S-11 1 ds11.htm FORM S-11 Form S-11
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As filed with the Securities and Exchange Commission on January 12, 2010

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-11

REGISTRATION STATEMENT

Under

THE SECURITIES ACT OF 1933

 

 

Phillips Edison – ARC Shopping Center REIT Inc.

(Exact name of registrant as specified in its charter)

 

Maryland   6798   27-1106076

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. employer

identification number)

11501 Northlake Drive

Cincinnati, Ohio 45249

(513) 554-1110

(Address, including zip code, and telephone number, including area code, of the registrant’s principal executive offices)

 

 

Jeffrey S. Edison

Chief Executive Officer

11501 Northlake Drive

Cincinnati, Ohio 45249

(513) 554-1110

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Robert H. Bergdolt, Esq.

Michael S. O’Sullivan, Esq.

DLA Piper LLP (US)

4141 Parklake Avenue, Suite 300

Raleigh, North Carolina 27612-2350

(919) 786-2000

 

Peter M. Fass, Esq.

James P. Gerkis, Esq.

Proskauer Rose LLP

1585 Broadway

New York, New York 10036-8299

(212) 969-3000

 

 

Approximate date of commencement of proposed sale to public: As soon as practicable after the effectiveness of the registration statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box:    x

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.    ¨


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If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.    ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.    ¨

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check One):

 

Large accelerated filer    ¨

 

Non-accelerated filer    ¨

 

(Do not check if a smaller reporting company)

 

Accelerated filer    ¨                  

 

Smaller reporting company    x

 

 

CALCULATION OF REGISTRATION FEE

 

 
Title of Shares to be Registered  

Amount

to be
Registered

  Proposed
Maximum
Offering Price
Per Share(1)
 

Proposed
Maximum
Aggregate

Offering Price(1)

 

Amount of

Registration Fee

Common Stock, $0.01 par value per share(2)

  150,000,000   $10.00   $1,500,000,000   106,950

Common Stock, $0.01 par value per share(3)

    30,000,000   $  9.50   $   285,000,000     20,321
 
 

 

(1)

Estimated solely for the purpose of determining the registration fee pursuant to Rule 457.

(2)

Represents shares issuable pursuant to the registrant’s primary offering.

(3)

Represents shares issuable pursuant to the registrant’s dividend reinvestment plan. The offering price per share issuable pursuant to the dividend reinvestment plan is estimated for purposes of calculating the registration fee at $9.50 per share. We reserve the right to reallocate the shares of common stock we are offering between the primary offering and our dividend reinvestment plan.

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment that specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, nor is it a solicitation of an offer to buy these securities, in any state where an offer or sale of the securities is not permitted.

SUBJECT TO COMPLETION, DATED                     , 2010

Phillips Edison—ARC Shopping Center REIT Inc.

Maximum Offering of 180,000,000 Shares of Common Stock

Minimum Offering of 250,000 Shares of Common Stock

 

 

Phillips Edison—ARC Shopping Center REIT Inc. is a newly organized Maryland corporation that will invest primarily in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase. In addition, we may invest in other retail properties including power and lifestyle shopping centers, multi-tenant shopping centers, free standing single-tenant retail properties, and other real estate and real estate-related loans and securities depending on real estate market conditions and investment opportunities that our board of directors determines are in the best interests of our stockholders. We expect that retail properties primarily would underlie or secure the real estate-related loans and securities in which we may invest. We intend to elect to qualify and be taxed as a real estate investment trust for U.S. federal income tax purposes, or REIT, commencing with our taxable year ending December 31, 2010, although such election may be postponed to our taxable year ending December 31, 2011.

We are offering up to 150,000,000 shares of our common stock at a price of $10.00 per share on a “best efforts” basis through Realty Capital Securities, LLC, our dealer manager. “Best efforts” means that our dealer manager is not obligated to purchase any specific number or dollar amount of shares. We also are offering up to 30,000,000 shares of our common stock pursuant to our dividend reinvestment plan at $9.50 per share. We reserve the right to reallocate the shares of common stock we are offering between the primary offering and our dividend reinvestment plan.

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 31 to read about risks you should consider before buying shares of our common stock. These risks include the following:

   

We are a “blind pool” offering because we do not currently own any investments, have not identified any investments to acquire and have no operating history.

   

No public market currently exists for our shares, and we have no plans to list our shares on an exchange. Until our shares are listed, if ever, you may not sell your shares unless the buyer meets applicable suitability and minimum purchase standards. If you are able to sell your shares, you would likely have to sell them at a substantial discount or loss.

   

No one may own more than 9.8% of our aggregate outstanding stock unless exempted by our board.

   

This price is arbitrary and unrelated to the book or net value of our assets or to our expected operating income.

   

We depend on our advisor to conduct our operations. Our advisor has no operating history and limited experience operating a public company.

   

We have no operating history, and our total assets consist of $200,000 cash and $445,028 of deferred offering costs.

   

All of our executive officers and some of our directors are also officers, managers, directors and/or holders of a controlling interest in our advisor, sub-advisor, dealer manager and other affiliates of our sponsors. As a result, they will face conflicts of interest, including significant conflicts created by our advisor’s compensation arrangements with us and other sponsor-advised programs. Fees paid to our advisor in connection with transactions involving the purchase and management of our properties will be based on the cost of the investment, not on the quality of the investment or services rendered to us. This arrangement could influence our advisor to recommend riskier transactions to us.

   

If we raise substantially less than the maximum offering, we may not be able to invest in a diverse portfolio of real estate assets and the value of your investment may vary more widely with the performance of specific assets.

   

We will pay substantial fees and expenses to our advisor, our sub-advisor and their respective affiliates and broker-dealers. These fees increase your risk of loss.

   

Although our distribution policy is not to use the proceeds of this offering to make distributions, our organizational documents permit us to pay distributions from any source, including offering proceeds. Until the proceeds from this offering are fully invested and from time to time during our operational stage, we expect to use proceeds from financings to fund distributions in anticipation of cash flow to be received in later periods. We may also fund such distributions from advances from our advisor or sponsors or from our advisor’s deferral of its fees.

   

We may incur debt exceeding 75.0% of the cost of our tangible assets with the approval of the conflicts committee. During the early stages of this offering, we expect that our conflicts committee will approve debt in excess of this limit. Higher debt levels increase the risk of your investment.

Neither the SEC, the Attorney General of the State of New York nor any other state securities regulator has approved or disapproved of our common stock, determined if this prospectus is truthful or complete or passed on or endorsed the merits of this offering. Any representation to the contrary is a criminal offense.

This investment involves a high degree of risk. You should purchase these securities only if you can afford a complete loss of your investment. The use of projections or forecasts in this offering is prohibited. No one is permitted to make any oral or written predictions about the cash benefits or tax consequences you will receive from your investment.

 

 

     

Price

to Public

   

Selling

Commissions

   

Dealer

Manager Fee

   

Net Proceeds

(Before Expenses)

Primary Offering

                              

Per Share

   $ 10.00   $ 0.70   $ 0.30   $ 9.00

Total Minimum

   $ 2,500,000.00   $ 175,000.00   $ 75,000.00   $ 2,250,000.00

Total Maximum

   $ 1,500,000,000.00   $ 105,000,000.00   $ 45,000,000.00   $ 1,350,000,000.00

Dividend Reinvestment Plan

                              

Per Share

   $ 9.50      $ 0.00      $ 0.00      $ 9.50

Total Maximum

   $ 285,000,000.00      $ 0.00      $ 0.00      $ 285,000,000.00

 

 

* Discounts are available for some categories of investors. Reductions in commissions and fees will result in corresponding reductions in the purchase price.

We will offer the shares on a “best efforts” basis through Realty Capital Securities, LLC, our dealer manager, a member firm of the Financial Industry Regulatory Authority. Realty Capital Securities, LLC is an affiliate of American Realty Capital II, LLC, one of our sponsors. “Best efforts” means that our dealer manager is not obligated to purchase any specific number or dollar amount of shares. The minimum permitted purchase is $2,500. We will not sell any shares unless we raise gross offering proceeds of $2,500,000 from persons who are not affiliated with us or our sponsors by                     , 2011. Pending satisfaction of this condition, all subscription payments will be placed in an account held by the escrow agent,                     , in trust for our subscribers’ benefit, pending release to us. You are entitled to receive the interest earned on your subscription payment while it is held in the escrow account. Once we have raised the minimum offering amount and instructed the escrow agent to disburse the funds in the account, funds representing the gross purchase price for the shares will be distributed to us and the escrow agent will disburse directly to you any interest earned on your subscription payment while it was held in the escrow account. If we do not raise gross offering proceeds of $2,500,000 by                     , we will promptly return all funds in the escrow account (including interest), and we will stop selling shares. We will not deduct any fees if we return funds from the escrow account.

We expect to sell the 150,000,000 shares offered in our primary offering over a three-year period. We may continue to offer shares under our dividend reinvestment plan beyond the termination of our primary offering until we have sold 30,000,000 shares through the reinvestment of distributions, but only if there is an effective registration statement with respect to the shares. We reserve the right to reallocate the shares of common stock we are offering between the primary offering and our dividend reinvestment plan. In many states, we will need to renew the registration statement or file a new registration statement to continue the offering beyond one year from the date of this prospectus. We may terminate this offering at any time.

We will not sell any shares to Pennsylvania investors unless we raise $50.0 million in gross offering proceeds (including sales made to residents of other jurisdictions) from persons not affiliated with us or our sponsors. If we do not raise this amount by                     , 2012, we will promptly return all funds held in escrow for the benefit of Pennsylvania investors.

The date of this prospectus is                     , 2010.


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INVESTOR SUITABILITY STANDARDS

An investment in our common stock involves significant risk and is suitable only for persons who have adequate financial means, desire a relatively long-term investment and who will not need immediate liquidity from their investment. Persons who meet this standard and seek to diversify their personal portfolios with a finite-life, real estate-based investment, which among its benefits hedges against inflation and the volatility of the stock market, seek to receive current income, seek to preserve capital, wish to obtain the benefits of potential long-term capital appreciation and who are able to hold their investment for a time period consistent with our liquidity plans are most likely to benefit from an investment in our company. On the other hand, we caution persons who require immediate liquidity or guaranteed income, or who seek a short-term investment not to consider an investment in our common stock as meeting these needs. Notwithstanding these investor suitability standards, potential investors should note that investing in shares of our common stock involves a high degree of risk and should consider all the information contained in this prospectus, including the “Risk Factors” section contained herein, in determining whether an investment in our common stock is appropriate.

In order to purchase shares in this offering, you must:

 

   

meet the applicable financial suitability standards as described below; and

 

   

purchase at least the minimum number of shares as described below.

We have established suitability standards for initial stockholders and subsequent purchasers of shares from our stockholders. These suitability standards require that a purchaser of shares have, excluding the value of a purchaser’s home, home furnishings and automobiles, either:

 

   

minimum net worth of at least $250,000; or

 

   

minimum annual gross income of at least $70,000 and a minimum net worth of at least $70,000.

The minimum purchase is 250 shares ($2,500). You may not transfer fewer shares than the minimum purchase requirement. In addition, you may not transfer, fractionalize or subdivide your shares so as to retain less than the number of shares required for the minimum purchase. In order to satisfy the minimum purchase requirements for individual retirement accounts, or IRAs, unless otherwise prohibited by state law, a husband and wife may jointly contribute funds from their separate IRAs, provided that each such contribution is made in increments of $100. You should note that an investment in shares of our common stock will not, in itself, create a retirement plan and that, in order to create a retirement plan, you must comply with all applicable provisions of the Internal Revenue Code.

Several states have established suitability requirements that are more stringent than the standards that we have established and described above. Shares will be sold to investors in these states only if they meet the special suitability standards set forth below. In each case, these special suitability standards exclude from the calculation of net worth the value of the investor’s home, home furnishings and automobiles.

General Standards for all Investors

 

   

Investors must have either (a) a net worth of at least $250,000 or (b) an annual gross income of $70,000 and a minimum net worth of $70,000.

 

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Kentucky

 

   

Investors must have either (a) a net worth of $250,000 or (b) a gross annual income of at least $70,000 and a net worth of at least $70,000, with the amount invested in this offering not to exceed 10% of the Kentucky investor’s liquid net worth.

Massachusetts, Michigan, Ohio, Iowa, Oregon, Pennsylvania and Washington

 

   

Investors must have either (a) a minimum net worth of at least $250,000 or (b) an annual gross income of at least $70,000 and a net worth of at least $70,000. The investor’s maximum investment in the issuer and its affiliates cannot exceed 10.0% of the Massachusetts, Michigan, Ohio, Iowa, Oregon, Pennsylvania or Washington resident’s net worth.

Tennessee

 

   

In addition to the general suitability requirements described above, investors’ maximum investment in our shares and our affiliates shall not exceed 10.0% of the resident’s net worth.

Kansas

 

   

In addition to the general suitability requirements described above, it is recommended that investors should invest no more than 10.0% of their liquid net worth in our shares and securities of other real estate investment trusts. “Liquid net worth” is defined as that portion of net worth (total assets minus total liabilities) that is comprised of cash, cash equivalents and readily marketable securities.

Missouri

 

   

In addition to the general suitability requirements described above, no more than 10.0% of any one Missouri investor’s liquid net worth shall be invested in the securities registered by us for this offering with the Securities Division.

California

 

   

In addition to the general suitability requirements described above, investors’ maximum investment in our shares will be limited to 10.0% of the investor’s net worth (exclusive of home, home furnishings and automobile).

Alabama and Mississippi

 

   

In addition to the general suitability requirements described above, shares will only be sold to Alabama and Mississippi residents that represent that they have a liquid net worth of at least 10 times the amount of their investment in this real estate investment program and other similar programs.

In addition, because the minimum offering amount is less than $100 million, Pennsylvania investors are cautioned to carefully evaluate our ability to fully accomplish our stated objectives and to inquire as to the current dollar volume of subscriptions proceeds. Further, the minimum aggregate closing amount for Pennsylvania investors is $50,000,000.

 

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In the case of sales to fiduciary accounts (such as an IRA, Keogh Plan or pension or profit-sharing plan), these minimum suitability standards must be satisfied by the beneficiary, the fiduciary account, or by the donor or grantor who directly or indirectly supplies the funds to purchase our common stock if the donor or the grantor is the fiduciary. Prospective investors with investment discretion over the assets of an individual retirement account, employee benefit plan or other retirement plan or arrangement that is covered by the Employee Retirement Income Security Act of 1974, as amended, or ERISA, or Section 4975 of the Internal Revenue Code should carefully review the information in the section of this prospectus entitled “ERISA Considerations.” Any such prospective investors are required to consult their own legal and tax advisors on these matters.

In the case of gifts to minors, the minimum suitability standards must be met by the custodian of the account or by the donor.

In order to ensure adherence to the suitability standards described above, requisite criteria must be met, as set forth in the subscription agreement in the form attached hereto as Appendix B. In addition, our sponsors, our dealer manager and the soliciting dealers, as our agents, must make every reasonable effort to determine that the purchase of our shares is a suitable and appropriate investment for an investor. In making this determination, the soliciting dealers will rely on relevant information provided by the investor in the investor’s subscription agreement, including information regarding the investor’s age, investment objectives, investment experience, income, net worth, financial situation, other investments, and any other pertinent information. Executed subscription agreements will be maintained in our records for six years. See “Plan of Distribution—Suitability Standards” for a detailed discussion of the determinations regarding suitability that we require.

 

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     Page

INVESTOR SUITABILITY STANDARDS

   i

PROSPECTUS SUMMARY

   1

RISK FACTORS

   31

Risks Related to an Investment in Us

   31

Risks Related to Conflicts of Interest

   38

Risks Related to This Offering and Our Corporate Structure

   41

General Risks Related to Investments in Real Estate

   48

Risks Related to Real Estate-Related Investments

   59

Risks Associated with Debt Financing

   63

U.S. Federal Income Tax Risks

   67

Retirement Plan Risks

   75

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

   77

ESTIMATED USE OF PROCEEDS

   78

MARKET OPPORTUNITY

   81

The Opportunity

   81

The Portfolio

   85

MANAGEMENT

   88

Board of Directors

   88

Committees of the Board of Directors

   89

Executive Officers and Directors

   90

Compensation of Directors

   91

2010 Independent Director Stock Plan

   91

Limited Liability and Indemnification of Directors, Officers, Employees and Other Agents

   92

Our Advisor and Sub-advisor

   93

The Property Manager

   98

Our Sponsors

   98

Our Dealer Manager

   103

Management Decisions

   105

COMPENSATION TABLE

   106

STOCK OWNERSHIP

   115

CONFLICTS OF INTEREST

   116

Our Sponsors’ Interests in Other Real Estate Programs

   116

Receipt of Fees and Other Compensation by Our Sponsors and Their Respective Affiliates

   118

Our Board’s Loyalties to Current and Possibly to Future Phillips Edison- or ARC-sponsored Programs

   119

Fiduciary Duties Owed by Some of Our Affiliates to Our Advisor, Our Sub-advisor and Their Respective Affiliates

   120

Affiliated Dealer Manager

   120

Certain Conflict Resolution Measures

   120

INVESTMENT OBJECTIVES AND CRITERIA

   128

General

   128

Necessity- and Grocery-Anchored Retail Properties Focus

   129

Other Real Estate and Real Estate-Related Loans and Securities

   129

Acquisition Policies

   131

Acquisition of Properties from Our Affiliates

   134

Joint Ventures /Co-Investments

   134

Borrowing Policies

   135

 

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Certain Risk Management Policies

   136

Equity Capital Policies

   136

Disposition Policies

   137

Exit Strategy—Liquidity Event

   137

Investment Limitations

   138

Disclosure Policies with Respect to Future Probable Acquisitions

   139

Investment Limitations to Avoid Registration as an Investment Company

   139

Change in Investment Objectives and Limitations

   140

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   141

General

   141

Liquidity and Capital Resources

   142

Results of Operations

   143

Critical Accounting Policies

   143

Distribution Policy

   146

Funds From Operations

   147

U.S. Federal Income Taxes

   147

PRIOR PERFORMANCE SUMMARY

   148

Private Programs Sponsored by Phillips Edison

   148

Prior Investment Programs Sponsored by ARC

   150

Three-Year Summary of Funds Raised by AFRT

   156

Adverse Business Developments and Conditions

   159

CERTAIN MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

   161

Taxation of Phillips Edison – ARC Shopping Center REIT Inc.

   162

Taxation of Stockholders

   178

Tax Aspects of Investments in Partnerships

   183

Backup Withholding and Information Reporting

   185

Other Tax Considerations

   186

ERISA CONSIDERATIONS

   188

Prohibited Transactions

   189

Plan Asset Considerations

   189

Other Prohibited Transactions

   192

Annual Valuation

   192

Reporting

   194

DESCRIPTION OF SHARES

   195

Common Stock

   195

Preferred Stock

   195

Meetings and Special Voting Requirements

   196

Advance Notice for Stockholder Nominations for Directors and Proposals of New Business

   196

Restriction on Ownership of Shares

   197

Distributions

   199

Inspection of Books and Records

   200

Business Combinations

   200

Control Share Acquisitions

   201

Subtitle 8

   202

Tender Offers by Stockholders

   202

Dividend Reinvestment Plan

   203

Share Redemption Program

   206

Registrar and Transfer Agent

   209

Restrictions on Roll-Up Transactions

   209

THE OPERATING PARTNERSHIP AGREEMENT

   211

 

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General

   211

Capital Contributions

   211

Operations

   212

Distributions and Allocations of Profits and Losses

   212

Rights, Obligations and Powers of the General Partner

   212

Exchange Rights

   213

Change in General Partner

   214

Transferability of Interests

   214

Amendment of Limited Partnership Agreement

   214

PLAN OF DISTRIBUTION

   215

General

   215

Compensation of Our Dealer Manager and Participating Broker-Dealers

   216

Subscription Procedures

   219

Suitability Standards

   220

Minimum Purchase Requirements

   221

Special Notice to Pennsylvania Investors

   222

Investments by Qualified Accounts

   222

Investments through IRA Accounts

   222

SUPPLEMENTAL SALES MATERIAL

   224

LEGAL MATTERS

   225

EXPERTS

   225

WHERE YOU CAN FIND MORE INFORMATION

   225

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

   F-1

Appendix A – Prior Performance Tables

   A-1

Appendix B – Form of Subscription Agreement with Instructions

   B-1

Appendix C – Dividend Reinvestment Plan

   C-1

 

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PROSPECTUS SUMMARY

As used herein and unless otherwise required by context, the term “prospectus” refers to this prospectus as amended and supplemented. This prospectus summary highlights material information contained elsewhere in this prospectus. Because it is a summary, it may not contain all of the information that is important to you. To understand this offering fully, you should read the entire prospectus carefully, including the “Risk Factors” section and the financial statements, before making a decision to invest in our common stock. In this prospectus, references to “Phillips Edison—ARC Shopping Center REIT Inc.,” “our company,” “the company,” “we,” “us” and “our” mean Phillips Edison—ARC Shopping Center REIT Inc., a Maryland corporation, and Phillips Edison—ARC Shopping Center Operating Partnership, L.P., a Delaware limited partnership and the subsidiary through which we will conduct substantially all of our business and which we refer to as “our operating partnership,” except where it is clear from the context that the term only means the issuer of the common shares in this offering, Phillips Edison—ARC Shopping Center REIT Inc. When we refer to our “charter” in this prospectus, we are referring to our charter as it will be amended and restated prior to the commencement of this offering.

As described in more detail throughout this prospectus, we have entered into a contractual relationship with our advisor. In exchange for services provided to us, we will pay our advisor certain fees and reimburse certain expenses. Our advisor has entered into a contractual relationship with a sub-advisor that provides some of these services to us on behalf of the advisor. Any fees that we pay to our advisor may be assigned by our advisor to the sub-advisor according to the terms of the agreement between those parties. Any references in this prospectus to fees or expenses that we pay or reimburse to “our sub-advisor” or its affiliates are actually fees or expenses paid or reimbursed to our advisor that are then paid or assigned to the sub-advisor by our advisor pursuant to the terms of agreement between those parties.

What is Phillips Edison—ARC Shopping Center REIT Inc.?

Phillips Edison—ARC Shopping Center REIT will invest primarily in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million per property. The shopping centers will have a mix of national, regional, and local retailers who sell essential goods and services to customers who live in the neighborhood. We expect to build a high quality portfolio with the following characteristics:

 

   

Necessity Based Retail—We expect to acquire well-occupied shopping centers that focus on serving the day-to-day shopping needs of the community in the surrounding trade area (e.g. grocery stores, general merchandise stores, discount stores, drug stores, restaurants, and neighborhood service providers);

 

   

Diversified Portfolio—Once we have substantially invested all of the proceeds of this offering, we expect to acquire a well diversified portfolio based on geography, anchor tenant diversity, tenant mix, lease expirations, and other factors;

 

   

Infill Locations—We will target properties in more densely populated locations with higher barriers to entry which limits additional competition;

 

 

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Growth Markets—Our properties will be located in established or growing markets based on trends in population growth, employment, household income, employment diversification, and other key demographic factors; and

 

   

Discount To Replacement Cost—In the current acquisition environment, we expect to acquire properties at values based on current rents and at a substantial discount to replacement cost.

We will focus on maximizing shareholder value and some of the key elements of our financial strategy include:

 

   

Institutional Seasoned Management—We will acquire and manage the portfolio through our advisor and sub-advisor and their affiliates, including Phillips Edison sponsor’s seasoned team of professional managers with over 180 years of combined operating history and extensive knowledge and expertise in the retail sector;

 

   

National PlatformWe will provide reliable execution of the investment and operating strategies through our advisor and sub-advisor and their affiliates who have a fully integrated, scalable, national operating platform with extensive knowledge of the retail marketplace and established national tenant relationships;

 

   

Property Focus—We will utilize a property-specific focus that combines intensive leasing and merchandising plans with cost containment measures and delivers a more solid and stable income stream;

 

   

Stable Dividend—We expect to pay monthly distributions to our shareholders that will be covered by funds from operations (FFO);

 

   

Low Leverage—We will target a prudent leverage strategy with no more than a 50.0% loan to value ratio on our portfolio (calculated once we have invested substantially all of the offering proceeds);

 

   

Upside Potential—We expect our portfolio to have upside potential from a combination of lease-up, rent growth, cost containment and increased cash flow; and

 

   

Exit Strategy—We expect to sell our assets, sell or merge our company, or list our company within three to five years after the end of this offering.

We were incorporated in the State of Maryland on October 13, 2009 and we currently do not own any real estate assets. Because we have not yet identified any specific assets to acquire, we are considered to be a blind pool.

Our external advisor and sub-advisor, American Realty Capital II Advisors, LLC (“ARC Advisor” or “our advisor”) and Phillips Edison & Company SubAdvisor LLC (the “Phillips Edison Sub-Advisor” or “our sub-advisor”), respectively, will conduct our operations and manage our portfolio of real estate investments. We have no paid employees.

Our office is located at 11501 Northlake Drive, Cincinnati, Ohio 45249. Our telephone number is (513) 554-1110. Our fax number is (513) 554-1820, and our web site address is                                        .

 

 

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What is a REIT?

In general, a REIT is an entity that:

 

   

combines the capital of many investors to acquire or provide financing for real estate investments;

 

   

allows individual investors to invest in a professionally managed, large-scale, diversified portfolio of real estate assets;

 

   

pays distributions to investors of at least 90.0% of its annual REIT taxable income (computed without regard to the dividends paid deduction and excluding net capital gain); and

 

   

avoids the “double taxation” treatment of income that normally results from investments in a corporation because a REIT is not generally subject to U.S. federal corporate income taxes on that portion of its income distributed to its stockholders, provided certain U.S. federal income tax requirements are satisfied.

However, under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), REITs are subject to numerous organizational and operational requirements. If we fail to qualify for taxation as a REIT in any year after electing REIT status, our income will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify. Even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to state and local taxes on our income and property and to federal income and excise taxes on our undistributed income.

What are your investment objectives?

Our primary investment objectives are:

 

   

to provide you with stable cash distributions;

 

   

to preserve and protect your capital contribution;

 

   

to realize growth in the value of our assets upon the sale of such assets; and

 

   

to provide you with the potential for future liquidity through the sale of our assets, a sale or merger of our company, a listing of our common stock on a national securities exchange, or other similar transaction. See “—What are your exit strategies?”

We may return all or a portion of your capital contribution in connection with the sale of the company or the assets we will acquire or upon maturity or payoff of debt investments we may make. Alternatively, you may be able to obtain a return of all or a portion of your capital contribution in connection with the sale of your shares.

Are there any risks involved in an investment in your shares?

Investing in our common stock involves a high degree of risk. You should carefully review the “Risk Factors” section of this prospectus beginning on page 31, which contains a detailed discussion of the material risks that you should consider before you invest in our

 

 

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common stock. Some of the more significant risks relating to an investment in our shares include:

 

   

No public market currently exists for our shares of common stock, and we currently have no plans to list our shares on a national securities exchange. Our shares cannot be readily sold and, if you are able to sell your shares, you would likely have to sell them at a substantial discount from their public offering price.

 

   

Our charter prohibits the ownership of more than 9.8% of our aggregate outstanding stock, unless exempted by our board of directors, which may inhibit large investors from purchasing your shares.

 

   

The offering price of our shares may not be indicative of the price at which our shares would trade if they were listed on an exchange or actively traded, and this price bears no relationship to the book or net value of our assets or to our expected operating income.

 

   

We are dependent on our advisor to select investments and conduct our operations. Our advisor has no operating history and limited experience operating a public company. This inexperience makes our future performance difficult to predict.

 

   

We have no operating history and, as of the date of this prospectus, our total assets consist of $200,000 cash and $445,028 deferred offering costs. Because we have not identified any real estate properties to acquire or real estate-related assets to acquire or originate with proceeds from this offering, you will not have an opportunity to evaluate our investments before we make them, making an investment in us more speculative.

 

   

All of our executive officers and some of our directors and other key real estate professionals are also officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, sub-advisor, deal manager and other sponsor-affiliated entities. As a result, our executive officers, some of our directors, some of our key real estate professionals, our advisor and sub-advisor and their respective affiliates will face conflicts of interest, including significant conflicts created by our advisor’s compensation arrangements with us and other programs and investors advised by our sponsors and their respective affiliates and conflicts in allocating time among us and these other programs and investors. These conflicts could result in action or inaction that is not in the best interests of our stockholders.

 

   

Affiliates of our sponsors will receive fees in connection with transactions involving the purchase of our investments. These fees, at least initially, will be based on the cost of the investment, and not based on the quality of the investment or the quality of the services rendered to us. This may influence our advisor to recommend riskier transactions to us.

 

   

We may also pay significant fees in connection with a liquidity event. Although most of the fees payable in connection with a liquidity event are contingent on our investors first receiving agreed-upon investment returns, affiliates of our sponsors could also receive significant payments even without our reaching the investment-return thresholds should we seek to become self-managed.

 

 

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If we raise substantially less than the maximum offering, we may not be able to invest in a diverse portfolio of real estate properties and real estate-related assets and the value of your investment may vary more widely with the performance of specific assets.

 

   

We will pay substantial fees to and expenses of our sponsors, our advisor, our sub-advisor and their respective affiliates and participating broker-dealers, which payments increase the risk that you will not earn a profit on your investment.

 

   

Our organizational documents permit us to pay distributions from any source, including offering proceeds. Until the proceeds from this offering are fully invested and from time to time during our operational stage, we expect to use proceeds from financings to fund distributions in anticipation of cash flow to be received in later periods. We may also fund such distributions from advances from our advisor or sponsors or from our advisor’s deferral of its fees.

 

   

Our policies do not limit us from incurring debt until our borrowings would exceed 75.0% of the cost (before deducting depreciation or other non-cash reserves) of our tangible assets, and we may exceed this limit with the approval of the conflicts committee of our board of directors. During the early stages of this offering and to the extent financing in excess of this limit is available on attractive terms, we expect that our conflicts committee will approve debt in excess of this limit. High debt levels could limit the amount of cash we have available to distribute and could result in a decline in the value of your investment.

 

   

We depend on tenants for our revenue and, accordingly, our revenue is dependent upon the success and economic viability of our tenants.

 

   

Our current and future investments in real estate properties and real estate-related loans and securities may be affected by unfavorable real estate market and general economic conditions, which could decrease the value of those assets and reduce the investment return to you.

 

   

Continued disruptions in the financial markets and challenging economic conditions could adversely affect our ability to obtain financing on favorable terms, if at all.

What is the role of the board of directors?

We operate under the direction of our board of directors, the members of which are accountable to us and our stockholders as fiduciaries. We will have seven members of our board of directors, four of which will be independent of our sponsors and their respective affiliates. Our charter requires that a majority of our directors be independent of our sponsors and creates a committee of our board consisting solely of all of our independent directors. This committee, which we call the conflicts committee, is responsible for reviewing the performance of ARC Advisor and must approve other matters set forth in our charter. Our directors are elected annually by the stockholders.

Who is your advisor and sub-advisor and what will they do?

American Realty Capital II Advisors, LLC, an affiliate of American Realty Capital II, LLC, one of our sponsors, is our advisor. As our advisor, ARC Advisor will be responsible for

 

 

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coordinating the management of our day-to-day operations and for identifying and making investments in real estate properties on our behalf, subject to the supervision of our board of directors. Subject to the terms of the advisory agreement between ARC Advisor and us, ARC Advisor will delegate certain duties, including the management of our day-to-day operations and our portfolio of real estate assets, to Phillips Edison Sub-Advisor, which is indirectly wholly-owned by Phillips Edison Limited Partnership, our other sponsor, and which we generally refer to throughout this prospectus as the “sub-advisor.” Notwithstanding such delegation to the sub-advisor, ARC Advisor retains ultimate responsibility for the performance of all the matters entrusted to it under the advisory agreement.

Because our advisor is owned by affiliates of American Realty Capital II, LLC and because our sub-advisor is owned by affiliates of Phillips Edison Limited Partnership, we consider ourselves to be co-sponsored by the individuals who own and control those entities. Unless the context dictates otherwise, throughout this prospectus we generally refer collectively to Phillips Edison Limited Partnership and the individuals who own and control it, as our “Phillips Edison sponsors.” We generally refer collectively to American Realty Capital II, LLC and the individuals who own and control it, as our “ARC sponsors.”

ARC Advisor and Phillips Edison Sub-Advisor will make most of the decisions regarding the selection and the negotiation of real estate investments. ARC Advisor or Phillips Edison Sub-Advisor will then make recommendations on all investments to our board of directors and the independent directors that constitute our conflicts committee will have the right to approve or reject all proposed investments. ARC Advisor and Phillips Edison Sub-Advisor will also provide asset-management, marketing, investor-relations and other administrative services on our behalf with the goal of maximizing our operating cash flow.

What is the experience of your advisor?

ARC Advisor is a recently organized limited liability company that was formed in the State of Delaware on December 28, 2009. Our advisor has no operating history and limited experience managing a public company.

What is the experience of your Phillips Edison sponsors?

Formed in 1991, Phillips Edison is a fully-integrated, real estate operating company that acquires and repositions underperforming (primarily anchored) neighborhood retail shopping centers throughout the United States. Since its inception, Phillips Edison has operated with financial partners through both property-specific joint ventures and multi-asset discretionary private equity funds. Phillips Edison and its affiliates have acquired and currently manage assets having an aggregate value of approximately $1.8 billion, providing its investors with a vehicle through which they could invest in a carefully selected and professionally managed portfolio of operating assets and development opportunities which have produced a track record of strong financial results. Phillips Edison and its affiliates have over 3,000 tenants and long standing relationships with national and regional companies with high credit ratings.

Michael C. Phillips, Co-Chairman of the Board, has served as a principal of Phillips Edison since 1991. Prior to forming Phillips Edison, Mr. Phillips was employed by Biggs Hypershoppes, Inc. as Vice President from 1989 until 1990, by May Centers as Senior Development Director from 1988 until 1989, and by The Taubman Company as Development Director from 1986 until 1988 and as a leasing agent from 1984 until 1986. Mr. Phillips received his bachelor’s degree in political science in 1977 from the University of Southern California.

 

 

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Jeffrey S. Edison, Co-Chairman of the Board and our Chief Executive Officer, has served as a principal of Phillips Edison since 1995. From 1991 to 1995. Mr. Edison was employed by Nations Bank’s South Charles Realty Corporation, serving as a Senior Vice President from 1993 until 1995 and as a Vice President from 1991 until 1993. Mr. Edison was employed by Morgan Stanley Realty Incorporated from 1987 until 1990 and The Taubman Company from 1984 until 1987. Mr. Edison received his bachelor’s degree in mathematics and economics from Colgate University in 1982 and a masters in business administration from Harvard Business School in 1984.

John Bessey, our President, has served as Chief Investment Officer for Phillips Edison since 2005. During that time he has managed the placement of over $1.2 billion in 140 individual shopping centers comprising over 14,000,000 square feet. Prior to that, he served Phillips Edison as Vice President of Development from 1999 starting the ground up development program for the company. During that time he started and completed over 25 projects which included Walgreen’s, Target, Kroger, Winn Dixie, Safeway and Wal-Mart. Prior to joining Phillips Edison, Mr. Bessey was employed by Kimco Realty Corporation as a Director of Leasing from 1995, by Koll Management Services as Director of Retail Leasing and Development from 1991 and by Tipton Associates as Leasing Manager from 1988. Prior to entering retail real estate in 1988, Mr. Bessey worked in the hospitality industry as a Convention Sales Director for the Cincinnati Convention and Visitors Bureau and for Hyatt Hotels in a number of sales management positions in Minneapolis and Cincinnati. Mr. Bessey received his Bachelor’s Degree in Hotel and Restaurant Management from the University of Wisconsin—Stout in 1981.

What is the experience of your ARC sponsors?

American Realty Capital II, LLC, our ARC sponsor, is owned by Nicholas S. Schorsch, William M. Kahane, one our directors, Peter M. Budko, Brian S. Block and Michael Weil. Each of these individuals is an executive officer of American Realty Capital Trust, Inc., a non-traded public REIT that focuses on acquiring a diversified portfolio of freestanding, single-tenant retail and commercial properties that are net leased to investment grade and other creditworthy tenants.

Nicholas S. Schorsch is the Chairman and Chief Executive Officer of American Realty Capital New York Recovery REIT, Inc. Mr. Schorsch has also been the Chief Executive Officer of American Realty Capital Trust, Inc., American Realty Capital Properties, LLC, and American Realty Capital Advisors, LLC. From September 2006 to July 2007, Mr. Schorsch was Chief Executive Officer of American Realty Capital, LLC, a real estate investment firm. Mr. Schorsch founded and formerly served as President, CEO and Vice-Chairman of American Financial Realty Trust since its inception in September 2002 (and election to be taxed as a REIT beginning in 2002) until August 2006. American Financial Realty Trust was a publicly traded REIT that invested exclusively in offices, operation centers, bank branches, and other operating real estate assets that are net leased to tenants in the financial service industry, such as banks and insurance companies. Through American Financial Resource Group and its successor corporation, American Financial Realty Trust, Mr. Schorsch executed in excess of 1,000 acquisitions, both in acquiring businesses and real estate property with transactional value of approximately $5 billion. In 2003, Mr. Schorsch received an Entrepreneur of the Year award from Ernst & Young. From 1995 to September 2002, Mr. Schorsch served as CEO and President of American Financial Resource Group, American Financial Realty Trust’s predecessor, a private equity firm founded for the purpose of acquiring operating companies and other assets in a number of industries. Prior to American Financial Resource Group, Mr. Schorsch served as President of a non-ferrous metal product manufacturing business, Thermal Reduction. He successfully built the business through mergers and acquisitions and ultimately sold his interests to Corrpro (NYSE) in 1994.

 

 

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William M. Kahane is the president, chief operating officer and treasurer of American Realty Capital Trust, Inc., American Realty Capital Properties, LLC and American Realty Capital Advisors, LLC and has been active in the structuring and financial management of commercial real estate investments for over 25 years. Mr. Kahane also is the president and treasurer of American Realty Capital New York Recovery REIT, Inc, as well as the chief operating officer and treasurer of New York Recovery Properties, LLC and New York Recovery Advisors, LLC. Mr. Kahane began his career as a real estate lawyer practicing in the public and private sectors from 1974-1979. From 1981-1992, Mr. Kahane worked at Morgan Stanley & Co., specializing in real estate, becoming a Managing Director in 1989. In 1992, Mr. Kahane left Morgan Stanley to establish a real estate advisory and asset sales business known as Milestone Partners which continues to operate and of which Mr. Kahane is currently the Chairman. Mr. Kahane worked very closely with Mr. Schorsch while a trustee at American Financial Realty Trust (2003 to 2006), during which time Mr. Kahane served as Chairman of the Finance Committee of the Board of Trustees. Mr. Kahane has been a Managing Director of GF Capital Management & Advisors LLC, a New York-based merchant banking firm, where he has directed the firm’s real estate investments since 2001. GF Capital offers comprehensive wealth management services through its subsidiary TAG Associates LLC, a leading multi-client family office and portfolio management services company with approximately $5 billion of assets under management. Mr. Kahane also was on the Board of Directors of Catellus Development Corp., an NYSE growth-oriented real estate development company, where he served as Chairman.

Please also see the section entitled “Management” in this prospectus.

How do you expect your portfolio to be allocated between real estate properties and real estate-related loans and securities?

We intend to acquire and manage a diverse portfolio of real estate properties and real estate-related loans and securities. We plan to diversify our portfolio by geographic region, tenant mix, investment size and investment risk with the goal of attaining a portfolio of income-producing real estate properties and real estate-related assets that provide stable returns to our investors. We intend to allocate approximately 90.0% of our portfolio to investments in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million per property. We define “well-located” as retail properties situated in more densely populated locations with higher barriers to entry which limits additional competition. We define “well occupied” as retail properties with typically 80.0% or greater occupancy at the time of purchase. We intend to allocate approximately 10.0% of our portfolio to other real estate properties, real estate-related loans and securities and the equity securities of other REITs and real estate companies, assuming we sell the maximum offering amount. We expect that retail properties primarily would underlie or secure the real estate-related loans and securities in which we may invest. We do not expect our non-controlling equity investments in other public companies to exceed 5.0% of the proceeds of this offering, assuming we sell the maximum offering amount, or to represent a substantial portion of our assets at any one time. Although this is our current target portfolio, we may make adjustments to our target portfolio based on real estate market conditions and investment opportunities. We will not forego a good investment because it does not precisely fit our expected portfolio composition.

How will you select potential properties for acquisition?

To find properties that best meet our criteria for investment, our advisor and sub-advisor have developed a disciplined investment approach that combines the experience of their teams of

 

 

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real estate professionals with a structure that emphasizes thorough market research, stringent underwriting standards and an extensive down-side analysis of the risks of each investment.

What types of debt-related investments do you expect to make?

Assuming that we sell the maximum offering amount, we expect that our real estate-related investments will constitute no more than 10.0% of our portfolio or to represent a substantial portion of our assets at any one time. With respect to our investments in such assets, we will primarily focus on investments in first mortgages. The other debt-related investments in which we may invest include mortgage, mezzanine, bridge and other loans; debt and derivative securities related to real estate assets, including mortgage-backed securities; collateralized debt obligations; debt securities issued by real estate companies; and credit default swaps. We may structure, underwrite and originate many of the debt products in which we invest. Our underwriting process will involve comprehensive financial, structural, operational and legal due diligence to assess the risks of investments so that we can optimize pricing and structuring. By originating loans directly, we will be able to efficiently structure a diverse range of products. For instance, we may sell some components of the debt we originate while retaining attractive, risk-adjusted strips of the debt for ourselves. A wholly-owned subsidiary of our advisor may source our debt investments and provide loan servicing. We will pay our ARC Advisor asset management fees for the loans that we hold for investment.

We may sell some of the loans that we originate to third parties for a profit. We expect to hold other loans for investment and in some instances to securitize these loans. We will fund the loans we originate with proceeds from this offering and from other lenders, including proceeds from warehouse lines of credit.

What types of investments will you make in the equity securities of other companies?

We expect to make equity investments in REITs and other real estate companies. We may purchase the common or preferred stock of these entities or options to acquire their stock. We will target a public company that owns commercial real estate or real estate-related assets when we believe its stock is trading at a discount to that company’s net asset value. We may eventually seek to acquire or gain a controlling interest in the companies that we target. We do not expect our non-controlling equity investments in other public companies to exceed 5.0% of the proceeds of this offering, assuming we sell the maximum offering amount, or to represent a substantial portion of our assets at any one time. In addition, we do not expect our non-controlling equity investments in other public companies combined with our investments in real estate properties outside of our target shopping center investments and other real estate-related investments to exceed 10.0% of our portfolio, assuming we sell the maximum offering amount.

We will make investments in other entities when we consider it more efficient to acquire an entity that already owns assets meeting our investment objectives than to acquire such assets directly. We may also participate with other entities (including non-affiliated entities) in property ownership through joint ventures, limited liability companies, partnerships and other types of common ownership.

Will you use leverage?

Yes. We expect that once we have fully invested the proceeds of this offering, assuming we sell the maximum amount, our debt financing will be approximately 50.0% of the value of our real estate investments (calculated after the close of this offering and once we have invested

 

 

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substantially all of the proceeds of this offering) plus the value of our other assets, but may be as high as 65.0%. There is no limitation on the amount we may borrow for the purchase of any single asset. Our charter limits our borrowings to 75.0% of the cost (before deducting depreciation or other non-cash reserves) of our tangible assets; however, we may exceed that limit if a majority of the conflicts committee approves each borrowing in excess of our charter limitation and we disclose such borrowing to our stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. In all events, we expect that our secured and unsecured borrowings will be reasonable in relation to the net value of our assets and will be reviewed by our board of directors at least quarterly.

We do not intend to exceed the leverage limit in our charter except in the early stages of our development when the costs of our investments are most likely to exceed our net offering proceeds. Careful use of debt will help us to achieve our diversification goals because we will have more funds available for investment. However, high levels of debt could cause us to incur higher interest charges and higher debt service payments, which would decrease the amount of cash available for distribution to our investors.

How will you structure the ownership and operation of your assets?

We plan to own substantially all of our assets and conduct our operations through Phillips Edison – ARC Shopping Center Operating Partnership, L.P., which we refer to as our operating partnership in this prospectus. Our wholly-owned subsidiary, Phillips Edison Shopping Center OP GP LLC, is the sole general partner of the operating partnership and, as of the date of this prospectus, we are the sole limited partner of the operating partnership. Because we plan to conduct substantially all of our operations through the operating partnership, we are considered an UPREIT.

What is an “UPREIT”?

UPREIT stands for “Umbrella Partnership Real Estate Investment Trust.” An UPREIT is a REIT that holds substantially all of its properties through a partnership in which the REIT holds an interest as a general partner and/or a limited partner, approximately equal to the value of capital raised by the REIT through sale of its capital stock. Using an UPREIT structure may give us an advantage in acquiring properties from persons who may not otherwise sell their properties because of certain unfavorable U.S. federal income tax consequences. Generally, a sale of property directly to a REIT is a taxable sale to the selling property owner. In an UPREIT structure, a seller of a property who desires to defer taxable gain on the sale of his property may, in some cases, transfer the property to the UPREIT in exchange for limited partnership units in the partnership and defer taxation of gain until the seller later exchanges his limited partnership units on a one-to-one basis for REIT shares or for cash pursuant to the terms of the limited partnership agreement.

What conflicts of interest will your sponsors face?

Each of our Phillips Edison and ARC sponsors, and their respective affiliates and personnel, will experience conflicts of interest in connection with the management of our business.

Similarly, Messrs. Phillips and Edison, our individual Phillips Edison sponsors, will face conflicts of interest due to their existing obligations to other programs. Messrs. Phillips and Edison are principals of our sponsor Phillips Edison which, through its affiliated funds, has more

 

 

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than $1.8 billion in commercial real estate assets that it indirectly owns and manages. In addition to their responsibilities with Phillips Edison, Messrs. Phillips and Edison hold important management positions in our company and our sub-advisor, Phillips Edison & Company SubAdvisor LLC.

ARC Advisor and its affiliates will experience conflicts of interest in connection with the management of our business. Messrs. Schorsch, Kahane, one or our directors, Budko, Block and Weil, our individual ARC sponsors, indirectly own and control ARC Advisor and Realty Capital Securities, LLC, our dealer manager. In addition, several of the key employees of ARC Advisor are also the key employees of other ARC-sponsored programs, including two other public, non-traded REITs, American Realty Capital New York Recovery REIT, Inc. and American Realty Capital Trust, Inc., the advisors to the other ARC-sponsored programs and the dealer manager of four other public, non-traded REITs, including the two identified above sponsored by ARC. Some of the material conflicts that our sponsors and their respective affiliates will face include the following:

 

   

Our Phillips Edison sponsor and its affiliates must determine which investment opportunities to recommend to us and to two other operating private Phillips Edison-sponsored programs for which the offering proceeds have not been fully invested, as well as any programs Phillips Edison affiliates may sponsor in the future;

 

   

Our ARC sponsor and its affiliates must determine which investment opportunities to recommend to us and to other ARC-sponsored programs, as well as any programs ARC affiliates may sponsor in the future;

 

   

Because our ARC sponsor is a sponsor of two other public offerings concurrently with this offering, we will have to compete with other programs sponsored by our ARC sponsor for the same investors when raising capital;

 

   

ARC Advisor and its affiliates may structure the terms of joint ventures between us and other Phillips Edison- or ARC-sponsored programs or Phillips Edison- or ARC-advised entities;

 

   

Our sponsors and their respective affiliates will have to allocate their time between us and other real estate programs and activities in which they are involved;

 

   

Our sponsors and their respective affiliates will receive fees in connection with transactions involving the purchase, origination, management and sale of our assets regardless of the quality of the asset acquired or the services provided to us;

 

   

Our dealer manager, Realty Capital Securities, LLC, is an affiliate of ARC Advisor and will receive fees in connection with our public offerings of equity securities;

 

   

We may only terminate our dealer manager in limited circumstances and, except under certain conditions, will be obligated to use our dealer manager in future offerings;

 

   

ARC Advisor may terminate the advisory agreement without penalty upon 60 days’ written notice and, upon termination of the advisory agreement, ARC Advisor may be entitled to a termination fee if (based upon an independent appraised value of the portfolio) it would have been entitled to a subordinated share of cash flows had the

 

 

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portfolio been liquidated on the termination date, which fee ARC Advisor may choose to defer until such time as we list our shares on a national securities exchange, if ever, or until such time as we liquidate substantially all of our assets; and

 

   

We may seek stockholder approval to internalize our management by acquiring assets and personnel from our advisor for consideration that would be negotiated at that time. The payment of such consideration could result in dilution to your interest in us and could reduce the net income per share and funds from operations per share attributable to your investment. Additionally, in an internalization transaction, members of our advisor’s management that become our employees may receive more compensation than they receive from our advisor. These possibilities may provide incentives to our advisor or its management to pursue an internalization transaction rather than an alternative strategy, even if such alternative strategy might otherwise be in our stockholders’ best interests.

 

 

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What is the ownership structure of the company and the entities that perform services for you?

The following chart shows the ownership structure of the various entities that perform or are likely to perform important services for us.

 

LOGO

 

 

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What are the fees that you will pay to the advisor, its affiliates, the dealer manager and your directors?

ARC Advisor and its affiliates will receive compensation and reimbursement for services relating to this offering and the investment and management of our assets. We will also compensate the dealer manager and our independent directors for their service to us. The most significant items of compensation are included in the table below. Unless otherwise noted, the fees to be paid and expenses to be reimbursed described below will be paid or reimbursed to our advisor, an affiliate of our ARC sponsor. ARC Advisor may then assign such fees or expense reimbursements to our sub-advisor, an affiliate of our Phillips Edison sponsor, in whole or in proportion to the amount of services provided or expenses incurred on our behalf (collectively the advisor and sub-advisor, the “Advisor Entities”) pursuant to the terms of the sub-advisory agreement between those parties. Selling commissions and dealer manager fees may vary for different categories of purchasers. This table assumes that we sell all shares at the highest possible selling commissions and dealer manager fees (with no discounts to any categories of purchasers) and assumes a $9.50 price for each share sold through our dividend reinvestment plan. No selling commissions or dealer manager fees are payable on shares sold through our dividend reinvestment plan or the “friends and family” program.

 

Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum
Offering

     Organization and Offering Stage     
Selling Commissions—Dealer
Manager
   7.0% of gross offering proceeds before reallowance of commissions earned by participating broker-dealers,
except no selling commissions are payable on shares
sold under the dividend reinvestment plan or our
“friends and family” program. We expect that the
dealer manager will reallow 100% of commissions
earned to participating broker-dealers.
   $175,000/$105,000,000
Dealer Manager Fee—Dealer
Manager
   3.0% of gross offering proceeds, except no dealer
manager fee is payable on shares sold under the
dividend reinvestment plan or our “friends and family”
program. The dealer manager may reallow all or a
portion of its dealer manager fees to participating
broker-dealers.
   $75,000/$45,000,000
Other Organization and Offering
Expenses
   To date, the sub-advisor has paid organization and
offering expenses on our behalf. We will reimburse on
a monthly basis the sub-advisor for these costs and
future organization and offering costs it, our advisor or
their respective affiliates may incur on our behalf but
only to the extent that the reimbursement would not
exceed 1.5% of gross offering proceeds over the life of
the offering or cause the selling commissions, the dealer
manager fee and such other organization and offering
expenses borne by us to exceed 15.0% of gross offering
proceeds as of the date of the reimbursement.
   $37,500/$22,500,000
   Acquisition and Development Stage   
Acquisition Fees    We will pay to our Advisor Entities 1.5% of the contract
purchase price of each property acquired (including our
   $33,188 (minimum offering
and no debt)/$19,912,500

 

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum
Offering

   pro rata share of debt attributable to such property) and
1.5% of the amount advanced for a loan or other
investment (including our pro rata share of debt
attributable to such investment). For purposes of this
prospectus, “contract purchase price” means the amount
actually paid or allocated in respect of the purchase,
development, construction or improvement of a
property or the amount actually paid or allocated in
respect of the purchase of loans or other real-estate
related assets, in each case exclusive of acquisition fees
and acquisition expenses, but in each case including any
indebtedness assumed or incurred in respect of such investment.
   (maximum offering and no debt)/$39,825,000
(maximum offering and
target leverage of 50.0% of
the cost of our investments)

Acquisition Expenses

   We will reimburse our Advisor Entities for expenses
actually incurred (including personnel costs) related to
selecting, evaluating and acquiring assets on our behalf,
regardless of whether we actually acquire the related
assets. In addition, we also will pay third parties, or
reimburse the advisor or its affiliates, for any
investment-related expenses due to third parties,
including, but not limited to, legal fees and expenses,
travel and communications expenses, costs of
appraisals, accounting fees and expenses, third-party
brokerage or finders fees, title insurance expenses,
survey expenses, property inspection expenses and other
closing costs regardless of whether we acquire the
related assets. We expect these expenses to be
approximately 0.5% of the purchase price of each
property (including our pro rata share of debt
attributable to such property) and 0.5% of the amount
advanced for a loan or other investment (including our
pro rata share of debt attributable to such investment).
In no event will the total of all acquisition fees and
acquisition expenses payable with respect to a particular
investment exceed 6.0% of the contract purchase price
of each property (including our pro rata share of debt
attributable to such property) or 6.0% of the amount
advanced for a loan or other investment (including our
pro rata share of debt attributable to such investment).
   $11,063/$6,637,500

 

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum
Offering

Development Fee

   If we engage an affiliate of one of our sponsors to
provide development services with respect to a
particular property, we will pay a development fee in an
amount that is usual and customary for comparable
services rendered to similar projects in the geographic
market of the project.
   We cannot determine these
amounts at the present time.
   Operational Stage   

Asset Management Fee

   We will pay our advisor a quarterly fee of 0.25% of the
sum of the cost of all real estate and real estate-related
investments we own and of our investments in joint
ventures, including acquisition fees, acquisition and
origination expenses and any debt attributable to such
investments until 18 months following the end of this or
any follow-on public offering. Thereafter, the quarterly
fee will equal 0.25% of the combined fair market value
of all real estate and real estate-related investments we
own and of our investments in joint ventures. Fair
market value shall be determined by the Advisor
Entities or by an independent third-party valuation.
This fee will be payable quarterly in advance, on
January 1, March 1, July 1 and October 1 based on
assets held by us during the pervious quarter, adjusted
for appropriate closing dates for individual property
acquisitions.
   The actual amounts depend on the total equity and debt capital we raise and the results of our operations; we cannot determine these amounts at the present time.

Financing Fee

   We will pay our advisor a financing fee equal to 1.0%
of all amounts made available under any loan or line of
credit.
   The actual amounts depend on the total debt capital made available to us; we cannot determine these amounts at the present time.

Leasing Fee—Property Manager

   If we engage an affiliate of one of our sponsors to
provide leasing services with respect to a particular
property, we will pay a leasing fee in an amount that is
usual and customary for comparable services rendered
in the geographic market of the property.
   We cannot determine these amounts at the present time.

Construction Oversight Fee

   If we engage an affiliate of one of our sponsors to
provide construction oversight services with respect to a
particular property, we will pay a construction oversight
fee in an amount that is usual and customary for
comparable services rendered to similar projects in the
geographic market of the property.
   We cannot determine these amounts at the present time.

Other Operating Expenses

   We will reimburse the expenses incurred by our
Advisor Entities in connection with its provision of
services to us, including our allocable share of our
Advisor Entities’ overhead, such as rent, personnel
costs, utilities and IT costs. Though our Advisor
Entities have contractual rights to seek reimbursement
for personnel costs, our Advisor Entities do not intend
to do so at this time. If our Advisor Entities do decide
   Actual amounts depend on
the results of our operations;
we cannot determine these
amounts at the present time.

 

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum
Offering

   to seek reimbursement for personnel costs, such costs
may include our proportionate share of the salaries of
persons involved in the preparation of documents to
meet SEC reporting requirements. We will also
reimburse our Advisor Entities and their respective
affiliates for expenses paid on our behalf in connection
with investigating and acquiring assets, regardless of
whether we acquire the assets. We may not, however,
reimburse expenses that exceed the greater of 6.0% of
the contract price of any real estate asset or, in the case
of a loan, 6.0% of the funds advanced. Reimbursable
expenses include items such as property appraisals,
environmental surveys, property audit fees, legal fees,
asset due diligence review and business travel, such as
airfare, hotel, meal and phone charges. We will not
reimburse for personnel costs in connection with
services for which our Advisor Entities receive
acquisition or disposition fees.
  

 

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum
Offering

Property Management Fees—
Property Manager
   Property management fees equal to 4.5% of the
annualized gross revenues of the properties managed by
Phillips Edison Property Manager, our property
manager, will be payable monthly. In the event that we
contract directly with a non-affiliated third-party
property manager in respect of a property, we will pay
the property manager an oversight fee equal to 1.0% of
the annualized gross revenues of the property managed
payable monthly. In no event will we pay both a
property management fee and an oversight fee to an
affiliated property manager with respect to any
particular property. In addition to the property
management fee or oversight fee, if our property
manager provides leasing services with respect to a
property, we will pay our property manager leasing fees
in an amount equal to the leasing fees charged by
unaffiliated persons rendering comparable services in
the same geographic location of the applicable property.
Our property manager may subcontract the performance
of its property management and leasing duties to third
parties, and our property manager may pay a portion of
its property management or leasing fees to the third
parties with whom it subcontracts for these services. We
will reimburse the costs and expenses incurred by our
property manager on our behalf, including legal, travel
and other out-of-pocket expenses that are directly
related to the management of specific properties, as well
as fees and expenses of third-party accountants. We
will not, however, reimburse our property manager for
the wages and salaries and other employee-related
expenses of on-site employees of our property manager
or its subcontractors who are engaged in the operation,
management, maintenance or access control of our
properties (including taxes, insurance and benefits
relating to such employees).
   Actual amounts depend on
gross revenues of specific
properties and actual
management fees or
property management fees
and customary leasing fees
and therefore cannot be
determined at the present
time.

Independent Director Compensation

   We will pay each of our independent directors an annual
retainer of $30,000. We will also pay our independent
directors for attending meetings as follows: (1) $1,000
for each board meeting attended in person or
telephonically and (2) $1,000 for each committee
meeting attended in person or telephonically. The audit
committee chair will also receive an annual retainer of
$5,000 and the conflicts committee chair an annual
retainer of $3,000. We expect to grant our independent
directors an annual award of 2,500 shares of restricted
stock. All directors will receive reimbursement of
reasonable out-of-pocket expenses incurred in
connection with attendance at meetings of the board of
directors.
   Actual amounts depend on the total number of board and committee meetings that each independent director attends; we cannot determine these amounts at the present time.

 

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum
Offering

   Liquidation/Listing Stage   
Disposition Fees   

For substantial assistance in connection with the sale of
properties or other investments, we will pay our Advisor
Entities or their respective affiliates 2.0% of the contract
sales price of each property or other investment sold;
provided, however, in no event may the disposition fees
paid to our Advisor Entities, their respective affiliates
and unaffiliated third parties exceed 6.0% of the
contract sales price. The conflicts committee will
determine whether our Advisor Entities or their
affiliates have provided substantial assistance to us in
connection with the sale of an asset. Substantial
assistance in connection with the sale of a property
includes our advisor’s or sub-advisor’s preparation of an

investment package for the property (including an
investment analysis, rent rolls, tenant information
regarding credit, a property title report, an
environmental report, a structural report and exhibits) or
such other substantial services performed by the advisor
or sub-advisor in connection with a sale. We do not
intend to sell properties or other assets to affiliates.
However, if we do sell an asset to an affiliate, our
organizational documents would not prohibit us from
paying our advisor or sub-advisor a disposition fee.
Before we sold an asset to an affiliate, the charter would
require that our conflicts committee conclude, by a
majority vote, that the transaction is fair and reasonable
to us and on terms and conditions no less favorable to us
than those available from third parties.

   Actual amounts depend on the results of our operations; we cannot determine these amounts at the present time.
Subordinated Share of Cash Flows    Our Advisor Entities will receive 15.0% of remaining
net cash flows after return of capital contributions plus
payment to investors of a 7.0% cumulative, pre-tax,
non-compounded return on the capital contributed by
investors. We cannot assure you that we will provide
this 7.0% return, which we have disclosed solely as a
measure for our Advisor Entities’ and their respective
affiliates’ incentive compensation.
   Actual amounts depend on the results of our operations; we cannot determine these amounts at the present time.
Subordinated Incentive Fee    Our Advisor Entities will receive 15.0% of the amount
by which the sum of our adjusted market value plus
distributions exceeds the sum of the aggregate capital
contributed by investors plus an amount equal to a 7.0%
cumulative, pre-tax, non-compounded annual return to
investors. We cannot assure you that we will provide
this 7.0% return, which we have disclosed solely as a
measure for our Advisor Entities’ and their respective
affiliates’ incentive compensation.
   Actual amounts depend on the results of our operations; we cannot determine these amounts at the present time.
Termination Fee    Upon termination or non-renewal of the advisory
   Not determinable at this

 

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum
Offering

   agreement, our advisor shall be entitled to a
subordinated termination fee. In addition, our advisor
may elect to defer its right to receive a subordinated
termination fee until either a listing on a national
securities exchange or other liquidity event occurs.
   time. There is no maximum amount of this fee.

How many real estate investments do you currently own?

We currently do not own any properties or other real estate investments. Because we have not yet identified any specific assets to acquire, we are considered to be a blind pool. As property acquisitions become probable, we will supplement this prospectus to provide information regarding the likely acquisition to the extent material to an investment decision with respect to our common stock. We will also describe material changes to our portfolio, including the closing of property acquisitions, by means of a supplement to this prospectus.

Will you acquire properties or other assets in joint ventures?

Possibly. Among other reasons, joint venture investments permit us to own interests in large assets without unduly restricting the diversity of our portfolio. We may also want to acquire properties and other investments through joint ventures in order to diversify our portfolio by investment size or investment risk. In determining whether to invest in a particular joint venture, ARC Advisor will evaluate the real estate assets that such joint venture owns or is being formed to own under the same criteria as our other investments.

What steps will you take to make sure you purchase environmentally compliant properties?

Generally, we will obtain a Phase I environmental assessment of each property purchased and, in our discretion, may obtain additional environmental assessments. We will not close the purchase of any property unless we are generally satisfied with the environmental status of the property.

If I buy shares, will I receive distributions and how often?

In order that investors may generally begin earning distributions immediately upon our acceptance of their subscription, we expect to authorize and declare daily distributions that will be paid on a monthly basis beginning no later than the first calendar month after the calendar month in which we make our first real estate investment. Once we commence paying distributions, we expect to pay distributions monthly and continue paying distributions monthly unless our results of operations, our general financial condition, general economic conditions or other factors make it imprudent to do so. The timing and amount of distributions will be determined by our board, in its sole discretion, may vary from time to time, and will be influenced in part by its intention to comply with REIT requirements of the Internal Revenue Code.

We expect to have little, if any, funds from operations available for distribution until we make substantial investments. Further, because we may receive income from interest or rents at various times during our fiscal year and because we may need funds from operations during a particular period to fund capital expenditures and other expenses, we expect that at least during

 

 

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the early stages of our development and from time to time during our operational stage, we will declare distributions in anticipation of funds that we expect to receive during a later period and we will pay these distributions in advance of our actual receipt of these funds. In these instances, we expect to look to third-party borrowings to fund our distributions. We may also fund such distributions from advances from our advisor or sponsors or from our advisor’s deferral of its fees.

Our distribution policy is not to use the proceeds of this offering to pay distributions. However, our board has the authority under our organizational documents, to the extent permitted by Maryland law, to pay distributions from any source, including proceeds from this offering or the proceeds from the issuance of securities in the future.

To maintain our qualification as a REIT, we must make aggregate annual distributions to our stockholders of at least 90.0% of our REIT taxable income (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). If we meet the REIT qualification requirements, we generally will not be subject to U.S. federal income tax on the income that we distribute to our stockholders each year. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Phillips Edison—ARC Shopping Center REIT Inc.—Annual Distribution Requirements.” Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant.

We have not established a minimum distribution level, and our charter does not require that we make distributions to our stockholders.

May I reinvest my distributions in shares of Phillips Edison—ARC Shopping Center REIT Inc.?

Yes. You may participate in our dividend reinvestment plan by checking the appropriate box on the subscription agreement or by filling out an enrollment form we will provide to you at your request. The purchase price for shares purchased under the dividend reinvestment plan will initially be $9.50. Once we establish an estimated value per share that is not based on the price to acquire a share in our primary offering or a follow-on public or private offering, shares issued pursuant to our dividend reinvestment plan will be priced at the estimated value per share of our common stock, as determined by our advisor or another firm chosen for that purpose. We expect to establish an estimated value per share not based on the price to acquire a share in the primary offering or a follow-on public or private offering after the completion of our offering stage. We will consider our offering stage complete when we are no longer offering equity securities—whether through this offering or follow-on public or private offerings—and have not done so for 18 months. No selling commissions or dealer manager fees will be payable on shares sold under our dividend reinvestment plan. We may amend or terminate the dividend reinvestment plan for any reason at any time upon 10 days’ notice to the participants. We may provide notice by including such information (1) in a current report on Form 8-K or in our annual or quarterly reports, all publicly filed with the SEC or (2) in a separate mailing to the participants.

Will the distributions I receive be taxable as ordinary income?

It depends. Generally, distributions that you receive (not designated as capital gains dividends), including distributions that are reinvested pursuant to our dividend reinvestment plan, will be taxed as ordinary income to the extent they are from current or accumulated earnings and

 

 

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profits. However, distributions that we designate as capital gain dividends will generally be taxable as long-term capital gain to the extent they do not exceed our annual net capital gain for the taxable year. Participants in our dividend reinvestment plan will also be treated for tax purposes as having received an additional distribution to the extent that they purchase shares under the dividend reinvestment plan at a discount to fair market value. As a result, participants in our dividend reinvestment plan may have tax liability with respect to their share of our taxable income, but they will not receive cash distributions to pay such liability.

We expect that some portion of your distributions will not be subject to tax in the year in which it is received because depreciation expense reduces the amount of taxable income but does not reduce cash available for distribution. The portion of your distribution which is not designated as a capital gain dividend and is in excess of our current and accumulated earnings and profits is considered a return of capital for tax purposes and will reduce the tax basis of your investment. Distributions that constitute a return of capital, in effect, defer a portion of your tax until your investment is sold or we are liquidated, at which time you will be taxed at capital gains rates. Please note that each investor’s tax considerations are different, therefore, we suggest that you consult with your tax advisor prior to making an investment in our shares.

How will you use the proceeds raised in this offering?

We expect to invest primarily in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million per property. The shopping centers will have a mix of national, regional, and local retailers who sell essential goods and services to customers who live in the neighborhood. We also expect to invest in other real estate properties and real estate-related loans and securities. Depending primarily upon the number of shares we sell in this offering and assuming a $10.00 purchase price for shares sold in the primary offering, we estimate that we will use approximately 86.8% of the gross proceeds to make investments in real estate properties and other real estate-related loans and securities. We will use the remainder of the offering proceeds to pay the costs of the offering, including selling commissions and the dealer manager fee, and to pay a fee to our advisor for its services in connection with the selection and acquisition of properties. We expect to use substantially all of the net proceeds from the sale of shares under our dividend reinvestment plan to repurchase shares under our share redemption program.

Until we invest the proceeds of this offering in real estate investments, we may invest in short-term, highly liquid or other authorized investments. Such short-term investments will not earn as high of a return as we expect to earn on our real estate investments, and we may be not be able to invest the proceeds in real estate promptly.

 

 

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     250,000 Shares     180,000,000 Shares  
     Minimum Offering
($10.00/share)
    Primary Offering
(150,000,000 shares)
($10.00/share)
    Div. Reinv. Plan
(30,000,000 shares)
($9.50/share)
 
     $    %     $     %     $    %  

Gross Offering Proceeds

     2,500,000    100.00     1,500,000,000      100.00     285,000,000    100.00

Selling Commissions

     175,000    7.00     105,000,000      7.00     0    0.00

Dealer Manager Fee

     75,000    3.00     45,000,000      3.00     0    0.00

Other Organization and Offering Expenses

     37,500    1.50     22,500,000      1.50     427,500    0.15
                                        

Amount available for investment

     2,212,500    88.50     1,327,500,000      88.50     284,572,500    99.85

Acquisition Fees (1)

     33,188    1.30     19,912,500  (2)    1.30     0    0.00

Acquisition Expenses

     11,063    0.40     6,637,500      0.40     0    0.00
                                        

Amount Invested in Properties (3)

   $ 2,168,250    86.80   $ 1,300,950,000      86.80   $ 284,572,500    99.85

 

(1)

For purposes of this table, we have assumed approximately 90.0% of our portfolio are necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and approximately 10.0% of our investments are other real estate and real estate-related loans and securities.

(2)

If we raise the maximum offering amount and our debt financing is equal to 65.0% of the value of our real estate investments, then acquisition fees would be approximately $56.9 million.

(3)

We expect any working capital reserves to be maintained at the property level.

What kind of offering is this?

We are offering up to 180,000,000 shares of common stock on a “best efforts” basis. We are offering 150,000,000 of these shares in our primary offering at $10.00 per share, with volume discounts available to investors who purchase more than $1,000,000 in shares through the same participating broker-dealer. Discounts are also available for investors who purchase shares through certain distribution channels. We are offering up to 30,000,000 shares pursuant to our dividend reinvestment plan at a purchase price initially equal to $9.50 per share. We reserve the right to reallocate the shares of common stock we are offering between the primary offering and our dividend reinvestment plan.

How does a “best efforts” offering work? What happens if you don’t raise at least $2.5 million in gross offering proceeds?

When shares are offered on a “best efforts” basis, the dealer manager will be required to use only its best efforts to sell the shares and it has no firm commitment or obligation to purchase any of the shares. Therefore, we may sell substantially less than what we are offering.

We will not sell any shares unless we raise a minimum of $2.5 million in gross offering proceeds from persons who are not affiliated with us or our sponsors. Pending satisfaction of this condition, all subscription payments will be placed in an account held by the escrow agent in trust for our subscribers’ benefit, pending release to us. You are entitled to receive the interest earned on your subscription payment while it is held in the escrow account. Once we have raised the minimum offering amount and instructed the escrow agent to disburse the funds in the account, funds representing the gross purchase price for the shares will be distributed to us and the escrow agent will disburse directly to you any interest earned on your subscription payment while it was held in the escrow account. If we do not raise $2.5 million in gross offering proceeds by , 2011, we will terminate this offering and promptly return all subscribers’ funds in the escrow

 

 

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account (plus interest). Funds in escrow will be invested in short-term investments that mature on or before the termination of the escrow period or that can be readily sold or otherwise disposed of for cash by such date without any dissipation of the offering proceeds invested. We will not deduct any fees if we return funds from the escrow account. Because of the higher minimum offering requirement for Pennsylvania investors (described below), subscription payments made by Pennsylvania investors will not count toward the $2.5 million minimum offering for all other jurisdictions.

Notwithstanding our $2.5 million minimum offering amount for all other jurisdictions, we will not sell any shares to Pennsylvania investors unless we raise a minimum of $50.0 million in gross offering proceeds (including sales made to residents of other jurisdictions). Pending satisfaction of this condition, all subscription payments by Pennsylvania investors will be placed in a separate account held by the escrow agent in trust for Pennsylvania subscribers’ benefit, pending release to us. If we have not reached this $50.0 million threshold within 120 days of the date that we first accept a subscription payment from a Pennsylvania investor, we will, within 10 days of the end of that 120-day period, notify Pennsylvania investors in writing of their right to receive refunds, with interest. If a Pennsylvania investor requests a refund within 10 days of receiving that notice, we will arrange for the escrow agent to promptly return by check such investor’s subscription amount with interest. Amounts held in the Pennsylvania escrow account from Pennsylvania investors not requesting a refund will continue to be held for subsequent 120-day periods until we raise at least $50.0 million or until the end of the subsequent escrow periods. At the end of each subsequent escrow period, we will again notify each Pennsylvania investor of his or her right to receive a refund of his or her subscription amount with interest. In the event we do not raise gross offering proceeds of $50.0 million by                     , 2012, we will promptly return all funds held in escrow for the benefit of Pennsylvania investors (in which case, Pennsylvania investors will not be required to request a refund of their investment). Purchases by persons affiliated with us or our advisor will not count toward the Pennsylvania minimum.

How long will this offering last?

We expect to sell the 150,000,000 shares offered in our primary offering over a three-year period, or until                     , 2013. We may continue to offer shares under our dividend reinvestment plan beyond the termination of our primary offering until we have sold 30,000,000 shares through the reinvestment of distributions, but only if there is an effective registration statement with respect to the shares. We reserve the right to reallocate the shares of common stock we are offering between the primary offering and our dividend reinvestment plan. In some states, we may not be able to continue the offering for these periods without filing a new registration statement, or in the case of shares sold under the dividend reinvestment plan, renew or extend the registration statement in such state. We may terminate this offering at any time.

If our board of directors determines that it is in our best interests, we may conduct follow-on offerings upon the termination of this offering. Our charter does not restrict our ability to conduct offerings in the future.

Who can buy shares?

An investment in our shares is only suitable for persons who have adequate financial means and who will not need immediate liquidity from their investment. Residents of most states can buy shares in this offering provided that they have either (1) a net worth of at least $70,000 and an annual gross income of at least $70,000 or (2) a net worth of at least $250,000. For the purpose of determining suitability, net worth does not include an investor’s home, home

 

 

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furnishings or personal automobiles. The minimum suitability standards are more stringent for investors in Alabama, California, Iowa, Kansas, Kentucky, Massachusetts, Michigan, Missouri, Mississippi, Ohio, Oregon, Pennsylvania, Tennessee and Washington.

Who might benefit from an investment in our shares?

An investment in our shares may be beneficial for you if you meet the minimum suitability standards described in this prospectus, seek to diversify your personal portfolio with a real estate-based investment, seek to receive current income, seek to preserve capital, seek to obtain the benefits of potential long-term capital appreciation and are able to hold your investment for a time period consistent with our liquidity strategy. On the other hand, we caution persons who require immediate liquidity or guaranteed income, or who seek a short-term investment, that an investment in our shares will not meet those needs.

Is there any minimum investment required?

Yes. We require a minimum investment of $2,500. After you have satisfied the minimum investment requirement, any additional purchases must be in increments of at least $100. The investment minimum for subsequent purchases does not apply to shares purchased pursuant to our dividend reinvestment plan.

Are there any special restrictions on the ownership or transfer of shares?

Yes. Our charter contains restrictions on the ownership of our shares that prevent any one person from owning more than 9.8% of our aggregate outstanding shares unless exempted by our board of directors. These restrictions are designed to enable us to comply with ownership restrictions imposed on REITs by the Internal Revenue Code. Our charter also limits your ability to sell your shares unless: (1) the prospective purchaser meets the suitability standards regarding income or net worth and (2) the transfer complies with the minimum purchase requirements.

Are there any special considerations that apply to employee benefit plans subject to ERISA or other retirement plans that are investing in shares?

Yes. The section of this prospectus entitled “ERISA Considerations” describes the effect the purchase of shares will have on individual retirement accounts (each an “IRA”) and retirement plans subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA), and/or the Internal Revenue Code. ERISA is a federal law that regulates the operation of certain tax-advantaged retirement plans. Any retirement plan trustee or individual considering purchasing shares for a retirement plan or an individual retirement account should carefully read this section of the prospectus. Prospective investors with investment discretion over the assets of an IRA, employee benefit plan or other retirement plan or arrangement that is covered by ERISA or Section 4975 of the Internal Revenue Code should carefully review the information in the section of this prospectus entitled “ERISA Considerations.” Any such prospective investors are required to consult their own legal and tax advisors on these matters.

We may make some investments that generate “excess inclusion income” which, when passed through to our tax-exempt stockholders, can be taxed as unrelated business taxable income (UBTI) or, in certain circumstances, can result in a tax being imposed on us. Although we do not expect the amount of such income to be significant, there can be no assurance in this regard.

 

 

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May I make an investment through my IRA, SEP or other tax-deferred account?

Yes. You may make an investment through your IRA, a simplified employee pension (“SEP”) plan or other tax-deferred account. In making these investment decisions, you should consider, at a minimum: (1) whether the investment is in accordance with the documents and instruments governing your IRA, plan or other account, (2) whether the investment satisfies the fiduciary requirements associated with your IRA, plan or other account, (3) whether the investment will generate UBTI to your IRA, plan or other account, (4) whether there is sufficient liquidity for such investment under your IRA, plan or other account, (5) the need to value the assets of your IRA, plan or other account annually or more frequently and (6) whether the investment would constitute a prohibited transaction under applicable law. Prospective investors with investment discretion over the assets of an IRA, employee benefit plan or other retirement plan or arrangement that is covered by ERISA or Section 4975 of the Internal Revenue Code should carefully review the information in the section of this prospectus entitled “ERISA Considerations.” Any such prospective investors are required to consult their own legal and tax advisors on these matters.

How do I subscribe for shares?

If you choose to purchase shares in this offering, you will need to complete and sign a subscription agreement (in the form attached to this prospectus as Appendix B) for a specific number of shares and pay for the shares at the time of your subscription.

If I buy shares in this offering, how may I later sell them?

At the time you purchase the shares, they will not be listed for trading on any securities exchange or over-the-counter market. In fact, we expect that there will not be any public market for the shares when you purchase them, and we cannot be sure if one will ever develop. In addition, our charter imposes restrictions on the ownership of our common stock that will apply to potential purchasers of your shares. As a result, if you wish to sell your shares, you may not be able to do so promptly or at all, or you may only be able to sell them at a substantial discount from the price you paid.

After you have held your shares for at least one year, you may be able to have your shares repurchased by us pursuant to our share redemption program. We will redeem shares on the last business day of each month (and in all events on a date other than a dividend payment date). The prices at which we will initially redeem shares are as follows:

 

   

The lower of $9.25 or 92.5% of the price paid to acquire the shares from us for stockholders who have held their shares for at least one year;

 

   

The lower of $9.50 or 95.0% of the price paid to acquire the shares from us for stockholders who have held their shares for at least two years;

 

   

The lower of $9.75 or 97.5% of the price paid to acquire the shares from us for stockholders who have held their shares for at least three years; and

 

   

The lower of $10.00 or 100% of the price paid to acquire the shares from us for stockholders who have held their shares for at least four years.

 

 

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Notwithstanding the above, once we establish an estimated value per share of our common stock that is not based on the price to acquire a share in our primary offering or a follow-on public or private offering, the redemption price per share for all stockholders would be equal to the estimated value per share, as determined by our advisor or another firm chosen for that purpose. We expect to establish an estimated value per share after the completion of our offering stage. We will consider our offering stage complete when we are no longer offering equity securities—whether through this offering or follow-on public or private offerings—and have not done so for 18 months.

The terms of our share redemption program are more generous with respect to redemptions sought upon a stockholder’s death or qualifying disability:

 

   

There is no one-year holding requirement;

 

   

Until we establish an estimated value per share, which we expect to be no later than three years after the completion of our offering stage, the redemption price is the amount paid to acquire the shares from us; and

 

   

Once we have established an estimated value per share, the redemption price would be the estimated value of the shares, as determined by our advisor or another firm chosen for that purpose.

The share redemption program also contains numerous restrictions on your ability to sell your shares to us. The decision to accept redemption requests will be made by our board of directors after consideration of a number of factors including the amount of net proceeds from the sale of shares under our dividend reinvestment plan during the prior calendar year and the amount of our revenues and expenses generally. Further, during any calendar year, we may redeem no more than 5.0% of the weighted average number of shares outstanding during the prior calendar year. We also have no obligation to redeem shares if the redemption would violate the restrictions on distributions under Maryland law, which prohibits distributions that would cause a corporation to fail to meet statutory tests of solvency. We may amend, suspend or terminate the program at any time upon 30 days’ notice.

What are your exit strategies?

It is our intention to begin the process of achieving a Liquidity Event not later than three to five years after the termination of this primary offering. A “Liquidity Event” could include a sale of our assets, a sale or merger of our company, a listing of our common stock on a national securities exchange, or other similar transaction.

If we do not begin the process of achieving a Liquidity Event by the fifth anniversary of the termination of this offering, our charter requires either (1) an amendment to our charter to extend the deadline to begin the process of achieving a Liquidity Event or (2) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio.

If we sought and failed to obtain stockholder approval of a charter amendment extending the deadline with respect to a Liquidity Event, our charter requires us to submit a plan of liquidation for the approval of our stockholders. If we sought and obtained stockholder approval of our liquidation, we would begin an orderly sale of our properties and other assets. The precise timing of such sales would take account of the prevailing real estate and financial markets, the economic conditions in the submarkets where our properties are located and the U.S. federal

 

 

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income tax consequences to our stockholders. In making the decision to apply for listing of our shares, our directors will try to determine whether listing our shares or liquidating our assets will result in greater value for stockholders.

One of the factors our board of directors will consider when making this determination is the liquidity needs of our stockholders. In assessing whether to list or liquidate, our board of directors would likely solicit input from financial advisors as to the likely demand for our shares upon listing. If, after listing, the board believed that it would be difficult for stockholders to dispose of their shares, then that factor would weigh against listing. However, this would not be the only factor considered by the board. If listing still appeared to be in the best long-term interests of our stockholders, despite the prospects of a relatively small market for our shares upon the initial listing, the board may still opt to list our shares of common stock in keeping with its obligations under Maryland law. The board would also likely consider whether there was a large pent-up demand to sell our shares when making decisions regarding listing or liquidation. The degree of participation in our dividend reinvestment plan and the number of requests for redemptions under the share redemption program at this time could be an indicator of stockholder demand to liquidate their investment.

Will I be notified of how my investment is doing?

Yes, we will provide you with periodic updates on the performance of your investment in us, including:

 

   

detailed quarterly dividend reports;

 

   

an annual report;

 

   

supplements to the prospectus, provided quarterly during the primary offering; and

 

   

three quarterly financial reports.

We will provide this information to you via one or more of the following methods, in our discretion and with your consent, if necessary:

 

   

U.S. mail or other courier;

 

   

facsimile;

 

   

electronic delivery; or

 

   

posting on our web site at                                             .

To assist the Financial Industry Regulatory Authority (“FINRA”) members and their associated persons that participate in this offering, pursuant to FINRA Conduct Rule 5110, we disclose in each annual report distributed to stockholders a per share estimated value of our shares, the method by which it was developed, and the date of the data used to develop the estimated value. In addition, ARC Advisor, our advisor, prepares annual statements of estimated share values to assist fiduciaries of retirement plans subject to the annual reporting requirements of ERISA in the preparation of their reports relating to an investment in our shares. Our advisor has indicated that it intends to use the most recent price paid to acquire a share in this offering (ignoring purchase price discounts for certain categories of purchasers) or a follow-on public or

 

 

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private offering as its estimated per share value of our shares until we have completed our offering stage. We will consider our offering stage complete when we are no longer publicly offering equity securities—whether through this offering or follow-on public or private offerings—and have not done so for 18 months. If our board of directors determines that it is in our best interest, we may conduct follow-on offerings upon the termination of this offering. Our charter does not restrict our ability to conduct offerings in the future. (For purposes of this definition, we do not consider a “public equity offering” to include offerings on behalf of selling stockholders or offerings related to a dividend reinvestment plan, employee benefit plan or the redemption of interests in our operating partnership.)

Although this initial estimated value represents the most recent price at which most investors are willing to purchase shares in this primary offering, this reported value is likely to differ from the price at which a stockholder could resell his or her shares because: (1) there is no public trading market for the shares at this time; (2) the estimated value does not reflect, and is not derived from, the fair market value of our properties and other assets, nor does it represent the amount of net proceeds that would result from an immediate liquidation of those assets, because the amount of proceeds available for investment from our primary public offering is net of selling commissions, dealer manager fees, other organization and offering costs and acquisition fees and expenses; (3) the estimated value does not take into account how market fluctuations affect the value of our investments, including how the current disruptions in the financial and real estate markets may affect the values of our investments and (4) the estimated value does not take into account how developments related to individual assets may have increased or decreased the value of our portfolio.

When will I get my detailed tax information?

We intend to issue and mail your Form 1099-DIV tax information, or such other successor form, by January 31 of each year.

Who can help answer my questions about the offering?

If you have more questions about the offering, or if you would like additional copies of this prospectus, you should contact your registered representative or contact:

Realty Capital Securities, LLC

Three Copley Place

Suite 3300

Boston, MA 02116

1-877-373-2522

www.americanrealtycap.com

Who is the transfer agent?

The name and address of our transfer agent is as follows:

DST Systems, Inc.

430 W 7th St

Kansas City, MO 64105-1407

Phone (866) 771-2088

Fax (877) 694-1113

 

 

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To ensure that any account changes are made promptly and accurately, all changes (including your address, ownership type and distribution mailing address) should be directed to the transfer agent.

 

 

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RISK FACTORS

An investment in our common stock involves various risks and uncertainties. You should carefully consider the following risk factors in conjunction with the other information contained in this prospectus before purchasing our common stock. The risks discussed in this prospectus could adversely affect our business, operating results, prospects and financial condition. This could cause the value of our common stock to decline and could cause you to lose all or part of your investment. The risks and uncertainties described below are not the only ones we face but do represent those risks and uncertainties that we believe are material to us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business.

Risks Related to an Investment in Us

Because no public trading market for our shares currently exists, it will be difficult for our stockholders to sell their shares and, if our stockholders are able to sell their shares, it will likely be at a substantial discount to the public offering price.

Our charter does not require our directors to seek stockholder approval to liquidate our assets by a specified date, nor does our charter require our directors to list our shares for trading on a national securities exchange by a specified date. There is no public market for our shares and we currently have no plans to list our shares on a national securities exchange. Until our shares are listed, if ever, stockholders may not sell their shares unless the buyer meets the applicable suitability and minimum purchase standards. In addition, our charter prohibits the ownership of more than 9.8% of our aggregate outstanding stock, unless exempted by our board of directors, which may inhibit large investors from purchasing your shares. In its sole discretion, our board of directors could amend, suspend or terminate our share redemption program upon 30 days’ notice. Further, the share redemption program includes numerous restrictions that would limit a stockholder’s ability to sell his or her shares. We describe these restrictions in more detail under “Description of Shares—Share Redemption Program.” Therefore, it will be difficult for our stockholders to sell their shares promptly or at all. If a stockholder is able to sell his or her shares, it would likely be at a substantial discount to the public offering price. It is also likely that our shares would not be accepted as the primary collateral for a loan. Because of the illiquid nature of our shares, investors should purchase our shares only as a long-term investment and be prepared to hold them for an indefinite period of time.

We are a recently formed company with no operating history and our advisor has no operating history and limited experience operating a public company, which makes our future performance difficult to predict.

We are a recently formed company and have no operating history. We were incorporated in the State of Maryland on October 13, 2009. As of the date of this prospectus, we have not made any investments, and our total assets consist of $200,000 cash and $445,028 deferred offering costs. Our stockholders should not assume that our performance will be similar to the past performance of other real estate investment programs sponsored by affiliates of our advisor.

Our advisor was formed on December 28, 2009 and has had no operations as of the date of this prospectus. Because the previous Phillips Edison-sponsored programs were conducted through privately held entities, they were not subject to the up-front commissions, fees and expenses associated with a public offering nor all of the laws and regulations that will apply to us.

 

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Our ARC sponsor and its affiliates have experience with only four similar public programs, whose offerings are ongoing. Our executive officers and directors have limited experience managing public companies. For all of these reasons, our stockholders should be especially cautious when drawing conclusions about our future performance and you should not assume that it will be similar to the prior performance of other Phillips Edison- or ARC-sponsored programs. Our lack of an operating history, our advisor’s limited experience operating a public company and the differences between us and the private Phillips Edison-sponsored programs significantly increase the risk and uncertainty our stockholders face in making an investment in our shares.

Our dealer manager, Realty Capital Securities, LLC, has a limited operating history and our ability to implement our investment strategy is dependent, in part, upon the ability of our dealer manager to successfully conduct this offering, which makes an investment in us more speculative.

We have retained Realty Capital Securities, LLC, an affiliate of our advisor, to conduct this offering. Realty Capital Securities, LLC has a limited operating history. This offering is the fourth public offering conducted by our dealer manager. The success of this offering, and our ability to implement our business strategy, is dependent upon the ability of Realty Capital Securities, LLC to build and maintain a network of broker-dealers to sell our shares to their clients. If Realty Capital Securities, LLC is not successful in establishing, operating and managing this network of broker-dealers, our ability to raise proceeds through this offering will be limited and we may not have adequate capital to implement our investment strategy. If we are unsuccessful in implementing our investment strategy, our stockholders could lose all or a part of their investment.

If our dealer manager terminates its dealer manager relationship with us, our ability to successfully complete this offering and implement our investment strategy would be significantly impaired.

We have retained Realty Capital Securities, LLC, an affiliate of our advisor, to conduct this offering. Realty Capital Securities, LLC has the right to terminate its relationship with us if, among other things, any of the following occur: (1) our voluntary or involuntary bankruptcy; (2) we materially change our business; (3) we become subject to a material action, suit, proceeding or investigation; (4) we materially reduce the rate of any dividend we may pay in the future without its prior written consent; (5) we suspend or terminate our share redemption program without its prior written consent; (6) the value of our common shares materially adversely changes, (7) a material breach of the dealer manager agreement by us (which breach has not been cured within the required timeframe), (8) our willful misconduct or a willful or grossly negligent breach of our obligations under the dealer manager agreement, (9) the issuance of a stop order suspending the effectiveness of the registration statement by the SEC and not rescinded within 10 business days of its issuance, (10) the occurrence of any event materially adverse to us and our prospects or our ability to perform our obligations under the dealer manager agreement. If our dealer manager elects to terminate its relationship with us our ability to complete this offering and implement our investment strategy would be significantly impaired and would increase the likelihood that our stockholders could lose all or a part of their investment.

If we are unable to find suitable investments, we may not be able to achieve our investment objectives or pay distributions.

Our ability to achieve our investment objectives and to pay distributions depends upon the performance of ARC Advisor, our advisor, in the acquisition of our investments, including the determination of any financing arrangements, and the ability of our advisor to source loan

 

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origination opportunities for us. Competition from competing entities may reduce the number of suitable investment opportunities offered to us or increase the bargaining power of property owners seeking to sell. Additionally, disruptions and dislocations in the credit markets have materially impacted the cost and availability of debt to finance real estate acquisitions, which is a key component of our acquisition strategy. This lack of available debt could result in a further reduction of suitable investment opportunities and create a competitive advantage to other entities that have greater financial resources than we do. We will also depend upon the performance of our property managers in the selection of tenants and negotiation of leasing arrangements. Rising vacancies across commercial real estate have resulted in increased pressure on real estate investors and their property managers to find new tenants and keep existing tenants. In order to do so, we may have to offer inducements, such as free rent and tenant improvements, to compete for attractive tenants. We are also subject to competition in seeking to acquire real estate-related investments. The more shares we sell in this offering, the greater our challenge will be to invest all of the net offering proceeds on attractive terms. Our investors must rely entirely on the management abilities of ARC Advisor and Phillips Edison Sub-Advisor, the property managers our advisor selects and the oversight of our board of directors. We can give no assurance that our advisor will be successful in obtaining suitable investments on financially attractive terms or that, if our advisor makes investments on our behalf, our objectives will be achieved. If we, through our sub-advisor, are unable to find suitable investments promptly, we will hold the proceeds from this offering in an interest-bearing account or invest the proceeds in short-term assets. If we would continue to be unsuccessful in locating suitable investments, we may ultimately decide to liquidate. In the event we are unable to timely locate suitable investments, we may be unable or limited in our ability to pay distributions and we may not be able to meet our investment objectives.

Continued disruptions in the financial markets and challenging economic conditions could adversely impact the commercial mortgage market as well as the market for real estate-related debt investments generally, which could hinder our ability to implement our business strategy and generate returns to our stockholders.

We intend to allocate a small percentage of our portfolio to real estate-related investments such as mortgage, mezzanine, bridge and other loans; debt and derivative securities related to real estate assets, including mortgage-backed securities; and the equity securities of other REITs and real estate companies. The returns available to investors in these investments are determined by: (1) the supply and demand for such investments, (2) the performance of the assets underlying the investments and (3) the existence of a market for such investments, which includes the ability to sell or finance such investments.

During periods of volatility, the number of investors participating in the market may change at an accelerated pace. As liquidity or “demand” increases the returns available to investors on new investments will decrease. Conversely, a lack of liquidity will cause the returns available to investors on new investments to increase.

For nearly two years, concerns pertaining to the deterioration of credit in the residential mortgage market have expanded to almost all areas of the debt capital markets including corporate bonds, asset-backed securities and commercial real estate bonds and loans. We cannot foresee when these markets will stabilize. This instability may interfere with the successful implementation of our business strategy.

 

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Continued disruptions in the financial markets and challenging economic conditions could adversely affect our ability secure debt financing on attractive terms, our ability to service any future indebtedness that we may incur and the values of our investments.

The capital and credit markets have been experiencing extreme volatility and disruption for nearly two years. Liquidity in the global credit market has been severely contracted by these market disruptions, making it costly to obtain new lines of credit. We will rely on debt financing to finance our properties and possibly other real estate-related investments. As a result of the ongoing credit market turmoil, we may not be able to obtain additional debt financing on attractive terms. As such, we may be forced to use a greater proportion of our offering proceeds to finance our acquisitions, reducing the number of acquisitions we would otherwise make, and/or to dispose of some of our assets. If the current debt market environment persists we may modify our investment strategy in order to optimize our portfolio performance. Our options would include limiting or eliminating the use of debt and focusing on those higher yielding investments that do not require the use of leverage to meet our portfolio goals.

The continued disruptions in the financial markets and challenging economic conditions could adversely affect the values of investments we will acquire. Turmoil in the capital markets has constrained equity and debt capital available for investment in commercial real estate, resulting in fewer buyers seeking to acquire commercial properties and possible increases in capitalization rates and lower property values. Furthermore, these challenging economic conditions could negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values of real estate properties and in the collateral securing any loan investments we may make. These could have the following negative effects on us:

 

   

the values of our investments in commercial properties could decrease below the amounts we will pay for such investments;

 

   

the value of collateral securing any loan investment that we may make could decrease below the outstanding principal amounts of such loans;

 

   

revenues from properties we acquire could decrease due to fewer tenants and/or lower rental rates, making it more difficult for us to pay dividends or meet our debt service obligations on future debt financings; and/or

 

   

revenues on the properties and other assets underlying any loan investments we may make could decrease, making it more difficult for the borrower to meet its payment obligations to us, which could in turn make it more difficult for us to pay dividends or meet our debt service obligations on future debt financings.

All of these factors could impair our ability to make distributions to our investors and decrease the value of an investment in us.

Because this is a blind-pool offering, our stockholders will not have the opportunity to evaluate our investments before we make them, which makes our stockholders’ investment more speculative.

Because we have not yet acquired or identified any investments that we may make, we are not able to provide our stockholders with any information to assist you in evaluating the merits of any specific properties or other investments that we may acquire, except for investments

 

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that may be described in one or more supplements to this prospectus. We will seek to invest substantially all of the net proceeds from the primary, after the payment of fees and expenses, in the acquisition of or investment in interests in real estate properties and real estate-related assets. However, because our stockholders will be unable to evaluate the economic merit of specific real estate projects before we invest in them, our stockholders will have to rely entirely on the ability of our advisor to select suitable and successful investment opportunities. Furthermore, our board of directors will have broad discretion in implementing policies regarding tenant or mortgagor creditworthiness and our stockholders will not have the opportunity to evaluate potential tenants, managers or borrowers. These factors increase the risk that our stockholders’ investment may not generate returns consistent with their expectations.

We may suffer from delays in locating suitable investments, which could limit our ability to make distributions and lower the overall return on your investment.

We rely upon our sponsors and the real estate professionals affiliated with our sponsors to identify suitable investments. The private Phillips Edison-sponsored programs, especially those for which the offering proceeds have not been fully invested, rely on our Phillips Edison sponsors for investment opportunities. Similarly, the ARC-sponsored programs rely on our ARC sponsors for investment opportunities. To the extent that our sponsors and the other real estate professionals employed by our advisor face competing demands upon their time at times when we have capital ready for investment, we may face delays in locating suitable investments. Further, the more money we raise in this offering, the more difficult it will be to invest the net offering proceeds promptly and on attractive terms. Therefore, the large size of this offering and the continuing high demand for the types of properties and other investments we desire to purchase increase the risk of delays in investing our net offering proceeds. Delays we encounter in the selection and acquisition or origination of income-producing assets would likely limit our ability to pay distributions to our stockholders and lower their overall returns. Further, if we acquire properties prior to the start of construction or during the early stages of construction, it will typically take several months to complete construction and rent available space. Therefore, our stockholders could suffer delays in the distribution of cash distributions attributable to those particular properties. Our stockholders should expect to wait at least several months after the closing of a property acquisition before receiving cash distributions attributable to that property.

We may change our targeted investments without stockholder consent.

We expect to allocate approximately 90.0% of our portfolio to investments in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million per property. We intend to allocate approximately 10.0% of our portfolio to other real estate properties and real estate-related loans and securities such as mortgage, mezzanine, bridge and other loans; debt and derivative securities related to real estate assets, including mortgage-backed securities; and the equity securities of other REITs and real estate companies. We do not expect our non-controlling equity investments in other public companies to exceed 5.0% of the proceeds of this offering, assuming we sell the maximum offering amount, or to represent a substantial portion of our assets at any one time. Though this is our current target portfolio, we may make adjustments to our target portfolio based on real estate market conditions and investment opportunities, and we may change our targeted investments and investment guidelines at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this prospectus. A change in our targeted investments or investment guidelines may increase our exposure to interest rate risk, default risk and real estate market fluctuations, all of

 

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which could adversely affect the value of our common stock and our ability to make distributions to our stockholders.

If we are unable to raise substantial funds, we will be limited in the number and type of investments we make and the value of our stockholders’ investment in us will fluctuate with the performance of the specific assets we acquire.

This offering is being made on a “best efforts” basis, meaning that the dealer manager is only required to use its best efforts to sell our shares and has no firm commitment or obligation to purchase any of the shares. As a result, the amount of proceeds we raise in this offering may be substantially less than the amount we would need to achieve a diversified portfolio of investments. We may be unable to raise even the minimum offering amount. If we are unable to raise substantially more than the minimum offering amount, we will make fewer investments resulting in less diversification in terms of the type, number and size of investments that we make. In that case, the likelihood that any single asset’s performance would adversely affect our profitability will increase. Additionally, we are not limited in the number or size of our investments or the percentage of net proceeds we may dedicate to a single investment. Our stockholders’ investment in our shares will be subject to greater risk to the extent that we lack a diversified portfolio of investments. Further, we will have certain fixed operating expenses, including certain expenses as a publicly offered REIT, regardless of whether we are able to raise substantial funds in this offering. Our inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, reducing our net income and cash flow and limiting our ability to make distributions.

Because we are dependent upon our advisor and its affiliates to conduct our operations, any adverse changes in the financial health of our advisor or its affiliates or our relationship with them could hinder our operating performance and the return on our stockholders’ investment.

We are dependent on ARC Advisor to manage our operations and our portfolio of real estate assets. Our advisor has no operating history and it will depend upon the fees and other compensation that it will receive from us in connection with the purchase, management and sale of assets to conduct its operations. Any adverse changes in the financial condition of our advisor or our relationship with our advisor could hinder its ability to successfully manage our operations and our portfolio of investments.

The loss of or the inability to obtain key real estate professionals at our advisor, sub-advisor or our dealer manager could delay or hinder implementation of our investment strategies, which could limit our ability to make distributions and decrease the value of your investment.

Our success depends to a significant degree upon the contributions of Messrs. Schorsch and Kahane at our advisor and dealer manager, and Messrs. Phillips, Edison and Bessey at our sub-advisor. Neither we nor our affiliates have employment agreements with these individuals and they may not remain associated with us. If any of these persons were to cease their association with us, our operating results could suffer. We do not intend to maintain key person life insurance on any person. We believe that our future success depends, in large part, upon our advisor’s and its affiliates’ ability to hire and retain highly skilled managerial, operational and marketing professionals. Competition for such professionals is intense, and our advisor and its affiliates may be unsuccessful in attracting and retaining such skilled individuals. Further, we intend to establish strategic relationships with firms, as needed, that have special expertise in certain services or detailed knowledge regarding real properties in certain geographic regions. Maintaining such relationships will be important for us to effectively compete with other

 

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investors for properties and tenants in such regions. We may be unsuccessful in establishing and retaining such relationships. If we lose or are unable to obtain the services of highly skilled professionals or do not establish or maintain appropriate strategic relationships, our ability to implement our investment strategies could be delayed or hindered, and the value of our stockholders’ investment may decline.

If we pay distributions from sources other than our funds from operations, we will have less funds available for investment in properties and other assets and our stockholders’ overall return may be reduced.

Our organizational documents permit us to pay distributions from any source. If we fund distributions from financings, the net proceeds from this offering or other sources, we will have less funds available for investment in real estate properties and other real estate-related assets and our stockholders’ overall return may be reduced. We expect to have little, if any, funds from operations available for distribution until we make substantial investments. Further, because we may receive income from interest or rents at various times during our fiscal year and because we may need funds from operations during a particular period to fund capital expenditures and other expenses, we expect that at least during the early stages of our development and from time to time during our operational stage, we will declare distributions in anticipation of funds that we expect to receive during a later period and we will pay these distributions in advance of our actual receipt of these funds. In these instances, we expect to use third-party borrowings to fund our distributions. We may also fund such distributions from advances from our advisor, sub-advisor or sponsors or from our advisor’s or sub-advisor’s deferral of their fees. To the extent distributions exceed our current and accumulated earnings and profits, a stockholder’s tax basis in our stock will be reduced and, to the extent distributions exceed a stockholder’s tax basis, the stockholder may recognize capital gain.

Our rights and the rights of our stockholders to recover claims against our independent directors are limited, which could reduce our stockholders’ and our recovery against them if they negligently cause us to incur losses.

Maryland law provides that a director has no liability in that capacity if he performs his duties in good faith, in a manner he reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter provides that no independent director shall be liable to us or our stockholders for monetary damages and that we will generally indemnify them for losses unless they are grossly negligent or engage in willful misconduct. As a result, our stockholders and we may have more limited rights against our independent directors than might otherwise exist under common law, which could reduce our stockholders’ and our recovery from these persons if they act in a negligent manner. In addition, we may be obligated to fund the defense costs incurred by our independent directors (as well as by our other directors, officers, employees (if we ever have employees) and agents) in some cases, which would decrease the cash otherwise available for distribution to our stockholders.

 

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Risks Related to Conflicts of Interest

Our sponsors and their respective affiliates, including all of our executive officers, some of our directors and other key real estate professionals, will 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.

Our advisor and sub-advisor and their respective affiliates will receive substantial fees from us. These fees could influence our advisor’s and sub-advisor’s advice to us as well as their judgment with respect to:

 

   

the continuation, renewal or enforcement of our agreements with affiliates of our ARC sponsor, including the advisory agreement and the dealer-manager agreement;

 

   

the continuation, renewal or enforcement of our agreements with Phillips Edison and its affiliates, including the sub-advisory agreement and the property management agreement;

 

   

public offerings of equity by us, which will likely entitle our advisor to increased acquisition and asset-management fees;

 

   

sales of properties and other investments, which entitle our advisor to disposition fees and possible subordinated incentive fees;

 

   

acquisitions of properties and other investments from other Phillips Edison- or ARC-sponsored programs, might entitle affiliates of ARC or Phillips Edison to disposition fees and possible subordinated incentive fees in connection with its services for the seller;

 

   

acquisitions of properties and other investments from third parties, which entitle our advisor to acquisition and asset-management fees, including acquisition fees related to loan originations;

 

   

borrowings to acquire properties and other investments and to originate loans, which borrowings will increase the acquisition, and asset-management fees payable to our advisor;

 

   

whether and when we seek to list our common stock on a national securities exchange, which listing could entitle our advisor to a subordinated incentive fee;

 

   

whether we seek stockholder approval to internalize our management, which may entail acquiring assets (such as office space, furnishings and technology costs) and negotiating compensation for real estate professionals at our advisor and its affiliates that may result in such individuals receiving more compensation from us than they currently receive from our advisor; and

 

   

whether and when we seek to sell the company or its assets, which sale could entitle our advisor to a subordinated incentive fee.

The fees our advisor receives in connection with transactions involving the acquisition of assets are based initially on the cost of the investment, including costs related to loan originations,

 

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and not based on the quality of the investment or the quality of the services rendered to us. This may influence our advisor to recommend riskier transactions to us.

Because other real estate programs sponsored by our sponsors and offered through our dealer manager may conduct offerings concurrently with our offering, our sponsors and our dealer manager will face potential conflicts of interest arising from competition among us and these other programs for investors and investment capital, and such conflicts may not be resolved in our favor.

An affiliate of our advisor is also the advisor of American Realty Capital Trust, Inc. and American Realty Capital New York Recovery REIT, Inc., each of which is raising capital in an ongoing public offering of its common stock. Realty Capital Securities, LLC, the affiliated dealer manager of our ARC sponsors and the dealer manager for our offering, also acts as the dealer manager for offerings by American Realty Capital Trust, Inc., American Realty Capital New York Recovery REIT, Inc., Healthcare Trust of America, Inc. and United Development Funding IV. In addition, our sponsors may decide to sponsor future programs that would seek to raise capital through public offerings conducted concurrently with our offering. As a result, our sponsors and our dealer manager may face conflicts of interest arising from potential competition with these other programs for investors and investment capital. Our sponsors generally seek to avoid simultaneous public offerings by programs that have a substantially similar mix of investment characteristics, including targeted investment types and key investment objectives. Nevertheless, there may be periods during which one or more programs sponsored by our sponsors will be raising capital and which might compete with us for investment capital. Such conflicts may not be resolved in our favor and you will not have the opportunity to evaluate the manner in which these conflicts of interest are resolved before or after making your investment.

Our sponsors will face conflicts of interest relating to the acquisition of assets and leasing of properties and such conflicts may not be resolved in our favor, meaning that we could invest in less attractive assets and obtain less creditworthy tenants, which could limit our ability to make distributions and reduce our stockholders’ overall investment return.

We rely on our sponsors and the executive officers and other key real estate professionals at our advisor and sub-advisor to identify suitable investment opportunities for us. Our individual ARC and Phillips Edison sponsors and several of the other key real estate professionals of our advisor and sub-advisor are also the key real estate professionals at our sponsor and their other public and private programs. Many investment opportunities that are suitable for us may also be suitable for other Phillips Edison- or ARC-sponsored programs. Generally, our advisor and sub-advisor will not pursue any opportunity to acquire any real estate properties or real estate-related loans and securities that are directly competitive with our investment strategies, unless and until the opportunity is first presented to us. See “Conflicts of Interest—Certain Conflict Resolution Measures—Restrictions on Competing Business Activities of Our Sponsors.” For so long as we are externally advised, our charter provides that it shall not be a proper purpose of the corporation for us to purchase real estate or any significant asset related to real estate unless the advisor has recommended the investment to us. Thus, the executive officers and real estate professionals of our advisor and sub-advisor could direct attractive investment opportunities to other entities or investors. Such events could result in us investing in properties that provide less attractive returns, which may reduce our ability to make distributions we may be able to pay to our stockholders.

We and other Phillips Edison- and ARC-sponsored programs also rely on these real estate professionals to supervise the property management and leasing of properties. If our advisor or

 

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sub-advisor directs creditworthy prospective tenants to properties owned by another Phillips Edison- or ARC-sponsored program when they could direct such tenants to our properties, our tenant base may have more inherent risk than might otherwise be the case. Further, existing and future Phillips Edison- and ARC-sponsored programs our executive officers and key real estate professionals are not prohibited from engaging, directly or indirectly, in any business or from possessing interests in any other business venture or ventures, including businesses and ventures involved in the acquisition, development, ownership, leasing or sale of real estate investments. For a detailed description of the conflicts of interest that our sponsors and their respective affiliates will face, see “Conflicts of Interest.”

Our advisor and sub-advisor will face conflicts of interest relating to joint ventures that we may form with affiliates of our sponsors, which conflicts could result in a disproportionate benefit to the other venture partners at our expense.

If approved by a majority of our independent directors, we may enter into joint venture agreements with other sponsor-affiliated programs or entities for the acquisition, development or improvement of properties or other investments. All of our executive officers, some of our directors and the key real estate professionals assembled by our advisor and sub-advisor are also executive officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, our sub-advisor, our dealer manager and other sponsor-affiliated entities. These persons will face conflicts of interest in determining which sponsor-affiliated program should enter into any particular joint venture agreement. These persons may also face a conflict in structuring the terms of the relationship between our interests and the interests of the sponsor-affiliated co-venturer and in managing the joint venture. Any joint venture agreement or transaction between us and a sponsor-affiliated co-venturer will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated co-venturers. The sponsor-affiliated co-venturer may have economic or business interests or goals that are or may become inconsistent with our business interests or goals. These co-venturers may thus benefit to our and your detriment.

Our sponsors, our officers, our advisor and our sub-advisor, and the real estate professionals assembled by our advisor and sub-advisor, will face competing demands relating to their time and this may cause our operations and our stockholders’ investment to suffer.

We rely on our sponsors, our officers, our advisor and our sub-advisor, and the real estate professionals assembled by our advisor and sub-advisor for the day-to-day operation of our business. Messrs. Phillips and Edison are principals of Phillips Edison and its affiliates that manage the assets of the other Phillips Edison-sponsored programs. Similarly, our individual ARC sponsors are key executives in other ARC-sponsored programs. As a result of their interests in other Phillips Edison- or ARC-sponsored programs, respectively, their obligations to other investors and the fact that they engage in and they will continue to engage in other business activities, these individuals will face conflicts of interest in allocating their time among us, ARC Advisor, Phillips Edison Sub-Advisor and other Phillips Edison- or ARC-sponsored programs and other business activities in which they are involved. During times of intense activity in other programs and ventures, these individuals may devote less time and fewer resources to our business than are necessary or appropriate to manage our business. If this occurs, the returns on our investments, and the value of our stockholders’ investment, may decline.

 

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All of our executive officers and some of our directors and the key real estate professionals assembled by our advisor, sub-advisor and dealer manager face conflicts of interest related to their positions and/or interests in its affiliates of our sponsors that could hinder our ability to implement our business strategy and to generate returns to our stockholders.

All of our executive officers, some of our directors and the key real estate professionals assembled by our advisor are also executive officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, the sub-advisor, our dealer manager and other sponsor-affiliated entities. Through our ARC sponsor’s affiliates, some of these persons work on behalf of American Realty Capital Trust, Inc., American Realty Capital New York Recovery REIT, Inc. and other ARC-sponsored programs. Through our Phillips Edison sponsor’s affiliates, some of these persons work on behalf of other Phillips Edison-sponsored programs. As a result, they owe fiduciary duties to each of these entities, their members and limited partners and these investors, which fiduciary duties may from time to time conflict with the fiduciary duties that they owe to us and our stockholders. Their loyalties to these other entities and investors could result in action or inaction that is detrimental to our business, which could harm the implementation of our business strategy and our investment and leasing opportunities. Conflicts with our business and interests are most likely to arise from involvement in activities related to (a) allocation of new investments and management time and services between us and the other entities, (b) our purchase of properties from, or sale of properties, to affiliated entities, (c) the timing and terms of the investment in or sale of an asset, (d) development of our properties by affiliates, (e) investments with affiliates of our advisor or sub-advisor, (f) compensation to our advisor or sub-advisor, and (g) our relationship with our dealer manager and property manager. If we do not successfully implement our business strategy, we may be unable to generate the cash needed to make distributions to our stockholders and to maintain or increase the value of our assets.

Risks Related to This Offering and Our Corporate Structure

The offering price of our shares was not established on an independent basis; the actual value of your investment may be substantially less than what you pay. We may use the most recent price paid to acquire a share in our offering or a follow-on public or private offering as the estimated value of our shares until we have completed our offering stage. Even when our advisor begins to use other valuation methods to estimate the value of our shares, the value of our shares will be based upon a number of assumptions that may not be accurate or complete.

We established the offering price of our shares on an arbitrary basis. The selling price of our shares bears no relationship to our book or asset values or to any other established criteria for valuing shares. Because the offering price is not based upon any independent valuation, the offering price may not be indicative of the proceeds that you would receive upon liquidation. Further, the offering price may be significantly more than the price at which the shares would trade if they were to be listed on an exchange or actively traded by broker-dealers.

To assist FINRA members and their associated persons that participate in this public offering of common stock, pursuant to FINRA Conduct Rule 5110, we intend to disclose in each annual report distributed to stockholders a per share estimated value of the shares, the method by which it was developed, and the date of the data used to develop the estimated value. In addition, ARC Advisor, our advisor, will prepare annual statements of estimated share values to assist fiduciaries of retirement plans subject to the annual reporting requirements of ERISA in the preparation of their reports relating to an investment in our shares. Our advisor has indicated that it intends to use the most recent price paid to acquire a share in this offering (ignoring purchase

 

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price discounts for certain categories of purchasers) or a follow-on public or private offering as its estimated per share value of our shares until we have completed our offering stage. We will consider our offering stage complete when we are no longer offering equity securities – whether through this offering or follow-on public or private offerings – and have not done so for 18 months. If our board of directors determines that it is in our best interest, we may conduct follow-on offerings upon the termination of this offering. (For purposes of this definition, we will not consider an “equity offering” to include offerings on behalf of selling stockholders or offerings related to a dividend reinvestment plan, employee benefit plan or the redemption of interests in our operating partnership.) Our charter does not restrict our ability to conduct offerings in the future.

Although this initial estimated value will represent the most recent price at which most investors will purchase shares in an offering, this reported value will likely differ from the price at which a stockholder could resell his or her shares because: (1) there is no public trading market for the shares at this time; (2) the estimated value will not reflect, and will not be derived from, the fair value of our properties and other assets, nor will it represent the amount of net proceeds that would result from an immediate liquidation of those assets, because the amount of proceeds available for investment from an offering will be net of selling commissions, dealer manager fees, other organization and offering costs and acquisition fees and expenses; (3) the estimated value will not take into account how market fluctuations affect the value of our investments, including how the current disruptions in the financial and real estate markets may affect the values of our investments and (4) the estimated value will not take into account how developments related to individual assets may increase or decrease the value of our portfolio.

When determining the estimated value of our shares by methods other than the last price paid to acquire a share in an offering, our advisor, or another firm we choose for that purpose, will estimate the value of our shares based upon a number of assumptions that may not be accurate or complete. Accordingly, these estimates may not be an accurate reflection of the fair market value of our investments and will not likely represent the amount of net proceeds that would result from an immediate sale of our assets.

Because the dealer manager is an affiliate of our ARC sponsor, you will not have the benefit of an independent due diligence review of us, which is customarily performed in underwritten offerings; the absence of an independent due diligence review increases the risks and uncertainty you face as a stockholder.

Our dealer manager, Realty Capital Securities, LLC, is an affiliate of our ARC sponsor. Because Realty Capital Securities, LLC is an affiliate of our ARC sponsor, its due diligence review and investigation of us and the prospectus cannot be considered to be an independent review. Therefore, you do not have the benefit of an independent review and investigation of this offering of the type normally performed by an unaffiliated, independent underwriter in a public securities offering.

Our charter limits the number of shares a person may own, which may discourage a takeover that could otherwise result in a premium price to our stockholders.

Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. To help us comply with the REIT ownership requirements of the Internal Revenue Code, our charter prohibits a person from directly or constructively owning more than 9.8% of our aggregate outstanding shares, unless exempted by our board of directors. This restriction may have the effect of delaying, deferring or

 

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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.

Our charter permits our board of directors to issue stock with terms that may subordinate the rights of our common stockholders or discourage a third party from acquiring us in a manner that could result in a premium price to our stockholders.

Our board of directors may classify or reclassify any unissued common stock or preferred stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications and terms or conditions of redemption of any such stock. Thus, our board of directors could authorize the issuance of preferred stock with priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock. Such preferred stock could also 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 to holders of our common stock.

Because Maryland law permits our board to adopt certain anti-takeover measures without stockholder approval, investors may be less likely to receive a “control premium” for their shares.

In 1999, the State of Maryland enacted legislation that enhances the power of Maryland corporations to protect themselves from unsolicited takeovers. Among other things, the legislation permits our board, without stockholder approval, to amend our charter to:

 

   

stagger our board of directors into three classes;

 

   

require a two-thirds stockholder vote for removal of directors;

 

   

provide that only the board can fix the size of the board;

 

   

provide that all vacancies on the board, however created, may be filled only by the affirmative vote of a majority of the remaining directors in office; and

 

   

require that special stockholder meetings may only be called by holders of a majority of the voting shares entitled to be cast at the meeting.

Under Maryland law, a corporation can opt to be governed by some or all of these provisions if it has a class of equity securities registered under the Securities Exchange Act of 1934 and has at least three independent directors. Our charter provides that we will be governed by the fourth bullet above with respect to vacancies on the board as soon as we are eligible, which we expect will occur as early as April 2011. Although our board has no current intention to opt in to any of the other above provisions permitted under Maryland law, our charter does not prohibit our board from doing so. Becoming governed by any of these provisions could discourage 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 securities.

 

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Our stockholders’ investment return may be reduced if we are required to register as an investment company under the Investment Company Act; if we become an unregistered investment company, we could not continue our business.

We do not intend to register as an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). If we were obligated to register as an investment company, we would have to comply with a variety of substantive requirements under the Investment Company Act that impose, 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 increase our operating expenses.

We intend to qualify for an exemption from registration under Section 3(c)(5)(C) of the Investment Company Act, which means we must engage primarily in the business of buying real estate, mortgages and other liens on or interests in real estate. The position of the SEC staff generally requires us to maintain at least 55.0% of our portfolio in “qualifying real estate assets” (that is, real estate, mortgage loans and commercial mortgage-backed securities (“CMBS”) that represent the entire ownership in a pool of mortgage loans and other qualifying interests in real estate) and at least another 25.0% of our portfolio in additional qualifying real estate assets or “real estate-related assets.” Participations in mortgage loans, mortgaged-backed securities, mezzanine loans, preferred equity investments, joint venture investments and the equity securities of other entities may not constitute qualifying real estate assets, depending on the characteristics of the specific investments, including the rights that we have with respect to the underlying assets. Our ownership of these investments, therefore, may be limited by provisions of the Investment Company Act and SEC staff interpretations.

To maintain compliance with the Investment Company Act exemption, 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 assets that we might not otherwise have acquired or may have to forego opportunities to make investments that we would otherwise want to make and would be important to our investment strategy.

If we were required to register 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.

Rapid changes in the values of our assets may make it more difficult for us to maintain our qualification as a REIT or our exemption from the Investment Company Act.

If the market value or income potential of our qualifying assets changes as compared to the market value or income potential of our non-qualifying assets, or if the market value or income potential of our assets that are considered “real estate-related assets” under the Investment Company Act or REIT qualification tests changes as compared to the market value or income potential of our assets that are not considered “real estate-related assets” under the Investment

 

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Company Act or REIT qualification tests, whether as a result of increased interest rates, prepayment rates or other factors, we may need to modify our investment portfolio in order to maintain our REIT qualification or exemption from the Investment Company Act. If the decline in real estate asset values and/or income occurs quickly, this may be especially difficult, if not impossible, to accomplish. This difficulty may be exacerbated by the illiquid nature of any non-real estate assets that we may own. We may have to make investment decisions that we otherwise would not make absent REIT and Investment Company Act considerations.

Our stockholders will have limited control over changes in our policies and operations, which increases the uncertainty and risks our stockholders face.

Our board of directors determines our major policies, including our policies regarding financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of the stockholders. Under Maryland General Corporation Law and our charter, our stockholders have a right to vote only on limited matters. Our board’s broad discretion in setting policies and our stockholders’ inability to exert control over those policies increases the uncertainty and risks our stockholders face.

Our stockholders may not be able to sell their shares under our share redemption program and, if they are able to sell their shares under the program, they may not be able to recover the amount of their investment in our shares.

Our share redemption program includes numerous restrictions that limit our stockholders’ ability to sell their shares. Our stockholders must hold their shares for at least one year in order to participate in the share redemption program, except for redemptions sought upon a stockholder’s death or “qualifying disability.” The decision to accept redemption requests will be made by our board of directors after consideration of a number of factors including the amount of net proceeds from the sale of shares under our dividend reinvestment plan during the prior calendar year and the amount of our revenues and expenses generally. In addition, we will limit the number of shares redeemed pursuant to the share redemption program to no more than 5.0% of the weighted-average number of shares outstanding during the prior calendar year. Further, we have no obligation to redeem shares if the redemption would violate the restrictions on distributions under Maryland law, which prohibits distributions that would cause a corporation to fail to meet statutory tests of solvency. These limits may prevent us from accommodating all redemption requests made in any year. Our board would be free to amend, suspend or terminate the share redemption program upon 30 days’ notice.

The prices at which we will initially redeem shares under the program are as follows:

 

   

The lower of $9.25 or 92.5% of the price paid to acquire the shares from us for stockholders who have held their shares for at least one year;

 

   

The lower of $9.50 or 95.0% of the price paid to acquire the shares from us for stockholders who have held their shares for at least two years;

 

   

The lower of $9.75 or 97.5% of the price paid to acquire the shares from us for stockholders who have held their shares for at least three years; and

 

   

The lower of $10.00 or 100% of the price paid to acquire the shares from us for stockholders who have held their shares for at least four years.

 

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Notwithstanding the above, once we establish an estimated value per share of our common stock that is not based on the price to acquire a share in our primary offering or a follow-on public or private offering, the redemption price per share for all stockholders would be equal to the estimated value per share, as determined by our advisor or another firm chosen for that purpose. We expect to establish an estimated value per share after the completion of our offering stage. We will consider our offering stage complete when we are no longer offering equity securities – whether through this offering or follow-on public or private offerings – and have not done so for 18 months. See “Description of Shares—Share Redemption Program” for more information about the program. These restrictions would severely limit your ability to sell your shares should you require liquidity and would limit your ability to recover the value you invested.

Our stockholders’ interests in us will be diluted if we issue additional shares, which could reduce the overall value of our stockholders’ investment.

Our common stockholders do not have preemptive rights to any shares we issue in the future. Our charter authorizes us to issue 1,010,000,000 shares of capital stock, of which 1,000,000,000 shares are designated as common stock and 10,000,000 shares are designated as preferred stock. Our board of directors may increase the number of authorized shares of capital stock without stockholder approval. After our investors purchase shares in this offering, our board may elect to (1) sell additional shares in this or future public offerings, (2) issue equity interests in private offerings, (3) adopt a stock-award plan (with stockholder approval and subject to the limitations set forth in our charter) and issue share-based awards to our independent directors, (4) issue shares to our advisor or sub-advisor, or its successors or assigns, in payment of an outstanding fee obligation or (5) issue shares of our common stock to sellers of properties or assets we acquire in connection with an exchange of limited partnership interests of the operating partnership. To the extent we issue additional equity interests after our investors purchase shares in this offering, their percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our real estate investments, our investors may also experience dilution in the book value and fair value of their shares.

Payment of fees to our advisor, sub-advisor and their respective affiliates will reduce cash available for investment and distribution and increases the risk that our stockholders will not be able to recover the amount of their investment in our shares.

Our advisor, sub-advisor and their respective affiliates will perform services for us in connection with the selection and acquisition of our investments, the management and leasing of our properties and the administration of our other investments. We will pay them substantial fees for these services, which will result in immediate dilution to the value of our stockholders’ investment and will reduce the amount of cash available for investment or distribution to stockholders. Depending primarily upon the number of shares we sell in this offering and assuming a $10.00 purchase price for shares sold in the primary offering and a $9.50 purchase price for shares sold under the dividend reinvestment plan, we estimate that we will use approximately 86.8% of the gross proceeds to make investments in real estate properties and other real estate-related loans and securities. We will use the remainder of the offering proceeds to pay the costs of the offering, including selling commissions and the dealer manager fee, and to pay a fee to our advisor for its services in connection with the selection and acquisition of properties, and to repurchase shares of our common stock under our share redemption program.

 

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We may also pay significant fees during our listing/liquidation stage. Although most of the fees payable during our listing/liquidation stage are contingent on our investors first receiving agreed-upon investment returns, affiliates of our advisor and sub-advisor could also receive significant payments even without our reaching the investment-return thresholds should we seek to become self-managed. Due to the apparent preference of the public markets for self-managed companies, a decision to list our shares on a national securities exchange might be preceded by a decision to become self-managed. Given our advisor’s and sub-advisor’s familiarity with our assets and operations, we might prefer to become self-managed by acquiring entities affiliated with our advisor and sub-advisor. Such an internalization transaction could result in significant payments to affiliates of our advisor or sub-advisor irrespective of whether our stockholders received the returns on which we have conditioned other incentive compensation.

Therefore, these fees increase the risk that the amount available for distribution to common stockholders upon a liquidation of our portfolio would be less than stockholders paid for our shares. These substantial fees and other payments also increase the risk that our stockholders will not be able to resell their shares at a profit, even if our shares are listed on a national securities exchange.

If we are unable to obtain funding for future capital needs, cash distributions to our stockholders and the value of our investments could decline.

When tenants do not renew their leases or otherwise vacate their space, we will often need to expend substantial funds for improvements to the vacated space in order to attract replacement tenants. Even when tenants do renew their leases we may agree to make improvements to their space as part of our negotiation. If we need additional capital in the future to improve or maintain our properties or for any other reason, we may have to obtain financing from sources, beyond our funds from operations, such as borrowings or future equity offerings. These sources of funding may not be available on attractive terms or at all. If we cannot procure additional funding for capital improvements, our investments may generate lower cash flows or decline in value, or both, which would limit our ability to make distributions to our stockholders and could reduce the value of your investment.

Our stockholders may be more likely to sustain a loss on their investment because our sponsors do not have as strong an economic incentive to avoid losses as do sponsors who have made significant equity investments in their companies.

Our sponsors have initially invested only $200,000 in us through the purchase of 20,000 shares of our common stock at $10.00 per share. Therefore, if we are successful in raising enough proceeds to reimburse our sponsors for our significant organization and offering expenses, our sponsors will have little exposure to loss in the value of our shares. Without this exposure, our investors may be at a greater risk of loss because our sponsors do not have as much to lose from a decrease in the value of our shares as do those sponsors who make more significant equity investments in their companies.

 

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Although we will not currently be afforded the protection of the Maryland General Corporation Law relating to deterring or defending hostile takeovers, our board of directors could opt into these provisions of Maryland law in the future, which may discourage others from trying to acquire control of us and may prevent our stockholders from receiving a premium price for their stock in connection with a business combination.

Under Maryland law, “business combinations” between a Maryland corporation and certain interested stockholders or affiliates of interested stockholders are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. Also under Maryland law, control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter. Shares owned by the acquirer, an officer of the corporation or an employee of the corporation who is also a director of the corporation are excluded from the vote on whether to accord voting rights to the control shares. Should our board opt into these provisions of Maryland law, it may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer. Similarly, provisions of Title 3, Subtitle 8 of the Maryland General Corporation Law could provide similar anti-takeover protection. For more information about the business combination, control share acquisition and Subtitle 8 provisions of Maryland law, see “Description of Shares—Business Combinations,” “Description of Shares—Control Share Acquisitions” and “Description of Shares—Subtitle 8.”

General Risks Related to Investments in Real Estate

Economic and regulatory changes that impact the real estate market generally may decrease the value of our investments and weaken our operating results.

Our properties and their performance will be subject to the risks typically associated with real estate, including:

 

   

downturns in national, regional and local economic conditions;

 

   

increased competition for real estate assets targeted by our investment strategy;

 

   

adverse local conditions, such as oversupply or reduction in demand for similar properties in an area and changes in real estate zoning laws that may reduce the desirability of real estate in an area;

 

   

vacancies, changes in market rental rates and the need to periodically repair, renovate and re-let space;

 

   

changes in interest rates and the availability of permanent mortgage financing, which may render the sale of a property or loan difficult or unattractive;

 

   

changes in tax, real estate, environmental and zoning laws;

 

   

periods of high interest rates and tight money supply; and

 

   

the illiquidity of real estate investments generally.

 

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Any of the above factors, or a combination thereof, could result in a decrease in the value of our investments, which would have an adverse effect on our operations, on our ability to pay distributions to our stockholders and on the value of our stockholders’ investment.

We will depend on our tenants for revenue, and, accordingly, our revenue and our ability to make distributions to our stockholders is dependent upon the success and economic viability of our tenants.

A property may incur vacancies either by the expiration of a tenant lease, the continued default of a tenant under its lease or the early termination of a lease by a tenant. If vacancies continue for a long period of time, we may suffer reduced revenues resulting in less cash available to distribute to stockholders. In addition, if we are unable to attract additional or replacement tenants, the resale value of the property could be diminished, even below our cost to acquire the property, because the market value of a particular property depends principally upon the value of the cash flow generated by the leases associated with that property. Such a reduction on the resale value of a property could also reduce the value of our stockholders’ investment.

Retail conditions may adversely affect our base rent and subsequently, our income.

Some of our leases may provide for base rent plus contractual base rent increases. A number of our retail leases may also include a percentage rent clause for additional rent above the base amount based upon a specified percentage of the sales our tenants generate. Under those leases which contain percentage rent clauses, our revenue from tenants may increase as the sales of our tenants increase. Generally, retailers face declining revenues during downturns in the economy. As a result, the portion of our revenue which we may derive from percentage rent leases could decline upon a general economic downturn.

Our revenue will be impacted by the success and economic viability of our anchor retail tenants. Our reliance on single or significant tenants in certain buildings may decrease our ability to lease vacated space and adversely affect the returns on our stockholders’ investment.

In the retail sector, a tenant occupying all or a large portion of the gross leasable area of a retail center, commonly referred to as an anchor tenant, may become insolvent, may suffer a downturn in business, or may decide not to renew its lease. Any of these events would result in a reduction or cessation in rental payments to us and would adversely affect our financial condition. A lease termination by an anchor tenant could result in lease terminations or reductions in rent by other tenants whose leases may permit cancellation or rent reduction if another tenant’s lease is terminated. In such event, we may be unable to re-lease the vacated space. Similarly, the leases of some anchor tenants may permit the anchor tenant to transfer its lease to another retailer. The transfer to a new anchor tenant could cause customer traffic in the retail center to decrease and thereby reduce the income generated by that retail center. A lease transfer to a new anchor tenant could also allow other tenants to make reduced rental payments or to terminate their leases. In the event that we are unable to re-lease the vacated space to a new anchor tenant, we may incur additional expenses in order to re-model the space to be able to re-lease the space to more than one tenant.

 

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Dislocations in the credit markets and real estate markets could have a material adverse effect on our results of operations, financial condition and ability to pay distributions to our stockholders.

Domestic and international credit markets currently are experiencing significant disruptions and dislocations which have been brought about in large part by failures in the U.S. banking system. These disruptions and dislocations have materially impacted the cost and availability of debt to finance real estate acquisitions, which is a key component of our acquisition strategy. If the lack of available debt persists, our ability to borrow monies to finance the purchase of, or other activities related to, real estate assets will be negatively impacted. This lack of available debt could result in a reduction of suitable investment opportunities and create a competitive advantage for other entities that have greater financial resources than we do. In addition, if we pay fees to lock in a favorable interest rate, falling interest rates or other factors could require us to forfeit these fees. If we acquire properties and other investments at higher prices and/or by using less-than-ideal capital structures, our returns will be lower and the value of our assets may not appreciate or may decrease significantly below the amount we paid for such assets. All of these events would have a material adverse effect on our results of operations, financial condition and ability to pay distributions.

The continued economic downturn in the United States has had, and may continue to have, an adverse impact on the retail industry generally. Slow or negative growth in the retail industry could result in defaults by retail tenants which could have an adverse impact on our financial operations.

The current economic downturn in the United States has had an adverse impact on the retail industry generally. As a result, the retail industry is facing reductions in sales revenues and increased bankruptcies throughout the United States. The continuation of adverse economic conditions may result in an increase in distressed or bankrupt retail companies, which in turn would result in an increase in defaults by tenants at our commercial properties. Additionally, slow economic growth is likely to hinder new entrants into the retail market which may make it difficult for us to fully lease the real properties that we plan to acquire. Tenant defaults and decreased demand for retail space would have an adverse impact on the value of the retail properties that we plan to acquire and our results of operations.

We anticipate that our properties will consist primarily of retail properties. Our performance, therefore, is linked to the market for retail space generally.

The market for retail space has been and could be adversely affected by weaknesses in the national, regional and local economies, the adverse financial condition of some large retailing companies, the ongoing consolidation in the retail sector, excess amounts of retail space in a number of markets and competition for tenants with other shopping centers in our markets. Customer traffic to these shopping areas may be adversely affected by the closing of stores in the same shopping center, or by a reduction in traffic to such stores resulting from a regional economic downturn, a general downturn in the local area where our store is located, or a decline in the desirability of the shopping environment of a particular shopping center. Such a reduction in customer traffic could have a material adverse effect on our business, financial condition and results of operations.

 

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A high concentration of our properties in a particular geographic area, or with tenants in a similar industry, would magnify the effects of downturns in that geographic area or industry.

We expect that our properties will be diverse according to geographic area and industry of our tenants. However, in the event that we have a concentration of properties in any particular geographic area, any adverse situation that disproportionately effects that geographic area would have a magnified adverse effect on our portfolio. Similarly, if tenants of our properties are concentrated in a certain industry or industries, any adverse effect to that industry generally would have a disproportionately adverse effect on our portfolio.

Our retail tenants will face competition from numerous retail channels, which may reduce our profitability and ability to pay distributions.

Retailers at our properties will face continued competition from discount or value retailers, factory outlet centers, wholesale clubs, mail order catalogues and operators, television shopping networks and shopping via the Internet. Such competition could adversely affect our tenants and, consequently, our revenues and funds available for distribution.

The bankruptcy or insolvency of a major tenant may adversely impact our operations and our ability to pay distributions to stockholders.

The bankruptcy or insolvency of a significant tenant or a number of smaller tenants may have an adverse impact on financial condition and our ability to pay distributions to our stockholders. Generally, under bankruptcy law, a debtor tenant has 120 days to exercise the option of assuming or rejecting the obligations under any unexpired lease for nonresidential real property, which period may be extended once by the bankruptcy court. If the tenant assumes its lease, the tenant must cure all defaults under the lease and may be required to provide adequate assurance of its future performance under the lease. If the tenant rejects the lease, we will have a claim against the tenant’s bankruptcy estate. Although rent owing for the period between filing for bankruptcy and rejection of the lease may be afforded administrative expense priority and paid in full, pre-bankruptcy arrears and amounts owing under the remaining term of the lease will be afforded general unsecured claim status (absent collateral securing the claim). Moreover, amounts owing under the remaining term of the lease will be capped. Other than equity and subordinated claims, general unsecured claims are the last claims paid in a bankruptcy and therefore funds may not be available to pay such claims in full.

If a sale-leaseback transaction is re-characterized in a tenant’s bankruptcy proceeding, our financial condition could be adversely affected.

We may enter into sale-leaseback transactions, whereby we would purchase a property and then lease the same property back to the person from whom we purchased it. In the event of the bankruptcy of a tenant, a transaction structured as a sale-leaseback may be re-characterized as either a financing or a joint venture, either of which outcomes could adversely affect our financial condition, cash flow and the amount available for distributions to our stockholders.

If the sale-leaseback were re-characterized as a financing, we might not be considered the owner of the property, and as a result would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. The tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding

 

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balance. If confirmed by the bankruptcy court, we could be bound by the new terms, and prevented from foreclosing our lien on the property. If the sale-leaseback were re-characterized as a joint venture, our lessee and we could be treated as co-venturers with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the lessee relating to the property.

Competition with third parties in acquiring properties and other investments may reduce our profitability and the return on our stockholders’ investment.

We will face competition from various entities for investment opportunities in retail properties, including other REITs, pension funds, insurance companies, investment funds and companies, partnerships, and developers. Many of these entities have substantially greater financial resources than we do and may be able to accept more risk than we can prudently manage, including risks with respect to the creditworthiness of a tenant or the geographic location of its investments. Competition from these entities may reduce the number of suitable investment opportunities offered to us or increase the bargaining power of property owners seeking to sell.

Properties that have significant vacancies could be difficult to sell, which could diminish the return on these properties.

A property may incur vacancies either by the expiration of a tenant lease, the continued default of a tenant under its lease or the early termination of a lease by a tenant. If vacancies continue for a long period of time, we may suffer reduced revenues resulting in less cash available to distribute to stockholders. In addition, the resale value of the property could be diminished because the market value of a particular property depends principally upon the value of the cash flow generated by the leases associated with that property. Such a reduction on the resale value of a property could also reduce the value of our stockholders’ investment.

Changes in supply of or demand for similar real properties in a particular area may increase the price of real properties we seek to purchase and decrease the price of real properties when we seek to sell them.

The real estate industry is subject to market forces. We are unable to predict certain market changes including changes in supply of, or demand for, similar real properties in a particular area. Any potential purchase of an overpriced asset could decrease our rate of return on these investments and result in lower operating results and overall returns to our stockholders.

We may be unable to adjust our portfolio in response to changes in economic or other conditions or sell a property if or when we decide to do so, limiting our ability to pay cash distributions to our stockholders.

Many factors that are beyond our control affect the real estate market and could affect our ability to sell properties for the price, on the terms or within the time frame that we desire. These factors include general economic conditions, the availability of financing, interest rates and other factors, including supply and demand. Because real estate investments are relatively illiquid, we have a limited ability to vary our portfolio in response to changes in economic or other conditions. Further, before we can sell a property on the terms we want, it may be necessary to expend funds to correct defects or to make improvements. However, we can give no assurance that we will have the funds available to correct such defects or to make such improvements. We may be unable to sell our properties at a profit. Our inability to sell properties at the time and on the terms we want could reduce our cash flow and limit our ability to make distributions to our

 

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stockholders and could reduce the value of our stockholders’ investment. Moreover, in acquiring a property, we may agree to restrictions that prohibit the sale of that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. We cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. Our inability to sell a property when we desire to do so may cause us to reduce our selling price for the property. Any delay in our receipt of proceeds, or diminishment of proceeds, from the sale of a property could adversely impact our ability to pay distributions to our stockholders.

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.

A lock-out provision is a provision that prohibits the prepayment of a loan during a specified period of time. Lock-out provisions may include terms that provide strong financial disincentives for borrowers to prepay their outstanding loan balance and exist in order to protect the yield expectations of investors. We expect that many of our properties will be subject to lock-out provisions. Lock-out provisions could materially restrict us from selling or otherwise disposing of or refinancing properties when we may desire to do so. Lock-out provisions may prohibit us from reducing the outstanding indebtedness with respect to any properties, refinancing such indebtedness on a non-recourse basis at maturity, or increasing the amount of indebtedness with respect to such properties. Lock-out provisions could impair our ability to take other actions during the lock-out period that could be in the best interests of our stockholders and, therefore, may have an adverse impact on the value of our shares relative to the value that would result if the lock-out provisions did not exist. 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.

If we sell a property by providing financing to the purchaser, we will bear the risk of default by the purchaser, which could delay or reduce the distributions available to our stockholders.

If we decide to sell any of our properties, we intend to use our best efforts to sell them for cash; however, in some instances, we may sell our properties by providing financing to purchasers. When we provide financing to a purchaser, we will bear the risk that the purchaser may default, which could reduce our cash distributions to stockholders. Even in the absence of a purchaser default, the distribution of the proceeds of the sale to our stockholders, or the reinvestment of the proceeds in other assets, will be delayed until the promissory notes or other property we may accept upon a sale 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. If any purchaser defaults under a financing arrangement with us, it could negatively impact our ability to pay cash distributions to our stockholders.

Potential development and construction delays and resultant increased costs and risks may hinder our operating results and decrease our net income.

Although we expect that we will invest primarily in properties that have operating histories or whose construction is complete, from time to time we may acquire unimproved real property or properties that are under development or construction. Investments in such properties will be subject to the uncertainties associated with the development and construction of real

 

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property, including those related to re-zoning land for development, environmental concerns of governmental entities and/or community groups and our builders’ ability to build in conformity with plans, specifications, budgeted costs and timetables. If a builder fails to perform, we may resort to legal action to rescind the purchase or the construction contract or to compel performance. A builder’s performance may also be affected or delayed by conditions beyond the builder’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 builders 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 such 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 such 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.

 

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Our joint venture partners could take actions that decrease the value of an investment to us and lower our stockholders’ overall return.

We may enter into joint ventures with third parties, including entities that are affiliated with our Advisor, to acquire properties and other assets. We may also purchase and develop properties in joint ventures or in partnerships, co-tenancies or other co-ownership arrangements with the sellers of the properties, affiliates of the sellers, developers or other persons. Such investments may involve risks not otherwise present with other methods of investment, including, for example, the following risks:

 

   

that our co-venturer, co-tenant or partner in an investment could become insolvent or bankrupt;

 

   

that such co-venturer, co-tenant or partner may at any time have economic or business interests or goals that are or that become inconsistent with our business interests or goals;

 

   

that such co-venturer, co-tenant or partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives;

 

   

the possibility that we may incur liabilities as a result of an action taken by such co-venturer, co-tenant or partner;

 

   

that disputes between us and a co-venturer, co-tenant or partner may result in litigation or arbitration that would increase our expenses and prevent our officers and directors from focusing their time and effort on our business;

 

   

the possibility that if we have a right of first refusal or buy/sell right to buy out a co-venturer, co-owner or partner, we may be unable to finance such a buy-out if it becomes exercisable or we may be required to purchase such interest at a time when it would not otherwise be in our best interest to do so; or

 

   

the possibility that we may not be able to sell our interest in the joint venture if we desire to exit the joint venture.

Under certain joint venture arrangements, neither venture partner may have the power to control the venture and an impasse could be reached, which might have a negative influence on the joint venture and decrease potential returns to our stockholders. In addition, to the extent that our venture partner or co-tenant is an affiliate of our Advisor, certain conflicts of interest will exist. Any of the above might subject a property to liabilities in excess of those contemplated and thus reduce our returns on that investment and the value of our stockholders’ investment.

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 such 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.

 

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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.

CC&Rs may restrict our ability to operate a property.

We expect that some of our properties will be contiguous to other parcels of real property, comprising part of the same retail center. In connection with such properties, we will be subject to significant covenants, conditions and restrictions, known as “CC&Rs,” restricting the operation of such properties and any improvements on such properties, and related to granting easements on such properties. Moreover, the operation and management of the contiguous properties may impact such properties. Compliance with CC&Rs may adversely affect our operating costs and reduce the amount of funds that we have available to pay distributions to our stockholders.

If we set aside insufficient capital reserves, we may be required to defer necessary capital improvements.

If we do not have enough reserves for capital to supply needed funds for capital improvements throughout the life of the investment in a property and there is insufficient cash available from our operations, we may be required to defer necessary improvements to a property, which may cause that property to suffer from a greater risk of obsolescence or a decline in value, or a greater risk of decreased cash flow as a result of fewer potential tenants being attracted to the property. If this happens, we may not be able to maintain projected rental rates for affected properties, and our results of operations may be negatively impacted.

Our operating expenses may increase in the future and, to the extent such increases cannot be passed on to tenants, our cash flow and our operating results would decrease.

Operating expenses, such as expenses for fuel, utilities, labor and insurance, are not fixed and may increase in the future. There is no guarantee that we will be able to pass such increases on to our tenants. To the extent such increases cannot be passed on to tenants, any such increase would cause our cash flow and our operating results to decrease.

Our real properties will be subject to property taxes that may increase in the future, which could adversely affect our cash flow.

Our real properties will be subject to real property taxes that may increase as tax rates change and as the real properties are assessed or reassessed by taxing authorities. We anticipate that certain of our leases will generally provide that the property taxes, or increases therein, are charged to the lessees as an expense related to the real properties that they occupy, while other leases will generally provide that we are responsible for such taxes. In any case, as the owner of the properties, we are ultimately responsible for payment of the taxes to the applicable government authorities. If real property taxes increase, our tenants may be unable to make the required tax payments, ultimately requiring us to pay the taxes even if otherwise stated under the terms of the lease. If we fail to pay any such taxes, the applicable taxing authority may place a lien on the real property and the real property may be subject to a tax sale. In addition, we will generally be responsible for real property taxes related to any vacant space.

 

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Uninsured losses relating to real property or excessively expensive premiums for insurance coverage could reduce our cash flows and the return on our stockholders’ investment.

We will attempt to adequately insure all of our real properties against casualty losses. 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 acts of terrorism could sharply increase the premiums we pay for coverage against property and casualty claims. Additionally, mortgage lenders in some cases have begun to insist that commercial property owners purchase coverage against terrorism as a condition for providing mortgage loans. Such insurance policies may not be available at reasonable costs, 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 may not have adequate, or any, coverage for such losses. Changes in the cost or availability of insurance could expose us to uninsured casualty losses. If any of our properties incurs a casualty loss that is not fully insured, the value of our assets will be reduced by any such uninsured loss, which may reduce the value of our stockholders’ investment. In addition, other than any working capital reserve or other reserves we may establish, we have no source of funding to repair or reconstruct any uninsured property. Also, to the extent we must pay unexpectedly large amounts for insurance, we could suffer reduced earnings that would result in lower distributions to stockholders. The Terrorism Risk Insurance Act of 2002 is designed for a sharing of terrorism losses between insurance companies and the federal government. We cannot be certain how this act will impact us or what additional cost to us, if any, could result.

Terrorist attacks and other acts of violence or war may affect the markets in which we plan to operate, which could delay or hinder our ability to meet our investment objectives and reduce our stockholders’ overall return.

Terrorist attacks or armed conflicts may directly impact the value of our properties through damage, destruction, loss or increased security costs. We expect that we will invest in major metropolitan areas. We may not be able to obtain insurance against the risk of terrorism because it may not be available or may not be available on terms that are economically feasible. The terrorism insurance that we obtain may not be sufficient to cover loss for damages to our properties as a result of terrorist attacks. The inability to obtain sufficient terrorism insurance or any terrorism insurance at all could limit our investment options as some mortgage lenders have begun to insist that specific coverage against terrorism be purchased by commercial owners as a condition of providing loans.

Costs of complying with governmental laws and regulations related to environmental protection and human health and safety may reduce our net income and the cash available for distributions to our stockholders.

Real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to protection of the environment and human health. We could be subject to liability in the form of fines, penalties or damages for noncompliance with these laws and regulations. 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, the remediation of contamination associated with the release or disposal of solid and hazardous materials, the presence of toxic building materials, and other health and safety-related concerns.

 

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Some of these laws and regulations may impose joint and several liability on the tenants, owners or operators of real property for the costs to investigate or remediate contaminated properties, regardless of fault, whether the contamination occurred prior to purchase, or whether the acts causing the contamination were legal. Our tenants’ operations, the condition of properties at the time we buy them, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties may affect our properties.

The presence of hazardous substances, or the failure to properly manage or remediate these substances, may hinder our ability to sell, rent or pledge such property as collateral for future borrowings. Environmental laws also may impose liens on property or restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures or prevent us from entering into leases with prospective tenants that may be impacted by such laws. Some of these laws and regulations have been amended so as to require compliance with new or more stringent standards as of future dates. Compliance with new or more stringent laws or regulations or stricter interpretation of existing laws may require us to incur material expenditures. Future laws, ordinances or regulations may impose material environmental liability. Any material expenditures, fines, penalties, or damages we must pay will reduce our ability to make distributions and may reduce the value of our stockholders’ investment.

The costs of defending against claims of environmental liability or of paying personal injury claims could reduce the amounts available for distribution to our stockholders.

Environmental laws provide for sanctions for noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Certain environmental laws and common law principles could be used to impose liability for the release of and exposure to hazardous substances, including asbestos-containing materials and lead-based paint. Third parties may seek recovery from real property owners or operators for personal injury or property damage associated with exposure to released hazardous substances. The costs of defending against claims of environmental liability or of paying personal injury claims could reduce the amounts available for distribution to our stockholders. Generally, we expect that the real estate properties that we will acquire will have been subject to Phase I environmental assessments at the time they were acquired.

Costs associated with complying with the Americans with Disabilities Act may decrease cash available for distributions.

Our properties may be subject to the Americans with Disabilities Act of 1990, as amended. Under the Disabilities Act, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. We are committed to complying with the act to the extent to which it applies. 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. The Disabilities Act’s requirements 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 will attempt to acquire properties that comply with the ADA or place the burden on the seller or other third party, such as a tenant, to ensure compliance with the ADA. We cannot assure our stockholders that we will be able to acquire properties or allocate responsibilities in this manner. Any funds used for Disabilities Act compliance will reduce our net income and the amount of cash available for distributions to our stockholders.

 

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The failure of any bank in which we deposit our funds could reduce the amount of cash we have available to pay distributions and make additional investments.

We intend to diversify our cash and cash equivalents among several banking institutions in an attempt to minimize exposure to any one of these entities. However, the Federal Deposit Insurance Corporation, or “FDIC,” only insures amounts up to $250,000 per depositor per insured bank. We expect that we will have cash and cash equivalents and restricted cash deposited in certain financial institutions in excess of federally insured levels. If any of the banking institutions in which we have deposited funds ultimately fails, we may lose our deposits over $250,000. The loss of our deposits could reduce the amount of cash we have available to distribute or invest and could result in a decline in the value of our stockholders’ investments.

Risks Related to Real Estate-Related Investments

Our investments in mortgage, mezzanine, bridge and other loans as well as our investments in mortgage-backed securities, collateralized debt obligations and other debt may be affected by unfavorable real estate market conditions, which could decrease the value of those assets and the return on your investment.

If we make or invest in mortgage, mezzanine or other real estate-related loans, we will be at risk of defaults by the borrowers on those loans. These defaults may be caused by many conditions beyond our control, including interest rate levels and local and other economic conditions affecting real estate values. We will not know whether the values of the properties ultimately securing our loans will remain at the levels existing on the dates of origination of those loans. If the values of the underlying properties drop, our risk will increase because of the lower value of the security associated with such loans. Our investments in mortgage-backed securities, collateralized debt obligations and other real estate-related debt will be similarly affected by real estate market conditions.

If we make or invest in mortgage, mezzanine, bridge or other real estate-related loans, our loans will be subject to interest rate fluctuations that will affect our returns as compared to market interest rates; accordingly, the value of your investment would be subject to fluctuations in interest rates.

If we make or invest in fixed-rate, long-term loans and interest rates rise, the loans could yield a return that is lower than then-current market rates. If interest rates decrease, we will be adversely affected to the extent that loans are prepaid because we may not be able to make new loans at the higher interest rate. If we invest in variable-rate loans and interest rates decrease, our revenues will also decrease. For these reasons, if we invest in mortgage, mezzanine, bridge or other real estate-related loans, our returns on those loans and the value of your investment will be subject to fluctuations in interest rates.

We have not established investment criteria limiting geographical concentration of our mortgage investments or requiring a minimum credit quality of borrowers.

We have not established any limit upon the geographic concentration of properties securing mortgage loans acquired or originated by us or the credit quality of borrowers of uninsured mortgage assets acquired or originated by us. As a result, properties securing our mortgage loans may be overly concentrated in certain geographic areas and the underlying borrowers of our uninsured mortgage assets may have low credit quality. We may experience losses due to geographic concentration or low credit quality.

 

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Mortgage investments that are not United States government insured and non-investment grade mortgage assets involve risk of loss.

We may originate and acquire real estate related uninsured and non-investment grade mortgage loans and mortgage assets, including mezzanine loans, as part of our investment strategy. While holding these interests, we will be subject to risks of borrower defaults, bankruptcies, fraud and losses and special hazard losses that are not covered by standard hazard insurance. Also, the costs of financing the mortgage loans could exceed the return on the mortgage loans. In the event of any default under mortgage loans held by us, we will bear the risk of loss of principal and non-payment of interest and fees to the extent of any deficiency between the value of the mortgage collateral and the principal amount of the mortgage loan. To the extent we suffer such losses with respect to our investments in mortgage loans, the value of our stockholders’ investments may be adversely affected.

We may invest in non-recourse loans, which will limit our recovery to the value of the mortgaged property.

Our mortgage loan assets may be non-recourse loans. With respect to our non-recourse mortgage loan assets, in the event of a borrower default, the specific mortgaged property and other assets, if any, pledged to secure the relevant mortgage loan, may be less than the amount owed under the mortgage loan. As to those mortgage loan assets that provide for recourse against the borrower and its assets generally, we cannot assure our stockholders that the recourse will provide a recovery in respect of a defaulted mortgage loan greater than the liquidation value of the mortgaged property securing that mortgage loan.

Interest rate fluctuations will affect the value of our mortgage assets, net income and common stock.

Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Interest rate fluctuations can adversely affect our income in many ways and present a variety of risks including the risk of variances in the yield curve, a mismatch between asset yields and borrowing rates, and changing prepayment rates.

Variances in the yield curve may reduce our net income. The relationship between short-term and longer-term interest rates is often referred to as the “yield curve.” Short-term interest rates are ordinarily lower than longer-term interest rates. If short-term interest rates rise disproportionately relative to longer-term interest rates (a flattening of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on our assets. Because our assets may bear interest based on longer-term rates than our borrowings, a flattening of the yield curve would tend to decrease our net income and the market value of our mortgage loan assets. Additionally, to the extent cash flows from investments that return scheduled and unscheduled principal are reinvested in mortgage loans, the spread between the yields of the new investments and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve inversion), in which event our borrowing costs may exceed our interest income and we could incur operating losses.

 

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Prepayment rates on our mortgage loans may adversely affect our yields.

The value of our mortgage loan assets may be affected by prepayment rates on investments. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. To the extent we originate mortgage loans, we expect that such mortgage loans will have a measure of protection from prepayment in the form of prepayment lock-out periods or prepayment penalties. However, this protection may not be available with respect to investments that we acquire but do not originate. In periods of declining mortgage interest rates, prepayments on mortgages generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the yields on the investments that were prepaid. In addition, the market value of mortgage investments may, because of the risk of prepayment, benefit less from declining interest rates than from other fixed-income securities. Conversely, in periods of rising interest rates, prepayments on mortgages generally decrease, in which case we would not have the prepayment proceeds available to invest in assets with higher yields. Under certain interest rate and prepayment scenarios we may fail to fully recoup our cost of acquisition of certain investments.

Before making any investment, we will consider the expected yield of the investment and the factors that may influence the yield actually obtained on such investment. These considerations will affect our decision whether to originate or purchase such an investment and the price offered for such an investment. No assurances can be given that we can make an accurate assessment of the yield to be produced by an investment. Many factors beyond our control are likely to influence the yield on the investments, including, but not limited to, competitive conditions in the local real estate market, local and general economic conditions and the quality of management of the underlying property. Our inability to accurately assess investment yields may result in our purchasing assets that do not perform as well as expected, which may adversely affect the value of our stockholders’ investments.

Volatility of values of mortgaged properties may adversely affect our mortgage loans.

Real estate property values and net operating income derived from real estate properties are subject to volatility and may be affected adversely by a number of factors, including the risk factors described in this prospectus relating to general economic conditions and owning real estate investments. In the event its net operating income decreases, a borrower may have difficulty paying our mortgage loan, which could result in losses to us. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our mortgage loans, which could also cause us to suffer losses.

Mezzanine loans involve greater risks of loss than senior loans secured by income producing properties.

We may make and acquire mezzanine loans. These types of mortgage loans are considered to involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property due to a variety of factors, including the loan being entirely unsecured or, if secured, becoming unsecured as a result of foreclosure by the senior lender. We may not recover some or all of our investment in these loans. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans resulting in less equity in the property and increasing the risk of loss of principal.

 

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Our investments in subordinated loans and subordinated mortgage-backed securities may be subject to losses.

We intend to acquire or originate subordinated loans and invest in subordinated mortgage-backed securities. In the event a borrower defaults on a subordinated loan and lacks sufficient assets to satisfy our loan, we may suffer a loss of principal or interest. In the event a borrower declares bankruptcy, we may not have full recourse to the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy the loan. If a borrower defaults on our loan or on debt senior to our loan, or in the event of a borrower bankruptcy, our loan will be satisfied only after the senior debt is paid in full. Where debt senior to our loan exists, the presence of intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through “standstill periods”), and control decisions made in bankruptcy proceedings relating to borrowers.

The CMBS in which we may invest are subject to all of the risks of the underlying mortgage loans and the risks of the securitization process.

CMBS, or commercial mortgage-backed securities, are securities that evidence interests in, or are secured by, a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, these securities are subject to all of the risks of the underlying mortgage loans.

In a rising interest rate environment, the value of CMBS may be adversely affected when payments on underlying mortgages do not occur as anticipated, resulting in the extension of the security’s effective maturity and the related increase in interest rate sensitivity of a longer-term instrument. The value of CMBS may also change due to shifts in the market’s perception of issuers and regulatory or tax changes adversely affecting the mortgage securities market as a whole. In addition, CMBS are subject to the credit risk associated with the performance of the underlying mortgage properties. In certain instances, third-party guarantees or other forms of credit support can reduce the credit risk.

CMBS are also subject to several risks created through the securitization process. Subordinate CMBS are paid interest only to the extent that there are funds available to make payments. To the extent the collateral pool includes delinquent loans, there is a risk that the interest payment on subordinate CMBS will not be fully paid. Subordinate CMBS are also subject to greater credit risk than those CMBS that are more highly rated.

Our investments in real estate-related common equity securities will be subject to specific risks relating to the particular issuer of the securities and may be subject to the general risks of investing in subordinated real estate securities, which may result in losses to us.

We expect to make equity investments in other REITs and other real estate companies. We will target a public company that owns commercial real estate or real estate-related assets when we believe its stock is trading at a discount to that company’s net asset value. We may eventually seek to acquire or gain a controlling interest in the companies that we target. We do not expect our non-controlling equity investments in other public companies to exceed 5.0% of the proceeds of this offering, assuming we sell the maximum offering amount, or to represent a substantial portion of our assets at any one time. Our investments in real estate-related common equity securities will involve special risks relating to the particular issuer of the equity securities, including the financial condition and business outlook of the issuer. Issuers of real estate-related common equity securities generally invest in real estate or real estate-related assets and are

 

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subject to the inherent risks associated with real estate-related investments discussed in this prospectus.

Real estate-related common equity securities are generally unsecured and may also be subordinated to other obligations of the issuer. As a result, investments in real estate-related common equity securities are subject to risks of: (1) limited liquidity in the secondary trading market, (2) substantial market price volatility resulting from changes in prevailing interest rates, (3) subordination to the prior claims of banks and other senior lenders to the issuer, (4) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower yielding assets, (5) the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations and (6) the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding real estate-related common equity securities and the ability of the issuers thereof to make distribution payments.

Risks Associated with Debt Financing

Continued disruptions in the financial markets and deteriorating economic conditions could also adversely affect our ability to secure debt financing on attractive terms and the values of investments we make.

The capital and credit markets have been experiencing extreme volatility and disruption for more than 18 months. Liquidity in the global credit market has been severely contracted by these market disruptions, making it costly to obtain new lines of credit or refinance existing debt. We expect to finance our investments in part with debt. As a result of the ongoing credit market turmoil, we may not be able to obtain debt financing on attractive terms, if at all. As such, we may be forced to use a greater proportion of our offering proceeds to finance our acquisitions and originations, reducing the number of investments we would otherwise make. If the current debt market environment persists, we may modify our investment strategy in order to optimize our portfolio performance. Our options would include limiting or eliminating the use of debt and focusing on those investments that do not require the use of leverage to meet our portfolio goals.

We will incur mortgage indebtedness and other borrowings, which increases our risk of loss due to foreclosure.

We may obtain lines of credit and long-term financing that may be secured by our properties and other assets. Under our charter, we have a limitation on borrowing which precludes us from borrowing in excess of 300% of the value of our net assets. Net assets for purposes of this calculation are defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts or other non-cash reserves, less total liabilities. Generally speaking, the preceding calculation is expected to approximate 75.0% of the aggregate cost of our investments before non-cash reserves and depreciation. We may temporarily borrow in excess of these amounts if such excess is approved by a majority of the independent directors and is disclosed to stockholders in our next quarterly report, along with justification for such excess. In some instances, we may acquire real properties by financing a portion of the price of the properties and mortgaging or pledging some or all of the properties purchased as security for that debt. We may also incur mortgage debt on properties that we already own in order to obtain funds to acquire additional properties. In addition, we may borrow as necessary or advisable to ensure that we maintain our qualification as a REIT for U.S. federal income tax purposes, including borrowings to satisfy the REIT requirement that we distribute at

 

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least 90.0% of our annual REIT taxable income to our stockholders (computed without regard to the dividends-paid deduction and excluding net capital gain). We, however, can give our stockholders no assurance that we will be able to obtain such borrowings on satisfactory terms.

High debt levels will cause us to incur higher interest charges, which would result in higher debt service payments and could be accompanied by restrictive covenants. If we do mortgage a property and there is a shortfall between the cash flow from that property and the cash flow needed to service mortgage debt on that property, then the amount of cash available for distributions to stockholders may be reduced. In addition, incurring mortgage debt increases the risk of loss of a property since defaults on indebtedness secured by a property may result in lenders initiating foreclosure actions. In that case, we could lose the property securing the loan that is in default, reducing the value of our stockholders’ investment. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure even though we would not necessarily receive any cash proceeds. We may give full or partial guaranties to lenders of mortgage debt on behalf of the entities that own our properties. When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of the debt if it is not paid by such entity. If any mortgages contain cross-collateralization or cross-default provisions, a default on a single property could affect multiple properties.

We may also obtain recourse debt to finance our acquisitions and meet our REIT distribution requirements. If we have insufficient income to service our recourse debt obligations, our lenders could institute proceedings against us to foreclose upon our assets. If a lender successfully forecloses upon any of our assets, our ability to pay cash distributions to our stockholders will be limited and our stockholders could lose all or part of their investment.

High mortgage rates may make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire, our cash flows from operations and the amount of cash distributions we can make.

If mortgage debt is unavailable at reasonable rates, we may not be able to finance the purchase of properties. If we place mortgage debt on properties, we run the risk of being unable to refinance the properties when the debt becomes due or of being unable to refinance on favorable terms. If interest rates are higher when we refinance the properties, our income could be reduced. We may be unable to refinance properties. If any of these events occurs, our cash flow would be reduced. This, in turn, would reduce cash available for distribution to our stockholders and may hinder our ability to raise capital by issuing more stock or borrowing more money.

We expect to use leverage in connection with our investments in real estate-related assets, which increases the risk of loss associated with this type of investment.

We may finance the acquisition and origination of certain real estate-related investments with warehouse lines of credit and repurchase agreements. In addition, we may engage in various types of securitizations in order to finance our loan originations. Although the use of leverage may enhance returns and increase the number of investments that we can make, it may also substantially increase the risk of loss. There can be no assurance that leveraged financing will be available to us on favorable terms or that, among other factors, the terms of such financing will parallel the maturities of the underlying assets acquired. If alternative financing is not available,

 

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we may have to liquidate assets at unfavorable prices to pay off such financing. Our return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that we can derive from the assets we acquire.

Our debt service payments will reduce our cash flow available for distributions. We may not be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to foreclosure or sale to satisfy our debt obligations. We may utilize repurchase agreements as a component of our financing strategy. Repurchase agreements economically resemble short-term, variable-rate financing and usually require the maintenance of specific loan-to-collateral value ratios. If the market value of the assets subject to a repurchase agreement decline, we may be required to provide additional collateral or make cash payments to maintain the loan-to-collateral value ratio. If we are unable to provide such collateral or cash repayments, we may lose our economic interest in the underlying assets. Further, credit facility providers and warehouse facility providers may require us to maintain a certain amount of cash reserves or to set aside unleveraged assets sufficient to maintain a specified liquidity position that would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.

We may not be able to access financing sources on attractive terms, which could adversely affect our ability to execute our business plan.

We may finance our assets over the long-term through a variety of means, including repurchase agreements, credit facilities, issuance of commercial mortgage-backed securities, collateralized debt obligations and other structured financings. Our ability to execute this strategy will depend on various conditions in the markets for financing in this manner that are beyond our control, including lack of liquidity and greater credit spreads. We cannot be certain that these markets will remain an efficient source of long-term financing for our assets. If our strategy is not viable, we will have to find alternative forms of long-term financing for our assets, as secured revolving credit facilities and repurchase facilities may not accommodate long-term financing. This could subject us to more recourse indebtedness and the risk that debt service on less efficient forms of financing would require a larger portion of our cash flows, thereby reducing cash available for distribution to our stockholders and funds available for operations as well as for future business opportunities.

Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions to our stockholders.

When providing financing, a lender may impose restrictions on us that affect our distribution and operating policies and our ability to incur additional debt. Loan agreements we enter may contain covenants that limit our ability to further mortgage a property, discontinue insurance coverage or replace our advisor. In addition, loan documents may limit our ability to replace a property’s property manager or terminate certain operating or lease agreements related to a property. These or other limitations would decrease our operating flexibility and our ability to achieve our operating objectives.

 

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Increases in interest rates could increase the amount of our debt payments and limit our ability to pay distributions to our stockholders.

We expect that we will incur additional debt in the future and increases in interest rates will increase the cost of that debt, which could reduce the cash we have available for distributions. Additionally, if we incur variable rate debt, increases in interest rates would increase our interest costs, which would reduce our cash flows and our ability to pay distributions to our stockholders. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments at times that may not permit realization of the maximum return on such investments.

Our derivative financial instruments that we may use to hedge against interest rate fluctuations may not be successful in mitigating our risks associated with interest rates and could reduce the overall returns on our stockholders’ investment.

We may use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets, but no hedging strategy can protect us completely. We cannot assure our stockholders that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. In addition, the use of such instruments may reduce the overall return on our investments. These instruments may also generate income that may not be treated as qualifying REIT income for purposes of the 75.0% or 95.0% REIT income test. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Phillips Edison—ARC Shopping Center REIT, Inc.—Income Tests.”

Interest-only indebtedness may increase our risk of default and ultimately may reduce our funds available for distribution to our stockholders.

We may finance our property acquisitions using interest-only mortgage indebtedness. During the interest-only period, the amount of each scheduled payment will be less than that of a traditional amortizing mortgage loan. The principal balance of the mortgage loan will not be reduced (except in the case of prepayments) because there are no scheduled monthly payments of principal during this period. After the interest-only period, we will be required either to make scheduled payments of amortized principal and interest or to make a lump-sum or “balloon” payment at 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 the mortgage loan has an adjustable interest rate, the amount of our scheduled payments also may increase at a time of rising interest rates. Increased payments and substantial principal or balloon maturity payments will reduce the funds available for distribution to our stockholders because cash otherwise available for distribution will be required to pay principal and interest associated with these mortgage loans.

If we enter into financing arrangements involving balloon payment obligations, it may adversely affect our ability to make distributions to our stockholders.

Some of our financing arrangements may require us to make a lump-sum or “balloon” payment at maturity. Our ability to make a balloon payment at maturity is uncertain and may depend upon our ability to obtain additional financing or our ability to sell the property. At the time the balloon payment is due, we may or may not be able to refinance the balloon payment on terms as favorable as the original loan or sell the property at a price sufficient to make the balloon payment. The effect of a refinancing or sale could affect the rate of return to stockholders and the

 

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projected time of disposition of our assets. In addition, payments of principal and interest made to service our debts may leave us with insufficient cash to pay the distributions that we are required to pay to maintain our qualification as a REIT. Any of these results would have a significant, negative impact on our stockholders’ investment.

We have broad authority to incur debt and high debt levels could hinder our ability to make distributions and decrease the value of your investment.

Our policies do not limit us from incurring debt until our borrowings would exceed 75.0% of the cost (before deducting depreciation or other non-cash reserves) of our tangible assets, and we may exceed this limit with the approval of the conflicts committee of our board of directors. During the early stages of this offering, we expect that our conflicts committee will approve debt in excess of this limit. See “Investment Objectives and Criteria—Borrowing Policies.” High debt levels would cause us to incur higher interest charges and higher debt service payments and could also be accompanied by restrictive covenants. These factors could limit the amount of cash we have available to distribute and could result in a decline in the value of your investment.

U.S. Federal Income Tax Risks

Failure to qualify as a REIT would reduce our net earnings available for investment or distribution.

Prior to the commencement of our offering we expect DLA Piper LLP (US) to render an opinion to us that we will be organized in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code for our taxable year ending December 31, 2010 (or ending December 31, 2011 if our REIT election is postponed to our taxable year ending December 31, 2011) and that our proposed method of operations will enable us to meet the requirements for qualification and taxation as a REIT beginning with our taxable year ending December 31, 2010 (or ending December 31, 2011 if our REIT election is postponed to our taxable year ending December 31, 2011). This opinion will be based upon, among other things, our representations as to the manner in which we are and will be owned and the manner in which we will invest in and operate assets. However, our qualification as a REIT will depend upon our ability to meet requirements regarding our organization and ownership, distributions of our income, the nature and diversification of our income and assets and other tests imposed by the Internal Revenue Code. DLA Piper LLP (US) will not review our compliance with the REIT qualification standards on an ongoing basis, and we may fail to satisfy the REIT requirements in the future. Also, this opinion will represent the legal judgment of DLA Piper LLP (US) based on the law in effect as of the date of the opinion. The opinion of DLA Piper LLP (US) will not be binding on the Internal Revenue Service or the courts. Future legislative, judicial or administrative changes to the U.S. federal income tax laws could be applied retroactively, which could result in our disqualification as a REIT.

If we fail to qualify as a REIT for any taxable year after electing REIT status, we will be subject to U.S. federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT status. Losing our REIT status would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the dividends paid deduction and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax. For a discussion of the

 

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REIT qualification tests and other considerations relating to our election to be taxed as REIT, see “Certain Material U.S. Federal Income Tax Considerations.”

Our stockholders may have current tax liability on distributions they elect to reinvest in our common stock.

If our stockholders participate in our dividend reinvestment plan, they will be deemed to have received, and for U.S. federal income tax purposes will be taxed on, the amount reinvested in shares of our common stock to the extent the amount reinvested was not a tax-free return of capital. In addition, our stockholders will be treated for tax purposes as having received an additional distribution to the extent the shares are purchased at a discount to fair market value. As a result, unless our stockholders are a tax-exempt entity, they may have to use funds from other sources to pay their tax liability on the value of the shares of common stock received. See “Description of Shares—Dividend Reinvestment Plan—U.S. Federal Income Tax Consequences of Participation.”

There is a risk that you may receive shares of our common stock as dividends.

We have the ability to declare a large portion of a dividend for the purpose of fulfilling our REIT distribution requirements in shares of our common stock instead of in cash. As long as a portion of such dividend is paid in cash and certain requirements are met, the entire distribution may be treated as a dividend for U.S. federal income tax purposes. As a result, a stockholder would be taxed on 100% of the dividend in the same manner as a cash dividend, even though most of the dividend was paid in shares of our common stock. Stockholders who elect cash may experience greater dilution than other stockholders if we elect to distribute our common stock as a dividend.

Failure to qualify as a REIT would subject us to U.S. federal income tax, which would reduce the cash available for distribution to our stockholders.

We expect to operate in a manner that is intended to cause us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ending on December 31, 2010, although such election may be postponed to our taxable year ending December 31, 2011. However, the U.S. federal income tax laws governing REITs are extremely complex, and interpretations of the U.S. federal income tax laws governing qualification as a REIT are limited. Qualifying as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. While we intend to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, including the tax treatment of certain investments we may make, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year. If we fail to qualify as a REIT in any calendar year and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income. We might need to borrow money or sell assets to pay that tax. Our payment of U.S. federal income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT and we do not qualify for certain statutory relief provisions, we no longer would be required to distribute substantially all of our REIT taxable income to our stockholders. Unless our failure to qualify as a REIT were excused under federal tax laws, we would be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost.

 

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Even if we qualify as a REIT for U.S. federal income tax purposes, we may be subject to other tax liabilities that reduce our cash flow and our ability to make distributions to our stockholders.

Even if we qualify as a REIT for U.S. federal income tax purposes, we may be subject to some federal, state and local taxes on our income or property. For example:

 

   

In order to qualify as a REIT, we must distribute annually at least 90.0% of our REIT taxable income to our stockholders (which is determined without regard to the dividends paid deduction or net capital gain). To the extent that we satisfy the distribution requirement but distribute less than 100% of our REIT taxable income, we will be subject to U.S. federal corporate income tax on the undistributed income.

 

   

We will be subject to a 4.0% nondeductible excise tax on the amount, if any, by which distributions we pay in any calendar year are less than the sum of 85.0% of our ordinary income, 95.0% 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 U.S. federal corporate income tax rate.

 

   

If we sell an asset, 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 unless such sale were made by one of our taxable REIT subsidiaries or the sale met certain “safe harbor” requirements under the Internal Revenue Code.

Our investments in debt instruments may cause us to recognize “phantom income” for U.S. federal income tax purposes even though no cash payments have been received on the debt instruments.

It is expected that we may acquire debt instruments in the secondary market for less than their face amount. The amount of such discount will generally be treated as “market discount” for U.S. federal income tax purposes. Moreover, pursuant to our involvement in public-private joint ventures, other similar programs recently announced by the federal government, or otherwise, we may acquire distressed debt investments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding debt are “significant modifications” under the applicable regulations promulgated by the U.S. Treasury Department (the “Treasury Regulations”), the modified debt may be considered to have been reissued to us in a debt-for-debt exchange with the borrower. This deemed reissuance may prevent the modified debt from qualifying as a good REIT asset if the underlying security has declined in value.

In general, we will be required to accrue original issue discount on a debt instrument as taxable income in accordance with applicable U.S. federal income tax rules even though no cash payments may be received on such debt instrument.

In the event a borrower with respect to a particular debt instrument encounters financial difficulty rendering it unable to pay stated interest as due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income. Similarly, we may be required to

 

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accrue interest income with respect to subordinate mortgage-backed securities at the stated rate regardless of when their corresponding cash payments are received.

As a result of these factors, there is a significant risk that we may recognize substantial taxable income in excess of cash available for distribution. In that event, we may need to borrow funds or take other action to satisfy the REIT distribution requirements for the taxable year in which this “phantom income” is recognized.

REIT distribution requirements could adversely affect our ability to execute our business plan.

We generally must distribute annually at least 90.0% of our REIT taxable income, subject to certain adjustments and excluding any net capital gain, in order for U.S. federal corporate income tax not to apply to earnings that we distribute. To the extent that we satisfy this distribution requirement, but distribute less than 100% of our REIT taxable income, we will be subject to U.S. federal corporate income tax on our undistributed REIT taxable income. In addition, we will be subject to a 4.0% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws. We intend to make distributions to our stockholders to comply with the REIT requirements of the Internal Revenue Code.

From time to time, we may generate taxable income greater than our taxable income for financial reporting purposes, or our taxable income may be greater than our cash flow available for distribution to stockholders (for example, where a borrower defers the payment of interest in cash pursuant to a contractual right or otherwise). If we do not have other funds available in these situations we could be required to borrow funds, sell investments at disadvantageous prices or find another alternative source of funds to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirement and to avoid U.S. federal corporate income tax and the 4.0% excise tax in a particular year. These alternatives could increase our costs or reduce our equity. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.

To maintain our REIT status, we may be forced to forego otherwise attractive opportunities, which may delay or hinder our ability to meet our investment objectives and reduce our stockholders’ overall return.

To qualify as a REIT, we must satisfy certain tests on an ongoing basis concerning, among other things, the sources of our income, nature of our assets and the amounts we distribute to our stockholders. We may be required to make distributions to stockholders at times when it would be more advantageous to reinvest cash in our business or when we do not have funds readily available for distribution. Compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of our stockholders’ investment.

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.

We may be deemed to be ourselves, or make investments in entities that own or are themselves deemed to be taxable mortgage pools. Similarly, certain of our securitizations or other borrowings could be considered to result in the creation of a taxable mortgage pool for U.S. 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

 

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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 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 by the amount of such tax paid by us that is attributable to such stockholder’s ownership. Moreover, we would generally 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 U.S. federal income tax purposes. These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions or other financing arrangements.

Potential characterization of distributions or gain on sale may be treated as unrelated business taxable income to tax-exempt investors.

If (1) all or a portion of our assets are subject to the rules relating to taxable mortgage pools, (2) we are a “pension-held REIT,” (3) a tax-exempt stockholder has incurred debt to purchase or hold our common stock or (4) the residual interests in any real estate mortgage investment conduits (“REMICs”), we acquire (if any) generate “excess inclusion income,” then a portion of the distributions to and, in the case of a stockholder described in clause (3), gains realized on the sale of common stock by such tax-exempt stockholder may be subject to U.S. federal income tax as unrelated business taxable income under the Internal Revenue Code. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Phillips Edison—ARC Shopping Center REIT Inc.—Taxable Mortgage Pools and Excess Inclusion Income.”

Complying with 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 75.0% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and mortgage-backed securities. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10.0% of the outstanding voting securities of any one issuer or more than 10.0% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5.0% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25.0% of the value of our total assets can be represented by securities of one or more taxable REIT subsidiaries. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Phillips Edison—ARC Shopping Center REIT Inc.” If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate from our portfolio otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

 

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Liquidation of assets may jeopardize our REIT qualification.

To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.

Characterization of any repurchase agreements we enter into to finance our investments as sales for tax purposes rather than as secured lending transactions would adversely affect our ability to qualify as a REIT.

We may enter into repurchase agreements with a variety of counterparties to achieve our desired amount of leverage for the assets in which we invest. When we enter into a repurchase agreement, we generally sell assets to our counterparty to the agreement and receive cash from the counterparty. The counterparty is obligated to resell the assets back to us at the end of the term of the transaction. We believe that for U.S. federal income tax purposes we will be treated as the owner of the assets that are the subject of repurchase agreements and that the repurchase agreements will be treated as secured lending transactions notwithstanding that such agreement may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could successfully assert that we did not own these assets during the term of the repurchase agreements, in which case we could fail to qualify as a REIT if tax ownership of these assets was necessary for us to meet the income and/or asset tests discussed in “Certain Material U.S. Federal Income Tax Considerations—Taxation of Phillips Edison—ARC Shopping Center REIT Inc.”

Complying with REIT requirements may limit our ability to hedge effectively.

The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generate from transactions intended to hedge our interest rate, inflation and/or currency risks will be excluded from gross income for purposes of the REIT 75.0% and 95.0% gross income tests if the instrument hedges (1) interest rate risk on liabilities incurred to carry or acquire real estate or (2) risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the REIT 75.0% or 95.0% gross income tests, and such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that do not meet these requirements will generally constitute nonqualifying income for purposes of both the REIT 75.0% and 95.0% gross income tests. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Phillips Edison—ARC Shopping Center REIT Inc.—Derivatives and Hedging Transactions.” As a result of these rules, we may have to limit our 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.

Ownership limitations may restrict change of control or business combination opportunities in which our stockholders might receive a premium for our stockholders shares.

In order for us to qualify as a REIT for each taxable year after 2010 (or 2011, if our REIT election is postponed to our taxable year ending December 31, 2011), no more than 50.0% in value of our outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. “Individuals” for this purpose include natural persons, and certain other entities including private foundations. To preserve our REIT

 

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qualification, our charter generally prohibits any person from directly or indirectly owning more than 9.8% of the aggregate outstanding shares of our capital stock. This ownership limit shall be applicable beginning the year after our initial REIT election. This ownership limitation could have the effect of discouraging a takeover or other transaction in which holders of our common stock might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests.

Our ownership of and relationship with our taxable REIT subsidiaries will be limited and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.

A REIT may own up to 100% of the stock of one or more taxable REIT subsidiaries. A taxable REIT subsidiary may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a taxable REIT subsidiary. A corporation of which a taxable REIT subsidiary directly or indirectly owns more than 35.0% of the voting power or value of the stock will automatically be treated as a taxable REIT subsidiary. Overall, no more than 25.0% of the value of a REIT’s assets may consist of stock or securities of one or more taxable REIT subsidiaries. A domestic taxable REIT subsidiary will pay U.S. federal, state and local income tax at regular corporate rates on any income that it earns. In addition, the taxable REIT subsidiary rules limit the deductibility of interest paid or accrued by a taxable REIT subsidiary to its parent REIT to assure that the taxable REIT subsidiary is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a taxable REIT subsidiary and its parent REIT that are not conducted on an arm’s-length basis. We cannot assure our stockholders that we will be able to comply with the 25.0% value limitation on ownership of taxable REIT subsidiary stock and securities on an ongoing basis so as to maintain REIT status or to avoid application of the 100% excise tax imposed on certain non-arm’s length transactions.

We may be subject to adverse legislative or regulatory tax changes.

At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation.

Dividends payable by REITs do not qualify for the reduced tax rates.

Legislation enacted in 2003 and modified in 2005 generally reduces the maximum tax rate for dividends payable to domestic stockholders that are individuals, trusts and estates to 15.0% (through 2010). Dividends payable by REITs, however, are generally not eligible for the reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates, to perceive investments in REITs to be relatively less attractive than investments in stock of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.

 

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If the operating partnership fails to maintain its status as a partnership, its income may be subject to taxation.

We intend to maintain the status of the operating partnership as a disregarded entity or partnership for U.S. federal income tax purposes. However, if the IRS were to successfully challenge the status of the operating partnership as a disregarded entity or partnership, it would be taxable as a corporation. In such event, this would reduce the amount of distributions that the operating partnership could make to us. This would also result in our losing REIT status, and becoming subject to a corporate level tax on our own income. This would substantially reduce our cash available to pay distributions and the yield on your investment. In addition, if any of the partnerships or limited liability companies through which the operating partnership owns its properties, in whole or in part, loses its characterization as a partnership for U.S. federal income tax purposes, it would be subject to taxation as a corporation, thereby reducing distributions to the operating partnership. Such a recharacterization of an underlying property owner could also threaten our ability to maintain REIT status.

Distributions to foreign investors may be treated as an ordinary income distribution to the extent that it is made out of current or accumulated earnings and profits.

In general, foreign investors will be subject to regular U.S. federal income tax with respect to their investment in our stock if the income derived therefrom is “effectively connected” with the foreign investor’s conduct of a trade or business in the United States. A distribution to a foreign investor that is not attributable to gain realized by us from the sale or exchange of a “U.S. real property interest” within the meaning of the Foreign Investment in Real Property Tax Act of 1980, as amended (“FIRPTA”), and that we do not designate as a capital gain distribution, will be treated as an ordinary income distribution to the extent that it is made out of current or accumulated earnings and profits. Generally, any ordinary income distribution will be subject to a U.S. federal income tax equal to 30% of the gross amount of the distribution, unless this tax is reduced by the provisions of an applicable treaty. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Stockholders—Taxation of Foreign Stockholders.”

Foreign investors may be subject to FIRPTA tax upon the sale of their shares of our stock.

A foreign investor disposing of a U.S. real property interest, including shares of stock of a U.S. corporation whose assets consist principally of U.S. real property interests, is generally subject to FIRPTA, on the gain recognized on the disposition. Such FIRPTA tax does not apply, however, to the disposition of stock in a REIT if the REIT is “domestically controlled.” A REIT is “domestically controlled” if less than 50.0% of the REIT’s stock, by value, has been owned directly or indirectly by persons who are not qualifying U.S. persons during a continuous five-year period ending on the date of disposition or, if shorter, during the entire period of the REIT’s existence. While we intend to qualify as a “domestically controlled” REIT we cannot assure you that we will. If we were to fail to so qualify, gain realized by foreign investors on a sale of shares of our stock would be subject to FIRPTA tax, unless the shares of our stock were traded on an established securities market and the foreign investor did not at any time during a specified testing period directly or indirectly own more than 5.0% of the value of our outstanding common stock. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Stockholders—Taxation of Foreign Stockholders.”

 

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Foreign investors may be subject to FIRPTA tax upon the payment of a capital gains dividend.

A capital gains dividend paid to foreign investors, if attributable to gain from sales or exchanges of U.S. real property interests, would not be exempt from FIRPTA and would be subject to FIRPTA tax. See “Certain Material U.S. Federal Income Tax Considerations—Taxation of Stockholders—Taxation of Foreign Stockholders.”

We encourage you to consult your own tax advisor to determine the tax consequences applicable to you if you are a foreign investor.

Retirement Plan Risks

If the fiduciary of an employee pension benefit plan subject to ERISA (such as profit sharing, Section 401(k) or pension plan) or any other retirement plan or account fails to meet the fiduciary and other standards under ERISA or the Internal Revenue Code as a result of an investment in our stock, the fiduciary could be subject to criminal and civil penalties.

There are special considerations that apply to employee benefit plans subject to ERISA (such as profit sharing, Section 401(k) or pension plans) and other retirement plans or accounts subject to Section 4975 of the Internal Revenue Code (such as an IRA) that are investing in our shares. Fiduciaries investing the assets of such a plan or account in our common stock should satisfy themselves that:

 

   

the investment is consistent with their fiduciary obligations under ERISA and the Internal Revenue Code;

 

   

the investment is made in accordance with the documents and instruments governing the plan or IRA, including the plan’s or account’s investment policy;

 

   

the investment satisfies the prudence and diversification requirements of Sections 404(a)(1)(B) and 404(a)(1)(C) of ERISA and other applicable provisions of ERISA and the Internal Revenue Code;

 

   

the investment will not impair the liquidity of the plan or IRA;

 

   

the investment will not produce an unacceptable amount of “unrelated business taxable income” for the plan or IRA;

 

   

the value of the assets of the plan can be established annually in accordance with ERISA requirements and applicable provisions of the plan or IRA; and

 

   

the investment will not constitute a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Internal Revenue Code.

Failure to satisfy the fiduciary standards of conduct and other applicable requirements of ERISA and the Internal Revenue Code may result in the imposition of civil and criminal penalties and could subject the fiduciary to equitable remedies. In addition, if an investment in our shares constitutes a non-exempt prohibited transaction under ERISA or the Internal Revenue Code, the fiduciary who authorized or directed the investment may be subject to the imposition of excise taxes with respect to the amount invested.

 

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Prospective investors with investment discretion over the assets of an IRA, employee benefit plan or other retirement plan or arrangement that is covered by ERISA or Section 4975 of the Internal Revenue Code should carefully review the information in the section of this prospectus entitled “ERISA Considerations.” Any such prospective investors are required to consult their own legal and tax advisors on these matters.

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements about our business, including, in particular, statements about our plans, strategies and objectives. You can generally identify forward-looking statements by our use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue” or other similar words. You should not rely on these forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our actual results, performance and achievements may be materially different from that expressed or implied by these forward-looking statements.

You should carefully review the “Risk Factors” section of this prospectus for a discussion of the risks and uncertainties that we believe are material to our business, operating results, prospects and financial condition. Except as otherwise required by federal securities laws, we do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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ESTIMATED USE OF PROCEEDS

The following tables set forth information about how we intend to use the proceeds raised in this offering assuming that we sell the minimum of 250,000 shares, a mid-point range of 90,000,000 shares and the maximum of 180,000,000 shares of common stock. Many of the amounts set forth below represent management’s best estimate since they cannot be precisely calculated at this time. Depending primarily upon the number of shares we sell in this offering and assuming a $10.00 purchase price for shares sold in the primary offering, we estimate that we will use approximately 86.8% of the gross proceeds to make investments in real estate properties and other real estate-related loans and securities. We will use the remainder of the offering proceeds to pay the costs of the offering, including selling commissions and the dealer manager fee, and to pay a fee to our advisor for its services in connection with the selection and acquisition of properties. We expect to use substantially all of the net proceeds from the sale of shares under our dividend reinvestment plan to repurchase shares under our share redemption program. Though our board has the authority under our organizational documents, our distribution policy is not to use the proceeds of this offering to pay distributions.

 

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     250,000 Shares     90,000,000 Shares  
     Minimum Offering
($10.00/share)
    Primary Offering
(75,000,000 shares)
($10.00/share)
    Div. Reinv. Plan
(15,000,000 shares)
($9.50/share)
 
     $    %     $    %     $    %  

Gross Offering Proceeds

   2,500,000    100.00   750,000,000    100.00   150,000,000    100.00

Selling Commissions

   175,000    7.00   52,500,000    7.00   0    0.00

Dealer Manager Fee

   75,000    3.00   22,500,000    3.00   0    0.00

Other Organization and Offering Expenses (1)

   37,500    1.50   11,250,000    1.50   225,000    0.15
                                 

Amount available for Investment (2)

   2,212,500    88.50   663,750,000    88.50   149,775,000    99.85

Acquisition Fees (3)

   33,188    1.30   9,956,250    1.30   0    0.00

Acquisition Expenses (4)

   11,063    0.40   3,318,750    0.40   0    0.00

Amount invested in properties (5)

   2,168,250    86.80   650,475,000    86.80   149,775,000    99.85
                                 

 

     180,000,000 Shares  
     Primary Offering
(150,000,000 shares)
($10.00/share)
    Div. Reinv. Plan
(30,000,000 shares)
($9.50/share)
 
     $    %     $    %  

Gross Offering Proceeds

   1,500,000,000    100.00   300,000,000    100.00

Selling Commissions

   105,000,000    7.00   0    0.00

Dealer Manager Fee

   45,000,000    3.00   0    0.00

Other Organization and Offering Expenses (1)

   22,500,000    1.50   427,500    0.15
                      

Amount available for Investment (2)

   1,327,500,000    88.5   284,572,500    99.85

Acquisition Fees (3)

   19,912,500    1.30   0    0.00

Acquisition Expenses (4)

   6,637,500    0.40   0    0.00

Amount invested in properties (5)

   1,300,950,000    86.80   284,572,500    99.85
                      

 

 

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(1)

Includes all expenses (other than selling commissions and the dealer manager fee) to be paid by us in connection with the offering, including our legal, accounting, printing, mailing and filing fees, charges of our escrow holder and transfer agent, reimbursement to our advisor and sub-advisor for our portion of the salaries and related employment costs of our advisor’s and sub-advisor’s employees who provide services to us (excluding costs related to employees who provide services for which the advisor or sub-advisor, as applicable, receive acquisition or disposition fees), reimbursement to the dealer manager for amounts it may pay to reimburse the bona fide due diligence expenses of broker-dealers, costs in connection with preparing supplemental sales materials, our costs of conducting bona fide training and education meetings held by us (primarily the travel, meal and lodging costs of non-registered officers of the company, our advisor and sub-advisor to attend such meetings) and cost reimbursement for non-registered employees of our affiliates to attend retail seminars conducted by broker-dealers. Our advisor has agreed to reimburse us to the extent the organization and offering expenses incurred by us exceed 1.5% of aggregate gross offering proceeds over the life of the offering. See “Plan of Distribution.” In addition, other organization and offering expenses shall include up to 0.5% for third-party due diligence fees included in a detailed and itemized invoice.

(2)

Until required in connection with investment in real properties or other real estate-related assets, substantially all of the net proceeds of the offering and, thereafter, our working capital reserves, may be invested in short-term, highly liquid investments, including government obligations, bank certificates of deposit, short-term debt obligations and interest-bearing accounts or other authorized investments as determined by our board of directors.

(3)

This table assumes that we will use all net proceeds from the sale of shares under our dividend reinvestment plan to repurchase shares under our share redemption program rather than for investments in real estate and real estate-related investments. To the extent we use such net proceeds to invest in real estate and real estate-related loans and securities, our advisor or its subsidiary would earn the related acquisition fees. We will pay our advisor an acquisition fee equal to 1.5% of the cost of the investment acquired or originated by us, including acquisition expenses and any debt attributable to such investment. We may also incur customary third-party acquisition expenses in connection with the acquisition (or attempted acquisition) of a property or real estate-related asset. See note 3 below.

     This table excludes debt proceeds. To the extent we fund our investments with debt, as we expect, the amount available for investment and the amount of acquisition fees will be proportionately greater. If we raise the maximum offering amount and our debt financing is equal to 65.0% of the value of our real estate investments, then acquisition fees would be approximately $56.9 million.
(4)

Acquisition expenses include legal fees and expenses, travel and communications expenses, costs of appraisals, accounting fees and expenses, title insurance premiums and other closing costs and miscellaneous expenses relating to the selection, evaluation and acquisition of real estate properties, whether or not acquired. For purposes of this table, we have assumed expenses of 0.5% of the purchase price of each property (including our pro rata share of debt attributable to such property) and 0.5% of the amount advanced for a loan or other investment (including our pro rate share of debt attributable to such investment); however, expenses on a particular acquisition may be higher. Acquisition fees and expenses for any particular property will not exceed 6.0% of the contract purchase price of each property (including our pro rata share of debt attributable to such property) or 6.0% of the amount advanced for a loan or other investment (including our pro rata share of debt attributable to such investment).

(5)

Amount available for investment will include customary third-party acquisition expenses, such as legal fees and expenses, costs of appraisals, accounting fees and expenses, title insurance premiums and other closing costs and miscellaneous expenses relating to the acquisition or origination of real estate and real estate-related investments. Includes amounts anticipated to be invested in properties net of fees, expenses and initial working capital reserves. Amount available for investment may also include anticipated capital improvement expenditures and tenant leasing costs.

     Because we expect that the vast majority of leases for the properties acquired by us will provide for tenant reimbursement of operating expenses, we do not anticipate that a permanent reserve for maintenance and repairs of real estate properties will be established. If established, we expect any working capital reserves to be maintained at the property level. However, to the extent that we have insufficient funds for such purposes, we may establish reserves from gross offering proceeds, out of cash flow generated by operating properties or out of the net cash proceeds received by us from any sale or exchange of properties.

 

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MARKET OPPORTUNITY

We are focused on providing an investment vehicle that will allow our shareholders to take advantage of this opportunity to participate in a carefully selected and professionally managed retail real estate portfolio.

Our investment goals are to acquire a portfolio of neighborhood and community shopping centers with one or more of the following attributes:

 

   

Well-located shopping centers in more densely populated growth markets in the United States;

 

   

Necessity-based retail typically with 80% or greater occupancy;

 

   

Diversified portfolio of anchor tenants, geographic locations, tenant mix, and lease expirations;

 

   

Purchased at a discount to replacement cost with potential for appreciation;

 

   

Financed at a target leverage of not more than 50% loan to value of the portfolio (calculated once we have invested substantially all of the proceeds from this offering);

 

   

Generating monthly distributions covered by funds from operations (FFO); and

 

   

Maximizing total returns through property focus and exit strategy.

The Opportunity

We will invest primarily in well-occupied shopping centers with a mix of national, regional, and local retailers who sell essential goods and services to customers living in the local trade area. These centers will be well-located in more densely populated neighborhoods in the United States, where there are few opportunities for competing shopping centers to enter the market. We will be selective and prudent in investing capital and focus on acquiring higher quality assets with strong anchors in established or growing markets.

We expect to acquire centers where significant opportunities exist to create value through leasing and intensive property management. We believe our advisor’s and sub-advisor’s careful selection and professional management of the shopping centers will allow us to maintain and enhance each property’s financial performance.

We have a seasoned real estate team with experience in acquiring and managing retail properties through all market cycles. We believe that our team’s real estate experience and established network of owners and brokers, combined with what we believe will be an increase in the supply of available shopping center properties meeting our investment criteria, will allow us to acquire assets at a discount to replacement cost.

 

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Established Sourcing Network

Our Phillips Edison sponsor is nationally recognized as one of the largest private owners of grocer-anchored shopping centers in the country. Over the last 18 years, they have acquired over 250 shopping centers through their national, regional and local network of relationships with real estate brokers and existing owners of shopping centers (including individuals, REITs, insurance companies, and other institutional direct owners of real estate). We believe this direct access to a continuous source of investment opportunities, not available to smaller, regional operators, allows us to see nearly all of the marketed opportunities available for sale, as well as a substantial number of off-market deals.

Our Phillips Edison sponsor’s reputation has been established through its acquisition history, consistent presence in the market and relationships with owners and brokers. Our Phillips Edison sponsor’s person-to-person marketing program provides continuous communication and market presence with owners and brokers. The program includes face-to-face meetings at owners’ and brokers’ offices, frequent telephone contact, networking at national and regional industry conferences, quarterly e-blasts to over 90,000 shopping center professionals and e-postcards sent to our proprietary database of over 6,500 accounts with 10,000 contacts.

Volume of Opportunities

We believe our investment strategy is well suited for the current real estate environment. We believe there is a window of opportunity that has been created as a result of events in the economy and the capital markets. This market dislocation is creating buying opportunities not seen since the early 1990s. As the economy and capital markets normalize, we expect a steady volume of acquisition opportunities meeting our investment criteria to appear. We believe several factors contribute to the anticipated volume of properties for acquisition, including:

 

   

We believe many owners of retail real estate are in distress as a result of debt maturities, are unable to cover their debt service obligations or are incapable of refinancing due to lender demands to resize their loans and are facing increasing pressure to sell.

 

   

We believe commercial banks, lenders, loan servicers of commercial mortgage-backed securities are culling their portfolios of assets. We expect banks will need to realize the losses from the distressed commercial real estate mortgages on their balance sheets. With current bank earnings quite strong, we believe they will begin to realize these losses by selling assets to manage to a smoother income stream.

 

   

The ownership of the more than 100,000 shopping centers in the United States is quite fragmented: only 6,783, or 6.6% are owned by the top 20 property owners (as illustrated in the chart below). This fragmentation of the retail shopping center industry has contributed to the long history of a healthy trading volume of shopping centers.

 

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LOGO

Source: ICSC Research (Apr 09), Retail Traffic (Apr 09)

Retail Outperforms other Real Estate

According to ICSC Research, the retail shopping center industry is comprised of over 100,000 retail shopping centers making retail one of the largest industries in the United States. The retail shopping center industry generates 12.6 million jobs and accounts for approximately 9.5% of the entire U.S. workforce which makes it an important segment of the economy and an important venue for retail commerce. In comparison to other investments, real estate has historically outperformed the S&P 500 during months leading up to and after the three recent recessions. Furthermore, when comparing the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index (NPI) average annual returns of the four real estate sectors (retail, apartment, office, and industrial), retail real estate has generally outperformed the other real estate sectors during periods of recession and the following years.

The NPI is an unmanaged, market-weighted index of non-traded, unleveraged properties owned by tax exempt entities. NCREIF was established to serve the institutional real estate investment community as a non-partisan collector, processor, validator and disseminator of real estate performance information. NCREIF members are not traded on any public exchange. This means that NCREIF members and their investors are less susceptible to severe market movements. Not being listed on an exchange aligns management and the investors’ incentives to view the investment over a longer investment horizon. NCREIF includes dividends.

The value of the NPI is computed as follows: NCREIF requires that properties included in the NPI be valued at least quarterly, either internally or externally, using standard commercial real estate appraisal methodology. Each property must be independently appraised a minimum of once every three years. The value of the capital component of the NPI return is predominately the product of the real property appraisals discussed below. In addition, property income results are reported quarterly for purposes of determining the income component of the index.

The qualifications for valuation of investments in the NPI are:

 

   

Operating properties only;

 

   

Property types—apartments, hotels, industrial properties, office buildings, and retail only;

 

   

Can be wholly owned or in a joint venture structure;

 

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Investment returns are reported on a non-leveraged basis. While there are properties in the index that have leverage, returns are reported to NCREIF as if there is no leverage;

 

   

Must be owned/controlled by a qualified tax-exempt institutional investor or its designated agent;

 

   

Existing properties only (no development projects);

 

   

Calculations are based on quarterly returns of individual properties before deduction of asset management fees;

 

   

Each property’s return is weighted by its market value;

 

   

Income and Capital Appreciation changes are also calculated;

 

   

The NPI is a quarterly time series composite total rate of return measure of investment performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only. All properties in the NPI have been acquired, at least in part, on behalf of tax-exempt institutional investors—the great majority being pension funds. As such, all properties are held in a fiduciary environment;

 

   

Properties in the NPI are accounted for using market value accounting standards. Data contributed to NCREIF is expected to comply with the Regional Economic Information System (REIS, Inc.). Because the NPI measures performance at the property level without considering investment or capital structure arrangements, information reported to the index will be different from information reported to investors. For example, interest expense reported to investors would not be included in the NPI. However, because the property information reported to the index is expected to be derived from the same underlying books and records, because it is expected to form the underlying basis for investor reporting, and because accounting methods are required to be consistent, fundamentally consistent information expectations exist;

 

   

NCREIF requires that properties included in the NPI be valued at least quarterly, either internally or externally, using standard commercial real estate appraisal methodology. Each property must be independently appraised a minimum of once every three years; and

 

   

Because the NPI is a measure of private market real estate performance, the capital value component of return is predominately the product of property appraisals. As such, the NPI is often referred to as an “appraisal based index.”

Shareholders should not expect the same performance as the NPI because the NPI does not factor in the fees or expenses to which we are subject.

 

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LOGO

Discount to Replacement Cost

Average rental rates have been falling during the most recent recession resulting in lower property values and pricing. In the current acquisition environment, we believe we will be able to acquire properties at values based on current rents which are at a substantial discount to replacement cost and have significant potential for appreciation.

The Portfolio

Once we have substantially invested all of the proceeds of this offering, we expect to have a well-diversified portfolio based upon tenants, geographic locations, tenant mix, and lease expirations. We will target properties in more densely populated locations with established or growing markets and higher barriers to entry. We expect that the properties we acquire will be well-occupied shopping centers that focus on serving the day-to-day needs of the community in the surrounding trade area. Grocers and other necessity-based retailers who supply these goods and services have historically been more resistant to economic fluctuations due to the nature of the goods and services they sell.

Diversified Portfolio

We expect to acquire a well diversified portfolio of properties based on geography, anchor tenant diversity, tenant mix, lease expirations, and other factors. A diversified portfolio reduces the economic risk of any one geographic or tenant-related event to impact the cash flow or value of the portfolio. As the map shows below, our Phillips Edison sponsor’s current portfolio is located in 35 states and has over 3,100 tenants. As of this offering, no one retailer accounts for more than 4.0% of the annual minimum rent of the portfolio. There is no guarantee that our portfolio, once we have invested substantially all of the proceeds of this offering, will be as well diversified geographically or by tenant concentration.

 

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LOGO

Necessity Based Retail

We will invest primarily in well-occupied shopping centers with a mix of national, regional, and local retailers who sell essential goods and services to the population living in the local trade area. Unlike industries that are routinely affected by cyclical fluctuations in the economy, the grocery and necessity-based retail shopping center industry has been more resistant to economic downturns.

LOGO

SOURCE: U.S. Census Bureau, December 2009

Grocery- and necessity-anchored shopping centers are tenanted by retailers that provide goods and services necessary for daily life. Many of these retailers also offer products or services that appeal to consumers trying to save money. Items such as food, postal services, discount merchandise, hardware and personal services tend to be required through both economic peaks and troughs and create consistent

 

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consumer demand. Even in the current economic environment, many necessity-based retailers have continued to experience same store sales growth.

Due to the resilience of this retail sector, many necessity and discount-retailers have survived the recent recession. We believe these retailers have right-sized and have re-emerged leaner, nimbler and tailored to the new realities. Many of them have strong balance sheets and are expanding in order to take market share from weaker competitors.

In-Fill Locations

As the economy recovers, we expect more industry-wide competition for the finite supply of quality space. In the aggregate, the number of shopping centers has been growing more slowly. Benchmarked against population, total shopping center gross leasable area (GLA) per capita growth declined in 2009. New developments are being cancelled or delayed indefinitely creating a three- to five-year lag in new construction. We believe this lack of new center development is pushing retailers towards existing centers.

LOGO

The supply fundamentals for infill grocery anchored retail locations are in line with retail demand because grocers and other necessity-based retailers did not over-expand in recent years. These retailers are now benefiting from weaker competition and are expanding selectively. Well-positioned grocery anchored centers are attracting other stronger and expanding tenants. We believe these centers will benefit with increased property values as the economy rebounds and rents increase. We will focus our acquisition efforts on locations in established or growing retail markets in more densely populated locations. These in-fill locations have higher barriers to entry with few opportunities for competing shopping centers to enter the market.

 

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MANAGEMENT

Board of Directors

We operate under the direction of our board of directors, the members of which are accountable to us and our stockholders as fiduciaries. The board is responsible for the management and control of our affairs. The board has retained ARC Advisor to manage our operations and our portfolio of real estate properties and real estate-related loans and securities, subject to the board’s supervision. ARC Advisor has entered into a sub-advisory agreement with Phillips Edison Sub-Advisor in which the sub-advisor will manage our day-to-day activities, among other duties. Because of the conflicts of interest created by the relationships among us, our sponsors, ARC Advisor, Phillips Edison Sub-Advisor and their respective affiliates, many of the responsibilities of the board have been delegated to a committee that consists solely of independent directors. This committee is the conflicts committee and is discussed below and under “Conflicts of Interest.”

We will have four independent directors. An “independent director” is a person who is not one of our officers or employees or an officer or employee of one of our sponsors or their respective affiliates and has not been so for the previous two years. Our independent directors will also meet the director independence standards of the New York Stock Exchange, Inc.

Each director serves until the next annual meeting of stockholders and until his successor has been duly elected and qualified. The presence in person or by proxy of stockholders entitled to cast 50.0% of all the votes entitled to be cast at any stockholder meeting constitutes a quorum. With respect to the election of directors, each candidate nominated for election to the board of directors must receive a majority of the votes present, in person or by proxy, in order to be elected. Therefore, if a nominee receives fewer “for” votes than “withhold” votes in an election, then the nominee will not be elected.

Although our board of directors may increase or decrease the number of directors, a decrease may not have the effect of shortening the term of any incumbent director. Any director may resign at any time or may be removed with or without cause by the stockholders upon the affirmative vote of at least a majority of all the votes entitled to be cast at a meeting called for the purpose of the proposed removal. The notice of the meeting will indicate that the purpose, or one of the purposes, of the meeting is to determine if the director shall be removed.

Unless otherwise provided by Maryland law, the board of directors is responsible for selecting its own nominees and recommending them for election by the stockholders, provided that the conflicts committee nominates replacements for any vacancies among the independent director positions. A vacancy on the board of directors for any cause will be filled by a majority of the remaining directors, even if such majority is less than a quorum, except that, until we have a class of equity securities registered under the Securities Exchange Act of 1934, as amended, a vacancy that results from the removal of a director may also be filled by a vote of the stockholders.

Our directors are accountable to us and our stockholders as fiduciaries. This means that our directors must perform their duties in good faith and in a manner each director believes to be in our and our stockholders’ best interests. Further, our directors must act with such care as a prudent person in a similar position would use under similar circumstances, including exercising reasonable inquiry when taking actions. However, our directors and executive officers are not required to devote all of their time to our business and must only devote such time to our affairs as their duties may require. We do not expect that our directors will be required to devote a substantial portion of their time to us in discharging their duties.

 

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In addition to meetings of the various committees of the board, which committees we describe below, we expect our directors to hold at least four regular board meetings each year. Our board has the authority to fix the compensation of all officers that it selects and may pay compensation to directors for services rendered to us in any other capacity.

Our general investment and borrowing policies are set forth in this prospectus. Our directors may establish further written policies on investments and borrowings and monitor our administrative procedures, investment operations and performance to ensure that our executive officers and advisor follow these policies and that these policies continue to be in the best interests of our stockholders. Unless modified by our directors, we will follow the policies on investments and borrowings set forth in this prospectus.

Committees of the Board of Directors

Our board of directors may delegate many of its powers to one or more committees. Our charter requires that each committee consist of at least a majority of independent directors, and our board has two committees, the audit committee and the conflicts committee, that consist solely of independent directors.

Audit Committee

Our board of directors has established an audit committee that consists solely of independent directors. The audit committee will assist the board in overseeing:

 

   

our accounting and financial reporting processes;

 

   

the integrity and audits of our financial statements;

 

   

our compliance with legal and regulatory requirements;

 

   

the qualifications and independence of our independent auditors; and

 

   

the performance of our internal and independent auditors.

The audit committee will select the independent public accountants to audit our annual financial statements, will review with the independent public accountants the plans and results of the audit engagement and will consider and approve the audit and non-audit services and fees provided by the independent public accountants. The members of the audit committee are             ,              and             .

Conflicts Committee

In order to reduce or eliminate certain potential conflicts of interest, our charter creates a conflicts committee of our board of directors consisting solely of all of our independent directors, that is, all of our directors who are not affiliated with our sponsors or their respective affiliates. Our charter authorizes the conflicts committee to act on any matter permitted under Maryland law. Both the board of directors and the conflicts committee must act upon those conflict-of-interest matters that cannot be delegated to a committee under Maryland law. Our charter also empowers the conflicts committee to retain its own legal and financial advisors. See “Conflicts of Interest—Certain Conflict Resolution Measures.”

Our charter requires that the conflicts committee discharge the board’s responsibilities relating to the nomination of independent directors and the compensation of our independent directors. Our conflicts

 

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committee also will discharge the board’s responsibilities relating to the compensation of our executives. Subject to the limitations in our charter and with stockholder approval, the conflicts committee may also create stock-award plans.

Executive Officers and Directors

We have provided below certain information about our executive officers and directors.

 

Name

   Age*        

Positions

Michael C. Phillips

   55       Co-Chairman of the Board

Jeffrey S. Edison

   49       Co-Chairman of the Board

John Bessey

   52       President

William M. Kahane

   61       Director

**

         Independent Director Nominee

**

         Independent Director Nominee

**

         Independent Director Nominee

**

         Independent Director Nominee

 

* As of January 12, 2010
** To be named by amendment

Michael C. Phillips – (Co-Chairman of the Board) Mr. Phillips has served as a principal of Phillips Edison since 1991. Prior to forming Phillips Edison, Mr. Phillips was employed by Biggs Hypershoppes, Inc. as Vice President from 1989 until 1990, by May Centers as Senior Development Director from 1988 until 1989, and by The Taubman Company as Development Director from 1986 until 1988 and as a leasing agent from 1984 until 1986. Mr. Phillips received his bachelor’s degree in political science in 1977 from the University of Southern California.

Jeffrey S. Edison – (Co-Chairman of the Board and Chief Executive Officer) Mr. Edison, together with Michael C. Phillips, founded Phillips Edison in 1991 and has served as a principal of Phillips Edison since 1995. From 1991 to 1995, Mr. Edison was employed by Nations Bank’s South Charles Realty Corporation, serving as a Senior Vice President from 1993 until 1995 and as a Vice President from 1991 until 1993. Mr. Edison was employed by Morgan Stanley Realty Incorporated from 1987 until 1990 and The Taubman Company from 1984 until 1987. Mr. Edison received his bachelor’s degree in mathematics and economics from Colgate University in 1982 and a masters in business administration from Harvard Business School in 1984.

John Bessey(President) Mr. Bessey has served as Chief Investment Officer for Phillips Edison since December 2005. During that time he has managed the placement of over $1.2 billion in 140 individual shopping centers comprising over 14,000,000 square feet. Prior to that, he served Phillips Edison as Vice President of Development from May 1999 starting the ground up development program for the company. During that time he started and completed over 25 projects which included Walgreen’s, Target, Kroger, Winn Dixie, Safeway and Wal-Mart. Prior to joining Phillips Edison, Mr. Bessey was employed by Kimco Realty Corporation as a Director of Leasing from 1995, by Koll Management Services as Director of Retail Leasing and Development from 1991 and by Tipton Associates as Leasing Manager from 1988. Prior to entering retail real estate in 1988, Mr. Bessey worked in the hospitality industry as a Convention Sales Director for the Cincinnati Convention and Visitors Bureau and for Hyatt Hotels in a number of sales management positions in Minneapolis and Cincinnati. Mr. Bessey received his Bachelor’s Degree in Hotel and Restaurant Management from the University of Wisconsin – Stout in 1981.

William M. Kahane – (Director) Mr. Kahane has served as President, Chief Operating Officer and Treasurer of American Realty Capital Trust, Inc. since its formation. He has been active in the

 

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structuring and financial management of commercial real estate investments for over 25 years. He is also President, Chief Operating Officer and Treasurer of American Realty Capital Properties, LLC. Mr. Kahane began his career as a real estate lawyer practicing in the public and private sectors from 1974 – 1979. From 1981 – 1992 Mr. Kahane worked at Morgan Stanley & Co., specializing in real estate, becoming a Managing Director in 1989. In 1992, Mr. Kahane left Morgan Stanley to establish a real estate advisory and asset sales business known as Milestone Partners which continues to operate and of which Mr. Kahane is currently the Chairman. From 2003 to 2006, Mr. Kahane was a trustee at American Financial Realty Trust, during which time Mr. Kahane served as Chairman of the Finance Committee of the Board of Trustees. Mr. Kahane has been a Managing Director of GF Capital Management & Advisors LLC, a New York based merchant banking firm, where he directs the firm’s real estate investments since 2001. GF Capital offers comprehensive wealth management services through its subsidiary TAG Associates LLC, a leading multi-client family office and portfolio management services company with approximately $5.0 billion of assets under management. Mr. Kahane also was on the Board of Directors of Catellus Development Corp., an NYSE growth-oriented real estate development company, where he served as Chairman.

Compensation of Directors

We compensate each of our independent directors with an annual retainer of $30,000. In addition, we pay independent directors for attending board and committee meetings as follows:

 

   

$1,000 in cash for each board meeting attended in person or telephonically.

 

   

$1,000 in cash for each committee meeting attended in person or telephonically.

In addition, the audit committee chair will receive an annual retainer of $5,000 and the conflicts committee chair an annual award of $3,000. All directors will receive reimbursement of reasonable out-of-pocket expenses incurred in connection with attendance at meetings of the board of directors. If a director is also one of our officers, we will not pay any compensation for services rendered as a director.

2010 Independent Director Stock Plan

We have adopted a long-term incentive plan that we will use to attract and retain qualified directors. Our 2010 Independent Director Stock Plan (the “Independent Director Plan”) offers these individuals an opportunity to participate in our growth through awards of shares of restricted common stock subject to time-based vesting. We expect to grant our independent directors an annual award of 2,500 shares of restricted stock.

Our board of directors or a committee appointed by the board of directors will administer the Independent Director Plan, with sole authority to determine all of the terms and conditions of the awards. No awards will be granted under the Independent Director Plan if the grant or vesting of the awards would jeopardize our status as a REIT under the Internal Revenue Code or otherwise violate the ownership and transfer restrictions imposed under our charter. Unless otherwise determined by our board of directors, no award granted under the Independent Director Plan will be transferable except through the laws of descent and distribution.

We have reserved                      shares for issuance under the Independent Director Plan. In the event of a transaction between our company and our stockholders that causes the per-share value of our common stock to change (including, without limitation, any stock dividend, stock split, spin-off, rights offering or large nonrecurring cash dividend), the share authorization limits under the Independent Director Plan will be adjusted proportionately and the board of directors will make such adjustments to

 

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the Independent Director Plan and awards as it deems necessary, in its sole discretion, to prevent dilution or enlargement of rights immediately resulting from such transaction. In the event of a stock split, a stock dividend or a combination or consolidation of the outstanding shares of common stock into a lesser number of shares, the authorization limits under the Independent Director Plan will automatically be adjusted proportionately and the shares then subject to each award will automatically be adjusted proportionately without any change in the aggregate purchase price.

Unless otherwise provided in an award certificate or any special plan document governing an award, upon the termination of a participant’s service due to death or disability, all time-based vesting restrictions on his or her outstanding shares of restricted stock will lapse as of the date of termination. Unless otherwise provided in an award certificate or any special plan document governing an award, upon the occurrence of a change in our control, all time-based vesting restrictions on outstanding shares of restricted stock will lapse.

Our board of directors may in its sole discretion at any time determine that all or a part of a director’s time-based vesting restrictions on all or a portion of a director’s outstanding shares of restricted stock will lapse, as of such date as the board may, in its sole discretion, declare. Our board may discriminate among participants or among awards in exercising such discretion.

The Independent Director Plan will automatically expire on the tenth anniversary of the date on which it is approved by our board of directors and stockholders, unless extended or earlier terminated by the board of directors. The board of directors may terminate the Independent Director Plan at any time. The expiration or other termination of the Independent Director Plan will not, without the participants’ consent, have an adverse impact on any award that is outstanding at the time the Independent Director Plan expires or is terminated. The board of directors may amend the Independent Director Plan at any time, but no amendment will adversely affect any award without the participant’s consent and no amendment to the Independent Director Plan will be effective without the approval of our stockholders if such approval is required by any law, regulation or rule applicable to the Independent Director Plan.

Limited Liability and Indemnification of Directors, Officers, Employees and Other Agents

Our charter limits the liability of our directors and officers to us and our stockholders for monetary damages and requires us to indemnify our directors, officers, ARC Advisor or Phillips Edison Sub-Advisor and their respective affiliates for losses they may incur by reason of their service in that capacity if all of the following conditions are met:

 

   

the party seeking exculpation or indemnification has determined, in good faith, that the course of conduct that caused the loss or liability was in our best interests;

 

   

the party seeking exculpation or indemnification was acting on our behalf or performing services for us;

 

   

in the case of an independent director, the liability or loss was not the result of gross negligence or willful misconduct by the independent director;

 

   

in the case of a non-independent director, ARC Advisor or Phillips Edison Sub-Advisor or one of their respective affiliates, the liability or loss was not the result of negligence or misconduct by the party seeking exculpation or indemnification; and

 

   

the indemnification is recoverable only out of our net assets and not from the stockholders.

 

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The SEC takes the position that indemnification against liabilities arising under the Securities Act of 1933 is against public policy and unenforceable. Furthermore, our charter prohibits the indemnification of our directors, ARC Advisor or Phillips Edison Sub-Advisor, their respective affiliates or any person acting as a broker-dealer for liabilities arising from or out of a violation of state or federal securities laws, unless one or more of the following conditions are met:

 

   

there has been a successful adjudication on the merits of each count involving alleged securities law violations;

 

   

such claims have been dismissed with prejudice on the merits by a court of competent jurisdiction; or

 

   

a court of competent jurisdiction approves a settlement of the claims against the indemnitee and finds that indemnification of the settlement and the related costs should be made, and the court considering the request for indemnification has been advised of the position of the SEC and of the published position of any state securities regulatory authority in which the securities were offered as to indemnification for violations of securities laws.

Our charter further provides that the advancement of funds to our directors and to ARC Advisor or Phillips Edison Sub-Advisor and their respective affiliates for reasonable legal expenses and other costs incurred in advance of the final disposition of a proceeding for which indemnification is being sought is permissible only if all of the following conditions are satisfied:

 

   

the proceeding relates to acts or omissions with respect to the performance of duties or services on our behalf;

 

   

the person seeking the advancement affirms in writing a good faith belief of having met the standard of conduct necessary for indemnification;

 

   

the legal proceeding was initiated by a third party who is not a stockholder or, if by a stockholder acting in his or her capacity as such, a court of competent jurisdiction approves such advancement; and

 

   

the person seeking the advancement undertakes to repay the amount paid or reimbursed by us, together with the applicable legal rate of interest thereon, if it is ultimately determined that such person is not entitled to indemnification.

We will have also purchased and will maintain insurance on behalf of all of our directors and officers against liability asserted against or incurred by them in their official capacities with us, whether or not we are required or have the power to indemnify them against the same liability.

Our Advisor and Sub-advisor

Our advisor is ARC Advisor. ARC Advisor is a newly organized limited liability company that was formed in the State of Delaware on December 28, 2009. Our advisor has no operating history and no experience managing a public company. As our advisor, ARC Advisor has contractual and fiduciary responsibilities to us and our stockholders.

Several of the key real estate professionals at ARC Advisor are also our individual ARC sponsors. Mr. Kahane is also a member of our board of directors. For more information regarding the background and experience of Mr. Kahane see “Management—Executive Officers and Directors.” For

 

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more information about the background and experience of the key real estate professionals at ARC Advisor who are not also one of our executive officers or directors, see “—Our Sponsors—Our ARC Sponsors.”

The Advisory Agreement

Under the terms of the advisory agreement, ARC Advisor will use its reasonable best efforts to present to us investment opportunities that provide a continuing and suitable investment program for us consistent with our investment policies and objectives as adopted by our board of directors. Pursuant to the advisory agreement, ARC Advisor will ultimately be responsible for the management of our day-to-day operations, retain the property managers for our property investments (subject to the authority of our board of directors and officers) and perform other duties, including, but not limited to, the following:

 

   

finding, presenting and recommending to us real estate property and real estate-related investment opportunities consistent with our investment policies and objectives;

 

   

structuring the terms and conditions of our investments, sales and joint ventures;

 

   

acquiring properties and other investments on our behalf in compliance with our investment objectives and policies;

 

   

sourcing and structuring our loan originations;

 

   

arranging for financing and refinancing of properties and our other investments;

 

   

entering into leases and service contracts for our properties;

 

   

supervising and evaluating each property manager’s performance;

 

   

reviewing and analyzing the properties’ operating and capital budgets;

 

   

assisting us in obtaining insurance;

 

   

generating an annual budget for us;

 

   

reviewing and analyzing financial information for each of our assets and the overall portfolio;

 

   

formulating and overseeing the implementation of strategies for the administration, promotion, management, operation, maintenance, improvement, financing and refinancing, marketing, leasing and disposition of our properties and other investments;

 

   

performing investor-relations services;

 

   

maintaining our accounting and other records and assisting us in filing all reports required to be filed with the SEC, the IRS and other regulatory agencies;

 

   

engaging and supervising the performance of our agents, including our registrar and transfer agent; and

 

   

performing any other services reasonably requested by us.

 

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See “Compensation Table” for a detailed discussion of the fees payable to ARC Advisor under the advisory agreement. We also describe in that section our obligation to reimburse ARC Advisor and our sub-advisor for organization and offering expenses, the costs of providing services to us (other than for services for which it earns acquisition or disposition fees for sales of properties or other investments) and payments made by ARC Advisor in connection with potential investments, whether or not we ultimately acquire or originate the investment.

The advisory agreement has a one-year term but may be renewed for an unlimited number of successive one-year periods upon the mutual consent of ARC Advisor and us. Additionally, either party may terminate the advisory agreement without penalty upon 60 days’ written notice and, in such event, ARC Advisor must cooperate with us and our directors in making an orderly transition of the advisory function.

Upon termination of the advisory agreement, our advisor shall be entitled to a subordinated termination fee. The subordinated termination fee, if any, will equal to the sum of (a) 15.0% of the amount, if any, by which (1) the fair market value of our assets on the termination date, less any indebtedness secured by such assets, plus total distributions paid through the termination date (excluding stock dividends and distributions paid on redeemed shares), exceeds (2) the sum of the total amount of capital raised from stockholders (less amounts paid to repurchase shares of our common stock pursuant to our share repurchase plan) and the total amount of cash that, if distributed to them as of the termination date, would have provided them an annual 7.0% cumulative, non-compounded return on the gross proceeds from the sale of shares of our common stock through the termination date, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor or its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties). In addition, our advisor may elect to defer its right to receive a subordinated termination fee until either a listing or other liquidity event occurs, including a liquidation, sale of substantially all of our assets or merger in which our stockholders receive in exchange for their shares of our common stock shares of a company that are traded on a national securities exchange.

If our advisor elects to defer its right to receive a subordinated termination fee and there is a listing of the shares of our common stock on a national securities exchange or a merger in which our stockholders receive in exchange for their shares of our common stock shares of a company that are traded on a national securities exchange, then our advisor will be entitled to receive a subordinated termination fee in an amount equal to 15.0% of the amount, if any, by which the sum of (a) (1) the fair market value of our assets (determined as of the listing date or merger date, as applicable) owned as of the termination of the advisory agreement, plus any assets acquired after such termination for which our advisor would have been entitled to receive an acquisition fee (referred to herein as the “included assets”) less any indebtedness secured by these assets, plus the cumulative distributions made by our operating partnership to us and the limited partners who received partnership units in connection with the acquisition of the included assets, from our inception through the listing date or merger date, as applicable, exceeds (2) the sum of the total amount of capital raised from stockholders and the capital value of partnership units issued in connection with the acquisition of the included assets through the listing date or merger date, as applicable (excluding any capital raised after the completion of this offering) (less amounts paid to repurchase shares of our common stock pursuant to our share repurchase plan), plus an amount equal to an annual 7.0% cumulative, non-compounded return on the total amount of capital raised from shareholders and the capital value of such partnership units measured for the period from inception through the listing date or merger date, as applicable, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor or its

 

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affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties).

If our advisor elects to defer its right to receive a subordinated termination fee and there is a liquidation or sale of all or substantially all of the assets of the operating partnership, then our advisor will be entitled to receive a subordinated termination fee in an amount equal to the sum of (a) 15.0% of the net proceeds from the sale of our assets owned as of the termination of the advisory agreement and the included assets, after subtracting the sum of (1) the total amount of capital raised from stockholders and the capital value of partnership units issued in connection with the acquisition of the included assets through the date of the liquidity event plus (2) an amount equal to an annual 7.0% cumulative, non-compounded return on such initial invested capital and the capital value of such partnership units measured for the period from inception through the date of the liquidity event date, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor or its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties). If our advisor receives the subordinated incentive fee, it would no longer be entitled to receive subordinated distributions of net sales proceeds or the subordinated termination fee. If our advisor receives the subordinated termination fee, it would no longer be entitled to receive subordinated distributions of net sales proceeds or the subordinated incentive fee. There are many additional conditions and restrictions on the amount of compensation our advisor and its affiliates may receive.

ARC Advisor and its affiliates engage in other business ventures, and, as a result, they will not dedicate their resources exclusively to our business. However, pursuant to the advisory agreement, ARC Advisor must devote sufficient resources to our business to discharge its obligations to us. ARC Advisor may assign the advisory agreement to an affiliate upon our approval. We may assign or transfer the advisory agreement to a successor entity.

The Sub-advisor

Subject to the terms of the advisory agreement between ARC Advisor and us, ARC Advisor will delegate its advisory duties to a sub-advisor, Phillips Edison Sub-Advisor, which is an indirect, wholly-owned subsidiary of Phillips Edison, one of our sponsors. The sub-advisor will agree to perform the duties of the Advisor as set forth in the Advisory Agreement. Notwithstanding such delegation to the sub-advisor, ARC Advisor retains ultimate responsibility for the performance of all the matters entrusted to it under the advisory agreement.

A portion of the compensation received by ARC Advisor pursuant to the advisory agreement is assigned and distributed to the sub-advisor in accordance with the terms of the sub-advisory agreement.

Based on these determinations, investment recommendations are made by our advisor or sub-advisor to our board of directors and our board of directors, or a majority of the conflicts committee that constitutes a majority of our board of directors, approves all proposed investments.

The advisor and sub-advisor have also agreed that, notwithstanding the delegation of the advisor’s responsibilities to the sub-advisor as described above, certain major decisions will be subject to joint approval of the advisor and sub-advisor. Those major decisions include: (1) decisions to recommend to the Board of Directors that the Company acquire or sell assets; (2) retaining investment banks for the

 

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Company; (3) marketing methods for the Company’s sale of its Shares; (4) extending, initiating or terminating this offering or any subsequent offering of the Company’s Shares; (5) issuing certain press releases; and (6) merging or otherwise engaging in any change of control transaction for the Company. Even though joint approval of the above decisions is required, in all cases the Company’s Board of Directors will need to approve such decisions, as well.

However, if there is a disagreement with respect to decisions to recommend to the Board of Directors asset acquisitions or dispositions, then (1) joint approval will not be required, (2) the sub-advisor and the advisor must discuss the proposed transaction before either party makes any recommendation of the proposed transaction to the Board of Directors, and (3) the sub-advisor and the advisor will each give due consideration to the opinions of the other party. If the parties cannot agree as to whether to recommend the proposed transaction to the Board of Directors, the sub-advisor’s decision will govern.

Initial and Continuing Investment by Our Sub-advisor

Our sponsors have invested $200,000 in us through the purchase of 20,000 shares of our common stock at $10.00 per share. Phillips Edison Sub-Advisor is the owner of these 20,000 shares. As of the date of this prospectus, this constitutes 100% of our issued and outstanding stock. Phillips Edison Sub-Advisor has agreed to purchase on a monthly basis 0.10% of the shares sold in this offering at a purchase price of $9.00 per share. Phillips Edison Sub-Advisor may not sell any of these shares during the period it serves as our sub-advisor. Although nothing prohibits Phillips Edison Sub-Advisor or its affiliates from acquiring additional shares of our common stock, Phillips Edison Sub-Advisor currently has no options or warrants to acquire any shares.

Voting Obligations of the Advisor and Sub-Advisor

Phillips Edison Sub-Advisor has agreed to abstain from voting any shares it acquires in any vote regarding (1) the removal of ARC Advisor or any affiliate of ARC Advisor, (2) the removal of Phillips Edison Sub-Advisor or any affiliate of Phillips Edison Sub-Advisor, (3) any transaction between us and ARC Advisor or any of its affiliates and (4) any transaction between us and Phillips Edison Sub-Advisor or any of its affiliates. Phillips Edison Sub-Advisor has agreed to vote any shares of our common stock it owns in favor of any person nominated by ARC Advisor for our board of directors. Any person nominated by ARC Advisor for our board of directors who is elected to the board will have executed an advance letter of resignation from our board immediately effective upon the termination of ARC Advisor as our advisor, if such termination shall ever occur. ARC Advisor has agreed to vote any shares of our common stock it owns in favor of any person nominated by Phillips Edison Sub-Advisor for our board of directors.

If ARC Advisor’s nominee to the board of directors is not elected by our stockholders at anytime during the first five years of this offering, ARC Advisor will appoint an individual to observe meetings of the board of directors and committees. The board observer would not be a member of the board of directors or be entitled to vote on any matters brought before the board or a committee of the board. The board observer would not have access to certain meetings of the independent directors and would not be able to review legally privileged materials presented to the board. The board observer would resign from his or her position upon the earlier to occur of (1) the fifth anniversary of the commencement of this initial public offering and (2) our termination of ARC Advisor as our advisor.

 

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The Property Manager

We expect that a substantial majority of our real properties will be managed and leased by Phillips Edison & Company NTR, LLC, our property manager (the “Phillips Edison Property Manager”), a newly formed Delaware limited liability company indirectly wholly-owned by our Phillips Edison sponsor. Messrs. Phillips, Edison and Bessey hold key positions at our property manager and it is affiliated with our sub-advisor. For more information about their background and experience, see “—Our Sponsors—Our Phillips Edison Sponsors.”

We will pay our property manager a monthly market-based property management fee of up to 4.5% of the annualized gross revenues generated at our properties for services it provides in connection with operating and managing the property. In the event that we contract directly with a non-affiliated third-party property manager in respect of a property, we will pay Phillips Edison Property Manager an oversight fee equal to 1.0% of the annualized gross revenues of the property managed. In no event will we pay both a property management fee and an oversight fee to Phillips Edison Property Manager with respect to any particular property. The property manager may pay some or all of these fees to third parties for management or leasing services.

Our property management agreement with Phillips Edison Property Manager will have a one-year term, and will be subject to successive one-year renewals unless Phillips Edison Property Manager provides written notice of its intent to terminate 30 days’ prior to the expiration of the initial or renewal term. We also will have the right to terminate the agreement upon 30 days’ prior written notice in the event of gross negligence or willful misconduct by the property manager. We and our operating partnership may assign our rights under the property management agreement as to any particular property to a lender or lenders pursuant to the terms of any loan or loans we obtain related to our assets.

Our property manager will hire, direct and establish policies for employees who will have direct responsibility for the operations of each real property it manages, which may include, but is not limited to, on-site managers and building and maintenance personnel. Certain employees of our property manager may be employed on a part-time basis and may also be employed by our advisor, our dealer manager or certain companies affiliated with them. Our property manager will also direct the purchase of equipment and supplies and will supervise all maintenance activity. The management fees we pay to our property manager will include, without additional expense to us, all of our property manager’s general overhead costs.

Our Sponsors

Because our advisor is owned by affiliates of American Realty Capital II, LLC and our Sub-advisor is owned by affiliates of Phillips Edison Limited Partnership, we consider ourselves to be co-sponsored by the individuals who own and control those entities. In addition to the directors and executive officers listed above, our advisor and sub-advisor will rely on our Phillips Edison and ARC sponsors and on key professionals employed or retained by affiliates of our sponsors. These individuals have extensive real estate industry experience through multiple real estate cycles in their careers and have the expertise gained through hands-on experience in property selection, acquisitions/development, financing, asset and property management, and dispositions.

Our Phillips Edison Sponsors

Our Phillips Edison sponsor has a fully-integrated, scalable, national operating platform. The acquired portfolio of assets will be managed by a seasoned team of more than 160 professionals with extensive knowledge and expertise in the retail sector. Our Phillips Edison sponsor’s 10-member senior

 

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management team has an average of 18 years of retail property and related real estate experience, an average tenure of 10 years with the sponsor, and currently manages over $1.8 billion of retail real estate and real estate related assets. Our Phillips Edison sponsor’s management team has institutional experience investing and performing throughout a variety of market conditions and real estate cycles. The management team has long-term relationships with regional and national grocery tenants, other national and necessity-based anchor and junior-anchor tenants and many small store retailers. Their established relationships with these retailers and other necessary players in the industry, including lenders, vendors, brokers and contractors will assist in providing reliable execution of our investment and operating strategies.

Our Phillips Edison sponsor’s national platform enables them to operate in markets throughout the United States. Corporate offices are located in Cincinnati, Ohio; Salt Lake City, Utah; Los Angeles, California; Baltimore, Maryland; Columbia, South Carolina; and Portland, Oregon; with satellite offices in other various cities to ensure that management personnel are located in relatively close proximity to every portfolio property. Property managements’ hub and spoke system allows for centralized control and constant on-site presence at every shopping center.

The national platform is supported with a scalable, state-of-the-art information technology system and disaster recovery system monitored with appropriate controls. Its proprietary document approval system creates efficient, paperless communication and process approval between departments in real time. The system provides secure access to important documents which are stored electronically and are accessible by query.

Fully-integrated Team

Our Phillips Edison sponsor’s in-house operating team is exclusively dedicated to its properties and those of its affiliates, including us. The fully-integrated operating team which includes acquisitions, due diligence, financing, leasing, research, lease administration, property management, and construction control every aspect of the property acquisition, leasing and management process. Key requirements of each group are:

 

   

Acquisitions: generates constant deal flow, streamlined evaluation process, and disciplined buying. This is enhanced through the advisor’s reputation, longstanding relationships with broker and property owners and a constant market presence.

 

   

Due Diligence assesses issues and any foreseeable risks associated with a property being acquired which might affect its value and price. This includes site visits, tenant interviews, tenant sales reviews, verification of leases, and review of environmental and property conditions. Upon acquisition, the team disseminates the information to the organization for an effective and efficient transition to operations.

 

   

Finance builds and leverages lender relationships to secure financing at the lowest cost while managing flexibility, underwrites and finances all new acquisitions and forecasts operating results.

 

   

Leasing teams are responsible for understanding each center’s market and creating a tailored merchandising plan to obtain a tenant mix that enhances the retail shopping experience and optimize the income stream. Agents are responsible for developing and cultivating

 

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relationships with existing and potential tenants through formal and informal meetings, telephone contact, portfolio reviews at tenants’ headquarters and tenant “call-ins.”

 

   

Research provides information including mapping, demographics, site specific data, market information, and trend and void analyses to every department.

 

   

Lease Administration negotiates the non-monetary provisions of leases and works closely with the leasing team to draft, review, and negotiate letters of intent, leases, amendments, renewals, and assignments while improving the quality of leases.

 

   

Property Management maintains an attractive, safe environment where retailers thrive and customers enjoy a pleasant shopping experience. This property-focus includes daily review and supervision of every center through a combination of regional and on-site managers.

 

   

Construction works closely with leasing and lease administration to provide cost estimating, analysis, conceptual design, and value engineering options. Supervision and management of all construction activities are completed in-house in an effort to minimize cost and time. Bidding and construction is completed through an established network of contractors.

Below is a brief description of the background and experience of our individual Phillips Edison sponsors and the senior real estate professionals employed or retained by Phillips Edison and its affiliates.

Michael C. Phillips, Co-Chairman of the Board, has served as a principal of Phillips Edison since 1991. Prior to forming Phillips Edison, Mr. Phillips was employed by Biggs Hypershoppes, Inc. as Vice President from 1989 until 1990, by May Centers as Senior Development Director from 1988 until 1989, and by The Taubman Company as Development Director from 1986 until 1988 and as a leasing agent from 1984 until 1986. Mr. Phillips received his bachelor’s degree in political science in 1977 from the University of Southern California.

Jeffrey S. Edison, Co-Chairman of the Board and our Chief Executive Officer, has served as a principal of Phillips Edison since 1995. From 1991 to 1995. Mr. Edison was employed by Nations Bank’s South Charles Realty Corporation, serving as a Senior Vice President from 1993 until 1995 and as a Vice President from 1991 until 1993. Mr. Edison was employed by Morgan Stanley Realty Incorporated from 1987 until 1990 and The Taubman Company from 1984 until 1987. Mr. Edison received his bachelor’s degree in mathematics and economics from Colgate University in 1982 and a masters in business administration from Harvard Business School in 1984.

John Bessey, our President, has served as Chief Investment Officer for Phillips Edison since 2005. During that time he has managed the placement of over $1.2 billion in 140 individual shopping centers comprising over 14,000,000 square feet. Prior to that, he served Phillips Edison as Vice President of Development from 1999 starting the ground up development program for the company. During that time he started and completed over 25 projects which included Walgreen’s, Target, Kroger, Winn Dixie, Safeway and Wal-Mart. Prior to joining Phillips Edison, Mr. Bessey was employed by Kimco Realty Corporation as a Director of Leasing from 1995, by Koll Management Services as Director of Retail Leasing and Development from 1991 and by Tipton Associates as Leasing Manager from 1988. Prior to entering retail real estate in 1988, Mr. Bessey worked in the hospitality industry as a Convention Sales Director for the Cincinnati Convention and Visitors Bureau and for Hyatt Hotels in a number of sales management positions in Minneapolis and Cincinnati. Mr. Bessey received his Bachelor’s Degree in Hotel and Restaurant Management from the University of Wisconsin – Stout in 1981.

 

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Our ARC Sponsors

Below is a brief description of the background and experience of our individual ARC sponsors and the senior real estate professionals employed or retained by ARC and its affiliates.

American Realty Capital II, LLC, our ARC sponsor, is owned by Nicholas S. Schorsch, William M. Kahane, one our directors, Peter M. Budko, Brian S. Block and Michael Weil. Each of these individuals is an executive officer of American Realty Capital Trust, Inc., a non-traded public REIT that focuses on acquiring a diversified portfolio of freestanding, single-tenant retail and commercial properties that are net leased to investment grade and other creditworthy tenants. American Realty Capital II, LLC wholly owns our advisor and our dealer manager.

Nicholas S. Schorsch is the Chairman and Chief Executive Officer of American Realty Capital New York Recovery REIT, Inc. Mr. Schorsch has also been the Chief Executive Officer of American Realty Capital Trust, Inc., American Realty Capital Properties, LLC, and American Realty Capital Advisors, LLC. From September 2006 to July 2007, Mr. Schorsch was Chief Executive Officer of American Realty Capital, LLC, a real estate investment firm. Mr. Schorsch founded and formerly served as President, CEO and Vice-Chairman of American Financial Realty Trust since its inception in September 2002 (and election to be taxed as a REIT beginning in 2002) until August 2006. American Financial Realty Trust was a publicly traded REIT that invested exclusively in offices, operation centers, bank branches, and other operating real estate assets that are net leased to tenants in the financial service industry, such as banks and insurance companies. Through American Financial Resource Group and its successor corporation, American Financial Realty Trust, Mr. Schorsch executed in excess of 1,000 acquisitions, both in acquiring businesses and real estate property with transactional value of approximately $5 billion. In 2003, Mr. Schorsch received an Entrepreneur of the Year award from Ernst & Young. From 1995 to September 2002, Mr. Schorsch served as CEO and President of American Financial Resource Group, American Financial Realty Trust’s predecessor, a private equity firm founded for the purpose of acquiring operating companies and other assets in a number of industries. Prior to American Financial Resource Group, Mr. Schorsch served as President of a non-ferrous metal product manufacturing business, Thermal Reduction. He successfully built the business through mergers and acquisitions and ultimately sold his interests to Corrpro (NYSE) in 1994.

William M. Kahane is the president, chief operating officer and treasurer of American Realty Capital Trust, Inc., American Realty Capital Properties, LLC and American Realty Capital Advisors, LLC and has been active in the structuring and financial management of commercial real estate investments for over 25 years. Mr. Kahane also is the president and treasurer of American Realty Capital New York Recovery REIT, Inc, as well as the chief operating officer and treasurer of New York Recovery Properties, LLC and New York Recovery Advisors, LLC. Mr. Kahane began his career as a real estate lawyer practicing in the public and private sectors from 1974-1979. From 1981-1992, Mr. Kahane worked at Morgan Stanley & Co., specializing in real estate, becoming a Managing Director in 1989. In 1992, Mr. Kahane left Morgan Stanley to establish a real estate advisory and asset sales business known as Milestone Partners which continues to operate and of which Mr. Kahane is currently the Chairman. Mr. Kahane worked very closely with Mr. Schorsch while a trustee at American Financial Realty Trust (2003 to 2006), during which time Mr. Kahane served as Chairman of the Finance Committee of the Board of Trustees. Mr. Kahane has been a Managing Director of GF Capital Management & Advisors LLC, a New York-based merchant banking firm, where he has directed the firm’s real estate investments since 2001. GF Capital offers comprehensive wealth management services through its subsidiary TAG Associates LLC, a leading multi-client family office and portfolio management services company with approximately $5 billion of assets under management. Mr. Kahane also was on the Board of Directors of Catellus Development Corp., an NYSE growth-oriented real estate development company, where he served as Chairman.

 

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Peter M. Budko is the Executive Vice President and Chief Investment Officer of American Realty Capital Trust, Inc. He is also the Executive Vice President of New York Recovery Advisors, LLC, New York Recovery Properties, LLC and Realty Capital Securities, LLC. Mr. Budko also is executive vice president and chief investment officer of the ARCT property manager and the ARCT advisor. Prior to his current position, from January 2007 to July 2007, Mr. Budko was Chief Operating Officer of an affiliated American Realty Capital real estate investment firm. Mr. Budko founded and formerly served as Managing Director and Group Head of the Structured Asset Finance Group, a division of Wachovia Capital Markets, LLC from 1997-2006. The Structured Asset Finance Group structures and invests in real estate that is net leased to corporate tenants. While at Wachovia, Mr. Budko acquired over $5 billion of net leased real estate assets. From 1987-1997, Mr. Budko worked in the Corporate Real Estate Finance Group at NationsBank Capital Market (predecessor to Bank of America Securities), becoming head of the group in 1990.

Brian S. Block has served as Executive Vice President and Chief Financial Officer of American Realty Capital Trust, Inc. since September 2007. He is also the Executive Vice President and Chief Financial Officer of the ARCT property manager and the ARCT advisor. In addition, Mr. Block serves as Executive Vice President and Chief Financial Officer of American Reality Capital New York Recovery REIT, Inc., New York Recovery Properties, LLC and New York Recovery Advisors, LLC. Mr. Block is responsible for the accounting, finance and reporting functions at ARC. He has extensive experience in SEC reporting requirements, as well as REIT tax compliance matters. Mr. Block has been instrumental in developing ARC’s infrastructure and positioning the organization for growth. Mr. Block began his career in public accounting at Ernst & Young and Arthur Andersen from 1994 to 2000. Subsequently, Mr. Block was the Chief Financial Officer of a venture capital-backed technology company for several years prior to joining AFRT in 2002. While at AFRT, Mr. Block served as Senior Vice President and Chief Accounting Officer from 2003 to 2007 and oversaw the financial, administrative and reporting functions of the organization. He is a certified public accountant and is a member of the AICPA and PICPA. Mr. Block serves on the REIT Committee of the Investment Program Association.

Michael Weil is the Executive Vice President and Secretary of American Realty Capital Trust, Inc. He is also the Executive Vice President and Secretary of the ARCT property manager and the ARCT advisor. In addition, Mr. Weil serves as Executive Vice President and Secretary of American Reality Capital New York Recovery REIT, Inc., New York Recovery Properties, LLC and New York Recovery Advisors, LLC. He was formerly the Senior Vice President of Sales and Leasing for AFRT (from April 2004 to October 2006), where he was responsible for the disposition and leasing activity for a 33 million square foot portfolio. Under the direction of Mr. Weil, his department was the sole contributor in the increase of occupancy and portfolio revenue through the sales of over 200 properties and the leasing of over 2.2 million square feet, averaging 325,000 square feet of newly executed leases per quarter. After working at AFR, from October 2006 to May 2007, Mr. Weil was managing director of Milestone Partners Limited and prior to joining AFR, from July 1987 to April 2004, Mr. Weil was president of Plymouth Pump & Systems Co.

Michael A. Happel, the Executive Vice President and Chief Investment Officer of American Realty Capital New York Recovery REIT, Inc., has over 20 years of experience investing in real estate, including office retail, multifamily, industrial, and hotel properties, as well as real estate companies. Mr. Happel also is executive vice president and chief investment officer of New York Recovery Properties, LLC and New York Recovery Advisors, LLC. From 1988 – 2002, he worked at Morgan Stanley & Co., specializing in real estate and becoming co-head of acquisitions for the Morgan Stanley Real Estate Funds, or MSREF, in 1994. While at MSREF, he was involved in acquiring over $10 billion of real estate and related assets in MSREF I and MSREF II. As stated in a report prepared by Wurts & Associates for the Fresno County Employees’ Retirement Association for the period ending September 30, 2008,

 

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MSREF I generated approximately a 48% gross IRR for investors and MSREF II generated approximately a 27% gross IRR for investors. In 2002, Mr. Happel left Morgan Stanley & Co. to join Westbrook Partners, a large real estate private equity firm with over $5 billion of real estate assets under management at the time. In 2004, he joined Atticus Capital, a multi-billion dollar hedge fund, as the head of real estate with responsibility for investing primarily in REITs and other publicly traded real estate securities.

Our Dealer Manager

Realty Capital Securities, LLC, our dealer manager, is a member firm of the Financial Industry Regulatory Authority (FINRA). Realty Capital Securities, LLC was organized on August 29, 2007 for the purpose of participating in and facilitating the distribution of securities of real estate programs sponsored by American Realty Capital Trust, Inc., its affiliates and its predecessors. Realty Capital Securities, LLC will also serve as our dealer manager.

Realty Capital Securities, LLC provides certain wholesaling, sales, promotional and marketing assistance services to us in connection with the distribution of the shares offered pursuant to this prospectus. It may also sell a limited number of shares at the retail level. The compensation we will pay to Realty Capital Securities, LLC in connection with this offering is described in the section of this prospectus captioned “Compensation Table.” See also “Plan of Distribution—Compensation of Our Dealer Manager and Participating Broker-Dealers.”

Realty Capital Securities, LLC is controlled by among others, Mr. Kahane, one of our directors. Realty Capital Securities, LLC is an affiliate of our advisor. See “Conflicts of Interest.”

The current officers of Realty Capital Securities, LLC are:

 

Name

  

Age

  

Position(s)

Nicholas Corvinus

   62    Chief Executive Officer

Louisa Quarto

   41    President

Kamal Jafarnia

   43    Executive Vice President and Chief Compliance Officer

Alex MacGillivray

   48    Senior Vice President and National Sales Manager

The backgrounds of Messrs. Corvinus, Jafarnia and MacGillivray and Ms. Quarto are described below:

Nicholas Corvinus joined Realty Capital Securities, LLC, in April 2008 and currently serves as CEO. Mr. Corvinus brings more than 30 years of financial industry experience in sales, business development and commercial real estate to Realty Capital Securities, LLC. Most recently, he served as Senior Vice President at Behringer Harvard. Additionally, Mr. Corvinus has over 15 years experience at Putnam Retail Management where he last served as Managing Director and was responsible for developing new business, building key relationships with wirehouses and broker-dealers and increasing sales and product recognition. Mr. Corvinus holds FINRA Series 7, 63 and 24 licenses.

Louisa Quarto joined Realty Capital Securities, LLC in April 2008 and currently serves as President. Ms Quarto served as Chief Compliance Officer for Realty Capital Securities, LLC from May

 

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2008 until February 2009. Ms Quarto’s responsibilities include overseeing national accounts, operations and compliance activities for Realty Capital Securities. From February 1996 through April 2008 Ms Quarto was with W. P. Carey & Co. LLC, most recently as Executive Director and Chief Management Officer of Carey Financial, LLC, the broker-dealer subsidiary of W. P. Carey, where she managed relationships with the broker-dealers that were part of the CPA® REIT selling groups. Ms Quarto earned a Bachelor of Arts from Bucknell University and an MBA in Finance and Marketing from The Stern School of Business at New York University. She holds FINRA Series 7, 63 and 24 licenses and is a member of the Investment Program Association’s, or IPA, Executive Committee, its Board of Trustees and serves as the IPA’s Treasurer and Chair of its Finance Committee.

Kamal Jafarnia is Executive Vice President and Chief Compliance Officer for Realty Capital Securities, LLC and is Senior Vice President for American Realty Capital. Mr. Jafarnia joined Realty Capital Securities, LLC in November 2008 and became its Chief Compliance Officer in February 2009. Mr. Jafarnia has more than 15 years experience both as an attorney and as a compliance professional, including 10 years of related industry experience in financial services. Before joining American Realty Capital, he served as Executive Vice President of Franklin Square Capital Partners and as Chief Compliance Officer of FB Income Advisor, LLC, the registered investment adviser to Franklin Square’s proprietary offering, where he was responsible for overseeing the regulatory compliance programs for the firm. Prior to Franklin Square Capital Partners, Mr. Jafarnia was Assistant General Counsel and Chief Compliance Officer for Behringer Harvard and Behringer Securities, LP, respectively, where he coordinated the selling group due diligence and oversaw the regulatory compliance efforts. Prior to Behringer Harvard, Mr. Jafarnia worked as Vice President of CNL Capital Markets, Inc. and Chief Compliance Officer of CNL Fund Advisors, Inc. Mr. Jafarnia earned a Bachelor of Arts from the University of Texas at Austin and his law degree from Temple University School of Law in Philadelphia, PA. He is currently participating in the Masters of Laws degree program in Securities and Finance Regulation at the Georgetown University Law Center in Washington, DC. Mr. Jafarnia holds FINRA Series 6, 7, 24, 63 and 65 licenses.

Alex MacGillivray joined Realty Capital Securities, LLC in June 2009 and currently serves as Senior Vice President and National Sales Manager. Mr. MacGillivray has over 20 years of sales experience and his current responsibilities include sales, marketing, and managing the distribution of all products offered by Realty Capital Securities, LLC. Prior to joining Realty Capital Securities, LLC, he was a Director of Sales at Prudential Financial with responsibility for managing a team focused on variable annuity sales through numerous channels. Before joining Prudential Financial in 2006, he was a National Sales Manager at Lincoln Financial overseeing a team focused on variable annuity sales. Before joining Lincoln Financial in 2003, he was a senior sales executive at AXA/Equitable. Mr. MacGillivray also has prior sales experience at Fidelity Investments and Van Kampen Merritt.

Our Dealer Manager Agreement

Under the terms of the dealer manager agreement, Realty Capital Securities, LLC will use its “best efforts” to sell a minimum of 250,000 shares and a maximum of 180,000,000 shares of our common stock. Because this is a “best efforts” offering, Realty Capital Securities, LLC must use only its best efforts to sell the shares and has no firm commitment or obligation to purchase any of our shares.

In general, Realty Capital Securities, LLC will receive selling commissions of 7.0% of the gross offering proceeds for shares sold in our primary offering. Our dealer manager will receive 3.0% of the gross offering proceeds as compensation for acting as the dealer manager, except that a reduced dealer manager fee will be paid with respect to certain volume discount sales. We do not pay any selling commissions or dealer manager fees for shares sold under our dividend reinvestment plan or our “friends

 

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and family” program. We will also reimburse our dealer manager for reasonable bona fide invoiced due diligence expenses. See “Plan of Distribution.”

Realty Capital Securities, LLC will act as our exclusive dealer manager until the end of our initial public offering or until the dealer manager agreement is terminated by us or them. We have the right to terminate the dealer manager agreement for, among other reasons: (1) cause; (2) a material breach of the agreement by the dealer manager that materially adversely affects its ability to perform its duties; (3) the dealer manager’s voluntary or involuntary bankruptcy; (4) the failure of the dealer manager to attain certain performance thresholds; and (5) the failure of certain key individuals to remain actively involved in the management of our dealer manager. Our dealer manager has the right to terminate the dealer manager agreement for, among other reasons: (1) our voluntary or involuntary bankruptcy; (2) a material change in our business; (3) a material action, suit, proceeding or investigation involving or against us; (4) a material reduction in the rate of any dividend we may pay in the future without our dealer manager’s prior written consent; (5) a suspension or termination of our share redemption program without our dealer manager’s prior written consent; or (6) a material adverse change in the value of our common shares. In certain cases, either we or the dealer manager, as applicable, would have a certain period of time to cure the event triggering the right to terminate the agreement.

To the extent permitted by law and our charter, we will indemnify the participating broker-dealers and the dealer manager against some civil liabilities, including certain liabilities under the Securities Act and liabilities arising from breaches of our representations and warranties contained in the dealer manager agreement. See “—Limited Liability and Indemnification of Directors, Officers, Employees and Other Agents.”

Management Decisions

The primary responsibility for the investment decisions of ARC Advisor and its affiliates, the negotiation for these investments, and the asset-management decisions resides with Nicholas S. Schorsch, William M. Kahane, Michael A. Happel, Peter M. Budko, Brian Block and Michael Weil. American Realty Capital II Advisors, LLC seeks to invest in commercial properties on our behalf that satisfy our investment objectives. To the extent we invest in properties, a majority of the directors will approve the consideration paid for such properties based on the fair market value of the properties. If a majority of independent directors so determines, or if an asset is acquired from our advisor, one or more of our directors, our sponsor or any of its affiliates, the fair market value will be determined by a qualified independent real estate appraiser selected by the independent directors.

Appraisals are estimates of value and should not be relied on as measures of true worth or realizable value. We will maintain the appraisal in our records for at least five years, and copies of each appraisal will be available for review by stockholders upon their request.

 

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COMPENSATION TABLE

Although we have executive officers who will manage our operations, we have no paid employees. Our advisor, ARC Advisor, will enter into a sub-advisory agreement with our sub-advisor, Phillips Edison Sub-Advisor, which will manage our day-to-day affairs and our portfolio of real estate investments, subject to the board’s supervision. The following table summarizes all of the compensation, fees and expenses that we will pay or reimburse to the respective affiliates of our sponsors including ARC Advisor (and its affiliates) and our dealer manager, Realty Capital Securities, LLC. The table also summarizes fees to be paid to our independent directors. Unless otherwise noted, the fees to be paid and expenses to be reimbursed described in this section will be paid or reimbursed to our advisor, an affiliate of our ARC sponsor. ARC Advisor may then assign such fees or expense reimbursements to our sub-advisor, an affiliate of our Phillips Edison sponsor, in whole or in proportion to the amount of services provided or expenses incurred on our behalf (collectively the advisor and sub-advisor, the “Advisor Entities”) pursuant to the terms of the sub-advisory agreement between those parties. Selling commissions and dealer manager fees may vary for different categories of purchasers as described under “Plan of Distribution.” This table assumes that we sell all shares at the highest possible selling commissions and dealer manager fees (with no discounts to any categories of purchasers) and assumes a $9.50 price for each share sold through our dividend reinvestment plan. No selling commissions or dealer manager fees are payable on shares sold through our dividend reinvestment plan or our “friends and family” program.

 

Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for
Minimum Offering/
Maximum

Offering (1)

     Organization and Offering Stage     
Selling Commissions—Dealer Manager (2)    7.0% of gross offering proceeds before reallowance of commissions earned by participating broker-dealers, except no selling commissions are payable on shares sold under the dividend reinvestment plan or our “friends and family” program. We expect that the dealer manager will reallow 100% of commissions earned to participating broker-dealers.    $175,000/$105,000,000
Dealer Manager Fee—Dealer Manager (2)    3.0% of gross offering proceeds, except no dealer manager fee is payable on shares sold under the dividend reinvestment plan or our “friends and family” program. The dealer manager may reallow all or a portion of its dealer manager fees to participating broker-dealers.    $75,000/$45,000,000
Other Organization and Offering Expenses (3)    To date, the sub-advisor has paid organization and offering expenses on our behalf. We will reimburse on a monthly basis the sub-advisor for these costs and future organization and offering costs it, our advisor or their respective affiliates may incur on our behalf but only to the extent that the reimbursement would not exceed 1.5% of gross offering proceeds over the life of the offering or cause the selling commissions, the dealer manager fee and such other organization and offering expenses borne by us to exceed 15.0% of gross offering proceeds as of the date of the reimbursement.    $37,500/$22,500,000

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for

Minimum Offering/

Maximum

Offering (1)

     Acquisition and Development Stage     
Acquisition Fees (4)    We will pay to our Advisor Entities 1.5% of the contract purchase price of each property acquired (including our pro rata share of debt attributable to such property) and 1.5% of the amount advanced for a loan or other investment (including our pro rata share of debt attributable to such investment). For purposes of this prospectus, “contract purchase price” means the amount actually paid or allocated in respect of the purchase, development, construction or improvement of a property or the amount actually paid or allocated in respect of the purchase of loans or other real-estate related assets, in each case exclusive of acquisition fees and acquisition expenses, but in each case including any indebtedness assumed or incurred in respect of such investment.    $33,188 (minimum offering and no debt)/$19,912,500 (maximum offering and no debt)/$39,825,000 (maximum offering and target leverage of 50.0% of the cost of our investments)
Acquisition Expenses    We will reimburse our Advisor Entities for expenses actually incurred (including personnel costs) related to selecting, evaluating and acquiring assets on our behalf, regardless of whether we actually acquire the related assets. In addition, we also will pay third parties, or reimburse the advisor or its affiliates, for any investment-related expenses due to third parties, including, but not limited to, legal fees and expenses, travel and communications expenses, costs of appraisals, accounting fees and expenses, third-party brokerage or finders fees, title insurance expenses, survey expenses, property inspection expenses and other closing costs regardless of whether we acquire the related assets. We expect these expenses to be approximately 0.5% of the purchase price of each property (including our pro rata share of debt attributable to such property) and 0.5% of the amount advanced for a loan or other investment (including our pro rata share of debt attributable to such investment). In no event will the total of all acquisition fees and acquisition expenses payable with respect to a particular investment exceed 6.0% of the contract purchase price of each property (including our pro rata share of debt attributable to such property) or 6.0% of the amount advanced for a loan or other investment (including our pro rata share of debt attributable to such investment).    $11,063/$6,637,500

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for

Minimum Offering/

Maximum

Offering (1)

Development Fee    If we engage an affiliate of one of our sponsors to provide development services with respect to a particular property, we will pay a development fee in an amount that is usual and customary for comparable services rendered to similar projects in the geographic market of the project.    We cannot determine these amounts at the present time.
   Operational Stage   
Asset Management Fee (5)    We will pay our advisor a quarterly fee of 0.25% of the sum of the cost of all real estate and real estate-related investments we own and of our investments in joint ventures, including acquisition fees, acquisition and origination expenses and any debt attributable to such investments until 18 months following the end of this or any follow-on public offering. Thereafter, the quarterly fee will equal 0.25% of the combined fair market value of all real estate and real estate-related investments we own and of our investments in joint ventures. Fair market value shall be determined by the Advisor Entities or by an independent third-party valuation. This fee will be payable quarterly in advance, on January 1, March 1, July 1 and October 1 based on assets held by us during the pervious quarter, adjusted for appropriate closing dates for individual property acquisitions.    The actual amounts depend on the total equity and debt capital we raise and the results of our operations; we cannot determine these amounts at the present time.
Financing Fee (5)    We will pay our advisor a financing fee equal to 1.0% of all amounts made available under any loan or line of credit.    The actual amounts depend on the total debt capital made available to us; we cannot determine these amounts at the present time.
Leasing Fee—Property Manager    If we engage an affiliate of one of our sponsors to provide leasing services with respect to a particular property, we will pay a leasing fee in an amount that is usual and customary for comparable services rendered in the geographic market of the property.    We cannot determine these amounts at the present time.
Construction Oversight Fee    If we engage an affiliate of one of our sponsors to provide construction oversight services with respect to a particular property, we will pay a construction oversight fee in an amount that is usual and customary for comparable services rendered to similar projects in the geographic market of the property.    We cannot determine these amounts at the present time.
Other Operating Expenses (5)    We will reimburse the expenses incurred by our Advisor Entities in connection with its provision of services to us, including our allocable share of our Advisor Entities’ overhead, such as rent, personnel costs, utilities and IT costs. Though our Advisor Entities have contractual rights to seek reimbursement for personnel costs, our Advisor Entities do not intend to do so at this time. If our Advisor Entities do decide    Actual amounts depend on the results of our operations; we cannot determine these amounts at the present time.

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for

Minimum Offering/

Maximum

Offering (1)

   to seek reimbursement for personnel costs, such costs may include our proportionate share of the salaries of persons involved in the preparation of documents to meet SEC reporting requirements. We will also reimburse our Advisor Entities and their respective affiliates for expenses paid on our behalf in connection with investigating and acquiring assets, regardless of whether we acquire the assets. We may not, however, reimburse expenses that exceed the greater of 6.0% of the contract price of any real estate asset or, in the case of a loan, 6.0% of the funds advanced. Reimbursable expenses include items such as property appraisals, environmental surveys, property audit fees, legal fees, asset due diligence review and business travel, such as airfare, hotel, meal and phone charges. We will not reimburse for personnel costs in connection with services for which our Advisor Entities receive acquisition or disposition fees.   

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for

Minimum Offering/

Maximum

Offering (1)

Property Management Fees—Property Manager    Property management fees equal to 4.5% of the annualized gross revenues of the properties managed by Phillips Edison Property Manager, our property manager, will be payable monthly. In the event that we contract directly with a non-affiliated third-party property manager in respect of a property, we will pay the property manager an oversight fee equal to 1.0% of the annualized gross revenues of the property managed payable monthly. In no event will we pay both a property management fee and an oversight fee to an affiliated property manager with respect to any particular property. In addition to the property management fee or oversight fee, if our property manager provides leasing services with respect to a property, we will pay our property manager leasing fees in an amount equal to the leasing fees charged by unaffiliated persons rendering comparable services in the same geographic location of the applicable property. Our property manager may subcontract the performance of its property management and leasing duties to third parties, and our property manager may pay a portion of its property management or leasing fees to the third parties with whom it subcontracts for these services. We will reimburse the costs and expenses incurred by our property manager on our behalf, including legal, travel and other out-of-pocket expenses that are directly related to the management of specific properties, as well as fees and expenses of third-party accountants. We will not, however, reimburse our property manager for the wages and salaries and other employee-related expenses of on-site employees of our property manager or its subcontractors who are engaged in the operation, management, maintenance or access control of our properties (including taxes, insurance and benefits relating to such employees).    Actual amounts depend on gross revenues of specific properties and actual management fees or property management fees and customary leasing fees and therefore cannot be determined at the present time.
Independent Director Compensation    We will pay each of our independent directors an annual retainer of $30,000. We will also pay our independent directors for attending meetings as follows: (1) $1,000 for each board meeting attended in person or telephonically and (2) $1,000 for each committee meeting attended in person or telephonically. The audit committee chair will also receive an annual retainer of $5,000 and the conflicts committee chair an annual retainer of $3,000. We expect to grant our independent directors an annual award of 2,500 shares of restricted stock. All directors will receive reimbursement of reasonable out-of-pocket expenses incurred in connection with attendance at meetings of the board of directors.    Actual amounts depend on the total number of board and committee meetings that each independent director attends; we cannot determine these amounts at the present time.

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for

Minimum Offering/

Maximum

Offering (1)

     Liquidation/Listing Stage     
Disposition Fees (6)    For substantial assistance in connection with the sale of properties or other investments, we will pay our Advisor Entities or their respective affiliates 2.0% of the contract sales price of each property or other investment sold; provided, however, in no event may the disposition fees paid to our Advisor Entities, their respective affiliates and unaffiliated third parties exceed 6.0% of the contract sales price. The conflicts committee will determine whether our Advisor Entities or their affiliates have provided substantial assistance to us in connection with the sale of an asset. Substantial assistance in connection with the sale of a property includes our advisor’s or sub-advisor’s preparation of an investment package for the property (including an investment analysis, rent rolls, tenant information regarding credit, a property title report, an environmental report, a structural report and exhibits) or such other substantial services performed by the advisor or sub-advisor in connection with a sale. We do not intend to sell properties or other assets to affiliates. However, if we do sell an asset to an affiliate, our organizational documents would not prohibit us from paying our advisor or sub-advisor a disposition fee. Before we sold an asset to an affiliate, the charter would require that our conflicts committee conclude, by a majority vote, that the transaction is fair and reasonable to us and on terms and conditions no less favorable to us than those available from third parties.    Actual amounts depend on the results of our operations; we cannot determine these amounts at the present time.
Subordinated Share of Cash Flows (7)(8)    Our Advisor Entities will receive 15.0% of remaining net cash flows after return of capital contributions plus payment to investors of a 7.0% cumulative, pre-tax, non-compounded return on the capital contributed by investors. We cannot assure you that we will provide this 7.0% return, which we have disclosed solely as a measure for our Advisor Entities’ and their respective affiliates’ incentive compensation.    Actual amounts depend on the results of our operations; we cannot determine these amounts at the present time.
Subordinated Incentive Fee (7)(8)    Our Advisor Entities will receive 15.0% of the amount by which the sum of our adjusted market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to a 7.0% cumulative, pre-tax, non-compounded annual return to investors. We cannot assure you that we will provide this 7.0% return, which we have disclosed solely as a measure for our Advisor Entities’ and their respective affiliates’ incentive compensation.    Actual amounts depend on the results of our operations; we cannot determine these amounts at the present time.
Termination Fee (9)    Upon termination or non-renewal of the advisory agreement, our advisor shall be entitled to a    Not determinable at this time. There is no maximum

 

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Form of Compensation and
Recipient

  

Determination of Amount

  

Estimated Amount for

Minimum Offering/

Maximum

Offering (1)

   subordinated termination fee. In addition, our advisor may elect to defer its right to receive a subordinated termination fee until either a listing on a national securities exchange or other liquidity event occurs.    amount of this fee.

 

(1)

The estimated minimum dollar amounts are based on the sale of the minimum of 250,000 shares to the public and the estimated maximum dollar amounts are based on the sale of the maximum of 180,000,000 shares to the public, including 30,000,000 shares through our dividend reinvestment plan. We reserve the right to reallocate the shares of common stock we are offering between the primary offering and our dividend reinvestment plan.

(2)

All or a portion of the selling commissions will not be charged with regard to shares sold to certain categories of purchasers. A reduced dealer manager fee is payable with respect to certain volume discount sales. See “Plan of Distribution.”

(3)

After raising at least $2,500,000 in gross offering proceeds from persons who are not affiliated with us or our sponsors, we expect to begin incurring some organization and offering expenses directly. Includes all expenses (other than selling commissions and the dealer manager fee) to be paid by us in connection with the offering, including our legal, accounting, printing, mailing and filing fees, charges of our escrow holder and transfer agent, reimbursement to our advisor and sub-advisor for our portion of the salaries and related employment costs of our advisor’s and sub-advisor’s employees who provide services to us (excluding costs related to employees who provide services for which the advisor or sub-advisor, as applicable, receive acquisition or disposition fees), reimbursement to the dealer manager for amounts it may pay to reimburse the bona fide due diligence expenses of broker-dealers, costs in connection with preparing supplemental sales materials, our costs of conducting bona fide training and education meetings held by us (primarily the travel, meal and lodging costs of non-registered officers of the company, our advisor and sub-advisor to attend such meetings, cost reimbursement for non-registered employees of our affiliates to attend retail seminars conducted by broker-dealers. Our advisor has agreed to reimburse us to the extent the organization and offering expenses incurred by us exceed 1.5% of aggregate gross offering proceeds over the life of the offering. See “Plan of Distribution.” In addition, other organization and offering expenses shall include up to 0.5% for third-party due diligence fees included in a detailed and itemized invoice.

(4)

Because the acquisition fees we pay our Advisor Entities are a percentage of the acquisition price of an investment, these fees will be greater to the extent we fund acquisitions and originations through (1) the incurrence of debt (which we expect to represent 50.0% of the total costs of our investments (including capital improvements, tenant improvements/allowances and leasing commissions invested in an asset) if we sell the maximum number of shares offered hereby but may be as high as the maximum permitted leverage of 65.0%), (2) retained cash flow from operations, (3) issuances of equity in exchange for properties and other assets and (4) proceeds from the sale of shares under our dividend reinvestment plan.

(5)

Commencing upon the end of the fourth fiscal quarter after we make our first investment, ARC Advisor must reimburse us the amount by which our aggregate total operating expenses for the four fiscal quarters then ended exceed the greater of 2.0% of our average invested assets or 25.0% of our net income, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. “Average invested assets” means the average monthly book value of our assets during the 12-month period before deducting depreciation, bad debts or other non-cash reserves. “Total operating expenses” means all expenses paid or incurred by us, as determined under GAAP, that are in any way related to our operation, including advisory fees, but excluding (1) the expenses of raising capital such as organization and offering expenses, legal, audit, accounting, underwriting, brokerage, listing, registration and other fees, printing and other such expenses and taxes incurred in connection with the issuance, distribution, transfer, registration and stock exchange listing of our stock; (2) interest payments; (3) taxes; (4) non-cash expenditures such as depreciation, amortization and bad debt reserves; (5) reasonable incentive fees based on the gain in the sale of our assets and (6) acquisition fees, origination fees, acquisition and origination expenses (including expenses relating to potential investments that we do not close), disposition fees on the resale of property and other expenses connected with the acquisition, origination, disposition and ownership of real estate interests, loans or other property (including property management fees and the costs of foreclosure, insurance premiums, legal

 

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services, maintenance, repair and improvement of property).

(6)

Although we are most likely to pay disposition fees to our advisor or sub-advisor or their respective affiliates in the event of our liquidation, these fees may also be incurred during our operational stage. Under our charter, a majority of the independent directors would have to approve any increase in the disposition fees payable to our advisor and its affiliates above 2.0% of the contract sales price (if no third-party broker is paid a commission) and one-half of any total brokerage commission paid (if a third-party broker is paid a commission). Our charter also limits the maximum amount of the disposition fees payable to the advisor and its affiliates to 3.0% of the contract sales price.

To the extent this disposition fee is paid upon the sale of any assets other than real property, it will count against the limit on “total operating expenses” described in note 5 above.

(7)

Our Advisor Entities cannot earn both the subordinated share of cash flows and the subordinated incentive fee. The subordinated share of cash flows or the subordinated incentive fee, as the case may be, will be paid in the form of a non-interest bearing promissory note that will be repaid from the net sale proceeds of each sale after the date of the termination or listing. Any portion of the subordinated share of cash flows that our Advisor Entities receive prior to our listing will offset the amount otherwise due pursuant to the subordinated incentive fee. In no event will the amount paid to our Advisor Entities under the promissory note, if any, exceed the amount considered “presumptively reasonable” by our charter. Under our charter, an interest in gain from the sale of assets is “presumptively reasonable” if it does not exceed 15.0% of the balance of net sale proceeds remaining after investors have received a return of their net capital contributions and a 6.0% per year cumulative, noncompounded return. Our advisory agreement sets a higher threshold for the payment of a subordinated incentive fee than that required by our charter. Any lowering of the threshold set forth in the advisory agreement would require the approval of a majority of the members of the conflicts committee. To the extent the subordinated share of cash flows fee is derived from cash flows other than net sales proceeds, the incentive fee will count against the limit on “total operating expenses” described in note 5 above, as would any amount paid pursuant to the subordinated incentive fee.

(8)

If for any reason our independent directors determine that we should become “self-administered,” including in contemplation of a listing on a national securities exchange, we may acquire the business conducted by our advisor or sub-advisor after a good faith negotiation with our advisor or sub-advisor, as applicable. Alternatively, if at any time the shares become listed on a national securities exchange and our independent directors determine that we should not become “self-administered,” we will negotiate in good faith with advisor a fee structure appropriate for an entity with a perpetual life. Our independent directors must approve the new fee structure negotiated with our advisor. The market value of our outstanding common stock will be calculated based on the average market value of the shares of common stock issued and outstanding at listing over the 30 trading days beginning 180 days after the shares are first listed or included for quotation. We have the option to pay the subordinated incentive fee in cash or a promissory note or any combination thereof. If any previous payments of the subordinated share of cash flows will offset the amounts due pursuant to the subordinated incentive fee, then we will not be required to pay our Advisor Entities any further subordinated share of cash flows.

(9)

The subordinated termination fee, if any, will equal to the sum of (a) 15.0% of the amount, if any, by which (1) the appraised value of our assets on the termination date, less any indebtedness secured by such assets, plus total distributions paid through the termination date, exceeds (2) the sum of the total amount of capital raised from stockholders (less amounts paid to repurchase shares of our common stock pursuant to our share repurchase plan) and the total amount of cash that, if distributed to them as of the termination date, would have provided them an annual 7.0% cumulative, non-compounded return on the gross proceeds from the sale of shares of our common stock through the termination date, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor and its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties). In addition, our Advisor Entities may elect to defer their right to receive a subordinated termination fee until either a listing or other liquidity event occurs, including a liquidation, sale of substantially all of our assets or merger in which our stockholders receive in exchange for their shares of our common stock shares of a company that are traded on a national securities exchange.

 

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If our advisor elects to defer its right to receive a subordinated termination fee and there is a listing of the shares of our common stock on a national securities exchange or a merger in which our stockholders receive in exchange for their shares of our common stock shares of a company that are traded on a national securities exchange, then our advisor will be entitled to receive a subordinated termination fee in an amount equal to the sum of (a) 15.0% of the amount, if any, by which (1) the fair market value of our assets (determined as of the listing date or merger date, as applicable) owned as of the termination of the advisory agreement, plus any assets acquired after such termination for which our advisor would have been entitled to receive an acquisition fee (referred to herein as the “included assets”) less any indebtedness secured by these assets, plus the cumulative distributions made by our operating partnership to us and the limited partners who received partnership units in connection with the acquisition of the included assets, from our inception through the listing date or merger date, as applicable, exceeds (2) the sum of the total amount of capital raised from stockholders and the capital value of partnership units issued in connection with the acquisition of the included assets through the listing date or merger date, as applicable (excluding any capital raised after the completion of this offering) (less amounts paid to repurchase shares of our common stock pursuant to our share repurchase plan), plus an amount equal to an annual 7.0% cumulative, non-compounded return on the total amount of capital raised from stockholders and the capital value of such partnership units measured for the period from inception through the listing date or merger date, as applicable, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor and its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties).

If our advisor elects to defer its right to receive a subordinated termination fee and there is a liquidation or sale of all or substantially all of the assets of the operating partnership, then our advisor will be entitled to receive a subordinated termination fee in an amount equal to the sum of (a) 15.0% of the net proceeds from the sale of our assets owned as of the termination of the advisory agreement and the included assets, after subtracting the sum of (1) the total amount of capital raised from stockholders and the capital value of partnership units issued in connection with the acquisition of the included assets through the date of the liquidity event plus (2) an amount equal to an annual 7.0% cumulative, non-compounded return on such initial invested capital and the capital value of such partnership units measured for the period from inception through the date of the liquidity event date, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor and its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties). If our advisor receives the subordinated incentive fee, it would no longer be entitled to receive subordinated distributions of net sales proceeds or the subordinated termination fee. If our advisor receives the subordinated termination fee, it would no longer be entitled to receive subordinated distributions of net sales proceeds or the subordinated incentive fee. There are many additional conditions and restrictions on the amount of compensation our advisor and its affiliates may receive.

 

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STOCK OWNERSHIP

The following table sets forth the beneficial ownership of our common stock as of the date of this prospectus for each person or group that holds more than 5.0% of our common stock, for each director and executive officer and for our directors and executive officers as a group. To our knowledge, each person that beneficially owns our shares has sole voting and dispositive power with regard to such shares.

 

Name of Beneficial Owner(1)

   Number of Shares
Beneficially Owned
   Percent of
All Shares
 

Phillips Edison & Company SubAdvisor LLC

   20,000    100.0

Michael C. Phillips

   —      —     

Jeffrey S. Edison

   —      —     

John Bessey

   —      —     

William M. Kahane

   —      —     

Independent director nominee(2)

   —      —     

Independent director nominee(2)

   —      —     

Independent director nominee(2)

   —      —     

Independent director nominee(2)

   —      —     

All directors and executive officers as a group

   —      —     

 

(1)

The address of each beneficial owner listed is 11501 Northlake Drive, Cincinnati, Ohio 45249.

(2)

To be included in amendment.

 

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CONFLICTS OF INTEREST

We are subject to various conflicts of interest arising out of our relationships with our Phillips Edison and ARC sponsors and their respective affiliates, some of whom serve as our executive officers and directors. We discuss these conflicts below and conclude this section with a discussion of the corporate governance measures we have adopted to ameliorate some of the risks posed by these conflicts.

Our Sponsors’ Interests in Other Real Estate Programs

General

All of our executive officers, some of our directors and other key professionals engaged by our advisor to provide services on our behalf are also officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, the sub-advisor, our dealer manager and other Phillips Edison and ARC affiliates that are the sponsors of other real estate programs. In addition, one of our directors is an executive officer of American Realty Capital Trust, Inc. and American Realty Capital New York Recovery REIT, Inc., which are also public, non-traded REITs sponsored by our ARC sponsor, advised by affiliates of our ARC sponsor and for which Realty Capital Securities, LLC acts as dealer manager. Realty Capital Securities, LLC also acts as dealer manager for two other ongoing public offerings of non-traded REITs. These individuals have legal and financial obligations with respect to those programs, entities and investors that are similar to their obligations to us. In the future, these individuals and other affiliates of our sponsors may organize other real estate programs, serve as the investment advisor to other investors and acquire for their own account real estate properties that may be suitable for us.

Since 1991, investment advisors affiliated with Phillips Edison have sponsored five privately offered real estate programs. Four of these programs are still operating. All of these programs have investment objectives that are similar to ours. Conflicts of interest may arise between us and the programs that have not yet been liquidated, between us and future programs and between us and the investors for which a Phillips Edison entity serves as an investment advisor.

Every transaction that we enter into with our advisor, our sub-advisor, our dealer manager or their respective affiliates is subject to an inherent conflict of interest. Our board of directors may encounter conflicts of interest in enforcing our rights against any affiliate in the event of a default by or disagreement with an affiliate or in invoking powers, rights or options pursuant to any agreement between us and our advisor, our sub-advisor, our dealer manager or any of their respective affiliates.

Competition for Investors

As of the date of this prospectus, American Realty Capital Trust, Inc., an ARC-sponsored program and an affiliate of our advisor and dealer manager, is raising capital in an ongoing public offering of its common stock, which is expected to continue until January 25, 2011. We expect that American Realty Capital Trust, Inc. will be raising capital in its public offering concurrently with our offering. In addition, our sponsors may decide to sponsor future programs that would seek to raise capital through public offerings conducted concurrently with our offering. As a result, we face a conflict of interest due to the potential competition among us and these other programs for investors and investment capital.

Our sponsors generally seek to reduce the conflicts that may arise among their various programs by avoiding simultaneous public offerings by programs that have a substantially similar mix of

 

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investment characteristics, including targeted investment types and key investment objectives. Nevertheless, there may be periods during which one or more programs sponsored by our sponsors will be raising capital and which might compete with us for investment capital.

Joint Ventures with Affiliates

We may enter into joint venture agreements with other Phillips Edison- or ARC-sponsored programs for the acquisition, development or improvement of properties or other investments that meet our investment objectives. ARC Advisor, our advisor, has some of the same executive officers and key employees as other affiliates of ARC, and these persons, may face conflicts of interest in determining whether and which ARC program or other entity advised by an affiliate of our ARC sponsor should enter into any particular joint venture agreement. Similarly our Phillips Edison sponsor and its affiliates have some of the same executive officers and key real estate professionals as we do, and, as a consequence, these persons may face conflicts of interest in determining whether and which Phillips Edison-sponsored program or other Phillips Edison-advised entity should enter into any particular joint venture agreement with us. These persons may also face a conflict in structuring the terms of the relationship between our interests and the interests of the sponsor-affiliated co-venturer and in managing the joint venture. Any joint venture agreement or transaction between us and a sponsor-affiliated co-venturer will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated co-venturers. The sponsor-affiliated co-venturer may have economic or business interests or goals that are or may become inconsistent with our business interests or goals. These co-venturers may thus benefit to our and your detriment.

Allocation of Investment Opportunities

We rely on our Phillips Edison and ARC sponsors, and the executive officers and the real estate professionals of our advisor to identify suitable investments. Messrs. Schorsch and Kahane and other real estate professionals at ARC Advisor are also the advisors to other ARC-sponsored programs. Messrs. Phillips and Edison and other real estate professionals at Phillips Edison Sub-Advisor are also the advisors to the private Phillips Edison-sponsored programs. As such, other ARC-sponsored programs, including American Realty Capital Trust, Inc., American Realty Capital New York Recovery REIT, Inc. and the private Phillips Edison-sponsored programs that are raising funds for investment as of the date of this prospectus, rely on many of the same real estate professionals as will future programs. Many investment opportunities that are suitable for us may also be suitable for other Phillips Edison- or ARC-sponsored programs. When these real estate professionals direct an investment opportunity to any Phillips Edison-or ARC-sponsored program, they, in their sole discretion, will offer the opportunity to the program or investor for which the investment opportunity is most suitable based on the investment objectives, portfolio and criteria of each program or investor. As a result, absent contractual restrictions on our sponsors with respect to the allocation of investment opportunities, these real estate professionals could direct attractive investment opportunities to other entities or investors. For so long as we are externally advised, our charter provides that it shall not be a proper purpose of the corporation for us to purchase real estate or any significant asset related to real estate unless the advisor has recommended the investment to us. See “—Certain Conflict Resolution Measures.”

Our advisory agreement with ARC Advisor requires that ARC Advisor inform the conflicts committee each quarter of the investments that have been purchased by other Phillips Edison- or ARC-sponsored programs or by ARC Advisor or Phillips Edison Sub-Advisor or their respective affiliates directly so that the conflicts committee can evaluate whether we are receiving our fair share of opportunities. ARC Advisor’s success in generating investment opportunities for us and the fair allocation of opportunities among Phillips Edison- and ARC-sponsored programs are important factors in the conflicts committee’s determination to continue or renew our arrangements with ARC Advisor and its

 

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affiliates. The conflicts committee has a duty to ensure that favorable investment opportunities are not disproportionately allocated to other Phillips Edison- or ARC-sponsored programs and investors. For so long as we are externally advised, our charter provides that it shall not be a proper purpose of the corporation for us to purchase real estate or any significant asset related to real estate unless the advisor has recommended the investment to us.

Competition for Tenants and Others

Conflicts of interest may exist to the extent that we acquire properties in the same geographic areas where other Phillips Edison- or ARC-sponsored programs or affiliated entities own properties. In such a case, a conflict could arise in the leasing of properties in the event that we and another Phillips Edison- or ARC-sponsored program or affiliated entity were to compete for the same tenants in negotiating leases, or a conflict could arise in connection with the resale of properties in the event that we and another Phillips Edison- or ARC-sponsored program or affiliated entity were to attempt to sell similar properties at the same time. See “Risk Factors—Risks Related to Conflicts of Interest.” Conflicts of interest may also exist at such time as we or our sponsors’ respective affiliates seek to employ developers, contractors, building managers or other third parties. Our sponsors and their respective affiliates will seek to reduce conflicts that may arise with respect to properties available for sale or rent by making prospective purchasers or tenants aware of all such properties. Our sponsors and their respective affiliates will also seek to reduce conflicts relating to the employment of developers, contractors or building managers by making prospective service providers aware of all properties in need of their services. However, our sponsors and their respective affiliates cannot fully avoid these conflicts because they may establish differing terms for resales or leasing of the various properties or differing compensation arrangements for service providers at different properties.

Allocation of Our Affiliates’ Time

As a result of their interests in other programs, their obligations to other investors and the fact that they engage in and they will continue to engage in other business activities on behalf of themselves and others, our executive officers and our Phillips Edison and ARC sponsors face conflicts of interest in allocating their time among us and other Phillips Edison- and ARC-sponsored programs and other business activities in which they are involved. In addition, many of the same key professionals associated with our Phillips Edison and ARC sponsors have existing obligations to other programs sponsored by our sponsors. Our executive officers and the key professionals associated with our sponsors who provide services to us are not obligated to devote a fixed amount of their time to us, but our sponsors believe that our executive officers and the other key professionals have sufficient time to fully discharge their responsibilities to us and to the other business in which they are involved.

Receipt of Fees and Other Compensation by Our Sponsors and Their Respective Affiliates

Our sponsors and their respective affiliates receive substantial fees from us, which fees have not been negotiated at arm’s length. These fees could influence our advisor’s and our sub-advisor’s advice to us as well as the judgment of affiliates of our sponsor, some of whom also serve as our executive officers and directors and the key real estate professionals of our sponsors. Among other matters, these compensation arrangements could affect their judgment with respect to:

 

   

the continuation, renewal or enforcement of our agreements with our ARC sponsor’s affiliates, including the advisory agreement and the dealer-manager agreement;

 

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public offerings of equity by us, which entitles Realty Capital Securities, LLC to dealer-manager fees and will likely entitle ARC Advisor to increased acquisition and asset-management fees;

 

   

sales of properties and other investments, which, through ARC Advisor, entitle our sponsors to disposition fees and possible subordinated incentive fees;

 

   

acquisitions of properties and other investments, which through ARC Advisor, entitle our sponsors to acquisition fees and asset management fees and, in the case of acquisitions of investments from other Phillips Edison- or ARC-sponsored programs, might entitle affiliates of our sponsors to disposition fees and possible subordinated incentive fees in connection with its services for the seller;

 

   

borrowings to acquire properties and other investments and to originate loans, which borrowings will generate financing fees and increase the acquisition and asset-management fees payable to our sponsors;

 

   

whether and when we seek to list our common stock on a national securities exchange, which listing could entitle our sponsors to a subordinated incentive fee;

 

   

whether we seek stockholder approval to internalize our management, which may entail acquiring assets (such as office space, furnishings and technology costs) and negotiating compensation for real estate professionals at our advisor and its affiliates that may result in these individuals receiving more compensation from us than they currently receive from our advisor and its affiliates; and

 

   

whether and when we seek to sell the company or its assets, which sale could entitle our sponsors to a subordinated incentive fee.

Our Board’s Loyalties to Current and Possibly to Future Phillips Edison- or ARC-sponsored Programs

Some of our directors are also directors of other Phillips Edison affiliates or ARC-sponsored programs and affiliates. The loyalties of our directors serving on the board of these other entities or possibly on the board of future Phillips Edison- or ARC-sponsored programs may influence the judgment of our board when considering issues for us that also may affect other Phillips Edison- or ARC-sponsored programs, such as the following:

 

   

The conflicts committee of our board of directors must evaluate the performance of ARC Advisor with respect to whether ARC Advisor is presenting to us our fair share of investment opportunities. If our advisor is not presenting a sufficient number of investment opportunities to us because it is presenting many opportunities to another Phillips Edison- or ARC-sponsored program or if our advisor is giving preferential treatment to another Phillips Edison- or ARC-sponsored program in this regard, our conflicts committee may not be well suited to enforce our rights under the terms of the advisory agreement or to seek a new advisor.

 

   

We could enter into transactions with other Phillips Edison- or ARC-sponsored programs, such as property sales, acquisitions, joint ventures or financing arrangements. Decisions of the board or the conflicts committee regarding the terms of those transactions may be

 

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influenced by the board’s or committee’s loyalties to such other Phillips Edison- or ARC-sponsored programs.

 

   

A decision of the board or the conflicts committee regarding the timing of a debt or equity offering could be influenced by concerns that the offering would compete with an offering of other Phillips Edison- or ARC-sponsored programs.

 

   

A decision of the board or the conflicts committee regarding the timing of property sales could be influenced by concerns that the sales would compete with those of other Phillips Edison- or ARC-sponsored programs.

Fiduciary Duties Owed by Some of Our Affiliates to Our Advisor, Our Sub-advisor and Their Respective Affiliates

All of our executive officers, some of our directors and the key real estate professionals at our advisor and sub-advisor are also officers, directors, managers, key professionals and/ or holders of a direct or indirect controlling interest in or for one or more of:

 

   

ARC Advisor, our advisor;

 

   

Phillips Edison Sub-Advisor, our sub-advisor;

 

   

Realty Capital Securities, LLC, our dealer manager;

 

   

other Phillips Edison-sponsored programs (see the “Prior Performance Summary” section of this prospectus); and

 

   

other ARC-sponsored programs (see the “Prior Performance Summary” section of this prospectus).

As a result, they owe fiduciary duties to each of these programs, their stockholders and members and limited partners advised by Phillips Edison- and ARC-affiliated entities. These fiduciary duties may from time to time conflict with the fiduciary duties that they owe to us.

Affiliated Dealer Manager

Since Realty Capital Securities, LLC, our dealer manager, is an affiliate of ARC Advisor, you will not have the benefit of an independent due diligence review and investigation of the type normally performed by an independent underwriter in connection with the offering of securities. See “Management—Our Dealer Manager” and “Plan of Distribution.”

Certain Conflict Resolution Measures

Conflicts Committee

In order to ameliorate the risks created by conflicts of interest, our charter creates a conflicts committee of our board of directors composed of all of our independent directors. An “independent director” is a person who is not one of our officers or employees or an officer or employee of one of our sponsors or their respective affiliates and has not been so for the previous two years. Serving as a director of, or having an ownership interest in, another Phillips Edison- or ARC-sponsored program will not, by itself, preclude independent-director status. Our charter authorizes the conflicts committee to act on any

 

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matter permitted under Maryland law. Both the board of directors and the conflicts committee must act upon those conflict-of-interest matters that cannot be delegated to a committee under Maryland law. Our charter also empowers the conflicts committee to retain its own legal and financial advisors. Among the matters we expect the conflicts committee to act upon are:

 

   

the continuation, renewal or enforcement of our agreements with our ARC sponsor’s affiliates, including the advisory agreement and the dealer-manager agreement;

 

   

public offerings of securities;

 

   

sales of properties and other investments;

 

   

investments in properties and other assets;

 

   

originations of loans;

 

   

borrowings;

 

   

transactions with affiliates;

 

   

compensation of our officers and directors who are affiliated with our advisor;

 

   

whether and when we seek to list our shares of common stock on a national securities exchange;

 

   

whether and when we seek to become self-managed, which decision could lead to our acquisition of entities affiliated with our sponsors at a substantial price; and

 

   

whether and when we seek to sell the company or its assets.

Our board of directors, or a majority of the conflicts committee that constitutes a majority of our board of directors, approves all proposed investments.

Restrictions on Competing Business Activities of Our Sponsors

The advisor is required to use commercially reasonable efforts to present a continuing and suitable investment program to us that is consistent with our investment policies and objectives. The advisor and sub-advisor will not pursue any opportunity to acquire any real estate properties or real estate-related investments that are directly competitive with our investment strategies, unless and until the opportunity is first presented to us. If we pass on such acquisition, then the advisor, the sub-advisor or their respective affiliates, as applicable, may acquire the subject investment. However, our ARC sponsors and its affiliates, including our advisor, may pursue any opportunity in respect of (1) any net leased retail, office and industrial properties or other property consistent with the investment policies of American Reality Capital Trust, Inc., or (2) any commercial real estate or other real estate investments that relate to office, retail, multi-family residential, industrial and hotel property types, located primarily in the New York metropolitan area or other property consistent with the investment policies of American Realty Capital New York Recovery REIT, Inc.

If a particular prior Phillips Edison program is not fully invested by the date we have raised a minimum of $2.5 million in gross offering proceeds from persons who are not affiliated with us or our sponsors, then our sub-advisor will cause its affiliate to: (1) terminate such prior program’s investment

 

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period, or (2) only pursue investments that fit within our strategy if such investment opportunities are first presented to us and (A) we pass on such investments, or (B) we and the prior Phillips Edison program elect to pursue such investment as co-investors on terms to be mutually agreed upon.

Other Charter Provisions Relating to Conflicts of Interest

In addition to the creation of the conflicts committee, our charter contains many other restrictions relating to conflicts of interest including the following:

Advisor Compensation. The conflicts committee evaluates at least annually whether the compensation that we contract to pay to ARC Advisor and its affiliates is reasonable in relation to the nature and quality of services performed and whether such compensation is within the limits prescribed by the charter. The conflicts committee supervises the performance of ARC Advisor and its affiliates and the compensation we pay to them to determine whether the provisions of our compensation arrangements are being carried out. This evaluation is based on the following factors as well as any other factors deemed relevant by the conflicts committee:

 

   

the amount of the fees and any other compensation, including stock-based compensation, if any, paid to ARC Advisor and its affiliates in relation to the size, composition and performance of our investments;

 

   

whether the expenses incurred by us are reasonable in light of our investment performance, net assets, net income and the fees and expenses of other comparable unaffiliated REITs;

 

   

the success of ARC Advisor in generating appropriate investment opportunities;

 

   

the rates charged to other companies, including other REITs, by advisors performing similar services;

 

   

additional revenues realized by ARC Advisor and its affiliates through their relationship with us, including whether we pay them or they are paid by others with whom we do business;

 

   

the quality and extent of service and advice furnished by ARC Advisor and its affiliates;

 

   

the performance of our investment portfolio; and

 

   

the quality of our portfolio relative to the investments generated by ARC Advisor and its affiliates for their own account and for their other clients.

Under our charter, we can only pay ARC Advisor a disposition fee in connection with the sale of a property or other asset if it provides a substantial amount of the services in the effort to sell the property or asset. If a third-party broker is involved in the disposition and ARC Advisor has provided a substantial amount of services in connection with the sale of the assets, ARC Advisor may receive up to one-half of the brokerage commission paid so long as the commission paid does not exceed 3.0% of the sales price of the property or other asset. If no brokerage commission to a third-party broker is paid, ARC Advisor may receive a commission of up to 3.0% of the sales price of the property or other asset. Although our charter limits this commission to 3.0% of the sales price, our advisory agreement provides for a 2.0% fee. The payment of a disposition fee would require the approval of a majority of the members of our conflicts committee. Moreover, our charter also provides that the commission, when added to all other disposition fees paid to unaffiliated parties in connection with the sale, may not exceed the lesser of a competitive real estate commission or 6.0% of the sales price of the property or other asset. To the extent this

 

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disposition fee is paid upon the sale of any assets other than real property, it will count against the limit on “total operating expenses” described below. We do not intend to sell properties or other assets to affiliates. However, if we do sell an asset to an affiliate, our organizational documents would not prohibit us from paying our advisor a disposition fee. Before we sold an asset to an affiliate, our charter would require that the conflicts committee conclude, by a majority vote, that the transaction is fair and reasonable to us and on terms and conditions no less favorable to us than those available from third parties.

Our charter also requires that any gain from the sale of assets that we may pay our advisor or an entity affiliated with our advisor be reasonable. Such an interest in gain from the sale of assets is presumed reasonable if it does not exceed 15.0% of the balance of the net sale proceeds remaining after payment to common stockholders, in the aggregate, of an amount equal to 100% of the original issue price of the common stock, plus an amount equal to 6.0% of the original issue price of the common stock per year cumulative. Our advisory agreement sets a higher threshold for the payment of a subordinated incentive fee than that required by our charter. Under the advisory agreement, an incentive fee may be paid only if the stockholders first receive an 7.0% per year cumulative, noncompounded return. Any lowering of the threshold set forth in the advisory agreement would require the approval of a majority of the members of the conflicts committee. The subordinated incentive fee payable under the advisory agreement is a subordinated share of cash flows, whether from continuing operations, net sale proceeds or otherwise; however, to the extent that this incentive fee is derived from cash flows other than net sales proceeds, the incentive fee will count against the limit on “total operating expenses” described below.

If we ever decided to become self-managed by acquiring entities affiliated with our advisor, our charter would require that the conflicts committee conclude, by a majority vote, that such internalization transaction is fair and reasonable to us and on terms and conditions no less favorable to us than those available from third parties.

Our charter also limits the amount of acquisition fees and acquisition expenses we can incur to a total of 6.0% of the contract purchase price for the property or, in the case of a loan, our charter limits origination fees and expenses we can incur to 6.0% of the funds advanced. This limit may only be exceeded if the conflicts committee approves (by majority vote) the fees and expenses and finds the transaction to be commercially competitive, fair and reasonable to us. Although our charter permits combined acquisition fees and expenses to equal 6.0% of the purchase price, our advisory agreement limits the acquisition fee to 1.5% of the purchase price (including any acquisition expenses and any debt attributable to such investments). The advisory agreement does not provide for an origination fee. Any increase in the acquisition fee stipulated in the advisory agreement or the creation of an origination fee would require the approval of a majority of the members of the conflicts committee.

Term of Advisory Agreement. Each contract for the services of our advisor may not exceed one year, although there is no limit on the number of times that we may retain a particular advisor. The conflicts committee or our advisor may terminate our advisory agreement with ARC Advisor without cause or penalty on 60 days’ written notice. In such event, ARC Advisor must cooperate with us and our directors in making an orderly transition of the advisory function.

Upon termination of the advisory agreement, our advisor shall be entitled to a subordinated termination fee. The subordinated termination fee, if any, will equal to the sum of (a) 15.0% of the amount, if any, by which (1) the fair market value of our assets on the termination date, less any indebtedness secured by such assets, plus total distributions paid through the termination date (excluding stock dividends and distributions on redeemed shares), exceeds (2) the sum of the total amount of capital raised from stockholders (less amounts paid to repurchase shares of our common stock pursuant to our share repurchase plan) and the total amount of cash that, if distributed to them as of the termination date,

 

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would have provided them an annual 7.0% cumulative, non-compounded return on the gross proceeds from the sale of shares of our common stock through the termination date, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor or its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties). In addition, our advisor may elect to defer its right to receive a subordinated termination fee until either a listing or other liquidity event occurs, including a liquidation, sale of substantially all of our assets or merger in which our stockholders receive in exchange for their shares of our common stock shares of a company that are traded on a national securities exchange.

If our advisor elects to defer its right to receive a subordinated termination fee and there is a listing of the shares of our common stock on a national securities exchange or a merger in which our stockholders receive in exchange for their shares of our common stock shares of a company that are traded on a national securities exchange, then our advisor will be entitled to receive a subordinated termination fee in an amount equal to 15.0% of the amount, if any, by which the sum of (a) (1) the fair market value of our assets (determined as of the listing date or merger date, as applicable) owned as of the termination of the advisory agreement, plus any assets acquired after such termination for which our advisor would have been entitled to receive an acquisition fee (referred to herein as the “included assets”) less any indebtedness secured by these assets, plus the cumulative distributions made by our operating partnership to us and the limited partners who received partnership units in connection with the acquisition of the included assets, from our inception through the listing date or merger date, as applicable, exceeds (2) the sum of the total amount of capital raised from stockholders and the capital value of partnership units issued in connection with the acquisition of the included assets through the listing date or merger date, as applicable (excluding any capital raised after the completion of this offering) (less amounts paid to repurchase shares of our common stock pursuant to our share repurchase plan), plus an amount equal to an annual 7.0% cumulative, non-compounded return on the total amount of capital raised from shareholders and the capital value of such partnership units measured for the period from inception through the listing date or merger date, as applicable, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor or its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties).

If our advisor elects to defer its right to receive a subordinated termination fee and there is a liquidation or sale of all or substantially all of the assets of the operating partnership, then our advisor will be entitled to receive a subordinated termination fee in an amount equal to the sum of (a) 15.0% of the net proceeds from the sale of our assets owned as of the termination of the advisory agreement and the included assets, after subtracting the sum of (1) the total amount of capital raised from stockholders and the capital value of partnership units issued in connection with the acquisition of the included assets through the date of the liquidity event plus (2) an amount equal to an annual 7.0% cumulative, non-compounded return on such initial invested capital and the capital value of such partnership units measured for the period from inception through the date of the liquidity event date, plus (b) deemed real estate commissions equal to 3.0% of the contract sales price that would have been paid to the advisor or its affiliates (assuming the sale of substantially all the assets of the operating partnership at the date of termination of the advisory agreement at fair market value on such date; provided that in no event may such deemed real estate commissions exceed the aggregate reasonable, customary and competitive real estate commission in light of the size, type and location of the properties). If our advisor receives the subordinated incentive fee, it would no longer be entitled to receive subordinated distributions of net sales

 

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proceeds or the subordinated termination fee. If our advisor receives the subordinated termination fee, it would no longer be entitled to receive subordinated distributions of net sales proceeds or the subordinated incentive fee. There are many additional conditions and restrictions on the amount of compensation our advisor and its affiliates may receive.

Our Acquisitions. We will not purchase or lease properties in which ARC Advisor, Phillips Edison Sub-Advisor, any of our directors or officers or any of their respective affiliates has an interest without a determination by a majority of the conflicts committee that such transaction is fair and reasonable to us and at a price to us no greater than the cost of the property to the affiliated seller or lessor, unless there is substantial justification for the excess amount. In no event will we acquire any such property at an amount in excess of its current appraised value as determined by an independent expert selected by our independent directors not otherwise interested in the transaction. An appraisal is “current” if obtained within the prior year. If a property with a current appraisal is acquired indirectly from an affiliated seller through the acquisition of securities in an entity that directly or indirectly owns the property, a second appraisal on the value of the securities of the entity shall not be required if (1) the conflicts committee determines that such transaction is fair and reasonable, (2) the transaction is at a price to us no greater than the cost of the securities to the affiliated seller, (3) the entity has conducted no business other than the financing, acquisition and ownership of the property and (4) the price paid by the entity to acquire the property did not exceed the current appraised value.

Mortgage Loans Involving Affiliates. Our charter prohibits us from investing in or making mortgage loans in which the transaction is with ARC Advisor, Phillips Edison Sub-Advisor, our directors or officers or any of their respective affiliates, unless an independent expert appraises the underlying property. We must keep the appraisal for at least five years and make it available for inspection and duplication by any of our stockholders. In addition, we must obtain a mortgagee’s or owner’s title insurance policy or commitment as to the priority of the mortgage or the condition of the title. Our charter prohibits us from making or investing in any mortgage loans that are subordinate to any mortgage or equity interest of ARC Advisor, Phillips Edison Sub-Advisor, our directors or officers or any of their respective affiliates.

Other Transactions Involving Affiliates. A majority of the conflicts committee must conclude that all other transactions between us and ARC Advisor, Phillips Edison Sub-Advisor, any of our officers or directors or any of their respective affiliates are fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.

Limitation on Operating Expenses. Commencing upon the earlier to occur of the four fiscal quarters after (1) we make our first investment or (2) six months after the commencement of this offering, ARC Advisor must reimburse us the amount by which our aggregate total operating expenses for the four fiscal quarters then ended exceed the greater of 2.0% of our average invested assets or 25.0% of our net income, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. “Average invested assets” means the average monthly book value of our assets during the 12-month period before deducting depreciation, bad debts or other non-cash reserves. “Total operating expenses” means all expenses paid or incurred by us, as determined under GAAP, that are in any way related to our operation, including advisory fees, but excluding: (1) the expenses of raising capital such as organization and offering expenses, legal, audit, accounting, underwriting, brokerage, listing, registration and other fees, printing and other such expenses and taxes incurred in connection with the issuance, distribution, transfer, registration and stock exchange listing of our stock; (2) interest payments; (3) taxes; (4) non-cash expenditures such as depreciation, amortization and bad debt reserves; (5) reasonable incentive fees based on the gain from the sale of our assets and (6) acquisition fees, origination fees, acquisition and origination expenses (including expenses relating to potential investments that we do not close), disposition fees on the resale of property and other expenses

 

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connected with the acquisition, origination, disposition and ownership of real estate interests, loans or other property (other than disposition fees on the sale of assets other than real property), including the costs of foreclosure, insurance premiums, legal services, maintenance, repair and improvement of property.

Issuance of Options and Warrants to Certain Affiliates. Until our shares of common stock are listed on a national securities exchange, we will not issue options or warrants to purchase our capital stock to ARC Advisor, Phillips Edison Sub-Advisor, our directors, the sponsors or any of their respective affiliates, except on the same terms as such options or warrants are sold to the general public. We may issue options or warrants to persons other than ARC Advisor, Phillips Edison Sub-Advisor, our directors, the sponsors and their respective affiliates prior to listing our common stock on a national securities exchange, but not at exercise prices less than the fair market value of the underlying securities on the date of grant and not for consideration (which may include services) that in the judgment of the conflicts committee has a market value less than the value of such option or warrant on the date of grant. Any options or warrants we issue to ARC Advisor, Phillips Edison Sub-Advisor, our directors, the sponsors or any of their respective affiliates shall not exceed an amount equal to 10.0% of the outstanding shares of our capital stock on the date of grant.

Repurchase of Our Shares. Our charter prohibits us from paying a fee to ARC Advisor, Phillips Edison Sub-Advisor, or our directors or officers or any of their respective affiliates in connection with our repurchase of our capital stock.

Loans. We will not make any loans to ARC Advisor, Phillips Edison Sub-Advisor, or to our directors or officers or any of their respective affiliates. In addition, we will not borrow from these affiliates unless a majority of the conflicts committee approves the transaction as being fair, competitive and commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties. These restrictions on loans will only apply to advances of cash that are commonly viewed as loans, as determined by the board of directors. By way of example only, the prohibition on loans would not restrict advances of cash for legal expenses or other costs incurred as a result of any legal action for which indemnification is being sought nor would the prohibition limit our ability to advance reimbursable expenses incurred by directors or officers or ARC Advisor, Phillips Edison Sub-Advisor, or their respective affiliates.

Reports to Stockholders. Our charter requires that we prepare an annual report and deliver it to our stockholders within 120 days after the end of each fiscal year. Our directors are required to take reasonable steps to ensure that the annual report complies with our charter provisions. Among the matters that must be included in the annual report or included in a proxy statement delivered with the annual report are:

 

   

financial statements prepared in accordance with GAAP that are audited and reported on by an independent registered public accounting firm;

 

   

the ratio of the costs of raising capital during the year to the capital raised;

 

   

the aggregate amount of advisory fees and the aggregate amount of other fees paid to ARC Advisor and any affiliates of ARC Advisor by us or third parties doing business with us during the year;

 

   

our total operating expenses for the year stated as a percentage of our average invested assets and as a percentage of our net income;

 

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a report from the conflicts committee that our policies are in the best interests of our common stockholders and the basis for such determination; and

 

   

a separately stated, full disclosure of all material terms, factors and circumstances surrounding any and all transactions involving us and our advisor, a director or any affiliate thereof during the year, which disclosure has been examined and commented upon in the report by the conflicts committee with regard to the fairness of such transactions.

Voting of Shares Owned by Affiliates. Before becoming a stockholder, our advisor, our sub-advisor, our directors and officers and their respective affiliates must agree not to vote their shares regarding (1) the removal of any of these affiliates or (2) any transaction between them and us.

Phillips Edison Sub-Advisor has agreed to abstain from voting any shares it acquires in any vote regarding (1) the removal of ARC Advisor or any affiliate of ARC Advisor, (2) the removal of Phillips Edison Sub-Advisor or any affiliate of Phillips Edison Sub-Advisor, (3) any transaction between us and ARC Advisor or any of its affiliates and (4) any transaction between us and Phillips Edison Sub-Advisor or any of its affiliates. Phillips Edison Sub-Advisor has agreed to vote any shares of our common stock it owns in favor of any person nominated by ARC Advisor for our board of directors. Any person nominated by ARC Advisor for our board of directors who is elected to the board will have executed an advance letter of resignation from our board immediately effective upon the termination of ARC Advisor as our advisor, if such termination shall ever occur. ARC Advisor has agreed to vote any shares of our common stock it owns in favor of any person nominated by Phillips Edison Sub-Advisor for our board of directors.

If ARC Advisor’s nominee to the board of directors is not elected by our stockholders at anytime during the first five years of this offering, ARC Advisor will appoint an individual to observe meetings of the board of directors and committees. The board observer would not be a member of the board of directors or be entitled to vote on any matters brought before the board or a committee of the board. The board observer would not have access to certain meetings of the independent directors and would not be able to review legally privileged materials presented to the board. The board observer would resign from his or her position upon the earlier to occur of (1) the fifth anniversary of the commencement of this initial public offering and (2) our termination of ARC Advisor as our advisor.

Ratification of Charter Provisions. Our board of directors and the conflicts committee have reviewed and ratified our charter by the vote of a majority of their respective members, as required by our charter.

 

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INVESTMENT OBJECTIVES AND CRITERIA

General

We will invest primarily in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million per property. The shopping centers will have a mix of national, regional, and local retailers who sell essential goods and services to customers who live in the neighborhood. We expect to build a high quality portfolio with the following characteristics:

 

   

Necessity Based Retail—We expect to acquire well-occupied shopping centers that focus on serving the day-to-day shopping needs of the community in the surrounding trade area (e.g. grocery stores, general merchandise stores, discount stores, drug stores, restaurants, and neighborhood service providers);

 

   

Diversified Portfolio—Once we have substantially invested all of the proceeds of this offering, we expect to acquire a well diversified portfolio based on geography, anchor tenant diversity, tenant mix, lease expirations, and other factors;

 

   

Infill Locations—We will target properties in more densely populated locations with higher barriers to entry which limits additional competition;

 

   

Growth Markets—Our properties will be located in established or growing markets based on trends in population growth, employment, household income, employment diversification, and other key demographic factors; and

 

   

Discount To Replacement Cost—In the current acquisition environment, we expect to acquire properties at values based on current rents and at a substantial discount to replacement cost.

We will focus on maximizing shareholder value and some of the key elements of our financial strategy include:

 

   

Institutional Seasoned Management—We will acquire and manage the portfolio through our advisor and sub-advisor and their affiliates, including Phillips Edison sponsor’s seasoned team of professional managers with over 180 years of combined operating history and extensive knowledge and expertise in the retail sector;

 

   

National Platform—We will provide reliable execution of the investment and operating strategies through our advisor and sub-advisor and their affiliates who have a fully integrated, scalable, national operating platform with extensive knowledge of the retail marketplace and established national tenant relationships;

 

   

Property Focus—We will utilize a property-specific focus that combines intensive leasing and merchandising plans with cost containment measures and delivers a more solid and stable income stream;

 

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Stable Dividend—We expect to pay monthly distributions to our shareholders that will be covered by FFO;

 

   

Low Leverage—We will target a prudent leverage strategy with no more than a 50.0% loan to value ratio on our portfolio (calculated once we have invested substantially all of the offering proceeds);

 

   

Upside Potential—We expect our portfolio to have upside potential from a combination of lease-up, rent growth, cost containment and increased cash flow; and

 

   

Exit Strategy—We expect to sell our assets, sell or merge our company, or list our company within three to five years after the end of this offering.

Our primary investment objectives are:

 

   

to provide you with stable cash distributions;

 

   

to preserve and protect your capital contribution;

 

   

to realize growth in the value of our assets upon the sale of such assets; and

 

   

to provide you with the potential for future liquidity through the sale of our assets, a sale or merger of our company, a listing of our common stock on a national securities exchange, or other similar transaction. See “—Exit Strategy—Liquidity Event.”

Necessity- and Grocery-Anchored Retail Properties Focus

We will invest primarily in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million per property. The shopping centers will have a mix of national, regional, and local retailers who sell essential goods and services to customers who live in the neighborhood. We believe necessity- and grocery-anchored retail is one of the most stable asset classes in real estate. Necessity- and grocery-oriented retail creates consistent consumer demand for goods and services typically located within neighborhood and community shopping centers in both economic upturns and downturns. Neighborhood shopping centers typically are between 30,000 and 150,000 square feet and provide consumers with convenience goods such as food and drugs and services for the daily living needs of residents in the immediate neighborhood. Community shopping centers generally are between 100,000 and 350,000 square feet and typically contain multiple anchors and provide facilities for the sale of apparel, accessories, home fashion, hardware or appliances in addition to the convenience goods provided by a grocery-anchored neighborhood retail shopping center. We define “well-located” as retail properties situated in more densely populated locations with higher barriers to entry which limits additional competition. We define “well occupied” as retail properties with typically 80.0% or greater occupancy at the time of purchase. However, there can be no assurance the historical stability of necessity-based retail real estate will continue in the future. See “Risk Factors—General Risks Related to Investments in Real Estate.”

Other Real Estate and Real Estate-Related Loans and Securities

Although not our primary focus, we may, from time to time, make investments in other real estate properties and real estate-related loans and securities. We do not expect these types of assets to exceed 10.0% of the proceeds of this offering, assuming we sell the maximum offering amount, or to represent a

 

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substantial portion of our assets at any one time. With respect to our investments in real estate-related assets, including mortgages, mezzanine, bridge and other loans, debt and derivative securities related to real estate, mortgage-backed securities and any non-controlling equity investments in other public REITs or real estate companies, we will primarily focus on investments in first mortgages secured by retail properties.

Real Estate Properties

We may pursue opportunities to acquire or develop lifestyle and power shopping centers which we believe provide higher average sales per square foot and lower common area maintenance costs compared to a traditional shopping mall. Lifestyle shopping centers typically provide open-air retail space that combine mixed-use commercial development with boutique stores geared to shoppers with higher disposable incomes. Power shopping centers also usually feature open-air retail space and contain three or more big box retailers and various smaller retailers.

We may invest in enhanced-return properties, which are higher-yield and higher-risk investments that may not be as well located or well occupied as the substantial majority of our neighborhood and community shopping center investments. Examples of enhanced-return properties that we may acquire and reposition include: properties with moderate vacancies or near-term lease rollovers; poorly managed and positioned properties; properties owned by distressed sellers; and build-to-suit properties. While we expect to focus on shopping center properties and related assets, our charter does not limit our investments to only those assets, and if we believe it to be in the best interests of our stockholders, we may also acquire additional real estate assets, such as office, multi-family, mixed-use, hospital, hospitality and industrial properties. The purchase of any property type will be based upon the best interests of our company and our stockholders as determined by our board of directors and taking into consideration the same factors discussed above. Additionally, we may acquire properties that are under development or construction, undeveloped land, options to purchase properties and other real estate assets. We may enter into arrangements with the seller or developer of a property whereby the seller or developer agrees that if, during a stated period, the property does not generate a specified cash flow, the seller or developer will pay in cash to us a sum necessary to reach the specified cash flow level, subject in some cases to negotiated dollar limitations. In fact, we may invest in whatever types of interests in real estate that we believe are in our best interests.

Although we can purchase any type of interest in real estate, our charter does limit certain types of investments, which we discuss below under “—Investment Limitations.” We do not expect to invest in properties located outside of the United States or in single-purpose properties, such as golf courses or specialized manufacturing buildings. We also do not intend to make loans to other persons (other than the loans described below), to underwrite securities of other issuers or to engage in the purchase and sale of any types of investments other than interests in real estate properties and real estate-related loans and securities.

Real Estate-Related Loans and Securities

In addition, we may invest in mortgage, bridge or mezzanine loans, and other loans and securities relating primarily to retail property, including loans in connection with the acquisition of investments in entities that own real property. These other real estate-related loans and securities may include mortgage, mezzanine, bridge and other loans; debt securities such as mortgage-backed securities and debt securities issued by other real estate companies; equity securities of real estate companies; and certain types of illiquid securities. Our criteria for investing in loans will be substantially the same as those involved in our investment in properties; however, we will also evaluate such investments based on the current income opportunities presented.

 

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Investments in Equity Securities

We may make equity investments in other REITs and other real estate companies that operate assets meeting our investment objectives. We may purchase the common or preferred stock of these entities or options to acquire their stock. We will target a public company that owns commercial real estate or real estate-related assets when we believe its stock is trading at a discount to that company’s net asset value. We may eventually seek to acquire or gain a controlling interest in the companies that we target. We do not expect our non-controlling equity investments in other public companies to exceed 5.0% of the proceeds of this offering, assuming we sell the maximum offering amount, or to represent a substantial portion of our assets at any one time. In addition, we do not expect our non-controlling equity investments in other public companies combined with our investments in real estate properties outside of our target shopping center investments and other real estate-related investments to exceed 10.0% of our portfolio, assuming we sell the maximum offering amount.

Acquisition Policies

Our advisor intends to diversify our portfolio by geographic region, tenant mix, investment size and investment risk so that event risk is minimized to achieve a portfolio of income-producing assets that provide a stable return for investors and preserve stockholders’ capital. We may make investments by acquiring single assets, portfolios of assets, other REITs or real estate companies.

Geography: Our affiliates have a national operating platform with over 25 million square feet comprised of 250 assets located in 35 states. We will initially focus on markets where our advisor’s and sub-advisor’s affiliates have an established market presence, market knowledge and access to potential investments, as well as an ability to efficiently direct property management and leasing operations.

Our initial target markets will have the following characteristics:

 

   

Infill locations with high barriers-of-entry, such as zoning and land use restrictions; and

 

   

Growth markets with strong demographic growth, such as employment, household income, and economic diversity.

Additionally, our advisor will pursue on a selective basis properties in other markets demonstrating strong fundamentals, national or regional credit tenants, as described below, and attractive pricing. Economic and real estate market conditions vary widely within each region and submarket, and we intend to spread our portfolio investments across the United States.

Tenant Mix: We expect that the anchor tenants underlying our investments, whether retail properties or real estate-related loans and securities, will be primarily large national or regional companies, or their operating subsidiaries, each with an extensive operating history and a financial profile that satisfies our credit underwriting standards. We refer to these tenants as “credit tenants.” We do not expect our exposure to any one tenant in our portfolio to be more than 10.0% of revenues, assuming revenues generated from a portfolio assembled using the maximum offering proceeds. By diversifying our tenant portfolio, we believe we will minimize our exposure to any single tenant default or bankruptcy, which we refer to as “event risk,” and the negative impact any such event would have on our overall revenues. In addition, we believe our national and regional relationships will serve a mutual benefit to retailers and our assets through both tenant retention and expansion, and efficient management of properties in our portfolio.

 

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Investment Size and Term: We expect the majority of our investments will typically be less than $20.0 million; however, we may make investments above or below this amount to complement our portfolio and meet our investment objectives.

We intend to hold our properties for four to seven years, which we believe is the optimal period to enable us to capitalize on the potential for increased income and capital appreciation of properties. We expect to sell our assets, sell or merge our company, or list our company within three to five years after the end of this offering. However, economic and market conditions may influence us to hold our investments for different periods of time.

Real Property Investment Considerations. Our advisor or sub-advisor will perform in-depth review of each property acquired in the portfolio, including, but not limited to:

 

   

geographic location and property type;

 

   

condition and use of the property;

 

   

market growth demographics;

 

   

historical performance;

 

   

current and projected cash flow;

 

   

potential for capital appreciation;

 

   

presence of existing and potential competition;

 

   

prospects for liquidity through sale, financing or refinancing of the assets; and

 

   

tax considerations.

Conditions to Closing Real Property Investments. Our advisor or sub-advisor will perform a diligence review on each property that we purchase. As part of this review, our advisor or sub-advisor will generally obtain an environmental site assessment for each proposed acquisition (which at a minimum will include a Phase I assessment). We will not close the purchase of any property unless we are satisfied with the environmental status of the property. Typically, our property acquisitions will also be supported by an appraisal prepared by a competent, independent appraiser who is a member-in-good standing of the Appraisal Institute. Our investment policy currently provides that the purchase price of each property will not exceed its appraised value at the time we acquire the property. Appraisals, however, are estimates of value and should not be relied upon as measures of true worth or realizable value. We will also generally seek to condition our obligation to close the purchase of any investment on the delivery of certain documents from the seller or developer. Such documents may include, where available:

 

   

plans and specifications;

 

   

surveys;

 

   

evidence of marketable title, subject to such liens and encumbrances as are acceptable to our advisor or sub-advisor;

 

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title and liability insurance policies; and

 

   

financial statements covering recent operations of properties having operating histories.

Tenant Improvements. We anticipate that tenant improvements required at the time we acquire a property will be funded from our offering proceeds. However, at such time as a tenant of one of our properties does not renew its lease or otherwise vacates its space in one of our buildings, it is likely that, in order to attract new tenants, we may be required to expend substantial funds for tenant improvements and tenant refurbishments to the vacated space. We would expect to fund those improvements with offering proceeds, through third-party financings or working capital.

Terms of Leases. We expect that the vast majority of the leases we enter or acquire will provide for tenant reimbursement of operating expenses. Operating expenses typically include real estate taxes, special assessments, insurance, utilities, common area maintenance and some building repairs. We also intend to include provisions in our leases that increase the amount of base rent payable at various points during the lease term and/or provide for the payment of additional rent calculated as a percentage of a tenant’s gross sales above predetermined thresholds. However, the terms and conditions of any leases we enter into may vary substantially from those described. To the extent material to our operations, we will describe the terms of the leases on properties we acquire by means of a supplement to this prospectus.

Tenant Creditworthiness. We will execute new tenant leases and tenant lease renewals, expansions and extensions with terms dictated by the current submarket conditions and the creditworthiness of each particular tenant. We will use a number of industry credit rating services to determine the creditworthiness of potential tenants and personal guarantors or corporate guarantors of potential tenants. We will compare the reports produced by these services to the relevant financial data collected from these parties before consummating a lease transaction. Relevant financial data from potential tenants and guarantors include income statements and balance sheets for the current year and for prior periods, net worth or cash flow statements of guarantors and other information we deem relevant.

Real Estate-Related Loans and Securities Considerations. Although not our primary focus, we may, from time to time, make or invest in mortgage, bridge or mezzanine loans, and other loans relating to real property, including loans in connection with the acquisition of investments in entities that own real property. Our criteria for investing in loans will be substantially the same as those involved in our investment in properties; however, we will also evaluate such investments based on the current income opportunities presented. When determining whether to make investments in mortgage and other loans and securities, we will consider such factors as: positioning the overall portfolio to achieve an optimal mix of real estate properties and real estate-related loans and securities; the diversification benefits of the loans relative to the rest of the portfolio; the potential for the investment to deliver high current income and attractive risk-adjusted total returns; and other factors considered important to meeting our investment objectives.

We may acquire or retain loan servicing rights in connection with investments in real estate-related loans that we acquire or originate. If we retain the loan servicing rights, our advisor, sub-advisor or one of their respective affiliates will service the loan or select a third-party provider to do so. We may structure, underwrite and originate some of the debt products in which we invest. Our underwriting process will involve comprehensive financial, structural, operational and legal due diligence to assess the risks of investments so that we can optimize pricing and structuring.

Our loan investments may be subject to regulation by federal, state and local authorities and subject to laws and judicial and administrative decisions imposing various requirements and restrictions, including, among other things, regulating credit granting activities, establishing maximum interest rates

 

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and finance charges, requiring disclosure to customers, governing secured transactions and setting collection, repossession and claims handling procedures and other trade practices. In addition, certain states have enacted legislation requiring the licensing of mortgage bankers or other lenders, and these requirements may affect our ability to effectuate our proposed investments in loans.

We will not make or invest in mortgage loans on any one property if the aggregate amount of all mortgage loans outstanding on the property, including our borrowings, would exceed an amount equal to 85.0% of the appraised value of the property, unless we find substantial justification due to the presence of other underwriting criteria. We may find such justification in connection with the purchase of mortgage loans in cases in which we believe there is a high probability of our foreclosure upon the property in order to acquire the underlying assets and in which the cost of the mortgage loan investment does not exceed the appraised value of the underlying property. Such mortgages may or may not be insured or guaranteed by a governmental agency or another third party.

Acquisition of Properties from Our Affiliates

We are not precluded form acquiring real properties, directly or through joint ventures, from our affiliates, including acquisitions of real properties from our affiliates or programs sponsored by Phillips Edison or ARC. Any such acquisitions will be approved consistent with the conflict of interest procedures described in this prospectus, including approval by a majority of the conflicts committee and independent third party appraisal of such asset to be acquired.

Joint Ventures /Co-Investments

We will generally hold fee title or a long-term leasehold estate in the properties we acquire. We may also enter into joint ventures, partnerships and other co-ownership arrangements or participations with third parties as well as entities affiliated with our advisor or sub-advisor for the purpose of obtaining interests in real estate properties and other real estate investments. We may also enter into joint ventures for the development or improvement of properties. Joint venture investments permit us to own interests in large properties and other investments without unduly restricting the diversity of our portfolio, allow us to potentially increase the return on invested capital, promote our brand name and increase market share and help us to obtain the participation of sophisticated partners in our real estate decisions. In determining whether to invest in a particular joint venture, our advisor will evaluate the real estate properties and/or real estate-related assets that such joint venture owns or is being formed to own under the same criteria described elsewhere in this prospectus for the selection of our investments.

Our advisor or sub-advisor will also evaluate the potential joint venture partner as to its financial condition, operating capabilities and integrity. If the potential joint venture partner is an affiliate of our advisor or sub-advisor, we will only enter into such joint venture if a majority of our directors, including a majority of our independent directors, approve the transaction as being fair and reasonable to us and on substantially the same terms and conditions as those received by other joint venturers.

We have not established the specific terms we will require in the joint venture agreements we may enter. Instead, we will establish the terms with respect to any particular joint venture agreement on a case-by-case basis after our board of directors considers all of the facts that are relevant, such as the nature and attributes of our other potential joint venture partners, the proposed structure of the joint venture, the nature of the operations, the liabilities and assets associated with the proposed joint venture and the size of our interest when compared to the interests owned by other partners in the venture. With respect to any joint venture we enter, we expect to consider the following types of concerns and safeguards:

 

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Our ability to manage and control the joint venture—we will consider whether we should obtain certain approval rights in joint ventures we do not control. For proposed joint ventures in which we are to share control with another co-venturer, we will consider the procedures to address decisions in the event of an impasse.

 

   

Our ability to exit a joint venture—we will consider requiring buy/sell rights, redemption rights or forced liquidation rights.

 

   

Our ability to control transfers of interests held by other partners to the joint venture—we will consider requiring consent provisions, a right of first refusal and/or forced redemption rights in connection with transfers.

Borrowing Policies

We may use borrowing proceeds to finance acquisitions of new properties or other real estate-related loans and securities; or to originate new loans; to pay for capital improvements, repairs or tenant build-outs to properties; to pay distributions; or to provide working capital. Careful use of debt will help us to achieve our diversification goals because we will have more funds available for investment. Our investment strategy is to utilize primarily secured and possibly unsecured debt to finance our investment portfolio; however, given the current debt market environment, we may elect to forego the use of debt on some or all of our future real estate acquisitions. We may elect to secure financing subsequent to the acquisition date on future real estate properties and initially acquire investments without debt financing. To the extent that we do not finance our properties and other investments, our ability to acquire additional properties and real estate-related investments will be restricted.

Once we have fully invested the proceeds of this offering, we expect our debt financing to be between 50.0% of the value of our tangible assets (calculated after the close of this offering and once we have invested substantially all of the proceeds of this offering), but may be as high as 65.0%, although the constraints imposed by the current debt market may result in leverage below this target range. There is no limit on the amount we may borrow for the purchase of any single asset. Our charter limits our borrowings to 75.0% of the cost (before deducting depreciation or other noncash reserves) of our tangible assets; however, we may exceed that limit if the majority of the conflicts committee approves each borrowing in excess of our charter limitation and we disclose such borrowings to our stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. During the early stages of this offering, and to the extent financing in excess of our charter limit is available at attractive terms, the majority of our conflicts committee may approve debt in excess of this limit. In all events, we expect that our secured and unsecured borrowings will be reasonable in relation to the net value of our assets and will be reviewed by our board of directors at least quarterly.

The form of our indebtedness may be long-term or short-term, secured or unsecured, fixed or floating rate or in the form of a revolving credit facility or repurchase agreements or warehouse lines of credit. Our advisor will seek to obtain financing on our behalf on the most favorable terms available. For a discussion of the risks associated with the use of debt, see “Risk Factors—Risks Associated with Debt Financing.”

Except with respect to the borrowing limits contained in our charter, we may reevaluate and change our debt policy in the future without a stockholder vote. Factors that we would consider when reevaluating or changing our debt policy include: then-current economic conditions, the relative cost and availability of debt and equity capital, any investment opportunities, the ability of our properties and other investments to generate sufficient cash flow to cover debt service requirements and other similar factors.

 

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Further, we may increase or decrease our ratio of debt to book value in connection with any change of our borrowing policies.

We will not borrow from our advisor or its affiliates to purchase properties or make other investments unless a majority of the conflicts committee approves the transaction as being fair, competitive and commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties.

Certain Risk Management Policies

Credit Risk Management. We may be exposed to various levels of credit and special hazard risk depending on the nature of our underlying assets and the nature and level of credit enhancements supporting our assets. Our advisor or sub-advisor will review and monitor credit risk and other risks of loss associated with each investment. In addition, we will seek to diversify our portfolio of assets to avoid undue geographic and other types of concentrations to the extent consistent with our investment objectives, focus and policies. Our board of directors will monitor the overall portfolio risk and levels of provision for loss.

Interest Rate Risk Management. Consistent with our intention to qualify as a REIT, we will follow an interest rate risk management policy intended to mitigate the negative effects of major interest rate changes. We intend to minimize our interest rate risk from borrowings by attempting to structure the key terms of our borrowings to generally correspond to the interest rate term of our assets and through hedging activities.

Hedging Activities. Consistent with our intention to qualify as a REIT, we may engage in hedging transactions to protect our investment portfolio from interest rate fluctuations and other changes in market conditions. These transactions may include interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, mortgage derivatives and other hedging instruments. These instruments may be used to hedge as much of the interest rate risk as we determine is in the best interest of our stockholders, given the cost of such hedges and the need to maintain our qualification as a REIT. We may from time to time enter into interest rate swap agreements to offset the potential adverse effects of rising interest rates under certain short-term repurchase agreements. We may elect to bear a level of interest rate risk that could otherwise be hedged when we believe, based on all relevant facts, that bearing such risk is advisable.

Equity Capital Policies

Our board of directors may increase the number of authorized shares of capital stock without stockholder approval. After your purchase in this offering, our board may elect to: (1) sell additional shares in this or future public offerings, (2) issue equity interests in private offerings, (3) issue shares to our advisor, or its successors or assigns, in payment of an outstanding fee obligation, (4) issue shares to our independent directors pursuant to our 2010 Independent Director Stock Plan or (5) issue shares of our common stock to sellers of assets we acquire in connection with an exchange of limited partnership interests of the operating partnership. To the extent we issue additional equity interests after your purchase in this offering, your percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our investments, you may also experience dilution in the book value and fair value of your shares.

 

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Disposition Policies

We expect to hold real property investments for four to seven years, which we believe is the optimal period to enable us to capitalize on the potential for increased income and capital appreciation. The period that we will hold our investments in real estate-related assets will vary depending on the type of asset, interest rates and other factors. Our advisor or sub-advisor will develop a well-defined exit strategy for each investment we make, initially at the time of acquisition as part of the original business plan for the asset, and thereafter by periodically reviewing each asset to determine the optimal time to sell the asset and generate a strong return. The determination of when a particular investment should be sold or otherwise disposed of will be made after considering relevant factors, including prevailing and projected economic conditions, whether the value of the asset is anticipated to decline substantially, whether we could apply the proceeds from the sale of the asset to make other investments consistent with our investment objectives, whether disposition of the asset would allow us to increase cash flow, and whether the sale of the asset would constitute a prohibited transaction under the Internal Revenue Code or otherwise impact our status as a REIT.

Exit Strategy—Liquidity Event

It is our intention to begin the process of achieving a Liquidity Event not later than three to five years after the termination of this primary offering. A “Liquidity Event” could include a sale of our assets, a sale or merger of our company, a listing of our common stock on a national securities exchange, or other similar transaction.

If we do not begin the process of achieving a Liquidity Event by the fifth anniversary of the termination of this offering, our charter requires either (1) an amendment to our charter to extend the deadline to begin the process of achieving a Liquidity Event or (2) the holding of a stockholders meeting to vote on a proposal for an orderly liquidation of our portfolio.

If we sought and failed to obtain stockholder approval of a charter amendment extending the deadline with respect to a Liquidity Event, our charter requires us to submit a plan of liquidation for the approval of our stockholders. If we sought and obtained stockholder approval of our liquidation, we would begin an orderly sale of our properties and other assets. The precise timing of such sales would take account of the prevailing real estate and financial markets, the economic conditions in the submarkets where our properties are located and the U.S. federal income tax consequences to our stockholders. In making the decision to apply for listing of our shares, our directors will try to determine whether listing our shares or liquidating our assets will result in greater value for stockholders.

One of the factors our board of directors will consider when making the determination of whether to list our shares of common stock on a national securities exchange is the liquidity needs of our stockholders. In assessing whether to list, our board of directors would likely solicit input from financial advisors as to the likely demand for our shares upon listing. If, after listing, the board believed that it would be difficult for stockholders to dispose of their shares, then that factor would weigh against listing. However, this would not be the only factor considered by the board. If listing still appeared to be in the best long-term interest of our stockholders, despite the prospects of a relatively small market for our shares upon the initial listing, the board may still opt to list our shares of common stock in keeping with its obligations under Maryland law. The board and the conflicts committee would also likely consider whether there was a large pent-up demand to sell our shares when making decisions regarding listing or liquidation. The degree of participation in our dividend reinvestment plan and the number of requests for redemptions under the share redemption program at this time could be an indicator of stockholder demand to liquidate their investment.

 

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Our board may revise our investment policies, which we describe in more detail below, without our stockholders’ approval. Our conflicts committee must review our investment policies at least annually to determine whether our policies are in the best interests of our stockholders. Our charter requires that the conflicts committee include the basis for its determination in the board of directors’ minutes and in an annual report delivered to stockholders.

Investment Limitations

Our charter places numerous limitations on us with respect to the manner in which we may invest our funds or issue securities. These limitations cannot be changed unless our charter is amended, which requires approval of our stockholders. Unless the charter is amended, we will not:

 

   

borrow in excess of 75.0% of the aggregate cost (before deducting depreciation or other non-cash reserves) of tangible assets owned by us, unless approved by a majority of the conflicts committee;

 

   

invest more than 10.0% of our total assets in unimproved property or mortgage loans on unimproved property, which we define as property not acquired for the purpose of producing rental or other operating income or on which there is no development or construction in progress or planned to commence within one year;

 

   

make or invest in mortgage loans unless an appraisal is obtained concerning the underlying property, except for those mortgage loans insured or guaranteed by a government or government agency;

 

   

make or invest in mortgage loans, including construction loans, on any one property if the aggregate amount of all mortgage loans on such property would exceed an amount equal to 85.0% of the appraised value of such property as determined by appraisal, unless substantial justification exists for exceeding such limit because of the presence of other underwriting criteria;

 

   

make an investment in a property if the related acquisition fees and acquisition expenses are not reasonable or exceed 6.0% of the purchase price of the property or, in the case of a loan, acquire or originate a loan if the related origination fees and expenses are not reasonable or exceed 6.0% of the funds advanced, provided that in the case of a property or loan, the investment may be made if a majority of the conflicts committee determines that the transaction is commercially competitive, fair and reasonable to us;

 

   

acquire equity securities unless a majority of our directors (including a majority of our conflicts committee) not otherwise interested in the transaction approves such investment as being fair, competitive and commercially reasonable, provided that investments in equity securities in “publicly traded entities” that are otherwise approved by a majority of our directors (including a majority of our conflicts committee) shall be deemed fair, competitive and commercially reasonable if we acquire the equity securities through a trade that is effected in a recognized securities market (a “publicly traded entity” shall mean any entity having securities listed on a national securities exchange or included for quotation on an inter—dealer quotation system), and provided further that this limitation does not apply to: (1) real estate acquisitions effected through the purchase of all of the equity securities of an existing entity, (2) the investment in wholly-owned subsidiaries of ours or (3) investments in mortgage-backed securities;

 

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invest in real estate contracts of sale, otherwise known as land sale contracts, unless the contract is in recordable form and is appropriately recorded in the chain of title;

 

   

invest in commodities or commodity futures contracts, except for futures contracts when used solely for the purpose of hedging in connection with our ordinary business of investing in real estate assets and mortgages;

 

   

issue equity securities on a deferred payment basis or similar arrangement;

 

   

issue debt securities in the absence of adequate cash flow to cover debt service unless the historical debt service coverage (in the most recently completed fiscal year), as adjusted for known changes, is sufficient to service that higher level of debt as determined by the board of directors or a duly authorized executive officer;

 

   

issue equity securities that are assessable after we have received the consideration for which our board of directors authorized their issuance; or

 

   

issue equity securities redeemable solely at the option of the holder, which restriction has no effect on our share redemption program or the ability of our operating partnership to issue redeemable partnership interests.

In addition, our charter includes many other investment limitations in connection with conflict-of-interest transactions, which limitations are described under “Conflicts of Interest.” Our charter also includes restrictions on roll-up transactions, which are described in the section, “Description of Shares.”

Disclosure Policies with Respect to Future Probable Acquisitions

As of the date of this prospectus, we have not acquired or contracted to acquire any specific real estate or real estate-related assets. Our advisor and sub-advisor are continually evaluating various potential investments and engaging in discussions and negotiations with sellers, developers and potential tenants regarding the purchase and development of properties and other investments for us. At such time while this offering is pending, if we believe that a reasonable probability exists that we will acquire a specific property or other asset, whether directly or through a joint venture or otherwise, this prospectus will be supplemented to disclose the negotiations and pending acquisition of such property. We expect that this will normally occur upon the signing of a purchase agreement for the acquisition of a specific asset, but may occur before or after such signing or upon the satisfaction or expiration of major contingencies in any such purchase agreement, depending on the particular circumstances surrounding each potential investment. A supplement to this prospectus will describe any improvements proposed to be constructed thereon and other information that we consider appropriate for an understanding of the transaction. Further data will be made available after any pending acquisition is consummated, also by means of a supplement to this prospectus, if appropriate. YOU SHOULD UNDERSTAND THAT THE DISCLOSURE OF ANY PROPOSED ACQUISITION CANNOT BE RELIED UPON AS AN ASSURANCE THAT WE WILL ULTIMATELY CONSUMMATE SUCH TRANSACTION OR THAT THE INFORMATION PROVIDED CONCERNING THE PROPOSED TRANSACTION WILL NOT CHANGE BETWEEN THE DATE OF THE SUPPLEMENT AND ANY ACTUAL PURCHASE.

Investment Limitations to Avoid Registration as an Investment Company

We do not intend to register as an investment company under the Investment Company Act of 1940, as amended. In order to maintain our exemption from regulation under the Investment Company Act, we intend to engage primarily in the business of buying real estate, mortgages and other liens on or

 

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interests in real estate. Our advisor will continually review our investment activity to attempt to ensure that we will not be regulated as an investment company. Among other things, our advisor will attempt to monitor the proportion of our portfolio that is placed in various investments. The position of the SEC staff generally requires us to maintain at least 55.0% of our assets directly in qualifying real estate interests in order for us to maintain our exemption. To constitute a qualifying real estate interest under this 55.0% requirement, a real estate interest must meet various criteria.

To maintain compliance with the Investment Company Act exemption, 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 assets that we might not otherwise have acquired or may have to forego opportunities to acquire interests in companies that we would otherwise want to acquire and would be important to our investment strategy.

Change in Investment Objectives and Limitations

Our charter requires that our conflicts committee review our investment policies at least annually to determine that the policies we follow are in the best interests of our stockholders. Each determination and the basis therefore shall be set forth in the minutes of our board of directors. The methods of implementing our investment policies also may vary as new investment techniques are developed. The methods of implementing our investment objectives and policies, except as otherwise provided in the organizational documents, may be altered by a majority of our directors, including a majority of the conflicts committee, without the approval of our stockholders.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

We are a newly organized Maryland corporation that will invest primarily in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million. We define “well-located” as retail properties situated in more densely populated locations with higher barriers to entry which limits additional competition. We define “well occupied” as retail properties with typically 80.0% or greater occupancy at the time of purchase. We plan to diversify our portfolio by investment size and investment risk with the goal of attaining a portfolio of income producing real estate and real estate-related assets that provide stable returns to our investors. Assuming we sell the maximum offering amount, we intend to allocate approximately 90.0% of our portfolio to these types of retail investments and approximately 10.0% of our portfolio to other real estate properties and real estate-related assets such as mortgages, mezzanine, bridge and other loans; debt and derivative securities related to real estate assets, including mortgage-backed securities; and the equity securities of other REITs and real estate companies. We do not expect our non-controlling equity investments in other public companies to exceed 5.0% of the proceeds of this offering, assuming we sell the maximum offering amount, or to represent a substantial portion of our assets at any one time. Although this is our current target portfolio, we may make adjustments to our target portfolio based on real estate market conditions and investment opportunities. We will not forego a good investment because it does not precisely fit our expected portfolio composition. Thus, to the extent that our advisor presents us with good investment opportunities that allow us to meet the REIT requirements under the Internal Revenue Code, our portfolio composition may vary from what we initially expect. As of the date of this prospectus, we have not commenced operations nor have we identified any properties or other investments in which there is a reasonable probability that we will invest.

American Realty Capital II Advisors, LLC, an affiliate of our ARC sponsor, is our advisor. As our advisor, ARC Advisor will be responsible for coordinating the management of our day-to-day operations and for identifying and making investments in real estate properties on our behalf, subject to the supervision of our board of directors. Subject to the terms of the advisory agreement between ARC Advisor and us, ARC Advisor will delegate certain duties pursuant to the terms of the sub-advisory agreement between ARC Advisor and Phillips Edison Sub-Advisor, including the management of our day-to-day operations and our portfolio of real estate assets, to Phillips Edison & Company SubAdvisor LLC, which is indirectly wholly-owned by Phillips Edison Limited Partnership, and which we generally refer to throughout this prospectus as the “sub-advisor.” Notwithstanding such delegation to the sub-advisor, ARC Advisor retains ultimate responsibility for the performance of all the matters entrusted to it under the advisory agreement.

We expect that a substantial majority of our real properties will be managed and leased by Phillips Edison Property Manager, a newly formed Delaware limited liability company indirectly wholly-owned by our Phillips Edison sponsor. In the event that we contract directly with a non-affiliated third-party property manager in respect of a property, we will engage Phillips Edison Property Manager to provide oversight with respect to such property’s third-party property management. The property manager may also engage third parties for certain management or leasing services. Services to tenants that would threaten the qualification of the rents from such property as rents from real property will be provided by a TRS or an independent contractor from who we would receive no income.

 

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We intend to make an election to be taxed as a REIT under the Internal Revenue Code, beginning with the taxable year ending December 31, 2010, although such election may be postponed to our taxable year ending December 31, 2011. If we qualify as a REIT for U.S. federal income tax purposes, we generally will not be subject to U.S. federal income tax to the extent we distribute qualifying dividends to our stockholders. If we fail to qualify as a REIT in any taxable year after electing REIT status, we will be subject to U.S. federal income tax on our taxable income at regular U.S. federal corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for U.S. federal income tax purposes for four years following the year in which our qualification is denied. Such an event could materially and adversely affect our net income and cash available for distribution. However, we believe that we will be organized and will operate in a manner that will enable us to qualify for treatment as a REIT for U.S. federal income tax purposes beginning with our taxable year ending December 31, 2010 (or ending December 31, 2011, if our REIT election is postponed to our taxable year ending December 31, 2011), and we intend to continue to operate so as to remain qualified as a REIT for U.S. federal income tax purposes thereafter.

Liquidity and Capital Resources

We are dependent upon the net proceeds from this offering to conduct our proposed operations. We will obtain the capital required to purchase properties and other investments and conduct our operations from the proceeds of this offering and any future offerings we may conduct, from secured or unsecured financings from banks and other lenders and from any undistributed funds from our operations. As of the date of this prospectus, we have not made any investments in real estate or otherwise, and our total assets consist of $200,000 cash and $445,028 deferred offering costs. For information regarding the anticipated use of proceeds from this offering, see “Estimated Use of Proceeds.”

We will not sell any shares in this offering unless we raise a minimum of $2.5 million in gross offering proceeds from persons who are not affiliated with us or our sponsors. If we are unable to raise substantially more funds in the offering than the minimum offering amount, we will make fewer investments resulting in less diversification in terms of the type, number and size of investments we make and the value of an investment in us will fluctuate with the performance of the specific assets we acquire. Further, we will have certain fixed operating expenses, including certain expenses as a publicly offered REIT, regardless of whether we are able to raise substantial funds in this offering. Our inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, reducing our net income and limiting our ability to make distributions. We do not expect to establish a permanent reserve from our offering proceeds for maintenance and repairs of real properties, as we expect the vast majority of leases for the properties we acquire will provide for tenant reimbursement of operating expenses. However, to the extent that we have insufficient funds for such purposes, we may establish reserves from gross offering proceeds, out of cash flow from operations or net cash proceeds from the sale of properties.

We currently have no outstanding debt. Once we have fully invested the proceeds of this offering, we expect our debt financing to be approximately 50.0% of the value of our real estate investments (calculated after the close of this offering and once we have invested substantially all of the proceeds of this offering) plus the value of our other assets, but may be as high as 65.0%. Our charter does not limit us from incurring debt until our borrowings would exceed 75.0% of the cost (before deducting depreciation or other non-cash reserves) of our tangible assets, though we may exceed this limit under certain circumstances. During the early stages of this offering, we expect that the conflicts committee will approve debt in excess of this limit. In all events, we expect that our secured and unsecured borrowings will be reasonable in relation to the net value of our assets and will be reviewed by our board of directors at least quarterly.

 

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In addition to making investments in accordance with our investment objectives, we expect to use our capital resources to make certain payments to our advisor and the dealer manager. During our organization and offering stage, these payments will include payments to the dealer manager for selling commissions and the dealer manager fee and payments to the dealer manager and our advisor for reimbursement of certain organization and offering expenses. However, our advisor has agreed to reimburse us to the extent that selling commissions, the dealer manager fee and other organization and offering expenses incurred by us exceed 15.0% of our gross offering proceeds. During our acquisition and development stage, we expect to make payments to our advisor in connection with the selection and origination or purchase of real estate investments, the management of our assets and costs incurred by our advisor in providing services to us. For a discussion of the compensation to be paid to our advisor and the dealer manager, see “Compensation Table.” The advisory agreement has a one-year term but may be renewed for an unlimited number of successive one-year periods upon the mutual consent of ARC Advisor and our conflicts committee.

We intend to elect to be taxed as a REIT and to operate as a REIT beginning with our taxable year ending December 31, 2010, although such election may be postponed to our taxable year ending December 31, 2011. To maintain our qualification as a REIT, we will be required to make aggregate annual distributions to our stockholders of at least 90.0% of our REIT taxable income (computed without regard to the dividends paid deduction and excluding net capital gain). Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant. Once we commence paying distributions, we expect to pay distributions monthly and continue paying distributions monthly unless our results of operations, our general financial condition, general economic conditions or other factors make it imprudent to do so. The timing and amount of distributions will be determined by our board, in its sole discretion, may vary from time to time, and will be influenced in part by its intention to comply with REIT requirements of the Internal Revenue Code. We have not established a minimum distribution level.

Results of Operations

We were incorporated in the State of Maryland on October 13, 2009 and, as of the date of this prospectus, we have not commenced operations. We expect to use substantially all of the net proceeds from this offering to invest primarily in necessity-based neighborhood and community shopping centers throughout the United States with a focus on well-located grocery anchored shopping centers that are well occupied at the time of purchase and typically cost less than $20.0 million. In addition, we may invest in other retail properties including power and lifestyle shopping centers, multi-tenant shopping centers, free standing single-tenant retail properties, and other real estate and real estate-related loans and securities depending on real estate market conditions and investment opportunities that our board of directors determines are in the best interests of our stockholders. We may also invest in entities that make similar investments. We will not commence any significant operations until we have raised the minimum offering amount of $2.5 million from persons who are not affiliated with us or our sponsors.

Critical Accounting Policies

Below is a discussion of the accounting policies that management believes will be critical once we commence operations. We consider these policies critical because they involve significant management judgments and assumptions, require estimates about matters that are inherently uncertain and because they are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be

 

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reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses.

Real Estate Assets

Depreciation and Amortization. Investments in real estate will be carried at cost and depreciated using the straight-line method over the estimated useful lives. Third party acquisitions costs will be expensed as incurred. Repair and maintenance costs will be charged to expense as incurred and significant replacements and betterments will be capitalized. Repair and maintenance costs include all costs that do not extend the useful life of the real estate asset. We will consider the period of future benefit of an asset to determine its appropriate useful life. Costs directly associated with the development of land and those incurred during construction will be capitalized as part of the investment basis. We anticipate the estimated useful lives of our assets by class to be generally as follows:

 

Buildings

   30 years

Building improvements

   30 years

Land improvements

   15 years

Tenant improvements

   Shorter of lease term or expected useful life

Tenant origination and absorption costs

   Remaining term of related lease

Furniture, fixtures and equipment

   5 – 7 years

Real Estate Acquisition Accounting. In accordance with Statement of ASC 805, Business Combinations (“ASC 805”), we will record real estate, consisting of land, buildings and improvements, at fair value. We will allocate the cost of an acquisition to the acquired tangible assets, identifiable intangibles and assumed liabilities based on their estimated acquisition-date fair values. In addition, ASC 805 requires that acquisition costs be expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recorded to income tax expense.

Intangible assets include the value of in-place leases, which represents the estimated value of the net cash flows of the in-place leases to be realized, as compared to the net cash flows that would have occurred had the property been vacant at the time of acquisition and subject to lease-up. Acquired in-place lease value will be amortized to expense over the average remaining non-cancelable terms of the respective in-place leases.

We will assess the acquisition-date fair values of all tangible assets, identifiable intangibles and assumed liabilities using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis) and that utilize appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. The fair value of tangible assets of an acquired property considers the value of the property as if it was vacant.

We will record above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. We will amortize any recorded above-market or below-market lease values as a reduction or increase, respectively, to rental income over the remaining non-cancelable terms of the respective lease.

 

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We will estimate the value of tenant origination and absorption costs by considering the estimated carrying costs during hypothetical expected lease-up periods, considering current market conditions. In estimating carrying costs, management will include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods.

We will amortize the value of in-place leases to depreciation and amortization expense over the remaining average non-cancelable term of the respective leases.

Estimates of the fair values of the tangible assets, identifiable intangibles and assumed liabilities will require us to estimate market lease rates, property-operating expenses, carrying costs during lease-up periods, discount rates, market absorption periods, and the number of years the property will be held for investment. The use of inappropriate estimates would result in an incorrect valuation of our acquired tangible assets, identifiable intangibles and assumed liabilities, which would impact the amount of our net income.

Impairment of Real Estate and Related Intangible Assets. We will monitor events and changes in circumstances that could indicate that the carrying amounts of our real estate and related intangible assets may be impaired. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets may be greater than fair value, we will assess the recoverability, considering recent operating results, expected net operating cash flow, and plans for future operations. If, based on this analysis, we do not believe that we will be able to recover the carrying value of the real estate and related intangible assets, we would record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the real estate and related intangible assets as defined by ASC 360, Accounting for the Impairment or Disposal of Long-Lived Assets.

Real Estate Loans Receivable

The real estate loans receivable will be recorded at cost and reviewed for potential impairment at each balance sheet date. A loan receivable is considered impaired when it becomes probable, based on current information, that we will be unable to collect all amounts due according to the loan’s contractual terms. The amount of impairment, if any, is measured by comparing the recorded amount of the loan to the present value of the expected cash flows or the fair value of the collateral. If a loan was deemed to be impaired, we would record a reserve for loan losses through a charge to income for any shortfall.

Revenue Recognition

We will recognize minimum rent, including rental abatements and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related lease and we will include amounts expected to be received in later years in deferred rents. Our policy for percentage rental income is to defer recognition of contingent rental income until the specified target (i.e. breakpoint) that triggers the contingent rental income is achieved. We will record property operating expense reimbursements due from tenants for common area maintenance, real estate taxes and other recoverable costs in the period the related expenses are incurred. We will make certain assumptions and judgments in estimating the reimbursements at the end of each reporting period. We do not expect the actual results to differ from the estimated reimbursement.

We will make estimates of the collectability of our tenant receivables related to base rents, expense reimbursements and other revenue or income. We will specifically analyze accounts receivable and historical bad debts, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, we will make estimates of the expected recovery of pre-petition and

 

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post-petition claims in assessing the estimated collectability of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. These estimates have a direct impact on our net income because a higher bad debt reserve results in less net income.

We will recognize gains on sales of real estate pursuant to the provisions of ASC 605-976, Accounting for Sales of Real Estate (“ASC 605-976”). The specific timing of a sale will be measured against various criteria in ASC 605-976 related to the terms of the transaction and any continuing involvement associated with the property. If the criteria for profit recognition under the full-accrual method are not met, we will defer gain recognition and account for the continued operations of the property by applying the percentage-of-completion, reduced profit, deposit, installment or cost recovery methods, as appropriate, until the appropriate criteria are met.

Interest income from loans receivable will be recognized based on the contractual terms of the debt instrument. Fees related to any buydown of the interest rate will be deferred as prepaid interest income and amortized over the term of the loan as an adjustment to interest income. Closing costs related to the purchase of a loan receivable will be amortized over the term of the loan and accreted as an adjustment against interest income.

Distribution Policy

We expect to authorize and declare daily distributions that will be paid on a monthly basis beginning no later than the first calendar month after the calendar month in which we make our first real estate investment. Once we commence paying distributions, we expect to pay distributions monthly and continue paying distributions monthly unless our results of operations, our general financial condition, general economic conditions or other factors make it imprudent to do so. The timing and amount of distributions will be determined by our board, in its sole discretion, may vary from time to time, and will be influenced in part by its intention to comply with REIT requirements of the Internal Revenue Code.

We expect to have little, if any, funds from operations available for distribution until we make substantial investments. Further, because we may receive income from interest or rents at various times during our fiscal year and because we may need funds from operations during a particular period to fund capital expenditures and other expenses, we expect that at least during the early stages of our development and from time to time during our operational stage, we will declare distributions in anticipation of funds that we expect to receive during a later period and we will pay these distributions in advance of our actual receipt of these funds. In these instances, we expect to look to third-party borrowings to fund our distributions. We may also fund such distributions from advances from our advisor or sponsors or from our advisor’s deferral of its fees.

Our distribution policy is not to use the proceeds of this offering to pay distributions. However, our board has the authority under our organizational documents, to the extent permitted by Maryland law, to pay distributions from any source, including proceeds from this offering or the proceeds from the issuance of securities in the future.

To maintain our qualification as a REIT, we must make aggregate annual distributions to our stockholders of at least 90.0% of our REIT taxable income (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). If we meet the REIT qualification requirements, we generally will not be subject to U.S. federal income tax on the income that we distribute to our stockholders each year.

We have not established a minimum distribution level, and our charter does not require that we make distributions to our stockholders.

 

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Funds From Operations

One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations and funds from operations, or FFO. FFO is not equivalent to our net operating income or loss as determined under GAAP, but rather it is a measure promulgated by the National Association of Real Estate Investment Trusts, or the NAREIT, an industry trade group. The NAREIT’s belief is that FFO is a more accurate reflection of the operating performance of a REIT because of certain unique operating characteristics of real estate companies. We define FFO, consistent with the NAREIT’s definition, as net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect FFO on the same basis.