Attached files
| file | filename |
|---|---|
| EX-32.1 - EXHIBIT 32.1 - Cole Office & Industrial REIT (CCIT II), Inc. | ccitii930201810qex321.htm |
| EX-31.2 - EXHIBIT 31.2 - Cole Office & Industrial REIT (CCIT II), Inc. | ccitii930201810qex312.htm |
| EX-31.1 - EXHIBIT 31.1 - Cole Office & Industrial REIT (CCIT II), Inc. | ccitii930201810qex311.htm |
| EX-10.1 - EXHIBIT 10.1 - Cole Office & Industrial REIT (CCIT II), Inc. | ccitii2018equityincentivep.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2018
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 000-55436
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
(Exact name of registrant as specified in its charter)
Maryland | 46-2218486 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
2325 East Camelback Road, 10th Floor Phoenix, Arizona 85016 | (602) 778-8700 | |
(Address of principal executive offices; zip code) | (Registrant’s telephone number, including area code) | |
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
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 x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | ¨ | Non-accelerated filer | x | ||
Smaller reporting company | ¨ | Emerging growth company | ¨ | ||||
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 x
As of November 7, 2018, there were approximately 64.7 million shares of Class A common stock, par value $0.01 per share, and 2.5 million shares of Class T common stock, par value $0.01 per share, of Cole Office & Industrial REIT (CCIT II), Inc. outstanding.
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
INDEX
2
PART I — FINANCIAL INFORMATION
Item 1. | Financial Statements |
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts) (Unaudited)
September 30, 2018 | December 31, 2017 | ||||||
ASSETS | |||||||
Real estate assets: | |||||||
Land | $ | 103,418 | $ | 102,055 | |||
Buildings and improvements | 1,003,545 | 997,738 | |||||
Intangible lease assets | 124,965 | 124,952 | |||||
Total real estate assets, at cost | 1,231,928 | 1,224,745 | |||||
Less: accumulated depreciation and amortization | (128,830 | ) | (99,882 | ) | |||
Total real estate assets, net | 1,103,098 | 1,124,863 | |||||
Cash and cash equivalents | 3,374 | 4,845 | |||||
Restricted cash | 1,541 | 1,431 | |||||
Rents and tenant receivables | 26,071 | 23,321 | |||||
Derivative assets, prepaid expenses and other assets | 4,697 | 3,679 | |||||
Deferred costs, net | 166 | 760 | |||||
Total assets | $ | 1,138,947 | $ | 1,158,899 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Credit facility and notes payable, net | $ | 599,736 | $ | 599,771 | |||
Accounts payable and accrued expenses | 9,408 | 6,897 | |||||
Due to affiliates | 1,162 | 1,274 | |||||
Intangible lease liabilities, net | 22,048 | 23,783 | |||||
Distributions payable | 3,472 | 3,589 | |||||
Deferred rental income and other liabilities | 4,326 | 4,231 | |||||
Total liabilities | 640,152 | 639,545 | |||||
Commitments and contingencies | |||||||
Redeemable common stock | 27,737 | 27,765 | |||||
STOCKHOLDERS’ EQUITY | |||||||
Preferred stock, $0.01 par value per share; 10,000,000 shares authorized, none issued and outstanding | — | — | |||||
Class A common stock, $0.01 par value per share; 245,000,000 shares authorized, 64,838,893 and 64,884,543 shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively | 648 | 649 | |||||
Class T common stock, $0.01 par value per share; 245,000,000 shares authorized, 2,548,374 and 2,515,860 shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively | 26 | 25 | |||||
Capital in excess of par value | 583,272 | 583,279 | |||||
Accumulated distributions in excess of earnings | (117,050 | ) | (95,306 | ) | |||
Accumulated other comprehensive income | 4,162 | 2,942 | |||||
Total stockholders’ equity | 471,058 | 491,589 | |||||
Total liabilities, redeemable common stock and stockholders’ equity | $ | 1,138,947 | $ | 1,158,899 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts) (Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Revenues: | ||||||||||||||||
Rental income | $ | 23,417 | $ | 23,832 | $ | 70,231 | $ | 69,039 | ||||||||
Tenant reimbursement income | 3,160 | 2,964 | 9,260 | 8,183 | ||||||||||||
Total revenues | 26,577 | 26,796 | 79,491 | 77,222 | ||||||||||||
Operating expenses: | ||||||||||||||||
General and administrative | 1,267 | 1,254 | 3,483 | 3,525 | ||||||||||||
Property operating | 1,655 | 1,661 | 4,885 | 4,071 | ||||||||||||
Real estate tax | 2,066 | 1,924 | 6,201 | 5,979 | ||||||||||||
Advisory fees and expenses | 2,599 | 2,620 | 7,907 | 7,682 | ||||||||||||
Acquisition-related | 4 | — | 89 | 2,214 | ||||||||||||
Depreciation and amortization | 9,620 | 9,552 | 28,855 | 28,411 | ||||||||||||
Total operating expenses | 17,211 | 17,011 | 51,420 | 51,882 | ||||||||||||
Operating income | 9,366 | 9,785 | 28,071 | 25,340 | ||||||||||||
Other expense: | ||||||||||||||||
Interest expense and other, net | (6,157 | ) | (5,733 | ) | (18,210 | ) | (16,840 | ) | ||||||||
Net income | $ | 3,209 | $ | 4,052 | $ | 9,861 | $ | 8,500 | ||||||||
Class A Common Stock: | ||||||||||||||||
Net income | $ | 3,137 | $ | 3,951 | $ | 9,635 | $ | 8,332 | ||||||||
Basic and diluted weighted average number of common shares outstanding | 64,837,707 | 65,454,626 | 64,859,565 | 65,243,906 | ||||||||||||
Basic and diluted net income per common share | $ | 0.05 | $ | 0.06 | $ | 0.15 | $ | 0.13 | ||||||||
Distributions declared per common share | $ | 0.16 | $ | 0.16 | $ | 0.47 | $ | 0.47 | ||||||||
Class T Common Stock: | ||||||||||||||||
Net income | $ | 72 | $ | 101 | $ | 226 | $ | 168 | ||||||||
Basic and diluted weighted average number of common shares outstanding | 2,545,215 | 2,500,427 | 2,534,054 | 2,481,363 | ||||||||||||
Basic and diluted net income per common share | $ | 0.03 | $ | 0.04 | $ | 0.09 | $ | 0.07 | ||||||||
Distributions declared per common share | $ | 0.16 | $ | 0.16 | $ | 0.47 | $ | 0.47 | ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands) (Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Net income | $ | 3,209 | $ | 4,052 | $ | 9,861 | $ | 8,500 | ||||||||
Other comprehensive (loss) income | ||||||||||||||||
Unrealized gain on interest rate swaps | 263 | 96 | 2,216 | 16 | ||||||||||||
Amount of (gain) loss reclassified from other comprehensive income into income as interest expense and other, net | (480 | ) | 91 | (996 | ) | 676 | ||||||||||
Total other comprehensive (loss) income | (217 | ) | 187 | 1,220 | 692 | |||||||||||
Total comprehensive income | $ | 2,992 | $ | 4,239 | $ | 11,081 | $ | 9,192 | ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands, except share amounts) (Unaudited)
Class A Common Stock | Class T Common Stock | Capital in Excess of Par Value | Accumulated Distributions in Excess of Earnings | Accumulated Other Comprehensive Income | Total Stockholders’ Equity | |||||||||||||||||||||||||
Number of Shares | Par Value | Number of Shares | Par Value | |||||||||||||||||||||||||||
Balance, January 1, 2018 | 64,884,543 | $ | 649 | 2,515,860 | $ | 25 | $ | 583,279 | $ | (95,306 | ) | $ | 2,942 | $ | 491,589 | |||||||||||||||
Issuance of common stock | 1,478,457 | 14 | 59,741 | 1 | 16,123 | — | — | 16,138 | ||||||||||||||||||||||
Distributions declared | — | — | — | — | — | (31,605 | ) | — | (31,605 | ) | ||||||||||||||||||||
Redemptions of common stock | (1,524,107 | ) | (15 | ) | (27,227 | ) | — | (16,158 | ) | — | — | (16,173 | ) | |||||||||||||||||
Changes in redeemable common stock | — | — | — | — | 28 | — | — | 28 | ||||||||||||||||||||||
Comprehensive income | — | — | — | — | — | 9,861 | 1,220 | 11,081 | ||||||||||||||||||||||
Balance, September 30, 2018 | 64,838,893 | $ | 648 | 2,548,374 | $ | 26 | $ | 583,272 | $ | (117,050 | ) | $ | 4,162 | $ | 471,058 | |||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (Unaudited)
Nine Months Ended September 30, | |||||||
2018 | 2017 | ||||||
Cash flows from operating activities: | |||||||
Net income | $ | 9,861 | $ | 8,500 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization, net | 27,213 | 26,754 | |||||
Amortization of deferred financing costs | 1,059 | 1,056 | |||||
Straight-line rental income | (3,378 | ) | (4,587 | ) | |||
Changes in assets and liabilities: | |||||||
Rents and tenant receivables | 628 | 306 | |||||
Prepaid expenses and other assets | 202 | 139 | |||||
Accounts payable and accrued expenses | 1,148 | 1,996 | |||||
Deferred rental income and other liabilities | 95 | (773 | ) | ||||
Due to affiliates | 38 | (1,098 | ) | ||||
Net cash provided by operating activities | 36,866 | 32,293 | |||||
Cash flows from investing activities: | |||||||
Investment in real estate assets | (1,363 | ) | (93,465 | ) | |||
Real estate developments and capital expenditures | (4,457 | ) | (10,113 | ) | |||
Payment of property escrow deposits | (50 | ) | (1,600 | ) | |||
Refund of property escrow deposits | 50 | 1,600 | |||||
Net cash used in investing activities | (5,820 | ) | (103,578 | ) | |||
Cash flows from financing activities: | |||||||
Distribution and stockholder servicing fees paid | (150 | ) | (147 | ) | |||
Redemptions of common stock | (16,173 | ) | (7,950 | ) | |||
Distributions to stockholders | (15,584 | ) | (15,166 | ) | |||
Proceeds from credit facility and notes payable | 28,000 | 113,600 | |||||
Repayments of credit facility and notes payable | (28,500 | ) | (24,600 | ) | |||
Deferred financing costs paid | — | (20 | ) | ||||
Net cash (used in) provided by financing activities | (32,407 | ) | 65,717 | ||||
Net decrease in cash and cash equivalents and restricted cash | (1,361 | ) | (5,568 | ) | |||
Cash and cash equivalents and restricted cash, beginning of period | 6,276 | 10,436 | |||||
Cash and cash equivalents and restricted cash, end of period | $ | 4,915 | $ | 4,868 | |||
Reconciliation of cash and cash equivalents and restricted cash to the condensed consolidated balance sheets: | |||||||
Cash and cash equivalents | $ | 3,374 | $ | 3,003 | |||
Restricted cash | 1,541 | 1,865 | |||||
Total cash and cash equivalents and restricted cash | $ | 4,915 | $ | 4,868 | |||
Supplemental Disclosures of Non-Cash Investing and Financing Activities: | |||||||
Distributions declared and unpaid | $ | 3,472 | $ | 3,504 | |||
Accrued capital expenditures | $ | 1,523 | $ | 1,139 | |||
Change in fair value of interest rate swaps | $ | 1,220 | $ | 692 | |||
Common stock issued through distribution reinvestment plan | $ | 16,138 | $ | 16,659 | |||
Supplemental Cash Flow Disclosures: | |||||||
Interest paid | $ | 17,155 | $ | 15,782 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
7
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited)
NOTE 1 — ORGANIZATION AND BUSINESS
Cole Office & Industrial REIT (CCIT II), Inc. (the “Company”) is a Maryland corporation, incorporated on February 26, 2013, that elected to be taxed, and currently qualifies, as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning with its taxable year ended December 31, 2014. The Company is the sole general partner of, and owns, directly or indirectly, 100% of the partnership interests in Cole Corporate Income Operating Partnership II, LP, a Delaware limited partnership.
On November 13, 2017, VEREIT Operating Partnership, L.P. (“VEREIT OP”), a former affiliated entity of the Company’s sponsor, CCO Group (as defined below), entered into a Purchase and Sale Agreement with CCA Acquisition, LLC (“CCA”), a newly-formed affiliate of CIM Group, LLC (“CIM”), pursuant to which CCA agreed to acquire all of the issued and outstanding shares of common stock of Cole Capital Advisors, Inc., the direct or indirect owner of Cole Corporate Income Advisors II, LLC (“CCI II Advisors”), Cole Capital Corporation and CREI Advisors, LLC (“CREI Advisors”), the Company’s external advisor, dealer manager and property manager, respectively (the “Transaction”).
On February 1, 2018, the Transaction was completed. Immediately following the completion of the Transaction, Cole Capital Advisors, Inc. and the Company’s dealer manager were each converted into Delaware limited liability companies, Cole Capital Advisors, Inc.’s name was changed to CCO Group, LLC, and the dealer manager’s name was changed to CCO Capital, LLC (“CCO Capital”). As a result of the Transaction, CIM owns and/or controls CCO Group, LLC and its subsidiaries (collectively, “CCO Group”), and CCO Group, LLC owns and controls CCI II Advisors, CCO Capital and CREI Advisors, the Company’s external advisor, dealer manager for the Offering (as defined below) and property manager, respectively.
In addition, as part of the Transaction, VEREIT OP and CCO Group, LLC entered into a services agreement (the “Services Agreement”) pursuant to which VEREIT OP is obligated to provide certain services to CCO Group and to the Company, Cole Credit Property Trust IV, Inc. (“CCPT IV”), Cole Credit Property Trust V, Inc. (“CCPT V”), Cole Office & Industrial (CCIT III), Inc. (“CCIT III”) and Cole Real Estate Income Strategy (Daily NAV), Inc. (“Cole Income NAV Strategy”) (CCPT IV, CCPT V, CCIT III, Cole Income NAV Strategy and the Company, collectively, the “Cole REITs®”), including operational real estate support. VEREIT OP is obligated to provide such services through March 31, 2019 (or, if later, the date of the last government filing other than a tax filing made by any of the Cole REITs with respect to its 2018 fiscal year) (the “Initial Services Term”) and is obligated to provide consulting and research services through December 31, 2023 as requested by CCO Group, LLC.
Despite the indirect change of ownership and control of the Company’s advisor, dealer manager, property manager and sponsor, the Company expects that, during the Initial Services Term of the Services Agreement, the advisory, dealer manager and property management services it receives will continue without any material changes in personnel (except as supplemented by the management oversight of CIM personnel) or material change in service procedures. CCO Group, LLC is evaluating and intends to effectuate during the Initial Services Term of the Services Agreement an appropriate transition of VEREIT OP’s services under the Services Agreement to other CIM affiliates or third parties with the goal of ensuring continuity and minimizing disruption.
Pursuant to a Registration Statement on Form S-11 (Registration No. 333-187470) (the “Registration Statement”) under the Securities Act of 1933, as amended (the “Securities Act”), and declared effective by the U.S. Securities and Exchange Commission (the “SEC”) on September 17, 2013, the Company commenced its initial public offering (the “Offering”) on a “best efforts” basis, initially offering up to a maximum of $2.5 billion in shares of a single class of common stock (now referred to as Class A Shares, as defined below) in the primary offering at a price of $10.00 per share, as well as up to $475.0 million in additional shares pursuant to a distribution reinvestment plan (the “Original DRIP”) at a price of $9.50 per share. In March, 2016, the Company reclassified a portion of its unissued Class A common stock (the “Class A Shares”) as Class T common stock (the “Class T Shares”) and commenced sales of Class T Shares thereafter upon receipt of the required regulatory approvals.
The Company ceased issuing shares in the Offering on September 17, 2016. The unsold Class A Shares and Class T Shares of $2.3 billion in the aggregate were subsequently deregistered. In addition, the Company registered an aggregate of $120.0 million of Class A Shares and Class T Shares under the Amended and Restated Distribution Reinvestment Plan (the “Amended and Restated DRIP” and collectively with the Original DRIP, the “DRIP”) pursuant to a Registration Statement on Form S-3 (Registration No. 333-213306), which was filed with the SEC on August 25, 2016 and automatically became effective with the SEC upon filing (the “DRIP Offering” and collectively with the Offering, the “Offerings”). The Company has continued to issue Class A Shares and Class T Shares under the DRIP Offering.
8
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
On March 28, 2018, the Company’s board of directors (the “Board”) established an updated estimated per share net asset value (“NAV”) of the Company’s common stock, as of December 31, 2017, of $10.58 per share for both Class A Shares and Class T Shares. As a result, commencing on March 28, 2018, distributions are reinvested under the DRIP Offering at a price of $10.58 per share for both Class A Shares and Class T Shares, the estimated per share NAV as of December 31, 2017, as determined by the Board. Additionally, $10.58 per share will serve as the most recent estimated per share NAV for purposes of the share redemption program. The Board establishes an updated per share NAV of the Company’s common stock on an annual basis for purposes of assisting broker-dealers that participated in the Offering in meeting their customer account reporting obligations under National Association of Securities Dealers Conduct Rule 2340, having previously established a per share NAV as of February 29, 2016 and December 31, 2016.
As of September 30, 2018, the Company had issued approximately 71.6 million shares of common stock in the Offerings, including 7.0 million shares issued in the DRIP Offering, for gross offering proceeds of $721.5 million ($694.3 million in Class A Shares and $27.2 million in Class T Shares) before offering costs, selling commissions, and dealer manager fees of $66.2 million. In addition, as of September 30, 2018, the Company paid distribution and stockholder servicing fees for Class T Shares sold in the primary portion of the Offering of $427,000 and accrued an estimated liability for future distribution and stockholder servicing fees payable of $592,000. As of September 30, 2018, the Company owned 36 office and industrial properties, comprising approximately 11.4 million rentable square feet of commercial space located in 19 states. As of September 30, 2018, the rentable square feet at these properties was 100% leased.
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of significant accounting policies presented below is designed to assist in understanding the Company’s condensed consolidated financial statements. These accounting policies conform to accounting principles generally accepted in the United States of America (“GAAP”) in all material respects, and have been consistently applied in preparing the accompanying condensed consolidated financial statements.
Principles of Consolidation and Basis of Presentation
The condensed consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the SEC regarding interim financial reporting, including the instructions to Form 10-Q and Article 10 of Regulation S-X, and do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the statements for the interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair presentation of the results for such periods. Results for these interim periods are not necessarily indicative of full year results. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2017, and related notes thereto, set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The condensed consolidated financial statements should also be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this Quarterly Report on Form 10-Q.
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Reclassifications
Certain amounts in the Company’s prior period condensed consolidated financial statements have been reclassified to conform to the current period presentation. In connection with the adoption of Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, transfers to or from restricted cash, which have previously been shown in the Company’s investing activities section of the condensed consolidated statements of cash flows, are now required to be shown as part of the total change in cash, cash equivalents and restricted cash in the condensed consolidated statements of cash flows. This change resulted in an increase in cash flows used in investing activities of $1.6 million during the nine months ended September 30, 2017.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires 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 condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
9
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
Real Estate Assets
Real estate assets are stated at cost, less accumulated depreciation and amortization. The Company considers the period of future benefit of each respective asset to determine the appropriate useful life. The estimated useful lives of the Company’s real estate assets by class are generally as follows:
Buildings | 40 years |
Site improvements | 15 years |
Tenant improvements | Lesser of useful life or lease term |
Intangible lease assets | Lease term |
Recoverability of Real Estate Assets
The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of its real estate assets may not be recoverable. Impairment indicators that the Company considers include, but are not limited to: bankruptcy or other credit concerns of a property’s major tenant, such as a history of late payments, rental concessions and other factors; a significant decrease in a property’s revenues due to lease terminations; vacancies; co-tenancy clauses; reduced lease rates; changes in anticipated holding periods; or other circumstances. When indicators of potential impairment are present, the Company assesses the recoverability of the assets by determining whether the carrying amount of the assets will be recovered through the undiscounted future cash flows expected from the use of the assets and their eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying amount, the Company will adjust the real estate assets to their respective fair values and recognize an impairment loss. Generally, fair value will be determined using a discounted cash flow analysis and recent comparable sales transactions. No impairment indicators were identified and no impairment losses were recorded during the nine months ended September 30, 2018 or 2017.
Assets Held for Sale
When a real estate asset is identified by the Company as held for sale, the Company will cease recording depreciation and amortization of the assets related to the property and estimate its fair value, net of selling costs. If, in management’s opinion, the fair value, net of selling costs, of the asset is less than the carrying amount of the asset, an adjustment to the carrying amount is then recorded to reflect the estimated fair value of the property, net of selling costs. There were no assets identified as held for sale as of September 30, 2018 or December 31, 2017.
Allocation of Purchase Price of Real Estate Assets
Upon the acquisition of real properties, the Company allocates the purchase price to acquired tangible assets, consisting of land, buildings and improvements, and to identified intangible assets and liabilities, consisting of the value of above- and below-market leases and the value of in-place leases and other intangibles, based in each case on their respective fair values. The Company utilizes independent appraisals to assist in the determination of the fair values of the tangible assets of an acquired property (which includes land and buildings). The information in the appraisal, along with any additional information available to the Company’s management, is used in estimating the amount of the purchase price that is allocated to land. Other information in the appraisal, such as building value and market rents, may be used by the Company’s management in estimating the allocation of purchase price to the building and to intangible lease assets and liabilities. The appraisal firm has no involvement in management’s allocation decisions other than providing this market information.
The determination of the fair values of the real estate assets and liabilities acquired requires the use of significant assumptions with regard to the current market rental rates, rental growth rates, capitalization and discount rates, interest rates and other variables. The use of alternative estimates may result in a different allocation of the Company’s purchase price, which could materially impact the Company’s results of operations.
In April 2017, the Company elected to early adopt ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”), which clarifies the definition of a business by adding guidance to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Beginning in April 2017, all real estate acquisitions qualified as asset acquisitions, and as such, acquisition-related fees and certain acquisition-related expenses related to these asset acquisitions were capitalized and allocated to tangible and intangible assets and liabilities, as described above. Prior to the adoption of ASU 2017-01 in April 2017, all of the Company’s real estate acquisitions were accounted for as business combinations and, as such, acquisition-related expenses related to these business combination acquisitions were expensed as incurred. Prior to April 2017, acquisition-related expenses in the Company’s
10
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
condensed consolidated statements of operations primarily consisted of legal, deed transfer and other costs related to real estate purchase transactions, including costs incurred for deals that were not consummated.
Development Activities
Project costs and expenses, including interest incurred, associated with the development, construction and lease-up of a real estate project are capitalized as construction in progress. Once the development and construction of the building is substantially completed, the amounts capitalized to construction in progress are transferred to (i) land and (ii) buildings and improvements, and are depreciated over their respective useful lives. During the nine months ended September 30, 2018 and 2017, the Company capitalized $51,000 and $160,000, respectively, of interest expense associated with development projects.
Restricted Cash
The Company had $1.5 million and $1.4 million in restricted cash as of September 30, 2018 and December 31, 2017, respectively. Included in restricted cash was $1.3 million and $1.2 million held by lenders in lockbox accounts as of September 30, 2018 and December 31, 2017, respectively. As part of certain debt agreements, rents from certain encumbered properties are deposited directly into a lockbox account, from which the monthly debt service payment is disbursed to the lender and the excess is disbursed to the Company. Restricted cash also included $201,000 and $165,000 held by a lender in an escrow account for a certain property in accordance with the associated loan agreement as of September 30, 2018 and December 31, 2017, respectively.
Revenue Recognition
Certain properties have leases where the minimum rental payment increases during the term of the lease. The Company records rental income for the full term of each lease on a straight-line basis when earned and collectability is reasonably assured. When the Company acquires a property, the terms of existing leases are considered to commence as of the acquisition date for the purpose of this calculation. The Company defers the recognition of contingent rental income, such as percentage rents, until the specific target that triggers the contingent rental income is achieved. Expected reimbursements from tenants for recoverable real estate taxes and operating expenses are included in tenant reimbursement income in the period when such costs are incurred. Effective January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which supersedes the revenue recognition requirements in Revenue Recognition, Accounting Standards Codification (“ASC”) Topic 605 and requires an entity to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company records revenue for real estate taxes and insurance reimbursed by its tenants on the leased properties, with offsetting expenses in real estate taxes and property operating expenses, respectively, within the condensed consolidated statements of operations as the Company has concluded it is the primary obligor. The Company has identified its revenue streams as rental income from leasing arrangements and tenant reimbursement income, which are outside of the scope of Topic 606. The Company adopted ASU 2014-09 using the modified retrospective approach and determined it did not have a material impact on the Company’s condensed consolidated financial statements.
The Company continually reviews receivables related to rent, including any straight-line rent, and current and future operating expense reimbursements from tenants, and determines their collectability by taking into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of a receivable is uncertain, the Company will record an increase in the allowance for uncollectible accounts. As of September 30, 2018 and December 31, 2017, the Company did not have an allowance for uncollectible accounts.
Earnings (Loss) and Distributions Per Share
The Company has two classes of common stock. Accordingly, the Company utilizes the two-class method to determine its earnings per share, which can result in different earnings per share for each of the classes. Under the two-class method, earnings per share of each class of common stock are computed by dividing the sum of the distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of shares for each class of common stock for the respective period. The distributed earnings to Class T Share common stockholders represents distributions declared less the distribution and stockholder servicing fees. Diluted income per share, when applicable, considers the effect of any potentially dilutive share equivalents, of which the Company had none for each of the three and nine months ended September 30, 2018 and 2017. Distributions per share are calculated based on the authorized daily distribution rate.
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
Recent Accounting Pronouncements
From time to time, new accounting pronouncements are issued by various standard setting bodies that may have an impact on the Company’s accounting and reporting. Except as otherwise stated below, the Company is currently evaluating the effect that certain new accounting requirements may have on the Company’s accounting and related reporting and disclosures in the Company’s condensed consolidated financial statements.
In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). The amendments in this update require that most lease obligations be recognized as a right of use asset with a corresponding liability on the balance sheet. The guidance also requires additional qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases. ASU 2016-02 and subsequent amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The guidance, including optional practical expedients, should be implemented for the earliest period presented using a modified retrospective approach. The Company is currently in the process of finalizing its assessment of its inventory of leases that will be impacted by adoption of the new guidance. The Company does not expect the adoption to have a material impact on the accounting treatment of the Company’s net leases, which are the primary source of the Company’s revenues.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). The targeted amendments in this ASU are designed to help simplify certain aspects of hedge accounting and result in a more accurate portrayal of the economics of an entity’s risk management activities in its financial statements. ASU 2017-12 applies to the Company’s interest rate swaps designated as cash flow hedges. ASU 2017-12 requires all changes in the fair value of highly effective cash flow hedges to be recorded in accumulated other comprehensive income. Under current GAAP, the ineffective portion of the change in fair value of cash flow hedges is recognized directly in earnings. This eliminates the requirement to separately measure and disclose ineffectiveness for qualifying cash flow hedges. ASU 2017-12 is effective for public entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. ASU 2017-12 is required to be adopted using a modified retrospective approach with early adoption permitted. The Company early adopted ASU 2017-12 during the first quarter of fiscal year 2018 and determined there was no material impact on the Company’s condensed consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). This ASU amends and removes several disclosure requirements including the valuation processes for Level 3 fair value measurements. ASU 2018-13 also modifies some disclosure requirements and requires additional disclosures for changes in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements and requires the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The provisions of ASU 2018-13 are effective January 1, 2020 using a prospective transition method for amendments effecting changes in unrealized gains and losses, significant unobservable inputs used to develop Level 3 fair value measurements and narrative description on uncertainty of measurements. The remaining provisions of the ASU are to be applied retrospectively, and early adoption is permitted. The Company is evaluating the impact of this ASU's adoption, and does not believe this ASU will have a material impact on its condensed consolidated financial statements.
NOTE 3 — FAIR VALUE MEASUREMENTS
GAAP defines fair value, establishes a framework for measuring fair value and requires disclosures about fair value measurements. GAAP emphasizes that fair value is intended to be a market-based measurement, as opposed to a transaction-specific measurement.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. Depending on the nature of the asset or liability, various techniques and assumptions can be used to estimate the fair value. Assets and liabilities are measured using inputs from three levels of the fair value hierarchy, as follows:
Level 1 — Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 — Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).
Level 3 — Unobservable inputs, which are only used to the extent that observable inputs are not available, reflect the Company’s assumptions about the pricing of an asset or liability.
The following describes the methods the Company uses to estimate the fair value of the Company’s financial assets and liabilities:
Credit facility and notes payable — The fair value is estimated by discounting the expected cash flows based on estimated borrowing rates available to the Company as of the measurement date. Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs. These financial instruments are valued using Level 2 inputs. As of September 30, 2018, the estimated fair value of the Company’s debt was $599.5 million, compared to a carrying value of $601.0 million. The estimated fair value of the Company’s debt was $603.0 million as of December 31, 2017, compared to a carrying value on that date of $601.5 million.
Derivative instruments — The Company’s derivative instruments are comprised of interest rate swaps. All derivative instruments are carried at fair value and are valued using Level 2 inputs. The fair value of these instruments is determined using interest rate market pricing models. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the respective counterparties.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and its counterparties. However, as of September 30, 2018 and December 31, 2017, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Other financial instruments — The Company considers the carrying values of its cash and cash equivalents, restricted cash, tenant receivables, accounts payable and accrued expenses, other liabilities, due to affiliates and distributions payable to approximate their fair values because of the short period of time between their origination and their expected realization as well as their highly-liquid nature. Due to the short-term maturities of these instruments, Level 1 inputs are utilized to estimate the fair value of these financial instruments.
Considerable judgment is necessary to develop estimated fair values of financial assets and liabilities. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize, or be liable for, upon disposition of the financial assets and liabilities. As of September 30, 2018 and December 31, 2017, there have been no transfers of financial assets or liabilities between fair value hierarchy levels.
In accordance with the fair value hierarchy described above, the following tables show the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis as of September 30, 2018 and as of December 31, 2017 (in thousands):
Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||
Balance as of | ||||||||||||||||
September 30, 2018 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Financial assets: | ||||||||||||||||
Interest rate swaps | $ | 4,162 | $ | — | $ | 4,162 | $ | — | ||||||||
Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||
Balance as of | ||||||||||||||||
December 31, 2017 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Financial assets: | ||||||||||||||||
Interest rate swaps | $ | 2,942 | $ | — | $ | 2,942 | $ | — | ||||||||
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
NOTE 4 — REAL ESTATE ASSETS
2018 Property Acquisitions
During the nine months ended September 30, 2018, the Company did not acquire any properties.
2018 Development Project
During the nine months ended September 30, 2018, the Company acquired one land parcel, upon which a 120,000 square foot expansion of an existing property is being constructed. The land was acquired for an aggregate cost of $1.4 million and is included in land on the accompanying condensed consolidated balance sheet.
As of September 30, 2018, the Company had $5.7 million in construction in progress included in buildings and improvements on the accompanying condensed consolidated balance sheet. During the nine months ended September 30, 2018, amounts capitalized to construction in progress consisted of $5.6 million of capitalized expenses and $51,000 of capitalized interest associated with the expansion. As of September 30, 2018, the Company has committed to invest an additional estimated $2.4 million related to the development project.
2017 Property Acquisitions
During the nine months ended September 30, 2017, the Company acquired three properties for an aggregate purchase price of $93.5 million (the “2017 Acquisitions”). The 2017 Acquisitions were all acquired prior to the adoption of ASU 2017-01 in April 2017 and thus were accounted for as business combinations. The Company funded the 2017 Acquisitions with net proceeds from the Offerings and available borrowings. The Company allocated the purchase price of these properties to the fair value of the assets acquired. The following table summarizes the purchase price allocations for the 2017 Acquisitions (in thousands):
2017 Acquisitions | |||
Land | $ | 9,807 | |
Buildings and improvements | 73,379 | ||
Acquired in-place leases and other intangibles (1) | 10,279 | ||
Total purchase price | $ | 93,465 | |
(1) | The weighted average amortization period for acquired in-place leases and other intangibles was 14.1 years for the 2017 Acquisitions. |
The Company recorded revenue for the three and nine months ended September 30, 2017 of $2.3 million and $5.3 million, respectively, and net income of $1.1 million and $451,000 for the three and nine months ended September 30, 2017, respectively, related to the 2017 Acquisitions.
The following table summarizes selected financial information of the Company as if all of the 2017 Acquisitions were completed on January 1, 2016 for each period presented below. The table below presents the Company’s estimated revenue and net income, on a pro forma basis, for the three and nine months ended September 30, 2017 and 2016, respectively (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||
Pro forma basis (unaudited): | |||||||||||||||
Revenue | $ | 26,796 | $ | 24,318 | $ | 78,172 | $ | 69,339 | |||||||
Net income | $ | 4,052 | $ | 2,190 | $ | 9,352 | $ | 1,087 | |||||||
The unaudited pro forma information for the nine months ended September 30, 2017 was adjusted to exclude $2.1 million of acquisition-related fees and expenses recorded during such period related to the 2017 Acquisitions. Accordingly, these costs were instead recognized in the pro forma information for the nine months ended September 30, 2016.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
The unaudited pro forma information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the transactions occurred at the beginning of the period, nor does it purport to represent the results of future operations.
2017 Development Project
During the nine months ended September 30, 2017, the Company capitalized expenses of $10.3 million as construction in progress associated with the expansion of an existing property. When the development project was substantially complete in September 2017, the amounts capitalized to construction in progress during the construction period were transferred to buildings and improvements and began depreciating over their respective useful lives.
NOTE 5 — INTANGIBLE LEASE ASSETS
Intangible lease assets as of September 30, 2018 and December 31, 2017 consisted of the following (in thousands, except weighted average life):
September 30, 2018 | December 31, 2017 | ||||||
In-place leases and other intangibles, net of accumulated amortization of $35,745 and $27,932, respectively (with a weighted average life remaining of 9.0 years and 9.7 years, respectively) | |||||||
$ | 87,658 | $ | 95,459 | ||||
Acquired above-market leases, net of accumulated amortization of $484 and $391, respectively (with a weighted average life remaining of 8.6 years and 9.3 years, respectively) | |||||||
1,078 | 1,170 | ||||||
$ | 88,736 | $ | 96,629 | ||||
Amortization of the above-market leases is recorded as a reduction to rental revenue, and amortization expense for the in-place leases and other intangibles is included in depreciation and amortization in the accompanying condensed consolidated statements of operations. The following table summarizes the amortization expense related to the intangible lease assets for the three and nine months ended September 30, 2018 and 2017 (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||
In-place lease and other intangible amortization | $ | 2,605 | $ | 2,653 | $ | 7,813 | $ | 7,828 | |||||||
Above-market lease amortization | $ | 31 | $ | 31 | $ | 93 | $ | 93 | |||||||
As of September 30, 2018, the estimated amortization expense relating to the intangible lease assets is as follows (in thousands):
Amortization Expense | ||||||||
In-Place Leases and Other Intangibles | Above-Market Leases | |||||||
Remainder of 2018 | $ | 2,604 | $ | 31 | ||||
2019 | $ | 10,417 | $ | 125 | ||||
2020 | $ | 10,417 | $ | 125 | ||||
2021 | $ | 10,417 | $ | 125 | ||||
2022 | $ | 10,417 | $ | 125 | ||||
NOTE 6 — DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In the normal course of business, the Company uses certain types of derivative instruments for the purpose of managing or hedging its interest rate risk. The Company did not enter into any interest rate swap agreements during the nine months ended September 30, 2018. As of September 30, 2018, the Company had three interest rate swap agreements.
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
The following table summarizes the terms of the Company’s executed interest rate swap agreements designated as hedging instruments as of September 30, 2018 and December 31, 2017 (dollar amounts in thousands):
Outstanding Notional Amount as of | Interest Rate (1) | Effective Date | Maturity Date | Fair Value of Assets as of | |||||||||||||||
Balance Sheet Location | September 30, 2018 | September 30, 2018 | December 31, 2017 | ||||||||||||||||
Interest Rate Swaps | Derivative assets, prepaid expenses and other assets | $ | 254,070 | 3.29% to 3.35% | 2/10/2015 to 3/19/2015 | 12/12/2019 to 4/1/2020 | $ | 4,162 | $ | 2,942 | |||||||||
(1) The interest rates consist of the underlying index swapped to a fixed rate and the applicable interest rate spread as of September 30, 2018.
Additional disclosures related to the fair value of the Company’s derivative instruments are included in Note 3 — Fair Value Measurements. The notional amount under the interest rate swap agreements is an indication of the extent of the Company’s involvement in each instrument, but does not represent exposure to credit, interest rate or market risks.
Accounting for changes in the fair value of a derivative instrument depends on the intended use and designation of the derivative instrument. The Company designated the interest rate swaps as cash flow hedges in order to hedge the variability of the anticipated cash flows on its variable rate debt. The change in fair value of the derivative instruments that are designated as hedges is recorded in other comprehensive income, with a portion of the amount subsequently reclassified to interest expense as interest payments are made on the Company’s variable rate debt. For the three months ended September 30, 2018 and 2017, the amounts reclassified were a gain of $480,000 and a loss of $91,000, respectively, and for the nine months ended September 30, 2018 and 2017, the amounts reclassified were a gain of $996,000 and a loss of $676,000, respectively. During the next 12 months, the Company estimates that an additional $3.2 million will be reclassified from other comprehensive income as a decrease to interest expense. The Company classifies cash flows from interest rate swap agreements as net cash provided by operating activities on the condensed consolidated statements of cash flows, as the Company’s accounting policy is to present cash flows from hedging instruments in the same category in the condensed consolidated statements of cash flows as the category for cash flows from hedged items.
The Company has agreements with each of its derivative counterparties that contain provisions whereby, if the Company defaults on certain of its unsecured indebtedness, the Company could also be declared in default on its derivative obligations, resulting in an acceleration of payment. If the Company breaches any of these provisions, it could be required to settle its obligations under these agreements at the aggregate termination value of the derivative instruments, inclusive of interest payments and accrued interest. As of September 30, 2018, all derivative instruments were in an asset position. Therefore, there was no termination value as of September 30, 2018. In addition, the Company is exposed to credit risk in the event of non-performance by its derivative counterparties. The Company believes it mitigates its credit risk by entering into agreements with creditworthy counterparties. The Company records credit risk valuation adjustments on its interest rate swaps based on the credit quality of the Company and the respective counterparty. There were no termination events or events of default related to the interest rate swaps as of September 30, 2018.
NOTE 7 — CREDIT FACILITY AND NOTES PAYABLE
As of September 30, 2018, the Company had $599.7 million of debt outstanding, including net deferred financing costs, with a weighted average interest rate of 3.8% and weighted average years to maturity of 1.7 years. The weighted average years to maturity is computed using the scheduled repayment date as specified in each loan agreement where applicable. The weighted average interest rate is computed using the interest rate in effect until the scheduled repayment date. Should a loan not be repaid by its scheduled repayment date, the applicable interest rate will increase as specified in the respective loan agreement until the extended maturity date.
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
The following table summarizes the debt balances as of September 30, 2018 and December 31, 2017 and the debt activity for the nine months ended September 30, 2018 (in thousands):
During the Nine Months Ended September 30, 2018 | ||||||||||||||||||||
Balance as of December 31, 2017 | Debt Issuance, Net | Repayments | Accretion | Balance as of September 30, 2018 | ||||||||||||||||
Fixed rate debt | $ | 295,545 | $ | — | $ | — | $ | — | $ | 295,545 | ||||||||||
Credit facility | 306,000 | 28,000 | (28,500 | ) | — | 305,500 | ||||||||||||||
Total debt | 601,545 | 28,000 | (28,500 | ) | — | 601,045 | ||||||||||||||
Deferred costs (1) | (1,774 | ) | — | — | 465 | (1,309 | ) | |||||||||||||
Total debt, net | $ | 599,771 | $ | 28,000 | $ | (28,500 | ) | $ | 465 | $ | 599,736 | |||||||||
______________________
(1) | Deferred costs relate to mortgage notes payable and the term portion of the Credit Facility, as defined below. |
As of September 30, 2018, the fixed rate debt outstanding of $295.5 million included $54.1 million of variable rate debt that is fixed through interest rate swap agreements, which has the effect of fixing the variable interest rate per annum through the maturity date of the variable rate debt. The fixed rate debt has interest rates ranging from 3.3% to 4.8% per annum and matures on various dates from March 2020 to October 2023. As of September 30, 2018, the fixed rate debt had a weighted average interest rate of 4.1%. The aggregate balance of gross real estate assets, net of gross intangible lease liabilities, securing the fixed rate debt was $488.5 million as of September 30, 2018. Each of the mortgage notes payable, comprising the fixed rate debt, is secured by the respective properties on which the debt was placed.
The Company has an amended, unsecured credit facility (the “Credit Facility”) with JPMorgan Chase Bank, N.A. (“JPMorgan Chase”), as administrative agent, and the lenders under the credit agreement (the “Credit Agreement”), that provides for borrowings of up to $400.0 million, which includes a $200.0 million unsecured term loan (the “Term Loan”) and up to $200.0 million in unsecured revolving loans (the “Revolving Loans”). The Revolving Loans are due to mature on December 12, 2018; however, the Company expects to extend the maturity date of such loans to December 12, 2019, subject to satisfying certain conditions described in the Credit Agreement. These conditions include providing notice of the election and paying an extension fee of 0.2% of the maximum amount of the Revolving Loans. The Term Loan matures on December 12, 2019.
Depending upon the type of loan specified and overall leverage ratio, the Credit Facility bears interest at (i) the one-month, two-month, three-month or six-month London Interbank Offered Rate (“LIBOR”), multiplied by the statutory reserve rate (the “Eurodollar Rate”), plus an interest rate spread ranging from 1.60% to 2.20%, or (ii) a base rate, ranging from 0.60% to 1.20%, plus the greater of: (a) JPMorgan Chase’s Prime Rate; (b) the Federal Funds Effective Rate (as defined in the Credit Agreement) plus 0.50%; or (c) the one-month LIBOR multiplied by the statutory reserve rate plus 1.00%. As of September 30, 2018, the amount outstanding under the Revolving Loans totaled $105.5 million at a weighted average interest rate of 4.2%, and the amount outstanding under the Term Loan totaled $200.0 million, all of which was subject to an interest rate swap agreement (the “Swapped Term Loan”). The interest rate swap agreement had the effect of fixing the Eurodollar Rate per annum of the Swapped Term Loan. As of September 30, 2018, the all-in rate for the Swapped Term Loan was 3.3%. The Company had $89.6 million in unused capacity, subject to borrowing availability, as of September 30, 2018.
The Credit Agreement contains provisions with respect to covenants, events of default and remedies customary for facilities of this nature. In particular, the Credit Agreement requires the Company to maintain a minimum consolidated net worth greater than or equal to the sum of (i) $194.0 million plus (ii) 75% of the equity issued from the date of the Credit Agreement, a leverage ratio less than or equal to 60%, a fixed charge coverage ratio equal to or greater than 1.50, an unsecured debt to unencumbered asset value ratio equal to or less than 60%, an unsecured debt service coverage ratio greater than 1.75, a secured debt ratio equal to or less than 40%, and recourse debt at less than or equal to 15% of total asset value. The Company believes it was in compliance with the financial covenants under the Credit Agreement, as well as the financial covenants under the Company’s various fixed and variable rate debt agreements as of September 30, 2018.
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
Maturities
The following table summarizes the scheduled aggregate principal repayments for the Company’s outstanding debt subsequent to September 30, 2018 (in thousands):
Principal Repayments | ||||
Remainder of 2018 | $ | 105,500 | ||
2019 | 200,000 | |||
2020 | 203,465 | |||
2021 | 35,100 | |||
2022 | — | |||
Thereafter | 56,980 | |||
Total | $ | 601,045 | ||
NOTE 8 — INTANGIBLE LEASE LIABILITIES
Intangible lease liabilities consisted of the following (in thousands, except weighted average life remaining amounts):
September 30, 2018 | December 31, 2017 | ||||||
Acquired below-market leases, net of accumulated amortization of $7,052 and $5,317, respectively (with a weighted average life remaining of 9.7 years and 10.5 years, respectively) | |||||||
$ | 22,048 | $ | 23,783 | ||||
Amortization of below-market leases is recorded as an increase to rental revenue in the accompanying condensed consolidated statements of operations. The following table summarizes the amortization related to the intangible lease liabilities for the three and nine months ended September 30, 2018 and September 30, 2017 (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||
Below-market lease amortization | $ | 579 | $ | 578 | $ | 1,735 | $ | 1,750 | |||||||
Estimated amortization of the intangible lease liabilities as of September 30, 2018 is as follows (in thousands):
Amortization of | ||||
Below-Market Leases | ||||
Remainder of 2018 | $ | 578 | ||
2019 | $ | 2,314 | ||
2020 | $ | 2,314 | ||
2021 | $ | 2,314 | ||
2022 | $ | 2,314 | ||
NOTE 9 — COMMITMENTS AND CONTINGENCIES
Litigation
In the ordinary course of business, the Company may become subject to litigation and claims. The Company is not aware of any material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company is a party or of which the Company’s properties are the subject.
Environmental Matters
In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. In addition, the Company may own or acquire certain properties that are subject to environmental remediation. Generally, the seller of the property, the tenant of the property and/or another third party is responsible for environmental remediation costs related to a property. Additionally, in connection with the purchase of certain properties, the respective sellers and/or tenants may agree to indemnify the Company against future remediation costs. The
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
Company also carries environmental liability insurance on its properties that provides limited coverage for any remediation liability and/or pollution liability for third-party bodily injury and/or property damage claims for which the Company may be liable. The Company is not aware of any environmental matters which it believes are reasonably likely to have a material effect on its results of operations, financial condition or liquidity.
NOTE 10 — RELATED-PARTY TRANSACTIONS AND ARRANGEMENTS
The Company has incurred fees and expenses payable to CCI II Advisors and certain of its affiliates in connection with the Offering and the acquisition, management and disposition of its assets.
Distribution and stockholder servicing fees
The Company pays CCO Capital a distribution and stockholder servicing fee for Class T Shares that is calculated on a daily basis in the amount of 1/365th of 0.8% of the per share NAV of the Class T Shares that were sold in the primary portion of the Offering. The distribution and stockholder servicing fee is paid monthly in arrears from cash flow from operations or, if the Company’s cash flow from operations is not sufficient to pay the distribution and stockholder servicing fee, from borrowings in anticipation of future cash flow. An estimated liability for future distribution and stockholder servicing fees payable to CCO Capital was recognized at the time each Class T Share was sold and included in due to affiliates in the condensed consolidated balance sheets with a corresponding decrease to capital in excess of par value. The Company will cease paying the distribution and stockholder servicing fee with respect to Class T Shares at the earliest of (i) the end of the month in which the transfer agent, on behalf of the Company, determines that total selling commissions and distribution and stockholder servicing fees paid by a stockholder within his or her individual account would be equal to 7.0% of the stockholder’s total gross investment amount at the time of the purchase of the primary Class T Shares held in such account; (ii) the date on which the aggregate underwriting compensation from all sources equals 10.0% of the gross proceeds from the sale of the Company’s shares in the Offering, excluding shares sold pursuant to the DRIP portion of the Offering; (iii) the fifth anniversary of the last day of the month in which the Offering (excluding the offering of shares pursuant to the DRIP portion of the Offering) terminates; (iv) the date such Class T Share is no longer outstanding; and (v) the date the Company effects a liquidity event. CCO Capital may, in its discretion, reallow to participating broker-dealers all or a portion of the distribution and stockholder servicing fee for services that such participating broker-dealers perform. No distribution and stockholder servicing fees are paid to CCO Capital or other participating broker-dealers with respect to shares sold pursuant to the DRIP portion of the Offering or the DRIP Offering.
Acquisition fees and expenses
The Company pays CCI II Advisors or its affiliates acquisition fees of up to 2.0% of: (i) the contract purchase price of each property or asset the Company acquires; (ii) the amount paid in respect of the development, construction or improvement of each asset the Company acquires; (iii) the purchase price of any loan the Company acquires; and (iv) the principal amount of any loan the Company originates. In addition, the Company reimburses CCI II Advisors or its affiliates for acquisition-related expenses incurred in the process of acquiring a property or the origination or acquisition of a loan, so long as the total acquisition fees and expenses relating to the transaction do not exceed 6.0% of the contract purchase price, unless otherwise approved by a majority of the Board, including a majority of the Company’s independent directors, as commercially competitive, fair and reasonable to the Company.
Advisory fees and expenses
The Company pays CCI II Advisors a monthly advisory fee based upon the Company’s monthly average invested assets, which, for those assets acquired prior to January 1, 2018, is based on the estimated market value of such assets used to determine the Company’s estimated per share NAV as of December 31, 2017, as discussed in Note 1 — Organization and Business, and for those assets acquired subsequent to December 31, 2017, is based on the purchase price. The monthly advisory fee is equal to the following amounts: (i) an annualized rate of 0.75% paid on the Company’s average invested assets that are between $0 and $2.0 billion; (ii) an annualized rate of 0.70% paid on the Company’s average invested assets that are between $2.0 billion and $4.0 billion; and (iii) an annualized rate of 0.65% paid on the Company’s average invested assets that are over $4.0 billion.
Operating expenses
The Company reimburses CCI II Advisors or its affiliates for the operating expenses they paid or incurred in connection with the services provided to the Company, subject to the limitation that the Company will not reimburse CCI II Advisors or its affiliates for any amount by which the operating expenses (including the advisory fee) at the end of the four preceding fiscal
19
COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
quarters exceed the greater of (i) 2.0% of average invested assets, or (ii) 25.0% of net income, excluding any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of assets for that period. The Company will not reimburse CCI II Advisors or its affiliates for the salaries and benefits paid to personnel in connection with the services for which CCI II Advisors or its affiliates receive acquisition fees, and the Company will not reimburse CCI II Advisors for salaries and benefits paid to the Company’s executive officers.
Disposition fees
If CCI II Advisors or its affiliates provide a substantial amount of services (as determined by a majority of the Company’s independent directors) in connection with the sale of one or more properties (or the Company’s entire portfolio), the Company will pay CCI II Advisors or its affiliates a disposition fee in an amount equal to up to one-half of the real estate or brokerage commission paid by the Company to third parties on the sale of such property, not to exceed 1.0% of the contract price of the property sold; provided, however, in no event may the total disposition fees paid to CCI II Advisors, its affiliates, and unaffiliated third parties, exceed the lesser of the customary competitive real estate commission or an amount equal to 6.0% of the contract sales price. In addition, if CCI II Advisors or its affiliates provides a substantial amount of services (as determined by a majority of the Company’s independent directors) in connection with the sale of one or more assets other than properties, the Company may separately compensate CCI II Advisors or its affiliates at such rates and in such amounts as the Board, including a majority of the Company’s independent directors, and CCI II Advisors agree upon, not to exceed an amount equal to 1.0% of the contract price of the assets sold. During the three and nine months ended September 30, 2018 and 2017, no disposition fees were incurred for any such services provided by CCI II Advisors or its affiliates.
Subordinated performance fees
If the Company is sold or its assets are liquidated, CCI II Advisors will be entitled to receive a subordinated performance fee equal to 15.0% of the net sale proceeds remaining after stockholders have received, from regular distributions plus special distributions paid from proceeds of such sale, a return of their net capital invested and an 8.0% annual cumulative, non-compounded return. Alternatively, if the Company’s shares are listed on a national securities exchange, CCI II Advisors will be entitled to a subordinated performance fee equal to 15.0% of the amount by which the market value of the Company’s outstanding stock plus all distributions paid by the Company prior to listing exceeds the sum of the total amount of capital raised from stockholders and the amount of distributions necessary to generate an 8.0% annual cumulative, non-compounded return to stockholders. As an additional alternative, upon termination of the advisory agreement, CCI II Advisors may be entitled to a subordinated performance fee similar to the fee to which it would have been entitled had the portfolio been liquidated (based on an independent appraised value of the portfolio) on the date of termination. During the three and nine months ended September 30, 2018 and 2017, no subordinated performance fees were incurred related to any such events.
The Company incurred fees and expense reimbursements as shown in the table below for services provided by CCI II Advisors and its affiliates related to the services described above during the periods indicated (in thousands):
______________________
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||
Distribution and stockholder servicing fees (1) | $ | 51 | $ | 49 | $ | 150 | $ | 147 | |||||||
Acquisition fees and expenses | $ | 4 | $ | 204 | $ | 89 | $ | 2,201 | |||||||
Advisory fees and expenses | $ | 2,599 | $ | 2,620 | $ | 7,907 | $ | 7,682 | |||||||
Operating expenses | $ | 379 | $ | 351 | $ | 1,128 | $ | 1,181 | |||||||
(1) | Amounts are calculated for the respective period in accordance with the dealer manager agreement and exclude the estimated liability for future distribution and stockholder servicing fees payable to CCO Capital of $592,000, which is included in due to affiliates in the condensed consolidated balance sheets with a corresponding decrease to capital in excess of par value. |
Services Agreement
Pursuant to the Services Agreement, VEREIT OP, which is affiliated with one of the Company’s directors, is obligated to provide certain services to CCO Group and to the Company, including operational real estate support. The Company is not a party to the Services Agreement. See Note 11 — Economic Dependency for a discussion of the Services Agreement.
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
Due to Affiliates
As of September 30, 2018 and December 31, 2017, $1.2 million and $1.3 million, respectively, was recorded for services and expenses incurred, but not yet reimbursed to, CCI II Advisors or its affiliates. These amounts are primarily for advisory fees and operating fees and expenses and distribution and stockholder servicing fees payable to CCO Capital. These amounts were included in due to affiliates in the condensed consolidated balance sheets for such periods.
NOTE 11 — ECONOMIC DEPENDENCY
Under various agreements, the Company has engaged and may in the future engage CCI II Advisors or its affiliates to provide certain services that are essential to the Company, including asset management services, supervision of the management and leasing of properties owned by the Company, asset acquisition and disposition decisions, as well as other administrative responsibilities for the Company including accounting services and stockholder relations. As a result of these relationships, the Company is dependent upon CCI II Advisors or its affiliates. In the event that these companies are unable to provide the Company with these services, the Company would be required to find alternative providers of these services.
Services Agreement
Pursuant to the Services Agreement, VEREIT OP is obligated to provide certain services to CCO Group and to the Company, including operational real estate support. VEREIT OP is obligated to provide such services through March 31, 2019 (or, if later, the date of the last government filing other than a tax filing made by any of the Cole REITs with respect to its 2018 fiscal year) and is obligated to provide consulting and research services through December 31, 2023 as requested by CCO Group, LLC.
Despite the indirect change of ownership and control of the Company’s advisor, dealer manager, property manager and sponsor, the Company expects that, during the Initial Services Term of the Services Agreement, the advisory, dealer manager and property management services the Company receives will continue without any material changes in personnel (except as supplemented by the management oversight of CIM personnel) or material change in service procedures. During the Initial Services Term of the Services Agreement, CCO Group, LLC intends to evaluate and effectuate an appropriate transition of VEREIT OP’s services under the Services Agreement to other CIM affiliates or third parties with the goal of ensuring continuity and minimizing disruption.
NOTE 12 — OPERATING LEASES
The Company’s real estate properties are leased to tenants under operating leases for which the terms and expirations vary. As of September 30, 2018, the leases had a weighted-average remaining term of 9.5 years. Certain leases include provisions to extend the lease agreements, options for early termination after paying a specified penalty, rights of first refusal to purchase the property at competitive market rates, and other terms and conditions as negotiated. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants.
The future minimum rental income from the Company’s real estate assets under non-cancelable operating leases, assuming no exercise of renewal options, as of September 30, 2018, was as follows (in thousands):
Future Minimum Rental Income | ||||
Remainder of 2018 | $ | 22,093 | ||
2019 | 87,856 | |||
2020 | 89,374 | |||
2021 | 90,586 | |||
2022 | 92,264 | |||
Thereafter | 500,457 | |||
Total | $ | 882,630 | ||
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COLE OFFICE & INDUSTRIAL REIT (CCIT II), INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (Unaudited) - (Continued)
NOTE 13 — SUBSEQUENT EVENTS
The following events occurred subsequent to September 30, 2018.
Redemption of Shares of Common Stock
Subsequent to September 30, 2018, the Company redeemed approximately 502,000 shares for $5.3 million at an average per share price of $10.54 pursuant to the Company’s share redemption program. Management, in its discretion, limited the amount of shares redeemed for the three months ended September 30, 2018 to an amount equal to the net proceeds the Company received from the sale of shares pursuant to the DRIP Offering during the period. The remaining redemption requests received during the three months ended September 30, 2018, totaling approximately 887,000 shares, went unfulfilled.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis should be read in conjunction with the accompanying condensed consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. Certain risks may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a complete discussion of such risk factors, see Item 1A — Risk Factors of this Quarterly Report on Form 10-Q and the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. Capitalized terms used herein, but not otherwise defined, shall have the meaning ascribed to those terms in “Part I — Financial Information” of this Quarterly Report on Form 10-Q, including the notes to the condensed consolidated financial statements contained therein, and the terms “we,” “us,” “our” and the “Company” refer to Cole Office & Industrial REIT (CCIT II), Inc.
Forward-Looking Statements
This Quarterly Report on Form 10-Q includes “forward-looking statements” (within the meaning of the federal securities laws, Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that reflect our expectations and projections about our future results, performance, prospects and opportunities. We have attempted to identify these forward-looking statements by the use of words such as “may,” “will,” “seek,” “expects,” “anticipates,” “believes,” “targets,” “intends,” “should,” “estimates,” “could,” “continue,” “assume,” “projects,” “plans” or similar expressions. These forward-looking statements are based on information currently available to us and are subject to a number of known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. These factors include, among other things, those discussed below. We intend for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act, as applicable by law. We do not undertake to publicly update or revise any forward-looking statements, whether as a result of changes in underlying assumptions or new information, future events or otherwise, except as may be required to satisfy our obligations under federal securities law. The forward-looking statements should be read in light of the risk factors identified in Item 1A — Risk Factors of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2017.
The following are some, but not all, of the assumptions, risks, uncertainties and other factors that could cause our actual results to differ materially from those presented in our forward-looking statements:
• | We may be unable to renew leases, lease vacant space or re-lease space as leases expire on favorable terms or at all. |
• | We are subject to risks associated with tenant, geographic and industry concentrations with respect to our properties. |
• | Our properties, intangible assets and other assets may be subject to impairment charges. |
• | We could be subject to unexpected costs or unexpected liabilities that may arise from potential dispositions of properties. |
• | We are subject to competition in the acquisition and disposition of properties and in the leasing of our properties and we may be unable to acquire, dispose of, or lease properties on advantageous terms. |
• | We could be subject to risks associated with bankruptcies or insolvencies of tenants or from tenant defaults generally. |
• | We have substantial indebtedness, which may affect our ability to pay distributions, and expose us to interest rate fluctuation risk and the risk of default under our debt obligations. |
• | We may be affected by the incurrence of additional secured or unsecured debt. |
• | We may not be able to maintain profitability. |
• | We may not generate cash flows sufficient to pay our distributions to stockholders or meet our debt service obligations. |
• | We may be affected by risks resulting from losses in excess of insured limits. |
• | We may fail to remain qualified as a REIT for U.S. federal income tax purposes. |
• | Our advisor has the right to terminate the advisory agreement upon 60 days’ written notice without cause or penalty. |
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Definitions
We use certain defined terms throughout this Quarterly Report on Form 10-Q that have the following meanings:
The phrase “annualized rental income” refers to the straight-line rental revenue under our leases on operating properties owned as of the respective reporting date, which includes the effect of rent escalations and any tenant concessions, such as free rent, and excludes any bad debt allowances and any contingent rent, such as percentage rent. Management uses annualized rental income as a basis for tenant, industry and geographic concentrations and other metrics within the portfolio. Annualized rental income is not indicative of future performance.
Under a “net lease,” the tenant occupying the leased property (usually as a single tenant) does so in much the same manner as if the tenant were the owner of the property. The tenant generally agrees that it will either have no ability or only limited ability to terminate the lease or abate rent prior to the expiration of the term of the lease as a result of real estate driven events such as casualty, condemnation or failure by the landlord to fulfill its obligations under the lease. There are various forms of net leases, most typically classified as either triple-net or double-net. Triple-net leases typically require the tenant to pay all expenses associated with the property (e.g., real estate taxes, insurance, maintenance and repairs, including roof, structure and parking lot). Double-net leases typically hold the landlord responsible for the capital expenditures for the roof and structure, while the tenant is responsible for all lease payments and remaining operating expenses associated with the property (e.g., real estate taxes, insurance and maintenance).
Overview
We were formed on February 26, 2013, and we elected to be taxed, and currently qualify, as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2014. We commenced principal operations on January 13, 2014 when we satisfied the minimum offering conditions of our escrow agreement and issued approximately 275,000 shares of our common stock in the Offering. We have no paid employees and are externally advised and managed by CCI II Advisors. On February 1, 2018, the Transaction, as discussed in Note 1 — Organization and Business to our condensed consolidated financial statements in this Quarterly Report on Form 10-Q, was completed. As a result of the Transaction, CIM indirectly owns and/or controls CCI II Advisors; our dealer manager, CCO Capital; our property manager, CREI Advisors; and CCO Group.
As part of the Transaction, pursuant to the Services Agreement, VEREIT OP is obligated to provide certain services to CCO Group and to us, including operational real estate support. VEREIT OP is obligated to provide such services through March 31, 2019 (or, if later, the date of the last government filing other than a tax filing made by any of the Cole REITs with respect to its 2018 fiscal year) and is obligated to provide consulting and research services through December 31, 2023 as requested by CCO Group, LLC.
Despite the indirect change of ownership and control of our advisor, dealer manager, property manager and sponsor, we expect that, during the Initial Services Term of the Services Agreement, the advisory, dealer manager and property management services we receive will continue without any material changes in personnel (except as supplemented by the management oversight of CIM personnel) or material change in service procedures. During the Initial Services Term of the Services Agreement, CCO Group intends to evaluate and effectuate an appropriate transition of VEREIT OP’s services under the Services Agreement to other CIM affiliates or third parties with the goal of ensuring continuity and minimizing disruption.
We ceased issuing shares in the Offering on September 17, 2016, but will continue to issue Class A Shares and Class T Shares under the DRIP Offering until a liquidity event occurs, such as the listing of our shares on a national securities exchange or the sale of our company, or the DRIP Offering is otherwise terminated by the Board. We expect that property acquisitions in 2018 and future periods will be funded by secured or unsecured borrowings from banks and other lenders, proceeds from our DRIP Offering, cash flows from operations and the strategic sale of properties and other assets.
Our operating results and cash flows are primarily influenced by rental income from our commercial properties, interest expense on our indebtedness, and acquisition and operating expenses. Rental income accounted for 88% of total revenue for both the three and nine months ended September 30, 2018, and 89% of total revenue for both the three and nine months ended September 30, 2017. As 100% of our rentable square feet was under lease as of September 30, 2018, with a weighted average remaining lease term of 9.5 years, we believe our exposure to changes in commercial rental rates on our portfolio is substantially mitigated, except for vacancies caused by tenant bankruptcies or other factors. Our advisor regularly monitors the creditworthiness of each of our tenants by reviewing each tenant’s financial results, any available credit rating agency reports on the tenant or guarantor, the operating history of the property with such tenant, the tenant’s market share and track record within its industry segment, the general health and outlook of the tenant’s industry segment, and other information for changes and possible trends. If our advisor identifies significant changes or trends that may adversely affect the creditworthiness of a tenant, it will gather a more in-depth knowledge of the tenant’s financial condition and, if necessary, attempt to mitigate the
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tenant credit risk by evaluating the possible sale of the property, or identifying a possible replacement tenant should the current tenant fail to perform on the lease.
Operating Highlights and Key Performance Indicators
2018 Activity
• | Acquired one land parcel for an aggregate amount of $1.4 million, upon which a 120,000 square foot expansion of an existing property is being constructed, and capitalized an aggregate amount of expenses and interest of $5.7 million associated with the expansion project. |
• | Issued approximately 1.5 million shares of common stock in the DRIP Offering for proceeds of $16.1 million ($15.5 million in Class A Shares and $627,000 in Class T Shares). |
• | Total debt decreased by $500,000, from $601.5 million to $601.0 million. |
Portfolio Information
As of September 30, 2018, we owned 36 properties comprising 11.4 million rentable square feet of commercial space located in 19 states, which were 100% leased with a weighted average remaining lease term of 9.5 years. As of September 30, 2018, three of our tenants, Keurig Green Mountain, Amazon, and Freeport-McMoRan, accounted for 13%, 12% and 10%, respectively, of our 2018 annualized rental income. As of September 30, 2018, we also had certain geographic concentrations in our property holdings. In particular, as of September 30, 2018, two of our properties were located in Arizona, two properties were located in Massachusetts and three properties were located in Ohio, which accounted for 13%, 13% and 12% of our 2018 annualized rental income, respectively. In addition, we had tenants in the manufacturing, logistics, wholesale, retail-internet, and mining and natural resource industries, which comprised 32%, 13%, 13%, 12% and 10%, respectively, of our 2018 annualized rental income. The following table shows the property statistics of our real estate assets as of September 30, 2018 and 2017:
September 30, | |||||
2018 | 2017 | ||||
Number of commercial properties (1) | 36 | 36 | |||
Rentable square feet (in thousands) | 11,376 | 11,385 | |||
Percentage of rentable square feet leased | 100 | % | 100 | % | |
Percentage of investment-grade tenants (2) | 69.6 | % | 56.5 | % | |
____________________________________
(1) | We completed an expansion project during the year ended December 31, 2017 that connected two existing buildings, resulting in a decrease to our property count. |
(2) | Investment-grade tenants are those with a credit rating of BBB- or higher by Standard & Poor’s Financial Services LLC (“Standard & Poor’s”) or a credit rating of Baa3 or higher by Moody’s Investor Service, Inc. (“Moody’s”). The ratings may reflect those assigned by Standard & Poor’s or Moody’s to the lease guarantor or the parent company, as applicable. The weighted average credit rating is weighted based on annualized rental income and is for only those tenants rated by Standard & Poor’s. |
The following table summarizes our real estate acquisition activity during the three and nine months ended September 30, 2018 and 2017:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||
Commercial properties acquired | — | — | — | 3 | |||||||||||
Purchase price of acquired properties (in thousands) | $ | — | $ | — | $ | — | $ | 93,465 | |||||||
Rentable square feet (in thousands) | — | — | — | 483 | |||||||||||
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Results of Operations
The following table provides summary information about our results of operations for the three and nine months ended September 30, 2018 and 2017 (in thousands):
Three Months Ended September 30, | 2018 vs 2017 Increase (Decrease) | Nine Months Ended September 30, | 2018 vs 2017 Increase (Decrease) | ||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||||||||||
Total revenues | $ | 26,577 | $ | 26,796 | $ | (219 | ) | $ | 79,491 | $ | 77,222 | $ | 2,269 | ||||||||||
General and administrative expenses | $ | 1,267 | $ | 1,254 | $ | 13 | $ | 3,483 | $ | 3,525 | $ | (42 | ) | ||||||||||
Property operating expenses | $ | 1,655 | $ | 1,661 | $ | (6 | ) | $ | 4,885 | $ | 4,071 | $ | 814 | ||||||||||
Real estate tax expenses | $ | 2,066 | $ | 1,924 | $ | 142 | $ | 6,201 | $ | 5,979 | $ | 222 | |||||||||||
Advisory fees and expenses | $ | 2,599 | $ | 2,620 | $ | (21 | ) | $ | 7,907 | $ | 7,682 | $ | 225 | ||||||||||
Acquisition-related expenses | $ | 4 | $ | — | $ | 4 | $ | 89 | $ | 2,214 | $ | (2,125 | ) | ||||||||||
Depreciation and amortization | $ | 9,620 | $ | 9,552 | $ | 68 | $ | 28,855 | $ | 28,411 | $ | 444 | |||||||||||
Operating income | $ | 9,366 | $ | 9,785 | $ | (419 | ) | $ | 28,071 | $ | 25,340 | $ | 2,731 | ||||||||||
Interest expense and other, net | $ | 6,157 | $ | 5,733 | $ | 424 | $ | 18,210 | $ | 16,840 | $ | 1,370 | |||||||||||
Net income | $ | 3,209 | $ | 4,052 | $ | (843 | ) | $ | 9,861 | $ | 8,500 | $ | 1,361 | ||||||||||
Revenue
Our revenues consist primarily of rental and other property income from net leased commercial properties. We also incur certain operating expenses that are subject to reimbursement by our tenants, which results in tenant reimbursement income.
Revenue remained consistent during the three months ended September 30, 2018 compared to the same period in 2017. Rental income from net leased commercial properties accounted for 88% of our total revenue for the three months ended September 30, 2018, compared to 89% of our total revenue for the same period in 2017. We also incurred certain operating expenses subject to reimbursement by our tenants, which resulted in $3.2 million of tenant reimbursement income during the three months ended September 30, 2018, compared to $3.0 million during the same period in 2017.
The increase in revenue of $2.3 million during the nine months ended September 30, 2018, as compared to the same period in 2017, was primarily due to recognizing a full period of revenue on three rental income-producing properties acquired during the nine months ended September 30, 2017. Rental income from net leased commercial properties accounted for 88% of our total revenue for the nine months ended September 30, 2018, compared to 89% of our total revenue for the same period in 2017. We also incurred certain operating expenses subject to reimbursement by our tenants, which resulted in $9.3 million of tenant reimbursement income during the nine months ended September 30, 2018, compared to $8.2 million during the same period in 2017.
General and Administrative Expenses
The primary general and administrative expense items are operating expense reimbursements to our advisor, escrow and trustee fees, accounting fees and unused fees on the Credit Facility.
General and administrative expenses remained consistent during the three and nine months ended September 30, 2018 compared to the same periods in 2017.
Property Operating Expenses
Property operating expenses such as property repairs, maintenance and property-related insurance include both reimbursable and non-reimbursable property expenses. We are reimbursed by tenants for certain property operating expenses in accordance with the respective lease agreements.
Property operating expenses remained consistent during the three months ended September 30, 2018 compared to the same period in 2017.
The increase in property operating expenses of $814,000 during the nine months ended September 30, 2018, as compared to the same period in 2017, was primarily due to recognizing a full period of property operating expenses on three properties acquired during the nine months ended September 30, 2017.
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Real Estate Tax Expenses
The increase in real estate tax expenses of $142,000 and $222,000 during the three and nine months ended September 30, 2018, respectively, as compared to the same periods in 2017, was primarily due to recognizing a full period of real estate tax expenses on three properties acquired during the nine months ended September 30, 2017.
Advisory Fees and Expenses
Pursuant to the advisory agreement with CCI II Advisors and based upon the amount of our current invested assets, we are required to pay to CCI II Advisors a monthly advisory fee equal to one-twelfth of 0.75% of the average invested assets. Additionally, we may be required to reimburse certain expenses incurred by CCI II Advisors in providing such advisory services, subject to limitations as set forth in the advisory agreement.
Advisory fees and expenses remained consistent during the three months ended September 30, 2018 compared to the same period in 2017.
The increase in advisory fees and expenses of $225,000 during the nine months ended September 30, 2018, as compared to the same period in 2017, was primarily due to an increase in our average invested assets to $1.32 billion for the nine months ended September 30, 2018, compared to $1.29 billion during the same period in 2017.
Acquisition-Related Expenses
We reimburse CCI II Advisors or its affiliates for acquisition-related expenses incurred in the process of acquiring a property or the origination or acquisition of a loan, so long as the total acquisition fees and expenses relating to the transaction do not exceed 6.0% of the contract purchase price, unless otherwise approved by a majority of the Board, including a majority of our independent directors, as commercially competitive, fair and reasonable to us. In April 2017, we adopted ASU 2017-01, which clarifies the definition of a business by adding guidance to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Our acquisitions made after the adoption of ASU 2017-01 qualify as asset acquisitions, and as such, acquisition-related fees and certain acquisition-related expenses related to these asset acquisitions will be capitalized. Prior to the adoption of ASU 2017-01 in April 2017, all of our costs related to property acquisitions, including acquisition fees described below, were expensed as incurred. Prior to April 2017, acquisition-related expenses primarily consisted of legal, deed transfer and other costs related to real estate purchase transactions, including costs incurred for deals that were not consummated. We also pay CCI II Advisors or its affiliates acquisition fees of up to 2.0% of: (1) the contract purchase price of each property or asset we acquire; (2) the amount paid in respect of the development, construction or improvement of each asset we acquire; (3) the purchase price of any loan we acquire; and (4) the principal amount of any loan we originate.
Acquisition-related expenses remained consistent during the three months ended September 30, 2018 compared to the same period in 2017.
The decrease in acquisition-related expenses of $2.1 million during the nine months ended September 30, 2018, as compared to the same period in 2017, was primarily due to having no property acquisitions during the nine months ended September 30, 2018, as compared to the acquisition of three properties for an aggregate purchase price of $93.5 million during the nine months ended September 30, 2017. The acquisitions were all acquired prior to the adoption of ASU 2017-01 in April 2017 and were accounted for as business combinations. Accordingly, acquisition-related costs related to those property acquisitions were expensed as incurred.
Depreciation and Amortization
The increase in depreciation and amortization expenses of $68,000 and $444,000 during the three and nine months ended September 30, 2018, respectively, as compared to the same periods in 2017, was primarily due to recognizing a full period of depreciation and amortization expenses on three properties acquired during the nine months ended September 30, 2017.
Interest Expense and Other, Net
The increase in interest expense and other, net of $424,000 and $1.4 million during the three and nine months ended September 30, 2018, respectively, as compared to the same periods in 2017, was primarily due to an increase in the weighted average interest rate to 3.8% as of September 30, 2018, from 3.7% as of September 30, 2017, coupled with an increase in the average aggregate amount of debt outstanding to $600.0 million and $599.5 million during the three and nine months ended September 30, 2018, respectively, compared to an average outstanding debt balance of $593.2 million and $586.5 million for the three and nine months ended September 30, 2017, respectively.
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Same Store Properties
We review our stabilized operating results, measured by contract rental revenue, from properties that we owned for the entirety of both the current and prior year reporting periods, referred to as “same store” properties, and we believe that the presentation of operating results for same store properties provides useful information to stockholders. Contract rental revenue is a supplemental non-GAAP financial measure of real estate companies’ operating performance. Contract rental revenue is considered by management to be a helpful supplemental performance measure, as it provides a consistent method for the comparison of our properties. In determining the same store property pool, we include all properties that were owned for the entirety of both the current and prior reporting periods, except for properties during the current or prior year that were under development or redevelopment.
“Non-same store” properties, for purposes of the table below, includes properties acquired on or after July 1, 2017 and any properties under development or redevelopment. As shown in the table below, contract rental revenue on the 35 same store properties for the three months ended September 30, 2018 increased $52,000 to $21.2 million, compared to $21.1 million for the three months ended September 30, 2017. The same store properties were 100% occupied as of September 30, 2018 and 2017. The following table shows the contract rental revenue from properties owned for both of the entire three months ended September 30, 2018 and 2017, along with a reconciliation to rental income, calculated in accordance with GAAP (dollar amounts in thousands):
Number of Properties | Three Months Ended September 30, | Increase (Decrease) | |||||||||||||||
2018 | 2017 | $ Change | % Change | ||||||||||||||
Rental income – as reported | $ | 23,417 | $ | 23,832 | $ | (415 | ) | (2 | )% | ||||||||
Less: Amortization(1) | 548 | 547 | 1 | *% | |||||||||||||
Less: Straight-line rental income | 1,087 | 1,787 | (700) | (39 | )% | ||||||||||||
Total contract rental revenue | 21,782 | 21,498 | 284 | 1 | % | ||||||||||||
Less: “Non-same store” properties | 1 | 602 | 370 | 232 | 63 | % | |||||||||||
“Same store” properties | 35 | $ | 21,180 | $ | 21,128 | $ | 52 | *% | |||||||||
______________________
* | Represents less than 1% change. |
(1) Includes amortization of above- and below-market lease intangibles.
“Non-same store” properties, for purposes of the table below, includes properties acquired on or after January 1, 2017 and any properties under development or redevelopment. As shown in the table below, contract rental revenue on the 32 same store properties for the nine months ended September 30, 2018 increased $1.2 million to $58.6 million compared to $57.4 million for the nine months ended September 30, 2017. The same store properties were 100% occupied as of September 30, 2018 and 2017. The following table shows the contract rental revenue from properties owned for both of the entire nine months ended September 30, 2018 and 2017, along with a reconciliation to rental income, calculated in accordance with GAAP (dollar amounts in thousands):
Number of Properties | Nine Months Ended September 30, | Increase (Decrease) | |||||||||||||||
2018 | 2017 | $ Change | % Change | ||||||||||||||
Rental income – as reported | $ | 70,231 | $ | 69,039 | $ | 1,192 | 2 | % | |||||||||
Less: Amortization(1) | 1,642 | 1,657 | (15) | *% | |||||||||||||
Less: Straight-line rental income | 3,378 | 4,587 | (1,209) | (26 | )% | ||||||||||||
Total contract rental revenue | 65,211 | 62,795 | 2,416 | 4 | % | ||||||||||||
Less: “Non-same store” properties | 4 | 6,559 | 5,384 | 1,175 | 22 | % | |||||||||||
“Same store” properties | 32 | $ | 58,652 | $ | 57,411 | $ | 1,241 | 2 | % | ||||||||
______________________
* | Represents less than 1% change. |
(1) Includes amortization of above- and below-market lease intangibles.
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Distributions
The Board authorized a daily distribution, based on 365 days in the calendar year, of $0.001726027 per Class A Share for stockholders of record of such class of shares as of the close of business on each day of the period commencing on January 1, 2018 and ending on March 31, 2019. The Board authorized a daily distribution on Class T Shares to our stockholders of record of such class of shares as of the close of business on each day of the period commencing on January 1, 2018 and ending on March 31, 2019, equal to $0.001726027 per Class T Share, less the per share distribution and stockholder servicing fees that are payable with respect to the Class T Shares (as calculated on a daily basis). As of September 30, 2018, we had distributions payable of $3.5 million.
The following table presents distributions and sources of distributions for the periods indicated below:
Nine Months Ended September 30, | |||||||||||||
2018 | 2017 | ||||||||||||
Amount | Percent | Amount | Percent | ||||||||||
Distributions paid in cash | $ | 15,584 | 49 | % | $ | 15,166 | 48 | % | |||||
Distributions reinvested | 16,138 | 51 | % | 16,659 | 52 | % | |||||||
Total distributions | $ | 31,722 | 100 | % | $ | 31,825 | 100 | % | |||||
Sources of distributions: | |||||||||||||
Net cash provided by operating activities (1) | $ | 31,722 | 100 | % | $ | 31,825 | 100 | % | |||||
____________________________________
(1) | Net cash provided by operating activities for the nine months ended September 30, 2018 and 2017 was $36.9 million and $32.3 million, respectively. |
Share Redemptions
Our share redemption program permits our stockholders to sell their shares of common stock back to us, subject to certain conditions and limitations, including a one-year holding period. We may waive the one-year holding period upon request in the event of death, bankruptcy or other exigent circumstances as determined by our advisor. Funding for the redemption of shares will be limited to the cumulative net proceeds we receive from the sale of shares under the DRIP Offering, net of shares redeemed to date. In addition, we will generally limit quarterly redemptions to approximately 1.25% of the weighted average number of shares outstanding during the trailing 12-month period ending on the last day of the fiscal quarter for which the redemptions are being paid, and to the net proceeds we receive from the sale of shares in the respective quarter under the DRIP Offering. In addition, the Board may choose to amend the terms of, suspend or terminate our share redemption program at any time upon 30 days’ notice. We will not redeem in excess of 5.0% of the weighted average number of shares outstanding during the trailing 12 months prior to the end of the fiscal quarter for which the redemptions are being paid. Any of the foregoing limits might prevent us from accommodating all redemption requests made in any fiscal quarter or in any 12-month period. We received redemption requests of approximately 887,000 shares for $9.3 million in excess of the net proceeds we received from the issuance of shares under the DRIP Offering during the three months ended September 30, 2018. Management, in its discretion, limited the amount of shares redeemed for the three months ended September 30, 2018, to shares issued pursuant to the DRIP Offering during the respective period. During the nine months ended September 30, 2018, we received valid redemption requests under our share redemption program totaling approximately 2.4 million shares, of which we redeemed approximately 1.0 million shares as of September 30, 2018 for $10.7 million at an average redemption price of $10.50 per share and approximately 502,000 shares subsequent to September 30, 2018 for $5.3 million at an average redemption price of $10.54 per share. The remaining redemption requests relating to approximately 887,000 shares went unfulfilled. A valid redemption request is one that complies with the applicable requirements and guidelines of our share redemption program then in effect. The share redemptions were funded with proceeds from the DRIP Offering.
Liquidity and Capital Resources
General
We expect to utilize cash flows from operations and future proceeds from secured or unsecured financing and funds from the DRIP Offering to fund certain capital expenditures, including tenant improvements, and for operating expenses, distributions to stockholders, general corporate uses and future property acquisitions. The sources of our operating cash flows will primarily be provided by the rental income received from current and future leased properties.
On August 25, 2016, we registered an aggregate of $120.0 million of Class A Shares and Class T Shares under the DRIP Offering. We will continue to issue Class A Shares and Class T Shares under the DRIP Offering at a price per share equal to the
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most recent estimated per share NAV as determined by the Board, which is currently $10.58 per share for both Class A Shares and Class T Shares as of December 31, 2017.
Our Credit Facility provides for borrowings of up to $400.0 million, which includes a $200.0 million unsecured term loan and up to $200.0 million in revolving loans. As of September 30, 2018, we had $89.6 million in unused capacity under the Credit Facility, subject to borrowing availability. As of September 30, 2018, we also had cash and cash equivalents of $3.4 million.
Short-term Liquidity and Capital Resources
On a short-term basis, our principal demands for funds will be for operating expenses, distributions to stockholders, redemptions, certain capital expenditures, and interest and principal on current and any future debt financings, including principal repayments of $105.5 million due December 2018. We expect to meet our short-term liquidity requirements through net cash flows provided by operations and proceeds from the DRIP Offering, as well as secured or unsecured borrowings from banks and other lenders. With respect to the Revolving Loans due to mature on December 12, 2018, we expect to extend the maturity date of such loans to December 12, 2019. We believe that the resources stated above will be sufficient to satisfy our operating requirements for the foreseeable future, and we do not anticipate a need to raise funds from sources other than those described above within the next 12 months.
Long-term Liquidity and Capital Resources
On a long-term basis, our principal demands for funds will be for the payment of capital expenditures, operating expenses, distributions and redemptions to stockholders, interest and principal on any current and future indebtedness and future property acquisitions. Generally, we expect to meet our long-term liquidity requirements through proceeds from net cash flows provided by operations, secured or unsecured borrowings from banks and other lenders, the strategic sale of properties and other assets and the DRIP Offering.
We expect that substantially all net cash flows from operations will be used to pay distributions to our stockholders after certain capital expenditures, including tenant improvements, are paid; however, we may use other sources to fund distributions, as necessary, including proceeds from the DRIP Offering, borrowings on our Credit Facility and/or future borrowings on unencumbered assets. To the extent that cash flows from operations are lower due to lower than expected returns on the properties, distributions paid to our stockholders may be lower. We expect that substantially all net cash flows from the DRIP Offering or debt financings will be used to fund certain capital expenditures, repayments of outstanding debt or distributions and redemptions to our stockholders.
Contractual Obligations
As of September 30, 2018, we had $601.0 million of debt outstanding with a weighted average interest rate of 3.8%. See Note 7 — Credit Facility and Notes Payable to our condensed consolidated financial statements in this Quarterly Report on Form 10-Q for certain terms of our debt outstanding. Our contractual obligations as of September 30, 2018 were as follows (in thousands):
Payments due by period (1) | |||||||||||||||||||
Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | |||||||||||||||
Principal payments – fixed rate debt | $ | 295,545 | $ | — | $ | 203,465 | $ | 35,100 | $ | 56,980 | |||||||||
Interest payments – fixed rate debt (2) | 29,659 | 12,148 | 13,289 | 4,222 | — | ||||||||||||||
Principal payments – Credit Facility | 305,500 | 105,500 | 200,000 | — | — | ||||||||||||||
Interest payments – Credit Facility (3) | 8,776 | 7,456 | 1,320 | — | — | ||||||||||||||
Total | $ | 639,480 | $ | 125,104 | $ | 418,074 | $ | 39,322 | $ | 56,980 | |||||||||
____________________________________
(1) | The table does not include amounts due to CCI II Advisors or its affiliates pursuant to our advisory agreement because such amounts are not fixed and determinable. |
(2) | As of September 30, 2018, we had $54.1 million of variable rate debt effectively fixed through the use of interest rate swap agreements. We used the effective interest rates fixed under our interest rate swap agreements to calculate the debt payment obligations in future periods. |
(3) | Payment obligations for the Term Loan outstanding under the Credit Facility are based on the interest rate of 3.3% as of September 30, 2018, which is the fixed rate under the interest rate swap agreement. Payment obligations for the Revolving Loans are based on the weighted average interest rate in effect of 4.2% as of September 30, 2018. |
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We expect to incur additional borrowings in the future to acquire additional properties and other real estate-related assets. There is no limitation on the amount we may borrow against any single improved property. Our borrowings will not exceed 75% of the cost of our gross assets (or 300% of net assets) as of the date of any borrowing, which is the maximum level of indebtedness permitted under the North American Securities Administrators Association Statement of Policy Regarding Real Estate Investment Trusts; however, we may exceed that limit if both approved by a majority of our independent directors and disclosed to our stockholders in the next quarterly report along with a justification for such excess borrowing. As of September 30, 2018, our ratio of debt to the cost (before deducting depreciation or other non-cash reserves) of our gross assets was 50.0% and our ratio of debt to the fair market value of our gross assets was 45.6%. Fair market value is based on the estimated market value of our real estate assets as of December 31, 2017 that were used to determine our estimated per share NAV, and for those assets acquired from January 1, 2018 through September 30, 2018, is based on the purchase price.
Our management reviews net debt as part of its management of our overall liquidity, financial flexibility, capital structure and leverage, and we therefore believe that the presentation of net debt provides useful information to stockholders. Net debt is a non-GAAP measure used to show our outstanding principal debt balance, excluding certain GAAP adjustments, such as financing and issuance costs and related accumulated amortization, less all cash and cash equivalents. As of September 30, 2018, our net debt leverage ratio, which is the ratio of net debt to total gross real estate assets net of gross intangible lease liabilities, was 49.7%. The following table provides a reconciliation of the credit facility and notes payable, net balance, as reported on our condensed consolidated balance sheet, to net debt as of September 30, 2018 (dollar amounts in thousands):
Balance as of September 30, 2018 | ||||
Credit facility and notes payable, net | $ | 599,736 | ||
Deferred costs (1) | 1,309 | |||
Less: Cash and cash equivalents | (3,374 | ) | ||
Net debt | $ | 597,671 | ||
Gross real estate assets, net (2) | $ | 1,202,828 | ||
Net debt leverage ratio | 49.7 | % | ||
______________________
(1) Deferred costs relate to mortgage notes payable and the term portion of the Credit Facility.
(2) Net of gross intangible lease liabilities.
Cash Flow Analysis
Operating Activities. Net cash provided by operating activities increased by $4.6 million for the nine months ended September 30, 2018, as compared to the same period in 2017. The increase was primarily due to the acquisition of three rental-income producing properties subsequent to September 30, 2017, resulting in increases in net income, depreciation and amortization, and a net increase in the changes in working capital accounts. See “ — Results of Operations” for a more complete discussion of the factors impacting our operating performance.
Investing Activities. Net cash used in investing activities decreased by $97.8 million for the nine months ended September 30, 2018, as compared to the same period in 2017. The decrease resulted primarily from there being no property acquisitions, coupled with a decrease in capital expenditures related to development projects, during the nine months ended September 30, 2018.
Financing Activities. Net cash used in financing activities was $32.4 million for the nine months ended September 30, 2018, compared to net cash provided by financing activities of $65.7 million for the nine months ended September 30, 2017. The change was primarily due to a decrease in net borrowings and an increase in redemptions of common stock.
Election as a REIT
We elected to be taxed, and currently qualify, as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2014. To maintain our qualification as a REIT, we must continue to meet certain requirements relating to our organization, sources of income, nature of assets, distributions of income to our stockholders and recordkeeping. As a REIT, we generally are not subject to federal income tax on taxable income that we distribute to our stockholders so long as we distribute at least 90% of our annual taxable income (computed without regard to the dividends paid deduction and excluding net capital gains).
If we fail to maintain our qualification as a REIT for any reason in a taxable year and applicable relief provisions do not apply, we will be subject to tax on our taxable income at regular corporate rates. We will not be able to deduct distributions paid
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to our stockholders in any year in which we fail to maintain our qualification as a REIT. We also will be disqualified for the four taxable years following the year during which qualification was lost, unless we are entitled to relief under specific statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to stockholders. However, we believe that we are organized and operate in such a manner as to maintain our qualification as a REIT for federal income tax purposes. No provision for federal income taxes has been made in our accompanying condensed consolidated financial statements. We are subject to certain state and local taxes related to the operations of properties in certain locations, which have been provided for in our accompanying condensed consolidated financial statements.
Critical Accounting Policies and Estimates
Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires us to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management believes that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. We believe the following critical accounting policies govern the significant judgments and estimates used in the preparation of our financial statements, which should be read in conjunction with the more complete discussion of our accounting policies and procedures included in Note 2 — Summary of Significant Accounting Policies to our audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2017. We consider our critical accounting policies to be the following:
• | Recoverability of Real Estate Assets; and |
• | Allocation of Purchase Price of Real Estate Assets. |
A complete description of such policies and our considerations is contained in our Annual Report on Form 10-K for the year ended December 31, 2017. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2017 and related notes thereto.
Related-Party Transactions and Agreements
We have entered into agreements with CCI II Advisors and its affiliates, whereby we agree to pay certain fees to, or reimburse certain expenses of, CCI II Advisors or its affiliates, such as acquisition and advisory fees and expenses, organization and offering costs, distribution and stockholder servicing fees, leasing fees and reimbursement of certain operating costs. In addition, pursuant to the Services Agreement, VEREIT OP, which is affiliated with one of our directors, is obligated to provide certain services to CCO Group and to us, including operational real estate support. We are not a party to the Services Agreement. See Note 10 — Related-Party Transactions and Arrangements to our condensed consolidated financial statements in this Quarterly Report on Form 10-Q for a discussion of the various related-party transactions, agreements and fees.
Conflicts of Interest
Avraham Shemesh, our chief executive officer, president and the chairman of our board of directors, who is also a founder and principal of CIM and certain of its affiliates as well as a director of CCPT V, and Nathan D. DeBacker, our chief financial officer and treasurer, act as executive officers and/or a director to one or more other programs sponsored by CCO Group. One of our directors, Calvin E. Hollis, also serves as a director of CCPT V. Similarly, Glenn J. Rufrano, one of our directors, serves as a director of CCPT V, CCIT III and Cole Income NAV Strategy, as well as chief executive officer and a director for VEREIT, Inc., the parent company of VEREIT OP, who provides certain services to us and our advisor through the Services Agreement. In addition, certain affiliates of CCI II Advisors act as advisors to CCPT IV, CCPT V, Cole Income NAV Strategy, CCIT III and/or other real estate offerings in registration, all of which are or intend to be public, non-listed REITs offered, distributed and/or managed by affiliates of CCI II Advisors. As such, there may be conflicts of interest where CCI II Advisors or its affiliates, while serving in the capacity as sponsor, general partner, officer, director, key personnel and/or advisor for CIM or another real estate program sponsored or operated by CCO Group, including other real estate offerings in registration, may be in conflict with us in connection with providing services to other real estate-related programs related to property acquisitions, property dispositions, and property management among others. The compensation arrangements between affiliates of CCI II
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Advisors and these other real estate programs sponsored or operated by CCO Group could influence the advice provided to us. See Part I, Item 1. Business — Conflicts of Interest in our Annual Report on Form 10-K for the year ended December 31, 2017.
Off-Balance Sheet Arrangements
As of September 30, 2018 and December 31, 2017, we had no material off-balance sheet arrangements that had or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity or capital resources.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Market Risk
The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our market risk arises primarily from interest rate risk relating to variable-rate borrowings. To meet our short and long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to manage our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We do not intend to hold or issue these derivative contracts for trading or speculative purposes. We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.
Interest Rate Risk
As of September 30, 2018, we had $105.5 million of variable rate debt, excluding any debt subject to interest rate swap agreements, and, therefore, we are exposed to interest rate changes in LIBOR. As of September 30, 2018, an increase or decrease of 50 basis points in interest rates would result in an increase or decrease in interest expense of $528,000 per year.
As of September 30, 2018, we had three interest rate swap agreements outstanding, which mature on various dates from December 2019 to April 2020, with an aggregate notional amount of $254.1 million and an aggregate fair value of the net derivative asset of $4.2 million. The fair value of these interest rate swap agreements is dependent upon existing market interest rates and swap spreads. As of September 30, 2018, an increase of 50 basis points in interest rates would result in a change of $1.5 million to the fair value of the net derivative asset, resulting in a net derivative asset of $5.7 million. A decrease of 50 basis points in interest rates would result in a change of $1.5 million to the fair value of the net derivative asset, resulting in a net derivative asset of $2.7 million.
As the information presented above includes only those exposures that existed as of September 30, 2018, it does not consider exposures or positions arising after that date. The information presented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.
These amounts were determined by considering the impact of hypothetical interest rate changes on our borrowing costs and assume no other changes in our capital structure.
Credit Risk
Concentrations of credit risk arise when a number of tenants are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to us, to be similarly affected by changes in economic conditions. We are subject to tenant, geographic and industry concentrations. Any downturn of the economic conditions in one or more of these tenants, states or industries could result in a material reduction of our cash flows or material losses to us.
The factors considered in determining the credit risk of our tenants include, but are not limited to: payment history; credit status and change in status (credit ratings for public companies are used as a primary metric); change in tenant space needs (i.e., expansion/downsize); tenant financial performance; economic conditions in a specific geographic region; and industry specific credit considerations. We believe that the credit risk of our portfolio is reduced by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants and mitigation options.
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Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.
As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of September 30, 2018 was conducted under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of September 30, 2018, were effective at a reasonable assurance level.
Changes in Internal Control Over Financial Reporting
No change occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the three months ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
Item 1. | Legal Proceedings |
In the ordinary course of business we may become subject to litigation or claims. We are not aware of any material pending legal proceedings, other than ordinary routine litigation incidental to our business, to which we are a party or to which our properties are the subject.
Item 1A. | Risk Factors |
There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2017.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
The Board has adopted a share redemption program that permits our stockholders to sell their shares of common stock back to us, subject to certain conditions and limitations described in the Registration Statement. Funding for the redemption of shares will be limited to the cumulative net proceeds we receive from the sale of shares under the DRIP Offering, net of shares redeemed to date. In addition, we will generally limit quarterly redemptions to approximately 1.25% of the weighted average number of shares outstanding during the trailing 12-month period ending on the last day of the fiscal quarter for which the redemptions are being paid, and to the net proceeds we receive from the sale of shares in the respective quarter under the DRIP Offering. In addition, the Board may choose to amend the terms of, suspend or terminate the share redemption program at any time upon 30 days’ notice. Under our share redemption program, we will not redeem in excess of 5.0% of the weighted average number of shares outstanding during the trailing 12 months prior to the end of the fiscal quarter for which the redemptions are being paid. Any of the foregoing limits might prevent us from accommodating all redemption requests made in any fiscal quarter or in any 12-month period. We received redemption requests of approximately 887,000 shares for $9.3 million in excess of the net proceeds we received from the issuance of shares under the DRIP Offering during the three months ended September 30, 2018. Management, in its discretion, limited the amount of shares redeemed for the three months ended September 30, 2018, to shares issued pursuant to the DRIP Offering during the respective period. The estimated per share NAV of $10.58 determined by the Board as of December 31, 2017 serves as the most recent estimated value for purposes of the share redemption program, effective March 28, 2018, until such time as the Board determines a new estimated per share NAV.
In general, we redeem shares on a quarterly basis. During the three months ended September 30, 2018, we redeemed shares, including those redeemable due to death, as follows:
Period | Total Number of Shares Redeemed | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | |||||||||
July 1, 2018 – July 31, 2018 | |||||||||||||
Class A Shares | 8,192 | $ | 10.58 | 8,192 | (1) | ||||||||
Class T Shares | — | $ | — | — | (1) | ||||||||
August 1, 2018 – August 31, 2018 | |||||||||||||
Class A Shares | 492,420 | $ | 10.53 | 492,420 | (1) | ||||||||
Class T Shares | 11,130 | $ | 10.28 | 11,130 | (1) | ||||||||
September 1, 2018 – September 30, 2018 | |||||||||||||
Class A Shares | — | $ | — | — | (1) | ||||||||
Class T Shares | — | $ | — | — | (1) | ||||||||
Total | 511,742 | 511,742 | (1) | ||||||||||
______________________
(1) | A description of the maximum number of shares that may be purchased under our share redemption program is included in the narrative preceding this table. |
Unregistered Sales of Equity Securities
None.
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Item 3. | Defaults Upon Senior Securities |
None.
Item 4. | Mine Safety Disclosures |
Not applicable.
Item 5. | Other Information |
None.
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Item 6. | Exhibits |
The following exhibits are included, or incorporated by reference, in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2018 (and are numbered in accordance with Item 601 of Regulation S-K).
Exhibit No. | Description | |
3.1 | ||
3.2 | ||
3.3 | ||
3.4 | ||
4.1 | ||
10.1* | ||
31.1* | ||
31.2* | ||
32.1** | ||
101.INS* | XBRL Instance Document. | |
101.SCH* | XBRL Taxonomy Extension Schema Document. | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document. | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document. | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document. | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document. | |
______________________
* | Filed herewith. |
** | In accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference. |
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SIGNATURE
Pursuant to the requirements 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.
Cole Office & Industrial REIT (CCIT II), Inc. | ||
(Registrant) | ||
By: | /s/ Nathan D. DeBacker | |
Name: | Nathan D. DeBacker | |
Title: | Chief Financial Officer and Treasurer | |
(Principal Financial Officer) | ||
Date: November 14, 2018
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