UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2017

OR

For the transition period from                      to                     

Commission File Number 333-200221

 

NexPoint Multifamily Capital Trust, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

(972) 628-4100

(Telephone Number, Including Area Code)

N/A

(Former name, former address or 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

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

As of November 9, 2017, the registrant had 1,143,186 shares of Class A common stock, $0.01 par value, outstanding and 0 shares of Class T common stock, $0.01 par value, outstanding.

 

 

 

 

 

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NEXPOINT MULTIFAMILY CAPITAL TRUST, INC.

Form 10-Q

September 30, 2017

 

TABLE OF CONTENTS

 

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NEXPOINT MULTIFAMILY CAPITAL TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

 

 

See Notes to Consolidated Financial Statements

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NEXPOINT MULTIFAMILY CAPITAL TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE LOSS

(in thousands, except per share amounts)

(Unaudited)

 

 

See Notes to Consolidated Financial Statements

 

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NEXPOINT MULTIFAMILY CAPITAL TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

(dollars in thousands)

(Unaudited)

 

 

See Notes to Consolidated Financial Statements

 

 

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NEXPOINT MULTIFAMILY CAPITAL TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

See Notes to Consolidated Financial Statements

 

 

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NEXPOINT MULTIFAMILY CAPITAL TRUST, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

See Notes to Consolidated Financial Statements

 

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NEXPOINT MULTIFAMILY CAPITAL TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Organization and Description of Business

NexPoint Multifamily Capital Trust, Inc. (the “Company”) was incorporated on November 12, 2013 as a Maryland corporation, and intends to elect to be taxed as a real estate investment trust (“REIT”) beginning with its 2017 tax year. The Company is externally managed by NexPoint Real Estate Advisors II, L.P. (the “Advisor”) through an agreement, as amended, dated August 10, 2015, and renewed on August 10, 2017 for an additional one-year term set to expire on August 10, 2018 (the “Advisory Agreement”). Substantially all of the Company’s assets are owned by NexPoint Multifamily Operating Partnership, L.P. (the “OP”), the Company’s operating partnership. The Company is the sole general partner and a limited partner of the OP. The special limited partner of the OP is the Advisor.

The Company’s primary investment objectives are to provide current income for stockholders through the payment of cash distributions, preserve and return stockholders’ capital contributions and realize capital appreciation on the Company’s assets. All assets may be acquired and operated by the Company alone or jointly with another party.

On August 12, 2015, the Company’s registration statement on Form S-11 (File No. 333-200221) (the “Registration Statement”) for a continuous offering of a maximum of $1.1 billion of common stock, $0.01 par value per share (the “Continuous Offering”), which consisted of $1.0 billion in shares of common stock in the Company’s primary offering and $100 million in shares of common stock pursuant to the Company’s distribution reinvestment plan (the “DRIP”), was declared effective by the U.S. Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933, as amended (the “Securities Act”). The initial offering price for the shares sold in the primary offering was $10.00 per Class A share of common stock and $9.58 per Class T share of common stock. The initial offering price for the shares sold in the DRIP was $9.50 per Class A share of common stock and $9.10 per Class T share of common stock. Highland Capital Funds Distributor, Inc. (the “Dealer Manager”), an entity under common ownership with the Advisor, served as the dealer manager of the Continuous Offering.

On July 21, 2017, the Company filed a post-effective amendment to the Registration Statement to terminate the Continuous Offering and deregister all of its unsold shares of Class A common stock and Class T common stock. The post-effective amendment was declared effective by the SEC on July 26, 2017.

If the Company’s common stock is not listed on a national securities exchange by 150 days after March 24, 2018, or the second anniversary of the date the Company broke escrow in the Continuous Offering, the Company will provide its stockholders with an initial estimated net asset value (“NAV”) per share of its Class A common stock based on a valuation conducted by an independent third-party valuation firm. The Company may provide an estimated NAV based on a valuation prior to such date. 

Substantially all of the net proceeds of the Continuous Offering were used to directly or indirectly acquire, own, operate and selectively develop well-located “core” and “core-plus” multifamily properties in large cities and suburban markets of large cities, primarily in the Southeastern and Southwestern United States. The Company also originates preferred equity investments with operators of well-located “core” and “core-plus” multifamily properties. Investing in both direct property investments and preferred equity investments is designed to minimize potential losses during market downturns and maximize risk adjusted total returns to the Company’s stockholders in all market cycles. To the extent practical, the Company implements a modest value-add component on “core-plus” properties that consists, on average, of investing $1,000 - $4,000 per unit in the first 24-36 months of ownership, in an effort to add value to the asset’s exterior and interior. The Company’s modest value-add program is implemented at the direction and supervision of the Advisor. The Company may also seek to invest in multifamily housing debt and mezzanine debt in situations where the risk/return correlation is more attractive than direct investments in common equity and originations of preferred equity investments. The Company may also invest in common and preferred stock of both publicly traded and private real estate companies. As of September 30, 2017, the Company owned one multifamily property and had one preferred equity investment in a multifamily property.

Pursuant to the terms of the Continuous Offering, offering proceeds were held in an escrow account until the Company raised the minimum offering amount of $2.0 million (the “Minimum Offering Requirement”). On March 24, 2016, the Company met the Minimum Offering Requirement and the proceeds held in escrow were released to the Company, thus allowing the Company to commence material operations. As of September 30, 2017, the Company had received a total of $6.2 million of gross offering proceeds, including approximately $458,700 of distributions reinvested through the DRIP.

On April 7, 2016, the Company acquired from Highland Capital Management, L.P., the Company’s sponsor (the “Sponsor”), the Sponsor’s indirect 95% interest (valued at approximately $39.6 million) in a 330-unit multifamily residential community located in Phoenix, Arizona, known as Estates on Maryland (“Estates”). The Sponsor contributed Estates to the Company at the original cost to

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the Sponsor of approximately $39.6 million, less assumed debt encumbering the property, in exchange for approximately 434,783 shares of the Company’s Class A common stock, $0.01 par value, at $9.20 per share, reflecting the fact that selling commissions and dealer manager fees were not paid in connection with the sale. The Company, pursuant to the agreement entered into for the acquisition of Estates (the “Contribution Agreement”), then transferred the acquired interests to the OP in exchange for approximately 434,783 partnership units in the OP.

As of September 30, 2017, the Company had issued 1,108,110 shares of Class A common stock, including 48,298 shares of Class A common stock issued pursuant to the DRIP.

On July 21, 2017, the Company filed a registration statement on Form S-11 (the "Underwritten Offering Registration Statement") to register shares of its common stock to be sold in an underwritten public offering (the "Underwritten Offering") and subsequently amended the Underwritten Offering Registration Statement. If declared effective by the SEC, there can be no assurance that the Company will be able to complete the Underwritten Offering. The Company has elected to not pursue the Underwritten Offering at this time (but may do so in the future) but rather is seeking equity capital through a private offering (the “Private Offering”), which the Company was actively pursuing as of September 30, 2017.

The Company has changed its investment strategy to primarily focus on originating and structuring mezzanine debt, preferred equity investments, alternative structured financing investments, bridge financing and first mortgage loans in properties benefiting from significant tenant diversification and short-term lease structures, including primarily multifamily and to a lesser extent, storage and select-service and extended-stay hospitality properties. The Company intends to target its structured financings in stabilized and well located properties, primarily located in large cities and suburban markets of large cities in the United States, which have been well-maintained, have few deferred maintenance issues and are owned by experienced and high quality operators. The Company expects the size of its investments will vary significantly, but generally expects them to range in value from $5 million to $20 million, with the average investment size being approximately $7 million. The Company believes that these investment opportunities best meet its primary investment objectives as they contractually provide a high percentage of total return from current pay, are structured to mitigate impairments in the investments, and potentially provide equity-like, long-term total return opportunities, with lower risk than a typical direct equity investment in real estate.

On September 11, 2017, the Company held its annual meeting of stockholders (the “Annual Meeting”). The matters voted on at the Annual Meeting were as follows: (1) reelection of directors for a one-year term expiring in 2018, (2) approval of a form of the Company’s articles of amendment and restatement, (3) approval of a form of the Company’s amended and restated advisory agreement, (4) approval of a form of a long-term incentive plan, and (5) ratification of appointment of KPMG LLP as the Company’s independent registered public accounting firm for 2017. All matters submitted for approval by the Company’s stockholders, as described in the Company’s proxy statement, were approved. The amendments to the Company’s charter and the advisory agreement and the adoption of the long-term incentive plan will become effective upon a capital raise pursuant to the Underwritten Offering or the Private Offering.

2. Summary of Significant Accounting Policies

Common Control

The contribution of Estates by the Sponsor was accounted for as a combination of entities under common control; therefore, the Company accounted for the acquisition at historical cost in a manner similar to the pooling of interest method. Information included in the accompanying unaudited consolidated financial statements is presented as if Estates had been combined throughout the periods presented in which common control existed; the amounts included relating to Estates were determined in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). As such, the acquisition of Estates by the Company was deemed to be made on the date it was purchased by the Sponsor, which was August 5, 2015 (the “Original Acquisition Date”). Therefore, the accompanying unaudited consolidated financial statements are presented reflecting the acquisition of Estates as if it occurred on the Original Acquisition Date, rather than on April 7, 2016, the date on which the Company actually acquired Estates from the Sponsor.

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements of the Company were prepared in accordance with GAAP as contained within the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) and the rules and regulations of the SEC. The accompanying unaudited consolidated financial statements include the accounts of the Company and the OP and its subsidiaries. Because the Company is the sole general partner and a limited partner of the OP and has unilateral control over its management and major operating decisions (even if additional limited partners are admitted to the OP), the accounts of the OP are consolidated in the Company’s consolidated financial statements. The Company consolidates entities in which it controls more than 50% of the voting equity. Investments in real estate joint ventures over which the Company has the ability to exercise significant influence, but for which it does not have financial or operating control, are accounted for using the equity method of accounting. The

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Company has one investment accounted for using the equity method of accounting that is reflected on the accompanying unaudited consolidated financial statements as “Preferred equity investment.” All intercompany balances and transactions are eliminated in consolidation.

In addition, the Company evaluates relationships with other entities to identify whether there are variable interest entities (“VIEs”) as required by FASB ASC 810, Consolidation (“FASB ASC 810”), and to assess whether the Company is the primary beneficiary of such entities. If the determination is made that the Company is the primary beneficiary, then that entity is included in the consolidated financial statements in accordance with FASB ASC 810.

On January 1, 2016, the Company adopted Accounting Standards Update (“ASU”) No. 2015-02, Amendments to the Consolidation Analysis (“ASU 2015-02”), which amends the current consolidation guidance affecting both the VIE and voting interest entity (“VOE”) consolidation models. The standard does not add or remove any of the characteristics in determining if an entity is a VIE or VOE, but rather enhances the way the Company assesses some of these characteristics. The OP meets the criteria as a VOE; and as the Company holds a majority of the voting interest of the OP, the Company consolidates the OP. Substantially all of the Company’s assets and liabilities represent those assets and liabilities of the OP. All of the Company’s debt is an obligation of the OP.

In the opinion of the Company’s management, the accompanying unaudited consolidated financial statements include all adjustments and eliminations, consisting only of normal recurring items necessary for their fair presentation in conformity with GAAP. The financial statements of the Company’s subsidiaries are prepared using accounting policies consistent with those of the Company. The unaudited consolidated financial statements, and the notes thereto, included in this quarterly report on Form 10-Q should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2016 and notes thereto included in its annual report on Form 10-K, filed with the SEC on March 28, 2017. There have been no significant changes to the Company’s significant accounting policies during the nine months ended September 30, 2017. 

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Real Estate Investments

Upon acquisition of real estate investments, except from related parties, the purchase price and related acquisition costs (“total consideration”) are allocated to land, buildings, improvements, furniture, fixtures, and equipment, and intangible lease assets in accordance with FASB ASC 805, Business Combinations, and the recently adopted ASU 2017-01, Clarifying the Definition of a Business (Topic 805) (“ASU 2017-01”), which the Company adopted on January 1, 2017 (see “Recent Accounting Pronouncements” below). The Company believes most future acquisition costs will be capitalized in accordance with ASU 2017-01. Prior to the Company’s adoption of ASU 2017-01, acquisition costs were expensed as incurred.

The allocation of total consideration, which is determined using inputs that are classified within Level 3 of the fair value hierarchy established by FASB ASC 820, Fair Value Measurement and Disclosures (“ASC 820”) (see Note 9), is based on management’s estimate of the property’s “as-if” vacant fair value. The “as-if” vacant fair value is calculated by using all available information such as the replacement cost of such asset, appraisals, property condition reports, market data and other related information. The allocation of the total consideration to intangible lease assets represents the value associated with the in-place leases, which may include lost rent, leasing commissions, legal and other related costs, which the Company, as buyer of the property, did not have to incur to obtain the residents. If any debt is assumed in an acquisition, the difference between the fair value, which is estimated using inputs that are classified within Level 2 of the fair value hierarchy, and the face value of the debt is recorded as a premium or discount and amortized to interest expense over the life of the debt assumed. Preferred equity investments are recorded at the value invested by the Company at the date of origination and accounted for under the equity method of accounting.

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Real estate assets, including land, buildings, improvements, furniture, fixtures and equipment, and intangible lease assets are stated at historical cost less accumulated depreciation and amortization. Costs associated with the development and improvement of the Company’s real estate assets are capitalized as incurred. Costs incurred in making repairs and maintaining real estate assets are expensed as incurred. Real estate-related depreciation and amortization are computed on a straight-line basis over the estimated useful lives as described in the following table: 

 

 

Impairment

Real estate assets are reviewed for impairment periodically whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In such cases, the Company will evaluate the recoverability of such real estate asset based on estimated future cash flows and the estimated liquidation value of such real estate asset, and provide for impairment if such undiscounted cash flows are insufficient to recover the carrying amount of the real estate asset. If impaired, the real estate asset will be written down to its estimated fair value.

The Company considers various factors to determine if a decrease in the value of its equity method investments is other-than-temporary. These factors include, but are not limited to, age of the investment, the Company’s intent and ability to retain its investment in the entity, the financial condition and long-term prospects of the entity, and the relationships with the other joint venture partners and its lenders. After determining an other-than-temporary decrease in the value of an equity method investment has occurred, the Company estimates the fair value of its investment by estimating the proceeds the Company would receive upon a hypothetical liquidation of the investment at the date of measurement.

For the three and nine months ended September 30, 2017 and 2016, the Company did not record any impairment charges related to real estate assets or equity method investments.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Cash equivalents may include cash and short-term investments. Short-term investments are stated at cost, which approximates fair value and may consist of investments in money market accounts. There are no restrictions on the use of the Company’s cash balance.

Restricted Cash

Restricted cash is comprised of security deposits, operating escrows, and renovation value-add reserves. Security deposits are held until they are due to tenants and are credited against the balance. Operating escrows are required and held by the joint venture’s first mortgage lender(s) for items such as real estate taxes, insurance, and required repairs. Lender held escrows are released back to the joint venture upon the borrower’s proof of payment of such expenses. Renovation value-add reserves are funds identified to finance the Company’s value-add renovations at its properties and are not required to be held in escrow by a third party. The Company may reallocate these funds, at its discretion, to pursue other investment opportunities. The following is a summary of the restricted cash held as of September 30, 2017 and December 31, 2016 (in thousands):

 

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Noncontrolling Interests

Noncontrolling interests are comprised of the Company’s joint venture partners’ interests in the joint venture in the multifamily property that the Company consolidates. The Company reports its joint venture partners’ interests in its consolidated real estate joint ventures and other subsidiary interests held by third parties as noncontrolling interests. The Company records these noncontrolling interests at their initial fair value, adjusting the basis prospectively for their share of the respective consolidated investment’s net income or loss and equity contributions and distributions. These noncontrolling interests are not redeemable by the equity holders and are presented as part of permanent equity. Income and losses are allocated to the noncontrolling interest holder based on its economic ownership percentage.

Accounting for Joint Ventures

The Company accounts for subsidiary partnerships, joint ventures and other similar entities in which it holds an ownership interest in accordance with FASB ASC 810. The Company first evaluates whether each entity is a VIE. Under the VIE model, the Company consolidates an entity when it has the power to direct the activities of the VIE and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. Under the voting model, the Company consolidates an entity when it controls the entity through ownership of a majority voting interest.

Revenue Recognition

The Company’s primary operations consist of rental income earned from its residents under lease agreements with terms of typically one year or less. Rental income is recognized when earned. This policy effectively results in rental income recognition on the straight-line method over the related terms of the leases. Resident reimbursements and other income consist of charges billed to residents for utilities, carport and garage rental, pets, administrative, application and other fees and are recognized when earned.

Equity in Income

The Company recognizes equity in income earned on a stated investment return from preferred equity investments it originates. Equity in income on the Company’s preferred equity investments is recorded under the equity method of accounting. The Company does not recognize equity in income earned on its preferred equity investments if there is a reason to doubt the Company’s ability to collect such income.

Asset Management & Property Management Services

Asset management fee and property management fee expenses are recognized when incurred in accordance with the Advisory Agreement and the property management agreement, respectively (see Note 10).

Organization and Offering Expenses

Organization and offering expenses include all expenses (other than selling commissions, the dealer manager fee and the distribution fee) to be paid by the Company in connection with the Continuous Offering. Typically, organization and offering expenses were initially paid by the Advisor and its affiliates and were reimbursed by the Company with certain limitations discussed below. Organization and offering expenses include, but are not limited to: (1) legal, accounting, printing, mailing and filing fees; (2) charges of the Company’s escrow agent and transfer agent; and (3) due diligence expense reimbursements to participating broker-dealers.

Organization expenses, when recognized, are expensed by the Company on the accompanying unaudited consolidated statements of operations and comprehensive loss. Offering costs, when recognized, are treated as a reduction of the total proceeds. Until recognized, these expenses are deferred and will be paid to the Advisor and its affiliates from the proceeds of the Continuous Offering, but only to the extent the reimbursement would not exceed 1.0% of the gross offering proceeds. The Advisor is responsible for the payment of organization and offering expenses the Company incurs in excess of 1.0% of the gross offering proceeds.

For the period from November 12, 2013 (inception) to September 30, 2017, the Advisor and its affiliates incurred organization and offering expenses of approximately $2.7 million. For the period from November 12, 2013 (inception) to September 30, 2017, the Company recognized approximately $0.1 million of organization and offering expenses as reimbursable to the Advisor and its affiliates, the maximum amount allowed under the 1.0% of gross offering proceeds limitation on reimbursement to the Advisor and its affiliates under the terms of the Continuous Offering. The remaining organization and offering expenses of approximately $2.6 million have not been accrued on the Company’s consolidated balance sheet as of September 30, 2017 and are not reimbursable under the current Advisory Agreement since the Continuous Offering was terminated on July 26, 2017.

In connection with the Underwritten Offering and the Private Offering, the Company has incurred approximately $2.2 million of offering costs. The Company initially records these costs in prepaid and other assets on the consolidated balance sheet. Upon a

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successful completion of the Underwritten Offering or the Private Offering, the portion of these costs that have not been expensed will be charged against the gross offering proceeds. If the Company decides to abort the Underwritten Offering or the Private Offering, these costs, and any subsequent offering costs incurred in connection with the offerings, will be reclassified to corporate general and administrative expenses on the consolidated statements of operations and comprehensive loss. As the Company is not pursuing the Underwritten Offering at this time (but may do so in the future), it has elected to expense the costs related exclusively to the Underwritten Offering. For the three and nine months ended September 30, 2017, the Company expensed approximately $1.6 million of these costs as corporate general and administrative expenses. As the Company continues to actively pursue the Private Offering, all costs associated with the Private Offering are recorded as prepaid and other assets on the consolidated balance sheet.

Operating Expenses

Operating expenses include, but are not limited to, payments of reimbursements to the Advisor and its affiliates for operating expenses paid on behalf of the Company, audit, legal, filing and tax fees, directors’ and officers’ liability insurance, board of director fees and offering costs incurred in connection with the Underwritten Offering which have been expensed. For more information on operating expenses and reimbursements to the Advisor and its affiliates, see Note 10.

Fees to Affiliates

Fees to affiliates include, but are not limited to, acquisition and disposition fees paid to the Advisor on qualifying assets that are acquired or sold, subject to certain limitations. For more information on fees to affiliates, see Note 10.

Income Taxes

The Company intends to elect to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”), beginning with its 2017 tax year. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including requirements to pass the “closely-held test” (in order for the Company to qualify as a REIT, no more than 50% in value of its outstanding stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year, beginning with the last half of 2018 assuming a valid 2017 REIT election, which the Company refers to as the “closely-held test”), and to distribute annually at least 90% of its “REIT taxable income,” as defined by the Code, to its stockholders. As a REIT, the Company will be subject to federal income tax on its undistributed REIT taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which distributions it pays with respect to any calendar year are less than the sum of (a) 85% of its ordinary income, (b) 95% of its capital gain net income and (c) 100% of its undistributed income from prior years. The Company intends to operate in such a manner so as to qualify as a REIT, including creating taxable REIT subsidiaries to hold assets that generate material income that would not be consistent with the rules applicable for qualification as a REIT if held directly by the REIT, but no assurance can be given that the Company will operate in a manner so as to qualify as a REIT.

If the Company were to fail to meet these requirements, it could be subject to federal income tax on all of its taxable income at regular corporate rates for that year. The Company would not be able to deduct distributions paid to stockholders in any year in which it fails to qualify as a REIT. Additionally, the Company will also be disqualified from electing to be taxed as a REIT for the four taxable years following the year during which qualification was lost unless it is entitled to relief under specific statutory provisions.

The Company evaluates the accounting and disclosure of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” (greater than 50 percent probability) of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current year. The Company’s management is required to analyze all open tax years, as defined by the statute of limitations, for all major jurisdictions, which include federal and certain states. The Company has no examinations in progress and none are expected at this time.

If the Company does not meet the qualifications to be taxed as a REIT, it will be taxed as a corporation for U.S. federal income tax purposes. The Company did not meet the qualifications to be taxed as a REIT for its 2016 tax year and will be taxed as a corporation for U.S. federal income tax purposes for its 2016 tax year. As such, the Company provides for income taxes using the asset and liability method under ASC 740. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company recognizes its tax positions and evaluates them by determining whether a tax position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The Company will determine the amount of benefit to recognize and record the amount that is more likely than not to be realized upon ultimate settlement. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.

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The Company had no material unrecognized tax benefit or expense, accrued interest or penalties as of September 30, 2017. The Company and its subsidiaries may be subject to federal income tax as well as income tax of various state and local jurisdictions. When applicable, the Company recognizes interest and/or penalties related to uncertain tax positions on its consolidated statements of operations and comprehensive loss.

Deferred Tax Assets

Deferred income taxes arise principally from temporary differences between book and tax recognition of income, expenses, and losses relating to financing and other transactions. As of September 30, 2017 and December 31, 2016, the Company recognized total deferred tax assets, net of valuation allowances, based on the fact that the Company did not qualify as a REIT for the 2016 tax year. The deferred income taxes on the accompanying consolidated balance sheets at September 30, 2017 (unaudited) and December 31, 2016 are comprised of the following (in thousands):

 

The valuation allowances at September 30, 2017 and December 31, 2016 were primarily related to incurring cumulative net operating losses without generating sufficient future taxable income to recover the deferred tax assets. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable losses and projections for future taxable income over the periods in which the deferred tax assets are deductible; management believes it is more likely than not that the Company will not realize the benefits of these deductible differences at September 30, 2017.

Acquisition Costs

Acquisition costs include costs incurred to acquire assets and are expensed upon acquisition. The amount of acquisition costs incurred depends on the specific circumstances of each closing and are one-time costs associated with each acquisition. Upon the Company’s adoption of ASU 2017-01 on January 1, 2017, as discussed below in “Recent Accounting Pronouncements,” the Company believes most future transaction costs relating to acquisitions of operating properties will be capitalized.

Reportable Segments

The Company has two reportable segments, with activities related to owning and operating multifamily properties and originating preferred equity investments in multifamily properties. The Company organizes and analyzes the operations and results of each of these segments independently, due to inherently different considerations for each segment. For more information regarding the Company’s reportable segments, see Note 3.

With the change in the Company’s strategy, the Company expects to have a third reportable segment, with activities related to originating mezzanine, bridge, and mortgage loans in multifamily, storage and select-service hospitality properties.

Concentration of Credit Risk

The Company maintains cash balances with high quality financial institutions, including NexBank, SSB, an affiliate of the Advisor, and periodically evaluates the creditworthiness of such institutions and believes that the Company is not exposed to significant credit risk. Cash balances may be in excess of the amounts insured by the Federal Deposit Insurance Corporation.

Per Share Data

On August 12, 2015, the SEC declared effective the Company’s Registration Statement, as described above. The Company had no operating activities or earnings (loss) per share before August 12, 2015. In accordance with GAAP, the Company’s acquisition of Estates was determined to be a combination of entities under common control. As such, the acquisition of Estates by the Company (through the issuance of the Company’s Class A common stock) was deemed to be made on the date it was purchased by the Sponsor, which was August 5, 2015. In the accompanying unaudited consolidated financial statements, operations are shown from the Original Acquisition Date, although the Company did not commence material operations until March 24, 2016, the date the Company met the

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Minimum Offering Requirement and broke escrow in the Continuous Offering, enabling it to commence material operations and reimburse the Advisor and its affiliates for certain expenses incurred on the Company’s behalf.

Basic earnings (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period. Diluted earnings (loss) per share is computed based on the weighted average number of shares of the Company’s common stock and all potentially dilutive securities, if any. Non-vested shares of the Company’s restricted Class A common stock give rise to potentially dilutive shares of the Company’s Class A common stock; such shares are excluded from the computation of diluted earnings (loss) per share if they are anti-dilutive.

Recent Accounting Pronouncements

Section 107 of the Jumpstart Our Business Startups Act (the “JOBS Act”) provides that an emerging growth company can take advantage of the extended transition period provided in Section 13(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for complying with new or revised accounting standards applicable to public companies. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, the Company has elected to “opt out” of such extended transition period. Therefore, the Company intends to comply with new or revised accounting standards on the applicable dates on which the adoption of standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that the Company’s decision to opt out of such extended transition period for compliance with new or revised accounting standards is irrevocable.

In January 2015, the FASB issued ASU No. 2015-01, Income Statement – Extraordinary and Unusual Items (Subtopic 225-20), Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items (“ASU 2015-01”). The amendments in ASU 2015-01 eliminate from GAAP the concept of extraordinary items. Although the amendment will eliminate the requirements for reporting entities to consider whether an underlying event or transaction is extraordinary, the presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained and will be expanded to include items that are both unusual in nature and infrequently occurring. The Company implemented the provisions of ASU 2015-01 as of January 1, 2016, which did not have a material impact on its consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, Amendments to the Consolidation Analysis (“ASU 2015-02”), which changes the way reporting enterprises evaluate whether (a) they should consolidate limited partnerships and similar entities, (b) fees paid to a decision maker or service provider are variable interests in a VIE, and (c) variable interests in a VIE held by related parties of the reporting enterprise require the reporting enterprise to consolidate the VIE. ASU 2015-02 also significantly changes how to evaluate voting rights for entities that are not similar to limited partnerships when determining whether the entity is a VIE, which may affect entities for which the decision making rights are conveyed through a contractual arrangement. The Company implemented the provisions of ASU 2015-02 as of January 1, 2016, as more fully described in Note 2 to the accompanying consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Interest – Imputation of Interest (“ASU 2015-03”), which changes the way reporting enterprises record debt issuance costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (“ASU 2015-15”). ASU 2015-15 supplements the requirements of ASU 2015-03 by allowing an entity to defer and present debt issuance costs related to a line of credit arrangement as an asset and subsequently amortize the deferred costs ratably over the term of the line of credit arrangement. The Company implemented the provisions of ASU 2015-03 and ASU 2015-15 as of January 1, 2016, which did not have a material impact on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”), which requires management to evaluate whether there are conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern, and to provide disclosures when it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. The Company implemented the provisions of ASU 2014-15 as of December 31, 2016, which did not have a material impact on its consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”), which clarifies the presentation of restricted cash in the statements of cash flows. Under ASU 2016-18, restricted cash is included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statements of cash flows. The Company adopted ASU 2016-18 during the three months ended December 31, 2016 on a retrospective basis. As a result, net cash provided by operating activities increased by approximately $0.1 million in the nine months ended September 30, 2016. Net cash used in investing activities increased by approximately $0.2 million in the nine months ended

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September 30, 2016. Beginning-of-period cash and restricted cash increased by $0.4 million in 2016. The following is a summary of the Company’s cash and restricted cash total as presented in the accompanying unaudited consolidated statements of cash flows for the nine months ended September 30, 2017 and 2016 (in thousands):

 

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which amends several aspects of the accounting for share-based payment transactions, including the income tax consequences, accrual of compensation cost, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this standard must be applied prospectively, retrospectively, or as of the beginning of the earliest comparative period presented in the year of adoption, depending on the type of amendment. The Company implemented the provisions of ASU 2016-09 as of January 1, 2017, on a prospective basis, which did not have a material impact on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, which clarifies the definition of a business and provides further guidance for evaluating whether a transaction will be accounted for as an acquisition of an asset or a business. ASU 2017-01 provides a test to determine when a set of assets and activities acquired is not a business. When substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. Under the updated guidance, an acquisition of a single property will likely be treated as an asset acquisition as opposed to a business combination and associated transaction costs will be capitalized rather than expensed as incurred. Additionally, assets acquired, liabilities assumed, and any noncontrolling interest will be measured at their relative fair values. The Company implemented the provisions of ASU 2017-01 as of January 1, 2017, which did not have a material impact on its consolidated financial statements. The Company believes most of its future acquisitions of properties will qualify as asset acquisitions and most future transaction costs associated with these acquisitions will be capitalized.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize revenue to depict the transfer of promised goods or 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. An entity should also disclose sufficient quantitative and qualitative information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers – Deferral of the Effective Date, which amends ASU 2014-09 to defer the effective date by one year. The new standard is effective for annual and interim periods in fiscal years beginning after December 15, 2017. The Company will implement the provisions of ASU 2014-09 as of January 1, 2018 at which time the Company expects to adopt the updated standard using the modified retrospective approach. However, as the majority of the Company’s revenue is from rental income related to leases, the Company does not expect ASU 2014-09 to have a material impact on its consolidated financial statements and related disclosures.

In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”), which changes certain recognition, measurement, presentation, and disclosure requirements for financial instruments. ASU 2016-01 requires all equity investments, except those accounted for under the equity method of accounting or resulting in consolidation, to be measured at fair value with changes in fair value recognized in net income. ASU 2016-01 also simplifies the impairment assessment for equity investments without readily determinable fair values, amends the presentation requirements for changes in the fair value of financial liabilities, requires presentation of financial instruments by measurement category and form of financial asset, and eliminates the requirement to disclose the methods and significant assumptions used in estimating the fair value of financial instruments. ASU 2016-01 is effective for annual and interim periods in fiscal years beginning after December 15, 2017. The Company will implement the provisions of ASU 2016-01 as of January 1, 2018. The Company does not expect ASU 2016-01 to have a material impact on its consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 addresses specific cash flow items with the objective of reducing existing diversity in practice, including the treatment of distributions received from equity method investees. ASU 2016-15 is effective for annual and interim periods in fiscal years beginning after December 15, 2017 and must be applied retrospectively to all periods presented; early adoption is permitted. The Company will implement the provisions of ASU 2016-15 as of January 1, 2018 and has determined the new standard will not have a material impact on its consolidated financial statements.

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In February 2016, the FASB issued ASU No. 2016-02, Leases. The standard amends the existing lease accounting guidance and requires lessees to recognize a lease liability and a right-of-use asset for all leases (except for short-term leases that have a duration of one year or less) on their balance sheets. Lessees will continue to recognize lease expense in a manner similar to current accounting. For lessors, accounting for leases under the new guidance is substantially the same as in prior periods, but eliminates current real estate-specific provisions and changes the treatment of initial direct costs. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparable period presented, with an option to elect certain transition relief. Full retrospective application is prohibited. The standard will be effective for the Company on January 1, 2019, with early adoption permitted. Based on a preliminary assessment, the Company expects most of its operating lease commitments will be subject to the new guidance and recognized as operating lease liabilities and right-of-use assets upon adoption, resulting in an immaterial increase in the assets and liabilities on its consolidated balance sheets.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. The standard requires entities to estimate a lifetime expected credit loss for most financial assets, including trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, and to present the net amount of the financial instrument expected to be collected. The updated standard will be effective for the Company on January 1, 2020; early adoption is permitted on January 1, 2019. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.

3. Segment Information

GAAP guidance requires that segment disclosures present the measure(s) used by the chief operating decision maker to decide how to allocate resources and for purposes of assessing such segments’ performance. The Company’s chief operating decision maker is comprised of several members of the Advisor’s investment committee who use several generally accepted industry financial measures to assess the performance of the business for its reportable operating segments.

The Company has two reportable segments, with activities related to owning and operating multifamily properties and originating preferred equity investments in multifamily properties. The Company’s operating multifamily properties segment generates rental income and other income through the operation of properties. The Company’s preferred equity investments segment earns equity in income on a stated investment return. The primary financial measure of segment profit and loss used by the chief operating decision maker is net operating income (“NOI”). NOI for the Company’s operating multifamily properties segment is defined as total revenues less total property operating expenses. NOI for the Company’s preferred equity investments segment is defined as equity in income of preferred equity investments less interest costs on debt used to finance such investments. Excluded from NOI for both of the Company’s reportable segments are: (1) asset management fees; (2) corporate general and administrative expenses; (3) fees to affiliates; (4) organization expenses; (5) acquisition costs; and (6) interest expense related to amortization of deferred financing costs and changes in fair value of derivative instruments designated as cash flow hedges. In addition to the aforementioned, excluded from NOI for the Company’s operating multifamily properties segment are: (1) certain property general and administrative expenses that are not reflective of the ongoing operations of the properties or are incurred on behalf of the Company at the properties; (2) depreciation and amortization; (3) interest costs on debt used to finance such acquisitions; and (4) equity in income of preferred equity investments.

The Company organizes and analyzes the operations and results of each of these segments independently, due to inherently different considerations for each segment. Such considerations include, but are not limited to, the nature and characteristics of the investment and investment strategies and objectives.

The following table presents the Company’s assets as of September 30, 2017 and December 31, 2016 by reportable segment (in thousands):

 

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The following table, which has not been adjusted for the effects of noncontrolling interests, reconciles the Company’s combined NOI for its reportable segments, as detailed in the tables below, for the three and nine months ended September 30, 2017 and 2016 to net loss, the most directly comparable GAAP financial measure (in thousands):

 

The following table presents the total revenues, total property operating expenses and NOI for the Company’s operating multifamily properties segment for the three and nine months ended September 30, 2017 and 2016 (in thousands):

 

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The following table presents the total equity in income of preferred equity investments, total interest costs on debt and NOI for the Company’s preferred equity investments segment for the three and nine months ended September 30, 2017 and 2016 (in thousands):

 

4. Acquisitions and Originations

As of September 30, 2017, through its consolidated and unconsolidated joint ventures, the Company holds investments in two multifamily properties. The following tables provide summary information regarding the Company’s acquisition and origination, which are either consolidated or accounted for under the equity method of accounting:

Operating Property Acquisition

In connection with its indirect equity investment in Estates, the Company, through the OP, directly holds a membership interest in a single-asset LLC that directly owns the property. This entity is deemed to be a VIE as the Company has disproportionate voting rights (in the form of substantive participating rights over all of the decisions that are made that most significantly affect economic performance) relative to the Company’s economic interests in the entity and substantially all of the activities of the entity are performed on the Company’s behalf. The Company is considered the primary beneficiary of the VIE as no single party meets both criteria to be the primary beneficiary, and the Company is the member of the related party group that has both the power to direct the activities that most significantly impact economic performance of the VIE and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. Within the related party group, the Company is the most closely associated to the VIE based on the purpose and design of the entity, the size of its ownership interests relative to the other investors, and the rights the Company holds with respect to the other investors’ equity interests, including the Company’s ability to preclude any transfers of its interests and ability to drag them along on the sale of the Company’s equity interest. This VIE is consolidated in the Company’s financial statements. The assets of this VIE can only be used to settle obligations of this entity, and the creditor of this entity has no recourse to the assets of other entities or the Company.

The other investors in Estates are BH Equities, LLC (“BH Equity”) and an affiliate of BH Equity. When this VIE was formed, BH Equity and its affiliate invested cash in the VIE and received a proportional share of the VIE. This VIE has a non-recourse mortgage that has standard scope non-recourse carve outs required by agency lenders and calls for protection by the borrower and the guarantor against losses by the lender for so-called “bad acts,” such as misrepresentations, and may include full recourse liability for more significant events such as bankruptcy. An affiliate of BH Equity provided a non-recourse carve out guarantee for the mortgage indebtedness currently outstanding relating to the VIE.

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Preferred Equity Investment Origination

The Company, through the OP, has entered into joint ventures with unrelated third parties to originate preferred equity investments. The Company’s preferred equity investments are typically funded with a combination of debt and equity. The Company’s losses are limited to its investment and the Company does not guarantee any debt, capital payout, or other obligations associated with the joint ventures.

The joint venture that the Company, through the OP, is invested in as of September 30, 2017 is deemed to be a VIE as it has equity investors that lack certain essential characteristics of a controlling financial interest. The Company has not, is not contractually required to, nor does it intend to, provide additional financial support to the joint venture beyond its original investment. The Company is not the primary beneficiary of this joint venture as it lacks the power to direct the activities that most significantly impact its economic performance and accounts for this interest under the equity method of accounting under FASB ASC 323-30, Investments in Partnerships, Joint Ventures, and Limited Liability Entities, on the Company’s consolidated financial statements.

 

 

5. Operating Real Estate Investments

As of September 30, 2017, the Company has one consolidated investment in a multifamily property. The following table contains summary information of the Company’s consolidated investment as of September 30, 2017 and December 31, 2016:

As of September 30, 2017, the major components of the Company’s consolidated investment in the multifamily property were as follows (in thousands) (unaudited):

 

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As of December 31, 2016, the major components of the Company’s consolidated investment in the multifamily property were as follows (in thousands):

 

For the three months ended September 30, 2017 and 2016, depreciation expense was $0.4 million and $0.3 million, respectively. For the nine months ended September 30, 2017 and 2016, depreciation expense was $1.2 million and $1.0 million, respectively.

For the three months ended September 30, 2017 and 2016, the Company did not incur amortization expense related to intangible lease assets. For the nine months ended September 30, 2017 and 2016, amortization expense related to the Company’s intangible lease assets was $0 and $0.2 million, respectively. Due to the six-month useful life attributable to intangible lease assets, the value of intangible lease assets on any acquisition prior to March 31, 2017 has been fully amortized and the assets and related accumulated amortization have been written off as of September 30, 2017.

 

 

6. Preferred Equity Investment

As of September 30, 2017, the Company has one preferred equity investment accounted for under the equity method of accounting. The following table contains summary information of the Company’s preferred equity investment as of September 30, 2017 and December 31, 2016:

 

Summary financial information for the property underlying the Company’s preferred equity investment as of September 30, 2017 and December 31, 2016 and for the three and nine months ended September 30, 2017 is as follows (in thousands):

 

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7. Debt

Mortgage Debt

The following table contains summary information concerning the mortgage debt of the Company as of September 30, 2017 (dollars in thousands):

 

The mortgage is a non-recourse obligation subject to customary provisions. The loan agreement contains customary events of default, including defaults in the payment of principal or interest, defaults in compliance with the covenants contained in the documents evidencing the loan, defaults in payments under any other security instrument covering any part of the property, whether junior or senior to the loan, and bankruptcy or other insolvency events.

Credit Facility

On April 7, 2016, the OP and the Sponsor entered into a revolving credit agreement as borrowers of up to $15.0 million (the “Commitment”) with KeyBank, N.A. (“KeyBank”) as administrative agent and lender (the “Credit Facility”), and the OP immediately drew $14.1 million on the Credit Facility and paid the full balance of the $10.0 million bridge loan with KeyBank the Company assumed upon the acquisition of Estates. On April 7, 2016, the OP used $4.0 million of proceeds from the Credit Facility and $2.0 million of cash on hand to originate its $6.0 million preferred equity investment in Bell Midtown. The Credit Facility is non-amortizing during the term it is outstanding, is pre-payable at any time without penalty, and accrues interest at an annual rate of 4.0% plus one-month LIBOR. In connection with the Credit Facility, the Company and an affiliate of BH Equity provided a guarantee to KeyBank. The Company pledged certain assets and proceeds from the Continuous Offering to KeyBank as collateral for the Credit Facility. The OP also pledged certain assets and equity interests to KeyBank as collateral for the Credit Facility, including 50% of its interest in Estates and 50% of its interest in Bell Midtown. In addition, an affiliate of the Sponsor pledged registered equity securities to KeyBank as collateral for the Credit Facility.

On August 19, 2016, the OP and the Sponsor amended the Credit Facility (the “Amendment”) to, among other things, increase the Commitment from $15.0 million to $20.0 million, and the Company, through the OP, immediately drew $5.25 million on the Credit Facility to originate its preferred equity investment in Overlook at Stone Oak Park. The Amendment reflects that, to the extent any principal payments are made on the outstanding principal balance, including any mandatory prepayment, at any time that the outstanding principal balance exceeds $15.0 million, the Commitment shall be permanently reduced by the amount of such prepayment and the amount prepaid shall not be available to be reborrowed. In connection with the Amendment, the OP pledged to KeyBank its 100% preferred equity interest in Overlook at Stone Oak Park as collateral for the Credit Facility. During the fourth quarter of 2016, using approximately $2.4 million of gross offering proceeds and $6.0 million of cash received from the redemption of the Company’s preferred equity investment in Bell Midtown, the Company reduced the principal balance of the Credit Facility to $11.0 million.

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On April 7, 2017, the OP and the Sponsor amended the Credit Facility (the “Second Amendment”) to extend the maturity date to June 30, 2017 and terminate the revolving feature of the Credit Facility. The Company paid an amendment fee of $27,500 in connection with the Second Amendment. Since June 30, 2017, the OP and the Sponsor have amended the Credit Facility three more times, extending the maturity date to December 15, 2017 (see Note 14). In conjunction with these amendments, the affiliate of BH Equity was released and discharged of the guarantee it had previously provided on the Credit Facility.

The Company continues to explore additional sources of capital to repay the Credit Facility in full on or before the maturity date. If the Company is unable to extend the maturity date of the Credit Facility or otherwise raise additional capital prior to December 15, 2017, or the Company does not have sufficient cash on hand to repay the outstanding principal balance on the maturity date, there is sufficient liquid collateral, in the form of registered equity securities (the “Collateral”), pledged from an affiliate of the Company’s Sponsor, to satisfy the Company’s obligations. The Collateral had a fair market value of approximately $22.3 million as of September 30, 2017. If the Collateral were used to satisfy the Company’s obligations on the Credit Facility, the Company may issue shares of its Class A common stock in an amount equal to the obligations that are relieved from the application of the Collateral. The Company does not believe there is a scenario where repayment of the Credit Facility would create a going concern issue for it whereby the Company would not be able to fund its operations for the next 12 months.

As of September 30, 2017, the Company, through the OP, has $11.0 million outstanding under the Credit Facility at an interest rate of 5.23%. The Credit Facility agreement, as amended, contains customary provisions with respect to events of default, covenants and borrowing conditions. Certain prepayments may be required upon a breach of covenants or borrowing conditions.

Deferred Financing Costs

The Company defers costs incurred in obtaining financing and amortizes the costs over the terms of the related debt using the straight-line method, which approximates the effective interest method. Deferred financing costs, net of amortization, are recorded as a reduction from the related debt on the Company’s consolidated balance sheet. Upon repayment of or in conjunction with a material change in the terms of the underlying debt agreement, any unamortized costs are charged to interest expense. Amortization of deferred financing costs, of less than $0.1 million and $0.1 million, is included in interest expense on the accompanying unaudited consolidated statements of operations and comprehensive loss for the three months ended September 30, 2017 and 2016, respectively. Amortization of deferred financing costs, of $0.1 million and $0.1 million, is included in interest expense on the accompanying unaudited consolidated statements of operations and comprehensive loss for the nine months ended September 30, 2017 and 2016, respectively.

Leverage Limit

Under the Company’s charter, the Company’s borrowings may not exceed 300% of its total “net assets” (as defined in the Company’s charter in accordance with the North American Securities Administrators Association Statement of Policy regarding Real Estate Investment Trusts (the “NASAA REIT Guidelines”)), as of the date of any borrowing, which is generally expected to be approximately 75% of the cost of its investment (the “Leverage Limit”). However, over time, the Company intends to target a leverage ratio of 50%-60% loan-to-value. The Company may exceed the Leverage Limit if such excess is approved by a majority of its independent directors and disclosed to stockholders in its next quarterly report following such borrowing, along with justification for exceeding such limit. This charter limitation, however, does not apply to individual real estate assets or investments and there is no limitation on the amount the Company may borrow against any single improved property. The Company has sought and will continue to seek such independent director approval of borrowings in excess of the Leverage Limit until such point as the Company’s borrowings do not exceed the Leverage Limit. As a result of the debt incurred on the acquisition of Estates and the additional debt incurred from the investment in Overlook at Stone Oak Park, borrowings of the Company exceeded the Leverage Limit. A majority of the Company’s independent directors approved borrowings in excess of the Leverage Limit. The Company’s independent directors determined that exceeding the Leverage Limit was justified because the Company was in the process of raising its equity capital in the Continuous Offering to acquire its portfolio. As a result, the Company expects that its debt levels will be higher until it has raised additional equity capital and repaid a portion of its initial leverage. If necessary, the Company expects to repay the Credit Facility by exchanging the Collateral, with proceeds from a subsequent offering of the Company’s common stock or from sales of its assets.

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Schedule of Debt Maturities

The aggregate scheduled maturities, including amortizing principal payments, of total debt for the next five calendar years subsequent to September 30, 2017 are as follows (in thousands):

 

 

 

8. Stockholders’ Equity

Common Stock

Under the Company’s Articles of Incorporation, the total number of shares of common stock, $0.01 par value per share, initially authorized for issuance was 200,000. In connection with the Company’s formation, NexPoint Advisors, L.P., an affiliate of the Company, purchased 11.11 shares of the Company’s common stock for an aggregate purchase price of $100. On October 24, 2014, the Company authorized and sold approximately 22,222 shares of common stock to the Advisor for an aggregate purchase price of $200,000. On October 24, 2014, the Company repurchased the 11.11 shares previously held by NexPoint Advisors, L.P. in exchange for $100. On July 7, 2015, the Company filed its Amended and Restated Articles of Incorporation with the State Department of Assessments and Taxation of the State of Maryland (the “Amended and Restated Articles of Incorporation”). Among other things, the Amended and Restated Articles of Incorporation provided for Class A and Class T shares of the Company’s common stock and increased the aggregate number of authorized shares of common stock from 200,000 to 1,000,000,000, 500,000,000 of which are classified as Class A common stock, $0.01 par value per share (the “Class A Shares”), and 500,000,000 of which are classified as Class T common stock, $0.01 par value per share (the “Class T Shares”), and 10,000,000 shares of preferred stock, $0.01 par value per share. Upon filing the Amended and Restated Articles of Incorporation, each share of the Company’s common stock that was issued to the Advisor was converted to one share of the Company’s Class A common stock.

As of September 30, 2017, the Company had issued 1,108,110 shares of its Class A common stock, which consisted of the issuance of 434,783 shares to acquire a 95% interest in Estates and the issuance of 673,327 shares, including 48,298 shares issued pursuant to the DRIP, resulting in gross offering proceeds of approximately $6.2 million, including approximately $458,700 of distributions reinvested through the DRIP. During the nine months ended September 30, 2017, the Company recognized offering costs of less than $0.1 million. As of September 30, 2017, the Company had issued a total of 1,133,332 shares of Class A common stock.

The initial offering price for the shares in the Continuous Offering was $10.00 per Class A Share and $9.58 per Class T Share. As of September 30, 2017, no Class T shares had been issued.

On July 21, 2017, the Company filed a post-effective amendment to the Registration Statement to terminate the Continuous Offering and deregister all of its unsold shares of Class A common stock and Class T common stock. The post-effective amendment was declared effective by the SEC on July 26, 2017.

Preferred Stock

Under the Company’s Amended and Restated Articles of Incorporation, the total number of shares of preferred stock authorized for issuance is 10,000,000.

On January 26, 2017, the Company sold 125 shares of 12.5% Series A Cumulative Non-Voting Preferred Stock, $0.01 par value per share (the “Series A Preferred Shares”), for $1,000 per Series A Preferred Share, pursuant to a private placement that was exempt from registration pursuant to Rule 506(b) of Regulation D under the Securities Act (the “Private Preferred Offering”) to 125 “accredited investors,” as such term is defined in Rule 501(a) of Regulation D under the Securities Act for aggregate gross proceeds of $125,000. The Company paid approximately $6,250 in commissions in connection with the sale of the Series A Preferred Shares in the Private Preferred Offering. The Company did not use general solicitation or advertising to market the Series A Preferred Shares. The outstanding Series A Preferred Shares are subject to redemption, at the Company’s election. In addition, the Series A Preferred Shares have a distribution and liquidation preference senior to the Company’s shares of common stock. 

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Distribution Reinvestment Plan

The Company adopted the now terminated DRIP pursuant to which the Company’s stockholders may elect to purchase shares of common stock with distributions. The Company may offer shares under the DRIP pursuant to a new registration statement. Any shares issued pursuant to the DRIP are subject to registration and renewal in any state in which such shares are offered and the offering of such shares is not exempt under applicable laws and regulations. On July 26, 2017, in connection with the termination of the Continuous Offering, the DRIP was terminated.

No dealer manager fees, selling commissions or distribution fees were paid with respect to shares purchased pursuant to the DRIP; therefore, the Company retained all of the proceeds from the reinvestment of distributions.

Share Repurchase Program

In order to provide stockholders with the benefit of some interim liquidity, the Company’s board of directors (the “Board”) has adopted a share repurchase program that will enable stockholders the opportunity to potentially sell their shares back to the Company, subject to the conditions and limitations in the share repurchase program. Neither the Sponsor, the Advisor, the Dealer Manager, the directors nor their respective affiliates will receive a fee on any share repurchases. The terms of the share repurchase program are more flexible in cases involving the death or qualifying disability (as determined by the applicable governmental agency), of a stockholder.

Repurchases of shares, when requested, are at the Company’s sole discretion and generally are expected to be made quarterly until the NAV pricing date. Prior to the NAV pricing date, the Company will limit the number of shares repurchased during any calendar year to 5% of the weighted average number of shares of common stock outstanding during the prior calendar year. Funding for the share repurchase program will be derived from operating funds, if any, as the Board, in its sole discretion, may reserve for this purpose. The Company cannot guarantee that the funds set aside for the share repurchase program will be sufficient to accommodate all requests made each year. Generally, the Company will pay repurchase proceeds, less any applicable tax or other withholding required by law, by the third business day following each quarterly financial filing. The repurchase price per share will be the Company’s then-current per share NAV.

Until the NAV pricing date, except with respect to repurchases sought within one year of a stockholder’s death or qualifying disability (as determined by the applicable governmental agency), common stockholders must hold their shares for at least one year in order to participate in the share repurchase program.

Prior to the time the Advisor begins calculating NAV, the price per share that the Company will pay to repurchase shares of its common stock will be as follows:

in each case, as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to the Company’s common stock.

The Board may amend the terms of the share repurchase program without stockholder approval. The Board may also amend, suspend or terminate the share repurchase program upon 30 days’ notice or reject any request for repurchase if it determines that the funds allocated to the share repurchase program are needed for other purposes, such as the acquisition, maintenance or repair of properties, or for use in making a declared distribution.

Distributions

The Company’s long-term policy is to pay distributions solely from cash flow from operations. However, because the Company may receive income from investments at various times during the Company’s fiscal year and because the Company may need cash flow from operations during a particular period to fund capital expenditures and other expenses, the Company expects that at least during the early stages of the Company’s development and from time to time during the Company’s operational stage, the Company

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will declare distributions in anticipation of cash flow that the Company expects to receive during a later period, and the Company expects to pay these distributions in advance of its actual receipt of these funds. The Board has the authority under its organizational documents, to the extent permitted by Maryland law, to fund distributions from sources such as borrowings, offering proceeds or advances and the deferral of fees and expense reimbursements by the Advisor, in its sole discretion. The Company has not established a limit on the amount of offering proceeds it may use to fund distributions. If the Company pays distributions from sources other than cash flow from operations, the Company will have fewer funds available for investments and stockholders’ overall return on their investment in the Company may be reduced.

To maintain the Company’s qualification as a REIT, the Company must make aggregate annual distributions to its stockholders of at least 90% of its REIT taxable income (which is computed without regard to the dividends-paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). If the Company meets the REIT qualification requirements, the Company generally will not be subject to federal income tax on the income that the Company distributes to its stockholders each year.

Distributions Declared

The Board previously approved daily distributions for the period from August 1, 2016 through February 28, 2017 that accrued at a rate of $0.00164 per day for each share of the Company’s Class A common stock which, if paid over a 365-day period, is equivalent to a 6.0% annualized distribution rate based on a purchase price of $10.00 per share of the Company’s Class A common stock. On March 16, 2017, the Board authorized the declaration of a special distribution to the Company’s Class A stockholders of record as of the close of business on March 16, 2017 of $0.0246 per Class A share, which is an amount equal to a daily distribution of $0.00164 per Class A share of common stock, for the period of March 1, 2017 to March 15, 2017. The Board has also approved and authorized the declaration of a daily distribution to the Company’s Class A stockholders of record as of the close of business on each day of the period commencing on March 16, 2017 and ending December 31, 2017. The distributions declared accrued daily to stockholders of record as of the close of business on each day and were payable in cumulative amounts on or before the third day of each calendar month with respect to the prior month. The distributions declared were payable to stockholders from legally available funds. There is no guarantee that the Company will continue to pay distributions at this rate or at all. 

Distributions declared on the Company’s Class A common stock during the three months ended September 30, 2017 were approximately $172,500, including approximately $48,300 attributable to Class A Shares to be issued in a private placement to the Sponsor and its affiliates at $10.00 per share. Distributions declared on the Company’s Class A common stock during the nine months ended September 30, 2017 were approximately $493,900, including approximately $270,400 attributable to the DRIP and approximately $48,300 attributable to Class A Shares to be issued in a private placement to the Sponsor and its affiliates at $10.00 per share. Distributions declared on the Company’s Class A common stock during the three and nine months ended September 30, 2016 were approximately $69,700, including approximately $57,500 attributable to the DRIP.

Distributions declared on the Company’s Series A cumulative preferred stock during the three and nine months ended September 30, 2017 were approximately $3,900 and $10,600, respectively.

Distributions Paid

During the three and nine months ended September 30, 2017, the Company paid cash distributions on its common stock of approximately $124,300 and $162,900, which related to distributions declared on the Company’s Class A common stock for each day in the period from June 1, 2017 through August 31, 2017 and December 1, 2016 through August 31, 2017, respectively. Additionally, during the three and nine months ended September 30, 2017, 4,842 and 33,589 shares, respectively, of Class A common stock were issued pursuant to the DRIP for gross offering proceeds of approximately $46,000 and $319,000, respectively. During the three and nine months ended September 30, 2016, the Company paid cash distributions on its common stock of approximately $10,800, which related to distributions declared on the Company’s Class A common stock for each day in the period from August 1, 2016 through August 31, 2016. Additionally, during the three and nine months ended September 30, 2016, 2,391 shares of Class A common stock were issued pursuant to the DRIP for gross offering proceeds of approximately $22,700.

During the three and nine months ended September 30, 2017, the Company paid cash distributions of $0 and approximately $6,700, respectively, on the Company’s 12.5% Series A cumulative preferred stock for each day in the period from January 26, 2016 through September 30, 2017.

During the three and nine months ended September 30, 2017, the Company paid total distributions of approximately $170,300 and $488,600, respectively. During the three and nine months ended September 30, 2016, the Company paid total distributions of approximately $33,500.

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9. Fair Value Measures and Financial Instruments

Fair value measurements are determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, FASB ASC 820, Fair Value Measurement and Disclosures, establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy):

The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. The Company utilizes an independent third party to perform the allocation of value analysis for each property acquisition and has established policies, as described above, processes and procedures intended to ensure that the valuation methodologies for investments are fair and consistent as of the measurement date.

Derivative Financial Instruments and Hedging Activities

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposure to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company may enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instrument is used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s investments and borrowings.

The Company utilizes an independent third party to perform the market valuations on its derivative financial instruments. The valuation of these instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate options are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the caps. The variable interest rates used in the calculation of projected receipts on the cap are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. To comply with the provisions of ASC 820, the Company incorporates credit valuation adjustments to appropriately reflect both the Company’s own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of the Company’s derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees. Although the Company has determined that the majority of the inputs used to value its derivative fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with the Company’s derivative utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. The Company has determined that the significance of the impact of the credit valuation adjustments made to its derivative contract, which determination was based on the fair value of the contract, was not significant to the overall valuation. As a result, the Company’s derivative held as of September 30, 2017 and December 31, 2016 was classified as Level 2 of the fair value hierarchy.

The Company’s objectives in using interest rate derivatives are to add stability to interest expense related to floating rate debt and to manage its exposure to interest rate movements. To accomplish this objective, the Company has an interest rate cap on its floating rate mortgage debt as part of its interest rate risk management strategy and feels the use of derivative financial instruments is the most efficient and cost-effective method for managing interest rate risk. Interest rate caps involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium. The

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interest rate cap obtained by the Company has a term of three years. During the three and nine months ended September 30, 2017 and 2016, the interest rate cap was used to hedge the variable cash flows associated with the Company’s floating rate mortgage debt. The interest rate cap the Company employs caps the related floating interest rate at 6.0%.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in other comprehensive loss (“OCI”) and subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. Amounts reported in OCI related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s floating rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three and nine months ended September 30, 2017 and 2016, the Company recorded no ineffectiveness in earnings attributable to derivatives designated as cash flow hedges. As of September 30, 2016, the Company had one derivative designated as a cash flow hedge of interest rate risk. 

As of September 30, 2017, the Company had the following outstanding interest rate derivative that was designated as a cash flow hedge of interest rate risk (dollars in thousands):

Derivatives not designated as hedges are not speculative and would be used to manage the Company’s exposure to interest rate movements but do not meet the strict hedge accounting requirements of FASB ASC 815, Derivatives and Hedging. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings. As of September 30, 2017 and 2016, the Company did not have any derivatives that were not designated as hedges in qualifying hedging relationships.

The table below presents the fair value of the Company’s derivative financial instrument as well as its classification on the accompanying consolidated balance sheets as of September 30, 2017 (unaudited) and December 31, 2016 (in thousands):

The table below presents the effect of the Company’s derivative financial instrument on the accompanying unaudited consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2017 and 2016 (in thousands):

Financial Instruments Not Carried at Fair Value

At September 30, 2017 and December 31, 2016, the fair values of cash and cash equivalents, restricted cash, accounts receivable, prepaid assets, accounts payable and other accrued liabilities, accrued real estate taxes payable, accrued interest payable, security deposits, prepaid rent and distributions payable approximated their carrying values because of the short term nature of these instruments. The estimated fair values of other financial instruments were determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company would realize on the disposition of the financial instruments. The use of different market assumptions or estimation methodologies may have

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a material effect on the estimated fair value amounts. The fair value of amounts due to affiliates is not determinable due to the related party nature of such amounts.

Long-term indebtedness is carried at an amount that reasonably approximates its fair value. In calculating the fair value of its long-term indebtedness, the Company used interest rate and spread assumptions that reflect current credit worthiness and market conditions available for the issuance of long-term debt with similar terms and remaining maturities. These financial instruments utilize Level 2 inputs.

10. Related Party Transactions

The Company has entered into the Advisory Agreement with the Advisor. Pursuant to the Advisory Agreement, the Company is obligated to pay the Advisor specified fees upon the provision of certain services related to the investment of funds in real estate-related investments and the management of the Company’s assets and for other services (including, but not limited to, the disposition of assets). Subject to the limitations described below, the Company is also obligated to reimburse the Advisor and its affiliates for organization and offering expenses incurred by the Advisor and its affiliates on behalf of the Company. The Company may be obligated to reimburse the Advisor or its affiliates for acquisition and due diligence expenses and certain operating expenses incurred on behalf of the Company or incurred in connection with providing services to the Company. If the Company completes the Underwritten Offering or the Private Offering, the amended and restated advisory agreement that was approved by the Company’s stockholders at the Annual Meeting will become effective.

The Company entered into the Dealer Manager Agreement with the Dealer Manager with respect to the Continuous Offering. Pursuant to the Dealer Manager Agreement, the Company was obligated to pay the Dealer Manager specified fees upon the provision of certain services related to the Continuous Offering. The Continuous Offering terminated on July 26, 2017. The Dealer Manager will not participate as a dealer manager in the Underwritten Offering or the Private Offering.

Advisory Agreement

On August 10, 2015, the Company entered into the Advisory Agreement with the Advisor. The Advisory Agreement is subject to annual renewal by the Board. On August 10, 2017, the Board, including the independent directors, unanimously approved the renewal of the Advisory Agreement with the Advisor for a one-year term that expires on August 10, 2018. Pursuant to the terms of the Advisory Agreement, the Company may pay the Advisor the fees described below:

Asset Management Fee to the Advisor

The Company pays the Advisor an asset management fee to manage the day-to-day affairs of the Company. The asset management fee is calculated on a monthly basis in an amount equal to 1/12th of 0.75% of the average of the aggregate book value of the Company’s gross assets (before reserves for depreciation or other non-cash reserves), which is not reduced by amounts borrowed to acquire such assets, and additional amounts used for improvements, computed by taking the average of the book value of the Company’s gross assets at the end of each month (or partial month), and is payable monthly in arrears. For the three months ended September 30, 2017 and 2016, the Company incurred asset management fees to the Advisor of approximately $0.1 million and $0.1 million, respectively. For the nine months ended September 30, 2017 and 2016, the Company incurred asset management fees to the Advisor of approximately $0.3 million and $0.2 million, respectively. 

Acquisition Fee

The Company may pay the Advisor an acquisition fee equal to 1.0% of the purchase price of each asset acquired, excluding any acquisition expenses. For the three and nine months ended September 30, 2017 and 2016, the Company did not incur any acquisition fees to the Advisor. In connection with the acquisition of Estates, the Company incurred acquisition fees payable to the Advisor of approximately $0.4 million, which are deemed to have been incurred on the Original Acquisition Date (see Note 2).

Organization and Offering Expenses

The Company will reimburse the Advisor and its affiliates for organization and offering expenses incurred on the Company’s behalf in connection with the Continuous Offering, but only to the extent the reimbursement does not exceed 1.0% of the gross offering proceeds received in the Continuous Offering. The Advisor is responsible for the payment of organization and offering expenses the Company incurs in excess of 1.0% of the gross offering proceeds. Organization and offering expenses (other than selling commissions, the dealer manager fee and the distribution fee) include, but are not limited to: (1) legal, accounting, printing, mailing and filing fees; (2) charges of the Company’s escrow agent and transfer agent; and (3) due diligence expense reimbursements to participating broker-dealers. For the period from November 12, 2013 (inception) to September 30, 2017, the Advisor and its affiliates incurred organization and offering expenses of approximately $2.7 million. For the three and nine months ended September 30, 2017,

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the Company recognized less than $0.1 million in organization expenses and $0 in offering costs, the maximum amount allowed under the 1.0% of gross offering proceeds limitation on reimbursement to the Advisor and its affiliates under the terms of the Continuous Offering. Subsequent to receiving $2.0 million in gross proceeds in the Continuous Offering and breaking escrow on March 24, 2016, the Company recognized less than $0.1 million in organization expenses for the three and nine months ended September 30, 2016, and $0 and less than $0.1 million in offering costs for the three and nine months ended September 30, 2016, respectively, the maximum amount allowed under the 1.0% of gross offering proceeds limitation on reimbursement to the Advisor and its affiliates. The remaining organization and offering expenses of approximately $2.6 million have not been accrued on the Company’s consolidated balance sheet as of September 30, 2017 and are not reimbursable under the current Advisory Agreement since the Continuous Offering was terminated on July 26, 2017.

The amount of reimbursable organization and offering expenses that have been paid or recognized from November 12, 2013 (inception) through September 30, 2017 is as follows (dollars in thousands):

As of September 30, 2017, the Company had recognized selling commissions, dealer manager fees, and organization and offering costs in the Continuous Offering in the amounts set forth below. The Dealer Manager reallowed all of the selling commissions and dealer manager fees to participating broker-dealers (dollars in thousands):

From the commencement of the Continuous Offering through September 30, 2017, the net offering proceeds to the Company, after deducting the total expenses incurred as described above, were approximately $6.1 million (exclusive of 434,783 shares of Class A common stock issued to the Sponsor in exchange for its 95% interest in Estates), including net offering proceeds from the DRIP of approximately $458,700. From the commencement of the Continuous Offering through September 30, 2017, the ratio of the cost of raising equity capital to the gross amount of equity capital raised was approximately 1.16%.

The amount of deferred organization and offering expenses that has not been reflected in the Company’s consolidated financial statements as of September 30, 2017 is as follows (in thousands):

 

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Investment-related Expenses

In addition, the Company will reimburse the Advisor or its affiliates for expenses actually incurred related to selecting, evaluating, acquiring and originating assets on its behalf, regardless of whether the Company actually acquires or originates the related assets. In addition, the Company will pay third parties, or reimburse the Advisor or its affiliates, for any investment-related expenses due to third parties, including legal fees and expenses, travel and communications expenses, costs of appraisals, accounting fees and expenses, third-party brokerage or finders’ fees, title insurance expenses, survey expenses, property inspection expenses and other closing costs regardless of whether the Company acquires or originates the related assets. The Company expects these expenses will be approximately 0.75% of the purchase price of each asset or real estate-related investment. For the three and nine months ended September 30, 2017 and 2016, the Advisor and its affiliates did not bill any investment-related expenses to the Company and any such expenses the Advisor or its affiliates incurred during the periods are considered to be permanently waived.

Operating Expenses

The Company will also reimburse the Advisor’s costs of providing administrative services and operating expenses incurred on behalf of the Company, subject to the limitation that the Company will not reimburse the Advisor for any amount by which the Company’s total operating expenses, as defined below, at the end of the four preceding fiscal quarters exceed the greater of (a) 2.0% of average invested assets and (b) 25.0% of net income other than any additions to reserves for depreciation, bad debt or other similar non-cash reserves and excluding any gain from the sale of assets for that period (the “2%/25% Guidelines”). For these purposes, “average invested assets” means, for any period, the average of the aggregate book value of the Company’s assets invested, directly or indirectly, in equity interests in and loans secured by real estate assets (including amounts invested in REITs and other real estate operating companies) before deducting reserves for depreciation, bad debts or other similar non-cash reserves, computed by taking the average of these values at the end of each month during the period. Additionally, the Company will not make operating expense reimbursements for personnel costs to the Advisor in connection with services for which the Advisor already receives acquisition fees, acquisition or disposition expenses, real estate commissions or asset management fees. The Company will not reimburse the Advisor for salaries and benefits paid to the Company’s executive officers. “Total Operating Expenses” means all expenses paid or incurred by the Company that are in any way related to the Company’s operation, including the Company’s allocable share of Advisor overhead and investment management fees, but excluding (a) the expenses of raising capital such as organization and offering expenses, legal, audit, accounting, underwriting, brokerage, listing, registration and other fees, printing and other such expenses and taxes incurred in connection with the issuance, distribution, transfer, listing and registration of shares of the Company’s common stock; (b) interest payments; (c) taxes; (d) non-cash expenditures such as depreciation, amortization and bad debt reserves; (e) reasonable incentive fees based on the gain in the sale of the Company’s assets; (f) acquisition fees and acquisition expenses (including expenses relating to potential acquisitions that the Company does not close); (g) real estate commissions on the resale of investments; and (h) other expenses connected with the acquisition, disposition, management and ownership of investments (including the costs of foreclosure, insurance premiums, legal services, maintenance, repair and improvement of real property). Notwithstanding the foregoing, the Company may reimburse the Advisor for expenses in excess of the 2%/25% Guidelines if a majority of the Company’s independent directors determines that such excess expenses (an “Excess Amount”) are justified based on unusual and non-recurring factors. The Advisor must reimburse the Company for the amount by which the Company’s Total Operating Expenses for the four preceding fiscal quarters then ended exceed the 2%/25% Guidelines, unless approved by the Company’s independent directors.

For the three and nine months ended September 30, 2017, the Company’s Total Operating Expenses were approximately $1,782,000 and $2,479,000, respectively. For the four fiscal quarters ended September 30, 2017, the Company’s Total Operating Expenses exceeded the 2%/25% Guidelines by approximately $1,887,000 (the “2017 Excess Amount”). On November 9, 2017, the Company’s independent directors determined that the 2017 Excess Amount was justified because (1) the amounts reflect legitimate operating expenses necessary for the operation of the Company’s business, (2) the Company is currently in its acquisition and development stage, (3) the expenses incurred as a result of being a public company are significant and disproportionate to the Company’s average invested assets and net income, and (4) the Company’s average invested assets was low due to the fact that the Company commenced material operations on March 24, 2016. As such, the Company will not seek reimbursement from the Advisor for the 2017 Excess Amount.

For the three and nine months ended September 30, 2016, the Company’s Total Operating Expenses were approximately $359,000 and $972,000, respectively, which exceeded the 2%/25% Guidelines. For the three and nine months ended September 30, 2016, the Advisor and its affiliates incurred approximately $125,000 and $507,000, respectively, of the Company’s Total Operating Expenses, all of which is included on the accompanying unaudited consolidated statements of operations and comprehensive loss. The Advisor made a contribution to the Company for $501,000 of these operating expenses, which was recorded as a reduction to due to affiliates and an increase to additional paid-in capital on the consolidated balance sheet. On May 11, 2016, the Company’s independent directors determined the approximately $6,000 of operating expenses the Advisor and its affiliates incurred for which it did not make a contribution to the Company for was justified; as such, these costs are reimbursable to the Advisor.

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Disposition Fee

The Company will pay the Advisor or its affiliates a disposition fee on the sale of real property, real estate-related assets or the Company’s real estate portfolio, if the Advisor or its affiliates provides a substantial amount of services in connection with a sale, as determined by a majority of the Company’s independent directors. The disposition fee will be equal to 0.5% of the sales price of each real property, real estate-related asset sold, or for the sale of the Company’s real estate portfolio, excluding selling costs. In the event of the sale of the Company, the Company would pay the Advisor or its affiliates a fee of the lesser of 0.5% of the sales price or 50% of the amount of the investment banking fees related to such sale that otherwise would be incurred. For the three and nine months ended September 30, 2017 and 2016, the Company did not incur any disposition fees payable to the Advisor or its affiliates.

Subordinated Participation in Net Sales Proceeds

In the event of the Company’s orderly liquidation, the Advisor (in its capacity as special limited partner of the OP) will receive 15.0% of remaining net sales proceeds after return of capital contributions plus payment to investors of a 6.0% annual cumulative, non-compounded return on the capital contributed by investors (the “Subordinated Participation in Net Sales Proceeds”).

Subordinated Incentive Listing Distribution

If the Company lists its shares on a national securities exchange, the Advisor (in its capacity as special limited partner of the OP) will receive 15.0% of the amount by which the sum of the Company’s market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to a 6.0% annual cumulative, non-compounded return to investors (the “Subordinated Incentive Listing Distribution”). Neither the Advisor nor any of its affiliates can earn both the Subordinated Participation in Net Sales Proceeds and the Subordinated Incentive Listing Distribution.

Subordinated Distribution Upon Termination of the Advisory Agreement

Upon termination or non-renewal of the Advisory Agreement with or without cause, the Advisor (in its capacity as special limited partner of the OP), will be entitled to receive distributions from the OP equal to 15.0% of the amount, if any, by which (i) the sum of the appraised value of the Company’s assets, plus the total distributions paid to stockholders from the Company’s inception through the termination date of the Advisory Agreement, less any amounts distributable as of the termination date of the Advisory Agreement to the limited partners of the OP, who receive partnership units, exceeds (ii) the aggregate capital contributed by investors, less the portion of any distribution that is attributable to net sales proceeds and by any amounts paid by the Company to repurchase shares, plus an amount equal to an annual 6.0% cumulative, pre-tax, non-compounded return to investors (the “Subordinated Distribution Upon Termination”). The Subordinated Distribution Upon Termination shall not be paid until after the Company’s stockholders have received distributions, in the aggregate, of a full return of capital raised from stockholders (less amounts paid to repurchase shares of the Company’s common stock pursuant to the Company’s share repurchase program) plus an annual 6.0% cumulative, non-compounded return on the gross proceeds from the shares of the Company’s common stock, as adjusted for distribution of net sale proceeds. The OP may satisfy the obligation to pay the Subordinated Distribution Upon Termination by either paying cash or issuing a non-interest bearing promissory note that will be repaid from the net sale proceeds of each sale after the date of the termination. If the promissory note is issued and not paid within five years of the termination date, then the Advisor, its successors or assigns, may elect to convert the balance of the fee into shares of the Company’s common stock.

Other Compensation Paid to the Advisor

Preferred Equity Placement Fee

The Advisor may receive a preferred equity placement fee, paid by the entity the preferred equity is placed with, equal to 1.0% of the preferred equity investment originated with the equity sponsor. During the three and nine months ended September 30, 2017, the Advisor did not receive any preferred equity placement fees. During the three and nine months ended September 30, 2016, the Advisor received approximately $0.1 million of preferred equity placement fees, which related to the preferred equity origination in Overlook at Stone Oak Park. 

Preferred Equity Exit Fee

The Advisor may receive a preferred equity exit fee, paid by the entity the preferred equity is placed with, equal to 1.0% of the amount of preferred equity investment that is redeemed. During the three and nine months ended September 30, 2017 and 2016, the Advisor did not receive any preferred equity exit fees.

Dealer Manager Agreement

The Dealer Manager, an entity under common ownership with the Advisor, served as the dealer manager of the Continuous Offering. The Dealer Manager and Advisor are related parties and the Dealer Manager received fees for services related to the Continuous Offering.

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Pursuant to the terms of the Dealer Manager Agreement, the Company paid the Dealer Manager the fees described below:

Selling Commissions

The Company paid the Dealer Manager selling commissions of up to 7.0% of gross offering proceeds from the sale of Class A Shares and up to 3.0% of gross offering proceeds from the sale of Class T Shares. The amount of selling commissions paid on the sale of Class A Shares and Class T Shares may be lower than the aforementioned percentages due to certain volume discounts. The Company did not pay selling commissions with respect to shares of any class sold pursuant to the DRIP. Additionally, the selling commissions were waived in connection with certain categories of sales. The Dealer Manager reallowed all selling commissions to participating broker-dealers. No Class T Shares were sold in the Continuous Offering.

Dealer Manager Fee

The Company paid a dealer manager fee of up to 1.0% of gross offering proceeds from the sale of Class A Shares and Class T Shares. The Dealer Manager reallowed all of its dealer manager fees to participating broker-dealers and servicing broker-dealers. The Company did not pay dealer manager fees in connection with purchases of shares made pursuant to the DRIP. Additionally, the dealer manager fee was waived in connection with certain categories of sales. No Class T Shares were sold in the Continuous Offering.

Distribution Fees

With respect to Class T Shares that were offered in the Continuous Offering, the Company would pay the Dealer Manager a distribution fee that accrues daily in an amount equal to 1/365th of 0.8% of the amount of the purchase price per share or, once reported, the NAV for the Class T Shares on a continuous basis from year to year, but only on shares purchased through the Continuous Offering. The Company would continue paying distribution fees with respect to Class T Shares sold in the Continuous Offering until the earlier to occur of the following: (i) a listing of the Class T Shares on a national securities exchange, (ii) following the completion of the Continuous Offering, total underwriting compensation in the Continuous Offering equaling 10% of the gross proceeds from the Continuous Offering, or (iii) such Class T Shares no longer being outstanding. The Dealer Manager may reallow all or a portion of the distribution fee to participating broker-dealers and servicing broker-dealers. The distribution fee would be payable monthly in arrears. The Company would accrue for the entire 0.8% distribution fee at the time of sale. The distribution fee would not be payable with respect to Class T Shares issued under the DRIP. The Company would not pay a distribution fee with respect to Class A Shares.

Agreement Regarding Certain Volume Discount Sales

On September 14, 2016, the Company entered into an agreement with the Advisor and the Dealer Manager whereby the Advisor agreed to pay a portion of the selling commissions payable to the Dealer Manager in connection with the sale of Class A Shares subject to certain volume discounts. For purchases by an investor of $1,000,001 up to $2,000,000, the Advisor agreed to pay a 0.5% selling commission to the Dealer Manager. For purchases by an investor of $2,000,001 up to $5,000,000, the Advisor agreed to pay a 1.0% selling commission to the Dealer Manager. For purchases by an investor of $5,000,001 up to $10,000,000, the Advisor agreed to pay the full amount of the selling commissions payable to the Dealer Manager, or 2.0% of the purchase price. For purchases by an investor of $10,000,001 or more, the Advisor agreed to pay the full amount of the selling commissions payable to the Dealer Manager, after taking into account the volume discount, or 1.0% of the purchase price, and the Advisor agreed to pay an additional 1.0% of the total purchase price to the investor, which was to be used to purchase additional Class A Shares at a purchase price of $9.10 per share, which reflects that no selling commissions or dealer manager fees were charged on such additional Class A Shares. For the three and nine months ended September 30, 2017, the Advisor incurred approximately $12,000 and $21,000, respectively, of selling commissions payable to the Dealer Manager in connection with the sale of Class A Shares. For the three and nine months ended September 30, 2016, the Advisor incurred approximately $1,700 of selling commissions payable to the Dealer Manager in connection with the sale of Class A Shares. 

Fees and Reimbursements to BH and its Affiliates

The Company, through one of its subsidiaries, has entered into a management agreement with BH Management Services, LLC (“BH”), the Company’s property manager and an independently owned third party, who manages Estates and supervises the implementation of the Company’s value-add program. BH is an affiliate of the noncontrolling interest members of the Company’s joint venture in Estates by virtue of ownership in Estates through BH’s affiliates. BH and its affiliates do not have common ownership in any joint venture with the Advisor; there is also no common ownership between BH and its affiliates and the Advisor. The property management fee paid to BH is approximately 3% of the monthly gross income from the property. Additionally, the Company may pay BH certain other fees, including: (1) a fee of $25.00 per unit for the one-time setup and inspection of properties, (2) a construction supervision fee of 5-6% of total project costs, which is capitalized, (3) acquisition fees and due diligence costs reimbursements, and (4) other owner approved fees at $55 per hour. BH also acts as a paymaster for Estates and is reimbursed at cost for various operating expenses it pays on behalf of the property. The following is a summary of fees that Estates incurred to BH and its affiliates, as well as

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reimbursements paid to BH from the property for various operating expenses, for the three and nine months ended September 30, 2017 and 2016 (in thousands):

Asset Management Fee to the Company

In accordance with the operating agreement of the entity that owns Estates, the Company earns an asset management fee for services provided in connection with monitoring the operations of the property. The asset management fee is equal to 0.5% per annum of the aggregate effective gross income of the property, as defined in the operating agreement. For the three months ended September 30, 2017 and 2016, Estates incurred asset management fees to the Company of less than $0.1 million and less than $0.1 million, respectively. For the nine months ended September 30, 2017 and 2016, Estates incurred asset management fees to the Company of less than $0.1 million and less than $0.1 million, respectively. Since the fees are paid to the Company (and not the Advisor) by a consolidated joint venture, they have been eliminated in consolidation. However, because the Company’s joint venture partners own a portion of the entity that owns Estates, they absorb their pro rata share of the asset management fee. This amount is reflected on the consolidated statements of operations and comprehensive loss in the net income (loss) attributable to noncontrolling interests.

11. Restricted Share Plan

The Company adopted a restricted share plan to:

The Company’s restricted share plan is administered by the Board. Upon the initial release from escrow of the Minimum Offering Requirement on March 24, 2016, each of the Company’s two independent directors received a grant of 3,000 restricted shares of the Company’s Class A common stock at a fair value of $10.00 per share. On May 16, 2016, upon unanimous approval by the stockholders to re-elect the Company’s directors to the Board for a one-year term expiring in 2017, the Company granted an additional 3,000 restricted shares of its Class A common stock at a fair value of $10.00 per share to each of its two independent directors. On September 11, 2017, upon unanimous approval by the stockholders to re-elect the Company’s directors to the Board for a one-year term expiring in 2018, the Company granted an additional 3,000 restricted shares of its Class A common stock at a fair value of $10.00 per share to each of its two independent directors. Restricted shares of Class A common stock issued to independent directors vest in equal amounts annually over a four-year period commencing on the first anniversary of the date of grant. An additional 3,000 restricted shares of the Company’s Class A common stock will be granted to each of the Company’s independent directors upon each re-election to the Board.

Included in corporate general and administrative expenses on the accompanying unaudited consolidated statements of operations and comprehensive loss for the three months ended September 30, 2017 and 2016 is approximately $8,000 and $7,000, respectively, of compensation expense recognized, which related to the vesting periods of restricted shares of Class A common stock granted to each of the Company’s two independent directors. Included in corporate general and administrative expenses on the accompanying unaudited consolidated statements of operations and comprehensive loss for the nine months ended September 30, 2017 and 2016 is

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approximately $23,000 and $13,000, respectively, of compensation expense recognized, which related to the vesting period of restricted shares of Class A common stock granted to each of the Company’s two independent directors. The weighted average remaining term of the restricted Class A common stock is 1.91 years as of September 30, 2017.

A summary of the Company’s restricted Class A common stock activities during the nine months ended September 30, 2017 is as follows:

As of September 30, 2017, the Company had issued 3,000 shares of its Class A common stock under the restricted share plan.

The Underwritten Offering Registration Statement contemplates that the restricted share plan will be terminated. Awards granted under the restricted share plan would remain outstanding upon a termination of the plan. In conjunction with the contemplated termination of the restricted share plan, the Company intends to adopt a long-term incentive plan, which has been approved by stockholders, which will authorize the compensation committee of the Board to provide equity-based compensation in the form of stock options, appreciation rights, restricted shares, restricted stock units, performance shares, performance units and certain other awards denominated or payable in, or otherwise based on, the Company’s common stock or factors that may influence the value of the Company’s common stock, plus cash incentive awards, for the purpose of providing the Company’s directors, officers and other key employees (and those of the Advisor and the Company’s subsidiaries), the Company’s non-employee directors, and potentially certain non-employees who perform employee-type functions, incentives and rewards for performance. If the Company completes a different offering of its common stock instead of the Underwritten Offering, such as the Private Offering, it expects to adopt the aforementioned long-term incentive plan and terminate the existing restricted share plan.

 

12. Economic Dependency

The Company is dependent on the Advisor for certain services that are essential to the Company, including asset acquisition and disposition decisions and other general and administrative responsibilities. In the event that the Advisor is unable to provide such services, the Company would be required to find an alternative advisor.

13. Commitments and Contingencies

Commitments

The Company may enter into various rehabilitation construction-related purchase commitments with parties that provide these goods and services. In the event the Company were to terminate rehabilitation construction services prior to the completion of projects, the Company could potentially be committed to satisfy outstanding or uncompleted purchase orders with such parties. As of September 30, 2017, the Company had not entered into any commitments with any parties.

Contingencies

In the normal course of business, the Company may become subject to claims, lawsuits and legal proceedings. While it is not possible to ascertain the ultimate outcome of any such matters, management believes that the aggregate amount of such liabilities, if any, in excess of amounts provided or covered by insurance, will not have a material adverse effect on the balance sheet of the Company. The Company is not involved in any material litigation nor, to management’s knowledge, is any material litigation currently threatened against the Company. Additionally, subject to the limitations on reimbursements to the Advisor and its affiliates of organization and offering expenses and operating and administrative expenses paid on the Company’s behalf, the Company may owe the Advisor or its affiliates payments in the future.

 

 

 

14. Subsequent Events

As of November 9, 2017, the Company had issued a total of 1,143,186 shares of Class A common stock and 0 shares of Class T common stock.

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Distributions Paid

On October 24, 2017, the Company paid distributions of approximately $55,600, which related to distributions declared for each day in the period from September 1, 2017 through September 30, 2017 and consisted of cash distributions paid in the amount of approximately $7,300 and approximately $48,300 in Class A Shares issued in a private placement to the Sponsor and its affiliates at $10.00 per share.

On November 2, 2017, the Company paid distributions of approximately $57,700, which related to distributions declared for each day in the period from October 1, 2017 through October 31, 2017 and consisted of cash distributions paid in the amount of approximately $7,500 and approximately $50,200 in Class A Shares issued in a private placement to the Sponsor and its affiliates at $10.00 per share.

Authorized Distributions

On November 9, 2017, the Board approved and authorized the declaration of a daily distribution to the Company’s Class A stockholders of record as of the close of business on each day of the period commencing on January 1, 2018 and ending March 31, 2018. The distributions will be calculated based on 365 days in the calendar year and will be equal to $0.00164 per share of Class A common stock per day. Distributions for all record dates of a given month will be paid approximately three days following month end. The distributions will be payable to stockholders from legally available funds therefor.

Extension of Credit Facility

On November 7, 2017, the OP and the Sponsor amended the Credit Facility to extend the maturity date to December 15, 2017.

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

The following is a discussion and analysis of our financial condition and our historical results of operations. The following should be read in conjunction with our consolidated financial statements and accompanying notes. As used herein, the terms “we,” “our” and “us” refer to NexPoint Multifamily Capital Trust, Inc., a Maryland corporation, and, as required by context, NexPoint Multifamily Operating Partnership, L.P., a Delaware limited partnership, which we refer to as the “OP,” and to its subsidiaries. Unless otherwise defined herein, capitalized terms used herein shall have the same meanings as set forth in our consolidated financial statements and accompanying notes included in this quarterly report.

Forward-Looking Statements

Certain statements included in this quarterly report on Form 10-Q that are not historical facts (including any statements concerning investment objectives, other plans and objectives of management for future operations or economic performance, or assumptions or forecasts related thereto) are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “would,” “could,” “should,” “seeks,” “intends,” “plans,” “projects,” “estimates,” “anticipates,” “predicts” or “potential,” or by the negative of these words and phrases, or by similar words or phrases. You can also identify forward-looking statements by discussions of strategy, plans or intentions. These forward-looking statements are based on information currently available to us and are subject to a number of known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. The forward-looking statements contained herein reflect our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our common stock.

For more information regarding risks that may cause our actual results to differ materially from any forward-looking statements, see Part I, Item 1A, “Risk Factors” of our annual report on Form 10-K for the year ended December 31, 2016 (our “Annual Report”), filed with the Securities and Exchange Commission (the “SEC”) on March 28, 2017. We disclaim any obligation to publicly update or revise any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

Overview

We are a Maryland corporation incorporated on November 12, 2013 that intends to elect to be taxed as a real estate investment trust (“REIT”) beginning with our 2017 tax year. We have changed our investment strategy to primarily focus on originating and structuring mezzanine debt, preferred equity investments, alternative structured financing investments, bridge financing and first mortgage loans in properties benefiting from significant tenant diversification and short-term lease structures, including primarily multifamily and to a lesser extent, storage and select-service and extended-stay hospitality properties. We intend to target our structured financings in stabilized and well located properties, primarily located in large cities and suburban markets of large cities in the United States, which have been well-maintained, have few deferred maintenance issues and are owned by experienced and high quality operators. We expect the size of our investments will vary significantly, but generally expect them to range in value from $5 million to $20 million, with the average investment size being approximately $7 million. The primary investment objectives will be to provide long-term, superior risk-adjusted total returns on our investments through all market cycles, provide attractive current income to stockholders through quarterly cash distributions and preserve and return capital contributions. We believe that these investment opportunities best meet our primary investment objectives as they contractually provide a high percentage of total return from current pay, are structured to mitigate impairments in the investments, and potentially provide equity-like, long-term total return opportunities, with lower risk than a typical direct equity investment in real estate. We may also invest in common and preferred stock of both publicly traded and private real estate companies.

On August 12, 2015, our registration statement on Form S-11 (File No. 333-200221) (the “Registration Statement”) for a continuous offering of a maximum of $1.1 billion of common stock, $0.01 par value per share (the “Continuous Offering”), which consisted of $1.0 billion in shares of common stock in our primary offering and $100 million in shares of common stock pursuant to our distribution reinvestment plan (the “DRIP”), was declared effective by the SEC under the Securities Act. The initial offering price for the shares sold in the primary offering was $10.00 per Class A share of common stock and $9.58 per Class T share of common stock. The initial offering price for the shares sold in the DRIP was $9.50 per Class A share of common stock and $9.10 per Class T

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share of common stock. Highland Capital Funds Distributor, Inc. (the “Dealer Manager”), an entity under common ownership with our advisor, served as the dealer manager of the Continuous Offering.

On July 21, 2017, we filed a post-effective amendment to the Registration Statement to terminate the Continuous Offering and deregister all of our unsold shares of Class A common stock and Class T common stock. The post-effective amendment was declared effective by the SEC on July 26, 2017.

NexPoint Real Estate Advisors II, L.P. (the “Advisor”) is our advisor. Subject to certain restrictions and limitations, the Advisor manages our day-to-day operations and our portfolio of properties and real estate-related assets. The Advisor and its personnel have no obligation to, but may present us with investment opportunities with a purchase price of less than $10.0 million. The Advisor’s investment committee may purchase on our account, without specific prior approval of our board of directors (the “Board”), assets with a purchase price of $15.0 million or less, so long as the investment in the asset would not, if consummated, violate our investment guidelines or any restrictions on indebtedness and the consideration to be paid for such assets does not exceed the fair market value of such assets. Any investment with a purchase price greater than $15.0 million or that, if consummated, would violate our investment guidelines or any restrictions on indebtedness, requires the approval of the Board, including approval by a majority of the independent directors.

Pursuant to the terms of our Continuous Offering, offering proceeds were held in an escrow account until we met the minimum offering amount of $2.0 million. On March 24, 2016, we raised the minimum offering amount and the Continuous Offering proceeds held in escrow were released to us. As of September 30, 2017, we had issued 1,108,110 shares of Class A common stock, which consisted of the issuance of 434,783 shares to acquire a 95% interest in Estates on Maryland (“Estates”) and the issuance of 673,327 shares, including 48,298 shares issued pursuant to the DRIP, resulting in gross offering proceeds of approximately $6.2 million plus the 95% ownership interest in Estates, including approximately $458,700 of distributions reinvested through the DRIP. In connection with our incorporation and prior to the effectiveness of the Continuous Offering, we sold approximately 22,222 shares of our common stock to the Advisor for an aggregate purchase price of $200,000, at $9.00 per share, reflecting the fact that selling commissions and dealer manager fees in effect at the time of the purchase were not paid in connection with the sale. These shares were subsequently renamed as shares of Class A common stock. The Advisor or any affiliate may not sell these shares while Highland Capital Management, L.P. (the “Sponsor”) remains our sponsor but it may transfer the shares to other affiliates.

On January 26, 2017, we sold 125 shares of 12.5% Series A Cumulative Non-Voting Preferred Stock, $0.01 par value per share (the “Series A Preferred Shares”), for $1,000 per Series A Preferred Share, pursuant to a private placement that was exempt from registration pursuant to Rule 506(b) of Regulation D under the Securities Act, to 125 “accredited investors,” as such term is defined in Rule 501(a) of Regulation D under the Securities Act for aggregate gross proceeds of $125,000 (the “Private Preferred Offering”). We paid approximately $6,250 in commissions in connection with the sale of the Series A Preferred Shares in the Private Preferred Offering. We did not use general solicitation or advertising to market the Series A Preferred Shares. The outstanding Series A Preferred Shares are subject to redemption, at our election. In addition, the Series A Preferred Shares have a distribution and liquidation preference senior to our shares of common stock.

Substantially all of our assets are held by the OP. We are the sole general partner and a limited partner of the OP. The special limited partner of the OP is the Advisor. If the OP requires additional funds at any time in excess of capital contributions made by us or from borrowing, we will borrow funds from a financial institution or other lender and lend such funds to the OP on the same terms and conditions as would be applicable to our borrowing of such funds. The limited partnership agreement of the OP provides that the OP be operated in a manner that will enable us to (1) satisfy the requirements for qualifying as a REIT for federal income tax purposes, (2) avoid any federal income or excise tax liability (with the exception of federal income tax incurred on activities conducted through a taxable REIT subsidiary) and (3) ensure that the OP will not be classified as a “publicly traded partnership” for purposes of Section 7704 of the Internal Revenue Code of 1986, as amended (the “Code”), which classification could result in the OP being taxed as a corporation.

We intend to elect to be taxed as a REIT under Sections 856 through 860 of the Code beginning with our 2017 tax year. To qualify as a REIT, we must meet a number of organizational and operational requirements, including requirements to pass the “closely-held test” (in order for us to qualify as a REIT, no more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year, beginning with the last half of 2018 assuming a valid 2017 REIT election, which we refer to as the “closely-held test”) and to distribute at least 90% of our “REIT taxable income,” as defined by the Code, to our stockholders. As a REIT, we will be subject to federal income tax on our undistributed REIT taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which distributions we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. We believe we operate in such a manner so as to qualify for taxation as a REIT under the Code, and we intend to continue to operate in such a manner, but no assurance can be given that we will operate in a manner so as to qualify as a REIT.

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On July 21, 2017, we filed a registration statement on Form S-11 (the "Underwritten Offering Registration Statement") to register shares of our common stock to be sold in an underwritten public offering (the "Underwritten Offering") and subsequently amended the Underwritten Offering Registration Statement. There can be no assurance that we will be able to complete the Underwritten Offering. We have elected to not pursue the Underwritten Offering at this time (but may do so in the future) but rather are seeking equity capital through a private offering (the “Private Offering”), which we were actively pursuing as of September 30, 2017.

Components of Our Revenues and Expenses

Revenues

Rental income. Rental income includes rental revenue from our multifamily properties. We anticipate that the leases we enter into for our multifamily properties will typically be for one year or less.

Other income. Other income includes ancillary income earned from tenants such as application fees, late fees, laundry fees, utility reimbursements, and other rental related fees charged to tenants.

Expenses

Property operating expenses. Property operating expenses include property maintenance costs, salary and employee benefit costs, utilities and other property operating costs.

Acquisition costs. Acquisition costs include the costs to acquire additional properties. On January 1, 2017, we adopted Accounting Standards Update (“ASU”) No. 2017-01, Business Combinations (Topic 805), Clarifying the Definition of a Business (“ASU 2017-01”), which requires an entity to capitalize acquisition costs associated with an acquisition that is determined to be an acquisition of an asset as opposed to an acquisition of a business. Prior to our adoption of ASU 2017-01, acquisition costs were expensed as incurred. We believe most future acquisition costs will be capitalized in accordance with ASU 2017-01 (see Note 2 to our consolidated financial statements).

Real estate taxes and insurance. Real estate taxes include the property taxes assessed by local and state authorities depending on the location of each property. Insurance includes the cost of commercial, general liability, and other needed insurance for each property.

Property management fees. Property management fees include fees paid to our property manager, BH Management Services, LLC (“BH”), or other third party management companies for managing each property.

Asset management fees. Asset management fees include the fees paid to our Advisor for managing our assets pursuant to the Advisory Agreement.

Corporate general and administrative expenses. Corporate general and administrative expenses include, but are not limited to, audit, legal, filing and tax fees, directors’ and officers’ liability insurance and board of director fees. Corporate general and administrative expenses also include offering costs incurred in connection with the Underwritten Offering which have been expensed (see Note 2 to our consolidated financial statements). We will also reimburse the Advisor for its costs of providing administrative services and operating expenses incurred on our behalf, subject to the limitation that we will not reimburse the Advisor for any amount by which our operating expenses at the end of the four preceding fiscal quarters exceed the greater of (a) 2.0% of average invested assets and (b) 25.0% of net income other than any additions to reserves for depreciation, bad debt or other similar non-cash reserves and excluding any gain from the sale of assets for that period (the “2%/25% Guidelines”) (see Note 10 to our consolidated financial statements). We may reimburse the Advisor for expenses in excess of the 2%/25% Guidelines if a majority of our independent directors determines that such excess expenses are justified based on unusual and non-recurring factors.

Fees to affiliates. Fees to affiliates include, but are not limited to, acquisition and disposition fees paid to our Advisor on qualifying assets that are acquired or sold, subject to certain limitations. For more information regarding fees to affiliates, see Note 10 to our consolidated financial statements.

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Organization expenses. We will reimburse the Advisor and its affiliates for organization expenses incurred on our behalf in connection with our formation and the Continuous Offering, but only to the extent the reimbursement does not exceed 1.0% of the gross offering proceeds received in the Continuous Offering. The Advisor is responsible for the payment of organization expenses we incur in excess of 1.0% of the gross offering proceeds. Organization expenses include, but are not limited to legal, accounting, printing, mailing and filing fees.

Property general and administrative expenses. Property general and administrative expenses include the costs of marketing, professional fees, general office supplies, and other administrative related costs of each property.

Depreciation and amortization. Depreciation and amortization costs primarily include depreciation of our multifamily properties and amortization of acquired in-place leases.

Other Income and Expense

Interest expense. Interest expense costs primarily include the cost of interest expense on debt and the amortization of deferred financing costs.

Equity in income of preferred equity investments. Equity in income of preferred equity investments includes income earned on a stated investment return from preferred equity investments we originate. Equity in income on our preferred equity investments is recorded under the equity method of accounting.

Results of Operations for the Three and Nine Months Ended September 30, 2017 and 2016

On August 12, 2015, the SEC declared effective our Registration Statement, as described above. We had no operating activities before August 12, 2015. In accordance with U.S. generally accepted accounting principles (“GAAP”), our acquisition of Estates on April 7, 2016 was determined to be a combination of entities under common control. As such, the acquisition of Estates was deemed to be made on the date it was purchased by our Sponsor, which was August 5, 2015 (the “Original Acquisition Date”). In the accompanying unaudited consolidated financial statements, operations are shown from the Original Acquisition Date, although we did not commence material operations until March 24, 2016, the date we broke escrow in the Continuous Offering, enabling us to commence material operations. On August 19, 2016, we originated a preferred equity investment in Overlook at Stone Oak Park, a multifamily property.

As of September 30, 2017, we owned a majority interest in one multifamily property, Estates on Maryland, that encompasses 330 units of apartment space that was approximately 95.2% leased with an average monthly effective rent per occupied unit of $971; we also had one preferred equity investment in a multifamily property, Overlook at Stone Oak Park, that was approximately 92.8% leased with an average monthly effective rent per occupied unit of $1,094. Our preferred equity investment has a minimum monthly preferred return of 8.0% annualized and an additional preferred return of 3.0% annualized, which accrues monthly on a compounding basis if not paid. Our preferred equity investment is accounted for under the equity method of accounting.

The following table sets forth a summary of our operating results for the three and nine months ended September 30, 2017 and 2016 (in thousands):

 

The change in our net loss for the three and nine months ended September 30, 2017 as compared to the net loss for the three and nine months ended September 30, 2016 primarily relates to an increase in corporate general and administrative expenses during the periods in 2017. The increase in corporate general and administrative expenses during the periods in 2017 primarily relates to

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approximately $1.6 million of offering costs incurred in connection with the Underwritten Offering that we expensed during the three months ended September 30, 2017.

Our results of operations for the three and nine months ended September 30, 2017 and 2016 are not indicative of those expected in future periods. We expect to raise additional capital, increase our borrowings and make future investments, which would have a significant impact on our future results of operations. In general, we expect that our income and expenses related to our portfolio will increase in future periods as a result of anticipated future investments.

Revenues

Rental income. Rental income remained flat at $0.9 million for the three months ended September 30, 2017 compared to $0.9 million for the three months ended September 30, 2016. Rental income was $2.7 million for the nine months ended September 30, 2017 compared to $2.6 million for the nine months ended September 30, 2016, which was an increase of approximately $0.1 million.

Other income. Other income was $0.2 million for the three months ended September 30, 2017 compared to $0.1 million for the three months ended September 30, 2016, which was an increase of approximately $0.1 million. Other income was $0.4 million for the nine months ended September 30, 2017 compared to $0.3 million for the nine months ended September 30, 2016, which was an increase of approximately $0.1 million.

Expenses

Property operating expenses. Property operating expenses were $0.3 million for the three months ended September 30, 2017 compared to $0.2 million for the three months ended September 30, 2016, which was an increase of approximately $0.1 million. Property operating expenses remained flat at $0.7 million for the nine months ended September 30, 2017 compared to $0.7 million for the nine months ended September 30, 2016.

Real estate taxes and insurance. Real estate taxes and insurance costs remained flat at $0.1 million for the three months ended September 30, 2017 compared to $0.1 million for the three months ended September 30, 2016. Real estate taxes and insurance costs remained flat at $0.3 million for the nine months ended September 30, 2017 compared to $0.3 million for the nine months ended September 30, 2016. The costs for property taxes incurred in the first year of ownership may be significantly less than subsequent years since the purchase price of the property may trigger a significant increase in assessed value by the taxing authority in subsequent years, increasing the costs of real estate taxes.

Property management fees. Property management fees remained flat at less than $0.1 million for the three months ended September 30, 2017 compared to less than $0.1 million for the three months ended September 30, 2016. Property management fees remained flat at $0.1 million for the nine months ended September 30, 2017 compared to $0.1 million for the nine months ended September 30, 2016.

Asset management fees. Asset management fees remained flat at $0.1 million for the three months ended September 30, 2017 compared to $0.1 million for the three months ended September 30, 2016. Asset management fees were $0.3 million for the nine months ended September 30, 2017 compared to $0.2 million for the nine months ended September 30, 2016, which was an increase of approximately $0.1 million. We did not incur any asset management fees during the three months ended March 31, 2016 as we did not have any real estate assets during the period.

Corporate general and administrative expenses. Corporate general and administrative expenses were $1.7 million for the three months ended September 30, 2017 compared to $0.3 million for the three months ended September 30, 2016, which was an increase of approximately $1.4 million. Corporate general and administrative expenses were $2.2 million for the nine months ended September 30, 2017 compared to $0.8 million for the nine months ended September 30, 2016, which was an increase of approximately $1.4 million. The increase in corporate general and administrative expenses during the periods in 2017 primarily relates to approximately $1.6 million of offering costs incurred in connection with the Underwritten Offering that we expensed during the three months ended September 30, 2017.

Organization expenses. Organization expenses remained flat at less than $0.1 million for the three months ended September 30, 2017 compared to less than $0.1 million for the three months ended September 30, 2016. Organization expenses remained flat at less than $0.1 million for the nine months ended September 30, 2017 compared to less than $0.1 million for the nine months ended September 30, 2016.

Property general and administrative expenses. Property general and administrative expenses remained flat at less than $0.1 million for the three months ended September 30, 2017 compared to less than $0.1 million for the three months ended September 30, 2016. Property general and administrative expenses remained flat at $0.1 million for the nine months ended September 30, 2017 compared to $0.1 million for the nine months ended September 30, 2016.

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Depreciation and amortization. Depreciation and amortization costs remained flat at $0.4 million for the three months ended September 30, 2017 compared to $0.4 million for the three months ended September 30, 2016. Depreciation and amortization costs remained flat at $1.2 million for the nine months ended September 30, 2017 compared to $1.2 million for the nine months ended September 30, 2016.

Other Income and Expense

Interest expense. Interest expense costs remained flat at $0.4 million for the three months ended September 30, 2017 compared to $0.4 million for the three months ended September 30, 2016. Interest expense costs remained flat at $1.1 million for the nine months ended September 30, 2017 compared to $1.1 million for the nine months ended September 30, 2016. The following is a table that details the various costs included in interest expense for the three and nine months ended September 30, 2017 and 2016 (in thousands):

 

Equity in income of preferred equity investments. Equity in income of preferred equity investments was $0.1 million for the three months ended September 30, 2017 compared to $0.2 million for the three months ended September 30, 2016, which was a decrease of less than $0.1 million. Equity in income of preferred equity investments remained flat at $0.4 million for the nine months ended September 30, 2017 compared to $0.4 million for the nine months ended September 30, 2016.

Non-GAAP and Key Financial Measures and Indicators

In connection with our contemplated new strategy, we believe the key financial measures and indicators for our business will be net operating income for real estate owned (“NOI”), funds from operations (“FFO”), Core Earnings, cash available for distributions (“CAD”), adjusted cash available for distributions (“ACAD”) and adjusted book value per share.

We believe providing NOI, FFO, Core Earnings, CAD and ACAD, which are non-GAAP measures of performance, on a supplemental basis to our net income (loss) as determined in accordance with GAAP is helpful to stockholders in assessing the overall performance of our business. We believe that adjusted book value per share, which is a non-GAAP measure, is helpful to stockholders in evaluating the growth of our company as we grow our equity capital base and make future investments. The key financial measures and indicators should not be considered as a substitute for GAAP measures. We caution that our methodology for calculating these key financial measures and indicators may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and as a result, our reported key financial measures and indicators may not be comparable to similar measures presented by other REITs.

Net Operating Income for Real Estate Owned

NOI is a non-GAAP financial measure used to measure performance for our direct property interests. We believe that NOI provides meaningful information that is used by investors, analysts and our management to evaluate and compare the performance of our properties to other comparable properties, to determine trends in earnings and to compute the fair value of our properties as NOI is not affected by (1) the cost of funds, (2) acquisition costs, (3) non-operating fees to affiliates, (4) the impact of depreciation and amortization expenses as well as gains or losses from the sale of operating real estate assets that are included in net income computed in accordance with GAAP, (5) corporate general and administrative expenses, (6) other gains and losses that are specific to us, (7) equity in income recognized on unconsolidated joint ventures, and (8) expenses that are not reflective of the ongoing operations of the properties or are incurred on our behalf at the property for expenses such as legal, professional and franchise tax fees.

NOI is a measure of the operating performance of our properties but does not measure our performance as a whole. NOI is therefore not a substitute for net income (loss) as computed in accordance with GAAP. This measure should be analyzed in conjunction with net income (loss) computed in accordance with GAAP and discussions elsewhere in “—Results of Operations” regarding the components of net income (loss) that are eliminated in the calculation of NOI. Other companies may use different methods for calculating NOI or similarly entitled measures and, accordingly, our NOI may not be comparable to similarly entitled measures reported by other companies that do not define the measure exactly as we do.

However, the usefulness of NOI is limited because it excludes corporate general and administrative expenses, interest expense, interest income and other expense, acquisition costs, certain fees to affiliates, depreciation and amortization expense, gains or losses

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from the sale of properties, equity in income from unconsolidated joint ventures, other gains and losses as stipulated by GAAP, and the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, all of which are significant economic costs or factors. NOI may fail to capture significant trends in these components of net income (loss) which further limits its usefulness.

We calculate NOI by adjusting net income (loss) by adding back acquisition costs, asset management fees, corporate general and administrative expenses, fees paid to affiliates, organization expenses, certain property general and administrative expenses that are not reflective of the ongoing operations of the properties or are incurred on our behalf at the property for expenses such as legal, professional and franchise tax fees, depreciation and amortization, interest expense and origination and disposition fee income and by removing equity in income of preferred equity investments. 

The following table, which has not been adjusted for the effects of any noncontrolling interests, reconciles our NOI for the three and nine months ended September 30, 2017 and 2016 to net loss, the most directly comparable GAAP financial measure (in thousands):

 

Funds from Operations

We believe that net income, as defined by GAAP, is the most appropriate earnings measure. We also believe that funds from operations, or FFO, as defined by the National Association of Real Estate Investment Trusts, or NAREIT, is an important non-GAAP supplemental measure of operating performance for a REIT.

Since the historical cost accounting convention used for real estate assets requires depreciation except on land, such accounting presentation implies that the value of real estate assets diminishes predictably over time. However, since real estate values have historically risen or fallen with market and other conditions, presentations of operating results for a REIT that use historical cost accounting for depreciation could be less informative. Thus, NAREIT created FFO as a supplemental measure of operating performance for REITs that excludes historical cost depreciation and amortization, among other items, from net income, as defined by GAAP. FFO is defined by NAREIT as net income computed in accordance with GAAP, excluding gains or losses from real estate dispositions, plus real estate depreciation and amortization and impairment charges. We compute FFO attributable to common stockholders in accordance with NAREIT’s definition.

We believe that the use of FFO, combined with the required GAAP presentations, improves the understanding of operating results of REITs among investors and makes comparisons of operating results among such companies more meaningful. While FFO is a relevant and widely used measure of operating performance of REITs, it does not represent cash flows from operations or net income (loss) as defined by GAAP and should not be considered as an alternative or substitute to those measures in evaluating our liquidity or operating performance. FFO does not purport to be indicative of cash available to fund our future cash requirements. Further, our computation of FFO may not be comparable to FFO reported by other REITs that do not define FFO in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than we do.

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The following table reconciles our calculation of FFO attributable to common stockholders to net loss attributable to common stockholders, the most directly comparable GAAP financial measure, for the three and nine months ended September 30, 2017 and 2016 (in thousands, except per share amounts):

 

Our FFO for the three and nine months ended September 30, 2017 and 2016 is not indicative of FFO expected in future periods.

Core Earnings

Core Earnings is a non-GAAP financial measure of performance primarily used to measure the performance of preferred equity, structured finance, mezzanine, bridge financing, and mortgage investments. We believe that Core Earnings provides meaningful information that is used by investors, analysts and our management to evaluate and compare the performance of our investments to other comparable investments, to determine trends in earnings and to compute the fair value of our investments as Core Earnings is not affected by certain transactions and GAAP adjustments that we believe are not necessarily indicative of our current portfolio and operations. Additionally, Core Earnings will be used in the calculation of asset management fees payable to our Advisor upon adoption of the amended advisory agreement (see Note 1 to our consolidated financial statements). Core Earnings does not represent GAAP net income (loss) or cash flows from operating activities and should not be considered as an alternative to GAAP net income (loss), an indication of our GAAP cash flows from operating activities, a measure of our liquidity or an indication of funds available for our cash needs. In addition, our methodology for calculating Core Earnings may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures and, accordingly, our reported Core Earnings may not be comparable to the Core Earnings reported by other companies. We calculate Core Earnings by adjusting net income (loss) attributable to common stockholders by adding back stock-based compensation expense, depreciation and amortization expense calculated on real estate owned and adjustments for noncontrolling interests.

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The following table reconciles our calculation of Core Earnings (Loss) attributable to common stockholders to net loss attributable to common stockholders, the most directly comparable GAAP financial measure, for the three and nine months ended September 30, 2017 and 2016 (in thousands, except per share amounts):

 

Our Core Earnings (Loss) for the three and nine months ended September 30, 2017 and 2016 is not indicative of Core Earnings (Loss) expected in future periods.

Cash Available for Distributions and Adjusted Cash Available for Distributions

CAD is a non-GAAP financial measure. We believe that CAD provides meaningful information that is used by investors, analysts and our management to evaluate and determine trends in cash flow as CAD is not affected by non-cash items. CAD is also a useful measure used by our Board to determine our dividend and the long-term viability of the current dividend. CAD does not represent GAAP net income (loss) or cash flows from operating activities and should not be considered as an alternative to GAAP net income (loss), an indication of our GAAP cash flows from operating activities, a measure of our liquidity or an indication of funds available for our cash needs. In addition, our methodology for calculating CAD may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures and, accordingly, our reported CAD may not be comparable to the CAD reported by other companies.

We calculate CAD by adjusting net income (loss) attributable to common stockholders by adding back depreciation and amortization expense on real estate owned, acquisition fees and costs, fees paid to affiliates, amortization of deferred financing costs, stock-based compensation expense and changes in the fair value of derivative financial instruments included in interest expense, and by removing non-cash equity in income of preferred equity investments and adjustments for noncontrolling interests.

ACAD is a non-GAAP financial measure that further adjusts CAD. We believe that ACAD provides meaningful information that is used by investors, analysts and our management to evaluate and determine longer term trends in cash flow as ACAD adds back the non-cash equity in income of preferred equity investments and origination and disposition fee income to CAD. ACAD is also a useful measure used by our Board to determine longer-term viability of the current dividend. ACAD does not represent GAAP net income (loss) or cash flows from operating activities and should not be considered as an alternative to GAAP net income (loss), an indication of our GAAP cash flows from operating activities, a measure of our liquidity or an indication of funds available for our cash needs. In addition, our methodology for calculating ACAD may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures and, accordingly, our reported ACAD may not be comparable to the ACAD reported by other companies.

We calculate ACAD by modifying CAD by adding back non-cash equity in income of preferred equity investments.

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The following table reconciles our calculations of CAD and ACAD attributable to common stockholders to net loss attributable to common stockholders, the most directly comparable GAAP financial measure, for the three and nine months ended September 30, 2017 and 2016 (in thousands, except per share amounts):

 

Our CAD and ACAD for the three and nine months ended September 30, 2017 and 2016 are not indicative of CAD and ACAD expected in future periods.

Adjusted Book Value per Share

We believe that adjusted book value per share, which is a non-GAAP measure, is helpful to stockholders in evaluating the growth of our company as we grow our equity capital base and make future investments. We calculate adjusted book value per share by adding accumulated depreciation on real estate owned back to stockholders’ equity and adjusting for Series A preferred stockholders and noncontrolling interests.

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The following table calculates our adjusted book value per share of Class A common stock as of September 30, 2017 and December 31, 2016 (in thousands, except per share amounts):

 

Liquidity and Capital Resources

Our principal demands for funds are for originating and structuring mezzanine debt, preferred equity investments, alternative structured financing investments, bridge financing and first mortgage loans in properties, either directly or through investment interests, for the payment of operating expenses and distributions, and for the payment of principal and interest on any outstanding indebtedness. Generally, cash needs for items other than originations and structured financing investments are met from operations, and cash needs for originations and structured financing investments will be funded by one or more offerings of our common stock and/or additional borrowings. If cash flows from operations are insufficient to cover our operating expenses, our Advisor will cover these costs on our behalf. To the extent the costs covered on our behalf exceed the 2%/25% Guidelines, and our Advisor does not seek approval from our independent directors to be reimbursed, these support payments will be treated as a non-equity contribution by our Advisor, meaning our Advisor receives no shares in exchange for the contribution.

On July 21, 2017, we filed a post-effective amendment to the Registration Statement to terminate the Continuous Offering and deregister all of our unsold shares of Class A common stock and Class T common stock. The post-effective amendment was declared effective by the SEC on July 26, 2017.

Cash needs for principal payments due in the next twelve months related to the Credit Facility will generally be funded from excess cash from operations. However, to the extent we are unable to generate sufficient excess cash from operations, raise sufficient proceeds through one or more offerings of our common stock and/or additional borrowings to make principal payments as they come due, or to extend the maturity date of the Credit Facility, it may be necessary to sell assets at less than their fair value or before we feel the full value has been recognized. However, pursuant to the terms of the pledge agreement entered into between KeyBank and an affiliate of our Sponsor on the Credit Facility, the affiliate of our Sponsor pledged registered equity securities (the “Collateral”) that had a fair market value of approximately $22.3 million as of September 30, 2017, as compared to a balance on the Credit Facility of $11.0 million as of the same date. Therefore, we believe it is unlikely we will be required to liquidate assets to repay the Credit Facility as the most likely course of action by KeyBank would be to seize the Collateral to the extent necessary to repay the Credit Facility. If this occurred, we may issue shares of Class A common stock to the affiliate of our Sponsor. If we were required to sell assets, this may cause a disruption in our operations and inhibit our ability to meet our objectives. We do not believe there is a scenario where repayment of the Credit Facility would create a going concern issue for us whereby we would not be able to fund our operations for the next 12 months.

Over time, as we become established, we do not expect our target leverage ratio to exceed 60% to 65% of the cost of our properties and 25% to 30% of our originations and structured financing investments. Over the long term, and on an aggregate basis, we do not expect our target leverage ratio to exceed 50% to 60% of the estimated value of our assets.

Our Advisor evaluates potential investments and engages in negotiations with sellers and lenders on our behalf. After a purchase contract is executed that contains specific terms, the investment will not be made until the successful completion of due diligence, which includes review of the title insurance commitment, an appraisal and an environmental analysis. In some instances, the proposed investment will require the negotiation of final binding agreements, which may include financing documents. During this period, we may decide to temporarily invest any unused proceeds from the Continuous Offering in certain investments that could yield lower returns than investments we intend to make. These lower returns may affect our ability to make distributions.

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Potential future sources of capital include proceeds from secured or unsecured financings from banks or other lenders, the sale of properties and redemption of preferred equity investments and one or more offerings of our common stock. If necessary, we may use financings or other sources of capital in cases of unforeseen significant capital expenditures. We have not identified any sources of such financing.

Cash Flows

The following table presents selected data from our consolidated statements of cash flows for the nine months ended September 30, 2017 and 2016 (in thousands):

 

Our overall cash flows from operating, investing, and financing activities for the nine months ended September 30, 2017 and 2016 are not indicative of those expected in future periods. We expect to continue to raise additional capital, increase our borrowings and make future investments, which would have a significant impact on our future results of operations and overall cash flows.

Cash Flows from Operating Activities

During the nine months ended September 30, 2017, net cash used in operating activities was less than $0.1 million compared to net cash provided by operating activities of $0.6 million for the nine months ended September 30, 2016. The change in cash flows from operating activities was mainly due to an increase in corporate general and administrative expenses and changes in working capital.

Cash Flows from Investing Activities

During the nine months ended September 30, 2017, net cash used in investing activities was approximately $0.2 million compared to net cash used in investing activities of $12.1 million for the nine months ended September 30, 2016. The change in cash flows from investing activities was mainly due to the origination of two preferred equity investments of approximately $11.3 million during the period in 2016, compared to no originations of preferred equity investments during the period in 2017.

Cash Flows from Financing Activities

During the nine months ended September 30, 2017, net cash provided by financing activities was $1.0 million compared to net cash provided by financing activities of $11.3 million for the nine months ended September 30, 2016. The change in cash flows from financing activities was mainly due to an increase in net debt proceeds of approximately $9.4 million during the period in 2016, compared to no debt activity during the period in 2017. The change in cash flows from financing activities was also due to $1.1 million of proceeds received in the Continuous Offering during the period in 2017 compared to $2.1 million during the period in 2016.

Mortgage Debt

As of September 30, 2017, our subsidiary had mortgage indebtedness to a third party of approximately $26.9 million at an interest rate of 3.13%. For additional information regarding our mortgage indebtedness, see Note 7 to our consolidated financial statements.

We entered into and expect to continue to enter into interest rate cap agreements with various third parties to cap the variable interest rates on a majority of floating rate mortgage indebtedness we may incur. These agreements generally have a term of three to four years and cover the outstanding principal amount of the underlying indebtedness. Under these agreements, we pay a fixed fee in exchange for the counterparty to pay any interest above a maximum rate. At September 30, 2017, we had one interest rate cap agreement that covered our $26.9 million of outstanding floating rate mortgage indebtedness. This interest rate cap agreement caps the related variable interest rate of our mortgage indebtedness at 6.0%.

Our subsidiary has a separate non-recourse mortgage, which is secured only by Estates. This non-recourse mortgage has standard scope non-recourse carve outs required by the agency lender and calls for protection by the borrower and the guarantor

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against losses by the lender for so-called “bad acts,” such as misrepresentations, and may include full recourse liability for more significant events such as bankruptcy. An affiliate of BH provided a non-recourse carve out guarantee for this mortgage.

We expect that future investments, including any improvements or renovations of current or newly-acquired properties, will depend on and will be financed by, in whole or in part, our existing cash, future borrowings and proceeds from one or more offerings of our common stock. In addition, we may seek financing from U.S. government agencies, including through the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association, and the U.S. Department of Housing and Urban Development, in appropriate circumstances in connection with the acquisition or refinancing of existing mortgage loans.

Although we expect to be subject to restrictions on our ability to incur indebtedness, we expect that we will be able to refinance existing indebtedness or incur additional indebtedness for future investments or other purposes, if needed. However, there can be no assurance that we will be able to refinance our indebtedness, incur additional indebtedness or access additional sources of capital, such as by issuing debt or other equity securities, on terms that are acceptable to us or at all.

Furthermore, following the completion of any modest value-add and capital expenditures programs we may implement and depending on the interest rate environment at the applicable time, we may seek to refinance any floating rate mortgage debt into longer-term fixed rate debt at lower leverage levels.

Credit Facility

As of September 30, 2017, we, through our OP, had $11.0 million outstanding under the Credit Facility at an interest rate of 5.23%. On April 7, 2017, our OP and the Sponsor amended the Credit Facility (the “Second Amendment”) to extend the maturity date to June 30, 2017 and terminate the revolving feature of the Credit Facility. We paid an amendment fee of $27,500 in connection with the Second Amendment. Since June 30, 2017, our OP and the Sponsor have amended the Credit Facility three more times, extending the maturity date to December 15, 2017 (see Note 14 to our consolidated financial statements). In conjunction with these amendments, the affiliate of BH Equity was released and discharged of the guarantee it had previously provided on the Credit Facility. We continue to explore additional sources of capital to repay the Credit Facility in full on or before the maturity date. If we are unable to extend the maturity date of the Credit Facility or otherwise raise additional capital prior to December 15, 2017, or we do not have sufficient cash on hand to repay the outstanding principal balance on the maturity date, there is sufficient liquid collateral, in the form of registered equity securities (the “Collateral”), pledged from an affiliate of our Sponsor, to satisfy our obligations. The Collateral had a fair market value of approximately $22.3 million as of September 30, 2017. If the Collateral were used to satisfy our obligations on the Credit Facility, we may issue shares of our Class A common stock in an amount equal to the obligations that are relieved from the application of the Collateral. We do not believe there is a scenario where repayment of the Credit Facility would create a going concern issue for us whereby we would not be able to fund our operations for the next 12 months.

The Credit Facility agreement, as amended, contains customary provisions with respect to events of default, covenants and borrowing conditions. Certain prepayments may be required upon a breach of covenants or borrowing conditions. As of September 30, 2017, we believe we are in compliance with all covenant provisions.

Leverage Limit

Pursuant to our charter, our borrowings may not exceed 300% of our total “net assets” (as defined in our charter in accordance with the North American Securities Administrators Association Statement of Policy regarding Real Estate Investment Trusts) (the “Leverage Limit”). However, over time, we intend to target a leverage ratio of 50%-60% loan-to-value. We may exceed the Leverage Limit if such excess is approved by a majority of our independent directors and disclosed to stockholders in our next quarterly report following such borrowing, along with justification for exceeding such limit. This charter limitation, however, does not apply to individual real estate assets or investments and there is no limitation on the amount we may borrow against any single improved property. We have sought and will continue to seek such independent director approval of borrowings in excess of the Leverage Limit until such point as our borrowings do not exceed the Leverage Limit. As a result of the debt incurred on the acquisition of Estates and the additional debt incurred from the investment in Overlook at Stone Oak Park, our borrowings exceeded the Leverage Limit. A majority of our independent directors approved borrowings in excess of the Leverage Limit. Our independent directors determined that exceeding the Leverage Limit was justified because we were in the process of raising our equity capital in the Continuous Offering to acquire our portfolio. As a result, we expect that our debt levels will be higher until we have raised additional equity capital and repaid a portion of our initial leverage. If necessary, we expect to repay the Credit Facility by exchanging the Collateral, or with proceeds from a subsequent offering of our common stock or from sales of our assets.

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Contractual Obligations and Commitments

The following table summarizes our contractual obligations and commitments as of September 30, 2017 for the next five calendar years subsequent to September 30, 2017. Interest expense due by period on our floating rate debt is based on one-month LIBOR, which was 1.2322% as of September 30, 2017.

 

Income Taxes

We anticipate that we will elect to be taxed as a REIT for U.S. federal income tax purposes beginning with our 2017 tax year, and we intend to continue to operate in a manner that will permit us to qualify as a REIT. To qualify as a REIT, we must meet certain organizational and operational requirements, including requirements to pass the “closely-held test” and to distribute at least 90% of our annual REIT taxable income to stockholders. As a REIT, we will be subject to federal income tax on our undistributed REIT taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which distributions we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. If we fail to qualify as a REIT in any taxable year, we will be subject to U.S. federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate income tax rates, and dividends paid to our stockholders would not be deductible by us in computing taxable income. Any resulting corporate liability could be substantial and could materially and adversely affect our net income and net cash available for distribution to stockholders. Unless we were entitled to relief under certain Code provisions, we also would be disqualified from re-electing to be taxed as a REIT for the four taxable years following the year in which we failed to qualify to be taxed as a REIT.

We evaluate the accounting and disclosure of tax positions taken or expected to be taken in the course of preparing our tax returns to determine whether the tax positions are “more-likely-than-not” (greater than 50 percent probability) of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current year. Our management is required to analyze all open tax years, as defined by the statute of limitations, for all major jurisdictions, which include federal and certain states. We have no examinations in progress and none are expected at this time.

If we do not meet the qualifications to be taxed as a REIT, we will be taxed as a corporation for U.S. federal income tax purposes. We did not meet the qualifications to be taxed as a REIT for the 2016 tax year and will be taxed as a corporation for U.S. federal income tax purposes for the 2016 tax year. As such, we provide for income taxes using the asset and liability method under ASC 740. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize our tax positions and evaluate them by determining whether a tax position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. We will determine the amount of benefit to recognize and record the amount that is more likely than not to be realized upon ultimate settlement. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.

We had no material unrecognized tax benefit or expense, accrued interest or penalties as of September 30, 2017. Our subsidiaries and us may be subject to federal income tax as well as income tax of various state and local jurisdictions. When applicable, we recognize interest and/or penalties related to uncertain tax positions on our consolidated statements of operations and comprehensive loss.

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Deferred Tax Assets

Deferred income taxes arise principally from temporary differences between book and tax recognition of income, expenses, and losses relating to financing and other transactions. As of September 30, 2017 and December 31, 2016, we recognized total deferred tax assets, net of valuation allowances, based on the fact that we did not qualify as a REIT for the 2016 tax year. The deferred income taxes on the accompanying consolidated balances sheet at September 30, 2017 (unaudited) and December 31, 2016 are comprised of the following (in thousands):

 

The valuation allowances at September 30, 2017 and December 31, 2016 were primarily related to incurring cumulative net operating losses without generating sufficient future taxable income to recover the deferred tax assets. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable losses and projections for future taxable income over the periods in which the deferred tax assets are deductible; management believes it is more likely than not that we will not realize the benefits of these deductible differences at September 30, 2017.

Distributions

Our Board previously declared daily distributions on our Class A common stock for the period from August 1, 2016 through February 28, 2017. On March 16, 2017, our Board authorized the declaration of a special distribution to our Class A stockholders of record as of the close of business on March 16, 2017 of $0.0246 per Class A share, which is an amount equal to a daily distribution of $0.00164 per Class A share of common stock, for the period of March 1, 2017 to March 15, 2017. Our Board has also approved and authorized the declaration of a daily distribution to our Class A stockholders of record as of the close of business on each day of the period commencing on March 16, 2017 and ending March 31, 2018. Distributions for all record dates of a given month are paid approximately three days following month end. We expect to continue paying monthly distributions unless our results of operations, our general financial condition, general economic conditions or other factors prohibit us from doing so. We may declare distributions in excess of our cash flows from operations. As a result, our distribution rate and payment frequency may vary from time to time.

Distributions declared (1) accrue daily to our Class A stockholders of record as of the close of business on each day, (2) are payable in cumulative amounts on or before the third day of each calendar month with respect to the prior month and (3) are calculated at a rate of $0.00164 per share per day during the period ended March 31, 2018, which if paid each day over a 365-day period is equivalent to a 6.0% annualized distribution rate based on a purchase price of $10.00 per share of Class A common stock.

During the three and nine months ended September 30, 2017, we declared distributions on our Series A cumulative preferred stock of approximately $3,900 and $10,600, respectively.

The Class A common stock distributions declared and paid during each of the last four fiscal quarters ended September 30, 2017, along with the amount of distributions reinvested pursuant to the DRIP, were as follows:

 

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For the three and nine months ended September 30, 2017, we paid aggregate distributions on our shares of Series A preferred stock of $0 and approximately $6,700, respectively.

For the three months ended September 30, 2017, we paid aggregate distributions on our shares of Class A common stock of approximately $170,300, including approximately $124,300 of distributions paid in cash and 4,842 shares of our Class A common stock issued pursuant to our DRIP for approximately $46,000. For the three months ended September 30, 2017, our net loss was approximately $1.9 million and we had net cash used in operating activities of approximately $0.2 million; we funded 100% of total distributions paid, including shares issued pursuant to our DRIP, from net public offering proceeds.

For the nine months ended September 30, 2017, we paid aggregate distributions on our shares of Class A common stock of approximately $481,900, including approximately $162,900 of distributions paid in cash and 33,589 shares of our Class A common stock issued pursuant to our DRIP for approximately $319,000. For the nine months ended September 30, 2017, our net loss was approximately $2.6 million and we had net cash used in operating activities of less than $0.1 million; we funded 100% of total distributions paid, including shares issued pursuant to our DRIP, from net public offering proceeds.

On July 26, 2017, in connection with the termination of the Continuous Offering, the DRIP was terminated.

We expect to continue paying monthly distributions to our stockholders. Because all of our operations are performed indirectly through the OP, our ability to pay distributions depends on the OP’s ability to pay distributions to its partners, including to us. If we do not have enough cash from operations to fund the distributions, we may borrow, issue additional securities or sell assets in order to fund the distributions. We have not established any limit on the amount of proceeds from the issuance of securities that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would: (1) cause us to be unable to pay our debts as they become due in the usual course of business; or (2) cause our total assets to be less than the sum of our total liabilities plus, unless our charter provides otherwise, senior liquidation preferences, if any.

In addition, the fees, distributions and reimbursements payable to the Advisor or its affiliates depend on various factors, including the assets we acquire, indebtedness incurred, and sales prices of assets sold, and therefore cannot be quantified or reserved for until such fees have been earned. We are required to pay these amounts to the Advisor or its affiliates regardless of the amount of cash we distribute to our stockholders and therefore our ability to make distributions from cash flow, as well as cash flow available for investment, to our stockholders may be negatively impacted.

Distributions are paid to our stockholders when and if authorized by the Board and declared by us out of legally available funds. Distributions are authorized at the discretion of the Board, which is influenced in part by its intention to comply with the REIT requirements of the Code. We intend to make distributions sufficient to meet the annual distribution requirement and to avoid U.S. federal income and excise taxes on our earnings; however, it may not always be possible to do so. Each distribution will be accompanied by a notice which sets forth: (a) the record date; (b) the amount per share that will be distributed; (c) the equivalent annualized yield; and (d) the amount and percentage of the distributions paid from operations, offering proceeds and other sources. The funds we receive from operations that are available for distribution may be affected by a number of factors, including the following:

We must annually distribute at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain, in order to meet the requirements for qualification as a REIT under the Code. The Board may authorize distributions in excess of this percentage

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as it deems appropriate. Because we may receive income or rents at various times during our fiscal year, distributions may not reflect our income earned in that particular distribution period, but may be made in anticipation of cash flow that we expect to receive during a later period and may be made in advance of actual receipt of funds in an attempt to make distributions relatively uniform. To allow for such differences in timing between the receipt of income and the payment of expenses, and the effect of required debt payments, among other things, we could be required to borrow funds from third parties on a short-term basis, issue new securities, or sell assets to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. These methods of obtaining funding could affect future distributions by increasing operating costs and decreasing available cash. In addition, such distributions may constitute a return of capital.

Distributions in kind will not be permitted, except for:

Off-Balance Sheet Arrangements

As of September 30, 2017, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. As of September 30, 2017, we own an interest in one joint venture that is accounted for under the equity method of accounting as we exercise significant influence over, but do not control, the investee.

Related-Party Transactions and Agreements

We have entered into agreements with the Advisor and its affiliates, whereby we pay certain fees to, or reimburse certain expenses of, the Advisor or its affiliates for acquisition and asset management fees and expenses, organization and offering expenses, reimbursement of certain operating costs, and possibly disposition fees. Refer to Note 10 to our consolidated financial statements for a discussion of the various related-party transactions, agreements and fees.

From the commencement of the Continuous Offering through July 26, 2017, the date which the Continuous Offering was terminated, we paid the Dealer Manager selling commissions and dealer manager fees totaling $5,000.

Inflation

Consistent with the multifamily property focus, the majority of the leases we enter into for multifamily apartment homes are for terms of typically one year or less. These terms provide us with maximum flexibility to implement rental increases when the market will bear such increases and may provide us with a hedge against inflation.

Valuation Guidelines; Calculation of NAV

Pursuant to rules recently promulgated by FINRA effective as of April 11, 2016, since we have not yet disclosed an estimated NAV per share, our stockholders’ customer account statements will include a value per share that is equal to the public offering price less all up-front underwriting compensation and certain organization and offering expenses. We are not required to provide an estimated NAV based on the value of our assets until August 21, 2018, which is 150 days following the second anniversary of the date we broke escrow in the Continuous Offering (the “NAV Pricing Date”). Prior to providing an estimated NAV based on a valuation of our assets, the per share values that we report will not reflect the proceeds our stockholders would receive upon liquidation or upon the sale of their shares. Furthermore, in the event of any voluntary or involuntary liquidation, dissolution or winding up of us, or any liquidating distribution of our assets, then such assets, or the proceeds therefrom, will be distributed between the holders of Class A shares and Class T shares ratably in proportion to the respective NAV for each class until the NAV for each class has been paid. The NAV will be calculated on a company-wide basis, with any adjustments to Class A or Class T shares made subsequent to such company-wide calculation. For purposes of calculating NAV, we intend to use the most recent price paid to acquire the applicable class of shares in the primary offering (ignoring purchase price discounts for certain categories of purchasers) as the estimated per share value of our shares until the Board determines our NAV. Each holder of shares of a particular class of common stock will be entitled to receive, ratably with each other holder of shares of such class, that portion of such aggregate assets available for distribution as the number of outstanding shares of such class held by such holder bears to the total number of outstanding shares of such class then outstanding.

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Prior to August 21, 2018, which is 150 days following the second anniversary of the date we broke escrow in the Continuous Offering (or earlier if the Board so directs or applicable regulations require), we are required to provide an initial estimated NAV per share of each class of our common stock based on the value of our assets. We will provide an update of the initial estimated NAV as of the end of each completed fiscal quarter (or fiscal year, in the case of a quarter ending at a fiscal year-end) thereafter. Once we are required to provide an estimated NAV per share, our NAV will be determined by the Board based on the input of the Advisor, our audit committee and, if engaged by the Board, one or more independent valuation firms. We intend to base our calculation of estimated NAV on the values of our assets and liabilities, without ascribing additional value to our enterprise or the going concern of our business. We expect that the values of our assets and liabilities will reflect the specific terms of our investments and our indebtedness, as well as conditions prevailing in the real estate, credit and broader financial markets. In addition, on a quarterly basis, management will update our NAV to reflect changes in the fair value of our indebtedness, estimated asset disposition costs (including estimates of fees payable to the Advisor and its affiliates), and our other net assets and liabilities. In general, after the NAV Pricing Date, we expect to report our quarterly estimated NAV in filings with the SEC and on our website.

Significant Accounting Policies and Critical Accounting Estimates

Our significant accounting policies are those having the most impact on the reporting of our financial condition and results and those requiring significant judgments and estimates. These policies include those related to: (1) principles of consolidation and basis of presentation, (2) real estate investments, (3) impairment and (4) equity in income.

Our significant accounting policies are disclosed in Note 2 “Summary of Significant Accounting Policies” to the consolidated financial statements.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the adverse effect on the value of assets and liabilities that results from a change in market conditions. Our primary market risk exposure is interest rate risk with respect to our indebtedness. As of September 30, 2017, we had total indebtedness of $37.9 million, which is floating rate debt with a variable interest rate.

An increase in interest rates could make the financing of any acquisition by us costlier. Rising interest rates could also limit our ability to refinance our debt when it matures or cause us to pay higher interest rates upon refinancing and increase interest expense on refinanced indebtedness. We may manage, or hedge, interest rate risks related to our borrowings by means of derivative financial instruments, such as interest rate swaps, interest rate caps and rate lock arrangements. As of September 30, 2017, an interest rate cap agreement covered $26.9 million of the $37.9 million of our total outstanding indebtedness. This interest rate cap agreement caps the related floating rate debt at 6.00% for the term of the agreement, which is 3 years. We also expect to manage our exposure to interest rate risk by maintaining a mix of fixed and variable rates for our indebtedness. Increasing rates may make fundraising more difficult if potential investors perceive a rise in rates as a negative for multifamily fundamentals.

As of September 30, 2017, the weighted average interest rate of our total indebtedness was 3.74%. Until the interest rate on our $26.9 million of floating rate mortgage debt reaches the cap provided by its interest rate cap agreement, each increase of 25 basis points to the interest rate would result in an approximate increase to our total annual interest expense of the amounts illustrated in the table below for our indebtedness as of September 30, 2017 (in thousands):

There is no assurance that we would realize such expense as such changes in interest rates could alter our liability positions or strategies in response to such changes.

We may also be exposed to credit risk in such derivative financial instruments we use. Credit risk is the failure of the counterparty to perform under the terms of the derivative financial instrument. We seek to minimize the credit risk in derivative financial instruments by entering into transactions with high-quality counterparties.

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Item 4. Controls and Procedures

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 (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 President 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 was conducted under the supervision and with the participation of our management, including our President 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 President and Chief Financial Officer concluded that our disclosure controls and procedures, as of September 30, 2017, were effective at a reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we are party to legal proceedings that arise in the ordinary course of our business. Management is not aware of any legal proceedings of which the outcome is reasonably likely to have a material adverse effect on our results of operations or financial condition, nor are we aware of any such legal proceedings contemplated by government agencies.

Item 1A. Risk Factors

We have disclosed under Part I, Item 1A, “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2016 (the “Annual Report”), filed with the U.S. Securities and Exchange Commission on March 28, 2017, risk factors which materially affect our business, financial condition or results of operations. There have been no material changes from the risk factors previously disclosed. You should carefully consider the risk factors set forth in the Annual Report and the other information set forth elsewhere in this quarterly report on Form 10-Q. You should be aware that these risk factors and other information may not describe every risk facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

Use of Proceeds

On August 12, 2015, our Registration Statement, registering a public offering of up to $1.1 billion in shares of our common stock, was declared effective under the Securities Act. We offered up to $1.0 billion in shares of our common stock to the public in our primary offering and up to $100 million in shares of our common stock pursuant to our DRIP. Highland Capital Funds Distributor, Inc., an affiliate of the Advisor, served as the dealer manager for our Continuous Offering.

As of September 30, 2017, we had issued 1,108,110 shares of Class A common stock, which consisted of the issuance of 434,783 shares to acquire a 95% interest in Estates and the issuance of 673,327 shares, including 48,298 shares issued pursuant to the DRIP, resulting in gross proceeds of approximately $6.2 million, including approximately $458,700 of distributions reinvested through the DRIP. In connection with raising the minimum offering amount and breaking escrow, we have recorded approximately $0.1 million of organization and offering expenses through September 30, 2017 for reimbursements to the Advisor and its affiliates for organization and offering expenses incurred on our behalf.

As of September 30, 2017, we had recognized selling commissions, dealer manager fees, and organization and other offering costs in the Continuous Offering in the amounts set forth below (dollars in thousands). The dealer manager for the Continuous Offering reallowed all of the selling commissions and dealer manager fees to participating broker-dealers.

 

From the commencement of the Continuous Offering through September 30, 2017, the net offering proceeds to us, after deducting the total expenses incurred as described above, were approximately $6.1 million (exclusive of 434,783 shares of Class A common stock issued to our Sponsor in exchange for its 95% interest in Estates), including offering proceeds from the DRIP of approximately $458,700. From the commencement of the Continuous Offering through September 30, 2017, the ratio of the cost of raising equity capital to the gross amount of equity capital raised was approximately 1.16%.

On July 21, 2017, we filed a post-effective amendment to the Registration Statement to terminate the Continuous Offering and deregister all of our unsold shares of Class A common stock and Class T common stock. The post-effective amendment was declared effective by the SEC on July 26, 2017.

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Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

Fifth Amendment to Revolving Credit Agreement

On November 7, 2017, the OP and the Sponsor (the “Borrowers”) and KeyBank entered into an amendment (the “Fifth Amendment”) to the revolving credit agreement, dated April 7, 2016, as amended (the “Credit Facility”) to extend the maturity date of the Credit Facility to December 15, 2017.

Item 6. Exhibits

EXHIBIT INDEX

 

 

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

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