Item 1B.
Unresolved Staff Comments
Not applicable.
Not applicable.
None.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
We are currently offering shares of our common stock pursuant to an effective registration statement at an offering price of $10.00 per share in our “best efforts” primary offering and a $9.50 purchase price for shares sold under our distribution reinvestment plan. There is no established public trading market for our shares of common stock. We do not expect that our shares will be listed for trading on a national securities exchange in the near future, if ever. Our board will determine when, and if, to apply to have our shares of common stock listed for trading on a national securities exchange, subject to satisfying existing listing requirements. Our board does have a stated term for evaluating a listing on a national securities exchange as we believe setting a finite date for a possible, but uncertain future liquidity transaction may result in actions that are not necessarily in the best interest or within the expectations of our stockholders.
In order for members of the Financial Industry Regulatory Authority, Inc., or FINRA, and their associated persons to have participated in the offering and sale of our common shares or to participate in any future offering of our common shares, we are required pursuant to FINRA Rule 5110 to disclose in each Annual Report distributed to our stockholders a per share estimated value of our common shares, the method by which it was developed and the date of the data used to develop the estimated value. In addition, our advisor must prepare annual statements of estimated share values to assist fiduciaries of retirement plans subject to the annual reporting requirements of ERISA in the preparation of their reports relating to an investment in our common shares. For these purposes, the estimated value of our shares shall be deemed to be $10.00 per share as of December 31, 2010. The basis for this valuation is the fact that we are currently conducting a public offering of our common shares at the price of $10.00 per share (not taking into consideration purchase price discounts for certain categories of purchasers).
Stockholders
As of March 24, 2011, we had 664 stockholders of record.
Distributions
For the period from January 1, 2010 to October 18, 2010, NSIO REIT paid cumulative cash distributions to the stockholders’ of record of $1,000,924.
On September 8, the board of directors approved a daily cash distribution of $0.002191781 per share of common stock, for (1) October for the period commencing October 18, 2010 and ending October 31, 2010, (2) November for the period commencing November 1, 2010 and ending November 30, 2010 and (3) December for the period commencing December 1, 2010 and ending December 31, 2010. The October, November and December distributions were paid in cumulative amounts on November 8, 2010, December 8, 2010 and January 10, 2011, respectively, and totaled $226,681. At December 31, 2010 recorded in distribution payable was $164,272 related to the approved December cash distribution which was paid in January 2011.
Distribution Reinvestment Plan
We have adopted a distribution reinvestment plan (the “DRP”) through which common stockholders may elect to reinvest an amount equal to the distributions declared on their shares in additional shares of our common stock in lieu of receiving cash distributions. The initial purchase price per share under the DRP will be $9.50. Once we establish an estimated value per share, shares issued pursuant to the distribution reinvestment plan will be priced at the estimated value per share of our common stock, as determined by the Advisor or another firm chosen for that purpose. We expect to establish an estimated value per share after the completion of our offering stage. The offering stage will be considered complete when we are no longer publicly offering equity securities-whether through the Offering or follow-on public offerings-and have not done so for 18 months. No selling commissions or Dealer Manager fees will be paid on shares sold under the DRP. The board of directors of the Company may amend or terminate the DRP for any reason upon 10 days’ notice to participants. For the period commencing October 18, 2010 and ending December 31, 2010, the Company issued 6,214 shares totaling $59,032 of gross offering proceeds pursuant to the DRP. At December 31, 2010, recorded in distribution payable was $44,321 related to the approved December cash distribution which was reinvested pursuant to the DRP in January 2011.
Share Repurchase Program
We have adopted a share repurchase program that may enable stockholders to sell their shares to us in limited circumstances. Share repurchases will be made at the sole discretion of the board of directors.
Recent Sales of Unregistered Securities
On July 19, 2010, each of our three independent directors received 5,000 shares of restricted stock in connection with the commencement of the Offering. The restricted stock will generally vest over four years; provided, however, that the restricted stock will become fully vested on the earlier occurrence of (i) the termination of the independent director’s service as a director due to his or her death or disability, or (ii) a change in control. Such shares were granted without registration under the Securities Act of 1933, as amended, (or, the Securities Act) in reliance upon the exemption from registration contained in Section 4(2) of the Securities Act.
On October 18, 2010, we completed the Merger Transaction with NSIO REIT. 2,828,552 shares of NSIO REIT, par value $0.01 per share, issued and outstanding immediately prior to the Merger Transaction were converted into 2,897,694 shares of our common stock, par value $0.01, at a conversion rate of 1.02444444 shares of our stock for every one share of NSIO REIT stock. Such shares were issued in a private placement exempt from registration under Section 4(2) of the Securities Act, and Regulation D promulgated thereunder.
Use of Proceeds from Registered Securities
On July 19, 2010, our Registration Statement on Form S-11 (File No. 333-157688), covering our offering of up to 100,000,000 shares of common stock in our primary offering and 10,526,315 shares of common stock under our distribution reinvestment plan, was declared effective under the Securities Act and we retained our Dealer Manager, an affiliate of ours, to serve as the dealer manager of the Offering. We are offering 100,000,000 shares of common stock in our primary offering at an aggregate offering price of up to $1.0 billion, or $10.00 per share, with discounts available to certain categories of purchasers. The 10,526,315 shares offered under our distribution reinvestment plan are initially being offered at an aggregate offering price of $100 million, or $9.50 per share.
As of December 31, 2010, we had sold the following securities in our Offering for the following aggregate offering prices:
In the aggregate, as of December 31, 2010, we had sold 256,681 shares resulting in gross proceeds of $2,556,068 excluding the 24,039 shares purchased by NRFC Sub-REIT Corp preceding the commencement of our Offering.
As of December 31, 2010, we have incurred the following offering costs in connection with the issuance and distribution of the registered securities:
The information below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes, each included elsewhere in this Form 10-K.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report.
Organization and Overview
We are an externally managed commercial real estate finance company that was formed in January 2009 to invest in and manage a diversified portfolio of commercial real estate loans, commercial real estate-related debt securities and select commercial real estate equity investments. We commenced our operations in October 2010 upon the consummation of the Merger Transaction and the elimination of the minimum offering requirement. We conduct substantially all of our operations and make investments through our operating partnership, of which we are the sole general partner. Through our operating partnership we:
•
originate, acquire, and asset manage;
(i)
commercial real estate loans, including senior mortgage loans, subordinate mortgage loans (or B-Notes), mezzanine loans, and participations in such loans;
(ii)
commercial real estate-related debt securities, such as CMBS, CDOs and REIT senior unsecured debt; and
(iii)
select commercial real estate equity investments.
We believe that these businesses are complementary to each other due to the overlapping sources of investment opportunities and common reliance on real estate fundamentals.
We intend to make an election to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, commencing with our taxable year ending December 31, 2010. If we qualify as a REIT for federal income tax purposes, we generally will not be subject to federal income tax to the extent we distribute qualifying dividends to our stockholders. If we fail to qualify as a REIT in any taxable year after electing REIT status, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied. Such an event could materially and adversely affect our net income and cash available for distribution. However, we believe that we will be organized and will operate in a manner that will enable us to qualify for treatment as a REIT for federal income tax purposes commencing with our taxable year ending December 31, 2010, and we intend to continue to operate so as to remain qualified as a REIT for federal income tax purposes thereafter.
Sources of Operating Revenues
We earn interest income from real estate fixed income securities. We may seek to minimize the impact of floating interest rates by financing floating rate assets with floating rate debt or by hedging fixed rate assets funded with floating rate debt.
Profitability and Performance Metrics
We calculate Adjusted funds from operations (“AFFO”) (see “Non-GAAP Financial Measures-Funds from Operations and Adjusted Funds from Operations” for a description of this metric) to evaluate the profitability and performance of our business.
Outlook and Recent Trends
Commercial real estate credit continues to remain scarce and costly for most commercial real estate assets as a result of the economic and capital markets disruptions begun in 2007 by the deterioration of credit in the residential mortgage market which quickly spread throughout the broader capital markets. From the second half of 2007 through most of 2009 the CMBS new issue market came to a virtual standstill. During 2010 approximately $10 billion of new issue CMBS transactions were completed (well below the over $200 billion issued in each of 2006 and 2007), but the underlying commercial mortgages were principally originated with terms that most owners of commercial real estate properties find unattractive or are unable to access. As a result of the scarcity of mortgage debt capital for commercial real estate, we believe there is strong demand for commercial real estate financing that is unmet by existing market participants.
We believe that current economic conditions, high unemployment in the U.S. and general risk aversion to economically sensitive asset classes will prolong the supply/demand imbalance which currently exists for commercial real estate debt capital. These conditions and the ability to underwrite collateral, in many cases at values significantly lower than several years ago, should create very attractive investment opportunities for those investors who have liquidity and expertise to invest in commercial real estate.
In addition, many investors who acquired real estate assets prior to this recent economic recession are devoting substantial resources to managing their investments through the recession and may not currently have the liquidity or personnel to take advantage of current market opportunities. We believe that companies such as ours, with no legacy asset issues, should have a competitive advantage in this market. Although real estate values may decline if economic conditions become worse, we believe that a debt-oriented strategy, where the real estate owner has capital at risk of loss before we lose capital, provides the best risk/return opportunities in our market.
Critical Accounting Policies
Below is a discussion of the accounting policies that management believes are critical. We consider these policies critical because we believe that understanding these policies is critical to understanding and evaluating our reported financial results. Additionally, these policies may involve significant management judgments and assumptions, or require estimates about matters that are inherently uncertain. These judgments will affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses.
Valuation of Financial Instruments
Proper valuation of financial instruments is a critical component of our financial statement preparation. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date (i.e., the exit price).
We categorize our financial instruments, based on the priority of the inputs to the valuation technique, into a three level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1:
•
Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities, listed derivatives, most U.S. Government and agency securities, and certain other sovereign government obligations).
Level 2:
•
Financial assets and liabilities whose values are based on the following:
•
quoted prices for similar assets or liabilities in active markets (for example, restricted stock);
•
quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);
•
pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and
•
pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (for example, certain mortgage loans).
Level 3:
•
Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include private equity investments, commercial mortgage backed securities, and long-dated or complex derivatives including certain foreign exchange options and long dated options on gas and power).
The fair value of our financial instruments is based on observable market prices when available. Such prices are based on the last sales price on the date of determination, or, if no sales occurred on such day, at the “bid” price at the close of business on such day and if sold short at the “asked” price at the close of business on such day. Interest rate swap contracts will be valued based on market rates or prices obtained from recognized financial data service providers. Generally these prices will be provided by a recognized financial data service provider.
Fair Value Option
The fair value option election allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. The fair value option election is permitted on an instrument by instrument basis at initial recognition. We determine the fair value of financial assets and financial liabilities for which the fair value option election is made.
Available for Sale Securities
We will determine the appropriate classification of our investments in securities at the time of purchase and reevaluate such determination at each balance sheet date. Securities for which we will not have the intent or the ability to hold to maturity will be classified as available for sale securities. We will determine the fair value of our available for sale securities pursuant to the fair value guidance.
Revenue Recognition
We recognize interest income from available for sale securities on an accrual basis over the life of the investment on a yield-to-maturity basis.
Basis of Presentation
The following discussion is based upon the historical carryover financial statements of NSIO REIT, the accounting acquirer, for the periods from January 26, 2009 (inception) to December 31, 2009 and from January 1, 2010 to October 18, 2010, the date of the Merger Transaction, and the financial statements of ours, as affected by the Merger Transaction, from October 19, 2010 to December 31, 2010.
Comparison of the Year Ended December 31, 2010 to the Year Ended December 31, 2009.
Revenues
Interest Income
Interest income for the year ended December 31, 2010 totaled $1,484,691, representing an increase of $1,389,896, compared to $94,795 for the year ended December 31, 2009. For the year ended December 31, 2010, the $1,389,896 increase in interest income was primarily attributable to the acquisition of two CMBS securities in 2010 totaling $29,616,265, partially offset by the sale of a CMBS security in June 2010 totaling $1,852,500.
Expenses
Interest Expense
Interest expense for the year ended December 31, 2010 totaled $799,911 and represented interest expense on two Term Asset-Backed Securities Loan Facility agreements which were used to finance CMBS acquisitions. We had no such interest expense for the year ended December 31, 2009.
Advisory Fees - Related Party
Advisory fees - related parties for the year ended December 31, 2010 totaled $53,760 and represented asset management fees paid to our Advisor. We had no such advisory fees - related parties for the year ended December 31, 2009.
Audit and Professional Fees
Audit and professional fees for the year ended December 31, 2010 totaled $238,059 and represented audit and tax, legal and consulting fees related to our registration statements, our periodic reporting, insurance consulting and the Merger Transaction. We had no such audit and professional fees for the year ended December 31, 2009.
General and Administrative
General and administrative expenses for the year ended December 31, 2010 totaled $687,282 and represented organizational expenses, transfer agent fees, director and officer insurance, public company expenses, stock based compensation expense and servicer fees. We had no such other general and administrative expenses for the year ended December 31, 2009.
Realized Gain on Investments
Realized gain on investments for the year ended December 31, 2010 totaled $199,604 and represented a realized gain on the sale of a CMBS security. We had no such realized gain on investments for the year ended December 31, 2009.
Unrealized Gain on Investments
Unrealized gain on investments for the year ended December 31, 2010 totaled a gain of $1,724,637, representing an increase of $1,137,541, compared to a gain of $587,096 for the year ended December 31, 2009. The unrealized gain on investments for the year ended December 31, 2010 consisted mark-to-market adjustments of $1,724,637 on two CMBS securities. The unrealized gain on investments for the year ended December 31, 2009 consisted of mark-to-market adjustments of $587,096 on one CMBS security.
Liquidity and Capital Resources
We are dependent upon the net proceeds from our Offering to conduct our operations. We will obtain the capital required to purchase and originate real estate-related investments and conduct our operations from the proceeds of our Offering and any future offerings we may conduct, from secured or unsecured financings from banks and other lenders and from any undistributed funds from our operations. As of December 31, 2010, we had $20,404,832 of cash.
If we are unable to raise substantially more funds in the Offering than the minimum offering amount, we will make fewer investments resulting in less diversification in terms of the type, number and size of investments we make and the value of an investment in us will fluctuate with the performance of the specific assets we acquire. Further, we will have certain fixed operating expenses, including certain expenses as a publicly offered REIT, regardless of whether we are able to raise substantial funds in this Offering. Our inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, reducing our net income and limiting our ability to make distributions.
Once we have fully invested the proceeds of our Offering, we expect that our debt financing will not exceed 50% of the greater of the cost or fair market value of our investments, although it may exceed this level during our offering stage. Our charter does not limit us from incurring debt until our borrowings would exceed 75% of our tangible assets. We cannot exceed this limit unless any excess in borrowing over such level is approved by our stockholders. In connection with the Merger Transaction, we acquired two CMBS securities, each financed with a TALF, which caused us to exceed the leverage limit in our charter. This acquisition, which was part of the Merger Transaction, was approved by a majority of the NSIO REIT stockholders.
In addition to making investments in accordance with our investment objectives, we expect to use our capital resources to make certain payments to our Advisor and our Dealer Manager. During our organization and offering stage, these payments will include payments to our Dealer Manager for selling commissions and the dealer manager fee and payments to our Dealer Manager and our Advisor for reimbursement of certain organization and offering expenses. However, our Advisor has agreed to reimburse us to the extent that selling commissions, the Dealer Manager fee and other organization and offering expenses incurred by us exceed 15% of our gross offering proceeds. During our acquisition and development stage, we expect to make payments to our Advisor in connection with the selection and origination or purchase of investments, the management of our assets and costs incurred by our Advisor in providing services to us. The advisory agreement has a one-year term but may be renewed for an unlimited number of successive one-year periods upon the mutual consent of our Advisor and our board of directors.
We intend to elect to be taxed as a REIT and to operate as a REIT commencing with our taxable year ending December 31, 2010. To maintain our qualification as a REIT, we will be required to make aggregate annual distributions to our stockholders of at least 90% of our REIT taxable income (computed without regard to the dividends paid deduction and excluding net capital gain). Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant. Provided we have sufficient available cash flow, we intend to authorize and declare daily distributions and pay distributions on a monthly basis. We have not established a minimum distribution level.
Cash flow Analysis
The following discussion is based upon the historical carryover financial statements of NSIO REIT, the accounting acquirer, for the periods from January 26, 2009 (inception) to December 31, 2009 and from January 1, 2010 to October 18, 2010, the date of the Merger Transaction, and the financial statements of ours, as affected by the Merger Transaction, from October 19, 2010 to December 31, 2010.
Net cash flow provided by operating activities was $1,423,328 for the year ended December 31, 2010 compared to net cash provided by operating activities of $53,630 for the year ended December 31, 2009. The principal source of cash for the year ended December 31, 2010 was attributable to new investment activity generating income. The principal source of cash for the year ended December 31, 2009 was attributable to initial investment activity generating income.
Net cash flow used in investing activities was $27,763,765 for the year ended December 31, 2010 compared to net cash used in investing activities of $1,000,000 for the year ended December 31, 2009. The principal use of cash for the year ended December 31, 2010 was the purchase of two CMBS securities. The principal use of cash for the year ended December 31, 2009 was the purchase of one CMBS security.
Net cash flow provided by financing activities was $46,689,639 for the year ended December 31, 2010 compared to net cash provided by financing activities of $1,002,000 for the year ended December 31, 2009. The principal sources of cash for the year ended December 31, 2010 were proceeds from the issuance of common stock and proceeds from two term asset-backed loan facilities. The principal sources of cash for the year ended December 31, 2009 were proceeds from the issuance of common stock.
Recent Developments
On March 23, 2011, our board of directors approved a daily cash distribution of $0.002191781 per share of common stock, for (1) the full month of April, 2011 (2) the full month of May, 2011 and (3) the full month of June, 2011. The April, May and June distributions will be paid in cumulative amounts to the stockholders of record who are entitled to receive such distributions on May 1, 2011, June 1, 2011 and July 1, 2011, respectively.
Our Sponsor has committed to purchase up to $10 million of shares of our common stock during the two-year period following commencement of our continuous, public offering under certain circumstances in which our distributions exceed our AFFO in order to provide additional funds to support distributions to stockholders. On March 23, 2011, our board of directors approved the sale of 43,439 shares of our common stock, $0.01 par value per share, to NRFC Sub-REIT Corp., a Maryland corporation and a subsidiary of the Sponsor, at a price of $9.00 per Share.
For the period from January 1, 2011 to March 24, 2011, we sold 841,976 common shares pursuant to our Offering, generating gross proceeds of $8,404,104.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.
Non-GAAP Financial Measures
Funds from Operations and Adjusted Funds from Operations
Management believes that funds from operations, or FFO, and adjusted funds from operations, or AFFO, each of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and of our company in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income or loss (computed in accordance with GAAP), excluding gains or losses from sales of depreciable properties, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, and after adjustments for unconsolidated/uncombined partnerships and joint ventures. FFO, as defined by NAREIT, is a computation made by analysts and investors to measure a real estate company’s cash flow generated by operations.
We calculate AFFO by subtracting from (or adding to) FFO:
•
the amortization or accrual of various deferred costs including equity based compensation; and
•
an adjustment to reverse the effects of unrealized gains/(losses).
Our calculation of AFFO differs from the methodology used for calculating AFFO by certain other REITs and, accordingly, our AFFO may not be comparable to AFFO reported by other REITs. Our management utilizes FFO and AFFO as measures of our operating performance, and believes they are also useful to investors, because they facilitate an understanding of our operating performance after adjustment for certain non-cash expenses. Additionally, FFO and AFFO serve as measures of our operating performance because they facilitate evaluation of our company without the effects of selected items required in accordance with GAAP that may not necessarily be indicative of current operating performance and that may not accurately compare our operating performance between periods. Furthermore, although FFO, AFFO and other supplemental performance measures are defined in various ways throughout the REIT industry, we also believe that FFO and AFFO may provide us and our investors with an additional useful measure to compare our financial performance to certain other REITs.
Neither FFO nor AFFO is equivalent to net income or cash generated from operating activities determined in accordance with U.S. GAAP. Furthermore, FFO and AFFO do not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Neither FFO nor AFFO should be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.
Set forth below is a reconciliation of FFO and AFFO to net income from continuing operations before non-controlling interest:
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
We may be exposed to the effects of interest rate changes as a result of borrowings used to maintain liquidity and to fund the acquisition, expansion and refinancing of our real estate investment portfolio and operations. Our profitability and the value of our investment portfolio may be adversely affected during any period as a result of interest rate changes. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. We may utilize a variety of financial instruments, including interest rate caps, floors, and swap agreements, in order to limit the effects of changes in interest rates on our operations. When we use these types of derivatives to hedge the risk of interest-earning assets or interest-bearing liabilities, we may be subject to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of our common stock and that the losses may exceed the amount we invested in the instruments. We will not enter into derivative or interest rate transactions for speculative purposes.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The consolidated financial statements of NorthStar Real Estate Income Trust, Inc. and the notes related to the foregoing financial statements, together with the independent registered public accounting firm’s reports thereon are included in this Item 8.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
NorthStar Real Estate Income Trust, Inc.
We have audited the accompanying consolidated balance sheets of NorthStar Real Estate Income Trust, Inc. and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year ended December 31, 2010 and for the period January 26, 2009 through December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NorthStar Real Estate Income Trust, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the year ended December 31, 2010 and for the period January 26, 2009 through December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
New York, New York
March 28,
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Formation and Organization
NorthStar Real Estate Income Trust, Inc. (the “Company”) was formed on January 26, 2009, as a Maryland corporation and intends to qualify as a real estate investment trust (“REIT”) beginning with the taxable year ending December 31, 2010. The Company was organized primarily to acquire commercial real estate loans, commercial real estate-related debt securities and select commercial real estate equity investments. The Company is externally managed by NS Real Estate Income Trust Advisor, LLC (the “Advisor”), a Delaware limited liability company, and has no employees.
Substantially all of the Company’s business is conducted through NorthStar Real Estate Income Trust Operating Partnership, LP, the Company’s operating partnership (the “OP”). The Company is the sole general partner of the OP. The initial limited partners of the OP are the Advisor and NorthStar OP Holdings, LLC, a Delaware limited liability company (the “Special Unit Holder”). The Advisor has invested $1,000 in the OP in exchange for common units and the Special Unit Holder has invested $1,000 in the OP and has been issued a separate class of limited partnership units (the “Special Units”), which is recorded as non-controlling interest in the consolidated balance sheet as of December 31, 2010. As the Company accepts subscriptions for shares, it will transfer substantially all of the net proceeds from the continuous public offering to the OP as a capital contribution.
The Company’s charter provides for the issuance of up to 400,000,000 shares of common stock with a par value $0.01 per share, and 50,000,000 shares of preferred stock, $0.01 par value per share. The Company’s board of directors is authorized to amend its charter, without the approval of the stockholders, to increase the aggregate number of authorized shares of capital stock or the number of shares of any class or series that the Company has authority to issue. On February 19, 2009, the Company was initially capitalized through the sale 24,039 shares of common stock to NRFC Sub-REIT Corp., a wholly-owned subsidiary of NorthStar Realty Finance Corp. (the “Sponsor”), for $200,004.
On March 4, 2009, the Company filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to offer a minimum of 200,000 shares (the “Minimum Number of Shares”) and a maximum of 110,526,315 shares of common stock for sale to the public (the “Offering”), of which 10,526,315 shares would be offered pursuant to the Company’s distribution reinvestment plan. The SEC declared the Company’s registration statement effective on July 19, 2010, and the Company retained NRF Capital Markets, LLC (the “Dealer Manager”), an affiliate of the Company, to serve as the dealer manager of the Offering. The Dealer Manager is responsible for marketing the Company’s shares being offered pursuant to the Offering. As described above, the Company intends to use substantially all of the net proceeds from the Offering to invest in a diverse portfolio of commercial real estate loans, commercial real estate-related debt securities and select commercial real estate equity investments.
On October 18, 2010, the Company completed a merger, accounted for as a reverse merger and recapitalization, with NorthStar Income Opportunity REIT I, Inc., a Maryland corporation (“NSIO REIT”) also sponsored by the Sponsor (the “Merger Transaction”). The Company was considered the surviving legal entity and NSIO REIT was considered the accounting acquirer and the surviving accounting entity. As the surviving accounting entity, NSIO REIT’s financial information is presented in these financial statements on a historical carryover basis.
2,828,552 shares of NSIO REIT, par value $0.01 per share, issued and outstanding immediately prior to the Merger Transaction were converted into 2,897,694 shares of the Company’s common stock, par value $0.01, at a conversion rate of 1.02444444 shares of the Company’s stock for every one share of NSIO REIT stock and 893,968 shares of NSIO REIT, par value $0.01 per share, issued and outstanding immediately prior to the Merger Transaction were converted into cash, without interest, in an amount of $9.22 per share. All NSIO REIT stockholders who would otherwise have been entitled to a fractional share of the Company’s shares received cash in an amount equal to such fraction of the Company’s shares based on a conversion price of $9.22. The Company used $8,242,385 of the cash received from NSIO REIT in connection with the closing of the Merger Transaction to satisfy the Company’s obligation to pay the cash consideration and intends to use the remaining cash after payment of transaction expenses for general corporate purposes, including investments consistent with the Company’s investment strategy. On the closing date, 411 NSIO REIT stockholders became stockholders of the Company with each of their shares of NSIO REIT common stock being converted to unregistered shares of the Company’s common stock at the ratio set forth above.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition, as a result of the Merger Transaction, the Company eliminated the minimum offering requirement and terminated its escrow agreement with Wells Fargo Bank, N.A.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying audited consolidated financial statements have been prepared on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles (“GAAP”) as contained within the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) and the rules and regulations of the SEC.
The financial statements presented herein are based upon the historical carryover financial statements of NSIO REIT, the accounting acquirer, for the periods from January 26, 2009 (inception) to December 31, 2009 and from January 1, 2010 to October 18, 2010, the date of the Merger Transaction, and the financial statements of the Company, as affected by the Merger Transaction, from October 19, 2010 to December 31, 2010.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, and its majority owned subsidiaries, which are controlled by the Company. All significant intercompany balances have been eliminated in consolidation.
Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could materially differ from those estimates.
Cash
The Company’s cash balance may exceed federally insurable limits of $250,000 per institution. The Company mitigates this risk by depositing funds with a major financial institution. There are no restrictions on the use of the Company’s cash as of December 31, 2010.
Fair Value Measurements
Fair value is used to measure many of the Company’s financial instruments. The fair value of these financial instruments is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., the exit price).
Fair Value Option
The fair value option election allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in fair value for assets and liabilities for which the election is made are recognized in earnings as they occur. The fair value option election is permitted on an instrument by instrument basis at initial recognition. The Company determines the fair value of financial assets and financial liabilities for which the fair value option election is made.
Available for Sale Securities
The Company determines the appropriate classification of its investments in securities at the time of purchase and reevaluates such determination at each balance sheet date. Securities for which the Company does not have the intent or the ability to hold to maturity are classified as available for sale securities. The Company determines the fair value of its available for sale securities pursuant to the fair value guidance.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition
The Company recognizes interest income from available for sale securities on an accrual basis over the life of the investment on a yield-to-maturity basis.
Stock Based Compensation
The Company has adopted the fair value method of accounting for equity-based compensation awards. The fair value method of accounting for equity-based compensation awards requires an estimate of the fair value of the equity award at the time of grant rather than the intrinsic value method. For all equity-based awards to the Company’s directors, which have no vesting conditions other than time of service, the fair value of the equity award at the grant date will be amortized to compensation expense over the award’s vesting period.
Organization, Offering and Related Costs
Organization and offering costs (other than selling commissions and the dealer manager fee) of the Company are initially being paid by the Advisor or its affiliates on behalf of the Company. These organization and offering costs include all expenses (other than selling commissions and the dealer manager fee) to be paid by the Company in connection with the formation of the Company and the qualification and registration of the Offering, and the marketing and distribution of shares, including, without limitation, expenses for printing, engraving and amending registration statements or supplementing prospectuses, mailing and distributing costs, telephones and other telecommunications costs, all advertising and marketing expenses, charges of transfer agents, registrars, trustees, escrow holders, depositories and experts and fees, expenses and taxes related to the filing, registration and qualification of the sale of shares under federal and state laws, including taxes and fees and accountants’ and attorneys’ fees. The Company anticipates that, pursuant to the advisory agreement dated as of March 17, 2010 (the “Advisory Agreement”) with its Advisor, the Company will be obligated to reimburse the Advisor, or its affiliates, as applicable, for organization and offering costs paid by the Advisor on behalf of the Company, provided that the Advisor would be obligated to reimburse the Company to the extent selling commissions, the dealer manager fee and other organization and offering costs incurred by the Company in the Offering exceed 15% of gross offering proceeds.
Organization and offering costs will only become a liability of the Company to the extent selling commissions, the dealer manager fee and other organization and offering costs do not exceed 15% of the gross proceeds of the Offering. When recorded by the Company, organization costs will be expensed as incurred and offering costs will be deferred and charged to stockholders’ equity as such amounts are reimbursed to the Advisor, the Dealer Manager or their affiliates from the gross proceeds of the Offering.
Income Taxes
The Company intends to elect to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and intends to operate as such, commencing with the taxable year ending December 31, 2010. To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company’s annual REIT taxable income to its stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Company generally will not be subject to federal income tax to the extent it distributes qualifying dividends to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the Company’s net income and net cash available for distribution to stockholders. However, the Company intends to organize and operate in such a manner as to qualify for treatment as a REIT.
Recent Accounting Pronouncements
In January 2010, the FASB issued guidance requiring additional disclosures about fair value measurements regarding transfers between fair value categories as well as purchases, sales, issuances and settlements related to fair value measurements of financial instruments with non-observable inputs. This update was effective and was adopted by the Company for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances and settlements of financial instruments with non-observable inputs, which are effective for years beginning after December 15, 2010.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2010, the FASB issued guidance requiring the disclosure of pro forma revenue and earnings for all business combinations that occurred during the current year to be presented as of the beginning of the comparable prior annual reporting period. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The guidance is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company adopted the guidance upon issuance in December 2010 and has provided such pro forma revenue and earnings disclosures in Note 11, Pro Forma Information. The adoption of the guidance did not have a material impact on our consolidated financial statements.
3. Fair Value of Financial Instruments
Fair Value Measurements
Fair Value Hierarchy
The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1.
Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities, listed derivatives, most U.S. government and agency securities, and certain other sovereign government obligations).
Level 2.
Financial assets and liabilities whose values are based on the following:
a)
Quoted prices for similar assets or liabilities in active markets (for example, restricted stock);
b)
Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);
c)
Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and
d)
Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (for example, certain mortgage loans).
Level 3.
Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include private equity investments, beneficial interest in securitizations and long-dated or complex derivatives, including certain foreign exchange options and long-dated options on gas and power).
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Determination of Fair Value
The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The Company’s market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The Company’s income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. The Company reviews the fair values determined by the third-party pricing models and dealer quotes and compares the results to internally generated pricing models on each asset or liability to validate reasonableness.
The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.
Available for sale securities
When available, the fair value of debt securities available for sale is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from nationally-recognized pricing services, broker quotes, or other model-based valuation techniques. The fair value of Level 2 securities is based on a market approach with prices obtained from nationally-recognized pricing services. Observable inputs used to value these securities can include: reported trades, benchmark yields, issuer spreads and broker/dealer quotes. The fair value of Level 3 securities is typically based on a single broker quote or the Company’s discounted cash flow analysis.
Financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company’s financial assets that were accounted for at fair value on a recurring basis as of December 31, 2010 by level within the fair value hierarchy:
The following table presents additional information about the Company’s available for sale securities which were measured at fair value on a recurring basis during the year ended December 31, 2010 for which the Company utilized Level 3 inputs to determine fair value:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3):
At December 31, 2010, the Company had no financial assets or liabilities that were accounted for at fair value on a non-recurring basis.
Fair Value Option
The Company has elected to apply the fair value option of accounting for available for sale securities for the purpose of enhancing the transparency of its financial condition.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. The fair value option may be elected on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
The following table sets forth the Company’s financial instruments as of December 31, 2010 for which the fair value option was elected:
The following table presents the difference between fair values and the aggregate contractual amounts of available for sale securities and liabilities, for which the fair value option has been elected:
For the period ended December 31, 2010, the Company recognized a net gain of $1,724,637 as the result of the change in fair value of financial assets and liabilities for which the fair value option was elected, which is recorded as unrealized gain on investments in the Company’s consolidated statement of operations.
4. Term Asset-Backed Loan Facilities
On January 28, 2010, the Company entered into a non-recourse Term Asset-Backed Securities Loan Facility (“TALF”) agreement with the Federal Reserve Bank of New York in the amount of $11,639,417, bearing interest at a fixed rate of 3.73%. Interest is payable monthly and principal is due at maturity on January 28, 2015. The proceeds were used to finance a AAA-rated Commercial Mortgage Back Security (“CMBS”) in the amount of $14,093,609 and a face value of $13,856,000. At December 31, 2010, the carrying amount of this TALF was $11,629,213.
On February 25, 2010, the Company entered into a non-recourse TALF agreement with the Federal Reserve Bank of New York in the amount of $12,450,000, bearing interest at a fixed rate of 3.69%. Interest is payable monthly and principal is due at maturity on February 25, 2015. The proceeds were used to finance a AAA-rated CMBS in the amount of $15,522,656 and a face value of $15,000,000. At December 31, 2010, the carrying amount of this TALF was $12,431,999.
5. Related Party Arrangements
NS Real Estate Income Trust Advisor, LLC
Subject to certain restrictions and limitations, the Advisor is responsible for managing the Company’s affairs on a day-to-day basis and for identifying and making acquisitions and investments on behalf of the Company.
The Advisor and certain affiliates of the Advisor receive fees and compensation in connection with the Company’s Offering, and the acquisition, management and sale of the Company’s real estate investments.
Prior to the merger, organization and offering costs (other than selling commissions and the dealer manager fee) of the accounting acquirer were being paid by the Advisor or its affiliates, subject to reimbursement. These fees were reimbursable up to a maximum of $1,000,000, which is 1.0% of the maximum gross offering proceeds of $100,000,000 or a minimum of $60,000. The accounting acquirer reimbursed $350,816 of these cost to the Advisor for the period of January 1, 2010 through October 18, 2010, (date of the Merger transaction), with no additional reimbursements required by the accounting acquirer.
Upon completion of the merger transaction, the Company will reimburse the Advisor for organization and offering costs up to a maximum of $15,000,000, which is 1.5% of the maximum gross offering proceeds of $1,000,000,000, or a minimum of $60,000 if the maximum offering proceeds are not met and the minimum offering of $2,000,000 is raised. The Advisor will be responsible for the payment of organization and offering expenses, other than selling commissions and dealer manager fees and to the extent they exceed 15% of gross offering proceeds, without recourse against or reimbursement by the Company.
As of December 31, 2010, the Advisor has incurred organization and offering costs of $2,773,580 on behalf of the Company. The Company raised net equity of $2,235,632 subsequent to the merger and has recorded the minimum allowable reimbursement of organization and offering cost, $60,000 to the Advisor. The $60,000 payable to the advisor is recorded in due to related parties in the Company’s consolidated balance sheet, of which $42,151 is included in general and administrative expenses in the Company’s consolidated statement of operations and $17,849 of which is recorded as a reduction of stockholders equity in the Company’s consolidated statement of stockholders’ equity for the year ended and as of December 31, 2010. Additional organization and offering costs will only become a liability of the Company to the extent selling commissions, the dealer manager fee and other organization and offering costs do not exceed 15% of the gross proceeds of the Offering. When recorded by the Company, organization costs will be expensed as incurred and offering costs will be deferred and charged to stockholders’ equity as such amounts are reimbursed to the Advisor, the Dealer Manager or their affiliates from the gross proceeds of the Offering.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Advisor also receives an acquisition fee equal to 1% of the amount funded by the Company to acquire or originate commercial real estate loans or the amount invested in the case of other real estate investments including any acquisition and origination expenses and any debt attributable to such investments. For the year ended December 31, 2010, no such fees were incurred by the Company.
The Company will pay the Advisor a monthly asset management fee equal to one-twelfth of 1.25% of the sum of the cost of all investments made and of the Company’s investments in joint ventures, including acquisition fees, acquisition and origination expenses and any debt attributable to such investments, less any principal repaid by borrowers on the Company’s debt investments (or the Company’s proportionate share thereof in the case of debt investments made through joint ventures). For substantial assistance in connection with the sale of investments, the Company will pay the Advisor or its affiliate a disposition fee of 1% of the contract sales price of each commercial real estate loan, commercial real estate-related debt security or select commercial real estate equity investment sold, including mortgage-backed securities or collateralized debt obligations issued by a subsidiary of the Company as part of a securitization transaction. The Company will not pay a disposition fee upon the maturity, prepayment, workout modification or extension of a loan or other debt-related investment unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of (i) 1% of the principal amount of the loan or debt-related investment prior to such transaction or (ii) the amount of the fee paid by the borrower in connection with such transaction. If the Company takes ownership of a property as a result of a workout or foreclosure of a loan, the Company will pay a disposition fee upon the sale of such property. As of December 31, 2010, the Company has incurred $53,760 which was recorded in advisory fees-related party in the consolidated statement of operations.
The Company will reimburse the Advisor for all expenses paid or incurred by the Advisor in connection with the services provided to the Company, subject to the limitation that the Company will not reimburse the Advisor for any amount by which its operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceeds the greater of: (i) 2% of its average invested assets or (ii) 25% of its net income determined without reduction for any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of the Company’s assets for that period. Notwithstanding the above, the Company may reimburse the Advisor for expenses in excess of this limitation if a majority of the independent directors determines that such excess expenses are justified based on unusual and non-recurring factors. The Company calculates the expense reimbursement quarterly and will true-up the calculation at the end of the twelve month period. As of December 31, 2010, the Advisor has incurred operating expenses of $588,549 on behalf of the Company. Based upon the quarterly calculation the Company has accrued $92,898 of these costs as due to related parties in the consolidated balance sheet and which are included in audit and professional fees and other general and administrative expenses in the consolidated statement of operations in the Company’s consolidated financial statements as of and for the year ended December 31, 2010.
NRF Capital Markets, LLC
Pursuant to a dealer manager agreement, the Company will pay the Dealer Manager selling commissions of up to 7% of gross offering proceeds. In addition, the Company will pay the Dealer Manager a dealer manager fee of 3% of gross offering proceeds, a portion of which may be reallowed to participating broker-dealers. No selling commissions or dealer manager fee will be paid for sales under the distribution reinvestment plan. For the year ended December 31, 2010, the Company incurred $2,475,920 in selling commissions and dealer manager fees, which are recorded as a cost of capital in the consolidated statements of stockholders’ equity.
6. Stockholders’ Equity
Common Stock
The holders of shares of the Company’s common stock are entitled to one vote per share on all matters voted on by stockholders, including election of the Company’s directors. The Company’s charter does not provide for cumulative voting in the election of directors. Therefore, the holders of a majority of the outstanding shares of the Company’s common stock can elect its entire board of directors. Subject to any preferential rights of any outstanding series of preferred stock, the holders of shares of the Company’s common stock are entitled to such distributions as may be authorized from time to time by its board of directors out of legally available funds and declared by the Company and, upon liquidation, are entitled to receive all assets available for distribution to stockholders. All shares of the Company’s common stock issued in the Offering will be fully paid and nonassessable shares of common stock. Holders of shares of the Company’s common stock will not have preemptive rights, which means that stockholders will not have an automatic option to purchase any new shares of common stock that the Company issues, or have appraisal rights, unless the Company’s board of directors determines that appraisal rights apply, with respect to all or any classes or series of its common stock, to one or more transactions occurring after the date of such determination in connection with which stockholders would otherwise be entitled to exercise such rights.
For the period from October 18, 2010 through December 31, 2010, the Company sold 250,468 shares of common stock generating net proceeds of $2,235,632, excluding 6,214 shares issued pursuant to the Company’s distribution reinvestment plan.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company had 3,193,414 and 113,828 shares of common stock outstanding as of December 31, 2010 and December 31, 2009, respectively.
Distributions
For the period from January 1, 2010 to October 18, 2010, NSIO REIT paid cumulative cash distributions to the stockholders’ of record of $1,000,924.
On September 8, the board of directors approved a daily cash distribution of $0.002191781 per share of common stock, for (1) October, for the period commencing October 18, 2010 and ending October 31, 2010, (2) November, for the period commencing November 1, 2010 and ending November 30, 2010 and (3) December, for the period commencing December 1, 2010 and ending December 31, 2010. The October, November and December distributions were paid in cumulative amounts on November 8, 2010, and December 8, 2010, respectively, and totaled $226,681. At December 31, 2010 recorded in distribution payable was $164,272, related to the approved December cash distribution which was paid in January 2011.
Distribution Reinvestment Plan
The Company has adopted a distribution reinvestment plan (the “DRP”) through which future common stockholders may elect to reinvest an amount equal to the distributions declared on their shares in additional shares of the Company’s common stock in lieu of receiving cash distributions. The initial purchase price per share under the DRP will be $9.50. Once the Company establishes an estimated value per share, shares issued pursuant to the distribution reinvestment plan will be priced at the estimated value per share of the Company’s common stock, as determined by the Advisor or another firm chosen for that purpose. The Company expects to establish an estimated value per share after the completion of its offering stage. The offering stage will be considered complete when the Company is no longer publicly offering equity securities-whether through the Offering or follow-on public offerings-and has not done so for 18 months. No selling commissions or dealer manager fees will be paid on shares sold under the DRP. The board of directors of the Company may amend or terminate the DRP for any reason upon 10 days’ notice to participants. For the period commencing October 18, 2010 and ending December 31, 2010, the Company issued 6,214 shares totaling $59,032 of gross offering proceeds pursuant to the DRP. At December 31, 2010, recorded in distribution payable was $44,321 related to the approved December cash distribution which was reinvested pursuant to the DRP in January 2011.
Preferred Shares
The Company’s charter authorizes its board of directors to classify and reclassify any unissued shares of its common stock and preferred stock into other classes or series of stock. Prior to issuance of shares of each class or series, the board of directors is required by the Company’s charter to set, subject to the charter restrictions on transfer of its stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could authorize the issuance of shares of common stock or preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or change in control that might involve a premium price for holders of the Company’s common stock or otherwise be in their best interest. The Company’s board of directors has no present plans to issue preferred stock, but may do so at any time in the future without stockholder approval. The issuance of preferred stock must be approved by a majority of the Company’s independent directors not otherwise interested in the transaction.
Share Repurchase Program
The Company has adopted a share repurchase program that may enable stockholders to sell their shares to the Company in limited circumstances. Share repurchases will be made at the sole discretion of the board of directors.
7. Equity-Based Compensation
Directors Shares
On July 19, 2010, each of the accounting acquiree’s three independent directors received 5,000 shares of restricted stock in connection with the commencement of the Offering. The non-vested stock will generally vest over four years; provided, however, that the non-vested stock will become fully vested on the earlier occurrence of (i) the termination of the independent director’s service as a director due to his or her death or disability, or (ii) a change in control of the Company. The total compensation cost recognized in connection with the granting of the non-vested stock is $135,000, which will be recorded in earnings ratably over the four year vesting period. Prior to the merger, the accounting acquiree recognized $6,654 of compensation expense and subsequent to the merger the Company recognized $8,439 of compensation expense for the year ended December 31, 2010, which was recorded in general and administrative expenses in the consolidated statement of operations.
Long-Term Incentive Plan
The Company has adopted a long-term incentive plan, which it uses to attract and retain qualified directors. The Company’s long-term incentive plan offers these individuals an opportunity to participate in its growth through awards in the form of, or based on, its common stock. The Company currently intends to issue awards only to its independent directors under its long-term incentive plan.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The long-term incentive plan authorizes the granting of restricted stock, stock options, stock appreciation rights, restricted or deferred stock units, performance awards, dividend equivalents, limited partnership interests in the Company’s operating partnership, other stock-based awards and cash-based awards to directors of the Company. Stock options granted under the long-term incentive plan will not exceed an amount equal to 10% of the outstanding shares of the Company’s common stock on the date of grant of any such stock options. Any stock options and stock appreciation rights granted under the long-term incentive plan will have an exercise price or base price that is not less than the fair market value of the Company’s common stock on the date of grant.
The Company’s board of directors, or a committee of the board, administers the long-term incentive plan, with sole authority to determine all of the terms and conditions of the awards, including whether the grant, vesting or settlement of awards may be subject to the attainment of one or more performance goals.
The Company accounts for stock-based compensation in accordance with the FASB fair value recognition provisions. Under these provisions, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. Stock-based compensation is classified within general and administrative expense in the consolidated statements of operations. As stock- based compensation expense recognized in the consolidated statement of operations is based on awards ultimately expected to vest, the amount of expense is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated on experience of other companies in the same industry until entity-specific information is available.
8. Commitments and Contingencies
Advisor and Dealer Manager Services
The Company is dependent on the Advisor and the Dealer Manager for certain services that are essential to the Company, including the sale of the Company’s shares of common and preferred stock available for issue; the identification, evaluation, negotiation, origination, acquisition and disposition of investments; management of the daily operations of the Company’s investment portfolio; and other general and administrative responsibilities. In the event that these companies are unable to provide the respective services, the Company will be required to obtain such services from other sources.
9. Fair Value of Financial Instruments
The following disclosures of estimated fair value were determined by the Company, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
As of December 31, 2010 and 2009, accounts receivable and accounts payable reasonably approximate their fair values due to the short-term maturities of these items. The available for sale securities are carried on the balance sheet at their estimated fair value.
As of December 31, 2010, the estimated fair value of the Company’s TALFs was approximately $24,976,000. The estimated fair value is based on interest rates available at December 31, 2010, for issuance of debt with similar terms and remaining maturities. The estimated fair value of the Company’s TALFs is not necessarily indicative of the amounts that the Company could realize in a current market exchange.
NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Non-controlling Interest
Operating Partnership
Non-controlling interest represents the aggregate limited partnership interests (“OP Units”) in the Operating Partnership held by limited partners (the “Special Unit Holders”). Income allocated to the non-controlling interest is based on the Special Unit Holders ownership percentage of the Operating Partnership. The ownership percentage is determined by dividing the numbers of OP Units held by the Special Unit Holders by the total number of dilutive shares. The issuance of additional shares of beneficial interest (the “Common Shares” or “Share”) or OP Units changes the percentage ownership of both the Special Unit Holders and the Company. Since a unit is generally redeemable for cash or Shares at the option of the Company, it is deemed to be equivalent to a Share. Therefore, such transactions are treated as capital transactions and result in an allocation between shareholders’ equity and non-controlling interest in the accompanying consolidated balance sheet to account for the change in the ownership of the underlying equity in the Operating Partnership. Income allocated to the operating partnership non-controlling interest for the years ended December 31, 2010 and 2009 was $328 and $1,361, respectively.
11. Pro Forma Information
The pro forma financial information set forth below is based upon the Company’s historical consolidated statements of operations for the years ended December 31, 2010 and 2009, respectively, adjusted to give effect of the Merger Transaction as of January 26, 2009 and reflects the merger of NSIO REIT which is accounted for as a reverse acquisition and recapitalization:
The pro forma financial information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the Merger Transactions occurred January 26, 2009, nor does it purport to represent the results of future operations.
Included in the accompanying consolidated statement of operations for the year ended December 31, 2010 is a net loss of $145,957 related to the Company before giving affect to the Merger Transaction.
12. Subsequent Events
On March 23, 2011, the Company’s board of directors approved a daily cash distribution of $0.002191781 per share of common stock, for (1) the full month of April, 2011 (2) the full month of May, 2011 and (3) the full month of June, 2011. The April, May and June distributions will be paid in cumulative amounts to the stockholders of record who are entitled to receive such distributions on May 1, 2011, June 1, 2011 and July 1, 2011, respectively.
The Sponsor has committed to purchase up to $10 million of shares of the Company’s common stock during the two-year period following commencement of its continuous, public offering under certain circumstances in which the Company’s distributions exceed its AFFO in order to provide additional funds to support distributions to stockholders. On March 23, 2011, the Company’s board of directors approved the sale of 43,439 shares of the Company’s common stock, $0.01 par value per share, to NRFC Sub-REIT Corp., a Maryland corporation and a subsidiary of the Sponsor, at a price of $9.00 per Share.
For the period from January 1, 2011 to March 24, 2011, we sold 841,976 common shares pursuant to our Offering, generating gross proceeds of $8,404,104.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Controls and Procedures
Disclosure Controls and Procedures
The management of the Company established and maintains disclosure controls and procedures that are designed to ensure that material information relating to the Company and its subsidiaries required to be disclosed in the reports that are filed or submitted under the 1934 Act are 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 management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
As of the end of the period covered by this report, the Company’s management conducted an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.
Internal Control over Financial Reporting
This Annual Report on Form 10-K does not include a report of management’s assessment regarding internal control over financial reporting and we have not evaluated any change in our internal control over financial reporting that occurred during our last fiscal quarter due to a transition period established by the rules of the Securities and Exchange Commission for newly public companies.
Not applicable.
PART III
Item 10.
Item 10.
Directors and Executive Officers and Corporate Governance
General
Our Board presently consists of four members. At the annual meeting, stockholders will vote on the election of Messrs. David T. Hamamoto, Jonathan T. Albro, Charles W. Schoenherr and Jack F. Smith, Jr., for a one-year term ending at the 2012 annual meeting of stockholders and until their successors are duly elected and qualify.
The director nominees listed below are leaders in business and real estate and financial communities because of their intellectual acumen and analytic skills, strategic vision and their records of outstanding accomplishments over a period of decades. Each has been chosen to stand for re-election in part because of his or her ability and willingness to understand our unique challenges, and evaluate and implement our strategies.
Set forth below are each director nominee’s name and age as of the date of this Form 10-K and his principal occupation, business history and public company directorships held during the past five years. Each of our director nominees currently serves on the Board and was initially appointed to the Board on January 12, 2010, with the exception of Mr. Hamamoto, who has served as one of our directors since our incorporation on January 26, 2009.
Current Directors Who are Nominees for Re-election
David T. Hamamoto. David T. Hamamoto is our Chairman and Chief Executive Officer. Mr. Hamamoto has served as Chairman of our sponsor since October 2007 and as its President and Chief Executive Officer since October 2004. In addition, Mr. Hamamoto has served as Chief Executive Officer and Chairman of NorthStar Senior Care and its advisor since October 2010. Mr. Hamamoto oversees the operations of our sponsor, NorthStar Senior Care and our company. In July 1997, Mr. Hamamoto co-founded NorthStar Capital, the predecessor company to our sponsor, for which he served as Co-Chief Executive Officer until October 2004. From July 1983 to July 1997, Mr. Hamamoto worked for Goldman, Sachs & Co. where he was co-head of the Real Estate Principal Investment Area and a general partner of the firm between February 1994 and June 1997. During Mr. Hamamoto’s tenure at Goldman, Sachs & Co., he initiated the firm’s effort to build a real estate principal investment business under the auspices of the Whitehall Funds. Mr. Hamamoto currently serves as Executive Chairman of the Board of Directors of Morgans Hotel Group Co. (NYSE: MHGC), a publicly-traded global hotel management and ownership company focused on the boutique sector. Mr. Hamamoto holds a Bachelor of Science. from Stanford University in Palo Alto, California, and a Master of Business Administration from the Wharton School of Business at the University of Pennsylvania in Philadelphia, Pennsylvania.
Consideration for Recommendation: We believe that Mr. Hamamoto’s broad and extensive experience in the real estate investment and finance industries and his service as President and Chief Executive Officer for our sponsor and its predecessor for over ten years supports his appointment to our board of directors.
Jonathan T. Albro. Jonathan T. Albro is one of our independent directors and a member of our audit committee. He is Chief Executive Officer and Managing Partner of Penn Square Real Estate Group, LLC, which he founded in September 2006. At Penn Square Real Estate Group, LLC, he is responsible for strategy, operations, marketing, and finance and fundraising. From April 2005 to August 2006, Mr. Albro served as Executive Vice President, National Sales Manager of Cole Capital Markets, Inc., or CCM, and Senior Vice President of Cole Capital Corporation, or CCC. He was responsible for the growth and management of CCM, a distribution company focused on Cole’s suite of real estate offerings in addition to serving on CCC executive committee. From September 2001 to April 2005, Mr. Albro served as Executive Vice President and National Sales Manager of MetLife Investors, Inc., a wholly-owned subsidiary of Met Life. He was responsible for sales and distribution of MLI Retirement products through financial intermediaries. In all, Mr. Albro has over 15 years of experience in the broker-dealer industry. Mr. Albro holds a Bachelor of Science from State University of New York in Fredonia, New York.
Consideration for Recommendation: We believe that Mr. Albro’s knowledge of and nearly 15 years of experience in the broker-dealer industry supports his appointment to our Board.
Charles W. Schoenherr. Charles W. Schoenherr is one of our independent directors and a member of our audit committee. Mr. Schoenherr serves as Chief Investment Officer of Broadway Partners Fund Manager, LLC, a position he has held since January 2011. Broadway Partners Fund Manager, LLC is a private real estate investment and management firm that invests in real estate across the U.S. Mr. Schoenherr is responsible for sourcing acquisition opportunities and overseeing property management. From June 2009 until January 2011, Mr. Schoenherr served as President of Scout Real Estate Capital, LLC, a full service real estate firm that focuses on acquiring, developing and operating hospitality assets, where he was responsible for managing and developing the company’s properties, and originating new acquisition and asset management opportunities. Mr. Schoenherr also serves on the Board of Trustees of Iona College and is on its Finance Committee. In addition, he serves on the University of Connecticut’s Real Estate Council. Prior to joining Scout Real Estate Capital, LLC, Mr. Schoenherr was the managing partner of Elevation Capital, LLC, where he advised real estate clients on debt and equity restructuring and performed due diligence and valuation analysis on new acquisitions between November 2008 and June 2009. Between September 1997 and October 2008, Mr. Schoenherr served as Senior Vice President and Managing Director of Lehman Brothers’ Global Real Estate Group. As Managing Director, he was responsible for originating debt, mezzanine and equity transactions on all major property types throughout the United States. During his career he has also held senior management positions with GE Capital Corporation, GE Investments, Inc. and KPMG LLP, where he also practiced as a certified public accountant. Mr. Schoenherr holds a Bachelor of Business Administration in Accounting from Iona College in New Rochelle, New York and a Master of Business Administration in Finance from the University of Connecticut in Stamford, Connecticut.
Consideration for Recommendation: We believe that Mr. Schoenherr’s knowledge of the real estate investment and finance industries, including extensive experience originating debt, mezzanine and equity transactions supports his appointment to our Board.
Jack F. Smith, Jr. Jack F. Smith, Jr. is one of our independent directors and the chairman and financial expert of our audit committee. Mr. Smith was a partner with Deloitte & Touche LLP from June 1984 until August 2009. He served as the head of the firm’s real estate industry practice for Atlanta, Georgia and the Southeast from June 1996 to June 2007. Mr. Smith began his career as an accountant with Deloitte & Touche LLP in 1973, where his responsibilities included audits, due diligence on acquisitions and mergers, business and accounting advice, and assistance in problem resolution. During the course of his career, Mr. Smith has served clients of varying sizes in many different industries, including public and private REITs, real estate developers, merchant builders, real estate investment funds, real estate operating companies and hotels. Mr. Smith is a member of the American Diabetes Association Leadership Council of Georgia, the Tennessee Technological University College of Business Foundation, the American Institute of Certified Public Accountants and the Tennessee Society of Certified Public Accountants. Mr. Smith holds a Bachelor of Science in Accounting from Tennessee Technological University in Cookeville, Tennessee and a Masters of Business Administration from Emory University in Atlanta, Georgia.
Consideration for Recommendation: We believe that Mr. Smith’s 25 years of experience as a partner with Deloitte & Touche LLP and his service as the head of the firm’s real estate industry practice in Atlanta and the Southeast supports his appointment to our Board.
Corporate Governance Profile
We are committed to good corporate governance practices and, as such, we have adopted the formal corporate governance guidelines and codes of ethics discussed below to enhance our effectiveness.
Code of Ethics
We have adopted a code of corporate ethics relating to the conduct of our business by our Chief Executive Officer, Chief Financial Officer, Treasurer, Controller and other Senior Financial Officers and Board. We intend to maintain the highest standards of honest and ethical business practices and compliance with all laws and regulations applicable to our business. Specifically, among other things, our code of ethics prohibits providing gifts, meals or anything of value to government officials or employees or members of their families without prior approval from the General Counsel. The code is available on our website at www.northstarreit.com under the heading “NorthStar REIT - Corporate Governance” and is also available without charge to stockholders upon written request to: NorthStar Real Estate Income Trust, Inc., 399 Park Avenue, New York, New York 10022, Attn: General Counsel.
Corporate Governance Guidelines
We have adopted corporate governance guidelines to assist the Board in the exercise of its responsibilities. The guidelines govern, among other things, Board composition, Board member qualifications, responsibilities and education, management succession, and self-evaluation. A copy of the corporate governance guidelines may be found on our website at www.northstarreit.com under the heading “ “NorthStar REIT - Corporate Governance” and are also available without charge to stockholders upon written request to: NorthStar Real Estate Income Trust, Inc., 399 Park Avenue, New York, New York 10022, Attn: General Counsel.
The Audit Committee
The Board has a separately designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act of 1934, or the Exchange Act. The Audit Committee’s primary function is to assist the Board in fulfilling its oversight responsibilities by reviewing the financial information to be provided to the stockholders and others, the system of internal controls which management has established and the audit and financial reporting process.
The Audit Committee acts under a written charter adopted by our Board that sets forth the committee’s responsibilities and duties, as well as requirements for the committee’s composition and meetings. Under the Audit Committee charter, the Audit Committee will always be comprised solely of independent directors. A copy of the Audit Committee charter is available on our website at www.northstarreit.com, under the heading “NorthStar REIT - Corporate Governance” and is also available without charge to stockholders upon written request to: NorthStar Real Estate Income Trust, Inc., 399 Park Avenue, New York, New York 10022, Attn: General Counsel.
Our Audit Committee held six meetings in 2010. Our Board has determined that each member of the Audit Committee is independent within the meaning of the applicable SEC rules. Even though our shares are not listed on the New York Stock Exchange, or NYSE, our Board has also determined that all of the independent members of our Board are independent under the NYSE rules. The members of the Audit Committee are Messrs. Albro, Schoenherr and Smith. Our Board has determined that independent director Mr. Smith, who chairs our Audit Committee, is an “audit committee financial expert,” as that term is defined by the SEC.
Compensation Committee Interlocks and Insider Participation
We currently do not have a compensation committee of our Board because we do not plan to pay any compensation to our officers. Our independent directors participate in the consideration of independent director compensation.
Director Independence
Although our shares are not listed on the NYSE, or any other national securities exchange, our Board has affirmatively determined at a meeting held on March 23, 2011, that all of the members of our Board, except Mr. Hamamoto, were independent under the NYSE rules. In determining director independence, the Board reviewed, among other things, whether any transactions or relationships exist currently or, existed since our incorporation, between each director and the Company and its subsidiaries, affiliates and equity investors or independent auditors. In particular, the Board reviewed current or recent business transactions or relationships or other personal relationships between each director and the Company, including such director’s immediate family and companies owned or controlled by the director or with which the director was affiliated. The purpose of this review was to determine whether any such transactions or relationships failed to meet any of the objective tests promulgated by the NYSE for determining independence or were otherwise sufficiently material as to be inconsistent with a determination that the director is independent. The Board also examined whether there were any transactions or relationships between each director and members of our senior management or our affiliates.
In addition, we have determined that all of the members of our Board, except David T. Hamamoto, are independent pursuant to the definition of independence in our charter, which is based on the definition included in the North American Securities Administrators Association, Inc.’s Statement of Policy Regarding Real Estate Investment Trusts, as revised and adopted on May 7, 2007, which we refer to as the NASAA Guidelines. Our charter is available on our website at www.northstarreit.com under the heading “NorthStar REIT - Corporate Governance”.
Board Leadership Structure; Meetings of Independent Directors
The Board believes it is important to select our chairman and chief executive officer in the manner it considers to be in our best interests and in the best interests of our stockholders at any given point in time. The members of the Board possess considerable business experience and in-depth knowledge of the issues we face, and are therefore in the best position to evaluate our needs and how best to organize our leadership structure to meet those needs. Accordingly, the chairman and chief executive officer positions may be filled by one individual or by two different individuals. After careful consideration, the Board believes that the most effective leadership structure for us and our stockholders at this time is for Mr. Hamamoto to serve as both our chairman and chief executive officer. Mr. Hamamoto’s combined role as chairman and chief executive officer creates a firm link between management and the Board and provides unified leadership for carrying out our strategic initiatives and business plans. The Board continually evaluates our leadership structure and could in the future decide not to combine the chairman and chief executive officer positions if it believes that doing so would serve our best interests and the best interests of our stockholders.
During the year ended December 31, 2010, the Board met on six occasions. Each director then serving attended all of the aggregate number of meetings of the Board and all committees on which they served.
Stockholder Communications with our Board
Our Board has established the following means for stockholders to communicate concerns to the Board. If the concern relates to our financial statements, accounting practices or internal controls, the concerns should be submitted in writing to the chairman of the Audit Committee at NorthStar Real Estate Income Trust, Inc., 399 Park Avenue, New York, New York 10022, Attn: Secretary. If the concern relates to our governance practices, business ethics or corporate conduct, the concern may be submitted in writing to our Secretary at the above address.
Section 16(a) Beneficial Ownership Reporting Compliance
Our executive officers, directors and greater than 10% stockholders are not currently subject to the beneficial ownership reporting requirement pursuant to Section 16(a) of the Exchange Act, and therefore no reports were filed in 2010 pursuant to Section 16(a).
Director Nomination Procedures
We do not have a standing nominating committee. Our Board has determined that it is appropriate for us not to have a nominating committee because our Board presently considers all matters for which a nominating committee would be responsible. Each member of our Board participates in the consideration of nominees. While we do not have any minimum qualifications with respect to nominees, our Board considers many factors in connection with each candidate, including judgment, integrity, diversity, prior experience, the value of the candidate’s experience relative to the experience of other board members and the candidate’s willingness to devote substantial time and effort to board responsibilities. Our Board does not have a formal written policy regarding the consideration of diversity in identifying director nominees. Nevertheless, considerations of diversity will continue to be important factors in identifying and recruiting new directors.
Risk Oversight
Risk is inherent with every business, and how well a business manages risk can ultimately determine its success. Our management team is responsible for our risk exposures on a day-to-day basis by identifying the material risks we face, implementing appropriate risk management strategies that are responsive to our risk profile, integrating consideration of risk and risk management into our decision-making process and, if necessary, promulgating policies and procedures to ensure that information with respect to material risks is transmitted to our Board. Our Board has the responsibility to oversee and monitor these risk management processes by informing itself of material risks and evaluating whether management has reasonable controls in place to address the material risks; the Board is not responsible, however, for defining or managing our various risks. The Board is regularly informed by management of potential material risks and activities related to those risks at Board meetings. The chief executive officer, chief financial officer, chief investment officer, chief operating officer and general counsel generally attend all Board meetings and management is readily available to the Board to address any questions or concerns raised by the Board on risk management and any other matters. Our Board’s oversight of risk has not specifically affected its leadership structure.
Director Attendance at Annual Meeting
Our Corporate Governance Guidelines encourage but do not require our directors to attend the annual meeting of stockholders.
Directors Offer of Resignation Policy
Whenever a member of the Board (i) resigns or is terminated from his or her existing principal employment position or (ii) violates our Code of Business Conduct and Ethics, Corporate Governance Guidelines or any other Company policy applicable to members of the Board, pursuant to our resignation policy, he or she is to offer his or her resignation to the Board for its consideration. The Board will consider the resignation offer, giving due consideration to all relevant factors that the Board deems appropriate under the circumstances, including, without limitation, any rule promulgated under the Exchange Act, and will recommend and approve the action to be taken with respect to the resignation offer.
Chief Executive Officer Succession Plan
Our Chief Executive Officer and Board are responsible for succession planning with respect to selecting a successor to our Chief Executive Officer.
EXECUTIVE OFFICERS
Our executive officers are appointed annually by our Board and serve at the discretion of our Board. Set forth below is information, as of the date of this Form 10-K, regarding our current executive officers:
*
Biographical information is provided above under “Board of Directors.”
Set forth below is biographical information regarding each of our executive officers.
Daniel R. Gilbert. Daniel R. Gilbert has been our Chief Investment Officer and Executive Vice President since inception and our President and Chief Investment Officer since March 15, 2011. Mr. Gilbert has served as Chief Investment Officer of our sponsor since January 2009 and as an Executive Vice President of our sponsor since its initial public offering in October 2004. Since October 2010, Mr. Gilbert has also served as Chief Investment Officer of NorthStar Senior Care and its advisor. Mr. Gilbert has primary responsibility for the asset management and investment business, including real estate debt and equity investments, of our sponsor, NorthStar Senior Care and our company. From July 2004 until October 2004, Mr. Gilbert served as an Executive Vice President and Managing Director of Mezzanine Lending of NorthStar Capital, which included responsibility for the oversight of NorthStar Funding, LLC, a joint venture with a single institutional investor organized for the purpose of making investments in real estate-related mezzanine debt. From September 1994 to June 2004, Mr. Gilbert held a number of positions with Merrill Lynch & Co., in its Global Principal Investments and Commercial Real Estate Department. At Merrill Lynch, he was responsible for making principal investments in real estate opportunity funds, mortgage loans, subordinated notes, mezzanine loans, preferred equity, distressed debt and related commercial mortgage-backed securities. Prior to joining Merrill Lynch, he held accounting and legal related positions at Prudential Securities Incorporated between October 1991 and June 2004. Mr. Gilbert received a Bachelor of Arts from Union College in Schenectady, New York.
Lisa Meyer. Lisa Meyer has been our Chief Financial Officer and Treasurer since March 23, 2011. Ms. Meyer has served as the Chief Accounting Officer of our sponsor since January 2005. Prior to joining our sponsor in January 2005, Ms. Meyer was a senior manager at Ernst & Young LLP in the Real Estate Assurance Services Practice. While at Ernst & Young LLP, Ms. Meyer was responsible for audit engagements, agreed upon procedure engagements, and accounting consultations. Her clients were public REITs and real estate investment funds. Ms. Meyer is a CPA and holds a Bachelor of Arts in Accounting and Economics from Queens College in Flushing, New York.
Albert Tylis. Albert Tylis is our Chief Operating Officer, General Counsel and Secretary. Mr. Tylis has served as the Chief Operating Officer of our sponsor since January 2010 and the General Counsel, Secretary and an Executive Vice President of our sponsor since April 2006. In addition, Mr. Tylis has served as General Counsel and Secretary of NorthStar Senior Care and its advisor since October 2010. Mr. Tylis is responsible for overseeing the real estate securities investment activities of our sponsor, NorthStar Senior Care and our company, the legal department of our sponsor and legal matters relating to NorthStar Senior Care and our company. Prior to joining our sponsor in August 2005, Mr. Tylis was the Director of Corporate Finance and General Counsel of ASA Institute and from September 1999 through February 2005, Mr. Tylis was a senior attorney at the law firm of Bryan Cave LLP, where he was a member of the Corporate Finance and Securities Group, the Transactions Group, the Banking, Business and Public Finance Group, and supported the firm’s Real Estate Group. Mr. Tylis holds a Bachelor of Science from the University of Massachusetts at Amherst and a Juris Doctor from Suffolk University Law School in Boston, Massachusetts.
We currently have no employees. Our day-to-day management functions are performed by NS Real Estate Income Trust Advisor, LLC and related affiliates. Our executive officers are all employees of NS Real Estate Income Trust Advisor, LLC and our sponsor, NorthStar Realty Finance Corp. We do not pay any of these individuals for serving in their respective positions. See “Certain Relationships and Related Transactions” below for a discussion of fees paid to NS Real Estate Income Trust Advisor, LLC and other affiliated companies.
DIRECTOR COMPENSATION
Non-Employee Directors
Each of our non-employee directors is paid an annual director’s fee of $45,000. The non-employee director who serves as our Audit Committee chairperson is paid an additional fee of $10,000 per year. Each non-employee director is also paid $2,500 per Board meeting attended and $2,000 per Board committee meeting attended (unless the meeting is telephonic, in which case the nonemployee directors is paid $1,000 if the meeting is less than one hour or $1,500 if the meeting is more than one hour). If a nonemployee director attends a Board meeting and a Board committee meeting on a single day, he shall only receive a meeting fee for the Board meeting attended. Directors who are our officers, including our chairman of the Board, do not receive compensation as directors. In addition, we reimburse all directors for reasonable out-of-pocket expenses incurred in connection with their services on the Board.
Pursuant to the independent directors compensation plan, which operates as a sub-plan of our long-term incentive plan, we automatically granted to each of our non-employee directors 5,000 shares of restricted common stock in connection with the commencement of our initial public offering. We will also automatically grant to any person who becomes a non-employee director 5,000 shares of restricted common stock on the date such non-employee director is appointed or elected to the Board. In addition, on the date following a non-employee director’s re-election to the Board, he or she will receive 2,500 shares of restricted stock. The restricted stock will generally vest quarterly over four years; provided, however, that the restricted stock will become fully vested on the earlier occurrence of (i) the termination of the independent director’s service as a director due to his or her death or disability, or (ii) a change in our control.
Director Compensation for 2010
The following table provides information concerning the compensation of our non-employee directors for 2010.
Director Compensation for 2011
In 2011, each of our non-employee directors will be paid an annual director’s fee of $65,000. The non-employee director who serves as our Audit Committee chairperson is paid an additional fee of $10,000 per year. Directors who are our officers, including our chairman of the Board, do not receive compensation as directors. In addition, we reimburse all directors for reasonable out-of-pocket expenses incurred in connection with their services on the Board.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth, as of March 24, 2011, the total number and the percentage of shares of our common stock beneficially owned by:
•
each of our directors and each nominee for director;
•
each of our named executive officers; and
•
all of our directors and executive officers as a group.
The following table also sets forth how many shares of our common stock are beneficially owned by each person known to us to be the beneficial owner of more than five percent (5%) of the outstanding shares of our common stock, in each case, based solely on, and as of the date of, such person’s filing of a Schedule 13D or Schedule 13G with the SEC. As of March 24, 2011, there were no beneficial owners of more than 5% of our outstanding common stock. The percentages of common stock beneficially owned are based on 4,035,391 shares of our common stock outstanding as of March 24, 2011.
(1)
Under SEC rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares (i) “voting power”, which includes the power to vote or to direct the voting of such security, or (ii) “investment power”, which includes the power to dispose of or direct the disposition of such security. A person also is deemed to be a beneficial owner of any securities which that person has a right to acquire within 60 days. Under these rules, more than one person may be deemed to be a beneficial owner of securities as to which he or she has no economic or pecuniary interest.
(2)
The address of each of the directors and executive officers is 399 Park Avenue, New York, NY 10022.
(3)
Includes 5,000 shares of restricted stock that were granted under our independent director stock plan in connection with the commencement of our initial public offering. The restricted stock will generally vest over four years; provided, however that the restricted stock will become fully vested on the earlier occurrence of (i) the termination of the independent director’s service as a director due to his or her death or disability or (ii) a change in control the Company.
Item 13.
Item 13.
Certain Relationships and Related Transactions and Directors Independence
The following describes all transactions and currently proposed transactions between us and any related person since January 1, 2009 in which more than $120,000 was or will be involved and such related person had or will have a direct or indirect material interest. Our independent directors are specifically charged with and have examined the fairness of such transactions to our stockholders, and have determined that all such transactions are fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
Ownership Interests
On February 4, 2009, NRF Sub-REIT Corp., a wholly-owned subsidiary of our sponsor, purchased 24,039 shares of common stock for an aggregate of $200,004.48 and was admitted as our initial stockholder. On March 17, 2010, we formed our operating partnership. On March 17, 2010, we, our advisor, NorthStar Real Estate Income Trust Advisor, LLC, or NS REIT Advisor, and NorthStar OP Holdings, LLC, or NorthStar OP Holdings, an affiliate of NS REIT Advisor, made initial capital contributions to our operating partnership of $200,004.48, $1,000 and $1,000, respectively. We used the proceeds from our sale of stock to our initial stockholder to make our capital contribution to our operating partnership.
NorthStar OP Holdings’ ownership interest in our operating partnership entitles it to a subordinated participation interest in addition to its right to subordinated participation with other limited partners in distributions to limited partners. The subordinated participation interest entitles NS Reit Advisors to receive a cash distribution in the event of (i) the listing of our common stock on a national securities exchange or (ii) the occurrence of certain events that result in the termination or non-renewal of our advisory agreement, in each case for an amount that NorthStar OP Holdings would have been entitled to receive had our operating partnership disposed of all of its assets at the enterprise valuation as of the date of the event triggering the redemption, provided that our stockholders have received, in the aggregate, cumulative distributions equal to their invested capital plus an 8% cumulative, non-compounded annual pre-tax return on such invested capital. If the event triggering the redemption is (i) a listing of our shares on a national securities exchange, the enterprise valuation will be calculated based on the average share price of our shares for a specified period or (ii) an underwritten public offering, the enterprise value will be based on the valuation of the shares as determined by the initial public offering price in such offering. If the triggering event is the termination or non-renewal of the advisory agreement other than for cause, the enterprise valuation will be calculated based on an appraisal of our assets.
To date, we have not paid any distributions to NS REIT Advisor pursuant to its subordinated participation interest.
Advisor
NS REIT Advisor supervises and manages our day-to-day operations and selects our real property investments and real estate related investments, subject to oversight by our Board. NS REIT Advisor also provides marketing, sales and client services on our behalf. NS REIT Advisor was formed on January 26, 2009 and is a wholly-owned subsidiary of our sponsor. All of our officers are officers of NS REIT Advisor and our sponsor.
We will pay NS REIT Advisor the following pursuant to an advisory agreement:
•
We will reimburse organization and offering expenses up to 15.0% of the gross proceeds from our primary offering (not to exceed actual expenses incurred by NS REIT Advisor). These expenses include all expenses (other than selling commissions and the dealer manager fee) to be paid by us in connection with the offering, including our legal, accounting, printing, mailing and filing fees, charges of our escrow agent and transfer agent, charges of our advisor for administrative services related to our formation and the offering, reimbursement of bona fide due diligence expenses of broker-dealers, reimbursement of our advisor for costs in connection with preparing supplemental sales materials, the cost of bona fide training and education meetings held by us (primarily the travel, meal and lodging costs of registered representatives of broker-dealers), attendance and sponsorship fees and travel, meal and lodging costs for registered persons associated with our dealer manager and officers and employees of our affiliates to attend retail seminars conducted by broker-dealers and, in special cases, reimbursement to participating broker-dealers for technology costs associated with the offering, costs and expenses related to such technology costs, and costs and expenses associated with the facilitation of the marketing of our shares and the ownership of our shares by such broker-dealers’ customers. For the year ended December 31, 2010, NS REIT Advisor had incurred $2,773,580 of organization and offering costs on our behalf, of which $2,713,580 have not been reimbursed.
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We will reimburse NS REIT Advisor for all expenses paid or incurred by the Advisor in connection with the services provided to the us, subject to the limitation that the we will not reimburse the NS REIT Advisor for any amount by which its operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceeds the greater of: (i) 2% of its average invested assets or (ii) 25% of its net income determined without reduction for any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of the assets for that period. Notwithstanding the above, the we may reimburse the NS REIT Advisor for expenses in excess of this limitation if a majority of the independent directors determines that such excess expenses are justified based on unusual and non-recurring factors. The Company calculates the expense reimbursement quarterly and will true-up the calculation at the end of the twelve month period. As of December 31, 2010, NS REIT Advisor has incurred operating expenses of $588,549 on our behalf. Based upon the quarterly calculation we reimbursed NS REIT Advisor $92,898 of these costs.
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We will reimburse NS REIT Advisor for acquisition expenses actually incurred in connection with the selection, acquisition or origination of an investment, whether or not we ultimately acquire or originate the investment. For the year ended December 31, 2010, NS REIT Advisor had not incurred any acquisition expenses on our behalf.
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We will pay NS REIT Advisor an acquisition fee of 1% of the amount funded by us to acquire or originate commercial real estate loans or the amount invested in the case of other real estate investments including any acquisition and origination expenses and any debt attributable to such investments. For the year ended December 31, 2010, we had not incurred any acquisition fees to NS REIT Advisor.
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We will pay NS REIT Advisor monthly asset management fees equal to one-twelfth of 1.25% of the sum of the cost of all investments made and of our investments in joint ventures, including acquisition fees, acquisition and origination expenses and any debt attributable to such investments, less any principal repaid by borrowers on our debt investments (or our proportionate share thereof in the case of debt investments made through joint ventures). For the year ended December 31, 2010, we had incurred $14,051 of asset management fees to NS REIT Advisor.
Our average invested assets for any specified period are equal to the average of the aggregate book value our assets invested, directly or indirectly, in equity interests in real estate and loans before reserves for depreciation or bad debts or other similar non-cash reserves, computed by taking the average of such values at the end of each month during such period. Our net income for any specified period is equal to our total revenues applicable to such period, less the total expenses applicable to such period excluding additions to reserves for depreciation, bad debts or other similar non-cash reserves; provided, however, net income for purposes of calculating total operating expenses pursuant to the 2%/25% Guidelines shall exclude the gain from the sale of our assets.
Within 60 days after the end of any Expense Year for which total operating expenses exceed the 2%/25% Guidelines, we will send our stockholders a written disclosure, together with an explanation of the factors the independent directors considered in arriving at the conclusion that the excess expenses were justified. During the Expense Year Ended December 31, 2010, our operating expenses, including general and administrative expenses incurred on our behalf, did not exceed the 2%/25% Guidelines.
Dealer Manager
The dealer manager for our current offering of common stock is NRF Capital Markets, LLC, or NRF Capital, a wholly owned subsidiary of our sponsor. NRF Capital is a licensed broker-dealer registered with the Financial Industry Regulatory Authority, Inc., or FINRA.
As the dealer manager for the offering, NRF Capital is entitled to certain dealer manager fees, selling commissions and reimbursements relating to the offering. Our dealer manager agreement with NRF Capital provides for the following compensation:
Borrowing Policies
We may not borrow money from our sponsor, directors, NS REIT Advisor or any of their affiliates unless such loan is approved by a majority of our directors, including a majority of the independent directors, not otherwise interested in such transaction, as fair, competitive, commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties under the same circumstances.
Policies Governing Related Person Transactions
In order to reduce or eliminate certain potential conflicts of interest, our charter and our advisory agreement contain restrictions and conflict resolution procedures relating to transactions we enter into with our sponsor, NS REIT Advisor, our directors or their respective affiliates. The types of transactions covered by these policies are described in detail in our prospectus dated July 19, 2010, as amended, under the heading “Conflicts of Interest-Certain Conflict Resolution Restrictions and Procedures.” Under the restrictions, these transactions must be approved by a majority of our directors, including a majority of our independent directors, not otherwise interested in such transaction.
In addition to the provisions in our charter restricting related-party transactions, our board of directors has adopted the following policies prohibiting us from entering into certain types of transactions with our directors, our advisor, our sponsor or any of their affiliates in order to further reduce the potential for conflicts inherent in transactions with affiliates. Pursuant to these conflicts of interest policies, we will not sell or lease any investments to, or acquire or lease any investments from, our directors, our advisor, our sponsor or any of their affiliates. We may, however, purchase an investment from our sponsor or its affiliate in the event that our sponsor or its affiliate initially acquires an investment that is suitable for us at a time when we are unable to do so, with the intention of providing us the opportunity to acquire the investment at a later date when we are able to acquire the investment. As required by our charter, we will not purchase investments from our sponsor or its affiliate in these circumstances without a determination by a majority of our board of directors (including a majority of the independent directors) not otherwise interested in the transaction that such transaction is fair and reasonable to us and at a price to us no greater than the cost of the asset to our sponsor or its affiliate. In addition, pursuant to these conflicts of interest policies, we will neither make any loans to our directors, our sponsor, our advisor or any of their affiliates nor borrow money from our directors, our sponsor, our advisor or any of their affiliates. We will not amend these policies unless a majority of our board of directors (including a majority of the independent directors) approves the amendment following a determination that the amendment is in the best interests of our stockholders.
We have also adopted a Code of Ethics that applies to each of our officers and directors and each of the officers, managers, principals and real estate professionals of our sponsor and NS REIT Advisor, whom we refer to as covered persons. The Code of Ethics sets forth certain conflicts of interest policies that limit and govern certain matters among us, the covered persons, our sponsor, NS REIT Advisor and their affiliates. The Audit Committee shall have the sole discretion to approve any deviation or waiver from or amendments to this Code and any such waiver must be promptly disclosed to stockholders. A copy of the Code of Ethics is available on our website at www.northstarreit.com under the heading “NorthStar REIT - Corporate Governance” and is also available without charge to stockholders upon written request to: NorthStar Real Estate Income Trust, Inc., 399 Park Avenue, New York, New York 10022, Attn: General Counsel.
Item 14.
Item 14.
Principal Accountant Fees and Services
Fees Paid to Independent Registered Public Accounting Firm
Aggregate fees for professional services rendered for the Company by Grant Thornton LLP for the fiscal years ended December 31, 2009 and December 31, 2010 were as follows:
Fees for audit services for the fiscal years ended December 31, 2009 and December 31, 2010 include fees associated with the annual audits for such years, including the quarterly review of the Form 10-Qs for the three month periods ended June 30, 2010 and September 30, 2010, the examination of our Annual Report on Form 10-K and for other attest services, including issuance of consents and review of the Company’s registration statements on Form S-11 and other documents filed by the Company with the SEC.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)
and (c) Financial Statement and Schedules-see Index to Financial Statements and Schedules included in Item 8.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on March 29, 2011.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints David T. Hamamoto and Albert Tylis and each of them severally, his true and lawful attorney-in-fact with power of substitution and re-substitution to sign in his name, place and stead, in any and all capacities, to do any and all things and execute any and all instruments that such attorney may deem necessary or advisable under the Securities Exchange Act of 1934 and any rules, regulations and requirements of the U.S. Securities and Exchange Commission in connection with this Annual Report on Form 10-K and any and all amendments hereto, as fully for all intents and purposes as he might or could do in person, and hereby ratifies and confirms all said attorneys-in-fact and agents, each acting alone, and his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below on behalf of the Registrant in the capacities and on the dates indicated.