
2018 | 702 | |||
2019 | 746 | |||
2020 | 746 | |||
2021 | 753 | |||
Thereafter | 37,083 | |||
$ | 40,205 | |||
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Note 11—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 $103,252,000 and $116,402,000 as of September 30, 2017 and December 31, 2016, respectively, as compared to the outstanding principal of $101,918,000 and $114,783,000 as of September 30, 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 $306,605,000 and $328,512,000 as of September 30, 2017 and December 31, 2016, respectively, as compared to the outstanding principal of $308,710,000 and $330,425,000 as of September 30, 2017 and December 31, 2016, respectively.
Notes payable – Variable—The outstanding principal of the notes payable – variable was $40,541,000 and $41,604,000 as of September 30, 2017 and December 31, 2016, respectively, which approximated its fair value. The fair value of the Company's variable rate notes payable is estimated based on the interest rates currently offered to the Company by financial institutions.
Unsecured credit facility—The outstanding principal balance of the unsecured credit facility – variable was $223,000,000 and $148,000,000, which approximated its fair value, as of September 30, 2017 and December 31, 2016, respectively. The estimated fair value of the unsecured credit facility – variable rate fixed through interest rate swap agreements (Level 2) was approximately $206,455,000 and $203,055,000 as of September 30, 2017 and December 31, 2016, respectively, as compared to the outstanding principal of $210,000,000 and $210,000,000 as of September 30, 2017 and December 31, 2016, respectively.
Notes receivable—The outstanding principal balance of the notes receivable approximated the fair value as of September 30, 2017. The fair value of the Company’s notes receivable is estimated using significant unobservable inputs not based on market activity, but rather through particular valuation techniques (Level 3). The fair value was measured based on the income approach valuation methodology, which requires certain judgments to be made by management.
Contingent consideration—The Company has a contingent consideration obligation to pay a former owner in conjunction with a certain acquisition if specified future operational objectives are met over future reporting periods. Liabilities for contingent consideration are measured at fair value each reporting period, with the acquisition-date fair value included as part of the consideration transferred, and subsequent changes in fair value recorded in earnings as change in fair value of contingent consideration.
The estimated fair value of the contingent consideration was $2,720,000 and $5,640,000 as of September 30, 2017 and December 31, 2016, respectively, which is reported in the accompanying condensed consolidated balance sheets in accounts payable and other liabilities. The Company uses an income approach to value the contingent consideration liability, which is determined based on the present value of probability-weighted future cash flows. The significant inputs to the discounted cash flow model were the discount rate and weighted probability scenarios. The Company has classified the contingent consideration liability as Level 3 of the fair value hierarchy due to the lack of relevant observable market data over fair value inputs such as probability-weighting for payment outcomes.
Increases in the assessed likelihood of a high payout under a contingent consideration arrangement contributes to increases in the fair value of the related liability. Conversely, decreases in the assessed likelihood of a higher payout under a contingent consideration arrangement contributes to decreases in the fair value of the related liability. Changes in assumptions could have an impact on the payout of the contingent consideration arrangement with a maximum payout of $8,122,000 and a minimum payout of $0 as of September 30, 2017.
Derivative instruments— Considerable judgment is necessary to develop estimated fair values of financial instruments. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize, or be liable for, on disposition of the financial instruments. The Company has determined that the majority of the inputs used to value its interest rate swaps fall within Level 2 of the fair value hierarchy. The credit valuation adjustments associated with these instruments utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and the respective counterparty. However, as of September 30, 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 in its entirety is classified in Level 2 of the fair value hierarchy. See Note 12—"Derivative Instruments and Hedging Activities" for a further discussion of the Company’s derivative instruments.
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The following table shows the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016 (amounts in thousands):
September 30, 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 | $ | — | $ | 3,437 | $ | — | $ | 3,437 | |||||||
Total assets at fair value | $ | — | $ | 3,437 | $ | — | $ | 3,437 | |||||||
Liabilities: | |||||||||||||||
Derivative liabilities | $ | — | $ | (288 | ) | $ | — | $ | (288 | ) | |||||
Contingent consideration obligation | — | — | (2,720 | ) | (2,720 | ) | |||||||||
Total liabilities at fair value | $ | — | $ | (288 | ) | $ | (2,720 | ) | $ | (3,008 | ) | ||||
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 | $ | — | $ | 3,070 | $ | — | $ | 3,070 | |||||||
Total assets at fair value | $ | — | $ | 3,070 | $ | — | $ | 3,070 | |||||||
Liabilities: | |||||||||||||||
Derivative liabilities | $ | — | $ | (1,247 | ) | $ | — | $ | (1,247 | ) | |||||
Contingent consideration obligation | — | — | (5,640 | ) | (5,640 | ) | |||||||||
Total liabilities at fair value | $ | — | $ | (1,247 | ) | $ | (5,640 | ) | $ | (6,887 | ) | ||||
The following table provides a rollforward of the fair value of recurring Level 3 fair value measurements for the three and nine months ended September 30, 2017 and 2016 (amounts in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||
Liabilities: | |||||||||||||||
Contingent consideration obligation: | |||||||||||||||
Beginning balance | $ | 4,600 | $ | 5,585 | $ | 5,640 | $ | 5,340 | |||||||
Additions to contingent consideration obligation | — | — | — | — | |||||||||||
Total changes in fair value included in earnings | (1,880 | ) | 125 | (2,920 | ) | 370 | |||||||||
Ending balance | $ | 2,720 | $ | 5,710 | $ | 2,720 | $ | 5,710 | |||||||
Unrealized (gains) losses still held (1) | $ | (1,880 | ) | $ | 125 | $ | (2,920 | ) | $ | 370 | |||||
(1) | Represents the unrealized (gains) losses recorded in earnings or other comprehensive income (loss) during the period for liabilities classified as Level 3 that are still held at the end of the period. |
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Note 12—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 nine months ended September 30, 2017, such derivatives were used to hedge the variable cash flows associated with variable rate debt. The ineffective portion of changes in fair value of the derivatives is recognized directly in earnings. During the three and nine months ended September 30, 2017, no gains or losses were recognized due to ineffectiveness of hedges of interest rate risk. During the three months ended September 30, 2016, no gains or losses were recognized due to ineffectiveness of hedges of interest rate risk. During the nine months ended September 30, 2016, the Company accelerated the reclassification of amounts in other comprehensive income to earnings as a result of a hedged forecasted transaction becoming probable not to occur due to a related debt extinguishment. The accelerated amount was a loss of $728,000, which was recorded in interest expense, net in the accompanying condensed consolidated statements of comprehensive income (loss).
Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable rate debt. During the next twelve months, the Company estimates that an additional $622,000 will be reclassified from accumulated other comprehensive income as a decrease to interest expense.
See Note 11—"Fair Value" for a further discussion of the fair value of the Company’s derivative instruments.
The following table summarizes the notional amount and fair value of the Company’s derivative instruments (amounts in thousands):
Derivatives Designated as Hedging Instruments | Balance Sheet Location | Effective Dates | Maturity Dates | September 30, 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 | 10/12/2012 to 05/03/2016 | 10/11/2017 to 08/21/2020 | $ | 519,960 | $ | 3,437 | $ | (288 | ) | $ | 540,425 | $ | 3,070 | $ | (1,247 | ) | |||||||||||||
The notional amount under the agreements is an indication of the extent of the Company’s involvement in each instrument at the time, but does not represent exposure to credit, interest rate or market risks.
Accounting for changes in the fair value of a derivative instrument depends on the intended use and designation of the derivative instrument. The Company designated the interest rate swaps as cash flow hedges to hedge the variability of the anticipated cash flows on its variable rate notes payable. The change in fair value of the effective portion of the derivative instrument that is designated as a hedge is recorded in other comprehensive income (loss), or OCI, in the accompanying condensed consolidated statements of comprehensive income (loss).
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The table below summarizes the amount of income and loss recognized on interest rate derivatives designated as cash flow hedges for the three and nine months ended September 30, 2017 and 2016 (amounts in thousands):
Derivatives in Cash Flow Hedging Relationships | Amount of Income (Loss) Recognized in OCI on Derivatives (Effective Portion) | Location Of Loss 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 and Accelerated Amounts) | |||||||
Three Months Ended September 30, 2017 | ||||||||||
Interest rate swaps | $ | 150 | Interest expense, net | $ | (57 | ) | ||||
Total | $ | 150 | $ | (57 | ) | |||||
Three Months Ended September 30, 2016 | ||||||||||
Interest rate swaps | $ | 2,206 | Interest expense, net | $ | (1,082 | ) | ||||
Total | $ | 2,206 | $ | (1,082 | ) | |||||
Nine Months Ended September 30, 2017 | ||||||||||
Interest rate swaps | $ | 240 | Interest expense, net | $ | (1,086 | ) | ||||
Total | $ | 240 | $ | (1,086 | ) | |||||
Nine Months Ended September 30, 2016 | ||||||||||
Interest rate swaps | $ | (7,114 | ) | Interest expense, net | $ | (3,933 | ) | |||
Total | $ | (7,114 | ) | $ | (3,933 | ) | ||||
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 unsecured indebtedness, then the Company could also be declared in default on its derivative obligations, 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 records credit risk valuation adjustments on its interest rate swaps based on the respective credit quality of the Company and the counterparty. The Company believes it mitigates its credit risk by entering into agreements with creditworthy counterparties. As of September 30, 2017, the fair value of derivatives in a net liability position, including accrued interest but excluding any adjustment for nonperformance risk related to these agreements, was $300,000.
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Tabular Disclosure Offsetting Derivatives
The Company has elected not to offset derivative positions in its condensed consolidated financial statements. The following table presents the effect on the Company’s financial position had the Company made the election to offset its derivative positions as of September 30, 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 | ||||||||||||||||||
September 30, 2017 | $ | 3,437 | $ | — | $ | 3,437 | $ | (39 | ) | $ | — | $ | 3,398 | ||||||||||
December 31, 2016 | $ | 3,070 | $ | — | $ | 3,070 | $ | (10 | ) | $ | — | $ | 3,060 | ||||||||||
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 | ||||||||||||||||||
September 30, 2017 | $ | 288 | $ | — | $ | 288 | $ | (39 | ) | $ | — | $ | 249 | ||||||||||
December 31, 2016 | $ | 1,247 | $ | — | $ | 1,247 | $ | (10 | ) | $ | — | $ | 1,237 | ||||||||||
The Company reports derivatives in the accompanying condensed consolidated balance sheets as other assets, net and accounts payable and other liabilities.
Note 13—Accumulated Other Comprehensive Income
The following table presents a rollforward of amounts recognized in accumulated other comprehensive income (loss), net of noncontrolling interests, by component for the nine months ended September 30, 2017 and 2016 (amounts in thousands):
Unrealized Income on Derivative Instruments | Accumulated Other Comprehensive Income | ||||||
Balance as of December 31, 2016 | $ | 2,303 | $ | 1,823 | |||
Other comprehensive income before reclassification | 240 | 240 | |||||
Amount of loss reclassified from accumulated other comprehensive income to net income (effective portion) | 1,086 | 1,086 | |||||
Other comprehensive income | 1,326 | 1,326 | |||||
Balance as of September 30, 2017 | $ | 3,629 | $ | 3,149 | |||
Unrealized Loss on Derivative Instruments | Accumulated Other Comprehensive Loss | ||||||
Balance as of December 31, 2015 | $ | (2,100 | ) | $ | (2,580 | ) | |
Other comprehensive loss before reclassification | (7,114 | ) | (7,114 | ) | |||
Amount of loss reclassified from accumulated other comprehensive loss to net income (effective portion and missed forecast) | 3,933 | 3,933 | |||||
Other comprehensive loss | (3,181 | ) | (3,181 | ) | |||
Balance as of September 30, 2016 | $ | (5,281 | ) | $ | (5,761 | ) | |
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The following table presents reclassifications out of accumulated other comprehensive income (loss) for the nine months ended September 30, 2017 and 2016 (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 Condensed Consolidated Statements of Comprehensive Income (Loss) | ||||||||
Nine Months Ended September 30, | ||||||||||
2017 | 2016 | |||||||||
Interest rate swap contracts | $ | 1,086 | $ | 3,933 | Interest expense, net | |||||
Note 14—Commitments and Contingencies
Litigation
In the ordinary course of business, the Company may become subject to litigation or claims. As of September 30, 2017, there were, and currently there are, no material pending legal proceedings to which the Company is a party.
Note 15—Subsequent Events
Distributions Paid
On October 2, 2017, the Company paid aggregate distributions of $10,728,000 ($5,248,000 in cash and $5,480,000 in shares of the Company’s common stock issued pursuant to the DRIP Offering), which related to distributions declared for each day in the period from September 1, 2017 through September 30, 2017.
On November 1, 2017, the Company paid aggregate distributions of $11,070,000 ($5,432,000 in cash and $5,638,000 in shares of the Company’s common stock issued pursuant to the DRIP Offering), which related to distributions declared for each day in the period from October 1, 2017 through October 31, 2017.
Distributions Declared
On November 2, 2017, the board of directors of the Company approved and declared a distribution to the Company’s stockholders of record as of the close of business on each day of the period commencing on December 1, 2017 and ending on February 28, 2018. The distributions will be calculated based on 365 days in the calendar year and will be equal to $0.001917808 per share of common stock. The distributions declared for each record date in December 2017, January 2018 and February 2018 will be paid in January 2018, February 2018 and March 2018, respectively. The distributions will be payable to stockholders from legally available funds therefor.
Purchase and Sale Agreement - Chicago Data Center
On October 23, 2017, the Company entered into a Purchase and Sale Agreement for the sale of a 251,141 square foot data center located in the Chicago-Naperville-Elgin, Illinois-Indiana-Wisconsin MSA, or the Chicago Data Center. The sale price for the Chicago Data Center is approximately $315,000,000. The net book value of the Chicago Data Center, including intangible assets recorded upon acquisition of the property, capitalized leasing costs and straight-line rent receivable was approximately $227,300,000 at September 30, 2017. The Company currently anticipates that the consummation of the sale of the Chicago Data Center will occur in the fourth quarter of 2017; provided, however, that there can be no assurance that the closing of the Chicago Data Center will ultimately be completed.
Purchase and Sale Agreement - 14-Data Center Property Portfolio
On October 24, 2017, the Company entered into a Purchase and Sale Agreement for the sale of a 14-property data center portfolio, including one property owned through a consolidated partnership, or the Portfolio. The sale price for the Portfolio is approximately $750,000,000. The net book value of the Portfolio, including intangible assets recorded upon acquisition of the properties and straight-line rent receivable, was approximately $598,400,000 at September 30, 2017. The Company currently anticipates that the consummation of the sale of the Portfolio will occur in the fourth quarter of 2017; provided, however, that there can be no assurance that the closing of the Portfolio will ultimately be completed.
Renewal of Advisory Agreement
On November 2, 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 November 26, 2010, as amended and renewed. The renewal will be for a one-year term and will be effective as of November 26, 2017.
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Renewal of Property Management Agreement
On November 2, 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 November 12, 2010, as amended and renewed. The renewal will be for a one-year term and will be effective as of November 12, 2017.
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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 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 U.S. Securities and Exchange Commission, or the SEC, on March 30, 2017, or the 2016 Annual Report on Form 10-K.
The terms “we,” “our,” "us" and the “Company” refer to Carter Validus Mission Critical REIT, Inc., Carter/Validus Operating Partnership, LP, all majority-owned subsidiaries and controlled 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. 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 accounting principles generally accepted 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 December 16, 2009 under the laws of Maryland to acquire and operate a diversified portfolio of income-producing commercial real estate in the data center and healthcare sectors. We may also invest in real estate-related investments that relate to such property types. We qualified and elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code, for federal income tax purposes.
We ceased offering shares of common stock in our initial public offering of up to $1,746,875,000 in shares of common stock, or our Offering, on June 6, 2014. Upon completion of our Offering, we raised gross proceeds of approximately $1,716,046,000 (including shares of common stock issued pursuant to our distribution reinvestment plan, or the DRIP).
On April 14, 2014, we registered 10,526,315 shares of common stock in the First DRIP Offering for a price per share of $9.50 for a proposed maximum offering price of $100,000,000 in shares of common stock under the DRIP pursuant to a registration statement on Form S-3. On November 25, 2015, we ceased offering shares of common stock pursuant to our First DRIP Offering and registered an additional 10,473,946 shares of common stock in the Second DRIP Offering for a price per share of $9.5475, which was the greater of (i) 95% of the fair market value per share as determined by our board of directors as of September 30, 2015 and (ii) $9.50 per share, for a proposed maximum offering price of $100,000,000 in shares of common stock under the DRIP pursuant to a new registration statement on Form S-3. On May 22, 2017, we ceased offering shares of common stock pursuant to our Second DRIP Offering and registered an additional 11,387,512 shares of common stock in the Third DRIP Offering for a price per share of $9.519, which was the greater of (i) 95% of the fair market value per share as determined by our board of directors as of September 30, 2016 and (ii) $9.50 per share, for a proposed maximum offering price of $108,397,727 in shares of common stock under the DRIP pursuant to a new registration statement on Form S-3.
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We will continue to issue shares of common stock under the Third DRIP Offering until such time as we sell all of the shares registered for sale under the Third DRIP Offering, unless we file a new registration statement with the SEC or the Third DRIP Offering is terminated by our board of directors.
We refer to the First DRIP Offering, Second DRIP Offering and Third DRIP Offering collectively as the "DRIP Offerings," and together with our Offering, our "Offerings." As of September 30, 2017, we had issued approximately 195,087,000 shares of common stock in our Offerings for gross proceeds of $1,930,203,000, before share repurchases of $87,060,000 and offering costs, selling commissions and dealer manager fees of $174,842,000.
On November 16, 2015, our board of directors, at the recommendation of the audit committee of the board, or the Audit Committee, which is comprised solely of independent directors, established an estimated net asset value, "NAV", per share of our common stock, or the "Estimated Per Share NAV", calculated as of September 30, 2015, of $10.05 for purposes of assisting broker-dealers that participated in our Offering in meeting their customer account statement reporting obligations under the National Association of Securities Dealers Conduct, or NASD, Rule 2340. On November 28, 2016, our board of directors, at the recommendation of the Audit Committee, established an updated Estimated Per Share NAV, calculated as of September 30, 2016, of $10.02 for purposes of assisting broker-dealers that participated in our Offering in meeting their customer account statement reporting obligations under NASD Rule 2340. We intend to publish an updated Estimated Per Share NAV on at least an annual basis. Each Estimated Per Share NAV was determined by our board of directors after consultation with Carter/Validus Advisors, LLC, or our Advisor, and an independent third-party valuation firm.
Substantially all of our operations are conducted through Carter/Validus Operating Partnership, LP, or our Operating Partnership. We are externally advised by our Advisor pursuant to an advisory agreement between us and our Advisor, which is our affiliate. 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 Investment Management Company, LLC, or our Sponsor. We have no paid employees and rely upon our Advisor to provide substantially all of our services.
Carter Validus Real Estate Management Services, 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 our acquisition and operational stages and our Advisor may be eligible to receive fees during the liquidation stage of the Company.
We currently operate through two reportable segments – commercial real estate investments in data centers and healthcare. As of September 30, 2017, we had completed acquisitions of 49 real estate investments (including one real estate investment owned through a consolidated partnership) consisting of 84 properties, comprised of 95 buildings and parking facilities and approximately 6,222,000 square feet of gross rentable area (excluding parking facilities), for an aggregate purchase price of $2,189,062,000.
On October 23, 2017, we entered into a Purchase and Sale Agreement for the sale of a 251,141 square foot data center located in the Chicago-Naperville-Elgin, Illinois-Indiana-Wisconsin metropolitan statistical area, or the Chicago Data Center. The sale price for the Chicago Data Center is approximately $315,000,000. In addition, on October 24, 2017, we entered into a Purchase and Sale Agreement for the sale of a 14-property data center portfolio, including one property owned through a consolidated partnership, or the Portfolio. The gross sale price for the Portfolio is approximately $750,000,000. We currently anticipate that the consummation of the sale of the Chicago Data Center and the Portfolio will occur in the fourth quarter of 2017; provided, however, that there can be no assurance that the closings of the Chicago Data Center and the Portfolio will ultimately be completed.
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
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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, or the IRS, 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
We report our financial performance based on two reporting segments—commercial real estate investments in data centers and healthcare. See Note 9—"Segment Reporting" to the condensed consolidated financial statements 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 September 30, 2017 and 2016:
September 30, | |||||
2017 | 2016 | ||||
Number of commercial operating properties (1) | 84 | 83 | |||
Leased rentable square feet | 5,875,000 | 6,048,000 | |||
Weighted average percentage of rentable square feet leased | 94 | % | 98 | % | |
(1) | As of September 30, 2017, we owned 84 real estate properties, one of which was vacated by the tenant on June 2, 2017 and remains unoccupied. Currently, we are seeking to re-lease the space. As of September 30, 2016, we owned 84 real estate properties, one of which was under construction. |
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The following table summarizes our real estate properties' activity for the three and nine months ended September 30, 2017 and 2016:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||
Commercial operating properties acquired | — | — | — | 5 | |||||||||||
Commercial operating properties placed in service | — | — | 1 | — | |||||||||||
Approximate aggregate purchase price of operating properties acquired | $ | — | $ | — | $ | — | $ | 71,000,000 | |||||||
Approximate aggregate cost of property placed in service | $ | — | $ | — | $ | 19,466,000 | $ | — | |||||||
Leased rentable square feet of operating properties acquired | — | — | — | 158,000 | |||||||||||
Leased rentable square feet of property placed in service | — | — | 34,000 | — | |||||||||||
The following discussion is based on our condensed consolidated financial statements for the three and nine months ended September 30, 2017 and 2016.
These sections describe and compare our results of operations for the three and nine months ended September 30, 2017 and 2016. We generate almost all of our net operating income from property operations. In order to evaluate our overall portfolio, we analyze 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 excludes 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.
Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016
Changes in our revenues are summarized in the following table (amounts in thousands):
Three Months Ended September 30, | |||||||||||
2017 | 2016 | Change | |||||||||
Same store rental and parking revenue | $ | 48,754 | $ | 38,062 | $ | 10,692 | |||||
Non-same store rental and parking revenue | 345 | — | 345 | ||||||||
Same store tenant reimbursement revenue | 4,339 | 4,916 | (577 | ) | |||||||
Non-same store tenant reimbursement revenue | 108 | — | 108 | ||||||||
Other operating income | 194 | 82 | 112 | ||||||||
Total revenue | $ | 53,740 | $ | 43,060 | $ | 10,680 | |||||
• | Same store rental and parking revenue increased primarily due to a decrease in bad debt expense related to delinquent accounts receivable recorded in the amount of $3.4 million during the three months ended September 30, 2017, as compared to $16.3 million during the three months ended September 30, 2016. In addition, there was an increase in contractual rental revenue resulting from average annual rent escalations of 3.29% at our same store properties, which was offset entirely by straight-line rental revenue. |
• | Non-same store rental and parking revenue increased primarily as a result of one property placed in service since July 1, 2016. |
• | Same store tenant reimbursement revenue decreased primarily due to bad debt expense recorded in the amount of $0.4 million during the three months ended September 30, 2017. |
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Changes in our expenses are summarized in the following table (amounts in thousands):
Three Months Ended September 30, | |||||||||||
2017 | 2016 | Change | |||||||||
Same store rental and parking expenses | $ | 7,925 | $ | 7,332 | $ | 593 | |||||
Non-same store rental and parking expenses | 162 | 40 | 122 | ||||||||
General and administrative expenses | 1,594 | 1,465 | 129 | ||||||||
Change in fair value of contingent consideration | (1,880 | ) | 125 | (2,005 | ) | ||||||
Acquisition related expenses | — | 5 | (5 | ) | |||||||
Asset management fees | 4,848 | 5,036 | (188 | ) | |||||||
Depreciation and amortization | 18,336 | 32,110 | (13,774 | ) | |||||||
Total expenses | $ | 30,985 | $ | 46,113 | $ | (15,128 | ) | ||||
• | Same store rental and parking expenses increased primarily due to an increase in real estate taxes and repair and maintenance costs. |
• | General and administrative expenses increased primarily due to an increase in professional fees related to strategic advice. |
• | The decrease in fair value of contingent consideration is due to a change in management's assessment of incurring a lower payout under the contingent consideration arrangement. |
• | Asset management fees decreased primarily due to the redemption of the preferred equity investment on October 4, 2016. |
• | Depreciation and amortization decreased primarily due to the acceleration of amortization of an in-place lease intangible in the amount of $14.6 million during the three months ended September 30, 2016, which was the result of one tenant experiencing financial difficulties, partially offset by an increase in the weighted average depreciable basis of real estate investments. |
Changes in other income (expense) are summarized in the following table (amounts in thousands):
Three Months Ended September 30, | |||||||||||
2017 | 2016 | Change | |||||||||
Other interest and dividend income: | |||||||||||
Cash deposits interest | $ | 22 | $ | 10 | $ | 12 | |||||
Dividends on preferred equity investment | — | 2,461 | (2,461 | ) | |||||||
Notes receivable interest and other income | 459 | 407 | 52 | ||||||||
Real estate-related notes receivable interest income | 16 | 15 | 1 | ||||||||
Total other interest and dividend income | 497 | 2,893 | (2,396 | ) | |||||||
Interest expense, net: | |||||||||||
Interest on notes payable | (5,565 | ) | (5,949 | ) | 384 | ||||||
Interest on unsecured credit facility | (3,393 | ) | (3,216 | ) | (177 | ) | |||||
Amortization of deferred financing costs | (934 | ) | (1,146 | ) | 212 | ||||||
Capitalized interest | 1,058 | 1,019 | 39 | ||||||||
Loss on debt extinguishment | (15 | ) | — | (15 | ) | ||||||
Total interest expense, net | (8,849 | ) | (9,292 | ) | 443 | ||||||
Provision for loan losses | (7,459 | ) | (42 | ) | (7,417 | ) | |||||
Total other expense | $ | (15,811 | ) | $ | (6,441 | ) | $ | (9,370 | ) | ||
• | Dividends on preferred equity investment decreased due to the redemption of the preferred equity investment on October 4, 2016. |
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• | Interest on notes payable decreased due to the payoff of three notes payable during 2017 in the amount of $26.1 million and the payoff of two notes payable during the year ended December 31, 2016 in the aggregate amount of $44.7 million. The outstanding principal balance on notes payable was $451.2 million as of September 30, 2017, as compared to $489.7 million as of September 30, 2016. |
• | Provision for loan losses increased due to $7.5 million recorded in bad debt expense on notes receivable and accrued interest related to one tenant during the three months ended September 30, 2017, as compared to $0.01 million recorded in bad debt expense related to one note receivable and accrued interest during the three months ended September 30, 2016. |
Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016
Changes in our revenues are summarized in the following table (amounts in thousands):
Nine Months Ended September 30, | |||||||||||
2017 | 2016 | Change | |||||||||
Same store rental and parking revenue | $ | 140,573 | $ | 141,400 | $ | (827 | ) | ||||
Non-same store rental and parking revenue | 6,798 | 2,786 | 4,012 | ||||||||
Same store tenant reimbursement revenue | 12,979 | 14,007 | (1,028 | ) | |||||||
Non-same store tenant reimbursement revenue | 285 | 4 | 281 | ||||||||
Other operating income | 484 | 260 | 224 | ||||||||
Total revenue | $ | 161,119 | $ | 158,457 | $ | 2,662 | |||||
• | Same store rental and parking revenue decreased primarily due to bad debt expense related to delinquent accounts receivable recorded in the amount of $11.2 million during the nine months ended September 30, 2017, as compared to $15.7 million during the nine months ended September 30, 2016, partially offset by an increase in contractual rental revenue due to lease amendments during the nine months ended September 30, 2017. |
• | Non-same store rental and parking revenue increased primarily as a result of the acquisition of five properties and one property placed in service since January 1, 2016. |
• | Same store tenant reimbursement revenue decreased primarily due to an increase in bad debt expense recorded in the amount of $1.9 million during the nine months ended September 30, 2017, as compared to $0.3 million during the nine months ended September 30, 2016. |
Changes in our expenses are summarized in the following table (amounts in thousands):
Nine Months Ended September 30, | |||||||||||
2017 | 2016 | Change | |||||||||
Same store rental and parking expenses | $ | 22,490 | $ | 21,166 | $ | 1,324 | |||||
Non-same store rental and parking expenses | 701 | 218 | 483 | ||||||||
General and administrative expenses | 5,274 | 4,633 | 641 | ||||||||
Change in fair value of contingent consideration | (2,920 | ) | 370 | (3,290 | ) | ||||||
Acquisition related expenses | — | 1,645 | (1,645 | ) | |||||||
Asset management fees | 14,494 | 14,700 | (206 | ) | |||||||
Depreciation and amortization | 54,491 | 66,458 | (11,967 | ) | |||||||
Total expenses | $ | 94,530 | $ | 109,190 | $ | (14,660 | ) | ||||
• | Non-same store rental and parking expenses increased primarily due to the acquisition of five properties and one property placed in service since January 1, 2016. |
• | General and administrative expenses increased primarily due to an increase in professional fees related to strategic advice. |
• | The decrease in fair value of contingent consideration is due to a change in management's assessment of incurring a lower payout under the contingent consideration arrangement. |
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• | Acquisition related expense decreased because during the nine months ended September 30, 2016, we acquired a five property portfolio that we accounted for as a business combination for an aggregate purchase price of $71.0 million. We did not acquire any properties during the nine months ended September 30, 2017. |
• | Asset management fees decreased primarily due to the redemption of the preferred equity investment on October 4, 2016. |
• | Depreciation and amortization decreased primarily due to the acceleration of amortization of an in-place lease intangible in the amount of $14.6 million during the nine months ended September 30, 2016, which was the result of one tenant experiencing financial difficulties, partially offset by an increase in the weighted average depreciable basis of real estate investments. |
Changes in other income (expense) are summarized in the following table (amounts in thousands):
Nine Months Ended September 30, | |||||||||||
2017 | 2016 | Change | |||||||||
Other interest and dividend income: | |||||||||||
Cash deposits interest | $ | 54 | $ | 36 | $ | 18 | |||||
Dividends on preferred equity investment | — | 7,383 | (7,383 | ) | |||||||
Notes receivable interest and other income | 1,450 | 1,107 | 343 | ||||||||
Real estate-related notes receivable interest income | 47 | 46 | 1 | ||||||||
Total other interest and dividend income | 1,551 | 8,572 | (7,021 | ) | |||||||
Interest expense, net: | |||||||||||
Interest on notes payable | (16,766 | ) | (18,347 | ) | 1,581 | ||||||
Interest on unsecured credit facility | (9,493 | ) | (8,034 | ) | (1,459 | ) | |||||
Amortization of deferred financing costs | (2,893 | ) | (3,425 | ) | 532 | ||||||
Capitalized interest | 2,794 | 1,820 | 974 | ||||||||
Loss on debt extinguishment | (15 | ) | (1,133 | ) | 1,118 | ||||||
Total interest expense, net | (26,373 | ) | (29,119 | ) | 2,746 | ||||||
Provision for loan losses | (11,631 | ) | (1,708 | ) | (9,923 | ) | |||||
Total other expense | $ | (36,453 | ) | $ | (22,255 | ) | $ | (14,198 | ) | ||
• | Dividends on preferred equity investment decreased due to the redemption of the preferred equity investment on October 4, 2016. |
• | Notes receivable interest and other income increased due to an increase in the weighted average outstanding principal balance of our notes receivable. The weighted average outstanding principal balance of our notes receivable was $17.6 million for the nine months ended September 30, 2017, as compared to $15.5 million for the nine months ended September 30, 2016. |
• | Interest on notes payable decreased due to the payoff of three notes payable during 2017 in the amount of $26.1 million and the payoff of two notes payable during the year ended December 31, 2016 in the aggregate amount of $44.7 million. The outstanding principal balance on notes payable was $451.2 million as of September 30, 2017, as compared to $489.7 million as of September 30, 2016. |
• | Interest on unsecured credit facility increased primarily due to an increase in the variable interest rate on the revolving line of credit portion of our unsecured credit facility, coupled with an increase in the weighted average outstanding principal balance on our unsecured credit facility. The weighted average outstanding principal balance of our unsecured credit facility was $389.7 million for the nine months ended September 30, 2017, as compared to $378.3 million for the nine months ended September 30, 2016. |
• | Capitalized interest increased due to an increase in the average accumulated expenditures on development properties to $56.2 million for the nine months ended September 30, 2017, as compared to $37.1 million for the nine months ended September 30, 2016. |
• | Provision for loan losses increased due to $11.6 million recorded in bad debt expense on notes receivable and accrued interest related to two tenants during the nine months ended September 30, 2017, as compared to $1.7 million recorded |
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in bad debt expense related to one note receivable and accrued interest during the nine months ended September 30, 2016.
Organization and Offering Costs
Prior to the termination of our Offering on June 6, 2014, we reimbursed our Advisor or its affiliates for organization and offering costs it incurred on our behalf, but only to the extent the reimbursement did not cause the selling commissions, dealer manager fees and the other organization and offering costs incurred by us to exceed 15% of gross offering proceeds as of the date of the reimbursement. Since inception and through the termination of our Offering on June 6, 2014, we paid approximately $156,519,000 in selling commissions and dealer manager fees to SC Distributors, LLC, or our Dealer Manager, which is an affiliate of our Advisor, and we reimbursed our Advisor or its affiliates approximately $14,207,000 in offering expenses, and incurred approximately $3,900,000 of other organization and offering costs, which totaled approximately $174,626,000, or 10.2% of total gross offering proceeds, which were approximately $1,716,046,000.
Subsequent to the termination of our Offering and as of September 30, 2017, we had incurred approximately $216,000 in other offering costs related to the DRIP Offerings.
Other organization costs were expensed as incurred and selling commissions and dealer manager fees were charged to stockholders’ equity as the amounts related to raising capital. For a further discussion of other organization and offering costs, see Note 8—"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 capital expenditures, operating expenses, distributions to and repurchases from stockholders and principal and interest on any current and any future indebtedness. Generally, cash needs for these items are generated from operations of our current and future investments. We may utilize funds equal to amounts reinvested in the DRIP Offerings and future proceeds from secured and unsecured financings to selectively acquire additional real estate properties and real estate-related investments. The sources of our operating cash flows will be primarily provided by the rental income received from current and future tenants of our leased properties.
We are required by the terms of applicable loan documents to meet certain financial covenants, such as coverage ratios and reporting requirements. In addition, certain loan agreements include cross-default provisions to financial covenants in lease agreements with our tenants so that a default in the financial covenant in the lease agreement is a default in our loan. We were in compliance with all financial covenant requirements as of September 30, 2017.
In the event we are not in compliance with these covenants in future periods and are unable to obtain a consent or waiver, the lender may choose to pursue remedies under the respective loan agreements, which could include, at the lender's discretion, declaring the loans to be immediately due and payable and payment of termination fees and costs incurred by the lender, among other potential remedies.
Short-term Liquidity and Capital Resources
On a short-term basis, our principal demands for funds will be for the payments of tenant improvements, operating expenses, distributions to and repurchases from stockholders, 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, borrowings on our unsecured credit facility, and secured and unsecured borrowings from banks and other lenders to finance our expected future acquisitions.
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Long-term Liquidity and Capital Resources
On a long-term basis, our principal demands for funds will be for the payments of tenant improvements, operating expenses, distributions to and repurchases from 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 our unsecured credit facility and proceeds from secured or unsecured borrowings from banks or other lenders.
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, funds equal to amounts reinvested in the DRIP Offerings, borrowing on our unsecured credit facility and/or future borrowings on unencumbered assets. To the extent cash flows from operations are lower due to lower-than-expected returns on the properties held, our distributions paid to stockholders may be lower. We expect that substantially all net cash flows from our Offerings 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 $4.8 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 September 30, 2017, we had $2.5 million of restricted cash in lender-controlled escrow reserve accounts for such capital expenditures. In addition, as of September 30, 2017, we had approximately $42.6 million in cash and cash equivalents. For the nine months ended September 30, 2017, we had capital expenditures of $20.0 million that primarily related to three healthcare real estate investments.
Unsecured Credit Facility
The proceeds of loans made under the unsecured 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. As of September 30, 2017, we had a total unencumbered pool availability under the unsecured credit facility of $475,826,000 and an aggregate outstanding principal balance of $433,000,000. As of September 30, 2017, $42,826,000 remained available to be drawn under the unsecured credit facility.
Cash Flows
Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016
Nine Months Ended September 30, | |||||||||||
(in thousands) | 2017 | 2016 | Change | ||||||||
Net cash provided by operating activities | $ | 87,940 | $ | 86,979 | $ | 961 | |||||
Net cash used in investing activities | $ | (32,975 | ) | $ | (129,665 | ) | $ | (96,690 | ) | ||
Net cash (used in) provided by financing activities | $ | (51,702 | ) | $ | 57,950 | $ | (109,652 | ) | |||
Operating Activities
• | Net cash provided by operating activities increased primarily due to annual rent increases at our same store properties, lease amendments and the acquisition of five operating properties and placing one property in service subsequent to September 30, 2016, partially offset by increased operating expenses. |
Investing Activities
• | Net cash used in investing activities decreased due to a decrease in investments in real estate of $71.0 million and a decrease in capital expenditures of $35.1 million, offset by a decrease in real estate deposits, net of $0.5 million and an increase in notes receivable, net of $8.9 million. |
Financing Activities
• | Net cash used in financing activities increased due to an increase in payments of deferred financing costs of $1.2 million related to the extension of the maturity date of the revolving line of credit portion of the credit facility, an increase in repurchases of our common stock of $13.1 million, an increase in distributions to common stockholders of $2.3 million, an increase in distributions to noncontrolling interests of $0.6 million, an increase in purchase of noncontrolling interests of $0.5 million and a decrease in proceeds from our unsecured credit facility of $110.0 million, offset by a decrease in payments on notes payable of $18.0 million. |
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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 funds available for distribution, financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our qualification as a REIT under the Code. To the extent that funds are available, we intend to continue to pay monthly distributions to stockholders. 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 assured. 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 funds equal to amounts reinvested in the DRIP Offerings, which may reduce the amount of capital we ultimately invest in properties or other permitted investments.
We have funded distributions with operating cash flows from our properties, funds equal to amounts reinvested in the DRIP Offerings and offering proceeds raised in our Offering. 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 the sources of distributions paid during the nine months ended September 30, 2017 and 2016:
Nine Months Ended September 30, | |||||||||||||
2017 | 2016 | ||||||||||||
Distributions paid in cash - common stockholders | $ | 47,128,000 | $ | 44,816,000 | |||||||||
Distributions reinvested | 50,435,000 | 51,227,000 | |||||||||||
Total distributions | $ | 97,563,000 | $ | 96,043,000 | |||||||||
Source of distributions: | |||||||||||||
Cash flows provided by operations (1) | $ | 47,128,000 | 48 | % | $ | 44,816,000 | 47 | % | |||||
Offering proceeds from issuance of common stock pursuant to the DRIP (1) | 50,435,000 | 52 | % | 51,227,000 | 53 | % | |||||||
Total sources | $ | 97,563,000 | 100 | % | $ | 96,043,000 | 100 | % | |||||
(1) | Percentages were calculated by dividing the respective source amount by the total sources of distributions. |
Total distributions declared but not paid as of September 30, 2017 were $10.7 million for common stockholders. These distributions were paid on October 2, 2017.
For the nine months ended September 30, 2017, we declared and paid distributions of approximately $97.5 million to common stockholders including shares issued pursuant to the DRIP Offerings, as compared to FFO (as defined below) for the nine months ended September 30, 2017 of $79.4 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 September 30, 2017, see Note 15—"Subsequent Events" to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
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Contractual Obligations
As of September 30, 2017, we had approximately $884,169,000 of principal debt outstanding, of which $451,169,000 related to notes payable and $433,000,000 related to the unsecured credit facility. See Note 7—"Notes Payable and Unsecured 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 September 30, 2017 were as follows (amounts in thousands):
Payments due by period | ||||||||||||||||||||
Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | Total | ||||||||||||||||
Principal payments — fixed rate debt | $ | 43,670 | $ | 7,945 | $ | 50,303 | $ | — | $ | 101,918 | (5) | |||||||||
Interest payments — fixed rate debt | 3,997 | 6,183 | 3,988 | — | 14,168 | |||||||||||||||
Principal payments — variable rate debt fixed through interest rate swap agreements (1) | 185,780 | (6),(9) | 314,489 | (9) | — | 18,441 | (10) | 518,710 | (7) | |||||||||||
Interest payments — variable rate debt fixed through interest rate swap agreements (2) | 18,169 | 12,787 | — | 95 | 31,051 | |||||||||||||||
Principal payments — variable rate debt | 224,377 | (8),(9) | 39,164 | — | — | 263,541 | ||||||||||||||
Interest payments — variable rate debt (3) | 6,915 | 1,366 | — | — | 8,281 | |||||||||||||||
Contingent consideration (4) | — | 2,720 | — | — | 2,720 | |||||||||||||||
Notes receivable to be funded | 2,500 | — | — | — | 2,500 | |||||||||||||||
Capital expenditures | 4,785 | 2,641 | — | — | 7,426 | |||||||||||||||
Ground lease payments | 726 | 1,537 | 1,563 | 36,706 | 40,532 | |||||||||||||||
Total | $ | 490,919 | $ | 388,832 | $ | 55,854 | $ | 55,242 | $ | 990,847 | ||||||||||
(1) | As of September 30, 2017, we had $518.7 million outstanding principal on notes payable and borrowings under the unsecured 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 September 30, 2017 to calculate the debt payment obligations in future periods. |
(3) | We used the London Interbank Offered Rate, or LIBOR, plus the applicable margin under our variable rate debt agreements as of September 30, 2017 to calculate the debt payment obligations in future periods. |
(4) | Contingent consideration represents our best estimate of the cash payments we will be obligated to make under contingent consideration arrangements with a former owner of a property we acquired if specified objectives are achieved by the acquired entity. Changes in assumptions could have an impact on the payout of contingent consideration arrangements with a maximum payout of $8.1 million in cash and a minimum payout of $0 as of September 30, 2017. |
(5) | Of this amount, $30.0 million relates to one loan agreement that was repaid on October 6, 2017 using proceeds from the unsecured credit facility. In addition, $53.6 million relates to properties that are currently under contract to be sold and may be repaid prior to maturity with sale proceeds. |
(6) | Of this amount, $75.0 million relates to the term loan portion of the unsecured credit facility with a maturity date of May 28, 2018, subject to our right to a 12-month extension. In addition, $104.6 million relates to a loan agreement that is secured by a property and currently under contract to be sold and may be repaid prior to maturity with sale proceeds. |
(7) | Of this amount, $120.2 million relates to properties currently under contract to be sold and may be repaid prior to maturity with sale proceeds. |
(8) | Of this amount, $223.0 million relates to the revolving line of credit under the unsecured credit facility with a maturity date of May 28, 2018, subject to our right to two 12-month extensions. |
(9) | As of September 30, 2017, we had a total unencumbered pool availability under the unsecured credit facility of $475.8 million, an aggregate outstanding principal balance of $433.0 million and $42.8 million remained available to be drawn on the unsecured credit facility. As of September 30, 2017, $126.2 million of the total unencumbered pool availability under the unsecured credit facility related to properties that are currently under contract to be sold. |
(10) | Of this amount, $18.4 million relates to one loan agreement with a maturity date of October 11, 2017. On October 11, 2017, the Company extended the maturity date of this loan agreement to October 11, 2022, subject to the Company's right to two one-year extensions. |
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Off-Balance Sheet Arrangements
As of September 30, 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 8—"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 their 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. 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
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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 cash flows from operations and debt financings 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 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 (loss), amortization of above and below-market leases, adjustments related to contingent purchase price obligations, gains or losses from the extinguishment of debt and hedges, 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 the adjustments of such items related to noncontrolling interests in our Operating Partnership. 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 (loss) and acquisition fees and expenses associated with transactions determined to be an asset purchase are capitalized.
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
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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, MFFO 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 and nine months ended September 30, 2017 and 2016 (amounts in thousands, except share data and per share amounts):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||||
Net income (loss) attributable to common stockholders | $ | 6,046 | $ | (10,500 | ) | $ | 27,118 | $ | 24,017 | |||||||
Adjustments: | ||||||||||||||||
Depreciation and amortization | 18,336 | 32,110 | 54,491 | 66,458 | ||||||||||||
Noncontrolling interests’ share of the above adjustments related to the consolidated partnerships | (719 | ) | (704 | ) | (2,172 | ) | (2,207 | ) | ||||||||
FFO attributable to common stockholders | $ | 23,663 | $ | 20,906 | $ | 79,437 | $ | 88,268 | ||||||||
Adjustments: | ||||||||||||||||
Acquisition related expenses (1) | $ | — | $ | 5 | $ | — | $ | 1,645 | ||||||||
Amortization of intangible assets and liabilities (2) | (781 | ) | (800 | ) | (2,334 | ) | (2,518 | ) | ||||||||
Change in fair value of contingent consideration | (1,880 | ) | 125 | (2,920 | ) | 370 | ||||||||||
Straight-line rent (3) | (2,324 | ) | 8,972 | (10,111 | ) | (3,717 | ) | |||||||||
Loss on debt extinguishment | 15 | — | 15 | 1,133 | ||||||||||||
Noncontrolling interests’ share of the above adjustments related to the consolidated partnerships | 446 | (4) | 33 | (5) | 849 | (6) | 708 | (7) | ||||||||
MFFO attributable to common stockholders | $ | 19,139 | $ | 29,241 | $ | 64,936 | $ | 85,889 | ||||||||
Weighted average common shares outstanding - basic for net income (loss) and FFO | 186,295,970 | 183,726,479 | 185,834,940 | 182,827,193 | ||||||||||||
Weighted average common shares outstanding - diluted for net income (loss) | 186,312,758 | 183,726,479 | 185,853,976 | 182,846,104 | ||||||||||||
Weighted average common shares outstanding - diluted for FFO | 186,312,758 | 183,743,239 | 185,853,976 | 182,846,104 | ||||||||||||
Net income (loss) per common share - basic | $ | 0.03 | $ | (0.06 | ) | $ | 0.15 | $ | 0.13 | |||||||
Net income (loss) per common share - diluted | $ | 0.03 | $ | (0.06 | ) | $ | 0.15 | $ | 0.13 | |||||||
FFO per common share - basic | $ | 0.13 | $ | 0.11 | $ | 0.43 | $ | 0.48 | ||||||||
FFO per common share - diluted | $ | 0.13 | $ | 0.11 | $ | 0.43 | $ | 0.48 | ||||||||
(1) | In evaluating investments in real estate assets, management differentiates the costs to acquire the investment from the operations derived from the investment. Such information would be comparable only for publicly registered, non-listed REITs that have completed their acquisitions activities and have other similar operating characteristics. By excluding expensed acquisition related expenses, management believes MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management’s analysis of the investing and operating performance of our properties. Acquisition fees and expenses include payments in cash to our Advisor and third parties. Acquisition fees and expenses incurred in a business combination, under GAAP, are considered operating expenses and as expenses are included in the determination of net income, which is a performance measure under GAAP. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to the property. |
(2) | Under GAAP, certain intangibles are accounted for at cost and reviewed at least annually for impairment, and certain intangibles are assumed to diminish predictably in value over time and are amortized, similar to depreciation and amortization of real estate-related assets that are excluded from FFO. However, because real estate values and market lease rates historically rise or fall with market conditions, management believes that by excluding charges related to amortization of these intangibles, MFFO provides useful supplemental information on the performance of the real estate. |
(3) | Under GAAP, rental revenue is recognized on a straight-line basis over the terms of the related lease (including rent holidays if applicable). This may result in income recognition that is significantly different than the underlying contract terms. By adjusting for the change in deferred rent receivables, MFFO may provide useful supplemental information on |
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the realized economic impact of lease terms, providing insight on the expected contractual cash flows of such lease terms, and aligns with our analysis of operating performance.
(4) | Of this amount, $254,000 related to straight-line rents and $192,000 related to above- and below-market leases. |
(5) | Of this amount, $(167,000) related to straight-line rents and $200,000 related to above- and below-market leases. |
(6) | Of this amount, $273,000 related to straight-line rents and $576,000 related to above- and below-market leases. |
(7) | Of this amount, $25,000 related to straight-line rents and $683,000 related to above- and below-market leases. |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. In pursuing our business plan, the primary market risk to which we are exposed is interest rate risk.
We have obtained variable rate debt financing to fund certain property acquisitions, and we are exposed to changes in the one-month LIBOR. Our objectives in managing interest rate risk seek to limit the impact of interest rate changes on operations and cash flows, and to lower overall borrowing costs. To achieve these objectives, we will borrow primarily at interest rates with the lowest margins available and, in some cases, with the ability to convert variable interest rates to fixed rates.
We have entered, and may continue to enter, into derivative financial instruments, such as interest rate swaps, in order to mitigate our interest rate risk on a given variable rate financial instrument. To the extent we do, we are exposed to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative contract is negative, we owe the counterparty and, therefore, it does not possess credit risk. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We manage the market risk associated with interest rate contracts by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. We have not entered, and do not intend to enter, into derivative or interest rate transactions for speculative purposes. We may also enter into rate-lock arrangements to lock interest rates on future borrowings.
In addition to changes in interest rates, the value of our future investments will be subject to fluctuations based on changes in local and regional economic conditions and changes in the creditworthiness of tenants, which may affect our ability to refinance our debt, if necessary.
The following table summarizes our principal debt outstanding as of September 30, 2017 (amounts in thousands):
September 30, 2017 | |||
Notes payable: | |||
Fixed rate notes payable | $ | 101,918 | |
Variable rate notes payable fixed through interest rate swaps | 308,710 | ||
Variable rate notes payable | 40,541 | ||
Total notes payable | 451,169 | ||
Unsecured credit facility: | |||
Variable rate unsecured credit facility fixed through interest rate swaps | 210,000 | ||
Variable rate unsecured credit facility | 223,000 | ||
Total unsecured credit facility | 433,000 | ||
Total principal debt outstanding (1) | $ | 884,169 | |
(1) | As of September 30, 2017, the weighted average interest rate on our total debt outstanding was 3.9%. |
As of September 30, 2017, $263.5 million of the $884.2 million total principal debt outstanding was subject to variable interest rates with a weighted average interest rate of 3.5% per annum. As of September 30, 2017, an increase of 50 basis points in the market rates of interest would have resulted in a change in interest expense of $1.3 million per year.
As of September 30, 2017, we had 17 interest rate swap agreements outstanding, which mature on various dates from October 2017 through August 2020, with an aggregate notional amount under the swap agreements of $520.0 million and an aggregate settlement asset value of $3.1 million. The settlement value of these interest rate swap agreements is dependent upon existing market interest rates and swap spreads. As of September 30, 2017, an increase of 50 basis points in the market rates of interest would have resulted in an increase to the settlement asset value of these interest rate swaps to $7.2 million. These interest rate swaps were designated as hedging instruments.
We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.
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Item 4. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs.
As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q was conducted under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of September 30, 2017, were effective at a reasonable assurance level.
(b) Changes in internal control over financial reporting. There have been no changes in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the three months ended September 30, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are not aware of any material pending legal proceedings to which we are a party or to which our properties are the subject.
Item 1A. Risk Factors.
There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on March 30, 2017, except as noted below.
Distributions paid from sources other than our cash flows from operations may adversely affect our ability to fund future distributions with cash flows from operations and may adversely affect a stockholder's overall return.
We have paid, and may continue to pay, distributions from sources other than from our cash flows from operations. For the nine months ended September 30, 2017, our cash flows provided by operations of approximately $87.9 million was a shortfall of $9.6 million, or 9.8%, of our distributions (total distributions were approximately $97.5 million, of which $47.1 million was cash and $50.4 million was reinvested in shares of our common stock pursuant to the DRIP Offerings) during such period and such shortfall was paid from proceeds from our DRIP Offerings. For the year ended December 31, 2016, our cash flows provided by operations of approximately $121.8 million was a shortfall of $6.3 million, or 4.9%, of our distributions (total distributions were approximately $128.1 million, of which $60.0 million was cash and $68.1 million was reinvested in shares of our common stock pursuant to the DRIP Offerings) during such period and such shortfall was paid from proceeds from our DRIP Offerings. If we cannot maintain certain tenant occupancy levels in our properties, we may not generate sufficient cash flows from operations to pay distributions, which may result in a lower return on a stockholder's investment than he or she may expect.
We may pay, and have no limits on the amounts we may pay, distributions from any source, such as from borrowings, the sale of assets, the sale of additional securities, advances from our Advisor, our Advisor’s deferral, and suspension and/or waiver of its fees and expense reimbursements. Funding distributions from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding distributions from the sale of assets may affect our ability to generate cash flows. Funding distributions from the sale of additional securities could dilute stockholders' interest in us if we sell shares of our common stock to third party investors. Our inability to acquire additional properties or real estate-related investments may have a negative effect on our ability to generate sufficient cash flow from operations from which to pay distributions. As a result, the return investors may realize on their investment may be reduced and investors who invested in us before we generated significant cash flow may realize a lower rate of return than later investors. Payment of distributions from any of the aforementioned sources could restrict our ability to generate sufficient cash flows from operations, affect our profitability and/or affect the distributions payable upon a liquidity event, any or all of which may have an adverse effect on an investment in us.
A high concentration of our properties in a particular geographic area, or of tenants in a similar industry, would magnify the effects of downturns in that geographic area or industry.
As of September 30, 2017, we owned real estate investments in 46 MSAs, (including one real estate investment owned through a consolidated partnership), two of which accounted for 10.0% or more of contractual rental revenue. Real estate investments located in the Houston-The Woodlands-Sugar Land, Texas MSA and the Chicago-Naperville-Elgin, Illinois-Indiana-Wisconsin MSA accounted for an aggregate of 10.1% and 12.3%, respectively, of contractual rental revenue for the nine months ended September 30, 2017. Accordingly, there is a geographic concentration of risk subject to fluctuations in each MSA’s economy. Geographic concentration of our properties exposes us to economic downturns in the areas where our properties are located. A regional or local recession in any of these areas could adversely affect our ability to generate or increase operating revenues, attract new tenants or dispose of unproductive properties. Similarly, if tenants of our properties become concentrated in a certain industry or industries, any adverse effect to that industry generally would have a disproportionately adverse effect on our portfolio.
As of September 30, 2017, we had two exposures to tenant concentration that accounted for 10.0% or more of rental revenue. The leases with AT&T Services, Inc. and Bay Area Regional Medical Center, LLC accounted for 12.0% and 10.0%, respectively, of contractual rental revenue for the nine months ended September 30, 2017.
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Our investments in properties where the underlying tenant has below investment grade credit rating, as determined by major credit rating agencies, or unrated tenants may have a greater risk of default.
As of September 30, 2017, approximately 62.4% of our tenants were not rated or did not have an investment grade credit rating from a major ratings agency or were not affiliates of companies having an investment grade credit rating. Our investments with such tenants may have a greater risk of default and bankruptcy than investments in properties leased exclusively to investment grade tenants. When we invest in properties where the tenant does not have a publicly available credit rating, we use certain credit assessment tools as well as rely on our own estimates of the tenant’s credit rating which includes reviewing the tenant’s financial information (i.e., financial ratios, net worth, revenue, cash flows, leverage and liquidity). If our lender or a credit rating agency disagrees with our ratings estimates, or our ratings estimates are otherwise inaccurate, we may not be able to obtain our desired level of leverage or our financing costs may exceed those that we projected. This outcome could have an adverse impact on our returns on that asset and hence our operating results.
Reductions in reimbursement from third party payors, including Medicare and Medicaid, could adversely affect the profitability of our tenants and hinder their ability to make rental payments to us.
Sources of revenue for our tenants may include the federal Medicare program, state Medicaid programs, private insurance carriers and health maintenance organizations, among others. Efforts by such payors to reduce healthcare costs will likely continue, which may result in reductions or slower growth in reimbursement for certain services provided by some of our tenants. In addition, the healthcare billing rules and regulations are complex, and the failure of any of our tenants to comply with various laws and regulations could jeopardize their ability to continue participating in Medicare, Medicaid and other government sponsored payment programs. Moreover, the state and federal governmental healthcare programs are subject to reductions by state and federal legislative actions. The American Taxpayer Relief Act of 2012 prevented the reduction in physician reimbursement of Medicare from being implemented in 2013. The Protecting Access to Medicare Act of 2014 prevented the reduction of 24.4% in the physician fee schedule by replacing the scheduled reduction with a 0.5% increase to the physician fee schedule through December 31, 2014, and a 0% increase for January 1, 2015 through March 31, 2015. The potential 21.0% cut in reimbursement that was to be effective April 1, 2015 was removed by the Medicare Access & CHIP Reauthorization Act of 2015 (MACRA) and replaced with two new methodologies that will focus upon payment based upon quality outcomes. The first model is the Merit-Based Incentive Payment System, or MIPS, which combines the Physician Quality Reporting System, or PQRS, and Meaningful Use program with the Value Based Modifier program to provide for one payment model based upon (i) quality, (ii) resource use, (iii) clinical practice improvement and (iv) advancing care information through the use of certified Electronic Health Record, or EHR, technology. The second model is the Advanced Alternative Payment Models, or APM, which requires the physician to participate in a risk share arrangement for reimbursement related to his or her patients while utilizing a certified health record and reporting on specific quality metrics. There are a number of physicians that will not qualify for the APM payment method. Therefore, this change in reimbursement models may impact our tenants’ payments and create uncertainty in the tenants’ financial condition.
The healthcare industry continues to face various challenges, including increased government and private payor pressure on healthcare providers to control or reduce costs. It is possible that our tenants will continue to experience a shift in payor mix away from fee-for-service payors, resulting in an increase in the percentage of revenues attributable to reimbursement based upon value based principles and quality driven managed care programs, and general industry trends that include pressures to control healthcare costs. The federal government's goal is to move approximately ninety percent (90%) of its reimbursement for providers to be based upon quality outcome models. Pressures to control healthcare costs and a shift away from traditional health insurance reimbursement to payment based upon quality outcomes have increased the uncertainty of payments.
In 2014, state insurance exchanges were implemented, which provide a new mechanism for individuals to obtain insurance. At this time, the number of payers that are participating in the state insurance exchanges varies, and in some regions there are very limited insurance plans available for individuals to choose from when purchasing insurance. In addition, not all healthcare providers will maintain participation agreements with the payers that are participating in the state health insurance exchange. Therefore, it is possible that our tenants may incur a change in their reimbursement if the tenant does not have a participation agreement with the state insurance exchange payers and a large number of individuals elect to purchase insurance from the state insurance exchange. Further, the rates of reimbursement from the state insurance exchange payers to healthcare providers will vary greatly. The rates of reimbursement will be subject to negotiation between the healthcare provider and the payer, which may vary based upon the market, the healthcare provider’s quality metrics, the number of providers participating in the area and the patient population, among other factors. Therefore, it is uncertain whether healthcare providers will incur a decrease in reimbursement from the state insurance exchange, which may impact a tenant’s ability to pay rent.
The insurance plans that participated on the health insurance exchanges created by the Patient Protection and Affordable Care Act of 2010 (“Healthcare Reform Act”) were expecting to receive risk corridor payments to address the high risk claims that it paid through the exchange product. However, the federal government currently owes the insurance companies approximately $8.3 billion under the risk corridor payment program that is currently disputed by the federal government. The federal government is currently defending several lawsuits from the insurance plans that participate on the health insurance
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exchange. If the insurance companies do not receive the payments, the insurance companies may cease to participate on the insurance exchange which limits insurance options for patients. If patients do not have access to insurance coverage it may adversely impact the tenant’s revenues and the tenant’s ability to pay rent.
In addition, the healthcare legislation passed in 2010 included new payment models with new shared savings programs and demonstration programs that include bundled payment models and payments contingent upon reporting on satisfaction of quality benchmarks. The new payment models will likely change how physicians are paid for services. These changes could have a material adverse effect on the financial condition of some or all of our tenants. The financial impact on our tenants could restrict their ability to make rent payments to us, which would have a material adverse effect on our business, financial condition and results of operations and our ability to pay distributions to stockholders.
Furthermore, beginning in 2016, the Centers for Medicare and Medicaid Services has applied a negative payment adjustment to individual eligible professionals, Comprehensive Primary Care practice sites, and group practices participating in the Physician Quality Reporting System, or PQRS, group practice reporting option (including Accountable Care Organizations) that do not satisfactorily report PQRS in 2014. Program participation during a calendar year will affect payments after two years, such that individuals and groups that receive the 2016 negative payment adjustment will not receive a 2014 PQRS incentive payment. Providers can appeal the determination, but if the provider is not successful, the provider’s reimbursement may be adversely impacted, which could adversely impact a tenant’s ability to make rent payments to us.
Moreover, President Trump signed an Executive Order on January 20, 2017 to “ease the burden of Obamacare”.
On May 4, 2017, members of the House of Representatives approved legislation to repeal portions of the Healthcare Reform Act, which legislation was submitted to the Senate for approval. On July 25, 2017, the Senate rejected a complete repeal and, further, on July 27, 2017, the Senate rejected a repeal on the Healthcare Reform Act’s individual and employer mandates and a temporary repeal on the medical device tax. Furthermore, on October 12, 2017, President Trump signed an Executive Order the purpose of which was to, among other things, (i) cut healthcare cost-sharing reduction subsidies, (ii) allow more small businesses to join together to purchase insurance coverage, (iii) extend short-term coverage policies, and (iv) expand employers’ ability to provide workers cash to buy coverage elsewhere. The Executive Order required the government agencies to draft regulations for consideration related to Associated Health Plans ("AHP"), short term limited duration insurance ("STLDI") and health reimbursement arrangements ("HRA"). At this time the proposed legislation has not been drafted. The Trump Administration also ceased to provide the cost-share subsidies to the insurance companies that offered the silver plan benefits on the Health Information Exchange. The termination of the cost-share subsidies would impact the subsidy payments due in 2017 and will likely adversely impact the insurance companies, causing an increase in the premium payments for the individual beneficiaries in 2018. Nineteen State Attorney Generals filed suit to force the Trump Administration to reinstate the cost shares subsidy payments. On October 25, 2017, a California Judge ruled in favor of the Trump Administration and found that the federal government was not required to immediately reinstate payment for the cost shares subsidy. The injunction sought by the Attorney Generals’ lawsuit was denied. Therefore, our tenants will likely see an increase in individuals who are self-pay or have a lower health benefit plan due to the increase in the premium payments. Our tenants’ collections and revenues may be adversely impacted by the change in the payor mix of their patients and it may adversely impact the tenants’ ability to make rent payments.
On October 17, 2017, Senate health committee leaders proposed a bill to address funding for the cost-sharing subsidies and the Healthcare Reform Act’s outreach funding. At this time, it is uncertain whether any healthcare reform legislation will ultimately become law. If our tenants’ patients do not have insurance, it could adversely impact the tenants’ ability to pay rent and operate a practice.
In addition, the current Administration has commented on the possibility that it may seek to cease the additional subsidies to the qualified health plans that provide coverage for beneficiaries on the health insurance exchange. There are also multiple lawsuits in several judicial districts brought by qualified health plans to recover the prior risk corridor payments that were anticipated to be paid as part of the health insurance exchange program. The multiple lawsuits are moving through the judicial process. Further, there is a current lawsuit, United States House of Representatives vs. Price, which alleges that the Executive Branch of the United States of America exceeded its authority in implementing the risk corridor payments under the HealthCare Reform and therefore the payments should not be made. At this time, the case is pending. If the Administration or the court system determines that risk corridor or risk share payments are not required to be paid to the qualified health plans offering insurance coverage on the health insurance exchange program, the insurance companies may cease offering the Health Insurance Exchange product to the current beneficiaries. Therefore, our tenants may have an increase of self-pay patients and collections may decline, adversely impacting the tenants’ ability to pay rent.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Unregistered Sales of Equity Securities
On August 18, 2017, we granted an aggregate of 9,000 shares of restricted common stock under our 2010 Restricted Share Plan to our three independent directors in connection with each independent director's re-election to our board of directors. Each independent director received 3,000 shares of restricted common stock. The shares were not registered under the Securities Act and were issued in reliance on Section 4(a)(2) of the Securities Act. There were no other sales of unregistered securities during the three months ended September 30, 2017.
Use of Public Offering Proceeds
As of September 30, 2017, we had issued approximately 195.1 million shares of common stock in our Offerings for gross proceeds of $1,930.2 million, out of which we paid $156.5 million in selling commissions and dealer manager fees, $18.3 million in organization and offering costs and $54.6 million in acquisition related expenses to our Advisor or its affiliates. With the net offering proceeds and associated borrowings, we had acquired $2,189.1 million in real estate investments, $117.2 million in real estate-related notes receivable, $36.9 million in notes receivable and $127.1 million in a preferred equity investment as of September 30, 2017. In addition, as of September 30, 2017, we had invested $178.3 million in capital improvements related to certain real estate investments.
Share Repurchase Program
Our share repurchase program permits stockholders to sell their shares back to us after they have held them for at least one year, subject to certain conditions and limitations. We will limit the number of shares repurchased during any calendar year to 5.0% of the number of shares of our common stock outstanding on December 31st of the previous calendar year. In addition, the share repurchase program provides that all redemptions during any calendar year, including those upon death or a qualifying disability of a stockholder, are limited to those that can be funded with equivalent reinvestments pursuant to the DRIP Offerings 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. The prices at which we repurchase our shares of common stock are based on the most recent Estimated per share NAV, which currently is $10.02, and the period of time each stockholder has held their shares. Our board of directors has the right, in its sole discretion, to waive such holding requirement in the event of the death or qualifying disability of a stockholder, or other involuntary exigent circumstances, such as bankruptcy, or a mandatory requirement under a stockholder’s IRA.
During the three months ended September 30, 2017, we fulfilled the following repurchase requests pursuant to our share repurchase program:
Period | Total Number of Shares Repurchased | Average Price Paid per Share | Total Numbers of Shares Purchased as Part of Publicly Announced Plans and Programs | Approximate Dollar Value of Shares Available that may yet be Repurchased under the Program | ||||||||||
07/01/2017 - 07/31/2017 | 587,810 | $ | 9.90 | 587,810 | $ | — | ||||||||
08/01/2017 - 08/31/2017 | 481,862 | $ | 9.87 | 481,862 | $ | — | ||||||||
09/01/2017 - 09/30/2017 | 515,996 | $ | 9.93 | 515,996 | $ | — | ||||||||
Total | 1,585,668 | 1,585,668 | ||||||||||||
During the three months ended September 30, 2017, we repurchased approximately $15,700,000 of common stock, which represented all repurchase requests received in good order and eligible for repurchase during the three months ended September 30, 2017.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
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Item 6. Exhibits.
Exhibit No: | ||
3.1 | ||
3.2 | ||
3.3 | ||
3.4 | ||
3.5 | ||
4.1 | ||
4.2 | ||
4.3 | ||
10.1 | ||
10.2 | ||
10.3 | ||
10.4 | ||
31.1* | ||
31.2* | ||
32.1** | ||
32.2** | ||
99.1 | ||
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
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101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document | |
* | Filed herewith. |
** | Furnished herewith in accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CARTER VALIDUS MISSION CRITICAL REIT, INC. | |||
(Registrant) | |||
Date: November 9, 2017 | By: | /s/ JOHN E. CARTER | |
John E. Carter | |||
Chief Executive Officer | |||
(Principal Executive Officer) | |||
Date: November 9, 2017 | By: | /s/ TODD M. SAKOW | |
Todd M. Sakow | |||
Chief Financial Officer | |||
(Principal Financial Officer and Principal Accounting Officer) | |||