0001674356-20-000007.txt : 20200515 0001674356-20-000007.hdr.sgml : 20200515 20200515173015 ACCESSION NUMBER: 0001674356-20-000007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 106 CONFORMED PERIOD OF REPORT: 20200331 FILED AS OF DATE: 20200515 DATE AS OF CHANGE: 20200515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Terra Property Trust, Inc. CENTRAL INDEX KEY: 0001674356 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 000000000 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-56117 FILM NUMBER: 20887011 BUSINESS ADDRESS: STREET 1: 805 THIRD AVENUE CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 212-754-5100 MAIL ADDRESS: STREET 1: 805 THIRD AVENUE CITY: NEW YORK STATE: NY ZIP: 10022 10-Q 1 tpt3312010-q.htm 10-Q Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2020
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-56117
Terra Property Trust, Inc.
(Exact name of registrant as specified in its charter)
Maryland
 
81-0963486
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
550 Fifth Avenue, 6th Floor
New York, New York 10036
(Address of principal executive offices)
(212) 753-5100
(Registrant’s telephone number, including area code)
Securities registered pursuant to section 12(b) of the Securities Exchange Act of 1934:
None
Securities registered pursuant to section 12(g) of the Securities Exchange Act of 1934:
Common Stock $0.01 par value per share

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer þ
Smaller reporting company þ
 
Emerging growth company þ
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of May 15, 2020, the registrant had 19,700,151 shares of common stock, $0.01 par value, outstanding. No market value has been computed based upon the fact that no active trading market had been established as of the date of this document.
 




TABLE OF CONTENTS
 
 
Page
 
 
 
PART I
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 


1

 



PART I – FINANCIAL INFORMATION
Item 1. Financial Statements.
Terra Property Trust, Inc.
Consolidated Balance Sheets
 
March 31, 2020
 
December 31, 2019
 
(unaudited)
 
 
Assets
 
 
 
Cash and cash equivalents
$
82,163,055

 
$
29,609,484

Restricted cash
16,255,423

 
18,542,163

Cash held in escrow by lender
2,062,941

 
2,398,053

Marketable securities
3,490,394

 

Loans held for investment, net
398,931,946

 
375,462,222

Loans held for investment acquired through participation, net
4,037,567

 
3,150,546

Real estate owned, net (Note 5)
 
 
 
Land, building and building improvements, net
64,358,637

 
64,751,247

Lease intangible assets, net
12,286,955

 
12,845,228

Operating lease right-of-use assets
16,111,217

 
16,112,925

Interest receivable
2,253,718

 
1,876,799

Other assets
2,535,476

 
2,594,411

Total assets
$
604,487,329

 
$
527,343,078

Liabilities and Equity
 
 
 
Liabilities:
 
 
 
Obligations under participation agreements (Note 7)
$
67,670,405

 
$
103,186,327

Repurchase agreement payable, net of deferred financing fees
91,352,312

 
79,608,437

Mortgage loan payable, net of deferred financing fees and other
44,687,123

 
44,753,633

Revolving credit facility payable, net of deferred financing fees
34,930,844

 

Interest reserve and other deposits held on investments
16,255,423

 
18,542,163

Operating lease liabilities
16,111,217

 
16,112,925

Lease intangible liabilities, net (Note 5)
11,276,085

 
11,424,809

Due to Manager (Note 7)
1,359,132

 
1,037,168

Interest payable
933,011

 
1,076,231

Accounts payable and accrued expenses
2,563,299

 
1,749,525

Unearned income
587,535

 
624,021

Distributions payable
3,906

 

Other liabilities
1,906,300

 
1,684,106

Total liabilities
289,636,592

 
279,799,345

Commitments and contingencies (Note 9)

 

Equity:
 
 
 
Preferred stock, $0.01 par value, 50,000,000 shares authorized and
   none issued

 

12.5% Series A Cumulative Non-Voting Preferred Stock at liquidation
preference, 125 shares authorized and 125 shares issued and outstanding at
both March 31, 2020 and December 31, 2019
125,000

 
125,000

Common stock, $0.01 par value, 450,000,000 shares authorized and
19,700,151 and 15,125,681 shares issued and outstanding at
March 31, 2020 and December 31, 2019, respectively
197,002

 
151,257

Additional paid-in capital
377,061,545

 
301,727,297

Accumulated deficit
(62,716,835
)
 
(54,459,821
)
Accumulated other comprehensive income
184,025

 

Total equity
314,850,737

 
247,543,733

Total liabilities and equity
$
604,487,329

 
$
527,343,078

See notes to unaudited consolidated financial statements.

2

 



Terra Property Trust, Inc.
Consolidated Statements of Operations
(Unaudited)

 
 
 
Three Months Ended March 31,
 
 
 
2020
 
2019
Revenues
 
 
 
 
 
Interest income
 
 
$
9,651,865

 
$
10,208,964

Real estate operating revenue
 
 
2,313,051

 
2,321,238

Prepayment fee income
 
 

 
98,775

Other operating income
 
 
112,655

 
108,957

 
 
 
12,077,571

 
12,737,934

Operating expenses
 
 
 
 
 
Operating expenses reimbursed to Manager
 
 
1,367,189

 
1,115,204

Asset management fee
 
 
1,029,533

 
880,355

Asset servicing fee
 
 
234,208

 
204,477

Provision for loan losses
 
 
1,144,994

 

Real estate operating expenses
 
 
944,518

 
755,855

Depreciation and amortization
 
 
946,494

 
946,494

Professional fees
 
 
294,761

 
172,786

Directors fees
 
 
83,750

 
83,750

Other
 
 
64,949

 
17,584

 
 
 
6,110,396

 
4,176,505

Operating income
 
 
5,967,175

 
8,561,429

Other income and expenses
 
 
 
 
 
Interest expense from obligations under participation agreements
 
 
(2,600,758
)
 
(2,924,310
)
Interest expense on repurchase agreement payable
 
 
(1,551,270
)
 
(933,973
)
Interest expense on mortgage loan payable
 
 
(750,636
)
 
(780,271
)
Interest expense on revolving credit facility
 
 
(174,989
)
 

Net loss on extinguishment of obligations under participation agreements
 
 
(319,453
)
 

Realized gains on marketable securities
 
 
8,894

 

 
 
 
(5,388,212
)
 
(4,638,554
)
Net income
 
 
$
578,963

 
$
3,922,875

Preferred stock dividend declared
 
 
(3,906
)
 
(3,906
)
Net income allocable to common stock
 
 
$
575,057

 
$
3,918,969

 
 
 
 
 
 
Earnings per share  basic and diluted
 
 
$
0.03

 
$
0.26

 
 
 
 
 
 
Weighted-average shares  basic and diluted
 
 
16,707,279

 
14,912,990

 
 
 
 
 
 
Distributions declared per common share
 
 
$
0.53

 
$
0.51


See notes to unaudited consolidated financial statements.


3

 



Terra Property Trust, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited)

 
 
 
Three Months Ended March 31,
 
 
 
2020
 
2019
Comprehensive income, net of tax
 
 
 
 
 
Net income
 
 
$
578,963

 
$
3,922,875

Other comprehensive income
 
 
 
 
 
Net unrealized gains on marketable securities
 
 
192,919

 

Reclassification of net realized gains on marketable securities into earnings
 
 
(8,894
)
 

 
 
 
184,025

 

Total comprehensive income
 
 
$
762,988

 
$
3,922,875

Preferred stock dividend declared
 
 
(3,906
)
 
(3,906
)
Comprehensive income attributable to common shares
 
 
$
759,082

 
$
3,918,969


See notes to unaudited consolidated financial statements.


4

 



Terra Property Trust, Inc.
Consolidated Statements of Changes in Equity
Three Months Ended March 31, 2020 and 2019
(Unaudited)

 
 
Preferred Stock
 
12.5% Series A Cumulative Non-Voting Preferred Stock
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
 
 
 
 
 
$0.01 Par Value
 
 
 
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Total equity
Balance at January 1, 2020
 
$

 
125

 
$
125,000

 
15,125,681

 
$
151,257

 
$
301,727,297

 
$
(54,459,821
)
 
$

 
$
247,543,733

Issuance of common stock (Note 3)
 

 

 

 
4,574,470

 
45,745

 
75,334,248

 

 

 
75,379,993

Distributions declared on common
   share ($0.53 per share)
 

 

 

 

 

 

 
(8,832,071
)
 

 
(8,832,071
)
Distributions declared on preferred
   shares
 

 

 

 

 

 

 
(3,906
)
 

 
(3,906
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 

 

 

 
578,963

 

 
578,963

Net unrealized gains on marketable
   securities
 

 

 

 

 

 

 

 
192,919

 
192,919

Reclassification of net realized
   gains on marketable securities
   into earnings
 

 

 

 

 

 

 

 
(8,894
)
 
(8,894
)
Balance at March 31, 2020
 
$

 
125

 
$
125,000

 
19,700,151

 
$
197,002

 
$
377,061,545

 
$
(62,716,835
)
 
$
184,025

 
$
314,850,737




See notes to unaudited consolidated financial statements.









5

 



Terra Property Trust, Inc.
Consolidated Statements of Changes in Equity
Three Months Ended March 31, 2020 and 2019 (Continued)
(Unaudited)

 
 
Preferred Stock
 
12.5% Series A Cumulative Non-Voting Preferred Stock
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
 
 
 
 
 
$0.01 Par Value
 
 
 
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Total equity
Balance at January 1, 2019
 
$

 
125

 
$
125,000

 
14,912,990

 
$
149,130

 
$
298,109,424

 
$
(33,091,195
)
 
$

 
$
265,292,359

Distributions declared on common
   share ($0.51 per share)
 

 

 

 

 

 

 
(7,556,413
)
 

 
(7,556,413
)
Distributions declared on preferred
   shares
 

 

 

 

 

 

 
(3,906
)
 

 
(3,906
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 

 

 

 
3,922,875

 

 
3,922,875

Net unrealized gains on marketable
securities
 

 

 

 

 

 

 

 

 

Reclassification of net realized
gains on marketable securities
into earnings
 

 

 

 

 

 

 

 

 

Balance at March 31, 2019
 
$

 
125

 
$
125,000

 
14,912,990

 
$
149,130

 
$
298,109,424

 
$
(36,728,639
)
 
$

 
$
261,654,915



See notes to unaudited consolidated financial statements.





6

 



Terra Property Trust, Inc.
Consolidated Statements of Cash Flows
(Unaudited)

 
Three Months Ended March 31,
 
2020
 
2019
Cash flows from operating activities:
 
 
 
Net income
$
578,963

 
$
3,922,875

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Paid-in-kind interest income, net
(80,116
)
 
(657,700
)
Depreciation and amortization
946,494

 
946,494

Provision for loan losses
1,144,994

 

Amortization of net purchase premiums on loans
11,112

 
12,654

Straight-line rent adjustments
(334,452
)
 
(121,395
)
Amortization of deferred financing costs
551,226

 
419,173

Net loss on extinguishment of obligations under participation agreements
319,453

 

Amortization of above- and below-market rent intangibles
(111,748
)
 
(111,750
)
Amortization and accretion of investment-related fees, net
(4,140
)
 
(105,567
)
Amortization of above-market rent ground lease
(32,587
)
 
(32,587
)
Changes in operating assets and liabilities:
 
 
 
Interest receivable
(376,919
)
 
(109,029
)
Other assets
(9,093
)
 
155,815

Due to Manager
22,520

 
(57,782
)
Unearned income
(167,104
)
 
563,412

Interest payable
(143,220
)
 
(93,939
)
Accounts payable and accrued expenses
839,938

 
(489,766
)
Other liabilities
222,194

 
(89,376
)
Net cash provided by operating activities
3,377,515

 
4,151,532

Cash flows from investing activities:
 
 
 
Origination and purchase of loans
(38,376,448
)
 
(70,813,882
)
Proceeds from repayments of loans
13,371,565

 
60,319,802

Purchase of marketable securities
(3,354,442
)
 

Proceeds from sale of marketable securities
48,073

 

Capital expenditures on real estate

 
(242,071
)
Net cash used in investing activities
(28,311,252
)
 
(10,736,151
)
Cash flows from financing activities:
 
 
 
Proceeds from borrowings under revolving credit facility
35,000,000

 

Proceeds from borrowings under repurchase agreement
14,807,834

 
45,347,521

Proceeds from issuance of common stock in the Merger
16,897,074

 

Proceeds from issuance of common stock to TIF3 REIT
8,600,000

 

Distributions paid
(8,832,071
)
 
(7,556,413
)
Proceeds from obligations under participation agreements
14,291,899

 
5,716,927

Repayment of borrowings under repurchase agreement
(3,395,740
)
 

Change in interest reserve and other deposits held on investments
(2,286,740
)
 
(2,250,093
)
Repayment of mortgage principal
(132,625
)
 

Payment of financing costs
(84,175
)
 
(226,738
)
Repayments of obligations under participation agreements

 
(24,903,061
)
Net cash provided by financing activities
74,865,456

 
16,128,143

Net increase in cash, cash equivalents and restricted cash
49,931,719

 
9,543,524

Cash, cash equivalents and restricted cash at beginning of period
50,549,700

 
28,538,853

Cash, cash equivalents and restricted cash at end of period (Note 2)
$
100,481,419

 
$
38,082,377


7

 



Terra Property Trust, Inc.
Consolidated Statements of Cash Flows (Continued)
(Unaudited)
 
Three Months Ended March 31,
 
2020
 
2019
Supplemental Disclosure of Cash Flows Information: 
 
 
 
Cash paid for interest
$
4,459,761

 
$
1,701,039


Supplemental Non-Cash Financing Activities:

Merger

On February 28, 2020, Terra Property Trust, Inc. (the “Company”) entered into certain Agreement and Plan of Merger (the “Merger Agreement”), by and among the Company, Terra Property Trust 2, Inc. (“TPT2”) and Terra Secured Income Fund 7, LLC (“Terra Fund 7”), the sole stockholder of TPT2, pursuant to which, effective March 1, 2020, TPT2 was merged with and into the Company, with the Company continuing as the surviving corporation (the “Merger”). In connection with the Merger, the Company issued 2,116,785.76 shares of common stock, par value $0.01 per share, were issued to Terra Fund 7 (Note 3). The following table presents a summary of the consideration exchanged and settlement of the Company’s obligations under participation agreements as a result of the Merger:
Total Consideration
 
 
Equity issued in the Merger
 
$
34,630,615

Proceeds from equity issued in the Merger
 
16,897,074

 
 
$
17,733,541

Net assets exchanged
 
 
Settlement of obligations under participation agreements
 
$
17,688,741

Interest receivable
 
134,543

Other assets
 
18,384

Accounts payable and accrued expenses
 
(57,433
)
Due to Manager
 
(50,694
)
 
 
$
17,733,541

Non-cash Proceeds from Issuance of Common Stock to TIF3 REIT

In addition, on March 2, 2020, the Company entered into two separate contribution agreements, one by and among the Company, Terra International Fund 3 REIT, LLC (“TIF3 REIT”) and Terra Income Fund International, and another by and among the Company, TIF3 REIT and Terra Secured Income Fund 5 International, pursuant to which the Company issued an aggregate of 2,457,684.59 shares of common stock in exchange for the settlement of $32.1 million of participation interests in loans held by the Company, $8.6 million in cash, and other net working capital (“Issuance of Common Stock to TIF3 REIT”) (Note 3). The following table presents a summary of the consideration exchanged and settlement of the Company’s obligations under participation agreements as a result of the Issuance of Common Stock to TIF3 REIT:
Total Consideration
 
 
Equity issued to TIF3 REIT
 
$
40,749,378

Proceeds from equity issued to TIF3 REIT
 
8,600,000

 
 
$
32,149,378

Net Assets exchanged
 
 
Settlement of obligations under participation agreements
 
$
32,112,257

Interest receivable
 
270,947

Due to Manager
 
(233,826
)
Net assets acquired excluding cash and cash equivalents
 
$
32,149,378


For the three months ended March 31, 2020, the Company declared distributions of $3,906 on its 12.5% Series A Cumulative Non-Voting Preferred Stock to be paid in June 2020.


8

 



Terra Property Trust, Inc.
Consolidated Statements of Cash Flows (Continued)
(Unaudited)


Supplemental Non-Cash Investing Activities    `:

Deed in Lieu of Foreclosure

On January 9, 2019, the Company acquired 4.9 acres of adjacent land encumbering a $14.3 million first mortgage via deed in lieu of foreclosure in exchange for the payment of the first mortgage and related fees and expenses (Note 5). The following table summarizes the carrying value of the first mortgage and the fair value of asset acquired in the transaction:
Carrying Value of First Mortgage
 
 
Loan held for investment
 
$
14,325,000

Interest receivable
 
439,300

Restricted cash applied against loan principal amount
 
(60,941
)
 
 
$
14,703,359

 
 
 
Assets Acquired at Fair Value
 
 
Land
 
$
14,703,359


    

See notes to unaudited consolidated financial statements.


9

 


Terra Property Trust, Inc.
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2020

Note 1. Business

Terra Property Trust, Inc. (and, together with its consolidated subsidiaries, the “Company” or “Terra Property Trust”) was incorporated under the general corporation laws of the State of Maryland on December 31, 2015. Terra Property Trust is a real estate credit focused company that originates, structures, funds and manages commercial real estate investments, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments. The Company’s loans finance the acquisition, construction, development or redevelopment of quality commercial real estate in the United States. The Company focuses on the origination of middle market loans in the approximately $10 million to $50 million range, to finance properties in primary and secondary markets. The Company believes these loans are subject to less competition and offer higher risk adjusted returns than larger loans with similar risk/return metrics.
 
On January 1, 2016, Terra Secured Income Fund 5, LLC (“Terra Fund 5”), the Company’s then parent, contributed its consolidated portfolio of net assets to the Company pursuant to a contribution agreement in exchange for shares of the Company’s common stock. Upon receipt of the contribution of the consolidated portfolio of net assets from Terra Fund 5, the Company commenced its operations on January 1, 2016. On March 2, 2020, the Company engaged in a series of transactions pursuant to which the Company issued an aggregate of 4,574,470.35 shares of our common stock in exchange for the settlement of an aggregate of $49.8 million of participation interests in loans held by the Company, cash of $25.5 million and other working capital. Following the completion of the transactions, as of March 31, 2020, Terra JV, LLC (“Terra JV”) held 86.4% of the issued and outstanding shares of the Company's common stock with the remainder held by TIF3 REIT (Note 3).

The Company has elected to be taxed, and to qualify annually thereafter, as a real estate investment trust (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), commencing with the taxable year ended December 31, 2016. As a REIT, the Company is not subject to federal income taxes on income and gains distributed to the stockholders as long as certain requirements are satisfied, principally relating to the nature of income and the level of distributions, as well as other factors. The Company also operates its business in a manner that permits it to maintain its exclusion from registration under the Investment Company Act of 1940, as amended.

The Company’s investment activities are externally managed by Terra REIT Advisors, LLC (“Terra REIT Advisors” or the “Manager”), a subsidiary of the Company’s sponsor, Terra Capital Partners, LLC, pursuant to a management agreement (the “Management Agreement”), under the oversight of the Company’s board of directors (Note 7). The Company does not currently have any employees and does not expect to have any employees. Services necessary for the Company’s business are provided by individuals who are employees of the Manager or by individuals who were contracted by the Company or by the Manager to work on behalf of the Company pursuant to the terms of the Management Agreement.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The interim consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) and include all of the Company’s accounts and those of its consolidated subsidiaries. The accompanying interim financial statements of the Company and related financial information have been prepared pursuant to the requirements for reporting on Form 10-Q and Articles 6 or 10 of Regulation S-X. All intercompany balances and transactions have been eliminated.

Loans Held for Investment

The Company originates, acquires, and structures real estate-related loans generally to be held to maturity. Loans held for investment are carried at the principal amount outstanding, adjusted for the accretion of discounts on investments and exit fees, and the amortization of premiums on investments and origination fees. The Company’s preferred equity investments, which are economically similar to mezzanine loans and subordinate to any loans but senior to common equity, are accounted for as loans held for investment. Loans are carried at cost less allowance for loan losses.


10

 


Notes to Unaudited Consolidated Financial Statements


Allowance for Loan Losses
    
The Company’s loans are typically collateralized by either the sponsors’ equity interest in the real estate properties or the underlying real estate properties. As a result, the Company regularly evaluates the extent and impact of any credit migration associated with the performance and/or value of the underlying collateral property as well as the financial and operating capability of the borrower/sponsor on a loan-by-loan basis. Specifically, a property’s operating results and any cash reserves are analyzed and used to assess (i) whether cash from operations and/or reserve balances are sufficient to cover the debt service requirements currently and into the future; (ii) the ability of the borrower to refinance the loan; and/or (iii) the property’s liquidation value. The Company also evaluates the financial wherewithal of the sponsor as well as its competency in managing and operating the real estate property. In addition, the Company considers the overall economic environment, real estate sector, and geographic sub-market in which the borrower operates. Such analyses are completed and reviewed by asset management and finance personnel, who utilize various data sources, including (i) periodic financial data such as debt service coverage ratio, property occupancy, tenant profile, rental rates, operating expenses, the borrower’s exit plan, the capitalization and discount rates; (ii) site inspections; and (iii) current credit spreads and discussions with market participants.

The Manager performs a quarterly evaluation for possible impairment of the Company’s portfolio of loans. A loan is impaired if it is deemed probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan. Impairment is measured based on the present value of expected future cash flows or the fair value of the collateral, if the loan is collateral dependent. Upon measurement of impairment, the Company records an allowance to reduce the carrying value of the loan with a corresponding charge to net income.

In conjunction with the quarterly evaluation of loans not considered impaired, the Manager assesses the risk factors of each loan and assigns each loan a risk rating between 1 and 5, which is an average of the numerical ratings in the following categories: (i) sponsor capability and financial condition; (ii) loan and collateral performance relative to underwriting; (iii) quality and stability of collateral cash flows and/or reserve balances; and (iv) loan to value. Based on a 5-point scale, the Company’s loans are rated “1” through “5”, from less risk to greater risk, as follows:
Risk Rating
 
Description
1
 
Very low risk
2
 
Low risk
3
 
Moderate/average risk
4
 
Higher risk
5
 
Highest risk

The Company records an allowance for loan losses equal to (i) 1.5% of the aggregate carrying amount of loans rated as a “4”, plus (ii) 5% of the aggregate carrying amount of loans rated as a “5”, plus (iii) impaired loan reserves, if any.

There may be circumstances where the Company modifies a loan by granting the borrower a concession that it might not otherwise consider when a borrower is experiencing financial difficulty or is expected to experience financial difficulty in the foreseeable future. Such concessionary modifications are classified as troubled debt restructurings (“TDR”s) unless the modification solely results in a delay in a payment that is insignificant. Loans classified as TDRs are considered impaired loans for reporting and measurement purposes.

Marketable Securities

The Company from time to time invests in short term debt and equity securities. These securities are classified as available-for-sale and are carried at fair value. Unrealized gains or losses on available-for-sale securities are reported in other comprehensive income or loss until they are realized.
    
Real Estate Owned, Net

Real estate acquired is recorded at its estimated fair value at acquisition and is shown net of accumulated depreciation and impairment charges.

Acquisition of properties generally are accounted for as asset acquisitions. Under asset acquisition accounting, the costs to acquire real estate, including transaction costs, are accumulated and then allocated to individual assets and liabilities acquired based upon their relative fair value. The Company allocates the purchase price of its real estate acquisitions to land, building,

11

 


Notes to Unaudited Consolidated Financial Statements


tenant improvements, acquired in-place leases, intangibles for the value of any above or below market leases at fair value and to any other identified intangible assets or liabilities. The Company amortizes the value allocated to in-place leases over the remaining lease term, which is reported in depreciation and amortization expense on its consolidated statements of operations. The value allocated to above or below market leases are amortized over the remaining lease term as an adjustment to rental income.

Real estate assets are depreciated using the straight-line method over their estimated useful lives: buildings and improvements - not to exceed 40 years, and tenant improvements - shorter of the lease term or life of the asset. Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred. Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their estimated useful life.

Management reviews the Company’s real estate for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The review of recoverability is based on estimated future cash flows and the estimated liquidation value of such real estate assets, and provide for impairment if such undiscounted cash flows are insufficient to recover the carrying amount of the real estate assets. If impaired, the real estate asset will be written down to its estimated fair value.

Leases

The Company determines if an arrangement is a lease at inception. Operating leases in which the Company is the lessee are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities in the consolidated balance sheets. 

ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As the Company’s lease typically does not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The Company uses the implicit rate when readily determinable. The operating lease ROU asset also includes any lease payments made in advance and excludes lease incentives if there were any. The Company’s lease term may include options to extend or terminate the lease when it is reasonably certain that it will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

Revenue Recognition

Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

Interest Income: Interest income is accrued based upon the outstanding principal amount and contractual terms of the loans and preferred equity investments that the Company expects to collect and it is accrued and recorded on a daily basis. Discounts and premiums on investments purchased are accreted or amortized over the expected life of the respective loan using the effective yield method, and are included in interest income in the consolidated statements of operations. Loan origination fees and exit fees, net of portions attributable to obligations under participation agreements, are capitalized and amortized or accreted to interest income over the life of the investment using the effective interest method. Income accrual is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of the Manager, recovery of income and principal becomes doubtful. Outstanding interest receivable is assessed for recoverability. Interest is then recorded on the basis of cash received until accrual is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability.

The Company holds loans in its portfolio that contain paid-in-kind (“PIK”) interest provisions. The PIK interest, which represents contractually deferred interest that is added to the principal balance that is due at maturity, is recorded on the accrual basis.

Real Estate Operating Revenues: Real estate operating revenue is derived from leasing of space to various types of tenants. The leases are for fixed terms of varying length and generally provide for annual rent increases and expense reimbursements to be paid in monthly installments. Lease revenue, or rental income from leases, is recognized on a straight-line basis over the term of the respective leases. Additionally, the Company recorded above- and below-market lease intangibles, which are included in real estate owned, net, in connection with the acquisition of the real estate properties. These intangible assets and liabilities are amortized to lease revenue over the remaining contractual lease term.
    
Other Revenues: Prepayment fee income is recognized as prepayments occur. All other income is recognized when earned.

12

 


Notes to Unaudited Consolidated Financial Statements



Cash, Cash Equivalents and Restricted Cash

The Company considers all highly liquid investments, with original maturities of ninety days or less when purchased, as cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. The Company maintains all of its cash at financial institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
 
Restricted cash represents cash held as additional collateral by the Company on behalf of the borrowers related to the investments in loans or preferred equity instruments for the purpose of such borrowers making interest and property-related operating payments. Restricted cash is not available for general corporate purposes. The related liability is recorded in “Interest reserve and other deposits held on investments” on the consolidated balance sheets.

Cash held in escrow by lender represents amounts funded to an escrow account for debt services and tenant improvements.

The following table provides a reconciliation of cash, cash equivalents and restricted cash in the Company’s consolidated balance sheets to the total amount shown in its consolidated statements of cash flows:
 
 
March 31, 2020

 
March 31, 2019

Cash and cash equivalents
 
$
82,163,055

 
$
20,738,351

Restricted cash
 
16,255,423

 
15,120,570

Cash held in escrow by lender
 
2,062,941

 
2,223,456

Total cash, cash equivalents and restricted cash shown in the consolidated
   statements of cash flows
 
$
100,481,419

 
$
38,082,377


 Participation Interests

Loan participations from the Company which do not qualify for sale treatment remain on the Company’s consolidated balance sheets and the proceeds are recorded as obligations under participation agreements. For the investments for which participation has been granted, the interest earned on the entire loan balance is recorded within “Interest income” and the interest related to the participation interest is recorded within “Interest expense from obligations under participation agreements” in the consolidated statements of operations. Interest expense from obligations under participation agreement is reversed when recovery of interest income on the related loan becomes doubtful. See “Obligations under Participation Agreements” in Note 8 for additional information.

Repurchase Agreement

    The Company finances certain of its senior loans through repurchase transactions under a master repurchase agreement. The Company accounts for the repurchase transactions as secured borrowing transactions, which are carried at their contractual amounts (cost), net of unamortized deferred financing fees.

Fair Value Measurements

U.S. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The Company has not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, obligations under participation agreements, mortgage loan payable, repurchase agreement payable and revolving credit facility payable. Such financial instruments are carried at cost, less impairment. Marketable securities are financial instruments that are reported at fair value.

Deferred Financing Costs

Deferred financing costs represent fees and expenses incurred in connection with obtaining financing for investments. These costs are presented in the consolidated balance sheets as a direct deduction of the debt liability to which the costs pertain. These costs are amortized using the effective interest method and are included in interest expense on mortgage loan payable in the consolidated statements of operations over the life of the borrowings.


13

 


Notes to Unaudited Consolidated Financial Statements


Income Taxes

The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code commencing with the taxable year ended December 31, 2016. In order to qualify as a REIT, the Company is required, among other things, to distribute at least 90% of its REIT net taxable income to the stockholders and meet certain tests regarding the nature of its income and assets. As a REIT, the Company is not subject to federal income taxes on income and gains distributed to the stockholders as long as certain requirements are satisfied, principally relating to the nature of income and the level of distributions, as well as other factors. If the Company fails to continue to qualify as a REIT in any taxable year and does not qualify for certain statutory relief provisions, the Company will be subject to U.S. federal and state income taxes at regular corporate rates (including any applicable alternative minimum tax for taxable years before 2018) beginning with the year in which it fails to qualify and may be precluded from being able to elect to be treated as a REIT for the Company’s four subsequent taxable years. Any gains from the sale of foreclosed properties within two years are subject to U.S. federal and state income taxes at regular corporate rates.

As of March 31, 2020, the Company has satisfied all the requirements for a REIT and accordingly, no provision for federal income taxes has been included in the consolidated financial statements for the three months ended March 31, 2020 and 2019.

The Company did not have any uncertain tax positions that met the recognition or measurement criteria of Accounting Standards Codification (“ASC”) 740-10-25, Income Taxes, nor did the Company have any unrecognized tax benefits as of the periods presented herein. The Company recognizes interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in its consolidated statements of operations. For the three months ended March 31, 2020 and 2019, the Company did not incur any interest or penalties. Although the Company files federal and state tax returns, its major tax jurisdiction is federal. The Company’s inception-to-date federal tax returns remain subject to examination by the Internal Revenue Service.

Earnings Per Share

The Company has a simple equity capital structure with only common stock and preferred stock outstanding. As a result, earnings per share, as presented, represent both basic and dilutive per-share amounts for the periods presented in the consolidated financial statements. Income per basic share of common stock is calculated by dividing net income allocable to common stock by the weighted-average number of shares of common stock issued and outstanding during such period.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. During the first quarter of 2020, there was a global outbreak of a novel coronavirus (“COVID-19”), which has spread to over 200 countries and territories, including the United States, and has spread to every state in the United States. The World Health Organization has designated COVID-19 as a pandemic, and numerous countries, including the United States, have declared national emergencies with respect to COVID-19. The global impact of the outbreak has been rapidly evolving, and as cases of COVID-19 have continued to be identified in additional countries, many countries have reacted by instituting quarantines and restrictions on travel, closing financial markets and/or restricting trading and operations of non-essential offices and retail centers. Such actions are creating disruption in global supply chains, and adversely impacting many industries. The outbreak could have a continued adverse impact on economic and market conditions and trigger a period of global economic slowdown. The rapid development and fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19 on economic and market conditions. The Company believes the estimates and assumptions underlying its consolidated financial statements are reasonable and supportable based on the information available as of March 31, 2020, however uncertainty over the ultimate impact COVID-19 will have on the global economy generally, and the Company’s business in particular, makes any estimates and assumptions as of March 31, 2020 inherently less certain than they would be absent the current and potential impacts of COVID-19. Actual results may ultimately differ from those estimates.

Segment Information

The Company’s primary business is originating, acquiring and structuring real estate-related loans related to high quality commercial real estate. From time to time, the Company may acquire real estate encumbering the senior loans through foreclosure. However, management treats the operations of the real estate acquired through foreclosure as the continuation of the original senior loans. The Company operates in a single segment focused on mezzanine loans, other loans and preferred equity investments, and to a lesser extent, owning and managing real estate.
    

14

 


Notes to Unaudited Consolidated Financial Statements


Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. In April 2019, the FASB issued additional amendments to clarify the scope of ASU 2016-13 and address issues related to accrued interest receivable balances, recoveries, variable interest rates and prepayments, among other things. In May 2019, the FASB issued ASU 2019-05 — Targeted Transition Relief, which provides an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. In October 2019, the FASB decided that for smaller reporting companies, ASU 2016-13 and related amendments will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company meets the definition of a smaller reporting company under the regulation of the Securities and Exchange Commission. As such, the Company will adopt this ASU and related amendments on January 1, 2023. Management is currently evaluating the impact this change will have on the Company’s consolidated financial statements and disclosures.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure framework — Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). The objective of ASU 2018-13 is to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of information required by U.S. GAAP. The amendments in ASU 2018-13 added, removed and modified certain fair value measurement disclosure requirements. ASU 2018-13 is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company adopted ASU 2018-13 on January 1, 2020. The adoption of ASU 2018-13 did not have a material impact on its consolidated financial statements and disclosures.

London Interbank Offered Rate (“LIBOR”) is a benchmark interest rate referenced in a variety of agreements that are used by all types of entities. At the end of 2021, banks will no longer be required to report information that is used to determine LIBOR. As a result, LIBOR could be discontinued. Other interest rates used globally could also be discontinued for similar reasons. In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) — Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). The amendments in ASU 2020-04 provide companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. The provisions of optional relief include: (i) contract modifications - account for the modification as a continuation of the existing contract without additional analysis; (ii) hedging accounting - continue hedge accounting when certain critical terms of a hedging relationship change; and (iii) held-to-maturity (HTM) debt securities - one-time sale and/or transfer to available for sale or trading may be made for HTM debt securities that both reference an eligible reference rate and were classified as HTM before January 1, 2020. Companies can apply the amendments in ASU 2020-04 immediately. However, ASU 2020-04 will only be available for a limited time (generally through December 31, 2022). The Company is currently evaluating the impact of the reference rate reform and ASU 2020-04 on its consolidated financial statements and disclosures.

Note 3. Merger and Issuance of Common Stock to TIF3 REIT

Merger

On February 28, 2020, the Company entered into the Merger Agreement pursuant to which TPT2 was merged with and into the Company, with the Company continuing as the surviving corporation, effective March 1, 2020. In connection with the Merger, each share of common stock, par value $0.01 per share, of TPT2 issued and outstanding immediately prior to the effective time of the Merger was converted into the right to receive from the Company a number of shares of common stock, par value $0.01 per share, of the Company equal to an exchange ratio, which was 1.2031. The exchange ratio was based on the relative net asset values of the Company and TPT2 as of December 31, 2019 as adjusted to reflect changes in the net working capital of each of the Company and TPT2 during the period from January 1, 2020 through March 1, 2020, the effective time for the Merger. For purposes of determining the respective fair values of the Company and TPT2, the value of the loans (or participation interests therein) held by each of the Company and TPT2 was the value of such loans (or participation interests) as set forth in the audited financial statements of the Company as of and for the year ended December 31, 2019. As a result, Terra Fund 7, the sole stockholder of TPT2, received 2,116,785.76 shares of common stock of the Company as consideration in the Merger. The shares of common stock were issued in a private placement in reliance on Section 4(a)(2) under the Securities Act of 1933, as amended (the “Securities Act”), and the rules and regulations promulgated thereunder.

15

 


Notes to Unaudited Consolidated Financial Statements


The following table presents a summary of the consideration exchanged and settlement of the Company’s obligations under participation agreements as a result of the Merger:
Total Consideration
 
 
Equity issued in the Merger
 
$
34,630,615

 
 
$
34,630,615

 
 
 
Net Assets of TPT2 Received in the Merger
 
 
Loans held for investment acquired through participation
 
$
17,688,741

Cash and cash equivalents
 
16,897,074

Interest receivable
 
134,543

Other assets
 
18,384

Accounts payable and accrued expenses
 
(57,433
)
Due to Manager
 
(50,694
)
Total identifiable net assets
 
$
34,630,615

The fair value of the 2,116,785.76 shares of the Company’s stock issued in the Merger as consideration paid for TPT2 was derived from the fair value per share of the Company as of December 31, 2019 as adjusted to reflect the change in the net working capital of the Company during the period from January 1, 2020 through March 1, 2020, the effective time of the Merger.
In connection with the Merger, the size of the board of directors of the Company was reduced from eight directors to four directors, with Andrew M. Axelrod, Vikram S. Uppal, Roger H. Beless and Michael L. Evans continuing as directors of the Company.
Issuance of Common Stock to TIF3 REIT
In addition, on March 2, 2020, the Company entered into two separate contribution agreements, one by and among the Company, TIF3 REIT and Terra Income Fund International, and another by and among the Company, TIF3 REIT and Terra Secured Income Fund 5 International, pursuant to which the Company issued 2,457,684.59 shares of common stock of the Company to TIF3 REIT in exchange for the settlement of $32.1 million of participation interests in loans also held by the Company, $8.6 million in cash and other net working capital. The shares of common stock were issued in a private placement in reliance on Section 4(a)(2) under the Securities Act and the rules and regulations promulgated thereunder.
The fair value of the 2,457,684.59 shares of the Company’s stock issued in the transaction as consideration paid for TIF3 REIT was derived from the fair value per share of the Company as of December 31, 2019, which was the most recently determined fair value per share of the Company.
The following table presents a summary of the consideration exchanged and settlement of the Company’s obligations under participation agreements as a result of the Issuance of Common Stock to TIF3 REIT:
Total Consideration
 
 
Equity issued to TIF3 REIT
 
$
40,749,378

 
 
$
40,749,378

Net Assets of TIF3 REIT Received
 
 
Investments through participation interest, at fair value
 
$
32,112,257

Cash and cash equivalents
 
8,600,000

Interest receivable
 
270,947

Due to Manager
 
(233,826
)
Total identifiable net assets
 
$
40,749,378


16

 


Notes to Unaudited Consolidated Financial Statements


Terra JV, LLC

Prior to the completion of the Merger and the Issuance of Common Stock to TIF3 REIT transactions described above, Terra Fund 5 owned approximately 98.6% of the issued and outstanding shares of the Company’s common stock indirectly through its wholly owned subsidiary, Terra JV, of which Terra Fund 5 was the sole managing member, and the remaining issued and outstanding shares of the Company’s common stock were owned by TIF3 REIT.

As described above, the Company acquired TPT2 in the Merger and, in connection with such transaction, Terra Fund 7 contributed the shares of the Company’s common stock received as consideration in the Merger to Terra JV and became a co-managing member of Terra JV pursuant to the amended and restated operating agreement of Terra JV, dated March 2, 2020 (the “JV Agreement”). The JV Agreement and related stockholders agreement between Terra JV and the Company, dated March 2, 2020, provide for the joint approval of Terra Fund 5 and Terra Fund 7 with respect to certain major decisions that are taken by Terra JV and the Company.

On March 2, 2020, the Company, Terra Fund 5, Terra JV and Terra REIT Advisors also entered into the Amended and Restated Voting Agreement (the “Voting Agreement”), pursuant to which Terra Fund 5 assigned its rights and obligations under the Voting Agreement to Terra JV. Consistent with the original voting agreement dated February 8, 2018, for the period that Terra REIT Advisors remains the external manager of the Company, Terra REIT Advisors will have the right to nominate two individuals to serve as directors of the Company and, until Terra JV no longer holds at least 10% of the outstanding shares of the Company’s common stock, Terra JV will have the right to nominate one individual to serve as a director of the Company.

Following the completion of the transactions described above, as of March 31, 2020, Terra JV owns 86.4% of the issued and outstanding shares of the Company’s common stock with the remainder held by TIF3 REIT, and Terra Fund 5 and Terra Fund 7 own an 87.6% and 12.4% interest, respectively, in Terra JV.

Net Loss on Extinguishment of Obligations Under Participation Agreements

As discussed in Note 7, in the normal course of business, the Company may enter into participation agreements with related parties, primarily other affiliated funds managed by the Manager, and to a lesser extent, unrelated parties. The obligations under participation agreements were released as a result of the Merger and the Issuance of Common Stock to TIF3 REIT. In connection with these transactions, the Company recognized a net loss of $0.3 million, which was primarily transaction costs incurred in connection with both transactions.
Note 4. Loans Held for Investment

Portfolio Summary

The following table provides a summary of the Company’s loan portfolio as of March 31, 2020 and December 31, 2019:
 
March 31, 2020
 
December 31, 2019
 
Fixed Rate
 
Floating
Rate
 (1)(2)(3)
 
Total
 
Fixed Rate
 
Floating
Rate
 (1)(2)(3)
 
Total
Number of loans
8

 
14

 
22

 
8

 
15

 
23

Principal balance
$
81,751,847

 
$
320,935,591

 
$
402,687,438

 
$
70,692,767

 
$
306,695,550

 
$
377,388,317

Carrying value
$
82,483,887

 
$
320,485,626

 
$
402,969,513

 
$
71,469,137

 
$
307,143,631

 
$
378,612,768

Fair value
$
82,249,333

 
$
317,360,045

 
$
399,609,378

 
$
71,516,432

 
$
307,643,983

 
$
379,160,415

Weighted-average coupon rate
12.76
%
 
8.50
%
 
9.36
%
 
11.93
%
 
9.13
%
 
9.65
%
Weighted-average remaining
 term (years)
1.76

 
2.05

 
1.99

 
2.28

 
2.09

 
2.13

_______________
(1)
These loans pay a coupon rate of LIBOR plus a fixed spread. Coupon rate shown was determined using LIBOR of 0.99% and 1.76% as of March 31, 2020 and December 31, 2019, respectively.
(2)
As of March 31, 2020 and December 31, 2019, amounts included $136.1 million and $114.8 million, respectively, of senior mortgages used as collateral for $92.5 million and $81.1 million, respectively, of borrowings under a repurchase agreement (Note 8). These borrowings bear interest at an annual rate of LIBOR plus a spread ranging from 2.00% to 2.50% as of March 31, 2020 and LIBOR plus a spread ranging from 2.25% to 2.50% as of December 31, 2019.
(3)
As of both March 31, 2020 and December 31, 2019, twelve of these loans are subject to a LIBOR floor.

17

 


Notes to Unaudited Consolidated Financial Statements



Lending Activities

The following table presents the activities of the Company’s loan portfolio for the three months ended March 31, 2020 and 2019:
 
Loans Held for Investment
 
Loans Held for Investment through Participation Interests
 
Total
Balance, January 1, 2020
$
375,462,222

 
$
3,150,546

 
$
378,612,768

New loans made
37,504,601

 
871,847

 
38,376,448

Principal repayments received
(13,371,565
)
 

 
(13,371,565
)
PIK interest (1)
294,237

 

 
294,237

Net amortization of premiums on loans
(15,348
)
 

 
(15,348
)
Accrual, payment and accretion of investment-related fees and other,
   net
202,793

 
15,174

 
217,967

Provision for loan losses
(1,144,994
)
 

 
(1,144,994
)
Balance, March 31, 2020
$
398,931,946

 
$
4,037,567

 
$
402,969,513

 
Loans Held for Investment
 
Loans Held for Investment through Participation Interests
 
Total
Balance, January 1, 2019
$
388,243,974

 
$

 
$
388,243,974

New loans made
70,813,882

 

 
70,813,882

Principal repayments received
(60,319,802
)
 

 
(60,319,802
)
Foreclosure of collateral (2)
(14,325,000
)
 

 
(14,325,000
)
PIK interest (1)
852,968

 

 
852,968

Net amortization of premiums on loans
(18,350
)
 

 
(18,350
)
Accrual, payment and accretion of investment-related fees, net
(651,089
)
 

 
(651,089
)
Balance, March 31, 2019
$
384,596,583

 
$

 
$
384,596,583

_______________
(1)
Certain loans in the Company’s portfolio contain PIK interest provisions. The PIK interest represents contractually deferred interest that is added to the principal balance. PIK interest related to obligations under participation agreements amounted to $0.2 million for both the three months ended March 31, 2020 and 2019.
(2)
On January 9, 2019, the Company acquired 4.9 acres of adjacent land encumbering a $14.3 million first mortgage via deed in lieu of foreclosure in exchange for the relief of the first mortgage and related fees and expenses (Note 5).


18

 


Notes to Unaudited Consolidated Financial Statements


Portfolio Information

The tables below detail the types of loans in the Company’s loan portfolio, as well as the property type and geographic location of the properties securing these loans as of March 31, 2020 and December 31, 2019:

 
 
March 31, 2020
 
December 31, 2019
Loan Structure
 
Principal Balance
 
Carrying Value
 
% of Total
 
Principal Balance
 
Carrying Value
 
% of Total
First mortgages
 
$
208,956,222

 
$
209,289,995

 
51.9
 %
 
$
178,130,623

 
$
178,203,675

 
47.1
%
Preferred equity investments
 
157,686,635

 
158,285,097

 
39.3
 %
 
157,144,040

 
157,737,763

 
41.6
%
Mezzanine loans
 
36,044,581

 
36,539,415

 
9.1
 %
 
42,113,654

 
42,671,330

 
11.3
%
Allowance for loan losses
 

 
(1,144,994
)
 
(0.3
)%
 

 

 
%
Total
 
$
402,687,438

 
$
402,969,513

 
100.0
 %
 
$
377,388,317

 
$
378,612,768

 
100.0
%
 
 
March 31, 2020
 
December 31, 2019
Property Type
 
Principal Balance
 
Carrying Value
 
% of Total
 
Principal Balance
 
Carrying Value
 
% of Total
Office
 
$
143,941,260

 
$
143,879,383

 
35.7
 %
 
$
142,055,845

 
$
141,870,355

 
37.5
%
Multifamily
 
83,318,419

 
83,907,425

 
20.8
 %
 
76,640,369

 
77,136,016

 
20.4
%
Student housing
 
75,155,569

 
75,608,070

 
18.8
 %
 
58,049,717

 
58,553,496

 
15.5
%
Hotel
 
47,859,380

 
48,029,027

 
11.9
 %
 
46,598,011

 
46,731,939

 
12.3
%
Infill land
 
34,812,810

 
34,992,810

 
8.7
 %
 
36,444,375

 
36,624,375

 
9.7
%
Condominium
 
10,600,000

 
10,697,792

 
2.7
 %
 
10,600,000

 
10,696,587

 
2.8
%
Industrial
 
7,000,000

 
7,000,000

 
1.7
 %
 
7,000,000

 
7,000,000

 
1.8
%
Allowance for loan losses
 

 
(1,144,994
)
 
(0.3
)%
 

 

 
%
Total
 
$
402,687,438

 
$
402,969,513

 
100.0
 %
 
$
377,388,317

 
$
378,612,768

 
100.0
%
 
 
March 31, 2020
 
December 31, 2019
Geographic Location
 
Principal Balance
 
Carrying Value
 
% of Total
 
Principal Balance
 
Carrying Value
 
% of Total
United States
 
 
 
 
 
 
 
 
 
 
 
 
California
 
$
178,222,394

 
$
178,498,419

 
44.3
 %
 
$
150,988,463

 
$
151,108,109

 
39.9
%
New York
 
74,681,066

 
74,830,437

 
18.6
 %
 
79,734,323

 
79,896,663

 
21.1
%
Georgia
 
64,832,131

 
65,075,669

 
16.1
 %
 
61,772,764

 
61,957,443

 
16.4
%
North Carolina
 
32,651,847

 
32,829,933

 
8.1
 %
 
32,592,767

 
32,766,311

 
8.7
%
Washington
 
23,500,000

 
23,666,693

 
5.9
 %
 
23,500,000

 
23,661,724

 
6.2
%
Illinois
 
4,004,877

 
4,039,438

 
1.0
 %
 
8,004,877

 
8,071,562

 
2.1
%
Massachusetts
 
7,000,000

 
7,000,000

 
1.7
 %
 
7,000,000

 
7,000,000

 
1.8
%
Kansas
 
6,200,000

 
6,253,504

 
1.6
 %
 
6,200,000

 
6,251,649

 
1.7
%
Texas
 
3,500,000

 
3,532,794

 
0.9
 %
 
3,500,000

 
3,531,776

 
0.9
%
Other (1)
 
8,095,123

 
8,387,620

 
2.1
 %
 
4,095,123

 
4,367,531

 
1.2
%
Allowance for loan losses
 

 
(1,144,994
)
 
(0.3
)%
 

 

 
%
Total
 
$
402,687,438

 
$
402,969,513

 
100.0
 %
 
$
377,388,317

 
$
378,612,768

 
100.0
%
_______________
(1)
Other includes $5.1 million and $1.1 million of unused portion of a credit facility at March 31, 2020 and December 31, 2019, respectively. Other also includes a $3.0 million loan with collateral located in South Carolina at both March 31, 2020 and December 31, 2019.


19

 


Notes to Unaudited Consolidated Financial Statements


Loan Risk Rating

As described in Note 2, the Manager evaluates the Company’s loan portfolio on a quarterly basis or more frequently as needed. In conjunction with the quarterly review of the Company’s loan portfolio, the Manager assesses the risk factors of each loan, and assigns a risk rating based on a five-point scale with “1” being the lowest risk and “5” being the greatest risk.
 
The following table allocates the principal balance and the carrying value of the Company’s loans based on the loan risk rating as of March 31, 2020 and December 31, 2019:
 
 
March 31, 2020
 
December 31, 2019
Loan Risk Rating
 
Number of Loans
 
Principal Balance
 
Carrying Value
 
% of Total
 
Number of Loans
 
Principal Balance
 
Carrying Value
 
% of Total
1
 
0

 
$

 
$

 
%
 
0
 
$

 
$

 
%
2
 
2

 
25,000,000

 
25,180,000

 
6.2
%
 
5
 
50,000,000

 
50,284,751

 
13.3
%
3
 
15

 
294,854,525

 
295,669,585

 
73.2
%
 
17
 
322,648,317

 
323,588,017

 
85.4
%
4 (1)
 
3

 
76,332,913

 
76,483,600

 
18.9
%
 
0
 

 

 
%
5
 
0

 

 

 
%
 
0
 

 

 
%
Other (2)
 
2

 
6,500,000

 
6,781,322

 
1.7
%
 
1
 
4,740,000

 
4,740,000

 
1.3
%
 
 
22

 
$
402,687,438

 
404,114,507

 
100.0
%
 
23
 
$
377,388,317

 
378,612,768

 
100.0
%
Allowance for loan losses
 
(1,144,994
)
 
 
 
 
 
 
 

 
 
Total, net of allowance for loan losses
 
$
402,969,513

 
 
 
 
 
 
 
$
378,612,768

 
 
_______________
(1)
The increase in number of loans with a loan risk rating of “4” was due to the higher risk in loans collateralized by hospitality and select other asset classes that are particularly negatively impacted by the COVID-19 pandemic.
(2)
These loans were deemed impaired and removed from the pool of loans on which a general allowance is calculated. As of March 31, 2020 and December 31, 2019, no specific reserve for loan losses was recorded on these loans because the fair value of the collateral was greater than carrying value for each loan. The Company entered into forbearance agreement with the borrower for the two loans categorized as “other” above as of March 31, 2020. The Company expects to recover in full the principal balance of these two loans. In March 2020, the loan categorized as “other” above as of December 31, 2019 was repaid in full.

As of March 31, 2020, the Company had three loans with a loan risk rating of “4” and recorded a general allowance for loan losses of $1.1 million

The following table presents the activity in the Company’s allowance for loan losses for the three months ended March 31, 2020 and 2019:
    
 
 
Three Months Ended March 31,
 
 
2020
 
2019
Allowance for loan losses, beginning of period
 
$

 
$

Provision for loan losses
 
1,144,994

 

Charge-offs
 

 

Recoveries
 

 

Allowance for loan losses, end of period
 
$
1,144,994

 
$


The allowance for loan losses reserve reflects the macroeconomic impact of the COVID-19 pandemic on commercial real estate markets generally and is not specific to any loan losses or impairments in our portfolio. See Note 2 and Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion of COVID-19.


20

 


Notes to Unaudited Consolidated Financial Statements


Note 5. Real Estate Owned, Net

Acquisition of Real Estate
    
2019    On January 9, 2019, the Company acquired 4.9 acres of adjacent land encumbering a first mortgage via deed in lieu of foreclosure in exchange for the payment of the first mortgage and related fees and expenses.

The following table summarizes the carrying value of the first mortgage prior to the deed in lieu of foreclosure on January 9, 2019:
Carrying Value of First Mortgage
 
 
Loan held for investment
 
$
14,325,000

Interest receivable
 
439,300

Restricted cash applied against loan principal amount
 
(60,941
)
 
 
$
14,703,359


The table below summarizes the allocation of the estimated fair value of the real estate acquired on January 9, 2019 based on the policy described in Note 2:
Assets Acquired
 
 
Real estate owned:
 
 
Land
 
$
14,703,359


The Company capitalized transaction costs of approximately $0.2 million to land.
    
Real Estate Owned, Net

Real estate owned is comprised of 4.9 acres of adjacent land located in Pennsylvania and a multi-tenant office building, with lease intangible assets and liabilities, located in California. The following table presents the components of real estate owned, net:
 
March 31, 2020
 
December 31, 2019
 
Cost
 
Accumulated Depreciation/Amortization
 
Net
 
Cost
 
Accumulated Depreciation/Amortization
 
Net
Real estate:
 
 
 
 
 
 
 
 
 
 
 
Land
$
13,395,430

 
$

 
$
13,395,430

 
$
13,395,430

 
$

 
$
13,395,430

Building and building
   improvements
51,725,969

 
(2,155,271
)
 
49,570,698

 
51,725,969

 
(1,831,980
)
 
49,893,989

Tenant improvements
1,854,640

 
(462,131
)
 
1,392,509

 
1,854,640

 
(392,812
)
 
1,461,828

Total real estate
66,976,039

 
(2,617,402
)
 
64,358,637

 
66,976,039

 
(2,224,792
)
 
64,751,247

Lease intangible assets:
 
 
 
 
 
 
 
 
 
 
 
In-place lease
15,852,232

 
(3,692,559
)
 
12,159,673

 
15,852,232

 
(3,138,675
)
 
12,713,557

Above-market rent
156,542

 
(29,260
)
 
127,282

 
156,542

 
(24,871
)
 
131,671

Total intangible assets
16,008,774

 
(3,721,819
)
 
12,286,955

 
16,008,774

 
(3,163,546
)
 
12,845,228

Lease intangible liabilities:
 
 
 
 
 
 
 
 
 
 
Below-market rent
(3,371,314
)
 
774,252

 
(2,597,062
)
 
(3,371,314
)
 
658,115

 
(2,713,199
)
Above-market ground lease
(8,896,270
)
 
217,247

 
(8,679,023
)
 
(8,896,270
)
 
184,660

 
(8,711,610
)
Total intangible liabilities
(12,267,584
)
 
991,499

 
(11,276,085
)
 
(12,267,584
)
 
842,775

 
(11,424,809
)
Total real estate
$
70,717,229

 
$
(5,347,722
)
 
$
65,369,507

 
$
70,717,229

 
$
(4,545,563
)
 
$
66,171,666



21

 


Notes to Unaudited Consolidated Financial Statements


Real Estate Operating Revenues and Expenses

The following table presents the components of real estate operating revenues and expenses that are included in the consolidated statements of operations:
 
 
Three Months Ended March 31, 2020
 
Three Months Ended March 31, 2019
Real estate operating revenues:
 
 
 
 
Lease revenue
 
$
1,922,128

 
$
1,922,538

Other operating income
 
390,923

 
398,700

Total
 
$
2,313,051

 
$
2,321,238

Real estate operating expenses:
 
 
 
 
Utilities
 
$
39,022

 
$
33,762

Real estate taxes
 
232,875

 
80,360

Repairs and maintenances
 
237,132

 
209,843

Management fees
 
56,701

 
61,349

Lease expense, including amortization of above-market ground lease
 
283,538

 
283,538

Other operating expenses
 
95,250

 
87,003

Total
 
$
944,518

 
$
755,855


Leases

On July 30, 2018, the Company foreclosed on a multi-tenant office building in full satisfaction of a first mortgage and related fees and expenses. In connection with the foreclosure, the Company assumed four leases whereby the Company is the lessor to the leases. These four tenant leases had remaining lease terms ranging from 6.3 years to 8.8 years as of July 30, 2018 and provide for annual fixed rent increase. Three of the tenant leases each provides two options to renew the lease for five years each and the remaining tenant lease provides one option to renew the lease for five years.

In addition, the Company assumed a ground lease whereby the Company is the lessee (or a tenant) to the ground lease. The ground lease had a remaining lease term of 68.3 years and provides for a new base rent every five years based on the greater of the annual base rent for the prior lease year or 9% of the fair market value of the land. The next rent reset on the ground lease is scheduled for November 1, 2020. Since future rent increase on the ground lease is unknown, the Company did not include the future rent increase in calculating the present value of future rent payments. The ground lease does not provide for renewal options.

On the date of foreclosure, the Company performed lease classification test on the tenant leases as well as the ground lease in accordance with ASC 840. The result of the lease classification test indicated that the tenant leases and the ground lease shall be classified as operating leases on the date of foreclosure.

On January 1, 2019, the Company adopted ASU 2016-02 using a modified retrospective transition approach and chose not to adjust comparable periods (Note 2). The Company elected to use the package of practical expedients for its existing leases whereby the Company did not need to reassess whether a contract is or contains a lease, lease classification and initial direct costs. As a result, the leases continue to be classified as operating leases under ASC 842, Leases. The adoption of ASU 2016-02 did not have any impact on the tenant leases; however, for the ground lease, the Company recognized $16.1 million of both operating lease right-of-use assets and operating lease liabilities on its consolidated balance sheets. No cumulative effect adjustment was recorded because there was no change to operating lease cost. In addition, as of January 1, 2019, the Company had $0.5 million of unamortized leasing commission (initial direct costs) on the tenant leases. The Company elected to continue to amortize the remaining leasing commission through the end of the lease terms.


22

 


Notes to Unaudited Consolidated Financial Statements


Scheduled Future Minimum Rent Income 

Scheduled future minimum rents, exclusive of renewals and expenses paid by tenants, under non-cancelable operating leases at March 31, 2020 are as follows: 
Years Ending December 31,
 
Total
2020 (April 1 through December 31)
 
$
5,060,780

2021
 
7,025,413

2022
 
7,547,261

2023
 
7,787,842

2024
 
8,026,942

Thereafter
 
5,836,010

Total
 
$
41,284,248


Scheduled Annual Net Amortization of Intangibles 

Based on the intangible assets and liabilities recorded at March 31, 2020, scheduled annual net amortization of intangibles for each of the next five calendar years and thereafter is as follows:
Years Ending December 31,
 
Net Decrease in Real Estate Operating Revenue (1)
 
Increase in Depreciation and Amortization (1)
 
Decrease in Rent Expense (1)
 
Total
2020 (April 1 through December 31)
 
$
(335,247
)
 
$
1,661,652

 
$
(97,761
)
 
$
1,228,644

2021
 
(446,995
)
 
2,215,536

 
(130,348
)
 
1,638,193

2022
 
(446,995
)
 
2,215,536

 
(130,348
)
 
1,638,193

2023
 
(446,995
)
 
2,215,536

 
(130,348
)
 
1,638,193

2024
 
(446,995
)
 
2,215,536

 
(130,348
)
 
1,638,193

Thereafter
 
(346,553
)
 
1,635,877

 
(8,059,870
)
 
(6,770,546
)
Total
 
$
(2,469,780
)
 
$
12,159,673

 
$
(8,679,023
)
 
$
1,010,870

_______________
(1)
Amortization of below-market rent and above-market rent intangibles is recorded as an adjustment to lease revenues; amortization of in-place lease intangibles is included in depreciation and amortization; and amortization of above-market ground lease is recorded as a reduction to rent expense.

Supplemental Ground Lease Disclosures
    
Supplemental balance sheet information related to the ground lease was as follows:    
 
 
March 31, 2020
Operating lease
 
 
Operating lease right-of-use assets
 
$
16,111,217

Operating lease liabilities
 
$
16,111,217

 
 
 
Weighted average remaining lease term — operating lease (years)
 
66.6

 
 
 
Weighted average discount rate — operating lease
 
7.9
%

The component of lease expense for the ground lease was as follows:
 
 
 
Three Months Ended March 31, 2020
Operating lease cost
 
 
$
316,125



23

 


Notes to Unaudited Consolidated Financial Statements


Supplemental non-cash information related to the ground lease was as follows:
 
 
Three Months Ended March 31, 2020
Cash paid for amounts included in the measurement of lease liabilities:
 
 
Operating cash flows from operating leases
 
$
316,125

 
 
 
Right-of-use assets obtained in exchange for lease obligations
 
 
Operating leases
 
$
316,125


Maturities of operating lease liabilities are as follows:
Years Ending December 31,
 
Operating Lease
2020 (April 1 through December 31) (Year of rent reset)
 
$
948,375

2021
 
1,264,500

2022
 
1,264,500

2023
 
1,264,500

2024
 
1,264,500

Thereafter
 
78,135,563

Total lease payments
 
84,141,938

Less: Imputed interest
 
(68,030,721
)
Total
 
$
16,111,217


Note 6. Fair Value Measurements

The Company adopted the provisions of ASC 820, Fair Value Measurement (“ASC 820”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 established a fair value hierarchy that prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is impacted by a number of factors, including the type of investment, the characteristics specific to the investment, and the state of the marketplace (including the existence and transparency of transactions between market participants). Investments with readily available, actively quoted prices or for which fair value can be measured from actively quoted prices in an orderly market will generally have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Investments measured and reported at fair value are classified and disclosed into one of the following categories based on the inputs as follows:

        Level 1 — Quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access.

        Level 2 — Pricing inputs are other than quoted prices in active markets, including, but not limited to, quoted prices for similar assets and liabilities in markets that are active, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates) or other market corroborated inputs.

        Level 3 — Significant unobservable inputs are based on the best information available in the circumstances, to the extent observable inputs are not available, including the Company’s own assumptions used in determining the fair value of investments. Fair value for these investments are determined using valuation methodologies that consider a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, and financing transactions subsequent to the acquisition of the investment. The inputs into the determination of fair value require significant management judgment.
       
     In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.


24

 


Notes to Unaudited Consolidated Financial Statements


As of March 31, 2020 and December 31, 2019, the Company has not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, obligations under participation agreements, mortgage loan payable, repurchase agreement payable and revolving credit facility payable. Such financial instruments are carried at cost, less impairment. Marketable securities are financial instruments that are reported at fair value.

Financial Instruments Carried at Fair Value on a Recurring Basis

In March 2020, the Company invested $3.4 million in short-term debt and equity securities. These securities are comprised of preferred stock and bonds. The Company classified these short-term marketable securities as available-for-sale securities, which are presented at fair value on the consolidated balance sheet with the change in fair value reported in other comprehensive income until the securities are realized.

The following tables present fair value measurements of marketable securities, by major class, as of March 31, 2020, according to the fair value hierarchy:
 
 
March 31, 2020
 
 
Fair Value Measurements
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Marketable Securities:
 
 

 
 

 
 

 
 

Preferred stock
 
$
1,028,189

 
$

 
$

 
$
1,028,189

Bonds