UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

 

For the quarterly period ended September 30, 2018

 

OR

 



For the transition period from                               to                            

 

001-36892

(Commission file number)

 

JERNIGAN CAPITAL, INC.

(Exact name of registrant as specified in its charter)

  







(901) 567-9510

Registrant’s telephone number, including area code

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes     ☒     No     ☐

 

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

 



 

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

 

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

 

As of November 1, 2018, Jernigan Capital, Inc. had 19,473,833 shares of common stock outstanding.

 



 

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Table of Contents

 





 



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In this quarterly report on Form 10-Q (“report”), unless the context indicates otherwise, references to “Jernigan Capital,” “we,” “the Company,” “our” and “us” refer to the activities of and the assets and liabilities of the business and operations of Jernigan Capital, Inc.; “Operating Company” refers to Jernigan Capital Operating Company, LLC, a Delaware limited liability company; and “our Manager” refers to JCAP Advisors, LLC, a Florida limited liability company.

 

PART I. FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



JERNIGAN CAPITAL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



See accompanying notes to consolidated financial statements.

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JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)







 





See accompanying notes to consolidated financial statements.

 



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JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

(in thousands, except share data)   



 

See accompanying notes to consolidated financial statements.    



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JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)



See accompanying notes to consolidated financial statements.    

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JERNIGAN CAPITAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(in thousands, except share and per share data, percentages and as otherwise indicated)

 

1. ORGANIZATION AND FORMATION OF THE COMPANY



Jernigan Capital, Inc. (together with its consolidated subsidiaries, the “Company”) makes debt and equity investments in self-storage development projects and existing self-storage facilities, most of which were recently constructed. The Company is a Maryland corporation that was organized on October 1, 2014 and completed its initial public offering (the “IPO”) on April 1, 2015. The Company is structured as an Umbrella Partnership REIT (“UPREIT”) and conducts its investment activities through its operating company, Jernigan Capital Operating Company, LLC (the “Operating Company”). The Company is externally managed by JCAP Advisors, LLC (the “Manager”).



The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986 (the “Code”), as amended. As a REIT, the Company generally will not be subject to U.S. federal income taxes on REIT taxable income, determined without regard to the deduction for dividends paid and excluded capital gains, to the extent that it annually distributes all of its REIT taxable income to stockholders and complies with various other requirements for qualification as a REIT set forth in the Code.

 

2. SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation



The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying interim consolidated financial statements include all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods included therein. Substantially all operations are conducted through the Operating Company, and all significant intercompany transactions and balances have been eliminated in consolidation.



Use of Estimates



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



Variable Interest Entities



The Company invests in entities that may qualify as variable interest entities (“VIEs”). A VIE is a legal entity that lacks one or more of the characteristics of a voting interest entity. A VIE is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The determination of whether an entity is a VIE includes both a qualitative and quantitative analysis. Management bases the qualitative analysis on its review of the design of the entity, its organizational structure including allocation of decision-making authority and relevant financial agreements and the quantitative analysis on the forecasted cash flow of the entity. Management reassesses the initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.



A VIE must be consolidated only by its primary beneficiary, which is defined as the party that, along with its affiliates and agents, has both the: (i) power to direct the activities that most significantly impact the VIE’s economic performance and (ii) obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. Management determines whether the Company is the primary beneficiary of a VIE by considering qualitative and quantitative factors, including, but not limited to: which activities most significantly impact the VIE’s economic performance and which party controls such activities; the amount and characteristics of its investment; the obligation or likelihood for the Company or other interests to provide financial support; and consideration of the VIE’s purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders and the similarity with and significance to the Company’s business activities and the other interests. Management reassesses the determination of whether the Company is the primary beneficiary of a VIE each reporting period.



Equity Investments



Investments in real estate ventures and entities over which the Company exercises significant influence but not control are accounted for using the equity method. In accordance with Accounting Standards Codification (“ASC”) 825, Financial Instruments (“ASC 825-10”), issued by the Financial Accounting Standards Board (“FASB”), the Company has elected the fair value option of accounting for its development property investments and bridge loan investments, which would otherwise be required to be accounted for under the equity method. The Company also holds an investment in a self-storage real estate venture that is accounted for under the equity method of accounting.



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Investments and Election of Fair Value Option of Accounting for Certain Investments



The Company has elected the fair value option of accounting for all of its investment portfolio loan and equity investments, including those that are required under GAAP to be accounted for under the equity method, in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance including its revenues and value inherent in the Company’s equity participation in development projects. Changes in the fair value of these investments are recorded in net unrealized gain on investments within other income. Interest income is reported in interest income from investments in the Consolidated Statements of Operations and is not included in the net unrealized gain on investments within other income. All direct loan costs are charged to expense as incurred.



Each loan investment, including those recorded at cost and presented on the Consolidated Balance Sheets as other loans, is evaluated for impairment on a periodic basis. For loans carried at fair value, indicators of impairment are reflected in measurement of the loan. For loans that are carried at cost, the Company estimates an allowance for loan loss at each reporting date. In evaluating loan impairment, the Company also periodically evaluates the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral property as well as the financial and operating capability of the borrower on a loan by loan basis. The Company also evaluates the financial wherewithal of any loan guarantors as well as the borrower’s competency in managing and operating the property. In addition, the Company considers the overall economic environment, real estate sector and geographic sub-market in which the borrower operates. A loan will be considered impaired when, based on current information and events, it is probable that the loan will not be collected according to the contractual terms of the loan agreement. Factors to be considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. At September 30, 2018 and December 31, 2017, there were no loans that were deemed to be impaired loans. Additionally, for loans recorded at cost, the Company determined that no allowance for loan loss was necessary at September 30, 2018 and December 31, 2017.



Realized Gains and Net Unrealized Gain on Investments



The Company measures realized gains by the difference between the net proceeds resulting from the sale of a self-storage property underlying one of the Company’s loan investments, excluding any prepayment penalties paid to the Company in connection with the repayment of the loan secured by the self-storage property, which are recognized in interest income from investments, and the cost basis of the investment, without regard to unrealized gain or loss previously recognized. Net unrealized gain on investments reflects the unrealized gains and losses recognized on certain investments during the reporting period, including any reversal of previously recorded unrealized gains when gains are realized. All fluctuations in fair value are included in net unrealized gain on investments on the Consolidated Statements of Operations. Prior to the quarter ended September 30, 2018, sale of a self-storage property underlying one of the Company’s loan investment had not yet occurred and, thus, the Company had not yet realized any fair value gains on its investments. Accordingly, net increases in fair value of the Company’s investments had previously been reported in a single line item ‘Changes in fair value of investments’ in the Consolidated Statements of Operations.



Fair Value Measurement



The Company carries certain financial instruments at fair value because it has elected to apply the fair value option on an instrument by instrument basis under ASC 825-10. The Company’s financial instruments consist of cash, development property investments and bridge loan investments (which are generally structured as first mortgages and a 49.9% Profits Interest in the project), operating property loans (loans secured by operating properties), the investment in self-storage real estate venture, other loans, receivables, the secured revolving Credit Facility (as defined below), the FirstBank Term Loans (as defined below), senior loan participation, and payables.



The following table presents the financial instruments measured at fair value on a recurring basis at September 30, 2018:







The following table presents the financial instruments measured at fair value on a recurring basis at December 31, 2017:



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Estimating fair value requires the use of judgment. The types of judgments involved depend upon the availability of observable market information. Management’s judgments include determining the appropriate valuation model to use, estimating unobservable inputs and applying valuation adjustments. See Note 4, Fair Value of Financial Instruments, for additional disclosure on the valuation methodology and significant assumptions, as well as the election of the fair value option for certain financial instruments.



Self-Storage Real Estate Owned



Land is carried at historical cost. Building and improvements are carried at historical cost less accumulated depreciation and impairment losses. The cost consists primarily of: (i) the funded principal balance of the loan to the Company, net of unamortized origination fees; (ii) unrealized appreciation recognized as of the acquisition date; and (iii) the cash consideration paid and assumed liabilities, if applicable, to acquire the interests of other equity owners of the project. Ordinary repairs and maintenance are expensed as incurred; major replacements and betterments, which improve or extend the life of the asset, are capitalized and depreciated over their estimated useful lives. The costs of building and improvements are generally depreciated using the straight-line method based on a useful life of 40 years.



The Company expects that the majority of future self-storage facility acquisitions will be considered asset acquisitions, however the Company will evaluate each acquisition using Accounting Standards Update (“ASU”) 2017-01 - Business Combinations (Topic 805): Clarifying the Definition of a Business to determine whether accounting for a business combination or asset acquisition applies.



When facilities are acquired, the cost is allocated to the tangible and intangible assets acquired and liabilities assumed based on relative fair values. Allocations to the individual assets and liabilities are based upon their relative fair values as estimated by management.



In allocating the purchase price for an acquisition, the Company determines whether the acquisition includes intangible assets or liabilities. The Company allocates a portion of the cost to an intangible asset attributable to the value of in-place leases. This intangible asset is amortized to expense over the expected remaining term of the respective leases, which is generally one year. Substantially all of the leases in place at acquired facilities are at market rates, as the majority of the leases are month-to-month contracts. Accordingly, to date, no portion of the basis for an acquired property has been allocated to above- or below-market lease intangibles. To date, no intangible asset has been recorded for the value of customer relationships, because the Company does not have any concentrations of significant customers and the average customer turnover is fairly frequent.



The Company evaluates long-lived assets for impairment when events and circumstances, such as declines in occupancy and operating results, indicate that there may be an impairment. The carrying value of these long-lived assets is compared to the undiscounted future net operating cash flows, plus a terminal value, attributable to the assets to determine if the facility’s basis is recoverable. If an asset’s basis is not considered recoverable, an impairment loss is recorded to the extent the net carrying value of the asset exceeds the fair value. The impairment loss recognized equals the excess of net carrying value over the related fair value of the asset. There were no impairment losses recognized in accordance with these procedures during the three and nine months ended September 30, 2018 and 2017.



Cash and Cash Equivalents



Cash, investments in money market accounts and certificates of deposit with original maturities of three months or less are considered to be cash equivalents. The Company places its cash and cash equivalents primarily with three financial institutions, and the balance at each financial institution exceeds the Federal Deposit Insurance Corporation insurance limit of $250,000 per institution.



Other Loans



The Company’s other loans balance primarily includes principal balances for certain revolving loan agreements and short-term mortgage loans made by the Company in situations where it was determined that making such loans would benefit the Company’s primary business. As of September 30, 2018, the Company had executed seven revolving loan agreements with an aggregate outstanding principal amount of $0.7 million. Six of the agreements are with individuals who are owners of limited liability companies, one is with a limited liability company, and all are personally guaranteed. Six of these borrowers are either directly or indirectly owners of certain of the Company’s development property investments. The revolving loans are typically unsecured but cross-defaulted against development loans. One of the revolving loans is guaranteed by a part owner of one of the Company’s development loan investments, and this guaranty is secured by a pledge of the owner’s membership interest in one of the Company’s development loan investments. The loans bear interest at 6.9 - 7.0% per annum and are due in full in three years. At December 31, 2017, the Company had executed nine revolving loan agreements with an aggregate outstanding principal amount of $1.0 million.



As of September 30, 2018, the Company had a balance of $3.8 million related to one land loan extended to a limited liability company that is under common control with a borrower in certain of the Company’s development property investments. The land loan is secured by a first mortgage on real and personal property, is personally guaranteed, is interest-only with a fixed interest rate of 6.9% per annum, and will mature on January 20, 2019. The maturity of the loan is based upon the estimated time needed to approve the site for closing into a development loan.



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These loans are accounted for under the cost method, and fair value approximates cost at September 30, 2018 and December 31, 2017. None of these loans are in non-accrual status as of September 30, 2018 and December 31, 2017. The Company determined that no allowance for loan loss was necessary at September 30, 2018 and December 31, 2017.



Fixed Assets



Fixed assets are recorded at cost and consist of furniture, office and computer equipment, and software. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets, which range from three to seven years. Fixed assets are generally purchased by the Manager and the cost reimbursed by the Company. Maintenance and repair costs are charged to expense as incurred. Upon sale or retirement, the asset cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in income.



Revenue Recognition



Interest income is recognized as earned on a simple interest basis and is reported in interest income from investments in the Consolidated Statements of Operations. Accrual of interest will be discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. The Company will recognize income on impaired loans when they are placed into non-accrual status on a cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company will not recognize income on such loans. Accrued interest generally is reversed when a loan is placed on non-accrual status. 



The Company’s loan origination fees are accreted into interest income over the term of the investment using the effective yield method.



The operations of the self-storage real estate owned are managed by a third-party self-storage management company. All rental leases are operating leases, and rental income is recognized in accordance with the terms of the leases, which generally are month to month.



Debt Issuance Costs



Costs related to the issuance of a debt instrument are deferred and amortized as interest expense over the estimated life of the related debt instrument using the straight-line method, which approximates the effective interest method. If a debt instrument is repurchased prior to its original maturity date, the Company evaluates both the unamortized balance of debt issuance costs as well as any new debt issuance costs, including third party fees, to determine if the costs should be written off to interest expense or, if significant, included in “loss on modification or extinguishment of debt” in the Consolidated Statements of Operations. Debt issuance costs related to the sale of senior participations or term loans are presented in the Consolidated Balance Sheets as a deduction from the carrying amount of the principal balance. Debt issuance costs related to the revolving Credit Facility are presented in the Consolidated Balance Sheets as Deferred Costs.



Offering and Registration Costs



Offering and registration costs represent underwriting discounts and commissions, professional fees, fees paid to various regulatory agencies, and other costs incurred in connection with the registration and sale of the Company’s securities. Offering and registration costs incurred in connection with the Company’s common stock offerings are reflected as a reduction of additional paid-in capital.



On July 27, 2016, the Company entered into a Purchase Agreement (as defined in Note 8, Stockholders’ Equity) which required the Company to issue and sell a minimum of $50.0 million of Series A Preferred Stock by July 27, 2018. On July 25, 2018, the Purchase Agreement was amended to allow the Company to issue the remaining portion of the Series A Preferred Stock on or before September 30, 2018. As of September 30, 2018, the Company has issued and sold $125.0 million in shares of of Series A Preferred Stock. The Company incurred $2.8 million of preferred stock offering costs in conjunction with the execution of the Purchase Agreement. Such costs were presented as deferred costs on the Consolidated Balance Sheets until such time as Series A Preferred Stock was issued. A pro rata portion of such deferred costs, based upon the ratio of the amount issued to the $50.0 million minimum issuance of Series A Preferred Stock, was reclassified to cumulative preferred stock upon each issuance of the Series A Preferred Stock. Of the $2.8 million of offering costs incurred, none and $0.6 million is in deferred costs on the Consolidated Balance Sheets at September 30, 2018 and December 31, 2017, respectively, and $2.8 million and $2.2 million has reduced the cumulative preferred stock balance on the Consolidated Balance Sheets at September 30, 2018 and December 31, 2017, respectively.



Income Taxes



The Company has elected to be taxed as a REIT and to comply with the related provisions of the Code. Accordingly, the Company will generally not be subject to U.S. federal income tax to the extent of its distributions to stockholders and as long as certain asset, income and share ownership tests are met. To qualify as a REIT, the Company must annually distribute at least 90% of its REIT taxable income to its stockholders and meet certain other requirements.



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Earnings per Share (“EPS”)



Basic EPS includes only the weighted average number of common shares outstanding during the period. Diluted EPS includes the weighted average number of common shares and the dilutive effect of restricted stock, accrued stock dividends, and redeemable Operating Company units when such instruments are dilutive.



All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are treated as participating in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted EPS must be applied.



Comprehensive Income



For the three and nine months ended September 30, 2018 and 2017, comprehensive income equaled net income; therefore, separate Consolidated Statements of Comprehensive Income are not included in the accompanying interim consolidated financial statements.



Segment Reporting



The Company does not evaluate performance on a relationship specific or transactional basis and does not distinguish its principal business or group its operations on a geographical basis for purposes of measuring performance. Accordingly, the Company believes it has a single operating segment for reporting purposes in accordance with GAAP.



Recent Accounting Pronouncements



In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This update creates a single accounting model for all share-based payments. As a result of this update, the existing employee guidance will apply to nonemployee share-based transactions, with the cost of nonemployee awards continuing to be recorded as if the grantor had paid cash for the goods or services. The equity-classified share-based payment awards issued to nonemployees will now be measured on the grant date, instead of the previous requirement to re-measure the awards through the performance completion date. This ASU is effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. As allowed, the Company has elected to early adopt the amendments in ASU 2018-07 effective April 1, 2018. As required by the ASU, the Company has established a grant date fair value of $18.10 based on the market value of the award as of April 1, 2018 for all nonemployee awards that have not vested as of April 1, 2018. The cumulative-effect adjustment to retained earnings as of January 1, 2018 was immaterial to the financial statements as a whole. As such, the Company recorded this adjustment through its consolidated statements of operations for the three months ended June 30, 2018.



In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which provides guidance on whether transactions should be accounted for as acquisitions or disposals of assets or businesses. Specifically, when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set of assets is not a business. Additionally, ASU 2017-01 also provides other guidance providing a more robust framework to use in determining whether a set of assets and activities is a business. This guidance is effective for annual periods beginning after December 15, 2017. Early adoption is permitted. The Company adopted ASU 2017-01 for new acquisitions beginning on July 1, 2017. Since adoption of the new guidance, the Company has considered its self-storage facility acquisitions to be asset acquisitions.  The costs related to the acquisitions of self-storage facilities that qualify as asset acquisitions are capitalized as part of the purchase.



In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance on the classification of certain cash receipts and payments in the statement of cash flows (defined in the ASU as “cash flow issues”), including distributions received from equity method investees. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption being allowed. The Company has elected to early adopt effective October 1, 2017 on a retrospective basis as required. The Company has concluded that the new accounting guidance does not impact its current classification of distributions received from equity method investees as an operating activity in its Consolidated Statements of Cash Flows. The Company further considered its components of cash flows under the cash flow issue “Separately Identifiable Cash Flow and Applicable of the Predominance Principle,” which addresses certain cash receipts and cash payments that may have aspects of more than one class of cash flows. In the absence of specific GAAP guidance, the Company evaluated its cash flows from origination fees received in cash, which have been historically presented as operating cash flows, on the basis of the nature of the underlying cash flows. The Company concluded that the origination fees are related to the origination of loans and the funding of our investment portfolio for which the associated cash flows are presented as investing activities. As a result, $3.1 million of origination fees received in cash for the nine months ended September 30, 2017, have been retrospectively presented as an investment activity in the Consolidated Statements of Cash Flows.



In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This guidance is effective for public business entities for fiscal years and for interim periods

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within those fiscal years, beginning after December 15, 2019, with early adoption being allowed as of the fiscal years beginning after December 15, 2018. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements; however, the Company does not expect the new accounting guidance to have a material impact on its consolidated financial statements.



In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which is the final standard on accounting for leases. The most significant change for lessees is the requirement under the new guidance to recognize right-of-use assets and lease liabilities for all leases not considered short term leases. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales type leases, direct financing leases and operating leases. The Company does have rental income from month-to-month self-storage leases within the scope of ASU 2016-02. The Company does not have material amounts of rental or lease expense. The amendments in ASU 2016-02 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements.



In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2017. This ASU outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry specific guidance. Several ASUs expanding and clarifying the initial guidance issued in ASU 2014-09 have been released since May 2014. The Company adopted the ASU effective January 1, 2018. The Company has evaluated all applicable contracts and revenue streams and has concluded that the adoption does not have an effect on its consolidated financial statements, primarily due to the new guidance not applying to revenue associated with loans or derived from lease contracts. 



Consolidated Statements of Cash Flows - Supplemental Disclosures



The following table provides supplemental disclosures related to the Consolidated Statements of Cash Flows:

































3. SELF-STORAGE INVESTMENT PORTFOLIO



The Company’s self-storage investments at September 30, 2018 consisted of the following:



Investments reported at fair value





 



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As of September 30, 2018, the aggregate committed principal amount of the Company’s development property investments, bridge loan investments and operating property loan was approximately $656.6 million and outstanding principal was $388.5 million, as described in more detail in the table below:









The following table provides a reconciliation of the funded principal to the fair market value of investments at September 30, 2018:





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As of December 31, 2017, the aggregate committed principal amount of the Company’s development property investments and operating property loans was approximately $523.8 million and outstanding principal was $213.1 million, as described in more detail in the table below:















The following table provides a reconciliation of the funded principal to the fair market value of investments at December 31, 2017:



The Company has elected the fair value option of accounting for all of its investment portfolio investments in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance, including its revenues and value inherent in its equity participation in development projects. See Note 4, Fair Value of Financial Instruments, for additional disclosure on the valuation methodology and significant assumptions.



No loans were in non-accrual status as of September 30, 2018 and December 31, 2017.



All of the Company’s development property investments and bridge loan investments with a Profits Interest would have been accounted for under the equity method had the Company not elected the fair value option. For these development property investments and bridge loan investments with a Profits Interest, the assets and liabilities of the equity method investees approximated $416.2 million and $368.7 million, respectively, at September 30, 2018 and approximated $234.7 million and $194.4 million, respectively, at December 31, 2017. These investees had revenues of approximately $1.5 million and $3.7 million and net operating income, excluding depreciation and interest expense, of less than $0.1 million and $0.3 million for the three and nine months ended September 30, 2018, respectively. These investees had revenues of approximately $0.9 million and $2.2 million and net operating income, excluding depreciation and interest expense, of approximately $0.2 million for the three and nine months ended September 30, 2017, respectively.



For 16 of the Company’s development property investments with a Profits Interest, an investor has an option to put its interest to the Company upon the event of default of the underlying property loans. The put, if exercised, requires the Company to purchase the member’s interest at the original purchase price plus a yield of 4.5% on such purchase price. The Company concluded that the likelihood of loss is remote and assigned no value to these put provisions as of September 30, 2018 and December 31, 2017.



Investments reported at cost (Self-Storage Real Estate Owned)



2018 Activity



On January 10, 2018, the Company purchased 100% of the Class A membership units of the limited liability company that owned the Jacksonville 1 development property investment with a Profits Interest for $2.7 million. Accordingly, as of January 10, 2018, the Company wholly owns and consolidates this investment in the accompanying consolidated financial statements.



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On February 2, 2018, the Company purchased 100% of the Class A membership units of the limited liability companies that owned the Atlanta 1 and Atlanta 2 development property investments with a Profits Interest for $2.4 million and $3.0 million, respectively. Accordingly, as of February 2, 2018, the Company wholly owns and consolidates these investments in the accompanying consolidated financial statements.



On February 20, 2018, the Company purchased 100% of the Class A membership units of the limited liability company that owned the Pittsburgh development property investment with a Profits Interest for $0.9 million and assumed liabilities of $1.3 million. Accordingly, as of February 20, 2018, the Company wholly owns and consolidates this investment in the accompanying consolidated financial statements.



On August 31, 2018, the Company purchased 100% of the Class A membership units of the limited liability company that owned the Charlotte 1 development property investment with a Profits Interest for $3.1 million. Accordingly, as of August 31, 2018, the Company wholly owns and consolidates this investment in the accompanying consolidated financial statements.



2017 Activity



On February 3, 2017, the Company purchased 50% of the economic rights of the Class A membership units of a limited liability company that owned the Orlando 1 development property investment with a Profits Interest for $1.3 million and increased its Profits Interest on this development property investment from 49.9% to 74.9%. The Class A member retained all management and voting rights in the limited liability company. Previously, the Company accounted for this investment as an equity method investment. Because the Company was entitled to greater than 50% of the residual profits from the investment, the Company accounted for this investment as a real estate investment in its consolidated financial statements in accordance with ASC 310, Receivables.



On August 9, 2017, the Company purchased the remaining 50% of the economic rights of the Class A membership units of a limited liability company that owned the Orlando 1 development property investment with a Profits Interest and 100% of the economic rights of the Class A membership units of a limited liability company that owned the Orlando 2 development property investment with a Profits Interest for $1.6 million and increased its Profits Interest on these development property investment from 74.9% to 100% and 49.9% to 100%, respectively. The Orlando 2 investment is an additional phase to the Orlando 1 investment that is being operated as one self-storage facility. The Company now owns all management and voting rights in the limited liability companies. Previously, the Company accounted for the Orlando 1 investment as a real estate investment and the Orlando 2 investment as an equity method investment. Because the Company is now entitled to greater than 50% of the residual profits from the Orlando 2 investment, the Company accounts for this investment as a real estate investment in its consolidated financial statements. The Company will continue to account for the Orlando 1 investment as a real estate investment. Accordingly, as of August 9, 2017, the Company wholly owns and consolidates these investments in the accompanying consolidated financial statements.



The Company evaluated the 2018 and 2017 purchases under ASU 2017-01 and concluded that the transactions consisted of a single identifiable asset that represents substantially all of the fair value of the gross assets acquired. Therefore, these transactions do not constitute the purchase of a business and have been treated as asset acquisitions. In accordance with ASU 2017-01, as of the respective acquisition dates, the Company’s basis in the self-storage real estate owned is recorded at cost (generally equal to the cash consideration paid, assumed liabilities, if applicable, and the funded loan balance, net of unamortized origination fees), plus unrealized gains recorded at the date of acquisition. The allocation to the basis of the assets acquired is based on their relative fair values.



The following table shows the Company’s basis as of the date of acquisition for the facilities acquired during the nine months ended September 30, 2018:











The following table shows the Company’s basis as of the date of acquisition for the facility acquired during the year ended December 31, 2017:







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The following table shows the impact of these real estate investments on the Company’s accompanying Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017:







The following tables show the impact of these real estate investments on the Company’s accompanying Consolidated Statement of Operations for the three and nine months ended September 30, 2018 and 2017:





























4. FAIR VALUE OF FINANCIAL INSTRUMENTS



The fair value option under ASC 825-10 allows companies to elect to report selected financial assets and liabilities at fair value. The Company has elected the fair value option of accounting for its development property investments, bridge loan investments and operating property loan investments in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance, including its revenues and value inherent in its equity participation in self-storage development projects.



The Company applies ASC 820, Fair Value Measurement (“ASC 820”), which defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosure of fair value measurements. ASC 820 defines fair value as the price that would be received for an investment in an orderly transaction between market participants on the measurement date. ASC 820 requires the Company to assume that the investment is sold in its principal market to market participants or, in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the Company considers its principal market as the market for the purchase and sale of self-storage properties, which the Company believes would be the most likely market for the Company’s loan and equity investments given the nature of the collateral securing such loans and the types of borrowers. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC 820, these inputs are summarized in the three broad levels listed below:

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The carrying values of cash, other loans, receivables, the secured revolving credit facility, FirstBank Term Loans, senior loan participation and payables approximate their fair values due to their short-term nature or due to a variable interest rate. Cash, receivables, and payables are categorized as Level 1 instruments in the measurement of fair value. Other loans, the secured revolving credit facility and senior loan participations are categorized as Level 2 instruments in the measurement of fair value as the fair values of these investments are determined using a discounted cash flow model with inputs from third-party pricing sources and similar instruments. The following table summarizes the instruments categorized in Level 3 of the fair value hierarchy and the valuation techniques and inputs used to measure their fair value. 















The Company’s development property investments, bridge loan investments and operating property loan investments are valued using two different valuation techniques. The first valuation technique is an income approach analysis of the debt instrument components of the Company’s investments. The second valuation technique is an option pricing model (“OPM”) that is used to determine the fair value of any Profits Interests associated with an investment. The valuation models are calibrated to the total investment net drawn amount as of the issuance date factoring in the value of the Profits Interests. At the issuance date of each development property investment, generally the value of the property underlying such investment approximates the sum of the net investment drawn amount plus the developer’s equity investment. Typically the calibration is done on an investment level basis. To the extent investments are entered into on a portfolio basis, the valuation models are calibrated on an aggregate basis to the aggregate net investment proceeds using the overall implied internal rate of return using a discounted cash flow for each investment.



For development property investments with a Profits Interest, at a certain stage of construction, the OPM incorporates an adjustment to measure entrepreneurial profit. Entrepreneurial profit is a monetary return above total construction costs that provides compensation for the risk of a development project. Under this method, the value of each property is estimated based on the cost incurred to date, plus an estimated earned entrepreneurial profit. Total entrepreneurial profit is estimated as the difference between the projected value of a property at stabilization and the total development costs, including land, building improvements, and lease-up costs. Utilizing information obtained from the market coupled with the Company’s own experience, the Company has estimated that in most cases, approximately one-third of the entrepreneurial profit is earned during the construction period beginning when construction is approximately 40% complete and ending when construction is substantially complete, and approximately two-thirds of the entrepreneurial profit is earned when construction is substantially complete through stabilization. For the fourteen development property investments that were 40% complete but for which construction was not substantially complete at September 30, 2018, the Company has estimated the entrepreneurial profit adjustment to the enterprise value input used in the option pricing model to be equal to one-third of the estimated entrepreneurial profit, allocated on a straight-line basis. Twenty-one development property and bridge loan investments, not including the properties reported as self-storage real estate owned, had reached substantial construction completion and/or received a certificate of occupancy at September 30, 2018. For the Company’s development property and bridge loan investments at substantial construction completion, a discounted cash flow model, based on periodically updated estimates of rental

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rates, occupancy and operating expenses, is the primary method for projecting value of a project. The Company also will consider inputs such as appraisals which differ from the developer’s equity investment, bona fide third-party offers to purchase development projects, sales of development projects, or sales of comparable properties in its markets.



Level 3 Fair Value Measurements



The following tables summarize the significant unobservable inputs the Company used to value its investments categorized within Level 3 as of September 30, 2018 and December 31, 2017. These tables are not intended to be all-inclusive, but instead to capture the significant unobservable inputs relevant to the Company’s determination of fair values.





























The fair value measurements are sensitive to changes in unobservable inputs. A change in those inputs to a different amount might result in a significantly higher or lower fair value measurement. The following provides a discussion of the impact of changes in each of the unobservable inputs on the fair value measurement.



Market yields - changes in market yields and discount rates, each in isolation, may change the fair value of certain of the Company’s investments. Generally, an increase in market yields or discount rates may result in a decrease in the fair value of certain of the Company’s investments. The following fluctuations in the market yields/discount rates would have had the following impact on the fair value of our investments:







Capitalization rate - changes in capitalization rate, in isolation and all else equal, may change the fair value of certain of the Company’s development investments containing Profits Interests. Generally an increase in the capitalization rate assumption may result in a decrease in the fair value of the Company’s investments. The following fluctuations in the capitalization rates would have had the following impact on the fair value of our investments:





Exit date - changes in exit date, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have Profits Interests. Generally, an acceleration in the exit date assumption may result in an increase in the fair value of the Company’s investments.



Volatility - changes in volatility, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have Profits Interests. Generally, an increase in volatility may result in an increase in the fair value of the Profits Interests in certain of the Company’s investments.



Operating cash flow projections - changes in the operating cash flow projections of the underlying self-storage facilities, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have Profits Interests. Generally, an increase in operating cash flow projections may result in an increase in the fair value of the Profits Interests in certain of the Company’s investments.



The Company also evaluates the impact of changes in instrument-specific credit risk in determining the fair value of investments. There were no gains or losses attributable to changes in instrument-specific credit risk in the three and nine months ended September 30, 2018 and 2017.



Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may fluctuate from period to period. Additionally, the fair value of the Company’s investments may differ

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significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If the Company was required to liquidate an investment in a forced or liquidation sale, it could realize significantly less than the value at which the Company has recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned. 



The following tables present changes in investments that use Level 3 inputs:











On August 28, 2018, the underlying asset for the Tampa 1 investment was sold to a third party and proceeds were distributed to the Company in settlement of the first mortgage loan and 49.9% Profits Interest.  The following tables reflect the various financial components related to the transaction:











As of September 30, 2018 and December 31, 2017, the total net unrealized appreciation on the investments that use Level 3 inputs was $37.5 million and $26.3 million, respectively.



For the three and nine months ended September 30, 2018 and 2017, substantially all of the net unrealized gain on investments in the Company’s Consolidated Statements of Operations were attributable to unrealized gains relating to the Company’s Level 3 assets still held as of the respective balance sheet date.



Transfers between levels, if any, are recognized at the beginning of the quarter in which the transfers occur.

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5. INVESTMENT IN SELF-STORAGE REAL ESTATE VENTURE



On March 7, 2016, the Company, through its Operating Company, entered into the Limited Liability Company Agreement (the “JV Agreement”) of Storage Lenders LLC, a Delaware limited liability company, to form a real estate venture (the “SL1 Venture”) with HVP III Storage Lenders Investor, LLC (“HVP III”), an investment vehicle managed by Heitman Capital Management LLC (“Heitman”). The SL1 Venture was formed for the purpose of providing capital to developers of self-storage facilities identified and underwritten by the Company. Upon formation, HVP III committed $110.0 million for a 90% interest in the SL1 Venture, and the Company committed $12.2 million for a 10% interest.



On March 31, 2016, the Company contributed to the SL1 Venture three of its existing development property investments with a Profits Interest located in Miami and Fort Lauderdale, Florida that were not yet under construction. These investments had an aggregate committed principal amount of approximately $41.9 million and an aggregate drawn balance of $8.1 million. In exchange, the Company’s initial funding commitment of $12.2 million was reduced by $8.1 million, representing the Company’s initial “Net Invested Capital” balance as defined in the JV Agreement. The Company accounted for this contribution in accordance with ASC 845, Nonmonetary Transactions, and recorded an investment in the SL1 Venture based on the fair value of the contributed development property investments, which is the same as carryover basis. The fair value of the contributed development property investments as of March 31, 2016 was $7.7 million. Pursuant to the JV Agreement, Heitman, in fulfilling its initial $110.0 million commitment, provides capital to the SL1 Venture as cash is required, including funding draws on the three contributed development property investments. During the year ended December 31, 2016, HVP III and the Company agreed to true up the balances in the respective members’ capital accounts to be in accordance with the 90% commitment and 10% commitment made by HVP III and the Company, respectively. Accordingly, during the year ended December 31, 2016, HVP III contributed cash of $7.3 million to the SL1 Venture, and the Company received a $7.3 million cash distribution as a return of its capital.



As of September 30, 2018, the SL1 Venture had closed on eight new development property investments with a Profits Interest with an aggregate commitment amount of approximately $81.4 million, bringing the total aggregate commitment of the SL1 Venture’s investments to $123.3 million as of September 30, 2018. Accordingly, HVP III’s total commitment for a 90% interest in the SL1 Venture is $111.0 million, and the Company’s total commitment for a 10% interest in the SL1 Venture is $12.3 million.



Under the JV Agreement, the Company receives a priority distribution (after debt service and any reserve but before any other distributions) out of operating cash flow and residual distributions based upon 1% of the committed principal amount of loans made by the SL1 Venture, exclusive of the loans contributed to the SL1 Venture by the Company. Operating cash flow of the SL1 Venture (after debt service, reserves and the foregoing priority distributions) is distributed in accordance with capital commitments. Residual cash flow from capital and other events (after debt service, reserves and priority distributions) will be distributed (i) pro rata in accordance with capital commitments (its “Percentage Interest”) until each member has received a return of all capital contributed; (ii) pro rata in accordance with each member’s Percentage Interest until Heitman has achieved a 14% internal rate of return; (iii) to Heitman in an amount equal to its Percentage Interest less 10% and to the Company in an amount equal to the Company’s Percentage Interest plus 10% until Heitman has achieved a 17% internal rate of return; (iv) to Heitman in an amount equal to its Percentage Interest less 20% and to the Company in an amount equal to the Company’s Percentage Interest plus 20% until Heitman has achieved a 20% internal rate of return; and (v) any excess to Heitman in an amount equal to its Percentage Interest less 30% and to the Company in an amount equal to the Company’s Percentage Interest plus 30%. However, the Company will not be entitled to any such promoted interest prior to the earlier to occur of the third anniversary of the JV Agreement and Heitman receiving distributions to the extent necessary to provide Heitman with a 1.48 multiple on its contributed capital.



Since the allocation of cash distributions and liquidating distributions are determined as described in the preceding paragraph, the Company has applied the hypothetical-liquidation-at-book-value (“HLBV”) method to allocate the earnings of the SL1 Venture. Under the HLBV approach, the Company’s share of the investee’s earnings or loss is calculated by:











The SL1 Venture has elected the fair value option of accounting for its development property investments with a Profits Interest, which are equity method investments of the SL1 Venture. The assumptions used to value the SL1 Venture’s investments are materially consistent with those used to value the Company’s investments. As of September 30, 2018, the SL1 Venture had eleven development property investments with a Profits Interest as described in more detail in the table below:

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As of September 30, 2018, the SL1 Venture had total assets of $132.7 million and total liabilities of $1.0 million. During the three and nine months ended September 30, 2018, the SL1 Venture had net income of $4.2 million and $13.3 million, of which $0.4 million and $1.4 million was allocated to the Company and $3.8 million and $11.9 million was allocated to HVP III, respectively, under the HLBV method. At September 30, 2018, $0.2 million of transaction expenses were included in the carrying amount of the Company’s investment in the SL1 Venture. Additionally, the Company may from time to time make advances to the SL1 Venture. At September 30, 2018 and December 31, 2017, the Company had $0.9 million and $3.2 million, respectively, in advances to the SL1 Venture, and the related interest on these advances are classified in equity in earnings from unconsolidated self-storage real estate venture in the Consolidated Statements of Operations.



In accordance with the JV Agreement, for each development property investment, the borrower must deliver to the SL1 Venture a completion guarantee whereby the borrower agrees to cover all costs in excess of the agreed-upon budget amount. Additionally, the Company is required to deliver to the SL1 Venture a backstop completion guarantee for each development property investment to guarantee completion in the event the borrower does not satisfy its obligations. The Company concluded that the likelihood of loss is remote and assigned no value to these guarantees as of September 30, 2018 and December 31, 2017.



Under the JV Agreement, Heitman and the Company will seek to obtain and, if obtained, will share joint rights of first refusal to acquire self-storage facilities that are the subject of development property investments made by the SL1 Venture. Additionally, so long as the Company, through its operating subsidiary, is a member of the SL1 Venture and the SL1 Venture holds any assets, the Company will not make any investment of debt or equity or otherwise, directly or indirectly, in one or more new joint ventures or similar programs for the purposes of funding or providing development loans or financing, directly or indirectly, for the development, construction or conversion of self-storage facilities, in each case without first offering such opportunity to Heitman to participate on substantially the same terms as those set forth in the JV Agreement, either through the SL1 Venture or a newly formed real estate venture.



The JV Agreement permits Heitman to cause the Company to repurchase from Heitman its Developer Equity Interests (as defined in the JV Agreement) in certain limited circumstances. Under the JV Agreement, if a developer causes to be refinanced a self-storage facility with respect to which the SL1 Venture has made a development property investment and such refinancing does not coincide with a sale of the underlying self-storage facility, then at any time after the fourth anniversary of the commencement of the SL1 Venture, Heitman may either put to the Company its share of the Developer Equity Interests in respect of each such development property investment, or sell Heitman’s Developer Equity Interests to a third party. The Company concluded that the likelihood of loss is remote and assigned no value to these puts as of September 30, 2018 and December 31, 2017.



The Company is the managing member of the SL1 Venture and will manage and administer (i) the day-to-day business and affairs of the SL1 Venture and any of its acquired properties and (ii) loan servicing and other administration of the approved development property investments. The Company will be paid a monthly expense reimbursement amount by the SL1 Venture in connection with its role as managing member, as set forth in the JV Agreement. Heitman may remove the Company as the managing member of the SL1 Venture if it commits an event of default (as defined in the JV Agreement), if it undergoes a change of control (as defined in the JV Agreement), or if it becomes insolvent.



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Heitman approves all “Major Decisions” of the SL1 Venture, as defined in the JV Agreement, including, but not limited to, each investment of capital, the incurrence of any indebtedness, the sale or other disposition of assets of the SL1 Venture, the replacement of the managing member, the acceptance of new members into the SL1 Venture and the liquidation of the SL1 Venture.



For four of the SL1 Venture development property investments with a Profits Interest, an investor has an option to put its interest to the Company upon the event of default of the underlying property loans. The put options, if exercised, require the Company to purchase the member’s interest at the original purchase price plus a yield of 4.5% on such purchase price. The Company concluded that the likelihood of loss is remote and assigned no value to these put options at September 30, 2018 and December 31, 2017.



6. VARIABLE INTEREST ENTITIES



Development Property Investments and Bridge Loan Investments



The Company holds variable interests in its development property investments and bridge loan investments. The Company has determined that these investees qualify as VIEs because the entities do not have enough equity to finance their activities without additional subordinated financial support. In determining whether the Company is the primary beneficiary of the development property VIEs, the Company identified the activities that most significantly impact the development property VIEs’ economic performance. Such activities are (1) managing the construction and operations of the project, (2) selecting the property manager, (3) making financing decisions, (4) authorizing capital expenditures and (5) disposing of the property. Although the Company has certain participating and protective rights, it does not have the power to direct the activities that most significantly impact the development property VIEs’ economic performance and is not the primary beneficiary; therefore, the Company does not consolidate the development property VIEs.



The Company has recorded assets of $417.4 million and $228.2 million at September 30, 2018 and December 31, 2017, respectively, for its variable interest in the development property and bridge loan VIEs which is included in the development property investments and bridge loan investments at fair value line items in the Consolidated Balance Sheets. The Company’s maximum exposure to loss as a result of its involvement with the development property and bridge loan VIEs is as follows:





The Company has a construction completion guaranty from the managing members of the development property VIEs or individual affiliates/owners of such managing members.



Investment in Real Estate Venture



The Company determined that the SL1 Venture qualifies as a VIE because it does not have enough equity to finance its activities without additional subordinated financial support. In determining whether the Company is the primary beneficiary of the entity, the Company identified the activities that most significantly impact the entity’s economic performance. Such activities are (1) approving self-storage development investments and acquiring self-storage properties, (2) managing directly-owned properties, (3) obtaining debt financing, and (4) disposing of investments. Although the Company has certain rights, it does not have the power to direct the activities that most significantly impact the entity’s economic performance and thus is not the primary beneficiary. As such, the Company does not consolidate the entity and accounts for its unconsolidated interest in the SL1 Venture using the equity method of accounting. The Company’s investment in the SL1 Venture is included in the investment in and advances to self-storage real estate venture balance in the Consolidated Balance Sheets, and earnings from the SL1 Venture are included in equity in earnings from unconsolidated real estate venture in the Company’s Consolidated Statements of Operations. The Company’s maximum contribution to the SL1 Venture is $12.3 million, and as of September 30, 2018 and December 31, 2017, the Company’s remaining unfunded commitment to the SL1 Venture is $1.2 million and $3.4 million, respectively. At September 30, 2018 and December 31, 2017, the Company had $0.9 million and $3.2 million, respectively, in advances to the SL1 Venture.



7. DEBT



Credit Facility



On July 25, 2017, the Operating Company entered into a $100 million senior secured revolving Credit Facility with KeyBank National Association, as administrative agent, KeyBanc Capital Markets Inc., as lead arranger, and the other lenders party thereto (the “Credit Facility”). Pursuant to an accordion feature, the Operating Company may from time to time increase the commitments up to an aggregate amount of $200 million, subject to, among other things, an absence of default under the Credit Facility, as well as receiving commitments from lenders for the additional amounts. The Operating Company typically uses borrowings under the Credit Facility to fund its investments, to make secured or unsecured loans to borrowers in connection with its investments and for general corporate purposes.



On July 25, 2017, the Company and certain wholly-owned subsidiaries of the Operating Company entered into an Unconditional Guaranty of Payment and Performance whereby they have agreed to unconditionally guarantee the obligations of the Operating Company under the Credit

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Facility. The Credit Facility is secured by a portion of the Company’s investments, and other subsidiaries of the Operating Company may be added as guarantors from time to time during the term of the Credit Facility. The Credit Facility has a scheduled maturity date on July 24, 2020. Borrowings under the Credit Facility are secured by two different pools of collateral: one consisting of the Company’s mortgage loans extended to developers and the other consisting of self-storage properties owned by the Company.



The amount available to borrow under the Credit Facility is limited according to a borrowing base valuation of the assets available as collateral. For loans secured by Company mortgage loans, the borrowing base availability is the lesser of (i) 60% of the value of the Company mortgage loans, (ii) the maximum principal amount which would not cause the outstanding loans under the Credit Facility secured by the Company mortgage loans to be greater than 50% of the underlying real estate asset fair value securing the Company mortgage loans and (iii) for any Company mortgage loan that has been included in the borrowing base for greater than 18 months, the maximum principal amount which would not cause the ratio of (a) adjusted net operating income for the underlying real estate asset securing such Company mortgage loan divided by (b) an implied debt service amount to be less than 1.30 to 1.00. For loans secured by self-storage properties, the borrowing base availability is the lesser of (i) the maximum principal amount that would not cause the outstanding loans under the Credit Facility secured by self-storage properties to be greater than 65% of the value of such self-storage properties and (ii) the maximum principal amount that would not cause the ratio of (i) aggregate adjusted net operating income from all self-storage properties included in the borrowing base divided by (ii) an implied debt service coverage amount to be less than 1.30 to 1.00.



The Credit Facility includes certain requirements that may limit the borrowing capacity available to the Company from time to time. Under the terms of the Credit Facility, the outstanding principal balance of the revolving credit loans, swing loans and letter of credit liabilities under the Credit Facility may not exceed the borrowing base availability.



Each loan made under the Credit Facility bears interest at either, at the Operating Company’s election, (i) a base rate plus a margin of either 1.75% or 2.75% or (ii) LIBOR plus a margin of either 2.75% or 3.75%, in each case depending on the borrowing base available for such loan. In addition, the Operating Company is required to pay a fee of a per diem rate of 0.35% per annum, times the excess of the sum of the commitments of the lenders, as in effect from time to time, over the outstanding principal amount of revolving credit loans under the Credit Facility.



The Credit Facility contains certain customary representations and warranties and financial and other affirmative and negative covenants. The Operating Company’s ability to borrow under the Credit Facility is subject to ongoing compliance by the Company and the Operating Company with various customary restrictive covenants, including but not limited to limitations on its incurrence of indebtedness, investments, dividends, asset sales, acquisitions, mergers and consolidations and liens and encumbrances. In addition, the Credit Facility contains certain financial covenants including the following:





The Credit Facility provides for standard events of default, including nonpayment of principal and other amounts when due, non-performance of covenants, breach of representations and warranties, certain bankruptcy or insolvency events, and changes in control. If an event of default occurs and is continuing under the Credit Facility, the lenders may, among other things, terminate their commitments under the Credit Facility and require the immediate payment of all amounts owed thereunder.



In January 2018, the Company entered into the First Amendment to the Credit Facility to clarify how acquisitions of developers’ interests would be addressed under the Credit Facility. On July 25, 2018, the Company entered into the Second Amendment to the Credit Facility, which amends the Credit Facility to, among other things, modify the restrictions on indebtedness so as to permit the Company to enter into certain other indebtedness.



As of September 30, 2018, the Company had no outstanding borrowings under the Credit Facility and $81.5 million was available for borrowing under the Credit Facility.



As of September 30, 2018, the Company was in compliance with all of its financial covenants of the Credit Facility.



As of September 30, 2018, the funded principal of $49.3 million of development property investments at fair value, the funded principal of $78.6 million of bridge loan investments at fair value, the funded principal of $2.5 million of operating property loans at fair value, and $11.8 

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million of the self-storage real owned, net, is pledged as collateral against the Credit Facility. As of December 31, 2017, the funded principal of $47.4 million of development property investments at fair value, the funded principal of $6.0 million of operating property loans at fair value, and $4.4 million of the self-storage real owned, net, is pledged as collateral against the Credit Facility.



Term Loans



On August 17, 2018, the Company entered into loan agreements (the “FirstBank Term Loans”) with FirstBank (“FirstBank”) with respect to three term loans in the aggregate principal amount of $24.9 million. The FirstBank Term Loans are secured by first mortgages on the Company’s three wholly-owned self-storage facilities located in Orlando, Florida and Atlanta, Georgia. As a condition to FirstBank providing the FirstBank Term Loans, the Company has agreed to unconditionally guarantee the Subsidiaries’ obligations under the FirstBank Term Loans pursuant to guaranty agreements with FirstBank (the “FirstBank Guaranties”).



The FirstBank Term Loans will mature on August 1, 2021.  Borrowings under the FirstBank Term Loans bear interest at a floating variable rate of one-month LIBOR plus 2.25%, which is reset monthly. 



The FirstBank Term Loans contain customary representations and warranties and affirmative and negative covenants. The FirstBank Term Loans contain a financial covenant that requires the Operating Company to maintain a debt service coverage ratio of 1.35 to 1. The debt service coverage ratio will be calculated pursuant to the terms of the Credit Facility. FirstBank is a lender under the Credit Facility. The First Bank Term Loans also contain a covenant that requires the Operating Company to maintain a loan to value ratio on the outstanding balance of the loan that does not exceed the loan to value ratio at closing.



The FirstBank Term Loans provide for standard events of default, including nonpayment of principal and other amounts when due, non-performance of covenants, breach of representations and warranties and certain bankruptcy or insolvency events. If an event of default occurs and is continuing under the FirstBank Term Loans, FirstBank may, among other things, terminate its commitments under the FirstBank Term Loans and require the immediate payment of all amounts owed thereunder. The FirstBank Term Loans each contain cross-default provisions with the Credit Facility, pursuant to which an event of default under the FirstBank Term Loans is triggered by the occurrence of an event of default under the Credit Facility that results in acceleration of the outstanding obligations of the Operating Company under the Credit Facility.  



As of September 30, 2018, the Company was in compliance with all of its financial covenants of the FirstBank Term Loans.



Senior Participation



On May 27, 2016, the Company sold a senior participation in a construction loan on a facility in the Miami, Florida MSA (“the Miami A Note”), having a commitment amount of $17.7 million in exchange for a commitment by the bank to provide net proceeds of $10.0 million to fund construction draws under the construction loan (the “Miami A Note Sale”) once the total outstanding principal balance exceeded $7.7 million. The Miami A Note Sale was effected pursuant to a participation agreement between the bank and the Company (the “Miami Participation Agreement”). Under the Miami Participation Agreement, the Company continued to service the underlying loan as long as it was not in default under the Miami Participation Agreement. The bank had the option to “put” the senior participation to the Company in the event the underlying borrower defaulted on the underlying loan or if the Company defaulted under the Miami Participation Agreement. As part of the Participation Agreement, the Company maintained a minimum aggregate balance of $0.5 million in depository or money market accounts at the bank, and if such balance was not maintained, the interest rate would have increased. The Company paid to the bank interest on the outstanding balance of the Miami A Note at the rate of 30-day LIBOR plus 3.10%.  The Company also paid a loan fee of 100 basis points, or $0.1 million upon closing of the loan. The Miami A Note initially had a maturity date of July 1, 2017. On March 31, 2018, the maturity date was extended to June 30, 2018. The Company repurchased the Miami A Note on June 19, 2018. There was no outstanding balance for the Miami A Note as of September 30, 2018.



As of December 31, 2017, the funded principal of $12.5 million of the Miami development property investment at fair value was pledged as collateral against the Company’s senior participation.



The table below details the bank commitments and outstanding balance of our senior participation at December 31, 2017:

















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8. STOCKHOLDERS’ EQUITY



The Company had 19,364,339 and 14,429,055 shares of common stock issued and outstanding, which included 160,832 and 185,002 shares of nonvested restricted stock, as of September 30, 2018 and December 31, 2017, respectively. The Company had 125,000 and 40,000 shares of Series A Preferred Stock issued and outstanding as of September 30, 2018 and December 31, 2017. The Company also had 1,571,734 shares of Series B Preferred Stock issued and outstanding as of September 30, 2018.



Common Stock Offerings



On April 5, 2017, the Company entered into an at-the-market continuous equity offering program (“ATM Program”) with an aggregate offering price of up to $50.0 million. As of September 30, 2018, the Company has issued and sold an aggregate of 1,323,722 shares of common stock at a weighted average price of $22.24 per share under the ATM Program, receiving net proceeds after commissions and other offering costs of $28.5 million.



On June 27, 2017, the Company received $83.9 million in proceeds, net of underwriters’ discounts and offering costs payable by the Company, related to the public offering of 4,025,000 shares of common stock.



On June 14, 2018, the Company received $81.1 million in proceeds, net of underwriters’ discounts and offering costs payable by the Company, related to the public offering of 4,600,000 shares of common stock.



Stock Repurchase Plan



On May 20, 2016, the Company’s Board of Directors authorized a share repurchase program for the repurchase of up to $10.0 million of the outstanding shares of common stock of the Company. As of September 30, 2018, the Company had repurchased and retired a total of 213,078 shares of its common stock at an aggregate cost of approximately $3.2 million. As of September 30, 2018, the Company has $6.8 million remaining under the Board’s authorization to repurchase shares of its common stock.



Equity Incentive Plan



In connection with the IPO, the Company established the 2015 Equity Incentive Plan for the purpose of attracting and retaining directors, executive officers, investment professionals and other key personnel and service providers, including officers and employees of the Manager and other affiliates, and to stimulate their efforts toward the Company’s continued success, long-term growth and profitability. The 2015 Equity Incentive Plan provides for the grant of stock options, share awards (including restricted common stock and restricted stock units), stock appreciation rights, dividend equivalent rights, performance awards, annual incentive cash awards and other equity-based awards, including Long-Term Incentive Plan (“LTIP”) units, which are convertible on a one-for-one basis into Operating Company Units (“OC Units”). A total of 200,000 shares of common stock were reserved for issuance pursuant to the 2015 Equity Incentive Plan, subject to certain adjustments set forth in the plan. On May 3, 2017, the Company’s stockholders approved, and the Company adopted, the Amended and Restated 2015 Stock Incentive Plan increasing the number of shares of common stock reserved for issuance under the Plan by 170,000 shares from 200,000 shares to 370,000 shares and extending the term of the Plan until May 2, 2027.



Restricted Stock Awards



The Amended and Restated 2015 Equity Incentive Plan permits the issuance of restricted shares of the Company’s common stock to employees of the Manager (as the Company has no employees) and the Company’s non-employee directors. As of September 30, 2018 and December 31, 2017, 363,587 and 288,254 shares of restricted stock, respectively, had been granted, of which 55,172 vested in 2016, 46,413 vested in 2017, 99,503 vested during the nine months ended September 30, 2018, 71,667 will vest in 2019, 71,663 will vest in 2020 and 17,502 will vest in 2021. Additionally, 1,667 were forfeited during the year ended December 31, 2016. Non-vested shares are earned over the respective vesting period based on a service condition only. Expenses related to restricted stock awards are charged to compensation expense and are recognized over the respective vesting period (primarily three to five years) of the awards. For restricted stock issued to non-employee directors of the Company, compensation expense is based on the market value of the shares at the grant date. For restricted stock awards issued to employees of the Manager, prior to the adoption of ASU 2018-07, compensation expense was re-measured at each reporting date until service was complete and the restricted shares became vested based on the then current value of the Company’s common stock. The Company early adopted ASU 2018-07 effective April 1, 2018, which established a grant date fair value of $18.10 based on the market value of the award as of April 1, 2018 for all nonemployee awards that have not vested as of April 1, 2018. Furthermore, for future awards, compensation expense is based on the market value of the shares at the grant date.



The Company recognized approximately $0.4 million and $0.3 million of stock-based compensation expense for the three months ended September 30, 2018 and 2017, respectively, and $1.6 million and $1.0 million of stock-based compensation expense for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018 and December 31, 2017, the total unrecognized compensation cost related to the Company’s restricted shares was approximately $2.5 million and $2.7 million, respectively, based on the grant date market value for awards issued to non-employee directors of the Company and the fair value of awards as of the adoption date of ASU 2018-07 for awards 

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issued to employees of the Manager. This cost is expected to be recognized over the remaining weighted average period of 2.0 years. The Company presents stock-based compensation expense in general and administrative expenses in the Consolidated Statements of Operations.



A summary of changes in the Company’s restricted shares of common stock for the three and nine months ended September 30, 2018 and 2017 is as follows:







Nonvested restricted shares of common stock receive dividends which are nonforfeitable.



Series A Preferred Stock Private Placement



On July 27, 2016 (the “Effective Date”), the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with accounts managed by NexPoint Advisors, L.P., an affiliate of Highland Capital Management, L.P. (collectively, the “Buyers”) relating to the issuance and sale, from time to time until the second anniversary of the Effective Date (such period, the “Commitment Period”), of up to $125 million in shares of the Company’s Series A Preferred Stock, par value $0.01 per share (the “Series A Preferred Stock”), at a price of $1,000 per share (the “Liquidation Value”). The sale of shares of Series A Preferred Stock pursuant to the Purchase Agreement may occur from time to time, in minimum monthly increments of $5 million, maximum monthly increments of $15 million and maximum increments of $35 million over any rolling three month period, all to be completed during the Commitment Period. As of September 30, 2018, the Company has issued all shares of Series A Preferred Stock available for issuance under the Purchase Agreement and the Articles Supplementary.



The Series A Preferred Stock ranks senior to the shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, on parity with any class or series of capital stock of the Company expressly designated as ranking on parity with the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, junior to any class or series of capital stock of the Company expressly designated as ranking senior to the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company and junior in right of payment to the Company’s existing and future indebtedness.



Holders of Series A Preferred Stock are entitled to a cumulative cash distribution (“Cash Distribution”) equal to (A) 7.0% per annum on the Liquidation Value for the period beginning on the respective date of issuance until the sixth anniversary of the Effective Date, payable quarterly in arrears, (B) 8.5% per annum on the Liquidation Value for the period beginning the day after the sixth anniversary of the Effective Date and for each year thereafter as long as the Series A Preferred Stock remains issued and outstanding, payable quarterly in arrears, and (C) an amount in addition to the amounts in (A) and (B) equal to 5.0% per annum on the Liquidation Value upon the occurrence of certain triggering events (a “Cash Premium”). In addition, the holders of the Series A Preferred Stock will be entitled to a cumulative dividend payable in-kind in shares of Common Stock or additional shares of Series A Preferred Stock, at the election of the holders (the “Stock Dividend”), equal in the aggregate to the lesser of (Y) 25% of the incremental increase in the Company’s book value (as adjusted for equity capital issuances, share repurchases and certain non-cash expenses) plus, to the extent the Company owns equity interests in income-producing real property, the incremental increase in net asset value (provided, however, that no interest in the same real estate asset will be double counted) and (Z) an amount that would, together with the Cash Distribution, result in a 14.0% internal rate of return for the holders of the Series A

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Preferred Stock from the date of issuance of the Series A Preferred Stock, as set forth in the Articles Supplementary classifying the Series A Preferred Stock (the “Articles Supplementary”). Triggering events that will trigger the payment of a Cash Premium with respect to a Cash Distribution include: (i) the occurrence of certain change of control events affecting the Company after the third anniversary of the Effective Date, (ii) the Company’s ceasing to be subject to the reporting requirements of Section 13 or Section 15(d) of the Exchange Act, (iii) the Company’s failure to remain qualified as a real estate investment trust, (iv) an event of default under the Purchase Agreement, (v) the failure by the Company to register for resale shares of Common Stock pursuant to the Registration Rights Agreement, (vi) the Company’s failure to redeem the Series A Preferred Stock as required by the Purchase Agreement, or (vii) the filing of a complaint, a settlement with, or a judgment entered by the Securities and Exchange Commission against the Company or any of its subsidiaries or a director or executive officer of the Company relating to the violation of the securities laws, rules or regulations with respect to the business of the Company.



On January 25, 2018, the Company filed, with the State Department of Assessments and Taxation of the State of Maryland (“MSDAT”), Amendment No. 1 (the “Series A Articles Supplementary Amendment”) to the Articles Supplementary (the “Series A Articles Supplementary”) to the Articles of Amendment and Restatement of the Company (the “Charter”), designating the terms of the Series A Preferred Stock. The Series A Articles Supplementary Amendment provides for certain amendments to the calculation of the cumulative dividend in the Series A Articles Supplementary, including, among other things, with respect to the computation and payment of the Aggregate Stock Dividend (as defined in the Series A Articles Supplementary) for the fiscal quarters beginning with the fiscal quarter ending March 31, 2018 through and including the fiscal quarter ending June 30, 2021.



For the first three fiscal quarters of the fiscal years 2018, 2019 and 2020 and for the first fiscal quarter of 2021, the Company will declare and pay an Aggregate Stock Dividend equal to $2,125,000 (the “Target Stock Dividend”). For the last fiscal quarter of each of 2018, 2019 and 2020 and for the second fiscal quarter of 2021, the Company will compute the cumulative Aggregate Stock Dividend for all periods after December 31, 2017 through the end of such fiscal quarter equal to 25% of the incremental increase in the Company’s book value (as adjusted for equity capital issuances, share repurchases and certain non-cash expenses) plus, to the extent that we own equity interests in income-producing real property, the incremental increase in net asset value (provided, however, that no interest in the same real estate asset will be double counted) (the “Computed Stock Dividend”), and will declare and pay for such quarter an Aggregate Stock Dividend equal to the greater of the Target Stock Dividend or the Computed Stock Dividend minus the sum of all Aggregate Stock Dividends declared and paid for all fiscal quarters after December 31, 2017 and before the fiscal quarter for which such payment is computed, in each case subject to an amount that would, together with the Cash Distribution (as defined in the Series A Articles Supplementary), result in a 14.0% internal rate of return for the holders of Series A Preferred Stock from the date of issuance of the Series A Preferred Stock. Accrued but unpaid Cash Distributions and Stock Dividends on the Series A Preferred Stock will accumulate and will earn additional Cash Distributions and Stock Dividends as calculated above, compounded quarterly.



Accrued but unpaid Cash Distributions and Stock Dividends on the Series A Preferred Stock will accumulate and will earn additional Cash Distributions and Stock Dividends as calculated above, compounded quarterly.



The holders of Series A Preferred Stock have the right to purchase their pro rata share of any qualified offering of Common Stock, which consists of any offering by the Company of Common Stock except any shares of Common Stock issued (i) in connection with a merger, consolidation, acquisition or similar business combination, (ii) in connection with a joint venture, strategic alliance or similar corporate partnering arrangement, (iii) in connection with any acquisition of assets by the Company, (iv) at market prices pursuant to a registered at-the-market program and/or (v) as part of a compensatory or employment arrangement.



As long as shares of Series A Preferred Stock remain outstanding, the Company is required to maintain a ratio of debt to total tangible assets determined under U.S. generally accepted accounting principles of no more than 0.4:1, measured as of the last day of each fiscal quarter. The Company has complied with this covenant as of September 30, 2018.



The Series A Preferred Stock may be redeemed at the Company’s option (i) after five years from the Effective Date at a price equal to 105% of the Liquidation Value per share plus the value of all accumulated and unpaid Cash Distributions and Stock Dividends, and (ii) after six years from the Effective Date at a price equal to 100% of the Liquidation Value per share plus the value of all accumulated and unpaid Cash Distributions and Stock Dividends. In the event of certain change of control events affecting the Company prior to the third anniversary of the Effective Date, the Company must redeem all shares of Series A Preferred Stock for a price equal to (a) the Liquidation Value, plus (b) accumulated and unpaid Cash Distributions and Stock Dividends, plus (c) a make-whole premium designed to provide the holders of the Series A Preferred Stock with a return on the redeemed shares equal to a 14.0% internal rate of return through the third anniversary of the Effective Date.



Holders of Series A Preferred Stock will be entitled to a separate class vote with respect to (i) any amendments to the Company’s Amended and Restated Articles of Incorporation (the “Charter”), as supplemented by the Articles Supplementary, or bylaws that would alter or change the rights, preferences, privileges or restrictions of the Series A Preferred Stock so as to materially and adversely affect such Series A Preferred Stock and (ii) reclassification or otherwise, any issuances by the Company of securities that are senior to, or equal in priority with, the Series A Preferred Stock.



In the event of any liquidation, dissolution or winding up of the Company, the holders of the Series A Preferred Stock shall be entitled to receive an amount equal to the greater of (i) the Liquidation Value, plus all accumulated but unpaid Cash Distributions and Stock Dividends

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thereon to, but not including, the date of any liquidation, but excluding any Cash Premium and (ii) the amount that would be paid on such date in the event of a redemption following a change of control.



Pursuant to the Series A Articles Supplementary, the Company increased the size of its Board by one director and elected James Dondero, as representative of the Buyers, to the Board for a term expiring at the Company’s 2017 annual meeting of stockholders (Mr. Dondero has subsequently been reelected to the Board for a term expiring at the Company’s 2019 annual meeting of stockholders). Thereafter, so long as any shares of the Series A Preferred Stock are outstanding, the holders of the Series A Preferred Stock, voting as a single class, are entitled to nominate and elect one individual to serve on our Board of Directors. If the Company has not paid the full amount of the Cash Distribution or the Stock Dividend on the shares of the Series A Preferred Stock for six or more quarterly dividend periods (whether or not consecutive), the Company will increase the size of the Board by two directors and the holders of the our Series A Preferred Stock are entitled to elect two additional directors to serve on our Board of Directors until the Company pays in full all accumulated and unpaid Cash Distributions and Stock Dividends.



Further, at any time that the Series A Preferred Stock remains outstanding, if Dean Jernigan, the Company’s current Chief Executive Officer and Chairman of the Board, voluntarily leaves the position of Chief Executive Officer, and is not serving as the Executive Chairman of the Board (a “Key Man Event”), the holders of the Series A Preferred Stock shall have the right to accept or reject the service of any person as Chief Executive Officer (or such person serving as the principal executive officer) of the Company.



The holders of the Series A Preferred Stock have certain customary registration rights with respect to the Common Stock issued as Stock Dividends pursuant to the terms of a Registration Rights Agreement.



The issuance and sale of the Series A Preferred Stock, and the issuance of shares of common stock and/or additional shares of Series A Preferred Stock issuable as Stock Dividends, will be exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”) pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D thereunder. The Buyers represented to the Company that they are “accredited investors” as defined in Rule 501 of the Securities Act and that the Series A Preferred Stock is being acquired for investment purposes and not with a view to, or for sale in connection with, any distribution thereof, and appropriate legends will be affixed to any certificates evidencing the shares of Series A Preferred Stock or Common Stock issuable pursuant to the Purchase Agreement.



On July 25, 2018, the Company entered into the First Amendment to the Purchase Agreement in order to extend the final date to issue Series A Preferred Stock under the Purchase Agreement from July 27, 2018 to September 30, 2018.



On September 28, 2018, the Company issued the final $15.0 million of Series A Preferred Stock that remained available for issuance under the Purchase Agreement.



On February 28, 2018, the Company declared a (i) cash distribution of $12.12 per share of Series A Preferred Stock, payable on April 13, 2018, to holders of Series A Preferred Stock of record on the close of business on April 1, 2018, and (ii) distributions payable in kind in a number of shares of common stock as determined in accordance with the terms of the designation of the Series A Preferred Stock, payable on April 13, 2018, to holders of Series A Preferred Stock of record on the close of business on April 1, 2018.



On May 2, 2018, the Company declared a (i) cash distribution of $16.07 per share of Series A Preferred Stock, payable on July 13, 2018, to holders of Series A Preferred Stock of record on the close of business on July 1, 2018, and (ii) distributions payable in kind in a number of shares of common stock as determined in accordance with the terms of the designation of the Series A Preferred Stock, payable on July 13, 2018, to holders of Series A Preferred Stock of record on the close of business on July 1, 2018.



On July 31, 2018, the Company declared a (i) cash distribution of $15.81 per share of Series A Preferred Stock, payable on October 15, 2018, to holders of Series A Preferred Stock of record on the close of business on October 1, 2018, and (ii) distributions payable in kind in a number of shares of common stock as determined in accordance with the terms of the designation of the Series A Preferred Stock, payable on October 15, 2018, to holders of Series A Preferred Stock of record on the close of business on October 1, 2018.



Public Offerings of Series B Preferred Stock



On January 25, 2018, the Company filed Articles Supplementary (the “Series B Articles Supplementary”) with MSDAT designating 1,725,000 of its authorized preferred stock as 7.00% Series B cumulative redeemable perpetual preferred stock (the “Series B Preferred Stock”).



The Series B Preferred Stock ranks senior to the Company’s common stock, with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, and on parity with the Series A Preferred Stock and any other class or series of capital stock of the Company expressly designated as ranking on parity with the Series B Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, junior to any class or series of capital stock of the Company expressly designated as ranking senior to the Series B Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company and junior in right of payment to the Company’s existing and future indebtedness.



Holders of Series B Preferred Stock are entitled to receive, when, as and if authorized by the Board and declared by the Company, out of funds legally available for the payment of dividends under Maryland law, cumulative cash dividends from, and including, the original issue date

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quarterly in arrears on the fifteenth (15th) day of January, April, July and October of each year (or if not a business day, on the immediately preceding business day) (each, a “dividend payment date”). These cumulative cash dividends will accrue on the liquidation preference amount of $25.00 per share at a rate per annum equal to 7.00% with respect to each dividend period from and including the original issue date (equivalent to an annual rate of $1.7500 per share) from the date of issuance of such Series B Preferred Stock. Dividends will be payable to holders of record as of 5:00 p.m., New York City time, on the related record date. The record dates for the Series B Preferred Stock are the close of business on the first (1st) day of January, April, July or October immediately preceding the relevant dividend payment date (each, a “dividend record date”). If any dividend record date falls on any day other than a business day as defined in the Series B Articles Supplementary, the dividend record date shall be the immediately succeeding business day.



On or after January 26, 2023, the Series B Preferred Stock may be redeemed, at the Company’s option, upon not less than 30 nor more than 60 days’ written notice, in whole or in part, at any time and from time to time, for cash at a redemption price equal to $25.00 per share, plus any accrued and unpaid dividends (whether or not authorized or declared) to, but excluding, the date fixed for redemption. Holders of Series B Preferred Stock will have no right to require the redemption or repurchase of the Series B Preferred Stock. Upon the occurrence of a Change of Control (as defined in the Series B Articles Supplementary), we may redeem for cash, in whole or in part, the Series B Preferred Stock within 120 days after the date on which such Change of Control occurred, by paying $25.00 per share, plus any accrued and unpaid dividends (whether or not authorized or declared) to, but excluding, the date fixed for redemption.



Upon the occurrence of a Change of Control, each holder of Series B Preferred Stock will have the right (unless, prior to the Change of Control conversion date, the company has provided or provides notice of its election to redeem, in whole or in part, the Series B Preferred Stock) to convert some or all of the Series B Preferred Stock held by such holder (the “Change of Control Conversion Right”), on the Change of Control Conversion Date (as defined below) into a number of the Company’s common stock per Series B Preferred Stock to be converted equal to the lesser of: (1) the quotient obtained by dividing (i) the sum of  (x) the liquidation preference amount of $25.00 per Series B Preferred Stock, plus (y) any accrued and unpaid dividends thereon (whether or not authorized or declared) to, but excluding, the Change of Control Conversion Date (unless the Change of Control Conversion Date is after a record date for a Series B Preferred Stock dividend payment for which dividends have been declared and prior to the corresponding Series B Preferred Stock dividend payment date, in which case no additional amount for such accrued and unpaid dividend will be included in this sum and such declared dividend will instead be paid, on such dividend payment date, to the holder of record of the Series B Preferred Stock to be converted as of 5:00 p.m. New York City time, on such record date) by (ii) the defined Stock Price; and (2) the 2.74876 share cap, subject to certain adjustments.



Holders of the Series B Preferred Stock generally will have no voting rights. However, if the Company is in arrears on dividends, whether or not authorized or declared, on the Series B Preferred Stock for six or more quarterly periods, whether or not consecutive, holders of Series B Preferred Stock (voting together as a single class with the holders of all other classes or series of parity preferred stock (which excludes holders of Series A Preferred Stock, who are entitled to a separate class vote to elect separate Series A Preferred directors, as described above, upon which like voting rights have been conferred and are exercisable)) will be entitled to elect two additional directors at a special meeting called upon the request of the holders of at least 10% of such outstanding shares of Series B Preferred Stock or the holders of at least 10% of outstanding shares of any such other class or series of the Company’s parity preferred stock or at the Company’s next annual meeting and each subsequent annual meeting of stockholders, until all accrued and unpaid dividends with respect to the Series B Preferred Stock have been paid. Such directors will be elected by a vote of holders of a majority of the outstanding Series B Preferred Stock and any other series of parity equity securities upon which like voting rights have been conferred and are exercisable, voting together as a single class (which excludes holders of Series A Preferred Stock, who are entitled to a separate class vote to elect separate Series A Preferred directors as described above).



In the event of any liquidation, dissolution or winding up of the Company, the holders of the Series B Preferred Stock shall be entitled to receive a liquidating distribution in the amount of  $25.00 per share, plus accrued and unpaid dividends (whether or not authorized or declared) to, but excluding, the date of final distribution to such holders.



On January 26, 2018, the Company received $36.0 million in proceeds, net of underwriter’s discount and offering costs, related to the issuance of 1,500,000 shares of Series B Preferred Stock.



In connection with the issuance of the Series B Preferred Stock, the Company, acting in its capacity as the sole managing member of the Operating Company, entered into Amendment No. 2 to the Limited Liability Company Agreement in order to provide for the issuance, and the designation of the terms and conditions, of newly classified 7.00% Series B preferred units of limited liability company interest in the Operating Company, the economic terms of which are identical to those of the Series B Preferred Stock. For more information about the Series B Preferred Stock, see our Current Report on Form 8-K filed on January 25, 2018.



Series B Preferred Stock At-the-Market Offering Program

 

On March 29, 2018, the Company and the Operating Company entered into a Distribution Agreement (the “Distribution Agreement”), by and among the Company, the Operating Company, the Manager and B. Riley FBR, Inc. (the “Agent”) in connection with the commencement of an at-the-market continuous offering program (the “Preferred ATM Program”). Pursuant to the terms and conditions of the Distribution Agreement, the Company may, from time to time, issue and sell through or to the Agent, shares of the Series B Preferred Stock, having an aggregate offering price of up to $45.0 million (the “Preferred ATM Shares”).



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In connection with the Preferred ATM Program, the Company filed, with MSDAT, Articles Supplementary (the “Preferred ATM Articles Supplementary”) to the Articles of Amendment and Restatement of the Company, designating 2,025,000 shares of its previously undesignated preferred stock as Series B Preferred Stock. The Preferred ATM Articles Supplementary increase the number of shares of the Company’s preferred stock designated as Series B Preferred Stock from 1,725,000 to 3,750,000.



As of September 30, 2018, the Company has sold 71,734 shares of Series B Preferred Stock at a weighted average price of $22.94, receiving net proceeds after commissions and other offering costs of $1.4 million under the Preferred ATM Program.



The Company or the Agent may at any time suspend the offering or terminate the Distribution Agreement pursuant to the terms of the Distribution Agreement. The actual sale of Preferred ATM Shares under the Program will depend on a variety of factors to be determined by the Company from time to time, including, among other things, market conditions, the trading price of the Series B Preferred Stock, capital needs and determinations by the Company of the appropriate sources of funding for the Company. The Company has no obligation to sell any of the Preferred ATM Shares, and may, at any time, suspend offers under the Distribution Agreement or terminate the Distribution Agreement.



9. EARNINGS PER SHARE



Basic earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of shares outstanding during the period. All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share. Both the unvested restricted shares and the assumed share-settlement of the accrued stock dividend to holders of the Series A Preferred Stock, and the related impacts to earnings, are considered when calculating earnings per share on a diluted basis with our diluted earnings per share being the more dilutive of the treasury stock or two-class methods. For the three and nine months ended September 30, 2018 and 2017, the Company’s basic earnings per share is computed using the two-class method, and our diluted earnings per share is computed using the more dilutive of the treasury stock method or two-class method:











10. RELATED PARTY TRANSACTIONS



Equity Method Investments



Certain of the Company’s development property investments and bridge loan investments are equity method investments for which the Company has elected the fair value option of accounting. The fair value of these equity method investments at September 30, 2018 and

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December 31, 2017 was $400.1 million and $215.9 million, respectively. The interest income realized and the net unrealized gain from these equity method investments was $18.4 million and $4.8 million for the three months ended September 30, 2018 and 2017, respectively, and $42.1 million and $13.0 million for the nine months ended September 30, 2018 and 2017, respectively.



The Company’s investment in the real estate venture, the SL1 Venture, has a carrying amount of $14.4 million and $13.9 million at September 30, 2018 and December 31, 2017, respectively, and the earnings from this venture were $0.4 million and $1.4 million for the three and nine months ended September 30, 2018. The earnings from this venture were $0.7 million and $1.7 million for the three and nine months ended September 30, 2017.



Management Agreement



On April 1, 2015, the Company entered into a Management Agreement with its Manager (the “Management Agreement”). Pursuant to the terms of the Management Agreement, the Manager will be responsible for (a) the Company’s day-to-day operations, (b) determining investment criteria and strategy in conjunction with the Company’s Board of Directors, (c) sourcing, analyzing, originating, underwriting, structuring, and acquiring the Company’s portfolio investments, and (d) performing portfolio management duties. The Manager has an Investment Committee that approves investments in accordance with the Company’s investment guidelines, investment strategy, and financing strategy.



On May 23, 2016, the Company entered into an Amended and Restated Management Agreement (the “Amended and Restated Management Agreement”) by and among the Company, the Operating Company and the Manager that amends and restates the original Management Agreement dated April 1, 2015. The Amended and Restated Management Agreement was approved on behalf of the Company and the Operating Company by a unanimous vote of the Nominating and Corporate Governance Committee of the Company’s Board of Directors, which consists solely of independent directors.



The Amended and Restated Management Agreement modified certain procedures with respect to the future internalization of the Manager (as described in the Amended and Restated Management Agreement, an “Internalization Transaction”). Prior to entry into the Amended and Restated Management Agreement, if no Internalization Transaction had occurred prior to the end of the last renewal term, the Manager would have been entitled to the Termination Fee (as defined in the Amended and Restated Management Agreement) and the Company would not have acquired the assets of the Manager. The Amended and Restated Management Agreement, however, requires an Internalization Transaction at the end of the last renewal term (if an Internalization Transaction or termination of the Amended and Restated Management Agreement has not occurred prior to that date). The Internalization Price in such event would equal the Termination Fee amount and the Company would receive the Manager’s assets. Accordingly, the amount the Manager would receive has not changed, but the Company now would receive the assets of the Manager, which it would not have received prior to the Amended and Restated Management Agreement. 



Under the Amended and Restated Management Agreement, if an Internalization Transaction has not occurred prior to March 31, 2023, the last day of the last renewal term, then the Manager and the Company shall consummate an Internalization Transaction to be effective as of that date and all assets of the Manager (or, alternatively, all of the equity interests in the Manager) shall be conveyed to and acquired by the Operating Company in exchange for the Internalization Price (as described herein). At such time, all employees of the Manager shall become employees of the Operating Company and the Manager shall discontinue all business activities. Unlike an Internalization Transaction that occurs prior to the end of the final renewal term of the Amended and Restated Management Agreement, an Internalization Transaction that occurs at the end of the final renewal term shall not require a fairness opinion, the approval of a special committee of the Company’s Board of Directors or the approval of the Company’s stockholders.



The “Internalization Price” payable in the event of an Internalization Transaction at the end of the last renewal term shall be equal to the Termination Fee and the Board of Directors of the Company has no discretion to change such Internalization Price or the conditions applicable to its payment.



The Internalization Price paid to the Manager in any Internalization Transaction will be payable by the Operating Company in the number of units of limited liability company interests (“OC Units”) of the Operating Company equal to the Internalization Price, divided by the volume-weighted average of the closing market price of the common stock of the Company for the ten consecutive trading days immediately preceding the date with respect to which value must be determined. However, if the common stock of the Company is not traded on a national securities exchange at the time of closing of any Internalization Transaction, then the number of OC Units shall be determined by agreement between the Board of Directors of the Company and the Manager or, in the absence of such agreement, the Internalization Price shall be paid in cash.



Prior to entry into the Amended and Restated Management Agreement, any Termination Fee would have been payable by the Operating Company in OC Units equal to the Termination Fee divided by the average of the daily market price of the Company’s common stock for the ten consecutive trading days immediately preceding the date of termination within 90 days after occurrence of the event requiring the payment of the Termination Fee. In accordance with ASC 505-50, Equity—Equity-based Payments to Non-Employees, since the number of OC Units to be issued was dependent upon different possible outcomes, the Company recognized the lowest aggregate amount within the range of outcomes. Accordingly, the Company estimated the deferred termination fee payable and accrued the expense over the term of the Management Agreement. Upon entry into the Amended and Restated Management Agreement, the Company ceased recognizing the deferred termination fee expense and reclassified the Non-Controlling Interests to Additional Paid-In-Capital since the Termination Fee is no longer

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certain of being paid other than in exchange for either the assets or equity of the Manager. Accordingly, the Company recorded no expense during the three and nine months ended September 30, 2018 and 2017.



On April 1, 2017, the Company, the Operating Company and the Manager entered into a Second Amended and Restated Management Agreement to modify the manner in which certain expenses incurred by the Manager are accounted for and paid by the Company. Under the Amended and Restated Management Agreement, the Manager may engage independent contractors that provide investment banking, securities brokerage, mortgage brokerage and other financial, legal and account services as may be required for the Company’s investments, and the Company agrees to reimburse the Manager for costs and expenses incurred in connection with these services. The Second Amended and Restated Management Agreement now provides that expenses incurred by the Manager are reimbursable to the Manager by the Company only to the extent such expenses are not otherwise directly reimbursed by an unaffiliated third party. The amount of expenses to be reimbursed to the Manager by the Company will be reduced dollar-for-dollar by the amount of any such payment or reimbursement.



On November 1, 2017, the Company, the Operating Company and the Manager entered into the Third Amended and Restated Management Agreement in order to clarify the original intent of the parties with respect to the definition of Core Earnings and to make other minor changes necessary to reflect the current and anticipated business model from and after this time. The Third Amended and Restated Management Agreement is otherwise substantially consistent with the Second Amended and Restated Management Agreement.



Under the Third Amended and Restated Management Agreement, “Core Earnings” is defined as (1) net income (loss) determined under GAAP, plus (2) non-cash equity compensation expense, the incentive fee, depreciation and amortization, plus (3) any unrealized losses or other non-cash expense items reflected in GAAP net income (loss), less (4) any unrealized gains reflected in GAAP net income (including any unrealized appreciation with respect to self-storage facilities that we have not yet acquired). The Third Amended and Restated Management Agreement clarifies that in addition to certain previously agreed upon adjustments, with respect to any self-storage facility acquired by the Company with respect to which we had an outstanding loan as of the time of such acquisition, the amount of Core Earnings determined pursuant to the formula above in the period of such acquisition shall also be increased by the difference between (A) the appraised value, as determined by a nationally recognized, independent third-party appraiser mutually agreed to by the Company and the Manager who has significant expertise in valuing self-storage properties, and (B) (i) the outstanding principal amount of any Company loan secured by such acquired self-storage facility at the time of such acquisition plus (ii) any other consideration given to the former owner upon such acquisition. This addition is intended to include in Core Earnings the amount of the Company’s unrealized gain on account of the Company’s acquisition of a self-storage facility without such facility being sold to a third party buyer in the open market.



The initial term of the Management Agreement will expire on March 31, 2020, with up to a maximum of three, one-year extensions that end on March 31, 2023. The Company’s independent directors review the Manager’s performance annually. Following the initial term, the Management Agreement may be terminated annually upon the affirmative vote of at least two-thirds of the Company’s independent directors based upon: (a) the Manager’s unsatisfactory performance that is materially detrimental to the Company; or (b) the Company’s determination that the management fees payable to the Manager are not fair, subject to the Manager’s right to prevent termination based on unfair fees by accepting a reduction of management fees agreed to by at least two-thirds of the independent directors. The Company is required to provide its Manager with 180 days’ prior notice of such a termination. Upon such a termination, the Company will pay the Manager a Termination Fee except as provided below.



No later than 180 days prior to the end of the initial term of the Management Agreement, the Manager will offer to contribute to the Company’s Operating Company at the end of the initial term all of the assets or equity interests in the Manager at the internalization price and on such terms and conditions included in a written offer provided by the Manager.



Upon receipt of the Manager’s initial internalization offer, a special committee consisting solely of the Company’s independent directors may accept the Manager’s proposal or submit a counter offer to the Manager. If the Manager and the special committee are unable to agree, the Manager and the special committee will repeat this process annually during the term of any extension of the Management Agreement. Acquisition of the Manager pursuant to this process requires a fairness opinion from a nationally recognized investment banking firm and stockholder approval, in addition to approval by the special committee. As described above, if an Internalization Transaction has not occurred prior to March 31, 2023, the last day of the last renewal term, then the Manager and the Company shall consummate an Internalization Transaction to be effective as of that date, and such Internalization Transaction shall not require a fairness opinion, the approval of a special committee of the Company’s Board of Directors or the approval of the Company’s stockholders.



If the Management Agreement terminates other than for Cause (as defined below), voluntary non-renewal by the Manager or the Company being required to register as an investment company under the 1940 Act, then the Company shall pay to the Manager, on the date on which such termination is effective, a Termination Fee equal to the greater of (i) three times the sum of the average annual Base Management Fee and Incentive Fee earned by the Manager during the 24-month period prior to such termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination, or (ii) the offer price, which will be based on the lesser of (a) the Manager’s earnings before interest, taxes, depreciation and amortization (adjusted for unusual, extraordinary and non-recurring charges and expenses), or “EBITDA” annualized based on the most recent quarter ended, multiplied by a specific multiple, or EBITDA Multiple, depending on the Company’s achieved total annual return, and (b) the Company’s equity market capitalization multiplied by a specific percentage, or Capitalization Percentage, depending on the Company’s achieved total return (the Internalization Price). Any Termination Fee will be payable by the Operating Company in cash.



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The Company also may terminate the Management Agreement at any time, including during the initial term, without the payment of any Termination Fee, with 30 days’ prior written notice from the Board of Directors, for cause. “Cause” is defined as: (i) the Manager’s continued breach of any material provision of the Management Agreement following a prescribed period; (ii) the occurrence of certain events with respect to the bankruptcy or insolvency of the Manager; (iii) a change of control of the Manager that a majority of the Company’s independent directors determines is materially detrimental to the Company; (iv) the Manager committing fraud against the Company, misappropriating or embezzling the Company’s funds, or acting grossly negligent in the performance of its duties under the Management Agreement; (v) the dissolution of the Manager; (vi) the Manager fails to provide adequate or appropriate personnel that are reasonably necessary for the Manager to identify investment opportunities for the Company and to manage and develop the Company’s investment portfolio if such default continues uncured for a period of 60 days after written notice thereof, which notice must contain a request that the same be remedied; (vii) the Manager is convicted (including a plea of nolo contendere) of a felony; or (viii) both the current Chief Executive Officer and the current President and Chief Operating Officer are no longer senior executive officers of the Manager or the Company during the term of the Management Agreement other than by reason of death or disability.



The Manager may terminate the Management Agreement if the Company becomes required to register as an investment company under the 1940 Act, with such termination deemed to occur immediately before such event, in which case the Company would not be required to pay the Manager a Termination Fee. The Manager may also decline to renew the Management Agreement by providing the Company with 180 days’ written notice, in which case the Company would not be required to pay a Termination Fee.



The Management Agreement provides for the Manager to earn a base management fee and an incentive fee, both of which are described further below. In addition, the Company will reimburse certain expenses of the Manager, excluding the salaries and cash bonuses of the Manager’s chief executive officer and chief financial officer, a portion of the salary of the president and chief operating officer, and certain other costs as determined by the Manager in accordance with the Management Agreement. Certain prepaid expenses and fixed assets are also purchased through the Manager and reimbursed by the Company. In the event that the Company terminates the Management Agreement pursuant to its terms, other than for Cause or the Company being required to register as an investment company under the 1940 Act, there will be a Termination Fee due to the Manager. Amounts reimbursable to the Manager for expenses are included in general and administrative expenses in the Consolidated Statements of Operations and totaled $1.0 million and $0.8 million for the three months ended September 30, 2018 and 2017, respectively, and $2.8 million and $2.3 million for the nine months ended September 30, 2018 and 2017, respectively.



Management Fees



As of September 30, 2018, the Company did not have any personnel. As a result, the Company is relying on the properties, resources and personnel of the Manager to conduct operations. Pursuant to the Management Agreement, the Company pays the Manager a base management fee in an amount equal to 0.375% of the Company’s stockholders’ equity (a 1.5% annual rate) calculated and payable quarterly in arrears in cash. For purposes of calculating the base management fee, the Company’s stockholder’s equity means: (a) the sum of (i) the net proceeds from all issuances of the Company’s equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus (ii) the Company’s retained earnings at the end of the most recently completed fiscal quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods); less (b) any amount that the Company pays to repurchase the Company’s common stock since inception, provided that if the Company’s retained earnings are in a net deficit position (following any required adjustments set forth below), then retained earnings shall not be included in stockholders’ equity. It also excludes (x) any unrealized gains and losses and other non-cash items that have impacted stockholders’ equity as reported in the Company’s financial statements prepared in accordance with accounting principles generally accepted in the United States, or GAAP, and (y) one-time events pursuant to changes in GAAP (such as a cumulative change to the Company’s operating results as a result of a codification change pursuant to GAAP), and certain non-cash items not otherwise described above (such as depreciation and amortization), in each case after discussions between the Company’s Manager and the Company’s independent directors and approval by a majority of the Company’s independent directors. As a result, the Company’s stockholders’ equity, for purposes of calculating the base management fee, could be greater or less than the amount of stockholders’ equity shown on the Company’s financial statements. The base management fee is payable independent of the performance of the Company’s portfolio. The Manager computes the base management fee within 30 days after the end of the fiscal quarter with respect to which such installment is payable and promptly delivers such calculation to the Company’s Board of Directors. The amount of the installment shown in the calculation is due and payable no later than the date which is five business days after the date of delivery of such computation to the Board of Directors. The calculation generally will be reviewed by the Board of Directors at their regularly scheduled quarterly board meeting. The base management fee was $1.9 million and $1.0 million for the three months ended September 30, 2018 and 2017, respectively, and $4.8 million and $2.4 million for the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018 and December 31, 2017, the Company had outstanding fees due to Manager of $2.3 million and $1.5 million, respectively, consisting of the management fees payable and certain general and administrative reimbursements payable.



Incentive Fee



The Manager is entitled to an incentive fee with respect to each fiscal quarter (or part thereof that the Management Agreement is in effect) in arrears in cash. The incentive fee is an amount, not less than zero, determined pursuant to the following formula:



Incentive Fee = .20 times (A minus (B times .08)) minus C



In the foregoing formula:

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 A equals the Company’s Core Earnings (as defined below) for the previous 12-month period;

 

 B equals (i) the weighted average of the issue price per share of the Company’s common stock of all of its public offerings of common stock, multiplied by (ii) the weighted average number of all shares of common stock outstanding (including (i) any restricted stock units and any restricted shares of common stock in the previous 12-month period and (ii) shares of common stock issuable upon conversion of outstanding OC Units); and

 

 C equals the sum of any incentive fees earned by the Manager with respect to the first three fiscal quarters of such previous 12-month period.



Notwithstanding application of the incentive fee formula, no incentive fee shall be paid with respect to any fiscal quarter unless cumulative annual stockholder total return for the four most recently completed fiscal quarters is greater than 8%. Any computed incentive fee earned but not paid because of the foregoing hurdle will accrue until such 8% cumulative annual stockholder total return is achieved. The total return is calculated by adding stock price appreciation (based on the volume-weighted average of the closing price of the Company’s common stock on the New York Stock Exchange (or other applicable trading market) for the last ten consecutive trading days of the applicable computation period minus the volume-weighted average of the closing market price of the Company’s common stock for the last ten consecutive trading days of the period immediately preceding the applicable computation period) plus dividends per share paid during such computation period, divided by the volume-weighted average of the closing market price of the Company’s common stock for the last ten consecutive trading days of the period immediately preceding the applicable computation period. For purposes of computing the Incentive Fee, “Core Earnings” is defined as net income (loss) determined under GAAP, plus non-cash equity compensation expense, the incentive fee, depreciation and amortization (to the extent that the Company forecloses on any facilities underlying the Company’s target investments), any unrealized losses or other non-cash expense items reflected in GAAP net income (loss), less any unrealized gains reflected in GAAP net income. The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the Manager and the Company’s independent directors and after approval by a majority of the independent directors.  The Third Amended and Restated Management Agreement clarifies that in addition to certain previously agreed upon adjustments, with respect to any self-storage facility acquired by the Company with respect to which we had an outstanding loan as of the time of such acquisition, the amount of Core Earnings determined pursuant to the formula above in the period of such acquisition shall also be increased by the difference between (A) the appraised value, as determined by a nationally recognized, independent third-party appraiser mutually agreed to by the Company and the Manager who has significant expertise in valuing self-storage properties, and (B) (i) the outstanding principal amount of any Company loan secured by such acquired self-storage facility at the time of such acquisition plus (ii) any other consideration given to the former owner upon such acquisition. This addition is intended to include in Core Earnings the amount of the Company’s unrealized gain on account of the Company’s acquisition of a self-storage facility without such facility being sold to a third party buyer in the open market.



The Manager computes each quarterly installment of the incentive fee within 45 days after the end of the fiscal quarter with respect to which such installment is payable and promptly delivers such calculation to the Company’s Board of Directors. The amount of the installment shown in the calculation is due and payable no later than the date which is five business days after the date of delivery of such computation to the Board of Directors. The calculation generally will be reviewed by the Board of Directors at their regularly scheduled quarterly board meeting. The Manager has not earned an incentive fee for the three and nine months ended September 30, 2018 and 2017.



11. SUBSEQUENT EVENTS



The Company’s management has evaluated subsequent events through the date of issuance of the consolidated financial statements included herein. Other than those disclosed below, there have been no subsequent events that occurred during such period that require disclosure or recognition in the accompanying consolidated financial statements.



Dividend Declarations



On October 31, 2018, the Company’s Board of Directors declared a cash dividend to the holders of the Series A Preferred Stock and a distribution payable in kind, if applicable, in a number of shares of common stock or Series A Preferred Stock as determined in accordance with the election of the holders of the Series A Preferred Stock for the quarter ending December 31, 2018. The dividends are payable on January 15, 2019 to holders of Series A Preferred Stock of record on January 1, 2019.



On October 31, 2018, the Company’s Board of Directors declared a cash dividend on the Series B Preferred Stock in the amount of $0.4375 per share for the quarter ending December 31, 2018. The dividends are payable on January 15, 2019 to holders of Series B Preferred Stock of record on January 2, 2019.



On October 31, 2018, the Company’s Board of Directors declared a cash dividend of $0.35 per share of common stock for the quarter ending December 31, 2018. The dividend is payable on January 15, 2019 to stockholders of record on January 2, 2019.



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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Note Regarding Forward-Looking Statements



We make statements in this Quarterly Report on Form 10-Q that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). These forward-looking statements include, without limitation, statements about our estimates, expectations, predictions and forecasts of our future business plans and financial and operating performance and/or results, as well as statements of management’s goals and objectives and other similar expressions concerning matters that are not historical facts. When we use the words “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” or similar expressions or their negatives, as well as statements in future tense, we intend to identify forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, beliefs and expectations, such forward-looking statements are not predictions of future events or guarantees of future performance and our actual financial and operating results could differ materially from those set forth in the forward-looking statements. Some factors that might cause such differences are described in the section entitled “Risk Factors” in this report and in our Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”), which was filed with the Securities and Exchange Commission (“SEC”) on March 2, 2018, and in other filings we make with the SEC from time to time, which factors include, without limitation, the following:



Given these uncertainties, undue reliance should not be placed on our forward-looking statements. We assume no duty or responsibility to publicly update or revise any forward-looking statement that may be made to reflect future events or circumstances or to reflect the occurrence of unanticipated events. We urge you to review the disclosures concerning risks in the sections entitled “Risk Factors,” “Forward-Looking Statements,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2017 Form 10-K and in other filings we make with the SEC from time to time.



Overview



We are a commercial real estate company that invests primarily in new or recently-constructed and opened self-storage facilities located predominately in dense urban submarkets within large United States MSAs. Facilities in which we invest are largely vertical (three to ten floors), 100% climate controlled and technologically adapted buildings, which we call Generation V facilities, located in submarkets with demographic profiles and competitive positions that management believes will support successful lease-up and value creation in the project. Our investments include mortgage loans typically coupled with equity interests as well as outright ownership of self-storage facilities.



Our principal business objective is to deliver attractive risk-adjusted returns by investing in new Generation V facilities primarily in urban submarkets. A substantial majority of our investments to date have been first mortgage loans to finance ground-up construction of and conversion of existing buildings into new Generation V self-storage facilities. These investments, which we refer to as “development property investments,” are typically structured as loans equal to between 90% and 97% of the cost of the facility. We receive a fixed rate of interest on loaned amounts and up to a 49.9% interest in the positive cash flows from operations, sales and /or refinancings of self-storage facilities, which we refer to as “Profits Interest”. We typically receive a right of first refusal to acquire the self-storage facility upon sale.



In order to adapt our investment activities to the current self-storage cycle, we opportunistically provide capital to refinance primarily Generation V facilities that have been developed since 2013 and are currently in lease-up. Facilities refinanced by our bridge loan investments will predominately be in locations and have demographic and competitive profiles that are very similar to our development property investments. On March 2, 2018, we closed our first bridge loan investment consisting of five separate loans with Profits Interest having an aggregate commitment amount of $83.3 million secured by first mortgages on five properties in the Miami, Florida MSA.



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During the nine months ended September  30, 2018, we acquired the 50.1% equity interests of our developer partners in our Jacksonville 1, Atlanta 1, Atlanta 2, Pittsburgh and Charlotte 1 development property investments. Each property is now wholly-owned by us and consolidated in the accompanying interim consolidated financial statements. As of September 30, 2018, we wholly-owned a total of six self-storage facilities.



We account for our development property investments, bridge loan investments, and operating property loans at fair value, with appreciation and depreciation in the value of these investments being reflected in the carrying value of the assets and in the determination of net income. In determining fair value, we re-value each development property investment, bridge loan investment, and operating property loan each quarter, which revaluation includes an analysis of the current value of any Profits Interest associated with the investment. We believe that carrying our assets at fair value and reflecting appreciation and depreciation in our earnings provide our stockholders and others who rely on our financial statements with a more complete and accurate understanding of our financial condition and economic performance, including our revenues and the intrinsic value inherent in our Profits Interests as self-storage facilities we finance are constructed, leased-up and become stabilized.



We have funded all of our on-balance sheet investments to date with the following sources of capital:





On March 7, 2016, we, through our Operating Company, entered into the Limited Liability Company Agreement of Storage Lenders (the “SL1

Venture”) with HVP III Storage Lenders Investor, LLC (“HVP III”), an investment vehicle managed by Heitman. The SL1 Venture was formed for the purpose of providing capital to developers of self-storage facilities identified and underwritten by us. Upon formation, HVP III committed $110.0 million for a 90% interest in the SL1 Venture, and we committed $12.2 million for a 10% interest. On March 31, 2016, we contributed to the SL1 Venture three self-storage development investments with an aggregate commitment amount of $41.9 million. As of September 30, 2018, the SL1 Venture had closed on eight additional development property investments with a Profits Interest with an aggregate commitment amount of approximately $81.4 million, bringing the total aggregate commitment of SL1 Venture’s investments to $123.3 million as of September 30, 2018.



We are externally managed and advised by JCAP Advisors, LLC (the “Manager”). The Manager is led by our founder and executive chairman, Dean Jernigan, and our chief executive officer, John A. Good. Mr. Jernigan is a 30-year veteran of the self-storage industry, including a combined 16 years as the chief executive officer of Storage USA and CubeSmart, both NYSE listed self-storage REITs. During his time at these two companies, Mr. Jernigan oversaw the investment of over $3 billion of capital in the self-storage industry. Mr. Good has over 29 years of experience working with senior management teams and boards of directors of public companies in the REIT and financial services industries on corporate finance, corporate governance, merger and acquisition, tax, executive compensation, joint venture, and strategic planning projects as a nationally recognized corporate and securities lawyer. Prior to joining the Company, he served as lead counsel on over 200 securities offerings, including our IPO, raising in excess of $25 billion over the past 25 years, with more than 125 of those deals being in the REIT industry. We believe the industry experience and depth of relationships of our senior management team and other investment professionals provide us with a significant competitive advantage in sourcing, evaluating, underwriting and servicing self-storage investments.



We are a Maryland corporation that was organized on October 1, 2014 that has elected to be taxed as a REIT under the Internal Revenue Code of 1986 (“the Code”), as amended. As a REIT, we generally will not be subject to U.S. federal income taxes on our taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gains, to the extent that we annually distribute all of our REIT taxable income to stockholders and comply with certain other requirements for qualification as a REIT set forth in the Code. We are structured as an UPREIT and conduct our investment activities through our Operating Company. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration under the 1940 Act.



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Factors Impacting Our Operating Results



The results of our operations have historically been affected, and will continue to be affected, by a number of factors including, among other things:

 



As the current development cycle winds down, we believe that developers who constructed new self-storage facilities earlier in the cycle will be seeking financing to pay off existing construction debt and buy out private equity partners. We believe our bridge financing program will meet the needs and plans of these developers in a way unlikely to be met by the traditional lending market. Moreover, we believe our current developer partners and other developers with whom we do not currently have financing relationships will be seeking early exits from their development projects, providing opportunities for us to acquire new Generation V facilities in the lease-up phase. We intend to continue to pursue bridge financings of recently built self-storage facilities in lease-up phase and to selectively evaluate acquisitions of our current developer partners’ membership interests in projects that we have financed. In addition to the factors described above, our results of operations will also be impacted by the following additional factors:





Our total investment income includes interest income from investments, which also reflects the accretion of origination fees, and is recognized utilizing the effective interest method based on the contractual rate and the outstanding principal balance of the loans we originate. The objective of the effective interest method is to arrive at periodic interest income that yields a level rate of return over the loan term. Interest rates may vary according to the type of loan, conditions in the financial markets, creditworthiness of our borrowers, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers. Our income also includes earnings from our investment in the SL1 Venture, which is calculated based on the allocation of earnings as prescribed in the JV Agreement. In addition, our operating results are affected by the valuation of our development property investments, bridge loan investments and our operating property loans. These investments are marked to fair value each quarter, and increases and decreases in fair value are reflected in the carrying values of the investments in our Consolidated Balance Sheets and as unrealized increases/decreases in fair value in our Consolidated Statements of Operations. We have made, and in the future we may make, additional equity investments in self-storage facilities, either for fee simple ownership by our Operating Company or in joint ventures with our developers, institutional or other strategic partners. In that regard, in connection with many of our development investments, we have obtained rights of first refusal in connection with potential future sales of self-storage facilities that we finance. Our operating results include rental income and related operating expenses from owned self-storage facilities. Our results for the three and nine months ended September 30, 2018 and 2017 also were impacted by our accounting methods as discussed below.



Changes in Fair Value of Our Assets



We have elected the fair value option of accounting for our investment portfolio. We have elected fair value accounting for these financial instruments because we believe such accounting provides stockholders and others who rely on our financial statements with a more complete and accurate understanding of our economic performance, including our revenues and the intrinsic value inherent in the Profits Interests we possess. Under the fair value option, we mark our development property investments, bridge loan investments, and operating property loans to estimated fair value at the end of each accounting period, with corresponding increases or decreases in fair value being reflected in our Consolidated Statements of Operations. There is no active secondary market for our development property investments, bridge loan investments, and operating property loans and no readily available market value; accordingly, our determination of fair value requires judgment and extensive use of estimates. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our development property investments, bridge loan investments, and operating property loans may fluctuate from period to period. Additionally, the fair value of our development property investments, bridge loan investments, and operating property loans may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that we may ultimately realize. Our development property investments, bridge loan investments, and operating property loans are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If we were required to liquidate an investment in a forced or liquidation sale, we could realize significantly less than the value at which we have

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recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned.



Changes in Market Interest Rates



With respect to our business operations, increases in interest rates, in general, may over time cause: the interest expense associated with our borrowings to increase; the value of our loan portfolio to decline; interest rates on any floating rate loans to reset, although on a delayed basis, to higher interest rates; and to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase. Conversely, decreases in interest rates, in general, may over time cause: the interest expense associated with our borrowings to decrease; the value of our mortgage loan portfolio to increase; interest rates on any floating rate loans to reset, although on a delayed basis, to lower interest rates; and to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease.



Credit Risk



We are subject to varying degrees of credit risk in connection with our target investments and other loans. Our Manager seeks to mitigate this risk by seeking to originate or acquire loans of higher quality at appropriate prices given anticipated and unanticipated losses, by utilizing a comprehensive selection, underwriting and due diligence review process, and by proactively monitoring originated or acquired loans. Although we expect that our borrowers will perform in full on their obligations under the loan documents, one of our underwriting principles is that we will generally not make a loan secured by a property that we, at the time of our investment decision, do not wish to ultimately own and operate. We believe this principle and our ability to effectively own and operate self-storage properties mitigates credit risk. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results.



Market Conditions



We believe that present conditions in certain markets continue to be conducive to realizing attractive risk-adjusted returns on investments in self-storage facilities owned by private operators. The self-storage sector has experienced increased construction starts recently and the trend is expected to continue upwards. The key demand drivers of the self-storage sector include population mobility and new job creation, both of which are experiencing increases since the recession, as well as population growth. These drivers have created demand for self-storage, which in turn have developers looking to develop and match demand with supply. The main deterrents for developers are government regulations (primarily zoning restrictions) and the lack of financing available in the sector. Currently, lenders are only willing to lend up to 70% of the loan-to-value ratio, whereas our substantial industry knowledge enables us to make loans at ratios of approximately 90% loan-to-cost (“LTC”). In certain situations, we will advance more than 90% of cost and receive a higher rate of interest, some of which will be received as payment-in-kind (“PIK”) interest rather than cash interest.



Recent Developments



Dividend Declarations



On October 31, 2018, our Board of Directors declared a cash dividend to the holders of the Series A Preferred Stock and a distribution payable in kind, if applicable, in a number of shares of common stock or Series A Preferred Stock as determined in accordance with the election of the holders of the Series A Preferred Stock for the quarter ending December 31, 2018. The dividends are payable on January 15, 2019 to holders of Series A Preferred Stock of record on January 1, 2019.



On October 31, 2018, our Board of Directors declared a cash dividend on the Series B Preferred Stock in the amount of $0.4375 per share for the quarter ending December 31, 2018. The dividends are payable on January 15, 2019 to holders of Series B Preferred Stock of record on January 2, 2019.



On October 31, 2018, our Board of Directors declared a cash dividend of $0.35 per share of common stock for the quarter ending December 31, 2018. The dividend is payable on January 15, 2019 to stockholders of record on January 2, 2019.



Investment Activity



Our self-storage investments at September 30, 2018 consisted of the following:









As of September 30, 2018, the aggregate committed principal amount of our development property investments, bridge loan investments and operating property loan was approximately $656.6 million and outstanding principal was $388.5 million, as described in more detail in the table below (dollars in thousands):













Real estate venture activity



As of September 30, 2018, the SL1 Venture had 11 development property investments with a Profits Interest as described in more detail in the table below (dollars in thousands):







Business Outlook



We continue to experience strong demand for our capital for the development of state-of-the-art Class A self-storage facilities in top U.S. markets. As of October 31, 2018, we had projects that were in various stages of our underwriting process, including several subject to executed term sheets, for prospective development property investment amounts of $370 million. While we typically estimate closing dates for investment transactions subject to executed term sheets, often the closings of such investments are subject to events, such as site plan approval, issuances of building permits and other occurrences outside of our control, which can result in delays beyond our estimated closing dates. Moreover, we can provide no assurance that any of the existing or future projects subject to term sheets will produce actual investment commitments or if all term sheets will meet all conditions necessary to consummate investment commitments, and we can provide no assurance that we will have adequate capital to close all such prospective commitments in the future. 



Throughout the nine months ended September 30, 2018, we have continued to fund draws, primarily consisting of interest and operating reserve draws, on the four development property investments, to which we had committed an aggregate of approximately $32.0 million at December 31, 2015. As of September 30, 2018, all of those development properties had achieved certificates of occupancy, and we have realized a significant portion of the potential profit on these developments through our fair value adjustments.



During the period January 1 through August 31, 2016, we made no on-balance sheet development property investments, with all such investments being made through the SL1 Venture pursuant to the terms of our joint venture agreement executed in March 2016. We have a 10% capital interest in the SL1 Venture that entitles us to 10% of operating earnings and profits from sales of properties by the joint venture, as well as potential residual interests upon our SL1 Venture partners achieving certain internal rates of return on their invested capital.

 

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During the second half of 2016 and throughout 2017 and 2018, we invested solely on-balance sheet, closing three development property investments with an aggregate committed principal of $25.6 million prior to the end of 2016, 32 development property investments with an aggregate committed principal of $408.8 million during 2017, and 13 additional development property and bridge investments with an aggregate committed principal of $175.2 million throughout the first nine months of 2018, although the majority of these development projects are not expected to be completed until later in 2018, 2019 or 2020. Accordingly, the amount of fair value adjustments for anticipated profits on projects during 2018 has been and should be substantially greater than the 2017 amount.



During the nine months ended September  30, 2018, the underlying self-storage facility of thirteen of our development property investments with a Profits Interest, four of which are in the SL1 Venture, received a certificate of occupancy and commenced operations. The following tables reflect occupancy data as of October 28, 2018 for all of the underlying self-storage facilities of our development property investments with a Profits Interest that have received a certificate of occupancy: 











In order to adapt our investment activities to the current self-storage cycle, we launched our bridge financing program to make bridge mortgage loans to refinance primarily Generation V facilities that have been developed since 2013 and are currently in lease-up, and facilities refinanced

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by our bridge loans will predominately be in locations and have demographic and competitive profiles that are very similar to our development property investments. On March 2, 2018, we closed our first bridge loan investment consisting of five separate bridge loans with an aggregate commitment amount of $83.3 million secured by first mortgages on five properties in the Miami, Florida MSA.



The following table reflects occupancy data as of October 28, 2018 for all of the underlying self-storage facilities of our bridge loan investments with a Profits Interest that have received a certificate of occupancy: 











The occupancy rates noted above pertain to the aforementioned 33 properties only and are not indicative of future lease-up rates of other facilities that will commence operations.



Critical Accounting Policies



There have been no significant changes to our critical accounting policies as disclosed in the 2017 Form 10-K.



Recent Accounting Pronouncements



See Note 2 to the accompanying interim consolidated financial statements, Significant Accounting Policies, for a discussion of recent accounting pronouncements.



Results of Operations



The following discussion of our results of operations for the three and nine months ended September 30, 2018 and 2017 should be read in conjunction with the interim consolidated financial statements and the accompanying notes thereto included elsewhere in this Quarterly Report on Form 10-Q. 



Comparison of the three months ended September 30, 2018 and September 30, 2017:







Revenues



Total interest income from investments for the three months ended September 30, 2018 was $8.1 million, an increase of approximately $4.9 million, or 155%, from the three months ended September 30, 2017. The increase is primarily attributed to the increase in the outstanding principal balances of our investment portfolio. We also had rental revenue of $1.0 million and $0.2 million from real estate owned during the three months ended September 30, 2018 and 2017, respectively, that is related to the revenues generated by the self-storage real estate owned that was acquired during 2017 and 2018. Other revenues of $35,000 and $28,000 earned during the three months ended September 30, 2018 and 2017, respectively, are derived primarily from management fee revenue generated from the SL1 Venture.



Expenses



The following table provides a detail of total general and administrative expenses (dollars in thousands):





Total general and administrative expenses



Total general and administrative expenses for the three months ended September 30, 2018 were $1.7 million, an increase of $0.3 million, or 25%, from the three months ended September 30, 2017. Compensation and benefits included non-cash expense of stock-based compensation of $385,000 and $296,000 for the three months ended September 30, 2018 and 2017, respectively. For the three months ended September 30, 2017, compensation and benefits also included $0.1 million of third party reimbursements to the Manager, which offset expenses reimbursed to the Manager by us on a dollar-for-dollar basis. We received $5,000 of third party reimbursements during the three months ended September 30, 2018. Compensation and benefits also increased as a result of annual compensation increases as well as the addition of a senior executive employee at the Manager during 2018. Professional fees increased $80,000, or 51%, as a result of the expansion of the volume and geographic footprint of our investments.



Other operating expenses



The management fees of $1.9 million and $1.0 million in the three months ended September 30, 2018 and 2017, respectively, relate to the fees earned by the Manager pursuant to the management agreement. The increase in management fees was primarily a result of the follow-on offerings of our common stock during the second quarter of 2018, the issuance of common stock under our ATM Program, and the issuances of our Series A and Series B preferred stock. Property operating expenses of real estate owned and depreciation and amortization of real estate owned relate to the operating activities of our self-storage real estate owned.



Other income (expense)



For the three months ended September 30, 2018 and 2017, we recorded other income of $11.8 million and $3.8 million, respectively, which primarily relates to the net unrealized gain on investments. The net unrealized gain on investments increased primarily due to a significant portion of the entrepreneurial profit adjustments on our on-balance sheet investments that were closed in late 2016 and 2017 being recognized in 2018.



On August 28, 2018, the underlying asset for the Tampa 1 investment was sold to a third party and proceeds were distributed to us in settlement of the first mortgage loan and 49.9% Profits Interest.  As a result of this transaction, in addition to funds received for the repayment of the loan, we received proceeds of $725,000 comprised of a $106,000  prepayment penalty, which is recognized in interest income from investments, and a  $619,000 gain, which is recognized as realized gain on investments in our Consolidated Statement of Operations.



The $0.4 million and $0.7 million of equity in earnings from unconsolidated real estate venture in the three months ended September 30, 2018 and 2017, respectively, relates to our allocated earnings from the SL1 Venture. Interest expense for the three months ended September 30, 2018 

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was $0.5 million and $0.3 million, respectively, and relates primarily to amortization of deferred financing costs and interest incurred on our senior participations, Credit Facility, and term loans. For the three months ended September 30, 2017, the $0.2 million loss on modification of debt was incurred in conjunction with the closing of the Credit Facility. Other interest income relates to interest earned on our cash deposits.







Comparison of the nine months ended September 30, 2018 and September 30, 2017:







Revenues



Total interest income from investments for the nine months ended September 30, 2018 was $19.1 million, an increase of approximately $11.3 million, or 146%, from the nine months ended September 30, 2017. The increase is primarily attributed to the increase in the outstanding principal balances of our investment portfolio. We also had rental revenue of $2.4 million and $0.3 million from real estate owned during the nine months ended September 30, 2018 and 2017, respectively, that is related to the revenues generated by the self-storage real estate owned that was acquired during 2017 and 2018. Other revenues of $0.1 million earned during the nine months ended September 30, 2018 is derived primarily from management fee revenue generated from the SL1 Venture. Other revenues of $0.2 million earned during the nine months ended September 30, 2017 is derived from borrower payment of internal costs in connection with closings during the first quarter of 2017 and management fee revenue generated from the SL1 Venture.



Expenses



The following table provides a detail of total general and administrative expenses (dollars in thousands):





Total general and administrative expenses



Total general and administrative expenses for the nine months ended September 30, 2018 were $5.6 million, an increase of $1.2 million, or 29%, from the nine months ended September 30, 2017. Compensation and benefits included non-cash expense of stock-based compensation of $1.5 million and $1.0 million for the nine months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018 and 2017, compensation and benefits also included $0.2 million and $0.3 million, respectively, of third party reimbursements to the Manager, which offset expenses reimbursed to the Manager by us on a dollar-for-dollar basis. Compensation and benefits also increased as a result of annual compensation increases as well as the addition of a senior executive employee at the Manager during the nine months ended September 30, 2018. Business development expenses increased $103,000, or 48%, primarily due to an additional developer conference held and self-storage conferences attended in 2018. Professional fees increased $115,000, or 19%, as a result of the expansion of the volume and geographic footprint of our investments. Other expense increased $108,000, or 18%, for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017,  primarily due to increased investor relations activities and travel.



Other operating expenses



The management fees of $4.8 million and $2.4 million in the nine months ended September 30, 2018 and 2017, respectively, relate to fees earned by the Manager pursuant to the management agreement. The increase in management fees was primarily a result of the follow-on offerings of our common stock during the second quarters of 2018 and 2017, the issuance of common stock under our ATM Program, and the issuances of our Series A and Series B preferred stock. Property operating expenses of real estate owned and depreciation and amortization of real estate owned relate to the operating activities of our self-storage real estate owned.



Other expenses



Other expenses consist of costs related to the termination of an employee contract during the nine months ended September 30, 2018. There were no other expenses for the nine months ended September 30, 2017.



Other income (expense)



For the nine months ended September 30, 2018 and 2017, we recorded other income of $24.8 million and $10.3 million, respectively, which primarily relates to the net unrealized gain on investments. The net unrealized gain on investments increased primarily due to a significant portion of the entrepreneurial profit adjustments on our on-balance sheet investments that were closed in late 2016 and 2017 being recognized in 2018.



On August 28, 2018, the underlying asset for the Tampa 1 investment was sold to a third party and proceeds were distributed to us in settlement of the first mortgage loan and 49.9% Profits Interest.  As a result of this transaction, in addition to funds received for the repayment of the loan, we received proceeds of $725,000 comprised of a $106,000  prepayment penalty, which is recognized in interest income from investments, and a  $619,000 gain, which is recognized as realized gain on investments in our Consolidated Statement of Operations. 



The $1.4 million and $1.7 million of equity in earnings from unconsolidated real estate venture in the nine months ended September 30, 2018 and 2017, respectively, relates to our allocated earnings from the SL1 Venture. Interest expense for the nine months ended September 30, 2018 was $1.5 million and relates primarily to amortization of deferred financing costs and interest incurred on our senior participations, Credit Facility, and term loans. Interest expense for the nine months ended September 30, 2017 was $0.8 million and related to interest incurred on our senior participations and Credit Facility, amortization of deferred financing costs incurred in connection with the Credit Facility, and unused commitment fees related to the Credit Facility. Other interest income for the nine months ended September 30, 2018 and 2017 relates to interest earned on our cash deposits.



Adjusted Earnings



Adjusted Earnings is a performance measure that is not specifically defined by GAAP and is defined as net income attributable to common stockholders (computed in accordance with GAAP) plus stock dividends payable to preferred stockholders, stock-based compensation expense, depreciation and amortization on real estate assets, loss on modification of debt, and other expenses.



Adjusted Earnings should not be considered as an alternative to net income or any other GAAP measurement of performance or as an alternative to cash flow from operating, investing, and financing activities as a measure of liquidity. We believe that Adjusted Earnings is helpful to investors as a starting point in measuring our operational performance, because it excludes various equity-based payments (including stock dividends) and other items included in net income that do not relate to or are not indicative of our operating performance, which can make periodic and peer analyses of operating performance more difficult. Our computation of Adjusted Earnings may not be comparable to other key performance indicators reported by other REITs or real estate companies.



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The following tables are reconciliations of Adjusted Earnings to net income attributable to common stockholders (dollars in thousands):















Liquidity and Capital Resources



Liquidity is a measure of our ability to meet potential cash requirements, including commitments to fund our investment portfolio, repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders and other general business needs. We use significant cash to originate our target investments, make distributions to our stockholders and fund our operations. We have not yet generated sufficient cash flow from operations or investment activities to enable us to cover our distributions to our stockholders. As a result, we are dependent on our Credit Facility, our ability to issue common stock under our ATM Program and preferred stock under our Preferred ATM Program and other access to third-party sources of capital to continue our investing activities and pay distributions to our stockholders.



Cash Flows



The following table sets forth changes in cash and cash equivalents (dollars in thousands):





Cash decreased $4.4 million during the nine months ended September 30, 2018 as compared to a decrease in cash of $12.4 million during the nine months ended September 30, 2017. Net cash used in operating activities for the nine months ended September 30, 2018 and 2017 was $4.5 million and $2.5 million, respectively. The primary components of cash used in operating activities during the nine months ended September 30, 2018 were net income adjusted for non-cash transactions of $5.7 million, offset by $0.6 million of return on investment from the SL1 Venture and the change in cash from working capital of $0.6 million. The primary components of cash used in operating activities during the nine months ended September 30, 2017 were net income adjusted for non-cash transactions of $3.6 million, offset by $0.5 million of return on investment from the SL1 Venture and a change in working capital of $0.6 million.  



Net cash used in investing activities for the nine months ended September 30, 2018 and 2017 was $205.7 million and $86.1 million, respectively. For the nine months ended September 30, 2018, the cash used for investing activities consisted primarily of $208.5 million to fund investments, $4.8 million to fund other loans, $13.1 million to purchase additional interests in five of our development property investments and capital additions to those properties, $2.0 million to fund capital contributions to the SL1 Venture, offset, in part, by origination fees received in cash of $1.9 million, cash received of $0.6 million related to proceeds received from the settlement of profits interest as a result of the sale of the asset underlying our Tampa 1 development investment, a net inflow of $2.3 million for advancements made on behalf of the SL1 Venture, and $18.1 million from repayments of development property investments, operating property loans and other loan investments. For the nine months ended September 30, 2017, the cash used for investing activities consisted primarily of $111.6 million to fund investments, $10.1 million to fund other loans, $2.9 million to purchase an additional interest in one of our development property loans, $4.8 million to fund

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capital contributions to the SL1 Venture, and a net use of $1.2 million for advancements made on behalf of the SL1 Venture, offset, in part, by $3.1 million of origination fees received in cash, and $41.4 million from repayments of construction loans and other loan investments.



Net cash provided by financing activities for the nine months ended September 30, 2018 totaled $205.8 million and primarily related to $122.4 million of net proceeds from preferred stock issuances, $81.8 million of net proceeds from common stock issuances, $24.6 million of net proceeds received from term loans, offset by a net outflow of $0.7 million related to draws and the subsequent repayment on the Credit Facility, $0.7 million repayment of our senior loan participation, $0.3 million of stock repurchases, and $21.2 million of dividends paid. For the nine months ended September 30, 2017, net cash provided by financing activities totaled $76.3 million and primarily related to $108.1 million of common stock issuances and $1.8 million of cash received in connection with draws on senior loan participations on certain of our investments, and $0.3 million net proceeds from the closing of the Credit Facility, offset, in part, by a $20.0 million paydown of the Credit Facility, $1.9 million paid to repurchase certain senior loan participations, and $11.8 million of dividends paid. 



Liquidity Outlook and Capital Requirements



As of September 30, 2018, we had unrestricted cash of approximately $42.6 million, and we had remaining unfunded commitments of $268.1 million related to our investment portfolio and $1.2 million related to the SL1 Venture. We believe that the sources of capital discussed below will provide us with adequate liquidity to fund our operations and investment activities for at least the next 12 months.



The timing of the remaining unfunded commitments of $269.3 million related to our investment portfolio and SL1 Venture is expected to be funded as follows:





Series A Preferred Stock



On July 27, 2016, we entered into the Purchase Agreement with accounts managed by NexPoint Advisors, L.P., an affiliate of Highland Capital Management, L.P., which provides that we may issue and sell up to $125.0 million of Series A Preferred Stock from time to time until July 27, 2018. On July 25, 2018, we entered into the First Amendment to the Purchase Agreement in order to extend the final date to issue shares of Series A Preferred Stock under the Purchase Agreement from July 27, 2018 to September 30, 2018. As of September 30, 2018, we had issued 125,000 restricted shares of the Series A Preferred Stock and received $125.0 million in proceeds pursuant to the terms of the Purchase Agreement. Accordingly, as of November 1, 2018, we have no funds available for issuance under the Purchase Agreement.



Common Stock ATM Program



On April 5, 2017, we entered into the ATM Program whereby we may issue and sell up to $50.0 million of our common stock from time to time. Since the inception of the ATM Program, we have sold 1,323,722 shares of common stock at a weighted average price of $22.24, receiving net proceeds after commissions and other offering costs of $28.5 million. As of November 1, 2018, we have approximately $20.6 million available for issuance under the ATM Program.



Preferred ATM Program



On March 29, 2018, we and the Operating Company entered into the Distribution Agreement in connection with the commencement of the Preferred ATM Program. Pursuant to the terms and conditions of the Distribution Agreement, we may, from time to time, issue and sell through or to the Agent, shares of the Series B Preferred Stock, having an aggregate offering price of up to $45.0 million. We or the Agent may at any time suspend the offering or terminate the Distribution Agreement pursuant to the terms of the Distribution Agreement. The actual sale of Preferred ATM Shares under the Program will depend on a variety of factors to be determined by us from time to time, including, among other things, market conditions, the trading price of the Series B Preferred Stock, capital needs and determinations by us of our appropriate sources of funding. We have no obligation to sell any of the Preferred ATM Shares, and may at any time suspend offers under the Distribution Agreement or terminate the Distribution Agreement.



Since the inception of the Preferred ATM Program, we have sold 71,734 shares of Series B preferred stock at a weighted average price of $22.94, receiving net proceeds after commissions and other offering costs of $1.4 million. As of November 1, 2018, we have approximately $43.4 million available for issuance under the Preferred ATM Program.



Credit Facility





On July 25, 2017, we entered into a $100 million Credit Facility, which has an accordion feature permitting expansion up to $200 million. Our development property investments and bridge loan investments are eligible to be added to the base of collateral available to secure loans under the Credit Facility once construction has been completed, thereby increasing the borrowing capacity under the Credit Facility. Accordingly, we believe our availability under the Credit Facility will increase substantially in the future as construction on our investments in our investment

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portfolio are completed. We expect such availability to increase over the balance of 2018 as our on-balance sheet self-storage investments continue to achieve certificates of occupancy and commence lease-up. As of November 1, 2018, we had no borrowings under the Credit Facility out of our $81.5 million in total availability under the Credit Facility.



During the remainder of 2018, we believe we will have substantial new opportunities for development property investments and bridge investments. Since our IPO, we have been able to issue publicly-traded common stock and preferred stock, access preferred equity in a private placement, sell senior participations in existing loans and procure the Credit Facility. Moreover, as self-storage facilities we have financed are completed, opened and leased up, developers will have the right and the opportunity to sell or refinance such facilities, providing us with an additional source of capital if refinancings occur or we choose to allow sales to occur without exercising our ROFRs with respect to sold facilities. Cash received from sales and refinancings can be recycled into new investments. Accordingly, we believe we will have adequate capital to finance new investments for at least the next 12 months.



Term Loans



On August 17, 2018, we entered into the FirstBank Term Loans with FirstBank (“FirstBank”) with respect to three term loans in the aggregate principal amount of $24.9 million. The FirstBank Term Loans are secured by first mortgages on three of our wholly-owned self-storage facilities. As a condition to FirstBank providing the FirstBank Term Loans, we have agreed to unconditionally guarantee the Subsidiaries’ obligations under the FirstBank Term Loans pursuant to guaranty agreements with FirstBank (the “FirstBank Guaranties”).



The FirstBank Term Loans will mature on August 1, 2021. Borrowings under the FirstBank Term Loans bear interest at a floating variable rate of one-month LIBOR plus 2.25%, which is reset monthly.



The FirstBank Term Loans contain customary representations and warranties and affirmative and negative covenants. The FirstBank Term Loans contain a financial covenant that requires the Operating Company to maintain a debt service coverage ratio of 1.35 to 1. The debt service coverage ratio will be calculated pursuant to the terms of the Credit Facility. FirstBank is a lender under the Credit Facility. The First Bank Term Loans also contain a covenant that requires the Operating Company to maintain a loan to value ratio on the outstanding balance of the loan that does not exceed the loan to value ratio at closing.



The FirstBank Term Loans provide for standard events of default, including nonpayment of principal and other amounts when due, non-performance of covenants, breach of representations and warranties and certain bankruptcy or insolvency events. If an event of default occurs and is continuing under the FirstBank Term Loans, FirstBank may, among other things, terminate its commitments under the FirstBank Term Loans and require the immediate payment of all amounts owed thereunder. The FirstBank Term Loans each contain cross-default provisions with the Credit Facility, pursuant to which an event of default under the FirstBank Term Loans is triggered by the occurrence of an event of default under the Credit Facility that results in acceleration of the outstanding obligations of the Operating Company under the Credit Facility.  





Equity Capital Policies



Subject to applicable law and NYSE listing standards, our board of directors has the authority, without further stockholder approval, to issue additional authorized common stock and preferred stock or otherwise raise capital, including through the issuance of senior securities, in any manner and on the terms and for the consideration it deems appropriate, including in exchange for property. Stockholders will have no preemptive right to additional shares issued in any offering, and any offering may cause a dilution of your investment.



Additionally, the holders of our Series A Preferred Stock have the right to purchase their pro rata share of any qualified offering of common stock, which consists of any offering of common stock except any shares of common stock issued (i) in connection with a merger, consolidation, acquisition or similar business combination, (ii) in connection with a joint venture, strategic alliance or similar corporate partnering arrangement, (iii) in connection with any acquisition of assets by us, (iv) at market prices pursuant to a registered at-the-market program and/or (v) as part of a compensatory or employment arrangement.



Leverage Policies



To date, we have funded all of our investments with the net proceeds from our IPO and concurrent private placement, which were consummated on April 1, 2015, proceeds from the sale of senior participations in certain investments, proceeds from the issuance of our Series A Preferred Stock, proceeds from three follow-on public offerings of common stock, which were consummated on December 13, 2016, June 27, 2017, and June 14, 2018, proceeds received from sales of shares from time to time under the ATM Program, proceeds from the issuance of our Series B Preferred Stock, and borrowings from our Credit Facility and FirstBank Term Loans. In the future, we may utilize equity raised in follow-on offerings, through the ATM Program, through the Preferred Stock ATM Program and/or borrowings under our Credit Facility or other borrowings against our target investments in accordance with our investment guidelines in order to increase the size of our loan portfolio and potential return to stockholders. Our investment guidelines state that our leverage will generally not exceed 50% of the total value of our loan portfolio. Additionally, as long as shares of Series A Preferred Stock remain outstanding, we are required to maintain a ratio of debt to total tangible assets determined under GAAP of no more than 0.4:1, measured as of the last day of each fiscal quarter. Our ability to issue shares of Series A Preferred Stock is also subject to certain conditions as outlined in Note 8 of the accompanying interim consolidated financial statements. Our Credit Facility contains certain financial covenants including: (i) total consolidated indebtedness not exceeding 50% of gross asset value; (ii) a minimum fixed charge coverage ratio (defined as the ratio of consolidated adjusted earnings before interest, taxes,

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depreciation and amortization to consolidated fixed charges) of 0.75 to 1.00 during the period between July 25, 2017 and June 30, 2018, 0.90 to 1 during the period between July 1, 2018 and December 31, 2018 and 1.20 to 1 during the period between January 1, 2019 through the maturity of the Credit Facility; (iii) a minimum consolidated tangible net worth (defined as gross asset value less total consolidated indebtedness) of $183.3 million plus 75% of the sum of any additional net offering proceeds; (iv) when aggregate loan commitments under the Credit Facility exceed $50 million, unhedged variable rate debt cannot exceed 25% of consolidated total indebtedness; (v) liquidity of no less than $50 million for the period between July 25, 2017 and December 31, 2018 or on and after December 31, 2018, liquidity of no less than the sum of (a) total unfunded loan commitments of us and our subsidiaries plus (b) $25 million; and (vi) a debt service coverage ratio (defined as the ratio of consolidated adjusted earnings before interest, taxes, depreciation and amortization to our consolidated interest expense and debt principal payments for any given period) of 2 to 1.



The amount available to borrow under the Credit Facility is limited according to a borrowing base valuation of the assets available as collateral. For loans secured by Company mortgage loans, the borrowing base availability is the lesser of (i) 60% of the value of our mortgage loans, (ii) the maximum principal amount which would not cause the outstanding loans under the Credit Facility secured by our mortgage loans to be greater than 50% of the underlying real estate assets securing our mortgage loans and (iii) for any of our mortgage loans that have been included in the borrowing base for greater than 18 months, the maximum principal amount which would not cause the ratio of (a) adjusted net operating income for the underlying real estate asset securing such Company mortgage loan divided by (b) an implied debt service amount to be less than 1.30 to 1.00. For loans secured by self-storage properties, the borrowing base availability is the lesser of (i) the maximum principal amount that would not cause the outstanding loans under the Credit Facility secured by self-storage properties to be greater than 65% of the value of such self-storage properties and (ii) the maximum principal amount that would not cause the ratio of (i) aggregate adjusted net operating income from all self-storage properties included in the borrowing base divided by (ii) an implied debt service coverage amount to be less than 1.30 to 1.00.



Our actual leverage will depend on our mix of loans. Our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our investment guidelines at any time. We will use corporate leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates. Our financing strategy focuses on the use of match-funded financing structures. This means that we will seek to match the maturities and/or repricing schedules of our financial obligations with those of our loan portfolio to minimize the risk that we will have to refinance our liabilities prior to the maturities of our loans and to reduce the impact of changing interest rates on earnings, which our new Credit Facility will help us better achieve. We will disclose any material changes to our leverage policies in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of the quarterly report on Form 10-Q or annual report on Form 10-K for the period in which the change was made, or in a Current Report on Form 8-K if required by the rules of the SEC or the board of directors deems it advisable, in its sole discretion.



Future Revisions in Policies and Strategies



The board of directors has the power to modify or waive our investment policies and strategies without the consent of our stockholders to the extent that the board of directors (including a majority of our independent directors) determines that a modification or waiver is in the best interest of our stockholders. Among other factors, developments in the market that either affect the policies and strategies mentioned herein or that change our assessment of the market may cause our board of directors to revise our policies and strategies. 



Contractual Obligations and Commitments



The following table reflects our total contractual cash obligations as of September 30, 2018 (dollars in thousands):















At September 30, 2018, we had $268.1 million of unfunded loan commitments related to our investment portfolio and $1.2 million related to the SL1 Venture. These commitments are primarily funded over the 18-24 months following the investment closing date as construction is completed. At September 30, 2018, we had $2.9 million of unfunded loan commitments related to our other assets.



As of September 30, 2018, we had unrestricted cash of approximately $42.6 million.



Off-Balance Sheet Arrangements



At September 30, 2018, we did not have any relationships, including those with unconsolidated entities or financial partnerships, for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes that have or are reasonably likely to

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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.



Our investment in real estate venture is recorded using the equity method as we do not have a controlling interest.



Dividends



For the quarter ended September 30, 2018, we declared a cash dividend to our stockholders of $0.35 per share, payable on October  15, 2018 to stockholders of record on October 1, 2018. We intend to make regular quarterly distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT annually distribute at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our stockholders in an amount equal to or greater than our net taxable income, if and to the extent authorized by our Board of Directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on any secured funding facilities, other lending facilities, repurchase agreements and other debt payable. If our cash available for distribution is less than our net taxable income, we could be required to reduce our dividends, sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.



Additionally, holders of our Series A Preferred Stock are entitled to a cumulative cash distribution (“Cash Distribution”) equal to (A) 7.0% per annum on the liquidation value, or $1,000 per share of Series A Preferred Stock (the “Liquidation Value”) for the period beginning on the respective date of issuance until the sixth anniversary of the Effective Date, payable quarterly in arrears, (B) 8.5% per annum on the Liquidation Value for the period beginning the day after the sixth anniversary of the Effective Date and for each year thereafter so long as the Series A Preferred Stock remains issued and outstanding, payable quarterly in arrears, and (C) an amount in addition to the amounts in (A) and (B) equal to 5.0% per annum on the Liquidation Value upon the occurrence of certain triggering events (a “Cash Premium”). In addition, the holders of the Series A Preferred Stock will be entitled to a cumulative dividend payable in-kind in shares of Common Stock or additional shares of Series A Preferred Stock, at the election of the holders (the “Stock Dividend”), equal in the aggregate to the lesser of (Y) 25% of the incremental increase in our book value (as adjusted for equity capital issuances, share repurchases and certain non-cash expenses) plus, to the extent we own equity interests in income-producing real property, the incremental increase in net asset value (provided, however, that no interest in the same real estate asset will be double counted) and (Z) an amount that would, together with the Cash Distribution, result in a 14.0% internal rate of return for the holders of the Series A Preferred Stock from the date of issuance of the Series A Preferred Stock, as set forth in the Articles Supplementary classifying the Series A Preferred Stock (the “Articles Supplementary”). For the first three fiscal quarters of the fiscal years 2018, 2019 and 2020 and for the first fiscal quarter of 2021, we will declare and pay a Series A Aggregate Stock Dividend equal to $2,125,000, or the Series A Target Stock Dividend. For the last fiscal quarter of each of 2018, 2019 and 2020 and for the second fiscal quarter of 2021, we will compute the cumulative Series A Aggregate Stock Dividend for all periods after December 31, 2017 through the end of such fiscal quarter equal to 25% of the incremental increase in our book value (as adjusted for equity capital issuances, share repurchases and certain non-cash expenses) plus, to the extent we own equity interests in income-producing real property, the incremental increase in net asset value (provided, however, that no interest in the same real estate asset will be double counted), or the Series A Computed Stock Dividend, and will declare and pay for such quarter a Series A Aggregate Stock Dividend equal to the greater of the Series A Target Stock Dividend or the Series A Computed Stock Dividend minus the sum of all Series A Aggregate Stock Dividends declared and paid for all fiscal quarters after December 31, 2017 and before the fiscal quarter for which such payment is computed, in each case subject to an amount that would, together with the Series A Cash Distribution, result in a 14.0% internal rate of return for the holders of the Series A Preferred Stock from the date of issuance of the Series A Preferred Stock.



Triggering events that will trigger the payment of a Cash Premium with respect to a Cash Distribution include: (i) the occurrence of certain change of control events affecting us after the third anniversary of the Effective Date, (ii) our ceasing to be subject to the reporting requirements of Section 13 or Section 15(d) of the Exchange Act, (iii) our failure to remain qualified as a real estate investment trust, (iv) an event of default under the Purchase Agreement, (v) the failure by us to register for resale shares of Common Stock pursuant to the Registration Rights Agreement (a “Registration Default”), (vi) our failure to redeem the Series A Preferred Stock as required by the Purchase Agreement, or (vii) the filing of a complaint, a settlement with, or a judgment entered by the Securities and Exchange Commission against us or any of our subsidiaries or any of our directors or executive officers relating to the violation of the securities laws, rules or regulations with respect to our business. Accrued but unpaid Cash Distributions and Stock Dividends on the Series A Preferred Stock will accumulate and will earn additional Cash Distributions and Stock Dividends as calculated above, compounded quarterly.



Holders of Series B Preferred Stock are entitled to receive, when, as and if authorized by our Board of Directors and declared by us, out of funds legally available for the payment of dividends under Maryland law, cumulative cash dividends from, and including, the original issue date quarterly in arrears on the fifteenth (15th) day of January, April, July and October of each year (or if not a business day, on the immediately preceding business day) (each, a “dividend payment date”). These cumulative cash dividends will accrue on the liquidation preference amount of $25.00 per share at a rate per annum equal to 7.00% with respect to each dividend period from and including the original issue date (equivalent to an annual rate of  $1.7500 per share) from the date of issuance of such Series B Preferred Stock. Dividends will be payable to holders of record as of 5:00 p.m., New York City time, on the related record date. The record dates for the Series B Preferred Stock are the close of business on the first (1st) day of January, April, July or October immediately preceding the relevant dividend payment date (each, a “dividend record date”). If any dividend record date falls on any day other than a business day as defined in the Series B Articles Supplementary, the dividend record date shall be the immediately succeeding business day.

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Inflation



Virtually all of our assets and liabilities will be interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions will be determined by our board of directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.



There have been no material changes in our credit risk, interest rate risk, interest rate mismatch risk, or real estate risks from what was disclosed in the 2017 Form 10-K.



Market Risk



Our development property investments, bridge loan investments, and operating property loans generally will be reflected at their estimated fair value, with changes in fair market value recorded in our income. The estimated fair value of these investments fluctuates primarily due to changes in interest rates, capitalization rates, and other factors. Generally, in a rising interest rate environment, the estimated fair value of the fixed-rate securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of the fixed-rate securities would be expected to increase. As market volatility increases or liquidity decreases, the fair value of our investments may be adversely impacted. If we are unable to readily obtain independent pricing to validate our estimated fair value of any loan investment in our portfolio, the fair value gains or losses recorded in income may be adversely affected.



The following fluctuations in the market yields/discount rates would have had the following impact on the fair value of our investments:







The following fluctuations in the capitalization rates would have had the following impact on the fair value of our investments:

















ITEM 4. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q. The controls evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer, President and Chief Operating Officer, and Chief Financial Officer. Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as this quarterly report on Form 10-Q, is recorded, processed,

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summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures are also designed to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.



Based on the controls evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC, and that material information related to our company and our consolidated subsidiaries is made known to management, including the Chief Executive Officer and Chief Financial Officer.



Changes in Internal Control over Financial Reporting



There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.



PART II. OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



From time to time, we may be involved in various claims and legal actions in the ordinary course of business. We are not currently involved in any material legal proceedings outside the ordinary course of our business.



ITEM 1A. RISK FACTORS



The discussion of our business and operations should be read together with the risk factors contained in Part I, Item 1A of our 2017 Form 10-K, which describes the various additional risks and uncertainties to which we are or may be subject. These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows and prospects in a material adverse manner.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS FROM REGISTERED SECURITIES



Unregistered Sales of Equity Securities



None.



Repurchases of Common Stock











On September 23, 2018, an officer of the Manager returned 456 shares of our common stock to us in connection with the vesting of 1,666 shares of restricted stock, in order to satisfy tax withholding obligations.



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



None.

 

ITEM 4. MINE SAFETY DISCLOSURES



Not applicable.



ITEM 5. OTHER INFORMATION



(a)       Not applicable.



(b)       Not applicable.



ITEM 6. EXHIBITS



The exhibits listed in the accompanying Exhibit Index, which is incorporated herein by reference, are filed or furnished as part of this Quarterly Report on Form 10-Q.

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EXHIBIT INDEX

 

*This certification is deemed not filed for purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.

 



 

* Filed herewith





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SIGNATURES

 

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

 



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