staff may cause us, our REIT subsidiary, or any of its subsidiaries relying on Section 3(c)(5)(C) to lose our or their exclusion from registration, or force us, our REIT subsidiary, or any of its subsidiaries to re-evaluate our or their portfolios and our or their investment strategy. Such changes may prevent us from operating our business successfully.
In order to maintain an exclusion from registration under the 1940 Act, we may be unable to sell assets that we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income or loss generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire assets that we would otherwise want to acquire and would be important to its strategy.
Although we monitor the portfolio of our REIT subsidiary and its subsidiaries periodically and prior to each acquisition and disposition, our REIT subsidiary or its subsidiaries may not be able to maintain an exclusion from registration as an investment company. If our REIT subsidiary or its subsidiaries were required to register as an investment company, but failed to do so, our REIT subsidiary or its subsidiaries failing to so qualify would be prohibited from engaging in their business, and legal proceedings could be instituted against our REIT subsidiary or any of its subsidiaries failing to so qualify. In addition, the contracts of our REIT subsidiary or any of its subsidiaries failing to so qualify may be unenforceable, and a court could appoint a receiver to take control of our REIT subsidiary or any of its subsidiaries failing to so qualify and liquidate their business.
Risks Related to Our Management and Our Relationship withWith Our Manager and its Affiliates
•We rely entirely on the management team of our Manager or its affiliates and the directors, employees and officers of our Manager or its affiliates for our day-to-day operations.
We have nooperations, and the directors, officers and employees and do not intend to have employees in the future. Our success depends substantially on the efforts and abilities of the management team of our Manager andor its affiliates including Messrs. Batkin, Axelrod, Mildé, Uppal, Hamrick, Pinkuswill face competing demands to their allocation of time and Cooperman. Messrs. Mildé and Batkin have entered into five-year employment agreements with Terra Capital Partners and Mr. Uppal has entered into a two-year employment agreement with Terra Capital Partners. If our Manager of its affiliates were to lose the benefit of the experience, efforts and abilities of any of these individuals at the expiration of their employment agreement or otherwise, our operating results could suffer.investment opportunities.
•We face certain conflicts of interest with respect to our operations and our relationship with our Manager.
We are subject to conflicts of interest arising out of ourManager and Terra Property Trust’s relationship with our Manager and its affiliates. We may enter into additional transactions with our Manager or its affiliates. In particular, we may invest in, or acquire, certain of our investments through joint ventures or co-investments with other affiliates or purchase assets from, sell assets to or arrange financing from or provide financing to other affiliates. Future joint venture investments could be adversely affected by our lack of sole decision-making authority, or reliance on our Manager’s and affiliates’ financial condition and liquidity, and disputes between us and our Manager. Certain of these transactions will be subject to certain regulatory restrictions as a result of the 1940 Act or the conditions of an order granting exemptive relief to our affiliate, Terra Fund 6. There can be no assurance that any procedural protections will be sufficient to assure that these transactions will be made on terms that will be at least as favorable to us as those that would have been obtained in an arm’s-length transaction.
In addition, we rely on our Manager or its affiliates for our day-to-day operations. Our Manager has a contractual, as opposed to a fiduciary, relationship with us that limits its obligations to us. Our Manager and its affiliates may be subject to conflicts of interest in making investment decisions on assets on our behalf as opposed to other entities that have similar investment objectives. Our Manager and its affiliates may have different incentives in determining when to sell assets with respect to which it is entitled to fees and compensation and such determinations may not be in our best interest.
Our Manager or its affiliates serve as manager of certain other funds and investment vehicles, all of which have investment objectives that overlap with ours. In addition, future programs may be sponsored by our Manager and its affiliates and Terra Capital Markets may serve as the dealer manager for these future programs. As a result, our Manager, Terra Capital Markets and their affiliates may face conflicts of interest arising from potential competition with other programs for investors and investment opportunities. There may be periods during which one or more programs managed by our Manager or its affiliates and distributed by Terra Capital Markets or its affiliates will be raising capital and which might compete with us for investment capital. Such conflicts may not be resolved in our favor and our investors will not have the opportunity to evaluate the manner in which these conflicts of interest are resolved before or after making their investment.
The officers of our Manager are also officers of other affiliates of our Manager; therefore, the officers of our Manager will face competing demands based on the allocation of investment opportunities between us and our affiliates.
We rely on the officers of our Manager and its affiliates, Bruce D. Batkin, Andrew M. Axelrod, Simon J. Mildé, Vikram S. Uppal, Stephen H. Hamrick, Gregory M. Pinkus and Daniel J. Cooperman, and the other debt finance professionals of our Manager to identify suitable investments. Certain other companies managed by Terra Capital Partners or its affiliates also rely on many of these same professionals. These funds have similar investment objectives as we do. Many investment opportunities that are suitable for us may also be suitable for other affiliates advised by our Manager or its affiliates.
When the officers of our Manager or its affiliates identify an investment opportunity that may be suitable for us as well as an affiliated entity, they, in their sole discretion, will first evaluate the investment objectives of each program to determine if the opportunity is suitable for each program. If the proposed investment is appropriate for more than one program, our Manager or its affiliates will then evaluate the portfolio of each program, in terms of diversity of geography, underlying property type, tenant concentration and borrower, to determine if the investment is most suitable for one program in order to create portfolio diversification. If such analysis is not determinative, our Manager or its affiliates will allocate the investment to the program with uncommitted funds available for the longest period of time or, to the extent feasible, prorate the investment between the programs in accordance with uninvested funds. As a result, the officers of our Manager or its affiliates could direct attractive investment opportunities to other affiliated entities or investors. Such events could result in our company acquiring investments that provide less attractive returns, which would reduce the level of distributions we may be able to pay you.
Our Manager, its officers and the real estate-related loan professionals assembled by our Manager or its affiliates will face competing demands relating to their time and this may cause our operations and our investors’ investments to suffer.
We rely on our Manager, its or its affiliates’ officers and on real estate-related loan professionals that our Manager or its affiliates retain to provide services to our company for the day-to-day operation of our business. Messrs. Batkin, Axelrod, Mildé, Uppal, Hamrick, Pinkus and Cooperman are executive officers of our Manager or its affiliates as well as certain other funds managed by Terra Capital Partners. As a result of their interests in other programs, their obligations to other investors and the fact that they engage in and will continue to engage in other business activities on behalf of themselves and others, Messrs. Batkin, Axelrod, Mildé, Uppal, Hamrick, Pinkus and Cooperman face conflicts of interest in allocating their time between us and other Terra Capital Partners-sponsored programs and other business activities in which they are involved. Should our Manager devote insufficient time or resources to our business, our returns on our direct or indirect investments, and the value of our units, may decline.
The compensation that our Manager, or an affiliate of our Manager, receives was not determined on an arm’s-length basis and therefore may not be on the same terms as we could achieve from a third-party.
The compensation paid to our Manager and its affiliates for services they provide to us were not determined on an arm’s-length basis. We cannot assure you that a third party unaffiliated with us would not be able to provide such services to us at a lower price.
The base management fee the REIT Manager receives for managing our REIT subsidiary may reduce its incentive to devote its time and effort to seeking attractive assets for our portfolio because the fee is payable regardless of our performance.Manager.
Our REIT subsidiary pays the REIT Manager a base management fee regardless of the performance of our portfolio. Our Manager’s entitlement to non-performance-based compensation might reduce its incentive to devote its time and effort to seeking assets that provide attractive risk-adjusted returns for our portfolio. This in turn could hurt both our ability to make distributions and the value of our units.
We cannot predict the amounts of compensation to be paid to the REIT Manager and its affiliates.
Because the fees that our REIT subsidiary will pay to the REIT Manager and its affiliates are based in part on the level of our business activity, it is not possible to predict the amounts of compensation that our REIT subsidiary will be required to pay these entities. In addition, because key employees of the REIT Manager and its affiliates are given broad discretion to determine when to consummate a transaction, we will rely on these key persons to dictate the level of our business activity. Fees paid to the REIT Manager and its affiliates reduce funds available for payment of distributions. Because we cannot predict the amount of fees due to these parties, we cannot predict how precisely such fees will impact such payments.
If our Manager or its affiliates causes us to enter into a transaction with an affiliate, our Manager or its affiliates may face conflicts of interest that would not exist if such transaction had been negotiated at arm’s-length with an independent party.
Our Manager and its affiliates may face conflicts of interest if we enter into transactions with an affiliate. In these circumstances, the persons who serve as the management team of our Manager or its affiliates may have a fiduciary responsibility to both us and the affiliate. Transactions between us and such affiliates will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated parties. This conflict of interest may cause our Manager or its affiliates to sacrifice our best interests in favor of its affiliate, thereby causing us to enter into a transaction that is not in our best interest and that may negatively impact our performance.
Our Manager and its affiliates have limited prior experience operating a REIT and therefore may have difficulty in successfully and profitably operating our business or complying with regulatory requirements, including REIT provisions of the Internal Revenue Code, which may hinder their ability to achieve our objectives or result in loss of our REIT subsidiary’s qualification as a REIT.
Prior to the completion of the REIT formation transactions, our Manager and its affiliates had no experience operating a REIT or complying with regulatory requirements, including the REIT provisions of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). The REIT rules and regulations are highly technical and complex, and the failure to comply with the income, asset, and other limitations imposed by these rules and regulations could prevent us from qualifying as a REIT or could force us to pay unexpected taxes and penalties. Our Manager and its affiliates have limited experience operating a business in compliance with the numerous technical restrictions and limitations set forth in the Internal Revenue Code or the 1940 Act applicable to REITs. We cannot assure you that our Manager, its affiliates or our management team will perform on our behalf as they have in their previous endeavors. The inexperience of our Manager and its affiliates described above may hinder its ability to achieve our objectives or result in loss of our REIT subsidiary’s qualification as a REIT, or in the payment of taxes and penalties. As a result, we cannot assure you that we will be able to successfully operate as a REIT, execute our business strategies or comply with regulatory requirements applicable to REITs.
Risks Related to Financing and Hedging
Our REIT subsidiary’s board of directors may change our REIT subsidiary’s leverage policy, and/or investment strategy and guidelines, asset allocation and financing strategy, without the consent of its common stockholders.
We expect to deploy moderate amounts of leverage as part of our operating strategy not in excess of 30%. Notwithstanding the foregoing, our governing documents contain no limit on the amount of debt we may incur, and we may significantly increase the amount of leverage it utilizes at any time without approval of our unitholders or our REIT subsidiary's stockholders. Depending on market conditions, such borrowings are expected to include credit facilities, repurchase agreements and securitizations. In addition, we may divide the loans we originate into senior and junior tranches and dispose of the more senior tranches as an additional means of providing financing to our business. To the extent that we use leverage to finance our assets, we would expect to have a larger portfolio of loan assets, but our financing costs relating to our borrowings will reduce cash available for distributions to our unitholders. We may not be able to meet our financing obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to liquidation or sale to satisfy such obligations. To the extent we use repurchase agreements to finance the purchase of assets, a decrease in the value of these assets may lead to margin calls which we will have to satisfy. We may not have the funds available to satisfy any such margin calls and may be forced to sell assets at significantly depressed prices due to market conditions or otherwise, which may result in losses. Any reduction in distributions to our unitholders may cause the value of our units to decline.
Our Manager is authorized to follow broad investment guidelines that have been approved by our REIT subsidiary's board of directors. Those investment guidelines, as well as our target assets, investment strategy, financing strategy and hedging policies with respect to investments, originations, acquisitions, growth, operations, indebtedness, capitalization and distributions, may be changed at any time without notice to, or the consent of, our unitholders or our REIT subsidiary's stockholders. This could result in an investment portfolio with a different risk profile. A change in our investment strategy may increase our exposure to interest rate risk, default risk and real estate market fluctuations. Furthermore, a change in our asset allocation could result in our making investments in asset categories different from those described in this annual report on Form 10-K. These changes could materially and adversely affect us.
We may pursue and not be able to successfully complete securitization transactions, which could limit potential future sources of financing and could inhibit the growth of our business.
We may use credit facilities or repurchase agreements or other borrowings to finance the origination and/or structuring of real estate-related loans until a sufficient quantity of eligible assets has been accumulated, at which time we may decide to refinance these short-term facilities or repurchase agreements through the securitization market which could include the creation of CMBS, collateralized debt obligations (“CDO”s), or the private placement of loan participations or other long-term financing. If we employ this strategy, we are subject to the risk that we would not be able to obtain, during the period that our short-term financing arrangements are available, a sufficient amount of eligible assets to maximize the efficiency of a CMBS, CDO or private placement issuance. We are also subject to the risk that we are not able to obtain short-term financing arrangements or are not able to renew any short-term financing arrangements after they expire should we find it necessary to extend such short-term financing arrangements to allow more time to obtain the necessary eligible assets for a long-term financing.
The inability to consummate securitizations of our portfolio to finance our real estate-related loans on a long-term basis could require us to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price, which could have a material and adverse effect on our business, financial condition and results of operations.
We may be required to repurchase loans or indemnify investors if we breach representations and warranties, which could harm our earnings.
We may, on occasion, consistent with our REIT subsidiary’s qualification as a REIT and our desire to avoid being subject to the “prohibited transaction” penalty tax, sell some of our loans in the secondary market or as a part of a securitization of a portfolio of our loans. If we sell loans, we would be required to make customary representations and warranties about such loans to the loan purchaser. Our loan sale agreements may require us to repurchase or substitute loans in the event we breach a representation or warranty given to the loan purchaser. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default on a loan. Likewise, we may be required to repurchase or substitute loans if we breach a representation or warranty in connection with our securitizations, if any.
The remedies available to a purchaser of loans are generally broader than those available to us against the originating broker or correspondent. Further, if a purchaser enforces its remedies against us, we may not be able to enforce the remedies we have against the sellers. The repurchased loans typically can only be financed at a steep discount to their repurchase price, if at all. They are also typically sold at a significant discount to the unpaid principal balance, or UPB. Significant repurchase activity could harm our cash flow, results of operations, financial condition and business prospects.
Our financing arrangements may contain financial covenants that could restrict our borrowings or subject us to additional risks.
Our financing arrangements may contain various financial and other restrictive covenants, including covenants that require us to maintain a certain interest coverage ratio and net asset value and that create a maximum balance sheet leverage ratio. If we fail to satisfy any of the financial or other restrictive covenants, or otherwise default under these agreements, the lender will have the right to accelerate repayment and terminate the facility. Accelerating repayment and terminating the facility will require immediate repayment by us of the borrowed funds, which may require us to liquidate assets at a disadvantageous time, causing us to incur further losses and adversely affecting our results of operations and financial condition, which may impair our ability to maintain our current level of distributions.
•Our inability to access funding could have a material adverse effect on our results of operations, financial condition and business. We may rely on short-term financing and thus are especially exposed to changes in the availability of financing.
We expect to use borrowings, such as first mortgage financings, credit facilities, repurchase agreements and other credit facilities, as part of our operating strategy. Our use of financings exposes us to the risk that our lenders may respond to market conditions by making it more difficult for us to renew or replace on a continuous basis our maturing short-term borrowings. If we are not able to renew our then existing short-term facilities or arrange for new financing on terms acceptable to us, or if we default on our covenants or are otherwise unable to access funds under these types of financing, we may have to curtail our asset origination activities and/or dispose of assets.
It is possible that the lenders that provide us with financing could experience changes in their ability to advance funds to us, independent of our performance or the performance of our portfolio of assets. Further, if many of our potential lenders are unwilling or unable to provide us with financing, we could be forced to sell our assets at an inopportune time when prices are depressed. In addition, if the regulatory capital requirements imposed on our lenders change, they may be required to significantly increase the
cost of the financing that they provide to us. Our lenders also may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings, based on, among other factors, the regulatory environment and their management of perceived risk, particularly with respect to assignee liability. Moreover, the amount of financing we receive under our short-term borrowing arrangements will be directly related to the lenders’ valuation of our targeted assets that cover the outstanding borrowings.
The dislocations in the mortgage sector in the financial crisis that began in 2007 have caused many lenders to tighten their lending standards, reduce their lending capacity or exit the market altogether. Further contraction among lenders, insolvency of lenders or other general market disruptions could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing on attractive terms or at all. This could increase our financing costs and reduce our access to liquidity.
Repurchase agreements that we may use to finance our assets may restrict us from leveraging our assets as fully as desired, and may require us to provide additional collateral.
We may use repurchase agreements to finance our assets. If the market value of the assets pledged or sold by us under a repurchase agreement borrowing to a financing institution declines, we will normally be required by the financing institution to pay down a portion of the funds advanced, but we may not have the funds available to do so, which could result in defaults. Repurchase agreements that we may use in the future may also require us to provide additional collateral if the market value of the assets pledged or sold by us to a financing institution declines. Posting additional collateral to support our credit will reduce our liquidity and limit our ability to leverage our assets, which could adversely affect our business. In the event we do not have sufficient liquidity to meet such requirements, financing institutions can accelerate repayment of our indebtedness, increase interest rates, liquidate our collateral or terminate our ability to borrow. Such a situation would likely result in a rapid deterioration of our financial condition and possibly necessitate a filing for bankruptcy protection. In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the U.S. Bankruptcy Code, the effect of which, among other things, would be to allow the lender under the applicable repurchase agreement to avoid the automatic stay provisions of the U.S. Bankruptcy Code.
Further, any financial institutions providing the repurchase facilities may require us to maintain a certain amount of cash that is not invested or to set aside non-leveraged assets sufficient to maintain a specified liquidity position which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on equity. If we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.
An increase in our borrowing costs relative to the interest we receive on our leveraged assets may adversely affect our profitability and our cash available for distribution to our unitholders.
As our financings mature, we will be required either to enter into new borrowings or to sell certain of our assets. An increase in short-term interest rates at the time that we seek to enter into new borrowings would reduce the spread between the returns on our assets and the cost of our borrowings. This would adversely affect the returns on our assets, which might reduce earnings and, in turn, cash available for distribution to our unitholders.
•We may enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.
Subject to maintaining our REIT subsidiary’s qualification as a REIT, part of our strategy may involve entering into hedging transactions that could require us to fund cash payments in certain circumstances (such as the early termination of a hedging instrument caused by an event of default or other early termination event). The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges, and these economic losses will be reflected in our results of operations. We may also be required to provide margin to our counterparties to collateralize our obligations under hedging agreements. Our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time. The need to fund these obligations could adversely impact our financial condition.
If we attempt to qualify for hedge accounting treatment for any derivative instruments, but we fail to so qualify, we may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction.
If we attempt to qualify for hedge accounting treatment for any derivative instruments, but we fail to so qualify for a number of reasons, including if we use instruments that do not meet the definition of a derivative (such as short sales), if we fail to satisfy hedge documentation and hedge effectiveness assessment requirements, or if our instruments are not highly effective, we may
suffer because losses on any derivatives we hold which may not be offset by a change in the fair value of the related hedged transaction.
Risks Related to Owning Our Units
•Units issued by us that you hold are not freely transferrable; thus, investors may not be able to liquidate their investment.
•Rapid changes in the values of our assets may make it more difficult for Terra Property Trust to maintain its qualification as a REIT or our exclusion from the 1940 Act.
Tax Risks
•Income taxes of members may exceed cash distributions.
•If Terra Property Trust does not qualify or maintain its qualification as a REIT, it will be subject to tax as a regular corporation and could face a substantial tax liability as a result, which would result in reduced returns to our members.
PART I
Item 1. Business.
Overview
We are a real estate credit focused company that originates, structures, funds and manages commercial real estate investments, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments throughout the United States, which we collectively refer to as our targeted assets. Our loans finance the acquisition, construction, development or redevelopment of quality commercial real estate in the United States. We focus on the origination of middle market loans in the approximately $10 million to $50 million range, to finance properties primarily in primary and secondary markets. We believe loans in this size range are subject to less competition, offer higher risk adjusted returns than larger loans with similar risk metrics and facilitate portfolio diversification. We were formed as a Delaware limited liability company on April 24, 2013 and commenced operations on August 8, 2013. We make substantially all of our investments, and conduct substantially all of our real estate lending business, through Terra Property Trust, which has elected to be taxed as a REIT for U.S. federal income tax purposes commencing with its taxable year ended December 31, 2016. Our investment objectives are to (i) preserve our members’ capital contributions, (ii) realize income from our investments and (iii) make monthly distributions to our members from cash generated from investments. There can be no assurances that we will be successful in meeting our investment objectives.
On January 1, 2016, the Terra Funds merged with and into our subsidiaries through a series of separate mergers (collectively, the “Merger”). Following the Merger, we contributed the consolidated portfolio of net assets of the Terra Funds to Terra Property Trust in exchange for all of its common shares. We elected to engage in these transactions, which we refer to as the “REIT formation transactions,” to make our investments through Terra Property Trust and to provide our members with a more broadly diversified portfolio of assets, while providing us with enhanced access to capital and borrowings, lower operating costs and enhanced opportunities for growth.
On March 2, 2020, Terra Fund 1, Terra Fund 2 and Terra Fund 3 merged with and into Terra Fund 4, with Terra Fund 4 continuing as the surviving company (the “Terra Fund Merger”), and we consolidated our holdings of shares of common stock of Terra Property Trust in Terra Fund 4. Subsequent to the Terra Fund Merger, the legal name of Terra Fund 4 was changed to Terra JV. On March 2, 2020, Terra Property Trust engaged in a series of transactions pursuant to which Terra Property Trust issued an aggregate of 4,574,470.35 shares of its common stock in exchange for the settlement of an aggregate of $49.8 million of participation interests in loans that Terra Property Trust owned, cash of $25.5 million and other working capital. On April 29, 2020, Terra Property Trust repurchased, at a purchase price of $17.02 per share, 212,691 shares of common stock that Terra Property Trust had previously sold to Terra Offshore REIT on September 30, 2019.
On October 1, 2022, pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022, Terra BDC merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the merger (the “BDC Merger”) and as a wholly owned subsidiary of Terra Property Trust. Following the consummation of the BDC Merger and as of December 31, 2022, Terra JV, former shareholders of Terra BDC and Terra Offshore REIT held 70.0%, 19.9% and 10.1% of the issued and outstanding shares of Terra Property Trust’s newly designated Class B Common Stock, par value $0.01 per share (“TPT Class B Common Stock”), respectively; and we and Terra Fund 7 owned an 87.6% and 12.4% interest, respectively, in Terra JV. Accordingly, as of December 31, 2022, we indirectly beneficially owned 61.3% of the outstanding shares of TPT Class B Common Stock of Terra Property Trust through Terra JV.
On the date that is 180 calendar days (or, if such date is not a business day, the next business day) after the date (the “First Conversion Date”) of initial listing of shares of Terra Property Trust’s Class A Common Stock, $0.01 par value per share (“TPT Class A Common Stock”), for trading on a national securities exchange or such earlier date as approved by Terra Property Trust’s board of directors (the “TPT Board”), one-third of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock. On the date that is 365 calendar days (or, if such date is not a business day, the next business day) after the date of initial listing of shares of TPT Class A Common Stock for trading on a national securities exchange or such earlier date following the First Conversion Date as approved by the TPT Board (the “Second Conversion Date”), one-half of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock. On the date that is 545 calendar days (or, if such date is not a business day, the next business day) after the date of initial listing of shares of TPT Class A Common Stock for trading on a national securities exchange or such earlier date following the Second Conversion Date as approved by the TPT Board(the
“Third Conversion Date”), all of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock.
Each of the loans was originated by Terra Capital Partners or its affiliates. The portfolio is diversified based on location of the underlying properties, loan structure and property type. As of December 31, 2022, the portfolio included underlying properties located in 31 markets, across ten states and includes property types such as multifamily housing, hotels, student housing, commercial offices, medical offices, mixed-use and industrial properties. The profile of these properties ranges from stabilized and value-added properties to pre-development and construction. The loans are structured across mezzanine debt, first mortgages, preferred equity investments and credit facilities.
Our sole member and managing member is Terra Fund Advisors, a registered investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). Terra Property Trust’s investment activities are externally managed by Terra REIT Advisors, a private investment firm affiliated with us, pursuant to a management agreement dated February 8, 2018 (the “Management Agreement”). Under the terms of the Management Agreement, the REIT Manager provides certain services to Terra Property Trust and Terra Property Trust pays fees associated with such services.
Our Manager intends to treat us as a partnership and not as an association or “publicly traded partnership,” taxed as a corporation for U.S. federal income tax purposes. Terra Property Trust has elected to be taxed as a REIT for U.S. federal income tax purposes commencing with its taxable year ended December 31, 2016. So long as Terra Property Trust qualifies as a REIT, it generally is not subject to U.S. federal income tax on its net taxable income to the extent that it annually distributes all of its net taxable income to its stockholders. We also operate our business in a manner that will permit us to be excluded from registration as an investment company under the 1940 Act.
Our Manager and Terra Capital Partners
Our sole member and managing member is our Manager. The external manager of Terra Property Trust is the REIT Manager. Both our Manager and the REIT Manager are registered as investment advisers under the Advisers Act.
On April 1, 2021, MAVIK Capital Management, LP (“Mavik”), an entity controlled by Vikram S. Uppal, our Chief Executive Officer, completed a series of related transactions that resulted in all of the outstanding interests in Terra Capital Partners being acquired by Mavik for a combination of cash and interests in Mavik (the “Recapitalization”). As part of the Recapitalization, a private fund managed by a division of a publicly-traded alternative asset manager, acquired a passive interest consisting of “non-voting securities,” as that term is defined under the 1940 Act, in Mavik.
Terra Capital Partners is led by Vikram S. Uppal (Chief Executive Officer), Gregory M. Pinkus (Chief Financial Officer) and Daniel Cooperman (Chief Originations Officer). Mr. Uppal was a Partner of Axar Capital Management L.P. (“Axar Capital Management”) and its Head of Real Estate. Prior to Axar Capital Management, Mr. Uppal was a Managing Director on the Investment Team at Fortress Investment Group’s Credit and Real Estate Funds and Co-Head of North American Real Estate Investments at Mount Kellett Capital Management. Members of the Terra Capital Partners management team have broad based, long-term relationships with major financial institutions, property owners and commercial real estate service providers. The entire senior management team has held leadership roles at many top international real estate and investment banking firms, including Mount Kellett Capital Management and Fortress Investment Group.
The REIT Manager is a subsidiary, and our Manager is an affiliate, of Terra Capital Partners, a real estate credit focused investment manager based in New York City with a 19-year track record focused primarily on the origination and management of mezzanine loans, as well as first mortgage loans, bridge loans and preferred equity investments in all major property types through multiple public and private pooled investment vehicles. Since its formation in 2001 and its commencement of operations in 2002, Terra Capital Partners has been engaged in providing financing on commercial properties of all major property types throughout the United States. In the lead up to the global financial crisis in 2007, believing that the risks associated with commercial real estate markets had grown out of proportion to the potential returns from such markets, Terra Capital Partners sold 100% of its investment management interests prior to the global financial crisis. It was not until mid-2009, after its assessment that commercial mortgage markets would begin a period of stabilization and growth, that Terra Capital Partners began to sponsor new investment vehicles, which included the predecessor private partnerships, to again provide debt capital to commercial real estate markets. The financings provided by all vehicles managed by Terra Capital Partners from January 2004 through December 31, 2022 have been secured by approximately 13.9 million square feet of office properties, 3.7 million square feet of retail properties, 5.9 million square feet of industrial properties, 5,058 hotel rooms and 28,493 apartment units. The value of the properties underlying this capital was approximately $11.2 billion based on appraised values as of the closing dates of each financing. In addition to its extensive experience originating and managing debt financings, Terra Capital Partners and its affiliates owned and operated over six million square feet of office and industrial space between 2005
and 2007, and this operational experience further informs its robust origination and underwriting standards and enables the REIT Manager to effectively operate property underlying a financing upon a foreclosure.
Our Investment Objective and Strategy
Our primary investment objectives are to:
•preserve our members’ capital contributions;
•realize income from our investment; and
•make monthly distributions to our members from cash generated by our investment.
We focus on providing commercial real estate loans to creditworthy borrowers and seek to generate an attractive and consistent low volatility cash income stream. Our focus on originating debt and debt-like instruments emphasizes the payment of current returns to investors and the preservation of invested capital.
The management teams of our Manager and the REIT Manager have extensive experience in originating, managing and disposing of real estate-related loans. The REIT Manager seeks to:
•target middle market loans of approximately $10 million to $50 million;
•focus on the origination of new loans, not on the acquisition of loans originated by other lenders;
•invest primarily in floating rate rather than fixed rate loans, but the REIT Manager reserves the right to make debt investments that bear interest at a fixed rate;
•originate loans expected to be repaid within one to five years;
•maximize current income;
•lend to creditworthy borrowers;
•construct a portfolio that is diversified by property type, geographic location, tenancy and borrower;
•source off-market transactions; and
•hold loans until maturity unless, in the REIT Manager’s judgment, market conditions warrant earlier disposition.
Our Financing Strategy
We have historically utilized only limited amounts of borrowings as part of our financing strategy. One of the reasons we completed the REIT formation transactions, as described under “— Overview,” is to expand our financing options, access to capital and capital flexibility in order to position us for future growth. We deploy moderate amounts of leverage as part of our operating strategy, which currently consists of unsecured notes payable, borrowings under first mortgage financings, a revolving line of credit, repurchase agreements and a term loan. We may in the future also deploy leverage through other credit facilities and senior notes and we may divide the loans we originate into senior and junior tranches and dispose of the more senior tranches as an additional means of providing financing to our business. In addition, we intend to match our use of floating rate leverage with floating rate investments.
As of December 31, 2022, Terra Property Trust had outstanding indebtedness, consisting of borrowings under a mortgage loan of $29.3 million, unsecured notes payable of $123.5 million, a term loan of $25.0 million, a line of credit of $90.1 million and the repurchase agreements of $170.9 million. As of December 31, 2022, the amount remaining available under the line of credit and the repurchase agreements was $34.9 million and $224.1 million, respectively.
Additionally, as of December 31, 2022, Terra Property Trust had obligations under participation agreements of $12.6 million. However, Terra Property Trust does not have direct liability to a participant under the participation agreements with respect to the underlying loan and the participants’ share of the investments is repayable only from the proceeds received from the related borrower/issuer of the investments and, therefore, the participants also are subject to credit risk (i.e., risk of default
by the underlying borrower/ issuer). With its larger size and enhanced access to capital and capital flexibility, Terra Property Trust expects to deemphasize its use of participation arrangements. For additional information concerning our indebtedness, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report on Form 10‑K.
Targeted Assets
Real Estate-Related Loans
Through Terra Property Trust, we originate, structure, fund and manage commercial real estate loans, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments related to high-quality commercial real estate in the United States. We may also, to the extent consistent with Terra Property Trust’s qualification as a REIT, acquire equity participations in the underlying collateral of some of such loans. Terra Property Trust originates, structures and underwrites most, if not all, of its loans. Terra Property Trust, in reliance on the REIT Manager, uses what we consider to be conservative underwriting criteria, and our underwriting process involves comprehensive financial, structural, operational and legal due diligence to assess the risks of financings so that we can optimize pricing and structuring. By originating, not purchasing, loans, Terra Property Trust is able to structure and underwrite financings that satisfy our standards, utilize our proprietary documentation and establish a direct relationship with our borrower. Described below are some of the types of loans we own and seek to originate with respect to high-quality properties in the United States. We continue to see attractive lending opportunities, and we expect market conditions to remain favorable for our strategy for the foreseeable future.
Mezzanine Loans. These are loans secured by ownership interests in an entity that owns commercial real estate and that generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. Mezzanine loans may be either short-term (one to five years) or long-term (up to 10 years) and may be fixed or floating rate. We may own mezzanine loans directly or we may hold a participation in a mezzanine loan or a sub-participation in a mezzanine loan. These loans generally pay interest on a specified due date (although there may be a portion of the interest that is deferred) and may, to the extent consistent with Terra Property Trust’s qualification as a REIT, provide for participation in the value or cash flow appreciation of the underlying property as described below. Generally, we invest in mezzanine loans with last dollar loan-to-value ratios ranging from 60% to 85%. As of December 31, 2022, Terra Property Trust owned five mezzanine loans with a total net principal amount of $26.8 million, which constituted 4.2% of its net loan investment portfolio.
Preferred Equity Investments. These are investments in preferred membership interests in an entity that owns commercial real estate and generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. These investments are expected to have characteristics and returns similar to mezzanine loans. As of December 31, 2022, Terra Property Trust owned five preferred equity investments with a total net principal amount of $121.2 million, which constituted 19.1% of its net loan investment portfolio..
First Mortgage Loans. These loans generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. First mortgage loans may be either short-term (one to five years) or long-term (up to 10 years), may be fixed or floating rate and are predominantly current-pay loans. The REIT Manager originates current-pay first mortgage loans backed by high-quality properties in the United States. that fit our investment strategy. Certain of our first mortgage loans finance the acquisition, rehabilitation and construction of infill land property and for these loans we target a weighted average last dollar loan-to-value of 70%. We may selectively syndicate portions of our first mortgage loans, including senior or junior participations to provide third-party financing for a portion of the loan or optimize returns which may include retained origination fees.
First mortgage loans are expected to provide for a higher recovery rate and lower defaults than other debt positions due to the lender’s senior position. However, such loans typically generate lower returns than subordinate debt such as mezzanine loans, B-notes, or preferred equity investments. As of December 31, 2022, Terra Property Trust owned 20 first mortgage loans with a total net principal amount of $456.4 million, which constituted 72.1% of its net loan investment portfolio. As of December 31, 2022, Terra Property Trust used $413.1 million of senior mortgage loans as collateral for $261.0 million of borrowings under a revolving line of credit and two repurchase agreements.
Subordinated Mortgage Loans (B-notes). B-notes include structurally subordinated mortgage loans and junior participations in first mortgage loans or participations in these types of assets. Like first mortgage loans, these loans generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. B-notes may be either short-term (one to five years) or long-term (up to 10 years), may be fixed or floating rate and are predominantly current-pay loans. We may create B-notes by tranching our directly originated first mortgage loans generally through syndications of senior first mortgages or buy these loans directly from third-party originators. As a result of the current credit market disruption related to
the most recent recession and the decrease in capital available in this part of the capital structure, we believe that the opportunities to both directly originate and to buy these types of loans from third-parties on favorable terms will continue to be attractive.
Investors in B-notes are compensated for the increased risk of such assets from a pricing perspective but still benefit from a mortgage lien on the related property. Investors typically receive principal and interest payments at the same time as senior debt unless a default occurs, in which case any such payments are made only after any senior debt is made whole. Rights of holders of B-notes are usually governed by participation and other agreements that, subject to certain limitations, typically provide the holders of subordinated positions of the mortgage loan with the ability to cure certain defaults and control certain decisions of holders of senior debt secured by the same properties (or otherwise exercise the right to purchase the senior debt), which provides for additional downside protection and higher recoveries. As of December 31, 2022, Terra Property Trust did not own any B-notes.
Equity Participations. In connection with our loan origination activities, we may pursue equity participation opportunities, or interests in the projects being financed, in instances when we believe that the risk-reward characteristics of the loan merit additional upside participation because of the possibility of appreciation in value of the underlying properties securing the loan. Equity participations can be paid in the form of additional interest, exit fees or warrants in the borrower. Equity participation can also take the form of a conversion feature, permitting the lender to convert a loan or preferred equity investment into equity in the borrower at a negotiated premium to the current net asset value of the borrower. We expect to obtain equity participations in certain instances where the loan collateral consists of a property that is being repositioned, expanded or improved in some fashion which is anticipated to improve future cash flow. In such case, the borrower may wish to defer some portion of the debt service or obtain higher leverage than might be merited by the pricing and leverage level based on historical performance of the underlying property. We can generate additional revenues from these equity participations as a result of excess cash flows being distributed or as appreciated properties are sold or refinanced. As of December 31, 2022, Terra Property Trust did not own any equity participations.
Other Real Estate-Related Investments. We may, through Terra Property Trust, invest in other real estate-related investments, which may include CMBS or other real estate debt or equity securities, so long as such investments do not constitute more than 15% of our assets. Certain of our real estate-related loans require the borrower to make payments of interest on the fully committed principal amount of the loan regardless of whether the full loan amount is outstanding. As of December 31, 2022, Terra Property Trust owned 27.9% equity interest in a limited partnership that invests in performing and non-performing mortgages, loans, mezzanines, B-notes and other credit instruments supported by underlying commercial real estate assets. Additionally, Terra Property Trust beneficially owned equity interests in three joint ventures that invest in real estate properties. Terra Property Trust also owned a credit facility that is collateralized by underlying commercial real estate assets. In 2022, in connection with a mezzanine loan Terra Property Trust originated, Terra Property Trust entered into a residual profit sharing arrangement with the borrower. Terra Property Trust accounted for this arrangement as an equity investment. These equity interests had a total carrying value of $62.5 million and the credit facility had a principal balance of $28.8 million as of December 31, 2022.
Operating Real Estate
From time to time, Terra Property Trust may acquire operating real estate properties, including properties acquired in connection with foreclosures or deed in lieu of foreclosure. In July 2018, Terra Property Trust acquired a multi-tenant office building through foreclosure of a first mortgage loan. In January 2019, Terra Property Trust acquired a 4.9 acre development parcel through deed in lieu of foreclosure. In June 2022, the development parcel was sold. As of December 31, 2022, the multi-tenant office building had a carrying value of $40.6 million, and the mortgage loan payable encumbering the office building had a principal amount of $29.3 million.
Investment Guidelines
The TPT Board adopted investment guidelines, which may be amended from time to time, that set forth certain criteria for the REIT Manager to use when evaluating specific investment opportunities as well as its overall portfolio composition. The TPT Board will review the REIT Manager’s compliance with the investment guidelines periodically and receive an investment report at each quarter-end in conjunction with the review of its quarterly results by its board of directors.
The TPT Board adopted the following investment guidelines:
•no origination or acquisition shall be made that would cause Terra Property Trust to fail to qualify as a REIT;
•no origination or acquisition shall be made that would cause Terra Property Trust or any of its subsidiaries to be required to register as an investment company under the 1940 Act; and
•until appropriate investments can be identified, Terra Property Trust may invest the proceeds of its equity or debt offerings in interest-bearing, short-term investments, including money market accounts and/or funds, that are consistent with its intention to qualify as a REIT.
These investment guidelines may be changed from time to time by a majority of the TPT Board without the approval of its stockholders.
Disposition Policies
The period Terra Property Trust holds its investments in real estate-related loans varies depending on the type of asset, interest rates and other factors. The REIT Manager had developed a well-defined exit strategy for each of Terra Property Trust’s investments. The REIT Manager continually performs a hold-sell analysis on each asset in order to determine the optimal time to hold the asset and generate a strong return to Terra Property Trust’s stockholders. Economic and market conditions may influence Terra Property Trust to hold investments for longer or shorter periods of time. Terra Property Trust may sell an asset before the end of the expected holding period if it believes that market conditions have maximized its value to us or the sale of the asset would otherwise be in our best interests. Terra Property Trust intends to make any such dispositions in a manner consistent with its qualification as a REIT and its desire to avoid being subject to the “prohibited transaction” penalty tax.
Operating and Regulatory Structure
REIT Qualification
Terra Property Trust elected to be taxed as a REIT under the Internal Revenue Code commencing with its taxable year ended December 31, 2016. We believe that Terra Property Trust has been organized and has operated in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code, and that its manner of operation will enable it to continue to meet the requirements for qualification and taxation as a REIT. To qualify as a REIT, Terra Property Trust must meet on a continuing basis, through its organization and actual investment and operating results, various requirements under the Internal Revenue Code relating to, among other things, the sources of its gross income, the composition and values of its assets, its distribution levels and the diversity of ownership of shares of its stock. If Terra Property Trust fails to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, it will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which it failed to qualify as a REIT. Even if Terra Property Trust qualifies for taxation as a REIT, it may be subject to some U.S. federal, state and local taxes on its income or property. In addition, subject to maintaining Terra Property Trust’s qualification as a REIT, a portion of its business may be conducted through, and a portion of its income may be earned with respect to, its taxable REIT subsidiaries (“TRSs”), should it decide to form TRSs in the future, which are subject to corporate income tax. Any distributions paid by Terra Property Trust generally will not be eligible for taxation at the preferential U.S. federal income tax rates that currently apply to certain distributions received by individuals from taxable corporations, unless such distributions are attributable to dividends received by Terra Property Trust from its TRSs, should it form a TRS in the future.
1940 Act Exclusion
Neither we nor Terra Property Trust are registered as an investment company under the 1940 Act. If we or Terra Property Trust were obligated to register as an investment company, we or Terra Property Trust would have to comply with a variety of substantive requirements under the 1940 Act that impose, among other things:
•limitations on our capital structure and the use of leverage;
•restrictions on specified investments;
•prohibitions on transactions with affiliates; and
•compliance with reporting, record keeping, and other rules and regulations that would significantly change our and Terra Property Trust’s operations.
We and Terra Property Trust conduct our operations, and intend to continue to conduct our operations, so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exclusion from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. Because we are organized as a holding company and conduct our business primarily through Terra Property Trust, the value of the “investment securities” held by an issuer must be less than 40% of the value of such issuer’s total assets on an unconsolidated basis (exclusive of U.S. government securities and cash items). In addition, we conduct our operations so that we will not be considered an investment company under Section 3(a)(1)(A) of the 1940 Act, as we are not engaged primarily nor do we hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through Terra Property Trust, we are primarily engaged in the non-investment company businesses.
Terra Property Trust and certain of its subsidiaries may at times reply primarily on the exclusion from the definition of an investment company under Section 3(c)(5)(C) of the 1940 Act, or any other exclusions available to Terra Property Trust and its subsidiaries (other than Section 3(c)(1) or Section 3(c)(7)). Section 3(c)(5)(C) of the 1940 Act is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exclusion generally requires that at least 55% of Terra Property Trust’s (and any of its subsidiaries relying on Section 3(c)(5)(C)) portfolio must be comprised of “qualifying real estate” assets and at least 80% of Terra Property Trust’s (and any of its subsidiaries’, in relying on Section 3(c)(5)(C)) portfolio must be comprised of “qualifying real estate” assets and “real estate-related” assets (and no more than 20% comprised of miscellaneous assets) as determined in accordance with the 1940 Act and the rules and regulations promulgated thereunder. For purposes of the exclusion provided by Section 3(c)(5)(C) of the 1940 Act, Terra Property Trust (and any of its subsidiaries relying on Section 3(c)(5)(C)) classifies its investments based in large measure on no-action letters issued by the SEC staff and other SEC interpretive guidance and, in the absence of SEC guidance, on our view of what constitutes a “qualifying real estate” asset and a “real estate-related” asset. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations Terra Property Trust (and any of its subsidiaries relying on Section 3(c)(5)(C)) may face, and a number of these no-action positions were issued more than twenty years ago. Pursuant to this guidance, and depending on the characteristics of the specific investments, certain mortgage loans, participations in mortgage loans, mortgage-backed securities, mezzanine loans, joint venture investments, preferred equity and equity securities of other entities may not constitute qualifying real estate assets and therefore investments in these types of assets may be limited. No assurance can be given that the SEC or its staff will concur with our classification of the assets held by Terra Property Trust and any of its subsidiaries for the purposes of the 3(c)(5)(C) exclusion or any other exclusion or exemption under the 1940 Act. Future revisions to the 1940 Act or further guidance from the SEC or its staff may cause us, Terra Property Trust, or any of its subsidiaries relying on Section 3(c)(5)(C) to lose our or their exclusion from registration, or force us, Terra Property Trust, or any of its subsidiaries to re-evaluate our or their portfolios and our or their investment strategy. Such changes may prevent us from operating our business successfully.
Further, in order to maintain an exclusion from registration under the 1940 Act, we may be unable to sell assets that we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income or loss generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire assets that we would otherwise want to acquire and would be important to its strategy.
Although we monitor the portfolio of Terra Property Trust and its subsidiaries periodically and prior to each acquisition and disposition, Terra Property Trust or its subsidiaries may not be able to maintain an exclusion from registration as an investment company. If Terra Property Trust or its subsidiaries were required to register as an investment company, but failed to do so, Terra Property Trust or its subsidiaries failing to so qualify would be prohibited from engaging in their business, and legal proceedings could be instituted against Terra Property Trust or any of its subsidiaries failing to so qualify. In addition, the contracts of Terra Property Trust or any of its subsidiaries failing to so qualify may be unenforceable, and a court could appoint a receiver to take control of Terra Property Trust or any of its subsidiaries failing to so qualify and liquidate their business.
Emerging Growth Company Status
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”), and as such, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended, reduced disclosure obligations
regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and unitholder approval of any golden parachute payments not previously approved. A number of these exemptions are not relevant to us, but we intend to take advantage of the exemption from the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
In addition, Section 107 of the JOBS Act provides that an emerging growth company can use the extended transition period provided in Section 13(a) of the Exchange Act for complying with new or revised accounting standards. This permits an emerging growth company to delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to take advantage of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.
We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.07 billion, (ii) the date on which we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, (iii) the date on which we have issued more than $1.0 billion in non-convertible debt during the preceding three-year period, and (iv) the end of the year in which the five-year anniversary of an initial public offering of our units occurs.
Term and Liquidity
Our amended and restated operating agreement provides that our existence will continue until December 31, 2023, unless sooner terminated. However, we expect that prior to such date we will consummate a liquidity transaction, which could occur as early as 2023 and may include an orderly liquidation of our assets or an alternative liquidity event such as a strategic business combination, a sale of our company or an initial public offering and listing or a direct listing of Terra Property Trust’s shares of common stock on a national securities exchange. The Manager would pursue an alternative liquidity event only if it believes such a transaction would be in the best interests of our members.
Competition
We compete with REITs, numerous regional and community banks, specialty finance companies, savings and loan associations and other entities, and we expect that others may be organized in the future. The effect of the existence of additional REITs and other institutions may be increased competition for the available supply of our targeted assets suitable for purchase, which may cause the price for such assets to rise.
In the face of this competition, we expect to have access to our Manager’s professionals and their industry expertise, which may provide us with a competitive advantage in sourcing transactions and help us assess origination and acquisition risks and determine appropriate pricing for potential assets. The more conservative underwriting standards used by many large commercial banks and traditional providers of commercial real estate capital following the 2008 downturn has, and we believe, will continue to constrain the lending capacity of these institutions. However, we may not be able to achieve our business goals or expectations due to the competitive risks that we face. For additional information concerning these competitive risks, see “Item 1A. Risk Factors — New entrants in the market for commercial loan originations and acquisitions could adversely impact our ability to originate and acquire real estate-related loans at attractive risk-adjusted returns” in this annual report on Form 10–K.
Governmental Regulations
As an owner of real estate, our operations are subject, in certain instances, to supervision and regulation by U.S. and other governmental authorities, and may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions, which, include among other things: (i) federal and state securities laws and regulations; (ii) federal, state and local tax laws and regulations, (ii) state and local laws relating to real property; (iv) federal, state and local environmental laws, ordinances, and regulations, and (v) various laws relating to housing, including permanent and temporary rent control and stabilization laws, the Americans with Disabilities Act of 1990 and the Fair Housing Amendment Act of 1988, among others.
Compliance with the federal, state and local laws described above has not had a material, adverse effect on our business, assets, results of operations, financial condition and ability to pay distributions, and we do not believe that our existing portfolio will require us to incur material expenditures to comply with these laws and regulations.
Employees; Staffing; Human Capital
Our sole managing member is our Manager. We conduct substantially all of our business through Terra Property Trust, which is supervised by the TPT Board consisting of six directors. Terra Property Trust has entered into a Management Agreement with the REIT Manager pursuant to which certain services are provided by the REIT Manager and paid for by Terra Property Trust. The REIT Manager is not obligated under the Management Agreement to dedicate any of its personnel exclusively to us, nor is it or its personnel obligated to dedicate any specific portion of its or their time to our business. We are responsible for the costs of our own employees; however, we do not currently have any employees and do not currently expect to have any employees. See “Item 10. Directors, Executive Officers and Corporate Governance” in this annual report on Form 10-K.
Available Information
We are subject to the information requirements of the Exchange Act. Therefore, we file periodic reports and other information with the SEC. The SEC maintains a website at www.sec.gov where our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and other filings we make with the SEC, including amendments to such filings, may be obtained free of charge. Our reports can be viewed and downloaded from our password protected website free of charge. Our investors and advisors may submit a request for access to the website at www.terrafund5.com. The information on our website does not form a part of and is not incorporated by reference into this annual report on Form 10-K.
Item 1A. Risk Factors.
Investing in our units involves a high degree of risk. Investors should carefully consider the following risk factors and all other information contained in this annual report on Form 10-K. The risks set forth below are not the only risks we face, and we may face other risks that we have not yet identified, which we do not currently deem material or which are not yet predictable. If any of the following risks occur, our business, financial condition, liquidity and results of operations could be materially and adversely affected. In that case, the value of our units could decline, and members may lose some or all of their investment. Some statements in this section constitute forward-looking statements. See “Forward-Looking Statements.”
Risks Related to Our Business
Changes in national, regional or local economic, demographic or real estate market conditions may adversely affect our results of operations, our financial position, the value of our assets and our cash flows.
We are subject to risks incident to the ownership of real estate-related assets including: changes in national, regional or local economic, demographic or real estate market conditions; changes in supply of, or demand for, similar properties in an area; increased competition for real estate assets targeted by our investment strategy; bankruptcies, financial difficulties or lease defaults by property owners and tenants; inflation; changes in interest rates and availability of financing; and changes in government rules, regulations and fiscal policies, including changes in tax, real estate, environmental and zoning laws. Our assets are also subject to the risk of significant adverse changes in financial market conditions that can result in a deleveraging of the global financial system and the forced sale of large quantities of mortgage-related and other financial assets. Concerns over economic recession, inflation, geopolitical issues, including events such as Russia’s invasion of Ukraine, the United Kingdom’s exit from the European Union, unemployment, the availability and cost of finance, or a prolonged government shutdown may contribute to increased volatility and diminished expectations for the economy and markets, which could result in an increase in mortgage defaults or a decline in the value of our assets. In addition, any increase in mortgage defaults in the residential market may have a negative impact on the credit markets generally as well as on economic conditions generally. We do not know whether the values of the property securing our real estate-related loans will remain at the levels existing on the dates of origination of such loans, and we are unable to predict future changes in national, regional or local economic, demographic or real estate market conditions. These conditions, or others we cannot predict, may adversely affect our results of operations, our financial position, the value of our assets and our cash flows.
Inflation in the U.S. has accelerated recently and is currently expected to continue at an elevated level in the near-to medium-term, which may have an adverse impact on the valuation of our investments.
Inflation in the U.S. has accelerated recently and is currently expected to continue at an elevated level in the near-to medium-term. Further, heightened competition for workers, supply chain issues, the relocation of foreign production and manufacturing businesses to the U.S., and rising energy and commodity prices have contributed to increasing wages and other economic inputs. Higher inflation and rising input costs may have adverse effects on our commercial real estate-related loans,
commercial real estate-related debt securities and select commercial real estate equity investments, which are subject to the risks typically associated with real estate. Inflation can negatively impact the profitability of real estate assets with long-term leases that do not provide for short-term rent increases or that provide for rent increases with a lower annual percentage increase than inflation. Continued inflation, particularly at higher levels, may have an adverse impact on the valuation of our investments.
The lack of liquidity of our assets may adversely affect our business, including our ability to value and sell our assets.
A portion of the real estate-related loans and other assets we originate or acquire may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly-traded securities. The illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less value than the value at which we have previously recorded our assets. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations, financial condition and cash flows.
Terra Property Trust’s investments are selected by the REIT Manager and our unitholders will not have input into investment decisions.
Pursuant to the terms of the Management Agreement, the REIT Manager is responsible for, among other services, managing the investment and reinvestment of Terra Property Trust’s assets, subject to the oversight and supervision of the TPT Board. Our unitholders will not have input into investment decisions. This will increase the uncertainty, and thus the risk, of investing in our units, as we may make investments with which you may not agree. Our Manager or its affiliates intends to conduct due diligence with respect to each investment and suitable investment opportunities may not be immediately available. The failure of our Manager or its affiliates to find investments that meet our investment criteria in sufficient time or on acceptable terms could result in unfavorable returns and could cause a material adverse effect on our results of operations, financial condition and cash flows. Even if investment opportunities are available, there can be no assurance that the due diligence processes of our Manager or its affiliates will uncover all relevant facts or that any particular investment will be successful.
From time to time, before appropriate real estate-related investments can be identified, our Manager or its affiliates may choose to have us invest in interest-bearing, short-term investments, including money market accounts and/or funds, that are consistent with Terra Property Trust’s intention to maintain its qualification as a REIT. These short-term, non-real estate-related investments, if any, are expected to provide a lower net return than we will seek to achieve from investments in real estate-related loans and other commercial real estate assets. Furthermore, when our Manager or its affiliates does identify suitable real estate-related loans and other commercial real estate assets that are the types of assets which we target, you will be unable to influence the decision of our Manager or its affiliates ultimately to invest in, or refrain from investing in, such assets.
Our Manager’s or its affiliates’ due diligence of potential real estate-related loans and other commercial real estate assets may not reveal all of the liabilities associated with such assets and may not reveal other weaknesses in our assets, which could lead to investment losses.
Before originating or acquiring a financing, our Manager or its affiliates calculates the level of risk associated with the real estate-related loans and other commercial real estate assets to be originated or acquired based on several factors which include the following: top-down reviews of both the current macroeconomic environment generally and the real estate and commercial real estate loan market specifically; detailed evaluation of the real estate industry and its sectors; bottom-up reviews of each individual investment’s attributes and risk/reward profile relative to the macroeconomic environment; and quantitative cash flow analysis and impact of the potential investment on our portfolio. In making the assessment and otherwise conducting customary due diligence, we employ standard documentation requirements and require appraisals prepared by local independent third-party appraisers selected by us. Additionally, we seek to have borrowers or sellers provide representations and warranties on loans we originate or acquire, and if we are unable to obtain representations and warranties, we factor the increased risk into the price we pay for such loans. Despite our review process, there can be no assurance that our due diligence process will uncover all relevant facts or that any investment will be successful.
If our Manager or its affiliates underestimates the borrower’s credit analysis or originates loans by using an exception to their loan underwriting guidelines, we may experience losses.
Our Manager or its affiliates values our real estate-related loans based on an initial credit analysis and the investment’s expected risk-adjusted return relative to other comparable investment opportunities available to us, taking into account estimated future losses on the loans, and the estimated impact of these losses on expected future cash flows. The loss estimates
may not prove accurate, as actual results may vary from estimates. In the event that our Manager or its affiliates underestimates the losses relative to the price we pay for a particular investment, we may experience losses with respect to such investment, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
Further, from time to time and in the ordinary course of business, our Manager or its affiliates may make exceptions to our predetermined loan underwriting guidelines. Loans originated with exceptions may result in a higher number of delinquencies and defaults, which could have a material and adverse effect on our results of operations, financial condition and cash flows.
Deficiencies in appraisal quality in the mortgage loan origination process may result in increased principal loss severity.
During the loan underwriting process, appraisals are generally obtained on the collateral underlying each prospective loan. The quality of these appraisals may vary widely in accuracy and consistency. The appraiser may feel pressure from the broker or lender to provide an appraisal in the amount necessary to enable the originator to make the loan, whether or not the value of the property justifies such an appraised value. Inaccurate or inflated appraisals may result in an increase in the severity of losses on the loans, which could have a material and adverse effect on our results of operations, financial condition and cash flows.
Our Manager or its affiliates utilizes analytical models and data in connection with the valuation of our real estate-related loans and other commercial real estate assets, and any incorrect, misleading or incomplete information used in connection therewith would subject us to potential risks.
As part of the risk management process our Manager or its affiliates uses detailed proprietary models, including loan level non-performing loan models, to evaluate collateral liquidation timelines and price changes by region, along with the impact of different loss mitigation plans. Additionally, our Manager or its affiliates uses information, models and data supplied by third parties. Models and data are used to value potential targeted assets. In the event models and data prove to be incorrect, misleading or incomplete, any decisions made in reliance thereon expose us to potential risks. For example, by relying on incorrect models and data, especially valuation models, our Manager or its affiliates may be induced to buy certain targeted assets at prices that are too high, to sell certain other assets at prices that are too low or to miss favorable opportunities altogether. Similarly, any hedging based on faulty models and data may prove to be unsuccessful. If any of the aforementioned occur, such event could have a material adverse effect on our results of operations, financial condition and cash flows.
Changes in interest rates could adversely affect the demand for our target loans, the value of our loans, CMBS, and other real-estate debt or equity assets and the availability and yield on our targeted assets.
We invest in real estate-related loans and other commercial real estate assets, which are subject to changes in interest rates. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Rising interest rates generally reduce the demand for mortgage loans due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of our targeted assets available to us, which could adversely affect our ability to originate and acquire assets that satisfy our objectives. Rising interest rates may also cause our targeted assets that were issued prior to an interest rate increase to provide yields that are below prevailing market interest rates. If rising interest rates cause us to be unable to originate or acquire a sufficient volume of our targeted assets with a yield that is above our borrowing cost, our ability to satisfy our objectives and to generate income and make distributions may be materially and adversely affected. Conversely, if interest rates decrease, we will be adversely affected to the extent that real estate-related loans are prepaid, because we may not be able to make new loans at the previously higher interest rate.
The relationship between short-term and longer-term interest rates is often referred to as the “yield curve.” Ordinarily, short-term interest rates are lower than longer-term interest rates. If short-term interest rates rise disproportionately relative to longer-term interest rates (a flattening of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on our assets. Because our loans and CMBS assets generally will bear, on average, interest based on longer-term rates than our borrowings, a flattening of the yield curve would tend to decrease our net income and the fair market value of our net assets. Additionally, to the extent cash flows from loans and CMBS assets that return scheduled and unscheduled principal are reinvested, the spread between the yields on the new loans and CMBS assets and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve inversion), in which event our borrowing costs may exceed our interest income and we could incur operating losses.
The values of our loans and CMBS assets may decline without any general increase in interest rates for a number of reasons, such as increases or expected increases in defaults, or increases or expected increases in voluntary prepayments for those loans and CMBS assets that are subject to prepayment risk or widening of credit spreads.
In addition, in a period of rising interest rates, our operating results will depend in large part on the difference between the income from our assets and our financing costs. We anticipate that, in most cases, the income from such assets will respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income. Increases in these rates will tend to decrease our net income, which may have a material adverse effect on our results of operations, financial condition and cash flows.
The expected discontinuance of regarding the London interbank offered rate (“LIBOR”) and transition to alternative reference rates may adversely impact our borrowings and assets.
The United Kingdom Financial Conduct Authority (“FCA”), which regulates LIBOR, has announced that the mostcommonly used tenors (overnight and one, three, six and 12 months) will cease to be published or will no longer be representative after June 30, 2023. The FCA’s announcement coincided with the March 5, 2021 announcement of LIBOR’s administrator, the ICE Benchmark Administration Limited (“IBA”), indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that any of our LIBOR-based borrowings and assets that mature beyond June 30, 2023 need to be converted to alternative interest rates. Many of Terra Property Trust’s counterparties are now subject to regulatory guidance not to enter new LIBOR contracts except in limited circumstances.
The Alternative Reference Rates Committee (“ARRC”), a group of private-market participants convened by the U.S. Federal Reserve Board and the New York Federal Reserve, has recommended the Secured Overnight Financing Rate (“SOFR”), a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, as a more robust reference rate alternative to U.S. dollar LIBOR. The use of SOFR as a substitute for U.S. dollar LIBOR is voluntary and may not be suitable for all market participants. To approximate economic equivalence to LIBOR, SOFR can be compounded over a relevant term and a spread adjustment may be added. There are significant differences between LIBOR and SOFR, such as LIBOR being an unsecured lending rate while SOFR is a secured lending rate, and SOFR is an overnight rate while LIBOR reflects term rates at different maturities. If our LIBOR-based borrowings are converted to SOFR, the differences between LIBOR and SOFR, plus the recommended spread adjustment, could result in interest costs that are higher than if LIBOR remained available, which could have a material adverse effect on our results. Although SOFR is the ARRC's recommended replacement rate, it is also possible that lenders may instead choose alternative replacement rates that may differ from LIBOR in ways similar to SOFR or in other ways that would result in higher borrowing costs for us. It is not yet possible to predict the magnitude of LIBOR’s end on Terra Property Trust’s borrowing costs given the uncertainty about which rates will replace LIBOR and the timing of actual replacement. Market practices related to SOFR calculation conventions continue to develop and may vary, and inconsistent calculation conventions may develop among financial products.
Certain of Terra Property Trust’s indebtedness, including the term loan, the repurchase agreement, the mortgage loan payable and its credit facility, as well as certain of its floating rate loan assets, are, and other future financings may be, linked to LIBOR. We are not able to predict when LIBOR will cease to be available; however, we expect that a significant portion of these financing arrangements and loan assets will not have matured, been prepaid or otherwise terminated prior to the time at which the IBA ceases to publish LIBOR. It is not possible to predict all consequences of the IBA's proposals to cease publishing LIBOR, any related regulatory actions and the expected discontinuance of the use of LIBOR as a reference rate for financial contracts. Some of our debt and loan assets may not include robust fallback language that would facilitate replacing LIBOR with a clearly defined alternative reference rate after LIBOR’s discontinuation, and we may need to amend these before the IBA ceases to publish LIBOR. If such debt or loan assets mature after LIBOR ceases to be published, our counterparties may disagree with us about how to calculate or replace LIBOR.Even when robust fallback language is included, there can be no assurance that the replacement rate plus any spread adjustment will be economically equivalent to LIBOR, which could result in a lower interest rate being paid to us on such assets. Modifications to any debt, loan assets, interest rate hedging transactions or other contracts to replace LIBOR with an alternative reference rate could result in adverse tax consequences. In addition, any resulting differences in interest rate standards among Terra Property Trust’s assets and its financing arrangements may result in interest rate mismatches between its assets and the borrowings used to fund such assets and accordingly impact the Company’s investment.
We and other market participants have less experience understanding and modeling SOFR-based assets and liabilities than LIBOR-based assets and liabilities, increasing the difficulty of investing, hedging, and risk management. Because the impact of LIBOR cessation is dependent on unknown future facts, the language of individual contracts, and the outcome of potential future legislation or litigation, it is not currently practical for our valuation models to account for the cessation of LIBOR.
The process of transition involves operational risks. References to LIBOR may be embedded in computer code or models, and we may not identify and correct all of those references. Because compounded SOFR is backward-looking rather than forward-looking, parties making or receiving LIBOR-based payments may be unable to calculate payment amounts until the day that payment is due. Proposed mechanisms to solve the operational timing issue may result in a payment amount that does not fully reflect interest rates during the calculation period.
Potential changes, or uncertainty related to such potential changes, may also adversely affect the market for LIBOR-based loans, including our portfolio of LIBOR-indexed, floating-rate loans, or the cost of our borrowings. In addition, changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the market for LIBOR-based loans, including the value of the LIBOR-indexed, floating-rate loans in Terra Property Trust’s portfolio, or the cost of its borrowings. There is no guarantee that a transition from LIBOR to an alternative will not result in financial market disruptions, significant increases in benchmark rates, or borrowing costs to borrowers, any of which could have a material adverse effect on our results of operations, financial condition, and cash flows.
New entrants in the market for commercial loan originations and acquisitions could adversely impact our ability to originate and acquire real estate-related loans at attractive risk-adjusted returns.
New entrants in the market for commercial loan originations and acquisitions could adversely impact our ability to execute our investment strategy on terms favorable to us. In originating and acquiring our targeted assets, we may compete with other REITs, numerous regional and community banks, specialty finance companies, savings and loan associations, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, other lenders and other entities, and we expect that others may be organized in the future. The effect of the existence of additional REITs and other institutions may be increased competition for the available supply of assets suitable for investment by us, which may cause the price for such assets to rise, which may limit our ability to generate desired returns. Additionally, origination of our target loans by our competitors may increase the availability of such loans which may result in a reduction of interest rates on these loans. Some competitors may have a lower cost of funds and access to funding sources that may not be available to us. Many of our competitors are not subject to the operating constraints associated with REIT tax compliance or maintenance of an exclusion or exemption from the 1940 Act. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of real estate-related loans and establish more relationships than us.
We cannot assure you that the competitive pressures we may face will not have a material adverse effect on our results of operations, financial condition and cash flows. Also, as a result of this competition, desirable investments in our targeted assets may be limited in the future and we may not be able to take advantage of attractive investment opportunities from time to time, as we can provide no assurance that we will be able to identify and make investments that are consistent with our investment objectives.
Our loans are dependent on the ability of the commercial property owner to generate net income from operating the property, which may result in the inability of such property owner to repay a loan, as well as the risk of foreclosure.
Our loans may be secured by office, multifamily, student housing, hotel, commercial or warehouse properties, and are subject to risks of delinquency, foreclosure and of loss that may be greater than similar risks associated with loans made on the security of single-family residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income-producing property can be adversely affected by, among other things:
•tenant mix;
•success of tenant businesses;
•property management decisions;
•property location, condition and design;
•competition from comparable types of properties;
•changes in national, regional or local economic conditions and/or specific industry segments;
•declines in regional or local real estate values;
•declines in regional or local rental or occupancy rates;
•increases in interest rates, real estate tax rates and other operating expenses;
•costs of remediation and liabilities associated with environmental conditions;
•the potential for uninsured or underinsured property losses;
•changes in governmental laws and regulations, including fiscal policies, zoning ordinances and environmental legislation and the related costs of compliance;
•pandemics or other calamities that may affect tenants' ability to pay their rent; and
•acts of God, terrorism, social and political unrest, armed conflict, geopolitical events and civil disturbances.
In the event of any default under a mortgage loan held directly by us, we bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our results of operations, financial condition and cash flows. In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law.
Foreclosure can be an expensive and lengthy process, and foreclosing on certain properties where we directly hold the mortgage loan and the borrower’s default under the mortgage loan is continuing could result in actions that could be costly to our operations, in addition to having a substantial negative effect on our anticipated return on the foreclosed mortgage loan. If property securing or underlying loans become real estate owned as a result of foreclosure, we bear the risk of not being able to sell the property and recovering our investment and of being exposed to the risks attendant to the ownership of real property.
Our loan portfolio may at times be concentrated in certain property types or secured by properties concentrated in a limited number of geographic areas, which increases our exposure to economic downturn with respect to those property types or geographic locations.
We are not required to observe specific diversification criteria. Therefore, our portfolio of assets may, at times, be concentrated in certain property types that are subject to higher risk of foreclosure, or secured by properties concentrated in a limited number of geographic locations.
Terra Property Trust’s loans are concentrated in California, New York, Georgia, Texas and New Jersey representing approximately 24.0%, 14.5%, 11.4%, 10.7% and 9.8%, respectively, of its net loan portfolio as of December 31, 2022. Additionally, Terra Property Trust owns a multi-tenant office building in California. If economic conditions in these or in any other state in which we have a significant concentration of borrowers were to deteriorate, such adverse conditions could have a material and adverse effect on our business by reducing demand for new financings, limiting the ability of customers to repay existing loans and impairing the value of our real estate collateral and real estate owned properties.
Further, Terra Property Trust’s loans are concentrated in office, industrial and multifamily property types representing approximately 27.1%, 23.3% and 16.5%, respectively, of its net loan portfolio as of December 31, 2022. As a result, a downturn in any particular industry in which Terra Property Trust are heavily invested may significantly impact the aggregate returns it realizes. If an industry in which Terra Property Trust is heavily invested suffers from adverse business or economic conditions, a material portion of its investment could be affected adversely, which, in turn, could adversely affect our results of operations, financial condition and cash flows.
In addition, from time to time, there have been proposals to base property taxes on commercial properties on their current market value, without any limit based on purchase price. In California, pursuant to an existing state law commonly referred to as Proposition 13, properties are reassessed to market value only at the time of change in ownership or completion of
construction, and thereafter, annual property reassessments are limited to 2% of previously assessed values. As a result, Proposition 13 generally results in significant below-market assessed values over time. From time to time, lawmakers and political coalitions have initiated efforts to repeal or amend Proposition 13 to eliminate its application to commercial and industrial properties. If successful, a repeal of Proposition 13 could substantially increase the assessed values and property taxes for our customers in California which in turn could limit their ability to borrow funds.
To the extent that our portfolio is concentrated in any region, or by type of property, downturns relating generally to such region, type of borrower or security may result in defaults on a number of our assets within a short time period, which may reduce our net income, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
We expect that a significant portion of the mortgage loans invested in by us may be development mortgage loans on infill land, which are speculative in nature.
We expect that a significant portion of Terra Property Trust’s assets may be mortgage loans for the development of real estate, which will initially be secured by infill land. These types of loans are speculative, because:
•until improvement, the property may not generate separate income for the borrower to make loan payments;
•the completion of planned development may require additional development financing by the borrower, which may not be available; and
•there is no assurance that we will be able to sell unimproved infill land promptly if we are forced to foreclose upon it.
If in fact the land is not developed, the borrower may not be able to refinance the loan and, therefore, may not be able to make the balloon payment when due. If a borrower defaults and we foreclose on the collateral, we may not be able to sell the collateral for the amount owed to us by the borrower. In calculating our loan-to-value ratios for the purpose of determining maximum borrowing capacity, we use the estimated value of the property at the time of completion of the project, which increases the risk that, if we foreclose on the collateral before it is fully developed, we may not be able to sell the collateral for the amount owed to us by the borrower, which in turn may have an adverse effect on our results of operations, financial condition and cash flows.
Loans to small businesses involve a high degree of business and financial risk, which can result in substantial losses that would adversely affect our business, results of operation and financial condition.
Our operations and activities include loans to small, privately owned businesses to purchase real estate used in their operations or by investors seeking to acquire small office, multifamily, student housing, hotel, warehouse properties. Additionally, such loans are also often accompanied by personal guarantees. Often, there is little or no publicly available information about these businesses. Accordingly, we must rely on our own due diligence to obtain information in connection with our investment decisions. Our borrowers may not meet net income, cash flow and other coverage tests typically imposed by banks. A borrower’s ability to repay its loan may be adversely impacted by numerous factors, including a downturn in its industry or other negative local or more general economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in the collateral for the loan. In addition, small businesses typically depend on the management talents and efforts of one person or a small group of people for their success. The loss of services of one or more of these persons could have a material and adverse impact on the operations of the small business. Small companies are typically more vulnerable to customer preferences, market conditions and economic downturns and often need additional capital to expand or compete. These factors may have an impact on loans involving such businesses. Loans to small businesses, therefore, involve a high degree of business and financial risk, which can result in substantial losses.
Terra Property Trust’s investments may include subordinated tranches of CMBS, which are subordinate in right of payment to more senior securities.
Terra Property Trust’s investments may include subordinated tranches of CMBS, which are subordinated classes of securities in a structure of securities collateralized by a pool of assets consisting primarily of commercial loans and, accordingly, are the first or among the first to bear the loss upon a restructuring or liquidation of the underlying collateral and the last to receive payment of interest and principal. Additionally, estimated fair values of these subordinated interests tend to be more sensitive to changes in economic conditions than more senior securities. As a result, such subordinated interests generally are not actively traded and may not provide holders thereof with liquid investments.
Any credit ratings assigned to our loans and CMBS assets will be subject to ongoing evaluations and revisions and we cannot assure you that those ratings will not be downgraded.
Some of our loan and CMBS assets may be rated by Moody’s Investors Service, Standard & Poor’s or Fitch Ratings. Any credit ratings on our loans and CMBS assets are subject to ongoing evaluation by credit rating agencies, and we cannot assure you that any such ratings will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. Rating agencies may assign a lower than expected rating or reduce or withdraw, or indicate that they may reduce or withdraw, their ratings of our loans and CMBS assets in the future. In addition, we may originate or acquire assets with no rating or with below investment grade ratings. If the rating agencies take adverse action with respect to the rating of our loans and CMBS assets or if our unrated assets are illiquid, the value of these loans and CMBS assets could significantly decline, which would adversely affect the value of our investment portfolio and could result in losses upon disposition or the failure of borrowers to satisfy their debt service obligations to us.
The mezzanine loans, preferred equity and other subordinated loans in which we invest involve greater risks of loss than senior loans secured by income-producing commercial properties.
We invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying real property or loans secured by a pledge of the ownership interests of the entity owning the real property. These types of investments involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to such loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is fully satisfied. As a result, we may not recover some or all of our investment. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the real property and increasing the risk of loss of principal.
Our investments in B-notes are generally subject to losses. The B-notes in which we may invest may be subject to additional risks relating to the privately negotiated structure and terms of the transaction, which may result in losses to us.
As part of our whole loan origination platform, we may retain from whole loans we originate or acquire, subordinate interests referred to as B-notes. B-notes are commercial real estate loans secured by a first mortgage on a single large commercial property or group of related properties and subordinated to a senior interest, referred to as an A-note. As a result, if a borrower defaults, there may not be sufficient funds remaining for B-note owners after payment to the A-note owners. In addition, our rights to control the process following a borrower default may be subject to the rights of A-note owners whose interests may not be aligned with ours. B-notes reflect similar credit risks to comparably rated CMBS. However, since each transaction is privately negotiated, B-notes can vary in their structural characteristics and risks. For example, the rights of holders of B-notes to control the process following a borrower default may be limited in certain investments. We cannot predict the terms of each B-note investment. Significant losses related to our B-notes would result in operating losses for us, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
Any disruption in the availability and/or functionality of our technology infrastructure and systems and any failure or our security measures related to these systems could adversely impact our business.
Our ability to originate and acquire real estate-related loans and manage any related interest rate risks and credit risks is critical to our success and is highly dependent upon the efficient and uninterrupted operation of our computer and communications hardware and software systems. For example, we rely on our proprietary database to track and maintain all loan performance and servicing activity data for loans in our portfolio. This data is used to manage the portfolio, track loan performance, and develop and execute asset disposition strategies. In addition, this data is used to evaluate and price new investment opportunities. If we lost access to our loan servicing activity data or other important business information due to a network or utility failure, our ability to effectively manage our business could be impaired.
Some of these systems are located at our facility and some are maintained by third-party vendors. Any significant interruption in the availability and functionality of these systems could harm our business. In the event of a systems failure or interruption by our third-party vendors, we will have limited ability to affect the timing and success of systems restoration. If such systems failures or interruptions continue for a prolonged period of time, there could be a material and adverse impact on our results of operations, financial condition and cash flows.
In addition, some of our security measures may not effectively prohibit others from obtaining improper access to our information. If a person is able to circumvent our security measures, he or she could destroy or misappropriate valuable information or disrupt our operations. Any security breach could expose us to risks of data loss, litigation and liability and could seriously disrupt our operations and harm our reputation.
Cybersecurity risk and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information and/or damage to our business relationships, all of which could have an adverse effect on our results of operations, financial condition and cash flows.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance cost, litigation and damage to our relationships. As our reliance on technology has increased, so have the risks posed to our information systems both internal and those provided by our Manager, the REIT Manager, Terra Capital Partners, its affiliates and third-party service providers. With respect to cybersecurity risk oversight, the TPT Board and its audit committee receive periodic reports and updates from management on the primary cybersecurity risks facing us and the Manager and its affiliates and the measures the Manager and its affiliates are taking to mitigate such risks. In addition to such periodic reports, the TPT Board and its audit committee receive updates from management as to changes to us and the Manager and its affiliates’ cybersecurity risk profile or certain newly identified risks. However, these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations or confidential information will not be negatively impacted by such an incident.
Terra Property Trust’s acquisitions and the integration of acquired businesses subject it to various risks and may not result in all of the cost savings and benefits anticipated, which could adversely affect our financial condition or results of operations.
Terra Property Trust has in the past and may in the future seek to grow its business by acquiring other businesses that it believes will complement or augment its existing businesses. For example, Terra Property Trust completed the BDC Merger in October 2022. Neither Terra Property Trust nor we can predict with certainty the benefits of such acquisitions, which often constitute multi-year endeavors. There is risk that Terra Property Trust’s acquisitions may not have the anticipated positive results, including results relating to: correctly assessing the asset quality of the assets being acquired; the total cost and time required to complete the integration successfully; being able to profitably deploy funds acquired in an acquisition; or the overall performance of the combined entity.
If Terra Property Trust is unable to successfully integrate its acquisitions into its business, it may never realize their expected benefits. With each acquisition, Terra Property Trust may discover unexpected costs, liabilities for which it is not indemnified, delays, lower than expected cost savings or synergies, or incurrence of other significant charges such as impairment of goodwill or other intangible assets and asset devaluation. Terra Property Trust also may be unable to successfully integrate the diverse company cultures, retain key personnel, apply its expertise to new competencies, or react to adverse changes in industry conditions.
Acquisitions may also result in business disruptions that could cause customers to move their business to Terra Property Trust’s competitors. It is possible that the integration process related to acquisitions could result in the disruption of Terra Property Trust’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that could adversely affect its ability to maintain relationships with borrowers, clients, customers, and employees. The loss of key employees in connection with an acquisition could adversely affect Terra Property Trust’s ability to successfully conduct its business. Additionally, the operation of the acquired businesses may adversely affect Terra Property Trust’s existing profitability, and it may not be able to achieve results in the future similar to those achieved in the past. Acquisition and integration efforts could divert the attention and resources of Terra Property Trust’s management, which could ultimately have an adverse effect on our results of operations, financial condition and cash flows.
Risks Related to Regulation
The increasing number of proposed U.S. federal, state and local laws may affect certain mortgage-related assets in which we invest and could materially increase our cost of doing business.
Various bankruptcy legislation has been proposed that, among other provisions, could allow judges to modify the terms of residential mortgages in bankruptcy proceedings, could hinder the ability of the servicer to foreclose promptly on defaulted mortgage loans or permit limited assignee liability for certain violations in the mortgage loan origination process, any or all of which could adversely affect our business or result in us being held responsible for violations in the mortgage loan origination process even where we were not the originator of the loan. We do not know what impact this type of legislation, which has been primarily, if not entirely, focused on residential mortgage originations, would have on the commercial loan market. We are unable to predict whether U.S. federal, state or local authorities, or other pertinent bodies, will enact legislation, laws, rules, regulations, handbooks, guidelines or similar provisions that will affect our business or require changes in our practices in the future, and any such changes could have a material adverse effect on our results of operations, financial condition and cash flows.
Failure to obtain or maintain required approvals and/or state licenses necessary to operate our mortgage-related activities may adversely impact our investment strategy.
We may be required to obtain and maintain various approvals and/or licenses from federal or state governmental authorities, government sponsored entities or similar bodies in connection with some or all of our activities. There is no assurance that we can obtain and maintain any or all of the approvals and licenses that we desire or that we will avoid experiencing significant delays in seeking such approvals and licenses. Furthermore, we may be subject to various disclosure and other requirements to obtain and maintain these approvals and licenses, and there is no assurance that we will satisfy those requirements. Our failure to obtain or maintain licenses will restrict our options and ability to engage in desired activities, and could subject us to fines, suspensions, terminations and various other adverse actions if it is determined that we have engaged without the requisite approvals or licenses in activities that required an approval or license, which could have a material adverse effect on our results of operations, financial condition and cash flows.
The impact of financial reform legislation and legislation promulgated thereunder on us is uncertain.
U.S. Federal government agencies, including the Federal Reserve, the Treasury Department and the SEC, as well as other governmental and regulatory bodies, have taken, are taking or may in the future take, various actions to address financial crises or other areas of national regulatory concern. Such actions could materially and adversely impact our business and investments, and dramatically increase the costs of complying with any additional laws and regulations.The elimination or reduction in scope of various existing laws and regulations could similarly materially and adversely impact our business and investments, results of operations and financial condition. Any far-ranging government intervention in the U.S. economic and financial systems may carry unintended consequences and cause market distortions. We are unable to predict at this time the extent and nature of such unintended consequences and market distortions, if any. The inability to evaluate such potential impacts could have a material adverse effect on our results of operations, financial condition and cash flows.
Accounting rules for certain of our transactions are highly complex and involve significant judgment and assumptions, and changes in such rules, accounting interpretations or our assumptions could adversely impact our ability to timely and accurately prepare our consolidated financial statements.
We are subject to Financial Accounting Standards Board (“FASB”) interpretations that can result in significant accounting changes that could have a material and adverse impact on our results of operations and financial condition. Accounting rules for financial instruments, including the origination, acquisition and sales or securitization of mortgage loans, derivatives, investment consolidations and other aspects of our anticipated operations are highly complex and involve significant judgment and assumptions. For example, our estimates and judgments are based on a number of factors, including projected cash flows from the collateral securing our loans, the likelihood of repayment in full at the maturity of a loan, potential for a loan refinancing opportunity in the future and expected market discount rates for varying property types. These complexities could lead to a delay in the preparation of financial information and the delivery of this information to our members.
Changes in accounting rules, interpretations or our assumptions could also undermine our ability to prepare timely and accurate financial statements, which could result in a lack of investor confidence in our financial information.
The Current Expected Credit Loss (“CECL”) accounting standard adopted by Terra Property Trust could result in a significant change in how it recognizes credit losses and its financial condition, which may in turn have a material adverse effect on our results of operations.
In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the CECL model. Terra Property Trust adopted this ASU and related amendments on January 1, 2023. Under the CECL model, Terra Property Trust is required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet of Terra Property Trust and periodically thereafter. This differs significantly from the “incurred loss” model required under current United States generally accepted accounting principles (“U.S. GAAP”), which delays recognition until it is probable a loss has been incurred. The adoption of ASU 2016-13 resulted in an incremental reserve of Terra Property Trust of approximately $4.6 million, which included reserve on future loan funding commitments. Accordingly, Terra Property Trust’s adoption of the CECL model may materially affect how it determines its allowance for credit losses and require Terra Property Trust to increase its allowance. If Terra Property Trust is required to materially increase its level of allowance for credit losses for any reason, such increase could adversely affect its business, financial condition and results of operations, which may in turn have a material adverse effect on our results of operations.
We are an “emerging growth company” and a “smaller reporting company” and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies or smaller reporting companies will make an investment in our units less attractive to investors. In particular, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act.
We are an “emerging growth company” as defined in the JOBS Act. We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.07 billion, (ii) the date on which we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, (iii) the date on which we have issued more than $1.0 billion in non-convertible debt during the preceding three-year period, and (iv) the end of the year in which the five-year anniversary of an initial public offering of our units occurs. We may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements.
Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal control over financial reporting, and generally requires in the same report a report by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting. Under the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until we are no longer an “emerging growth company.”
In addition, we are also a smaller reporting company, as defined in Rule 12b-2 under the Exchange Act. In the event that we are still considered a smaller reporting company at such time as we cease being an emerging growth company, the disclosure we will be required to provide in our SEC filings will increase, but will still be less than it would be if we were not considered either an emerging growth company or a smaller reporting company.
Rule 12b-2 of the Exchange Act defines a “smaller reporting company” as an issuer that is not an investment company, an asset-backed issuer or a majority-owned subsidiary of a parent that is not a smaller reporting company and that:
(1)had a public float of less than $250 million; or
(2)had annual revenues of less than $100 million during the most recently completed fiscal year for which audited financial statements are available and either had no public float or a public float of less than $700 million.
Similar to emerging growth companies, smaller reporting companies are able to provide simplified executive compensation disclosures in their filings, and have certain other decreased disclosure obligations in their SEC filings, including, among other things, being required to provide only two years of audited financial statements in annual reports.
To the extent we take advantage of some or all of the reduced reporting requirements applicable to emerging growth companies or smaller reporting companies, an investment in our units may be less attractive to investors.
We may be exposed to environmental liabilities with respect to properties to which we take title, which may in turn decrease the value of the underlying properties.
In the course of our business, we may take title to real estate, and, as a result, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third-parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity, and results of operations could be materially and adversely affected. In addition, an owner or operator of real property may become liable under various federal, state and local laws, for the costs of removal of certain hazardous substances released on its property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The presence of hazardous substances may adversely affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of an underlying property becomes liable for removal costs, the ability of the owner to make debt payments may be reduced, which in turn may adversely affect the value of the relevant mortgage-related assets held by us.
Insurance on the properties underlying our loans may not adequately cover all losses and uninsured losses could materially and adversely affect us.
Generally, our borrowers will be responsible for the costs of insurance coverage for the properties we lease, including for casualty, liability, fire, floods, earthquakes, extended coverage and rental or business interruption loss. However, there are certain risks, such as losses from terrorism, that are not generally insured against, or that are not generally fully insured against, because it is not deemed economically feasible or prudent to do so. In addition, changes in the cost or availability of insurance could expose us to uninsured casualty losses. Under certain circumstances insurance proceeds may not be sufficient to restore our economic position with respect to an affected property, and we could be materially and adversely affected. Furthermore, we do not have any insurance designated to limit any losses that we may incur as a result of known or unknown environmental conditions which are not caused by an insured event.
In addition, certain of the properties underlying our loans may be located in areas that are more susceptible to, and could be significantly affected by, natural disasters that could cause significant damage to the properties. If we or our borrowers experience a loss, due to such natural disasters or other relevant factors, that is uninsured or that exceeds policy limits, we could incur significant costs, which could have a material adverse effect on our results of operations, financial condition and cash flows.
Maintenance of our 1940 Act exclusion imposes limits on our operations.
Neither we nor Terra Property Trust are registered as an investment company under the 1940 Act. If we or Terra Property Trust were obligated to register as an investment company, we or Terra Property Trust would have to comply with a variety of substantive requirements under the 1940 Act that impose, among other things:
•limitations on our capital structure and the use of leverage;
•restrictions on specified investments;
•prohibitions on transactions with affiliates; and
•compliance with reporting, record keeping, and other rules and regulations that would significantly change our and Terra Property Trust’s operations.
We and Terra Property Trusty conduct our operations, and intend to continue to conduct our operations, so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government
securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exclusion from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. Because we are organized as a holding company and conduct our business primarily through Terra Property Trust, the value of the “investment securities” held by us must be less than 40% of the value of our total assets on an unconsolidated basis (exclusive of U.S. government securities and cash items). In addition, we conduct our operations so that we will not be considered an investment company under Section 3(a)(1)(A) of the 1940 Act, as we are not engaged primarily nor do we hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through Terra Property Trust, we are primarily engaged in the non-investment company businesses of Terra Property Trust.
Terra Property Trust and certain of its subsidiaries may at times rely primarily on the exclusion from the definition of an investment company under Section 3(c)(5)(C) of the 1940 Act, or any other exclusions available to Terra Property Trust and its subsidiaries (other than Section 3(c)(1) or Section 3(c)(7)). Section 3(c)(5)(C) of the 1940 Act is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exclusion generally requires that at least 55% of Terra Property Trust’s (and any of its subsidiaries relying on Section 3(c)(5)(C)) portfolio must be comprised of “qualifying real estate” assets and at least 80% of Terra Property Trust’s (and any of its subsidiaries’, in relying on Section 3(c)(5)(C)) portfolio must be comprised of “qualifying real estate” assets and “real estate-related” assets (and no more than 20% comprised of miscellaneous assets) as determined in accordance with the 1940 Act and the rules and regulations promulgated thereunder. For purposes of the exclusion provided by Section 3(c)(5)(C) of the 1940 Act, Terra Property Trust (and any of its subsidiaries relying on Section 3(c)(5)(C)) classifies its investments based in large measure on no-action letters issued by the SEC staff and other SEC interpretive guidance and, in the absence of SEC guidance, on our view of what constitutes a “qualifying real estate” asset and a “real estate-related” asset. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations Terra Property Trust (and any of its subsidiaries relying on Section 3(c)(5)(C)) may face, and a number of these no-action positions were issued more than twenty years ago. Pursuant to this guidance, and depending on the characteristics of the specific investments, certain mortgage loans, participations in mortgage loans, mortgage-backed securities, mezzanine loans, joint venture investments, preferred equity and equity securities of other entities may not constitute qualifying real estate assets and therefore investments in these types of assets may be limited. No assurance can be given that the SEC or its staff will concur with our classification of the assets held by Terra Property Trust and any of its subsidiaries for purposes of the 3(c)(5)(C) exclusion or any other exclusion or exemption under the 1940 Act. Future revisions to the 1940 Act or further guidance from the SEC or its staff may cause us, Terra Property Trust, or any of its subsidiaries relying on Section 3(c)(5)(C) to lose our or their exclusion from registration, or force us, Terra Property Trust, or any of its subsidiaries to re-evaluate our or their portfolios and our or their investment strategy. Such changes may prevent us from operating our business successfully.
Further, in order to maintain an exclusion from registration under the 1940 Act, we may be unable to sell assets that we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income or loss generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire assets that we would otherwise want to acquire and would be important to its strategy.
Although we monitor the portfolio of Terra Property Trust and its subsidiaries periodically and prior to each acquisition and disposition, Terra Property Trust or its subsidiaries may not be able to maintain an exclusion from registration as an investment company. If Terra Property Trust or its subsidiaries were required to register as an investment company, but failed to do so, Terra Property Trust or its subsidiaries failing to so qualify would be prohibited from engaging in their business, and legal proceedings could be instituted against Terra Property Trust or any of its subsidiaries failing to so qualify. In addition, the contracts of Terra Property Trust or any of its subsidiaries failing to so qualify may be unenforceable, and a court could appoint a receiver to take control of Terra Property Trust or any of its subsidiaries failing to so qualify and liquidate their business, all of which could have a material adverse effect on our results of operations, financial condition and cash flows.
Risks Related to Our Management and Our Relationship With Our Manager and its Affiliates
We rely entirely on our Manager or its affiliates and the directors, employees and officers of our Manager or its affiliates for our day-to-day operations, and the directors, officers and employees of our Manager or its affiliates will face competing demands to their allocation of time and investment opportunities.
We have no employees and do not intend to have employees in the future. We rely entirely on the management team and employees of our Manger and its affiliates for our day-to-day operations, and our Manager and its affiliates have significant discretion as to the implementation of our operating policies and strategies. Our success depends substantially on the efforts and abilities of the directors and officers of our Manager and its affiliates, including Messrs. Uppal, Pinkus and Cooperman and our
REIT Manager’s debt finance professionals. The loss of any of such individuals could have a material adverse effect on our results of operations, financial condition and cash flows.
Certain other companies managed by our Manager or its affiliates, which have investment objectives similar to ours, also rely on many of these same officers and professionals. Our Manager or its affiliates may face conflicts of interest if we enter into transactions with an affiliate. In these circumstances, the persons who serve as the management team of our Manager or its affiliates may have a fiduciary responsibility to both us and the affiliate. Transactions between us and such affiliates will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated parties, possibly causing us to enter into a transaction that is not in our best interest and that may negatively impact our performance. Further, many investment opportunities that are suitable for us may also be suitable for other affiliates advised by our Manager or its affiliates. When the officers of our Manager or its affiliates identify an investment opportunity that may be suitable for us as well as an affiliated entity, they, in their sole discretion, will first evaluate the investment objectives of each program to determine if the opportunity is suitable for each program. If the proposed investment is appropriate for more than one program, our Manager or its affiliates will then evaluate the portfolio of each program, in terms of diversity of geography, underlying property type, tenant concentration and borrower, to determine if the investment is most suitable for one program in order to create portfolio diversification. If such analysis is not determinative, our Manager or its affiliates will allocate the investment to the program with uncommitted funds available for the longest period or, to the extent feasible, prorate the investment between the programs in accordance with uninvested funds. As a result, the officers of our Manager or its affiliates could direct attractive investment opportunities to other affiliated entities or investors. Such events could result in the fund acquiring investments that provide less attractive returns, which would reduce the level of distributions we may be able to pay you.
Our Manager and certain of its affiliates are presently, and plan in the future to continue to be, involved with activities that are unrelated to us. As a result of these activities, our Manager, its employees and certain of its affiliates will have conflicts of interest in allocating their time between us and the other activities in which they are or may become involved, including the management of Terra Property Trust, Terra LLC and RESOF. The employees of our Manager or its affiliates will devote only as much of its or their time to our business as it and its employees, in their judgment, determine is reasonably required, which may be substantially less than their full time. Therefore, our Manager, its personnel and certain affiliates may experience conflicts of interest in allocating management time, services and functions among us and any other business ventures in which they or any of their key personnel, as applicable, are or may become involved. This could result in actions that are more favorable to other affiliated entities than to us. Should our Manager or its affiliates, or the members of our Manager’s or its affiliates’ management teams, devote insufficient time or resources to our business, our returns on our direct or indirect investments, and the value of our units, may decline.
We face certain conflicts of interest with respect to our operations and our relationship with our Manager and Terra Property Trust’s relationship with the REIT Manager.
We are subject to conflicts of interest arising out of our and Terra Property Trust’s respective relationships with our Manager, the REIT Manager and their affiliates. We may enter into additional transactions with our Manager, its affiliates, or entities managed by our Manager or its affiliates. In particular, we may invest in, or acquire, certain of our investments through joint ventures or co-investments with other affiliates or purchase assets from, sell assets to or arrange financing from or provide financing to other affiliates or engage in other transactions with entities managed by our Manager or its affiliates. Future joint venture investments could be adversely affected by our lack of sole decision-making authority, or reliance on our Manager’s and its affiliates’ financial condition and liquidity, and disputes between us and our Manager or its affiliates. There can be no assurance that any procedural protections will be sufficient to assure that these transactions will be made on terms that will be at least as favorable to us as those that would have been obtained in an arm’s-length transaction.
Our Manager and its affiliates may be subject to conflicts of interest in making investment decisions on assets on our behalf as opposed to other entities that have similar investment objectives. Our Manager and its affiliates may have different incentives in determining when to sell assets with respect to which it is entitled to fees and compensation and such determinations may not be in our best interest.
Our Manager and its affiliates serve as manager of certain other funds and investment vehicles, all of which have investment objectives that overlap with ours. In addition, future programs may be sponsored by our Manager and its affiliates may serve as the dealer manager for these future programs. As a result, our Manager and its affiliates may face conflicts of interest arising from potential competition with other programs for investors and investment opportunities. There may be periods during which one or more programs managed by our Manager or its affiliates will be raising capital and which might compete with us for investment capital. Such conflicts may not be resolved in our favor and our investors will not have the opportunity to evaluate the manner in which these conflicts of interest are resolved before or after making their investment.
The compensation that the REIT Manager receives was not determined on an arm’s-length basis and therefore may not be on the same terms as we could achieve from a third-party.
The compensation paid by Terra Property Trust to the REIT Manager or its affiliates for services they provide to Terra Property Trust were not determined on an arm’s-length basis. We cannot assure you that a third-party unaffiliated with us would not be able to provide such services to us at a lower price.
The base management fee the REIT Manager receives for managing Terra Property Trust may reduce its incentive to devote its time and effort to seeking attractive assets for our portfolio because the fee is payable regardless of our performance.
Terra Property Trusty pays the REIT Manager a base management fee regardless of the performance of our portfolio. The REIT Manager’s entitlement to non-performance-based compensation might reduce its incentive to devote its time and effort to seeking assets that provide attractive risk-adjusted returns for our portfolio. This in turn could hurt both our ability to make distributions and the value of our units.
We cannot predict the amounts of compensation to be paid to the REIT Manager and its affiliates.
Because the fees that Terra Property Trust will pay to the REIT Manager and its affiliates are based in part on the level of our business activity, it is not possible to predict the amounts of compensation that Terra Property Trust will be required to pay these entities. In addition, Terra Property Trust has entered into a cost sharing and reimbursement agreement with Terra LLC, effective October 1, 2022, pursuant to which Terra LLC will be responsible for its allocable share of Terra Property Trust’s expenses, including fees paid by Terra Property Trust to the REIT Manager. Because key employees of the REIT Manager and its affiliates are given broad discretion to determine when to consummate a transaction, we will rely on these key persons to dictate the level of our business activity. Fees paid to the REIT Manager and its affiliates reduce funds available for payment of distributions to us and principal and interest payments on Terra Property Trust’s outstanding indebtedness. Because we cannot predict the amount of fees due to these parties, we cannot predict how precisely such fees will impact such payments.
If our Manager or its affiliates causes us to enter into a transaction with an affiliate, our Manager or its affiliates may face conflicts of interest that would not exist if such transaction had been negotiated at arm’s-length with an independent party.
Our Manager and its affiliates may face conflicts of interests if we enter into transactions with an affiliate. In these circumstances, the persons who serve as the management team of our Manager or its affiliates may have a fiduciary responsibility to both us and the affiliate. Transactions between us and our Manager’s affiliates, including entities managed by our Manager or its affiliates, will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated parties. This conflict of interest may cause our Manager or its affiliates to sacrifice our best interests in favor of its affiliate or the entity it or its affiliates manage, thereby causing us to enter into a transaction that is not in our best interest and that may negatively impact our results of operations, financial condition and cash flows.
Risks Related to Financing and Hedging
The TPT Board may change Terra Property Trust’s leverage policy, and/or investment strategy and guidelines, asset allocation and financing strategy, without the consent of its common stockholders.
We currently have outstanding indebtedness and expect to deploy moderate amounts of additional leverage as part of our operating strategy. Our governing documents contain no limit on the amount of debt we may incur, and, subject to compliance with financial covenants under Terra Property Trust’s borrowings, including under its term loan, the unsecured notes, the repurchase agreement and revolving credit facility, we may significantly increase the amount of leverage we utilize at any time without approval of our unitholders or Terra Property Trust’s stockholders. Depending on market conditions, additional borrowings may include credit facilities, senior notes, repurchase agreements, additional first mortgage loans and securitizations. In addition, we may divide the loans we originate into senior and junior tranches and dispose of the more senior tranches as an additional means of providing financing to our business. To the extent that we use leverage to finance our assets, we would expect to have a larger portfolio of loan assets, but our financing costs relating to our borrowings will reduce cash available for distributions to our unitholders. We may not be able to meet our financing obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to liquidation or sale to satisfy such obligations.
The REIT Manager is authorized to follow broad investment guidelines that have been approved by TPT Board. Those investment guidelines, as well as our target assets, investment strategy, financing strategy and hedging policies with respect to investments, originations, acquisitions, growth, operations, indebtedness, capitalization and distributions, may be changed at any time without notice to, or the consent of, our unitholders or Terra Property Trust’s stockholders. This could result in a loan
portfolio with a different risk profile. A change in our investment strategy may increase our exposure to interest rate risk, default risk and real estate market fluctuations. Furthermore, a change in our asset allocation could result in our making investments in asset categories different from those described herein. These changes could have a material adverse effect on our results of operations, financial condition and cash flows.
Terra Property Trust may pursue and not be able to successfully complete securitization transactions, which could limit potential future sources of financing and could inhibit the growth of our business.
Terra Property Trust may use additional credit facilities, senior notes, term loans, repurchase agreements, first mortgage loans or other borrowings to finance the origination and/or structuring of real estate-related loans until a sufficient quantity of eligible assets have been accumulated, at which time it may decide to refinance these short-term facilities or repurchase agreements through the securitization market which could include the creation of CMBS, collateralized debt obligations (“CDO”s), or the private placement of loan participations or other long-term financing. If Terra Property Trust employs this strategy, it is subject to the risk that it would not be able to obtain, during the period that its short-term financing arrangements are available, a sufficient amount of eligible assets to maximize the efficiency of a CMBS, CDO or private placement issuance. Terra Property Trust is also subject to the risk that it is not able to obtain short-term financing arrangements or is not able to renew any short-term financing arrangements after they expire should it find it necessary to extend such short-term financing arrangements to allow more time to obtain the necessary eligible assets for a long-term financing.
The inability to consummate securitizations of its portfolio to finance its real estate-related loans on a long-term basis could require Terra Property Trust to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price, which could have a material and adverse effect its results of operations, financial condition and cash flows.
We may be required to repurchase loans or indemnify investors if we breach representations and warranties, which could harm our earnings.
We may, on occasion, consistent with Terra Property Trust’s qualification as a REIT and our desire to avoid being subject to the “prohibited transaction” penalty tax, sell some of our loans in the secondary market or as a part of a securitization of a portfolio of our loans. If we sell loans, we would be required to make customary representations and warranties about such loans to the loan purchaser. Our loan sale agreements may require us to repurchase or substitute loans in the event we breach a representation or warranty given to the loan purchaser. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default on a loan. Likewise, we may be required to repurchase or substitute loans if we breach a representation or warranty in connection with our securitizations, if any.
The remedies available to a purchaser of loans are generally broader than those available to us against the originating broker or correspondent. Further, if a purchaser enforces its remedies against us, we may not be able to enforce the remedies we have against the sellers. The repurchased loans typically can only be financed at a steep discount to their repurchase price, if at all. They are also typically sold at a significant discount to the unpaid principal balance (“UPB”). Significant repurchase activity could have a material adverse effect on our results of operations, financial condition and cash flows.
Covenants in Terra Property Trust’s debt agreements may restrict our operating activities and adversely affect our financial condition, operating results and cash flows.
Terra Property Trust’s debt agreements contain various financial and operating covenants, including, among other things, certain coverage ratios and limitations on our ability to incur secured and unsecured debt. These restrictive covenants and operating restrictions could have a material adverse effect on its operating results, cause Terra Property Trust to lose its REIT status, restrict its ability to finance or securitize new originations and acquisitions, force us to liquidate collateral and negatively affect its financial condition and its ability to pay dividends. The breach of any of these covenants, if not cured within any applicable cure period, could result in a default, including a cross-default, and acceleration of certain of Terra Property Trust indebtedness. Accelerating repayment and terminating the agreements will require immediate repayment by Terra Property Trust of the borrowed funds, which may require Terra Property Trust to liquidate assets at a disadvantageous time, causing it to incur further losses and adversely affecting its results of operations and financial condition, which may impair its ability to make principal and interest payments on its debt obligations. Any failure to make payments when due or upon acceleration could result in the foreclosure upon our assets by the lenders.
Our inability to access funding could have a material adverse effect on our results of operations, financial condition and cash flows. We may rely on short-term financing and thus are especially exposed to changes in the availability of financing.
We currently have outstanding indebtedness and expect to use additional borrowings, such as first mortgage financings, credit facilities, senior notes, term loans and repurchase agreements and other financings, as part of our operating strategy. Our use of financings exposes us to the risk that our lenders may respond to market conditions by making it more difficult for us to renew or replace on a continuous basis our maturing short-term borrowings. If we are not able to renew our then existing short-term facilities or arrange for new financing on terms acceptable to us, or if we default on our covenants or are otherwise unable to access funds under these types of financing, we may have to curtail our asset origination activities and/or dispose of assets.
It is possible that the lenders that provide us with financing could experience changes in their ability to advance funds to us, independent of our performance or the performance of our portfolio of assets. Further, if many of our potential lenders are unwilling or unable to provide us with financing, we could be forced to sell our assets at an inopportune time when prices are depressed. In addition, if the regulatory capital requirements imposed on our lenders change, they may be required to significantly increase the cost of the financing that they provide to us. Our lenders also may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings, based on, among other factors, the regulatory environment and their management of perceived risk, particularly with respect to assignee liability. Moreover, the amount of financing we receive under our short-term borrowing arrangements will be directly related to the lenders’ valuation of our targeted assets that cover the outstanding borrowings. This could increase our financing costs and reduce our access to liquidity, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
An increase in our borrowing costs relative to the interest we receive on our leveraged assets may have a material adverse effect on our results of operations, financial condition and cash flows.
As our financings mature, we will be required either to enter into new borrowings or to sell certain of our assets. An increase in short-term interest rates at the time that we seek to enter into new borrowings would reduce the spread between the returns on our assets and the cost of our borrowings. This could adversely affect the returns on our assets, which would reduce our net income and, in turn, have a material adverse effect on our results of operations, financial condition and cash flows.
We may enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.
Subject to maintaining Terra Property Trust’s qualification as a REIT, part of our strategy may involve entering into hedging transactions that could require us to fund cash payments in certain circumstances (such as the early termination of a hedging instrument caused by an event of default or other early termination event). The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges, and these economic losses will be reflected in our results of operations. We may also be required to provide margin to our counterparties to collateralize our obligations under hedging agreements. Our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time. The need to fund these obligations could have a material adverse effect on our results of operations, financial condition and cash flows.
Risks Related to Owning Our Units
The interests of our company and our unitholders in respect of the matters covered by the voting agreement may differ from or conflict with the interests of our REIT subsidiary,Terra Property Trust, the REIT Manager and its affiliates.
In connection with the Axar Transaction, our Our company, the REIT Manager and our REIT subsidiaryTerra Property Trust entered into a voting agreement in respect of the shares of common stock of our REIT subsidiaryTerra Property Trust owned by our company (the “Voting(as amended and restated on March 2, 2020, the “2020 Voting Agreement”), which was intended, in part, to provide for continuity on the board of directors of our REIT subsidiary.TPT Board. For additional details related to the 2020 Voting Agreement, see “Item 13. Certain Relationships and Related Transactions, and Director Independence — Voting Agreement”Agreements Involving Terra Property Trust”. However, theThe nomination and voting terms contained in the 2020 Voting Agreement give the holders of such rights the ability to exercise substantial influence over our REIT subsidiaryTerra Property Trust and may otherwise limit the ability of the board of directors of the REIT subsidiaryTPT Board to appoint certain members to its board of directors which could adversely impact the composition of the board. In any of these matters, the interests of our company and our unitholders may differ from or conflict with the interests of our REIT subsidiary,Terra Property Trust, the REIT Manager and its affiliates.
Units issued by us that you hold are not freely transferrable; thus investors may not be able to liquidate their investment.
The issuance of our units in the REIT formation transactions and the concurrent private placement were not registered under the Securities Act or the securities laws of any state. Our units were offered in reliance upon an exclusion or exemption from the registration provisions of the Securities Act and state securities laws applicable only to offers and sales to investors meeting the suitability requirements set forth herein.
Each member has been required to represent that, unless waived by our Manager, he or she (i) is an “accredited investor” within the meaning of Rule 501(a) of the Securities Act at the time of acquisition of the units, (ii) acquired the units for investment and not with a view to distribution or resale, and (iii) understood that our units have not been registered under the Securities Act or any state “blue sky” or securities laws, are not freely transferable, and that such member must bear the economic risk of investment in the units for an indefinite period, of time, and the units cannot be sold unless they are subsequently registered or an exclusion or exemption from such registration is available and such member complies with the other applicable provisions of our amended and restated operating agreement. There is no public market for the units and members cannot expect to be able to liquidate their units in the case of an emergency. Further, the sale of the units may have adverse federal income tax consequences. Our members may not sell, assign or transfer all or a portion of their units without the prior written consent of our Manager, which consent may be withheld in our Manager’s sole and absolute discretion.
The value you may receive upon the occurrence of an alternative liquidity transaction is uncertain, and there can be no assurance that you will receive a full return of your invested capital.
Under our amended and restated operating agreement, our Manager may cause us to consummate an alternative liquidity transaction without the approval of members. If we pursue and consummate an alternative liquidity transaction, the value you will receive upon the occurrence of such transaction will depend on the loans in the portfolio at the time of such transaction, the performance of the loans, market conditions, and other factors. There is no assurance that we will pursue or consummate an alternative liquidity transaction. In addition, if we pursue and consummate an alternative liquidity transaction, we cannot predict the value you will receive in such transaction, nor can we provide any assurance that you will receive a full return of your invested capital.
If we complete an alternative liquidity transaction by pursuing an IPOinitial public offering and listing or a direct listing of our REIT subsidiary’sTerra Property Trust’s common stock in the future, you will be subject to additional risks.
Examples of the alternative liquidity transactions that may be available to us include a liquidation of assets, a sale of our REIT subsidiarycompany or an IPO andits subsidiaries or affiliates, or a strategic business combination, a listing of our REIT subsidiary’sthe shares of common stock of Terra Property Trust on a national securities exchange.exchange, or an adoption of a share repurchase plan, in each case, which may include the distribution of our common stock of Terra Property Trust indirectly owned by our company and certain other fund vehicles managed by Terra Capital Partners or its affiliates to the ultimate investors in these vehicles. If we complete an alternative liquidity transaction that involves our REIT subsidiaryTerra Property Trust becoming a publicly traded company through an IPOinitial public offering and listing or a direct listing of our REIT subsidiary’sTerra Property Trust’s shares on an exchange, you will subject to the following additional risks:
Trading Value of our REIT Subsidiary’sTerra Property Trust’s Shares: If an alternative liquidity transaction involves our REIT subsidiaryTerra Property Trust becoming a publicly traded company through an IPOinitial public offering and listing or a direct listing of our REIT subsidiary’sTerra Property Trust’s shares on ana national securities exchange, our REIT subsidiary’sTerra Property Trust’s shares will be publicly traded and investors will be able to assess the value of their shares by reference to their public trading prices.
Distributions: If anFollowing any alternative liquidity event, involves our REIT subsidiary becoming a publicly traded company through an IPO or listing of our REIT subsidiary on an exchange we do not expect that the distributions investors receive following any such liquidity event would be adversely impacted. Following any such transaction, our REIT subsidiaryTerra Property Trust would be expected to pay regular monthly distributions to its stockholders and would continue to be required to distribute dividends equal to at least 90% of its taxable income (excluding(calculated without regard to its net capital gains)gain and the dividends paid deduction) to its investors each year in order to maintain its qualification as a REIT.
Manager Compensation: If an alternative liquidity event involves our REIT subsidiaryTerra Property Trust becoming a publicly traded company through an IPOinitial public offering and listing or a direct listing of our REIT subsidiary,Terra Property Trust’s shares on an exchange, it is expected that our REIT subsidiaryTerra Property Trust will enter into a new management agreement with ourthe REIT Manager or an affiliate of ourthe REIT Manager. The base management fees, incentive distributions or other amounts that would be payable to ourthe REIT Manager in the case of any such transaction are expected to be market basedmarket-based fees determined in the case of any IPOinitial public offering by discussions between ourthe REIT Manager and the underwriters involved in the IPO.initial public offering. Any such fees are expected to be paid in lieu of the fees currently payable to ourthe REIT Manager by us or our REIT subsidiary.Terra Property Trust. In addition, if
in connection with any such alternative liquidity event or other transaction, we distribute shares of our REIT subsidiaryTerra Property Trust to our members, our Manager may be entitled to receive a portion of such distributed shares based on its incentive distribution interest in our Fund, with shares of our REIT subsidiaryTerra Property Trust being valued at the date of distribution at their book value (if distributed prior to an liquidity event), at the IPOinitial public offering price in the case of an IPOinitial public offering (if distributed within 60 days after such IPO)initial public offering) or at the trading value for such shares over the 10-trading period prior to such distribution (if distributed at any time after the expiration of such 60-day period).
Transfer Restrictions: If an alternative liquidity event involves our REIT subsidiaryTerra Property Trust becoming a publicly traded company through an IPOinitial public offering and listing or a direct listing of our REIT subsidiaryTerra Property Trust’s shares on ana national securities exchange, it is expected that, after the expiration of any lock-up period, our members will become the direct owners of shares of our REIT subsidiaryTerra Property Trust by way of a distribution of shares of our REIT subsidiaryTerra Property Trust to our members as described above. Our REIT subsidiary’sTerra Property Trust’s shares distributed to members will constitute restricted securities under the Securities Act and will be subject to restrictions on transfer under applicable U.S. securities laws.
Investors’ return may be reduced as a resultAs described above, following the consummation of the additional expenseBDC Merger and as of operating as a reporting company under the Exchange Act.
We are subject to the periodic and current reporting requirementsDecember 31, 2022, Terra JV held 70.0% of the Exchange Act. As a reporting company,issued and outstanding shares of TPT Class B Common Stock and we have to comply with a varietyand Terra Fund 7 owned an 87.6% and 12.4% interest, respectively, in Terra JV. On the date the First Conversion Date, one-third of substantive requirements under the Exchange Act that impose, among other things:issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock. On the Second Conversion Date, one-half of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock. On the Third Conversion Date, all of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock.
preparation and filing of current reports on Form 8-K;
preparation and filing of quarterly reports on Form 10-Q; and
preparation and filing of annual reports on Form 10-K.
We are subject to these reporting and other requirements even though we have not yet completed an IPO or listed our units. Compliance with the Exchange Act will increase our operating expenses, which may reduce our ability to make distributions and the value of our units.
A compulsory redemption could result in adverse tax and economic consequences for members.
Our Manager may, in its sole discretion, require a compulsory redemption of all or a portion of a member’s units, or Termination Units, including but not limited to cases in which the ownership of units or Termination Units would result in our assets being deemed “plan assets” for Employee Retirement Income Security Act of 1974 (“ERISA”) purposes, as defined under ERISA or by any regulation of the U.S. Department of Labor, or other federal agency having jurisdiction, or the units or the Termination Units have been transferred without our permission, or a member has acquired units or Termination Units otherwise than in compliance with applicable rules and regulations. Such compulsory redemption may result in adverse tax or economic consequences for the member.
Your interests may be diluted if we issue additional units in the future.
Members will not have preemptive rights to acquire any units issued by us in the future. Therefore, investors may experience dilution of their investment if we sell additional units in the future.
Our members do not have legal representation.
Pursuant to the terms of our amended and restated operating agreement, each of our members acknowledges and agrees that counsel representing us, our Manager and its affiliates does not represent and shall not be deemed under the applicable codes of professional responsibility to have represented or to be representing any or all of our members in any respect.
We may not have sufficient funds to make cash distributions.
Following the completion of the REIT formation transactions, our Manager approved an increase in the monthly distribution payable in respect of each unit in respect of the first full quarterly period following the closing of the REIT formation transactions to 9.0% per annum on $50,000 per unit. In addition, our Manager approved an initial payment on each Termination Unit in respect of the first full quarterly period following the closing of the REIT formation transactions equal to 6.0% per annum on the Unreturned Invested Capital (as defined below) associated with each Termination Unit. The timing and amount of future distributions and payments will continue to be made at the sole discretion of our Manager and subject to such factors our Manager considers to be relevant, including the amount of funds available for distribution or payment, our financial condition, whether to reinvest or distribute such funds, capital expenditure and reserve requirements and general operational requirements. Because we cannot predict future cash flows or the performance of our REIT subsidiary, no assurance can be given that we will be able to continue to maintain in future periods distributions on units and payments on the Termination Units at levels approved by our Manager.
The Termination Units do not participate in potential increases in cash distributions and are subject to risks relating to fluctuations in our book value.
Termination Units are structured so as not to participate in any potential increases in cash distributions. In addition, because the amount payable in redemption of the Termination Units is not fixed but tied into the book value attributable to the Termination Units at the end of the calendar quarter prior to their redemption, Termination Units are impacted by changes in book value and will receive a lower amount upon redemption if their allocable share of the book value declines.
Rapid changes in the values of our assets may make it more difficult for our REIT subsidiaryTerra Property Trust to maintain its qualification as a REIT or our exclusion from the 1940 Act.
If the fair market value or income potential of our assets declines as a result of increased interest rates, prepayment rates, general market conditions, government actions or other factors, we may need to increase our real estate assets and income or liquidate our non-qualifying assets to maintain our REIT subsidiary’sTerra Property Trust’s or its subsidiaries’ qualification or our exclusion from the 1940 Act. If the decline in real estate asset values or income occurs quickly, this may be especially difficult to accomplish. We may have to make decisions that we otherwise would not make absent the REIT and 1940 Act considerations.
Tax Risks
Tax risks in general.
An investment in us involves complex U.S. federal, state and local income tax considerations that will differ for each investor. We intend to be treated as a partnership for U.S. federal income tax purposes. Assuming that we are so treated, we will not be subject to U.S. federal income tax, and each member and each holder of Termination Units will be required to include its allocable share of the items of our income, gain, loss and deduction in computing its U.S. federal income tax liability. We may, however, be subject to state and local tax, depending on the location and scope of our activities. In addition, entities through which we may make investments, including our REIT subsidiary,Terra Property Trust, may in certain circumstances be subject to U.S. federal, state, local or foreign tax.
No Internal Revenue Service ruling.
We have not sought rulings from the Internal Revenue Service with respect to any of the U.S. federal income tax considerations discussed herein. Thus, positions to be taken by the Internal Revenue Service as to tax consequences could differ from the positions taken by us.
Publicly traded partnership risk.
If we were treated as a publicly traded partnership (“PTP”) taxable as a corporation, we would be subject to U.S. federal income tax and applicable state and local taxes on our income, which would result in reduced returns to our members and holders of Termination Units.members.
Our Manager intends to treat us as a partnership and not as an association or PTP taxed as a corporation for U.S. federal income tax purposes. No assurance can be given that the Internal Revenue Service will not challenge such classification or that a court will not sustain any such challenge.
A PTP is a partnership the interests in which are: (i) traded on an established securities market; or (ii) readily tradable on a secondary market or the substantial equivalent thereof. We may not qualify for any of the safe harbors set forth in the applicable Treasury regulations under which a partnership is not treated as a PTP. However, our Manager intends to operate us in such a manner so that we will not be classified as a PTP. Even if the Internal Revenue Service were to assert that we are a PTP, we will not be taxable as a corporation within a particular taxable year if 90% or more of our gross income is “qualifying income” for each taxable year in which we were a PTP and we were not required to register under the Investment Company1940 Act. Qualifying income generally includes interest (other than interest generated from a financial business), dividends, real property rents, gain from the sale of assets that produce qualifying income and certain other items. Since we conduct our real estate business through our REIT subsidiary,Terra Property Trust, substantially all of our income should be dividends from our REIT subsidiary,Terra Property Trust, which would be qualifying income. If, for any reason, we were treated as an association taxable as a corporation, we would be subject to U.S. federal income tax and applicable state and local taxes on our income.
Legislative, regulatory or administrative changes could adversely affect us.
Legislative, regulatory or administrative changes could be enacted or promulgated at any time, either prospectively or with retroactive effect, and may adversely affect us. No assurance can be given as to whether, when, or in what form, the U.S. federal income tax laws applicable to us and our members and holders of Termination Units may be enacted. Changes to the U.S. federal income tax laws and interpretations of U.S. federal tax laws could adversely affect an investment in our units. The Tax Cuts and Jobs Act (the “TCJA”) which was signed into law on December 22, 2017, made significant changes to the U.S. federal income tax laws applicable to businesses and their owners, including REITs and their stockholders, and may lessen the relative competitive advantage of investing in a REIT rather than a C corporation.
Certain key provisions of the TCJA that could impact our members and holders of Termination Units, beginning in 2018, include the following changes:
temporarily reducing the individual U.S. federal income tax rates on ordinary income from the 39.6% maximum U.S. federal income tax rate to 37% (through taxable years ending in 2025);
reducing the maximum corporate U.S. federal income tax rate from 35% to 21%;
permitting non-corporate taxpayers a deduction for certain pass-through business income, including dividends received from our REIT subsidiary that are not capital gain dividends or qualified dividend income, which allows individuals, trusts, and estates to generally deduct up to 20% of such amounts, resulting in an effective maximum U.S. federal income tax rate of 29.6% on such dividends (through taxable years ending in 2025);
reducing the highest rate of withholding with respect to distributions to non-U.S. stockholders that are treated as attributable to gains from the sale or exchange of U.S. real property interests from 35% to 21%;
limiting the deduction for net operating losses incurred after January 1, 2018 to 80% of taxable income (prior to the application of the dividends paid deduction) and eliminating the ability to carryback such net operating losses;
limiting the deduction of net interest expense for all businesses, other than for certain electing real estate businesses;
eliminating the corporate alternative minimum tax;
imposing a 10% withholding tax on the amount realized on the disposition by a non-U.S. person of an interest in a partnership engaged in a U.S. trade or business; and
accelerating the accrual of certain items of income for U.S. federal income tax purposes that are reported for financial statement purposes earlier than would be the case under the otherwise applicable tax rules.
Our members holders of Termination Units and prospective investors are urged to consult with their tax advisors regarding the potential effects of the TCJA or other legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our units.
Income taxes of members and holders of Termination Units may exceed cash distributions.
Even if we have income or gains for U.S. federal income tax purposes, we will not be required to make distributions (or may lack sufficient cash available for distributions) to enable our members and holders of Termination Units to pay their U.S. federal, state and local taxes as a result of such income or gain allocations. For example, in order to qualify as a REIT, our REIT subsidiaryTerra Property Trust must distribute dividends equal to at least 90% of its nettaxable income (excluding(calculated without regard to its net capital gain)gain and the dividends paid deduction) to its shareholders on an annual basis. Differences in timing between the recognition of taxable income and the actual receipt of cash may occur for our REIT subsidiary,Terra Property Trust, resulting in “phantom income,” which could impact our REIT subsidiary’sTerra Property Trust’s ability to satisfy its annual distribution requirements. For example, under the recently enacted TCJA, our REIT subsidiaryTerra Property Trust generally will be required to recognize certain amounts in income no later than the time such amounts are reflected on its financial statements. The application of this rule may require our REIT subsidiaryTerra Property Trust to accrue certain items of income with respect to its debt instruments such as market discount and, for tax years beginning after December 31, 2018, original issue discount, earlier than would be the case under the otherwise applicable tax rules, althoughrules; however, recently promulgated Treasury regulations, which are effective for taxable years beginning on or after January 1, 2021, generally would exclude, among other items, original issue discount and market discount income from the precise applicationapplicability of this rule is unclear at this time.rule. This rule could in certain circumstances increase our REIT subsidiary’sTerra Property Trust’s “phantom income,” which may require our REIT subsidiaryTerra Property Trust to borrow funds or take other action to satisfy its REIT distribution requirements. For example, our REIT subsidiaryTerra Property Trust may request that we and its other shareholders, if any, agree to a consent dividend in order to meet the annual distribution requirements or avoid paying corporate tax on any undistributed net income. When a REIT makes a consent dividend, the REIT and its stockholders are generally treated for U.S. federal income tax purposes as if the REIT distributed cash to the stockholders and the stockholders immediately re-contributed the cash to the REIT as a contribution to capital. A consent dividend would result in the recognition of income by our members and holders of Termination Units as if an actual distribution were made, but without any distribution of cash. As a result, our members and holders of Termination Units
would be required to utilize other resources to satisfy tax liabilities and would not be able resort to distributions made by us to assist in satisfying such tax liabilities.
If our REIT subsidiaryTerra Property Trust does not qualify or maintain its qualification as a REIT, it will be subject to tax as a regular corporation and could face a substantial tax liability as a result, which would result in reduced returns to our members and holders of Termination Units.
We expect to make substantially all of our investments through our REIT subsidiary.Terra Property Trust. Our Manager believes that itthe REIT Manager has taken and intends to continue to take such actions as are necessary or appropriate to cause our REIT subsidiaryTerra Property Trust to qualify for taxation as a REIT within the meaning of the Internal Revenue Code. However, qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code for which only limited judicial and administrative authorities exist and, accordingly, may require interpretations of such provisions, which could be successfully challenged by the Internal Revenue Service. Even a technical or inadvertent mistake could jeopardize the REIT qualification of our REIT subsidiary.Terra Property Trust. The continued REIT qualification of our REIT subsidiaryTerra Property Trust will depend on the ability of our REIT subsidiaryTerra Property Trust to satisfy certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis.
Furthermore, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it difficult or impossible for our REIT subsidiaryTerra Property Trust to qualify as a REIT. If our REIT subsidiaryTerra Property Trust were to fail to qualify as a REIT in any taxable year, then: (i) the REIT subsidiaryTerra Property Trust would be unable to deduct dividends it distributes in computing taxable income and would be subject to U.S. federal income tax on its taxable income at regular corporate rates; (ii) the REIT subsidiaryTerra Property Trust would no longer be required to distribute substantially all of its taxable income to us, and (iii) unless it were entitled to relief under applicable statutory provisions, our REIT subsidiaryTerra Property Trust would be disqualified from treatment as a REIT for the subsequent four taxable years following the year during which it failed to qualify.
Accordingly, our REIT subsidiary’sTerra Property Trust’s failure to maintain its qualification as a REIT could have an adverse effect on our income, general financial condition and ability to pay distributions.
Complying with the REIT requirements may force our REIT subsidiaryTerra Property Trust to liquidate or forego otherwise attractive investments.
In order to qualify as a REIT, our REIT subsidiaryTerra Property Trust annually must satisfy two gross income requirements. First, at least 75% of its gross income for each taxable year, excluding gross income from prohibited transactions and certain hedging and foreign currency transactions, must be derived from investments relating to real property or mortgages on real property, including “rents
from real property,” dividends received from and gain from the disposition of shares of other REITs, interest income derived from mortgage loans secured by real property (including certain types of qualified mezzanine loans and mortgage-backed securities), and gains from the sale of real estate assets, as well as income from certain kinds of qualified temporary investments. Second, at least 95% of our REIT subsidiary’sTerra Property Trust’s gross income in each taxable year, excluding gross income from prohibited transactions and certain hedging and foreign currency transactions, must be derived from some combination of income that qualifies under the 75% gross income test described above, as well as other dividends, interest, and gain from the sale or disposition of stock or securities, which need not have any relation to real property.
Further, at the end of each calendar quarter, at least 75% of the value of our REIT subsidiary’sTerra Property Trust’s total assets must consist of cash, cash items, government securities, shares in other REITs and other qualifying real estate assets, including certain mortgage loans, mezzanine loans and certain kinds of mortgage-backed securities. The remainder of our REIT subsidiary’sTerra Property Trust’s investment in securities (other than government securities, securities issued by a taxable REIT subsidiary (“TRS”)TRS and securities that are qualifying real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our REIT subsidiary’sTerra Property Trust’s total assets (other than government securities, TRS securities and securities that are qualifying real estate assets) can consist of the securities of any one issuer, no more than 20% of the value of our REIT subsidiary’sTerra Property Trust’s total assets can be represented by securities of one or more TRSs it may own, and no more than 25% of the value of ourTerra Property Trust’s total assets can consist of debt instruments issued by publicly offered REITs that are not otherwise secured by real property. If our REIT subsidiaryTerra Property Trust fails to comply with these requirements at the end of any calendar quarter, it must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing its REIT qualification and suffering adverse tax consequences.
As a result, our REIT subsidiaryTerra Property Trust may be required to liquidate from its portfolio, or contribute to a TRS, should it decide to form one in the future, otherwise attractive investments, and may be unable to pursue investments that would be otherwise advantageous to it in order to satisfy the source of income or asset diversification requirements for qualifying as a REIT. These actions could have the effect of reducing our REIT subsidiary’sTerra Property Trust’s income and amounts available for distribution to us. Thus,
compliance with the REIT requirements may hinder our REIT subsidiary’sTerra Property Trust’s ability to make, and, in certain cases, maintain ownership of certain attractive investments.
RiskTerra Property Trust’s preferred equity and mezzanine loan investments may fail to qualify as real estate assets for purposes of mezzanine loans failingthe REIT gross income and asset tests, which could jeopardize Terra Property Trust’s ability to qualify as a real estate asset.REIT.
The Internal Revenue Service has issued Revenue Procedure 2003-65, which provides a safe harbor pursuant to which a mezzanine loan that is secured by interests in a partnership or other pass-through entity will be treated by the Internal Revenue Service as a real estate asset for purposes of the REIT assets tests, and interest derived from such a loan will be treated as qualifying mortgage interest for purposes of the REIT 75% and 95% gross income tests. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. Our REIT subsidiaryTerra Property Trust owns, and may acquire in the future, certain mezzanine loans and preferred equity investments (which it intends to treat as mezzanine loans for U.S. federal income tax purposes) that do not satisfy all of the requirements for reliance on the safe harbor set forth in the Revenue Procedure. Consequently, there can be no assurance that the Internal Revenue Service will not successfully challenge the tax treatment of such mezzanine loans or preferred equity investments as qualifying real estate assets. To the extent that such mezzanine loans or preferred equity investments do not qualify as real estate assets, the interest income from such mezzanine loans or preferred equity investments would be qualifying income for the REIT 95% gross income test, but not for the REIT 75% gross income test and such mezzanine loans or preferred equity investments would not be qualifying assets for the 75% asset test and would be subject to the REIT 5% and 10% asset tests, which could jeopardize our REIT subsidiary’sTerra Property Trust’s ability to qualify as a REIT.
Risk of the Internal Revenue Service successfully challenging our REIT subsidiary’sTerra Property Trust’s treatment of its preferred equity and mezzanine loan investments as debt for U.S. federal income tax purposes.
Our REIT subsidiary Terra Property Trust invests in certain real estate related investments, including mezzanine loans, first mortgage loans, and preferred equity investments. There is limited case law and administrative guidance addressing whether certain preferred equity investments or mezzanine loans will be treated as equity or debt for U.S. federal income tax purposes. OurThe REIT Manager received an opinion of prior tax counsel regarding the treatment of theone of Terra Property Trust’s fixed return preferred equity investments acquired by our REIT subsidiary pursuant to the REIT formation transactionsand future similarly structured investments as debt for U.S. federal income tax purposes. Our REIT subsidiaryTerra Property Trust treats the preferred equity investments which it currently holds as debt for U.S. federal income tax purposes and as mezzanine loans that qualify as real estate assets, as discussed above. No private letter rulings have been obtained on the characterization of these investments for U.S. federal income tax purposes and an opinion of counsel is not binding on the Internal Revenue Service; therefore, no assurance can be given that the Internal Revenue Service will not successfully challenge the treatment of such preferred equity investments as debt and as qualifying real estate assets. If a preferred equity investment or mezzanine loan owned by our REIT subsidiaryTerra Property Trust was treated as equity for U.S. federal income tax purposes, our REIT subsidiaryTerra Property Trust would be treated as owning its proportionate share of the assets and earning its proportionate share of the gross income of the partnership or limited liability company that issued the preferred equity interest. Certain of these partnerships and limited liability companies are engaged in activities, which could cause our REIT
subsidiaryTerra Property Trust to be considered as earning significant nonqualifying income which would likely cause our REIT subsidiaryTerra Property Trust to fail to qualify as a REIT or pay a significant penalty tax to maintain its REIT qualification.
The failure of assets subject to repurchase agreements that our REIT subsidiary may enterTerra Property Trust enters into to qualify as real estate assets could adversely affect the ability of our REIT subsidiaryTerra Property Trust to qualify as a REIT.REIT.
Our REIT subsidiary may enter Terra Property Trust has entered into financing arrangements that are structured as sale and repurchase agreements pursuant to which our REIT subsidiary nominallyTerra Property Trust sells certain of its assets to a counterparty and simultaneously enters into an agreement to repurchase such assets at a later date in exchange for a purchase price. Economically, these agreements are financings that are secured by the assets sold pursuant thereto. We believe that our REIT subsidiaryTerra Property Trust will be treated for REIT asset and gross income test purposes as the owner of the assets that are the subject of such sale and repurchase agreement notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the Internal Revenue Service could assert that our REIT subsidiaryTerra Property Trust is not the owner of the assets during the term of the sale and repurchase agreement, in which case our REIT subsidiaryTerra Property Trust could fail to qualify as a REIT.
Complying with REIT requirements may limit our ability to hedge effectively.
We make substantially all of our investments, and conduct substantially all of our real estate lending business, through Terra Property Trust, which has elected to be taxed as a REIT for U.S. federal income tax purposes. The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generateTerra Property Trust generates from transactions intended to hedge ourits interest rate and currency risks will generally be excluded from gross income for purposes of the 75% and 95% gross income tests if (i) the instrument (A) hedges interest rate risk or foreign
currency exposure on liabilities used to carry or acquire real estate assets, (B) hedges risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the 75% or 95% gross income tests or (C) hedges an instrument described in clause (A) or (B) for a period following the extinguishment of the liability or the disposition of the asset that was previously hedged by the hedged instrument, and (ii) such instrument is properly identified under the applicable regulations promulgated by the Treasury Regulations.
Dividends payableGeneral Risk Factors
The effects of the ongoing COVID-19 pandemic, as well as any future pandemics or similar events, and the actions taken in response thereto, may adversely affect our investments and operations.
In March 2020, the World Health Organization publicly characterized the outbreak of COVID-19 as a global pandemic. The COVID-19 pandemic has caused, and may continue to cause, significant disruptions to the U.S. and global economy and cause significant volatility and negative pressure in the financial markets. During the early part of the pandemic, the U.S. and global economy came under severe pressure due to numerous factors, including measures taken by REITs generally do not qualify forgoverning authorities to prevent the reduced tax ratesspread of COVID-19, such as instituting quarantines, restrictions on dividend incometravel, school closures, bans on public events and on public gatherings, “shelter in place” or “stay at home” rules, restrictions on types of business that may continue to operate, and/or restrictions on types of construction projects that may continue. Many of such restrictions have long since been lifted, and the unprecedented global impact of the COVID-19 pandemic appears to have largely subsided. Nevertheless, the negative impacts of COVID-19 on the U.S. and global economy were quite severe and recovery is still in progress.
As a result of a significant portion of Terra Property Trust’s investments being in preferred equity of entities that own, mezzanine loans and first mortgages secured by office, multifamily and hospitality properties located in the United States, the ongoing COVID-19 pandemic will impact Terra Property Trust’s investments and operating results to the extent that it reduces occupancy, increases the cost of operation or results in limited hours or necessitates the closure of such properties. The borrowers under the first mortgages, mezzanine loans or preferred equity in which Terra Property Trust invests may fail to make timely and required payments under the terms of such instruments. In addition, quarantines, states of emergencies and other measures taken to curb the spread of the COVID-19 pandemic may negatively impact the ability of such properties to continue to obtain necessary goods and services or provide adequate staffing, which may also adversely affect Terra Property Trust’s investments and our operating results.
The world-wide economic downturn resulting from regular C corporations,the COVID-19 pandemic could negatively impact our investments and operations, as well as our ability to make distributions to our unitholders. The extent to which the COVID-19 pandemic impacts our investments and operations will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the future rate of occurrence or mutation of COVID-19, continuation of or changes in governmental responses to the ongoing COVID-19 pandemic, and the effectiveness of responsive actions taken in the United States and other countries to contain and manage the disease. Public and private responses to the pandemic may lead to deterioration of economic conditions, an economic downturn or a recession at a global scale, which could adverselymaterially affect our performance, financial condition, results of operations and cash flows. Any other pandemics or similar events in the value offuture could also similarly have a material adverse effect on our units.investments and operations, as well as our ability to make distributions to our unitholders.
The maximum U.S. federal income tax rate for certain qualified dividends payable to U.S. stockholders that are individuals, trustsWe and estates is 20%. For taxable years beginning after December 31, 2017 and before January 1, 2026, under the recently enacted TCJA, non-corporate taxpayersTerra Property Trust are subject to environmental, social and governance (“ESG”) risks that could adversely affect
our reputation, business, operations and earnings.
Certain organizations that provide corporate risk information to investors and shareholders have developed scores and ratings to evaluate companies based upon various ESG metrics. Currently, there are no universal standards for such scores or ratings, but ESG evaluations are increasingly being integrated into investment analysis. Views about ESG matters are diverse and rapidly changing, and companies are facing increasing scrutiny from regulators, investors, and other stakeholders related to their ESG practices and disclosure. If we or Terra Property Trust fail to adapt to or comply with regulatory requirements or investor or stakeholder ESG standards, our reputation, ability to do business with certain partners, access to capital, operations and earnings could be adversely affected.
Future recessions, downturns, disruptions or instability could have a 37% maximummaterially adverse effect on our results of operations, financial condition and cash flows.
From time to time, the global capital markets may experience periods of disruption and instability, which could cause disruptions in liquidity in the debt capital markets, significant write-offs in the financial services sector, the re-pricing of credit
risk in the broadly syndicated credit market and the failure of major financial institutions. Despite actions of U.S. federal income tax rateand foreign governments, these events could contribute to worsening general economic conditions that materially and adversely impact the broader financial and credit markets and reduce the availability of debt and equity capital for the market as a whole and financial services firms in particular.
Deterioration of economic and market conditions in the future could negatively impact credit spreads as well as our ability to obtain financing, particularly from the debt markets, which in turn may have a material adverse effect on ordinary income,our results of operations, financial condition and are entitled to deduct up to 20% of certain pass-through business income, including “qualified REIT dividends” (generally, dividends receivedcash flows.
Returnson our real estate-related loans may be limited by a REIT shareholder that are not designated as capital gain dividends or qualified dividend income),regulations.
Our loan investments may be subject to certain limitations, resultingregulation by federal, state and local authorities and subject to various laws and judicial and administrative decisions. We may determine not to make or invest in real estate-related loans in any jurisdiction in which we believe we have not complied in all material respects with applicable requirements, which could reduce the amount of income we would otherwise receive.
Investors’ return may be reduced as a result of the additional expense of operating as a reporting company under the Exchange Act.
We are subject to the periodic and current reporting requirements of the Exchange Act. As a reporting company, we have to comply with a variety of substantive requirements under the Exchange Act that impose, among other things:
•preparation and filing of current reports on Form 8-K;
•preparation and filing of quarterly reports on Form 10-Q; and
•preparation and filing of annual reports on Form 10-K.
We are subject to these reporting and other requirements even though we have not yet completed an effective maximum U.S. federal income tax rate of 29.6% on such income. Although the reduced U.S. federal income tax rate applicable to qualified dividends from C corporations does not adversely affect the taxation of REITsinitial public offering or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends, togetherlisted our units. Compliance with the recently reduced 21% corporate tax rate in effect for taxable years beginning after December 31, 2017, could cause non-corporate investorsExchange Act will increase our operating expenses, which may reduce our ability to perceive investments in REITs to be relatively less attractive than investments in non-REIT corporations that pay dividends, which could adversely affect the value of REIT shares. Because we are organized as a holding companymake distributions and conduct our business primarily through our REIT subsidiary, this perception could adversely affect the value of our units.
Your interests may be diluted if we issue additional units in the future.
Members will not have preemptive rights to acquire any units issued by us in the future. Therefore, investors may experience dilution of their investment if we sell additional units in the future.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our administrative and principal executive offices are located at 805 Third Avenue, 8th205 West 28th Street, 12th Floor, New York, New York 10022.10001. We believe that our office facilities are suitable and adequate for our business as it is presently conducted.
Item 3. Legal Proceedings.
Neither we, our REIT subsidiaryTerra JV, Terra Property Trust nor our Manager is currently subject to any material legal proceedings, nor, to our knowledge, are material legal proceedings threatened against us, our REIT subsidiaryTerra JV, Terra Property Trust or our Manager. From time to time, we, our REIT subsidiaryTerra JV, Terra Property Trust and individuals employed by our Manager or its affiliates may be a party to certain legal proceedings in the ordinary course of business. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
There is no established trading market for our units. As of December 31, 2017,March 10, 2023, we had 6,697.46,622.2 units outstanding held by a total of approximately 3,1483,204 investors. As of December 31, 2017,March 10, 2023, there were no outstanding options, warrants to purchase our units or securities convertible into our units. In addition, as of December 31, 2017, there were no units
We currently expect that could be sold pursuant to Rule 144 under the Securities Act or that we have agreed to register under the Securities Act for sale and there were no units that were being, or were proposed to be, publicly offered by us.
Distributions
Following the completion of the REIT formation transactions, our Manager approved an increase in the monthly distribution payable in respect of each unit in respect of the first full quarterly period following the closing of the REIT formation transactions to 9.0% per annum on $50,000 per unit. In addition, our Manager approved an initial payment on each Termination Unit in respect of the first full quarterly period following the closing of the REIT formation transactions equal to 6.0% per annum on the Unreturned Invested Capital (as defined in our operating agreement) associated with each Termination Unit. The timing and amount of future distributions and paymentscomparable cash dividends will continue to be paid in the future. However, these dividends will be made at the sole discretion of our Manager and subject to such factorswill depend upon, among other things, our Manager considers to be relevant, including the amountactual results of funds available for distribution or payment, our financial condition, whether to reinvest or distribute such funds, capital expenditureoperations and reserve requirements and general operational requirements. Because we cannot predict future cash flows or the performance of our REIT subsidiary, no assurance can be given that we will be able to continue to maintain in future periods distributions on units and payments on the Termination Units at levels approved by our Manager.liquidity.
The following tables summarize our distributions declared during the years ended December 31, 2017 and 2016:
|
| | | | | | | | | | | | | | | | | | | | |
Distribution Date | | Distributions Per Regular Unit | | Distributions Per Terra Fund 1 Termination Unit (1) | | Distributions Per Terra Fund 2 Termination Unit (2) | | Distributions Per Terra Fund 3 Termination Unit (3) | | Distributions Per Terra Fund 4 Termination Unit |
Year Ended December 31, 2017: | | | | | | | | |
January 31, 2017 | | $ | 375 |
| | $ | — |
| | $ | — |
| | $ | 240 |
| | $ | 247 |
|
February 28, 2017 | | 375 |
| | — |
| | — |
| | 240 |
| | 247 |
|
March 31, 2017 | | 375 |
| | — |
| | — |
| | 240 |
| | 247 |
|
April 30, 2017 | | 375 |
| | — |
| | — |
| | 240 |
| | 247 |
|
May 31, 2017 | | 375 |
| | — |
| | — |
| | 240 |
| | 247 |
|
June 30, 2017 | | 375 |
| | — |
| | — |
| | 240 |
| | 247 |
|
July 31, 2017 | | 375 |
| | — |
| | — |
| | 240 |
| | 247 |
|
August 31, 2017 | | 375 |
| | — |
| | — |
| | 178 |
| | 247 |
|
September 30, 2017 | | 375 |
| | — |
| | — |
| | 94 |
| | 247 |
|
October 31, 2017 | | 375 |
| | — |
| | — |
| | — |
| | 247 |
|
November 30, 2017 | | 375 |
| | — |
| | — |
| | — |
| | 247 |
|
December 31, 2017 | | 375 |
| | — |
| | — |
| | — |
| | 247 |
|
Total | | $ | 4,500 |
| | $ | — |
| | $ | — |
| | $ | 1,952 |
| | $ | 2,964 |
|
|
| | | | | | | | | | | | | | | | | | | | |
Distribution Date | | Distributions Per Regular Unit | | Distributions Per Terra Fund 1 Termination Unit (1) | | Distributions Per Terra Fund 2 Termination Unit (2) | | Distributions Per Terra Fund 3 Termination Unit (3) | | Distributions Per Terra Fund 4 Termination Unit |
Year Ended December 31, 2016: | | | | | | | | |
January 31, 2016 | | $ | 375 |
| | $ | 240 |
| | $ | 248 |
| | $ | 240 |
| | $ | 247 |
|
February 28, 2016 | | 375 |
| | 240 |
| | 248 |
| | 240 |
| | 247 |
|
March 31, 2016 | | 375 |
| | 240 |
| | 248 |
| | 240 |
| | 247 |
|
April 30, 2016 | | 375 |
| | 188 |
| | 248 |
| | 240 |
| | 247 |
|
May 31, 2016 | | 375 |
| | 97 |
| | 248 |
| | 240 |
| | 247 |
|
June 30, 2016 | | 375 |
| | — |
| | 248 |
| | 240 |
| | 247 |
|
July 31, 2016 | | 375 |
| | — |
| | 248 |
| | 240 |
| | 247 |
|
August 31, 2016 | | 375 |
| | — |
| | 248 |
| | 240 |
| | 247 |
|
September 30, 2016 | | 375 |
| | — |
| | 248 |
| | 240 |
| | 247 |
|
October 31, 2016 | | 375 |
| | — |
| | 248 |
| | 240 |
| | 247 |
|
November 30, 2016 | | 375 |
| | — |
| | 173 |
| | 240 |
| | 247 |
|
December 31, 2016 | | 375 |
| | — |
| | 89 |
| | 240 |
| | 247 |
|
Total | | $ | 4,500 |
| | $ | 1,005 |
| | $ | 2,742 |
| | $ | 2,880 |
| | $ | 2,964 |
|
_______________
| |
(1) | Terra Fund 1 Termination Units were fully redeemed in May 2016. |
| |
(2) | Terra Fund 2 Termination Units were fully redeemed in December 2016. |
| |
(3) | Terra Fund 3 Termination Units were fully redeemed in September 2017. |
Unregistered Sales of Equity Securities and Use of Proceeds
Sales of Unregistered Equity Securities
On January 1, 2016, we consummatedThere were no sales of unregistered equity securities during the REIT formation transactions as described in “Item 1. Business.” In connection with the REIT formation transaction, we issued 3,206.64 units to investors in Funds 1 through 4 who wished to continue their investment in our Fund (as reorganized in the REIT formation transactions) and 463.69 Termination Units to investors in Funds 1 through 4 who wished to enter the liquidity phase of their investment, in each case in exchange for their existing interests in Funds 1 through 4. We also issued 573.46 units to investors in a private placement concurrent with the REIT formation transactions at a price of $47,000 per unit, which reflects the reduced front-end load relative to the existing members’ initial investment of $50,000 per unit.year ended December 31, 2022.
The aforementioned units and Termination Units were issued in reliance upon an exemption from registration under the federal securities laws provided by Regulation D promulgated under Section 4(a)(2) of the Securities Act and Regulation S promulgated thereunder, and from qualification under state securities laws. Each investor who received units and Termination Units has represented that it (i) is an “accredited investor” within the meaning of Rule 501(a) of the Securities Act and (ii) has acquired such securities for its own account for investment purposes only and not for resale or distribution.
Issuer Purchases of Equity Securities
The following table provides information with respect to repurchasesThere were no issuer purchases of our unitsequity securities during the year ended December 31, 2017:
|
| | | | | | | | | | | |
Period | | Total number of units purchased | | Average price paid per unit | | Total number of units purchased as part of publicly announced plans or program | | Maximum number (or approximate dollar value) of units that may yet be purchased under the plans or programs |
January 2017 | | — |
| | — |
| | N/A | | N/A |
February 2017 | | — |
| | — |
| | N/A | | N/A |
March 2017 | | — |
| | — |
| | N/A | | N/A |
April 2017 | | — |
| | — |
| | N/A | | N/A |
May 2017 | | — |
| | — |
| | N/A | | N/A |
June 2017 | | — |
| | — |
| | N/A | | N/A |
July 2017 | | 31.4 (1) |
| | $ | 41,445 |
| | N/A | | N/A |
August 2017 | | 42.4 (1) |
| | $ | 41,445 |
| | N/A | | N/A |
September 2017 | | 55.4 (2) |
| | $ | 40,538 |
| | N/A | | N/A |
October 2017 | | — |
| | — |
| | N/A | | N/A |
November 2017 | | — |
| | — |
| | N/A | | N/A |
December 2017 | | — |
| | — |
| | N/A | | N/A |
Total | | 129.2 |
| | — |
| | N/A | | N/A |
_______________
| |
(1) | Represents the number of Termination Units issued to former members of Terra Fund 3, which were redeemed during the period. |
| |
(2) | Consists of 47.3 Termination Units issued to former members of Terra Fund 3 and 8.1 non-Termination Units, which were redeemed at a 15% discount. |
Item 6. Selected Financial Data.[Reserved].
The selected financial data presented below under the captions “Statement of operations data”, “Per unit data”, “Other information” and “Balance sheet data” as of and for the years ended December 31, 2017 and 2016 are derived from our consolidated financial statements, which have been audited by KPMG LLP, an independent registered public accounting firm. The data should be read in conjunction with our “Management's Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto.
|
| | | | | | | | |
| | Years Ended December 31, |
| | 2017 | | 2016 |
Statements of Operations Data: | | | | |
Investment income | | $ | 21,361,570 |
| | $ | 31,674,995 |
|
Total operating expenses | | 528,861 |
| | 1,567,003 |
|
Net investment income | | 20,832,709 |
| | 30,107,992 |
|
Net increase in members’ capital resulting from operations | | 21,908,940 |
| | 29,058,742 |
|
| | | | |
Per Unit Data: | | | | |
Net asset value | | $ | 41,143 |
| | $ | 42,423 |
|
Net investment income | | 3,075 |
| | 4,344 |
|
Net increase in members capital resulting from operations | | 3,234 |
| | 4,193 |
|
Capital distributions | | 4,523 |
| | 4,418 |
|
| | | | |
Other Information: | | | | |
Internal rate of return at year end | | 6.26 | % | | 5.43 | % |
Number of investments at year end | | 1 |
| | 1 |
|
Purchases of stock | | $ | — |
| | $ | 10,000,000 |
|
Return of capital | | 16,066,595 |
| | 6,791,237 |
|
|
| | | | | | | | |
| | December 31, |
| | 2017 | | 2016 |
Balance Sheet Data: | | | | |
Total assets | | $ | 275,645,183 |
| | $ | 290,468,284 |
|
Total investments | | 275,428,953 |
| | 290,419,317 |
|
Members’ capital | | 275,549,455 |
| | 289,586,404 |
|
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our audited consolidated financial statements and related notes thereto and other financial information included elsewhere in this annual report on Form 10-K.
Overview
We are a specialized real estate financecredit focused company that originates, structures, funds and manages high yielding commercial real estate investments, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments throughout the United States. Our investmentsloans finance the acquisition, construction, development or redevelopment of quality commercial real estate in the United States. We focus on smaller,the origination of middle market loans in the approximately $3$10 million to $50 million range, which are financingto finance properties primarily in primary and secondary markets because wemarkets. We believe these loans in this size range are subject to less competition, offer higher risk adjusted returns than larger loans with similar risk metrics and facilitate portfolio diversification. We were formed as a Delaware limited liability company on April 24, 2013 and commenced operations on August 8, 2013. We make substantially all of our investments, and conduct substantially all of our real estate lending business, through our REIT subsidiary,Terra Property Trust, which has elected to be taxed as a REIT for U.S. federal income tax purposes commencing with its taxable year ended December 31, 2016. Our investment objectives are to (i) preserve our members’ capital contributions, (ii) realize income from our investments and (iii) make monthly distributions to our members from cash generated from investments. There can be no assurances that we will be successful in meeting our investment objectives.
On January 1, 2016, the Terra Funds 1 through 4 merged with and into our subsidiaries of our Fund, which in turnthrough the Merger. Following the Merger, we contributed the consolidated portfolio of our net assets and the net assets of the Terra Funds to our REIT subsidiary.Terra Property Trust in exchange for all of the shares of common stock of Terra Property Trust. We elected to engage in the REIT formation transactions, to continuemake our business as a REIT for U.S. federal income tax purposes,investments through Terra Property Trust and to provide our members with a more broadly diversified portfolio of assets, while at the same time providing us with enhanced access to capital and borrowings, lower operating costs and enhanced opportunities for growth.
Our investment activities are externally On March 2, 2020, Terra Fund 1, Terra Fund 2 and Terra Fund 3 merged with and into Terra Fund 4, with Terra Fund 4 continuing as the surviving company, and we consolidated our holdings of shares of common stock of Terra Property Trust in Terra Fund 4. Subsequent to the Terra Fund Merger, the legal name of Terra Fund 4 was changed to Terra JV, LLC. On March 2, 2020, Terra Property Trust engaged in a series of transactions pursuant to which Terra Property Trust issued an aggregate of 4,574,470.35 shares of its common stock in exchange for the settlement of an aggregate of $49.8 million of participation interests in loans that Terra Property Trust owned, cash of $25.5 million and other working capital. Following the consummation of the BDC Merger and as of December 31, 2022, former Terra BDC stockholders owned approximately 19.9%
of Terra Property Trust’s common equity, Terra JV held 70.0% of the issued and outstanding shares of Terra Property Trust’s common stock with the remainder of 10.1% held by Terra Offshore REIT; and we and Terra Fund 7 owned an 87.6% and 12.4% interest, respectively, in Terra JV. Accordingly, as of December 31, 2022, we indirectly beneficially owned 61.3% of the outstanding shares of common stock of Terra Property Trust through Terra JV.
As previously disclosed, we continue to explore alternative liquidity transactions on an opportunistic basis to maximize value for our investors. Examples of the alternative liquidity transactions that, depending on market conditions, may be available to us, or our subsidiaries or affiliates, include a listing of our shares of common stock of Terra Property Trust on a national securities exchange, adoption of a share repurchase plan, a liquidation of assets, a sale of our company or its subsidiaries or affiliates or a strategic business combination, in each case, which may include the in-kind distribution of shares of common stock of Terra Property Trust indirectly owned by our company and certain other fund vehicles managed by our Manager,Terra Capital Partners or its affiliates to the ultimate investors in these vehicles. We cannot provide any assurance that any alternative liquidity transaction will be available to us or, if available, that we will pursue or be successful in completing any such alternative liquidity transaction.
Recent Developments
Terra BDC Merger
On October 1, 2022, pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022 , Terra BDC merged with and into Terra LLC, a wholly owned subsidiary of Terra Capital Partners,Property Trust, with Terra LLC continuing as the surviving entity of the merger and as a real estate financewholly owned subsidiary of Terra Property Trust. The Certificate of Merger and investment firm based in New York City that focus primarilyArticles of Merger with respect to the Terra BDC Merger were filed with the Secretary of State of the State of Delaware and the State Department of Assessments and Taxation of Maryland (the “SDAT”), respectively, with an effective time and date of 12:02 a.m., Eastern Time, on the originationClosing Date (the “Effective Time”).
At the Effective Time, except for any shares of common stock, par value $0.001 per share (“Terra BDC Common Stock”), of Terra BDC held by Terra Property Trust or any of its wholly owned subsidiaries or Terra BDC, which shares were automatically retired and managementceased to exist with no consideration paid therefor, each issued and outstanding share of mezzanine loans,Terra BDC Common Stock was automatically cancelled and retired and converted into the right to receive (i) 0.595 shares of TPT Class B Common Stock, and (ii) cash, without interest, in lieu of any fractional shares of TPT Class B Common Stock otherwise issuable in an amount, rounded to the nearest whole cent, determined by multiplying (x) the fraction of a share of TPT Class B Common Stock to which such holder would otherwise be entitled by (y) $14.38.
Pursuant to the terms of the transactions described in the Terra BDC Merger Agreement, approximately 4,847,910 shares of TPT Class B Common Stock were issued to former Terra BDC stockholders in connection with the Terra BDC Merger, based on the number of outstanding shares of Terra BDC Common Stock as wellof the Closing Date. Following the consummation of the Terra BDC Merger, former Terra BDC stockholders owned approximately 19.9% of the common equity of Terra Property Trust and we indirectly beneficially owned approximately 61.3% of the common equity of Terra Property Trust.
On the Closing Date, Terra Property Trust filed with the SDAT its Articles of Amendment to the Articles of Amendment and Restatement (the “TPT Charter Amendment”). Pursuant to the TPT Charter Amendment, (i) the authorized shares of its stock which Terra Property Trust has authority to issue were increased from 500,000,000 to 950,000,000, consisting of 450,000,000 shares of TPT Class A Common Stock, 450,000,000 shares of TPT Class B Common Stock, and 50,000,000 shares of Preferred Stock, $0.01 par value per share, and (ii) each share of Terra Property Trust’s common stock issued and outstanding immediately prior to the Effective Time was automatically changed into one issued and outstanding share of TPT Class B Common Stock.
The TPT Class B Common Stock rank equally with and have identical preferences, rights, voting powers, restrictions, limitations as first mortgage loans, bridge loans,to dividends and preferred equity investmentsother distributions, qualifications, and terms and conditions of redemption as each other share of our common stock, except as set forth below with respect to conversion.
On the First Conversion Date, one-third of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock. On the Second Conversion Date, one-half of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock. On the Third Conversion Date, all of the issued and outstanding shares of TPT Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of TPT Class A Common Stock.
As of the Effective Time and in all major property types.accordance with the Terra BDC Merger Agreement, the size of the TPT Board was increased by three members and each of Spencer Goldenberg, Adrienne Everett and Gaurav Misra (each a “Terra BDC Designee”, and collectively, the “Terra BDC Designees”) were elected to the TPT Board to fill the vacancies created by such increase, with each Terra BDC Designee to serve until Terra Property Trust’s next annual meeting of stockholders and until his or her successor is duly elected and qualifies. Each of the other members of the TPT Board immediately prior to the Effective Time continued as members following the Effective Time.
Portfolio Summary
The following tables provide a summary of our REIT subsidiary’sTerra Property Trust’s net loan portfolio as of December 31, 20172022 and 2016:2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| Fixed Rate | | Floating Rate (1)(2)(3) | | Total Gross Loans | | Obligations under Participation Agreements | | Total Net Loans |
Number of loans | 8 | | | 23 | | | 31 | | | 1 | | | 31 | |
Principal balance | $ | 90,990,183 | | | $ | 554,805,276 | | | $ | 645,795,459 | | | $ | 12,584,958 | | | $ | 633,210,501 | |
Amortized cost | 92,274,998 | | | 534,215,769 | | | 626,490,767 | | | 12,680,594 | | | 613,810,173 | |
Fair value | 90,729,098 | | | 532,416,656 | | | 623,145,754 | | | 12,680,595 | | | 610,465,159 | |
Weighted average coupon rate | 13.82 | % | | 11.23 | % | | 11.59 | % | | 16.36 | % | | 11.50 | % |
Weighted-average remaining term (years) | 1.35 | | | 1.10 | | | 1.14 | | | 1.69 | | | 1.13 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Fixed Rate | | Floating Rate (1)(2)(3) | | Total Gross Loans | | Obligations under Participation Agreements and Secured Borrowing | | Total Net Loans |
Number of loans | 6 | | | 15 | | | 21 | | | 4 | | | 21 | |
Principal balance | $ | 74,880,728 | | | $ | 405,270,423 | | | $ | 480,151,151 | | | $ | 76,569,398 | | | $ | 403,581,753 | |
Amortized cost | 75,520,212 | | | 394,153,102 | | | 469,673,314 | | | 76,818,156 | | | 392,855,158 | |
Fair value | 75,449,410 | | | 391,752,209 | | | 467,201,619 | | | 75,900,089 | | | 391,301,530 | |
Weighted average coupon rate | 12.39 | % | | 7.01 | % | | 7.85 | % | | 10.40 | % | | 7.37 | % |
Weighted-average remaining term (years) | 1.93 | | | 1.45 | | | 1.53 | | | 0.82 | | | 1.66 | |
_______________
(1)These loans pay a coupon rate of LIBOR or SOFR plus a fixed spread. Coupon rate shown was determined using LIBOR of 4.39%, average SOFR of 4.06% and forward-looking term rate based on SOFR (“Term SOFR”) of 4.36% as of December 31, 2022 and LIBOR of 0.10% as of December 31, 2021.
(2)As of December 31, 2022 and 2021, amount included $413.1 million and $163.1 million of senior mortgages used as collateral for $261.0 million and $93.8 million of borrowings under credit facilities, respectively.
(3)As of December 31, 2022 and 2021, twenty-one and thirteen of these loans, respectively, are subject to a LIBOR or SOFR floor, as applicable.
In addition to Terra Property Trust’s net loan portfolio, as of December 31, 2022, Terra Property Trust owned a multi-tenant office building acquired pursuant to a foreclosure and as of December 31, 2021, Terra Property Trust owned 4.9 acres of land acquired pursuant to a deed in lieu of foreclosure and the aforementioned multi-tenant office building. The land was sold in the second quarter of 2022. The real estate and related lease intangible assets and liabilities had a net carrying value of $40.6 million and $56.1 million as of December 31, 2022 and December 31, 2021, respectively. The mortgage loan payable encumbering the multi-tenant office building had an outstanding principal amount of $29.3 million and $32.0 million as of December 31, 2022 and 2021, respectively.
|
| | | | | | | | | | | | | | | | | | | |
| December 31, 2017 |
| Fixed Rate | | Floating Rate (1) | | Total Gross Loans | | Obligations under Participation Agreements | | Total Net Loans |
Number of loans | 33 |
| 1 |
| 1 |
| | 34 |
| | 19 |
| | 34 |
|
Principal balance | $ | 299,311,201 |
| | $ | 53,749,794 |
| | $ | 353,060,995 |
| | 75,077,891 |
| | $ | 277,983,104 |
|
Amortized cost | 302,816,709 |
| | 54,277,021 |
| | 357,093,730 |
| | 76,053,279 |
| | 281,040,451 |
|
Fair value | 302,951,869 |
| | 54,282,803 |
| | 357,234,672 |
| | 75,991,436 |
| | 281,243,236 |
|
Weighted average coupon rate | 12.79 | % | | 9.97 | % | | 12.36 | % | | 12.67 | % | | 12.23 | % |
Weighted-average remaining term (years) | 1.62 |
| | 0.19 |
| | 1.40 |
| | 1.14 |
| | 1.47 |
|
|
| | | | | | | | | | | | | | | | | | |
| December 31, 2016 |
| Fixed Rate | | Floating Rate (1) | | Total Gross Loans | | Obligations under Participation Agreements | | Total Net Loans |
Number of loans | 37 |
| | 1 |
| | 38 |
| | 11 |
| | 38 |
|
Principal balance | $ | 275,554,910 |
| | $ | 50,450,061 |
| | $ | 326,004,971 |
| | 32,635,785 |
| | $ | 293,369,186 |
|
Amortized cost | 279,781,074 |
| | 50,902,766 |
| | 330,683,840 |
| | 32,986,194 |
| | 297,697,646 |
|
Fair value | 278,931,283 |
| | 50,924,056 |
| | 329,855,339 |
| | 32,904,955 |
| | 296,950,384 |
|
Weighted average coupon rate | 12.98 | % | | 9.19 | % | | 12.38 | % | | 12.96 | % | | 12.33 | % |
Weighted-average remaining term (years) | 1.42 |
| | 1.19 |
| | 1.39 |
| | 1.35 |
| | 1.37 |
|
Additionally, as of December 31, 2022 and 2021, Terra Property Trust owned 27.9% and 50.0%, respectively, of equity interest in a limited partnership that invests primarily in performing and non-performing mortgages, loans, mezzanines and other credit instruments supported by underlying commercial real estate assets. Terra Property Trust also beneficially owned equity interests in three joint ventures that invest in real estate properties. In 2022, in connection with a mezzanine loan Terra Property Trust originated, Terra Property Trust entered into a residual profit sharing arrangement with the borrower. Terra Property Trust accounted for this arrangement as an equity investment. As of December 31, 2022 and 2021, these equity investments had total carrying value of $62.5 million and $69.7 million, respectively.
_______________
| |
(1) | This loan pays an annual coupon rate of London Interbank Offered Rate (“LIBOR”) plus 8.5% with a LIBOR floor of 0.5%. Coupon rate shown was determined using the applicable annual coupon rate as of December 31, 2017 and 2016.
|
Portfolio Investment Activity
For the years ended December 31, 2022 and 2021, Terra Property Trust invested $126.9 million and $117.3 million in new and add-on investments and had $33.3 million and $85.1 million of repayments, resulting in net investments of $93.6 million and $32.2 million, respectively. Amounts are net of obligations under participation agreements, secured borrowing, borrowings under the master repurchase agreement, the term loan, the repurchase agreements and the revolving line of credit.
Portfolio Information
The tables below detailset forth the types of loansassets in our REIT subsidiary’s loanTerra Property Trust’s portfolio, as well as the property type and geographic location of the properties securing thesethe loans in the portfolio, on a net loan basis, which represents our REIT subsidiary'sTerra Property Trust’s proportionate share of the loans, based on its economic ownership of these loans.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | December 31, 2021 |
Investment Structure | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total |
First mortgages | | $ | 456,408,889 | | | $ | 461,299,182 | | | $ | 458,085,397 | | | 63.1 | % | | $ | 310,933,350 | | | $ | 313,515,326 | | | $ | 312,735,452 | | | 58.3 | % |
Preferred equity investments | | 121,231,434 | | | 122,132,177 | | | 97,127,877 | | | 13.4 | % | | 63,441,546 | | | 63,515,633 | | | 49,187,299 | | | 9.2 | % |
Mezzanine loans | | 26,767,345 | | | 26,770,521 | | | 26,325,341 | | | 3.6 | % | | 17,444,357 | | | 17,622,804 | | | 17,518,902 | | | 3.3 | % |
Credit facility | | 28,802,833 | | | 29,080,183 | | | 28,926,544 | | | 4.0 | % | | 11,762,500 | | | 11,859,876 | | | 11,859,877 | | | 2.2 | % |
Allowance for loan losses | | — | | | (25,471,890) | | | — | | | — | % | | — | | | (13,658,481) | | | — | | | — | % |
Total loan investments | | $ | 633,210,501 | | | 613,810,173 | | | 610,465,159 | | | 84.1 | % | | $ | 403,581,753 | | | 392,855,158 | | | 391,301,530 | | | 73.0 | % |
Marketable securities | | | | 136,265 | | | 147,960 | | | — | % | | | | 1,176,006 | | | 1,310,000 | | | 0.2 | % |
Real estate owned | | | | 40,581,847 | | | 52,500,000 | | | 7.2 | % | | | | 56,067,129 | | | 75,043,111 | | | 14.0 | % |
Equity investment in unconsolidated Investments | | | | 62,498,340 | | | 63,161,348 | | | 8.7 | % | | | | 69,713,793 | | | 68,898,535 | | | 12.8 | % |
Total | | | | $ | 717,026,625 | | | $ | 726,274,467 | | | 100.0 | % | | | | $ | 519,812,086 | | | $ | 536,553,176 | | | 100.0 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2017 | | December 31, 2016 |
Loan Structure | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total |
First mortgages | | $ | 109,231,733 |
| | $ | 110,306,919 |
| | $ | 110,308,371 |
| | 39.2 | % | | $ | 117,890,016 |
| | $ | 118,995,391 |
| | $ | 119,018,338 |
| | 40.1 | % |
Mezzanine loans | | 101,115,711 |
| | 102,386,404 |
| | 102,670,907 |
| | 36.5 | % | | 118,524,437 |
| | 121,037,421 |
| | 120,466,609 |
| | 40.6 | % |
Preferred equity investments | | 67,635,660 |
| | 68,347,128 |
| | 68,263,958 |
| | 24.3 | % | | 47,415,691 |
| | 48,229,921 |
| | 47,838,821 |
| | 16.1 | % |
Other (1) | | — |
| | — |
| | — |
| | — | % | | 9,539,042 |
| | 9,626,616 |
| | 9,626,616 |
| | 3.2 | % |
Allowance for loan losses | | — |
| | — |
| | — |
| | — | % | | — |
| | (191,703 | ) | | — |
| | — | % |
Total | | $ | 277,983,104 |
| | $ | 281,040,451 |
| | $ | 281,243,236 |
| | 100.0 | % | | $ | 293,369,186 |
| | $ | 297,697,646 |
| | $ | 296,950,384 |
| | 100.0 | % |
_______________
| |
(1) | Other represents unused cash from credit facilities. |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2017 | | December 31, 2016 |
Property Type | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total |
Hotel | | $ | 59,319,892 |
| | $ | 60,026,750 |
| | $ | 59,958,385 |
| | 21.3 | % | | $ | 66,351,287 |
| | $ | 67,557,902 |
| | $ | 67,077,247 |
| | 22.6 | % |
Office | | 58,145,794 |
| | 58,714,480 |
| | 58,722,267 |
| | 20.9 | % | | 69,506,033 |
| | 70,159,209 |
| | 70,158,868 |
| | 23.6 | % |
Land | | 55,481,939 |
| | 56,029,898 |
| | 56,025,568 |
| | 19.9 | % | | 53,746,133 |
| | 54,255,486 |
| | 54,258,353 |
| | 18.2 | % |
Condominium | | 38,511,274 |
| | 38,829,923 |
| | 38,868,479 |
| | 13.8 | % | | 20,586,832 |
| | 20,744,035 |
| | — |
| | — | % |
Multifamily | | 37,456,258 |
| | 37,988,040 |
| | 37,848,395 |
| | 13.5 | % | | 62,924,101 |
| | 64,277,164 |
| | 84,556,067 |
| | 28.5 | % |
Student housing | | 22,067,947 |
| | 22,451,360 |
| | 22,820,142 |
| | 8.1 | % | | 5,700,000 |
| | 6,125,635 |
| | 6,215,839 |
| | 2.1 | % |
Industrial | | 7,000,000 |
| | 7,000,000 |
| | 7,000,000 |
| | 2.5 | % | | — |
| | — |
| | — |
| | — | % |
Mixed use | | — |
| | — |
| | — |
| | — | % | | 2,515,758 |
| | 2,533,450 |
| | 2,527,566 |
| | 0.9 | % |
Other (1) | | — |
| | — |
| | — |
| | — | % | | 12,039,042 |
| | 12,236,468 |
| | 12,156,444 |
| | 4.1 | % |
Allowance for loan losses | | — |
| | — |
| | — |
| | — | % | | — |
| | (191,703 | ) | | — |
| | — | % |
Total | | $ | 277,983,104 |
| | $ | 281,040,451 |
| | $ | 281,243,236 |
| | 100.0 | % | | $ | 293,369,186 |
| | $ | 297,697,646 |
| | $ | 296,950,384 |
| | 100.0 | % |
_______________
| |
(1) | Other includes $9.5 million of unused cash from two credit facilities and $2.5 million of retail properties at December 31, 2016. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | December 31, 2021 |
Property Type | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total |
Office | | $ | 171,611,750 | | | $ | 172,042,063 | | | $ | 159,780,622 | | | 22.0 | % | | $ | 166,071,342 | | | $ | 166,836,320 | | | $ | 163,723,036 | | | 30.6 | % |
Industrial | | 147,796,164 | | | 148,891,742 | | | 148,409,441 | | | 20.4 | % | | 18,762,500 | | | 18,859,876 | | | 18,841,978 | | | 3.5 | % |
Multifamily | | 104,589,464 | | | 105,570,432 | | | 103,784,913 | | | 14.3 | % | | 72,999,417 | | | 73,955,240 | | | 74,017,225 | | | 13.9 | % |
Mixed use | | 64,880,450 | | | 65,838,965 | | | 52,303,392 | | | 7.2 | % | | 28,940,658 | | | 28,977,024 | | | 16,069,378 | | | 3.0 | % |
Infill land | | 48,860,291 | | | 49,565,437 | | | 49,864,054 | | | 6.9 | % | | 28,960,455 | | | 28,923,827 | | | 29,173,344 | | | 5.4 | % |
Hotel - full/select service | | 43,222,382 | | | 43,758,804 | | | 43,062,933 | | | 5.9 | % | | 56,847,381 | | | 57,395,682 | | | 57,565,411 | | | 10.7 | % |
Student housing | | 31,000,000 | | | 31,774,261 | | | 31,816,276 | | | 4.4 | % | | 31,000,000 | | | 31,565,670 | | | 31,911,158 | | | 5.9 | % |
Infrastructure | | 21,250,000 | | | 21,840,359 | | | 21,443,528 | | | 3.0 | % | | — | | | — | | | — | | | — | % |
Allowance for loan losses | | — | | | (25,471,890) | | | — | | | — | % | | — | | | (13,658,481) | | | — | | | — | % |
Total loan investments | | $ | 633,210,501 | | | 613,810,173 | | | 610,465,159 | | | 84.1 | % | | $ | 403,581,753 | | | 392,855,158 | | | 391,301,530 | | | 73.0 | % |
Marketable securities | | | | 136,265 | | | 147,960 | | | — | % | | | | 1,176,006 | | | 1,310,000 | | | 0.2 | % |
Real estate owned | | | | 40,581,847 | | | 52,500,000 | | | 7.2 | % | | | | 56,067,129 | | | 75,043,111 | | | 14.0 | % |
Equity investment in unconsolidated Investments | | | | 62,498,340 | | | 63,161,348 | | | 8.7 | % | | | | 69,713,793 | | | 68,898,535 | | | 12.8 | % |
Total | | | | $ | 717,026,625 | | | $ | 726,274,467 | | | 100.0 | % | | | | $ | 519,812,086 | | | $ | 536,553,176 | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | December 31, 2021 |
Geographic Location | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total |
United States | | | | | | | | | | | | | | | | |
California | | $ | 151,668,387 | | | $ | 153,158,967 | | | $ | 150,237,383 | | | 20.8 | % | | $ | 187,209,547 | | | $ | 189,082,380 | | | $ | 189,447,577 | | | 35.3 | % |
New York | | 91,845,479 | | | 91,877,084 | | | 67,737,205 | | | 9.3 | % | | 63,441,546 | | | 63,515,633 | | | 49,187,299 | | | 9.1 | % |
Georgia | | 72,401,718 | | | 73,101,964 | | | 71,971,448 | | | 9.9 | % | | 53,289,288 | | | 53,536,884 | | | 52,031,363 | | | 9.7 | % |
Texas | | 67,625,000 | | | 68,142,046 | | | 68,142,046 | | | 9.4 | % | | 13,625,000 | | | 13,725,690 | | | 13,735,569 | | | 2.6 | % |
New Jersey | | 62,228,622 | | | 62,958,482 | | | 63,290,218 | | | 8.7 | % | | — | | | — | | | — | | | — | % |
Washington | | 56,671,267 | | | 57,027,639 | | | 57,191,604 | | | 7.9 | % | | 3,523,401 | | | 3,382,683 | | | 3,553,330 | | | 0.7 | % |
Utah | | 49,250,000 | | | 50,698,251 | | | 50,345,762 | | | 6.9 | % | | 28,000,000 | | | 28,420,056 | | | 28,851,547 | | | 5.4 | % |
North Carolina | | 43,520,028 | | | 44,041,162 | | | 43,634,806 | | | 6.0 | % | | 44,492,971 | | | 44,704,699 | | | 44,453,133 | | | 8.3 | % |
Arizona | | 31,000,000 | | | 31,276,468 | | | 31,276,468 | | | 4.3 | % | | — | | | — | | | — | | | — | % |
Massachusetts | | 7,000,000 | | | 7,000,000 | | | 6,638,219 | | | 0.9 | % | | 7,000,000 | | | 7,000,000 | | | 6,982,101 | | | 1.3 | % |
South Carolina | | — | | | — | | | — | | | — | % | | 3,000,000 | | | 3,145,614 | | | 3,059,611 | | | 0.6 | % |
Allowance for loan losses | | — | | | (25,471,890) | | | — | | | — | % | | — | | | (13,658,481) | | | — | | | — | % |
Total loan investments | | $ | 633,210,501 | | | 613,810,173 | | | 610,465,159 | | | 84.1 | % | | $ | 403,581,753 | | | 392,855,158 | | | 391,301,530 | | | 73.0 | % |
Marketable securities | | | | 136,265 | | | 147,960 | | | — | % | | | | 1,176,006 | | | 1,310,000 | | | 0.2 | % |
Real estate owned | | | | 40,581,847 | | | 52,500,000 | | | 7.2 | % | | | | 56,067,129 | | | 75,043,111 | | | 14.0 | % |
Equity investment in unconsolidated Investments | | | | 62,498,340 | | | 63,161,348 | | | 8.7 | % | | | | 69,713,793 | | | 68,898,535 | | | 12.8 | % |
Total | | | | $ | 717,026,625 | | | $ | 726,274,467 | | | 100.0 | % | | | | $ | 519,812,086 | | | $ | 536,553,176 | | | 100.0 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2017 | | December 31, 2016 |
Geographic Location | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total | | Principal Balance | | Amortized Cost | | Fair Value | | % of Total |
United States | | | | | | | | | | | | | | | | |
California | | $ | 104,362,267 |
| | $ | 105,490,614 |
| | $ | 105,391,192 |
| | 37.5 | % | | $ | 89,925,061 |
| | $ | 91,165,200 |
| | $ | 90,798,926 |
| | 30.5 | % |
New York | | 43,761,274 |
| | 44,121,538 |
| | 44,164,421 |
| | 15.7 | % | | 37,032,965 |
| | 37,324,858 |
| | 37,315,430 |
| | 12.6 | % |
Florida | | 39,926,892 |
| | 40,281,901 |
| | 40,296,964 |
| | 14.2 | % | | 49,122,324 |
| | 49,520,673 |
| | 49,320,018 |
| | 16.6 | % |
Washington | | 20,354,875 |
| | 20,469,129 |
| | 20,527,134 |
| | 7.3 | % | | — |
| | — |
| | — |
| | — | % |
Pennsylvania | | 15,585,000 |
| | 15,731,551 |
| | 15,732,064 |
| | 5.6 | % | | 18,982,000 |
| | 19,162,115 |
| | 19,184,642 |
| | 6.5 | % |
Georgia | | 15,846,939 |
| | 16,126,857 |
| | 15,998,575 |
| | 5.7 | % | | 4,250,000 |
| | 4,604,941 |
| | 4,387,683 |
| | 1.5 | % |
Texas | | 6,093,243 |
| | 6,188,077 |
| | 6,157,971 |
| | 2.2 | % | | 9,139,038 |
| | 9,363,678 |
| | 9,330,002 |
| | 3.1 | % |
Massachusetts | | 7,000,000 |
| | 7,000,000 |
| | 7,000,000 |
| | 2.5 | % | | 4,000,000 |
| | 4,112,275 |
| | 4,071,618 |
| | 1.4 | % |
Delaware | | 4,396,000 |
| | 4,437,459 |
| | 4,439,464 |
| | 1.6 | % | | 7,000,000 |
| | 7,057,616 |
| | 7,086,338 |
| | 2.4 | % |
Ohio | | 4,000,000 |
| | 4,040,000 |
| | 4,039,499 |
| | 1.4 | % | | — |
| | — |
| | — |
| | — | % |
Alabama | | 3,700,000 |
| | 3,772,716 |
| | 3,736,507 |
| | 1.3 | % | | 3,844,445 |
| | 3,928,742 |
| | 3,882,318 |
| | 1.3 | % |
Oregon | | 3,140,000 |
| | 3,246,472 |
| | 3,263,587 |
| | 1.2 | % | | 5,000,000 |
| | 5,356,923 |
| | 5,324,812 |
| | 1.8 | % |
North Carolina | | 2,198,000 |
| | 2,220,813 |
| | 2,219,723 |
| | 0.8 | % | | 4,921,404 |
| | 4,985,576 |
| | 4,985,280 |
| | 1.7 | % |
Tennessee | | 1,884,000 |
| | 1,952,329 |
| | 1,946,605 |
| | 0.7 | % | | 9,877,843 |
| | 10,179,485 |
| | 10,047,055 |
| | 3.4 | % |
New Jersey | | — |
| | — |
| | — |
| | — | % | | 22,639,955 |
| | 22,865,291 |
| | 22,864,082 |
| | 7.7 | % |
Virginia | | — |
| | — |
| | — |
| | — | % | | 6,675,510 |
| | 6,737,238 |
| | 6,737,238 |
| | 2.3 | % |
Arizona | | — |
| | — |
| | — |
| | — | % | | 5,719,598 |
| | 5,772,487 |
| | 5,772,487 |
| | 1.9 | % |
Other (1) | | 5,734,614 |
| | 5,960,995 |
| | 6,329,530 |
| | 2.3 | % | | 15,239,043 |
| | 15,752,251 |
| | 15,842,455 |
| | 5.3 | % |
Allowance for loan losses | | — |
| | — |
| | — |
| | — | % | | — |
| | (191,703 | ) | | — |
| | — | % |
Total | | $ | 277,983,104 |
| | $ | 281,040,451 |
| | $ | 281,243,236 |
| | 100.0 | % | | $ | 293,369,186 |
| | $ | 297,697,646 |
| | $ | 296,950,384 |
| | 100.0 | % |
_______________
| |
(1) | Other includes $2.7 million of properties in Indiana, $1.9 million of properties in South Carolina and $1.1 million of properties in Utah at December 31, 2017. Other includes $9.5 million of unused cash from two credit facilities, $2.7 million of properties in Indiana and $3.0 million of properties in South Carolina at December 31, 2016. |
Factors Impacting Operating Results
Our operating results of operations are affected by a number of factors and primarily depend on, among other things, the level of the interest income generated by Terra Property Trust from targeted assets, the market value of our assets and the supply of, and demand for, real estate-related loans, including mezzanine loans, first and second mortgage loans, subordinated mortgage loans, bridge loans, preferred equity investments and other loans related to high quality commercial real estate in the United States, and the financing and other costs associated with our business. Interest income and borrowing costs of Terra Property Trust may vary as a result of changes in interest rates, which could impact the net interest we receive on our assets. Our operating results may also be impacted by conditions in the financial markets and unanticipated credit events experienced by borrowers under our loan assets.
Market Risk
Our REIT subsidiary’s Terra Property Trust’s loans are highly illiquid, and there is no assurance that it will achieve its investment objectives, including targeted returns. Due to the illiquidity of the loans, valuation of our REIT subsidiary’sTerra Property Trust’s loans may be difficult, as there generally will be no established markets for these loans.
Credit Risk
Credit risk represents the potential loss that our REIT subsidiaryTerra Property Trust would incur if the borrowers failed to perform pursuant to the terms of their obligations to our REIT subsidiary. Our REIT subsidiary minimizes itsTerra Property Trust. Terra Property Trust manages exposure to credit risk by limiting exposure to any one individual borrower and any one asset class. Additionally, our REIT subsidiaryTerra Property Trust employs an asset management approach and monitormonitors the portfolio of loans through, at a minimum, quarterly financial review of property performance including net operating income, loan-to-value ratio, debt service coverage ratio, and the debt yield. Our REIT subsidiaryTerra Property Trust also requires certain borrowers to establish a cash reserve, as a form of additional collateral, for the purpose of providing for future interest or property-related operating payments.
The performance and value of Terra Property Trust’s loans depend upon the sponsors’ ability to operate or manage the development of the respective properties that serve as collateral so that each property’s value ultimately supports the repayment of the loan balance. Mezzanine loans and preferred equity investments are subordinate to senior mortgage loans and, therefore, involve a higher degree of risk. In the event of a default, mezzanine loans and preferred equity investments will be satisfied only after the senior lender’s investment is fully recovered. As a result, in the event of a default, our REIT subsidiaryTerra Property Trust may not recover all of its investments.
In addition, Terra Property Trust is exposed to the risks generally associated with the commercial real estate market, including variances in occupancy rates, capitalization rates, absorption rates, and other macroeconomic factors beyond its control. Terra Property Trust seeks to manage these risks through its underwriting and asset management processes.
The COVID-19 pandemic has significantly impacted the commercial real estate markets, causing reduced occupancy, requests from tenants for rent deferral or abatement, and delays in construction and development projects currently planned or underway. These negative conditions may persist into the future and impair Terra Property Trust’s borrowers’ ability to pay principal and interest due to Terra Property Trust under its loan agreements.
We and our REIT subsidiaryTerra Property Trust maintain all of our cash at financial institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
Concentration Risk
Our REIT subsidiary Terra Property Trust holds real estate-related loans. Thus, its loan portfolio may be subject to a more rapid change in value than would be the case if it were required to maintain a wide diversification among industries, companies and types of loans. The result of such concentration in real estate assets is that a loss in such loans could materially reduce our REIT subsidiary’sTerra Property Trust’s capital.
Liquidity Risk
Liquidity risk represents the possibility that we may not be able to sell, directly or indirectly, our positionsequity interest in Terra Property Trust or Terra JV at a reasonable price in times of low trading volume, high volatility and financial stress.
Interest Rate Risk
Interest rate risk represents the effect from a change in interest rates, which could result in an adverse change in the fair value of our interest-bearing financial instruments. With respect to our REIT subsidiary’sTerra Property Trust’s business operations, increases in interest rates, in general, may over time cause: (i) the interest expense associated with variable rate borrowings to increase; (ii) the value of real estate-related loans to decline; (iii) coupons on variable rate loans to reset, although on a delayed basis, to higher interest rates; (iv) to the extent applicable under the terms of our REIT subsidiary’sTerra Property Trust’s investments, prepayments on real estate-related loans to slow,slow; and (v) to the extent we enter into interest rate swap agreements as part of our REIT subsidiary’sTerra Property Trust’s hedging strategy, the value of these agreements to increase.
Conversely, decreases in interest rates, in general, may over time cause: (i) the interest expense associated with variable rate borrowings to decrease; (ii) the value of real estate-related loans to increase; (iii) coupons on variable rate real estate-related loans to reset, although on a delayed basis, to lower interest rates (iv) to the extent applicable under the terms of our REIT subsidiary’sTerra Property Trust’s investments, prepayments on real estate-related loans to increase,increase; and (v) to the extent our REIT subsidiaryTerra Property Trust enters into interest rate swap agreements as part of its hedging strategy, the value of these agreements to decrease.
Prepayment Risk
Prepayments can either positively or adversely affect the yields on our REIT subsidiary’sTerra Property Trust’s loans. Prepayments on debt instruments, where permitted under the debt documents, are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. If our REIT subsidiaryTerra Property Trust does not collect a prepayment fee in connection with a prepayment or are unable to invest the proceeds of such prepayments received, the yield on the portfolio will decline. In addition, our REIT subsidiaryTerra Property Trust may acquire assets at a discount or premium and if the asset does not repay when expected, the anticipated yield may be impacted. Under certain interest rate and prepayment scenarios our REIT subsidiaryTerra Property Trust may fail to recoup fully its cost of acquisition of certain loans.
Extension Risk
Extension risk is the risk that Terra Property Trust’s assets will be repaid at a slower rate than anticipated and generally increases when interest rates rise. In which case, to the extent Terra Property Trust has financed the acquisition of an asset, Terra Property Trust may have to finance its asset at potentially higher costs without the ability to reinvest principal into higher yielding securities because borrowers prepay their mortgages at a slower pace than originally expected, adversely impacting its net interest spread, and thus its net interest income.
Real Estate Risk
The market values of commercial and residential mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; pandemics; natural disasters; and other acts of god. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause Terra Property Trust to suffer losses.
Use of Leverage
Our REIT subsidiary may deploy Terra Property Trust deploys moderate amounts of leverage as part of ourits operating strategy, which may consist of borrowings under first mortgage financings, warehouse facilities, term loans, repurchase agreements and other credit facilities. While borrowing and leverage present opportunities for increasing total return, they may have the effect of potentially creating or increasing losses.
35
Results of Operations
The following table presents the comparative results of our operations for the years ended December 31, 20172022 and 2016:2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Years Ended December 31, |
| | | | | | | | | | | | 2022 | | 2021 | | Change |
Investment income | | | | | | | | | | | | | | | | |
Dividend income | | | | | | | | | | | | $ | 6,868,609 | | | $ | 1,883,284 | | | $ | 4,985,325 | |
Other operating income | | | | | | | | | | | | 65 | | | 53 | | | 12 | |
Total investment income | | | | | | | | | | | | 6,868,674 | | | 1,883,337 | | | 4,985,337 | |
Operating expenses | | | | | | | | | | | | | | | | |
Professional fees | | | | | | | | | | | | 538,348 | | | 442,093 | | | 96,255 | |
Other | | | | | | | | | | | | 4,666 | | | 3,310 | | | 1,356 | |
Total operating expenses | | | | | | | | | | | | 543,014 | | | 445,403 | | | 97,611 | |
Net investment income | | | | | | | | | | | | 6,325,660 | | | 1,437,934 | | | 4,887,726 | |
Net change in unrealized depreciation on investment | | | | | | | | | | | | (2,682,270) | | | (6,822,621) | | | 4,140,351 | |
Net increase (decrease) in members’ capital resulting from operations | | | | | | | | | | | | $ | 3,643,390 | | | $ | (5,384,687) | | | $ | 9,028,077 | |
|
| | | | | | | | | | | | |
| | Years Ended December 31, |
| | 2017 | | 2016 | | Change |
Investment income | | | | | | |
Dividend income | | $ | 21,360,569 |
| | $ | 31,666,409 |
| | $ | (10,305,840 | ) |
Other operating income | | 1,001 |
| | 8,586 |
| | (7,585 | ) |
Total investment income | | 21,361,570 |
| | 31,674,995 |
| | (10,313,425 | ) |
Operating expenses | | | | | | |
Professional fees | | 489,884 |
| | 1,139,749 |
| | (649,865 | ) |
Merger transaction fees | | — |
| | 388,692 |
| | (388,692 | ) |
Other | | 38,977 |
| | 38,562 |
| | 415 |
|
Total operating expenses | | 528,861 |
| | 1,567,003 |
| | (1,038,142 | ) |
Net investment income | | 20,832,709 |
| | 30,107,992 |
| | (9,275,283 | ) |
Net change in unrealized depreciation on investment | | 1,076,231 |
| | (1,049,250 | ) | | 2,125,481 |
|
Net increase in members’ capital resulting from operations | | $ | 21,908,940 |
| | $ | 29,058,742 |
| | $ | (7,149,802 | ) |
Dividend Income
Dividend income associated with our indirect ownership of our REIT subsidiaryTerra Property Trust primarily represents our REIT subsidiary’sproportionate share of Terra Property Trust’s net income or loss for the period. Any excess of distributions received from our REIT subsidiaryTerra Property Trust over its net income is recorded as return of capital. As of December 31, 2022 and 2021, through Terra JV we indirectly beneficially owned 61.3% and 76.5%, respectively, of the outstanding shares of common stock of Terra Property Trust.
For the years ended December 31, 20172022 and 2016,2021, we received distributions of $37.4$11.5 million and $38.5$13.1 million, respectively, or $2.51$0.78 and $2.58$0.88 per share, respectively, from our REIT subsidiary,Terra Property Trust, of which $21.4$6.9 million and $31.7$1.9 million was recorded as dividend income respectively, representing our REIT subsidiary’s net income for the periods presented, and $16.1$4.6 million and $6.8$11.2 million was recorded as return of capital, respectively. The $10.3 million decrease in our REIT subsidiary’s net income was primarily due to (i) $3.6 million of prepayment fee income received from one loan during
For the year ended December 31, 20162022 as compared to the borrower repaid the loan two years before the scheduled maturity date; (ii) a decreasesame period in 2021 Terra Property Trust’s net loss decreased by $5.4 million, primarily due to an increase in net interest income of $5.1$6.6 million as a result of loweran increase in the weighted average principal balance lowerof net loans and an increase in the weighted average coupon rate and the suspension of $1.2 million ofon net interest income accrual on two loans as discussed in “Annual Net Effective Yield” below; and (iii) operating income of $2.2 million for year ended December 31, 2016 from Terra Park Green which was subsequently sold in November 2016. The $13.7 million increase in return of capital was primarily due to the decreasenew loans Terra Property Trust entered into in our REIT subsidiary’s net income2022 and as well as additional cash neededloans acquired in connection with the BDC Merger, a gain on extinguishment of debt of $3.4 million due to redeemobligations under participation agreements with Terra Fund 3’s Termination Units.BDC being released in connection with the BDC Merger, a decrease in real estate operating loss of $2.1 million as a result of lease termination income recognized in 2022 in connection with a termination notice received in November 2021, and an increase in prepayment fee income of $1.8 million as a result of an increase in loans with minimum yield provisions repaid before maturity. These increases in net income were partially offset by an increase in fees paid and operating expenses reimbursed to the Manager of $3.0 million as a result of an increase in total assets under management resulting, a decrease in equity income from unconsolidated investments of $3.2 million resulting from a decrease in ownership interest in RESOF and loss generated from the three joint ventures and an increase in professional fees of $1.9 million resulting from legal fees incurred in connection with litigation related to the ground rent reset as well as a loan refinancing in 2022 which was accounted for as a loan modification.
Net Loan Portfolio
In assessing the performance of our REIT subsidiary’sTerra Property Trust’s loans, we believe it is appropriate to evaluate the loans on an economic basis, that is, gross loans net of obligations under participation agreements and mortgagesecured borrowing, term loan payable, revolving line of credit and repurchase agreement payable.
The following tables present a reconciliation of our REIT subsidiary’sTerra Property Trust’s loan portfolio on a weighted average basis from a gross basis to a net basis for the years ended December 31, 20172022 and 2016:2021:
|
| | | | | | | | | | | | |
| | Year Ended December 31, 2017 | | Year Ended December 31, 2016 |
| | Weighted Average Principal Amount | | Weighted Average Coupon Rate | | Weighted Average Principal Amount | | Weighted Average Coupon Rate |
Gross loans | | $ | 341,479,601 |
| | 12.0% | | $ | 313,035,355 |
| | 12.7% |
Obligations under participation agreements | | (61,483,438 | ) | | 12.5% | | (24,279,495 | ) | | 13.3% |
Mortgage loan payable | | (36,190,698 | ) | | 6.2% | | (27,775,956 | ) | | 5.8% |
Net loans | | $ | 243,805,465 |
| | 12.7% (1) | | $ | 260,979,904 |
| | 13.4% (1) |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2022 | | Year Ended December 31, 2021 |
| | Weighted Average Principal Amount (1) | | Weighted Average Coupon Rate (2) | | Weighted Average Principal Amount (1) | | Weighted Average Coupon Rate (2) |
Total portfolio | | | | | | | | |
Gross loans | | $ | 550,062,087 | | | 10.7 | % | | $ | 456,344,152 | | | 8.5 | % |
Obligations under participation agreements and secured borrowing | | (59,931,021) | | 12.1 | % | | (114,437,021) | | 11.0 | % |
Repurchase agreement payable | | (167,507,961) | | | 6.2 | % | | (6,349,642) | | 2.6 | % |
Term loan payable | | (10,303,678) | | | 5.3 | % | | (103,433,296) | | | 5.3 | % |
Revolving line of credit | | (47,383,467) | | | 7.6 | % | | (16,721,744) | | | 4.0 | % |
Net loans (3) | | $ | 264,935,960 | | | 14.0 | % | | $ | 215,402,449 | | | 9.2 | % |
Senior loans | | | | | | | | |
Gross loans | | 408,607,321 | | 9.7 | % | | 272,577,220 | | 6.5 | % |
Obligations under participation agreements and secured borrowing | | (24,800,580) | | 8.1 | % | | (51,693,824) | | 8.9 | % |
Repurchase agreement payable | | (167,507,961) | | | 6.2 | % | | (6,349,642) | | 2.6 | % |
Term loan payable | | (10,303,678) | | | 5.3 | % | | (103,433,296) | | 5.3 | % |
Revolving line of credit | | (47,383,467) | | | 7.6 | % | | (16,721,744) | | | 4.0 | % |
Net loans (3) | | $ | 158,611,635 | | | 14.6 | % | | $ | 94,378,714 | | | 7.2 | % |
Subordinated loans (4) | | | | | | | | |
Gross loans | | 141,454,766 | | 13.6 | % | | 183,766,932 | | 11.4 | % |
Obligations under participation agreements | | (35,130,441) | | 13.7 | % | | (62,743,197) | | 12.8 | % |
Net loans (3) | | $ | 106,324,325 | | | 13.6 | % | | $ | 121,023,735 | | | 10.7 | % |
_______________
| |
(1) | Represents net interest income over the period calculated using the weighted average coupon rate and weighted average principal amount shown on the table (interest income on the loans less interest expense) divided by the weighted average principal amount of the net loans during the period. |
(1)Amount is calculated based on the number of days each loan is outstanding.
(2)Amount is calculated based on the underlying principal amount of each loan.
36
For the year ended December 31, 2017 as compared to the same period in 2016, the decrease in(3)The weighted average coupon rate was due to an increase in investments in seniorrepresents net interest income over the period calculated using the weighted average coupon rate and weighted average principal amount shown on the table (interest income on the loans which are typically larger principal-balanceless interest expense) divided by the weighted average principal amount of the net loans paying lower levels of interest reflecting the lower perceived risk due to their senior position in the borrower's capital structure as compared to investments in subordinated loans, as well as the new subordinated loans we originated and purchased during the current periods have coupon rates that are lower than those of the maturing subordinated loans.period.
(4)Subordinated loans include mezzanine loans, preferred equity investments and credit facilities.
Annual Net Effective Yield
The following table presents a calculation of our REIT subsidiary’s annual net effective yield on its net loan portfolio for the periods presented:
|
| | | | | | | | | | | | |
| | Years Ended December 31, |
| | 2017 | | 2016 (2) | | Change |
Interest income | | $ | 38,271,866 |
| | $ | 38,749,785 |
| | $ | (477,919 | ) |
Interest expense — obligations under participation agreements | | (6,999,500 | ) | | (3,278,676 | ) | | (3,720,824 | ) |
Interest expense — mortgage loan payable | | (2,652,137 | ) | | (1,774,986 | ) | | (877,151 | ) |
Net interest income | | $ | 28,620,229 |
| | $ | 33,696,123 |
| | $ | (5,075,894 | ) |
| | | | | | |
Weighted average carrying value of gross loans | | $ | 347,589,329 |
| | $ | 320,799,592 |
| | $ | 26,789,737 |
|
Weighted average carrying value of obligations under participation agreements | | (60,643,955 | ) | | (24,743,802 | ) | | (35,900,153 | ) |
Weighted average carrying value of mortgage loan payable | | (36,024,188 | ) | | (28,388,269 | ) | | (7,635,919 | ) |
Weighted average carrying value of net loans | | $ | 250,921,186 |
| | $ | 267,667,521 |
| | $ | (16,746,335 | ) |
| | | | | | |
Annual net effective yield (1) | | 11.4 | % | | 12.6 | % | | (1.2 | )% |
| | | | | | |
Senior loans | | | | | | |
Weighted average carrying value of net loans | | $ | 98,001,049 |
| | $ | 67,594,963 |
| | $ | 30,406,086 |
|
Annual net effective yield (1) | | 9.4 | % | | 12.8 | % | | (3.4 | )% |
Subordinated loans | | | | | | |
Weighted average carrying value of net loans | | $ | 152,920,137 |
| | $ | 200,072,558 |
| | $ | (47,152,421 | ) |
Annual net effective yield (1) | | 12.7 | % | | 12.5 | % | | 0.2 | % |
_______________
| |
(1) | Represents the annual net interest income divided by the weighted average carrying value of net loans during the period. |
| |
(2) | Amounts for 2016 exclude the operations of Terra Park Green, a wholly-owned entity that held a multi-tenant office portfolio comprised of two commercial office parks and the related operations in South Carolina. |
The following table presents the components of the annualized net effective yield on our REIT subsidiary’s net loan portfolio:
|
| | | | | | | | | | | |
| | | | Years Ended December 31, |
| | | | 2017 | | 2016 | | Change |
Net contractual interest income (1) | | | | 12.7 | % | | 13.4 | % | | (0.7 | )% |
Non-collection of interest income, net (2) | | | | (0.5 | )% | | — | % | | (0.5 | )% |
Amortization of net purchase premium (3) | | | | (0.6 | )% | | (0.8 | )% | | 0.2 | % |
Net transaction fee income (expense) | | | | (0.2 | )% | | — | % | | (0.2 | )% |
Total | | | | 11.4 | % | | 12.6 | % | | (1.2 | )% |
_______________
| |
(1) | The decrease was primarily due to a decrease in weighted average coupon rate (see “Net Loan Portfolio” above).
|
| |
(2) | During the year ended December 31, 2017, we did not receive interest income payments of $1.2 million, net of interest expense on obligations under participation agreements, on a senior loan and a subordinated loan. In July 2017, the principal balances of these two loans were repaid in full. |
| |
(3) | The increase was primarily due to a decrease in amortization of net purchase premium as a result of the majority of the net purchase premium recognized in connection with the REIT formation transactions in 2016 became substantially amortized. |
Professional Fees
For the year ended December 31, 2017 as compared to the same period in 2016, professional fees decreased by $0.6 million, primarily due to professional fees incurred in 2016 related to the additional SEC financial statement audit and reporting requirements in relation to the initial filing of our registration statement on Form 10.
Merger Transaction Fees
Merger transaction fees represent fees incurred in connection with the REIT formation transactions. Terra Capital Markets, an affiliate of our Manager, served as the dealer manager for the consent solicitation and was paid a voting advisory fee of $750 per initial unit sold to members of the Terra Funds and a dealer manager fee of 0.5% of the aggregate offering price of the units originally issued by the Terra Funds. Most of these fees were re-allowed to participating dealers. The Terra Funds also incurred costs for legal, accounting, and other professional services in connection with the consent solicitation.
For the year ended December 31, 2017, there were no merger transaction fees recorded. For the year ended December 31, 2016, we recorded additional merger transaction fees of $0.4 million.
Net Change in Unrealized Depreciation on Investment
Net change in unrealized appreciation or depreciation on investment reflects the change in our REIT subsidiary’s net loan portfolioTerra Property Trust’s fair value during the reporting period, including any reversal of previously recorded unrealized gains or losses, when gains or losses are realized.period. There may be fluctuations in unrealized gains and losses of the underlying portfolio as loans within the portfolio approach their respective maturity dates and fair value premiums are amortized or discounts are accreted to each loan’s respective collectible value.dates. In addition, the unrealized gains or losses in the portfolio may fluctuate over time due to changes in the market yields or carrying value adjustments such as the amortization or accretion of premiums, discounts, origination fees, and exit fees.yields.
2017 — For the year ended December 31, 2017, we recorded a decrease2022 as compared to the same period in 2021, net change in unrealized depreciation on investment decreased by $4.1 million, as a result of $1.1 million,a decrease in the fair value of Terra Property Trust’s investment portfolio, the decline in which was primarily due to the amortizationimpact of a substantial portion ofincreases in the net purchase premiums recognized in connection with the REIT formation transactions, which reduced the carrying value of the loans.
2016 — For the year ended December 31, 2016, we recorded an increase in unrealized depreciation on investment of $1.0 million, primarilyunderlying discount rates due to amortizationthe macro-economic conditions, partially offset by a decrease in the trading price of fair value premiums on loans within the portfolio as they neared their respective maturity dates, which reduced the fair value of the loans.Terra Property Trust’s unsecured notes payable.
Net Increase (Decrease) in Members’ Capital Resulting from Operations
For the year ended December 31, 2017 as compared to the same period in 2016,2022, the resulting net increase in members’members’ capital resultsresulting from operations decreased by $7.1 million.was $3.6 million, compared to the resulting net decrease in members’ capital resulting from operations of $5.4 million for the same period in 2021.
Financial Condition, Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including funding and maintaining our assets and operations, making distributions to our members and other general business needs. Our primary cash requirements for the next twelve months are making the discretionary recurring distributions to our members and, to a lesser extent, redeeming Terra Fund 4 Termination Units for approximately $2.1 million.members. We expect to use cash distributions received from our REIT subsidiaryTerra Property Trust to meet such cash requirements. Our REIT subsidiary’s expected loan and liability maturities duringDistributions are made at the next twelve months include the sole mortgage loan payable with a principal amount of $34.0 million which matures in March 2018, assuming no extensions, and obligations under participation agreements totaling $46.9 million. The first mortgage loan held by our REIT subsidiary has a coupon rate of LIBOR plus 8.5%, the borrowings under the mortgage loan incurred to finance the asset bear interest at an annual rate of LIBOR plus 5.25%, and the weighted average net interest spread between the yield on the first mortgage loan and the cost of funds under the mortgage loan payable was 2.30% for the year ended December 31, 2017. Our REIT subsidiary expects to use proceeds from the repaymentdiscretion of the corresponding investments to repay the mortgage loan payableTPT Board and participation obligations. Additionally, our REIT subsidiarywill depend upon, among other things, its actual results of operations and liquidity.
Terra Property Trust expects to fund approximately $23.4$44.1 million of the unfunded commitments to borrowers during
the next twelve months. Our REIT subsidiaryTerra Property Trust expects to maintain sufficient cash on hand to fund such commitmentcommitments through matching these commitments with principal repayments on outstanding loans.loans or draw downs on its credit facilities. Additionally, Terra Property Trust had $29.3 million of borrowings outstanding under a mortgage loan payable that bears interest at an annual rate of LIBOR plus 3.85% with a LIBOR floor of 2.23%, that is collateralized by an office building. The mortgage loan payable matures on May 31, 2023. Terra Property Trust expects to refinance the mortgage loan payable before it matures. In connection with the BDC Merger, Terra Property Trust assumed a $25.0 million delayed draw term loan. This term loan bears interest at an annual rate of 5.625% and matures on July 1, 2023. Terra Property Trust expects to either maintain sufficient cash on hand to repay the facility or refinance the facility. Terra Property Trust may also issue additional equity, equity-related and debt securities to fund its investment strategies. Terra Property Trust may issue these securities to unaffiliated third parties or to vehicles advised by affiliates of Terra Capital Partners or third parties. As part of its capital raising transactions, Terra Property Trust may grant to one or more of these vehicles certain control rights over its activities including rights to approve major decisions it takes as part of its business.
Summary of Financing
The table below summarizes Terra Property Trust’s debt financing as of December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Type of Financing | | Maximum Amount Available | | Outstanding Balance | | Amount Remaining Available | | Interest Rate | | Maturity Date |
Fixed Rate: | | | | | | | | | | |
Senior unsecured notes | | N/A | | $ | 85,125,000 | | | N/A | | 6.00% | | 6/30/2026 |
Senior unsecured notes | | N/A | | 38,375,000 | | | N/A | | 7.00% | | 3/31/2026 |
Delayed draw term loan | | $ | 25,000,000 | | | 25,000,000 | | | — | | | 5.63% | | 7/1/2023 |
| | $ | 25,000,000 | | | $ | 148,500,000 | | | $ | — | | | | | |
Variable Rate: | | | | | | | | | | |
Mortgage loan payable | | N/A | | $ | 29,252,308 | | | N/A | | LIBOR plus 3.85% with a LIBOR floor of 2.23% | | 5/31/2023 |
Line of credit | | $ | 125,000,000 | | | 90,135,865 | | | $ | 34,864,135 | | | LIBOR plus 3.25% with a combined floor of 4.00% | | 3/12/2024 |
UBS repurchase agreement | | 195,000,000 | | | 51,050,000 | | | 143,950,000 | | | LIBOR or Term SOFR depending on repurchased asset index plus a spread ranging from 1.60% to 2.25% | | 11/7/2024 |
GS repurchase agreement | | 200,000,000 | | | 119,826,606 | | | 80,173,394 | | | Term SOFR (subject to underlying loan floors on a case-by-case basis) plus a spread ranging from 1.75% to 3.00%) | | 2/18/2024 |
| | $ | 520,000,000 | | | $ | 290,264,779 | | | $ | 258,987,529 | | | | | |
Cash Flows Provided by Operating Activities
20172022 — For the year ended December 31, 2017,2022, cash flows provided by operating activities were $36.1$11.0 million, primarily due to $37.4$11.5 million of dividends received from our REIT subsidiary,Terra JV, of which $16.1$4.6 million was recorded as a return of capital.
20162021— For the year ended December 31, 2016,2021, cash flows provided by operating activities were $15.6$12.6 million, primarily due to $38.5$13.1 million of dividends received from our REIT subsidiary,Terra JV, of which $6.8$11.2 million was recorded as a return of capital, partially offset by (i) $10.0 million used to purchase shares of common stock of our REIT subsidiary; (ii) the payment of $5.2 million related to merger transaction fees that were accrued; (iii) $5.0 million of cash transferred to our REIT subsidiary in connection with the REIT formation transactions; (iv) $0.7 million reimbursed to the predecessor to our Manager for merger transaction fees paid; and (v) a $0.6 million of state and local tax paid in connection with the filing of the 2015 tax returns.capital.
Cash Flows used in Financing Activities
20172022 — For the year ended December 31, 2017,2022, cash flows used in financing activities were $11.7 million, primarily related to distributions paid to members of $11.3 million and payment for capital redemptions of $0.5 million.
2021— For the year ended December 31, 2021, cash flows used in financing activities was $35.9 million, consisting of distributions paid to members of $30.6 million and cash of $5.3 million used to primarily redeem Terra Fund 3 Termination Units.
2016— For the year ended December 31, 2016, cash flows used in financing activities was $17.4$12.0 million, primarily duerelated to distributions paid to members of $30.6 million and cash used for capital redemptions of $15.8 million, of which $12.3 million was used to redeem Terra Fund 1 and Terra Fund 2 Termination Units and $3.4 million was paid to other redeeming members. These cash outflows were partially offset by $25.6 million of proceeds from capital contributions from the offering concurrent with the REIT formation transactions, net of selling commissions and dealer manager fees, and cash of $3.5 million acquired in the REIT formation transactions.
Critical Accounting Policies and Use of Estimates
Our consolidated financial statements are prepared in conformity with United States generally accepted accounting principles, (“U.S. GAAP”), which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing the consolidated financial statements, management has utilized available information, including industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. As we execute our expected operating plans, we will describe additional critical accounting policies in the notes to our future consolidated financial statements in addition to those discussed below.
Allowance for Loan Losses
Our REIT subsidiary’s investments are typically collateralized by either the sponsors’ equity interest in real estate properties or real estate properties. As a result, our REIT subsidiary regularly evaluates the extent and impact of any credit migration associated with the performance and/or value of the underlying collateral property as well as the financial and operating capability of the borrower/sponsor on a loan by loan basis. Our Manager employs an asset management approach and monitors the portfolio of investments, through, at a minimum, quarterly financial review of property performance including net operating income, loan-to-value, debt-service coverage ratio and the debt yield, supplemented by occasional site visits to evaluate the assets. Our Manager also requires certain borrowers to establish a cash reserve, as a form of additional collateral, for the purpose of providing for future interest or property-related operating payments. The information gathered by way of the asset management process is sufficient in assessing collectability.
Using the information gathered by way of the asset management process, our Manager performs a quarterly, or more frequently as needed, review of our REIT subsidiary’s portfolio of investments. In conjunction with this review, our Manager assesses the risk factors of each investment and assigns each investment a risk rating. Based on a 5-point scale, our REIT subsidiary’s investments are rated “1” through “5”, from less risk to greater risk. For investments with a risk rating of “4” and “5”, our Manager assesses
each investment for collectability. This includes the ability to realize the full amount of principal and interest in the event that our REIT subsidiary needs to exercise its rights under the terms of the agreement and/or any other contemplated workout or modification. To the extent the net realizable amount analysis indicates the principal amount of the recorded investment as of the reporting date is in jeopardy, an appropriate allowance for loan losses will be recorded. Additionally, our REIT subsidiary records a general allowance for loan losses equal to 1.5% of the aggregate principal amount of loans rated as a “4” and 5% of the aggregate principal amount of loans rated as a “5”. Loans on which a specific allowance is recorded are removed from the pool of loans on which a general allowance is calculated.
Fair Value Measurements
The fair value of financial instrumentsour investment is categorized based on the priority of the inputs to the valuation technique and categorized into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Our financial assets and liabilities wereinvestment was recorded at fair value on our consolidated statements of assets and liabilities and were categorized based on the inputs valuation techniques as follows:
•Level 1. Quoted prices for identical assets or liabilities in an active market.
•Level 2. Financial assets and liabilities whose values are based on the following:
◦Quoted prices for similar assets or liabilities in active markets.
◦Quoted prices for identical or similar assets or liabilities in non-active markets.
◦Pricing models whose inputs are observable for substantially the full term of the asset or liability.
◦Pricing models whose inputs are derived principally from or corroborated by observable market data for
substantially full term of the asset or liability.
•Level 3. Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement.
Unobservable inputs reflect our assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available.
Any changes to the valuation methodology will be reviewed by management to ensure the changes are appropriate. As markets and products develop and the pricing for certain products becomes more transparent, we will continue to refine our valuation methodologies. The methods used may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. We will use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.
Income Taxes
No provision for U.S. federal and state income taxes has been made in the accompanying consolidated financial statements, as individual members are responsible for their proportionate share of our taxable income. We, however, may be liable for New York City Unincorporated Business Tax (the “NYC UBT”) and similar taxes of various other municipalities. New York City imposes the NYC UBT at a statutory rate of 4% on net income generated from ordinary business activities carried on in New York City. For the years ended December 31, 2017 and 2016, none of our income was subject to the NYC UBT.
We did not have any uncertain tax positions that met the recognition or measurement criteria of Accounting Standards Codification 740-10-25, Income Taxes, nor did we have any unrecognized tax benefits as of the periods presented herein. We recognize interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in our consolidated statements of operations. For the years ended December 31, 2017 and 2016, we did not incur any interest or penalties. Although we file federal
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Management Agreement with Terra REIT Advisors
and state tax returns, our major tax jurisdiction is federal. Our inception-to-date federal tax years remain subject to examination by the Internal Revenue Service.
Contractual Obligations
As part of the Axar Transaction, Terra Income Advisors assigned all of its rights, title and interest in and to its current external management agreement with our REIT subsidiary to the REIT Manager and immediately thereafter, the REIT Manager and our REIT subsidiary amended and restated such management agreement. Such amended and restated management agreement has the same economic terms and is in all material respects otherwise on the same terms as the management agreement between Terra Income Advisors and our REIT subsidiary in effect immediately prior to the Axar Transaction, except for the identity of our manager.
Our REIT subsidiaryTerra Property Trust currently pays the following fees to theTerra REIT ManagerAdvisors pursuant to a management agreement:
Origination and Extension Fee. An origination fee in the amount of 1.0% of the amount used to originate, acquire, fund, acquire or structure real estate-related loans,investments, including any third-party expenses related to such loan. In the event that the term of any real estate-related loan is extended, theTerra REIT ManagerAdvisors also receives an originationextension fee equal to the lesser of (i) 1.0% of the principal amount of the loan being extended or (ii) the amount of fee paid by the borrower in connection with such extension. The origination fee is offset by the amount of any origination fee received by our REIT subsidiary from borrowers.
Asset Management Fee. A monthly asset management fee at an annual rate equal to 1.0% of the aggregate funds under management, which includes the loan origination amount or aggregate gross acquisition cost, as applicable, for each real estate-related loan and cash held by our REIT subsidiary.Terra Property Trust.
Asset Servicing Fee. A monthly asset servicing fee at an annual rate equal to 0.25% of the aggregate gross origination price or aggregate gross acquisition price for each real estate related loan then held by our REIT subsidiaryTerra Property Trust (inclusive of closing costs and expenses).
Disposition Fee. A disposition fee in the amount of 1.0% of the gross sale price received by usTerra Property Trust from the disposition of each loan, but not upon the maturity, prepayment, workout, modification or extension of a loan unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of (i) 1.0% of the principal amount of the loan and (ii) the amount of the fee paid by the borrower in connection with such transaction. If our REIT subsidiaryTerra Property Trust takes ownership of a property as a result of a workout or foreclosure of a loan, our REIT subsidiaryTerra Property Trust will pay a disposition fee upon the sale of such property equal to 1.0% of the sales price.
Transaction Breakup Fee. In the event that our REIT subsidiaryTerra Property Trust receives any “breakup fees,” “busted-deal fees,” termination fees, or similar fees or liquidated damages from a third-party in connection with the termination or non-consummation of any loan or disposition transaction, theTerra REIT ManagerAdvisors will be entitled to receive one-half of such amounts, in addition to the reimbursement of all out-of-pocket fees and expenses incurred by theTerra REIT ManagerAdvisors with respect to its evaluation and pursuit of such transactions.
In addition to the fees described above, ourTerra Property Trust reimburses Terra REIT subsidiary reimburses the REIT ManagerAdvisors for operating expenses incurred in connection with services provided to the operations of our REIT subsidiary,Terra Property Trust, including our REIT subsidiary’sTerra Property Trust’s allocable share of theTerra REIT Manager’sAdvisors’s overhead, such as rent, employee costs, utilities, and technology costs.
The following table presents a summary of fees paid and costs reimbursed to Terra REIT Advisors in the predecessor to the REIT Manageraggregate in connection with providing services to our REIT subsidiary:Terra Property Trust:
| | | | | | | | | | Years Ended December 31, |
| | Years Ended December 31, | | | | 2022 | | 2021 |
| | 2017 | | 2016 | |
Origination fee expense (1) | | $ | 3,640,800 |
| | $ | 2,862,189 |
| |
Origination and extension fee expense (1)(2) | | Origination and extension fee expense (1)(2) | | | | $ | 2,967,291 | | | $ | 2,729,598 | |
Asset management fee | | 3,168,839 |
| | 3,316,435 |
| Asset management fee | | | | 6,556,492 | | | 5,134,149 | |
Asset servicing fee | | 701,697 |
| | 798,133 |
| Asset servicing fee | | | | 1,560,044 | | | 1,181,924 | |
Operating expenses reimbursed to Manager | | 3,343,738 |
| | 3,348,629 |
| |
Disposition fee (2) | | 1,087,533 |
| | 1,081,751 |
| |
Operating expenses reimbursed to Terra REIT Advisors | | Operating expenses reimbursed to Terra REIT Advisors | | | | 8,076,321 | | | 6,916,371 | |
Disposition fee (3) | | Disposition fee (3) | | | | 890,194 | | | 1,006,302 | |
Total | | $ | 11,942,607 |
| | $ | 11,407,137 |
| Total | | | | $ | 20,050,342 | | | $ | 16,968,344 | |
_______________
| |
(1) | (1)Origination and extension fee expense is generally offset with origination and extension fee income. Any excess is deferred and amortized to interest income over the term of the investment. |
| |
(2) | Disposition fee is generally offset with exit fee income on the consolidated statements of operations. Any excess is deferred and amortized to interest income over the term of the investment. |
Off-Balance Sheet Arrangements
Other than contractual commitments and other legal contingencies incurred in the normal course of our business, we do not have any off-balance sheet financings or liabilities.
Recent Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). The core principle of the revenue model is that an entity recognizes revenueloan.
(2)Amount for the years ended December 31, 2022 and 2021 excluded $0.2 million and $0.3 million, respectively, of origination fees paid to depict the transfer of promised goods or services to customersTerra REIT Advisors in connection with its equity investment in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. We adopted this standard on January 1, 2018 using the cumulative effect transition method. The adoption of ASU 2014-09 did not have a material impact on our consolidated financial statements and disclosures.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 retains many current requirements for the classification and measurement of financial instruments; however, it significantly revises an entity’s accounting related to (i) the classification and measurement of investments in equity securities and (ii) the presentation of certain fair value changes for financial liabilities measured at fair value. ASU 2016-01 also amends certain disclosure requirements associated with the fair value of financial instruments. This guidance is effective for us beginning on January 1, 2018. The adoption of ASU 2016-01 did not have a material impact on our consolidated financial statements and disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 outlines a new model for accounting by lessees, whereby their rights and obligations under substantially all leases, existing and new, would beunconsolidated investment. These origination fees were capitalized and recorded on the balance sheet. For lessors, however, the accounting remains largely unchanged from the current model, with the distinction between operating and financing leases retained, but updated to align with certain changes to the lessee model and the new revenue recognition standard. The new standard also replaces existing sale-leaseback guidance with a new model applicable to both lessees and lessors. Additionally, the new standard requires extensive quantitative and qualitative disclosures. ASU 2016-02 is effective for U.S. GAAP public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application will be permitted for all entities. The new standard must be adopted using a modified retrospective transition of the new guidance and provides for certain practical expedients. Transition will require application of the new model at the beginning of the earliest comparative period presented. This ASU is not expected to have any impact on our consolidated financial statements and disclosures as we do not have any lease arrangements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, a Consensus of the FASB’s Emerging Issues Task Force (“ASU 2016-15”). ASU 2016-15 provides guidance on how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for annual and interim periods beginning after December 15, 2017. The guidance requires application using a retrospective transition method. The adoption of ASU 2016-15 did not have a material impact on our consolidated financial statements and disclosures.
In October 2016, the SEC adopted new rules and amended rules (together, “Final Rules”) intended to modernize the reporting and disclosure of information by registered investment companies. In part, the Final Rules amend Regulation S-X and require standardized, enhanced disclosure about derivatives in investment company financial statements, as well as other amendments. The compliance date for the amendments to Regulation S-X was August 1, 2017. The adoption of the Final Rules did not have a material impact on our consolidated financial statements and disclosures.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 intends to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the current implementation guidance in Topic 805, there are three elements of a business: inputs, processes, and outputs. While an integrated set of assets and activities, collectively referred to as a “set,” that is a business usually has outputs, outputs are not required to be present. ASU 2017-01 provides a screen to determine when a set is not a business. The screen requires that when substantially all of the faircarrying value of the gross assets acquired (or disposed of)unconsolidated investment as a transaction cost.
(3)Disposition fee is concentratedgenerally offset with exit fee income and included in a single identifiable asset or a groupinterest income on the consolidated statements of similar identifiable assets, the set is not a business. ASU 2017-01 is effective for public business entities in fiscal yearsoperations.
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beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. The adoption of ASU 2017-01 did not have a material impact on our consolidated financial statements and disclosures.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We may be subject to financial market risks, including changes in interest rates. To the extent that we borrow money to make investments, our net investment income will be dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. In periods of rising interest rates, our cost of funds would increase, which may reduce our net investment income. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income.
As of December 31, 2017, our REIT subsidiary2022, Terra Property Trust had one investment10 investments with aan aggregate principal balance of approximately $53.7$295.0 million, net of obligations under participation agreements, that providesprovide for interest income indexedat an annual rate of LIBOR plus a spread, 8 of which are subject to LIBOR, with a LIBOR floorfloor. A decrease of 0.5%.100 basis points in LIBOR would decrease Terra Property Trust’s annual interest income, net of interest expense on participation agreements, by approximately $2.9 million, and an increase of 100 basis points in LIBOR would increase Terra Property Trust’s annual interest income, net of interest expense on participation agreements, by approximately $2.9 million. Additionally, our REIT subsidiary financed this assetTerra Property Trust had 13 investments with approximately $34.0an aggregate principal balance of $247.2 million that provide for interest income at an annual rate of SOFR or Term SOFR plus a spread, all of which were subject to a SOFR or Term SOFR floor. A decrease of 100 basis points in SOFR or Term SOFR would decrease Terra Property Trust’s annual interest income by $2.5 million, and an increase of 100 basis points would increase Terra Property Trust’s annual interest income by $2.5 million.
Additionally, as of December 31, 2022, Terra Property Trust had $29.3 million of borrowings outstanding under a mortgage loan payable that bear interest at an annual rate of LIBOR plus 5.25%.a spread that is collateralized by an office building; a revolving line of credit with an outstanding balance of $90.1 million that bears interest at an annual rate of LIBOR plus a spread that is collateralized by $177.4 million of first mortgages; a repurchase agreement with an outstanding balance of $51.1 million that bears interest at an annual rate of LIBOR or Term SOFR, as applicable, plus a spread that is collateralized by $68.1 million of first mortgages; and another repurchase agreement with an outstanding balance of $119.8 million that bears interest at an annual rate of Term SOFR plus a spread that is collateralized by $167.5 million of first mortgages. A decrease of 10%100 basis points in LIBOR and Term SOFR would decrease ourTerra Property Trust’s annual net interest expense by approximately $0.01$2.9 million, and an increase of 10%100 basis points in LIBOR and Term SOFR would increase ourTerra Property Trust’s annual net interest incomeexpense by approximately $2.0$2.9 million.
In July 2017, the U.K. Financial Conduct Authority, which regulates the LIBOR administrator, IBA, announced that it would cease to compel banks to participate in setting LIBOR as a benchmark by the end of 2021, which has subsequently been delayed to June 30, 2023. The Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions convened by the U.S. Federal Reserve, has recommended SOFR as a more robust reference rate alternative to U.S. dollar LIBOR. SOFR is calculated based on overnight transactions under repurchase agreements, backed by Treasury securities. SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question. As such, the future of LIBOR at this time is uncertain.
Potential changes, or uncertainty related to such potential changes, may adversely affect the market for LIBOR-based loans, including Terra Property Trust’s portfolio of LIBOR-indexed, floating-rate loans, or the cost of its borrowings. In addition, changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the market for LIBOR-based loans, including the value of the LIBOR-indexed, floating-rate loans in Terra Property Trust’s portfolio, or the cost of its borrowings. In the event LIBOR is unavailable, Terra Property Trust’s investment documents provide for a substitute index, on a basis generally consistent with market practice, intended to put us in substantially the same economic position as LIBOR.
We may hedge against interest rate and currency exchange rate fluctuations by using standard hedging instruments, such as futures, options and forward contracts, subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in benefits of lower interest rates with respect to our portfolio of investments with fixed interest rates. For the years ended December 31, 20172022 and 2016,2021, we did not engage in interest rate hedging activities.
In addition, we may have risks regarding portfolio valuation. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Fair Value Measurements” in this annualquarterly report on Form 10-K.
Item 8. Financial Statements and Supplementary Data.
Our financial statements are annexed to this annual report on Form 10-K beginning on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including the chief executive officer and chief financial officer of our Manager (performing functions equivalent to those a principal executive officer and principal financial officer of our company would perform if we had any officers), of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2017.2022. Based on that evaluation, the chief executive officer and chief financial officer of our Manager concluded that our disclosure controls and procedures were effective to provide reasonable assurance that we would meet our disclosure obligations. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within our company to disclose material information otherwise required to be set forth in our periodic reports.
Evaluation of Internal Controls over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our Manager, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements in our consolidated financial statements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including the chief executive officer and chief financial officer of our Manager (performing functions equivalent to those a principal executive officer and principal financial officer of our company would perform if we had any officers), we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on its evaluation, our management concluded that our internal control over financial reporting was effective as of the end of the fiscal year covered by this Annual Report on Form 10-K.
This annual reportAnnual Report on Form 10-K does not include aan attestation report of management’s assessment regarding internal control over financial reporting, and we have not evaluated any change in our internal control over financial reporting that occurred during our last fiscal quarterindependent registered accounting firm due to a transition period established by the rules of the SEC for newly public“emerging growth companies.”
Changes in Internal Control Over Financial Reporting
During the most recent fiscal quarter, there was no change in our internal controls over financial reporting, as defined under
Rule 13a-15(f) under the Exchange Act, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
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