UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


(Mark One)

x

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31,September 30, 2007

OR

 

¨

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from                    to                    

Commission file number 000-51262


WELLS REAL ESTATE INVESTMENT TRUST II, INC.

(Exact name of registrant as specified in its charter)

 


 

Maryland 20-0068852

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

6200 The Corners Parkway

Norcross, Georgia 30092

(Address of principal executive offices)

(Zip Code)

(770) 449-7800

(Registrant’s telephone number, including area code)

N/A

(Former name, former address, and former fiscal year, if changed since last report)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

Large Accelerated filer  ¨                     Accelerated filer  ¨                     Non-Accelerated filer  x

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

Yes  ¨    No  x

Number of shares outstanding of the registrant’s

only class of common stock, as of April 30,October 31, 2007: 311,851,504359,850,706 shares

 



FORM 10-Q

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

TABLE OF CONTENTS

 

     Page No.

PART I.

FINANCIAL INFORMATION

  

Item 1.

 

Consolidated Financial Statements

  4
 

Consolidated Balance Sheets as of March 31,September 30, 2007 (unaudited) and December 31, 2006

  5
 

Consolidated Statements of Operations for the Three Months and Nine Months Ended March 31,September 30, 2007 (unaudited) and 2006 (unaudited)

  6
 

Consolidated Statements of Stockholders’ Equity for the Year Ended December 31, 2006 and the ThreeNine Months Ended March 31,September 30, 2007 (unaudited)

  7
 

Consolidated Statements of Cash Flows for the ThreeNine Months Ended March 31,September 30, 2007 (unaudited) and 2006 (unaudited)

  8
 

Condensed Notes to Consolidated Financial Statements (unaudited)

  9

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  1720

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  2632

Item 4.

 

Controls and Procedures

  2733

PART II.

OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

  2833

Item 1A.

 

Risk Factors

  2833

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

  2933

Item 3.

 

Defaults Upon Senior Securities

  2934

Item 4.

 

Submission of Matters to a Vote of Security Holders

  2934

Item 5.

 

Other Information

  2934

Item 6.

 

Exhibits

  2935

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Form 10-Q of Wells Real Estate Investment Trust II, Inc. (“Wells REIT II,” “we,” “our” or “us”) other than historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend for all such forward-looking statements to be covered by the applicable safe harbor provisions for forward-looking statements contained in those acts. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, as well asincluding known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this report is filed with the Securities and Exchange Commission. We make no representations or warranties (express or implied) about the accuracy of any such forward-looking statements contained in this Form 10-Q, and we do not intend to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Any such forward-looking statements are subject to unknown risks, uncertainties, and other factors and are based on a number of assumptions involving judgments with respect to, among other things, future economic, competitive, and market conditions, all of which are difficult or impossible to predict accurately. To the extent that our assumptions differ from actual results, our ability to meet such forward-looking statements, including our ability to generate positive cash flow from operations, make distributions to stockholders, and maintain the value of our real estate properties, may be significantly hindered. See Item 1A herein, as well as Item 1A in Wells REIT II’s Annual Report on Form 10-K for the year ended December 31, 2006, for a discussion of some, of the risks and uncertainties, although not all, of the risks and uncertainties that could cause actual results to differ materially from those presented in our forward-looking statements.

PART I. FINANCIAL INFORMATION

 

ITEM 1.

ITEM 1.

CONSOLIDATED FINANCIAL STATEMENTS

The information furnished in the accompanying consolidated balance sheets and related consolidated statements of operations, stockholders’ equity, and cash flows reflects all adjustments that are, in management’s opinion, necessary for a fair and consistent presentation of the aforementioned financial statements.

The accompanying financial statements should be read in conjunction with the notes to Wells REIT II’s financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Quarterly Report on Form 10-Q and with Wells REIT II’s Annual Report on Form 10-K for the year ended December 31, 2006. Wells REIT II’s results of operations for the three months and nine months ended March 31,September 30, 2007 are not necessarily indicative of the operating results expected for the full year.

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per-share amounts)

 

  

(Unaudited)

March 31,

2007

 

December 31,

2006

   

(Unaudited)

September 30,

2007

 

December 31,

2006

 

Assets:

      

Real estate assets, at cost:

      

Land

  $384,308  $370,971   $488,263  $370,971 

Buildings and improvements, less accumulated depreciation of $93,198 and $79,175 as of March 31, 2007 and December 31, 2006, respectively

   1,973,865   1,922,523 

Intangible lease assets, less accumulated amortization of $123,519 and $106,147 as of March 31, 2007 and December 31, 2006, respectively

   463,285   458,917 

Buildings and improvements, less accumulated depreciation of $123,089 and $79,175 as of September 30, 2007 and December 31, 2006, respectively

   2,342,143   1,922,523 

Intangible lease assets, less accumulated amortization of $162,345 and $106,147 as of September 30, 2007 and December 31, 2006, respectively

   607,754   458,917 

Construction in progress

   873   420    8,889   420 
              

Total real estate assets

   2,822,331   2,752,831    3,447,049   2,752,831 

Cash and cash equivalents

   43,624   46,100    33,272   46,100 

Tenant receivables, net of allowance for doubtful accounts of $1,605 and $1,548 as of March 31, 2007 and December 31, 2006, respectively

   60,148   53,372 

Tenant receivables, net of allowance for doubtful accounts of $1,797 and $1,548 as of September 30, 2007 and December 31, 2006, respectively

   68,621   53,372 

Prepaid expenses and other assets

   36,099   35,554    50,015   35,554 

Deferred financing costs, less accumulated amortization of $1,834 and $1,535 as of March 31, 2007 and December 31, 2006, respectively

   2,861   3,184 

Deferred lease costs, less accumulated amortization of $62,638 and $52,906 as of March 31, 2007 and December 31, 2006, respectively

   314,243   319,184 

Deferred financing costs, less accumulated amortization of $2,349 and $1,535 as of

September 30, 2007 and December 31, 2006, respectively

   4,142   3,184 

Deferred lease costs, less accumulated amortization of $84,144 and $52,906 as of

September 30, 2007 and December 31, 2006, respectively

   359,189   319,184 

Investment in bonds

   78,000   78,000    78,000   78,000 
              

Total assets

  $3,357,306  $3,288,225   $4,040,288  $3,288,225 
       
       

Liabilities:

      

Line of credit and notes payable

  $690,212  $774,523   $983,051  $774,523 

Accounts payable, accrued expenses, and accrued capital expenditures

   35,780   41,817    46,896   41,817 

Due to affiliates

   3,662   13,977    3,973   13,977 

Dividends payable

   7,924   7,317    8,665   7,317 

Deferred income

   12,309   9,138    12,821   9,138 

Intangible lease liabilities, less accumulated amortization of $12,777 and $10,638 as of March 31, 2007 and December 31, 2006, respectively

   89,895   92,343 

Intangible lease liabilities, less accumulated amortization of $18,020 and $10,638 as of September 30, 2007 and December 31, 2006, respectively

   112,179   92,343 

Obligations under capital leases

   78,000   78,000    78,000   78,000 
              

Total liabilities

   917,782   1,017,115    1,245,585   1,017,115 

Commitments and Contingencies

   —     —      —     —   

Minority Interest

   3,094   3,090    3,068   3,090 

Redeemable Common Stock

   12,563   —      609,518   —   

Stockholders’ Equity:

      

Common stock, $0.01 par value; 900,000,000 shares authorized; 304,020,721 and 280,119,233 shares issued and outstanding as of March 31, 2007 and December 31, 2006, respectively

   3,040   2,801 

Common stock, $0.01 par value; 900,000,000 shares authorized; 353,992,554 and 280,119,233 shares issued and outstanding as of September 30, 2007 and December 31, 2006, respectively

   3,540   2,801 

Additional paid-in capital

   2,706,767   2,491,817    3,154,840   2,491,817 

Cumulative distributions in excess of earnings

   (272,257)  (225,549)   (365,605)  (225,549)

Redeemable common stock

   (12,563)  —      (609,518)  —   

Other comprehensive loss

   (1,120)  (1,049)   (1,140)  (1,049)
              

Total stockholders’ equity

   2,423,867   2,268,020    2,182,117   2,268,020 
              

Total liabilities, minority interest, redeemable common stock, and stockholders’ equity

  $3,357,306  $3,288,225   $4,040,288  $3,288,225 
              

See accompanying notes.

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per-share amounts)

 

  

(Unaudited)

Three Months Ended
March 31,

   

(Unaudited)

Three Months Ended

September 30,

 

(Unaudited)

Nine Months Ended

September 30,

 
  2007 2006   2007 2006 2007 2006 

Revenues:

        

Rental income

  $73,577  $56,285   $82,794  $59,446  $232,136  $174,185 

Tenant reimbursements

   20,291   12,914    20,271   13,287   61,262   40,657 

Hotel income

   4,554   4,369    6,989   7,426   18,552   17,811 
       

Other rental income

   751   —     2,762   77 
   98,422   73,568              
   110,805   80,159   314,712   232,730 

Expenses:

        

Property operating costs

   30,638   21,500    35,140   22,266   98,088   65,272 

Hotel operating costs

   4,027   3,787    4,894   5,483   13,835   13,479 

Asset and property management fees:

        

Related-party

   6,222   4,708    7,140   5,170   19,816   14,806 

Other

   1,411   1,147    1,142   1,183   3,877   3,560 

Depreciation

   14,194   10,678    15,796   11,937   44,087   33,846 

Amortization

   30,905   19,470    28,883   20,475   86,292   59,988 

General and administrative

   3,491   2,918    4,623   2,919   12,581   8,807 
                    
   90,888   64,208    97,618   69,433   278,576   199,758 
                    

Real estate operating income

   7,534   9,360    13,187   10,726   36,136   32,972 

Other income (expense):

        

Interest expense

   (11,722)  (11,172)   (12,572)  (9,415)  (34,682)  (30,755)

Loss on early extinguishment of debt

   —     (1,115)   —     —     —     (1,115)

Gain (loss) on interest rate swaps

   (5,481)  (30)  (5,496)  33 

Interest and other income

   1,604   1,756    2,834   1,848   7,130   5,526 
                    
   (10,118)  (10,531)   (15,219)  (7,597)  (33,048)  (26,311)
                    

Loss before minority interest and income tax (expense) benefit

   (2,584)  (1,171)

Income (loss) before minority interest and income tax expense

   (2,032)  3,129   3,088   6,661 

Minority interest in earnings of consolidated entities

   (21)  (204)  (39)  (580)
             

Minority interest in (earnings) loss of consolidated entities

   (8)  29 

Income (loss) before income tax expense

   (2,053)  2,925   3,049   6,081 

Income tax expense

   (400)  (288)  (436)  (239)
                    

Loss before income tax (expense) benefit

   (2,592)  (1,142)

Net income (loss)

  $(2,453) $2,637  $2,613  $5,842 
             

Income tax (expense) benefit

   (18)  261 

Per share information – basic and diluted:

     

Net income (loss) per-share

  $(0.01) $0.01  $0.01  $0.03 
                    

Net loss

  $(2,610) $(881)

Weighted-average common shares outstanding – basic and diluted

   342,924   247,285   317,232   226,983 
                    

Net loss per-share—basic and diluted

  $(0.01) $0.00 
       

Weighted-average common shares outstanding—basic and diluted

   291,017   206,104 
       

See accompanying notes.

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEAR ENDED DECEMBER 31, 2006

AND THE THREENINE MONTHS ENDED MARCH 31,SEPTEMBER 30, 2007 (UNAUDITED)

(in thousands, except per-share amounts)

 

  

Common Stock

 

Additional
Paid-In

Capital

  Cumulative
Distributions
in Excess of
Earnings
  

Redeemable
Common

Stock

  

Other
Comprehensive

Loss

  Total
Stockholders’
Equity
   Common Stock Additional
Paid-In
 

Cumulative
Distributions

in Excess of

 Redeemable
Common
 Other
Comprehensive
 Total
Stockholders’
 
  Shares Amount   Shares Amount Capital Earnings Stock Loss Equity 

Balance, December 31, 2005

  197,403  $1,974  $1,752,162  $(94,382) $—    $—    $1,659,754   197,403  $1,974  $1,752,162  $(94,382) $—    $—    $1,659,754 

Issuance of common stock

  86,526   865   864,395   —     —     —     865,260   86,526   865   864,395   —     —     —     865,260 

Redemptions of common stock

  (3,810)  (38)  (36,236)  —     —     —     (36,274)  (3,810)  (38)  (36,236)  —     —     —     (36,274)

Dividends ($0.60 per share)

  —     —     —     (142,435)  —     —     (142,435)  —     —     —     (142,435)  —     —     (142,435)

Commissions and discounts on stock sales and related dealer-manager fees

  —     —     (77,814)  —     —     —     (77,814)  —     —     (77,814)  —     —     —     (77,814)

Other offering costs

  —     —     (10,690)  —     —     —     (10,690)  —     —     (10,690)  —     —     —     (10,690)

Components of comprehensive income:

                

Net income

  —     —     —     11,268   —     —     11,268   —     —     —     11,268   —     —     11,268 

Loss on interest rate swap

  —     —     —     —     —     (1,049)  (1,049)
          

Market value adjustment to interest rate swap

  —     —     —     —     —     (1,049)  (1,049)

Comprehensive income

  —     —     —     —     —     —     10,219   —     —     —     —     —     —     10,219 
                                            

Balance, December 31, 2006

  280,119   2,801   2,491,817   (225,549)  —     (1,049)  2,268,020   280,119   2,801   2,491,817   (225,549)  —     (1,049)  2,268,020 

Adjustment resulting from the adoption of FIN 48 (Note 2)

  —     —     —     (410)  —     —     (410)  —     —     —     (410)  —     —     (410)
                                            

Balance, January 1, 2007

  280,119   2,801   2,491,817   (225,959)  —     (1,049)  2,267,610   280,119   2,801   2,491,817   (225,959)  —     (1,049)  2,267,610 

Issuance of common stock

  25,152   252   251,275   —     —     —     251,527   78,034   780   779,555   —     —     —     780,335 

Redemptions of common stock

  (1,250)  (13)  (11,840)  —     —     —     (11,853)  (4,160)  (41)  (39,410)  —     —     —     (39,451)

Redeemable common stock

  —     —     —     —     (12,563)  —     (12,563)  —     —     —     —     (609,518)  —     (609,518)

Dividends ($0.15 per share)

  —     —     —     (43,688)  —     —     (43,688)

Dividends ($0.45 per share)

  —     —     —     (142,259)  —     —     (142,259)

Commissions and discounts on stock sales and related dealer-manager fees

  —     —     (22,561)  —     —     —     (22,561)  —     —     (69,783)  —     —     —     (69,783)

Other offering costs

  —     —     (1,924)  —     —     —     (1,924)  —     —     (7,339)  —     —     —     (7,339)

Components of comprehensive loss:

        

Net loss

  —     —     —     (2,610)  —     —     (2,610)

Loss on interest rate swap

  —     —     —     —     —     (71)  (71)

Components of comprehensive income:

        

Net income

  —     —     —     2,613   —     —     2,613 

Market value adjustment to interest rate swap

  —     —     —     —     —     (91)  (91)

Comprehensive income

  —     —     —     —     —     —     2,522 
                                

Comprehensive loss

  —     —     —     —     —     —     (2,681)

Balance, September 30, 2007

  353,993  $3,540  $3,154,840  $(365,605) $(609,518) $(1,140) $2,182,117 
                                            

Balance, March 31, 2007

  304,021  $3,040  $2,706,767  $(272,257) $(12,563) $(1,120) $2,423,867 
                      

See accompanying notesnotes..

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

  

(unaudited)

Three Months Ended
March 31,

   

(unaudited)

Nine Months Ended
September 30,

 
  2007 2006   2007 2006 

Cash Flows from Operating Activities:

      

Net loss

  $(2,610) $(881)

Adjustments to reconcile net loss to net cash provided by operating activities:

   

Net income

  $2,613  $5,842 

Adjustments to reconcile net income to net cash provided by operating activities:

   

Depreciation

   14,194   10,678    44,087   33,846 

Other amortization

   35,531   22,356    96,850   70,396 

Loss on interest rate swap

   5,496   —   

Non-cash interest expense

   1,272   487    4,649   1,354 

Loss on early extinguishment of debt

   —     1,115    —     1,115 

Minority interest in earnings (loss) of consolidated entities

   8   (29)

Minority interest in earnings of consolidated entities

   39   580 

Changes in assets and liabilities:

      

Increase in tenant receivables, net

   (6,776)  (4,675)   (15,404)  (19,330)

(Increase) decrease in prepaid expenses and other assets

   (4,455)  2,644    (8,483)  3,161 

Increase in accounts payable and accrued expenses

   2,552   5,587    9,025   7,169 

Decrease in due to affiliates

   (5,808)  (857)   (5,686)  (2,079)

Increase in deferred income

   3,171   1,529    3,683   71 
              

Net cash provided by operating activities

   37,079   37,954    136,869   102,125 

Cash Flows from Investing Activities:

      

Investment in real estate and earnest money paid

   (117,014)  (12,332)   (837,107)  (401,916)

Proceeds from master leases

   176   174    1,385   6,040 

Acquisition fees paid

   (7,940)  (6,197)   (18,007)  (14,677)

Deferred lease costs paid

   (1,097)  (1,572)   (16,441)  (3,708)
              

Net cash used in investing activities

   (125,875)  (19,927)   (870,170)  (414,261)

Cash Flows from Financing Activities:

      

Deferred financing costs paid

   —     (28)   (1,868)  (840)

Proceeds from line of credit and notes payable

   73,602   128,130    498,036   450,654 

Repayments of line of credit and notes payable

   (158,886)  (278,810)   (293,272)  (536,934)

Prepayment penalty on early extinguishment of debt

   —     (5,734)   —     (5,734)

Distributions paid to minority interest partners

   (4)  (49)   (61)  (101)

Issuance of common stock

   249,834   204,088    774,470   630,463 

Redemptions of common stock

   (10,789)  (6,249)   (42,864)  (24,424)

Dividends paid to stockholders

   (43,081)  (30,413)   (140,911)  (100,561)

Commissions on stock sales and related dealer-manager fees paid

   (20,725)  (16,664)   (64,102)  (52,571)

Other offering costs paid

   (3,631)  (5,118)   (8,955)  (10,220)
              

Net cash provided by (used in) financing activities

   86,320   (10,847)

Net cash provided by financing activities

   720,473   349,732 
       

Net (decrease) increase in cash and cash equivalents

   (2,476)  7,180 

Net increase (decrease) in cash and cash equivalents

   (12,828)  37,596 

Cash and cash equivalents, beginning of period

   46,100   35,352    46,100   35,352 
              

Cash and cash equivalents, end of period

  $43,624  $42,532   $33,272  $72,948 
              

See accompanying notes.

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31,SEPTEMBER 30, 2007

(unaudited)

 

1.

Organization

Wells Real Estate Investment Trust II, Inc. (“Wells REIT II”) is a Maryland corporation that has elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes. Wells REIT II engages in the acquisition and ownership of commercial real estate properties, throughout the United States, including properties that are under construction, are newly constructed, or have operating histories. Wells REIT II was incorporated on July 3, 2003 and commenced operations on January 22, 2004. Wells REIT II conducts business primarily through Wells Operating Partnership II, L.P. (“Wells OP II”), a Delaware limited partnership. Wells REIT II is the sole general partner of Wells OP II and possesses full legal control and authority over the operations of Wells OP II. Wells REIT II owns more than 99.9% of the equity interests in Wells OP II. Wells Capital, Inc. (“Wells Capital”), the external advisor to Wells REIT II, is the sole limited partner of Wells OP II. Wells OP II acquires, develops, owns, leases, and operates real properties directly, through wholly owned subsidiaries or through joint ventures. References to Wells REIT II herein shall include Wells REIT II, all subsidiaries of Wells REIT II, including consolidated joint ventures, Wells OP II, and Wells OP II’s subsidiaries. See Note 78 for a discussion of the advisory services provided by Wells Capital.

As of March 31,September 30, 2007, Wells REIT II owned interests in 4955 office properties, one industrial building, one hotel, and one hotel,office property under construction, comprising approximately 15.216.8 million square feet of commercial space located in 1820 states and the District of Columbia. Forty-fiveFifty-two of the properties are wholly owned and six are owned through consolidated joint ventures. As of March 31,September 30, 2007, the office and industrial properties were approximately 98% leased.

On December 1, 2003, Wells REIT II commenced its initial public offering of up to 785.0 million shares of common stock, of which 185.0 million shares were reserved for issuance through Wells REIT II’s dividend reinvestment plan, pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933. Except for continuing to offer shares for sale through its dividend reinvestment plan, Wells REIT II stopped offering shares for sale under its initial public offering on November 26, 2005. Wells REIT II raised gross offering proceeds of approximately $2.0 billion from the sale of approximately 197.1 million shares under its initial public offering, including shares sold under the dividend reinvestment plan through March 2006. On November 10, 2005, Wells REIT II commenced a follow-on offering of up to 300.6 million shares of common stock, of which 0.6 million shares were reserved for issuance under Wells REIT II’s dividend reinvestment plan, pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933. On April 14, 2006, Wells REIT II amended the aforementioned registration statements to offer in a combined prospectus 300.6 million shares registered under the follow-on offering and 174.4 million unsold shares related to the dividend reinvestment plan andoriginally registered under the initial public offering. As of March 31,September 30, 2007, Wells REIT II had raised gross offering proceeds of approximately $1.1$1.7 billion from the sale of approximately 113.7166.5 million shares under the follow-on offering.

As of March 31,September 30, 2007, Wells REIT II has raised gross offering proceeds from the sale of common stock under the initial public offering and follow-on offering of approximately $3.1$3.7 billion. After deductions from such gross offering proceeds for payments of acquisition fees of approximately $61.9$72.4 million, selling commissions and dealer-manager fees of approximately $288.6$335.9 million, other organization and offering expenses of approximately $45.0$50.4 million, and common stock redemptions of approximately $67.3$96.4 million under the share redemption program, Wells REIT II had received aggregate net offering proceeds of approximately $2.6$3.1 billion. Substantially all of Wells REIT II’s net offering proceeds have been invested in real properties.properties and related assets.

On July 9, 2007, Wells REIT II filed a registration statement with the SEC to register 375,000,000 shares of its common stock, of which up to 300,000,000 shares are to be offered in a primary offering for $10 per share, with volume discounts available to investors who purchase more than 50,000 shares at any one time. As described in the registration statement,

discounts may also be available for other categories of purchasers. The remaining 75,000,000 shares of common stock are to be offered under Wells REIT II’s amended and restated dividend reinvestment plan at a purchase price equal to the higher of $9.55 per share or 95% of the estimated value of a share of its common stock. Wells REIT II has not issued any shares under the aforementioned registration statement as it has not been declared effective by the SEC. Wells REIT II does not expect to commence an offering under the aforementioned registration statement until the earlier of the date Wells REIT II sells all the shares available for sale in its current offering or November 10, 2008.

Wells REIT II’s stock is not listed on a public securities exchange. However, Wells REIT II’s charter requires that in the event Wells REIT II’s stock is not listed on a national securities exchange by October 2015, Wells REIT II must either seek stockholder approval of an extension or amendment of this listing deadline or stockholder approval to begin liquidating investments and distributing the resulting proceeds to the stockholders. In the event that Wells REIT II seeks stockholder approval for an extension or amendment to this listing date and does not obtain it, Wells REIT II will then be required to seek stockholder approval to liquidate. In this circumstance, if Wells REIT II seeks and does not obtain approval to liquidate, Wells REIT II will not be required to list or liquidate and could continue to operate indefinitely as an unlisted company.

2.

Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements of Wells REIT II have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”), including the instructions to Form 10-Q and Article 10 of Regulation S-X, and do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, the statements for these unaudited interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair and consistent presentation of the results for such periods. Results for these interim periods are not necessarily indicative of a full year’s results. Wells REIT II’s consolidated financial statements include the accounts of Wells REIT II, Wells OP II, and a variable interest entity in which Wells REIT II is the primary beneficiary. For further information, refer to the financial statements and footnotes included in Wells REIT II’s Annual Report on Form 10-K for the year ended December 31, 2006.

Redeemable Common Stock

As of March 31,September 30, 2007, Wells REIT II’s share redemption program provided that “Ordinary Redemptions” (those that do not occurWells REIT II will honor all redemption requests made within two years following the death of death or qualifying disability) and those sought upon qualifying disability during any calendar year are limited to those that can be funded with proceeds raised in the current calendar year from Wells REIT II’s dividend reinvestment plan. Althougha stockholder. Wells REIT II is party to an agreement under no obligation to redeem anywhich an affiliate of London Life and Casualty Reinsurance Corporation will provide an insurance-backed funding source for the redemption of shares under its share redemption program in the event Wells REIT II receives an unusually large number of redemption requests due to the extent that totaldeath of investors (the “Insurance Agreement”). As the decision to honor redemptions would exceedsought within two years following the foregoing limit,death of a stockholder is outside of the board of directorscontrol of Wells REIT II, has reservedand the rightInsurance Agreement provides Wells REIT II with the ability to redeem additional shares uponfund all of such redemptions, the present value of the future estimated deductible amounts under the Insurance Agreement are recorded as redeemable common stock in the temporary equity section of the accompanying consolidated balance sheet.

In addition, Wells REIT II is required to honor redemptions other than those sought within two years following the death of stockholders.

Asa stockholder up to the useamount of proceeds raised in the current calendar year fromunder the dividend reinvestment plan. Accordingly, the amount of proceeds raised under the dividend reinvestment plan, is outside the control of Wells REIT II, those proceeds are considered to be temporary equity under Accounting Series Release No. 268,Presentation in Financial Statements of Redeemable Preferred Stock. Therefore, Wells REIT II has included an amount equal to proceeds from shares issued through Wells REIT II’s dividend reinvestment planless redemptions funded in the current calendar year, less the amount of redemptions previously funded during the current calendar year,is also recorded as redeemable common stock in the temporary equity section of the accompanying consolidated financial statements as of March 31, 2007.balance sheet.

Further, upon being tendered for redemption by the holder, Wells REIT II reclassifies redeemable common shares from mezzaninetemporary equity to a liability at settlement value. As of March 31,September 30, 2007 and December 31, 2006, shares tendered for redemption and not yet redeemed of approximately $4.9$0.4 million and approximately $3.9 million, respectively, are included in accounts payable, accrued expenses, and accrued capital expenditures in the accompanying consolidated balance sheets.

Income Taxes

Wells REIT II has elected to be taxed as a REIT under the Internal Revenue Code of 1986 (the “Code”), as amended, and has operated as such beginning with its taxable year ended December 31, 2003. To qualify as a REIT, Wells REIT II must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of its adjusted taxable income, as defined in the Code, to its stockholders. As a REIT, Wells REIT II generally is not subject to income tax on income it distributes to stockholders. Wells REIT II is subject to certain state and local taxes related to the operations of properties in certain locations, which have been provided for in the accompanying consolidated financial statements.

Wells TRS II, LLC (“Wells TRS”), is a wholly owned subsidiary of Wells REIT II and is organized as a Delaware limited liability company, which owns, among other things, a full-service hotel. Wells REIT II has elected to treat Wells TRS as a taxable REIT subsidiary. Wells REIT II may perform additional, non-customary services for tenants of buildings owned by Wells REIT II through Wells TRS, including any real estate or non-real estate related services; however, any earnings related to such services are subject to

federal and state income taxes. In addition, for Wells REIT II to continue to qualify as a REIT, Wells REIT II’s investments in taxable REIT subsidiaries cannot exceed 20% of the value of the total assets of Wells REIT II. Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities at the enacted rates expected to be in effect when the temporary differences reverse.

Interest Rate Swap Agreements

Wells REIT II has entered into interest rate swap agreements to hedge its exposure to changing interest rates on variable rate debt instruments. Wells REIT II accounts for interest rate swap agreements in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133,Accounting for Derivative Instruments and Hedging Activities. Accordingly, the fair value of all interest rate swap agreements are included in either prepaid expenses and other assets or accounts payable, accrued expenses, and accrued capital expenditures in the accompanying consolidated balance sheets. The change in fair value of the effective portion of an interest rate swap agreement that is designated as a hedge is recorded as other comprehensive income (loss) in the accompanying consolidated statement of stockholders’ equity. The changes in fair value of all other interest rate swap agreements are recorded as gain (loss) on interest rate swaps in the accompanying consolidated statements of operations. Net amounts received or paid under interest rate swap agreements are recorded as adjustments to interest expense as incurred.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period financial statement presentation.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, (“FIN 48”), which clarifies the relevant criteria and approach for the recognition, derecognition, and measurement of uncertain tax positions. Wells REIT II records interest and penalties related to uncertain tax positions as general and administrative expense in the accompanying consolidated statements of operations. Upon adopting FIN 48 effective January 1, 2007, Wells REIT II wrote-off deferred tax assets classified as prepaid expenses and other assets of approximately $388,000 and recorded a liability for unrecognized tax benefits of approximately $22,000 as reductions to the January 1, 2007 balance of cumulative distributions in excess of earnings. During the three months ended March 31, 2007, Wells REIT II recorded an additional liability for unrecognized tax benefits of approximately $18,000 as income tax expense. Wells REIT II does not currently anticipate the total amount of unrecognized tax benefits will significantly increase or decrease by the end of 2007. As of March 31,September 30, 2007, returns for the calendar years 20022003 through 2006 remain subject to examination by U.S. andor various state tax jurisdictions.

In September 2006, the FASB issued Statement of Financial Accounting StandardsSFAS No. 157,Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures required for fair value measurements under GAAP. SFAS 157 emphasizes that fair value is a market-based measurement, as opposed to a transaction-specific

measurement. SFAS 157 will be effective for Wells REIT II beginning January 1, 2008. Wells REIT II is currently assessing the provisions and evaluating the financial impact of SFAS 157 on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will be effective for Wells REIT II beginning January 1, 2008. Wells REIT II is currently assessing the provisions and evaluating the financial statement impact of SFAS 159 on its consolidated financial statements.

In June 2007, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 07-1,Clarification of the Scope of the Audit and Accounting Guide “Investment Companies” and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies, which provides guidance for determining which entities fall within the scope of the AICPA Audit and Accounting Guide for Investment Companies and requires additional disclosures for certain of those entities. In October 2007, the FASB elected to indefinitely defer the effective date of SOP 07-1. As such, Wells REIT II has postponed its evaluation of the provisions of SOP 07-1 and related impact on its consolidated financial statements and accompanying notes.

 

3.

Real Estate Acquisitions

Summary

As of March 31,September 30, 2007, Wells REIT II owned interests in 5158 properties as a result of acquiring the 27 properties described below during the third quarter of 2007, acquiring 2 properties during the first quartertwo quarters of 2007, acquiring 9 properties and completing construction of the LakePointe 3 building during the year ended December 31, 2006, and acquiring 39 properties in prior periods.

One Century Place BuildingPasadena Corporate Park Buildings Acquisition

On January 4,July 11, 2007, Wells REIT II purchased two three-story office buildings and a single-story retail building containing approximately 265,000 aggregate rentable square feet located on an approximate 8.2-acre parcel of land at 3453, 3455, 3465 and 3475 East Foothill Boulevard in Pasadena, California for a purchase price of approximately $116.0 million, exclusive of closing costs.

7031 Columbia Gateway Building Acquisition

On July 12, 2007, Wells REIT II purchased a five-story office building containing approximately 248,000 rentable square feet located on an approximate 14.6-acre parcel of land at 7031 Columbia Gateway Drive in Columbia, Maryland for a purchase price of approximately $62.1 million, exclusive of closing costs.

Cranberry Woods Drive Land Acquisition

On August 1, 2007, Wells REIT II purchased an eight-story83.4 acre parcel of land in Cranberry, Pennsylvania (the “Cranberry Woods Drive Land”) for approximately $14.6 million, exclusive of closing costs. Wells REIT II also entered into a development agreement for the construction of three office buildings on the Cranberry Woods Drive Land. See Note 6 for a discussion of this development agreement.

222 E. 41st Street Building Acquisition

On August 17, 2007, Wells REIT II purchased a 25-story office building containing approximately 539,000372,000 rentable square feet (the “One Century Placelocated at 222 E. 41st Street in New York, New York (“the 222 E. 41st Street Building”) located on an approximate 28.2-acre parcel of land at 26 Century Place Boulevard in Nashville, Tennessee, for a purchase price of approximately $72.0$319.8 million, exclusive of closing costs. The 222 E. 41st Street Building was acquired subject to a 49-year ground lease.

120 Eagle RockBannockburn Lake III Building

On March 27,September 10, 2007, Wells REIT II purchased a three-story office building containing approximately 178,000106,000 rentable square feet (the “120 Eagle Rock Building”) located on an approximate 15.2-acre10.2-acre parcel of land at 120 Eagle Rock Avenue in East Hanover, New Jersey,2355 Waukegan Road, Bannockburn, Illinois for a purchase price of approximately $34.5$20.2 million, exclusive of closing costs.

1200 Morris Drive Building

On September 14, 2007, Wells REIT II purchased a three-story office building containing approximately 114,000 rentable square feet located on an approximate 11.7-acre parcel of land at 1200 Morris Drive, Wayne, Pennsylvania for a purchase price of approximately $29.3 million, exclusive of closing costs and purchase price adjustments.

South Jamaica Street Buildings

On September 26, 2007, Wells REIT II purchased three four-story office buildings and one five-story office building containing approximately 478,000 aggregate rentable square feet located on an approximate 30.8-acre parcel of land at 9127, 9189, 9191 and 9193 South Jamaica Street, Englewood, Colorado for a purchase price of approximately $138.5 million, exclusive of closing costs.

4.

Line of Credit and Notes Payable

As of March 31,September 30, 2007 and December 31, 2006, Wells REIT II had the following indebtedness outstanding (in thousands):

 

Facility

  March 31,
2007
  December 31,
2006
  

September 30,

2007

  

December 31,

2006

Wachovia Line of Credit

  $146,500  $126,000

222 E. 41st Street Building mortgage note

   131,037   —  

100 East Pratt Street Building mortgage note

  $105,000  $105,000   105,000   105,000

Wildwood Buildings mortgage note

   90,000   90,000   90,000   90,000

5 Houston Center Building mortgage note

   90,000   90,000   90,000   90,000

Manhattan Towers Building mortgage note

   75,000   75,000   75,000   75,000

80 Park Plaza Building mortgage note

   49,055   46,667

263 Shuman Boulevard Building mortgage note

   49,000   —  

One West Fourth Street Building mortgage note

   48,029   48,414   47,243   48,414

80 Park Plaza Building mortgage note

   47,438   46,667

800 North Frederick Building mortgage note

   46,400   46,400   46,400   46,400

Line of credit

   40,000   126,000

SanTan Corporate Center mortgage note

   39,000   39,000   39,000   39,000

Highland Landmark Building mortgage note

   31,942   30,840   33,038   30,840

9 Technology Drive Building mortgage note

   23,800   23,800   23,800   23,800

One and Four Robbins Road Buildings mortgage note

   23,000   23,000   23,000   23,000

215 Diehl Road Building mortgage note

   21,000   —  

Key Center Complex mortgage notes

   13,978   13,375

LakePointe 3 construction loan

   17,027   17,027   —     17,027

Key Center Complex mortgage notes

   13,576   13,375
            

Total indebtedness

  $690,212  $774,523  $983,051  $774,523
            

During the three months ended September 30, 2007, Wells REIT II engaged in the following significant activities with respect to its notes payable:

On August 16, 2007, Wells REIT II obtained a $130.3 million loan secured by the 222 East 41st Street Building in favor of Anglo Irish Bank Corporation, PLC (“Anglo Irish Bank”), the proceeds of which were used to purchase the 222 East 41st Street Building (See Note 3). The note bears interest at LIBOR plus 120 basis points (approximately 6.953% per annum as of September 30, 2007); however, interest has been effectively fixed at 6.675% for the life of the loan through an interest rate swap agreement with Anglo Irish Bank. The note matures in August 2017. Interest is due monthly; however,

under the terms of the loan agreement, monthly debt service amounts are added to the outstanding balance of the note over the term.

Wells REIT II made interest payments, including amounts capitalized, of approximately $10.0$26.6 million and $9.3$26.3 million during the threenine months ended March 31,September 30, 2007 and 2006, respectively. In addition, Wells REIT II paid a $5.7 million penalty in January 2006 related to repaying the University Circle Buildings mortgage note, which is included in loss on early extinguishment of debt in the accompanying consolidated statementstatements of operations.

Wells REIT II has a $400.0 million unsecured revolving financing facility (the “Wachovia Line of Credit”) with a syndicate of banks led by Wachovia Bank, N.A., which expires May 9, 2008. As of March 31,September 30, 2007, Wells REIT II had remaining borrowing capacity of up to approximately $334.7$214.5 million remaining under the Wachovia Line of Credit.

 

5.

Share Redemption Program

The board of directors of Wells REIT II approved an amendment to the share redemption program (“SRP”), which became effective September 7, 2007. The amendment obligates Wells REIT II to honor all redemption requests that are made within two years following the death of a stockholder. The redemption limits set forth in the amended SRP are summarized below:

Wells REIT II will not make an “Ordinary Redemption” (those that do not occur within two years of death or qualifying disability) until one year after the issuance of the shares to be redeemed.

Wells REIT II will not redeem shares on any redemption date to the extent that such redemptions would cause the amount paid for Ordinary Redemptions since the beginning of the then-current calendar year to exceed 50% of the net proceeds from the sale of shares under Wells REIT II’s dividend reinvestment plan during such period.

Wells REIT II will limit Ordinary Redemptions and those upon the qualifying disability of a stockholder so that the aggregate of such redemptions during any calendar year do not exceed:

100% of the net proceeds from Wells REIT II’s dividend reinvestment plan during the calendar year, or

5% of the weighted-average number of shares outstanding in the prior calendar year.

6.

Commitments and Contingencies

Property Under Construction

On August 1, 2007, Wells REIT II executed a development agreement with an unrelated third party for the purpose of constructing three office buildings with an aggregate total of approximately 772,000 rentable square feet at 900 - 1100 Cranberry Woods Drive in Cranberry, Pennsylvania (the “Cranberry Woods Drive Buildings”). As of September 30, 2007, Wells REIT II had approximately $157.8 million in costs remaining to be incurred under the agreement. The Cranberry Woods Drive Buildings are scheduled to be constructed in two phases, with the first phase (approximately 413,000 rentable square feet) scheduled to be completed in 2009 and the second phase (approximately 359,000 rentable square feet) to be completed in 2010. Upon completion of construction, the Cranberry Woods Drive Buildings will be entirely leased to Westinghouse Electric Company, LLC.

Three Glenlake Building

On August 10, 2007, Wells REIT II entered into a contribution agreement to acquire a 95% ownership interest in a joint venture that will own a 14-story office building currently under construction in Atlanta, Georgia (the “Three Glenlake Building”) for approximately $100.6 million. In connection with the execution of this agreement, Wells REIT II paid an earnest money deposit of $10.0 million, which will be applied as a credit towards Wells REIT II’s $100.6 million contribution due at closing, which is currently anticipated to be July 2008. The Three Glenlake Building, which is

expected to be completed in April 2008, will contain approximately 356,000 rentable square feet and will be entirely leased to Newell Rubbermaid Inc. at rental rates to be determined based upon total construction costs.

Commitments Under Existing Lease Agreements

Certain lease agreements include provisions that, at the option of the tenant, may obligate Wells REIT II to expend capital to expand an existing property or provide other expenditures for the benefit of the tenant. As of March 31,September 30, 2007, no tenants have exercised such options that had not been materially satisfied.

Litigation

Wells REIT II is from time to time a party to legal proceedings that arise in the ordinary course of its business. Wells REIT II is not currently involved in any legal proceedings of which the outcome is reasonably likely to have a material adverse effect on the results of operations or financial condition of Wells REIT II. Wells REIT II is not aware of any such legal proceedings contemplated by governmental authorities.

6.7.

Supplemental Disclosures of Noncash Activities

Outlined below are significant noncash investing and financing transactions for the threenine months ended March 31,September 30, 2007 and 2006 (in thousands):

 

  

Three Months Ended

March 31,

  

Nine Months Ended

September 30,

  2007  2006  2007  2006

Investment in real estate funded with other assets

  $750  $—    $750  $3,368
            

Acquisition fees applied to real estate assets

  $4,997  $4,007  $15,489  $11,781
            

Liabilities assumed upon acquisition of properties

  $282  $—  

Other assets assumed upon acquisition of properties

  $—    $58
      

Other liabilities assumed upon acquisition of properties

  $1,786  $965
      

Market value adjustment to interest rate swap

  $91  $1,112
      

Proceeds from note payable in escrow

  $—    $2,112
            

Accrued capital expenditures and deferred lease costs

  $34  $6,328  $2,967  $5,087
            

Acquisition fees due to affiliate

  $981  $330
      

Accrued redemptions of common stock

  $4,917  $—    $440  $8
      

Loss on interest rate swap

  $71  $—  
      

Acquisition fees due to affiliate

  $556  $320
            

Commissions on stock sales and related dealer-manager fees due to affiliate

  $1,195  $832  $868  $789
            

Other offering costs due to affiliate

  $676  $797  $767  $834
            

Dividends payable

  $7,924  $5,652  $8,665  $6,310
            

Discounts applied to issuance of common stock

  $1,693  $1,132  $5,865  $3,837
            

Redeemable common stock

  $12,563  $11,196  $609,518  $33,156
            

 

7.8.

Related-Party Transactions and Agreements

Advisory Agreement

Wells REIT II and Wells Capital are party to an advisory agreement (the “Advisory Agreement”) under which Wells Capital receives the following fees and reimbursements:

 

Reimbursement of organization and offering costs paid by Wells Capital on behalf of Wells REIT II, not to exceed 2.0% of gross offering proceeds;

 

Acquisition fees of 2.0% of gross offering proceeds, subject to certain limitations; Wells REIT II also reimburses Wells Capital for expenses it pays to third parties in connection with acquisitions or potential acquisitions;

Monthly asset management fees equal to one-twelfth of 0.75% of the cost of (i) all properties of Wells REIT II and (ii) investments in joint ventures. The amount of these fees paid in any calendar quarter may not exceed 0.25% of the net asset value of those investments at each quarter-end after deducting debt used to acquire or refinance properties;

 

Reimbursement for all costs and expenses Wells Capital incurs in fulfilling its duties as the asset portfolio manager, including (i) wages and salaries and other employee-related expenses of Wells Capital’s employees, who perform a full range of real estate services for Wells REIT II, including management, administration, operations, and marketing, and are billed to Wells REIT II based on the amount of time spent on Wells REIT II by such personnel, provided that such expenses are not reimbursed if incurred in connection with services for which Wells Capital receives a disposition fee (described below) or an acquisition fee, and (ii) amounts paid for IRA custodial service costs allocated to Wells REIT II accounts;

 

For any property sold by Wells REIT II, a disposition fee equal to 1.0% of the sales price, with the limitation that the total real estate commissions (including such disposition fee) for any Wells REIT II property sold may not exceed the lesser of (i) 6.0% of the sales price of each property or (ii) the level of real estate commissions customarily charged in light of the size, type, and location of the property;

Incentive fee of 10% of net sales proceeds remaining after stockholders have received distributions equal to the sum of the stockholders’ invested capital plus an 8% return of invested capital; and

 

Listing fee of 10% of the excess by which the market value of the stock plus dividends paid prior to listing exceeds the sum of 100% of the invested capital plus an 8% return on invested capital.

Either party may terminate the Advisory Agreement without cause or penalty upon providing 60 days’ prior written notice to the other. Under the terms of the Advisory Agreement, Wells REIT II is required to reimburse Wells Capital for certain organization and offering costs up to the lesser of actual expenses or 2% of gross equity proceeds raised. As of March 31,September 30, 2007, Wells REIT II has incurred and charged to additional paid-in capital cumulative other offering costs of approximately $31.7 million related to the initial public offering and $13.3$18.7 million related to the follow-on offering, which represents approximately 1.6% and 1.2%1.1% of cumulative gross proceeds raised by Wells REIT II under each offering, respectively.

Dealer-Manager Agreement

Wells REIT II is party to a Dealer-Manager Agreement with Wells Investment Securities, Inc. (“WIS”), whereby WIS, an affiliate of Wells Capital, performs the dealer-manager function for Wells REIT II. For these services, WIS earns a commission of up to 7% of the gross offering proceeds from the sale of the shares of Wells REIT II, of which a portion is re-allowed to participating broker dealers. Wells REIT II pays no commissions on shares issued under its dividend reinvestment plan.

Additionally, Wells REIT II is required to pay WIS a dealer-manager fee of 2.5% of the gross offering proceeds from the sale of Wells REIT II’s stock at the time the shares are sold. Under the dealer-manager agreement, up to 1.5% of the gross offering proceeds may be reallowed by WIS to participating broker dealers. Wells REIT II pays no dealer-manager fees on shares issued under its dividend reinvestment plan.

Property Management, Leasing, and Construction Agreement

Wells REIT II and Wells Management Company, Inc. (“Wells Management”), an affiliate of Wells Capital, are party to a Master Property Management, Leasing, and Construction Agreement (the “Management Agreement”) under which Wells Management receives the following fees and reimbursements in consideration for supervising the management, leasing, and construction of certain Wells REIT II properties:

 

Property management fees in an amount equal to a percentage negotiated for each property managed by Wells Management of the gross monthly income collected for that property for the preceding month;

Leasing commissions for new, renewal, or expansion leases entered into with respect to any property for which Wells Management serves as leasing agent equal to a percentage as negotiated for that property of the total base rental and operating expenses to be paid to Wells REIT II during the applicable term of the lease, provided, however, that no commission shall be payable as to any portion of such term beyond ten years;

 

Initial lease-up fees for newly constructed properties under the agreement, generally equal to one month’s rent;

��

Initial lease-up fees for newly constructed properties under the agreement, generally equal to one month’s rent;

 

Fees equal to a specified percentage of up to 5% of all construction build-out funded by Wells REIT II, given as a leasing concession, and overseen by Wells Management; and

 

Other fees as negotiated with the addition of each specific property covered under the agreement.

Related-Party Costs

Pursuant to the terms of the agreements described above, Wells REIT II incurred the following related-party costs for the three months and nine months ended March 31,September 30, 2007 and 2006, respectively (in thousands):

 

   Three Months Ended
March 31,
   2007  2006

Commissions (1)

  $16,273  $13,414

Dealer-manager fees (1)

   6,288   5,130

Asset management fees

   5,960   4,602

Acquisition fees (2)

   4,997   4,119

Other offering costs (1)

   1,924   3,168

Administrative reimbursements

   1,712   1,466

Property management fees

   262   106
        

Total

  $37,416  $32,005
        

   

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

   2007  2006  2007  2006

Commissions(1)

  $14,685  $13,598  $50,275  $41,256

Asset management fees

   6,515   4,940   18,545   14,345

Dealer-manager fees(1)

   5,805   5,264   19,508   15,857

Acquisition fees(2)

   4,601   4,181   15,489   12,610

Administrative reimbursements

   2,649   1,594   6,278   4,380

Other offering costs(1)

   2,759   2,381   7,339   8,307

Property management fees

   625   230   1,271   461

Construction fees

   —     —     —     150
                
  $37,639  $32,188  $118,705  $97,366
                

(1)

Commissions, dealer-manager fees, and other offering costs are charged against stockholders’ equity as incurred.

(2)

Acquisition fees are capitalized to prepaid expenses and other assets as incurred and allocated to properties upon fundingusing investor proceeds to fund acquisitions or repayingrepay debt used to finance property acquisitions, with investor proceeds.acquisitions.

Wells REIT II incurred no related-party disposition fees, construction fees, incentive fees, listing fees, or leasing commissions during the three months or nine months ended March 31,September 30, 2007 or 2006, respectively.

Due to Affiliates

The detail of amounts due to affiliates is provided below as of March 31,September 30, 2007 and December 31, 2006 (in thousands):

 

  

March 31,

2007

  December 31,
2006
  

September 30,

2007

  December 31,
2006

Administrative reimbursements due to Wells Capital and/or Wells Management

  $1,210  $1,586  $1,206  $1,586

Acquisition fees due to Wells Capital

   981   3,499

Commissions and dealer-manager fees due to WIS

   1,195   1,052   868   1,052

Other offering cost reimbursements due to Wells Capital

   676   2,383   767   2,383

Acquisition fees due to Wells Capital

   556   3,499

Asset and property management fees due to Wells Capital

   25   5,457

Asset and property management fees due to Wells Capital and/or Wells Management

   151   5,457
            
  $3,662  $13,977  $3,973  $13,977
            

Economic Dependency

Wells REIT II has engaged Wells Capital and its affiliates, Wells Management and WIS, to provide certain services that are essential to Wells REIT II, including asset management services, supervision of the property management and leasing of some properties owned by Wells REIT II, asset acquisition and disposition services, the sale of shares of Wells REIT II’s common stock, as well as other administrative responsibilities for Wells REIT II, including accounting services, stockholder communications, and investor relations. As a result of these relationships, Wells REIT II is dependent upon Wells Capital, Wells Management, and WIS.

Wells Capital, Wells Management, and WIS are owned and controlled by Wells Real Estate Funds, Inc. (“WREF”). The operations of Wells Capital, Wells Management, and WIS represent substantially all of the business of WREF. Accordingly, Wells REIT II focuses on the financial condition of WREF when assessing the financial condition of Wells Capital, Wells Management, and WIS. In the event that WREF were to become unable to meet its obligations as they become due, Wells REIT II might be required to find alternative service providers.

Future net income generated by WREF will be largely dependent upon the amount of fees earned by Wells Capital and Wells Management based on, among other things, the level of investor proceeds raised and the volume of future acquisitions and dispositions of real estate assets by Wells REIT II and other WREF-sponsored programs, as well as dividend income earned from equity interests in another REIT. In addition, WREF guarantees unsecured debt of $160 million held by another WREF-sponsored product that is in the start-up phase of its operations. As of March 31,September 30, 2007, Wells REIT II believes that WREF is generating adequate cash flow from operations and has adequate liquidity available in the form of cash on hand and current receivables necessary to meet its current and future obligations as they become due.

 

8.9.

Subsequent EventEvents

Sale of Shares of Common Stock

From AprilOctober 1, 2007 through April 30,October 31, 2007, Wells REIT II raised approximately $82.8$64.4 million through the issuance of approximately 8.36.4 million shares of common stock under its follow-on offering. As of April 30,October 31, 2007, approximately 168.2142.9 million shares remained available for sale to the public under the follow-on offering, exclusive of shares available under Wells REIT II’s dividend reinvestment plan.

Dvintsev Business Center Tower B

On October 2, 2007, Well REIT II acquired Wells International RE II Limited (“Wells International”), a Cypriot corporation, for approximately $32.0 million. Wells International RE II is party to a shared construction agreement with an unrelated third party for the development of a nine-story office tower in Moscow, Russia (“Dvintsev Business Center

Tower B”). Construction of Dvintsev Business Center Tower B, which will contain approximately 136,000 rentable square feet, is expected to be completed in late 2008. Upon its completion, Wells International will acquire Dvintsev Business Center Tower B for a purchase price of approximately $63.2 million towards which Wells International will receive a credit of $32.0 million plus additional earnest money deposits made by Wells International during the construction phase.

On October 2, 2007, in anticipation of its future acquisition of Dvintsev Business Center Tower B, Wells International entered into a 7-year, unsecured, fixed-rate line of credit with Zenit Bank for 930.0 million Russian rubles (“Zenit Bank Line”). Prior to Wells International’s acquisition of the Dvintsev Business Center Tower B, the Zenit Bank Line is unsecured and bears interest at a fixed rate of 11.61%. After Wells International acquires the Dvintsev Business Center Tower B, the Zenit Bank Line becomes secured and the fixed interest rate drops to 11.0%. As of October 31, 2007, no amounts have been drawn from the Zenit Bank line of credit. In connection with entering into the Zenit Bank Line, Wells REIT II entered into a foreign currency exchange agreement with Wachovia Bank, N.A., under which Wells REIT II will purchase 802.4 million Russian rubles at a fixed price of $0.04 per Russian ruble from September 2008 through March 2009.

ITEM 2.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our accompanying consolidated financial statements and notes thereto. See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I, as well as our consolidated financial statements and the notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2006.

We commenced our initial public offering on December 1, 2003 and have received investor proceeds under our public offerings of common stock and invested in real estate assets through March 31,September 30, 2007. Thus, our results of operations for the three months and nine months ended March 31,September 30, 2007 and 2006, respectively, reflect growing operational revenues and expenses and general and administrative expenses. Operational revenues and expenses have increased due to real property acquisitions. General and administrative expenses have increased commensurate with our overall growth, however, as a percent of total revenues, have remained stable at approximately 4% for the three months and nine months ended March 31,September 30, 2007 and 2006.

Liquidity and Capital Resources

Overview

From January 2004 through MarchSeptember 2007, we raised significant funds through the sale of our common stock under our public offerings. We primarily used the proceeds from these sales of common stock, net of offering costs and other expenses, to acquire real properties and fund certain capital improvements identified at the time of acquisition. We anticipate receiving proceeds from the sale of our common stock under our follow-on offering in the future, and investing such proceeds in future acquisitions of real properties. We also anticipate receiving proceeds from the sale of our common stock under our dividend reinvestment plan in the future, and using a significant portion of such proceeds to fund redemptions of our common stock under our share redemption program. We expect that our primary source of future operating cash flows will be cash generated from the operations of the properties currently in our portfolio and those to be acquired in the future. The amount of future dividends to be paid to our stockholders will be largely dependent upon the amount of cash generated from our operating activities, how quickly we are able to invest investor proceeds in quality income-producing assets, our expectations of future cash flows, and our determination of near-term cash needs for capital improvements, tenant re-leasing, redemptions of our common stock, and debt repayments.

The competition to acquire high-quality commercial office properties remains high. Timing differences arise between acquiring properties and raising capital and between making operating payments and collecting operating receipts. Accordingly, we may periodically be required to borrow funds on a short-term basis to meet our dividend payment schedule. Our primary focus, however, is to continue to maintain the quality of our portfolio. Thus, in this intensely competitive environment, we may opt to lower the dividend rather than compromise that quality or accumulate significant borrowings to meet a dividend level higher than operating cash flow would support. We continue to carefully monitor our cash flows and market conditions and their impact on our earnings and future dividend projections.

Short-term Liquidity and Capital Resources

During the threenine months ended March 31,September 30, 2007, we generated net cash flows from operating activities of approximately $37.1$136.9 million, which is primarily comprised of receipts for rental income, tenant reimbursements, hotel income, and interest and other income, partially offset by payments for operating costs, interest expense, asset and property management fees, hotel operating costs and general and administrative expenses. From net cash flows from operating activities and cash on hand, we paid dividends to stockholders of approximately $43.1$140.9 million during the threenine months ended March 31,September 30, 2007. We generated net cash flows from financing activities of approximately $86.3$720.5 million during the threenine months ended March 31,September 30, 2007, primarily as a result of raising proceeds from the sale of common stock under our public offerings, net of commissions, dealer-manager fees, and other offering costs, of approximately $225.5 million, reduced by net debt repayments of approximately $85.3 million.offerings. Such net cash flows from financing activities and cash on hand were used primarily to invest approximately $117.0$837.1 million in real estate and pay acquisition fees of approximately $7.9 million.estate. We expect to utilize theour residual cash balance of approximately $43.6$33.3 million as of March 31,September 30, 2007 to satisfy current liabilities, pay future dividends, fund future acquisitions of real properties, or reduce indebtedness.

We intend to continue to generate capital from the sale of common stock under our follow-on offering and from third-party borrowings, and to use such capital primarily to fund future acquisitions of real estate. We expect that we will use a significant portion of the proceeds from sales under our dividend reinvestment plan to fund redemptions under the share redemption program. As of April 30,October 31, 2007, we had a remaining borrowing capacity of approximately $374.7$235.5 million under the Wachovia Line of Credit. Accordingly, we believe that we have adequate capacity to continue to expand our portfolio and meet our future operating cash flow needs. We expect to use substantially all of our future operating cash flow, after payments for certain capital expenditures, to pay dividends to stockholders.

On March 2,September 4, 2007, our board of directors declared a daily dividend for stockholders of record from MarchSeptember 16, 2007 through JuneDecember 15, 2007 in an amount equal to an annualized dividend of $0.60 per share, which is consistent with the rate of dividends declared for the first quarterthree quarters of 2007 and each quarter of 2006 on a per-share basis. Such dividend will be paid in JuneDecember 2007.

Long-term Liquidity and Capital Resources

We expect that our primary sources of capital over the long term will include proceeds from the sale of our common stock, proceeds from secured or unsecured borrowings from third-party lenders, and net cash flows from operations. Our follow-on offering, which we commenced in November 2005, was extended until the earlier of the sale of all 300.0 million shares or December 1,November 10, 2008. Thereafter, our board of directors maywe expect to commence a second follow-on offering.offering pursuant to a registration statement on form S-11 that we filed with the SEC on July 9, 2007. We may continue to offer the 175.0 million dividend reinvestment plan shares beyond these dates until we have sold all of these shares through the reinvestment of dividends. We expect that our primary uses of capital will be for property acquisitions, either directly or through investments in joint ventures, tenant improvements, offering-related costs, operating expenses, including interest expense on any outstanding indebtedness, and dividends.

In determining how and when to allocate cash resources, we initially consider the source of the cash. We expect that substantially all future net operating cash flows, after payments for certain capital expenditures such as tenant improvements and leasing commissions, will be used to pay dividends. However, we may temporarily use other sources of cash, such as short-term borrowings, to fund dividends from time to time (see “Liquidity and Capital Resources – Overview” above). We expect to use substantially all net cash flows generated from raising equity or debt financing to fund acquisitions, certain capital expenditures identified upon acquisition, the repayment of outstanding borrowings, and the redemption of shares under the share redemption program. If sufficient equity or debt capital is not available, our future investments in real estate will be lower.

To the extent that future cash flows provided by operations are lower due to lower returns on properties, future dividends paid may be lower as well. Our cash flow from operations depends significantly on market rents and our tenants’ ability to make rental payments. We believe that the diversity of our tenant base and the concentration of creditworthy tenants in our portfolio help to mitigate the risk of a tenant defaulting on a lease. However, general economic downturns, downturns in one or more of our core markets, or downturns in the particular industries in which our tenants operate could adversely impact the ability of our tenants to make lease payments and our ability to re-lease space on favorable terms when leases expire. In the event of any of these situations, our cash flow and consequently our ability to meet capital needs, could adversely affect our ability to pay dividends in the future.

Contractual Commitments and Contingencies

Our contractual obligations as of March 31,September 30, 2007 will become payable in the following periods (in thousands):

 

Contractual Obligations

  Total  2007  2008-2009  2010-2011  Thereafter

Outstanding debt obligations (1)

  $690,212  $17,612  $155,625  $71,646  $445,329

Capital lease obligations(2)

   78,000   —     —     —     78,000

Operating lease obligations

   3,105   45   120   120   2,820
                    

Total

  $771,317  $17,657  $155,745  $71,766  $526,149
                    

Contractual Obligations

  Total  2007  2008-2009  2010-2011  Thereafter

Outstanding debt obligations (1)

  $983,051  $201  $262,125  $71,646  $649,079

Capital lease obligations(2)

   78,000   —     —     —     78,000

Operating lease obligations

   3,075   15   120   120   2,820
                    

Total

  $1,064,126  $216  $262,245  $71,766  $729,899
                    

(1)

Amounts include principal payments only. We made interest payments of $10.0$26.6 million during the threenine months ended March 31,September 30, 2007 and expect to pay interest in future periods on outstanding debt obligations based on the rates and terms disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006 and in Note 4 to our accompanying consolidated financial statements.

(2)

Amount includes principal payments only. We made interest payments of $1.2$3.5 million during the threenine months ended March 31,September 30, 2007 and expect to pay interest in future periods based on the terms disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.

Results of Operations

Overview

Our results of operations are not indicative of those expected in future periods, as we expect that rental income, tenant reimbursements, property operating costs, asset and property management fees, depreciation, amortization, and net income will increase in future periods as a result of owning the assets we acquired prior to and during the periods presented for an entire period and as a result of anticipated future acquisitions of real estate assets.

We commenced our initial public offering on December 1, 2003. Following the receipt and acceptance of subscriptions for the minimum offering of $2,500,000$2.5 million on January 22, 2004, we acquired 18 properties during the year ended December 31, 2004, 21 properties during the year ended December 31, 2005, and 10 properties during the year ended December 31, 2006. During the threenine months ended March 31,September 30, 2007, we acquired two8 properties and started construction on one build-to-suit, bringing our total portfolio to 5158 properties as of March 31,September 30, 2007. Accordingly, the results of operations presented for the three months and nine months ended March 31,September 30, 2007 and 2006, respectively, are not directly comparable.

Comparison of the three months ended March 31,September 30, 2006 versus the three months ended March 31,September 30, 2007

Rental income and tenant reimbursements increased from approximately $56.3$59.4 million and $12.9$13.3 million, respectively, for the three months ended March 31,September 30, 2006 to approximately $73.6$82.8 million and $20.3 million, respectively, for the three months ended March 31,September 30, 2007, primarily as a result of the growth in the portfolio during 2006 and the first three months of 2007.portfolio. Rental income and tenant reimbursements are expected to continue to increase in future periods, as compared to historical periods, as a result of owning the assetsrecently acquired during 2006 and the first three months of 2007properties for an entire period and future acquisitions of real estate assets.

Property operating costs and asset and property management fees increased from approximately $21.5$22.3 million and $5.9$6.4 million, respectively, for the three months ended March 31,September 30, 2006 to approximately $30.6$35.1 million and $7.6$8.3 million, respectively, for the three months ended March 31,September 30, 2007, primarily as a result of the growth in the portfolio during 2006 and the first three months of 2007.portfolio. Property operating costs and asset and property management fees are expected to continue to increase in future periods, as compared to historical periods, due to owning therecently acquired assets acquired during 2006 and the first three months of 2007 for an entire period and future acquisitions of additional real estate assets.

Depreciation of real estateand amortization increased from approximately $10.7$11.9 million and $20.5 million, respectively, for the three months ended March 31,September 30, 2006 to approximately $14.2$15.8 million and $28.9 million, respectively, for the three months ended March 31,September 30, 2007, primarily as a result of the growth in the portfolio during 2006portfolio. Depreciation and the first three months of 2007. Depreciation isamortization are expected to continue to increase in future periods, as compared to historical periods, due to owning therecently acquired assets acquired during 2006 and the first three months of 2007 for an entire period and future acquisitions of additional real estate assets.

AmortizationGeneral and administrative expenses increased from approximately $19.5$2.9 million for the three months ended March 31,September 30, 2006 to approximately $30.9$4.6 million for the three months ended March 31,September 30, 2007 due to the increase in the size of our portfolio of real estate assets. General and administrative expenses, as a percent of total revenues, remained stable at approximately 4% for the three months ended September 30, 2006 and 2007.

Interest expense increased from approximately $9.4 million for the three months ended September 30, 2006 to approximately $12.6 million for the three months ended September 30, 2007, primarily due to obtaining new mortgage notes, which is partially offset by a decrease in the average balance outstanding under the Wachovia Line of Credit. Future levels of interest expense will vary primarily based on the amounts of future borrowings and the costs of such borrowings. Future borrowings will be used primarily to fund future acquisitions of real estate or interests therein. Accordingly, the amounts of future borrowings and future interest expense will largely depend on the level of additional proceeds we raise under our ongoing public offering, the opportunities to acquire real estate assets consistent with our investment objectives, and the timing of such future acquisitions.

Loss on interest rate swaps increased from approximately $30,000 for the three months ended September 30, 2006 to approximately $5.5 million for the three months ended September 30, 2007, primarily due to a market valuation adjustment to the interest rate swap agreement on the 222 E. 41st Street Building loan prompted by the decline in market interest rates in September 2007.

Interest and other income increased from approximately $1.8 million for the three months ended September 30, 2006 to approximately $2.8 million for the three months ended September 30, 2007, primarily due to a timing difference arising from raising capital under our public offerings in advance of using such capital to acquire properties or repay borrowings.

We recognized net income and net income per share of approximately $2.6 million and $0.01, respectively, for the three months ended September 30, 2006, as compared to a net loss and net loss per share of approximately $2.5 million and $0.01, respectively, for the three months ended September 30, 2007. These decreases are primarily attributable to the loss on interest rate swaps and the increase in interest expense described above. We expect future earnings to increase as a result of current and future real estate acquisitions, and expect future net income per share to fluctuate primarily based on the level of proceeds raised in our ongoing public offering and the rate at which we are able to invest such proceeds in income-generating real estate assets.

Comparison of the nine months ended September 30, 2006 versus the nine months ended September 30, 2007

Rental income and tenant reimbursements increased from approximately $174.2 million and $40.7 million, respectively, for the nine months ended September 30, 2006 to approximately $232.1 million and $61.3 million, respectively, for the nine months ended September 30, 2007, primarily as a result of the growth in the portfolio. Rental income and tenant reimbursements are expected to continue to increase in future periods, as compared to historical periods, as a result of owning recently acquired properties for an entire period and future acquisitions of real estate assets.

Other rental income increased from approximately $77,000 for the nine months ended September 30, 2006 to approximately $2.8 million for the nine months ended September 30, 2007 primarily as a result of earning fees related to lease restructuring activities at 5 Houston and 100 E. Pratt. Unlike the majority of rental income, which is recognized ratably over long-term contracts, fees earned in connection with lease restructurings are recognized once we have completed our obligation to provide space to the tenant.

Property operating costs and asset and property management fees increased from approximately $65.3 million and $18.4 million, respectively, for the nine months ended September 30, 2006 to approximately $98.1 million and $23.7 million, respectively, for the nine months ended September 30, 2007, primarily as a result of the growth in the portfolio. Property operating costs and asset and property management fees are expected to continue to increase in future periods, as compared to historical periods, due to owning recently acquired assets for an entire period and future acquisitions of additional real estate assets.

Depreciation increased from approximately $33.8 million for the nine months ended September 30, 2006 to approximately $44.1 million for the nine months ended September 30, 2007, primarily as a result of the growth in the portfolio.

Depreciation is expected to increase in future periods, as compared to historical periods, due to owning recently acquired assets for an entire period and future acquisitions of real estate assets.

Amortization increased from approximately $60.0 million for the nine months ended September 30, 2006 to approximately $86.3 million for the nine months ended September 30, 2007 due to the growth in the portfolio during 2006 and recognizing write-offs of unamortized lease-specific assets related to aan early termination of the right to lease space at 5 Houston Center of approximately $5.2 million in the first quarter of 2007. Exclusive of the aforementioned write-off of $5.2 million, amortization is expected to increase in future periods, as compared to historical periods, due to owning the assetsrecently acquired during 2006 and the first three monthsassets for an entire period and future acquisitions of additional real estate assets.

General and administrative expenses increased from approximately $2.9$8.8 million for the threenine months ended March 31,September 30, 2006 to approximately $3.5$12.6 million for the threenine months ended March 31,September 30, 2007, primarily due to the increase in the size of our portfolio of real estate assets during 2006 and the first three months of 2007.assets. General and administrative expenses, as a percent of total revenues, remained stable at approximately 4.0%4% for the threenine months ended March 31, 2007September 30, 2006 and 2006.2007.

Interest expense increased from approximately $11.2$30.8 million for the threenine months ended March 31,September 30, 2006 to approximately $11.7$34.7 million for the threenine months ended March 31,September 30, 2007, primarily due to obtaining new mortgage notes, as well as an increase in the interest rate under our line of credit, which is partially offset theby a decrease in the average balance outstanding under the lineWachovia Line of credit.Credit. Future levels of interest expense will vary primarily based on the amounts of future borrowings and the costs of such borrowings. Future borrowings will be used primarily to fund future acquisitions of real estate or interests therein. Accordingly, the amounts of future borrowings and future interest expense will largely depend on the level of additional proceeds we raise under our ongoing public offering, the opportunities to acquire real estate assets consistent with our investment objectives, and the timing of such future acquisitions.

We recognized a loss on early extinguishment of debt of approximately $1.1 million during the threenine months ended March 31,September 30, 2006 in connection with prepaying the University Circle Buildings mortgage note in January 2006. The loss resulted from a prepayment penalty of approximately $5.7 million and a write-off of approximately $0.6 million in deferred financing costs, partially offset by a write-off of the unamortized fair value adjustment to debt of approximately $5.2 million.

We recognized a loss on interest rate swaps of approximately $5.5 million for the nine months ended September 30, 2007 compared to a gain of approximately $33,000 for the nine months ended September 30, 2006, primarily due to a market valuation adjustment to the interest rate swap agreement on the 222 E. 41st Street Building loan prompted by the decline in market interest rates in September 2007.

Interest and other income increased from approximately $5.5 million for the nine months ended September 30, 2006 to approximately $7.1 million for the nine months ended September 30, 2007, primarily due to a timing difference arising from raising capital under our public offerings in advance of using such capital to acquire properties or repay borrowings.

Net income and net income per share decreased from approximately $1.8 million for the three months ended March 31, 2006 to approximately $1.6 million for the three months ended March 31, 2007, primarily as a result of holding lower average cash balances during the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, due to timing differences in raising capital in our public offerings and closing on property acquisitions between periods.

Net loss and net loss per share increased from approximately $0.9$5.8 million and $0.00,$0.03, respectively, for the threenine months ended March 31,September 30, 2006 to approximately $2.6 million and $0.01, respectively, for the threenine months ended March 31,September 30, 2007 primarily as a resultdue to the loss on interest rate swaps and write-offs of unamortized lease-specific assets related to the termination at 5 Houston Center described above, partially offset by additionalother rental income from the growth of our portfolio.recognized for early lease terminations. We expect future earnings to increase as a result of current and future real estate acquisitions to increase net income in future periods and expect future net income per share to fluctuate primarily based on the level of proceeds raised in our ongoing public offering and the rate at which we are able to invest such proceeds in income-generating real estate assets.

Funds From Operations

Funds from operations (“FFO”) is a non-GAAP financial measure and should not be viewed as an alternative to net income as a measurement of our operating performance. We believe that FFO is a beneficial indicator of the performance of equity REITs. Specifically, FFO calculations exclude factors such as depreciation and amortization of real estate assets and gains or losses from sales of operating real estate assets. As such factors can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates, FFO may provide a valuable comparison of operating performance between periods and with other REITs. Management believes that accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we believe that the use of FFO, together with the required GAAP presentation, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities. We calculate FFO in accordance with the current National Association of Real Estate Investment TrustTrusts (“NAREIT”) definition. However, other REITs may not define FFO in accordance with the NAREIT definition, or may interpret the current NAREIT definition differently than we do.

As presented below, FFO is adjusted to exclude the impact of certain noncash items, such as depreciation, amortization, and gains on the sale of real estate assets. Reconciliations of net lossincome (loss) to FFO are presented below (in thousands):

 

  For the Three Months Ended
March 31,
   

For the Three Months Ended

September 30,

  

For the Nine Months Ended

September 30,

  2007 2006   2007 2006  2007  2006

Net loss

  $(2,610) $(881)

Net income (loss)

  $(2,453) $2,637  $2,613  $5,842

Add:

          

Depreciation of real assets

   14,194   10,678    15,796   11,937   44,087   33,846

Amortization of lease-related costs

   30,905   19,470    28,883   20,475   86,292   59,988
                   

FFO

  $42,489  $29,267   $42,226  $35,049  $132,992  $99,676
                   

Weighted-average common shares outstanding

   291,017   206,104    342,924   247,285   317,232   226,983
                   

Set forth below is additional information related to certain cash and noncash items included in or excluded from net lossincome (loss) above, which may be helpful in assessing our operating results. In addition, cash flows generated from FFO may be used to fund all or a portion of certain capitalizable items that are excluded from FFO, such as capitalized interest, tenant improvements, building improvements, and deferred lease costs. Please see the accompanying consolidated statements of cash flows for detaildetails of our operating, investing, and financing cash activities.

Noncash Items Included in Net Loss:Income (Loss):

 

Straight-line rental revenue of approximately $5.0$3.7 million and $5.8$5.1 million was recognized for the three months ended March 31,September 30, 2007 and 2006, respectively, and approximately $12.6 million and $16.1 million was recognized for the nine months ended September 30, 2007 and 2006, respectively;

 

Amortization of above-market/below-market in-place leases and lease incentives was recognized as net decreases to rental income of approximately $2.9 million and $4.6 million and $2.9 millionwas recognized for the three months ended March 31,September 30, 2007 and 2006, respectively, and approximately $10.4 million and $10.3 million was recognized for the nine months ended September 30, 2007 and 2006, respectively;

 

Amortization of deferred financing costs, discounts on notes payable, and interest accrued into the basis of notes payable of approximately $1.3$2.4 million and $0.5$0.4 million was recognized as interest expense for the three months ended March 31,

ended September 30, 2007 and 2006, respectively, and approximately $5.0 million and $1.3 million was recognized as interest expense for the nine months ended September 30, 2007 and 2006, respectively;

Approximately $5.5 million was recognized as a loss on interest rate swap for the three and nine months ended September 30, 2007, respectively;

 

Approximately $1.1 million was recognized as a loss on early extinguishment of debt for the threenine months ended March 31,September 30, 2006 in connection with prepayment of the University Circle Buildings mortgage note during January 2006; and2006.

Cash Item Excluded from Net Loss:Income (Loss):

 

Master lease proceeds relating to previous acquisitions of approximately $0.2$1.2 million and $0.2$5.7 million were collected during the three months ended March 31,September 30, 2007 and 2006, respectively, and approximately $1.4 million and $6.0 million were collected during the nine months ended September 30, 2007 and 2006, respectively. Master lease proceeds are recorded as an adjustment to the basis of real estate assets during the period acquired and, accordingly, are not included in net lossincome or FFO. We consider master lease proceeds when determining cash available for dividends to our stockholders.

Election as a REIT

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), and have operated as such beginning with our taxable year ended December 31, 2003. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our adjusted taxable income, as defined in the Code, to our stockholders, computed without regard to the dividends-paid deduction and by excluding our net capital gain. As a REIT, we generally will not be subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income for that year and for the four years following the year during which qualification is lost, unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT for federal income tax purposes.

Wells TRS is a wholly owned subsidiary of Wells REIT II that is organized as a Delaware limited liability company and includes the operations of, among other things, a full-service hotel. We have elected to treat Wells TRS as a taxable REIT subsidiary. We may perform additional, non-customary services for tenants of buildings that we own through Wells TRS, including any real estate or non-real estate related services; however, any earnings related to such services are subject to federal and state income taxes. In addition, for us to continue to qualify as a REIT, our investments in taxable REIT subsidiaries cannot exceed 20% of the value of our total assets. Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities at the enacted rates expected to be in effect when the temporary differences reverse.

No provision for federal income taxes has been made in our accompanying consolidated financial statements, other than the provision relating to Wells TRS, as we made distributions in excess of taxable income for the periods presented. We are subject to certain state and local taxes related to property operations in certain locations, which have been provided for in our accompanying consolidated financial statements.

Inflation

We are exposed to inflation risk, as income from long-term leases is the primary source of our cash flows from operations. There are provisions in the majority of our tenant leases that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include rent steps, reimbursement billings for operating expense pass-through charges, real estate tax and insurance reimbursements on a per-square-foot basis, or in some cases, annual reimbursement of operating expenses above a certain per-square-foot allowance. However, due to the long-term nature of the leases, the leases may not re-setreset frequently enough to fully cover inflation.

Application of Critical Accounting Policies

Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses.

Investment in Real Estate Assets

We are required to make subjective assessments as to the useful lives of our depreciable assets. We consider the period of future benefit of the asset to determine the appropriate useful lives. These assessments have a direct impact on net income. The estimated useful lives of our assets by class are as follows:

 

Buildings

  

40 years

Building improvements

  

5-25 years

Tenant improvements

  

Shorter of economic life or lease term

Intangible lease assets

  

Lease term

Allocation of Purchase Price of Acquired Assets

Upon the acquisition of real properties, we allocate the purchase price of properties to acquired tangible assets, consisting of land and building, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases and the value of in-place leases, based in each case on our estimate of their fair values.

The fair values of the tangible assets of an acquired property (which includes land and building) are determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land and building based on our determination of the relative fair value of these assets. We determine the as-if-vacant fair value of a property using methods similar to those used by independent appraisers. Factors we consider in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases, including leasing commissions and other related costs. In estimating carrying costs, we include real estate taxes, insurance, and other operating expenses during the expected lease-up periods based on current market conditions.

The fair values of above-market and below-market in-place leases are recorded based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) our estimate of market rates for the corresponding in-place leases, measured over a period equal to the remaining terms of the leases. The capitalized above-market and below-market lease values are recorded as intangible lease assets or liabilities and amortized as an adjustment to rental income over the remaining terms of the respective leases.

The fair values of in-place leases include direct costs associated with obtaining a new tenant, opportunity costs associated with lost rentals that are avoided by acquiring an in-place lease, and tenant relationships. Direct costs associated with

obtaining a new tenant include commissions, tenant improvements, and other direct costs and are estimated based on our consideration of current market costs to execute a similar lease. These direct costs are included in deferred lease costs in the accompanying consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases. The value of opportunity costs is calculated using the contractual amounts to be paid pursuant to the in-place leases over a market absorption period for a similar lease. Customer relationships are valued based on expected renewal of a lease or the likelihood of obtaining a particular tenant for other locations. These lease intangibles are included in intangible lease assets in the accompanying consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases.

Estimates of the fair values of the tangible and intangible assets require us to estimate market lease rates, property operating expenses, carrying costs during lease-up periods, discount rates, market absorption periods, and the number of years the property is held for investment. The use of inappropriate estimates would result in an incorrect assessment of our purchase price allocations, which would impact the amount of our reported net income.

Valuation of Real Estate Assets

We continually monitor events and changes in circumstances that could indicate that the carrying amounts of the real estate and related intangible assets of both operating properties and properties under construction, in which we have an ownership interest, either directly or through investments in joint ventures, may not be recoverable. When indicators of potential impairment are present that suggest that the carrying amounts of real estate and related intangible assets may not be recoverable, we assess the recoverability of these assets by determining whether the carrying value will be recovered through the undiscounted future operating cash flows

expected from the use of the asset and its eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying value, we decrease the carrying value of the real estate and related intangible assets to the estimated fair values, as defined by SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, and recognize an impairment loss. Estimated fair values are calculated based on the following information, in order of preference, dependent upon availability: (i) recently quoted market prices, (ii) market prices for comparable properties, or (iii) the present value of undiscounted cash flows, including estimated salvage value. We have determined that there has been no impairment in the carrying value of our real estate assets to date.

Projections of expected future operating cash flows require that we estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, the number of months it takes to re-lease the property, and the number of years the property is held for investment, among other factors. The subjectivity of assumptions used in the future cash flow analysis, including discount rates, could result in an incorrect assessment of the property’s fair value and could result in the misstatement of the carrying value of our real estate and related intangible assets and net income.

Related-PartiesRelated Parties

Transactions and Agreements

We have entered into agreements with our advisor, Wells Capital, and its affiliates, whereby we pay certain fees and reimbursements to Wells Capital or its affiliates, for acquisition fees, commissions, dealer-manager fees, asset and property management fees, construction fees, reimbursement of organizational and offering costs, and reimbursement of operating costs. See Note 78 to our accompanying consolidated financial statements included herein for a discussion of the various related-party transactions, agreements, and fees.

Our Relationship with Wells REIT and the Impact of Its Internalization Transaction on Us

Wells Real Estate Investment Trust, Inc. (“Wells REIT”) is a separate REIT from us that also was sponsored by WREF, our sponsor and the sole stockholder of Wells Capital, WIS, and Wells Management. Prior to April 16, 2007, we and Wells REIT shared a common advisor, Wells Capital, and a common property manager, Wells Management. We also shared with Wells REIT all of the same executive officers and many of the same directors, except that we had separate presidents from February 2, 2007, which is the date that Wells REIT entered into the merger agreement relating to the internalization transaction described below.

On April 16, 2007, Wells REIT acquired entities affiliated with WREF. Wells REIT entered into the merger in order to internalize advisory, asset management, property management, and other services previously provided to Wells REIT by WREF and its affiliates. As a result of the internalization transaction, 81 employees of WREF and its affiliates became employees of Wells REIT. A majority of those employees did not previously provide significant services to us. Following the internalization transaction, WREF and its affiliates have 351 employees. WREF and its affiliates are seeking successors to some of the personnel who had provided services to us and became employees of Wells REIT in the internalization transaction.

Some of the personnel acquired by Wells REIT in the internalization had primary responsibility for the management of six of our properties. To ensure continuity of property management services, we amended our existing Management Agreement to eliminate the provision of property management services for those six properties effective upon consummation of the Wells REIT internalization transaction. We also entered into a property management agreement with a subsidiary of Wells REIT to provide property management services to us for the six properties. Wells Management and unaffiliated third parties, however, will continue to provide leasing services for the six properties. The terms of our agreement with Wells REIT for property management services are substantially similar to the terms under which we engage Wells Management for property management services.

In connection with the Wells REIT internalization transaction, all three of our officers resigned from their officer positions with Wells REIT, four of our board members resigned from their positions as board members of Wells REIT, and two Wells REIT directors resigned from our board. On May 9, 2007, Leo F. Wells, III resigned as chairman of the board of directors of Wells REIT. As a result, we and Wells REIT share no common officers and no common directors.

On April 18, 2007, E. Nelson Mills became one of our independent directors. He is also an independent director of Institutional REIT, Inc. and Wells Timberland REIT, Inc. Since December 2004, Mr. Mills has served as the chief operations officer and chief financial officer of Williams Realty Advisors, LLC, where he is responsible for investment and financial strategy and is in charge of the design, formation, and operation of a series of real estate investment funds. From April 2004 to December 2004, Mr. Mills was a financial consultant to Timbervest, LLC, an investment manager specializing in timberland investments. From September 2000 to April 2004, Mr. Mills served as chief financial officer of Lend Lease Real Estate Investments (US), Inc., an investment manager specializing in the acquisition and management of commercial real estate, and from August 1998 to August 2000 served as a senior vice president of Lend Lease with responsibility for tax planning and administration and the supervision of various merger and acquisition activities. Prior to joining Lend Lease, Mr. Mills was a tax partner with KPMG LLP from January 1987 to August 1998. Mr. Mills received a Bachelor of Science degree in Business Administration from the University of Tennessee and a Master’s of Business Administration degree from the University of Georgia. Mr. Mills is also a Certified Public Accountant.

Legal ActionActions Against Related-PartiesRelated Parties

On March 12, 2007, a stockholder of Piedmont Office Realty Trust, Inc., formerly known as Wells REITReal Estate Investment Trust, Inc. (referenced herein as “Piedmont REIT”) filed a purportedputative class action and derivative complaint, styledWashtenaw County Employees’ Retirement System v. Wells Real Estate Investment Trust, Inc., et al., in the United States District Court for the District of Maryland against, among others, WellsPiedmont REIT, our advisor, certain affiliates of WREF and certain of our officers and directors who formerly served as officers andor directors of WellsPiedmont REIT prior to the closing of the internalization transaction on April 16, 2007. The complaint alleges, among other things, violations of the

federal proxy rules and breaches of fiduciary duty arising from the WellsPiedmont REIT internalization transaction and the related proxy statement filed with the SEC on February 26, 2007, as amended. The complaint seeks, among other things, unspecified monetary damages.damages and nullification of the Piedmont REIT internalization transaction. On April 9, 2007, the District Court denied the plaintiff’s motion for an order enjoining the internalization transaction. On April 17, 2007, the Court granted the defendants’ motion to transfer venue to the United States District Court for the Northern District of Georgia, and the case was docketed in the Northern District of Georgia on April 24, 2007. On June 7, 2007, the court granted a motion to designate the class lead plaintiff and class co-lead counsel. On June 27, 2007, the plaintiff filed an amended complaint, which attempts to assert class action claims on behalf of those persons who received and were entitled to vote on the Piedmont REIT proxy statement filed with the SEC on February 26, 2007 and derivative claims on behalf of Piedmont REIT. On July 9, 2007, the court denied the plaintiff’s motion for expedited discovery related to an anticipated motion for a preliminary injunction. On August 13, 2007, the defendants filed a motion to dismiss the amended complaint. The motion to dismiss has been fully briefed and is currently pending before the court. Our advisor and officers and directors who are named in the complaint intend to vigorously defend this action. Any financial loss incurred by Wells Capital, Wells Management, or their affiliates could hinder their ability to successfully manage our operations and our portfolio of investments.

On August 24, 2007, two stockholders of Piedmont REIT, filed a putative derivative complaint styledDonald and Donna Goldstein, Derivatively on behalf of Defendant Wells Real Estate Investment Trust, Inc. v. Leo F. Wells, III, et. al., in the Superior Court of Fulton County, Georgia, on behalf of Piedmont REIT against, among others, our advisor, certain affiliates of WREF and certain of our officers and directors who formerly served as officers and directors of Piedmont REIT prior to the closing of the Piedmont REIT internalization transaction on April 16, 2007. The complaint alleges, among other things, that the consideration paid by Piedmont REIT as part of the internalization transaction was excessive; that the defendants breached their fiduciary duties to Piedmont REIT; and that the internalization transaction unjustly enriched the defendants. The complaint seeks, among other things, a judgment declaring that the defendants have committed breaches of their fiduciary duties and were unjustly enriched at the expense of Piedmont REIT; monetary damages equal to the amount by which Piedmont REIT has been damaged by the defendants; an order awarding Piedmont REIT restitution from the defendants and ordering disgorgement of all profits and benefits obtained by the defendants from their wrongful conduct and fiduciary breaches; an order rescinding the internalization transaction; and the establishment of a constructive trust upon any benefits improperly received by the defendants as a result of their wrongful conduct. On October 19, 2007, the court granted the defendants’ motion for a protective order staying discovery until the court rules on the defendants’ motion to dismiss the complaint. On October 31, 2007, the defendants filed their motion to dismiss the plaintiffs’ derivative complaint, which is currently pending before the Court. Our advisor and officers and directors who are named in the complaint intend to vigorously defend this action. Any financial loss incurred by Wells Capital or its affiliates could hinder their ability to successfully manage our operations and our portfolio of investments.

Commitments and Contingencies

We are subject to certain commitments and contingencies with regard to certain transactions. Refer to Note 56 of our accompanying consolidated financial statements for further explanation. Examples of such commitments and contingencies include:

 

Property under construction

Property under contract

Commitments under existing lease agreements; and

 

Litigation.

Share Redemption Program

Our board of directors approved an amendment to the SRP, which became effective September 7, 2007. The amendment obligates us to honor all redemption requests that are made within two years following the death of a stockholder. The redemption limits set forth in the SRP are summarized below:

We will not make an “Ordinary Redemption” (those that do not occur within two years of death or qualifying disability) until one year after the issuance of the share to be redeemed.

We will not redeem shares on any redemption date to the extent that such redemptions would cause the amount paid for Ordinary Redemptions since the beginning of the then-current calendar year to exceed 50% of the net proceeds from the sale of shares under our dividend reinvestment plan during such period.

We will limit Ordinary Redemptions and those upon the qualifying disability of a stockholder so that the aggregate of such redemptions during any calendar year do not exceed:

100% of the net proceeds from our dividend reinvestment plan during the calendar year or

5% of the weighted-average number of shares outstanding in the prior calendar year.

Under the terms of our Corporate Governance Guidelines, until our board of directors decides to commence a liquidation of Wells REIT II, we may not amend the SRP in a way that materially adversely affects the rights of redeeming heirs without the approval of our stockholders.

In June 2006, we entered into an insurance agreement with an affiliate of London Life and Casualty Reinsurance Corporation to provide us with an insurance-backed funding source for the redemption of the shares under our share redemption program in the event we receive an unusually large number of redemption requests due to the death of investors. The insurance proceeds will be paid to us after a quarterly adjusted deductible, currently $17.1 million for the quarter ending September 30, 2007, is met. The deductible adjusts with additional investment proceeds raised and with the changing demographics of our stockholder base (age, gender, etc.). The maximum dollar value of proceeds that we can collect under the insurance agreement is $6.0 billion in aggregate or $5.0 million for any individual redemption request. The insurance agreement has a 10-year term unless it expires earlier upon the occurrence of one of the following liquidity events: (i) the listing of our shares on a national exchange, (ii) our liquidation, or (iii) the acquisition of a majority of our shares by an unaffiliated entity or a merger in which we are not the surviving entity. Under our Corporate Governance Guidelines, we must seek the approval of our stockholders prior to terminating this insurance program.

Subsequent EventEvents

Sale of Shares of Common Stock

From AprilOctober 1, 2007 through April 30,October 31, 2007, we raised approximately $82.8$64.4 million through the issuance of approximately 8.36.4 million shares of our common stock under our follow-on offering. As of April 30,October 31, 2007, approximately 168.2142.9 million shares remained available for sale to the public under the follow-on offering, exclusive of shares available under our dividend reinvestment plan.

Dvintsev Business Center Tower B

On October 2, 2007, we acquired Wells International RE II Limited (“Wells International”), a Cypriot corporation, for approximately $32.0 million. Wells International RE II is party to a shared construction agreement with an unrelated third party for the development of a nine-story office tower in Moscow, Russia (“Dvintsev Business Center Tower B”). Construction of Dvintsev Business Center Tower B, which will contain approximately 136,000 rentable square feet, is expected to be completed in late 2008. Upon its completion, Wells International will acquire Dvintsev Business Center Tower B for a purchase price of approximately $63.2 million towards which Wells International will receive a credit of $32.0 million plus additional earnest money deposits made by Wells International during the construction phase.

On October 2, 2007, in anticipation of its future acquisition of Dvintsev Business Center Tower B, Wells International entered into a 7-year, unsecured, fixed rate line of credit with Zenit Bank for 930.0 million Russian rubles (“Zenit Bank Line”). Prior to Wells International’s acquisition of the Dvintsev Business Center Tower B, the Zenit Bank Line is unsecured and bears interest at a fixed rate of 11.61%. After Wells International acquires the Dvintsev Business Center Tower B, the Zenit Bank Line becomes secured and the fixed interest rate drops to 11.0%. As of October 31, 2007, no amounts have been drawn from the Zenit Bank line of credit. In connection with entering into the Zenit Bank Line, we entered into a foreign currency exchange agreement with Wachovia Bank, N.A., under which we will purchase 802.4 million Russian rubles at a fixed price of $0.04 per Russian ruble from September 2008 through March 2009.

ITEM 3.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

As a result of our debt facilities, we are exposed to interest rate changes. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flow primarily through a low to moderate level of overall borrowings. However, we currently have a substantial amount of debt outstanding. We manage our ratio of fixed to floating rate debt with the objective of achieving a mix that we believe is appropriate in light of anticipated changes in interest rates. We closely monitor interest rates and will continue to consider the sources and terms of our borrowing facilities to determine whether we have appropriately guarded ourselves against the risk of increasing interest rates in future periods.

Additionally, we have entered into an interest rate swaps,swap, and may enter into other interest rate swaps, caps, or other arrangements in order to mitigate our interest rate risk on a related financial instrument. We do not enter into derivative or interest rate transactions for speculative purposes. All of our debt was entered into for other than trading purposes.

Our financial instruments consist of both fixed and variable rate debt. The Wachovia Line of Credit, the LakePointe 3 construction loan,80 Park Plaza Building mortgage note, and the 80 Park Plaza222 E. 41st Street Building mortgage note are our only debt instruments that bear interest at a variable rate. As of March 31,September 30, 2007, we had $40.0$146.5 million outstanding balance on the Wachovia Line of Credit, $17.0 million outstanding on the LakePointe 3 construction loan, $47.4$49.1 million outstanding on the 80 Park Plaza Building mortgage note, $131.0 million outstanding on the 222 E. 41st Street Building mortgage note, and $585.8$656.5 million in fixed-rate term mortgage loans. The weighted-average interest rate of our fixed and variable rate debt at March 31,September 30, 2007 was 5.35%5.8%.

The Wachovia Line of Credit is subject to interest costs based on, at our option, the London Interbank Offered Rate (“LIBOR”) for 7-, 30-, 60-, 90-, or 180-day periods, plus an applicable margin ranging from 0.85% to 1.20% (“LIBOR Loans”), or the floating base rate. The applicable margin for LIBOR Loans is based on the ratio of debt to total asset value. The base rate for any day is the higher of Wachovia’s prime rate for such day, or the Federal Funds Rate for such day plus 50 basis points. The maturity date of the Wachovia Line of Credit is May 9, 2008. We are able to extend the initial maturity date to May 9, 2009 if we seek an extension and meet the related conditions set forth in the agreement. An increase in the variable interest rate on this line of credit constitutes a market risk, as an increase in rates would increase interest incurred and, therefore, decrease cash flows available for distribution to stockholders.

The LakePointe 3 construction loan is a debt instrument used to fund a portion of the costs necessary to build an office building in Charlotte, North Carolina, which was completed in May 2006. The loan matures in 2007 and requires monthly interest payments at a rate of monthly LIBOR, plus 100 basis points (approximately 6.32% per annum as of March 31, 2007).

The $45.9 million 80 Park Plaza Building mortgage note was used to purchase the 80 Park Plaza Building. The note bears interest at LIBOR plus 130 basis points (approximately 6.62%6.449% per annum as of March 31,September 30, 2007) and matures in September 2016. In connection with obtaining the 80 Park Plaza Building mortgage note, we entered into an interest rate swap agreement to hedge exposure to changing interest rates. The interest rate swap agreement has an effective date of September 22, 2006 and terminates September 21, 2016. Under the terms of the interest rate swap agreement, we will pay monthly interest at a fixed rate of 5.275% per annum and receive LIBOR-based monthly interest payments. The interest rate swap effectively fixes our interest rate on the 80 Park Plaza Building mortgage note at 6.575%.

The 222 E. 41st Street Building mortgage note was used to purchase the 222 E. 41st Street Building. The note bears interest at LIBOR plus 120 basis points (approximately 6.953% per annum as of September 30, 2007) and matures in August 2017. In connection with obtaining the 222 E. 41st Street Building mortgage note, we entered into an interest rate swap agreement to hedge exposure to changing interest rates. The interest rate swap agreement has an effective date of August 16, 2007 and terminates August 16, 2017. Under the terms of the interest rate swap agreement, we will pay monthly interest at a fixed rate of 5.475% per annum and receive LIBOR-based monthly interest payments. The interest rate swap effectively fixes our interest rate on the 222 E. 41st Street Building mortgage note at 6.675%.

Approximately $585.8$656.5 million of our total debt outstanding as of March 31,September 30, 2007 is subject to fixed rates, with an average interest rate of 5.16%5.2% and expirations ranging from 2008 to 2018. A change in the market interest rate impacts the net financial instrument position of our fixed-rate debt portfolio but has no impact on interest incurred or cash flows.

ITEM 4.

ITEM 4.

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As of the end of the period covered by this report, management performed, with the participation of our Principal Executive Officer and Principal Financial Officer, an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, to allow timely decisions regarding required disclosures. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31,September 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

 

ITEM 1.

ITEM 1.

LEGAL PROCEEDINGS

From time to time, we are party to legal proceedings, which arise in the ordinary course of our business. We are not currently involved in any legal proceedings of which the outcome is reasonably likely to have a material adverse effect on our results of operations or financial condition, nor are we aware of any such legal proceedings contemplated by governmental authorities.

 

ITEM 1A.

ITEM 1A.

RISK FACTORS

The following risk factor hasThere have been updated to include a discussion of possible payments to Wells Capital or its affiliates during our listing/liquidation stage should we seek to become self-managed by acquiring entities affiliated with Wells Capital. We are currently in our offering stage with no charter-imposed obligation to take action with respect to a listing or liquidation until 2015, and we have no current plans to seek to become self-managed. This risk factor should be read together withmaterial changes from the risk factors disclosed under Item 1Ain the “Risk Factors” section of our Annual Reportannual report on Form 10-K for the year ended December 31, 2006.2006 or any subsequently filed quarterly report on Form 10-Q.

Payment of compensation to Wells Capital and its affiliates will reduce cash available for investment and distribution and increases the risk that you will not be able to recover the amount of your investment in our shares.

Wells Capital and its affiliates will perform services for us in connection with the offer and sale of our shares, the selection and acquisition of our investments, the management and leasing of our properties and the administration of our other investments. We will pay them substantial up-front fees for some of these services, which will result in immediate dilution to the value of your investment and will reduce the amount of cash available for investment in properties or distribution to stockholders. Largely as a result of these substantial fees, we expect that, for each share sold in our primary offering of up to 300.0 million shares of common stock, no more than $8.71 will be available for the purchase of real estate, depending primarily upon the number of shares we sell.

We will also pay significant fees to Wells Capital and its affiliates during our operational stage. Those fees include obligations to reimburse Wells Capital and its affiliates for expenses they incur in connection with their providing services to us, including certain personnel services. There is a risk that those reimbursement obligations could increase following the recently completed Wells REIT internalization transaction. Our advisor and our property manager previously allocated certain of their personnel and other expenses between Wells REIT and us. Following the Wells REIT internalization transaction, there will be expenses of our advisor and our property manager that can no longer be shared between Wells REIT and us, and those expenses may be higher than our allocable share of those expenses before the internalization transaction.

We may also pay significant fees during our listing/liquidation stage. Although most of the fees payable during our listing/liquidation stage are contingent on our investors first enjoying agreed-upon investment returns, affiliates of Wells Capital could also receive significant payments even without our reaching the investment return thresholds should we seek to become self-managed. Due to the public market’s preference for self-managed companies, a decision to list our shares on a national securities exchange might well be preceded by a decision to become self-managed. And given our advisor’s familiarity with our assets and operations, we might prefer to become self-managed by acquiring entities affiliated with our advisor. Such an internalization transaction could result in significant payments to affiliates of our advisor irrespective of whether investors enjoyed the returns on which we have conditioned other back-end incentive compensation.

These fees and other potential payments increase the risk that the amount available for distribution to common stockholders upon a liquidation of our portfolio would be less than the purchase price of the shares in this offering. Substantial consideration paid to our advisor and its affiliates also increases the risk that investors will not be able to resell their shares at a profit, even if our shares are listed on a national securities exchange.

ITEM 2.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a)

On September 12, 2007, we issued options to purchase 5,000 shares of common stock at an exercise price of $12.00 per share to our independent directors under our Independent Director Stock Option Plan. These options were issued pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933. All equity securities sold by us in the quarter ended March 31,September 30, 2007 were sold in an offering registered under the Securities Actact of 1933.

 

(b)

Not applicable.

(c)

During the quarter ended March 31,September 30, 2007, we redeemed shares as follows (in thousands, except per-share amounts):

 

Period

  Total Number of
Shares Redeemed(1)
  Average Price
Paid per Share
  

Approximate Dollar Value of Shares

Available That May Yet Be
Redeemed Under the Program

January 2007

  414  $9.50  (2)

February 2007

  319  $9.43  (2)

March 2007

  517  $9.50  (2)

Period

  Total Number of
Shares Redeemed (1)
  Average Price
Paid per Share
  

Approximate Dollar

Value of Shares Available
That May Yet Be Redeemed
Under the Program

July 2007

  518  $9.53  (2)

August 2007

  627  $9.42  (2)

September 2007

  426  $9.45  (2)

(1)

We announced the commencement of the program on December 10, 2003 and amendments to the program on April 22, 2004; March 28, 2006; May 11, 2006; August 10, 2006; and August 10, 2006.8, 2007.

(2)

We currentlyEffective September 7, 2007 we limit redemptions under the share redemption program as follows: We will not make “Ordinary Redemptions” (those that do not occur within two years of death or qualifying disability) until one year after the issuance of the shares to be redeemed. We will not redeem shares on any redemption date to the extent that such redemptions would cause the amount paid for Ordinary Redemptions since the beginning of the then-current calendar year to exceed 50% of the net proceeds from the sale of shares under our dividend reinvestment plan during such period. We will limit Ordinary Redemptions and those upon the qualifying disability of a stockholder so that the aggregate of such redemptions during any calendar year do not exceed 100% of the net proceeds from our dividend reinvestment plan during the calendar year or 5% of the weighted-average number of shares outstanding in the prior calendar year. Although thereWe will honor all redemption requests if the request is no limit under the SRP on the numbermade within two years of shares we may redeem upon the death of stockholders, we are under no obligation to redeem such shares to the extent such redemptions would cause total redemptions to exceed the two limits set forth immediately above. See our Annual Report on Form 10-K for the year ended December 31, 2006 for additional discussion of the share redemption program.a stockholder’s death.

 

ITEM 3.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

 

(a)

There have been no defaults with respect to any of our indebtedness.

 

(b)

Not applicable.

 

ITEM 4.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our stockholders during the first quarter of 2007.

(a)

On September 12, 2007, we held our annual meeting of stockholders at The Atlanta Athletic Club in Duluth, Georgia.

 

(b)

Our stockholders elected the following individuals to the board of directors: Leo Wells, III; Douglas Williams; Charles Brown; Richard Carpenter; Bud Carter; Nelson Mills; and Neil Strickland.

(c)

The above matter was approved by our stockholders at the annual meeting by the casting of the following votes:

Name

  Votes For  Votes Withheld

Leo Wells, III

  165,642,230  1,990,184

Douglas Williams

  165,747,603  1,884,811

Charles Brown

  165,676,701  1,955,713

Richard Carpenter

  165,686,293  1,946,121

Bud Carter

  165,666,431  1,965,983

Nelson Mills

  165,706,684  1,925,730

Neil Strickland

  165,606,420  2,025,994

ITEM 5.

ITEM 5.

OTHER INFORMATION

 

(a)

During the firstthird quarter of 2007, there was no information that was required to be disclosed in a report on Form 8-K that was not disclosed in a report on Form 8-K.

(b)

There are no material changes to the procedures by which stockholders may recommend nominees to our board of directors since the filing of our Schedule 14A.

 

ITEM 6.

EXHIBITSITEM 6.

EXHIBITS

The exhibits required to be filed with this report are set forth on the Exhibit Index to this quarterly report attached hereto.

SIGNATURES

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

 

  

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

(Registrant)

Dated: May 9,November 7, 2007

  

By:

 

/s/ DOUGLAS P. WILLIAMS

   

Douglas P. Williams

Executive Vice President, Treasurer and

Principal Financial Officer

EXHIBIT INDEX TO

FIRSTTHIRD QUARTER 2007 FORM 10-Q OF

WELLS REAL ESTATE INVESTMENT TRUST II, INC.

The following documents are filed as exhibits to this report. Exhibits that are not required for this report are omitted.

 

Exhibit No.

  

Description

  3.1  

Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to Amendment No. 3 to the Registration Statement on Form S-11 (No. 333-107066) filed with the Commission on November 25, 2003 (the “IPO Registration Statement”))

  3.2  

Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the IPO Registration Statement)Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)

  3.3

Amendment No. 1 to Amended and Restated Bylaws (incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)

  4.1  

Form of Subscription Agreement with Consent to Electronic Delivery (incorporated by reference to Appendix A to the Prospectus included in Amendment No. 1 to the Registration Statement on Form S-11 (No. 333-125643) filed with the Commission on October 19, 2005 (the “Follow-on Registration Statement”))

  4.2  

Statement regarding restrictions on transferability of shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates) (incorporated by reference to Exhibit 4.2 to the IPO Registration Statement)

  4.3  

Amended and Restated Dividend Reinvestment Plan (incorporated by reference to Appendix B to the Prospectus included in the Follow-on Registration Statement)

  4.4  

Description of Share Redemption Program (incorporated by reference to Exhibit 4.4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006)2007)

10.1

Advisory Agreement between the Company and Wells Capital, Inc. dated October 31, 2007.

31.1  

Certification of the Chief Executive Officer of the Company, pursuant to Securities Exchange Act Rules 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2  

Certification of the Chief Financial Officer of the Company, pursuant to Securities Exchange Act Rules 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1  

Certification of the Chief Executive Officer and Chief Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002