| Summary of Significant Accounting Policies | 2. Summary of
Significant Accounting Policies
Basis of
Presentation:
The
accompanying condensed consolidated financial statements of the
Company include all the accounts of the Company and all entities in
which the Company has a controlling interest. The financial
statements have been prepared in accordance with generally accepted
accounting principles (“GAAP”) for interim financial
information and with instructions to Form 10-Q and Article 10 of
Regulation S-X. They do not include all the information and
footnotes required by GAAP for complete financial statements and
have not been audited by independent registered public
accountants.
The unaudited
interim condensed consolidated financial statements should be read
in conjunction with the audited financial statements and notes
thereto in the Company’s Annual Report on Form 10-K for the
year ended December 31, 2014. In the opinion
of management, all adjustments (consisting of normal recurring
adjustments) necessary for a fair presentation of the financial
statements for the interim periods have been made. Operating
results for the six months ended June 30, 2015 are not
necessarily indicative of the results that may be expected for the
year ending December 31, 2015. All significant intercompany
balances and transactions have been eliminated in
consolidation.
The Company is
required to continually evaluate its VIE relationships and
consolidate investments in these entities when it is determined to
be the primary beneficiary of their operations. A VIE is broadly
defined as an entity where either (1) the equity investors as
a group, if any, lack the power through voting or similar rights to
direct the activities of an entity that most significantly impact
the entity’s economic performance or (2) the equity
investment at risk is insufficient to finance that entity’s
activities without additional subordinated financial
support.
A variable
interest holder is considered to be the primary beneficiary of a
VIE if it has both (1) the power to direct matters that most
significantly impact the VIE’s economic performance and
(2) the obligation to absorb losses or the right to receive
benefits of the VIE that could potentially be significant to the
VIE. The Company considers a variety of factors in identifying the
entity that holds the power to direct matters that most
significantly impact the VIE’s economic performance
including, but not limited to, the ability to direct financing,
leasing, construction and other operating decisions and activities.
In addition, the Company considers the form of ownership interest,
voting interest, the size of the investment (including loans) and
the rights of other investors to participate in policy making
decisions, to replace or remove the manager and to liquidate or
sell the entity. The obligation to absorb losses and the right to
receive benefits when a reporting entity is affiliated with a VIE
must be based on ownership, contractual, and/or other pecuniary
interests in that VIE.
Cash and
Cash Equivalents:
The Company
considers all highly liquid investments with an original maturity
of three months or less when purchased to be cash equivalents, for
which cost approximates fair value, due to their short term
maturities.
Restricted Cash:
Restricted cash
is comprised of impound reserve accounts for property taxes,
insurance, capital improvements and tenant improvements.
Accounts
Payable and Other Liabilities:
Included in
accounts payable and other liabilities are deferred rents in the
amount of $2.4 million and $3.0 million at June 30, 2015 and
December 31, 2014, respectively.
Revenue
Recognition:
The Company
commences revenue recognition on its leases based on a number of
factors. In most cases, revenue recognition under a lease begins
when the lessee takes possession of or controls the physical use of
the leased asset. Generally, this occurs on the lease commencement
date. In determining what constitutes the leased asset, the Company
evaluates whether the Company or the lessee is the owner, for
accounting purposes, of the tenant improvements. If the Company is
the owner, for accounting purposes, of the tenant improvements,
then the leased asset is the finished space and revenue recognition
begins when the lessee takes possession of the finished space,
typically when the improvements are substantially complete. If the
Company concludes that it is not the owner, for accounting
purposes, of the tenant improvements (the lessee is the owner),
then the leased asset is the unimproved space and any tenant
improvement allowances funded under the lease are treated as lease
incentives, which reduce revenue recognized on a straight-line
basis over the remaining non-cancelable term of the respective
lease. In these circumstances, the Company begins revenue
recognition when the lessee takes possession of the unimproved
space for the lessee to construct improvements. The determination
of who is the owner, for accounting purposes, of the tenant
improvements is highly subjective and determines the nature of the
leased asset and when revenue recognition under a lease begins. The
Company considers a number of different factors to evaluate whether
it or the lessee is the owner of the tenant improvements for
accounting purposes. These factors include:
•
whether the lease stipulates how and on what a tenant
improvement allowance may be spent;
•
whether the tenant or landlord retains legal title to the
improvements;
•
the uniqueness of the improvements;
•
the expected economic life of the tenant improvements relative
to the length of the lease;
•
the responsible party for construction cost overruns;
and
•
who constructs or directs the construction of the
improvements.
Minimum rental
revenues are recognized on a straight-line basis over the terms of
the related lease. The difference between the amount of cash rent
due in a year and the amount recorded as rental income is referred
to as the “straight-line rent adjustment.” Rental
income (net of write-offs for uncollectible amounts) increased by
$767,000 and $552,000 in the three months ended June 30, 2015
and 2014, respectively, and by $1.5 million and $1.2 million in the
six months ended June 30, 2015 and 2014, respectively, due to
the straight-line rent adjustment. Percentage rent is recognized
after tenant sales have exceeded defined thresholds (if applicable)
and was $202,000 and $183,000 in the three months ended
June 30, 2015 and 2014, respectively, and $465,000 and
$398,000 in the six months ended June 30, 2015 and 2014,
respectively.
Estimated
recoveries from certain tenants for their pro rata share of real
estate taxes, insurance and other operating expenses are recognized
as revenues in the period the applicable expenses are incurred or
as specified in the leases. Other tenants pay a fixed rate and
these tenant recoveries are recognized as revenue on a
straight-line basis over the term of the related leases.
Property:
Costs incurred
in connection with the development or construction of properties
and improvements are capitalized. Capitalized costs include
pre-construction costs essential to the development of the
property, development costs, construction costs, interest costs,
real estate taxes and related costs and other direct costs incurred
during the period of development. The Company capitalizes costs on
land and buildings under development until construction is
substantially complete and the property is held available for
occupancy. The determination of when a development project is
substantially complete and when capitalization must cease involves
a degree of judgment. The Company considers a construction project
as substantially complete and held available for occupancy upon the
completion of landlord-owned tenant improvements or when the lessee
takes possession of the unimproved space for construction of its
own improvements, but no later than one year from cessation of
major construction activity. The Company ceases capitalization on
the portion substantially completed and occupied or held available
for occupancy, and capitalizes only those costs associated with any
remaining portion under construction.
The Company has
agreed to provide the developer/manager for development projects at
the Plaza at Rockwall, Southlake Park Village and Chimney Rock
properties with a profit participation interest based on a
percentage interest in the positive cash flows of the completed
project after the Company has received distributions returning all
of its capital investment plus a required rate of return (ranging
from an 8% to 12% annualized rate of return). The Company initially
records the profit participation interests at the estimated fair
value of the obligation at the time of execution of the related
agreement. The obligation is adjusted at each reporting date to the
greater of the initial fair value at execution, or the estimated
amount that would be owed if the obligation were to be settled as
of the reporting date. As of June 30, 2015, the Company has
recorded $2.4 million for payments expected to be made related
to the grants of these profit participation interests within
construction in progress for the respective projects under
development. The Company made a payment of approximately $1.1
million to the developer as a result of the disposition of the
Cedar Square property in May 2015 and the final distribution of
funds. The Company recognized a charge to earnings of approximately
$560,000 related to changes in the estimated amount owed for the
six months ended June 30, 2015, which is included in other
operating expenses on the accompanying condensed consolidated
statements of operations and comprehensive income.
Maintenance and
repairs expenses are charged to operations as incurred. Costs for
major replacements and betterments, which include HVAC equipment,
roofs, parking lots, etc., are capitalized and depreciated over
their estimated useful lives. Gains and losses are recognized upon
disposal or retirement of the related assets and are reflected in
earnings.
Property is
recorded at cost and is depreciated using the straight-line method
over the estimated lives of the assets as follows:
Building and
improvements 15 to 40 years
Tenant
improvements Shorter of the useful lives or the terms
Impairment of Long-Lived Assets and Long-Lived Assets to
be Disposed:
The Company
reviews long-lived assets and certain identifiable intangible
assets for impairment whenever events or circumstances indicate
that the carrying amount of an asset may not be recoverable. This
assessment considers expected future operating income, trends and
prospects, as well as the effects of demand, competition and other
economic factors. Such factors include the tenants’ ability
to perform their duties and pay rent under the terms of the leases.
The determination of recoverability is made based upon the
estimated undiscounted future net cash flows, excluding interest
expense, expected to result from the long-lived asset’s use
and eventual disposition. The Company’s evaluation as to
whether impairment may exist, including estimates of future
anticipated cash flows, are highly subjective and could differ
materially from actual results in future periods. The amount of
impairment loss, if any, is determined by comparing the fair value,
as determined by a discounted cash flows analysis, with the
carrying value of the related assets. Although the Company’s
strategy is to hold its properties over a long-term period, if the
strategy changes or market conditions dictate that the sale of
properties at an earlier date would be preferable, a property may
be classified as held for sale and an impairment loss may be
recognized to reduce the property to the lower of the carrying
amount or fair value less cost to sell. There was no impairment
recorded for the six months ended June 30, 2015 or
2014.
Investments in Partnerships and Limited Liability
Companies:
The Company
evaluates its investments in limited liability companies and
partnerships to determine whether any such entities may be a VIE
and, if a VIE, whether the Company is the primary beneficiary.
Generally, an entity is determined to be a VIE when either
(1) the equity investment at risk is insufficient to finance
that entity’s activities without additional subordinated
financial support provided by any parties or (2) as a group,
the holders of the equity investment lack one or more of the
essential characteristics of a controlling financial interest. The
primary beneficiary is the entity that has both (1) the power
to direct matters that most significantly impact the VIE’s
economic performance and (2) the obligation to absorb losses
or the right to receive benefits of the VIE that could potentially
be significant to the VIE. The Company considers a variety of
factors in identifying the entity that holds the power to direct
matters that most significantly impact the VIE’s economic
performance including, but not limited to, the ability to direct
financing, leasing, construction and other operating decisions and
activities. In addition, the Company considers the form of
ownership interest, voting interest, the size of the investment
(including loans) and the rights of other investors to participate
in policy making decisions, to replace or remove the manager and to
liquidate or sell the entity. The obligation to absorb losses and
the right to receive benefits when a reporting entity is affiliated
with a VIE must be based on ownership, contractual, and/or other
pecuniary interests in that VIE.
If the
foregoing conditions do not apply, the Company considers whether a
general partner or managing member controls a limited partnership
or limited liability company. The general partner in a limited
partnership or managing member in a limited liability company is
presumed to control that limited partnership or limited liability
company. The presumption may be overcome if the limited partners or
members have either (1) the substantive ability to dissolve
the limited partnership or limited liability company or otherwise
remove the general partner or managing member without cause or
(2) substantive participating rights, which provide the
limited partners or members with the ability to effectively
participate in significant decisions that would be expected to be
made in the ordinary course of the limited partnership’s or
limited liability company’s business and thereby preclude the
general partner or managing member from exercising unilateral
control over the partnership or company. If these criteria are not
met and the Company is the general partner or the managing member,
as applicable, the Company will consolidate the partnership or
limited liability company.
Investments
that are not consolidated, over which the Company exercises
significant influence but does not control, are accounted for under
the equity method of accounting. These investments are recorded
initially at cost and subsequently adjusted for the Company’s
portion of earnings or losses and for cash contributions and
distributions. Under the equity method of accounting, the
Company’s investment is reflected in the condensed
consolidated balance sheets and its share of net income or loss is
included in the condensed consolidated statements of operations and
comprehensive income.
For all
investments in unconsolidated entities, if a decline in the fair
value of an investment below its carrying value is determined to be
other-than-temporary, such investment is written down to its
estimated fair value with a non-cash charge to earnings. The
factors that the Company considers in making these assessments
include, but are not limited to, severity and duration of the
unrealized loss, market prices, market conditions, the occurrence
of ongoing financial difficulties, available financing, new product
initiatives and new collaborative agreements.
Investments in Equity Securities:
The Company,
through the Operating Partnership, may hold investments in equity
securities in certain publicly-traded companies. The Company does
not acquire investments for trading purposes and, as a result, all
of the Company’s investments in publicly-traded companies are
considered “available-for-sale” and are recorded at
fair value. Changes in the fair value of investments classified as
available-for-sale are recorded in other comprehensive income. The
fair value of the Company’s equity securities in
publicly-traded companies is determined based upon the closing
trading price of the equity security as of the balance sheet date.
The cost of investments sold is determined by the specific
identification method, with net realized gains and losses included
in other income. For all investments in equity securities, if a
decline in the fair value of an investment below its carrying value
is determined to be other-than-temporary, such investment is
written down to its estimated fair value with a non-cash charge to
earnings. The factors that the Company considers in making these
assessments include, but are not limited to, severity and duration
of the unrealized loss, market prices, market conditions, the
occurrence of ongoing financial difficulties, available financing,
new product initiatives and new collaborative
agreements.
During the year
ended December 31, 2014, the Company purchased approximately
436,000 shares of preferred stock in public companies within the
real estate industry for an initial cost basis of approximately
$10.5 million. During the three months ended March 31, 2015,
the Company sold all of its investments in equity securities based
on a specific identification of the shares sold. The sales resulted
in net proceeds of approximately $10.8 million and the recognition
of a gain on sale of approximately $308,000, which is included in
other income in the accompanying condensed consolidated statements
of operations and comprehensive income.
Investments in
equity securities, which are included in other assets on the
accompanying condensed consolidated balance sheets, consisted of
the following (in thousands):
June 30, December 31,
Equity securities, initial
cost basis $ — $ 10,512
Gross unrealized
gains — 185
Gross unrealized
losses — (14 )
Equity securities, fair
value (1) $ — $ 10,683
(1)
Determination of fair value is classified as Level 1 in the
fair value hierarchy based on the use of quoted prices in active
markets (see section entitled “Fair Value of Financial
Instruments” below).
Share-Based Payments:
All share-based
payments to employees are recognized in earnings based on their
fair value on the date of grant. Through June 30, 2015, the
Company has awarded only restricted stock awards under its
incentive award plan, which are based on shares of the Parent
Company’s common stock. The fair value of equity awards that
include only service or performance vesting conditions is
determined based on the closing market price of the underlying
common stock on the date of grant. The fair value of equity awards
that include one or more market vesting conditions is determined
based on the use of a widely accepted valuation model. The fair
value of equity grants is amortized to general and administrative
expense ratably over the requisite service period for awards that
include only service or performance vesting conditions and
utilizing a graded vesting method (an accelerated vesting method in
which the majority of compensation expense is recognized in earlier
periods) for awards that include one or more market vesting
conditions, adjusted for anticipated forfeitures.
Purchase
Accounting:
The Company,
with the assistance of independent valuation specialists as needed,
records the purchase price of acquired properties as tangible and
identified intangible assets and liabilities based on their
respective fair values. Tangible assets (building and land) are
recorded based upon the Company’s determination of the value
of the property as if it were vacant using discounted cash flow
models similar to those used by independent appraisers. Factors
considered include an estimate of carrying costs during the
expected lease-up periods taking into account current market
conditions and costs to execute similar leases. The fair value of
land is derived from comparable sales of land within the same
submarket and/or region. The fair value of buildings and
improvements, tenant improvements, site improvements and leasing
costs are based upon current market replacement costs and other
relevant market rate information. Additionally, the purchase price
of the applicable property is recorded as the above- or
below-market value of in-place leases, the value of in-place leases
and above- or below-market value of debt assumed, as
applicable.
The value
recorded as the above- or below-market component of the acquired
in-place leases is determined based upon the present value (using a
discount rate which reflects the risks associated with the acquired
leases) of the difference between: (1) the contractual amounts
to be paid pursuant to the lease over its remaining term, and
(2) the Company’s estimate of the amounts that would be
paid using fair market rates at the time of acquisition over the
remaining term of the lease. The amounts recorded as above-market
leases are included in lease intangible assets, net in the
Company’s accompanying consolidated balance sheets and
amortized to rental income over the remaining non-cancelable lease
term of the acquired leases with each property. The amounts
recorded as below-market lease values are included in lease
intangible liabilities, net in the Company’s accompanying
condensed consolidated balance sheets and amortized to rental
income over the remaining non-cancelable lease term plus any
below-market fixed price renewal options of the acquired leases
with each property.
The value
recorded as above- or below-market debt is determined based upon
the present value of the difference between the cash flow stream of
the assumed mortgage and the cash flow stream of a market rate
mortgage. The amounts recorded as above- or below-market debt are
included in mortgage payables, net in the Company’s
accompanying condensed consolidated balance sheets and are
amortized to interest expense over the remaining term of the
assumed mortgage.
Tenant
Receivables:
Tenant
receivables and deferred rent are carried net of the allowances for
uncollectible current tenant receivables and deferred rent. An
allowance is maintained for estimated losses resulting from the
inability of certain tenants to meet the contractual obligations
under their lease agreements. The Company maintains an allowance
for deferred rent receivable arising from the straight-lining of
rents. Such allowances are charged to bad debt expense which is
included in other operating expenses on the accompanying condensed
consolidated statement of operations. The Company’s
determination of the adequacy of these allowances is based
primarily upon evaluations of historical loss experience, the
tenant’s financial condition, security deposits, letters of
credit, lease guarantees, current economic conditions and other
relevant factors. At June 30, 2015 and December 31, 2014,
the Company had $706,000 and $521,000, respectively, in allowances
for uncollectible accounts (including straight-line deferred rent
receivables) as determined to be necessary to reduce receivables to
the estimate of the amount recoverable. During the three months
ended June 30, 2015 and 2014, ($3,000) and $165,000,
respectively, of receivables were charged to bad debt expense.
During the six months ended June 30, 2015 and 2014, $446,000
and $372,000, respectively, of receivables were charged to bad debt
expense.
Non-controlling Interests:
Non-controlling
interests on the condensed consolidated balance sheets of the
Parent Company relate to the OP units that are not owned by the
Parent Company and the portion of consolidated joint ventures not
owned by the Parent Company. The OP units not held by the Parent
Company may be redeemed by the Parent Company at the holder’s
option for cash. The Parent Company, at its option, may satisfy the
redemption obligation with common stock on a one-for-one basis,
which has been further evaluated to determine that permanent equity
classification on the balance sheets is appropriate.
Non-controlling
interests on the condensed consolidated balance sheets of the
Operating Partnership represent the portion of equity that the
Operating Partnership does not own in those entities it
consolidates.
Concentration of Risk:
The Company
maintains its cash accounts in a number of commercial banks.
Accounts at these banks are guaranteed by the Federal Deposit
Insurance Corporation (“FDIC”) up to $250,000. At
various times during the periods, the Company had deposits in
excess of the FDIC insurance limit.
In the three
months ended June 30, 2015 and 2014, no tenant accounted for
more than 10% of revenues.
At
June 30, 2015, the Company’s real estate assets in the
states of California, Florida, Virginia, Texas and Utah represented
approximately 30.0%, 13.7%, 12.5%, 11.9% and 10.1%, respectively,
of the Company’s total assets. At December 31, 2014, the
Company’s real estate assets in the states of California,
Florida, Arizona, Virginia, Texas and Utah represented
approximately 23.8%, 14.2%, 12.5%, 12.4%, 11.7% and 11.4% of the
Company’s total assets, respectively. For the six months
ended June 30, 2015, the Company’s revenues derived from
properties located in the states of California, Florida, Texas,
Arizona and Utah represented approximately 25.9%, 14.5%, 11.9%,
10.8% and 10.7%, respectively, of the Company’s total
revenues. For the six months ended June 30, 2014, the
Company’s revenues derived from properties located in the
states of California, Arizona, Texas and Virginia represented
approximately 23.9%, 17.4%, 14.1% and 11.4%, respectively, of the
Company’s total revenues.
Management Estimates:
The preparation
of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
Fair
Value of Financial Instruments:
The Company
measures financial instruments and other items at fair value where
required under GAAP, but has elected not to measure any additional
financial instruments and other items at fair value as permitted
under fair value option accounting guidance.
Fair value
measurement is determined based on the assumptions that market
participants would use in pricing the asset or liability. As a
basis for considering market participant assumptions in fair value
measurements, there is a fair value hierarchy that distinguishes
between market participant assumptions based on market data
obtained from sources independent of the reporting entity
(observable inputs that are classified within Levels 1 and 2 of the
hierarchy) and the reporting entity’s own assumptions about
market participant assumptions (unobservable inputs classified
within Level 3 of the hierarchy).
Level 1
inputs utilize quoted prices in active markets for identical assets
or liabilities that the Company has the ability to access.
Level 2 inputs are inputs other than quoted prices included in
Level 1 that are observable for the asset or liability, either
directly or indirectly. Level 2 inputs may include quoted
prices for similar assets and liabilities in active markets, as
well as inputs that are observable for the asset or liability
(other than quoted prices), such as interest rates, foreign
exchange rates and yield curves that are observable at commonly
quoted intervals. Level 3 inputs are unobservable inputs for
the assets or liabilities, which are typically based on an
entity’s own assumptions, as there is little, if any, related
market activity. In instances where the determination of the fair
value measurement is based on inputs from different levels of the
fair value hierarchy, the level in the fair value hierarchy within
which the entire fair value measurement falls is based on the
lowest level input that is significant to the fair value
measurement in its entirety.
The
Company’s assessment of the significance of a particular
input to the fair value measurement in its entirety requires
judgment, and considers factors specific to the asset or
liability.
The Company has
used interest rate swaps to manage its interest rate risk. The
valuation of these instruments is determined using widely accepted
valuation techniques, including discounted cash flow analysis on
the expected cash flows of each derivative. This analysis reflects
the contractual terms of the derivatives, including the period to
maturity, and uses observable market-based inputs, including
interest rate curves. The fair values of interest rate swaps are
determined using the market standard methodology of netting the
discounted future fixed cash receipts (or payments) and the
discounted expected variable cash payments (or receipts). The
variable cash payments (or receipts) are based on an expectation of
future interest rates (forward curves) derived from observable
market interest rate curves. The Company incorporates credit
valuation adjustments to appropriately reflect both its own
nonperformance risk and the respective counterparty’s
nonperformance risk in the fair value measurements. In adjusting
the fair value of its derivative contracts for the effect of
nonperformance risk, the Company has considered the impact of
netting and any applicable credit enhancements, such as collateral
postings, thresholds, mutual puts and guarantees.
Changes in the
fair value of financial instruments (other than derivative
instruments for which an effective hedging relationship exists and
available-for-sale securities) are recorded as a charge against
earnings in the condensed consolidated statements of operations in
the period in which they occur. The Company estimates the fair
value of financial instruments at least quarterly based on current
facts and circumstances, projected cash flows, quoted market prices
and other criteria (primarily utilizing Level 3 inputs). The
Company may also utilize the services of independent third-party
valuation experts to estimate the fair value of financial
instruments, as necessary.
The
Company’s investments in equity securities fall within Level
1 of the fair value hierarchy as the Company utilizes observable
market-based inputs, based on the closing trading price of
securities as of the balance sheet date, to determine the fair
value of the investments.
Derivative Instruments:
The Company is
exposed to certain risks arising from both its business operations
and economic conditions. The Company principally manages its
exposures to a wide variety of business and operational risks
through management of its core business activities. The Company
manages economic risks, including interest rate, liquidity and
credit risk primarily by managing the amount, sources and duration
of its debt funding and the use of derivative financial
instruments. Specifically, from time to time the Company enters
into derivative financial instruments to manage exposures that
arise from business activities that result in the receipt or
payment of future known and uncertain cash amounts, the value of
which are determined by interest rates. The Company’s
derivative financial instruments are used to manage differences in
the amount, timing and duration of the Company’s known or
expected cash receipts and its known or expected cash payments
principally related to the Company’s investments and
borrowings.
In addition,
from time to time the Company may execute agreements in connection
with business combinations that include embedded derivative
instruments as part of the consideration provided to the sellers of
the properties. Although these embedded derivative instruments are
not intended as hedges of risks faced by the Company, they can
provide additional consideration to the Company’s selling
counterparties and may be a key component of
negotiations.
The
Company’s objectives in using interest rate derivatives are
to add stability to interest expense and to manage its exposure to
interest rate movements. To accomplish this objective, the Company
primarily uses interest rate swaps as part of its interest rate
risk management strategy. Interest rate swaps designated as cash
flow hedges involve the receipt of variable amounts from a
counterparty in exchange for the Company making fixed-rate payments
over the life of the |
