UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549 

FORM 10-Q

(Mark One)

 

 

GLADSTONE COMMERCIAL CORPORATION

FORM 10-Q FOR THE QUARTER ENDED

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Gladstone Commercial Corporation

Condensed Consolidated Balance Sheets

(Dollars in Thousands, Except Share and Per Share Data)

(Unaudited) 

Gladstone Commercial Corporation

Condensed Consolidated Statements of Operations and Other Comprehensive Income (Loss)

(Dollars in Thousands, Except Share and Per Share Data)

(Unaudited) 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

Gladstone Commercial Corporation

Condensed Consolidated Statements of Cash Flows

(Dollars in Thousands)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

Gladstone Commercial Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

Gladstone Commercial Corporation is a real estate investment trust (“REIT”) that was incorporated under the General Corporation Law of the State of Maryland on February 14, 2003. We focus on acquiring, owning and managing primarily office and industrial properties. On a selective basis, we may make long term industrial and commercial mortgage loans; however, we do not have any mortgage loans currently outstanding. Subject to certain restrictions and limitations, our business is managed by Gladstone Management Corporation, a Delaware corporation or the Adviser,("Adviser"), and administrative services are provided by Gladstone Administration, LLC, a Delaware limited liability company or the Administrator,("Administrator"), each pursuant to a contractual arrangement with us. Our Adviser and Administrator collectively employ all of our personnel and pay their salaries, benefits, and general expenses directly. Gladstone Commercial Corporation conducts substantially all of its operations through a subsidiary, Gladstone Commercial Limited Partnership, a Delaware limited partnership, or the Operating Partnership.

All further references herein to “we,” “our,” and “us” mean Gladstone Commercial Corporation and its consolidated subsidiaries, except where it is made clear that the term means only Gladstone Commercial Corporation.

Our interim financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and pursuant to the requirements for reporting on Form 10-Q and in accordance with Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. The year-end balance sheet data presented herein was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of our management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair statement of financial statements for the interim period, have been included. The interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the U.S. Securities and Exchange Commission on February 15, 2017. The results of operations for the three and sixnine months ended JuneSeptember 30, 2017 are not necessarily indicative of the results that may be expected for other interim periods or for the full fiscal year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could materially differ from those estimates.

In preparation of our financial statements in accordance with GAAP, we apply certain critical accounting policies which require management to make judgments that are subjective in nature to make certain estimates and assumptions. Application of our accounting policies involves the exercise of judgment regarding the use of assumptions as to future uncertainties, and as a result, actual results could materially differ from these estimates. A summary of all of our significant accounting policies is provided in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016. There were no material changes to our critical accounting policies during the sixthree and nine months ended JuneSeptember 30, 2017.

Certain items on condensed consolidated statement of operations and other comprehensive income (loss) for the three and sixnine months ended JuneSeptember 30, 2016 have been reclassified to conform to the current period's presentation. These reclassifications had no impact on previously-reported equity, net loss attributable to common stockholders, or net change in cash and cash equivalents.

In May 2014, the FASB issued Accounting Standards Update 2014-09, “Revenueguidance regarding the recognition of revenue from Contractscontracts with Customers” (“ASU 2014-09”),customers. Under this guidance, an entity will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which was amendedthe entity expects to be entitled in March 2016 by FASB Accounting Standards Update 2016-08, “Principal versus Agent Considerations” (“ASU 2016-08”), in April 2016 by FASB Accounting Standards Update 2016-10, “Identifying Performance Obligationsexchange for those goods or services. This guidance also requires improved disclosures regarding the nature, amount, timing and Licensing” (“ASU 2016-10”), in May 2016 by FASB Accounting Standards Update 2016-12, “Narrow-Scope Improvementsuncertainty of revenue and Practical Expedients” (“ASU 2016-12”), and in December 2016 by FASB Accounting Standards Update 2016-20, “Technical Corrections and Improvements to Topic 606” (“ASU 2016-20”). ASU 2014-09, as amended, supersedes or replaces nearly all GAAPcash flows arising from contracts with customers. We expect the new revenue recognition guidance. The new guidance establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time and will expand disclosures about revenue. We do not believe this standard will have a material impact on our resultsapply to executory costs and other components of operations or financial condition, primarily because the leasing impact of this update is primarily relatedrevenue due under leases that are deemed to be non-lease components (examples include common area maintenance and other material tenant reimbursements. A majorityprovision of our properties are accountedutilities), even when the revenue for such activities is not separately stipulated in the lease. Revenue from these non-lease components, which were previously recognized on a netstraight-line basis andunder current lease guidance, would be recognized under the new revenue guidance as the related services are delivered. As a result, while the total revenue recognized over the lease term would not impacted by tenant recoveries from common area maintenance. In July 2015,differ under the FASB issued Accounting Standards Update 2015-14, “Deferralnew guidance, the revenue recognition pattern could be different. We are in the process of evaluating the significance of the Effective Date,”difference in the revenue recognition pattern that would result from this change, and adjustments in revenue recognition attributable to non-lease components will take effect in tandem with the new leasing standard described below, which deferred theis effective date of ASU 2014-09. ASU 2014-09, as amended by ASU 2015-14, ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20, is now effectiveJanuary 1, 2019. We will adopt this guidance for our annual reporting periods beginning after December 15, 2017 and interim periods within those years, with early adoption permitted for annual reporting periods beginning after December 15, 2016January 1, 2018 and interim periods within those years.expect to use the modified retrospective method, under which the cumulative effect of initially applying the guidance is recognized at the date of initial application.

In February 2016, the FASB issued ASU 2016-02, “Leases: Amendments to the FASB Accounting Standards Codification” (“ASU 2016-02”). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. ASU 2016-02 is expected to minimally impact our consolidated financial statements as we currently have four operating ground lease arrangements with terms greater than one year for which we are the lessee.lessee, and we don't expect the purchase of properties with ground leases to be crucial to our acquisition strategy. We also expect our general and administrative expense to increase as the new standard requires us to expense indirect leasing costs that were previously capitalized to leasing commissions. ASC 2016-02 supersedes the previous leases standard, ASC 840 "Leases." The standard is effective on January 1, 2019, with early adoption permitted and we expect to use the modified retrospective method, under which the cumulative effect of initially applying the guidance is recognized at the date of initial application.

In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging issues Task Force)," which clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows with the objective of reducing the existing diversity in practice related to eight specific cash flow issues. The areas addressed in the new guidance relate to debt prepayment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned and bank-owned life insurance policies, distributions received from equity method investments, beneficial interest in securitization transactions and separately identifiable cash flows and application of the predominance principle. The guidance is effective for us beginning January 1, 2018 with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

We are externally managed pursuant to contractual arrangements with our Adviser and our Administrator, which collectively employ all of our personnel and pay their salaries, benefits, and general expenses directly. Both our Adviser and Administrator are affiliates of ours, as their parent company is owned and controlled by Mr. David Gladstone, our chairman and chief executive officer. Two of our executive officers, Mr. Gladstone and Mr. Terry Brubaker (our vice chairman and chief operating officer) serve as directors and executive officers of our Adviser and our Administrator. Our president, Mr. Robert Cutlip, is an executive managing director of our Adviser. Mr. Michael LiCalsi, our general counsel and secretary, serves as our Administrator’s president, general counsel and secretary. We have entered into an advisory agreement with our Adviser, as amended from time to time, or the Advisory Agreement, and an administration agreement with our Administrator, or the Administration Agreement. The services and fees under the Advisory Agreement and Administration Agreement are described below. As of JuneSeptember 30, 2017 and December 31, 2016, $2.1$2.3 million and $2.1 million, respectively, waswere collectively due to our Adviser and Administrator.

On July 24, 2015, we entered into a Second Amended and Restated Advisory Agreement with the Adviser, effective July 1, 2015. We subsequently entered into a Third Amended and Restated Advisory Agreement with the Adviser on July 12, 2016, effective July 1, 2016, and, as described below, a Fourth Amended and Restated Investment Advisory Agreement with the Adviser on January 10, 2017, effective October 1, 2016. Our entrance into each of the amended Advisory Agreements was approved unanimously by our Board of Directors. Our Board of Directors reviews and considers renewing the agreement with our Adviser each July. As such, during the July 2017 meeting, the Board of Directors reviewed and renewed the Advisory Agreement for another year, through August 31, 2018.

As a result of the July 2015 amendment, the calculation of the annual base management fee equals 1.5% of our adjusted total stockholders’ equity, which is our total stockholders’ equity (before giving effect to the base management fee and incentive fee), adjusted to exclude the effect of any unrealized gains or losses that do not affect realized net income (including impairment charges) and adjusted for any one-time events and certain non-cash items (the later to occur for a given quarter only upon the approval of our Compensation Committee). The fee is calculated and accrued quarterly as 0.375% per quarter of such adjusted total stockholders’ equity figure. As a result of the July 2016 amendment, the definition of adjusted total stockholders' equity in the calculation of the base management fee and the incentive fee (described below) includes total mezzanine equity. Our Adviser does not charge acquisition or disposition fees when we acquire or dispose of properties, as is common in other externally managed REITs; however, our Adviser may earn fee income from our borrowers, tenants or other sources. Prior to the 2015 amendment, the Advisory Agreement provided for an annual base management fee equal to 2.0% of our common stockholders’ equity, which was our total stockholders’ equity, less the recorded value of any preferred stock and adjusted to exclude the effect of any unrealized gains, losses, or other items that did not affect realized net income (including impairment charges).

For the three and sixnine months ended JuneSeptember 30, 2017, we recorded a base management fee of $1.2$1.3 million and $2.4$3.7 million, respectively. For the three and sixnine months ended JuneSeptember 30, 2016, we recorded a base management fee of $0.9$1.1 million and $1.7$2.8 million, respectively.

As a result of the July 2015 amendment, the calculation of the incentive fee was revised to reward the Adviser in circumstances where our quarterly Core FFO (defined at the end of this paragraph), before giving effect to any incentive fee, or pre-incentive fee Core FFO, exceeds 2.0% quarterly, or 8.0% annualized, of adjusted total stockholders’ equity (after giving effect to the base management fee but before giving effect to the incentive fee, and which, as a result of the July 2016 amendment to the Advisory Agreement, now includes total mezzanine equity). We refer to this as the new hurdle rate. The Adviser will receive 15.0% of the amount of our pre-incentive fee Core FFO that exceeds the new hurdle rate. However, in no event shall the incentive fee for a particular quarter exceed by 15.0% (the cap) the average quarterly incentive fee paid by us for the previous four quarters (excluding quarters for which no incentive fee was paid). Core FFO (as defined in the Advisory Agreement) is GAAP net income (loss) available to common stockholders, excluding the incentive fee, depreciation and amortization, any realized and unrealized gains, losses or other non-cash items recorded in net income (loss) available to common stockholders for the period, and one-time events pursuant to changes in GAAP.

The incentive fee prior to the July 2015 amendment rewarded the Adviser in circumstances where our quarterly funds from operations, or FFO, before giving effect to any incentive fee, or pre-incentive fee FFO, exceeded 1.75%, or 7.0% annualized, or the hurdle rate, of common stockholders’ equity. FFO, included any realized capital gains and capital losses, less any distributions paid on preferred stock and Senior Common Stock, but FFO did not include any unrealized capital gains or losses (including impairment charges). The Adviser received 100.0% of the amount of the pre-incentive fee FFO that exceeded the hurdle rate, but was less than 2.1875% of our common stockholders’ equity. The Adviser also received an incentive fee of 20.0% of the amount of our pre-incentive fee FFO that exceeded 2.1875% of common stockholders’ equity.

For the three and sixnine months ended JuneSeptember 30, 2017, we recorded an incentive fee of $0.6 million and $1.1$1.8 million, respectively. For the three and sixnine months ended JuneSeptember 30, 2016, we recorded an incentive fee of $0.7$0.6 million and $1.3$1.8 million, respectively. The Adviser did not waive any portion of the incentive fee for the three and sixnine months ended JuneSeptember 30, 2017 or 2016, respectively.2016. Waivers are unconditional and cannot be recouped by the Adviser in the future.

Under the Advisory Agreement, as amended in July 2015, we will pay to the Adviser a capital gains-based incentive fee that will be calculated and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement). In determining the capital gain fee, we will calculate aggregate realized capital gains and aggregate realized capital losses for the applicable time period. For this purpose, aggregate realized capital gains and losses, if any, equals the realized gain or loss calculated by the difference between the sales price of the property, less any costs to sell the property and the current gross value of the property (which is calculated as the original acquisition price plus any subsequent non-reimbursed capital improvements). At the end of the fiscal year, if this number is positive, then the capital gain fee payable for such time period shall equal 15.0% of such amount. No capital gain fee was recognized during the three and sixnine months ended JuneSeptember 30, 2017 or 2016.

On January 10, 2017, we amended and restated the Advisory Agreement by entering into the Fourth Amended and Restated Investment Advisory Agreement between us and the Adviser to revise the calculation of the capital gains fee. Based upon the amendment, the calculation of the capital gains fee is based on the all-in acquisition cost of disposed of properties. The impact of this amendment would not have resulted in a capital gains fee for previously reported periods.

As a result of the July 2015 amendment, theThe Advisory Agreement includes a termination fee whereby, in the event of our termination thereof without cause (with 120 days’ prior written notice and the vote of at least two-thirds of our independent directors), a termination fee would be payable to the Adviser equal to two times the sum of the average annual base management fee and incentive fee earned by the Adviser during the 24-month period prior to such termination. A termination fee is also payable if the Adviser terminates the Advisory Agreement after we have defaulted and applicable cure periods have expired. The Advisory Agreement may also be terminated for cause by us (with 30 days’ prior written notice and the vote of at least two-thirds of our independent directors), with no termination fee payable. Cause is defined in the agreement to include if the Adviser breaches any material provisions thereof, the bankruptcy or insolvency of the Adviser, dissolution of the Adviser and fraud or misappropriation of funds.

Under the terms of the Administration Agreement, we pay separately for our allocable portion of the Administrator’s overhead expenses in performing its obligations to us including, but not limited to, rent and our allocable portion of the salaries and benefits expenses of our Administrator’s employees, including, but not limited to, our chief financial officer, treasurer, chief compliance officer, general counsel and secretary (who also serves as our Administrator’s president, general counsel and secretary), and their respective staffs. Our allocable portion of the Administrator’s expenses are generally derived by multiplying our Administrator’s total expenses by the approximate percentage of time the Administrator's employees perform services for us in relation to their time spent performing services for all companies serviced by our Administrator under contractual agreements. For the three and sixnine months ended JuneSeptember 30, 2017, we recorded an administration fee of $0.3 million and $0.7$1.0 million, respectively, and for the three and sixnine months ended JuneSeptember 30, 2016, we recorded an administration fee of $0.4$0.3 million and $0.8$1.1 million, respectively.

Gladstone Securities, LLC, or Gladstone Securities, is a privately held broker dealer registered with the Financial Industry Regulatory Authority and insured by the Securities Investor Protection Corporation. Gladstone Securities is an affiliate of ours, as its parent company is owned and controlled by Mr. David Gladstone, our chairman and chief executive officer. Mr. Gladstone also serves on the board of managers of Gladstone Securities.

We entered into an agreement with Gladstone Securities, effective June 18, 2013, for it to act as our non-exclusive agent to assist us with arranging mortgage financing for properties we own. In connection with this engagement, Gladstone Securities will, from time to time, continue to solicit the interest of various commercial real estate lenders or recommend to us third party lenders offering credit products or packages that are responsive to our needs. We pay Gladstone Securities a financing fee in connection with the services it provides to us for securing mortgage financing on any of our properties. The amount of these financing fees, which are payable upon closing of the financing, are based on a percentage of the amount of the mortgage, generally ranging from 0.15% to a maximum of 1.0% of the mortgage obtained. The amount of the financing fees may be reduced or eliminated, as determined by us and Gladstone Securities, after taking into consideration various factors, including, but not limited to, the involvement of any third party brokers and market conditions. We paid financing fees to Gladstone Securities of $0.06$0.1 million and $0.2 million during both the three and sixnine months ended JuneSeptember 30, 2017, respectively, which are included in mortgage notes payable, net, in the consolidated balance sheets, or 0.31%0.25% and 0.27%, respectively, of mortgage principal secured. We paid financing fees to Gladstone Securities of $0.07$0.1 million and $0.15$0.2 million during the three and sixnine months ended JuneSeptember 30, 2016, respectively, which are included in mortgage notes payable, net, in the condensed consolidated balance sheets, or 0.35%0.28% and 0.39%0.36%, respectively, of mortgage principal secured. Our Board of Directors renewed the agreement for an additional year, through August 31, 2018, at its July 2017 meeting.

The following tables set forth the computation of basic and diluted loss per share of common stock for the three and sixnine months ended JuneSeptember 30, 2017 and 2016. We computed basic loss per share for the three and sixnine months ended JuneSeptember 30, 2017 and 2016 using the weighted average number of shares outstanding during the periods. Diluted loss per share for the three and sixnine months ended JuneSeptember 30, 2017 and 2016, reflects additional shares of common stock, related to our convertible Senior Common Stock (if the effect would be dilutive), that would have been outstanding if dilutive potential shares of common stock had been issued, as well as an adjustment to net income available to common stockholders as applicable to common stockholders that would result from their assumed issuance (dollars in thousands, except per share amounts).

 

The following table sets forth the components of our investments in real estate as of JuneSeptember 30, 2017 and December 31, 2016 excluding real estate held for sale as of June 30, 2017 and December 31, 2016 (dollars in thousands):

 

Real estate depreciation expense on building and tenant improvements was $6.4$6.9 million and $12.8$19.8 million for the three and sixnine months ended JuneSeptember 30, 2017, respectively, and $5.9$6.1 million and $11.8$17.9 million for the three and sixnine months ended JuneSeptember 30, 2016, respectively.

Acquisitions

Acquisitions during the sixnine months ended JuneSeptember 30, 2016 were accounted for as business combinations in accordance with Accounting Standards Codification (“ASC”) 805 “Business Combinations” (“ASC 805”), as there was a prior leasing history on the property. The fair value of all assets acquired and liabilities assumed were determined in accordance with ASC 805, and all acquisition-related costs were expensed as incurred. Commencing in the fourth quarter of 2016, we early adopted Accounting Standards Update (“ASU”) 2017-01, “Clarifying the Definition of a Business” (“ASU 2017-01”), which narrows the scope of transactions that would be accounted under ASC 805. Under ASU 2017-01, if substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the grouping is not a business, and rather an asset acquisition. Beginning in the fourth quarter 2016, acquisitions have been deemed an asset acquisition when evaluated under the new guidance, and all acquisition-related costs have been capitalized.

We determined the fair value of assets acquired and liabilities assumed related to the properties acquired during the sixnine months ended JuneSeptember 30, 2017 and 2016 as follows (dollars in thousands):

Below is a summary of the total revenue and earnings (loss)loss recognized on the one asset acquisitiontwo acquisitions treated as a business combinationcombinations completed during the sixnine months ended JuneSeptember 30, 2016 (dollars in thousands):

 

The following table reflects pro-forma consolidated statements of operations as if the business combinations completed through June 30, 2017, were completed as of January 1, 2016, and the business combinations completed in 2016, were completed as of January 1, 2015. The pro-forma earnings for the three and sixnine months ended JuneSeptember 30, 2017 and 2016 were adjusted to assume that the acquisition-related costs were incurred as of the beginning of the comparative period (dollars in thousands, except per share amounts):

During the sixnine months ended JuneSeptember 30, 2017 and 2016, we executed onesix and threeseven lease extensions and/or modifications, or new leases, respectively, which are aggregated below (dollars in thousands):

The following table summarizes the carrying value of intangible assets, liabilities and the accumulated amortization for each intangible asset and liability class as of JuneSeptember 30, 2017 and December 31, 2016, excluding real estate held for sale as of June 30, 2017 and December 31, 2016 (in(dollars in thousands):

Total amortization expense related to in-place leases, leasing costs and customer relationship lease intangible assets was $3.5$3.9 million and $7.0$10.9 million for the three and sixnine months ended JuneSeptember 30, 2017, respectively, and $3.3$3.4 million and $6.6$9.9 million for the three and sixnine months ended JuneSeptember 30, 2016, respectively, and is included in depreciation and amortization expense in the condensed consolidated statementstatements of operations.operations and other comprehensive income (loss).

Total amortization related to above-market lease values was $0.1$0.2 million and $0.3$0.4 million for the three and sixnine months ended JuneSeptember 30, 2017, respectively, and $0.1 million and $0.2$0.4 million for the three and sixnine months ended JuneSeptember 30, 2016, respectively, and is included in rental revenue in the condensed consolidated statementstatements of operations.operations and other comprehensive income (loss). Total amortization related to below-market lease values was $0.4 million and $1.1 million for the three and nine months ended September 30, 2017, respectively, and $0.3 million and $0.7 million for the three and sixnine months ended June 30, 2017, respectively, and $0.2 million and $0.5 million for the three and six months ended JuneSeptember 30, 2016, respectively, and is included in rental revenue in the condensed consolidated statementstatements of operations.operations and other comprehensive income (loss).

The weighted average amortization periods in years for the intangible assets acquired and liabilities assumed during the sixnine months ended JuneSeptember 30, 2017 and 2016 were as follows:

 

During the sixnine months ended JuneSeptember 30, 2017, we continued to execute our capital recycling program, whereby we sold properties outside of our core markets and redeployed proceeds to fund property acquisitions in our target secondary growth markets, as well as repay outstanding debt. During the sixnine months ended JuneSeptember 30, 2017, we sold threefour non-core properties located in Franklin, New Jersey, Hazelwood, Missouri, and Concord Township, Ohio, and Newburyport, Massachusetts, which are summarized below (dollars in thousands):

Our dispositions during the sixnine months ended JuneSeptember 30, 2017 were not classified as discontinued operations because they did not represent a strategic shift in operations, nor will they have a major effect on our operations and financial results. Accordingly, the operating results of these properties are included within continuing operations for all periods reported.

The table below summarizes the components of operating income from the real estate and related assets disposed of during the three and sixnine months ended JuneSeptember 30, 2017, and 2016 (dollars in thousands):

During the three and six months ended JuneAt September 30, 2017, we did not have any properties classified one property located in Newburyport, Massachusetts as held for sale. We considered the property to be non-core to our long term strategy. The property is under contract to sell, andAt December 31, 2016, we anticipate completing the sale in the third quarter of 2017. This property was previously impaired during the three months ended March 31, 2017, and was further impaired by $0.3 million during the three months ended June 30, 2017 when the property met the held for sale classification, and we adjusted the carrying value to equal the sales price less estimated selling costs. The assets and liabilities of the propertyhad two properties classified as held for sale, are presented separatelylocated in our condensed consolidated balance sheets asHazelwood, Missouri and Franklin, New Jersey. Both of June 30, 2017.

The table below summarizes the components of the assets and liabilities held for sale reflected on the accompanying condensed consolidated balance sheet (dollars in thousands):

 

We performed an evaluation and analysis ofevaluated our entire portfolio for triggering events to determine if any of our held and used assets were impaired during the sixnine months ended JuneSeptember 30, 2017 and identified two held and used assets which were impaired during first quarter 2017, and2017. We did not identify any impairment on held and used assets during the second or third quarter of 2017. For these properties, during first quarter 2017, we received unsolicited interest from potential buyers, and as a result, we included a sale scenario and shortened our hold period when comparing the undiscounted cash flows against the respective carrying values. Based upon our analysis, we concluded that the undiscounted cash flows for these properties were below their respective carrying values indicating that these assets were impaired as of March 31, 2017, and accordingly, we recorded an impairment charge of $3.7 million during the three months ended March 31, 2017. During the three months ended June 30, 2017, we sold one of these impaired properties to the tenant for a further loss on sale of $1.8 million. During the second quarter of 2017, we became aware of a decline in the tenant's financial results. The tenant expressed interest in acquiring our property as part of their corporate reorganization. Due to the re-tenanting risk of the property if it were to go vacant and as the location was in a non-core market, we executed a sale with this tenant.We executed a sales contract fortenant. We sold the other impaired property and accordingly classified the property as held for sale during the three months ended June 30, 2017. Prior to the three months ended JuneSeptember 30, 2017, we had received an unsolicited offer to sell this property, and management concludedrecognizing a gain on sale was the appropriate course of action subsequent to March 31, 2017.$1,000.

As part of ourWe did not classify any properties as held for sale process,at September 30, 2017. During our previous two quarters where we performhad held for sale activity, we performed an analysis of all properties classified as held for sale, during the three and six months ended June 30, 2017, and comparecompared the fair market value of the asset less selling costs against the carrying value of assets available for sale. We classified one property as held for sale as we executed a purchase and sale agreement and expect the property to sell during the third quarter of 2017. We recorded an additional impairment charge of $0.3 million during the three months ended June 30, 2017 to reduce the carrying value equal to the sales price per the executed purchase and sale agreement, less estimated selling costs.

Fair market value for these assets was calculated using Level 3 inputs, which were determined using comparable asset sale data from the respective asset locations, as well as sales prices from an executed purchase and sale agreement. We continue to evaluate our properties on a quarterly basis for changes that could create the need to record impairment. Future impairment losses may result, and could be significant, should market conditions deteriorate in the markets in which we hold our assets or we are unable to secure leases at terms that are favorable to us, which could impact the estimated cash flow of our properties over the period in which we plan to hold our properties. Additionally, changes in management’s decisions to either own and lease long-term or sell a particular asset will have an impact on this analysis.

We recognized $0.2$2.0 million of impairment charges on threefive properties during the sixnine months ended JuneSeptember 30, 2016. These properties were classified as held for sale during the three and six months ended June 30, 2016, andimpaired through our held for sale carrying value analysis, during the three and nine months ended September 30, 2016, and we concluded that the fair market value less selling costs was below the carrying value of this property. We have sold four of these properties, and one of these properties is classified as a held and used asset during the three and nine months ended September 30, 2017.

The fair values for the above held for sale property was calculated using Level 3 inputs which were calculated using an estimated sales price, less estimated costs to sell. The estimated sales price was determined using an executed purchase and sale agreement.

On July 25, 2014, we closed a $5.6 million second mortgage development loan for the construction of an 81,371 square foot, build-to-suit transitional care facility located on a major hospital campus in Phoenix, Arizona. Subsequently, on April 14, 2015, we closed an additional $0.3 million interim financing loan for the development of the Phoenix, Arizona property. Construction was completed in July 2015 and we earned 9.0% interest, paid currently in cash, on the loan during construction and through maturity. Prior to completion of the facility, we were granted a right of first offer to purchase the property at fair value. We elected not to purchase the property, and received an exit fee upon maturity of the loan in an amount sufficient for us to earn an internal rate of return of 22.0% on the second mortgage development loan, inclusive of interest earned. The principal balance of the loans and all associated interest income and exit fee revenue was received in January 2016. We recognized nodid not recognize any interest income or exit fee revenue during the three and sixnine months ended JuneSeptember 30, 2017. We recognized $0.0 million and $0.4 million in both cash interest income and exit fee revenue during the three and sixnine months ended JuneSeptember 30, 2016, respectively. We currently have no mortgage notes receivable outstanding.

Our mortgage notes payable and Credit Facility as of JuneSeptember 30, 2017 and December 31, 2016 are summarized below (dollars in thousands):

 

 

N/A - Not Applicable

As of JuneSeptember 30, 2017, we had 4445 mortgage notes payable, collateralized by a total of 6667 properties with a net book value of $625.6$674.9 million. We have limited recourse liabilities that could result from any one or more of the following circumstances: a borrower voluntarily filing for bankruptcy, improper conveyance of a property, fraud or material misrepresentation, misapplication or misappropriation of rents, security deposits, insurance proceeds or condemnation proceeds, or physical waste or damage to the property resulting from a borrower’s gross negligence or willful misconduct. We have full recourse for $11.7 million of the mortgages notes payable outstanding, or 2.8%2.6% of the outstanding balance. We will also indemnify lenders against claims resulting from the presence of hazardous substances or activity involving hazardous substances in violation of environmental laws on a property. 

During the sixnine months ended JuneSeptember 30, 2017, we repaid 3four mortgages, collateralized by 7ten properties, which are aggregated below (dollars in thousands):

 

During the sixnine months ended JuneSeptember 30, 2017, we issued or assumed 2four mortgages, collateralized by 3seven properties, and drew an additional advance on an existing mortgage note, collateralized by one property, which are aggregated in the table below (dollars in thousands):

We made payments of $0.4 million for deferred financing costs during both the three and six months ended June 30, 2017. We made payments of $0.3$0.6 million and $0.7$1.0 million for deferred financing costs during the three and sixnine months ended JuneSeptember 30, 2017, respectively. We made payments of $0.4 million and $1.0 million for deferred financing costs during the three and nine months ended September 30, 2016, respectively.

Scheduled principal payments of mortgage notes payable for the remainder of 2017, and each of the five succeeding fiscal years and thereafter are as follows (dollars in thousands):

 

We have entered into interest rate cap agreements that cap the interest rate on certain of our variable-rate debt and we have assumed an interest rate swap agreement in which we hedged our exposure to variable interest rates by agreeing to pay fixed interest rates to our counterparty. We have adopted the fair value measurement provisions for our financial instruments recorded at fair value. The fair value guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Generally, we will estimate the fair value of our interest rate caps and interest rate swap, in the absence of observable market data, using estimates of value including estimated remaining life, counterparty credit risk, current market yield and interest rate spreads of similar securities as of the measurement date. At JuneSeptember 30, 2017 and December 31, 2016, our interest rate cap agreements and interest rate swap were valued using Level 2 inputs.

The fair value of the interest rate cap agreements is recorded in other assets on our accompanying condensed consolidated balance sheets. We record changes in the fair value of the interest rate cap agreements quarterly based on the current market valuations at quarter end as interest expense on our accompanying condensed consolidated statements of operations.operations and other comprehensive income (loss). The following table summarizes the interest rate caps at JuneSeptember 30, 2017 and December 31, 2016 (dollars in thousands):

 

We assumed an interest rate swap agreement in connection with our June 22, 2017 acquisition, whereby we will pay our counterparty an interest rate equivalent to 1.80% on a monthly basis, and receive payments from our counterparty equivalent to one month LIBOR. The fair value of our interest rate swap agreement is recorded in other assets on our accompanying condensed consolidated balance sheets. We have designated our interest rate swap as a cash flow hedge, and we record changes in the fair value of the interest rate swap agreement to accumulated other comprehensive income on the condensed consolidated balance sheet. We record changes in fair value on a quarterly basis, using current market valuations at quarter end. We assumed our interest rate swap with a value of $0.04 million on the date of assumption, and the fair market value increased to $0.2 million at JuneSeptember 30, 2017. The swap has a notional value equal to the debt we assumed of $11.2 million, and has a termination date of April 1, 2026, which is also the maturity date of the assumed debt.

The fair value of all mortgage notes payable outstanding as of JuneSeptember 30, 2017 was $428.2$461.8 million, as compared to the carrying value stated above of $427.5$455.4 million. The fair value is calculated based on a discounted cash flow analysis, using management’s estimate of market interest rates on long-term debt with comparable terms and loan to value ratios. The fair value was calculated using Level 3 inputs of the hierarchy established by ASC 820, “Fair Value Measurements and Disclosures.”

In August 2013, we procured a senior unsecured revolving credit facility, or the Revolver, with KeyBank National Association (“KeyBank”) (serving as a lender, a letter of credit issuer and an administrative agent). On October 5, 2015, we expanded our Revolver to $85.0 million, extended the maturity date one year through August 2018, with a one-year extension option through August 2019. We also added a $25.0 million term loan facility, or the Term Loan, which matures in October 2020. The Revolver and the Term Loan are referred to collectively herein as the Credit Facility. The interest rate on the Revolver was also reduced by 25 basis points at each of the leverage tiers and the total maximum commitment under the Credit Facility was increased from $100.0 million to $150.0 million. We also added 3three new lenders to the bank syndicate, which is now comprised of KeyBank, Comerica Bank, Fifth Third Bank, US Bank and Huntington Bank.

The Term Loan is subject to the same leverage tiers as the Revolver; however the interest rate at each leverage tier is five basis points lower. We have the option to repay the Term Loan in full, or in part, at any time without penalty or premium prior to the maturity date.

The amount outstanding under the Credit Facility approximates fair value as of JuneSeptember 30, 2017.

In February 2012, we completed a public offering of 1,540,000 shares of 7.125% Series C Cumulative Term Preferred Stock (“Term Preferred Stock”), par value $0.001 per share, at a public offering price of $25.00 per share. Gross proceeds of the offering totaled $38.5 million and net proceeds, after deducting offering expenses borne by us, were $36.7 million. The shares of the Term Preferred Stock had a mandatory redemption date of January 31, 2017.

The Term Preferred Stock was recorded as a liability in accordance with ASC 480, “Distinguishing Liabilities from Equity,” which states that mandatorily redeemable financial instruments should be classified as liabilities and therefore the related dividend payments are treated as a component of interest expense in the condensed consolidated statements of operations.operations and other comprehensive income (loss).

We are obligated as lessee under four ground leases. Future minimum rental payments due under the terms of these leases as of JuneSeptember 30, 2017 are as follows (dollars in thousands):

 

Expenses recorded in connection to rental expense incurred for the properties listed above during the three and sixnine months ended JuneSeptember 30, 2017 were $0.1 million and $0.2$0.4 million, respectively, and during the three and sixnine months ended JuneSeptember 30, 2016 were $0.1 million and $0.2$0.4 million, respectively. Rental expenses are reflected in property operating expenses on the condensed consolidated statements of operations.operations and other comprehensive income (loss).

As of JuneSeptember 30, 2017, there was $1.0 million outstanding under letters of credit. These letters of credit are not reflected on our condensed consolidated balance sheet.

The following table summarizes the changes in our stockholders’ equity for the sixnine months ended JuneSeptember 30, 2017 (dollars in thousands):