UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For The Fiscal Year Ended December 31, 2017

 

or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from ____________ to ____________

 

Commission file number 000-55773

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC.

(Exact Name of Registrant as Specified in Its Charter)

   

Maryland	46-1796830
(State or other jurisdiction	(I.R.S. Employer Identification No.)
of incorporation or organization)

 

1985 Cedar Bridge Avenue, Suite 1, Lakewood, NJ	08701
(Address of principal executive offices)	(Zip code)

 

Registrant's telephone number, including area code:  732-367-0129

 

Securities registered under Section 12(b) of the Exchange Act:

 

Title of Each Class		Name of Each Exchange on Which Registered
None		None

 

Securities registered under Section 12(g) of the Exchange Act:

 

Common Stock, $0.01 par value per share

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨  

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company x
	Emerging growth company x

 

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. x

 

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

 

There is no established market for the Registrant’s common shares. As of June 30, 2017, the last business day of the most recently completed second quarter, there were 8.7 million shares of the registrant’s common stock held by non-affiliates of the registrant. On February 27, 2018, the board of directors of the Registrant approved an estimated value per share of the Registrant’s common stock of $10.00 per share derived from the estimated value of the Registrant’s assets less the estimated value of the Registrant’s liabilities divided by the number of shares outstanding, all as of December 31, 2017. For a full description of the methodologies used to value the Registrant's assets and liabilities in connection with the calculation of the estimated value per share, see Part II, Item 5, “Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Market Information.” As of February 15, 2018, there were approximately 8.6 million shares of common stock held by non-affiliates of the registrant.

 

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC.

 

Table of Contents

 

		Page
PART I
Item 1.	Business	2
Item 1A.	Risk Factors	9
Item 1B.	Unresolved Staff Comments	36
Item 2.	Properties	36
Item 3.	Legal Proceedings	36
Item 4.	Mine Safety Disclosures	36
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities	37
Item 6.	Selected Financial Data	46
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	46
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	57
Item 8.	Financial Statements and Supplementary Data	58
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	80
Item 9A.	Controls and Procedures	80
Item 9B.	Other Information	81
PART III
Item 10.	Directors and Executive Officers of the Registrant	81
Item 11.	Executive Compensation	83
Item 12.	Security Ownership of Certain Beneficial Owners and Management	84
Item 13.	Certain Relationships and Related Transactions	84
Item 14.	Principal Accounting Fees and Services	86
PART IV
Item 15.	Exhibits and Financial Statement Schedules	89
Item 16.	Form 10-K Summary	90
	Signatures	91

 

 

Special Note Regarding Forward-Looking Statements  

 

This annual report on Form 10-K, together with other statements and information publicly disseminated by Lightstone Real Estate Income Trust Inc.  (the “Lightstone Income Trust”) contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Exchange Act”), and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and which could materially affect actual results, performances or achievements. Factors which may cause actual results to differ materially from current expectations include, but are not limited to, (i) general economic and local real estate conditions, (ii)  changes in governmental laws and regulations, (iii) the level and volatility of interest rates, (iv) the availability of suitable acquisition opportunities and (v) increases in operating costs. Accordingly, there is no assurance that our expectations will be realized.

 

All forward-looking statements should be read in light of the factors identified herein at Part 1, Item 1A

 

PART I.

 

ITEM 1. BUSINESS:

 

General Description of Business, Offering and Structure

 

The Lightstone Income Trust, incorporated on September 9, 2014, in Maryland, elected to be taxed as a real estate investment trust for U.S. federal income tax purposes (‘‘REIT’’) beginning with the taxable year ended December 31, 2016.

 

Lightstone Income Trust sold 20,000 Common Shares to Lightstone Real Estate Income LLC, a Delaware limited liability company (the ‘‘Advisor’’), an entity majority owned by David Lichtenstein, on September 12, 2014, for $10.00 per share. Mr. Lichtenstein also is a majority owner of the equity interests of Lightstone Income Trust’s sponsor, The Lightstone Group, LLC (the ‘‘Sponsor’’). Subject to the oversight of the Company’s board of directors (the “Board of Directors”), the Advisor has primary responsibility for making investment decisions and managing the Company’s day-to-day operations. Mr. Lichtenstein also acts as the Company’s Chairman and Chief Executive Officer. As a result, he exerts influence over but does not control the Lightstone Income Trust.

 

Lightstone Income Trust, together with its subsidiaries, is collectively referred to as the ‘‘Company’’ and the use of ‘‘we,’’ ‘‘our,’’ ‘‘us’’ or similar pronouns refers to Lightstone Income Trust or the Company as required by the context in which any such pronoun is used.

 

The Company filed a Registration Statement on Form S-11 (File No. 333-200464) (the “Registration Statement”) pursuant to which it offered to sell (the “Offering”) up to 30,000,000 shares of its common stock, par value $0.01 per share (which may be referred to herein as ‘‘shares of common stock’’ or as ‘‘Common Shares’’) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10,000,000 shares available pursuant to its distribution reinvestment program (the ‘‘DRIP’’) which were offered at a discounted price equivalent to 95% of the initial price of $10.00 per Common Share) was declared effective by the SEC under the Securities Act of 1933 on February 26, 2015. On June 30, 2016, the Company adjusted its offering price to $9.14 per Common Share in its Primary Offering, which was equal to the Company’s estimated net asset value (“NAV”) per Common Share as of March 31, 2016, and effective July 25, 2016, the Company’s offering price was adjusted to $10.00 per Common Share in its Primary Offering, which was equal to the estimated NAV per Common Share as of June 30, 2016. Our estimated NAV per Common Share remained unchanged at $10.00 as of both September 30, 2016 and December 31, 2016.

 

The Offering, which terminated on March 31, 2017, raised aggregate gross proceeds of approximately $85.6 million from the sale of approximately 8.9 million shares of common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein, who also owns a majority interest in the Company’s Sponsor). After including aggregate advances from our Sponsor of $12.6 million under the Subordinated Agreement (as discussed below) and allowing for the payment of approximately $7.6 million in selling commissions and dealer manager fees and $3.2 million in organization and offering expenses, the Offering generated aggregate net proceeds of approximately $87.5 million.

 

On April 21, 2017, the Board of Directors approved the termination of our DRIP effective May 15, 2017. All future distributions will be in the form of cash.  In addition, through May 15, 2017 (the termination date of the DRIP), the Company issued approximately 0.1 million shares of common stock under its DRIP, representing approximately $1.2 million of additional proceeds under the Offering.

 

 

On March 18, 2016, the Company and its Sponsor entered into a subordinated unsecured loan agreement (the “Subordinated Agreement”) pursuant to which the Sponsor had committed to make a significant investment in the Company of up to $36.0 million, which was equivalent to 12.0% of the $300.0 million maximum offering amount of Common Shares under the Offering, which was terminated on March 31, 2017. The outstanding advances under the Subordinated Agreement (the “Subordinated Advances”) accrue interest at a rate of 1.48%, but no interest or outstanding advances are due and payable to the Sponsor until holders of the Company’s Common Shares have received liquidation distributions equal to their respective net investments (defined as $10.00 per Common Share) plus a cumulative, pre-tax, non-compounded annual return of 8.0% on their respective net investments.

  

Distributions in connection with a liquidation of the Company initially will be made to holders of its Common Shares until holders of its Common Shares have received liquidation distributions equal to their respective net investments plus a cumulative, pre-tax, non-compounded annual return of 8.0% on their respective net investments. Thereafter, only if additional liquidating distributions are available, the Company will be obligated to repay the outstanding advances under the Subordinated Agreement and accrued interest to the Sponsor, pursuant to the terms of the Subordinated Agreement. In the event that additional liquidation distributions are available after the Company repays its holders of common stock their respective net investments plus their 8% return on investment and then the outstanding advances under the Subordinated Agreement and accrued interest to its Sponsor, such additional distributions will be paid to holders of its Common Shares and its Sponsor: 85.0% of the aggregate amount will be payable to holders of the Company’s Common Shares and the remaining 15.0% will be payable to the Sponsor.

 

The Subordinated Advances and its related interest are subordinate to all of the Company’s obligations as well as to the holders of its Common Shares in an amount equal to the shareholder’s net investment plus a cumulative, pre-tax, non-compounded annual return of 8.0% and only potentially payable in the event of a liquidation of the Company.

 

In connection with the termination of the Offering on March 31, 2017, the Company and the Sponsor terminated the Subordinated Agreement. As a result of the termination, the Sponsor is no longer obligated to make any additional Subordinated Advances to the Company. Interest will continue to accrue on the aggregate outstanding Subordinated Advances and repayment, if any, of the Subordinated Advances and accrued interest will be made according to the terms of the Subordinated Agreement disclosed above.

 

As of both December 31, 2017 and 2016 an aggregate of approximately $12.6 million of Subordinated Advances had been funded, which along with the related accrued interest of $258,817 and $71,863, respectively, are classified as a liability on the consolidated balance sheets. During the years ended December 31, 2017 and 2016, the Company accrued $186,954 and $71,863, respectively, of interest on the Subordinated Advances.

 

The Company has and will continue to seek to originate, acquire and manage a diverse portfolio of real estate-related investments. The Company may invest in mezzanine loans, first lien mortgage loans, second lien mortgage loans, bridge loans and preferred equity interests, in each case with a focus on investments intended to finance development or redevelopment opportunities. The Company may also invest in debt and derivative securities related to real estate assets. The Company expects that a majority of its investments by value will be secured by or related to properties or entities advised by, or wholly or partially, directly or indirectly owned by, the Sponsor, by its affiliates or by real estate investment programs sponsored by it. Although the Company expects that most of its investments will be of these types, it may make other investments. In fact, it may invest in whatever types of real estate-related investments that it believes are in its best interests.

 

The Company has no employees. The Company retains the Advisor to manage its affairs on a day-to-day basis. Orchard Securities, LLC (the ‘‘Dealer Manager’’), a third party not affiliated with the Company, the Sponsor or the Advisor, served as the dealer manager of the Offering. Orchard Securities LLC had a branch office that does business as “Lightstone Capital Markets” and focused primarily on distributing interests in programs sponsored by our Sponsor. The Advisor is an affiliate of the Sponsor and will receive compensation and fees for services related to the investment and management of the Company’s assets. The Advisor has received and will receive fees during the Company’s organization and offering, operational and liquidation/listing stages.

 

The Company’s shares of common stock are not currently listed on a national securities exchange. The Company may seek to list its shares of common stock for trading on a national securities exchange only if a majority of its independent directors believe listing would be in the best interest of its stockholders. The Company does not intend to list its shares of common stock at this time. The Company does not anticipate that there would be any market for its shares of common stock until they are listed for trading. In the event the Company does not begin the process of achieving a liquidity event prior to March 31, 2022 (the fifth anniversary of the termination of our Offering), our charter requires either (a) an amendment to our charter to extend the deadline to begin the process of achieving a liquidity event, or (b) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio.

 

Related Parties

 

Our Advisor and its affiliates are related parties. Certain of these entities have received compensation and fees for services related to our offering and have and will continue to receive compensation and fees and services for the investment of our assets. These entities have or will receive fees during our offering, acquisition, operational and liquidation stages. The compensation levels during the offering, acquisition and operational stages are based on percentages of the offering proceeds sold, the cost of acquired properties or other investments and the annual revenue earned from such properties or other investments, and other such fees outlined in each of the respective agreements.

 

 

Primary Investment Objectives, Acquisition and Investment Policies 

 

Our primary investment objectives are:

 

•

to pay stable monthly cash distributions to our stockholders; and

 

•

to preserve and protect your capital contribution.

 

Our strategy is to originate, acquire and manage a diverse portfolio of real estate-related investments secured by or related to properties located primarily in the United States. A majority of our investments by value currently are and we expect will continue to be related-party investments located in large metropolitan areas. We have and will continue to seek to create and maintain a portfolio of investments that generate attractive and consistent cash distributions. Our focus on investing in debt instruments emphasizes the payment of stable monthly cash distributions to our stockholders and the preservation and protection of their capital contribution as some of our primary investment objectives. We place a lesser emphasis on, but still may target, capital appreciation from our investments, compared to more opportunistic or equity-oriented strategies.

 

We have not established any limits on the percentage of our portfolio that may be comprised of various categories of assets which present differing levels of risk. The allocation of our assets under management is dependent, in part, upon the then-current commercial real estate market, the investment opportunities it presents and available financing, if any, as well as other micro and macro market conditions.

 

We have and expect to continue to originate, acquire and manage a diverse portfolio of real estate-related investments such as mezzanine loans, first lien mortgage loans, second lien mortgage loans, bridge loans and preferred equity interests, in each case with a focus on investments intended to finance development or redevelopment opportunities. We may also invest in debt and derivative securities related to real estate assets, such as commercial mortgage-backed securities (“CMBS”); collateralized debt obligations (“CDOs”); debt securities issued by real estate companies; and credit default swaps. We have and expect to continue to focus our origination and acquisition activity on real estate-related investments secured by or related to properties located in the United States, and primarily related-party investments. We sometimes refer to the foregoing types of investments as our targeted investments. We have and will continue to target investments that generally offer predictable current cash flow and attractive risk-adjusted returns based on the underwriting criteria established and employed by our Advisor, which includes the anticipated leverage point, market and economic conditions, the location and quality of the underlying collateral and the borrower’s exit or refinancing plan. We believe our ability to execute our investment strategy is enhanced through access to our Sponsor’s extensive experience in financing real estate projects it has sponsored, as opposed to a strategy that relies solely on buying assets in the open market from third-party originators. We have and will continue to seek to build a portfolio that includes some of or all the following investment characteristics: (a) provides current income; (b) is secured by high-quality commercial real estate; (c) includes subordinate capital investments by strong sponsors that support our investments and provide downside protection; and (d) possesses strong structural features that maximize repayment potential, such as a clear exit or refinancing plan by the borrower.

 

We have and may continue to invest in real estate-related loans and debt securities both by directly originating them and by purchasing them from third-party sellers. Although we generally prefer the benefits of direct origination, situations may arise to purchase real estate-related loans and debt securities, possibly at discounts to par, which compensate for the lack of control or structural enhancements typically associated with directly structured investments.

 

Investments

 

Through December 31, 2017, we have made the following three real estate and real estate-related investments:

 

105-109 W. 28^th Street Preferred Investment 

 

On November 25, 2015, we entered into an agreement (the “Moxy Transaction”) with various related party entities that initially provided for us to make aggregate preferred equity contributions (the “105-109 W. 28^th Street Preferred Investment”) of up to $20.0 million in various affiliates of our Sponsor (the “Moxy Developer”), which owns a parcel of land located at 105-109 W. 28^thStreet, New York, New York, on which they are constructing a 343-room Marriott Moxy hotel, which is currently expected to open during the third quarter of 2018. The 105-109 W. 28^th Street Preferred Investment was made pursuant to an instrument that entitles us to monthly preferred distributions at a rate of 12% per annum and we could redeem on the earlier of (i) the date that was two years from the date of our final contribution or (ii) the third anniversary of 105-109 W. 28^th Street Preferred Investment. We also could have requested redemption or a restructuring of the agreement prior to the acceptance of any construction financing. On June 30, 2016, we and the Moxy Developer amended the Moxy Transaction so that our contributions would become redeemable on the fifth anniversary of the Moxy Transaction. The 105-109 W. 28^th Street Preferred Investment is classified as a held-to-maturity security and recorded at cost.

 

 

On August 30, 2016, we and the Moxy Developer further amended the Moxy Transaction so that our total aggregate contributions under the 105-109 W. 28^th Street Preferred Investment increased by $17.0 million, or up to $37.0 million.

 

We made an initial contribution of $4.0 million during the fourth quarter of 2015 and additional aggregate contributions of $33.0 million during the year ended December 31, 2016. As a result, as of both December 31, 2017 and 2016, the 105-109 W. 28^th Street Preferred Investment had an outstanding balance of $37.0 million, which is classified in investment in related party on the consolidated balance sheets. We funded our contributions using proceeds generated from our Offering and draws under the Subordinated Agreement. During the years ended December 31, 2017 and 2016, we recorded $4.5 million and $1.9 million, respectively, of investment income related to the 105-109 W. 28^th Street Preferred Investment. Our Advisor elected to waive the acquisition fees associated with this transaction.​

 

The Cove Joint Venture 

 

On September 29, 2016, we, through our wholly owned subsidiary, REIT Cove LLC (“REIT Cove”) along with LSG Cove LLC (“LSG Cove”), an affiliate of our Sponsor and a related party, and Maximus Cove Investor LLC (“Maximus”), an unrelated third party (collectively, the “Buyer”), entered into an agreement of sale and purchase (the “Cove Transaction”) with an unrelated third party, RP Cove, L.L.C (the “Seller”), pursuant to which the Buyer would acquire the Seller’s membership interest in RP Maximus Cove, L.L.C. (the “Cove Joint Venture”) for approximately $255.0 million. The Cove Joint Venture owns and operates The Cove at Tiburon (“The Cove”), a 281-unit, luxury waterfront multifamily rental property located in Tiburon, California. Prior to entering into the Cove Transaction, Maximus previously owned a separate noncontrolling interest in the Cove Joint Venture.

 

On January 31, 2017, REIT Cove entered into an Assignment and Assumption Agreement (the “Assignment”) with another one of our wholly owned subsidiaries, REIT IV COVE LLC (“REIT IV Cove”) and REIT III COVE LLC (“REIT III Cove”), a subsidiary of the operating partnership of Lightstone Value Plus Real Estate Investment Trust III, Inc., a real estate investment trust also sponsored by our Sponsor and a related party, and together with REIT IV Cove, collectively, the “Assignees”. Under the terms of the Assignment, the Assignees were assigned the rights and obligations of REIT Cove with respect to the Cove Transaction.

  

On January 31, 2017, REIT IV Cove, REIT III Cove, LSG Cove, and Maximus (the “Members”) completed the Cove Transaction for aggregate consideration of approximately $255.0 million, which consisted of $80.0 million of cash and $175.0 million of proceeds from a loan from a financial institution to the Cove Joint Venture. We paid approximately $20.0 million for a 22.5% membership interest in the Cove Joint Venture. In connection with the acquisition, we paid our Advisor an acquisition fee of $573,750, equal to 1.0% of our pro-rata share of the contractual purchase price.

 

Our ownership interest in the Cove Joint Venture is a non-managing interest. We have determined that the Cove Joint Venture is a variable interest entity (“VIE”) and because we exert significant influence over but do not control the Cove Joint Venture, we account for our ownership interest in the Cove Joint Venture in accordance with the equity method of accounting. All distributions of earnings from the Cove Joint Venture are made on a pro rata basis in proportion to each Member’s equity interest percentage. Any distributions in excess of earnings from the Cove Joint Venture are made to the Members pursuant to the terms of the Cove Joint Venture’s operating agreement. An affiliate of Maximus is the asset manager of The Cove and receives certain fees as defined in the Property Management Agreement for the management of The Cove. We commenced recording our allocated portion of profit and cash distributions beginning as of January 31, 2017 with respect to our membership interest of 22.5% in the Cove Joint Venture. 

 

In connection with the closing of the Cove Transaction, the Cove Joint Venture simultaneously entered into a $175.0 million loan (the “Loan”) initially scheduled to mature on January 31, 2020 with two, one-year extension options, subject to certain conditions. The Loan requires monthly interest payments through its maturity date.  The Loan bears interest at Libor plus 3.85% through its initial maturity and Libor plus 4.15% during each of the extension periods. The Loan is collateralized by The Cove and an affiliate of our Sponsor (the “Guarantor”) has guaranteed the Cove Joint Venture‘s obligation to pay the outstanding balance of the Loan up to approximately $43.8 million (the “Loan Guarantee”). The Members have agreed to reimburse the Guarantor for any balance that may become due under the Loan Guarantee, of which our share is up to approximately $10.9 million.

 

 

The Cove is a multi-family complex consisting of 281-units, or 289,690 square feet, contained within 32 apartment buildings over 20.1 acres originally constructed in 1967.  

 

Starting in 2013, The Cove has been undergoing an extensive refurbishment which is substantially completed. The Members have and intend to continue to use the remaining proceeds from the Loan and to invest additional capital if necessary to complete the remainder of the refurbishment. The Guarantor has provided an additional guarantee of up to approximately $13.4 million (the “Refurbishment Guarantee”) to provide any necessary funds to complete the remaining renovations as defined in the Loan. The Members have agreed to reimburse the Guarantor for any balance that may become due under the Refurbishment Guarantee, of which our share is up to approximately $3.3 million.

 

40 East End Ave. Joint Venture

 

On March 31, 2017, we entered into a joint venture agreement (the “40 East End Ave. Transaction”) with SAYT Master Holdco LLC, an entity majority-owned and controlled by David Lichtenstein, who also majority owns and controls our Sponsor, and a related party, (the “Seller”), pursuant to which we acquired 33.3% of the Seller’s approximate 100% membership interest in 40 East End Ave. Pref Member LLC ( “40 East End Ave. Joint Venture”) for aggregate consideration of approximately $10.3 million. We subsequently made additional capital contributions aggregating $2.6 million to the 40 East End Ave. Joint Venture during 2017.

 

In accordance with our charter, a majority of our Board of Directors, including a majority of the our independent directors not otherwise interested in the transaction, approved the 40 East End Ave. Transaction as fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.

 

Our ownership interest in the 40 East End Ave. Joint Venture is a non-managing interest. Because we exert significant influence over but do not control the 40 East End Ave. Joint Venture, we account for our ownership interest in the 40 East End Ave. Joint Venture in accordance with the equity method of accounting. All contributions to and distributions of earnings from the 40 East End Ave. Joint Venture are made on a pro rata basis in proportion to each Member’s equity interest percentage. Any distributions in excess of earnings from the 40 East End Ave. Joint Venture will be made to the Members pursuant to the terms of its operating agreement. We commenced recording our allocated portion of earnings and cash distributions from the 40 East End Ave. Joint Venture beginning as of March 31, 2017 with respect to our membership interest of approximately 33.3% in the 40 East End Ave. Joint Venture. Additionally, Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”), a real estate investment trust also sponsored by our Sponsor, has made $30.0 million of contributions to a subsidiary of the 40 East End Ave. Joint Venture, pursuant to an instrument that entitles Lightstone I to monthly preferred distributions at a rate of 12% per annum.

 

The 40 East End Ave. Joint Venture, through affiliates, owns a parcel of land located at the corner of 81^st Street and East End Avenue in the Upper East Side neighborhood of New York City on which it is constructing a luxury residential project consisting of 29 condominium units (the “40 East End Project”). As of and for the year ended December 31, 2017, the 40 East End Project was under development, therefore, the 40 East End Ave. Joint Venture had no results of operations. 

 

Financing Strategy and Policies

 

There is no limitation on the amount we may invest or borrow for the purchase or origination of any single property or investment. Our charter allows us to incur leverage up to 300% of our total “net assets” (as defined in our charter) as of the date of any borrowing, which is generally expected to be approximately 75% of the cost of our investments. We may only exceed this 300% limit if a majority of our independent directors approves each borrowing in excess of this limit and we disclose such borrowing to our stockholders in our next quarterly report along with a justification for the excess borrowing. In all events, we expect that our secured and unsecured borrowings will be reasonable in relation to the net value of our assets and will be reviewed by our board of directors at least quarterly.

 

We do not currently intend to exceed the leverage limit in our charter. We believe that careful use of debt helps us to achieve our diversification goals because we may have more funds available for investment. However, high levels of debt could cause us to incur higher interest charges and higher debt service payments, which would decrease the amount of cash available for distribution to our investors.

 

 

Distribution Objectives  

 

U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with generally accepted accounting principles in the United States (“GAAP”)) determined without regard to the deduction for dividends paid and excluding any net capital gain. In order to continue to qualify as a REIT, we may be required to make distributions in excess of cash available.

 

Distributions are authorized at the discretion of our Board of Directors based on their analysis of our performance over the previous periods and expectations of performance for future periods. Such analyses may include actual and anticipated operating cash flow, capital expenditure needs, general financial and market conditions, proceeds from asset sales and redemptions and other factors that our board of directors deem relevant. Our Board of Directors’ decisions will be substantially influenced by their obligation to ensure that we maintain our federal tax status as a REIT. We have and may continue to fund distributions with cash proceeds from the sale of shares of our common stock or borrowings if we do not generate sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the size of these distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.

 

We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, but only to the extent of a shareholder’s adjusted tax basis in our shares, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.

 

On October 28, 2015, our Board of Directors authorized and we declared a distribution rate which is calculated based on stockholders of record each day during the applicable period at a rate of $0.002191781 per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 8.0% annualized rate based on a share price of $10.00. Our first distribution began to accrue on June 12, 2015 (date of breaking escrow for our Offering) through November 30, 2015 (the end of the month following our initial real estate-related investment) and subsequent distributions have been on a monthly basis thereafter. The first distribution was paid on December 15, 2015 and subsequent distributions have been paid on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month.

 

Total distributions declared during the year ended December 31, 2017 and 2016 were $6.8 million and $2.3 million, respectively.

 

Distribution Reinvestment and Share Repurchase Programs

 

On April 21, 2017, our Board of Directors approved the termination of the DRIP effective May 15, 2017. Previously, our stockholders had an option to elect the receipt of shares of our common stock in lieu of cash distributions under the DRIP, however, all future distributions will be in the form of cash. In addition, through May 15, 2017 (the termination date of the DRIP), we issued approximately 0.1 million shares of common stock under the DRIP, representing approximately $1.2 million of additional proceeds under the Offering.

 

Our DRIP provided our stockholders with an opportunity to purchase additional shares of our common stock at a discount by reinvesting distributions. The Offering provided for 10.0 million shares available for issuance under our DRIP which were offered at a discounted price equivalent to 95% of our Primary Offering price per Common Share. Through May 15, 2017 (the termination date of the DRIP), 128,554 shares of common stock had been issued under our DRIP, which is now terminated.

 

Our share repurchase program may provide our stockholders with limited, interim liquidity by enabling them to sell their shares of common stock back to us, subject to restrictions. From our date of inception through December 31, 2015, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the year ended December 31, 2016 we repurchased 18,798 shares of common stock, pursuant to our share repurchase program at an average price per share of $9.75 per share. For the year ended December 31, 2017 we repurchased 20,236 shares of common stock, pursuant to our share repurchase program at an average price per share of $9.71 per share. We funded share repurchases for the periods noted above from the cumulative proceeds of the sale of our shares pursuant to our DRIP and from our operating funds.

 

Our Board of Directors may amend the terms of our share repurchase program without stockholder approval upon at least 30 days’ written notice to all stockholders. Our Board of Directors also is free to suspend or terminate the program upon at least 30 days’ written notice to all stockholders or to reject any request for repurchase and there is no assurance our Board of Directors will not suspend or terminate the program or reject requests for repurchases.

 

 

Tax Status

 

We elected to be taxed as a REIT commencing with the taxable year ended December 31, 2016. As a REIT, we generally will not be subject to U.S. federal income tax on our net taxable income that we distribute currently to our stockholders. To maintain our REIT qualification under the Internal Revenue Code of 1986, as amended, (the “Code”), we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. If we fail to remain qualified for taxation as a REIT in any subsequent year and do not qualify for certain statutory relief provisions, our income for that year will be taxed at the regular corporate rate, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.

 

As of December 31, 2017 and 2016, we had no material uncertain income tax positions. Additionally, even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.  

 

Market Overview and Opportunity

 

We believe that the market for investment in real estate-related investments secured by or related to real estate located primarily in the United States continues to be compelling from a risk-return perspective. We have and intend primarily to continue to focus on investing in development or redevelopment opportunities because, since the economic dislocation that occurred in the United States from approximately 2007–10, demand for development and or redevelopment projects has increased; funding sources to fund such projects have not kept pace with demand; and traditional lenders have tightened lending standards, making it difficult for developers to obtain traditional financing.

 

We favor a strategy weighted toward targeting debt investments that balance current income with significant subordinate capital and downside structural protections. We believe that our investment strategy, combined with the experience and expertise of our Advisor’s management team, provides opportunities to: (a) originate loans with attractive current returns and strong structural features directly with borrowers, thereby taking advantage of market conditions in order to seek the best risk-return dynamic for our stockholders; and (b) purchase real estate-related investments from third parties, in some instances at discounts to their face amounts (or par value). We believe the combination of these strategies and the application of prudent leverage to our investments may also allow us to (i) realize appreciation opportunities in the portfolio and (ii) diversify our capital and enhance returns.

 

Environmental  

 

As an owner of real estate, we are subject to various environmental laws of U.S. federal, state and local governments. Compliance with existing laws has not had a material adverse effect on our financial condition or results of operations, and management does not believe it will have such an impact in the future. However, we cannot predict the impact of unforeseen environmental contingencies or new or changed laws or regulations on properties in which we hold an interest, or on properties that may be acquired directly or indirectly in the future.

 

Employees  

 

We do not have employees. We entered into an advisory agreement with our Advisor pursuant to which our Advisor supervises and manages our day-to-day operations and selects our real estate and real estate related investments, subject to oversight by our Board of Directors. We pay our Advisor fees for services related to the investment and management of our assets, and we have and expect to continue to reimburse our Advisor for certain expenses incurred on our behalf.

 

Economic Dependence  

 

We were initially dependent upon the net proceeds received from our Offering and Subordinated Advances to conduct our proposed activities. The capital required to acquire additional real estate and real estate related investments may be obtained from the remaining proceeds from our Offering, proceeds from asset sales and redemptions, and/or proceeds from any financings.

 

Available Information  

 

We electronically file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and proxy statements, with the SEC. Stockholders may obtain copies of our filings with the SEC, free of charge, from the website maintained by the SEC at http://www.sec.gov, or at the SEC's Public Reference Room at 100 F. Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our office is located at 1985 Cedar Bridge Avenue, Lakewood, NJ 08701. Our telephone number is (732) 367-0129. Our website is www.lightstonecapitalmarkets.com.

 

 

ITEM 1A. RISK FACTORS:

 

Set forth below are the risk factors that we believe are material to our investors.  This section contains forward-looking statements.  You should refer to the explanation of the qualifications and limitations on forward-looking statements on page 2. If any of the risk events described below actually occurs, our business, financial condition or results of operations could be adversely affected. 

 

Risks Related to an Investment in Lightstone Real Estate Income Trust Inc.

 

We and our Advisor have a relatively limited operating history, and the performance of the prior real estate investment programs of our Sponsor may not be indicative of our future results.

 

We and our Advisor have a relatively limited operating history, and you should not rely upon the past performance of other real estate investment programs sponsored by our Sponsor to predict our future results. We were incorporated on September 9, 2014, and have made three investments through the date of this filing. Accordingly, the prior performance of real estate investment programs sponsored by our Sponsor may not be indicative of our future results.

 

Moreover, if our capital resources are insufficient to support our operations, we will not be successful. You should consider our prospects in light of the risks, uncertainties and difficulties frequently encountered by companies that are, like us, in their early stage of development. To be successful in this market, we or our Advisor must, among other things:

 

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identify and originate or acquire investments that further our investment strategies; and

 

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respond to competition for our targeted investments, as well as for potential investors in us.

 

We cannot guarantee that we will succeed in achieving these goals, and our failure to do so could cause you to lose all or a portion of your investment.

 

There is no established trading market for our Common Shares, and there may never be one; therefore, it will be difficult for you to sell your Common Shares except pursuant to our share repurchase program.

 

There currently is no established public trading market for our Common Shares and no assurance that one will develop. Further, even if you are able to find a buyer for your Common Shares, you may not be able to sell your Common Shares unless the buyer meets applicable suitability and minimum purchase standards and the sale does not violate state securities laws. Our charter also prohibits the ownership of more than 9.8% in value of the aggregate of our outstanding shares of stock or more than 9.8% (in value or in number of shares, whichever is more restrictive) of our outstanding Common Shares, unless exempted by our board of directors (prospectively or retroactively), which may further inhibit the transferability of your Common Shares.

 

You are limited in your ability to sell your Common Shares pursuant to our share repurchase program and may have to hold your Common Shares for an indefinite period of time.

 

Repurchases of Common Shares through our share repurchase program may be the only way to dispose of your Common Shares, but there are a number of limitations placed on such repurchases. Our board of directors may amend the terms of our share repurchase program without stockholder approval upon at least 30 days’ written notice to all stockholders. Our board of directors also is free to suspend or terminate the program upon at least 30 days’ written notice to all stockholders or to reject any request for repurchase and there is no assurance our board of directors will not suspend or terminate the program or reject requests for repurchases. In addition, our share repurchase program includes numerous restrictions that would limit your ability to sell your Common Shares under the program. Importantly, funding for our share repurchase program will come exclusively from any proceeds we received from the sale of Common Shares under our DRIP that our board of directors may reserve for this purpose. In addition, we will not repurchase in excess of 5% of the weighted average number of Common Shares outstanding during the prior calendar year, although Common Shares repurchased in the case of the death of a stockholder will not count against this 5% limit. You may have to hold your Common Shares for an indefinite period of time, and if you sell your Common Shares to us under our share repurchase program, you may receive less than the total price you paid for the Common Shares.

 

Distributions paid from sources other than our cash flows from operations, particularly from proceeds of our Offering, have and may continue to result in us having fewer funds available for the acquisition of real estate-related investments which may dilute our stockholders' interests in us, adversely affecting our ability to fund future distributions with cash flows from operations and adversely affect our stockholders’ overall return.

 

Our cash flows provided by operations were $3.6 million for the year ended December 31, 2017. During the year ended December 31, 2017, we declared distributions of $6.8 million, of which $3.6 million, or 53%, was funded from our cash flows provided by operations, $2.7 million, or 39%, was funded from proceeds from our Offering and $513,325, or 8%, was funded from proceeds from common stock issued under the DRIP. Our cash provided by operations were $1.4 million for the year ended December 31, 2016. During the year ended December 31, 2016, we paid distributions of $2.3 million, of which $1.4 million, or 62%, was funded from our cash flows provided by operations, $189,754, or 8%, was funded from proceeds from our Offering and $683,136, or 30%, was funded from proceeds from common stock issued under the DRIP. Additionally, we may in the future pay distributions from sources other than from our cash flows from operations. Our organizational documents permit us to make distributions from any source, including from the proceeds of our offerings, cash advances to us by our Advisor, cash resulting from a waiver of fees, and borrowings, including borrowings secured by our assets.

 

 

On April 21, 2017, the Board of Directors approved the termination of our DRIP effective May 15, 2017. All future distributions will be in the form of cash.  

 

If we do not generate sufficient cash flows from our operations, we will use other sources, such as from remaining Offering proceeds, borrowings, the sale of additional securities, advances from our Advisor, and our Advisor's deferral, suspension or waiver of its fees and expense reimbursements, to fund distributions. Moreover, our board of directors may change our distribution policy, in its sole discretion, at any time. Distributions made from offering proceeds are a return of capital to stockholders, from which we will have already paid offering expenses in connection with this offering. We have not established any limit on the amount of proceeds from this offering that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would: (1) cause us to be unable to pay our debts as they become due in the usual course of business; (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences, if any; or (3) jeopardize our ability to qualify as a REIT.

 

Funding distributions from the proceeds of our Offering results in us having less funds available for acquiring properties or other real estate-related investments and may impact the value of an investment in our Common Shares. As a result, the return realized on an investment in our shares may be reduced. Funding distributions from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding distributions with the sale of assets may affect our ability to generate cash flows. Funding distributions from the sale of additional securities could dilute our stockholders’ interest in us if we sell shares of our common stock or securities that are convertible or exercisable into shares of our common stock to third-party investors. Payment of distributions from the mentioned sources could restrict our ability to generate sufficient cash flows from operations, affect our profitability or affect the distributions payable to you upon a liquidity event, any or all of which may have an adverse effect on your investment.

 

We have and expect to continue to have a concentration of related-party investments. Therefore, if adverse business developments were to occur with respect to our Sponsor or its related parties, our results of operations and the value of your Common Shares could be adversely affected.

 

A majority of our investments by value currently are and we expect to them to continue to be related-party investments. Therefore, we are subject to borrower or investee concentration risk, meaning that if adverse developments were to occur with respect to our Sponsor or its related parties, our results of operations and the value of your Common Shares could be adversely affected. To the extent that we have or continue to invest in or lend to our Sponsor, its affiliates or other Lightstone-sponsored real estate investment programs, our operations and the value of our investments will depend on the solvency and liquidity of such parties. If their solvency or liquidity suffers, or if they suffer from adverse economic conditions, tenant defaults, construction delays, negative publicity, regulatory scrutiny or any of the other risks that attend real estate owners, operators and developers and real estate investment programs, our business also may be at risk.

 

We may suffer from delays in identifying suitable investments, which could adversely affect our ability to pay distributions and the value of your investment.

 

We may suffer from delays in identifying suitable investments, particularly as a result of our reliance on our Advisor at times when management of our Advisor is simultaneously seeking to identify suitable investments for other programs. Further, we may have difficulty identifying suitable investments on attractive terms, and there could be delays in the time we invest our remaining proceeds from our offering, proceeds from asset sales or redemptions and/or proceeds from financings. This could cause a substantial delay in, and could adversely affect, our ability to pay distributions to you. In addition, if we fail to timely invest or to make quality investments, our ability to achieve our investment objectives, including, without limitation, diversification of our portfolio, could be materially adversely affected.

 

Certain investments in which our Sponsor or entities that it has advised have directly or indirectly owned equity interests have faced adverse business developments, including bankruptcies.

 

Certain investments in which our Sponsor or entities that it has advised have directly or indirectly owned equity interests have faced adverse business developments, including bankruptcy filings. These adverse developments may negatively affect our ability to meet our investment objectives. As a result, we will be limited in the number and type of investments we may make, which may negatively affect the value of your investment. Additionally, there can be no assurance that we will not face similar adverse business developments.

 

 

This is the first real estate investment program that our Sponsor has ever sponsored that is focused on investments similar to our targeted investments, which could adversely affect the value of our Common Shares.

 

Of the 10 real estate investment programs sponsored by our Sponsor since 2004, none has sought, as the primary focus of its investment objectives, to originate, acquire and manage investments similar to our targeted investments. Instead, the prior real estate investment programs sponsored by our Sponsor have focused primarily on the acquisition and management of commercial real estate properties. Our Sponsor’s relative inexperience in sponsoring a real estate investment program focused on originating, acquiring and managing investments similar to our targeted investments may adversely affect the value of our Common Shares.

 

We may have to make decisions on whether to make certain investments without detailed information.

 

To effectively compete for acquisitions, our Advisor and board of directors may be required to make decisions prior to the completion of our analysis and due diligence on the potential investments. In such cases, the information available to our Advisor and board of directors at the time of making any particular investment decision, and the decision to undertake any particular origination or acquisition, may be limited, and our Advisor and board of directors may not have access to detailed information regarding any particular investment, such as collateral quality, tenant financials, payment terms, maturity, credit rating, sponsor quality, priority and other important information. Therefore, no assurance can be given that our Advisor and board of directors will have knowledge of all circumstances that may adversely affect an investment. In addition, our Advisor and board of directors expect to rely upon independent consultants in connection with their evaluation of proposed investments. There can be no assurance regarding the accuracy or completeness of the information provided by such independent consultants.

 

If we lose or are unable to obtain key personnel, our ability to implement our investment strategies could be delayed or hindered.

 

Our success depends to a significant degree upon the continued contributions of our Chairman, certain executive officers and other key personnel of us, our Advisor and its affiliates. Neither we nor our Advisor have employment agreements with our Chairman and executive officers, and we cannot guarantee that they will remain affiliated with or employed by our Advisor. If any of our key personnel were to cease their affiliation or employment with our Advisor, our operating results could suffer. We do not intend to maintain key person life insurance on any of these key personnel. We believe that our future success depends, in large part, upon our Advisor’s and its affiliates’ ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition for persons with these skills is intense, and we cannot assure you that our Advisor will be successful in attracting and retaining such skilled personnel. If we lose or are unable to obtain the services of key personnel, our ability to implement our investment strategies could be delayed or hindered.

 

If we internalize our management functions, your interest in us could be reduced, and we could incur other significant costs associated with being self-managed.

 

Our strategy may involve becoming ‘‘self-managed’’ by internalizing our management functions, particularly if we seek to list our Common Shares on an exchange as a way of providing our stockholders with a liquidity event. The method by which we could internalize these functions could take many forms. We may hire our own group of executives and other employees or we may elect to negotiate to acquire our Advisor’s assets and personnel. At this time, we cannot be sure of the form or amount of consideration or other terms relating to any such acquisition. Such consideration could take many forms, including cash payments, promissory notes and shares of our stock. An internalization transaction could result in significant payments to affiliates of our Advisor irrespective of whether you enjoyed the returns on which we have conditioned our annual subordinated performance fee. The payment of such consideration in the form of equity securities would reduce your interests as a stockholder and would reduce the value of your investment. We will not be required to seek a stockholder vote to become self-managed.

 

If stockholders or other interested parties were to file a lawsuit related to, or challenging, an internalization transaction, we could incur litigation costs that would adversely affect the value of your Common Shares. We would also be responsible for the compensation and benefits costs of our officers and other employees and consultants that are now paid by our Advisor or its affiliates.

 

As currently organized, we do not directly employ any employees. If we elect to internalize our management functions, we would employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims, potential labor disputes and other employee-related liabilities and grievances. Nothing in our charter prohibits us from entering into the transaction described above.

 

Additionally, there is no assurance that internalizing our management functions will prove to be beneficial to us and our stockholders. We could have difficulty integrating our management functions as a stand-alone entity. Certain personnel of our Advisor and its affiliates perform asset management and general and administrative functions, including accounting and financial reporting, for multiple entities. We could fail to properly identify the appropriate mix of personnel and capital needs to operate as a stand-alone entity. An inability to manage an internalization transaction effectively could thus result in our incurring excess costs or suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. Such deficiencies could cause us to incur additional costs, and our management’s attention could be diverted from most effectively managing our portfolio of investments.

 

 

If we were to internalize our management or if another investment program, whether sponsored by our sponsor or otherwise, were to hire the employees of our Advisor in connection with its own internalization transaction or otherwise, our ability to conduct our business could be adversely affected.

 

We rely on persons employed by our Advisor and its affiliates to manage our day-to-day operations. If we were to effectuate an internalization of our Advisor, we might not be able to retain all the employees of our Advisor or to maintain a relationship with our sponsor. In addition, some of the employees of the Advisor may provide services to one or more other investment programs. These programs or third parties may decide to retain some of or all of our Advisor’s key employees in the future. If this occurs, these programs could hire certain of the persons currently employed by our Advisor who are most familiar with our business and operations, thereby potentially adversely impacting our business.

 

Our rights and the rights of our stockholders to recover claims against our independent directors are limited, which could reduce your and our recovery against them if they negligently cause us to incur losses.

 

Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter provides that no independent director will be liable to us or our stockholders for monetary damages and that we will generally indemnify our independent directors for losses unless they are grossly negligent or engage in willful misconduct. As a result, you and we may have more limited rights against our independent directors than might otherwise exist under common law, which could reduce your and our recovery from these persons if they act in a grossly negligent manner. In addition, we may be obligated to fund the defense costs incurred by our independent directors (as well as by our other directors, officers, employees and agents) in some cases, which would decrease the cash otherwise available for distributions to you.

 

If our Advisor or its affiliates waive certain fees due to them, our results of operations and distributions may be artificially high.

 

From time to time, our Advisor or its affiliates may agree to waive all or a portion of the acquisition, asset management or other fees, compensation or incentives due to them, pay general administrative expenses or otherwise supplement stockholder returns in order to increase the amount of cash available to pay distributions to stockholders. If our Advisor or its affiliates choose to no longer waive such fees and incentives, our results of operations will be lower than in previous periods and your return on your investment could be negatively affected.

 

On February 27, 2018, our Board of Directors established our most current estimated NAV per Common Share as of December 31, 2017. We currently expect that our Advisor will estimate our NAV per Common Share on at least an annual basis. The estimated NAV per Common Share may not be an accurate reflection of the fair value of our assets and liabilities and likely will not represent the amount of net proceeds that would result if we were liquidated or dissolved or completed a merger or other sale of our Company.

 

On February 27, 2018 our board of directors established our most current estimated NAV per Common Share as of December 31, 2017. We currently expect that our advisor will estimate our NAV on at least an annual basis.

 

The price of our estimated NAV per Common Share is likely to differ from the price at which a stockholder could resell such shares because: (i) there is no public trading market for our shares at this time; (ii) the purchase price does not reflect, and will not reflect, the fair value of our assets as we acquire them, nor does it represent the amount of net proceeds that would result from an immediate liquidation of our assets or sale of our Company; (iii) the estimated NAV per Common Share does not take into account how market fluctuations affect the value of our investments, including how the current conditions in the financial and real estate markets may affect the values of our investments; (iv) the estimated NAV per Common Share does not take into account how developments related to individual assets may increase or decrease the value of our portfolio; and (v) the estimated NAV per Common Share does not take into account any portfolio premium or premiums to value that may be achieved in a liquidation of our assets or sale of our portfolio and may not reflect the price that our stockholders would receive for their shares in a market transaction, upon liquidation of the Company and distribution of the proceeds or what a third party would pay to acquire our company.

 

Risks Related to Conflicts of Interest

 

We are subject to conflicts of interest arising out of our relationships with our Advisor and its affiliates, including the material conflicts discussed below.

 

 

Our Advisor and its affiliates, including all our executive officers and some of our directors, face conflicts of interest caused by their compensation arrangements with us, which could result in actions that are not in the long-term best interests of our stockholders.

 

Our Advisor and its affiliates are entitled to substantial fees from us. These fees could influence our Advisor’s advice to us as well as the judgment of affiliates of our Advisor performing services for us. Among other matters, these compensation arrangements could affect their judgment with respect to:

 

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whether and when we seek to sell or otherwise dispose of any of our investments, which events may entitle our Advisor to the annual subordinated performance fee;

 

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the continuation, renewal or enforcement of our agreements with our Advisor and its affiliates, including the advisory agreement, because our Advisor has an incentive to continue receiving fees under these agreements;

 

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public offerings of equity by us, which will likely entitle our Advisor to increased acquisition and asset management fees;

 

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sales of our investments, which may result in compensation to our Advisor in the form of disposition fees;

 

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originations and acquisitions, which entitle our Advisor to acquisition fees and asset management fees, which are not calculated based on investment quality, and which could encourage our Advisor to make investments at higher prices;

 

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borrowings to originate or acquire investments, which borrowings may increase the acquisition and asset management fees payable to our Advisor;

 

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determining the compensation paid to employees for services provided to us, which could be influenced in part by whether our Advisor is reimbursed by us for the related salaries and benefits;

 

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whether we seek to internalize our management functions, which internalization could result in our retaining some of our Advisor’s and its affiliates’ key officers and employees for compensation that is greater than that which they currently earn or which could require additional payments to affiliates of our Advisor to purchase the assets and operations of our Advisor and its affiliates;

 

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whether and when we seek to list our Common Shares on a national securities exchange or sell our assets, which events may entitle our Advisor to receive the subordinated incentive listing fee or the subordinated participation in net sales proceeds, respectively; and

 

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whether and when to terminate the Advisory agreement or to allow the Advisory agreement to expire without renewal, in either case with or without cause, including on account of poor performance by our Advisor, either of which events may entitle our Advisor to receive the subordinated fee upon termination of the Advisory agreement.

 

The fees our Advisor receives in connection with transactions involving the origination, purchase and management of an investment may be based on the contract purchase price or the book value of the investment rather than the quality of the investment or the quality of the services rendered to us. This may influence our Advisor to recommend riskier transactions to us.

 

Our Advisor faces conflicts of interest relating to the incentive fee structure, which could result in actions that are not necessarily in the long-term best interests of our stockholders.

 

Under our advisory agreement, our Advisor is entitled to fees and other amounts that may result in our Advisor recommending actions that maximize these amounts even if the actions are not in our best interest. Further, because our Advisor does not maintain a significant equity interest in us and is entitled to receive substantial minimum compensation regardless of performance, our Advisor’s interests are not wholly aligned with those of our stockholders. In that regard, our Advisor could be motivated to recommend riskier or more speculative investments in order for us to generate the specified levels of performance or sales proceeds that would entitle our Advisor to incentive compensation. In addition, our Advisor’s entitlement to fees upon the sale of our investments and to participate in net sales proceeds could result in our Advisor recommending sales of our investments at the earliest possible time at which sales of investments would produce the level of return that would entitle our Advisor to compensation relating to such sales, even if continued ownership of those investments might be in our best long-term interest. Our advisory agreement also requires us to pay a performance-based termination fee to our Advisor if we terminate the advisory agreement prior to the listing of our Common Shares for trading on an exchange or, absent such listing, in respect of its participation in net sales proceeds. To avoid paying these fees, our independent directors may decide against terminating the advisory agreement prior to our listing of our Common Shares or disposition of our investments even if, but for the termination fee, termination of the advisory agreement would be in our best interest. In addition, the requirement to pay the fee to our Advisor upon our Advisor’s termination could cause us to make different investment or disposition decisions than we would otherwise make, in order to satisfy our obligation to pay the fee to our Advisor. In addition, our Advisor will be entitled to an annual subordinated performance fee, which may encourage our Advisor to recommend riskier investments or to dispose of investments earlier than they should be disposed of.

 

 

Our sponsor’s other public programs, Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”), Lightstone Value Plus Real Estate Investment Trust II, Inc. (“Lightstone II” )and Lightstone Value Plus Real Estate Investment Trust III, Inc. (“Lightstone III” and collectively, “Sponsor’s Other Public Programs”) , may be engaged in competitive activities, including the origination and acquisition of assets similar to our targeted investments. Additionally, on February 10, 2017, an affiliate of our sponsor became the advisor of Behringer Harvard Opportunity REIT I, Inc.(“BH Opp I”) and Lightstone Value Plus Real Estate Investment Trust V, Inc. (“Lightstone V,” formerly Behringer Harvard Opportunity REIT II, Inc.) which may also be engaged in competitive activities, including the origination and acquisition of assets similar to our targeted investments.

 

Our Advisor and its affiliates, through the activities of Lightstone I, Lightstone II, Lightstone III, Lightstone V and BH Opp I, may be engaged in other activities that could result in potential conflicts of interest with the services that they will provide to us. Lightstone I, Lightstone II, Lightstone III, Lightstone V and BH Opp I may compete with us for the origination and acquisition of assets similar to our targeted investments.

 

We may experience difficulty in objectively evaluating potential related-party investments, which may result in a misallocation of our assets and adversely affect our results of operations and the value of your Common Shares.

 

We may experience difficulty in objectively evaluating potential related-party investments. Our Chairman, certain executive officers and other key personnel of us and our Advisor have, or may in the future have, ownership or employment relationships with borrowers or investees related to our sponsor, which could affect such individuals’ judgment with respect to the merits of our making such related-party investments. Additionally, to the extent we seek third-party advice about potential related-party investments, our Chairman, certain executive officers and other key personnel of us and our Advisor may have an incentive to discount the third-party advice in their desire to facilitate the related-party investment, among other reasons because, in certain cases, their compensation from affiliates of our sponsor or from Lightstone-sponsored real estate investment programs may be related to the scale of the respective entities or projects. Any lack of objectivity on the part of the individuals evaluating our investment opportunities may result in a misallocation of our assets and adversely affect our results of operations and the value of your Common Shares.

 

Our Advisor will face conflicts of interest with respect to related-party investments, which could result in a disproportionate benefit to our Sponsor, its affiliates or other Lightstone-sponsored real estate investment programs.

 

A majority of our investments by value currently are and we expect will continue to be related-party investments. Our Chairman, certain executive officers and other key personnel of us and our Advisor have, or may in the future have, ownership or employment relationships with borrowers or investees related to our sponsor, which could affect their judgment in structuring the terms of a relationship between us and a related-party borrower or investee. Such individuals may prioritize the commercial interests of a related-party borrower or investee over ours. Further, the fiduciary obligations that our Advisor or our board of directors may owe to a related-party borrower or investee may make it more difficult for us to enforce our rights.

 

If we lend to or invest in affiliates of our Sponsor or other Lightstone-sponsored real estate investment programs, our Advisor and its affiliates may have a conflict of interest in determining how or when to make major decisions. Because The Lightstone Group and its affiliates influence our management and may control any other Lightstone-sponsored entities, as well as the agreements and transactions among the parties to any related-party investment, we will not have the benefit of arm’s-length negotiation of the type normally conducted between entities seeking capital and entities seeking to provide it.

 

Our Advisor will face conflicts of interest relating to joint ventures or other co-ownership arrangements that we enter into with affiliates of our Sponsor or Advisor or with other programs sponsored by our sponsor or Advisor, which could result in a disproportionate benefit to affiliates of our sponsor or Advisor or to another program.

 

We may enter into joint ventures or other co-ownership arrangements with other Lightstone-sponsored programs for the acquisition, origination or management of real estate-related investments. The executive officers of our Advisor are also the executive officers of other real estate investment vehicles, and may in the future sponsor or be the executive officers of other REITs and their Advisors, the general partners of other Lightstone-sponsored partnerships or the Advisors or fiduciaries of other Lightstone-sponsored programs. These executive officers will face conflicts of interest in determining which Lightstone-sponsored program should enter into any particular joint venture or co-ownership arrangement. These persons also may have a conflict in structuring the terms of the relationship between our interests and the interests of the Lightstone-sponsored co-venturer or partner as well as conflicts of interest in managing the joint venture. Further, the fiduciary obligations that our Advisor or our board of directors may owe to a co-venturer or partner affiliated with our Sponsor or Advisor may make it more difficult for us to enforce our rights.

 

 

If we enter into a joint venture or other co-ownership arrangement with another program (whether sponsored by our Advisor or by our Sponsor or its affiliates) or joint venture, our Advisor and its affiliates may have a conflict of interest when determining when and whether to buy or sell a particular investment, exercise buy/sell rights or make other major decisions, and you may face certain additional risks. For example, if we become listed for trading on a national securities exchange, and any of the other programs sponsored by our Advisor or our Sponsor or its affiliates are not traded on any exchange, we may develop more divergent goals and objectives from such joint venturer with respect to the sale of investments in the future. In addition, if we enter into a joint venture with another program sponsored by our Advisor or our Sponsor or their respective affiliates that has a term shorter than ours, the joint venture may be required to sell its investments at the time of the other program’s liquidation. We may not desire to sell the investments at such time. Even if the terms of any joint venture agreement between us and another program sponsored by our Advisor or our Sponsor or their respective affiliates grant us a right of first refusal to buy such investments, we may not have sufficient funds to exercise our right of first refusal under these circumstances.

 

Because The Lightstone Group and its affiliates influence our management and may control any other Lightstone-sponsored programs, agreements and transactions among the parties with respect to any joint venture or other co-ownership arrangement between or among such parties will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated co-venturers. Under these joint ventures, neither co-venturer may have the power to control the venture, and under certain circumstances, an impasse could be reached regarding matters pertaining to the co-ownership arrangement, which might have a negative influence on the joint venture and decrease potential returns to you. If a co-venturer has a right of first refusal to buy out the other co-venturer, it may be unable to finance such buyout at that time. If our interest is subject to a buy/sell right, we may not have sufficient cash, available borrowing capacity or other capital resources to allow us to elect to purchase an interest of a co-venturer subject to the buy/sell right, in which case we may be forced to sell our interest as the result of the exercise of such right when we would otherwise prefer to keep our interest. Furthermore, we may not be able to sell our interest in a joint venture if we desire to exit the venture for any reason or, if our interest is likewise subject to a right of first refusal of our co-venturer or partner, our ability to sell such interest may be adversely impacted by such right.

 

Our executive officers and key personnel and the executive officers and key personnel of Lightstone-affiliated entities that conduct our day-to-day operations and our offering face competing demands on their time, and this may cause our investment returns to suffer.

 

We rely upon our executive officers and key personnel and the executive officers and key personnel of Lightstone-affiliated entities to conduct our day-to-day operations. These individuals also conduct the day-to-day operations of other investment programs and may have other business interests as well. Because these persons have competing interests on their time and resources, they may have conflicts of interest in allocating their time between our business and these other activities. During times of intense activity in other programs and ventures, they may devote less time and fewer resources to our business than is necessary or appropriate. If this occurs, the returns on our investments may suffer.

 

Our executive officers face conflicts of interest related to the positions they hold with entities affiliated with our Advisor, which could impact the value of the services they provide to us.

 

Our executive officers are also officers of our Advisor and other entities affiliated with our Advisor, which may include the Advisors and fiduciaries to other Lightstone-sponsored programs. As a result, these individuals owe fiduciary duties to these other entities and their investors, which may conflict with the fiduciary duties that they owe to us and our stockholders. Their loyalties to these other entities and investors could result in action or inaction that is detrimental to our business, which could harm the implementation of our business strategy and our investment opportunities. Conflicts with our business and interests are most likely to arise from involvement in activities related to (a) allocation of new investments and management time and services among us and the other entities, (b) the timing and terms of the making or disposition of an investment, (c) investments in or with affiliates of our Advisor, and (d) compensation to our Advisor and its affiliates. If we do not successfully implement our business strategy, we may be unable to generate the cash needed to pay distributions to you and to maintain or increase the value of our assets.

 

Additionally, Mr. Lichtenstein is also a director of Lightstone I, Lightstone II, Lightstone III and Lightstone V. Accordingly, Mr. Lichtenstein owes fiduciary duties to Lightstone I, Lightstone II, Lightstone III and Lightstone V and their respective stockholders. The duties of Mr. Lichtenstein to Lightstone I, Lightstone II , Lightstone III and Lightstone V may influence Mr. Lichtenstein’s judgment when considering issues that may affect us. For example, we are permitted to enter into a joint venture or preferred equity investment with Lightstone I, Lightstone II , Lightstone III and Lightstone V for the origination or acquisition of real estate-related investments. Decisions of our board of directors regarding the terms of those transactions may be influenced by Mr. Lichtenstein’s duties to Lightstone I, Lightstone II , Lightstone III and Lightstone V and their respective stockholders.

 

Risks Related to Our Business in General

 

A limit on the number of shares a person may own may discourage a takeover of our company.

 

Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Our charter prohibits the ownership of more than 9.8% in value of the aggregate of our outstanding shares of stock or more than 9.8% (in value or number of shares, whichever is more restrictive) of the outstanding shares of any class or series of our stock, unless exempted by our board of directors (prospectively or retroactively), which may inhibit large investors from purchasing your Common Shares. This restriction may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might otherwise provide stockholders with the opportunity to receive a control premium for their Common Shares.

 

 

Our charter permits our board of directors to issue stock with terms that may subordinate the rights of the holders of our Common Shares or discourage a third party from acquiring us.

 

Our charter permits our board of directors to issue up to 200 million Common Shares and up to 50 million shares of preferred stock, $0.01 par value per share. Our board of directors, without any action by our stockholders, may (a) amend our charter from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series we have authority to issue or (b) classify or reclassify any unissued Common Shares or shares of preferred stock into other classes or series of stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications, and terms and conditions of the repurchase of any such stock. Thus, our board of directors could authorize the issuance of such stock with terms and conditions that could subordinate the rights of the holders of our Common Shares, or have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our Common Shares.

 

Maryland law prohibits certain business combinations, which may make it more difficult for us to be acquired.

 

Under Maryland law, ‘‘business combinations’’ between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer, an issuance or reclassification of equity securities, liquidations or dissolutions in which an interested stockholder will receive something other than cash and any loans, advances, pledges, guarantees or similar arrangements in which an interested stockholder receives a benefit. An interested stockholder is defined as:

 

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any person who beneficially owns, directly or indirectly, 10% or more of the voting power of the then-outstanding voting stock of the corporation; or

 

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an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner, directly or indirectly, of 10% or more of the voting power of the then-outstanding stock of the corporation.

 

A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which he otherwise would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board.

 

After the expiration of the five-year period described above, any business combination between a Maryland corporation and an interested stockholder must generally be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:

 

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80% of the votes entitled to be cast by holders of the then outstanding shares of voting stock of the corporation voting together as a single group; and

 

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two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder voting together as a single group.

 

These supermajority vote requirements do not apply if the corporation’s holders of voting stock receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. Maryland law also permits various exemptions from these provisions, including business combinations that are exempted by the board of directors before the time that the interested stockholder becomes an interested stockholder. Our board, by resolution, has exempted any business combinations involving us and The Lightstone Group or any of its affiliates from these provisions. As a result, the five-year prohibition and the supermajority vote requirement will not apply to any business combinations between any affiliate of The Lightstone Group and us. As a result, any affiliate of The Lightstone Group may be able to enter into business combinations with us, which may or may not be in the best interests of our stockholders. The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.

 

Maryland law also limits the ability of a third party to buy a large stake in us and exercise voting power in electing directors.

 

Maryland law provides that ‘‘control shares’’ of a Maryland corporation acquired in a ‘‘control share acquisition’’ have no voting rights except to the extent approved by the affirmative vote of stockholders entitled to cast two-thirds of the votes entitled to be cast on the matter. Shares of stock owned by interested stockholders, that is, by the acquirer, by officers or by employees who are directors of the corporation, are excluded from the vote on whether to accord voting rights to the control shares. ‘‘Control shares’’ are voting shares of stock that would entitle the acquirer to exercise voting power in electing directors within specified ranges of voting power. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval or shares acquired directly from the corporation. A ‘‘control share acquisition’’ means the acquisition of issued and outstanding control shares. The control share acquisition statute does not apply (a) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (b) to acquisitions approved or exempted by a corporation’s charter or bylaws. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. We can offer no assurance that this provision will not be amended or eliminated at any time in the future. This statute could have the effect of discouraging offers from third parties to acquire us and increasing the difficulty of successfully completing this type of offer by anyone other than our affiliates or any of their affiliates.

 

 

Our charter includes a provision that may discourage a stockholder from launching a tender offer for our Common Shares.

 

Our charter provides that any tender offer made by a stockholder, including any ‘‘mini-tender’’ offer, must comply with most provisions of Regulation 14D of the Exchange Act. The offering stockholder must provide our company notice of such tender offer at least ten business days before initiating the tender offer. A stockholder may not transfer any shares to an offering stockholder who does not comply with these requirements unless such stockholder first offers such shares to us at a price equal to the greater of the tender offer price offered in such tender offer or the repurchase price under our share repurchase program as it is in effect at such time. In addition, the non-complying stockholder shall be responsible for all our company’s expenses in connection with that stockholder’s noncompliance. This provision of our charter may discourage a stockholder from initiating a tender offer for our Common Shares and prevent you from receiving a premium price for your Common Shares in such a transaction.

 

Our Advisor and its affiliates have limited experience sourcing and managing a portfolio of assets in the manner necessary to maintain our exemption under the Investment Company Act.

 

In order to maintain our exemption from registration under the Investment Company Act, the assets in our portfolio are subject to certain restrictions that limit our operations meaningfully. Our Advisor and its affiliates have limited experience sourcing and managing a portfolio in the manner necessary to maintain our exemption from registration under the Investment Company Act.

 

Your investment return may be reduced if we are required to register as an investment company under the Investment Company Act, and maintenance of our exemption from registration under the Investment Company Act imposes significant limits on our operations.

 

We have and intend to continue to conduct our operations so that neither we nor any of our subsidiaries are required to register as an investment company under the Investment Company Act. We believe we currently are not and will not be considered an investment company under Section 3(a)(1)(A) of the Investment Company Act because we have not and will not engage primarily, or hold ourselves out as being engaged primarily, in the business of investing, reinvesting or trading in securities. Rather, through our wholly owned subsidiaries, we have and will continue to be primarily engaged in the non-investment company businesses of these subsidiaries. However, under Section 3(a)(1)(C) of the Investment Company Act, because we are a holding company that has and will continue to conduct its businesses primarily through wholly owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of ‘‘investment company’’ under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis. This requirement limits the types of businesses in which we may engage through our subsidiaries. In addition, the assets we and our subsidiaries may originate or acquire are limited by the provisions of the Investment Company Act and the rules and regulations promulgated under the Investment Company Act, which may adversely affect our business.

 

If the value of securities issued by our subsidiaries that are excepted from the definition of ‘‘investment company’’ by Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we own, exceeds 40% of our total assets on an unconsolidated basis, or if one or more of such subsidiaries fail to maintain an exception or exemption from the Investment Company Act, we could, among other things, be required either (a) to substantially change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company under the Investment Company Act, either of which could have an adverse effect on us and the market price of our securities. If we or any of our subsidiaries were required to register as an investment company under the Investment Company Act, the registered entity would become subject to substantial regulation with respect to capital structure (including the ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration, compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly change our operations.

 

Failure to maintain an exemption would require us to significantly restructure our investment strategy. For example, because affiliate transactions are generally prohibited under the Investment Company Act, we would not be able to enter into transactions with any of our affiliates if we are required to register as an investment company, and we might be required to terminate our management agreement and any other agreements with affiliates, which could have a material adverse effect on our ability to operate our business and pay distributions. If we were required to register us as an investment company but failed to do so, we would be prohibited from engaging in our business, and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business.

 

 

We expect certain subsidiaries that we may form in the future to rely upon the exclusion from registration as an investment company under the Investment Company Act pursuant to Section 3(c)(5)(C) of the Investment Company Act, which is available for entities ‘‘primarily engaged’’ in the business of ‘‘purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.’’ This exclusion generally requires that at least 55% of these subsidiaries’ assets must comprise qualifying real estate assets and at least 80% of each of their portfolios must comprise qualifying real estate assets and real estate-related assets under the Investment Company Act. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to rely on guidance published by the SEC staff or on our analyses of such guidance to determine which assets are qualifying real estate assets and real estate-related assets. However, the SEC’s guidance was issued in accordance with factual situations that may be substantially different from the factual situations we may face, and much of the guidance was issued more than 20 years ago. No assurance can be given that the SEC staff will concur with our classification of our assets. In addition, the SEC staff may, in the future, issue further guidance that may require us to re-classify our assets for purposes of qualifying for an exclusion from regulation under the Investment Company Act. If we are required to re-classify our assets, we may no longer be in compliance with the exclusion from the definition of an ‘‘investment company’’ provided by Section 3(c)(5)(C) of the Investment Company Act. To the extent that the SEC staff publishes new or different guidance with respect to any assets we have determined to be qualifying real estate assets, we may be required to adjust our strategy accordingly. In addition, we may be limited in our ability to make certain investments and these limitations could result in a subsidiary holding assets we might wish to sell or selling assets we might wish to hold.

 

The SEC has not published guidance with respect to the treatment of CMBS for purposes of the Section 3(c)(5)(C) exclusion. Unless we receive further guidance from the SEC or its staff with respect to CMBS, we intend to treat CMBS as a real estate-related asset.

 

Certain of our subsidiaries may rely on the exemption provided by Section 3(c)(6) to the extent that they hold mortgage assets through majority-owned subsidiaries that rely on Section 3(c)(5)(C). The SEC staff has issued little interpretive guidance with respect to Section 3(c)(6) and any guidance published by the staff could require us to adjust our strategy accordingly.

 

We determine whether an entity is one of our majority-owned subsidiaries. The Investment Company Act defines a majority-owned subsidiary of a person as a company 50% or more of the outstanding voting securities of which are owned by such person, or by another company which is a majority-owned subsidiary of such person. The Investment Company Act further defines voting securities as any security presently entitling the owner or holder thereof to vote for the election of directors of a company. We treat companies in which we own at least a majority of the outstanding voting securities as majority-owned subsidiaries for purposes of the 40% test. We have not requested the SEC to approve our treatment of any company as a majority-owned subsidiary and the SEC has not done so. If the SEC were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.

 

In August 2011, the SEC solicited public comment on a wide range of issues relating to Section 3(c)(5)(C) of the Investment Company Act, including the nature of the assets that qualify for purposes of the exclusion and whether mortgage REITs should be regulated in a manner similar to investment companies. There can be no assurance that the laws and regulations governing the Investment Company Act status of REITs, including the SEC or its staff providing more specific or different guidance regarding these exemptions, will not change in a manner that adversely affects our operations. If we or our subsidiaries fail to maintain an exception or exemption from the Investment Company Act, we could, among other things, be required either to (a) change the manner in which we conduct our operations to avoid being required to register as an investment company, (b) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (c) register as an investment company, any of which could negatively affect the value of our Common Shares, the sustainability of our business model, and our ability to pay distributions which could have an adverse effect on our business and the market price for our shares of common stock.

 

Rapid and steep declines in the values of our investments may make it more difficult for us to maintain our qualification as a REIT or exemption from the Investment Company Act.

 

If the market value or income potential of real estate-related investments declines as a result of increased interest rates or other factors, we may need to increase our real estate-related investments and income or liquidate our non-qualifying assets in order to maintain our REIT qualification or exemption from the Investment Company Act. If the decline in real estate asset values and/or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of any non-qualifying assets that we may own. We may have to make investment decisions that we otherwise would not make absent the REIT and Investment Company Act considerations.

 

Stockholders have limited control over changes in our policies and operations.

 

Our board of directors determines our major policies, including our policies regarding financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of the stockholders. Under our charter and the Maryland General Corporation Law, our stockholders generally have a right to vote only on the following matters:

 

  

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the election or removal of directors;

 

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any amendment of our charter, except that our board of directors may amend our charter without stockholder approval to:

 

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change our name;

 

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increase or decrease the aggregate number of shares that we have the authority to issue;

 

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increase or decrease the number of our shares of any class or series that we have the authority to issue; and

 

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effect reverse stock splits;

 

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our liquidation and dissolution; and

 

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our being a party to any merger, consolidation, conversion, sale or other disposition of all or substantially all of our assets or statutory share exchange.

 

All other matters are subject to the discretion of our board of directors.

 

Our board of directors may change our investment policies and objectives generally and at the individual investment level without stockholder approval, which could alter the nature of your investment.

 

Our charter requires that our independent directors review our investment policies at least annually to determine that the policies we are following are in the best interests of the stockholders. In addition to our investment policies and objectives, we also may change our stated strategy for any particular investment. These policies may change over time. The methods of implementing our investment policies also may vary, as new investment techniques are developed. Our investment policies, the methods for their implementation, and our other objectives, policies and procedures may be altered by our board of directors without the approval of our stockholders except to the extent that the policies are set forth in our charter. As a result, the nature of your investment could change without your consent.

 

We may not successfully implement our exit strategy, in which case you may have to hold your investment for an indefinite period.

 

Depending upon then-prevailing market conditions, it is our intention to consider beginning the process of liquidating our assets and distributing the net proceeds to our stockholders within five years after the termination of our initial public offering. If we do not begin the process of achieving a liquidity event by March 31, 2022, the fifth anniversary of the termination of our offering, our charter requires either (a) an amendment to our charter to extend the deadline to begin the process of achieving a liquidity event, or (b) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio.

 

Market conditions and other factors could cause us to delay the commencement of our liquidation or to delay the listing of our Common Shares on a national securities exchange beyond five years from the termination of our initial public offering. If so, our board of directors and our independent directors may conclude that it is not in our best interest to hold a stockholders meeting for the purpose of voting on a proposal for our orderly liquidation. Therefore, if we are not successful in implementing our exit strategy, your Common Shares will continue to be illiquid and you may, for an indefinite period of time, be unable to convert your investment into cash easily with minimum loss.

 

Your interest will be diluted if we issue additional securities.

 

Stockholders do not have preemptive rights to any shares issued by us in the future. Our charter currently authorizes us to issue 200 million Common Shares and 50 million shares of preferred stock. Our board of directors may amend our charter from time to time to increase or decrease the number of authorized shares of capital stock, or the number of authorized shares of any class or series of stock designated, and may classify or reclassify any unissued shares into one or more classes or series without the necessity of obtaining stockholder approval. Shares will be issued at the discretion of our board of directors. Stockholders will experience dilution of their percentage ownership interest in us if we: (a) sell Common Shares in this offering or sell additional Common Shares in the future, including those issued pursuant to our DRIP; or (b) sell securities that are convertible into Common Shares. Because of these and other reasons described in this ‘‘Risk Factors’’ section, you should not expect to be able to own a significant percentage of our Common Shares.

 

We are an ‘‘emerging growth company’’ under the federal securities laws and will be subject to reduced public company reporting requirements.

 

In April 2012, President Obama signed into law the Jumpstart Our Business Startups Act, or the JOBS Act. We are an ‘‘emerging growth company,’’ as defined in the JOBS Act, and are eligible to take advantage of certain exemptions from, or reduced disclosure obligations relating to, various reporting requirements that are normally applicable to public companies.

 

 

We could remain an ‘‘emerging growth company’’ for up to five years, or until the earliest to occur of (1) the last day of the first fiscal year in which we have total annual gross revenue of $1 billion or more, (2) December 31 of the fiscal year that we become a ‘‘large accelerated filer’’ as defined in Rule 12b-2 under the Exchange Act (which would occur if the market value of our Common Shares held by non-affiliates exceeds $700 million, measured as of the last business day of our most recently completed second fiscal quarter, and we have been publicly reporting for at least 12 months) and (3) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period. Under the JOBS Act, emerging growth companies are not required to (1) provide an auditor’s attestation report on management’s assessment of the effectiveness of internal control over financial reporting, pursuant to Section 404 of the Sarbanes-Oxley Act, (2) comply with new audit rules adopted by the Public Company Accounting Oversight Board, or the PCAOB, after April 5, 2012 (unless the SEC determines otherwise), (3) provide certain disclosures relating to executive compensation generally required for larger public companies or (4) hold shareholder advisory votes on executive compensation. We have not yet made a decision as to whether to take advantage of some of the JOBS Act exemptions that are applicable to us. If we do avail ourselves of any of such exemptions, we do not know if some investors will find our Common Shares less attractive as a result.

 

Additionally, the JOBS Act provides that an ‘‘emerging growth company’’ may take advantage of an extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies. This means an ‘‘emerging growth company’’ can delay adopting certain accounting standards until such standards are otherwise applicable to private companies. However, we are electing to ‘‘opt out’’ of such extended transition period, and will therefore comply with new or revised accounting standards on the applicable dates on which the adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of such extended transition period for compliance with new or revised accounting standards is irrevocable.

 

We have disclosed funds from operations, or FFO, and modified funds from operations, or MFFO, which are non-GAAP financial measures that may not be meaningful for comparing the performances of different REITs, and that have certain other limitations.

 

We will use, and have disclosed to investors, FFO and MFFO, which are non-GAAP measures, as additional measures of our operating performance. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, Inc., or NAREIT, a trade group. We compute MFFO in accordance with the definition established by the Investment Program Association, or the IPA, another trade group. However, our computation of FFO and MFFO may not be comparable to that of other REITs that do not calculate FFO or MFFO using these definitions without further adjustments.

 

Neither FFO nor MFFO is equivalent to net income or cash generated from operating activities determined in accordance with GAAP and should not be considered as an alternative to net income, as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.

 

Payment of fees to our Advisor and its affiliates reduces cash available for investment and payment of distributions.

 

Our Advisor and its affiliates perform services for us in connection with, among other things, the selection, financing and acquisition or origination of our investments, the servicing of our mezzanine, mortgage and bridge loans, the administration of our other investments and the disposition of our investments. They will be paid substantial fees for these services. These fees will reduce the amount of cash available for investment or distributions to stockholders.

 

There can be no assurance that we will be able to achieve expected cash flows necessary to continue to pay initially established distributions or maintain distributions at any particular level, or that distributions will increase over time.

 

There are many factors that can affect the availability and timing of cash distributions to stockholders. Distributions generally will be based upon such factors as the amount of cash available or anticipated to be available from our assets, current and projected cash requirements and tax considerations. Because we may receive income from interest or dividends at various times during our fiscal year, distributions paid may not reflect our income earned in that particular distribution period. The amount of cash available for distributions will be affected by many factors, such as our ability to undertake originations or acquisitions as offering proceeds become available, the income from those investments and yields on securities of other real estate programs that we invest in, and our operating expense levels, as well as many other variables. Actual cash available for distributions may vary substantially from estimates. We can give no assurance that we will be able to achieve our anticipated cash flow or that distributions will increase over time. There is no assurance that our investments will increase in value or provide constant or increased distributions over time, that loans we make will be repaid or paid on time, that loans will generate the interest payments that we expect, or that future originations or acquisitions of real estate-related loans or debt securities will increase our cash available for distributions to stockholders. Our actual results may differ significantly from the assumptions used by our board of directors in establishing the distribution rates to stockholders.

 

Many of the factors that can affect the availability and timing of cash distributions to stockholders are beyond our control, and a change in any one factor could adversely affect our ability to pay future distributions. For instance:

 

  

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Any failure by a debtor under any of our real estate-related investments to repay the instrument or to pay interest on it will reduce our income and distributions to stockholders.

 

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Cash available to pay distributions may decrease if the investments we acquire have lower yields than expected.

 

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In connection with future investments, we may issue additional Common Shares or interests in other entities that own our assets. If we issue such additional equity, it could reduce the cash available for distributions to you.

 

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Differences in timing between the receipt of income and the payment of expenses, and the effect of required debt payments, could require us to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT, or could reduce the cash available for distributions to you.

 

In addition, our board of directors, in its discretion, may retain any portion of our cash on hand for working capital. We cannot assure you that sufficient cash will be available to pay distributions to you.

 

The failure of any bank in which we deposit our funds could reduce the amount of cash we have available to pay distributions and make additional investments.

 

The Federal Deposit Insurance Corporation, or FDIC, only insures limited amounts per depositor per insured bank. In the future, we may deposit cash, cash equivalents and restricted cash in certain financial institutions in excess of federally insured levels. If any of the banking institutions in which we have deposited funds ultimately fails, we may lose our deposits over the federally insured levels. The loss of our deposits could reduce the amount of cash we have available to distribute or invest and could result in a decline in the value of your investment.

 

Security breaches through cyber-attacks, cyber-intrusions, or otherwise, could disrupt our IT networks and related systems.

 

Risks associated with security breaches, whether through cyber-attacks or cyber-intrusions over the Internet, malware, computer viruses, attachments to e-mails, or otherwise, against persons inside our organization, persons with access to systems inside our organization, the U.S. government, financial markets or institutions, or major businesses, including tenants, could disrupt or disable networks and related systems, other critical infrastructures, and the normal operation of business.  The risk of a security breach or disruption, particularly through cyber-attack or cyber-intrusion, including by computer hackers, foreign governments, and cyber-terrorists, has generally increased as the number, intensity, and sophistication of attempted attacks and intrusions from around the world have increased.  Even though we may not be specifically targeted, cyber-attacks on the U.S. government, financial markets, financial institutions, or other major businesses, including tenants, could disrupt our normal business operations and networks, which may in turn have a material adverse impact on our financial condition and results of operations.

 

Our information technology (“IT”) networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations and they are subject to cybersecurity risks and threats.  They also may be critical to the operations of certain of our tenants.  Further, our Advisor provides our IT services, and there can be no assurance that their security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. It has been reported that unknown entities or groups have mounted cyber-attacks on businesses and other organizations solely to disable or disrupt computer systems, disrupt operations and, in some cases, steal data. Even the most well protected information, networks, systems, and facilities remain potentially vulnerable because the techniques used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected.  Due to the nature of cyber-attacks, breaches to our systems could go unnoticed for a prolonged period of time. These cybersecurity risks could disrupt our operations and result in downtime, loss of revenue, or the loss of critical data as well as result in higher costs to correct and remedy the effects of such incidents. If our systems for protecting against cyber incidents or attacks prove to be insufficient and an incident were to occur, it could have a material adverse effect on our business, financial condition, results of operations or cash flows. While, to date, we have not experienced a cyber-attack or cyber-intrusion, neither our Advisor nor we may be able to anticipate or implement adequate security barriers or other preventive measures.  A security breach or other significant disruption involving our IT networks and related systems could:

 

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disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our tenants;

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result in misstated financial reports, violations of loan covenants, missed reporting deadlines and/or missed permitting deadlines;

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result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT;

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result in the unauthorized access to, and destruction, loss, theft, misappropriation, or release of proprietary, confidential, sensitive, or otherwise valuable information of ours or others, which others could use to compete against us or for disruptive, destructive, or otherwise harmful purposes and outcomes;

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result in our inability to maintain the building systems relied upon by our tenants for the efficient use of their leased space;

 

  

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require significant management attention and resources to remedy any damages that result;

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subject us to claims for breach of contract, damages, credits, penalties, or termination of leases or other agreements; or

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damage our reputation among our tenants and stockholders generally.

 

Any or all of the foregoing could have a material adverse effect on our results of operations, financial condition, and cash flows.

 

Risks Related to Our Investments

 

We may suffer adverse consequences due to the financial difficulties, bankruptcy or insolvency of our borrowers.

 

The success of our investments in real estate-related loans, real estate-related debt securities and other real estate-related investments will materially depend on the financial stability of the debtors underlying such investments. The inability of a single major debtor or a number of smaller debtors to meet their payment obligations could have an adverse impact on our financial condition and results of operations.

 

In the case of an unsecured investment, if a borrower defaults on our debt, we may suffer a loss of principal or interest, and will not have the right to foreclose on any collateral that would potentially mitigate the loss of principal. Additionally, the borrower under an unsecured investment may have insufficient incentive to avoid a default, considering that it has no collateral at risk, so unsecured investments may increase our risks and harm our results of operations. In the case of a secured investment, a borrower defaults on our debt and the mortgaged real estate or other borrower assets collateralizing our debt are insufficient to satisfy the loan, we may suffer a loss of principal or interest. In the event of the bankruptcy or insolvency of a borrower, we may not have full recourse to the assets of the borrower or the assets of the borrower may not be sufficient to satisfy our debt. In addition, certain of our debt investments may be subordinate to other debt of the borrower. If a borrower defaults on our debt or on debt senior to our debt or in the event of the bankruptcy or insolvency of a borrower, our debt will be satisfied only after the senior debt, if any. Bankruptcy and borrower litigation can significantly increase the time needed for us to acquire underlying collateral in the event of a default, during which time the collateral may decline in value. In addition, there are significant monetary costs and delays associated with the process of taking title to collateral.

 

Insurance may not cover all potential losses on the properties underlying our investments, which may harm the value of our investments.

 

There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, which may be uninsurable or not economically insurable. We may not require borrowers to obtain certain types of insurance if it is deemed commercially unreasonable. Inflation, changes in building codes and ordinances, environmental considerations and other factors, including terrorism or acts of war, also might make it infeasible to use insurance proceeds to replace a property if it is damaged or destroyed. Under these circumstances, the insurance proceeds, if any, might not be adequate to restore our economic position with respect to our investment. Any uninsured loss could result in the loss of cash flow from, and the investment value of, the affected property and the value of our investment related to such property.

 

We have not established investment criteria limiting geographical concentration of our debt investments or requiring a minimum credit quality of borrowers.

 

We have not established any limit upon the geographic concentration of properties securing debt investments acquired or originated by us or the credit quality of borrowers of uninsured debt investments acquired or originated by us. As a result, properties securing our debt investments may be overly concentrated in certain geographic areas and the underlying borrowers of our uninsured debt investments may have low credit quality. We may experience losses due to geographic concentration or low credit quality.

 

We are subject to the general market risks associated with real estate construction and development.

 

Our financial performance depends on the successful development and redevelopment of properties that serve as security for the loans we make to developers or that are owned by entities in which we make preferred equity investments. As a result, we are be subject to the general market risks of real estate development and redevelopment, including weather conditions, the price and availability of materials used, environmental liabilities and zoning laws, and numerous other factors that may materially and adversely affect the success of the projects. If the market softens, the developer may require additional funding and such funding may not be available. In addition, if the market softens, the amount of capital required to be advanced and the required marketing time for such development or redevelopment may both increase, and the developer’s incentive to complete a particular real estate development or redevelopment may decrease. Furthermore, the downside risks of development and redevelopment property investments may be greater than the downside risks of other property investments, and may be more severely impacted by downturns in the economy. Such circumstances may reduce our profitability and the return on your investment.

 

 

Our operating results may be negatively affected by potential development and construction delays and resultant increased costs and risks.

 

We have and may continue to provide financing to entities that will develop and construct improvements to land or existing buildings at a fixed contract price. We are and will be subject to risks relating to uncertainties associated with rezoning for development and environmental concerns of governmental entities or community groups and our borrower’s or investee’s ability to control land development costs or to build infrastructure in conformity with plans, specifications and timetables deemed necessary by builders. In cases where we have extended debt financing, a developer’s failure to perform may necessitate legal action by us to compel performance. Performance also may be affected or delayed by conditions beyond such developer’s control. These and other such factors can result in increased costs to the developer that may make it difficult for the developer to make interest payments or to pay preferred dividends to us. Furthermore, we must rely upon projections of the fair market value of property post-development or post-redevelopment, as applicable, when evaluating whether to make loans or preferred equity investments. If our projections are inaccurate, our return on investment could suffer.

 

Our failure to fund our entire commitment on a construction or development loan could harm our results of operations.

 

If we fail to fund our entire commitment on a construction or development loan, there could be adverse consequences associated with the loan, including: a loss of the value of the property securing the loan, especially if the borrower is unable to raise funds to complete it from other sources; a borrower claim against us for failure to perform under the loan documents; increased costs to the borrower that the borrower is unable to pay; a bankruptcy filing by the borrower; and abandonment by the borrower of the collateral for the loan, any of which could harm our results of operations.

 

If we invest in commercial mortgage-backed securities (“CMBS”), such investments would pose additional risks, including the risks of the securitization process and the risk that the special servicer may take actions that could adversely affect our interests.

 

We may invest in CMBS. In general, losses on a mortgaged property securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit, if any, then by the holder of a mezzanine loan or B-Note, if any, then by the ‘‘first loss’’ subordinated security holder (generally, the ‘‘B-Piece’’ buyer) and then by the holder of a higher-rated security. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit, mezzanine loan or B-Note, and any classes of securities junior to those in which we invest, we will not be able to recover all our investment in the securities we purchase. In addition, if the underlying mortgage portfolio has been overvalued by the originator, or if the values subsequently decline, then less collateral value will be available to satisfy interest and principal payments due on the related CMBS. The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments.

 

With respect to the CMBS in which we may invest, overall control over the special servicing of the related underlying mortgage loans will be held by a ‘‘directing certificate holder’’ or a ‘‘controlling class representative,’’ which is appointed by the holders of the most subordinated class of CMBS in such series. Because we may acquire classes of existing series of CMBS, we will not have the right to appoint the directing certificate holder. In connection with the servicing of the specially serviced mortgage loans, the related special servicer may, at the direction of the directing certificate holder, take actions with respect to the specially serviced mortgage loans that could adversely affect our interests.

 

Market disruptions could adversely impact aspects of our operating results and operating condition.

 

We believe the risks associated with our investments will be more acute during periods of economic slowdown or recession, especially if these periods are accompanied by declining real estate values. Our results of operations will be materially affected by conditions in the mortgage market, the commercial real estate markets, the financial markets and the economy generally. A prolonged economic slowdown may result in decreased demand for commercial property, including properties under development, forcing property owners to lower rents on properties with excess supply. To the extent that a property owner has fewer tenants or receives lower rents, such property owner will generate less cash flow on its properties, which increases significantly the likelihood that such property owner will default on its debt service obligations to us. If borrowers default, we may incur losses on our investments with them if the value of any collateral we foreclose upon is insufficient to cover the full amount of such investment, and the funds from such foreclosure may take a significant amount of time to realize. Additionally, we may not be able to cause the borrower to provide us with additional collateral or pay down the loan to maintain loan-to-value ratios.

 

For the foregoing reasons, a weakening economy also may result in the increased likelihood of default even after we have completed loan modifications. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income from loans in our portfolio as well as our Advisor’s ability to acquire, sell and securitize loans. A deterioration of the real estate market may result in a decline in the market value of our investments or cause us to experience losses related to our investments, which may adversely affect our results of operations, the availability and cost of credit and our ability to pay distributions to our stockholders.

 

 

With respect to certain mortgage loans and other debt included in the securities in which we may invest, the collateral that secures the mortgage loan or other debt underlying the securities may also secure one or more related mortgage loans or other debt that are not in the securitization pool, which may conflict with our interest.

 

Certain mortgage loans or other debt included in the securities in which we may invest may be part of a loan combination or split loan structure that includes one or more additional cross-collateralized mortgage loans (senior, subordinate or pari passu and not included in the securitization pool) that are secured by the same mortgage instrument(s) encumbering the same mortgaged property or properties, as applicable, as is the subject mortgage loan. Pursuant to one or more co-lender or similar agreements, a holder, or a group of holders, of a mortgage loan in a subject loan combination or split loan structure may be granted various rights and powers that affect the mortgage loan in that loan combination or split loan structure, including: (a) cure rights; (b) a purchase option; (c) the right to advise, direct or consult with the applicable servicer regarding various servicing matters affecting that loan combination; or (d) the right to replace the directing certificate holder (without cause). These rights could adversely affect our position.

 

Our investments in securities, which include a preferred equity investment with a related party, are subject to the specific risks relating to the particular issuer of the securities and may involve greater risk of loss than secured debt financings.

 

Our investments in securities, which include a preferred equity investment with a related party, involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Issuers that are REITs and other real estate companies are subject to risks associated with real estate and real estate-related investments. Furthermore, securities, including preferred equity, may involve greater risk of loss than secured financings due to a variety of factors, including that such investments are generally unsecured and may also be subordinated to other obligations of the issuer. As a result, investments in securities, including preferred equity, are subject to risks of: (a) limited liquidity in the secondary trading market; (b) substantial market price volatility resulting from changes in prevailing interest rates; (c) subordination to the prior claims of banks and other senior lenders to the issuer; (d) the operation of mandatory sinking fund or call or redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower-yielding investments; (e) the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations; and (f) the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding securities, including preferred equity, and the ability of the issuers thereof to make principal, interest and distribution payments to us.

 

Declines in the fair value of our investments may adversely affect our periodically reported results of operations and credit availability, which may reduce earnings and, in turn, cash available for distribution to you.

 

Our securities investments may be classified for accounting purposes as ‘‘available-for-sale.’’ Such securities will be carried at estimated fair value and temporary changes in the fair value of those investments will generally be directly charged or credited to equity with no impact in our consolidated statements of operations. If we determine that a decline in the estimated fair value of an available-for-sale security falls below its amortized value and is not temporary, we will recognize the appropriate loss on that security in our consolidated statements of operations, which will reduce our earnings in the period.

 

A decline in the fair value of our investments may adversely affect us particularly in instances where we have borrowed money based on the fair value of those investments. If the fair value of those investments declines, the lender may require us to post additional collateral to support the investment. If we were unable to post the additional collateral, our lenders may refuse to continue to lend to us or reduce the amounts they are willing to lend to us. Additionally, we may have to sell investments at a time when we might not otherwise choose to do so. A reduction in credit available may reduce our earnings and, in turn, cash available for distribution to you.

 

Further, lenders may require us to maintain a certain amount of cash reserves or to set aside unlevered assets sufficient to maintain a specified liquidity position, which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our investments as fully as we would choose, which could reduce our return on equity. If we are unable to meet these contractual obligations, our financial condition could deteriorate rapidly.

 

The fair value of our investments may decline for a number of reasons, such as changes in prevailing market rates, increases in defaults, increases in voluntary prepayments for those investments that we have that are subject to prepayment risk, widening of credit spreads and downgrades of ratings of the securities by ratings agencies.

 

We may invest in collateralized debt obligations (“CDOs”), which may involve significant risks.

 

We may invest in CDOs, which are multiple-class securities secured by pools of assets, such as CMBS, mortgage loans, subordinate mortgage and mezzanine loans and REIT debt. Like typical securitization structures, in a CDO, the assets are pledged to a trustee for the benefit of the holders of the CDO. Like CMBS, CDOs are affected by payments, defaults, delinquencies and losses on the underlying loans or securities. CDOs often have reinvestment periods that typically last for five years during which proceeds from the sale of a collateral asset may be invested in substitute collateral. Upon termination of the reinvestment period, the static pool functions very similarly to a CMBS where repayment of principal allows for redemption of bonds sequentially. To the extent we may invest in the equity interest of a CDO, we will be entitled to all the income generated by the CDO after the payment of all interest due on the senior securities and certain expenses. However, there may be little or no income or principal available to the holders of CDO equity interests if defaults or losses on the underlying collateral exceed a certain amount. In that event, the value of our investment in any equity interest of a CDO could decrease substantially, and could even decrease to zero. In addition, the equity interests of CDOs are illiquid, and because they represent a leveraged investment in the CDO’s assets, the value of the equity interests will generally have greater fluctuations than the value of the underlying collateral.

 

 

We may invest in credit default swaps, which may subject us to an increased risk of loss.

 

Subject to maintaining our qualification as a REIT, we may invest in credit default swaps. A credit default swap is a contract between two parties which transfers the risk of loss if a borrower fails to pay principal or interest on time or files for bankruptcy. Credit default swaps can be used to hedge a portion of the default risk on a single corporate debt or a portfolio of loans. In addition, credit default swaps can be used to implement our Advisor’s view that a particular credit, or group of credits, will experience credit improvement. In the case of expected credit improvement, we may ‘‘write’’ credit default protection in which we receive spread income. We may also ‘‘purchase’’ credit default protection even in the case in which we do not own the referenced instrument if, in the judgment of our Advisor, there is a high likelihood of credit deterioration. The credit default swap market in high-yield securities is comparatively new and rapidly evolving compared to the credit default swap market for more seasoned and liquid investment grade securities. Swap transactions dependent upon credit events are priced incorporating many variables, including the potential loss upon default. As such, there are many factors upon which market participants may have divergent views.

 

Interest rate fluctuations could increase our financing costs and reduce our ability to generate income on our investments, either of which could lead to a significant decrease in our results of operations and cash flows and the market value of our investments.

 

Our primary interest rate exposures will relate to the yield on our investments and the financing cost of our debt, as well as our interest rate swaps that we utilize for hedging purposes. Changes in interest rates will affect our net interest income, which is the difference between the interest income we earn on our interest-earning investments and the interest expense we incur in financing these investments. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for us. Changes in the level of interest rates also may affect our ability to invest in investments, the value of our investments and our ability to realize gains from the disposition of investments. Changes in interest rates may also affect borrower default rates.

 

To the extent that our financing costs will be determined by reference to floating rates, such as LIBOR or a Treasury index, plus a margin, the amount of such costs will depend on a variety of factors, including, without limitation, (a) for collateralized debt, the value and liquidity of the collateral, and for non-collateralized debt, our credit, (b) the level and movement of interest rates, and (c) general market conditions and liquidity. In a period of rising interest rates, our interest expense on floating rate debt would increase, while any additional interest income we earn on our floating rate investments may not compensate for such increase in interest expense. At the same time, the interest income we earn on our fixed-rate investments would not change, the duration and weighted average life of our fixed-rate investments would increase and the market value of our fixed-rate investments would decrease. Similarly, in a period of declining interest rates, our interest income on floating-rate investments would decrease, while any decrease in the interest we are charged on our floating-rate debt may not compensate for such decrease in interest income and interest we are charged on our fixed-rate debt would not change. Any such scenario could materially and adversely affect us.

 

Our operating results will depend, in part, on differences between the income earned on our investments, net of credit losses, and our financing costs. For any period during which our investments are not match-funded, the income earned on such investments may respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may immediately and significantly decrease our results of operations and cash flows and the market value of our investments.

 

To hedge against exchange rate and interest rate fluctuations, we may use derivative financial instruments that may be costly and ineffective and may reduce the overall returns on your investment and affect cash available for distribution to our stockholders.

 

We may use derivative financial instruments to hedge exposures to changes in exchange rates and interest rates on loans secured by our investments. Derivative instruments may include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions will be determined in light of the facts and circumstances existing at the time of the hedge and may differ from time to time. Our hedging may fail to protect or could adversely affect us because, among other things:

 

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interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;

 

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available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;

 

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the duration of the hedge may not match the duration of the related liability or asset;

 

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the amount of income that a REIT may earn from hedging transactions to offset interest rate losses is limited by federal income tax provisions governing REITs;

 

  

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the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction;

 

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the party owing money in the hedging transaction may default on its obligation to pay; and

 

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we may purchase a hedge that turns out not to be necessary, i.e., a hedge that is out of the money.

 

Any hedging activity we engage in may adversely affect our earnings, which could adversely affect cash available for distribution to our stockholders. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged or liabilities being hedged may vary materially. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended accounting treatment and may expose us to risk of loss.

 

To the extent that we use derivative financial instruments to hedge against exchange rate and interest rate fluctuations, we will be exposed to credit risk, basis risk and legal enforceability risks. In this context, credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. Basis risk occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset or liability is based, thereby making the hedge less effective. Finally, legal enforceability risks encompass general contractual risks, including the risk that the counterparty will breach the terms of, or fail to perform its obligations under, the derivative contract. If we are unable to manage these risks effectively, our results of operations, financial condition and ability to pay distributions to you will be adversely affected.

 

Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities and involve risks and costs.

 

The cost of using hedging instruments increases as the period covered by the instrument increases and during periods of rising and volatile interest rates. We may increase our hedging activity and thus increase our hedging costs during periods when interest rates are volatile or rising and hedging costs have increased. In addition, hedging instruments involve risk because they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities. Consequently, there are no requirements with respect to recordkeeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then-current market price. It may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot be certain that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.

 

All of our current investments are illiquid, and we may not be able to adjust our portfolio in response to changes in economic and other conditions.

 

Certain of the real estate-related securities that we have or may purchase or originate in connection with privately negotiated transactions will not be registered under the applicable securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, those laws. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited. The mezzanine and bridge loans we may purchase or originate will be particularly illiquid investments due to their short life, their unsuitability for securitization and the greater difficulty of recoupment following a borrower’s default.

 

 

We are subject to interest rate risk, which means that changing interest rates may reduce the value of our real estate-related investments.

 

Interest rate risk is the risk that prevailing market interest rates will change relative to the current yield on fixed-income instruments such as loans and preferred and debt securities, and to a lesser extent dividend-paying common stock. Generally, when interest rates rise, the market value of these instruments declines, and vice versa. In addition, when interest rates fall, borrowers and issuers are more likely to repurchase or prepay their existing preferred and debt instruments to take advantage of the lower cost of financing. As repurchases and prepayments occur, principal is returned to the investor sooner than expected, thereby lowering the effective yield on the investment and frequently leaving the investor unable to invest in new instruments of similar quality at the previously higher interest rate or yield. If we invest in variable-rate investments and interest rates fall, our revenues also may decrease. On the other hand, when interest rates rise, borrowers and issuers are more likely to maintain their existing preferred and debt instruments. As a result, repurchases and prepayments decrease, thereby extending the average maturity of the instruments. Finally, if we invest in variable-rate investments and interest rates rise, borrowers will be more likely to repurchase or prepay their variable-rate debt, thereby lowering the effective yield on our investment, and leaving us unable to invest in new instruments of similar quality at the previously higher interest rate or yield. If we are unable to manage interest rate risk effectively, our results of operations, financial condition and ability to pay distributions to you will be adversely affected.

 

We may acquire real estate-related securities through tender offers, which may require us to spend significant amounts of time and money that otherwise could be allocated to our operations.

 

We may acquire real estate-related securities through tender offers, negotiated or otherwise, in which we solicit a target company’s stockholders to purchase their securities. The acquisition of these securities could require us to spend significant amounts of money that otherwise could be allocated to our operations. Additionally, in order to acquire the securities, the employees of our Advisor likely will need to devote a substantial portion of their time to pursuing the tender offer — time that otherwise could be allocated to managing our business. These consequences could adversely affect our operations and reduce the cash available for distribution to our stockholders.

 

Our dependence on the management of other entities in which we invest may adversely affect our business.

 

We may not control the management, investment decisions or operations of the companies in which we may invest. Management of those enterprises may decide to change the nature of their assets, or management may otherwise change in a manner that is not satisfactory to us. We will have no ability to affect these management decisions, and we may have only limited ability to dispose of our investments.

 

Our due diligence may not reveal all of a borrower’s liabilities and may not reveal other weaknesses in its business.

 

Before making a loan to a borrower or acquiring debt or equity securities of a company, we will assess the strength and skills of such entity’s management and other factors that we believe are material to the performance of the investment. In making the assessment and otherwise conducting customary due diligence, we will rely on the resources available to us and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly organized or private entities because there may be little or no information publicly available about the entities. There can be no assurance that our due diligence processes will uncover all relevant facts or that any investment will be successful.

 

The employees and key personnel of our Advisor and its affiliates have relatively less experience investing in mezzanine, mortgage or bridge loans as compared to investing directly in real property, which could adversely affect our return on loan investments.

 

The experience of the employees and key personnel of our Advisor and its affiliates with respect to investing in mezzanine, mortgage or bridge loans is not as extensive as it is with respect to investments directly in real properties. Such individuals’ relatively less extensive experience with respect to mezzanine, mortgage or bridge loans could adversely affect our return on loan investments.

 

Delays in liquidating defaulted mortgage, mezzanine or bridge loans could reduce our investment returns.

 

If there are defaults under our loans, we may not be able foreclose on, and sell, any collateral securing the defaulted loan. An action to foreclose on a property securing a loan is regulated by state statutes and regulations which may delay foreclosure and result in litigation and the attendant costs and uncertainty of litigation. If there is a default by a mortgagor, these restrictions, among other things, may impede our ability to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due to us on the loan.

 

The mezzanine loans and second lien mortgage loans in which we may invest would involve greater risks of loss than senior loans secured by income-producing real properties.

 

We may invest in subordinated loans secured by second mortgages on the underlying real property or loans secured by a pledge of the ownership interests of either the entity owning the real property or the entity that owns the interest in the entity owning the real property. These types of investments involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property because the investment may become unsecured as a result of foreclosure by the senior lender, or the value of the collateral may not be sufficient to repay the loan. Mezzanine loans and second lien mortgage loans that fund development projects involve additional risks, including dependence for repayment on successful completion and operation of the project, difficulties in estimating construction or rehabilitation costs and loan terms that often require little or no amortization. If there is a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of the entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our loan or on debt senior to our loan, or if there is a borrower bankruptcy, our loan will be satisfied only after the senior debt is paid in full. Further, if debt senior to our loan exists, the presence of intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through ‘‘standstill periods’’), and control decisions made in bankruptcy proceedings relating to borrowers. As a result, we may not recover some of or all our investment.

 

 

Returns on our mezzanine, mortgage or bridge loans may be limited by regulations.

 

The mezzanine, mortgage or bridge loans in which we invest, or that we originate, may be subject to regulation by federal, state and local authorities and subject to various laws and judicial and administrative decisions that limit returns. We may determine not to make mezzanine, mortgage or bridge loans in any jurisdiction in which we believe we have not complied in all material respects with applicable requirements.

 

Foreclosures create additional ownership risks that could adversely impact our returns on mortgage investments.

 

If we acquire property by foreclosure following defaults under our mortgage, bridge or mezzanine loans, we will have the economic and liability risks as the owner, and our investment will be subject to all the risks associated with the ownership of commercial property, including:

 

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changes in general or local economic conditions;

 

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changes in supply of or demand for similar or competing properties in an area;

 

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changes in interest rates and availability of permanent mortgage funds that may render the sale of a property difficult or unattractive;

 

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changes in tax, real estate, environmental and zoning laws; and

 

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the risk of uninsured or underinsured casualty loss.

 

These and other risks may prevent us from being profitable or from realizing growth or maintaining the value of our real estate properties.

 

A liquidation of our investments could be delayed as a result of our investment in mezzanine loans, bridge loans and preferred equity, which could delay distributions to our stockholders.

 

The mezzanine loans, bridge loans and preferred equity we own or may own will be particularly illiquid investments. Mezzanine loans and bridge loans are relatively illiquid due to their short life, their unsuitability for securitization and the greater difficulty of recoupment following a borrower’s default. Preferred equity is relatively illiquid because secondary markets are not as large or well developed as the secondary markets for common stock and debt. Any intended liquidation of our company may be delayed until all mezzanine loans, bridge loans and preferred equity expire, are redeemed or are sold, which could delay distributions to our stockholders.

 

Investments that are not U.S. government-insured involve risk of loss.

 

We may originate and acquire uninsured investments as part of our investment strategy. Such investments may include mezzanine loans, mortgage loans and bridge loans. While holding such interests, we will be subject to risks of borrower defaults, bankruptcies, fraud, losses and special losses that are not covered by standard insurance.

 

Liabilities relating to environmental matters may impact the value of properties that we may acquire upon foreclosure of the properties underlying our investments.

 

To the extent we foreclose on properties with respect to which we have extended mortgage loans, we may be subject to environmental liabilities arising from such foreclosed properties. Under various U.S. federal, state and local laws, an owner or operator of real property may become liable for the costs of removal of certain hazardous substances released on its property. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances.

 

The presence of hazardous substances may adversely affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of a property underlying one of our debt investments becomes liable for removal costs, the ability of the owner to make payments to us may be reduced, which in turn may adversely affect the value of the relevant mortgage asset held by us and our ability to pay distributions to our stockholders.

 

If we foreclose on any properties underlying our investments, the presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs, thus harming our financial condition. The discovery of environmental liabilities attached to such properties could have a material adverse effect on our results of operations and financial condition and our ability to pay distributions to our stockholders.

 

 

We may fail to qualify for hedge accounting treatment.

 

We intend to record derivative and hedging transactions in accordance with Financial Accounting Standards Board, or FASB, ASC 815, Derivatives and Hedging. Under these standards, we may fail to qualify for hedge accounting treatment for a number of reasons, including if we use instruments that do not meet the FASB ASC 815 definition of a derivative (such as short sales), we fail to satisfy FASB ASC 815 hedge documentation and hedge effectiveness assessment requirements or our instruments are not highly effective. If we fail to qualify for hedge accounting treatment, our operating results may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction or item.

 

Risks Associated with Debt Financing

 

We have incurred and may in the future incur indebtedness, which may increase our business risks.

 

Under our charter, the maximum amount of our indebtedness may not exceed 300% of our ‘‘net assets’’ (as defined by our charter) as of the date of any borrowing unless approved by a majority of our independent directors. In addition to our charter limitation, our board of directors has adopted a policy to generally limit our aggregate borrowings to approximately 25% of the greater of the aggregate cost and the fair market value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests. Our policy limitation, however, does not apply to individual investments and only will apply once we have ceased raising capital under this or any subsequent offering and invested substantially all our capital. As a result, we expect to borrow more than 25% of the aggregate cost and the fair market value of each investment we acquire to the extent our board of directors determines that borrowing these amounts is prudent. For these purposes, the value of our assets is based on methodologies and policies determined by our board of directors that may include, but do not require, independent valuations.

 

Our debt may be at a level that is higher than REITs with similar investment objectives or criteria. High debt levels could cause us to incur higher interest charges, could result in higher debt service payments, and could be accompanied by restrictive covenants. These factors could limit the amount of cash we have available to distribute and could result in a decline in the value of your investment.

 

It is also possible that we will borrow to originate or acquire investments that are themselves leveraged. In this way we could have a higher level of leverage than our disclosed loan-to-value ratio, either on a portfolio-wide basis or on the level of one or more individual investments, either of which could further increase our business risks.

 

Any bank credit facilities and repurchase agreements that we may use in the future to finance our investments may require us to provide additional collateral or pay down debt.

 

We anticipate that we may utilize bank credit facilities or repurchase agreements (including term loans and revolving facilities) to finance our investments if they become available on acceptable terms. Such financing arrangements would involve the risk that the market value of the loans pledged or sold by us to the provider of the bank credit facility or repurchase agreement counterparty may decline in value, in which case the lender may require us to provide additional collateral or to repay all or a portion of the funds advanced. We may not have the funds available to repay our debt at that time, which would likely result in defaults unless we are able to raise the funds from alternative sources, which we may not be able to achieve on favorable terms or at all. Posting additional collateral would reduce our liquidity and limit our ability to leverage our investments. If we cannot meet these requirements, the lender could accelerate our indebtedness, increase the interest rate on advanced funds and terminate our ability to borrow funds from it, which could materially and adversely affect our financial condition and ability to implement our investment strategy. In addition, if the lender files for bankruptcy or becomes insolvent, our loans may become subject to bankruptcy or insolvency proceedings, thus depriving us, at least temporarily, of the benefit of these investments. Such an event could restrict our access to bank credit facilities and increase our cost of capital. A lender may require us to pay down other debt as a condition to extending credit, which could reduce our liquidity and cause us to incur prepayment or breakage costs. The providers of bank credit facilities and repurchase agreement financing may also require us to maintain a certain amount of cash or set aside assets sufficient to maintain a specified liquidity position that would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our investments as fully as we would choose, which could reduce our return on investment. If we are unable to meet these collateral obligations, our financial condition and prospects could deteriorate rapidly.

 

In addition, if a counterparty to our repurchase transactions defaults on its obligation to resell the underlying security back to us at the end of the transaction term, or if the value of the underlying security has declined as of the end of that term, or if we default on our obligations under the repurchase agreement, we will likely incur a loss on our repurchase transactions.

 

There can be no assurance that we will be able to obtain additional bank credit facilities or repurchase agreements on favorable terms, or at all.

 

Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to pay distributions to our stockholders.

 

In connection with obtaining financing, a lender could impose restrictions on us that affect our ability to incur additional debt and our distribution and operating policies. In general, we expect our loan agreements to restrict our ability to encumber or otherwise transfer our interest in the respective investments without the prior consent of the lender. Loan documents we enter into may contain other customary negative covenants that may limit our ability to further finance the investments, replace Lightstone Real Estate Income LLC as our Advisor or impose other limitations. Any such restriction or limitation may have an adverse effect on our operations and our ability to pay distributions to you.

 

 

Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to pay distributions to our stockholders.

 

We may incur indebtedness that bears interest at a variable rate. In addition, from time to time we may pay loans or finance and refinance our investments in a rising interest rate environment. Accordingly, increases in interest rates could increase our interest costs, which could have an adverse effect on our operating cash flow and our ability to pay distributions to you. In addition, if rising interest rates cause us to need additional capital to repay indebtedness in accordance with its terms or otherwise, we may need to liquidate one or more of our investments at times that may not permit realization of the maximum return on such investments. Prolonged interest rate increases also could negatively impact our ability to make investments with positive economic returns.

 

If we enter into financing arrangements involving balloon payment obligations, it may adversely affect our ability to pay distributions.

 

Some of our financing arrangements may require us to make a lump-sum or ‘‘balloon’’ payment at maturity. Our ability to make a balloon payment at maturity is uncertain and may depend upon our ability to obtain additional financing or our ability to sell the underlying investments. At the time the balloon payment is due, we may not be able to refinance the balloon payment on terms as favorable as the original loan or sell the underlying investments at a price sufficient to make the balloon payment, either of which could increase our risk of default on the loan. The effect of a refinancing or sale could affect the rate of return to stockholders and the projected time of disposition of our investments. In addition, payments of principal and interest made to service our debts may leave us with insufficient cash to pay the distributions that we are required to pay to maintain our qualification as a REIT and minimize U.S. federal income and excise tax. Any of these results would have a significant negative impact on your investment.

 

We may not successfully align the maturities of our liabilities with the maturities of our assets, which could harm our operating results and financial condition.

 

Our general financing strategy is focused on the use of ‘‘match-funded’’ structures. This means that we seek to align the maturities of our liabilities with the maturities on our assets in order to manage the risks of being forced to refinance our liabilities prior to the maturities of our assets. In addition, we plan to match interest rates on our assets with like-kind borrowings, so fixed-rate investments are financed with fixed-rate borrowings and floating-rate assets are financed with floating-rate borrowings, directly or indirectly through the use of interest rate swaps, caps and other financial instruments or through a combination of these strategies. We may fail to appropriately employ match-funded structures on favorable terms, or at all. We also may determine not to pursue a match-funded strategy with respect to a portion of our financings for a variety of reasons. If we fail to appropriately employ match-funded strategies or determine not to pursue such a strategy, our exposure to interest rate volatility and exposure to matching liabilities prior to the maturity of the corresponding asset may increase substantially, which could harm our operating results, liquidity and financial condition.

 

U.S. Federal Income Tax Risks

 

Our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and potentially state and local tax, and would adversely affect our operations and the market price of our common stock.

 

We elected to be taxed as a REIT commencing with our taxable year ending December 31, 2016, and intend to operate in a manner that would allow us to continue to qualify as a REIT. However, we may terminate our REIT election, if our board of directors determines that not qualifying as a REIT is in our best interests, or inadvertently. Our qualification as a REIT depends upon our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. The REIT qualification requirements are extremely complex and interpretation of the U.S. federal income tax laws governing qualification as a REIT is limited. Furthermore, any opinion of our counsel, including tax counsel, as to our eligibility to qualify or remain qualified as a REIT is not binding on the Internal Revenue Service (the “IRS”) and is not a guarantee that we will qualify, or continue to qualify, as a REIT. Accordingly, we cannot be certain that we will be successful in operating so we can qualify or remain qualified as a REIT. Our ability to satisfy the REIT asset tests depends on our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the annual income and quarterly asset requirements also depends on our ability to successfully manage the composition of our income and assets on an ongoing basis. Accordingly, if certain of our operations were to be recharacterized by the IRS, such recharacterization would jeopardize our ability to satisfy all requirements for qualification as a REIT. Furthermore, future legislative, judicial or administrative changes to the U.S. federal income tax laws could be applied retroactively, which could result in our disqualification as a REIT.

 

 

If we fail to qualify as a REIT for any taxable year, and we do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT qualification. Losing our REIT qualification would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the dividends paid deduction, and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.

 

REITs, in certain circumstances, may incur tax liabilities that would reduce our cash available for distribution to you.

 

Even if we maintain our qualifiaction as a REIT, we may be subject to U.S. federal, state and local income taxes. For example, net income from the sale of properties that are ‘‘dealer’’ properties sold by a REIT (a ‘‘prohibited transaction’’ under the Code) will be subject to a 100% tax. We may not make sufficient distributions to avoid excise taxes applicable to REITs. Similarly, if we were to fail an income test (and did not lose our REIT status because such failure was due to reasonable cause and not willful neglect) we would be subject to tax on the income that does not meet the income test requirements. We also may decide to retain net capital gain we earn from the sale or other disposition of our property and pay U.S. federal income tax directly on such income. In that event, our stockholders would be treated as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability unless they file U.S. federal income tax returns thereon and seek a refund of such tax. We also will be subject to corporate tax on any undistributed REIT taxable income. We also may be subject to state and local taxes on our income or property, including franchise, payroll and transfer taxes, either directly or at the level of the other companies through which we indirectly own our assets, such as our taxable REIT subsidiaries, or TRSs, which are subject to full U.S. federal, state, local and foreign corporate-level income taxes. Any taxes we pay directly or indirectly will reduce our cash available for distribution to you.

 

To qualify as a REIT we must meet annual distribution requirements, which may force us to forgo otherwise attractive opportunities or borrow funds during unfavorable market conditions. This could delay or hinder our ability to meet our investment objectives and reduce your overall return.

 

In order to qualify and maintain our status as a REIT, we must distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. We will be subject to U.S. federal income tax on our undistributed REIT taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which distributions we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. These requirements could cause us to distribute amounts that otherwise would be spent on investments in real estate assets and it is possible that we might be required to borrow funds, possibly at unfavorable rates, or sell assets to fund these distributions. Although we intend to make distributions sufficient to meet the annual distribution requirements and to avoid U.S. federal income and excise taxes on our earnings while we qualify as a REIT, it is possible that we might not always be able to do so.

 

Certain of our business activities are potentially subject to the prohibited transaction tax, which could reduce the return on your investment.

 

For so long as we qualify as a REIT, our ability to dispose of property during the first few years following acquisition may be restricted to a substantial extent as a result of our REIT qualification. Under applicable provisions of the Code regarding prohibited transactions by REITs, while we qualify as a REIT, we will be subject to a 100% penalty tax on the net income recognized on the sale or other disposition of any property (other than foreclosure property) that we own, directly or indirectly through any subsidiary entity, but generally excluding our TRSs, that is deemed to be inventory or property held primarily for sale to customers in the ordinary course of a trade or business. Whether property is inventory or otherwise held primarily for sale to customers in the ordinary course of a trade or business depends on the particular facts and circumstances surrounding each property. We intend to avoid the 100% prohibited transaction tax by (1) conducting activities that may otherwise be considered prohibited transactions through a TRS (but such TRS would incur corporate rate income taxes with respect to any income or gain recognized by it), (2) conducting our operations in such a manner so that no sale or other disposition of an asset we own, directly or indirectly through any subsidiary, will be treated as a prohibited transaction, or (3) structuring certain dispositions of our assets to comply with the requirements of the prohibited transaction safe harbor available under the Code for assets that, among other requirements, have been held for at least two years. Despite our present intention, no assurance can be given that any particular property we own, directly or through any subsidiary entity, but generally excluding TRSs, will not be treated as inventory or property held primarily for sale to customers in the ordinary course of a trade or business.

 

 

The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing mortgage loans that would be treated as sales for U.S. federal income tax purposes.

 

A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including mortgage loans, held as inventory or primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell or securitize loans in a manner that was treated as a sale of the loans as inventory for U.S. federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans, other than through a TRS, and we may be required to limit the structures we use for our securitization transactions, even though such sales or structures might otherwise be beneficial for us.

 

Our TRSs are subject to corporate-level taxes and our dealings with our TRSs may be subject to 100% excise tax.

 

A REIT may own up to 100% of the stock of one or more TRSs. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 20% (25% for taxable years beginning prior to January 1, 2018) of the gross value of a REIT’s assets may consist of stock or securities of one or more TRSs. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation.

 

A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT. For example, to the extent that we acquire loans with an intention of selling such loans in a manner that might expose us to a 100% tax on ‘‘prohibited transactions,’’ we expect such loans will be acquired by a TRS. We may use our TRSs generally for such activities as holding loans for sale in the ordinary course of a trade or business or to hold assets or conduct activities that we cannot conduct directly as a REIT. A TRS will be subject to applicable U.S. federal, state, local and foreign income tax on its taxable income. In addition, the rules, which are applicable to us as a REIT, also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.

 

Our investments in certain debt instruments may cause us to recognize income for U.S. federal income tax purposes even though no cash payments have been received on the debt instruments, and certain modifications of such debt by us could cause the modified debt to not qualify as a good REIT asset, thereby jeopardizing our REIT qualification.

 

Our taxable income may substantially exceed our net income as determined based on GAAP, or differences in timing between the recognition of taxable income and the actual receipt of cash may occur. For example, we may acquire assets, including debt securities requiring us to accrue original issue discount, or OID, or recognize market discount income, that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets. In addition, if a borrower with respect to a particular debt instrument encounters financial difficulty rendering it unable to pay stated interest as due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income with the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our stockholders.

 

As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to (a) sell assets in adverse market conditions, (b) borrow on unfavorable terms, (c) distribute amounts that would otherwise be used for future acquisitions or used to repay debt, or (d) make a taxable distribution of our Common Shares as part of a distribution in which stockholders may elect to receive Common Shares or (subject to a limit measured as a percentage of the total distribution) cash, in order to comply with the REIT distribution requirements.

 

Moreover, we may acquire distressed debt investments that require subsequent modification by agreement with the borrower. If the amendments to the outstanding debt are ‘‘significant modifications’’ under the applicable Treasury Regulations, the modified debt may be considered to have been reissued to us in a debt- for-debt taxable exchange with the borrower. This deemed reissuance may prevent the modified debt from qualifying as a good REIT asset if the underlying security has declined in value and would cause us to recognize income to the extent the principal amount of the modified debt exceeds our adjusted tax basis in the unmodified debt.

 

The failure of a mezzanine loan to qualify as a real estate asset would adversely affect our ability to qualify as a REIT.

 

In general, in order for a loan to be treated as a qualifying real estate asset producing qualifying income for purposes of the REIT asset and income tests, the loan must be secured by real property or an interest in real property. We may originate or acquire mezzanine loans that are not directly secured by real property or an interest in real property but instead secured by equity interests in a partnership or limited liability company that directly or indirectly owns real property or an interest in real property. In Revenue Procedure 2003-65, the IRS provided a safe harbor pursuant to which a mezzanine loan that is not secured by real estate would, if it meets each of the requirements contained in the Revenue Procedure, be treated by the IRS as a qualifying real estate asset. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law and in many cases it may not be possible for us to meet all the requirements of the safe harbor. We cannot provide assurance that any mezzanine loan in which we invest would be treated as a qualifying asset producing qualifying income for REIT qualification purposes. If any such loan fails either the REIT income or asset tests, we may be disqualified as a REIT.

 

 

Our qualification as a REIT and exemption from U.S. federal income tax with respect to certain assets may be dependent on the accuracy of legal opinions or advice rendered or given or statements by the issuers of assets that we acquire, and the inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax.

 

When purchasing securities, we may rely on opinions or advice of counsel for the issuer of such securities, or statements made in related offering documents, for purposes of determining whether such securities represent debt or equity securities for U.S. federal income tax purposes, and also to what extent those securities constitute real estate assets for purposes of the REIT asset tests and produce qualifying income for purposes of the 75% gross income test. In addition, when purchasing the equity tranche of a securitization, we may rely on opinions or advice of counsel regarding the qualification of the securitization for exemption from U.S. corporate income tax and the qualification of interests in such securitization as debt for U.S. federal income tax purposes. The inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate level tax.

 

The taxable mortgage pool, or ‘‘TMP,’’ rules may increase the taxes that we or our stockholders may incur, and may limit the manner in which we effect future securitizations.

 

Securitizations originated or acquired by us or our subsidiaries could result in the creation of TMPs for U.S. federal income tax purposes. As a result, we could have ‘‘excess inclusion income.’’ Certain categories of stockholders, such as non-U.S. stockholders eligible for treaty or other benefits, stockholders with net operating losses, and certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to any such excess inclusion income. In the case of a stockholder that is a REIT, regulated investment company, or RIC, common trust fund or other pass-through entity, our allocable share of our excess inclusion income could be considered excess inclusion income of such entity. In addition, to the extent that our common stock is owned by tax-exempt ‘‘disqualified organizations,’’ such as certain government-related entities and charitable remainder trusts that are not subject to tax on unrelated business income, we may incur a corporate-level tax on a portion of any excess inclusion income. Because this tax generally would be imposed on us, all of our stockholders, including stockholders that are not disqualified organizations, generally will bear a portion of the tax cost associated with the classification of us or a portion of our assets as a TMP. A RIC, or other pass-through entity owning our common stock in record name will be subject to tax at the highest U.S. federal corporate tax rate on any excess inclusion income allocated to their owners that are disqualified organizations. Moreover, we could face limitations in selling equity interests in these securitizations to outside investors, or selling any debt securities issued in connection with these securitizations that might be considered to be equity interests for tax purposes. Finally, if we were to fail to qualify as a REIT, any TMP securitizations would be treated as separate taxable corporations for U.S. federal income tax purposes that could not be included in any consolidated U.S. federal corporate income tax return. These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions.

 

We may choose to make distributions in our own stock, in which case you may be required to pay U.S. federal income taxes in excess of the cash dividends you receive.

 

In connection with our qualification as a REIT, we are required to distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. In order to satisfy this requirement, we may make distributions that are payable in cash and/or our shares (which could account for up to 80% of the aggregate amount of such distributions) at the election of each stockholder. Taxable stockholders receiving such distributions will be required to include the full amount of such distributions as ordinary dividend income to the extent of our current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. As a result, U.S. Stockholders, may be required to pay U.S. federal income taxes with respect to such distributions in excess of the cash portion of the distribution received.

 

Accordingly, U.S. Stockholders receiving a distribution of our shares may be required to sell shares received in such distribution or may be required to sell other stock or assets owned by them, at a time that may be disadvantageous, in order to satisfy any tax imposed on such distribution. If a U.S. Stockholder sells the stock that it receives as part of the distribution in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the distribution, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain Non-U.S. Stockholders, we may be required to withhold U.S. tax with respect to such distribution, including in respect of all or a portion of such distribution that is payable in stock, by withholding or disposing of part of the shares included in such distribution and using the proceeds of such disposition to satisfy the withholding tax imposed. In addition, if a significant number of our stockholders determine to sell our Common Shares in order to pay taxes owed on dividend income, such sale may put downward pressure on the market price of our Common Shares.

 

 

The taxation of distributions to our stockholders can be complex; however, distributions that we make to our stockholders generally will be taxable as ordinary income or constitute a return of capital, which may reduce your anticipated return from an investment in us.

 

Distributions that we make to our taxable stockholders out of current and accumulated earnings and profits (and not designated as capital gain dividends or qualified dividend income) generally will be taxable as ordinary income. For tax years beginning after December 31, 2017, noncorporate stockholders are entitled to a 20% deduction with respect to these ordinary REIT dividends which would, if allowed in full, result in a maximum effective federal income tax rate on them of 29.6% (or 33.4% including the 3.8% surtax on net investment income). However, a portion of our distributions may (1) constitute a return of capital generally to the extent that they exceed our accumulated earnings and profits as determined for U.S. federal income tax purposes, (2) be designated by us as capital gain dividends generally taxable as long-term capital gain to the extent that they are attributable to net capital gain recognized by us, or (3) be designated by us as qualified dividend income, taxable at capital gains rates, generally to the extent they are attributable to dividends we receive from our TRSs. A return of capital is not taxable, but has the effect of reducing the basis of a stockholder’s investment in our Common Shares. Distributions that exceed our current and accumulated earnings and profits and a stockholder’s tax basis in our common stock generally will be taxable as capital gain.

 

Our stockholders may have tax liability on distributions that they elected to reinvest in Common Shares, but they would not receive the cash from such distributions to pay such tax liability.

 

If our stockholders participate in our DRIP, they will be deemed to have received, and for U.S. federal income tax purposes will be taxed on, the amount reinvested in our Common Shares to the extent the amount reinvested was not a tax-free return of capital. In addition, our stockholders will be treated for tax purposes as having received an additional distribution to the extent the Common Shares are purchased at a discount to fair market value. As a result, unless a stockholder is a tax-exempt entity, it may have to use funds from other sources to pay its tax liability on the value of the Common Shares received pursuant to our DRIP.

 

Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.

 

The maximum tax rate applicable to qualified dividend income payable to U.S. Stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, generally are not eligible for this reduced rate. The more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the shares of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our Common Shares. Tax rates could be changed in future legislation.

 

Complying with REIT requirements may limit our ability to hedge our liabilities effectively and may cause us to incur tax liabilities.

 

The REIT provisions of the Code may limit our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets, or in certain cases to hedge previously acquired hedges entered into to manage risks associated with property that has been disposed of or liabilities that have been extinguished if properly identified under applicable Treasury Regulations, does not constitute ‘‘gross income’’ for purposes of the 75% Gross Income Test or 95% Gross Income Test. To the extent that we enter into other types of hedging transactions, the income from those transactions will likely be treated as non-qualifying income for purposes of both of the Gross Income Tests. As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit, except for being carried forward against future taxable income of such TRS.

 

Complying with REIT requirements may force us to forego or liquidate otherwise attractive investment opportunities.

 

To qualify as a REIT, we must ensure that we meet the REIT gross income tests, annually and that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets, including certain mortgage loans and certain kinds of mortgage-related securities. The remainder of our investment in securities (other than securities of one or more TRSs, government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities (other than securities of one or more TRSs, government securities and qualified real estate assets) of any one issuer, no more than 25% of the value of our assets may be securities, excluding government securities, stock issued by our qualified REIT subsidiaries, and other securities that qualify as real estate assets and no more than 20% of the value of our total assets may consist of stock or securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate assets from our portfolio or not make otherwise attractive investments in order to maintain our qualification as a REIT. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

 

 

The ability of our board of directors to revoke our REIT qualification without stockholder approval may subject us to U.S. federal income tax and reduce distributions to our stockholders.

 

Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. While we elected to qualify to be taxed as a REIT, we may terminate our REIT election if we determine that qualifying as a REIT is no longer in the best interests of our stockholders. If we cease to be a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders and on the value

of our Common Shares.

 

We may be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the value of our Common Shares.

 

In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of U.S. federal income tax laws applicable to investments similar to an investment in our Common Shares. Additional changes to the tax laws are likely to continue to occur, and we cannot assure you that any such changes will not adversely affect the taxation of a stockholder. Any such changes could have an adverse effect on an investment in our Common Shares or on the market value or the resale potential of our assets. You are urged to consult with your tax Advisor with respect to the impact of recent legislation on your investment in our Common Shares and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our Common Shares. You also should note that our counsel’s tax opinion is based upon existing law, applicable as of the date of its opinion, all of which will be subject to change, either prospectively or retroactively.

 

Although REITs generally receive better tax treatment than entities taxed as regular corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be treated for U.S. federal income tax purposes as a corporation. As a result, our charter provides our board of directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a regular corporation, without the vote of our stockholders. Our board of directors has fiduciary duties to us and our stockholders and could only cause such changes in our tax treatment if it determines in good faith that such changes are in the best interest of our stockholders.

 

The share ownership restrictions of the Code for REITs and the 9.8% share ownership limit in our charter may inhibit market activity in shares of stock and restrict our business combination opportunities.

 

In order to qualify as a REIT, five or fewer individuals, as defined in the Code, may not own, actually or constructively, more than 50% in value of our issued and outstanding shares of stock at any time during the last half of each taxable year, other than the first year for which a REIT election is made. Attribution rules in the Code determine if any individual or entity actually or constructively owns our shares of stock under this requirement. Additionally, at least 100 persons must beneficially own our shares of stock during at least 335 days of a taxable year for each taxable year, other than the first year for which a REIT election is made. To help insure that we meet these tests, among other purposes, our charter restricts the acquisition and ownership of our shares of stock.

 

Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT while we so qualify. Unless exempted, prospectively or retroactively, by our board of directors, for so long as we qualify as a REIT, our charter prohibits, among other limitations on ownership and transfer of shares of our stock, any person from beneficially or constructively owning (applying certain attribution rules under the Code) more than 9.8% in value of the aggregate of our outstanding shares of stock and more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. Our board of directors may not grant an exemption from these restrictions to any proposed transferee whose ownership in excess of the 9.8% ownership limit would result in the termination of our qualification as a REIT. These restrictions on transferability and ownership will not apply, however, if our board of directors determines that it is no longer in our best interest to continue to qualify as a REIT or that compliance with the restrictions is no longer required in order for us to continue to so qualify as a REIT.

 

These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our Common Shares or otherwise be in the best interest of our stockholders.

 

Non-U.S. Stockholders will be subject to U.S. federal withholding tax and may be subject to U.S. federal income tax on distributions received from us and upon the disposition of our Common Shares.

 

Subject to certain exceptions, distributions received from us will be treated as dividends of ordinary income to the extent of our current or accumulated earnings and profits. Such dividends ordinarily will be subject to U.S. withholding tax at a 30% rate, or such lower rate as may be specified by an applicable income tax treaty, unless the distributions are treated as ‘‘effectively connected’’ with the conduct by the Non-U.S. Stockholder of a U.S. trade or business. Pursuant to Foreign Investment in Real Property Tax Act of 1980, or FIRPTA, capital gain distributions attributable to sales or exchanges of ‘‘U.S. real property interests,’’ or USRPIs, generally will be taxed to a Non-U.S. Stockholder (other than a qualified pension plan, entities wholly owned by a qualified pension plan and certain foreign publicly traded entities) as if such gain were effectively connected with a U.S. trade or business. However, a capital gain dividend will not be treated as effectively connected income if (a) the distribution is received with respect to a class of stock that is regularly traded on an established securities market located in the United States and (b) the Non-U.S. Stockholder does not own more than 10% of the class of our stock at any time during the one-year period ending on the date the distribution is received. We do not anticipate that our Common Shares will be ‘‘regularly traded’’ on an established securities market for the foreseeable future, and therefore, this exception is not expected to apply.

 

 

Gain recognized by a Non-U.S. Stockholder upon the sale or exchange of our Common Shares generally will not be subject to U.S. federal income taxation unless such stock constitutes a USRPI under FIRPTA. The Common Shares will not be treated as a USRPI if less than 50% of our assets throughout a prescribed testing period consist of interests in real property located within the United States, excluding, for this purpose, interests in real property solely in a capacity as a creditor. We do not expect that 50% or more of our assets will consist of interests in real property located in the United States.

 

Even if our Common Shares constitute a USRPI under the foregoing test, our Common Shares will not constitute a USRPI so long as we are a ‘‘domestically-controlled qualified investment entity.’’ A domestically-controlled qualified investment entity includes a REIT if at all times during a specified testing period, less than 50% in value of such REIT’s stock is held directly or indirectly by Non-U.S. Stockholders. We believe, but cannot assure you, that we will be a domestically-controlled qualified investment entity.

 

Furthermore, even if we do not qualify as a domestically-controlled qualified investment entity at the time a Non-U.S. Stockholder sells or exchanges our Common Shares, gain arising from such a sale or exchange would not be subject to U.S. taxation under FIRPTA as a sale of a USRPI if (a) our Common Shares are ‘‘regularly traded,’’ as defined by applicable Treasury regulations, on an established securities market, and (b) such Non-U.S. Stockholder owned, actually and constructively, 10% or less of our Common Shares at any time during the five-year period ending on the date of the sale. However, it is not anticipated that our Common Shares will be ‘‘regularly traded’’ on an established market. We encourage you to consult your tax Advisor to determine the tax consequences applicable to you if you are a Non-U.S. Stockholder.

 

Potential characterization of distributions or gain on sale may be treated as unrelated business taxable income to tax-exempt investors.

 

If (a) we are a ‘‘pension-held REIT,’’ (b) a tax-exempt stockholder has incurred (or deemed to have incurred) debt to purchase or hold our Common Shares, or (c) a holder of Common Shares is a certain type of tax-exempt stockholder, dividends on, and gains recognized on the sale of, Common Shares by such tax-exempt stockholder may be subject to U.S. federal income tax as unrelated business taxable income under the Code.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS:

 

None.

 

ITEM 2. PROPERTIES:

 

Unconsolidated Affiliated Real Estate Entitiy:

 

Multi - Family Residential		Location		Year Built		Leasable Units				Percentage Occupied as of December 31, 2017				Annualized Revenues based on rents at December 31, 2017			Annualized Revenues per unit at December 31, 2017
The Cove  (Multi-Family Complex)		Tiburon, California		1967			281				88	%		$	13.8 million		$	56,009

 

ITEM 3. LEGAL PROCEEDINGS:  

 

From time to time in the ordinary course of business, we may become subject to legal proceedings, claims or disputes.

 

ITEM 4. Mine Safety Disclosures

 

Not applicable.

 

 

PART II.

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES:

 

Shareholder Information

 

As of February 15, 2018, we had approximately 8.8 million shares of common stock outstanding, held by a total of 2,165 stockholders. The number of stockholders is based on the records of DST Systems Inc., which serves as our registrar and transfer agent.

 

Estimated Net Asset Value (“NAV”) and NAV per Share of Common Stock (“NAV per Share”)

 

On February 27, 2018, our board of directors approved our estimated NAV of approximately $64.0 million and resulting estimated NAV per Share of $10.00, both as of December 31, 2017 and after the addition of subordinated advances from our Sponsor. From our inception through the termination of our offering on March 31, 2017, our Sponsor funded an aggregate of approximately $12.6 million of subordinated advances. In the calculation of our estimated NAV, an approximately $0.8 million allocation of value was made to our Sponsor’s subordinated advances representing the amount by which the estimated NAV per Share would have exceeded an aggregate $10.00 price per share plus a cumulative, pre-tax non-compounded annual return of 8.0% as of December 31, 2017. Accordingly, the net portion of the NAV attributable to subordinated advances from our Sponsor was approximately $11.8 million as of December 31, 2017.

 

Process and Methodology

 

Our Advisor, along with any necessary material assistance or confirmation of a third-party valuation expert or service, is responsible for calculating our NAV, which we currently expect will be done on at least an annual basis unless and until our Common Shares are approved for listing on a national securities exchange. Our board of directors will review each estimate of NAV and approve the resulting NAV per Share.

 

Our estimated NAV per Share as of December 31, 2017 was calculated with the assistance of both our Advisor and Marshall & Steven’s Incorporated (“M&S”), an independent third-party valuation firm engaged by us to assist with the valuation of our assets, liabilities and any allocations of value to the Sponsor’s subordinated advances. The Advisor recommended and the board of directors established the estimated NAV per Share as of December 31, 2017 based upon the analyses and reports provided by the Advisor and M&S. The process for estimating the value of our assets, liabilities and allocations of value to our Sponsor’s subordinated advances is performed in accordance with the provisions of the Investment Program Association (the “IPA”) Practice Guideline 2013-01, “Valuations of Publicly Registered Non-Listed REITs,” issued April 29, 2013. We believe that our valuations were developed in a manner reasonably designed to ensure their reliability.

 

The engagement of M&S with respect to our NAV per Share as of December 31, 2017 was approved by our board of directors, including all of our independent directors. M&S has extensive experience in conducting asset valuations, included valuations of commercial real estate, debt, properties and real estate-related investments.

 

With respect to our NAV per Share as of December 31, 2017, M&S prepared appraisal reports (the “M&S Appraisal Reports”) summarizing key inputs and assumptions on our investments in unconsolidated affiliated real estate entities in which we held ownership interests as of December 31, 2017. M&S also prepared a NAV report (the “December 2017 NAV Report”) which estimated the NAV per Share as of December 31, 2017. The December 2017 NAV Report relied upon M&S’s estimated value of our investment in related party, M&S’s Appraisal Reports and the Advisor’s estimate of the value of our cash, due from/(to) related parties, other assets, other liabilities and allocations of value to the Sponsor’s subordinated advances, to calculate estimated NAV per Share, all as of December 31, 2017.

 

The table below sets forth the calculation of our estimated NAV and resulting estimated NAV per Share as of December 31, 2017 compared to December 31, 2016:

 

  

		As of December 31, 2017								As of December 31, 2016
		Value				Per Share				Value				Per Share
Net Assets:
Real Estate Assets:
Investment in related party		$	37,000,000							$	37,000,000
Investments in unconsolidated affiliated real estate entities			39,979,582								-
Total real estate assets			76,979,582			$	8.60				37,000,000			$	5.78
Non-Real Estate Assets:
Cash			14,064,001								21,874,240
Due from related parties			-								28,696
Other assets			8,878								6,093,162
Total non-real estate assets			14,072,879				1.57				27,996,098				4.38
Total Assets			91,052,461				10.17				64,996,098				10.16
Liabilities:
Due to related parties			(54,882	)							-
Other liabilities			(663,001	)							(681,000	)
Subordinated advances - related party			(813,258	)							(345,048	)
Total liabilities			(1,531,141	)			(0.17	)			(1,026,048	)			(0.16	)
Adjusted NAV after giving effect to advances from sponsor under subordinated agreement		$	89,521,320			$	10.00			$	63,970,050			$	10.00
Shares of Common Stock Outstanding			8,952,132								6,397,005
NAV attributable to advances from sponsor under  the subordinated agreement		$	11,818,755			$	1.32			$	12,286,965			$	1.92
NAV without advances from sponsor under the subordinated agreement		$	77,702,565			$	8.68			$	51,683,085			$	8.08

 

 

Use of an Independent Valuation Firm

 

As discussed above, our Advisor is responsible for calculating our NAV. In connection with determining our NAV, our Advisor may rely on the material assistance or confirmation of a third-party valuation expert or service. In this regard, M&S was selected by our board of directors to assist our Advisor in the calculation of our estimated NAV and resulting estimated NAV per Share as of December 31, 2017. M&S services included estimating the fair values of our investment in related party and our investments in unconsolidated affiliated real estate entities and preparing the December 2017 NAV Report. M&S is engaged in the business of appraising commercial real estate properties and is not affiliated with us or the Advisor. The compensation we paid to M&S was based on the scope of work and not on the estimated fair values of our investment in related party and appraised values of our ownership interests in two unconsolidated affiliated real estate entities. The appraisals were performed in accordance with the Code of Ethics and the Uniform Standards of Professional Appraisal Practice, or USPAP, the real estate appraisal industry standards created by The Appraisal Foundation. The M&S Appraisal Reports were reviewed, approved, and signed by an individual with the professional designation of MAI licensed in the state where each real property is located. The use of the reports is subject to the requirements of the Appraisal Institute relating to review by its duly authorized representatives. In preparing its reports, M&S did not, and was not requested to; solicit third-party indications of interest for our common stock in connection with possible purchases thereof or the acquisition of all or any part of us. In preparing its reports, M&S did not, and was not requested to solicit third-party indications of interest for our common stock in connection with possible purchases thereof or the acquisition of all or any part of us.

 

M&S collected reasonably available material information that it deemed relevant in estimating the fair values of our investment in related party and our investments in unconsolidated affiliated real estate entities. M&S relied in part on property-level information provided by our Advisor, including (i) property historical and projected operating revenues and expenses; and/or (ii) information regarding recent or planned capital expenditures.

 

In conducting their investigation and analyses, M&S took into account customary and accepted financial and commercial procedures and considerations as they deemed relevant. Although M&S reviewed information supplied or otherwise made available by us or the Advisor for reasonableness, they assumed and relied upon the accuracy and completeness of all such information and of all information supplied or otherwise made available to them by any other party and did not independently verify any such information. M&S assumed that any operating or financial forecasts and other information and data provided to or otherwise reviewed by or discussed with M&S were reasonably prepared in good faith on bases reflecting the then best currently available estimates and judgments of our management, our board of directors, and/or the Advisor. M&S relied on us to advise them promptly if any information previously provided became inaccurate or was required to be updated during the period of their review.

 

In performing its analyses, M&S made numerous other assumptions as of various points in time with respect to industry performance, general business, economic, and regulatory conditions, and other matters, many of which are beyond their control and our control. M&S also made assumptions with respect to certain factual matters. For example, unless specifically informed to the contrary, M&S assumed that our joint ventures have clear and marketable title to each real estate property appraised, that no title defects exist, that any improvements were made in accordance with law, that no hazardous materials are present or were present previously, that no significant deed restrictions exist, and that no changes to zoning ordinances or regulations governing use, density, or shape are pending or being considered. Furthermore, M&S’s analyses, opinions, and conclusions were necessarily based upon market, economic, financial, and other circumstances and conditions existing as of or prior to the date of the M&S Appraisal Reports, and any material change in such circumstances and conditions may affect M&S’s analyses and conclusions. The M&S Appraisal Reports contain other assumptions, qualifications, and limitations that qualify the analyses, opinions, and conclusions set forth therein. Furthermore, the prices at which the real estate properties may actually be sold could differ from M&S’s analyses.

 

M&S is actively engaged in the business of appraising commercial real estate properties and real estate related-investments similar to those owned or invested by us in connection with public security offerings, private placements, business combinations, and similar transactions. We do not believe that there are any material conflicts of interest between M&S, on the one hand, and us, the Sponsor, the Advisor, and our affiliates, on the other hand. Our Advisor engaged M&S on behalf of our board of directors to deliver their reports to assist in the NAV calculation as of December 31, 2017 and M&S received compensation for those efforts. In addition, we agreed to indemnify M&S against certain liabilities arising out of this engagement. M&S has previously assisted in our prior NAV calculations and has also been engaged by us for certain valuation services with respect to our investments. M&S may from time to time in the future perform other services for us and our Sponsor or other affiliates of the Sponsor, so long as such other services do not adversely affect the independence of M&S as certified in the M&S Appraisal Reports. During the past two years M&S has also been engaged to provide appraisal services to another non-traded REIT sponsored by our Sponsor for which it was paid usual and customary fees.

 

Although M&S considered any comments received from us and the Advisor relating to their reports, the final estimated fair values of our investment in related party and investments in unconsolidated affiliated real estate entities were determined by M&S. The reports were addressed to our board of directors to assist our board of directors in calculating an estimated NAV per Share as of December 31, 2017. The reports were not addressed to the public, may not be relied upon by any other person to establish an estimated NAV per Share, and do not constitute a recommendation to any person to purchase or sell any shares of our common stock.

 

 

Our goal in calculating our estimated NAV is to arrive at values that are reasonable and supportable using what we deem to be appropriate valuation methodologies and assumptions. The reports, including the analysis, opinions, and conclusions set forth in such reports, are qualified by the assumptions, qualifications, and limitations set forth in the respective reports. The following is a summary of our valuation methodologies used to value our assets and liabilities by key component:

 

Investment in Related Party:  As of December 31, 2017, we have made aggregate preferred equity contributions of $37.0 million in various affiliates of our Sponsor which own a parcel of land located at 105-109 W. 28th Street, New York, New York on which they are constructing a 343-room Marriott Moxy hotel, which is currently expected to open during the third quarter of 2018. These contributions were made pursuant to an instrument (the “Preferred Investment”) that entitles us to monthly preferred distributions at a rate of 12% per annum. Our Preferred Investment is classified as a held-to-maturity security and is recorded at cost. As of December 31, 2017, the estimated value of our Preferred Investment of $37.0 million approximated its carrying value based on market rates for similar instruments.

 

Investments in Unconsolidated Affiliated Real Estate Entities: We have ownership interests in two unconsolidated affiliated real estate entities as of December 31, 2017. As of December 31, 2017, we held (i) a 22.5% membership interest in The Cove Joint Venture, an affiliated real estate entity, which owns a 281-unit luxury waterfront multi-family rental property located in Tiburon, California (“The Cove”) and (ii) a 33.3% membership interest in the 40 East End Ave Joint Venture, which owns at parcel of land located, at the corner of 81^st Street and East End Avenue in the Upper East Side neighborhood of New York City on which it is constructing a luxury residential project consisting of 29 condominium units (the “40 East End Project”). We do not consolidate our ownership interests in these joint ventures but rather account for them under the equity method of accounting.

 

As described above, we engaged M&S to provide an appraisal of our investments in unconsolidated affiliated real estate entities, which included the two properties in which we held ownership interests as of December 31, 2017. In preparing the appraisal reports, M&S, among other things:

 

·

performed a site visit of each property in connection with this assignment or other assignments;

·

interviewed our officers or our Advisor’s personnel to obtain information relating to the physical condition of each appraised property, including known environmental conditions, status of ongoing or planned property additions and reconfigurations, and other factors for such leased properties;

·

reviewed lease agreements for those properties subject to a long-term lease and discussed with us or our Advisor certain lease provisions and factors on each property; and

·

reviewed the acquisition criteria and parameters used by real estate investors for properties similar to the subject properties, including a search of real estate data sources and publications concerning real estate buyer’s criteria, discussions with sources deemed appropriate, and a review of transaction data for similar properties.

 

The following summarizes the valuation approach used for The Cove Joint Venture:

 

M&S employed both an income approach and a sales comparison approach to estimate the value of The Cove. For the income approach, M&S used a direct capitalization analysis which was based upon the net operating income of the property capitalized at an appropriate capitalization rate for the property based upon property characteristics and competitive position and market conditions at the date of the appraisal. The sales comparison approach utilized indices of value derived from actual or proposed sales of comparable properties to estimate the value of the subject property. The appraiser analyzed such comparable sales data as was available to develop a market value conclusion for the subject property.

 

M&S prepared an appraisal report for The Cove summarizing key inputs and assumptions, using financial information provided by us and our Advisor. From such review, M&S determined a gross fair value of $255.0 million for The Cove, which equates to a capitalization rate of 3.82% for their direct capitalization analysis and a price per unit of $901,060 for their sales comparison analysis.

 

While we believe that the assumptions made by M&S are reasonable, a change in these assumptions would impact the calculations of the estimated values of The Cove. Assuming all other factors remain unchanged, a 25 basis point increase and decrease in the capitalization rates would result in a total decrease of $15.9 million ($3.6 million for our 22.5% ownership interest) and a total increase of $17.6 million ($4.0 million for our 22.5% ownership interest), respectively, in the value of The Cove as of December 31, 2017.

 

As of December 31, 2017, the estimated fair value of our 22.5% ownership interest in the Cove Joint Venture of approximately $18.6 million was calculated based on the gross appraised value of The Cove of $255.0 million less the fair value of the outstanding mortgage indebtedness of $173.5 million plus all other non-real estate assets, net of $1.2 million. The estimated fair value of our 22.5% ownership interest in the Cove Joint Venture compared to our carrying value of $17.8 million, both as of December 31, 2017, equates to an increase in value of 4.5%.

 

The following summarizes the valuation approach used for The 40 East End Ave. Joint Venture:

 

 

The 40 East End Project was under construction as of December 31, 2017. Accordingly, M&S deemed it appropriate to determine its gross fair value as of December 31, 2017 of $118.5 million based on the fair value of the land parcel of $65.3 million (using a sales comparison approach) plus construction costs incurred of $53.2 million through that date.

 

As of December 31, 2017, the estimated fair value of our 33.3% ownership interest in the 40 East End Ave. Joint Venture of approximately $21.4 million was calculated based on the gross appraised value of The 40 East End Project of $118.5 million less (i) the fair value of the outstanding mortgage indebtedness of $20.8 million, (ii) the preferred member interests of $30.0 million and (iii) all other non-real estate liabilities, net of $3.6 million. The estimated fair value of our 33.3% ownership interest in the 40 East End Ave. Joint Venture compared to our carrying value of $12.9 million, both as of December 31, 2017, equates to an increase in value of 65.5%.

 

Cash:  The estimated value of our cash equals its carrying value.

 

Other Assets: Our other assets consist of deposits, prepaid expenses and other assets, and subscriptions receivable. The estimated values of these items approximate their carrying values due to their short maturities.

 

Due from/(to) Related Parties:  The estimated value of our due from/(to) related parties approximates its carrying value due to its short maturity.

 

Other Liabilities:  Our other liabilities consist of our accounts payable and accrued expenses and distributions payable. The carrying values of these items were considered to equal their fair value due to their short maturities.

 

Subordinated Advances – Related Party: Our subordinated advances from our Sponsor, including related accrued interest of approximately $0.3 million as of December 31, 2017, are classified as a liability on our consolidated balance sheet. However, for purposes of our NAV, we do not estimate their fair value in accordance with GAAP. Rather, the IPA’s Practice Guideline 2013-01provides for adjustments to the NAV for preferred securities, special interests and incentive fees based on the aggregate NAV of the company and payable to the Sponsor in a hypothetical liquidation of the company as of the valuation date in accordance with the provisions of the partnership or Advisory agreements and the terms of the preferred securities. Because our subordinated advances are only payable to our Sponsor in a liquidation event, we believe they should be valued for our NAV in accordance with these provisions.

 

Accordingly, no allocations of value are made to our Sponsor’s advances unless the estimated NAV per Share would have exceeded $10.00 per share plus a cumulative, pre-tax non-compounded annual return of 8.0% as of the indicated valuation date. From our inception through the termination of our offering on March 31, 2017, our Sponsor funded an aggregate of approximately $12.6 million of subordinated advances. In the calculation of our estimated NAV as of December 31, 2017, an approximately $0.8 million allocation of value was made to our Sponsor’s subordinated advances representing the amount by which the estimated NAV per Share would have exceeded an aggregate $10.00 price per share plus a cumulative, pre-tax non-compounded annual return of 8.0% as of December 31, 2017. Accordingly, the net portion of the NAV attributable to subordinated advances from our Sponsor was approximately $11.8 million as of December 31, 2017.

 

Limitations and Risks

 

As with any valuation methodology, the methodology used to determine our estimated NAV and resulting estimated NAV per Share is based upon a number of estimates and assumptions that may prove later not to be accurate or complete. Further, different market participants with different property-specific and general real estate and capital market assumptions, estimates, judgments and standards could derive different estimated NAVs per share, which could be significantly different from the estimated NAV per Share approved by our board of directors. The estimated NAV per Share approved by our board of directors does not represent the fair value of our assets less liabilities in accordance GAAP, and such estimated NAV per Share is not a representation, warranty or guarantee that:

 

•

a stockholder would be able to resell his or her shares of common stock at the estimated NAV per Share;

•

a stockholder would ultimately realize distributions per share of common stock equal to the estimated NAV per Share upon liquidation of our assets and settlement of our liabilities or a sale of the company;

•

our shares of common stock would trade at the estimated NAV per Share on a national securities exchange;

•

an independent third-party appraiser or other third-party valuation firm would agree with the estimated NAV per Share; or

•

the methodology used to estimate our NAV per Share would be acceptable to FINRA or under the Employee Retirement Income Security Act with respect to their respective requirements.

 

The Internal Revenue Service and the Department of Labor do not provide any guidance on the methodology an issuer must use to determine its estimated NAV per Share.

 

FINRA guidance provides that NAV valuations be derived from a methodology that conforms to industry practice.

 

 

As with any valuation methodology, our methodology is based upon a number of estimates and assumptions that may not be accurate or complete. Different parties with different assumptions and estimates could derive different estimated NAVs per share, and these differences could be significant. The estimated NAV per Share is not audited and does not represent the fair value of our assets less our liabilities in accordance with GAAP, nor do they represent an actual liquidation value of our assets and liabilities or the price that shares of our common stock would trade at on a national securities exchange. As of the date of this filing, although we have not sought stockholder approval to adopt a plan of liquidation of the Company, certain distributions may be payable to our Sponsor in connection with a liquidation event. Accordingly, our estimated NAV per Share reflects any allocation of value to the Sponsor’s subordinated advances representing the amount that would be payable to the sponsor in connection with a liquidation event pursuant to the guidelines for estimating NAV contained in IPA Practice Guideline 2013-01, “Valuation of Publicly Registered Non-Listed REITs”. Our estimated NAV per Share is based on the estimated value of our assets less the estimated value of our liabilities less any allocations of value to the Sponsor’s subordinated advances divided by the number of our diluted shares of common stock outstanding, all as of the date indicated. Our estimated NAV per Share does not reflect a discount for the fact we are externally managed, nor does it reflect a real estate portfolio premium/discount versus the sum of the individual property values. Our estimated NAV per Share does not take into account estimated disposition costs or fees or penalties, if any, that may apply upon the prepayment of certain of our debt obligations or the impact of restrictions on the assumption of certain debt. Our NAV per Share will fluctuate over time as a result of, among other things, future acquisitions or dispositions of assets, developments related to individual assets and the management of those assets and changes in the real estate and capital markets. Different parties using different assumptions and estimates could derive different NAVs and resulting estimated NAVs per share, and these differences could be significant. Markets for real estate and real estate-related investments can fluctuate and values are expected to change in the future. We currently expect that our Advisor will estimate our NAV on at least an annual basis. Our board of directors will review and approve each estimate of NAV.

 

The following factors may cause a stockholder not to ultimately realize distributions per share of common stock equal to the estimated NAV per Share upon liquidation:

 

•

The methodology used to determine estimated NAV per Share includes a number of estimates and assumptions that may not prove to be accurate or complete as compared to the actual amounts received in the liquidation;

•

In a liquidation, certain assets may not be liquidated at their estimated values because of transfer fees and disposition fees, which are not reflected in the estimated NAV calculation;

•

In a liquidation, debt obligations may have to be prepaid and the costs of any prepayment penalties may reduce the liquidation amounts. Prepayment penalties are not included in determining the estimated value of liabilities in determining estimated NAV;

•

In a liquidation, the real estate assets may derive a portfolio premium which premium is not considered in determining estimated NAV;

•

In a liquidation, the potential buyers of the assets may use different estimates and assumptions than those used in determining estimated NAV;

•

If the liquidation occurs through a listing of the common stock on a national securities exchange, the capital markets may value the Company’s net assets at a different amount than the estimated NAV. Such valuation would likely be based upon customary REIT valuation methodology including funds from operation, or FFO, multiples of other comparable REITs, FFO coverage of dividends and adjusted FFO payout of the Company’s anticipated dividend; and

•

If the liquidation occurs through a merger of the Company with another REIT, the amount realized for the common stock may not equal the estimated NAV per Share because of many factors including the aggregate consideration received, the make-up of the consideration (e.g., cash, stock or both), the performance of any stock received as part of the consideration during the merger process and thereafter, the reception of the merger in the market and whether the market believes the pricing of the merger was fair to both parties.

 

Share Repurchase Program

 

Our share repurchase program may provide eligible stockholders with limited, interim liquidity by enabling them to sell shares of common stock back to us, subject to restrictions and applicable law. A selling stockholder must be unaffiliated with us, and must have beneficially held the shares of common stock for at least one year prior to offering the shares of common stock for sale to us through the share repurchase program. Subject to the limitations described in the Registration Statement, we will also redeem shares of common stock upon the request of the estate, heir or beneficiary of a deceased stockholder.

 

The prices at which stockholders who have held shares of common stock for the required one-year period may sell shares of common stock back to us are as follows:

 

·

in the case of the death of a stockholder: (a) before we have first disclosed an estimated value per Common Share based on data supported by appraisals of our assets and operations, the price paid to acquire the Common Shares from us; and (b) after we have first disclosed an estimated value per Common Share, our estimated value per Common Share;

 

  

•

the below percentages, except for in the case of the death of a stockholder: (a) before we have first disclosed an estimated value per Common Share based on data supported by appraisals of our assets and operations, the price paid to acquire the Common Shares from us; and (b) after we have first disclosed an estimated value per Common Share, our estimated value per Common Share:

 

•

92.5% for stockholders who have continuously held their Common Shares for at least one year;

 

•

95% for stockholders who have continuously held their Common Shares for at least two years;

 

•

97.5% for stockholders who have continuously held their Common Shares for at least three years; and

 

•

100% for stockholders who have continuously held their Common Shares for at least four years.

 

Pursuant to the terms of our share repurchase program, we will make repurchases, if requested, at least once quarterly provided repurchases do not impair our capital or operations, as discussed further below. Each stockholder whose repurchase request is granted will receive the repurchase amount 30 days after the fiscal quarter in which we grant his, her or its repurchase request. Subject to the limitations described in the Registration Statement, we will also repurchase Common Shares upon the request of the estate, heir or beneficiary of a deceased stockholder. We will limit the number of Common Shares repurchased pursuant to our share repurchase program as follows: during any 12-month period, we will not repurchase in excess of 5.0% of the weighted average number of Common Shares outstanding during the prior calendar year; provided, however, that Common Shares repurchased in the case of the death of a stockholder will not count against this 5.0% limit.

 

Our Board of Directors, in its sole discretion, may choose at any time to terminate our share repurchase program, or reduce or increase the number of Common Shares purchased under the program, if it determines that the funds allocated to our share repurchase program are needed for other purposes, such as the acquisition, maintenance or repair of properties, or for use in making a declared distribution. A determination by our board of directors to eliminate, reduce or increase our share repurchase program will require the affirmative vote of our independent directors. From our date of inception through December 31, 2015, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the year ended December 31, 2016 we repurchased 18,798 shares of common stock, pursuant to our share repurchase program at an average price per share of $9.75 per share. For the year ended December 31, 2017 we repurchased 20,236 shares of common stock, pursuant to our share repurchase program at an average price per share of $9.71 per share. We funded share repurchases for the periods noted above from the cumulative proceeds of the sale of our shares pursuant to our DRIP, which is now terminated.

 

Distributions

 

U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with GAAP) determined without regard to the deduction for dividends paid and excluding any net capital gain. In order to qualify or continue to qualify for REIT status, we may be required to make distributions in excess of cash available.

 

Distributions are authorized at the discretion of our Board of Directors based on their analysis of our performance over the previous periods and expectations of performance for future periods. Such analyses may include actual and anticipated operating cash flow, capital expenditure needs, general financial and market conditions, proceeds from asset sales and redemptions and other factors that our board of directors deem relevant. Our Board of Directors’ decisions will be substantially influenced by their obligation to ensure that we maintain our federal tax status as a REIT. We have and may continue to fund distributions with cash proceeds from the sale of shares of our common stock to fund distributions. We may continue to fund such distributions with cash proceeds from the sale of shares of our common stock or borrowings if we do not generate sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the size of these distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.

 

We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, but only to the extent of a shareholder’s adjusted tax basis in our shares, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.

 

Distributions Declared by our Board of Directors and Source of Distributions

 

On October 28, 2015, our Board of Directors authorized and we declared a distribution rate which is calculated based on stockholders of record each day during the applicable period at a rate of $0.002191781 per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 8.0% annualized rate based on a share price of $10.00. Our first distribution began to accrue on June 12, 2015 (date of breaking escrow) through November 30, 2015 (the end of the month following our initial real estate-related investment) and subsequent distributions have been on a monthly basis thereafter. The first distribution was paid on December 15, 2015 and subsequent distributions have been paid on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month.

 

Total distributions declared during the year ended December 31, 3017 and 2016 were $6.8 million and $2.3 million.

 

 

The following tables provide a summary of the quarterly distributions declared during the periods indicated:

 

		Year Ended December 31, 2017								Three Months Ended December 31, 2017								Three Months Ended September 30, 2017								Three Months Ended June 30, 2017								Three Months Ended March 31, 2017
Distribution period:		2017 Year				Percentage of Distributions				Q4 2017				Percentage of Distributions				Q3 2017				Percentage of Distributions				Q2 2017				Percentage of Distributions				Q1 2017				Percentage of Distributions
Date distribution declared																			May 12, 2017								March 27, 2017								November 14, 2016
Date distribution paid											November 15, 2017 December 15, 2017 January 16, 2018								August 15, 2017,  September 15, 2017, & October 16, 2017								May 15, 2017, June 15, 2017, & July 14, 2017								February 15, 2017, March 15, 2017, & April 14, 2017
Distribution paid		$	6,331,676							$	1,801,112							$	1,801,111							$	1,782,830							$	946,623
Distribution reinvested			513,325								-								-								98								513,227
Total Distributions		$	6,845,001							$	1,801,112							$	1,801,111							$	1,782,928							$	1,459,850
											.
Source of distributions:
Cash flows provided by operations		$	3,633,549				53	%		$	858,194				48	%		$	853,784				47	%		$	725,412				41	%		$	946,623				65	%
Offering proceeds			2,698,127				39	%			942,918				52	%			947,327				53	%			1,057,418				59	%			-				-
Proceeds from issuance of common stock through DRIP			513,325				8	%			-				-				-				-				98				-				513,227				35	%
Total Sources		$	6,845,001				100	%		$	1,801,112				100	%		$	1,801,111				100	%		$	1,782,928				100	%		$	1,459,850				100	%
Cash flows provided by operations (GAAP  basis)		$	3,633,549							$	858,194							$	853,784							$	725,412							$	1,196,159
Number of shares of common stock issued pursuant to the Company's DRIP			54,034								-								-								10								54,024

 

		Year Ended December 31, 2016								Three Months Ended December 31, 2016								Three Months Ended September 30, 2016								Three Months Ended June 30, 2016								Three Months Ended March 31, 2016
Distribution period:						Percentage of Distributions				Q4 2016				Percentage of Distributions				Q3 2016				Percentage of Distributions				Q2 2016				Percentage of Distributions				Q1 2016				Percentage of Distributions
Date distribution declared											November 14, 2016								August 5, 2016								May 12, 2016								March 27, 2016
Date distribution paid											November 15, 2016, December 15, 2016, & January 13, 2017								August 15, 2016, September 15, 2016, & October 14, 2016								May 14, 2016, June 15, 2016, & July 15, 2016								February 16, 2016, March 15, 2016, & April 15, 2016
Distributions paid		$	1,623,131							$	733,484							$	507,217							$	250,216								132,214
Distributions reinvested			683,136								378,047								241,022								27,019								37,048
Total Distributions		$	2,306,267							$	1,111,531							$	748,239							$	277,235							$	169,262
Source of distributions:
Cash flows provided by operations		$	1,433,377				62	%		$	576,436				52	%		$	507,217				68	%		$	250,216				90	%		$	65,948				39	%
Offering proceeds		$	189,754				8	%			157,048				14	%			-				-				-				-				66,266				39	%
Proceeds from issuance of common stock through DRIP			683,136				30	%			378,047				34	%			241,022				32	%			27,019				10	%			37,048				22	%
Total Sources		$	2,306,267				100	%		$	1,111,531				100	%		$	748,239				100	%		$	277,235				100	%		$	169,262				100	%
Cash flows provided by operations (GAAP basis)		$	1,433,377							$	576,436							$	515,675							$	275,318							$	65,948
Number of shares of common stock issued pursuant to the Company's DRIP		$	72,178								39,794								25,371								3,113								3,900

 

 

 

Use of Public Offering Proceeds

 

Our registration statement on Form S-11 (the “Offering”), pursuant to which we offered to sell up to 30,000,000 shares of our common stock, par value $0.01 per share (which may be referred to herein as ‘‘shares of common stock’’ or as ‘‘Common Shares’’) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10,000,000 shares available pursuant to our distribution reinvestment plan (the “DRIP”) at an initial purchase price of $9.50 per share) was declared effective by the Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933 on February 26, 2015. On June 30, 2016, the Company adjusted its offering price to $9.14 per Common Share in its Primary Offering, which was equal to the Company’s estimated net asset value (“NAV”) per Common Share as of March 31, 2016, and effective July 25, 2016, the Company’s offering price was adjusted to $10.00 per Common Share in its Primary Offering, which was equal to the estimated NAV per Common Share as of June 30, 2016. Our estimated NAV per Common Share remained unchanged at $10.00 as of both September 30, 2016 and December 31, 2016.

 

The Offering, which terminated on March 31, 2017, raised aggregate gross proceeds of approximately $85.6 million from the sale of approximately 8.9 million shares of common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein, who also owns a majority interest in the Company’s Sponsor). After including aggregate advances from our Sponsor of $12.6 million under the Subordinated Agreement (as discussed below) and allowing for the payment of approximately $7.6 million in selling commissions and dealer manager fees and $3.2 million in organization and offering expenses, the Offering generated aggregate net proceeds of approximately $87.5 million.  In addition, the Company had issued approximately 0.1 million shares of common stock under its DRIP, representing approximately $1.2 million of additional proceeds under the Offering. The DRIP was terminated effective May 15, 2017.

 

On March 18, 2016, the Company and its Sponsor entered into a subordinated unsecured loan agreement (the “Subordinated Agreement”) pursuant to which the Sponsor committed to make a significant investment in the Company of up to $36.0 million, which was equivalent to 12.0% of the $300.0 million maximum offering amount of Common Shares under the Offering, which was terminated on March 31, 2017.  

  

In connection with the termination of the Offering, on March 31, 2017, the Company and the Sponsor terminated the Subordinated Agreement. As a result of the termination, the Sponsor is no longer obligated to make any additional Subordinated Advances to the Company. Interest will continue to accrue on the aggregate outstanding Subordinated Advances and repayment, if any, of the Subordinated Advances and accrued interest will be made according to the terms of the Subordinated Agreement disclosed above.

 

As of both December 31, 2017 and 2016 an aggregate of approximately $12.6 million of Subordinated Advances had been funded, which along with the related accrued interest of $258,817 and $71,863, respectively, are classified as a liability on the consolidated balance sheet. During the years ended December 31, 2017 and 2016, the Company accrued $186,954 and $71,863, respectively, of interest on the Subordinated Advances.

 

Below is a summary of the expenses we have incurred in connection with the issuance and distribution of the registered securities since inception:

 

Type of Expense Amount
Selling commissions and dealer manager fees		$	7,557,885
Other expenses incurred			3,180,431
Total  offering costs incurred from inception through December 31, 2017		$	10,738,316

 

Cumulatively, we have used our net offering proceeds of $87.5 million (including aggregate advances from our Sponsor of $12.6 million under the Subordinated Agreement), after deduction of offering expenses paid since inception of $10.7 million, as follows:

 

Cash		$	12,368,123
Cash distributions not funded by operations			3,335,783
Investment in related party			37,000,000
Investments in unconsolidated affiated real estate entities			33,531,466
Other uses  (primarily timing of payables)			1,234,052
Total uses		$	87,469,424

 

 

ITEM 6. SELECTED FINANCIAL DATA:

 

The following selected financial data are qualified by reference to and should be read in conjunction with our consolidated financial statements and Notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.

 

Lightstone Real Estate Income Trust Inc.

Selected Financial Data

 

														For the Period
														September 9,
														2014
		For the Year				For the Year				For the Year				(date of inception)
		Ended				Ended				Ended				through
		December 31,				December 31,				December 31,				December 31,
		2017				2016				2015				2014
Operating Data:
Investment income		$	4,501,667			$	1,928,708			$	49,333			$	-
Loss from investment in unconsolidated affiliated real estate entity		$	(2,813,825	)		$	-			$	-			$	-
Net income/(loss)		$	419,506			$	1,537,999			$	(113,824	)		$	-
Basic and diluted net income/(loss) per Company's common share		$	0.05			$	0.53			$	(0.45	)		$	-
Dividends declared on Company's common shares		$	6,845,001			$	2,306,267			$	187,053			$	-
Weighted average common shares outstanding-basic and diluted			8,577,336				2,894,887				251,901				6,082
Balance Sheet Data:
Total assets		$	81,790,520			$	64,721,649			$	5,213,448			$	200,000
Subordinated advances - related party		$	12,890,830			$	12,703,876			$	-			$	-
Company's Stockholder's Equity		$	68,181,807			$	51,336,772			$	4,130,737			$	200,000
Other financial data:
Funds from operations (FFO) attributable to Company's common shares		$	3,045,409			$	1,537,999			$	(113,824	)		$	-

 

1.

For more information about FFO and MFFO, including a reconciliation to our GAAP net income/(loss) for each period reported, please see Management’s Discussion and Analysis of Financial Condition and Results of Operations - “Funds from Operations and Modified Funds from Operations.”

 

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:

 

You should read the following discussion and analysis together with our consolidated financial statements and notes thereto included in this Annual Report on Form 10-K. The following information contains forward-looking statements, which are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize, actual results may differ materially from those expressed or implied by the forward-looking statements. Please see “Special Note Regarding Forward-Looking Statements” above for a description of these risks and uncertainties.  

 

Overview

 

Lightstone Real Estate Income Trust Inc. (the “Lightstone Income Trust” or “Company”) has and primarily intends to continue to originate, acquire and manage a diverse portfolio of real estate-related investments. The Company has and may continue invest in mezzanine loans, first lien mortgage loans, second lien mortgage loans, bridge loans and/or preferred equity interests, in each case with a focus on investments intended to finance development or redevelopment opportunities. The Company may also invest in debt and derivative securities related to real estate assets. A majority of the Company’s investments by value are or will be secured by or related to properties or entities advised by, or wholly or partially, directly or indirectly owned by, the Sponsor, by its affiliates or by real estate investment programs sponsored by it.

 

Our registration statement on Form S-11 (the “Offering”), pursuant to which we offered to sell up to 30,000,000 shares of our common stock, par value $0.01 per share (which may be referred to herein as ‘‘shares of common stock’’ or as ‘‘Common Shares’’) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10,000,000 shares available pursuant to its distribution reinvestment plan (the “DRIP”) at an initial purchase price of $9.50 per share) was declared effective by the Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933 on February 26, 2015. On June 30, 2016, the Company adjusted its offering price to $9.14 per Common Share in its Primary Offering, which was equal to the Company’s estimated net asset value (“NAV”) per Common Share as of March 31, 2016, and effective July 25, 2016, the Company’s offering price was adjusted to $10.00 per Common Share in its Primary Offering, which was equal to the estimated NAV per Common Share as of June 30, 2016. Our estimated NAV per Common Share remained unchanged at $10.00 as of both September 30, 2016 and December 31, 2016.

 

The Offering, which terminated on March 31, 2017, raised aggregate gross proceeds of approximately $85.6 million from the sale of approximately 8.9 million shares of common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein, who also owns a majority interest in the Company’s Sponsor). After including aggregate advances from our Sponsor of $12.6 million under the Subordinated Agreement (as discussed below) and allowing for the payment of approximately $7.6 million in selling commissions and dealer manager fees and $3.2 million in organization and offering expenses, the Offering generated aggregate net proceeds of approximately $87.5 million.  In addition, the Company had issued approximately 0.1 million shares of common stock under its DRIP, representing approximately $1.2 million of additional proceeds under the Offering. The DRIP was terminated effective May 15, 2017.

 

 

On March 18, 2016, the Company and its Sponsor entered into a subordinated unsecured loan agreement (the “Subordinated Agreement”) pursuant to which the Sponsor committed to make a significant investment in the Company of up to $36.0 million, which is equivalent to 12.0% of the $300.0 million maximum offering amount of Common Shares under the Offering, which was terminated on March 31, 2017.  The outstanding advance under the Subordinated Agreement (the “Subordinated Advances”) accrue interest at a of 1.48%, but not interest or outstanding advances are due or payable to the Sponsor until holders of the Company’s Common Shares have received liquidation distributions equal to their respective net investments (defined as $10.00 per Common Share) plus a cumulative, pre-tax, non-compounded annual rate of 8% on their respective net investments.

  

Distributions in connection with a liquidation of the Company initially will be made to holders of its Common Shares until holders of its Common Shares have received liquidation distributions equal to their respective net investments plus a cumulative, pre-tax, non-compounded annual return of 8.0% on their respective net investments. Thereafter, only if additional liquidating distributions are available, the Company will be obligated to repay the outstanding advances under the Subordinated Agreement and accrued interest to the Sponsor, pursuant to the terms of the Subordinated Agreement. In the event that additional liquidation distributions are available after the Company repays its holders of common stock their respective net investments plus their 8% return on investment and then the outstanding advances under the Subordinated Agreement and accrued interest to its Sponsor, such additional distributions will be paid to holders of its Common Shares and its Sponsor: 85.0% of the aggregate amount will be payable to holders of the Company’s Common Shares and the remaining 15.0% will be payable to the Sponsor.

 

The Subordinated Advances and its related interest are subordinate to all of the Company’s obligations as well as to the holders of its Common Shares in an amount equal to the shareholder’s net investment plus a cumulative, pre-tax, non-compounded annual return of 8.0% and only potentially payable in the event of a liquidation of the Company.

 

In connection with the termination of the Offering, on March 31, 2017, the Company and the Sponsor terminated the Subordinated Agreement. As a result of the termination, the Sponsor is no longer obligated to make any additional Subordinated Advances to the Company. Interest will continue to accrue on the aggregate outstanding Subordinated Advances and repayment, if any, of the Subordinated Advances and accrued interest will be made according to the terms of the Subordinated Agreement disclosed above.

 

As of both December 31, 2017 and 2016 an aggregate of approximately $12.6 million of Subordinated Advances had been funded, which along with the related accrued interest of $258,817 and $71,863, respectively, are classified as a liability on the consolidated balance sheet. During the years ended December 31, 2017 and 2016, the Company accrued $186,954 and $71,863, respectively, of interest on the Subordinated Advances.

 

We do not have employees. We entered into an advisory agreement with Lightstone Real Estate Income LLC, a Delaware limited liability company, which we refer to as the “Advisor,” pursuant to which the Advisor supervises and manages our day-to-day operations and selects our real estate and real estate related investments, subject to oversight by our Board of Directors. We pay the Advisor fees for services related to the investment and management of our assets, and we will reimburse the Advisor for certain expenses incurred on our behalf.

 

To qualify and maintain our qualification as a REIT, we engage in certain activities through a wholly-owned taxable REIT subsidiary (“TRS”). As such, we are subject to U.S. federal and state income and franchise taxes from these activities.

 

Acquisitions and Investment Strategy

 

We were formed to primarily originate, acquire and manage a diverse portfolio of real estate-related investments such as mezzanine loans, first lien mortgage loans, second lien mortgage loans, bridge loans and preferred equity interests, in each case with a focus on investments intended to finance development or redevelopment opportunities some of which have been and may be with related parties. We may also invest in debt and derivative securities related to real estate assets, such as CMBS; CDOs; debt securities issued by real estate companies; and credit default swaps. We have and expect to continue to focus our origination and acquisition activity on real estate-related investments secured by or related to properties located in the United States, and primarily related-party investments. We sometimes refer to the foregoing types of investments as our targeted investments. We expect to target investments that generally will offer predictable current cash flow and attractive risk-adjusted returns based on the underwriting criteria established and employed by our Advisor, which may include the anticipated leverage point, market and economic conditions, the location and quality of the underlying collateral and the borrower’s exit or refinancing plan. Our ability to execute our investment strategy is enhanced through access to our Sponsor’s extensive experience in financing real estate projects it has sponsored, as opposed to a strategy that relies solely on buying assets in the open market from third-party originators. We have and will continue to seek to build a portfolio that includes some of or all the following investment characteristics: (a) provides current income; (b) is secured by high-quality commercial real estate; (c) includes subordinate capital investments by strong sponsors that support our investments and provide downside protection; and (d) possesses strong structural features that maximize repayment potential, such as a clear exit or refinancing plan by the borrower.

 

 

We have and intend to continue to invest in real estate-related loans and debt securities both by directly originating them and by purchasing them from third-party sellers. Although we generally prefer the benefits of direct origination, situations may arise to purchase real estate-related loans and debt securities, possibly at discounts to par, which compensate for the lack of control or structural enhancements typically associated with directly structured investments. Although we expect that most of our investments will be of these types, we may make other investments. In fact, we may invest in whatever types of real estate-related investments that we believe are in our best interests.

 

Investments

 

Through December 31, 2017, we have made the following three real estate and real estate-related investments:

 

105-109 W. 28^th Street Preferred Investment 

 

On November 25, 2015, we entered into an agreement (the “Moxy Transaction”) with various related party entities that initially provided for us to make aggregate preferred equity contributions (the “105-109 W. 28^th Street Preferred Investment”) of up to $20.0 million in various affiliates of our Sponsor (the “Moxy Developer”), which owns a parcel of land located at 105-109 W. 28^thStreet, New York, New York, on which they are constructing a 343-room Marriott Moxy hotel, which is currently expected to open during the third quarter of 2018. The 105-109 W. 28^th Street Preferred Investment was made pursuant to an instrument that entitles us to monthly preferred distributions at a rate of 12% per annum and we could redeem on the earlier of (i) the date that was two years from the date of our final contribution or (ii) the third anniversary of 105-109 W. 28^th Street Preferred Investment. We could also have requested redemption or a restructuring of the agreement prior to the acceptance of any construction financing. On June 30, 2016, we and the Developer amended the Moxy Transaction so that our contributions would become redeemable on the fifth anniversary of the Moxy Transaction. The 105-109 W. 28^th Street Preferred Investment is classified as a held-to-maturity security and recorded at cost.

 

On August 30, 2016, we and the Developer further amended the Moxy Transaction so that our total aggregate contributions under the 105-109 W. 28^th Street Preferred Investment increased by $17.0 million, or up to $37.0 million.

 

We made an initial contribution of $4.0 million during the fourth quarter of 2015 and additional aggregate contributions of $33.0 million during the year ended December 31, 2016. As of both December 31, 2017 and 2016, the 105-109 W. 28^th Street Preferred Investment had an outstanding balance of $37.0 million, which is classified in investment in related party on the consolidated balance sheets. We funded our contributions using proceeds generated from our Offering and draws under the Subordinated Agreement. During the years ended December 31, 2017 and 2016, we recorded $4.5 million and $1.9 million, respectively, of investment income related to the 105-109 W. 28^th Street Preferred Investment. Our Advisor elected to waive the acquisition fee associated with this transaction.​

 

The Cove Joint Venture

 

On September 29, 2016, we, through our wholly owned subsidiary, REIT Cove LLC (“REIT Cove”) along with LSG Cove LLC (“LSG Cove”), an affiliate of our Sponsor and a related party, and Maximus Cove Investor LLC (“Maximus”), an unrelated third party (collectively, the “Buyer”), entered into an agreement of sale and purchase (the “Cove Transaction”) with an unrelated third party, RP Cove, L.L.C (the “Seller”), pursuant to which the Buyer would acquire the Seller’s membership interest in RP Maximus Cove, L.L.C. (the “Cove Joint Venture”) for approximately $255.0 million. The Cove Joint Venture owns and operates The Cove at Tiburon (“The Cove”), a 281-unit, luxury waterfront multifamily rental property located in Tiburon, California. Prior to entering into the Cove Transaction, Maximus previously owned a separate noncontrolling interest in the Cove Joint Venture.

 

On January 31, 2017, REIT Cove entered into an Assignment and Assumption Agreement (the “Assignment”) with another one of our wholly owned subsidiaries, REIT IV COVE LLC (“REIT IV Cove”) and REIT III COVE LLC (“REIT III Cove”), a subsidiary of the operating partnership of Lightstone Value Plus Real Estate Investment Trust III, Inc., a real estate investment trust also sponsored by our Sponsor and a related party, and together with REIT IV Cove, collectively, the “Assignees”. Under the terms of the Assignment, the Assignees were assigned the rights and obligations of REIT Cove with respect to the Cove Transaction.

  

On January 31, 2017, REIT IV Cove, REIT III Cove, LSG Cove, and Maximus (the “Members”) completed the Cove Transaction for aggregate consideration of approximately $255.0 million, which consisted of $80 million of cash and $175 million of proceeds from a loan from a financial institution. We paid approximately $20.0 million for a 22.5% membership interest in the Cove Joint Venture.

 

Our ownership interest in the Cove Joint Venture is a non-managing interest. We have determined that the Cove Joint Venture is a variable interest entity (“VIE”) and, because we exert significant influence over but do not control the Cove Joint Venture, we account for our ownership interest in the Cove Joint Venture in accordance with the equity method of accounting. All distributions of earnings from the Joint Venture are made on a pro rata basis in proportion to each Member’s equity interest percentage. Any distributions in excess of earnings from the Joint Venture are made to the Members pursuant to the terms of the Cove Joint Venture’s operating agreement. An affiliate of Maximus is the asset manager of The Cove and receives certain fees as defined in the Property Management Agreement for the management of The Cove. We commenced recording our allocated portion of profit and cash distributions beginning as of January 31, 2017 with respect to our membership interest of 22.5% in the Cove Joint Venture. 

 

 

In connection with the closing of the Cove Transaction, the Cove Joint Venture simultaneously entered into a $175.0 million loan (the “Loan”) initially scheduled to mature on January 31, 2020 with two, one-year extension options, subject to certain conditions. The Loan requires monthly interest payments through its maturity date.  The Loan bears interest at Libor plus 3.85% through its initial maturity and Libor plus 4.15% during each of the extension periods. The Loan is collateralized by The Cove and an affiliate of our Sponsor (the “Guarantor”) has guaranteed the Cove Joint Venture‘s obligation to pay the outstanding balance of the Loan up to approximately $43.8 million (the “Loan Guarantee”). The Members have agreed to reimburse the Guarantor for any balance that may become due under the Loan Guarantee, of which our share is up to approximately $10.9 million.

 

The Cove is a multi-family complex consisting of 281-units, or 289,690 square feet, contained within 32 apartment buildings over 20.1 acres originally constructed in 1967.

 

Starting in 2013, The Cove has been undergoing an extensive refurbishment which is substantially complete. The Members have and intend to continue to use the remaining proceeds from the Loan and to invest additional capital if necessary to complete the remainder of the refurbishment. The Guarantor has provided an additional guarantee of up to approximately $13.4 million (the “Refurbishment Guarantee”) to provide any necessary funds to complete the remaining renovations as defined in the Loan. The Members have agreed to reimburse the Guarantor for any balance that may become due under the Refurbishment Guarantee, of which our share is up to approximately $3.3 million.

 

40 East End Ave. Joint Venture

 

On March 31, 2017, we entered into a joint venture agreement (the “40 East End Ave. Transaction”) with SAYT Master Holdco LLC, an entity majority-owned and controlled by David Lichtenstein, who also majority owns and controls our Sponsor, and a related party, (the “Seller”), pursuant to which we acquired 33.3% of the Seller’s approximate 100% membership interest in 40 East End Ave. Pref Member LLC ( “40 East End Ave. Joint Venture”) for aggregate consideration of approximately $10.3 million. We subsequently made additional capital contributions aggregating $2.6 million to the 40 East End Ave. Joint Venture during 2017.

 

In accordance with our charter, a majority of our Board of Directors, including a majority of the our independent directors not otherwise interested in the transaction, approved the 40 East End Ave. Transaction as fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.

 

Our ownership interest in the 40 East End Ave. Joint Venture is a non-managing interest. Because we exert significant influence over but do not control the 40 East End Ave. Joint Venture, we account for our ownership interest in the 40 East End Ave. Joint Venture in accordance with the equity method of accounting. All contributions to and distributions of earnings from the 40 East End Ave. Joint Venture are made on a pro rata basis in proportion to each Member’s equity interest percentage. Any distributions in excess of earnings from the 40 East End Ave. Joint Venture are made to the Members pursuant to the terms of its operating agreement. We commenced recording our allocated portion of earnings and cash distributions from the 40 East End Ave. Joint Venture beginning as of March 31, 2017 with respect to our membership interest of approximately 33.3% in the 40 East End Ave. Joint Venture. Additionally, Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”), a real estate investment trust also sponsored by our Sponsor, has made $30.0 million of contributions to a subsidiary of the 40 East End Ave. Joint Venture, pursuant to an instrument that entitles Lightstone I to monthly preferred distributions at a rate of 12% per annum.

 

The 40 East End Ave. Joint Venture, through affiliates, owns a parcel of land located at the corner of 81^st Street and East End Avenue in the Upper East Side neighborhood of New York City on which it is constructing a luxury residential project consisting of 29 condominium units (the “40 East End Project”). As of and for the year ended December 31, 2017, the 40 East End Project was still under development, therefore, the 40 East End Ave. Joint Venture had no results of operations. 

 

 Current Environment

 

Our operating results as well as our investment opportunities are impacted by the health of the North American economies.  Our business and financial performance may be adversely affected by current and future economic conditions, such as availability of credit, financial markets volatility, and recession.

 

Our business may be affected by market and economic challenges experienced by the U.S. and global economies. These conditions may materially affect the value and performance of our properties, and may affect our ability to pay distributions, the availability or the terms of financing that we have or may anticipate utilizing, and our ability to make principal and interest payments on, or refinance, any outstanding debt when due.

 

We are not aware of any other material trends or uncertainties, favorable or unfavorable, other than national economic conditions affecting real estate generally, that may be reasonably anticipated to have a material impact on either capital resources or the revenues or income to be derived from the acquisition and operation of real estate and real estate related investments, other than those referred to in this Form 10-K.

 

 

Critical Accounting Estimates and Policies

 

General.

 

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of our consolidated financial statements requires us to make estimates and judgments about the effects of matters or future events that are inherently uncertain. These estimates and judgments may affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

 

On an ongoing basis, we evaluate our estimates, including contingencies and litigation. We base these estimates on historical experience and on various other assumptions that we believe to be reasonable in the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

To assist in understanding our results of operations and financial position, we have identified our critical accounting policies and discussed them below. These accounting policies are most important to the portrayal of our results and financial position, either because of the significance of the financial statement items to which they relate or because they require management's most difficult, subjective or complex judgments.  

 

Real Estate-Related Debt Investments in General

 

Our real estate-related debt investments generally are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan fees, origination fees, premium, discount and unfunded commitments. Real estate-related debt investments that are deemed to be impaired are carried at amortized cost less a loan loss reserve, if deemed appropriate, which approximates fair value. Real estate-related debt investments that we do not intend to hold for the foreseeable future or until their expected payoff are classified as available for sale and recorded at the lower of cost or fair value.

 

Revenue Recognition

 

Real Estate-Related Debt Investments

 

Interest income is recognized on an accrual basis and any related premium, discount, origination costs and fees is amortized over the life of the investment using the effective interest method. The amortization is reflected as an adjustment to interest income in our consolidated statements of operations. The amortization of a premium or accretion of a discount is discontinued if such debt investment is reclassified to held for sale.

 

Credit Losses and Impairment on Investments

 

Real Estate-Related Debt Investments

 

Real estate-related debt investments will be considered impaired when, based on current information and events, it is probable that we will not be able to collect principal and interest amounts due according to the contractual terms. We will assess the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis, or more frequently as necessary. Significant judgment of management will be required in this analysis. We will consider the estimated net recoverable value of the debt investment as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the quality and financial condition of the borrower and the competitive situation of the area where the underlying collateral is located. Because this determination will be based on projections of future economic events, which are inherently subjective, the amount ultimately realized may differ materially from the carrying value as of the balance sheet date. If upon completion of the assessment, the estimated fair value of the underlying collateral is less than the net carrying value of the debt investment, a loan loss reserve will be recorded with a corresponding charge to provision for loan losses. The loan loss reserve for each debt investment will be maintained at a level that is determined to be adequate by management to absorb probable losses.

 

Income recognition will be suspended for a debt investment at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. When the ultimate collectability of the principal of an impaired debt investment is in doubt, all payments will be applied to principal under the cost recovery method. When the ultimate collectability of the principal of an impaired debt investment is not in doubt, contractual interest will be recorded as interest income when received, under the cash basis method, until an accrual is resumed when the debt investment becomes contractually current and performance is demonstrated to be resumed. A debt investment will be written off when it is no longer realizable or is legally discharged.

  

 

Investments in Unconsolidated Entities

 

We evaluate our investments in other entities for consolidation. We consider the percentage interest in the joint venture, evaluation of control and whether a variable interest entity exists when determining if the investment qualifies for consolidation.

 

Under the equity method, an investment is recorded initially at cost, and subsequently adjusted for equity in net income (loss) and cash contributions and distributions. The net income or loss of each investor is allocated in accordance with the provisions of the operating agreement of the entity. The allocation provisions in these agreements may differ from the ownership interest held by each investor. Differences between the carrying amount of our investment in the respective joint venture and our share of the underlying equity of such unconsolidated entity are amortized over the respective lives of the underlying assets as applicable. These items are reported as a single line item in the consolidated statements of operations as income or loss from investments in unconsolidated affiliated entities. Under the cost method of accounting, an investment is recorded initially at cost, and subsequently adjusted for cash contributions and distributions resulting from any capital events. Dividends earned from the underlying entity are recorded as interest income.

 

On a quarterly basis, we assess whether the value of our investments in unconsolidated entities has been impaired. An investment is impaired only if management’s estimate of the fair value of the investment is less than the carrying value of the investment, and such decline in value is deemed to be other than temporary. The ultimate realization of our investment in partially owned entities is dependent on a number of factors including the performance of that entity and market conditions. If we determine that a decline in the value of a partially owned entity is other than temporary, we will record an impairment charge.

 

Accounting for Organization and Other Offering Costs

 

We record selling commissions and dealer manager fees paid to our dealer manager, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs and professional fees, as a reduction against additional paid-in capital. Any organization costs are expensed to general and administrative costs.

 

Treatment of Management Compensation and Expense Reimbursements

 

Management of our operations is outsourced to our Advisor and certain other affiliates of our Sponsor. Fees related to each of these services are accounted for based on the nature of such service and the relevant accounting literature. Fees for services performed that represent our period costs are expensed as incurred. Such fees include acquisition fees associated with the purchase of interests in real estate entities; and asset management fees paid to our Advisor. These fees are expensed or capitalized to the basis of acquired assets, as appropriate.

 

Expense reimbursements made to our Advisor are expensed or capitalized to the basis of acquired assets, as appropriate. 

 

Income Taxes

 

We elected to be taxed as a REIT in conjunction with the filing of our 2016 U.S. federal income tax return. As a REIT, we generally will not be subject to U.S. federal income tax on our net taxable income that we distribute currently to our stockholders. To maintain our REIT qualification under the Code, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. If we fail to remain qualified for taxation as a REIT in any subsequent year and do not qualify for certain statutory relief provisions, our income for that year will be taxed at the regular corporate rate, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.

 

As of December 31, 2017 and 2016, we had no material uncertain income tax positions. Additionally, as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.

 

To qualify and maintain our qualification as a REIT, we may engage in certain activities through taxable REIT subsidiaries (“TRSs”). As such, we are subject to U.S. federal and state income and franchise taxes from these activities.

 

 

Results of Operations

 

Through December 31, 2017, we have made three real estate and real estate-related investments. During the fourth quarter of 2015 we made an initial contribution of $4.0 million in our first investment, the 105-109 W. 28^th Street Preferred Investment, which was made pursuant to an instrument that entitles us to monthly preferred distributions at a rate of 12% per annum. We subsequently made additional contributions aggregating $33.0 million towards the 105-109 W. 28^th Street Preferred Investment during the year ended December 31, 2016. As a result, the outstanding balance of our 105-109 W. 28^th Street Preferred Investment, which is fully funded, was $37.0 million as of both December 31, 2017 and 2016. On January 21, 2017, we made our second investment when we acquired a 22.5% membership in the Cove Joint Venture . And on March 31, 2017, we made our third investment when we acquired an approximate 33.3% interest in 40 East End Ave. Pref Member LLC ( “40 East End Ave. Joint Venture”). We account for our ownership interests in the Cove Joint Venture and 40 East End Ave. Joint Venture under the equity method of accounting. Our ownership interests in the Cove Joint Venture and the 40 East End Ave. Joint Venture are classified on our consolidated balance sheets in investments in unconsolidated affiliated real estate entities.

 

The operating results of our investments, if any, are reflected in our consolidated statements of operations commencing from their respective dates of acquisition. The Cove Joint Venture owns and operates The Cove, a 281-unit, luxury waterfront multifamily rental property located in Tiburon, California. The 40 East End Ave. Joint Venture, through affiliates, owns a parcel of land located at the corner of 81^st Street and East End Avenue in the Upper East Side neighborhood of New York, New York, on which it is constructing a luxury residential project consisting of 29 condominium units (the “40 East End Ave. Project”). As of and for the year ended December 31, 2017, the 40 East End Ave. Project was under development, therefore, the 40 East End Ave. Joint Venture had no results of operations.

 

See Note 4 of the Notes to Consolidated Financial Statements for additional information on our investments.

 

For the Year Ended December 31, 2017 vs. December 31, 2016

 

Investment income

 

Investment income, which is earned on our 105-109 W. 28^th Street Preferred Investment, was $4.5 million for the year ended December 31, 2017 compared to $1.9 million for the same period in 2016. The increase of $2.6 million was attributable to the timing of our additional aggregate contributions of $33.0 million during the 2016 period.

 

Loss from investment in unconsolidated affiliated real estate entity

 

Our loss from investment in unconsolidated affiliated real estate entity for the year ended December 31, 2017 was $2.8 million. Our loss from investment in unconsolidated affiliated real estate entity is attributable to our 22.5% ownership interest in the Cove Joint Venture, which we account for under the equity method of accounting.

 

General and administrative expenses

 

General and administrative expenses increased by $0.8 million to $1.1 million during the year ended December 31, 2017 compared to $0.3 million for the same period in 2016. The increase reflects an increase in the asset management fees paid to our Advisor as a result of the timing of our investments as well as higher accounting and transfer agent fees during the 2017 period.

 

Interest expense

 

Interest expense, which is attributable to the Subordinated Advances – Related Party, was $0.2 million for the year ended December 31, 2017 compared to $0.1 million for the same period in 2016 as a result of the timing of Subordinated Advances funded by our Sponsor during the 2016 and 2017 periods.

 

Financial Condition, Liquidity and Capital Resources  

 

Overview:

 

For the year ended December 31, 2017, our primary source of funds was $25.2 million of proceeds from our sale of shares of common stock under our Offering, which was terminated on March 31, 2017, and approximately $3.6 million of cash flows from operations.

 

Our future sources of funds will primarily consist of cash on hand and cash flows from our operations. We currently believe that these cash resources will be sufficient to satisfy our cash requirements (primarily operating expenses and distributions) for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.

 

We intend to limit our aggregate long-term permanent borrowings to 75% of the aggregate fair market value of all properties unless any excess borrowing is approved by a majority of the independent directors and is disclosed to our stockholders. Market conditions will dictate our overall leverage limit; as such our aggregate long-term permanent borrowings may be less than 75% of aggregate fair market value of all properties. We may also incur short-term indebtedness, having a maturity of two years or less.

 

 

Our charter provides that the aggregate amount of our borrowing, both secured and unsecured, may not exceed 300% of net assets in the absence of a satisfactory showing that a higher level is appropriate, the approval of our Board of Directors and disclosure to stockholders. Net assets means our total assets, other than intangibles, at cost before deducting depreciation or other non-cash reserves less our total liabilities, calculated at least quarterly on a basis consistently applied. Any excess in borrowing over such 300% of net assets level must be approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report to stockholders, along with justification for such excess. Market conditions will dictate our overall leverage limit; as such our aggregate borrowings may be less than 300% of net assets.

 

Our future borrowings may consist of single-property mortgages as well as mortgages cross-collateralized by a pool of properties. Such mortgages may be put in place either at the time we acquire a property or subsequent to our purchasing a property for cash. In addition, we may acquire properties that are subject to existing indebtedness where we choose to assume the existing mortgages. Generally, though not exclusively, we intend to seek to encumber our properties with non-recourse debt. This means that a lender’s rights on default will generally be limited to foreclosing on the property. However, we may, at our discretion, secure recourse financing or provide a guarantee to lenders if we believe this may result in more favorable terms. When we give a guaranty for a property owning entity, we will be responsible to the lender for the satisfaction of the indebtedness if it is not paid by the property owning entity.

 

In general the type of future financing executed by us to a large extent will be dictated by the nature of the investment and current market conditions. For long-term real estate investments, it is our intent to finance future acquisitions using long-term fixed rate debt. However there may be certain types of investments and market circumstances which may result in variable rate debt being the more appropriate choice of financing. To the extent floating rate debt is used to finance the purchase of real estate, management will evaluate a number of protections against significant increases in interest rates, including the purchase of interest rate cap instruments.

 

We may also obtain lines of credit to be used to acquire real estate and/or real estate related investments. If obtained, these lines of credit will be at prevailing market terms and will be repaid from offering proceeds, proceeds from the sale or refinancing of real estate and/or real estate related investments, working capital and/or permanent financing. Our Sponsor and/or its affiliates may guarantee our lines of credit although they are not obligated to do so. We may draw upon lines of credit to acquire properties pending our receipt of proceeds from our public offerings. We expect that such properties may be purchased by our Sponsor’s affiliates on our behalf, in our name, in order to minimize the imposition of a transfer tax upon a transfer of such properties to us.

 

In addition to making investments in accordance with our investment objectives, we have used and expect to continue to use our capital resources to make certain payments to our Advisor and our Dealer Manager during the various phases of our organization and operation. During our organizational and offering stage, these payments included payments to our Dealer Manager for selling commissions and the dealer manager fee, and payments to our Advisor for the reimbursement of organization and other offering costs.

 

Selling commissions and dealer manager fees were paid to the Dealer Manager or soliciting dealers, as applicable, pursuant to various agreements, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs, and professional fees have been accounted for as a reduction against additional paid-in capital as costs are incurred. Any organizational costs were accounted for as general and administrative costs.

 

The following table represents the selling commissions and dealer manager fees and other offering costs for the periods indicated:

 

		For the Years Ended December 31,
		2017				2016
Selling commissions and dealer manager fees		$	2,330,905			$	4,968,164
Other offering costs		$	25,493			$	1,044,980

 

Cumulatively for the Offering, we incurred approximately $7.6 million in selling commissions and dealer manager fees and $3.2 million of other offering costs.

 

During our acquisition and development stage, payments include asset acquisition fees and financing coordination fees, and the reimbursement of acquisition related expenses to our Advisor. During our operational stage, we pay our Advisor an asset management fee or asset management participation or construction management fees. We also reimburse our Advisor and its affiliates for actual expenses it incurs for administrative and other services provided to us. Upon the liquidation of assets, we may pay our Advisor or its affiliates a real estate disposition commission.

 

 

We have agreements with the Advisor to pay certain fees, in exchange for services performed by the Advisor and/or its affiliated entities.

 

The following table represents the fees incurred associated with the payments to the Company’s Advisor for the period indicated:

 

		For the Years Ended December 31,
		2017				2016
Acquisition fee (1)		$	573,750			$	-
Asset management fees (general and administrative costs)			574,072				-
Total		$	1,147,822			$	-

 

(1)

The acquisition fee for the Cove Joint Venture of $573,750 was capitalized and included in unconsolidated affiliated real estate entities on the consolidated balance sheets.

 

Summary of Cash Flows. The following summary discussion of our cash flows is based on the consolidated statements of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below:

 

		Year Ended December 31, 2017				Year Ended December 31, 2016
Cash flows provided by operating activities		$	3,633,549			$	1,433,377
Cash flows used in investing activities			(27,844,216	)			(38,687,250	)
Cash flows provided by financing activities			16,400,428				57,915,099
Net change in cash and cash equivalents			(7,810,239	)			20,661,226
Cash and cash equivalents, beginning of the year			21,874,240				1,213,014
Cash and cash equivalents, end of the year		$	14,064,001			$	21,874,240

 

Our principal sources of cash flow were derived from proceeds received from our Offering, which terminated on March 31, 2017, and operating cash flows provided by our investments. In the future, we expect that cash available on hand and earnings from our investments will provide us with a relatively consistent stream of cash flow to sufficiently fund our operating expenses, any scheduled debt service and any monthly distributions authorized by our Board of Directors.

 

Our principal demands for liquidity currently are expected to be acquisition and development activities, including contributions to our investments in unconsolidated affiliated real estate entities. The principal sources of funding for our operations are currently expected to be available cash on hand, operating cash flows and financings.

 

Operating activities

 

The net cash provided by operating activities of $3.6 million during the 2017 period primarily related to our net income of $0.4 million adjusted by adding back our loss from investment in unconsolidated affiliated real estate entity of $2.8 million and by changes in assets and liabilities of $0.4 million. 

 

Investing activities

 

The cash used in investing activities of $27.8 million during the 2017 period consisted of investments in unconsolidated affiliated real estate entities.

 

Financing activities

 

The net cash provided by financing activities of $16.4 million during the 2017 period principally consists of proceeds from the issuance of our common stock of $25.2 million; partially offset by the payment of selling commissions, dealer manager fees and other offering costs of approximately $2.6 million, distributions of $6.0 million to common stockholders and redemptions and cancellation of common stock of $0.2 million.

 

We believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.

 

 

Distribution Reinvestment and Share Repurchase Programs

 

On April 21, 2017, the Board of Directors approved the termination of our DRIP effective May 15, 2017. All future distributions will be in the form of cash.

 

Our DRIP provided our stockholders with an opportunity to purchase additional shares of our common stock at a discount by reinvesting distributions. The offering provided for 10.0 million shares available for issuance under our DRIP which were offered at a discounted price equivalent to 95% of our Primary Offering price per Common Share. Through May 15, 2017 (the termination date of the DRIP), 128,554 shares of common stock had been issued under our DRIP.

 

Our share repurchase program may provide our stockholders with limited, interim liquidity by enabling them to sell their shares of common stock back to us, subject to restrictions. From our date of inception through December 31, 2015, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the year ended December 31, 2016 we repurchased 18,798 shares of common stock, at an average price per share of $9.75 per share. For the year ended December 31, 2017 we repurchased 20,236 shares of common stock, pursuant to our share repurchase program at an average price per share of $9.71 per share. We funded share repurchases for the periods noted above from the cumulative proceeds of the sale of our shares pursuant to our DRIP, which is now terminated.

 

Our Board of Directors reserves the right to terminate our share repurchase program without cause by providing written notice of termination of the share repurchase program to all stockholders.

 

Funds from Operations and Modified Funds from Operations

 

The historical accounting convention used for real estate assets requires straight-line depreciation of buildings, improvements, and straight-line amortization of intangibles, which implies that the value of a real estate asset diminishes predictably over time. We believe that, because real estate values historically rise and fall with market conditions, including, but not limited to, inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using the historical accounting convention for depreciation and certain other items may be less informative.

 

Because of these factors, the National Association of Real Estate Investment Trusts ("NAREIT"), an industry trade group, has published a standardized measure of performance known as funds from operations ("FFO"), which is used in the REIT industry as a supplemental performance measure. We believe FFO, which excludes certain items such as real estate-related depreciation and amortization, is an appropriate supplemental measure of a REIT's operating performance. FFO is not equivalent to our net income or loss as determined under GAAP.

 

We define FFO, a non-GAAP measure, consistent with the standards set forth in the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the "White Paper"). The White Paper defines FFO as net income or loss computed in accordance with GAAP, but excluding gains or losses from sales of property and real estate related impairments, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.

 

We believe that the use of FFO provides a more complete understanding of our performance to investors and to management and reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income.

 

Changes in the accounting and reporting promulgations under GAAP that were put into effect in 2009 subsequent to the establishment of NAREIT's definition of FFO, such as the change to expense as incurred rather than capitalize and depreciate acquisition fees and expenses incurred for business combinations, have prompted an increase in cash-settled expenses, specifically acquisition fees and expenses, as items that are expensed under GAAP across all industries. These changes had a particularly significant impact on publicly registered, non-listed REITs, which typically have a significant amount of acquisition activity in the early part of their existence, particularly during the period when they are raising capital through ongoing initial public offerings.

 

Because of these factors, the Investment Program Association (the "IPA"), an industry trade group, published a standardized measure of performance known as modified funds from operations ("MFFO"), which the IPA has recommended as a supplemental measure for publicly registered, non-listed REITs. MFFO is designed to be reflective of the ongoing operating performance of publicly registered, non-listed REITs by adjusting for those costs that are more reflective of acquisitions and investment activity, along with other items the IPA believes are not indicative of the ongoing operating performance of a publicly registered, non-listed REIT, such as straight-lining of rents as required by GAAP. We believe it is appropriate to use MFFO as a supplemental measure of operating performance because we believe that both before and after we have deployed all of our offering proceeds and are no longer incurring a significant amount of acquisition fees or other related costs, it reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income. MFFO is not equivalent to our net income or loss as determined under GAAP.

 

 

We define MFFO, a non-GAAP measure, consistent with the IPA's Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations (the "Practice Guideline") issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for acquisition and transaction-related fees and expenses and other items. In calculating MFFO, we follow the Practice Guideline and acquisition and transaction-related fees and expenses (which includes costs incurred in connection with strategic alternatives), amounts relating to deferred rent receivables and amortization of market lease and other intangibles, net (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments), accretion of discounts and amortization of premiums on debt investments and borrowings, mark-to-market adjustments included in net income (including gains or losses incurred on assets held for sale), gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. Certain of the above adjustments are also made to reconcile net income (loss) to net cash provided by (used in) operating activities, such as for the amortization of a premium and accretion of a discount on debt and securities investments, amortization of fees, any unrealized gains (losses) on derivatives, securities or other investments, as well as other adjustments.

 

MFFO excludes non-recurring impairment of real estate-related investments. We assess the credit quality of our investments and adequacy of reserves on a quarterly basis, or more frequently as necessary. Significant judgment is required in this analysis. We consider the estimated net recoverable value of a loan as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive situation of the region where the borrower does business.

 

We believe that, because MFFO excludes costs that we consider more reflective of acquisition activities and other non-operating items, MFFO can provide, on a going-forward basis, an indication of the sustainability (that is, the capacity to continue to be maintained) of our operating performance after the period in which we are acquiring properties and once our portfolio is stabilized. We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry and allows for an evaluation of our performance against other publicly registered, non-listed REITs.

 

Not all REITs, including publicly registered, non-listed REITs, calculate FFO and MFFO the same way. Accordingly, comparisons with other REITs, including publicly registered, non-listed REITs, may not be meaningful. Furthermore, FFO and MFFO are not indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as determined under GAAP as an indication of our performance, as an alternative to cash flows from operations as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders. FFO and MFFO should be reviewed in conjunction with other GAAP measurements as an indication of our performance. FFO and MFFO should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or in its applicability in evaluating our operating performance. The methods utilized to evaluate the performance of a publicly registered, non-listed REIT under GAAP should be construed as more relevant measures of operational performance and considered more prominently than the non-GAAP measures, FFO and MFFO, and the adjustments to GAAP in calculating FFO and MFFO.

 

Neither the SEC, NAREIT, the IPA nor any other regulatory body or industry trade group has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, NAREIT, the IPA or another industry trade group may publish updates to the White Paper or the Practice Guidelines or the SEC or another regulatory body could standardize the allowable adjustments across the publicly registered, non-listed REIT industry, and we would have to adjust our calculation and characterization of FFO or MFFO accordingly.

 

 

The following table presents a reconciliation of FFO and MFFO to net income:

 

		For the Years Ended December 31,
		2017				2016
Net income		$	419,506			$	1,537,999
FFO adjustments:
Adjustments to equity earnings from unconsolidated affiliated real estate entities, net			2,625,903				-
FFO			3,045,409				1,537,999
MFFO adjustments:
Other adjustments:
Acquisition and other transaction related costs expensed			-				4,348
MFFO			3,045,409				1,542,347
Straight-line rent(1)			-				-
MFFO - IPA recommended format		$	3,045,409			$	1,542,347
Net income		$	419,506			$	1,537,999
Less: net income attributable to noncontrolling interests			-				-
Net income applicable to Company's common shares		$	419,506			$	1,537,999
Net loss per common share, basic and diluted		$	0.05			$	0.53
FFO		$	3,045,409			$	1,537,999
Less: FFO attributable to noncontrolling interests			-				-
FFO attributable to Company's common shares		$	3,045,409			$	1,537,999
FFO per common share, basic and diluted		$	0.36			$	0.53
MFFO - IPA recommended format		$	3,045,409			$	1,542,347
Less: MFFO attributable to noncontrolling interests			-				-
MFFO attributable to Company's common shares		$	3,045,409			$	1,542,347
Weighted average number of common shares outstanding, basic and diluted			8,577,336				2,894,887

 

(1)

Under GAAP, rental receipts are allocated to periods using various methodologies. This may result in income recognition that is significantly different than underlying contract terms. By adjusting for these items (to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments), MFFO provides useful supplemental information on the realized economic impact of lease terms and debt investments, providing insight on the contractual cash flows of such lease terms and debt investments, and aligns results with management’s analysis of operating performance.

 

The table below presents our cumulative distributions declared and cumulative FFO:

 

		For the period September 9, 2014
		(date of inception) through
		December 31, 2017
FFO		$	4,469,584
Cumulative distributions declared		$	9,338,320

 

New Accounting Pronouncements  

 

See Note 2 to the Notes to Consolidated Financial Statements for further information of certain accounting standards that have been adopted during 2017 and certain accounting standards that we have not yet been required to implement and may be applicable to our future operations.

 

Subsequent Events

 

See the Notes to Consolidated Financial Statements for further information related to subsequent events during the period from January 1, 2018 through the date of the financial statements.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:

 

The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or rates. As of December 31, 2017, we do not have any long-term debt, but anticipate incurring long-term debt in the future. Our interest rate risk management objectives with respect to our long-term debt will be to limit the impact of interest rate changes in earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, collars, and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We would not hold or issue these derivative contracts for trading or speculative purposes. We do not anticipate having any foreign operations and thus we do not expect to be exposed to foreign currency fluctuations.

 

 

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Lightstone Real Estate Income Trust Inc. and Subsidiaries

(a Maryland corporation)

 

Index

 

	Page
Report of Independent Registered Public Accounting Firm	59
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2017 and 2016	60
Consolidated Statements of Operations for the years ended December 31, 2017 and 2016	61
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2017 and 2016	62
Consolidated Statements of Cash Flows for the years ended December 31, 2017 and 2016	63
Notes to Consolidated Financial Statements	64

 

Schedules not filed:

 

All schedules have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.

 

  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders of

Lightstone Real Estate Income Trust, Inc. and Subsidiaries

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Lightstone Real Estate Income Trust, Inc. and Subsidiaries (the “Company") as of December 31, 2017 and 2016, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017 and 2016, and the consolidated results of their operations and their cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ EisnerAmper LLP
We have served as the Company’s auditor since 2014.
EISNERAMPER LLP
Iselin, New Jersey
March 12, 2018

 

  

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

		December 31, 2017				December 31, 2016
Assets
Investment in related party		$	37,000,000			$	37,000,000
Investments in unconsolidated affiliated real estate entities			30,717,641				-
Cash			14,064,001				21,874,240
Deposit and other assets			8,878				5,818,713
Due from related parties			-				28,696
Total Assets		$	81,790,520			$	64,721,649
Liabilities and Stockholders' Equity
Accounts payable and other accrued expenses		$	56,104			$	267,726
Due to related parties			54,882				-
Distributions payable			606,897				413,275
Subordinated advances - related party			12,890,830				12,703,876
Total liabilities			13,608,713				13,384,877
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $0.01 par value; 50,000,000 shares authorized, none issued and outstanding			-				-
Common stock, $0.01 par value; 200,000,000 shares authorized, 8,952,132 and 6,397,005 shares issued and outstanding, respectively			89,521				63,970
Additional paid-in-capital			75,586,926				52,616,396
Subscription receivable			-				(274,449	)
Accumulated deficit			(7,494,640	)			(1,069,145	)
Total Stockholders' Equity			68,181,807				51,336,772
Total Liabilities and Stockholders' Equity		$	81,790,520			$	64,721,649

 

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

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

		For the Years Ended December, 31
		2017				2016
Income:
Investment income		$	4,501,667			$	1,928,708
Loss from investment in unconsolidated affiliated real estate entity			(2,813,825	)			-
Total income			1,687,842				1,928,708
Expenses:
General and administrative costs			1,081,382				318,846
Interest expense			186,954				71,863
Total expenses			1,268,336				390,709
Net income		$	419,506			$	1,537,999
Net income per common share, basic and diluted		$	0.05			$	0.53
Weighted average number of common shares outstanding, basic and diluted			8,577,336				2,894,887

 

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

 

  

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

										Additional
		Common								Paid-In				Subscription				Accumulated				Total
		Shares				Amount				Capital				Receivable				Deficit				Equity
BALANCE, December 31, 2015			723,975			$	7,240			$	4,425,374			$	(1,000	)		$	(300,877	)		$	4,130,737
Net income			-				-				-				-				1,537,999				1,537,999
Distributions declared			-				-				-				-				(2,306,267	)			(2,306,267	)
Proceeds from offering			5,634,177				56,342				53,842,682				(273,449	)			-				53,625,575
Shares issued from distribution reinvestment program			57,651				576				544,548				-				-				545,124
Redemption and cancellation of shares			(18,798	)			(188	)			(183,064	)			-								(183,252	)
Selling commissions and dealer manager fees			-				-				(4,968,164	)			-				-				(4,968,164	)
Other offering costs			-				-				(1,044,980	)			-				-				(1,044,980	)
BALANCE, December 31, 2016			6,397,005			$	63,970			$	52,616,396			$	(274,449	)		$	(1,069,145	)		$	51,336,772
Net income			-				-				-				-				419,506				419,506
Distributions declared			-				-				-				-				(6,845,001	)			(6,845,001	)
Proceeds from offering			2,506,031				25,060				24,865,186				274,449				-				25,164,695
Shares issued from distribution reinvestment program			69,332				693				657,959				-				-				658,652
Redemption and cancellation of shares			(20,236	)			(202	)			(196,217	)			-								(196,419	)
Selling commissions and dealer manager fees			-				-				(2,330,905	)			-				-				(2,330,905	)
Other offering costs			-				-				(25,493	)			-				-				(25,493	)
BALANCE, December 31, 2017			8,952,132			$	89,521			$	75,586,926			$	-			$	(7,494,640	)		$	68,181,807

 

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

 

  

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		For the year ended December 31, 2017				For the year ended December 31, 2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	419,506			$	1,537,999
Adjustments to reconcile net income to net cash provided by operating activities:
Loss from investment in unconsolidated affiliated real estate entity			2,813,825				-
Changes in assets and liabilities:
Decrease/(increase) in other assets			122,585				(131,029	)
Increase in accounts payable and other accrued expenses			7,101				22,550
Increase in accrued interest on subordinated advances - related party			186,954				71,863
Increase/(decrease) in due to related parties			83,578				(68,006	)
Net cash provided by operating activities			3,633,549				1,433,377
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in related party			-				(33,000,000	)
Deposit on real estate investment			-				(5,687,250	)
Investments in unconsolidated affiliated real estate entities			(27,844,216	)			-
Cash used in investing activities			(27,844,216	)			(38,687,250	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock			25,164,695				53,625,575
Proceeds from subordinated advances - related party			-				12,632,013
Payment of commissions and offering costs			(2,575,121	)			(6,765,199	)
Redemption and cancellation of common stock			(196,419	)			(183,252	)
Distributions paid to Company's common stockholders			(5,992,727	)			(1,394,038	)
Net cash provided by financing activities			16,400,428				57,915,099
Net change in cash			(7,810,239	)			20,661,226
Cash, beginning of year			21,874,240				1,213,014
Cash, end of year		$	14,064,001			$	21,874,240
Supplemental disclosure of cash flow information:
Distributions declared, but not paid		$	606,897			$	413,275
Commissions and other offering costs accrued but not paid		$	-			$	218,723
Subscription receivable		$	-			$	273,449
Value of shares issued from distribution reinvestment program		$	658,652			$	545,124
Application of deposit to acquisition of investment property		$	5,687,250			$	-

 

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

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

1. Organization and Offering

 

Lightstone Real Estate Income Trust Inc. (‘‘Lightstone Income Trust’’), incorporated on September 9, 2014, in Maryland, elected to qualify to be taxed as a real estate investment trust for U.S. federal income tax purposes (‘‘REIT’’) beginning with the taxable year ended December 31, 2016.

 

Lightstone Income Trust sold 20,000 Common Shares to Lightstone Real Estate Income LLC, a Delaware limited liability company (the ‘‘Advisor’’), an entity majority owned by David Lichtenstein, on September 12, 2014, for $200,000, or $10.00 per share. Mr. Lichtenstein also is a majority owner of the equity interests of Lightstone Income Trust’s sponsor, The Lightstone Group, LLC (the ‘‘Sponsor’’).

 

Subject to the oversight of the Company’s board of directors (the “Board of Directors”), the Advisor has primary responsibility for making investment decisions and managing the Company’s day-to-day operations. Mr. Lichtenstein also acts as the Company’s Chairman and Chief Executive Officer. As a result, he exerts influence over but does not control the Lightstone Income Trust.

 

Lightstone Income Trust, together with its subsidiaries is collectively referred to as the ‘‘Company’’ and the use of ‘‘we,’’ ‘‘our,’’ ‘‘us’’ or similar pronouns refers to Lightstone Income Trust or the Company as required by the context in which any such pronoun is used.

 

The Company’s registration statement on Form S-11 (the “Offering”), pursuant to which it offered to sell up to 30,000,000 shares of its common stock, par value $0.01 per share (which may be referred to herein as ‘‘shares of common stock’’ or as ‘‘Common Shares’’) for an initial price of $10.00 per share, subject to certain volume and other discounts (the “Primary Offering”) (exclusive of 10,000,000 shares available pursuant to its distribution reinvestment program (the ‘‘DRIP’’) which were offered at a discounted price equivalent to 95% of the initial price per Common Share) was declared effective by the Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933 on February 26, 2015. On June 30, 2016, the Company adjusted its offering price to $9.14 per Common Share in its Primary Offering, which was equal to the Company’s estimated net asset value (“NAV”) per Common Share as of March 31, 2016, and effective July 25, 2016, the Company’s offering price was adjusted to $10.00 per Common Share in its Primary Offering, which was equal to the estimated NAV per Common Share as of June 30, 2016. Our estimated NAV per Common Share remained unchanged at $10.00 as of both September 30, 2016 and December 31, 2016.

 

The Offering, which terminated on March 31, 2017, raised aggregate gross proceeds of approximately $85.6 million from the sale of approximately 8.9 million shares of common stock (including $2.0 million in Common Shares at a purchase price of $9.00 per Common Share to an entity 100% owned by David Lichtenstein, who also owns a majority interest in the Company’s Sponsor). After including aggregate advances from our Sponsor of $12.6 million under a subordinated agreement (the “Subordinated Agreement”) (as discussed in Note 4) and allowing for the payment of approximately $7.6 million in selling commissions and dealer manager fees and $3.2 million in organization and offering expenses, the Offering generated aggregate net proceeds of approximately $87.5 million.

 

On April 21, 2017, the Company’s board of directors approved the termination of the DRIP effective May 15, 2017. Previously, the Company’s stockholders had an option to elect the receipt of shares of the Company’s common stock in lieu of cash distributions under the Company’s DRIP, however, all future distributions will be in the form of cash. In addition, through May 15, 2017 (the termination date of the DRIP), the Company issued approximately 0.1 million shares of common stock under its DRIP, representing approximately $1.2 million of additional proceeds under the Offering.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

The Company has and will continue to seek to originate, acquire and manage a diverse portfolio of real estate and real estate-related investments. The Company may invest in mezzanine loans, first lien mortgage loans, second lien mortgage loans, bridge loans and preferred equity interests, in each case with a focus on investments intended to finance development or redevelopment opportunities. The Company may also invest in debt and derivative securities related to real estate assets. The Company expects that a majority of its investments by value will be secured by or related to properties or entities advised by, or wholly or partially, directly or indirectly owned by, the Sponsor, by its affiliates or by real estate investment programs sponsored by it. Although the Company expects that most of its investments will be of these types, it may make other investments. In fact, it may invest in whatever types of real estate-related investments that it believes are in its best interests.

 

The Company has no employees. The Company retains the Advisor to manage its affairs on a day-to-day basis. Orchard Securities, LLC (the ‘‘Dealer Manager’’), a third party not affiliated with the Company, the Sponsor or the Advisor, served as the dealer manager of the Offering through its termination on March 31, 2017. The Advisor is an affiliate of the Sponsor and will receive compensation and fees for services related to the investment and management of the Company’s assets. The Advisor will receive fees during the organization and offering, operational and liquidation/listing stages. (See Note 4 for a summary of related-party fees.)

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Lightstone Income Trust and its subsidiaries (over which it exercises financial and operating control).  All inter-company balances and transactions have been eliminated in consolidation.  

 

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during a reporting period. The most significant assumptions and estimates relate to the valuation of real estate and investments in other real estate entities, depreciable lives of long-lived assets and revenue recognition. Application of these assumptions requires the exercise of judgment as to future uncertainties and, as a result, actual results could differ from these estimates.

 

Investments in other real estate entities where the Company has the ability to exercise significant influence, but does not exercise financial and operating control, and is not considered to be the primary beneficiary are accounted for using the equity method. Investments in other real estate entities where the Company has virtually no influence are accounted for using the cost method.

 

Cash and cash equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents.

 

Real Estate-Related Debt Investments

 

The Company’s real estate-related debt investments are intended to be held until maturity and accordingly, are carried at cost, net of unamortized loan fees, origination fees, discounts, premiums and unfunded commitments. Real estate-related debt investments that are deemed impaired are carried at amortized cost less a loan loss reserve, if deemed appropriate, which approximates fair value. Real estate-related debt investments that we do not intend to hold for the foreseeable future or until their expected payoff are classified as held for sale and recorded at the lower of cost or fair value.

 

Investment income is recognized on an accrual basis and any related premium, discount, origination costs and fees are amortized over the life of the investment using the effective interest method. The amortization is reflected as an adjustment to investment income in the Company’s statements of operations. The amortization of a premium or accretion of a discount is discontinued if such debt investment is reclassified to held for sale.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Credit Losses and Impairment on Investments

 

Real Estate-Related Debt Investments

 

Real estate-related debt investments will be considered impaired when, based on current information and events, it is probable that the Company will not be able to collect principal and interest amounts due according to the contractual terms. The Company will assess the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis, or more frequently as necessary. Significant judgment of management will be required in this analysis. The Company will consider the estimated net recoverable value of the debt investment as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the quality and financial condition of the borrower and the competitive situation of the area where the underlying collateral is located. Because this determination will be based on projections of future economic events, which are inherently subjective, the amount ultimately realized may differ materially from the carrying value as of the balance sheet date. If upon completion of the assessment, the estimated fair value of the underlying collateral is less than the net carrying value of the debt investment, a loan loss reserve will be recorded with a corresponding charge to provision for loan losses. The loan loss reserve for each debt investment will be maintained at a level that is determined to be adequate by management to absorb probable losses.

 

Income recognition will be suspended for a debt investment at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. When the ultimate collectability of the principal of an impaired debt investment is in doubt, all payments will be applied to principal under the cost recovery method. When the ultimate collectability of the principal of an impaired debt investment is not in doubt, contractual interest will be recorded as interest income when received, under the cash basis method, until an accrual is resumed when the debt investment becomes contractually current and performance is demonstrated to be resumed. A debt investment will be written off when it is no longer realizable or is legally discharged.

 

Investments in Unconsolidated Entities

 

The Company evaluates investments in other entities for consolidation. It considers the percentage interest in the joint venture, evaluation of control and whether a variable interest entity exists when determining if the investment qualifies for consolidation.

 

Under the equity method, an investment is recorded initially at cost, and subsequently adjusted for equity in net income (loss) and cash contributions and distributions. The net income or loss of each investor is allocated in accordance with the provisions of the operating agreement of the entity. The allocation provisions in these agreements may differ from the ownership interest held by each investor. Differences between the carrying amount of our investment in the respective joint venture and the Company’s share of the underlying equity of such unconsolidated entity are amortized over the respective lives of the underlying assets as applicable. These items are reported as a single line item in the statements of operations as income or loss from investments in unconsolidated affiliated entities. Under the cost method of accounting, the investment is recorded initially at cost, and subsequently adjusted for cash contributions and distributions resulting from any capital events. Dividends earned from the underlying entity are recorded as interest income.

 

On a quarterly basis, the Company assesses whether the value of its investments in unconsolidated entities has been impaired. An investment is impaired only if management’s estimate of the fair value of the investment is less than the carrying value of the investment, and such decline in value is deemed to be other than temporary. The ultimate realization of the Company’s investment in partially owned entities is dependent on a number of factors including the performance of that entity and market conditions. If the Company determines that a decline in the value of a partially owned entity is other than temporary, it will record an impairment charge.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Income Taxes

 

The Company elected to be taxed as a REIT commencing with the taxable year ended December 31, 2016. If the Company qualifies as a REIT, it generally will not be subject to U.S. federal income tax on its taxable income or capital gain that it distributes to its stockholders. To maintain its REIT qualification, the Company must meet a number of organizational and operational requirements, including a requirement that it annually distribute to its stockholders at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. If the Company fails to remain qualified for taxation as a REIT in any subsequent year and does not qualify for certain statutory relief provisions, its income for that year will be taxed at the regular corporate rate, and it may be precluded from qualifying for treatment as a REIT for the four-year period following its failure to qualify as a REIT. Such an event could materially adversely affect the Company’s net income and net cash available for distribution to stockholders.

 

As of December 31, 2017 and 2016, the Company had no material uncertain income tax positions. Additionally, even if the Company qualifies as a REIT, it may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on its undistributed income.  

 

Organization and Offering Costs

 

Organization costs were expensed as incurred as general and administrative costs.

 

Offering costs are accounted for as a reduction against additional paid-in capital as costs are incurred and included all costs and expenses paid by the Company in connection with its formation and the Offering, including the Company’s legal, accounting, printing, mailing and filing fees, charges of the escrow agent, reimbursements to the Dealer Manager and participating broker-dealers for due diligence expenses set forth in detailed and itemized invoices, amounts to reimburse the Advisor for its portion of the salaries of the employees of its affiliates who provide services to the Advisor, and other costs in connection with oversight of such Offering and the marketing process, such as preparing supplemental sales materials, holding educational conferences and attending retail seminars conducted by the Dealer Manager or participating broker-dealers.

 

Concentration of Risk

 

The Company maintains its cash in bank deposit accounts, which, at times, may exceed U.S. federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.

 

Net Earnings per Common Share

 

Net earnings per Common Share will be computed by dividing the earnings by the weighted average number of shares of common stock outstanding.

 

New Accounting Pronouncements

 

In January 2017, the Financial Accounting Standards Board (“FASB”) issued guidance that clarifies the definition of a business and assists in the evaluation of whether a transaction will be accounted for as an acquisition of an asset or as a business combination. The guidance provides a test to determine when a set of assets and activities acquired is not a business. When substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. Under the updated guidance, an acquisition of a single property will likely be treated as an asset acquisition as opposed to a business combination and associated transaction costs will be capitalized rather than expensed as incurred. Additionally, assets acquired, liabilities assumed, and any noncontrolling interest will be measured at their relative fair values. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2017, with early adoption permitted. This guidance will not have a material impact on the Company’s consolidated financial statements.

 

In August 2016, the FASB issued an accounting standards update which provides guidance on the classification of certain cash receipts and cash payments in the statement of cash flows, including those related to debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance, and distributions received from equity method investees.  This guidance is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years.  The guidance must be adopted on a retrospective basis and must be applied to all periods presented, but may be applied prospectively if retrospective application would be impracticable.  This guidance will not have a material impact on the Company’s consolidated financial statements.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

In June 2016, the FASB issued an accounting standards update which replaces the incurred loss impairment methodology currently in use with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.  The new guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  The Company does not expect that this guidance will have a material impact on its consolidated financial statements.

 

In January 2016, the FASB issued an accounting standards update that eliminates the requirement for public business entities to disclose the method and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet and is effective for periods beginning after December 15, 2017 and early adoption is not permitted. This guidance will not have a material impact on the Company’s consolidated financial statements.

 

In May 2014, the FASB issued an accounting standards update that provides for a single five-step model to be applied to all revenue contracts with customers as well as requires additional financial statement disclosures that will enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows relating to customer contracts.  Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard.  This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period.  The adoption of this standard will not have a material impact on the Company’s consolidated financial statements.

 

The Company has reviewed and determined that other recently issued accounting pronouncements will not have a material impact on its financial position, results of operations and cash flows, or do not apply to its current operations.

 

3. Stockholders’ Equity

 

Preferred Stock

 

The Company’s charter authorizes the Company’s board of directors to designate and issue one or more classes or series of preferred stock without approval of the holders of Common Shares. On February 11, 2015, the Company amended and restated its charter to authorize the issuance of 50,000,000 shares of preferred stock. Prior to the issuance of shares of each class or series, the board of directors will be required by Maryland law and by the charter to set, subject to the charter restrictions on ownership and transfer of stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption of each class or series of preferred stock so issued, which may be more beneficial than the rights, preferences and privileges attributable to Common Shares. The issuance of preferred stock could have the effect of delaying, deferring or preventing a change in control of the Company. As of December 31, 2017 and 2016, the Company had no outstanding shares of preferred stock.

 

Common Shares

 

On February 11, 2015, the Company amended and restated its charter to authorize the issuance of 200,000,000 Common Shares. Under the charter, the Company will not be able to make certain material changes to its business form or operations without the approval of stockholders holding at least a majority of the shares of its stock entitled to vote on the matter.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Subject to the restrictions on ownership and transfer of stock contained in the Company’s charter and except as may otherwise be specified in the charter, the holders of Common Shares are entitled to one vote per Common Share on all matters submitted to a stockholder vote, including the election of the Company’s directors. There is no cumulative voting in the election of directors. Therefore, the holders of a majority of outstanding Common Shares are able to elect the Company’s entire board of directors. Except as the Company’s charter may provide with respect to any series of preferred stock that the Company may issue in the future, the holders of Common Shares possess exclusive voting power.

 

Holders of the Company’s Common Shares are entitled to receive distributions as authorized from time to time by the Company’s board of directors and declared out of legally available funds, subject to any preferential rights of any preferred stock that the Company issues in the future. In any liquidation, each outstanding Common Share will entitle its holder to share (based on the percentage of Common Shares held) in the assets that remain after the Company pays its liabilities and any preferential distributions owed to preferred stockholders. Holders of Common Shares do not have preemptive rights, which means that there is no automatic option to purchase any new Common Shares that the Company issues, nor do holders of Common Shares have any preference, conversion, exchange, sinking fund or redemption rights. Holders of Common Shares do not have appraisal rights unless the board of directors determines that appraisal rights apply, with respect to all or any classes or series of stock, to a particular transaction or all transactions occurring after the date of such determination in connection with which holders of such Common Shares would otherwise be entitled to exercise appraisal rights. Common Shares are nonassessable by the Company upon its receipt of the consideration for which the board of directors authorized their issuance.

 

Subscription Receivable

 

The subscription receivable relates to shares issued to the Company’s shareholders for which the proceeds have not yet been received by the Company solely due to a fact of timing of transfers from the escrow agent holding the funds. All such amounts have been received by the Company as of December 31, 2017.

 

Distribution Declaration

 

On October 28, 2015, the Board of Directors authorized and the Company declared a distribution rate which is calculated based on stockholders of record each day during the applicable period at a rate of $0.002191781 per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 8.0% annualized rate based on a share price of $10.00. Our first distribution began to accrue on June 12, 2015 (date of breaking escrow) through November 30, 2015 (the end of the month following our initial real estate-related investment) and subsequent distributions have been paid on a monthly basis thereafter. The first distribution was paid on December 15, 2015 and subsequent distributions have been paid on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month.

 

Total distributions declared during the years ended December 31, 2017 and 2016 were $6.8 million and $2.3 million, respectively.

 

On February 27, 2018, the Board of Directors authorized and the Company declared a distribution for each month during the three-month period ending June 30, 2018. The distributions will be calculated based on shareholders of record at a rate of $0.002191781 per day, and will equal a daily amount that, if paid each day for a 365-day period, would equal a 8.0% annualized rate based on a share price of $10.00 payable on or about the 15th day following each month end to stockholders of record at the close of business on the last day of the prior month.

 

Distribution Payments

 

On November 14, 2017, December 15, 2017 and January 14, 2018, the Company paid distributions for the months ended October 31, 2017, November 30, 2017 and December 31, 2017, respectively, totaling $1.8 million. The distributions were paid in cash. The distributions were paid from a combination of cash flows provided by operations ($858,194 or 48%) and offering proceeds ($942,918 or 52%).

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

4. Related Party Transactions and Other Arrangements

 

The Company had an agreement with the Dealer Manager for service related to the Offering which was terminated on March 31, 2017. In addition, the Company has agreements with the Advisor to pay certain fees, in exchange for services performed by these entities and other affiliated entities.

 

During the year ended December 31, 2016, the Company paid $36,298 to an affiliate of the Sponsor for the Sponsor’s marketing expenses related to the Offering that were recorded as a reduction to additional paid in capital.

 

The following table summarizes all the compensation and fees the Company paid or may pay to the Dealer Manager or to the Advisor or its affiliates, including amounts to reimburse their costs in providing services.

 

Organization and Offering Stage
Fees		Amount
Selling Commissions		The Dealer Manager received selling commissions in an amount of up to  7% of the gross proceeds in the Primary Offering.  From the Company’s inception through March 31, 2017 (the termination date of the Offering), the Company has incurred $5.1 million of selling commissions.
Dealer Manager Fee		The Dealer Manager received a dealer manager fee in an amount of up to 3% of gross proceeds in the Primary Offering. From the Company’s inception through March 31, 2017 (the termination date of the Offering), the Company has incurred $2.5 million of dealer manager fees.
Organization and Offering Expenses		The Company reimbursed the Advisor for all organization and offering expenses that it funded in connection with the Offering, other than the selling commissions and dealer manager fee. From the Company’s inception through March 31, 2017 (the termination date of the Offering), approximately $3.2 million of organization and offering costs have been incurred.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Operational Stage
Fees		Amount
Acquisition Fee		The Company pays to the Advisor or its affiliates 1% of the amount funded by us to originate or acquire an investment (including the Company’s pro rata share (direct or indirect) of debt incurred in respect of such investment, but excluding acquisition fees and acquisition expenses). Notwithstanding the foregoing, the Company will not pay any acquisition fee to the Advisor or any of its affiliates with respect to any transaction between the Company and the Sponsor, any of its affiliates or any program sponsored by it.
Acquisition Expenses		The Company reimburses the Advisor for expenses actually incurred related to selecting, originating or acquiring investments on the Company’s behalf, regardless of whether the Company actually acquires the related investments. In addition, the Company pays third parties, or reimburses the Advisor or its affiliates, for any investment-related expenses due to third parties, including, but not limited to, legal fees and expenses, travel and communications expenses, accounting fees and expenses and other closing costs and miscellaneous expenses, regardless of whether the Company acquires the related investments. The Company estimates that total acquisition expenses (including those paid to third parties, as described above) will be approximately 0.6% of the amount funded by us to originate or acquire an investment (including the Company’s pro rata share (direct or indirect) of debt attributable to such investment, but excluding acquisition fees and acquisition expenses). In no event will the total of all acquisition fees and acquisition expenses (including those paid to third parties, as described above) with respect to a particular investment be unreasonable or, except in limited circumstances, exceed 5% of the amount funded by us to originate or acquire an investment (including the Company’s pro rata share (direct or indirect) of debt attributable to such investment, but exclusive of acquisition fees and acquisition expenses).
Asset Management Fee		The Company pays the Advisor or its assignees a monthly asset management fee equal to one-twelfth (1⁄12) of 1% of the cost of the Company’s assets. The cost of the Company’s assets means the amount funded by the Company for investments, including expenses and any financing attributable to such investments, less any principal received on such investments.

 

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Operational Stage
Fees		Amount
Operating Expenses		Beginning 12 months after the original effective date of the Offering, the Company reimburses the Advisor’s costs of providing administrative services, subject to the limitation that the Company generally will not reimburse the Advisor for any amount by which the total operating expenses at the end of the four preceding fiscal quarters exceeds the greater of (i) 2% of average invested assets (as defined in the advisory agreement), and (ii) 25% of net income other than any additions to reserves for depreciation, bad debt or other similar non-cash reserves and excluding any gain from the sale of investments for that period. After the end of any fiscal quarter for which the Company’s total operating expenses exceed this 2%/25% limitation for the four fiscal quarters then ended, if the Company’s independent directors exercise their right to conclude that this excess was justified, this fact will be disclosed in writing to the holders of Common Shares within 60 days. If the Company’s independent directors do not determine such excess expenses are justified, the Advisor is required to reimburse the Company, at the end of the four preceding fiscal quarters, by the amount that the Company’s aggregate annual total operating expenses paid or incurred exceed this 2%/25% limitation.
		Additionally, the Company reimburses the Advisor for personnel costs in connection with other services; however, the Company does not reimburse the Advisor for (a) services for which the Advisor or its affiliates are entitled to compensation in the form of a separate fee, or (b) the salaries and benefits of the Company’s named executive officers.

  

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Liquidation/Listing Stage
Fees		Amount
Disposition Fee		For substantial assistance in connection with the sale of investments and based on the services provided, as determined by the Company’s independent directors, the Company will pay to the Advisor or any of its affiliates a disposition fee equal to up to 1% of the contract sales price of each investment sold. The Company will not pay a disposition fee upon the maturity, prepayment, workout, modification or extension of a debt instrument unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of: (a) 1% of the principal amount of the debt prior to such transaction; and (b) the amount of the fee paid by the borrower in connection with such transaction. If the Company takes ownership of a property as a result of a workout or foreclosure of debt, the Company will pay a disposition fee upon the sale of such property.
Annual Subordinated Performance Fee		The Company will pay the Advisor an annual subordinated performance fee calculated on the basis of the annual return to holders of Common Shares, payable annually in arrears. Specifically, in any year in which holders of Common Shares receive payment of an 8% annual cumulative, pre-tax, non- compounded return on the aggregate capital contributed by them, the Advisor will be entitled to 15% of the amount in excess of the 8% per annum return; provided, that the annual subordinated performance fee will not exceed 10% of the aggregate return paid to the holders of Common Shares for the applicable year, and provided, further, that the annual subordinated performance fee will not be paid unless and until holders of Common Shares receive a return of the aggregate capital contributed by them. This fee will be payable only from net sales proceeds, which results in, or is deemed to result in, the return on the aggregate capital contributed by holders of Common Shares plus 8% per annum thereon.
Subordinated Participation in Net Sales Proceeds (payable only if the Company is not listed on an exchange and the advisory agreement is not terminated or non-renewed)		The Advisor will receive from time to time, when available, including in connection with a merger, consolidation or sale, or other disposition of all or substantially all the Company’s assets, 15% of remaining “net sales proceeds” (as defined in the Company’s charter) after return of capital contributions plus payment to holders of Common Shares of an 8% annual cumulative, pre-tax, non-compounded return on the aggregate capital contributed by them.
Subordinated Incentive Listing Fee (payable only if we are listed on an exchange)		Upon the listing of the Common Shares on a national securities exchange, including a listing in connection with a merger or other business combination, the Advisor will receive a fee equal to 15% of the amount by which the sum of the Company’s market value (determined after listing) plus distributions attributable to net sales proceeds paid to the holders of Common Shares exceeds the sum of the aggregate capital contributed by them plus an amount equal to an 8% annual cumulative, pre-tax, non-compounded return.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Liquidation/Listing Stage (continued)
Fees		Amount
Subordinated Fee upon Termination or Non- Renewal of the Advisory Agreement		Upon termination or non-renewal of the advisory agreement with or without cause, including for poor performance by the Advisor, the Advisor will be entitled to receive a fee equal to 15% of the amount by which the sum of the market value of the Company’s investments (as of the date of termination or non-renewal) plus distributions attributable to net sales proceeds paid to holders of Common Shares exceeds the sum of the aggregate capital contributed by them plus an amount equal to an 8% annual cumulative, pre-tax, non-compounded return; provided, however, that the subordinated fee upon termination or non-renewal of the advisory agreement will not be paid unless and until holders of Common Shares receive a return of the aggregate capital contributed by them plus 8% annually thereon.

 

The following table represents the fees incurred associated with the payments to the Company’s Advisor for the period indicated:

 

		For the Years Ended December 31,
		2017				2016
Acquisition fee (1)		$	573,750			$	-
Asset management fees (general and administrative costs)			574,072				-
Total		$	1,147,822			$	-

 

(1)

The acquisition fee for the Cove Joint Venture (see below) of $573,750 was capitalized and included in unconsolidated affiliated real estate entities on the consolidated balance sheets.

 

The following table represents the selling commissions and dealer manager fees and other offering costs for the periods indicated:

 

		For the Years Ended December 31,
		2017				2016
Selling commissions and dealer manager fees		$	2,330,905			$	4,968,164
Other offering costs		$	25,493			$	1,044,980

 

Cumulatively, we have incurred approximately $7.6 million in selling commissions and dealer manager fees and $3.2 million of organization and other offering costs.

 

Investments in Unconsolidated Affiliated Real Estate Entities

 

The entities listed below are partially owned by the Company. The Company accounts for these investments under the equity method of accounting as the Company exercises significant influence, but does not exercise financial and operating control, and is not considered to be the primary beneficiary of these entities. A summary of the Company’s investments in the unconsolidated affiliated real estate entities is as follows:

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

								As of
Entity		Date of Ownership		Ownership %				December 31, 2017				December 31, 2016
RP Maximus Cove, L.L.C. (the "Cove Joint Venture")		January 31, 2017			22.50	%		$	17,805,871			$	-
40 East End Ave. Pref Member LLC ( “40 East End Ave. Joint Venture”)		March 31, 2017			33.30	%			12,911,770				-
Total investments in unconsolidated affiliated real estate entities								$	30,717,641			$	-

 

The Cove Joint Venture

 

On September 29, 2016, the Company, through its wholly owned subsidiary, REIT Cove LLC (“REIT Cove”) along with LSG Cove LLC (“LSG Cove”), an affiliate of the Company’s Sponsor and a related party, and Maximus Cove Investor LLC (“Maximus”), an unrelated third party (collectively, the “Buyer”), entered into an agreement of sale and purchase (the “Cove Transaction”) with an unrelated third party, RP Cove, L.L.C (the “Cove Seller”), pursuant to which the Buyer would acquire the all of the Cove Seller’s membership interest in RP Maximus Cove, L.L.C. (the “Cove Joint Venture”) for approximately $255.0 million. The Cove Joint Venture owns and operates The Cove at Tiburon (“The Cove”), a 281-unit, luxury waterfront multifamily rental property located in Tiburon, California. Prior to entering into the Cove Transaction, Maximus previously owned a separate noncontrolling interest in the Cove Joint Venture.

 

On January 31, 2017, REIT Cove entered into an Assignment and Assumption Agreement (the “Assignment”) with another one of the Company’s wholly owned subsidiaries, REIT IV COVE LLC (“REIT IV Cove”) and REIT III COVE LLC (“REIT III Cove”), a subsidiary of the operating partnership of Lightstone Value Plus Real Estate Investment Trust III, Inc., a real estate investment trust also sponsored by the Company’s Sponsor and a related party, and together with REIT IV Cove, collectively, the “Assignees”. Under the terms of the Assignment, the Assignees were assigned the rights and obligations of REIT Cove with respect to the Cove Transaction.

  

On January 31, 2017, REIT IV Cove, REIT III Cove, LSG Cove, and Maximus (the “Members”) completed the Cove Transaction for aggregate consideration of approximately $255.0 million, which consisted of $80 million of cash and $175 million of proceeds from a loan from a financial institution. The Company paid approximately $20.0 million for a 22.5% membership interest in the Cove Joint Venture. In connection with the acquisition, the Company paid the Advisor an acquisition fee of $0.6 million, equal to 1.0% of the Company’s pro-rata share of the contractual purchase price which has been included in investments in unconsolidated affiliated real estate entities on the consolidated balance sheets.

 

The Company’s ownership interest in the Cove Joint Venture is a non-managing interest. The Company has determined that the Cove Joint Venture is a variable interest entity (“VIE”) and, because it exerts significant influence over but does not control the Cove Joint Venture, the Company accounts for its ownership interest in the Cove Joint Venture in accordance with the equity method of accounting. All distributions of earnings from the Cove Joint Venture are made on a pro rata basis in proportion to each Member’s equity interest percentage. Any distributions in excess of earnings from the Cove Joint Venture are made to the Members pursuant to the terms of the Cove Joint Venture’s operating agreement. An affiliate of Maximus is the asset manager of The Cove and receives certain fees as defined in the Property Management Agreement for the management of The Cove. The Company commenced recording its allocated portion of profit/loss and cash distributions beginning as of January 31, 2017 with respect to its membership interest of 22.5% in the Cove Joint Venture. 

 

The Cove is a multi-family complex consisting of 281-units, or 289,690 square feet, contained within 32 apartment buildings over 20.1 acres originally constructed in 1967.

 

In connection with the closing of the Cove Transaction, the Cove Joint Venture simultaneously entered into a $175.0 million loan (the “Loan”) initially scheduled to mature on January 31, 2020 with two, one-year extension options, subject to certain conditions. The Loan requires monthly interest payments through its maturity date.  The Loan bears interest at Libor plus 3.85% through its initial maturity and Libor plus 4.15% during each of the extension periods. The Loan is collateralized by The Cove and an affiliate of the Company’s Sponsor (the “Guarantor”) has guaranteed the Cove Joint Venture‘s obligation to pay the outstanding balance of the Loan up to approximately $43.8 million (the “Loan Guarantee”). The Members have agreed to reimburse the Guarantor for any balance that may become due under the Loan Guarantee, of which the Company’s share is up to approximately $10.9 million. 

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Starting in 2013, the Cove has been undergoing an extensive refurbishment which is substantially completed. The Members have and intend to continue to use the remaining proceeds from the Loan and to invest additional capital if necessary to complete the refurbishment. The Guarantor has provided an additional guarantee of up to approximately $13.4 million (the “Refurbishment Guarantee”) to provide any necessary funds to complete the remaining renovations as defined in the Loan. The Members have agreed to reimburse the Guarantor for any balance that may become due under the Refurbishment Guarantee, of which the Company’s share is up to approximately $3.3 million.

 

The Company has determined that the fair value of both the Loan Guarantee and the Refurbishment Guarantee are immaterial.

 

During the year ended December 31, 2016, the Buyer made nonrefundable deposits of approximately $12.6 million which were applied towards the Cove Transaction, of which the Company’s share was approximately $5.7 million which was included in deposits and other assets on the consolidated balance sheet as of December 31, 2016.

 

The Cove Joint Venture Condensed Financial Information

 

The Company’s carrying value of its interest in the Cove Joint Venture differs from its share of member’s equity reported in the condensed balance sheet of the Cove Joint Venture due to the Company’s basis of its investment in excess of the historical net book value of the Cove Joint Venture. The Company’s additional basis allocated to depreciable assets is being recognized on a straight-line basis over the lives of the appropriate assets.

 

The following table represents the condensed income statement for the Cove Joint Venture:

 

(amounts in thousands)		For the Period January 31, 2017 (date of investment) through December 31, 2017
Revenue		$	12,291
Property operating expenses			4,300
General and administrative costs			249
Depreciation and amortization			8,743
Operating loss			(1,001	)
Interest expense and other, net			(8,578	)
Net loss		$	(9,579	)
Company's share of net loss (22.50%)		$	(2,155	)
Additional depreciation and amortization expense (1)			(659	)
Company's loss from investment		$	(2,814	)

 

The following table represents the condensed balance sheet for the Cove Joint Venture:

 

		As of
(amounts in thousands)		December 31, 2017
Real estate, at cost (net)		$	149,727
Cash and restricted cash			2,538
Other assets			1,541
Total assets		$	153,806
Mortgage payable, net		$	173,534
Other liabilities			2,830
Members' deficit (1)			(22,558	)
Total liabilities and members' deficit		$	153,806

 

(1)

Additional depreciation and amortization expense relates to the difference between the Company’s basis in the Cove Joint Venture and the amount of the underlying equity in net assets of the Cove Joint Venture.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

40 East End Ave. Joint Venture

 

On March 31, 2017, the Company entered into a joint venture agreement (the “40 East End Ave. Transaction”) with SAYT Master Holdco LLC, an entity majority-owned and controlled by David Lichtenstein, who also majority owns and controls the Company’s Sponsor, and a related party, (the “40 East End Seller”), providing for the Company to acquire 33.3% of the 40 East End Seller’s approximate 100% membership interest in 40 East End Ave. Pref Member LLC ( “40 East End Ave. Joint Venture”) for aggregate consideration of approximately $10.3 million. The Company subsequently made additional capital contributions aggregating $2.6 million to the 40 East End Ave. Joint Venture during 2017.

 

In accordance with the Company’s charter, a majority of the Company’s board of directors, including a majority of the Company’s independent directors not otherwise interested in the transaction, approved the 40 East End Ave. Transaction as fair and reasonable to the Company and on terms and conditions not less favorable to the Company than those available from unaffiliated third parties.

 

The Company’s ownership interest in the 40 East End Ave. Joint Venture is a non-managing interest. Because the Company exerts significant influence over but does not control the 40 East End Ave. Joint Venture, it accounts for its ownership interest in the 40 East End Ave. Joint Venture in accordance with the equity method of accounting. All contributions to and distributions of earnings from the 40 East End Ave. Joint Venture are made on a pro rata basis in proportion to each Member’s equity interest percentage. Any distributions in excess of earnings from the 40 East End Ave. Joint Venture are made to the Members pursuant to the terms of its operating agreement. The Company commenced recording its allocated portion of earnings and cash distributions from the 40 East End Ave. Joint Venture beginning as of March 31, 2017 with respect to its membership interest of approximately 33.3% in the 40 East End Ave. Joint Venture. Additionally, Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”), a real estate investment trust also sponsored by the Company’s Sponsor, has made $30.0 million of preferred equity contributions to a subsidiary of the 40 East End Ave. Joint Venture, pursuant to an instrument that entitles Lightstone I to monthly preferred distributions at a rate of 12% per annum.

 

The 40 East End Ave. Joint Venture, through affiliates, owns a parcel of land located at the corner of 81^st Street and East End Avenue in the Upper East Side neighborhood of New York City on which it is constructing a luxury residential project consisting of 29 condominium units (the “40 East End Ave. Project”). As of and for the year ended December 31, 2017, the 40 East End Project was still under development and the 40 East End Ave. Joint Venture had no results of operations.

 

The following table represents the condensed balance sheet for the 40 East End Ave. Joint Venture:

 

		As of
(amounts in thousands)		December 31, 2017
Real estate inventory		$	93,228
Cash and restricted cash			765
Other assets			227
Total assets		$	94,220
Mortgage payable, net		$	20,792
Other liabilities			4,593
Members' capital			68,835
Total liabilities and members' capital		$	94,220

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

Investment in Related Party

 

105-109 W. 28^th Street Preferred Investment 

 

On November 25, 2015, the Company entered into an agreement (the “Moxy Transaction”) with various related party entities that provides for the Company to make aggregate preferred equity contributions (the “105-109 W. 28^th Street Preferred Investment”) of up to $20.0 million in various affiliates of its Sponsor (the “Moxy Developer”) which owns a parcel of land located at 105-109 W. 28^thStreet, New York, New York on which they are constructing a 343-room Marriott Moxy hotel, which currently is expected to open during the third quarter of 2018. The 105-109 W. 28^th Street Preferred Investment was made pursuant to an instrument that entitles the Company to monthly preferred distributions at a rate of 12% per annum and the Company could redeem at the earlier of (i) the date that was two years from the date of the Company’s final contribution or (ii) the third anniversary of 105-109 W. 28^th Street Preferred Investment. The Company could also have requested redemption or a restructuring of the agreement prior to the acceptance of any construction financing. On June 30, 2016, the Company and the Developer amended the Moxy Transaction so that the Company’s contributions would become redeemable on the fifth anniversary of the Moxy Transaction. The 105-109 W. 28^th Street Preferred Investment is classified as a held-to-maturity security and recorded at cost. 

 

On August 30, 2016, the Company and the Developer further amended the Moxy Transaction so that Company’s total aggregate contributions under the 105-109 W. 28^th Street Preferred Investment increased by $17.0 million, to up to $37.0 million.

 

The Company made an initial contribution of $4.0 million during the fourth quarter of 2015 and additional aggregate contributions of $33.0 million during the year ended December 31, 2016. As of both December 31, 2017 and 2016, the 105-109 W. 28th Street Preferred Investment had an outstanding balance of $37.0 million, which is classified in investment in related party on the consolidated balance sheets. The Company funded its contributions using proceeds generated from the Offering and draws under the Subordinated Agreement (see below). During the years ended December 31, 2017 and 2016, the Company recorded $4.5 million and $1.9 million, respectively; of investment income related to the 105-109 W. 28^th Street Preferred Investment. The Company’s Advisor elected to waive the acquisition fee associated with this transaction.​

 

Subordinated Advances – Related Party

 

On March 18, 2016, the Company and its Sponsor entered into the Subordinated Agreement, a subordinated unsecured loan agreement pursuant to which the Sponsor had committed to make a significant investment in the Company of up to $36.0 million, which was equivalent to 12.0% of the $300.0 million maximum offering amount of Common Shares under the Offering, which was terminated on March 31, 2017. The outstanding advances under the Subordinated Agreement (the “Subordinated Advances”) bear interest at a rate of 1.48%, but no interest or outstanding advances are due and payable to the Sponsor until holders of the Company’s Common Shares have received liquidation distributions equal to their respective net investments (defined as $10.00 per Common Share) plus a cumulative, pre-tax, non-compounded annual return of 8.0% on their respective net investments.

 

Distributions in connection with a liquidation of the Company initially will be made to holders of its Common Shares until holders of its Common Shares have received liquidation distributions equal to their respective net investments plus a cumulative, pre-tax, non-compounded annual return of 8.0% on their respective net investments. Thereafter, only if additional liquidating distributions are available, the Company will be obligated to repay the outstanding advances under the Subordinated Agreement and accrued interest to the Sponsor, as described in the Subordinated Agreement. In the event that additional liquidation distributions are available after the Company repays its holders of common stock their respective net investments plus their 8% return on investment and then the outstanding advances under the Subordinated Agreement and accrued interest to its Sponsor, such additional distributions will be paid to holders of its Common Shares and its Sponsor: 85.0% of the aggregate amount will be payable to holders of the Company’s Common Shares and the remaining 15.0% will be payable to the Sponsor.

 

The Subordinated Advances and its related interest are subordinate to all of the Company’s obligations as well as to the holders of its Common Shares in an amount equal to the shareholder’s net investment plus a cumulative, pre-tax, non-compounded annual return of 8.0% and only potentially payable in the event of a liquidation of the Company.

 

In connection with the termination of the Offering on March 31, 2017, the Company and the Sponsor terminated the Subordinated Agreement. As a result of the termination, the Sponsor is no longer obligated to make any additional Subordinated Advances to the Company. Interest will continue to accrue on the aggregate Subordinated Advances and repayment, if any, of the Subordinated Advances and accrued interest will be made according to the terms of the Subordinated Agreement disclosed above.

 

As of both December 31, 2017 and 2016 an aggregate of approximately $12.6 million of Subordinated Advances had been funded, which along with the related accrued interest of $258,817 and $71,863, respectively, are classified as a liability on the consolidated balance sheet. During the years ended December 31, 2017 and 2016, the Company accrued $186,954 and $71,863, respectively, of interest on the Subordinated Advances.

 

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2017 and December 31, 2016

 

5. Commitments and Contingencies

 

Legal Proceedings 

 

From time to time in the ordinary course of business, the Company may become subject to legal proceedings, claims or disputes.

 

6. Quarterly Financial Data (Unaudited)    

 

The following table presents selected unaudited quarterly financial data for each quarter during the years ended December 31, 2017 and 2016:

 

		2017
		Year ended				Quarter ended				Quarter ended				Quarter ended				Quarter ended
		December 31,				December 31,				September 30,				June 30,				March 31,
Total income		$	1,687,842			$	387,721			$	393,665			$	309,163			$	597,293
Net income		$	419,506			$	26,212			$	80,583			$	15,978			$	296,733
Net income applicable to Company's common shares		$	419,506			$	26,212			$	80,583			$	15,978			$	296,733
Net income per common share, basic and diluted		$	0.05			$	-			$	0.01			$	-			$	0.04

 

		2016
		Year ended				Quarter ended				Quarter ended				Quarter ended				Quarter ended
		December 31,				December 31,				September 30,				June 30,				March 31,
Total income		$	1,928,708			$	825,575			$	600,366			$	347,634			$	155,133
Net income		$	1,537,999			$	675,206			$	493,955			$	275,357			$	93,481
Net income applicable to Company's common shares		$	1,537,999			$	675,206			$	493,955			$	275,357			$	93,481
Net income per common share, basic and diluted		$	0.53			$	0.12			$	0.13			$	0.20			$	0.11

 

  

PART II. CONTINUED:

 

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:

 

None.

 

Item 9A. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures. As of December 31, 2017, we conducted an evaluation under the supervision and with the participation of the Advisor’s management, including our Chairman and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chairman and Chief Executive Officer and Chief Financial Officer concluded as of December 31, 2017 that our disclosure controls and procedures were adequate and effective.

 

Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system is a process designed by, or under the supervision of, our Chairman and Chief Executive Officer and Chief Financial Officer and effected by our Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles.

 

Our internal control over financial reporting includes policies and procedures that:

 

•

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and disposition of assets;

 

•

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial  statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with the authorization of our management and directors; and

 

•

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

 

Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. In making this assessment, they used the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in its report entitled Internal Control—Integrated Framework (2013). Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2017.

 

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

 

Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION:

 

None.

 

PART III.

 

ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE REGISTRANT

 

Directors

 

The following table presents certain information as of February 15, 2018 concerning each of our directors serving in such capacity:

 

Name		Age		Principal Occupation and Positions Held		Year Term of Office Will Expire		Served as a Director Since
David Lichtenstein		57		Chief Executive Officer and Chairman of the Board of Directors		2018		2015
Edwin J. Glickman		85		Director		2018		2015
Steven Spinola		69		Director		2018		2015

 

David Lichtenstein is our Chief Executive Officer and Chairman of our board of directors. . Mr. Lichtenstein founded both American Shelter Corporation and The Lightstone Group. From 1988 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of The Lightstone Group, directing all aspects of the acquisition, financing and management of a diverse portfolio of multifamily, lodging, retail and industrial properties located in 20 states and Puerto Rico. From June 2004 to the present, Mr. Lichtenstein has served as the Chairman of the Board of Directors and Chief Executive Officer of Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”) and Chief Executive Officer of Lightstone Value Plus REIT LLC, its advisor. From April 2008 to the present, Mr. Lichtenstein has served as the Chairman of the Board of Directors and Chief Executive Offer of Lightstone Value Plus Real Estate Investment Trust II, Inc. (“Lightstone II”) and Lightstone Value Plus REIT II LLC, its advisor. From September 2014 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of Lightstone Value Plus Real Estate Investment Trust III, Inc. (“Lightstone III”), and as Chief Executive Officer of Lightstone Value Plus REIT II ILLC, its advisor. From October 2014 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of Lightstone Enterprises Limited (“Lightstone Enterprises”). Mr. Lichtenstein was appointed Chairman of the Board of Directors of Lightstone Value Plus Real Estate Investment Trust V, Inc. (“Lightstone V”), formerly known as Behringer Harvard Opportunity REIT II, Inc., effective as of September 28, 2017 and is Chairman and Chief Executive Officer of the its advisor. Mr. Lichtenstein was the president and/or director of certain subsidiaries of Extended Stay Hotels, Inc. (“Extended Stay”) that filed for Chapter 11 protection with Extended Stay. Extended Stay and its subsidiaries filed for bankruptcy protection on June 15, 2009 so they could reorganize their debts in the face of looming amortization payments. Extended Stay emerged from bankruptcy on October 8, 2010. Mr. Lichtenstein is no longer affiliated with Extended Stay. From July 2015 to the present, Mr. Lichtenstein has served as a member of the Board of Directors of the New York City Economic Development Corporation. Mr. Lichtenstein is also a member of the International Council of Shopping Centers and the National Association of Real Estate Investment Trusts, Inc., an industry trade group, as well as a member of the Board of Directors of Touro College and New York Medical College. Mr. Lichtenstein has been selected to serve as a director due to his experience and networking relationships in the real estate industry, along with his experience in acquiring and financing real estate properties.

 

 

Edwin J. Glickman is one of our independent directors and the chairman of our audit committee. From April 2008 to the present, Mr. Glickman has served as a member of the board of directors of Lightstone II and from September 2014 to the present has served as a member of the board of directors of Lightstone III. From December 2004 through January 2015, Mr. Glickman previously served as a member of the board of directors of Lightstone I. In January 1995, Mr. Glickman co-founded Capital Lease Funding, a leading mortgage lender for properties net leased to investment grade tenants, where he remained as Executive Vice President until May 2003 when he retired. Mr. Glickman was previously a trustee of publicly traded RPS Realty Trust from October 1980 through May 1996 and Atlantic Realty Trust from May 1996 to March 2006. Mr. Glickman graduated from Dartmouth College. Mr. Glickman has been selected to serve as an independent director due to his experience in mortgage lending and finance.

 

Stephen Spinola is one of our independent directors and is a member of our audit committee. Since 1986, Mr. Spinola has been the President of the Real Estate Board of New York (“REBNY”), and as of July 1, 2015 serves as President Emeritus. Prior to becoming REBNY’s President, Mr. Spinola served as President of the New York City Public Development Corporation (now known as the New York City Economic Development Corporation). Mr. Spinola holds a Bachelor of Arts degree from the City College of New York with a concentration in political science and government. Mr. Spinola has been selected to serve as an independent director due to his extensive experience in the real estate industry.

 

Executive Officers:

 

The following table presents certain information as of February 15, 2018 concerning each of our executive officers serving in such capacities:

 

Name		Age		Principal Occupation and Positions Held
David Lichtenstein		57		Chief Executive Officer and Chairman of the Board of Directors
Mitchell Hochberg		65		President and Chief Operating Officer
Joseph Teichman		44		General Counsel and Secretary
Donna Brandin		60		Chief Financial Officer and  Treasurer

 

David Lichtenstein for biographical information about Mr. Lichtenstein, see ‘‘Management — Directors.”

 

Mitchell Hochberg is our President and Chief Operating Officer and also serves as President and Chief Operating Officer of Lightstone I, Lightstone II and Lightstone III and their respective advisors. Mr. Hochberg also serves as the President and Chief Operating Officer of our sponsor and our advisor. From October 2014 to the present, Mr. Hochberg has served as President of Lightstone Enterprises. Mr. Hochberg was appointed Chief Executive Officer of Behringer Harvard Opportunity REIT I, Inc. (“BH OPP I”) and Lightstone V effective as of September 28, 2017. Prior to joining The Lightstone Group in August 2012, Mr. Hochberg served as principal of Madden Real Estate Ventures from 2007 to August 2012 when it combined with our sponsor. Mr. Hochberg held the position of President and Chief Operating Officer of Ian Schrager Company, a developer and manager of innovative luxury hotels and residential projects in the United States from early 2006 to early 2007 and prior to that Mr. Hochberg founded Spectrum Communities, a developer of luxury neighborhoods in the northeast of the United States, in 1985 where for 20 years he served as its President and Chief Executive Officer. Additionally, Mr. Hochberg serves on the board of directors of Orient-Express Hotels Ltd and as Chairman of the board of directors of Orleans Homebuilders, Inc. Mr. Hochberg received his law degree as a Harlan Fiske Stone Scholar from Columbia University School of Law and graduated magna cum laude from New York University College of Business and Public Administration with a Bachelor of Science degree in accounting and finance.

 

Joseph E. Teichman is our General Counsel and Secretary and also serves as General Counsel of Lightstone I, Lightstone II and Lightstone III and their respective advisors. Mr. Teichman also serves as Executive Vice President and General Counsel of our sponsor and as General Counsel of our advisor. From October 2014 to the present, Mr. Teichman has served as Secretary and a Director of Lightstone Enterprises. Prior to joining The Lightstone Group in January 2007, Mr. Teichman practiced law at the law firm of Paul, Weiss, Rifkind, Wharton & Garrison LLP in New York, NY from September 2001 to January 2007. Mr. Teichman earned a J.D. from the University of Pennsylvania Law School and a B.A. from Beth Medrash Govoha, Lakewood, New Jersey. Mr. Teichman is licensed to practice law in New York and New Jersey. Mr. Teichman was also a director of certain subsidiaries of Extended Stay that filed for Chapter 11 protection with Extended Stay. Extended Stay and its subsidiaries filed for bankruptcy protection on June 15, 2009 so they could reorganize their debts in the face of looming amortization payments. Extended Stay emerged from bankruptcy on October 8, 2010. Mr. Teichman is no longer affiliated with Extended Stay. Mr. Teichman is also a member of the Board of Directors of Yeshiva Orchos Chaim, Lakewood, New Jersey and was appointed to the Ocean County College Board of Trustees in February 2016.

 

 

Donna Brandin is our Chief Financial Officer and Treasurer and also serves as the Chief Financial Officer and Treasurer of Lightstone I, Lightstone II and Lightstone III. Ms. Brandin also serves as the Executive Vice President, Chief Financial Officer and Treasurer of our sponsor and as the Chief Financial Officer and Treasurer of our advisor and the advisors of Lightstone I, Lightstone II and Lightstone III. From October 2014 to the present, Ms. Brandin has served as a Director of Lightstone Enterprises. Ms. Brandin was appointed Chief Financial Officer, Senior Vice President, and Treasurer of OP I and Lightstone V effective as of June 15, 2017. Prior to joining The Lightstone Group in April 2008, Ms. Brandin held the position of Executive Vice President and Chief Financial Officer of US Power Generation from September 2007 through November 2007 and before that was the Executive Vice President and Chief Financial Officer of Equity Residential, the largest publicly traded apartment REIT in the country, from August 2004 through September 2007. Prior to joining Equity Residential, Ms. Brandin held the position of Senior Vice President and Treasurer for Cardinal Health from June 2000 through August 2004. Prior to 2000, Ms. Brandin held various executive-level positions at Campbell Soup, Emerson Electric Company and Peabody Holding Company. Ms. Brandin earned a Bachelor of Science at Kutztown University and a Masters in Finance at St. Louis University and is a certified public accountant.

 

Section 16 (a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires each director, officer and individual beneficially owning more than 10% of our common stock to file initial statements of beneficial ownership (Form 3) and statements of changes in beneficial ownership (Forms 4 and 5) of our common stock with the Securities Exchange Commission ("SEC"). Officers, directors and greater than 10% beneficial owners are required by Securities and Exchange Commission rules to furnish us with copies of all such forms they file. Based solely on a review of the copies of such forms furnished to us during and with respect to the fiscal year ended December 31, 2017, or written representations that no additional forms were required, we believe that all of our officers and directors and persons that beneficially own more than 10% of the outstanding shares of our common stock complied with these filing requirements in 2017.

 

Information Regarding Audit Committee

 

Our Board established an audit committee in September 2014. The charter of audit committee is available at www.lightstonecapitalmarkets.com/sec-filings or in print to any stockholder who requests it c/o Lightstone Real Estate Income Trust Inc., 1985 Cedar Bridge Avenue, Lakewood, NJ 08701. Our audit committee consists of Messrs. Edwin J. Glickman and Steven Spinola each of whom is “independent” within the meaning of the NYSE listing standards. The Board determined that Mr. Glickman is qualified as an audit committee financial expert as defined in Item 401 (h) of Regulation S-K. For more information regarding the relevant professional experience of Messrs. Glickman and Spinola see “Directors.”

 

Code of Conduct and Ethics

 

We have adopted a Code of Conduct and Ethics that applies to all of our executive officers and directors, including but not limited to, our principal executive officer and principal financial officer. Our Code of Conduct and Ethics can be found at www.lightstonecapitalmarkets.com/sec-filings

 

ITEM 11.  EXECUTIVE COMPENSATION

 

Compensation of Executive Officers

 

Our officers will not receive any cash compensation from us for their services as our officers. Additionally, our officers are officers of one or more of our related parties and are compensated by those entities (including our sponsor), in part, for their services rendered to us. From our inception through December 31, 2017, the Company has not compensated the officers.

 

Compensation of Board of Directors  

 

We pay our independent directors an annual fee of $40,000 and are responsible for reimbursement of their out-of-pocket expenses, as incurred.

 

 

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

Executive Officers:

 

The following table presents certain information as of February 15, 2018 concerning each of our directors and executive officers serving in such capacities:

 

Name and Address of Beneficial Owner		Number of Shares of Common Stock of the Lightstone Income Trust Beneficially Owned				Percent of All Common Shares of the Lightstone   Income Trust
David Lichtenstein (1)			242,222				2.7	%
Edwin J. Glickman			-				-
Steven Spinola			-				-
Mitchell Hochberg			-				-
Donna Brandin			-				-
Joseph Teichman			-				-
Our directors and executive officers as a group (6 persons)			242,222				2.7	%

 

(1)

Includes 20,000 shares owned by our Advisor and 222,222 shares owned by an entity 100% owned by David Lichtenstein. Our Advisor is majority owned by David Lichtenstein. The beneficial owner’s business address is 1985 Cedar Bridge Avenue, Lakewood, New Jersey 08701.

 

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS  

 

David Lichtenstein serves as the Chairman of our Board of Directors and our Chief Executive Officer. Our Advisor is majority owned by Mr. Lichtenstein. We entered into agreements with our Advisor and Property Managers to pay certain fees, as described below, in exchange for services performed by these and other affiliated entities. As a majority owner of those entities, Mr. Lichtenstein benefits from fees and other compensation that they receive pursuant to these agreements.

 

Advisor

 

We pay our Advisor an acquisition fee equal to 1.0% of the gross contractual purchase price (including any mortgage assumed) of each property purchased and reimburse our Advisor for expenses that it incurs in connection with the purchase of a property. We anticipate that acquisition expenses will be 0.6% of a property's purchase price, and acquisition fees and expenses are capped at 5% of the gross contract purchase price of a property.

 

Beginning on March 31, 2017, the date on which our initial public offering ended, the Advisor is paid an advisor asset management fee of one-twelfth (1/12) of 0.75% of our average invested assets and we reimburse some expenses of the Advisor relating to asset management.

 

If our Advisor provides services in connection with the financing of an asset, assumption of a loan in connection with the acquisition of an asset or origination or refinancing of any loan on an asset, we will pay our Advisor a financing coordination fee equal to 0.75% of the amount available or outstanding under such financing.

 

For substantial services in connection with the sale of a property, we will pay to our Advisor a commission in an amount equal to the lesser of (a) one-half of a real estate commission that is reasonable, customary and competitive in light of the size, type and location of the property and (b) 2.0% of the contract sales price of the property. The commission will not exceed the lesser of 6.0% of the contract sales price or commission that is reasonable, customary and competitive in light of the size, type and location of the property.

 

 

We will pay our Advisor an annual subordinated performance fee calculated on the basis of our annual return to holders of our Common Shares, payable annually in arrears, such that for any year in which holders of our Common Shares receive payment of a 8.0% annual cumulative, pre-tax, non-compounded return on their respective net investments, our Advisor will be entitled to 15.0% of the amount in excess of such 8.0% per annum return, provided, that the amount paid to the Advisor will not exceed 10.0% of the aggregate return for such year, and provided, further, that the annual subordinated performance fee will not be paid unless holders of our Common Shares receive a return of their respective net investments.

 

The following table represents the fees incurred associated with the payments to the Company’s Advisor for the period indicated:

 

		For the Years Ended December 31,
		2017				2016
Acquisition fee (1)		$	573,750			$	-
Asset management fees (general and administrative costs)			574,072				-
Total		$	1,147,822			$	-

 

(1)

The acquisition fee for the Cove Joint Venture of $573,750 was capitalized and included in unconsolidated affiliated real estate entities on the consolidated balance sheets.

 

Sponsor

 

During the year ended December 31, 2016, we paid $36,298 to an affiliate of the Sponsor for the Sponsor’s marketing expenses related to the offering that were recorded as a reduction to additional paid in capital.

 

On March 18, 2016, the Company and its Sponsor entered into a subordinated unsecured loan agreement (the “Subordinated Agreement”) pursuant to which the Sponsor had committed to make a significant investment in the Company of up to $36.0 million, which is equivalent to 12.0% of the $300.0 million maximum offering amount of Common Shares under the Offering, which was terminated on March 31, 2017. The outstanding advances under the Subordinated Agreement (the “Subordinated Advances”) bear interest at a rate of 1.48%, but no interest or outstanding advances is due and payable to the Sponsor until holders of the Company’s Common Shares have received liquidation distributions equal to their respective net investments (defined as $10.00 per Common Share) plus a cumulative, pre-tax, non-compounded annual return of 8.0% on their respective net investments.

 

Distributions in connection with a liquidation of the Company initially will be made to holders of its Common Shares until holders of its Common Shares have received liquidation distributions equal to their respective net investments plus a cumulative, pre-tax, non-compounded annual return of 8.0% on their respective net investments. Thereafter, only if additional liquidating distributions are available, the Company will be obligated to repay the outstanding advances under the Subordinated Agreement and accrued interest to the Sponsor, as described in the Subordinated Agreement. In the unlikely event that additional liquidation distributions are available after the Company repays its holders of common stock their respective net investments plus their 8% return on investment and then the outstanding advances under the Subordinated Agreement and accrued interest to its Sponsor, such additional distributions will be paid to holders of its Common Shares and its Sponsor: 85.0% of the aggregate amount will be payable to holders of the Company’s Common Shares and the remaining 15.0% will be payable to the Sponsor.

 

The Subordinated Advances and its related interest are subordinate to all of the Company’s obligations as well as to the holders of its Common Shares in an amount equal to the shareholder’s net investment plus a cumulative, pre-tax, non-compounded annual return of 8.0% and only potentially payable in the event of a liquidation of the Company.

 

In connection with the termination of the Offering on March 31, 2017, the Company and the Sponsor terminated the Subordinated Agreement. As a result of the termination, the Sponsor is no longer obligated to make any additional Subordinated Advances to the Company. Interest will continue to accrue on the aggregate Subordinated Advances and repayment, if any, of the Subordinated Advances and accrued interest will be made according to the terms of the Subordinated Agreement disclosed above.

 

As of both December 31, 2017 and 2016 an aggregate of approximately $12.6 million of Subordinated Advances had been funded, which along with the related accrued interest of $258,817 and $71,863, respectively, are classified as a liability on the consolidated balance sheet. During the years ended December 31, 2017 and 2016, the Company accrued $186,954 and $71,863, respectively, of interest on the Subordinated Advances.

 

 

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

  

Principal Accounting Firm Fees

 

The following table presents the aggregate fees billed to us for the years presented by our principal accounting firm:

  

		Year ended December 31, 2017				Year ended December 31, 2016
Audit Fees     (a)		$	89,250			$	123,475
Audit-Related Fees (b)			-				-
Tax Fees (c)			18,950				10,000
Total Fees		$	108,200			$	133,475

 

(a)

Fees for audit services consisted of the audit of the Company’s annual financial statements and interim reviews, including services normally provided in connection with statutory and regulatory filings and including registration statements and consents.

   

(b)

Fees for audit-related services related to audits of entities that the Company has acquired.

   

(c)

Fees for tax services.

 

In considering the nature of the services provided by the independent auditor, the audit committee determined that such services are compatible with the provision of independent audit services. The audit committee discussed these services with the independent auditor and our management to determine that they are permitted under the rules and regulations concerning auditor independence promulgated by the Securities and Exchange Commission to implement the related requirements of the Sarbanes-Oxley Act of 2002, as well as the American Institute of Certified Public Accountants.

 

AUDIT COMMITTEE REPORT

 

To the Directors of Lightstone Real Estate Income Trust Inc.:  

 

We have reviewed and discussed with management Lightstone Real Estate Income Trust Inc.’s audited financial statements as of and for the year ended December 31, 2017.  

 

We have discussed with the independent auditors the matters required to be discussed by Statement on Auditing Standards No. 61, “Communication with Audit Committees,” (Codification of Statements of Auditing Standards, August 2, 2007 AU 380), as amended, as adopted by the Public Company Accounting Oversight Board in Rule 3200T.  

 

We have received and reviewed the written disclosures and the letter from the independent auditors required by Public Company Accounting Oversight Board Rule 3526, Communication with Audit Committees Concerning Independence and have discussed with the auditors the auditors’ independence.

 

Based on the reviews and discussions referred to above, we recommend to the board of directors that the financial statements referred to above be included in Lightstone Real Estate Income Trust Inc.’s Annual Report on Form 10-K for the year ended December 31, 2017.  

 

Audit Committee
Edwin J. Glickman
Steven Spinola

 

 

INDEPENDENT DIRECTORS’ REPORT

 

To the Stockholders of Lightstone Real Estate Income Trust Inc.:

 

We have reviewed the Company’s policies and determined that they are in the best interest of the Company’s stockholders. Set forth below is a discussion of the basis for that determination.

 

General

 

The Company has and will continue to seek to originate, acquire and manage a diverse portfolio of real estate-related investments. The Company may invest in mezzanine loans, first lien mortgage loans, second lien mortgage loans, bridge loans and preferred equity interests, in each case with a focus on investments intended to finance development or redevelopment opportunities. The Company may also invest in debt and derivative securities related to real estate assets, such as CMBS; CDOs; debt securities issued by real estate companies; and credit default swaps. The Company expects that a majority of its investments by value will be secured by or related to properties or entities advised by, or wholly or partially, directly or indirectly, owned by, the Company’s Sponsor, by its affiliates or real estate investment programs sponsored by it. Although the Company expects that most of its investments will be of these types, it may make other investments. In fact, it may invest in whatever types of real estate-related investments that it believes are in its best interests.

 

The Company has and expects to continue to focus its origination and acquisition activity on real estate-related investments secured by or related to properties located in the United States, and primarily related-party investments. The Company sometimes refers to the foregoing types of investments as its targeted investments. The Company expects to target investments that generally will offer predictable current cash flow and attractive risk-adjusted returns based on the underwriting criteria established and employed by tis advisor, which may include the anticipated leverage point, market and economic conditions, the location and quality of the underlying collateral and the borrower’s exit or refinancing plan. The Company’s ability to execute its investment strategy is enhanced through access to its Sponsor’s extensive experience in financing real estate projects it has sponsored, as opposed to a strategy that relies solely on buying assets in the open market from third-party originators. The Company has and will continue to seek to build a portfolio that includes some of or all the following investment characteristics: (a) provides current income; (b) is secured by high-quality commercial real estate; (c) includes subordinate capital investments by strong sponsors that support tis investments and provide downside protection; and (d) possesses strong structural features that maximize repayment potential, such as a clear exit or refinancing plan by the borrower.

 

The Company has and intends to continue to invest in real estate-related loans and debt securities both by directly originating them and by purchasing them from third-party sellers. Although the Company generally prefers the benefits of direct origination, situations may arise to purchase real estate-related loans and debt securities, possibly at discounts to par, which compensate for the lack of control or structural enhancements typically associated with directly structured investments.

 

Financing Policies

 

There is no limitation on the amount the Company may invest or borrow for the purchase or origination of any single property or investment. The Company’s charter allows it to incur leverage up to 300% of its total “net assets” (as defined in its charter) as of the date of any borrowing, which is generally expected to be approximately 75% of the cost of its investments. The Company may only exceed this 300% limit if a majority of its independent directors approves each borrowing in excess of this limit and the Company discloses such borrowing to its stockholders in its next quarterly report along with a justification for the excess borrowing. In all events, the Company expects that its secured and unsecured borrowings will be reasonable in relation to the net value of its assets and will be reviewed by the Company’s board of directors at least quarterly.

 

The Company does not currently intend to exceed the leverage limit in its charter. The Company believes that careful use of debt helps the Company to achieve its diversification goals because the Company may have more funds available for investment. However, high levels of debt could cause the Company to incur higher interest charges and higher debt service payments, which would decrease the amount of cash available for distribution to the Company’s investors.

 

 

Policy on Sale or Disposition of Properties

 

The Company’s board of directors will determine whether a particular property should be sold or otherwise disposed of after considering the relevant factors, including performance or projected performance of the property and market conditions, with a view toward achieving its principal investment objectives.

 

The Company currently intends to hold each investment it originates or acquires for an extended period of time, generally for three to five years from the termination of the Company’s initial public offering, which occurred on March 31, 2017. The determination of whether an investment will be sold or otherwise disposed of will be made after consideration of relevant factors, including prevailing economic conditions, specific real estate market conditions, tax implications for the Company’s stockholders and other factors. The requirements for qualification as a REIT also will put some limits on the Company’s ability to sell investments after short holding periods. However, in accordance with the Company’s investment objective of realizing growth in the value of its investments, the Company may sell a particular investment before or after this anticipated holding period if, in the judgment of its advisor and its board of directors, selling the investment is in the Company’s best interest. The determination of when a particular investment should be sold or otherwise disposed of will be made after consideration of relevant factors, including prevailing and projected economic conditions, whether the value of the investment is anticipated to decline substantially, whether the Company could apply the proceeds from the sale of the investment to make other investments consistent with its investment objectives, whether disposition of the investment would allow the Company to increase cash flow, and whether the sale of the investment would constitute a prohibited transaction under the Code or otherwise impact the Company’s status as a REIT. The Company’s ability to dispose of an investment during the first few years following its acquisition is restricted to a substantial extent as a result of its REIT status. Under applicable provisions of the Code regarding prohibited transactions by REITs, a REIT that sells an asset other than foreclosure property that is deemed to be inventory or property held primarily for sale in the ordinary course of business is deemed a “dealer” and subject to a 100% penalty tax on the net income from any such transaction. As a result, the Company’s board of directors will attempt to structure any disposition of the Company’s investments to avoid this penalty tax through reliance on safe harbors available under the Code for assets held at least two years or through the use of a TRS.

 

When the Company determines to sell a particular investment, it will seek to achieve a selling price that maximizes the capital appreciation for investors based on then-current market conditions. The Company cannot assure its investors that this objective will be realized.

 

Independent Directors
Edwin J. Glickman
Steven Spinola

 

 

PART IV.

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES:

 

LIGHTSTONE REAL ESTATE INCOME TRUST INC.

Annual Report on Form 10-K

For the fiscal year ended December 31, 2017

 

EXHIBIT INDEX

 

The following exhibits are included, or incorporated by reference, as part of this Annual Report on Form 10-K (and are numbered in accordance with Item 601 of Regulation S-K):

 

EXHIBIT NO.		DESCRIPTION
1.1(5)		Amended and Restated Dealer Manager Agreement by and between Lightstone Real Estate Income Trust Inc. and Orchard Securities, LLC
1.2(9)		Form of Soliciting Dealer Agreement
3.1(3)		Articles of Amendment and Restatement of Lightstone Real Estate Income Trust Inc.
3.2(1)		Bylaws of Lightstone Real Estate Income Trust Inc.
3.3(4)		Articles of Amendment of Lightstone Real Estate Income Trust Inc.
4.1(8)		Distribution Reinvestment Program, included as Appendix C to prospectus
5.1(2)		Opinion of Venable LLP re legality
10.1(6)		Advisory Agreement, dated as of March 4, 2015,  by and between Lightstone Real Estate Income Trust Inc. and Lightstone Real Estate Income LLC
10.2(6)		Amended and Restated Limited Liability Company Agreement of NYC Acquisitions IV LLC between LSG Fulton Street LLC and Lightstone Real Estate Income Trust Inc.
10.3(7)		Subordinated Unsecured Loan Agreement, dated as of March 18, 2016, between Lightstone Real Estate Income Trust Inc. and The Lightstone Group, LLC.
10.4(9)		Purchase and Sale Agreement, dated as of September 29, 2016, by and among REIT Cove LLC, LSG Cove LLC and Maximus Cove Investor LLC, on the one hand, and RP Cove, L.L.C., on the other.
10.5(9)		Assignment and Assumption Agreement, dated as of January 31, 2017, by and among REIT Cove LLC, REIT IV Cove LLC and REIT III Cove LLC.
10.6 (10)		DMA Termination Agreement by and between Lightstone Real Estate Income Trust Inc. and Orchard Securities, LLC
10.7 (10)		Loan Termination Agreement by and between Lightstone Real Estate Income Trust Inc. and The Lightstone Group, LLC
10.8 (11)		Amended And Restated Limited Liability Company Operating Agreement, dated as of January 31, 2017, by and among RP Maximus Cove, L.L.C., LSG Cove LLC, REIT III Cove LLC, REIT IV Cove LLC and Maximus Cove Investor LLC.
10.9 (11)		Amended And Restated Limited Liability Company Agreement, dated as of March 31, 2017, of 40 East End Ave. Pref Member LLC, by and among SAYT Master Holdco LLC and Lightstone Real Estate Income Trust, Inc.
21*		Subsidiaries of the Registrant.
31.1*		Certification Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*		Certification Pursuant to Rule 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certification Pursuant to Rule 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101*		XBRL (eXtensible Business Reporting Language).The following financial information from Lightstone Real Estate Income Trust Inc. on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 12, 2018, formatted in XBRL includes: (1) Consolidated Balance Sheets, (2) Consolidated Statements of Operations, (3) Consolidated Statements of Stockholders’ Equity, (4) Consolidated Statements of Cash Flows, and (5) the Notes to the Consolidated Financial Statements.

 

  

*

As filed herewith

 

(1)

Previously filed as an exhibit to the Registrant’s Registration Statement on Form S-11 (Reg. No. 333-200464) filed with the SEC on November 24, 2014.

 

(2)

Previously filed as an exhibit to Amendment No. 1 to the Registrant’s Registration Statement on Form S-11 (Reg. No. 333-200464) filed with the SEC on January 29, 2015.

  

(3)

Previously filed as an exhibit to Amendment No. 2 to the Registrant’s Registration Statement on Form S-11 (Reg. No. 333-200464) filed with the SEC on February 12, 2015.

 

(4)

Previously filed as an exhibit to the Current Report on Form 8-K that we filed with the Securities and Exchange Commission on June 15, 2015.

 

(5)

Previously filed as an exhibit to the Current Report on Form 8-K that we filed with the Securities and Exchange Commission on January 12, 2017.

 

(6)

Previously filed as an exhibit to the Annual Report on Form 10-K that we filed with the Securities and Exchange Commission on March 15, 2016.

 

(7)

Previously filed as an exhibit to Post-Effective Amendment No. 2 to the Registrant’s Registration Statement on Form S-11 (Reg No. 333-200464) filed with the SEC on March 21, 2016.

 

(8)

Previously filed as Appendix C  to the Registrant’s Prospectus filed pursuant to Rule 424(b)(3) (Reg. No. 333-200464) filed with the SEC on June 30, 2016.

 

(9)

Previously filed as an exhibit to the Annual Report on Form 10-K that we filed with the Securities and Exchange Commission on March 28, 2017.

 

(10)

Previously filed as an exhibit to the Current Report on Form 8-K that we filed with the Securities and Exchange Commission on April 5, 2017.

 

(11)

Previously filed as an exhibit to the Quarterly Report on Form 10-Q that we filed with the Securities and Exchange Commission on August 14, 2017.

 

Item 16. Form 10-K Summary.

 

None.

 

  

SIGNATURES

 

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

 

	LIGHTSTONE REAL ESTATE INCOME TRUST INC.
Date: March 12, 2018	By:	s/ David Lichtenstein
		David Lichtenstein
		Chief Executive Officer and Chairman of the Board of Directors
		(Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated.

 

NAME		CAPACITY		DATE
/s/ David Lichtenstein		Chief Executive Officer and Chairman of the Board		March 12, 2018
David Lichtenstein		of Directors (Principal Executive Officer)
/s/ Donna Brandin		Chief Financial Officer and Treasurer		March 12, 2018
Donna Brandin		(Principal Financial Officer and Principal
		Accounting Officer)
/s/ Edwin J. Glickman		Director		March 12, 2018
Edwin J. Glickman
/s/ Steven Spinola		Director		March 12, 2018
Steven Spinola