PRINCIPAL ACTIVITY AND SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of Sterling, Sterling Properties, LLLP, and wholly-owned limited liability companies. All significant intercompany transactions and balances have been eliminated in consolidation.

Additionally, we evaluate the need to consolidate affiliates based on standards set forth in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation (“ASC 810”). In determining whether we have a requirement to consolidate the accounts of an entity, management considers factors such as our ownership interest, our authority to make decisions and contractual and substantive participating rights of the limited partners and shareholders, as well as whether the entity is a variable interest entity (“VIE”) for which we have both: a) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance, and b) the obligation to absorb losses or the right to receive benefits from the VIE that could be potentially significant to the VIE.

Concentration of Credit Risk

Concentration of Credit Risk

Our cash balances are maintained in various bank deposit accounts. The bank deposit amounts in these accounts may exceed federally insured limits at various times throughout the year.

Real Estate Investments

Real Estate Investments

Real estate investments are recorded at cost less accumulated depreciation. Ordinary repairs and maintenance are expensed as incurred.

The Trust allocates the purchase price of each acquired investment property accounted for as an asset acquisition based upon the estimated acquisition date fair value of the individual assets acquired and liabilities assumed, which generally include (i) land, (ii) building and other improvements, (iii) in-place lease value intangibles, (iv) acquired above and below market lease intangibles, and (v) any assumed financing that is determined to be above or below market, if any. Transaction costs related to acquisitions accounted for as asset acquisitions are capitalized as incurred and included as a cost of the Building in the accompanying balance sheet.

For tangible assets acquired, including land, building and other improvements, the Trust considers available comparable market and industry information in estimating fair value on the acquisition date. Key factors considered in the calculation of fair value of both real property and intangible assets include the current market rent values, “dark” periods (building in vacant status), direct costs estimated with obtaining a new tenant, discount rates, escalation factors, standard lease terms, and tenant improvement costs. The Trust allocates a portion of the purchase price to the estimated acquired in-place lease value intangibles based on factors available in third party appraisals or cash flow estimates of the property prepared by our internal analysis. These estimates are based upon cash flow projections for the property, existing leases, lease origination costs for similar leases as well as lost rental payments during an assumed lease-up period. The Trust also evaluates each acquired lease as compared to current market rates. If an acquired lease is determined to be above or below market, the Trust allocates a portion of the purchase price to such above or below market leases based upon the present value of the difference between the contractual lease payments and estimated market rent payments over the remaining lease term. Renewal periods are included within the lease term in the calculation of above and below market lease values if, based upon factors known at the acquisition date, market participants would consider it reasonably assured that the lessee would exercise such options. Fair value estimates used in acquisition accounting, including the discount rate used, require the Trust to consider various factors, including, but not limited to, market knowledge, demographics, age and physical condition of the property, geographic location, and size and location of tenant spaces within the acquired investment property.

The portion of the purchase price allocated to acquired in-place lease value intangibles is amortized on a straight-line basis over the life of the related lease as amortization expense. The Trust incurred amortization expense pertaining to acquired in-place lease value intangibles of $315 and $418 for the three months ended June 30, 2020 and 2019, respectively and $656 and $847 for the six months ended June 30, 2020 and 2019, respectively.

The portion of the purchase price allocated to acquired above and below market lease intangibles is amortized on a straight-line basis over the life of the related lease as an adjustment to real estate rental income. Amortization pertaining to above market lease intangibles of $47 and $54 for the three months ended June 30, 2020 and 2019, respectively, was recorded as a reduction to real estate rental income. Amortization pertaining to below market lease intangibles of $54 and $66 for the three months ended June 30, 2020 and 2019, respectively, was recorded as an increase to real estate rental income. Amortization pertaining to above market lease intangibles of $99 and $107 for the six months ended June 30, 2020 and 2019, respectively, was recorded as a reduction to real estate rental income. Amortization pertaining to below market lease intangibles of $110 and $133 for the six months ended June 30, 2020 and 2019, respectively, was recorded as an increase to real estate rental income.

Furniture and fixtures are stated at cost less accumulated depreciation. Expenditures for renewals and improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. Expenditures for routine maintenance and repairs, which do not add to the value or extend useful lives, are charged to expense as incurred.

Depreciation is provided for over the estimated useful lives of the individual assets using the straight-line method over the following estimated useful lives:


Buildings and improvements		40 years
Furniture, fixtures and equipment		5-9 years

Depreciation expense for the three months ended June 30, 2020 and 2019 totaled $4,887 and $4,893, respectively. Depreciation expense for the six months ended June 30, 2020 and 2019 totaled $9,755 and $9,906, respectively.

The Trust’s investment properties are reviewed for potential impairment at the end of each reporting period whenever events or changes in circumstances indicate that the carrying value may not be recoverable. At the end of each reporting period, the Trust separately determines whether impairment indicators exist for each property.

Examples of situations considered to be impairment indicators include, but are not limited to:

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a substantial decline or continued low occupancy rate;

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continued difficulty in leasing space;

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significant financially troubled tenants;

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a change in plan to sell a property prior to the end of its useful life or holding period;

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a significant decrease in market price not in line with general market trends; and

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any other quantitative or qualitative events or factors deemed significant by the Trust’s management or board of trustees.

If the presence of one or more impairment indicators as described above is identified at the end of the reporting period or throughout the year with respect to an investment property, the asset is tested for recoverability by comparing its carrying value to the estimated future undiscounted cash flows. An investment property is considered to be impaired when the estimated future undiscounted cash flows are less than its current carrying value. When performing a test for recoverability or estimating the fair value of an impaired investment property, the Trust makes complex or subjective assumptions which include, but are not limited to:

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projected operating cash flows considering factors such as vacancy rates, rental rates, lease terms, tenant financial strength, demographics, holding period and property location;

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projected capital expenditures and lease origination costs;

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projected cash flows from the eventual disposition of an operating property using a property specific capitalization rate;

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comparable selling prices; and

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property specific discount rates for fair value estimates as necessary.

To the extent impairment has occurred, the Trust will record an impairment charge calculated as the excess of the carrying value of the asset over its fair value for impairment of investment properties. There were no impairment losses during the six months ended June 30, 2020 and 2019.

Construction in Progress

Construction in Progress

The Trust capitalizes direct and certain indirect project costs incurred during the development period such as construction, insurance, architectural, legal, interest and other financing costs, and real estate taxes. At such time as the development is considered substantially complete, the capitalization of certain indirect costs such as real estate taxes and interest and financing costs cease and all project-related costs included in construction in process are reclassified to land and building and other improvements.

Construction in progress as of June 30, 2020 consists primarily of development and planning costs associated with the Glen Pond development in Eagan, Minnesota and the Goldmark Office Park 1715 building located in Fargo, North Dakota. The Glen Pond development consists of 114 units of multifamily property. Current expectations are that the project will be completed in the third quarter of calendar year 2020 and the current project budget approximates $16,175 of which $15,698 has been incurred and is included in Construction in progress. The Goldmark Office Park consists of three commercial office buildings. Current expectations are that the project which includes building renovations, reconstruction of portions of the office park and additional amenities will be completed in phases with the primary phase completed in the third quarter of calendar year 2020. The current project budget is approximately $6,674 of which $5,266 has been incurred and is included in Construction in progress.

Investment in Unconsolidated Affiliates

Investment in Unconsolidated Affiliates

We account for unconsolidated affiliates using the equity method of accounting per guidance established under FASB ASC 323, Investments – Equity Method and Joint Ventures (“ASC 323”). The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for our share of equity in the affiliates’ earnings, contributions and distributions. We evaluate the carrying amount of the investments for impairment in accordance with FASB ASC 323. Unconsolidated affiliates are reviewed for potential impairment if the carrying amount of the investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until the carrying amount is fully recovered. The evaluation of an investment in an affiliate for potential impairment can require our management to exercise significant judgments. No impairment losses were recorded related to the unconsolidated affiliates for the six months ended June 30, 2020 and 2019.

We use the equity method to account for investments that qualify as variable interest entities where we are not the primary beneficiary and entities that we do not control or where we do not own a majority of the economic interest but have the ability to exercise significant influence over the operations and financial policies of the investee and entities where we have joint control and other attributes resulting in a joint venture. We will also use the equity method for investments that do not qualify as variable interest entities and do not meet the control requirements for consolidation, as defined in ASC 810. For a joint venture accounted for under the equity method, our share of net earnings and losses is reflected in income when earned and distributions are credited against our investment in the joint venture as received.

In determining whether an investment in a limited liability company or tenant in common is a variable interest entity, we consider: the form of our ownership interest and legal structure; the size of our investment; the financing structure of the entity, including the necessity of subordinated debt; estimates of future cash flows; our and our partner’s ability to participate in the decision making related to acquisitions, dispositions, budgeting and financing on the entity; and obligation to absorb losses and preferential returns. As of June 30, 2020, our tenant in common arrangements do not qualify as variable interest entities and do not meet the control requirements for consolidation, as defined in ASC 810. As of June 30, 2020, our investment in the joint venture does not qualify as a variable interest entity, does not meet the control requirements for consolidation or significant influence requirements, as defined in ASC 810, and does meet the definition of a joint venture.

As of June 30, 2020 and December 31, 2019, the unconsolidated affiliates held total assets of $34,285 and $31,261 and mortgage notes payable of $21,878 and $16,690, respectively.

The operating partnership is a 50% owner of a retail center as a tenant in common through 100% ownership in a limited liability company. The retail center has approximately 183,000 square feet of commercial space in Grand Forks, North Dakota. The property is encumbered by a non-recourse first mortgage with a balance at June 30, 2020 and December 31, 2019 of $10,140 and $10,264, respectively. The Trust is jointly and severally liable for the full mortgage balance.

The operating partnership owns a 66.67% interest as tenant in common in an office building with approximately 75,000 square feet of commercial rental space in Fargo, North Dakota. The property is encumbered by a first mortgage with a balance at June 30, 2020 and December 31, 2019 of $6,331 and $6,426, respectively. The Trust is jointly and severally liable for the full mortgage balance.

The operating partnership owns a 60% interest in a joint venture that is developing a 190 unit multifamily property in Savage, Minnesota. The property is encumbered by a first construction mortgage with a balance at June 30, 2020 of $5,407 and no mortgage balance at December 31, 2019. The operating partnership has contributed $3,305 in cash as of June 30, 2020. The partnership holds total assets of $12,407. The Trust is jointly and severally liable for the full mortgage balance.

The operating partnership owns a 60% interest in a joint venture that intends to develop a 160 unit multifamily property. The operating partnership has contributed $2,461 in cash as of June 30, 2020. The Partnership holds land located in Maple Grove, Minnesota, total assets of $4,100, and no mortgage payable.

Financing and Lease Costs

Financing and Lease Costs

Financing costs have been capitalized and are being amortized over the life of the financing (line of credit) using the effective interest method. Unamortized financing costs are written off when debt is retired before the maturity date and included in interest expense at that time.

Lease costs incurred in connection with new leases have been capitalized and are being amortized over the life of the lease using the straight-line method. We record the amortization of leasing costs in depreciation and amortization on the consolidated statements of operations and comprehensive income. If an applicable lease terminates prior to the expiration of its initial lease term, we write off the carrying amount of the costs to amortization expense.

Lease Intangible Assets

Lease Intangible Assets

Lease intangibles are a purchase price allocation recorded on property acquisition. The lease intangibles represent the estimated value of in-place leases, tenant relationships and the value of leases with above or below market lease terms. Lease intangibles are amortized over the term of the related lease.

The carrying amount of intangible assets is regularly reviewed for indicators of impairments in value. Impairment is recognized only if the carrying amount of the intangible asset is considered to be unrecoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the estimated fair value of the asset. Based on the review, management determined no impairment charges were necessary at June 30, 2020 and December 31, 2019.

Syndication Costs

Syndication Costs

Syndication costs consist of costs paid to attorneys, accountants, and selling agents, related to the raising of capital. Syndication costs are recorded as a reduction to beneficial and noncontrolling interest.

Revenue Recognition

Revenue Recognition

The Trust is the lessor for its residential and commercial leases. Leases are analyzed on an individual basis to determine lease classification. The Trust has determined any lease less than ten years in length will not be looked at in the classification process and will be presumed an operating lease. As of June 30, 2020, all leases analyzed under the Trust’s lease classification process were determined to be operating leases. As of June 30, 2019, all leases continued to be accounted for as operating leases under the new standard as described under Recent Accounting Pronouncements.

As of June 30, 2020, we derived 79.7% of our revenues from residential leases that are generally for terms of one year or less. The residential leases may include lease income related to such items as parking, storage and non-refundable deposits that we treat as a single lease component because the amenities cannot be leased on their own and the timing and pattern of revenue recognition are the same. The collection of lease payments at lease commencement is probable and therefore we subsequently recognize lease income over the lease term on a straight-line basis. Residential leases are renewable upon consent of both parties on an annual or monthly basis.

As of June 30, 2020, we derived 20.3% of our revenues from commercial leases primarily under long-term lease agreements. Substantially all commercial leases contain fixed escalations or, in some instances, changes based on the Consumer Price Index, which occur at specified times during the term of the lease. In certain commercial leases, variable lease income, such as percentage rent, is recognized when rents are earned. We recognize rental income and rental abatements from our commercial leases when earned on a straight-line basis over the lease term. Recognition of rental income commences when control of the leased space has been transferred to the tenant.

We recognize variable income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements. When we pay pass-through expenses, subject to reimbursement by the tenant, they are included within “Operating expenses, excluding real estate taxes” and “Real estate taxes,” and reimbursements are included within “Real estate rental income” along with the associated base rent in the accompanying consolidated financial statements.

We record base rents on a straight-line basis. The monthly base rent income according to the terms of our leases is adjusted so that an average monthly rent is recorded for each tenant over the term of its lease. The straight-line rent adjustment decreased revenue by $73 and $48 for the three months ended June 30, 2020 and 2019, respectively. The straight-line rent adjustment decreased revenue by $138 and increased revenue by $55 the six months ended June 30, 2020 and 2019, respectively. The straight-line receivable balance included in receivables on the consolidated balance sheets as of June 30, 2020 and December 31, 2019 was $3,014 and $3,331, respectively. We receive payments for expense reimbursements from substantially all our multi-tenant commercial tenants throughout the year based on estimates. Differences between estimated recoveries and the final billed amounts, which generally are immaterial, are recognized in the subsequent year.

Upon adoption of ASU 2016-02 on January 1, 2019, we elected not to bifurcate lease contracts into lease and non-lease components, since the timing and pattern of revenue is not materially different and the non-lease component is not the primary component of the lease. Accordingly, both lease and non-lease components are presented in “Real estate rental income” beginning January 1, 2019 in our consolidated financial statements. The adoption of ASU 2016-02 did not result in a material change to our recognition of real estate rental income.

Lease income related to the Trust’s operating leases is comprised of the following:


	Three months ended June 30, 2020
	Residential		Commercial		Total

	(in thousands)
Lease income related to fixed lease payments	$	23,613	$	5,035	$	28,648
Lease income related to variable lease payments		—		1,451		1,451
Other (a)		(88)		(76)		(164)
Lease Income (b)	$	23,525	$	6,410	$	29,935


	Three months ended June 30, 2019
	Residential		Commercial		Total

	(in thousands)
Lease income related to fixed lease payments	$	23,077	$	4,929	$	28,006
Lease income related to variable lease payments		—		1,551		1,551
Other (a)		(188)		(35)		(223)
Lease Income (b)	$	22,889	$	6,445	$	29,334

(a)

For the three months ended June 30, 2020 and 2019, “Other” is comprised of revenue adjustments related to changes in collectability and amortization of above and below market lease intangibles and lease inducements.

(b)

Excludes other rental income for the three months ended June 30, 2020 and 2019 of $886 and $936, respectively, which is accounted for under the revenue recognition standard.


	Six months ended June 30, 2020
	Residential		Commercial		Total

	(in thousands)
Lease income related to fixed lease payments	$	46,816	$	9,749	$	56,565
Lease income related to variable lease payments		—		2,712		2,712
Other (a)		(342)		(166)		(508)
Lease Income (b)	$	46,474	$	12,295	$	58,769


	Six months ended June 30, 2019
	Residential		Commercial		Total

	(in thousands)
Lease income related to fixed lease payments	$	45,874	$	9,706	$	55,580
Lease income related to variable lease payments		—		3,038		3,038
Other (a)		(405)		81		(324)
Lease Income (b)	$	45,469	$	12,825	$	58,294

(c)

For the six months ended June 30, 2020 and 2019, “Other” is comprised of revenue adjustments related to changes in collectability and amortization of above and below market lease intangibles and lease inducements.

(d)

Excludes other rental income for the six months ended June 30, 2020 and 2019 of $1,958 and $1,808, respectively, which is accounted for under the revenue recognition standard.

As of June 30, 2020, non-cancelable in place commercial operating leases provide for future minimum rental income as follows (in thousands). Apartment leases are not included as the terms are generally for one year or less.


Years ending December 31,	Amount
	(in thousands)
2020 (July 1, 2020 - December 31, 2020)	$	8,828
2021		14,879
2022		11,493
2023		9,505
2024		9,035
Thereafter		42,596
	$	96,336

Earnings per Common Share

Earnings per Common Share

Basic earnings per common share is computed by dividing net income available to common shareholders (the “numerator”) by the weighted average number of common shares outstanding (the “denominator”) during the period. Sterling had no dilutive potential common shares as of June 30, 2020 and 2019, and therefore, basic earnings per common share was equal to diluted earnings per common share for both periods.

For the three months ended June 30, 2020 and 2019, Sterling’s denominators for both basic and diluted earnings per common share were approximately 9,611,000 and 9,209,000, respectively. For the six months ended June 30, 2020 and 2019, Sterling’s denominators for the basic and diluted earnings per common share were approximately 9,587,000 and 9,151,000, respectively.

Reclassifications

Reclassifications

Certain reclassifications considered necessary for a fair presentation have been made to the prior period financial statements in order to conform to the current year presentation. These reclassifications have not changed the results of operations or equity.