PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
KBS GROWTH & INCOME REIT, INC.
Reimbursable operating expenses primarily related to directors and officers liability insurance, legal fees, state and local taxes, accounting software and cybersecurity related expenses incurred by the Advisor under the Advisory Agreement. The Company has reimbursed the Advisor for the Company’s allocable portion of the salaries, benefits and overhead of internal audit department personnel providing services to the Company. These amounts totaled $40,071$47,000 and $0.1 million$73,000 for the three and ninesix months ended SeptemberJune 30, 2017,2022, respectively, and $33,121$70,000 and $70,399$159,000 for the three and ninesix months ended SeptemberJune 30, 2016,2021, respectively, and were the only type of employee costs reimbursed under the Advisory Agreement for the three and nine months ended September 30, 2017 and 2016, respectively.periods. The Company does not reimburse for employee costs in connection with services for which the Advisor earned or earns acquisition, origination or disposition fees (other than reimbursement of travel and communication expenses) or for the salaries or benefits the Advisor or its affiliates may pay to the Company’s executive officers. In addition to the amounts above, the Company reimburses the Advisor for certain of the Company’s direct costs incurred from third parties that were initially paid by the Advisor on behalf of the Company.
The Advisor advanced funds to the Company, which are non-interest bearing, for distribution record dates through the period ended May 31, 2016. As of SeptemberJune 30, 2017,2022, the total advanced funds due to the Advisor from the Company was approximately $1.3 million.million, which is included in due to affiliates in the Company’s consolidated balance sheet. The Company is only obligated to repay the Advisor for its advance if and to the extent that:
In determining whether Excess Proceeds are available to repay the advance, the Company’s conflicts committee will consider whether cash on hand could have been used to reduce the amount of third-party financing provided to us.the Company. If such cash could have been used instead of third-party financing, the third-party financing proceeds will be available to repay the advance.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
KBS GROWTH & INCOME REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SeptemberJune 30, 20172022
(unaudited)
9. RELATED PARTY TRANSACTIONS (CONTINUED)
The Advisor may defer repayment of the advance notwithstanding that the Company would otherwise be obligated to repay the advance.
Real Estate Property Co-Management Agreements
In connection with its property acquisitions, the Company, through separate, indirect, wholly-owned subsidiaries, entered into separate property management agreements (each, a “Property Management Agreement”) with the Co-Manager for each of its properties. Under each Property Management Agreement, the Co-Manager will provide certain management services related to these properties in addition to those provided by the third-party property managers. In exchange for these services, the Company will paypays the Co-Manager a monthly fee equal to a percentage of the rent, payable and actually collected for the month from each of the properties. Each Property Management Agreement has an initial term of one year and will be deemed renewed for successive one-year periods provided it is not terminated. Each party may terminate the Property Management Agreement without cause on 30 days’ written notice to the other party and may terminate each Property Management Agreement for cause on 5 days’ written notice to the other party upon the occurrence of certain events as detailed in each Property Management Agreement.
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| Property Name | | Effective Date | | Annual Fee Percentage |
Von Karman Tech CenterCommonwealth Building | | 07/31/201501/2016 | | 1.50%1.25% |
Commonwealth Building | | 07/01/2016 | | 1.25% |
| The Offices at Greenhouse | | 11/14/2016 | | 0.25% |
| Institute Property | | 11/09/2017 | | 1.00% |
Organization and Offering Costs
Offering costs include all expenses incurred in connection with the offerings of securities by the Company. Organization costs include all expenses incurred in connection with the formation of the Company, including but not limited to legal fees and other costs to incorporate the Company.
With respect to the Public Offering, the Advisor and the Dealer Manager generally paid the organization and offering expenses of the Company incurred in the Primary Offering (other than selling commissions, dealer manager fees and stockholder servicing fees) directly.
The Company reimbursed the Advisor, the Dealer Manager and its affiliates up to 1% of gross proceeds raised in the Primary Offering for commercially reasonable organization and offering expenses. The Advisor, the Dealer Manager and their affiliates were responsible for all organization and other offering expenses (which excludes selling commissions, dealer manager fees and stockholder servicing fees) paid related to the Primary Offering to the extent they exceeded 1% of gross proceeds raised in the Primary Offering. The Company did not reimburse the Dealer Manager for wholesaling compensation expenses.10. COMMITMENTS AND CONTINGENCIES
During the Initial Private Offering, the Company was obligated to reimburse the Advisor and its affiliates for all organization and offering costs (excluding wholesaling compensation expenses) paid by them on behalf of the Company.
The Advisor has agreed to pay directly all offering expenses related to the Second Private Offering without reimbursement by the Company.
Through September 30, 2017, the Advisor and its affiliates had incurred organization and other offering costs (which exclude selling commissions, dealer manager fees and stockholder servicing fees) on the Company’s behalf in connection with the Public Offering of approximately $4.2 million. As of September 30, 2017, the Company had recorded $39,358 of organization and other offering expenses related to the Public Offering, which amounts represent the Company's maximum liability for organization and other offering costs as of September 30, 2017 based on the limitations described above. As of September 30, 2017, the Company had recorded $1.5 million of organization and other offering costs related to the Initial Private Offering. Organization costs were expensed as incurred and offering costs are deferred and charged to stockholders’ equity as such amounts were reimbursed to the Advisor, the Dealer Manager or their affiliates from the gross proceeds of the applicable offering.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
KBS GROWTH & INCOME REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 2017
(unaudited)
As of September 30, 2017, the Advisor had incurred $0.9 million in offering expenses related to the Second Private Offering.
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8. | COMMITMENTS AND CONTINGENCIES |
Economic Dependency
The Company depends on the Advisor for certain services that are essential to the Company, including the identification, evaluation, negotiation, acquisition and disposition of investments; management of the daily operations of the Company’s investment portfolio;portfolio, disposition of investments and other general and administrative responsibilities. In the event that the Advisor is unable to provide such services, the Company will be required to obtain such services from other sources.
Legal Matters
From time to time, the Company may become party to legal proceedings that arise in the ordinary course of its business. Management is not aware of any legal proceedings of which the outcome is probable or reasonably possible to have a material adverse effect on the Company’s results of operations or financial condition, which would require accrual or disclosure of the contingency and possible range of loss. Additionally, the Company has not recorded any loss contingencies related to legal proceedings in which the potential loss is deemed to be remote.
Environmental
As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. Although there can be no assurance, the Company is not aware of any environmental liability that could have a material adverse effect on its financial condition or results of operations. However, changes in applicable environmental laws and regulations, the uses and conditions of properties in the vicinity of the Company’s property, the activities of its tenants and other environmental conditions of which the Company is unaware with respect to the property could result in future environmental liabilities.
The Company evaluates subsequent events up until the date the consolidated financial statements are issued.
Cash Distributions Paid
On October 2, 2017, the Company paid cash distributions of $0.4 million and $11,013, which related to Class A and Class T cash distributions, respectively, declared for daily record dates for each day in the period from September 1, 2017 through September 30, 2017. On November 1, 2017, the Company paid cash distributions of $0.4 million and $11,421, which related to Class A and Class T cash distributions, respectively, declared for daily record dates for each day in the period from October 1, 2017 through October 31, 2017.
Distributions Authorized
On October 10, 2017, the Company’s board of directors authorized cash distributions on the outstanding shares of all classes of the Company’s common stock based on daily record dates for the period from November 1, 2017 through November 30, 2017, which the Company expects to pay in December 2017. On November 8, 2017, the Company’s board of directors authorized cash distributions on the outstanding shares of all classes of the Company’s common stock based on daily record dates for the period from December 1, 2017 through December 31, 2017, which the Company expects to pay in January 2018. Investors may choose to receive cash distributions or purchase additional shares through the Company’s distribution reinvestment plan. Distributions for these periods will be calculated based on stockholders of record each day during these periods at a rate of $0.00131849 per share per day.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
KBS GROWTH & INCOME REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SeptemberJune 30, 20172022
(unaudited)
11. SUBSEQUENT EVENTS
The Company evaluates subsequent events up until the date the consolidated financial statements are issued.
Real Estate Acquisition and Financing Subsequent to September 30, 2017
Acquisition and Related Financing of the Institute PropertyModified Term Loan
On November 9, 2017,August 1, 2022, the Company, through an indirectits wholly owned subsidiary, acquiredsubsidiaries (collectively, the “Borrower”), entered into a seven-story office building containing 157,166 rentable square feet located on approximately 0.5 acres of land and a parking lot containing approximately 8,038 square feet on approximately 0.18 acres of land in Chicago, Illinois (together,modification agreement to the “Institute Property”). The seller is not affiliated with the Company or the Advisor.
The total purchase price of the Institute Property was $43.5 million plus closing costs. The Company funded the purchase of the Institute Property with proceeds from the Amended and Restated Term Loan (discussed below) and proceeds from its now-terminated Initial Private Offering and Primary Offering.
On November 9, 2017, in connection with the acquisition of the Institute Property, the Company amended the(the “Modified Term Loan,Loan”) with JP Morgan Chase Bank, N.A., (the “Lender”) to increase(i) extend the loan amountmaturity date from November 9, 2022 to $72.8 million (consisting of $48.5 million ofNovember 9, 2023, (ii) convert the revolving commitment to term commitment and $24.3(iii) reset the interest rate of the Term Loan. The Modified Term Loan has an outstanding balance of $52.3 million, of revolving commitment)which is the maximum term commitment available under the Modified Term Loan. The Modified Term Loan continues to be secured by the Offices at Greenhouse and to add the Institute Property as collateral to the Term Loan (the “Amended and Restated Term Loan”). Property.
The Amended and RestatedModified Term Loan bears interest at the forward-looking term rate based on SOFR (“Secured Overnight Financing Rate”) with a floating rate of interesttenor comparable to one-month plus 10 basis points (“Adjusted Term SOFR”) plus 200 basis points per annum equalprior to 2.0% over one-month LIBOR. The initial maturity date is NovemberMay 9, 2020, with two one-year extension options, subject to certain terms and conditions contained in2023. After May 9, 2023, the loan agreement.Modified Term Loan will bear interest at Adjusted Term SOFR plus 250 basis points per annum. Monthly payments are interest onlyinterest-only with the entire unpaidremaining principal balance, all accrued and unpaid interest and all outstanding interest and feesother sums due at maturity. Also on November 9, 2017, the Company drew $40.3 million under the Amended and Restated Term Loan (consisting of $16.0 million of term commitment and $24.3 million of revolving commitment) which, when combined with $32.5 million already outstanding under the Term Loan, was the maximum amount available to be drawn.loan documents payable at maturity. The Company has the right to prepay all or a portion of the Modified Term Loan at any time, subject to certain fees and conditions contained in the loan documents.
Subject to certain terms and conditions contained in the loan documents, cash currently held by the Company may only be used for the Company’s operating costs including but not limited to the Company’s general and administrative costs, liquidation costs (which may include proxy solicitation costs, DST transfer agent costs, legal costs, tail insurance policy costs and other reasonable and customary costs to maintain the Company in good standing), capital costs (including building improvements, tenant improvements and leasing commissions at its owned properties) and any other reasonable costs and expenses required to maintain the Company as a going concern (collectively “REIT Operating Costs”), but for no other purpose. Further, the Company is required to deposit any cash amount exceeding $7.0 million into an account controlled by the Lender or apply it to pay down the Modified Term Loan. The Company is prohibited from making any cash distributions (other than REIT Operating Costs) except for amounts needed to maintain REIT status and redemptions sought upon a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program) not exceeding $250,000 annually, in the aggregate, for any calendar year. In addition, on a monthly basis, any excess cash flow (as defined in the modification agreement) from the Offices at Greenhouse and the Institute Property is required to be deposited into an account which will serve as additional security for the loan.
KBSGI REIT Properties, LLC (“KBS GI REIT Properties”), the Company’s wholly owned subsidiary, in connection with the Modified Term Loan, is providing a guaranty of the payment of (i) principal balance and any interest or other sums outstanding under the Modified Term Loan as of the date such amounts become due, and (ii) the principal balance and any interest or other sums outstanding under the Modified Term Loan in the event of: certain bankruptcy, insolvency or related proceedings involving the Borrower and KBS GI REIT Properties, as described in the loan documents. KBS GI REIT Properties is also providing a guaranty of the payment of certain liabilities, losses, damages, costs and expenses (including legal fees) incurred by the Lender as a result of certain intentional actions or omissions committed by the Borrower, KBS GI REIT Properties and/or any of their affiliates in violation of the loan documents, or certain other occurrences in relation to The Offices at Greenhouse, the Institute Property and/or the Borrower, as further described in the amended and restated guaranty.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the accompanying financial statements of KBS Growth & Income REIT, Inc. and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to KBS Growth & Income REIT, Inc., a Maryland corporation, and, as required by context, KBS Growth & Income Limited Partnership, a Delaware limited partnership, which we refer to as the “Operating Partnership,” and to their subsidiaries.
Forward-Looking Statements
Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Those statements include statements regarding the intent, belief or current expectations of KBS Growth & Income REIT, Inc. and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. These include statements about our plans, strategies, prospects and a proposed Plan of Liquidation (defined herein) and these statements are subject to known and unknown risks and uncertainties. Readers are cautioned not to place undue reliance on these forward-looking statements. Actual results may differ materially from those contemplated by such forward-looking statements. Further, forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law. Moreover, you should interpret many of the risks identified in this report, as well as the risks set forth below, as being heightened as a result of the ongoing and numerous adverse impacts of the COVID-19 pandemic.
The following are some of the risks and uncertainties, although not all of the risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:
•The COVID-19 pandemic continues to be one of the most significant risks and uncertainties facing us and the real estate industry generally, and in particular office REITs like our company. We commenced investment operations on August 12, 2015cannot predict to what extent economic activity, including the use of and demand for office space, will return to pre-pandemic levels. Even after the pandemic has ceased to be active, potential changes in connection withcustomer behavior, such as the continued social acceptance, desirability and perceived economic benefits of work-from-home arrangements, resulting from the COVID-19 pandemic, could materially and negatively impact the future demand for office space, resulting in slower overall leasing and an adverse impact to our first investmentoperations.
•Although our board of directors expects to approve the sale of all of our assets and our dissolution pursuant to a Plan of Liquidation and submit such plan to our stockholders for approval, we havecan give no assurance that our board of directors and/or our stockholders will approve a limited operating history. Plan of Liquidation, or if approved, that we will be able to successfully implement a Plan of Liquidation and sell our assets, pay our debts and distribute the net proceeds from liquidation to our stockholders as we intend. Given the uncertainty and current business disruptions as a result of the outbreak of COVID-19, as well as the current economic slowdown, the rising interest rate environment and inflation (or the public perception that any of these events may continue), and continued social unrest and increased crime in the Portland area where one of our properties is located, our implementation of a Plan of Liquidation, if approved by our board of directors and/or stockholders, may be materially and adversely impacted.
•We are dependent onpay substantial fees to and expenses of our advisor and its affiliates. These payments decrease the amount of cash available for distribution to identify suitable investments and to manage our investments.stockholders.
•All of our executive officers, one of our affiliated directors and other key real estate and debt finance professionals are also officers, affiliated directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, our dealer manager, our affiliated property manager and/or other KBS-affiliated entities. As a result, they face conflicts of interest, including significant conflicts created by our advisor’s and its affiliates’ compensation arrangements with us and other KBS-sponsored programs and KBS-advised investors and conflicts in allocating time among us and these other programs and investors. TheseAlthough we have adopted corporate governance measures to ameliorate some of the risks posed by these conflicts, these conflicts could result in action or inaction that is not in the best interests of our stockholders.
Because investment opportunities that are suitable for us may also be suitable for other KBS-sponsored programs or KBS-advised investors, our advisor and its affiliates face conflicts•As of interest relating to the purchase of properties and such conflicts may not be resolved in our favor, meaning thatJune 30, 2022, we could invest in less attractive assets, which could reduce the investment return to our stockholders.
Our advisor and its affiliates receive fees in connection with transactions involving the management of our investments. These fees are based on the cost of the investment, and not based on the quality of the investment or services rendered to us. We may also pay significant fees during our listing/liquidation stage. These fees decrease the amount of cash available for distribution to our stockholders.
If we are unable to raise substantial funds during our offering stage, which may include any subsequent offerings of securities other than under our distribution reinvestment plan, we may not be able to acquirehad a diverselimited portfolio of four real estate investments, which may cause the value of an investment in us to vary more widely with the performance of specific assets in our portfolio and cause our general and administrative expenses to constitute a greater percentage of our revenue. Raising fewer proceeds during our offering stage, therefore, could increase
•Our advisor waived its asset management fee for the risk that our stockholders will lose money in their investment.
We may fund distributionssecond and third quarters of 2017 and deferred its asset management fee related to the periods from any source, including, without limitation, offering proceeds or borrowings (which may constitute a return of capital). Until the proceeds from our offering stage are fully invested and from time to time during our operational stage, we expect to use proceeds from financings, either fromOctober 2017 through June 2022. If our advisor determines to no longer waive or a third-party,defer certain fees owed to them, our ability to fund at least a portion of distributions in anticipation of cash flow to be received in later periods. We may also fund distributions from the sale of assets. As of September 30, 2017, some of our distributions have been funded with advances from our advisor and debt financing. Distributions funded from sources other than our cash flow from operations will result in dilution to subsequent investors, reduce funds available for investment in assets and may reduce the overall return to our stockholders.
If we are unable to locate investments with attractive yields while we are investing the proceeds raised in our offering stage, our distributions and the long-term returns of our investors may be lower.
adversely affected.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
•Our policies do not limit us from incurring debt until our aggregate borrowings would exceed 300%75% of our net assetsthe cost (before deducting depreciation andor other non-cash reserves), of our tangible assets, and we may exceed this limit with the approval of the conflicts committee of our board of directors. To the extent financing in excess of this limit is available on attractive terms, our conflicts committee may approve debt such that our aggregate borrowings would exceed this limit. High debt levels could limit the amount of cash we have available to distribute and could result in a decline in the value of our stockholders’ investment.
We depend on tenants for the revenue generated by any real estate investments we make and, accordingly, the revenue generated by our real estate investments is dependent upon the success and economic viability of our tenants. Revenues from any properties we acquire could decrease due to a reduction in occupancy (caused by factors including, but not limited to, tenant defaults, tenant insolvency, early termination of tenant leases and non-renewal of existing tenant leases) and/or lower rental rates, making it more difficult for us to meet any debt service obligations we have incurred and limiting our ability to pay distributions to our stockholders.
Any real estate investments we make may be affected by unfavorable real estate market and general economic conditions, which could decrease the value of those assets and reduce the investment return to our stockholders. These events could in turn make it more difficult for us to meet debt service obligations and limit our ability to pay distributions to our stockholders.
We cannot predict with any certainty how much, if any, of our distribution reinvestment plan proceeds will be available for general corporate purposes including, but not limited to: the repurchase of shares under our share redemption program; capital expenditures, tenant improvement costs and leasing costs related to any real estate properties we acquire; reserves required by any financings of real estate investments; the acquisition of real estate investments; and the repayment of debt. If such funds are not available from our distribution reinvestment plan offering, then we may have to use a greater proportion of our cash flow from operations to meet these cash requirements, which would reduce cash available for distributions and could limit our ability to redeem shares under our share redemption program.
Disruptions in the financial markets and uncertain economic conditions could adversely affect our ability to implement our business strategy and generate returns to our stockholders.
•We have debt obligations with variable interest rates and may incur additional variable rate debt in the future.rates. The interest and related payments will vary with the movement of LIBOR or other indexes. Increases in the indexes could increase the amount of our debt payments and limit our ability to pay distributions to our stockholders.
•We depend on tenants for the revenue generated by our real estate investments and, accordingly, the revenue generated by our real estate investments is dependent upon the success and economic viability of our tenants. Revenues from our properties could decrease due to a reduction in occupancy (caused by factors including, but not limited to, tenant defaults, tenant insolvency, early termination of tenant leases and non-renewal of existing tenant leases), rent deferrals or abatements, tenants becoming unable to pay their rent and/or lower rental rates, making it more difficult for us to meet our debt service obligations and reducing our stockholders’ returns. Further, the resale value of a property depends principally upon the value of the cash flow generated by the leases associated with that property. Non-renewals, terminations or lease defaults could reduce any net sales proceeds received upon the sale of the property and would adversely affect the amount of liquidating distributions our stockholders would receive if a Plan of Liquidation is approved by our board of directors and/or our stockholders.
•Our investments in real estate may be affected by unfavorable real estate market, the rising interest rate environment, and general economic conditions, which could decrease the value of those assets. Revenues from our properties could decrease. Such events would make it more difficult for us to meet our debt service obligations and successfully implement a Plan of Liquidation, which could in turn reduce our stockholders’ returns and the amount of any liquidating distributions they receive.
•Continued disruptions in the financial markets, including the current economic slowdown, the rising interest rate environment and inflation (or the public perception that any of these events may continue) as well as changes in the demand for office properties and uncertain economic conditions could adversely affect our ability to successfully implement our business strategy and any Plan of Liquidation approved by our board of directors and/or our stockholders, which could reduce our stockholders’ returns and the amount of any liquidating distributions they receive.
•Our share redemption program only provides for redemptions sought upon a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program, and collectively “special redemptions”). The dollar amounts available for such redemptions are determined by the board of directors and may be adjusted from time to time. The dollar amount limitation for such redemptions for the calendar year 2022 was $250,000 in the aggregate, of which $26,000 was used for such special redemptions from January through July 2022. Our share redemption program does not provide for ordinary redemptions and we can provide no assurances, when, if ever, we will provide for redemptions other than special redemptions.
All forward-looking statements should be read in light of the risks identified herein and in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, all2021, each as filed with the Securities and Exchange Commission (the “SEC”).
Overview
We were formed on January 12, 2015 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2015 and we intend to continue to operate in such a manner. Substantially all of our business is conducted through our Operating Partnership, of which we are the sole general partner. Subject to certain restrictions and limitations, our business is externally managed by our advisor pursuant to an advisory agreement. KBS Capital Advisors manages our operations and our portfolio of core real estate properties. KBS Capital Advisors also provides asset-management, marketing, investor-relations and other administrative services on our behalf. Our advisor acquired 20,000 shares of our Class A common stock for an initial investment of $200,000. We have no paid employees.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
We commenced a private placement offering of our shares of common stock that was exempt from registration pursuant to Rule 506(b) of Regulation D of the Securities Act of 1933, as amended (the “Securities Act”), on June 11, 2015, pursuant to which we offered a maximum of $105,000,000 of shares of our Class A common stock for sale to certain accredited investors, of which $5,000,000 of Class A shares were being offered pursuant to our distribution reinvestment plan.2015. We ceased offering shares in the primary portion of our initial private offering on April 27, 2016 and processed subscriptions for the primary portion of the initial private offering dated on or prior to April 27, 2016 through May 30, 2016. KBS Capital Markets Group LLC, an affiliate of our advisor, served as the dealer manager of the offering pursuant to a dealer manager agreement.
We sold 8,548,972On April 26, 2016, the SEC declared our registration statement on Form S-11, pursuant to which we registered shares of our Class A common stock for grosssale to the public, effective, and we retained KBS Capital Markets Group LLC to serve as the dealer manager of the initial public offering. We terminated the primary initial public offering proceedseffective June 30, 2017. We terminated the distribution reinvestment plan offering effective August 20, 2020.
On October 3, 2017, we launched a second private placement offering of $76.8 millionour shares of common stock that exempt from registration pursuant to Rule 506(c) of Regulation D of the Securities Act. In connection with the offering, we entered into a dealer manager agreement with KBS Capital Advisors and an unaffiliated third party. In December 2019, in connection with its consideration of strategic alternatives for us, our initialboard of directors determined to suspend the second private offering including 74,744and terminated the second private offering on August 5, 2020.
Through our capital raising activities, we raised $94.0 million from the sale of 10,403,922 shares of our Class Acommon stock, including $8.5 million from the sale of 924,286 shares of common stock under our distribution reinvestment plan. As of June 30, 2022, we had 9,851,052 and 310,974 Class A and Class T shares outstanding, respectively.
We have used substantially all of the net proceeds from our offerings to invest in a portfolio of core real estate properties. We consider core properties to be existing properties with at least 80% occupancy. As of June 30, 2022, we owned four office buildings.
Going Concern Considerations
The accompanying consolidated financial statements and notes have been prepared assuming we will continue as a going concern. We have experienced a decline in occupancy from 90.4% as of December 31, 2020 to 74.5% as of June 30, 2022 and such occupancy may continue to decrease in the future as tenant leases expire. The decrease in occupancy has resulted in a decrease in cash flow from operations and has negatively impacted the market values of our properties in our portfolio. Additionally, the Commonwealth Building Mortgage Loan with an outstanding principal balance of $45.7 million is maturing in February 2023. Due to the decrease in occupancy and a decrease in market value of the property securing the Commonwealth Building Mortgage Loan, we do not expect to be able to extend or refinance that loan at current terms and may be required to pay down a portion of the maturing debt in order to extend or refinance the loan. With our limited amount of cash on hand, our ability to make any loan paydowns, without the sale of real estate assets, is severely limited. Additionally, in order to attract or retain tenants needed to increase occupancy and sustain operations, we will need to spend a substantial amount on capital leasing costs, however we have limited amounts of liquidity to make these capital commitments. These conditions raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability to exercise our extension option or refinance our mortgage debt. No assurances can be given that we will be successful in achieving these objectives.
Plan of Liquidation
Our board of directors and a special committee composed of all of our independent directors (the “Special Committee”) has undertaken a review of various strategic alternatives available to us and expects to approve the sale of all of our assets and our dissolution pursuant to the terms of a plan of complete liquidation and dissolution (a “Plan of Liquidation”). Once approved by our board of directors, a Plan of Liquidation will be submitted to our stockholders for gross offeringapproval. Our advisor has been working diligently to develop a Plan of Liquidation to present to our board of directors for approval; however, the impact of the COVID-19 pandemic on a Plan of Liquidation for our portfolio, as well as the decreased demand for office space as employees continue to work from home, the rising interest rate environment that is impacting the ability of buyers to obtain favorable financing and continued social unrest and increased crime in the Portland area where one of our properties is located, have created significant headwinds to finalizing a Plan of Liquidation. The principal purpose of a Plan of Liquidation will be to provide liquidity to our stockholders by selling our assets, paying our debts and distributing the net proceeds from liquidation to our stockholders. Although this is the current intention of $0.7 million.
our board of directors, we can provide no assurances as to the ultimate approval of a Plan of Liquidation or the timing of the liquidation of the company.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
On February 4, 2015,If our board of directors and our stockholders approve a Plan of Liquidation, we filed a registration statement on Form S-11 with the SECintend to registerpursue an initial public offering to offer a maximum of $1,500,000,000 in shares of common stock for sale to the public in the primary offering, consisting of two classes of shares: Class A and Class T. We also registered a maximum of $800,000,000 in both classes of sharesorderly liquidation of our common stock pursuant to our distribution reinvestment plan. The SEC declared our registration statement effective on April 28, 2016 and we retained KBS Capital Markets Group LLC to serve as the dealer manager of the initial public offering. We terminated our primary initial public offering effective June 30, 2017. We are continuing to offer shares of common stock pursuant to our publicly registered distribution reinvestment plan offering.
We sold 122,721 and 270,415 shares of Class A and Class T common stock in the initial public offering, respectively, for aggregate gross offering proceeds of $3.9 million. As of September 30, 2017, we had sold 297,753 and 6,250 shares of Class A and Class T common stock under our distribution reinvestment plan, respectively, for aggregate gross offering proceeds of $2.9 million.
On October 3, 2017, we launched a second private placement offering exempt from registration pursuant to Rule 506(c) of Regulation D of the Securities Act pursuant to which we are offering a maximum of $500,000,000 in sharescompany by selling all of our Class A common stock to certain accredited investors. Prior toremaining assets, paying our debts and our known liabilities, providing for the launchpayment of the second private placement offering, on September 29, 2017, we entered a dealer manager agreement (the “NCPS Dealer Agreement”) with KBS Capital Advisors and North Capital Private Securities Corporation (“NCPS”) in connection with the second private placement offering.
As of September 30, 2017, we had redeemed 45,225 Class A shares for $0.4 million.
We intend to use substantially all ofunknown or contingent liabilities, distributing the net proceeds from liquidation to our offeringsstockholders and winding up our operations and dissolving our company. In the interim, we intend to invest in a diversecontinue to manage our portfolio of core real estate properties. We consider coreassets to maintain and, if possible, improve the quality and income-producing ability of our properties to be existing properties with at least 80% occupancy. Based on the current market outlook, we expectenhance property stability and better position our core focus in the U.S. office sectorassets for a potential sale. A Plan of Liquidation remains subject to reflect a value-creating core strategy, which is also known as a core-plus strategy. As of September 30, 2017, we owned three office properties.
KBS Capital Advisors makes recommendations on all investments to our board of directors. All proposed real estate investments must be approvedapproval by at least a majority of our board of directors includingand our stockholders and we can give no assurance regarding the timing of our liquidation. Additional information regarding a majorityPlan of the conflicts committee. Unless otherwiseLiquidation will be provided byto our charter, the conflicts committee may approvestockholders in a proposed real estate investment without action by the fullproxy statement to be distributed to stockholders in connection with a liquidation vote.
In connection with its consideration of a Plan of Liquidation, our board of directors if the approving members of the conflicts committee constitute at least a majority of the board of directors.determined to cease regular quarterly distributions. We expect any future distributions to our stockholders will be liquidating distributions.
We elected to be taxed as a REIT under the Internal Revenue Code, beginning with the taxable year ended December 31, 2015. If we meet the REIT qualification requirements, we generally will not be subject to federal income tax on the income that we distribute to our stockholders each year. If we fail to qualify for taxation as a REIT in any year after electing REIT status, our income will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify. Such an event could materially and adversely affect our net income and cash available for distribution to our stockholders. However, we are organized and will operate in a manner that will enable us to qualify for treatment as a REIT for federal income tax purposes beginning with our taxable year ended December 31, 2015, and we will continue to operate so as to remain qualified as a REIT for federal income tax purposes thereafter.
Market Outlook – Real Estate and Real Estate Finance Markets
The following discussion is based on management’s beliefs, observations and expectations with respect to the real estate and real estate finance markets.
Current economic data and financial market developments suggest that the global economy is improving, although at a slow and uneven pace. European economic growth has recently picked up, with improving employment dataVolatility in most of the European Union countries. The U.K. and China remain areas of concern. The U.K. is working through its BREXIT process, whereas the Chinese economy has shown signs of stabilization, but is still struggling with uncertainty in its banking system in relation to bad loans. Against this backdrop, the central banks of the world’s major industrialized economies are beginning to back away from their strong monetary accommodation. Quantitative easing (“QE”) in Japan and Europe is slowing, but the liquidity generated from these programs continues to impact the global capital markets.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
At a duration of 100 months (as of the end of third quarter 2017), the current business cycle, which commenced in June 2009, is the third longest in U.S. history, behind only the periods between 1961 - 1969 and 1991 - 2001. In June 2017, the U.S. Federal Reserve (the “Fed”) increased interest rates for the fourth time in three years. Expectations are that the Fed will increase rates again in December, citing strong economic growth despite a lack of meaningful inflation. The Fed is still attempting to normalize the level of interest rates in the United States. U.S. interest rates are relatively high when compared to Europe, where the European Central Bank is still engaging in QE. Global inflation is starting to show signs of life as U.S. inflation has grown to approximately 1.9% versus 2.9% in the U.K. and 1.5% in the Eurozone. Real gross domestic product (“GDP”) in the United States has had two consecutive quarters of 3.0% or greater growth, and the U.S. unemployment rate is currently a relatively low 4.2%. Personal income growth has started to pick up and unemployment statistics indicate that labor force conditions are finally showing real improvements. Political uncertainty surrounding the current administration’s budget, tax reform plans, attempts to repeal the Affordable Care Act, the future of the Chair of the FED, and the continued weakness in retailers, all may adversely impact business and consumer confidence.
In 2017 the U.S. commercial real estate market has seen a decline in transaction volume and a slowing of price increases. In the aggregate, property level operating income growth has begun to slow, while lending standards have tightened. The United States continues to benefit from inflows of foreign capital, albeit at a slowing rate. The capital flows from China have dropped as the Chinese government has successfully imposed constraints on capital leaving the country. The industrial property sector is a standout for investors, as internet sales volumes continue to increase the demand for warehouses and logistics-related assets. There are other pockets of growth in the commercial real estate sector, like suburban markets in southern and western tier 2 markets. Traditional sources of capital are favoring a “risk-off” approach, as capital flows have shifted equity towards debt, or secured, investing. Commercial real estate returns are increasingly being driven by property income (yield), as opposed to price appreciation through cap rate compression.
Lenders with long memories remain disciplined in their underwriting of investments. For balance sheet lenders, such as banks and insurance companies, underwriting standards for commercial real estate have tightened. This has resulted in lower loan-to-value and higher debt coverage ratios. CMBS originations rebounded in the third quarter as banks and insurance companies tightened loan terms. CMBS volumes are on pace to beat 2016 issuance volumes. This is a positive for the U.S. commercial real estate markets as it illustrates the virtues of having a diversified set of funding sources.
Impact on Our Real Estate Investments
The volatility in the global financial markets, changing political environments and political environment continues tocivil unrest can cause a level of uncertaintyfluctuations in our outlook for the performance of the U.S. commercial real estate markets. Both the investing and leasing environments are highly competitive. While foreign capital continues to flow into U.S. real estate markets, albeit at a slower rate, concerns regarding the political, regulatory and economic environments have introduced uncertainty into the markets. Possible future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to renew tenants early, to retain tenants who are up for renewal or to attract new tenants, may result in decreases in cash flows. Historically low interest rates could help offset some of the impact of these potential decreases in operating cash flow for properties financed with variable rate mortgages; however, interest rates in the United States have started to increase. The Fed raised interest rates four times between the period December 2015 and June 2017. The real estate and finance markets anticipate further rate increases if the economy remains strong, but a flattening U.S. treasury yield curve is signaling a weakening in economic conditions, and highlights the degree of uncertainty surrounding the near-term U.S. economic prospects. Management continuously reviews our debt financing strategies to optimize the cost of our debt exposure.
Impact on Our Financing Activities
In light of the risks associated with potentially volatile operating cash flows from someinvestment properties. Further, revenues from our properties could decrease due to a reduction in occupancy (caused by factors including, but not limited to, tenant defaults, tenant insolvency, early termination of tenant leases and non-renewal of existing tenant leases), rent deferrals or abatements, tenants being unable to pay their rent and/or lower rental rates. Reductions in revenues from our real estate properties andwould adversely impact the increasetiming of any asset sales and/or the sales price we will receive for our properties if a Plan of Liquidation is approved by our board of directors and/or our stockholders. To the extent there are increases in the cost of financing due to higher interest rates, wethis may havecause difficulty in refinancing some of our debt obligations prior to or at maturity or we may not be able to refinance these obligations at terms as favorable as the terms of our existing indebtedness. Short-term interest rates in the United States have increased, and are expected to increase again by the end of the year. Market conditions can change quickly, potentially negatively impacting the value of real estate investments. Management continuously reviews our investments.investment and debt financing strategies to optimize our portfolio and the cost of our debt exposure. Most recently, the outbreak of COVID-19 as well as the current economic slowdown, the rising interest rate environment and inflation (or the public perception that any of these events may continue) have had a negative impact on the office real estate market as discussed below.
COVID-19 Pandemic and Portfolio Outlook
One of the most significant risks and uncertainties facing us and the real estate industry generally, and in particular office REITs like our company, continues to be the effect of the public health crisis of the novel coronavirus disease (“COVID-19”) pandemic. We recognized impairment charges related to a projected reduction in cash flows as a result of changes in leasing projections that were impacted in part by the COVID-19 pandemic at the Institute Property and 210 W. Chicago during the year ended December 31, 2020, the Commonwealth Building during the year ended December 31, 2021 and the Commonwealth Building and the Institute Property during the six months ended June 30, 2022.
We cannot predict to what extent economic activity, including the use of and demand for office space, will return to pre-pandemic levels. During 2021 and the first and second quarters of 2022, the usage of our assets remained lower than pre-pandemic levels. In addition, we experienced a significant reduction in leasing interest and activity when compared to pre-pandemic levels. Even after the pandemic has ceased to be active, potential changes in customer behavior, such as the continued social acceptance, desirability and perceived economic benefits of work-from-home arrangements, resulting from the COVID-19 pandemic, could materially and negatively impact the future demand for office space, resulting in slower overall leasing and an adverse impact to our operations.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The current challenging economic circumstances have created a difficult environment in which to continue to create value in our portfolio consistent with our core-plus investment strategy. The properties in our portfolio were acquired to provide an opportunity for us to achieve more significant capital appreciation by increasing occupancy, negotiating new leases with higher rental rates and/or executing enhancement projects, all of which have become more difficult as a result of the impacts of COVID-19 on the demand for office space, in particular in the Portland area where one of our properties is located due to the social unrest that continues in the area. In addition, due to the impact of COVID-19, the leasing environment in the short-term will be challenging and the time to lease up and stabilize a property will be extended. More specifically, our office properties in Portland and Chicago will likely take more time to stabilize than previously anticipated and our ability to create value for our stockholders through the stabilization and disposition of these assets will be adversely affected. In addition, the timing in which we may be able to implement a liquidation strategy will be affected.
Liquidity and Capital Resources
WeAs described above under “—Overview – Going Concern Considerations,” in preparing our financial statements for this annual reporting period, our management determined that substantial doubt exists about our ability to continue as a going concern within one year after the date that the financial statements are dependent uponissued. In addition, as described above under “—Overview – Plan of Liquidation,” our board of directors expects to approve the sale of all of our assets and our dissolution pursuant to the terms of a Plan of Liquidation and submit such plan to our stockholders for approval. The principal purpose of a Plan of Liquidation will be to provide liquidity to our stockholders by selling our assets, paying our debts and distributing the net proceeds from liquidation to our offering stagestockholders. Subject to conduct our proposed operations. We will obtain the capital required to make real estate and conduct our operations from the proceedsapproval of our offering stage, from secured or unsecured financings from banksboard of directors and other lendersour stockholders of a Plan of Liquidation we expect our principal demands for funds during the short and from any undistributed funds fromlong-term are and will be for the payment of operating expenses, capital expenditures and general and administrative expenses, including expenses in connection with a Plan of Liquidation; payments under debt obligations; special redemptions of common stock; capital commitments; and payments of distributions to stockholders pursuant to a Plan of Liquidation. If a Plan of Liquidation is approved by our operations. Asboard of September 30, 2017,directors and our stockholders, we had raised approximately $83.1 million in gross offeringexpect to use our cash on hand and proceeds from the sale of shares of our common stock in our initial private offering, separate private transactions and initial public offering. We terminatedproperties as our primary initial public offering effective June 30, 2017 and launched a private offering solely to accredited investors pursuant to Rule 506(c)sources of Regulation D of the Securities Act on October 3, 2017. We continue to offer shares of common stock under our publicly registered distribution reinvestment plan.
If we are unable to raise substantial funds during our offering stage, we will make fewer investments resulting in less diversification in terms of the type, number and size of investments we make and the value of an investment in us will fluctuate more significantly with the performance of the specific assets we acquire. Further, we will have certain fixed operating expenses, including certain expenses as a publicly offered REIT, regardless of whether we are able to raise substantial funds during our offering stage. Our inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, reducing our net income and cash flow and limiting our ability to make distributions to our stockholders. We expect to establish a modest working capital reserve from our offering proceeds for maintenance and repairs of real properties, as we expect the vast majority of leases for the properties we acquire will provide for tenant reimbursement of operating expenses. However, toliquidity. To the extent thatavailable, we have insufficient funds for such purposes, we may establish additional reserves from gross offering proceeds, out of cash flow from operations or net cash proceeds from the sale of properties.
As of September 30, 2017, we owned three office properties that collectively were 95% occupied. We acquired these investments with the proceeds from the sale of our common stock in the initial private offering and debt financing, including a bridge loan from our advisor that we have since repaid. Operating cash needs during the nine months ended September 30, 2017 were met throughalso intend to use cash flow generated by our real estate investments and with proceeds from debt financing; however, asset sales will further reduce cash flow from these sources during the implementation of a Plan of Liquidation, if it is approved by our initial private offeringboard of directors and initial public offering.our stockholders. Although this is the current intention of our board of directors, we can provide no assurance as to the ultimate approval of a Plan of Liquidation or the timing of the liquidation of the company.
Our share redemption program only provides for special redemptions. The dollar amounts available for such redemptions are determined by the board of directors and may be adjusted from time to time. The dollar amount limitation for such redemptions for the calendar year 2022 is $250,000 in the aggregate, of which $26,000 was used for such special redemptions from January through July 2022. Our share redemption program does not provide for ordinary redemptions and we can provide no assurances, when, if ever, we will provide for redemptions other than special redemptions.
Our investments in real estate generate cash flow in the form of rental revenues and tenant reimbursements, which are reduced by operating expenditures, capital expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from real estate investments will beis primarily dependent upon the occupancy level of our portfolio, the net effective rental rates on our leases, the collectibility of rent and operating recoveries from our tenants and how well we manage our expenditures.expenditures, all of which may be adversely affected by the impact of the COVID-19 pandemic as discussed above and more recently inflation.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Our advisor advanced funds to us, which are non-interest bearing, for distribution record dates through the period ended May 31, 2016. We are only obligated to repay our advisor for its advance if and to the extent that:
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(i) | Our modified funds from operations (“MFFO”), as such term is defined by the Investment Program Association and interpreted by us, for the immediately preceding month exceeds the amount of distributions declared for record dates of such prior month (an “MFFO Surplus”), and we will pay our advisor the amount of the MFFO Surplus to reduce the principal amount outstanding under the advance, provided that such payments shall only be made if management in its sole discretion expects an MFFO Surplus to be recurring for at least the next two calendar quarters, determined on a quarterly basis; or |
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(ii) | Excess proceeds from third-party financings are available (“Excess Proceeds”), provided that the amount of any such Excess Proceeds that may be used to repay the principal amount outstanding under the advance shall be determined by the conflicts committee in its sole discretion. |
(i)Our modified funds from operations (“MFFO”), as such term is defined by the Institute for Portfolio Alternatives and interpreted by us, for the immediately preceding quarter exceeds the amount of distributions declared for record dates of such prior quarter (an “MFFO Surplus”), and we will pay our advisor the amount of the MFFO Surplus to reduce the principal amount outstanding under the advance, provided that such payments shall only be made if management in its sole discretion expects an MFFO Surplus to be recurring for at least the next two calendar quarters, determined on a quarterly basis;
(ii)Excess proceeds from third-party financings are available (“Excess Proceeds”), provided that the amount of any such Excess Proceeds that may be used to repay the principal amount outstanding under the advance shall be determined by the conflicts committee in its sole discretion; or
(iii)Net sales proceeds from the sale of our real estate portfolio, after the pay down of any related debt and selling costs and expenses, are available.
In determining whether Excess Proceeds are available to repay the advance, our conflicts committee will consider whether cash on hand could have been used to reduce the amount of third-party financing provided to us. If such cash could have been used instead of third-party financing, the third-party financing proceeds will be available to repay the advance.
Our advisor may defer repayment of the advance notwithstanding that we would otherwise be obligated to repay the advance.
We expect that once we have fully invested the proceeds raised during our offering stage, our debt financing and other liabilities will be between 45% and 65% of the cost of our tangible assets (before deducting depreciation and other non-cash reserves). Though this is our target leverage, our charter does not limit us from incurring debt until our aggregate borrowings would exceed 300% of our net assets (before deducting depreciation and other non-cash reserves), which is effectively 75% of the cost of our tangible assets (before deducting depreciation and other non-cash reserves), though we may exceed this limit under certain circumstances. To the extent financing in excess of this limit is available at attractive terms, the conflicts committee may approve debt in excess of this limit. As of SeptemberJune 30, 2017,2022, we had mortgage debt obligations in the aggregate principal amount of $101.6 million and our aggregate borrowings were approximately 54%62% of our net assets before deducting depreciation and other non-cash reserves.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s DiscussionJune 30, 2022, we had two loans totaling $97.9 million maturing during the 12 months ending June 30, 2023. On August 1, 2022, we refinanced the Term Loan with an outstanding principal balance of $52.3 million, extending its maturity date to November 9, 2023. Due to the decrease in occupancy and Analysisa decrease in market value of Financial Conditionthe property securing the Commonwealth Building Mortgage Loan, we may be unable to extend or refinance the upcoming loan maturity of that loan at current terms and Resultsmay be required to pay down a portion of Operations (continued)
the maturing debt in order to extend or refinance the loan. In addition, asset sales pursuant to a Plan of Liquidation, if approved by our board of directors and our stockholders, will further reduce proceeds available from debt financing.
In addition to making investments in accordance withusing our investment objectives,capital resources to meet our debt service obligations, for capital expenditures and for operating costs, we have used a portion ofuse our capital resources to make certain payments to our advisor the dealer manager of our initial private offering and initial public offering and our affiliated property manager. These payments include payments to our dealer manager for selling commissions, the dealer manager fee and the stockholder servicing fee, and payments to the dealer manager and
We paid our advisor for reimbursementfees in connection with the acquisition of certain organizationour assets and other offering expenses. See “—Organization and Offering Costs” below.
We will make payments topay our advisor fees in connection with the management of our assets and costs incurred by our advisor in providing certain services to us. Through August 8, 2017, theThe asset management fee payable to our advisor was a monthly fee equal to one-twelfth of 1.6% of the cost of our investments, less any debt secured by or attributable to our investments. As of August 9, 2017, the asset management fee will beis a monthly fee payable to our advisor in an amount equal to one-twelfth of 1.0% of the cost of our investments including the portion of the investment that is debt financed. The cost of our real property investments is calculated as the amount paid or allocated to acquire the real property, plus budgeted capital improvement costs for the development, construction or improvements to the property once such funds are disbursed pursuant to a final approved budget and fees and expenses related to the acquisition, but excluding acquisition fees paid or payable to our advisor. The cost of our real estate-related investments and any investments other than real property is calculated as the lesser of: (x) the amount paid or allocated to acquire or fund the investment, including fees and expenses related to the acquisition or origination (but excluding acquisition or origination fees paid or payable to our advisor), and (y) the outstanding principal amount of such investment, including fees and expenses related to the acquisition or funding of such investment (but excluding acquisition or origination fees paid or payable to our advisor). In the case of investments made through joint ventures, the asset management fee is determined based on our proportionate share of the underlying investment. Our advisor agreed to waivewaived asset management fees for the second and third quarters of 2017.2017 and deferred payment of asset management fees related to the periods from October 2017 through June 30, 2022. Our advisor’s waiver and deferral of its asset management fees resulted in additional cash being available to fund our operations. If our advisor chooses to no longer defer such fees, our ability to fund our operations may be adversely affected. We also continue to reimburse our advisor and our dealer manager for certain stockholder services.
We also pay fees to KBS Management Group, LLC (the “Co-Manager”), an affiliate of our advisor, pursuant to property management agreements with the Co-Manager, for certain property management services at our properties.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
We elected to be taxed as a REIT and to operate as a REIT beginning with our taxable year ended December 31, 2015. To maintain our qualification as a REIT, we will be required to make aggregate annual distributions to our stockholders of at least 90% of our REIT taxable income (computed without regard to the dividends-paid deduction and excluding net capital gain). Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant. ProvidedWe do not expect to pay regular quarterly distributions during the liquidation process. Further, we have sufficient available cash flow, we intend to authorize and declare cash distributions based on daily record dates and pay cash distributions on a monthly basis. We have not established a minimum distribution level.
Under our charter, we are required to limit our total operating expenses to the greater of 2% of our average invested assets or 25% of our net income for the four most recently completed fiscal quarters, as these terms are defined in our charter, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. Operating expenses for the four fiscal quarters ended SeptemberJune 30, 20172022 did not exceed the charter-imposed limitation.
Cash Flows from Operating Activities
As of SeptemberJune 30, 2017,2022, we owned threefour office properties. During the ninesix months ended SeptemberJune 30, 2017,2022, net cash used in operating activities was $0.9 million. During six months ended June 30, 2021, net cash provided by operating activities was $2.9$0.6 million. Net cash used in operating activities increased due to a decrease in rental income and the payment of lease commissions and lease incentives during 2022. We expect that our cash flows fromprovided by operating activities will increaseto decrease in future periods to the extent a Plan of Liquidation is approved by our board of directors and our stockholders and we make additional acquisitionsbegin selling our assets. In addition, to the extent the impacts of real estateCOVID-19 continue to be felt by our tenants, our tenants may defer rent payments or be unable to pay rent or we may be unable to re-lease space vacated by our current tenants which could reduce our cash flow provided by operating activities. Further, downtown Portland, where one of our properties is located is experiencing record high vacancies due to the impact of the disruptions caused by protests and real estate-related investmentsdemonstrations and increased crime in the related operations of such investments.downtown area, and it is uncertain when the market will fully recover which we expect to adversely impact our cash flows from operating activities.
Cash Flows from Investing Activities
NetDuring the six months ended June 30, 2022, net cash used in investing activities was $3.9$0.6 million for the nine months ended September 30, 2017 and consisted of cash fordue to improvements to real estate and an escrow deposit for a future real estate purchase.estate.
Cash Flows from Financing Activities
During the ninesix months ended SeptemberJune 30, 2017,2022, net cash used in financing activities was $9.1 million and consisted primarily of the following:
$9.4 million of net cash used in debt financing as a result of$51,000 due to principal payments on notes payable and redemption of $11.3common stock.
Debt Obligations
The following is a summary of our contractual obligations as of June 30, 2022 (in thousands).
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Payments Due During the Years Ending December 31, |
| Debt Obligations | | Total | | Remainder of 2022 | | 2023-2024 | | 2025-2026 |
Outstanding debt obligations (1) (2) | | $ | 101,629 | | | $ | 52,297 | | | $ | 49,332 | | | $ | — | |
Interest payments on outstanding debt obligations (2) (3) | | 2,088 | | | 1,720 | | | 368 | | | — | |
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(1) Amounts include principal payments only.
(2) On August 1, 2022, we entered into a modification agreement with the lender of the Term Loan to (i) extend the maturity date to November 9, 2023, (ii) convert the revolving commitment to term commitment and (iii) reset the interest rate of the loan. See “– Subsequent Events – Modified Term Loan.”
(3) Projected interest payments are based on the outstanding principal amount, maturity date and contractual interest rate in effect as of June 30, 2022 (consisting of the contractual interest rate and the effect of interest rate swaps). We incurred interest expense of $1.6 million, and paymentsexcluding amortization of deferred financing costs oftotaling $0.1 million partially offset by proceeds from notes payableand unrealized gains on derivative instruments of $2.0 million;$0.6 million during the six months ended June 30, 2022.
$2.3 million of net cash provided by offering proceeds related to our public offering, net of payments of commissions, dealer manager fees and other organization and offering costs of $0.2 million; and
$1.6 million of net cash distributions, after giving effect to distributions reinvested by stockholders of $1.8 million.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Contractual Commitments and Contingencies
The following is a summary of our contractual obligations as of September 30, 2017 (in thousands).
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| | | | | Payments Due During the Years Ending December 31, |
| Contractual Obligations | | Total | | Remainder of 2017 | | 2018-2019 | | 2020-2021 | | Thereafter |
Outstanding debt obligations (1) | | $ | 73,500 |
| | $ | — |
| | $ | 32,500 |
| | $ | 41,000 |
| | $ | — |
|
Interest payments on outstanding debt obligations (2) | | 7,694 |
| | 644 |
| | 4,963 |
| | 2,087 |
| | — |
|
_____________________(1) Amounts include principal payments only.
(2) Projected interest payments are based on the outstanding principal amount, maturity date and contractual interest rate in effect as of September 30, 2017. We incurred interest expense of $1.9 million, excluding amortization of deferred financing costs totaling $0.4 million during the nine months ended September 30, 2017.
Results of Operations
Overview
We conducted a primary initial public offering from April 28, 2016 throughAs of June 30, 20172022 and are continuing to offer shares in2021, we owned four office properties. If a Plan of Liquidation is approved by our publicly registered distribution reinvestment plan offering. On October 3, 2017board of directors and our stockholders, we launched a private placement offering exemptwill undertake an orderly liquidation by selling all of our assets, paying our debts, providing for known and unknown liabilities and distributing the net proceeds from registration pursuant to Rule 506(c) of Regulation D of the Securities Act. Priorliquidation to our initial public offering,stockholders. There can be no assurances regarding the amounts of any liquidating distributions or the timing thereof. In general, subject to other factors as described below, we conducted a private placement offering exempt from registration pursuantexpect income and expenses to Rule 506(b) of Regulation D of the Securities Act, that commenced on June 11, 2015. Ourdecrease in future periods due to disposition activity.
The following table provides summary information about our results of operations as of September 30, 2017 are not indicative of those expected in future periods as we commenced investment operations on August 12, 2015 in connection with our first investment and have since been raising money in and investing the proceeds from our offerings. As of September 30, 2016, we owned two office properties. We acquired one office property after September 30, 2016 and owned three office properties as of September 30, 2017. The results of operations presented for the three and six months ended SeptemberJune 30, 20172022 and 2016 are not directly comparable due to our acquisition activity. In general, we expect that our income and expenses related to our portfolio will increase2021 (dollar amounts in future periods to the extent we make additional acquisitions of real estate investments.thousands):
Comparison of the three months ended SeptemberJune 30, 20172022 versus the three months ended SeptemberJune 30, 20162021
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| | | | | | | | | | | | | | | | | | | | | | | |
| | | For the Three Months Ended September 30, | | Increase (Decrease) | | Percentage Change | | $ Change Due to Acquisitions (1) | | $ Change Due to Property Held Throughout Both Periods (2) |
| | | 2017 | | 2016 | | | | |
| Rental income | | $ | 3,188 |
| | $ | 2,245 |
| | $ | 943 |
| | 42 | % | | $ | 1,005 |
| | $ | (62 | ) |
| Tenant reimbursements | | 821 |
| | 168 |
| | 653 |
| | 389 | % | | 595 |
| | 58 |
|
| Other operating income | | 19 |
| | 28 |
| | (9 | ) | | (32 | )% | | 1 |
| | (10 | ) |
| Operating, maintenance and management costs | | 983 |
| | 451 |
| | 532 |
| | 118 | % | | 291 |
| | 241 |
|
| Property management fees | | 30 |
| | 24 |
| | 6 |
| | 25 | % | | 3 |
| | 3 |
|
| Real estate taxes and insurance | | 537 |
| | 176 |
| | 361 |
| | 205 | % | | 342 |
| | 19 |
|
| Asset management fees to affiliate | | — |
| | 153 |
| | (153 | ) | | (100 | )% | | — |
| | (153 | ) |
| Real estate acquisition fees and expenses | | — |
| | 3 |
| | (3 | ) | | (100 | )% | | n/a |
| | n/a |
|
| General and administrative expenses | | 461 |
| | 446 |
| | 15 |
| | 3 | % | | n/a |
| | n/a |
|
| Depreciation and amortization | | 2,031 |
| | 1,130 |
| | 901 |
| | 80 | % | | 596 |
| | 305 |
|
| Interest expense | | 776 |
| | 392 |
| | 384 |
| | 98 | % | | 249 |
| | 135 |
|
| Interest and other income | | 7 |
| | 30 |
| | (23 | ) | | (77 | )% | | — |
| | (23 | ) |
_____________________ | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | Increase
(Decrease) | | Percentage Change | | | | |
| | 2022 | | 2021 | | | | |
| Rental income | $ | 3,631 | | | $ | 4,081 | | | $ | (450) | | | (11) | % | | | | |
| Other operating income | 35 | | | 48 | | | (13) | | | (27) | % | | | | |
| Operating, maintenance and management costs | 942 | | | 935 | | | 7 | | | 1 | % | | | | |
| Property management fees and expenses to affiliate | 22 | | | 28 | | | (6) | | | (21) | % | | | | |
| Real estate taxes and insurance | 772 | | | 728 | | | 44 | | | 6 | % | | | | |
| Asset management fees to affiliate | 436 | | | 434 | | | 2 | | | — | % | | | | |
| General and administrative expenses | 412 | | | 445 | | | (33) | | | (7) | % | | | | |
| Depreciation and amortization | 1,504 | | | 1,896 | | | (392) | | | (21) | % | | | | |
| Interest expense | 689 | | | 608 | | | 81 | | | 13 | % | | | | |
| Impairment charges on real estate | 8,409 | | | — | | | 8,409 | | | 100 | % | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
(1) Represents the dollar amount increase
Rental income decreased from $4.1 million for the three months ended SeptemberJune 30, 2017 compared2021 to the three months ended September 30, 2016 related to real estate investments acquired on or after July 1, 2016.
(2) Represents the dollar amount increase (decrease)$3.6 million for the three months ended SeptemberJune 30, 2017 compared2022, primarily due to a decrease in occupancy rate from 82.1% as of June 30, 2021 to 74.5% as of June 30, 2022 as a result of lease expirations. Overall, we expect rental income to decrease in future periods due to anticipated future dispositions of real estate properties and uncertainty and business disruptions as a result of the outbreak of COVID-19 and social unrest in the Portland area where one of our properties is located. See “Market Outlook - Real Estate and Real Estate Finance Markets - COVID-19 Pandemic and Portfolio Outlook” for a discussion on the impact of the COVID-19 pandemic on our business.
Operating, maintenance, and management costs remained consistent at $0.9 million for the three months ended SeptemberJune 30, 2016 with respect2022 and 2021. We expect operating, maintenance, and management costs to decrease in future periods due to anticipated future dispositions of real estate properties, offset by general increase due to inflation and as physical occupancy increases as employees return to the office.
Real estate taxes and insurance increased slightly from $0.7 million for the three months ended June 30, 2021 to $0.8 million for the three months ended June 30, 2022, primarily due to an increase in property taxes due to increased property values and rates. We expect real estate investment ownedtaxes and insurance to decrease in future periods due to anticipated future dispositions of real estate properties, partially offset by us throughout bothgeneral increase due to inflation.
Asset management fees to affiliate remained consistent at $0.4 million for the three months ended June 30, 2022 and 2021. We expect asset management fees to decrease in future periods presented.due to anticipated future dispositions of real estate properties, partially offset by increases in capital improvements. As of June 30, 2022, we had accrued and deferred payment of $8.5 million of asset management fees related to the periods from October 2017 through June 30, 2022.
General and administrative expenses remained consistent at $0.4 million for the three months ended June 30, 2022 and 2021. General and administrative costs consisted primarily of legal fees, internal audit compensation expense, errors and omissions insurance, board of directors fees and audit cost.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Rental incomeDepreciation and tenant reimbursements increasedamortization decreased from $2.4$1.9 million for the three months ended SeptemberJune 30, 20162021 to $4.0$1.5 million for the three months ended SeptemberJune 30, 2017,2022, primarily due to lease expirations, early lease terminations and reduced depreciable asset basis for the Commonwealth Building as a result of the growth in our real estate portfolio.non-cash impairment charges recorded subsequent to June 30, 2021. We expect rental incomedepreciation and tenant reimbursementsamortization to increasedecrease in future periods due to the extent we make additional acquisitionsanticipated future dispositions of real estate investments.properties and fully amortized tenant origination and absorption costs related to lease expirations, partially offset by increases in capital improvements.
Operating, maintenance, and management costsInterest expense increased from $0.5$0.6 million for the three months ended SeptemberJune 30, 20162021 to $1.0$0.7 million for the three months ended SeptemberJune 30, 2017, as a result of (a) the growth in our real estate portfolio (b) increase in utility and repairs and maintenance costs for properties held throughout both periods and (c) increase in bad debt expense related to a tenant default at a property held throughout both periods. We expect operating, maintenance, and management expenses to increase in future periods to the extent we make additional acquisitions of real estate investments.
Real estate taxes and insurance increased from $0.2 million for the three months ended September 30, 2016 to $0.5 million for the three months ended September 30, 2017, primarily as a result of the growth in our real estate portfolio. We expect real estate taxes and insurance to increase in future periods as a result of inflation and to the extent we make additional acquisitions of real estate investments.
Asset management fees to affiliate for the three months ended September 30, 2016 was $0.2 million. Asset management fees to our affiliate for the three months ended September 30, 2017 was $0.3 million, all of which were waived by our advisor. We amended our advisory agreement on August 9, 2017 to change how asset management fees are calculated. We expect asset management fees to increase in future periods as a result of this change and also to the extent we make additional real estate investments.
Depreciation and amortization increased from $1.1 million for the three months ended September 30, 2016 to $2.0 million for the three months ended September 30, 2017, primarily as a result of the growth in our real estate portfolio and the acceleration of amortization of intangible assets related to a tenant default at a property held throughout both periods. We expect depreciation and amortization to increase in future periods to the extent we make additional acquisitions of real estate investments.
Interest expense increased from $0.4 million for the three months ended September 30, 2016 to $0.8 million for the three months ended September 30, 2017.2022. Included in interest expense is the amortization of deferred financing costs of $46,064 and $0.1 million for the three months ended SeptemberJune 30, 20162022 and 2017, respectively.2021. Interest expense (including gains and losses) incurred as a result of our derivative instruments, decreased interest expense by $0.1 million for the three months ended June 30, 2022 and increased interest expense by $28,000 for the three months ended June 30, 2021. The increase in interest expense is primarily due to increased borrowings in connection with the acquisition of real estate, resulting in an increase in one-month LIBOR and its impact on interest expense related to our variable rate debt, offset by a decrease in interest expense due to the average loan balance. Weexpiration of an interest rate swap in November 2021 that was not accounted for as a cash flow hedge. In general, we expect interest expense to increasedecrease in future periods due to debt repayments related to anticipated future asset sales, which may be offset by certain fees and costs that may be incurred due to the prepayment of certain loans. Our interest expense in future periods will also vary based on fluctuations in one-month LIBOR (for our unhedged variable rate debt) and our level of future borrowings, which will depend on the availability and cost of debt financing, draws on our debts and any debt repayments we make.
During the three months ended June 30, 2022, we recorded non-cash impairment charges of $8.4 million related to the Commonwealth Building as a result of a continued decrease in occupancy and changes in cash flow estimates including a change in leasing projections, which triggered the future estimated undiscounted cash flows to be lower than the net carrying value of the property. As of June 30, 2022, the Commonwealth Building was 51.8% occupied. We are projecting longer lease-up periods for the vacant space as demand for office space in Portland has significantly declined as a result of both the COVID-19 pandemic, with employees continuing to work from home, and the impact of the disruptions caused by protests and demonstrations and increased crime in the downtown area. Downtown Portland is experiencing record high office vacancies and it is uncertain when the market will fully recover.
Comparison of the six months ended June 30, 2022 versus the six months ended June 30, 2021
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Six Months Ended June 30, | | Increase
(Decrease) | | Percentage Change | | | | |
| | 2022 | | 2021 | | | | |
| Rental income | $ | 7,317 | | | $ | 8,375 | | | $ | (1,058) | | | (13) | % | | | | |
| Other operating income | 76 | | | 69 | | | 7 | | | 10 | % | | | | |
| Operating, maintenance and management costs | 1,825 | | | 1,765 | | | 60 | | | 3 | % | | | | |
| Property management fees and expenses to affiliate | 46 | | | 59 | | | (13) | | | (22) | % | | | | |
| Real estate taxes and insurance | 1,556 | | | 1,494 | | | 62 | | | 4 | % | | | | |
| Asset management fees to affiliate | 866 | | | 862 | | | 4 | | | — | % | | | | |
| General and administrative expenses | 1,033 | | | 922 | | | 111 | | | 12 | % | | | | |
| Depreciation and amortization | 3,052 | | | 3,878 | | | (826) | | | (21) | % | | | | |
| Interest expense | 1,141 | | | 1,181 | | | (40) | | | (3) | % | | | | |
| Impairment charges on real estate | 11,733 | | | — | | | 11,733 | | | 100 | % | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Rental income decreased from $8.4 million for the six months ended June 30, 2021 to $7.3 million for the six months ended June 30, 2022, primarily due to a decrease in occupancy rate from 82.1% as of June 30, 2021 to 74.5% as of June 30, 2022 as a result of lease expirations. Overall, we expect rental income to decrease in future periods due to anticipated borrowings to the extent we make additional acquisitionsfuture dispositions of real estate investments.
properties and uncertainty and business disruptions as a result of the outbreak of COVID-19 and social unrest in the Portland area where one of our properties is located. See “Market Outlook - Real Estate and Real Estate Finance Markets - COVID-19 Pandemic and Portfolio Outlook” for a discussion on the impact of the COVID-19 pandemic on our business.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Comparison of the nine months ended September 30, 2017 versus the nine months ended September 30, 2016
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | | For the Nine Months Ended September 30, | | Increase (Decrease) | | Percentage Change | | $ Change Due to Acquisitions (1) | | $ Change Due to Property Held Throughout Both Periods (2) |
| | | 2017 | | 2016 | | �� | | |
| Rental income | | $ | 9,714 |
| | $ | 3,402 |
| | $ | 6,312 |
| | 186 | % | | $ | 6,303 |
| | $ | 9 |
|
| Tenant reimbursements | | 2,478 |
| | 248 |
| | 2,230 |
| | 899 | % | | 2,175 |
| | 55 |
|
| Other operating income | | 56 |
| | 28 |
| | 28 |
| | 100 | % | | 27 |
| | 1 |
|
| Operating, maintenance and management costs | | 2,606 |
| | 788 |
| | 1,818 |
| | 231 | % | | 1,769 |
| | 49 |
|
| Property management fees | | 91 |
| | 41 |
| | 50 |
| | 122 | % | | 48 |
| | 2 |
|
| Real estate taxes and insurance | | 1,507 |
| | 319 |
| | 1,188 |
| | 372 | % | | 1,193 |
| | (5 | ) |
| Asset management fees to affiliate | | 214 |
| | 212 |
| | 2 |
| | 1 | % | | 62 |
| | (60 | ) |
| Real estate acquisition fees to affiliate | | — |
| | 1,383 |
| | (1,383 | ) | | (100 | )% | | n/a |
| | n/a |
|
| Real estate acquisition fees and expenses | | — |
| | 233 |
| | (233 | ) | | (100 | )% | | n/a |
| | n/a |
|
| General and administrative expenses | | 1,224 |
| | 1,032 |
| | 192 |
| | 19 | % | | n/a |
| | n/a |
|
| Depreciation and amortization | | 5,571 |
| | 1,575 |
| | 3,996 |
| | 254 | % | | 3,681 |
| | 315 |
|
| Interest expense | | 2,275 |
| | 665 |
| | 1,610 |
| | 242 | % | | 1,571 |
| | 39 |
|
| Interest and other income | | 42 |
| | 104 |
| | (62 | ) | | (60 | )% | | — |
| | (62 | ) |
| Loss from extinguishment of debt | | (206 | ) | | — |
| | (206 | ) |
| (100 | )% |
| — |
| | (206 | ) |
_____________________(1)Represents the dollar amount increase for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 related to real estate investments acquired on or after January 1, 2016.
(2) Represents the dollar amount increase (decrease) for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 with respect to the real estate investment owned by us throughout both periods presented.
Rental income and tenant reimbursements increased from $3.7 million for the nine months ended September 30, 2016 to $12.2 million for the nine months ended September 30, 2017, primarily as a result of the growth in our real estate portfolio. We expect rental income and tenant reimbursements to increase in future periods to the extent we make additional acquisitions of real estate investments.
Operating, maintenance, and management costs increased from $0.8remained consistent at $1.8 million for the ninesix months ended SeptemberJune 30, 2016 to $2.6 million for the nine months ended September 30, 2017, primarily as a result of the growth in our real estate portfolio.2022 and 2021. We expect operating, maintenance, and management expensescosts to increasedecrease in future periods due to the extent we make additional acquisitionsanticipated future dispositions of real estate investments.properties, offset by general increase due to inflation and as physical occupancy increases as employees return to the office.
Real estate taxes and insurance increased slightly from $0.3 million for the nine months ended September 30, 2016 to $1.5 million for the ninesix months ended SeptemberJune 30, 2017,2021 to $1.6 million for the six months ended June 30, 2022, primarily asdue to a result of the growthnet increase in our real estate portfolio.property taxes due to increased property values and rates. We expect real estate taxes and insurance to increasedecrease in future periods due to the extent we make additional acquisitionsanticipated future dispositions of real estate investments.properties, partially offset by general increase due to inflation.
Asset management fees to affiliate remained consistent at $0.9 million for the ninesix months ended SeptemberJune 30, 2016 was $0.2 million for this period. Asset management fees to affiliate for the nine months ended September 30, 2017 was $0.7 million, of which $0.5 million was waived by our advisor. We amended our advisory agreement on August 9, 2017 to change how asset management fees are calculated.2022 and 2021. We expect asset management fees to increasedecrease in future periods due to anticipated future dispositions of real estate properties, partially offset by increases in capital improvements. As of June 30, 2022, we had accrued and deferred payment of $8.5 million of asset management fees related to the periods from October 2017 through June 30, 2022.
General and administrative expenses increased from $0.9 million for the six months ended June 30, 2021 to $1.0 million for the six months ended June 30, 2022, primarily due to legal fees related to our plan of liquidation incurred during the six months ended June 30, 2022. General and administrative costs consisted primarily of legal fees, internal audit compensation expense, errors and omissions insurance, board of directors fees and audit cost.
Depreciation and amortization decreased from $3.9 million for the six months ended June 30, 2021 to $3.1 million for the six months ended June 30, 2022, primarily due to lease expirations, early lease terminations and reduced depreciable asset basis for the Commonwealth Building as a result of this changenon-cash impairment charges recorded subsequent to June 30, 2021. We expect depreciation and alsoamortization to the extent we make additional real estate investments.
Real estate acquisition fees and expensesdecrease in future periods due to affiliate and non-affiliates were $1.6 million for the nine months ended September 30, 2016, which related to the acquisition of one real estate property for $68.5 million. During the nine months ended September 30, 2017, we did not acquire any real estate properties. We amended our advisory agreement August 9, 2017 to eliminate the payment of an acquisition fee to our advisor and do not expect to incur real estate acquisition fees to affiliates going forward. In addition, we adopted ASU No. 2017-01 for the reporting period beginning January 1, 2017. As a result of the adoption of ASU No. 2017-01, our acquisitionsanticipated future dispositions of real estate properties beginning January 1, 2017 could qualifyand fully amortized tenant origination and absorption costs related to lease expirations, partially offset by increases in capital improvements.
Interest expense decreased slightly from $1.2 million for the six months ended June 30, 2021 to $1.1 million for the six months ended June 30, 2022. Included in interest expense is the amortization of deferred financing costs of $0.1 million for the six months ended June 30, 2022 and 2021. Interest expense (including gains and losses) incurred as a result of our derivative instruments, decreased interest expense by $0.2 million for the six months ended June 30, 2022 and increased interest expense by $31,000 for the six months ended June 30, 2021. The decrease in interest expense is primarily due to the expiration of an interest rate swap in November 2021 that was not accounted for as a cash flow hedge, offset by an increase in one-month LIBOR and its impact on interest expense related to our variable rate debt. In general, we expect interest expense to decrease in future periods due to debt repayments related to anticipated future asset acquisitionssales, which may be offset by certain fees and costs that may be incurred due to the prepayment of certain loans. Our interest expense in future periods will also vary based on fluctuations in one-month LIBOR (for our unhedged variable rate debt) and our level of future borrowings, which will depend on the availability and cost of debt financing, draws on our debts and any debt repayments we make.
During the six months ended June 30, 2022, we recorded non-cash impairment charges of $11.7 million to write down the carrying value of the Commonwealth Building, an office property located in Portland, Oregon and the Institute Property, an office property located in Chicago, Illinois, to their estimated fair values as opposed to business combinations. Transaction costs associated with asset acquisitions are capitalized, while transaction costs associated with business combinations will continuea result of changes in cash flow estimates including a change in leasing projections, which triggered the future estimated undiscounted cash flows to be expensed.lower than the net carrying value of the properties. In addition, the Commonwealth Building has experienced a continued decrease in occupancy. As of June 30, 2022, the Commonwealth Building was 51.8% occupied. The decrease in cash flow projections during the six months ended June 30, 2022 was primarily due to reduced demand for the office space at both properties resulting in longer lease-up periods and a decrease in projected rental rates due to the COVID-19 pandemic which resulted in additional challenges to re-lease the vacant space. Moreover, the decrease in cash flow projections during the six months ended June 30, 2022 for the Commonwealth building was also affected by the disruptions caused by protests and demonstrations and increased crime in the downtown area of Portland, where the property is located. Further, tenants at the Institute Property have been adversely impacted by the measures put in place to control the spread of COVID-19 and certain tenants at the Institute Property were granted rent concessions as their businesses have been severely impacted. We did not record any impairment charges on our real estate properties during the six months ended June 30, 2021.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
General and administrative expenses increased from $1.0 million for the nine months ended September 30, 2016 to $1.2 million for the nine months ended September 30, 2017, due to higher portfolio legal fees, board of director fees, external auditor fees and internal audit compensation. We expect general and administrative costs to increase in future periods to the extent we make additional acquisitions of real estate investments.
Depreciation and amortization increased from $1.6 million for the nine months ended September 30, 2016 to $5.6 million for the nine months ended September 30, 2017, primarily as a result of the growth in our real estate portfolio. We expect depreciation and amortization to increase in future periods to the extent we make additional acquisitions of real estate investments.
Interest expense increased from $0.7 million for the nine months ended September 30, 2016 to $2.3 million for the nine months ended September 30, 2017. Included in interest expense is the amortization of deferred financing costs of $77,034 and $0.4 million for the nine months ended September 30, 2016 and 2017, respectively. The increase in interest expense is primarily due to increased borrowings in connection with the acquisition of real estate, resulting in an increase in the average loan balance. We expect interest expense to increase in the future as a result of anticipated borrowings in future periods to the extent we make additional acquisitions of real estate investments.
During the nine months ended September 30, 2017, we recognized a loss from extinguishment of debt of $0.2 million related to the write-off of unamortized deferred financing costs as a result of the pay-off of the Von Karman Tech Center Mortgage Loan on May 9, 2017.
Funds from Operations and Modified Funds from Operations
We believe that funds from operations (“FFO”) is a beneficial indicator of the performance of an equity REIT. We compute FFO in accordance with the current National Association of Real Estate Investment Trusts (“NAREIT”) definition. FFO represents net income, excluding gains and losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), gains and losses from change in control, impairment losses on real estate assets, depreciation and amortization of real estate assets, and adjustments for unconsolidated partnerships and joint ventures. We believe FFO facilitates comparisons of operating performance between periods and among other REITs. However, our computation of FFO may not be comparable to other REITs that do not define FFO in accordance with the NAREIT definition or that interpret the current NAREIT definition differently than we do. Our management believes that historical cost accounting for real estate assets in accordance with U.S. generally accepted accounting principles (“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 presentations, provides a more complete understanding of our performance relative to our competitors and provides a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.
Changes in accounting rules have resulted in a substantial increase in the number of non-operating and non-cash items included in the calculation of FFO. As a result, our management also uses MFFO as an indicator of our ongoing performance as well as our dividend sustainability. MFFO excludes from FFO: acquisition fees and expenses (to the extent that such fees and expenses have been recorded as operating expenses); adjustments related to contingent purchase price obligations; amounts relating to straight-line rents and amortization of above and below market intangible lease assets and liabilities; accretion of discounts and amortization of premiums on debt investments; amortization of closing costs relating to debt investments; impairments of real estate-related investments; mark-to-market adjustments included in net income; and gains or losses included in net income for the extinguishment or sale of debt or hedges. We compute MFFO in accordance with the definition of MFFO included in the practice guideline issued by the IPA in November 2010 as interpreted by management. Our computation of MFFO may not be comparable to other REITs that do not compute MFFO in accordance with the current IPA definition or that interpret the current IPA definition differently than we do.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
We believe that MFFO is helpful as a measure of ongoing operating performance because it excludes costs that management considers more reflective of investing activities and other non-operating items included in FFO. Management believes that, by excluding acquisition costs (to the extent such costs have been recorded as operating expenses) as well as non-cash items such as straight line rental revenue, MFFO provides investors with supplemental performance information that is consistent with the performance indicators and analysis used by management, in addition to net income and cash flows from operating activities as defined by GAAP, to evaluate the sustainability of our operating performance. MFFO provides comparability in evaluating the operating performance of our portfolio with other non-traded REITs which typically have limited lives with short and defined acquisition periods and targeted exit strategies. MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes.
FFO and MFFO are non-GAAP financial measures and do not represent net income as defined by GAAP. Net income as defined by GAAP is the most relevant measure in determining our operating performance because FFO and MFFO include adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization and the other items described above. Accordingly, FFO and MFFO should not be considered as alternatives to net income as an indicator of our current and historical operating performance. In addition, FFO and MFFO do not represent cash flows from operating activities determined in accordance with GAAP and should not be considered an indication of our liquidity. We believe FFO and MFFO, in addition to net income and cash flows from operating activities as defined by GAAP, are meaningful supplemental performance measures.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Although MFFO includes other adjustments, the exclusion of adjustments for straight-line rent, the amortization of above- and below-market leases loss from extinguishment of debt and acquisition fees and expensesunrealized (gains) losses on derivative instruments are the most significant adjustments for the periods presented. We have excluded these items based on the following economic considerations:
•Adjustments for straight-line rent. These are adjustments to rental revenue as required by GAAP to recognize contractual lease payments on a straight-line basis over the life of the respective lease. We have excluded these adjustments in our calculation of MFFO to more appropriately reflect the current economic impact of our in-place leases, while also providing investors with a useful supplemental metric that addresses core operating performance by removing rent we expect to receive in a future period or rent that was received in a prior period;
•Amortization of above- and below-market leases.Similar to depreciation and amortization of real estate assets and lease related costs that are excluded from FFO, GAAP implicitly assumes that the value of intangible lease assets and liabilities diminishes predictably over time and requires that these charges be recognized currently in revenue. Since market lease rates in the aggregate have historically risen or fallen with local market conditions, management believes that by excluding these charges, MFFO provides useful supplemental information on the realized economics of the real estate;
andLoss•Unrealized (gains) losses on derivative instruments. These adjustments include unrealized (gains) losses from extinguishment of debt. A loss from extinguishment of debt represents the difference between the carryingmark-to-market adjustments on interest rate swaps. The change in fair value of any consideration transferred to the lenderinterest rate swaps not designated as a hedge are non-cash adjustments recognized directly in return for the extinguishment of a debtearnings and the net carrying value of the debt at the time of settlement.are included in interest expense. We have excluded the loss from extinguishment of debtthese adjustments in our calculation of MFFO because these losses do not impact the current operating performance of our investments and do not provide an indication of future operating performance; and
Acquisition fees and expenses. Prior to our early adoption of ASU No. 2017-01 on January 1, 2017, acquisition fees and expenses related to the acquisition of real estate were expensed. Although these amounts reduce net income, we exclude them from MFFO to more appropriately presentreflect the ongoing operating performanceeconomic impact of our real estate investments on a comparative basis. Additionally, acquisition fees and expenses have been funded from the proceeds from our private and public offerings, net proceeds from our distribution reinvestment plan, and from debt financings, and not from our operations. We believe this exclusion is useful to investors as it allows investors to more accurately evaluate the sustainability of our operating performance.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
interest rate swap agreements.
Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by NAREIT, is presented in the following table, along with our calculation of MFFO, for the three and ninesix months ended SeptemberJune 30, 20172022 and 2016,2021, respectively (in thousands). No conclusions or comparisons should be made from the presentation of these periods.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended
June 30, | | For the Six Months Ended
June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Net loss | | $ | (9,515) | | | $ | (945) | | | $ | (13,854) | | | $ | (1,717) | |
| Depreciation of real estate assets | | 922 | | | 1,141 | | | 1,859 | | | 2,309 | |
| Amortization of lease-related costs | | 582 | | | 755 | | | 1,193 | | | 1,569 | |
| Impairment charges on real estate | | 8,409 | | | — | | | 11,733 | | | — | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| FFO | | 398 | | | 951 | | | 931 | | | 2,161 | |
| Straight-line rent and amortization of above- and below-market leases, net | | (320) | | | (133) | | | (657) | | | (216) | |
| Unrealized gain on derivative instruments | | (223) | | | (417) | | | (564) | | | (850) | |
| | | | | | | | |
| | | | | | | | |
| MFFO | | $ | (145) | | | $ | 401 | | | $ | (290) | | | $ | 1,095 | |
|
| | | | | | | | | | | | | | | | |
| | | For the Three Months Ended September 30, | | For the Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| Net loss | | $ | (783 | ) | | $ | (304 | ) | | $ | (1,404 | ) | | $ | (2,466 | ) |
| Depreciation of real estate assets | | 644 |
| | 425 |
| | 1,891 |
| | 522 |
|
| Amortization of lease-related costs | | 1,387 |
| | 705 |
| | 3,680 |
| | 1,053 |
|
| FFO | | 1,248 |
| | 826 |
| | 4,167 |
| | (891 | ) |
| Straight-line rent and amortization of above- and below-market leases, net | | (408 | ) | | (549 | ) | | (1,482 | ) | | (679 | ) |
| Loss from extinguishment of debt | | — |
| | — |
| | 206 |
| | — |
|
| Real estate acquisition fees to affiliate | | — |
| | — |
| | — |
| | 1,383 |
|
| Real estate acquisition fees and expenses | | — |
| | 3 |
| | — |
| | 233 |
|
| MFFO | | $ | 840 |
| | $ | 280 |
| | $ | 2,891 |
| | $ | 46 |
|
FFO and MFFO may also be used to fund all or a portion of certain capitalizable items that are excluded from FFO and MFFO, such as tenant improvements, building improvements and deferred leasing costs.
Organization and Offering Costs
Offering costs include all expenses incurred in connection with our offerings of securities. Organization costs include all expenses incurred in connection with our formation, including but not limited to legal fees and other costs to incorporate.
With respect to our public offering, our advisor and dealer manager generally paid our organization and offering expenses incurred in the primary portion of our initial public offering (other than selling commissions, dealer manager fees and stockholder servicing fees) directly.
We reimbursed our advisor, the dealer manager and their affiliates up to 1.0% of gross primary offering proceeds raised in our initial public offering for commercially reasonable organization and offering expenses. Our advisor, the dealer manager, and their affiliates were responsible for all organization and other offering expenses (which excludes selling commissions, dealer manager fees and stockholder servicing fees) related to the primary portion of our initial public offering to the extent they exceeded 1.0% of gross proceeds raised in the primary portion of our initial public offering. We did not reimburse the dealer manager for wholesaling compensation expenses.
During our initial private offering, we were obligated to reimburse our advisor, our dealer manager or their affiliates, as applicable, for organization and offering costs (excluding wholesaling compensation expenses) paid by them on our behalf. We recorded $1.5 million of offering costs (other than selling commissions and dealer manager fees) related to our initial private offering, all of which have been reimbursed to our advisor or its affiliates.
Our advisor has agreed to pay all offering expenses related to our recently launched second private placement offering directly on our behalf without reimbursement by us.
Through September 30, 2017, our advisor and its affiliates had incurred organization and other offering costs (which exclude selling commissions, dealer manager fees and stockholder servicing fees) on our behalf in connection with the initial public offering of approximately $4.2 million. As of September 30, 2017, we had recorded $39,358 of organization and other offering expenses related to the initial public offering, which amounts represent our maximum liability for organization and other offering costs as of the termination of our primary initial public offering based on the limitation described above.
As of September 30, 2017, KBS Capital Advisors had incurred $0.9 million in offering expenses on our behalf related to the second private placement offering. The advisor has agreed to pay these expenses on our behalf without reimbursement by us.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Distributions
During our offering stage, when we may raise capital more quickly than we acquire income producing assets, and from time to time during our operational stage, we may not pay distributions solely from our cash flows from operations, in which case distributions may be paid in whole or in part from debt financing, including advances from our advisor, if necessary. Distributions declared, distributions paid and cash flows from operations were as follows for the first, second and third quarters of 2017 (in thousands, except per share amounts):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Cash Distributions Declared (1) | | Cash Distribution Declared Per Class A Share (1) (2) | | Cash Distribution Declared Per Class T Share (1) (2) | | Cash Distributions Paid (3) | | Cash Flows from Operations |
| Period | | | | | Cash | | Reinvested | | Total | |
| First Quarter 2017 | | $ | 1,115 |
| | $ | 0.123 |
| | $ | 0.099 |
| | $ | 516 |
| | $ | 588 |
| | $ | 1,104 |
| | $ | 83 |
|
| Second Quarter 2017 | | 1,154 |
| | 0.125 |
| | 0.100 |
| | 549 |
| | 611 |
| | 1,160 |
| | 1,521 |
|
| Third Quarter 2017 | | 1,170 |
| | 0.124 |
| | 0.124 |
| | 592 |
| | 587 |
| | 1,179 |
| | 1,331 |
|
| | | $ | 3,439 |
| | $ | 0.372 |
| | $ | 0.323 |
| | $ | 1,657 |
| | $ | 1,786 |
| | $ | 3,443 |
| | $ | 2,935 |
|
_____________________
(1) Distributions for the periods from January 1, 2017 through August 31, 2017 were based on daily record dates and were calculated based on stockholders of record each day during this period at a rate of (i) $0.00136986 per share per day, less (ii) the applicable daily class-specific stockholder servicing fees accrued for and allocable to any class of common stock, divided by the number of shares of common stock of such class outstanding as of the close of business on each respective record date. Distributions for the period from September 1, 2017 through September 30, 2017 were based on daily record dates and were calculated based on stockholders of record each day during this period at a rate of $0.00131849 per day.
(2) Assumes Class A and Class T shares were issued and outstanding each day that was a record date for distributions during the period presented.
(3) Distributions are paid on a monthly basis. In general, distributions for all record dates of a given month are paid on or about the first business day of the following month.
For the nine months ended September 30, 2017, we paid aggregate distributions of $3.4 million, including $1.6 million of distributions paid in cash and $1.8 million of distributions reinvested through our distribution reinvestment plan. Our net loss for the nine months ended September 30, 2017 was $1.4 million.FFO for the nine months ended September 30, 2017 was $4.2 million and cash flows from operations for the nine months ended September 30, 2017 was $2.9 million. See the reconciliation of FFO to net loss above. We funded our total distributions paid, which includes net cash distributions and distributions reinvested by stockholders, with $2.4 million of cash flows from operations and $1.0 million of debt financing.
From inception through September 30, 2017, we paid cumulative distributions of $7.0 million and our cumulative net loss during the same period was $6.3 million. To the extent that we pay distributions from sources other than our cash flow from operating activities, we will have less funds available for the acquisition of real estate investments, the overall return to our stockholders may be reduced and subsequent investors will experience dilution.
In addition, through August 31, 2017, our board of directors declared stock dividends for each month based on a single record date at the end of each month in an amount that would equal a 1% annualized stock dividend per share of common stock if paid each month for a year. Stock dividends are issued in the same class of shares as the shares for which such stockholder received the stock dividend.
Going forward we expect our board of directors to continue to authorize and declare cash distributions based on daily record dates and to pay these distributions on a monthly basis. Cash distributions will be determined by our board of directors based on our financial condition and such other factors as our board of directors deems relevant. Our board of directors has not pre-established a percentage rate of return for cash distributions to stockholders. We have not established a minimum distribution level, and our charter does not require that we make distributions to our stockholders. In connection with its consideration of a Plan of Liquidation, our board of directors determined to cease paying regular quarterly distributions with the expectation that any future distributions to our stockholders would be liquidating distributions from the sale of our remaining assets.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Over the long-term, we expect that a greater percentage of our distributions will be paid from cash flow from operations and FFO (except with respect to distributions related to sales of our assets and distributions related to the repayment of principal under real estate-related investments). Our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including those discussed under “Forward - Looking Statements,” “Market Outlook - Real Estate and Real Estate Finance Markets,” “Liquidity and Capital Resources” and “Results of Operations” herein and the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC. Those factors include: our ability to raise capital to make additional investments; the future operating performance of our current and future real estate investments in the existing real estate and financial environment; our advisor’s ability to identify additional real estate investments that are suitable to execute our investment objectives; the success and economic viability of our tenants; our ability to refinance existing indebtedness at comparable terms; changes in interest rates on any variable rate debt obligations we incur; and the level of participation in our distribution reinvestment plan. In the event our FFO and/or cash flow from operations decrease in the future, the level of our distributions may also decrease. In addition, future distributions declared and paid may exceed FFO and/or cash flow from operations.
Critical Accounting Policies
Our consolidated interim financial statements and condensed notes thereto have been prepared in accordance with GAAP and in conjunction with the rules and regulations of the SEC. The preparation of our financial statements requires significant management judgments, assumptions and estimates about matters that are inherently uncertain. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses. A discussion of the accounting policies that management considers critical in that they involve significant management judgments, assumptions and estimates is included in our Annual Report on Form 10-K for the year ended December 31, 20162021 filed with the SEC. There have been no significant changes to our accounting policies during 2017.2022.
Subsequent Events
We evaluate subsequent events up until the date the consolidated financial statements are issued.
Cash Distributions PaidModified Term Loan
On October 2, 2017,August 1, 2022, we, paid cash distributions of $0.4 million and $11,013, which related to Class A and Class T cash distributions, respectively, declared for daily record dates for each day in the period from September 1, 2017 through September 30, 2017. On November 1, 2017, we paid cash distributions of $0.4 million and $11,421, which related to Class A and Class T cash distributions, respectively, declared for daily record dates for each day in the period from October 1, 2017 through October 31, 2017.
Distributions Authorized
On October 10, 2017, our board of directors authorized cash distributions on the outstanding shares of all classes of our common stock based on daily record dates for the period from November 1, 2017 through November 30, 2017, which we expect to pay in December 2017. On November 8, 2017, our board of directors authorized cash distributions on the outstanding shares of all classes of our common stock based on daily record dates for the period from December 1, 2017 through December 31, 2017, which we expect to pay in January 2018. Investors may choose to receive cash distributions or purchase additional shares through our distribution reinvestment plan. Distributions for these periods will be calculated based on stockholders of record each day during these periods at a rate of $0.00131849 per share per day.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Real Estate Acquisition and Financing Subsequent to September 30, 2017
Acquisition and Related Financing of the Institute Property
On November 9, 2017, we, through an indirect wholly owned subsidiary, acquiredsubsidiaries (collectively, the “Borrower”), entered into a seven-story office building containing 157,166 rentable square feet located on approximately 0.5 acres of land and a parking lot containing approximately 8,038 square feet on approximately 0.18 acres of land in Chicago, Illinois (together, the “Institute Property”). The seller is not affiliated with us or our advisor.
The total purchase price of the Institute Property was $43.5 million plus closing costs. We funded the purchase of the Institute Property with proceeds from the Amended and Restated Term Loan (discussed below) and proceeds from our now-terminated initial private offering and initial public offering.
On November 9, 2017, in connection with the acquisition of the Institute Property, we amendedmodification agreement to the Term Loan (the “Modified Term Loan”) with JP Morgan Chase Bank, N.A., (the “Lender”) to increase(i) extend the loan amountmaturity date from November 9, 2022 to $72.8 million (consisting of $48.5 million ofNovember 9, 2023, (ii) convert the revolving commitment to term commitment and $24.3(iii) reset the interest rate of the Term Loan. The Modified Term Loan has an outstanding balance of $52.3 million, of revolving commitment)which is the maximum term commitment available under the Modified Term Loan. The Modified Term Loan continues to be secured by the Offices at Greenhouse and to add the Institute Property as collateral to the Term Loan (the “Amended and Restated Term Loan”). Property.
The Amended and RestatedModified Term Loan bears interest at the forward-looking term rate based on SOFR (“Secured Overnight Financing Rate”) with a floating rate of interesttenor comparable to one-month plus 10 basis points (“Adjusted Term SOFR”) plus 200 basis points per annum equalprior to 2.0% over one-month LIBOR. The initial maturity date is NovemberMay 9, 2020, with two one-year extension options, subject to terms and conditions contained in2023. After May 9, 2023, the loan agreement.Modified Term Loan will bear interest at Adjusted Term SOFR plus 250 basis points per annum. Monthly payments are interest onlyinterest-only with the entire unpaidremaining principal balance, all accrued and unpaid interest and all outstanding interest and feesother sums due at maturity. Also on November 9, 2017, we drew $40.3 million under the Amended and Restated Term Loan (consisting of $16.0 million of term commitment and $24.3 million of revolving commitment) which, when combined with $32.5 million already outstanding under the Term Loan, was the maximum amount available to be drawn.loan documents payable at maturity. We have the right to prepay all or a portion of the Modified Term Loan at any time, subject to certain fees and conditions contained in the loan documents.
Subject to certain terms and conditions contained in the loan documents, cash currently held by us may only be used for our operating costs including but not limited to our general and administrative costs, liquidation costs (which may include proxy solicitation costs, DST transfer agent costs, legal costs, tail insurance policy costs and other reasonable and customary costs to maintain the company in good standing), capital costs (including building improvements, tenant improvements and leasing commissions at its owned properties) and any other reasonable costs and expenses required to maintain the company as a going concern (collectively “REIT Operating Costs”), but for no other purpose. Further, we are required to deposit any cash amount exceeding $7.0 million into an account controlled by the Lender or apply it to pay down the Modified Term Loan. We are prohibited from making any cash distributions (other than REIT Operating Costs) except for amounts needed to maintain REIT status and redemptions sought upon a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program) not exceeding $250,000 annually, in the aggregate, for any calendar year. In addition, on a monthly basis, any excess cash flow (as defined in the modification agreement) from the Offices at Greenhouse and the Institute Property is required to be deposited into an account which will serve as additional security for the loan.
KBSGI REIT Properties, LLC (“KBS GI REIT Properties”), our wholly owned subsidiary, in connection with the Modified Term Loan, is providing a guaranty of the payment of (i) principal balance and any interest or other sums outstanding under the Modified Term Loan as of the date such amounts become due, and (ii) the principal balance and any interest or other sums outstanding under the Modified Term Loan in the event of: certain bankruptcy, insolvency or related proceedings involving the Borrower and KBS GI REIT Properties, as described in the loan documents. KBS GI REIT Properties is also providing a guaranty of the payment of certain liabilities, losses, damages, costs and expenses (including legal fees) incurred by the Lender as a result of certain intentional actions or omissions committed by the Borrower, KBS GI REIT Properties and/or any of their affiliates in violation of the loan documents, or certain other occurrences in relation to The Offices at Greenhouse, the Institute Property and/or the Borrower, as further described in the amended and restated guaranty.
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to the effects of interest rate changes as a result of borrowings used to maintain liquidity and to fund the acquisition, expansionfinancing and refinancing of our real estate investment portfolio and operations. Our profitability and the value of our real estate investment portfolio may be adversely affected during any period as a result of interest rate changes. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs. We may manage interest rate risk by maintaining a ratio of fixed rate, long-term debt such that variable rate exposure is kept at an acceptable level or we may utilize a variety of financial instruments, including interest rate caps, floors, and swap agreements, in order to limit the effects of changes in interest rates on our operations. When we use these types of derivatives to hedge the risk of interest-earning assets or interest‑bearinginterest-bearing liabilities, we may be subject to certain risks, including the risk that losses on a hedge position will reduce the funds available for the payment of distributions to our stockholders and that the losses may exceed the amount we invested in the instruments.
We expect to borrow funds and make investments at a combination of fixed and variable rates. Interest rate fluctuations will generally not affect future earnings or cash flows on fixed rate debt unless such debt mature or is otherwise terminated. However, interest rate changes will affect the fair value of fixed rate instruments. At SeptemberJune 30, 2017,2022, we did not have any fixed rate debt outstanding.
Conversely, movements in interest rates on variable rate debt would change future earnings and cash flows, but not significantly affect the fair value of the debt. However, changes in required risk premiums would result in changes in the fair value of variable rate instruments. At SeptemberJune 30, 2017,2022, we were exposed to market risks related to fluctuations in interest rates on $73.5$71.6 million of variable rate debt outstanding.outstanding, after giving consideration to the impact of interest rate swap agreements on approximately $30.0 million of our variable debt. Based on interest rates as of SeptemberJune 30, 2017,2022, if interest rates were 100 basis points higher or lower during the 12 months ending SeptemberJune 30, 2018,2023, interest expense on our variable rate debt would increase or decrease by $0.7 million.
The weighted average interest rate of our variable rate debt at SeptemberJune 30, 20172022 was 3.5%4.0%. The interest rate represents the actual interest rate in effect at SeptemberJune 30, 20172022 (consisting of the contractual interest rate)rate and the effect of interest rate swaps, if applicable), using interest rate indices as of SeptemberJune 30, 20172022 where applicable.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our principal executive officer and principal financial officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
WeThere have not evaluated any changebeen no changes in our internal control over financial reporting that occurred during our last fiscalthe quarter dueended June 30, 2022 that have materially affected, or are reasonably likely to a transition period established by the rules of the Securities and Exchange Commission for newly public companies. We expect to issue management’s first assessment regardingmaterially affect, our internal control over financial reporting for the year ending December 31, 2017 and to evaluate any changes in our internal controls over financial reporting in each quarterly and annual report thereafter.
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
Please see the risks discussed below and in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016.2021 as filed with the SEC.
We have paid distributions from advances fromIf our advisor and debt financing. In the future we may continuedetermines to pay distributions from financings, including an advance from our advisor, and we may not pay distributions solely from our cash flow from operations. To the extent we pay distributions from sources other than our cash flows from operations, we will have less funds available for investment in assets, the overall returnno longer waive or defer certain fees due to our stockholders may be reduced and subsequent investors will experience dilution.
We expect to have little, if any, cash flow from operations available for distribution until we make substantial investments, and we therefore expect that portions of distributions made during our first few years of operations will be considered a return of capital. During our offering stage, when we may raise capital more quickly than we acquire income-producing assets, and for some period after our offering stage, we may not be able to pay distributions solely from our cash flow from operations, in which case distributions may be paid in whole or in part from debt financing, including advances from our advisor. Our distributions paid through September 30, 2017 have been paid from cash flow from operating activities, advances from our advisor and debt financing and we expect that in the future we may not pay distributions solely from our cash flow from operations.
We may fund distributions from any source, including, without limitation, offering proceeds or borrowings (which may constitute a return of capital). We may also fund such distributions from the sale of assets. If we fund distributions from borrowings, our interest expense and other financing costs, as well as the repayment of such borrowings, will reduce our earnings and cash flow from operations available for distribution in future periods. If we fund distributions from the sale of assets, this will affectthem, our ability to generate cash flow fromfund our operations in future periods. To the extent that we pay distributions from sources other than our cash flow from operations, we will have fewer funds available with which to make real estate investments, the overall return to our stockholders may be reduced and subsequent investors will experience dilution. In addition,adversely affected.
From time to time, our advisor may agree to waive or defer all or a portion of the extent distributions exceed cash flow from operations, a stockholder’s basisasset management or other fees, compensation or incentives due to it, pay general administrative expenses or otherwise supplement stockholder returns in our stock will be reduced and,order to the extent distributions exceed a stockholder’s basis, the stockholder may recognize capital gain. There is no limit onincrease the amount of cash available to fund our operations or make distributions we may fund from sources other than from cash flow from operations.
Forto stockholders. Specifically, in the nine months ended September 30, 2017, we paid aggregate distributionssecond and third quarters of $3.4 million, including $1.6 million of distributions paid in cash and $1.8 million of distributions reinvested through our distribution reinvestment plan. We funded our total distributions paid, which includes net cash distributions and distributions reinvested by stockholders, with $2.4 million of cash flows from operations and $1.0 million of debt financing. For the nine months ended September 30, 2017, our cash flows fromadvisor waived its asset management fee and beginning October 2017 through June 30, 2022, the advisor deferred its asset management fee. If our advisor chooses to no longer waive or defer such fees, our ability to fund our operations to distributions paid coverage ratio was 85% and our funds from operations to distributions paid coverage ratio was 121%.may be adversely affected.
See Part I, Item II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations and Modified Funds from Operations” and “- Distributions” herein.
PART II. OTHER INFORMATION (CONTINUED)
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
a).During the period covered by this Form 10-Q, no equity securities that were not registered under the Securities Act of 1933 (the “Act”) were sold.
b).Not applicable.
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a) | During the period covered by this Form 10-Q, no equity securities that were not registered under the Securities Act were sold. |
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b) | On April 28, 2016, our Registration Statement on Form S-11 (File No. 333-207471), covering a public offering of up to $1,500,000,000 in shares of common stock in our primary offering and up to $800,000,000 in shares of common stock in our distribution reinvestment plan offering was declared effective under the Securities Act. Our shares of common stock consist of two classes of shares: Class A shares and Class T shares. We commenced our initial public offering on April 28, 2016 upon retaining KBS Capital Markets Group LLC, an affiliate of our advisor, as the dealer manager of our offering. From commencement of the primary initial public offering through its termination on June 30, 2017, we offered Class A shares at $10.39 per share and Class T shares at $10.00 per share, with discounts available to certain categories of investors. Through August 9, 2017, we offered shares under our distribution reinvestment plan at $9.40 per share. |
c).We continue to offer shares of common stock under our distribution reinvestment plan athave adopted a price of $8.75 per share which is our estimated net asset value per share as established by our board of directors on August 9, 2017. In some states, we will need to renew the registration statement annually to continue our distribution reinvestment plan offering. We may terminate our distribution reinvestment plan offering at any time.
We sold 122,721 and 270,415 shares of Class A and Class T common stock in our primary initial public offering for aggregate gross offering proceeds of $3.9 million. Through September 30, 2017, we had sold 297,753 and 6,250 shares of Class A and Class T common stock in our distribution reinvestment plan offering for aggregate gross offering proceeds of $2.9 million.
As of September 30, 2017, we had incurred selling commissions, dealer manager fees and organization and other offering costs in connection with our initial public offering in the amounts set forth below. We paid selling commissions and dealer manager fees to KBS Capital Markets Group, and KBS Capital Markets Group reallowed all selling commissions and a portion of the dealer manager fees to participating broker-dealers. In addition, we reimbursed KBS Capital Advisors and KBS Capital Markets Group for certain organization and other offering expenses.
|
| | | | | | |
| | | Amount | | |
| Type of Expense Amount | | (in thousands) | | Estimated/Actual |
Selling commissions and dealer manager fees (1) | | $ | 199 |
| | Actual |
Organization and other offering costs (excluding selling commissions, dealer manager fees and stockholder servicing fees) (2) | | 39 |
| | Actual |
| Total expenses for the issuer's account | | $ | 238 |
| | |
_____________________
(1) Except as described in the “Plan of Distribution” section of our prospectus, as amended and supplemented, an annual stockholder servicing fee of 1.0% of the purchase price per share (ignoring any discountsredemption program that may be availableenable stockholders to certain categories of purchasers) for the Class Tsell their shares sold in our primary initial public offering was paid to our dealer manager. This fee for our initial public offering accrued daily and was paid monthly in arrears through the termination of our primary initial public offering on June 30, 2017. Our dealer manager reallowed all of the stockholder servicing fee paid to it. The stockholder servicing fee was an ongoing fee that was not paid at the time of purchase and was not intended to be a principal use of offering proceeds; it is therefore excluded from the table above. We paid approximately $12,000 in stockholder servicing fees related to all Class T shares sold in the primary portion of our initial public offering.
(2) KBS Capital Advisors and its affiliates generally paid our organization and other offering expenses incurred in the primary portion of our initial public offering directly and we reimbursed KBS Capital Advisors and its affiliates for the commercially reasonable organization and other offering expenses they incurred on our behalf in connection with the primary portion of our initial public offering subject to the following limitation.
We reimbursed our advisor, the dealer manager and their affiliates for up to 1.0% of gross proceeds raised in the primary portion of our initial public offering. Our advisor, the dealer manager, and their affiliates are responsible for all organization and other offering expenses (which excludes selling commissions, dealer manager fees and stockholder servicing fees) related to the primary portion of our initial public offering to the extent they exceed 1.0% of gross proceeds raised in the primary portion of our initial public offering. The amount included above represents our maximum liability for organization and other offering costs based on the limits described. As of September 30, 2017, KBS Capital Advisors and its affiliates had incurred an additional $4.2 million in organization and other offering costs on our behalf in connection with our initial public offering.
PART II. OTHER INFORMATION (CONTINUED)
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds (continued)
From the commencement of our initial public offering through the June 30, 2017 primary offering termination, the net offering proceeds to us after deducting the total expenses incurred as described above, were approximately $6.1 million, including net offering proceeds from our distribution reinvestment plan of $2.4 million.in limited circumstances.
We expect to use substantially all of the net proceeds from our offering stage to acquire and manage a diverse portfolio of core real estate properties. We expect to use substantially all of the net proceeds from the sale of shares under our distribution reinvestment plan for general corporate purposes, including, but not limited to: the repurchase of shares underCurrently, our share redemption program; capital expenditures, tenant improvement costsprogram is only available for redemptions sought upon a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program, and leasing costs related to our real estate properties; reserves required by any financings of our real estate investments; the acquisition of real estate investments; and the repayment of debt.collectively “special redemptions”).
As of September 30, 2017, except for a working capital reserve, we had used substantially all the net proceeds from our now-terminated private and primary initial public offering and debt financing to invest $139.7 million in three office properties, including $3.3 million of acquisition fees and expenses and closing costs.
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c) | We have adopted a share redemption program that may enable stockholders to sell their shares to us in limited circumstances. |
Pursuant to the share redemption program, as amended to date, there are several limitations on our ability to redeem shares:
Unless the shares are being redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined under the share redemption program), we may not redeem shares until the stockholder has held his or her shares for one year.
•During anyeach calendar year, wespecial redemptions are limited to an annual dollar amount determined by our board of directors, which may redeem only the number of shares that we could purchase with the amount of net proceeds from the sale of shares under our distribution reinvestment planbe reviewed during the prior calendar year. However, we may increaseyear and increased or decrease the funding available for the redemption of shares pursuant to the programdecreased upon ten business days’ notice to our stockholders. The dollar amount limitation for the calendar year 2022 is $250,000 in the aggregate, as may be reviewed and adjusted from time to time by our board of directors.
•During any calendar year, we may redeem no more than 5% of the weighted‑averageweighted-average number of shares outstanding during the prior calendar year.
•We have no obligation to redeem shares if the redemption would violate the restrictions on distributions under Maryland law, which prohibits distributions that would cause a corporation to fail to meet statutory tests of solvency.
We will redeem shares submitted in connection with an ordinary redemptionSpecial redemptions are redeemed at 95.0% of oura price equal to the most recent estimated NAV per share as of the applicable redemption date.
For purposes of determining whether a redeeming stockholder has held the share submitted for redemption for at least one year, the time period begins as of the date the stockholder acquired the share; provided, that shares purchased by the redeeming stockholder pursuant to the distribution reinvestment plan or received as a stock dividend will be deemed to have been acquired on the same date as the initial share to which the distribution reinvestment plan shares or stock dividend shares relate.
Upon a transfer of shares any pending redemption requests with respect to such transferred shares will be canceled as of the date the transfer is accepted by the Company. Stockholders wishing to continue to have a redemption request related to any transferred shares considered by the Company must resubmit their redemption request.
On August 9, 2017December 6, 2021, our board of directors approved an estimated NAV per share of our common stock of $8.75$3.38 based on the estimated value of our assets less the estimated value of our liabilities, or NAV, divided by the number of shares outstanding, all as of JuneSeptember 30, 2017.2021. For a full description of the methodologies used to value our assets and liabilities in connection with the calculation of our estimated NAV per share as of JuneSeptember 30, 2017,2021, see the Current Report on Form 8-K filed with the SEC on AugustDecember 10, 2017, and incorporated herein by reference.2021. We expect to update the estimated NAV annually in December.
We may amend, suspend or terminate our share redemption program upon 10 business days’ notice. We redeem shares on the last business day of each month. For a stockholder’s shares to be eligible for redemption in a given month or to withdraw a redemption request, we must receive a written notice from the stockholder or from an authorized representative of the stockholder in good order and on a form approved by us at least five business days before the redemption date.
PART II. OTHER INFORMATION (CONTINUED)
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds (continued)
In several respects the Company treats redemptions sought upon a stockholder’s death, qualifying disability or determination of incompetence differently from other redemptions:
there is no one-year holding requirement; and
the redemption price will be the estimated NAV per share as of the redemption date.
We may amend, suspend or terminate the program upon 30 days’ notice to our stockholders, provided that we may increase or decrease the funding available for the redemption of shares pursuant to the share redemption program upon 10 business days’ notice. We may provide this notice by including such information in a Current Report on Form 8-K or in our annual or quarterly reports, all publicly filed with the SEC, or by a separate mailing to our stockholders.
During the ninesix months ended SeptemberJune 30, 2017, we fulfilled all redemption requests eligible for redemption under our share redemption program and received in good order. We funded2022, redemptions under our share redemption program were funded with the net proceeds from our distribution reinvestment plan,existing cash on hand and weshares were redeemed shares pursuant to our share redemption program as follows:
|
| | | | | | | | | |
| Month | | Total Number of Shares Redeemed | | Average Price Paid Per Share (1) | | Approximate Dollar Value of Shares Available That May Yet Be Redeemed Under the Program |
| January 2017 | | — |
| | $ | — |
| | (2) |
| February 2017 | | — |
| | $ | — |
| | (2) |
| March 2017 | | — |
| | $ | — |
| | (2) |
| April 2017 | | 3,047 |
| | $ | 8.50 |
| | (2) |
| May 2017 | | 4,555 |
| | $ | 8.51 |
| | (2) |
| June 2017 | | — |
| | $ | — |
| | (2) |
| July 2017 | | 2,351 |
| | $ | 8.84 |
| | (2) |
| August 2017 | | 17,621 |
| | $ | 8.31 |
| | (2) |
| September 2017 | | 17,651 |
| | $ | 8.31 |
| | (2) |
| Total | | 45,225 |
| | | | |
_____________________ | | | | | | | | | | | | | | | | | | | | |
| Month | | Total Number of Shares Redeemed | | Average Price Paid Per Share (1) | | Approximate Dollar Value of Shares Available That May Yet Be Redeemed Under the Program |
| January 2022 | | 166 | | | $ | 3.38 | | | (2) |
| February 2022 | | 4,112 | | | $ | 3.38 | | | (2) |
| March 2022 | | — | | | $ | — | | | (2) |
| April 2022 | | — | | | $ | — | | | (2) |
| May 2022 | | — | | | $ | — | | | (2) |
| June 2022 | | — | | | $ | — | | | (2) |
| | | | | | |
| | | | | | |
| | | | | | |
| Total | | 4,278 | | | | | |
_____________________
(1) The prices at which we redeem shares under the program are as set forth above.
(2) We limit the dollar value of shares that may be redeemed under the program as described above. One of these limitations is that during each calendar year, our shareBased on the redemption program limits the number of shareslimitation described above and redemptions through June 30, 2022, we may redeem up to those that we could purchase with the amount of the net proceeds from the sale$236,000 of shares under our distribution reinvestment plan during the prior calendar year. However, we may increase or decrease the funding available for the redemption of shares upon ten business days’ notice to our stockholders. During the nine months ended September 30, 2017, we redeemed $0.4 million of shares of common stock and $1.4 million was available for redemptions of shares eligible for redemption for the remainder of 2017.2022.
Item 3. Defaults uponUpon Senior Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information
None.
43
Item 6. Exhibits