0001674356-21-000018.txt : 20211112 0001674356-21-000018.hdr.sgml : 20211112 20211112162746 ACCESSION NUMBER: 0001674356-21-000018 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 116 CONFORMED PERIOD OF REPORT: 20210930 FILED AS OF DATE: 20211112 DATE AS OF CHANGE: 20211112 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: 001-40496 FILM NUMBER: 211404006 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 tpt-20210930.htm 10-Q tpt-20210930
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2021
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)
Maryland81-0963486
(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:

Title of each classTrading Symbol(s)Name of exchange on
which registered
6.00% Notes due 2026TPTANew York Stock Exchange
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 þSmaller reporting company
Emerging growth company
    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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No ☑
As of November 12, 2021, the registrant had 19,487,460 shares of common stock, $0.01 par value, outstanding.



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
September 30, 2021December 31, 2020
(unaudited)
Assets
Cash and cash equivalents$51,975,601 $18,607,952 
Restricted cash10,201,589 12,145,616 
Cash held in escrow by lender3,941,142 2,166,755 
Marketable securities4,437,855 1,287,500 
Loans held for investment, net480,462,652 417,986,462 
Loans held for investment acquired through participation, net 4,294,053 
Equity investment in a limited partnership, net49,909,985 36,259,959 
Real estate owned, net (Note 6)
Land, building and building improvements, net62,136,708 63,385,339 
Lease intangible assets, net8,233,891 9,793,600 
Operating lease right-of-use assets27,398,786 16,105,888 
Deal deposits9,529,476  
Interest receivable2,692,367 2,509,589 
Other assets3,334,108 3,934,468 
Total assets$714,254,160 $588,477,181 
Liabilities and Equity
Liabilities:
Term loan payable, net of deferred financing fees$91,633,624 $105,245,801 
Unsecured notes payable, net of debt issuance cost81,706,136  
Obligations under participation agreements (Note 8 )
106,190,225 71,581,897 
Mortgage loan payable, net of deferred financing fees and other32,301,666 44,117,293 
Revolving line of credit payable, net of deferred financing fees24,832,405  
Secured borrowing31,525,439 18,187,663 
Interest reserve and other deposits held on investments10,201,589 12,145,616 
Operating lease liabilities27,398,786 16,105,888 
Lease intangible liabilities, net (Note 6)
9,885,182 10,249,776 
Due to Manager (Note 8)
1,912,557 1,257,098 
Interest payable 1,950,670 1,185,502 
Accounts payable and accrued expenses1,315,337 3,968,603 
Unearned income424,976 677,856 
Distributions payable3,906  
Other liabilities1,231,289 429,123 
Total liabilities422,513,787 285,152,116 
Commitments and contingencies (Note 10)
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 September
   30, 2021 and December 31, 2020
125,000 125,000 
Common stock, $0.01 par value, 450,000,000 shares authorized and 19,487,460
   shares issued and outstanding at both September 30, 2021 and December 31,
   2020, respectively
194,875 194,875 
Additional paid-in capital373,443,672 373,443,672 
Accumulated deficit(82,023,174)(70,438,482)
Total equity291,740,373 303,325,065 
Total liabilities and equity$714,254,160 $588,477,181 
See notes to unaudited consolidated financial statements.

2


Terra Property Trust, Inc.
Consolidated Statements of Operations
(Unaudited)
Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
Revenues
Interest income$9,918,763 $9,994,763 $26,790,178 $29,231,803 
Real estate operating revenue2,191,1782,990,9196,468,519 7,555,065 
Prepayment fee income190,997190,997  
Other operating income345,18076,736741,973 417,750 
12,646,118 13,062,418 34,191,667 37,204,618 
Operating expenses
Operating expenses reimbursed to Manager1,528,2231,719,7674,878,050 4,781,831 
Asset management fee 1,420,1191,151,1663,733,358 3,321,125 
Asset servicing fee 311,127258,860861,324 746,384 
Provision for loan losses716,16442,4431,565,245 1,356,737 
Real estate operating expenses1,264,501841,7083,751,921 2,657,433 
Depreciation and amortization931,7251,811,2662,795,173 3,704,254 
Professional fees 535,564407,4441,525,915 1,075,303 
Directors fees36,24936,250108,748 153,750 
Other95,77572,231299,960 404,882 
6,839,447 6,341,135 19,519,694 18,201,699 
Operating income5,806,671 6,721,283 14,671,973 19,002,919 
Other income and expenses
Interest expense from obligations under
   participation agreements
(3,278,294)(1,975,269)(7,931,176)(6,358,657)
Interest expense on repurchase agreement payable(706,527) (3,727,466)
Interest expense on mortgage loan payable(573,687)(756,509)(1,916,696)(2,256,898)
Interest expense on revolving line of credit(223,902)(463,333)(404,399)(1,238,311)
Interest expense on term loan payable(1,653,250)(476,411)(4,972,200)(476,411)
Interest expense on unsecured notes payable(1,409,274) (1,746,135)
Interest expense on secured borrowing(467,957)(236,632)(1,102,667)(446,745)
Net loss on extinguishment of obligations under
   participation agreements
 (319,453)
Net unrealized (losses) gains on marketable
   securities
(257,329)(38,527)(23,063)28,995 
Income from equity investment in a limited
   partnership
1,824,825  4,563,491 
Realized loss on loan repayments(517,989)(517,989) 
Realized gains on marketable securities22,42875,05522,428 1,160,162 
(6,534,429)(4,578,153)(14,028,406)(13,634,784)
Net (loss) income$(727,758)$2,143,130 $643,567 $5,368,135 
Series A preferred stock dividend declared(3,906)(3,906)(11,718)(11,718)
Net (loss) income allocable to common stock$(731,664)$2,139,224 $631,849 $5,356,417 
(Loss) earnings per share basic and diluted
$(0.04)$0.11 $0.03 $0.29 
Weighted-average shares basic and diluted
19,487,460 19,487,461 19,487,460 18,586,627 
Distributions declared per common share$0.20 $0.20 $0.63 $0.96 
See notes to unaudited consolidated financial statements.

3


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

Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
Comprehensive (loss) income, net of tax
Net (loss) income$(727,758)$2,143,130 $643,567 $5,368,135 
Other comprehensive loss
Net unrealized gains on marketable securities 192,919 
Reclassification of net realized gains on
   marketable securities into earnings
 (192,919)
    
Total comprehensive (loss) income$(727,758)$2,143,130 $643,567 $5,368,135 
Series A preferred stock dividend declared(3,906)(3,906)(11,718)(11,718)
Comprehensive (loss) income attributable to
   common shares
$(731,664)$2,139,224 $631,849 $5,356,417 

See notes to unaudited consolidated financial statements.


4


Terra Property Trust, Inc.
Consolidated Statements of Changes in Equity
(Unaudited)

Preferred Stock12.5% Series A Cumulative Non-Voting Preferred StockCommon StockAdditional
Paid-in
Capital
Accumulated DeficitAccumulated Other Comprehensive Income
$0.01 Par Value
SharesAmountSharesAmountTotal equity
Balance at January 1, 2021$ 125$125,000 19,487,460$194,875 $373,443,672 $(70,438,482)$ $303,325,065 
Distributions declared on common shares ($0.20 per share)— — — — (3,893,595)— (3,893,595)
Distributions declared on preferred shares— — — — (3,906)— (3,906)
Comprehensive income:
Net income— — — — 1,476,096 — 1,476,096 
Balance at March 31, 2021 125125,000 19,487,460 194,875 373,443,672 (72,859,887) 300,903,660 
Distributions declared on common shares ($0.23 per share)— — — — — — (4,429,352) (4,429,352)
Distributions declared on preferred shares— — — — — — (3,906)— (3,906)
Comprehensive loss:
Net loss— — — — — — (104,771)— (104,771)
Balance at June 30, 2021 125125,000 19,487,460 194,875 373,443,672 (77,397,916) 296,365,631 
Distributions declared on common shares ($0.20 per share)— — — — — — (3,893,594)— (3,893,594)
Distributions declared on preferred shares— — — — — — (3,906)— (3,906)
Comprehensive loss:
Net loss— — — — — — (727,758)— (727,758)
Balance at September 30, 2021 125 $125,000 19,487,460 $194,875 $373,443,672 $(82,023,174)$ $291,740,373 


See notes to unaudited consolidated financial statements.








5


Terra Property Trust, Inc.
Consolidated Statements of Changes in Equity
(Unaudited)

Preferred Stock12.5% Series A Cumulative Non-Voting Preferred StockCommon StockAdditional
Paid-in
Capital
Accumulated DeficitAccumulated Other Comprehensive Income
$0.01 Par Value
SharesAmountSharesAmountTotal equity
Balance at January 1, 2020$ 125$125,000 15,125,681$151,257 $301,727,297 $(54,459,821)$ $247,543,733 
Issuance of common stock (Note 3)
— — 4,574,47045,745 75,334,248 — — 75,379,993 
Distributions declared on common shares ($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 
Repurchase of common stock— — — (212,691)(2,127)(3,617,873)— — (3,620,000)
Distributions declared on common share ($0.23 per share)— — — — — — (4,459,975)— (4,459,975)
Distributions declared on preferred shares— — — — — — (3,906)— (3,906)
Comprehensive income:
Net income— — — — — — 2,646,042 — 2,646,042 
Reclassification of net realized gains on marketable securities
   into earnings
— — — — — — — (184,025)(184,025)
Balance at June 30, 2020 125 125,000 19,487,460 194,875 373,443,672 (64,534,674) 309,228,873 
Distributions declared on common share ($0.20 per share)— — — — — — (4,033,127)(4,033,127)
Distributions declared on preferred shares— — — — — — (3,906)(3,906)
Comprehensive income:
Net income— — — — — — 2,143,130 2,143,130 
Balance at September 30, 2020$ 125 $125,000 19,487,460 $194,875 $373,443,672 $(66,428,577)$ $307,334,970 

See notes to unaudited consolidated financial statements.


6


Terra Property Trust, Inc.
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30,
20212020
Cash flows from operating activities:
Net income$643,567 $5,368,135 
Adjustments to reconcile net income to net cash provided by operating activities:
Paid-in-kind interest income, net(1,000,028)(1,813,230)
Depreciation and amortization2,795,173 3,704,254 
Provision for loan losses1,565,245 1,356,737 
Lease termination fee income (236,000)
Amortization of net purchase premiums on loans46,043 41,807 
Straight-line rent adjustments(299,396)(727,806)
Amortization of deferred financing costs852,250 1,484,995 
Amortization of discount on unsecured notes payable136,913  
Net loss on extinguishment of obligations under participation agreements 319,453 
Amortization of above- and below-market rent intangibles(253,665)(942,574)
Amortization and accretion of investment-related fees, net(89,846)(16,424)
Amortization of above-market rent ground lease(97,762)(97,761)
Realized loss on loan repayments517,989  
Realized gains on marketable securities(22,428)(1,160,162)
Net unrealized losses (gains) on marketable securities23,063 (28,995)
Income from equity investment in a limited partnership(4,563,491) 
Distributions from equity investment in a limited partnership4,563,491  
Changes in operating assets and liabilities:
Deal deposits(9,529,476) 
Interest receivable(182,778)(983,769)
Other assets899,756 (128,693)
Due to Manager93,226 111,076 
Unearned income(179,499)(559,002)
Interest payable765,168 110,304 
Accounts payable and accrued expenses(2,653,266)1,228,370 
Other liabilities802,166 (805,229)
Net cash (used in) provided by operating activities(5,167,585)6,225,486 
Cash flows from investing activities:
Origination and purchase of loans(163,504,926)(85,758,523)
Proceeds from repayments of loans105,909,237 28,690,175 
Purchase of partnership interest in a limited partnership(14,065,197) 
Purchase of marketable securities(6,479,147)(6,039,567)
Proceeds from sale of marketable securities3,328,157 6,023,723 
Return of capital from equity investment in a limited partnership415,172  
Net cash used in investing activities(74,396,704)(57,084,192)






See notes to unaudited consolidated financial statements.

7


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

Nine Months Ended September 30,
20212020
Cash flows from financing activities:
Proceeds from borrowings under the term loan2,595,576 105,888,747 
Proceeds from borrowings under revolving line of credit25,299,713 35,000,000 
Repayments of obligations under participation agreements(23,625,186)(557,778)
Distributions paid(12,224,353)(17,332,985)
Proceeds from secured borrowing13,196,034 15,604,562 
Proceeds from issuance of unsecured notes payable, net of discount82,464,844  
Proceeds from obligations under participation agreements57,103,598 19,784,155 
Repayment of mortgage principal(11,855,650)(404,252)
Change in interest reserve and other deposits held on investments(1,944,027)7,475,137 
Repayment of borrowings under the term loan(16,585,001)— 
Payment of financing costs(1,663,250)(2,279,872)
Repayment of borrowings under repurchase agreement— (103,994,570)
Repayment of borrowings under revolving line of credit (10,000,000)
Payment for repurchase of common stock (3,620,000)
Proceeds from borrowings under repurchase agreement 22,860,134 
Proceeds from issuance of common stock in the Merger— 16,897,074 
Proceeds from issuance of common stock to Terra Offshore REIT— 8,600,000 
Net cash provided by financing activities112,762,298 93,920,352 
Net increase in cash, cash equivalents and restricted cash33,198,009 43,061,646 
Cash, cash equivalents and restricted cash at beginning of period32,920,323 50,549,700 
Cash, cash equivalents and restricted cash at end of period (Note 2)
$66,118,332 $93,611,346 

Nine Months Ended September 30,
20212020
Supplemental Disclosure of Cash Flows Information:
Cash paid for interest$14,973,631 $12,030,182 














See notes to unaudited consolidated financial statements.

8


Terra Property Trust, Inc.
Consolidated Statements of Cash Flows (Continued)
(Unaudited)
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, 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 Merger16,897,074 
$17,733,541 
Net assets exchanged
Settlement of obligations under participation agreements$17,688,741 
Interest receivable134,543 
Other assets18,384 
Accounts payable and accrued expenses(57,433)
Due to Manager(50,694)
$17,733,541 
Non-cash Proceeds from Issuance of Common Stock to Terra Offshore REIT

    In addition, on March 2, 2020, the Company entered into two separate contribution agreements, (i) by and among the Company, Terra Offshore Funds REIT, LLC (the “Terra Offshore REIT”) and Terra Income Fund International, and (ii) by and among the Company, Terra Offshore 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 Terra Offshore 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 Terra Offshore REIT:
Total Consideration
Equity issued to Terra Offshore REIT$40,749,378 
Proceeds from equity issued to Terra Offshore REIT8,600,000 
$32,149,378 
Net Assets exchanged
Settlement of obligations under participation agreements$32,112,257 
Interest receivable270,947 
Due to Manager(233,826)
Net assets acquired excluding cash and cash equivalents$32,149,378 

        

See notes to unaudited consolidated financial statements.

9


Terra Property Trust, Inc.
Notes to Consolidated Financial Statements (Unaudited)
September 30, 2021

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.
    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 its 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. As of September 30, 2021, Terra JV, LLC (“Terra JV”) held 87.4% of the issued and outstanding shares of the Company's common stock with the remainder held by Terra Offshore 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 exemption from registration as an “investment company” 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 (“Terra Capital Partners”), pursuant to a management agreement (the “Management Agreement”), under the oversight of the Company’s board of directors (Note 8). 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. On April 1, 2021, Mavik Capital Management, LP (“Mavik”), an entity controlled by Vikram S. Uppal, the Chief Executive Officer of the Company, completed a series of related transactions that resulted in all of the outstanding interests in Terra Capital Partners, being acquired by Mavik for a combination of cash and interests in Mavik (the “Recapitalization”). No amendments or other modifications were made to the Management Agreement in connection with the Recapitalization and the Manager and its personnel continue to serve as the external manager of the Company pursuant to the terms of the Management Agreement.

Note 2. Summary of Significant Accounting Policies

Principles of Consolidation

    The consolidated financial statements include all of the Company’s accounts and those of its consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation.

The Company consolidates entities in which it has a controlling financial interest based on either the variable interest entity (“VIE”) or voting interest model. The Company is required to first apply the VIE model to determine whether it holds a variable interest in an entity, and if so, whether the entity is a VIE. If the Company determines it does not hold a variable interest in a VIE, it then applies the voting interest model. Under the voting interest model, the Company consolidates an entity when it holds a majority voting interest in an entity.

The Company accounts for investments in which it has significant influence but not a controlling financial interest using the equity method of accounting (see Note 5).
10



Notes to Unaudited Consolidated Financial Statements


VIE Model

An entity is considered to be a VIE if any of the following conditions exist: (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) the holders of the equity investment at risk, as a group, lack either the direct or indirect ability through voting rights or similar rights to make decisions that have a significant effect on the success of the entity or the obligation to absorb the entity’s expected losses or right to receive the entity’s expected residual returns, or (c) the voting rights of some equity investors are disproportionate to their obligation to absorb losses of the entity, their rights to receive returns from an entity, or both and substantially all of the entity’s activities either involve or are conducted on behalf of an investor with disproportionately few voting rights.

Under the VIE model, limited partnerships are considered a VIE unless the limited partners hold substantive kick-out or participating rights over the general partner. The Company consolidates entities that are VIEs when the Company determines it is the primary beneficiary. Generally, the primary beneficiary of a VIE is a reporting entity that has (a) the power to direct the activities that most significantly affect the VIE’s economic performance, and (b) the obligation to absorb losses of, or the right to receive benefits from, the VIE that could potentially be significant to the VIE.

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.

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 RatingDescription
1Very low risk
2Low risk
3Moderate/average risk
4Higher risk
5Highest risk

11


Notes to Unaudited Consolidated Financial Statements


    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.

Equity Investment in a Limited Partnership

The Company accounts for its equity interest in a limited partnership under the equity method of accounting, i.e., at cost, increased or decreased by its share of earnings or losses, less distributions, plus contributions and other adjustments required by equity method accounting.

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. Changes in the fair value of equity securities are recognized in earnings. Changes in the fair value of debt securities are reported in other comprehensive income until a gain or loss on the securities is 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, 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.