10-K 1 idiv-12x31x13x10xk.htm 10-K IDIV-12-31-13-10-K

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
FORM 10-K
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM             TO  
COMMISSION FILE NUMBER: 000-53945
Inland Diversified Real Estate Trust, Inc.
(Exact name of registrant as specified in its charter)
Maryland
 
26-2875286
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
2901 Butterfield Road, Oak Brook, Illinois
 
60523
(Address of principal executive offices)
 
(Zip Code)
630-218-8000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, $0.001 par value per share
(Title of Class) 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.45 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. (See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).
Large accelerated filer
 
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Accelerated filer
  
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Non-accelerated filer
 
ý
  
 
  
Smaller reporting company
  
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
There is no established market for the registrant’s shares of common stock. The number of shares held by non-affiliates as of June 30, 2013 (the last business day of the registrant’s most recently completed second fiscal quarter) was 115,933,852.
As of March 3, 2014, there were 117,809,586 shares of the registrant’s common stock outstanding.

 
 
 
 
 



INLAND DIVERSIFIED REAL ESTATE TRUST, INC.

TABLE OF CONTENTS

 
 
 
 
 
Page
 
Part I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
 
Part II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
 
Part III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
 
Part IV
 
Item 15.
 




PART I

Item 1. Business
General
Inland Diversified Real Estate Trust, Inc. (which we refer to herein as the “Company,” “we,” “our” or “us”) was incorporated in June 2008 as a Maryland corporation. We were formed to acquire and develop a diversified portfolio of commercial real estate located in the United States and Canada. We also may invest in other real estate assets such as interests in real estate investment trusts, or “REITs,” or other “real estate operating companies” that own these assets, joint ventures and commercial mortgage debt. Our sponsor, Inland Real Estate Investment Corporation, referred to herein as our “Sponsor” or “IREIC,” is a subsidiary of The Inland Group, Inc. Various affiliates of our Sponsor are involved in our business. We are externally managed and advised by Inland Diversified Business Manager & Advisor, Inc. referred to herein as our “Business Manager,” a wholly owned subsidiary of our Sponsor. Our Business Manager is responsible for overseeing and managing our day-to-day operations. Our properties are managed by one of Inland Diversified Real Estate Services LLC, Inland Diversified Asset Services LLC, Inland Diversified Leasing Services LLC or Inland Diversified Development Services LLC, referred to collectively herein as our “Real Estate Managers.” These entities are indirectly controlled by the four principals of The Inland Group, Inc.; Messrs. Daniel Goodwin, Robert Baum, G. Joseph Cosenza and Robert Parks. Unless otherwise noted, all dollar amounts are stated in thousands, except per share amounts.
On August 24, 2009, we commenced our initial public offering of up to 500,000,000 shares of our common stock to the public at a price of $10.00 per share on a “best efforts” basis and up to 50,000,000 shares of our common stock at a price of $9.50 per share to our stockholders pursuant to our distribution reinvestment plan, or “DRP.” The dealer manager of our public offering was Inland Securities Corporation, a wholly owned subsidiary of our Sponsor. The "best efforts" portion of the offering was completed on August 23, 2012. As of the termination of our best efforts public offering on August 23, 2012, we sold a total of 110,485,936 shares, generating $1,099,311 in aggregate gross offering proceeds. Following the termination of the best efforts portion of the offering, we filed another registration statement to permit us to continue offering and selling shares of common stock to stockholders who choose to participate in the DRP. On November 13, 2013, our board of directors voted to suspend the DRP, effective immediately. In our initial public offering we sold 119,839,478 shares, including 9,353,542 shares pursuant to the DRP, generating $1,188,170 in aggregate gross offering proceeds.
At December 31, 2013, we owned 135 retail properties, four office properties and two industrial properties collectively totaling 12.5 million square feet including 24 multi-family units and two multi-family properties totaling 420 units. The properties are located in 31 states. As of December 31, 2013, we had a diversified portfolio of properties with our top two tenants, Kohl's Department Stores, Inc. and Walgreens comprising 4.3% and 4.1% of our total annualized base rent, respectively and our top two tenant types, dollar stores including off price clothing and grocery stores comprising 17.3% and 11.9% of our total square feet, respectively. As of December 31, 2013, our portfolio had a weighted average physical occupancy and economic occupancy of 96.1% and 97.2%, respectively. Economic occupancy excludes square footage associated with an earnout component. At the time that we acquired certain properties, the purchase agreement contained an earnout component to the purchase price, meaning we did not pay a portion of the purchase price at closing for certain vacant spaces, although we own the entire property. We are not obligated to settle this contingent purchase price unless the seller obtains leases for the vacant space within the time limits and parameters set forth in the applicable acquisition agreement.
Net Lease Sale Transactions
On December 16, 2013, we, Inland Diversified Cumming Market Place, L.L.C., a Delaware limited liability company and our subsidiary, and Bulwark Corporation, a Delaware corporation and our subsidiary, entered into two Purchase and Sale Agreements (collectively, the “Purchase and Sale Agreements”) with Realty Income Corporation, a Maryland corporation and unaffiliated third party purchaser (“Realty Income”). The Purchase and Sale Agreements collectively provide for the sale of a total of 84 of our single tenant, net leased properties (the “Net Lease Properties”) to Realty Income in a series of transactions which we refer to as the “Net Lease Sale Transactions.”
The Purchase and Sale Agreements provide that the Net Lease Properties will be sold in multiple separate tranches. The closing of each tranche is subject to the satisfaction of various closing conditions. On January 31, 2014, we closed the first tranche of Net Lease Properties (the “Tranche I Closing”), resulting in the sale to Realty Income of a total of 46 of the Net Lease Properties for an aggregate cash purchase price of approximately $201,955. The Tranche I Closing resulted in net proceeds to us of $126,312. Subject to the satisfaction of all closing conditions, the sale of the remainder of the Net Lease Sale Transactions

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is expected to close by April 30, 2014. However, there are no assurances that the remainder of the Net Lease Sale Transactions will be consummated on the expected timetable, or at all.
Following the Tranche I Closing, our portfolio consisted of 91 retail properties, three office properties and one industrial property collectively totaling 11.5 million square feet including 24 multi-family units and two multi-family properties totaling 420 units. Assuming the completion of the Net Lease Sale Transactions and the sale of all of the properties contemplated to be sold therein, following the completion of the Net Lease Sale Transactions we will own 57 retail properties, collectively totaling approximately 10.2 million square feet including 24 multi-family units and two multi-family properties with a total of 420 units.
Proposed Merger
On February 9, 2014, we entered into an agreement and plan of merger (the “Merger Agreement”) with Kite Realty Group Trust, a publicly traded (NYSE: KRG) Maryland real estate investment trust (“Kite”), and KRG Magellan, LLC, a Maryland limited liability company and a direct wholly owned subsidiary of Kite (“Merger Sub”). The Merger Agreement provides for, upon the terms and conditions of the Merger Agreement, the merger of the Company with and into Merger Sub, with Merger Sub surviving the Merger as a direct wholly owned subsidiary of Kite (the “Merger”). Pursuant to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of our common stock will be converted into the right to receive shares of beneficial interest of Kite, par value $0.01 per share (“Kite Common Shares”), based on:
an exchange ratio of 1.707 Kite Common Shares for each share of our common stock if the volume-weighted average trading price of Kite Common Shares for the ten consecutive trading days ending on the third trading day preceding the meeting of our stockholders to approve the Merger (the “Reference Price”) is equal to or less than $6.36;
a floating exchange ratio if the Reference Price is more than $6.36 or less than $6.58 (with such floating exchange ratio being determined by dividing $10.85 by the Reference Price); and
an exchange ratio of 1.650 Kite Common Shares for each share of our common stock if the Reference Price is $6.58 or greater.
Pursuant to the Merger Agreement, upon the effective time of the Merger, the board of trustees of Kite will consist of nine members, six of whom will be current trustees of Kite and three of whom will be designated by us.
The completion of the Merger is subject to a number of closing conditions, including, among others: (i) approval by Kite’s stockholders and our stockholders, including the approval of Kite’s stockholders of an amendment to Kite’s declaration of trust to increase the number of Kite Common Shares that Kite is authorized to issue; (ii) the absence of a material adverse effect on either us or Kite; (iii) the receipt of tax opinions relating to the REIT status of Kite and the Company and the tax-free nature of the transaction; (iv) the completion of the Net Lease Sale Transactions; and (v) the completion of the redeployment of certain proceeds from the Net Lease Sale Transactions to acquire replacement properties for purposes of Section 1031 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). As a result of the closing conditions to which the Merger is subject, there are no assurances that the proposed Merger will be consummated on the expected timetable, or at all. If the closing conditions are satisfied, it is anticipated that the Merger will close during the second or third quarter of 2014.
The Merger Agreement may be terminated under certain circumstances, including by either us or Kite if the Merger has not been consummated on or before the outside date of August 31, 2014, subject to extension under certain circumstances. The Merger Agreement provides that, in connection with the termination of the Merger Agreement under specified circumstances, we may be required to pay to Kite a termination fee of $43,000 and/or reimburse Kite’s transaction expenses up to an amount equal to $8,000. Where termination is in connection with a failure to close the Net Lease Sale Transactions, we may be required to (i) reimburse Kite for its transaction expenses up to an amount equal to $8,000 and (ii) pay Kite a termination fee of $3,000. The Merger Agreement also provides that, under specified circumstances, Kite may be required to pay us a termination fee of $30,000 and/or reimburse our transaction expenses up to an amount equal to $8,000. Under certain circumstances, including upon payment of the applicable termination fee, either party is permitted to terminate the Merger Agreement to enter into a definitive agreement with a third party with respect to a superior acquisition proposal.
If the Merger is consummated, it is expected to significantly change the scope of our business and as a result our 2013 results of operations may not necessarily be representative of our future results of operations. Unless otherwise stated, all disclosures and discussion in this Form 10-K do not include the expected effects of the Merger.
In connection with the execution of Merger Agreement, we entered into a Master Liquidity Event Agreement (the “Master Agreement”) with the Business Manager, the Real Estate Managers, and certain other affiliates of the Business Manager. The Master Agreement sets forth the terms of the consideration due to the Business Manager and the Real Estate Managers in connection with the Merger, provides for the automatic termination upon the closing of the Merger of our agreements with the Business Manager and the Real Estate Managers and certain other agreements between us and affiliates of the Business

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Manager and includes certain other agreements in order to facilitate the Merger. See Part III, Item 13 of this Annual Report on Form 10-K, “Certain Relationships and Related Transactions, and Director Independence,” for additional information.
Segment Data
We have one reportable segment as defined by accounting principles generally accepted in the United States (“U.S. GAAP”) for the years ended December 31, 2013, 2012 and 2011. Accordingly, we did not report any other segment disclosures in this annual report.
Investment Policies
Investments in Real Estate
We acquire commercial real estate located throughout the United States and Canada, with a focus on investments in retail properties, office buildings, multi-family properties, including student housing properties, industrial/distribution and warehouse facilities, and lodging properties. We may also purchase medical office buildings and other healthcare-related facilities and public infrastructure assets, including toll roads, water utilities, correctional facilities, airports, ports, electricity and gas transmission and distribution networks and telecommunications facilities. We may purchase properties with operating histories, newly constructed properties, properties under development, or undeveloped properties.
We have not focused on any one particular geographic location and seek to invest in a geographically diverse portfolio in order to reduce the risk of reliance on a particular market, a particular property or a particular tenant. We are not specifically limited in the number or size of properties we may acquire, or with respect to the amount that we may invest in a single property. We have sought investments in properties with existing “net” leases. “Net” leases require tenants to pay a share, either prorated or fixed, of all, or a majority, of a particular property’s operating expenses, including real estate taxes, special assessments, utilities, insurance, common area maintenance and building repairs, as well as base rent payments.
We may acquire assets by purchasing the property directly or indirectly by purchasing interests, including controlling interests, in REITs, or other “real estate operating companies” that own these assets, such as real estate management companies and real estate development companies. We may purchase the common or preferred stock of these entities (or debt securities issued by these entities) or options to acquire interests in these entities. We do not have any policies limiting its acquisitions of REITs or other real estate operating companies to those conducting a certain type of real estate business or owning a specific property type or real estate asset. We may also acquire, develop or improve properties through joint ventures, partnerships, co-tenancies and other co-ownership arrangements or participations with real estate developers, owners and other unaffiliated third parties. In determining whether to invest in a particular joint venture, the Business Manager evaluates the real estate assets that the joint venture owns or is being formed to own under the same criteria used for the selection of direct investments in properties.
Investments in Real Estate Mortgages
We may originate and invest in real estate-related loans, including first and second mortgage loans, mezzanine loans, B-Notes, bridge loans, convertible mortgages, wraparound mortgage loans, construction mortgage loans and participations in these loans. These loans may be secured by first or second mortgages on commercial real estate or a pledge of ownership interests in the entity owning commercial real estate. Our underwriting process typically involves comprehensive financial, structural, operational and legal due diligence.
We will not make, or invest in, mortgage loans, excluding investments in CMBS, unless we obtain an appraisal of the underlying property from a certified independent appraiser, except for mortgage loans insured or guaranteed by a government or governmental agency. In addition to the appraisal, we will seek to obtain a customary lender’s title insurance policy or commitment as to the priority of the mortgage or condition of the title. We will not make, or invest in, mortgage loans, excluding investments in CMBS, secured by a property if the aggregate amount of all mortgage loans secured by the property, including our loans, would exceed an amount equal to 85% of the appraised value of the property, unless we find substantial justification due to the presence of other underwriting criteria, as determined in the sole discretion of our board of directors, including a majority of our independent directors, and provided further that the loans do not exceed the appraised value of the property at the date of the loans. We are not limited in the percentage of our assets that may be invested in any type of loan or in any single loan or the types of properties subject to mortgages or other loans in which we may invest.
Tax Status
We have elected to be taxed as a REIT for federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code beginning with the tax year ended December 31, 2009. Because we qualify for taxation as a REIT, we generally will not be subject to federal income tax on taxable income that is distributed to stockholders. If we fail to qualify as a REIT in any taxable year, without the benefit of certain relief provisions, we will be subject to federal (including any applicable alternative

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minimum tax) and state income tax on our taxable income at regular corporate rates. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income, property or net worth, respectively, and to federal income and excise taxes on our undistributed income.
Competition
We are subject to significant competition in seeking real estate investments and tenants. We compete with many third parties engaged in real estate investment activities including other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, lenders, hedge funds, governmental bodies and other entities. Some of these competitors, including larger REITs, have substantially greater financial resources than we do and generally enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies.
Employees
We do not have any employees. In addition, all of our executive officers are officers of IREIC or one or more of its affiliates and are compensated by those entities, in part, for their service rendered to us. We do not separately compensate our executive officers for their service as officers or, except as set forth below with respect to our corporate secretary, reimburse either our Business Manager or Real Estate Managers or any of their affiliates for any compensation paid to individuals who also serve as our executive officers, or the executive officers of our Business Manager or our Real Estate Managers or their affiliates. Our corporate secretary is employed by The Inland Real Estate Group, Inc., an affiliate of the Business Manager. We reimburse The Inland Real Estate Group, based on hourly billing rates, for the time that our secretary spends providing legal services related to our company or for our benefit.
Conflicts of Interest
Certain persons performing services for our Business Manager and Real Estate Managers are employees of IREIC or its affiliates, and may also perform services for its affiliates and other IREIC-sponsored entities. These individuals face competing demands for their time and services and may have conflicts in allocating their time between our business and assets and the business and assets of these other entities. IREIC also may face a conflict of interest in allocating personnel and resources among these entities. In addition, conflicts exist to the extent that we acquire properties in the same geographic areas where properties owned by other IREIC-sponsored programs are located. In these cases, a conflict may arise in the acquisition or leasing of properties if we and another IREIC-sponsored program are competing for the same properties or tenants in negotiating leases, or a conflict may arise in connection with the resale of properties if we and another IREIC-sponsored program are selling similar properties at the same time.
Our charter contains provisions setting forth our ability to engage in certain related party transactions. Our board of directors reviews all of these transactions and, as a general rule, any related party transactions must be approved by a majority of the directors, including a majority of the independent directors, not otherwise interested in the transaction. Further, we may not engage in certain transactions with entities sponsored by, or affiliated with, IREIC unless a majority of our board of directors, including a majority of our independent directors, finds the transaction to be fair and reasonable and on terms no less favorable to us than those from an unaffiliated party under the same circumstances. Our board has adopted a policy prohibiting us from engaging in the following types of transactions with IREIC-affiliated entities:
purchasing real estate assets from, or selling real estate assets to, any IREIC-affiliated entities (this excludes circumstances where we have entered into an agreement for services with an entity affiliated with IREIC, such as Inland Real Estate Acquisitions, Inc. (“IREA”), who from time to time may enter into a purchase agreement to acquire a property and then assigns the purchase agreement to us);
making loans to, or borrowing money from, any IREIC-affiliated entities (this excludes expense advancements under existing agreements and the deposit of monies in any banking institution affiliated with IREIC); and
investing in joint ventures with any IREIC-affiliated entities.
This policy does not impact agreements or relationships between us and IREIC and its affiliates that relate to the day-to-day management of our business.
Environmental Matters
As an owner of real estate, we are subject to various environmental laws, rules and regulations adopted by various governmental bodies or agencies. Compliance with these laws, rules and regulations has not had a material adverse effect on our business, assets, or results of operations, financial condition and ability to pay distributions. We do not believe that our existing portfolio as of December 31, 2013 will require us to incur material expenditures to comply with these laws and regulations.

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Access to Company Information
We are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and, as a result, we electronically file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and other information with the Securities and Exchange Commission (“SEC”). We have filed and we will continue to file documents in connection with the Merger with the SEC. The public may read and copy any of the reports that are filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at (800)-SEC-0330. The SEC maintains an Internet site at www.sec.gov that contains our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Report on Form 8-K, proxy statements and other filings with the SEC. Access to these filings is free of charge.
We make available, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other filings with the SEC, including all amendments to such filing, on our website, www.inlanddiversified.com. These filings are available as soon as reasonably practicable after such material is electronically filed or furnished to the SEC.
Item 1A. Risk Factors
The factors described below represent our principal risks. Other factors may exist that we do not consider to be significant based on information that is currently available or that we are not currently able to anticipate. The occurrence of any of the risks discussed below could have a material adverse effect on our business, financial condition, results of operations and ability to pay distributions to our stockholders. Potential investors and our stockholders may be referred to as “you” or “your” in this Item 1A, “Risk Factors,” section.
Risks Related to Our Business
Failure to complete the Merger could negatively impact the value of our common stock and the future value of our business and financial results.
If the Merger is not completed, our ongoing business could be adversely affected and we will be subject a variety of risks associated with the failure to complete the Merger, including but not limited to:
being required, under certain circumstances, to pay to Kite a termination fee of $43,000 and/or reimburse Kite’s transaction expenses up to an amount equal to $8,000;
incurrence of substantial costs relating to the proposed merger, such as legal, accounting, financial advisory, filing, printing and mailing fees; and
diversion of resources and the focus of our management from operational matters and other strategic opportunities while working to implement the Merger.
If the Merger is not completed, these risks could negatively impact the value of our common stock, the future value of our business and our financial results.
The pendency of the Merger could adversely affect our business and operations.
In connection with the pending Merger, some of our tenants or vendors may delay or defer decisions, which could negatively impact our revenues, earnings, cash flows and expenses regardless of whether the Merger is completed. Similarly, current and prospective employees of the Business Manager or the Property Managers may experience uncertainty about their future roles with the combined company following the Merger, which may materially adversely affect the ability of the Business Manager or the Property Managers to attract and retain key personnel during the pendency of the Merger. In addition, due to operating covenants in the Merger Agreement, we may be unable, during the pendency of the Merger, to pursue certain strategic transactions, undertake certain significant capital projects, undertake certain significant financing transactions and otherwise pursue other actions that are not in the ordinary course of business, even if such actions could prove beneficial.
If we do not complete the Merger, there will continue to be no public trading market for our shares and a public market may never develop.
There currently is no public market for our shares and, absent the completion of the pending Merger or a similar transaction, there is no assurance that a public market may develop. In addition, our charter does not require our board of directors to seek stockholder approval to liquidate our assets by a specified date. If the Merger is not completed, our stockholders will not have the opportunity to sell their shares and our board of directors will review other alternatives for a liquidity event, which may not occur in the near term or on terms as attractive as the terms of the Merger. Our charter also prohibits the ownership of more than 9.8% of our common stock, in value or number of shares (whichever is more restrictive), by a single investor, unless exempted by our board of directors, which may further limit your ability to sell or otherwise dispose of your shares. Furthermore, our board of directors has voted to suspend our share repurchase program until further notice, effective December 13, 2013, and we do not anticipate that the board of directors will resume our share redemption program while the Merger is pending. As a result, if we do not complete the Merger, you may have to hold your shares for an indefinite period of time or, if you are able to sell your shares, you likely would have to sell them at a substantial discount to the price you paid for the shares. If our share repurchase program was resumed, the program contains numerous restrictions that limit our stockholders' ability to sell their shares, including those relating to the number of shares of our common stock that we can repurchase at any time and limiting the funds we will use to repurchase shares pursuant to the program.
The Merger Agreement contains provisions that could discourage a potential competing acquiror of our company or could result in any competing acquisition proposal being at a lower price than it might otherwise be.
The Merger Agreement contains provisions that, subject to limited exceptions, restrict our ability to solicit, initiate, knowingly encourage or facilitate any third-party proposals to acquire all or a significant part of our company. With respect to any bona fide third-party acquisition proposal, we generally have an opportunity to offer to modify the terms of the Merger Agreement in response to such proposal before our board of directors, or committee thereof, may withdraw or modify its recommendation to our shareholders in response to such acquisition proposal. Upon termination of the Merger Agreement in certain circumstances, we may be required to pay a substantial termination fee and/or expense reimbursement to Kite.
These provisions could discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of our company from considering or proposing a competing acquisition, even if the potential competing acquirer was prepared to pay consideration with a higher per share cash value than that value proposed to be received or realized in the Merger, or might result in a potential competing acquirer proposing to pay a lower price than it might otherwise have proposed to pay because of the added expense of the termination fee and expense reimbursement that may become payable in certain circumstances under the Merger Agreement.
On U.S. GAAP basis we have incurred a net loss attributable to common stockholders in two of the last three years.
We have incurred a net loss attributable to common stockholders on a U.S. GAAP basis in two of the last three years. Our losses can be attributed, in part, to startup costs and expenses incurred while we increased the size of our portfolio. In addition, depreciation and amortization substantially reduced our net income attributable to common stockholders on a U.S. GAAP basis. If we incur future losses, our financial condition, operations, cash flow, and our ability to pay our debt service and pay distributions to our stockholders may be materially and adversely affected. We are subject to all of the business risks and uncertainties associated with any business, including the risk that the value of an investor’s investment could decline substantially. We were formed in June 2008 and, as of December 31, 2013, had acquired 135 retail properties, four office properties, two industrial properties and two multi-family properties. We cannot assure you that, in the future, we will be profitable or that we will realize growth in the value of our assets.
Economic conditions disruptions may adversely impact many aspects of our operating results and operating condition.
U.S. and international markets continue to experience volatility due to a combination of many factors, including, the tapering of bond purchases by the Federal Reserve, the potential for rising interest rates, and uncertain growth. This volatility may have an adverse impact on the availability of credit to businesses generally, and real estate in particular, and could lead to weakening of the U.S. and global economies. The availability of debt financing secured by commercial real estate could decline as a result of tightened underwriting standards. Our business may be affected by market and economic challenges experienced by the U.S. economy or real estate industry as a whole or by the local economic conditions in the markets in which our real estate assets are located, including the dislocations in the credit markets and general global economic recession. Economic conditions may also impact the ability of certain of our tenants to satisfy rental payments under existing leases. Specifically, these conditions may have the following consequences:
the financial condition of our tenants may be adversely affected, which may result in us having to reduce rental rates in order to retain the tenants;
an increase in the number of bankruptcies or insolvency proceedings of our tenants and lease guarantors, which could delay our efforts to collect rent and any past due balances under the relevant leases and ultimately could preclude collection of these sums;
credit spreads for major sources of capital may widen if stockholders demand higher risk premiums or interest rates could increase due to inflationary expectations, resulting in an increased cost for debt financing;
a reduction in the amount of capital that is available to finance real estate, which, in turn, could lead to a decline in real estate values generally, slow real estate transaction activity and reduce the loan to value ratio upon which lenders are willing to lend;
the value of certain of real estate assets may decrease below the amounts we pay for them, which would limit our ability to dispose of assets at attractive prices or to obtain debt financing secured by these assets and could reduce the availability of unsecured loans;
the value and liquidity of short-term investments, if any, could be reduced as a result of the dislocation of the markets for our short-term investments and increased volatility in market rates for these investments or other factors; and
one or more counterparties to derivative financial instruments that we enter into could default on their obligations to us, or could fail, increasing the risk that we may not realize the benefits of these instruments.
For these and other reasons, we cannot assure you that we will be profitable or that we will realize growth in the value of our investments.
The amount and timing of distributions may vary.
There are many factors that can affect the availability and timing of cash distributions paid to our stockholders such as our ability to earn positive yields on, real estate assets, the yields on securities of other entities in which we invest, our operating expense levels, as well as many other variables. The actual amount and timing of distributions is determined by our board of directors in its discretion, based on its analysis of our earnings, cash flow, anticipated cash flow, capital expenditure investments and general financial condition. Actual cash available for distribution may vary substantially from estimates. In addition, to the extent we invest in development or redevelopment projects, or in properties requiring significant capital requirements, our ability to make distributions may be negatively impacted. If we are not able to generate sufficient cash flow from operations, determined in accordance with U.S. GAAP, to fully fund distributions, some or all of our distributions may be paid from other sources, including cash flow generated from investing activities, including the net proceeds from the sale of our assets. Distributions reduce the amount of money available to invest in properties or other real estate assets.
In addition, our credit facility agreement imposes limits on our ability to pay distributions. More specifically, without lender consent, we may not declare and pay distributions if any default under the agreement then exists or if distributions, excluding any distributions reinvested through our DRP, for the then-current quarter and the three immediately preceding fiscal quarters in the aggregate for such period would exceed 95% of our funds from operations, or “FFO,” for such period. If distributions did exceed 95% of our FFO, we would be required to reduce distributions unless the lenders agreed to waive the requirement. There is no assurance that the lenders would agree to waive the requirement, if that became necessary.
Our ongoing strategy contemplates future acquisitions, and we may not be successful in identifying and consummating these transactions.
Our business strategy involves, among other things, further acquisitions. We may not be successful in identifying suitable properties or other assets or in consummating these acquisitions on satisfactory terms, if at all.
Further, we face significant competition for attractive investment opportunities from an indeterminate number of other real estate investors, including investors with significant capital resources such as domestic and foreign corporations and financial institutions, publicly traded and privately held REITs, private institutional investment funds, investment banking firms, life insurance companies and pension funds. As a result of competition, we may be unable to acquire additional properties on terms acceptable to us, if at all.
Of the limited number of desirable properties that we are seeing come to market, we are either facing significant competition to acquire stabilized properties, or having to accept lease-up risk associated with properties that have lower occupancy. As market conditions and real estate values recover, more properties may become available for acquisition, but we can provide no assurances that these properties will meet our investment objectives or that we will be successful in acquiring these properties. Although conditions in the credit markets have improved over the past year, the ability of buyers to utilize higher levels of leverage to finance property acquisitions has been, and remains, somewhat limited.
Actions of our joint venture partners could negatively impact our performance.
As of December 31, 2013, we had entered into four joint ventures with unaffiliated third parties, and may enter into additional joint ventures in the future. As noted below we are not, and generally do not expect to be, in a position to exercise sole decision-making authority regarding the, joint ventures. Consequently, our joint venture investments may involve risks not otherwise present with other methods of investment in real estate. Per the terms of each of the joint venture operating agreements, we have the right to manage the joint venture business property operations on a day to day basis. However, we may need the approval of our joint venture partners in order to sell or refinance the properties, subject to the terms of the joint venture agreements. If we determine that it is in our best interest to either sell or refinance any one of the joint venture properties and our joint venture partners do not provide their approval, our ability to achieve our goals in regard to such investments may be restricted. If we enter into additional joint ventures in the future, we may be subject to similar or other restrictions with regard to those joint ventures.
Our joint ventures have and may continue to issue redeemable noncontrolling interests to our current and future joint venture partners. At the noncontrolling interest holders’ option, we may be required to pay cash, but if the noncontrolling interest holder elects to redeem its interest for the Company’s stock, we have the option to pay cash, issue common stock, or a mixture of both. This may cause cash restraints on us which may, among other things, limit our ability to pay distributions. If these redeemable noncontrolling interests are redeemed for common shares it may cause dilution of the common shares outstanding.
The failure of any bank in which we deposit our funds could reduce the amount of cash we have available to pay distributions and invest in real estate assets.
We have deposited our cash and cash equivalents in several banking institutions in an attempt to minimize exposure to the failure or takeover of any one of these entities. However, the Federal Insurance Deposit Corporation, or “FDIC,” generally only insures limited amounts per depositor per insured bank. At December 31, 2013, we had cash and cash equivalents and restricted cash deposited in interest bearing transaction accounts at certain financial institutions, exceeding these federally insured levels. If any of the banking institutions in which we have deposited funds ultimately fails, we may lose our deposits over the federally insured levels. The loss of our deposits could reduce the amount of cash we have available to distribute or invest.
Your return may be reduced if we are required to register as an investment company under the Investment Company Act.
The company is not registered, and does not intend to register itself or any of its subsidiaries, as an investment company under the Investment Company Act. If we become obligated to register the company or any of its subsidiaries as an investment company, the registered entity would have to comply with a variety of substantive requirements under the Investment Company Act imposing, among other things:
limitations on capital structure;
restrictions on specified investments;
prohibitions on transactions with affiliates; and
compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly change our operations.
The company intends to continue conducting its operations, directly and through wholly or majority-owned subsidiaries, so that the company and each of its subsidiaries are exempt from registration as an investment company under the Investment Company Act. Under Section 3(a)(1)(A) of the Investment Company Act, a company is not deemed to be an “investment company” if it neither is, nor holds itself out as being, engaged primarily, nor proposes to engage primarily, in the business of investing, reinvesting or trading in securities. Under Section 3(a)(1)(C) of the Investment Company Act, a company is not deemed to be an “investment company” if it neither is engaged, nor proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and does not own or propose to acquire “investment securities” having a value exceeding 40% of the value of its total assets on an unconsolidated basis, which we refer to as the “40% test.”
As of the date of this report, the company and all of its wholly and majority-owned subsidiaries are not considered investment companies under either Section 3(a)(1)(A) or Section 3(a)(1)(C) of the Investment Company Act. In the event that the company or any of its wholly or majority-owned subsidiaries would ever inadvertently fall within one of the definitions of “investment company,” we intend to rely on the exception provided by Section 3(c)(5)(C) of the Investment Company Act.
Under Section 3(c)(5)(C), the SEC staff generally requires the company to maintain at least 55% of its assets directly in qualifying assets to qualify for this exception. Mortgage-backed securities may or may not constitute such qualifying assets, depending on the characteristics of the mortgage-backed securities, including the rights that we have with respect to the underlying loans. The company’s ownership of mortgage-backed securities, therefore, is limited by provisions of the Investment Company Act and SEC staff interpretations.
The method we use to classify our assets for purposes of the Investment Company Act is based in large measure upon no-action positions taken by the SEC staff in the past. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations we may face, and a number of these no-action positions were issued more than ten years ago. No assurance can be given that the SEC staff will concur with our classification of our assets. In addition, the SEC staff may, in the future, issue further guidance that may require us to re-classify our assets for purposes of qualifying for exemption from regulation under the Investment Company Act. If we are required to re-classify our assets, we may no longer be in compliance with the exemption from the definition of an “investment company” provided by Section 3(c)(5)(C) of the Investment Company Act.
A change in the value of any of our assets could cause us to fall within the definition of “investment company” and negatively affect our ability to maintain our exemption from regulation under the Investment Company Act. To avoid being required to register the company or any of its subsidiaries as an investment company under the Investment Company Act, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income- or loss-generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire interests in companies that we would otherwise want to acquire and would be important to our investment strategy.
If we were required to register the company as an investment company but failed to do so, we would be prohibited from engaging in our business, and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business.
The occurrence of cyber incidents, or a deficiency in our cybersecurity, could negatively impact our business by causing a disruption to our operations, a compromise or corruption of our confidential information, and/or damage to our business relationships, all of which could negatively impact our financial results.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity, or availability of our information resources. More specifically, a cyber incident is an intentional attack or an unintentional event that can include gaining unauthorized access to systems to disrupt operations, corrupt data, or steal confidential information. As our reliance on technology has increased, so have the risks posed to our systems, both internal and those we have outsourced. Our three primary risks that could directly result from the occurrence of a cyber incident include operational interruption, damage to our relationship with our tenants, and private data exposure. We have implemented processes, procedures and controls to help mitigate these risks, but these measures, as well as our increased awareness of a risk of a cyber incident, do not guarantee that our financial results will not be negatively impacted by such an incident.
Risks Related to Investments in Real Estate
There are inherent risks with real estate investments.
Investments in real estate assets are subject to varying degrees of risk. For example, an investment in real estate cannot generally be quickly converted to cash, limiting our ability to promptly vary our portfolio in response to changing economic, financial and investment conditions. Investments in real estate assets also are subject to adverse changes in general economic conditions which, for example, reduce the demand for rental space. Among the factors that could impact our real estate assets and the value of an investment in us are:
local conditions such as an oversupply of space or reduced demand for real estate assets of the type that we seek to acquire, including, with respect to any lodging properties we may acquire, quick changes in supply of and demand for rooms that are rented or leased on a day-to-day basis;
inability to collect rent from tenants;
vacancies or inability to rent space on favorable terms;
inflation and other increases in operating costs, including insurance premiums, utilities and real estate taxes;
increases in energy costs or airline fares or terrorist incidents which impact the propensity of people to travel and therefore impact revenues from any lodging properties we may acquire, especially because operating costs cannot be adjusted as quickly;
federal, state or local regulations and controls affecting rents, zoning, prices of goods, fuel and energy consumption, water and environmental restrictions, as well as any adverse changes in these or other laws and regulations applicable to us;
the relative illiquidity of real estate investments;
changing market demographics;
an inability to acquire and finance properties on favorable terms, if at all;
acts of God, such as earthquakes, floods or other uninsured losses; and
changes or increases in interest rates and availability of financing.
In addition, periods of economic slowdown or recession, or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or increased defaults under existing leases.
We face significant competition in the leasing market, which may decrease or prevent increases in the occupancy and rental rates of our properties.
We own properties located throughout the United States. We compete with numerous developers, owners and operators of commercial properties, many of which own properties similar to, and in the same market areas as, our properties. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge in order to attract new tenants and retain existing tenants when their leases expire. Also, if our competitors develop additional properties in locations near our properties, there may be increased competition for creditworthy tenants, which may require us to make capital improvements to properties that we would not have otherwise made.
We depend on tenants for the majority of our revenue from real property investments, and lease terminations or the exercise of any co-tenancy rights will adversely affect our operations.
Any defaults on lease payment obligations by a tenant will cause us to lose the revenue associated with the relevant lease. If these defaults become significant, we will be forced to use other funds to make payments on the mortgage indebtedness secured by the impacted property to prevent a foreclosure action. If a tenant defaults, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment. In addition, if a tenant at a single-user facility, which has been designed or built primarily for a particular tenant or a specific type of use, fails to renew its lease or defaults on its lease obligations, we may not be able to readily market a single-user facility to a new tenant, if at all, without making substantial capital improvements or incurring other significant re-leasing costs.
Further, with respect to any retail properties we acquire, we have and may continue to enter into leases containing co-tenancy provisions. Co-tenancy provisions may allow a tenant to exercise certain rights if, among other things, another tenant fails to open for business, delays its opening or ceases to operate, or if a percentage of the property’s gross leasable space or a particular portion of the property is not leased or subsequently becomes vacant. A tenant exercising co-tenancy rights may be able to abate minimum rent, reduce its share or the amount of its payments of common area operating expenses and property taxes or cancel its lease. In addition, in the case of leases with retail tenants, the majority of the leases contain provisions giving the particular tenant the exclusive right to sell particular types of merchandise or provide specific types of services within the particular retail center. In the event of a default at one of these properties, these lease provisions may limit the number and types of prospective tenants interested in leasing space at that property.
We may suffer adverse consequences due to the financial difficulties, bankruptcy or insolvency of our tenants.
An economic downturn may cause our tenants to experience financial difficulties, including bankruptcy, insolvency or a general downturn in their business. The retail sector in particular could be, adversely affected by weakness in the national, regional and local economies, the level of consumer spending and consumer confidence, the adverse financial condition of some large retailing companies, the ongoing consolidation in the retail sector and increasing competition from discount retailers, outlet malls, internet retailers and other online businesses. As of December 31, 2013, retail properties represented approximately 91.9% of our real property portfolio, based on aggregate purchase price paid at closing. We cannot provide assurance that any tenant that files for bankruptcy protection will continue to pay us rent. A bankruptcy filing by, or relating to, one of our tenants or a lease guarantor would bar efforts by us to collect pre-bankruptcy debts from that tenant or lease guarantor, or its property, unless we receive an order permitting us to do so from the bankruptcy court. In addition, we cannot evict a tenant solely because of bankruptcy. The bankruptcy of a tenant or lease guarantor could delay our efforts to collect past due balances under the relevant leases, and could ultimately preclude collection of these sums. If a lease is assumed by the tenant in bankruptcy, all pre-bankruptcy balances due under the lease must be paid to us in full. If, however, a lease is rejected by a tenant in bankruptcy, we would have only a general, unsecured claim for damages. An unsecured claim would only be paid to the extent that funds are available and only in the same percentage as is paid to all other holders of general, unsecured claims. Restrictions under the bankruptcy laws further limit the amount of any other claims that we can make if a lease is rejected. As a result, it is likely that we would recover substantially less than the full value of the remaining rent during the term.
Certain of our tenants generated a significant portion of our revenue, and rental payment defaults by this significant tenant could adversely affect our results of operations.
As of December 31, 2013, approximately 4.3% and 4.1% of our consolidated annualized base rental revenue was generated from leases with Kohl’s Department Stores Inc. and Walgreens, respectively and the top five tenants in our portfolio totaled 15.8% of our annualized base rental revenue. If any of these tenants were to cease paying rent or fulfilling their other monetary obligations, we could have significantly reduced rental revenues or higher expenses until the default was cured or the properties were leased to a new tenant or tenants. In addition, there is no assurance that the properties could be re-leased on similar or better terms, if at all.
Leases representing approximately 2.5% (excluding multi-family units) of our portfolio square footage are scheduled to expire in 2014. We may be unable to renew leases or lease vacant space at favorable rates or at all.
As of December 31, 2013, leases representing approximately 2.5% (excluding multi-family units) of our portfolio were scheduled to expire in 2014, and an additional 3.8% (excluding multi-family units) of the square footage of our portfolio was available for lease as of December 31, 2013. We may be unable to extend or renew any of the expiring leases, or we may be able to re-lease these spaces only at rental rates equal to or below existing rental rates. We also may not be able to lease space which is currently not occupied on acceptable terms and conditions, if at all. In addition, some of our tenants have leases that include early termination provisions that permit the lessee to terminate all or a portion of its lease with us after a specified date or upon the occurrence of certain events with little or no compensation to us. We may be required to offer substantial rent abatements, tenant improvements, early termination rights or below-market renewal options to retain these tenants or attract new ones. Portions of our properties may remain vacant for extended periods of time. Further, some of our leases currently provide tenants with options to renew the terms of their leases at rates that are less than the current market rate or to terminate their leases prior to the expiration date thereof. If we are unable to obtain new rental rates that are on average comparable to our asking rents across our portfolio, then our ability to generate cash flow growth will be negatively impacted.
We may be required to make significant capital expenditures to improve our properties in order to retain and attract tenants.
We expect that, upon the expiration of leases at our properties, we may be required to make rent or other concessions to tenants, accommodate requests for renovations, build-to-suit remodeling and other improvements or provide additional services to our tenants. As a result, we may have to pay for significant leasing costs or tenant improvements in order to retain tenants whose leases are expiring or to attract new tenants. Additionally, we may need to raise capital to fund these expenditures. If we are unable to do so, we will not be able to fund the required expenditures. This could result in non-renewals by tenants upon expiration of their leases or inhibit our ability to attract new or replacement tenants, which would result in declines in revenues from operations.
Geographic concentration of our portfolio makes us particularly susceptible to adverse economic developments in the real estate markets of those areas.
As of December 31, 2013, approximately 14.7% and 12.0% of our consolidated annualized base rental revenue of our consolidated portfolio was generated by properties located in the States of Florida and Nevada, respectively. Accordingly, our rental revenues and property operating results are likely to be impacted by economic changes affecting these states. This geographic concentration also exposes us to risks of oversupply and competition in these real estate markets.
Acquiring or attempting to acquire multiple properties in a single transaction may adversely affect our operations.
From time to time, we have acquired multiple properties in a single transaction. Portfolio acquisitions typically are more complex and expensive than single property acquisitions, and the risk that a multiple-property acquisition does not close may be greater than in a single-property acquisition. Portfolio acquisitions may also result in us owning investments in geographically dispersed markets, placing additional demands on our Business Manager and Real Estate Managers in managing the properties in the portfolio. In addition, a seller may require that a group of properties be purchased as a package even though we may not want to purchase one or more properties in the portfolio. In these situations, if we are unable to identify another person or entity to acquire the unwanted properties, we may be required to operate or attempt to dispose of these properties. We also may be required to accumulate a large amount of cash to fund such acquisitions. We would expect the returns that we earn on such cash to be less than the returns on real property. Therefore, acquiring multiple properties in a single transaction may reduce the overall yield on our portfolio.
Short-term leases may expose us to the effects of declining market rent.
Certain types of the properties we own, such as multi-family properties, typically have short-term leases, generally one year or less, with tenants. There is no assurance that we will be able to renew these leases as they expire or attract replacement tenants on comparable terms, if at all.
Inflation may adversely affect our financial condition and results of operations.
Increases in the rate of inflation may adversely affect our net operating income from leases with stated rent increases or limits on the tenant’s obligation to pay its share of operating expenses, which could be lower than the increase in inflation at any given time. Inflation could also have an adverse effect on consumer spending, which may impact our tenants’ sales and, with respect to those leases including percentage rent clauses, our average rents.
Operating expenses may increase in the future and to the extent these increases cannot be passed on to our tenants, our cash flow and our operating results would decrease.
Operating expenses, such as expenses for fuel, utilities, labor, building materials and insurance are not fixed and may increase in the future. There is no guarantee that we will be able to pass these increases on to our tenants. To the extent these increases cannot be passed on to our tenants, any increases would cause our cash flow and our operating results to decrease.
We depend on the availability of public utilities and services, especially for water and electric power. Any reduction, interruption or cancellation of these services may adversely affect us.
Public utilities, especially those that provide water and electric power, are fundamental for the sound operation of our assets. The delayed delivery or any material reduction or prolonged interruption of these services could allow certain tenants to terminate their leases or result in an increase in our costs, as we may be forced to use backup generators, which also could be insufficient to fully operate our facilities and could result in our inability to provide services. Accordingly, any interruption or limitation in the provision of these essential services may adversely affect us.
An increase in real estate taxes may decrease our income from properties.
Local real property tax assessors may seek to reassess the value of a property or properties at the time of acquisition. Generally, from time to time our property taxes will increase as property values or assessment rates change or for other reasons deemed relevant by the assessors. An increase in the assessed valuation of a property for real estate tax purposes will result in an increase in the related real estate taxes on that property. Although some tenant leases may permit us to pass through the tax increases to the tenants for payment, there is no assurance that renewal leases or future leases will be negotiated on the same basis. Increases not passed through to tenants will adversely affect our income, cash available for distributions, and the amount of distributions.
CC&Rs may restrict our ability to operate a property.
We have and may continue to acquire properties that are contiguous to other parcels of real property, comprising part of the same commercial center. These properties may be subject to significant covenants, conditions and restrictions, known as “CC&Rs,” that restrict our operation of these properties and any improvements on these properties, and our ability to grant easements on such properties. Moreover, the operation and management of contiguous properties may impact those properties. Currently no material restrictions exist, however compliance with CC&Rs in the future may adversely affect our operating costs.
We do not own or control the land in any ground lease properties that we have or may acquire.
We have and may continue to acquire property on land owned by a governmental entity or other third party, while we own a leasehold, permit, or similar interest. This means that while we have a right to use the property, we do not retain fee ownership in the underlying land. Accordingly, we will have no economic interest in the land or building at the expiration of the ground lease or permit. As a result, we will not share in any increase in value of the land associated with the underlying property. Further, because we do not control the underlying land, the lessor could take certain actions to disrupt our rights in the property or our tenants’ operation of the properties or the case of a governmental entity, take the property in an eminent domain proceeding.
We may be unable to sell assets if or when we decide to do so.
Maintaining our REIT qualification and continuing to avoid registration under the Investment Company Act as well as many other factors, such as general economic conditions, the availability of financing, interest rates and the supply and demand for the particular asset type, may limit our ability to sell real estate assets. These factors are beyond our control. We cannot predict whether we will be able to sell any real estate asset on favorable terms and conditions, if at all, or the length of time needed to sell an asset.
If we sell properties by providing financing to purchasers, we will bear the risk of default by the purchaser.
We may, from time to time, sell a property or other asset by providing financing to the purchaser. There are no limits or restrictions on our ability to accept purchase money obligations secured by a mortgage as payment for the purchase price. The terms of payment to us will be affected by custom in the area where the property being sold is located and then-prevailing economic conditions. If we receive promissory notes or other property in lieu of cash from property sales, the distribution of the proceeds of sales to our stockholders, or reinvestment in other properties, will be delayed until the promissory notes or other property are actually paid, sold, refinanced or otherwise disposed. In some cases, we may receive initial down payments in cash and other property in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years. We will bear the risk of default by the purchaser and may incur significant litigation costs in enforcing our rights against the purchaser.
Uninsured losses or premiums for insurance coverage may adversely affect your returns.
The nature of the activities at certain properties we may acquire will expose us and our tenants or operators to potential liability for personal injuries and, in certain instances, property damage claims. In addition, there are types of losses, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters that are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. Insurance risks associated with potential terrorist acts could sharply increase the premiums we pay for coverage against property and casualty claims. Mortgage lenders generally require property owners to purchase specific coverage insuring against terrorism as a condition for providing mortgage, bridge or mezzanine loans. These policies may or may not be available at a reasonable cost, if at all, which could inhibit our ability to finance or refinance our properties. In such instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We cannot assure you that we will have adequate coverage for these losses. In the event that any of our properties incurs a casualty loss that is not fully covered by insurance, the value of the particular asset will likely be reduced by the uninsured loss. In addition, we cannot assure you that we will be able to fund any uninsured losses.
Potential development and construction delays and resulting increased costs and risks may hinder our operating results and decrease our net income.
We have acquired, and may again in the future acquire, unimproved real property or properties that are under development or construction. Investments in these properties will be subject to the uncertainties associated with the development and construction of real property, including those related to re-zoning land for development, environmental concerns of governmental entities or community groups and the developers’ ability to complete the property in conformity with plans, specifications, budgeted costs and timetables. If a developer fails to perform, we may resort to legal action to rescind the purchase or the construction contract or to compel performance. A developer’s performance may also be affected or delayed by conditions beyond the developer’s control. Delays in completing construction could also give tenants the right to terminate preconstruction leases. We may incur additional risks when we make periodic progress payments or other advances to developers before they complete construction. These and other factors can result in increased costs of a project or loss of our investment. In addition, we will be subject to normal lease-up risks relating to newly constructed projects. We also must rely on rental income and expense projections and estimates of the fair market value of property upon completion of construction when agreeing upon a purchase price at the time we acquire the property. If our projections are inaccurate, we may pay too much for a property, and the return on our investment could suffer.
If we contract with a development company for newly developed property, our earnest money deposit made to the development company may not be fully refunded.
We may enter into one or more contracts, either directly or indirectly through joint ventures with affiliates or others, to acquire real property from a development company that is engaged in construction and development of commercial real properties. Properties acquired from a development company may be either existing income-producing properties, properties to be developed or properties under development. We anticipate that we will be obligated to pay a substantial earnest money deposit at the time of contracting to acquire these properties. In the case of properties to be developed by a development company, we anticipate that we will be required to close the purchase of the property upon completion of the development of the property. At the time of contracting and the payment of the earnest money deposit by us, the development company typically will not have acquired title to any real property. Typically, the development company will only have a contract to acquire land, a development agreement to develop a building on the land and an agreement with one or more tenants to lease all or part of the property upon its completion. We may enter into a contract with the development company even if at the time we enter into the contract we have not yet raised sufficient proceeds in our offering to enable us to close the purchase of such property. However, we may not be required to close a purchase from the development company, and may be entitled to a refund of our earnest money, in the following circumstances:
the development company fails to develop the property;
all or a specified portion of the pre-leased tenants fail to take possession under their leases for any reason; or
we are unable to raise sufficient proceeds from our offering to pay the purchase price at closing.
The obligation of the development company to refund our earnest money will be unsecured, and we may not be able to obtain a refund of such earnest money deposit from it under these circumstances since the development company may be an entity without substantial assets or operations.
We may obtain only limited warranties when we purchase a property and would have only limited recourse in the event our due diligence did not identify any issues that lower the value of our property.
The seller of a property often sells the property in its “as is” condition on a “where is” basis and “with all faults,” without any warranties of merchantability or fitness for a particular use or purpose. In addition, purchase agreements may contain only limited warranties, representations and indemnifications that will only survive for a limited period after the closing. The purchase of properties with limited warranties increases the risk that we may lose some or all of our invested capital in the property, as well as the loss of rental income from that property.
We have acquired properties in regions that are particularly susceptible to natural disasters.
We have acquired, and may continue to acquire, properties located in geographical areas, including in the states of Florida, Louisiana and Texas, that are regularly impacted by severe storms, hurricanes, and flooding. In addition, according to some experts, global climate change could result in heightened hurricane activity, thus further impacting these areas. Natural disasters in these or other areas may cause damage to our properties beyond the scope of our insurance coverage, thus requiring us to make substantial expenditures to repair these properties and resulting in a loss of revenues from these properties. We have acquired 22 properties and may acquire additional properties located in regions that are particularly susceptible to natural disasters which can be exposed to more severe weather than properties located in other regions. Elements such as salt water and humidity in these areas can increase or accelerate wear on the properties’ weatherproofing and mechanical, electrical and other systems, and cause mold issues over time. As a result, we may incur additional operating costs and expenditures for capital improvements at properties that we have acquired and may continue to acquire in these areas.
The costs of complying with environmental laws and other governmental laws and regulations may adversely affect us.
All real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials, and the remediation of contamination associated with disposals. We also are required to comply with various local, state and federal fire, health, life-safety and similar regulations. Some of these laws and regulations may impose joint and several liability on tenants, owners or operators for the costs of investigating or remediating contaminated properties. These laws and regulations often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of the hazardous or toxic substances. The cost of removing or remediating could be substantial. In addition, the presence of these substances, or the failure to properly remediate these substances, may adversely affect our ability to sell or rent a property or to use the property as collateral for borrowing.
Environmental laws and regulations also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures by us. Environmental laws and regulations provide for sanctions in the event of noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances. Compliance with new or more stringent laws or regulations or stricter interpretations of existing laws may require material expenditures by us. For example, various federal, regional and state laws and regulations have been implemented or are under consideration to mitigate the effects of climate change caused by greenhouse gas emissions. Among other things, “green” building codes may seek to reduce emissions through the imposition of standards for design, construction materials, water and energy usage and efficiency, and waste management. These requirements could increase the costs of maintaining or improving our existing properties or developing new properties.
Our properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem.
The presence of mold at any of our properties could require us to undertake a costly program to remediate, contain or remove the mold. Mold growth may occur when moisture accumulates in buildings or on building materials. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing because exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. The presence of mold could expose us to liability from our tenants, their employees and others if property damage or health concerns arise.
We may incur significant costs to comply with the Americans With Disabilities Act or similar laws.
Our properties generally are subject to the Americans With Disabilities Act of 1990, as amended, which we refer to as the Disabilities Act. Under the Disabilities Act, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. The Disabilities Act has separate compliance requirements for “public accommodations” and “commercial facilities” that generally require that buildings and services be made accessible and available to people with disabilities. In addition, with respect to any apartment properties, we also must comply with the Fair Housing Amendment Act of 1988, or “FHAA,” which requires that apartment communities first occupied after March 13, 1991 be accessible to handicapped residents and visitors.
The requirements of the Disabilities Act or FHAA could require removal of access barriers and could result in the imposition of injunctive relief, monetary penalties or, in some cases, an award of damages. We attempt to acquire properties that comply with the Disabilities Act and the FHAA or place the burden on the seller or other third party, such as a tenant, to ensure compliance with these laws. However, we cannot assure you that we will be able to acquire properties or allocate responsibilities in this manner. We may incur significant costs to comply with these laws.
Terrorist attacks and other acts of violence or war may affect the markets in which we operate, our operations and our profitability.
We may acquire real estate assets located in areas that are susceptible to attack. In addition, any kind of terrorist activity, including terrorist acts against public institutions or buildings or modes of public transportation (including airlines, trains or buses) could lessen travel by the public, which could have a negative effect on any of our properties especially if we acquire lodging properties. These attacks may directly impact the value of our assets through damage, destruction, loss or increased security costs. Although we may obtain terrorism insurance, we may not be able to obtain sufficient coverage to fund any losses we may incur. Risks associated with potential acts of terrorism could sharply increase the premiums we pay for coverage against property and casualty claims. Further, certain losses resulting from these types of events are uninsurable or not insurable at reasonable costs.
More generally, any terrorist attack, other act of violence or war, including armed conflicts, could result in increased volatility in, or damage to, the United States and worldwide financial markets and economy. Additionally, increased economic volatility could adversely affect our tenants’ ability to pay rent on their leases or our ability to fund our operations including raising additional capital.
We may have increased exposure to liabilities as a result of any participation by us in Section 1031 Exchange Transactions.
We may enter into transactions that qualify for like-kind exchange treatment under Section 1031 of the Code, referred to herein as “1031 Exchange Transactions.” Real estate acquired through a 1031 Exchange Transaction is commonly structured as the acquisition of real estate owned in co-tenancy arrangements as tenants-in-common with persons (referred to as “1031 Participants”), generally held in tax pass-through entities, including single-member limited liability companies or similar entities. Changes in tax laws may adversely affect 1031 Exchange Transactions. Owning co-tenancy interests involves risks generally not otherwise present with an investment in real estate such as:
the risk that a co-tenant may at any time have economic or business interests or goals that are or that become inconsistent with our business interests or goals;
the risk that a co-tenant may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives; or
the possibility that a co-tenant might become insolvent or bankrupt, which may be an event of default under mortgage loan financing documents or allow a bankruptcy court to reject the tenants in common agreement or management agreement entered into by the co-tenants owning interests in the property.
Actions by a co-tenant might have the result of subjecting the property to liabilities in excess of those contemplated and may have the effect of reducing your returns.
If our interests become adverse to those of the other co-tenants in a 1031 Exchange Transaction, we may not have the contractual right to purchase the co-tenancy interests from the other co-tenants. Even if we are given the opportunity to purchase the co-tenancy interests, we cannot guarantee that we will have sufficient funds available to complete a purchase.
In addition, we may desire to sell our co-tenancy interests in a given property at a time when the other co-tenants do not desire to sell their interests. Therefore, we may not be able to sell our interest in a property at the time we would like to sell. We also expect it to be more difficult to find a willing buyer for our co-tenancy interests in a property than it would be to find a buyer for a property we owned outright. Further, agreements that contain obligations to acquire unsold co-tenancy interests in properties may be viewed by institutional lenders as a contingent liability against our cash or other assets, limiting our ability to borrow funds in the future.
Risks Related to Investments in Other Real Estate Assets
Through owning equity interests in REITs or other real estate operating companies that invest in real estate or real estate-related assets, we are subject to the risks impacting each entity’s assets.
We have invested, and may continue to invest, in real estate-related securities. Equity securities are always unsecured and subordinated to other obligations of the issuer. Investments in real estate-related equity securities are subject to numerous risks including: (1) limited liquidity in the secondary trading market in the case of unlisted or thinly traded securities; (2) substantial market price volatility resulting from, among other things, changes in prevailing interest rates in the overall market or related to a specific issuer, as well as changing investor perceptions of the market as a whole, REIT or real estate securities in particular or the specific issuer in question; (3) subordination to the liabilities of the issuer; (4) the possibility that earnings of the issuer may be insufficient to meet its debt service obligations or to pay distributions; and (5) with respect to investments in real estate-related preferred equity securities, the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to redeem the securities. In addition, investments in real estate-related securities involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Issuers of real estate-related securities generally invest in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed herein. Investing in real estate-related securities exposes our results of operations and financial condition to the factors impacting the trading prices of publicly-traded entities.
Market volatility and the risk of market deterioration may reduce the value of any real estate related securities in which we may invest.
Mortgage loans experienced increasing rates of delinquency, foreclosure and loss during the recent dislocations in the world credit markets. These and other related events significantly impacted the capital markets associated not only with mortgage-backed securities, asset-backed securities and collateralized debt obligations, but also with the credit and financial markets as a whole. Investing significant amounts in real estate-related securities, including CMBS, will expose our results of operations and financial condition to the volatility of the credit markets.
Because there may be significant uncertainty in the valuation of, or in the stability of the value of, certain securities holdings, the fair values of these investments might not reflect the prices that we would obtain if we sold these investments. Furthermore, these investments are subject to rapid changes in value caused by sudden developments that could have a material adverse effect on the value of these investments.
To the extent that these volatile market conditions persist or deteriorate, they may negatively impact our ability to both acquire and potentially sell our real estate related securities holdings at a price and on terms acceptable to us, and we may be required to recognize impairment charges or unrealized losses.
Risks Associated with Debt Financing
Volatility in the financial markets and challenging economic conditions could adversely affect our ability to secure debt financing on attractive terms and our ability to service any future indebtedness that we may incur.
The domestic and international commercial real estate debt markets could become very volatile like recent years as a result of, among other things, the tightening of underwriting standards by lenders and credit rating agencies. This could result in less availability of credit and increasing costs for what is available. If the overall cost of borrowing increases, either by increases in the index rates or by increases in lender spreads, the increased costs may result in existing or future acquisitions generating lower overall economic returns and potentially reducing future cash flow available for distribution. If these disruptions in the debt markets persist, our ability to borrow monies to finance the purchase of, or other activities related to, real estate assets will be negatively impacted. If we are unable to borrow monies on terms and conditions that we find acceptable, we likely will have to reduce the number of properties we can purchase, and the return on the properties we do purchase may be lower. In addition, we may find it difficult, costly or impossible to refinance indebtedness which is maturing.
Further, economic conditions could negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values in our real estate portfolio and in the collateral securing any loan investments we may make, which could have various negative impacts. Specifically, the value of collateral securing any loan investment we may make could decrease below the outstanding principal amounts of such loans, requiring us to pledge more collateral.
Borrowings may reduce the funds available for distribution and increase the risk of loss since defaults may cause us to lose the properties securing the loans.
We typically borrow money to finance a portion of the purchase price of assets that we acquire. We may also borrow money for other purposes to, among other things, satisfy the requirement that we distribute at least 90% of our “REIT annual taxable income,” subject to certain adjustments, to our stockholders, or as is otherwise necessary or advisable to assure that we continue to qualify as a REIT for federal income tax purposes. Over the long term, however, payments required on any amounts we borrow reduce the funds available for, among other things, acquisitions, capital expenditures for existing properties or distributions to our stockholders because cash otherwise available for these purposes is used to pay principal and interest on this debt.
Defaults on loans secured by a property or properties we own may result in us losing the property or properties securing the loan that is in default as a result of foreclosure actions initiated by a lender. For tax purposes, a foreclosure is treated as a sale of the property or properties for a purchase price equal to the outstanding balance of the debt secured by the property or properties. If the outstanding balance of the debt exceeds our tax basis in the property or properties, we would recognize taxable gain on the foreclosure but would not receive any cash proceeds. We also may fully or partially guarantee any monies that subsidiaries borrow to purchase or operate properties. In these cases, we will likely be responsible to the lender for repaying the loans if the subsidiary is unable to do so. If any mortgage contains cross-collateralization or cross-default provisions, more than one property may be affected by a default.
If we are unable to borrow at favorable rates, we may not be able to acquire new assets.
If we are unable to borrow money at favorable rates, we may be unable to acquire additional real estate assets or refinance existing loans at maturity. Further, we may enter into loan agreements or other credit arrangements that require us to pay interest on amounts we borrow at variable or “adjustable” rates. Increases in interest rates increase our interest costs. If interest rates are higher when we refinance our loans, our expenses will increase and we may not be able to pass on this added cost in the form of increased rents, thereby reducing our cash flow and the amount available for distribution to you. Further, during periods of rising interest rates, we may be forced to sell one or more of our properties in order to repay existing loans, which may not permit us to maximize the return on the particular properties being sold.
Lenders may restrict certain aspects of our operations, which could, among other things, limit our ability to make distributions to you.
The terms and conditions contained in any of our loan documents may require us to maintain cash reserves, limit the aggregate amount we may borrow on a secured and unsecured basis, require us to satisfy restrictive financial covenants, prevent us from entering into certain business transactions, such as a merger, sale of assets or other business combination, restrict our leasing operations or require us to obtain consent from the lender to complete transactions or make investments that are ordinarily approved only by our board of directors. In addition, secured lenders may restrict our ability to discontinue insurance coverage on a mortgaged property even though we may believe that the insurance premiums paid to insure against certain losses, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, are greater than the potential risk of loss. Our credit facility, in particular, contains certain financial and operating covenants, including, among other things, leverage ratios, coverage ratios, as well as limitations on our ability to incur secured indebtedness. In addition, our credit facility could also limit our ability to pay distributions. More specifically, without lender consent, we may not declare and pay distributions if any default under the agreement then exists or if distributions, excluding any distributions reinvested through our DRP, for the then-current quarter and the three immediately preceding fiscal quarters in the aggregate for such period would exceed 95% of our funds from operations, or “FFO,” for such period. If distributions did exceed 95% of our FFO, we would be required to reduce distributions unless the lenders agreed to waive the requirement. There is no assurance that the lenders would agree to waive the requirement, if that became necessary. The credit facility also contains customary default provisions including the failure to timely pay debt service issued thereunder and the failure to comply with the financial and operating covenants. These covenants could limit our ability to obtain additional funds needed to address liquidity needs or pursue future acquisitions. In addition, the failure to comply with any of these covenants could cause a default and accelerate payment of advances under the credit facility. Violating the covenants would likely result in us incurring higher financing costs and fees or an acceleration of the maturity date of advances under the credit facility all of which would have a material adverse effect on our results of operations and financial condition.
Interest-only indebtedness may increase our risk of default and ultimately may reduce our funds available for distribution to our stockholders.
We have obtained, and may continue to enter into, mortgage indebtedness that does not require us to pay principal for all or a portion of the life of the debt instrument. During the period when no principal payments are required, the amount of each scheduled payment is less than that of a traditional amortizing mortgage loan. The principal balance of the mortgage loan is not reduced (except in the case of prepayments). After the interest-only period, we may be required either to make scheduled payments of principal and interest or to make a lump-sum or “balloon” payment at or prior to maturity. These required principal or balloon payments will increase the amount of our scheduled payments and may increase our risk of default under the related mortgage loan if we do not have funds available or are unable to refinance the obligation.
Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to make distributions to our stockholders.
We have borrowed money, including under our line of credit, which bears interest at variable rates, and therefore are exposed to increases in costs in a rising interest rate environment. Increases in interest rates would increase our interest expense on any variable rate debt, as well as any debt that must be refinanced at higher interest rates at the time of maturity. Our future earnings and cash flows could be adversely affected due to the increased requirement to service our debt and could reduce the amount we are able to distribute to our stockholders. As of December 31, 2013, we had $247,278 or 19.8% of our total outstanding debt that bore interest at variable rates, which begins to mature in 2015. As of December 31, 2013, we had $7,638 of fixed rate debt maturing by the end of 2014 of which $6,720 was subsequently repaid on March 10, 2014.
To hedge against interest rate fluctuations, we have and may use derivative financial instruments. Derivative financial instruments may be costly and ineffective.
From time to time we have used, and may continue to use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our properties. Derivative instruments include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions are determined in light of the facts and circumstances existing at the time of the hedge and may differ from time to time. There is no assurance that our hedging activities will have a positive impact on our results of operations or financial condition. We might be subject to costs, such as transaction fees or breakage costs, if we terminate these arrangements.
To the extent that we use derivative financial instruments to hedge against interest rate fluctuations, we are exposed to credit risk, basis risk and legal enforceability risks. In this context, credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. Basis risk occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset or liability is based, thereby making the hedge less effective. Finally, legal enforceability risks encompass general contractual risks including the risk that the counterparty will breach the terms of, or fail to perform its obligations under, the derivative contract, particularly in light of current market conditions. Further, the REIT provisions of the Code may limit our ability to hedge the risks inherent to our operations. We may be unable to manage these risks effectively.
We may enter into derivative contracts that could expose us to contingent liabilities in the future.
Derivative financial instruments may require us to fund cash payments upon the early termination of a derivative agreement caused by an event of default or other early termination event. The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. In addition, some of these derivative arrangements may require that we maintain specified percentages of cash collateral with the counterparty to fund potential liabilities under the derivative contract. We may have to make cash payments in order to maintain the required percentage of collateral with the counterparty. These economic losses would be reflected in our results of operations, and our ability to fund these obligations and financial condition would depend on the liquidity of our respective assets and access to capital at the time.
We may acquire or finance properties with lock-out provisions, which may prohibit us from selling a property, or may require us to maintain specified debt levels for a period of years on some properties.
The terms of any loan that we may enter into may preclude us from pre-paying the principal amount of the loan or could restrict us from selling or otherwise disposing of or refinancing properties. For example, lock-out provisions may prohibit us from reducing the outstanding indebtedness secured by any of our properties, refinancing this indebtedness on a non-recourse basis at maturity, or increasing the amount of indebtedness secured by our properties. Lock-out provisions could impair our ability to take other actions during the lock-out period. In particular, lock-out provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or change in control might be in the best interests of our stockholders. As of December 31, 2013, we had 23 loans with lock-out provisions in effect totaling $424,270 or approximately 35.8% of our total mortgage debt.
We may be contractually obligated to purchase property even if we are unable to secure financing for the acquisition.
We typically finance a portion of the purchase price for each property that we acquire. However, to ensure that our offers are as competitive as possible, we generally do not enter into contracts to purchase property that include financing contingencies. Thus, we may be contractually obligated to purchase a property even if we are unable to secure financing for the acquisition. In this event, we may choose to close on the property by using cash on hand, which would result in less cash available for our operations and distributions to stockholders. Alternatively, we may choose not to close on the acquisition of the property and default on the purchase contract. If we default on any purchase contract, we could lose our earnest money and become subject to liquidated or other contractual damages and remedies.
The total amount we may borrow is limited by our charter.
Our charter generally limits the total amount we may borrow to 300% of our net assets, equivalent to a 75% loan-to-asset value ratio, unless our board of directors (including a majority of our independent directors) determines that a higher level is appropriate and the excess in borrowing is disclosed to stockholders in our next quarterly report along with the justification for the excess. This limit could adversely affect our business, including:
limiting our ability to purchase real estate assets;
causing us to lose our REIT status if we cannot borrow to fund the monies needed to satisfy the REIT distribution requirements;
causing operational problems if there are cash flow shortfalls for working capital purposes; and
causing the loss of a property if, for example, financing is necessary to cure a default on a mortgage.
Risks Related to Conflicts of Interest
There are conflicts of interest between us and affiliates of our sponsor that may affect our acquisition of properties and financial performance.
Our sponsor and Inland Private Capital Corporation (“IPCC”) sponsored other REITs real estate exchange private placement limited partnerships and limited liability companies. Two of the REITs, Inland American Real Estate Trust, Inc. and Inland Real Estate Income Trust, Inc., are managed by affiliates of our Business Manager. Two other REITs, Inland Real Estate Corporation, Inc. and Retail Properties of America, Inc., formally known as Inland Western Retail Real Estate Trust, Inc., is self-managed, but our sponsor and its affiliates continue to hold a significant investment in these entities. We may be seeking to buy real estate assets at the same time as certain of these other programs. Further, certain programs sponsored by our sponsor or IPCC own and manage the type of properties that we own, and in the same geographical areas in which we own them. Therefore, our properties may compete for tenants with other properties owned and managed by these other programs. Persons performing services for our Real Estate Managers may face conflicts of interest when evaluating tenant leasing opportunities for our properties and other properties owned and managed by these programs, and these conflicts of interest may have an adverse impact on our ability to attract and retain tenants.
Our sponsor may face a conflict of interest in allocating personnel and resources between its affiliates, our Business Manager and our Real Estate Managers.
We currently rely, to a great extent, and will continue to rely if the Merger is not completed, on persons performing services for our Business Manager and Real Estate Managers and their affiliates to manage our day-to-day operations. Some of these persons also provide services to one or more investment programs previously sponsored by our sponsor. These individuals face competing demands for their time and service and may have conflicts in allocating their time between our business and assets and the business and assets of our sponsor, its affiliates and the other programs formed and organized by our sponsor. In addition, if another investment program sponsored by our sponsor decides to internalize its management functions in the future, it may do so by hiring and retaining certain of the persons currently performing services for our Business Manager and Real Estate Managers, and if it did so, would likely not allow these persons to perform services for us.
We do not have arm’s-length agreements with our Business Manager, our Real Estate Managers or any other affiliates of IREIC.
None of the agreements and arrangements with our Business Manager, our Real Estate Managers or any other affiliates of our sponsor was negotiated at arm’s-length. These agreements may contain terms and conditions that are not in our best interest and would not otherwise be applicable if we entered into arm’s length agreements with third parties.
Our Business Manager and its affiliates face conflicts of interest caused by their compensation arrangements with us, which could result in actions that are not in the long-term best interests of our stockholders.
We pay significant fees to our Business Manager, Real Estate Managers and other affiliates of our sponsor for services provided to us. Most significantly, our Business Manager receives fees based on the aggregate book value, including acquired intangibles, of our invested assets. Further, our Real Estate Managers receive fees based on the gross income from properties under management. Other parties related to, or affiliated with, our Business Manager or Real Estate Managers may also receive fees or cost reimbursements from us. These compensation arrangements may cause these entities to take or not take certain actions. For example, these arrangements may provide an incentive for our Business Manager to borrow more money than prudent to increase the amount we can invest. Ultimately, the interests of these parties in receiving fees conflict with the interest of our stockholders in earning income on their investment in our common stock.
We rely on entities affiliated with our sponsor to identify real estate assets.
We rely on Inland Real Estate Acquisitions, Inc. (“IREA”) and other affiliates of our sponsor to identify suitable investment opportunities for us. Other public or private programs sponsored by our sponsor or IPCC also rely on these entities to identify potential investments. These entities invest in some of the same property types that we seek and have, in some cases, rights of first refusal or other pre-emptive rights to the properties that IREA identifies. Our right to acquire properties identified by IREA is subject to the exercise of any prior rights vested in these entities. We may not, therefore, be presented with opportunities to acquire properties that we otherwise would be interested in acquiring.
Three of our seven directors face conflicts of interest because of their positions or affiliations with our real estate manager and our business manager.
Three of our directors, Mr. Parks, Ms. Gujral and Mr. Lazarus also serve as officers or directors of other entities affiliated with Real Estate Manager or Business Manager. Their affiliation with these other entities could result in conflicts with our business and interests that are most likely to arise in their participating in deliberations or voting on matters by our board of directors related to, among others:
enforcing our agreements with the Business Manager or Real Estate Manager and their affiliates; and
property sales, which reduce the amount of property management fees payable to our Real Estate Manager.
Risks Related to Our Corporate Structure
Our board of directors may change our investment policies without stockholder approval, which could alter the nature of your investment.
Our charter requires that our independent directors review our investment policies at least annually to determine that the policies we are following are in the best interest of our stockholders. These policies may change over time. The methods of implementing our investment policies may also vary, as new investment techniques are developed. Our investment policies, the methods for implementing them, and our other objectives, policies and procedures may be altered by a majority of the directors (which must include a majority of the independent directors), without the approval of our stockholders. As a result, the nature of your investment could change without your consent. A change in our investment strategy may, among other things, increase our exposure to interest rate risk, default risk and commercial real property market fluctuations, all of which could materially adversely affect our ability to achieve our investment objectives.
Our charter authorizes us to issue additional shares of stock, which may reduce the percentage of our common stock owned by our other stockholders, subordinate your rights or discourage a third party from acquiring us.
Investors who purchased shares in our public offering will not have preemptive rights to purchase any shares issued by us in the future. Our charter authorizes us to issue up to 2.5 billion shares of capital stock, of which 2.46 billion shares are classified as common stock and 40 million are classified as preferred stock. We may, in the sole discretion of our board:
sell additional shares in future offerings;
issue equity interests in a private offering of securities;
classify or reclassify any unissued shares of common or preferred stock by setting or changing the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, or terms or conditions of redemption of the stock;
amend our charter from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series that we have authority to issue;
issue shares of our capital stock in exchange for real estate assets;
issue shares of our capital stock to our Business Manager or Real Estate Managers in connection with any business combination between us and any of them; or
cause dilution of our earnings per common share due to the conversion of redeemable noncontrolling interests into common shares.
Future issuances of common stock will reduce the percentage of our outstanding shares owned by our other stockholders. Further, our board of directors could authorize the issuance of stock with terms and conditions that could subordinate the rights of the holders of our current common stock or have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for our stockholders.
Our rights, and the rights of our stockholders, to recover claims against our officers, directors, Business Manager and Real Estate Managers are limited.
Under our charter, we may generally indemnify our directors, our Business Manager, our Real Estate Managers and their respective affiliates for any losses or liabilities suffered by any of them and hold these persons or entities harmless for any loss or liability suffered by us as long as: (1) these persons or entities have determined in good faith that the course of conduct that caused the loss or liability was in our best interest; (2) these persons or entities were acting on our behalf or performing services for us; (3) the loss or liability was not the result of the negligence or misconduct of the directors (gross negligence or willful misconduct of the independent directors), Business Manager, the Real Estate Managers or their respective affiliates; or (4) the indemnity or agreement to hold harmless is recoverable only out of our net assets and not from our stockholders. As a result, we and our stockholders may have more limited rights against our directors, officers, employees and agents, our Business Manager and our Real Estate Managers and their respective affiliates, than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors, officers, employees and agents or our Business Manager and the Real Estate Managers and their respective affiliates in some cases.
Our board of directors may, in the future, adopt certain measures under Maryland law without stockholder approval that may have the effect of making it less likely that you would receive a “control premium” for your shares.
Corporations organized under Maryland law with a class of registered securities and at least three independent directors are permitted to protect themselves from unsolicited proposals or offers to acquire the company by electing to be subject, by a charter or bylaw provision or a board of directors resolution and notwithstanding any contrary charter or bylaw provision, to any or all of five provisions:
staggering the board of directors into three classes;
requiring a two-thirds vote of stockholders to remove directors;
providing that only the board can fix the size of the board;
providing that all vacancies on the board, regardless of how the vacancy was created, may be filled only by the affirmative vote of a majority of the remaining directors in office and for the remainder of the full term of the class of directors in which the vacancy occurred; and
requiring that special stockholders meetings be called only by holders of shares entitled to cast a majority of the votes entitled to be cast at the meeting.
These provisions may discourage an extraordinary transaction, such as a merger, tender offer or sale of all or substantially all of our assets, all of which might provide a premium price for your shares.
Further, under the Maryland Business Combination Act, we may not engage in any merger or other business combination with an “interested stockholder” or any affiliate of that interested stockholder for a period of five years after the most recent date on which the interested stockholder became an interested stockholder. After the five-year period ends, any merger or other business combination with the interested stockholder must be recommended by our board of directors and approved by the affirmative vote of at least:
80% of all votes entitled to be cast by holders of outstanding shares of our voting stock; and
two-thirds of all of the votes entitled to be cast by holders of outstanding shares of our voting stock other than those shares owned or held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder unless, among other things, our stockholders receive a minimum payment for their common stock equal to the highest price paid by the interested stockholder for its common stock.
Our directors have adopted a resolution exempting any business combination involving us and The Inland Group or any affiliate of The Inland Group, including our Business Manager and Real Estate Managers, from the provisions of this law.
Our charter places limits on the amount of common stock that any person may own without the prior approval of our board of directors.
To maintain our qualification as a REIT, no more than 50% of the outstanding shares of our common stock may be beneficially owned, directly or indirectly, by five or fewer individuals at any time during the last half of each taxable year (other than the first taxable year for which an election to be a REIT has been made). Our charter prohibits any persons or groups from owning more than 9.8% of our common stock, in value or number of shares (whichever is more restrictive), without the prior approval of our board of directors. These provisions may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction such as a merger, tender offer or sale of all or substantially all of our assets that might involve a premium price for holders of our common stock. Further, any person or group attempting to purchase shares exceeding these limits could be compelled to sell the additional shares and, as a result, to forfeit the benefits of owning the additional shares.
Our charter permits our board of directors to issue preferred stock on terms that may subordinate the rights of the holders of our current common stock or discourage a third party from acquiring us.
Our board of directors is permitted, subject to certain restrictions set forth in our charter, to issue up to forty million shares of preferred stock without stockholder approval. Further, our board may classify or reclassify any unissued common or preferred stock and establish the preferences, conversions or other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, and terms or conditions of redemption of the stock and may increase or decrease the aggregate number of shares or the number of shares of any class or series that we have authority to issue without stockholder approval. Thus, our board of directors could authorize us to issue shares of preferred stock with terms and conditions that could subordinate the rights of the holders of our common stock or have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction such as a merger, tender offer or sale of all or substantially all of our assets, that might provide a premium price for holders of our common stock.
Maryland law limits, in some cases, the ability of a third party to vote shares acquired in a “control share acquisition.”
The Maryland Control Share Acquisition Act provides that “control shares” of a Maryland corporation acquired in a “control share acquisition” have no voting rights except to the extent approved by stockholders by a vote of two-thirds of the votes entitled to be cast on the matter. Shares of stock owned by the acquirer, by officers or by employees who are directors of the corporation, are excluded from shares entitled to vote on the matter. “Control shares” are voting shares of stock which, if aggregated with all other shares of stock owned by the acquirer or in respect of which the acquirer can exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquirer to exercise voting power in electing directors within specified ranges of voting power. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval. A “control share acquisition” means the acquisition of issued and outstanding control shares. The control share acquisition statute does not apply (1) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction, or (2) to acquisitions approved or exempted by the charter or bylaws of the corporation. Our bylaws contain a provision exempting from the Control Share Acquisition Act any and all acquisitions of our stock by any person. There can be no assurance that this provision will not be amended or eliminated at any time in the future.
Federal Income Tax Risks
If we fail to maintain our qualification as a REIT, our operations and distributions to stockholders will be adversely affected.
Qualification as a REIT involves the application of highly technical and complex rules related to, among other things, the composition of our assets, the income generated by those assets and distributions paid to our stockholders. There are limited judicial or administrative interpretations regarding these rules. The determination of various factual matters and circumstances not entirely within our control may affect our ability to continue to qualify as a REIT. In addition, new legislation, new regulations, administrative interpretations or court decisions could significantly change the tax laws with respect to qualifying as a REIT or the federal income tax consequences of such qualification.
If we were to fail to qualify as a REIT, without the benefit of certain relief provisions, in any taxable year:
we would not be allowed to deduct distributions paid to stockholders when computing our taxable income;
we would be subject to federal (including any applicable alternative minimum tax) and state income tax on our taxable income at regular corporate rates;
we would be disqualified from being taxed as a REIT for the four taxable years following the year during which we failed to qualify, unless entitled to relief under certain statutory provisions;
we would have less cash to pay distributions to stockholders; and
we may be required to borrow additional funds or sell some of our assets in order to pay corporate tax obligations we may incur as a result of being disqualified.
In addition, if we were to fail to qualify as a REIT, we would not be required to pay distributions to stockholders, and all distributions to stockholders that we did pay would be subject to tax as regular corporate dividends to the extent of our current and accumulated earnings and profits. This means that, under current law, which is subject to change, our U.S. stockholders who are taxed as individuals would be taxed on our dividends at long-term capital gains rates through 2012 and that our corporate stockholders would be entitled to the dividends received deduction with respect to such dividends, subject, in each case, to applicable limitations under the Code.
The taxation of distributions to our stockholders can be complex; however, distributions that we make to our stockholders generally will be taxable as ordinary income.
Distributions that we make to our taxable stockholders out of current and accumulated earnings and profits (and not designated as capital gain dividends, or, for tax years beginning before January 1, 2013, qualified dividend income) generally will be taxable as ordinary income. However, a portion of our distributions may: (1) be designated by us as capital gain dividends generally taxable as long-term capital gain to the extent that they are attributable to net capital gain recognized by us; (2) be designated by us, as qualified dividend income generally to the extent they are attributable to dividends we receive from any taxable REIT subsidiaries or certain other taxable C corporations in which we own shares of stock; or (3) constitute a return of capital generally to the extent that they exceed our current and accumulated earnings and profits as determined for U.S. federal income tax purposes. A return of capital is not taxable, but has the effect of reducing the basis of a stockholder’s investment in our common stock. Distributions that exceed our current and accumulated earnings and profits and a stockholder’s basis in our common stock generally will be taxable as capital gain.
To maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions to make distributions to our stockholders.
To qualify as a REIT, we must distribute to our stockholders each year 90% of our taxable income, subject to certain adjustments and excluding any net capital gain. At times, we may not have sufficient funds to satisfy these distribution requirements and may need to borrow funds to make these distributions and maintain our REIT status and avoid the payment of income and excise taxes. These borrowing needs could result from: (1) differences in timing between the actual receipt of cash and inclusion of income for federal income tax purposes; (2) the effect of non-deductible capital expenditures; (3) the creation of reserves; or (4) required debt amortization payments. We may need to borrow funds at times when market conditions are unfavorable. Further, if we are unable to borrow funds when needed for this purpose, we would have to find alternative sources of funding or risk losing our status as a REIT.
If we were considered to actually or constructively pay a “preferential dividend” to certain of our stockholders, our status as a REIT could be adversely affected.
The requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income is determined without regard to the deduction for dividends paid and excluding net capital gain. In order for distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction, the distributions must not be “preferential dividends.” A dividend is not a preferential dividend if the distribution is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences among different classes of stock as set forth in our organizational documents. Guidance from the Internal Revenue Service generally permits a discount in the price paid for stock purchased under a distribution reinvestment plan of up to 5% of the value of the stock without creating a preferential dividend. Currently, however, there is uncertainty as to the Internal Revenue Service’s position regarding whether certain arrangements that REITs have with their stockholders could give rise to the inadvertent payment of a preferential dividend (e.g., the pricing methodology for stock purchased under a distribution reinvestment plan inadvertently causing a greater than 5% discount on the price of such stock purchased). There is no de minimis exception with respect to preferential dividends; therefore, if the Internal Revenue Service were to take the position that we inadvertently paid a preferential dividend, we may be deemed to have failed the 90% distribution requirement, and our status as a REIT could be terminated for the year in which the determination is made if we were unable to cure such failure.
Certain of our business activities are potentially subject to the prohibited transaction tax.
Our ability to dispose of property during the first two years following acquisition is restricted to a substantial extent as a result of our REIT status. Under applicable provisions of the Code regarding prohibited transactions by REITs, we will be subject to a 100% tax on any gain realized on the sale or other disposition of any property (other than foreclosure property) we own, directly or through any wholly owned subsidiary (or entity in which we are treated as a partner), excluding our taxable REIT subsidiaries, that is deemed to be inventory or property held primarily for sale to customers in the ordinary course of trade or business. Determining whether property is inventory or otherwise held primarily for sale to customers in the ordinary course of a trade or business depends on the particular facts and circumstances surrounding each property. We cannot provide assurance that any particular property we own, directly or through any wholly owned subsidiary (or entity in which we are treated as a partner), excluding our taxable REIT subsidiaries, will not be treated as inventory or property held primarily for sale to customers in the ordinary course of a trade or business. The Code sets forth a safe harbor for REITs that wish to sell property without risking the imposition of the 100% tax; however there is no assurance that we will be able to qualify for the safe harbor. Even if we do not hold property for sale in the ordinary course of a trade or business, there is no assurance that our position will not be challenged by the Internal Revenue Service, especially if we make frequent sales or sales of property in which we have short holding periods.
Certain fees paid to us may affect our REIT status.
Income received in the nature of rental subsidies or rent guarantees, in some cases, may not qualify as rental income from real estate and could be characterized by the Internal Revenue Service as non-qualifying income for purposes of satisfying the 75% and 95% gross income tests required for REIT qualification. If the aggregate of non-qualifying income under the 95% gross income test in any taxable year ever exceeded 5% of our gross revenues for the taxable year or non-qualifying income under the 75% gross income test in any taxable year ever exceeded 25% of our gross revenues for the taxable year, we could lose our REIT status for that taxable year and the four taxable years following the year of losing our REIT status.
Complying with the REIT requirements may force us to liquidate otherwise attractive investments.
To qualify as a REIT, we must ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, certain government securities and qualified real estate assets, including shares of stock in other REITs, certain mortgage loans and mortgage backed securities. The remainder of our investment in securities (other than qualified government securities, qualified real estate assets and taxable REIT subsidiaries) generally may not include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than qualified government securities, qualified real estate assets and taxable REIT subsidiaries) may consist of the securities of any one issuer, and no more than 25% of the value of our total assets may be securities (including securities issued by our taxable REIT subsidiaries), excluding government securities, stock issued by our qualified REIT subsidiaries and other securities that qualify as REIT real estate assets. In order to meet these tests, we may be required to forego investments we might otherwise make. Thus, compliance with the REIT requirements may hinder our performance.
If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within thirty days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments.
The “taxable mortgage pool” rules may increase the taxes that we or our stockholders incur and may limit the manner in which we conduct securitizations.
If we securitize mortgages, certain of our securitizations could be considered to result in the creation of taxable mortgage pools for federal income tax purposes. As a REIT, provided that we own 100% of the equity interests in a taxable mortgage pool, we generally would not be adversely affected by the characterization of the securitization as a taxable mortgage pool. Certain categories of stockholders, however, such as foreign stockholders eligible for treaty or other benefits, stockholders with net operating losses, and certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to the taxable mortgage pool. In addition, to the extent that our stock is owned by tax-exempt “disqualified organizations,” such as certain government-related entities and charitable remainder trusts that are not subject to tax on unrelated business income, we will incur a corporate-level tax on a portion of our income from the taxable mortgage pool. In that case, we are authorized to reduce and intend to reduce the amount of our distributions to any disqualified organization whose stock ownership gave rise to the tax. Moreover, we would be precluded from selling equity interests in these securitizations to outside investors, or selling any debt securities issued in connection with these securitizations that might be considered to be equity interests for federal income tax purposes. These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions.
Our ability to dispose of some of our properties may be constrained by their tax attributes.
Federal tax laws may limit our ability to sell properties and this may affect our ability to sell properties without adversely affecting returns to our stockholders. These restrictions may reduce our ability to respond to changes in the performance of our investments.
Our ability to dispose of some of our properties is constrained by their tax attributes. Properties which we own for a significant period of time often have low tax bases. If we dispose of low-basis properties outright in taxable transactions, we may recognize a significant amount of taxable gain that we must distribute to our stockholders in order to avoid tax, and potentially, if the gain does not qualify as a net capital gain, in order to meet the minimum distribution requirements of the Code for REITs, which in turn would impact our cash flow. To dispose of low basis or tax-protected properties efficiently we may use like-kind exchanges, which qualify for non-recognition of taxable gain, but can be difficult to consummate and result in the property for which the disposed assets are exchanged inheriting their low tax bases and other tax attributes (including tax protection covenants).
You may have tax liability on distributions that you elect to reinvest in our common stock.
If you participate in our distribution reinvestment plan, you will be deemed to have received, and for income tax purposes will be taxed on, the fair market value of the share of our common stock that you receive in lieu of cash distributions. As a result, unless you are a tax-exempt entity, you will have to use funds from other sources to pay your tax liability.
In certain circumstances, we may be subject to federal, state and local income taxes as a REIT.
Even if we maintain our status as a REIT, we may become subject to federal, state and local income taxes. For example:
We will be subject to tax on any undistributed income. We will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions we pay in any calendar year plus amounts retained for which federal income tax was paid are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years.
If we have net income from the sale of foreclosure property that we hold primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, we must pay a tax on that income at the highest corporate income tax rate.
If we sell a property, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of business, our gain would be subject to the 100% “prohibited transaction” tax.
We will be subject to a 100% penalty tax on certain amounts if the economic arrangements of our tenants, our taxable REIT subsidiaries and us are not comparable to similar arrangements among unrelated parties.
Certain equity participation in mortgage loans may result in taxable income and gains from these properties, which could adversely impact our REIT status.
If we participate under a mortgage loan in any appreciation of the properties securing the mortgage loan or its cash flow and the Internal Revenue Service characterizes this participation as “equity,” we might have to recognize income, gains and other items from the property. This could affect our ability to maintain our status as a REIT.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Code may limit our ability to hedge the risks inherent to our operations. Under current law, any income that we generate from derivatives or other transactions intended to hedge our interest rate risk with respect to borrowings made or to be made to acquire or carry real estate assets generally will not constitute gross income for purposes of the 75% and 95% income requirements applicable to REITs. In addition, any income from certain other qualified hedging transactions would generally not constitute gross income for purposes of both the 75% and 95% income tests. However, we may be required to limit the use of hedging techniques that might otherwise be advantageous, which could result in greater risks associated with interest rate or other changes than we would otherwise incur.
Legislative or regulatory action could adversely affect investors.
Changes to the tax laws are likely to occur, and these changes may adversely affect the taxation of a stockholder. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets. You are urged to consult with your own tax advisor with respect to the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares.
The maximum tax rate on qualified dividends paid by corporations to individuals is 20%. REIT dividends, however, generally do not constitute qualified dividends and consequently are not eligible for the current reduced tax rates. Therefore, our stockholders will pay federal income tax on distributions out of our current and accumulated earnings and profits (excluding distributions of amounts either subject to corporate-level taxation or designated as a capital gain dividend) at the applicable “ordinary income” rate, the maximum of which is 39.6%. In addition this income also might be subject to the 3.8% Medicare surtax on certain investment income. However, as a REIT, we generally would not be subject to federal or state corporate income taxes on that portion of our ordinary income or capital gain that we distribute currently to our stockholders, and we thus expect to avoid the “double taxation” to which other corporations are typically subject.
Future legislation might result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be taxed, for federal income tax purposes, as a corporation. As a result, our charter provides our board of directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a corporation, without the vote of our stockholders. Our board of directors has fiduciary duties to us and our stockholders and could only cause changes in our tax treatment if it determines in good faith that such changes are in the best interest of our stockholders.
Item 1B. Unresolved Staff Comments
None.

Item 2. Properties
All dollar amounts are stated in thousands, except share data, per share amounts, rent per square foot, and rent per unit.
As of December 31, 2013, we owned interests in 135 retail properties, four office properties, two industrial properties and two multi-family properties. As of December 31, 2013, we, through our wholly-owned subsidiaries, either owned a fee simple interests in each of our properties or a controlling interest in the joint ventures which owns each of our properties. Our properties are encumbered by mortgage loans with an aggregate outstanding principal balance as of December 31, 2013 of $1,184,256. For additional information regarding our mortgage indebtedness, see Note 10 to the consolidated financial statements included in “Item 8. Consolidated Financial Statements and Supplementary Data” to this annual report.
As of December 31, 2013 and 2012, annualized base rent per square foot for all of our properties other than the multi-family properties averaged $13.69 and $13.51, respectively. As of December 31, 2013 and 2012, annualized base rent per square foot for our multi-family properties averaged $12,415 and $12,098 per unit, respectively. Annualized base rent is calculated by annualizing the current, in-place monthly base rent for leases, including any tenant concessions, such as rent abatement or allowances, which may have been granted.
The following table sets forth additional information regarding our property portfolio as of December 31, 2013:
 
 
 
 
As of December 31, 2013
Property/Type
 
Location
 
Square
Footage/Units
 
Physical
Occupancy
 
Economic
Occupancy (a)
Retail:
 
 
 
 
 
 
 
 
Merrimack Village Center
 
Merrimack, NH
 
82,292

 
100.0
%
 
100.0
%
Pleasant Hill Commons
 
Kissimmee, FL
 
70,642

 
93.5
%
 
93.5
%
Regal Court
 
Shreveport, LA
 
363,174

 
91.4
%
 
91.4
%
Draper Crossing
 
Draper, UT
 
167,148

 
99.1
%
 
99.1
%
Tradition Village Center
 
Port St. Lucie, FL
 
112,421

 
75.4
%
 
75.4
%
The Landing at Tradition
 
Port St. Lucie, FL
 
359,758

 
90.4
%
 
90.4
%
Temple Terrace
 
Temple Terrace, FL
 
87,213

 
98.0
%
 
98.0
%
Kohl’s at Calvine Pointe*
 
Elk Grove, CA
 
89,887

 
100.0
%
 
100.0
%
Lake City Commons
 
Lake City, FL
 
66,510

 
88.9
%
 
92.4
%
Publix Shopping Center
 
St. Cloud, FL
 
78,820

 
97.8
%
 
97.8
%
Kohl’s Bend River Promenade*
 
Bend, OR
 
69,000

 
100.0
%
 
100.0
%
Whispering Ridge
 
Omaha, NE
 
69,676

 
100.0
%
 
100.0
%
Bell Oaks Shopping Center
 
Newburgh, IN
 
94,811

 
100.0
%
 
100.0
%
Colonial Square Town Center
 
Fort Myers, FL
 
272,354

 
93.8
%
 
96.3
%
Shops at Village Walk
 
Fort Myers, FL
 
78,533

 
90.0
%
 
90.0
%
Lima Marketplace
 
Fort Wayne, IN
 
106,880

 
98.7
%
 
98.7
%
Dollar General- Ariton*
 
Ariton, AL
 
9,014

 
100.0
%
 
100.0
%
Dollar General- Collins*
 
Collins, GA
 
9,014

 
100.0
%
 
100.0
%
Dollar General- Decatur*
 
Decatur, AL
 
9,014

 
100.0
%
 
100.0
%
Dollar General- Dublin*
 
Dublin, GA
 
10,640

 
100.0
%
 
100.0
%
Dollar General- Duncanville*
 
Duncanville, AL
 
9,026

 
100.0
%
 
100.0
%
Dollar General- Excel*
 
Frisco City, AL
 
8,982

 
100.0
%
 
100.0
%
Dollar General- LaGrange*
 
LaGrange, GA
 
9,014

 
100.0
%
 
100.0
%
Dollar General- Milledgeville*
 
Milledgeville, GA
 
9,014

 
100.0
%
 
100.0
%

5


 
 
 
 
As of December 31, 2013
Property/Type
 
Location
 
Square
Footage/Units
 
Physical
Occupancy
 
Economic
Occupancy (a)
Dollar General- Uriah*
 
Uriah, AL
 
9,100

 
100.0
%
 
100.0
%
Waxahachie Crossing
 
Waxahachie, TX
 
97,127

 
98.8
%
 
98.8
%
Village at Bay Park
 
Ashwaubenon, WI
 
180,754

 
94.6
%
 
94.6
%
Northcrest Shopping Center
 
Charlotte, NC
 
133,674

 
94.9
%
 
98.9
%
Prattville Town Center
 
Prattville, AL
 
168,842

 
97.5
%
 
97.5
%
Landstown Commons
 
Virginia Beach, VA
 
409,747

 
92.0
%
 
92.0
%
Silver Springs Pointe
 
Oklahoma City, OK
 
135,028

 
92.0
%
 
92.8
%
Copps Grocery Store
 
Neenah, WI
 
61,065

 
100.0
%
 
100.0
%
University Town Center
 
Norman, OK
 
158,516

 
97.4
%
 
98.2
%
Pick N Save Grocery Store
 
Burlington, WI
 
48,403

 
100.0
%
 
100.0
%
Walgreens – Lake Mary
 
Lake Mary, FL
 
21,370

 
100.0
%
 
100.0
%
Walgreens Plaza
 
Jacksonville, NC
 
42,219

 
87.9
%
 
87.9
%
Walgreens – Heritage Square
 
Conyers, GA
 
22,385

 
80.1
%
 
80.1
%
Perimeter Woods
 
Charlotte, NC
 
303,328

 
97.4
%
 
100.0
%
Draper Peaks
 
Draper, UT
 
229,794

 
90.4
%
 
97.8
%
Shoppes at Prairie Ridge
 
Pleasant Prairie, WI
 
232,629

 
97.3
%
 
100.0
%
Fairgrounds Crossing
 
Hot Springs, AR
 
155,127

 
98.7
%
 
98.7
%
Mullins Crossing
 
Evans, GA
 
297,168

 
99.5
%
 
99.5
%
Fox Point
 
Neenah, WI
 
171,121

 
98.1
%
 
98.1
%
Harvest Square
 
Harvest, AL
 
70,590

 
97.2
%
 
97.2
%
Palm Coast Landing
 
Palm Coast, FL
 
171,297

 
97.6
%
 
97.6
%
Dollar General – Sycamore*
 
Sycamore, AL
 
9,026

 
100.0
%
 
100.0
%
Dollar General Market - Port St. Joe*
 
Port St. Joe, FL
 
20,707

 
100.0
%
 
100.0
%
Hamilton Crossing
 
Alcoa, TN
 
179,864

 
97.6
%
 
100.0
%
Dollar General - Buffalo*
 
Buffalo, NY
 
10,566

 
100.0
%
 
100.0
%
Shoppes at Branson Hills
 
Branson, MO
 
447,718

 
99.4
%
 
99.4
%
Shoppes at Hawk Ridge
 
Lake St. Louis, MO
 
75,951

 
98.2
%
 
100.0
%
Bayonne Crossing
 
Bayonne, NJ
 
360,045

 
98.6
%
 
100.0
%
Eastside Junction
 
Athens, AL
 
79,700

 
96.3
%
 
96.3
%
Shops at Julington Creek
 
Jacksonville, FL
 
40,207

 
89.4
%
 
96.2
%
Dollar General Store - Lillian*
 
Lillian, AL
 
9,026

 
100.0
%
 
100.0
%
Dollar General Market - Slocomb*
 
Slocomb, AL
 
20,707

 
100.0
%
 
100.0
%
Dollar General Store - Clanton*
 
Clanton, AL
 
10,566

 
100.0
%
 
100.0
%
BB&T - Plantation*
 
Plantation, FL
 
3,750

 
100.0
%
 
100.0
%
BB&T - Wilmington*
 
Wilmington, NC
 
4,375

 
100.0
%
 
100.0
%
KeyBank - Beachwood*
 
Beachwood, OH
 
4,460

 
100.0
%
 
100.0
%
KeyBank - Euclid*
 
Euclid, OH
 
7,879

 
100.0
%
 
100.0
%
KeyBank - Mentor*
 
Mentor, OH
 
4,231

 
100.0
%
 
100.0
%
KeyBank - Pepper Pike*
 
Pepper Pike, OH
 
3,353

 
100.0
%
 
100.0
%
KeyBank - Shaker Heights*
 
Shaker Heights, OH
 
7,049

 
100.0
%
 
100.0
%
Regions Bank - Acworth*
 
Acworth, GA
 
3,933

 
100.0
%
 
100.0
%
Regions Bank - Alpharetta*
 
Alpharetta, GA
 
3,852

 
100.0
%
 
100.0
%
Dollar General Store*
 
Marbury, AL
 
9,026

 
100.0
%
 
100.0
%
Dollar General Store*
 
Gilbertown, AL
 
12,406

 
100.0
%
 
100.0
%
South Elgin Commons
 
Elgin, IL
 
128,000

 
100.0
%
 
100.0
%
Walgreens - Berlin
 
Berlin, CT
 
14,820

 
100.0
%
 
100.0
%
Walgreens - Brandford
 
Brandford, CT
 
13,548

 
100.0
%
 
100.0
%
Walgreens - Brockton
 
Brockton, MA
 
16,704

 
100.0
%
 
100.0
%
Walgreens - Derry
 
Derry, NH
 
14,820

 
100.0
%
 
100.0
%
Walgreens - Dover
 
Dover, NH
 
14,418

 
100.0
%
 
100.0
%
Walgreens - Ledgewood
 
Ledgewood, NJ
 
14,696

 
100.0
%
 
100.0
%
Walgreens - Melrose
 
Melrose, MA
 
16,053

 
100.0
%
 
100.0
%
Walgreens - Mount Ephraim
 
Mount Ephraim, NJ
 
14,739

 
100.0
%
 
100.0
%
Walgreens - Sewell
 
Sewell, NJ
 
14,820

 
100.0
%
 
100.0
%
Saxon Crossing
 
Orange City, FL
 
119,894

 
98.0
%
 
99.0
%

6


 
 
 
 
As of December 31, 2013
Property/Type
 
Location
 
Square
Footage/Units
 
Physical
Occupancy
 
Economic
Occupancy (a)
Dollar General Store - Enterprise*
 
Enterprise, AL
 
9,002

 
100.0
%
 
100.0
%
Dollar General Store - Odenville*
 
Odenville, AL
 
9,100

 
100.0
%
 
100.0
%
BP - Gordonsville*
 
Gordonsville, VA
 
5,756

 
100.0
%
 
100.0
%
BP - Fontaine*
 
Charlottesville, VA
 
3,589

 
100.0
%
 
100.0
%
BP - Monticello*
 
Charlottesville, VA
 
2,257

 
100.0
%
 
100.0
%
BP - Seminole*
 
Charlottesville, VA
 
2,573

 
100.0
%
 
100.0
%
Citgo - Gordonsville*
 
Gordonsville, VA
 
4,136

 
100.0
%
 
100.0
%
BJ's at Ritchie Station
 
Capital Heights, MD
 
117,875

 
100.0
%
 
100.0
%
Dollar General Market - Candler*
 
Candler, NC
 
20,700

 
100.0
%
 
100.0
%
Shops at Moore
 
Moore, OK
 
259,903

 
97.1
%
 
97.5
%
Kohl's - Cummings
 
Cumming, GA
 
86,584

 
100.0
%
 
100.0
%
Dollar General Market - Vienna*
 
Vienna, GA
 
20,707

 
100.0
%
 
100.0
%
Centre Point Commons
 
Bradenton, FL
 
119,275

 
83.7
%
 
98.8
%
Dollar General Store - Borger
 
Borger, TX
 
9,014

 
100.0
%
 
100.0
%
Dollar General Store - Brookshire
 
Brookshire, TX
 
12,480

 
100.0
%
 
100.0
%
Dollar General Store - Bullard
 
Bullard, TX
 
9,100

 
100.0
%
 
100.0
%
Dollar General Store - Cisco
 
Cisco, TX
 
9,014

 
100.0
%
 
100.0
%
Dollar General Store - Glen Rose
 
Glen Rose, TX
 
12,480

 
100.0
%
 
100.0
%
Dollar General Store - Hamilton
 
Hamilton, TX
 
9,100

 
100.0
%
 
100.0
%
Dollar General Store - Itasca
 
Itasca, TX
 
9,014

 
100.0
%
 
100.0
%
Dollar General Store - Joaquin
 
Joaquin, TX
 
12,480

 
100.0
%
 
100.0
%
Dollar General Store - Llano
 
Llano, TX
 
12,000

 
100.0
%
 
100.0
%
Dollar General Store - Memphis
 
Memphis, TX
 
9,100

 
100.0
%
 
100.0
%
Dollar General Store - Mt. Vernon
 
Mt. Vernon, TX
 
9,100

 
100.0
%
 
100.0
%
Dollar General Store - Pineland
 
Pineland, TX
 
11,914

 
100.0
%
 
100.0
%
Dollar General Store - Rockdale
 
Rockdale, TX
 
9,014

 
100.0
%
 
100.0
%
Dollar General Store - Sealy
 
Sealy, TX
 
9,014

 
100.0
%
 
100.0
%
Dollar General Store - Van Horn
 
Van Horn, TX
 
12,500

 
100.0
%
 
100.0
%
Lake City Commons II
 
Lake City, FL
 
16,291

 
100.0
%
 
100.0
%
Pathmark - Seaford
 
Seaford, NY
 
41,030

 
100.0
%
 
100.0
%
Pathmark - Upper Darby
 
Upper Darby, PA
 
52,791

 
100.0
%
 
100.0
%
Pathmark - Wilmington
 
Wilmington, DE
 
48,622

 
100.0
%
 
100.0
%
Schnucks - Arsenal*
 
St. Louis, MO
 
61,514

 
100.0
%
 
100.0
%
Schnucks - Festus*
 
Festus, MO
 
52,223

 
100.0
%
 
100.0
%
Schnucks - Grand*
 
St. Louis, MO
 
71,985

 
100.0
%
 
100.0
%
Dollar General Store - Anson
 
Anson, TX
 
9,100

 
100.0
%
 
100.0
%
Dollar General Store - East Bernard
 
East Bernard, TX
 
9,014

 
100.0
%
 
100.0
%
City Center (b)
 
White Plains, NY
 
365,905

 
100.0
%
 
100.0
%
Miramar Square
 
Miramar, FL
 
238,334

 
85.6
%
 
85.6
%
Crossing at Killingly Commons
 
Dayville, CT
 
395,084

 
96.5
%
 
100.0
%
Wheatland Town Center
 
Dallas, TX
 
158,103

 
100.0
%
 
100.0
%
Dollar General Store - Hertford*
 
Hertford, NC
 
12,406

 
100.0
%
 
100.0
%
Dollar General Market - Resaca*
 
Resaca, GA
 
20,707

 
100.0
%
 
100.0
%
Landings at Ocean Isle Beach
 
Ocean Isle Beach, NC
 
53,220

 
94.5
%
 
94.5
%
The Corner
 
Tucson, AZ
 
79,902

 
95.5
%
 
100.0
%
University Town Center Phase II
 
Norman, OK
 
259,133

 
96.4
%
 
100.0
%
Dollar General Store - Remlap*
 
Remlap, AL
 
9,100

 
100.0
%
 
100.0
%
Dollar General Market - Canton*
 
Canton, MS
 
20,707

 
100.0
%
 
100.0
%
Cannery Corner
 
Las Vegas, NV
 
44,472

 
84.8
%
 
88.7
%
Centennial Center
 
Las Vegas, NV
 
857,831

 
95.3
%
 
97.5
%
Centennial Gateway
 
Las Vegas, NV
 
193,009

 
89.9
%
 
96.2
%
Eastern Beltway
 
Las Vegas, NV
 
525,226

 
99.8
%
 
100.0
%
Eastgate
 
Henderson, NV
 
96,589

 
87.2
%
 
87.2
%
Lowe's Plaza
 
Las Vegas, NV
 
30,208

 
37.1
%
 
58.8
%
Dollar General Store - Samson*
 
Samson, AL
 
12,480

 
100.0
%
 
100.0
%

7


 
 
 
 
As of December 31, 2013
Property/Type
 
Location
 
Square
Footage/Units
 
Physical
Occupancy
 
Economic
Occupancy (a)
Copps Grocery - Stevens Point
 
Stevens Point, WI
 
69,911

 
100.0
%
 
100.0
%
Office:
 
 
 
 
 
 
 
 
Siemens’ Building
 
Buffalo Grove, IL
 
105,106

 
100.0
%
 
100.0
%
Time Warner Cable Division HQ
 
East Syracuse, NY
 
102,924

 
100.0
%
 
100.0
%
Elementis Worldwide Global HQ
 
East Windsor, NJ
 
65,552

 
100.0
%
 
100.0
%
Hasbro Office Building*
 
Providence, RI
 
135,908

 
100.0
%
 
100.0
%
Industrial:
 
 
 
 
 
 
 
 
Siemens Gas Turbine Service Division
 
Deer Park, TX
 
160,000

 
100.0
%
 
100.0
%
FedEx Distribution Centers*
 
Houston, TX
 
256,815

 
100.0
%
 
100.0
%
Multi-Family:
 
 
 
 
 
 
 
 
The Crossings at Hillcroft
 
Houston, TX
 
300 units

 
92.0
%
 
92.0
%
One Webster
 
Chelsea, MA
 
120 units

 
94.2
%
 
94.2
%
City Center (b)
 
White Plains, NY
 
24 units

 
100.0
%
 
100.0
%
Portfolio Totals
 
 
 
12,521,013 sq. ft.
and 444 units

 
96.1
%
 
97.2
%
(a)
Economic occupancy excludes square footage associated with an earnout component. At the time of acquisition, certain properties have an earnout component to the purchase price, meaning we did not pay a portion of the purchase price at closing for certain vacant spaces, although we own the entire property. We are not obligated to settle this contingent purchase price unless the seller obtains leases for the vacant spaces within the time limits and parameters set forth in the applicable acquisition agreement.
(b)
City Center is a multi-tenant retail property that also includes 24 multifamily units.
* Property was sold to Realty Income in Tranche I Closing on January 31, 2014. Following the Tranche I Closing, we owned interests in 91 retail properties, three office properties and one industrial property, collectively totaling 11.5 million square feet including 24 multi-family units, and two multi-family properties with a total of 420 units.
Assuming the completion of the Net Lease Sale Transactions and the sale of all of the properties contemplated to be sold therein, following the completion of the Net Lease Sale Transactions we will own 57 retail properties, collectively totaling approximately 10.2 million square feet including 24 multi-family units, and two multi-family properties with a total of 420 units.
The following table sets forth a summary, as of December 31, 2013, of lease expirations scheduled to occur during each of the calendar years from 2014 to 2018 and thereafter, assuming no exercise of renewal options or early termination rights for leases commenced on or prior to December 31, 2013 and excluding multi-family leases. 
Lease Expiration Year
Number of
Expiring
Leases
 
Gross Leasable
Area of 
Expiring
Leases -
Square Footage
 
Percent of
Total
Gross Leasable
Area of 
Expiring
Leases
 
Total
Annualized
Base Rent of Expiring Leases (a)
 
Percent of Total
Annualized
Base Rent of Expiring
Leases
 
Annualized Base
Rent per Leased
Square Foot
2014 (b)
114
 
297,176

 
2.5%
 
$
6,377

 
3.5%
 
$
21.46

2015
108
 
326,204

 
2.7%
 
6,446

 
3.6%
 
19.76

2016
144
 
546,347

 
4.5%
 
9,297

 
5.2%
 
17.02

2017
149
 
835,545

 
6.9%
 
14,739

 
8.1%
 
17.64

2018
200
 
1,535,454

 
12.7%
 
24,638

 
13.6%
 
16.05

Thereafter
399
 
8,537,593

 
70.7%
 
119,551

 
66.0%
 
14.00

Leased Total
1,114
 
12,078,319

 
100.0%
 
$
181,048

 
100.0%
 
$
14.99

(a)
Represents the base rent in place at the time of lease expiration.
(b)
Includes month-to-month leases.

8


The following table sets forth the top five tenants in our portfolio based on annualized base rent for leases in-place on December 31, 2013 excluding multi-family leases.
Tenant
Number of
Leases
 
Gross Leasable
Area - Square Footage
 
Percent of
Portfolio Total Gross Leasable
Area
 
Total
Annualized
Base Rent
 
Percent of
Portfolio Total Annualized
Base Rent
 
Annualized Base
Rent per
Square Foot
Kohl’s Department Stores Inc.
10
 
832,839

 
6.7
%
 
$
7,587

 
4.3
%
 
$
9.11

Walgreens
14
 
204,167

 
1.6
%
 
7,299

 
4.1
%
 
35.75

Dollar General
44
 
502,721

 
4.0
%
 
5,077

 
2.9
%
 
10.10

PetSmart
15
 
281,848

 
2.3
%
 
4,277

 
2.4
%
 
15.17

Ross Dress For Less
12
 
342,967

 
2.7
%
 
3,757

 
2.1
%
 
10.95

Top Five Tenants
95
 
2,164,542

 
17.3
%
 
$
27,997

 
15.8
%
 
$
12.93

We believe our properties are adequately covered by insurance and are generally suitable for their intended purposes. Our properties face competition in attracting new tenants and residents, as applicable, and in retaining current tenants and residents, as applicable, from other properties in and around their respective submarkets.

The following table sets forth a summary of tenant diversity for our entire portfolio based on leases in-place on December 31, 2013.
Tenant Type
Square Footage Including Multi-family Units
 
Percent of Total Square Footage
Dollar stores and off price clothing
2,156,783

 
17.3
%
Grocery
1,482,062

 
11.9
%
Lifestyle, health clubs, books and phones
1,289,614

 
10.3
%
Department
1,138,365

 
9.1
%
Home Improvement
768,894

 
6.2
%
Clothing and accessories
722,743

 
5.8
%
Restaurants and fast food
719,646

 
5.8
%
Home goods
675,283

 
5.4
%
Sporting goods
607,968

 
4.9
%
Multi-family
445,309

 
3.6
%
Consumer services, salons, cleaners and banks
430,651

 
3.4
%
Industrial
416,815

 
3.3
%
Commercial office
409,490

 
3.3
%
Pet supplies
406,285

 
3.2
%
Health, doctors and health food
396,876

 
3.2
%
Electronics
254,276

 
2.0
%
Other
166,327

 
1.3
%
Total
12,487,387

 
100.0
%
Item 3. Legal Proceedings
We are not a party to, and none of our properties is subject to, any material pending legal proceedings.

Item 4. Mine Safety Disclosures
Not applicable.


9


PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
All dollar amounts are stated in thousands, except per share amounts.
Market Information
There is no established public trading market for our shares of common stock.
The Financial Industry Regulatory Authority, or “FINRA,” requires registered broker-dealers, including the soliciting dealers who had sold shares in our initial “best efforts” public offering, to disclose in customer account statements an estimated per share value of our common stock if our annual report discloses an estimated per share value. FINRA rules currently prohibit broker-dealers from using an estimated per share value developed from data that is more than eighteen months old. As a result, broker-dealers are prohibited from disclosing on a customer account statement a per share value derived from the per share public offering price from our best efforts public offering for more than eighteen months following the termination of the offering. Our initial best efforts public offering terminated in August 2012.
On February 19, 2014, for the sole purpose of assisting broker-dealers that sold our common stock in our initial best efforts public offering to comply with the rules regarding account statement reporting published by FINRA, our board of directors, including our independent directors, adopted an estimated per share value of our common stock as of February 18, 2014 of $10.70. As discussed in Part I, Item 1 of this Annual Report on Form 10-K, “Business-Formation,” on February 9, 2014, we entered into the Merger Agreement with Kite. Pursuant to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of our common stock will be converted into the right to receive Kite common shares, based on:
an exchange ratio of 1.707 Kite common shares for each share of our common stock if the Reference Price is equal to or less than $6.36;
a floating exchange ratio if the Reference Price is more than $6.36 or less than $6.58 (with such floating exchange ratio being determined by dividing $10.85 by the Reference Price); and
an exchange ratio of 1.650 Kite common shares for each share of our common stock if the Reference Price is $6.58 or greater.
The $10.70 estimated per share value as of February 18, 2014 was determined by multiplying (i) the final closing price of the Kite common shares on February 18, 2014 of $6.27 per share by (ii) the exchange ratio of 1.707 Kite common shares for each share of our common stock, which is the exchange ratio that would be applied at the effective time of the merger if the Reference Price was equal to the $6.27 per share closing price of the Kite common shares on February 18, 2014. In accordance with the requirements of FINRA, beginning on February 21, 2014, we made available to broker-dealers information for inclusion in the customer account statements they provide to holders of our common stock that referenced the $10.70 estimated per share value of our common stock as of February 18, 2014. The estimated per share value as of February 18, 2014 was calculated as of a moment in time based solely upon the final closing price of the Kite common shares on February 18, 2014. The trading price of the Kite common shares will fluctuate daily, and as a result the Reference Price (which will be calculated based on the ten day volume-weighted average trading price of Kite common shares, rather than a single day’s closing price) actually used to determine the exchange ratio for our common stock at the effective time of the Merger may differ significantly from the assumed Reference Price of $6.27 per share used to determine our estimated per share value as of February 18, 2014. Therefore, the estimated per share value as of February 18, 2014 most likely does not represent the actual per share value of the Kite common shares that our stockholders would receive pursuant to the Merger or the price that our stockholders would receive if they were able to sell their shares of our common stock prior to the closing of the Merger.
Stockholders
As of March 3, 2014, we had 117,809,586 shares of common stock outstanding, held by 27,616 stockholders of record. The number of stockholders is based on the records of DST Systems, Inc., which serves as our registrar and transfer agent.
Distributions
We currently pay distributions based on daily record dates, payable monthly in arrears. For 2013, we paid distributions that equal to a daily amount equal to $0.00164384, which if paid each day for the 365-day period, would equal to $0.60 per share or

10


a 6.0% annualized rate based on a purchase price of $10.00 per share. During the years ended December 31, 2013, 2012 and 2011, we paid cash distributions, which were paid monthly in arrears to stockholders, totaling $69,824, $51,767, and $23,641, respectively. For federal income tax purposes for the years ended December 31, 2013, 2012 and 2011, 39%, 38% and 27% of the distributions constituted a non-dividend distribution, respectively.
Notification Regarding Payments of Distributions
Stockholders should be aware that the method by which a stockholder has chosen to receive his or her distributions affects the timing of the stockholder's receipt of those distributions. Specifically, under our transfer agent's payment processing procedures, distributions are paid in the following manner:
(1) those stockholders who have chosen to receive their distributions via ACH wire transfers receive their distributions on the distribution payment date (as determined by our board of directors);
(2) those stockholders who have chosen to receive their distributions by paper check are typically mailed those checks on the distribution payment date, but sometimes paper checks are mailed on the day following the distribution payment date; and
(3) for those stockholders holding shares through a broker or other nominee, the distributions payments are wired, or paper checks are mailed, to the broker or other nominee on the day following the distribution payment date.
All stockholders who hold shares directly in record name may change at any time the method through which they receive their distributions from our transfer agent, and those stockholders will not have to pay any fees to us or our transfer agent to make such a change. Accordingly, each stockholder may select the timing of receipt of distributions from our transfer agent by selecting the method above that corresponds to the desired timing for receipt of the distributions.
On November 13, 2013 our board of directors voted to suspend the DRP until further notice, effective immediately. If the DRP is reinstated, all stockholders are eligible to participate at no cost in our DRP. Because all stockholders may elect to have their distributions sent via ACH wire on the distribution payment date or credited on the distribution payment date to their DRP, we will treat all of our stockholders, regardless of the method by which they have chosen to receive their distributions, as having constructively received their distributions from us on the distribution payment date for federal income tax purposes. In the event the Merger does not occur, we plan to reinstate the DRP.
Stockholders who hold shares directly in record name and who would like to change their distribution payment method should complete a “Change of Distribution Election Form.”
We note that the payment method for stockholders who hold shares through a broker or nominee is determined by the broker or nominee. Similarly, the payment method for stockholders who hold shares in a tax-deferred account, such as an IRA, is generally determined by the custodian for the account. Stockholders that currently hold shares through a broker or other nominee and would like to receive distributions via ACH wire or paper check should contact their broker or other nominee regarding their processes for transferring shares to record name ownership. Similarly, stockholders who hold shares in a tax deferred account may need to hold shares outside of their tax-deferred accounts to change the method through which they receive their distributions. Stockholders who hold shares through a tax-deferred account and who would like to change the method through which they receive their distributions should contact their custodians regarding the transfer process and should consult their tax advisor regarding the consequences of transferring shares outside of a tax-deferred account.
Share Repurchase Program
We adopted a share repurchase program (“SRP”), effective August 24, 2009. The SRP was amended and restated effective as of May 20, 2010. On November 13, 2013 our board of directors voted to suspend the amended and restated SRP until further notice, effective December 13, 2013. We do not anticipate that the board of directors will resume our SRP while the Merger is pending. In the event the Merger does not occur, our board of directors may consider reinstatement of the SRP.
As a result of the suspension of the SRP, all redemption requests received from stockholders during the fourth quarter of 2013 on or before December 13, 2013 and that were determined by us to be in good order on or before December 13, 2013 were honored in accordance with the terms, conditions and limitations of the SRP. We did not process or accept any requests for redemption received after December 13, 2013 and will not process or accept any future requests until such time as our board of directors may approve resumption of the SRP.
Under the SRP, we could make “ordinary repurchases,” which are defined as all repurchases other than upon the death of a stockholder, at prices ranging from 92.5% of the “share price,” as defined in the SRP, for stockholders who have owned their shares continuously for at least one year, but less than two years, to 100% of the “share price” for stockholders who have owned their shares continuously for at least four years. In the case of “exceptional repurchases,” which are defined as

11


repurchases upon the death of a stockholder, we could repurchase shares at a repurchase price equal to 100% of the “share price.”
With respect to ordinary repurchases, we could make repurchases only if we had sufficient funds available to complete the repurchase. In any given calendar month, we were authorized to use only the proceeds generated from our DRP during that month to fund ordinary repurchases under the program; provided that, if we had excess funds during any particular month, we could, but are not obligated to, carry those excess funds to the subsequent calendar month for the purpose of making ordinary repurchases. Subject to funds being available, in the case of ordinary repurchases, we further would limit the number of shares repurchased during any calendar year to 5% of the number of shares of common stock outstanding on December 31st of the previous calendar year. With respect to exceptional repurchases, we were authorized to use all available funds to repurchase shares. In addition, the one-year holding period and 5% limit described herein would not apply to exceptional repurchases. We must, however, receive the written request for an exceptional repurchase within one year after the death of the stockholder.
The SRP will immediately terminate if our shares are listed on any national securities exchange. In addition, our board of directors, in its sole discretion, may amend, suspend (in whole or in part), or terminate our SRP. In the event that we amend, suspend or terminate the SRP, however, we will send stockholders notice of the amendment, suspension or termination at least thirty days prior to the effective date thereof, and we will disclose the amendment, suspension or termination in a report filed with the Securities and Exchange Commission on either Form 8-K, Form 10-Q or Form 10-K, as appropriate. Further, our board reserves the right in its sole discretion at any time and from time to time to reject any requests for repurchases. For the years ended December 31, 2013 and 2012, we processed all of the requests we received for share repurchases.
The table below outlines the shares of common stock we repurchased during the quarter ended December 31, 2013, pursuant to the SRP.
 
Total Requests Received for Shares Repurchased
 
Total Number of Shares Repurchased
 
Average Price Paid per Share
 
Total Number of Shares Repurchased as Part of Publicly Announced Plans or Programs
 
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
October 2013
73,003

 
73,003

 
$
9.43

 
73,003

 
(1)
November 2013
117,047

 
117,047

 
$
9.58

 
117,047

 
(1)
December 2013
117,460

 
117,460

 
$
9.63

 
117,460

 
(1)
Total
307,510

 
307,510

 
$
9.60

 
307,510

 
(1)
(1)
A description of the maximum number of shares that may be purchased under our repurchase program is included in the narrative preceding this table.
Securities Authorized for Issuance under Equity Compensation Plans
None.
Use of Proceeds from Registered Securities
None.
Recent Shares of Unregistered Securities
None.

12


Item 6. Selected Financial Data
The following table shows our selected financial data relating to our consolidated historical financial condition and results of operations. This selected data should be read in conjunction with “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto appearing elsewhere in this annual report (all amounts are in thousands, except share and per share amounts).
 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Total assets
$
2,327,598

 
$
2,393,523

 
$
1,010,386

 
$
450,114

 
$
26,439

Mortgages, credit facility and securities margin payable including held for sale
$
1,248,273

 
$
1,249,422

 
$
464,956

 
$
192,871

 
$

 
For the years ended December 31,
 
 
 
2013
 
2012
 
2011
 
2010
 
2009
Total income
$
185,808

 
$
113,364

 
$
64,430

 
$
16,504

 
$
96

Net (loss) income attributable to common stockholders
$
(283
)
 
$
2,616

 
$
(2,279
)
 
$
(1,743
)
 
$
(297
)
Net (loss) income attributable to common stockholders per common share, basic and diluted (a)
$
0.00

 
$
0.03

 
$
(0.05
)
 
$
(0.13
)
 
$
(0.81
)
Distributions declared to common stockholders
$
70,002

 
$
54,687

 
$
25,263

 
$
8,203

 
$
212

Distributions per weighted average common share (a)
$
0.60

 
$
0.60

 
$
0.60

 
$
0.60

 
$
0.15

Cash flows provided by (used in) operating activities
$
84,333

 
$
56,670

 
$
27,872

 
$
2,658

 
$
(342
)
Cash flows used in investing activities
$
(43,606
)
 
$
(1,215,402
)
 
$
(454,168
)
 
$
(346,755
)
 
$
(9,691
)
Cash flows (used in) provided by financing activities
$
(44,793
)
 
$
1,134,777

 
$
445,649

 
$
369,262

 
$
25,369

Weighted average number of common shares outstanding, basic and diluted
116,667,708

 
91,146,154

 
42,105,681

 
13,671,936

 
367,888

(a)
The net (loss) income attributable to common stockholders, per common share basic and diluted is based upon the weighted average number of common shares outstanding for the year or period ended. The distributions per common share are based upon the weighted average number of common shares outstanding for the year or period ended.

13


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Certain statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Annual Report on Form 10-K constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Words such as “may,” “could,” “should,” “expect,” “intend,” “plan,” “goal,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “variables,” “potential,” “continue,” “expand,” “maintain,” “create,” “strategies,” “likely,” “will,” “would” and variations of these terms and similar expressions, or the negative of these terms or similar expressions, are intended to identify forward-looking statements.
These forward-looking statements are not historical facts but reflect the intent, belief or current expectations of the management of Inland Diversified Real Estate Trust, Inc. (which we refer to herein as the “Company,” “we,” “our” or “us”) based on their knowledge and understanding of the business and industry, the economy and other future conditions. These statements are not guarantees of future performance, and we caution stockholders not to place undue reliance on forward-looking statements. Actual results may differ materially from those expressed or forecasted in the forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to the factors listed and described under “Risk Factors” in this Annual Report on Form 10-K and the factors described below:
our investment policies and strategies are very broad and permit us to invest in numerous types of commercial real estate;
if we cannot generate sufficient cash flow from operations to fully fund distributions, some or all of our distributions may be paid from other sources, including cash flow generated by investing activities, which will reduce the amount of money available to invest in assets;
no established public trading market currently exists, and one may never exist, for our shares, and we are not required to liquidate;
we may borrow up to 300% of our net assets, and principal and interest payments will reduce the funds available for distribution;
we do not have employees and rely on our Business Manager and Real Estate Managers to manage our business and assets;
employees of our Business Manager and three of our directors are also employed by our Sponsor or its affiliates and face competing demands for their time and service and may have conflicts in allocating their time to our business and assets;
we do not have arm’s length agreements with our Business Manager, Real Estate Managers or any other affiliates of our Sponsor;
we may pay significant fees to our Business Manager, Real Estate Managers and other affiliates of our Sponsor;
our Business Manager could recommend investments in an attempt to increase its fees which are generally based on a percentage of our invested assets and, in certain cases, the purchase price for the assets;
in connection with the pending Merger, some of our tenants or vendors may delay or defer decisions, which could negatively impact our revenues, earnings, cash flows and expenses regardless of whether the Merger is completed;
the Merger may not be consummated on the terms described in the Merger Agreement or at all, which could adversely affect our ongoing business and expose us to a number of risks, including but not limited to significant transaction costs incurred by us related to the Merger and potential termination fee payable by us to Kite in certain circumstances; and
we may fail to continue to qualify as a REIT.
Forward-looking statements in this Annual Report on Form 10-K reflect our management’s view only as of the date of this Report, and may ultimately prove to be incorrect or false. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results. We intend for these forward-looking statements to be covered by the applicable safe harbor provisions created by Section 27A of the Securities Act and Section 21E of the Exchange Act.
The following discussion and analysis relates to the years ended December 31, 2013, 2012 and 2011 and as of December 31, 2013 and 2012. You should read the following discussion and analysis in conjunction with the “Selected Financial Data” section of this annual report and our consolidated financial statements and the related notes included in this report. Unless otherwise noted, all dollar amounts are stated in thousands, except share data, per share amounts, rent per square foot, and rent per unit.
Overview
We are a Maryland corporation sponsored by Inland Real Estate Investment Corporation (“IREIC” or the “Sponsor”), formed to acquire and develop commercial real estate located in the United States and Canada. We also may invest in other real estate assets such as interests in real estate investment trusts, or REITs, or other “real estate operating companies” that own these assets, joint

14


ventures and commercial mortgage debt. We may originate or invest in real estate-related loans made to third parties. Our primary investment objectives are to balance investing in real estate assets that produce attractive current yield and long-term risk-adjusted returns to our stockholders, with our desire to preserve stockholders’ capital and to pay sustainable and predictable distributions to our stockholders. We elected to be taxed as a REIT commencing with the tax year ended December 31, 2009 and intend to continue to qualify as a REIT for federal income tax purposes.
On August 24, 2009, we commenced our initial public offering of up to 500,000,000 shares of our common stock to the public at a price of $10.00 per share on a “best efforts” basis and up to 50,000,000 shares of our common stock at a price of $9.50 per share to our stockholders pursuant to our distribution reinvestment plan, or “DRP.” The dealer manager of our public offering was Inland Securities Corporation, a wholly owned subsidiary of our Sponsor. The “best efforts” portion of the offering was completed on August 23, 2012. As of the termination of our best efforts public offering on August 23, 2012, we sold a total of 110,485,936 shares, generating $1,099,311 in aggregate gross offering proceeds. Following the termination of the best efforts portion of the offering, we filed another registration statement to permit us to continue offering and selling shares of common stock to stockholders who choose to participate in the DRP. On November 13, 2013, our board of directors voted to suspend the DRP, effective immediately. In our initial public offering we sold 119,839,478 shares, including 9,353,542 shares pursuant to the DRP, generating $1,188,170 in aggregate gross offering proceeds.
At December 31, 2013, we owned 135 retail properties, four office properties, and two industrial properties collectively totaling 12.5 million square feet including 24 multi-family units and two multi-family properties totaling 420 units. As of December 31, 2013, our combined portfolio had weighted average physical and economic occupancy of 96.1% and 97.2%, respectively. Economic occupancy excludes square footage associated with an earnout component. At the time of acquisition, certain properties have an earnout component to the purchase price, meaning we did not pay a portion of the purchase price at closing related to certain vacant spaces, although we own the entire property. We are not obligated to settle this contingent purchase price obligation unless the seller obtains leases for the vacant space within the time limits and parameters set forth in the applicable acquisition agreement.
As of December 31, 2013 and 2012, annualized base rent per square foot averaged $13.69 and $13.51, respectively for all properties other than the multi-family properties and $12,415 and $12,098 per unit, respectively for the multi-family properties. Annualized base rent is calculated by annualizing the current, in-place monthly base rent for leases, including any tenant concessions, such as rent abatement or allowances, which may have been granted.
Net Lease Sale Transactions
On December 16, 2013, we, Inland Diversified Cumming Market Place, L.L.C., a Delaware limited liability company and our subsidiary, and Bulwark Corporation, a Delaware corporation and our subsidiary, entered into the Purchase and Sale Agreements with Realty Income. The Purchase and Sale Agreements collectively provide for the sale of the Net Lease Properties to Realty Income in a series of transactions which we refer to as the “Net Lease Sale Transactions.”
The Purchase and Sale Agreements provide that the Net Lease Properties will be sold in multiple separate tranches. The closing of each tranche is subject to the satisfaction of various closing conditions. On January 31, 2014, we closed the first tranche of Net Lease Properties, the Tranche I Closing, resulting in the sale to Realty Income of a total of 46 of the Net Lease Properties for an aggregate cash purchase price of approximately $201,955. The Tranche I Closing resulted in net proceeds to us of $126,312. Subject to the satisfaction of all closing conditions, the sale of the remainder of the Net Lease Sale Transactions is expected to close by April 30, 2014. However, there are no assurances that the remainder of the Net Lease Sale Transactions will be consummated on the expected timetable, or at all.
Following the Tranche I Closing, our portfolio consisted of 91 retail properties, three office properties and one industrial property collectively totaling 11.5 million square feet including 24 multi-family units and two multi-family properties totaling 420 units.
Proposed Merger
On February 9, 2014, we entered into the Merger Agreement with Kite and Merger Sub. The Merger Agreement provides for, upon the terms and conditions of the Merger Agreement, the merger of the Company with and into Merger Sub, with Merger Sub surviving the Merger as a direct wholly owned subsidiary of Kite. Pursuant to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of our common stock will be converted into the right to receive Kite Common Shares, based on:
an exchange ratio of 1.707 Kite Common Shares for each share of our common stock if the volume-weighted average trading price of Kite Common Shares for the ten consecutive trading days ending on the third trading day preceding the meeting of our stockholders to approve the Merger (the “Reference Price”) is equal to or less than $6.36;
a floating exchange ratio if the Reference Price is more than $6.36 or less than $6.58 (with such floating exchange ratio being determined by dividing $10.85 by the Reference Price); and
an exchange ratio of 1.650 Kite Common Shares for each share of our common stock if the Reference Price is $6.58 or greater.

15


Pursuant to the Merger Agreement, upon the effective time of the merger, the board of trustees of Kite will consist of nine members, six of whom will be current trustees of Kite and three of whom will be designated by us.
The completion of the Merger is subject to a number of closing conditions, including, among others: (i) approval by Kite’s stockholders and our stockholders, including the approval of Kite’s stockholders of an amendment to Kite’s declaration of trust to increase the number of Kite Common Shares that Kite is authorized to issue; (ii) the absence of a material adverse effect on either us or Kite; (iii) the receipt of tax opinions relating to the REIT status of Kite and the Company and the tax-free nature of the transaction; (iv) the completion of the Net Lease Sale Transactions; and (v) the completion of the redeployment of certain proceeds from the Net Lease Sale Transactions to acquire replacement properties for purposes of Section 1031 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). As a result of the closing conditions to which the Merger is subject, there are no assurances that the proposed Merger will be consummated on the expected timetable, or at all. If the closing conditions are satisfied, it is anticipated that the Merger may close during the second or third quarter of 2014.
The Merger Agreement may be terminated under certain circumstances, including by either us or Kite if the Merger has not been consummated on or before the outside date of August 31, 2014, subject to extension under certain circumstances. The Merger Agreement provides that, in connection with the termination of the Merger Agreement under specified circumstances, we may be required to pay to Kite a termination fee of $43,000 and/or reimburse Kite’s transaction expenses up to an amount equal to $8,000. Where termination is in connection with a failure to close the Net Lease Sale Transactions, we may be required to (i) reimburse Kite for its transaction expenses up to an amount equal to $8,000 and (ii) pay Kite a termination fee of $3,000. The Merger Agreement also provides that, under specified circumstances, Kite may be required to pay us a termination fee of $30,000 and/or reimburse our transaction expenses up to an amount equal to $8,000. Under certain circumstances, including upon payment of the applicable termination fee, either party is permitted to terminate the Merger Agreement to enter into a definitive agreement with a third party with respect to a superior acquisition proposal.
In connection with the execution of Merger Agreement, we entered into the Master Agreement with the Business Manager, the Real Estate Managers, and certain other affiliates of the Business Manager. The Master Agreement sets forth the terms of the consideration due to the Business Manager and the Real Estate Managers in connection with the Merger, provides for the automatic termination upon the closing of the Merger of our agreements with the Business Manager and the Real Estate Managers and certain other agreements between us and affiliates of the Business Manager and includes certain other agreements in order to facilitate the Merger. See Part III, Item 13 of this Annual Report on Form 10-K, “Certain Relationships and Related Transactions, and Director Independence,” for additional information.
Market Outlook
After almost three years of uneven growth, the economy has improved to a level at which most indicators show progress has been achieved and some consumer confidence has returned. The unemployment rate has broken below the 7% range for the first time in several quarters. The Dow Jones Industrial Average has been at a record high for almost all of 2014. And in the real estate industry, we have seen increases in rental and occupancy rates over the past year. Our portfolio is reflective of this trend in that rental rates have increased and our economic occupancy levels have remained above 97% since we began operating.
There are other signs of progress. Development activity has reached a level not seen since 2007. We feel this signifies demand for space by tenants who can no longer satisfy their needs by backfilling existing shopping centers. We expect that this also means that construction lenders are providing funds to the industry. To date, our portfolio has benefitted from lower levels of competition resulting from sparse development activity, yet no industry can survive without at least some growth. We believe that demand based growth of retail tenants means corresponding demand from their customers, a healthy sign for everyone.
We are faced with a constantly changing environment, bringing new challenges to the industry. Our industry knowledge leads us to believe most operators of retail real estate portfolios are attempting to decrease their exposure to tenants who are affected by internet business. Many such tenants are closing their doors, or downsizing the size of their stores. The profile of a typical shopping center includes fewer book stores, electronics retailers and smaller office supply space. Instead, we are seeing service businesses, health clubs and upscale value oriented stores replace them. Other retailers have innovated to meet this challenge by offering same day delivery of items purchased in store or over the internet.
Our acquisition philosophy has been to acquire newer, well located properties occupied by tenants who provide necessity based goods and services. Our property management philosophy has been to work with our tenants to help ensure their success in light of specific or industry wide challenges. With a moderately improving economy, a portfolio built upon conservative principles and our dedication to focused management, we are optimistic as we enter 2014.
Liquidity and Capital Resources
General
Our principal demands for funds are to acquire real estate and real estate-related assets, to pay capital expenditures including tenant improvements, to pay our operating expenses including property operating expenses, to pay principal and interest on our outstanding

16


indebtedness, to fund repurchases of previously issued common stock and to pay distributions to our stockholders. We seek to fund our cash needs for items other than asset acquisitions, capital expenditures and related financings from operations. Our cash needs for acquisitions (including any contingent earnout payments), capital improvements and related financings have been funded primarily from the sale of our shares, including through our DRP, as well as debt financings. For the years ended December 31, 2013, 2012 and 2011, $38,286, $31,349 and $14,657, respectively, have been provided by the DRP which have been used to fund redemptions and other capital needs. On November 13, 2013, our board of directors voted to suspend the DRP, effective immediately, and the SRP, effective December 13, 2013. We do not believe that the suspension of the DRP will have a material impact on our ability to fund capital needs. Our primary source to fund our future cash needs, including cash to fund earnout payments, are expected to come from our undistributed cash flow from operations as well as secured or unsecured financings, including proceeds from lines of credit. The maximum total earnout payments which are expected to be paid in cash, issuance of redeemable noncontrolling interests by our consolidated joint ventures or from proceeds from mortgages payable during the next three years related to our acquisitions was $32,906 at December 31, 2013 and will not materially affect our liquidity. During the years ended December 31, 2013, we paid $8,806 related to construction in progress, capital expenditures and tenant improvements. We anticipate capital expenditures including tenant improvements to further increase in future years relating to signing new leases as our tenant's leases expire and as our properties age. These costs may be material.
On December 16, 2013, we entered into the Purchase and Sale Agreements with Realty Income. All or the majority of the net proceeds from the Net Lease Sale Transactions will be used to pay down the line of credit and mortgage debt secured by the remaining properties held by the Company. The Tranche I Closing occurred on January 31, 2014, from which we received approximately $126,312 in net proceeds.
As of December 31, 2013, $52,500 was outstanding on our line of credit with an interest rate of 2.14% per annum which was subsequently repaid on January 31, 2014. We may borrow, on an unsecured basis, up to $105,000 on the line of credit. Our general strategy is to target borrowing 55% of the total value of our assets on a portfolio basis. As of December 31, 2013, our borrowings did not exceed our target of 55% of the total value of our assets. For these purposes, the value of each asset is equal to the purchase price paid for the asset or the value reported in the most recent appraisal of the asset, whichever is the later to occur. Our charter limits the amount we may borrow to 300% of our net assets (as defined in our charter) unless any excess borrowing is approved by the board of directors including a majority of the independent directors and is disclosed to our stockholders in our next quarterly report along with justification for the excess. As of December 31, 2013, our borrowings did not exceed 300% of our net assets and we had a principal balance outstanding on mortgage loans of $1,184,256 with a weighted average stated interest rate including interest rate swaps of 4.30% per annum. As of December 31, 2013, we had $247,278 or 19.8% of our total outstanding debt that bore interest at variable rates, at a weighted average interest rate equal to 2.25% per annum, including the effect of interest rate swaps. This variable rate debt will begin to mature in 2015. As of December 31, 2013, we had $999,819 or 80.2% of our total outstanding debt that bore interest at fixed rates at a weighted average interest rate equal to 4.66% per annum. As of December 31, 2013, we had $7,638 of fixed rate debt maturing by the end of 2014 with a weighted average interest rate equal to 5.84% per annum of which $6,720 was repaid on March 10, 2014. See “Quantitative and Qualitative Disclosures About Market Risk” below.
As of December 31, 2013, our consolidated joint ventures had issued $67,950 in noncontrolling interests that will become redeemable at future dates generally no earlier than in 2015 but generally no later than 2022 based on certain redemption criteria. The redeemable noncontrolling interests are not mandatorily redeemable. At the noncontrolling interest holders’ option, we may be required to pay cash, but if the noncontrolling interest holder elects to redeem its interest for the Company’s stock, we have the option to pay cash, issue common stock, or a mixture of both.
As of December 31, 2013, we had invested $34,070 in marketable securities, primarily in real estate-related equity securities issued by publicly traded companies and publicly traded corporate bonds and had borrowed $10,341 on margin.
As of December 31, 2013 and December 31, 2012, we owed $2,074 and $2,532, respectively, to our Sponsor and its affiliates for business management fees not otherwise waived, advances from these parties used to pay administrative costs and certain accrued expenses which are included in due to related parties on the consolidated balance sheets. These amounts represent non-interest bearing advances by the Sponsor and its affiliates, which the Company has subsequently repaid.
Distributions
All or the majority of the net proceeds from the Net Lease Sale Transactions will be used to pay down the line of credit and mortgage debt secured by the remaining properties held by the Company and will not be distributed to stockholders as stated in the Merger Agreement. We generated sufficient cash flow from operations, determined in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), to fully fund distributions paid during the years ended December 31, 2013. Cash retained by us of $164 from the waiver of the business management fee for the years ended December 31, 2013 by our Business Manager had the effect of increasing cash flow from operations for this period because we did not have to use cash to pay the fee. However, even if the Business Manager had not waived this business management fee during the years ended December 31, 2013, we would have still generated sufficient cash flow from operations to fund the distributions paid for the period. There is no assurance that any deferral or waiver of any fee or reimbursement will be available to fund distributions in the future.

17


We intend to fund cash distributions to our stockholders from cash generated by our operations. Cash generated by operations is not equivalent to our net income from continuing operations as determined under U.S. GAAP or our taxable income for federal income tax purposes. If we are unable to generate sufficient cash flow from operations, determined in accordance with U.S. GAAP, to fully fund distributions, some or all of our distributions may be paid from cash flow generated from investing activities, including the net proceeds from the sale of our assets. In addition, we may fund distributions from, among other things, advances or contributions from our Business Manager or IREIC or from the cash retained by us in the case that our Business Manager defers or waives all, or a portion, of its business management fee, or waives its right to be reimbursed for certain expenses. As noted above a deferral or waiver of any fee or reimbursement owed to our Business Manager has the effect of increasing cash flow from operations for the relevant period because we do not have to use cash to pay any fee or reimbursement which was deferred or waived during the relevant period. We will, however, use cash in the future if we pay any fee or reimbursement that was deferred. Neither our Business Manager nor IREIC has any obligation to provide us with advances or contributions, and our Business Manager is not obligated to defer or waive any portion of its business management fee or reimbursements. Further, there is no assurance that these other sources will be available to fund distributions.
We have not funded any distributions from the net proceeds from the sale of our shares but may need to if the Merger Agreement is delayed or does not close. In addition, we have not funded any distributions from the proceeds generated by borrowings, and do not intend to do so.
We intend to continue paying distributions for future periods in the amounts and at times as determined by our board of directors.
During the years ended December 31, 2013, 2012 and 2011, we paid distributions in the amount of $69,824, $51,767 and $23,641 respectively. These distributions were funded from cash flows from operations determined in accordance with U.S. GAAP.
One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations determined under U.S. GAAP. Cash generated from operations is not equivalent to our net income from continuing operations as determined under U.S. GAAP.
A summary of the distributions declared, distributions paid and cash flows provided by operations for the years ended December 31, 2013, 2012 and 2011 follows:
Distributions Paid
Year Ended December 31,
 
Distributions Declared
 
Distributions Declared Per Share (1)
 
Cash
 
Reinvested via DRP (2)
 
Total
 
Cash Flows From Operations
 
Funds From Operations (3)
2013
 
$
70,002

 
$
0.60

 
$
31,538

 
$
38,286

 
$
69,824

 
$
84,333

 
$
88,999

2012
 
$
54,687

 
$
0.60

 
$
20,418

 
$
31,349

 
$
51,767

 
$
56,670

 
$
55,830

2011
 
$
25,263

 
$
0.60

 
$
8,984

 
$
14,657

 
$
23,641

 
$
27,872

 
$
26,672

(1)
Assumes a share was issued and outstanding each day during the period.
(2)
On November 13, 2013, the Company's board of directors voted to suspend the DRP until further notice, effective immediately.
(3)
Funds from operations is defined in the following section.
Share Repurchase Program
We have a share repurchase program that provides limited liquidity to eligible stockholders. During the year ended December 31, 2013, we received requests to repurchase 947,968 shares and used $9,100 to repurchase all 947,968 requested shares at an average per share repurchase price during this period of $9.60. Since the start of the program through December 31, 2013, we have used $19,604 to repurchase an aggregate of 2,049,892 shares. These repurchases were funded from proceeds from our DRP. On November 13, 2013, the Company's board of directors voted to suspend the SRP until further notice, effective December 13, 2013. Written notice of the suspension was provided to each stockholder pursuant to the terms of the SRP.
Cash Flow Analysis
 
For the Years Ended December 31,
 
2013
 
2012
 
2011
Net cash flows provided by operating activities
$
84,333

 
$
56,670

 
$
27,872

Net cash flows used in investing activities
$
(43,606
)
 
$
(1,215,402
)
 
$
(454,168
)
Net cash flows (used in) provided by financing activities
$
(44,793
)
 
$
1,134,777

 
$
445,649

Net cash provided by operating activities was $84,333, $56,670 and $27,872 for the years ended December 31, 2013, 2012 and 2011, respectively. The funds generated in 2013, 2012 and 2011 were primarily from property operations from our real estate portfolio. The increase from 2011 to 2012 as well as 2012 to 2013 is due to the growth of our real estate portfolio and related, full period, property operations.

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Net cash flows used in investing activities was $43,606, $1,215,402 and $454,168 for the years ended December 31, 2013, 2012 and 2011, respectively. We used $44,945, $1,191,719 and $447,559 during the years ended December 31, 2013, 2012 and 2011, respectively, to purchase properties. We had $6,297 provided by net repayment of notes receivables during the year ended December 31, 2013, and used $19,543 and $12,362 to purchase marketable securities net of sales during the years ended December 31, 2012 and 2011, respectively.
Net cash flows (used in) provided by financing activities was $(44,793), $1,134,777 and $445,649 for the years ended December 31, 2013, 2012 and 2011, respectively. Of these amounts, cash flows from financing activities of $38,286, $31,349 and $14,657, resulted from the sale of our common stock through our DRP during the years ended December 31, 2013, 2012 and 2011, respectively. We used $69,824, $51,767 and $23,641 during the years ended December 31, 2013, 2012 and 2011, respectively, to pay distributions to our stockholders. During the years ended December 31, 2012 and 2011, we generated $536,094 and $308,222, respectively through our “best efforts” offering which was completed on August 23, 2012. During the years ended December 31, 2013, 2012 and 2011, we generated $27,674, $675,470 and $185,697, respectively, from net loan proceeds from borrowings secured by properties in our portfolio. During the year ended December 31, 2013, we used $28,531 to pay down our credit facility and securities margin payable. During the year ended December 31, 2012, we generated $16,580, from net borrowings from securities margin debt. We also used $54,269 and 33,741 to pay offering costs during the years ended December 31, 2012 and 2011, respectively.
 
Results of Operations
The following discussions are based on our consolidated financial statements for the three and years ended December 31, 2013, 2012 and 2011.
We generate almost all of our net operating income from property operations. In order to evaluate our overall portfolio, management analyzes the net operating income of properties that we have owned and operated for both periods presented, in their entirety, referred to herein as “same store” properties. By evaluating the property net operating income of our “same store” properties, management is able to monitor the operations of our existing properties for comparable periods to measure the performance of our current portfolio and determine the effects of our new acquisitions on net income. Property net operating income, a non-U.S. GAAP measure, is also meaningful as an indicator of the effectiveness of our management of properties because property net operating income excludes certain items that are not reflective of the effectiveness of our management, such as depreciation and amortization and interest expense.
Comparison of the years ended December 31, 2013 and 2012
A total of 32 of our investment properties are considered “same store” properties during the years ended December 31, 2013 and 2012. These “same store” properties are properties classified as held and used that were acquired on or before January 1, 2012. Our “Other investment properties,” as reflected in the table below, include one redevelopment property and properties classified as held and used that were acquired after January 1, 2012. For the years ended December 31, 2013 and 2012, 27 and 26 properties were included in “other investment properties,” respectively. The following table presents the property net operating income (reconciled to U.S. GAAP net income) broken out between “same store” and “other investment properties,” prior to straight-line rental income, amortization of lease intangibles, interest, depreciation, amortization and bad debt expense for the years ended December 31, 2013 and 2012 along with a reconciliation to net income attributable to common stockholders, calculated in accordance with U.S. GAAP.
We had 84 Net Lease Properties held for sale as of December 31, 2013, pursuant to the Purchase and Sale Agreements with Realty Income. These properties are excluded from the “same store” and “other investment properties,” and are included in income from discontinued operations.

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Year December 31,
 
2013
 
2012
Property operating revenue:
 
 
 
“Same store” investment properties, 32 properties:
 
 
 
   Rental income
$
69,314

 
$
68,498

   Tenant recovery income
15,965

 
15,881

   Other property income
2,009

 
2,099

Other investment properties:
 
 
 
   Rental income
69,810

 
21,756

   Tenant recovery income
18,662

 
5,689

   Other property income
4,526

 
233

Total property income
180,286

 
114,156

 
 
 
 
Property operating expenses:
 
 
 
“Same store” investment properties, 32 properties:
 
 
 
   Property operating expenses
15,934

 
15,095

   Real estate taxes
9,950

 
9,712

Other investment properties:
 
 
 
   Property operating expenses
16,677

 
4,305

   Real estate taxes
10,614

 
3,589

Total property operating expenses
53,175

 
32,701

 
 
 
 
Property net operating income:
 
 
 
   “Same store” investment properties, 32 properties
61,404

 
61,671

   Other investment properties
65,707

 
19,784

Total property net operating income
127,111

 
81,455

 
 
 
 
Other income:
 
 
 
   Tenant recovery income related to prior periods
938

 
(394
)
   Straight-line rents
4,082

 
2,725

   Amortization of lease intangibles
(2,443
)
 
(2,274
)
   Fair value adjustment of earnout liability
2,945

 
(849
)
   Interest, dividend and other income
3,135

 
2,556

   Realized gain on sale of marketable securities
641

 
26

   Equity in loss of unconsolidated entities
260

 
17

Total other income
9,558

 
1,807

 
 
 
 
Other expenses:
 
 
 
   Bad debt expense
1,366

 
819

   Depreciation and amortization
73,608

 
44,833

   General and administrative expenses
9,223

 
4,269

   Acquisition related costs
619

 
5,019

   Interest expense
42,669

 
28,069

   Business management fee
14,666

 
1,500

Total other expenses
142,151

 
84,509

 
 
 
 
Loss from continuing operations
(5,482
)
 
(1,247
)
Income from discontinued operations
7,639

 
4,113

Net income
2,157

 
2,866

 
 
 
 
Noncontrolling interests:
 
 
 
Noncontrolling interests

 
(41
)
Redeemable noncontrolling interests
(2,440
)
 
(209
)
Net income attributable to noncontrolling interests