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Investments and Fair Value

9 Months Ended

Sep. 30, 2022

Note 3. Investments and Fair Value

The following tables show the composition of the investment portfolio, at amortized cost and fair value at September 30, 2022 and December 31, 2021, respectively (with corresponding percentage of total portfolio investments):


	September 30, 2022
	Investments at Amortized Cost		Percentage of Amortized Cost		Investments at Fair Value		Percentage of Fair Value
Loans	$	75,818,192	65.4	%	$	76,311,192	67.5	%
Loans through participation interest (Note 4)	40,089,419		34.6	%	36,738,949		32.5	%
Marketable securities	—		—	%	—		—	%
Total	$	115,907,611	100.0	%	$	113,050,141	100.0	%


	December 31, 2021
	Investments at Amortized Cost		Percentage of Amortized Cost		Investments at Fair Value		Percentage of Fair Value
Loans	$	60,352,932	54.9	%	$	61,281,259	55.4	%
Loans through participation interest (Note 4)	48,780,897		44.4	%	48,349,374		43.8	%
Marketable securities	789,335		0.7	%	879,272		0.8	%
Total	$	109,923,164	100.0	%	$	110,509,905	100.0	%

Obligations under Participation Agreements

The Company has elected the fair value option relating to accounting for debt obligations at their fair value for its obligations under participation agreements which arose due to partial loan sales which did not meet the criteria for sale treatment. The Company employs the same yield approach valuation methodology used for the real estate-related loan investments on the Company’s obligations under participation agreements. As of September 30, 2022 and December 31, 2021, obligations under participation agreements at fair value was $6.1 million and $4.9 million and the weighted average contractual interest rate on the obligations under participation agreements was 11.1% and 8.3%, respectively. For the nine months ended September 30, 2022, the Company transferred $1.2 million of investments to affiliates through participation agreements and did not make any repayments on obligations under participation agreements. For the nine months ended September 30, 2021, the Company transferred $21.2 million of investments to affiliates through participation agreements and made $25.7 million of repayments on obligations under participation agreements.

Valuation Methodology

The fair value of the Company’s investment in preferred stock and common stock within the marketable securities portfolio, if any, is determined based on quoted prices in an active market and is classified as Level 1 of the fair value hierarchy. Additionally, the fair value of the Company’s unsecured notes payable is determined based on quoted price in an active market and is also classified as Level 1.

Market quotations are not readily available for the Company’s real estate-related loan investments, all of which are included in Level 3 of the fair value hierarchy, as these investments are valued utilizing a yield approach, i.e. a discounted cash flow methodology to arrive at an estimate of the fair value of each respective investment in the portfolio using an estimated market yield. In following this methodology, investments are evaluated individually, and management takes into account, in determining the risk-adjusted discount rate for each of the Company’s investments, relevant factors, including available current market data on applicable yields of comparable debt/preferred equity instruments; market credit spreads and yield curves; the investment’s yield; covenants of the investment, including prepayment provisions; the portfolio company’s ability to make payments, net operating income and debt service coverage ratio; construction progress reports and construction budget analysis; the nature, quality and realizable value of any collateral (and loan-to-value ratio); the forces that influence the local markets in which the asset (the collateral) is purchased and sold, such as capitalization rates, occupancy rates, rental rates and replacement costs; and the anticipated duration of each real estate-related loan investment.

These valuation techniques are applied in a consistent and verifiable manner to all investments that are categorized within Level 3 of the fair value hierarchy and Terra Income Advisors provides the valuation committee of the Board (which is made up exclusively of independent directors) with portfolio security valuations that are based on this discounted cash flow methodology. Valuations are prepared quarterly, or more frequently as needed, with each asset in the portfolio subject to a valuation prepared by a third-party valuation service at a minimum of once during every 12-month period. The valuation committee reviews the preliminary valuation with Terra Income Advisors and, together with an independent valuation firm, if applicable, responds and supplements the preliminary valuation to reflect any comments provided by the valuation committee. The Board discusses valuations and determines the fair value of each investment in the portfolio in good faith based on various

metrics and other factors, including the input and recommendation provided by Terra Income Advisors, the valuation committee and any third-party valuation firm, if applicable.

The following tables present fair value measurements of investments, by major class, as of September 30, 2022 and December 31, 2021, according to the fair value hierarchy:


	September 30, 2022
	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
Investments:
Loans	$	—	$	—	$	76,311,192	$	76,311,192
Loans through participation interest	—		—		36,738,949		36,738,949
Marketable securities	—		—		—		—
Total Investments	$	—	$	—	$	113,050,141	$	113,050,141

Obligations under participation agreements	$	—	$	—	$	6,114,979	$	6,114,979


	December 31, 2021
	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
Investments:
Loans	$	—	$	—	$	61,281,259	$	61,281,259
Loans through participation interest	—		—		48,349,374		48,349,374
Marketable securities	879,272		—		—		879,272
Total Investments	$	879,272	$	—	$	109,630,633	$	110,509,905

Obligations under participation agreements	$	—	$	—	$	4,883,877	$	4,883,877

Changes in the Company’s Level 3 investments for the nine months ended September 30, 2022 and 2021 were as follows:


	Nine Months Ended September 30, 2022
	Loans		Loans Through Participation		Total Loan Investments		Obligations under Participation Agreements
Balance as of January 1, 2022	$	61,281,259	$	48,349,374	$	109,630,633	$	4,883,877
Purchases of investments	29,872,400		18,204,715		48,077,115		—
Repayments of investments	(15,000,000)		(27,082,531)		(42,082,531)		—
Net change in unrealized (depreciation) appreciation on investments	(435,327)		(2,918,956)		(3,354,283)		—
Amortization and accretion of investment-related fees, net	592,860		186,347		779,207		47,955
Proceeds from obligations under participation agreements	—		—		—		1,225,275
Net change in unrealized depreciation on obligations under participation agreements	—		—		—		(42,128)
Balance as of September 30, 2022	$	76,311,192	$	36,738,949	$	113,050,141	$	6,114,979
Net change in unrealized appreciation or depreciation for the period relating to those Level 3 assets that were still held by the Company at the end of the period:
Net change in unrealized appreciation or depreciation on loan investments and obligations under participation agreements	$	(232,375)	$	(2,918,947)	$	(3,151,322)	$	(42,128)


	Nine Months Ended September 30, 2021
	Loans		Loans Through Participation		Total Loan Investments		Obligations under Participation Agreements
Balance as of January 1, 2021	$	20,209,473	$	45,963,805	$	66,173,278	$	4,293,971
Purchases of investments	65,985,000		27,384,684		93,369,684		—
Repayments of investments	(52,520,000)		(18,871,678)		(71,391,678)		—
Net change in unrealized (depreciation) appreciation on investments	267,447		(29,714)		237,733		—
PIK interest income, net	—		94,524		94,524		—
Amortization and accretion of investment-related fees, net	535,981		314,070		850,051		219,171
Realized loss on loan repayment	—		(168,106)		(168,106)		—
Proceeds from obligations under participation agreements	—		—		—		21,223,404
Repayment of obligations under participation agreements	—		—		—		(25,728,138)
Net change in unrealized depreciation on obligations under participation agreements	—		—		—		(8,408)
Balance as of September 30, 2021	$	34,477,901	$	54,687,585	$	89,165,486	$	—
Net change in unrealized appreciation or depreciation for the period relating to those Level 3 assets that were still held by the Company at the end of the period:
Net change in unrealized depreciation or appreciation on loan investments and obligations under participation agreements	$	325,200	$	(18,660)	$	306,540	$	—

Transfers between levels, if any, are recognized at the beginning of the period in which transfers occur. For the nine months ended September 30, 2022 and 2021, there were no transfers.

Significant Unobservable Inputs

The following table summarizes the significant unobservable inputs used by the Company to value the Level 3 investments as of September 30, 2022 and December 31, 2021. The table is not intended to be all-inclusive, but instead identifies the significant unobservable inputs relevant to the determination of fair values.


September 30, 2022
			Primary Valuation Technique	Unobservable Input	Range				Weighted
Asset Category	Fair Value				Minimum		Maximum		Average
Assets:
Loans	$	76,311,192	Discounted cash flow	Discount rate	11.14	%	18.04	%	14.12	%
Loans through participation interest	36,738,949		Discounted cash flow	Discount rate	15.00	%	15.25	%	15.05	%
Total Level 3 Assets	$	113,050,141
Liabilities:
Obligations under participation agreements	$	6,114,979	Discounted cash flow	Discount rate	11.14	%	11.14	%	11.14	%


December 31, 2021
			Primary Valuation Technique	Unobservable Input	Range				Weighted
Asset Category	Fair Value				Minimum		Maximum		Average
Assets:
Loans	$	61,281,259	Discounted cash flow	Discount rate	8.25	%	15.00	%	12.58	%
Loans through participation interest	48,349,374		Discounted cash flow	Discount rate	12.37	%	15.00	%	14.40	%
Total Level 3 Assets	$	109,630,633
Liabilities:
Obligations under participation agreements	$	4,883,877	Discounted cash flow	Discount rate	8.25	%	8.25	%	8.25	%

If the weighted average discount rate used to value the Company’s investments were to increase, the fair value of the Company’s investments would decrease. Conversely, if the weighted average discount rate used to value the Company’s investments were to decrease, the fair value of Company’s investments would increase.

Financial Instruments Not Carried at Fair Value

The Company has not elected the fair value option for its unsecured notes payable and term loan payable (Note 5). The table below presents detailed information regarding the unsecured notes payable and term loan payable at September 30, 2022 and December 31, 2021:


		September 30, 2022						December 31, 2021
	Level	Principal Balance		Carrying Value		Fair Value		Principal Balance		Carrying Value		Fair Value
Unsecured notes payable (1)(2)	1	$	38,375,000	$	36,782,463	$	33,770,000	$	38,375,000	$	36,497,612	$	39,403,450
Term loan payable (3)(4)	3	25,000,000		24,279,081		25,000,000		5,000,000		4,170,164		5,000,000
		$	63,375,000	$	61,061,544	$	58,770,000	$	43,375,000	$	40,667,776	$	44,403,450

_______________

(1)Carrying value is net of unamortized issue discount of $0.9 million and $1.0 million, and unamortized deferred financing costs of $0.7 million and $0.9 million as of September 30, 2022 and December 31, 2021, respectively.

(2)Valuation falls under Level 1 of the fair value hierarchy, which is based on the trading price of $22.00 and $25.67 as of the close of business day on September 30, 2022 and December 31, 2021, respectively.

(3)Carrying value is net of unamortized issue discount of $0.5 million and $0.6 million, and unamortized deferred financing costs of $0.2 million and $0.2 million as of September 30, 2022 and December 31, 2021, respectively.

(4)Valuation falls under Level 3 of the fair value hierarchy, which is based on a discounted cash flow model with a discount rate of 5.625%.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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