Item 1.
Business.
The use of the words “we,” “us” or “our” refers to G REIT, Inc. and its subsidiaries, including G REIT, L.P., our Operating Partnership, except where the context otherwise requires.
OUR COMPANY
We were incorporated on December 18, 2001 as G REIT, Inc. under the laws of the Commonwealth of Virginia and were qualified and elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code, for federal income tax purposes. On September 27, 2004, G REIT, Inc. was reincorporated in the State of Maryland in accordance with the approval of our stockholders at the 2004 Annual Meeting of Stockholders. We were originally organized to acquire, manage and invest in office, industrial and service real estate properties which have a government-tenant orientation. As described below, on February 27, 2006, our stockholders approved a plan of liquidation and eventual dissolution of our company. Accordingly, we are engaging in an ongoing liquidation of our assets. As of December 31, 2006, we owned interests in 15 properties aggregating a total gross leaseable area, or GLA, of 3.6 million square feet, including interests in 14 consolidated office properties and one unconsolidated office property. As of December 31, 2006, 87.5% of the total GLA of our consolidated properties was leased and tenants with a government orientation occupied 32.4% of the total GLA.
We conduct business and own properties through G REIT, L.P., or our Operating Partnership, which was formed as a Virginia limited partnership in December 2001. As of December 31, 2006, we are the sole general partner of our Operating Partnership and have control over the affairs of our Operating Partnership. We own 100.0% of the equity interests therein, except for 100 incentive non-voting ownership units issued to Triple Net Properties, LLC, or Triple Net Properties, or our Advisor.
We are externally advised by Triple Net Properties which manages us pursuant to the terms of an advisory agreement, or the Advisory Agreement. Our Advisor is primarily responsible for managing our day-to-day operations and assets, subject to the supervision of our board of directors. The Advisory Agreement expired on July 22, 2005, and was not renewed for consecutive one-year terms. However, our Advisor continues to manage us on a month-to-month basis pursuant to the terms of the Advisory Agreement. In view of the approval of our plan of liquidation by our stockholders discussed below, we do not intend to renew the existing Advisory Agreement for a one year term or execute a new advisory agreement. Our Advisor engages affiliated entities, including Triple Net Properties Realty, Inc., or Realty, to provide various services for our properties.
In the fourth quarter of 2006, NNN Realty Advisors Inc., or NNN Realty Advisors, acquired all of the outstanding ownership interests of Triple Net Properties, NNN Capital Corp. and Realty. NNN Realty Advisors was formed in September 2006 and is a full-service commercial real estate asset management and services firm. Anthony W. Thompson, our Chairman of the board of directors, is the founder of our Advisor, and the Chairman of the board of directors of NNN Realty Advisors and owns 25.9% of its outstanding common stock.
Our Advisor’s principal executive offices are located at 1551 N. Tustin Avenue, Suite 200, Santa Ana, California 92705 and its telephone number is (714) 667-8252. We make our periodic and current reports available on our Advisor’s web-site at www.1031nnn.com as soon as reasonably practicable after such materials are electronically filed with the Securities and Exchange Commission, or the SEC. They are also available for printing by any stockholder upon request. We do not maintain our own website or have an address or telephone number separate from our Advisor. Since we pay fees to our Advisor for its services, we do not pay rent for the use of their space.
Plan of Liquidation
On December 19, 2005, our board of directors approved a plan of liquidation which was thereafter approved by our stockholders at the Special Meeting of Stockholders held on February 27, 2006. Our plan of liquidation contemplates the orderly sale of all our assets, the payment of our liabilities and the winding up of operations and the dissolution of our company. We engaged Robert A. Stanger & Co., Inc. to perform financial advisory services in connection with our plan of liquidation, including rendering opinions as to whether our net real estate liquidation value range estimate and our estimated per share distribution range were reasonable. In December 2005, Stanger opined that our net real estate liquidation value range estimate and our estimated per share distribution range were reasonable from a financial point of view. Actual values realized for assets and settlement of liabilities may differ materially from the amounts estimated by us or reflected in Stanger’s opinion.
We continually evaluate our existing portfolio and adjust our net real estate liquidation value accordingly. It is our policy that when we execute a purchase and sale agreement or become aware of market conditions or other circumstances that indicate that the present value of our properties materially differ from our expected net sales price, we will adjust our liquidation value accordingly.
Our plan of liquidation gives our board of directors the power to sell any and all of our assets without further approval by our stockholders and provides that liquidating distributions be made to our stockholders as determined by our board of directors. Although we can provide no assurances, we currently expect to sell all of our assets and anticipate completing our liquidation by February 27, 2008. Further, while we expect to continue to qualify as a REIT until our dissolution, no assurance can be given that we will not lose or terminate our status as a REIT. As a result of the approval of our plan of liquidation by our stockholders, we adopted the liquidation basis of accounting as of December 31, 2005 and for all periods subsequent to December 31, 2005. For a more detailed discussion of our plan of liquidation, including the risk factors and certain other uncertainties associated herewith, please read our definitive proxy statement filed with the Securities and Exchange Commission, or the SEC, on January 13, 2006.
Liquidation Progress During 2006 and 2007
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In October 2006, we paid a special liquidating distribution of approximately $171,289,000, or $3.90 per share; and
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We sold the following properties in 2006:
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On July 18, 2006, we sold our 600 B St. (Comerica) property located in San Diego, California, to an unaffiliated third party for a sales price of $95,500,000;
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On September 14, 2006, we sold our Hawthorne Plaza property located in San Francisco, California, to an unaffiliated third party for a sales price of $125,000,000;
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On September 29, 2006, we sold our AmberOaks Corporate Center property located in Austin, Texas, to an unaffiliated third party for a sales price of $46,837,000;
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On October 6, 2006, we sold our Brunswig Square property located in Los Angeles, California, to an unaffiliated third party for a sales price of $26,900,000;
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On October 17, 2006 we sold our Centerpointe Corporate Park property located in Kent, Washington, to an unaffiliated third party for a sales price of $77,525,000;
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On November 14, 2006, we sold our 5508 Highway 290 property located in Austin, Texas, to an unaffiliated third party for a sales price of $10,200,000;
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On November 15, 2006, we sold our Department of Children and Family Campus property located in Plantation, Florida, to tenant in common, or TIC, investors managed by our Advisor for a sales price of $13,000,000;
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On November 22, 2006, we sold our Public Ledger Building property located in Philadelphia, Pennsylvania, to an unaffiliated third party for a sales price of $43,000,000;
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On December 15, 2006, we sold our Atrium Building property located in Lincoln, Nebraska, to an unaffiliated third party for a sales price of $5,805,000; and
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On December 29, 2006, we sold our Gemini Plaza property located in Houston, Texas, to an unaffiliated third party for a sales price of $17,000,000
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We have sold the following property in 2007:
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On January 11, 2007, we sold our Two Corporate Plaza property located in Clear Lake, Texas, to an unaffiliated third party for a sales price of $18,000,000
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We have contracted to sell the following properties in 2007:
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On August 17, 2006, we entered into an agreement, as amended, to sell our One World Trade Center property located in Long Beach, California, to an unaffiliated third party for a sales price of $148,900,000
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On March 1, 2007, we entered into an agreement to sell our One Financial Plaza property, located in St. Louis, Missouri, of which we own 77.63%, to an unaffiliated third party for a sales price of $47,000,000
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On March 16, 2007, we entered into an agreement to sell our Opus Plaza at Ken Caryl property, located in Littleton, Colorado, to an unaffiliated third party for a sales price of $10,400,000
CURRENT INVESTMENT OBJECTIVES AND POLICIES
General
In accordance with our plan of liquidation, our primary objective is to obtain the highest possible sales value for our properties, while maintaining current income from these investments. Pursuant thereto, we have sought to:
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hold our income producing real property (or interests therein) generally through equity investments in a manner which permits us to continue to qualify as a REIT for federal income tax purposes;
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generate cash through the sale of our properties;
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preserve and protect stockholder capital; and
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realize capital appreciation upon the ultimate sale of our properties.
Due to the adoption of our plan of liquidation, we will not acquire any new properties, and we are focused on liquidating our properties. However, we cannot assure our stockholders that we will attain all of these objectives or that stockholder capital will not decrease.
As of December 31, 2006, five of our properties were located in California, four in Texas and one in each of Delaware, Maryland, Missouri, Arizona and Colorado. Our consolidated properties were 87.5% leased as of December 31, 2006. Most of our leases are “gross” leases with terms of five years or more, usually providing for a base minimum annual rent with periodic increases. Our gross leases typically require that we pay all or a majority of the operating expenses, including real estate taxes, special assessments, utilities, insurance and building repairs related to the property. In addition, most of our government tenant leases may permit tenants to terminate under certain circumstances, including, for example, in the event of their failure to obtain financial appropriations or in the event of the termination or non-renewal of a material contract.
Disposition Strategies
In accordance with our plan of liquidation, we currently consider various factors when evaluating potential property dispositions. These factors include, without limitation, the following:
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the ability to sell our properties at the highest possible price in order to maximize the return to our stockholders;
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the ability of our buyers to finance the acquisition of our asset; and
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the ability to complete the sales transactions within the timeframe of our plan of liquidation.
Operating Strategies
In accordance with our plan of liquidation, our primary operating strategy is to enhance the performance and value of our properties through management strategies designed to address the needs of current and prospective tenants. Management strategies include:
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managing costs and seeking to minimize operating expenses by centralizing management, leasing, marketing, financing, accounting, renovation and data processing activities;
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aggressively leasing available space through targeted marketing augmented, where possible, by our Advisor’s local asset and property management offices;
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improving rental income and cash flow by aggressively marketing rentable space and raising rents when feasible;
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emphasizing regular maintenance and periodic renovation to meet the needs of tenants and to maximize returns; and
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refinancing properties when favorable financing terms are available to increase the cash flow.
FINANCING POLICIES
We conduct substantially all of our investment and debt-financing activities through our Operating Partnership. To date, we have financed our investments through a combination of equity as well as secured debt. The terms of our credit facility, or Credit Facility, with LaSalle Bank National Association, or LaSalle, and secured notes contain various financial covenants which require satisfaction of certain total debt-to-asset ratios, secured debt-to-total-asset ratios, debt service coverage ratios, as well as other customary limitations. A primary objective of our financing policy is to manage our financial position to allow us to raise capital at competitive rates. As of December 31, 2006, 11 of our properties were subject to existing mortgages with an aggregate principal amount outstanding of $238,010,000 ($225,836,000 on a liquidation basis), consisting of $196,321,000 on a liquidation basis, or 86.9%, of fixed rate debt at a weighted-average interest rate of 5.32% per annum and $29,515,000 on a liquidation basis, or 13.1%, of variable rate debt at a weighted-average interest rate of 7.86% per annum. We utilize certain derivative financial instruments at times to limit interest rate risk. The fixed interest rates and the interest rate swap, cap and collar agreements on the variable interest rates limit the risk of fluctuating interest rates. The derivatives we enter into, and the only derivative transactions approved by our board of directors, are those which are used only for hedging purposes rather than speculation. If an anticipated hedged transaction does not occur, any positive or negative value of the derivative will be recognized immediately in net income. We did not have any derivative financial instruments as of December 31, 2006.
TAX STATUS
We have been organized and operated, and intend to continue to operate until our liquidation is complete, so as to qualify for taxation as a REIT under the Code. Our qualification and taxation as a REIT depends on our ability to meet, through actual annual operating results, asset diversification, distribution levels and diversity in stock ownership, numerous requirements established under highly technical and complex Code provisions subject to interpretation. As long as we qualify for taxation as a REIT, we generally will not be
subject to federal income tax to the extent we distribute at least 100.0% of our REIT taxable income to our stockholders.
If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. Unless entitled to relief under specific statutory provisions, we will also be disqualified for taxation as a REIT for the four taxable years following the year in which we lose our qualification. Even if we qualify as a REIT, we may be subject to certain state and local taxes on our income and property and to federal income and excise taxes on our undistributed income.
We expect to continue to qualify as a REIT until our dissolution, but given the change in the nature of our assets and in our sources of income that could result from dispositions of our real estate assets and the need to retain liquid assets in order to meet the liabilities, no assurance can be given that we will not lose or terminate our status as a REIT.
DISTRIBUTION POLICY
In order to qualify as a REIT for federal income tax purposes, we must distribute at least 90.0% of our taxable income (excluding capital gains) to our stockholders. Subsequent to March 31, 2006, all distributions have been in the form of liquidating distributions to our stockholders and recorded when approved. On October 11, 2006, we paid a special liquidating distribution of $171,289,000, or $3.90 per share, to our stockholders of record as of September 30, 2006. While the plan of liquidation provided that monthly liquidating distributions would terminate following the payment of liquidating distributions totaling $150,000,000, our board of directors has decided to continue the payment of monthly liquidating distributions at an annualized rate of 7.50% on the remaining share value of $6.10. Our board of directors will continue to evaluate the payment of regular monthly liquidating distributions on an on-going basis as more properties are sold and additional special liquidating distributions are paid to stockholders. We expect to satisfy the REIT distribution requirements through any liquidating distributions made pursuant to our plan of liquidation. Every payment of liquidating distributions will be subject to the availability of cash and the discretion of our board of directors.
COMPETITION
We compete with a considerable number of other real estate companies seeking to lease office space, some of which have greater marketing and financial resources than we do. Principal factors of competition in our business are the quality of properties (including the design and condition of improvements), leasing terms (including rent and other charges and allowances for tenant improvements), attractiveness and convenience of location, the quality and breadth of tenant services provided, and the reputation as an owner and operator of quality office properties in the relevant market. Our ability to compete also depends on, among other factors, trends in the national and local economies, financial condition and operating results of current and prospective tenants, availability and cost of capital, including capital raised by incurring debt, construction and renovation costs, taxes, governmental regulations, legislation and population trends.
When we sell our properties, we will be in competition with other sellers of similar properties to locate suitable purchasers, which may result in us receiving lower proceeds than our estimated liquidation proceeds.
As of March 20, 2007, we hold interests in properties located in California, Texas, Delaware, Missouri, Maryland, Illinois, Colorado and Arizona. Other entities managed by our Advisor also own property interests in some of the same regions in which we own property interests and such properties are managed by Realty. Our properties may face competition in these geographic regions from such other properties owned, operated or managed by our Advisor or Realty. Our Advisor and Realty have interests that may vary from those we may have in such geographic markets.
GOVERNMENT REGULATIONS
Many laws and government regulations are applicable to our properties and changes in these laws and regulations, or their interpretation by agencies and the courts, occur frequently.
Costs of Compliance with the Americans with Disabilities Act. Under the Americans with Disabilities Act of 1990, or ADA, all public accommodations must meet federal requirements for access and use by disabled persons. Although we believe that we are in substantial compliance with present requirements of the ADA, none of our properties have been audited, nor have investigations of our properties been conducted to determine compliance. We may incur additional costs in connection with the ADA. Additional federal, state and local laws also may require modifications to our properties or restrict our ability to renovate our properties. We cannot predict the cost of compliance with the ADA or other legislation. If we incur substantial costs to comply with the ADA or any other legislation, our financial condition, results of operations, cash flow and ability to satisfy our debt service obligations and pay liquidating distributions could be adversely affected.
Costs of Government Environmental Regulation and Private Litigation. Environmental laws and regulations hold us liable for the costs of removal or remediation of certain hazardous or toxic substances which may be on our properties. These laws could impose liability without regard to whether we are responsible for the presence or release of the hazardous materials. Government investigations and remediation actions may have substantial costs and the presence of hazardous substances on a property could result in personal injury or similar claims by private plaintiffs. Various laws also impose liability on persons who arrange for the disposal or treatment of hazardous or toxic substances for the cost of removal or remediation of hazardous substances at the disposal or treatment facility. These laws often impose liability whether or not the person arranging for the disposal ever owned or operated the disposal facility. As the owner and operator of our properties, we may be deemed to have arranged for the disposal or treatment of hazardous or toxic substances.
Use of Hazardous Substances by Some of Our Tenants. Some of our tenants may handle hazardous substances and wastes on our properties as part of their routine operations. Environmental laws and regulations subject these tenants, and potentially us, to liability resulting from such activities. We require the tenants, in their leases, to comply with these environmental laws and regulations and to indemnify us for any related liabilities. We are unaware of any material noncompliance, liability or claim relating to hazardous or toxic substances or petroleum products in connection with any of our properties.
Other Federal, State and Local Regulations. Our properties are subject to various federal, state and local regulatory requirements, such as state and local fire and life safety requirements. If we fail to comply with these various requirements, we may incur governmental fines or private damage awards. While we believe that our properties are currently in material compliance with all of these regulatory requirements, we do not know whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that will adversely affect our ability to make liquidating distributions to our stockholders. We believe, based in part on engineering reports which we generally obtain at the time we acquire the properties, that all of our properties comply in all material respects with current regulations. However, if we were required to make significant expenditures under applicable regulations, our financial condition, results of operations, cash flow and ability to satisfy our debt service obligations and to pay liquidating distributions could be adversely affected.
SIGNIFICANT TENANTS
As of December 31, 2006, none of our tenants accounted for 10.0% or more of our aggregate annual rental income. However, separate agencies of the General Services Administration had 11 leases at five of our consolidated properties which accounted for 15.2% of our aggregate annual rental income as of December 31, 2006.
Our ten largest tenants at our consolidated properties, based upon the aggregate annual contractual base rent set forth in leases in effect as of December 31, 2006, accounted for 44.1% of our aggregate annual rental income as of December 31, 2006. These tenants are:
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Federal Deposit Insurance Corp., or FDIC, at Pacific Place, at 9.9%;
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Jacobs Engineering at One Financial Plaza, at 6.1%;
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General Services Administration (IRS) at North Pointe Corporate Center, at 4.9%;
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American Honda Finance Corporation at Madrona Buildings, at 4.3%;
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General Services Administration (U.S. Bankruptcy Court) at 824 Market Street, at 4.1%;
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Southwestern Energy Production at North Belt, at 3.5%;
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Stifel, Nicolaus and Company at One Financial Plaza, at 3.3%;
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Navcom Technology, Inc. at Madrona Buildings, at 3.0%;
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General Services Administration (U.S. Customs) at One World Trade Center, at 2.9%; and
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Federal Bureau of Investigation, or FBI, at One World Trade Center, at 2.1%.
The loss of these above-mentioned tenants or their inability to pay rent could have a material adverse effect on our business and results of operations.
We are also subject to a concentration of regional economic exposure as 42.4% and 31.3% of our aggregate annual base rental income is generated by our consolidated properties located in California and Texas, respectively. Regional economic downturns in California and Texas could adversely impact our operations.
EMPLOYEES
We have no employees and our executive officers are all employees of our Advisor or its affiliates. Substantially all of our work is performed by employees of our Advisor and its affiliates.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
We internally evaluate all of our properties as one industry segment, and, accordingly, we do not report segment information.
Item 1A.
Item 1A.
Risk Factors.
Risks Associated with Our Liquidation
We may delay or reduce our liquidating distributions to our stockholders.
As of March 17, 2007, we estimate that our net proceeds from liquidation will be approximately $481,521,000 (of which approximately $192,782,000 has already been paid to our stockholders) and we expect that our stockholders will receive approximately $10.96 per share in liquidating distributions (of which $4.39 per share has already been paid to our stockholders), which we anticipate paying within 24 months after our adoption of our plan of liquidation (that is, February 27, 2008). However, our expectations about the amount of liquidating distributions to our stockholders that we will make and when we will make them are based on many estimates and assumptions, one or more of which may prove to be incorrect. As a result, the actual amount of liquidating distributions we pay to our stockholders may be more or less than we currently estimate. In addition, the liquidating distributions to our stockholders may be paid later than we predict.
If we are unable to find buyers for our assets at our expected sales prices, our liquidating distributions may be delayed or reduced.
As of March 20, 2007, three of our 15 property interests are subject to binding sale agreements providing for their sale. In calculating our estimated range of liquidating distributions to our stockholders, we assumed that we would be able to find buyers for our properties at amounts based on our estimated range of market values for each property. However, we may have overestimated the sales prices that we will ultimately be able to obtain for these assets. For example, in order to find buyers in a timely manner, we may be required to lower our asking price below the low end of our current estimate of the property’s market value. If we are not able to find buyers for these assets in a timely manner or if we have overestimated the sales prices we will receive, our liquidating payments to our stockholders would be delayed or reduced. Furthermore, the projected liquidating distribution to our stockholders is based upon the market value for each property, but real estate market values are constantly changing and fluctuate with changes in interest rates, supply and demand dynamics, occupancy percentages, lease rates, the availability of suitable buyers, the perceived quality and dependability of income flows from tenancies and a number of other factors, both local and national. The net liquidation proceeds from each property may also be affected by the terms of prepayment or assumption costs associated with debt encumbering each property. In addition, minority ownership matters, transactional fees and expenses, environmental contamination at our properties or unknown liabilities, if any, may adversely impact the net liquidation proceeds from those assets.
Decreases in property values may reduce the amount that we receive upon a sale of our assets.
The underlying value of our interests in office properties may be reduced by a number of factors that are beyond our control, including, without limitation, the following:
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adverse changes in economic conditions;
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the financial performance of our tenants, and the ability of our tenants to satisfy their obligations under their leases;
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potential major repairs which are not presently contemplated;
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terminations and renewals of leases by our tenants;
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changes in interest rates and the availability of financing;
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competition; and
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changes in real estate tax rates and other operating expenses.
Any reduction in the value of our properties would make it more difficult for us to sell our assets for the amounts that we have estimated. Reductions in the amounts that we receive when we sell our assets could decrease or delay the payment of liquidating distributions to stockholders.
If we are unable to maintain the occupancy rates of currently leased space and lease currently available space, if tenants default under their leases or other obligations to us during the liquidation process or if our cash flow during the liquidation is otherwise less than we expect, our liquidating distributions to our stockholders may be delayed or reduced.
In calculating our estimated liquidating distributions to our stockholders, we assumed that we would maintain the occupancy rates of currently-leased space, that we would be able to rent certain currently available space at market rents and that we would not experience any significant tenant defaults during the liquidation process that were not subsequently cured. Negative trends in one or more of these factors during the liquidation process may adversely affect the resale value of the properties, which would reduce our liquidating distributions to our stockholders. To the extent that we receive less rental income than we expect during the liquidation process, our liquidating distributions to our stockholders will be reduced. We may also decide in the event of a tenant default to restructure the lease, which could require us to substantially reduce
the rent payable to us under the lease, or make other modifications that are unfavorable to us which could decrease or delay the payment of liquidating distributions to our stockholders.
If our liquidation costs or unpaid liabilities are greater than we expect, our liquidating distributions to our stockholders may be delayed or reduced.
Before making the final liquidating distribution to our stockholders, we will need to pay or arrange for the payment of all of our transaction costs in the liquidation, and all other costs and all valid claims of our creditors. Our board of directors may also decide to acquire one or more insurance policies covering unknown or contingent claims against us, for which we would pay a premium which has not yet been determined. Our board of directors may also decide to establish a reserve fund to pay these contingent claims. The amounts of transaction costs in the liquidation are not yet final, so we have used estimates of these costs in calculating the amounts of our projected liquidating distributions to our stockholders. To the extent that we have underestimated these costs in calculating our projections, our actual net liquidation value may be lower than our estimated range. In addition, if the claims of our creditors are greater than we have anticipated or we decide to acquire one or more insurance policies covering unknown or contingent claims against us, our liquidating distributions to our stockholders may be delayed or reduced. Further, if a reserve fund is established, payment of liquidating distributions to our stockholders may be delayed or reduced.
If any of the parties to our future sale agreements default thereunder, or if these sales do not otherwise close, our liquidating distributions to our stockholders may be delayed or reduced.
We will seek to enter into binding sale agreements for all of our properties. The consummation of the potential sales for which we will enter into sale agreements in the future will be subject to satisfaction of closing conditions. If any of the transactions contemplated by these future sale agreements do not close because of a buyer default, failure of a closing condition or for any other reason, we will need to locate a new buyer for the assets which we may be unable to do promptly or at prices or on terms that are as favorable as the original sale agreement. We will also incur additional costs involved in locating a new buyer and negotiating a new sale agreement for this asset. These additional costs are not included in our projections. In the event that we incur these additional costs, our liquidating payments to our stockholders would be delayed or reduced.
Pursuing our plan of liquidation may cause us to fail to qualify as a REIT, which would dramatically lower the amount of our liquidating distributions.
We value our status as a REIT under the Code because for so long as we qualify as a REIT and distribute all of our taxable income, we generally would not be subject to federal income tax. While our board of directors does not presently intend to terminate our REIT status prior to the final distribution of our assets and our dissolution, pursuant to our plan of liquidation, our board of directors may take actions which would result in such a loss of REIT status. Upon the final distribution of our assets and our dissolution, our existence and our REIT status will terminate. However, there is a risk that our actions in pursuit of our plan of liquidation may cause us to fail to meet one or more of the requirements that must be met in order to qualify as a REIT. For example, to qualify as a REIT, at least 75.0% of our gross income must come from real estate sources and 95.0% of our gross income must come from real estate sources and certain other sources that are itemized in the REIT tax laws, mainly interest and dividends. We may encounter difficulties satisfying these requirements as part of the liquidation process. In addition, in selling our assets, we may recognize ordinary income in excess of the cash received, especially after deducting from those cash proceeds any amounts that we are contractually obligated to immediately repay to the lenders under any credit facility. The REIT rules require us to pay out a large portion of our ordinary income in the form of a dividend to stockholders. However, to the extent that we recognize ordinary income without any cash available for distribution to our stockholders, and if we are unable to borrow to fund the required dividend or find another alternative way to meet the REIT distribution requirements, we may cease to qualify as a REIT. While we expect to comply with the
requirements necessary to qualify as a REIT in any taxable year, if we are unable to do so, we will, among other things (unless entitled to relief under certain statutory provisions):
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not be allowed a deduction for dividends paid to stockholders in computing our taxable income;
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be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates;
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be subject to increased state and local taxes; and
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be disqualified from treatment as a REIT for the taxable year in which we lose our qualification and for the four following taxable years.
As a result of these consequences, our failure to qualify as a REIT could substantially reduce the funds available for distribution to our stockholders.
Pursuing our plan of liquidation may cause us to be subject to federal income tax, which would reduce the amount of our liquidating distributions.
We generally are not subject to federal income tax to the extent that we distribute to our stockholders during each taxable year (or, under certain circumstances, during the subsequent taxable year) dividends equal to our taxable income for the year. However, we are subject to federal income tax to the extent that our taxable income exceeds the amount of dividends paid to our stockholders for the taxable year. In addition, we are subject to a 4.0% nondeductible excise tax on the amount, if any, by which certain distributions paid by us with respect to any calendar year are less than the sum of 85.0% of our ordinary income for that year, plus 95.0% of our capital gain net income for that year, plus 100.0% of our undistributed taxable income from prior years. While we intend to make liquidating distributions to our stockholders sufficient to avoid the imposition of any federal income tax on our taxable income and the imposition of the excise tax, differences in timing between the actual receipt of income and actual payment of deductible expenses, and the inclusion of such income and deduction of such expenses in arriving at our taxable income, could cause us to have to either borrow funds on a short-term basis to meet the REIT distribution requirements, find another alternative for meeting the REIT distribution requirements, or pay federal income and excise taxes. The cost of borrowing or the payment of federal income and excise taxes would reduce the funds available for distribution to our stockholders.
The sale of our assets may cause us to be subject to a 100.0% excise tax on “prohibited transactions,” which would reduce the amount of our liquidating distributions.
REITs are subject to a 100.0% excise tax on any gain from “prohibited transactions,” which include sales or other dispositions of assets held for sale to customers in the ordinary course of the REIT’s trade or business. The determination of whether property is held for sale to customers in the ordinary course of our trade or business is inherently factual in nature and, thus, cannot be predicted with certainty. The Code does provide a “safe harbor” which, if all its conditions are met, would protect a REIT’s property sales from being considered prohibited transactions, but we may not be able to satisfy these conditions. While we do not believe that any of our properties should be considered to be held for sale to customers in the ordinary course of our trade or business, because of the substantial number of properties that would have to be sold and the active marketing that would be necessary, there is a risk that the Internal Revenue Service would seek to treat some or all of the property sales as prohibited transactions, resulting in the payment of taxes by us as described above, in which case the amount available for distribution to our stockholders could be significantly reduced.
The pending SEC investigation of our Advisor could result in lawsuits or other actions against us or our affiliates.
On September 16, 2004, our Advisor learned that the SEC, is conducting an investigation referred to as “In the matter of Triple Net Properties, LLC.” The SEC has requested information from our Advisor relating to disclosure in public and private securities offerings sponsored by our Advisor and its affiliates, or the Triple
Net securities offerings (including offerings by us). The SEC has requested financial and other information regarding the Triple Net securities offerings and the disclosures included in the related offering documents.
Our Advisor is engaged in settlement negotiations with the SEC staff regarding this matter. Based on these negotiations, our Advisor believes that the conclusion to this matter will not result in a material adverse affect to its results of operations, financial condition or ability to conduct our business. The settlement negotiations are continuing, and any settlement negotiated with the SEC staff must be approved by the Commission. Since the matter is not concluded, it remains subject to the risk that the SEC may seek additional remedies, including substantial fines and injunctive relief against our Advisor that, if obtained, could harm our Advisor’s ability to perform its duties to us and/or delay the payment of liquidating distributions to our stockholders under our plan of liquidation. The matters that are the subject of this investigation could also give rise to claims against our Advisor by investors in its existing real estate investment programs which could adversely affect our Advisor’s performance to us. At this time, we cannot assess how or when the outcome of the matter will be ultimately determined and its impact on us. Therefore, at this time, we have not accrued any loss contingencies in accordance with Statement of Financial Accounting Standards, or SFAS, No. 5, Accounting for Contingencies.
If we are unable to retain our Advisor and our executives to complete our plan of liquidation, our liquidating distributions might be delayed or reduced.
Our day-to-day operations are managed by our Advisor. We have no employees and our executive officers are all employees of our Advisor or its affiliates. We face the risk that we may lose the services of our Advisor and consequently our executive officers. The Advisory Agreement with our Advisor expired on July 22, 2005. Our Advisor proposed that we bear additional costs under the terms of any new advisory agreement to reflect current market rates in our sector; however, in connection with the approval of our plan of liquidation by our stockholders, our Advisor’s then Board of Managers has agreed to continue to provide such services to us on a month-to-month basis pursuant to the terms of the expired Advisory Agreement. However, we have no binding agreement with our Advisor to continue to provide services pursuant to the expired Advisory Agreement and thus face the risk that our Advisor will not continue to provide services to us. If we are unable to retain the services of our Advisor throughout the period of the liquidation process, we may be unable to complete our plan of liquidation in as expeditious a manner as might otherwise be the case or on terms as favorable to us as our Advisor may be able to do so, because of the loss of our Advisor’s experience and familiarity with our assets and business. In addition, we would also incur transitional costs if we were either to become self-managed or enter an advisory relationship with a new advisor.
Even if we are able to retain the services of our Advisor throughout the period of the liquidation process, our ability to complete our plan of liquidation in a timely manner also depends on the continued services of our executive officers. Our ability to complete any sales, to locate qualified buyers for our other assets and to negotiate and complete any such sales, depends to a large extent upon the experience and abilities of our executive officers, including, without limitation, Scott D. Peters and Andrea R. Biller, their familiarity with our assets, our counter-parties to any sale agreements and the market for our properties, and their ability to efficiently manage the professionals in the process as well as our Advisor. We face the risk that our Advisor or its affiliate’s employees may seek other employment rather than remain with our Advisor or its affiliate throughout the period of the liquidation process. If our Advisor is unable to retain appropriate qualified key executives and staff to complete our plan of liquidation in a reasonably expeditious manner, liquidating distributions to our stockholders might be delayed or reduced. Furthermore, the fees to be paid to our Advisor pursuant to the Advisory Agreement are based in part upon the value of our assets managed by our Advisor. As we sell our properties during the period of the liquidation process, our Advisor’s fees for managing our portfolio of properties will decrease. Accordingly, we face the risk that our Advisor will reassign certain of our executive officers to the management of other entities advised by our Advisor, and/or that our Advisor may reduce the number or the amount of resources dedicated to the management of our properties as we sell our assets during the period of the liquidation process. Moreover, we face the risk that our Advisor will not continue to provide services to us if we transfer of our assets to a liquidating trust. If we lose the services of our executive officers or if we do not have sufficient resources dedicated to our management, we may be
unable to complete our plan of liquidation in as expeditious a manner as we anticipate and, therefore, any liquidating distributions received by our stockholders may be delayed and/or reduced.
Our stockholders may not receive any profits resulting from the sale of one or more of our properties, or receive such profits in a timely manner, because we may provide financing to the purchaser of such property.
Our stockholders may experience a delay before receiving their share of the net proceeds of such liquidation. In liquidation, we may sell our properties either subject to or upon the assumption of any then outstanding mortgage debt or, alternatively, may provide financing to purchasers. We do not have any limitations or restrictions on the right to take such purchase money obligations. To the extent we receive promissory notes or other property in lieu of cash from sales, such proceeds, other than any interest payable on those proceeds, will not be included in net sale proceeds until and to the extent the promissory notes or other property are actually paid, sold, refinanced or otherwise disposed of. We may receive initial down payments in the year of sale in an amount less than the selling price and subsequent payments may be spread over a number of years. In such event, our stockholders may experience a delay in the distribution of the net proceeds of a sale until such time as the installment payments are received.
Our entity value may be adversely affected by our adoption of our plan of liquidation.
Based on the approval of our plan of liquidation, we are committed to winding-up our operations. This may adversely affect the value that a potential acquirer might place on us or put pressure on us to sell our remaining assets at or below the low end of the estimated range, which would reduce the amount of liquidating distributions to our stockholders.
There can be no assurance that our plan of liquidation will result in greater returns to our stockholders on their investment within a reasonable period of time than our stockholders would receive through other alternatives reasonably available to us at this time.
Our stockholders will no longer participate in any future earnings or growth of our assets or benefit from any increases in the value of our assets once such assets are sold. While our board of directors and the special committee each believed that a liquidation at this time would be more likely to provide our stockholders with a greater return on their investment within a reasonable period of time, than our stockholders would receive through other alternatives reasonably available to us, such belief relied on certain assumptions and judgments concerning future events which may be unreliable or incorrect.
Our board of directors may amend our approved plan of liquidation without further stockholder approval.
Our board of directors may amend our plan of liquidation without further stockholder approval, to the extent permitted by Maryland law. Thus, to the extent that Maryland law permits us to do so, we may decide to conduct the liquidation differently than previously described in our definitive proxy statement filed with the SEC on January 13, 2006.
Our board of directors will have the authority to sell our assets under terms less favorable that those assumed for the purpose of estimating our net liquidation value range.
Our directors will have the authority to sell any and all of our assets on such terms and to such parties as our board of directors determines in its sole discretion. Our stockholders will have no subsequent opportunity to vote on such matters and will, therefore, have no right to approve or disapprove the terms of such sales. Accordingly, our stockholders must rely solely on our judgment with respect to the sale process and our judgment may not always be the best judgment when evaluating in hind sight.
Approval of our plan of liquidation may lead to stockholder litigation which could result in substantial costs and distract our management.
Historically, extraordinary corporate actions by a company, such as our plan of liquidation, sometimes lead to securities class action lawsuits being filed against that company. We may become involved in this type of litigation as a result of our plan of liquidation. As of March 20, 2007, no such lawsuits relative to our plan of liquidation have been filed. However, if such a lawsuit is filed against us, the litigation is likely to be expensive and, even if we ultimately prevail, the process will divert management’s attention from implementing our plan of liquidation and otherwise operating our business. If we do not prevail in any such a lawsuit which may be filed against us in the future, we may be liable for damages. In such event, we cannot predict the amount of any such damages, however, if applicable, they may be significant and may reduce our cash available for distribution to our stockholders.
Our officers and directors and our Advisor have conflicts of interest that may influence their implementation of our plan of liquidation and may cause them to manage our liquidation in a manner not solely in the best interests of our stockholders.
Some of our officers and directors and our Advisor have interests in the liquidation that are different from our stockholders’ interests as a stockholder. Our board of directors is aware of these actual and potential conflicts of interest. Some of the conflicts of interest presented by the liquidation are summarized below.
Four of our executive officers are executive officers of our Advisor and all of our executive officers are employed and compensated by our Advisor or its parent company, NNN Realty Advisors. Moreover, Anthony W. Thompson, the Chairman of our board of directors, is the founder of our Advisor and the Chairman of the board of directors of NNN Realty Advisors. NNN Realty Advisors owns 100% of the equity interest in our Advisor. Mr. Thompson, our executive officers and executive officers of our Advisor collectively own approximately 35.0% of the equity interest in NNN Realty Advisors as of December 31, 2006.
Our Advisor or its affiliates receive compensation under the Advisory Agreement, including fees for disposing of our interests in our consolidated and unconsolidated properties. Our Advisor has engaged Realty, an affiliate of our Advisor, to provide various services to us in connection with our properties, including disposing of our remaining properties. In accordance with our plan of liquidation, our Advisor or Realty will be paid to liquidate our assets pursuant to the Advisory Agreement. Based on the estimated sales prices of our properties as of December 31, 2006, we estimate that we will pay fees to Realty or its affiliates of approximately $7,189,000 for disposing of our property interests during liquidation. Our Advisor or Realty also have agreements with certain affiliated co-owners of our properties, pursuant to which our Advisor will also receive fees for the disposition of the affiliated co-owners’ interests in the properties. Based on our estimated sales prices as of December 31, 2006, we estimate that the total fees that will be received by our Advisor or Realty from the affiliated co-owners will be approximately $1,884,000, which includes the fees to be received by our Advisor under the Advisory Agreement. Moreover, if we sell one or more of our properties to an affiliate of our company or an affiliate of our Advisor, our Advisor and Realty may receive additional fees from the purchaser of the property.
Our Advisor owns 23,138 shares of our common stock, and, therefore, in accordance with our plan of liquidation, based on the net assets in liquidation as of December 31, 2006, plus liquidating distributions to our stockholders through December 31, 2006, will be entitled to receive approximately $254,000 in liquidating distributions. These estimates include projections of costs and expenses expected to be incurred during the period required to complete our plan of liquidation. These projections could change materially based on the timing of any sales, the performance of the underlying assets and change in the underlying assumptions of the projected cash flows.
Our executive officers and non-independent director own a total of 26,175 shares of our common stock, and, therefore, in accordance with our plan of liquidation, based on the net assets in liquidation as of December 31, 2006, plus liquidating distributions to our stockholders through December 31, 2006, will be entitled to receive approximately $287,000 in liquidating distributions. These estimates include projections of
costs and expenses expected to be incurred during the period required to complete our plan of liquidation. These projections could change materially based on the timing of any sales, the performance of the underlying assets and change in the underlying assumptions of the projected cash flows.
As of February 27, 2006, our independent directors owned a total of 55,000 vested shares of restricted common stock granted pursuant to our 2004 incentive award plan and, therefore, in accordance with our plan of liquidation, based on the net assets in liquidation as of December 31, 2006, plus liquidating distributions to our stockholders through December 31, 2006, will be entitled to receive approximately $603,000 in liquidating distributions. These estimates include projections of costs and expenses expected to be incurred during the period required to complete our plan of liquidation. These projections could change materially based on the timing of any sales, the performance of the underlying assets and change in the underlying assumptions of the projected cash flows. As of February 27, 2006, all outstanding stock options issued pursuant to our independent director and officer and employee stock options plans were terminated and forfeited.
Our independent directors will become entitled to receive milestone payments, if they remain a member of our board of directors and the special committee, of $25,000 on each of December 31, 2006 and December 31, 2007, as well as a milestone payment of $50,000 when we have made aggregate liquidating distributions of at least $11.00 per share to our stockholders. Assuming that these directors receive the maximum amount of milestone payments, they will each receive aggregate payments of up to $100,000.
We will pay Scott D. Peters, our Chief Executive Officer and President, and Andrea R. Biller, our Executive Vice President and Secretary, retention bonuses of $50,000 and $25,000, respectively, upon the filing of each of our annual and quarterly reports with the SEC during the period of the liquidation process, beginning with the annual report for the year ending December 31, 2005. As of December 31, 2006, Mr. Peters and Ms. Biller have received retention bonuses of $200,000 and $100,000 from us, respectively. Additionally, our Advisor will pay to each of Scott D. Peters and Andrea R. Biller a performance-based bonus of $100,000 upon the receipt by our Advisor of net commissions aggregating $5,000,000 or more from the sale of our properties. As of December 31, 2006, Mr. Peters and Ms. Biller have not received their performance-based bonuses of $100,000 each from our Advisor.
Our plan of liquidation permits us to sell one or more of our properties to one or more of our affiliates, but only if the transaction is approved by the special committee. If we enter such a transaction, the special committee will only approve the transaction if (i) they determine that the consideration to be received by us in connection with such transaction is fair to us and the transaction is in our best interests, and (ii) we have obtained an appraisal of such asset showing that the proposed sale price is within the appraiser’s range of estimated values for the asset, or we have obtained an opinion from Stanger, or another financial advisor with similar qualifications, that the consideration to be received by us in connection with such sale is fair to us from a financial point of view. We expect that the special committee will require that Stanger opine to us, from a financial point of view, as to the fairness of the consideration to be received by us in such transaction or conduct an appraisal of the underlying property. In no event will the special committee approve a transaction if we have received a higher offer for the property from a credible party whom we reasonably believe is ready, able and willing to close the transaction on the proposed terms. Additionally, if we sell one or more of our properties to unaffiliated third parties or our affiliates, our Advisor, Realty or an affiliate of our Advisor may manage one or more of such properties following their sale, which would entitle our Advisor, Realty or an affiliate of our Advisor to receive additional fees.
Our Advisor also owns 100 non-voting incentive performance units in the Operating Partnership. These incentive units entitle our Advisor to receive certain incentive distributions from net proceeds from the sale of our properties after our stockholders have received their invested capital, as defined in our Operating Partnership Agreement, plus an 8.0% return on such invested capital. After the sale of the Operating Partnership’s assets, and payment of, or adequate provision for, the debts and obligations of the Operating Partnership, our Advisor will receive an incentive performance distribution between approximately $0 and $9,070,000. Based on the valuation of our portfolio as of December 31, 2006 we have reserved for an estimated incentive fee distribution to our Advisor of $3,226,000.
Consequently, our officers and directors and our Advisor are more likely to support our plan of liquidation than might otherwise be the case if they did not expect to receive those payments. Additionally, because of the above conflicts of interest, our officers and directors and our Advisor may make decisions or take actions based on factors other than the best interests of our stockholders throughout the period of the liquidation process.
Distributing interests in a liquidating trust may cause our stockholders to recognize gain prior to the receipt of cash.
The REIT provisions of the Code generally require that each year we distribute as a dividend to our stockholders 90.0% of our REIT taxable income. Under certain provision of the Code, our liquidating distributions to our stockholders will not qualify as dividends for this purpose unless, among other things, we make such distributions within 24 months after the adoption of our plan of liquidation. Although we anticipate that we will meet this timetable, conditions may arise which cause us not to be able to liquidate within such 24-month period. For instance, it may not be possible to sell our assets at acceptable prices during such period. In such event, rather than retain our assets and risk losing our status as a REIT, we may elect to contribute our remaining assets and liabilities to a liquidating trust in order to meet the 24-month requirement. We may also elect to contribute our remaining assets and liabilities to a liquidating trust within such 24-month period to avoid the costs of operating as a public company. Such a contribution would be treated as a distribution of our remaining assets to our stockholders, followed by a contribution of the assets to the liquidating trust. As a result, a stockholder would recognize gain to the extent his share of the cash and the fair market value of any assets received by the liquidating trust was greater than the stockholder’s basis in his stock, notwithstanding that the stockholder would not contemporaneously receive a distribution of cash or any other assets with which to satisfy the resulting tax liability. In addition, it is possible that the fair market value of the assets received by the liquidating trust, as estimated for purposes of determining the extent of the stockholder’s gain at the time interests in the liquidating trust are distributed to the stockholders, will exceed the cash or fair market value of property received by the liquidating trust on a sale of the assets. In this case, the stockholder would recognize a loss in a taxable year subsequent to the taxable year in which the gain was recognized, which loss may be limited under the Code.
Our adoption of our plan of liquidation caused our accounting basis to change, which could require us to write-down our assets.
Due to the adoption of our plan of liquidation, we must change our basis of accounting from the going-concern basis to that of the liquidation basis of accounting.
In order for our financial statements to be in accordance with generally accepted accounting principles, or GAAP, under the liquidation basis of accounting, all of our assets must be stated at their estimated net realizable value and all of our liabilities must be recorded at the estimated amounts at which the liabilities are expected to be settled. Based on the most recent available information, we may make liquidating distributions to our stockholders that exceed the carrying amount of our net assets. However, we cannot assure our stockholders what the ultimate amounts of such liquidating distributions will be. Therefore, there is a risk that the liquidation basis of accounting may entail write-downs of certain of our assets to values substantially less than their respective carrying amounts, and may require that certain of our liabilities be increased or certain other liabilities be recorded to reflect the anticipated effects of an orderly liquidation.
A write-down in our assets could make it more difficult to negotiate amendments to our credit agreements or result in defaults under any restructured credit agreements that we may enter. In addition, write-downs in our assets could reduce the price that a third party would be willing to pay to acquire our assets.
Stockholders could be liable to the extent of liquidating distributions received if contingent reserves are insufficient to satisfy our liabilities.
If we fail to create an adequate contingency reserve for payment of our expenses and liabilities, or if we transfer our assets to a liquidating trust and the contingency reserve and the assets held by the liquidating trust
are less than the amount ultimately found payable in respect of expenses and liabilities, each stockholder could be held liable for the payment to creditors of such stockholder’s pro rata portion of the excess, limited to the amounts previously received by the stockholder in distributions from us or the liquidating trust.
If a court holds at any time that we have failed to make adequate provision for our expenses and liabilities or if the amount ultimately required to be paid in respect of such liabilities exceeds the amount available from the contingency reserve and the assets of the liquidating trust, our creditors could seek an injunction to prevent us from making liquidating distributions to our stockholders under our plan of liquidation on the grounds that the amounts to be distributed are needed to provide for the payment of our expenses and liabilities. Any such action could delay or substantially diminish the cash distributions to be made to stockholders and/or holders of beneficial interests of the liquidation trust under our plan of liquidation.
We may have underestimated the amount of prepayment fees or defeasance charges on our mortgages.
In calculating our estimated net liquidation value range and our estimated per share distribution range, we have assumed that the purchasers of our properties will assume certain mortgages on the underlying property, which contain penalties in the event of the prepayment of those mortgages. The sale of our properties pursuant to our plan of liquidation will trigger these penalties unless the purchasers assume (and/or are allowed to assume) the corresponding mortgage. We may be unsuccessful in negotiating the assumption of any underlying mortgages in the sale of any of our properties, which could negatively affect the amount of cash available for distribution to our stockholders pursuant to our plan of liquidation. As of December 31, 2006, the total amount of prepayment fees or defeasance charges on our mortgages, which we may be liable for, is approximately $5,604,000.
We expect to incur increasingly significant costs in connection with Sarbanes-Oxley compliance and we may become subject to liability for any failure to comply.
The Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act, and related laws, regulations and standards relating to corporate governance and disclosure requirements applicable to public companies have increased the costs of corporate governance, reporting and disclosure practices which are now required of us. We expect that our efforts to comply with the Sarbanes-Oxley Act and applicable laws and regulations will continue to involve significant, and potentially increasing, costs. In addition, these laws, rules and regulations create new legal bases for administrative enforcement, civil and criminal proceedings against us in case of non-compliance, thereby increasing our risks of liability and potential sanctions.
While we are not aware of any material non-compliance with the Sarbanes-Oxley Act and related laws and regulations, we were formed prior to the enactment of these corporate governance standards and as a result we did not have all necessary procedures and policies in place at the time of their enactment. Any failure to comply with the Sarbanes-Oxley Act could result in fees, fines, penalties or administrative remedies, which could reduce and/or delay the amount of liquidating distributions to our stockholders under our plan of liquidation.
RISKS OF OUR BUSINESS
Erroneous disclosures in the prior performance tables in our initial and second public offering documents could result in lawsuits or other actions against us which could have a material adverse effect upon our business and results of operations.
In connection with our initial and second public offerings of common stock conducted through best efforts offerings from July 22, 2002 through April 30, 2004, we disclosed the prior performance of all public and non-public investment programs sponsored by our Advisor. Our Advisor determined that there were certain errors in those prior performance tables. In particular, the financial information in the tables was stated to be presented on a GAAP basis. In general, the tables for the public programs were not presented on a GAAP basis and the tables for the non-public programs were prepared and presented on a tax or cash accounting basis. Moreover, a number of the prior performance data figures were themselves erroneous, even as presented on a tax or cash basis. In particular, certain programs sponsored by our Advisor have invested
either along side or in other programs sponsored by our Advisor. The nature and results of these investments were not fully and accurately disclosed in the tables. In addition, for the private programs, certain calculations of depreciation and amortization were not on an income tax basis for a limited liability company investment, certain operating expenses were not reflected in the operating results, and monthly mortgage and principal payments were not reported. In general, the resulting effect is an overstatement of our Advisor’s program and aggregate portfolio operating results. The overstatement of results could result in lawsuits or other actions against us which could have a material adverse effect upon our business and results of operations.
Distributions by us may include a return of capital.
Distributions, including liquidating distributions, payable to stockholders may include a return of capital as well as a return in excess of capital. Distributions exceeding taxable income will constitute a return of capital for federal income tax purposes to the extent of a stockholder’s basis. Distributions in excess of tax basis will generally constitute capital gain.
Due to the risks involved in the ownership of real estate, there is no guarantee of any return on our stockholders’ investments and our stockholders may lose some or all of their investment.
By owning shares of our common stock, our stockholders will be subjected to the risks associated with owning real estate. Ownership of real estate is subject to significant risks. The performance of our stockholders’ investments in us are subject to risks related to the ownership and operation of real estate, including:
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changes in the general economic climate;
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changes in local conditions such as an oversupply of space or reduction in demand for real estate;
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changes in interest rates and the availability of financing; and
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changes in laws and governmental regulations, including those governing real estate usage, zoning and taxes.
If our assets decrease in value, the value of our stockholders’ investments will likewise decrease and they could lose some or all of their investment.
Our properties face significant competition.
We face significant competition from other owners, operators and developers of office properties. All or substantially all of our properties face competition from similar properties owned by others in the same markets. Such competition may affect our ability to attract and retain tenants and may reduce the rents we are able to charge. These competing properties may have vacancy rates higher than our properties, which may cause their owners to rent space at lower rental rates than those charged by us or to provide greater tenant improvement allowances or other leasing concessions than we provide to our tenants. As a result, we may be required to provide rent concessions, incur charges for tenant improvements and other inducements, or we may not be able to timely lease the space, all of which would adversely impact our results of operations, liquidity and financial condition, which could reduce liquidating distributions to our stockholders. As we dispose of each of our properties, we will be in competition with sellers of similar properties to locate suitable purchasers, which may result in us receiving lower proceeds from the sale or result in us not being able to sell the property due to the lack of an acceptable return.
We depend upon our tenants to pay rent, and their inability to pay rent may substantially reduce our revenues and cash available for distribution to our stockholders.
Our investments in office properties are subject to varying degrees of risk that generally arise from the ownership of real estate. The value of our properties and the ability to make distributions to our stockholders depend upon the ability of the tenants at our properties to generate enough income in excess of their operating expenses to make their lease payments to us. Changes beyond our control may adversely affect our tenants’
ability to make their lease payments to us and, in such event, would substantially reduce both our income from operations and our ability to make distributions to our stockholders. These changes include, among others, the following:
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downturns in national, regional or local economic conditions where our properties are located, which generally will negatively impact the demand for office space and rental rates;
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changes in local market conditions such as an oversupply of office properties, including space available by sublease, or a reduction in demand for the lease of office properties, making it more difficult for us to lease space at attractive rental rates or at all;
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competition from other available office properties owned by others, which could cause us to lose current or prospective tenants or cause us to reduce rental rates to competitive levels;
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our ability to pay for adequate maintenance, insurance, utility, security and other operating costs, including real estate taxes and debt service payments, that are not necessarily reduced when circumstances such as market factors and competition cause a reduction in income from a property; and
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changes in federal, state or local regulations and controls affecting rents, prices of goods, interest rates, fuel and energy consumption.
Due to these changes, among others, tenants and lease guarantors, if any, may be unable to make their lease payments. A default by a tenant or the failure of a tenant’s guarantor to fulfill its obligations to us, or an early termination of a lease as a result of a tenant default or otherwise could, depending upon the size of the leased premises and our Advisor’s ability to successfully find a substitute tenant, have a material adverse effect on our revenues and cash available for distribution to its members. Moreover, as of December 31, 2006, rent paid by the ten largest tenants at our consolidated properties represented 44.1% of our annualized revenues. The revenues generated by the properties these tenants occupy is substantially dependent on the financial condition of these tenants and, accordingly, any event of bankruptcy, insolvency or a general downturn in the business of any of these large tenants may result in the failure or delay of such tenants’ rental payments which may have an adverse impact on our financial performance and our ability to pay liquidating distributions to our stockholders.
Lack of diversification and illiquidity of real estate may make it difficult for us to sell underperforming properties or recover our investment in one or more properties.
Our business is subject to risks associated with investment solely in real estate. Real estate investments are relatively illiquid. Our ability to vary our portfolio in response to changes in economic and other conditions is limited. We cannot provide assurance that it will be able to dispose of a property when we want or need to. Consequently, the sale price for any property may not recoup or exceed the amount of our investment.
Lack of geographic diversity may expose us to regional economic downturns that could adversely impact our operations or our ability to recover our investment in one or more properties.
Our portfolio lacks geographic diversity, as we own a majority of our properties in two states: California and Texas. This geographic concentration of properties exposes us to economic downturns in these regions. A recession in either of these states could adversely affect our ability to generate or increase operating revenues, attract new tenants or dispose of properties. In addition, our properties may face competition in either of these states from other properties owned, operated or managed by our Advisor or its affiliates or third parties. Our Advisor or its affiliates have interests that may vary from our interests in such states.
Our properties depend upon the California and Texas economies and the demand for office space.
As of December 31, 2006, we had a 42.4% and 31.3% concentration of tenants in our California and Texas properties, respectively, based on aggregate annual rental income. We are susceptible to adverse developments in California and Texas (such as business layoffs or downsizing, industry slowdowns, relocations
of businesses, changing demographics, increased telecommuting, terrorist targeting of high-rise structures, infrastructure quality, California and Texas state budgetary constraints and priorities, increases in real estate and other taxes, costs of complying with government regulations or increased regulation and other factors) and the national, California and Texas office space market (such as oversupply of or reduced demand for office space). In addition, the State of California continues to address issues related to budget deficits, shortages of electricity, interruptions in power service, increased energy costs, and the continued solvency of its utility companies, any or all of which may create the perception that the State is not able to effectively manage itself, in turn reducing demand for office space in California. The State of California is also generally regarded as more litigious and more highly regulated and taxed than many states, which may reduce demand for office space in California. Any adverse economic or real estate developments in California and Texas, or any decrease in demand for office space resulting from California’s regulatory environment, business climate or energy or fiscal problems, could adversely impact our financial condition, results of operations, cash flow, and our ability to satisfy our debt service obligations and to pay liquidating distributions to our stockholders. We cannot assure the continued growth of the California and Texas economies or the national economy or our future growth rate.
Losses for which we either could not or did not obtain insurance will adversely affect our earnings and we may be unable to comply with insurance requirements contained in mortgage or other agreements due to high insurance costs.
We endeavor to maintain comprehensive insurance on each of the properties we own, including liability and fire and extended coverage, in amounts sufficient to permit the replacement of the properties in the event of a total loss, subject to applicable deductibles. However, we could still suffer a loss due to the cost to repair any damage to properties that are not insured or are underinsured. There are types of losses, generally of a catastrophic nature, such as losses due to terrorism, wars, earthquakes, floods or acts of God that are either uninsurable or not economically insurable. If such a catastrophic event were to occur, or cause the destruction of one or more of our properties, we could lose both our invested capital and anticipated profits from such property or properties. Additionally, we could default under debt or other agreements if the cost and/or availability of certain types of insurance make it impractical or impossible to comply with covenants relating to the insurance we are required to maintain under such agreements. In such instances, we may be required to self-insure against certain losses or seek other forms of financial assurance. Additionally, inflation, changes in building codes and ordinances, environmental considerations, and other factors also might make it infeasible to use insurance proceeds to replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds received by us might not be adequate to restore our economic position with respect to the affected property.
Our co-ownership arrangements with affiliated entities may not reflect solely our stockholders’ best interests and may subject these investments to increased risks.
We have acquired our interests in the Congress Center, Western Place I & II, One Financial Plaza and Bay View Plaza properties through co-ownership arrangements with other entities managed or advised by our Advisor and its affiliates. These acquisitions were financed, in part, by loans under which we are jointly and severally liable for the entire loan amount along with the other co-owners. The terms of these co-ownership arrangements may be more favorable to the co-owner than to our stockholders. In addition, investing in properties through co-ownership arrangements subjects that investment to risks not present in a wholly-owned property, including, among others, the following:
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the risk that the co-owner(s) in the investment might become bankrupt;
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the risk that the co-owner(s) may at any time have economic or business interests or goals which are inconsistent with our business interests or goals;
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the risk that the co-owner(s) may be unable to make required payments on loans under which we are jointly and severally liable; or
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the risk that the co-owner(s) may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives, such as selling a property at a time when it would have adverse consequences to us.
Actions by co-owner(s) might have the result of subjecting the applicable property to liabilities in excess of those otherwise contemplated and may have the effect of reducing our cash available for distribution to our stockholders. It also may be difficult for us to sell our interest in any co-ownership arrangement at the time we deem best for our stockholders.
There is currently no public market for our common stock. Therefore, it will likely be difficult for our stockholders to sell their shares and, if our stockholders are able to sell their shares in a fully liquid manner, our stockholders may elect to do so at a substantial discount from the price they paid for these matters.
There currently is no public market for our common stock. Additionally, our charter contains restrictions on the ownership and transfer of our stock, and these restrictions may inhibit our stockholders’ ability to sell their common stock. It may be difficult for our stockholders to sell their shares promptly or at all. If our stockholders are able to sell their common stock, they may only be able to do so at a substantial discount from the price they paid.
Our success will be dependent on the performance of our Advisor as well as key employees of our Advisor.
We are managed by our Advisor, subject to the oversight of our board of directors. Thus, our ability to achieve our investment objectives and to pay distributions is dependent upon the performance of our Advisor and its key employees in finding purchasers for our assets, the discovery and acquisition of investments, the selection of tenants, the determination of any financing arrangements, the management of our assets and operation of our day-to-day activities. We rely on the management ability of our Advisor and the oversight of our board of directors as well as the management of any entities or ventures in which we co-invest. If our Advisor suffers or is distracted by adverse financial or operational problems in connection with its operations unrelated to us, our Advisor’s ability to allocate time and/or resources to our operations may be adversely affected. If our Advisor is unable to allocate sufficient resources to oversee and perform our operations for any reason, our results of operations would be adversely impacted.
Our use of borrowings to partially fund improvements on properties could result in foreclosures and unexpected debt service expenses upon refinancing, both of which could have an adverse impact on our operations and cash flow. Additionally, restrictive covenants in our loan documents may restrict our operating or acquisition activities.
We rely on borrowings to partially fund the costs of capital expenditures and other items. As of December 31, 2006, we had $335,318,000 of debt outstanding related to properties in which we have interests, which includes our consolidated and unconsolidated properties. Based upon our interest in such properties, our aggregate debt approximates $255,028,000 (on a liquidation basis) as of December 31, 2006. Accordingly, we are subject to the risks normally associated with debt financing, including, without limitation, the risk that our cash flow may not be sufficient to cover required debt service payments. There is also a risk that, if necessary, existing indebtedness will not be able to be refinanced or that the terms of such refinancing will not be as favorable as the terms of the existing indebtedness.
In addition, if we cannot meet our required mortgage payment obligations, the property or properties subject to such mortgage indebtedness could be foreclosed upon by, or otherwise transferred to, our lender, with a consequent loss of income and asset value to us. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but we may not receive any cash proceeds.
The mortgages on our properties contain customary restrictive covenants such as satisfaction of certain total debt-to-asset ratios, secured debt-to-total-asset ratios, and debt service coverage ratios. The mortgages also include provisions that may limit the borrowing subsidiary’s ability, without the prior consent of the lender, to incur additional indebtedness, further mortgage or transfer the applicable property, discontinue insurance coverage, change the conduct of its business or make loans or advances to, enter into any transaction of merger or consolidation with, or acquire the business, assets or equity of, any third party. In addition, any future lines of credit or loans may contain financial covenants, further restrictive covenants and other obligations.
If we materially breach such covenants or obligations in our debt agreements, the lender may, including, without limitation, seize our income from the property securing the loan or legally declare a default on the loan obligation, require us to repay the debt immediately and foreclose on the property securing the loan. If we were to breach such covenants or obligations, we may then have to sell properties either at a loss or at a time that prevents us from achieving a higher price. Any failure to pay our indebtedness when due or failure to cure events of default could result in higher interest rates during the period of the loan default and could ultimately result in the loss of properties through foreclosure. Additionally, if the lender were to seize our income from the property securing the loan, we would no longer have any discretion over the use of the income, which may adversely impact our ability to fund our liquidating distribution and, thus may cause us to fail to satisfy the REIT distribution requirements.
The pending SEC investigation of our Advisor could result in defaults or alleged defaults under our loan documents or limit our ability to obtain debt financing in the future.
We rely on debt financing for meeting capital expenditure obligations, among other things. The SEC investigation of our Advisor described above, or any related other enforcement action by government authorities against our Advisor or us, could result in defaults or alleged defaults under our existing Credit Facility or loan agreements or could make it more difficult for us to obtain new debt financing or prevent us from satisfying customary debt covenants or conditions required by existing loan documents, including conditions for additional advances.
The real estate we purchased may not appreciate or may decrease in value.
The commercial real estate market is currently experiencing a substantial influx of capital from investors. This substantial flow of capital, combined with significant competition for real estate, may result in inflated purchase prices for such assets. To the extent we purchased real estate in such an environment, we are subject to the risk that if the real estate market ceases to attract the same level of capital investment in the future as it is currently attracting, or if the number of companies seeking to acquire such assets decreases, our returns will be lower and the value of our assets may not appreciate or may decrease significantly below the amount we paid for such assets.
Because some of our principal tenants are U.S. government and state agencies, our properties may have a higher risk of terrorist attack than similar properties leased to non-governmental tenants.
Because some of our principal tenants are U.S. government and state agencies, our properties may have a higher risk of terrorist attack than similar properties that are leased to non-government tenants. Some of our properties could be considered “high profile” targets because of the particular government tenant (e.g., the FBI). Certain losses resulting from terrorist attacks may be uninsurable. Additional terrorism insurance may not be available at a reasonable price or at all.
We depend on the U.S. government for a significant portion of our revenues. Any failure by the U.S. government to perform its obligations or renew its leases upon expiration may harm our cash flow and ability to pay liquidating distributions.
Rent from our government tenants represented 39.1% of our revenues from consolidated properties for the year ended December 31, 2006. In addition, our government tenants leased 37.0% of our total leased square
feet of properties as of December 31, 2006. Any default by the U.S. government, or its failure to renew its leases with us upon their expiration, could cause interruptions in the receipt of lease revenue or result in vacancies, or both, which would reduce our revenues and could decrease the ultimate value of the affected property upon sale. Further, failure on the part of a tenant to comply with the terms of a lease may cause us to find another tenant. We cannot assure our stockholders that we would be able to find another tenant without incurring substantial costs, or at all, or that, if another tenant were found, we would be able to enter into a new lease on favorable terms.
An increase in the operating costs of our government-leased properties would harm our cash flow and ability to pay liquidating distributions.
Leased properties in which the tenant is wholly responsible for any increases in operating costs that apply to the property are not typical of the leases entered into through the General Services Administration, or GSA, the principal leasing agency of the federal government. Under present practice, most GSA leases only cover increases in real estate taxes above a base amount and these GSA leases also increase that portion of the rent applicable to other operating expenses by an agreed upon percentage based upon the Consumer Price Index. Typically, operating expenses in these leases do not include insurance cost. To the extent operating costs other than real estate taxes and insurance increase at a rate greater than the specified percentage, our cash flow would be harmed and our ability to pay liquidating distributions to our stockholders may be harmed.
Since our cash flow is not assured, we may not pay distributions in the future.
Our ability to pay distributions, including liquidating distributions to our stockholders, may be adversely affected by the risks described herein. We cannot assure our stockholders that we will be able to pay distributions in the future at the same level or at all. We also cannot assure our stockholders that the level of our distributions will increase over time or the receipt of income from additional property acquisitions will necessarily increase our cash available for distribution to our stockholders.
Our board of directors may alter our investment policies at any time without stockholder approval.
Our board of directors may alter our investment policies at any time without stockholder approval. Changes to these policies may adversely affect our financial performance and our ability to maintain or pay liquidating distributions to our stockholders.
Our Advisor’s past performance is not a predictor of our future results.
Neither the performance of our Advisor in managing us, nor its performance with entities similar to ours shall imply or predict (directly or indirectly) any level of our future performance or the future performance of our Advisor. Our Advisor’s performance and our performance is dependent on future events and is, therefore, inherently uncertain. Past performance cannot be relied upon to predict future events for a variety of factors, including, without limitation, varying business strategies, different local and national economic circumstances, different supply and demand characteristics relevant to buyers and sellers of assets, varying degrees of competition and varying circumstances pertaining to the capital markets.
Certain provisions of Maryland law and our charter and bylaws could hinder, delay or prevent a change in control.
Certain provisions of Maryland law and our charter and bylaws could have the effect of discouraging, delaying or preventing transactions that involve an actual or threatened change in control of us, and may have the effect of entrenching our management and members of our board of directors, regardless of performance.
The conflicts of interest of our Advisor’s officers with us means we may not be managed by our Advisor solely in the best interests of our stockholders.
Our Advisor’s officers have conflicts of interest relating to the management of our business and properties. Accordingly, those parties may make decisions or take actions based on factors other than in the
sole best interest of our stockholders. Our Advisor also advises T REIT, Inc., NNN 2002 Value Fund, LLC, NNN 2003 Value Fund, LLC, NNN Apartment REIT, Inc. and NNN Healthcare/Office REIT, Inc. and other private TIC programs and other programs that may compete with us or otherwise have similar business interests and/or investment objectives. Some of our Advisor’s executives also serve as officers and directors of T REIT, Inc., NNN 2002 Value Fund, LLC, NNN 2003 Value Fund, LLC, NNN Apartment REIT, Inc. and NNN Healthcare/Office REIT, Inc. Mr. Thompson, our Chairman of the board of directors, our executive officers and executive officers of our Advisor collectively own approximately 35.0% of NNN Realty Advisors. As officers, directors, and partial owners of entities that do business with us or that have interests in competition with our own interests, these individuals will experience conflicts between their fiduciary obligations to us and their fiduciary obligations to, and pecuniary interests in, our Advisor and its affiliated entities. These conflicts of interest could:
•
limit the time and services that our Advisor devotes to us, because it will be providing similar services to T REIT, Inc., NNN 2002 Value Fund, LLC, NNN 2003 Value Fund, LLC, NNN Apartment REIT, Inc., NNN Healthcare/Office REIT, Inc. and other real estate programs and properties;
•
impair our ability to compete for tenants in geographic areas where other properties are advised by our Advisor and its affiliates; and
•
impair our ability to compete for the disposition of properties with other real estate entities that are also advised by our Advisor and its affiliates and seeking to dispose of properties at or about the same time as us.
If our Advisor or its affiliates breach their fiduciary obligations to us, we may not meet our investment objectives, which could reduce the expected cash available for distribution to our stockholders.
The absence of arm’s length bargaining may mean that our agreements are not as favorable to our stockholders as these agreements otherwise would have been.
Any existing or future agreements between us and our Advisor, Realty or their affiliates were not and will not be reached through arm’s length negotiations. Thus, such agreements may not solely reflect our stockholders’ interests. For example, the Advisory Agreement was not the result of arm’s length negotiations. As a result, this agreement may be relatively more favorable to our Advisor than to us.
If we fail to qualify as a REIT, our stockholders could be adversely affected.
We have elected to be taxed as a REIT. To maintain REIT status, we must satisfy a number of highly technical requirements on a continuing basis. Those requirements seek to ensure, among other things, the following:
•
that the gross income and investments of a REIT are largely real estate related, including mortgages secured by real estate;
•
that a REIT distributes substantially all its ordinary taxable income to its stockholders on a current basis; and
•
that the REIT’s equity ownership is not overly concentrated.
Due to the complex nature of these rules, the available guidance concerning interpretation of the rules, the importance of ongoing factual determinations and the possibility of adverse changes in the law, administrative interpretations of the law and changes in our business, no assurance can be given that we will qualify as a REIT for any particular year.
If we fail to qualify as a REIT, we will be taxed as a regular corporation, and distributions to our stockholders will not be deductible in computing our taxable income. The resulting corporate income tax liabilities could materially reduce the distributable cash flow to our stockholders and funds available for reinvestment. Moreover, we might not be able to elect to be treated as a REIT for the next four taxable years after the year during which we ceased to qualify as a REIT. In addition, if we later requalified as a REIT, we
might be required to pay a full corporate-level tax on any unrealized gains in our assets as of the date of requalification and to make distributions to our stockholders equal to any earnings accumulated during the period of non-REIT status. Subject to the plan of liquidation, if we do not maintain our status as a REIT, we will not be required to make distributions to our stockholders in accordance with the REIT provisions of the Code.
We may not be able to meet, or we may need to incur borrowings that would otherwise not be incurred to meet, REIT minimum distribution requirements.
In order to qualify and maintain our qualification as a REIT, we are required to distribute to our stockholders at least 90.0% of our annual ordinary taxable income. In addition, the Code will subject us to a 4.0% nondeductible excise tax on the amount, if any, by which certain distributions paid by us with respect to any calendar year are less than the sum of (i) 85.0% of our ordinary income for that year, (ii) 95.0% of our capital gain net income for that year, and (iii) 100.0% of our undistributed taxable income from prior years.
We expect our income, if any, to consist almost solely of our portion of the Operating Partnership’s income, and the cash available for the payment of distributions by us to our stockholders will consist of our portion of cash distributions made by the Operating Partnership. As the general partner of the Operating Partnership, we will determine the amount of any distributions made by the Operating Partnership. However, we must consider a number of factors in making such distributions, including:
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the amount of the cash available for distribution;
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the impact of such distribution on other partners of the Operating Partnership;
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the Operating Partnership’s financial condition;
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the Operating Partnership’s capital expenditure requirements and reserves therefore; and
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the annual distribution requirements contained in the Code necessary to qualify and maintain our qualification as a REIT.
Differences in timing between the actual receipt of income and actual payment of deductible expenses and the inclusion of such income and deduction of such expenses when determining our taxable income, as well as the effect of nondeductible capital expenditures, the creation of reserves or required debt amortization payments, could result in our having taxable income that exceeds cash available for distribution to our stockholders.
In view of the foregoing, we may be unable to meet the REIT minimum distribution requirements and/or avoid the 4.0% excise tax described above. In certain cases, we may decide to borrow funds in order to meet the REIT minimum distribution and/or avoid the 4.0% excise tax even if our management believes that the then prevailing market conditions generally are not favorable for such borrowings or that such borrowings would not be advisable in the absence of such tax considerations.
We may be harmed by changes in laws, including tax laws applicable to REITs, or the reduced 15.0% tax rate on certain corporate dividends.
Changes to the laws and regulations affecting us, including changes to securities laws and changes to the Code applicable to the taxation of REITs may harm our business. New legislation may be enacted into law or new interpretations, rulings or regulations could be adopted, any of which could harm us and our stockholders, potentially with retroactive effect.
Generally, distributions paid by REITs are not eligible for the 15.0% U.S. federal income tax rate on certain corporate dividends, with certain exceptions. The more favorable treatment of regular corporate dividends could cause domestic non-corporate investors to consider stocks of other corporations that pay dividends as more attractive relative to stocks of REITs. It is not possible to predict whether the reduced 15.0% tax rate on certain corporate dividends will affect the value of our common stock or what the effect will be.
Dramatic increases in insurance rates could adversely affect our cash flow and our ability to make liquidating distributions to our stockholders pursuant to our plan of liquidation.
Due to recent natural disasters resulting in massive property destruction, prices for insurance coverage have been increasing dramatically. We cannot assure that we will be able to renew our insurance premiums at our current or reasonable rates or the amount of the potential increase of such premiums. As a result, our cash flow could be adversely impacted by increased premiums. In addition, the sales prices of our properties may be affected by these rising costs and adversely affect our ability to make liquidating distributions to our stockholders pursuant to our plan of liquidation.
Item 2.
Item 2.
Properties.
As of December 31, 2006, we owned 14 consolidated office properties located in seven states with an aggregate GLA of 3.0 million square feet. We also owned an interest in one unconsolidated office property located in Illinois with an aggregate GLA of 525,000 square feet. As of December 31, 2006, 32.4% of the aggregate GLA of our consolidated properties was leased to government-oriented tenants.
The following table presents certain additional information about our consolidated properties as of December 31, 2006:
(1)
Annualized rental income is based on contractual base rent from leases in effect as of December 31, 2006.
(2)
As of December 31, 2006, approximately 87.5% of the total GLA in our consolidated properties was leased.
(3)
Average annual rent per occupied square foot as of December 31, 2006.
The following information generally applies to the properties:
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we believe all of our properties are adequately covered by insurance and are suitable for their intended purposes;
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we have no plans for any material renovations, improvements or development of our properties, except in accordance with planned budgets;
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our properties are located in markets where we are subject to competition in attracting new tenants and retaining current tenants; and
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prior to the adoption of our plan of liquidation, depreciation was provided on a straight-line basis over the estimated useful lives of the buildings, ranging primarily from 15 to 39 years and over the shorter of the lease term or useful lives of the tenant improvements. Properties cease to be depreciated under the liquidation basis of accounting.
G REIT, Inc.
The following is a summary of our organizational structure and the properties we own and hold interests in as of December 31, 2006:
The following is a summary of our ownership information for the properties in which we own less than a 100.0% interest:
Congress Center Ownership
The following is a summary of our relationships with entities with ownership interests in Congress Center as of December 31, 2006:
Bay View Plaza Ownership
The following is a summary of our relationships with entities with ownership interests in Bay View Plaza as of December 31, 2006:
Western Place I & II Ownership
The following is a summary of our relationships with entities with ownership interests in Western Place I & II as of December 31, 2006:
One Financial Plaza Ownership
The following is a summary of our relationships with entities with ownership interests in One Financial Plaza as of December 31, 2006:
Lease Expiration Table
The following table presents the sensitivity of our annual base rent due to lease expirations for the next 10 years at our consolidated properties as of December 31, 2006, by number, square feet, percentage of leased area and annual base rent.
(1)
The annual rent percentage is based on the total annual base rent as of December 31, 2006, which, in addition to leases with scheduled expirations as included in this table, include certain tenants that have leases extended on a monthly basis.
Concentration of Tenants
The following table sets forth information as to the ten largest tenants at our consolidated properties as of December 31, 2006, based upon aggregate annual rental income.
(*)
Government entity or government contractor.
Geographic Diversification; Concentration Table
The following table lists, in alphabetical order, the states in which our consolidated properties are located and provides certain information regarding our portfolio’s geographic diversification/concentration as of December 31, 2006.
Indebtedness
As of December 31, 2006, we had secured mortgage loans outstanding on 11 of our consolidated properties, representing aggregate indebtedness in the principal amount of $238,010,000 ($225,836,000 on a
liquidation basis) consisting of $196,321,000 on a liquidation basis, or 86.9%, of fixed rate debt at a weighted-average interest rate of 5.32% per annum and $29,515,000 on a liquidation basis, or 13.1%, variable rate debt at a weighted-average interest rate of 7.86% per annum. As of December 31, 2006, we did not have any advances outstanding under our Credit Facility. See Item 7: “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Notes 9 - “Mortgage Loans Payable” and 10 - “Credit Facility and Other Debt” to the consolidated financial statements included with this report.
Item 3.
Item 3.
Legal Proceedings.
SEC Investigation
On September 16, 2004, our Advisor advised us that it learned that the SEC is conducting an investigation referred to as “In the matter of Triple Net Properties, LLC.” The SEC has requested information from our Advisor relating to disclosure in public and private securities offerings sponsored by our Advisor and its affiliates, or the Triple Net securities offerings (including offerings by us). The SEC has requested financial and other information regarding the Triple Net securities offerings and the disclosures included in the related offering documents.
Our Advisor is engaged in settlement negotiations with the SEC staff regarding this matter. Based on these negotiations, our Advisor believes that the conclusion to this matter will not result in a material adverse affect to its results of operations, financial condition or ability to conduct our business. The settlement negotiations are continuing, and any settlement negotiated with the SEC staff must be approved by the Commission. Since the matter is not concluded, it remains subject to the risk that the SEC may seek additional remedies, including substantial fines and injunctive relief against our Advisor that, if obtained, could materially adversely affect our Advisor’s ability to perform its duties to us and/or delay the payment of liquidating distributions to our stockholders under our plan of liquidation. The matters that are the subject of this investigation could also give rise to claims against our Advisor by investors in its existing real estate investment programs which could adversely affect our Advisor’s performance to us. At this time, we cannot assess how or when the outcome of the matter will be ultimately determined and its impact on us. Therefore, at this time, we have not accrued any loss contingencies in accordance with Statement of Financial Accounting Standards, or SFAS, No. 5.
Prior Performance Tables
In connection with our initial and second public offerings of common stock conducted through “best efforts” offerings from July 22, 2002 through April 30, 2004, we disclosed the prior performance of all public and private investment programs sponsored by our Advisor. Our Advisor determined that there were certain errors in those prior performance tables. In particular, the financial information in the tables was stated to be presented on a GAAP basis. Generally the tables for the public programs were not presented on a GAAP basis and the tables for the private programs were prepared and presented on a tax or cash accounting basis. Moreover, a number of the prior performance data figures were themselves erroneous, even as presented on a tax or cash basis. In particular, certain programs sponsored by our Advisor have invested either along side or in other programs sponsored by our Advisor. The nature and results of these investments were not fully and accurately disclosed in the tables. In addition, for the private programs certain calculations of depreciation and amortization were not on an income tax basis for limited liability company investments; certain operating expenses were not reflected in the operating results; and monthly mortgage and principal payments were not reported. In general, the resulting effect is an overstatement of our Advisor’s program and aggregate portfolio operating results.
Litigation
To our knowledge, there are no material pending legal proceedings, other than routine litigation incidental to our business to which we are a party or of which certain of our properties are subject.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth quarter of 2006.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
During the period covered by this report, there was no established public trading market for our shares of common stock. Effective July 22, 2002, we adopted a share repurchase plan, or Repurchase Plan, which provided eligible stockholders with limited liquidity by enabling them to request the repurchase of their common stock by us subject to various limitations. Repurchases were made at the sole discretion of our board of directors. The price paid by us per repurchased share of common stock varies in accordance with the terms of the Repurchase Plan. A total of 46,000 shares of our common stock were repurchased under the terms of the Repurchase Plan, which was terminated on April 30, 2004.
Stockholders
As of March 20, 2007, we had 14,000 stockholders of record.
Distributions
During the years ended December 31, 2006 and 2005, we paid monthly cash distributions to the holders of our common stock at an annual rate of $0.750 per share (7.50% based on a $10.00 purchase price through October 2006 and a $6.10 per share value remaining subsequent to October 2006). The declaration of distributions was at the discretion of our board of directors who determined the amount of distributions on a regular basis. On October 11, 2006, we paid a special liquidating distribution to our stockholders of $171,289,000, or $3.90 per share, to our stockholders of record as of September 30, 2006. While the plan of liquidation provided that monthly liquidating distributions would terminate following the payment of liquidating distributions to our stockholders totaling $150,000,000, our board of directors has decided to continue the payment of monthly liquidating distributions at an annualized rate of 7.50% on the remaining share value of $6.10. Our board of directors will continue to evaluate the payment of regular monthly liquidating distributions to our stockholders on an on-going basis as more properties are sold and additional special liquidating distributions are paid to stockholders. Every payment of distributions will be subject to the availability of cash and the discretion of our board of directors. For the years ended December 31, 2006 and 2005, we paid distributions of $201,017,000 and $32,888,000, respectively.
Additionally, we are required to distribute 90.0% of our REIT taxable income (excluding capital gains) on an annual basis in order to qualify as a REIT for federal income tax purposes. We have historically distributed amounts in excess of our taxable income resulting in a return of capital to our stockholders. We anticipate that we will continue to satisfy the requirements necessary to qualify as a REIT throughout the period of our liquidation process and make distributions sufficient to ensure that we will not be required to pay federal income tax. However, in view of the changes in the nature of our assets and our sources of income throughout the period of our liquidation process, and the need to retain assets to meet liabilities, we face the risk that we may not continue to qualify as a REIT and thus might be required to pay federal income tax. While we believe that this is unlikely, if we are unable to retain our status as a REIT or we become subject to federal income tax during the period of our liquidation process, the amount available for distribution to our stockholders would be reduced. Amounts accumulated for distribution to our stockholders are invested primarily in interest-bearing accounts and short-term interest-bearing securities, which are consistent with our intention to maintain our qualification as a REIT. Such investments may include, for example, investments in marketable equity securities, certificates of deposit and interest-bearing bank deposits.
Equity Compensation Plan Information
In accordance with the adoption of our plan of liquidation by our stockholders on February 27, 2006, all outstanding options under our equity compensation plans were forfeited and the plans were terminated.
Item 6.
Item 6.
Selected Financial Data.
The following sets forth our selected consolidated financial and operating information on a historical basis. The following should be read with the sections titled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto. Our historical results are not necessarily indicative of results for any future period.
SELECTED FINANCIAL DATA
G REIT, INC.
(a Maryland corporation)
(1)
The above selected financial data should be read in conjunction with the historical consolidated financial statements and related notes appearing elsewhere in this report.
(2)
The net assets in liquidation as of December 31, 2006 and 2005 of $288,739,000 and $453,459,000, respectively, plus the liquidating distributions to our stockholders through December 31, 2006 and 2005 of approximately $192,782,000 and $0, respectively, would result in liquidating distributions to our stockholders per share of approximately $10.96 and $10.34 as of December 31, 2006 and 2005, respectively.
(3)
Net income (loss) and distributions per share are based upon the weighted-average number of shares of common stock outstanding. Distributions by us of the current and accumulated earnings and profits for federal income tax purposes are taxable to our stockholders as ordinary income. Distributions in excess of these earnings and profits generally are treated as a non-taxable reduction of our stockholder’s basis in the shares of common stock to the extent thereof (a return of capital for tax purposes), and thereafter as taxable gain. These distributions in excess of earnings and profits will have the effect of deferring taxation of the distributions until the sale of the stockholder’s shares. For the years ended December 31, 2006, 2005, 2004, 2003 and 2002, 1.3%, 53.5%, 51.6%, 53.6% and 34.7%, respectively, represented a return of
capital for tax purposes. In order to maintain our qualification as a REIT, we must make annual distributions to our stockholders of at least 90.0% of our REIT taxable income. REIT taxable income does not include net capital gains. Under certain circumstances, we may be required to make distributions in excess of cash available for distribution in order to meet the REIT distribution requirements. Distributions are determined by our board of directors and are dependent on a number of factors, including the amount of funds available for distribution, our financial condition, any decision by our board of directors to reinvest funds rather than to distribute funds, our capital expenditures, the annual distribution required to maintain REIT status under the Code and other factors our board of directors may deem relevant.
(4)
Prior to the adoption of our plan of liquidation, one of our objectives was to provide cash distributions to our stockholders from cash generated from operations. We consider Funds From Operations, or FFO, to be an appropriate supplemental measure of a REIT’s operating performance as it is based on a net income analysis of property portfolio performance that excludes non-cash items such as depreciation. We compute FFO in accordance with the White Paper on FFO approved by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, as revised in February 2004. The White Paper defines FFO as net income or loss computed in accordance with GAAP excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, but including real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships and joint ventures. Other REITs may use different methodologies for calculating FFO and, accordingly, our FFO calculations may not be comparable to other REITs.
Because FFO excludes depreciation and amortization, gains and losses from property dispositions and extraordinary items, it provides a performance measure that, when compared year over year, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses and interest costs, providing a perspective not immediately apparent from net income. In addition, we believe FFO provides useful information to the investment community about our financial performance when compared to other REITs since FFO is generally recognized as the industry standard for reporting the operations of REITs.
However, FFO should not be viewed as an alternative measure of our operating performance since it does not reflect either depreciation and amortization costs or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, which are significant economic costs and could materially impact our results of operations.
Non-cash adjustments to arrive at FFO consisted of adjustments for, depreciation and amortization and net gain (loss) from the sale of real estate and a joint venture. For additional information, see “Funds from Operations,” which includes a reconciliation of our GAAP net income available to our stockholders to FFO for the years ended December 31, 2005 and 2004.
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 Item 6: “Selected Financial Data” and our consolidated financial statements and notes appearing elsewhere in this report.
Forward-Looking Statements
Historical results and trends should not be taken as indicative of future operations. Our statements contained in this report that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results may differ materially from those included in the forward-looking statements. We intend those forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of us, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “prospects,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions generally and the real estate market specifically; legislative/regulatory changes (including changes to laws governing the taxation of real estate investment trusts, or REITs); availability of capital; interest rates; our ability to service our debt, competition; supply and demand for operating properties in our current market areas; the prospect of a continuing relationship with our Advisor (as defined below); generally accepted accounting principles, or GAAP, and policies and guidelines applicable to REITs; predictions of the amount of liquidating distributions to be received by stockholder; statements regarding the timing of asset dispositions and the sales price we will receive for assets; the effect of the liquidation; and litigation, including, without limitation, the investigation by the Securities and Exchange Commission, or the SEC, of our Advisor. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning us and our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.
Overview and Background
We were incorporated on December 18, 2001 under the laws of the Commonwealth of Virginia. On September 27, 2004, we were reincorporated in the State of Maryland in accordance with the approval of our stockholders at the 2004 Annual Meeting of Stockholders. We have been operating and intend to continue operating as a real estate investment trust, or REIT, for federal and state income tax purposes. As a REIT, we are generally not subject to income taxes. To maintain our REIT status, we are required to distribute annually as distributions at least 90.0% of our REIT taxable income, as defined by the Internal Revenue Code of 1986, as amended, or the Code, to our stockholders, among other requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate tax rates. As of December 31, 2006, we believe we were in compliance with all relevant REIT requirements.
We were originally incorporated to acquire, manage and invest in office, industrial and service real estate properties with a government-tenant orientation. As described below, on February 27, 2006, our stockholders approved a plan of liquidation and eventual dissolution of our company. Accordingly, we are engaging in an ongoing liquidation of our assets. As of December 31, 2006, we own interests in 15 properties, aggregating a total gross leaseable area, or GLA, of 3.6 million square feet, including interests in 14 consolidated and one unconsolidated office property. As of December 31, 2006, 87.5% of gross leaseable area, or GLA, of the consolidated properties was leased and tenants with a government orientation occupied 32.4% of the total GLA.
We are externally advised by Triple Net Properties, LLC, or Triple Net Properties, or our Advisor, which manages us pursuant to the terms of an advisory agreement, or the Advisory Agreement. Our Advisor is primarily responsible for managing our day-to-day operations and assets, subject to the supervision of our
board of directors. The Advisory Agreement expired on July 22, 2005, and was not reviewed for consecutive one-year terms. The Advisory Agreement has not been renewed since its expiration, however, our Advisor continues to manage us on a month-to-month basis pursuant to the terms of the Advisory Agreement. In view of the approval of our plan of liquidation by our stockholders discussed below, we do not intend to renew the existing Advisory Agreement for a one year term or execute a new advisory agreement. Our Advisor engages affiliated entities, including Triple Net Properties Realty, Inc., or Realty, to provide various services for our properties.
In the fourth quarter of 2006, NNN Realty Advisors Inc., or NNN Realty Advisors, acquired all of the outstanding ownership interests of Triple Net Properties, NNN Capital Corp. and Realty. NNN Realty Advisors was formed in September 2006 and is a full-service commercial real estate asset management and services firm. Anthony W. Thompson, our Chairman of the board of directors, is the founder of our Advisor and the Chairman of the board of directors of NNN Realty Advisors and owns 25.9% of its outstanding common stock.
Business Strategy and Plan of Liquidation
As set forth in our original registration statement filed in 2002, we were formed with the intent to have our board of directors determine by July 1, 2008 whether our common stock should be listed on a national stock exchange, quoted on a quotation system of a national securities association or merged with an entity whose shares are so listed or quoted. At that time, we intended that if we were not so listed or quoted by 2012, we would submit for stockholders’ vote a proposal to liquidate. In February 2004, we began to evaluate the possibility of pursuing an underwritten offering and listing of our common stock on a national securities exchange, and on February 8, 2004, a special committee of our independent directors at that time was formed to evaluate this alternative. In late 2004 the special committee broadened the scope of its examination and began to generally examine the strategic alternatives reasonably available to us, including the alternative of liquidating all of our assets. We initiated this examination at this time, rather than waiting until 2008, because of the inherent uncertainty of the future and our view of: (i) the current market conditions; (ii) the current increasing costs of corporate compliance (including, without limitation, all federal, state and local regulatory requirements applicable to us, including the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act); (iii) the current possible need to reduce our monthly distributions; and (iv) the other factors discussed in more detail in our definitive proxy statement filed with the SEC on January 13, 2006.
To assist the special committee in its examination, we engaged Robert A. Stanger & Co., Inc., or Stanger, as our financial advisor to (i) assist in a review of the pros and cons of those alternatives, including a potential plan of liquidation and (ii) render opinions as to the fairness of the consideration to be received in any potential transactions. In December 2005, Stanger opined that our net real estate liquidation value range estimate and our estimated per share distribution range were reasonable from a financial point of view. Actual values realized for assets and settlement of liabilities may differ materially from the amounts estimated. On December 19, 2005, our board of directors approved a plan of liquidation which was thereafter approved by our stockholders at the Special Meeting of Stockholders held on February 27, 2006.
We continually evaluate our existing portfolio and adjust our net real estate liquidation value accordingly. It is our policy that when we execute a purchase and sale agreement or become aware of market conditions or other circumstances that indicate that the present value of our properties materially differ from our expected net sales price, we will adjust our liquidation value accordingly.
Our plan of liquidation gives our board of directors the power to sell any and all of our assets without further approval by our stockholders and provides that liquidating distributions be made to our stockholders as determined by our board of directors. Although we can provide no assurances, we currently expect to sell all of our assets and anticipate completing our plan of liquidation by February 27, 2008. Further, while we expect to continue to qualify as a REIT until our dissolution, no assurance can be given that we will not lose or terminate our status as a REIT. As a result of the approval of our plan of liquidation by our stockholders, we adopted the liquidation basis of accounting as of December 31, 2005 and for all periods subsequent to December 31, 2005.
In accordance with our plan of liquidation, we continue to actively manage our property portfolio to seek to achieve higher occupancy rates, control operating expenses and maximize income from ancillary operations and services. However, due to the adoption of our plan of liquidation, we will not acquire any new properties, and are focused on liquidating our properties.
Dispositions in 2006
Pursuant to the Advisory Agreement, our Advisor or its affiliate, is entitled to property disposition fees in connection with our disposition of properties. Certain disposition fees paid to Realty were passed through to our Advisor pursuant to the Realty-Triple Net Agreement.
600 B Street - San Diego, California
On July 18, 2006, we sold our 600 B Street property in San Diego, California, to Legacy Partners Realty Fund II, LLC, an unaffiliated third party, for a sales price of $95,500,000. Our cash proceeds were $91,730,000 after closing costs and other transaction expenses. A property disposition fee was paid to Realty of $1,433,000, or 1.5% of the sales price, and sales commissions to unaffiliated brokers of $573,000, or 0.6% of the sales price. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $755,000 as a result of the sale.
Hawthorne Plaza - San Francisco, California
On September 14, 2006, we sold our Hawthorne Plaza property in San Francisco, California, to TMG Partners, an unaffiliated third party, for a sales price of $125,000,000. Our cash proceeds were $68,261,000 after payment of the related mortgage loan, closing costs and other transaction expenses. A property disposition fee was paid to Realty of $1,875,000, or 1.5% of the sales price, and sales commissions to unaffiliated brokers of $750,000, or 0.6% of the sales price. The mortgage loan at the property of $51,719,000 was paid in full upon sale of the property. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $19,960,000 as a result of the sale.
AmberOaks - Austin, Texas
On September 29, 2006, we sold our AmberOaks property in Austin, Texas, to Chase Merritt, LP, an unaffiliated third party, for a sales price of $46,837,000. Our cash proceeds were $27,584,000 after payment of the related mortgage loan, closing costs and other transaction expenses. A property disposition fee was paid to Realty of $703,000, or 1.5% of the sales price, and sales commissions to unaffiliated brokers of $611,000, or 1.3% of the sales price. The mortgage loan at the property of $18,050,000 was paid in full upon sale of the property. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $5,268,000 as a result of the sale.
Brunswig Square - Los Angeles, California
On October 6, 2006, we sold our Brunswig Square property located in Los Angeles, California, to Jamison Properties Inc., an unaffiliated third party, for a sales price of $26,900,000. Our net cash proceeds were $9,639,000 after payment of the related mortgage loan, closing costs and other transaction expenses. A property disposition fee of $404,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $336,000, or 1.2% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $2,062,000 as a result of the sale.
Centerpoint Corporate Park - Kent, Washington
On October 17, 2006, we sold our Centerpoint Corporate Park property located in Kent, Washington, to Archon Acquisition, LLC, an unaffiliated third party, for a sales price of $77,525,000. Our net cash proceeds were $33,707,000 after payment of the related credit facility attributable to the Centerpoint Corporate Park
property, closing costs and other transaction expenses. A property disposition fee of $1,163,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $465,000, or 0.6% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $17,173,000 as a result of the sale.
Highway 290 - Austin, Texas
On November 14, 2006, we sold our 5508 Highway 290 property located in Austin, Texas, to The Commons at Cliff Creek LTD, an unaffiliated third party, for a sales price of $10,200,000. We paid $862,000 upon the disposition of the property to pay off the related credit facility and to pay closing costs and other transaction expenses. A property disposition fee of $150,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $450,000, or 4.4% of the sales price, was also paid to unaffiliated brokers. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $705,000 as a result of the sale.
Department of Children and Family Campus - Plantation, Florida
On November 15, 2006, we sold our Department of Children and Family Campus property located in Plantation, Florida, to tenant in common, or TIC, investors managed by our Advisor for a sales price of $13,000,000. Our net cash proceeds were $2,898,000 after pay-off of the related credit facility and the payment of closing costs and other transaction expenses. As compared to December 31, 2005, our net assets available in liquidation as the sales date increased by approximately $3,147,000 as a result of the sale.
Public Ledger Building - Philadelphia, Pennsylvania
On November 22, 2006, we sold our Public Ledger Building property located in Philadelphia, Pennsylvania, to J Grasso Properties, LLC, an unaffiliated third party for a sales price of $43,000,000. Our net cash proceeds were $13,933,000 after pay-off of the related mortgage loan and the payment of closing costs and other transaction expenses. A property disposition fee of $645,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $430,000, or 1.0% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $558,000 as a result of the sale.
Atrium Building - Lincoln, Nebraska
On December 15, 2006, we sold our Atrium Building property located in Lincoln, Nebraska, to Sequoia Investments XVIII, LLC, an unaffiliated third party for a sales price of $5,805,000. We paid $219,000 upon the disposition of the property to pay off the related mortgage loan and to pay closing costs and other transaction expenses. A property disposition fee of $87,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $174,000, or 3.0% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $480,000 as a result of the sale.
Gemini Plaza - Houston, Texas
On December 29, 2006, we sold our Gemini Plaza property located in Houston, Texas, to Manuchehr Khoshbin, an unaffiliated third party for a sales price of $17,000,000. Our net cash proceeds were $5,633,000 after pay-off of the related mortgage loan and the payment of closing costs and other transaction expenses. A property disposition fee of $255,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $251,000, or 1.5% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $2,437,000 as a result of the sale.
Dispositions in 2005
Pursuant to the Advisory Agreement, our Advisor or its affiliate, is entitled to property disposition fees in connection with our disposition of properties. Certain disposition fees paid to Realty were passed through to our Advisor pursuant to the Realty-Triple Net Agreement.
525 B Street - San Diego, California
On August 10, 2005, we sold the 525 B Street property located in San Diego, California to an unaffiliated third party, for a sales price of $116,000,000. In conjunction with the sale of the 525 B Street property, we paid off our existing cross-collateralized debt of $126,000,000 on the 525 B and 600 B Street properties. The sale resulted in us recording a gain of $10,550,000. A property disposition fee of $1,115,000, or 1.0% of the sales price, was paid to Realty and sales commissions of $862,000, or 0.7% of the sales price, was also paid to unaffiliated brokers.
Park Sahara - Las Vegas, Nevada
On December 20, 2005, the Park Sahara property in Las Vegas, Nevada, of which we own a 4.75% TIC interest, was sold to an unaffiliated third party for a total sales price of $17,455,000. We received net cash proceeds totaling approximately $273,000 after repayment of debt, closing costs and other transaction expenses. The sale resulted in us recording a net gain of approximately $132,000. A property disposition fee of $320,000, or approximately 1.8% of the total sales price, was paid to Realty and sales commissions of $639,000, or approximately 3.7% of the total sales price, was also paid to unaffiliated brokers.
Acquisitions in 2005
Pursuant to the Advisory Agreement, our Advisor or its affiliate, is entitled to property acquisition fees in connection with our acquisition of properties. Certain acquisition fees paid to Realty were passed through to our Advisor pursuant to the Realty-Triple Net Agreement.
We acquired the following properties during 2005 (for further discussion on these properties, see Note 6 - “Real Estate Investments”):
During the year ended December 31, 2005, we completed the acquisition of two wholly-owned properties, adding a total of 124,000 square feet of GLA to our property portfolio. The aggregate purchase price of the two consolidated properties was $17,764,000, of which $11,700,000 was financed with mortgage debt. Realty was paid $448,000 in real estate acquisition fees. In accordance with Statement of Financial Accounting Standards, or SFAS, No. 141, Business Combinations, we allocated the purchase price to the fair value of the assets acquired and the liabilities assumed, including the allocation of the intangibles associated with the in-place leases considering the following factors: lease origination costs; tenant relationships; and above or below market leases. During 2005, we have allocated and recorded $2,846,000 of intangible assets associated with in-place lease origination costs and tenant relationships, as well as above market leases. Such intangible assets are being amortized over the term of each of the underlying tenant leases ranging from 44 to 140 months. Total amortization of the lease intangible assets for 2005 was $109,000. On one of our acquisitions, we have recorded a lease intangible liability related to the acquired below market lease which aggregated $127,000 during 2005. The lease intangible liability is being amortized over the term of the underlying tenant lease of 56 months. Amortization of $5,000 was recorded for this lease intangible liability during 2005.
Acquisitions in 2004
Pursuant to the Advisory Agreement, our Advisor or its affiliate, is entitled to property acquisition fees in connection with our acquisition of properties. Certain acquisition fees paid to Realty were passed through to our Advisor pursuant to the Realty-Triple Net Agreement.
We acquired the following properties during 2004 (for further discussion on these properties, See Note 6 - “Real Estate Investments”):
During the year ended December 31, 2004, we completed the acquisition of ten wholly-owned properties and two TIC interests in two properties with TIC interests of 78.5% and 77.6%, adding a total of 3,798,000 square feet of GLA to our property portfolio. The aggregate purchase price was $536,755,000, of which $327,038,000 was financed with mortgage debt. We paid $13,315,000 in real estate acquisition fees to Realty in connection with these acquisitions. In accordance with SFAS No. 141, we allocated the purchase price to the fair value of the assets acquired and the liabilities assumed, including the allocation of the intangibles associated with the in-place leases considering the following factors: lease origination costs; tenant relationships; and above or below market leases. During 2004, we have allocated and recorded $93,192,000 of intangible assets associated with in-place lease origination costs and tenant relationships, as well as above market leases. Such intangible assets are being amortized over the term of each of the underlying tenant leases ranging from one to 107 months. Total amortization of the lease intangible assets for 2005 and 2004 was $14,775,000 and $14,132,000, respectively. On certain acquisitions, we have recorded lease intangible liabilities related to the acquired below market leases of $23,433,000 during 2004. The lease intangible liabilities are being amortized over the term of each of the underlying tenant leases ranging from two to 123 months. Amortization of $3,349,000 and $5,406,000 was recorded for these lease intangibles during 2005 and 2004, respectively.
Critical Accounting Policies
Use of Estimates
The preparation of financial statements in accordance with GAAP and under the liquidation basis of accounting requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets (including net assets in liquidation), liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We believe that our critical accounting policies are those that require significant judgments and estimates such as those related to revenue recognition, allowance for doubtful accounts, impairment of real estate and intangible assets, purchase price allocation, deferred assets and qualification as a REIT. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions
believed to be reasonable under the circumstances. Actual results could vary from those estimates, perhaps in material adverse ways, and those estimates could be different under different assumptions or conditions.
Liquidation Basis of Accounting
As a result of the approval of our plan of liquidation by our stockholders, we adopted the liquidation basis of accounting as of December 31, 2005, and for all periods subsequent to December 31, 2005. Accordingly, all assets were adjusted to their estimated fair value (on an undiscounted basis). Liabilities, including estimated costs associated with implementing our plan of liquidation, were adjusted to their estimated settlement amounts. Minority liabilities due to interests in properties held by tenants-in-common, or TICs, were offset against the respective properties. The valuation of real estate held for sale and investments in unconsolidated real estate is based on current contracts, estimates and other indications of sales value net of estimated selling costs. Actual values realized for assets and settlement of liabilities may differ materially from the amounts estimated. Estimated future cash flows from property operations were made based on the anticipated sales dates of the assets. Due to the uncertainty in the timing of the anticipated sales dates and the cash flows there from, operations may differ materially from amounts estimated. These amounts are presented in the accompanying statement of net assets included in the consolidated financial statements. The net assets represent the estimated liquidation value of our assets available to our stockholders upon liquidation. The actual settlement amounts realized for assets and settlement of liabilities may differ materially, perhaps in adverse ways, from the amounts estimated.
We continually evaluate our existing portfolio and adjust our net real estate liquidation value accordingly. It is our policy that when we execute a purchase and sale agreement or become aware of market conditions or other circumstances that indicate that the present value of our properties materially differ from our expected net sales price, we will adjust our liquidation value accordingly.
Asset (Liability) for Estimated Receipts ( Costs) in Excess of Estimated (Costs) Receipts During Liquidation
Under the liquidation basis of accounting, we are required to estimate the cash flows from operations and accrue the costs associated with implementing and completing our plan of liquidation. We currently estimate that we will have operating cash inflows from our estimated receipts in excess of the estimated costs of liquidation. These amounts can vary significantly due to, among other things, the timing and estimates for executing and renewing leases, along with the estimates of tenant improvements incurred and paid, the timing of the property sales, the timing and amounts associated with discharging known and contingent liabilities and the costs associated with winding up of our operations. These costs are estimated and are expected to be paid over the liquidation period. The change in the asset (liability) for estimated receipts (costs) in excess of estimated (costs) receipts during liquidation as of December 31, 2006 is as follows:
Accrued distributions to stockholders included in the liability for estimated costs in excess of estimated receipts during liquidation at December 31, 2005 included the estimated monthly liquidating distributions at an annualized rate of 7.50% expected to be paid pursuant to our plan of liquidation. The cash payments in distributions to stockholders include distributions paid of $8,235,000 for the first quarter of 2006. Subsequent to March 31, 2006, all distributions have been in the form of liquidating distributions to our stockholders and recorded when approved.
Net Assets in Liquidation
The following is a reconciliation of total stockholders’ equity under the going concern basis of accounting to net assets in liquidation under the liquidation basis of accounting as of December 31, 2005:
The net assets in liquidation as of December 31, 2006 of $288,739,000, plus the liquidating distributions to our stockholders through December 31, 2006 of approximately $192,782,000 would result in liquidating distributions to our stockholders per share of approximately $10.96. These estimates for liquidating distributions to our stockholders per share include projections of costs and expenses expected to be incurred during the period required to complete the plan of liquidation. These projections could change materially based on the timing of sales, the performance of the underlying assets and any changes in the underlying assumptions of the projected cash flows.
Properties Held for Sale
Prior to the adoption of our plan of liquidation, we accounted for our properties held for sale in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires that, in a period in which a component of an entity either has been disposed of or is classified as held for sale, the income statements for current and prior periods shall report the results of operations of the component as discontinued operations. Prior to the adoption of our plan of liquidation, we reclassified amounts related to the operating properties in the consolidated financial statements to reflect the reclassification required by SFAS No. 144.
Accordingly, revenues, operating costs and expenses, and other non-operating results for the discontinued operations of all consolidated properties have been excluded from our results from continuing operations for all periods presented herein. The financial results for all consolidated properties are presented in our consolidated statements of operations in a single line item entitled “Income (loss) from discontinued operations.”
Revenue Recognition and Allowance for Doubtful Accounts
Prior to the adoption of our plan of liquidation, we recognized base rental income on a straight-line basis over the terms of the respective lease agreements (including rent holidays). Differences between rental income recognized and amounts contractually due under the lease agreements were credited or charged, as applicable, to rent receivable. We maintained an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required payments under lease agreements. We also maintained an allowance for deferred rent receivables arising from the straight-lining of rents. We determined the adequacy of this allowance by continually evaluating individual tenant receivables considering the tenant’s financial condition,
security deposits, letters of credit, lease guarantees, if applicable, and current economic conditions. Tenant reimbursement revenue, which is comprised of additional amounts recoverable from tenants for common area maintenance expenses and certain other recoverable expenses, is recognized as revenue in the period in which the related expenses are incurred. Rental revenue is recorded on a contractual basis under the liquidation basis of accounting. In accordance with our plan of liquidation, as of December 31, 2006 and 2005, we adjusted tenant receivables and deferred rent receivable to their net realizable value.
Impairment
Prior to the adoption of our plan of liquidation, our properties were carried at the lower of historical cost less accumulated depreciation or fair value. We assessed the impairment of a real estate asset when events or changes in circumstances indicated that the net book value may not be recoverable. Indicators we considered important and which we believed could trigger an impairment review include the following:
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significant negative industry or economic trend;
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a significant underperformance relative to historical or projected future operating results; and
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a significant change in the manner in which the asset is used.
In the event that the carrying amount of a property exceeded the sum of the undiscounted cash flows (excluding interest) that were expected to result from the use and eventual disposition of the property, we would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value of the property. The estimate of expected future net cash flows was inherently uncertain and relied on subjective assumptions which were dependent upon future and current market conditions and events that affect the ultimate value of the property. It required us to make assumptions related to future rental rates, tenant allowances, operating expenditures, property taxes, capital improvements, occupancy levels, and the estimated proceeds generated from the future sale of the property. We did not record any impairment losses for the years ended December 31, 2005 and 2004.
As of December 31, 2005, the operating properties were adjusted to fair value, less estimated costs to sell, through the adjustments to reflect the change to the liquidation basis of accounting. Subsequent to December 31, 2005, all changes in the estimated fair value of the operating properties, less estimated costs to sell, are adjusted to fair value with a corresponding change to our net assets in liquidation.
Purchase Price Allocation
Prior to the adoption of our plan of liquidation, in accordance with SFAS No. 141, Business Combinations, we, with assistance from independent valuation specialists, allocated the purchase price of acquired properties to tangible and identified intangible assets based on their respective fair values. The allocation to tangible assets (building and land) was based upon our determination of the value of the property as if it were vacant using discounted cash flow models similar to those used by independent appraisers. Factors considered by us included an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. Additionally, the purchase price of the applicable property was allocated to the above or below market value of in-place leases and the value of in-place leases and related tenant relationships.
The value allocable to the above or below market component of the acquired in-place leases was determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term and (ii) our estimate of the amounts that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above market leases were included in the intangible assets and below market lease values were included in intangible liabilities in the accompanying consolidated financial statements and are amortized to rental income over the weighted-average remaining term of the acquired leases with each property.
The total amount of other intangible assets acquired was further allocated to in-place lease costs and the value of tenant relationships based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant. Characteristics considered by us in allocating these values included the nature and extent of the credit quality and expectations of lease renewals, among other factors.
These allocations were subject to change based on information received within one year of the purchase related to one or more events identified at the time of purchase which confirmed the value of an asset or liability received in an acquisition of property.
Deferred Assets
Prior to the adoption of our plan of liquidation, costs incurred for debt financing and property leasing were capitalized as deferred assets. Deferred financing costs included amounts paid to lenders and others to obtain financing. Such costs were amortized over the term of the related loan. Amortization of deferred financing costs was included in interest expense in the consolidated statements of operations. Deferred leasing costs included leasing commissions that were amortized using the straight-line method over the term of the related lease. Unamortized financing and leasing costs were charged to expense in the event of debt prepayment or early termination of the lease.
Qualification as a REIT
Since our taxable year ended December 31, 2002, we were organized and have operated, and intend to continue to operate, so as to qualify for taxation as a REIT under the Code. Our qualification and taxation as a REIT depends on our ability to meet, through actual annual operating results, asset diversification, distribution levels and diversity of stock ownership, numerous requirements established under highly technical and complex Code provisions subject to interpretation.
If we fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. Moreover, unless entitled to relief under specific statutory provisions, we also would be disqualified as a REIT for four taxable years following the year during which qualification was lost.
Factors Which May Influence Future Changes in Net Assets in Liquidation
Rental Income
The amount of rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space and space available from unscheduled lease terminations at the existing rental rates. Negative trends in one or more of these factors could adversely affect our rental income in future periods.
Scheduled Lease Expirations
As of December 31, 2006, our consolidated properties were 87.5% leased. 26.3% of the leased GLA expires during 2007. Our leasing strategy for 2007 and through our plan of liquidation focuses on negotiating renewals for leases scheduled to expire during the year and identifying new tenants or existing tenants seeking additional space to occupy the GLA for which we are unable to negotiate such renewals with the existing tenant. Of the leases expiring in 2007, we anticipate, but cannot assure, that approximately 53.1% of the tenants will renew for another term.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act, and related laws, regulations and standards relating to corporate governance and disclosure requirements applicable to public companies have increased the costs of compliance with corporate governance, reporting and disclosure practices which are now required of us. In addition, these laws, rules and regulations create new legal bases for administrative enforcement, civil and criminal proceedings against us in case of non-compliance, thereby increasing our risk of liability and potential sanctions. If we are unable to
complete our plan of liquidation by December 31, 2007, we expect that our efforts to comply with these laws and regulations will involve significant costs, and any failure on our part to comply could result in fees, fines, penalties or administrative remedies against us, which could reduce and/or delay the amount of liquidating distributions to our stockholders under our plan of liquidation.
Changes in Net Assets in Liquidation
For the Year Ended December 31, 2006
Net assets in liquidation decreased $164,720,000, or $3.75 per share, during the year ended December 31, 2006. The primary reasons for the decrease in our net assets includes: (i) a decrease in real estate investments of $418,779,000, or $9.54 per share; (ii) a decrease in restricted cash of $5,733,000, or $0.13 per share; (iii) a decrease in investment in marketable securities of $7,617,000, or $0.17 per share; and (iv) a decrease in the liability for estimated costs in excess of estimated receipts during liquidation of $4,560,000, or $0.10 per share, resulting in an asset for estimated receipts in excess of estimated costs during liquidation as offset by (v) an increase in cash and cash equivalents of $69,639,000, or $1.59 per share; (vi) a decrease in mortgage loans payable and credit facility and other debt of $185,530,000, or $4.22 per share; (vii) a decrease in accounts payable and accrued liabilities of $5,614,000, or $0.13 per share; and (viii) a decrease in security deposits and prepaid rent of $2,360,000, or $0.05 per share.
The overall decrease in the value of real estate assets during the year ended December 31, 2006 includes: (i) a decrease due to the sale of our 600 B Street, Hawthorne Plaza, AmberOaks, Brunswig Square, Centerpointe Corporate Park, 5508 Highway 290, Department of Children and Family Campus, Public Ledger Building, Atrium Building and Gemini Plaza properties during the year ended December 31, 2006; (ii) decreases in the anticipated sales prices of our One World Trade Center and One Financial Plaza properties pursuant to executed purchase and sale agreements; and (iii) a decrease in the expected liquidation values of certain other properties; as offset by (i) an increase as a result of the anticipated sale of our Two Corporate Park property which closed on January 11, 2007; (ii) an increase as a result of the anticipated sales price of our Opus Plaza at Ken Caryl property pursuant to an executed purchase and sale agreement and (iii) an increase in the expected liquidation value of certain other properties. The increase in cash and cash equivalents is primarily due to the proceeds received on the sale of our properties which closed in the fourth quarter of 2006. The decrease in restricted cash, accounts payable and accrued liabilities, security deposits and prepaid rent, mortgage loans payable and our credit facility is primarily due to the sale of our properties during the year ended December 31, 2006. The decrease in investment in marketable securities is due to the liquidation of our investments in marketable securities during the year ended December 31, 2006.
Results of Operations
The operating results are primarily comprised of income derived from our portfolio of properties. Because of the significant property acquisitions throughout the years ended December 31, 2005 and 2004, the comparability of financial data from period to period is limited.
Comparison of the year ended December 31, 2005 to the year ended December 31, 2004
General and Administrative Expenses
General and administrative expenses consist primarily of third party professional legal and accounting fees related to our SEC filing requirements. General and administrative expenses increased $1,587,000, or 66.0%, to $4,006,000 during the year ended December 31, 2005 compared to general and administrative expenses of $2,419,000 for the year ended December 31, 2004. The increases were attributable to an increase in fees for services rendered by the independent auditors, outside consultants and outside counsel in 2005.
Interest Expense
Interest expense increased $811,000, or 65.0%, to $2,054,000 during the year ended December 31, 2005 compared to interest expense of $1,243,000 for the year ended December 31, 2004. $599,000, or 74.0%, of the increases were due to the breakage of mortgage rate lock deposits in June 2005 and September 2005. $75,000, or 9.0%, of the increases were due to an increase in margin loan interest due to the margin borrowings on our Margin Securities Account with the Margin Lending Program at Merrill Lynch in 2005. Further contributing to the increase was the increase in loan fee amortization as a result of the increase in loan fees related to our credit facility, or Credit Facility, with LaSalle Bank National Association, or LaSalle, in April 2004.
Interest and Dividend Income
Interest and dividend income increased $363,000, or 109.0%, to $695,000 during the year ended December 31, 2005 compared to interest and dividend income of $332,000 for the year ended December 31, 2004. $200,000, or 55.0%, of the increase was attributable to the breakage of a rate lock deposit in August 2005. $52,000, or 14.0%, of the increase was due to interest income earned on the refinancing proceeds that
were held in an escrow account for two and a half months after the refinancing of one of our properties. $39,000, or 11.0%, of the increase was attributable to the interest income earned on the mortgage rate lock deposit in accordance with the terms of the rate lock agreement. $21,000, or 6.0%, of the increase was primarily attributable to the interest and dividend income earned on our investment in marketable equity securities. The remaining increase of $51,000, or 14.0%, is primarily attributable to higher cash balances in interest bearing accounts during the year ended December 31, 2005.
Gain on Sale of Marketable Securities, Unconsolidated Real Estate and Joint Venture
Gain on sale of marketable securities, unconsolidated real estate and joint venture of $572,000 for the year ended December 31, 2005 was due to the purchase and sale of the investments in our Merrill Lynch account of $440,000 and the gain on sale of Park Sahara of $132,000 in 2005. Gain on sale of marketable securities and joint venture of $1,231,000 for the year ended December 31, 2004 was due to the purchase and sale of the investment in the joint venture at G REIT-TRS, Inc. resulting in a gain of $980,000 and the gain on sale of marketable securities of $251,000.
Equity in Earnings (Losses) of Unconsolidated Real Estate
Equity in earnings (losses) of unconsolidated real estate increased by $1,941,000, or 321.0%, to earnings of $1,337,000 during the year ended December 31, 2005 compared to equity in (losses) of ($604,000) for the year ended December 31, 2004. The increase was due primarily to the decrease in depreciation and amortization expense resulting from the listing for sale of the Congress Center and Park Sahara properties on February 8, 2005 and April 11, 2005, respectively. In accordance with SFAS No. 144, depreciation was not recorded after the two properties were listed for sale. Park Sahara was sold on December 20, 2005.
Income Taxes
Income taxes decreased by $398,000, or 100.0%, to income taxes of $0 during the year ended December 31, 2005 compared to income taxes of $398,000 for the year ended December 31, 2004. Income taxes for the year ended December 31, 2004 consisted of the provision recorded as a result of the gain on sale of the joint venture at G REIT-TRS, Inc., a taxable REIT subsidiary, in July 2004.
Other Expense
Other expense during the year ended December 31, 2005 is comprised of $309,000 of defeasance costs associated with the refinancing of Sutter Square on November 18, 2005 offset by other income of $59,000 associated with property management and accounting fee reimbursements related to our investments in Congress Center and Park Sahara in 2005.
Loss From Continuing Operations
Loss from continuing operations was $3,706,000, or $0.08 per basic and diluted share, for the year ended December 31, 2005, compared to $3,101,000, or $0.08 per basic and diluted share, for the year ended December 31, 2004.
Income (Loss) from Discontinued Operations
Income (loss) from discontinued operations was ($4,215,000) and $1,225,000 for the years ended December 31, 2005 and 2004, respectively, and is comprised of the net operating results of consolidated properties. In accordance with our plan of liquidation, all consolidated properties are included in discontinued operations.
Gain on Sale of Real Estate - Discontinued operations
Gain on sale of real estate was $10,550,000 for the year ended December 31, 2005 and is comprised of the gain on sale of the 525 B Street property which was sold on August 10, 2005.
Net Income (Loss)
Net income for the year ended December 31, 2005 was $2,629,000, or $0.06 per basic and dilutive share, compared with net loss of ($1,876,000), or ($0.05) per basic and dilutive share, for the year ended December 31, 2004.
Liquidity and Capital Resources
As of December 31, 2006, our total assets and net assets in liquidation were $526,905,000 and $288,739,000, respectively. Our ability to meet our obligations is contingent upon the disposition of our assets in accordance with our plan of liquidation. We estimate that the net proceeds from the sale of assets pursuant to our plan of liquidation will be adequate to pay our obligations; however, we cannot provide any assurance as to the prices we will receive for the disposition of our assets or the net proceeds therefrom.
Current Sources of Capital and Liquidity
We anticipate, but can not assure, that our cash flow from operations and sales of property will be sufficient during the liquidation period to fund our cash needs for payment of expenses, capital expenditures, recurring debt service payments and repayment of debt maturities. Due to the uncertain timing of property sales and the maturity of certain debt obligations coming due, we may need to refinance one or more of our properties and/or request extensions of the terms of existing financing agreements.
Our plan of liquidation gives our board of directors the power to sell any and all of our assets without further approval by our stockholders and provides that liquidating distributions be made to our stockholders as determined at the discretion of our board of directors. Although we can provide no assurances, we currently expect to sell all of our assets and anticipate completing our plan of liquidation by February 27, 2008.
Factors Which May Influence Future Sources of Capital and Liquidity
SEC Investigation
On September 16, 2004, our Advisor advised us that it learned that the SEC is conducting an investigation referred to as “In the matter of Triple Net Properties, LLC.” The SEC has requested information from our Advisor relating to disclosure in public and private securities offerings sponsored by our Advisor and its affiliates, or the Triple Net securities offerings (including offerings by us). The SEC has requested financial and other information regarding the Triple Net securities offerings and the disclosures included in the related offering documents.
Our Advisor is engaged in settlement negotiations with the SEC staff regarding this matter. Based on these negotiations, our Advisor believes that the conclusion to this matter will not result in a material adverse affect to its results of operations, financial condition or ability to conduct our business. The settlement negotiations are continuing, and any settlement negotiated with the SEC staff must be approved by the Commission. Since the matter is not concluded, it remains subject to the risk that the SEC may seek additional remedies, including substantial fines and injunctive relief against our Advisor that, if obtained, could materially adversely affect our Advisor’s ability to perform its duties to us and/or delay the payment of liquidating distributions to our stockholders under our plan of liquidation. The matters that are the subject of this investigation could also give rise to claims against our Advisor by investors in its existing real estate investment programs which could adversely affect our Advisor’s performance to us. At this time, we cannot assess how or when the outcome of the matter will be ultimately determined and its impact on us. Therefore, at this time, we have not accrued any loss contingencies in accordance with SFAS No. 5, Accounting for Contingencies.
Prior Performance Tables
In connection with our initial and second public offerings of common stock conducted through “best efforts” offerings from July 22, 2002 through April 30, 2004, we disclosed the prior performance of all public and private investment programs sponsored by our Advisor. We now have determined that there were certain
errors in those prior performance tables. In particular, the financial information in the tables was stated to be presented on a GAAP basis. Generally the tables for the public programs were not presented on a GAAP basis and the tables for the private programs were prepared and presented on a tax or cash accounting basis. Moreover, a number of the prior performance data figures were themselves erroneous, even as presented on a tax or cash basis. In particular, certain programs sponsored by our Advisor have invested either along side or in other programs sponsored by our Advisor. The nature and results of these investments were not fully and accurately disclosed in the tables. In addition, for the private programs certain calculations of depreciation and amortization were not on an income tax basis for limited liability company investments; certain operating expenses were not reflected in the operating results; and monthly mortgage and principal payments were not reported. In general, the resulting effect is an overstatement of our Advisor’s program and aggregate portfolio operating results.
Revised prior performance tables reflecting corrected numbers and disclosures from those initially included in our prospectuses dated July 22, 2002 and January 23, 2004 were included in our definitive proxy statement and our Current Report on Form 8-K filed with the SEC on January 13, 2006.
Debt Financing
Our properties financed by borrowings are required by the terms of the applicable loan documents to meet certain minimum loan to value, debt service coverage, performance covenants and other requirements on a combined and individual basis. As of December 31, 2006, we were in compliance with all such requirements.
The composition of our aggregate debt balances as of December 31, 2006 and 2005 (liquidation basis) were as follows:
The percentage of fixed rate debt to total debt as of December 31, 2006 and 2005 does not take into consideration the portion of variable rate debt capped by our interest-rate cap agreements. There were no derivative financial instruments held by us as of December 31, 2006. Including the effects of the interest-rate cap agreements, we had fixed or capped 86.9% and 79.6% of our total outstanding debt as of December 31, 2006 and 2005, respectively.
As of December 31, 2006, 13.1% of our total debt required interest payments based on variable rates. Although the interest payments on 86.9% of our debt are fixed as of December 31, 2006, the remaining 13.1% of our debt is exposed to fluctuations on the one-month LIBOR rate.
We have restricted cash balances of $8,555,000 as of December 31, 2006 that are held as credit enhancements and as reserves for property taxes, capital expenditures and capital improvements in connection with our loan portfolio. When we repay the loans, the restricted balances that are outstanding at that time will become available to us as unrestricted funds.
Other Liquidity Needs
We are required to distribute 90.0% of our REIT taxable income, excluding capital gains, on an annual basis in order to qualify as a REIT for federal income tax purposes. All such distributions are at the discretion of our board of directors. The amount of distributions will depend on our funds from operations, financial condition, capital requirements, annual distribution requirements under the REIT provisions of the Code and other factors our board of directors deem relevant. In the event that there is a shortfall in net cash available due to factors including, without limitation, the timing of such distributions or the timing of the collections of receivables, we may seek to obtain capital to pay distributions by means of secured debt financing through one or more third parties. We have additional unleveraged equity from our consolidated properties, against which we may borrow, that could be used for such purposes. We may also pay distributions from cash from capital transactions including, without limitation, the sale of one or more of our properties. We have historically distributed amounts in excess of our taxable income resulting in a return of capital to our stockholders. We anticipate that our current distribution rate will meet our REIT distribution requirements for 2006. Amounts accumulated for distribution to our stockholders are invested primarily in interest-bearing accounts and short-term interest-bearing securities, which are consistent with our intention to maintain our qualification as a REIT. Such investments may include, for example, investments in marketable equity securities, certificates of deposit and interest-bearing bank deposits.
We believe that we will have sufficient capital resources to satisfy our liquidity needs during the liquidation period. We made and declared distributions to our stockholders in the aggregate amount of $201,017,000 during the year ended December 31, 2006. The source for payment of these distributions was funds from operating activities, proceeds from the sale of marketable securities and proceeds from the sales of properties. While the plan of liquidation provided that monthly liquidating distributions would terminate following the payment of liquidating distributions totaling $150,000,000, our board of directors has decided to continue the payment of monthly liquidating distributions at an annualized rate of 7.50% on the remaining share value of $6.10. Our board of directors will continue to evaluate the payment of regular monthly liquidating distributions on an on-going basis as more properties are sold and additional special liquidating distributions are paid to stockholders. We expect to satisfy the REIT distribution requirements through any liquidating distributions made pursuant to our plan of liquidation. Each distribution payment will be subject to the availability of cash and the discretion of our board of directors.
As of December 31, 2006 we estimate that we will have $9,383,000 of commitments and expenditures during the liquidation period comprised of the following: $5,291,000 of liquidation costs and $4,092,000 of capital expenditures. However, there can be no assurance that we will not exceed the amounts of these estimated expenditures or that we will be able to obtain additional sources of financing on commercially favorable terms, or at all.
A material adverse change in the net cash provided by operating activities or net proceeds expected from the liquidation of real estate assets may affect our ability to fund these items and may affect our ability to satisfy the financial performance covenants under our mortgages. If we fail to meet our financial performance covenants and are unable to reach a satisfactory resolution with the lenders, the maturity dates for the secured notes could be accelerated. Any of these circumstances could adversely affect our ability to fund working capital, liquidation costs and unanticipated cash needs.
Liquidating distributions to our stockholders will be determined by our board of directors in their sole discretion and are dependent on a number of factors, including the amount of funds available for distribution, our financial condition, our capital expenditures, the annual distribution required to maintain REIT status under the Code and other factors the board of directors may deem relevant. To the extent any distributions are made to our stockholders in excess of accumulated earnings, the excess distributions are considered a return of capital to stockholders for Federal income tax purposes.
The stated range of stockholder distributions disclosed in our plan of liquidation are estimates only and actual results may be higher or lower than estimated. The potential for variance on either end of the range could occur for reasons including, but not limited to: (i) unanticipated costs that could reduce net assets actually realized; (ii) winding up our business significantly faster than anticipated which could eliminate some
of the anticipated costs and result in higher net liquidation proceeds; (iii) a delay in our liquidation that could result in higher than anticipated costs and lower net liquidation proceeds; and (iv) circumstances that may change and lower the actual net proceeds realized from the sale of some of the assets, or significantly lower actual net proceeds, than currently estimated, including, for example, the discovery of new environmental issues or loss of a tenant.
Our distributions of amounts in excess of our taxable income have resulted in a return of capital to our stockholders. The income tax treatment for distributions reportable for the years ended December 31, 2006, 2005 and 2004, was as follows:
Subsequent to March 31, 2006, approximately $192,782,000, or $4.39 per share, of liquidating distributions to our stockholders were paid for the year ended December 31, 2006 and are treated by stockholders as proceeds from the sale of their stock.
Subject to our board of directors’ determinations and in accordance with our plan of liquidation, we expect to meet our liquidity requirements through the completion of the liquidation, through retained cash flow, dispositions of assets, and additional long-term secured and unsecured borrowings. We do not intend to reserve funds to retire existing debt upon maturity. We will instead, seek to refinance such debt at maturity or retire such debt through the disposition of the underlying property.
If we experience lower occupancy levels and reduced rental rates, reduced revenues as a result of asset sales, increased capital expenditures and leasing costs compared to historical levels due to competitive market conditions for new and renewal leases, the effect would be a reduction of net cash provided by operating activities. If any or all of these events occur and if our board of directors continues to declare distributions to our stockholders at current levels, we may experience a cash flow deficit in subsequent periods. In connection with such a shortfall in net cash available, we may seek to obtain capital to pay distributions by means of secured debt financing through one or more third parties. This estimate is based on various assumptions which are difficult to predict, including the levels of leasing activity at year end and related leasing costs. Any changes in these assumptions could adversely impact our financial results and our ability to fund working capital and our other unanticipated cash needs. To the extent any distributions are made to our stockholders in excess of accumulated earnings, the excess distributions are considered a return of capital to our stockholders for federal income tax purposes.
Cash Flows
Years Ended December 31, 2005 and 2004
Cash flows provided by operating activities decreased by $20,208,000 for the year ended December 31, 2005 compared to the year ended December 31, 2004. The decrease was primarily due to decreases in accounts payable and accrued liabilities, accounts and other receivables, other assets, and distributions received in excess of equity in earnings from investments in unconsolidated real estate. The decreases were offset by increases in depreciation and amortization relating to the assets acquired in 2005 and 2004.
Cash flows provided by investing activities were $80,432,000 for the year ended December 31, 2005 and were primarily related to the sale of the 525 B Street property in August 2005 offset by increases in capital expenditures, the purchase of the Opus Plaza and Eaton Freeway properties in September 2005 and October 2005, respectively, and increases in restricted cash. Cash flows used in investing activities of $563,218,000 for
the year ended December 31, 2004 were primarily due to the purchases of operating properties, purchases of marketable securities, increases in capital expenditures and decreases in restricted cash.
Cash flows used in financing activities were $110,351,000 for the year ended December 31, 2005. The decrease of $635,698,000 during 2005 compared to 2004 was primarily due to the proceeds received on the second offering which terminated on April 30, 2004 plus borrowings under the Credit Facility and through mortgages payable throughout 2004 offset by borrowings under our Credit Facility and mortgages payable in 2005. Further contributing to the decrease were repayments under the Credit Facility and mortgage debt. In addition, cash distributions paid to stockholders in 2005 were $32,888,000 compared to $26,335,000 in 2004.
As a result of the above, cash and cash equivalents decreased $10,222,000 for the year ended December 31, 2005 to $7,345,000.
Capital Resources
General
Prior to the adoption of our plan of liquidation, our primary sources of capital were our real estate operations, our ability to leverage the increased market value in the real estate assets we own and our ability to obtain debt financing from third parties. We derive substantially all of our revenues from tenants under leases at our properties. Our operating cash flow, therefore, depends materially on the rents that we are able to charge to our tenants and the ability of these tenants to make their rental payments.
Our primary uses of cash are to fund distributions to our stockholders, to fund capital investment in our existing portfolio of operating assets and for debt service. We may also regularly require capital to invest in our existing portfolio of operating assets in connection with routine capital improvements, deferred maintenance on our properties recently acquired and leasing activities, including funding tenant improvements, allowances and leasing commissions. The amounts of the leasing-related expenditures can vary significantly depending on negotiations with tenants and the willingness of tenants to pay higher base rents over the life of the leases.
In accordance with our plan of liquidation, we anticipate our source for the payment of distributions to be primarily from the net proceeds from the sale of our properties and funds from operating activities. We will require up to $4,092,000 for the year ended December 31, 2007 for capital expenditures, including, without limitation, tenant and/or capital improvements and lease commissions. We intend to use proceeds from the sale of properties to provide funds to the extent the reserves on deposit with the lender of $8,555,000 as of December 31, 2006, are not sufficient or cannot be used for these expenditures.
Distributions payable to our stockholders may include a return of capital as well as a return in excess of capital. Distributions exceeding taxable income will constitute a return of capital for federal income tax purposes to the extent of a stockholder’s basis. Distributions in excess of tax basis will generally constitute capital gain.
Financing
Total debt decreased as a result of the sale of the ten properties during the year ended December 31, 2006 that had mortgage debt or borrowings on our credit facility that were paid off upon sale of the property. As of December 31, 2006 and December 31, 2005, our mortgage loans payable balances, including mortgage loans payable secured by property held for sale, were $225,836,000 and $350,402,000, respectively. Our Credit Facility balance was $0 and $58,369,000 as of December 31, 2006 and 2005, respectively. Our Margin Security Account balances as of December 31, 2006 and 2005 were $0 and $2,595,000, respectively.
Our Credit Facility with LaSalle matured on January 30, 2006. On January 25, 2006, G REIT, Inc., as the general partner for G REIT, L.P., entered into a Second Amended and Restated Credit Agreement, or Amended Credit Agreement, for our Credit Facility in the amount of $58,369,000, with lenders: (i) LaSalle; (ii) Bank of America, National Association; and (iii) Citizens Financial Bank; with LaSalle acting as agent for the lenders. The Credit Facility matured on January 30, 2007. Advances under this Credit Facility were collateralized by our mortgaged properties and proceeds thereof. Advances bore interest, at our election, at the prime rate or the one-month LIBOR rate plus a margin of 2.25%, when we met certain conditions, which included no default on advances, and full compliance with the other covenants. The advances were subject to a floor rate of 3.5% and required interest only payments on a monthly basis.
The Amended Credit Agreement contained covenants that were comparable to those of other real estate investment trusts and facilitated our plan of liquidation which was thereafter approved by our stockholders on February 27, 2006. These covenants included, among others: a limitation on the incurrence of additional indebtedness; a limitation on mergers, investments, acquisitions, and dividend distributions; and maintenance of specified financial ratios. The Amended Credit Agreement contained normal events of default for an agreement of this type. The nonpayment of any outstanding principal, interest, fees or amounts due under the Credit Facility and the failure to perform or observe covenants in the loan documents, among other things, could have resulted in events of default. Additionally, under the terms of the Amended Credit Agreement, at no time during the loan should the borrowing base be made up of less than two properties or our minimum net worth equal to less than $150,000,000.
On October 17, 2006, we entered into a First Amendment to Second Amended and Restated Credit Agreement, or the Amendment, to the Amended Credit Agreement. The material terms of the Amendment provided for the following: (i) the release of the Centerpoint Corporate Park property as a mortgaged property under the terms of the Amended Credit Agreement; (ii) that upon receipt of their proceeds, or the Proceeds, from the Release Price (as defined in the Amended Credit Agreement) resulting from the sale of Centerpoint Corporate Park property, Bank of America and Citizens Financial Bank would have received full payment of their Commitments (as defined in the Amended Credit Agreement); (iii) and that upon receipt of the Proceeds, Bank of America and Citizens Financial Bank should no longer serve as lenders under the Credit Agreement and should each deem any promissory notes or note assumptions they hold as paid in full and returned to us. On October 17, 2006, we paid down $39,900,000 on the Credit Facility in conjunction with the sale of our Centerpoint Corporate Park property. With the $39,900,000 payment, Bank of America and Citizens Financial Bank received full repayment of their Commitments and LaSalle received the remaining balance of the Release Price payment. As a result, the principal balance of LaSalle’s Commitment was $18,469,000 and Bank of America and Citizens Financial Bank were no longer lenders under the Credit Agreement. On November 14, 2006, we paid down $9,588,000 on the Credit Facility in conjunction with the sale of our 5508 Highway 290 property. We paid off the remaining principal balance on the Credit Facility of $8,881,000 in conjunction with the sale of our Department of Children and Family Campus property on November 15, 2006.
As of December 31, 2006, we had $76,812,000 in cash and cash equivalents . In addition, we have restricted cash balances of $8,555,000 as of December 31, 2006 that are held as credit enhancements and as reserves for property taxes, capital expenditures and capital improvements in connection with our loan portfolio. When we repay the loans, the restricted balances that are outstanding at that time will become available to us as unrestricted funds.
Unconsolidated Debt
Total mortgage debt of unconsolidated properties was $97,308,000 and $97,500,000 as of December 31, 2006 and 2005, respectively. Our share of unconsolidated debt, based on our ownership percentage, was $29,192,000 and $29,250,000 as of December 31, 2006 and 2005, respectively. The decrease of $192,000 in unconsolidated debt was due to principal payments made on the mortgage loan of our Congress Center property in 2006.
On December 21, 2006, we received a termination notice from Employer’s Reinsurance Corporation notifying us of their intent to exercise their option to terminate their lease effective January 1, 2008 at the
Congress Center property. Pursuant to the Property Reserves Agreement with the lender, the lender is entitled to receive an early termination fee penalty of $3,800,000 from the borrower (all the owners of the Congress Center property) to be placed in a reserve account controlled by the lender. In addition, the lender is entitled to receive $225,000 on a monthly basis beginning January 1, 2007 and continuing through and including the payment date occurring on December 1, 2007 from the borrower. Beginning January 1, 2008 and continuing through and including the payment date occurring on December 1, 2011, the lender is entitled to receive $83,000 on a monthly basis from the borrower. In the event that the Congress Center property does not generate sufficient funds from operations to satisfy the monthly reserve payments to the lender, we, along with T REIT Inc. and NNN 2002 Value Fund, LLC, or our Affiliate co-owners, will advance the required amounts to the lender on behalf of the borrower. It is anticipated that upon the sale of the Congress Center property, we, along with our Affiliate co-owners will receive repayment of any advances made to the lender for reserves. All payments to the lender are to be placed in a reserve account to be held by the lender for reimbursement to the borrower for tenant improvement and leasing commissions incurred in connection with re-leasing the space.
Certain properties financed by borrowings are required by the terms of the applicable loan documents to meet certain minimum loan to value, debt service coverage, performance covenants and other requirements on a combined and individual basis . As of December 31, 2006, our unconsolidated property was in compliance with all such covenants.
Insurance
Property Damage, Business Interruption, Earthquake and Terrorism
The insurance coverage provided through third-party insurance carriers is subject to coverage limitations. Should an uninsured or underinsured loss occur, we could lose all or a portion of our investment in, and anticipated cash flows from, one or more of our properties. In addition, there can be no assurance that third-party insurance carriers will be able to maintain reinsurance sufficient to cover any losses that may be incurred.
Debt Service Requirements
One of our principal liquidity needs are payments of interest and principal on outstanding indebtedness, which includes mortgages on 11 of our properties. As of December 31, 2006, 11 of our properties were subject to existing mortgages, including mortgage loans payable secured by property held for sale, which had an aggregate principal amount outstanding of $238,010,000 ($225,836,000 liquidation basis). Our total debt consisted of $196,321,000 on a liquidation basis, or 86.9%, of allocable fixed rate debt at a weighted-average interest rate of 5.32% per annum and $29,515,000 on a liquidation basis, or 13.1%, of variable rate debt at a weighted-average interest rate of 7.86% per annum. As of December 31, 2006, the weighted-average interest rate on our outstanding debt was 5.65% per annum. The scheduled principal payments for the next five years, as of December 31, 2006 (liquidation basis) are as follows:
Contractual Obligations
The following table provides information with respect to the maturities, including scheduled principal repayments of our secured debt, as well as scheduled interest payments of our fixed and variable rate debt as of December 31, 2006. It also provides information about the minimum commitments due in connection with our ground lease obligations as of December 31, 2006. The table does not reflect any available extension options.
(1)
The Sutter Square Galleria property is subject to a ground lease expiring in 2040 with one ten-year option period thereafter. Future minimum rents to be paid under this non-cancelable operating lease are computed at 12.5% of gross rents, as defined in the ground lease agreement.
Off-Balance Sheet Arrangements
There are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in the financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Inflation
We will be exposed to inflation risk as income from long-term leases is expected to be the primary source of our cash flows from operations. We expect that there will be provisions in the majority of our tenant leases that would protect us from the impact of inflation. These provisions include rent steps, reimbursement billings for operating expense pass-through charges, real estate tax and insurance reimbursements on a per square foot allowance. However, due to the long-term nature of the leases, among other factors, the leases may not re-set frequently enough to cover inflation.
Funds from Operations
We define Funds from Operations, or FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of the National Association of Real Estate Investment Trust, or NAREIT, as revised in February 2004. The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property but including asset impairment write downs, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated joint ventures are calculated to reflect FFO.
We consider FFO to be an appropriate supplemental measure of a REIT’s operating performance as it is based on a net income analysis of property portfolio performance that excludes non-cash items such as depreciation. The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time. Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT, using historical accounting for depreciation, could be less informative. The use of FFO is recommended by the REIT industry as a supplemental performance measure.
We believe our FFO reporting complies with NAREIT’s policy described above.
Presentation of this information is intended to assist the reader in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO is not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income as an indication of our performance.
The following is the calculation of FFO for the years ended December 31, 2005 and 2004, respectively:
Subsequent Events
On January 5, 2007, January 19, 2007, January 26, 2007, January 31, 2007, February 15, 2007, February 22, 2007 and February 28, 2007, we entered into amendments to the One World Trade Center Purchase and Sale Agreement to extend the closing date to January 22, 2007, January 26, 2006, January 31, 2007, February 15, 2007, February 22, 2007, February 28, 2007 and March 2, 2007, respectively. On March 2, 2007, we entered into a ninth amendment to the agreement. The material terms of the ninth amendment provide for: (i) a reduction in the sales price from $150,000,000 to $148,900,000; (ii) the installation of a filtration system required by the National Pollutant Discharge Elimination System and Water Discharge Elimination System Permit; (iii) a closing date of March 28, 2007; (iv) deletions of any indemnity or release by the buyer relating to the pre-closing groundwater matters in the agreement, and similarly, release of seller for liability for any post-closing groundwater matters; (v) buyer’s acknowledgement that the reduction in the purchase price is intended as full compensation for all ongoing costs, testing, impact on the property, and risk of losses or liabilities arising from the post-closing groundwater matters; and (vi) seller’s delivery of estoppel certificates from tenants representing 75% of the leased square footage, including major tenants identified in the agreement as a closing condition. We anticipate that a property disposition fee will be paid to Realty of $2,250,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $900,000, or 0.6% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in the first quarter of 2007.
On January 11, 2007, we sold our Two Corporate Plaza property located in Houston, Texas to Metro Properties, LLC, an unaffiliated third party, for a sales price of $18,000,000. Our net cash proceeds were $7,127,000 after payment of the related mortgage loan, closing costs and other transaction expenses, and the return of lender required reserves. A property disposition fee of $270,000, or 1.5% of the sales price was paid to Realty and a sales commission of $380,000, or 2.1% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets in liquidation as of December 31, 2006 increased by approximately $1,021,000 as a result of the sale.
On March 1, 2007, we entered into an agreement to sell our One Financial Plaza property, located in St. Louis, Missouri, of which we own 77.63%, to an unaffiliated third party for a sales price of $47,000,000. We anticipate that a property disposition fee will be paid to our Advisor or its affiliate of $705,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $470,000, or 1.0% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in March or April 2007.
On March 16, 2007, we entered into an agreement to sell our Opus Plaza at Ken Caryl property, located in Littleton, Colorado, to an unaffiliated third party for a sales price of $10,400,000. We anticipate that a property disposition fee will be paid to our Advisor or its affiliate of $156,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $260,000, or 2.5% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in the second quarter of 2007.
Recently Issued Accounting Pronouncements
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN No. 48. This interpretation, among other things, creates a two-step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN No. 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements. FIN No. 48 is effective for fiscal years beginning after December 15, 2006, in which the impact of adoption should be accounted for as a cumulative-effect adjustment to the beginning balance of retained earnings. We do not believe that the adoption of FIN No. 48 will have a material impact on our consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards, or SFAS, No. 157, Fair Value Measurement, or SFAS No. 157. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007. If we have not liquidated our company prior to the required adoption of SFAS No. 157, we will adopt SFAS No. 157 on January 1, 2008. We do not believe that the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.
In September 2006, the SEC released Staff Accounting Bulletin, or SAB, No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Current Year Misstatements, or SAB No. 108, to address diversity in practice regarding consideration of the effects of prior year errors when quantifying misstatements in current year financial statements. The SEC staff concluded that registrants should quantify financial statement errors using both a balance sheet approach and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB No. 108 states that if correcting an error in the current year materially affects the current year’s income statement, the prior period financial statements must be restated. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 in the fourth quarter of 2006 did not have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS No. 159. SFAS No. 159 permits entities to choose to measure many financial
instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the fiscal year beginning on or before November 15, 2007, provided the provisions of SFAS No. 157 are applied. If we have not liquidated our company prior to the required adoption of SFAS No. 159, we will adopt SFAS No. 159 on January 1, 2008. We are evaluating SFAS No. 159 and have not yet determined the impact the adoption, if any, will have on our consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to interest rate changes primarily as a result of our long-term debt used to maintain liquidity and fund capital expenditures and expansion of our real estate investment portfolio and operations. Our interest rate risk objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives we borrow primarily at fixed rates or variable rates with the lowest margins available and, in some cases, with the ability to convert variable rate debt to fixed rate debt. We may enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to seek to mitigate our interest rate risk on a related financial instrument. We do not enter into derivative or interest rate transactions for speculative purposes.
Our interest rate risk is monitored using a variety of techniques. The table below presents, as of December 31, 2006 (on a liquidation basis), the principal amounts and weighted-average interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
The weighted-average interest rate of our mortgage debt as of December 31, 2006 was 5.65% per annum. As of December 31, 2006, our mortgage debt consisted of $196,321,000, or 86.9%, of the total debt at a fixed interest rate of 5.32% per annum and $29,515,000, or 13.1%, of the total debt at a variable interest rate of 7.86% per annum. An increase in the variable interest rate on certain mortgages payable constitutes a market risk. As of December 31, 2006, for example a 0.50% increase in LIBOR would have decreased our overall net assets by $148,000, or less than 0.06%.
Our exposure to market changes in interest rates is similar to that which we faced as of December 31, 2005. The table below presents, as of December 31, 2005, the principal amounts and weighted-average interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
The weighted-average interest rate of our mortgage debt as of December 31, 2005 was 5.62% per annum. As of December 31, 2005, our mortgage debt consisted of $269,062,000, or 65.0%, of the total debt at a fixed interest rate of 5.28% per annum and $142,304,000, or 35.0%, of the total debt at a variable interest rate of 6.27% per annum. An increase in the variable interest rate on certain mortgages payable constitutes a market risk. As of December 31, 2006, for example a 0.50% increase in LIBOR would have decreased our overall net assets by $705,000, or less than 0.16%.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
See the index included at “Item 15. Exhibits, Financial Statement Schedules.”
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission, or the SEC, rules and forms, and that such information is accumulated and communicated to us, including our Chief Executive Officer and Chief Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs.
Following the signatures section of this Annual Report on Form 10-K are certifications of our Chief Executive Officer and Chief Accounting Officer required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 and Rules 13a-14(a) and 15d-14(a) under the Exchange Act, or the Section 302 Certification. This portion of our Annual Report on Form 10-K is our disclosure of the results of our controls evaluation referred to in paragraphs (4) and (5) of the Section 302 Certification and should be read in conjunction with the Section 302 Certification for a more complete understanding of the topics presented.
As of December 31, 2006, an evaluation was conducted under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on this evaluation, the Chief Executive Officer and the Chief Accounting Officer concluded that the design and operation of these disclosure controls and procedures were effective.
(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The following table and biographical descriptions set forth information with respect to our executive officers and directors as of March 20, 2007.
(1)
Mr. Thompson previously served as our Chief Executive Officer and President from December 2001 until December 2005.
(2)
Mr. Peters previously served as our Executive Vice President and Chief Financial Officer from September 2004 until December 2005.
There are no family relationships between any directors, executive officers or between any director and executive officer.
Anthony W. (“Tony”) Thompson has served as Chairman of our board of directors since December 2001, and previously served as Chief Executive Officer and President from December 2001 until December 2005. He is also the Chairman of the board of directors of NNN Realty Advisors, Inc., or NNN Realty Advisors, the parent company of Triple Net Properties, LLC, or Triple Net Properties, or our Advisor, and owns 25.9% of NNN Realty Advisors’ outstanding common stock. Mr. Thompson is also the founder of our Advisor and served as its Chairman of the board of managers from its inception in April 1998 to November 2006, its Chief Executive Officer from inception to October 2006, and its President from inception until September 2004. He is also the Chairman of Triple Net Properties Realty, Inc., or Realty, and served as its Chief Executive Officer from its inception to July 2006. From 1986 to 1995 he was a 50.0% shareholder, director and an executive officer of TMP Group, Inc., a full-service real estate investment group. Mr. Thompson is a NASD-registered securities principal and Chairman of NNN Capital Corp., the dealer-manager of our initial and second public offerings. Mr. Thompson has also served as the Chairman of the board of directors of T REIT, Inc. Mr. Thompson is also a member of the Sterling College Board of Trustees and various other charitable and civic organizations. Mr. Thompson is a graduate of Sterling College with a B.S. degree in Economics.
Gary T. Wescombe has served as a director of our company since December 2001. Mr. Wescombe provides consulting services to various entities in the real estate sector. From October 1999 to December 2001, he was a partner in Warmington Wescombe Realty Partners in Costa Mesa, California, where he focused on real estate investments and financing strategies. Prior to retiring in 1999, Mr. Wescombe was a Partner with Ernst & Young, LLP (previously Kenneth Leventhal & Company) from 1970 to 1999. In addition, Mr. Wescombe is director, Chief Financial Officer and Treasurer of the Arnold and Mabel Beckman Foundation, a nonprofit foundation established for the purpose of supporting scientific research. Mr. Wescombe also serves as a director and audit committee member of NNN Healthcare/Office REIT, Inc. Mr. Wescombe received a B.S. degree in Accounting and Finance from California State University, San Jose in 1965 and is a
member of the American Institute of Certified Public Accountants and California Society of Certified Public Accountants.
Edward A. Johnson has served as a director of our company since December 2001. Dr. Johnson has served as President of the University of the New West, Phoenix, Arizona since November 2003. Dr. Johnson served as President of Sterling College, a small liberal arts college affiliated with the Presbyterian Church (USA), in Sterling, Kansas, from 1997 to November 2003 where his major accomplishments include development of strategic and business plans, initiation of the nation’s first undergraduate program in social entrepreneurship and selection as its first leadership college by Habitat for Humanity International. From 1992 to 1997, he served as executive director of the Arizona Commission for Postsecondary Education. Dr. Johnson received a B.S. degree in History and Political science from Morningside College, Sioux City, Iowa in 1973, a J.D. degree from Creighton University School of Law, Omaha, Nebraska in 1976, and a Ph.D. degree in Higher Education Administration - Law and Education specialization from Arizona State University, Tempe, Arizona in 1984.
D. Fleet Wallace has served as an independent director of our company since April 2002. Mr. Wallace is also a director of NNN Realty Advisors and serves as a member of its audit and nominating/corporate governance committees. He is a Principal and Co-Founder of McCann Realty Partners, LLC, an apartment investment company focusing on garden apartment properties in the Southeast formed in October 2004. Mr. Wallace also serves as a Principal of Greystone Capital Management, LLC, formed in September 2001, and helps manage Greystone Fund, L.P. and Greystone Finance, LLC. Greystone Fund, L.P. is a professionally managed opportunity fund invested primarily in promising venture capital opportunities and distressed assets in the form of real estate, notes and accounts receivable, inventory and other assets. Greystone Finance, LLC provides debt financing to commercial borrowers in Virginia which have limited access to more traditional sources of funding. From April 1998 to August 2001, Mr. Wallace served as Corporate Counsel and Assistant Secretary of United Dominion Realty Trust, Inc., a publicly-traded real estate investment trust. At United Dominion, he managed general corporate matters for over 150 affiliated entities, negotiated and executed numerous real estate acquisitions and dispositions, and provided legal support on over $1 billion in financing transactions. From September 1994 to April 1998, Mr. Wallace was in the private practice of law with the firm of McGuire Woods in Richmond, Virginia. Mr. Wallace also serves as a director of T REIT, Inc. Mr. Wallace received a B.A. degree in History from the University of Virginia in 1990 and a J.D. degree from the University of Virginia in 1994.
W. Brand Inlow has served as an independent director of our company since April 2002. He is a Principal, Co-Founder, and serves as Director of Acquisitions for McCann Realty Partners, LLC, an apartment investment company focusing on garden apartment communities in the Southeast formed in October 2004. Since October 2003, Mr. Inlow has provided professional consulting services to the multifamily industry on matters related to acquisitions, dispositions, asset management and property management operations, and through an affiliation with LAS Realty in Richmond, Virginia conducts commercial real estate brokerage. Mr. Inlow is also President of Jessie’s Wish, Inc., a Virginia non-profit corporation dedicated to awareness, education and financial assistance for patients and families dealing with eating disorders. Mr. Inlow also serves as a director of T REIT, Inc. and a director and audit committee member of NNN Apartment REIT, Inc. Mr. Inlow served as President of Summit Realty Group, Inc. in Richmond, Virginia, from September 2001 through October 2003. From November 1999 to September 2001, he was Vice President of Acquisitions for EEA Realty, LLC in Alexandria, Virginia where he was responsible for acquisition, disposition and financing of company assets, which were primarily garden apartment properties. From November 1991 to November 1999, Mr. Inlow worked for United Dominion Realty Trust, Inc., a publicly traded real estate investment trust, as Assistant Vice President and Senior Acquisition Analyst, where he was responsible for the acquisition of garden apartment communities.
Gary H. Hunt has served as the managing partner of California Strategies, a privately held consulting firm in Irvine, California that works with large homebuilders, real estate companies and government entities since 2001. Mr. Hunt is also a director of NNN Realty Advisors and serves as a member and chairman of its compensation committee and a member of its nominating/corporate governance committee. Prior to serving with California Strategies, Mr. Hunt was the Executive Vice President of The Irvine Company, a 110-year-old
privately held company that plans, develops and invests in real estate primarily in Orange County, California for 25 years. At The Irvine Company, Mr. Hunt worked at local, regional, state and federal levels directing the company’s major entitlement, regional infrastructure, planning and strategic government, media and community relations activities. Additionally, Mr. Hunt served on the board of directors and the Executive Committee of The Irvine Company for 10 years. Some of Mr. Hunt’s other work experience includes staff positions with the California State Legislature, U.S. House of Representatives, California Governor Ronald Reagan and Executive Director of the Californian Republican Party. He also serves on the board of directors of Glenair Inc., The Beckman Foundation and the Irvine Health Foundation. Mr. Hunt holds a J.D. degree from the Irvine University School of Law and teaches courses on business and government at the Graduate School of Management, University of California, Irvine.
Scott D. Peters has served as our Chief Executive Officer and President since December 2005, having previously served as our Executive Vice President and Chief Financial Officer since September 2004. He is also the Chief Executive Officer and President of NNN Realty Advisors. Mr. Peters has served as the Chief Executive Officer of our Advisor since November 2006. From September 2004 to October 2006, Mr. Peters served as the Executive Vice President and Chief Financial Officer of our Advisor and was responsible for all areas of finance, including accounting and financial reporting, as well as a liaison for institutional investors, lenders and investment banks. Mr. Peters has also served as the Executive Vice President and Chief Financial Officer of T REIT, Inc. from September 2004 to December 2006, the Executive Vice President of NNN Apartment REIT, Inc. since January 2006 and as the Chairman and Chief Executive Officer of NNN Healthcare/Office REIT, Inc. since June 2006. From February 1997 to February 2007, Mr. Peters served as Senior Vice President, Chief Financial Officer and a director of Golf Trust of America, Inc., a publicly traded real investment trust. Mr. Peters received his B.B.A. degree in Accounting and Finance from Kent State University in Ohio.
Courtney A. Brower has served as our Chief Accounting Officer since January 2006. Ms. Brower has served as a Financial Reporting Manager for our Advisor since July 2004, as the Chief Accounting Officer of T REIT, Inc. since December 2006 and as a senior REIT accountant for our Advisor from October 2003 to July 2004. From September 2001 to October 2003, Ms. Brower gained public accounting experience while employed at Deloitte & Touche, LLP. Ms. Brower is a Certified Public Accountant and received her B.A. degree in Business-Economics with a minor in Accounting from the University of California, Los Angeles.
Talle A. Voorhies has served as our Vice President since December 2001. Ms. Voorhies has served as an Executive Vice President and Secretary of our Advisor since 1998. She also served as our Advisor’s Executive Vice President from April 1998 to December 2001, when she became Chief Operating Officer. Ms. Voorhies served as President from April 1998 through February 2005 and financial principal from April 1998 through November 2004 of NNN Capital Corp. From December 1987 to January 1999, Ms. Voorhies worked with the TMP Group, Inc., where she served as Chief Administrative Officer and Vice President of broker-dealer relations. Ms. Voorhies is responsible for our Advisor’s investor services department and is a registered financial principal with the NASD.
Jack R. Maurer has served as our Executive Vice President since December 2001. Mr. Maurer has also served as Chief Executive Officer and President of T REIT, Inc. since August 2004 and as its Secretary and Treasurer from December 1999 through August 2004. Mr. Maurer has also served as Senior Vice President, Office of the Chairman of NNN Realty Advisors since its formation. Mr. Maurer has served as Chief Financial Officer of our Advisor from April 1998 to December 2001, when he became Financial Principal of NNN Capital Corp. Mr. Maurer has over 33 years of real estate financial management experience, including Chief Financial Officer and Controller positions in residential and commercial development and the banking industry. From 1986 to April 1998, he was a General Partner and CEO of Wescon Properties, where he was involved in finance, accounting and forecasting. Mr. Maurer’s previous experience also includes the national accounting firm of Kenneth Leventhal & Company. Mr. Maurer received a B.S. degree in Business Administration - Accounting from California State University at Northridge in 1973 and is a registered general securities principal with the NASD.
Andrea R. Biller has served as our Executive Vice President since December 2005 and as our Secretary since June 2004. She also is the General Counsel, Secretary and an Executive Vice President of NNN Realty Advisors. Ms. Biller has served as Executive Vice President of our Advisor since January 2007 and as its General Counsel since March 2003, overseeing all legal functions and coordinating with outside counsel. She has also served as Secretary of T REIT, Inc. since May 2004 and as Secretary of NNN Apartment REIT, Inc. since December 2005. Ms. Biller practiced as a private attorney specializing in securities and corporate law from 1990 to 1995 and 2000 to 2002. She practiced at the Securities and Exchange Commission from 1995 to 2000, including two years as special counsel for the Division of Corporation Finance. Ms. Biller earned a B.A. degree in Psychology from Washington University, an M.A. degree in Psychology from Glassboro State University and a J.D. degree from George Mason University School of Law in 1990, where she graduated “With Distinction.” Ms. Biller is a member of the California, Virginia and the District of Columbia State Bars.
Our Advisor’s Executive Officers
The following table and biographical descriptions set forth information with respect to our Advisor’s executive officers as of March 20, 2007.
There are no family relationships between any executive officers.
For biographical information regarding Mr. Peters, Ms. Biller, Mr. Maurer and Ms. Voorhies see - Directors, Executive Officers and Corporate Governance, above.
Louis J. Rogers has served as President of our Advisor since September 2004. Mr. Rogers also serves as a Director of NNN Realty Advisors; a director of NNN Capital Corp.; and Vice President, Secretary and a Director of Realty. Mr. Rogers is the President and a Director of NNN Apartment REIT, Inc. and served as Chairman of its board of directors from January to December 2006. He has also served as President of NNN Apartment REIT, Inc.’s advisor since its formation. He is a founding member and director of the Tenants in Common Association. Mr. Rogers has been with the law firm of Hirschler Fleischer since 1988, was a shareholder from 1994 to December 31, 2004, and since January 2005, has served as senior counsel. Mr. Rogers’ law practice focused on formation and operation of real estate investments, including REITs, and acquisition financings for real estate transactions, structuring like-kind (Section 1031) exchanges, private placements and syndications. Mr. Rogers earned a B.S. degree from Northeastern University (with highest honors) in Massachusetts, a B.A. degree (with honors) and an M.A. degree in Jurisprudence from Oxford University in England and a J.D. degree from the University of Virginia School of Law. Mr. Rogers is a member of the Virginia State Bar and is a registered securities principal and broker with the NASD.
Francene LaPoint has served as the Chief Financial Officer of our Advisor since November 2006, having served as its Executive Vice President and Controller, responsible for all aspects of its accounting and reporting for corporate, as well as private entity property and limited liability company accounting since July 2004. Ms. LaPoint has also served as the Chief Financial Officer of NNN Realty Advisors since its formation. Ms. LaPoint served as Senior Vice President and Corporate Controller of Hawthorne Savings, FSB (Hawthorne Financial Corporation), a publicly traded financial institution, from June 1999 to June 2004. From January 1996 to June 1999, Ms. LaPoint was a Certified Public Accounting with Pricewaterhouse Coopers.
She graduated from California State University, Fullerton with a B.A. degree in Business Administration - Accounting Concentration and is a member of the American Institute of Certified Public Accountants.
Jeffrey T. Hanson has served as the Chief Investment Officer of our Advisor since January 2007, having served as the President and Chief Executive Officer of Realty since July 2006. He is also the Chief Investment Officer of NNN Realty Advisors. Mr. Hanson’s responsibilities include managing the company’s real estate portfolio and directing acquisitions and dispositions nationally for its public and private real estate programs. From 1996 to July 2006, Mr. Hanson served as Senior Vice President with Grubb & Ellis Company’s Institutional Investment Group in the firm’s Newport Beach, California office. While with Grubb & Ellis, he managed investment sale assignments throughout Southern California and other Western US markets for major private and institutional clients. Mr. Hanson is am ember of the Sterling College Board of Trustees and formerly served as a member of the Grubb & Ellis President’s Counsel and Institutional Investment Group Board of Advisors. Mr. Hanson earned a B.S. degree in Business from the University of Southern California with an emphasis in Real Estate Finance.
Richard T. Hutton, Jr. has served as an Executive Vice President of our Advisor since September 2005. From April 1999 to August 2003, Mr. Hutton served as Senior Vice President - real estate acquisitions and vice president property management for our Advisor, where he oversaw the management of the real estate portfolios and property management staff of our Advisor and its affiliates. Mr. Hutton has also served as our interim Chief Financial Officer from October 2003 through December 2003 and April 2004 through September 2004 and also serves as the Chief Executive Officer of NNN 2003 Value Fund, LLC. Mr. Hutton has over 15 years experience in real estate accounting, finance and property operations. Mr. Hutton’s previous experience includes serving as controller for the TMP Group from November 1997 to April 1999. Mr. Hutton has also served as our interim Chief Financial Officer and our Advisor from October 2003 through December 2003 and April 2004 through September 2004. Mr. Hutton has a B.A. degree in Psychology from Claremont McKenna College and has been licensed as a certified public accountant in California since 1984.
NNN Realty Advisors and Triple Net Properties
NNN Realty Advisors was formed in September 2006 and is a full-service commercial real estate asset management and services firm. In the fourth quarter of 2006 NNN Realty Advisors, acquired all of the outstanding ownership interests of Triple Net Properties, NNN Capital Corp. and Realty.
Fiduciary Relationship of our Advisor to Us
Our Advisor is deemed to be in a fiduciary relationship to us pursuant to the Advisory Agreement and under applicable law. Our Advisor’s fiduciary duties include responsibility for our control and management and exercising good faith and integrity in handling our affairs. Our Advisor has a fiduciary responsibility for the safekeeping and use of all of our funds and assets, whether or not they are in its immediate possession and control, and may not use or permit another to use such funds or assets in any manner except for our exclusive benefit.
Our funds will not be commingled with the funds of any other person or entity except for operating revenue from our properties.
Our Advisor may employ persons or firms to carry out all or any portion of our business. Some or all such persons or entities employed may be affiliates of our Advisor or Mr. Thompson. It is not clear under current law the extent, if any, that such parties will have a fiduciary duty to us or our stockholders. Investors who have questions concerning the fiduciary duties of our Advisor should consult with their own legal counsel.
Committees of the Board of Directors
Audit Committee
Our audit committee, consisting of a majority of independent directors, is comprised of Messrs. Inlow, Wallace and Wescombe. The board of directors has determined that Mr. Wescombe qualifies as an “audit committee financial expert” under the rules of the SEC. Our audit committee:
•
makes recommendations to our board of directors concerning the engagement of independent public accountants;
•
reviews the plans and results of the audit engagement with the independent public accountants;
•
approves professional services provided by, and the independence of, the independent public accountants;
•
considers the range of audit and non -audit fees;
•
consults with the independent public accountants regarding the adequacy of the internal accounting controls; and
•
periodically meets with representatives of our disclosure committee on various subjects within the scope of the disclosure committee’s charter (the disclosure committee is comprised of representatives of our management).
(i) Gary T. Wescombe, who is an audit committee financial expert, will not be deemed expert for any purpose including, without limitation, for purposes of section 11 of the Securities Act as a result of being designated or identified as an audit committee financial expert.
(ii) The designation or identification of Mr. Wescombe as an audit committee financial expert does not impose on such person any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of the audit committee and board of directors in the absence of such designation or identification.
(iii) The designation or identification of Mr. Wescombe as an audit committee financial expert does not affect the duties, obligations or liability of any other member of the audit committee or board of directors.
Executive Compensation Committee
Our board of directors has established an executive compensation committee consisting of up to three directors, including at least two independent directors, to establish compensation policies and programs for our directors and executive officers. Currently, our executive compensation committee is comprised all members of our board of directors. Prior to the adoption of the plan of liquidation, the executive compensation committee served only to review recommendations of management for awarding stock option grants, restricted stock and other awards available under our two stock option plans and the 2004 incentive award plan. Pursuant to our plan of liquidation, as of February 27, 2006, all plans were terminated and all options under the plans were forfeited.
Special Committee
Effective February 8, 2004, the board of directors formed the special committee consisting of our independent directors to consider and review several proposed corporate transactions. Mr. Wallace was elected chairperson of the special committee. The special committee engaged an independent financial advisor and independent counsel to assist them in their review. On December 19, 2005, each of our special committee and our board of directors approved a plan of liquidation which was thereafter approved by our stockholders at the Special Meeting of Stockholders held on February 27, 2006.
Compensation of Directors
Effective June 29, 2004, we pay each independent and outside director an annual retainer fee of $15,000. In addition, each independent and outside director is paid the following fees for attending board of directors and committee meetings:
•
$1,000 per regular monthly board of directors meeting, whether in person or by telephone;
•
$500 per committee meeting, whether in person or by telephone, unless the committee meeting follows a regularly scheduled monthly board meeting; and
•
an additional $500 per committee meeting to the committee chairperson for each meeting attended in person or by telephone.
Prior to the adoption of our plan of liquidation, the independent and outside directors also qualified for the independent director stock option plan and 2004 incentive award plan. As of February 27, 2006, all stock option plans were terminated.
Our non-independent director did not receive any compensation from us.
The following table sets forth the compensation earned by our directors in 2006:
(1)
Consists of the amounts described below.
(2)
Mr. Thompson is not an independent director.
(3)
Our independent directors will become entitled to receive milestone payments, if they remain a member of our board of directors and the special committee, of $25,000 on each of December 31, 2006 and December 31, 2007, as well as a milestone payment of $50,000 when we have made aggregate liquidating distributions of at least $11.00 per share to our stockholders. Assuming that these directors receive the maximum amount of milestone payments, they will each receive aggregate payments of up to $100,000.
Independent Director Stock Option Plan
On July 22, 2002, we adopted the independent director stock option plan, or Director Plan, which was approved by our stockholders at our annual meeting on June 28, 2003. We had authorized and reserved a total of 100,000 shares of common stock for issuance under the Director Plan. The Director Plan provided for the grant of options to purchase 5,000 shares of common stock to each independent or outside director as of the
date such individual became a director, and subsequent grants of options to purchase 5,000 shares of common stock on the date of each annual meeting of stockholders to each independent and outside director still in office. No options were granted during the years ended December 31, 2006 and 2005. As of December 31, 2006 and 2005, there were 0 and 80,000 options outstanding, respectively, for the purchase of 0 and 80,000 shares of our common stock, respectively. During the years ended December 31, 2006 and 2005, no options were exercised under this plan. Upon approval of our plan of liquidation by stockholders on February 27, 2006, all outstanding options were forfeited for no consideration and the Director Plan was terminated.
Officer and Employee Stock Option Plan
On July 22, 2002, we adopted the officer and employee stock option plan, or Officer Plan. We authorized and reserved a total of 400,000 shares of common stock for issuance under the Officer Plan. No options were granted during the years ended December 31, 2006 and 2005. As of December 31, 2006 and 2005, our officers had options outstanding for the purchase of 0 and 340,000 shares of our common stock, respectively. During the years ended December 31, 2006 and 2005, no options were exercised under this plan. Upon approval of our plan of liquidation by stockholders on February 27, 2006, all outstanding options were forfeited for no consideration and the Officer Plan was terminated.
Incentive Award Plan
On May 10, 2004, we adopted the 2004 incentive award plan, or 2004 Plan, to provide for equity awards to our employees, directors and consultants, which was approved at our Annual Meeting of Stockholders on June 29, 2004. The 2004 Plan authorized the grant of options to our employees, directors and consultants intended to qualify as incentive stock options under Section 422 of the Code. The 2004 Plan also authorized the grant of awards consisting of nonqualified stock options, restricted stock, stock appreciation rights and other awards, including cash bonuses. The aggregate number of shares of common stock subject to such awards was not to exceed 6,000,000 shares of our common stock. Our board of directors administered the 2004 Plan. The 2004 Plan provided that each of our non-employee directors would receive an automatic grant of 5,000 shares of restricted stock on the date of each of our annual meetings.
As of December 31, 2006 and 2005 there were 55,000 restricted shares of common stock granted. Restricted shares vested at 20.0% per year on each of the first through fifth anniversaries of the grant date, or sooner upon a change of control of our company. Compensation expense related to the restricted stock awards under the 2004 Plan is recorded over the related vesting periods based on the fair value of the underlying awards. Included in the general and administrative expenses in the accompanying consolidated statement of operations is compensation expense of $98,000 for the year ended December 31, 2005, related to such awards. During the year ended December 31, 2005, 4,000 restricted shares vested. The 2004 Plan was terminated upon approval of our plan of liquidation by stockholders on February 27, 2006 and all outstanding restricted shares became fully vested.
Under the liquidation basis of accounting, the accelerated vesting of the restricted shares did not change the net assets available for liquidation. In addition, the forfeitures of all the outstanding vested and unvested stock options did not change net assets available for liquidation. SFAS No. 123(R), Share-Based Payment, did not have any impact on the net assets in liquidation during the year ended December 31, 2006.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our officers and directors, and persons who own 10.0% or more of our common stock, to report their beneficial ownership of our common stock (and any related options) to the SEC. Their initial reports must be filed using the SEC’s Form 3 and they must report subsequent stock purchases, sales, option exercises and other changes using the SEC’s Form 4, which must be filed within two business days of most transactions. In some cases, such as changes in ownership arising from gifts and inheritances, the SEC allows delayed reporting at year-end on Form 5. Officers, directors and stockholders owning more than 10.0% of our common stock are required by SEC regulations to furnish us with copies of all of reports they file pursuant to Section 16(a). We have made the services of our legal counsel available to our officers and directors to assist them in meeting their filing obligations.
Based solely on our review of copies of these reports filed by or on behalf of our officers and directors (or oral representations that no such reports were required) as of March 20, 2007, we believe that all Section 16(a) filing requirements applicable to our reporting persons during 2006 were complied with.
Code of Business Conduct and Ethics
We have adopted a Code of Business Conduct and Ethics, or the Code of Ethics, which contains general guidelines for conducting our business and is designed to help directors, employees and independent consultants resolve ethical issues in an increasingly complex business environment. The Code of Ethics applies to all directors, consultants and employees, including our Chief Executive Officer and the Chief Accounting Officer and any other employee with any responsibility for the preparation and filing of documents with the SEC. The Code of Ethics covers topics including, but not limited to, conflicts of interest, confidentiality of information, and compliance with laws and regulations. Stockholders may request a copy of the Code of Ethics, which will be provided without charge, by writing to G REIT, Inc. at 1551 N. Tustin Avenue, Suite 200, Santa Ana, California 92705, Attention: Secretary.
Item 11.
Item 11.
Executive Compensation.
Compensation of Executive Officers
We have no employees and our executive officers are all employees of our Advisor and/or its affiliates. These executive officers are compensated by our Advisor and/or its affiliates and have not received any compensation from us for their services other than as listed in the table below.
SUMMARY COMPENSATION TABLE
(1)
In accordance with our plan of liquidation approved by our stockholders, we will pay Scott D. Peters, our Chief Executive Officer and President, and Andrea R. Biller, our Executive Vice President and Secretary, retention bonuses of $50,000 and $25,000, respectively, upon the filing of each of our annual and quarterly reports with the SEC during the period of the liquidation process, beginning with the annual report for the year ending December 31, 2005. As of December 31, 2006, Mr. Peters and Ms. Biller have
received retention bonuses of $200,000 and $100,000 from us, respectively. Additionally, our Advisor will pay to each of Scott D. Peters and Andrea R. Biller a performance-based bonus of $100,000 upon the receipt by our Advisor of net commissions aggregating $5,000,000 or more from the sale of our properties. As of December 31, 2006, Mr. Peters and Ms. Biller have not received their performance-based bonuses of $100,000 each from our Advisor.
Option/SAR Grants in Last Fiscal Year
Pursuant to our plan of liquidation, our equity compensation plans and any outstanding options were forfeited as of February 27, 2006.
Compensation Committee Interlocks and Insider Participation
During 2006, all of our directors served on the executive compensation committee.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
PRINCIPAL STOCKHOLDERS
The following table shows, as of March 20, 2007, the number and percentage of shares of our common stock owned by (1) any person who is known by us to be the beneficial owner of more than 5.0% of our outstanding shares of common stock, (2) our chief executive officer (3) each director and (4) all directors and executive officers as a group.
*
Represents less than 1.0% of the outstanding common stock.
(1)
All outstanding options were forfeited on February 27, 2006 pursuant to the adoption of our plan of liquidation by stockholders.
(2)
Includes 6,175 shares of our common stock owned by AWT Family LP, a limited partnership 70.0% owned by Mr. Thompson and 23,138 shares of our common stock owned by our Advisor.
Equity Compensation Plan Information
In accordance with the adoption of our plan of liquidation by our stockholders on February 27, 2006, all of the plans were terminated and all outstanding options and warrants under the plans were forfeited and all restricted stock awards under the 2004 Incentive Award Plan became fully vested.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
Our Advisor is primarily responsible for managing our day-to-day business affairs and assets and carrying out the directives of our board of directors. Our Advisor is a Virginia limited liability company that was formed in April of 1998 to advise syndicated limited partnerships, limited liability companies, and other
entities regarding the acquisition, management and disposition of real estate assets. Four of our executive officers are executive officers of our Advisor and all of our executive officers are employed and compensated by our Advisor or its parent company, NNN Realty Advisors. Moreover, Anthony W. Thompson, the Chairman of our board of directors, is the Chairman of the board of directors of NNN Realty Advisors. NNN Realty Advisors owns 100% of the equity interest in our Advisor. Mr. Thompson, our executive officers and executive officers of our Advisor collectively own approximately 35.0% of the equity interest in NNN Realty Advisors as of December 31, 2006.
Before the commencement of our initial offering, our Advisor purchased 22,000 shares of our common stock at a price of $9.05 per share for $200,000 in cash. Our Advisor intends to retain such shares while serving as our Advisor.
Advisory Agreement
Our Advisor bears the expenses incurred in connection with supervising, monitoring and inspecting real property or other assets owned by us (excluding proposed acquisitions) or otherwise relating to its duties under the Advisory Agreement. Such expenses include employing its personnel, rent, telephone, equipment and other administrative expenses. We reimburse our Advisor for certain expenses incurred, including those related to proposed acquisitions and travel expenses. However, we will not reimburse our Advisor for any operating expenses that, in any four consecutive fiscal quarters, exceed the greater of 2.0% of average invested assets or 25.0% of net income for such year. If our Advisor receives an incentive distribution, net income (for purposes of calculating operating expenses) excludes any gain from the sale of assets. Any amount exceeding the greater of 2.0% of average invested assets or 25.0% of net income paid to our Advisor during a fiscal quarter will be repaid to us within 60 days after the end of the fiscal year. We bear our own expenses for functions not required to be performed by our Advisor under the Advisory Agreement, which generally include capital raising and financing activities, corporate governance matters, and other activities not directly related to real estate properties and other assets. To date, except as disclosed below, no reimbursements have been made to our Advisor pursuant to the provisions of the Advisory Agreement.
The Advisory Agreement expired on July 22, 2005, and is renewable every anniversary thereof for a one-year term. Based on the adoption of our plan of liquidation, our Advisor has agreed to continue to provide its services to us on a month-to-month basis pursuant to the terms of the expired Advisory Agreement. Under the terms of the Advisory Agreement, our Advisor has responsibility for our day to day operations, administers our accounting and bookkeeping functions, serves as a consultant in connection with policy decisions to be made by our board of directors, manages our properties and renders other services deemed appropriate by our board of directors. Our Advisor bears expenses incurred for the performance of its services and is entitled to reimbursement subject to certain limitations. Fees and costs reimbursed to our Advisor cannot exceed the greater of 2.0% of average invested assets or 25.0% of net income for the previous four quarters. As of December 31, 2006, 2005 and 2004, such reimbursement had not exceeded these limitations. During the years ended December 31, 2006, 2005 and 2004, we reimbursed our Advisor for expenses of $2,830,000, $2,941,000 and $1,711,000, respectively, related to our operations. During the years ended December 31, 2006, 2005, and 2004, we paid our Advisor $0, $0, and $1,804,000, respectively, for organizational and offering expenses.
Pursuant to the Advisory Agreement, our Advisor or its affiliate is entitled to receive the following payments and fees described below. These payments and fees were not negotiated at arm’s length and may be higher than payments and fees that would have resulted from an arm’s length transaction with an unrelated entity. Certain fees paid to Realty were passed through to our Advisor pursuant to an agreement between our Advisor and Realty, or the Realty-Triple Net Agreement.
Real Estate Acquisition Fee
Prior to the adoption of our plan of liquidation, our Advisor or its affiliate was entitled to a real estate acquisition fee of up to 3.0% of the purchase price of a property. For the years ended December 31, 2006, 2005 and 2004, we paid $0, $448,000 and $13,315,000, respectively, to Realty for real estate acquisition fees.
Real Estate Disposition Fee
Prior to the adoption of our plan of liquidation, our Advisor or its affiliate was entitled to a real estate disposition fee equal to the lesser of 3.0% of the sales price or 50.0% of the sales commission that would have been paid to third-party sales broker. For properties sold after the adoption of our plan of liquidation, we anticipate paying our Advisor or its affiliate a real estate disposition fee of up to 1.5% of the sales price of the property. For the years ended December 31, 2006, 2005 and 2004, we paid Realty, our Advisor or its affiliate $6,713,000, $1,115,000, and $0 for real estate disposition fees.
Lease Commissions
We pay our Advisor or its affiliate a leasing commission for its services in leasing any of our properties of 6.0% of the value of any lease (based upon the contract rent during the term of the lease) entered into during the term of the Advisory Agreement and 3.0% with respect to any renewals. For the years ended December 31, 2006, 2005 and 2004, we paid Realty leasing commissions of $3,705,000, $2,756,000 and $869,000, respectively.
Property Management Fees
We pay our Advisor or its affiliate a property management fee of 5.0% of the gross revenues from our properties. For the years ended December 31, 2006, 2005 and 2004, we incurred and paid property management fees to Realty of $4,811,000, $5,617,000, and $4,293,000, respectively.
Incentive Distributions
Our Advisor owns non-voting incentive performance units in our Operating Partnership and is entitled to incentive distributions of operating cash flow, as defined, after our stockholders have received an 8.0% annual return on their invested capital. No incentive distributions were made to our Advisor for the years ended December 31, 2006, 2005 and 2004. In accordance with our plan of liquidation, the estimated incentive fee distribution to our Advisor is between $0 and $9,070,000. Based on the valuation of our portfolio as of December 31, 2006 and 2005, we have reserved for an estimated incentive fee distribution to our Advisor of $3,226,000 and $1,831,000, respectively.
Retention Bonuses and Milestone Payments
In accordance with our plan of liquidation approved by our stockholders, we will pay Scott D. Peters, our Chief Executive Officer and President, and Andrea R. Biller, our Executive Vice President and Secretary, retention bonuses of $50,000 and $25,000, respectively, upon the filing of each of our annual and quarterly reports with the SEC during the period of the liquidation process, beginning with the annual report for the year ending December 31, 2005. As of December 31, 2006, Mr. Peters and Ms. Biller have received retention bonuses of $200,000 and $100,000 from us, respectively. Additionally, our Advisor will pay to each of Scott D. Peters and Andrea R. Biller a performance-based bonus of $100,000 upon the receipt by our Advisor of net commissions aggregating $5,000,000 or more from the sale of our properties. As of December 31, 2006, Mr. Peters and Ms. Biller have not received their performance-based bonuses of $100,000 each from our Advisor.
D. Fleet Wallace, W. Brand Inlow, Edward A. Johnson, Gary T. Wescombe and Gary H. Hunt, our independent directors and members of our board of directors and the special committee, are entitled to receive milestone payments, if they remain a member of our board of directors and the special committee, of $25,000 on each of December 31, 2006 and December 31, 2007, as well as a milestone payment of $50,000 when we have made aggregate liquidating distributions of at least $11.00 per share to our stockholders. Assuming that these directors receive the maximum amount of milestone payments, they will each receive aggregate payments of up to $100,000. As of December 31, 2006, based upon the satisfaction of performance milestones, each of Messrs. Wallace, Inlow, Johnson, Wescombe and Hunt have earned milestone payments of $25,000 each. The milestone payment of $25,000 to each of Messrs. Wallace, Inlow, Johnson, Wescombe and Hunt was paid in January 2007.
Dealer Manager Agreement
We entered into a dealer manager agreement, or the Dealer Manager Agreement, with NNN Capital Corp. whereby NNN Capital Corp. served as the managing broker dealer for each of our offerings. During the period of our offerings, NNN Capital Corp. was 100.0% owned by Anthony W. Thompson. Pursuant to the terms of the Dealer Manager Agreement, for the years ended December 31, 2006, 2005 and 2004, we incurred and paid $0, $0 and $25,149,000, respectively, of selling commissions and marketing and due diligence fees.
Real Estate Commissions
In August 2006, Jeffrey T. Hanson was appointed to serve as a member of the then Board of Managers and the Managing Director-Real Estate of our Advisor and the President and Chief Executive Officer of Realty. Prior to his employment with our Advisor and Realty, Mr. Hanson was employed with Grubb & Ellis Co. In connection with his previous employment with Grubb & Ellis Co., and subsequent to his employment with our Advisor and Realty, Mr. Hanson has been or will be paid real estate commissions relating to transactions involving properties sold by us of approximately $329,000.
Related Party Accounts Receivable/Payable
Related party accounts receivable consists primarily of amounts due to us from our Advisor and affiliates. Related party accounts payable consists primarily of amounts due from us to our Advisor and affiliates.
Unconsolidated Debt Due to Related Parties
Our properties may obtain financing through our Advisor and Cunningham Lending Group, LLC, or Cunningham, an affiliate of Mr. Thompson. As of December 31, 2006 and 2005, we did not have any notes outstanding.
Cunningham Lending Group, LLC
Park Sahara borrowed $40,000 in September 2005 at an interest rate of 8% per annum, which was due 30 days from origination. On October 14, 2005, Park Sahara repaid the note plus all accrued interest.
Triple Net Properties, LLC
Park Sahara had $44,000 due to our Advisor as of December 31, 2004. This unsecured note bore interest at 12.0% per annum and was due and payable upon demand. The note, plus all accrued interest was repaid on December 20, 2005 in conjunction with the sale of Park Sahara.
Business Relationships with Legal Counsel
Hirschler Fleischer, a Professional Corporation, or Hirschler Fleischer, acts as legal counsel to us. During the year ended December 31, 2006, we paid legal fees to Hirschler Fleischer in the amount of $215,000. Mr. Rogers, the President of our Advisor since August 2004, has been a member of Hirschler Fleischer since 1988, was a shareholder from 1994 to December 31, 2004, and since January 2005, has served as their senior counsel. As senior counsel, Mr. Rogers received compensation from Hirschler Fleischer attributable to fees paid by us and our Advisor to Hirschler Fleischer.
Item 14.
Item 14.
Principal Accounting Fees and Services.
Deloitte & Touche, LLP, or Deloitte, has served as our independent auditors since February 8, 2004 and has audited our financial statements for the years ended December 31, 2006, 2005 and 2004.
The following table lists the fees for services rendered by the independent auditors for 2006 and 2005:
(1)
Audit fees billed in 2006 and 2005 consisted of the audit of our annual financial statements, acquisition audits, reviews of our quarterly financial statements, and statutory and regulatory audits, consents and other services related to filings with the SEC.
(2)
Audit-related fees billed in 2006 and 2005 consisted of financial accounting and reporting consultations.
(3)
Tax services billed in 2006 and 2005 consisted of tax compliance and tax planning and advice.
The audit committee has determined that the provision by Deloitte of non-audit services for us in 2006 is compatible with Deloitte’s maintaining its independence.
The audit committee has approved Deloitte to perform the following non-audit services for us during 2006:
•
consultations and consents related to SEC filings and registration statements;
•
consultation of accounting matters; and
•
tax planning and tax compliance for the U.S. income and other taxes.
The audit committee pre-approves all auditing services and permitted non-audit services (including the fees and terms thereof) to be performed for us by our independent auditor, subject to the de minims exceptions for non-audit services described in Section 10A(i)(1)(B) of the Exchange Act and the rules and regulations of the SEC.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements:
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(a)(2) Financial Statement Schedules:
The following financial statement schedules for the year ended December 31, 2006 are submitted herewith:
All schedules other than the ones listed above have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
(a)(3) Exhibits:
The exhibits listed on the Exhibit Index (following the signatures section of this report) are included, or incorporated by reference, in this annual report.
(b) Exhibits:
See Item 15(a)(3) above.
(c) Financial Statement Schedules:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of G REIT, Inc.
We have audited the accompanying consolidated statements of net assets in liquidation of G REIT, Inc. and subsidiaries (the “Company”) as of December 31, 2006 and 2005 and the related consolidated statement of changes in net assets in liquidation for the year ended December 31, 2006. In addition, we have audited the related consolidated statements of operations and comprehensive income, stockholders’ equity and cash flows for the years ended December 31, 2005 and 2004. Our audits also include the consolidated financial statement schedules listed in the index to the consolidated financial statements. These financial statements and financial statement schedules 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 audit 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 audits 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 also 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.
As described in Note 2 to the consolidated financial statements, the stockholders of the Company approved a plan of liquidation and, as a result, the Company has changed its basis of accounting to the liquidation basis effective December 31, 2005.
In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated statements of net assets in liquidation of G REIT, Inc. and subsidiaries as of December 31, 2006 and 2005 and the related consolidated statement of changes in net assets in liquidation for the year ended December 31, 2006 applied on the basis described in the preceding paragraph and the related results of operations and cash flows for the years ended December 31, 2005 and 2004 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects, the information set forth therein.
/s/ Deloitte & Touche, LLP
Los Angeles, California
March 20, 2007
G REIT, INC.
CONSOLIDATED STATEMENTS OF NET ASSETS
(Liquidation Basis)
As of December 31, 2006 and 2005
The accompanying notes are an integral part of these consolidated financial statements.
G REIT, INC.
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
(Liquidation Basis)
For the Year Ended December 31, 2006
The accompanying notes are an integral part of these consolidated financial statements.
G REIT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Going Concern Basis)
For the Years Ended December 31, 2005 and 2004
The accompanying notes are an integral part of these consolidated financial statements.
G REIT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Going Concern Basis)
For the Years Ended December 31, 2005 and 2004
The accompanying notes are an integral part of these consolidated financial statements.
G REIT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Going Concern Basis)
For the Years Ended December 31, 2005 and 2004
The accompanying notes are an integral part of these consolidated financial statements.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2006, 2005 and 2004
The use of the words “we,” “us” or “our” refers to G REIT, Inc. and its subsidiaries, including G REIT, L.P., or our Operating Partnership, except where the context otherwise requires.
1.
Organization and Description of Business
We were incorporated on December 18, 2001 as G REIT, Inc. under the laws of the Commonwealth of Virginia and were qualified and elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code, for federal income tax purposes. On September 27, 2004, G REIT, Inc. was reincorporated in the State of Maryland in accordance with the approval of our stockholders at the 2004 Annual Meeting of Stockholders. We were originally organized to acquire, manage and invest in office, industrial and service real estate properties which have a government-tenant orientation. As described below, on February 27, 2006, our stockholders approved a plan of liquidation and eventual dissolution of our company. Accordingly, we are engaging in an ongoing liquidation of our assets. As of December 31, 2006, we owned interests in 15 properties aggregating a total gross leaseable area, or GLA, of 3.6 million square feet, including interests in 14 consolidated office properties and one unconsolidated office property. As of December 31, 2006, 87.5% of the total GLA of our consolidated properties was leased and tenants with a government orientation occupied 32.4% of the total GLA.
We conduct business and own properties through G REIT, L.P., or our Operating Partnership, which was formed as a Virginia limited partnership in December 2001. As of December 31, 2006, we are the sole general partner of our Operating Partnership and have control over the affairs of our Operating Partnership. We own 100.0% of the equity interests therein, except for 100 incentive non-voting ownership units issued to Triple Net Properties, LLC, or Triple Net Properties, or our Advisor.
We are externally advised by Triple Net Properties which manages us pursuant to the terms of an advisory agreement, or the Advisory Agreement. Our Advisor is primarily responsible for managing our day-to-day operations and assets, subject to the supervision of our board of directors. The Advisory Agreement expired on July 22, 2005, and was not renewed for consecutive one-year terms. However, our Advisor continues to manage us on a month-to-month basis pursuant to the terms of the Advisory Agreement. In view of the approval of our plan of liquidation by our stockholders discussed below, we do not intend to renew the existing Advisory Agreement for a one year term or execute a new advisory agreement. Our Advisor engages affiliated entities, including Triple Net Properties Realty, Inc., or Realty, to provide various services for our properties.
In the fourth quarter of 2006, NNN Realty Advisors Inc., or NNN Realty Advisors, acquired all of the outstanding ownership interests of Triple Net Properties, NNN Capital Corp. and Realty. NNN Realty Advisors was formed in September 2006 and is a full-service commercial real estate asset management and services firm. Anthony W. Thompson, our Chairman of the board of directors, is the founder of our Advisor, and the Chairman of the board of directors of NNN Realty Advisors and owns 25.9% of its outstanding common stock.
2.
Plan of Liquidation
On December 19, 2005, our board of directors approved a plan of liquidation which was thereafter approved by our stockholders at the Special Meeting of Stockholders held on February 27, 2006. Our plan of liquidation contemplates the orderly sale of all our assets, the payment of our liabilities and the winding up of operations and the dissolution of our company. We engaged Robert A. Stanger & Co., Inc. to perform financial advisory services in connection with our plan of liquidation, including rendering opinions as to whether our net real estate liquidation value range estimate and our estimated per share distribution range were reasonable. In December 2005, Stanger opined that our net real estate liquidation value range estimate and our estimated per share distribution range were reasonable from a financial point of view. Actual values realized
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
for assets and settlement of liabilities may differ materially from the amounts estimated by us or reflected in Stanger’s opinion.
We continually evaluate our existing portfolio and adjust our net real estate liquidation value accordingly. It is our policy that when we execute a purchase and sale agreement or become aware of market conditions or other circumstances that indicate that the present value of our properties materially differ from our expected net sales price, we will adjust our liquidation value accordingly.
Our plan of liquidation gives our board of directors the power to sell any and all of our assets without further approval by our stockholders and provides that liquidating distributions be made to our stockholders as determined by our board of directors. Although we can provide no assurances, we currently expect to sell all of our assets and anticipate completing our plan of liquidation by February 27, 2008. If we have not completed our plan of liquidation by December 31, 2007, we expect that we will have to provide management’s assessment of our internal control over financial reporting as of December 31, 2007 as part of our compliance with the Sarbanes Oxley Act of 2002. Further, while we expect to continue to qualify as a REIT until our dissolution, no assurance can be given that we will not lose or terminate our status as a REIT. As a result of the approval of our plan of liquidation by our stockholders, we adopted the liquidation basis of accounting as of December 31, 2005 and for all periods subsequent to December 31, 2005.
3.
Summary of Significant Accounting Policies
The summary of significant accounting policies presented below is designed to assist in understanding our consolidated financial statements. Such financial statements and accompanying notes are the representations of our management, who are responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America, or GAAP, in all material respects, and have been consistently applied in preparing the accompanying consolidated financial statements.
Use of Estimates
The preparation of our financial statements in conformity with GAAP and the liquidation basis of accounting requires management to make estimates and assumptions that affect the reported amounts of the assets, including net assets in liquidation, and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could differ, perhaps in adverse ways, and those estimates could be different under different assumptions or conditions from those estimates.
Principles of Consolidation
Our accompanying consolidated financial statements include our accounts and those of the Operating Partnership, the wholly owned subsidiaries of the Operating Partnership and any variable interest entities, as defined in Financial Accounting Standards Board, or FASB, Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, as revised, or FIN No. 46(R), that we have concluded should be consolidated. All significant intercompany balances and transactions have been eliminated in consolidation and all references to us include our operating partnership and its subsidiaries. Prior to the adoption of the plan of liquidation, we accounted for all unconsolidated real estate investments using the equity method of accounting. Accordingly, we reported our net equity in our proportionate share of the total investments in real estate as “Investments in unconsolidated real estate” on our consolidated balance sheet. We reported our proportionate share of the total earnings of our investments in unconsolidated real estate as “Equity in earnings of unconsolidated real estate” on our consolidated statement of operations.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Liquidation Basis of Accounting
As a result of the approval of our plan of liquidation by our stockholders, we adopted the liquidation basis of accounting as of December 31, 2005, and for all periods subsequent to December 31, 2005. Accordingly, all assets have been adjusted to their estimated fair value (on an undiscounted basis). Liabilities, including estimated costs associated with implementing our plan of liquidation, were adjusted to their estimated settlement amounts. Minority liabilities due to interests in properties held by tenants-in-common, or TICs, were offset against the respective properties. The valuation of real estate held for sale and investments in unconsolidated real estate is based on current contracts, estimates and other indications of sales value net of estimated selling costs. Estimated future cash flows from property operations were made based on the anticipated sales dates of the assets. Due to the uncertainty in the timing of the anticipated sales dates and the cash flows there from, operations may differ materially from amounts estimated. These amounts are presented in the accompanying statement of net assets. The net assets represent the estimated liquidation value of our assets available to our stockholders upon liquidation. The actual settlement amounts realized for assets and settlement of liabilities may differ materially, perhaps in adverse ways, from the amounts estimated.
We continually evaluate our existing portfolio and adjust our net real estate liquidation value accordingly. It is our policy that when we execute a purchase and sale agreement or become aware of market conditions or other circumstances that indicate that the present value of our properties materially differ from our expected net sales price, we will adjust our liquidation value accordingly.
Operating Properties
Prior to the adoption of our plan of liquidation, operating properties were carried at the lower of historical cost less accumulated depreciation or fair value. The cost of the operating properties included the cost of land and completed buildings and related improvements. Expenditures that increased the service life of properties were capitalized; the cost of maintenance and repairs was charged to expense as incurred. The cost of building and improvements were depreciated on a straight-line basis over the estimated useful lives of the buildings and improvements, ranging primarily from 15 to 39 years and the shorter of the lease term or useful life, ranging from one to 10 years for tenant improvements. When depreciable property was retired or disposed of, the related costs and accumulated depreciation were removed from the accounts and any gain or loss reflected in operations.
Prior to the adoption of our plan of liquidation, an operating property was evaluated for potential impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Impairment losses were recorded on long-lived assets used in operations. Impairment losses were recorded on an operating property when indicators of impairment were present and the carrying amount of the asset was greater than the sum of the future undiscounted cash flows expected to be generated by that asset. We would recognize an impairment loss to the extent the carrying amount exceeded the fair value of the property. We did not record any impairment losses for the years ended December 31, 2005 and 2004.
As of December 31, 2005, the operating properties were adjusted to fair value, less estimated costs to sell, through the adjustments to reflect the change to the liquidation basis of accounting. Subsequent to December 31, 2005, all changes in the estimated fair value of the operating properties, less estimated costs to sell, are adjusted to fair value with a corresponding change to our net assets in liquidation.
Property Held for Sale
Statement of Financial Accounting Standard, or SFAS, No. 144, Accounting for Impairment or Disposal of Long-Lived Assets, addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires that, in a period in which a component of an entity either has been disposed of or is classified as held for sale, the income statements for current and prior periods shall report the results of
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operations of the component as discontinued operations. Prior to the adoption of our plan of liquidation, we reclassified amounts related to the operating properties in the consolidated financial statements to reflect the reclassification required by SFAS No. 144.
Accordingly, revenues, operating costs and expenses, and other non-operating results for the discontinued operations of the operating properties have been excluded from our results from continuing operations for all periods presented herein. The financial results for the operating properties are presented in our consolidated statements of operations in a single line item entitled “Income (loss) from discontinued operations.”
Prior to the adoption of our plan of liquidation, in accordance with SFAS No. 144 at such time as a property was held for sale, such property was carried at the lower of (i) its carrying amount or (ii) fair value less costs to sell. In addition, a property being held for sale ceased to be depreciated. We classified operating properties as property held for sale in the period in which all of the following criteria were met:
•
management, having the authority to approve the action, committed to a plan to sell the asset;
•
the asset was available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets;
•
an active program to locate a buyer and other actions required to complete the plan to sell the asset had been initiated;
•
the sale of the asset was probable and the transfer of the asset was expected to qualify for recognition as a completed sale within one year;
•
the asset was being actively marketed for sale at a price that was reasonable in relation to its current fair value; and
•
given the actions required to complete the plan, it was unlikely that significant changes to the plan would be made or that the plan would be withdrawn.
Cash and Cash Equivalents
Cash and cash equivalents consist of all highly liquid investments with a maturity of three months or less when purchased. Certificates of deposit and short-term investments with remaining maturities of three months or less when acquired are considered cash equivalents.
Restricted Cash
Restricted cash is comprised of credit enhancements and impound reserve accounts for property taxes, insurance, capital improvements and tenant improvements. As of December 31, 2006 and 2005, we had restricted cash of $8,555,000 and $14,288,000, respectively.
Investments in Marketable Securities
Prior to the adoption of the liquidation basis of accounting, marketable securities were carried at fair value and consist primarily of investments in marketable equity securities. We classified our marketable securities portfolio as available-for-sale. Our portfolio was continually monitored for differences between the cost and estimated fair value of each security. If we believed that a decline in the value of an equity security was temporary in nature, we recorded the change in other comprehensive income (loss) in stockholders’ equity. If the decline was believed to be other than temporary, the equity security was written down to the fair value and a realized loss was recorded on our statement of operations. There were no realized losses recorded by us due to the write down in value for the years ended December 31, 2005 and 2004. Our assessment of a decline in value includes, among other things, our current judgment as to the financial position and future
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prospects of the entity that issued the security. If that judgment changes in the future, we may ultimately record a realized loss after having initially concluded that the decline in value was temporary.
As of December 31, 2005, the marketable securities were adjusted to fair value, less estimated costs to sell, through the adjustments to reflect the change to the liquidation basis of accounting. Subsequent to December 31, 2005, the marketable securities have been continually marked to fair value, less estimated costs to sell, with a corresponding change to our net assets in liquidation. As of December 31, 2006, we liquidated our investment in marketable securities.
Minority Interests
Minority interests relate to the tenant in common, or TIC, interests in the consolidated properties that are not wholly owned by us, which, as of December 31, 2006, amounted to a 22.4%, 21.5% and 2.3% interest in One Financial Plaza, Western Place I & II and Bay View Plaza, respectively. In accordance with the adoption of our plan of liquidation, we applied the minority interest liability of $5,349,000 and $5,973,000 as of December 31, 2006 and December 31, 2005, respectively, against the related assets and liabilities to properly reflect our portion of the estimated fair value of such assets.
Purchase Price Allocation
Prior to the adoption of our plan of liquidation, in accordance with SFAS No. 141, Business Combinations, we, with the assistance of independent valuation specialists, allocated the purchase price of acquired properties to tangible and identified intangible assets based on their respective fair values. The allocation to tangible assets (building and land) was based upon our determination of the value of the property as if it were vacant using discounted cash flow models similar to those used by independent appraisers. Factors considered by us included an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. Additionally, the purchase price of the applicable property was allocated to the above or below market value of in-place leases and the value of in-place leases and related tenant relationships.
The value allocable to the above or below market component of the acquired in-place leases was determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term, and (ii) our estimate of the amounts that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above market leases were included in the intangible in-place lease asset and below market lease values were included in intangible lease liability in the accompanying consolidated financial statements and were amortized to rental income over the weighted-average remaining term of the acquired leases with each property.
The total amount of other intangible assets acquired was further allocated to in-place lease costs and the value of tenant relationships based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant. Characteristics considered by us in allocating these values included the nature and extent of the credit quality and expectations of lease renewals, among other factors.
These allocations are subject to change based on information received within one year of the purchase related to one or more events identified at the time of purchase which confirm the value of an asset or liability received in an acquisition of property.
Tenant Receivables and Allowance for Uncollectible Accounts
Prior to the adoption of our plan on liquidation, tenant receivables and unbilled deferred rent receivables were carried net of the allowances for uncollectible current tenant receivables and unbilled deferred rent. An
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
allowance was maintained for estimated losses resulting from the inability of certain tenants to meet the contractual obligations under their lease agreements. Our determination of the adequacy of these allowances was based primarily upon evaluations of historical loss experience, individual tenant receivables considering the tenant’s financial condition, security deposits, letters of credit, lease guarantees and current economic conditions and other relevant factors. In accordance with our plan of liquidation, as of December 31, 2006 and 2005, we adjusted tenant receivables and deferred rent receivable to their net realizable value.
Real Estate Deposits
Real estate deposits were paid on properties we were evaluating for purchase. Real estate deposits were capitalized when paid and would become nonrefundable under certain circumstances. When properties were acquired, the deposits paid by us were applied at the time of purchase. When a decision was made not to acquire a property, any nonrefundable deposits were expensed at that time.
Other Assets
Prior to the adoption of our plan of liquidation, other assets consisted primarily of leasing commissions, deferred rent receivables, prepaid expenses and deposits. Costs incurred for property leasing were capitalized as deferred assets. Deferred leasing costs included leasing commissions that were amortized using the straight-line method over the term of the related lease. In accordance with the adoption of our plan of liquidation, deferred leasing costs and other assets were adjusted to their net realizable value as of December 31, 2006 and 2005, which was $0.
Deferred Financing Costs
Prior to the adoption of our plan of liquidation, financing costs consisted of loan fees and other deferred loan costs. Costs incurred for debt financing were capitalized as deferred assets. Deferred financing costs included amounts paid to lenders and others to obtain financing. Such costs were amortized over the term of the respective loan using a method that approximates the effective interest method. Amortization of deferred financing costs was included in interest expense in our consolidated statements of operations. In accordance with the adoption of our plan of liquidation, deferred financing costs were adjusted to their net realizable value as of December 31, 2006 and 2005, which was $0.
Derivative Financial Instruments
We are exposed to the effect of interest rate changes in the normal course of business. We seek to mitigate these risks by following established risk management policies and procedures which include the occasional use of derivatives. Our primary strategy in entering into derivative contracts is to minimize the volatility that changes in interest rates could have on its future cash flows. We employ derivative instruments, including interest rate swaps and caps, to effectively convert a portion of our variable-rate debt to fixed-rate debt. We do not enter into derivative instruments for speculative purposes.
Derivatives are recognized as either assets or liabilities in the balance sheet and measured at fair value in accordance with SFAS No. 133, Derivative Instruments and Hedging Activities. Changes in fair value are included as a component of interest expense in the consolidated statement of operations in the period of change.
Revenue Recognition
Prior to the adoption of our plan of liquidation, in accordance with SFAS No. 13, “Accounting for Leases,” minimum annual rental revenue was recognized on a straight-line basis over the term of the related lease (including rent holidays). Tenant reimbursement revenue, which is comprised of additional amounts
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recoverable from tenants for common area maintenance expenses and certain other recoverable expenses, was recognized as revenue in the period in which the related expenses are incurred. Rental revenue is recorded on the contractual basis under the liquidation basis of accounting for periods subsequent to the year ended December 31, 2005.
Concentration of Credit Risk
Financial instruments that potentially subject us to a concentration of credit risk are primarily cash investments and accounts receivable from tenants. Cash is generally invested in investment-grade short-term instruments and the amount of credit exposure to any one commercial issuer is limited. We have cash in financial institutions which is insured by the Federal Deposit Insurance Corporation, or FDIC, up to $100,000 per institution. As of December 31, 2006, we had cash accounts in excess of FDIC insured limits. We believe this risk is not significant. Concentration of credit risk with respect to accounts receivable from tenants is limited. We perform credit evaluations of prospective tenants and security deposits are obtained upon lease execution.
As of December 31, 2006, we had interests in five properties located in California which accounted for 42.4% of our total revenue and four properties located in Texas which accounted for 31.3% of our total revenue based on contractual base rent from leases in effect as of December 31, 2006. As of December 31, 2005, we had interests in eight properties located in California which accounted for 46.1% of our total revenue and seven properties located in Texas which accounted for 23.9% of our total revenue based on contractual base rent from leases in effect as of December 31, 2005. As of December 31, 2006 and 2005, none of our tenants accounted for 10.0% or more of our aggregate annual rental income.
Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of fair value of financial instruments, whether or not recognized on the face of the balance sheet, for which it is practical to estimate that value. SFAS No. 107 defines fair value as the quoted market prices for those instruments that are actively traded in financial markets. In cases where quoted market prices are not available, fair values are estimated using present value or other valuation techniques such as discounted cash flow analysis. The fair value estimates are made at the end of each year based on available market information and judgments about the financial instrument, such as estimates of timing and amount of expected future cash flows. Such estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument, nor do they consider that tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument.
Our consolidated statement of net assets and our balance sheet include the following financial instruments: cash and cash equivalents, marketable securities, tenant rent and other receivables, accounts payable and accrued expenses and notes payable. We consider the carrying values of cash and cash equivalents, tenant rent and other receivables and accounts payable and accrued expenses to approximate fair value for these financial instruments because of the short period of time between origination of the instruments and their expected realization. The fair value of payable to affiliates is not determinable due to its related party nature. Based on borrowing rates available to us as of December 31, 2006 and 2005, the fair value and the net settlement value of the mortgage loans payable were $225,836,000 and $350,402,000, respectively. The fair value and the net settlement value of the credit facility from LaSalle Bank National Association, or LaSalle, or the Credit Facility, as of December 31, 2006 and 2005 were $0 and $58,369,000, respectively. Marketable securities are carried at fair value in our consolidated financial statements. See Note 8 - “Investment in Marketable Equity Securities.”
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Income Taxes
We operate as a real estate investment trust for federal income tax purposes. As a REIT, we are generally not subject to income taxes. To maintain our REIT status, we are required to distribute annually as distributions at least 90.0% of our REIT taxable income for the year, as defined by the Internal Revenue Code of 1986, as amended, or the Code, to our stockholders, among other requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate tax rates. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income and property and federal income and excise taxes on our undistributed income. We believe that we have met all of the REIT distribution and technical requirements for the years ended December 31, 2006, 2005 and 2004 and were not subject to any federal income taxes. It is our present intention to continue to adhere to these requirements and maintain our REIT status until the liquidation is complete.
On June 14, 2004, we formed G REIT TRS, Inc., or TRS, a taxable REIT subsidiary. In general, a taxable REIT subsidiary may perform non-customary services for tenants, hold assets that we cannot hold directly and generally may engage in any real estate or non-real estate related business. Accordingly, through TRS we were subject to corporate federal income taxes on TRS taxable income of $1,000,000 for the year ended December 31, 2004. During the year ended December 31, 2004, income tax expense was $398,000 which related to the activities of the TRS.
Comprehensive Income
Prior to the adoption of our plan of liquidation, we reported comprehensive income in accordance with SFAS No. 130, Reporting Comprehensive Income. This statement defines comprehensive income as the changes in equity of an enterprise except those resulting from stockholders’ transactions. Accordingly, comprehensive income included certain changes in equity that are excluded from net income. Our only comprehensive income items were net income and the unrealized change in fair value of marketable securities. Subsequent to December 31, 2005, and in accordance with the adoption of our plan of liquidation, the unrealized change in fair value of marketable securities will be adjusted to our net assets in liquidation.
Per Share Data
Prior to the adoption of our plan of liquidation, we reported earnings per share pursuant to SFAS No. 128, “Earnings Per Share.” Basic earnings (loss) per share attributable for all periods presented are computed by dividing the net income (loss) by the weighted-average number of shares outstanding during the period. Diluted earnings (loss) per share are computed based on the weighted-average number of shares and all potentially dilutive securities, if any. Our potentially dilutive securities were options and non-vested restricted shares of stock. As of December 31, 2006, 2005 and 2004, there were 0, 420,000 and 420,000 options, respectively, which were accounted for under the treasury stock method. There were 0, 51,000 and 20,000 non-vested restricted shares of stock as of December 31, 2006, 2005 and 2004, respectively. Upon approval of our plan of liquidation by our stockholders, all outstanding options were forfeited on February 27, 2006. The options and restricted stock did not have a dilutive effect on earnings (loss) per share and, therefore, basic and diluted earnings (loss) per share were equivalent.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Net income (loss) per share is calculated as follows:
Stock Based Compensation
Prior to the adoption of our plan of liquidation, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure, we have elected to follow Accounting Principles Board Opinion, or APB, No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for our employee stock options. Under APB No. 25, compensation expense is recorded when the exercise price of employee stock options is less than the fair value of the underlying stock on the date of grant. We have implemented the disclosure-only provisions of SFAS No. 123 and SFAS No. 148. If we had elected to adopt the expense recognition provisions of SFAS No. 123 the impact on net income (loss) and earnings (loss) per share of common stock would have been as follows:
The pro forma amounts were determined by estimating the fair value of each option using the Black-Scholes option-pricing model, assuming a 7.5% dividend yield, a 3.5% to 4.4% risk-free interest rate based on the 10-year U.S. Treasury Bond at the date of issuance, an expected life of 10 years and a volatility rate of 10.0%.
We granted options to purchase 0, 0 and 315,000 shares of our common stock during the years ended December 31, 2006, 2005 and 2004, respectively. The fair value of the options granted during the years ended
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2006, 2005 and 2004 was $0, $0 and $355,000, respectively. Upon approval of our plan of liquidation, all outstanding options were forfeited on February 27, 2006.
SFAS No. 123(R), Share-Based Payment, requires that all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Our January 1, 2006 adoption of SFAS No. 123(R) did not have any impact on our net assets in liquidation during the year ended December 31, 2006.
Asset Retirement Obligations
In March 2005, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”, or FIN 47. FIN 47 clarifies guidance provided in FASB Statement No. 143, “Accounting for Asset Retirement Obligations.” The term asset retirement obligation refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Entities are required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 was effective as of the end of the first fiscal year ending after December 15, 2005. The adoption of the interpretation did not have a material effect on our consolidated financial statements.
Segments
We internally evaluate all of our properties as one industry segment and accordingly do not report segment information.
Recently Issued Accounting Pronouncements
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN No. 48. This interpretation, among other things, creates a two-step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN No. 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements. FIN No. 48 is effective for fiscal years beginning after December 15, 2006, in which the impact of adoption should be accounted for as a cumulative-effect adjustment to the beginning balance of retained earnings. We do not believe that the adoption of FIN No. 48 will have a material impact on our consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards, or SFAS, No. 157, Fair Value Measurement, or SFAS No. 157. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007. If we have not liquidated our company prior to the required adoption of SFAS No. 157, we will adopt SFAS No. 157 on January 1, 2008. We do not believe that the adoption of SFAS No. 157 will have a material effect on our consolidated financial statements.
In September 2006, the SEC released Staff Accounting Bulletin, or SAB, No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Current Year Misstatements, or SAB No. 108, to address diversity in practice regarding consideration of the effects of prior year errors when quantifying misstatements in current year financial statements. The SEC staff concluded that registrants should quantify
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
financial statement errors using both a balance sheet approach and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB No. 108 states that if correcting an error in the current year materially affects the current year’s income statement, the prior period financial statements must be restated. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 in the fourth quarter of 2006 did not have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS No. 159. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the fiscal year beginning on or before November 15, 2007, provided the provisions of SFAS No. 157 are applied. If we have not liquidated our company prior to the required adoption of SFAS No. 159, we will adopt SFAS No. 159 on January 1, 2008. We are evaluating SFAS No. 159 and have not yet determined the impact the adoption, if any, will have on our consolidated financial statements.
4.
Asset (Liability) for Estimated Receipts (Costs) in Excess of Estimated (Costs) Receipts During Liquidation
Under the liquidation basis of accounting, we are required to estimate the cash flows from operations and accrue the costs associated with implementing our plan of liquidation. We currently estimate that we will have operating cash inflows from our estimated receipts in excess of the estimated costs of liquidation. These amounts can vary significantly due to, among other things, the timing and estimates for executing and renewing leases, estimates of tenant improvements incurred and paid, the timing of the property sales, the timing and amounts associated with discharging known and contingent liabilities and the costs associated with the winding up of our operations. These costs are estimated and are expected to be paid out over the liquidation period. The change in the asset (liability) for estimated receipts (costs) in excess of estimated (costs) receipts during liquidation as of December 31, 2006 is as follows:
Accrued distributions to our stockholders included in the liability for estimated costs in excess of estimated receipts during liquidation at December 31, 2005 included the estimated monthly liquidating distributions at an annualized rate of 7.50% expected to be paid pursuant to our plan of liquidation. The cash payments in distributions to stockholders include distributions paid of $8,235,000 for the first quarter of 2006.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Subsequent to March 31, 2006, all distributions have been in the form of liquidating distributions and recorded when approved.
5.
Net Assets in Liquidation
The following is a reconciliation of total stockholders’ equity under the going concern basis of accounting to net assets in liquidation under the liquidation basis of accounting as of December 31, 2005:
Net assets in liquidation decreased $164,720,000, or $3.75 per share, during the year ended December 31, 2006. The primary reasons for the decrease in our net assets includes: (i) a decrease in real estate investments of $418,779,000, or $9.54 per share; (ii) a decrease in restricted cash of $5,733,000, or $0.13 per share; (iii) a decrease in investment in marketable securities of $7,617,000, or $0.17 per share; and (iv) a decrease in the liability for estimated costs in excess of estimated receipts during liquidation of $4,560,000, or $0.10 per share, resulting in an asset for estimated receipts in excess of estimated costs during liquidation as offset by (v) an increase in cash and cash equivalents of $69,639,000, or $1.59 per share; (vi) a decrease in mortgage loans payable and credit facility and other debt of $185,530,000, or $4.22 per share; (vii) a decrease in accounts payable and accrued liabilities of $5,614,000, or $0.13 per share; and (viii) a decrease in security deposits and prepaid rent of $2,360,000, or $0.05 per share.
The overall decrease in the value of real estate assets during the year ended December 31, 2006 includes: (i) a decrease due to the sale of our 600 B Street, Hawthorne Plaza, AmberOaks, Brunswig Square, Centerpointe Corporate Park, 5508 Highway 290, Department of Children and Family Campus, Public Ledger Building, Atrium Building and Gemini Plaza properties during the year ended December 31, 2006; (ii) decreases in the anticipated sales prices of our One World Trade Center and One Financial Plaza properties pursuant to executed purchase and sale agreements; and (iii) a decrease in the expected liquidation values of certain other properties; as offset by (i) an increase as a result of the anticipated sale of our Two Corporate Park property which closed on January 11, 2007; (ii) an increase as a result of the anticipated sales price of our Opus Plaza at Ken Caryl property pursuant to an executed purchase and sale agreement and (iii) an increase in the expected liquidation value of certain other properties. The increase in cash and cash equivalents is primarily due to the proceeds received on the sale of our properties which closed in the fourth quarter of 2006. The decrease in restricted cash, accounts payable and accrued liabilities, security deposits and prepaid rent, mortgage loans payable and our credit facility is primarily due to the sale of our properties during the year ended December 31, 2006. The decrease in investment in marketable securities is due to the liquidation of our investments in marketable securities during the year ended December 31, 2006.
The net assets in liquidation as of December 31, 2006 of $288,739,000, plus the liquidating distributions to our stockholders through December 31, 2006 of approximately $192,782,000 would result in liquidating distributions to our stockholders per share of approximately $10.96. These estimates for liquidating distributions to our stockholders per share include projections of costs and expenses expected to be incurred during the period required to complete the plan of liquidation. These projections could change materially based on the timing of sales, the performance of the underlying assets and any changes in the underlying assumptions of the projected cash flows.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6.
Real Estate Investments
Our real estate investments are comprised of consolidated properties and investments in unconsolidated real estate. As of December 31, 2006 and 2005, all of our consolidated properties are considered held for sale.
In accordance with our plan of liquidation, all of our consolidated properties are classified as properties held for sale. We had the following acquisitions and dispositions during the years ended December 31, 2006, 2005 and 2004:
Dispositions in 2006
We pay property disposition fees to Realty in connection with our disposition of properties. Certain disposition fees paid to Realty are passed through to our Advisor pursuant to the terms of the Realty-Triple Net Agreement.
600 B Street - San Diego, California
On July 18, 2006, we sold our 600 B Street property in San Diego, California, to Legacy Partners Realty Fund II, LLC, an unaffiliated third party, for a sales price of $95,500,000. Our cash proceeds were $91,730,000 after closing costs and other transaction expenses. A property disposition fee was paid to Realty of $1,433,000, or 1.5% of the sales price, and sales commissions to unaffiliated brokers of $573,000, or 0.6% of the sales price. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $755,000 as a result of the sale.
Hawthorne Plaza - San Francisco, California
On September 14, 2006, we sold our Hawthorne Plaza property in San Francisco, California, to TMG Partners, an unaffiliated third party, for a sales price of $125,000,000. Our cash proceeds were $68,261,000 after payment of the related mortgage loan, closing costs and other transaction expenses. A property disposition fee was paid to Realty of $1,875,000, or 1.5% of the sales price, and sales commissions to unaffiliated brokers of $750,000, or 0.6% of the sales price. The mortgage loan at the property of $51,719,000 was paid in full upon sale of the property. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $19,960,000 as a result of the sale.
AmberOaks - Austin, Texas
On September 29, 2006, we sold our AmberOaks property in Austin, Texas, to Chase Merritt, LP, an unaffiliated third party, for a sales price of $46,837,000. Our cash proceeds were $27,584,000 after payment of the related mortgage loan, closing costs and other transaction expenses. A property disposition fee was paid to Realty of $703,000, or 1.5% of the sales price, and sales commissions to unaffiliated brokers of $611,000, or 1.2% of the sales price. The mortgage loan at the property of $18,050,000 was paid in full upon sale of the property. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $5,268,000 as a result of the sale.
Brunswig Square - Los Angeles, California
On October 6, 2006, we sold our Brunswig Square property located in Los Angeles, California, to Jamison Properties Inc., an unaffiliated third party, for a sales price of $26,900,000. Our net cash proceeds were $9,639,000 after payment of the related mortgage loan, closing costs and other transaction expenses. A property disposition fee of $404,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $336,000, or 1.3% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $2,062,000 as a result of the sale.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Centerpoint Corporate Park - Kent, Washington
On October 17, 2006, we sold our Centerpoint Corporate Park property located in Kent, Washington, to Archon Acquisition, LLC, an unaffiliated third party, for a sales price of $77,525,000. Our net cash proceeds were $33,707,000 after payment of the related credit facility attributable to the Centerpoint Corporate Park property, closing costs and other transaction expenses. A property disposition fee of $1,163,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $465,000, or 0.6% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $17,173,000 as a result of the sale.
Highway 290 - Austin, Texas
On November 14, 2006, we sold our 5508 Highway 290 property located in Austin, Texas, to The Commons at Cliff Creek LTD, an unaffiliated third party, for a sales price of $10,200,000. We paid $862,000 upon the disposition of the property to pay off the related credit facility and to pay closing costs and other transaction expenses. A property disposition fee of $150,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $450,000, or 4.4% of the sales price, was also paid to unaffiliated brokers. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $705,000 as a result of the sale.
Department of Children and Family Campus - Plantation, Florida
On November 15, 2006, we sold our Department of Children and Family Campus property located in Plantation, Florida, to tenant in common, or TIC, investors managed by our Advisor for a sales price of $13,000,000. Our net cash proceeds were $2,898,000 after pay-off of the related credit facility and the payment of closing costs and other transaction expenses. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $3,147,000 as a result of the sale.
Public Ledger Building - Philadelphia, Pennsylvania
On November 22, 2006, we sold our Public Ledger Building property located in Philadelphia, Pennsylvania, to J Grasso Properties, LLC, an unaffiliated third party for a sales price of $43,000,000. Our net cash proceeds were $13,933,000 after pay-off of the related mortgage loan and the payment of closing costs and other transaction expenses. A property disposition fee of $645,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $430,000, or 1.0% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date increased by approximately $558,000 as a result of the sale.
Atrium Building - Lincoln, Nebraska
On December 15, 2006, we sold our Atrium Building property located in Lincoln, Nebraska, to Sequoia Investments XVIII, LLC, an unaffiliated third party for a sales price of $5,805,000. We paid $219,000 upon the disposition of the property to pay off the related mortgage loan and to pay closing costs and other transaction expenses. A property disposition fee of $87,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $174,000, or 3.0% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $480,000 as a result of the sale.
Gemini Plaza - Houston, Texas
On December 29, 2006, we sold our Gemini Plaza property located in Houston, Texas, to Manuchehr Khoshbin, an unaffiliated third party for a sales price of $17,000,000. Our net cash proceeds were $5,633,000
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
after pay-off of the related mortgage loan and the payment of closing costs and other transaction expenses. A property disposition fee of $255,000, or 1.5% of the sales price, was paid to Realty and a sales commission of $251,000, or 1.5% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets available in liquidation as of the sales date decreased by approximately $2,437,000 as a result of the sale.
Properties Under Contract
On August 17, 2006, we entered into an agreement to sell our One World Trade Center property located in Long Beach, California, to an unaffiliated third party for a sales price of $150,000,000. On September 21, 2006, we entered into an amendment to the agreement to include buyer’s written confirmation, after the expiration of the inspection period, of its desire to proceed with the purchase of the property in accordance with, and subject to, the terms of the agreement, or the Approval Notice, as defined and required under Section 6.1 of the agreement. Pursuant to such amendment and the agreement, buyer deposited an additional $1,000,000 in escrow towards the purchase price of the property. The amendment also replaced previously provided service contract, lease schedule, and personal property exhibits to the agreement and set forth additional provisions regarding elevator maintenance, estoppels, permits and disputed charges. On January 5, 2007, January 19, 2007, January 26, 2007, January 31, 2007, February 15, 2007, February 22, 2007 and February 28, 2007, we entered into amendments to the One World Trade Center Purchase and Sale Agreement to extend the closing date to January 22, 2007, January 26, 2006, January 31, 2007, February 15, 2007, February 22, 2007, February 28, 2007 and March 2, 2007, respectively. On March 2, 2007, we entered into a ninth amendment to the agreement. The material terms of the ninth amendment provide for: (i) a reduced purchase price of $148,900,000; (ii) the installation of a filtration system required by the National Pollutant Discharge Elimination System and Water Discharge Elimination System Permit; (iii) a closing date of March 28, 2007; (iv) deletions of any indemnity or release by the buyer relating to the pre-closing groundwater matters in the agreement, and similarly, release of seller for liability for any post-closing groundwater matters; (v) buyer’s acknowledgement that the reduction in the purchase price is intended as full compensation for all ongoing costs, testing, impact on the property, and risk of losses or liabilities arising from the post-closing groundwater matters; and (vi) seller’s delivery of estoppel certificates from tenants representing 75% of the leased square footage, including major tenants identified in the agreement as a closing condition. We anticipate that a property disposition fee will be paid to Realty of $2,250,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $900,000, or 0.6% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in the first quarter of 2007.
On March 1, 2007, we entered into an agreement to sell our One Financial Plaza property, located in St. Louis, Missouri, of which we own 77.63%, to an unaffiliated third party for a sales price of $47,000,000. We anticipate that a property disposition fee will be paid to Realty of $705,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $470,000, or 1.0% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in March or April 2007.
On March 16, 2007, we entered into an agreement to sell our Opus Plaza at Ken Caryl property, located in Littleton, Colorado, to an unaffiliated third party for a sales price of $10,400,000. We anticipate that a property disposition fee will be paid to our Advisor or its affiliate of $156,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $260,000, or 2.5% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in the second quarter of 2007.
Dispositions in 2005
We pay property disposition fees to Realty in connection with our disposition of properties. Certain disposition fees paid to Realty are passed through to our Advisor pursuant to the Realty-Triple Net Agreement.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
525 B Street - San Diego, California
On August 10, 2005, we sold the 525 B Street property located in San Diego, California to an unaffiliated third party, for a sales price of $116,000,000. In conjunction with the sale of the 525 B Street property, we paid off our existing cross-collateralized debt of $126,000,000 on the 525 B and 600 B Street properties. The sale resulted in us recording a gain of $10,550,000. A property disposition fee of $1,115,000, or 1.0% of the sales price, was paid to Realty and sales commissions of $862,000, or 0.7% of the sales price, was also paid to unaffiliated brokers.
Park Sahara - Las Vegas, Nevada
On December 20, 2005, the Park Sahara property in Las Vegas, Nevada, of which we own a 4.75% TIC interest, was sold to an unaffiliated third party for a total sales price of $17,455,000. We received net cash proceeds totaling approximately $273,000 after repayment of debt, closing costs and other transaction expenses. The sale resulted in us recording a net gain of approximately $132,000. A property disposition fee of $320,000, or approximately 1.8% of the total sales price, was paid to Realty and sales commissions of $639,000, or approximately 3.7% of the total sales price, was also paid to unaffiliated brokers.
Acquisitions in 2005
We pay property acquisition fees to Realty in connection with our acquisition of properties. Certain acquisition fees paid to Realty are passed through to our Advisor pursuant to the Realty-Triple Net Agreement.
Opus Plaza at Ken Caryl - Littleton, Colorado
On September 12, 2005, through our wholly-owned subsidiary G REIT - Opus Plaza at Ken Caryl, LLC, we purchased a 100.0% interest in Opus Plaza at Ken Caryl, a single-story office building of 62,000 square feet of GLA located in Littleton, Colorado. The property was purchased from an unaffiliated third party for a purchase price of $10,176,000. The seller paid Realty a sales commission of $296,000, or 2.9% of the purchase price. At the time of acquisition, we obtained a first mortgage loan from LaSalle secured by the property in the amount of $6,700,000. The loan bears interest at a fixed rate of 5.24% per annum and its maturity date is October 1, 2015.
Eaton Freeway - Phoenix, Arizona
On October 21, 2005, through our wholly-owned subsidiary G REIT - Eaton Freeway Industrial Park, LLC, we purchased a 100.0% interest in Eaton Freeway, a four-building multi-tenant industrial complex totaling 62,000 of GLA square feet located in Phoenix, Arizona. The property was purchased from an unaffiliated third party for a purchase price of $7,588,000. We paid Realty a sales commission of $152,000, or 2.0% of the purchase price. At acquisition, we obtained a first mortgage loan secured by the property from Principal Bank in the amount of $5,000,000. The loan bears interest at a fixed rate of 5.21% per annum and the maturity date of the loan is May 1, 2011.
Acquisitions in 2004
We pay property acquisition fees to Realty in connection with our acquisition of properties. Certain acquisition fees paid to Realty are passed through to our Advisor pursuant to the Realty-Triple Net Agreement.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2004, our investment in consolidated real estate consisted of 23 properties, which represents an increase of 12 properties from December 31, 2003. Our 2004 acquisitions are as follows:
(1)
Represents the amount of the mortgage loan assumed by us upon the closing of the acquisition by us or newly placed on the property at closing.
(2)
Realty, an affiliate of our Advisor, which was solely owned by Anthony W. Thompson, through December 31, 2004 (At December 31, 2005, Mr. Thompson owned 84.0% of Realty).
(3)
Our TIC ownership interest.
During the year ended December 31, 2004, we completed the acquisition of ten wholly-owned properties and two TIC interests in two properties with TIC interests of 78.5% and 77.6%, adding a total of 3,798,000 square feet of GLA to our property portfolio. The aggregate purchase price of these properties was $536,755,000, of which $327,038,000 was financed with mortgage debt. We paid $13,315,000 in commissions to Realty in connection with these acquisitions. In accordance with SFAS No. 141, we allocated the purchase price of these properties to the fair value of the assets acquired and the liabilities assumed, including the allocation of the intangibles associated with the in-place leases considering the following factors: lease origination costs; tenant relationships; and above or below market leases. During 2004, we have allocated and recorded $93,192,000 of intangible assets associated with in-place lease origination costs and tenant relationships, as well as above market leases. Such intangible assets are being amortized over the term of each of the underlying tenant leases ranging from 1 to 107 months. Total amortization of the lease intangible assets for 2005 and 2004 was $14,775,000 and $14,132,000, respectively. On certain acquisitions, we have recorded lease intangible liabilities related to the acquired below market leases of $23,433,000 during 2004. The lease intangible liabilities are being amortized over the term of each of the underlying tenant leases ranging from 2 to 123 months. Amortization of $3,349,000 and $5,406,000 was recorded for these lease intangibles during 2005 and 2004, respectively.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Investments in Unconsolidated Real Estate
Prior to the adoption of our plan of liquidation, investments in unconsolidated real estate consisted of our investments in undivided TIC interests. Under the liquidation basis of accounting all of our investments in unconsolidated real estate are recorded at estimated fair value less costs to sell.
The summarized condensed combined historical financial information of investments in our unconsolidated real estate is as follows:
7.
Restricted Cash
Restricted cash is comprised of credit enhancements and impound reserve accounts for property taxes, insurance, capital improvements and tenant improvements. As of December 31, 2006 and 2005, we had restricted cash of $8,555,000 and $14,288,000, respectively.
8.
Investment in Marketable Equity Securities
Sales of equity securities resulted in realized gains of $457,000 and realized losses of $17,000 for the year ended December 31, 2005. Sales of equity securities resulted in realized gains of $289,000 and realized losses of $38,000 for the year ended December 31, 2004. During the year ended December 31, 2006, our net assets in liquidation have decreased by $132,000 as a result of changes in the fair value of equity securities. As of December 31, 2006, we liquidated our investment in marketable securities.
9.
Mortgage Loans Payable
As of December 31, 2006, we had secured mortgage loans outstanding on 11 of our consolidated properties, representing aggregate indebtedness in the principal amount of $238,010,000 ($225,836,000 on a liquidation basis) consisting of $196,321,000 on a liquidation basis, or 86.9%, of fixed rate debt at a weighted-average interest rate of 5.32% per annum and $29,515,000 on a liquidation basis, or 13.1%, variable rate debt at a weighted-average interest rate of 7.86% per annum. As of December 31, 2005, we had secured mortgage loans outstanding on 17 of our consolidated properties, representing aggregate indebtedness in the principal amount of $362,580,000 ($350,402,000 on a liquidation basis) consisting of $269,062,000 on a liquidation basis, or 76.8%, of fixed rate debt at a weighted-average interest rate of 5.28% per annum and $81,340,000 on a liquidation basis, or 23.2%, variable rate debt at a weighted-average interest rate of 6.18% per annum. As of December 31, 2006 and 2005, the effective interest rates on mortgage loans ranged from 5.18% to 8.22% per annum and 5.08% to 7.19% per annum, respectively, and the weighted-average effective interest rate was 5.65% and 4.39% per annum, respectively. The loans mature at various dates through October 2015.
As of December 31, 2006 and 2005, we have adjusted the carrying values of the outstanding mortgage loans payable to the estimated settlement amount in the consolidated statements of net assets. The adjusted amount excludes that portion of the mortgage debt attributable to the minority ownership interest in the property.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Our properties financed by borrowings are required by the terms of the applicable loan documents to meet certain minimum loan to value, debt service coverage, performance covenants and other requirements on a combined and individual basis. As of December 31, 2006, we were in compliance with all such covenants.
The principal payments due on notes payable for each of the next five years ending December 31 and thereafter are summarized as follows (liquidation basis):
Our Madrona and North Belt properties have loan documents with cross-default and cross-collateralization provisions. In accordance with the loan documents, defeasance is prohibited during a lockout period that expires on April 30, 2007. During the lockout period, the loans can be assumed by the same buyer, but cannot be assumed by two separate buyers. In accordance with the loan documents, simultaneous defeasance by two separate buyers can occur during the open period beginning May 1, 2007. Such provisions in the loan documents may interfere with our ability to sell the Madrona and North Belt properties during the lockout period.
Derivatives are recognized as either assets or liabilities in the consolidated balance sheet and measured at fair value in accordance with SFAS No. 133, Derivative Instruments and Hedging Activities. Changes in fair value are included as a component of interest expense in the statement of operations in the period of change. We recorded $226,000 as an increase to interest expense for the year ended December 31, 2005 and $347,000 as a reduction to interest expense for the year ended December 31, 2004 for interest rate swaps and collars. We did not have any derivative financial instruments as of December 31, 2006 and 2005.
10.
Credit Facility and Other Debt
Credit Facility
In January 2003, we obtained the Credit Facility which matured on January 30, 2006. As of December 31, 2005, the terms of the Credit Facility, as amended, provided for maximum potential borrowings of $175,000,000 to the extent we have secured properties with comparable equity. Advances under this Credit Facility bear interest, at our election, at either the prime rate or the one-month LIBOR rate plus a margin of 2.25%. Advances are subject to a floor interest rate of 3.5%. We are required to make interest-only payments on a monthly basis. In connection with the terms of the Credit Facility, we granted LaSalle a right of first refusal to finance the purchase of other properties we may acquire.
On January 25, 2006, G REIT, Inc., as the general partner for G REIT, L.P., entered into a Second Amended and Restated Credit Agreement, or Amended Credit Agreement, for the Credit Facility in the amount of $58,369,000, with lenders: (i) LaSalle Bank National Association; (ii) Bank of America, National Association; and (iii) Citizens Financial Bank; with LaSalle acting as agent for the lenders. The Credit Facility matures on January 30, 2007. Advances under this Credit Facility are collateralized by our mortgaged properties and proceeds thereof. Advances bear interest, at our election, at the prime rate or the one-month LIBOR rate plus a margin of 2.25%, when we meet certain conditions, which include no default on advances,
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
and full compliance with the other covenants. The advances are subject to a floor rate of 3.5% and require interest only payments on a monthly basis.
The Amended Credit Agreement contains covenants that are comparable to those of other real estate investment trusts and facilitates our plan of liquidation which was thereafter approved by our stockholders on February 27, 2006. These covenants include, among others: a limitation on the incurrence of additional indebtedness; a limitation on mergers, investments, acquisitions, and dividend distributions; and maintenance of specified financial ratios. The Amended Credit Agreement contains normal events of default for an agreement of this type. The nonpayment of any outstanding principal, interest, fees or amounts due under the Credit Facility and the failure to perform or observe covenants in the loan documents, among other things, could result in events of default. Additionally, under the terms of the Amended Credit Agreement, at no time during the loan shall the borrowing base be made up of less than two properties or our minimum net worth equal to less than $150,000,000.
On October 17, 2006, we entered into a First Amendment to Second Amended and Restated Credit Agreement, or the Amendment, to our Amended Credit Agreement with LaSalle, Bank of America, and Citizens Financial Bank entered into on January 25, 2006. The material terms of the Amendment provide for the following: (i) the release of the Centerpoint Corporate Park property as a mortgaged property under the terms of the Amended Credit Agreement; (ii) that upon receipt of their proceeds, or the Proceeds, from the Release Price (as defined in the Amended Credit Agreement) resulting from the sale of Centerpoint Corporate Park property, Bank of America and Citizens Financial Bank will have received full payment of their Commitments (as defined in the Amended Credit Agreement); (iii) and that upon receipt of the Proceeds, Bank of America and Citizens Financial Bank shall no longer serve as lenders under the Credit Agreement and shall each deem any promissory notes or note assumptions they hold as paid in full and returned to us. On October 17, 2006, we paid down $39,900,000 on the Credit Facility in conjunction with the sale of our Centerpoint Corporate Park property. With the $39,900,000 payment, Bank of America and Citizens Financial Bank received full repayment of their Commitments and LaSalle received the remaining balance of the Release Price payment. As a result, the principal balance of LaSalle’s Commitment was $18,469,000 and Bank of America and Citizens Financial Bank are no longer lenders under the Credit Agreement. On November 14, 2006, we paid down $9,588,000 on the Credit Facility in conjunction with the sale of our 5508 Highway 290 property. We paid off the remaining principal balance on the Credit Facility of $8,881,000 in conjunction with the sale of our Department of Children and Family Campus property on November 15, 2006.
As of December 31, 2006, there were no borrowings under the Credit Facility. As of December 31, 2005, borrowings under the Credit Facility totaled $58,369,000 and bore interest at the interest rate of 6.34% per annum.
Other Debt
We have a Margin Securities Account with the Margin Lending Program at Merrill Lynch which allows us to purchase securities on margin. The margin is secured by the securities we purchase and cannot exceed 50.0% of the fair market value of the securities purchased. If the balance of the margin account exceeds 50.0% of the fair market value of the securities purchased, we will be subject to a margin call and required to fund the account to return the margin balance to 50.0% of the fair market value of the securities purchased. The Margin Securities Account bears interest at the Merrill Lynch based lending rate, subject to additional interest on a sliding scale based on the value of the margin account. During the year ended December 31, 2006, we borrowed $11,954,000 and repaid $14,549,000 on margin. During the year ended December 31, 2005, we borrowed $6,436,000 and repaid $3,841,000 on margin. As of December 31, 2006, we did not have any margin liabilities outstanding. As of December 31, 2005, we had $2,595,000 in margin liabilities outstanding at an interest rate of 7.75% per annum.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11.
Minority Interests
Minority interests relate to the TIC interests in the consolidated properties that are not wholly owned by us, which, as of December 31, 2006, amounted to a 22.4%, 21.5% and 2.3% interest in One Financial Plaza, Western Place I & II and Bay View Plaza, respectively. In accordance with the adoption of our plan of liquidation, we applied the minority interest liability of $5,349,000 and $5,973,000 as of December 31, 2006 and December 31, 2005, respectively, against the related assets and liabilities to properly reflect our portion of the estimated fair value of such assets.
We have the right to purchase all or any portion of the outstanding undivided TIC interest in Bay View Plaza at fair market value beginning as of July 31, 2006. We have the right to purchase all or any portion of the outstanding unrelated TIC interests in Western Place I & II and One Financial Plaza at fair market value beginning as of July 23, 2005 and August 6, 2005, respectively.
As of December 31, 2006, we have advanced $335,000 and $100,000 to our Bay View Plaza and Western Place I & II properties, respectively. In addition, as of December 31, 2006 the TICs at our Bay View Plaza and Western Place I & II properties received distributions of $9,000 and $113,000, respectively, while we have not received our pro rata share of such distributions. We expect to receive repayment of these advances and to reconcile the payment of distributions to TICs upon the sale of each of the respective properties pursuant to our plan of liquidation.
12.
Stockholders’ Equity
Common Stock
As of December 31, 2006, 2005 and 2004, 43,920,000, 43,869,000 and 43,865,000 shares of our common stock were outstanding, respectively. The aggregate gross proceeds to us before offering costs and selling commissions were $437,315,000 pursuant to our initial public offering, or Initial Offering, and our second public offering, or Second Offering. See Note 14 - “Related Party Transactions”. An aggregate of 22,000 shares of our common stock, or $200,000 of our common stock, were sold to our Advisor in accordance with the requirements of the North American Securities Administrators Association.
Pursuant to our Initial Offering, our limitation on all offering expenses is 15.0% of the gross offering proceeds. Effective October 17, 2002, our board of directors lowered the limitation on offering and organizational expenses to be borne by us on a prospective basis from 15.0% to 14.0% of the gross offering proceeds. Organizational and offering costs did not exceed these limitations during our Initial and Second Offerings.
In connection with our Initial Offering, we incurred $20,944,000 of costs related to the issuance and distribution of our common stock through December 31, 2004. Such amount includes $18,565,000 paid to NNN Capital Corp., the dealer manager of the Offering, a company 100.0% owned by Anthony W. Thompson during the offering period, principally comprised of selling commissions, marketing and due diligence costs. In addition, we paid $1,630,000 to our Advisor for reimbursement of offering expenses.
Beginning September 1, 2002, we began monthly distributions to stockholders of record as of the end of the preceding month at an annual rate of 7.00% of the per share purchase price to the extent of lawfully available funds. The distribution rate increased to 7.25% effective January 1, 2003 and to 7.50% effective June 1, 2003. Distribution rates were based on a $10.00 per share purchase price from September 1, 2002 through October 2006 and a $6.10 per share value remaining subsequent to October 2006. The declaration of distributions was at the discretion of our board of directors who determined the amount of distributions on a regular basis. On October 11, 2006, we paid a special liquidating distribution of $171,289,000, or $3.90 per share, to our stockholders of record as of September 30, 2006. While the plan of liquidation provided that monthly liquidating distributions would terminate following the payment of liquidating distributions totaling
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
$150,000,000, our board of directors has decided to continue the payment of monthly liquidating distributions at an annualized rate of 7.50% on the remaining share value of $6.10. Our board of directors will continue to evaluate the payment of regular monthly liquidating distributions on an on-going basis as more properties are sold and additional special liquidating distributions are paid to stockholders. Every payment of distributions will be subject to the availability of cash and the discretion of our board of directors. For the year ended December 31, 2006, we declared distributions of $201,017,000, which consisted of $8,235,000 in distributions declared prior to our stockholders approving our plan of liquidation on February 27, 2006 and $192,782,000 in liquidating distributions. For the year ended December 31, 2005, we declared distributions of $32,888,000. We did not have any distributions payable as of December 31, 2006 and 2005.
Dividend Reinvestment Program
In July 2002, we adopted a dividend reinvestment plan, or DRIP, that allowed our stockholders to purchase additional shares of common stock through reinvestment of dividends, subject to certain conditions. We registered and reserved 1,000,000 and 1,500,000 shares of our common stock for distribution pursuant to the DRIP in our Initial and Second Offerings, respectively. A total of 587,000 shares of our common stock were issued under the terms of the DRIP, which was terminated on April 30, 2004.
Share Repurchase Plan
Effective July 22, 2002, we adopted a share repurchase plan, or Repurchase Plan, which provided eligible stockholders with limited liquidity by enabling them to request the repurchase of their common stock by us subject to various limitations. Repurchases were made at the sole discretion of our board of directors. To be eligible to request a repurchase, a stockholder must have offered for resale at least 25.0% of the total number of shares of common stock owned and must have owned the shares for at least one year.
The price paid by us per repurchased share of common stock varied in accordance with the terms of the Repurchase Plan. Repurchases, if any, were affected by us on or about the last day of each calendar quarter. Funding for the Repurchase Plan came from our operations and DRIP. We repurchased 0, 0, and 18,000 shares of our common stock for $0, $0 and $164,000 for the years ended December 31, 2006, 2005 and 2004, respectively. The Repurchase Plan was terminated on April 30, 2004.
Stock Option Plans
Independent Director Stock Option Plan
On July 22, 2002, we adopted the independent director stock option plan, or Director Plan, which was approved by our stockholders at our annual meeting on June 28, 2003. We had authorized and reserved a total of 100,000 shares of common stock for issuance under the Director Plan. The Director Plan provided for the grant of options to purchase 5,000 shares of common stock to each independent or outside director as of the date such individual became a director, and subsequent grants of options to purchase 5,000 shares of common stock on the date of each annual meeting of stockholders to each independent and outside director still in office. No options were granted during the years ended December 31, 2006 and 2005. During the year ended December 31, 2004, we granted options to purchase 10,000 shares at $9.00 per share to each of the four independent and outside directors. As of December 31, 2006 and 2005, there were 0 and 80,000 options outstanding, respectively. During the year ended December 31, 2006, no options were exercised under this plan. Upon approval of our plan of liquidation by stockholders on February 27, 2006, all outstanding options were forfeited for no consideration and the Director Plan was terminated.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Officer and Employee Stock Option Plan
On July 22, 2002, we adopted the officer and employee stock option plan, or Officer Plan. We authorized and reserved a total of 400,000 shares of common stock for issuance under the Officer Plan. No options were granted during the years ended December 31, 2006 and 2005. During the year ended December 31, 2004, we granted options to purchase 275,000 shares of our common stock at $9.00 per share to our officers under the Officer Plan. As of December 31, 2006 and December 31, 2005, our officers had options outstanding for the purchase of 0 and 340,000 shares of our common stock, respectively. During the year ended December 31, 2006, no options were exercised under this plan. Upon approval of our plan of liquidation by stockholders on February 27, 2006, all outstanding options were forfeited for no consideration and the Officer Plan was terminated.
Incentive Award Plan
On May 10, 2004, we adopted the 2004 incentive award plan, or 2004 Plan, to provide for equity awards to our employees, directors and consultants, which was approved at our Annual Meeting of Stockholders on June 29, 2004. The 2004 Plan authorizes the grant of options to our employees, directors and consultants intended to qualify as incentive stock options under Section 422 of the Code. The 2004 Plan also authorizes the grant of awards consisting of nonqualified stock options, restricted stock, stock appreciation rights and other awards, including cash bonuses. The aggregate number of shares of common stock subject to such awards was not to exceed 6,000,000 shares of our common stock. Our board of directors administered the 2004 Plan. The 2004 Plan provided that each of our non-employee directors would receive an automatic grant of 5,000 shares of restricted stock on the date of each of our annual meetings.
As of December 31, 2006 and 2005 there were 55,000 restricted shares of common stock granted. Restricted shares vested at 20.0% per year on each of the first through fifth anniversaries of the grant date, or sooner upon a change of control of our company. Compensation expense related to the restricted stock awards under the 2004 Plan is recorded over the related vesting periods based on the fair value of the underlying awards. Included in the general and administrative expenses in the accompanying consolidated statement of operations is compensation expense of $98,000 and $21,000 for the years ended December 31, 2005 and 2004, respectively, related to such awards. During the year ended December 31, 2005, 4,000 restricted shares vested. The 2004 Plan was terminated upon approval of our plan of liquidation by stockholders on February 27, 2006 and all outstanding restricted shares became fully vested.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Under the liquidation basis of accounting, the accelerated vesting of the restricted shares did not change the net assets available for liquidation. In addition, the forfeitures of all the outstanding vested and unvested stock options did not change net assets available for liquidation nor the amount of net assets available for liquidation per share. SFAS No. 123(R), Share-Based Payment, did not have any impact on the net assets in liquidation during the year ended December 31, 2006
13.
Future Minimum Rent
Rental Income
We have operating leases with tenants that expire at various dates through 2016 and are either subject to scheduled fixed increases or adjustments based on the Consumer Price Index. Generally, the leases grant tenants renewal options. Leases also provide for additional rents based on certain operating expenses. Future minimum rent contractually due under operating leases, excluding tenant reimbursements of certain costs, as of December 31, 2006, are summarized as follows:
A certain amount of our rental income is from tenants with leases which are subject to contingent rent provisions. These contingent rents are subject to the tenant achieving periodic revenues in excess of specified levels. For the years ended December 31, 2006, 2005 and 2004, the amount of contingent rent earned by us was not significant.
14.
Related Party Transactions
Advisory Agreement
Advisory Fees
The Advisory Agreement between our Advisor and us expired on July 22, 2005. Based on the adoption of our plan of liquidation, our Advisor has agreed to continue to provide its services to us on a month-to-month basis pursuant to the terms of the expired Advisory Agreement. Under the terms of the Advisory Agreement, our Advisor has responsibility for our day-to-day operations, administers our accounting and bookkeeping functions, serves as a consultant in connection with policy decisions to be made by our board of directors, manages our properties and renders other services deemed appropriate by our board of directors. Our Advisor is affiliated with us in that we and our Advisor have common officers and a common director, some of whom also own an equity interest in our Advisor. Our Advisor is entitled to reimbursement from us for expenses incurred in rendering its services, subject to certain limitations. Fees and costs reimbursed to our Advisor cannot exceed the greater of 2.0% of average invested assets, as defined, or 25.0% of net income for the previous four quarters, as defined. As of December 31, 2006, 2005 and 2004, such reimbursement had not exceeded these limitations. For the years ended December 31, 2006, 2005, and 2004 we reimbursed our Advisor for expenses of $2,830,000, $2,941,000, and $1,711,000, respectively, related to our operations.
Pursuant to the Advisory Agreement, our Advisor or its affiliate is entitled to receive the following payments and fees described below. These payments and fees were not negotiated at arm’s length and may be
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
higher than payments and fees that would have resulted from an arm’s length transaction with an unrelated entity. Certain fees paid to Realty were passed through to our Advisor pursuant to an agreement between our Advisor and Realty, or the Realty-Triple Net Agreement.
Real Estate Acquisition Fee
Prior to the adoption of our plan of liquidation, our Advisor or its affiliates was entitled to a real estate acquisition fee of up to 3.0% of the purchase price of a property. For the years ended December 31, 2006, 2005 and 2004, we paid Realty, $0, $448,000 and $13,315,000, respectively, for real estate acquisition fees (Note 6).
Real Estate Disposition Fee
Prior to the adoption of our plan of liquidation, we paid Realty a real estate disposition fee equal to the lesser of 3.0% of the sales price or 50.0% of the sales commission that would have been paid to third-party sales broker, of which 75.0% was passed through to our Advisor pursuant to the Realty-Triple Net Agreement. We anticipate paying a real estate disposition fee of up to 1.5% of the sales price of the properties to be sold after adoption of our plan of liquidation. For the years ended December 31, 2006, 2005 and 2004, we paid real estate disposition fees to Realty of $6,713,000, $1,115,000 and $0, respectively.
Lease Commissions
We pay our Advisor or its affiliates a leasing commission for its services in leasing any of our properties of 6.0% of the value of any lease (based upon the contract rent during the term of the lease) entered into during the term of the Advisory Agreement and 3.0% with respect to any renewals. For the years ended December 31, 2006, 2005 and 2004, we paid Realty leasing commissions of $3,705,000, $2,756,000 and $869,000, respectively.
Property Management Fees
We pay our Advisor or its affiliates a property management fee of 5.0% of the gross revenues from our properties. For the years ended December 31, 2006, 2005 and 2004 we incurred and paid management fees to Realty of $4,811,000, $5,617,000 and $4,293,000, respectively.
Incentive Distributions
Our Advisor owns non-voting incentive performance units in G REIT, L.P., our Operating Partnership, and is entitled to incentive distributions of operating cash flow, as defined, after our stockholders have received an 8.0% annual return on their invested capital. No incentive distributions were made to our Advisor for the years ended December 31, 2006, 2005 and 2004. In accordance with our plan of liquidation, the estimated incentive fee distribution to our Advisor is between $0 and $9,070,000. Based on the valuation of our portfolio as of December 31, 2006 and 2005, we have reserved for an estimated incentive fee distribution to our Advisor of $3,226,000 and $1,831,000, respectively.
Retention Bonuses and Milestone Payments
In accordance with our plan of liquidation approved by our stockholders, we will pay Scott D. Peters, our Chief Executive Officer and President, and Andrea R. Biller, our Executive Vice President and Secretary, retention bonuses of $50,000 and $25,000, respectively, upon the filing of each of our annual and quarterly reports with the SEC during the period of the liquidation process, beginning with the annual report for the year ending December 31, 2005. As of December 31, 2006, Mr. Peters and Ms. Biller have received retention bonuses of $200,000 and $100,000 from us, respectively. Additionally, our Advisor will pay to each of Scott
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
D. Peters and Andrea R. Biller a performance-based bonus of $100,000 upon the receipt by our Advisor of net commissions aggregating $5,000,000 or more from the sale of our properties. As of December 31, 2006, Mr. Peters and Ms. Biller have not received their performance-based bonuses of $100,000 each from our Advisor.
D. Fleet Wallace, W. Brand Inlow, Edward A. Johnson, Gary T. Wescombe and Gary H. Hunt, members of our board of directors and the special committee, are entitled to receive milestone payments, if they remain a member of our board of directors and the special committee, of $25,000 on each of December 31, 2006 and December 31, 2007, as well as a milestone payment of $50,000 when we have made aggregate liquidating distributions of at least $11.00 per share to our stockholders. Assuming that these directors receive the maximum amount of milestone payments, they will each receive aggregate payments of up to $100,000. As of December 31, 2006, based upon the satisfaction of performance milestones, each of Messrs. Wallace, Inlow, Johnson, Wescombe and Hunt have earned milestone payments of $25,000. The milestone payment of $25,000 to each of Messrs. Wallace, Inlow, Johnson, Wescombe and Hunt was paid in January 2007.
Real Estate Commissions
As of August 2006, Jeffrey T. Hanson was appointed to serve as a member of the Board of Managers and the Managing Director-Real Estate of our Advisor and the president and chief executive officer of Realty. Prior to his employment with our Advisor and Realty, Mr. Hanson was employed with Grubb & Ellis Co. In connection with his previous employment with Grubb & Ellis Co., and subsequent to his employment with our Advisor and Realty, Mr. Hanson has been or will be paid real estate commissions relating to transactions involving properties sold by us of approximately $329,000.
Related Party Accounts Receivable/Payable
Related party accounts receivable consists primarily of amounts due to us from our Advisor and affiliates. Related party accounts payable consists primarily of amounts due from us to our Advisor and affiliates.
Unconsolidated Debt Due to Related Parties
Our properties may obtain financing through our Advisor and Cunningham Lending Group, LLC, or Cunningham, an affiliate of Mr. Thompson. As of December 31, 2006 and 2005, we did not have any notes outstanding.
Cunningham Lending Group, LLC
Park Sahara borrowed $40,000 in September 2005 at an interest rate of 8% per annum, which was due 30 days from origination. On October 14, 2005, Park Sahara repaid the note plus all accrued interest.
Triple Net Properties, LLC
Park Sahara had $44,000 due to our Advisor as of December 31, 2004. This unsecured note bore interest at 12.0% per annum and was due and payable upon demand. The note, plus all accrued interest was repaid on December 20, 2005 in conjunction with the sale of Park Sahara.
Offering Expenses
Selling Commissions
NNN Capital Corp., the dealer manager of our Offerings, or the Dealer Manager was wholly owned during the offering period by Anthony W. Thompson. Pursuant to the Dealer Manager Agreement, the Dealer Manager received selling commissions of 7.5% and 7.0% of the aggregate gross offering proceeds from our
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Initial and Second Offerings, respectively. The Dealer Manager received selling commissions from us of $0, $0 and $17,753,000 for the years ended December 31, 2006, 2005 and 2004, respectively. The Dealer Manager re-allowed 100.0% of commissions earned by it to participating broker dealers.
Marketing and Due Diligence Expense Reimbursement Fees
The Dealer Manager also received marketing and due diligence expense reimbursements from us of 2.0% and 3.0% of the aggregate gross offering proceeds from our Initial and Second Offerings, respectively. The Dealer Manager received marketing and due diligence expense reimbursement fees of $0, $0 and $7,396,000 for the years ended December 31, 2006, 2005 and 2004, respectively. The Dealer Manager may re-allow up to 1.0% of these fees paid by us to participating broker dealers.
Organization and Offering Expenses
Our Advisor bears some of our organization and offering costs incurred in our offerings. Our Advisor may be reimbursed by us for actual expenses incurred by it for up to 2.5% and 2.0% of the aggregate gross offering proceeds from our Initial and Second Offerings, respectively. Our Advisor was reimbursed $0, $0 and $1,804,000 for the years ended December 31, 2006, 2005 and 2004, respectively, for the reimbursement of organization and offering expenses incurred.
Business Relationships with Legal Counsel
Hirschler Fleischer, a Professional Corporation, or Hirschler Fleischer, acts as legal counsel to us. During the year ended December 31, 2006, we paid legal fees to Hirschler Fleischer in the amount of $215,000. Mr. Rogers, the President of our Advisor since August 2004, has been a member of Hirschler Fleischer since 1988, was a shareholder from 1994 to December 31, 2004, and since January 2005, has served as their senior counsel. As senior counsel, Mr. Rogers received compensation from Hirschler Fleischer attributable to fees paid by us and our Advisor to Hirschler Fleishcher.
Joint Venture
On June 15, 2004, through our wholly owned subsidiary, GREIT TRS, Inc., we formed NNN/GREIT-TRS JV, LLC, or the JV, a joint venture with our Advisor. We contributed $20,000,000, for an 87.2% ownership interest in the JV. The JV subsequently invested in NNN Emerald Plaza, LLC. The JV agreement required a guaranteed payment to us at the time the investment in NNN Emerald Plaza, LLC is sold to third parties. On July 14, 2004, following the sale to unaffiliated third parties, we received the $20,000,000 investment along with the guaranteed payment of $1,000,000 pursuant to the JV agreement. Such amount is included in the gain on sale of marketable securities and joint venture in the accompanying statement of operations.
15.
Commitments and Contingencies
Operating Leases
The 600 B Street (Comerica Building) property in San Diego was encumbered by two ground leases under portions of the office building. Both ground leases expire in 2012, with five options to extend for 10 years each, and no option to purchase. Rent increases every five years by the increase in the wholesale price index. The lease end dates are June 30, 2062 if all options are exercised. The total annual rent payment for both ground leases was $330,000 as of December 31, 2005. We sold the 600 B Street property on July 18, 2006.
The Sutter Square Galleria property is subject to a ground lease expiring in 2040 with one ten-year option period thereafter. Future minimum rents to be paid under this non-cancelable operating lease are computed at 12.5% of gross rents, as defined in the ground lease agreement.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Atrium Building property was encumbered by two ground leases under parts of the office building. One ground lease expires in 2015, with one 40-year extension option, and requires annual rental payments of $25,000. The other ground lease expires in 2014, with one 40-year extension option, and required annual rental payments of $16,000. We sold the Atrium Building property on December 15, 2006.
The aggregate ground lease rent for the years ended December 31, 2006, 2005 and 2004 was $372,000, $515,000 and $388,000, respectively. We do not have any future minimum ground lease obligations under noncancelable leases as of December 31, 2006 as a result of the sale of our 600 B Street and Atrium Building properties during the year ended December 31, 2006.
SEC Investigation
On September 16, 2004, our Advisor advised us that it learned that the SEC is conducting an investigation referred to as “In the matter of Triple Net Properties, LLC.” The SEC has requested information from our Advisor relating to disclosure in public and private securities offerings sponsored by our Advisor and its affiliates, or the Triple Net securities offerings (including offerings by us). The SEC has requested financial and other information regarding the Triple Net securities offerings and the disclosures included in the related offering documents.
Our Advisor is engaged in settlement negotiations with the SEC staff regarding this matter. Based on these negotiations, our Advisor believes that the conclusion to this matter will not result in a material adverse affect to its results of operations, financial condition or ability to conduct our business. The settlement negotiations are continuing, and any settlement negotiated with the SEC staff must be approved by the Commission. Since the matter is not concluded, it remains subject to the risk that the SEC may seek additional remedies, including substantial fines and injunctive relief against our Advisor that, if obtained, could materially adversely affect our Advisor’s ability to perform its duties to us and/or delay the payment of liquidating distributions to our stockholders under our plan of liquidation. The matters that are the subject of this investigation could also give rise to claims against our Advisor by investors in its existing real estate investment programs which could adversely affect our Advisor’s performance to us. At this time, we cannot assess how or when the outcome of the matter will be ultimately determined and its impact on us. Therefore, at this time, we have not accrued any loss contingencies in accordance with SFAS No. 5, Accounting for Contingencies.
Prior Performance Tables
In connection with our Initial and Second public offerings of common stock conducted through best efforts offerings from July 22, 2002 through April 30, 2004, we disclosed the prior performance of all public and private investment programs sponsored by our Advisor. Our Advisor determined that there were certain errors in those prior performance tables. In particular, the financial information in the tables was stated to be presented on a GAAP basis. Generally the tables for the public programs were not presented on a GAAP basis and the tables for the private programs were prepared and presented on a tax or cash accounting basis. Moreover, a number of the prior performance data figures were themselves erroneous, even as presented on a tax or cash basis. In particular, certain programs sponsored by our Advisor have invested either along side or in other programs sponsored by our Advisor. The nature and results of these investments were not fully and accurately disclosed in the tables. In addition, for the private programs certain calculations of depreciation and amortization were not on an income tax basis for a limited liability company investment; certain operating expenses were not reflected in the operating results; and monthly mortgage and principal payments were not reported. In general, the resulting effect is an overstatement of our Advisor’s program and aggregate portfolio operating results.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Revised prior performance tables reflecting corrected numbers and disclosures from those initially included in our prospectuses dated July 22, 2002 and January 23, 2004 were included in each of our definitive proxy statement and our Current Report on Form 8-K filed with the SEC on January 13, 2006.
Litigation
Neither we nor any of our properties are presently subject to any other material litigation nor, to our knowledge, is any material litigation threatened against us or any of our properties which if determined unfavorably to us would have a material adverse effect on our cash flows, financial condition or results of operations. We are a party to litigation arising in the ordinary course of business, none of which if determined unfavorably to us, individually or in the aggregate, is expected to have a material adverse effect on our cash flows, financial condition or results of operations.
Environmental Matters
We follow the policy of monitoring our properties for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist, we are not currently aware of any environmental liability with respect to the properties that would have a material effect on our financial condition, results of operations and cash flows. Further, we are not aware of any environmental liability or any unasserted claim or assessment with respect to an environmental liability that we believe would require additional disclosure or the recording of a loss contingency.
Unconsolidated Debt
Total mortgage debt of unconsolidated properties was $97,308,000 and $97,500,000 as of December 31, 2006 and 2005, respectively. Our share of unconsolidated debt, based on our ownership percentage, was $29,192,000 and $29,250,000 as of December 31, 2006 and 2005, respectively. The decrease of $192,000 in unconsolidated debt was due to principal payments made on the mortgage loan of our Congress Center property in 2006.
On December 21, 2006, we received a termination notice from Employer’s Reinsurance Corporation notifying us of their intent to exercise their option to terminate their lease effective January 1, 2008 at the Congress Center property. Pursuant to the Property Reserves Agreement with the lender, the lender is entitled to receive an early termination fee penalty of $3,800,000 from the borrower (all the owners of the Congress Center property) to be placed in a reserve account controlled by the lender. In addition, the lender is entitled to receive $225,000 on a monthly basis beginning January 1, 2007 and continuing through and including the payment date occurring on December 1, 2007 from the borrower. Beginning January 1, 2008 and continuing through and including the payment date occurring on December 1, 2011, the lender is entitled to receive $83,000 on a monthly basis from the borrower. In the event that the Congress Center property does not generate sufficient funds from operations to satisfy the monthly reserve payments to the lender, we, along with T REIT Inc. and NNN 2002 Value Fund, LLC, or our Affiliate co-owners, will advance the required amounts to the lender on behalf of the borrower. It is anticipated that upon the sale of the Congress Center property, we, along with our Affiliate co-owners will receive repayment of any advances made to the lender for reserves. All payments to the lender are to be placed in a reserve account to be held by the lender for reimbursement to the borrower for tenant improvement and leasing commissions incurred in connection with re-leasing the space.
Certain properties financed by borrowings are required by the terms of the applicable loan documents to meet certain minimum loan to value, debt service coverage, performance covenants and other requirements on a combined and individual basis. As of December 31, 2006, our unconsolidated property was in compliance with all such covenants.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other
Our commitments and contingencies include the usual obligations of real estate owners and operators in the normal course of business. In the opinion of management, these matters are not expected to have a material impact on our consolidated financial position and results of operations.
16.
Discontinued Operations - Properties Held for Sale
Prior to adoption of our plan of liquidation, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the net income and the net gain on dispositions of operating properties sold subsequent to December 31, 2004 classified as held for sale are reflected in the consolidated statement of operations as discontinued operations for all periods presented. In accordance with our plan of liquidation, all of our operating properties for all periods presented are considered discontinued operations. The following tables summarize the properties held for sale and income (loss) and expense components that comprise discontinued operations for the years ended December 31, 2005 and 2004:
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Intangible Assets
Amortization expense recorded on the identified intangible assets, for each of fiscal years ended December 31, 2005 and 2004 was $16,030,000 and $14,132,000, respectively.
As of December 31, 2005, all intangible assets and related accumulated amortization balances were adjusted to net realizable value.
Intangible Liabilities
Amortization expense recorded on the identified intangible liabilities, for each of fiscal years ended December 31, 2005 and 2004 was $4,604,000 and $5,406,000, respectively.
As of December 31, 2005, all intangible liabilities and related accumulated amortization balances adjusted to net settlement value.
17.
Tax Treatment of Distributions
The income tax treatment for distributions reportable for the years ended December 31, 2006, 2005 and 2004 was as follows:
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Subsequent to March 31, 2006, approximately $192,782,000, or $4.39 per share, of liquidating distributions to our stockholders were paid for the year ended December 31, 2006 and are treated by stockholders as proceeds from the sale of their stock.
18.
Business Combinations
During the year ended December 31, 2005, we completed the acquisition of two wholly-owned properties, adding a total of 124,000 square feet of GLA to our property portfolio. The aggregate purchase price of the two consolidated properties was $17,764,000, of which $11,700,000 was financed with mortgage debt. Realty was paid $448,000 in commissions in connection with these acquisitions. In accordance with SFAS No. 141, we allocated the purchase price to the fair value of the assets acquired and the liabilities assumed, including the allocation of the intangibles associated with the in-place leases considering the following factors: lease origination costs; tenant relationships; and above or below market leases. During 2005, we have allocated and recorded $2,846,000 of intangible assets associated with in-place lease origination costs and tenant relationships, as well as above market leases. In addition, we have recorded a lease intangible liability related to the acquired below market lease which aggregated $127,000 during 2005.
Assuming all of the 2005 acquisitions had occurred January 1, 2005, pro forma net income and net income/(loss) per diluted share would have been $2.4 million and $0.05 respectively, for the year ended December 31, 2005. The pro forma results are not necessarily indicative of the operating results that would have been obtained had the acquisitions occurred at the beginning of the periods presented, nor are they necessarily indicative of future operating results.
19.
Selected Quarterly Financial Data (Unaudited)
Set forth below is the unaudited selected quarterly financial data. We believe that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly, and in accordance with generally accepted accounting principles, the unaudited selected quarterly financial data when read in conjunction with the consolidated financial statements.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Subsequent Events
On January 5, 2007, January 19, 2007, January 26, 2007, January 31, 2007, February 15, 2007, February 22, 2007 and February 28, 2007, we entered into amendments to the One World Trade Center Purchase and Sale Agreement to extend the closing date to January 22, 2007, January 26, 2006, January 31, 2007, February 15, 2007, February 22, 2007, February 28, 2007 and March 2, 2007, respectively. On March 2, 2007, we entered into a ninth amendment to the agreement. The material terms of the ninth amendment provide for: (i) a reduction in the sales price from $150,000,000 to $148,900,000; (ii) the installation of a filtration system required by the National Pollutant Discharge Elimination System and Water Discharge Elimination System Permit; (iii) a closing date of March 28, 2007; (iv) deletions of any indemnity or release by the buyer relating to the pre-closing groundwater matters in the agreement, and similarly, release of seller for liability for any post-closing groundwater matters; (v) buyer’s acknowledgement that the reduction in the purchase price is intended as full compensation for all ongoing costs, testing, impact on the property, and risk of losses or liabilities arising from the post-closing groundwater matters; and (vi) seller’s delivery of estoppel certificates from tenants representing 75.0% of the leased square footage, including major tenants identified in the agreement as a closing condition. We anticipate that a property disposition fee will be paid to Realty of $2,250,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $900,000, or 0.6% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in the first quarter of 2007.
On January 11, 2007, we sold our Two Corporate Plaza property located in Houston, Texas to Metro Properties, LLC, an unaffiliated third party, for a sales price of $18,000,000. Our net cash proceeds were $7,127,000 after payment of the related mortgage loan, closing costs and other transaction expenses, and the return of lender required reserves. A property disposition fee of $270,000, or 1.5% of the sales price was paid to Realty and a sales commission of $380,000, or 2.1% of the sales price, was also paid to an unaffiliated broker. As compared to December 31, 2005, our net assets in liquidation as of December 31, 2006 increased by approximately $1,021,000 as a result of the sale.
On March 1, 2007, we entered into an agreement to sell our One Financial Plaza property, located in St. Louis, Missouri, of which we own 77.63%, to an unaffiliated third party for a sales price of $47,000,000.
G REIT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
We anticipate that a property disposition fee will be paid to Realty of $705,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $470,000, or 1.0% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in March or April 2007.
On March 16, 2007, we entered into an agreement to sell our Opus Plaza at Ken Caryl property, located in Littleton, Colorado, to an unaffiliated third party for a sales price of $10,400,000. We anticipate that a property disposition fee will be paid to our Advisor or its affiliate of $156,000, or 1.5% of the sales price, and sales commissions will be paid to unaffiliated brokers of $260,000, or 2.5% of the sales price. The sale, which is subject to customary closing conditions, is expected to close in the second quarter of 2007.
G REIT, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
G REIT, INC.
SCHEDULE III - REAL ESTATE OPERATING PROPERTIES AND ACCUMULATED DEPRECIATION
(a)
The changes in total real estate for the year ended December 31, 2006 are as follows:
(1)
Under the liquidation basis of accounting, our real estate holding are now carried at their estimated fair value, as a result the net liquidation adjustment is the net adjustment that we have made to the carrying value of the property in order to reflect its fair value.
(2)
Depreciation expense will not be recorded subsequent to December 31, 2005 as a result of the adoption of our plan of liquidation, because all assets are considered held for sale.
SIGNATURES
Pursuant to the requirements of the 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.
G Reit, Inc.
By:
/s/ Scott D. Peters
Scott D. Peters
Chief Executive Officer and President
Date: March 20, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit index immediately precedes the exhibits.
The following exhibits are included, or incorporated by reference, in this Annual Report on Form 10-K for the fiscal year 2006 (and are numbered in accordance with Item 601 of Regulation S-K).
*
Filed herewith.