Item 7. Managements Discussion and Analysis of Financial Condition
and Results of Operations
The following analysis of our financial condition and results of operations should be read in conjunction
with our financial statements and the notes thereto contained elsewhere in this Form 10-K.
OVERVIEW
General
We are a real estate investment
trust, or REIT, that was incorporated under the General Corporation Law of the State of Maryland on February 14, 2003, primarily for the purpose of investing in and owning net leased industrial, commercial and retail real property and
selectively making long-term industrial and commercial mortgage loans. Our portfolio of real estate is leased to a wide cross section of tenants ranging from small businesses to large public companies, many of which are corporations that do not have
publicly-rated debt. We have historically entered into, and intend in the future to enter into, purchase agreements for real estate having triple net leases with terms of approximately 10 to 15 years and built in rental rate increases. Under a
triple net lease, the tenant is required to pay all operating, maintenance and insurance costs and real estate taxes with respect to the leased property. We actively communicate with buyout funds, real estate brokers and other third parties to
locate properties for potential acquisition or to provide mortgage financing in an effort to build our portfolio. We currently own 80 properties totaling 8.0 million square feet, which have a total gross and net carrying value, including
intangible assets, of $618.6 million and $525.3 million, respectively. We do not currently have any mortgage loan receivables outstanding.
Business Environment
The United States,
or U.S., continues to feel the lingering impact of the recession that began in late 2007. The U.S. is beginning to see long-term signs of recovery as the unemployment rate has decreased over the last several months, housing starts and building
permits rose in September 2012 to the highest level in four years, and prices for single-family homes increased across 20 U.S. cities because of a dwindling surplus in the housing market. However, the economic situation in Europe continues to be
unpredictable and will need to stabilize for the economy to fully recover and the U.S. will need to come to a long-term solution for the debt crisis the country currently faces. As a result, conditions within the U.S. capital markets generally, and
the U.S. real estate capital markets particularly, continue to experience certain levels of dislocation and stress.
These economic conditions
could materially and adversely impact the financial condition of one or more of our tenants and, therefore, could increase the likelihood that a tenant may declare bankruptcy or default upon its payment obligations arising under a related lease. We
currently have two vacant buildings in our portfolio, one of the buildings is located in Hazelwood, Missouri and the other building is located in Richmond, Virginia. The leases on these two vacant buildings comprised 2.0% of our annualized rental
income as of December 31, 2012 and the annual carrying costs are $0.3 million. We are actively seeking new tenants for both of these buildings. All of our remaining properties are currently occupied and the tenants are paying in accordance with
their leases. However; in January 2013, we were notified by our tenant in our Baytown, Texas property that they would not be renewing the lease that expires in April 2013. We are aggressively pursuing new tenants for this building. This tenant
comprised less than 1.0% of our annualized rental income as of December 31, 2012.
Moreover, our ability to make new investments is
highly dependent upon our ability to procure external financing. Our principal sources of external financing generally include the issuance of equity securities, long-term mortgage loans secured by properties and borrowings under our line of credit,
or the Line of Credit. The market for long-term mortgages was limited for the past several years; however, long-term mortgages have become more obtainable. The collateralized mortgage backed securities, or CMBS, market has made a comeback,
but it is more conservative and restrictive than it was prior to the recession. Consequently, we continue to look to regional banks, insurance companies and other non-bank lenders, in addition to the CMBS market to issue mortgages to finance our
real estate activities.
41
In addition to leverage, we were active in the equity markets during 2012 and we issued 138,205 of common
shares for gross proceeds of $2.5 million, and net proceeds of $2.4 million, through our At the Market, or ATM program and $38.5 million of 7.125% Series C Cumulative Term Preferred Stock, or Term Preferred Stock, which is mandatorily redeemable
five years from issuance. We also assumed or issued $124.4 million in mortgages during 2012, to finance our new properties or re-finance existing properties. In addition, we issued 129,278 of common shares for gross proceeds of $2.4 million, and net
proceeds of $2.3 million, from the issuance of equity in January 2013 under our ATM program.
Recent Developments
2012 Investment Activities
Ashburn, Virginia:
On January 25, 2012, we acquired a 52,130 square foot office building located in Ashburn, Virginia for
$10.8 million, excluding related acquisition expenses of $0.1 million. We funded this acquisition using borrowings from our Line of Credit. Independent Project Analysis, Inc., an energy consultant, is the tenant in this building and has leased the
property for 15 years and has 2 options to renew the lease for additional periods of 5 years each. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of $1.0 million.
Ottumwa, Iowa:
On May 30, 2012, we acquired a 352,860 square foot bottling plant located in Ottumwa, Iowa for $7.1 million,
excluding related acquisition expenses of $0.1 million. We funded this acquisition through a combination of cash on hand and the issuance of $5.0 million of mortgage debt on the property. The American Bottling Company, the largest operating
subsidiary of Dr. Pepper Snapple Group, Inc., is the tenant in this building and has leased the property for 12 years and has 3 options to renew the lease for additional periods of 5 years each. The lease provides for prescribed rent
escalations over the life of the lease, with annualized straight line rents of $0.68 million.
New Albany, Ohio:
On
June 5, 2012, we acquired an 89,000 square foot office building located in New Albany, Ohio for $13.3 million, excluding related acquisition expenses of $0.2 million. We funded this acquisition with existing cash on hand. Commercial Vehicle
Group, Inc., a global supplier of fully integrated interiors system solutions for the global commercial vehicle market, is the tenant in this building and has leased the property for 10.5 years and has 2 options to renew the lease for additional
periods of 5 years each. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of $1.36 million.
Columbus, Georgia:
On June 21, 2012, we acquired a 32,000 square foot office and classroom facility located in Columbus, Georgia for $7.3 million, excluding related acquisition expenses of
$0.1 million. We funded this acquisition through a combination of cash on hand and the issuance of $4.8 million of mortgage debt on the property. University of Phoenix, a private education provider, which has been in the education business for more
than 35 years, is the tenant in this building and has leased the property for 11.5 years and has 2 options to renew the lease for additional periods of 5 years each. The lease provides for prescribed rent escalations over the life of the lease, with
annualized straight line rents of $0.66 million.
Columbus, Ohio:
On June 28, 2012, we acquired a 31,293 square
foot office building located in Columbus, Ohio for $4.0 million, excluding related acquisition expenses of $0.1 million. We funded this acquisition with existing cash on hand. Nationwide Childrens Hospital, one of the largest childrens
hospital systems in the U.S., is the tenant in this building and has leased the property for 10 years. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of $0.34 million.
42
Jupiter, Florida:
On September 26, 2012, we acquired a 60,000 square foot office
building located in Jupiter, Florida for $15.5 million, excluding related acquisition expenses of $0.1 million. We funded this acquisition with existing cash on hand and the assumption of $10.8 million of mortgage debt on the property. G4S Secure
Solutions USA, Inc., one of the largest operating subsidiaries of G4S and the worlds largest provider of security solutions, with operations in 125 countries, is the tenant in this building and has leased the property for 10.5 years and has 2
options to renew the lease for additional periods of 5 years each. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of $1.37 million.
Fort Worth, Texas:
On November 8, 2012, we acquired a 208,234 square foot office building located in Fort Worth, Texas for
$20.0 million, excluding related acquisition expenses of $0.1 million. We funded this acquisition with a combination of borrowings from our Line of Credit and the assumption of $14.2 million of mortgage debt on the property. The National Archives
and Records Administration Southwest Region Records Center is the tenant in this building and has leased the property for 14 years. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of
$1.63 million.
Columbia, South Carolina:
On November 21, 2012, we acquired a 146,483 square foot office building
located in Columbia, South Carolina for $29.2 million, excluding related acquisition expenses of $0.1 million. We funded this acquisition through a combination of cash on hand and the issuance of $19.0 million of mortgage debt on the property.
Verizon Wireless is the tenant in this building and has leased the property for 10 years and has 3 options to renew the lease for additional periods of 5 years each. The lease provides for prescribed rent escalations over the life of the lease, with
annualized straight line rents of $2.61 million.
2012 Financing Activities
Line of Credit Expansion
On January 31, 2012, we amended our Line of Credit
to increase the current maximum availability of credit thereunder from $50.0 million to $75.0 million. The Line of Credit was arranged by Capital One, N.A. as administrative agent, and Branch Banking and Trust Company as an additional lender.
Citizens Bank of Pennsylvania also joined the Line of Credit as an additional lender. All other terms of the agreement remained the same.
Fixed-Rate Long-Term Notes Payable
KeyBank:
On April 5, 2012, through wholly-owned subsidiaries, we borrowed $19.0 million pursuant to a long-term note payable from KeyBank National Association, which is collateralized by
security interests in four of our properties. The note accrues interest at a fixed rate of 6.1% per year and we may not repay this note prior to the last three months of the term, or we would be subject to a substantial prepayment penalty. The
note has a maturity date of May 1, 2022. We used the proceeds from this note for future acquisitions and working capital.
City National Bank
: On May 16, 2012, through a wholly-owned subsidiary, we borrowed $2.94 million pursuant to a long-term
note payable from City National Bank, which is collateralized by a security interest in one of our properties. The note accrues interest at a fixed rate of 4.3% per year for the first five years, and resets at five year intervals thereafter. We
may repay this note after five years and would not be subject to any prepayment penalty. The note has a maturity date of December 31, 2026. We used the proceeds from this note for future acquisitions and working capital.
Modern Woodmen of America:
On May 30, 2012, through a wholly-owned subsidiary, we borrowed $5.0 million pursuant to a
long-term note payable from Modern Woodmen of America, which is collateralized by a security interest in one of our properties. The note accrues interest at a fixed rate of 6.5% per year and we may not repay this note prior to the last nine
months of the term, or we would be subject to a substantial prepayment penalty. The note has a maturity date of May 10, 2027. We used the proceeds from this note for future acquisitions and working capital.
43
Citigroup
: On June 21, 2012, through a wholly-owned subsidiary, we borrowed
$4.75 million pursuant to a long-term note payable from Citigroup, which is collateralized by a security interest in one of our properties. The note accrues interest at a rate of fixed 5.05% per year and we may not repay this note prior to the
last two months of the term, or we would be subject to a substantial prepayment penalty. The note has a maturity date of July 6, 2022. We used the proceeds from this note to purchase the property located in Columbus, Georgia discussed above.
American Equity Investment Life Insurance Company
: On June 27, 2012, through a wholly-owned subsidiary, we
borrowed $2.0 million pursuant to a long-term note payable from American Equity Investment Life Insurance Company, which is collateralized by a security interest in one of our properties. The note accrues interest at a fixed rate of 5.1% per
year and we may not repay this note prior to the last five years of the term, or we would be subject to a substantial prepayment penalty. The note has a maturity date of July 1, 2029. We used the proceeds from this note for future acquisitions
and working capital.
American National Insurance Company
: On July 24, 2012, through a wholly-owned subsidiary, we
borrowed $9.8 million pursuant to a long-term note payable from American National Insurance Company, which is collateralized by a security interest in one of our properties. The note accrues interest at a fixed rate of 5.6% per year and we may
not repay this note during the first five years of the term; however, we may repay the note during the last five years of the term although we would be subject to a prepayment penalty. The note has a maturity date of August 1, 2022. We used the
proceeds from this note for both a future acquisition and working capital.
Farmers Citizens Bank
: On August 3,
2012, through a wholly-owned subsidiary, we borrowed $3.0 million pursuant to a long-term note payable from Farmers Citizens Bank, which is collateralized by a security interest in one of our properties. The note accrues interest at a fixed rate of
5.0% per year and we may repay this note during the first five years of the term although we would be subject to a prepayment penalty; however, we may repay the note during the last five years of the term without penalty. The note has a
maturity date of July 31, 2022. We used the proceeds from this note for working capital.
Midland National Life
Insurance Company
: On September 26, 2012, through a wholly-owned subsidiary, we assumed $10.8 million pursuant to a long-term note payable from Midland National Life Insurance Company, in connection with the acquisition of our property in
Jupiter, Florida on the same date. The note accrues interest at a fixed rate of 5.75% per year and we may not repay this note prior to the last three months of the term, or we would be subject to a prepayment penalty. The note has a maturity
date of July 1, 2018.
KeyBank:
On October 1, 2012, through certain of our wholly-owned subsidiaries, we
borrowed $34.0 million, pursuant to a long-term note payable from KeyBank National Association, which is collateralized by security interests in seven of our properties. The note accrues interest at a fixed rate of 4.86% per year and we may not
repay this note prior to the last three months of the term, or we would be subject to a prepayment penalty. The note has a maturity date of October 1, 2022. We used the proceeds of this note, along with existing cash on hand, to repay our $45.2
million mortgage, which, with extension options, was due October 1, 2013. We repaid the mortgage in full on October 1, 2012 without incurring any exit fees.
American United Life Insurance Company
: On November 8, 2012, through a wholly-owned subsidiary, we assumed $14.2 million pursuant to a long-term note payable from American United Life
Insurance Company, in connection with the acquisition of our property in Fort Worth, Texas on the same date. The note accrues interest at a fixed rate of 5.69% per year and we may not repay this note prior to the last two months of the term, or
we would be subject to a prepayment penalty. The note has a maturity date of February 1, 2027.
44
Cantor Commercial Real Estate
: On November 21, 2012, through a wholly-owned
subsidiary, we borrowed $19.0 million pursuant to a long-term note payable from Cantor Commercial Real Estate, in connection with the acquisition of our property in Columbia, South Carolina on the same date. The note accrues interest at a fixed rate
of 4.04% per year and we may not repay this note prior to the last three months of the term, or we would be subject to a prepayment penalty. The note has a maturity date of December 6, 2022.
2012 Leasing Activities
San Antonio, Texas:
On February 14, 2012, we extended the lease with the tenant occupying our property located in San Antonio,
Texas. The lease covering this property was extended for an additional eight-year period, through November 2021. The lease was originally set to expire in February 2014. The lease provides for prescribed rent escalations over the life
of the lease, with annualized straight line rents of approximately $0.8 million. Furthermore, the lease grants the tenant two options to extend the lease for a period of five years each. In connection with the extension of the lease and the
modification of certain terms under the lease, we provided a tenant allowance of $0.6 million, payable over two years, and paid $0.3 million in leasing commissions.
Roseville, Minnesota
: On February 27, 2012, we extended the lease with the tenant occupying our property located in Roseville, Minnesota. The new lease covers approximately one-third of this
property and was extended for an additional five year period, through December 2017. The lease was originally set to expire in December 2012. The tenant in this property paid rent on the entire building through 2012, and we continue to
search for new tenants to lease the remainder of the building. The new lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of $1.2 million. Furthermore, the lease grants the tenant one
option to extend the lease for a period of five years. In connection with the extension of the lease and the modification of certain terms under the lease, we provided a tenant allowance of $0.4 million, payable over two years, and paid $0.8 million
in leasing commissions.
Hialeah, Florida:
On June 29, 2012, we extended the lease with the tenant occupying our
property located in Hialeah, Florida. The lease covering this property was extended for an additional five-year period, through March 2027. The lease was originally set to expire in March 2022. The lease provides for prescribed rent
escalations over the life of the lease, with annualized straight line rents of approximately $1.1 million. In connection with the extension of the lease and the modification of certain terms under the lease, we provided a tenant allowance of
$0.3 million.
Wichita, Kansas
: On August 7, 2012, we extended the lease with the tenant occupying our property
located in Wichita, Kansas. The lease covering this property was extended for an additional five-year period, through September 2017. The lease was originally set to expire in September 2012. The lease provides for prescribed rent
escalations over the life of the lease, with annualized straight line rents of approximately $0.8 million. In connection with the extension of the lease and the modification of certain terms under the lease, we paid $0.2 million in leasing
commissions.
South Hadley, Massachusetts
: On September 10, 2012, we extended the lease with the tenant occupying
our property located in South Hadley, Massachusetts. The lease covering this property was extended for an additional one-year period, through January 2014. The lease was originally set to expire in February 2013. The lease provides
for annual rents of approximately $0.3 million.
Mason, Ohio
: On September 11, 2012, we extended the lease with the
tenant occupying our property located in Mason, Ohio. The lease covering this property was extended for an additional seven-year period, through June 2020. The lease was originally set to expire in January 2013. The lease provides for
prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $0.6 million. In connection with the extension of the lease and the modification of certain terms under the lease, we provided a tenant
allowance of $0.5 million, and paid $0.3 million in leasing commissions.
45
Arlington, Texas
: On September 27, 2012, our tenant in our property located in
Arlington, Texas exercised their right to extend the lease covering this property for an additional five-year period, through March 2018. The lease was originally set to expire in April 2013. The lease provides that the option period rent
be at fair market rent, but not less than the current rental rate.
Concord Township, Ohio
: On October 5, 2012, we
modified and extended the lease with the tenant occupying our property located in Concord Township, Ohio. The lease covering this property was extended for an additional six-year period, through August 2034, in exchange for a reduction in rent
over the next two years. The lease was originally set to expire in March 2028. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $1.7 million. In
connection with the extension of the lease and the modification of certain terms under the lease, we provided a tenant allowance of $0.2 million.
Big Flats, New York
: On November 8, 2012, we extended the lease with the tenant occupying our property located in Big, Flats, New York. The lease covering this property was extended for
an additional 10 years, through September 2023. The lease was originally set to expire in September 2013. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately
$0.5 million. In connection with the extension of the lease and the modification of certain terms under the lease, we paid $0.2 million in leasing commissions.
2013 Leasing Activities
Champaign, Illinois
: On January 14,
2013, we extended the lease with the tenant occupying our property located in Champaign, Illinois. The lease covering this property was extended for an additional 11 years, through December 2024. The lease was originally set to expire in
December 2013. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $1.4 million. In connection with the extension of the lease and the modification of certain
terms under the lease, we paid $0.4 million in leasing commissions.
2012 Equity Activities
The equity issuances summarized below were issued under our effective shelf registration statement (File No. 333-169290) on file with the Securities
and Exchange Commission.
Preferred Equity:
In February 2012, we completed a public offering of 1,540,000 shares of our
Series C Term Preferred Stock at a public offering price of $25.00 per share. Gross proceeds of the offering totaled $38.5 million, and net proceeds, after deducting underwriting discounts and offering expenses borne by us, were $36.7 million, which
were used to repay a portion of outstanding borrowings under our Line of Credit, for acquistions of real estate and for working capital. The shares are traded under the ticker symbol GOODN on the NASDAQ Global Select Market, or the NASDAQ. The Term
Preferred Stock is not convertible into our common stock or any other security. Generally, we may not redeem shares of the Term Preferred Stock prior to January 31, 2016, except in limited circumstances to preserve our status as a Real Estate
Investment Trust, or REIT. On or after January 31, 2016, we may redeem the shares at a redemption price of $25.00 per share, plus any accumulated and unpaid dividends to and including the date of redemption. The shares of the Term Preferred
Stock have a mandatory redemption date of January 31, 2017. In accordance with Accounting Standards Codification, or ASC, 480, Distinguishing Liabilities from Equity, mandatorily redeemable financial instruments should be classified
as liabilities in the balance sheet and therefore we recorded the Term Preferred Stock as a liability and the related dividend payments as a component of interest expense in the statement of operations.
46
Common Equity:
During November and December 2012, we raised approximately $2.4
million in net proceeds under our ATM program with Jefferies & Company, Inc., or Jefferies. Under this agreement we may, from time to time, offer to sell shares of our common stock with an aggregate sales price of up to $25.0 million on the
open market through Jefferies, as agent, or to Jefferies, as principal based upon our instructions (including any price, time or size limits or other customary parameters or conditions that we may impose). Sales of shares of our common stock through
Jefferies will be executed by means of ordinary brokers transactions on the NASDAQ or otherwise at market prices, in privately negotiated transactions, crosses or block transactions, as may be agreed between us and Jefferies, including a
combination of any of these transactions. We will pay Jefferies a commission equal to 2.0% of the gross sales proceeds of any common stock sold through Jefferies as agent under the ATM program.
Senior Common Equity:
During 2011 and 2012, we have sold 118,738 shares of our senior common stock at $15.00 per share in an
ongoing best-efforts public offering and issued 1,395 shares of our senior common stock under the Dividend Reinvestment Program, or DRIP program. The net proceeds, after deducting the underwriting discount and commission were $1.6 million. We can
issue up to 3,000,000 shares of senior common stock and the offering will continue until the earlier of March 28, 2013 or the date on which 3,000,000 shares of senior common stock are sold. We have used the proceeds of the offering for general
corporate purposes.
Diversity of Our Portfolio
Gladstone Management Corporation, or our Adviser, seeks to diversify our portfolio to avoid dependence on any one particular tenant, industry or geographic market. By diversifying our portfolio, our
Adviser intends to reduce the adverse effect on our portfolio of a single under-performing investment or a downturn in any particular industry or geographic market. The table below reflects the breakdown of our total rental income by tenant industry
classification for the years ended December 31, 2012, 2011 and 2010, respectively (dollars in thousands):
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For the year ended December 31,
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2012
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2011
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2010
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Industry Classification
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Rental Income
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Percentage of
Rental Income
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Rental Income
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Percentage of
Rental Income
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Rental Income
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Percentage of
Rental Income
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Telecommunications
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$
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7,351
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14.4
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%
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$
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6,206
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14.1
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%
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$
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5,447
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13.3
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%
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Electronics
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6,189
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12.3
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6,046
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13.9
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6,164
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15.0
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Healthcare
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5,228
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10.3
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4,108
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9.4
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3,787
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9.2
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Diversified/Conglomerate Manufacturing
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3,664
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7.2
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3,664
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8.4
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3,664
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8.9
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Chemicals, Plastics & Rubber
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3,153
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6.2
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3,146
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7.2
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3,130
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7.6
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Beverage, Food & Tobacco
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2,844
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5.6
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2,271
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5.2
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2,189
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5.3
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Personal & Non-Durable Consumer Products
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2,507
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4.9
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2,316
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5.3
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1,228
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3.0
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Personal, Food & Miscellaneous Services
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2,479
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4.9
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649
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1.5
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575
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1.4
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Containers, Packaging & Glass
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2,344
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4.6
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2,339
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5.4
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2,331
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5.7
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Machinery
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2,259
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4.4
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2,256
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5.2
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2,332
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5.7
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Buildings and Real Estate
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2,144
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4.2
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2,120
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4.9
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2,076
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5.0
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Education
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2,138
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4.2
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1,775
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4.1
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1,775
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4.3
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Automobile
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1,944
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3.8
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1,168
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2.7
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1,168
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2.8
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Printing & Publishing
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1,894
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3.7
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1,979
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4.5
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2,188
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5.3
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Oil & Gas
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1,271
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2.5
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1,271
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2.9
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1,283
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3.1
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Diversified/Conglomerate Services
|
|
|
1,244
|
|
|
|
2.4
|
|
|
|
1,001
|
|
|
|
2.3
|
|
|
|
308
|
|
|
|
0.7
|
|
Banking
|
|
|
1,149
|
|
|
|
2.3
|
|
|
|
204
|
|
|
|
0.5
|
|
|
|
|
|
|
|
0.0
|
|
Childcare
|
|
|
583
|
|
|
|
1.1
|
|
|
|
583
|
|
|
|
1.3
|
|
|
|
583
|
|
|
|
1.4
|
|
Home & Office Furnishings
|
|
|
530
|
|
|
|
1.0
|
|
|
|
530
|
|
|
|
1.2
|
|
|
|
530
|
|
|
|
1.3
|
|
Insurance
|
|
|
|
|
|
|
0.0
|
|
|
|
|
|
|
|
0.0
|
|
|
|
422
|
|
|
|
1.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
50,915
|
|
|
|
100.0
|
%
|
|
$
|
43,632
|
|
|
|
100.0
|
%
|
|
$
|
41,180
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our Adviser and Administrator
Our Adviser is led by a management team which has extensive experience purchasing real estate and originating mortgage loans. Our Adviser is controlled by Mr. David Gladstone, our chairman and chief
executive officer. Mr. Gladstone is also the chairman and chief executive officer of our Adviser. Terry Lee Brubaker, our vice chairman, chief operating officer and a director, is a member of the Board of Directors of our Adviser as well as its
vice chairman and chief operating officer. Gladstone Administration, LLC, or our Administrator, employs our chief financial officer and treasurer, chief compliance officer, internal counsel and their respective staffs.
47
Our Adviser and Administrator also provide investment advisory and administrative services, respectively, to
our affiliates, including, but not limited to, Gladstone Capital Corporation and Gladstone Investment Corporation, both publicly-traded business development companies, as well as Gladstone Land Corporation, a publicly traded real estate company.
With the exception of Danielle Jones, our chief financial officer and treasurer, and Robert Cutlip, our president, all of our executive officers serve as either directors or executive officers, or both, of Gladstone Capital Corporation and Gladstone
Investment Corporation. In addition, with the exception of our president, all of our officers and eight of our nine directors are also officers and directors of Gladstone Land. In the future, our Adviser may provide investment advisory services to
other funds, both public and private.
Advisory and Administration Agreements
We are externally managed pursuant to contractual arrangements with our Adviser and our Administrator. Our Adviser and Administrator employ all of our personnel and pay their payroll, benefits and general
expenses directly. We have an investment advisory agreement with our Adviser, or the Advisory Agreement, and an administration agreement with our Administrator, or the Administration Agreement.
Under the terms of the Advisory Agreement, we are responsible for all expenses incurred for our direct benefit. Examples of these expenses include legal,
accounting, interest on short-term debt and mortgages, tax preparation, directors and officers insurance, stock transfer services, stockholder-related fees, consulting and related fees. In addition, we are also responsible for all fees
charged by third parties that are directly related to our business, which include real estate brokerage fees, mortgage placement fees, lease-up fees and transaction structuring fees (although we may be able to pass some or all of such fees on to our
tenants and borrowers).
Management Services and Fees under the Advisory Agreement
The Advisory Agreement provides for an annual base management fee equal to 2.0% of our total stockholders equity, less the recorded value of any
preferred stock, or total common stockholders equity, and for an incentive fee based on funds from operations, or FFO. Our Adviser does not charge acquisition or disposition fees when we acquire or dispose of properties as is common with other
externally-advised REITs. Furthermore, there are no fees charged when our Adviser secures long or short term credit or arranges mortgage loans on our properties; however, our Adviser may earn fee income from our borrowers or tenants or other
sources.
For purposes of calculating the incentive fee, FFO includes any realized capital gains and capital losses, less any distributions
paid on preferred stock and senior common stock, but FFO does not include any unrealized capital gains or losses. The incentive fee would reward our Adviser if our quarterly FFO, before giving effect to any incentive fee, or pre-incentive fee FFO,
exceeds 1.75%, or the hurdle rate, of total common stockholders equity. We pay our Adviser an incentive fee with respect to our pre-incentive fee FFO quarterly as follows:
|
|
|
no incentive fee in any calendar quarter in which our pre-incentive fee FFO does not exceed the hurdle rate of 1.75% (7% annualized);
|
|
|
|
100% of the amount of the pre-incentive fee FFO that exceeds the hurdle rate, but is less than 2.1875% in any calendar quarter (8.75% annualized); and
|
|
|
|
20% of the amount of our pre-incentive fee FFO that exceeds 2.1875% in any calendar quarter (8.75% annualized).
|
48
Quarterly Incentive Fee Based on FFO
Pre-incentive fee FFO
(expressed as a percentage of total common stockholders equity)
Percentage of pre-incentive fee FFO allocated to the incentive fee
The incentive fee may be reduced because of a covenant which exists in our Line of Credit agreement which limits distributions to our stockholders to 95%
of FFO with acquisition-related costs that are required to be expensed under ASC 805, Business Combinations, added back to FFO. In order to comply with this covenant, our Board of Directors accepted our Advisers offer to unconditionally,
irrevocably and voluntarily waive on a quarterly basis a portion of the incentive fee for the years ended December 31, 2012, 2011 and 2010, which allowed us to maintain the current level of distributions to our stockholders. These waived fees
may not be recouped by our Adviser in the future. Our Adviser has indicated that it intends to continue to waive all or a portion of the incentive fee in order to support the current level of distributions to our stockholders; however, our Adviser
is not required to issue any such waiver, either in whole or in part.
Administration Agreement
Pursuant to the Administration Agreement, we pay for our allocable portion of our Administrators overhead expenses incurred while performing its
obligations to us, including, but not limited to, rent and the salaries and benefits expenses of our personnel, including our chief financial officer and treasurer, chief compliance officer, internal counsel, investor relations department and their
respective staffs. Our allocable portion of expenses is generally derived by multiplying our Administrators total expenses by the percentage of our total assets at the beginning of each quarter in comparison to the total assets of all
companies managed by our Adviser under similar agreements.
Critical Accounting Policies
The preparation of our financial statements in accordance with Generally Accepted Accounting Principles in the United States, or GAAP, requires management
to make judgments that are subjective in nature in order to make certain estimates and assumptions. Application of these accounting policies involves the exercise of judgment regarding the use of assumptions as to future uncertainties, and as a
result, actual results could materially differ from these estimates. A summary of all of our significant accounting policies is provided in Note 1 to our consolidated financial statements included elsewhere in this Form 10-K. Below is a summary of
accounting polices involving estimates and assumptions that require complex, subjective or significant judgments in their application and that materially affect our results of operations.
Allocation of Purchase Price
When we acquire real estate, we allocate the purchase price
to (i) the acquired tangible assets and liabilities, consisting of land, building, tenant improvements and long-term debt and (ii) the identified intangible assets and liabilities, consisting of the value of above-market and below-market
leases, in-place leases, unamortized lease origination costs, tenant relationships and capital lease obligations, based in each case on their fair values. All expenses related to the acquisition are expensed as incurred, rather than capitalized into
the cost of the acquisition as had been required by the previous accounting.
Our Adviser estimates value 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. Our Adviser also consider information obtained about each property as a
49
result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets and liabilities 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 hypothetical expected lease-up periods, which primarily range from 9 to 18 months, depending on
specific local market conditions. Our Adviser also estimates costs to execute similar leases, including leasing commissions, legal and other related expenses to the extent that such costs are not already incurred in connection with a new lease
origination as part of the transaction. Our Adviser also considers the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenants credit quality and
managements expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors. A change in any of the assumptions above, which are very subjective, could have a material impact on our results
of operations.
The allocation of the purchase price directly affects the following in our consolidated financial statements:
|
|
|
The amount of purchase price allocated to the various tangible and intangible assets on our balance sheet;
|
|
|
|
The amounts allocated to the value of above-market and below-market lease values are amortized to rental income over the remaining non-cancelable terms
of the respective leases. The amounts allocated to all other tangible and intangible assets are amortized to depreciation or amortization expense. Thus, depending on the amounts allocated between land and other depreciable assets, changes in the
purchase price allocation among our assets could have a material impact on our FFO, a metric which is used by many REIT investors to evaluate our operating performance; and
|
|
|
|
The period of time over which tangible and intangible assets are depreciated varies greatly, and thus, changes in the amounts allocated to these assets
will have a direct impact on our results of operations. Intangible assets are generally amortized over the respective life of the leases, which normally range from 10 to 15 years. Also, we depreciate our buildings over 39 years, but do not
depreciate our land. These differences in timing could have a material impact on our results of operations.
|
Asset
Impairment Evaluation
We periodically review the carrying value of each property to determine if circumstances that indicate impairment in
the carrying value of the investment exist or that depreciation periods should be modified. In determining if impairment exists, our Adviser considers such factors as our tenants payment histories, the financial condition of our tenants,
including calculating the current leverage ratios of tenants, the likelihood of lease renewal, business conditions in the industries in which our tenants operate and whether the carrying value of our real estate has decreased. If any of the factors
above indicate the possibility of impairment, we prepare a projection of the undiscounted future cash flows, without interest charges, of the specific property and determine if the carrying amount of such property is recoverable. In preparing the
projection of undiscounted future cash flows, we estimate the holding periods of the properties and cap rates using information that we obtain from market comparability studies and other comparable sources. If impairment were indicated, the carrying
value of the property would be written down to its estimated fair value based on our best estimate of the propertys discounted future cash flows using assumptions from market participants. Any material changes to the estimates and assumptions
used in this analysis could have a significant impact on our results of operations, as the changes would impact our determination of whether impairment is deemed to have occurred and the amount of impairment loss that we would recognize.
Using the methodology discussed above and in light of the current economic conditions discussed above in
Overview
Business
Environment
, we evaluated our entire portfolio as of December 31, 2012 for any impairment indicators and performed an impairment analysis on those select properties that had an indication of impairment. As a result of this analysis,
we concluded that none of our properties were impaired and we will continue to monitor our portfolio for any indicators of impairment.
50
Results of Operations
The weighted-average yield on our total portfolio was 9.3% as of December 31, 2012. The weighted-average yield on our portfolio is calculated by taking the annualized straight-line rents, reflected
as rental income on our consolidated statements of operations, of each acquisition as a percentage of the acquisition. The weighted-average yield does not account for the interest expense incurred on the mortgages placed on our properties.
A comparison of our operating results for the years ended December 31, 2012 and 2011 is below (dollars in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
Operating revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental income
|
|
$
|
50,915
|
|
|
$
|
43,632
|
|
|
$
|
7,283
|
|
|
|
17
|
%
|
Tenant recovery revenue
|
|
|
355
|
|
|
|
344
|
|
|
|
11
|
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
51,270
|
|
|
|
43,976
|
|
|
|
7,294
|
|
|
|
17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
16,831
|
|
|
|
14,149
|
|
|
|
2,682
|
|
|
|
19
|
%
|
Property operating expenses
|
|
|
1,588
|
|
|
|
986
|
|
|
|
602
|
|
|
|
61
|
%
|
Due diligence expense
|
|
|
949
|
|
|
|
700
|
|
|
|
249
|
|
|
|
36
|
%
|
Base management fee
|
|
|
1,467
|
|
|
|
1,629
|
|
|
|
(162
|
)
|
|
|
-10
|
%
|
Incentive fee
|
|
|
3,569
|
|
|
|
3,398
|
|
|
|
171
|
|
|
|
5
|
%
|
Administration fee
|
|
|
1,118
|
|
|
|
1,024
|
|
|
|
94
|
|
|
|
9
|
%
|
General and administrative
|
|
|
1,594
|
|
|
|
1,497
|
|
|
|
97
|
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses before credit from Adviser
|
|
|
27,116
|
|
|
|
23,383
|
|
|
|
3,733
|
|
|
|
16
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit to incentive fee
|
|
|
(2,221
|
)
|
|
|
(2,113
|
)
|
|
|
108
|
|
|
|
5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
24,895
|
|
|
|
21,270
|
|
|
|
3,625
|
|
|
|
17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(20,226
|
)
|
|
|
(17,076
|
)
|
|
|
3,150
|
|
|
|
18
|
%
|
Distributions attributable to mandatorily redeemable preferred stock
|
|
|
(2,515
|
)
|
|
|
|
|
|
|
2,515
|
|
|
|
NM
|
|
Other income
|
|
|
127
|
|
|
|
84
|
|
|
|
43
|
|
|
|
51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expense
|
|
|
(22,614
|
)
|
|
|
(16,992
|
)
|
|
|
(5,622
|
)
|
|
|
33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
3,761
|
|
|
|
5,714
|
|
|
|
(1,953
|
)
|
|
|
-34
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions attributable to preferred stock
|
|
|
(4,093
|
)
|
|
|
(4,094
|
)
|
|
|
(1
|
)
|
|
|
0
|
%
|
Distributions attributable to senior common stock
|
|
|
(113
|
)
|
|
|
(62
|
)
|
|
|
51
|
|
|
|
82
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income available to common stockholders
|
|
$
|
(445
|
)
|
|
$
|
1,558
|
|
|
$
|
(2,003
|
)
|
|
|
-129
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income available to common stockholders per weighted average share of common stockdiluted
|
|
$
|
(0.04
|
)
|
|
$
|
0.00
|
|
|
$
|
(0.04
|
)
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FFO available to common stockholders
|
|
$
|
16,386
|
|
|
$
|
15,707
|
|
|
$
|
679
|
|
|
|
4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted FFO per weighted average share of common stock
|
|
$
|
1.48
|
|
|
$
|
1.53
|
|
|
$
|
(0.05
|
)
|
|
|
-4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NM = Not meaningful
Operating Revenues
Rental income increased for the year ended December 31, 2012, as
compared to the year ended December 31, 2011, because of the eight properties acquired during 2012.
Tenant recovery revenue increased
for the year ended December 31, 2012, as compared to the year ended December 31, 2011. There was an increase in insurance premiums from 2011, resulting in increased reimbursements from our tenants coupled with an increase in insurance
reimbursements we received from certain of our tenants at our properties acquired during 2012.
Operating Expenses
Depreciation and amortization expenses increased for the year ended December 31, 2012, as compared to the year ended December 31, 2011, because
of the eight properties acquired during 2012.
51
Property operating expenses consist of franchise taxes, management fees, insurance, ground lease payments
and overhead expenses paid on behalf of certain of our properties. Property operating expenses increased for the year ended December 31, 2012, as compared to the year ended December 31, 2011, primarily because of ground lease payments we
are responsible for paying at two of our properties acquired in the fourth quarter of 2011, coupled with an increase in overhead expenses and franchise taxes paid at certain of our vacant properties.
Due diligence expense primarily consists of legal fees and fees incurred for third-party reports prepared in connection with potential acquisitions and
our due diligence analyses related thereto. Due diligence expense increased for the year ended December 31, 2012, as compared to the year ended December 31, 2011, as a result of costs incurred related to the eight properties acquired
during 2012 coupled with costs incurred for other potential acquisitions, partially offset by an out of period adjustment of $250,000 recorded during the year ended December 31, 2011, related to the acquisition of the property in Orange City,
Iowa in December 2010.
The base management fee decreased for the year ended December 31, 2012, as compared to the year ended
December 31, 2011, due to a decrease in total common stockholders equity, the main component of the calculation. The calculation of the base management fee is described in detail above under
Advisory and Administration
Agreements.
The incentive fee increased for the year ended December 31, 2012, as compared to the year ended December 31,
2011, because of an increase in pre-incentive fee FFO. The increase in pre-incentive fee FFO was due to an increase in rental revenues from the eight acquisitions made in 2012, which was partially offset by an increase in property operating, due
diligence and interest expenses during the year ended December 31, 2012, as compared to the year ended December 31, 2011.
The incentive fee credit increased slightly for the year ended December 31, 2012, as compared to the year ended December 31, 2011,
because of the increase in the amount of common dividends paid for 2012, which resulted in a larger portion of the incentive fee which was credited. The calculation of the incentive fee is described in detail above within
Advisory and
Administration Agreements.
The administration fee increased for the year ended December 31, 2012, as compared to the year
ended December 31, 2011, primarily as a result of an increase in the amount of the total expenses our Administrator incurred during 2012. The calculation of the administration fee is described in detail above within
Advisory and
Administration Agreements.
General and administrative expenses increased for the year ended December 31, 2012, as compared to
the year ended December 31, 2011, primarily due to increase in legal fees incurred at certain of our properties for various projects at those properties coupled with an increase in stockholder related expenses.
Other Income and Expense
Interest
expense increased for the year ended December 31, 2012, as compared to the year ended December 31, 2011. This increase was primarily a result of interest on the $124.4 million of mortgage debt assumed and issued during 2012, partially
offset by reduced interest expense on our long-term financings from amortizing and balloon principal payments made during the last 12 months.
Distributions on our mandatorily redeemable preferred stock for the year ended December 31, 2012, are from the public offering of 1,540,000 shares
of our 7.125% Series C Term Preferred Stock completed in February 2012. Gross proceeds of the offering totaled $38.5 million, and net proceeds were $36.7 million. There were no distributions on our mandatorily redeemable preferred stock for the year
ended December 31, 2011 as there was none outstanding.
52
Other income increased during the year ended December 31, 2012, as compared to the year ended
December 31, 2011, because of an easement payment and a bankruptcy settlement from a former tenant received in 2012 related to our property located in Sterling Heights, Michigan. This was partially offset by lower interest income on employee
loans during the year ended December 31, 2012, as compared to the year ended December 31, 2011 due to principal repayments made by employees of our Adviser during 2012.
Net (Loss) Income Available to Common Stockholders
Net (loss) income available to common
stockholders decreased for the year ended December 31, 2012, as compared to the year ended December 31, 2011, primarily because of increased interest expense and increased distributions to our preferred stockholders from the issuance of
our Term Preferred Stock, partially offset by an increase in rental income earned from the eight properties acquired in 2012.
53
A comparison of our operating results for the years ended December 31, 2011 and 2010 is below
(dollars in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended December 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
(Dollars in Thousands)
|
|
Operating revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental income
|
|
$
|
43,632
|
|
|
$
|
41,180
|
|
|
$
|
2,452
|
|
|
|
6
|
%
|
Interest income from mortgage note receivable
|
|
|
|
|
|
|
421
|
|
|
|
(421
|
)
|
|
|
-100
|
%
|
Tenant recovery revenue
|
|
|
344
|
|
|
|
327
|
|
|
|
17
|
|
|
|
5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
43,976
|
|
|
|
41,928
|
|
|
|
2,048
|
|
|
|
5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
14,149
|
|
|
|
13,264
|
|
|
|
885
|
|
|
|
7
|
%
|
Property operating expenses
|
|
|
986
|
|
|
|
971
|
|
|
|
15
|
|
|
|
2
|
%
|
Due diligence expense
|
|
|
700
|
|
|
|
412
|
|
|
|
288
|
|
|
|
70
|
%
|
Base management fee
|
|
|
1,629
|
|
|
|
1,199
|
|
|
|
430
|
|
|
|
36
|
%
|
Incentive fee
|
|
|
3,398
|
|
|
|
3,480
|
|
|
|
(82
|
)
|
|
|
-2
|
%
|
Administration fee
|
|
|
1,024
|
|
|
|
1,063
|
|
|
|
(39
|
)
|
|
|
-4
|
%
|
General and administrative
|
|
|
1,497
|
|
|
|
3,408
|
|
|
|
(1,911
|
)
|
|
|
-56
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses before credit from Adviser
|
|
|
23,383
|
|
|
|
23,797
|
|
|
|
(414
|
)
|
|
|
-2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit to base management fee
|
|
|
|
|
|
|
(225
|
)
|
|
|
225
|
|
|
|
100
|
%
|
Credit to incentive fee
|
|
|
(2,113
|
)
|
|
|
(158
|
)
|
|
|
(1,955
|
)
|
|
|
1237
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
21,270
|
|
|
|
23,414
|
|
|
|
(2,144
|
)
|
|
|
-9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(17,076
|
)
|
|
|
(17,063
|
)
|
|
|
(13
|
)
|
|
|
0
|
%
|
Other income
|
|
|
84
|
|
|
|
3,477
|
|
|
|
(3,393
|
)
|
|
|
-98
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expense
|
|
|
(16,992
|
)
|
|
|
(13,586
|
)
|
|
|
(3,406
|
)
|
|
|
25
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
5,714
|
|
|
|
4,928
|
|
|
|
786
|
|
|
|
16
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions attributable to preferred stock
|
|
|
(4,094
|
)
|
|
|
(4,094
|
)
|
|
|
|
|
|
|
0
|
%
|
Distributions attributable to senior common stock
|
|
|
(62
|
)
|
|
|
(20
|
)
|
|
|
(42
|
)
|
|
|
210
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common stockholders
|
|
$
|
1,558
|
|
|
$
|
814
|
|
|
$
|
744
|
|
|
|
91
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per weighted average share of common
|
|
$
|
0.15
|
|
|
$
|
0.09
|
|
|
$
|
0.06
|
|
|
|
60
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FFO available to common stockholders
|
|
$
|
15,707
|
|
|
$
|
14,078
|
|
|
$
|
1,629
|
|
|
|
12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted FFO per weighted average share of common stock
|
|
$
|
1.53
|
|
|
$
|
1.64
|
|
|
$
|
(0.11
|
)
|
|
|
-7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Revenues
Rental income increased for year ended December 31, 2011, as compared to the year ended December 31, 2010, because of the seven properties acquired during 2011 and the full year of income from
our property acquired in December 2010, partially offset by the lost rental income from two of our properties, which became vacant in 2010.
Interest income from mortgage notes receivable decreased for the year ended December 31, 2011, as compared to the year ended December 31, 2010,
as our only mortgage loan was fully repaid in July 2010.
Tenant recovery revenue increased slightly for the year ended December 31,
2011, as compared to the year ended December 31, 2010, because of an increase in insurance premiums from 2010, resulting in increased reimbursements from our tenants.
Operating Expenses
Depreciation and amortization expenses increased for the year ended
December 31, 2011, as compared to the year ended December 31, 2010, because we acquired seven properties in 2011 and a full year of depreciation was recorded from our property acquired in December 2010.
54
Property operating expenses consist of franchise taxes, management fees, insurance, ground lease payments
and overhead expenses paid on behalf of certain of our properties. Property operating expenses increased during the year ended December 31, 2011, as compared to the year ended December 31, 2010, because of overhead expenses for which we
became responsible, which were previously paid directly by our tenants, at our two vacant properties.
Due diligence expense primarily
consists of legal fees and fees incurred for third-party reports prepared in connection with potential acquisitions and our due diligence analyses related thereto. Due diligence expense increased for the year ended December 31, 2011, as
compared to the year ended December 31, 2010, as a result of costs incurred related to the seven properties acquired during 2011, partially offset by an out of period adjustment of $250,000 recorded during 2011 related to the acquisition of the
property in Orange City, Iowa in December 2010.
The base management fee increased for the year ended December 31, 2011, as compared to
the year ended December 31, 2010, due to an increase in total common stockholders equity from the issuance of common stock during 2011, the main component of the calculation. There was no base management fee credit in 2011, as there was
in 2010, and we currently do not anticipate having credits to the base management fee in the future. The calculation of the base management fee is described in detail above under
Advisory and Administration Agreements.
The incentive fee decreased for the year ended December 31, 2011, as compared to the year ended December 31, 2010, due to the increase in
common stockholders equity from the issuance of common stock during 2011, resulting in a higher hurdle rate to overcome, which is the main component of the calculation.
The incentive fee credit increased for the year ended December 31, 2011, as compared to the year ended December 31, 2010, because of the increase in the amount of common stock dividends
paid in 2011, which resulted in a larger portion of the incentive fee which was credited. The calculation of the incentive fee is described in the detail above under
Advisory and Administration Agreement.
The administration fee decreased for the year ended December 31, 2011, as compared to the year ended December 31, 2010, primarily as a result
of a decrease in the amount of the total expenses allocated from our Administrator during the periods, partially offset by an increase in our allocable portion of the total expenses. The calculation of the administration fee is described in detail
above under
Advisory and Administration Agreements.
General and administrative expenses decreased for the year ended
December 31, 2011, as compared to the year ended December 31, 2010, primarily due to the write-off of approximately $1.6 million of fees and expenses incurred in relation to the termination of the private offering of unregistered senior
common stock in 2010.
Other Income and Expense
Interest expense increased for the year ended December 31, 2011, as compared to the year ended December 31, 2010. This increase was primarily a result of an increase in the rate on our $45.2
million mortgage loan in October 2011 of 0.18% when the mortgage loan was renewed coupled with interest on the $31.7 million of mortgage debt assumed and issued during 2011. This was partially offset by a decrease of 2.3% in the interest rate
charged on our $45.2 million mortgage loan that was renewed in September 2010, and reduced interest expense on our long-term financings from amortizing principal payments made during 2010 and 2011.
Other income decreased during the year ended December 31, 2011, as compared to the year ended December 31, 2010, because of $3.3 million in
additional income and prepayment fees we received in connection with the early repayment of our mortgage loan in July 2010 coupled with a decrease in interest income from employee loans during the year ended December 31, 2011, as compared to
the year ended December 31, 2010. This decrease was a result of loan payoffs made by employees of our Adviser during 2010 and 2011, coupled with other principal repayments made during the periods.
55
Net Income Available to Common Stockholders
Net income available to common stockholders increased for the year ended December 31, 2011, as compared to the year ended December 31, 2010, primarily because of the write-off of $1.6 million of
fees related to the termination of the private offering of unregistered senior common stock in 2010 and income earned from the seven properties acquired during 2011, partially offset by the $3.3 million in additional income that was recognized
during 2010 related to the early repayment of our mortgage loan.
Liquidity and Capital Resources
Overview
Our sources of liquidity
include cash flows from operations, cash and cash equivalents, borrowings under our Line of Credit, obtaining mortgages on our unencumbered properties and issuing additional equity securities. Our available liquidity at December 31, 2012, was
$10.8 million, including $5.5 million in cash and cash equivalents and an available borrowing capacity of $5.3 million under our Line of Credit.
Future Capital Needs
We actively seek conservative investments that are likely to produce
income to pay distributions to our stockholders. We intend to use the proceeds received from future equity raised and debt capital borrowed to continue to invest in industrial, commercial and retail real property, make mortgage loans, or pay down
outstanding borrowings under our Line of Credit. Accordingly, to ensure that we are able to effectively execute our business strategy, we routinely review our liquidity requirements and continually evaluate all potential sources of liquidity. Our
short-term liquidity needs include proceeds necessary to fund our distributions to stockholders, pay the debt service costs on our existing long-term mortgages, and fund our current operating costs. Our long-term liquidity needs include proceeds
necessary to grow and maintain our portfolio of investments.
We believe that our available liquidity is sufficient to fund our distributions
to stockholders, pay the debt service costs on our existing long-term mortgages and fund our current operating costs in the near term. We further believe that our cash flow from operations coupled with the financing capital available to us in the
future are sufficient to fund our long-term liquidity needs. Additionally, to satisfy either our short-term or long-term obligations, or both, we may require credits to our management fees that are issued from our Adviser, although our Adviser is
under no obligation to provide any such credits, either in whole or in part.
Equity Capital
During 2012, we raised $2.5 million of common equity under our ATM program, or $2.4 million in net proceeds, at an average share price of $17.79. We also
raised $1.6 million in net proceeds of senior common equity. Additionally, we raised $36.7 million of mandatorily redeemable preferred equity, net of offering costs, in February 2012. We used these proceeds to repay a portion of the outstanding
balance of the Line of Credit, to acquire additional properties and the remainder for general corporate and working capital needs.
We have
also raised $2.4 million of additional common equity thus far in 2013 under our ATM program, or $2.3 million in net proceeds, at an average share price of $18.49.
As of December 31, 2012, we have the ability to raise up to $214.2 million of additional equity capital through the sale and issuance of securities that are registered under our universal shelf
registration statement on Form S-3 (File No. 333-169290), or the Universal Shelf, in one or more future public offerings. Of the $214.2 million of available capacity under our Universal Shelf, $18.9 million of common
56
stock is reserved for additional sales under our ATM Program, which we recently extended through November 2014, and $50.7 million is reserved for sales of our senior common stock. Our Universal
Shelf expires in September 2013; however, we intend to file a new registration statement in order to continue to raise equity capital.
Debt Capital
As of December 31,
2012, we had 30 fixed-rate mortgage notes payable in the aggregate principal amount of $358.3 million, collateralized by a total of 64 properties with terms at issuance ranging from 5 years to 17 years. The weighted-average interest rate on the
mortgage notes payable as of December 31, 2012 was 5.64%.
The CMBS market has returned, see the discussion in
OverviewBusiness Environment
above. Specifically, we continue to see banks and other non-bank lenders willing to issue 10-year mortgages. Consequently, we are focused on obtaining mortgages through regional banks, non-bank
lenders and CMBS.
We have mortgage debt in the aggregate principal amount of $15.6 million payable during 2013 and $24.4 million payable
during 2014. The 2013 and 2014 principal amounts payable includes both amortizing principal payments and balloon principal payments due in December of 2013 of $8.5 million and June of 2014 of $17.3 million; however, we are initiating conversations
with these lenders in advance of these maturities and anticipate being able to extend the maturity dates or refinance with new lenders. We intend to pay the 2013 and 2014 debt amortization payments from operating cash flow and borrowings under our
Line of Credit.
Our Line of Credit matures in December 2013. We are currently in discussions with both our existing lender and various other
lenders to either renew our existing line or to implement a new line of credit. We anticipate being able to extend or issue a new line in advance of the maturity of our existing line in an amount similar to our existing Line of Credit.
If we cannot find replacement financing, we would not have enough existing liquidity to continue our existing operations. If that were to happen,
management would pursue and expect to obtain an extension from the current lender in order to provide additional time to obtain replacement financing. In the unlikely scenario that we are unable to find replacement financing, management has reviewed
its cash uses and sources and has identified plans that could be implemented to continue operations despite the maturity of the Line of Credit. These steps could include suspension of capital spending, cost reductions, an equity raise and possible
asset disposals. Additionally management has assessed that the remaining assets in the portfolio would produce sufficient cash flows to fund operating cash needs and meet remaining debt service requirements in the near term.
Operating Activities
Net cash provided
by operating activities during the year ended December 31, 2012, was $23.4 million, as compared to net cash provided by operating activities of $19.7 million for the year ended December 31, 2011. This increase was primarily a result of
rental income received from the eight properties acquired in 2012, partially offset by $1.7 million of leasing commissions paid for renewing existing leases. The majority of cash from operating activities is generated from the rental payments that
we receive from our tenants. We utilize this cash to fund our property-level operating expenses and use the excess cash primarily for debt and interest payments on our mortgage notes payable, interest payments on our Line of Credit, distributions to
our stockholders, management fees to our Adviser, and other entity-level expenses.
Investing Activities
Net cash used in investing activities during the year ended December 31, 2012, was $92.0 million, which primarily consisted of the acquisition of
eight properties during 2012, coupled with tenant improvements performed at certain of our properties and net payments to our lenders for reserves, as compared to net cash
57
used in investing activities during the year ended December 31, 2011, of $46.0 million, which primarily consisted of the acquisition of seven properties, coupled with tenant improvements
performed at certain of our properties and net payments to our lenders for reserves.
Financing Activities
Net cash provided by financing activities during the year ended December 31, 2012, was $70.8 million, which primarily consisted of proceeds from the
sale of our Term Preferred Stock, common stock, net borrowings on our Line of Credit and proceeds from the issuance of mortgage notes payable, partially offset by distributions paid to our stockholders and principal repayments on mortgage notes
payable. Net cash provided by financing activities for the year ended December 31, 2011, was $22.6 million, which primarily consisted of proceeds from the sale of our common stock and proceeds from the issuance of mortgage notes payable,
partially offset by distributions paid to our stockholders, principal repayments on mortgage notes payable and net repayments on our Line of Credit.
Line of Credit
In December 2010, we procured a $50.0 million Line of Credit maturing on
December 28, 2013, with Capital One, N.A. serving as a revolving lender, a letter of credit issuer and an administrative agent and Branch Banking and Trust Company serving as a revolving lender and letter of credit issuer. The Line of Credit
originally provided for a senior secured revolving credit facility of up to $50.0 million, with a standby letter of credit sublimit of up to $20.0 million. In January 2012, the Line of Credit was expanded to $75.0 million and Citizens Bank of
Pennsylvania was added as a revolving lender and letter of credit issuer. The interest rate per annum applicable to the Line of Credit is equal to the London Interbank Offered Rate, or LIBOR, plus an applicable margin of up to 3.00% depending upon
our leverage. Our leverage ratio used in determining the applicable margin for interest on the Line of Credit is recalculated quarterly. We are subject to an annual maintenance fee of 0.25% per year. Our ability to access this source of
financing is subject to our continued ability to meet customary lending requirements such as compliance with financial and operating covenants and our meeting certain lending limits. One such covenant requires us to limit distributions to our
stockholders to 95% of our FFO, with acquisition-related costs required to be expensed under ASC 805 added back to FFO for covenant purposes. In addition, the maximum amount that we may draw under this agreement is based on a percentage of the value
of properties pledged as collateral to the banks, which must meet agreed upon eligibility standards. Currently, 14 of our properties are pledged as collateral under our Line of Credit.
When we are able to procure mortgages for these pledged properties, the banks will release the properties from the Line of Credit and reduce the availability under the Line of Credit by the advanced
amount of the released property. Conversely, as we purchase new properties meeting the eligibility standards, we may pledge these new properties to obtain additional advances under the Line of Credit. Our availability under the Line of Credit will
also be reduced by letters of credit used in the ordinary course of business. We may use the advances under the Line of Credit for both general corporate purposes and the acquisition of new investments.
As of February 19, 2013, there was $19.7 million outstanding under the Line of Credit at an interest rate of approximately 3.0% and $6.1 million
outstanding under letters of credit at a weighted average interest rate of 3.0%. As of February 19, 2013, the remaining borrowing capacity available under the Line of Credit was $10.6 million. Our ability to increase the availability under our
Line of Credit is dependent upon our pledging additional properties as collateral. Traditionally, we have pledged new properties to the Line of Credit as we arrange for long-term mortgages for these pledged properties. Currently, only 16 of our
properties do not have long-term mortgages, and 14 of those are pledged as collateral under our Line of Credit. Accordingly, we have only 2 properties which are unencumbered. We were in compliance with all covenants under the Line of Credit as of
December 31, 2012.
58
Contractual Obligations
The following table reflects our material contractual obligations as of December 31, 2012 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
Contractual Obligations
|
|
Total
|
|
|
Less than 1 Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
More than 5 Years
|
|
Debt Obligations
(1)
|
|
$
|
421,790
|
|
|
$
|
40,602
|
|
|
$
|
65,572
|
|
|
$
|
183,107
|
|
|
$
|
132,509
|
|
Interest on Debt Obligations
(2)
|
|
|
120,497
|
|
|
|
23,777
|
|
|
|
41,984
|
|
|
|
24,803
|
|
|
|
29,933
|
|
Operating Lease Obligations
(3)
|
|
|
7,400
|
|
|
|
413
|
|
|
|
826
|
|
|
|
829
|
|
|
|
5,332
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
549,687
|
|
|
$
|
64,792
|
|
|
$
|
108,382
|
|
|
$
|
208,739
|
|
|
$
|
167,774
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Debt obligations represent borrowings under our Line of Credit, which represents $25.0 million of the debt obligation due in 2013, mortgage notes payable that were
outstanding as of December 31, 2012 and amounts due to the holders of our Term Preferred Stock.
|
(2)
|
Interest on debt obligations includes estimated interest on our borrowings under our Line of Credit, mortgage notes payable and interest due to the holders of our Term
Preferred Stock. The balance and interest rate on our Line of Credit is variable; thus, the amount of interest calculated for purposes of this table was based upon rates and balances as of December 31, 2012.
|
(3)
|
Operating lease obligations represent the ground lease payments due on our Tulsa, Oklahoma, Dartmouth, Massachusetts, and Springfield, Missouri properties.
|
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of December 31, 2012.
59