Filed Pursuant to Rule 424(b)(3)
Registration No. 333-126087
KBS REAL ESTATE INVESTMENT TRUST, INC.
SUPPLEMENT NO. 54 DATED AUGUST 22, 2008
TO THE PROSPECTUS DATED JANUARY 13, 2006
This document supplements, and should be read in conjunction with, the prospectus of KBS Real Estate Investment Trust, Inc. dated January 13, 2006, as supplemented by supplement no. 28 dated July 3, 2007, supplement no. 37 dated October 3, 2007, supplement no. 45 dated January 3, 2008, supplement no. 50 dated April 4, 2008, supplement no. 52 dated June 24, 2008 and supplement no. 53 dated August 5, 2008. As used herein, the terms “we,” “our” and “us” refer to KBS Real Estate Investment Trust, Inc. and, as required by context, KBS Limited Partnership, which we refer to as our “Operating Partnership” and to their subsidiaries. Capitalized terms used in this supplement have the same meanings as set forth in the prospectus. The purpose of this supplement is to disclose:
| • | the status of the offering; |
| • | updated risks related to an investment in us; |
| • | an amendment and restatement of our dividend reinvestment plan; |
| • | an amendment and restatement of our share redemption program; |
| • | the declaration of daily distributions and an amendment to our advisory agreement made in connection with the declaration of distributions; |
| • | information with respect to distributions declared for the second quarter of 2008; |
| • | the financing of a single-story distribution building containing 205,645 rentable square feet in Suwanee, Georgia; |
| • | the execution of an agreement for a secured four-year mortgage loan facility to refinance existing bridge loans; |
| • | the execution of an agreement to acquire an eight-story office building containing 223,726 rentable square feet in West Conshohocken, Pennsylvania; |
| • | the acquisition and related financing of four single-story office buildings containing 235,224 rentable square feet in Alpharetta, Georgia; |
| • | the acquisition of two two-story office buildings containing 127,085 rentable square feet in Sacramento, California; |
| • | the acquisition of a 10-story office building containing 205,659 rentable square feet in Tulsa, Oklahoma; |
| • | information regarding our indebtedness; |
| • | “Management’s Discussion and Analysis of Financial Condition and Results of Operations” similar to that filed in our Quarterly Report on Form 10-Q for the three and six months ended June 30, 2008, filed on August 14, 2008; and |
| • | our unaudited financial statements and the notes thereto as of and for the three months and six months ended June 30, 2008. |
Status of the Offering
We ceased offering shares of common stock in our primary offering of 200,000,000 shares on May 30, 2008 but are continuing to process subscriptions from qualified accounts. For investments by qualified accounts, subscription agreements must be dated on or before May 30, 2008 with all documents and funds received by us by the end of business on September 1, 2008. We are continuing to offer shares of common stock under our dividend reinvestment plan and may do so until we have sold all 80,000,000 shares. As of August 19, 2008, we had accepted aggregate gross offering proceeds of approximately $1.75 billion.
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Risk Factors
Before purchasing our common stock, you should carefully consider the following risks as well as those described in the prospectus under “Risk Factors,” in supplement no. 28 under “Risk Factors,” in supplement no. 37 under “Risks Related to an Investment in Us,” in supplement no. 45 under “Risks Related to an Investment in Us,” in supplement no. 50 under “Risk Factors” and in supplement no. 52 under “Risk Factors.”
The amount of cash available for distributions in future periods will be decreased by the repayment of the advance from the advisor and the payment of the advisor’s deferred asset management fee.
Our advisor has advanced $1.6 million to us for cash distributions and expenses in excess of revenues through August 14, 2008, all of which is outstanding. Of the $1.6 million advanced from our advisor to cover distributions and expenses in excess of revenues as of August 14, 2008, no amount has been advanced since January 2007. We are obligated to reimburse our advisor on demand for the $1.6 million advance if and to the extent that our cumulative funds from operations for the period commencing January 1, 2006 through the date of any such reimbursement exceed the lesser of (i) the cumulative amount of any distributions declared and payable to our stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for our stockholders for the period from July 18, 2006 through the date of such reimbursement. No interest will accrue on the advance being made by the advisor.
Our advisor has deferred, without interest, the payment of approximately $2.2 million of accrued but unpaid asset management fees related to the months of July 2006 through September 2007. Although pursuant to the advisory agreement, the advisor may demand payment of accrued but unpaid asset management fees at any time, the advisor does not intend to request payment of accrued but unpaid asset management fees until our cumulative funds from operations for the period commencing January 1, 2006 plus the amount of the advance from the advisor through the date of payment of accrued but unpaid asset management fees exceed the lesser of (i) the cumulative amount of any distributions declared and payable to our stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for our stockholders for the period from July 18, 2006 through the date of such payment. Based on these criteria for payment of deferred asset management fees, on October 31, 2007 we paid the advisor $1.0 million of the $3.2 million of asset management fees that had been accrued but unpaid for the months of July 2006 through September 2007. In addition, we have paid our advisor asset management fees of $8.0 million earned pursuant to the advisory agreement for services related to the months of October 2007 through June 2008. If necessary in future periods, the advisor intends to defer payment of its asset management fee if the cumulative amount of our funds from operations for the period commencing January 1, 2006 plus the amount of the advance from the advisor is less than the cumulative amount of distributions declared and currently payable to our stockholders.
In addition to deferred asset management fees for the months of July 2006 through September 2007, we have incurred but unpaid performance fees totaling $2.2 million related to our joint venture investment in the National Industrial Portfolio. The performance fee is earned by the advisor only upon our meeting certain funds from operations thresholds and makes the advisor’s cumulative fees related to our investment in the National Industrial Portfolio joint venture equal to 0.75% of the cost of the joint venture investment on an annualized basis from the date of our investment in the joint venture through the date of calculation. As of June 30, 2008, our operations were sufficient to meet the funds from operations condition in the advisory agreement. Although these performance fees have been incurred as of June 30, 2008, the advisory agreement further provides that the payment of the performance fee shall only be made after the repayment of advances from the advisor discussed above. The amount of cash available for distributions in future periods will be decreased by the repayment of the advance from the advisor, the payment of our advisor’s deferred asset management fee and the performance fee related to our joint venture investment in the National Industrial Portfolio.
Second Amended and Restated Dividend Reinvestment Plan
On August 12, 2008, we amended and restated our dividend reinvestment plan to make two clarifications. With respect to commissions on shares sold under the dividend reinvestment plan, the plan now specifically provides that to the extent permitted under state securities laws, we will pay selling commissions on shares of common stock purchased under the dividend reinvestment plan if we paid selling commissions on the underlying shares to which the distributions relate in our primary offering. Participating broker-dealers may agree to waive selling commissions on dividend reinvestment plan shares in which case no selling commissions will be paid to any person in connection with sales of such shares. All sales of shares under the dividend reinvestment plan will be at the same price, which initially will be $9.50 per share, regardless of the distribution channel through which we sell the shares and regardless of whether a participating broker-dealer has agreed to waive selling commissions on dividend reinvestment plan shares. If no selling commissions are paid on sales of dividend reinvestment plan shares, the amount that would have been paid as a selling commission is retained and used by us.
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The second change to the dividend reinvestment plan clarifies that three years after completion of our offering stage, participants will acquire common stock at a price equal to the estimated value per share of our common stock, as determined by our advisor or other firm chosen by the board of directors for that purpose. Our offering stage will be complete when we are no longer publicly offering equity securities and have not done so for one year. For the purpose of determining when our offering stage is complete, public equity offerings do not include offerings on behalf of selling stockholders or offerings related to any dividend reinvestment plan, employee benefit plan or redemption of interests in our Operating Partnership.
The second amended and restated dividend reinvestment plan will take effect on August 24, 2008. The second amended and restated dividend reinvestment plan has been filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended June 30, 2008, which is available at the SEC’s Web site at http://www.sec.gov.
Share Redemption Program
On August 12, 2008, our board of directors approved a share redemption program plan document. Previously the share redemption program was a narrative description in this prospectus, as supplemented to date. There are no material changes to the share redemption program. The plan document clarifies that once we establish an estimated value per share, the redemption price per share for all stockholders will be equal to the estimated value per share, as determined by our advisor or another firm chosen for that purpose. We expect to establish an estimated value per share three years after completion of our offering stage.
The share redemption program as amended pursuant to the plan document will take effect on September 13, 2008. The share redemption program plan document is filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended June 30, 2008, which is available at the SEC’s Web site at http://www.sec.gov.
Declaration of Distributions and Advance from Advisor
On July 31, 2008, our board of directors declared a daily distribution for the period from August 1, 2008 through August 31, 2008, which distribution we expect to pay in September 2008. On August 12, 2008, our board of directors declared a daily distribution for the period from September 1, 2008 through September 30, 2008, which distribution we expect to pay in October 2008 and a daily distribution for the period from October 1, 2008 through October 31, 2008, which distribution we expect to pay in November 2008. Investors may choose to receive cash distributions or purchase additional shares through our dividend reinvestment plan. Distributions are calculated based on stockholders of record each day during the period at a rate of $0.0019178 per share per day and equal a daily amount that, if paid each day for a 365-day period, would equal a 7.0% annualized rate based on a purchase price of $10.00 per share.
Also on July 31, 2008 and August 12, 2008, in connection with the declaration of distributions, we entered into amendments to our advisory agreement with KBS Capital Advisors. Pursuant to the amendments, our advisor agreed to advance funds to us equal to the amount by which the cumulative amount of distributions declared by our board of directors from January 1, 2006 through the period ending October 31, 2008 exceeds the amount of our funds from operations (as defined by NAREIT) from January 1, 2006 through October 31, 2008.
We are only obligated to reimburse the advisor for these expenses if and to the extent that our cumulative funds from operations for the period commencing January 1, 2006 through the date of any such reimbursement exceed the lesser of (i) the cumulative amount of any distributions declared and payable to our stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for our stockholders for the period from July 18, 2006 through the date of such reimbursement. No interest will accrue on the advance being made by the advisor.
From July 18, 2006 through August 14, 2008, the advisor had advanced an aggregate of $1.6 million to us, all of which is outstanding, for the payment of distributions and to cover our expenses, excluding depreciation and amortization, in excess of our revenues. No amount has been advanced since January 2007.
Distributions for the Second Quarter of 2008
Each day during the period from January 1, 2008 through June 30, 2008 was a record date for distributions. The distributions were calculated at a rate of $0.0019178 per share per day and equal a daily amount that, if paid each day for a 365-day period, would equal a 7.0% annualized rate based on a purchase price of $10.00 per share. Stockholders may choose whether to have distributions paid in cash or to have cash distributions otherwise payable to them invested in additional shares of common stock through our dividend reinvestment plan.
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For the six months ended June 30, 2008, we declared aggregate distributions of approximately $42,228,000 and our funds from operations (“FFO”) was approximately $44,726,000. (See the reconciliation of FFO to net income below). For detailed information with respect to distributions and FFO for the three months ended March 31, 2008, see Supplement no. 52. For the three months ended June 30, 2008, we declared aggregate distributions of approximately $25,162,000 and our FFO was approximately $22,094,000. For the month ended April 30, 2008, we declared distributions of approximately $7,058,000 that were paid on May 15, 2008 and our FFO was approximately $9,090,000. For the month ended May 31, 2008, we declared distributions of approximately $8,407,000 that were paid on June 16, 2008 and our FFO was approximately $10,010,000. For the month ended June 30, 2008, we declared distributions of approximately $9,697,000 that were paid on July 15, 2008 and our FFO was approximately $2,994,000. During the month ended June 30, 2008, we recognized an other-than-temporary impairment of marketable securities of approximately $7.0 million. The other-than-temporary impairment was recognized due to a prolonged decrease of the market value of our floating rate commercial mortgage-back securities below our cost basis and a downgrade in the credit rating of these securities in July 2008. In addition to the other-than-temporary impairment of marketable securities, other noncash adjustments impact net income and FFO. These other noncash adjustments, including amortization of discounts on real estate loans receivable, are described more fully below under “—Funds from Operations.” Until we have fully invested the proceeds from our primary offering in income-producing assets, there is a greater risk that we will not be able to pay distributions solely from our FFO.
As described above under “Declaration of Distributions and Advance from Advisor,” our advisor agreed to advance funds to us equal to the amount by which the cumulative amount of distributions declared by our board of directors from January 1, 2006 through the period ending October 31, 2008 exceeds the amount of our funds from operations (as defined by NAREIT) from January 1, 2006 through October 31, 2008. Through August 14, 2008, our advisor has advanced an aggregate of $1.6 million to us for cash distributions and expenses in excess of revenues, all of which is outstanding. No amount has been advanced since January 2007.
In addition, our advisor has deferred, without interest, the payment of approximately $2.2 million of accrued but unpaid asset management fees related to the months of July 2006 through September 2007. Although pursuant to the advisory agreement, our advisor may demand payment of accrued but unpaid asset management fees at any time, our advisor does not intend to request payment of accrued but unpaid asset management fees until our cumulative funds from operations for the period commencing January 1, 2006 plus the amount of the advance from our advisor through the date of payment of accrued but unpaid asset management fees exceed the lesser of (i) the cumulative amount of any distributions declared and payable to our stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for our stockholders for the period from July 18, 2006 through the date of such payment. Based on this criteria for payment of deferred asset management fees, on October 31, 2007 we paid our advisor $1.0 million of the $3.2 million of asset management fees that had been accrued but unpaid for the months of July 2006 through September 2007. In addition, we have paid our advisor asset management fees of $8.0 million earned pursuant to the advisory agreement for services related to the months of October 2007 through June 2008. If necessary in future periods, our advisor intends to defer payment of its asset management fee if the cumulative amount of our funds from operations for the period commencing January 1, 2006 plus the amount of the advance from our advisor is less than the cumulative amount of distributions declared and currently payable to our stockholders.
In addition to deferred asset management fees for the months of July 2006 through September 2007, we have incurred but unpaid performance fees totaling $2.2 million related to our joint venture investment in the National Industrial Portfolio. The performance fee is earned by our advisor only upon us meeting certain funds from operations thresholds and makes the advisor’s cumulative fees related to our investment in the National Industrial Portfolio joint venture equal to 0.75% of the cost of the joint venture investment on an annualized basis from the date of our investment in the joint venture through the date of calculation. As of June 30, 2008, our operations were sufficient to meet the funds from operations condition in the advisory agreement. Although these performance fees have been incurred as of June 30, 2008, the advisory agreement further provides that the payment of the performance fee shall only be made after the repayment of advances from our advisor discussed above. The amount of cash available for distributions in future periods will be decreased by the repayment of the advance from our advisor, the payment of our advisor’s deferred asset management fee and the performance fee related to our joint venture investment in the National Industrial Portfolio.
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Funds from Operations
We believe that FFO is a beneficial indicator of the performance of any equity REIT. Because FFO calculations exclude such factors as depreciation and amortization of real estate assets and gains 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), they facilitate comparisons of operating performance between periods and between other REITs. Our management believes that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictability 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 a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities. Other REITs may not define FFO in accordance with the current National Association of Real Estate Investment Trusts (“NAREIT”) definition or may interpret the current NAREIT definition differently than we do.
FFO is a non-GAAP financial measure and does not represent net income as defined by GAAP. Net income as defined by GAAP is the most relevant measure in determining operating performance because FFO includes adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization. Accordingly, FFO should not be considered as an alternative to net income as an indicator of our operating performance.
The calculation of FFO, which we believe is consistent with the calculation of FFO as defined by NAREIT, is presented in the following table for the months ended April 30, May 31, and June 30, 2008 and the three and six months ended June 30, 2008 (in thousands):
| For the Month Ended April 30, 2008 | For the Month Ended May 31, 2008 | For the Month Ended June 30, 2008 | For the Three Months Ended June 30, 2008 | For the Six Months Ended June 30, 2008 | ||||||||||||||||
Net income (loss) | $ | 2,533 | $ | 3,629 | $ | (4,388 | ) | $ | 1,774 | $ | 3,963 | |||||||||
Add: | ||||||||||||||||||||
Depreciation of real estate assets | 2,453 | 2,473 | 2,667 | 7,593 | 14,846 | |||||||||||||||
Amortization of lease-related costs | 4,663 | 4,466 | 5,270 | 14,399 | 29,524 | |||||||||||||||
Deduct: | ||||||||||||||||||||
Adjustments for minority interest-consolidated entity (1) | (559 | ) | (558 | ) | (555 | ) | (1,672 | ) | (3,607 | ) | ||||||||||
FFO | $ | 9,090 | $ | 10,010 | $ | 2,994 | $ | 22,094 | $ | 44,726 | ||||||||||
(1) Relates to consolidated joint venture minority interest portion of depreciation of real estate assets and amortization of lease-related costs.
Set forth below is additional information related to certain noncash items included in net income above, which may be helpful in assessing our operating results. In addition, cash flows generated from FFO may be used to fund all or a portion of certain capitalizable items that are excluded from FFO, such as capitalized interest, tenant improvements, building improvements, and deferred lease costs.
Noncash Items Included in Net Income:
| • | Revenues in excess of actual cash received of $1.0 million (net of adjustment for minority interest of $51,365) for the three months ended June 30, 2008 and $2.4 million (net of adjustment for minority interest of $0.1 million) for the six months ended June 30, 2008, as a result of straight-line rent; |
| • | Revenues in excess of actual cash received of approximately $1.1 million (net of adjustment for minority interest of $0.2 million) for the three months ended June 30, 2008 and approximately $2.5 million (net of adjustment for minority interest of $0.6 million) for the six months ended June 30, 2008, as a result of amortization of above-market/below-market in-place leases; |
| • | Amortization of deferred financing costs related to notes payable of approximately $1.7 million (net of adjustment for minority interest of $0.2 million) for the three months ended June 30, 2008 were recognized as interest expense and approximately $3.3 million (net of adjustment for minority interest of $0.5 million) for the six months ended June 30, 2008 were recognized as interest expense; |
| • | Amortization of discounts on real estate loans receivable of $5.7 million and $9.4 million were recognized for the three and six months ended June 30, 2008, respectively; |
| • | Other-than-temporary impairment of marketable securities of $7.0 million was recognized for the three and six months ended June 30, 2008; and |
| • | Gain on an interest rate cap of $0.3 million and $0.2 million (net of adjustment for minority interest of $72,265 and $38,444) were recognized for the three and six months ended June 30, 2008, respectively. |
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Suwanee Pointe Financing
On July 11, 2008, we, through an indirect wholly owned subsidiary, completed the secured financing of Suwanee Pointe, a single-story distribution building containing 205,645 rentable square feet in Suwanee, Georgia. We obtained four-year financing from a financial institution in the amount of approximately $9.8 million through the Portfolio Secured Mortgage Loan Facility described below.
Portfolio Secured Mortgage Loan Facility
On July 11, 2008, certain of our wholly owned subsidiaries, entered into a secured four-year mortgage loan agreement with an unaffiliated lender providing for a secured mortgage loan facility in the maximum principal amount of $158.7 million (the “Portfolio Secured Mortgage Loan Facility”), subject to certain borrowing limitations. The determination of the total amount of the Portfolio Secured Mortgage Loan Facility was based on a percentage of the appraised value of the properties in the portfolio that will serve as collateral for the facility. The maturity date of the loan is July 9, 2012, with two one-year extension options subject to certain conditions. The Portfolio Secured Mortgage Loan Facility bears interest at a floating rate of 220 basis points over 30-day LIBOR. We have purchased interest rate protection for the majority of the loan in the form of an interest rate swap agreement, effectively fixing the interest rate on a majority of the loan at 6.02%. Proceeds from the Portfolio Secured Mortgage Loan Facility were used to pay off short-term bridge loans on 11 properties, aggregating to $139.3 million as of June 30, 2008, which now secure this loan. See the table of outstanding debt obligations under “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Contractual Commitments and Contingencies” in this supplement. In addition, the Portfolio Secured Mortgage Loan Facility was used to fund $19.3 million of the purchase price of Great Oaks Center (see below), which secures the loan. Further, $9.8 million was drawn on this facility to finance Suwanee Pointe, which also secures the loan.
Purchase and Sale Agreement for the Five Tower Bridge Building
On July 16, 2008, we, through an indirect wholly owned subsidiary, entered into a purchase and sale agreement with a seller unaffiliated with us or our advisor to purchase an eight-story office building containing 223,726 rentable square feet located on an approximate 10.3-acre parcel of land in West Conshohocken, Pennsylvania (the “Five Tower Bridge Building”). Pursuant to the purchase and sale agreement, we would be obligated to purchase the property only after satisfactory completion of agreed upon closing conditions. The purchase price of the Five Tower Bridge Building is approximately $73.0 million plus closing costs. There can be no assurance that we will complete the acquisition. In some circumstances, if we fail to complete the acquisition, we may forfeit $500,000 of earnest money.
Acquisition and Related Financing of Great Oaks Center
On July 18, 2008, we, through an indirect wholly owned subsidiary, purchased four single-story office buildings totaling 235,224 rentable square feet (“Great Oaks Center”) from a seller unaffiliated with us or our advisor. Great Oaks Center is located on an approximate 31.0-acre parcel of land in Alpharetta, Georgia. The purchase price of Great Oaks Center was approximately $34.8 million plus closing costs.
We funded the acquisition with a $19.3 million mortgage loan that is included in the Portfolio Secured Mortgage Loan Facility completed on July 11, 2008 (described above) and with proceeds from our primary offering.
Acquisition of the University Park Buildings
On July 31, 2008, we, through an indirect wholly owned subsidiary, purchased two two-story office buildings containing 127,085 rentable square feet (the “University Park Buildings”) from a seller unaffiliated with us or our advisor. The University Park Buildings are located on an approximate 10.9-acre parcel of land in Sacramento, California. The purchase price of the University Park Buildings was approximately $23.9 million plus closing costs.
The acquisition of the University Park Buildings was funded with proceeds from our primary offering, but we may later place mortgage debt on the property.
Acquisition of the Meridian Tower
On August 18, 2008, we, through an indirect wholly owned subsidiary, purchased a 10-story office building totaling 205,659 rentable square feet (the “Meridian Tower”) from a seller unaffiliated with us or our advisor. The Meridian Tower is located on an approximate 3.2-acre parcel of land in Tulsa, Oklahoma. The purchase price of the Meridian Tower was approximately $17.5 million plus closing costs.
The acquisition of the Meridian Tower was funded with proceeds from our primary offering, but we may later place mortgage debt on the property.
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Indebtedness
As of August 14, 2008, our total long-term notes payable with a maturity of longer than one year was approximately $616.9 million. For more information regarding our indebtedness, see the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in this supplement.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our accompanying consolidated financial statements and the notes thereto as of and for the three and six months ended June 30, 2008 contained in this supplement as well as our consolidated financial statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as of and for the year ended December 31, 2007 included in supplement no. 50 dated April 4, 2008.
This discussion contains forward-looking statements that can be identified with the use of forward-looking terminology such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. Actual results may differ from those described in forward-looking statements. For a discussion of the factors that could cause actual results to differ from those anticipated, see “Risk Factors” in the prospectus, “Risk Factors” in supplement no. 28 dated July 3, 2007, “Risks Related to an Investment in Us” in supplement no. 37 dated October 3, 2007, “Risks Related to an Investment in Us” in supplement no. 45 dated January 3, 2008, “Risk Factors” in supplement no. 50 dated April 4, 2008, “Risk Factors” in supplement no. 52 dated June 24, 2008 and “Risk Factors” in this supplement.
Overview
We are a Maryland corporation that elected to be taxed as a real estate investment trust, or REIT, beginning with the taxable year that ended December 31, 2006. On June 23, 2005, we filed a registration statement on Form S-11 (File No. 333-126087) with the SEC to offer a maximum of 280,000,000 shares of common stock for sale to the public. Of the 280,000,000 shares offered, 200,000,000 shares were registered in our primary public offering and 80,000,000 shares were registered under our dividend reinvestment plan. The SEC declared the registration statement effective on January 13, 2006, and we launched our offering on January 27, 2006. On July 5, 2006, we broke escrow in our public offering and then commenced our real estate operations. As of June 30, 2008, we had sold 172,153,293 shares of common stock in our public offering for gross offering proceeds of approximately $1.72 billion. As of June 30, 2008, we had redeemed 452,319 of the shares sold in the offering pursuant to our share redemption program for approximately $4.4 million. We ceased offering shares of common stock in our primary offering of 200,000,000 shares on May 30, 2008, but are continuing to process subscriptions from qualified accounts. For investments by qualified accounts, subscription agreements must be dated on or before May 30, 2008 with all documents and funds received by us by the end of business on September 1, 2008. We continue to offer shares of common stock under our dividend reinvestment plan.
We have used the proceeds of our offering to acquire and manage a diverse portfolio of real estate properties and real estate-related investments. We own substantially all of our assets and conduct our operations through our Operating Partnership, of which we are the sole general partner. We have no paid employees. Our advisor, KBS Capital Advisors, conducts our operations and manages our portfolio of real estate investments.
As of June 30, 2008, we owned 58 real estate properties, one master lease, 19 real estate loans receivable, and two investments in securities directly or indirectly backed by commercial mortgage-backed loans. The 58 real estate properties total 19.7 million square feet, including properties held through a consolidated joint venture. The real estate property portfolio includes 16 office properties, one light industrial property, three corporate research properties, two distribution facilities, one industrial portfolio consisting of nine distribution and office/warehouse properties, one office/flex portfolio consisting of four properties and an 80% membership interest in a joint venture that owns a portfolio of 23 institutional quality industrial properties and a master lease with respect to another property. At June 30, 2008, the portfolio was approximately 95% leased. Our real estate loans receivable portfolio includes three secured loans that we originated as well as six mezzanine real estate loans, two B-Notes, a partial ownership interest in three mezzanine real estate loans, two first mortgage loans, a partial ownership interest in a senior mortgage loan and two loans representing senior subordinated debt of a private REIT. Our marketable securities portfolio includes two investments in securities directly or indirectly backed by commercial mortgage-backed loans.
In constructing our portfolio, we have targeted to acquire approximately 70% core investments, which are generally existing properties with at least 80% occupancy and minimal near-term lease rollover, and approximately 30% real estate-related investments and enhanced-return properties. Though our target portfolio would consist of 30% real estate-related investments and enhanced-return properties, we will not forgo a good investment opportunity because it does not precisely fit our expected portfolio composition. Thus, to the extent that our advisor presents us with good investment opportunities that allow us to meet the REIT requirements under the Internal Revenue Code, our portfolio may consist of a greater percentage of enhanced-return properties and real estate-related investments.
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Real estate-related investments and enhanced-return properties are higher-yield and higher-risk investments that our advisor will actively manage. The real estate-related investments in which we may invest include: (i) mortgage loans; (ii) equity securities such as common stocks, preferred stocks and convertible preferred securities of real estate companies; (iii) debt securities such as mortgage-backed securities, commercial mortgages, mortgage loan participations and debt securities issued by other real estate companies; and (iv) certain types of illiquid securities, such as mezzanine loans and bridge loans. While we may invest in any of these real estate-related investments, we expect that the substantial majority of these investments will consist of mezzanine loans, commercial mortgage-backed securities (“CMBS”) and B-Notes as well as collateralized debt obligations. The enhanced-return properties that we will seek to acquire and reposition include: properties with moderate vacancies or near-term lease rollovers; poorly managed and positioned properties; properties owned by distressed sellers; and built-to-suit properties.
Market Outlook – Real Estate and Real Estate Finance Markets
Through the end of the second quarter of 2008, the U.S. economy faced a continued slowdown as many global financial institutions continued to write-down investments in residential mortgage-backed securities. As a result of losses from these write-downs and general volatility in the markets, financial institutions have tightened underwriting standards and widened credit spreads resulting in an increasing cost of capital to finance all assets, including commercial real estate, commercial mortgage and mezzanine loans, CMBS, residential mortgage-backed securities and corporate-level debt generally. As financial institutions such as banks, insurance companies and brokers seek to replenish lost capital from write-downs and the cost of capital continues to increase, financial institutions have responded by selling real estate, loans related to real estate and other structured finance investments to raise inexpensive capital, resulting in an increased supply of these investments in the marketplace. The increased supply of these assets has driven down their value. Over the short-term, management expects continued volatility in commercial real estate values and the real estate finance and structured finance markets. This may present a short-term opportunity to acquire assets that are undervalued. However, the opportunity is hampered by the increased cost of capital and uncertainty as to when markets will stabilize.
Widening credit spreads affect not only our ability to finance real estate investments but also the value of investments in mortgage and mezzanine loans and real estate-related debt securities. Credit spreads on commercial mortgages (i.e., the interest rate spread overall given benchmarks such as LIBOR or U.S. Treasury securities) are significantly influenced by (i) supply and demand for such mortgage loans and (ii) capital markets execution for the sale or financing of such commercial mortgage assets. In the case of the former, the number of potential lenders in the market and the amount of funds they are willing to devote to commercial mortgage assets will impact credit spreads. As liquidity or “demand” increases, spreads on equivalent commercial mortgage loans will decrease. Conversely, a lack of liquidity will result in credit spreads increasing. During periods of volatility, the number of lenders participating in the market may change at an accelerated pace. Further, many lenders are subject to the capital markets in order to finance their portfolio of commercial loans. Lenders are forced to increase the credit spread at which they are willing to lend as liquidity in the capital markets decrease. As the market tightens, many lenders have requested additional collateral or repayments with respect to their loans in order to maintain margins that are acceptable to them.
For existing loans, when credit spreads widen, the fair value of these existing loans decrease in market price. If a lender were to originate a similar loan today, such loan would carry a greater credit spread than the existing loan. Even though a loan may be performing in accordance with its loan agreement and the underlying collateral has not changed, the fair value of the loan may be negatively impacted by the incremental interest foregone from the widened credit spread. Accordingly, when a lender wishes to sell the loan in a whole loan transaction, a CMBS issuance, finance the loan under a warehouse facility, or pledge the loan in a commercial real estate collateralized debt obligation financing, the reduced fair value of the loan will impact the total proceeds that the lender will receive.
Liquidity and Capital Resources
Since breaking escrow in our public offering on July 5, 2006 and then commencing real estate operations with the acquisition of our first real estate investment on July 7, 2006, our principal demand for funds during the short and long-term is and will be for the acquisition of properties, loans and other real estate-related investments, the payment of operating expenses, payments under debt obligations and distributions to stockholders.
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Net cash flows from financing activities for the six months ended June 30, 2008 were $867.5 million, consisting primarily of net offering proceeds of $776.1 million (after payment of selling commissions, dealer manager fees and other organization and offering expenses of $79.5 million and redemptions of common stock of $3.5 million), aggregate borrowings related to the purchase of real estate and real estate-related investments of $244.2 million, the purchase of three separate interest rate floor agreements for $2.5 million, and borrowing and subsequent payoff of repurchase agreements totaling $99.7 million, relating to the $86.4 million financing of the Arden Portfolio Mezzanine Loans and the $13.3 million financing of marketable securities. We paid distributions of $37.5 million to our investors and repaid $96.6 million of borrowings related to our acquisitions during the six months ended June 30, 2008, bringing our aggregate borrowings related to the purchase of real estate and real estate-related investments to $1,142.9 million as of June 30, 2008. With capital and borrowings from our financing activities, we invested approximately $299.1 million in real estate and $246.1 million in real estate loans receivable, including acquisition fees and closing costs of $5.5 million, and $44.2 million in marketable securities during the six months ended June 30, 2008. Net cash provided by operating activities was $50.1 million from the operation of our real estate investments and interest income from our investments in real estate loans. At June 30, 2008, we had cash and cash equivalents of $403.2 million available for investment in properties and real estate-related investments and the repayment of debt.
As of June 30, 2008, our liabilities totaled $1.2 billion and consisted primarily of long-term notes payable with a maturity of longer than one year of $889.9 million and short-term notes payable with a maturity of one year or less of $253.0 million. Long-term notes payable consisted of $458.2 million of fixed-rate mortgage loans with a weighted-average interest rate of 5.72% and $431.7 million of variable-rate mortgage loans with a weighted-average interest rate of 3.74% for the six months ended June 30, 2008. Short-term notes payable consisted of $253.0 million of variable-rate mortgage loans with a weighted-average interest rate of 4.49% for the six months ended June 30, 2008. These financings are described below under “—Contractual Commitments and Contingencies.”
We expect to continue to use debt to acquire properties and other real estate-related investments. Once we have fully invested the proceeds of our primary offering, we expect our debt financing to be approximately 50% of the cost of our real estate investments (before deducting depreciation or other non-cash reserves) plus the value of our other assets. Our charter limits our borrowings to 75% of the cost (before deducting depreciation or other non-cash reserves) of all our assets; however, we may exceed that limit if a majority of the conflicts committee approves each borrowing in excess of our charter limitation and we disclose such borrowing to our stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. As of June 30, 2008, our borrowings were approximately 51% of the cost (before depreciation or other non-cash reserves) of all of our real estate investments.
We will obtain the capital required to purchase properties and other investments and conduct our operations from the proceeds of our primary offering and any future offerings we may conduct, from secured or unsecured financings from banks and other lenders and from any undistributed funds from our operations.
In addition to making investments in accordance with our investment objectives, we expect to use our capital resources to make certain payments to our advisor and the dealer manager. During our organization and offering stage, these payments will include payments to the dealer manager for selling commissions and the dealer manager fee and payments to the dealer manager, our advisor and their affiliates for reimbursement of certain organization and offering expenses. However, our advisor has agreed to reimburse us to the extent that selling commissions, the dealer manager fee and other organization and offering expenses incurred by us exceed 15% of our gross offering proceeds. During our acquisition and development stage, we will make payments to our advisor in connection with the selection and purchase of real estate investments, the management of our assets and costs incurred by our advisor in providing services to us.
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We have elected to be taxed as a REIT and to operate as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). 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. Provided we have sufficient available cash flow, we intend to authorize and declare daily distributions that will be paid on a monthly basis. We have not established a minimum distribution level.
Contractual Commitments and Contingencies
The following is a summary of our contractual obligations as of June 30, 2008 (in thousands):
| Total | Payments Due During the Years Ending December 31, | ||||||||||||||
Contractual Obligations | Remainder of 2008 | 2009-2010 | 2011-2012 | Thereafter | |||||||||||
Outstanding debt obligations (1) | $ | 1,142,868 | $ | 253,048 | $ | 431,644 | $ | 205,208 | $ | 252,968 | |||||
Interest payments on outstanding debt obligations (2) | $ | 178,592 | $ | 31,436 | $ | 61,558 | $ | 36,783 | $ | 48,815 | |||||
Outstanding funding obligations under real estate loans receivable | $ | 19,737 | $ | 19,737 | $ | - | $ | - | $ | - | |||||
Purchase obligations (3) | $ | 34,750 | $ | 34,750 | $ | - | $ | - | $ | - | |||||
(1) Amounts include principal payments only.
(2) Projected interest payments are based on the outstanding principal amounts and weighted-average interest rates as of June 30, 2008. We incurred interest expense of $26.4 million, excluding amortization of deferred financing costs totaling $3.7 million, during the six months ended June 30, 2008.
(3) As of June 30, 2008, we had entered into a purchase and sale agreement to acquire Great Oaks Center, which consists of four single-story office buildings containing 235,224 rentable square feet in Alpharetta, Georgia. These buildings were acquired by us on July 18, 2008. Subsequent to June 30, 2008, we entered into purchase and sale agreements to acquire the following investments: the Five Tower Bridge Building ($73.0 million plus closing costs), the University Park Buildings ($23.9 million plus closing costs), and the Meridian Tower ($17.5 million plus closing costs). The acquisition of the University Park Buildings was completed on July 31, 2008 and the acquisition of the Meridian Tower was completed on August 18, 2008.
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Our outstanding debt obligations as of June 30, 2008 were as follows (in thousands):
| Principal | Average Interest Rate (1) | Fixed/Variable Interest Rate | Maturity Date(2) | Percent of Total Indebtedness | |||||||
Sabal Pavilion Building - Mortgage Loan | $ | 14,700 | 6.3800% | Fixed | 8/01/2036 | 1.29% | |||||
Plaza in Clayton - Mortgage Loan | 62,200 | 5.8990% | Fixed | 10/06/2016 | 5.44% | ||||||
Southpark Commerce Center II Buildings - Mortgage Loan | 18,000 | 5.6725% | Fixed | 12/06/2016 | 1.57% | ||||||
825 University Avenue Building - Mortgage Loan | 19,000 | 5.5910% | Fixed | 12/06/2013 | 1.66% | ||||||
Midland Industrial Buildings - Mortgage Loan | 24,050 | 5.7550% | Fixed | 1/06/2011 | 2.10% | ||||||
Crescent Green Building - Mortgage Loan | 32,400 | 5.1800% | Fixed | 2/01/2012 | 2.83% | ||||||
625 Second Street Building - Mortgage Loan | 33,700 | 5.8500% | Fixed | 2/01/2014 | 2.95% | ||||||
Sabal VI Building - Mortgage Loan | 11,040 | 5.1400% | Fixed | 10/01/2011 | 0.97% | ||||||
The Offices at Kensington - Mortgage Loan | 18,500 | 5.5200% | Fixed | 4/01/2014 | 1.62% | ||||||
Bridgeway Technology Center - Mortgage Loan | 26,824 | 6.0700% | Fixed | 8/01/2013 | 2.35% | ||||||
Royal Ridge Building - Mortgage Loan | 21,718 | 5.9600% | Fixed | 9/01/2013 | 1.90% | ||||||
Plano Corporate Center I & II - Mortgage Loan | 30,591 | 5.9000% | Fixed | 9/01/2012 | 2.68% | ||||||
2200 West Loop South Building - Mortgage Loan | 17,426 | 5.8900% | Fixed | 10/01/2014 | 1.52% | ||||||
Cedar Bluffs - Mortgage Loan | 4,627 | 5.8600% | Fixed | 7/01/2011 | 0.40% | ||||||
National Industrial Portfolio - Mortgage Loan (3) | 300,000 | 3.3369% | Variable | 8/09/2009 | 26.25% | ||||||
National Industrial Portfolio - Mezzanine Loan A (3) | 40,200 | 4.2028% | Variable | 8/09/2009 | 3.52% | ||||||
National Industrial Portfolio - Mezzanine Loan B (3) | 32,300 | 4.5028% | Variable | 8/09/2009 | 2.83% | ||||||
National Industrial Portfolio - Mezzanine Loan C (3) | 32,300 | 4.7528% | Variable | 8/09/2009 | 2.83% | ||||||
National Industrial Portfolio - Mezzanine Loan D (3) | 26,200 | 5.5028% | Variable | 8/09/2009 | 2.29% | ||||||
National Industrial Portfolio - Mezzanine Loan E (3) | 644 | 3.7428% | Variable | 8/09/2009 | 0.06% | ||||||
Hartman Business Center One - Mortgage Loan (4) | 9,479 | 4.5746% | Variable | 11/09/2008 | 0.83% | ||||||
Cardinal Health - Mortgage Loan (4) | 6,900 | 4.5746% | Variable | 11/09/2008 | 0.60% | ||||||
Corporate Express - Mortgage Loan (4) | 5,318 | 4.5746% | Variable | 11/09/2008 | 0.46% | ||||||
Rickenbacker IV - Medline - Mortgage Loan (4) | 9,465 | 4.5122% | Variable | 11/15/2008 | 0.83% | ||||||
Plainfield Business Center - Mortgage Loan (4) | 10,200 | 4.5122% | Variable | 11/15/2008 | 0.89% | ||||||
Crystal Park II - Buildings D & E - Mortgage Loan (4) | 12,009 | 4.5122% | Variable | 11/15/2008 | 1.05% | ||||||
Park 75 - Dell - Mortgage Loan (4) | 10,138 | 4.5122% | Variable | 11/15/2008 | 0.89% | ||||||
Advo-Valassis - Mortgage Loan (4) | 4,988 | 4.5486% | Variable | 11/15/2008 | 0.44% | ||||||
ADP Plaza - Mortgage Loan | 20,900 | 5.5600% | Fixed | 10/01/2013 | 1.83% | ||||||
Woodfield Preserve Office Center - Mortgage Loan (5) | 80,000 | 5.3000% | Fixed | 5/01/2011 | 7.00% | ||||||
Nashville Flex Portfolio - Mortgage Loan (4) | 32,430 | 4.5122% | Variable | 11/15/2008 | 2.84% | ||||||
Patrick Henry Corporate Center - Mortgage Loan (4) | 11,100 | 4.5714% | Variable | 11/29/2008 | 0.97% | ||||||
South Towne Corporate Center I and II - Mortgage Loan (5) | 22,500 | 5.3000% | Fixed | 5/01/2011 | 1.97% | ||||||
Rivertech I and II - Mortgage Loan (4) | 27,300 | 4.0948% | Variable | 11/20/2008 | 2.39% | ||||||
Millennium I Building - Mortgage Loan | 36,000 | 4.6981% | Variable | 12/05/2008 | 3.15% | ||||||
Tysons Dulles Plaza - Mortgage Loan | 77,721 | 4.6994% | Variable | 12/06/2008 | 6.80% | ||||||
| $ | 1,142,868 | 100.00% | |||||||||
(1) Represents the weighted-average interest rate for the current year to date.
(2) Represents initial maturity date or the maturity date as extended as of June 30, 2008; subject to certain conditions, the maturity dates of some loans may be extended beyond the date shown.
(3) Held through a consolidated joint venture. On March 28, 2008 and May 8, 2008, the mortgage and mezzanine loans were restructured to provide for additional debt tranches with varying interest rates. In the aggregate, the weighted-average interest rate of the loans is 125 basis points over 30-day LIBOR.
(4) On July 11, 2008, we paid off the principal and interest under these short-term bridge loans and completed four-year secured financing of the referenced properties described above under “Portfolio Secured Mortgage Loan Facility.”
(5) On April 29, 2008, we paid off the principal and interest under the short-term bridge loans on these properties and completed three-year secured financing of the referenced properties, which is shown above.
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In addition to the contractual obligations set forth above, at June 30, 2008, we have contingent liability with respect to advances to us from our advisor in the amount of $1.6 million for payment of distributions and to cover expenses, excluding depreciation and amortization, in excess of our revenues. We are only obligated to reimburse the advisor for these advances if and to the extent that our cumulative funds from operations for the period commencing January 1, 2006 through the date of any such reimbursement exceed the lesser of (i) the cumulative amount of any distributions declared and payable to our stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for our stockholders for the period from July 18, 2006 through the date of such reimbursement. No interest will accrue on the advance being made by the advisor.
We also have a liability with respect to the payment of asset management fees earned by the advisor of approximately $4.4 million at June 30, 2008. Our advisor has agreed to defer, without interest, the payment of $2.2 million of asset management fees it has earned for the months of July 2006 through September 2007. Although pursuant to the advisory agreement, the advisor may demand payment of accrued but unpaid asset management fees at any time, the advisor does not intend to request payment of accrued but unpaid asset management fees until our cumulative funds from operations for the period commencing January 1, 2006, plus the amount of the advance from the advisor through the date of payment of the accrued but unpaid asset management fees exceed the lesser of (i) the cumulative amount of any distributions declared and payable to our stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for our stockholders for the period from July 18, 2006 through the date of such payment. Based on this criteria for payment of deferred asset management fees, on October 31, 2007, we paid our advisor $1.0 million of the $3.2 million of asset management fees that had been deferred for the months of July 2006 through September 2007. In addition, we have paid our advisor asset management fees of $8.0 million earned pursuant to the advisory agreement for services related to the months of October 2007 through June 2008. If necessary in future periods, our advisor intends to defer payment of its asset management fee if the cumulative amount of our funds from operations for the period commencing January 1, 2006 plus the amount of the advance from our advisor is less than the cumulative amount of distributions declared and currently payable to our stockholders.
In addition to deferred asset management fees for the months of July 2006 through September 2007, we have incurred but unpaid performance fees totaling $2.2 million related to our joint venture investment in the National Industrial Portfolio. The performance fee is earned by the advisor only upon our meeting certain funds from operations thresholds and makes the advisor’s cumulative fees related to our investment in the National Industrial Portfolio joint venture equal to 0.75% of the cost of the joint venture investment on an annualized basis from the date of our investment in the joint venture through the date of calculation. As of June 30, 2008, our operations were sufficient to meet the funds from operations condition in the advisory agreement. Although these performance fees have been incurred as of June 30, 2008, the advisory agreement further provides that the payment of the performance fee shall only be made after the repayment of advances from the advisor discussed above. The amount of cash available for distributions in future periods will be decreased by the repayment of the advance from the advisor, the payment of our advisor’s deferred asset management fee and the performance fee related to our joint venture investment in the National Industrial Portfolio.
Results of Operations
Overview
Our results of operations for the three and six months ended June 30, 2008 are not indicative of those expected in future periods as we expect that rental income and tenant reimbursements, interest income from real estate loans receivable, parking revenues and other operating income, property operating expenses, asset management fees, depreciation, amortization, and net income will each increase in future periods as a result of owning the assets acquired during the three and six months ended June 30, 2008 for an entire period and as a result of anticipated future acquisitions of real estate investments.
Our initial public offering commenced on January 27, 2006. Following the receipt and acceptance of subscriptions for the minimum offering of $2.5 million on July 5, 2006, we acquired 12 real estate properties, three mezzanine real estate loans, a partial ownership interest in a third mezzanine real estate loan, a partial ownership interest in a senior mortgage loan, and an investment in CMBS during 2006 and the first six months of 2007. During the remainder of 2007 and first six months of 2008, we invested in 10 real estate properties, one industrial portfolio consisting of nine distribution and office/warehouse properties, one office/flex portfolio consisting of four properties and an 80% membership interest in a joint venture that owns a portfolio of 23 institutional quality industrial properties and holds a master lease with a remaining term of 14.75 years with respect to another industrial property. Also during this period, we acquired three mezzanine real estate loans, two B-Notes, a partial ownership interest in two mezzanine real estate loans, two loans representing senior subordinated debt of a private REIT and two first mortgage loans. We also originated three secured loans and made an investment in securities indirectly backed by CMBS. Accordingly, the results of operations presented for the three and six months ended June 30, 2008 and 2007, respectively, are not directly comparable.
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Comparison of the three months ended June 30, 2008 versus the three months ended June 30, 2007
Rental income and tenant reimbursements increased from $8.6 million and $1.3 million, respectively, for the three months ended June 30, 2007 to $36.9 million and $8.8 million, respectively, for the three months ended June 30, 2008, primarily as a result of the growth in the real property investment portfolio during 2007 and the six months ended June 30, 2008. Rental income and tenant reimbursements are expected to continue to increase in future periods, as compared to historical periods, as a result of owning the assets acquired during the three months ended June 30, 2008 for an entire period and future acquisitions of real estate assets.
Interest income from real estate loans receivable increased from $2.4 million for the three months ended June 30, 2007 to $15.5 million for the three months ended June 30, 2008, primarily as a result of the growth in the real estate loans receivable portfolio during 2007 and the six months ended June 30, 2008. While interest income from real estate loans receivable is expected to continue to increase in future periods compared to historical periods, as a result of owning assets acquired during the three months ended June 30, 2008 for the entire period and future acquisitions of real estate loans receivable, interest income on loans receivable will also be dependent on our ability to reinvest maturing real estate loans receivable at similar yields. The Tribeca Loans, which contributed $2.8 million or 18% of interest income from real estate loans receivable for the three months ended June 30, 2008, are scheduled to mature on November 1, 2008. The Arden Portfolio Mezzanine loans, which contributed $4.9 million or 32% of interest income from real estate loans receivable during the three months ended June 30, 2008, are scheduled to mature on August 9, 2009.
Parking revenues and other operating income increased from $0.4 million for the three months ended June 30, 2007 to $0.9 million for the three months ended June 30, 2008. The increase is primarily related to parking revenues totaling $0.2 million from 2200 West Loop South Building and ADP Plaza, which were purchased in September 2007 and November 2007, respectively, and loan receivable extension fees from the Tribeca Senior Mortgage Participation of $0.3 million. Parking and other operating income may increase in future periods, as compared to historical periods, as a result of future acquisitions of real estate assets.
Property operating costs and real estate and other property-related taxes increased from $1.5 million and $1.2 million, respectively, for the three months ended June 30, 2007 to $7.6 million and $6.2 million, respectively, for the three months ended June 30, 2008, primarily as a result of the growth in the real property investment portfolio during 2007 and the six months ended June 30, 2008. Property operating costs and real estate and other property-related taxes are expected to continue to increase in future periods, as compared to historical periods, as a result of owning the assets acquired during the three months ended June 30, 2008 for an entire period and future acquisitions of real estate assets.
Asset management fees incurred and payable to our advisor with respect to real estate investments increased from $0.8 million for the three months ended June 30, 2007 to $5.2 million for the three months ended June 30, 2008 as a result of the growth in the portfolio during 2007 and the six months ended June 30, 2008. As of June 30, 2008, we have paid the advisor asset management fees earned pursuant to the advisory agreement for services related to the months of October 2007 through June 2008, other than $2.2 million of performance fees discussed below. In addition, the payment of asset management fees earned by our advisor from July 2006 through September 2007 of $2.2 million has been deferred without interest. Although, pursuant to the advisory agreement, the advisor may demand payment of deferred asset management fees at any time, the advisor does not intend to request payment of deferred asset management fees until our cumulative funds from operations for the period commencing January 1, 2006 plus the amount of the advance from the advisor through the date of payment of the deferred asset management fees exceed the lesser of (i) the cumulative amount of any distributions declared and payable to our stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for our stockholders for the period from July 18, 2006 through the date of such payment. If necessary in future periods, our advisor intends to defer payment of its asset management fee if the cumulative amount of our funds from operations for the period commencing January 1, 2006 plus the amount of the advance from our advisor is less than the cumulative amount of distributions declared and currently payable to our stockholders. As of June 30, 2008, our advisor had also earned $2.2 million of performance fees related to our joint venture investment in the National Industrial Portfolio, which are included in the $5.2 million of asset management fees for the three months ended June 30, 2008. The performance fee is incurred but unpaid as of June 30, 2008. The performance fee is earned by the advisor only upon our meeting certain funds from operations thresholds and makes the advisor’s cumulative fees related to our investment in the National Industrial Portfolio joint venture equal to 0.75% of the cost of the joint venture investment on an annualized basis from the date of our investment in the joint venture through the date of calculation. As of June 30, 2008, our operations were sufficient to meet the funds from operations condition in the advisory agreement. Although these performance fees have been incurred as of June 30, 2008, the advisory agreement further provides that the payment of the performance fee shall only be made after the repayment of advances from the advisor. Advances from the advisor total $1.6 million and have not been paid as of June 30, 2008.
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General and administrative expenses increased from $0.9 million for the three months ended June 30, 2007 to $1.3 million for the three months ended June 30, 2008. These general and administrative costs consisted primarily of legal, audit and other professional fees. We expect general and administrative costs to increase in the future as we make additional investments, but to decrease as a percentage of total revenue.
Depreciation and amortization increased from $4.7 million for the three months ended June 30, 2007 to $22.0 million for the three months ended June 30, 2008, primarily as a result of the growth in the real property investment portfolio during 2007 and the six months ended June 30, 2008. Depreciation and amortization are expected to continue to increase in future periods, as compared to historical periods, as a result of owning the assets acquired during the three months ended June 30, 2008 for an entire period and future acquisitions of real estate assets.
We have financed the acquisition of our investments in part with debt. See above “—Contractual Commitments and Contingencies.” Interest expense (including amortization of deferred financing costs) increased from $3.5 million for the three months ended June 30, 2007 to $14.3 million for the three months ended June 30, 2008, primarily as a result of our use of debt in acquiring real property investments during 2007 and the six months ended June 30, 2008. Our interest expense in future periods will vary based on our level of future borrowings, which will depend on the amount of proceeds raised in our primary offering, the cost of borrowings and the opportunity to acquire real estate assets and real estate-related investments meeting our investment objectives.
During the three months ended June 30, 2008, we recognized an other-than-temporary impairment of marketable securities of approximately $7.0 million. The other-than-temporary impairment was recognized due to a prolonged decrease of the market value of our floating rate CMBS below our cost basis and a downgrade in the credit rating of these securities in July 2008.
Interest income increased from $1.9 million for the three months ended June 30, 2007 to $2.4 million for the three months ended June 30, 2008, due to interest income earned on cash from offering proceeds being held throughout the period prior to its investment in real estate or real estate-related investments and an increase in gross offering proceeds raised from $246.0 million for the three months ended June 30, 2007 to $577.4 million for the three months ended June 30, 2008.
Net income of $1.9 million was recognized for the three months ended June 30, 2007 as compared to net income of $1.8 million for the three months ended June 30, 2008, due primarily to increased revenue as a result of significant real estate and real estate loans receivable acquisitions during 2007 and the six months ended June 30, 2008 and lower operating expenses as a percentage of revenue offset by other-than-temporary impairment of marketable securities of $7.0 million for the three months ended June 30, 2008.
Comparison of the six months ended June 30, 2008 versus the six months ended June 30, 2007
Rental income and tenant reimbursements increased from $15.3 million and $2.5 million, respectively, for the six months ended June 30, 2007 to $71.3 million and $18.7 million, respectively, for the six months ended June 30, 2008, primarily as a result of the growth in the real property investment portfolio during 2007 and the six months ended June 30, 2008. Rental income and tenant reimbursements are expected to continue to increase in future periods, as compared to historical periods, as a result of owning the assets acquired during the six months ended June 30, 2008 for an entire period and future acquisitions of real estate assets.
Interest income from real estate loans receivable increased from $3.1 million for the six months ended June 30, 2007 to $27.5 million for the six months ended June 30, 2008, primarily as a result of the growth in the real estate loans receivable portfolio during 2007 and the six months ended June 30, 2008. While interest income from real estate loans receivable is expected to continue to increase in future periods compared to historical periods, as a result of owning assets acquired during the six months ended June 30, 2008 for the entire period and future acquisitions of real estate loans receivable, interest income on loans receivable will also be dependent on our ability to reinvest maturing real estate loans receivable at similar yields. The Tribeca Loans, which contributed $5.7 million or 21% of interest income from real estate loans receivable for the six months ended June 30, 2008, are scheduled to mature on November 1, 2008. The Arden Portfolio Mezzanine loans, which contributed $8.0 million or 29% of interest income from real estate loans receivable during the six months ended June 30, 2008, are scheduled to mature on August 9, 2009.
Parking revenues and other operating income increased from $0.7 million for the six months ended June 30, 2007 to $1.5 million for the six months ended June 30, 2008. The increase is primarily related to parking revenues totaling $0.4 million from 2200 West Loop South Building and ADP Plaza, which were purchased in September 2007 and November 2007, respectively, and Tribeca Senior Mortgage Participation loan receivable extension fees of $0.3 million. Parking and other operating income may increase in future periods, as compared to historical periods, as a result of future acquisitions of real estate assets.
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Property operating costs and real estate and other property-related taxes increased from $2.8 million and $2.4 million, respectively, for the six months ended June 30, 2007 to $15.7 million and $12.1 million, respectively, for the six months ended June 30, 2008, primarily as a result of the growth in the real property investment portfolio during 2007 and the six months ended June 30, 2008. Property operating costs and real estate and other property-related taxes are expected to continue to increase in future periods, as compared to historical periods, as a result of owning the assets acquired during the six months ended June 30, 2008 for an entire period and future acquisitions of real estate assets.
Asset management fees incurred and payable to our advisor with respect to real estate investments increased from $1.4 million for the six months ended June 30, 2007 to $8.0 million for the six months ended June 30, 2008 as a result of the growth in the portfolio during 2007 and the six months ended June 30, 2008 and the recognition of incurred but unpaid performance fees totaling $2.2 million related to our joint venture investment in the National Industrial Portfolio. The payment of asset management fees from July 2006 through September 2007 has been deferred as explained above.
General and administrative expenses increased from $1.5 million for the six months ended June 30, 2007 to $2.5 million for the six months ended June 30, 2008. These general and administrative costs consisted primarily of legal, audit and other professional fees. We expect general and administrative costs to increase in the future as we make additional investments, but to decrease as a percentage of total revenue.
Depreciation and amortization increased from $8.6 million for the six months ended June 30, 2007 to $44.4 million for the six months ended June 30, 2008, primarily as a result of the growth in the real property investment portfolio during 2007 and the six months ended June 30, 2008. Depreciation and amortization are expected to continue to increase in future periods, as compared to historical periods, as a result of owning the assets acquired during the six months ended June 30, 2008 for an entire period and future acquisitions of real estate assets.
Interest expense (including amortization of deferred financing costs) increased from $6.9 million for the six months ended June 30, 2007 to $30.1 million for the six months ended June 30, 2008, primarily as a result of our use of debt in acquiring real property investments during 2007 and the six months ended June 30, 2008. Our interest expense in future periods will vary based on our level of future borrowings, which will depend on the amount of proceeds raised in our primary offering, the cost of borrowings and the opportunity to acquire real estate assets and real estate-related investments meeting our investment objectives.
During the six months ended June 30, 2008, we recognized an other-than-temporary impairment of marketable securities of approximately $7.0 million. The other-than-temporary impairment was recognized due to a prolonged decrease of the market value of our floating rate CMBS below our cost basis and a downgrade in the credit rating of these securities in July 2008.
Interest income increased from $2.3 million for the six months ended June 30, 2007 to $3.2 million for the six months ended June 30, 2008 due to interest income earned on cash from offering proceeds being held throughout the period prior to its investment in real estate or real estate-related investments and an increase in gross offering proceeds raised from $369.1 million for the six months ended June 30, 2007 to $859.1 million for the six months ended June 30, 2008.
Net income of $0.2 million was recognized for the six months ended June 30, 2007 as compared to net income of $4.0 million for the six months ended June 30, 2008 due primarily to increased revenue as a result of significant real estate and real estate loans receivable acquisitions during 2007 and the six months ended June 30, 2008 and lower operating expenses as a percentage of revenue offset by other-than-temporary impairment of marketable securities of $7.0 million for the six months ended June 30, 2008.
Organization and Offering Costs
Our organization and offering costs (other than selling commissions and the dealer manager fee) may be paid by our advisor, the dealer manager and their affiliates on our behalf. These other organization and offering costs include all expenses to be paid by us in connection with our public offering, including but not limited to (i) legal, accounting, printing, mailing, and filing fees; (ii) charges of the escrow holder and expenses of the advisor for administrative services related to the issuance of shares; (iii) reimbursement of the dealer manager for amounts it may pay to reimburse the bona fide diligence expenses of broker-dealers; (iv) reimbursement to the advisor for the salaries of its employees and other costs in connection with preparing supplemental sales materials; (v) the cost of educational conferences held by us (including the travel, meal, and lodging costs of registered representatives of broker-dealers); and (vi) reimbursement to the dealer manager for travel, meals, lodging, and attendance fees incurred by employees of the dealer manager to attend retail seminars conducted by broker-dealers.
15
Pursuant to the advisory agreement and the dealer manager agreement, we are obligated to reimburse the advisor, the dealer manager or their affiliates, as applicable, for organization and offering costs paid by them on our behalf, provided that the advisor is obligated to reimburse us to the extent selling commissions, the dealer manager fee, and other organization and offering costs incurred by us in the offering exceed 15% of our gross offering proceeds. Our advisor and its affiliates have incurred on our behalf organization and offering costs (excluding selling commissions and the dealer manager fee) of $10.4 million through June 30, 2008; all such amounts have been reimbursed as of June 30, 2008. Such costs are only a liability to us to the extent selling commissions, the dealer manager fee and other organization and offering costs do not exceed 15% of the gross proceeds of the offering. From commencement of our offering through June 30, 2008, including shares sold through our dividend reinvestment plan, we had sold 172,153,293 shares for gross offering proceeds of $1.72 billion and recorded organization and offering costs of $15.5 million and selling commissions and dealer manager fees of $153.2 million.
Funds from Operations
We believe that FFO is a beneficial indicator of the performance of any equity REIT. Because FFO calculations exclude such items as depreciation and amortization of real estate assets and gains 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), they facilitate comparisons of operating performance between periods and between other REITs. Our management believes that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictability 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 a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities. Other REITs may not define FFO in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently than we do.
FFO is a non-GAAP financial measure and does 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 includes adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization. Accordingly, FFO should not be considered as an alternative to net income as an indicator of our operating performance.
Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by NAREIT, is presented in the following table for the three and six months ended June 30, 2008 and 2007, respectively (in thousands, except share amounts):
| For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||
Net income | $ | 1,774 | $ | 1,862 | $ | 3,963 | $ | 229 | ||||||
Add: | ||||||||||||||
Depreciation of real estate assets | 7,593 | 2,796 | 14,846 | 5,082 | ||||||||||
Amortization of lease-related costs | 14,399 | 1,948 | 29,524 | 3,528 | ||||||||||
Deduct: | ||||||||||||||
Adjustments for minority interest in consolidated entity (1) | (1,672 | ) | - | (3,607 | ) | - | ||||||||
FFO | $ | 22,094 | $ | 6,606 | $ | 44,726 | $ | 8,839 | ||||||
Weighted-average shares outstanding, basic and diluted | 144,176,496 | 35,481,479 | 120,978,761 | 25,975,536 | ||||||||||
(1) Relates to consolidated joint venture minority interest portion of depreciation of real estate assets in the amount of $483 and $963 and amortization of lease-related costs in the amount of $1,189 and $2,644 for the three and six months ended June 30, 2008, respectively.
16
Set forth below is additional information related to certain noncash items included in net income above, which may be helpful in assessing our operating results. In addition, cash flows generated from FFO may be used to fund all or a portion of certain capitalizable items that are excluded from FFO, such as capitalized interest, tenant improvements, building improvements, and deferred lease costs. Please see the accompanying consolidated statements of cash flows for details of our operating, investing, and financing cash activities.
Noncash Items Included in Net Income:
| • | Revenues in excess of actual cash received of $1.0 million (net of adjustment for minority interest of $51,365) for the three months ended June 30, 2008 and $0.3 million for the three months ended June 30, 2007, and $2.4 million (net of adjustment for minority interest of $0.1 million) for the six months ended June 30, 2008 and $0.5 million for the six months ended June 30, 2007, as a result of straight-line rent; |
| • | Revenues in excess of actual cash received of approximately $1.1 million (net of adjustment for minority interest of $0.2 million) for the three months ended June 30, 2008 and $0.3 million for the three months ended June 30, 2007, and approximately $2.5 million (net of adjustment for minority interest of $0.6 million) for the six months ended June 30, 2008 and $0.5 million for the six months ended June 30, 2007, respectively, as a result of amortization of above-market/below-market in-place leases; |
| • | Amortization of deferred financing costs related to notes payable of approximately $1.7 million (net of adjustment for minority interest of $0.2 million) for the three months ended June 30, 2008 and $89,320 for the three months ended June 30, 2007 were recognized as interest expense; and approximately $3.3 million (net of adjustment for minority interest of $0.5 million) for the six months ended June 30, 2008 and $0.5 million for the six months ended June 30, 2007 were recognized as interest expense; |
| • | Amortization of discounts on real estate loans receivable of $5.7 million and $9.4 million were recognized for the three and six months ended June 30, 2008, respectively; |
| • | Other-than-temporary impairment of marketable securities of $7.0 million was recognized for the three and six months ended June 30, 2008; and |
| • | Gain on an interest rate cap of $0.3 million and $0.2 million (net of adjustment for minority interest of $72,265 and $38,444) were recognized for the three and six months ended June 30, 2008, respectively. |
Critical Accounting Policies
Below is a discussion of the accounting policies that management considers critical in that they involve significant management judgments and assumptions, require estimates about matters that are inherently uncertain and because they are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. 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.
Real Estate
Depreciation and Amortization
We have to make subjective assessments as to the useful lives of our depreciable assets. These assessments have a direct impact on our net income, because, if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis throughout the expected useful lives of these investments. We consider the period of future benefit of an asset to determine its appropriate useful life. We anticipate the estimated useful lives of our assets by class to be as follows:
Buildings | 25-40 years | |
Building improvements | 10-25 years | |
Tenant improvements | Shorter of lease term or expected useful life | |
Tenant origination and absorption costs | Remaining term of related lease |
17
Real Estate Purchase Price Allocation
In accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 141,Business Combinations, we record above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. We amortize any capitalized above-market or below-market lease values as a reduction or increase to rental income, respectively, over the remaining non-cancelable terms of the respective leases, which range from one month to 12 years. Should a tenant terminate its lease, the unamortized portion of the above-market or below-market lease intangible associated with that tenant’s lease would be charged to rental income in that period.
We measure the aggregate value of other intangible assets acquired based on the difference between (i) the property valued with existing in-place leases adjusted to market rental rates and (ii) the property valued as if vacant. The value of these intangible assets is classified as tenant origination and absorption costs and is amortized over the remaining non-cancelable terms of the respective leases. We include the amortization of tenant origination and absorption costs as depreciation and amortization expense on the consolidated statement of operations. Management’s estimates of value are made using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis). Factors considered by management in its analysis include an estimate of carrying costs during hypothetical expected lease-up periods, considering current market conditions and costs to execute similar leases.
We also consider information obtained about each property as a result of our preacquisition due diligence, marketing, and leasing activities in estimating the fair value of the tangible and intangible assets acquired. In estimating carrying costs, management also includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods. Management also estimates costs to execute similar leases including leasing commissions and legal and other related expenses to the extent that such costs have not already been incurred in connection with a new lease origination as part of the transaction.
The total amount of other intangible assets acquired is further allocated to in-place lease values and customer relationship intangible values, if any, based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant. Characteristics considered by management in allocating these values include the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors.
We amortize the value of in-place leases to expense over the initial term of the respective leases, which range from one month to 12 years. The value of customer relationship intangibles are amortized to expense over the initial term and any renewal periods in the respective leases, but in no event will the amortization period for the intangible assets exceed the remaining depreciable life of the building. Should a tenant terminate its lease, the unamortized portion of the in-place lease value and customer relationship intangibles associated with that tenant would be charged to expense in that period.
Estimates of the fair values of the tangible and intangible assets require us to estimate market lease rates, property operating expenses, carrying costs during lease-up periods, discount rates, market absorption periods, and the number of years the property is held for investment. The use of inappropriate estimates would result in an incorrect assessment of our purchase price allocation, which would impact the amount of our net income.
Impairment of Real Estate Assets and Related Intangible Assets and Liabilities
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of our real estate and related intangible assets may not be recoverable. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets and liabilities may not be recoverable, we assess the recoverability by estimating whether we will recover the carrying value of the real estate and related intangible assets and liabilities through its undiscounted future cash flows and its eventual disposition. If based on this analysis we do not believe that we will be able to recover the carrying value of the real estate and related intangible assets and liabilities, we record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the real estate and related intangible assets and liabilities as defined by SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. We did not record any impairment losses during the six months ended June 30, 2008 and 2007.
Projections of future cash flows require us to estimate the expected future operating income and expenses related to an asset as well as market and other trends. The use of inappropriate assumptions in our future cash flows analyses would result in an incorrect assessment of our assets’ future cash flows and fair values and could result in the overstatement of the carrying values of our real estate assets and an overstatement of our net income.
18
Real Estate Loans Receivable
The real estate loans receivable are recorded at cost and reviewed for potential impairment at each balance sheet date. A loan receivable is considered impaired when it becomes probable, based on current information, that we will be unable to collect all amounts due according to the loan’s contractual terms. The amount of impairment, if any, is measured by comparing the recorded amount of the loan to the present value of the expected cash flows or the fair value of the collateral. If a loan was deemed to be impaired, we would record a reserve for loan losses through a charge to income for any shortfall. Failure to recognize impairment would result in the overstatement of the carrying values of our real estate loans receivable and an overstatement of our net income. We recorded no impairment losses during the six months ended June 30, 2008 and 2007.
Marketable Securities
In accordance with the standards set forth in SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities, we classify our investments in marketable securities as available-for-sale since we may sell them prior to their maturity but do not hold them principally for the purpose of making frequent investments and sales with the objective of generating profits on short-term differences in price. These investments are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss). Estimated fair values are based on quoted market prices, when available, or on estimates provided by independent pricing sources or dealers who make markets in such securities. Upon the sale of a security, the realized net gain or loss is computed on a specific identification basis.
We monitor our available-for-sale securities for impairments. A loss is recognized when we determine that a decline in the estimated fair value of a security below its amortized cost is other-than-temporary. We consider many factors in determining whether the impairment of a security is deemed to be other-than-temporary, including, but not limited to, the length of time the security has had a decline in estimated fair value below its amortized cost, the amount of the unrealized loss, our intent and ability to hold the security for a period of time sufficient for a recovery in value, recent events specific to the issuer or industry, external credit ratings and recent changes in such ratings.
We account for our CMBS in accordance with the Emerging Issues Task Force 99-20,Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets(“EITF 99-20”).Under EITF 99-20, we review on a quarterly basis, the projected future cash flows of CMBS investments for changes in assumptions due to prepayments, credit loss experience and other factors. If based on our quarterly estimate of cash flows that a market participant would use to determine the current fair value of the security, there has been an adverse change in the estimated cash flows from the cash flows previously estimated and the present value of the revised cash flow is less than the present value previously estimated, an other-than-temporary impairment is deemed to have occurred. When a security is deemed to be other-than-temporarily impaired, the security is written down to its fair value (with the reduction in fair value recorded as a charge to earnings) and a new cost basis is established. We calculate a revised yield for the security based on the current amortized cost of the investment (including any other-than-temporary impairments recognized to date) and the revised yield for the securities is then applied prospectively to recognize interest income. If there have been no adverse changes to our assumptions and the change in value is solely due to interest rate changes, we do not recognize an impairment of our CMBS investments in our consolidated statements of operations. It is difficult to predict the timing or magnitude of these other-than-temporary impairments and significant judgments, including, but not limited to, assumptions regarding estimated prepayments, loss assumptions, and assumptions with respect to changes in interest rates, are required in determining impairment. As a result, actual impairment losses could materially differ from these estimates.
Revenue Recognition
We recognize minimum rent, including rental abatements and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related lease and amounts expected to be received in later years are recorded as deferred rent. We record property operating expense reimbursements due from tenants for common area maintenance, real estate taxes and other recoverable costs in the period the related expenses are incurred.
We make estimates of the collectibility of our tenant receivables related to base rents, including straight-line rentals, expense reimbursements and other revenue or income. We specifically analyze accounts receivable and analyze historical bad debts, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, we make estimates of the expected recovery of pre-petition and post-petition claims in assessing the estimated collectibility of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. These estimates have a direct impact on our net income because a higher bad debt reserve results in less net income.
19
We recognize gains on sales of real estate pursuant to the provisions of SFAS No. 66,Accounting for Sales of Real Estate (“SFAS 66”). The specific timing of a sale is measured against various criteria in SFAS 66 related to the terms of the transaction and any continuing involvement associated with the property. If the criteria for profit recognition under the full-accrual method are not met, we defer gain recognition and account for the continued operations of the property by applying the percentage-of-completion, reduced profit, deposit, installment or cost recovery methods, as appropriate, until the appropriate criteria are met.
Interest income from loans receivable, including any discounts and premiums, is recognized based on the contractual terms of the debt instrument. Fees related to any buydown of interest rate are deferred as prepaid interest income and amortized over the term of the loan as an adjustment to interest income using the effective interest method. Closing costs related to the purchase of the loan receivable are amortized over the term of the loan and accreted as an adjustment against interest income using the effective interest method.
Income Taxes
We have elected to be taxed as a REIT under the Code. To continue to qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our annual REIT taxable income to our stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, we generally will not be subject to federal income tax on income that we distribute to stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost, unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to stockholders. However, we intend to organize and operate in such a manner as to qualify for treatment as a REIT.
Derivative Instruments
In the normal course of business, we use certain types of derivative instruments for the purpose of managing or hedging interest rate risks. We have entered into various interest rate cap and floor agreements to hedge our exposure to changing interest rates on variable-rate real estate loans receivable and notes payable. We account for these derivative instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities(“SFAS 133”). The change in fair value of the effective portion of a derivative instrument that is designated as a hedge is recorded as other comprehensive income (loss) in the accompanying consolidated statement of stockholders’ equity. The changes in fair value for derivative instruments that are not designated as a hedge or that do not meet the hedge accounting criteria of SFAS 133 are recorded as gain or loss on derivative instruments in the accompanying consolidated statements of operations. Net amounts received or paid under the derivative instruments are amortized as adjustments to interest income or expense, respectively, based on the fair value and intrinsic value of the related derivative instrument.
20
INDEX TO FINANCIAL STATEMENTS
F-1
KBS REAL ESTATE INVESTMENT TRUST, INC.
(in thousands, except share and per share amounts)
| June 30, 2008 | December 31, 2007 | |||||||||
| (unaudited) | ||||||||||
Assets | ||||||||||
Real estate: | ||||||||||
Land | $ | 235,123 | $ | 186,773 | ||||||
Buildings and improvements, less accumulated depreciation of | 1,353,621 | 1,139,050 | ||||||||
Tenant origination and absorption costs, less accumulated amortization of | 124,290 | 124,329 | ||||||||
Total real estate, net | 1,713,034 | 1,450,152 | ||||||||
Real estate loans receivable | 459,905 | 214,908 | ||||||||
Marketable securities | 55,261 | 15,600 | ||||||||
Total real estate investments, net | 2,228,200 | 1,680,660 | ||||||||
Cash and cash equivalents | 403,237 | 67,337 | ||||||||
Restricted cash | 6,536 | 7,574 | ||||||||
Rents and other receivables, net | 12,248 | 10,631 | ||||||||
Above-market leases, net of accumulated amortization of | 22,388 | 21,345 | ||||||||
Deferred financing costs, prepaid and other assets | 31,614 | 29,625 | ||||||||
Total assets | $ | 2,704,223 | $ | 1,817,172 | ||||||
Liabilities and stockholders’ equity | ||||||||||
Notes payable | $ | 1,142,868 | $ | 1,008,564 | ||||||
Accounts payable and accrued liabilities | 20,097 | 16,569 | ||||||||
Due to affiliates | 6,735 | 4,540 | ||||||||
Distributions payable | 9,697 | 4,953 | ||||||||
Below-market leases, net of accumulated amortization of | 41,754 | 35,624 | ||||||||
Other liabilities | 7,009 | 7,607 | ||||||||
Total liabilities | 1,228,160 | 1,077,857 | ||||||||
Commitments and contingencies (Note 16) | ||||||||||
Minority interest | 15,337 | 18,230 | ||||||||
Redeemable common stock | 31,932 | 14,645 | ||||||||
Stockholders’ equity: | ||||||||||
Preferred stock, $.01 par value; 10,000,000 shares authorized, no shares issued and outstanding | - | - | ||||||||
Common stock, $.01 par value; 1,000,000,000 shares authorized, 172,153,293 and 86,051,975 shares issued and outstanding as of June 30, 2008 and December 31, 2007, respectively | 1,721 | 860 | ||||||||
Additional paid-in capital | 1,509,526 | 751,582 | ||||||||
Cumulative distributions and net losses | (82,182 | ) | (43,917 | ) | ||||||
Accumulated other comprehensive loss | (271 | ) | (2,085 | ) | ||||||
Total stockholders’ equity | 1,428,794 | 706,440 | ||||||||
Total liabilities and stockholders’ equity | $ | 2,704,223 | $ | 1,817,172 | ||||||
See accompanying notes.
F-2
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except share and per share amounts)
| For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||||
Revenues: | ||||||||||||||||
Rental income | $ | 36,926 | $ | 8,616 | $ | 71,253 | $ | 15,251 | ||||||||
Tenant reimbursements | 8,845 | 1,257 | 18,689 | 2,518 | ||||||||||||
Interest income from real estate loans receivable | 15,486 | 2,396 | 27,488 | 3,143 | ||||||||||||
Parking revenues and other operating income | 946 | 398 | 1,539 | 738 | ||||||||||||
Total revenues | 62,203 | 12,667 | 118,969 | 21,650 | ||||||||||||
Operating expenses: | ||||||||||||||||
Operating, maintenance, and management | 7,613 | 1,526 | 15,744 | 2,797 | ||||||||||||
Real estate taxes, property-related taxes, and insurance | 6,175 | 1,240 | 12,056 | 2,442 | ||||||||||||
Asset management fees to affiliate | 5,227 | 794 | 8,004 | 1,366 | ||||||||||||
General and administrative expenses | 1,314 | 911 | 2,510 | 1,546 | ||||||||||||
Depreciation and amortization | 21,992 | 4,744 | 44,370 | 8,610 | ||||||||||||
Total operating expenses | 42,321 | 9,215 | 82,684 | 16,761 | ||||||||||||
Operating income | 19,882 | 3,452 | 36,285 | 4,889 | ||||||||||||
Other income (expenses): | ||||||||||||||||
Interest expense | (14,292 | ) | (3,457 | ) | (30,141 | ) | (6,910 | ) | ||||||||
Other-than-temporary impairment of marketable securities | (7,027 | ) | - | (7,027 | ) | - | ||||||||||
Interest income | 2,361 | 1,867 | 3,172 | 2,250 | ||||||||||||
Unrealized gain on derivative instruments | 361 | - | 192 | - | ||||||||||||
Total other income (expenses), net | (18,597 | ) | (1,590 | ) | (33,804 | ) | (4,660 | ) | ||||||||
Net income before minority interest and provision for income taxes | 1,285 | 1,862 | 2,481 | 229 | ||||||||||||
Minority interest in net loss of consolidated entity | 677 | - | 1,848 | - | ||||||||||||
Net income before provision for income taxes | 1,962 | 1,862 | 4,329 | 229 | ||||||||||||
Provision for income taxes | (188 | ) | - | (366 | ) | - | ||||||||||
Net income | $ | 1,774 | $ | 1,862 | $ | 3,963 | $ | 229 | ||||||||
Net income per common share, basic and diluted | $ | 0.01 | $ | 0.05 | $ | 0.03 | $ | 0.01 | ||||||||
Weighted-average number of common shares outstanding, basic | 144,176,496 | 35,481,479 | 120,978,761 | 25,975,536 | ||||||||||||
Distributions declared per common share | $ | 0.17 | $ | 0.17 | $ | 0.35 | $ | 0.35 | ||||||||
See accompanying notes.
F-3
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Year Ended December 31, 2007 and Six Months Ended June 30, 2008 (unaudited)
(dollar amounts in thousands)
Common Stock | Additional Paid-in Capital | Cumulative Distributions and Net Income (Losses) | Accumulated Other Comprehensive Gain (Loss) | Total Stockholders’ Equity | |||||||||||||||||||
| Shares | Amounts | ||||||||||||||||||||||
Balance, December 31, 2006 | 11,309,222 | $ | 113 | $ | 97,400 | $ | (3,857 | ) | $ | - | $ | 93,656 | |||||||||||
Comprehensive loss: | |||||||||||||||||||||||
Net loss | - | - | - | (7,198 | ) | - | (7,198 | ) | |||||||||||||||
Unrealized loss on | - | - | - | - | (2,085 | ) | (2,085 | ) | |||||||||||||||
Total comprehensive loss | (9,283 | ) | |||||||||||||||||||||
Issuance of | 74,838,013 | 748 | 743,884 | - | - | 744,632 | |||||||||||||||||
Redemptions of | (95,260 | ) | (1 | ) | (951 | ) | - | - | (952 | ) | |||||||||||||
Additions to redeemable | - | - | (14,276 | ) | - | - | (14,276 | ) | |||||||||||||||
Distributions declared | - | - | - | (32,862 | ) | - | (32,862 | ) | |||||||||||||||
Commissions on stock sales and | - | - | (66,961 | ) | - | - | (66,961 | ) | |||||||||||||||
Other offering costs | - | - | (7,514 | ) | - | - | (7,514 | ) | |||||||||||||||
Balance, December 31, 2007 | 86,051,975 | 860 | 751,582 | (43,917 | ) | (2,085 | ) | 706,440 | |||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net income | - | - | - | 3,963 | - | 3,963 | |||||||||||||||||
Unrealized gain on | - | - | - | - | 356 | 356 | |||||||||||||||||
Unrealized loss on | - | - | - | - | (320 | ) | (320 | ) | |||||||||||||||
Reclassification of unrealized | - | - | - | - | 2,405 | 2,405 | |||||||||||||||||
Unrealized loss on | - | - | - | - | (627 | ) | (627 | ) | |||||||||||||||
Total comprehensive income | 5,777 | ||||||||||||||||||||||
Issuance of common stock | 86,458,377 | 865 | 858,200 | - | - | 859,065 | |||||||||||||||||
Redemptions of | (357,059 | ) | (4 | ) | (3,467 | ) | - | - | (3,471 | ) | |||||||||||||
Additions to redeemable | - | - | (17,287 | ) | - | - | (17,287 | ) | |||||||||||||||
Distributions declared | - | - | - | (42,228 | ) | - | (42,228 | ) | |||||||||||||||
Commissions on stock sales and | - | - | (75,985 | ) | - | - | (75,985 | ) | |||||||||||||||
Other offering costs | - | - | (3,517 | ) | - | - | (3,517 | ) | |||||||||||||||
Balance, June 30, 2008 | 172,153,293 | $ | 1,721 | $ | 1,509,526 | $ | (82,182 | ) | $ | (271 | ) | $ | 1,428,794 | ||||||||||
See accompanying notes.
F-4
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
| Six Months Ended June 30, | ||||||||
| 2008 | 2007 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net income | $ | 3,963 | $ | 229 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Deferred rent | (2,559 | ) | (470 | ) | ||||
Allowance for doubtful accounts | 239 | - | ||||||
Depreciation and amortization of real estate | 44,370 | 8,610 | ||||||
Amortization of discounts on real estate loans receivable | (9,428 | ) | - | |||||
Amortization of investment in master lease | 429 | - | ||||||
Amortization of notes receivable closing costs | 868 | - | ||||||
Amortization of deferred financing costs | 3,643 | 464 | ||||||
Amortization of above- and below-market leases, net | (3,109 | ) | (470 | ) | ||||
Amortization of discount on marketable securities | (42 | ) | - | |||||
Amortization of cost of derivative instruments | 1,041 | - | ||||||
Unrealized gain on derivative instruments | (192 | ) | - | |||||
Other-than-temporary impairment of marketable securities | 7,027 | - | ||||||
Minority interest in net loss of consolidated entity | (1,848 | ) | - | |||||
Changes in operating assets and liabilities: | ||||||||
Restricted cash for operational expenditures | 50 | - | ||||||
Rents and other receivables | 703 | (1,203 | ) | |||||
Prepaid and other assets | (204 | ) | (225 | ) | ||||
Accounts payable and accrued liabilities | 3,528 | 3,463 | ||||||
Due to affiliates | 2,205 | 1,366 | ||||||
Other liabilities | (598 | ) | 696 | |||||
Net cash provided by operating activities | 50,086 | 12,460 | ||||||
Cash Flows from Investing Activities: | ||||||||
Acquisitions of real estate | (291,436 | ) | (244,892 | ) | ||||
Additions to real estate | (7,620 | ) | (316 | ) | ||||
Investments in real estate loans receivable | (238,150 | ) | (77,759 | ) | ||||
Principal payments on loans receivable | 6,674 | - | ||||||
Payments of real estate loans receivable closing costs | (1,952 | ) | - | |||||
Advances on real estate loans receivable | (6,011 | ) | (1,698 | ) | ||||
Purchase of marketable securities | (44,205 | ) | (17,680 | ) | ||||
Increase in restricted cash for capital expenditures | 988 | - | ||||||
Net cash used in investing activities | (581,712 | ) | (342,345 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Proceeds from notes payable | 244,164 | 104,094 | ||||||
Principal payments on notes payable | (96,600 | ) | (50,200 | ) | ||||
Purchase of derivative instruments | (2,524 | ) | - | |||||
Advances from affiliates | - | 565 | ||||||
Payments of deferred financing costs | (1,807 | ) | (1,308 | ) | ||||
Proceeds from repurchase agreements | 86,400 | - | ||||||
Payments on repurchase agreements | (99,660 | ) | - | |||||
Distributions to minority interest holder | (1,045 | ) | - | |||||
Proceeds from issuance of common stock | 859,065 | 369,102 | ||||||
Redemptions of redeemable common stock | (3,471 | ) | (340 | ) | ||||
Payments of commissions on stock sales and related dealer manager fees | (76,396 | ) | (32,776 | ) | ||||
Payments of other offering costs | (3,116 | ) | (2,133 | ) | ||||
Distributions paid to common stockholders | (37,484 | ) | (7,046 | ) | ||||
Net cash provided by financing activities | 867,526 | 379,958 | ||||||
Net increase in cash and cash equivalents | 335,900 | 50,073 | ||||||
Cash and cash equivalents, beginning of period | 67,337 | 48,754 | ||||||
Cash and cash equivalents, end of period | $ | 403,237 | $ | 98,827 | ||||
Supplemental Disclosure of Cash Flow Information: | ||||||||
Interest paid | $ | 26,938 | $ | 6,097 | ||||
Supplemental Disclosure of Non-Cash Transactions: | ||||||||
(Decrease) increase in commissions on stock sales and related dealer manager fees due to affiliates | $ | (411 | ) | $ | 629 | |||
Increase in other offering costs due to affiliates | $ | 401 | $ | 1,016 | ||||
Increase in distributions payable | $ | 4,744 | $ | 2,551 | ||||
See accompanying notes.
F-5
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(unaudited)
| 1. | ORGANIZATION |
KBS Real Estate Investment Trust, Inc. (the “Company”) is a Maryland corporation that has elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year that ended December 31, 2006. The Company was formed on June 13, 2005. Substantially all of the Company’s assets are held by, and the Company conducts substantially all of its operations through, KBS Limited Partnership (the “Operating Partnership”) and its subsidiaries. The Company is the sole general partner of and directly owns a 99% partnership interest in the Operating Partnership. The Company’s wholly owned subsidiary, KBS REIT Holdings LLC (“KBS REIT Holdings”), owns the remaining 1% partnership interest in the Operating Partnership and is its sole limited partner.
The Company invests in a diverse portfolio of real estate assets. The primary types of properties the Company invests in include office, industrial, and retail properties located throughout the United States. All such real estate assets may be acquired directly by the Company or the Operating Partnership, though the Company may invest in other entities that make similar investments. The Company also invests in mezzanine loans, mortgage loans and mortgage-backed securities and intends to make investments in other real estate-related assets, including other structured finance investments. As of June 30, 2008, the Company owned 58 real estate properties, one master lease, 19 real estate loans receivable, and two investments in securities directly or indirectly backed by commercial mortgage-backed loans. The 58 real estate properties total approximately 19.7 million square feet, including properties held through a consolidated joint venture. The real estate portfolio includes 16 office properties, one light industrial property, three corporate research properties, two distribution facilities, one industrial portfolio consisting of nine distribution and office/warehouse properties, one office/flex portfolio consisting of four properties and an 80% membership interest in a joint venture that owns a portfolio of 23 institutional quality industrial properties and holds a master lease with a remaining term of 14.75 years with respect to another industrial property. In addition, the Company owns six mezzanine real estate loans, two B-Notes, a partial ownership interest in three mezzanine real estate loans, a partial ownership interest in a senior mortgage loan, two loans representing senior subordinated debt of a private REIT and two first mortgage loans. The Company has also originated three secured loans and holds two investments in securities directly or indirectly backed by commercial mortgage-backed loans. See Note 3, “Real Estate,” Note 5, “Real Estate Loans Receivable,” and Note 6, “Marketable Securities.”
Subject to certain restrictions and limitations, the business of the Company is managed by KBS Capital Advisors LLC (the “Advisor”) pursuant to an Advisory Agreement with the Company (the “Advisory Agreement”) in effect through November 8, 2008. The Advisory Agreement may be renewed for an unlimited number of one-year periods upon the mutual consent of the Advisor and the Company. Either party may terminate the Advisory Agreement upon 60 days written notice. The Advisor owns 20,000 shares of the Company’s common stock.
On June 23, 2005, the Company filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to offer a maximum of 280,000,000 shares of common stock for sale to the public (the “Offering”), of which 200,000,000 shares were registered in the Company’s primary offering and 80,000,000 shares were registered under the Company’s dividend reinvestment plan. The SEC declared the Company’s registration statement effective on January 13, 2006, and the Company launched the Offering on January 27, 2006, upon retaining KBS Capital Markets Group LLC (the “Dealer Manager”), an affiliate of the Advisor, to serve as the dealer manager of the Offering. From commencement of the Offering through June 30, 2008, including shares sold through the Company’s dividend reinvestment plan, the Company had sold 172,153,293 shares in the Offering for gross offering proceeds of $1.72 billion. As of June 30, 2008, the Company had redeemed 452,319 of the shares sold in the Offering pursuant to its share redemption program for $4.4 million. The Company ceased offering shares of common stock in its primary offering of 200,000,000 shares on May 30, 2008, but is continuing to process subscriptions from qualified accounts. For investments by qualified accounts, subscription agreements must be dated on or before May 30, 2008 with all documents and funds received by the Company by the end of business on September 1, 2008. The Company continues to offer shares of common stock under its dividend reinvestment plan.
F-6
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company, KBS REIT Holdings, the Operating Partnership, their direct and indirect wholly owned subsidiaries, and joint ventures the Company controls or for which it is the primary beneficiary, as well as the related amounts of minority interest. All significant intercompany balances and transactions are eliminated in consolidation.
The Company evaluates the need to consolidate joint ventures based on standards set forth in Financial Accounting Standards Board (“FASB”) Financial Interpretation (“FIN”) No. 46R,Consolidation of Variable Interest Entities(“FIN 46R”), and Statement of Position 78-9,Accounting for Investments in Real Estate Ventures (“SOP 78-9”), as amended by Emerging Issues Task Force No. 04-5,Investor’s Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights. In accordance with these accounting standards, the Company consolidates joint ventures that it determines to be variable interest entities for which it is the primary beneficiary. The Company also consolidates joint ventures that are not determined to be variable interest entities, but for which it exercises control over major operating decisions through substantive participation rights, such as approval of budgets, selection of property managers, asset management, investment activity and changes in financing.
The consolidated financial statements are prepared in accordance with the rules and regulations of the SEC, including the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements have been condensed or omitted; although, management believes the disclosures are adequate to make the information presented not misleading. In the opinion of management, the consolidated financial statements for the unaudited interim periods presented include all adjustments (which are of a normal recurring nature) considered necessary to fairly present the results for those periods in accordance with GAAP. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto as of and for the year ended December 31, 2007 included in the Company’s Annual Report on Form 10-K.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could materially differ from those estimates.
Real Estate
Depreciation and Amortization
Real estate costs related to the acquisition and improvement of properties are capitalized. Repair and maintenance costs are charged to expense as incurred and significant replacements and betterments are capitalized. Repair and maintenance costs include all costs that do not extend the useful life of the real estate asset. The Company considers the period of future benefit of an asset to determine its appropriate useful life. The Company anticipates the estimated useful lives of its assets by class to be generally as follows:
Buildings | 25-40 years | |
Building improvements | 10-25 years | |
Tenant improvements | Shorter of lease term or expected useful life | |
Tenant origination and absorption costs | Remaining term of related lease |
F-7
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Real Estate Purchase Price Allocation
In accordance with standards set forth in FASB Statement of Financial Accounting Standards (“SFAS”) No. 141,Business Combinations, the Company records above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The Company amortizes any capitalized above-market or below-market lease values as a reduction or increase to rental income, respectively, over the remaining non-cancelable terms of the respective leases, which range from one month to 12 years. Should a tenant terminate its lease, the unamortized portion of the above-market or below-market lease intangible associated with that tenant’s lease would be charged to rental income in that period.
The Company measures the aggregate value of other intangible assets acquired based on the difference between (i) the property valued with existing in-place leases adjusted to market rental rates and (ii) the property valued as if vacant. The value of these intangible assets is classified as tenant origination and absorption costs and is amortized over the remaining non-cancelable terms of the respective leases. The Company includes the amortization of tenant origination and absorption costs as depreciation and amortization expense on the consolidated statement of operations. Management’s estimates of value are made using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis). Factors considered by management in its analysis include an estimate of carrying costs during hypothetical expected lease-up periods, considering current market conditions and costs to execute similar leases.
The Company also considers information obtained about each property as a result of its preacquisition due diligence, marketing, and leasing activities in estimating the fair value of the tangible and intangible assets acquired. In estimating carrying costs, management also includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods. Management also estimates costs to execute similar leases including leasing commissions and legal and other related expenses to the extent that such costs have not already been incurred in connection with a new lease origination as part of the transaction.
The total amount of other intangible assets acquired is further allocated to in-place lease values and customer relationship intangible values, if any, based on management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics considered by management in allocating these values include the nature and extent of the Company’s existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality, and expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors.
The Company amortizes the value of in-place leases to expense over the initial term of the respective leases, which range from one month to 12 years. The value of customer relationship intangibles are amortized to expense over the initial term and any renewal periods in the respective leases, but in no event will the amortization period for the intangible assets exceed the remaining depreciable life of the building. Should a tenant terminate its lease, the unamortized portion of the in-place lease value and customer relationship intangibles associated with that tenant would be charged to expense in that period.
F-8
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Impairment of Real Estate and Related Intangible Assets and Liabilities
The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of its real estate and related intangible assets and liabilities may not be recoverable. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets and liabilities may not be recoverable, the Company assesses the recoverability by estimating whether the Company will recover the carrying value of the real estate and related intangible assets and liabilities through its undiscounted future cash flows and its eventual disposition. If, based on this analysis, the Company believed that it would not be able to recover the carrying value of the real estate and related intangible assets and liabilities the Company records an impairment loss to the extent that the carrying value exceeded the estimated fair value of the real estate and related intangible assets and liabilities as defined by SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. There were no impairment losses related to real estate and related intangible assets and liabilities recorded by the Company during the six months ended June 30, 2008 and 2007.
Real Estate Loans Receivable
The real estate loans receivable are recorded at cost and reviewed for potential impairment at each balance sheet date. A loan receivable is considered impaired when it becomes probable, based on current information, that the Company will be unable to collect all amounts due according to the loan’s contractual terms. The amount of impairment, if any, would be measured by comparing the recorded amount of the loan receivable to the present value of the expected cash flows or the fair value of the collateral. If a loan was deemed to be impaired, the Company would record a reserve for loan losses through a charge to income for any shortfall. There were no impairment losses on real estate loans receivable recorded by the Company during the six months ended June 30, 2008 and 2007.
Marketable Securities
In accordance with the standards set forth in SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities, the Company classifies its investments in marketable securities as available-for-sale since the Company may sell them prior to their maturity but does not hold them principally for the purpose of making frequent investments and sales with the objective of generating profits on short-term differences in price. These investments are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss). Estimated fair values are based on quoted market prices, when available, or on estimates provided by independent pricing sources or dealers who make markets in such securities. Upon the sale of a security, the realized net gain or loss is computed on a specific identification basis.
The Company monitors its available-for-sale securities for impairments. A loss is recognized when the Company determines that a decline in the estimated fair value of a security below its amortized cost is other-than-temporary. The Company considers many factors in determining whether the impairment of a security is deemed to be other-than-temporary, including, but not limited to, the length of time the security has had a decline in estimated fair value below its amortized cost, the amount of the unrealized loss, the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value, recent events specific to the issuer or industry, external credit ratings and recent changes in such ratings.
F-9
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
The Company accounts for its commercial mortgage-backed securities (“CMBS”) in accordance with the Emerging Issues Task Force 99-20,Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets(“EITF 99-20”).Under EITF 99-20, the Company reviews on a quarterly basis, the projected future cash flows of CMBS investments for changes in assumptions due to prepayments, credit loss experience and other factors. If based on the Company’s quarterly estimate of cash flows that a market participant would use to determine the current fair value of the security, there has been an adverse change in the estimated cash flows from the cash flows previously estimated and the present value of the revised cash flow is less than the present value previously estimated, an other-than-temporary impairment is deemed to have occurred. When a security is deemed to be other-than-temporarily impaired, the security is written down to its fair value (with the reduction in fair value recorded as a charge to earnings) and a new cost basis is established. The Company calculates a revised yield based on the current amortized cost of the investment (including any other-than-temporary impairments recognized to date) and the revised yield for the securities is then applied prospectively to recognize interest income. If there have been no adverse changes to the Company’s assumptions and the change in value is solely due to interest rate changes, the Company does not recognize an impairment of its CMBS investments in its consolidated statements of operations. It is difficult to predict the timing or magnitude of these other-than-temporary impairments and significant judgments, including, but not limited to, assumptions regarding estimated prepayments, loss assumptions, and assumptions with respect to changes in interest rates, are required in determining impairment. As a result, actual impairment losses could materially differ from these estimates.
Unamortized premiums and discounts on securities available-for-sale are recognized in interest income over the contractual life, adjusted for actual prepayments, of the securities using the effective interest method.
Cash and Cash Equivalents
The Company considers all short-term (with an original maturity of three months or less), highly liquid investments utilized as part of the Company’s cash-management activities to be cash equivalents. Cash equivalents may include cash and short-term investments. Short-term investments are stated at cost, which approximates fair value.
The Company’s cash and cash equivalents balance exceeds federally insurable limits as of June 30, 2008. The Company mitigates this risk by depositing funds with a major financial institution.
Restricted Cash
Restricted cash consists primarily of the following as of June 30, 2008 (in thousands):
Capital expenditure reserve accounts required by mortgage loans(1) | $ | 995 | |
Operational expenditure reserve accounts required by mortgage loans(1) | 3,541 | ||
Separate cash accounts related to security deposits as required by certain lease agreements | 2,000 | ||
Total restricted cash | $ | 6,536 | |
(1) The terms of several of the Company’s mortgage loans payable require the Company to deposit certain replacement and other reserves with its lenders. Such restricted cash is generally available only for property-level requirements for which the reserve was established and is not available to fund other property-level or Company-level obligations.
F-10
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Rents and Other Receivables
The Company periodically evaluates the collectibility of amounts due from tenants and maintains an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required payments under lease agreements. In addition, the Company maintains an allowance for deferred rent receivable that arises from the straight-lining of rents. The Company exercises judgment in establishing these allowances and considers payment history and current credit status of its tenants in developing these estimates.
Deferred Financing Costs
Deferred financing costs represent commitment fees, legal fees and other third party costs associated with obtaining commitments for financing, which result in a closing of such financing. These costs are amortized over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing costs are expensed when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financial transactions that do not close are expensed in the period in which it is determined that the financing will not close.
Redeemable Common Stock
The Company has adopted a share redemption program that may enable stockholders to sell their shares to the Company in limited circumstances.
There are several limitations on the Company’s ability to redeem shares under the program:
| • | Unless the shares are being redeemed in connection with a stockholder’s death or “qualifying disability” (as defined under the program), the Company may not redeem shares until they have been outstanding for one year. |
| • | The share redemption program limits the number of shares the Company may redeem to those that the Company could purchase with the net proceeds from the sale of shares under the dividend reinvestment plan during the prior calendar year. |
| • | During any calendar year, the Company may redeem no more than 5% of the weighted-average number of shares outstanding during the prior calendar year. |
| • | The Company has 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. |
As the use of the proceeds from the dividend reinvestment plan for redemptions is outside the Company’s control, they are considered to be temporary equity under Accounting Series Release No. 268,Presentation in Financial Statements of Redeemable Preferred Stock.
The Company has adopted SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity(“SFAS 150”), which requires, among other things, that financial instruments that represent a mandatory obligation of the Company to repurchase shares be classified as liabilities and reported at settlement value. The Company’s redeemable common shares are contingently redeemable at the option of the holder. As such, SFAS 150 is not applicable until such shares are tendered for redemption by the holder, at which time the Company will reclassify such obligations from mezzanine equity to a liability based upon their respective settlement values.
F-11
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
During the six months ended June 30, 2008, the Company redeemed shares pursuant to its share redemption program as follows:
| Month | Total Number of Shares Redeemed (1) | Average Price Paid Per Share (2) | Approximate Dollar Value of Shares Available That May Yet Be Redeemed Under the Program | |||
January 2008 | 101,024 | $9.85 | (3) | |||
February 2008 | 21,619 | $9.55 | (3) | |||
March 2008 | 17,146 | $9.54 | (3) | |||
April 2008 | 115,642 | $9.81 | (3) | |||
May 2008 | 34,183 | $9.48 | (3) | |||
June 2008 | 67,445 | $9.60 | (3) | |||
| Total | 357,059 | |||||
(1) The Company announced commencement of the program on April 6, 2006 and amendments to the program on August 16, 2006 (which amendment became effective on December 14, 2006) and August 1, 2007 (which amendment became effective on September 13, 2007).
(2) Pursuant to the amendment to the program adopted by the board of directors on July 6, 2007 and that became effective on September 13, 2007, the Company currently redeems shares as follows:
| • | The lower of $9.25 or 92.5% of the price paid to acquire the shares from the Company for stockholders who have held their shares for at least one year; |
| • | The lower of $9.50 or 95.0% of the price paid to acquire the shares from the Company for stockholders who have held their shares for at least two years; |
| • | The lower of $9.75 or 97.5% of the price paid to acquire the shares from the Company for stockholders who have held their shares for at least three years; and |
| • | The lower of $10.00 or 100% of the price paid to acquire the shares from the Company for stockholders who have held their shares for at least four years. |
Notwithstanding the above, once the Company establishes a net asset value per share of common stock, the redemption price per share for all stockholders will be equal to the net asset value per share, as estimated by the Advisor or another firm chosen for that purpose. The Company expects to establish a net asset value per share beginning three years after the completion of its offering stage. The Company will consider its offering stage complete when it is no longer publicly offering equity securities and has not done so for one year. Until the Company establishes a net asset value per share, the redemption price for shares being redeemed upon a stockholder’s death or qualifying disability will be the amount paid to acquire the shares from the Company.
(3) The Company limits the dollar value of shares that may be redeemed under the program as described above.
F-12
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Organization, Offering, and Related Costs
Organization and offering costs (other than selling commissions and the dealer manager fee) of the Company may be paid by the Advisor, the Dealer Manager or their affiliates on behalf of the Company. These other organization and offering costs include all expenses to be paid by the Company in connection with the Offering, including but not limited to (i) legal, accounting, printing, mailing, and filing fees; (ii) charges of the escrow holder and expenses of the Advisor for administrative services related to the issuance of shares in the Offering; (iii) reimbursement of the Dealer Manager for amounts it may pay to reimburse the bona fide diligence expenses of broker-dealers; (iv) reimbursement to the Advisor for the salaries of its employees and other costs in connection with preparing supplemental sales materials; (v) the cost of educational conferences held by the Company (including the travel, meal, and lodging costs of registered representatives of broker-dealers); and (vi) reimbursement to the Dealer Manager for travel, meals, lodging and attendance fees incurred by employees of the Dealer Manager to attend retail seminars conducted by broker-dealers. Pursuant to the Advisory Agreement and the Dealer Manager Agreement, the Company is obligated to reimburse the Advisor, the Dealer Manager or their affiliates, as applicable, for organization and offering costs paid by them on behalf of the Company, provided that the Advisor is obligated to reimburse the Company to the extent selling commissions, the dealer manager fee and other organization and offering costs incurred by the Company in the Offering exceed 15% of gross offering proceeds.
As a result, these costs are only a liability of the Company to the extent selling commissions, the dealer manager fee and other organization and offering costs do not exceed 15% of the gross proceeds of the Offering. Through June 30, 2008, including shares sold through the Company’s dividend reinvestment plan, the Company had sold 172,153,293 shares for gross offering proceeds of $1.72 billion and recorded organization and offering costs of $15.5 million and selling commissions and dealer manager fees of $153.2 million. Organization costs are expensed as incurred, and offering costs, which include selling commissions and dealer manager fees, are charged to stockholders’ equity as such amounts are reimbursed from the gross proceeds of the Offering.
Revenue Recognition
The Company recognizes minimum rent, including rental abatements and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related lease, and amounts expected to be received in later years are recorded as deferred rents. The Company records property operating expense reimbursements due from tenants for common area maintenance, real estate taxes, and other recoverable costs as tenant reimbursements revenue in the period in which the related expenses are incurred.
The Company makes estimates of the collectibility of its tenant receivables related to base rents, including straight-line rentals, expense reimbursements and other revenue or income. Management specifically analyzes accounts receivable and analyzes historical bad debts, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, management makes estimates of the expected recovery of pre-petition and post-petition claims in assessing the estimated collectibility of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. These estimates have a direct impact on the Company’s net income because a higher bad debt reserve results in less net income.
The Company recognizes gains on sales of real estate pursuant to the provisions of SFAS No. 66,Accounting for Sales of Real Estate (“SFAS 66”). The specific timing of a sale is measured against various criteria in SFAS 66 related to the terms of the transaction and any continuing involvement associated with the property. If the criteria for profit recognition under the full-accrual method are not met, the Company defers gain recognition and accounts for the continued operations of the property by applying the percentage-of-completion, reduced profit, deposit, installment or cost recovery methods, as appropriate, until the appropriate criteria are met.
F-13
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Interest income from loans receivable, including any discounts and premiums, is recognized based on the contractual terms of the related debt instrument. Fees related to buydowns of interest rates are deferred as prepaid interest income and amortized over the term of the loans as an adjustment to interest income using the effective interest method. Closing costs and discounts received related to the purchase of loans receivable are amortized over the term of the loans and accreted as an adjustment against interest income using the effective interest method.
General and Administrative Expenses
General and administrative expenses totaled $1.3 million and $2.5 million for the three and six months ended June 30, 2008, respectively, and consisted primarily of legal, audit and other professional fees. In addition, asset management fees to affiliates totaled $5.2 million and $8.0 million for the three and six months ended June 30, 2008, respectively. To the extent included in the definition of total operating expenses (as set forth in Note 13), general and administrative expenses, including asset management fees due to affiliates, are an operating expense of the Company that is subject to the operating expense reimbursement obligation of the Advisor (as discussed in Note 13). Pursuant to the operating expense reimbursement obligation, the Advisor will reimburse the Company at the end of any fiscal quarter for total operating expenses that in the four consecutive fiscal quarters then ended exceed the greater of 2% of its average invested assets or 25% of its net income, unless the conflicts committee of the Company’s board of directors determines that such excess expenses are justified based on unusual and non-recurring factors. The Company’s total operating expenses were not in excess of the operating expense reimbursement obligation for the four trailing fiscal quarters ending June 30, 2008 or 2007. See Note 13, “Related Party Transactions – Due to Affiliates.”
Independent Director Compensation
The Company pays each of its independent directors an annual retainer of $25,000. In addition, the independent directors are paid for attending meetings as follows: (i) $2,500 for each board meeting attended, (ii) $2,000 for each committee meeting attended (except that the committee chairman is paid $3,000 for each meeting attended), (iii) $1,000 for each teleconference board meeting attended, and (iv) $1,000 for each teleconference committee meeting attended (except that the committee chairman is paid $3,000 for each teleconference committee meeting attended). All directors also receive reimbursement of reasonable out-of-pocket expenses incurred in connection with attendance at meetings of the board of directors. For the three and six months ended June 30, 2008, the Company incurred independent director fees of $54,747 and $111,993, respectively, which are included in general and administrative expenses in the accompanying financial statements. At June 30, 2008, $11,249 of independent directors fees were payable. Director compensation is an operating expense of the Company that is subject to the operating expense reimbursement obligation of the Advisor discussed in Note 13.
Income Taxes
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. To continue to qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company’s annual REIT taxable income to stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Company generally will not be subject to federal income tax on income that it distributes to stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost, unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the Company’s net income and net cash available for distribution to stockholders. However, the Company intends to organize and operate in such a manner as to qualify for treatment as a REIT.
F-14
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
The Company adopted FIN No. 48,Accounting for Uncertainty in Income Taxes (“FIN 48”) on January 1, 2007. The Company’s policy is to classify interest related to the underpayment of income taxes as a component of interest expense and penalties related to the underpayment of income taxes as a component of general and administrative expenses. Based on its evaluation, the Company has concluded that there are no significant uncertain tax positions requiring recognition in its financial statements, nor has the Company or its subsidiaries been assessed interest or penalties by any major tax jurisdictions. The Company’s evaluation was performed for the tax year ending December 31, 2006, the only tax year which remains subject to examination by major tax jurisdictions as of June 30, 2008.
Per Share Data
Income (loss) per basic share of common stock is calculated by dividing net income (loss) by the weighted-average number of shares of common stock issued and outstanding during such period. Diluted income (loss) per share of common stock equals basic income (loss) per share of common stock as there were no potentially dilutive securities outstanding during the three and six months ended June 30, 2008 and 2007, respectively.
Distributions declared per common share assumes the share was issued and outstanding each day during the three and six months ended June 30, 2008 and 2007, respectively, and is based on a daily distribution for the periods of $0.0019178 per share per day. Each day during the periods from January 1, 2007 through June 30, 2007 and January 1, 2008 through June 30, 2008 was a record date for distributions.
Industry Segments
SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information, establishes standards for the way that public entities report information about operating segments in their financial statements. The Company acquires and operates commercial properties and invests in real estate-related assets, including real estate loans, and as a result, the Company operates in two business segments. For financial data by segment, see Note 15, “Segment Information.”
Derivative Instruments
In the normal course of business, the Company uses certain types of derivative instruments for the purpose of managing or hedging interest rate risks. The Company has entered into various interest rate cap and floor agreements to hedge its exposure to changing interest rates on variable-rate debt instruments, including certain of the Company’s real estate loans receivable and notes payable. The Company accounts for these derivative instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”). The change in fair value of the effective portion of a derivative instrument that is designated as a hedge is recorded as other comprehensive income (loss) in the accompanying consolidated statement of stockholders’ equity. The changes in fair value for derivative instruments that are not designated as a hedge or that do not meet the hedge accounting criteria of SFAS 133 are recorded as gain or loss on derivative instruments in the accompanying consolidated statements of operations. Net amounts received or paid under the derivative instruments are amortized as adjustments to interest income or expense, respectively, based on the fair value and intrinsic value of the related derivative instrument.
F-15
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Recently Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(“SFAS 157”). SFAS 157 defines fair value and establishes a framework for measuring fair value under GAAP. The Company adopted SFAS 157 on January 1, 2008. However, in February 2008, FASB issued FSP SFAS No. 157-2,Effective Date of FASB Statement No. 157 (“FSP SFAS 157-2”). FSP SFAS 157-2 delays the effective date of SFAS 157 by one year for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. FSP SFAS 157-2 is effective in fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The adoption of SFAS 157 for the Company’s financial assets and liabilities did not have a material impact on its consolidated financial statements. The Company is currently evaluating the impact that FSP SFAS 157-2 will have on its financial statements.
In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities(“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. On January 1, 2008, the Company did not elect to apply the fair value option to any specific assets or liabilities.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),Business Combinations (“SFAS 141R”), which replaces FASB Statement No. 141,Business Combinations (“SFAS 141”). SFAS 141R expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date. SFAS 141R also requires that all assets, liabilities, contingent considerations, and contingencies of an acquired business be recorded at fair value at the acquisition date. In addition, SFAS 141R requires that acquisition costs generally be expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. The Company is currently evaluating the impact that SFAS 141R will have on its financial statements.
In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. In addition, SFAS 160 provides reporting requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company is currently evaluating the impact that SFAS 160 will have on its financial statements.
F-16
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The guidance in SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Early application is encouraged. The Company is currently evaluating the impact that SFAS 161 will have on its financial statements.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting principles to be used in the preparation and presentation of financial statements in accordance with GAAP. This statement will be effective 60 days after the SEC approves the Public Company Accounting Oversight Board’s amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not anticipate the adoption of SFAS 162 will have a significant effect on its consolidated financial statements.
F-17
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 3. | REAL ESTATE |
As of June 30, 2008, the Company’s real estate portfolio (including properties held through a consolidated joint venture) was comprised of approximately 19.7 million square feet and was 95% leased. The properties are located in 21 states and include office and industrial properties. The following table provides summary information regarding the properties owned by the Company as of June 30, 2008 (in thousands):
Asset Name | Acquisition Date | City | State | Total Cost | Accumulated Depreciation and Amortization | Real Estate, Net | ||||||||||
Properties Held Through Wholly Owned Subsidiaries | ||||||||||||||||
Opus National Industrial Portfolio | ||||||||||||||||
Cardinal Health | 7/25/2007 | Champlin | MN | $ | 13,307 | $ | (372 | ) | $ | 12,935 | ||||||
Cedar Bluffs Business Center | 7/25/2007 | Eagan | MN | 6,628 | (258 | ) | 6,370 | |||||||||
Crystal Park II-Buildings D & E | 7/25/2007 | Round Rock | TX | 20,636 | (1,016 | ) | 19,620 | |||||||||
Corporate Express | 7/25/2007 | Arlington | TX | 9,325 | (286 | ) | 9,039 | |||||||||
Park 75-Dell | 7/25/2007 | West Chester | OH | 18,692 | (584 | ) | 18,108 | |||||||||
Plainfield Business Center | 7/25/2007 | Plainfield | IN | 17,359 | (745 | ) | 16,614 | |||||||||
Hartman Business Center One | 7/25/2007 | Austell | GA | 16,829 | (534 | ) | 16,295 | |||||||||
Rickenbacker IV-Medline | 7/25/2007 | Groveport | OH | 16,907 | (708 | ) | 16,199 | |||||||||
Advo-Valassis Building | 7/25/2007 | Van Buren | MI | 9,025 | (265 | ) | 8,760 | |||||||||
| 128,708 | (4,768 | ) | 123,940 | |||||||||||||
Nashville Flex Portfolio | ||||||||||||||||
Royal Parkway Center I & II | 11/15/2007 | Nashville | TN | 13,220 | (449 | ) | 12,771 | |||||||||
Greenbriar Business Park | 11/15/2007 | Nashville | TN | 17,084 | (750 | ) | 16,334 | |||||||||
Cumberland Business Center | 11/15/2007 | Nashville | TN | 11,055 | (369 | ) | 10,686 | |||||||||
Riverview Business Center I & II | 11/15/2007 | Nashville | TN | 13,982 | (1,042 | ) | 12,940 | |||||||||
| 55,341 | (2,610 | ) | 52,731 | |||||||||||||
Sabal Pavilion Building | 7/07/2006 | Tampa | FL | 26,025 | (3,048 | ) | 22,977 | |||||||||
Plaza in Clayton | 9/27/2006 | Saint Louis | MO | 94,872 | (8,311 | ) | 86,561 | |||||||||
Southpark Commerce Center II Buildings | 11/21/2006 | Austin | TX | 30,604 | (3,022 | ) | 27,582 | |||||||||
825 University Avenue Building | 12/05/2006 | Norwood | MA | 31,249 | (2,026 | ) | 29,223 | |||||||||
Midland Industrial Buildings | 12/22/2006 | McDonough | GA | 35,618 | (1,661 | ) | 33,957 | |||||||||
Crescent Green Buildings | 1/31/2007 | Cary | NC | 48,857 | (3,854 | ) | 45,003 | |||||||||
625 Second Street Building | 1/31/2007 | San Francisco | CA | 52,085 | (3,372 | ) | 48,713 | |||||||||
Sabal VI Building | 3/05/2007 | Tampa | FL | 17,616 | (1,076 | ) | 16,540 | |||||||||
The Offices at Kensington | 3/29/2007 | Sugar Land | TX | 29,604 | (1,801 | ) | 27,803 | |||||||||
Royal Ridge Building | 6/21/2007 | Alpharetta | GA | 36,793 | (1,728 | ) | 35,065 | |||||||||
9815 Goethe Road Building | 6/26/2007 | Sacramento | CA | 17,256 | (784 | ) | 16,472 | |||||||||
Bridgeway Technology Center | 6/27/2007 | Newark | CA | 46,053 | (2,134 | ) | 43,919 | |||||||||
Plano Corporate Center I & II | 8/28/2007 | Plano | TX | 51,615 | (2,198 | ) | 49,417 | |||||||||
2200 West Loop South Building | 9/05/2007 | Houston | TX | 39,949 | (1,508 | ) | 38,441 | |||||||||
ADP Plaza | 11/07/2007 | Portland | OR | 33,865 | (1,307 | ) | 32,558 | |||||||||
Patrick Henry Corporate Center | 11/29/2007 | Newport News | VA | 18,960 | (799 | ) | 18,161 | |||||||||
Woodfield Preserve Office Center | 11/13/2007 | Schaumburg | IL | 128,992 | (6,103 | ) | 122,889 | |||||||||
South Towne Corporate Center I and II | 11/30/2007 | Sandy | UT | 50,940 | (2,100 | ) | 48,840 | |||||||||
Rivertech I and II | 2/20/2008 | Billerica | MA | 46,061 | (762 | ) | 45,299 | |||||||||
Suwanee Pointe | 5/22/2008 | Suwanee | GA | 18,215 | (96 | ) | 18,119 | |||||||||
Millennium I Building | 6/05/2008 | Addison | TX | 75,219 | (220 | ) | 74,999 | |||||||||
Tysons Dulles Plaza | 6/06/2008 | McLean | VA | 160,525 | (342 | ) | 160,183 | |||||||||
Total Properties Held Through Wholly Owned Subsidiaries | 1,275,022 | (55,630 | ) | 1,219,392 | ||||||||||||
F-18
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Asset Name | Acquisition Date | City | State | Total Cost | Accumulated Depreciation and Amortization | Real Estate, Net | ||||||||||
Properties Held Through Consolidated Joint Venture | ||||||||||||||||
National Industrial Portfolio | ||||||||||||||||
9410 Heinz Way | 8/08/2007 | Commerce City | CO | 10,681 | (339 | ) | 10,342 | |||||||||
74 Griffin Street South | 8/08/2007 | Bloomfield | CT | 23,001 | (2,710 | ) | 20,291 | |||||||||
85 Moosup Pond Road | 8/08/2007 | Plainfield | CT | 25,854 | (1,400 | ) | 24,454 | |||||||||
555 Taylor Road | 8/08/2007 | Enfield | CT | 82,819 | (5,717 | ) | 77,102 | |||||||||
15 & 30 Independence Drive | 8/08/2007 | Devens | MA | 32,591 | (817 | ) | 31,774 | |||||||||
50 Independence Drive | 8/08/2007 | Devens | MA | 15,012 | (555 | ) | 14,457 | |||||||||
1040 Sheridan | 8/08/2007 | Chicopee | MA | 4,139 | (222 | ) | 3,917 | |||||||||
1045 Sheridan | 8/08/2007 | Chicopee | MA | 3,694 | (264 | ) | 3,430 | |||||||||
151 Suffolk Lane | 8/08/2007 | Gardner | MA | 3,674 | (258 | ) | 3,416 | |||||||||
1111 Southampton Road | 8/08/2007 | Westfield | MA | 30,223 | (2,497 | ) | 27,726 | |||||||||
100 & 111 Adams Road | 8/08/2007 | Clinton | MA | 40,830 | (2,372 | ) | 38,458 | |||||||||
100 Simplex Drive | 8/08/2007 | Westminster | MA | 25,353 | (2,663 | ) | 22,690 | |||||||||
495-515 Woburn | 8/08/2007 | Tewksbury | MA | 69,528 | (3,482 | ) | 66,046 | |||||||||
480 Sprague Street | 8/08/2007 | Dedham | MA | 15,404 | (1,036 | ) | 14,368 | |||||||||
625 University Avenue(1) | 8/08/2007 | Norwood | MA | 1,460 | (385 | ) | 1,075 | |||||||||
57-59 Daniel Webster Highway | 8/08/2007 | Merrimack | NH | 24,271 | (1,691 | ) | 22,580 | |||||||||
133 Jackson Avenue | 8/08/2007 | Ellicott | NY | 10,325 | (336 | ) | 9,989 | |||||||||
1200 State Fair Boulevard | 8/08/2007 | Geddes | NY | 17,509 | (501 | ) | 17,008 | |||||||||
3407 Walters Road | 8/08/2007 | Van Buren | NY | 9,357 | (272 | ) | 9,085 | |||||||||
851 Beaver Drive | 8/08/2007 | Du Bois | PA | 7,388 | (209 | ) | 7,179 | |||||||||
Shaffer Road and Route 255 | 8/08/2007 | Du Bois | PA | 11,222 | (356 | ) | 10,866 | |||||||||
9700 West Gulf Bank Road | 8/08/2007 | Houston | TX | 12,815 | (1,968 | ) | 10,847 | |||||||||
1000 East I-20 | 8/08/2007 | Abilene | TX | 10,021 | (285 | ) | 9,736 | |||||||||
2200 South Business 45 | 8/08/2007 | Corsicana | TX | 40,665 | (3,859 | ) | 36,806 | |||||||||
Total Properties Held Through Consolidated Joint Venture | 527,836 | (34,194 | ) | 493,642 | ||||||||||||
Total Real Estate | $ | 1,802,858 | $ | (89,824 | ) | $ | 1,713,034 | |||||||||
(1) The joint venture purchased the rights to a master lease with a remaining term of 14.75 years with respect to this property as part of the National Industrial Portfolio acquisition.
Real estate consists of the following (in thousands):
| June 30, 2008 | December 31, 2007 | |||||||
Land | $ | 235,123 | $ | 186,773 | ||||
Buildings | 1,316,547 | 1,104,422 | ||||||
Building improvements | 4,069 | 2,202 | ||||||
Tenant improvements | 75,897 | 53,855 | ||||||
Tenant origination and absorption costs | 171,222 | 148,354 | ||||||
Real estate at cost | 1,802,858 | 1,495,606 | ||||||
Accumulated depreciation and amortization | (89,824 | ) | (45,454 | ) | ||||
Total real estate, net | $ | 1,713,034 | $ | 1,450,152 | ||||
F-19
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Real Estate Acquisitions During the Three Months Ended June 30, 2008
During the three months ended June 30, 2008, the Company acquired one distribution facility and two office properties, as follows:
Acquisition of Suwanee Pointe
On May 22, 2008, the Company, through an indirect wholly owned subsidiary, purchased a single-story build-to-suit distribution building containing 205,645 rentable square feet located on an approximate 16.0-acre parcel of land in Suwanee, Georgia (“Suwanee Pointe”) from an unaffiliated seller. The purchase price of Suwanee Pointe was approximately $17.8 million plus closing costs. The acquisition was funded with proceeds from the Offering.
Acquisition of the Millennium I Building
On June 5, 2008, the Company, through an indirect wholly owned subsidiary, purchased a 14-story office building totaling 353,461 rentable square feet located on an approximate 3.34-acre site in Addison, Texas (the “Millennium I Building”) from an unaffiliated seller. The purchase price of the Millennium I Building was approximately $72.0 million plus closing costs. The acquisition was funded with proceeds from the Offering and debt financing.
Acquisition of Tysons Dulles Plaza
On June 6, 2008, the Company, through an indirect wholly owned subsidiary, purchased three six-story office buildings totaling 487,775 rentable square feet located on an approximate 15.0-acre campus in McLean, Virginia (“Tysons Dulles Plaza”) from an unaffiliated seller. The purchase price of Tysons Dulles Plaza was approximately $152.8 million plus closing costs. The acquisition was funded with proceeds from the Offering and debt financing.
Operating Leases
Substantially all of the Company’s real estate assets are leased to tenants under operating leases for which the terms and expirations vary. As of June 30, 2008, the leases have remaining terms of up to 12 years and may have provisions to extend the lease agreements, options for early termination after paying a specified penalty, rights of first refusal to purchase the property at competitive market rates, and other terms and conditions as negotiated. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants. Amounts required as security deposits vary depending upon the terms of the respective leases and the creditworthiness of the tenant, but generally are not significant amounts. Therefore, exposure to credit risk exists to the extent that a tenant’s receivable exceeds the amount of its security deposit. Security deposits related to tenant leases are included in accounts payable and accrued expenses in the accompanying consolidated balance sheets.
As of June 30, 2008, the future minimum rental income from the Company’s properties under non-cancelable operating leases is as follows (in thousands):
July 1, 2008 through December 31, 2008 | $ | 82,541 | |
2009 | 139,726 | ||
2010 | 111,452 | ||
2011 | 88,078 | ||
2012 | 68,174 | ||
Thereafter | 168,168 | ||
| $ | 658,139 | ||
F-20
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
For the three and six months ended June 30, 2008, the Company earned approximately 10% of its rental income from 30 tenants in the financial services industry and approximately 7% of its rental income from 22 tenants in the insurance industry. Further, for the three and six months ended June 30, 2008, the Company earned approximately 6% of its rental income from one tenant in the retail-home improvements industry. The weighted-average remaining lease term for this tenant’s five leases with the Company is approximately two years.
| 4. | TENANT ORIGINATION AND ABSORPTION COSTS, ABOVE-MARKET LEASE ASSETS, AND BELOW-MARKET LEASE LIABILITIES |
As of June 30, 2008 and December 31, 2007, the Company’s tenant origination and absorption costs, above-market lease assets, and below-market lease liabilities are as follows (in thousands):
| Tenant Origination and Absorption Costs | Above-Market Lease Assets | Below-Market Lease Liabilities | ||||||||||||||||||||||
| June 30, 2008 | December 31, 2007 | June 30, 2008 | December 31, 2007 | June 30, 2008 | December 31, 2007 | |||||||||||||||||||
Cost | $ | 171,222 | $ | 148,354 | $ | 27,263 | $ | 23,388 | $ | 53,928 | $ | 41,857 | ||||||||||||
Accumulated Amortization | (46,932 | ) | (24,025 | ) | (4,875 | ) | (2,043 | ) | (12,174 | ) | (6,233 | ) | ||||||||||||
Net Amount | $ | 124,290 | $ | 124,329 | $ | 22,388 | $ | 21,345 | $ | 41,754 | $ | 35,624 | ||||||||||||
Amortization of the Company’s tenant origination and absorption costs, above-market lease assets, and below-market lease liabilities for the three and six months ended June 30, 2008 and 2007 are as follows (in thousands):
|
| |||||||||||||||||||||||
| Tenant Origination and Absorption Costs | Above-Market Lease Assets | Below-Market Lease Liabilities | ||||||||||||||||||||||
| For the Three Months Ended June 30, | For the Three Months Ended June 30, | For the Three Months Ended June 30, | ||||||||||||||||||||||
| 2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||||||
Amortization | $ | 10,959 | $ | 1,948 | $ | 1,558 | $ | 212 | $ | (2,845 | ) | $ | (500 | ) | ||||||||||
| Tenant Origination and Absorption Costs | Above-Market Lease Assets | Below-Market Lease Liabilities | ||||||||||||||||||||||
| For the Six Months Ended June 30, | For the Six Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||||||||||||
| 2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||||||
Amortization | $ | 22,907 | $ | 3,528 | $ | 2,832 | $ | 388 | $ | (5,941 | ) | $ | (858 | ) | ||||||||||
The remaining unamortized balance for these outstanding intangible assets and liabilities as of June 30, 2008 will be amortized as follows (in thousands):
| Tenant Origination and Absorption Costs | Above-Market Lease Assets | Below-Market Lease Liabilities | ||||||||
July 1, 2008 through December 31, 2008 | $ | 22,128 | $ | 3,010 | $ | (6,091 | ) | |||
2009 | 36,142 | 5,497 | (11,043 | ) | ||||||
2010 | 22,030 | 4,795 | (7,587 | ) | ||||||
2011 | 13,780 | 3,170 | (5,261 | ) | ||||||
2012 | 9,807 | 2,664 | (3,814 | ) | ||||||
Thereafter | 20,403 | 3,252 | (7,958 | ) | ||||||
| $ | 124,290 | $ | 22,388 | $ | (41,754 | ) | ||||
Weighted-Average Amortization Period | 4.90 years | 5.03 years | 5.25 years | |||||||
F-21
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 5. | REAL ESTATE LOANS RECEIVABLE |
As of June 30, 2008 and December 31, 2007, the Company, through wholly owned subsidiaries, had invested in real estate loans receivable as follows (in thousands):
Property Name Location of Property | Property Type | Loan Type | Acquisition Date | Book Value as of 6/30/08 | Book Value as of 12/31/07 | Index and Margin | Interest Rate at 6/30/2008 | Maturity Date | ||||||||||
First Tribeca Mezzanine Loan | Multi Family | |||||||||||||||||
New York, New York | Residential | Mezzanine | 7/18/2006 | $ | 15,896 | $ | 15,896 | 30-day LIBOR + 8.50% | 11.48% | 11/01/2008 | ||||||||
Second Tribeca Mezzanine Loan | Multi Family | |||||||||||||||||
New York, New York | Residential | Mezzanine | 5/03/2007 | 31,967 | 31,224 | Fixed rate of 25.0% | 25.00% | 11/01/2008 | ||||||||||
Tribeca Senior Mortgage Participation | Multi Family | |||||||||||||||||
New York, New York | Residential | Mortgage | 6/28/2007 | 19,139 | 25,593 | 30-day LIBOR + 3.00% | 5.68% | 11/01/2008 | ||||||||||
Sandmar Mezzanine Loan | ||||||||||||||||||
Southeast retail portfolio | Retail | Mezzanine | 1/09/2007 | 8,000 | 8,000 | Fixed rate of 12.0% | 12.00% | 1/01/2017 | ||||||||||
Park Central Mezzanine Loan | ||||||||||||||||||
New York, New York | Hotel | Mezzanine | 3/23/2007 | 15,000 | 15,000 | 30-day LIBOR + 4.48% | 7.46% | 11/09/2008 | ||||||||||
200 Professional Drive Loan Origination | ||||||||||||||||||
Gaithersburg, Maryland(1) | Office | Mortgage | 7/31/2007 | 8,530 | 7,681 | 30-day LIBOR + 3.00% | 8.00% | 7/31/2009 | ||||||||||
Lawrence Village Plaza Loan Origination | ||||||||||||||||||
New Castle, Pennsylvania(2) | Retail | Mortgage | 8/06/2007 | 6,238 | 6,170 | 30-day LIBOR + 2.50% | 7.50% | 9/01/2010 | ||||||||||
11 South LaSalle Loan Origination | ||||||||||||||||||
Chicago, Illinois(3) | Office | Mortgage | 8/08/2007 | 27,618 | 23,486 | 30-day LIBOR + 2.95% | 7.95% | 9/01/2010 | ||||||||||
San Diego Office Portfolio B-Note | ||||||||||||||||||
San Diego, CA(4) | Office | B-Note | 10/26/2007 | 13,647 | 13,460 | Fixed rate of 5.775% | 5.775% | 10/11/2017 | ||||||||||
Petra Subordinated Debt Tranche A | Various | Subordinated | 10/26/2007 | 25,000 | 25,000 | Fixed rate of 11.5% | 11.50% | 4/27/2009 | ||||||||||
Petra Subordinated Debt Tranche B | Various | Subordinated | 10/26/2007 | 25,000 | 25,000 | Fixed rate of 11.5% | 11.50% | 10/26/2009 | ||||||||||
4929 Wilshire B-Note | ||||||||||||||||||
Los Angeles, CA(4) | Office | B-Note | 11/19/2007 | 2,596 | 2,548 | Fixed rate of 6.05% | 6.05% | 7/11/2017 | ||||||||||
Artisan Multifamily Portfolio Mezzanine Loan | Multi Family | |||||||||||||||||
Las Vegas, Nevada(4) | Residential | Mezzanine | 12/11/2007 | 16,938 | 15,850 | 30-day LIBOR + 2.50% | 5.48% | 8/09/2009 | ||||||||||
Arden Portfolio M3 Mezzanine Loan | ||||||||||||||||||
Southern California (4) | Office | Mezzanine | 1/30/2008 | 63,184 | - | 30-day LIBOR + 5.25% | 8.23% | 8/09/2009 | ||||||||||
Arden Portfolio M2 Mezzanine Loan | ||||||||||||||||||
Southern California(4) | Office | Mezzanine | 1/30/2008 | 86,880 | - | 30-day LIBOR + 3.50% | 6.48% | 8/09/2009 | ||||||||||
San Antonio Business Park Mortgage Loan | ||||||||||||||||||
San Antonio, Texas(4) | Office | Mortgage | 3/28/2008 | 23,901 | - | Fixed rate of 6.54% | 6.54% | 11/11/2017 | ||||||||||
2600 Michelson Mezzanine Loan | ||||||||||||||||||
Irvine, California(4) | Office | Mezzanine | 6/02/2008 | 8,496 | - | Fixed rate of 8.0% | 8.00% | 5/11/2017 | ||||||||||
18301 Von Karman Mortgage Loan | ||||||||||||||||||
Irvine, California(4) | Office | Mortgage | 6/12/2008 | 57,760 | - | Fixed rate of 5.73% | 5.73% | 5/11/2017 | ||||||||||
18301 Von Karman Mezzanine Loan | ||||||||||||||||||
Irvine, California(4) | Office | Mezzanine | 6/12/2008 | 4,115 | - | Fixed rate of 5.73% | 5.73% | 5/11/2017 | ||||||||||
| $ | 459,905 | $ | 214,908 | |||||||||||||||
(1) As of June 30, 2008, the Company may be obligated to fund up to an additional $2.0 million, subject to satisfaction of certain conditions by the borrower.
(2) As of June 30, 2008, the Company may be obligated to fund up to an additional $2.0 million, subject to satisfaction of certain conditions by the borrower.
(3) As of June 30, 2008, the Company may be obligated to fund up to an additional $15.7 million, subject to satisfaction of certain conditions by the borrower.
(4) As of June 30, 2008, the real estate loan receivable has been fully drawn. However, this loan was purchased at a discount. The discount is being amortized over the term of the loan. As the discount on the real estate loan receivable continues to be amortized, the book value of the related real estate loan receivable will accrete, or increase, to the face value.
F-22
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
The following summarizes the activity related to real estate loans receivable for the six months ended June 30, 2008 (in thousands):
Real estate loans receivable - December 31, 2007 | $ | 214,908 | ||
Purchases of real estate loans receivable | 305,600 | |||
Advances under real estate loans receivable | 6,011 | |||
Principal payments on real estate loan receivable | (6,674 | ) | ||
Discount on purchase of real estate loans receivable | (69,368 | ) | ||
Amortization of discount on purchase of real estate loans receivable | 9,428 | |||
Real estate loans receivable - June 30, 2008 | $ | 459,905 | ||
The following summarizes the Company’s investments in real estate loans receivable as of June 30, 2008 (in thousands):
Face value of real estate loans receivable | $ | 560,478 | ||
Additional funding on real estate loan receivable | 743 | |||
Discounts on real estate loan receivable | (81,579 | ) | ||
Unfunded commitments on real estate loans receivable | (19,737 | ) | ||
Real estate loans receivable - June 30, 2008 | $ | 459,905 | ||
During the three and six months ended June 30, 2008, the Company earned $10.8 million and $19.8 million, respectively, in interest income from its interests in real estate loans, of which $2.8 million was receivable at June 30, 2008. During the three and six months ended June 30, 2008, the Company amortized, as an offset against interest income, $0.3 million and $0.7 million of closing costs related to the purchase of these real estate loans. Additionally, based on the fair value and intrinsic value of its derivative instruments, the Company amortized, as an offset against interest income, the cost of its derivative instruments totaling $0.7 million and $1.0 million for the three and six months ended June 30, 2008, respectively. During the three and six months ended June 30, 2008, the Company also recognized interest income of $5.7 million and $9.4 million, respectively, related to amortization of purchase discounts on the real estate loans. During the three months ended June 30, 2008, the borrower under the Tribeca Senior Mortgage Participation paid down $6.7 million on the principal of this loan.
The following is a schedule of maturities for all real estate loans receivable outstanding as of June 30, 2008 (in thousands):
July 1, 2008 through December 31, 2008 | $ | 82,002 | |
2009 | 225,532 | ||
2010 | 33,856 | ||
2011 | - | ||
2012 | - | ||
Thereafter | 118,515 | ||
| $ | 459,905 | ||
F-23
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Real Estate-Related Investments
Extension of Maturity Date on Tribeca Loans
As of June 30, 2008, the Company had invested an aggregate of $47.9 million in two junior mezzanine loans (the first in the principal amount of approximately $15.9 million, and the second in the principal amount of approximately $32.0 million) (together, the “First and Second Tribeca Mezzanine Loans”) and $19.1 million in a 25% participation interest in the senior mortgage loans (the “Senior Mortgage Loans” and, collectively, the “Tribeca Loans”) related to the conversion of an eight-story loft building into a 10-story condominium building (the “Tribeca Building”) located at 415 Greenwich Street in New York, New York. The Tribeca Loans had an initial maturity date of May 1, 2008, with a one-year extension option subject to the satisfaction of certain conditions.
The First and Second Tribeca Mezzanine Loans are subordinate to the Senior Mortgage Loans totaling approximately $76.6 million and a $25.0 million senior mezzanine loan.
The First and Second Tribeca Mezzanine Loans are secured by, among other things, a first lien priority pledge of the borrower’s member interest (the “Member Interest”) in 415 Greenwich Senior Mezzanine Owner LLC (the “Owner Member”). The Owner Member is the sole member in 415 Greenwich Fee Owner LLC (the “Fee Owner”), which is the owner of the Tribeca Building. With respect to certain material misrepresentations or other acts of bad faith as set forth in the guarantee agreement, amounts outstanding under the First and Second Tribeca Mezzanine Loans are guaranteed by the two individuals who have indirect interests in the Tribeca Building.
On April 30, 2008, the Company entered into loan modification agreements with the borrower to extend the maturity date of the First and Second Tribeca Mezzanine Loans to November 1, 2008. The Senior Mortgage Loan documents and the senior mezzanine loan documents with the mortgage lender and the senior mezzanine lender, respectively, were also simultaneously modified in order to extend the maturity dates of the other Tribeca Loans to November 1, 2008, subject to certain terms, debt covenants, and loan extension fees. Pursuant to the loan modification agreements, the loan extension fees will be pro-rated over the six-month extension period. During the three and six months ended June 30, 2008, the Company recognized $0.3 million of loan extension fees related to the extension of the Senior Mortgage Loans.
With respect to the loan extension fees for the First and Second Tribeca Mezzanine Loans, payment of the loan extension fees will be based upon available cash flow and amounts due to the Company will be placed in an escrow account and released upon full repayment of the Senior Mortgage Loans and the senior mezzanine loan. In the event that full payment of the Senior Mortgage Loans and the senior mezzanine loan is not made, loan extension fees held in escrow shall be used to first satisfy remaining amounts outstanding under the Senior Mortgage Loans and the senior mezzanine loan. In addition, the loan modification agreements, among other things, revise the “waterfall” structure to fund payment of debt service on all of the loans prior to principal payments on all of the loans.
Investment in the 2600 Michelson Mezzanine Loan
On June 2, 2008, the Company, through an indirect wholly owned subsidiary, purchased at a discount a $15.0 million mezzanine loan (the “2600 Michelson Mezzanine Loan”) secured by, among other things, a pledge by the mezzanine borrower of all of its right, title and interest in the entity that holds title to a 16-story office building with a five-level parking structure located at 2600 Michelson Avenue in Irvine, California. The 2600 Michelson Mezzanine Loan matures on May 11, 2017 and bears interest at a fixed rate of 8.00%. There is $95.0 million of mortgage debt senior to the 2600 Michelson Mezzanine Loan. The senior financing is secured by a deed of trust on the property. The purchase price of the loan was funded with proceeds from the Offering.
F-24
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Investment in the 18301 Von Karman First Mortgage and Mezzanine Loans
On June 12, 2008, the Company, through an indirect wholly owned subsidiary, purchased at a discount a $76.0 million first mortgage loan (the “Von Karman Mortgage Loan”) and a $9.0 million mezzanine loan (the “Von Karman Mezzanine Loan”). The Von Karman Mortgage Loan is secured by an 11-story office building located at 18301 Von Karman Avenue in Irvine, California and the Von Karman Mezzanine Loan is secured by, among other things, a pledge by the mezzanine borrower of all of its right, title and interest in the entity that owns the property. Both the Von Karman Mortgage Loan and the Von Karman Mezzanine Loan have a fixed interest rate of 5.73% and a maturity date of May 11, 2017. The purchase price of the loan was funded with proceeds from the Offering.
| 6. | MARKETABLE SECURITIES |
At June 30, 2008, the Company held two investments in securities classified as available for sale. The Company evaluates its investments in available for sale marketable securities for impairment and determines if a decline in market value of the security below the Company’s cost basis is other-than-temporary based upon (i) the length of time and the extent to which the fair value has been less than cost, (ii) an analysis of the anticipated future cash flow from the underlying collateral and (iii) the Company’s ability and intent to retain the investments for a period of time sufficient to allow for the recovery in the fair value.
On April 19, 2007, the Company acquired at a discount approximately $17.8 million of CMBS that accrue interest at a coupon rate of 30-day LIBOR plus 2.30% (“Floating Rate CMBS”). The Floating Rate CMBS were rated BBB- and BB+ by Standard & Poor’s and Fitch, respectively, on the date of acquisition. Since the time the Company acquired the securities there have been disruptions in the commercial mortgage markets in general, and the CMBS market in particular. In addition, spreads in the primary mortgage market have widened significantly. While this capital market stress has not to date been reflected in the performance of the commercial mortgages in the form of increased defaults in mortgage pools underlying the Floating Rate CMBS, pricing of the Floating Rate CMBS has been adversely affected by market perceptions that underlying mortgage defaults will increase. In addition, in July 2008, the credit rating for Floating Rate CMBS was downgraded to B and BB- by Standard & Poor’s and Fitch, respectively. As a result of these factors, the Company recognized $7.0 million of other-than-temporary impairment charges in the three months ended June 30, 2008 and established a new cost basis for the Floating Rate CMBS of $10.7 million. The Company had recognized $2.4 million of unrealized losses on these securities through accumulated other comprehensive gain (loss) in the consolidated statements of stockholders’ equity in previous periods, of which $0.3 million of the unrealized losses were recognized in the first quarter of 2008. The $2.4 million of unrealized losses were reclassified out of accumulated other comprehensive gain (loss) in the consolidated statements of stockholders’ equity as part of the $7.0 million other-than-temporary impairment charge included in the consolidated statements of operations for the three and six months ended June 30, 2008.
Additionally, on June 13, 2008, the Company acquired $82.0 million of investment grade securities at a discount, which accrue interest at a coupon rate of 4.5% and that are indirectly backed by CMBS (“Fixed Rate Securities”). As of June 30, 2008, the Company’s investments in Fixed Rate Securities had unrealized gains of $0.4 million, which was recognized through accumulated other comprehensive gain (loss) in the consolidated statements of stockholders’ equity during the six months ended June 30, 2008.
F-25
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
The following table presents fair value and unrealized gains of the Company’s investments in marketable securities at June 30, 2008.
| Holding Period of Unrealized Gains of Investments in Marketable Securities (dollar amounts in thousands) | ||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | ||||||||||||||||
Investment | Fair Value | Unrealized Gains | Fair Value | Unrealized Gains | Fair Value | Unrealized Gains | ||||||||||||
Floating Rate CMBS | $ | 10,662 | $ | - | $ | - | $ | - | $ | 10,662 | $ | - | ||||||
Fixed Rate Securities | 44,599 | 356 | - | - | 44,599 | 356 | ||||||||||||
| $ | 55,261 | $ | 356 | $ | - | $ | - | $ | 55,261 | $ | 356 | |||||||
| 7. | RENTS AND OTHER RECEIVABLES |
Rents and other receivables consist of the following (in thousands):
| June 30, 2008 | December 31, 2007 | |||||
Tenant receivables, net of allowance for doubtful accounts of $473 and $234 | $ | 3,502 | $ | 2,687 | ||
Deferred rent | 4,996 | 2,437 | ||||
Interest receivable on real estate loans receivable | 2,771 | 1,631 | ||||
Interest receivable on cash and cash equivalents | 55 | 79 | ||||
Interest receivable on marketable securities | 266 | 93 | ||||
Other receivables | 658 | 3,704 | ||||
| $ | 12,248 | $ | 10,631 | |||
F-26
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 8. | DEFERRED FINANCING COSTS AND PREPAID AND OTHER ASSETS |
Deferred financing costs and prepaid and other assets consist of the following (in thousands):
| June 30, 2008 | December 31, 2007 | |||||
Investment in master lease, net of accumulated amortization of $750 and $321 | $ | 12,611 | $ | 13,040 | ||
Deferred financing costs, net of accumulated amortization of $6,755 and $3,112 | 8,868 | 10,704 | ||||
Derivative instruments at fair value, net of accumulated loss of $3,000 and $1,524 as of | 3,276 | 310 | ||||
Prepaid insurance | 2,076 | 1,428 | ||||
Closing costs on loans receivable, net of accumulated amortization of | 2,867 | 1,783 | ||||
Escrow deposits for future real estate purchases | 1,000 | 1,000 | ||||
Other assets and prepaid expenses | 916 | 1,360 | ||||
| $ | 31,614 | $ | 29,625 | |||
Derivative Instruments
The following table summarizes the notional and fair value of the Company’s derivative financial instruments at June 30, 2008. The notional value is an indication of the extent of the Company’s involvement in each instrument at that time, but does not represent exposure to credit, interest rate or market risks (in thousands):
| Notional Value | Interest Rate | Effective Date | Maturity Date | Fair Value | ||||||||
Interest Rate Cap(1) | $ | 405,000 | 5.75% | 8/08/2007 | 8/15/2010 | $ | 501 | |||||
Interest Rate Cap(1) | 46,000 | 6.00% | 8/08/2007 | 8/15/2009 | 2 | |||||||
Interest Rate Floor(2) | 83,721 | 4.50% | 1/30/2008 | 8/09/2009 | 1,452 | |||||||
Interest Rate Floor(2) | 60,279 | 4.50% | 1/30/2008 | 8/09/2009 | 1,045 | |||||||
Interest Rate Floor(2) | 15,850 | 4.50% | 3/09/2008 | 8/09/2009 | 276 | |||||||
| $ | 610,850 | $ | 3,276 | |||||||||
(1) The Company has not designated either of these contracts as cash flow hedges for accounting purposes. The interest rate caps have been recorded at their estimated fair value in the accompanying consolidated balance sheet as of June 30, 2008. The gain resulting from the increase in fair value of the interest rate caps for the three and six months ended June 30, 2008 of approximately $361,000 and $192,000, respectively, is reflected on the accompanying unaudited consolidated statements of operations as an unrealized gain on derivative instruments. The Company marks the interest rate cap agreements to their estimated fair values as of each balance sheet date and records the changes in fair value in the consolidated statement of operations.
(2) The Company designated each of these three interest rate floor agreements as cash flow hedges. The interest rate floor agreements have been recorded at their estimated fair value in the accompanying consolidated balance sheet as of June 30, 2008. Changes in the fair value of the effective portion of the interest rate floor agreements designated as hedges are recorded as other comprehensive loss in the accompanying consolidated statement of stockholders’ equity. Other comprehensive loss for the three and six months ended June 30, 2008 relating to the fair value adjustments of the three interest rate floor agreements amounted to approximately $1.6 million and $627,000, respectively. During the three and six months ended June 30, 2008, the Company also amortized, as an offset to interest income, the cost of the interest rate floor agreements of approximately $695,000 and $1.0 million, respectively.
F-27
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 9. | NOTES PAYABLE |
Notes payable, all of which are interest-only loans during the term with principal payable upon maturity, consist of the following as of June 30, 2008 (in thousands):
| Principal as of 6/30/08 | Principal as of 12/31/07 | Average Interest Rate(1) | Fixed/ Variable Interest Rate | Maturity Date (2) | |||||||||
Sabal Pavilion Building - Mortgage Loan | $ | 14,700 | $ | 14,700 | 6.3800 | % | Fixed | 8/01/2036 | |||||
Plaza in Clayton - Mortgage Loan | 62,200 | 62,200 | 5.8990 | % | Fixed | 10/06/2016 | |||||||
Southpark Commerce Center II Buildings - Mortgage Loan | 18,000 | 18,000 | 5.6725 | % | Fixed | 12/06/2016 | |||||||
825 University Avenue Building - Mortgage Loan | 19,000 | 19,000 | 5.5910 | % | Fixed | 12/06/2013 | |||||||
Midland Industrial Buildings - Mortgage Loan | 24,050 | 24,050 | 5.7550 | % | Fixed | 1/06/2011 | |||||||
Crescent Green Building - Mortgage Loan | 32,400 | 32,400 | 5.1800 | % | Fixed | 2/01/2012 | |||||||
625 Second Street Building - Mortgage Loan | 33,700 | 33,700 | 5.8500 | % | Fixed | 2/01/2014 | |||||||
Sabal VI Building - Mortgage Loan | 11,040 | 11,040 | 5.1400 | % | Fixed | 10/01/2011 | |||||||
Sabal VI Building - Mezzanine Loan(3) | - | 3,000 | 5.3556 | % | Variable | (3) | |||||||
The Offices at Kensington - Mortgage Loan | 18,500 | 18,500 | 5.5200 | % | Fixed | 4/01/2014 | |||||||
Bridgeway Technology Center - Mortgage Loan | 26,824 | 26,824 | 6.0700 | % | Fixed | 8/01/2013 | |||||||
Marketable Securities - Repurchase Agreement(4) | - | 13,261 | 4.2577 | % | Variable | (4) | |||||||
Royal Ridge Building - Mortgage Loan | 21,718 | 21,718 | 5.9600 | % | Fixed | 9/01/2013 | |||||||
Plano Corporate Center I & II - Mortgage Loan | 30,591 | 30,591 | 5.9000 | % | Fixed | 9/01/2012 | |||||||
2200 West Loop South Building - Mortgage Loan | 17,426 | 17,426 | 5.8900 | % | Fixed | 10/01/2014 | |||||||
Cedar Bluffs - Mortgage Loan | 4,627 | 4,627 | 5.8600 | % | Fixed | 7/01/2011 | |||||||
National Industrial Portfolio - Mortgage Loan(5) | 300,000 | 315,000 | 3.3369 | % | Variable | 8/09/2009 | |||||||
National Industrial Portfolio - Mezzanine Loan A(5) | 40,200 | 116,000 | 4.2028 | % | Variable | 8/09/2009 | |||||||
National Industrial Portfolio - Mezzanine Loan B(5) | 32,300 | - | 4.5028 | % | Variable | 8/09/2009 | |||||||
National Industrial Portfolio - Mezzanine Loan C(5) | 32,300 | - | 4.7528 | % | Variable | 8/09/2009 | |||||||
National Industrial Portfolio - Mezzanine Loan D(5) | 26,200 | - | 5.5028 | % | Variable | 8/09/2009 | |||||||
National Industrial Portfolio - Mezzanine Loan E(5) | 644 | - | 3.7428 | % | Variable | 8/09/2009 | |||||||
Hartman Business Center One - Mortgage Loan(6) | 9,479 | 9,479 | 4.5746 | % | Variable | 11/09/2008 | |||||||
Cardinal Health - Mortgage Loan(6) | 6,900 | 6,900 | 4.5746 | % | Variable | 11/09/2008 | |||||||
Corporate Express - Mortgage Loan(6) | 5,318 | 5,318 | 4.5746 | % | Variable | 11/09/2008 | |||||||
Rickenbacker IV - Medline - Mortgage Loan(6) | 9,465 | 9,465 | 4.5122 | % | Variable | 11/15/2008 | |||||||
Plainfield Business Center - Mortgage Loan(6) | 10,200 | 10,200 | 4.5122 | % | Variable | 11/15/2008 | |||||||
Crystal Park II - Buildings D & E - Mortgage Loan(6) | 12,009 | 12,009 | 4.5122 | % | Variable | 11/15/2008 | |||||||
Park 75 - Dell - Mortgage Loan(6) | 10,138 | 10,138 | 4.5122 | % | Variable | 11/15/2008 | |||||||
Advo-Valassis - Mortgage Loan(6) | 4,988 | 4,988 | 4.5486 | % | Variable | 11/15/2008 | |||||||
ADP Plaza - Mortgage Loan | 20,900 | 20,900 | 5.5600 | % | Fixed | 10/01/2013 | |||||||
Woodfield Preserve Office Center - Mortgage Loan | 80,000 | 68,400 | 5.3000 | % | Fixed | 5/01/2011 | |||||||
Nashville Flex Portfolio - Mortgage Loan(6) | 32,430 | 32,430 | 4.5122 | % | Variable | 11/15/2008 | |||||||
Patrick Henry Corporate Center - Mortgage Loan(6) | 11,100 | 11,100 | 4.5714 | % | Variable | 11/29/2008 | |||||||
South Towne Corporate Center I and II - Mortgage Loan | 22,500 | 25,200 | 5.3000 | % | Fixed | 5/01/2011 | |||||||
Rivertech I and II - Mortgage Loan(6) | 27,300 | - | 4.0948 | % | Variable | 11/20/2008 | |||||||
Millennium I Building - Mortgage Loan | 36,000 | - | 4.6981 | % | Variable | 12/05/2008 | |||||||
Tysons Dulles Plaza - Mortgage Loan | 77,721 | - | 4.6994 | % | Variable | 12/06/2008 | |||||||
| $ | 1,142,868 | $ | 1,008,564 | ||||||||||
(1) Represents the weighted-average interest rate for the current year to date.
(2) Represents initial maturity date or the maturity date as extended as of June 30, 2008; subject to certain conditions, the maturity dates of some loans may be extended beyond the date shown.
(3) On February 22, 2008, the Company paid off the principal and interest outstanding under the note.
(4) On April 16, 2008, the Company paid off the principal and interest outstanding under the agreement.
(5) Held through a consolidated joint venture. On March 28, 2008 and May 8, 2008, the mortgage and mezzanine loans were restructured to provide for additional debt tranches with varying interest rates. In the aggregate, the weighted-average interest rate of the mortgage and mezzanine loans is 125 basis points over 30-day LIBOR.
(6) On July 11, 2008, the Company paid off the principal and interest under these short-term bridge loans and completed four-year secured financing of the referenced properties described in Note 17, “Subsequent Events.”
F-28
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
During the three months ended June 30, 2008, the Company entered into the following financings related to its real property portfolio.
Woodfield Preserve Office Center and South Towne Corporate Center I and II Financing
On April 29, 2008, the Company, through two wholly owned subsidiaries, entered into an agreement to obtain three-year secured financing in the total amount of $106.5 million (including $4.0 million of future funding capacity) on Woodfield Preserve Office Center and South Towne Corporate Center I and II (the “Mortgage Loan”) with a financial institution. The Mortgage Loan matures on May 1, 2011 and bears interest at a fixed rate of 5.30% per annum. As part of the above transaction, the Company fully repaid two outstanding short-term bridge loans obtained at the time the Company acquired Woodfield Preserve Office Center and South Towne Corporate Center I and II.
Millennium I Building Financing
On June 5, 2008, the Company, through a wholly owned subsidiary, entered into a bridge loan with a financial institution for $36.0 million secured by the Millennium I Building (the “Millennium I Mortgage Loan”). The maturity date for the Millennium I Mortgage Loan is December 5, 2008. At the Company’s option, interest accrues under the loan at either the Prime Rate as established from time to time by the lender or 30-day LIBOR plus 225 basis points.
The loan agreements for the Millennium I Mortgage Loan contain cross-default and cross-collateralization provisions such that this loan as well as the secured loan on Tysons Dulles Plaza are cross-defaulted and cross-collateralized with each other.
Tysons Dulles Plaza Financing
On June 6, 2008, the Company, through a wholly owned subsidiary, entered into a bridge loan with a financial institution for $77.7 million secured by Tysons Dulles Plaza (the “Tysons Dulles Plaza Mortgage Loan”). The maturity date for the loan is December 6, 2008. At the Company’s option, interest accrues under the loan at either the Prime Rate as established from time to time by the lender or 30-day LIBOR plus 225 basis points.
The loan documents for the Tysons Dulles Plaza Mortgage Loan contain cross-default and cross-collateralization provisions such that this loan as well as the secured loan on the Millennium I Building are cross-defaulted and cross-collateralized with each other.
During the three and six months ended June 30, 2008, the Company incurred $12.4 million and $26.4 million of interest expense, respectively. Of this amount, $3.6 million was payable at June 30, 2008. The Company also incurred $1.9 million and $3.7 million of amortization of deferred financing costs, which is included in interest expense for the three and six months ended June 30, 2008, respectively.
The following is a schedule of maturities for all notes payable outstanding as of June 30, 2008 (in thousands):
July 1, 2008 through December 31, 2008 | $ | 253,048 | |
2009 | 431,644 | ||
2010 | - | ||
2011 | 142,217 | ||
2012 | 62,991 | ||
Thereafter | 252,968 | ||
| $ | 1,142,868 | ||
F-29
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Guarantees
The Company provides financial guarantees as required by creditors in connection with certain debt financing. As of June 30, 2008, the following financial guarantees were outstanding (in thousands):
Legal Entity - Guarantor (Name of Entity) | Amount of Guarantee | Type | |||||
Sabal Pavilion Building - Mortgage Loan | KBS Limited Partnership | $ | 1,500 | Tenant Improvement & Leasing | |||
Sabal VI Building - Mortgage Loan | KBS Limited Partnership | 189 | Repayment Guarantee | ||||
The Offices at Kensington - Mortgage Loan | KBS Limited Partnership | 135 | Repayment Guarantee | ||||
Royal Ridge Building - Mortgage Loan | KBS REIT Properties, LLC | 5,000 | Tenant Improvement & Leasing | ||||
ADP Plaza - Mortgage Loan | KBS REIT Properties, LLC | 3,650 | Tenant Improvement & Leasing | ||||
| $ | 10,474 | ||||||
| 10. | ACCOUNTS PAYABLE AND ACCRUED LIABILITIES |
Accounts payable and accrued liabilities consisted of the following (in thousands):
| June 30, 2008 | December 31, 2007 | |||||||
Accounts payable and other accrued liabilities | $ | 10,766 | $ | 9,052 | ||||
Accrued interest expense | 3,587 | 4,027 | ||||||
Real estate taxes payable | 5,744 | 3,490 | ||||||
| $ | 20,097 | $ | 16,569 | |||||
| 11. | OTHER LIABILITIES |
Other liabilities consist of the following (in thousands):
| June 30, 2008 | December 31, 2007 | |||||||
Tenant security deposits | $ | 4,758 | $ | 3,952 | ||||
Prepaid rent and other | 2,251 | 3,655 | ||||||
| $ | 7,009 | $ | 7,607 | |||||
F-30
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 12. | FAIR VALUE OF FINANCIAL INSTRUMENTS |
The Company adopted SFAS 157,Fair Value Measurements, on January 1, 2008, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements for financial instruments. The framework required for the valuation of investments uses a three-tiered approach in the valuation of investments. The statement requires fair value measurement be classified and disclosed in one of the following three categories:
| • | Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities; |
| • | Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and |
| • | Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable. |
When available, the Company utilizes quoted market prices from an independent third party source to determine fair value and classifies such items in Level 1. In some instances where a market price is available, but in an inactive or over-the-counter market where significant fluctuations in pricing can occur, the Company consistently applies the dealer (market maker) pricing estimate and classifies the financial asset or liability in Level 2. If quoted market prices or inputs are not available, fair value measurements are based on valuation techniques that utilize current market or independently sourced market inputs and could be classified in either Level 2 or 3 depending on the level of input significant to the fair value measurement.
At June 30, 2008, the Company held the following financial instruments measured under the SFAS 157 hierarchy (in thousands):
| Fair Value Measurements Using | ||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||
Marketable Securities | $ | 55,261 | $ | - | $ | 55,261 | $ | - | ||||
Derivative Instruments | $ | 3,276 | $ | - | $ | 3,276 | $ | - | ||||
| 13. | RELATED PARTY TRANSACTIONS |
Due to Affiliates
Upon the launch of the Offering, the Company executed a Dealer Manager Agreement with the Dealer Manager on January 27, 2006 and entered into an Advisory Agreement with the Advisor that is in effect through November 8, 2008. These agreements entitle the Advisor and the Dealer Manager to specified fees upon the provision of certain services with regard to the Offering and the investment of funds in real estate assets, among other services, as well as reimbursement of organization and offering costs incurred by the Advisor, the Dealer Manager, and their affiliates on behalf of the Company (as discussed in Note 2) and certain costs incurred by the Advisor in providing services to the Company.
F-31
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Pursuant to the terms of the agreements described above, summarized below are the related-party costs incurred by the Company for the three and six months ended June 30, 2008 and 2007, respectively, and any related amounts payable as of June 30, 2008 and December 31, 2007 (in thousands):
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||
Incurred | ||||||||||||
Expensed | ||||||||||||
Asset management fees | $ | 5,227 | $ | 794 | $ | 8,004 | $ | 1,366 | ||||
Additional Paid-in Capital | ||||||||||||
Selling commissions(1) | 30,449 | 13,789 | 46,702 | 20,618 | ||||||||
Dealer manager fees(1) | 19,726 | 8,517 | 29,283 | 12,787 | ||||||||
Reimbursements of organization and offering costs(1) (2) | 1,212 | 1,349 | 2,423 | 1,564 | ||||||||
Capitalized | ||||||||||||
Acquisition fees(3) | 2,355 | 1,154 | 3,957 | 2,407 | ||||||||
| $ | 58,969 | $ | 25,603 | $ | 90,369 | $ | 38,742 | |||||
| June 30, 2008 | December 31, 2007 | |||||||||||
Payable | ||||||||||||
Expensed | ||||||||||||
Asset management fees | $ | 4,420 | $ | 2,215 | ||||||||
Additional Paid-in Capital | ||||||||||||
Selling commissions(1) | 41 | 337 | ||||||||||
Dealer manager fees(1) | 117 | 232 | ||||||||||
Reimbursements of organization and offering costs(1) (2) | 557 | 156 | ||||||||||
Capitalized | ||||||||||||
Advances from Advisor(4) | 1,600 | 1,600 | ||||||||||
| $ | 6,735 | $ | 4,540 | |||||||||
(1) Selling commissions, dealer manager fees and reimbursements of organization and offering costs are charged as incurred against stockholders’ equity in the accompanying consolidated financial statements.
(2) Reimbursements of organization and offering costs represent the portion of the Company’s organization and offering costs incurred by the Advisor and its affiliates on behalf of the Company and subsequently reimbursed by the Company. The Company has recorded organization and offering costs related to the Offering of $3.5 million for the six months ended June 30, 2008, including both organization and offering costs incurred directly by the Company and those costs incurred by the Advisor and its affiliates on behalf of the Company, which were subsequently reimbursed by the Company.
(3) Represents acquisition fees related to purchases of real estate and real estate-related investments during the three and six months ended June 30, 2008. The acquisition fees for the real estate loans receivable are capitalized as deferred financing costs and prepaid and other assets in the accompanying consolidated financial statements and amortized over the life of the loans.
(4) In order that the Company’s investors could begin earning cash distributions, the Advisor agreed to advance funds to the Company equal to the amount by which the cumulative amount of distributions declared by the Company from January 1, 2006 through the period ending August 31, 2008 exceeds the amount of the Company’s funds from operations (as defined by the National Association of Real Estate Investment Trusts) from January 1, 2006 through August 31, 2008. The Advisor agreed that the Company will only be obligated to reimburse the Advisor for these expenses if and to the extent that the Company’s cumulative funds from operations for the period commencing January 1, 2006 through the date of any such reimbursement exceed the lesser of (i) the cumulative amount of any distributions declared and payable to the Company’s stockholders as of the date of such reimbursement or (ii) an amount that is equal to a 7.0% cumulative, non-compounded, annual return on invested capital for the Company’s stockholders for the period from July 18, 2006 through the date of such reimbursement. No interest will accrue on the advance being made by the Advisor. No amounts have been advanced since January 2007.
F-32
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
The Company had granted no stock-based compensation awards and it had not incurred any disposition fees, subordinated participation in net cash flows, or subordinated incentive listing fees during the three and six months ended June 30, 2008.
Form of Compensation | Amount | |||
| Selling Commission | The Company pays the Dealer Manager up to 6% of the gross offering proceeds (up to 3% for sales of shares under the dividend reinvestment plan) before reallowance of commissions earned by participating broker-dealers. The Dealer Manager reallows 100% of commissions earned to participating broker-dealers.
Assuming all shares are sold at the highest possible selling commissions (with no discounts to any categories of purchasers) and a $9.50 price for each share sold through the dividend reinvestment plan, estimated selling commissions are approximately $142.8 million if the Company sells the maximum of 280,000,000 shares. | |||
| Dealer Manager Fee | The Company pays the Dealer Manager 3.5% of gross offering proceeds. No dealer manager fee is payable on shares sold under the dividend reinvestment plan. The Dealer Manager may reallow to any participating broker-dealer up to 1% of the gross offering proceeds attributable to that participating broker-dealer as a marketing fee, provided that the Dealer Manager may increase the amount of the reallowance in special cases. The dealer manager fee is reduced for certain volume discount sales.
The estimated dealer manager fee is approximately $70.0 million if the Company sells the maximum of 280,000,000 shares. | |||
Reimbursement of Organization and Offering Expenses | The Company reimburses the Advisor or its affiliates for organization and offering expenses (as discussed in Note 2) incurred by the Advisor or its affiliates on behalf of the Company to the extent that reimbursement would not cause selling commissions, the dealer manager fee and the other organization and offering expenses borne by the Company to exceed 15% of gross offering proceeds as of the date of reimbursement.
The Company estimates organization and offering costs of approximately $22.4 million if the Company sells the maximum of 280,000,000 shares. | |||
| Acquisition Fee | The Company pays the Advisor 0.75% of the cost of investments acquired, including acquisition expenses and any debt attributable to such investments. | |||
F-33
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Form of Compensation | Amount | |||
Asset Management Fee* | The Company pays the Advisor a monthly asset management fee equal to one-twelfth of 0.75% of the sum of the cost of all real estate investments the Company owns and of the Company’s investments in joint ventures, including acquisition fees, acquisition expenses and any debt attributable to such investments, provided that with respect to the Company’s investment in the Joint Venture that owns the National Industrial Portfolio, the asset management fee is calculated as a monthly fee equal to one-twelfth of 0.27% of the cost of the Joint Venture investment, which equals the product of (i) the amount actually paid or allocated to the purchase, development, construction or improvement of properties by the Joint Venture, inclusive of expenses related thereto, and the amount of any outstanding debt associated with such properties and the Joint Venture and (ii) the percentage that represents the Company’s economic interest in the Joint Venture. The Advisor may earn a performance fee related to the joint venture investment in the National Industrial Portfolio that would in effect make the Advisor’s cumulative fees related to the investment equal to 0.75% of the cost of the joint venture investment on an annualized basis from the date of the Company’s investment in the Joint Venture through the date of calculation. This fee is conditioned upon the Company’s funds from operations. As of June 30, 2008, the Company’s operations were sufficient to meet the funds from operations condition per the Advisory Agreement. As a result, as of June 30, 2008, the Company had accrued for incurred but unpaid performance fees of $2.2 million. Although these performance fees have been incurred as of June 30, 2008, the Advisory Agreement further provides that the payment of these fees shall only be made after the repayment of advances from the Advisor. As of June 30, 2008, $1.6 million of advances from the Advisor remain unpaid.
Although the asset management fees earned by the Advisor through June 30, 2008 have been accrued for and expensed in the appropriate period in the Company’s financial statements, the Advisor deferred, without interest, payment of the asset management fees it earned from July 2006 through September 2007. Per the terms of the Advisory Agreement, the Advisor may choose to be paid the accrued but unpaid asset management fees in such future period as the Advisor may determine. At June 30, 2008, there were $2.2 million of accrued but unpaid asset management fees for the months of July 2006 through September 2007 outstanding. The Company had paid the Advisor asset management fees earned pursuant to the Advisory Agreement for services related to the months of October 2007 through June 2008, other than the $2.2 million performance fee discussed above related to the Company’s investment in the Joint Venture that owns the National Industrial Portfolio. |
F-34
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Form of Compensation | Amount | |||
Reimbursement of Operating Expenses* | The Company may reimburse certain operating expenses incurred by the Advisor or its affiliates in connection with their provision of services to the Company, including the Company’s allocable share of the Advisor’s overhead, such as rent, personnel costs, utilities and IT costs. However, the Company does not reimburse the Advisor or its affiliates for personnel costs in connection with services for which the Advisor or its affiliates receive acquisition fees or disposition fees. | |||
| Disposition Fee | For substantial assistance in connection with the sale of properties or other investments, the Company will pay the Advisor or its affiliate a disposition fee of 1% of the contract sales price of the properties or other investments sold. However, in no event may the real estate commissions paid to the Advisor, its affiliates and unaffiliated third parties exceed 6% of the contract sales price of the properties or other investments sold. | |||
Subordinated Participation in Net Cash Flows* | After investors receive a return of their net capital contributions and an 8.0% per year cumulative, noncompounded return, the Advisor is entitled to receive 15.0% of the net cash flows produced by the Company, whether from continuing operations, net sale proceeds or otherwise. | |||
| Subordinated Incentive Listing Fee | Upon listing the Company’s common stock on a national securities exchange, the Advisor or its affiliates will receive 15% of the amount by which (1) the market value of the Company’s outstanding stock plus distributions paid by the Company prior to listing exceeds (2) the sum of invested capital and the amount of cash flow necessary to generate an 8.0% per year cumulative, noncompounded return to stockholders. | |||
F-35
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Form of Compensation | Amount | |||
Stock-based Compensation Awards* | The Company may issue stock-based awards to affiliates of the Advisor. As of June 30, 2008, no awards had been granted under the plan. The Company has no timetable for the grant of any awards under the Employee and Independent Director Incentive Stock Plan, and the Company’s board of directors has adopted a policy that prohibits grants of any awards of shares of common stock to any person under the Employee and Independent Director Stock Plan. |
* The Advisor will reimburse the Company at the end of any fiscal quarter for total operating expenses that in the four consecutive fiscal quarters then ended exceed the greater of 2% of its average invested assets or 25% of its net income for such year, unless the conflicts committee of the Company’s board of directors has determined that such excess expenses were justified based on unusual and non-recurring factors. The Company’s total operating expenses were not in excess of the operating expense reimbursement obligation for the four trailing fiscal quarters ending June 30, 2008 or 2007.
“Average invested assets” means the average monthly book value of the Company’s assets during the 12-month period before deducting depreciation, bad debts or other non-cash reserves. “Total operating expenses” means all expenses paid or incurred by the Company, as determined under GAAP, that are in any way related to the Company’s operation, including advisory fees, but excluding (a) the expenses of raising capital such as organization and offering expenses, legal, audit, accounting, underwriting, brokerage, listing, registration and other fees, printing, and other such expenses and taxes incurred in connection with the issuance, distribution, transfer, registration and stock exchange listing of the Company’s stock; (b) interest payments; (c) taxes; (d) non-cash expenditures such as depreciation, amortization, and bad debt reserves; (e) reasonable incentive fees based on the gain in the sale of the Company’s assets; and (f) acquisition fees, acquisition expenses (including expenses relating to potential acquisitions that the Company does not close), real estate commissions on the resale of property and other expenses connected with the acquisition, disposition, management and ownership of real estate interests, mortgage loans or other property (including the costs of foreclosure, insurance premiums, legal services, maintenance, repair and improvement of property). To the extent the Advisor receives the fee described above at “Subordinated Participation in Net Cash Flows” and such fee is derived from cash flows other than net sales proceeds, that fee may be limited by the restriction on “total operating expenses.” In addition, stock-based awards treated as an expense under GAAP will count, toward the restriction on “total operating expenses.”
F-36
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 14. | MINORITY INTEREST |
On August 8, 2007, the Company entered into an operating agreement with New Leaf Industrial Partners Fund, L.P (“New Leaf”) for the Joint Venture (the “Operating Agreement”). The purpose of the Joint Venture, which is managed by New Leaf, is to invest in 23 institutional quality industrial properties and hold a master lease with a remaining term of approximately 14.75 years with respect to another industrial property (collectively, the “National Industrial Portfolio”). The Company made an initial capital contribution of approximately $85.5 million and holds an 80% membership interest in the Joint Venture. New Leaf made an initial capital contribution of approximately $21.4 million and owns a 20% membership interest in the Joint Venture. Pursuant to the Operating Agreement, the Company and New Leaf may be required to make additional capital contributions to the Joint Venture to fund operating reserves or expenses approved by the budget or business plan.
New Leaf is the manager of the Joint Venture; however, its authority is limited. It may not cause the Joint Venture to undertake activities or incur expenses with respect to the National Industrial Portfolio properties not authorized by the Operating Agreement, the approved budget or the approved business plan, except certain limited expenditures. New Leaf also may not cause the Joint Venture to make certain decisions without the Company’s consent, including any action that would reasonably be expected to have a substantial or material effect upon the Joint Venture, any of its subsidiaries or the National Industrial Portfolio properties.
New Leaf received acquisition fees in connection with the acquisition by the Joint Venture of the National Industrial Portfolio and is entitled to asset management fees and disposition fees for its services for the Joint Venture.
So long as New Leaf is the manager of the Joint Venture, distributions will be made generally as follows: (i) first, to return to the members, pro rata, their capital contributions, (ii) second, to pay the members a return of 8%, compounded annually, (iii) third, 36% of the distributable cash to New Leaf and 64% of the distributable cash to the Company, until the Company has received a return of 10%, compounded annually, and (iv) thereafter, 44% of the distributable cash to New Leaf and 56% of the distributable cash to the Company. If New Leaf is no longer the manager in the Joint Venture, distributions will be made generally first to return to the members, pro rata, their capital contributions and second to the members pro rata in proportion to each member’s membership interest. At all times, the following special distributions may be given a higher priority: (i) special distributions to the Company necessary in connection with its status as a REIT for federal income tax purposes and (ii) special distributions to a member that has made additional capital contributions on behalf of the other.
The Company concluded that the Joint Venture meets the definition of a variable interest entity under FIN 46R and it is the primary beneficiary of the Joint Venture. Therefore, the Company consolidates the Joint Venture in its financials statements and records a minority interest for the portions not owned by the Company.
F-37
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 15. | SEGMENT INFORMATION |
The Company presently operates in two business segments in the real estate markets: real property investments and investments in real estate-related assets. Under the real property investments segment, the Company invests primarily in office, industrial, and retail properties located throughout the United States. Under the real estate-related assets segment, the Company invests in and originates mezzanine loans, mortgage loans and other real estate-related assets, including mortgage-backed securities and other structured finance investments. The Company does not allocate corporate-level accounts to its operating segments. Corporate-level accounts include corporate general and administrative expenses, non-operating interest income and other corporate-level expenses.
The following tables summarize total revenues and net income for each reportable segment for the three and six months ended June 30, 2008 and 2007, respectively, and total assets and total liabilities for each reportable segment as of June 30, 2008 and December 31, 2007 (in thousands):
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||||
Total Revenues | ||||||||||||||||
Real Property Investments Segment | $ | 46,425 | $ | 10,271 | $ | 91,189 | $ | 18,507 | ||||||||
Real Estate-Related Assets Segment | 15,778 | 2,396 | 27,780 | 3,143 | ||||||||||||
Consolidated Total Revenues | $ | 62,203 | $ | 12,667 | $ | 118,969 | $ | 21,650 | ||||||||
Net Income (Loss) | ||||||||||||||||
Real Property Investments Segment | $ | (3,206 | ) | $ | (716 | ) | $ | (9,272 | ) | $ | (2,240 | ) | ||||
Real Estate-Related Assets Segment | 9,129 | 2,403 | 20,700 | 3,151 | ||||||||||||
Corporate-Level Accounts | (4,149 | ) | 175 | (7,465 | ) | (682 | ) | |||||||||
Consolidated Net Income | $ | 1,774 | $ | 1,862 | $ | 3,963 | $ | 229 | ||||||||
| June 30, 2008 | December 31, 2007 | |||||||||||||||
Total Assets | ||||||||||||||||
Real Property Investments Segment | $ | 1,797,061 | $ | 1,527,538 | ||||||||||||
Real Estate-Related Assets Segment | 524,822 | 234,546 | ||||||||||||||
Corporate-Level Accounts(1) | 382,340 | 55,088 | ||||||||||||||
Consolidated Total Assets | $ | 2,704,223 | $ | 1,817,172 | ||||||||||||
Total Liabilities | ||||||||||||||||
Real Property Investments Segment | $ | 1,210,244 | $ | 1,052,692 | ||||||||||||
Real Estate-Related Assets Segment | 484 | 13,941 | ||||||||||||||
Corporate-Level Accounts(2) | 17,432 | 11,224 | ||||||||||||||
Consolidated Total Liabilities | $ | 1,228,160 | $ | 1,077,857 | ||||||||||||
(1) Total assets in the corporate-level accounts consisted primarily of offering proceeds being held in the form of cash and cash equivalents of approximately $380.5 million and $53.5 million as of June 30, 2008 and December 31, 2007, respectively, for future real estate and real estate-related investments.
(2) As of June 30, 2008 and 2007, total liabilities in the corporate-level accounts consisted primarily of amounts due to affiliates for commissions, dealer manager fees, reimbursements of organizational and offering costs, accruals for legal and accounting fees and distributions payable.
F-38
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
| 16. | COMMITMENTS AND CONTINGENCIES |
Economic Dependency
The Company is dependent on the Advisor and the Dealer Manager for certain services that are essential to the Company, including the sale of the Company’s shares of common and preferred stock available for issue; the identification, evaluation, negotiation, purchase, and disposition of properties and other investments; management of the daily operations of the Company’s real estate portfolio; and other general and administrative responsibilities. In the event that these companies are unable to provide the respective services, the Company will be required to obtain such services from other sources.
Concentration of Credit Risk
The Company invests in real estate loans receivable including loans that are in the form of mezzanine loans that are secured by a pledge of the ownership interests of an entity that indirectly owns real property. This type of investment involves a higher degree of risk relative to a long-term senior mortgage secured by the underlying real property because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, the Company may not have full recourse to the assets of such entity, or the assets of the entity may not be sufficient to satisfy the loan.
Environmental
As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. Compliance with existing environmental laws is not expected to have a material adverse effect on the Company’s financial condition and results of operations as of June 30, 2008.
Legal Matters
From time to time, the Company is 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 reasonably likely to have a material adverse effect on its results of operations or financial condition.
Magazine Article
On May 21, 2007, Real Estate Finance & Investment newsweekly published an interview between Institutional Investor, Inc. reporter William Sprouse and Peter M. Bren, who is the Company’s president, the president of the Advisor and the chairman of the board and president of KBS Realty Advisors LLC. The interview was also made available to Real Estate Finance & Investment subscribers on the Institutional Investor, Inc. website on May 21, 2007. If the Company’s involvement with the article were held by a court to be in violation of Section 5 of the Securities Act of 1933, the Company could be required to repurchase the shares from investors in the Offering who received the newsweekly article before receiving a written prospectus. Such potential repurchase obligation would last for a period of one year following the date of the alleged violation. The repurchase price would be the original purchase price, plus statutory interest from the date of purchase.
The Company intends to contest vigorously any claim that a Section 5 violation occurred; nevertheless, the Company can give no assurance that a court would agree with its determination. Because the Company does not know the amount of shares purchased in the Offering, if any, from those who received the newsweekly before receiving a prospectus, the Company cannot know the amount of the Company’s potential liability should a court hold that a Section 5 violation occurred. Therefore, the Company can give no assurance that the ultimate outcome with respect to any such Section 5 claim would not materially adversely affect the Company’s operating results, financial position or liquidity.
F-39
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Journal Article
The St. Louis Business Journal published an article dated October 27, 2006 related to the Company’s acquisition of the Plaza in Clayton, a 16-story office building containing 325,172 rentable square feet in St. Louis, Missouri. The article included statements about the acquisition and statements about the Company made by the national sales manager of the Dealer Manager. The article is also available on the St. Louis Business Journal’s web site.
If the Dealer Manager’s involvement with the article were held by a court to be in violation of Section 5 of the Securities Act of 1933, the Company could be required to repurchase the shares from investors in the Offering who received the article before receiving a written prospectus. Such potential repurchase obligation would last for a period of one year following the date of the alleged violation. The repurchase price would be the original purchase price, plus statutory interest from the date of purchase.
The Company intends to contest any claim that a Section 5 violation occurred; nevertheless, the Company can give no assurance that a court would agree with its determination. Because the Company does not know the amount of shares purchased in the Offering, if any, from those who received the article before receiving a prospectus, the Company cannot know the amount of the Company’s potential liability should a court hold that a Section 5 violation occurred. Therefore, the Company can give no assurance that the ultimate outcome with respect to any such Section 5 claim would not materially adversely affect the Company’s operating results, financial position or liquidity.
| 17. | SUBSEQUENT EVENTS |
Distributions Paid
On July 15, 2008, the Company paid distributions of approximately $9.7 million, which related to distributions declared for each day in the period from June 1, 2008 through June 30, 2008.
Distributions Declared
On July 31, 2008, the Company’s board of directors declared a daily distribution for the period from August 1, 2008 through August 31, 2008, which distribution the Company expects to pay in September 2008. On August 12, 2008, the Company’s board of directors declared a daily distribution for the period from September 1, 2008 through September 30, 2008, which distribution the Company expects to pay in October 2008, and a daily distribution for the period from October 1, 2008 through October 31, 2008, which distribution the Company expects to pay in November 2008. Investors may choose to receive cash distributions or purchase additional shares through the Company’s dividend reinvestment plan.
Distributions are calculated based on stockholders of record each day during the period at a rate of $0.0019178 per share per day and equal a daily amount that, if paid each day for a 365-day period, would equal a 7.0% annualized rate based on a purchase price of $10.00 per share. The Advisor has agreed to advance funds to the Company equal to the amount by which the cumulative amount of distributions declared by the Company from January 1, 2006 through the period ending October 31, 2008 exceeds the amount of the Company’s funds from operations (as defined by NAREIT) from January 1, 2006 through October 31, 2008, see Note 13, “Related Party Transactions – Due to Affiliates.”
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KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Second Amended and Restated Dividend Reinvestment Plan
On August 12, 2008, the Company amended and restated its dividend reinvestment plan to make two clarifications. With respect to commissions on shares sold under the dividend reinvestment plan, the plan now specifically provides that to the extent permitted under state securities laws, the Company will pay selling commissions on shares of common stock purchased under the dividend reinvestment plan if the Company paid selling commissions on the underlying shares to which the distributions relate in the Offering. Participating broker-dealers may agree to waive selling commissions on dividend reinvestment plan shares in which case no selling commissions will be paid to any person in connection with sales of such shares. All sales of shares under the dividend reinvestment plan will be at the same price, which initially will be $9.50 per share, regardless of the distribution channel through which the Company sells the shares and regardless of whether a participating broker-dealer has agreed to waive selling commissions on dividend reinvestment plan shares. If no selling commissions are paid on sales of dividend reinvestment plan shares, the amount that would have been paid as a selling commission is retained and used by the Company.
The second change to the dividend reinvestment plan clarifies that three years after completion of the Company’s offering stage, participants will acquire common stock at a price equal to the estimated value per share of the Company’s common stock, as determined by the Advisor or other firm chosen by the board of directors for that purpose. The Company’s offering stage will be complete when the Company is no longer publicly offering equity securities and has not done so for one year. For the purpose of determining when the Company’s offering stage is complete, public equity offerings do not include offerings on behalf of selling stockholders or offerings related to any dividend reinvestment plan, employee benefit plan or redemption of interests in the Operating Partnership.
The second amended and restated dividend reinvestment plan will take effect on August 24, 2008.
Share Redemption Program
On August 12, 2008, the Company’s board of directors approved a share redemption program plan document. Previously the share redemption program was a narrative description in the prospectus for the Offering. There are no material changes to the share redemption program. The plan document clarifies that once the Company establishes an estimated value per share, the redemption price per share for all stockholders will be equal to the estimated value per share, as determined by the Advisor or another firm chosen for that purpose. The Company expects to establish an estimated value per share three years after completion of the Company’s offering stage.
The share redemption program as amended pursuant to the plan document will take effect on September 13, 2008.
Subsequent Investments and Financings
Suwanee Pointe Financing
On July 11, 2008, the Company, through an indirect wholly owned subsidiary, completed the secured financing of Suwanee Pointe. The Company obtained four-year financing from a financial institution in the amount of approximately $9.8 million through the Portfolio Secured Mortgage Loan Facility described below.
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KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Portfolio Secured Mortgage Loan Facility
On July 11, 2008, certain of the Company’s wholly owned subsidiaries, entered into a secured four-year mortgage loan agreement with an unaffiliated lender providing for a secured mortgage loan facility in the maximum principal amount of $158.7 million (the “Portfolio Secured Mortgage Loan Facility”), subject to certain borrowing limitations. The determination of the total amount of the Portfolio Secured Mortgage Loan Facility was based on a percentage of the appraised value of the properties in the portfolio that will serve as collateral for the facility. The maturity date of the loan is July 9, 2012, with two one-year extension options subject to certain conditions. The Portfolio Secured Mortgage Loan Facility bears interest at a floating rate of 220 basis points over 30-day LIBOR. The Company has purchased interest rate protection for the majority of the loan in the form of an interest rate swap agreement, effectively fixing the interest rate on a majority of the loan at 6.02%. Proceeds from the Portfolio Secured Mortgage Loan Facility were used to pay off short-term bridge loans on 11 properties, aggregating to $139.3 million as of June 30, 2008, which now secure this loan. See Note 9, “Notes Payable.” In addition, the Portfolio Secured Mortgage Loan Facility was used to fund $19.3 million of the purchase price of Great Oaks Center (see below), which secures the loan. Further, $9.8 million was drawn on this facility to finance Suwanee Pointe, which also secures the loan.
Purchase and Sale Agreement for the Five Tower Bridge Building
On July 16, 2008, the Company, through an indirect wholly owned subsidiary, entered into a purchase and sale agreement with a seller unaffiliated with the Company or the Advisor to purchase an eight-story office building containing 223,736 rentable square feet located on an approximate 10.3-acre parcel of land in West Conshohocken, Pennsylvania (the “Five Tower Bridge Building”). Pursuant to the purchase and sale agreement, the Company would be obligated to purchase the property only after satisfactory completion of agreed upon closing conditions. The purchase price of the Five Tower Bridge Building is approximately $73.0 million plus closing costs. There can be no assurance that the Company will complete the acquisition. In some circumstances, if the Company fails to complete the acquisition, the Company may forfeit $500,000 of earnest money.
Acquisition and Related Financing of Great Oaks Center
On July 18, 2008, the Company, through an indirect wholly owned subsidiary, purchased four single-story office buildings totaling 235,224 rentable square feet (“Great Oaks Center”) from a seller unaffiliated with the Company or the Advisor. Great Oaks Center is located on an approximate 31.0-acre parcel of land in Alpharetta, Georgia. The purchase price of Great Oaks Center was approximately $34.8 million plus closing costs.
The Company funded the acquisition with a $19.3 million mortgage loan that is included in the Portfolio Secured Mortgage Loan Facility completed on July 11, 2008 (described above) and with proceeds from the Offering.
Acquisition of the University Park Buildings
On July 31, 2008, the Company, through an indirect wholly owned subsidiary, purchased two two-story office buildings containing 127,085 rentable square feet (the “University Park Buildings”) from a seller unaffiliated with the Company or the Advisor. The University Park Buildings are located on an approximate 10.9-acre parcel of land in Sacramento, California. The purchase price of the University Park Buildings was approximately $23.9 million plus closing costs.
The acquisition of the University Park Buildings was funded with proceeds from the Offering, but the Company may later place mortgage debt on the property.
F-42
KBS REAL ESTATE INVESTMENT TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2008
(unaudited)
Purchase and Sale Agreement for the Meridian Tower
On August 4, 2008, the Company, through an indirect wholly owned subsidiary, entered into a purchase and sale agreement with a seller unaffiliated with the Company or the Advisor to purchase a 10-story office building totaling 205,659 rentable square feet located on an approximate 3.2-acre parcel of land in Tulsa, Oklahoma (the “Meridian Tower”). Pursuant to the purchase and sale agreement, the Company would be obligated to purchase the property only after satisfactory completion of agreed upon closing conditions. The purchase price of the Meridian Tower is approximately $17.5 million plus closing costs. There can be no assurance that the Company will complete the acquisition. In some circumstances, if the Company fails to complete the acquisition, the Company may forfeit $300,000 of earnest money.
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