Attached files
| file | filename |
|---|---|
| EX-32.2 - EXHIBIT 32.2 - Resource REIT, Inc. | rreoii-20170930xex322.htm |
| EX-32.1 - EXHIBIT 32.1 - Resource REIT, Inc. | rreoii-20170930xex321.htm |
| EX-31.2 - EXHIBIT 31.2 - Resource REIT, Inc. | rreoii-20170930xex312.htm |
| EX-31.1 - EXHIBIT 31.1 - Resource REIT, Inc. | rreoii-20170930xex311.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2017
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission file number 000-55430
Resource Real Estate Opportunity REIT II, Inc.
(Exact name of registrant as specified in its charter)
Maryland | 80-0854717 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
1845 Walnut Street, 18th Floor, Philadelphia, PA, 19103 |
(Address of principal executive offices) (Zip code) |
(215) 231-7050 |
(Registrant's telephone number, including area code) |
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 R No o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No o
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 definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer o | (Do not check if a smaller reporting company) | Smaller reporting company þ |
Emerging growth company þ | ||
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 Act). Yes o No þ
As of November 10, 2017, there were 60,520,482 outstanding shares of common stock of Resource Real Estate Opportunity REIT II, Inc.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
PAGE | ||
PART I | FINANCIAL INFORMATION | |
ITEM 1. | Financial Statements | |
ITEM 2. | ||
ITEM 3. | ||
ITEM 4. | ||
PART II | OTHER INFORMATION | |
ITEM 2. | ||
ITEM 6. | ||
Forward-Looking Statements
Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expects,” “intend,” “may,” “plan,” “potential,” “project,” “should,” “will” and “would” or the negative of these terms or other comparable terminology. Actual results may differ materially from those contemplated by such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this report, except as may be required under applicable law.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
September 30, 2017 | December 31, 2016 | |||||||
(unaudited) | ||||||||
ASSETS | ||||||||
Investments: | ||||||||
Rental properties, net | $ | 803,126 | $ | 754,588 | ||||
Identified intangible assets, net | 286 | 2,689 | ||||||
803,412 | 757,277 | |||||||
Cash | 87,457 | 104,889 | ||||||
Restricted cash | 8,420 | 6,620 | ||||||
Tenant receivables, net | 92 | 68 | ||||||
Due from related parties | 121 | 604 | ||||||
Prepaid expenses and other assets | 2,379 | 1,852 | ||||||
Total assets | $ | 901,881 | $ | 871,310 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Liabilities: | ||||||||
Mortgage notes payable, net | $ | 531,403 | $ | 455,361 | ||||
Accounts payable and accrued expenses | 14,002 | 11,997 | ||||||
Due to related parties | 614 | 2,648 | ||||||
Tenant prepayments | 565 | 546 | ||||||
Security deposits | 1,244 | 1,097 | ||||||
Distributions payable | 9,021 | 8,769 | ||||||
Total liabilities | 556,849 | 480,418 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock (par value $.01, 10,000,000 shares authorized, none issued and outstanding) | — | — | ||||||
Convertible stock (par value $.01; 50,000 shares authorized, 50,000 issued and outstanding) | 1 | 1 | ||||||
Common stock (par value $.01; 1,000,000,000 shares authorized, 60,309,199 and 59,160,177 issued and outstanding at September 30, 2017 and December 31, 2016, respectively) | 602 | 591 | ||||||
Additional paid-in capital | 530,602 | 520,746 | ||||||
Accumulated other comprehensive loss | (437 | ) | (74 | ) | ||||
Accumulated deficit | (185,736 | ) | (130,372 | ) | ||||
Total stockholders’ equity | 345,032 | 390,892 | ||||||
Total liabilities and stockholders’ equity | $ | 901,881 | $ | 871,310 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share data)
(unaudited)
Three Months Ended | Nine Months Ended | ||||||||||||||
September 30, | September 30, | ||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||
Revenues: | |||||||||||||||
Rental income | $ | 19,952 | $ | 15,143 | $ | 56,850 | $ | 37,378 | |||||||
Total revenues | 19,952 | 15,143 | 56,850 | 37,378 | |||||||||||
Expenses: | |||||||||||||||
Rental operating | 8,167 | 7,719 | 23,557 | 18,619 | |||||||||||
Acquisition costs | — | 2 | 1,361 | 6,846 | |||||||||||
Management fees | 3,242 | 2,635 | 9,455 | 6,566 | |||||||||||
General and administrative | 2,066 | 2,183 | 6,637 | 5,848 | |||||||||||
Loss on disposal of assets | 260 | 474 | 842 | 2,323 | |||||||||||
Depreciation and amortization expense | 9,538 | 8,214 | 29,033 | 22,940 | |||||||||||
Total expenses | 23,273 | 21,227 | 70,885 | 63,142 | |||||||||||
Loss before other income (expense) | (3,321 | ) | (6,084 | ) | (14,035 | ) | (25,764 | ) | |||||||
Other income (expense): | |||||||||||||||
Interest income | 24 | 54 | 99 | 163 | |||||||||||
Interest expense | (5,221 | ) | (3,369 | ) | (14,458 | ) | (7,524 | ) | |||||||
Net loss | (8,518 | ) | (9,399 | ) | (28,394 | ) | (33,125 | ) | |||||||
Other comprehensive loss: | |||||||||||||||
Designated derivatives, fair value adjustment | (33 | ) | (23 | ) | (363 | ) | (106 | ) | |||||||
Comprehensive loss | $ | (8,551 | ) | $ | (9,422 | ) | $ | (28,757 | ) | $ | (33,231 | ) | |||
Weighted average common shares outstanding | 60,318 | 58,321 | 59,626 | 57,462 | |||||||||||
Basic and diluted net loss per common share | $ | (0.14 | ) | $ | (0.16 | ) | $ | (0.48 | ) | $ | (0.58 | ) | |||
The accompanying notes are an integral part of these consolidated financial statements.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2017
(in thousands)
(unaudited)
Common Stock | Convertible Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Loss | Accumulated Deficit | ||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Total | ||||||||||||||||||||||||||
Balance, at January 1, 2017 | 59,160 | $ | 591 | 50 | $ | 1 | $ | 520,746 | $ | (74 | ) | $ | (130,372 | ) | $ | 390,892 | ||||||||||||||
Common stock issued through distribution reinvestment plan | 1,794 | 18 | — | — | 15,464 | — | — | 15,482 | ||||||||||||||||||||||
Distributions declared | — | — | — | — | — | — | (26,970 | ) | (26,970 | ) | ||||||||||||||||||||
Common stock redemptions | (645 | ) | (7 | ) | — | — | (5,608 | ) | — | — | (5,615 | ) | ||||||||||||||||||
Designated derivatives, fair value adjustment | — | — | — | — | — | (363 | ) | — | (363 | ) | ||||||||||||||||||||
Net loss | — | — | — | — | — | — | (28,394 | ) | (28,394 | ) | ||||||||||||||||||||
Balance, at September 30, 2017 | 60,309 | $ | 602 | 50 | $ | 1 | $ | 530,602 | $ | (437 | ) | $ | (185,736 | ) | $ | 345,032 | ||||||||||||||
The accompanying notes are an integral part of this consolidated financial statement.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended September 30, | ||||||||
2017 | 2016 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (28,394 | ) | $ | (33,125 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Loss on disposal of assets | 842 | 2,323 | ||||||
Depreciation and amortization | 29,033 | 22,940 | ||||||
Amortization of deferred financing costs | 864 | 510 | ||||||
Amortization of mortgage premiums | (89 | ) | (91 | ) | ||||
Change in fair value of interest rate swap | 7 | 147 | ||||||
Changes in operating assets and liabilities: | ||||||||
Restricted cash | (2,630 | ) | (2,694 | ) | ||||
Tenant receivables, net | (24 | ) | (32 | ) | ||||
Due from related parties | 484 | (284 | ) | |||||
Prepaid expenses and other assets | (744 | ) | 2,615 | |||||
Due to related parties | (2,034 | ) | (3,271 | ) | ||||
Accounts payable and accrued expenses | 1,925 | 6,959 | ||||||
Tenant prepayments | 10 | 146 | ||||||
Security deposits | 58 | (41 | ) | |||||
Net cash used in operating activities | (692 | ) | (3,898 | ) | ||||
Cash flows from investing activities | ||||||||
Property acquisitions | (55,160 | ) | (239,427 | ) | ||||
Capital expenditures | (20,730 | ) | (22,832 | ) | ||||
Restricted cash - capital reserves | 830 | (540 | ) | |||||
Net cash used in investing activities | (75,060 | ) | (262,799 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from issuance of common stock | — | 49,599 | ||||||
Redemptions of common stock | (5,615 | ) | — | |||||
Payment of deferred financing costs | (1,147 | ) | (3,418 | ) | ||||
Increase in borrowings | 79,039 | 240,307 | ||||||
Repayments on borrowings | (2,625 | ) | (1,076 | ) | ||||
Purchase of interest rate caps | (97 | ) | (145 | ) | ||||
Distributions paid on common stock | (11,235 | ) | (10,433 | ) | ||||
Offering costs | — | (6,263 | ) | |||||
Net cash provided by financing activities | 58,320 | 268,571 | ||||||
Net (decrease) increase in cash | (17,432 | ) | 1,874 | |||||
Cash at beginning of period | 104,889 | 180,826 | ||||||
Cash at end of period | $ | 87,457 | $ | 182,700 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)
NOTE 1 - NATURE OF BUSINESS AND OPERATIONS (LOSS)
Resource Real Estate Opportunity REIT II, Inc. (the “Company”) was organized in Maryland on September 28, 2012. During the primary portion of the offering, the Company offered up to 100,000,000 shares of common stock in its primary initial public offering for $10 per share, with volume discounts available to certain categories of investors.The primary portion of the offering closed on February 6, 2016. The Company is currently offering up to 10,000,000 shares pursuant to the Company’s distribution reinvestment plan at a purchase price equal to $8.65 per share ($8.56 per share prior to September 30, 2017 and $9.50 per share prior to September 30, 2016). The Company has adopted a fiscal year ending December 31.
Resource Real Estate Opportunity Advisor II, LLC (the "Advisor”) is a wholly owned subsidiary of Resource Real Estate, Inc. (the "Sponsor") and an indirect wholly owned subsidiary of Resource America, Inc. (“RAI”). The Advisor acts as the Company's external advisor and manages the Company's day-to-day operations and its portfolio of real estate investments and provides asset-management, marketing, investor relations and other administrative services on the Company's behalf, all subject to the supervision of the Company's Board of Directors.
RAI is a wholly owned subsidiary of C-III Capital Partners, LLC ("C-III"), a leading commercial real estate investment management and services company engaged in a broad range of activities. C-III controls the Advisor and Resource Real Estate Opportunity Manager II, LLC, the Company's property manager (the "Manager"). C-III also controls all of the shares of common stock held by the Advisor.
As of September 30, 2017, a total of 60,880,525 shares, including the additional shares purchased by the Advisor and shares issued through the distribution reinvestment plan (but excluding shares issued through stock distributions), have been issued resulting in gross offering proceeds of $601.1 million. As of September 30, 2017, the Company had issued 5,074,228 shares for $44.7 million pursuant to its distribution reinvestment plan.
The Company’s objective is to take advantage of the Sponsor's dedicated multifamily investing and lending platforms to invest in multifamily assets across the entire spectrum of investments in order to provide stockholders with growing cash flow and increasing asset values. The Company has acquired and may continue to acquire commercial real estate assets, principally underperforming multifamily rental properties which the Company will renovate and stabilize in order to increase rents, and may acquire, to a lesser extent, real estate related debt.
The Company is organized and conducts its operations in a manner intended to allow it to qualify as a real estate investment
trust (“REIT”) for U.S. federal income tax purposes under Subchapter M of the Internal Revenue Code of 1986, as amended. The
Company also operates its business in a manner intended to maintain its exemption from registration under the Investment Company
Act of 1940, as amended.
The consolidated financial statements and the information and tables contained in the notes thereto, as of September 30, 2017, are unaudited and prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). However, in the opinion of management, these interim financial statements include all of the necessary adjustments to fairly present the results of the interim periods presented. The unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016. The results of operations for the three and nine months ended September 30, 2017 may not necessarily be indicative of the results of operations for the full year ending December 31, 2017. The consolidated balance sheet as of December 31, 2016 was derived from the audited consolidated financial statements as of December 31, 2016.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:
Basis of Presentation
The consolidated financial statements have been prepared in conformity with GAAP.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries as follows:
Subsidiary | Apartment Complex | Number of Units | Property Location | |||
RRE Opportunity Holdings II, LLC | N/A | N/A | N/A | |||
RRE Opportunity OP II, LP | N/A | N/A | N/A | |||
RRE Bear Creek Holdings, LLC, or Bear Creek | Adair off Addison | 152 | Dallas, TX | |||
RRE Oak Hill Holdings, LLC, or Oak Hill | Overton Trails Apartment Homes | 360 | Fort Worth, TX | |||
RRE Buckhead Holdings, LLC, or Buckhead | Uptown Buckhead | 216 | Atlanta, GA | |||
RRE Farrington Holdings, LLC, or Farrington | Crosstown at Chapel Hill | 411 | Chapel Hill, NC | |||
RRE Mayfair Chateau Holdings, LLC, or Mayfair Chateau | The Brookwood | 274 | Homewood, AL | |||
RRE Fairways of Bent Tree Holdings, LLC, or Fairways of Bent Tree | Adair off Addison Apartment Homes | 200 | Dallas, TX | |||
RRE Montclair Terrace Holdings, LLC, or Montclair Holdings | Montclair Terrace | 188 | Portland, OR | |||
RRE Grand Reserve Holdings, LLC, or Grand Reserve | Grand Reserve | 319 | Naperville, IL | |||
RRE Canterwood Holdings, LLC, or Canterwood | Verdant Apartment Homes | 216 | Boulder, CO | |||
RRE Spalding Crossing Holdings, LLC, or Spalding Crossing | 1000 Spalding Apartment Homes | 252 | Atlanta, GA | |||
RRE Fox Ridge Holdings, LLC, or Fox Ridge | Arcadia Apartment Homes | 300 | Centennial, CO | |||
RRE Riverlodge Holdings, LLC, or Riverlodge | Ravina Apartment Homes | 498 | Austin, TX | |||
RRE Breckenridge Holdings, LLC, or Breckenridge | Breckenridge | 357 | Portland, OR | |||
RRE Santa Rosa Holdings, LLC, or Santa Rosa | The Palmer at Las Colinas | 476 | Irving, TX | |||
RRE Windbrooke Holdings, LLC, or Windbrooke Crossing | Windbrooke Crossing | 236 | Buffalo Grove, IL | |||
RRE Woods Holdings, LLC, or The Woods of Burnsville | The Woods of Burnsville | 400 | Burnsville, MN | |||
RRE Indigo Creek Holdings, LLC | Indigo Creek | 408 | Glendale, AZ | |||
RRE Martin's Point Holdings, LLC | N/A | N/A | N/A | |||
N/A - Not Applicable
All intercompany accounts and transactions have been eliminated in consolidation.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Segment Reporting
The Company does not evaluate performance on a relationship-specific or transactional basis and does not distinguish its principal business or group its operations on a geographical basis for purposes of measuring performance. Accordingly, the Company believes it has a single operating segment for reporting purposes in accordance with GAAP.
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 financial statements and accompanying notes. Actual results could differ from those estimates.
Rental Properties
The Company records acquired rental properties at fair value on their acquisition date. The Company considers the period of future benefit of an asset to determine its appropriate useful life, and depreciates the asset using the straight line method. The Company's estimated useful lives of its assets by class are as follows:
Buildings | 27.5 years |
Building improvements | 5.0 to 27.5 years |
Furniture, fixtures and equipment | 3.0 to 5.0 years |
Tenant improvements | Shorter of lease term or expected useful life |
Lease intangibles | Remaining term of related lease |
Improvements and replacements in excess of $1,000 are capitalized when they have a useful life greater than or equal to
one year. Resource Real Estate Opportunity Manager II (the "Manager") earns a construction management fee of 5.0% of actual aggregate costs to construct improvements, or to repair, rehab or reconstruct a property. These costs are capitalized along with the related asset. Costs of repairs and maintenance
are expensed as incurred.
As four of the Company's multifamily properties are located in the Dallas-Fort Worth area, two properties are located in Portland, Oregon, two properties are located in the Atlanta area and two properties are located in the Denver area, the Company's portfolio is currently particularly susceptible to adverse economic developments in these real estate markets. Any adverse economic or real estate developments in these markets, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for multifamily rentals resulting from the local business climate, could negatively affect the Comapny's liquidity and adversely affect its ability to fund our ongoing operations.
Impairment of Long Lived Assets
When circumstances indicate the carrying value of a property may not be recoverable, the Company reviews the asset for impairment. This review is based on an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. These estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors.
If impairment exists, due to the inability to recover the carrying value of a property, an impairment loss will be recorded to the extent that the carrying value exceeds the estimated fair value of the property for properties to be held and used. For properties held for sale, the impairment loss is the adjustment to fair value less estimated cost to dispose of the asset. These assessments have a direct impact on net income because recording an impairment loss results in an immediate negative adjustment to net income. The Company did not recognize any impairment charges during the three and nine months ended September 30, 2017 and 2016.
Allocation of Purchase Price of Acquired Assets
Upon the acquisition of real properties, the Company allocates the purchase price of properties to acquired tangible assets, consisting of land, buildings, fixtures and improvements, identified intangible lease assets, consisting of the value of above-market
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
and below-market leases, as applicable, the value of in-place leases, the value of tenant relationships, and liabilities, based in each case on their fair values.
Fair value estimates are based on information obtained from a number of sources, including information obtained about each property as a result of pre-acquisition due diligence, marketing and leasing activities. In addition, the Company may obtain independent appraisal reports. The information in the appraisal reports, along with the aforementioned information available to the Company's management, is used in allocating the purchase price. The independent appraisers have no involvement in management's allocation decisions other than providing market information.
The Company records above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The Company amortizes any capitalized above-market or below-market lease values as an increase or reduction to rental income over the remaining non-cancelable terms of the respective leases.
The Company measures the aggregate value of other intangible assets acquired based on the difference between (i) the property valued with existing in-place leases adjusted to market rental rates and (ii) the property valued as if vacant. Management’s estimates of value are expected to be made using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis). Factors to be considered by management in its analysis include an estimate of carrying costs during hypothetical expected lease-up periods considering current market conditions and costs to execute similar leases.
In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods. Management also estimates costs to execute similar leases including leasing commissions and legal and other related expenses to the extent that such costs have not already been incurred in connection with a new lease origination as part of the transaction.
The total amount of other intangible assets acquired is further allocated to customer relationship intangible values based on management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics considered by management in allocating these values include the nature and extent of the Company’s existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors.
The Company amortizes the value of in-place leases to expense over the remaining term of the underlying leases. The value of customer relationship intangibles is amortized to expense over the initial term and any renewal periods in the respective leases, but in no event does amortization periods for the intangible assets exceed the remaining depreciable life of the building. Should a tenant terminate its lease, the unamortized portion of the in-place lease value and relationship intangibles related to that customer would be charged to expense in that period.
The determination of the fair value of the assets and liabilities acquired requires the use of significant assumptions with regard to current market rental rates, discount rates and other variables. These estimates are subject to change until all information is finalized, which is generally within one year of the acquisition date.
Revenue Recognition
The Company recognizes minimum rent, including rental abatements and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related lease and includes amounts expected to be received in later years in deferred rents. The Company records property operating expense reimbursements due from tenants for common area maintenance, real estate taxes and other recoverable costs in the period the related expenses are incurred.
The specific timing of a sale is measured against various criteria related to the terms of the transaction and any continuing involvement associated with the property. If the criteria for profit recognition under the full-accrual method are not met, the Company defers the gain recognition and accounts for the continued operations of the property by applying the percentage-of-completion, reduced profit, deposit, installment or cost recovery methods, as appropriate, until the appropriate criteria are met.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
The future minimum rental payments to be received from noncancelable operating leases are $44.4 million and $306,000 for the 12-month periods ending September 30, 2018 and 2019, respectively, and none thereafter.
Revenue is primarily derived from the rental of residential housing units, however, included within rental income is other income such as pet fees, parking fees, and late fees, as well as property operating expense reimbursements due from tenants for common area maintenance, real estate taxes and other recoverable costs. The Company records the ancillary charges in the period in which they are earned or received and records the reimbursements in the period in which the related expenses are incurred.Total other income included within rental income was $1.8 million and $1.4 million for the three months ended September 30, 2017 and 2016, respectively. Total other income included within rental income was $5.7 million and $3.4 million for the nine months ended September 30, 2017 and 2016, respectively.
Tenant Receivables
The Company makes estimates of the collectability of its tenant receivables related to base rents, including straight-line rentals, expense reimbursements and other revenue or income. The Company specifically analyzes accounts receivable and historic bad debts, tenant creditworthiness, current economic trends when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, the Company makes estimates of the expected recovery of pre-petition and post-petition claims in assessing the estimated collectability of the related receivable. The Company writes off receivables when they become uncollectible. In some cases, the ultimate resolution of these claims can exceed one year. At September 30, 2017 and December 31, 2016, there were allowances for uncollectible accounts of $1,097 and $5,000, respectively.
Income Taxes
The Company elected to be taxed as a REIT, commencing with its taxable year ended December 31, 2014. To maintain its REIT qualification for U.S. federal income tax purposes, the Company is generally required to distribute at least 90% of its taxable net income (excluding net capital gains) to its stockholders as well as comply with other requirements, including certain asset, income and stock ownership tests. As a REIT, the Company is not subject to federal corporate income tax to the extent that it distributes 100% of its REIT taxable income each year. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it is subject to U.S. federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which it fails its REIT qualification. Accordingly, the Company’s failure to qualify as a REIT could have a material adverse impact on its results of operations and amounts available for distribution to its stockholders.
The dividends paid deduction of a REIT for qualifying dividends to its stockholders is computed using the Company’s taxable income as opposed to net income reported on the financial statements. Taxable income, generally, will differ from net income reported on the financial statements because the determination of taxable income is based on tax provisions and not financial accounting principles.
The Company may elect to treat certain of its subsidiaries as taxable REIT subsidiaries (“TRSs”). In general, the Company’s TRSs may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. A TRS is subject to U.S. federal, state and local corporate income taxes.
While a TRS may generate net income, a TRS can declare dividends to the Company which will be included in the Company’s taxable income and necessitate a distribution to its stockholders. Conversely, if the Company retains earnings at a TRS level, no distribution is required and the Company can increase book equity of the consolidated entity. As of September 30, 2017 and December 31, 2016, the Company had no TRSs.
Earnings Per Share
Basic earnings (loss) per share is calculated on the basis of the weighted-average number of common shares outstanding during the year. Basic earnings (loss) per share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted to common stock. None of the convertible shares (see Note 11) are included in the diluted earnings per share calculations because the necessary conditions for conversion have not been satisfied as of September 30, 2017 (were such date to represent the end of the contingency period). For the three and nine months ended September 30, 2017 and 2016, common shares potentially issuable to settle distributions payable are excluded from the calculation of diluted earnings per share calculations, as their inclusion would be anti-dilutive.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Organization and Offering Costs
The Company incurred organizational, accounting, and offering costs in pursuit of its financing. Organization and offering costs (other than selling commissions and dealer-manager fees) of the Company were initially paid by the Advisor on behalf of the Company. Organization costs were expensed as incurred and included all expenses incurred by the Company in connection with the formation of the Company, including, but not limited to, legal fees and other costs to incorporate the Company.
Pursuant to the Amended and Restated Advisory Agreement between the Company and the Advisor dated January 9, 2014, as amended (the “Advisory Agreement”), the Company is obligated to reimburse the Advisor for organization and offering costs it incurred on the Company's behalf, but only to the extent that such reimbursements did not cause organization and offering expenses (other than selling commissions and the dealer manager fees) to exceed 2.5% of the gross offering proceeds raised in the offering, when recorded by the Company. The primary portion of the offering closed on February 6, 2016, at which point total organization and offering costs incurred did not exceed 2.5% of the gross offering proceeds raised in the offering.
During the offering period, the Company incurred $11.2 million for the payment of offering costs consisting of accounting, advertising, allocated payroll, due diligence, marketing, legal and similar costs. During the offering period, the Advisor had incurred $7.2 million of these costs on behalf of the Company, all of which had been reimbursed. A portion of these costs was charged to equity upon the sale of each share of common stock sold under the public offering. Similarly, a portion of the proceeds received from the sales of shares in the Company's public offering was paid to the Advisor to reimburse it for the amount incurred on behalf of the Company.
Adoption of New Accounting Standards
Accounting Standards Issued But Not Yet Effective
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, “Revenue from Contracts with Customers”, which will replace most existing revenue recognition guidance in GAAP. The core principle of ASU No. 2014-09 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASU No. 2014-09 requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. ASU No. 2014-09 will be effective for the Company beginning January 1, 2018, including interim periods in 2018, and allows for both retrospective and prospective methods of adoption. In accordance with the Company's plan for adoption of ASU No. 2014-09, the Company has identified revenue streams and is performing an in-depth review to identify the related performance obligations and to evaluate the impact on the Company's consolidated financial statements and internal accounting processes and controls. As the majority of the Company's revenue is derived from lease contracts, the Company does not expect the adoption of ASU No. 2014-09 or related amendments and modifications issued by FASB to have a material effect on its consolidated financial statements.
In February 2016, FASB issued ASU No. 2016-02, "Leases" ("ASU No. 2016-02"), which is intended to improve financial reporting about leasing transactions and requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. In September 2017, FASB issued ASU 2017-13, "Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842)", which provides additional implementation guidance on the previously issued ASU No. 2016-02 Leases (Topic 842). ASU No. 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is continuing to evaluate this guidance, however, the Company expects that its operating leases where it is the lessor will be accounted for on its balance sheet similar to its current accounting with the underlying leased asset recognized as real estate. The Company expects that executory costs and certain other non-lease components will need to be accounted for separately from the lease component of the lease with the lease component continuing to be recognized on a straight-line basis over the lease term and the executory costs and certain other non-lease components being accounted for under the new revenue recognition guidance in ASU 2014-09. For leases in which the Company is the lessee, primarily consisting of office equipment leases, the Company expects to recognize a right-of-use asset and a lease liability equal to the present value of the minimum lease payments with rental payments being applied to the lease liability and to interest expense and the right-of-use asset being amortized to expense on a straight-line basis over the term of the lease.
In June 2016, FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses”, which requires measurement and recognition of expected credit losses for financial assets held. ASU No. 2016-13 will be effective for the Company beginning
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
January 1, 2019. The Company is evaluating this guidance; however, it does not expect the adoption of ASU No. 2016-13 to have a significant impact on its consolidated financial statements.
In January 2017, FASB issued ASU No. 2017-01, "Business Combinations (Topic 850): Clarifying the Definition of Business", which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of businesses. ASU No. 2017-01 will be effective for the Company beginning January 1, 2018. Early application is permitted. The Company is evaluating this guidance and assessing the impact of this guidance on its consolidated financial statements.
In January 2017, FASB issued ASU No. 2017-04, "Intangibles- Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment", which alters the current goodwill impairment testing procedures. ASU No. 2017-04 will be effective for the Company beginning December 15, 2019. Early application is permitted. The Company is evaluating this guidance and assessing the impact of this guidance on its consolidated financial statements.
In August 2017, FASB issued ASU No. 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities", which expands and refines hedge accounting for both financial and non-financial risk components, aligns the recognition and presentation of the effects of hedging instruments and hedge items in the financial statements, and includes certain targeted improvements to ease the application of current guidance related to the assessment of hedge effectiveness. The update to the standard is effective for the Company on January 1, 2019, with early adoption permitted in any interim period. The Company is continuing to evaluate this guidance.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
NOTE 3 - SUPPLEMENTAL CASH FLOW INFORMATION
The following table presents supplemental cash flow information (in thousands):
Nine Months Ended | |||||||
September 30, | |||||||
2017 | 2016 | ||||||
Non-cash operating, financing and investing activities: | |||||||
Distributions on common stock declared but not yet paid | $ | 9,021 | $ | 8,788 | |||
Stock issued pursuant to distribution reinvestment plan | 15,482 | 15,410 | |||||
Rental property and other assets acquired through assumption of mortgage notes payable | — | 28,074 | |||||
Cash paid during the period for: | |||||||
Interest | $ | 13,159 | $ | 5,723 | |||
NOTE 4 - RESTRICTED CASH
Restricted cash represents escrow deposits with lenders to be used to pay real estate taxes, insurance, and capital improvements. A summary of the components of restricted cash follows (in thousands):
September 30, 2017 | December 31, 2016 | ||||||
Real estate taxes | $ | 5,482 | $ | 3,252 | |||
Insurance | 722 | 671 | |||||
Capital improvements | 1,866 | 2,697 | |||||
$ | 8,420 | $ | 6,620 | ||||
In addition, the Company had unrestricted cash earmarked for capital expenditures of $49.2 million and $71.7 million as of September 30, 2017 and December 31, 2016, respectively.
NOTE 5 - RENTAL PROPERTIES, NET
The Company’s investments in rental properties consisted of the following (in thousands):
September 30, 2017 | December 31, 2016 | ||||||
Land | $ | 115,789 | $ | 108,587 | |||
Building and improvements (1) | 714,845 | 650,385 | |||||
Furniture, fixtures and equipment (1) | 19,553 | 14,982 | |||||
Construction in progress | 5,163 | 7,641 | |||||
855,350 | 781,595 | ||||||
Less: accumulated depreciation | (52,224 | ) | (27,007 | ) | |||
$ | 803,126 | $ | 754,588 | ||||
(1) The Company has reclassified $21.3 million at December 31, 2016 from Furniture, fixtures and equipment to Building and improvements. This reclassification had no impact on accumulated depreciation or estimated useful lives.
Depreciation expense for the three and nine months ended September 30, 2017 was $9.0 million and $25.5 million, respectively. Depreciation expense for the three and nine months ended September 30, 2016 was $6.3 million and $15.1 million, respectively.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
NOTE 6 - ACQUISITIONS
As of September 30, 2017, the Company owned 17 properties. In order to finalize the fair values of the acquired assets and liabilities, the Company obtained third-party appraisals. The Company has up to 12 months from the date of acquisition to finalize the valuation for each property. All valuations for acquisitions in 2016 and prior had been finalized as of December 31, 2016. The initial purchase price allocation for Indigo Creek has not been finalized as of September 30, 2017.
The table below summarizes the Company's wholly-owned acquisition during the three and nine months ended September 30, 2017 and the respective fair values assigned (in thousands):
Fair Value Assigned | ||||||||||||||||||||||||||||||||
Multifamily Community Name | City and State | Date of Acquisition | Contractual Purchase Price (1) | Land | Building and Improvements | Furniture, Fixture and Equipment | Intangible Assets | Debt assumed | Other Liabilities | |||||||||||||||||||||||
Indigo Creek | Glendale, Arizona | 4/4/2017 | $ | 55,200 | $ | 7,202 | $ | 46,348 | $ | 508 | $ | 1,143 | $ | — | $ | (97 | ) | |||||||||||||||
(1) Contractual purchase price excludes closing costs and acquisition expenses and other immaterial settlement date adjustments and pro-rations.
The table below summarizes the total revenues, net loss, and acquisition costs and fees of the Company's 2017 acquisition (in thousands):
Three Months Ended | Nine Months Ended | ||||||||
September 30, | September 30, | ||||||||
Multifamily Community | 2017 | 2017 | |||||||
Indigo Creek | |||||||||
Total Revenues | $ | 1,257 | $ | 2,352 | |||||
Net Loss | (660 | ) | (1,343 | ) | |||||
Acquisition Costs | — | 137 | |||||||
Acquisition Fee | — | 1,141 | |||||||
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
NOTE 7 - IDENTIFIED INTANGIBLE ASSETS, NET
Identified intangible assets, net, consist of in-place rental leases. The gross value of acquired in-place leases totaled $17.4 million and $16.3 million as of September 30, 2017 and December 31, 2016, and the intangible assets are reported net of accumulated amortization of $17.1 million and $13.6 million, respectively. The weighted average remaining life of the in-place rental leases is one month as of September 30, 2017. Amortization for the three months ended September 30, 2017 and 2016 was $552,846 and $1.9 million, respectively. Amortization for the nine months ended September 30, 2017 and 2016 was $3.5 million and $7.8 million, respectively. As of September 30, 2017, expected amortization for the in-place rental leases for the next 12 months is $285,746 and none thereafter.
NOTE 8 - MORTGAGE NOTES PAYABLE, NET
The following is a summary of the Company's mortgage notes payable (in thousands):
Outstanding borrowings | Premium, net | Deferred Finance Costs, net | Carrying Value | Outstanding borrowings | Premium, net | Deferred Finance Costs, net | Carrying Value | |||||||||||||||||||||||||
Collateral | September 30, 2017 | December 31, 2016 | ||||||||||||||||||||||||||||||
Overton Trails Apartment Homes | $ | 30,646 | $ | — | $ | (302 | ) | $ | 30,344 | $ | 31,075 | $ | — | $ | (344 | ) | $ | 30,731 | ||||||||||||||
Uptown Buckhead | 20,135 | — | (257 | ) | 19,878 | 20,200 | — | (284 | ) | 19,916 | ||||||||||||||||||||||
Crosstown at Chapel Hill | 31,930 | — | (292 | ) | 31,638 | 32,000 | — | (373 | ) | 31,627 | ||||||||||||||||||||||
The Brookwood - Key Bank | 17,968 | 426 | (200 | ) | 18,194 | 18,247 | 508 | (239 | ) | 18,516 | ||||||||||||||||||||||
The Brookwood - Capital One | 2,668 | 33 | (35 | ) | 2,666 | 2,699 | 39 | (41 | ) | 2,697 | ||||||||||||||||||||||
Adair off Addison and Adair off Addison Apartment Homes | 25,205 | — | (377 | ) | 24,828 | 25,500 | — | (464 | ) | 25,036 | ||||||||||||||||||||||
1000 Spalding Apartment Homes | 24,600 | — | (245 | ) | 24,355 | 24,600 | — | (289 | ) | 24,311 | ||||||||||||||||||||||
Ravina Apartment Homes | 27,802 | — | (335 | ) | 27,467 | 28,292 | — | (393 | ) | 27,899 | ||||||||||||||||||||||
Verdant Apartment Homes | 37,300 | — | (303 | ) | 36,997 | 37,300 | — | (345 | ) | 36,955 | ||||||||||||||||||||||
Arcadia Apartment Homes | 40,200 | — | (333 | ) | 39,867 | 40,200 | — | (379 | ) | 39,821 | ||||||||||||||||||||||
Grand Reserve | 41,738 | — | (390 | ) | 41,348 | 42,395 | — | (446 | ) | 41,949 | ||||||||||||||||||||||
Montclair Terrace | 20,774 | — | (302 | ) | 20,472 | 21,083 | — | (345 | ) | 20,738 | ||||||||||||||||||||||
Breckenridge | 52,975 | — | (613 | ) | 52,362 | 52,975 | — | (697 | ) | 52,278 | ||||||||||||||||||||||
The Palmer at Las Colinas | 45,700 | — | (591 | ) | 45,109 | 45,700 | — | (643 | ) | 45,057 | ||||||||||||||||||||||
Windbrooke Crossing | 38,320 | — | (431 | ) | 37,889 | 38,320 | — | (490 | ) | 37,830 | ||||||||||||||||||||||
Woods of Burnsville | 38,250 | — | (558 | ) | 37,692 | — | — | — | — | |||||||||||||||||||||||
Indigo Creek | 40,789 | — | (492 | ) | 40,297 | — | — | — | — | |||||||||||||||||||||||
$ | 537,000 | $ | 459 | $ | (6,056 | ) | $ | 531,403 | $ | 460,586 | $ | 547 | $ | (5,772 | ) | $ | 455,361 | |||||||||||||||
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Maturity Date | Margin over LIBOR | Annual Interest Rate | Average Monthly Debt Service | Average Monthly Escrow | ||||||||||||
Overton Trails Apartment Homes | 1/1/2025 | 1.91 | % | 3.14 | % | 118 | 117 | (1) (3) (6) | ||||||||
Uptown Buckhead | 7/1/2025 | 2.22 | % | 3.45 | % | 79 | 58 | (1) (3) (5) | ||||||||
Crosstown at Chapel Hill | 7/10/2020 | 1.70 | % | 2.93 | % | 100 | — | (1) (4) (5) | ||||||||
The Brookwood - Key Bank | 11/1/2021 | N/A | 4.73 | % | 104 | 48 | (2) (7) | |||||||||
The Brookwood - Capital One | 11/1/2021 | N/A | 5.40 | % | 16 | — | (2) (7) | |||||||||
Adair off Addison and Adair off Addison Apartment Homes | 1/1/2021 | 1.55 | % | 2.78 | % | 88 | — | (1) (3) | ||||||||
1000 Spalding Apartment Homes | 1/1/2022 | N/A | 3.88 | % | 113 | 47 | (2) (5) | |||||||||
Ravina Apartment Homes | 5/1/2022 | N/A | 3.76 | % | 144 | 157 | (2) (7) | |||||||||
Verdant Apartment Homes | 5/1/2023 | N/A | 3.89 | % | 159 | 29 | (2) (5) | |||||||||
Arcadia Apartment Homes | 5/1/2023 | N/A | 3.89 | % | 172 | 20 | (2) (5) | |||||||||
Grand Reserve | 6/1/2023 | 2.57 | % | 3.80 | % | 184 | 86 | (1) (3) (6) | ||||||||
Montclair Terrace | 6/1/2023 | 2.45 | % | 3.68 | % | 93 | 24 | (1) (3) (7) | ||||||||
Breckenridge | 7/1/2023 | 2.36 | % | 3.59 | % | 223 | 58 | (1) (3) (5) | ||||||||
The Palmer at Las Colinas | 9/1/2026 | 2.11 | % | 3.34 | % | 149 | 146 | (1) (3) (5) | ||||||||
Windbrooke Crossing | 1/1/2024 | 2.69 | % | 3.92 | % | 203 | 67 | (1) (3) (5) | ||||||||
Woods of Burnsville | 2/1/2024 | 2.13 | % | 3.36 | % | 171 | 67 | (1) (3) (5) | ||||||||
Indigo Creek | 4/1/2024 | 1.93 | % | 3.16 | % | 220 | 52 | (1) (3) (5) | ||||||||
(1) | Variable rate based on one-month LIBOR of 1.2322% (as of September 30, 2017) plus a fixed margin |
(2) | Fixed rate |
(3) | Variable rate hedged with interest rate cap cash flow hedge |
(4) | Fixed rate interest swap associated with the variable rate debt |
(5) | Monthly interest-only payment currently required |
(6) | Monthly fixed principal plus interest payment required |
(7) | Fixed monthly payment of principal and interest payment required |
On August 21, 2015, the Company recorded a premium, which represented the fair value of the debt assumed over its principal amount in connection with The Brookwood Apartment Homes acquisition. The premium will be amortized to interest expense over the term of the related mortgages loans using the effective interest method. As of September 30, 2017, the net unamortized premium was $459,000 and was included as a component of mortgage loans payable in the accompanying consolidated balance sheets.
At September 30, 2017, the weighted average interest rate of all the Company's outstanding indebtedness was 3.57%.
All mortgage notes are collateralized by mortgage liens on the assets of the respective property as named in the table above. The amount outstanding on the mortgages may be prepaid in full during the entire term with a prepayment penalty on the majority of the mortgages held.
As of September 30, 2017 and December 31, 2016, the Company had $8.4 million and $6.6 million, respectively of restricted cash related to escrow deposits held by mortgage lenders for real estate taxes, insurance and capital reserves (see Note 4).
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Annual principal payments on the mortgage notes payable, excluding amortization of the mortgage premium, for each of the next five 12-month periods ending September 30, and thereafter, are as follows (in thousands):
2018 | $ | 5,668 | |
2019 | 9,391 | ||
2020 | 42,877 | ||
2021 | 35,261 | ||
2022 | 77,360 | ||
Thereafter | 366,443 | ||
Total principal payments | $ | 537,000 | |
The mortgage notes payable are recourse only with respect to the properties that secure the notes, subject to certain limited standard exceptions, as defined in each mortgage note. These exceptions are referred to as “carveouts.” The Company has guaranteed the mortgage notes by executing a guarantee with respect to the properties. In general, carveouts relate to damages suffered by the lender for a borrower’s failure to pay rents, insurance or condemnation proceeds to lender, failure to pay water, sewer and other public assessments or charges, failure to pay environmental compliance costs or to deliver books and records, in each case as required in the loan documents. The exceptions also require the Company to guarantee payment of audit costs, lender’s enforcement of its rights under the loan documents and payment of the loan if the borrower voluntarily files for bankruptcy or seeks reorganization, or if a related party of the borrower does so with respect to the subsidiary. The Company had also guaranteed the completion and payment of costs of completion of no less than $1.8 million for renovations at Uptown Buckhead by June 30, 2017, all of which were completed as of September 30, 2017. For the Crosstown at Chapel Hill Mortgage Loan, beginning with the calendar quarter ending December 31, 2017, the property must maintain a certain level of debt service coverage.
Deferred financing costs incurred to obtain financing are amortized over the term of the related debt. As of September 30, 2017 and December 31, 2016, accumulated amortization of deferred financing costs was $1.7 million and $877,000, respectively. Amortization of deferred financing costs for the next five 12-month periods ending September 30, and thereafter, is as follows (in thousands):
2018 | $ | 1,176 | |
2019 | 1,159 | ||
2020 | 1,110 | ||
2021 | 931 | ||
2022 | 750 | ||
Thereafter | 930 | ||
$ | 6,056 | ||
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
NOTE 9 - ACCUMULATED OTHER COMPREHENSIVE LOSS
The following table presents the changes in accumulated other comprehensive loss (in thousands):
Net unrealized loss on derivatives | |||
January 1, 2017 | (74 | ) | |
Designated derivatives, fair value adjustment | (363 | ) | |
Balance, September 30, 2017 | $ | (437 | ) |
NOTE 10 - RELATED PARTY TRANSACTIONS
Relationship with the Advisor
Pursuant to the terms of the Advisory Agreement, the Advisor provides the Company with the services of its management team, including its officers, along with appropriate support personnel. The Advisor is reimbursed for the Company’s allocable share of costs for Advisor personnel, including allocable personnel salaries and benefits. Each of the Company’s officers is an employee of the Sponsor or one of its affiliates. The Company does not have any employees. The Advisor is not obligated to dedicate any specific portion of its time or the time of its personnel to the Company’s business. The Advisor is at all times subject to the supervision and oversight of the Company’s Board of Directors and has only such functions and authority as the Company delegates to it.
During the course of the primary offering, the Advisor provided offering-related services to the Company and advanced funds to the Company for both operating costs and organization and offering costs. These amounts were reimbursed to the Advisor from the proceeds from the offering. During the offering period, which closed in 2016, the Advisor had incurred costs on a cumulative basis on behalf of the Company of approximately $7.2 million, all of which had been reimbursed as of December 31, 2016.
The Advisory Agreement has a one-year term and renews for an unlimited number of successive one-year terms upon the approval of the conflicts committee of the Company's Board of Directors. Under the Advisory Agreement, the Advisor receives fees and is reimbursed for its expenses as set forth below:
Acquisition fees. The Advisor earns an acquisition fee of 2.0% of the cost of investments acquired on behalf of the Company, plus any capital expenditure reserves allocated, or the amount funded by the Company to acquire loans, including acquisition expenses and any debt attributable to such investments.
Asset management fees. The Advisor earns a monthly asset management fee equal to one-twelfth of 1.0% of the cost of each asset, without deduction for depreciation, bad debts or other non-cash reserves. The asset management fee is based only on the portion of the costs or value attributable to the Company’s investment in an asset if the Company does not own all of an asset and does not manage or control the asset.
Disposition fees. The Advisor earns a disposition fee in connection with the sale of a property equal to the lesser of one-half of the aggregate brokerage commission paid, or if none is paid, 2.0% of the contract sales price.
Debt financing fees. The Advisor earns a debt financing fee equal to 0.5% of the amount available under any debt financing obtained for which it provided substantial services.
Expense reimbursements. The Company also pays directly or reimburses the Advisor for all of the expenses paid or incurred by the Advisor or its affiliates on behalf of the Company or in connection with the services provided to the Company in relation to its public offering, including its distribution reinvestment plan offering. This included all organization and offering costs of up to 2.5% of gross offering proceeds. Reimbursements also include expenses the Advisor incurs in connection with providing services to the Company, including the Company’s allocable share of costs for Advisor personnel and overhead, out-of-pocket expenses incurred in connection with the selection and acquisition of properties or other real estate related debt investments, whether or not the Company ultimately acquires the investment. However, the Company will not reimburse the Advisor or its affiliates for employee costs in connection with services for which the Advisor earns acquisition or disposition fees.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Relationship with RAI and C-III
Property loss pool: The Company's properties participate in a property loss self-insurance pool with other properties directly and indirectly managed by RAI and C-III, which is backed by a catastrophic insurance policy. Substantially all of the receivables from related parties represent insurance deposits held in escrow by RAI and C-III related to the self-insurance pool which, if unused, will be returned to the Company. The pool covers losses up to $2.5 million, in aggregate, after a $25,000 deductible per incident. Claims beyond the insurance pool limits will be covered by the catastrophic insurance policy, which covers claims up to $250.0 million, after a $100,000 deductible per incident. Therefore, unforeseen or catastrophic losses in excess of the Company's insured limits could have a material adverse effect on the Company's financial condition and operating results.
During the nine months ended September 30, 2017, the Company paid $398,000 into the insurance pool.
General liability loss pool: The Company's properties also participated in a general liability pool with other properties directly or indirectly managed by RAI and C-III until April 22, 2017. The pool covers claims up to $50,000 per incident through April 22, 2017. Effective April 23, 2017, the loss pool was eliminated and the Company now participates (with other properties directly or indirectly managed by RAI and C-III) in a general liability policy. The insured limit for the general liability policy is $76.0 million in total claims, after a $25,000 deductible per incident.
Internal audit fees. RAI performs internal audit services for the Company.
The Company utilizes the services of The Planning and Zoning Resource Company, an affiliate of C-III, for zoning reports for acquisitions.
Relationship with Resource Real Estate Opportunity Manager II
The Manager manages real estate properties and real estate-related debt investments and coordinates the leasing of, and manages construction activities related to the Company’s real estate properties pursuant to the terms of the management agreement with the Manager.
Property management fees. The Manager earns a property management fee equal to 4.5% of actual gross cash receipts from the operations of real property investments.
Construction management fees. The Manager earns a construction management fee of 5.0% of actual aggregate costs to construct improvements, or to repair, rehab or reconstruct a property.
Debt servicing fees. The Manager earns a debt servicing fee of 2.75% on payments received from loans held by the Company for investment. No debt servicing fees were earned during the nine months ended September 30, 2017 and 2016.
Expense reimbursement. During the ordinary course of business, the Manager or other affiliates of RAI may pay certain shared operating expenses on behalf of the Company.
Relationship with Resource Securities
Resource Securities LLC. (“Resource Securities”), an affiliate of the Advisor, serves as the Company’s dealer-manager and was responsible for marketing the Company’s shares during the primary portion of its public offering. Pursuant to the terms of the dealer-manager agreement with Resource Securities, the Company paid Resource Securities a selling commission of up to 7% of gross primary offering proceeds and a dealer-manager fee of up to 3% of gross primary offering proceeds. Resource Securities reallowed all selling commissions earned and a portion of the dealer-manager fee as a marketing fee to participating broker-dealers. No selling commissions or dealer-manager fees are earned by Resource Securities in connection with sales under the distribution reinvestment plan.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Relationship with Other Related Party
The Company utilizes the services of a printing company, Graphic Images, LLC (“Graphic Images”), the principal owner of which is the father of RAI’s Chief Financial Officer.
The fees earned/expenses incurred and the amounts payable to such related parties are summarized in the following tables (in thousands):
September 30, 2017 | December 31, 2016 | ||||||
Due from related parties: | |||||||
RAI - self-insurance funds held | $ | 121 | $ | 604 | |||
$ | 121 | $ | 604 | ||||
Due to related parties: | |||||||
Advisor | |||||||
Acquisition fees | $ | — | $ | 1,022 | |||
Operating expense reimbursements | 44 | 1,078 | |||||
Manager | |||||||
Property management fees | 296 | 244 | |||||
Operating expense reimbursements | 238 | 304 | |||||
RAI | |||||||
Internal audit fees | 36 | — | |||||
$ | 614 | $ | 2,648 | ||||
Three Months Ended | Nine Months Ended | ||||||||||||||
September 30, | September 30, | ||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||
Fees earned / expenses incurred: | |||||||||||||||
Advisor | |||||||||||||||
Acquisition fees (1) | $ | — | $ | — | $ | 1,142 | $ | 6,450 | |||||||
Asset management fees (2) | $ | 2,362 | $ | 1,955 | $ | 6,935 | $ | 4,910 | |||||||
Debt financing fees (3) | $ | — | $ | 229 | $ | 395 | $ | 1,346 | |||||||
Organization and offering costs (4) | $ | — | $ | — | $ | — | $ | 86 | |||||||
Operating expense reimbursements (5) | $ | 961 | $ | 832 | $ | 3,011 | $ | 2,135 | |||||||
Manager | |||||||||||||||
Property management fees (2) | $ | 880 | $ | 672 | $ | 2,519 | $ | 1,602 | |||||||
Construction management fees (7) | $ | 342 | $ | 389 | $ | 1,174 | $ | 910 | |||||||
Operating expense reimbursements (5) | $ | — | $ | 36 | $ | — | $ | 97 | |||||||
Information technology fees (5) | $ | — | 46 | $ | — | $ | 118 | ||||||||
Resource Securities | |||||||||||||||
Selling commissions and dealer-manager fees (6) | $ | — | $ | — | $ | — | $ | 4,192 | |||||||
Other | |||||||||||||||
Graphic Images (5) | $ | — | $ | — | $ | 9 | $ | 3 | |||||||
The Planning & Zoning Resource Company (1) | $ | — | $ | — | $ | 1 | $ | — | |||||||
(1) Included in Acquisition costs on the consolidated statements of operations and comprehensive loss per income statement.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
(2) Included in Management fees on the consolidated statements of operations and comprehensive loss per income statement.
(3) Included in Mortgage notes payable, net on the consolidated balance sheets.
(4) Included in Deferred offering costs and Stockholders' Equity on the consolidated balance sheets.
(5) Included in General and administrative on the consolidated statements of operations and comprehensive loss per income statement.
(6) Included in Stockholders' equity on the consolidated balance sheets.
(7) Included in Rental properties, net on the consolidated balance sheets.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
NOTE 11 - EQUITY
Preferred Stock
The Company’s charter authorizes the Company to issue 10,000,000 shares of its $0.01 par value preferred stock. As of September 30, 2017, no shares of preferred stock were issued or outstanding.
Convertible Stock
As of September 30, 2017, the Company had 50,000 shares of $0.01 par value convertible stock outstanding, which are owned by the Advisor and affiliated persons. The convertible stock will convert into shares of the Company’s common stock upon the occurrence of (a) the Company having paid distributions to common stockholders that in the aggregate equal 100% of the price at which the Company originally sold the shares plus an amount sufficient to produce a 7% cumulative, non-compounded annual return on the shares at that price; or (b) if the Company lists its common stock on a national securities exchange and, on or after the 31st trading day following the listing, the Company’s value based on the average trading price of its common stock since the listing, plus prior distributions, combine to meet the same 7% return threshold.
Each of these two events is a “Triggering Event.” Upon a Triggering Event, the Company's convertible stock will, unless its advisory agreement has been terminated or not renewed on account of a material breach by its Advisor, generally be converted into a number of shares of common stock equal to 1/50,000 of the quotient of:
(A) | the lesser of |
(i) 15% of the amount, if any, by which
(1) | the value of the Company as of the date of the event triggering the conversion plus the total distributions paid to its stockholders through such date on the then-outstanding shares of its common stock exceeds |
(2) | the sum of the aggregate issue price of those outstanding shares plus a 7% cumulative, non-compounded, annual return on the issue price of those outstanding shares as of the date of the event triggering the conversion, divided by |
(B) | the value of the Company divided by the number of outstanding shares of common stock, in each case, as of the date of the event triggering the conversion. |
No triggering events have occurred as of September 30, 2017.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Common Stock
As of September 30, 2017, the Company had an aggregate of 60,309,199 shares of $0.01 par value common stock outstanding, including the Advisor's additional purchase of 117,778 shares of common stock for $1.1 million, as follows (dollars in thousands):
Shares Issued | Gross Proceeds | ||||||
Shares issued through initial public offering | 55,791,297 | $ | 556,197 | ||||
Shares issued through stock distributions | 246,365 | — | |||||
Shares issued through distribution reinvestment plan | 5,074,228 | 44,729 | |||||
Advisor's initial investment, net of 5,000 share conversion | 15,000 | 150 | |||||
Total | 61,126,890 | 601,076 | |||||
Shares redeemed and retired | (817,691 | ) | (7,064 | ) | |||
Total shares outstanding | 60,309,199 | $ | 594,012 | ||||
Redemptions
During the nine months ended September 30, 2017, the Company redeemed shares as follows (in thousands, except per share data):
Month | Total Number of Shares Redeemed | Average Price Paid per Share | Cumulative Number of Shares Purchased as Part of a Publicly Announced Plan or Program (1) | Approximate Dollar Value of Shares Available That May Yet Be Redeemed Under the Program | ||||
January 2017 | — | $— | — | (2) | ||||
February 2017 | — | $— | — | (2) | ||||
March 2017 | 121 | $8.74 | 121 | (2) | ||||
April 2017 | — | $— | — | (2) | ||||
May 2017 | — | $— | — | (2) | ||||
June 2017 | 188 | $8.58 | 309 | (2) | ||||
July 2017 | — | $— | — | (2) | ||||
August 2017 | — | $— | — | (2) | ||||
September 2017 | 336 | $8.51 | 645 | (2) | ||||
(1) | All purchases of equity securities by the Company in the nine months ended September 30, 2017 were made pursuant to the Company's share redemption program. |
(2) | The Company currently limits the dollar value and number of shares that may be repurchased under the program, as discussed below. |
All redemption requests tendered were honored during the nine months ended September 30, 2017.
The Company will not redeem in excess of 5% of the weighted-average number of shares outstanding during the 12-month period immediately prior to the effective date of redemption. Generally, the cash available for redemption will be limited to proceeds from the distribution reinvestment plan plus, if the Company had positive operating cash flow from the previous fiscal year, 1% of all operating cash flow from the previous fiscal year. These limitations apply to all redemptions, including redemptions sought upon a stockholder’s death, qualifying disability or confinement to a long-term care facility.
The Company's board of directors, in its sole discretion, may suspend, terminate or amend the Company's share redemption program without stockholder approval upon 30 days' notice if it determines that such suspension, termination or amendment is in the Company's best interest. The Company's board may also reduce the number of shares purchased under the share redemption
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
program if it determines the funds otherwise available to fund the Company's share redemption program are needed for other purposes. These limitations apply to all redemptions, including redemptions sought upon a stockholder's death, qualifying disability or confinement to a long-term care facility.
Distributions
For the nine months ended September 30, 2017, the Company paid aggregate distributions of $26.7 million, including $11.2 million of distributions paid in cash and $15.5 million of distributions reinvested in shares of common stock through the Company's distribution reinvestment plan, as follows (in thousands):
Authorization Date | Per Common Share | Record Dates | Distribution Date | Distributions reinvested in shares of Common Stock | Net Cash Distributions | Total Aggregate Distributions | ||||||||||||||
December 15, 2016 | $ | 0.00164384 | December 30, 2016 through January 30, 2017 | January 31, 2017 | $ | 1,748 | $ | 1,265 | $ | 3,013 | ||||||||||
December 15, 2016 | 0.00164384 | January 31, 2017 through February 27, 2017 | February 28, 2017 | 1,587 | 1,144 | 2,731 | ||||||||||||||
December 15, 2016 | 0.00164384 | February 28, 2017 through March 30, 2017 | March 31, 2017 | 1,755 | 1,276 | 3,031 | ||||||||||||||
March 28, 2017 | 0.00164384 | March 31, 2017 through April 27, 2017 | April 28, 2017 | 1,593 | 1,156 | 2,749 | ||||||||||||||
March 28, 2017 | 0.00164384 | April 28, 2017 through May 30, 2017 | May 31, 2017 | 1,877 | 1,366 | 3,243 | ||||||||||||||
March 28, 2017 | 0.00164384 | May 31, 2017 through June 29, 2017 | June 30, 2017 | 1,713 | 1,243 | 2,956 | ||||||||||||||
June 16, 2017 | 0.00164384 | June 30, 2017 through July 30, 2017 | July 31, 2017 | $ | 1,774 | 1,286 | $ | 3,060 | ||||||||||||
June 16, 2017 | 0.00164384 | July 31, 2017 through August 30, 2017 | August 31, 2017 | $ | 1,777 | 1,292 | $ | 3,069 | ||||||||||||
June 16, 2017 | 0.00164384 | August 31, 2017 through September 28, 2017 | September 29, 2017 | 1,658 | 1,208 | $ | 2,866 | |||||||||||||
$ | 15,482 | $ | 11,236 | $ | 26,718 | |||||||||||||||
On September 12, 2017, the Board of Directors approved distributions in an amount of $0.00164384 per share of common stock for stockholders of record each day in the period from September 29, 2017 through and including December 28, 2017, payable on October 31, 2017, November 30, 2017 and December 29, 2017.
The following is a reconciliation of total aggregate distributions paid to total distributions declared for the nine months ended September 30, 2017 (in thousands):
Total aggregate distributions paid | $ | 26,718 | ||
Less: distribution payable at December 31, 2016 | (8,769 | ) | ||
Add: distribution payable at September 30, 2017 | 9,021 | |||
Total distributions declared | $ | 26,970 | ||
Distributions are payable in cash or reinvested in shares of common stock at the discretion of the shareholder.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
NOTE 12 - FAIR VALUE MEASURES AND DISCLOSURES
In analyzing the fair value of its investments accounted for on a fair value basis, the Company follows the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company determines fair value based on quoted prices when available or, if quoted prices are not available, through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The fair value of cash, tenant receivables and accounts payable, approximate their carrying value due to their short nature. The hierarchy followed defines three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.
Level 3 - Unobservable inputs that reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.
The determination of where an asset or liability falls in the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter; depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects that changes in classifications between levels will be rare.
The fair value of rental properties is usually estimated based on information obtained from a number of sources, including information obtained about each property as a result of pre-acquisition due diligence, marketing and leasing activities. The Company allocates the purchase price of properties to acquired tangible assets, consisting of land, buildings, fixtures and improvements, and identified intangible lease assets and liabilities, consisting of the value of above-market and below-market leases, as applicable, the value of in-place leases and the value of tenant relationships, based in each case on their fair values.
Derivatives (interest rate caps) which are reported at fair value in the consolidated balance sheets are valued by a third party pricing agent using an income approach with models that use, as their primary inputs, readily observable market parameters. This valuation process considers factors including interest rate yield curves, time value, credit and volatility factors (Level 2).
The following table presents information about the Company's assets measured at fair value on a recurring basis and
indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value as follows (in thousands):
Level 1 | Level 2 | Level 3 | Total | ||||||||||||
September 30, 2017 | |||||||||||||||
Assets: | |||||||||||||||
Interest rate caps | $ | — | $ | 57 | $ | — | $ | 57 | |||||||
Cancelable swap | — | 37 | — | 37 | |||||||||||
$ | — | $ | 94 | $ | — | $ | 94 | ||||||||
Level 1 | Level 2 | Level 3 | Total | ||||||||||||
December 31, 2016 | |||||||||||||||
Assets: | |||||||||||||||
Interest rate caps | $ | — | $ | 365 | $ | — | $ | 365 | |||||||
Canceleable swap | — | 43 | — | 43 | |||||||||||
$ | — | $ | 408 | $ | — | $ | 408 | ||||||||
Interest rate caps and the cancelable swap are included in Prepaid expenses and other assets on the consolidated balance sheets.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
The outstanding balance and estimated fair value of the Company’s mortgage notes payable are as follows (in thousands):
September 30, 2017 | December 31, 2016 | ||||||||||||||
Outstanding Balance | Estimated Fair Value | Outstanding Balance | Estimated Fair Value | ||||||||||||
Mortgage notes payable | $ | 537,000 | $ | 510,765 | $ | 460,586 | $ | 449,977 | |||||||
The carrying amount of the mortgage notes payable presented is the outstanding borrowings excluding premium and deferred finance costs, net. The fair value of the mortgage notes payable was estimated using rates available to the Company for debt with similar terms and remaining maturities (Level 3).
NOTE 13 - DERIVATIVES AND HEDGING ACTIVITIES
Risk Management Objective of Using Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures 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 enters 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 instruments are 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.
As a condition of the Company’s mortgage loans, from time to time the Company may be required to enter into certain derivative transactions as may be required by the lender. These transactions would generally be in line with the Company’s own risk management objectives and also serve to protect the lender.
Interest Rate Caps
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company entered into interest rate caps that were designated as cash flow hedges. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the nine months ended September 30, 2017, such derivatives were used to hedge the variable cash flows, indexed to London InterBank Offered Rate ("LIBOR"), associated with existing variable-rate loan agreements. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the nine months ended September 30, 2017, the Company did not record any hedge ineffectiveness in earnings.
Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next 12 months, the Company estimates that an additional $92,298 will be reclassified as an increase to interest expense.
Cancelable swap
To manage its exposure to interest rate movements, the Company has also entered into a cancelable interest rate swap that was not designated as a hedging instrument. Interest rate swaps involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Derivatives not designated as hedges are not speculative and are used to manage the Company’s exposure to interest rate movements but do not meet the strict hedge accounting requirements.
As of September 30, 2017, the Company had the following outstanding interest rate derivatives (dollars in thousands):
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
Interest Rate Derivatives | Number of Instruments | Notional Amount | Maturity Dates | |||||
Derivatives designated as hedging instruments: | ||||||||
Interest rate caps | 10 | $ | 358,941 | January 1, 2018 through September 1, 2020 | ||||
Derivatives not designated as hedging instruments | ||||||||
Cancelable swap | 1 | $ | 31,930 | July 28, 2020 | ||||
Tabular Disclosure of Fair Value of Derivative Instrument on the Balance Sheet
The table below presents the fair value of the Company’s derivative financial instruments on the consolidated balance sheets as of September 30, 2017 and December 31, 2016 (in thousands):
Asset Derivatives | Liabilities Derivatives | |||||||||||||||||||||
September 30, 2017 | December 31, 2016 | September 30, 2017 | December 31, 2016 | |||||||||||||||||||
Balance Sheet | Fair Value | Balance Sheet | Fair Value | Balance Sheet | Fair Value | Balance Sheet | Fair Value | |||||||||||||||
Derivatives designated as hedging instruments: | ||||||||||||||||||||||
Interest rate caps | $ | 57 | Interest rate caps | $ | 365 | NA | $ | — | NA | $ | — | |||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||||||
Cancelable swap | $ | 37 | Cancelable swap | 43 | NA | — | NA | — | ||||||||||||||
Interest rate caps and the cancelable swap are included in Prepaid expenses and other assets on the consolidated balance sheets.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
The table below presents the effect of the Company's derivative financial instruments on the consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2017 and 2016 (in thousands):
Amount of Gain (Loss) Recognized in Income for the Three Months Ended | Amount of Gain (Loss) Recognized in Income for the Nine Months Ended | |||||||||||||||
Derivatives Designated as Hedging Instruments | Location of Gain (Loss) Recognized in Income | September 30, 2017 | September 30, 2016 | September 30, 2017 | September 30, 2016 | |||||||||||
Interest rate caps | Interest expense | $ | (20 | ) | (3 | ) | $ | (42 | ) | (6 | ) | |||||
Amount of Gain (Loss) Recognized in Income for the Three Months Ended | Amount of Gain (Loss) Recognized in Income for the Nine Months Ended | |||||||||||||||
Derivatives Not Designated as Hedging Instruments | Location of Gain (Loss) Recognized in Income | September 30, 2017 | September 30, 2016 | September 30, 2017 | September 30, 2016 | |||||||||||
Cancelable swap | Interest expense | $ | (58 | ) | 42 | $ | (217 | ) | (492 | ) | ||||||
Derivatives in Cash Flow Hedging Relationships | Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion) for the Three Months Ended | Location of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) for the Three Months Ended | |||||||||||||||
September 30, 2017 | September 30, 2016 | September 30, 2017 | September 30, 2016 | |||||||||||||||
Interest rate products | $ | (53 | ) | $ | (26 | ) | Interest expense | $ | (20 | ) | $ | (3 | ) | |||||
Derivatives in Cash Flow Hedging Relationships | Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion) for the Nine Months Ended | Location of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) for the Nine Months Ended | |||||||||||||||
September 30, 2017 | September 30, 2016 | September 30, 2017 | September 30, 2016 | |||||||||||||||
Interest rate products | $ | (405 | ) | $ | (111 | ) | Interest expense | $ | (42 | ) | $ | (5 | ) | |||||
Credit-risk-related Contingent Features
The Company has agreements with its derivative counterparties that contain provisions where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. As of September 30, 2017, the Company has not posted any collateral related to these agreements.
NOTE 14 - OPERATING EXPENSE LIMITATION
As required under the Company's charter, the Advisor must reimburse the Company the amount by which the aggregate total operating expenses for the four fiscal quarters then ended exceed the greater of 2% of the average invested assets or 25% of net income, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. “Average invested assets” means the average monthly book value of assets invested, directly or indirectly, in equity interests in and loans secured by real estate during the 12-month period before deducting depreciation, bad debts or other non-cash reserves. “Total operating expenses” means all expenses paid or incurred by the Company, as determined under GAAP, that are in any way related to operations, including advisory 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
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 2017
(unaudited)
such expenses and taxes incurred in connection with the issuance, distribution, transfer, registration and stock exchange listing of 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 assets; and (f) acquisition fees, acquisition expenses (including expenses relating to potential investments that do not close), disposition fees on the resale of property and other expenses connected with the acquisition, disposition and ownership of real estate interests, loans or other property (including the costs of foreclosure, insurance premiums, legal services, maintenance, repair and improvement of property). Operating expenses for the four quarters ended September 30, 2017 did not exceed the charter imposed limitation.
Allocated payroll associated with a portion of the compensation paid by the Advisor or its affiliates to the Company’s executive officers was included in general and administrative expenses in the consolidated statements of operations and comprehensive loss and was reimbursed to the Advisor during the three and nine months ended September 30, 2017 and 2016. This expense is included in "operating expense reimbursements" in Note 10.
Allocated payroll expense from the Manager is included in rental operating expenses in the consolidated statements of operations and comprehensive loss. Allocated payroll for the three months ended September 30, 2017 and 2016 was $110,312 and $279,027, respectively. Allocated payroll for the nine months ended September 30, 2017 and 2016 was $404,095 and $762,304, respectively.
NOTE 15 - SUBSEQUENT EVENTS
On October 31, 2017, the Company purchased a 256-unit multifamily community located in Lombard, Illinois from an unaffiliated seller for $38.3 million.
The Company has evaluated subsequent events and determined that no additional events have occurred which would require an adjustment to or additional disclosure in the consolidated financial statements.
ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION |
AND RESULTS OF OPERATIONS (unaudited)
The following discussion and analysis should be read in conjunction with the accompanying financial statements of Resource Real Estate Opportunity REIT II, Inc. and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to Resource Real Estate Opportunity REIT II, Inc., a Maryland corporation, and, as required by context, RRE Opportunity OP II, LP, a Delaware limited partnership, and to their subsidiaries.
Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expects,” “intend,” “may,” “plan,” “potential,” “project,” “should,” “will” and “would” or the negative of these terms or other comparable terminology. Actual results may differ materially from those contemplated by such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this report, except as may be required under applicable law.
Overview
We are a Maryland corporation that invests in multifamily assets across the entire spectrum of investments in order to provide investors with growing cash flow and increasing asset values. Our targeted portfolio consists of commercial real estate assets, principally underperforming multifamily rental properties which we will renovate and stabilize in order to increase rents, and to a lesser extent, real estate related debt. We may make adjustments to our target portfolio based on real estate market conditions and investment opportunities. We will not forego a good investment because it does not precisely fit our expected portfolio composition. Thus, to the extent that Resource Real Estate Opportunity Advisor II, LLC, our external advisor, or the Advisor, presents us with investment opportunities that allow us to meet the requirements to be treated as a real estate investment trust, or REIT, under the Internal Revenue Code, and to maintain our exclusion from regulation as an investment company under the Investment Company Act of 1940, our portfolio composition may vary from what we initially expect.
We commenced the public offering of our common stock in February 2014 and terminated the primary portion of the offering in February 2016. We describe this offering in “Liquidity and Capital Resources,” below.
Results of Operations
As of September 30, 2017, we owned 17 multifamily properties. Our management is not aware of any material trends or uncertainties, favorable, or unfavorable, other than local and national economic conditions affecting our targeted portfolio, the multifamily residential housing industry and real estate generally, which may reasonably be expected to have a material impact on either capital resources or the revenues or income to be derived from the operation of such assets or those that we expect to acquire.
Three Months Ended September 30, 2017 Compared to the Three Months Ended September 30, 2016
The following table sets forth the results of our operations (in thousands):
Three Months Ended | |||||||
September 30, | |||||||
2017 | 2016 | ||||||
Revenues: | |||||||
Rental income | $ | 19,952 | $ | 15,143 | |||
Total revenues | 19,952 | 15,143 | |||||
Expenses: | |||||||
Rental operating | 8,167 | 7,719 | |||||
Acquisition costs | — | 2 | |||||
Management fees | 3,242 | 2,635 | |||||
General and administrative | 2,066 | 2,183 | |||||
Loss on disposal of assets | 260 | 474 | |||||
Depreciation and amortization expense | 9,538 | 8,214 | |||||
Total expenses | 23,273 | 21,227 | |||||
Loss before other income (expense) | (3,321 | ) | (6,084 | ) | |||
Other income (expense): | |||||||
Interest income | 24 | 54 | |||||
Interest expense | (5,221 | ) | (3,369 | ) | |||
Net loss | $ | (8,518 | ) | $ | (9,399 | ) | |
The following table presents the results of operations separated into three categories: the results of operations of the 14 properties we owned for the entirety of both periods presented, properties purchased since the prior period and company level expenses for the three months ended September 30, 2017 and 2016 (in thousands):
For the three months ended September 30, 2017 | For the three months ended September 30, 2016 | |||||||||||||||||||||||||||||||
Properties owned both periods | Properties purchased since prior period | Company level | Total | Properties owned both periods | Properties purchased since prior period | Company level | Total | |||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
Rental income | $ | 16,169 | $ | 3,783 | $ | — | $ | 19,952 | $ | 15,143 | $ | — | $ | — | $ | 15,143 | ||||||||||||||||
Total revenues | 16,169 | 3,783 | — | 19,952 | 15,143 | — | — | 15,143 | ||||||||||||||||||||||||
Expenses: | ||||||||||||||||||||||||||||||||
Rental operating | 6,725 | 1,501 | (59 | ) | 8,167 | 7,209 | — | 510 | 7,719 | |||||||||||||||||||||||
Acquisition costs | — | — | — | — | 2 | — | — | 2 | ||||||||||||||||||||||||
Management fees | 713 | 167 | 2,362 | 3,242 | 681 | — | 1,954 | 2,635 | ||||||||||||||||||||||||
General and administrative | 548 | 91 | 1,427 | 2,066 | 771 | — | 1,412 | 2,183 | ||||||||||||||||||||||||
Loss on disposal of assets | 183 | 77 | — | 260 | 474 | — | — | 474 | ||||||||||||||||||||||||
Depreciation and amortization expense | 7,546 | 1,992 | — | 9,538 | 8,214 | — | — | 8,214 | ||||||||||||||||||||||||
Total expenses | 15,715 | 3,828 | 3,730 | 23,273 | 17,351 | — | 3,876 | 21,227 | ||||||||||||||||||||||||
Income (loss) before other income (expense) | 454 | (45 | ) | (3,730 | ) | (3,321 | ) | (2,208 | ) | — | (3,876 | ) | (6,084 | ) | ||||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||||||||||
Interest income | 23 | 1 | — | 24 | 39 | — | 15 | 54 | ||||||||||||||||||||||||
Interest expense | (4,116 | ) | (1,105 | ) | — | (5,221 | ) | (3,369 | ) | — | — | (3,369 | ) | |||||||||||||||||||
Net loss | $ | (3,639 | ) | $ | (1,149 | ) | $ | (3,730 | ) | $ | (8,518 | ) | $ | (5,538 | ) | $ | — | $ | (3,861 | ) | $ | (9,399 | ) | |||||||||
Revenues. Rental income increased by $4.8 million during the three months ended September 30, 2017 as compared to the three months ended September 30, 2016. The increase is primarily due to the acquisition of three additional properties since September 30, 2016, as well as the implementation of our investment strategy to increase monthly rental income and occupancy rates after renovating and stabilizing operations and was primarily comprised of:
Increase in Effective | |||||||||||
Monthly Revenue | |||||||||||
Multifamily Community | Rental Increase (in thousands) | Change in Occupancy % | per Unit (in dollars) | ||||||||
Adair off Addison | $ | (9 | ) | (3.3 | )% | $ | 43 | ||||
Overton Trails Apartment Homes | 172 | 1.7 | % | 166 | |||||||
Uptown Buckhead | 69 | 3.2 | % | 95 | |||||||
Crosstown at Chapel Hill | 163 | (2.0 | )% | 136 | |||||||
The Brookwood | 20 | (1.8 | )% | 81 | |||||||
Adair off Addison Apartment Homes | 16 | — | % | 58 | |||||||
1000 Spalding Crossing | 95 | 4.4 | % | 93 | |||||||
Montclair | (6 | ) | (7.5 | )% | 129 | ||||||
Grand Reserve | 93 | (3.1 | )% | 151 | |||||||
Verdant Apartment Homes | 119 | 6.5 | % | 200 | |||||||
Arcadia Apartment Homes | 136 | 5.7 | % | 45 | |||||||
Ravina Apartment Homes | 78 | (1.9 | )% | 117 | |||||||
Breckenridge | 6 | (3.9 | )% | 100 | |||||||
The Palmer at Las Colinas | 74 | 4.1 | % | 119 | |||||||
Windbrooke Crossing | 1,181 | N/A | N/A | ||||||||
Woods of Burnsville | 1,344 | N/A | N/A | ||||||||
Indigo Creek | 1,258 | N/A | N/A | ||||||||
$ | 4,809 | ||||||||||
Expenses. Our operating expenses for the three months ended September 30, 2017 were from the ongoing operations of our business and the ownership of 17 operating properties and increased as a result of the ownership of three additional properties acquired after September 30, 2016.
Management fees increased by $607,000 during the three months ended September 30, 2017 as compared to the three months ended September 30, 2016 primarily due to the increase in the asset management fees paid to the Advisor related to the ownership of three additional properties acquired after September 30, 2016. The monthly asset management fee is equal to one-twelfth of 1.0% of the cost of each asset, without deduction for deprecation, bad debts or other non-cash reserves.
Loss on disposal of assets of approximately $260,000 related primarily to the replacement of appliances at our rental properties in conjunction with unit upgrades.
Depreciation and amortization is comprised of the depreciation on our rental properties and amortization of intangible assets related to in-place leases, which are amortized over a period of approximately six to nine months after acquisition. The increases (decreases) in the components of depreciation and amortization during the three months ended September 30, 2017, as follows (in thousands):
Properties owned during both periods | All other | Total | ||||||||||
Depreciation | $ | 1,233 | $ | 1,440 | $ | 2,673 | ||||||
Amortization of intangibles | (1,902 | ) | 553 | (1,349 | ) | |||||||
$ | (669 | ) | $ | 1,993 | $ | 1,324 | ||||||
The overall increase in depreciation expense for all properties was due to additional capital improvements made since September 30, 2016 on properties owned during both periods, as well as properties purchased since September 30, 2016. The decrease in amortization expense was due to amortization no longer being taken on properties that have been owned for a period of six to nine months. As of September 30, 2017, only one property has a remaining unamortized intangible balance for a total of $286,000. There were no acquisitions during the three months ended September 30, 2017.
Interest expense increased by $1.9 million during the three months ended September 30, 2017 as compared to the three months ended September 30, 2016 as a result of three additional mortgages either entered into or assumed since September 30, 2016, all of which were used to finance property acquisitions and all of which increased amortization of deferred financing costs.
Nine Months Ended September 30, 2017 Compared to the Nine Months Ended September 30, 2016
The following table sets forth the results of our operations (in thousands):
Nine Months Ended | |||||||
September 30, | |||||||
Revenues: | 2017 | 2016 | |||||
Rental income | |||||||
Total revenues | $ | 56,850 | $ | 37,378 | |||
56,850 | 37,378 | ||||||
Expenses: | |||||||
Rental operating | 23,557 | 18,619 | |||||
Acquisition costs | 1,361 | 6,846 | |||||
Management fees | 9,455 | 6,566 | |||||
General and administrative | 6,637 | 5,848 | |||||
Loss on disposal of assets | 842 | 2,323 | |||||
Depreciation and amortization expense | 29,033 | 22,940 | |||||
Total expenses | 70,885 | 63,142 | |||||
Loss before other income (expense) | (14,035 | ) | (25,764 | ) | |||
Other income (expense): | |||||||
Interest income | |||||||
Interest expense | 99 | 163 | |||||
Net loss | (14,458 | ) | (7,524 | ) | |||
$ | (28,394 | ) | $ | (33,125 | ) | ||
The following table presents the results of operations separated into three categories: the results of operations of the 10 properties we owned for the entirety of both periods presented, properties purchased since the prior period and company level expenses for the nine months ended September 30, 2017 and 2016 (in thousands):
For the nine months ended September 30, 2017 | For the nine months ended September 30, 2016 | |||||||||||||||||||||||||||||||
Properties owned both periods | Properties purchased since prior period | Company level | Total | Properties owned both periods | Properties purchased since prior period | Company level | Total | |||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
Rental income | $ | 29,189 | $ | 27,661 | $ | — | $ | 56,850 | $ | 26,907 | $ | 10,471 | $ | — | $ | 37,378 | ||||||||||||||||
Total revenues | 29,189 | 27,661 | — | 56,850 | 26,907 | 10,471 | — | 37,378 | ||||||||||||||||||||||||
Expenses: | ||||||||||||||||||||||||||||||||
Rental operating | 11,852 | 11,506 | 199 | 23,557 | 13,605 | 4,902 | 112 | 18,619 | ||||||||||||||||||||||||
Acquisition costs | — | 220 | 1,141 | 1,361 | (142 | ) | 572 | 6,416 | 6,846 | |||||||||||||||||||||||
Management fees | 1,293 | 1,226 | 6,936 | 9,455 | 1,201 | 455 | 4,910 | 6,566 | ||||||||||||||||||||||||
General and administrative | 1,065 | 1,032 | 4,540 | 6,637 | 1,400 | 708 | 3,740 | 5,848 | ||||||||||||||||||||||||
Loss on disposal of assets | 601 | 241 | — | 842 | 486 | 1,837 | — | 2,323 | ||||||||||||||||||||||||
Depreciation and amortization expense | 13,678 | 15,355 | — | 29,033 | 15,164 | 7,776 | — | 22,940 | ||||||||||||||||||||||||
Total expenses | 28,489 | 29,580 | 12,816 | 70,885 | 31,714 | 16,250 | 15,178 | 63,142 | ||||||||||||||||||||||||
Income (loss) before other income (expense) | 700 | (1,919 | ) | (12,816 | ) | (14,035 | ) | (4,807 | ) | (5,779 | ) | (15,178 | ) | (25,764 | ) | |||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||||||||||
Interest income | 35 | 47 | 17 | 99 | 66 | 35 | 62 | 163 | ||||||||||||||||||||||||
Interest expense | (7,220 | ) | (7,238 | ) | — | (14,458 | ) | (5,596 | ) | (1,928 | ) | — | (7,524 | ) | ||||||||||||||||||
Net loss | $ | (6,485 | ) | $ | (9,110 | ) | $ | (12,799 | ) | $ | (28,394 | ) | $ | (10,337 | ) | $ | (7,672 | ) | $ | (15,116 | ) | $ | (33,125 | ) | ||||||||
Revenues. Rental income increased by $19.5 million during the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016. The increase is primarily due to the acquisition of three additional properties since September 30, 2016, as well as the implementation of our investment strategy to increase monthly rental income and occupancy rate after renovating and stabilizing operations and was primarily comprised of:
Increase in Effective | |||||||||||
Monthly Revenue | |||||||||||
Multifamily Community | Rental Increase (in thousands) | Change in Occupancy % | per Unit (in dollars) | ||||||||
Adair off Addison | $ | 77 | (3.3 | )% | $ | 168 | |||||
Overton Trails Apartment Homes | 560 | 1.7 | % | 273 | |||||||
Uptown Buckhead | 232 | 3.2 | % | 164 | |||||||
Crosstown at Chapel Hill | 561 | (2.0 | )% | 231 | |||||||
The Brookwood | 76 | (1.8 | )% | 88 | |||||||
Adair off Addison Apartment Homes | 224 | — | % | 204 | |||||||
1000 Spalding Crossing | 228 | 4.4 | % | 97 | |||||||
Montclair | (7 | ) | (7.5 | )% | 200 | ||||||
Grand Reserve | 254 | (3.1 | )% | 206 | |||||||
Verdant Apartment Homes | 77 | 6.5 | % | 53 | |||||||
Arcadia Apartment Homes | 373 | 5.7 | % | 58 | |||||||
Ravina Apartment Homes | 1,620 | (1.9 | )% | (532 | ) | ||||||
Breckenridge | 2,007 | (3.9 | )% | 1,152 | |||||||
The Palmer at Las Colinas | 3,321 | 4.1 | % | 1,316 | |||||||
Windbrooke Crossing | 3,457 | N/A | N/A | ||||||||
Woods of Burnsville | $ | 4,060 | N/A | N/A | |||||||
Indigo Creek | $ | 2,352 | N/A | N/A | |||||||
$ | 19,472 | ||||||||||
Expenses. Our operating expenses for the nine months ended September 30, 2017 were from the ongoing operations of our business and the ownership of 17 operating properties and increased as a result of the ownership of three additional properties acquired after September 30, 2016.
Acquisition costs decreased by $5.5 million during the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016, as we only purchased one property during the nine months ended September 30, 2017, while we acquired four multifamily properties during the nine months ended September 30, 2016 with an aggregate purchase price of $268.8 million.
Management fees increased by $2.9 million during the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 primarily due to the increase in the asset management fees paid to the Advisor related to the ownership of three additional properties acquired after September 30, 2016. The monthly asset management fee is equal to one-twelfth of 1.0% of the cost of each asset, without deduction for deprecation, bad debts or other non-cash reserves.
General and administrative expenses increased by approximately $789,000 during the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016, primarily related to the following an increase in payroll, rent and other costs allocated to us by our Advisor.
Loss on disposal of assets of approximately $842,000 related primarily to the replacement of appliances at our rental properties in conjunction with unit upgrades.
Depreciation and amortization is comprised of the depreciation on our rental properties and amortization of intangible assets related to in-place leases, which are amortized over a period of approximately six to nine months after acquisition. The increases (decreases) in the components of depreciation and amortization during the nine months ended September 30, 2017, as follows (in thousands):
Properties owned during both periods | All other | Total | ||||||||||
Depreciation | $ | 6,530 | $ | 3,811 | $ | 10,341 | ||||||
Amortization of intangibles | (7,282 | ) | 3,034 | (4,248 | ) | |||||||
$ | (752 | ) | $ | 6,845 | $ | 6,093 | ||||||
The overall increase in depreciation expense for all properties was due to additional capital improvements made since September 30, 2016 on properties owned during both periods, as well as properties purchased since September 30, 2016. The decrease in amortization expense was due to amortization no longer being taken on properties which have been owned for a period of six to nine months. As of September 30, 2017, only one property has an unamortized intangible balance remaining for a total of $286,000. There was one acquisition during the nine months ended September 30, 2017.
Interest expense increased by $6.9 million during nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 as a result of three additional mortgages either entered into or assumed since September 30, 2016, all of which were used to finance property acquisitions and all of which increased amortization of deferred financing costs.
Liquidity and Capital Resources
From February 2014 to February 2016, we offered in our public offering up to $1.0 billion in shares of common stock, $0.01 par value per share, at $10 per share. At the termination of the primary offering, we had raised $556.2 million in gross proceeds. We have also offered and continue to offer up to $95.0 million in shares of our common stock to be issued pursuant to our distribution reinvestment plan under which our stockholders may elect to have distributions reinvested in additional shares at $8.65 per share ($8.56 per share prior to March 31, 2017).
We derive the capital required to purchase real estate investments and conduct our operations from secured or unsecured financings from banks or other lenders, from proceeds from the sale of assets and from any undistributed funds from our operations.
We allocate funds as necessary to a reserve to support the maintenance and viability of properties we acquire in the future in order to preserve value for our investors. If such allocations and any other available income become insufficient to cover our operating expenses and liabilities, it may be necessary to obtain additional funds by borrowing, refinancing properties or liquidating our investment in one or more properties, debt investments or other assets we may hold. We cannot assure you that we will be able to access additional funds when we need them or upon acceptable terms.
We may seek to obtain REIT-level financing through a line of credit from third-party financial institutions or other commercial lenders. Our assets will serve as collateral for this type of debt incurred to acquire real estate investments. In addition to debt financing at the REIT-level, we have financed, and may continue to finance, the acquisition costs of individual real estate investments, as well as the acquisition costs of all or a group of real estate investments acquired by us, by causing our subsidiaries to borrow directly from third-party financial institutions or other commercial lenders. Under these circumstances, our Advisor anticipates that certain properties will serve as collateral for the debt we incur to acquire those particular properties and that we will seek to obtain nonrecourse financing for the acquisition of the properties. However, there is no guarantee that our Advisor will be successful in obtaining financing arrangements on a property-by-property basis and that the loans would be nonrecourse to us. Finally, we may also obtain seller financing with respect to specific assets that we acquire.
Capital Expenditures
We deployed a total of $20.7 million during the nine months ended September 30, 2017 for capital expenditures. The properties in which we deployed the most capital during the nine months ended September 30, 2017 are listed separately and the capital expenditures made on all other properties are aggregated in "All other properties" below (in thousands):
Capital deployed during the nine months ended | Remaining capital budgeted | |||||||
September 30, 2017 | ||||||||
Overton Trails Apartment Homes | $ | 928 | $ | 1,401 | ||||
Uptown Buckhead | 615 | 12 | ||||||
Crosstown at Chapel Hill | 1,400 | 2,814 | ||||||
The Brookwood | 954 | 2,969 | ||||||
1000 Spalding Apartment Homes | 1,169 | 1,330 | ||||||
Montclair | 745 | 4,534 | ||||||
Grand Reserve | 1,537 | 2,748 | ||||||
Verdant Apartment Homes | 1,089 | 1,573 | ||||||
Arcadia Apartment Homes | 1,318 | 3,556 | ||||||
Riverlodge | 2,575 | 6,475 | ||||||
Breckenridge | 2,488 | 5,337 | ||||||
Santa Rosa | 3,462 | 7,445 | ||||||
All other properties | 2,450 | 9,050 | ||||||
$ | 20,730 | $ | 49,244 | |||||
Common Stock
As of September 30, 2017, we had an aggregate of 60,309,199 shares of $0.01 par value common stock outstanding, including the Advisor's additional purchase of 117,778 shares of common stock for $1.1 million, as follows (dollars in thousands):
Shares Issued | Gross Proceeds | ||||||
Shares issued through initial public offering | 55,791,297 | $ | 556,197 | ||||
Shares issued through stock distributions | 246,365 | — | |||||
Shares issued through distribution reinvestment plan | 5,074,228 | 44,729 | |||||
Advisor's initial investment, net of 5,000 share conversion | 15,000 | 150 | |||||
Total | 61,126,890 | 601,076 | |||||
Shares redeemed and retired | (817,691 | ) | (7,064 | ) | |||
Total shares outstanding | 60,309,199 | $ | 594,012 | ||||
Mortgage Debt
The following is a summary of our mortgage notes payable (in thousands):
September 30, 2017 | December 31, 2016 | |||||||||||||||||||||||||||||||
Collateral | Outstanding borrowings | Premium, net | Deferred Finance Costs, net | Carrying Value | Outstanding borrowings | Premium | Deferred Finance Costs, net | Carrying Value | ||||||||||||||||||||||||
Overton Trails Apartment Homes | $ | 30,646 | $ | — | $ | (302 | ) | $ | 30,344 | $ | 31,075 | $ | — | $ | (344 | ) | $ | 30,731 | ||||||||||||||
Uptown Buckhead | 20,135 | — | (257 | ) | 19,878 | 20,200 | — | (284 | ) | 19,916 | ||||||||||||||||||||||
Crosstown at Chapel Hill | 31,930 | — | (292 | ) | 31,638 | 32,000 | — | (373 | ) | 31,627 | ||||||||||||||||||||||
The Brookwood - Key Bank | 17,968 | 426 | (200 | ) | 18,194 | 18,247 | 508 | (239 | ) | 18,516 | ||||||||||||||||||||||
The Brookwood - Capital One | 2,668 | 33 | (35 | ) | 2,666 | 2,699 | 39 | (41 | ) | 2,697 | ||||||||||||||||||||||
Adair off Addison and Adair off Addison Apartment Homes | 25,205 | — | (377 | ) | 24,828 | 25,500 | — | (464 | ) | 25,036 | ||||||||||||||||||||||
1000 Spalding Apartment Homes | 24,600 | — | (245 | ) | 24,355 | 24,600 | — | (289 | ) | 24,311 | ||||||||||||||||||||||
Ravina Apartment Homes | 27,802 | — | (335 | ) | 27,467 | 28,292 | — | (393 | ) | 27,899 | ||||||||||||||||||||||
Verdant Apartment Homes | 37,300 | — | (303 | ) | 36,997 | 37,300 | — | (345 | ) | 36,955 | ||||||||||||||||||||||
Arcadia Apartment Homes | 40,200 | — | (333 | ) | 39,867 | 40,200 | — | (379 | ) | 39,821 | ||||||||||||||||||||||
Grand Reserve | 41,738 | — | (390 | ) | 41,348 | 42,395 | — | (446 | ) | 41,949 | ||||||||||||||||||||||
Montclair Terrace | 20,774 | — | (302 | ) | 20,472 | 21,083 | — | (345 | ) | 20,738 | ||||||||||||||||||||||
Breckenridge | 52,975 | — | (613 | ) | 52,362 | 52,975 | — | (697 | ) | 52,278 | ||||||||||||||||||||||
The Palmer at Las Colinas | 45,700 | — | (591 | ) | 45,109 | 45,700 | — | (643 | ) | 45,057 | ||||||||||||||||||||||
Windbrooke Crossing | 38,320 | — | (431 | ) | 37,889 | 38,320 | — | (490 | ) | 37,830 | ||||||||||||||||||||||
Woods of Burnsville | 38,250 | — | (558 | ) | 37,692 | — | — | — | — | |||||||||||||||||||||||
Indigo Creek | 40,789 | — | (492 | ) | 40,297 | — | — | — | — | |||||||||||||||||||||||
$ | 537,000 | $ | 459 | $ | (6,056 | ) | $ | 531,403 | $ | 182,613 | $ | 547 | $ | (5,772 | ) | $ | 455,361 | |||||||||||||||
Maturity Date | Margin over LIBOR | Annual Interest Rate | Average Monthly Debt Service | Average Monthly Escrow | ||||||||||||
Overton Trails Apartment Homes | 1/1/2025 | 1.91 | % | 3.14 | % | 118 | 117 | (1) (3) (6) | ||||||||
Uptown Buckhead | 7/1/2025 | 2.22 | % | 3.45 | % | 79 | 58 | (1) (3) (5) | ||||||||
Crosstown at Chapel Hill | 7/10/2020 | 1.70 | % | 2.93 | % | 100 | — | (1) (4) (5) | ||||||||
The Brookwood - Key Bank | 11/1/2021 | N/A | 4.73 | % | 104 | 48 | (2) (7) | |||||||||
The Brookwood - Capital One | 11/1/2021 | N/A | 5.40 | % | 16 | — | (2) (7) | |||||||||
Adair off Addison and Adair off Addison Apartment Homes | 1/1/2021 | 1.55 | % | 2.78 | % | 88 | — | (1) (3) | ||||||||
1000 Spalding Apartment Homes | 1/1/2022 | N/A | 3.88 | % | 113 | 47 | (2) (5) | |||||||||
Ravina Apartment Homes | 5/1/2022 | N/A | 3.76 | % | 144 | 157 | (2) (7) | |||||||||
Verdant Apartment Homes | 5/1/2023 | N/A | 3.89 | % | 159 | 29 | (2) (5) | |||||||||
Arcadia Apartment Homes | 5/1/2023 | N/A | 3.89 | % | 172 | 20 | (2) (5) | |||||||||
Grand Reserve | 6/1/2023 | 2.57 | % | 3.80 | % | 184 | 86 | (1) (3) (6) | ||||||||
Montclair Terrace | 6/1/2023 | 2.45 | % | 3.68 | % | 93 | 24 | (1) (3) (7) | ||||||||
Breckenridge | 7/1/2023 | 2.36 | % | 3.59 | % | 223 | 58 | (1) (3) (5) | ||||||||
The Palmer at Las Colinas | 9/1/2026 | 2.11 | % | 3.34 | % | 149 | 146 | (1) (3) (5) | ||||||||
Windbrooke Crossing | 1/1/2024 | 2.69 | % | 3.92 | % | 203 | 67 | (1) (3) (5) | ||||||||
Woods of Burnsville | 2/1/2024 | 2.13 | % | 3.36 | % | 171 | 67 | (1) (3) (5) | ||||||||
Indigo Creek | 4/1/2024 | 1.93 | % | 3.16 | % | 220 | 52 | (1) (3) (5) | ||||||||
(1) | Variable rate based on one-month LIBOR of 1.2322% (as of September 30, 2017) plus a fixed margin |
(2) | Fixed rate |
(3) | Variable rate hedged with interest rate cap cash flow hedge |
(4) | Fixed rate interest rate swap associated with the variable rate debt |
(5) | Monthly interest-only payment currently required |
(6) | Monthly fixed principal plus interest payment required |
(7) | Fixed monthly principal and interest payment required |
On August 21, 2015, we recorded a fair value adjustment, which represented the fair value of the debt assumed over its principal amount in connection with The Brookwood Apartment Homes acquisition. The fair value is being amortized to interest expense over the term of the related mortgages loans using the effective interest method. As of September 30, 2017, the net unamortized fair value of debt was $459,000 and was included as a component of mortgage loans payable in the accompanying consolidated balance sheets.
At September 30, 2017, the weighted average interest rate of all our outstanding indebtedness was 3.57%.
Operating Properties
As of September 30, 2017, our wholly-owned interests in multifamily properties were as follows:
Subsidiary | Apartment Complex | Number of Units | Property Location | |||
RRE Bear Creek Holdings, LLC, or Bear Creek | Adair off Addison | 152 | Dallas, TX | |||
RRE Oak Hill Holdings, LLC, or Oak Hill | Overton Trails Apartment Homes | 360 | Fort Worth, TX | |||
RRE Buckhead Holdings, LLC, or Buckhead | Uptown Buckhead | 216 | Atlanta, GA | |||
RRE Farrington Holdings, LLC, or Farrington | Crosstown at Chapel Hill | 411 | Chapel Hill, NC | |||
RRE Mayfair Chateau Holdings, LLC, or Mayfair Chateau | The Brookwood | 274 | Homewood, AL | |||
RRE Fairways of Bent Tree Holdings, LLC, or Fairways of Bent Tree | Adair off Addison Apartment Homes | 200 | Dallas, TX | |||
RRE Spalding Crossing Holdings, LLC, or Spalding Crossing | 1000 Spalding Apartment Homes | 252 | Atlanta, GA | |||
RRE Montclair Terrace Holdings, LLC, or Montclair Holdings | Montclair Terrace | 188 | Portland, OR | |||
RRE Grand Reserve Holdings, LLC, or Grand Reserve | Grand Reserve | 319 | Naperville, IL | |||
RRE Canterwood Holdings, LLC, or Canterwood | Verdant Apartment Homes | 216 | Boulder, CO | |||
RRE Fox Ridge Holdings, LLC, or Fox Ridge | Arcadia Apartment Homes | 300 | Centennial, CO | |||
RRE Riverlodge Holdings, LLC, or Riverlodge | Ravina Apartment Homes | 498 | Austin, TX | |||
RRE Breckenridge Holdings, LLC, or Breckenridge | Breckenridge | 357 | Portland, OR | |||
RRE Santa Rosa Holdings, LLC, or Santa Rosa | The Palmer at Las Colinas | 476 | Irving, TX | |||
RRE Windbrooke Holdings, LLC, or Windbrooke Crossing | Windbrooke Crossing | 236 | Buffalo Grove, IL | |||
RRE Woods Holdings, LLC, or The Woods of Burnsville | The Woods of Burnsville | 400 | Burnsville, MN | |||
RRE Indigo Creek Holdings, LLC | Indigo Creek | 408 | Glendale, AZ | |||
5,263 | ||||||
As four of our multifamily properties are located in the Dallas-Fort Worth area, two of our properties are located in the Atlanta area, two of our properties are located in Portland, Oregon and two of our properties are located in the Denver area, our portfolio is currently particularly susceptible to adverse economic developments in these real estate markets. Any adverse economic or real estate developments in these markets, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for multifamily rentals resulting from the local business climate, could negatively affect our liquidity and adversely affect our ability to fund our ongoing operations.
Acquisition and Asset Management Costs
In addition to making investments in accordance with our investment objectives, we expect to use our capital resources to make payments to our Advisor. During our acquisition stage, we expect to make payments to our Advisor in connection with the acquisition of real estate investments. In addition, we expect to continue to make payments to our Advisor for the management of our assets and costs incurred by our Advisor in providing services to us. We describe these payments in more detail in Note 10 of the notes to our consolidated financial statements.
Operating Costs
In addition to making investments in accordance with our investment objectives, we expect to use our capital resources
to make payments to our Advisor and its affiliates. We make payments to our Advisor and its affiliates in connection with the acquisition of real estate investments and for the management of our assets and costs incurred by our Advisor and its affiliates in
providing services to us. We describe these payments in more detail in Note 10 of the notes to our consolidated financial statements.
Under our charter, our Advisor must reimburse us the amount by which our aggregate total operating expenses for the four fiscal quarters then ended exceed the greater of 2% of our average invested assets or 25% of our net income, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. “Average invested assets” means the average monthly book value of our assets invested, directly or indirectly, in equity interests in and loans secured by real estate during the 12-month period before deducting depreciation, bad debts or other non-cash reserves. “Total operating expenses” means all expenses paid or incurred by us, as determined under GAAP, that are in any way related to our operation, including advisory 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, registration and stock exchange listing of our 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 our assets; and (f) acquisition fees, acquisition expenses (including expenses relating to potential investments that we do not close), disposition fees on the resale of property and other expenses connected with the acquisition, disposition and ownership of real estate interests, loans or other property (including the costs of foreclosure, insurance premiums, legal services, maintenance, repair and improvement of property). Operating expenses for the four quarters ended September 30, 2017 did not exceed the charter imposed limitation.
Critical Accounting Policies
For a discussion on our critical accounting policies and estimates, see our Annual Report on Form 10-K for the year ended December 31, 2016.
Distributions
For the nine months ended September 30, 2017, we paid aggregate distributions of $26.7 million, including $11.2 million of distributions paid in cash and $15.5 million of distributions reinvested in shares of common stock through our distribution reinvestment plan. Distributions declared, distributions paid and cash flows provided by (used in) operating activities were as follows for the nine months ended September 30, 2017 (in thousands, except per share data):
Distributions Paid | Distributions Declared | Sources of Distributions Paid | |||||||||||||||||||||||||||||
2017 | Cash | Distributions Reinvested (DRIP) | Total | Cash Provided By (Used In) Operating Activities - Quarter to Date | Cash Provided By (Used In) Operating Activities - Year to Date | Total | Per Share | Amount Paid from Operating Activities/Percent of Total Distributions Paid | Amount Paid from Debt Financing/Percent of Total Distributions Paid | ||||||||||||||||||||||
First Quarter | $ | 3,685 | $ | 5,090 | $ | 8,775 | $ | (1,466 | ) | $ | (1,466 | ) | $ | 8,948 | $ | 0.149589 | -/- | $8,948/100% | |||||||||||||
Second Quarter | 3,765 | 5,183 | $ | 8,948 | $ | (426 | ) | $ | (1,892 | ) | 8,994 | $ | 0.149589 | -/- | $8,994/100% | ||||||||||||||||
Third Quarter | $ | 3,786 | $ | 5,209 | $ | 8,995 | $ | 1,200 | $ | (692 | ) | $ | 9,021 | $ | 0.149589 | -/- | $9,021/100% | ||||||||||||||
$ | 11,236 | $ | 15,482 | $ | 26,718 | $ | (692 | ) | |||||||||||||||||||||||
Cash distributions paid since inception were as follows (in thousands, except per share data):
Fiscal Year | Per Common Share per day | Distributions invested in shares of Common Stock | Net Cash Distribution | Total Aggregate Distribution | |||||||||||
2014 | $ | 0.00071223 | $ | 215 | $ | 114 | $ | 329 | |||||||
2015 | 0.00164384 | 8,424 | 5,654 | 14,078 | |||||||||||
2016 | 0.00164384 | 20,608 | 14,025 | 34,633 | |||||||||||
2017 | 0.00164384 | 15,482 | 11,236 | 26,718 | |||||||||||
$ | 44,729 | $ | 31,029 | $ | 75,758 | ||||||||||
Our net loss attributable to common stockholders' for the nine months ended September 30, 2017 was $28.4 million and net cash used in operating activities was $692,000. Our cumulative cash distributions and net loss attributable to common
shareholders from inception through September 30, 2017 were $75.8 million and $98.5 million, respectively. We have funded our cumulative distributions, which includes net cash distributions and distributions reinvested by stockholders, with cash flows from operating activities and proceeds from debt financing. To the extent that we pay distributions from sources other than our cash flow from operating activities, we will have fewer funds available for investment and the overall return to our stockholders may be reduced.
On September 12, 2017, our Board of Directors approved distributions in an amount of $0.00164384 per share of common stock for stockholders of record each day in the period from September 29, 2017 through and including December 28, 2017, payable on October 31, 2017, November 30, 2017 and December 29, 2017.
Funds from Operations and Modified Funds from Operations
Funds from operations, or FFO, is a non-GAAP financial performance measure that is widely recognized as a measure of REIT operating performance. We use FFO as defined by the National Association of Real Estate Investment Trusts to be net income (loss), computed in accordance with GAAP excluding extraordinary items, as defined by GAAP, and gains (or losses) from sales of property (including deemed sales and settlements of pre-existing relationships), plus depreciation and amortization on real estate assets, and after related adjustments for unconsolidated partnerships, joint ventures and subsidiaries and noncontrolling interests. We believe that FFO is helpful to our investors and our management as a measure of operating performance because it excludes real estate-related depreciation and amortization, gains and losses from property dispositions, and extraordinary items, and as a result, when compared year to year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, which are not immediately apparent from net income. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate and intangibles diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting alone to be insufficient. As a result, our management believes that the use of FFO, together with the required GAAP presentations, is helpful for our investors in understanding our performance. Factors that impact FFO include start-up costs, fixed costs, delays in buying assets, lower yields on cash held in accounts, income from portfolio properties and other portfolio assets, interest rates on acquisition financing and operating expenses. In addition, FFO will be affected by the types of investments in our targeted portfolio which will consist of, but are not limited to, commercial real estate assets, principally (i) underperforming multifamily rental properties which we will renovate and stabilize in order to increase rents, (ii) distressed real estate owned by financial institutions, usually as a result of foreclosure, and non-performing or distressed loans, including first- and second-priority mortgage loans and other loans which we will resolve, and (iii) performing loans, including first- and second-priority mortgage loans and other loans we originate or purchase either directly or with a co-investor or joint venture partner.
Since FFO was promulgated, GAAP has adopted several new accounting pronouncements, such that management and many investors and analysts have considered the presentation of FFO alone to be insufficient. Accordingly, in addition to FFO, we use modified funds from operations, or MFFO, as defined by the Investment Program Association, or IPA. MFFO excludes from FFO the following items:
(1) | acquisition fees and expenses; |
(2) | straight-line rent amounts, both income and expense; |
(3) | amortization of above- or below-market intangible lease assets and liabilities; |
(4) | amortization of discounts and premiums on debt investments; |
(5) | impairment charges; |
(6) | gains or losses from the early extinguishment of debt; |
(7) | gains or losses on the extinguishment or sales of hedges, foreign exchange, securities and other derivatives holdings except where the trading of such instruments is a fundamental attribute of our operations; |
(8) | gains or losses related to fair-value adjustments for derivatives not qualifying for hedge accounting, including interest rate and foreign exchange derivatives; |
(9) | gains or losses related to consolidation from, or deconsolidation to, equity accounting; |
(10) | gains or losses related to contingent purchase price adjustments; and |
(11) | adjustments related to the above items for unconsolidated entities in the application of equity accounting. |
We believe that MFFO is helpful in assisting management assess the sustainability of operating performance in future periods and, in particular, after our acquisition stage is complete, primarily because it excludes acquisition expenses that affect
property operations only in the period in which the property is acquired. Although MFFO includes other adjustments, the exclusion of acquisition expenses is the most significant adjustment to us at the present time, as we are currently in our acquisition stage. Thus, MFFO provides helpful information relevant to evaluating our operating performance in periods in which there is no acquisition activity.
As explained below, management’s evaluation of our operating performance excludes the items considered in the calculation based on the following economic considerations. Many of the adjustments in arriving at MFFO are not applicable to us. Nevertheless, we explain below the reasons for each of the adjustments made in arriving at our MFFO definition:
• | Acquisition expenses. In evaluating investments in real estate, including both business combinations and investments accounted for under the equity method of accounting, management’s investment models and analysis differentiate costs to acquire the investment from the operations derived from the investment. Prior to 2009, acquisition costs for both of these types of investments were capitalized under GAAP; however, beginning in 2009, acquisition costs related to business combinations are expensed. Both of these acquisition costs have been and will continue to be funded from the proceeds of our offering and debt proceeds, and not from operations. We believe by excluding expensed acquisition costs, MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management’s analysis of the investing and operating performance of our properties. Acquisition expenses include those paid to our Advisor or third parties. |
• | Adjustments for straight-line rents and amortization of discounts and premiums on debt investments. In the proper application of GAAP, rental receipts and discounts and premiums on debt investments are allocated to periods using various systematic methodologies. This application will result in income recognition that could be significantly different than underlying contract terms. By adjusting for these items, MFFO provides useful supplemental information on the realized economic impact of lease terms and debt investments and aligns results with management’s analysis of operating performance. |
• | Adjustments for amortization of above or below market intangible lease assets. Similar to depreciation and amortization of other real estate related assets that are excluded from FFO, GAAP implicitly assumes that the value of intangibles diminishes predictably over time and that these charges be recognized currently in revenue. Since real estate values and market lease rates in the aggregate have historically risen or fallen with market conditions, management believes that by excluding these charges, MFFO provides useful supplemental information on the performance of the real estate. |
• | Impairment charges, gains or losses related to fair-value adjustments for derivatives not qualifying for hedge accounting and gains or losses related to contingent purchase price adjustments. Each of these items relates to a fair value adjustment, which is based on the impact of current market fluctuations and underlying assessments of general market conditions and specific performance of the holding which may not be directly attributable to current operating performance. As these gains or losses relate to underlying long-term assets and liabilities, management believes MFFO provides useful supplemental information by focusing on the changes in our core operating fundamentals rather than changes that may reflect anticipated gains or losses. In particular, because GAAP impairment charges are not allowed to be reversed if the underlying fair values improve or because the timing of impairment charges may lag the onset of certain operating consequences, we believe MFFO provides useful supplemental information related to current consequences, benefits and sustainability related to rental rate, occupancy and other core operating fundamentals. |
• | Adjustment for gains or losses related to early extinguishment of hedges, debt, consolidation or deconsolidation and contingent purchase price. Similar to extraordinary items excluded from FFO, these adjustments are not related to continuing operations. By excluding these items, management believes that MFFO provides supplemental information related to sustainable operations that will be more comparable between other reporting periods and to other real estate operators. |
By providing MFFO, we believe we are presenting useful information that also assists investors and analysts in the assessment of the sustainability of our operating performance after our acquisition stage is completed. We also believe that MFFO is a recognized measure of sustainable operating performance by the real estate industry. MFFO is useful in comparing the sustainability of our operating performance after our acquisition stage is completed with the sustainability of the operating performance of other real estate companies that are not as involved in acquisition activities or as affected by other MFFO adjustments. However, investors are cautioned that MFFO should only be used to assess the sustainability of our operating performance after our acquisition stage is completed, as it excludes acquisition costs that have a negative effect on our operating performance and the reported book value of our common stock and stockholders’ equity during the periods in which properties are acquired.
Neither FFO nor MFFO should be considered as an alternative to net income (loss), nor as an indication of our liquidity, nor are any of these measures indicative of funds available to fund our cash needs, including our ability to fund distributions. In particular, as we are currently in the acquisition phase of our life cycle, acquisition costs and other adjustments that are increases to MFFO are, and may continue to be, a significant use of cash. Accordingly, FFO and MFFO should be reviewed in connection with other GAAP measurements. Our FFO and MFFO as presented may not be comparable to amounts calculated by other REITs.
The following section presents our calculation of FFO and MFFO and provides additional information related to our operations (in thousands, except per share amounts). As a result of the timing of our active real estate operations and the general and administrative expenses incurred in connection with this events, FFO and MFFO are not relevant to a discussion comparing operations for the two periods presented. We expect revenues and expenses to increase in future periods as we acquire additional investments.
Three Months Ended | Nine Months Ended | ||||||||||||||
September 30, | September 30, | ||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||
Net loss – GAAP | $ | (8,518 | ) | $ | (9,399 | ) | $ | (28,394 | ) | $ | (33,125 | ) | |||
Depreciation expense | 8,985 | 6,299 | 25,487 | 15,146 | |||||||||||
FFO | 467 | (3,100 | ) | (2,907 | ) | (17,979 | ) | ||||||||
Adjustments for straight-line rents | 54 | (4 | ) | 175 | 32 | ||||||||||
Fair value adjustment for cancelable swap | (58 | ) | (42 | ) | (217 | ) | 492 | ||||||||
Amortization of intangible lease assets | 553 | 1,916 | 3,546 | 7,794 | |||||||||||
Acquisition costs | — | 2 | 1,360 | 6,846 | |||||||||||
MFFO | $ | 1,016 | $ | (1,228 | ) | $ | 1,957 | $ | (2,815 | ) | |||||
Basic and diluted net loss per common share - GAAP | $ | (0.14 | ) | $ | (0.16 | ) | $ | (0.48 | ) | $ | (0.58 | ) | |||
FFO per share | $ | 0.01 | $ | (0.05 | ) | $ | (0.05 | ) | $ | (0.31 | ) | ||||
MFFO per share | $ | 0.02 | $ | (0.02 | ) | $ | 0.03 | $ | (0.05 | ) | |||||
Weighted average shares outstanding | 60,318 | 58,321 | 59,626 | 57,462 | |||||||||||
Off-Balance Sheet Arrangements
As of September 30, 2017 and 2016, we did not have any off-balance sheet arrangements or obligations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Omitted as permitted under rules applicable to smaller reporting companies.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in
our periodic reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to our principal executive officer and our principal financial officer, as appropriate, to allow
timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our
management recognized that any controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Under the supervision of our principal executive officer and principal financial officer, we have carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective as of September 30, 2017.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting that occurred in the quarter ended September 30, 2017 that has materially affected, or is reasonable likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unregistered Sales of Equity Securities
All securities sold by us during the three months ended September 30, 2017 were sold in an offering registered under the Securities Act of 1933, as amended (the "Securities Act").
Redemption of Securities
Our board of directors has adopted a share redemption program that may enable stockholders to sell their shares to us after they have held them for at least one year, subject to the significant conditions and limitations of the program. In its sole discretion, our board of directors could choose to amend, suspend or terminate the program upon 30 days’ notice without stockholder approval. Except for redemptions sought upon a stockholder’s death, qualifying disability or confinement to a long-term care facility, the price at which shares are redeemed under our share redemption program is as follows:
• | For those shares held by the redeeming stockholder for at least one year, 92.5% of our current estimated value per share; |
• | For those shares held by the redeeming stockholder for at least two years, 95.0% of our current estimated share value; |
• | For those shares held by the redeeming stockholder for at least three years, 97.5% of our current estimated share value and |
• | For those shares held by the redeeming stockholder for at least four years, 100% of our current estimated share value. |
We will not redeem in excess of 5% of the weighted-average number of shares outstanding during the 12-month period immediately prior to the effective date of redemption. Generally, the cash available for redemption will be limited to proceeds from our distribution reinvestment plan plus, if we had positive operating cash flow from the previous fiscal year, 1% of all operating cash flow from the previous fiscal year. These limitations apply to all redemptions, including redemptions sought upon a stockholder’s death, qualifying disability or confinement to a long-term care facility.
During the three months ended September 30, 2017, we redeemed shares as follows (in thousands, except per share data):
Month | Total Number of Shares Redeemed | Average Price Paid per Share | Cumulative Number of Shares Purchased as Part of a Publicly Announced Plan or Program (1) | Approximate Dollar Value of Shares Available That May Yet Be Redeemed Under the Program | ||||
July 2017 | — | $— | — | (2) | ||||
August 2017 | — | $— | — | (2) | ||||
September 2017 | 336 | $8.51 | 645 | (2) | ||||
(1) | All purchases of equity securities by us in the nine months ended September 30, 2017 were made pursuant to our share redemption program. |
(2) | We currently limit the dollar value and number of shares that may be repurchased under the program, as discussed above. |
All redemption requests tendered were honored during the three months ended September 30, 2017.
ITEM 6. EXHIBITS
Exhibit No. | Description | |
3.1 | Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Pre-Effective Amendment No. 3 to the Registration Statement on Form S-11 (No. 333-184476) filed December 20, 2013) | |
3.2 | Bylaws (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-11 (No. 333-184476) filed October 17, 2012) | |
4.1 | Statement regarding restrictions on transferability of shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates) (incorporated by reference to the Company’s Registration Statement on Form S-11 (No. 333-184476) filed October 17, 2012) | |
4.2 | Amended and Restated Distribution Reinvestment Plan (incorporated by reference to Appendix A to the prospectus included in the Company’s Post-Effective Amendment no. 9 to the Registration Statement on Form S-11 on Form S-3 (No. 333-184476) filed February 16, 2016) | |
31.1 | ||
31.2 | ||
32.1 | ||
32.2 | ||
99.1 | Third Amended and Restated Share Redemption Program (incorporated by reference to Exhibit 99.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.) | |
101.1 | The following information from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations and Comprehensive (Loss) Income; (iii) Consolidated Statement of Changes in Stockholders' Equity; and (iv) Consolidated Statements of Cash Flows | |
SIGNATURES
Pursuant to the requirements of Section 12 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.
RESOURCE REAL ESTATE OPPORTUNITY REIT II, INC. | |
November 13, 2017 | By: /s/ Alan F. Feldman |
Alan F. Feldman | |
Chief Executive Officer | |
(Principal Executive Officer) | |
November 13, 2017 | By: /s/ Steven R. Saltzman |
Steven R. Saltzman | |
Chief Financial Officer | |
(Principal Financial and Accounting Officer) | |