Item 1. Business.
Overview
VEREIT is a full-service real estate operating company which owns and manages one of the largest portfolios of single-tenant commercial properties in the U.S. Omitting the square feet of one redevelopment property and including the pro rata share of square feet and annualized rental income from the Company’s unconsolidated joint ventures, the Company has 3,858 retail, restaurant, office and industrial operating properties with an aggregate of 89.5 million square feet, of which 99.1% was leased as of December 31, 2019, with a weighted-average remaining lease term of 8.3 years. VEREIT’s business model provides equity capital to creditworthy corporations in return for long-term leases on their properties.
Substantially all of our real estate operations are conducted through the Operating Partnership. VEREIT, Inc. is the sole general partner and holder of 99.9% of the common partnership interests in the Operating Partnership (the “OP Units”) as of December 31, 2019.
Prior to the fourth quarter of 2017, the Company operated through two business segments, the real estate investment segment and the investment management segment, Cole Capital. The Company completed the sale of Cole Capital on February 1, 2018. The assets, liabilities and related financial results of substantially all of the Cole Capital segment are reflected in the financial statements as discontinued operations.
VEREIT, Inc. was incorporated in the State of Maryland on December 2, 2010 and has elected to be treated as a REIT for U.S. federal income tax purposes. The Operating Partnership was formed in the State of Delaware on January 13, 2011. We operate our business in a manner that permits us to maintain our exemption from registration under the Investment Company Act of 1940, as amended. VEREIT, Inc.’s shares of common stock (“Common Stock”) and 6.70% Series F Cumulative Redeemable Preferred Stock (“Series F Preferred Stock”) trade on the New York Stock Exchange (the “NYSE”) under the trading symbols “VER” and “VER PRF,” respectively.
2019 Developments
Real Estate Acquisitions
During the year ended December 31, 2019, the Company acquired controlling financial interests in 66 commercial properties for an aggregate purchase price of $403.6 million, which includes $2.3 million of external acquisition-related expenses that were capitalized.
Real Estate Dispositions
During the year ended December 31, 2019, the Company disposed of 201 properties, including the sale of six consolidated properties to two newly-formed joint ventures in which the Company owns a 20% equity interest (the “Industrial Partnership”) and one property sold through a foreclosure as discussed in Note 6 - Debt, for an aggregate gross sales price of $1.2 billion, of which our share was $1.1 billion after the profit participation payments related to the disposition of 36 Red Lobster properties. The dispositions resulted in proceeds of $1.1 billion after closing costs and contributions to the Industrial Partnership. The Company recorded a gain of $293.9 million related to the dispositions which is included in gain on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
Litigation Activity
During the year ended December 31, 2019, the Company also entered into agreements to settle certain outstanding litigation, including the pending class action lawsuit. In accordance with the terms of the agreements, certain defendants agreed to pay in the aggregate $1.025 billion, comprised of contributions from principals of the Company's former external manager, ARC Properties Advisors, LLC, (the “Former Manager”) totaling $225.0 million, $12.5 million from the Company’s former Chief Financial Officer (the “Former CFO”), $49.0 million from the Company’s former auditor, and the balance of $738.5 million from the Company. The contribution from the Company’s Former Manager and Former CFO were subsequently satisfied with a combination of (i) Limited Partner OP Units held by the Former Manager and the Former CFO, (ii) amounts due related to dividends on certain of
such Limited Partner OP Units previously withheld from distribution, (iii) the value of substantially all of the Limited Partner OP Units and dividends surrendered to the Company in July 2019 as a result of a settlement by the Former Manager with the SEC, and (iv) cash paid by the Former Manager and Former CFO. On October 15, 2019, the Company paid $966.3 million to fund its contribution and a portion of the Former Manager and Former CFO’s contributions in connection with their 19.9 million surrendered Limited Partner OP Units and dividends related to certain of such Limited Partner OP Units. The Company also reached an agreement on the material terms of a negotiated resolution relating to the U.S. Securities and Exchange Commission’s (the “SEC”) investigation pertaining to the findings of the investigation conducted in 2014 by the audit committee (the “Audit Committee”) of the General Partner’s Board of Directors (the “Audit Committee Investigation”), among other things, as discussed in Note 10 - Commitments and Contingencies.
Balance Sheet and Liquidity
Credit Agreement
On May 23, 2018, the General Partner, as guarantor, and the OP, as borrower, entered into a credit agreement with Wells Fargo Bank, National Association, as administrative agent and the other lenders party thereto (the “Credit Agreement”). The Credit Agreement provided for maximum borrowings of $2.9 billion, originally consisting of a $2.0 billion unsecured revolving credit facility (the “Revolving Credit Facility”) and a $900.0 million unsecured term loan facility (the “Credit Facility Term Loan,” together with the Revolving Credit Facility, the “Credit Facility”). In connection with entering into the Credit Agreement, the OP repaid all of the outstanding obligations under the Amended and Restated Credit Agreement dated as of June 30, 2014 (as amended, the “2014 Credit Agreement”) and the 2014 Credit Agreement was terminated. Effective December 27, 2019, the Company reduced its Revolving Credit Facility capacity from $2.0 billion to $1.5 billion. At December 31, 2019, $150.0 million was outstanding under the Revolving Credit Facility and the full $900.0 million was drawn on the Credit Facility Term Loan.
Derivatives and Hedging Activities
During the year ended December 31, 2019, the Company entered into interest rate swap agreements with an aggregate $900.0 million notional amount, effective on February 6, 2019 and maturing on January 31, 2023, which were designated as cash flow hedges. Due to an improvement in the Company's credit rating during the fourth quarter of 2019, the interest rate spread on the $900.0 million Credit Facility Term Loan was reduced by 25 bps to LIBOR + 1.10%, and beginning on November 1, 2019, the swap agreements effectively fixed the Credit Facility Term Loan interest rate at 3.59%.
During the year ended December 31, 2019, the Company also entered into forward starting interest rate swaps with a total notional amount of $400.0 million, which were designated as cash flow hedges to hedge the risk of changes in the interest-related cash outflows associated with the anticipated issuance of long-term debt.
Debt Activity
During the year ended December 31, 2019, the Company’s total debt decreased by $382.2 million, from $6.1 billion to $5.7 billion, primarily due to the redemption of the 2019 Senior Notes of $750.0 million, the redemption of the 4.125% senior notes due 2021 (the “2021 Senior Notes”) of $400.0 million, the repurchase of $80.7 million of the 3.75% convertible senior notes due 2020 (the “2020 Convertible Notes”), net repayments on the Revolving Credit Facility of $103.0 million and a reduction of $388.1 million in secured debt, offset by the issuance of the 3.10% senior notes due 2029 (the “2029 Senior Notes”) of $600.0 million and borrowings on the Credit Facility Term Loan of $750.0 million.
Common Stock Offering
On September 26, 2019, the Company completed a public equity offering (the "Offering"), selling a total of 94.3 million shares of Common Stock, which included the full exercise of the underwriters' option to purchase additional shares, for net proceeds, after underwriting discounts and offering expenses, of $886.9 million. The Company contributed the net proceeds from the Offering to the OP in exchange for additional General Partner OP Units, which have substantially identical economic terms as the Company’s Common Stock. Subsequent to September 30, 2019, the net proceeds of the Offering were used to pay amounts owed in connection with the settlement of certain litigation, as described in Note 10 - Commitments and Contingencies, and for general corporate purposes.
Common Stock Continuous Offering Programs
On September 19, 2016, the Company registered a continuous equity offering program (the “Prior Program”) pursuant to which the Company could offer and sell, from time to time, in “at-the-market” offerings or certain other transactions, shares of Common Stock with an aggregate gross sales price of up to $750.0 million, through its sales agents. As of and during the year ended December 31, 2019, the Company had issued 5.0 million shares under the Prior Program, at a weighted average price per share of $8.42, for gross proceeds of $42.5 million. The weighted average price per share, net of offering costs, was $8.30, for net proceeds of $41.8 million.
On April 15, 2019, the Company established a new continuous equity offering program pursuant to which the Company may sell shares of Common Stock having an aggregate offering price of up to $750.0 million from time to time through April 15, 2022 in “at-the-market” offerings or certain other transactions (the “Current ATM Program”). The Current ATM Program replaced the Prior Program. The proceeds from any sale of shares under the Current ATM Program have been or will be used for general corporate purposes, which may include funding potential acquisitions and repurchasing or repaying outstanding indebtedness. As of and during the year ended December 31, 2019, the Company had issued 9.0 million shares under the Current ATM Program, at a weighted average price per share of $9.60, for gross proceeds of $86.7 million. The weighted average price per share, net of offering costs, was $9.46, for net proceeds of $85.4 million. As of December 31, 2019, the Company had $663.3 million available to be sold under the Current ATM Program.
Share Repurchase Programs
On May 3, 2018, the Company’s Board of Directors terminated its prior share repurchase program and authorized a new program (the “2018 Share Repurchase Program”) that permitted the Company to repurchase up to $200.0 million of its outstanding Common Stock through May 3, 2019, as market conditions warranted. On May 6, 2019, the Company’s Board of Directors authorized a new share repurchase program (the “2019 Share Repurchase Program”) that permits the Company to repurchase up to $200.0 million of its outstanding Common Stock through May 6, 2022. Under the share repurchase programs, repurchases can be made through open market purchases, privately negotiated transactions, structured or derivative transactions, including accelerated stock repurchase transactions, or other methods of acquiring shares in accordance with applicable securities laws and other legal requirements. The share repurchase programs do not obligate the Company to make any repurchases at a specific time or in a specific situation, and repurchases are influenced by prevailing market conditions, the trading price of the Common Stock, the Company’s financial performance and other conditions. Shares of Common Stock repurchased by the Company under the share repurchase programs, if any, will be returned to the status of authorized but unissued shares of Common Stock.
There were no share repurchases under the 2018 Share Repurchase Program or the 2019 Share Repurchase Program during the year ended December 31, 2019. As of December 31, 2019, the Company had $200.0 million available for share repurchases under the 2019 Share Repurchase Program. During the year ended December 31, 2018, the Company repurchased 0.8 million shares of Common Stock in multiple open market transactions, at a weighted average share price of $6.95 for an aggregate purchase price of $5.6 million under the 2018 Share Repurchase Program.
Series F Preferred Stock and Series F Preferred OP Units
During the year ended December 31, 2019, the Company redeemed a total of 12.0 million shares of Series F Preferred Stock, representing approximately 28.02% of the issued and outstanding preferred shares as of the beginning of the year. The shares of Series F Preferred Stock were redeemed at a redemption price of $25.00 per share plus all accrued and unpaid dividends.
As of December 31, 2019, there were approximately 30.9 million shares of Series F Preferred Stock, approximately 30.9 million corresponding General Partner Series F Preferred Units and 49,766 Limited Partner Series F Preferred Units issued and outstanding.
Termination of Services Agreement with the Cole Purchaser (as defined below)
During the year ended December 31, 2019, the Company’s obligation to provide certain initial transition services for CCA Acquisition, LLC (the “Cole Purchaser”), an affiliate of CIM Group, LLC, terminated in accordance with the terms of the services agreement (the “Services Agreement”). Under the Services Agreement, the Company had continued to provide certain initial transition services to the Cole Purchaser and the Cole REITs subsequent to the sale of Cole Capital on February 1, 2018. The Company recorded $10.5 million of restructuring expenses related to the reorganization of its business after the sale of Cole Capital and cessation of initial transition services performed pursuant to the Services Agreement. Under the Services Agreement, the Company continues to be obligated to provide certain other services through December 31, 2023, which may be extended to December 31, 2024 under certain circumstances.
Primary Investment Focus
We own and actively manage a diversified portfolio of single-tenant retail, restaurant, office and industrial real estate assets subject to long-term net leases with creditworthy tenants. Our focus is on single-tenant, net-leased properties that are strategically located and essential to the business operations of the tenant, as well as retail properties that offer necessity and value-oriented products or services. We actively manage the portfolio by considering several metrics including property type, tenant concentration, geography, credit and key economic factors for appropriate balance and diversity. We believe that actively managing our portfolio allows us to attain the best operating results for each asset and the overall portfolio through strategic planning, implementation of these plans and responding proactively to changes and challenges in the marketplace.
Investment Policies
When evaluating prospective investments in or dispositions of real property, our management considers relevant real estate and financial factors, including the location of the property, the leases and other agreements affecting the property and business operations of the tenant, the creditworthiness of major tenants, its income-producing capacity, its physical condition, its prospects for appreciation, its prospects for liquidity, tax considerations and other factors. In this regard, our management will have substantial discretion with respect to the selection of specific investments, subject in certain instances to the approval of the Board of Directors.
As part of our overall portfolio strategy, we seek to lease space and/or acquire properties leased to creditworthy tenants that meet our underwriting and operating guidelines. Prior to entering into any transaction, our corporate credit analysis and underwriting professionals conduct a review of a tenant’s credit quality. In addition, we consistently monitor the credit quality of our portfolio by actively reviewing the creditworthiness of certain tenants, focusing primarily on those tenants representing the greatest concentration of our portfolio. This review primarily includes an analysis of the tenant’s financial statements either quarterly, or as frequently as the lease permits. We also consider tenant credit quality when assessing our portfolio for strategic dispositions. When we assess tenant credit quality, we, among other factors that we may deem relevant: (i) review relevant financial information, including financial ratios, net worth, revenue, cash flows, leverage and liquidity; (ii) evaluate the depth and experience of the tenant’s management team; and (iii) assess the strength/growth of the tenant’s industry. On an on-going basis, we evaluate the need for an allowance for doubtful accounts arising from estimated losses that could result from the tenant’s inability to make required current rent payments and an allowance against accrued rental revenue for future potential losses that we deem to be unrecoverable over the term of the lease. The factors considered in determining the credit risk of our tenants include, but are not limited to: payment history; credit status and change in status (credit ratings for public companies are used as a primary metric); change in tenant space needs (i.e., expansion/downsize); tenant financial performance; economic conditions in a specific geographic region; and industry specific credit considerations. We are of the opinion that the credit risk of our portfolio is reduced by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants and mitigation options.
Real Estate Investments
As of December 31, 2019, the Company owned 3,858 operating properties comprising 89.5 million square feet of retail and commercial space located in 49 states and Puerto Rico, of which 99.1% was leased with a weighted-average remaining lease term of 8.3 years, which includes properties owned through consolidated joint ventures and the pro rata share of square feet and annualized rental income from the Company’s unconsolidated joint ventures and omits the square feet of one redevelopment property. There were no tenants exceeding 10% of our consolidated annualized rental income as of December 31, 2019 or 2018. As of December 31, 2019 and 2018, properties located in Texas represented 12.8% and 12.5%, respectively, of our consolidated annualized rental income. As of December 31, 2019 and 2018, tenants in the casual dining restaurant industry accounted for 12.0%, and 12.8%, respectively, of our consolidated annualized rental income. As of December 31, 2019 and 2018, tenants in the manufacturing industry accounted for 9.3% and 10.1%, respectively, of our consolidated annualized rental income.
Financing Policies
We rely on leverage to allow us to invest in a greater number of assets and enhance our asset returns. We intend to finance future acquisitions with the most advantageous source of capital available to us at the time of the transaction, which may include a combination of public and private offerings of our equity and debt securities, unsecured corporate-level debt, and other public, private or bank debt. In addition, we may acquire properties in exchange for the issuance of Common Stock or OP Units and we may acquire properties subject to existing mortgage indebtedness.
We also may obtain secured or unsecured debt to acquire properties, and we expect that our financing sources will include the public debt market, banks and institutional investment firms, including asset managers and life insurance companies. Although we intend to maintain a conservative capital structure, our charter does not contain a specific limitation on the amount of debt we may incur and the Board of Directors may implement or change target debt levels at any time without the approval of our stockholders.
We intend to continue to emphasize unsecured corporate-level or OP-level debt in our financing and to seek to reduce the percentage of our assets which are secured by mortgage loans. For information relating to our Credit Facility, see Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.
Competition
We are subject to competition in the acquisition and disposition of properties and in the leasing of our properties. We compete with a number of developers, owners and operators of retail, restaurant, office and industrial real estate, many of which own properties similar to ours in the same markets in which our properties are located. We also may face new competitors and, due to our focus on single-tenant properties located throughout the United States, and because many of our competitors are locally or regionally focused, we do not expect to encounter the same competitors in each region of the United States. Our competitors may be willing to accept lower returns on their investments and may succeed in buying the properties that we have targeted for acquisition. Foreign investors may view the U.S. real estate market as being more stable than other international markets and may increase investments in high-quality single-tenant properties, especially in gateway cities. We may also incur costs in connection with unsuccessful acquisitions that we will not be able to recover.
Regulations
Our investments are subject to various federal, state, local and foreign laws, ordinances and regulations, including, among other things, health, safety and zoning regulations, land use controls, environmental controls relating to air and water quality, noise pollution and indirect environmental impacts such as increased motor vehicle activity. We believe that we have all material permits and approvals necessary under current law to operate our investments.
Our properties are also subject to laws such as the Americans with Disabilities Act of 1990 (“ADA”), which require that all public accommodations must meet federal requirements related to access and use by disabled persons. Some of our properties may currently not be in compliance with the ADA. If one or more of the properties in our portfolio is not in compliance with the ADA or any other regulatory requirements, we may be required to incur additional costs to bring the property into compliance.
Environmental Matters
Under various federal, state and local environmental laws, a current owner of real estate may be required to investigate and clean up contaminated property. Under these laws, courts and government agencies have the authority to impose cleanup responsibility and liability even if the owner did not know of and was not responsible for the contamination. For example, liability can be imposed upon us based on the activities of our tenants or a prior owner. In addition to the cost of the cleanup, environmental contamination on a property may adversely affect the value of the property and our ability to sell, rent or finance the property, and may adversely impact our investment in that property.
Prior to acquisition of a property, we will obtain Phase I environmental reports, or will rely on recent Phase I environmental reports. These reports will be prepared in accordance with an appropriate level of due diligence based on our standards and generally include a physical site inspection, a review of relevant federal, state and local environmental and health agency database records, one or more interviews with appropriate site-related personnel, review of the property’s chain of title and review of historic aerial photographs and other information on past uses of the property and nearby or adjoining properties. We may also obtain a Phase II investigation which may include limited subsurface investigations and tests for substances of concern where the results of the Phase I environmental reports or other information indicates possible contamination or where our consultants recommend such procedures.
Employees
As of December 31, 2019, we had approximately 160 employees.
Available Information
We electronically file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports, and proxy statements, with the SEC. You may access any materials we file with the SEC through the EDGAR database at the SEC’s website at http://www.sec.gov. In addition, copies of our filings with the SEC may be obtained from our website at www.ir.vereit.com. We are providing our website address solely for the information of investors. We do not intend for the information contained on our website to be incorporated into this Annual Report on Form 10-K or other filings with the SEC.
Supplemental Federal Income Tax Considerations
This summary is for general information purposes only and is not tax advice. This discussion does not address all aspects of taxation that may be relevant to particular holders of our securities in light of their personal investment or tax circumstances.
The following discussion supplements and updates the disclosures under “Certain U.S. Federal Income Tax Considerations” in the prospectus dated April 15, 2019 contained in our Registration Statement on Form S-3 filed with the SEC on April 15, 2019.
The sixth sentence of the discussion under “Certain U.S. Federal Income Tax Considerations - Taxation of Non-U.S. Stockholders - Distributions Attributable to Sale or Exchange of Real Property” is revised to read, “We must withhold 21% of any distribution that is a distribution attributable to USRPI gain,” such that the revised paragraph reads in full as follows:
Distributions Attributable to Sale or Exchange of Real Property. Except as discussed below with respect to 10% or less holders of regularly traded classes of stock, “qualified shareholders” and “qualified foreign pension funds” (for periods on and after December 18, 2015), for any year in which we qualify as a REIT, a Non-U.S. Stockholder will incur tax on distributions by us that are attributable to gain from our sale or exchange of USRPIs under special provisions of the U.S. federal income tax laws known as the Foreign Investment in Real Property Act, or FIRPTA. The term USRPIs includes interests in real property and shares in corporations at least 50% of whose real estate and business assets consist of interests in U.S. real property. Under those rules, a Non-U.S. Stockholder is taxed on distributions by us attributable to gain from sales of USRPIs as if the gain were effectively connected with a U.S. trade or business of the Non-U.S. Stockholder. A Non-U.S. Stockholder thus would be taxed on such a distribution at regular tax rates applicable to U.S. Stockholders, subject to any applicable alternative minimum tax. A corporate Non-U.S. Stockholder not entitled to treaty relief or exemption also may be subject to the 30% branch profits tax on such a distribution. We must withhold 21% of any distribution that is a distribution attributable to USRPI gain. A Non-U.S. Stockholder may receive a credit against its tax liability for the amount we withhold. However, FIRPTA and the 21% withholding tax will not apply to any distribution with respect to any class of our stock that is regularly traded on an established securities market located in the United States if the recipient Non-U.S. Stockholder did not own more than 10% of such class of stock at any time during the one-year period ending on the date of distribution. Instead, any distribution will be treated as an ordinary distribution subject to the rules discussed above.
The second sentence of the discussion under “Certain U.S. Federal Income Tax Considerations - Taxation of Non-U.S. Stockholders - U.S. Federal Income Tax Withholding on Distributions not Subject to FIRPTA” is revised to read, “We also may be require to withhold tax at the rate of 21% on the portion of any dividend to a Non-U.S. Stockholder that is or could be designated by us as a capital gain dividend, even if not attributable to gain on a sale or exchange of an interest in U.S. real property,” such that the revised paragraph reads in full as follows:
U.S. Federal Income Tax Withholding on Distributions not Subject to FIRPTA. For U.S. federal income tax withholding purposes, we generally will withhold tax at the rate of 30% on the amount of any distribution (other than distributions designated as capital gain dividends or distributions of USRPI gain subject to FIRPTA as discussed above) made to a Non-U.S. Stockholder, unless the Non-U.S. Stockholder provides us with appropriate documentation (1) evidencing that such Non-U.S. Stockholder is eligible for an exemption or reduced rate under an applicable income tax treaty, generally an IRS Form W-8BEN or W-8BEN-E (in which case we will withhold at the lower treaty rate) or (2) claiming that the dividend is effectively connected with the Non-U.S. Stockholder’s conduct of a trade or business within the U.S., generally an IRS Form W-8ECI (in which case we will not withhold tax). We also may be require to withhold tax at the rate of 21% on the portion of any dividend to a Non-U.S. Stockholder that is or could be designated by us as a capital gain dividend, even if not attributable to gain on a sale or exchange of an interest in U.S. real property. Such withheld amounts of tax do not represent actual tax liabilities, but rather, represent payments in respect of those tax liabilities described in the preceding
two paragraphs. Therefore, such withheld amounts are creditable by the Non-U.S. Stockholder against its actual U.S. federal income tax liabilities, including those described in the preceding two paragraphs. The Non-U.S. Stockholder would be entitled to a refund of any amounts withheld in excess of such Non-U.S. Stockholder’s actual U.S. federal income tax liabilities, provided the required information is timely furnished to the IRS.
The paragraph under “Certain U.S. Federal Income Tax Considerations - Taxation of Non-U.S. Stockholders - Qualified Foreign Pension Funds” is replaced in its entirety, such that the revised paragraph reads in full as follows:
Qualified Foreign Pension Funds. For periods on or after December 18, 2015, for FIRPTA purposes neither a “qualified foreign pension fund” nor any “qualified controlled entity” is treated as a Non-U.S. Stockholder. A “qualified foreign pension fund” is an organization or arrangement (i) created or organized in a foreign country, (ii) established by a foreign country (or one or more political subdivisions thereof) or one or more employers to provide retirement or pension benefits to current or former employees (including self-employed individuals) or their designees as a result of, or in consideration for, services rendered, (iii) which does not have a single participant or beneficiary that has a right to more than 5% of its assets or income, (iv) which is subject to government regulation and with respect to which annual information about its beneficiaries is provided, or is otherwise available, to relevant local tax authorities and (v) with respect to which, under its local laws, (A) contributions that would otherwise be subject to tax are deductible or excluded from its gross income or taxed at a reduced rate, or (B) taxation of its investment income is deferred, or such income is excluded from its gross income or taxed at a reduced rate. A “qualified controlled entity” is an entity all the interests of which are held by a qualified foreign pension fund. Alternatively, under proposed Treasury Regulations that taxpayers generally may rely on, but which are subject to change, a “qualified controlled entity” is a trust or corporation organized under the laws of a foreign country all of the interests of which are held by one or more qualified foreign pension funds either directly or indirectly through one or more qualified controlled entities or partnerships. Distributions received by qualified foreign pension funds and qualified controlled entities will be taxed as described above at - Distributions - In General regardless of whether the distribution is attributable to the sale of a USRPI. Gain of a qualified foreign pension fund or qualified controlled entity treated as gain from the sale or exchange of our stock as well as our capital gain dividends and distributions treated as gain from the sale or exchange of our stock under the rules described above at - Distributions - In General, will not be subject to tax unless such gain is treated as effectively connected with the qualified foreign pension fund's (or the qualified controlled entity's, as applicable) conduct of a U.S. trade or business, in which case the qualified foreign pension fund (or qualified controlled entity) generally will be subject to a tax at the same graduated rates applicable to U.S. Stockholders, unless an applicable income tax treaty provides otherwise, and may be subject to the 30% branch profits tax on its effectively connected earnings and profits, subject to adjustments, in the case of a foreign corporation.
Item 1A.
Item 1A. Risk Factors.
Investors should carefully consider the following factors, together with all the other information included in this Annual Report on Form 10-K, in evaluating the Company and our business. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected, the trading price of VEREIT's securities could decline and its stockholders and/or the Operating Partnership's unitholders may lose all or part of their investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. This “Risk Factors” section contains references to our “capital stock” and to our “stockholders” and “unitholders.” Unless expressly stated otherwise, references to our “capital stock” represent VEREIT’s Common Stock and any class or series of its preferred stock, references to our “stockholders” represent holders of VEREIT’s Common Stock and any class or series of its preferred stock, and references to our “unitholders” represent holders of the OP Units and any class of series of the Operating Partnership’s preferred units.
Risks Related to Our Business
We are primarily dependent on single-tenant leases for our revenue and, accordingly, if we are unable to renew leases, lease vacant space, including vacant space resulting from tenant defaults, or re-lease space as leases expire, on favorable terms or at all, our financial condition could be adversely affected.
We focus our investment activities on ownership of freestanding, single-tenant net leased commercial properties. Therefore, the financial failure of, or other default by, a significant tenant or multiple tenants could cause a material reduction in our revenues and operating cash flows. In addition, this risk is increased where we lease multiple properties to a single tenant under a master lease. In such an instance, a default specific to a particular property could result in a termination of the entire master lease, resulting in the loss of revenue from all properties under the master lease.
We are subject to competition in the leasing of our properties. We compete with numerous developers, owners and operators of retail, restaurant, industrial and office real estate, many of which have greater financial and other resources than we do. We cannot assure you that our leases will be renewed or that we will be able to lease or re-lease the properties on favorable terms, or at all, or that lease terminations will not cause us to sell the properties at a loss. If our properties are nearing the end of the lease term or become vacant and our competitors offer alternative space at rental rates below current market rates or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge, offer substantial rent or other concessions, and accommodate requests for remodeling and other improvements in order to retain tenants when such tenants’ leases expire or to attract new tenants. Certain of our properties may be specifically suited to the particular needs of a tenant (e.g., a retail bank branch or distribution warehouse) and major renovations and expenditures may be required in order for us to re-lease the space for other uses. Any of our properties that become vacant could be difficult to sell or re-lease at similar or favorable rental rates or at all. We have and may continue to experience vacancies due to the default of a tenant under its lease, the expiration of one of our leases or if we are not willing to agree to existing or new tenant accommodations or concessions. We typically must incur all of the costs of ownership for a property that is vacant. If vacancies continue, we may suffer reduced rental income, resulting in less cash available for distribution to our stockholders and unitholders. If we are unable to renew leases, lease vacant space, including vacant space resulting from tenant defaults, or re-lease space as leases expire, on favorable terms or at all, our financial condition, liquidity and results of operations could be adversely affected.
We are subject to tenant, geographic and industry concentrations that make us more susceptible to adverse events with respect to certain tenants, geographic areas or industries.
We have tenant, geographic and industry concentrations within our portfolio and as we continue to acquire properties, our portfolio may become more concentrated by tenant, geographic area or industry. Any adverse change in the financial condition of a tenant with whom we may have a significant credit concentration now or in the future, or any downturn of the economy in any state or industry in which we may have a significant credit concentration now or in the future, could result in a material reduction of our cash flows or material losses to us. These concentrations may also strengthen tenant bargaining power and make us more susceptible to adverse regulatory changes, natural disasters or other unexpected events that may impact a particular tenant, geographic location or industry which could negatively affect our operations or result in a material reduction of our cash flows or material losses to us.
Our net leases may require us to pay property-related expenses that are not the obligations of our tenants.
Under the terms of the majority of our net leases, in addition to satisfying their rent obligations, our tenants are responsible for the payment or reimbursement of property expenses such as real estate taxes, insurance and ordinary maintenance and repairs. However, under the provisions of certain existing leases and leases that we may enter into in the future with our tenants, we may be required to pay some or all of the expenses of the property, such as the costs of environmental liabilities, roof and structural repairs, real estate taxes, insurance, certain non-structural repairs and maintenance. If our properties incur significant expenses that must be paid by us under the terms of our leases, our business, financial condition and results of operations may be adversely affected and the amount of cash available to meet expenses and to make distributions to our stockholders and unitholders may be reduced.
Real estate investments are relatively illiquid and therefore we may not be able to dispose of properties when appropriate or on favorable terms which could, among other things, adversely impact our ability to make cash distributions to our stockholders and unitholders.
We expect to hold our real estate investments until such time as we decide that a sale or other disposition is appropriate given our investment objectives and REIT qualification limitations. We generally intend to hold properties for an extended period of time, but our management or Board of Directors may exercise their discretion as to whether and when to sell a property (including
in connection with joint venture arrangements) to achieve investment or portfolio objectives. Real estate investments are, in general, relatively illiquid and may become even more illiquid during periods of economic downturn. Our ability to dispose of properties on advantageous terms or at all depends on certain factors beyond our control, including competition from other sellers, the availability of attractive financing for potential buyers of our properties and the quality of the underlying tenant. In addition, if our competitors sell assets similar to assets we intend to divest and/or at valuations below our valuations for comparable assets, we may be unable to divest our assets at all or at favorable pricing or terms. Furthermore, we may be required to seek modifications of an underlying lease or expend funds to correct defects or to make improvements before a property can be sold. We cannot predict the various market conditions affecting real estate investments that will exist at any particular time in the future. As a result, once we determine to sell a property we may not be able to do so quickly, on favorable terms or at all. Due to the uncertainty of market conditions that may affect the disposition of our properties, we cannot assure you that we will be able to sell our properties at a profit or at all in the future, which may impact the extent to which our stockholders and unitholders will receive cash distributions and realize potential appreciation on our real estate investments.
In addition, certain significant real property expenditures generally do not change in response to economic or other conditions, including debt service obligations, real estate taxes, and operating and maintenance costs. This combination of variable disposition revenue and relatively fixed expenditures may result, under certain market conditions, in reduced earnings. Therefore, we may be unable to adjust our portfolio promptly in response to economic, market or other conditions, which could adversely affect our business, financial condition, liquidity and results of operations.
A substantial portion of our properties are leased to tenants with a below investment grade rating, as determined by major credit rating agencies, or are leased to tenants that are not rated, and may have a greater risk of default.
As of December 31, 2019, approximately 61.4% of our tenants were not rated or did not have an investment grade credit rating from a major ratings agency or were not affiliates of companies having an investment grade credit rating, which percentage may increase over time, including as property acquisition volume increases. Our investments in properties leased to such tenants may have a greater risk of default and bankruptcy than investments in properties leased exclusively to investment grade tenants, and these tenants may be more susceptible to default if economic conditions decline, including in the tenant’s industry. When we invest in properties where the tenant does not have a publicly available credit rating, we will use certain credit-assessment tools as well as rely on our own underwriting and analysis of the tenant’s credit rating which includes, among other things, reviewing the tenant’s financial information (e.g., financial ratios, net worth, revenue, cash flows, leverage and liquidity, if applicable). If our ratings estimates are inaccurate, the default or bankruptcy risk for the subject tenant may be greater than anticipated. These outcomes could have an adverse impact on our returns on the assets and hence our operating results.
Dividends paid from sources other than our cash flow from operations could affect our profitability, restrict our ability to generate sufficient cash flow from operations, and dilute stockholders’ and unitholders’ interests in us.
We may not generate sufficient cash flow from operations to pay dividends and we may in the future pay dividends from sources other than from our cash flow from operations, such as from the proceeds of property or other asset dispositions, borrowings (including on our existing Revolving Credit Facility), cash and cash equivalents balances, and/or offerings of debt and/or equity securities. We have not established any limit on the amount of borrowings and/or the sale of property or other assets or the proceeds from an offering of debt or equity securities that may be used to fund dividends, except that, in accordance with our organizational documents and Maryland law, we may not make dividend distributions that would: (1) cause us to be unable to pay our debts as they become due in the usual course of business; (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences; or (3) jeopardize our ability to qualify as a REIT.
Funding dividends from borrowings could restrict the amount we can borrow for portfolio investments, which may affect our ability to increase our property acquisitions and our profitability. Funding dividends with the sale of property or other assets or the proceeds of offerings of debt or equity securities may affect our ability to generate cash flows. Payment of dividends from these sources could affect our profitability, restrict our ability to generate sufficient cash flow from operations, and dilute stockholders’ and unitholders’ interests in us, any or all of which may adversely affect your overall return. In addition, funding dividends from the sale of additional debt or equity securities could dilute your interest in us if we sell shares of our Common Stock or securities that are convertible or exercisable into shares of our Common Stock. As a result, the return you realize on your investment may be reduced.
We could face potential adverse effects from the bankruptcies or insolvencies of tenants or from tenant defaults generally.
The bankruptcy or insolvency of our tenants may adversely affect the income produced by our properties. Under bankruptcy law, a tenant cannot be evicted solely because of its bankruptcy and has the option to assume or reject any unexpired lease. If the tenant rejects the lease, any resulting claim we have for breach of the lease (excluding collateral securing the claim) will be treated as a general unsecured claim. Our claim against the bankrupt tenant for unpaid and future rent will be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease, and it is unlikely that a bankrupt tenant that rejects its lease would pay in full amounts it owes us under the lease. Even if a lease is assumed and brought current, we still run the risk that a tenant could condition lease assumption on a restructuring of certain terms, including rent, that would have an adverse impact on us. Any shortfall resulting from the bankruptcy of one or more of our tenants could adversely affect our cash flows and results of operations and could cause us to reduce the amount of distributions to our stockholders and unitholders.
In addition, the financial failure of, or other default by, one or more of the tenants to whom we have exposure could have an adverse effect on the results of our operations. While we evaluate the creditworthiness of our tenants by reviewing available financial and other pertinent information, there can be no assurance that any tenant will be able to make timely rental payments or avoid defaulting under its lease. If any of our tenants’ businesses experience adverse changes, they may fail to make rental payments when due, close a number of business locations, exercise early termination rights (to the extent such rights are available to the tenant) or declare bankruptcy. A default by a significant tenant or multiple tenants could cause a material reduction in our revenues and operating cash flows. In addition, if a tenant defaults, we may incur substantial costs in protecting our investment.
If a sale-leaseback transaction is re-characterized by the IRS or in a tenant’s bankruptcy proceeding, our REIT status or financial condition could be adversely affected.
We have entered and may continue to enter into sale-leaseback transactions. In a sale-leaseback transaction, we purchase a property and then lease it back to the third party from whom we purchased it. The IRS could challenge our characterization of certain leases and re-characterize them as financing transactions or loans for U.S. federal income tax purposes or, in the event of the bankruptcy of a tenant, a sale-leaseback transaction might be re-characterized as either a financing or a joint venture.
If a sale-leaseback transaction is re-characterized by the IRS, we might fail to satisfy the REIT qualification tests and, consequently, lose our REIT status effective with the year of re-characterization. Alternatively, such a re-characterization could cause the amount of our REIT taxable income to be recalculated, which might also cause us to fail to meet the distribution requirement for a taxable year and thus lose our REIT status. Further, if a sale-leaseback is re-characterized as a financing, we would not be considered the owner of the property and, as a result, would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. In bankruptcy, the tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding balance. If confirmed by the bankruptcy court, we could be bound by the new terms and prevented from foreclosing our lien on the property. If the sale-leaseback is re-characterized as a joint venture, our tenant and we could be treated as co-venturers with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the tenant relating to the property.
We have a history of operating losses and cannot assure you that we will achieve or maintain profitability.
Since our inception in 2010, we have experienced net losses (calculated in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) and as of December 31, 2019, had an accumulated deficit of $6.40 billion. The extent of our future operating losses and the timing of when we will achieve profitability are uncertain, and together depend on the demand for, and value of, our portfolio of properties. We may never achieve or maintain profitability.
We may be unable to enter into and consummate property acquisitions on advantageous terms or our property acquisitions may not perform as we expect due to competitive conditions and other factors.
We intend to acquire properties in the future. The acquisition of properties entails various risks, including the risks that our investments may not perform as we expect and that our cost estimates for bringing an acquired property up to market standards may prove inaccurate. Further, we expect to finance any future acquisitions through a combination of borrowings (including under our Revolving Credit Facility), cash and cash equivalent balances, proceeds from equity and/or debt offerings by VEREIT, the Operating Partnership or their subsidiaries, cash flow from operations and proceeds from property or other asset dispositions which, if unavailable, could adversely affect our cash flows.
In addition, our ability to acquire properties in the future on satisfactory terms and successfully integrate and operate such properties is subject to the following significant risks:
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we may be unable to acquire desired properties or the purchase price of a desired property may increase significantly because of competition from other real estate investors, including other real estate operating companies, REITs and investment funds;
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we may acquire properties that are not accretive to our earnings upon acquisition;
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we may be unable to obtain the necessary debt or equity financing to consummate an acquisition or, if obtainable, financing may not be on satisfactory terms;
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we may need to spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;
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agreements for the acquisition of properties are typically subject to customary conditions to closing, including satisfactory completion of due diligence investigations, and we may spend significant time and money on potential acquisitions that we do not consummate;
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we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations; and
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we may acquire properties and assume existing liabilities without any recourse, or with only limited recourse, for liabilities, whether known or unknown, quantifiable or unquantifiable, such as tax liabilities, accrued but unpaid liabilities, cleanup of environmental contamination, remediation of latent defects, claims by tenants, vendors or other persons against the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
Any of the above risks could adversely affect our business, financial condition, liquidity and results of operations.
The value of our real estate investments is subject to risks including risks associated with the real estate industry.
Our real estate investments are subject to various risks, fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may decrease our cash available for distribution to our stockholders and unitholders, as well as the value of our properties. These risks and events include, but are not limited to:
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adverse changes in international, national or local economic and demographic conditions;
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vacancies or our inability to lease space on favorable terms, including possible market pressures to offer tenants rent abatements, tenant improvements, early termination rights or tenant-favorable renewal options;
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adverse changes in financial conditions of buyers, sellers and tenants of properties;
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ongoing disruption and/or consolidation in the retail sector;
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negative developments in the real estate market, including tenant performance, that may cause management to reevaluate the business and macro-economic assumptions used in the impairment analysis of our properties, which may cause us to determine that an impairment has occurred and may have a material impact on the Company’s financial statements;
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inability to collect rent from tenants, or other failures by tenants to perform the obligations under their leases;
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competition from other real estate investors, including other real estate operating companies, REITs and institutional investment funds;
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the obsolescence of our properties over time, including as a result of age or a shift in market preference, which could impact our ability to re-tenant a property, particularly if the property was built to suit a particular tenant;
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our ownership or future acquisition of properties subject to leasehold interests in the land (i.e., ground leases) or other similar agreements with terms different than the related operating lease for the property, may limit our uses of these properties and may restrict our ability to sell or otherwise transfer such properties without the ground landlord’s consent, all of which may impair their value;
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reductions in the level of demand for commercial space generally, and freestanding net leased properties specifically, and changes in the relative popularity of our tenants and/or properties;
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increases in the supply of freestanding single-tenant properties;
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fluctuations in interest rates, which could adversely affect our ability, or the ability of buyers and tenants of our properties, to obtain financing on favorable terms or at all;
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increases in expenses, including, but not limited to, insurance costs, labor costs, energy prices, real estate assessments and other taxes and costs of compliance with laws, regulations and governmental policies, all of which have an adverse impact on the rent a tenant may be willing to pay us in order to lease one or more of our properties;
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loss of property rights, adverse impacts on our tenants’ business operations and/or increases in tenant vacancies resulting from eminent domain proceedings;
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civil unrest, acts of God, including earthquakes, floods, hurricanes and other natural disasters, including extreme weather events or damage from rising sea levels from possible future climate change, which may result in uninsured losses, and acts of war or terrorism; and
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changes in, and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning and tax laws, governmental fiscal policies and the ADA.
In addition, our properties are subject to the ADA and while our tenants are obligated to comply with the ADA and may be obligated under our leases to pay for the costs associated with compliance with the ADA, if compliance involves expenditures that are greater than anticipated or if tenants fail or are unable to comply, we may be required to incur expenses to bring a property into compliance.
Any or all of these factors could materially adversely affect our results of operations through decreased revenues or increased costs.
Uninsured losses or losses in excess of our insurance coverage could materially adversely affect our financial condition and cash flows, and there can be no assurance as to future costs and the scope of coverage that may be available under insurance policies.
We carry commercial general liability, flood, earthquake, and property and rental loss insurance covering all of the properties in our portfolio under one or more blanket insurance policies with policy specifications, limits and deductibles customarily carried for similar properties. We carry professional liability, directors’ and officers’ insurance, and cyber liability insurance. We select policy specifications and insured limits that we believe are appropriate and adequate given the relative risk of loss, insurance coverages provided by tenants, the cost of the coverage and industry practice. There can be no assurance, however, that the insured limits on any particular policy will adequately cover an insured loss if one occurs. If any such loss is insured, we may be required to pay a significant deductible on any claim for recovery of such a loss prior to our insurer being obligated to reimburse us for the loss, or the amount of the loss may exceed our coverage for the loss. In addition, we may reduce or discontinue certain coverages on some or all of our properties in the future if the cost of premiums for any of these policies exceeds, in our judgment, the value of the coverage discounted for the risk of loss. Our title insurance policies may not insure for the current aggregate market value of our portfolio, and we do not intend to increase our title insurance coverage as the market value of our portfolio increases.
We do not carry insurance for certain losses and certain types of losses may be either uninsurable or not economically insurable, such as losses due to nuclear explosions, riots or acts of war. If we experience a loss that is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. If the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if these properties were irreparably damaged. In addition, we carry several different lines of insurance, placed with several large insurance carriers. If any one of these large insurance carriers were to become insolvent, we would be forced to replace the existing insurance coverage with another suitable carrier, and any outstanding claims would be at risk for collection. In such an event, we cannot be certain that we would be able to replace the coverage at similar or otherwise favorable terms. As a result of any of the situations described above, our financial condition and cash flows may be materially and adversely affected.
We face possible risks associated with the physical effects of climate change which could have a material adverse effect on our properties, operations and business.
Climate change, including rising sea levels, flooding, extreme weather, changes in precipitation and temperature, and air quality, may result in physical damage to, a decrease in demand for, and/or a decrease in rent from and value of our properties located in the areas affected by these conditions. A number of our properties are located in areas that have historically been impacted by earthquakes, floods, hurricanes, and tornadoes. To the extent climate change causes increased changes in weather patterns, our markets could experience heightened storm intensity and rising sea-levels. These conditions could result in declining demand for leased space in our buildings or an inability to operate the buildings at all. Climate change may also have indirect effects on our business by increasing the cost of (or making unavailable) property insurance on terms we and/or our tenants find acceptable. There can be no assurance that climate change will not have a material adverse effect on our properties, operations or business.
Our participation in joint ventures creates additional risks as compared to direct real estate investments, and the actions of our joint venture partners could adversely affect our operations or performance.
We participate in and may in the future participate in additional transactions structured to purchase and dispose of assets jointly with unaffiliated third parties (a “joint venture”), including the management of these joint ventures. There are additional risks involved in joint venture transactions apart from those associated with purchasing property directly. For example, as a co-investor in a joint venture, we may not be in a position to exercise sole decision-making authority relating to significant decisions affecting
the property. In addition, there is the potential of the co-participant in the joint venture becoming bankrupt and the possibility of diverging or inconsistent economic or business interests of us and that participant. We may also provide non-recourse guarantees of the indebtedness of the joint venture. These diverging interests could result in, among other things, exposure to liabilities of the joint venture in excess of our proportionate share of these liabilities.
If we are unable to maintain effective disclosure controls and procedures and effective internal control over financial reporting, investor confidence and our stock price could be adversely affected.
Our management is responsible for establishing and maintaining effective disclosure controls and procedures and internal control over financial reporting. There were no changes to our internal control over financial reporting that occurred during the year ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, however, there can be no guarantee as to the effectiveness of our disclosure controls and procedures and we cannot assure you that our internal control over financial reporting will not be subject to material weaknesses in the future. If we fail to maintain the adequacy of our internal controls over financial reporting and our operating internal controls, including any failure to implement required new or improved controls as a result of changes to our business or otherwise, or if we experience difficulties in their implementation, our business, results of operations and financial condition could be adversely affected and we could fail to meet our reporting obligations.
Historical 1031 real estate programs we manage may divert resources from our core business operations and may subject us to unexpected liabilities and costs.
We continue to serve as the asset manager of certain 1031 real estate programs. While the volume of programs under management has been decreasing, we continue to manage the remaining properties which requires the allocation of staff and other Company resources. Continuing management of these programs may divert resources from our core business operations and could result in unexpected liabilities and costs, including potential litigation.
Changes in accounting pronouncements could adversely impact our or our tenants’ reported financial performance.
Accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time the Financial Accounting Standards Board and the SEC, who create and interpret appropriate accounting standards, may change the financial accounting and reporting standards or their interpretation and application of these standards that govern the preparation of our financial statements. These changes could have a material impact on our reported financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in restating prior period financial statements. Similarly, these changes could have a material impact on our tenants’ reported financial condition or results of operations and affect their preferences regarding leasing real estate.
We may not be able to maintain our competitive advantages if we are not able to attract and retain key personnel.
Our success depends to a significant extent on our ability to attract and retain key members of our executive and senior management teams and staff supporting our continuing operations. If there are changes in senior leadership affecting our continuing operations, such changes could be disruptive and could compromise our ability to operate our business. While we have entered into employment agreements with certain key personnel, there can be no assurance that we will be able to retain the services of individuals whose knowledge and skills are important to our businesses. Our success also depends on our ability to prospectively attract, integrate, train and retain qualified management personnel. Because the competition for qualified personnel is intense, costs related to compensation and retention could increase significantly in the future. If we were to lose a sufficient number of our key employees and were unable to replace them in a reasonable period of time, these losses could damage our business and adversely affect our results of operations.
Competition that traditional retail tenants face from e-commerce retail sales, or the integration of brick and mortar stores with e-commerce retailers, could adversely affect our business.
Our retail tenants continue to face increased competition from e-commerce retailers. E-commerce sales continue to account for an increasing percentage of retail sales, and this trend is expected to continue as our retail tenants continue to look for ways to increase their e-commerce presence and/or integrate their brick and mortar stores with an e-commerce platform. These trends may have an impact on decisions that retailers make regarding their brick and mortar stores. Changes in shopping trends as a result of the growth in e-commerce may also impact the profitability of retailers that do not adapt to changes in market conditions. The continued growth of e-commerce sales could decrease the need for traditional retail outlets and reduce retailers' space and property requirements. These conditions could adversely impact our results of operations and cash flows if we are unable to meet the needs of our tenants or if our tenants encounter financial difficulties as a result of changing market conditions.
Cybersecurity risks and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information, and/or damage to our business relationships or reputation, all of which could negatively impact our financial results.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack (e.g., the application of banking or other malware to intercept funds) or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations (e.g., disruption of finance or accounting systems that process or receive payment obligations, manage cash, warehouse data and other processes and procedures), misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our tenant and investor relationships. In addition, from time to time, we update, modify or change our information systems and, although we have taken steps to protect the security of the data and systems, our security measures may not be able to prevent cyber incidents resulting from such modifications or changes. As our reliance on technology has increased, so have the risks posed to our information systems, both internal and those we have outsourced. We have implemented processes, procedures (including training and recovery procedures) and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations, business relationships or confidential information will not be negatively impacted by such an incident. The remediation of a cyber incident could result in significant unplanned expenditures and our cash flows and results of operations could be adversely affected.
We may acquire properties or portfolios of properties through tax deferred contribution transactions, which could result in the dilution of our stockholders and unitholders, and limit our ability to sell or refinance such assets.
We have in the past and may in the future acquire properties or portfolios of properties through tax deferred contribution transactions in exchange for OP Units. Under the Third Amended and Restated Agreement of Limited Partnership of the OP, as amended (the “LPA”), after holding OP Units for a period of one year, unless otherwise consented to by the General Partner, holders of OP Units have a right to redeem the OP Units for the cash value of a corresponding number of shares of the General Partner’s Common Stock or, at the option of the General Partner, a corresponding number of shares of the General Partner’s Common Stock. This could result in the dilution of our stockholders and unitholders through the issuance of OP Units that may be exchanged for shares of our Common Stock. This acquisition structure may also have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties, and may require that we agree to restrictions on our ability to dispose of, or refinance the debt on, the acquired properties in order to protect the contributors’ ability to defer recognition of taxable gain. Similarly, we may be required to incur or maintain debt we would otherwise not incur so we can allocate the debt to the contributors to maintain their tax bases. These restrictions could limit our ability to sell or refinance an asset at a time, or on terms, that would be favorable absent such restrictions.
Risks Related to Financing
We intend to rely on external sources of capital to fund future capital needs, and if we encounter difficulty in obtaining such capital, we may not be able to meet maturing obligations or make any additional investments.
In order to qualify as a REIT under the Internal Revenue Code, we are required, among other things, to distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with U.S. GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. Because of this dividend requirement, we may not be able to fund from cash retained from operations all of our future capital needs, including capital needed to refinance maturing obligations or make investments.
Market volatility and disruption could hinder our ability to obtain new debt financing or refinance our maturing debt on favorable terms or at all or to raise debt and equity capital. Our access to capital will depend upon a number of factors, including: general market conditions; the market’s perception of our future growth potential; the extent of investor interest; analyst reports about us and the REIT industry; the general reputation of REITs and the attractiveness of their equity securities in comparison to other equity securities, including securities issued by other real estate-based companies; our financial performance and that of our tenants; our current debt levels; our current and expected future earnings; our cash flow and cash dividends, including our ability to satisfy the dividend requirements applicable to REITs; and the market price per share of our Common Stock. If we are unable to obtain needed capital on satisfactory terms or at all, we may not be able to meet our obligations and commitments as they mature or make any additional investments.
We have substantial amounts of indebtedness outstanding, which may affect our ability to pay dividends, and may expose us to interest rate fluctuation risk and to the risk of default under our debt obligations.
As of December 31, 2019, we had $5.7 billion of debt outstanding, including net premiums and net deferred financing costs. We cannot assure you that our business will generate sufficient cash flow from operations or that future sources of cash will be available to us in an amount sufficient to enable us to pay amounts due on our indebtedness or to fund our other liquidity needs. We may incur substantial additional debt in the future, including borrowings under our Revolving Credit Facility and other types of debt, as our business strategy contemplates the use of debt to finance long-term growth and our organizational documents contain no limitations on the amount of debt that we may incur upon approval by our Board, without stockholder approval. We may incur additional debt for various purposes including, without limitation, the funding of future acquisitions, capital improvements and leasing commissions in connection with the repositioning of properties which would increase our debt service obligations. Our substantial outstanding indebtedness, and the limitations imposed on us by our debt agreements, could have significant adverse consequences, including as follows:
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our cash flow may be insufficient to meet our required principal and interest payments;
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we may be unable to borrow additional funds as needed or on satisfactory terms to fund future working capital, capital expenditures and other general corporate requirements, which could, among other things, adversely affect our ability to capitalize upon any acquisition opportunities or fund capital improvements and leasing commissions;
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we may be unable to pay off or refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness and will depend on, among other things, our financial condition and market conditions at the time, restrictions in the agreements governing our indebtedness, general economic and capital market conditions, the availability of credit from banks or other lenders, and investor confidence in us;
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payments of principal and interest on borrowings may leave us with insufficient cash resources to make the dividend payments necessary to maintain our REIT qualification or may otherwise impose restrictions on our ability to make distributions;
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we may be forced to dispose of properties, possibly on disadvantageous terms;
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we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations;
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certain of the property subsidiaries’ loan documents may include restrictions that limit the subsidiary’s ability to take certain actions with respect to the property, including restrictions on the subsidiary’s ability to make dividends to us or restrictions that require us to obtain lender consent which could adversely affect our ability to sell, lease or otherwise address issues with the property;
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certain of our borrowings, and our future borrowings may, bear interest at variable rates and increases in interest rates would result in higher interest expenses on our existing unhedged variable rate debt and increase the costs of refinancing existing debt or incurring new debt;
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we may be unable to hedge floating-rate debt, counterparties may fail to honor their obligations under our hedge agreements, these agreements may not effectively hedge interest rate fluctuation risk, and, upon the expiration of any hedge agreements, we would be exposed to then-existing market rates of interest and future interest rate volatility;
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we may default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans and exercise their rights under any assignment of rents and leases;
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we may be vulnerable to general adverse economic and industry conditions; and
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we may be at a disadvantage compared to our competitors with less indebtedness.
If we default under a loan or indenture (including any default in respect of the financial maintenance and negative covenants contained in the Credit Agreement, or the indenture governing the Senior Notes), we may automatically be in default under any other loan or indenture that has cross-default provisions (including the Credit Agreement), and (x) further borrowings under the Credit Facility will be prohibited, and outstanding indebtedness under the Credit Facility, and our indenture (including the indenture governing the Senior Notes) or such other loans may be accelerated and (y) to the extent any such debt is secured, directly or
indirectly, by any properties or assets, the lenders may foreclose on the properties or assets securing such indebtedness. Further, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which could adversely affect our ability to meet the REIT dividend requirements imposed by the Internal Revenue Code.
In addition, increases in interest rates may impede our operating performance and payments of required debt service obligations or amounts due at maturity, or creation of additional reserves under loan agreements or indentures, could adversely affect our financial condition and operating results. Further, the REIT provisions of the Internal Revenue Code may limit our ability to hedge our liabilities. Generally, any income from a hedging transaction we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets or to offset certain other positions, if properly identified under applicable Treasury Regulations, does not constitute “gross income” for purposes of the 75% or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions will likely be treated as non-qualifying income for purposes of one or both of the gross income tests. As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through taxable REIT subsidiaries (“TRS”). This could increase the cost of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit, except for being carried forward against future taxable income of such TRS.
The indenture governing our Senior Notes and the Credit Agreement contain restrictive covenants that limit our operating flexibility.
The indenture governing our Senior Notes and the Credit Agreement require us to comply with customary affirmative and negative covenants and other financial and operating covenants that, among other things, restrict our ability to take specific actions (e.g., consummate a merger, consolidation or sale of all or substantially all of our assets or incur or guarantee additional secured and unsecured indebtedness).
In addition, the indenture governing our Senior Notes requires us, among other things, to maintain a maximum unencumbered leverage ratio and the Credit Agreement requires us, among other things, to maintain a maximum consolidated leverage ratio, a minimum fixed charge coverage ratio, a maximum secured leverage ratio, a maximum unencumbered leverage ratio and a minimum unencumbered interest coverage ratio. The Credit Agreement also includes customary restrictions on, among other items, liens, negative pledges, intercompany transfers, fundamental changes, transactions with affiliates and restricted payments.
Our ability to comply with these and other provisions of the indenture governing our Senior Notes and the Credit Agreement may be affected by changes in our operating and financial performance, changes in general business and economic conditions, adverse regulatory developments or other events adversely impacting us. Any failure to comply with these covenants would constitute a default under the indenture governing our Senior Notes and/or the Credit Agreement, as applicable, and would prevent further borrowings under the Credit Agreement and could cause those and other obligations to become due and payable. If any of our indebtedness is accelerated, we may not be able to repay it.
Adverse changes in our credit ratings could affect our borrowing capacity and borrowing terms.
Credit rating agencies continually evaluate their ratings for the companies that they follow, including us. The credit ratings are based on our operating performance, liquidity and leverage ratios, overall financial position, and other factors viewed by the credit rating agencies as relevant to our industry and the economic outlook in general. The credit rating agencies also evaluate our industry as a whole and may change their credit ratings for us based on their overall view of our industry. Our Senior Notes are periodically rated by nationally recognized credit rating agencies, but we cannot be sure that credit rating agencies will maintain their ratings on the Senior Notes. Our current corporate credit and issue-level ratings for our Senior Notes are “BBB-” with a “stable” outlook from Standard & Poor’s Rating Services, “Baa3” with a “positive” outlook assigned by Moody’s Investor Service, Inc., and are “BBB” with a “stable” outlook assigned by Fitch Ratings, Inc. A deterioration in our credit ratings could adversely affect the cost and availability of capital, as well as the terms of any financing we obtain. Since we depend in part on debt financing to fund our business, an adverse change in our credit ratings could have a material adverse effect on our financial condition, liquidity, results of operations and the trading price of our Senior Notes.
We may be adversely affected by changes in LIBOR reporting practices, the method in which LIBOR is determined, or the use of alternative reference rates.
In July 2017, the Financial Conduct Authority (“FCA”) announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. As a result, the Federal Reserve Board and the Federal Reserve Bank of New York organized the Alternative Reference Rates Committee which identified the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative to USD-LIBOR. We are not able to predict when LIBOR will cease to be published or precisely how SOFR will be calculated and published. Any changes adopted by FCA or other governing bodies in the method used for determining LIBOR
may result in a sudden or prolonged increase or decrease in reported LIBOR. If that were to occur, our interest payments could change. In addition, uncertainty about the extent and manner of future changes may result in interest rates and/or payments that are higher or lower than if LIBOR were to remain available in its current form.
We have contracts that are indexed to LIBOR and are monitoring and evaluating the related risks, which include interest amounts on our variable rate debt and the swap rate for our interest rate swaps. In the event that LIBOR is discontinued, the interest rates will be based on a fallback reference rate specified in the applicable documentation governing such debt or swaps or as otherwise agreed upon. Such an event would not affect our ability to borrow or maintain already outstanding borrowings or swaps, but the alternative reference rate could vary from the underlying exposure or be higher and more volatile than LIBOR.
Certain risks arise in connection with transitioning contracts to an alternative reference rate, including any resulting value transfer that may occur. The value of loans, securities, or derivative instruments tied to LIBOR could also be impacted if LIBOR is limited or discontinued. For some instruments, the method of transitioning to an alternative rate may be challenging, as they may require substantial negotiation with each respective counterparty.
If a contract is not transitioned to an alternative reference rate and LIBOR is discontinued, the impact is likely to vary by contract. If LIBOR is discontinued or if the method of calculating LIBOR changes from its current form, interest rates on our current or future indebtedness may be adversely affected.
While we expect LIBOR to be available in substantially its current form until the end of 2021, it is possible that LIBOR will become unavailable prior to that point. This could result, for example, if sufficient banks decline to make submissions to the LIBOR administrator. In that case, the risks associated with the transition to an alternative reference rate will be accelerated and magnified.
Risks Related to Equity
The Board of Directors may create and issue a class or series of common or preferred stock without stockholder approval.
Subject to applicable legal and regulatory requirements, the Board may amend our charter from time to time to increase or decrease the aggregate number of shares of our stock, or of any class or series of stock that we have authority to issue, to designate and issue from time to time one or more classes or series of stock and to classify or reclassify any unissued shares of our Common Stock or preferred stock without stockholder approval. The Board may determine the relative preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption of any class or series of stock issued. As a result, we may issue series or classes of stock with voting rights, rights to dividends or other rights, senior to the rights of holders of our outstanding capital stock. The issuance of any such stock could also have the effect of diluting our existing equity holders and our expected earnings per share or delaying or preventing a change of control transaction that might otherwise be in the best interests of our stockholders.
The trading price of our Common Stock has been and may continue to be subject to wide fluctuations.
The sales price of our Common Stock on the NYSE has fluctuated and may continue to fluctuate in response to a number of events and factors, including: future offerings of our debt and equity securities or the perception that such sales could occur; actual or anticipated variations in our operating results, earnings, or liquidity, or those of our competitors; changes in our dividend policy or our dividend yield relative to yields on other financial instruments; publication of research reports about us, our competitors, our tenants, or the REIT industry; changes in market valuations of companies similar to us; speculation in the press or investment community; our failure to meet, or changes to, our earnings estimates, or those of any securities analysts; increases in market interest rates; adverse market reaction to the amount of or the maturity of our debt and our ability to refinance such debt and the terms thereof; changes in our credit ratings; changes in our key management; the financial condition, liquidity, results of operations, and prospects of our tenants; regulatory changes affecting our industry or our tenants; failure to maintain our REIT qualification; general market and economic conditions, including the current state of the credit and capital markets; and as a result of the events or realization of the risks described in this “Risk Factors” section or in our future filings with the SEC.
Future offerings of debt, which would be senior to our Common Stock upon liquidation, or preferred equity securities that may be senior to our Common Stock for purposes of dividend distributions or upon liquidation, may adversely affect the market price of our Common Stock.
In the future, we may issue debt or preferred equity securities. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our Common Stock. Additional equity offerings, including offerings of convertible preferred stock, may dilute the holdings of our existing stockholders or otherwise reduce the market price of our Common Stock, or both. Holders of our Common Stock are not entitled to preemptive rights or other protections against dilution. Preferred stock, if issued, could have a preference on liquidating
distributions or a preference on distribution payments that could limit our ability to make distributions to holders of our Common Stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our Common Stock and diluting their stock holdings in us.
The change of control conversion feature of the Series F Preferred Stock may make it more difficult for a party to take over the Company or discourage a party from taking over the Company.
Upon the occurrence of a change of control (as defined in the Articles Supplementary for the Series F Preferred Stock) the result of which is that our Common Stock or the common securities of the acquiring or surviving entity are not listed on a national stock exchange, holders of the Series F Preferred Stock will have the right (unless, prior to the change of control conversion date, we have provided or provide notice of our election to redeem the Series F Preferred Stock) to convert some or all of their Series F Preferred Stock into shares of our Common Stock (or equivalent value of alternative consideration). The change of control conversion feature of the Series F Preferred Stock may have the effect of discouraging a third party from making an acquisition proposal for the Company or of delaying, deferring or preventing certain change of control transactions of the Company under circumstances that stockholders may otherwise believe are in their best interests.
Risks Relating to our Real Estate Investments
Because we own real property, we are subject to extensive environmental regulation, which creates uncertainty regarding future environmental expenditures and liabilities.
Environmental laws regulate, and impose liability for, releases of hazardous or toxic substances into the environment. Under various provisions of these laws, an owner or operator of real estate, such as us, is or may be liable for costs related to soil or groundwater contamination on, in, or migrating to or from its property. In addition, persons who arrange for the disposal or treatment of hazardous or toxic substances may be liable for the costs of cleaning up contamination at the disposal site. Such laws often impose liability regardless of whether the person knew of, or was responsible for, the presence of the hazardous or toxic substances that caused the contamination. The presence of, or contamination resulting from, any of these substances, or the failure to properly remediate them, may adversely affect our ability to sell or lease our property or to borrow using such property as collateral. In addition, persons exposed to hazardous or toxic substances may sue us for personal injury damages. As a result, in connection with our current or former ownership, operation, management and development of real properties, we may be potentially liable for investigation and cleanup costs, penalties, and damages under environmental laws. Further, environmental laws may impose liabilities, costs or operating limitations on our tenants which could adversely affect our tenants’ operations and their ability to make rental payments to us.
Although our properties are generally subjected to preliminary environmental assessments, known as Phase I assessments, by independent environmental consultants that identify certain liabilities, Phase I assessments are limited in scope, and may not include or identify all potential environmental liabilities or risks associated with the property. Further, any environmental liabilities that arose since the date the studies were done would not be identified in the assessments. Unless required by applicable laws or regulations, we may not further investigate, remedy or ameliorate the liabilities disclosed in the Phase I assessments.
We cannot assure you that these or other environmental studies identified all potential environmental liabilities, or that we will not incur material environmental liabilities in the future. If we do incur material environmental liabilities in the future, we may face significant remediation costs, and we may find it difficult to finance or sell any affected properties.
Our build-to-suit acquisitions are subject to additional risks related to properties under development.
From time to time, we engage in build-to-suit acquisitions and the acquisition of properties under development. In connection with these businesses, we enter into purchase and sale arrangements with sellers or developers of suitable properties under development or construction. In such cases, we are generally obligated to purchase the property at the completion of construction, provided that the construction conforms to definitive plans, specifications, and costs approved by us in advance, and if other conditions have been met, such as there being an effective lease for the property, and the tenant having accepted the property and commenced paying rent. We may also engage in development and construction activities involving existing properties, including the construction of new buildings or the expansion of existing facilities (typically at the request of a tenant) or the development or build-out of vacant space. We may advance significant amounts in connection with certain development projects.
As a result, we are subject to potential development risks and construction delays and the resultant increased costs and risks, as well as the risk of loss of certain amounts that we have advanced should a development project not be completed. To the extent that we engage in development or construction projects, we may be subject to uncertainties associated with obtaining permits or re-zoning for development, environmental and land use concerns of governmental entities and/or community groups, and the
builder’s ability to build in conformity with plans, specifications, budgeted costs and timetables. If a developer or builder fails to perform, we may terminate the purchase, modify the construction contract or resort to legal action to compel performance (or in certain cases, we may elect to take over the project and pursue completion of the project ourselves). A developer’s or builder’s performance may also be affected or delayed by conditions beyond that party’s control. Delays in obtaining permits or completion of construction could also give tenants the right to terminate preconstruction leases.
We may incur additional risks if we make periodic progress payments or other advances to builders before they complete construction. These and other such factors can result in increased project costs or the loss of our investment. Although we rarely engage in construction activities relating to space that is not already leased to one or more tenants, to the extent that we do so, we may be subject to normal lease-up risks relating to newly constructed projects. We also will rely on rental revenue and expense projections and estimates of the fair market value of property upon completion of construction when agreeing upon a price at the time we acquire the property. If these projections are inaccurate, we may pay too much for a property and our return on our investment could suffer. If we contract with a development company for a newly developed property, there is a risk that money advanced to that development company for the project may not be fully recoverable if the developer fails to successfully complete the project.
Risks Related to our Organization and Structure
We are a holding company with no direct operations. As a result, we rely on funds received from the Operating Partnership to pay liabilities and dividends, our stockholders’ claims will be structurally subordinated to all liabilities of the Operating Partnership and our stockholders do not have any voting rights with respect to the Operating Partnership’s activities, including the issuance of additional OP Units.
We are a holding company and conduct all of our operations through the Operating Partnership. We do not have, apart from our ownership of the Operating Partnership, any independent operations. As a result, we rely on distributions from the Operating Partnership to pay any dividends we might declare on shares of our Common Stock. We also rely on distributions from the Operating Partnership to meet our debt service and other obligations, including our obligations to make distributions required to maintain our REIT qualification. The ability of subsidiaries of the Operating Partnership to make distributions to the Operating Partnership, and the ability of the Operating Partnership to make distributions to us in turn, will depend on their operating results and on the terms of any loans that encumber the properties owned by them. Such loans may contain lockbox arrangements, reserve requirements, financial covenants and other provisions that restrict the distribution of funds. In the event of a default under these loans, the defaulting subsidiary would be prohibited from distributing cash. As a result, a default under any of these loans by the borrower subsidiaries could cause us to have insufficient cash to make distributions on our Common Stock required to maintain our REIT qualification.
In addition, because we are a holding company, stockholders’ claims will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of the Operating Partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, claims of our stockholders will be satisfied only after all of our and the Operating Partnership’s and its subsidiaries’ liabilities and obligations have been paid in full.
As of December 31, 2019, we owned approximately 99.9% of the OP Units in the Operating Partnership. However, the Operating Partnership may issue additional OP Units in the future. Such issuances could reduce our ownership percentage in the Operating Partnership. Because our stockholders would not directly own any such OP Units, they would not have any voting rights with respect to any such issuances or other partnership-level activities of the Operating Partnership.
Our charter and bylaws and Maryland law, as well as certain provisions in the LPA, contain provisions that may delay or prevent a change of control transaction.
Our charter, subject to certain exceptions, limits any person to actual or constructive ownership of no more than 9.8% in value of the aggregate of our outstanding shares of stock and not more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. In addition, our charter provides that we may not consolidate, merge, sell all or substantially all of our assets or engage in a share exchange unless such actions are approved by the affirmative vote of at least two-thirds of the Board of Directors. The ownership limits and the other restrictions on ownership and transfer of our stock and the Board approval requirements contained in our charter may delay or prevent a transaction or a change of control that might involve a premium price for our Common Stock or otherwise be in the best interest of our stockholders.
Further, certain provisions in the LPA may delay or make more difficult unsolicited acquisitions of us or changes in our control. These provisions could discourage third parties from making such proposals, although some stockholders might consider such proposals, if made, desirable. These provisions include, among others, redemption rights of qualifying parties; the ability of the General Partner in some cases to amend the LPA without the consent of the limited partners; the right of the limited partners to
consent to transfers of the general partnership interest of the General Partner and mergers or consolidations of the Company under specified limited circumstances; and restrictions relating to our qualification as a REIT under the Internal Revenue Code. The LPA also contains other provisions that may have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for our Common Stock or otherwise be in the best interest of our stockholders.
The Company’s fiduciary duties as sole general partner of the Operating Partnership could create conflicts of interest.
The Company has fiduciary duties to the Operating Partnership and the limited partners in the Operating Partnership, the discharge of which may conflict with the interests of its stockholders. The LPA provides that, in the event of a conflict between the duties owed by the Company’s directors to the Company and the duties that the Company owes in its capacity as the sole general partner of the Operating Partnership to the Operating Partnership’s limited partners, the Company’s directors are under no obligation to give priority to the interests of such limited partners. As a holder of OP Units, the Company will have the right to vote on certain amendments to the LPA (which require approval by a majority in interest of the limited partners, including the Company) and individually to approve certain amendments that would adversely affect the rights of the Operating Partnership’s limited partners, as well as the right to vote on mergers and consolidations of the Company in its capacity as sole general partner of the Operating Partnership in certain limited circumstances. These voting rights may be exercised in a manner that conflicts with the interests of the Company’s stockholders. For example, the Company cannot adversely affect the limited partners’ rights to receive distributions, as set forth in the LPA, without their consent, even though modifying such rights might be in the best interest of the Company’s stockholders generally.
The Board of Directors may change significant corporate policies without stockholder approval.
Our investment, financing, borrowing and dividend policies and our policies with respect to other activities, including growth, debt, capitalization, operations and other governance matters, will be determined by the Board. These policies may be amended or revised at any time and from time to time at the discretion of the Board without a vote of our stockholders. In addition, the Board may change our policies with respect to conflicts of interest provided that such changes are consistent with applicable legal requirements. A change in these policies could have an adverse effect on our business, financial condition, liquidity and results of operations and our ability to satisfy our debt service obligations and to make distributions to our stockholders and unitholders.
Our rights and the rights of our stockholders to take action against our directors and officers are limited under Maryland law.
Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (1) actual receipt of an improper personal benefit or profit in money, property or services or (2) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision and limits the liability of our directors and officers to the maximum extent permitted by Maryland law. Maryland law requires us to indemnify our directors and officers for liability actually incurred in connection with any proceeding to which they may be made, or threatened to be made, a party, except to the extent that the act or omission of the director or officer was material to the matter giving rise to the proceeding and was either committed in bad faith or was the result of active and deliberate dishonesty, the director or officer actually received an improper personal benefit in money, property or services, or, in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, our charter obligates us to advance the reasonable defense costs incurred by our directors and officers. Finally, we have entered into agreements with our directors and officers pursuant to which we have agreed to indemnify them to the maximum extent permitted by Maryland law.
U.S. Federal Income and Other Tax Risks
Our failure to remain qualified as a REIT would subject us to U.S. federal income tax and potentially state and local tax, and would adversely affect our operations and the market price of our capital stock.
We elected to be taxed as a REIT commencing with the taxable year ended December 31, 2011 and believe we have operated, and intend to operate, in a manner that has allowed us to qualify as a REIT and will allow us to continue to qualify as a REIT. However, we may terminate our REIT qualification if the Board determines that not qualifying as a REIT is in our best interests, or the qualification may be terminated inadvertently. Our qualification as a REIT depends upon our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. We structured our activities in a manner designed to satisfy the requirements for qualification as a REIT. However, the REIT qualification requirements are extremely complex and interpretation of the U.S. federal income tax laws governing qualification as a REIT is limited.
Accordingly, we cannot be certain that we have been or will be successful in continuing to be taxed as a REIT. Our ability to satisfy the asset tests depends on our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the annual income and quarterly asset requirements also depends on our ability to successfully manage the composition of our income and assets on an ongoing basis. Accordingly, if certain of our operations were to be recharacterized by the Internal Revenue Service (the “IRS”), such recharacterization would jeopardize our ability to satisfy the requirements for qualification as a REIT. Furthermore, future legislative, judicial or administrative changes to the U.S. federal income tax laws could result in our disqualification as a REIT for past or future periods.
If we fail to qualify as a REIT for any taxable year and we do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT qualification. Losing our REIT qualification would reduce our net earnings because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the dividends paid deduction, and we would no longer be required to make distributions and, accordingly, distributions the Operating Partnership makes to its unitholders could be similarly reduced. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.
Even if we continue to qualify as a REIT, in certain circumstances, we may incur tax liabilities that would reduce our cash available for distribution to our stockholders and unitholders.
Even if we continue to qualify as a REIT, we may be subject to U.S. federal, state and local income taxes. For example, net income from the sale of properties that are considered held for sale and not for investment (a “prohibited transaction” under the Internal Revenue Code) will be subject to a 100% tax (which may cause us to forgo or defer sales of properties that otherwise would be favorable). In addition, we may not make sufficient distributions to avoid income and excise taxes on retained income. We also may decide to retain net capital gain we earn from the sale or other disposition of our property or other assets and pay U.S. federal income tax directly on such income. In that event, our stockholders would be treated for federal income tax purposes as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability unless they file U.S. federal income tax returns and thereon seek a refund of such tax. We may, in certain circumstances, be required to pay an excise or penalty tax (which could be significant in amount) in order to utilize one or more relief provisions under the Internal Revenue Code to maintain our qualification as a REIT.
A REIT may own up to 100% of the stock of one or more TRS. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS of the REIT. A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT. We may use TRSs generally to hold properties for sale in the ordinary course of business or to hold assets or conduct activities that we cannot conduct directly as a REIT. Our TRS will be subject to applicable U.S. federal, state, local and foreign income tax on their taxable income. These rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.
Not all taxing jurisdictions recognize the favorable tax treatment afforded to REITs under the Internal Revenue Code. As such, we may be subject to regular corporate net income taxes in certain state, local or foreign taxing jurisdictions. In addition, we, the Operating Partnership, our TRS, and/or other entities through which we conduct our business may also be subject to state, local or foreign income, franchise, sales, transfer, excise or other taxes. Any taxes that we incur directly or indirectly will reduce our cash available for distribution to our stockholders and unitholders. Additionally, changes in state, local or foreign tax law could reduce the cash flow from certain investments made by us and could make such investments less attractive to potential buyers when we seek to liquidate such investments.
Complying with REIT requirements (including annual distribution requirements) may force us to forgo or liquidate otherwise attractive investment opportunities . This could reduce our operating flexibility, cause us to borrow funds during unfavorable market conditions, delay or hinder our ability to meet our investment objectives and reduce your overall return.
In order to qualify as a REIT, we must satisfy certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. For example, we must distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with U.S. GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. We will be subject to U.S. federal income tax on our undistributed taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which dividends we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. We must also meet the REIT gross income tests annually and that at the end of each calendar quarter which generally require that at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and certain kinds of mortgage-related securities.
If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences.
These requirements could cause us to distribute amounts that otherwise would be spent on investments in real estate assets and it is possible that we might be required to borrow funds, possibly at unfavorable rates, sell assets or make taxable stock dividends. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders. Although we intend to make distributions sufficient to meet the annual distribution requirements and to avoid U.S. federal income and excise taxes on our earnings while we qualify as a REIT, it is possible that we might not always be able to do so.
If the Operating Partnership or certain other subsidiaries fail to qualify as a partnership or are not otherwise disregarded for U.S. federal income tax purposes, then we would cease to qualify as a REIT.
We intend to maintain the status of the Operating Partnership as a partnership for U.S. federal income tax purposes. However, if the IRS were to successfully challenge the status of the Operating Partnership as a partnership, it would be taxed as a corporation. This would result in our failure to qualify as a REIT and would cause us to be subject to a corporate-level tax on our income which would substantially reduce our cash available to pay distributions and the yield on your investments. In addition, if one or more of the partnerships or limited liability companies through which the Operating Partnership owns its properties, in whole or in part, loses its characterization as a partnership and is otherwise not disregarded for U.S. federal income tax purposes, then such partnership or limited liability company would be subject to taxation as a corporation, thereby reducing distributions to the Operating Partnership. Such a recharacterization of a subsidiary could also threaten our ability to maintain our REIT qualification.
We may be subject to adverse legislative or regulatory tax changes including changes that modify the taxation of REITs and their shareholders increasing tax liability as well as reduce our operating flexibility and the market price of our capital stock.
Numerous legislative, judicial and administrative changes have been made to the U.S. federal income tax laws applicable to investments in shares of our Common Stock. In particular, on December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was signed into law which included changes to the Internal Revenue Code that affect the taxation of REITs and their stockholders. Among other changes, the TCJA permanently reduced the generally applicable corporate tax rate, generally reduced the tax rate applicable to individuals and other non-corporate taxpayers for tax years before January 1, 2026, eliminated or modified certain previously allowed deductions (including substantially limiting interest deductibility and, for individuals, the deduction for non-business state and local taxes), and, for taxable years before January 1, 2026, provided for preferential rates of taxation through a deduction of up to 20% (subject to certain limitations) on most ordinary REIT dividends and certain trade or business income of non-corporate taxpayers. Dividends payable by REITs are generally not eligible for the reduced tax rate applicable to qualified dividend income payable to US stockholders that are individuals, trusts or estates. This deduction provided by the TCJA mitigates but does not eliminate the difference in the effective tax rates between REIT dividends and qualified dividends. The TCJA also imposed new limitations on the deduction of net operating losses and requires us to recognize income for tax purposes no later than when we take it into account on our financial statements, which may result in us having to make additional taxable distributions to our stockholders in order to comply with REIT distribution requirements or avoid taxes on retained income and gains. The effect of the significant changes made by the TCJA is still uncertain, and administrative guidance will be required in order to fully evaluate the effect of many provisions. The effect of any technical corrections with respect to the TCJA could have an adverse effect on us or our stockholders. Our stockholders are urged to consult with their tax advisor with respect to the impact of recent legislation on their investment in our shares and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares.
Further, although REITs generally receive better tax treatment than entities taxed as regular corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be treated for U.S. federal income tax purposes as a regular corporation. Additional changes to the tax laws are likely to continue to occur, and we cannot assure you that any such changes will not adversely affect our taxation and our ability to qualify as a REIT or the taxation of a stockholder. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets.
If we were considered to have actually or constructively paid a “preferential dividend” to certain of our stockholders, our status as a REIT could be adversely affected.
For our taxable years that ended on or before December 31, 2014, and for any year in which we fail to be a “publicly offered” REIT within the meaning of Section 562 of the Internal Revenue Code, in order for our distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction, the distributions could not have been “preferential dividends.” We believe we qualify as a publicly offered REIT, but there can be no assurance that we will continue to so qualify. A dividend is not a preferential dividend if the distribution is pro rata among all outstanding shares of stock within
a particular class, and in accordance with the preferences among different classes of stock as set forth in our organizational documents. There is uncertainty as to the IRS’s position regarding whether certain arrangements that REITs have with their stockholders could give rise to the inadvertent payment of a preferential dividend. While we believe that our operations have been structured in such a manner that we will not be treated as inadvertently paying preferential dividends, there is no de minimis or reasonable cause exception with respect to preferential dividends under the Internal Revenue Code. Therefore, if the IRS were to take the position that we inadvertently paid a preferential dividend prior to January 1, 2015 (or any later year in which we are not a publicly offered REIT), we may be deemed either to (a) have distributed less than 100% of our REIT taxable income and be subject to tax on the undistributed portion, or (b) have distributed less than 90% of our REIT taxable income and our status as a REIT could be terminated for the year in which such determination is made and for the four taxable years following the year of termination if we were unable to cure such failure.
Non-U.S. stockholders may be subject to U.S. federal withholding tax and may be subject to U.S. federal income tax upon the disposition of our shares.
Gain recognized by a non-U.S. stockholder upon the sale or exchange of our Common Stock generally will not be subject to U.S. federal income taxation unless such stock constitutes a “U.S. real property interest” (“USRPI”) under the Foreign Investment in Real Property Tax Act of 1980 (the “FIRPTA”). Our Common Stock will not constitute a USRPI so long as we are a “domestically-controlled qualified investment entity,” which includes a REIT if at all times during a specified testing period, less than 50% in value of such REIT’s stock is held directly or indirectly by non-U.S. stockholders. While we believe that we are a domestically-controlled qualified investment entity, our Common Stock is publicly traded, and so no assurances can be given. Even if we do not qualify as a domestically-controlled qualified investment entity at the time a non-U.S. stockholder sells or exchanges our Common Stock, gain arising from such a sale or exchange would not be subject to U.S. taxation under FIRPTA as a sale of a USRPI if: (a) our Common Stock is “regularly traded,” as defined by applicable Treasury regulations, on an established securities market, and (b) such non-U.S. stockholder owned, actually and constructively, 10% or less of our Common Stock at any time during the five-year period ending on the date of the sale. While we anticipate that our shares will be “regularly traded” on an established securities market for the foreseeable future, no assurance can be given that this will be the case. We encourage you to consult your tax advisor to determine the tax consequences applicable to you if you are a non-U.S. stockholder.
Our property taxes could increase due to property tax rate changes or reassessment, which would impact our cash flows.
Even if we qualify as a REIT for federal income tax purposes, we will be required to pay some state and local taxes on our properties. The real property taxes on our properties may increase as property tax rates change or as our properties are assessed or reassessed by taxing authorities. Therefore, the amount of property taxes we pay in the future may increase substantially. If the property taxes we pay increase and if any such increase is not reimbursable under the terms of our lease, then our cash flows will be impacted, and our ability to pay expected distributions to our stockholders and unitholders could be adversely affected.
The share ownership restrictions of the Internal Revenue Code for REITs and the 9.8% share ownership limit in our charter may inhibit market activity in our shares of stock and restrict our business combination opportunities.
In order to qualify as a REIT, five or fewer individuals, as defined in the Internal Revenue Code, may not own, actually or constructively, more than 50% in value of our issued and outstanding shares of stock at any time during the last half of each taxable year, other than the first year for which a REIT election is made. Attribution rules in the Internal Revenue Code determine if any individual or entity actually or constructively owns our shares of stock under this requirement. Additionally, at least 100 persons must beneficially own our shares of stock during at least 335 days of a taxable year for each taxable year, other than the first year for which a REIT election is made. To help insure that we meet these tests, among other purposes, our charter restricts the acquisition and ownership of our shares of stock.
Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by the Board, for so long as we qualify as a REIT, our charter prohibits, among other limitations on ownership and transfer of shares of our stock, any person from beneficially or constructively owning (applying certain attribution rules under the Internal Revenue Code) more than 9.8% in value of the aggregate of our outstanding shares of stock and more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. The Board, in its sole discretion and upon receipt of certain representations and undertakings, may exempt a person (prospectively or retrospectively) from the ownership limits. However, the Board may not, among other limitations, grant an exemption from these ownership restrictions to any proposed transferee whose ownership, direct or indirect, in excess of the 9.8% ownership limit would result in the termination of our qualification as a REIT. These restrictions on transferability and ownership will not apply, however, if the Board determines that it is no longer in our best interest to continue to qualify as a REIT or that compliance with the restrictions is no longer required in order for us to continue to so qualify as a REIT. These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our Common Stock or otherwise be in the best interest of our stockholders.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
The Company is the lessee for our corporate office space, including our corporate headquarters, which is located in Phoenix, Arizona. As of December 31, 2019, the Company owned 3,858 operating properties comprising 89.5 million square feet of retail and commercial space located in 49 states and Puerto Rico, of which 99.1% was leased with a weighted-average remaining lease term of 8.3 years, which includes the pro rata share of square feet and annualized rental income from the Company’s unconsolidated joint ventures and omits the square feet of one redevelopment property. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Real Estate Portfolio Metrics for a discussion of the properties we hold for rental operations and Schedule III - Real Estate and Accumulated Depreciation for a detailed listing of such properties.
Item 3.
Item 3. Legal Proceedings.
The information contained under the heading “Litigation” in Note 10 - Commitments and Contingencies to our consolidated financial statements is incorporated by reference into this Part I, Item 3. Except as set forth therein, as of the end of the period covered by this Annual Report on Form 10-K, we are not a party to, and none of our properties are subject to, any material pending legal proceedings.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Effective July 31, 2015, we transferred the listing of the General Partner’s Common Stock and Series F Preferred Stock to the NYSE from NASDAQ Global Select Market. The General Partner’s Common Stock and Series F Preferred Stock trade under the trading symbols “VER” and “VER PRF,” respectively.
Stock Price Performance Graph
Set forth below is a line graph comparing the cumulative total stockholder return on the General Partner’s Common Stock, based on the market price of the Common Stock and assuming reinvestment of dividends, with the FTSE National Association of Real Estate Investment Trusts All Equity REITs Index (“FTSE NAREIT All Equity REITs”) and the S&P 500 Index (“S&P 500”) for the period commencing December 31, 2014 and ending December 31, 2019. The graph assumes an investment of $100 on December 31, 2014.
The graph above and the accompanying text are not “soliciting material,” are not deemed filed with the SEC and are not to be incorporated by reference in any filing by us under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. In addition, the stock price performance in the graph above is not indicative of future stock price performance.
Distributions
On February 25, 2020, the Company’s Board of Directors declared a quarterly cash dividend of $0.1375 per share of Common Stock (equaling an annualized dividend rate of $0.55 per share) for the first quarter of 2020 to stockholders of record as of March 31, 2020, which will be paid on April 15, 2020. An equivalent distribution by the Operating Partnership is applicable per OP Unit.
On February 25, 2020, the Company’s Board of Directors declared a monthly cash dividend to holders of the Series F Preferred Stock as of April 1, May 1, and June 1, 2020, which will be paid on April 15, May 15, and June 15, 2020, respectively. The dividend for the Series F Preferred Stock accrues daily on a 360-day annual basis equal to an annualized dividend rate of $1.675 per share, or $0.1395833 per 30-day month.
Our future distributions may vary and will be determined by the General Partner’s Board of Directors based upon the circumstances prevailing at the time, including our financial condition, operating results, estimated taxable income and REIT distribution requirements, and may be adjusted at the discretion of the Board of Directors.
As of February 21, 2020, the General Partner had approximately 3,245 registered stockholders of record of its Common Stock. This figure does not reflect the beneficial ownership of shares held in nominee name. There is no established trading market for the Operating Partnership's OP Units. As of February 21, 2020, there were 14 record holders of the OP Units.
Recent Sales of Unregistered Securities
During 2019, the Operating Partnership redeemed an aggregate of 37,108 Series F Preferred Units for 37,108 shares of Series F Preferred Stock. Additionally, the General Partner issued an aggregate of 130,291 shares of Common Stock in redemption of 130,291 Limited Partner OP Units (which refers to OP Units issued to parties other than the General Partner). These shares of Series F Preferred Stock and Common Stock were issued in reliance on an exemption from registration under Section 4(a)(2) of the Securities Act, based upon factual representations received from the limited partners who received the shares of Series F Preferred Stock and Common Stock.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table shows the amount of securities remaining available for future issuance under our equity compensation plans as of December 31, 2019:
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(1)
Represents the total number of shares of Common Stock reserved for the issuance of equity under our equity-based compensation plans. Shares available under the Equity Plan are equal to 10.0% of the total number of issued and outstanding shares of our Common Stock (on a fully diluted basis assuming the redemption of all OP Units for shares of Common Stock) at any time. As such, the number of shares available for issuance under the Equity Plan changes automatically with changes in the total number of outstanding shares of Common Stock, outstanding OP Units, and dilutive securities. See Note 13- Equity-based Compensation to our consolidated financial statements for a discussion of the Company’s equity-based compensation plans.
Repurchases of Equity Securities
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(1)
During the three months ended December 31, 2019, the Company redeemed an aggregate of 8.0 million shares of its Series F Preferred Stock.
We are authorized to repurchase shares of the General Partner’s Common Stock to satisfy employee withholding tax obligations related to stock-based compensation. During the fourth quarter of 2019, there were no repurchased shares of Common Stock or corresponding OP Units made in order to satisfy the minimum tax withholding obligation for state and federal payroll taxes as all employee restricted shares of Common Stock (“Restricted Shares”) had previously vested during the year ended December 31, 2019.
There were also no share repurchases under the 2018 Share Repurchase Program or 2019 Share Repurchase Program during the fourth quarter of 2019. As of December 31, 2019, the Company had $200.0 million available for share repurchases under the 2019 Share Repurchase Program. During the year ended December 31, 2018, the Company repurchased 0.8 million shares of Common Stock in multiple open market transactions, at a weighted average share price of $6.95 for an aggregate purchase price of $5.6 million under the 2018 Share Repurchase Program. See Note 13- Equity-based Compensation for further discussion of the share repurchase programs.
Item 6.
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with the accompanying consolidated financial statements and related notes thereto and Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this report entitled “Forward-Looking Statements” Certain risks may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the section in this report entitled “Risk Factors”.
Overview
VEREIT is a full-service real estate operating company which owns and manages one of the largest portfolios of single-tenant commercial properties in the U.S. The Company has 3,858 retail, restaurant, office and industrial operating properties with an aggregate 89.5 million rentable square feet, of which 99.1% was leased as of December 31, 2019, with a weighted-average remaining lease term of 8.3 years.
Critical Accounting Policies and Significant Accounting Estimates
Our accounting policies have been established to conform with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires us to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management believes that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different assumptions or estimates that may impact comparability of our results of operations to those of companies in similar businesses. We believe the following critical accounting policies govern the significant judgments and estimates used in the preparation of our financial statements, which should be read in conjunction with the more complete discussion of our accounting policies and procedures included in Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements.
Goodwill Impairment
In connection with prior mergers, we recorded goodwill as a result of the merger consideration exceeding the net assets acquired. We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable. We have the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative goodwill impairment test. As part of the annual qualitative assessment performed during the fourth quarter of each year, we evaluate relevant events and circumstances that affect the fair value or carrying value including, but not limited to, the following:
•
Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets.
•
Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (considered in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development.
•
Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows.
•
Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.
•
Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation.
•
Events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
•
Sustained decrease in share price (both in absolute terms and relative to peers).
We performed the annual qualitative assessment for goodwill during the fourth quarter of 2019. As a result of the qualitative analysis, we believe that it is more-likely-than-not that the fair value is greater than the carrying value. As such, no further testing was performed.
Real Estate Investment Impairment
We invest in real estate assets and subsequently monitor those investments quarterly for impairment, including the review of real estate properties subject to direct financing leases. Additionally, we record depreciation and amortization related to our investments. The risks and uncertainties involved in applying the principles related to real estate investments include, but are not limited to, the following:
•
The estimated useful lives of our depreciable assets affect the amount of depreciation and amortization recognized on our investments.
•
The review of impairment indicators and subsequent determination of the undiscounted future cash flows could require us to reduce the value of assets and recognize an impairment loss.
•
The fair value of held for sale assets is estimated by management. This estimated value could result in a reduction of the carrying value of the asset.
•
The evaluation of real estate assets for potential impairment requires our management to exercise significant judgment and make certain key assumptions. There are inherent uncertainties in making these estimates such as market conditions and performance and sustainability of our tenants.
•
Changes related to management’s intent to sell or lease the real estate assets used to develop the forecasted cash flows may have a material impact on our financial results.
Allocation of Purchase Price of Real Estate Assets
In connection with our acquisition of properties, we allocate the purchase price to the tangible and intangible assets and liabilities acquired based on their respective estimated fair values. Tangible assets consist of land, buildings, fixtures and tenant improvements. Intangible assets consist of above- and below- market lease values and the value of in-place leases. Our purchase price allocations are developed utilizing third-party appraisal reports, industry standards and management experience. The risks and uncertainties involved in applying the principles related to purchase price allocations include, but are not limited to, the following:
•
The value allocated to land as opposed to buildings, fixtures and tenant improvements affects the amount of depreciation expense we record. If more value is attributed to land, depreciation expense is lower than if more value is attributed to buildings, fixtures and tenant improvements.
•
Intangible lease assets and liabilities can be significantly affected by estimates, including market rent, lease term including renewal options at rental rates below estimated market rental rates, carrying costs of the property during a hypothetical expected lease-up period, and current market conditions and costs, including tenant improvement allowances and rent concessions.
•
We determine whether any financing assumed is above- or below- market based upon comparison to similar financing terms for similar investment properties.
Recently Issued Accounting Pronouncements
Recently issued accounting pronouncements are described in Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements.
Operating Highlights and Key Performance Indicators
2019 Activity
Operations
•
Acquired controlling financial interests in 66 commercial properties for an aggregate purchase price of $403.6 million, which includes $2.3 million of external acquisition-related expenses that were capitalized.
•
Disposed of 201 properties, including the sale of six consolidated properties to the Industrial Partnership and one property sold through a foreclosure, for an aggregate gross sales price of $1.2 billion, of which the Company’s share was $1.1 billion, resulting in proceeds of $1.1 billion after closing costs. The Company recorded a gain of $293.9 million related to the sales.
•
Entered into agreements to settle outstanding litigation and reached an agreement on the material terms of a negotiated resolution relating to the SEC’s investigation pertaining to the findings of the Audit Committee Investigation, among other things.
•
Recorded $10.5 million of restructuring expenses related to reorganization of business related to the termination of the Services Agreement in 2019 and the sale of the Company’s investment management segment, Cole Capital, in 2018.
Debt
•
Reduced the capacity under the Revolving Credit Facility from $2.0 billion to $1.5 billion.
•
Entered into interest rate swap agreements with an aggregate $900.0 million notional amount to hedge interest rate volatility.
•
Due to an improvement in the Company’s credit rating during the fourth quarter, the interest rate spread on the $900.0 million Credit Facility Term Loan was reduced by 25 bps to LIBOR + 1.10%, and the interest rate spread on the Revolving Credit Facility was reduced by 20 bps to LIBOR + 1.00%.
•
Entered into forward starting interest rate swaps with a total notional amount of $400.0 million. The swaps are structured to hedge our interest rate risk associated with anticipated issuance of 10-year public debt.
•
The Company’s 2019 Senior Notes matured and the principal outstanding balance of $750.0 million, plus accrued and unpaid interest thereon, was repaid utilizing borrowings under the Credit Facility Term Loan.
•
The Company closed a senior note offering, consisting of $600.0 million aggregate principal amount of the Operating Partnership’s 2029 Senior Notes.
•
The Company’s 2021 Senior Notes consisting of $400.0 million aggregate principal amount were redeemed, and the principal plus accrued and unpaid interest thereon was repaid.
•
Repurchased $80.7 million of the 2020 Convertible Notes.
•
Total secured debt decreased by $388.1 million, from $1.9 billion to $1.5 billion.
Equity
•
Completed a public equity offering of 94.3 million shares of Common Stock for net proceeds, after underwriting discounts and offering expenses, of $886.9 million.
•
Aggregate shares issued under the continuous equity offering programs totaled 14.1 million at a weighted average price per share of $9.18, for gross proceeds of $129.1 million.
•
Redeemed a total of 12.0 million shares of Series F Preferred Stock, representing approximately 28.02% of the issued and outstanding preferred shares as of the beginning of the year. The shares of Series F Preferred Stock were redeemed at a redemption price of $25.00 per share plus all accrued and unpaid dividends.
•
Declared a quarterly dividend of $0.1375 per share of Common Stock for each quarter of 2019, representing an annualized dividend of $0.55 per share.
Real Estate Portfolio Metrics
In managing our portfolio, we are committed to diversification by property type, tenant, geography and industry. Below is a summary of our operating property type diversification and our top ten concentrations as of December 31, 2019, based on annualized rental income of $1.1 billion.
(1)
Includes redevelopment property, billboards, land and parking lots.
Our financial performance is influenced by the timing of acquisitions and dispositions and the operating performance of our operating properties. The following table shows the property statistics of our operating properties as of December 31, 2019 and 2018:
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(1)
As of December 31, 2019, rentable square feet, economic occupancy rate and annualized rental income include the Company’s pro rata share of square feet and annualized rental income from the Company’s unconsolidated joint ventures. As of December 31, 2019, rentable square feet and economic occupancy rate exclude one redevelopment property.
(2)
Economic occupancy rate equals the sum of square feet leased (including space subject to month-to-month agreements) divided by rentable square feet.
(3)
Based on annualized rental income of our real estate portfolio as of December 31, 2019, 2018 and 2017, respectively. Investment-grade tenants are those with a credit rating of BBB- or higher by Standard & Poor’s Financial Services LLC or a credit rating of Baa3 or higher by Moody’s Investor Service, Inc. The ratings may reflect those assigned by Standard & Poor’s Financial Services LLC or Moody’s Investor Service, Inc. to the lease guarantor or the parent company, as applicable.
The following table shows the economic metrics of our operating properties as of December 31, 2019 and 2018:
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(1)
Based on annualized rental income of our real estate portfolio as of December 31, 2019, 2018 and 2017, respectively. As of December 31, 2019, includes the Company’s pro rata share of annualized rental income from the Company’s unconsolidated joint ventures.
(2)
Through the end of the next five years as of the respective reporting date.
Operating Performance
In addition, management uses the following financial metrics to assess our operating performance (dollar amounts in thousands, except per share amounts). Data presented includes both continuing operations, which primarily represent the Company's real estate operations, and discontinued operations, which represent substantially all of Cole Capital, except as otherwise indicated.
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(1)
Represents continuing operations as presented on the statements of operations in accordance with U.S. GAAP.
(2)
Amounts may not total due to rounding. See Note 16 - Net Income (Loss) Per Share/Unit for calculation of net (loss) income per share.
(3)
See the Non-GAAP Measures section below for descriptions of our non-GAAP measures and reconciliations to the most comparable U.S. GAAP measure.
Property Financing
Our mortgage notes payable consisted of the following as of December 31, 2019 and 2018 (dollar amounts in thousands):
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(1)
Effective interest rates ranged from 2.8% to 6.0% at December 31, 2019, 3.1% to 6.1% at December 31, 2018, and 3.1% to 7.2% at December 31, 2017.
(2)
Weighted average effective interest rate is computed using the interest rate in effect until the anticipated repayment date. Should the loan not be repaid at the anticipated repayment date, the applicable interest rate would increase as specified in the respective loan agreement until the extended maturity date.
(3)
Weighted average years remaining to maturity is computed using the anticipated repayment date as specified in each loan agreement, where applicable.
(4)
Omits mortgage notes associated with unconsolidated joint ventures of $269.3 million, which is non-recourse to the Company. The mortgage notes have a weighted-average fixed interest rate of 3.57% and mature on June 6, 2024.
In addition, we have financing which is not secured by interests in real property, which is described under Liquidity and Capital Resources.
Future Lease Expirations
The following is a summary of lease expirations for the next 10 years and beyond at the operating properties we owned as of December 31, 2019 (dollar amounts and square feet in thousands):
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(1)
The Company has certain leases comprised of multiple properties.
Results of Operations
On February 1, 2018, the Company completed the sale of its investment management segment, Cole Capital, which is presented as discontinued operations for all periods presented. The Company’s continuing operations represent primarily those of the real estate investment segment. Please refer to the discussion in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company’s Form 10-K for the year ended December 31, 2018, filed February 21, 2019, for a discussion of 2017 items and a comparison of the years ended December 31, 2018 and 2017.
Rental Revenue
The table below sets forth, for the periods presented, rental revenue information and the dollar amount change year over year (dollar amounts in thousands):
The decrease in rental revenue of $20.6 million during the year ended December 31, 2019 as compared to the same period in 2018 was primarily due to real estate dispositions, partially offset by real estate acquisitions. Subsequent to January 1, 2018, the Company acquired 118 occupied properties for an aggregate purchase price of $904.3 million and disposed of 351 consolidated properties for an aggregate sales price of $1.6 billion.
Operating Expenses
The table below sets forth, for the periods presented, certain operating expense information and the dollar amount change year over year (dollar amounts in thousands):
Acquisition-Related Expenses
Acquisition-related expenses consist of allocated internal salaries related to time spent on acquiring commercial properties and costs associated with unconsummated deals.
Litigation and non-routine costs, net
Litigation and non-routine costs, net increased $524.5 million during the year ended December 31, 2019 as compared to the same period in 2018. The increase was primarily due to a $587.0 million increase in litigation settlement costs to $820.2 million during the year ended December 31, 2019 as compared to $233.2 million during the same period 2018, which related to litigation filed as a result of the findings of the Audit Committee Investigation. This increase was offset by $48.4 million of insurance recoveries received pursuant to a settlement and release agreement with certain insurance carriers, related to litigation filed as a result of the findings of the Audit Committee Investigation and $26.5 million of other recoveries related to the surrender of Limited Partner OP Units by the Former Manager and certain of its principals as described in Note 12 - Equity.
Property Operating Expenses
Property operating expenses such as taxes, insurance, ground rent and maintenance include both reimbursable and non-reimbursable property expenses. The increase in property operating expenses of $3.3 million during the year ended December 31, 2019 as compared to the same period in 2018 was primarily due to additional reimbursable ground rent recorded in conjunction with the adoption of Accounting Standards Codification (“ASC”) Topic 842, Leases (“ASC 842”) on January 1, 2019 and an increase in reimbursable operating expenses, offset by the net impact of property dispositions and acquisitions.
General and Administrative Expenses
The decrease in general and administrative expenses of $1.2 million during the year ended December 31, 2019 as compared to the same period in 2018 was primarily due to a decrease in insurance expenses and bank fees.
Depreciation and Amortization Expenses
The decrease in depreciation and amortization expenses of $158.6 million during the year ended December 31, 2019 as compared to the same period in 2018 was primarily due to furniture and fixtures that were fully depreciated during 2018, as they had reached the end of their useful lives, and real estate dispositions, partially offset by real estate acquisitions.
Impairments
Impairments of $47.1 million recorded during the year ended December 31, 2019 relate to certain office, retail and restaurant properties that, during 2019, management identified for potential sale or determined, based on discussions with the current tenants, would not be re-leased by the tenant and the Company believes the property will not be leased to another tenant at a rental rate that supports the current book value.
Restructuring Expenses
During the year ended December 31, 2019, the Company recorded $10.5 million of restructuring expenses related to the reorganization of the business after the sale of its investment management segment, Cole Capital, and cessation of services performed pursuant to the Services Agreement.
Other Income, Provision for Income Taxes and Income (Loss) from Discontinued Operations
The table below sets forth, for the periods presented, certain financial information and the dollar amount change year over year (dollar amounts in thousands):
Interest Expense
The decrease in interest expense of $2.3 million during the year ended December 31, 2019 as compared to the same period in 2018 was primarily due to a decrease in average debt outstanding.
(Loss) Gain on Extinguishment and Forgiveness of Debt, Net
The loss on extinguishment and forgiveness of debt, net was $17.9 million during the year ended December 31, 2019 as compared to the gain on extinguishment and forgiveness of debt, net of $5.4 million for the same period in 2018. During the year ended December 31, 2019, the Company recognized losses on extinguishment of debt related to the redemption of $400.0 million of the 2021 Senior Notes, prepayments of mortgage notes payable, and the repurchase of $80.7 million of the 2020 Convertible Notes, offset by a gain on the foreclosure sale of one property. During the year ended December 31, 2018, the Company recognized a gain related to one deed-in-lieu of foreclosure transaction with the lender of a mortgage loan, which was secured by one property.
Other Income, Net
The decrease in other income, net of $2.1 million during the year ended December 31, 2019 as compared to the same period in 2018 was primarily due to a $5.1 million gain in 2018 from measuring the Company’s investments in Cole Office & Industrial REIT (CCIT II), Inc. (“CCIT II”), Cole Office & Industrial REIT (CCIT III), Inc. (“CCIT III”) and Cole Credit Property Trust V, Inc. (“CCPT V”) at fair value after the investments were no longer accounted for using the equity method and a $4.8 million payment received in 2018 related to a fully reserved loan receivable recorded in other income, offset by $4.2 million of payments received in 2019 related to the Company’s bankruptcy claims related to two prior tenants and a $2.2 million loss in 2018 related to the sale of six commercial mortgage-backed securities.
Equity in Income and Gain on Disposition of Unconsolidated Entities
The increase in equity in income and gain on disposition of unconsolidated entities of $0.7 million during the year ended December 31, 2019 as compared to the same period in 2018, was primarily due to the Company’s investment in the Industrial Partnership.
Gain on Disposition of Real Estate and Real Estate Assets Held for Sale, Net
The increase in gain on disposition of real estate and real estate assets held for sale, net of $198.3 million during the year ended December 31, 2019 as compared to the same period in 2018, was due to the Company’s disposition of 200 properties, excluding one property conveyed to a lender in a deed-in-lieu of foreclosure transaction, for an aggregate sales price of $1.2 billion which resulted in a gain of $293.9 million during the year ended December 31, 2019, as compared to the disposition of 148 properties, excluding one property conveyed to a lender in a deed-in-lieu of foreclosure transaction, for an aggregate sales price of $526.4 million during the same period in 2018, which resulted in a gain of $96.2 million. During the year ended December 31, 2019, the Company also recognized a loss of $1.3 million related to assets classified as held for sale, as compared to a loss of $1.9 million during the same period in 2018.
Provision for Income Taxes
The provision for income taxes consists of certain state, local and federal income and franchise taxes.
Income (Loss) from Discontinued Operations, Net of Income Taxes
The change in income (loss) from discontinued operations, net of income taxes of $3.7 million during the year ended December 31, 2019 as compared to the same period in 2018 was primarily due to the completion of the sale of the company’s investment management segment, Cole Capital, on February 1, 2018.
Non-GAAP Measures
Our results are presented in accordance with U.S. GAAP. We also disclose certain non-GAAP measures, as discussed further below. Management uses these non-GAAP financial measures in our internal analysis of results and believes these measures are useful to investors for the reasons explained below. These non-GAAP financial measures should not be considered as substitutes for any measures derived in accordance with U.S. GAAP.
Funds from Operations and Adjusted Funds from Operations
Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts, Inc. (“Nareit”), an industry trade group, has promulgated a supplemental performance measure known as funds from operations (“FFO”), which we believe to be an appropriate supplemental performance measure to reflect the operating performance of a REIT. FFO is not equivalent to our net income or loss as determined under U.S. GAAP.
Nareit defines FFO as net income or loss computed in accordance with U.S. GAAP adjusted for gains or losses from disposition of property, depreciation and amortization of real estate assets, impairment write-downs on real estate, and our pro rata share of FFO adjustments related to unconsolidated partnerships and joint ventures. We calculate FFO in accordance with Nareit’s definition described above.
In addition to FFO, we use adjusted funds from operations (“AFFO”) as a non-GAAP supplemental financial performance measure to evaluate the operating performance of the Company. AFFO, as defined by the Company, excludes from FFO non-routine items such as acquisition-related expenses, litigation and non-routine costs, net, loss on disposition of discontinued operations, net revenue or expense earned or incurred that is related to the Services Agreement, gains or losses on sale of investment securities or mortgage notes receivable, payments on fully reserved loan receivables and restructuring expenses. We also exclude certain non-cash items such as impairments of goodwill and intangible assets, straight-line rent, net of bad debt expense related to straight-line rent, net direct financing lease adjustments, gains or losses on derivatives, reserves for loan loss, gains or losses on the extinguishment or forgiveness of debt, non-current portion of the tax benefit or expense, equity-based compensation and amortization of intangible assets, deferred financing costs, premiums and discounts on debt and investments, above-market lease assets and below-market lease liabilities. We omit the impact of the Excluded Properties and related non-recourse mortgage notes from FFO to calculate AFFO. Management believes that excluding these costs from FFO provides investors with supplemental performance information that is consistent with the performance models and analysis used by management, and provides investors a view of the performance of our portfolio over time. AFFO allows for a comparison of the performance of our operations with other publicly-traded REITs, as AFFO, or an equivalent measure, is routinely reported by publicly-traded REITs, and we believe often used by analysts and investors for comparison purposes.
For all of these reasons, we believe FFO and AFFO, in addition to net income (loss), as defined by U.S. GAAP, are helpful supplemental performance measures and useful in understanding the various ways in which our management evaluates the performance of the Company over time. However, not all REITs calculate FFO and AFFO the same way, so comparisons with other REITs may not be meaningful. FFO and AFFO should not be considered as alternatives to net income (loss) and are not intended to be used as a liquidity measure indicative of cash flow available to fund our cash needs. Neither the SEC, Nareit, nor any other regulatory body has evaluated the acceptability of the exclusions used to adjust FFO in order to calculate AFFO and its use as a non-GAAP financial performance measure.
The table below presents FFO and AFFO for the years ended December 31, 2019 and 2018 (in thousands, except share and per share data) and includes both continuing operations, which primarily represent the Company's real estate operations, and discontinued operations, which represent substantially all of Cole Capital. Please refer to the discussion in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company’s Form 10-K for the year ended December 31, 2018, filed February 21, 2019, for a discussion of 2017 items.
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(1)
This adjustment represents the non-current portion of the benefit from income taxes in order to show only the current portion of the benefit from income taxes as an impact to AFFO.
(2)
Upon adoption of ASC 842, the Company recognizes all changes in the collectability assessment for an operating lease as an adjustment to rental revenue and does not record bad debt expense for uncollectible accounts.
(3)
In connection with the Class Action Settlement, the Former Manager and Former CFO surrendered 19.9 million Limited Partner OP Units that were canceled during the three months ended December 31, 2019. Dilutive securities include unvested Restricted Shares, unvested Restricted Stock Units and Stock Options. During the year ended December 31, 2019, all Restricted Shares vested.
(4)
Weighted-average shares for all periods presented exclude the effect of the convertible debt as the Company would expect to settle the debt with cash and any shares underlying Restricted Stock Units that are not issuable based on the Company’s level of achievement of certain performance targets through the respective reporting period.
Liquidity and Capital Resources
General
Our principal liquidity needs for the next twelve months and beyond are to:
•
fund normal operating expenses;
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fund potential capital expenditures, tenant improvements and leasing costs;
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meet debt service and principal repayment obligations, including balloon payments on maturing debt;
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pay dividends;
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pay litigation costs and expenses (including the cost of the SEC settlement); and
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fund property acquisitions.
We expect to be able to satisfy these obligations using one or more of the following sources:
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cash flow from operations;
•
proceeds from real estate dispositions;
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utilization of the existing Revolving Credit Facility;
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cash and cash equivalents balance; and
•
issuance of VEREIT debt and equity securities.
Common Stock Offering
On September 26, 2019, the Company completed the Offering, selling a total of 94.3 million shares of Common Stock, which included the full exercise of the underwriters' option to purchase additional shares, for net proceeds, after underwriting discounts and offering expenses, of $886.9 million. The Company contributed the net proceeds from the Offering to the OP in exchange for additional General Partner OP Units, which have substantially identical economic terms as the Company’s common stock. Subsequent to September 30, 2019, the net proceeds of the Offering were used to pay amounts owed in connection with the settlement of certain litigation, as described in Note 10 - Commitments and Contingencies, and for general corporate purposes.
Common Stock Continuous Offering Programs
On September 19, 2016, the Company registered the Prior Program pursuant to which the Company could offer and sell, from time to time, in “at-the-market” offerings or certain other transactions, shares of Common Stock with an aggregate gross sales price of up to $750.0 million, through its sales agents. As of and during the year ended December 31, 2019, the Company had issued 5.0 million shares under the Prior Program, at a weighted average price per share of $8.42, for gross proceeds of $42.5 million. The weighted average price per share, net of offering costs, was $8.30, for net proceeds of $41.8 million. The proceeds from the sale of shares were used for general corporate purposes, including funding potential acquisitions and repurchasing or repaying outstanding indebtedness.
On April 15, 2019, the Company established the Current ATM Program, a new continuous equity offering program pursuant to which the Company may sell shares of Common Stock having an aggregate offering price of up to $750.0 million from time to time through April 15, 2022 in “at-the-market” offerings or certain other transactions. The Current ATM Program replaced the Prior Program. The proceeds from any sale of shares under the Current ATM Program have been or will be used for general corporate purposes, which may include funding potential acquisitions and repurchasing or repaying outstanding indebtedness. As of and during the year ended December 31, 2019, the Company had issued 9.0 million shares under the Current ATM Program, at a weighted average price per share of $9.60, for gross proceeds of $86.7 million. The weighted average price per share, net of offering costs, was $9.46, for net proceeds of $85.4 million. As of December 31, 2019, the Company had $663.3 million available to be sold under the Current ATM Program.
Share Repurchase Programs
On May 3, 2018, the Company’s Board of Directors terminated its 2018 Share Repurchase Program that permitted the Company to repurchase up to $200.0 million of its outstanding Common Stock through May 3, 2019, as market conditions warranted. On May 6, 2019, the Company’s Board of Directors authorized the 2019 Share Repurchase Program that permits the Company to repurchase up to $200.0 million of its outstanding Common Stock through May 6, 2022. Under the share repurchase programs, repurchases can be made through open market purchases, privately negotiated transactions, structured or derivative transactions, including accelerated stock repurchase transactions, or other methods of acquiring shares in accordance with applicable securities laws and other legal requirements. The share repurchase programs do not obligate the Company to make any repurchases at a specific time or in a specific situation and repurchases are influenced by prevailing market conditions, the trading price of the
Common Stock, the Company’s financial performance and other conditions. Shares of Common Stock repurchased by the Company under the share repurchase programs, if any, will be returned to the status of authorized but unissued shares of Common Stock.
There were no share repurchases under the 2018 Share Repurchase Program or 2019 Share Repurchase Program during the year ended December 31, 2019. As of December 31, 2019, the Company had $200.0 million available for share repurchases under the 2019 Share Repurchase Program. During the year ended December 31, 2018, the Company repurchased 0.8 million shares of Common Stock in multiple open market transactions, at a weighted average share price of $6.95 for an aggregate purchase price of $5.6 million under the 2018 Share Repurchase Program.
Series F Preferred Stock and Series F Preferred OP Units
During the year ended December 31, 2019, the Company redeemed a total of 12.0 million shares of Series F Preferred Stock, representing approximately 28.02% of the issued and outstanding preferred shares as of the beginning of the year. The shares of Series F Preferred Stock were redeemed at a redemption price of $25.00 per share plus all accrued and unpaid dividends.
As of December 31, 2019, there were approximately 30.9 million shares of Series F Preferred Stock, approximately 30.9 million corresponding General Partner Series F Preferred Units and 49,766 Limited Partner Series F Preferred Units issued and outstanding.
Disposition Activity
As part of our effort to optimize our real estate portfolio by focusing on holding core assets, during the year ended December 31, 2019, the Company disposed of 201 properties, including the sale of six consolidated properties to the Industrial Partnership and one property sold through a foreclosure, for an aggregate gross sales price of $1.2 billion, of which our share was $1.1 billion, resulting in proceeds of $1.1 billion after closing costs and contributions to the Industrial Partnership. We expect to continue to explore opportunities to sell additional properties to provide us further financial flexibility and to fund property acquisitions.
Credit Facility
Summary and Obligations
On May 23, 2018, the Company, as guarantor, and the Operating Partnership, as borrower, entered into a Credit Agreement with Wells Fargo Bank, National Association, as administrative agent, and the other lenders party thereto that allows for maximum borrowings of $2.9 billion, originally consisting of a $2.0 billion Revolving Credit Facility and a $900.0 million Credit Facility Term Loan. Effective December 27, 2019, the Company reduced its Revolving Credit Facility capacity from $2.0 billion to $1.5 billion. At December 31, 2019, $150.0 million was outstanding under the Revolving Credit Facility and the full $900.0 million was drawn on the Credit Facility Term Loan. The maximum aggregate dollar amount of letters of credit that may be outstanding at any one time under the Credit Facility is $50.0 million. As of December 31, 2019, letters of credit outstanding were $3.9 million. Subsequent to December 31, 2019, all letters of credit outstanding were terminated.
The Revolving Credit Facility generally bears interest at an annual rate of LIBOR plus 0.775% to 1.55% or Base Rate plus 0.00% to 0.55% (based upon our then current credit rating). “Base Rate” is defined as the highest of the prime rate, the federal funds rate plus 0.50% or a floating rate based on one month LIBOR plus 1.0%, determined on a daily basis. The Credit Facility Term Loan generally bears interest at an annual rate of LIBOR plus 0.85% to 1.75%, or Base Rate plus 0.00% to 0.75% (based upon our then current credit rating). In addition, the Credit Agreement provides the flexibility for interest rate auctions, pursuant to which, at the Company’s election, the Company may request that lenders make competitive bids to provide revolving loans, which competitive bids may be at pricing levels that differ from the foregoing interest rates.
Credit Facility Covenants
The Credit Facility requires restrictions on corporate guarantees, as well as the maintenance of certain financial covenants. The key financial covenants in the Credit Facility, as defined and calculated per the terms of the Credit Agreement include maintaining the following:
The Company believes that it was in compliance with the financial covenants pursuant to the Credit Agreement and is not restricted from accessing any borrowing availability under the Credit Facility as of December 31, 2019.
Corporate Bonds
Summary and Obligations
On February 6, 2019, the Company’s 2019 Senior Notes matured and the principal outstanding balance of $750.0 million, plus accrued and unpaid interest thereon, was repaid, utilizing borrowings under the Credit Facility Term Loan.
On December 4, 2019, the Company closed a senior note offering, consisting of $600.0 million aggregate principal amount of the Operating Partnership’s 2029 Senior Notes.
On December 20, 2019, the $400.0 million 2021 Senior Notes were redeemed, and the principal plus accrued and unpaid interest thereon was repaid.
As of December 31, 2019, the Operating Partnership had $2.85 billion aggregate principal amount of Senior Notes outstanding. The indenture governing the Senior Notes requires that the Company be in compliance with certain key financial covenants, including maintaining the following:
As of December 31, 2019, the Company believes that it was in compliance with these financial covenants based on the covenant limits and calculations in place at that time.
Convertible Debt
Summary and Obligations
During the year ended December 31, 2019, the Company repurchased $80.7 million of the 2020 Convertible Notes and paid accrued and unpaid interest thereon. As of December 31, 2019, the Company had $321.8 million aggregate principal amount of the 2020 Convertible Notes outstanding. The OP has issued corresponding identical convertible notes to the General Partner. There were no changes to the terms of the 2020 Convertible Notes during the year ended December 31, 2019 and the Company believes that it was in compliance with the financial covenants pursuant to the indenture governing the 2020 Convertible Notes as of December 31, 2019.
Mortgage Notes Payable
Summary and Obligations
As of December 31, 2019, the Company had non-recourse mortgage indebtedness of $1.5 billion, which was collateralized by 355 properties, reflecting a decrease from December 31, 2018 of $388.1 million during the year ended December 31, 2019, primarily related to prepayments of mortgage notes payable. Our mortgage indebtedness bore interest at the weighted-average rate of 5.05% per annum and had a weighted-average maturity of 2.8 years. We may in the future incur additional mortgage debt on the properties we currently own or use long-term non-recourse financing to acquire additional properties.
The payment terms of our loan obligations vary. In general, only interest amounts are payable monthly with all unpaid principal and interest due at maturity. Some of our loan agreements require that we comply with specific reporting and financial covenants mainly related to debt coverage ratios and loan-to-value ratios. Each loan that has these requirements has specific ratio thresholds that must be met.
Restrictions on Loan Covenants
Our mortgage loan obligations generally restrict corporate guarantees and require the maintenance of financial covenants, including maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios), as well as the maintenance of a minimum net worth. The mortgage loan agreements contain no dividend restrictions except in the event of default or when a distribution would drive liquidity below the applicable thresholds. The Company believes that it was in compliance with the financial covenants under the mortgage loan agreements and had no restrictions on the payment of dividends as of December 31, 2019.
Derivative Activity
As discussed in Note 6 - Debt and Note 7 - Derivatives and Hedging Activities, during the year ended December 31, 2019, the Company entered into interest rate swap agreements with an aggregate $900.0 million notional amount, effective on February 6, 2019 and maturing on January 31, 2023, to hedge interest rate volatility. Due to an improvement in the Company's credit rating during the fourth quarter of 2019, the interest rate spread on the $900.0 million Credit Facility Term Loan was reduced by 25 bps to LIBOR + 1.10%, and beginning on November 1, 2019, the swap agreements effectively fixed the Credit Facility Term Loan interest rate at 3.59%.
During the year ended December 31, 2019, the Company also entered into forward starting interest rate swaps with a total notional amount of $400.0 million, which were designated as cash flow hedges to hedge the risk of changes in the interest-related cash outflows associated with the anticipated issuance of long-term debt. The Company is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 120 months (excluding forecasted transactions related to the payment of variable interest on existing financial instruments), with anticipated issuance of 10-year public debt.
Dividends
On November 5, 2019, the Company’s Board of Directors declared a quarterly cash dividend of $0.1375 per share of Common Stock (equaling an annualized dividend of $0.55 per share) for the fourth quarter of 2019 to stockholders of record as of December 31, 2019, which was paid on January 15, 2020. An equivalent distribution by the Operating Partnership is applicable per OP Unit.
Our Series F Preferred Stock, as discussed in Note 12 - Equity to our consolidated financial statements, will pay cumulative cash dividends at the rate of 6.70% per annum on their liquidation preference of $25.00 per share (equivalent to $1.675 per share on an annual basis).
Contractual Obligations
The following is a summary of our contractual obligations as of December 31, 2019 (in thousands):
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(1)
Interest payments due in future periods on the $164.4 million of variable rate debt were calculated using a forward LIBOR curve.
(2)
As of December 31, 2019, we had $900.0 million of variable rate debt on the Credit Facility Term Loan effectively fixed through the use of interest rate swap agreements. We used the interest rates effectively fixed under our swap agreements to calculate the debt payment obligations in future periods.
(3)
Includes the Company’s share of capital expenditures related to an expansion project of the property held within an unconsolidated joint venture and letters of credit outstanding. Subsequent to December 31, 2019, all letters of credit outstanding were terminated.
Cash Flow Analysis for the year ended December 31, 2019
Operating Activities - During the year ended December 31, 2019, net cash used in operating activities increased $601.5 million to $107.6 million from $493.9 million net cash provided by operating activities during the same period in 2018. The increase was primarily due to a $524.5 million increase in litigation and non-routine costs, net, including litigation settlements, paid during the year ended December 31, 2019.
Investing Activities - Net cash provided by investing activities for the year ended December 31, 2019 increased $462.1 million to $613.2 million from $151.1 million during the same period in 2018. The increase was primarily related to an increase in cash proceeds from dispositions of real estate and joint ventures of $565.2 million and a decrease in investments in real estate assets of $106.0 million, offset by a decrease in net proceeds from disposition of discontinued operations of $122.9 million, a decrease in proceeds from the sale of CMBS and mortgage notes receivables of $37.1 million and an increase in payments for capital expenditures and leasing costs and real estate developments of $34.6 million.
Financing Activities - Net cash used in financing activities of $525.4 million decreased $130.0 million during the year ended December 31, 2019 from $655.4 million during the same period in 2018. The decrease was primarily related to $1.0 billion of proceeds received from the issuance of Common Stock in 2019, offset by the redemption of $300.1 million of Series F Preferred Stock in 2019, an increase in payments on mortgage notes payable and other debt, including debt extinguishment costs of $236.2 million, and a decrease of $170.0 million in net proceeds related to the credit facilities, corporate bonds and convertible notes. In addition, during the year ended December 31, 2019, $192.0 million of payments were made related to the surrender of Limited Partner OP Units, with no comparable activity during the same period in 2018.
Please refer to the discussion in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company’s Form 10-K for the year ended December 31, 2018, filed February 21, 2019, for the cash flow analysis for the years ended December 31, 2018 and 2017.
Election as a REIT
The General Partner elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, commencing with the taxable year ended December 31, 2011. As a REIT, except as discussed below, the General Partner generally is not subject to federal income tax on taxable income that it distributes to its stockholders so long as it distributes at least 90% of its annual taxable income (computed without regard to the deduction for dividends paid and excluding net capital gains). REITs are subject to a number of other organizational and operational requirements. Even if the General Partner maintains its qualification for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, federal income taxes on certain income and excise taxes on its undistributed income. We believe we are organized and operating in such a manner as to qualify to be taxed as a REIT for the taxable year ended December 31, 2019.
The Operating Partnership is classified as a partnership for U.S. federal income tax purposes. As a partnership, the Operating Partnership is not a taxable entity for U.S. federal income tax purposes. Instead, each partner in the Operating Partnership is required to take into account its allocable share of the Operating Partnership’s income, gains, losses, deductions and credits for each taxable year. However, the Operating Partnership may be subject to certain state and local taxes on its income and property. Under the LPA, the Operating Partnership is required to conduct business in such a manner as to permit the General Partner at all times to qualify as a REIT.
As discussed in Note 14 -Discontinued Operations, on February 1, 2018, the Company completed the sale of its investment management segment, Cole Capital. The Company conducted substantially all of the Cole Capital business activities through a TRS. A TRS is a subsidiary of a REIT that is subject to corporate federal, state and local income taxes, as applicable. The Company’s use of a TRS enables it to engage in certain business activities while complying with the REIT qualification requirements and to retain any income generated by these businesses for reinvestment without the requirement to distribute those earnings. The Company conducts all of its business in the United States and Puerto Rico and, as a result, it files income tax returns in the U.S. federal jurisdiction, Puerto Rico, and various state and local jurisdictions. Certain of the Company’s inter-company transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation.
Inflation
We may be adversely impacted by inflation on any leases that do not contain indexed escalation provisions. However, net leases that require the tenant to pay its allocable share of operating expenses, including common area maintenance costs, real estate taxes and insurance, may reduce our exposure to increases in costs and operating expenses resulting from inflation.
Related Party Transactions and Agreements
Through the closing of the Cole Capital sale, we were contractually responsible for managing the Cole REITs’ affairs on a day-to-day basis. For further explanation of the various related party transactions, agreements and fees see Note 15 - Related Party Transactions and Arrangements to our consolidated financial statements in this report.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements that have had or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market Risk
The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our market risk arises primarily from interest rate risk relating to variable-rate borrowings. To meet our short and long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to manage our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, caps, collars, treasury locks, options and forwards in order to mitigate our interest rate risk with respect to various debt instruments. We would not hold or issue these derivative contracts for trading or speculative purposes.
Interest Rate Risk
As of December 31, 2019, our debt included fixed-rate debt, including debt that has interest rates that are fixed with the use of derivative instruments, with a fair value and carrying value of $5.8 billion and $5.6 billion, respectively. Changes in market interest rates on our fixed rate debt impact the fair value of the debt, but they have no impact on interest incurred or cash flow. For instance, if interest rates rise 100 basis points, and the fixed rate debt balance remains constant, we expect the fair value of our debt to decrease, the same way the price of a bond declines as interest rates rise. The sensitivity analysis related to our fixed-rate debt assumes an immediate 100 basis point move in interest rates from their December 31, 2019 levels, with all other variables held constant. A 100 basis point increase in market interest rates would result in a decrease in the fair value of our fixed rate debt of $217.6 million. A 100 basis point decrease in market interest rates would result in an increase in the fair value of our fixed-rate debt of $236.0 million.
As of December 31, 2019, our debt included variable-rate debt with a fair value and carrying value of $164.5 million and $164.4 million, respectively. The sensitivity analysis related to our variable-rate debt assumes an immediate 100 basis point move in interest rates from their December 31, 2019 levels, with all other variables held constant. A 100 basis point increase or decrease in variable interest rates on our variable-rate debt would increase or decrease our interest expense by $1.6 million annually. See Note 6 - Debt to our consolidated financial statements.
As of December 31, 2019, our interest rate swaps had a fair value that resulted in net liabilities of $27.8 million. See Note 7 - Derivatives and Hedging Activities to our consolidated financial statements for further discussion.
As the information presented above includes only those exposures that existed as of December 31, 2019, it does not consider exposures or positions arising after that date. The information presented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.
These amounts were determined by considering the impact of hypothetical interest rate changes on our borrowing costs and assume no other changes in our capital structure.
In July 2017, the FCA announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Company is not able to predict when LIBOR will cease to be available or when there will be sufficient liquidity in the SOFR markets. The Company has contracts that are indexed to LIBOR and is monitoring and evaluating the related risks, which include interest amounts on our variable rate debt as discussed in Note 6 - Debt and the swap rate for our interest rate swaps, as discussed in Note 7 - Derivatives and Hedging Activities. See Item 1A. Risk Factors for further discussion on risks related to changes in LIBOR reporting practices, the method in which LIBOR is determined, or the use of alternative reference rates.
Credit Risk
Concentrations of credit risk arise when a number of tenants are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. The Company is subject to tenant, geographic and industry concentrations. Any downturn of the economic conditions in one or more of these tenants, geographies or industries could result in a material reduction of our cash flows or material losses to us.
The factors considered in determining the credit risk of our tenants include, but are not limited to: payment history; credit status and change in status (credit ratings for public companies are used as a primary metric); change in tenant space needs (i.e., expansion/downsize); tenant financial performance; economic conditions in a specific geographic region; and industry specific credit considerations. We believe that the credit risk of our portfolio is reduced by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The information required by Item 8 is hereby incorporated by reference to our consolidated financial statements beginning on page of this document.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
I. Discussion of Controls and Procedures of the General Partner
For purposes of the discussion in this Part I of Item 9A, the “Company” refers to the General Partner.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2019 and determined that the disclosure controls and procedures were effective at a reasonable assurance level as of that date.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2019.
The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report in this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
No change occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d -15(f) of the Exchange Act) during the three months ended December 31, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
II. Discussion of Controls and Procedures of the Operating Partnership
In the information incorporated by reference into this Part II of Item 9A, the term “Company” refers to the Operating Partnership, except as the context otherwise requires.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2019 and determined that the disclosure controls and procedures were effective at a reasonable assurance level as of that date.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2019.
Changes in Internal Control Over Financial Reporting
No change occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d -15(f) of the Exchange Act) during the three months ended December 31, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of VEREIT, Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of VEREIT, Inc. and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2019, of the Company and our report dated February 25, 2020, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
Phoenix, Arizona
February 25, 2020
Item 9B.
Item 9B. Other Information.
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item will be included in our Proxy Statement, to be filed within 120 days following the end of our fiscal year, and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
Financial Statements
The Financial Statements are included herein at pages through.
Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts is included herein on page.
Schedule III - Real Estate and Accumulated Depreciation is included herein on pages through.
Schedule IV - Mortgage Loans Held for Investment is included herein on page.
Exhibits
The following exhibits are included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (and are numbered in accordance with Item 601 of Regulation S-K):
_____________________________
*
Filed herewith
**
In accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
† Management contract or compensatory plan or arrangement.
Item 16. Form 10-K Summary.
Not Applicable
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, each registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized.
VEREIT, INC.
By:
/s/ Michael J. Bartolotta
Michael J. Bartolotta
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
VEREIT OPERATING PARTNERSHIP, L.P.
By: VEREIT, Inc., its sole general partner
By:
/s/ Michael J. Bartolotta
Michael J. Bartolotta
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Dated: February 25, 2020
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Form 10-K has been signed below by the following persons on behalf of each registrant and in the capacities and on the dates indicated.
_________________________________
*
Each person is signing in his or her capacity as an officer and/or director of VEREIT, Inc., which is the sole general partner of VEREIT Operating Partnership, L.P.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of VEREIT, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of VEREIT, Inc. and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income (loss), changes in equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2020 expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Real Estate Investments - Impairments- Refer to Note 2 and Note 5 to the financial statements
Critical Audit Matter Description
The Company performs quarterly impairment review procedures, primarily through monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable. The Company assesses the recoverability of real estate assets by determining whether the carrying value of the assets will be recovered from the undiscounted future cash flows expected from the use of the assets and their eventual disposition. Estimating future undiscounted cash flows requires management to make significant estimates and assumptions, including estimating the expected holding period of the assets when assessing recoverability.
In the event that such expected undiscounted future cash flows do not exceed the carrying value, the Company will adjust the carrying value of real estate assets to their respective fair values and recognize an impairment loss. Generally, fair value is determined using a discounted cash flow analysis and recent comparable sales transactions. During 2019, the Company recorded $47.1 million of impairment charges.
We identified the impairment of real estate assets as a critical audit matter because of the significant estimates and assumptions required to evaluate the recoverability of real estate assets, including the estimated holding period of the assets when assessing recoverability. Auditing the assumptions used by the Company in estimating future undiscounted cash flows required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of the Company’s recoverability analysis.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures to test the assumptions used by management to estimate forecasted cash flows, including management’s expected holding period of such real estate assets, consisted of the following, among others:
•
We tested the effectiveness of internal controls over the inputs of the forecasted cash flows used in the recoverability analysis.
•
With the assistance of our fair value specialists, we evaluated the undiscounted future cash flows analysis, including estimates of future occupancy levels, market rental revenue, and capitalization rates, in addition to the assessment of expected remaining holding period and changes in management’s intent with respect to the expected holding period for each real estate asset with possible impairment indicators by:
1.
Making inquiries of accounting and operations management.
2.
Comparing the source data and management’s assumptions to the Company’s historical results and external market sources.
3.
Testing the mathematical accuracy of the undiscounted future cash flows analysis.
/s/ DELOITTE & TOUCHE LLP
Phoenix, Arizona
February 25, 2020
We have served as the Company’s auditor since 2015.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the partners of VEREIT Operating Partnership, L.P.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of VEREIT Operating Partnership, L.P and subsidiaries (the "Operating Partnership") as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Operating Partnership as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Operating Partnership's management. Our responsibility is to express an opinion on the Operating Partnership's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Operating Partnership in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Operating Partnership is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Operating Partnership’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ DELOITTE & TOUCHE LLP
Phoenix, Arizona
February 25, 2020
We have served as the Operating Partnership’s auditor since 2015.
VEREIT, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share data)
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share data)
_______________________________________________
(1)
Represents net loss (income) attributable to limited partners and a consolidated joint venture partner.
(2)
Amounts may not total due to rounding.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
_______________________________________________
(1)
Represents comprehensive loss (income) attributable to limited partners and a consolidated joint venture partner.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except for share data)
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY - (Continued)
(In thousands, except for share data)
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for unit data)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per unit data)
_______________________________________________
(1)
Represents net loss attributable to a consolidated joint venture partner.
(2)
Amounts may not total due to rounding.
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
_______________________________________________
(1)
Represents comprehensive loss attributable to a consolidated joint venture partner.
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except for unit data)
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY - (Continued)
(In thousands, except for unit data)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
The accompanying notes are an integral part of these statements.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 1 - Organization
VEREIT is a Maryland corporation, incorporated on December 2, 2010, that qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning in the taxable year ended December 31, 2011. The OP is a Delaware limited partnership of which the General Partner is the sole general partner. VEREIT’s common stock, par value $0.01 per share (“Common Stock”), and its 6.70% Series F Cumulative Redeemable Preferred Stock, par value $0.01 per share (“Series F Preferred Stock”) trade on the New York Stock Exchange (“NYSE”) under the trading symbols, “VER” and “VER PRF,” respectively. As used herein, the terms the “Company,” “we,” “our” and “us” refer to VEREIT, together with its consolidated subsidiaries, including the OP.
VEREIT is a full-service real estate operating company which owns and manages one of the largest portfolios of single-tenant commercial properties in the U.S. VEREIT’s business model provides equity capital to creditworthy corporations in return for long-term leases on their properties. The Company actively manages its portfolio considering a number of metrics including property type, concentration and key economic factors for appropriate balance and diversity.
Substantially all of the Company’s operations are conducted through the OP. VEREIT is the sole general partner and holder of 99.9% of the common equity interests in the OP as of December 31, 2019. Under the limited partnership agreement of the OP, as amended (the “LPA”), after holding common units of limited partner interests in the OP (“OP Units”) or Series F Preferred Units of limited partnership interests in the OP (“Series F Preferred Units”), for a period of one year and meeting the other requirements in the LPA, unless we otherwise consent to an earlier redemption, holders have the right to redeem the units for the cash value of a corresponding number of shares of Common Stock or Series F Preferred Stock, as applicable, or, at our option, a corresponding number of shares of Common Stock or Series F Preferred Stock, as applicable, subject to adjustment pursuant to the terms of the LPA. The remaining rights of the holders of OP Units are limited, however, and do not include the ability to replace the General Partner or to approve the sale, purchase or refinancing of the OP’s assets.
The actions of the OP and its relationship with the General Partner are governed by the LPA. The General Partner does not have any significant assets other than its investment in the OP. Therefore, the assets and liabilities of the General Partner and the OP are the same. Additionally, pursuant to the LPA, all administrative expenses and expenses associated with the formation, continuity, existence and operation of the General Partner incurred by the General Partner on the OP’s behalf shall be treated as expenses of the OP. Further, when the General Partner issues any equity instrument that has been approved by the General Partner’s Board of Directors, the LPA requires the OP to issue to the General Partner equity instruments with substantially similar terms, to protect the integrity of the Company’s umbrella partnership REIT structure, pursuant to which each holder of interests in the OP has a proportionate economic interest in the OP reflecting its capital contributions thereto. OP Units and Series F Preferred Units issued to the General Partner are referred to as “General Partner OP Units” and “General Partner Series F Preferred Units,” respectively. OP Units and Series F Preferred Units issued to parties other than the General Partner are referred to as “Limited Partner OP Units” and “Limited Partner Series F Preferred Units,” respectively. The LPA also provides that the OP issue debt with terms and provisions consistent with debt issued by the General Partner. The LPA will be amended to provide for the issuance of any additional class of equivalent equity instruments to the extent the General Partner’s Board of Directors authorizes the issuance of any new class of equity securities.
Note 2 - Summary of Significant Accounting Policies
Basis of Accounting
The consolidated financial statements of the Company presented herein include the accounts of the General Partner and its consolidated subsidiaries, including the OP. All intercompany transactions have been eliminated upon consolidation. The financial statements are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”).
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and its consolidated subsidiaries and a consolidated joint venture. The portion of the consolidated joint venture not owned by the Company is presented as non-controlling interest in VEREIT’s and the OP’s consolidated balance sheets, statements of operations, statements of comprehensive income (loss) and statements of changes in equity. In addition, as described in Note 1 - Organization and Note 12 - Equity, certain third parties have been issued OP Units and Series F Preferred Units. Holders of OP Units are considered to be non-controlling interest holders in the OP and their ownership interest in the limited partner’s share is presented as non-controlling interests in VEREIT’s consolidated balance sheets, statements of operations, statements of comprehensive income (loss) and statements of changes in equity. Further, a portion of the earnings and losses of the OP are allocated to non-controlling interest holders based on their respective ownership percentages. Equity is reallocated between controlling and noncontrolling interests in the OP upon a change in ownership. At the end of each reporting period, noncontrolling interests in the OP are adjusted to reflect their ownership percentage in the OP through a reallocation between controlling and noncontrolling interests in the OP, as applicable. As of December 31, 2019 and 2018, there were approximately 0.8 million and 23.7 million Limited Partner OP Units issued and outstanding, respectively, and 49,766 and 86,874 Limited Partner Series F Preferred Units issued and outstanding, respectively.
For legal entities being evaluated for consolidation, the Company must first determine whether the interests that it holds and fees it receives qualify as variable interests in the entity. A variable interest is an investment or other interest that will absorb portions of an entity’s expected losses or receive portions of the entity’s expected residual returns. The Company’s evaluation includes consideration of fees paid to the Company where the Company acts as a decision maker or service provider to the entity being evaluated. If the Company determines that it holds a variable interest in an entity, it evaluates whether that entity is a variable interest entity (“VIE”). VIEs are entities where investors lack sufficient equity at risk for the entity to finance its activities without additional subordinated financial support or where equity investors, as a group, lack one of the following characteristics: (a) the power to direct the activities that most significantly impact the entity’s economic performance, (b) the obligation to absorb the expected losses of the entity, or (c) the right to receive the expected returns of the entity.
The Company then qualitatively assesses whether it is (or is not) the primary beneficiary of a VIE, which is generally defined as the party who has a controlling financial interest in the VIE. Consideration of various factors include, but are not limited to, the Company’s ability to direct the activities that most significantly impact the entity’s economic performance and its obligation to absorb losses from or right to receive benefits of the VIE that could potentially be significant to the VIE. The Company consolidates any VIEs when the Company is determined to be the primary beneficiary of the VIE and the difference between consolidating the VIE and accounting for it using the equity method could be material to the Company’s consolidated financial statements. The Company continually evaluates the need to consolidate these VIEs based on standards set forth in U.S. GAAP.
Reclassification
The (loss) gain on derivative instruments, net line item has been combined into other income, net for prior periods presented to be consistent with the current year presentation.
Use of Estimates
The preparation of 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management makes significant estimates regarding goodwill and intangible asset impairments, real estate investment impairment, allocation of purchase price of real estate asset acquisitions and income taxes.
Real Estate Investments
The Company records acquired real estate at cost and makes assessments as to the useful lives of depreciable assets. The Company considers the period of future benefit of the asset to determine the appropriate useful lives. Depreciation is computed using a straight-line method over the estimated useful life of 40 years for buildings, five to 15 years for building fixtures and improvements and the remaining lease term for intangible lease assets.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Allocation of Purchase Price of Real Estate Assets
The Company allocates the purchase price of acquired properties to tangible and identifiable intangible assets and liabilities acquired based on their relative fair values. Tangible assets include land, buildings, fixtures and improvements on an as-if vacant basis. The Company utilizes various estimates, processes and information to determine the as-if vacant property value. Identifiable intangible assets and liabilities include amounts allocated to acquired leases for above-market and below-market lease rates and the value of in-place leases. In estimating fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other market data. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, as well as subsequent marketing and leasing activities, in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.
The aggregate value of intangible assets related to in-place leases is primarily the difference between the property valued with existing in-place leases adjusted to market rental rates and the property valued as if vacant. Factors considered by the Company in its analysis of the in-place lease intangibles include an estimate of carrying costs during the expected lease-up period for each property, taking into account current market conditions and costs to execute similar leases. In estimating carrying costs, the Company includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up period, which typically ranges from six to 18 months. The Company also estimates costs to execute similar leases, including leasing commissions, legal and other related expenses. The value of in-place leases is amortized over the initial term of the respective leases. If a tenant terminates its lease, then the unamortized portion of the in-place lease value is charged to expense.
Above-market and below-market in-place lease values for owned properties are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be paid pursuant to the in-place leases and management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease, including any bargain renewal periods. Above-market leases are amortized as a reduction to rental revenue over the remaining terms of the respective leases. Below-market leases are amortized as an increase to rental revenue over the remaining terms of the respective leases, including any bargain renewal periods.
The determination of the fair values of the real estate assets and liabilities acquired requires the use of significant assumptions with regard to the current market rental rates, rental growth rates, capitalization and discount rates, interest rates and other variables. The use of alternative estimates may result in a different allocation of the Company’s purchase price, which could materially impact the Company’s results of operations.
During the years ended December 31, 2019, 2018 and 2017, all real estate acquisitions qualified as asset acquisitions, and external acquisition costs related to asset acquisitions were capitalized and allocated to tangible and intangible assets and liabilities as described above. Internal costs, such as employee salaries, related to activities necessary to complete, or affect, self-originating asset acquisitions or business combinations are classified as acquisition-related expenses in the accompanying consolidated statements of operations for all periods presented.
Assets Held for Sale
Upon classifying a real estate investment as held for sale, the Company will no longer recognize depreciation expense related to the depreciable assets of the property. Assets held for sale are recorded at the lower of carrying value or estimated fair value, less the estimated cost to dispose of the assets. See Note 3- Real Estate Investments and Related Intangibles for further discussion regarding properties held for sale.
If circumstances arise that the Company previously considered unlikely and, as a result, the Company decides not to sell a property previously classified as held for sale, the Company will reclassify the property as held and used. The Company measures and records a property that is reclassified as held and used at the lower of (i) its carrying value before the property was classified as held for sale, adjusted for any depreciation expense that would have been recognized had the property been continuously classified as held and used or (ii) the estimated fair value at the date of the subsequent decision not to sell.
Development Activities
Project costs, which include interest expense, associated with the development, construction and lease-up of a real estate project are capitalized as construction in progress. Once the development and construction of the building is substantially completed, the amounts capitalized to construction in progress are transferred to (i) land and (ii) buildings, fixtures and improvements and are depreciated over their respective useful lives.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Discontinued Operations
The Company reports discontinued operations when a component of an entity or group of components that has been disposed of or classified as held for sale represents a strategic shift that has or will have a major effect on an entity’s operations and financial results. The results of operations for assets meeting the definition of discontinued operations are reflected in the Company’s consolidated statements of operations as discontinued operations for all periods presented. See Note 14 - Discontinued Operations for further discussion regarding discontinued operations.
Investment in Unconsolidated Entities
Unconsolidated Joint Ventures
The Company accounts for its investment in unconsolidated joint venture arrangements using the equity method of accounting as the Company has the ability to exercise significant influence, but not control, over operating and financing policies of these investments. The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the joint ventures’ earnings and distributions. The Company records its proportionate share of net income (loss) from the unconsolidated joint ventures in equity in income and gain on disposition of unconsolidated entities in the consolidated statements of operations. See Note 3- Real Estate Investments and Related Intangibles for further discussion on investments in unconsolidated joint ventures.
Investment in Cole REITs
On February 1, 2018, the Company sold certain of its equity investments to CCA Acquisition, LLC (the “Cole Purchaser”), an affiliate of CIM Group, LLC, retaining interests retaining interests in Cole Office & Industrial REIT (CCIT II), Inc. (“CCIT II”), Cole Office & Industrial REIT (CCIT III), Inc. (“CCIT III”) and Cole Credit Property Trust V, Inc. (“CCPT V”). Subsequent to the sale of Cole Capital, the Company carries these investments at fair value, as the Company does not exert significant influence over CCIT II, CCIT III or CCPT V, and any changes in the fair value are recognized in other income, net in the accompanying consolidated statement of operations for the years ended December 31, 2019 and 2018. Prior to the sale of Cole Capital, the Company accounted for these investments using the equity method of accounting, which required the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the respective Cole REIT’s earnings and distributions. The Company recorded its proportionate share of net income or loss from the Cole REITs in equity in income and gain on disposition of unconsolidated entities in the consolidated statement of operations for the year ended December 31, 2017.
Leasehold Improvements and Property and Equipment
The Company leases its corporate office facilities under operating leases. Leasehold improvements related to these are recorded at cost less accumulated amortization. Leasehold improvements are amortized over the lesser of the estimated useful life or remaining lease term.
Property and equipment, which typically include computer hardware and software, furniture and fixtures, among other items, are stated at cost less accumulated depreciation. Property and equipment are depreciated on a straight-line method over the estimated useful lives of the assets, which range from three to seven years. The Company reassesses the useful lives of its property and equipment and adjusts the future monthly depreciation expense based on the new useful life, as applicable. If the Company disposes of an asset, the asset and related accumulated depreciation are written off upon disposal.
Goodwill
In the case of a business combination, after identifying all tangible and intangible assets and liabilities, the excess consideration paid over the fair value of the assets and liabilities acquired and assumed, respectively, represents goodwill. In connection with prior mergers, the Company recorded goodwill as a result of the merger consideration exceeding the net assets acquired. As of December 31, 2019 and 2018, the carrying value of goodwill was $1.3 billion.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Impairments
Real Estate Assets
The Company performs quarterly impairment review procedures, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable. Impairment indicators that the Company considers include, but are not limited to, decrease in net operating income, bankruptcy or other credit concerns of a property’s major tenant or tenants, such as history of late payments, rental concessions and other factors, as well as significant decreases in a property’s revenues due to lease terminations, vacancies, co-tenancy clauses or reduced lease rates. When impairment indicators are identified or if a property is considered to have a more likely than not probability of being disposed of within the next 12 to 24 months, the Company assesses the recoverability of the assets by determining whether the carrying value of the assets will be recovered through the undiscounted future cash flows expected from the use of the assets and their eventual disposition. U.S. GAAP requires us to utilize the Company’s expected holding period of our properties when assessing recoverability. In the event that such expected undiscounted future cash flows do not exceed the carrying value, the Company will adjust the real estate assets to their respective fair values and recognize an impairment loss. Generally, fair value is determined using a discounted cash flow analysis and recent comparable sales or leasing transactions. The assumptions and uncertainties utilized in the evaluation of the impairment of real estate assets are discussed in Note 5 - Fair Value Measures.
Goodwill
The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable. To determine whether it is necessary to perform a quantitative goodwill impairment test, the Company first assesses qualitative factors, including, but not limited to macro-economic conditions such as deterioration in the entity's operating environment or industry or market considerations; entity-specific events such as increasing costs, declining financial performance, or loss of key personnel; or other events such as an expectation that a reporting unit will be sold or a sustained decrease in the stock price on either an absolute basis or relative to peers. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not (i.e. greater than 50% chance) that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no quantitative testing is required. If it is determined, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value is less than the carrying amount, the provisions of guidance require that the Company then compares the fair value to the carrying value. Goodwill is considered impaired if the carrying value exceeds the fair value.
The Company performed the annual qualitative assessment for goodwill during the fourth quarter of 2019. As a result of the qualitative testing, the Company believes that it is more-likely-than-not that the fair value of the goodwill is greater than the carrying value. As such, no further testing was performed. The Company performed a quantitative analysis for the annual goodwill tests during the years ended December 31, 2018 and 2017, which also resulted in no impairments.
Investment in Unconsolidated Joint Ventures
The Company is required to determine whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of any of its investment in the unconsolidated joint ventures. If an event or change in circumstance has occurred, the Company is required to evaluate its investment in the unconsolidated joint venture for potential impairment and determine if the carrying value of its investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until the carrying value is fully recovered. The evaluation of an investment in an unconsolidated joint venture for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. The use of different judgments and assumptions could result in different conclusions. No impairments of unconsolidated joint ventures were identified during the years ended December 31, 2019, 2018 and 2017.
Leasehold Improvements and Property and Equipment
Leasehold improvements and property and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If this review indicates that the carrying value of the asset is not recoverable, the Company records an impairment loss, measured at fair value by estimated discounted cash flows or market appraisals. The evaluation of leasehold improvements and property and equipment for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. The use of different judgments and assumptions could result in different conclusions. No impairments of leasehold improvements and property and equipment were identified during the years ended December 31, 2019, 2018 and 2017.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Cash and Cash Equivalents
Cash and cash equivalents include cash in bank accounts, as well as investments in highly-liquid money market funds with original maturities of three months or less. The Company deposits cash with several high quality financial institutions. These deposits are guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) up to an insurance limit of $250,000. At times, the Company’s cash and cash equivalents may exceed federally insured levels. Although the Company bears risk on amounts in excess of those insured by the FDIC, it has not experienced and does not anticipate any losses due to the high quality of the institutions where the deposits are held.
Restricted Cash
The Company had $21.0 million and $22.9 million, respectively, in restricted cash as of December 31, 2019 and 2018. Restricted cash primarily consists of reserves related to lease expirations, as well as maintenance, structural and debt service reserves. In accordance with certain debt agreements, rent from certain of the Company’s tenants is deposited directly into a lockbox account, from which the monthly debt service payments are disbursed to the lender and the excess funds are then disbursed to the Company. Included in restricted cash at December 31, 2019 was $18.8 million in lender reserves and $2.2 million held in restricted lockbox accounts. Included in restricted cash at December 31, 2018 was $21.5 million in lender reserves and $1.4 million held in restricted lockbox accounts.
Deferred Financing Costs
Deferred financing costs represent commitment fees, legal fees and other costs associated with obtaining commitments for financing. Deferred financing costs, other than those associated with the Revolving Credit Facility (as defined in Note 6 - Debt ), are presented on the consolidated balance sheets as a direct deduction from the carrying amount of the related debt liability rather than as an asset. Deferred financing costs related to the Revolving Credit Facility are included in rent and tenant receivables and other assets, net in the accompanying consolidated balance sheets. These costs are amortized to interest expense over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing costs are written off when the associated debt is refinanced or repaid before maturity. Costs incurred in connection with potential financial transactions that are not completed are expensed in the period in which it is determined the financing will not be completed.
Convertible Debt
The Company has an outstanding aggregate balance of $321.8 million related to the 2020 Convertible Notes (as defined in Note 6 - Debt ). The 2020 Convertible Notes are convertible into cash or shares of the Company’s Common Stock at the Company’s option. In accordance with U.S GAAP, the 2020 Convertible Notes are accounted for as a liability with a separate equity component recorded for the conversion option. A liability was recorded for the 2020 Convertible Notes on the issuance date at fair value based on a discounted cash flow analysis using current market rates for debt instruments with similar terms. The difference between the initial proceeds from the 2020 Convertible Notes and the estimated fair value of the debt instruments resulted in a debt discount, with an offset recorded to additional paid-in capital representing the equity component. The debt discount is being amortized to interest expense over the respective term of the 2020 Convertible Notes.
Derivative Instruments
The Company may use derivative financial instruments, including interest rate swaps, caps, collars, treasury locks, options and forwards to hedge all or a portion of the interest rate risk associated with its borrowings. The Company’s interest rate management objectives are intended to limit the impact of interest rate fluctuations on earnings and cash flows and to manage the Company’s overall borrowing costs. To accomplish this objective, the Company primarily uses interest rate swaps as part of its cash flow hedging strategy. Interest rate swaps designated as cash flow hedges are used to hedge forecasted issuances of fixed rate debt and the variable cash flows associated with floating rate debt. The Company does not intend to utilize derivatives for purposes other than interest rate risk management. The use of derivative financial instruments carries certain risks, including the risk that the counterparties to these contractual arrangements are not able to perform under the agreements. To mitigate this risk, the Company only enters into derivative financial instruments with counterparties with high credit ratings and with major financial institutions with which the Company may also have other financial relationships. The Company does not anticipate that any of the counterparties will fail to meet their obligations.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The Company records all derivatives on the consolidated balance sheets at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
The accounting for subsequent changes in the fair value of these derivatives depends on whether each has been designated and qualifies for hedge accounting treatment. If the Company elects not to apply hedge accounting treatment, any changes in the fair value of these derivative instruments is recognized immediately in other income, net in the consolidated statements of operations and consolidated statements of comprehensive income (loss). If the derivative is designated and qualifies for hedge accounting treatment, the change in fair value of the derivative is recorded in other comprehensive income (loss). Unrealized gains and losses in other comprehensive income (loss) are reclassified to interest expense when the related hedged items impact earnings. See Note 7 - Derivatives and Hedging Activities for further discussion.
Leases
ASC 842 (effective January 1, 2019)
The adoption of ASC 842, effective January 1, 2019, did not have a material impact on the Company’s consolidated statements of operations. The most significant impact was the recognition of operating lease right-of-use (“ROU”) assets and operating lease liabilities for operating leases pursuant to which the Company is the lessee. The Company did not have a cumulative effect adjustment to retained earnings upon adoption. The lessor accounting model under ASC 842 is similar to existing guidance, however, it limits the capitalization of initial direct leasing costs, such as internally generated costs, and modifies the lease classification criteria through the elimination of "bright-line" tests.
The Company elected the package of practical expedients permitted under ASC 842 (which included: (i) an entity need not reassess whether any expired or existing contracts are or contain leases, (ii) an entity need not reassess the lease classification for any expired or existing leases, and (iii) an entity need not reassess initial direct costs for any existing leases), the land easement practical expedient to carry forward existing accounting treatment on existing land easements, the practical expedient which allows a lessee to combine lease and non-lease components, and the short-term lease election that allows a lessee not to apply the balance sheet recognition requirements to leases with a term of 12 months or less. The Company elected not to apply the practical expedients related to hindsight or assessing impairment of ROU assets.
Lessor (effective January 1, 2019)
At the inception of a new lease arrangement, including new leases that arise from amendments, the Company assesses the terms and conditions to determine the proper lease classification. When the terms of a lease effectively transfer control of the underlying asset, the lease is classified as a sales-type lease. When a lease does not effectively transfer control of the underlying asset to the lessee, but the Company obtains a guarantee for the value of the asset from a third party, the Company classifies the lease as a direct financing lease. All other leases are classified as operating leases.
Prior to the adoption of ASC 842, the Company has acquired certain properties that are subject to leases that qualified as direct financing leases. Investments in direct financing leases represent the fair value of the remaining lease payments on the leases and the estimated fair value of any expected residual property value at the end of the lease term. The fair value of the remaining lease payments is estimated using a discounted cash flow analysis based on interest rates that would represent the Company’s incremental borrowing rate for similar types of debt. The expected residual property value at the end of the lease term is estimated using market data and assessments of the remaining useful lives of the properties at the end of the lease terms, among other factors. Income from direct financing leases is calculated using the effective interest method over the remaining term of the lease. The Company does not have any sales-type leases as of December 31, 2019.
For operating leases with minimum scheduled rent increases, the Company recognizes rental revenue on a straight-line basis, including the effect of any free rent periods, over the lease term when collectability of lease payments is probable. Variable lease payments are recognized as rental revenue in the period when the changes in facts and circumstances on which the variable lease payments are based occur. Variable lease payments, including contingent rent, which is paid by a tenant when the tenant's sales exceed an agreed upon minimum amount, are recognized once tenant sales exceed contractual tenant lease thresholds and is calculated by multiplying the sales in excess of the minimum amount by a percentage defined in the lease.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The Company, as lessor, identified three separate lease components as follows: i) land lease component, ii) single property lease component comprised of building, land improvements and tenant improvements, and iii) furniture and fixtures. The Company’s leases also contain provisions for tenants to reimburse the Company for real estate taxes and insurance, which are considered noncomponents of the lease, and maintenance and other property operating expenses, which are considered to be non-lease components. The Company elected the practical expedient to combine lease and non-lease components and the non-lease components will be included with the single property lease component as the predominant component.
The Company continually reviews receivables related to rent, straight-line rent and property operating expense reimbursements and determines collectability by taking into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. The review includes a binary assessment of whether or not substantially all of the amounts due under a tenant’s lease agreement are probable of collection. For leases that are deemed probable of collection, revenue continues to be recorded on a straight-line basis over the lease term. For leases that are deemed not probable of collection, revenue is recorded as cash is received. The Company recognizes all changes in the collectability assessment for an operating lease as an adjustment to rental income and does not record an allowance for uncollectible accounts.
Rental revenue also includes lease termination income collected from tenants to allow for the tenant to vacate their space prior to their scheduled termination dates, as well as amortization of above and below-market leases.
Lessee (effective January 1, 2019)
To account for leases for which the Company is the lessee, contracts must be analyzed upon inception to determine if the arrangement is, or contains, a lease. A lease conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Lease classification tests and measurement procedures are performed at the lease commencement date.
The lease liability is initially measured as the present value of the lease payments over the lease term, discounted using the interest rate implicit in the lease, if that rate is readily determinable; otherwise, the lessee’s incremental borrowing rate is used. The incremental borrowing rate is determined based on the estimated rate of interest that the lessee would pay to borrow on a collateralized basis over a similar term at an amount equal to the lease payments in a similar economic environment. The lease term is the noncancelable period of the lease and includes any renewal and termination options the Company is reasonably certain to exercise. The lease liability balance is amortized using the effective interest method. The lease liability is remeasured when the contract is modified, upon the resolution of a contingency such that variable payments become fixed or if the assessment of exercising an extension, termination or purchase option changes.
The ROU asset balance is initially measured as the lease liability amount, adjusted for any lease payments made prior to the commencement date, initial direct costs, estimated costs to dismantle, remove, or restore the underlying asset and incentives received.
The Company’s impairment assessment for ROU assets is consistent with the impairment analysis for the Company's other long-lived assets and is reviewed quarterly.
Policy applicable to periods prior to January 1, 2019
The accounting policy for leases in which the Company is the lessor or lessee prior to the adoption of ASC 842 can be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2018.
Revenue Recognition
In May 2014, the U.S. Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) (Topic 606), which requires an entity to recognize revenue in a way that depicts 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. Revenues generated through leasing arrangements are within the scope of ASC 842, as discussed above, and are excluded from Topic 606.
Revenue Recognition - Cole Capital
As discussed in Note 14 - Discontinued Operations, on February 1, 2018, the Company completed the sale of its investment management segment, Cole Capital. The assets, liabilities and related financial results of substantially all of the Cole Capital segment are reflected in the financial statements as discontinued operations.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Cole Capital earned securities sales commissions, dealer manager fees, distribution and stockholder servicing fees, real estate acquisition fees, financing coordination fees, property management fees, advisory fees, asset management fees and performance fees for services relating to the Cole REITs’ offerings and the investment and management of their respective assets, in accordance with the respective dealer manager and advisory agreements. The Company was also reimbursed for certain costs incurred in providing these services, which were recorded as revenue as the expenses were incurred subject to revenue constraint due to the limitations on the amount that was reimbursable based on the terms of the respective dealer manager and advisory agreements. Refer to Note 15 - Related Party Transactions and Arrangements for a disaggregation of Cole Capital revenues.
The Company entered into a services agreement (the “Services Agreement”) with the Cole Purchaser, pursuant to which the Company will continue to provide certain services to the Cole Purchaser and the Cole REITs, including operational real estate support, (“Transition Services Revenues”) through March 31, 2019 (or, if later, the date of the last government filing other than a tax filing made by any of the Cole REITs with respect to its 2018 fiscal year). Under the terms of the Services Agreement, the Company will be entitled to receive reimbursement for certain of the services provided. The Company recorded Transition Services Revenues as costs associated with providing such services were incurred, which coincided with the timing in which the performance obligations of the contract had been met. During the year ended December 31, 2019 the Company incurred $2.1 million of such costs and recognized revenues of $2.4 million, including acquisition fees, and during the period from February 1, 2018 through December 31, 2018, the Company incurred $15.0 million of such costs and recognized revenues of $15.0 million, which are recorded in other income, net in the consolidated statement of operations. The Company may also earn additional fees in each calendar year through December 31, 2023 if future revenues of Cole Capital exceed a specified dollar threshold in a calendar year (the “Net Revenue Payments”), up to an aggregate of $80.0 million in Net Revenue Payments.
Litigation and non-routine costs, net
The Company has incurred legal fees and other costs associated with litigations and investigations resulting from the Audit Committee Investigation (defined below), which are considered non-routine. The Company’s insurance carriers have paid certain defense costs subject to standard reservation of rights under the respective policies.
Litigation and non-routine costs, net include the following costs and recoveries (amounts in thousands):
___________________________________
(1)
Includes all fees and costs associated with various litigations and investigations prompted by the results of the 2014 investigation conducted by the audit committee (the “Audit Committee”) of the Company’s Board of Directors (the “Audit Committee Investigation”), including fees and costs incurred pursuant to the Company’s advancement obligations, litigation related thereto and in connection with related insurance recovery matters, net of accrual reversals.
(2)
Includes legal fees and expenses associated with litigation resulting from prior mergers and excludes amounts presented in income from discontinued operations, net of income taxes in the consolidated statements of operations for the year ended December 31, 2018.
(3)
Refer to Note 10 - Commitments and Contingencies for additional information.
(4)
The negative balance for the year ended December 31, 2017 is a result of estimated costs accrued in prior periods that exceeded actual expenses incurred.
(5)
$2.3 million during the year ended December 31, 2018 relates to litigation resulting from prior mergers.
(6)
Represents the surrender of 2.9 million Limited Partner OP Units. Refer to Note 12 - Equity for additional information.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Loss Contingencies
The Company records a liability in the consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount is reasonably estimable. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a material loss is reasonably possible but not known or probable, and is reasonably estimable, the estimated loss or range of loss is disclosed.
Equity-based Compensation
The Company has an equity-based incentive award plan (the “Equity Plan”) for non-executive directors, officers, other employees and advisors or consultants who provide services to the Company, as applicable, and a non-executive director restricted share plan, which are accounted for under U.S. GAAP for share-based payments. The expense for such awards is recognized over the vesting period or when the requirements for exercise of the award have been met. See Note 13- Equity-based Compensation for additional information on these plans.
Restructuring
During the year ended December 31, 2019, the Company’s obligation to provide certain initial transition services for the Cole Purchaser terminated in accordance with the terms of the Services Agreement and the Company recorded $10.5 million of restructuring expenses related to the reorganization of its business, of which $9.2 million related to office lease terminations and modifications and $1.8 million related to the cessation of services under the Services Agreement, including severance, net of ASC 842 operating lease adjustments of $0.5 million. No restructuring expenses were recorded prior to January 1, 2019 in connection with the sale.
Per Share Data
Income (loss) per basic share of Common Stock is calculated by dividing net income (loss) less dividends on unvested restricted shares of Common Stock (“Restricted Shares”) and dividends on preferred stock by the weighted-average number of shares of Common Stock issued and outstanding during such period. Diluted income (loss) per share of Common Stock considers the effect of potentially dilutive shares of Common Stock outstanding during the period.
Income Taxes
The General Partner elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code commencing with the taxable year ended December 31, 2011. We believe we are organized and operating in such a manner as to qualify to be taxed as a REIT for the taxable year ended December 31, 2019. As a REIT, the General Partner is generally not subject to federal income tax on taxable income that it distributes to its stockholders so long as it distributes at least 90% of its annual taxable income (computed without regard to the deduction for dividends paid and excluding net capital gains). However, the General Partner, its taxable REIT subsidiaries (“TRS”) entities, and the OP are still subject to certain state and local income, franchise and property taxes in the various jurisdictions in which they operate. The General Partner may also be subject to federal income taxes on certain income and excise taxes on its undistributed income.
The OP is classified as a partnership for U.S. federal income tax purposes. As a partnership, the OP is not a taxable entity for U.S. federal income tax purposes. Instead, each partner in the OP is required to include its allocable share of the OP’s income, gains, losses, deductions and credits for each taxable year. Under the LPA, the OP is to conduct business in such a manner as to permit the General Partner at all times to qualify as a REIT.
A TRS is a subsidiary of a REIT that is subject to federal, state and local income taxes, as applicable. The Company’s use of a TRS enables it to engage in certain business activities while complying with the REIT qualification requirements and to retain any income generated by these businesses for reinvestment without the requirement to distribute those earnings. The Company conducted substantially all of the Cole Capital business activities through a TRS until it sold the Cole Capital business on February 1, 2018.
During the year ended December 31, 2019, the Company conducted all of its business in the United States and Puerto Rico and filed income tax returns in the U.S. federal jurisdiction, Puerto Rico, and various state and local jurisdictions. With few exceptions, the Company is no longer subject to routine examinations by taxing authorities for years before 2015. Certain of the Company’s intercompany transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation.
The Company provides for income taxes in accordance with current authoritative accounting and tax guidance. The tax provision or benefit related to significant or unusual items is recognized in the quarter in which those items occur. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the quarter in which the change occurs. The accounting
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
estimates used to compute the provision for or benefit from income taxes may change as new events occur, additional information is obtained or the tax environment changes.
During the years ended December 31, 2019, 2018 and 2017, the Company recognized state and local income and franchise tax expense of $4.3 million, $4.7 million and $6.9 million, respectively, which are included in provision for income taxes in the accompanying consolidated statements of operations. In addition, the Company recorded a provision for federal income taxes of $0.4 million for the year ended December 31, 2018 related to a TRS entity, which is also included in provision for income taxes in the accompanying consolidated statements of operations. No provision for federal income taxes related to a TRS entity was recorded for the years ended December 31, 2019 or 2017. The provision for or benefit from income taxes attributable to the Cole Capital business, substantially all of which was conducted through a TRS entity, is included in discontinued operations for all periods presented, as discussed in Note 14 - Discontinued Operations.
The Company had no unrecognized tax benefits as of or during the years ended December 31, 2019, 2018 and 2017. Any interest and penalties related to unrecognized tax benefits would be recognized in provision for income taxes in the accompanying consolidated statements of operations.
As of December 31, 2019, the OP and the General Partner had no material uncertain income tax positions.
Recent Accounting Pronouncements
Financial Instruments - Credit Losses
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) and subsequent amendments to the initial guidance, intended to clarify and improve certain topics, under ASU 2018-19, ASU 2019-04, ASU 2019-05 and ASU 2019-11 (collectively Topic 326). Topic 326 is intended to improve financial reporting by requiring more timely recognition of credit losses on loans and other financial instruments that are not accounted for at fair value through net income and requires that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The amendments in Topic 326 require the Company to measure all expected credit losses based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets and eliminates the “incurred loss” methodology under current U.S. GAAP. The effective date for Topic 326 is for fiscal years (including the interim periods therein) beginning after December 15, 2019. Topic 326 must be adopted by applying a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company does not expect Topic 326 will have a material impact on its consolidated financial statements upon adoption during the first quarter of 2020.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Note 3- Real Estate Investments and Related Intangibles
Property Acquisitions
During the year ended December 31, 2019, the Company acquired controlling financial interests in 66 commercial properties for an aggregate purchase price of $403.6 million (the “2019 Acquisitions”), which includes $2.3 million of external acquisition-related expenses that were capitalized. Additionally, the Company placed in service one build-to-suit development project in which the Company invested $27.6 million, including $0.7 million of external acquisition-related expenses and interest that were capitalized and including the land parcel acquired during the year ended December 31, 2018.
During the year ended December 31, 2018, the Company acquired a controlling interest in 52 commercial properties for an aggregate purchase price of $502.7 million (the “2018 Acquisitions”), which includes one land parcel for build-to-suit development, $2.1 million related to an outstanding tenant improvement allowance and $2.6 million of external acquisition-related expenses that were capitalized.
During the year ended December 31, 2017, the Company acquired a controlling interest in 88 commercial properties and three land parcels for an aggregate purchase price of $748.8 million (the “2017 Acquisitions”), which includes $3.3 million of external acquisition-related expenses that were capitalized and includes 22 properties acquired in a nonmonetary exchange discussed below.
The following table presents the allocation of the fair values of the assets acquired and liabilities assumed during the periods presented (in thousands):
____________________________________
(1)
The weighted average amortization period for acquired in-place leases and other intangibles is 16.5 years, 16.3 years and 15.8 years for 2019 Acquisitions, 2018 Acquisitions and 2017 Acquisitions, respectively.
(2)
The weighted average amortization period for acquired above-market leases is 10.8 years and 18.0 years for 2018 Acquisitions and 2017 Acquisitions, respectively.
(3)
The weighted average amortization period for assumed intangible lease liabilities is 9.9 years and 13.8 years for 2018 Acquisitions and 2017 Acquisitions, respectively.
Property Dispositions and Real Estate Assets Held for Sale
During the year ended December 31, 2019, the Company disposed of 201 properties, including the sale of six consolidated properties to two newly-formed joint ventures in which the Company owns a 20% equity interest (the “Industrial Partnership”) and one property sold through a foreclosure as discussed in Note 6 - Debt, for an aggregate gross sales price of $1.2 billion, of which our share was $1.1 billion after the profit participation payments related to the disposition of 36 Red Lobster properties. The dispositions resulted in proceeds of $1.1 billion after closing costs and contributions to the Industrial Partnership. The Company recorded a gain of $293.9 million related to the dispositions, which is included in gain on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
During the year ended December 31, 2018, the Company disposed of 149 properties, including one property conveyed to a lender in a deed-in-lieu of foreclosure transaction, for an aggregate gross sales price of $526.4 million, of which our share was $504.3 million after the profit participation payment related to the disposition of 34 Red Lobster properties. The dispositions resulted in proceeds of $496.7 million after closing costs. The Company recorded a gain of $96.2 million related to the sales which is included in gain on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
During the year ended December 31, 2018, the Company also disposed of one property owned by an unconsolidated joint venture for a gross sales price of $34.1 million, of which our share was $17.1 million based on our ownership interest in the joint venture, resulting in proceeds of $5.6 million after debt repayments of $20.4 million and closing costs. The Company recorded a gain of $0.7 million related to the sale and liquidation of the joint venture, which is included in equity in income and gain on disposition of unconsolidated entities in the accompanying consolidated statements of operations.
During the year ended December 31, 2017, the Company disposed of 137 properties, including one property owned by a consolidated joint venture, six properties transferred to the lender in either a deed-in-lieu of foreclosure or foreclosure sale transaction as discussed in Note 6 - Debt and 15 properties disposed of in connection with a nonmonetary exchange discussed below, for an aggregate gross sales price of $594.9 million, of which our share was $574.4 million after the profit participation payment related to the disposition of 31 Red Lobster properties and the consolidated joint venture partner’s share of the sales price. The dispositions resulted in proceeds of $445.5 million after a mortgage loan assumption of $66.0 million and closing costs. Additionally, the Company’s tax provision for the year ended December 31, 2017 included $1.7 million of Canadian tax gain on the sale of certain Canadian properties. The Company recorded a gain of $64.7 million, which is included in gain on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
As of December 31, 2019, there were five properties classified as held for sale with a carrying value of $27.0 million, included in real estate assets held for sale, net, primarily comprised of land of $6.3 million and building, fixtures and improvements, net of $19.8 million, in the accompanying consolidated balance sheets, which are expected to be sold in the next 12 months as part of the Company’s portfolio management strategy. As of December 31, 2018, there were five properties classified as held for sale. During the years ended December 31, 2019, 2018 and 2017, the Company recorded losses of $1.3 million, $1.9 million and $3.1 million respectively, related to held for sale properties.
Intangible Lease Assets and Liabilities
Intangible lease assets and liabilities of the Company consisted of the following as of December 31, 2019 and December 31, 2018 (amounts in thousands, except weighted-average useful life):
The aggregate amount of amortization of above- and below-market leases and deferred lease incentives included as a net decrease to rental revenue was $2.5 million, $4.2 million and $5.4 million for the years ended December 31, 2019, 2018 and 2017, respectively. The aggregate amount of in-place leases, leasing commissions and other lease intangibles amortized and included in depreciation and amortization expense was $127.5 million, $139.6 million and $154.2 million for the years ended December 31, 2019, 2018 and 2017, respectively.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The following table provides the projected amortization expense and adjustments to rental revenue related to the intangible lease assets and liabilities for the next five years as of December 31, 2019 (amounts in thousands):
Nonmonetary Exchange
During the year ended December 31, 2017, the Company completed a nonmonetary exchange through the simultaneous acquisition of 22 Bob Evans properties and disposition of 15 Red Lobster properties. Pursuant to Nonmonetary Transactions, ASC (Topic 845), the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset is the fair value of the asset surrendered to obtain the acquired nonmonetary asset, and a gain or loss should be recognized on the exchange. The fair value of the asset received should be used to measure the cost if the fair value of the asset received is more reliable than the fair value of the asset surrendered. The Company estimated the fair value of the Bob Evans and Red Lobster properties using valuation techniques consistent with the income approach and concluded that the fair value was $50.1 million. As the fair value of the assets received exceeded the book value of the assets surrendered, the Company recorded a gain of $7.4 million, which is included in gain on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
Consolidated Joint Ventures
The Company had an interest in one consolidated joint venture that owned one property as of December 31, 2019 and December 31, 2018. As of each of December 31, 2019 and December 31, 2018, the consolidated joint venture had total assets of $32.5 million, of which $29.6 million and $29.9 million, respectively, were real estate investments, net of accumulated depreciation and amortization at each of the respective dates. The property is secured by a mortgage note payable, which is non-recourse to the Company and had a balance of $14.3 million and $14.0 million as of December 31, 2019 and December 31, 2018, respectively. The Company has the ability to control operating and financing policies of the consolidated joint venture. There are restrictions on the use of these assets as the Company would generally be required to obtain the approval of the joint venture partner in accordance with the joint venture agreement for any major transactions. The Company and the joint venture partner are subject to the provisions of the joint venture agreement, which includes provisions for when additional contributions may be required to fund certain cash shortfalls.
Unconsolidated Joint Ventures
The Company’s investment in unconsolidated joint ventures consisted of interests in the Industrial Partnership and one unconsolidated joint venture as of December 31, 2019 and an interest in one unconsolidated joint venture as of December 31, 2018.
During the year ended December 31, 2018, the Company disposed of one property owned by an unconsolidated joint venture as previously discussed in the “Property Dispositions and Real Estate Assets Held for Sale” section herein.
The unconsolidated joint ventures had total aggregate debt outstanding of $269.3 million as of December 31, 2019, which is non-recourse to the Company, as discussed in Note 6 - Debt. There was no debt outstanding related to the unconsolidated joint ventures as of December 31, 2018.
The Company and the respective unconsolidated joint venture partners are subject to the provisions of the applicable joint venture agreement, which includes provisions for when additional contributions may be required to fund certain cash shortfalls, including the Company’s share of expansion project capital expenditures. The following is a summary of the Company’s investments in unconsolidated joint ventures as of December 31, 2019, December 31, 2018 and for the years ended December 31, 2019, 2018 and 2017 (dollar amounts in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
____________________________________
(1)
The total carrying amount of the investments was greater than the underlying equity in net assets by $4.7 million as of December 31, 2019 and December 31, 2018. This difference relates to a purchase price allocation of goodwill and a step up in fair value of the investment assets acquired in connection with mergers. The step up in fair value was allocated to the individual investment assets and is being amortized in accordance with the Company’s depreciation policy.
(2)
During the years ended December 31, 2018 and December 31, 2017, the Company recognized $0.7 million and $0.2 million, respectively, of equity in income and gain on disposition of unconsolidated entities from the unconsolidated joint venture which disposed of its property during the year ended December 31, 2018.
(3)
The Company’s ownership interest reflects its legal ownership interest. Legal ownership may, at times, not equal the Company’s economic interest in the listed properties because of various provisions in certain joint venture agreements regarding distributions of cash flow based on capital account balances, allocations of profits and losses and payments of preferred returns. As a result, the Company’s actual economic interest (as distinct from its legal ownership interest) in certain of the properties could fluctuate from time to time and may not wholly align with its legal ownership interests.
Note 4 -Rent and Tenant Receivables and Other Assets, Net
Rent and tenant receivables and other assets, net consisted of the following as of December 31, 2019 and December 31, 2018 (in thousands):
___________________________________
(1)
As of December 31, 2018, allowance for uncollectible accounts included in straight-line rent receivable, net and accounts receivable, net was $1.0 million and $5.3 million, respectively. Upon adoption of ASC 842, the Company recognizes all changes in the collectability assessment for an operating lease as an adjustment to rental revenue and does not record an allowance for uncollectible accounts. Any recoveries for those receivables reserved prior to adoption of ASC 842 will be recorded as an adjustment to rental revenue.
(2)
Amortization expense for deferred costs related to the revolving credit facilities totaled $2.1 million, $7.3 million and $10.4 million for the years ended December 31, 2019, 2018 and 2017, respectively, inclusive of write-offs of $1.8 million for the year ended December 31, 2019. There were no related write-offs for the years ended December 31, 2018 or 2017. Accumulated amortization for deferred costs related to the revolving credit facilities was $49.8 million and $47.6 million as of December 31, 2019 and December 31, 2018, respectively.
(3)
On February 1, 2018, the Company completed the sale of Cole Capital (as described in Note 14 - Discontinued Operations), retaining interests in CCIT II, CCIT III and CCPT V.
(4)
Amortization expense for leasehold improvements totaled $0.7 million for the year ended December 31, 2019 with no related write-offs and $1.2 million for each of the years ended December 31, 2018 and 2017, with no related write-offs. Accumulated amortization was $2.8 million and $5.9 million as of December 31, 2019 and December 31, 2018, respectively. Depreciation expense for property and equipment totaled $1.3 million, $2.3 million and $1.8 million for the years ended December 31, 2019, 2018 and 2017, respectively, inclusive of write-offs of less than $0.1 million, $0.8 million and $0.6 million for the years ended December 31, 2019, 2018 and 2017, respectively. Accumulated depreciation was $5.4 million and $7.0 million as of December 31, 2019 and December 31, 2018, respectively. The Company disposed of $4.3 million, net, of leasehold improvements, property and equipment, which is included in restructuring expenses in the accompanying consolidated statements of operations for the year ended December 31, 2019.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Note 5 - Fair Value Measures
The Company determines fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. U.S. GAAP guidance defines three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.
Level 3 - Unobservable inputs reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. Changes in the type of inputs may result in a reclassification for certain assets. The Company does not expect that changes in classifications between levels will be frequent.
Items Measured at Fair Value on a Recurring Basis
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2019 and December 31, 2018, aggregated by the level in the fair value hierarchy within which those instruments fall (in thousands):
Derivative Assets and Liabilities - The Company’s derivative financial instruments relate to interest rate swaps. The valuation of derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the counterparties.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Although the Company determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of December 31, 2019 and December 31, 2018, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Investment in Cole REITs - The fair values of CCIT II, CCIT III and CCPT V were estimated using the net asset value per share. Each of the Cole REIT’s share redemption programs includes restrictions that limit the number of shares redeemed by the respective Cole REIT.
The following are reconciliations of the changes in assets and liabilities with Level 3 inputs in the fair value hierarchy for the year ended December 31, 2019 (in thousands):
The following are reconciliations of the changes in assets and liabilities with Level 3 inputs in the fair value hierarchy for the year ended December 31, 2018 (in thousands):
Items Measured at Fair Value on a Non-Recurring Basis
Certain financial and nonfinancial assets and liabilities are measured at fair value on a non-recurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.
Real Estate Investments - The Company performs quarterly impairment review procedures, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable.
As part of the Company’s quarterly impairment review procedures, net real estate assets representing 77 properties were deemed to be impaired resulting in impairment charges of $47.1 million during the year ended December 31, 2019. The impairment charges relate to certain office, retail and restaurant properties that, during 2019, management identified for potential sale or determined, based on discussions with the current tenants, would not be re-leased by the tenant and the Company believes the property will not be leased to another tenant at a rental rate that supports the current book value.
During the years ended December 31, 2018 and 2017 net real estate assets related to 70 and 69 properties, respectively, were deemed to be impaired resulting in impairment charges of $54.6 million and $50.5 million for the years ended December 31, 2018 and 2017, respectively.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The Company estimates fair values using Level 3 inputs and uses a combined income and market approach, specifically using discounted cash flow analysis and recent comparable sales transactions. The evaluation of real estate assets for potential impairment requires the Company’s management to exercise significant judgment and make certain key assumptions, including, but not limited to, the following: (1) capitalization rate; (2) discount rates; (3) number of years property will be held; (4) property operating expenses; and (5) re-leasing assumptions including number of months to re-lease, market rental revenue and required tenant improvements. There are inherent uncertainties in making these estimates such as market conditions and performance and sustainability of the Company’s tenants. For the Company’s impairment tests for the real estate assets during the year ended December 31, 2019, the Company used a range of discount rates from 7.9% to 8.7% with a weighted-average rate of 8.5% and capitalization rates from 7.4% to 8.2% with a weighted-average rate of 8.0%.
Fair Value of Financial Instruments
The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash and accounts payable approximate their carrying value in the accompanying consolidated balance sheets due to their short-term nature and are classified as Level 1 under the fair value hierarchy. The fair values of the Company’s financial instruments are reported below (dollar amounts in thousands):
_______________________________________________
(1)
Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs.
Debt - The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of observable market interest rates. Corporate bonds and convertible debt are valued using quoted market prices in active markets with limited trading volume when available.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Note 6 - Debt
As of December 31, 2019, the Company had $5.7 billion of debt outstanding, including net premiums and net deferred financing costs, with a weighted-average years to maturity of 4.8 years and a weighted-average interest rate of 4.30%. The following table summarizes the carrying value of debt as of December 31, 2019 and December 31, 2018, and the debt activity for the year ended December 31, 2019 (in thousands):
____________________________________
(1)
Net premiums on mortgage notes payable were recorded upon the assumption of the respective mortgage notes in relation to the various mergers and acquisitions. Amortization of these net premiums is recorded as a reduction to interest expense over the remaining term of the respective mortgage notes using the effective-interest method.
(2)
Discounts on the corporate bonds and convertible debt were recorded based upon the fair value of the respective debt instruments as of the respective issuance dates. Amortization of these discounts is recorded as an increase to interest expense over the remaining term of the respective debt instruments using the effective-interest method.
(3)
Deferred costs relate to the Credit Facility Term Loan, as defined in the “Credit Facility” section below.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Mortgage Notes Payable
The Company’s mortgage notes payable consisted of the following as of December 31, 2019 (dollar amounts in thousands):
____________________________________
(1)
Gross carrying value is gross real estate assets, including investment in direct financing leases, net of gross real estate liabilities.
(2)
Weighted average interest rate is computed using the interest rate in effect until the anticipated repayment date. Should the loan not be repaid at the anticipated repayment date, the applicable interest rate will increase as specified in the respective loan agreement until the extended maturity date.
(3)
Weighted average years remaining to maturity is computed using the anticipated repayment date as specified in each loan agreement, where applicable.
(4)
Weighted-average interest rate for variable-rate debt represents the interest rate in effect as of December 31, 2019.
(5)
The table above does not include mortgage notes associated with unconsolidated joint ventures of $269.3 million, which are non-recourse to the Company. The mortgage notes have a weighted-average fixed interest rate of 3.57% and mature on June 6, 2024.
The Company’s mortgage loan agreements generally restrict corporate guarantees and require the maintenance of financial covenants, including maintenance of certain financial ratios (such as debt service coverage ratios and minimum net operating income). The mortgage loan agreements contain no dividend restrictions except in the event of default or when a distribution would drive liquidity below the applicable thresholds. At December 31, 2019, the Company believes that it was in compliance with the financial covenants under the mortgage loan agreements and had no restrictions on the payment of dividends.
On June 6, 2019, the Company received a notice of default from the lender of a non-recourse loan secured by one property, which had an outstanding balance of $19.5 million on the notice date, due to intentional non-payment of amounts due in accordance with the loan documents. On July 2, 2019, a foreclosure sale occurred to settle the mortgage note obligation.
On April 12, 2018, the Company entered into a deed-in-lieu of foreclosure agreement with the lender of a mortgage loan, secured by one property, with an outstanding balance of $16.2 million at the time of default and conveyed all interest in the property to satisfy the mortgage loan.
The following table summarizes the scheduled aggregate principal repayments due on mortgage notes subsequent to December 31, 2019 (in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Corporate Bonds
As of December 31, 2019, the OP had $2.85 billion aggregate principal amount of senior unsecured notes (the “Senior Notes”) outstanding comprised of the following (dollar amounts in thousands):
On February 6, 2019, $750.0 million of senior notes (the “2019 Senior Notes”) matured and the principal plus accrued and unpaid interest thereon, were repaid, utilizing borrowings under the Credit Facility Term Loan.
On December 4, 2019, the Company closed a senior note offering, consisting of $600.0 million aggregate principal amount of the Operating Partnership’s 3.10% Senior Notes due 2029 (the “2029 Senior Notes”).
On December 20, 2019, $400.0 million of the 4.125% senior notes due 2021 (the “2021 Senior Notes”) were redeemed, and the principal plus accrued and unpaid interest thereon was repaid.
The Senior Notes are guaranteed by the General Partner. The OP may redeem all or a part of any series of the Senior Notes at any time, at its option, for the redemption prices set forth in the indenture governing the Senior Notes. If the redemption date is 60 or fewer days prior to the maturity date with respect to the 2025 Senior Notes or is 90 or fewer days prior to the maturity date with respect to the 2024 Senior Notes, the 2026 Senior Notes, the 2027 Senior Notes and the 2029 Senior Notes, the redemption price will equal 100% of the principal amount of the Senior Notes of the applicable series to be redeemed, plus accrued and unpaid interest on the amount being redeemed to, but excluding, the applicable redemption date. The Senior Notes are registered under the Securities Act of 1933, as amended (the “Securities Act”) and are freely transferable.
The indenture governing our Senior Notes requires us to maintain financial ratios which include maintaining (i) a maximum limitation on incurrence of total debt less than or equal to 65% of Total Assets (as defined in the indenture), (ii) maximum limitation on incurrence of secured debt less than or equal to 40% of Total Assets (as defined in the indenture), (iii) a minimum debt service coverage ratio of at least 1.5x and (iv) a minimum unencumbered asset value of at least 150% of the aggregate principal amount of all of the outstanding Unsecured Debt (as defined in the indenture). As of December 31, 2019, the Company believes that it was in compliance with the financial covenants of our Senior Notes based on the covenant limits and calculations in place at that time.
Convertible Debt
During the year ended December 31, 2019, the Company repurchased $80.7 million of the 3.75% convertible senior notes due 2020 (the “2020 Convertible Notes”) and paid accrued and unpaid interest thereon.
As of December 31, 2019, the Company’s 2020 Convertible Notes had a balance of $321.8 million outstanding, which excludes the carrying value of the conversion options recorded within additional paid-in capital of $12.3 million and the unamortized discount of $1.9 million. The discount will be amortized over the remaining term of 1.0 year. The 2020 Convertible Notes bear interest at an annual rate of 3.75%.
The 2020 Convertible Notes may be converted into cash, shares of the Company’s Common Stock or a combination thereof, in limited circumstances prior to June 15, 2020, and may be converted into such consideration at any time on or after June 15, 2020. As of December 31, 2019, the conversion rate was 66.7249 shares of the Company’s Common Stock per $1,000 principal amount of 2020 Convertible Notes, which reflects adjustments to the initial conversion rate pursuant to the terms of the applicable indenture as a result of cash dividend payments. There were no changes to the terms of the 2020 Convertible Notes during the year ended December 31, 2019 and the Company believes that it was in compliance with the financial covenants pursuant to the indenture governing the 2020 Convertible Notes as of December 31, 2019.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Credit Facility
On May 23, 2018, the General Partner, as guarantor, and the OP, as borrower, entered into a credit agreement with Wells Fargo Bank, National Association as administrative agent and other lenders party thereto (the “Credit Agreement”). The Credit Agreement provided for maximum borrowings of $2.9 billion, originally consisting of a $2.0 billion unsecured revolving credit facility (the “Revolving Credit Facility”) and a $900.0 million unsecured term loan facility (the “Credit Facility Term Loan,” together with the Revolving Credit Facility, the “Credit Facility”). Effective December 27, 2019, the Company reduced its Revolving Credit Facility from $2.0 billion to $1.5 billion.
As of December 31, 2019, $150.0 million was outstanding under the Revolving Credit Facility and the full $900.0 million was drawn on the Credit Facility Term Loan. The maximum aggregate dollar amount of letters of credit that may be outstanding at any one time under the Credit Facility is $50.0 million. As of December 31, 2019, letters of credit outstanding were $3.9 million. Subsequent to December 31, 2019, all letters of credit outstanding were terminated.
As discussed in Note 7 - Derivatives and Hedging Activities, on January 24, 2019, the Company entered into interest rate swap agreements with an aggregate $900.0 million notional amount, effective on February 6, 2019 and maturing on January 31, 2023, to hedge interest rate volatility. Due to an improvement in the Company's credit rating during the fourth quarter of 2019, the interest rate spread on the $900.0 million Credit Facility Term Loan was reduced by 25 bps to LIBOR + 1.10%, and beginning on November 1, 2019, the swap agreements effectively fixed the Credit Facility Term Loan interest rate at 3.59%.
The Revolving Credit Facility generally bears interest at an annual rate of London Interbank Offered Rate (“LIBOR”) plus 0.775% to 1.55% or Base Rate plus 0.00% to 0.55% (based upon the General Partner’s then current credit rating). “Base Rate” is defined as the highest of the prime rate, the federal funds rate plus 0.50% or a floating rate based on one month LIBOR plus 1.0%, determined on a daily basis. The Credit Facility Term Loan generally bears interest at an annual rate of LIBOR plus 0.85% to 1.75%, or Base Rate plus 0.00% to 0.75% (based upon the General Partner’s then current credit rating). In addition, the Credit Agreement provides the flexibility for interest rate auctions, pursuant to which, at the Company’s election, the Company may request that lenders make competitive bids to provide revolving loans, which competitive bids may be at pricing levels that differ from the foregoing interest rates.
In the event of default, at the election of a majority of the lenders (or automatically upon a bankruptcy event of default with respect to the OP or the General Partner), the commitments of the lenders under the Credit Facility will terminate, and payment of any unpaid amounts in respect of the Credit Facility will be accelerated. The Revolving Credit Facility terminates on May 23, 2022, unless extended in accordance with the terms of the Credit Agreement. The Credit Agreement provides for two six-month extension options with respect to the Revolving Credit Facility, exercisable at the OP’s election and subject to certain customary conditions, as well as certain customary “amend and extend” provisions. The outstanding Credit Facility Term Loan matures on May 23, 2023. At any time, upon timely notice by the OP and subject to any breakage fees, the OP may prepay borrowings under the Credit Facility (subject to certain limitations applicable to the prepayment of any loans obtained through an interest rate auction, as described above). The OP incurs a facility fee equal to 0.10% to 0.30% per annum (based upon the General Partner’s then current credit rating) multiplied by the commitments (whether or not utilized) in respect of the Revolving Credit Facility. The OP also incurs customary administrative agent, letter of credit issuance, letter of credit fronting, extension and other fees.
The Credit Facility requires restrictions on corporate guarantees, as well as the maintenance of financial covenants, including the maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios). The key financial covenants in the Credit Facility, as defined and calculated per the terms of the Credit Agreement, include maintaining (i) a maximum leverage ratio less than or equal to 60%, (ii) a minimum fixed charge coverage ratio of at least 1.5x, (iii) a secured leverage ratio less than or equal to 45%, (iv) a total unencumbered asset value ratio less than or equal to 60% and (v) a minimum unencumbered interest coverage ratio of at least 1.75x. The Company believes that it was in compliance with the financial covenants pursuant to the Credit Agreement and is not restricted from accessing any borrowing availability under the Credit Facility as of December 31, 2019.
Note 7 - Derivatives and Hedging Activities
Cash Flow Hedges of Interest Rate Risk
During the year ended December 31, 2019, the Company entered into interest rate swap agreements with an aggregate $900.0 million notional amount, effective on February 6, 2019 and maturing on January 31, 2023, which were designated as cash flow hedges. Due to an improvement in the Company's credit rating during the fourth quarter of 2019, the interest rate spread on the $900.0 million Credit Facility Term Loan was reduced by 25 bps to LIBOR + 1.10%, and beginning on November 1, 2019, the swap agreements effectively fixed the Credit Facility Term Loan interest rate at 3.59%.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
During the year ended December 31, 2019, the Company also entered into forward starting interest rate swaps with a total notional amount of $400.0 million, which were designated as cash flow hedges to hedge the risk of changes in the interest-related cash outflows associated with the anticipated issuance of long-term debt. The Company is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 120 months (excluding forecasted transactions related to the payment of variable interest on existing financial instruments), with anticipated issuance of 10-year public debt between May 1, 2020 and December 31, 2021.
The table below presents the fair value of the Company’s derivative financial instruments designated as cash flow hedges as well as their classification in the consolidated balance sheets as of December 31, 2019 (in thousands). There were no financial instruments designated as cash flow hedges as of December 31, 2018.
During the years ended December 31, 2019 and 2017, the Company recorded unrealized losses of $29.9 million and less than $0.1 million, respectively, for changes in the fair value of the cash flow hedges in accumulated other comprehensive income. There were no similar amounts recorded during the year ended December 31, 2018.
The Company reclassified previous losses of $2.5 million, $0.3 million and $0.2 million for the years ended December 31, 2019, 2018 and 2017, respectively, from accumulated other comprehensive income into interest expense as a result of the hedged transactions impacting earnings. During the year ended December 31, 2017, the Company also reclassified losses of $0.8 million from accumulated other comprehensive income into interest expense associated with settled interest rate derivatives and reclassified a gain of $1.1 million from accumulated other comprehensive income into interest expense in connection with the early termination of its interest rate swaps related to early repayment of mortgage loans and borrowings under the Credit Facility Term Loan.
During the next twelve months, the Company estimates that an additional $8.3 million will be reclassified from other comprehensive income as an increase to interest expense.
Derivatives Not Designated as Hedging Instruments
As of December 31, 2019, the Company had no interest rate swaps that were not designated as qualifying hedging relationships. As of December 31, 2018, the Company had one interest rate swap that was not designated as a qualifying hedging relationship, with a notional amount of $50.7 million.
The table below presents the fair value of the Company’s derivative financial instruments not designated as a hedge as well as their classification in the consolidated balance sheets as of December 31, 2018 (in thousands):
A loss of $0.1 million for the year ended December 31, 2019 and gains of $0.4 million and $3.0 million for the years ended December 31, 2018 and 2017, respectively, related to the change in the fair value of derivatives not designated as hedging instruments were recorded in other income, net in the accompanying consolidated statements of operations.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Tabular Disclosure of Offsetting Derivatives
The table below details a gross presentation, the effects of offsetting and a net presentation of the Company’s derivatives as of December 31, 2019 and December 31, 2018 (in thousands). The net amounts of derivative assets or liabilities can be reconciled to the tabular disclosure of fair value.
Credit Risk Related Contingent Features
The Company has agreements with each of its derivative counterparties that contain a provision specifying that if the Company either defaults or is capable of being declared in default on any of its indebtedness, the Company could also be declared in default on its derivative obligations.
As of December 31, 2019, the Company has not posted any collateral related to these agreements and was not in breach of any provisions in these agreements. If the Company had breached any of these agreements, it could have been required to settle its obligations under the agreements at their aggregate termination value of $28.2 million at December 31, 2019.
Note 8 - Supplemental Cash Flow Disclosures
Supplemental cash flow information was as follows for the years ended December 31, 2019, 2018 and 2017 (in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Note 9 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following as of December 31, 2019 and December 31, 2018 (in thousands):
Note 10 - Commitments and Contingencies
Litigation
The Company is involved in various routine legal proceedings and claims incidental to the ordinary course of its business. There are no material legal proceedings pending against the Company, except as follows:
Government Investigations and Litigation Relating to the Audit Committee Investigation
As previously reported, on October 29, 2014, the Company filed a Current Report on Form 8-K (the “October 29 8-K”) reporting the Audit Committee’s conclusion, based on the preliminary findings of its investigation, that certain previously issued consolidated financial statements of the Company, including those included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2014 and June 30, 2014, and related financial information should no longer be relied upon. The Company also reported that the Audit Committee had based its conclusion on the preliminary findings of its investigation into concerns regarding accounting practices and other matters that were first reported to the Audit Committee in early September 2014 and that the Audit Committee believed that an error in the calculation of adjusted funds from operations for the first quarter of 2014 had been identified but intentionally not corrected when the Company reported its financial results for the three and six months ended June 30, 2014. Prior to the filing of the October 29 8-K, the Audit Committee previewed for the SEC the information contained in the filing. Subsequent to that filing, the SEC provided notice that it had commenced a formal investigation and issued subpoenas calling for the production of various documents. In addition, the United States Attorney’s Office for the Southern District of New York contacted counsel for the Audit Committee and counsel for the Company with respect to this matter, and the Secretary of the Commonwealth of Massachusetts issued a subpoena calling for the production of various documents. The Company has been cooperating with these regulators in their investigations.
In connection with these investigations, on September 8, 2016, the United States Attorney’s Office for the Southern District of New York announced the filing of criminal charges against the Company’s former Chief Financial Officer (the “Former CFO”) and former Chief Accounting Officer (the “Criminal Action”), as well as the fact that the former Chief Accounting Officer pleaded guilty to the charges filed. Also on September 8, 2016, the SEC announced the filing of a civil complaint against the same two individuals in the United States District Court for the Southern District of New York. On June 30, 2017, following a jury trial, the Former CFO was convicted of the charges filed. Both the former Chief Accounting Officer and the Former CFO have entered into settlement agreements with the SEC resolving the charges brought against them.
The United States Attorney’s Office has indicated that it does not intend to bring criminal charges against the Company arising from its investigation. In addition, the Company has not been in contact with the Massachusetts regulator since June 2015 and believes the investigation is concluded. On November 18, 2019, the Company announced it had reached agreement with the staff of the Enforcement Division of the SEC on the material terms of a negotiated resolution relating to the SEC's investigation of the matters disclosed in the Company's October 29 8-K. The agreement with the SEC staff, which is subject to documentation and approval by the SEC's Commissioners, includes payment of $8.0 million as a civil penalty.
As discussed below, the Company and certain of its former officers and directors were named as defendants in a number of lawsuits filed following the October 29 8-K, including class actions, individual actions and derivative actions seeking money damages and other relief under the federal securities laws and state laws in both federal and state courts in New York, Maryland and Arizona.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Between October 30, 2014 and January 20, 2015, the Company and certain of its former officers and directors, among other individuals and entities, were named as defendants in ten securities class action complaints filed in the United States District Court for the Southern District of New York. The court consolidated these actions under the caption In re American Realty Capital Properties, Inc. Litigation, No. 15-MC-00040 (AKH) (the “Class Action”). The plaintiffs filed a second amended class action complaint on December 11, 2015, which asserted claims for violations of Sections 11, 12(a)(2) and 15 of the Securities Act and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 promulgated thereunder. On September 30, 2016, plaintiffs filed a third amended complaint to reflect certain prior rulings by the court in connection with various motions to dismiss. On August 31, 2017, the court issued an order granting plaintiffs’ motion for class certification. Defendants’ petitions seeking leave to appeal the court’s order granting class certification were denied on January 24, 2018. On September 8, 2019, the Company, along with the other parties to the Class Action, signed a Memorandum of Understanding (“MOU”) providing for the settlement of the Class Action, and on September 30, 2019, the parties entered into a Stipulation of Settlement (the “Class Action Settlement”) consistent with the terms of the MOU. Pursuant to the Class Action Settlement, certain defendants agreed to pay in the aggregate $1.025 billion, comprised of contributions from the principals of the Company's former external manager, ARC Properties Advisors, LLC, (the “Former Manager”) totaling $225.0 million, $12.5 million from the Company’s Former CFO, $49.0 million from the Company’s former auditor, and the balance of $738.5 million from the Company, which is included in litigation and non-routine costs, net in the accompanying consolidated statements of operations for the year ended December 31, 2019. The contribution from the Company’s Former Manager is inclusive of the value of substantially all of the Limited Partner OP Units and dividends surrendered to the Company in July 2019 as a result of a settlement by the Former Manager and certain of its principals with the SEC, totaling approximately $32.0 million, which is included in litigation and non-routine costs, net in the accompanying consolidated statements of operations for the year ended December 31, 2019. The Class Action Settlement does not contain any admission of liability, wrongdoing or responsibility by any of the parties. The Class Action Settlement was approved by the court on January 21, 2020, and a final judgment dismissing the Class Action was entered on January 22, 2020.
The Company, certain of its former officers and directors, and the OP, among others, were also named as defendants in thirteen individual securities fraud actions filed in the United States District Court for the Southern District of New York: Jet Capital Master Fund, L.P. v. American Realty Capital Properties, Inc., et al., No. 15-cv-307 (the “Jet Capital Action”); Twin Securities, Inc. v. American Realty Capital Properties, Inc., et al., No. 15-cv-1291; HG Vora Special Opportunities Master Fund, Ltd v. American Realty Capital Properties, Inc., et al., No. 15-cv-4107; BlackRock ACS US Equity Tracker Fund, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08464; PIMCO Funds: PIMCO Diversified Income Fund, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08466; Clearline Capital Partners LP, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08467; Pentwater Equity Opportunities Master Fund Ltd., et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08510; Archer Capital Master Fund, et al. v. American Realty Capital Properties, Inc. et al, No. 16-cv-05471; Atlas Master Fund et al. v. American Realty Capital Properties, Inc. et al., No. 16-cv-05475; Eton Park Fund, L.P. v. American Realty Capital Properties, Inc., et al., No. 16-cv-09393; Reliance Standard Life Insurance Company, et al, v. American Realty Capital Properties, Inc. et al, No. 17-cv-02796; Fir Tree Capital Opportunity Master Fund, L.P. et al. v. American Realty Capital Properties, Inc. et al., No. 17-cv-04975; and Cohen & Steers Institutional Realty Shares, Inc. et al v. American Realty Capital Properties, Inc. et al., No. 18-cv-06770, (collectively, the “Opt-Out Actions”). The Opt-Out Actions asserted claims arising out of allegedly false and misleading statements in connection with the purchase or sale of the Company’s securities. The Company entered into a series of agreements dated September 30 through October 26, 2018, to settle all of the Opt-Out Actions other than the Jet Capital Action (the “Opt-Out Settlement Agreements”), which were brought by plaintiffs holding shares of common stock and swaps referencing common stock representing approximately 18.0% of VEREIT’s outstanding shares of common stock held at the end of the period covered by the litigations, for an aggregate payment of $127.5 million. The Opt-Out Settlement Agreements contain mutual releases by both plaintiffs and the Company and do not contain any admission of liability, wrongdoing or responsibility by any of the parties.
On October 27, 2015, the Company and certain of its former officers, among others, were also named as defendants in an individual securities fraud action filed in the United States District Court for the District of Arizona, captioned Vanguard Specialized Funds, et al. v. VEREIT, Inc. et al., No. 15-cv-02157 (the “Vanguard Action”). The Vanguard Action asserted claims arising out of allegedly false and misleading statements in connection with the purchase or sale of the Company’s securities. On June 7, 2018, the Company entered into a Settlement Agreement and Release (the “Vanguard Settlement Agreement”) to settle the Vanguard Action for a payment of $90.0 million. The Vanguard Settlement Agreement contains mutual releases by Plaintiffs and the Company, and does not contain any admission of liability, wrongdoing or responsibility by any of the parties. Vanguard’s holdings accounted for approximately 13.0% of the Company’s outstanding shares of common stock held at the end of the period covered by the various pending shareholder actions.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
In addition to the settlement of the Opt-Out Actions and the Vanguard Action discussed above, between February 5, 2019 and April 5, 2019, the Company entered into a series of agreements to settle claims with shareholders who decided not to participate as class members in the Class Action. Pursuant to the terms of these settlement agreements, the shareholders released all claims that were the subject matter of the Class Action and the Company made payments totaling $27.9 million.
On June 24, 2019, the Company and certain of its former officers were named as defendants in an individual action filed in the Supreme Court of the State of New York captioned Lakewood Capital Partners, L.P. v. American Realty Capital Properties, Inc., et al., Index No. 653676/2019 (the “Lakewood Action”), alleging claims of common law fraud arising out of allegedly false and misleading statements similar to those that were the subject of the Class Action.
On September 6 and September 9, 2019, the Company entered into settlement agreements and releases similar to the Opt-Out Settlement Agreements to settle the only two remaining opt-out actions - the Jet Capital Action and the Lakewood Action - for a total of $27.0 million, which is included in litigation and non-routine costs, net in the accompanying consolidated statements of operations for the year ended December 31, 2019.
The Company was also named as a nominal defendant, and certain of its former officers and directors were named as defendants, in shareholder derivative actions filed in the United States District Court for the Southern District of New York: Witchko v. Schorsch, et al., No. 15-cv-06043 (the “Witchko Action”); and Serafin, et al. v. Schorsch, et al., No. 15-cv-08563 (the “Serafin Action”). The court consolidated the Witchko Action and the Serafin Action (together the “SDNY Derivative Action”) and the plaintiffs designated the complaint filed in the Witchko Action as the operative complaint in the SDNY Derivative Action. The SDNY Derivative Action sought money damages and other relief on behalf of the Company for alleged breaches of fiduciary duty, among other claims. In conjunction with entering into the Class Action Settlement, the Company entered into an agreement to resolve the claims asserted in the SDNY Derivative Action, as well as the claims asserted in the Frampton Action, the Kosky Action, and the Meloche Action (each as defined below) (the “Derivative Settlement”). On January 21, 2020, the court granted final approval of the settlement, and a final judgment dismissing the SDNY Derivative Action was entered on January 22, 2020.
On December 3, 2015, the Company was named as a nominal defendant and certain of its former officers and directors were named as defendants in a shareholder derivative action filed in the Circuit Court for Baltimore City in Maryland, Frampton v. Schorsch, et al., No. 24-C-15-006269 (the “Frampton Action”). The Frampton Action sought money damages and other relief on behalf of the Company for, among other things, alleged breaches of fiduciary duty and contribution and indemnification. By order dated November 4, 2016, the Frampton Action was stayed pending resolution of the SDNY Derivative Action. On January 31, 2020, the plaintiff in the Frampton Action filed a notice dismissing the Frampton Action with prejudice.
On June 10, 2016, the Company was named as a nominal defendant, and certain of its former officers and directors, among others, were named as defendants, in a shareholder derivative action filed in the Supreme Court of the State of New York, Kosky v. Schorsch, et al., No. 653093/2016 (the “Kosky Action”). The Kosky Action sought money damages and other relief on behalf of the Company for, among other things, alleged breaches of fiduciary duty, negligence, and breach of contract. On October 6, 2016, the parties filed a stipulation staying the Kosky Action until resolution of the Class Action. In light of the release of claims in the Derivative Settlement, the Company expects that the parties in the Kosky Action will jointly seek to dismiss the Kosky Action with prejudice.
On October 6, 2016, the Company was named as a nominal defendant, and certain of its former officers and directors, among others, were named as defendants, in a shareholder derivative action filed in the United States District Court for the District of Maryland, captioned Meloche v. Schorsch, et al., 16-cv-03366 (the “Meloche Action”). An amended complaint was filed on January 17, 2017. The Meloche Action seeks money damages and other relief on behalf of the Company for alleged breaches of fiduciary duty and negligence. By order dated May 16, 2017, the Meloche Action was stayed until resolution of the SDNY Derivative Action, and by order dated October 25, 2019, the stay was continued. In light of the release of claims in the Derivative Settlement, the Company expects that the parties in the Meloche Action will jointly seek to dismiss the Meloche Action with prejudice.
Cole Litigation Matter
In December 2013, Realistic Partners filed a putative class action lawsuit against the Company and the then-members of its board of directors in the Supreme Court for the State of New York, captioned Realistic Partners v. American Realty Capital Partners, et al., No. 654468/2013. The plaintiff alleged, among other things, that the board of the Company breached its fiduciary duties in connection with the transactions contemplated under the agreement and plan of merger with Cole Real Estate Investments, Inc. In January 2014, the parties entered into a memorandum of understanding regarding settlement of all claims asserted on behalf of the alleged class of the Company’s stockholders. The proposed settlement terms required the Company to make certain additional disclosures related to this merger, which were included in a Current Report on Form 8-K filed by the Company with the SEC on
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
January 17, 2014. The memorandum of understanding also contemplated that the parties would enter into a stipulation of settlement, which would be subject to customary conditions, including confirmatory discovery and court approval following notice to the Company’s stockholders, and provided that the defendants would not object to a payment of up to $625,000 for attorneys’ fees. If the parties enter into a stipulation of settlement, which has not occurred, a hearing will be scheduled at which the court will consider the fairness, reasonableness and adequacy of the settlement. There can be no assurance that the parties will enter into a stipulation of settlement, that the court will approve any proposed settlement, or that any eventual settlement will be under the same terms as those contemplated by the memorandum of understanding.
Purchase Commitments
In the normal course of business, the Company enters into various types of commitments to purchase real estate properties. These commitments are generally subject to the Company’s customary due diligence process and, accordingly, a number of specific conditions must be met before the Company is obligated to purchase the properties.
Environmental Matters
In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. The Company has not been notified by any governmental authority of any non-compliance, liability or other claim, and is not aware of any other environmental condition, in each case, that it believes will have a material adverse effect on the results of operations.
Note 11 - Leases
Lessor
The Company is the lessor for its 3,858 retail, restaurant, office and industrial properties. The Company’s operating and direct financing leases have non-cancelable lease terms of 0.08 years to 25.1 years. Certain leases with tenants include options to extend or terminate the lease agreements or to purchase the underlying asset. Lease agreements may also contain rent increases that are based on an index or rate (e.g., the consumer price index (“CPI”) or LIBOR). The Company believes the residual value risk is not a primary risk because of the long-lived nature of the assets.
The components of rental revenue from the Company’s operating and direct financing leases were as follows (in thousands):
____________________________________
(1)
The Company’s tenants are generally sub-tenants under certain ground leases and are responsible for paying the rent under these leases.
(2)
Includes costs reimbursed related to property operating expenses, common area maintenance and percentage rent, including these costs reimbursed by ground lease sub-tenants.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The following table presents future minimum operating lease payments due to the Company over the next five years and thereafter as of December 31, 2019 (in thousands). These amounts exclude contingent rent payments, as applicable, that may be collected from certain tenants based on provisions related to sales thresholds and increases in annual rent based on exceeding certain economic indexes.
____________________________________
(1)
Related to 22 properties which are subject to direct financing leases and, therefore, revenue is recognized as rental income on the discounted cash flows of the lease payments. Amounts reflect undiscounted cash flows to be received by the Company under the lease agreements on these respective properties.
Lessee
The Company is the lessee under ground lease arrangements and corporate office leases. All leases for which the Company is the lessee meet the criteria of an operating lease. The Company’s leases have remaining lease terms of 0.2 years to 79.6 years, some of which include options to extend. The weighted average remaining lease term for the Company’s operating leases was 16.3 years as of December 31, 2019. Under certain ground lease arrangements, the Company pays variable costs, including property operating expenses and common area maintenance, which are generally reimbursed by the ground lease sub-tenants. The weighted average discount rate for the Company’s operating leases was 4.91% as of December 31, 2019. As the Company’s leases do not provide an implicit rate, the Company used an estimated incremental borrowing rate based on the information available at the adoption date in determining the present value of lease payments.
The Company incorporated renewal periods in the calculation of the majority of ground lease right-of-use assets and lease liabilities. Pursuant to certain leases, the Company is required to execute renewal options available under the ground lease through the building lease term. No renewals were incorporated in the calculation of the corporate lease right-of-use assets and liabilities, as it is not reasonably certain that the Company will exercise the options. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
The following table presents the lease expense components for the year ended December 31, 2019 (in thousands):
___________________________________
(1)
No cash paid for operating lease liabilities was capitalized.
(2)
The Company’s tenants are generally sub-tenants under certain ground leases and are responsible for paying the rent under these leases.
Subsequent to initial measurement of $233.3 million and $236.3 million, respectively, the Company reduced the right-of-use assets by $2.1 million and operating lease liabilities by $2.6 million, for non-cash activity related to additions, dispositions and lease modifications during the year ended December 31, 2019.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The following table reflects the future minimum lease payments due from the Company over the next five years and thereafter for ground lease obligations, which are substantially reimbursable by our tenants, and office lease obligations as of December 31, 2019 (in thousands).
The following table reflects the future minimum lease payments due from the Company over the five years subsequent to December 31, 2018, as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2018 (in thousands), which excluded certain ground leases under which the Company's sub-tenants are responsible for paying the rent under these leases directly to the ground lessor.
Note 12 - Equity
Common Stock and General Partner OP Units
The General Partner is authorized to issue up to 1.5 billion shares of Common Stock. As of December 31, 2019, the General Partner had approximately 1.1 billion shares of Common Stock issued and outstanding. Additionally, the Operating Partnership had approximately 1.1 billion General Partner OP Units issued and outstanding as of December 31, 2019, corresponding to the General Partner’s outstanding shares of Common Stock.
Common Stock Offering
On September 26, 2019, the Company completed a public equity offering (the "Offering"), selling a total of 94.3 million shares of Common Stock, which included the full exercise of the underwriters' option to purchase additional shares, for net proceeds, after underwriting discounts and offering expenses, of $886.9 million. The Company contributed the net proceeds from the Offering to the OP in exchange for additional General Partner OP Units, which have substantially identical economic terms as the Company’s common stock. The net proceeds of the Offering were subsequently used to pay amounts owed in connection with the settlement of certain litigation, as described in Note 10 - Commitments and Contingencies, and for general corporate purposes.
Common Stock Continuous Offering Programs
On September 19, 2016, the Company registered a continuous equity offering program (the “Prior Program”) pursuant to which the Company could offer and sell, from time to time, in “at-the-market” offerings or certain other transactions, shares of Common Stock with an aggregate gross sales price of up to $750.0 million, through its sales agents. As of and during the year ended December 31, 2019, the Company had issued 5.0 million shares under the Prior Program, at a weighted average price per share of $8.42, for gross proceeds of $42.5 million. The weighted average price per share, net of offering costs, was $8.30, for net proceeds of $41.8 million. Prior to 2019, no shares of Common Stock had been issued pursuant to the Prior Program.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
On April 15, 2019, the Company established a new continuous equity offering program pursuant to which the Company may sell shares of Common Stock having an aggregate offering price of up to $750.0 million from time to time through April 15, 2022 in “at-the-market” offerings or certain other transactions ( the “Current ATM Program”). The Current ATM Program replaced the Prior Program. The proceeds from any sale of shares under the Current ATM Program have been or will be used for general corporate purposes, which may include funding potential acquisitions and repurchasing or repaying outstanding indebtedness. As of and during the year ended December 31, 2019, the Company had issued 9.0 million shares under the Current ATM Program, at a weighted average price per share of $9.60, for gross proceeds of $86.7 million. The weighted average price per share, net of offering costs, was $9.46, for net proceeds of $85.4 million. As of December 31, 2019, the Company had $663.3 million available to be sold under the Current ATM Program.
Series F Preferred Stock and Series F Preferred OP Units
The Series F Preferred Stock pays cumulative cash dividends at the rate of 6.70% per annum on their liquidation preference of $25.00 per share (equivalent to $1.675 per share on an annual basis). The Series F Preferred Stock was not redeemable by the Company before January 3, 2019, the fifth anniversary of the date on which such Series F Preferred Stock was issued (the “Initial Redemption Date”), except under circumstances intended to preserve the General Partner’s status as a REIT for federal and/or state income tax purposes and except upon the occurrence of a change of control. On and after the Initial Redemption Date, the General Partner may, at its option, redeem shares of the Series F Preferred Stock, in whole or from time to time in part, at a redemption price of $25.00 per share plus, subject to exceptions, any accrued and unpaid dividends thereon to the date fixed for redemption. The shares of Series F Preferred Stock have no stated maturity, are not subject to any sinking fund or mandatory redemption and will remain outstanding indefinitely unless the General Partner redeems or otherwise repurchases them or they become convertible and are converted into Common Stock (or, if applicable, alternative consideration). The Series F Preferred Stock trades on the NYSE under the symbol VER PRF. The Series F Preferred Units contain the same terms as the Series F Preferred Stock.
During the year ended December 31, 2019, the Company redeemed a total of 12.0 million shares of Series F Preferred Stock, in two separate transactions, representing approximately 28.02% of the issued and outstanding preferred shares as of the beginning of the year. The shares of Series F Preferred Stock were redeemed at a redemption price of $25.00 per share plus all accrued and unpaid dividends.
As of December 31, 2019, there were approximately 30.9 million shares of Series F Preferred Stock, approximately 30.9 million corresponding General Partner Series F Preferred Units and 49,766 Limited Partner Series F Preferred Units issued and outstanding.
For federal income tax purposes, distributions to stockholders are characterized as ordinary dividends, capital gain distributions, or nondividend distributions. Nondividend distributions will reduce U.S stockholders’ basis (but not below zero) in their shares. The following table shows the character of the Series F Preferred Stock distributions paid on a percentage basis for the years ended December 31, 2019, 2018 and 2017:
Limited Partner OP Units
As of December 31, 2019 the Operating Partnership had approximately 0.8 million Limited Partner OP Units outstanding.
On July 16, 2019, the SEC filed a complaint in United States District Court for the Southern District of New York charging the Company’s Former Manager (including certain of its principals) with securities law violations for, among other things, wrongfully obtaining certain incentive fees in connection with mergers entered into by the Company in 2013 and 2014. Simultaneously with the filing of the complaint, the parties entered into proposed settlement agreements, without admitting or denying the allegations of the complaint, pursuant to which 2.9 million Limited Partner OP Units were surrendered by the Former Manager and the Former CFO to the Company. The Company recorded the surrender of the Limited Partner OP Units as a reduction to litigation and non-routine costs, net, of $26.5 million, using a per share price of $9.08, during the second quarter of 2019. In addition to surrendering the 2.9 million Limited Partner OP Units, the Former Manager and the Former CFO relinquished any rights to $6.4 million of dividends on those units, which the Company had withheld payment of since October 2015. The court
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
approved the settlements on July 17, 2019 and the Limited Partner OP Units were subsequently canceled on July 26, 2019. As discussed in Note 10 - Commitments and Contingencies, the contribution to the Class Action Settlement by the Company’s Former Manager included the value of substantially all of these surrendered Limited Partner OP Units and dividends.
During the fourth quarter of 2019, the Former Manager and Former CFO surrendered an aggregate of 19.9 million Limited Partner OP Units to the Company to fund a portion of their contributions toward the Class Action Settlement. On October 15, 2019, the Company contributed cash to the settlement fund equal to the value of the surrendered Limited Partner OP Units and the surrendered Limited Partner OP Units were canceled. The Company reduced additional paid-in capital, distributions payable and non-controlling interests in the accompanying financial statements of VEREIT, Inc. for both of the above-mentioned transactions and made a corresponding reduction in distributions payable, General Partner's common equity and Limited Partner's common equity in the accompanying financial statements of the OP. Refer to Note 10 - Commitments and Contingencies for additional information.
Common Stock Dividends
The Company declared quarterly dividends to stockholders of record each quarter from the first quarter of the year ended December 31, 2017 through the third quarter of the year ended December 31, 2019 of $0.1375 per share of Common Stock (representing an annualized dividend of $0.55 per share). The Company’s Board of Directors declared a quarterly cash dividend of $0.1375 per share of Common Stock (equaling an annualized dividend of $0.55 per share) for the fourth quarter of 2019 on November 5, 2019 to stockholders of record as of December 31, 2019, which was paid on January 15, 2020. An equivalent distribution by the Operating Partnership is applicable per OP unit.
For federal income tax purposes, distributions to stockholders are characterized as ordinary dividends, capital gain distributions, or nondividend distributions. Nondividend distributions will reduce U.S stockholders’ basis (but not below zero) in their shares. The following table shows the character of the Common Stock distributions paid on a percentage basis for the years ended December 31, 2019, 2018 and 2017:
Share Repurchase Programs
On May 3, 2018, the Company’s Board of Directors terminated its prior share repurchase program and authorized a new program (the “2018 Share Repurchase Program”) that permitted the Company to repurchase up to $200.0 million of its outstanding Common Stock through May 3, 2019, as market conditions warranted. On May 6, 2019, the Company’s Board of Directors authorized a new share repurchase program (the “2019 Share Repurchase Program”) that permits the Company to repurchase up to $200.0 million of its outstanding Common Stock through May 6, 2022. Under the share repurchase programs, repurchases can be made through open market purchases, privately negotiated transactions, structured or derivative transactions, including accelerated stock repurchase transactions, or other methods of acquiring shares in accordance with applicable securities laws and other legal requirements. The share repurchase programs do not obligate the Company to make any repurchases at a specific time or in a specific situation and repurchases are influenced by prevailing market conditions, the trading price of the Common Stock, the Company’s financial performance and other conditions. Shares of Common Stock repurchased by the Company under the share repurchase programs, if any, will be returned to the status of authorized but unissued shares of Common Stock.
There were no share repurchases under the 2018 Share Repurchase Program or 2019 Share Repurchase Program during the year ended December 31, 2019. As of December 31, 2019, the Company had $200.0 million available for share repurchases under the 2019 Share Repurchase Program. During the year ended December 31, 2018, the Company repurchased 0.8 million shares of Common Stock in multiple open market transactions, at a weighted average share price of $6.95 for an aggregate purchase price of $5.6 million under the 2018 Share Repurchase Program.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Note 13- Equity-based Compensation
Equity Plans
The General Partner has an Equity Plan, which provides for the grant of stock options (“Stock Options”), stock appreciation rights, Restricted Shares, restricted stock units (“Restricted Stock Units”), deferred stock units (“Deferred Stock Units”), dividend equivalent rights and other stock-based awards to non-executive directors, officers, other employees and advisors or consultants who provide services to the Company, as applicable, and a non-executive director restricted share plan, which are accounted for under U.S. GAAP for share-based payments. The expense for such awards is recognized over the requisite service period. Restricted Shares provide for rights identical to those of Common Stock. Restricted Stock Units do not provide for any rights of a common stockholder prior to the vesting of such Restricted Stock Units. Restricted Shares are considered issued and outstanding. As is the case when fully vested shares of Common Stock are issued from the Equity Plan, for each Restricted Share awarded under the Equity Plan, the Operating Partnership issues a General Partner OP Unit to the General Partner with identical terms. Upon vesting or settlement of Restricted Stock Units or Deferred Stock Units, respectively, the Operating Partnership issues a General Partner OP Unit to the General Partner for each share of Common Stock issued as a result of such vesting.
The General Partner has authorized and reserved a total number of shares equal to 10.0% of the total number of issued and outstanding shares of Common Stock (on a fully diluted basis assuming the redemption of all OP Units for shares of Common Stock) to be issued at any time under the Equity Plan for equity incentive awards. As of December 31, 2019, the General Partner had cumulatively awarded under its Equity Plan approximately 16.4 million shares of Common Stock, which was comprised of 4.0 million Restricted Shares, net of the forfeiture of 3.7 million Restricted Shares through that date, 6.4 million Restricted Stock Units, net of the forfeiture/cancellation of 2.0 million Restricted Stock Units through that date, 0.6 million Deferred Stock Units, and 5.4 million Stock Options, net of forfeiture/cancellation/exercise of 0.2 million Stock Options through that date. Accordingly, as of such date, approximately 96.6 million additional shares were available for future issuance, excluding the effect of the 5.4 million Stock Options. As of December 31, 2019, a total of 45,000 shares had been awarded under the non-executive director restricted share plan out of the 99,000 shares reserved for issuance.
Restricted Shares
The Company issued Restricted Shares to certain employees and non-executive directors beginning in 2011. In addition, the Company issued Restricted Shares to employees of affiliates of the Former Manager prior to 2015. The fair value of the Restricted Shares granted to employees under the Equity Plan is generally determined using the closing stock price on the grant date and is expensed over the requisite service period on a straight-line basis. The fair value of Restricted Shares granted to non-executive directors and employees of affiliates of the Former Manager under the Equity Plan was measured based upon the fair value of goods or services received or the equity instruments granted, whichever was more reliably determinable, and was expensed in full at the date of grant.
During the years ended December 31, 2019, 2018 and 2017, the Company recorded $0.1 million, $0.6 million and $2.0 million, respectively, of compensation expense related to the Restricted Shares. During the year ended December 31, 2019, all 71,000 of the Restricted Shares vested. As such, there was no further unrecognized compensation expense related to the Restricted Shares as of December 31, 2019.
The following table details the activity of the Restricted Shares during the year ended December 31, 2019:
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Time-Based Restricted Stock Units
Under the Equity Plan, the Company may award Restricted Stock Units to employees that will vest if the recipient maintains employment over the requisite service period (the “Time-Based Restricted Stock Units”). The fair value of the Time-Based Restricted Stock Units granted to employees under the Equity Plan is generally determined using the closing stock price on the grant date and is expensed over the requisite service period on a straight-line basis, which is generally three years. During each of the years ended December 31, 2019 and 2018, the Company recorded $5.1 million of compensation expense related to Time-Based Restricted Stock Units. During the year ended December 31, 2019, this includes compensation expense attributable to awards for which the requisite service period begins prior to the assumed future grant date. During the year ended December 31, 2017, the Company recorded $6.3 million of such expenses. As of December 31, 2019, there was $5.7 million of unrecognized compensation expense related to the Time-Based Restricted Stock Units with a weighted-average remaining term of 2.0 years.
The following table details the activity of the Time-Based Restricted Stock Units during the year ended December 31, 2019.
Deferred Stock Units
The Company may award Deferred Stock Units to non-executive directors under the Equity Plan. Each Deferred Stock Unit represents the right to receive one share of Common Stock. The Deferred Stock Units provide for immediate vesting on the grant date and will be settled with Common Stock either on the earlier of the date on which the respective director separates from the Company, dies or the third anniversary of the grant date, or if granted pursuant to the director’s voluntary election to participate in the director’s deferred compensation program, on the date the director separates from the Company (or upon a change of control or death). The fair value of the Deferred Stock Units is determined using the closing stock price on the grant date and is expensed over the requisite service period or on the grant date for awards with no requisite service period. During each of the years ended December 31, 2019 and 2018, the Company recorded approximately $1.2 million of expense related to Deferred Stock Units. During the year ended December 31, 2017 the Company recorded $1.0 million of such expenses. As of December 31, 2019, there is no unrecognized compensation expense related to the Deferred Stock Units.
The following table details the activity of the Deferred Stock Units during the year ended December 31, 2019.
Long-Term Incentive Awards
The General Partner may award long-term incentive-based Restricted Stock Units (the “LTI Target Awards”) to employees under the Equity Plan. Vesting of the LTI Target Awards is based upon the General Partner’s level of achievement of total stockholder return (“TSR”), including both share price appreciation and Common Stock dividends, as measured equally against a market index and against a peer group generally over a three year period.
The fair value and derived service period of the LTI Target Awards as of their grant date is determined using a Monte Carlo simulation which takes into account multiple input variables that determine the probability of satisfying the required TSR, as outlined in the award agreements. This method requires the input of assumptions, including the future dividend yield, the expected volatility of the Common Stock and the expected volatility of the market index constituents and the peer group. Compensation expense is recognized on a straight-line basis over the requisite service period regardless of whether the necessary TSR is attained, provided that the requisite service condition has been achieved. During the years ended December 31, 2019, 2018 and 2017, the Company recorded $5.5 million, $5.8 million and $7.4 million, respectively, of expense related to the LTI Target Awards. As
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
of December 31, 2019, there was $6.4 million of unrecognized compensation expense related to the LTI Target Awards with a weighted-average remaining term of 2.1 years.
The following table details the activity of the LTI Target Awards during the year ended December 31, 2019.
Stock Options
The General Partner may award Stock Options to employees that will vest if the recipient maintains constant employment through the end of the requisite service period.
The fair value of the Stock Options as of their grant date is determined using the Black-Scholes option pricing model, which requires the input of assumptions including expected terms, expected volatility, dividend yield and risk free rate. Expected term was calculated using the midpoint between the three year cliff vesting period and the 10-year contractual term. Expected volatilities were based on both historical and implied volatilities. The risk-free interest rate was based on zero-coupon yields derived from the U.S. Treasury Constant Maturity yield curve in effect as of the grant date.
The following inputs and assumptions were used to calculate the weighted-average fair values of the options granted at the date of grant as follows:
Compensation expense is recognized on a straight-line basis over the service period above. During the years ended December 31, 2019 and 2018, the Company recorded $1.2 million and $0.6 million, respectively, of expense related to Stock Options. As of December 31, 2019, there was $2.2 million of unrecognized compensation expense related to Stock Options with a weighted-average remaining term of 1.8 years.
The following table details the activity of the Stock Options during the year ended December 31, 2019.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Note 14 - Discontinued Operations
On November 13, 2017, the Company entered into a purchase and sale agreement (as amended by that certain First Amendment to the Purchase and Sale Agreement, dated as of February 1, 2018, the “Cole Capital Purchase and Sale Agreement”). On February 1, 2018, the Company completed the sale of its investment management segment, Cole Capital, under the terms of the Cole Capital Purchase and Sale Agreement. Substantially all of the Cole Capital segment operations were conducted through Cole Capital Advisors, Inc. (“CCA”), an Arizona corporation and a wholly owned subsidiary of the OP. The OP sold all of the issued and outstanding shares of common stock of CCA and certain of CCA’s subsidiaries to the Cole Purchaser, an affiliate of CIM Group, LLC for approximately $120.0 million paid in cash at closing. The Company could also earn up to an aggregate of $80.0 million of Net Revenue Payments in each calendar year through December 31, 2023 if future revenues of Cole Capital exceed a specified dollar threshold in a calendar year. There were no Net Revenue Payments received or earned since the sale. Substantially all of the Cole Capital segment financial results are reflected in the financial statements as discontinued operations. There were no discontinued operations or cash flows for the year ended December 31, 2019. There were also no assets and liabilities related to discontinued operations and real estate assets held for sale as of December 31, 2019 and 2018.
The following is a summary of the financial information for discontinued operations for the years ended December 31, 2018 and 2017 (in thousands):
___________________________________
(1)
The negative balance for the year ended December 31, 2018 is a result of estimated costs accrued in prior periods that exceeded actual expenses incurred.
The following is a summary of cash flows related to discontinued operations for the years ended December 31, 2018 and 2017 (in thousands):
Income Taxes
Cole Capital’s business, substantially all of which was conducted through a TRS, recognized a benefit of $2.1 million for the year ended December 31, 2018 and a provision of $13.8 million the year ended December 31, 2017. There was no related benefit or provision for the year ended December 31, 2019.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The following table presents the reconciliation of the (benefit from) provision for income taxes with the amount computed by applying the statutory federal income tax rate to loss before income taxes for the years ended December 31, 2018 and 2017 (in thousands):
The following table presents the components of the (benefit from) provision for income taxes for the years ended December 31, 2018 and 2017 (in thousands):
Note 15 - Related Party Transactions and Arrangements
Cole Capital
Through February 1, 2018, the Company was contractually responsible for managing CCIT II, CCIT III, Cole Credit Property Trust IV, Inc. (“CCPT IV”), CCPT V, and CIM Income NAV, Inc. (formerly known as Cole Real Estate Income Strategy (Daily NAV), Inc.) (“INAV” and collectively with CCIT II, CCIT III, CCPT IV, CCPT V, the “Cole REITs”) affairs on a day-to-day basis, identifying and making acquisitions and investments on the Cole REITs’ behalf, and recommending to the respective board of directors of each of the Cole REITs an approach for providing investors with liquidity. In addition, the Company was responsible for raising capital for certain Cole REITs, advised them regarding offerings, managed relationships with participating broker-dealers and financial advisors, and provided assistance in connection with compliance matters relating to the offerings. The Company received compensation and reimbursement for services relating to the Cole REITs’ offerings and the investment, management and disposition of their respective assets, as applicable. As discussed in Note 14 -Discontinued Operations, on February 1, 2018, the Company completed the sale of Cole Capital. The Cole Capital financial results are reflected in the consolidated statements of operations as discontinued operations for all periods presented. As a result of the sale of Cole Capital, the Cole REITs are no longer affiliated with the Company.
During the years ended December 31, 2018 and 2017, the Company earned $8.0 million and $106.7 million, respectively of offering-related, transaction services and management fees and reimbursements from the Cole REITs. No such fees were earned during the year ended December 31, 2019.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Investment in the Cole REITs
On February 1, 2018, the Company sold certain of its equity investments, recognizing a gain of $0.6 million, which is included in other income, net in the accompanying consolidated statement of operations for the year ended December 31, 2018, to the Cole Purchaser, retaining interests in CCIT II, CCIT III and CCPT V. As of December 31, 2019 and December 31, 2018, the Company owned aggregate equity investments of $7.6 million and $7.8 million, respectively, in CCIT II, CCIT III and CCPT V. During the year ended December 31, 2019, the Company recognized a loss of $0.3 million related to the change in fair value, which is included in other income, net in the accompanying consolidated statements of operations. During the year ended December 31, 2018, the Company recognized a $5.1 million gain from measuring the Company’s investments in CCIT II, CCIT III and CCPT V at fair value after the investments were no longer accounted for using the equity method, which is included in other income, net in the accompanying consolidated statements of operations. During the year ended December 31, 2017, the Company recognized a net loss of $0.5 million from the Cole REITs, which was included in equity in income and gain on disposition of unconsolidated entities.
Note 16 - Net Income (Loss) Per Share/Unit
The General Partner’s unvested Restricted Shares contain non-forfeitable rights to dividends and are considered to be participating securities in accordance with U.S. GAAP and, therefore, are included in the computation of earnings per share under the two-class computation method. Under the two-class computation method, net losses are not allocated to participating securities unless the holder of the security has a contractual obligation to share in the losses. The unvested Restricted Shares are not allocated losses as the awards do not have a contractual obligation to share in losses of the General Partner. The two-class computation method is an earnings allocation formula that determines earnings per share for each class of shares of Common Stock and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings.
Net Income (Loss) Per Share
The following is a summary of the basic and diluted net loss per share computation for the General Partner for the years ended December 31, 2019, 2018 and 2017 (dollar amounts in thousands):
_______________________________________________
(1)
Amounts may not total due to rounding.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
The following were excluded from diluted net loss per share attributable to common stockholders, as the effect would have been antidilutive:
_______________________________________________
(1)
Net of assumed repurchases in accordance with the treasury stock method.
Net Income (Loss) Per Unit
The following is a summary of the basic and diluted net loss per unit attributable to common unitholders, which includes all common General Partner unitholders and limited partner unitholders, for the years ended December 31, 2019, 2018 and 2017 (dollar amounts in thousands):
_______________________________________________
(1)
Amounts may not total due to rounding.
The following were excluded from diluted net loss per unit attributable to common unitholders, as the effect would have been antidilutive:
_______________________________________________
(1)
Net of assumed repurchases in accordance with the treasury stock method.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Note 17 - Quarterly Results (Unaudited)
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2019 for the General Partner (in thousands, except share and per share amounts):
_______________________________________________
(1)
The sum of the quarterly net income (loss) per share amounts may not agree to the full year net loss per share amounts. The Company calculates net income (loss) per share based on the weighted-average number of outstanding shares of Common Stock during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2019 for the OP (in thousands, except share and per share amounts):
_______________________________________________
(1)
The sum of the quarterly net income (loss) per unit amounts may not agree to the full year loss income per unit amounts. The Company calculates net income (loss) per unit based on the weighted-average number of outstanding units during the reporting period. The average number of units fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2018 for the General Partner (in thousands, except share and per share amounts):
_______________________________________________
(1)
Represents revenue from continuing operations as presented on the statement of operations in accordance with U.S. GAAP. Substantially all of Cole Capital is presented as discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented.
(2)
The sum of the quarterly net income (loss) per share amounts may not agree to the full year loss per share amounts. The Company calculates net income (loss) per share based on the weighted-average number of outstanding shares of Common Stock during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019 - (Continued)
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2018 for the OP (in thousands, except share and per share amounts):
_______________________________________________
(1)
Represents revenue from continuing operations as presented on the statement of operations in accordance with U.S. GAAP. Substantially all of Cole Capital is presented as discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented.
(2)
The sum of the quarterly net income (loss) per unit amounts may not agree to the full year net loss per unit amounts. The Company calculates net income (loss) per unit based on the weighted-average number of outstanding units during the reporting period. The average number of units fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
Note 18 - Subsequent Events
The following events occurred subsequent to December 31, 2019:
Real Estate Investment Activity
From January 1, 2020 through February 12, 2020 the Company disposed of 13 properties, including the sale of two consolidated office properties to a newly-formed joint venture in which the Company owns a 20% equity interest (the “Office Partnership”), for an aggregate gross sales price of $118.1 million, of which four properties were held for sale with an aggregate carrying value of $14.2 million as of December 31, 2019, for an estimated gain of $20.8 million.
From January 1, 2020 through February 12, 2020 the Company also acquired 23 properties for an aggregate purchase price of $127.8 million, excluding capitalized external acquisition-related expenses.
Office Partnership
From January 1, 2020 through February 12, 2020, the Office Partnership acquired one property from a third party for a purchase price of $33.1 million.
Common Stock Dividend
On February 25, 2020, the Company’s Board of Directors declared a quarterly cash dividend of $0.1375 per share of Common Stock (equaling an annualized dividend rate of $0.55 per share) for the first quarter of 2020 to stockholders of record as of March 31, 2020, which will be paid on April 15, 2020. An equivalent distribution by the Operating Partnership is applicable per OP Unit.
Preferred Stock Dividend
On February 25, 2020, the Company’s Board of Directors declared a monthly cash dividend to holders of the Series F Preferred Stock for April 2020 through June 2020 with respect to the periods included in the table below. The corresponding record and payment dates for each month's Series F Preferred Stock dividend are also shown in the table below. The dividend for the Series F Preferred Stock accrues daily on a 360-day annual basis equal to an annualized dividend rate of $1.675 per share, or $0.1395833 per 30-day month.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
December 31, 2019 (in thousands)
Schedule II - Valuation and Qualifying Accounts
_______________________________________________
(1)
Upon adoption of ASC 842, the Company recognizes all changes in the collectability assessment for an operating lease as an adjustment to rental revenue and does not record an allowance for uncollectable accounts.
(2)
Classified as discontinued operations.
(3)
Represents additions to the reserve during the period from January 1, 2018 through January 31, 2018, prior to the sale of Cole Capital.
(4)
Includes $1.0 million classified as discontinued operations.
(5)
Deductions related to the return of the Company's interest in two funds not yet in offering ($1.3 million) and the closing of CCPT V's primary offering ($32.0 million).
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2019 (in thousands)
Schedule III - Real Estate and Accumulated Depreciation
_______________________________________________
(1)
Initial costs exclude subsequent impairment charges.
(2)
Consists of capital expenditures and real estate development costs, net of condemnations, easements and impairment charges.
(3)
Gross intangible lease assets of $1.9 billion and the associated accumulated amortization of $867.2 million are not reflected in the table above.
(4)
The aggregate cost for Federal income tax purposes of land, buildings, fixtures and improvements as of December 31, 2018 was $13.0 billion.
(5)
Depreciation is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, five to 15 years for building fixtures and improvements.
The following is a reconciliation of the gross real estate activity for the years ended December 31, 2019, 2018 and 2017 (amounts in thousands):
The following is a reconciliation of the accumulated depreciation for the years ended December 31, 2019, 2018 and 2017 (amounts in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE
December 31, 2019 (in thousands)
Schedule IV - Mortgage Loans on Real Estate
During the year ended December 31, 2018, the Company decided to sell its mortgage notes receivable and classified them as held for sale. During the year ended December 31, 2019, the Company sold all outstanding mortgage notes receivable.