UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018

FOR THE TRANSITION PERIOD FROM ____________ TO ____________

COMMISSION FILE NUMBER: 000-55146

Inland Real Estate Income Trust, Inc.

(Exact name of registrant as specified in its charter)

 

 

630-218-8000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    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 (§232.405 of this chapter) 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ☐    No  ☒

As of November 1, 2018, there were 35,592,905 shares of the registrant’s common stock, $.001 par value, outstanding.

 

 

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

TABLE OF CONTENTS

 

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited, dollar amounts in thousands, except per share amounts) 

 

 

 

See accompanying notes to consolidated financial statements.

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited, dollar amounts in thousands, except per share amounts) 

 

 

 

See accompanying notes to consolidated financial statements.

 

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INLAND REAL ESTATE INCOME TRUST, INC.

CONSOLIDATED STATEMENT OF EQUITY

(Unaudited, dollar amounts in thousands) 

 

See accompanying notes to consolidated financial statements.

 

 

5

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INLAND REAL ESTATE INCOME TRUST, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, dollar amounts in thousands)

 

See accompanying notes to consolidated financial statements.

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INLAND REAL ESTATE INCOME TRUST, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited, dollar amounts in thousands) 

 

 

See accompanying notes to consolidated financial statements.

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited, dollar amounts in thousands, except per share amounts) 

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Readers of this Quarterly Report should refer to the audited consolidated financial statements of Inland Real Estate Income Trust, Inc. (which may be referred to herein as the “Company,” “we,” “us,” or “our”) for the year ended December 31, 2017, which are included in the Company’s 2017 Annual Report on Form 10-K, as certain footnote disclosures contained in such audited consolidated financial statements have been omitted from this Quarterly Report.

 

 

NOTE 1 – ORGANIZATION

The Company was formed on August 24, 2011 to acquire and manage a portfolio of commercial real estate investments located in the United States. The Company has acquired primarily retail properties.  The Company has invested in joint ventures and may continue to invest in additional joint ventures or acquire other real estate assets such as office and medical office buildings, multi-family properties and industrial/distribution and warehouse facilities if its management believes the expected returns from those investments exceed that of retail properties. The Company also may invest in real estate-related equity securities of both publicly traded and private real estate companies, as well as commercial mortgage-backed securities.

The Company entered into a Business Management Agreement with IREIT Business Manager & Advisor, Inc. (the “Business Manager”), an indirect wholly owned subsidiary of Inland Real Estate Investment Corporation (the “Sponsor”), to be the Business Manager to the Company.

At September 30, 2018, the Company owned 59 retail properties, totaling 6,870,124 square feet.  The properties are located in 24 states.  At September 30, 2018, the portfolio had a weighted average physical occupancy of 94.1% and economic occupancy of 94.7%.  

On January 16, 2018, the Company effected a 1-for-2.5 reverse stock split of its issued and outstanding common stock whereby every 2.5 shares of issued and outstanding common stock were converted into one share of its common stock (the “Reverse Stock Split”). In accordance with U.S. GAAP, all share information presented has been retroactively adjusted to reflect the Reverse Stock Split.

 

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Disclosures discussing all significant accounting policies are set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission on March 16, 2018, under the heading Note 2 – “Summary of Significant Accounting Policies.” There have been no changes to the Company’s significant accounting policies during the nine months ended September 30, 2018, except as noted below. 

General

The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. In the opinion of management, all adjustments necessary for a fair statement, in all material respects, of the financial position and results of operations for the periods are presented. Actual results could differ from those estimates. The results of operations for the interim periods are not necessarily indicative of the results for the entire year.

Certain amounts in the prior period consolidated financial statements have been reclassified to conform with the current year presentation.

Recently Adopted Accounting Pronouncements

In November 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that amounts described as restricted cash and restricted cash equivalents be included in beginning and ending-of-period reconciliation of cash shown on the statement of cash flows. The Company adopted ASU No. 2016-18 on a retrospective basis as of January 1, 2018. The Company now includes restricted cash in beginning, change and ending-of-period total amounts on the statement of cash flows rather than within an activity on the statement of cash flows. The Company applied ASU No. 2016-18 retrospectively to all prior periods presented that resulted in a decrease of $878 in net cash used in investing activities for the nine months ended September 30, 2017.

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

Amounts included in restricted cash represent those required to be set aside by lenders for real estate taxes, insurance, capital expenditures and tenant improvements on our existing properties. These amounts also include post close escrows for tenant improvements, leasing commissions, master lease, general repairs and maintenance, and are classified as restricted cash on the Company’s consolidated balance sheets.

 

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported on the Company’s consolidated balance sheets to such amounts shown in the Company’s consolidated statements of cash flows:

 

On January 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The Company selected the modified retrospective transition method which would include a cumulative effect of applying the standard on January 1, 2018. As the Company has reviewed its revenue streams and has concluded its previous recognition of revenue is in compliance with the new standard, no cumulative effect adjustment is required. Common area maintenance reimbursements that may be impacted will not be addressed until the Company's adoption of ASU No. 2016-02, Leases (Topic 842) considering its revisions to accounting for common area maintenance.

Recently Issued Accounting Pronouncements

 

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018. The Company will adopt the ASU with a modified retrospective transition as of the initial application date. The Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. The Company continues to assess all potential impacts of the standard.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). For lessors, lease accounting under ASU No. 2016-02 will remain mostly unchanged except that ASU No. 2016-02 allows only incremental costs of signing a lease to be capitalizable. Historically, the Company capitalized initial direct costs (commissions) that will still be considered capitalizable under the new standard.

 

On July 30, 2018 the FASB issued ASU No. 2018-11, Targeted Improvements, Leases (Topic 842), which would provide lessors with a practical expedient, by class of underlying assets, to not separate non-lease components from the related lease components and, instead, to account for those components as a single lease component, if certain criteria are met. The Company believes that it will meet the criteria to account for lease and non-lease components as a single lease component.

 

ASU No. 2018-11 also provides companies with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company expects to adopt the ASU No. 2016-02 on its effective date and utilize the practical expedients available in the amendment as part of its adoption. The package of practical expedients, which must be elected for all leases, include relief from re-assessing a lease using the standard’s new definition of a lease, relief from re-assessing the classification of a lease and allowing previously capitalized initial direct costs to continue to be amortized.

 

For lessees, ASU No. 2016-02 establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. The Company is the lessee under a ground lease, for which it will be required to recognize a ROU asset and a related lease liability on its consolidated balance sheets upon adoption.  

 

Both ASU No. 2016-02 and ASU No. 2018-11 are effective for the Company on January 1, 2019. The Company is continuing to evaluate this guidance and the impact, both as lessor and lessee on its consolidated financial statements.

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

 

NOTE 3 – EQUITY

The Company commenced an initial public “best efforts” offering (the “Offering”) on October 18, 2012, which concluded on October 16, 2015. The Company issued 33,534,022 shares of common stock generating gross proceeds of $834,399 from the Offering.  As of September 30, 2018, there were 35,338,249 shares of common stock outstanding including 4,147,832 shares issued through the distribution reinvestment plan (“DRP”), net of 2,345,045 shares repurchased through the share repurchase program (“SRP”).    

 

On March 20, 2018, the Company’s board of directors determined an estimated per share net asset value (the “Estimated Per Share NAV”) as reported in the Company’s Form 8-K filed with the Securities and Exchange Commission on March 21, 2018.  

The Company provides the following programs to facilitate additional investment in the Company’s shares and to provide limited liquidity for stockholders.

Distribution Reinvestment Plan

 

The Company provides stockholders with the option to purchase additional shares from the Company by automatically reinvesting distributions through the DRP, subject to certain share ownership restrictions. The Company does not pay any selling commissions or a marketing contribution and due diligence expense allowance in connection with the DRP. Pursuant to the DRP, the price per share for shares of common stock purchased under the DRP is equal to the estimated value of a share, as determined by the Company’s board of directors and reported by the Company from time to time, until the shares become listed for trading, if a listing occurs, assuming that the DRP has not been terminated or suspended in connection with such listing.

 

Distributions reinvested through the DRP were $13,720 and $20,415 for the nine months ended September 30, 2018 and 2017, respectively.

Share Repurchase Program

 

The Company adopted a share repurchase program effective October 18, 2012 which was subsequently amended effective January 1, 2018 to change the processing of repurchase requests from a monthly to a quarterly basis to align with the move to quarterly distributions.  Under the amended and restated SRP, the Company is authorized to purchase shares from stockholders who purchased their shares from the Company or received their shares through a non-cash transfer and who have held their shares for at least one year, if requested, if the Company chooses to purchase them. Subject to funds being available, the Company limits the number of shares repurchased during any calendar year to 5% of the number of shares outstanding on December 31^st of the previous calendar year, as adjusted by the Reverse Stock Split. Funding for the SRP comes from proceeds the Company receives from the DRP during the same period. In the case of repurchases made upon the death of a stockholder or qualifying disability, as defined in the SRP, the one year holding period does not apply. The SRP will immediately terminate if the Company’s shares become listed for trading on a national securities exchange. In addition, the Company’s board of directors, in its sole direction, may, at any time, amend, suspend or terminate the SRP.

 

Pursuant to the SRP, the Company may repurchase shares at prices ranging from 92.5% of the “share price,” as defined in the SRP, for stockholders who have owned shares for at least one year to 100% of the “share price” for stockholders who have owned shares for at least four years. For repurchases sought upon a stockholder’s death or qualifying disability, the Company may repurchase shares at a price equal to 100% of the “share price.” As used in the SRP, “share price” means the lesser of (1) the offering price of the Company’s shares in the Offering (unless the shares were purchased at a discount from that price, and then that purchase price), as adjusted by the Reverse Stock Split, reduced by any distributions of net sale proceeds that the Company designates as constituting a return of capital; or (2) the most recently disclosed estimated value per share.

 

Repurchases through the SRP were $17,084 and $13,085 for the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018 and December 31, 2017, the Company’s liability related to the SRP was $5,618 and $2,530, respectively, recorded in other liabilities on the Company’s consolidated balance sheets.

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

NOTE 4 – ACQUISITIONS

2018 Acquisitions

During the nine months ended September 30, 2018, the Company did not acquire any additional properties.

The Company incurred a total of $12 of acquisition related costs, during the three months ended September 30, 2018, all of which are capitalized as the acquisition of net investment properties in the consolidated balance sheets. The Company incurred $65 of acquisition related costs during the nine months ended September 30, 2018, $12 of which are capitalized as the acquisition of net investment properties in the consolidated balance sheets and $53 of which was recorded in acquisition related costs, net of an adjustment to the deferred investment property acquisition obligation of ($25), that were recorded in acquisition related costs in the consolidated statements of operations and comprehensive income (loss). For the three months ended September 30, 2017, the Company incurred $222 of total acquisition costs and fees, $160 of which are capitalized as the acquisition of net investment properties in the consolidated balance sheets and $62 of such costs are included in acquisition related costs in the consolidated statements of operations and comprehensive income (loss). For the nine months ended September 30, 2017, the Company incurred $2,781 of total acquisition costs and fees, $1,519 of which are capitalized as the acquisition of net investment properties in the consolidated balance sheets and $1,262 of such costs are included in acquisition related costs in the consolidated statements of operations and comprehensive income (loss).

NOTE 5 – INVESTMENT IN UNCONSOLIDATED ENTITIES

 

The following table summarizes the Company’s joint ventures:

 

 

 

 

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

NOTE 6 – ACQUIRED INTANGIBLE ASSETS AND LIABILITIES

The following table summarizes the Company’s identified intangible assets and liabilities as of September 30, 2018 and December 31, 2017: 

 

 

As of September 30, 2018, the weighted average amortization periods for acquired in-place lease, above market lease intangibles, below market lease intangibles and above market ground leases are 10, 14, 19 and 55 years, respectively.

The portion of the purchase price allocated to acquired above market lease value and acquired below market lease value is amortized on a straight-line basis over the term of the related lease as an adjustment to rental income. For below market lease values, the amortization period includes any renewal periods with fixed rate renewals. The acquired above market ground lease is amortized on a straight-line basis as an adjustment to property operating expense over the term of the lease and includes renewal periods. The portion of the purchase price allocated to acquired in-place lease value is amortized on a straight-line basis over the acquired leases’ weighted average remaining term.

Amortization pertaining to acquired in-place lease value, above market ground lease, above market lease value and below market lease value is summarized below:

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

Estimated amortization of the respective intangible lease assets and liabilities as of September 30, 2018 for each of the five succeeding years and thereafter is as follows:  

 

 

 

NOTE 7 – DEBT AND DERIVATIVE INSTRUMENTS

 

As of September 30, 2018 and December 31, 2017, the Company had the following mortgages and credit facility payable:

 

 

The Company estimates the fair value of its total debt by discounting the future cash flows of each instrument at rates currently offered for similar debt instruments of comparable maturities by the Company’s lenders using Level 3 inputs.  The carrying value of the Company’s debt excluding mortgage premium and unamortized debt issuance costs was $703,150 and $693,321 as of September 30, 2018 and December 31, 2017, respectively, and its estimated fair value was $700,117 and $684,621 as of September 30, 2018 and December 31, 2017, respectively.

As of September 30, 2018, scheduled principal payments and maturities on the Company’s debt were as follows:

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

 

Credit Facility Payable

On August 1, 2018, the Company amended and restated its credit facility (the “Credit Facility”) to among other things:

 

 

At September 30, 2018, the Company has $128,523 outstanding under the Revolving Credit Facility and $150,000 outstanding under the Term Loan.  At September 30, 2018 the interest rate on the Revolving Credit Facility and the Term Loan was 3.82% and 4.29%, respectively. The Revolving Credit Facility matures on August 1, 2022, and the Company has the option to extend the maturity date for one additional year subject to the payment of an extension fee and certain other conditions.  The Term Loan matures on August 1, 2023. As of September 30, 2018, the Company had $71,477 available for borrowing under the Revolving Credit Facility.

The Company’s performance of the obligations under the Credit Facility, including the payment of any outstanding indebtedness under the Credit Facility, is guaranteed by certain subsidiaries of the Company, including each of the subsidiaries of the Company which owns or leases any of the properties included in the pool of unencumbered properties comprising the borrowing base.  Additional properties will be added to and removed from the pool from time to time to support amounts borrowed under the Credit Facility. At September 30, 2018, there were 28 properties included in the pool of unencumbered properties. The Company paid-off twelve mortgage loans with a principal balance of $184,700 and ten interest rate swap agreements with a notional amount of $131,300. 

 

The Credit Facility requires compliance with certain covenants, including a minimum tangible net worth requirement, a distribution limitation, restrictions on indebtedness and investment restrictions, as defined. It also contains customary default provisions including the failure to comply with the Company's covenants and the failure to pay when amounts outstanding under the Credit Facility become due.  The Company is in compliance with all financial covenants related to the Credit Facility.

Gain on early termination of interest rate swap agreements

During the three and nine months ended September 30, 2018, the Company recorded a gain of $1,151 related to the early termination of certain interest rate swap agreements that had corresponding early mortgage pay-offs.

Loss on extinguishment of debt

During the three and nine months ended September 30, 2018, the Company realized a loss on extinguishment of debt in the consolidated statements of operations and comprehensive income (loss) of $411 due to the write-off of the unamortized balance of debt issuance costs associated with ten loans that were repaid prior to maturity.

Mortgages Payable

The mortgage loans require compliance with certain covenants, such as debt service ratios, investment restrictions and distribution limitations. As of September 30, 2018, the Company was current on all of the payments and in compliance with all financial covenants. All of the Company’s mortgage loans are secured by first mortgages on the respective real estate assets. As of September 30, 2018, the weighted average years to maturity for the Company’s mortgages payable was approximately 4.84 years.  

Interest Rate Swap Agreements

The Company entered into interest rate swaps to fix certain of its floating LIBOR based debt under variable rate loans to a fixed rate to manage its risk exposure to interest rate fluctuations. The Company will generally match the maturity of the underlying variable rate debt with the maturity date on the interest swap. See Note 14 - "Fair Value Measurements" for further information.

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

The following table summarizes the Company’s interest rate swap contracts outstanding as of September 30, 2018.

 

(a)   Receive floating rate index based upon 1 month LIBOR. At September 30, 2018, the 1 month LIBOR was 2.26%.

For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the unrealized gain or loss on the derivative is reported as a component of comprehensive income (loss).  The ineffective portion of the change in fair value, if any, is recognized directly in earnings. The table below presents the effect of the Company’s derivative financial instruments on the consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2018 and 2017.

 

 

 

The amount that is expected to be reclassified from accumulated other comprehensive income into income in the next twelve months is approximately $2,293.

 

 

NOTE 8 – DISTRIBUTIONS

 

The Company currently pays quarterly distributions in an amount equal to $0.335 per share, which represents an annualized rate of 6% based on the Estimated Per Share NAV, payable in arrears the following quarter. For 2017, the Company paid distributions based on daily record dates, payable in arrears the following month, equal to a daily amount of $0.00410959 per share, based upon a 365-day year.

 

The table below presents the distributions paid and declared during the three and nine months ended September 30, 2018 and 2017.

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

 

 

NOTE 9 – EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share (“EPS”) are computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period (the “common shares”). Diluted EPS is computed by dividing net income (loss) by the common shares plus common share equivalents. The Company excludes antidilutive restricted shares and units from the calculation of weighted-average shares for diluted EPS.  As a result of a net loss in the three and nine months ended September 30, 2018, 1,460 shares and 2,333 shares, respectively, were excluded from the computation of diluted EPS, because they would have been antidilutive. As a result of a net loss in the three and nine months ended September 30, 2017, 2,087 shares and 2,751 shares, respectively, were excluded from the computation of diluted EPS, because they would have been antidilutive.

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

NOTE 10 – COMMITMENTS AND CONTINGENCIES

The acquisition of certain of the Company’s properties included an earnout component to the purchase price that was recorded as a deferred investment property acquisition obligation (“Earnout liability”). At September 30, 2018 there is no earnout liability outstanding.

The table below presents the change in the Company’s Earnout liability for the nine months ended September 30, 2018 and 2017.

 

 

The Company may be subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business. While the resolution of these matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material adverse effect on the consolidated financial statements of the Company.

 

NOTE 11 – EQUITY-BASED COMPENSATION

Under the Company’s Employee and Director Restricted Share Plan (“RSP”), restricted shares and restricted share units generally vest over a one to three year vesting period from the date of the grant, subject to the specific terms of the grant. In accordance with the RSP, restricted shares and restricted share units were issued to non-employee directors as compensation. Each restricted share and restricted share unit entitle the holder to receive one common share when it vests. Restricted shares and restricted share units are included in common stock outstanding on the date of vesting. The grant-date value of the restricted shares and restricted share units is amortized over the vesting period representing the requisite service period. Compensation expense associated with the restricted shares and restricted share units issued to the non-employee directors was $13 and $35, in the aggregate, for the three and nine months ended September 30, 2018, respectively. Compensation expense associated with the restricted shares and restricted share units issued to the non-employee directors was $9 and $22, in the aggregate, for the three and nine months ended September 30, 2017, respectively. As of September 30, 2018, the Company had $60 of unrecognized compensation expense related to the unvested restricted shares and restricted share units, in the aggregate. The weighted average remaining period that compensation expense related to unvested restricted shares and restricted share units will be recognized is 1.6 years.

A summary table of the status of the restricted shares and restricted share units is presented below:

 

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

NOTE 12 – SEGMENT REPORTING

The Company has one reportable segment as defined by U.S. GAAP, retail real estate, for the nine months ended September 30, 2018 and 2017.

 

 

 

NOTE 13 – TRANSACTIONS WITH RELATED PARTIES

 

The following table summarizes the Company’s related party transactions for the three and nine months ended September 30, 2018 and 2017. Certain compensation and fees payable to the Business Manager for services provided to the Company are limited to maximum amounts.

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

 

 

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

NOTE 14 – FAIR VALUE MEASUREMENTS

Fair Value Hierarchy

The Company defines fair value based on the price that it believes would be received upon sale of an asset or the exit price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value. The fair value hierarchy consists of three broad levels, which are described below:

 

The Company has estimated the fair value of its financial and non-financial instruments using available market information and valuation methodologies the Company believes to be appropriate for these purposes.

Recurring Fair Value Measurements

 

For assets and liabilities measured at fair value on a recurring basis, the table below presents the fair value of the Company’s cash flow hedges as well as their classification on the consolidated balance sheets as of September 30, 2018 and December 31, 2017, respectively.

 

The fair value of derivative instruments was estimated based on data observed in the forward yield curve which is widely observed in the marketplace. The Company also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the counterparty's nonperformance risk in the fair value measurements which utilize Level 3 inputs, such as estimates of current credit spreads. The Company has determined that the credit valuation adjustments are not significant to the overall valuation of its derivative interest rate swap agreements and therefore has classified these in Level 2 of the hierarchy.

 

 

 

 

 

 

 

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INLAND REAL ESTATE INCOME TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited, dollar amounts in thousands, except per share amounts)

 

Non-recurring Fair Value Measurements

The table below presents activity for the Company’s assets measured at fair value on a non-recurring basis. The Company recognized an impairment charge of $5,000 to its investment in the Mainstreet JV to reflect this investment at its estimated fair value for the three and nine months ended September 30, 2018 which is included in provision for impairment of unconsolidated entities on the consolidated statements of operations and comprehensive income (loss). During the three and nine months ended September 30, 2017, the Company incurred no impairment charges.

 

 

As of September 30, 2018, the Company identified indicators of impairment in its investment in the Mainstreet JV. Such indicators included construction overruns, loss of a planned tenant and the related cost of re-leasing.  The fair value of this investment was based on the value of the underlying properties and was estimated using a 10-year discounted cash flow model. The Company utilized a capitalization rate of 7.0% and a discount rate of 7.6% which it believes are reasonable based on current market rates.  

 

 

 

NOTE 15 – SUBSEQUENT EVENTS

 

Distributions

On September 5, 2018, the Company’s board of directors declared cash distributions payable to stockholders of record at the close of business on September 28, 2018, in the amount equal to $0.335 per share, or $11,924, which represents an annualized rate of 6% based on the Estimated Per Share NAV, payable in arrears the following quarter.

In October 2018, the Company reinvested and repurchased the following shares and amounts:

 

 

 

 

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

Certain statements in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Words such as “may,” “could,” “should,” “expect,” “intend,” “plan,” “goal,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “variables,” “potential,” “continue,” “expand,” “maintain,” “create,” “strategies,” “likely,” “will,” “would” and variations of these terms and similar expressions, or the negative of these terms or similar expressions, are intended to identify forward-looking statements.

These forward-looking statements are not historical facts but reflect the intent, belief or current expectations of the management of Inland Real Estate Income Trust, Inc. (which we refer to herein as the “Company,” “we,” “our” or “us”) based on their knowledge and understanding of the business and industry, the economy and other future conditions. These statements are not guarantees of future performance, and we caution stockholders not to place undue reliance on forward-looking statements. Actual results may differ materially from those expressed or forecasted in the forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to the factors listed and described under “Risk Factors” in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission on March 16, 2018, and factors described below:

Forward-looking statements in this Quarterly Report on Form 10-Q reflect our management’s view only as of the date of this Quarterly Report, and may ultimately prove to be incorrect or false. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results except as required by applicable law. We intend for these forward-looking statements to be covered by the applicable safe harbor provisions created by Section 27A of the Securities Act and Section 21E of the Exchange Act.

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The following discussion and analysis relates to the three and nine months ended September 30, 2018 and 2017 and as of September 30, 2018 and December 31, 2017. You should read the following discussion and analysis along with our consolidated financial statements and the related notes included in this report.

Overview

We were formed as a Maryland corporation on August 24, 2011 and elected to be taxed as a real estate investment trust for U.S. federal income tax purposes (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, commencing with the year ended December 31, 2013.  We are managed by our business manager, IREIT Business Manager & Advisor, Inc., referred to herein as our “Business Manager.”

 

We have acquired retail properties, and we have invested in a joint venture to develop three transitional care/rapid recovery centers in Texas. We may continue to invest in additional joint ventures or acquire other real estate assets such as office and medical office buildings, multi-family properties and industrial/distribution and warehouse facilities if management believes the expected returns from those investments exceed that of retail properties. We also may invest in real estate-related equity securities of both publicly traded and private real estate companies, as well as commercial mortgage-backed securities.

At September 30, 2018, we had total assets of approximately $1.4 billion and owned 59 properties located in 24 states containing approximately 6.9 million square feet.  A majority of our properties are multi-tenant, necessity-based retail shopping centers primarily located in major regional markets and growing secondary markets throughout the United States. The portfolio properties have staggered lease maturity dates and anchor tenants generally with strong credit ratings.

On January 16, 2018, we effected a 1-for-2.5 reverse stock split whereby every 2.5 shares of our issued and outstanding common stock were converted into one share of our common stock (the “Reverse Stock Split”). As a result of the Reverse Stock Split, the number of our outstanding shares was reduced from approximately 88,746,109 to approximately 35,498,444. In accordance with U.S. GAAP, all share information presented has been retroactively adjusted to reflect the Reverse Stock Split.

We commenced our “best efforts” offering (the “Offering”) on October 18, 2012, which concluded on October 16, 2015.  We sold 33,534,022 shares of common stock generating gross proceeds of $834.4 million from the Offering.  On March 20, 2018, our board of directors determined an estimated per share net asset value of our common stock of $22.35.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Company Highlights - Three Months Ended September 30, 2018

On August 1, 2018, we amended and restated our credit facility (“Credit Facility”) to among other things:

 

 

 

As a result of the additional liquidity available under the amended Credit Facility, we paid-off twelve mortgage loans with a principal balance of $184.7 million and ten interest rate swap agreements with a notional amount of $131.3 million. We realized a loss on extinguishment of debt in the consolidated statements of operations and comprehensive income (loss) of $0.4 million due to the write-off of the unamortized balance of debt issuance costs associated with ten loans that were repaid prior to maturity.

We recorded a loss of $0.4 million for the write-off of debt issuance costs and a gain of $1.2 million related to the early termination of certain interest rate swap agreements that had corresponding early mortgage pay-offs.

SELECT PROPERTY INFORMATION (All dollar amounts in thousands, except per square foot amounts)

Investment Properties

 

 

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The table below presents information for each of our investment properties as of September 30, 2018.

 

 

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Tenancy Highlights

The following table presents information regarding the top ten tenants in our portfolio based on annualized base rent for leases in-place as of September 30, 2018.

 

 

The following table sets forth a summary of our tenant diversity for our entire portfolio and is based on leases in-place at September 30, 2018.

 

 

The following table sets forth a summary, as of September 30, 2018, of the percent of total annualized base rent and the weighted average lease expiration by size of tenant.

 

 

Lease Expirations

The following table sets forth a summary, as of September 30, 2018, of lease expirations scheduled to occur during the remainder of 2018 and each of the calendar years from 2019 to 2027 and thereafter, assuming no exercise of renewal options or early termination

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rights for leases commenced on or prior to September 30, 2018. Annualized base rent represents the rent in-place of the applicable property at September 30, 2018. The table below includes ground leases. If ground leases are excluded, annualized base rent would equal $87,633, or $17.32 per square foot for total expiring leases.

 

LIQUIDITY AND CAPITAL RESOURCES

General

Our primary uses and sources of cash are as follows:

At September 30, 2018, we had $128.5 million outstanding under the Revolving Credit Facility and $150.0 million outstanding under the Term Loan.  At September 30, 2018 the interest rate on the Revolving Credit Facility and the Term Loan was 3.82% and 4.29%, respectively. The Revolving Credit Facility matures on August 1, 2022, and we have the option to extend the maturity date for one additional year subject to the payment of an extension fee and certain other conditions.  The Term Loan matures on August 1, 2023. As of September 30, 2018, we had $71.5 million available for borrowing under the Revolving Credit Facility.

As of September 30, 2018, we had total debt outstanding of approximately $703.2 million, excluding mortgage premiums and unamortized debt issuance costs, which bore interest at a weighted average interest rate of 3.85% per annum.  As of September 30, 2018, the weighted average years to maturity for our debt was 4.66 years. As of September 30, 2018 and December 31, 2017, our

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borrowings were 50% and 49%, respectively, of the purchase price of our investment properties. At September 30, 2018 our cash and cash equivalents balance is $16.6 million.

For information related to our debt maturities reference is made to Note 7 – “Debt and Derivative Instruments” which is included in our September 30, 2018 Notes to Consolidated Financial Statements in Item 1.

 

Cash Flow Analysis

 

 

Operating activities

The decrease in cash from operating activities during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was primarily due to the timing of real estate tax payments, a decrease in prepaid rent and the payment of a deferred investment property acquisition obligation.

Investing activities

We used less cash in our investing activities in the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017. The decrease is primarily due to the purchase of three properties in the nine months ended September 30, 2017 and no purchases of investment properties in 2018. The decrease in cash used in investing activities in 2018 is partially offset with an increase in capital improvements at certain of our properties and funding of notes receivable.

Financing activities

 

During the nine months ended September 30, 2018 and 2017, changes in total debt decreased $67.3 million. The decrease is primarily due to the funding of purchases of investment properties in the nine months ended September 30, 2017 and no purchases in 2018.  During the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017, proceeds from the distribution reinvestment plan (“DRP”) after shares repurchased decreased $8.0 million. During the nine months ended September 30, 2018 and 2017, we paid approximately $28.4 million and $40.0 million, respectively, in distributions.

 

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Distributions

For 2018, distributions are payable quarterly in arrears, and for 2017, distributions were payable monthly in arrears. A summary of the distributions declared, distributions paid and cash flows provided by operations for the nine months ended September 30, 2018 and 2017 follows (Dollar amounts in thousands except per share amounts):

 

 

Results of Operations

The following discussions are based on our consolidated financial statements for the three and nine months ended September 30, 2018 and 2017. Dollar amounts are stated in thousands. We are continuing to evaluate strategies to position the Company for future growth, all with a view toward increasing stockholder value. Our Board engaged Barclays to assist in this process.

This section describes and compares our results of operations for the three and nine months ended September 30, 2018 and 2017. We generate almost all of our net operating income from property operations. In order to evaluate our overall portfolio, management analyzes the net operating income of properties that we have owned and operated for both periods presented, in their entirety, referred to herein as “same store” properties. By evaluating the property net operating income of our “same store” properties, management is able to monitor the operations of our existing properties for comparable periods to measure the performance of our current portfolio and determine the effects of our new acquisitions on net income.

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

A total of 58 investment properties were acquired on or before July 1, 2017 and represent our “same store” properties during the three months ended September 30, 2018 and 2017.  “Non-same store,” as reflected in the table below, consists of properties acquired after July 1, 2017. For the three months ended September 30, 2018, one property constituted a non-same store property. The following table presents the property net operating income broken out between same store and non-same store, prior to straight-line income, net, amortization of intangibles, interest, and depreciation and amortization for the three months ended September 30, 2018 and 2017, along with a reconciliation to net loss, calculated in accordance with U.S. GAAP.

 

 

Net loss.  Net loss was $5,791 and $2,856 for the three months ended September 30, 2018 and 2017, respectively.

 

Total property net operating income.  On a “same store” basis, comparing the results of operations of investment properties owned during the three months ended September 30, 2018 with the results of the same investment properties owned during the three months ended September 30, 2017, property net operating income increased $419, total property income increased $60, and total property operating expenses including real estate tax expense decreased $359. The increase in “same store” total property operating income is primarily due to an increase in rental income. The decrease in total property operating expenses is primarily due to a decrease in current year real estate taxes and a decrease in management fee expense.

 

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“Non-same store” total property net operating income increased $6 during 2018 as compared to 2017. The increase is a result of acquiring one retail property after July 1, 2017. On a “non-same store” basis, total property income decreased $3 and total property operating expenses decreased $9 during the three months ended September 30, 2018 as compared to 2017.

 

Straight-line income, net. Straight-line rent income decreased by $292 during the three months ended September 30, 2018 compared to 2017. This decrease is due to certain tenant rent abatements in 2017 that increased straight-line rental income.

Intangible amortization.  Intangible amortization income increased $414 in 2018 compared to 2017. The increase is primarily attributable to intangible liabilities being written off in 2018.

General and administrative expenses.  General and administrative expenses increased $29 in 2018 compared to 2017.  The increase is primarily due to state tax estimates.

Acquisition related costs.  Acquisition related expenses decreased $62 in 2018 compared to 2017. The decrease is attributable to the fact that there were no acquisitions in 2018.

Business management fee. Business management fees increased $27 in 2018 compared to 2017. The increase in the three months ended September 30, 2018 is due to the 2017 acquisitions of real estate which increased assets under management.  There have been no acquisitions in 2018.

Depreciation and amortization.  Depreciation and amortization decreased $1,102 in 2018 compared to 2017. The decrease is primarily due to write-offs of replaced assets in 2017.

Provision for impairment of investment in unconsolidated entities.  During the three months ended September 30, 2018, the Company recorded an impairment to its investment in the Mainstreet JV of $5,000 to write down the investment to its estimated fair value based on the Company’s evaluations.

Interest expense.  Interest expense increased $464 in 2018 compared to 2017. The increase is primarily due to additional amounts drawn under the Credit Facility and higher interest rates on our floating debt.

Gain on early termination of interest rate swap agreements. During the three months ended September 30, 2018, the Company recorded a gain of $1,151 related to the early termination of certain interest rate swap agreements that had corresponding early mortgage pay-offs.

Loss on extinguishment of debt. During the three months ended September 30, 2018, the Company realized a loss on extinguishment of debt in the consolidated statements of operations and comprehensive income (loss) of $411 due to the write-off of the unamortized balance of debt issuance costs associated with ten loans that were repaid prior to maturity.

Interest and other income.  Interest and other income increased $154 in 2018 compared to 2017.  The increase is primarily due to interest earned on our note receivable and settlement income during the three months ended September 30, 2018.

 

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

A total of 56 investment properties were acquired on or before January 1, 2017 and represent our “same store” properties during the nine months ended September 30, 2018 and 2017.  “Non-same store,” as reflected in the table below, consists of properties acquired after January 1, 2017. For the nine months ended September 30, 2018 and 2017, three properties constituted non-same store properties. The following table presents the property net operating income broken out between same store and non-same store, prior to straight-line income, net, amortization of intangibles, interest, and depreciation and amortization for the nine months ended September 30, 2018 and 2017, along with a reconciliation to net loss, calculated in accordance with U.S. GAAP.

 

 

Net loss.  Net loss was $10,205 and $8,291 for the nine months ended September 30, 2018 and 2017, respectively.

 

Total property net operating income.  On a “same store” basis, comparing the results of operations of investment properties owned during the nine months ended September 30, 2018 with the results of the same investment properties owned during the nine months ended September 30, 2017, property net operating income decreased $361, total property income decreased $49, and total property operating expenses including real estate tax expense increased $312.

 

The decrease in “same store” total property income is primarily due to a decrease in tenant recovery income. The increase in “same store” total property operating expenses is primarily due to an increase in current year non-recoverable property expenses.

 

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“Non-same store” total property net operating income increased $791 during 2018 as compared to 2017. The increase is a result of acquiring three retail properties after January 1, 2017. On a “non-same store” basis, total property income increased $956 and total property operating expenses increased $165 during the nine months ended September 30, 2018 as compared to 2017 as a result of these acquisitions.

Straight-line income, net. Straight-line rent income decreased $301 in 2018 compared to 2017. This decrease is due to certain tenant rent abatements in 2017 that increased straight-line rental income.

Intangible amortization.  Intangible amortization income decreased $395 in 2018 compared to 2017. The decrease is primarily attributable to intangible assets and liabilities being written off or fully amortized.

General and administrative expenses.  General and administrative expenses decreased $94 in 2018 compared to 2017.  This decrease is primarily due to lower legal costs, lower salary expense and a decrease in conference costs, partially offset by an increase in state tax estimates.

Acquisition related costs.  Acquisition related expenses decreased $1,234 in 2018 compared to 2017. The decrease is attributable to the fact that there were no acquisitions in 2018.

Business management fee. Business management fees increased $129 in 2018 compared to 2017. The increase in the nine months ended September 30, 2018 is due to the 2017 acquisitions of real estate which increased assets under management.  There have been no acquisitions in 2018.

Depreciation and amortization.  Depreciation and amortization decreased $2,779 in 2018 compared to 2017. The decrease is primarily due to write-offs of replaced assets and Harris Plaza’s redevelopment in 2017.

Interest expense.  Interest expense increased $1,654 in 2018 compared to 2017. The increase is primarily due to additional financing of properties after January 1, 2017, increased amounts drawn under the Credit Facility and higher interest rates on our floating debt.

 

Gain on early termination of interest rate swap agreements. During the nine months ended September 30, 2018, the Company recorded a gain of $1,151 related to the early termination of certain interest rate swap agreements that had corresponding early mortgage pay-offs.

Loss on extinguishment of debt. During the nine months ended September 30, 2018, the Company realized a loss on extinguishment of debt in the consolidated statements of operations and comprehensive income (loss) of $411 due to the write-off of the unamortized balance of debt issuance costs associated with ten loans that were repaid prior to maturity.

Provision for impairment of investment in unconsolidated entities.  During the nine months ended September 30, 2018, the Company recorded an impairment to its investment in the Mainstreet JV of $5,000 to write down the investment to its estimated fair value based on the Company’s evaluations.

Interest and other income.  Interest and other income increased $308 in 2018 compared to 2017.  The increase is primarily due to interest earned on our note receivable and settlement income.

Critical Accounting Policies

Disclosures discussing all critical accounting policies are set forth in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission on March 16, 2018, under the heading “Critical Accounting Policies.” There have been no changes to our critical accounting policies during the three months ended September 30, 2018.

 

Off-Balance Sheet Arrangements

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

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Leasing Activity

The following table sets forth leasing activity during the nine months ended September 30, 2018. Leases with terms of less than 12 months have been excluded from the table.

 

 

 

Non-GAAP Financial Measures

Accounting for real estate assets in accordance with U.S. GAAP assumes the value of real estate assets is reduced over time due primarily to non-cash depreciation and amortization expense. Because real estate values may rise and fall with market conditions, operating results from real estate companies that use U.S. GAAP accounting may not present a complete view of their performance. We use Funds from Operations, or “FFO”, a widely accepted metric to evaluate our performance. FFO provides a supplemental measure to compare our performance and operations to other REITs. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or “NAREIT”, has promulgated a standard known as FFO, which it believes more accurately reflects the operating performance of a REIT. As defined by NAREIT, FFO means net income (loss) computed in accordance with U.S. GAAP, excluding gains (or losses) from sales of depreciable properties, plus depreciation and amortization and impairment charges on depreciable property after adjustments for unconsolidated entities in which the REIT holds an interest. We have adopted the NAREIT definition for computing FFO.

Under U.S. GAAP, acquisition related costs are treated differently if the acquisition is a business combination or an asset acquisition. An acquisition of a single property will likely be treated as an asset acquisition as opposed to a business combination and acquisition related costs will be capitalized rather than expensed when incurred. Publicly registered, non-listed REITs typically engage in a significant amount of acquisition activity in the early years of their operations, and thus incur significant acquisition related costs, during these initial years. Although other start up entities may engage in significant acquisition activity during their initial years, REITs such as us that are not listed on an exchange are unique in that they typically have a limited timeframe during which they acquire a significant number of properties and thus incur significant acquisition related costs. Due to the above factors and other unique features of publicly registered, non-listed REITs, the Institute for Portfolio Alternatives, or “IPA”, an industry trade group, published a standardized measure known as Modified Funds from Operations, or “MFFO”, which the IPA has promulgated as a supplemental measure for publicly registered non-listed REITs and which may be another appropriate supplemental measure to reflect the operating performance of a non-listed REIT.

MFFO excludes expensed costs associated with investing activities, some of which are acquisition related costs that affect our operations only in periods in which properties are acquired, and other non-operating items that are included in FFO. By excluding acquisition related costs, the use of MFFO provides another measure of our operating performance. Because MFFO may be a recognized measure of operating performance within the non-listed REIT industry, MFFO and the adjustments used to calculate it may be useful in order to evaluate our performance against other non-listed REITs. Like FFO, MFFO is not equivalent to our net income or loss as determined under U.S. GAAP, as detailed in the table below, and MFFO may not be a useful measure of the impact of long-term operating performance on value if we continue to acquire a significant amount of properties. MFFO should only be used as a measurement of our operating performance while we are acquiring a significant amount of properties because it excludes, among other things, acquisition costs incurred during the periods in which properties were acquired.

We believe our definition of MFFO, a non-U.S. GAAP measure, is consistent with the IPA's Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations, or the “Practice Guideline,” issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of U.S. GAAP net income: acquisition fees and expenses; amounts relating to straight-line rents and amortization of above and below market lease assets and liabilities, accretion of discounts and amortization of premiums on

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debt investments; mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis.

Our presentation of FFO and MFFO may not be comparable to other similarly titled measures presented by other REITs. We believe that the use of FFO and MFFO provides a more complete understanding of our operating performance to stockholders and to management, and when compared year over year, reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs. Neither FFO nor MFFO is intended to be an alternative to “net income” or to “cash flows from operating activities” as determined by U.S. GAAP as a measure of our capacity to pay distributions. Management uses FFO and MFFO to compare our operating performance to that of other REITs and to assess our operating performance.

Our FFO and MFFO for the nine months ended September 30, 2018 and 2017 are calculated as follows:

 

Subsequent Events

For information related to subsequent events, reference is made to Note 15 – “Subsequent Events” which is included in our September 30, 2018 Notes to Consolidated Financial Statements in Item 1.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Market Risk

We are exposed to various market risks, including those caused by changes in interest rates and commodity prices. Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates and commodity prices. We do not enter into derivatives or other financial instruments for trading or speculative purposes. We have entered into, and may continue to enter into, financial instruments to manage and reduce the impact of changes in interest rates. The counterparties are, and are expected to continue to be, major financial institutions.

 

Interest Rate Risk

We are exposed to interest rate changes primarily as a result of long-term debt used to purchase properties or other real estate assets and to fund capital expenditures.

 

As of September 30, 2018, we had outstanding debt of approximately $703.2 million, excluding mortgage premium and unamortized debt issuance costs, bearing interest rates ranging from 2.95% to 5.48% per annum. The weighted average interest rate was 3.85%, which includes the effect of interest rate swaps. As of September 30, 2018, the weighted average years to maturity for our mortgages and credit facility payable was approximately 4.66 years.

 

As of September 30, 2018, our fixed-rate debt consisted of secured mortgage financings with a carrying value of $171.7 million and a fair value of $168.5 million. Changes in interest rates do not affect interest expense incurred on our fixed-rate debt until their maturity or earlier repayment, but interest rates do affect the fair value of our fixed rate debt obligations.  If market interest rates were to increase by 1% (100 basis points), the fair market value of our fixed-rate debt would decrease by $7.9 million at September 30, 2018.

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If market interest rates were to decrease by 1% (100 basis points), the fair market value of our fixed-rate debt would increase by $8.5 million at September 30, 2018.

As of September 30, 2018, we had $129.2 million of debt or 18.38% of our total debt, excluding mortgage premium and unamortized debt issuance costs, bearing interest at variable rates with a weighted average interest rate equal to 3.82% per annum. We had variable rate debt subject to swap agreements of $402.2 million, or 57.21% of our total debt, excluding mortgage premium and unamortized debt issuance costs, at September 30, 2018.

If interest rates on all debt which bears interest at variable rates as of September 30, 2018 increased by 1% (100 basis points), the increase in interest expense on all debt would decrease earnings and cash flows by approximately $2.8 million annually. If interest rates on all debt which bears interest at variable rates as of September 30, 2018 decreased by 1% (100 basis points), the decrease in interest expense would increase earnings and cash flows by the same amount.

With regard to variable rate financing, our Business Manager assesses our interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. Our Business Manager maintains risk management control systems to monitor interest rate cash flow risk attributable to both of our outstanding or forecasted debt obligations as well as our potential offsetting hedge positions.

We use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets. Derivative instruments may include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions are determined in light of the facts and circumstances existing at the time of the hedge. We have used derivative financial instruments, specifically interest rate swap contracts, to hedge against interest rate fluctuations on variable rate debt, which exposes us to both credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty will owe us, which creates credit risk for us because the counterparty may not perform. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We seek to manage the market risk associated with interest-rate contracts by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. There is no assurance we will be successful.

Derivatives

For information related to our derivatives, reference is made to Note 7 – “Debt and Derivative Instruments” which is included in our September 30, 2018 Notes to Consolidated Financial Statements in Item 1.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures

Our management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the principal executive and principal financial officers have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) or Rule 15d-15(f)) during the three months ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

Part II - Other Information

Item 1.  Legal Proceedings

We are not a party to, and none of our properties are subject to, any material pending legal proceedings.

Item 1A.  Risk Factors

The following risk factors supplement the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2017.

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We have incurred net losses on a U.S. GAAP basis for the quarterly period ended September 30, 2018.

We have incurred net losses on a U.S. GAAP basis for the three and nine months ended September 30, 2018 of $5.8 million and $10.2 million, respectively. Our losses can be attributed, in part, to non-cash expenses, such as depreciation and amortization. We may incur net losses in the future, which could have a material adverse impact on our financial condition, operations, cash flow, and our ability to service our indebtedness and pay distributions to our stockholders. We are subject to all of the business risks and uncertainties associated with any business. We cannot assure our stockholders that, in the future, we will be profitable or that we will realize growth in the value of our assets.

The financial covenants under our credit agreement may restrict our ability to make distributions and our operating and acquisition activities. If we breach the financial covenants we could be held in default under the credit agreement, which could accelerate our repayment date and materially adversely affect our liquidity and financial condition.

We entered into a credit agreement, as amended, for a $200.0 million Revolving Credit Facility and $150.0 million Term Loan.  The credit agreement provides us with the ability from time to time to increase the size of the Credit Facility, subject to certain conditions. Our performance of the obligations under the credit agreement, including the payment of any outstanding indebtedness, is secured by a minimum pool of ten unencumbered properties with an unencumbered pool value of $200.0 million or above and by a guaranty by certain of our subsidiaries. As of September 30, 2018, we have borrowed $278.5 million of the $350 million available. Our availability under the Credit Facility was $71.5 million as of September 30, 2018.

The credit agreement requires compliance with certain financial covenants, including, among other conditions, a minimum tangible net worth requirement, restrictions on indebtedness, a distribution limitation and other material covenants. These covenants could inhibit our ability to make distributions to our stockholders and to pursue certain business initiatives or effect certain transactions that might otherwise be beneficial to us. For example, without lender consent, we may not declare and pay distributions or honor any redemption requests if any default under the agreement then exists or if distributions, excluding any distributions reinvested through our DRP, for the then-current quarter and the three immediately preceding quarters would exceed 95% of our FFO, excluding acquisition expenses, or “adjusted FFO,” for that period. For the fiscal quarter ended September 30, 2018, distributions did not exceed 95% of our adjusted FFO.

The credit agreement also provides for several customary events of default, including, among other things, the failure to comply with our covenants and the failure to pay when amounts outstanding under the credit agreement become due. Declaration of a default by the lenders under the credit agreement could restrict our ability to borrow additional monies and could cause all amounts to become immediately due and payable, which would materially adversely affect our liquidity and financial condition.

Investing in subordinated debt involves greater risks of loss than senior loans secured by the same properties.

 

We entered into mezzanine loan agreements pursuant to which we made a mezzanine financing commitment of approximately $5.4 million in the aggregate. We may continue to invest in mezzanine debt and other subordinated debt. These types of investments carry a higher degree of risk of loss than senior secured debt investments because in the event of default and foreclosure, holders of senior liens will be paid in full before subordinated investors and, depending on the value of the underlying collateral, there may not be sufficient assets to pay all or any part of amounts owed to subordinated investors. Moreover, mezzanine debt and other subordinated debt investments may have higher loan-to-value ratios than conventional senior lien financing, resulting in less equity in the collateral and increasing the risk of loss of principal. If a borrower defaults or declares bankruptcy, we may be subject to agreements restricting or eliminating our rights as a creditor, including rights to call a default, foreclose on collateral, accelerate maturity or control decisions made in bankruptcy proceedings. In addition, senior lenders may limit the amount or timing of interest and principal payments while the senior secured debt is outstanding.

 

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

Recent Sales of Unregistered Equity Securities

During the period covered by this quarterly report, we did not sell any equity securities that were not registered under the Securities Act.

Share Repurchase Program

We adopted a share repurchase program effective October 18, 2012 which was subsequently amended effective January 1, 2018 to change the processing of repurchase requests from a monthly to a quarterly basis to align with the move to quarterly distributions.  Under the SRP, we are authorized, in our discretion, to purchase shares from stockholders who purchased their shares from us or

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received their shares through a non-cash transfer and who have held their shares for at least one year, if requested.  Under the SRP, we may make “ordinary repurchases,” which are defined as all repurchases other than “exceptional repurchases,” which are defined as repurchases upon the death or qualifying disability of a stockholder, at prices ranging from 92.5% of the “share price,” as defined in the SRP, for stockholders who have owned their shares continuously for at least one year, but less than two years, to 100% of the “share price” for stockholders who have owned their shares continuously for at least four years. In the case of “exceptional repurchases,” we may repurchase shares at a repurchase price equal to 100% of the “share price.”

As used in the SRP, “share price” means: (1) prior to our initial valuation date, the offering price of our shares in the Offering (unless the shares were purchased at a discount from that price, and then that purchase price), as adjusted by the Reverse Stock Split, reduced by any distributions of net sale proceeds that we designate as constituting a return of capital; and (2) on and after our initial valuation date, the lesser of: (A) the share price determined in (1); or (B) the most recently disclosed estimated value per share, which is $22.35.

Subject to funds being available, we limit the number of shares repurchased during any calendar year to 5% of the number of shares outstanding on December 31st of the previous calendar year, as adjusted by the Reverse Stock Split. Funding for the SRP is limited to the proceeds we receive from the DRP during the same period.  In the case of exceptional repurchases, the one year holding period does not apply.

The SRP will immediately terminate if our shares are listed on any national securities exchange. In addition, our board of directors, in its sole discretion, may amend, suspend (in whole or in part), or terminate our SRP. In the event that we amend, suspend or terminate the SRP, however, we will send stockholders notice of the change at least thirty days prior to the change, and we will disclose the change in a report filed with the Securities and Exchange Commission on either Form 8-K, Form 10-Q or Form 10-K, as appropriate. Further, our board reserves the right in its sole discretion, at any time, and from time to time to reject any requests for repurchases.

The table below outlines the shares we repurchased pursuant to our SRP during the three months ended September 30, 2018.

 

(Dollar amounts in thousands, except per share amounts)

 

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not Applicable.

Item 5.  Other Information

Not Applicable.

Item 6.  Exhibits

The representations, warranties and covenants made by us in any agreement filed as an exhibit to this Form 10-Q are made solely for the benefit of the parties to the agreement, including, in some cases, for the purpose of allocating risk among the parties to the agreement, and should not be deemed to be representations, warranties or covenants to, or with, you. Moreover, these representations, warranties and covenants should not be relied upon as accurately describing or reflecting the current state of our affairs.

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The exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index attached hereto and are incorporated herein by reference.

 

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Exhibit Index

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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