424B3 1 kbsriiisupp.htm FORM 424B3 RIII 2013_Prospectus_Supp no.3 -10K flip 12-31-12
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-164703


KBS REAL ESTATE INVESTMENT TRUST III, INC.
SUPPLEMENT NO. 3 DATED MARCH 12, 2013
TO THE PROSPECTUS DATED FEBRUARY 6, 2013
 
This document supplements, and should be read in conjunction with, the prospectus of KBS Real Estate Investment Trust III, Inc. dated February 6, 2013, as supplemented by supplement no. 1 dated February 6, 2013 and supplement no. 2 dated February 6, 2013. As used herein, the terms “we,” “our” and “us” refer to KBS Real Estate Investment Trust III, Inc. and, as required by context, KBS Limited Partnership III, which we refer to as our “Operating Partnership,” and to their subsidiaries. Capitalized terms used in this supplement have the same meanings as set forth in the prospectus. The purpose of this supplement is to disclose:
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the status of the offering;
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the declaration of distributions for April 2013 through May 2013;
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updated risks related to an investment in us;
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information regarding the net tangible book value of our shares;
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information regarding our share redemption program and the amendment and restatement of our share redemption program;
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information regarding our indebtedness;
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“Management’s Discussion and Analysis of Financial Condition and Results of Operations” similar to that filed in our annual report on Form 10-K for the year ended December 31, 2012; and
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our audited financial statements and the notes thereto for the year ended December 31, 2012.
Status of the Offering
We commenced this offering of 280,000,000 shares of common stock on October 26, 2010. As of March 4, 2013, we had sold 30,884,910 shares of common stock in this offering for gross offering proceeds of $307.5 million, including 845,983 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $8.0 million.
As of March 4, 2013, there were 249,115,090 shares of common stock available for sale in this offering, including 79,154,017 shares under our dividend reinvestment plan.
Distributions Declared
On March 6, 2013, our board of directors declared distributions based on daily record dates for the period from April 1, 2013 through April 30, 2013, which we expect to pay in May 2013, and distributions based on daily record dates for the period from May 1, 2013 through May 31, 2013, which we expect to pay in June 2013. Investors may choose to receive cash distributions or purchase additional shares through our dividend reinvestment plan.
Distributions for these periods will be calculated based on stockholders of record each day during these periods at a rate of $0.00178082 per share per day and equal a daily amount that, if paid each day for a 365-day period, would equal a 6.5% annualized rate based on a purchase price of $10.00 per share.

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Risk Factors
The following risk factors supplement the risk factors appearing in the prospectus and in supplement no.2.
We have paid distributions in part from financings and expect that in the future we may not pay distributions solely from our cash flows from operations. To the extent that we pay distributions from sources other than our cash flows from operations, we will have less funds available for investment in properties and other assets, the overall return to our stockholders may be reduced and subsequent investors will experience dilution.
Our organizational documents permit us to pay distributions from any source, including offering proceeds or borrowings (which may constitute a return of capital), and our charter does not limit the amount of funds we may use from any source to pay such distributions. We have paid distributions in part from financings (including with an advance from our advisor that we have repaid with debt financing) and expect that in the future we may not pay distributions solely from our cash flows from operations, in which case distributions may be paid in whole or in part from debt financing. We may also fund such distributions from the sale of assets or from the maturity, payoff or settlement of debt investments. If we fund distributions from borrowings, our interest expense and other financing costs, as well as the repayment of such borrowings, will reduce our earnings and cash flows from operations available for distribution in future periods. If we fund distributions from the sale of assets or the maturity, payoff or settlement of debt investments, this will affect our ability to generate cash flows from operations in future periods. To the extent that we pay distributions from sources other than our cash flows from operations, we will have fewer funds available for investment in real estate properties and real estate-related assets, the overall return to our stockholders may be reduced and subsequent investors will experience dilution. In addition, to the extent distributions exceed cash flows from operations, a stockholder’s basis in our stock will be reduced and, to the extent distributions exceed a stockholder’s basis, the stockholder may recognize capital gain. There is no limit on the amount of distributions we may fund from sources other than from cash flows from operations.
We expect to have little, if any, cash flows from operations available for distribution until we make substantial investments. During our offering stage, when we may raise capital in this offering (and possibly future offerings) more quickly than we acquire income-producing assets, and from time to time during our operational stage, we may not pay distributions solely from our cash flows from operations.
For the year ended December 31, 2011, we paid aggregate distributions of $1.7 million, including $0.9 million of distributions paid in cash and $0.7 million of distributions reinvested through our dividend reinvestment plan. We funded 100% of total distributions paid for the year ended December 31, 2011, which includes cash distributions and dividends reinvested by stockholders, with debt financing. For the year ended December 31, 2012, we paid aggregate distributions of $11.6 million, including $6.4 million of distributions paid in cash and $5.2 million of distributions reinvested through our dividend reinvestment plan. We funded our total distributions paid, which includes net cash distributions and dividends reinvested by stockholders, with $8.1 million (70%) of cash flows from operations and $3.5 million (30%) of debt financing. For the year ended December 31, 2012, our distributions paid to cash flows from operations coverage ratio was 66% and our distributions paid to funds from operations coverage ratio was 53%. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Distributions” in this supplement.
Because the offering price in this offering exceeds our net tangible book value per share, investors in this offering will experience immediate dilution in the net tangible book value of their shares.
We are currently offering shares in this primary offering at $10.00 per share, with discounts available to certain categories of purchasers. Our current offering price exceeds our net tangible book value per share. Our net tangible book value per share is a rough approximation of value calculated as total book value of assets minus total liabilities, divided by the total number of shares of common stock outstanding. Net tangible book value is used generally as a conservative measure of net worth that we do not believe reflects our estimated value per share. It is not intended to reflect the value of our assets upon an orderly liquidation of the company in accordance with our investment objectives. However, net tangible book value does reflect certain dilution in value of our common stock from the issue price as a result of (i) the substantial fees paid in connection with this offering, including selling commissions and marketing fees re-allowed by our dealer manager to participating broker dealers, (ii) the fees and expenses paid to our advisor and its affiliates in connection with the selection, acquisition, management and sale of our investments, (iii) general and administrative expenses and (iv) accumulated depreciation and amortization of real estate investments.
As of December 31, 2012, our net tangible book value per share was $7.81. To the extent we are able to raise substantial proceeds in this offering, some of the expenses that cause dilution of the net tangible book value per share are expected to decrease on a per share basis, resulting in increases in the net tangible book value per share. This increase would be partially offset by increases in depreciation and amortization expenses related to our real estate investments.

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Our offering price was not established on an independent basis and bears no relationship to the net value of our assets. Further, the factors described above with respect to the dilution in the value of our common stock are likely to cause our offering price to be higher than the amount our stockholders would receive per share if we were to liquidate at this time.
Continued disruptions in the financial markets and uncertain economic conditions could continue to 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 approximately 30% of our portfolio to, and expect that, once we have fully invested the proceeds from our public offerings, approximately 20% to 40% of our portfolio will consist of: 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: (i) the supply and demand for such investments; (ii) the terms we are able to negotiate for our investments; (iii) the performance of the assets underlying the investments; and (iv) 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.
From 2008 to 2011, concerns pertaining to the deterioration of credit in the residential mortgage market expanded to almost all areas of the debt capital markets including corporate bonds, asset-backed securities and commercial real estate bonds and loans. In 2012, however, the economic stimulus provided by the Federal Reserve programs and an increased demand for U.S.-based assets began to fuel the U.S. commercial real estate market recovery. Transaction volumes have improved and the re-emergence of the CMBS market and the availability of debt capital have spurred on the recovery. Commercial real estate transaction volumes have improved as the U.S. has become a safe haven for global capital. While these signs of improvement for commercial real estate are heartening, outstanding economic, credit and regulatory issues remain. As such, we cannot foresee when these markets will stabilize. This instability may interfere with the successful implementation of our business model and/or force us to modify.
Continued disruptions in the financial markets and uncertain economic conditions could adversely affect market rental rates, commercial real estate values and our ability to secure debt financing, service future debt obligations, or pay distributions to our stockholders.
While there have been signs of improvement for commercial real estate, outstanding economic, credit and regulatory issues remain. Certain markets will continue to benefit from employment gains specific to the market location and regionally‑based growth industries such as technology, energy and health care. Lending activity increased in 2012, but not evenly. Certain markets in the commercial real estate sector are still having problems attracting capital, while others are experiencing increased development and construction.
Residential real estate markets have been experiencing an uneven recovery. The market for residential mortgages saw significant gains in 2012, but problem loans on bank balance sheets still remain a material challenge for U.S. banks. The slow and steady recovery in the single family home market continues to progress. The Federal Reserve’s low interest rate policy has pushed capital into the residential mortgage markets and has helped consumer balance sheets by establishing some stability in home valuations.
The global capital markets have begun to improve, but uncertainties still exist and it is unlikely that transaction volumes will return to pre-2007 levels. Central bank interventions in the banking system and the persistence of a highly expansionary monetary policy by a number of government entities have introduced additional complexity and uncertainty to the markets. These conditions are expected to continue, and combined with a challenging macro-economic environment, may interfere with the implementation of our business strategy and/or force us to modify it.
Looking forward, it is widely assumed that mortgage delinquencies have not yet peaked.  Liquidity in the global credit market has been affected by market disruptions, and new lending activity has only recently increased.  We have relied on debt financing to finance our properties and real estate-related assets.  As a result of the uncertainties in the credit market, we may not be able to refinance our existing indebtedness or to obtain additional debt financing on attractive terms.  If we are not able to refinance existing indebtedness on attractive terms at or prior to its maturity, we may be forced to dispose of some of our assets.

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Further disruptions in the financial markets and continued uncertain economic conditions could adversely affect the values of our investments.  Lending activity has only recently increased; however, it remains uncertain whether the capital markets can sustain the current transaction levels. Any disruption to the debt and capital markets could result in in fewer buyers seeking to acquire commercial properties and possible increases in capitalization rates and lower property values.  Furthermore, declining economic conditions could negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values in our real estate portfolio and in the collateral securing our loan investments, which could have the following negative effects on us:
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the values of our investments in commercial properties could decrease below the amounts paid for such investments;
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the value of collateral securing our loan investments could decrease below the outstanding principal amounts of such loans;
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revenues from our properties 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 debt financing; and/or
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revenues from the properties and other assets underlying our loan investments could decrease, making it more difficult for the borrowers to meet their payment obligations to us, which could in turn make it more difficult for us to pay dividends or meet our debt service obligations on debt financing.
All of these factors could impair our ability to make distributions to our investors and decrease the value of an investment in us.
Properties that have significant vacancies could be difficult to sell, which could diminish the return on these properties and adversely affect our cash flow and ability to pay distributions to our stockholders.
A property may incur vacancies either by the expiration and non-renewal of tenant leases or the continued default of tenants under their leases. If vacancies continue for a long period of time, we may suffer reduced revenues resulting in less cash available for distribution to our stockholders. In addition, the resale value of the property could be diminished because the market value of core properties, which we intend to target, depends principally upon the value of the cash flows generated by the leases associated with that property. Such a reduction in the resale value of a property could also reduce the value of our stockholders’ investment.
Since 2007 and the emergence of the global economic crisis, there have been persistent concerns regarding the creditworthiness and refinancing capabilities of both corporations and sovereign governments, and regarding access to capital in the U.S. and global financial markets. Beginning in 2010, the U.S. commercial real estate industry experienced some improvement in fundamental credit statistics such as occupancy, rental rates and pricing. Continued improvement in these fundamentals remains contingent upon sustainable economic growth, which is by no means certain. Any setbacks or deterioration of these and other industry fundamentals may result in reduced revenue and lower resale value of properties, which may reduce our stockholders’ return. In general, borrower defaults may rise, and occupancy and rental rate stabilization will vary by market and by property type.
One of our tenants represents a significant percentage of our total annualized base rent and thus, the value of our stockholders’ investment in us will fluctuate with the performance of this tenant.
The largest tenant in Domain Gateway, OneWest Bank, FSB, leases 100% of the building and represented approximately 11.2% of our total annualized base rent as of December 31, 2012. As such, the value of our stockholders’ investment in us will fluctuate with the performance of this tenant. Additionally, revenues from this property could decrease significantly if OneWest Bank, FSB were to default, become insolvent, terminate its lease early or choose not to renew its lease upon its termination and we were unable to re-lease the building at similar rental rates. This would make it more difficult for us to meet our debt service obligations and limit our ability to pay distributions to our stockholders.
The offering price of our shares in this offering was not established in reliance on a valuation of our assets and liabilities; the actual value of an investment in us may be substantially less than the purchase price of our shares. We may use the most recent price paid to acquire a share in this offering or a follow-on public 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 valuation (independent or otherwise), the offering price is likely to be higher than the proceeds that an investor would receive upon liquidation or a resale of his or her shares if they were to be listed on an exchange or actively traded by broker‑dealers, especially in light of the upfront fees that we pay in connection with the issuance of our shares.

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To assist Financial Industry Regulatory Authority (“FINRA”) members and their associated persons that participate in this initial public offering of common stock in meeting their customer account statement reporting obligations, pursuant to NASD Conduct Rule 2340, 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. For this purpose, our advisor estimated the value of our common stock as $10.00 per share as of December 31, 2012. The basis for this valuation is the fact that the current public offering price of our shares of common stock in this offering is $10.00 per share (ignoring purchase price discounts for certain categories of purchasers). 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 follow-on public offerings 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 offerings-and have not done so for up to 18 months. We currently expect to update the estimated value per share every 12 to 18 months thereafter. 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 equity offerings in the future. For purposes of determining when our offering stage is complete, 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 have been willing to purchase shares in this primary offering, this reported value is likely to differ from the price that a stockholder would receive in the near term upon a resale of his or her shares or upon our liquidation because (i) there is no public trading market for the shares at this time; (ii) the $10.00 primary public offering price involves the payment of underwriting compensation and other directed selling efforts, which payments and efforts are likely to produce a higher sale price than could otherwise be obtained; (iii) the estimated value does not reflect, and is not derived from, the fair market value of our assets because the amount of proceeds available for investment from this offering is net of selling commissions, dealer manager fees, other organization and offering costs and acquisition and origination fees and expenses; (iv) 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 (v) 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 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 or may not be an accurate reflection of the fair market value of our investments and likely will not represent the amount of net proceeds that would result from an immediate sale of our assets.
We have broad authority to incur debt and high debt levels could hinder our ability to make distributions and decrease the value of our stockholders’ investment.
Our policies do not limit us from incurring debt until our total liabilities would exceed 75% of the cost of our tangible assets (before deducting depreciation or other noncash reserves) and we may exceed this limit with the approval of the conflicts committee of our board of directors. As of December 31, 2012, our total liabilities were approximately 37% of both the cost (before depreciation or other noncash reserves) and book value (before depreciation) of our tangible assets, respectively. High debt levels would cause us to incur higher interest charges and higher debt service payments and may 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 our stockholders’ investment.
Net Tangible Book Value Per Share
In connection with this offering of shares of our common stock, we are providing information about our net tangible book value per share. Our net tangible book value per share is a rough approximation of value calculated as total book value of assets minus total book value of liabilities, divided by the total number of shares of common stock outstanding. Net tangible book value is used generally as a conservative measure of net worth that we do not believe reflects our estimated value per share. It is not intended to reflect the value of our assets upon an orderly liquidation of the company in accordance with our investment objectives. However, net tangible book value does reflect certain dilution in value of our common stock from the issue price as a result of (i) the substantial fees paid in connection with this offering, including selling commissions and marketing fees re-allowed by our dealer manager to participating broker dealers, (ii) the fees and expenses paid to our advisor and its affiliates in connection with the selection, acquisition, management and sale of our investments, (iii) general and administrative expenses and (iv) accumulated depreciation and amortization of real estate investments. As of December 31, 2012, our net tangible book value per share was $7.81. To the extent we are able to raise substantial proceeds in this offering, some of the expenses that cause dilution of the net tangible book value per share are expected to decrease on a per share basis, resulting in increases in the net tangible book value per share. This increase would be partially offset by increases in depreciation and amortization expenses related to our real estate investments.

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The offering price under our primary offering (ignoring purchase price discounts for certain categories of purchasers) as of December 31, 2012 was $10.00 per share.
Our offering price was not established on an independent basis and bears no relationship to the net value of our assets. Further, the factors described above with respect to the dilution in the value of our common stock are likely to cause our offering price to be higher than the amount you would receive per share if we were to liquidate at this time.
Share Redemption Program
Our share redemption program contains numerous restrictions on your ability to redeem your shares. Among other restrictions, during each calendar year, redemptions are limited to the amount of net proceeds from the sale of shares under our dividend reinvestment plan during the prior calendar year. This restriction may significantly limit your ability to have your shares redeemed pursuant to our share redemption program. In 2011, our net proceeds from the dividend reinvestment plan were $0.7 million. During the year ended December 31, 2012, we redeemed $0.7 million of shares of common stock and funded these redemptions with the net proceeds from our dividend reinvestment plan. The average price paid by us to redeem shares during the year ended December 31, 2012 was $9.87 per share. As of December 31, 2012, we had $0.4 million of outstanding and unfulfilled redemption requests, representing approximately 43,194 shares. Effective January 2013, the above‑referenced limitation was re-set, and we are able to redeem the number of shares that we could purchase with the amount of net proceeds raised from the sale of shares under the dividend reinvestment plan during 2012. For the year ended December 31, 2012, our net proceeds from the dividend reinvestment plan were $5.2 million. Our board of directors may amend, suspend or terminate the share redemption program upon 30 days’ notice to our stockholders.
On March 6, 2013, our board of directors approved a second amended and restated share redemption program (the “Second Amended Share Redemption Program”). Pursuant to the Second Amended Share Redemption Program, we have modified how we will process redemptions that would result in a stockholder owning less than the minimum purchase requirement described in our currently effective, or the most recently effective, registration statement as such registration statement has been amended or supplemented (the “Minimum Purchase Requirement”). Specifically, if we cannot repurchase all shares presented for redemption in any month because of the limitations on redemptions set forth in the program, then we will honor redemption requests on a pro rata basis, except that if a pro rata redemption would result in a stockholder owning less than the Minimum Purchase Requirement, then we would redeem all of such stockholder’s shares. If we are redeeming all of a stockholder’s shares, there would be no holding period requirement for shares purchased pursuant to our dividend reinvestment plan.
There were no other changes to the share redemption program. The Second Amended Share Redemption Program will be effective for redemptions under the program on April 7, 2013.
Indebtedness
As of December 31, 2012, we had $119.8 million of mortgage debt outstanding. Our mortgage debt consisted of $56.6 million under the Town Center Mortgage Loan and $63.2 million under the U.S. Bank Portfolio Loan. The Town Center Mortgage Loan matures on March 27, 2013. The U.S. Bank Portfolio Loan matures on May 1, 2014, with two one-year extension options, subject to certain conditions contained in the loan agreement. As of December 31, 2012, our borrowings and other liabilities were approximately 37% of both the cost (before depreciation and other noncash reserves) and book value (before depreciation) of our tangible assets, respectively.
On January 29, 2013, we entered into a loan modification agreement to add the Tower on Lake Carolyn as additional collateral to the U.S. Bank Portfolio Loan and to increase the amount available under the loan to $200.0 million, of which $80.0 million is non-revolving debt and $120.0 million is revolving debt. We also extended the initial maturity date to February 1, 2016, with two one-year extension options, subject to certain conditions contained in the loan agreement. As of January 29, 2013, the outstanding balance under the loan was $98.2 million and was composed of $80.0 million of term debt and $18.2 million of revolving debt. As of January 29, 2013, an additional $101.8 million remained available for future disbursements, subject to certain conditions set forth in the loan agreement. On January 31, 2013, in connection with our acquisition of the RBC Plaza, we, through an indirect wholly owned subsidiary, entered into a four-year mortgage loan for borrowings of up to $75.9 million secured by the RBC Plaza. We drew $68.7 million at the closing of the loan and the remaining portion will be used for tenant improvements, leasing commissions and capital improvements, subject to certain terms and conditions contained in the loan documents. The RBC Plaza Mortgage Loan matures on February 1, 2017, with an option to extend the maturity date to February 1, 2018, subject to certain terms and conditions contained in the loan documents.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our accompanying consolidated balance sheets as of December 31, 2012 and 2011, the related consolidated statements of operations, stockholders’ equity and cash flows for the years ended December 31, 2012 and 2011, the related notes thereto and the accompanying financial statement schedule included in this supplement. This discussion contains forward-looking statements that can be identified with the use of forward-looking terminology such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. Actual results may differ from those described in forward-looking statements. For a discussion of the factors that could cause our actual results to differ from those anticipated, see “Risk Factors” in the prospectus and in this supplement.
Overview
We were formed on December 22, 2009 as a Maryland corporation that elected to be taxed as a REIT beginning with the taxable year ended December 31, 2011 and intend to operate in such a manner. On February 4, 2010, we filed a registration statement on Form S-11 with the SEC to offer a minimum of 250,000 shares and a maximum of 280,000,000 shares of common stock for sale to the public, of which 200,000,000 shares were registered in this primary offering and 80,000,000 shares were registered under our dividend reinvestment plan. The SEC declared our registration statement effective on October 26, 2010 and we retained KBS Capital Markets Group, an affiliate of our advisor, to serve as the dealer manager of this offering pursuant to a dealer manager agreement. The dealer manager is responsible for marketing our shares in this offering.
We intend to invest in a diverse portfolio of real estate investments. The types of properties that we may invest in include office, industrial and retail properties located throughout the United States. Although we may invest in any of these types of properties, we expect to invest primarily in office and industrial properties. All such real estate assets may be acquired directly by us or the Operating Partnership, though we may invest in other entities that make similar investments. We also expect to invest in or originate real estate-related investments, including 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. As of December 31, 2012, we owned six office properties and had originated one first mortgage loan.
As our advisor, KBS Capital Advisors manages our day-to-day operations and our portfolio of real estate properties and real estate-related investments. KBS Capital Advisors makes recommendations on all investments to our board of directors. All proposed investments must be approved by at least a majority of our board of directors, including a majority of the conflicts committee. Unless otherwise provided by our charter, the conflicts committee may approve a proposed investment without action by the full board of directors if the approving members of the conflicts committee constitute at least a majority of the board of directors. KBS Capital Advisors also provides asset-management, marketing, investor-relations and other administrative services on our behalf. Our advisor owns 20,000 shares of our common stock. We have no paid employees.
On March 24, 2011, we broke escrow in this offering and through December 31, 2012, we had sold 27,203,043 shares of common stock for gross offering proceeds of $270.9 million, including 629,560 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $6.0 million. We have extended this primary offering until the earlier of the sale of all 200,000,000 shares or October 11, 2013.
Also as of December 31, 2012, we had redeemed 74,912 shares sold in this offering for $0.7 million.
On February 14, 2013, we filed a registration statement on Form S-11 with the SEC to register a follow-on public offering (the “Follow-on Offering”). Pursuant to the Follow-on Offering registration statement, we propose to register up to $2,000,000,000 of shares of common stock for sale to the public in the primary Follow-on Offering. We also expect to register up to $760,000,000 of shares pursuant to our dividend reinvestment plan in the Follow-on Offering. We currently expect to commence the Follow-on Offering during the fourth quarter of 2013.
Market Outlook – Real Estate and Real Estate Finance Markets
The following discussion is based on management’s beliefs, observations and expectations with respect to the real estate and real estate finance markets.
Since 2007 and the emergence of the global economic crisis, there have been persistent concerns regarding the creditworthiness and refinancing capabilities of both corporations and sovereign governments. Economies throughout the world have experienced lingering levels of high unemployment and low levels of consumer and business confidence due to a global downturn in economic activity. While some markets have shown some signs of recovery, concerns remain regarding job growth, income growth and the overall health of consumers, businesses, and governments.

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Recent global economic events remain centered on the potential for the default of several European sovereign debt issuers and the impact that such an event would have on the European Union and the rest of the world’s financial markets. During 2011, Standard and Poor’s (“S&P”) downgraded the credit rating of the United States to AA+ from AAA. In November 2012, Moody’s downgraded France’s sovereign debt rating to Aa1 from AAA and, in February 2013, Moody’s downgraded the U.K. government debt to Aa1 from AAA as well. The global ratings agencies continue to have a number of western sovereign issuers on negative watch as governments have struggled to resolve their fiscal obligations. At the end of 2012 the U.S. government barely escaped the self-imposed fiscal cliff by enacting legislation that temporarily postponed legislated spending cuts to many government programs, commonly referred to as “sequestration,” until March of 2013. European governments have had no success in resolving their own political and fiscal issues. These events continue to build in importance as government and political leaders have been unable to establish plans to correct the economic imbalances that are increasingly dominating and driving global economic performance. Uncertainty and volatility have crept back into the capital markets.
The role of the government-controlled central banks in the global capital markets continues to expand. Beginning in the fall of 2008, the U.S. government initiated a number of financial programs designed to provide financial institutions and the auto industry with the capital needed to survive the economic crisis. These programs included the Troubled Asset Relief Program (“TARP”), the Legacy Securities Public-Private Investment Program (“PPIP”), several rounds of what is known as “quantitative easing” (“QE: I, II and III”), and the maturity extension program known as “Operation Twist”. Combined, these programs have provided unprecedented levels of capital to the financial markets and have pushed interest rates and the cost of debt to historical lows. Now, as the markets for hard assets have improved, concerns have shifted from deflation to inflation. Many economists have pointed to the very real possibility of new asset bubbles developing as an area of concern.
In the U.S., the banking industry has been experiencing improved earnings. This is a positive, but the relatively low growth economic environment and the slow recovery in the residential mortgage segment of the industry, has caused investors to question whether financial institutions are adequately capitalized. The credit downgrade of the United States and the continued political infighting between the branches of government have increased these concerns. The U.S. Federal Reserve has taken a number of actions to ensure that banks have adequate access to the capital markets, but the slow recovery in the values of single family homes remains a material concern.
In Europe, the unresolved sovereign debt crisis continues. Some European banks hold material quantities of sovereign debt on their balance sheets. The possible default or restructuring of the sovereign debt obligations of certain European Union countries and the resulting negative impact on the global banking system is a significant concern. The uncertainty surrounding the size of the problem and how regulators and governments intend to deal with the situation has caused many investors to reassess their pricing of risks. In response to the growing crisis some nations have experienced a significant increase in the cost of capital. In some cases the increase in the cost of debt has pushed nations to the brink of default.
From 2008 through 2011, the financial crisis and global economic downturn caused transaction volumes in the U.S. commercial real estate market to experience a sharp decline. While high-quality assets in primary (top-tier) markets experienced some transaction volume, most markets remained illiquid, with little or no buying or selling. Uncertainty in areas such as the cost of capital and the ability to hedge asset risks produced enough friction to bring transaction volumes down.
In 2012, however, the economic stimulus provided by the Federal Reserve programs and an increased demand for U.S.‑based assets began to fuel the U.S. commercial real estate market recovery. Transaction volumes have rebounded and the re-emergence of the CMBS market and the availability of debt capital have spurred on the recovery. Commercial real estate transaction volumes have improved, as the U.S. has become a safe haven for global capital.
While these signs of improvement for commercial real estate are heartening, outstanding economic, credit and regulatory issues remain. Certain markets will continue to benefit from employment gains specific to the location and regionally-based growth industries such as technology, energy and health care. Lending activity increased in 2012, but not evenly. Certain markets in the commercial real estate sector are still having problems attracting capital, while others are experiencing increased development and construction.
Residential real estate markets have also been experiencing an uneven recovery. The market for residential mortgages saw significant gains in 2012, but problem loans on bank balance sheets still remain a material challenge for U.S. banks. The slow and steady recovery in the single family home market continues to progress. The Federal Reserve’s low interest rate policy has pushed capital into the residential mortgage markets and has helped consumer balance sheets by establishing some stability in home valuations.
The global capital markets have begun to improve, but uncertainties still exist and it is unlikely that transaction volumes will return to pre-2007 levels. Central bank interventions in the banking system and the persistence of a highly expansionary monetary policy by a number of government entities have introduced additional complexity and uncertainty to the markets. These conditions are expected to continue and, combined with a challenging macro-economic environment, may interfere with the implementation of our business strategy and/or force us to modify it.

8

Impact on Our Real Estate Investments
These market conditions may have a significant impact on our current and future real estate investments and will likely create a highly competitive leasing environment. In addition, these market conditions have impacted or may impact our tenants’ businesses, making it more difficult for them to meet current lease obligations and placing pressure on them to negotiate more favorable lease terms upon renewal in order for their businesses to remain viable. Possible future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to retain tenants who are up for renewal or to sign new tenants, may result in decreases in cash flow. Historically low interest rates could help offset some of the impact of decreases in operating cash flow for properties financed with variable rate mortgages; however, interest rates may not remain at these historically low levels for the life of many of our investments.
Impact on Our Real Estate‑Related Investment
Our real estate‑related investment is directly secured by commercial real estate. As a result, our real estate‑related investment may be impacted to some degree by the same factors that may impact our real estate investments, as may future investments in real estate-related assets.
As of December 31, 2012, we had a fixed rate real estate loan receivable with a principal balance of $13.6 million and a carrying value of $13.7 million that matures in 2016.
Impact on Our Financing Activities
In light of the risks associated with possible declines of operating cash flows on our properties and the current underwriting environment for commercial real estate mortgages, we may have difficulty refinancing some of our mortgage notes at maturity or may not be able to refinance our obligations at terms as favorable as the terms of our existing indebtedness. As of December 31, 2012, we had variable rate notes payable with an aggregate principal amount outstanding of $119.8 million, all of which mature between 2013 and 2014, including one mortgage loan with an outstanding principal balance of $56.6 million scheduled to mature during the 12 months ending December 31, 2013. See “Indebtedness” above.
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 real estate and real estate-related investments and conduct our operations from: the proceeds of this offering, including our dividend reinvestment plan, and any future follow-on offerings we may conduct; secured or unsecured financings from banks and other lenders; and any undistributed funds from our operations.
On March 24, 2011, we broke escrow in this offering and through December 31, 2012, we had sold 27,203,043 shares for gross offering proceeds of $270.9 million, including 629,560 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $6.0 million. Also as of December 31, 2012, we had redeemed 74,912 shares sold in this offering for $0.7 million. If we are unable to raise substantial funds in this offering, we will make fewer investments resulting in less diversification in terms of the type, number, size and geographic region of investments we make and the value of an investment in us will be tied more closely to 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 have extended this primary offering until the earlier of the sale of all 200,000,000 shares or October 11, 2013.
On February 14, 2013, we filed a registration statement on Form S-11 with the SEC to register the Follow-on Offering. Pursuant to the Follow-on Offering registration statement, we propose to register up to $2,000,000,000 of shares of common stock for sale to the public in the primary Follow-on Offering. We also expect to register up to $760,000,000 of shares of common stock pursuant to our dividend reinvestment plan in the Follow-on Offering. We currently expect to commence the Follow-on Offering during the fourth quarter of 2013.
During the year ended December 31, 2012, we acquired four office properties. Our cash needs for those investments were met with proceeds from this offering and debt financing. Operating cash needs during the same period were met through cash flow generated by our real estate properties and real-estate related investment.
Our investments in real estate generate cash flow in the form of rental revenues and tenant reimbursements, which are reduced by operating expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flows from operations from real estate investments is primarily dependent upon the occupancy level of our portfolio, the net effective rental rates on our leases, the collectibility of rent and operating recoveries from our tenants and how well we manage our expenditures. As of December 31, 2012, we owned six office properties that were collectively 92% occupied.

9

Our real estate-related investment generates cash flows in the form of interest income, which is reduced by loan servicing fees, the payment of asset management fees and corporate general and administrative expenses. Cash flows from operations from our real estate-related investment is primarily dependent on the operating performance of the underlying collateral and the borrower’s ability to make its debt service payments. As of December 31, 2012, the borrower under our real estate loan receivable was current on all contractual debt service payments to us. However, as of December 31, 2012, our real estate loan receivable had not begun generating cash flows in the form of interest income, as the borrower has drawn on its debt service reserve fund under the loan, which we funded, to cover its debt service payments.
As of December 31, 2012, we had mortgage debt obligations in the aggregate principal amount of $119.8 million, which mature between 2013 and 2014, including one mortgage loan with an outstanding principal balance of $56.6 million scheduled to mature during the 12 months ending December 31, 2013. As of December 31, 2012, we had $44.8 million of revolving debt available for future disbursements under a portfolio loan, subject to certain conditions set forth in the loan agreement. See “Indebtedness” above.
We made distributions to our stockholders during the year ended December 31, 2012 using a combination of cash flows from operations and debt financing. We believe that our cash flows from operations, cash on hand, proceeds from our dividend reinvestment plan and anticipated financing activities are sufficient to meet our liquidity needs for the foreseeable future.
Under our charter, we are required to limit our total operating expenses to the greater of 2% of our average invested assets or 25% of our net income for the four most recently completed fiscal quarters, as these terms are defined in our charter, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. Operating expense reimbursements for the four fiscal quarters ended December 31, 2012 did not exceed the charter imposed limitation.
Cash Flows from Operating Activities
We commenced operations in connection with the origination of our first investment on June 24, 2011. As of December 31, 2012, we owned six office properties and one real estate loan receivable. During the year ended December 31, 2012, net cash provided by operating activities was $7.7 million, compared to $0.7 million during the year ended December 31, 2011. Net cash from operations increased in 2012 primarily as a result of acquisition activity and we expect that our cash flows from operating activities will increase in future periods as a result of owning investments acquired in 2012 for an entire period and anticipated future acquisitions of real estate investments and acquisitions or originations of real estate‑related investments.
Cash Flows from Investing Activities
Net cash used in investing activities was $233.4 million for the year ended December 31, 2012 and primarily consisted of the following:
•
$228.3 million for the acquisition of four real estate properties;
•
$3.4 million to fund obligations under our real estate loan receivable; and
•
$1.7 million of improvements to real estate.
Cash Flows from Financing Activities
Our cash flows from financing activities consist primarily of proceeds from this offering, debt financings and distributions paid to our stockholders. During the year ended December 31, 2012, net cash provided by financing activities was $212.1 million and primarily consisted of the following:
•
$143.2 million of net cash provided by offering proceeds related to this offering, net of payments of commissions, dealer manager fees and other organization and offering expenses of $18.4 million;
•
$76.0 million of net cash provided by debt financing as a result of proceeds from notes payable of $180.2 million, partially offset by payments on notes payable of $102.7 million and by payments of deferred financing costs of $1.5 million;
•
$6.4 million of net cash distributions, after giving effect to distributions reinvested by stockholders of $5.2 million; and
•
$0.7 million of cash used for redemptions of common stock.

10

Once we have fully invested the proceeds of our offerings, we expect that our debt financing and other liabilities will be between 35% and 65% of the cost of our tangible assets (before deducting depreciation or other non-cash reserves). We expect our debt financing related to the acquisition of core properties to be between 45% and 65% of the aggregate cost of all such assets. We expect our debt financing related to the acquisition or origination of real‑estate related investments to be between 0% and 65% of the aggregate cost of all such assets, depending upon the availability of such financings in the marketplace. Though this is our target leverage, our charter does not limit our leverage until our total liabilities would exceed 75% of the cost of our tangible assets (before deducting depreciation or other non-cash reserves), and we may exceed this limit with the approval of the conflicts committee of our board of directors. To the extent financing in excess of this limit is available on attractive terms, our conflicts committee may approve debt in excess of this limit. As of December 31, 2012, our borrowings and other liabilities were approximately 37% of both the cost (before depreciation and other noncash reserves) and book value (before depreciation) of our tangible assets, respectively.
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 our dealer manager. Pursuant to the advisory agreement and the dealer manager agreement, we are obligated to reimburse our advisor, our dealer manager or their affiliates, as applicable, for organization and other offering costs paid by them on our behalf. See the discussion under “ - Organization and Offering Costs” below. During our acquisition and development stage, we expect to make payments to our advisor in connection with the selection and origination or purchase of investments, the management of our assets and costs incurred by our advisor in providing services to us. 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 our advisor and our conflicts committee.
Contractual Commitments and Contingencies
The following is a summary of our contractual obligations as of December 31, 2012 (in thousands):
 
 
 
 
Payments Due During the Years Ended December 31,
Contractual Obligations
 
Total
 
2013
 
2014-2015
 
2016-2017
 
Thereafter
Outstanding debt obligations (1)
 
$
119,800

 
$
56,600

 
$
63,200

 
$
—

 
$
—

Interest payments on outstanding debt obligations (2)
 
2,191

 
1,727

 
464

 
—

 
—

Outstanding funding obligations under real estate loan receivable
 
10,301

 
(3) 

 
(3) 

 
(3) 

 
—

_____________________
(1) Amounts include principal payments only.
(2) Projected interest payments are based on the outstanding principal amounts and interest rates in effect as of December 31, 2012 (consisting of the contractual interest rate). We incurred interest expense of $2.7 million, excluding amortization of deferred financing costs totaling $0.9 million, during the year ended December 31, 2012.
(3) On June 24, 2011, we originated the Aberdeen First Mortgage Loan. As of December 31, 2012, we had disbursed $13.6 million to the borrower under the Aberdeen First Mortgage Loan and another $10.3 million remained available for future funding, subject to certain conditions set forth in the loan agreement. This amount does not have a fixed funding date, but may be funded in any future year, subject to certain conditions set forth in the loan agreement. The Aberdeen First Mortgage Loan matures on July 1, 2016.
Results of Operations
Our results of operations as of December 31, 2012 are not indicative of those expected in future periods, as we broke escrow in this offering on March 24, 2011 and commenced operations on June 24, 2011 in connection with our first investment, the origination of a real estate loan receivable. We acquired our first real estate investment, an office property, on September 29, 2011. As of December 31, 2011, we owned two office properties and one real estate loan receivable. As of December 31, 2012, we owned six office properties and one real estate loan receivable. In general, we expect that our income and expenses related to our portfolio will increase in future periods as a result of owning investments acquired in 2012 for an entire period and anticipated future acquisitions of real estate and real estate-related investments. The results of operations presented for the years ended December 31, 2012 and 2011 are not directly comparable because since 2011 we have been raising money in and investing the proceeds from this offering. During the period from inception (December 22, 2009) to December 31, 2010, we had been formed but had not yet commenced any significant operations, as we had not broken escrow in this offering. As a result, we had no material results of operations for that period.
Rental income and tenant reimbursements increased from $2.1 million for the year ended December 31, 2011 to $26.3 million for the year ended December 31, 2012, primarily as a result of the growth in our real estate portfolio and holding the properties acquired in 2011 for an entire period. We expect rental income and tenant reimbursements to increase in future periods as a result of owning real estate acquired in 2012 for an entire period and anticipated future acquisitions of real estate.

11

Interest income from our real estate loan receivable, recognized using the interest method, increased from $0.4 million for the year ended December 31, 2011 to $0.9 million for the year ended December 31, 2012, primarily as a result of owning the real estate loan receivable acquired in 2011 for an entire period and an increase in the overall loan balance as a result of advances made under the loan receivable.
Operating, maintenance and management costs increased from $0.4 million for the year ended December 31, 2011 to $5.9 million for the year ended December 31, 2012, primarily as a result of the growth in our real estate portfolio and holding the properties acquired in 2011 for an entire period. We expect operating, maintenance and management costs to increase in future periods as a result of owning real estate acquired in 2012 for an entire period and anticipated future acquisitions of real estate.
Real estate taxes and insurance increased from $0.3 million for the year ended December 31, 2011 to $4.6 million for the year ended December 31, 2012, primarily as a result of the growth in our real estate portfolio and holding the properties acquired in 2011 for an entire period. We expect real estate taxes and insurance to increase in future periods as a result of owning real estate acquired in 2012 for an entire period and anticipated future acquisitions of real estate.
Asset management fees with respect to our real estate and real estate-related investments increased from $0.2 million for the year ended December 31, 2011 to $1.7 million for the year ended December 31, 2012, as a result of the growth in our real estate and real estate-related investment portfolio. All asset management fees incurred as of December 31, 2012 have been paid. We expect asset management fees to increase in future periods as a result of owning real estate acquired in 2012 for an entire period and anticipated future acquisitions of real estate and real estate-related investments.
Real estate acquisition fees and expenses to affiliates and non-affiliates increased from $1.3 million for the year ended December 31, 2011 to $3.4 million for the year ended December 31, 2012. The increase in real estate acquisition fees and expenses was due to an overall increase in real estate acquisition activities during 2012 and we expect real estate acquisition fees and expenses to vary in future periods based upon acquisition activity.
Depreciation and amortization increased from $1.1 million for the year ended December 31, 2011 to $13.9 million for the year ended December 31, 2012, primarily as a result of the growth in our real estate portfolio and holding the properties acquired in 2011 for an entire period. We expect depreciation and amortization to increase in future periods as a result of owning the properties acquired during 2012 for a full year and anticipated future acquisitions of real estate assets.
Interest expense increased from $0.3 million for the year ended December 31, 2011 to $3.6 million for the year ended December 31, 2012. Included in interest expense is the amortization of deferred financing costs of $0.1 million and $0.9 million for the years ended December 31, 2011 and 2012, respectively. The increase in interest expense is primarily a result of our use of debt in acquiring real estate assets in 2011 and 2012. We expect interest expense to increase in future periods as a result of additional borrowing for anticipated future acquisitions of real estate and acquisitions or originations of real estate-related investments.
Organization and Offering Costs
Our organization and offering costs (other than selling commissions and dealer manager fees) may be paid by our advisor, the dealer manager or their affiliates on our behalf. Other offering costs include all costs incurred or to be incurred by us in connection with this offering. Organization costs include all expenses incurred by us in connection with our formation, including but not limited to legal fees and other costs to incorporate. Organization costs are expensed as incurred and offering costs, which include selling commissions and dealer manager fees, are charged as incurred as a reduction to stockholders’ equity.

12

Pursuant to the advisory agreement and the dealer manager agreement, we are obligated to reimburse our advisor, our dealer manager and their affiliates for organization and offering costs they incur on our behalf.  However, at the termination of this primary offering and at the termination of the offering pursuant to our dividend reinvestment plan, our advisor has agreed to reimburse us to the extent that selling commissions, dealer manager fees and other organization and offering expenses incurred by us exceed 15% of the gross offering proceeds of the respective offering. In addition, at the end of this primary offering and again at the end of the offering pursuant to our dividend reinvestment plan, our advisor has agreed to reimburse us to the extent that organization and offering expenses excluding underwriting compensation (which includes selling commissions, dealer manager fees and any other items viewed as underwriting compensation by FINRA) exceed 2% of the gross proceeds we raised in the respective offering. We reimburse our dealer manager for underwriting compensation as discussed in the prospectus, provided that within 30 days after the end of the month in which this primary offering terminates, our dealer manager must reimburse us to the extent that our reimbursements cause total underwriting compensation for this primary offering to exceed 10% of the gross offering proceeds from this offering. We also directly pay or reimburse our dealer manager for bona fide invoiced due diligence expenses of broker dealers. However, no reimbursements made by us to our advisor or our dealer manager may cause total organization and offering expenses incurred by us (including selling commissions, dealer manager fees and all other items of organization and offering expenses) to exceed 15% of the aggregate gross proceeds from this primary offering and the offering pursuant to our dividend reinvestment plan as of the date of reimbursement. As of December 31, 2012, selling commissions, dealer manager fees, and organization and other offering costs did not exceed 15% of the gross offering proceeds. Through December 31, 2012, including shares issued through our dividend reinvestment plan, we had sold 27,203,043 shares in this offering for gross offering proceeds of $270.9 million and incurred selling commissions and dealer manager fees of $24.4 million and other offering costs of $8.6 million.
Funds from Operations
We believe that FFO is a beneficial indicator of the performance of an equity REIT. We compute FFO in accordance with the current NAREIT definition. FFO represents net income, excluding gains and losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful‑life estimates), impairment losses on real estate assets, depreciation and amortization of real estate assets, and adjustments for unconsolidated partnerships and joint ventures. We believe FFO facilitates comparisons of operating performance between periods and among other REITs. However, our computation of FFO may not be comparable to other REITs that do not define FFO in accordance with the NAREIT definition or that interpret the current NAREIT definition differently than we do. Our management believes that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.
FFO is a non-GAAP financial measure and does not represent net income as defined by GAAP. Net income as defined by GAAP is the most relevant measure in determining our operating performance because FFO includes adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization. Accordingly, FFO should not be considered as an alternative to net income as an indicator of our operating performance.
Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by NAREIT, is presented in the following table for the years ended December 31, 2012 and 2011 (in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
Net loss
(7,682
)
 
$
(2,440
)
        Depreciation of real estate assets
4,150

 
387

        Amortization of lease-related costs
9,715

 
713

FFO
$
6,183

 
$
(1,340
)

13

Set forth below is additional information related to certain items included in net loss above, which may be helpful in assessing our operating results. Please see the accompanying consolidated statements of cash flows for details of our operating, investing, and financing cash activities.
Significant Items Included in Net Loss:
•
Revenues in excess of actual cash received as a result of straight‑line rent of $2.3 million and $0.3 million for the years ended December 31, 2012 and 2011, respectively;
•
Revenues in excess of actual cash received as a result of amortization of above-market/below-market in-place leases of $0.4 million for the year ended December 31, 2012;
•
Acquisition fees and expenses related to the purchase of real estate of approximately $3.4 million and $1.3 million for the years ended December 31, 2012 and 2011, respectively; and
•
Interest expense from the amortization of deferred financing costs related to notes payable of approximately $0.9 million and $0.1 million for the years ended December 31, 2012 and 2011, respectively.
FFO may also be used to fund all or a portion of certain capitalizable items that are excluded from FFO, such as tenant improvements, building improvements and deferred leasing costs. We expect FFO to improve as we continue to acquire additional real estate and real estate-related assets.
Distributions
Until we have fully invested the proceeds of our public offerings, and from time to time during our operational stage, we may not pay distributions solely from our cash flows from operations or FFO, in which case distributions may be paid in whole or in part from debt financing. Distributions declared, distributions paid and cash flows from operations were as follows during 2012 (in thousands, except per share amounts):
 
 
Distributions Declared (1)
 
Distributions Declared Per Share (1) (2)
 
Distributions Paid (3)
 
Cash Flows Provided by
(Used in)
Operating
Activities
Sources of Distributions Paid
Period
 
 
 
Cash
 
Reinvested
 
Total
 
 
Amount Paid from
 Cash Flows from Operations/ Percentage of Distributions Paid
 
Amount Paid from Borrowings/Percentage of Distributions Paid
First Quarter 2012
 
$
2,026

 
$
0.160

 
$
981

 
$
791

 
$
1,772

 
$
(428
)
 
$
—

 
/ 0%
 
$
1,772

 
/ 100%
Second Quarter 2012
 
2,850

 
0.162

 
1,435

 
1,186

 
2,621

 
1,796

 
1,796

 
/ 69%
 
825

 
/ 31%
Third Quarter 2012
 
3,516

 
0.164

 
1,825

 
1,494

 
3,319

 
2,948

 
2,948

 
/ 89%
 
371

 
/ 11%
Fourth Quarter 2012
 
4,133

 
$
0.164

 
$
2,111

 
$
1,770

 
$
3,881

 
$
3,341

 
3,341

 
/ 86%
 
$
540

 
/ 14%
 
 
$
12,525

 
$
0.650

 
$
6,352

 
$
5,241

 
$
11,593

 
$
7,657

 
$
8,085

 
/ 70%
 
$
3,508

 
/ 30%
_____________________
(1) Distributions for the periods from January 1, 2012 through February 28, 2012 and March 1, 2012 through December 31, 2012 were based on daily record dates and were calculated at a rate of $0.00178082 per share per day.
(2) Assumes share was issued and outstanding each day during the periods presented.
(3) Distributions are paid on a monthly basis. We have historically paid distributions for all record dates of a given month approximately 15 days following month end. However, commencing with distributions for November 2012 record dates, distributions are paid on or about the first business day of the following month.
For the year ended December 31, 2012, we paid aggregate distributions of $11.6 million, including $6.4 million of distributions paid in cash and $5.2 million of distributions reinvested through our dividend reinvestment plan. Our net loss for the year ended December 31, 2012 was $7.7 million. FFO for the year ended December 31, 2012 was $6.2 million and cash flows provided by operations was $7.7 million. See the reconciliation of FFO to net loss above. We funded our total distributions paid, which includes net cash distributions and dividends reinvested by stockholders, with $8.1 million of cash flows from operations from the second, third and fourth quarters of 2012 and $3.5 million of debt financing. For purposes of determining the source of our distributions paid, we assume first that we use cash flows from operations from the relevant periods to fund distribution payments.
From inception through December 31, 2012, we paid cumulative distributions of $13.3 million and our cumulative net loss during the same period was $10.1 million. From inception through December 31, 2012, our cash flows provided by operations was $8.4 million. To the extent that we pay distributions from sources other than our cash flows from operations, we will have less funds available for investment in properties and other assets, the overall return to our stockholders may be reduced and subsequent investors will experience dilution.

14

Over the long-term, we expect that a greater percentage of our distributions will be paid from cash flows from operations and FFO (except with respect to distributions related to sales of our assets and distributions related to the repayment of principal under investments we make in mortgage, mezzanine and other loans). However, we expect to have little, if any, cash flows from operations available for distribution until we make substantial investments. During our offering stage, when we may raise capital in this offering (and possibly future offerings) more quickly than we acquire income‑producing assets, and from time to time during our operational stage, we may not pay distributions solely from our cash flows from operations. Further, our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including those discussed under “Risk Factors” in the prospectus and in this supplement. Those factors include: our ability to continue to raise capital to make additional investments; the future operating performance of our investments and future investments in the existing real estate and financial environment; our advisor’s ability to identify investments that are suitable to execute our investment objectives; the success and economic viability of our tenants; the ability of our borrowers and their sponsors to continue to make their debt service payments and/or to repay their loans upon maturity; our ability to refinance existing indebtedness at comparable terms; changes in interest rates on any variable rate debt obligations we incur; and the level of participation in our dividend reinvestment plan. In the event our FFO and/or cash flows from operations decrease in the future, the level of our distributions may also decrease.  In addition, future distributions declared and paid may exceed FFO and/or cash flows from operations.
Critical Accounting Policies
Below is a discussion of the accounting policies that management considers critical in that 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 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.
Revenue Recognition
Real Estate
We recognize minimum rent, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight‑line basis over the term of the related leases when collectibility is reasonably assured and record amounts expected to be received in later years as deferred rent receivable. If the lease provides for tenant improvements, we determine whether the tenant improvements, for accounting purposes, are owned by the tenant or by us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:
•
whether the lease stipulates how a tenant improvement allowance may be spent;
•
whether the amount of a tenant improvement allowance is in excess of market rates;
•
whether the tenant or landlord retains legal title to the improvements at the end of the lease term;
•
whether the tenant improvements are unique to the tenant or general‑purpose in nature; and
•
whether the tenant improvements are expected to have any residual value at the end of the lease.
We 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 make estimates of the collectibility of our tenant receivables related to base rents, including deferred rent receivable, expense reimbursements and other revenue or income. We specifically analyze accounts receivable, deferred rent receivable, 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 make estimates of the expected recovery of pre‑petition and post‑petition claims in assessing the estimated collectibility of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. When a tenant is in bankruptcy, we will record a bad debt reserve for the tenant’s receivable balance and generally will not recognize subsequent rental revenue until cash is received or until the tenant is no longer in bankruptcy and has the ability to make rental payments.

15

Real Estate Loans Receivable
Interest income on our real estate loans receivable is recognized on an accrual basis over the life of the investment using the interest method. Direct loan origination fees and origination or acquisition costs, as well as acquisition premiums or discounts, are capitalized and amortized over the term of the loan as an adjustment to interest income. We will place loans on nonaccrual status when any portion of principal or interest is 90 days past due, or earlier when concern exists as to the ultimate collection of principal or interest. When a loan is placed on nonaccrual status, we will reverse the accrual for unpaid interest and generally will not recognize subsequent interest income until the cash is received, or the loan returns to accrual status. We will resume the accrual of interest if we determine the collection of interest according to the contractual terms of the loan is probable.
Real Estate Securities
We will recognize interest income on real estate securities that are beneficial interests in securitized financial assets and are rated “AA” and above on an accrual basis according to the contractual terms of the securities. Discounts or premiums are amortized to interest income over the life of the investment using the interest method.
We will recognize interest income on real estate securities that are beneficial interests in securitized financial assets that are rated below “AA” using the effective yield method, which requires us to periodically project estimated cash flows related to these securities and recognize interest income at an interest rate equivalent to the estimated yield on the security, as calculated using the security’s estimated cash flows and amortized cost basis, or reference amount. Changes in the estimated cash flows are recognized through an adjustment to the yield on the security on a prospective basis. Projecting cash flows for these types of securities requires significant judgment, which may have a significant impact on the timing of revenue recognized on these investments.
Cash and Cash Equivalents
We recognize interest income on our cash and cash equivalents as it is earned and record such amounts as other interest income.
Real Estate
Depreciation and Amortization
Real estate costs related to the acquisition and improvement of properties are capitalized and amortized over the expected useful life of the asset on a straight-line basis. Repair and maintenance costs are charged to expense as incurred and significant replacements and betterments are capitalized. Repair and maintenance costs include all costs that do not extend the useful life of the real estate asset. We consider the period of future benefit of an asset to determine its appropriate useful life. Expenditures for tenant improvements are capitalized and amortized over the shorter of the tenant’s lease term or expected useful life. We anticipate the estimated useful lives of our assets by class to be generally as follows:
Buildings
25-40 years
Building improvements
10-25 years
Tenant improvements
Shorter of lease term or expected useful life
Tenant origination and absorption costs
Remaining term of related leases, including below-market renewal periods
Real Estate Acquisition Valuation
We record the acquisition of income-producing real estate or real estate that will be used for the production of income as a business combination. All assets acquired and liabilities assumed in a business combination are measured at their acquisition‑date fair values. Acquisition costs are expensed as incurred and restructuring costs that do not meet the definition of a liability at the acquisition date are expensed in periods subsequent to the acquisition date.
We assess the acquisition date fair values of all tangible assets, identifiable intangibles and assumed liabilities using methods similar to those used by independent appraisers, generally utilizing a discounted cash flow analysis that applies 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 were vacant.

16

We 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 above-market in-place leases and for the initial term plus any extended term for any leases with below-market renewal options. We 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, including any below-market renewal periods.
We 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, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease up periods.
We amortize the value of tenant origination and absorption costs to depreciation and amortization expense over the remaining average non-cancelable term of the leases.
Estimates of the fair values of the tangible assets, identifiable intangibles and assumed liabilities require us to make significant assumptions 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 assumptions 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 and Liabilities
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of our real estate and related intangible assets and liabilities may not be recoverable or realized. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets and liabilities may not be recoverable, we assess the recoverability by estimating whether we will recover the carrying value of the real estate and related intangible assets and liabilities through its undiscounted future cash flows and its eventual disposition. 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 and liabilities, 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 and liabilities.
Projecting future cash flows involves estimating expected future operating income and expenses related to the real estate and its related intangible assets and liabilities as well as market and other trends. Using inappropriate assumptions to estimate cash flows could result in incorrect fair values of the real estate and its related intangible assets and liabilities and could result in the overstatement of the carrying values of our real estate and related intangible assets and liabilities and an overstatement of our net income.
Real Estate Loan Receivable
Our real estate loan receivable is recorded at amortized cost, net of loan loss reserves (if any), and evaluated for impairment at each balance sheet date. The amortized cost of a real estate loan receivable is the outstanding unpaid principal balance, net of unamortized acquisition premiums or discounts and unamortized costs and fees directly associated with the origination or acquisition of the loan.
The reserve for loan losses is a valuation allowance that reflects our estimate of loan losses inherent in the loan portfolio as of the balance sheet date. The reserve is adjusted through “Provision for loan losses” in our consolidated statements of operations and is decreased by charge‑offs to specific loans when losses are confirmed. The reserve for loan losses may include a portfolio‑based component and an asset‑specific component.
An asset‑specific reserve relates to reserves for losses on loans considered impaired. We consider a loan to be impaired when, based upon current information and events, we believe that it is probable that we will be unable to collect all amounts due under the contractual terms of the loan agreement. We also consider a loan to be impaired if we grant the borrower a concession through a modification of the loan terms or if we expect to receive assets (including equity interests in the borrower) with fair values that are less than the carrying value of our loan in satisfaction of the loan. A reserve is established when the present value of payments expected to be received, observable market prices, the estimated fair value of the collateral (for loans that are dependent on the collateral for repayment) or amounts expected to be received in satisfaction of a loan are lower than the carrying value of that loan.

17

A portfolio‑based reserve covers the pool of loans that do not have asset‑specific reserves. A provision for loan losses is recorded when available information as of each balance sheet date indicates that it is probable that the pool of loans will incur a loss and the amount of the loss can be reasonably estimated. Required reserve balances for this pool of loans are derived from estimated probabilities of default and estimated loss severities assuming a default occurs. On a quarterly basis, we assign estimated probabilities of default and loss severities to each loan in the portfolio based on factors such as the debt service coverage of the underlying collateral, the estimated fair value of the collateral, the significance of the borrower’s investment in the collateral, the financial condition of the borrower and/or its sponsors, the likelihood that the borrower and/or its sponsors would allow the loan to default, our willingness and ability to step in as owner in the event of default, and other pertinent factors.
Failure to recognize impairments would result in the overstatement of earnings and the carrying value of our real estate loans held for investment. Actual losses, if any, could differ significantly from estimated amounts.
Fair Value Measurements
Under GAAP, we are required to measure certain financial instruments at fair value on a recurring basis. In addition, we are required to measure other non-financial and financial assets and liabilities at fair value on a non‑recurring basis (e.g., carrying value of impaired real estate loans receivable and long‑lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three‑tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:
•
Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;
•
Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model‑derived valuations in which significant inputs and significant value drivers are observable in active markets; and
•
Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.
When available, we utilize quoted market prices from independent third‑party sources to determine fair value and classify such items in Level 1 or Level 2. In instances where the market for a financial instrument is not active, regardless of the availability of a nonbinding quoted market price, observable inputs might not be relevant and could require us to make a significant adjustment to derive a fair value measurement. Additionally, in an inactive market, a market price quoted from an independent third party may rely more on models with inputs based on information available only to that independent third party. When we determine the market for a financial instrument owned by us to be illiquid or when market transactions for similar instruments do not appear orderly, we use several valuation sources (including internal valuations, discounted cash flow analysis and quoted market prices) and establish a fair value by assigning weights to the various valuation sources. Additionally, when determining the fair value of liabilities in circumstances in which a quoted price in an active market for an identical liability is not available, we measure fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach.
Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In this regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in an immediate settlement of the instrument.
We consider the following factors to be indicators of an inactive market: (i) there are few recent transactions, (ii) price quotations are not based on current information, (iii) price quotations vary substantially either over time or among market makers (for example, some brokered markets), (iv) indexes that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability, (v) there is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with our estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability, (vi) there is a wide bid‑ask spread or significant increase in the bid‑ask spread, (vii) there is a significant decline or absence of a market for new issuances (that is, a primary market) for the asset or liability or similar assets or liabilities, and (viii) little information is released publicly (for example, a principal‑to‑principal market).

18

We consider the following factors to be indicators of non‑orderly transactions: (i) there was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions, (ii) there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant, (iii) the seller is in or near bankruptcy or receivership (that is, distressed), or the seller was required to sell to meet regulatory or legal requirements (that is, forced), and (iv) the transaction price is an outlier when compared with other recent transactions for the same or similar assets or liabilities.
Income Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our annual REIT taxable income to stockholders (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). As a REIT, we generally will not be subject to federal income tax on income that we distribute as dividends to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost, unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially and adversely affect our net income and net cash available for distribution to stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT.
We have concluded that there are no significant uncertain tax positions requiring recognition in our financial statements. Neither we nor our subsidiaries have been assessed interest or penalties by any major tax jurisdictions. Our evaluations were performed for the tax year ended December 31, 2012 and 2011. As of December 31, 2012, the returns for the calendar year 2011 and 2010 remain subject to examination by major tax jurisdictions.
Experts
The consolidated financial statements of KBS Real Estate Investment Trust III, Inc. as of December 31, 2012 and 2011, and for each of the two years in the period ended December 31, 2012, and the accompanying financial statement schedule, appearing in this supplement have been audited by Ernst & Young LLP, independent registered public accounting firm, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing.

19


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
KBS Real Estate Investment Trust III, Inc.

We have audited the accompanying consolidated balance sheets of KBS Real Estate Investment Trust III, Inc. (“the Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years ended December 31, 2012 and 2011. Our audits also included the financial statement schedule in Item 15(a), Schedule III‑Real Estate Assets and Accumulated Depreciation and Amortization. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of KBS Real Estate Investment Trust III, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for the years ended December 31, 2012 and 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.


/s/ Ernst & Young LLP

Irvine, California
March 8, 2013



F-2

KBS REAL ESTATE INVESTMENT TRUST III, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
 
 
December 31,
2012
 
December 31,
2011
 
 
 
 
 
Assets
 
 
 
 
Real estate:
 
 
 
 
Land
 
$
32,384

 
$
7,500

Buildings and improvements
 
246,258

 
63,849

Tenant origination and absorption costs
 
40,418

 
12,080

Total real estate, cost
 
319,060

 
83,429

Less accumulated depreciation and amortization
 
(14,090
)
 
(1,100
)
Total real estate, net
 
304,970

 
82,329

Real estate loan receivable, net
 
13,691

 
10,310

Cash and cash equivalents
 
23,518

 
37,179

Rents and other receivables, net
 
3,545

 
383

Above-market leases, net
 
881

 
101

Deferred financing costs, prepaid expenses and other assets
 
2,779

 
556

Total assets
 
$
349,384

 
$
130,858

Liabilities and stockholders’ equity
 
 
 
 
Notes payable
 
$
119,800

 
$
42,250

Accounts payable and accrued liabilities
 
8,054

 
1,920

Due to affiliates
 
16

 
13

Distributions payable
 
1,465

 
533

Below-market leases, net
 
5,152

 
298

Other liabilities
 
2,872

 
833

Total liabilities
 
137,359

 
45,847

Commitments and contingencies (Note 13)
 
 
 
 
Redeemable common stock
 
4,804

 
740

Stockholders’ equity
 
 
 
 
Preferred stock, $.01 par value; 10,000,000 shares authorized, no shares issued and outstanding
 
—

 
—

Common stock, $.01 par value; 1,000,000,000 shares authorized, 27,148,131 and 10,468,043 shares issued and outstanding as of December 31, 2012 and December 31, 2011, respectively
 
271

 
105

Additional paid-in capital
 
231,792

 
88,801

Cumulative distributions and net losses
 
(24,842
)
 
(4,635
)
Total stockholders’ equity
 
207,221

 
84,271

Total liabilities and stockholders’ equity
 
$
349,384

 
$
130,858

See accompanying notes to consolidated financial statements.
 




F-3

KBS REAL ESTATE INVESTMENT TRUST III, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
 
 
Years Ended December 31,
 
 
2012
 
2011
Revenues:
 
 
 
 
Rental income
 
$
21,155

 
$
1,426

Tenant reimbursements
 
5,122

 
691

Interest income from real estate loan receivable
 
889

 
395

Other operating income
 
117

 
—

Total revenues
 
27,283

 
2,512

Expenses:
 
 
 
 
Operating, maintenance, and management
 
5,922

 
421

Real estate taxes and insurance
 
4,567

 
314

Asset management fees to affiliate
 
1,732

 
178

Real estate acquisition fees to affiliates
 
2,296

 
836

Real estate acquisition fees and expenses
 
1,069

 
432

General and administrative expenses
 
1,974

 
1,386

Depreciation and amortization
 
13,865

 
1,100

Interest expense
 
3,568

 
300

Total expenses
 
34,993

 
4,967

Other income:
 
 
 
 
Other interest income
 
28

 
15

Net loss
 
$
(7,682
)
 
$
(2,440
)
Net loss per common share, basic and diluted
 
$
(0.40
)
 
$
(0.66
)
Weighted-average number of common shares outstanding, basic and diluted
 
19,253,338

 
3,724,745

See accompanying notes to consolidated financial statements.


F-4

KBS REAL ESTATE INVESTMENT TRUST III, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(dollars in thousands)
 
 
 
 
 
 
Additional Paid-in Capital
 
Cumulative Distributions and Net Losses
 
Total Stockholders’ Equity
 
 
 
Common Stock
 
 
 
Shares
 
Amounts
 
Balance, December 31, 2010
 
20,000

 
$
1

 
$
199

 
$
—

 
$
200

Issuance of common stock
 
10,448,043

 
104

 
103,926

 
—

 
104,030

Transfers to redeemable common stock
 
—

 
—

 
(740
)
 
—

 
(740
)
Distributions declared
 
—

 
—

 
—

 
(2,195
)
 
(2,195
)
Commissions on stock sales and related dealer manager fees to affiliate
 
—

 
—

 
(9,434
)
 
—

 
(9,434
)
Other offering costs
 
—

 
—

 
(5,150
)
 
—

 
(5,150
)
Net loss
 
—

 
—

 
—

 
(2,440
)
 
(2,440
)
Balance, December 31, 2011
 
10,468,043

 
$
105

 
$
88,801

 
$
(4,635
)
 
$
84,271

Issuance of common stock
 
16,755,000

 
167

 
166,690

 
—

 
166,857

Transfers to redeemable common stock
 
—

 
—

 
(4,501
)
 
—

 
(4,501
)
Redemptions of common stock
 
(74,912
)
 
(1
)
 
(739
)
 
—

 
(740
)
Distributions declared
 
—

 
—

 
—

 
(12,525
)
 
(12,525
)
Commissions on stock sales and related dealer manager fees to affiliate
 
—

 
—

 
(14,972
)
 
—

 
(14,972
)
Other offering costs
 
—

 
—

 
(3,487
)
 
—

 
(3,487
)
Net loss
 
—

 
—

 
—

 
(7,682
)
 
(7,682
)
Balance, December 31, 2012
 
27,148,131

 
$
271

 
$
231,792

 
$
(24,842
)
 
$
207,221

See accompanying notes to consolidated financial statements.


F-5

KBS REAL ESTATE INVESTMENT TRUST III, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
 
 Years Ended December 31,
 
 
2012
 
2011
Cash Flows from Operating Activities:
 
 
 
 
Net loss
 
$
(7,682
)
 
$
(2,440
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
13,865

 
1,100

Noncash interest income on real estate-related investment
 
22

 
2

Deferred rents
 
(2,281
)
 
(279
)
Amortization of above- and below-market leases, net
 
(383
)
 
(1
)
Amortization of deferred financing costs
 
881

 
71

Changes in operating assets and liabilities:
 
 
 
 
Rents and other receivables
 
(878
)
 
(104
)
Deferred financing costs, prepaid expenses and other assets
 
(1,495
)
 
(315
)
Accounts payable and accrued liabilities
 
4,006

 
1,857

Other liabilities
 
1,602

 
833

Net cash provided by operating activities
 
7,657

 
724

Cash Flows from Investing Activities:
 
 
 
 
Acquisitions of real estate
 
(228,308
)
 
(83,087
)
Improvements to real estate
 
(1,712
)
 
(128
)
Investment in real estate loan receivable
 
—

 
(10,312
)
Advances on real estate loans receivable
 
(3,403
)
 
—

Net cash used in investing activities
 
(233,423
)
 
(93,527
)
Cash Flows from Financing Activities:
 
 
 
 
Proceeds from notes payable
 
180,250

 
42,250

Principal repayments on notes payable
 
(102,700
)
 
—

Payments of deferred financing costs
 
(1,544
)
 
(312
)
Proceeds from issuance of common stock
 
161,616

 
103,290

Payments to redeem common stock
 
(740
)
 
—

Payments of commissions on stock sales and related dealer manager fees
 
(14,972
)
 
(9,434
)
Payments of other offering costs
 
(3,453
)
 
(5,090
)
Distributions paid to common stockholders
 
(6,352
)
 
(922
)
Net cash provided by financing activities
 
212,105

 
129,782

Net (decrease) increase in cash and cash equivalents
 
(13,661
)
 
36,979

Cash and cash equivalents, beginning of period
 
37,179

 
200

Cash and cash equivalents, end of period
 
$
23,518

 
$
37,179

Supplemental Disclosure of Cash Flow Information:
 
 
 
 
Interest paid
 
$
2,539

 
$
138

Supplemental Disclosure of Noncash Transactions:
 
 
 
 
Distributions paid to common stockholders through common stock issuances pursuant to the dividend reinvestment plan
 
$
5,241

 
$
740

Increase in other offering costs payable
 
$
47

 
$
60

Increase in distributions payable
 
$
932

 
$
533

Increase in redeemable common stock payable
 
$
437

 
—

Increase in capital expenses payable
 
$
1,974

 
$
16

Increase in lease commissions payable
 
$
123

 
$
—

See accompanying notes to consolidated financial statements.


F-6
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2012

1.
ORGANIZATION
KBS Real Estate Investment Trust III, Inc. (the “Company”) was formed on December 22, 2009 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2011. Substantially all of the Company’s business is expected to be conducted through KBS Limited Partnership III (the “Operating Partnership”), a Delaware limited partnership. The Company is the sole general partner of and owns a 0.1% partnership interest in the Operating Partnership. KBS REIT Holdings III LLC (“REIT Holdings III”), the limited partner of the Operating Partnership, owns the remaining 99.9% interest in the Operating Partnership and is its sole limited partner. The Company is the sole member and manager of REIT Holdings III.
Subject to certain restrictions and limitations, the business of the Company is externally managed by KBS Capital Advisors LLC (the “Advisor”), an affiliate of the Company, pursuant to an advisory agreement the Company entered into with the Advisor (the “Advisory Agreement”). On January 26, 2010, the Company issued 20,000 shares of its common stock to the Advisor at a purchase price of $10.00 per share. As of December 31, 2012, the Advisor owned 20,000 shares of the Company’s common stock.
The Company intends to invest in a diverse portfolio of real estate properties and real estate-related assets. The primary types of properties the Company expects to invest in include office, industrial and retail properties located throughout the United States. All such real estate assets may be acquired directly by the Company or the Operating Partnership, though the Company may invest in other entities that make similar investments. The Company also expects to invest in real estate-related assets 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. As of December 31, 2012, the Company owned six office properties and one first mortgage loan secured by a deed of trust.
On February 4, 2010, the Company filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to offer a minimum of 250,000 shares and a maximum of 280,000,000 shares of common stock for sale to the public (the “Offering”), of which 80,000,000 shares are being offered pursuant to the Company’s dividend reinvestment plan. The SEC declared the Company’s registration statement effective on October 26, 2010, and the Company retained KBS Capital Markets Group LLC (the “Dealer Manager”), an affiliate of the Company, to serve as the dealer manager of the Offering pursuant to a dealer manager agreement, as amended and restated (the “Dealer Manager Agreement”). As described above, the Company intends to use substantially all of the net proceeds from the Offering to invest in a diverse portfolio of real estate properties and real estate-related assets.
On March 24, 2011, the Company broke escrow in the Offering and through December 31, 2012, the Company had sold 27,203,043 shares of common stock for gross offering proceeds of $270.9 million, including 629,560 shares of common stock under its dividend reinvestment plan for gross offering proceeds of $6.0 million. The Company has extended its primary offering until the earlier of the sale of all 200,000,000 shares or October 11, 2013.
As of December 31, 2012, the Company had redeemed 74,912 shares sold in the Offering for $0.7 million.
On February 14, 2013, the Company filed a registration statement on Form S-11 with the SEC to register a follow-on public offering (the “Follow-on Offering”). Pursuant to the Follow-on Offering registration statement, the Company proposes to register up to $2,000,000,000 of shares of common stock for sale to the public in the primary offering. The Company also expects to register up to $760,000,000 of shares of common stock pursuant to the Company’s dividend reinvestment plan in the Follow-on Offering. The Company currently expects to commence the Follow-on Offering during the fourth quarter of 2013.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) as contained within the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) and the rules and regulations of the SEC.
The consolidated financial statements include the accounts of the Company, REIT Holdings III, the Operating Partnership and their direct and indirect wholly owned subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.


F-7
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

Use of Estimates
The preparation of the consolidated financial statements and the notes thereto in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could materially differ from those estimates.
Revenue Recognition
Real Estate
The Company recognizes minimum rent, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight‑line basis over the term of the related leases when collectibility is reasonably assured and records amounts expected to be received in later years as deferred rent receivable. If the lease provides for tenant improvements, the Company determines whether the tenant improvements, for accounting purposes, are owned by the tenant or the Company. When the Company is the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:
•whether the lease stipulates how a tenant improvement allowance may be spent;
•whether the amount of a tenant improvement allowance is in excess of market rates;
•whether the tenant or landlord retains legal title to the improvements at the end of the lease term;
•whether the tenant improvements are unique to the tenant or general‑purpose in nature; and
•whether the tenant improvements are expected to have any residual value at the end of the lease.
The Company records 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.
The Company makes estimates of the collectibility of its tenant receivables related to base rents, including deferred rent, expense reimbursements and other revenue or income. Management specifically analyzes accounts receivable, deferred rent receivable, 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, management makes estimates of the expected recovery of pre‑petition and post‑petition claims in assessing the estimated collectibility of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. When a tenant is in bankruptcy, the Company will record a bad debt reserve for the tenant’s receivable balance and generally will not recognize subsequent rental revenue until cash is received or until the tenant is no longer in bankruptcy and has the ability to make rental payments.
Real Estate Loans Receivable
Interest income on the Company’s real estate loans receivable is recognized on an accrual basis over the life of the investment using the interest method. Direct loan origination fees and origination or acquisition costs, as well as acquisition premiums or discounts, are amortized over the term of the loan as an adjustment to interest income. The Company will place loans on nonaccrual status when any portion of principal or interest is 90 days past due, or earlier when concern exists as to the ultimate collection of principal or interest. When a loan is placed on nonaccrual status, the Company will reverse the accrual for unpaid interest and generally will not recognize subsequent interest income until the cash is received, or the loan returns to accrual status. The Company will resume the accrual of interest if it determines the collection of interest according to the contractual terms of the loan is probable.
Real Estate Securities
The Company will recognize interest income on real estate securities that are beneficial interests in securitized financial assets and are rated “AA” and above on an accrual basis according to the contractual terms of the securities. Discounts or premiums are amortized to interest income over the life of the investment using the interest method.

F-8
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

The Company will recognize interest income on real estate securities that are beneficial interests in securitized financial assets that are rated below “AA” using the effective yield method, which requires the Company to periodically project estimated cash flows related to these securities and recognize interest income at an interest rate equivalent to the estimated yield on the security, as calculated using the security’s estimated cash flows and amortized cost basis, or reference amount. Changes in the estimated cash flows are recognized through an adjustment to the yield on the security on a prospective basis. Projecting cash flows for these types of securities requires significant judgment, which may have a significant impact on the timing of revenue recognized on these investments. As of December 31, 2012, the Company had made no investment in real estate securities.
Cash and Cash Equivalents
The Company recognizes interest income on its cash and cash equivalents as it is earned and classifies such amounts as other interest income.
Real Estate
Depreciation and Amortization
Real estate costs related to the acquisition and improvement of properties are capitalized and amortized over the expected useful life of the asset on a straight-line basis. Repair and maintenance costs are charged to expense as incurred and significant replacements and betterments are capitalized. Repair and maintenance costs include all costs that do not extend the useful life of the real estate asset. The Company considers the period of future benefit of an asset to determine its appropriate useful life. Expenditures for tenant improvements are capitalized and amortized over the shorter of the tenant’s lease term or expected useful life. The Company anticipates the estimated useful lives of its assets by class to be generally as follows:
Buildings
25-40 years
Building improvements
10-25 years
Tenant improvements
Shorter of lease term or expected useful life
Tenant origination and absorption costs
Remaining term of related leases, including below-market renewal periods
Real Estate Acquisition Valuation
The Company records the acquisition of income-producing real estate or real estate that will be used for the production of income as a business combination. All assets acquired and liabilities assumed in a business combination are measured at their acquisition-date fair values. Acquisition costs are expensed as incurred and restructuring costs that do not meet the definition of a liability at the acquisition date are expensed in periods subsequent to the acquisition date.
The Company assesses the acquisition date fair values of all tangible assets, identifiable intangibles and assumed liabilities using methods similar to those used by independent appraisers, generally utilizing a discounted cash flow analysis that applies 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 were vacant.
The Company records 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 above-market in-place leases and for the initial term plus any extended term for any leases with below-market renewal options. The Company amortizes 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, including any below-market renewal periods.

F-9
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

The Company estimates 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, the Company includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease up periods.
The Company amortizes the value of tenant origination and absorption costs to depreciation and amortization expense over the remaining average non-cancelable term of the leases.
Estimates of the fair values of the tangible assets, identifiable intangibles and assumed liabilities require the Company to make significant assumptions 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 assumptions would result in an incorrect valuation of the Company’s acquired tangible assets, identifiable intangibles and assumed liabilities, which would impact the amount of the Company’s net income.
Impairment of Real Estate and Related Intangible Assets and Liabilities
The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of its real estate and related intangible assets and liabilities may not be recoverable or realized. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets and liabilities may not be recoverable, the Company assesses the recoverability by estimating whether the Company will recover the carrying value of the real estate and related intangible assets and liabilities through its undiscounted future cash flows and its eventual disposition. If, based on this analysis, the Company does not believe that it will be able to recover the carrying value of the real estate and related intangible assets and liabilities, the Company 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 and liabilities. The Company did not record any impairment loss on its real estate and related intangible assets and liabilities during the years ended December 31, 2012 and 2011.
Real Estate Loan Receivable
The Company’s real estate loan receivable is recorded at amortized cost, net of loan loss reserves (if any), and evaluated for impairment at each balance sheet date. The amortized cost of a real estate loan receivable is the outstanding unpaid principal balance, net of unamortized acquisition premiums or discounts and unamortized costs and fees directly associated with the origination or acquisition of the loan.
As of December 31, 2012, there was no loan loss reserve and the Company did not record any impairment losses related to its real estate loan receivable during the years ended December 31, 2012 and 2011. However, in the future, the Company may experience losses from its investments in loans receivable requiring the Company to record loan loss reserves. Realized losses on individual loans could be material and significantly exceed any recorded reserves.
The reserve for loan losses is a valuation allowance that reflects management’s estimate of loan losses inherent in the loan portfolio as of the balance sheet date. The reserve is adjusted through “Provision for loan losses” on the Company’s consolidated statements of operations and is decreased by charge‑offs to specific loans when losses are confirmed. The reserve for loan losses may include a portfolio‑based component and an asset‑specific component.
An asset‑specific reserve relates to reserves for losses on loans considered impaired. The Company considers a loan to be impaired when, based upon current information and events, it believes that it is probable that the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. The Company also considers a loan to be impaired if it grants the borrower a concession through a modification of the loan terms or if it expects to receive assets (including equity interests in the borrower) with fair values that are less than the carrying value of the loan in satisfaction of the loan. A reserve is established when the present value of payments expected to be received, observable market prices, the estimated fair value of the collateral (for loans that are dependent on the collateral for repayment) or amounts expected to be received in satisfaction of a loan are lower than the carrying value of that loan.

F-10
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

A portfolio‑based reserve covers the pool of loans that do not have asset‑specific reserves. A provision for loan losses is recorded when available information as of each balance sheet date indicates that it is probable that the pool of loans will incur a loss and the amount of the loss can be reasonably estimated. Required reserve balances for this pool of loans are derived from estimated probabilities of default and estimated loss severities assuming a default occurs. On a quarterly basis, the Company’s management assigns estimated probabilities of default and loss severities to each loan in the portfolio based on factors such as the debt service coverage of the underlying collateral, the estimated fair value of the collateral, the significance of the borrower’s investment in the collateral, the financial condition of the borrower and/or its sponsors, the likelihood that the borrower and/or its sponsors would allow the loan to default, the Company’s willingness and ability to step in as owner in the event of default, and other pertinent factors.
Failure to recognize impairments would result in the overstatement of earnings and the carrying value of the Company’s real estate loans held for investment. Actual losses, if any, could differ significantly from estimated amounts.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents may include cash and short term investments. Cash and cash equivalents are stated at cost, which approximates fair value. There are no restrictions on the use of the Company’s cash and cash equivalents as of December 31, 2012.
The Company’s cash and cash equivalents balance exceeds federally insurable limits as of December 31, 2012. The Company monitors the cash balances in its operating accounts and adjusts the cash balances as appropriate; however, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets. To date, the Company has experienced no loss or lack of access to cash in its operating accounts. The Company has a corporate banking relationship with Wells Fargo Bank, N.A. in which it deposits the majority of its funds.
Deferred Financing Costs
Deferred financing costs represent commitment fees, loan fees, legal fees and other third‑party costs associated with obtaining financing. These costs are amortized over the terms of the respective financing agreements using the interest method. Unamortized deferred financing costs are generally expensed when the associated debt is refinanced or repaid before maturity unless specific rules are met that would allow for the carryover of such costs to the refinanced debt. Costs incurred in seeking financing transactions that do not close are expensed in the period in which it is determined that the financing will not close.
Fair Value Measurements
Under GAAP, the Company is required to measure certain financial instruments at fair value on a recurring basis. In addition, the Company is required to measure other non-financial and financial assets and liabilities at fair value on a non‑recurring basis (e.g., carrying value of impaired real estate loans receivable and long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:
•
Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;
•
Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model‑derived valuations in which significant inputs and significant value drivers are observable in active markets; and
•
Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.

F-11
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

When available, the Company utilizes quoted market prices from independent third-party sources to determine fair value and classifies such items in Level 1 or Level 2. In instances where the market for a financial instrument is not active, regardless of the availability of a nonbinding quoted market price, observable inputs might not be relevant and could require the Company to make a significant adjustment to derive a fair value measurement. Additionally, in an inactive market, a market price quoted from an independent third party may rely more on models with inputs based on information available only to that independent third party. When the Company determines the market for a financial instrument owned by the Company to be illiquid or when market transactions for similar instruments do not appear orderly, the Company uses several valuation sources (including internal valuations, discounted cash flow analysis and quoted market prices) and establishes a fair value by assigning weights to the various valuation sources. Additionally, when determining the fair value of liabilities in circumstances in which a quoted price in an active market for an identical liability is not available, the Company measures fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities or similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach.
Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In this regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in an immediate settlement of the instrument.
The Company considers the following factors to be indicators of an inactive market: (i) there are few recent transactions, (ii) price quotations are not based on current information, (iii) price quotations vary substantially either over time or among market makers (for example, some brokered markets), (iv) indexes that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability, (v) there is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the Company’s estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability, (vi) there is a wide bid-ask spread or significant increase in the bid-ask spread, (vii) there is a significant decline or absence of a market for new issuances (that is, a primary market) for the asset or liability or similar assets or liabilities, and (viii) little information is released publicly (for example, a principal-to-principal market).
The Company considers the following factors to be indicators of non-orderly transactions: (i) there was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions, (ii) there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant, (iii) the seller is in or near bankruptcy or receivership (that is, distressed), or the seller was required to sell to meet regulatory or legal requirements (that is, forced), and (iv) the transaction price is an outlier when compared with other recent transactions for the same or similar assets or liabilities.
Dividend Reinvestment Plan
The Company has adopted a dividend reinvestment plan (the “DRP”) pursuant to which common stockholders may elect to have all or a portion of their dividends and other distributions reinvested in additional shares of the Company’s common stock in lieu of receiving cash distributions. The initial purchase price per share under the DRP is $9.50. Once the Company establishes an estimated value per share that is not based on the price to acquire a share in its primary offering or follow-on public offerings, shares issued pursuant to the dividend reinvestment plan will be priced at the estimated value per share of the Company’s common stock, as updated by the Advisor or another firm chosen for that purpose. The Company expects to establish an estimated value per share that is not based on the price to acquire a share in its primary offering or follow-on public offerings after the completion of its offering stage. The Company will consider its offering stage complete when it is no longer publicly offering equity securities— whether through the Offering or follow-on public offerings – and has not done so for up to 18 months. The Company currently expects to update the estimated value per share every 12 to 18 months thereafter. For purposes of determining when its offering stage is complete, the Company does not consider a public equity offering to include offerings on behalf of selling stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests in its Operating Partnership. No selling commissions or dealer manager fees will be paid on shares sold under the DRP. The board of directors of the Company may amend or terminate the DRP for any reason upon 10 days’ notice to participants.

F-12
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

Redeemable Common Stock
The Company’s board of directors has adopted an amended and restated share redemption program that may enable stockholders to sell their shares to the Company in limited circumstances.
There are several limitations on the Company’s ability to redeem shares under the share redemption program:
•
Unless the shares are being redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program document), the Company may not redeem shares unless the stockholder has held the shares for one year.
•
During any calendar year, the share redemption program limits the number of shares the Company may redeem to those that the Company could purchase with the amount of the net proceeds from the sale of shares under the dividend reinvestment plan during the prior calendar year.
•
During any calendar year, the Company may redeem no more than 5% of the weighted‑average number of shares outstanding during the prior calendar year.
•
The Company has 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.
Unless the shares are being redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program document), the prices at which the Company will redeem shares are as follows:
•
The lower of $9.25 or 92.5% of the price paid to acquire the shares from the Company 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 the Company 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 the Company 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 the Company for stockholders who have held their shares for at least four years.
Notwithstanding the above, the redemption price for redemptions sought upon a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption plan document) will initially be the amount paid to acquire the shares from the Company. Furthermore, once the Company establishes an estimated value per share of common stock that is not based on the price to acquire a share in the Company’s primary offering or a follow-on public offering, the redemption price per share for all stockholders would be equal to the estimated value per share as of the redepmtion date, as determined by the Advisor or another firm chosen for that purpose. The Company expects to establish an estimated value per share that is not based on the price to acquire a share in its primary initial public offering or a follow-on public offering after the completion of its offering stage. The Company will consider its offering stage complete when it is no longer publicly offering equity securities - whether through the Offering or follow-on public offerings - and has not done so for up to 18 months. The Company currently expects to update the estimated value per share every 12 to 18 months thereafter. For purposes of determining when its offering stage is complete, the Company does not consider a public equity offering to include offerings on behalf of selling stockholders or offerings related to a DRP, employee benefit plan or the redemption of interests in its Operating Partnership.
The Company’s board of directors may amend, suspend or terminate the share redemption program with 30 days’ notice to the Company’s stockholders. The Company may provide this notice by including such information in a Current Report on Form 8‑K or in the Company’s annual or quarterly reports, all publicly filed with the SEC, or by a separate mailing to its stockholders.

F-13
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

The Company records amounts that are redeemable under the share redemption program as redeemable common stock in the accompanying consolidated balance sheets because the shares are mandatorily redeemable at the option of the holder and therefore their redemption is outside the control of the Company. The maximum amount redeemable under the Company’s share redemption program is limited to the number of shares the Company could purchase with the amount of the net proceeds from the sale of shares under the dividend reinvestment plan during the prior calendar year. However, because the amounts that can be redeemed in future periods are determinable and only contingent on an event that is likely to occur (e.g., the passage of time), the Company presents the net proceeds from the current year dividend reinvestment plan as redeemable common stock in the accompanying consolidated balance sheets.
The Company classifies financial instruments that represent a mandatory obligation of the Company to redeem shares as liabilities. The Company’s redeemable common shares are contingently redeemable at the option of the holder. When the Company determines it has a mandatory obligation to redeem shares under the share redemption program, it will reclassify such obligations from temporary equity to a liability based upon their respective settlement values.
The Company limits the dollar value of shares that may be redeemed under the program as described above. During the year ended December 31, 2012, the Company redeemed $0.7 million of shares of common stock. As of December 31, 2012, the Company had $0.4 million of outstanding and unfulfilled redemption requests, representing 43,194 shares, and recorded $0.4 million of other liabilities on the accompanying consolidated balance sheets related to these unfulfilled redemption requests. Effective January 1, 2013, this limitation was reset, and based on the amount of net proceeds raised from the sale of shares under the dividend reinvestment plan during 2012, the Company has $5.2 million available for redemption in 2013. The Company redeemed the remaining outstanding and unfulfilled redemption requests as of December 31, 2012 of $0.4 million on the January 31, 2013 redemption date.
Related Party Transactions
The Company has entered into the Advisory Agreement with the Advisor and the Dealer Manager Agreement with the Dealer Manager. These agreements entitle the Advisor and/or the Dealer Manager to specified fees upon the provision of certain services with regard to the Offering and entitle the Advisor to specified fees upon the provision of certain services with regard to the investment of funds in real estate and real estate-related investments, the management of those investments, among other services, and the disposition of investments, as well as reimbursement of organization and offering costs incurred by the Advisor and the Dealer Manager on behalf of the Company, such as expenses related to the Offering and dividend reinvestment plan, and certain costs incurred by the Advisor in providing services to the Company. In addition, the Advisor is entitled to certain other fees, including an incentive fee upon achieving certain performance goals, as detailed in the Advisory Agreement. The Company has also entered into a fee reimbursement agreement (the “AIP Reimbursement Agreement”) with the Dealer Manager pursuant to which the Company agreed to reimburse the Dealer Manager for certain fees and expenses it incurs for administering the Company’s participation in the DTCC Alternative Investment Product Platform with respect to certain accounts of the Company’s investors serviced through the platform. The Advisor and Dealer Manager also serve as the advisor and dealer manager, respectively, for KBS Real Estate Investment Trust, Inc., KBS Real Estate Investment Trust II, Inc., KBS Strategic Opportunity REIT, Inc. and KBS Legacy Partners Apartment REIT, Inc. During the years ended December 31, 2012, 2011 and 2010, no transactions occurred between the Company and these other KBS-sponsored programs. See Note 9, “Related Party Transactions.”
The Company records all related party fees as incurred, subject to any limitations described in the Advisory Agreement, the Dealer Manager Agreement or the AIP Reimbursement Agreement.
Selling Commissions and Dealer Manager Fees
The Company pays the Dealer Manager up to 6.5% and 3.0% of the gross offering proceeds from the primary offering as selling commissions and dealer manager fees, respectively. A reduced sales commission and dealer manager fee is paid with respect to certain volume discount sales. No sales commission or dealer manager fee is paid with respect to shares issued through the dividend reinvestment plan. The Dealer Manager reallows 100% of sales commissions earned to participating broker‑dealers. The Dealer Manager may reallow to any participating broker‑dealer up to 1% of the gross offering proceeds attributable to that participating broker‑dealer as a marketing fee and, in special cases, the Dealer Manager may increase the reallowance.

F-14
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

Organization and Offering Costs
Organization and offering costs (other than selling commissions and dealer manager fees) of the Company may be paid by the Advisor, the Dealer Manager or their affiliates on behalf of the Company or may be paid directly by the Company. Other offering costs include all expenses incurred by the Company in connection with the Offering. Organization costs include all expenses incurred by the Company in connection with the formation of the Company, including but not limited to legal fees and other costs to incorporate the Company.
The Company reimburses the Advisor for organization and offering costs up to an amount that, when combined with selling commissions, dealer manager fees and all other amounts spent by the Company on organization and offering expenses, does not exceed 15% of the gross proceeds of the Company’s primary offering and the offering under its dividend reinvestment plan as of the date of reimbursement. At the termination of the primary offering and at the termination of the offering pursuant to the dividend reinvestment plan, the Advisor has agreed to reimburse the Company to the extent that selling commissions, dealer manager fees and other organization and offering expenses incurred by the Company exceed 15% of the gross offering proceeds of the respective offering. In addition, at the end of the primary offering and again at the end of the offering pursuant to the dividend reinvestment plan, the Advisor has agreed to reimburse the Company to the extent that organization and offering expenses, excluding underwriting compensation (which includes selling commissions, dealer manager fees and any other items viewed as underwriting compensation by the Financial Industry Regulatory Authority) exceed 2% of the gross proceeds the Company raised in the respective offering.
The Company directly pays or reimburses the Dealer Manager for underwriting compensation as discussed in the prospectus for the Offering, provided that within 30 days after the end of the month in which the primary initial public offering terminates, the Dealer Manager must reimburse the Company to the extent that the Company’s reimbursements cause total underwriting compensation for the primary initial public offering to exceed 10% of the gross offering proceeds from such offering. The Company also pays directly or reimburses the Dealer Manager for bona fide invoiced due diligence expenses of broker dealers. However, no reimbursements made by the Company to the Dealer Manager may cause total organization and offering expenses incurred by the Company (including selling commissions, dealer manager fees and all other items of organization and offering expenses) to exceed 15% of the aggregate gross proceeds from the Company’s primary offering and the offering pursuant to its dividend reinvestment plan as of the date of reimbursement.
As of December 31, 2012, the Company’s selling commissions, dealer manager fees, and organization and other offering costs did not exceed 15% of the gross offering proceeds. Through December 31, 2012, including shares issued through the Company’s dividend reinvestment plan, the Company had sold 27,203,043 shares in the Offering for gross offering proceeds of $270.9 million and recorded selling commissions and dealer manager fees of $24.4 million and other offering costs of $8.6 million.  Organization costs are expensed as incurred and offering costs, which include selling commissions, dealer manager fees and other offering-related costs, are charged as incurred as a reduction to stockholders’ equity.
Acquisition and Origination Fees
The Company pays the Advisor an acquisition fee equal to 1.0% of the cost of investments acquired, including acquisition expenses and any debt attributable to such investments. With respect to investments in and originations of loans, the Company pays an origination fee equal to 1.0% of the amount to be funded by the Company to acquire or originate mortgage, mezzanine, bridge or other loans, including any expenses related to such investments and any debt the Company uses to fund the acquisition or origination of these loans. The Company does not pay an acquisition fee with respect to investments in loans.
Asset Management Fee
With respect to investments in real estate, the Company pays the Advisor a monthly asset management fee equal to one‑twelfth of 0.75% of the amount paid or allocated to acquire the investment. This amount includes any portion of the investment that was debt financed and is inclusive of acquisition expenses related thereto (but excludes acquisition fees paid or payable to the Advisor). In the case of investments made through joint ventures, the asset management fee will be determined based on the Company’s proportionate share of the underlying investment.

F-15
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

With respect to investments in loans and any investments other than real estate, the Company pays the Advisor a monthly fee calculated, each month, as one‑twelfth of 0.75% of the lesser of (i) the amount paid or allocated to acquire or fund the loan or other investment (which amount includes any portion of the investment that was debt financed and is inclusive of acquisition or origination expenses related thereto but is exclusive of acquisition or origination fees paid or payable to the Advisor) and (ii) the outstanding principal amount of such loan or other investment, plus the acquisition or origination expenses related to the acquisition or funding of such investment (but excluding acquisition or origination fees paid or payable to the Advisor), as of the time of calculation.
Income Taxes
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company’s annual REIT taxable income to stockholders (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). As a REIT, the Company generally will not be subject to federal income tax on income that it distributes as dividends to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost, unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially and adversely affect the Company’s net income and net cash available for distribution to stockholders. However, the Company believes that it is organized and operates in such a manner as to qualify for treatment as a REIT.
The Company has concluded that there are no significant uncertain tax positions requiring recognition in its financial statements. Neither the Company nor its subsidiaries has been assessed interest or penalties by any major tax jurisdictions. The Company’s evaluations were performed for the tax years ended December 31, 2012 and 2011. As of December 31, 2012, the return for 2011 remains subject to examination by major tax jurisdictions.
Per Share Data
Basic net income (loss) per share of common stock is calculated by dividing net income (loss) by the weighted-average number of shares of common stock issued and outstanding during such period. Diluted net income (loss) per share of common stock equals basic net income (loss) per share of common stock as there were no potentially dilutive securities outstanding during the years ended December 31, 2012 and 2011.
Distributions declared per share were $0.65 and $0.34 during the years ended December 31, 2012 and 2011, respectively. Distributions declared per common share assumes each share was issued and outstanding each day from June 24, 2011 through December 31, 2012. For each day that was a record date for distributions during the period from June 24, 2011 through December 31, 2012, distributions were calculated at a rate of $0.00178082 per share per day. Each day during the periods from June 24, 2011 through February 28, 2012 and March 1, 2012 through December 31, 2012 was a record date for distributions.
Segments
The Company’s segments are based on the Company’s method of internal reporting, which classifies its operations by investment type: real estate and real estate-related. For financial data by segment, see Note 10, “Segment Information.”
Square Footage, Occupancy and Other Measures
Square footage, number of acres, occupancy and other measures used to describe real estate and real estate-related investments included in these Notes to Consolidated Financial Statements are presented on an unaudited basis.

F-16
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

Recently Issued Accounting Standards Update
In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU No. 2011-11”). ASU No. 2011-11 requires entities to provide enhanced disclosures about financial instruments and derivative instruments that are either presented on a net basis on the balance sheet or subject to an enforceable master netting arrangement or similar agreement including (i) a description of the rights of offset associated with relevant agreements and (ii) both net and gross information, including amounts of financial collateral, for relevant assets and liabilities. The purpose of the update is to enhance comparability between those companies that prepare their financial statements on the basis of GAAP and those that prepare their financial statements in accordance with International Financial Reporting Standards and to enable users of the financial statements to understand the effect or potential effect of the offsetting arrangements on the balance sheet. ASU No. 2011-11 is effective for fiscal years beginning on or after January 1, 2013, and for interim periods within those years. Disclosures are required retrospectively for all comparative periods presented in an entity’s financial statements. The Company does not expect the adoption of ASU No. 2011-11 will have a material impact to its consolidated financial statements.
3.
RECENT ACQUISITIONS OF REAL ESTATE
During the year ended December 31, 2012, the Company acquired the following properties (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
Intangibles
 
 
Property Name
 
City
 
State
 
Acquisition Date
 
Land
 
Building and Improvements
 
Tenant Origination and Absorption Costs
 
Above-Market Lease Assets
 
Below-Market
Lease Liabilities
 
Total 
Purchase
Price
Town Center
 
Plano
 
TX
 
03/27/2012
 
$
7,428

 
$
95,780

 
$
12,767

 
$
9

 
$
(3,412
)
 
$
112,572

McEwen Building
 
Franklin
 
TN
 
04/30/2012
 
5,600

 
28,946

 
5,758

 
192

 
(496
)
 
40,000

Gateway Tech Center
 
Salt Lake City
 
UT
 
05/09/2012
 
9,800

 
15,284

 
4,767

 
398

 
(13
)
 
30,236

Tower on Lake Carolyn
 
Irving
 
TX
 
12/21/2012
 
2,056

 
38,869

 
5,710

 
317

 
(1,452
)
 
45,500

 
 
 
 
 
 
 
 
$
24,884

 
$
178,879

 
$
29,002

 
$
916

 
$
(5,373
)
 
$
228,308

The intangible assets and liabilities acquired in connection with these acquisitions have weighted-average amortization periods as of the date of acquisition as follows (in years):
 
 
Tenant Origination and
Absorption Costs
 
Above-Market
Lease Assets
 
Below-Market
Lease Liabilities
Town Center
 
6.2
 
1.7
 
7.9
McEwen Building
 
6.6
 
6.1
 
8.7
Gateway Tech Center
 
5.5
 
5.2
 
2.1
Tower on Lake Carolyn
 
5.4
 
3.5
 
6.9
The Company recorded each real estate acquisition as a business combination and expensed $3.4 million of acquisition costs. For the year ended December 31, 2012, the Company recognized $16.0 million of total revenues and $9.6 million of operating expenses from these properties.

F-17
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

4.
REAL ESTATE
As of December 31, 2012, the Company’s real estate portfolio was composed of six office properties encompassing in the aggregate approximately 1.6 million rentable square feet. As of December 31, 2012, the Company’s real estate portfolio was collectively 92% occupied. The following table summarizes the Company’s investments in real estate as of December 31, 2012 (in thousands):
Property
 
Date Acquired
 
City
 
State
 
Property Type
 
Total
Real Estate
at Cost
 
Accumulated Depreciation and Amortization
 
Total Real Estate, Net
Domain Gateway
 
09/29/2011
 
Austin
 
TX
 
Office
 
$
47,373

 
$
(2,779
)
 
$
44,594

Las Cimas IV
 
10/28/2011
 
Austin
 
TX
 
Office
 
36,089

 
(2,679
)
 
33,410

Town Center
 
03/27/2012
 
Plano
 
TX
 
Office
 
118,698

 
(5,302
)
 
113,396

McEwen Building
 
04/30/2012
 
Franklin
 
TN
 
Office
 
40,304

 
(1,497
)
 
38,807

Gateway Tech Center
 
05/09/2012
 
Salt Lake City
 
UT
 
Office
 
29,961

 
(1,693
)
 
28,268

Tower on Lake Carolyn
 
12/21/2012
 
Irving
 
TX
 
Office
 
46,635

 
(140
)
 
46,495

 
 
 
 
 
 
 
 
 
 
$
319,060

 
$
(14,090
)
 
$
304,970

Operating Leases
The Company’s real estate properties are leased to tenants under operating leases for which the terms and expirations vary. As of December 31, 2012, the leases had remaining terms, excluding options to extend, of up to 10.7 years with a weighted-average remaining term of 5.1 years. Some of the leases have provisions to extend the term of the leases, options for early termination after paying a specified penalty, rights of first refusal to purchase the property at competitive market rates, and other terms and conditions as negotiated. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants. Generally, upon the execution of a lease, the Company requires a security deposit from tenants in the form of a cash deposit and/or a letter of credit. The amount required as a security deposit varies depending upon the terms of the respective leases and the creditworthiness of the tenant, but generally are not significant amounts. Therefore, exposure to credit risk exists to the extent that a receivable from a tenant exceeds the amount of its security deposit. Security deposits received in cash related to tenant leases are included in other liabilities in the accompanying consolidated balance sheets and totaled $1.7 million and $0.4 million as of December 31, 2012 and December 31, 2011, respectively.
During the years ended December 31, 2012 and 2011, the Company recognized deferred rent from tenants of $2.3 million and $0.3 million, respectively. As of December 31, 2012 and December 31, 2011, the cumulative deferred rent balance was $2.6 million and $0.3 million, respectively, and is included in rents and other receivables on the accompanying balance sheets.
As of December 31, 2012, the future minimum rental income from the Company’s properties under its non-cancelable operating leases was as follows (in thousands):
2013
$
30,953

2014
29,678

2015
27,081

2016
24,961

2017
20,698

Thereafter
41,873

 
$
175,244


F-18
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

As of December 31, 2012, the Company’s highest tenant industry concentrations (greater than 10% of annualized base rent) were as follows:
Industry
 
Number of Tenants
 
Annualized
Base Rent (1)
(in thousands)
 
Percentage of Annualized Base Rent
Finance
 
20
 
$
6,476

 
19.5
%
Other Services
 
15
 
4,648

 
14.0
%
 
 
 
 
$
11,124

 
33.5
%
_____________________
(1) Annualized base rent represents annualized contractual base rental income as of December 31, 2012, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.
No other tenant industries accounted for more than 10% of annualized base rent. No material tenant credit issues have been identified at this time.
As of December 31, 2012, the Company had a concentration of credit risk related to the following tenant lease that represented more than 10% of the Company’s annualized base rent:
 
 
 
 
 
 
 
 
Annualized Base Rent Statistics
 
 
Tenant
 
Property
 
Tenant
Industry
 
Square Feet
 
% of Portfolio Rentable Sq. Ft. Leased
 
Annualized Base Rent (1)
(in thousands)
 
% of Portfolio Annualized Base Rent
 
Annualized Base Rent per Square Foot
 
Lease Expiration (2)
OneWest Bank
 
Domain Gateway
 
Finance
 
173,962
 
12.0
%
 
$
3,716

 
11.2
%
 
$
21.36

 
08/31/2019
_____________________
(1) Annualized base rent represents annualized contractual base rental income as of December 31, 2012, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.
(2) Represents the expiration date of the lease as of December 31, 2012 and does not take into account any tenant renewal or termination options.
Geographic Concentration Risk
As of December 31, 2012, the Company’s net investments in real estate in Texas represented 68% of the Company’s total assets.  As a result, the geographic concentration of the Company’s portfolio makes it particularly susceptible to adverse economic developments in the Texas real estate market.  Any adverse economic or real estate developments in this market, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for office space resulting from the local business climate, could adversely affect the Company’s operating results and its ability to make distributions to stockholders.

F-19
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

5.
TENANT ORIGINATION AND ABSORPTION COSTS, ABOVE-MARKET LEASE ASSETS AND BELOW-MARKET LEASE LIABILITIES
As of December 31, 2012 and December 31, 2011, the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities (excluding fully amortized assets and liabilities and accumulated amortization) were as follows (in thousands):
 
 
Tenant Origination and
Absorption Costs
 
Above-Market
Lease Assets
 
Below-Market
Lease Liabilities
 
 
December 31,
2012
 
December 31,
2011
 
December 31,
2012
 
December 31,
2011
 
December 31,
2012
 
December 31,
2011
Cost
 
$
40,418

 
$
12,080

 
$
1,025

 
$
110

 
$
(5,659
)
 
$
(308
)
Accumulated Amortization
 
(6,268
)
 
(508
)
 
(144
)
 
(9
)
 
507

 
10

Net Amount
 
$
34,150

 
$
11,572

 
$
881

 
$
101

 
$
(5,152
)
 
$
(298
)
Increases (decreases) in net income as a result of amortization of the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities for the years ended December 31, 2012 and 2011 were as follows (in thousands):
 
 
Tenant Origination and
Absorption Costs
 
Above-Market
Lease Assets
 
Below-Market
Lease Liabilities
 
 
For the Year Ended December 31,
 
For the Year Ended December 31,
 
For the Year Ended December 31,
 
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Amortization
 
$
(6,424
)
 
$
(508
)
 
$
(136
)
 
$
(9
)
 
$
519

 
$
10

The remaining unamortized balance for these outstanding intangible assets and liabilities as of December 31, 2012 is estimated to be amortized for the years ending December 31 as follows (in thousands):
 
 
Tenant
Origination and
Absorption Costs
 
Above-Market
Lease Assets
 
Below-Market
Lease Liabilities
2013
 
$
(7,899
)
 
$
(287
)
 
$
834

2014
 
(6,469
)
 
(198
)
 
818

2015
 
(5,281
)
 
(137
)
 
760

2016
 
(4,614
)
 
(115
)
 
678

2017
 
(3,526
)
 
(102
)
 
560

Thereafter
 
(6,361
)
 
(42
)
 
1,502

 
 
$
(34,150
)
 
$
(881
)
 
$
5,152

Weighted-Average Remaining Amortization Period
 
5.8 years
 
4.2 years
 
7.2 years

F-20
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

6.
REAL ESTATE LOAN RECEIVABLE
As of December 31, 2012 and December 31, 2011, the Company, through an indirect wholly owned subsidiary, had originated one real estate loan receivable as follows (dollars in thousands):
Loan Name
     Location of Related Property or Collateral
 
Date Originated
 
Property Type
 
Loan Type
 
Outstanding Principal Balance as of December 31,
 2012 (1)
 
Book Value
as of
December 31, 2012 (2)
 
Book Value
as of
December 31,
 2011 (2)
 
Contractual Interest
Rate (3)
 
Annualized Effective Interest
Rate (3)
 
Maturity Date
Aberdeen First Mortgage Origination (4)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dallas, Texas
 
06/24/2011
 
Office
 
Mortgage
 
$
13,599

 
$
13,691

 
$
10,310

 
7.5%
 
7.5%
 
07/01/2016
_____________________
(1) Outstanding principal balance as of December 31, 2012 represents original principal balance outstanding under the loan, increased for any subsequent fundings and reduced for any principal paydowns.
(2) Book value represents outstanding principal balance, adjusted for unamortized origination fees and direct origination and acquisition costs.
(3) Contractual interest rate is the stated interest rate on the face of the loan. Annualized effective interest rate is calculated as the actual interest income recognized in 2012, using the interest method, divided by the average amortized cost basis of the investment. The annualized effective interest rate and contractual interest rate presented are as of December 31, 2012.
(4) As of December 31, 2012, $13.6 million had been disbursed under the Aberdeen First Mortgage Loan and an additional $10.3 million remained available for future funding, subject to certain conditions set forth in the loan agreement.
The following summarizes the activity related to the real estate loan receivable for the year ended December 31, 2012 (in thousands):
Real estate loan receivable - December 31, 2011
$
10,310

Advances on real estate loan receivable
3,403

Amortization of closing costs and origination fees on originated real estate loan receivable
(22
)
Real estate loan receivable - December 31, 2012
$
13,691

  
For the years ended December 31, 2012 and 2011, interest income from the real estate loan receivable consisted of the following (in thousands):
 
For the Year Ended December 31,
 
2012
 
2011
Contractual interest income
$
911

 
$
397

Amortization of closing costs and origination fees
(22
)
 
(2
)
Interest income from real estate loan receivable
$
889

 
$
395

As of December 31, 2012 and December 31, 2011, interest receivable from the real estate loan receivable was $0.1 million and $0.1 million, respectively, and was included in rents and other receivables.

F-21
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

7.
NOTES PAYABLE
As of December 31, 2012 and December 31, 2011, the Company’s notes payable consisted of the following (dollars in thousands):
 
 
Principal as of
December 31, 2012
 
Principal as of
December 31, 2011
 
Contractual Interest Rate as of
December 31, 2012(1)
 
Effective
 Interest Rate as of
December 31, 2012 (1)
 
Payment Type
 
Maturity Date
Portfolio Bridge Loan (2)
 
$
—

 
$
42,250

 
(2) 
 
(2) 
 
(2) 
 
(2) 
Town Center Mortgage Loan
 
56,600

 
—

 
One-month LIBOR + 2.25%
 
2.46%
 
Interest Only
 
03/27/2013
U.S. Bank Portfolio Loan (3)
 
63,200

 
—

 
One-month LIBOR + 2.00%
 
2.21%
 
Interest Only
 
05/01/2014
Total Notes Payable
 
$
119,800

 
$
42,250

 
 
 
 
 
 
 
 
_____________________
(1) Contractual interest rate represents the interest rate in effect under the loan as of December 31, 2012. Effective interest rate is calculated as the actual interest rate in effect as of December 31, 2012 (consisting of the contractual interest rate), using interest rate indices as of December 31, 2012, where applicable.
(2) In connection with the closing of the U.S. Bank Portfolio Loan, the Company repaid this loan in full. See “U.S. Bank Portfolio Loan.”
(3) As of December 31, 2012, the U.S. Bank Portfolio Loan was secured by Domain Gateway, Las Cimas IV, the McEwen Building and Gateway Tech Center. The Tower on Lake Carolyn was subsequently added as security. See “U.S. Bank Portfolio Loan” for events subsequent to December 31, 2012.
As of December 31, 2012 and 2011, the Company’s deferred financing costs were $0.9 million and $0.2 million, respectively, net of amortization, and are included in deferred financing costs, prepaid expenses and other assets on the accompanying consolidated balance sheets.
During the years ended December 31, 2012 and 2011, the Company incurred $3.6 million and $0.3 million of interest expense, respectively. As of December 31, 2012 and December 31, 2011, $0.2 million and $0.1 million of interest expense were payable. Included in interest expense for the years ended December 31, 2012 and 2011, were $0.9 million and $0.1 million of amortization of deferred financing costs, respectively.
The Company’s notes payable contain financial debt covenants. As of December 31, 2012, the Company was in compliance with these debt covenants.
U.S. Bank Portfolio Loan
On April 30, 2012, in connection with the Company’s acquisition of the McEwen Building, the Company, through indirect wholly owned subsidiaries, entered into a two-year portfolio loan with U.S. Bank National Association (the “Lender”), an unaffiliated lender, for an amount up to $100.0 million (the “U.S. Bank Portfolio Loan”), of which $40 million was term debt and $60 million was revolving debt. During the term of the U.S. Bank Portfolio Loan, the Company had an option to increase the loan amount by up to an additional $100.0 million to a maximum of $200 million, 60% of which amount would be revolving debt and 40% would be term debt, with the addition of one or more properties to secure the U.S. Bank Portfolio Loan, subject to certain conditions contained in the loan agreement. At the closing of the acquisition of the McEwen Building, the Company drew $80.7 million, of which $42.5 million was used to repay in full the principal balance outstanding under the Portfolio Bridge Loan. On May 9, 2012, in connection with the acquisition of Gateway Tech Center, the Company added Gateway Tech Center as additional collateral for the loan and drew an additional $19.3 million on the U.S. Bank Portfolio Loan, bringing the total funded amount to $100.0 million as of May 9, 2012. On June 8, 2012, the Company increased the amount available under the loan by an additional $8.0 million and paid down the revolving debt by $26.0 million. As of December 31, 2012, the outstanding balance under the loan was $63.2 million and was composed of $43.2 million of term debt and $20.0 million of revolving debt. As of December 31, 2012, an additional $44.8 million remained available for future disbursements, subject to certain conditions set forth in the loan agreement.

F-22
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

On January 29, 2013, the Company entered into a loan modification agreement, to add the Tower on Lake Carolyn as additional collateral to the U.S. Bank Portfolio Loan and to increase the amount available under the loan to $200.0 million, of which $80.0 million is non-revolving debt and $120.0 million is revolving debt. As a result of this modification, the Company has no further options to increase the maximum loan amount under the U.S. Bank Portfolio Loan, though a portion of the debt is revolving. The Company also extended the initial maturity date to February 1, 2016, with two one-year extension options, subject to certain conditions contained in the loan agreement. As of January 29, 2013, the outstanding balance under the loan was $98.2 million and was composed of $80.0 million of term debt and $18.2 million of revolving debt. As of January 29, 2013, an additional $101.8 million remained available for future disbursements, subject to certain conditions set forth in the loan agreement.
For each calendar quarter, the interest rate on the U.S. Bank Portfolio Loan will be determined by the borrowing base leverage ratio as defined in the loan agreement and will range from 185 to 300 basis points over one-month LIBOR. Monthly payments are interest only with the entire unpaid principal balance and all outstanding interest and fees due at maturity. The Company will have the right to prepay all or a portion of the U.S. Bank Portfolio Loan, subject to certain fees and conditions contained in the loan agreement.
The U.S. Bank Portfolio Loan is secured by Domain Gateway, Las Cimas IV, the McEwen Building, Gateway Tech Center and the Tower on Lake Carolyn. The Company and KBS REIT Properties III, LLC, the Company’s wholly owned subsidiary (together, the “Guarantors”), are providing a guaranty of up to 50% of the amount outstanding under the U.S. Bank Portfolio Loan. Additionally, the Guarantors are providing a guaranty of any deficiency, loss or damage suffered by the Lender that may result from certain intentional acts committed by the borrowers under the loan, or that may result from certain bankruptcy or insolvency proceedings involving the borrowers, pursuant to the terms of the repayment guaranty.
8.
FAIR VALUE DISCLOSURES
Under GAAP, the Company is required to measure certain financial instruments at fair value on a recurring basis. In addition, the Company is required to measure other financial instruments and balances at fair value on a non-recurring basis (e.g., carrying value of impaired real estate loans receivable and long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:
•
Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;
•
Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model‑derived valuations in which significant inputs and significant value drivers are observable in active markets; and
•
Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.
The fair value for certain financial instruments is derived using a combination of market quotes, pricing models and other valuation techniques that involve significant management judgment. The price transparency of financial instruments is a key determinant of the degree of judgment involved in determining the fair value of the Company’s financial instruments. Financial instruments for which actively quoted prices or pricing parameters are available and for which markets contain orderly transactions will generally have a higher degree of price transparency than financial instruments for which markets are inactive or consist of non-orderly trades. The Company evaluates several factors when determining if a market is inactive or when market transactions are not orderly. The following is a summary of the methods and assumptions used by management in estimating the fair value of each class of financial instruments for which it is practicable to estimate the fair value:
Cash and cash equivalents, restricted cash, rent and other receivables, and accounts payable and accrued liabilities: These balances approximate their fair values due to the short maturities of these items.

F-23
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

Real estate loan receivable: The Company’s real estate loan receivable is presented in the accompanying consolidated balance sheets at its amortized cost net of recorded loan loss reserves and not at fair value. The fair value of the real estate loan receivable was estimated using an internal valuation model that considered the expected cash flows for the loan, underlying collateral values (for collateral-dependent loans) and estimated yield requirements of institutional investors for loans with similar characteristics, including remaining loan term, loan-to-value, type of collateral and other credit enhancements. The Company classifies these inputs as Level 3 inputs.
Notes payable: The fair values of the Company’s notes payable are estimated using a discounted cash flow analysis based on management’s estimates of current market interest rates for instruments with similar characteristics, including remaining loan term, loan-to-value ratio, type of collateral and other credit enhancements. Additionally, when determining the fair value of a liability in circumstances in which a quoted price in an active market for an identical liability is not available, the Company measures fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach. The Company classifies these inputs as Level 3 inputs.
The following were the face values, carrying amounts and fair values of the Company’s real estate loan receivable and notes payable as of December 31, 2012 and 2011, which carrying amounts generally do not approximate the fair values (in thousands):
 
 
December 31, 2012
 
December 31, 2011
 
 
Face Value        
 
Carrying Amount    
 
Fair Value        
 
Face Value        
 
Carrying Amount    
 
Fair Value        
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loan receivable
 
$
13,599

 
$
13,691

 
$
13,563

 
$
10,196

 
$
10,310

 
$
10,239

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Notes payable
 
$
119,800

 
$
119,800

 
$
119,284

 
$
42,250

 
$
42,250

 
$
42,239

Disclosure of the fair values of financial instruments is based on pertinent information available to the Company as of the period end and requires a significant amount of judgment. Despite increased capital market and credit market activity, transaction volume for certain financial instruments remains relatively low. This has made the estimation of fair values difficult and, therefore, both the actual results and the Company’s estimate of value at a future date could be materially different.
9.
RELATED PARTY TRANSACTIONS
The Company has entered into the Advisory Agreement with the Advisor and the Dealer Manager Agreement with the Dealer Manager. These agreements entitle the Advisor and/or the Dealer Manager to specified fees upon the provision of certain services with regard to the Offering and entitle the Advisor to specified fees upon the provision of certain services with regard to the investment of funds in real estate and real estate-related investments, the management of those investments, among other services, and the disposition of investments, as well as reimbursement of organization and offering costs incurred by the Advisor and the Dealer Manager on behalf of the Company, such as expenses related to the Offering and dividend reinvestment plan, and certain costs incurred by the Advisor in providing services to the Company. In addition, the Advisor is entitled to certain other fees, including an incentive fee upon achieving certain performance goals, as detailed in the Advisory Agreement. The Company has also entered into the AIP Reimbursement Agreement with the Dealer Manager pursuant to which the Company agreed to reimburse the Dealer Manager for certain fees and expenses it incurs for administering the Company’s participation in the DTCC Alternative Investment Product Platform with respect to certain accounts of the Company’s investors serviced through the platform. The Advisor and Dealer Manager also serve as the advisor and dealer manager, respectively, for KBS Real Estate Investment Trust, Inc., KBS Real Estate Investment Trust II, Inc., KBS Strategic Opportunity REIT, Inc. and KBS Legacy Partners Apartment REIT, Inc. During the years ended December 31, 2012, 2011 and 2010, no transactions occurred between the Company and these other KBS-sponsored programs.


F-24
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

Pursuant to the terms of these agreements, summarized below are the related-party costs incurred by the Company for the years ended December 31, 2012 and 2011, respectively, and any related amounts payable as of December 31, 2012 and December 31, 2011 (in thousands):
 
 
Incurred
 
Payable as of
 
 
2012
 
2011
 
2012
 
2011
Expensed
 
 
 
 
 
 
 
 
Reimbursement of operating expenses (1)
 
$
116

 
$
314

 
$
—

 
$
—

Asset management fees
 
1,732

 
178

 
—

 
—

Real estate acquisition fees
 
2,296

 
836

 
—

 
—

Additional Paid-in Capital
 
 
 
 
 
 
 
 
Selling commissions
 
10,138

 
6,332

 
—

 
—

Dealer manager fees
 
4,834

 
3,102

 
—

 
—

Reimbursable other offering costs
 
1,516

 
4,904

 
16

 
13

 
 
 
 
 
 
 
 
 
Cumulative Distributions
 
 
 
 
 
 
 
 
Advance for distributions paid
 
—

 
820

 
—

 
—

 
 
 
 
 
 
 
 
 
Capitalized
 
 
 
 
 
 
 
 
Origination fees
 
—

 
239

 
—

 
—

 
 
$
20,632

 
$
16,725

 
$
16

 
$
13

_____________________
(1) The Advisor may seek reimbursement for certain employee costs under the Advisory Agreement. The Company has reimbursed the Advisor for the Company’s allocable portion of the salaries, benefits and overhead of internal audit department personnel providing services to the Company. These amounts totaled $103,000 and $55,000 for the years ended December 31, 2012 and 2011, respectively, and were the only employee costs reimbursed under the Advisory Agreement through December 31, 2012. The Company will not reimburse for employee costs in connection with services for which the Advisor earns acquisition, origination or disposition fees (other than reimbursement of travel and communication expenses) or for the salaries or benefits the Advisor or its affiliates may pay to the Company’s executive officers.
In connection with the Offering, the Company’s sponsors agreed to provide additional indemnification to one of the participating broker dealers.  The Company agreed to add supplemental coverage to its directors’ and officers’ insurance coverage to insure the sponsors’ obligations under this indemnification agreement in exchange for reimbursement by the sponsors to the Company for all costs, expenses and premiums related to this supplemental coverage.  During the year ended December 31, 2012, the Advisor incurred $73,000 for the costs of the supplemental coverage obtained by the Company.

F-25
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

10.
SEGMENT INFORMATION
The Company presently operates in two reportable business segments based on its investment types: real estate and real estate-related. Under the real estate segment, the Company has invested in office properties. Under the real estate-related segment, the Company has originated a mortgage loan. All revenues earned from the Company’s two operating segments were from external customers and there were no intersegment sales or transfers. The Company does not allocate corporate-level accounts to its operating segments. Corporate-level accounts include corporate general and administrative expenses, non‑operating interest income, non-operating interest expense and other corporate-level expenses. The accounting policies of the segments are consistent with those described in Note 2, “Summary of Significant Accounting Policies.”
The Company evaluates the performance of its segments based upon net operating income (“NOI”), which is a non‑GAAP supplemental financial measure. The Company defines NOI for its real estate segment as operating revenues (rental income, tenant reimbursements and other operating income) less property and related expenses (property operating expenses, real estate taxes, insurance, asset management fees and provision for bad debt) less interest expense. The Company defines NOI for its real estate-related segment as interest income less loan servicing costs and asset management fees. NOI excludes certain items that are not considered to be controllable in connection with the management of an asset such as non‑property income and expenses, depreciation and amortization, real estate acquisition fees and expenses and corporate general and administrative expenses. The Company uses NOI to evaluate the operating performance of the Company’s real estate and real estate-related investments and to make decisions about resource allocations. The Company believes that net income is the GAAP measure that is most directly comparable to NOI; however, NOI should not be considered as an alternative to net income as the primary indicator of operating performance, as it excludes the items described above. Additionally, NOI as defined above may not be comparable to other REITs or companies as their definitions of NOI may differ from the Company’s definition.
The following tables summarize total revenues and NOI for each reportable segment for the years ended December 31, 2012 and 2011 (in thousands):
 
 
Years Ended December 31,
 
 
2012
 
2011
Revenues:
 
 
 
 
Real estate segment
 
$
26,394

 
$
2,117

Real estate-related segment
 
889

 
395

Total segment revenues
 
$
27,283

 
$
2,512

 
 
 
 
 
Interest Expense:
 
 
 
 
Real estate segment
 
$
3,465

 
$
300

Real estate-related segment
 
—

 
—

Total segment interest expense
 
3,465

 
300

Corporate-level
 
103

 
—

Total interest expense
 
$
3,568

 
$
300

 
 
 
 
 
NOI:
 
 
 
 
Real estate segment
 
$
10,795

 
$
967

Real estate-related segment
 
802

 
332

Total NOI
 
$
11,597

 
$
1,299


F-26
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

The following table summarizes total assets and total liabilities for each reportable segment as of December 31, 2012 and 2011 (in thousands):
 
 
December 31,
 
 
2012
 
2011
Assets:
 
 
 
 
Real estate segment
 
$
317,133

 
$
84,686

Real estate-related segment
 
13,811

 
10,409

Total segment assets
 
330,944

 
95,095

Corporate-level (1)
 
18,440

 
35,763

Total assets
 
$
349,384

 
$
130,858

Liabilities:
 
 
 
 
Real estate segment
 
$
135,082

 
$
45,063

Real estate-related segment
 
2

 
—

Total segment liabilities
 
135,084

 
45,063

Corporate-level (2)
 
2,275

 
784

Total liabilities
 
$
137,359

 
$
45,847

_____________________
(1) Total corporate-level assets consisted primarily of proceeds from the Offering being held in the form of cash and cash equivalents of approximately $18.2 million and $35.6 million as of December 31, 2012 and December 31, 2011, respectively.
(2) As of December 31, 2012 and December 31, 2011, corporate-level liabilities consisted primarily of distributions payable and accruals for general and administrative expenses.
The following table reconciles the Company’s net loss to its NOI for the years ended December 31, 2012 and 2011 (in thousands):
 
 
Years Ended December 31,
 
 
2012
 
2011
Net loss
 
$
(7,682
)
 
$
(2,440
)
Other interest income
 
(28
)
 
(15
)
Real estate acquisition fees to affiliates
 
2,296

 
836

Real estate acquisition fees and expenses
 
1,069

 
432

General and administrative expenses
 
1,974

 
1,386

Depreciation and amortization
 
13,865

 
1,100

Corporate-level interest expense
 
103

 
—

NOI
 
$
11,597

 
$
1,299



F-27
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

11. UNAUDITED PRO FORMA FINANCIAL INFORMATION
The following table summarizes, on an unaudited pro forma basis, the combined results of operations of the Company for the years ended December 31, 2012 and 2011. The Company acquired four office properties during the year ended December 31, 2012, which were accounted for as business combinations. The following unaudited pro forma information for the years ended December 31, 2012 and 2011 has been prepared to give effect to the acquisitions of Town Center, the McEwen Building, Gateway Tech Center and the Tower on Lake Carolyn as if the acquisitions occurred on January 1, 2011. This pro forma information does not purport to represent what the actual results of operations of the Company would have been had these acquisitions occurred on this date, nor does it purport to predict the results of operations for future periods (in thousands, except share and per share amounts).
 
 
For the Year Ended December 31,
 
 
2011
 
2012
Revenues
 
$
28,968

 
$
39,734

Depreciation and amortization
 
$
10,990

 
$
18,424

Net loss
 
$
(2,166
)
 
$
(3,270
)
Net loss per common share, basic and diluted
 
$
(0.12
)
 
$
(0.12
)
Weighted-average number of common shares outstanding, basic and diluted
 
17,750,503

 
26,719,390

The unaudited pro forma information for the year ended December 31, 2012 was adjusted to exclude $3.4 million of acquisition costs related to the above properties incurred in 2012.
12.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Presented below is a summary of the unaudited quarterly financial information for the years ended December 31, 2012 and 2011 (in thousands, except per share amounts):
 
 
2012
 
 
First Quarter
 
Second Quarter
 
Third Quarter
 
Fourth Quarter
Revenues
 
$
2,840

 
$
7,217

 
$
8,300

 
$
8,926

Net loss
 
$
(2,133
)
 
$
(2,759
)
 
$
(1,354
)
 
$
(1,436
)
Net loss per common share, basic and diluted
 
$
(0.17
)
 
$
(0.16
)
 
$
(0.06
)
 
$
(0.06
)
Distributions declared per common share (1)
 
$
0.160

 
$
0.162

 
$
0.164

 
$
0.164


 
 
2011
 
 
First Quarter
 
Second Quarter
 
Third Quarter
 
Fourth Quarter
Revenues
 
$
—

 
$
16

 
$
212

 
$
2,284

Net loss
 
$
(285
)
 
$
(278
)
 
$
(1,032
)
 
$
(845
)
Net loss per common share, basic and diluted
 
$
(5.58
)
 
$
(0.18
)
 
$
(0.22
)
 
$
(0.10
)
Distributions declared per common share (1)
 
$
—

 
$
0.012

 
$
0.164

 
$
0.164

__________________
(1) Distributions declared per common share assumes each share was issued and outstanding each day during the respective periods from June 24, 2011 through December 31, 2012. Each day during the periods from June 24, 2011 through February 28, 2012 and March 1, 2012 through December 31, 2012 was a record date for distributions. Distributions were calculated at the rate of $0.00178082 per share per day.


F-28
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

13.
COMMITMENTS AND CONTINGENCIES
Economic Dependency
The Company is dependent on the Advisor and the Dealer Manager for certain services that are essential to the Company, including the sale of the Company’s shares of common and, if applicable, preferred stock available for issue; the identification, evaluation, negotiation, origination, acquisition and disposition of investments; management of the daily operations of the Company’s investment portfolio; and other general and administrative responsibilities. In the event that these companies are unable to provide the respective services, the Company will be required to obtain such services from other sources.
Legal Matters
From time to time, the Company may be party to legal proceedings that arise in the ordinary course of its business. Management is not aware of any legal proceedings of which the outcome is probable or reasonably possible to have a material adverse effect on its results of operations or financial condition, which would require accrual or disclosure of the contingency and possible range of loss. Additionally, the Company has not recorded any loss contingencies related to legal proceedings in which the potential loss is deemed to be remote.
Environmental
As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. Compliance with existing environmental laws is not expected to have a material adverse effect on the Company’s financial condition and results of operations as of December 31, 2012.
14.
SUBSEQUENT EVENTS
The Company evaluates subsequent events up until the date the consolidated financial statements are issued.
Status of the Offering
The Company commenced the Offering on October 26, 2010. As of March 4, 2013, the Company had sold 30,884,910 shares of common stock in the Offering for gross offering proceeds of $307.5 million, including 845,983 shares of common stock under its dividend reinvestment plan for gross offering proceeds of $8.0 million. Also as of March 4, 2013, the Company had redeemed 135,165 of the shares sold in the Offering for $1.3 million.
Distributions Paid
On January 2, 2013, the Company paid distributions of $1.5 million, which related to distributions declared for daily record dates for each day in the period from December 1, 2012 through December 31, 2012. On February 1, 2013, the Company paid distributions of $1.5 million, which related to distributions declared for daily record dates for each day in the period from January 1, 2013 through January 31, 2013. On March 1, 2013, the Company paid distributions of $1.5 million, which related to distributions declared for daily record dates for each day in the period from February 1, 2013 through February 28, 2013.
Distributions Declared
On January 16, 2013, the Company’s board of directors declared distributions based on daily record dates for the period from March 1, 2013 through March 31, 2013, which the Company expects to pay in April 2013. On March 6, 2013, the Company’s board of directors declared distributions based on daily record dates for the period from April 1, 2013 through April 30, 2013, which the Company expects to pay in May 2013, and distributions based on daily record dates for the period from May 1, 2013 through May 31, 2013, which the Company expects to pay in June 2013. Investors may choose to receive cash distributions or purchase additional shares through the Company’s dividend reinvestment plan.
Distributions for these periods will be calculated based on stockholders of record each day during these periods at a rate of $0.00178082 per share per day and equal a daily amount that, if paid each day for a 365-day period, would equal a 6.5% annualized rate based on a purchase price of $10.00 per share.

F-29
KBS REAL ESTATE INVESTMENT TRUST III, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 2012

Investment and Financing Subsequent to December 31, 2012
Acquisition of the RBC Plaza
On January 31, 2013, the Company, through an indirect wholly owned subsidiary, acquired an office property containing 609,368 rentable square feet of office space and 68,677 rentable square feet of retail space (the “RBC Plaza”) located in Minneapolis, Minnesota on approximately 1.3 acres of land. The seller is not affiliated with the Company or the Advisor. The purchase price (net of closing credits) of the RBC Plaza was approximately $118.1 million plus closing costs. The Company funded the acquisition of the RBC Plaza with proceeds from the RBC Plaza Mortgage Loan (discussed below), proceeds from the Offering and $35.0 million of proceeds drawn from the U.S. Bank Portfolio Loan on January 29, 2013.
At acquisition, the RBC Plaza was 83% leased to 34 tenants. 
RBC Plaza Mortgage Loan
On January 31, 2013, in connection with the acquisition of the RBC Plaza, the Company, through an indirect wholly owned subsidiary, entered into a four-year secured mortgage loan with Bank of America, N.A., an unaffiliated lender, for borrowings of up to $75.9 million secured by the RBC Plaza (the “RBC Plaza Mortgage Loan”). The Company drew $68.7 million at the closing of the loan and the remaining portion will be used for tenant improvements, leasing commissions and capital improvements, subject to certain terms and conditions contained in the loan documents. The RBC Plaza Mortgage Loan matures on February 1, 2017, with an option to extend the maturity date to February 1, 2018, subject to certain terms and conditions contained in the loan documents.  The RBC Plaza Loan Mortgage Loan bears interest at a floating rate of 180 basis points over one-month LIBOR during the initial term of the loan and monthly payments are interest only with the entire balance and all outstanding interest and fees due at maturity, assuming no prior prepayment.  Should the borrower under the loan exercise its option to extend the loan, monthly payments would be principal and interest, with principal calculated using an amortization schedule of 30 years and an annual interest rate equal to 6.5%. The Company will have the right to prepay all of the RBC Plaza Mortgage Loan, subject to certain expenses potentially incurred by the lender as a result of the prepayment and to certain conditions contained in the loan documents. In connection with the closing of the RBC Plaza Mortgage Loan, the Company entered into an interest rate swap agreement with Bank of America, N.A., which effectively fixes the interest rate on the initial $68.7 million drawn under the loan at approximately 2.59% for the initial loan term.
Share Redemption Program
On March 6, 2013, the Company’s board of directors approved a second amended and restated share redemption program (the “Second Amended Share Redemption Program”). Pursuant to the Second Amended Share Redemption Program, the Company has modified how it will process redemptions that would result in a stockholder owning less than the minimum purchase requirement described in the Company’s currently effective, or the most recently effective, registration statement as such registration statement has been amended or supplemented (the “Minimum Purchase Requirement”). Specifically, if the Company cannot repurchase all shares presented for redemption in any month because of the limitations on redemptions set forth in the program, then it will honor redemption requests on a pro rata basis, except that if a pro rata redemption would result in a stockholder owning less than the Minimum Purchase Requirement, then the Company would redeem all of such stockholder’s shares. If the Company is redeeming all of a stockholder’s shares, there would be no holding period requirement for shares purchased pursuant to the Company’s dividend reinvestment plan.
There were no other changes to the share redemption program. The Second Amended Share Redemption Program will be effective April 7, 2013.

F-30

KBS REAL ESTATE INVESTMENT TRUST III, INC.
SCHEDULE III
REAL ESTATE ASSETS AND ACCUMULATED DEPRECIATION AND AMORTIZATION
December 31, 2012
(in thousands)
 
 
 
 
 
 
 
 
 
Initial Cost to Company
 
 
 
Gross Amount at which Carried at Close of Period
 
 
 
 
 
 
Description
 
Location
 
Ownership
Percent
 
Encumbrances
 
Land
 
Building and Improvements(1)
 
Total
 
Cost
Capitalized
Subsequent
to Acquisition (2)
 
Land
 
Building and
Improvements (1)
 
Total (3)
 
Accumulated
Depreciation and
Amortization
 
Original
Date of
Construction
 
Date Acquired
Domain Gateway
 
Austin, TX
 
100%
 
$
$— 
 
$
2,850

 
$
44,523

 
$
47,373

 
$
—

 
$
2,850

 
$
44,523

 
$
47,373

 
$
(2,779
)
 
2009
 
9/29/2011
Las Cimas IV
 
Austin, TX
 
100%
 
 
— 
 
4,650

 
31,262

 
35,912

 
177

 
4,650

 
31,439

 
36,089

 
(2,679
)
 
2008
 
10/28/2011
Town Center
 
Plano, TX
 
100%
 
 
56,600

 
7,428

 
108,547

 
115,975

 
2,723

 
7,428

 
111,270

 
118,698

 
(5,302
)
 
2001/2002/2006
 
3/27/2012
McEwen Building
 
Franklin, TN
 
100%
 
 
— 
 
5,600

 
34,704

 
40,304

 
—

 
5,600

 
34,704

 
40,304

 
(1,497
)
 
2009
 
04/30/2012
Gateway Tech Center
 
Salt Lake City, UT
 
100%
 
 
— 
 
9,800

 
20,051

 
29,851

 
110

 
9,800

 
20,161

 
29,961

 
(1,693
)
 
1909
 
05/09/2012
Tower on Lake Carolyn
 
Irving, TX
 
100%
 
 
—

 
2,056

 
44,579

 
46,635

 
—

 
2,056

 
44,579

 
46,635

 
(140
)
 
1988
 
12/21/2012
 
 
 
 
TOTAL
 
$
56,600

 
$
32,384

 
$
283,666

 
$
316,050

 
$
3,010

 
$
32,384

 
$
286,676

 
$
319,060

 
$
(14,090
)
 
 
 
 
____________________
(1) Building and improvements includes tenant origination and absorption costs.
(2) Costs capitalized subsequent to acquisition is net of write-offs of fully depreciated/amortized assets.
(3) The aggregate cost of real estate for federal income tax purposes was $319.9 million as of December 31, 2012.
(4) As of December 31, 2012, these properties served as the security for the U.S. Bank Portfolio Loan, which had an outstanding principal balance of $63.2 million as of December 31, 2012. Subsequent to December 31, 2012, the Tower on Lake Carolyn was added as security.




F-31

KBS REAL ESTATE INVESTMENT TRUST III, INC.
SCHEDULE III
REAL ESTATE ASSETS AND ACCUMULATED DEPRECIATION AND AMORTIZATION (CONTINUED)
December 31, 2012
(in thousands)
 
 
2012
 
2011
Real Estate:
 
 
 
 
Balance at the beginning of the year
 
$
83,429

 
$
—

Acquisitions
 
232,765

 
83,285

Improvements
 
3,686

 
144

Write off of fully depreciated and fully amortized assets
 
(820
)
 
—

Balance at the end of the year
 
$
319,060

 
$
83,429

Accumulated depreciation:
 
 
 
 
Balance at the beginning of the year
 
$
(1,100
)
 
$
—

Depreciation expense
 
(13,810
)
 
(1,100
)
Write off of fully depreciated and fully amortized assets
 
820

 
—

Balance at the end of the year
 
$
(14,090
)
 
$
(1,100
)




F-32