Item 1. Business
Business Overview
The principal business of CIM Commercial Trust Corporation and its subsidiaries (which may be referred to in this Form 10-K as "we," "us," "our," "our company", "CIM Commercial" or the "Company") is to acquire, own, and operate Class A and creative office properties in vibrant and improving urban communities throughout the United States. These communities are located in areas that include traditional downtown areas and suburban main streets, which have high barriers-to-entry, high population density, improving demographic trends and a propensity for growth. We believe that the critical mass of redevelopment in such areas creates positive externalities, which enhance the value of substantially stabilized assets in the area. We believe that these assets will provide greater returns than similar assets in other markets, as a result of the improving demographics, public commitment, and significant private investment that characterize these areas.
We are managed by affiliates of CIM Group, L.P. ("CIM Group" or "CIM"). CIM Group is a vertically-integrated, full-service investment manager with multi-disciplinary expertise and in-house research, acquisition, investment, development, finance, leasing, and management capabilities. CIM Group is headquartered in Los Angeles, California and has offices in Oakland, California; Bethesda, Maryland; Dallas, Texas; and New York, New York. See "Item 1 - Business-Overview and History of CIM Group", "-CIM Urban Partnership Agreement" and "-Investment Management Agreement".
We seek attractive risk-adjusted returns by utilizing the CIM platform which has generated superior returns across multiple market cycles by focusing on improved asset and community performance, and capitalizing on market inefficiencies and distressed situations. Over time, we seek to expand our real estate holdings in communities targeted by CIM Group for investment, supported by CIM Group's broad real estate investment capabilities, as part of our plan to prudently grow market value and earnings.
We invest primarily in substantially stabilized real estate and real estate-related assets located in areas that CIM has targeted for opportunistic investment. These areas include traditional downtown areas and suburban main streets, which have high barriers to entry, high population density, improving demographic trends and a propensity for growth. CIM believes that the critical mass of redevelopment in such areas creates positive externalities, which enhance the value of substantially stabilized assets in the area. CIM targets investments in diverse types of real estate assets, including office, retail, for-rent and for-sale multifamily residential, hotel, parking, and signage through CIM's extensive network and its current opportunistic investment activities.
On July 8, 2013, PMC Commercial Trust ("PMC Commercial"), entered into a merger agreement (the "Merger Agreement") with CIM Urban REIT, LLC ("CIM REIT"), an affiliate of CIM Group, and subsidiaries of the respective parties. CIM REIT, a private commercial REIT, was the owner of CIM Urban Partners, LP ("CIM Urban"). The transaction (the "Merger") was completed on March 11, 2014 (the "Acquisition Date").
Furthermore, on April 28, 2014, we filed Articles of Amendment (the "Reverse Split Amendment") to effectuate a one-for-five reverse stock split of our common stock ("Common Stock"), effective April 29, 2014. Pursuant to the reverse stock split, each five shares of Common Stock issued and outstanding immediately prior to the effective time of the reverse stock split were converted into one share of Common Stock. All per share and outstanding share information from before the Reverse Split Amendment included herein has been presented to reflect the reverse stock split unless otherwise noted.
The Merger Agreement provided for the business combination of CIM REIT's wholly owned subsidiary, CIM Urban, and PMC Commercial. Pursuant to the Merger Agreement, Urban Partners II, LLC ("Urban II"), an affiliate of CIM REIT, received 4,400,000 shares of newly-issued PMC Commercial common stock and approximately 65,000,000 shares of newly-issued PMC Commercial preferred stock. Following the Merger and subsequent increase in our authorized number of shares, each share of preferred stock was converted into 1.4 shares of PMC Commercial common stock, resulting in the issuance of 95,440,000 shares of PMC Commercial common stock in the aggregate in connection with the Merger, representing approximately 97.8% of PMC Commercial's outstanding shares of common stock.
All shares of PMC Commercial common stock that were outstanding immediately prior to the closing of the Merger continue to remain outstanding following the Acquisition Date. In addition, stockholders of record of PMC Commercial at the close of the business day prior to the Acquisition Date received a special cash dividend of $27.50 per share of common stock plus that pro-rata portion of PMC Commercial's regular quarterly cash dividend accrued through the Acquisition Date, each of which was paid March 25, 2014.
Upon completion of the Merger, PMC Commercial became the parent of CIM Urban. PMC Commercial reincorporated from Texas to Maryland on April 28, 2014 and, on the same day, changed its name from "PMC Commercial Trust" to "CIM Commercial Trust Corporation."
The Merger was accounted for as a reverse acquisition under the acquisition method of accounting with CIM Urban considered to be the accounting acquirer based upon the terms of the Merger Agreement. Based on the determination that CIM Urban was the accounting acquirer in the transaction, CIM Urban allocated the purchase price to the fair value of PMC Commercial's assets and liabilities as of the Acquisition Date.
In order to allow CIM Commercial to increase its focus in Class A and creative office properties, our board of directors (the "Board of Directors") approved a plan for the legacy lending business (the "lending business") that, when completed, will result in the deconsolidation of the lending segment. Accordingly, as of December 31, 2014, the lending segment is held for sale.
As of December 31, 2014, our portfolio consisted of 33 assets, all of which are fee simple properties except one leasehold property. As of December 31, 2014, our 24 office properties, totaling
approximately 5.6 million rentable square feet, were 85.1% occupied; our multifamily properties, composed of 930 units, were 92.8% occupied; and our hotels, which have a total of 1,070 rooms, had revenue per available room ("RevPAR") of $99.61 for the year ended December 31, 2014. Our office portfolio contributed approximately 70.0% of revenue from continuing operations for the year ended December 31, 2014, while our hotel portfolio contributed approximately 21.9%, and our multifamily portfolio contributed approximately 8.1%.
Our office, multifamily and hotel assets are located in 11 U.S. markets. The breakdown by segment, market and submarket, as of December 31, 2014, is as follows:
Overview of our Portfolio as of December 31, 2014
(1)901 N Capitol Street is a 39,696 square foot parcel of land located between 899 and 999 N Capitol Street. We are entitled to develop a building with up to 270,172 square feet.
Segments
We operate in four business segments: (i) the acquisition, redevelopment, ownership, and management of office real estate; (ii) multifamily real estate; (iii) hotels; and (iv) lending operations, which was added in connection with the Merger in March 2014 and is classified as held for sale at December 31, 2014. Information related to our business segments for the years ended December 31, 2014, 2013 and 2012 is set forth in Note 18 to our consolidated financial statements in Item 15 of this report.
Business Objectives and Growth Strategies
Our objective is to achieve superior long-term returns relative to the risk that we are undertaking. We intend to achieve this objective by continuing to deploy the investment processes that CIM Group has developed during 21 years as an investor in urban markets and identifying opportunities to invest at prices below intrinsic values.
We intend to drive portfolio growth through a combination of acquisition and asset management strategies, which are designed to increase cash flows and asset value.
Our investment strategy is centered around CIM's community qualification process. We believe this strategy provides us with a significant competitive advantage when making urban real estate investments. The qualification process generally takes between six months and five years and is a critical component of CIM's investment evaluation. CIM examines the characteristics of a market to determine whether the district justifies the extensive efforts CIM undertakes in reviewing and making potential investments in its qualified communities ("Qualified Communities"). Qualified Communities generally fall into one of two categories: (i) transitional urban districts and (ii) well-established, thriving urban areas (typically major central business districts). Qualified Communities are distinct districts which have dedicated resources to become or are currently vibrant communities where people can live, work, shop and be entertained-all within walking distance or close proximity to public transportation. These areas also generally have high barriers to entry, high population density, improving demographic trends and a propensity for growth. In addition to the urbanization of North America in the last 21 years due to the growing preference for an urban lifestyle, today's economic environment has further fueled urban growth due to the need for efficient solutions to meet continued population growth and limited natural resources. CIM believes that a vast majority of the risks associated with making real asset investments are mitigated by accumulating local market knowledge of the community where the investment lies. CIM typically spends significant time and resources qualifying targeted investment communities prior to making any acquisitions. Since 1994, CIM Group has qualified 97 communities and has deployed capital in 48 of these Qualified Communities. Although we may not invest exclusively in Qualified Communities, it is expected that most of our investments will be identified through this systematic process.
CIM seeks to maximize the value of its investments through active asset management. CIM has extensive in-house research, acquisition, investment, development, financing, leasing and property management capabilities, which leverage its deep understanding of urban communities to position properties for multiple uses and to maximize operating income. As a fully integrated owner and operator, CIM's asset management capabilities are complemented by its in-house property management capabilities. Property managers prepare annual capital and operating budgets and monthly operating reports, monitor results and oversee vendor services, maintenance and capital improvement schedules. In addition, they ensure that revenue objectives are met, lease terms are followed, receivables are collected, preventative maintenance programs are implemented, vendors are evaluated and expenses are controlled. CIM's Asset Management Committee (the "Asset Management Committee") reviews and approves strategic plans for each investment, including financial, leasing, marketing, property positioning and strategic and disposition plans. In addition, the Asset Management Committee reviews
and approves the annual business plan for each property, including its capital and operating budget. CIM's organizational structure provides for investment and asset management continuity through multi-disciplinary teams responsible for an asset from the time of the original investment recommendation through the implementation of the asset's business plan, and any disposition activities.
Competitive Advantages
We believe that CIM Group's experienced team, and integrated and multi-disciplinary organization, coupled with its community-focused and disciplined urban real estate investment philosophy, results in a competitive advantage that benefits us. Additionally, CIM's investment strategy is complemented by a number of other competitive advantages including its use of low leverage, underwriting approach, disciplined capital deployment, and strong network of relationships. CIM's competitive advantages include:
• Vertically-Integrated Organization and Team
CIM is managed by its senior management team, which is comprised of its three founders, Shaul Kuba, Richard Ressler and Avi Shemesh, and includes seven other principals. CIM Group is vertically-integrated and organized into seven functional groups including Investments, Development, Property Management, Financial Reporting, Compliance, Operations, and Internal Audit.
To support CIM's organic growth and related investment platforms, CIM has invested substantial time and resources in building a strong and integrated team of over 235 experienced professionals. Each of CIM Group's departments is managed by seasoned professionals and CIM continues to develop the extensive team of senior management, which represents the next generation of CIM's leaders. In addition to developing a core team of principals and senior level management, CIM has proactively managed its growth through career development and mentoring at both the mid and junior staffing levels, and has hired ahead of its needs, thus ensuring appropriate management and staffing for its investment activities.
CIM leverages its deep operating and industry experience of CIM's principals and professionals, as well as their extensive relationships, to source and execute opportunistic, stabilized, and infrastructure investments. Each investment opportunity is overseen by a dedicated team comprised of an oversight principal (Richard Ressler, Avi Shemesh, Shaul Kuba or Charles E. Garner II, our Chief Executive Officer), a team lead (vice president level and above), associate vice presidents and associates, as necessary, who are responsible for managing the investment from sourcing through underwriting, acquisition, development (if required), asset management, and disposition. As part of this process, the team draws upon CIM's extensive in-house expertise in legal matters, finance, development, leasing, and property management. Each dedicated investment team is purposefully staffed with professionals from multiple CIM offices, regardless of the location of the asset being evaluated. As a result, all investment professionals work across a variety of Qualified Communities and CIM's knowledge base is shared across all of its offices.
• Community Qualification
Since inception, CIM's proven community qualification process has served as the foundation for its investment strategy. CIM targets high barrier-to-entry markets and submarkets with high population density and applies rigorous research to qualify for potential investments. Since 1994, CIM has qualified 97 communities in high barrier-to-entry markets and has deployed capital in 48 of these Qualified Communities. CIM examines the characteristics of a market to determine whether the district justifies the extensive efforts its investment professionals undertake in reviewing and making potential investments in its Qualified Communities. Qualified Communities generally fall into one of two categories: (i) underserved/transitional urban districts
that have dedicated resources to become vibrant urban communities and (ii) well-established, thriving urban areas (typically major central business districts) where market values have dropped below intrinsic values (i.e., long-term values to which CIM expects market values to recover).
As more fully described in "-Principles," once a community is qualified, CIM continues to differentiate itself by applying various business principles including: (i) product non-specific-CIM has extensive experience investing in a diverse range of property types, including retail, residential, office, parking, hotel, signage, and mixed-use, which gives CIM the ability to execute and capitalize on its urban strategy effectively; (ii) community-based tenanting-CIM's investment strategy focuses on the entire community and the best use of assets in that community; owning a significant number of key properties in an area better enables CIM to meet the needs of national retailers and office tenants and thus optimize the value of these real estate properties; (iii) local market leadership with North American footprint-CIM maintains local market knowledge and relationships, along with a diversified North American presence, through its 97 Qualified Communities (thus, CIM has the flexibility to invest in its Qualified Communities only when the market environment meets CIM's investment and underwriting standards); and (iv) investing across the capital stack-CIM has extensive experience investing across the capital stack including equity, preferred equity, debt and mezzanine investments, giving it the flexibility to structure transactions in efficient and creative ways.
• Investment Discipline
CIM's investment strategy relies on its sound business plan and value creation execution to produce strong returns, rather than financial engineering. CIM Group's underwriting of its investments is performed both on a leveraged and unleveraged basis. Additionally, CIM has generally not utilized recourse or cross-collateralized debt due to its conservative underwriting standards.
CIM employs multiple underwriting scenarios when evaluating potential investment opportunities. CIM Group generally underwrites investments utilizing long-term average exit capitalization rates for similar product types and long-term average interest rates. Where possible, these long-term averages cross multiple market cycles, thereby mitigating the risk of cyclical volatility. CIM's "long-term average" underwriting is based on its belief, reinforced by its experience through multiple market cycles, that over the life of any given fund that it manages, such fund should be able to exit its investments at long-term historical averages. CIM also underwrites a "current market case" scenario, which generally utilizes current submarket specific exit assumptions and interest rates, in order to reflect anticipated investment results under current market conditions. CIM believes that utilizing multiple underwriting scenarios enables CIM to assess potential returns relative to risk within a range of potential investment outcomes.
Investment Strategy
Our investment strategy is to continue to invest in Class A and creative office properties in vibrant and improving urban communities throughout the U.S. in a manner that will allow us to increase the value of our assets and to grow our revenue and cash flow in order to enhance the dividends paid to stockholders. By employing a similar investment strategy to that which CIM has consistently utilized to target stabilized real estate assets, our objective is to utilize CIM's extensive knowledge of Qualified Communities to identify investment opportunities at prices below intrinsic values and achieve superior returns relative to the risk which we are undertaking.
2014 Acquisitions
Acquisitions during 2014, funded with proceeds from drawdowns on our unsecured credit facilities, consisted of the following:
(1)100% fee-simple interest in an office building built in 1984 and renovated in 2014, located in the Mid-Wilshire submarket of Los Angeles, California.
(2)100% fee-simple interest in a portfolio of creative office buildings located in the West Los Angeles submarket of Los Angeles, California. Two of the buildings were built in 1930 and the third was built in 1957. The buildings were renovated in 2010.
Financing Strategy
We have substantial borrowing capacity, and will likely finance our future activities through any of the following methods: (i) offerings of common shares, preferred shares, senior unsecured securities, and other equity and debt securities; (ii) the use and potential expansion of our existing revolving credit lines including the use of the credit line we obtained in September 2014 or the use of a new credit line; (iii) the addition of senior recourse or non-recourse debt using target acquisitions as well as existing investments as collateral; and/or (iv) the sale of existing investments. We expect to maintain leverage levels that are comparable to those of other commercial property Real Estate Investment Trusts (each, a "REIT") engaged in business strategies similar to our own.
Risk Management
As part of its risk management strategy, CIM will continually evaluate our investments and actively manage the risks involved in its business strategies. CIM's investment professionals will provide asset management oversight by closely monitoring the performance of our investments relative to market and industry benchmarks and internal underwriting assumptions using direct knowledge of local markets provided by CIM's in-house asset management, property management, and leasing professionals. In-house property management capabilities include monthly and annual budgeting and reporting as well as vendor services management, property maintenance and capital expenditures management. Management seeks to ensure that revenue objectives are met, lease terms are followed, receivables are collected, preventative maintenance programs are implemented, vendors are evaluated and expenses are controlled. CIM's Asset Management Committee oversees the asset management of investments, and consists of CIM's four most senior investment professionals: Shaul Kuba, Richard Ressler, Avi Shemesh and our Chief Executive Officer, Charles E. Garner II (the "Oversight Principals"), each of whom has extensive experience in investment, development, asset and property management and leasing. Every investment is directly overseen by an Oversight Principal, who is ultimately responsible for the performance of the investment. The Oversight Principals work with each CIM department to ensure that every investment benefits from the full range of CIM's real estate expertise. CIM believes that empowering its most seasoned investment professionals to bring their breadth of experience to bear directly on investments will optimize investment returns.
The Oversight Principals meet informally on a frequent basis, generally weekly, to review and discuss the performance of investments, and meet formally at least annually to review and approve strategic plans for the investments, including: financial and operational analyses, operating strategies and agreements, tenant composition and marketing, asset positioning, market conditions affecting the asset, hold/sell analyses and timing considerations, and the annual business plan for each investment, including its capital and operating budget.
The size, composition, and policies of the Asset Management Committee may be changed from time to time.
Regulatory Matters
Environmental Matters
Environmental laws regulate, and impose liability for, releases of hazardous or toxic substances into the environment. Under some of these laws, an owner or operator of real estate is or may be liable for costs related to soil or groundwater contamination on, in, or migrating to or from its property. In addition, persons who arrange for the disposal or treatment of hazardous or toxic substances may be liable for the costs of cleaning up contamination at the disposal site. Such laws often impose liability regardless of whether the person knew of, or was responsible for, the presence of the hazardous or toxic substances that caused the contamination. The presence of, or contamination resulting from, any of these substances, or the failure to properly remediate them, may adversely affect our ability to sell or rent our property or to borrow using such property as collateral. Third parties may also make claims against owners or operators of properties for personal injuries and property damage associated with releases of hazardous materials. As part of our efforts to mitigate these risks, we typically engage third parties to perform assessments of potential environmental risks when evaluating a new acquisition of property.
Americans with Disabilities Act of 1990
Under the Americans with Disabilities Act of 1990 (the "ADA"), all public accommodations must meet federal requirements related to access and use by disabled persons. Although we believe that our properties substantially comply with present requirements of the ADA, we have not conducted an audit or investigation of all of our properties to determine our compliance. If one or more of our properties or future properties is not in compliance with the ADA, then we would be required to incur additional costs to bring the property into compliance. We cannot predict the ultimate amount of the cost of compliance with the ADA. If we incur substantial costs to comply with the ADA, our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends could be materially adversely affected.
Competition
We compete with other investors engaged in the acquisition, development, and management of real estate and real estate-related investments. Our competitors include other REITs, insurance companies, pension funds, private equity funds, sovereign wealth funds, hedge funds, mortgage banks, investment banks, commercial banks, savings and loan associations, specialty finance companies, and other private and institutional investors and financial companies that pursue strategies similar to ours. Some of our competitors may be larger than us and have greater access to capital and other resources and may have other advantages over us. In addition, some of our competitors may have higher risk tolerances or lower profitability targets than us, which could allow them to pursue new business more aggressively than us. We believe that our relationship with CIM Group gives us a competitive advantage that allows us to operate more effectively in the markets in which we conduct our business.
Overview and History of CIM Group
CIM is a privately held California domiciled limited partnership, specializing in private equity real estate and infrastructure investments. CIM Group was founded in 1994 by Shaul Kuba, Richard Ressler and Avi Shemesh and has assets under management ("AUM") of approximately $18.7 billion as of September 30, 2014.1 CIM has systematically developed its urban investing discipline over the past 21 years. CIM Group's three founding principals have worked together since inception and continue to direct the business of CIM and are actively involved in the day-to-day management along with seven other principals of CIM Group's leadership team. CIM Group's successful track record is anchored by CIM's community-oriented approach to urban investing as well as a number of other competitive advantages including its use of low leverage, underwriting approach, disciplined capital deployment, vertically-integrated capabilities and strong network of relationships.
CIM is a premier full service urban real estate and infrastructure fund manager with in-house research, acquisition, investment, development, finance, leasing and management capabilities. CIM Group is headquartered in Los Angeles, California and has offices in Oakland, California; Bethesda, Maryland; Dallas, Texas; and New York, New York. CIM has over 500 employees, including more than 235 professionals. CIM has generated strong risk-adjusted returns across multiple market cycles by focusing on improved asset and community performance, and capitalizing on market inefficiencies and distressed situations.
Principles
As described in "-Business Objectives and Growth Strategies" and "-Competitive Advantages," the community qualification process is one of CIM Group's core competencies, which demonstrates a disciplined investing program and strategic outlook on urban communities. Once a community is qualified, CIM Group believes it continues to differentiate itself through the following business principles:
•Product Non-Specific: CIM has extensive experience investing in a diverse range of property types, including retail, residential, office, parking, hotel, signage, and mixed-use, which gives CIM the ability to execute and capitalize on its urban strategy effectively. Successful investment requires selecting the right markets coupled with providing the right product. CIM's experience with multiple assets types does not predispose CIM Group to select certain asset types, but instead ensures that we deliver a product mix that is consistent with the market's requirements and needs. Additionally, there is a growing trend towards developing mixed-use real estate properties in urban markets which requires a diversified investment platform to successfully execute.
•Community-Based Tenanting: CIM's investment strategy focuses on the entire community and the best use of assets in that community. Owning a significant number of key properties in an area better enables CIM to meet the needs of national retailers and office tenants and thus optimizes the value of these real estate properties. CIM believes that its community perspective gives it a significant competitive advantage in attracting tenants to its retail, office and mixed-use properties and creating synergies between the different tenant types.
•Local Market Leadership with North American Footprint: CIM maintains local market knowledge and relationships, along with a diversified North American presence, through its
1For CIM Group's private funds and CIM's strategic partnership accounts, AUM includes total gross assets at fair value as of September 30, 2014 (including the shares of such assets owned by joint venture partners), as well as committed but as-yet unfunded capital commitments as of September 30, 2014. For CIM Commercial Trust, AUM is based on management's estimate of the fair value of total gross assets as of September 30, 2014.
97 Qualified Communities. Thus, CIM has the flexibility to invest in its Qualified Communities only when the market environment meets CIM's investment and underwriting standards. CIM does not need to invest in a given community or product type at a specific time due to its broad proprietary pipeline of communities.
•Investing Across the Capital Stack: CIM has extensive experience investing across the capital stack including equity, preferred equity, debt and mezzanine investments, giving it the flexibility to structure transactions in efficient and creative ways.
CIM Urban Partnership Agreement
Our subsidiary, CIM Urban, is governed by CIM Urban's partnership agreement (the "CIM Urban Partnership Agreement"). The general partner of CIM Urban, Urban Partners GP, LLC ("CIM Urban GP"), is an affiliate of CIM Group and has the full, exclusive and complete right, power, authority, discretion and responsibility vested in or assumed by a general partner of a limited partnership under the Delaware Revised Uniform Limited Partnership Act and as otherwise provided by law and is vested with the full, exclusive and complete right, power and discretion to operate, manage and control the affairs of CIM Urban, subject to the terms of the CIM Urban Partnership Agreement.
Removal of General Partner
The class A members of CIM REIT, upon a two-thirds vote of the interests of such members, may remove and replace CIM Urban GP as the general partner of CIM Urban if (a) certain affiliates and related parties of CIM Urban GP cease to own at least 85% of the class A membership units of CIM REIT that they have acquired or (b) any two of Shaul Kuba, Richard Ressler or Avi Shemesh cease to be actively engaged in the management of the general partner.
Amendments
Subject to certain limited exceptions, amendments of the CIM Urban Partnership Agreement may be adopted only with the consent of the majority in interest of the class A members of CIM REIT who are not affiliates of CIM Urban GP.
Liability for Acts and Omissions
None of CIM Urban GP or any of its affiliates, members, stockholders, partners, managers, officers, directors, employees, agents and representatives will have any liability in damages or otherwise to any limited partner, any investors in CIM REIT or CIM Urban, and CIM Urban will indemnify such persons from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, proceedings, costs, expenses and disbursements of any kind which may be imposed on, incurred by or asserted against such persons in any way relating to or arising out of any action or inaction on the part of such persons when acting on behalf of CIM Urban or any of its investments, except for those liabilities that result from such persons' fraud, gross negligence, willful misconduct or breach of the terms of the CIM Urban Partnership Agreement or any other agreement between such person and CIM Urban or its affiliates.
Investment Management Agreement
CIM Urban and CIM Urban REIT Management L.P. (the "Advisor"), each an affiliate of CIM REIT and CIM Group, are parties to an Investment Management Agreement pursuant to which CIM Urban engaged the Advisor to provide investment advisory services to CIM Urban. The Advisor manages CIM Urban's investments in real estate and other assets, including debt, equity and equity-related interests in real estate, securities and investments (including cash), and has the power and authority to determine, and with full discretion to place orders in respect of, the purchase, retention
and disposition of such investments and to execute agreements relating thereto in accordance with the investment objectives, policies and restrictions set forth in the CIM Urban Partnership Agreement.
The Advisor is entitled to receive from CIM Urban, as compensation for the Advisor's management services, an annual management fee, payable quarterly in arrears, in an amount that is based on the daily average gross fair value of CIM Urban's investments during such quarter as follows:
For the years ended December 31, 2014, 2013 and 2012, the Advisor earned asset management fees of $23,223,000, $21,767,000 and $20,924,000.
The Advisor is responsible for the payment of all costs and expenses relating to the general operation of its business, including administrative expenses, employment expenses and office expenses. All costs and expenses incurred by the Advisor on behalf of CIM Urban are borne by CIM Urban. In addition, CIM Urban will indemnify the Advisor against losses, claims, damages or liabilities, and reimburse the Advisor for its legal and other expenses, in each case incurred in connection with any action, proceeding or investigation arising out of or in connection with CIM Urban's business or affairs, except to the extent such losses or expenses result from fraud, gross negligence or willful misconduct of, or any violation of securities law or other intentional criminal wrongdoing or a breach of the terms of the Investment Management Agreement by, the Advisor. The Advisor will indemnify CIM Urban against any losses, claims, damages or liabilities to which CIM Urban becomes subject in connection with any matter arising out of or in connection with CIM Urban's business or affairs that results from the Advisor's fraud, gross negligence, willful misconduct or breach of the Investment Management Agreement.
Nothing in the Investment Management Agreement limits or restricts the right of any partner, officer or employee of the Advisor to engage in any other business or to devote his time and attention in part to any other business. Nothing in the Investment Management Agreement limits or restricts the right of the Advisor to engage in any other business or to render services of any kind to any other person.
The Investment Management Agreement will remain in effect until CIM Urban is dissolved or CIM Urban and the Advisor otherwise mutually agree.
Master Services Agreement
On March 11, 2014, we entered into the Master Services Agreement (the "Master Services Agreement") with CIM Service Provider, LLC (the "Manager"), an affiliate of CIM Group, pursuant to which the Manager agrees to provide or arrange for other service providers to provide management and administration services to us ("Base Service"). Pursuant to the Master Services Agreement, we appointed an affiliate of CIM Group as the manager ("Urban GP Manager") of CIM Urban GP. Under the Master Services Agreement, we pay a base service fee (the "Base Service Fee") to the Manager equal to $1,000,000 per year (subject to an annual escalation by a specified inflation factor beginning on January 1, 2015), payable quarterly in arrears. The Base Service Fee began to accrue on March 11, 2014 and was pro-rated based on the number of days during the first quarter in which the Master Services Agreement was in effect. For the year ended December 31, 2014, the Manager earned
a Base Service Fee of $806,000. In addition, pursuant to the terms of the Master Services Agreement, the Manager may receive compensation for performing certain services for us and our subsidiaries that are not covered under the Base Service Fee. During the year ended December 31, 2014, such services performed by the Manager included accounting, tax, reporting, internal audit, legal, compliance, risk management, IT, human resources and corporate communications. The Manager's compensation is based on the salaries and benefits of the employees of the Manager and/or its affiliates who performed these services (allocated based on the percentage of time spent on our affairs and the affairs of our subsidiaries). For the year ended December 31, 2014, we expensed $1,193,000 for such services. At December 31, 2014, $725,000 was due to the Manager.
As of January 1, 2015, all of our employees moved to CIM SBA Staffing, LLC, an affiliate of CIM Group ("CIM SBA"), except for two of our executives, who became jointly employed by us and CIM SBA and their employment agreements with us continue in full force and effect. In connection with this, on January 1, 2015, we entered into a Staffing and Reimbursement Agreement with CIM SBA and our subsidiary, PMC Commercial Lending, LLC, which provides that CIM SBA will provide personnel and resources to us and that we will reimburse CIM SBA for the costs and expenses of providing such personnel and resources.
Other Services
CIM Management, Inc. and certain of its affiliates (collectively, the "CIM Management Entities"), all affiliates of CIM REIT, provide property management, leasing, and development services to CIM Urban. The CIM Management Entities earned property management fees, which are included in rental and other property operating expenses, totaling $5,284,000, $4,828,000 and $4,171,000 for the years ended December 31, 2014, 2013 and 2012, respectively. CIM Urban also reimbursed the CIM Management Entities $7,369,000, $5,082,000 and $2,726,000 during the years ended December 31, 2014, 2013 and 2012, respectively, for the cost of on-site personnel incurred on behalf of CIM Urban, which is included in rental and other property operating expenses. The CIM Management Entities earned leasing commissions of $1,904,000, $537,000 and $744,000 for the years ended December 31, 2014, 2013, and 2012, respectively, which were capitalized to deferred charges. In addition, the CIM Management Entities earned development management fees of $566,000, $834,000 and $973,000 for the years ended December 31, 2014, 2013 and 2012, respectively, which were capitalized to investments in real estate.
Lending Segment
Overview
The lending segment represents the real estate lending platform conducting business as PMC Commercial Trust, formerly the business of PMC Commercial, which was combined with our real estate business through the Merger completed on the Acquisition Date. In order to allow CIM Commercial to increase its focus in Class A and creative office properties, our Board of Directors approved a plan for the lending business that, when completed, will result in the deconsolidation of the lending segment. Accordingly, the assets and liabilities of the lending segment have been reflected as held for sale in our consolidated December 31, 2014 balance sheet; the results of its operations are included in the consolidated statements of operations and comprehensive income as income from operations of assets held for sale, included in discontinued operations, and its cash flows are included in the consolidated cash flows for the period from the Acquisition Date through December 31, 2014.
Through our lending segment, we are a national lender that primarily originates loans to small businesses, principally in the limited service hospitality industry. We identify loan origination opportunities through personal contacts, internet referrals, attendance at trade shows and meetings, direct mailings, advertisements in trade publications and other marketing methods. We also generate
loans through referrals from real estate and loan brokers, franchise representatives, existing borrowers, lawyers and accountants.
Information on our loans receivable at December 31, 2014 was as follows (dollars in thousands):
(1)The calculation of average yield divides our interest income, prepayment fees and other loan related fees, adjusted by the provision for loan losses, by the weighted average loans receivable outstanding on an annualized basis.
In addition to our retained portfolio described above, we service $96.5 million of aggregate principal balance remaining on secondary market loan sales.
From the Acquisition Date to December 31, 2014, we funded $51.0 million of loans and received principal payments of $49.4 million including principal prepayments of $39.1 million.
SBA 7(a) Program
Our SBA lending subsidiary, First Western SBLC, Inc. ("First Western"), is licensed as a small business lending company ("SBLC") that originates loans through the Small Business Administration's ("SBA") 7(a) Program ("SBA 7(a) Program").
The SBA maintains a Preferred Lender Program wherein it grants Preferred Lender Program ("PLP") status to certain lenders originating SBA 7(a) Program loans based on achievement of certain standards in lending which are regularly monitored by the SBA. First Western has been granted national PLP status and originates, sells and services small business loans. As a Preferred Lender, First Western is authorized to place SBA guarantees on loans without seeking prior SBA review and approval. Being a national lender, PLP status allows First Western to expedite loans since First Western is not required to present applications to the SBA for concurrent review and approval.
We continue to focus our lending activity on the origination of SBA 7(a) Program loans due to their profitability. We utilize the SBA 7(a) Program to originate small business loans, primarily secured by real estate, and then sell the government guaranteed portion to investors.
The SBA 7(a) Program is the SBA's primary loan program. In general, the SBA reduces risks to lenders by guaranteeing major portions of qualified loans made to small businesses. This enables lenders to provide financing to small businesses when funding may otherwise be unavailable or not available on reasonable terms.
Under the SBA 7(a) Program, the SBA typically guarantees 75% of qualified loans over $150,000. The eligibility requirements of the SBA 7(a) Program vary by the industry of the borrower and affiliates and other factors. In order to operate as an SBLC, a licensee is required to maintain a minimum regulatory capital (as defined by SBA regulations) of the greater of (1) 10% of its outstanding loans receivable and other investments or (2) $1.0 million, and is subject to certain other regulatory restrictions such as change in control provisions. First Western is periodically examined and audited by the SBA to determine compliance with SBA regulations.
New Commercial Loans
To take advantage of the expertise of CIM, we have begun to originate commercial real estate loans for properties that are primarily located in CIM Group's Qualified Communities. We are targeting investments between $20 million and $100 million with a focus on developing a diversified pool of loans. These loans are typically short duration (five years or less, inclusive of extension options), floating rate and are expected to be:
• limited and/or non-recourse junior (mezzanine, b-note or 2nd lien) and senior construction loans; or
• limited and/or non-recourse junior (mezzanine, b-note or 2nd lien) and senior acquisition, bridge or repositioning loans.
We intend to participate a portion of these loans with, and/or syndicate a portion of these loans to, one or more institutional investors.
Employees
As of December 31, 2014, we had 33 employees, all of whom moved to CIM SBA on January 1, 2015, except for two of our executives, who became jointly employed by us and CIM SBA and their employment agreements with us continue in full force and effect. See "Item 1 Business-Master Services Agreement."
Offices
We are headquartered in Dallas, Texas and are provided office space in Los Angeles, California.
Available Information
Our corporate information website is www.cimcommercial.com. The information on our website is not part of this Annual Report on Form 10-K. However, on the Investors Relation section of this website the public can access free of charge our annual, quarterly and current reports, changes in the stock ownership of our directors and certain executive officers and other documents filed with the Securities and Exchange Commission ("SEC") as soon as reasonably practicable after the filing dates. Further, the SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.
We have adopted a written code of ethics that applies to all directors, officers and employees of the Company, the Advisor and the Manager, including our principal executive officer and senior financial officer, in accordance with Section 406 of the Sarbanes-Oxley Act of 2002 and the rules of the SEC promulgated thereunder. The code of ethics, which we call our Code of Business Conduct and Ethics, is available on our corporate website, www.cimcommercial.com, in the section entitled "Corporate Overview"-"Corporate Governance." In the event that we make changes in, or provide waivers from, the provisions of this code of ethics that the SEC requires us to disclose, we intend to disclose these events on our corporate website in such section. In the Corporate Governance section of our corporate website, we have also posted the charter for our Audit Committee, as well as our Governance Principles.
Item 1A.
Item 1A. Risk Factors
The following information should be read in conjunction with Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related notes in Part II, Item 8, "Financial Statements and Supplemental Data" of this Form 10-K. A wide range of factors could materially affect our future developments and performance. In addition to the factors described elsewhere in this report, management has identified the following important factors that could cause actual results to differ materially from those reflected in forward-looking statements or from our historical results. These factors, which are not all-inclusive, could have a material impact on our asset valuations, results of operations or financial condition and could also impair our ability to maintain dividend distributions at current or anticipated levels. This discussion of risk factors includes many forward-looking statements. For cautions about relying on forward-looking statements, please refer to the section entitled "Forward-Looking Statements" at the beginning of this Report immediately prior to Item 1.
Risks Related to Our Real Estate Business
Our operating performance is subject to risks associated with the real estate industry.
Real estate investments are subject to various risks and fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may decrease cash available for dividends, as well as the value of our properties. These events include, but are not limited to:
• adverse changes in economic and socioeconomic conditions;
• vacancies or our inability to rent space on favorable terms;
• adverse changes in financial conditions of buyers, sellers and tenants of properties;
• inability to collect rent from tenants;
• competition from other real estate investors with significant capital, including but not limited to other real estate operating companies, publicly-traded REITs and institutional investment funds;
• reductions in the level of demand for office, hotel and apartment community space and changes in the relative popularity of properties;
• increases in the supply of office, hotel and apartment community space;
• fluctuations in interest rates and the availability of credit, which could adversely affect our ability, or the ability of buyers and tenants of properties, to obtain financing on favorable terms or at all;
• dependence on third parties to provide leasing, brokerage, property management and other services with respect to certain of our investments;
• increases in expenses, including insurance costs, labor costs, utility prices, real estate assessments and other taxes and costs of compliance with laws, regulations and governmental policies, and our inability to pass on some or all of these increases to our tenants; and
• changes in, and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning, real estate tax, federal and state laws, governmental fiscal policies and the ADA.
In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases. If we cannot operate our properties so as to meet our financial expectations, our business, financial condition, results of
operations, cash flow or ability to satisfy our debt service obligations or to pay dividends could be materially adversely affected.
There can be no assurance that we can achieve our economic objectives.
A significant portion of our properties, by aggregate net operating income and square feet, are located in California and the District of Columbia. We are dependent on the California and the District of Columbia real estate markets and economies, and are therefore susceptible to risks of events in those markets that could adversely affect our business, such as adverse market conditions, changes in local laws or regulations and natural disasters.
Because our properties in California (and particularly, in the San Francisco Bay area, including Oakland, California and San Francisco, California (the "San Francisco Bay Area")) and the District of Columbia represent a significant portion of our portfolio by aggregate net operating income and square feet, we are exposed to greater economic risks than if we owned a more geographically diverse portfolio. We are susceptible to adverse developments in the California (and particularly, in the San Francisco Bay Area) and the District of Columbia economic and regulatory environments (such as business layoffs or downsizing, industry slowdowns, relocations of businesses, increases in real estate and other taxes, costs of complying with governmental regulations or increased regulation and other factors) as well as natural disasters that occur in these areas (such as earthquakes, floods and other events). In addition, the State of California is regarded as more litigious and more highly regulated and taxed than many states, which may reduce demand for office, lodging and apartment space in California. Any adverse developments in the economy or real estate markets in California (and particularly, in the San Francisco Bay Area) or the District of Columbia, or any decrease in demand for office, lodging and apartment space resulting from the California (and particularly, in the San Francisco Bay Area) or the District of Columbia regulatory or business environments, could have a material adverse effect on our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends.
We may be adversely affected by any significant reductions in federal government spending, which could have a material adverse effect on our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends.
Some of our properties are occupied by tenants that are U.S. federal government agencies. A significant reduction in federal government spending could decrease the likelihood that they will renew their leases with us. Further, economic conditions in the District of Columbia are significantly dependent upon the level of federal government spending in the region as a whole. In the event of a significant reduction in federal government spending, there could be negative economic changes in the District of Columbia which could adversely impact the ability of our tenants to perform their financial obligations under our leases or the likelihood of their lease renewals. As a result, such a reduction in federal government spending could have a material adverse effect on our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends.
Capital and credit market conditions may adversely affect demand for our properties and the overall availability and cost of credit.
In periods when the capital and credit markets experience significant volatility, demand for our properties and the overall availability and cost of credit may be adversely affected. No assurances can be given that the capital and credit market conditions will not have a material adverse effect on our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends.
In addition, we could be adversely affected by significant volatility in the capital and credit markets as follows:
• the tenants in our office properties may experience a deterioration in their sales or other revenue, or experience a constraint on the availability of credit necessary to fund operations, which in turn may adversely impact those tenants' ability to pay contractual base rents and tenant recoveries. Some tenants may terminate their occupancy due to an inability to operate profitably for an extended period of time, impacting our ability to maintain occupancy levels;
• constraints on the availability of credit to tenants, necessary to purchase and install improvements, fixtures and equipment and to fund business expenses, could impact our ability to procure new tenants for spaces currently vacant in existing office properties or properties under development; and
• any joint venture or other co-investment partners could experience difficulty obtaining financing in the future for the same reasons discussed above. Their inability to obtain financing on acceptable terms, or at all, could negatively impact our ability to acquire additional properties.
Adverse economic conditions could have an adverse effect on the office, lodging and apartment communities industries.
The United States has been recovering from a post-recessionary slow-growth environment, which has experienced historically high levels of unemployment or underemployment. Relative uncertainty over the depth and duration of the economic recovery may have a negative impact on the office, lodging and apartment communities industries. There is some general consensus among economists that the economy in the United States emerged from a recessionary environment in 2009, but high unemployment or underemployment levels have only begun to subside recently. As a result, our office, lodging and apartment properties, among other things, may experience reductions in revenue resulting from lower rental rates and occupancy levels. Accordingly, our financial results could be impacted by the economic environment, and future financial results and growth could be further harmed until a more expansive and consistent national economic environment is prevalent. A continued weaker than anticipated economic recovery, or a return to a recessionary national economic environment, could result in low or decreased levels of business and consumer travel, negatively impacting the lodging industry. Moreover, in the event of another recession, the office and apartment communities industries could experience reductions in rental rates, occupancy levels, property valuations and increases in operating costs such as advertising and turnover expenses. Such an economic outcome could also negatively impact our tenants' future growth prospects and could adversely affect our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends.
Investments in office buildings that have government tenants are subject to the risks associated with conducting business with the U.S. federal government.
Investments in office buildings that have government tenants are subject to risks associated with conducting business with the U.S. federal government. Congressional action to reduce budgetary spending by the United States could limit or reduce the funding of government agencies or other organizations. Adverse developments and/or conditions affecting government tenants could reduce demand for space or force such tenants to curtail operations, which could result in less rent to us and, accordingly, could have a material adverse effect on our results of operations. The risks of conducting business with the U.S. federal government also include the risk of civil and criminal fines and the risk of public scrutiny of our performance at high profile sites.
The U.S. Government's "green lease" policies may adversely affect us.
In recent years the U.S. Government has instituted "green lease" policies which allow a government tenant to require leadership in energy and environmental design for commercial interiors, or LEED®-CI, certification in selecting new premises or renewing leases at existing premises. In addition, the Energy Independence and Security Act of 2007 allows the General Services Administration to give preference to buildings for lease that have received an "Energy Star" label. Obtaining such certifications and labels may be costly and time consuming, but our failure to do so may result in our competitive disadvantage in acquiring new or retaining existing government tenants.
Changes in the United States and state government's requirements for leased space may adversely affect us.
Some of our current rents come from government tenants. Government agencies have been seeking to increase their space utilization under their leases, including reducing the amount of square footage per employee at leased properties, which has reduced the demand for government leased space. If a significant number of such events occur, our income and cash flow may materially decline and our ability to make or sustain regular distributions to our stockholders may be jeopardized.
Tenant concentration increases the risk that cash flow could be interrupted.
We are, and expect that we will continue to be, subject to a degree of tenant concentration at certain of our properties or across multiple properties. In the event that a tenant occupying a significant portion of one or more of our properties or whose rental income represents a significant portion of the rental revenue at such property or properties were to experience financial weakness or file bankruptcy, it would more negatively impact our financial condition and results of operations.
We have incurred indebtedness and expect to incur significant additional indebtedness on a consolidated basis, which may affect our ability to pay dividends, may expose us to interest rate fluctuation risk and may expose us to the risk of default under our debt obligations.
As of December 31, 2014, our total consolidated indebtedness was approximately $650.6 million, inclusive of debt associated with assets held for sale. We expect to incur significant additional indebtedness, including through the use and potential expansion of our existing unsecured credit facility or the use of one or more new credit facilities, to fund future acquisitions and development activities and operational needs. The degree of leverage could make us more vulnerable to a downturn in business or the economy generally.
Payments of principal and interest on borrowings may leave us with insufficient cash resources to operate our properties and/or pay distributions. The incurrence of substantial outstanding indebtedness, and the limitations imposed by our debt agreements, could have significant other adverse consequences, including the following:
• our cash flows may be insufficient to meet our required principal and interest payments;
• we may be unable to borrow additional funds as needed or on favorable terms, which could, among other things, adversely affect our liquidity for acquisitions or operations;
• we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our existing indebtedness;
• we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms;
• we may violate restrictive covenants in our debt documents, which would entitle the lenders to accelerate our debt obligations;
• we may default on our obligations and the lenders or mortgagees may foreclose on our properties and take possession of any collateral that secures their loans; and
• our default under any of our indebtedness with cross-default provisions could result in a default on other indebtedness.
If any one of these events were to occur, our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends could be materially adversely affected. In addition, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which could adversely affect our ability to meet the REIT distribution requirements imposed by the Internal Revenue Code of 1986, as amended (the "Code").
Increases in interest rates could increase the amount of our debt payments and adversely affect our cash flow and ability to pay dividends.
We may incur indebtedness that bears interest at a variable rate. In addition, from time to time, we may pay mortgage loans or finance and refinance our properties in a rising interest rate environment. Accordingly, increases in interest rates could increase our interest costs, which could have an adverse effect on our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends. In addition, if rising interest rates cause us to need additional capital to repay our indebtedness, we may need to liquidate one or more of our investments at times that may not permit realization of the maximum return on such investments. Prolonged interest rate increases also could negatively impact our ability to make investments with positive economic returns.
We may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our current indebtedness.
Upon maturity of indebtedness incurred by us, there is no assurance that replacement financing can be obtained or, if it is obtained, that interest rates and other terms would be as favorable as the original indebtedness. Inability to refinance indebtedness on favorable terms may compel us to attempt to dispose of one or more properties, including any properties that may be secured by such debt, on terms less favorable than might be obtained at a later date. In addition, if any secured indebtedness matured before refinancing could be procured, the lender could foreclose on the applicable collateral and we might suffer losses as a result of that foreclosure. Further, lenders may require insurance against terrorist acts, particularly for large properties in urban areas, and the unavailability of such insurance may make it difficult to finance or refinance investments.
We may be unable to renew leases or lease vacant office space.
As of December 31, 2014, 13.4% of the rentable square footage of our office portfolio was available for lease. As of December 31, 2014, 15.3% of the occupied square footage in our office portfolio was scheduled to expire in 2015. Local economic environment may make the renewal of these leases more difficult, or renewal may occur at rental rates equal to or below existing rental rates. As a result, portions of our office properties may remain vacant for extended periods of time. In addition, we may have to offer substantial rent abatements, tenant improvements, concessions, early termination rights or below-market renewal options to attract new tenants or retain existing tenants. The factors described above could have an adverse effect on our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends.
Short-term leases in our multifamily portfolio may expose us to the effects of declining market rents.
Substantially all of our leases in our multifamily portfolio are for a term of one year or less. Therefore, our rental revenues are impacted by declines in market rents more quickly than if our leases were for longer terms.
Our operating performance is subject to risks associated with the lodging industry.
The success of our hotel properties depends largely on the property operators' ability to adapt to dominant trends in the lodging industry as well as disruptions such as greater competitive pressures, increased consolidation, industry overbuilding, dependence on consumer spending patterns and changing demographics, the introduction of new concepts and products, availability of labor, price levels and macroeconomic and microeconomic conditions. The success of a particular hotel brand, the ability of a hotel brand to fulfill any obligations to operators of our business, and trends in the lodging industry may affect our income and cash available for dividends.
The performance of the lodging industry has historically been closely linked to the performance of the general economy and, specifically, growth in U.S. gross domestic product. The lodging industry is also sensitive to business and personal discretionary spending levels. The lodging industry could experience a significant decline in occupancy and average daily rates due to a reduction in business and/or leisure travel. General economic conditions, increased fuel costs, natural disasters and terrorist attacks are a few factors that could affect an individual's willingness to travel.
We face significant competition.
Our office portfolio competes with a number of developers, owners and operators of office real estate, many of which own properties similar to ours in the same markets in which our properties are located. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge or to offer more substantial rent abatements, tenant improvements, early termination rights or below-market renewal options in order to retain tenants when our tenants' leases expire. As a result of any of the foregoing factors, the market price of our Common Stock, our business, financial condition, results of operations, cash flow and/or ability to satisfy our debt service obligations or to pay dividends could be materially adversely affected.
Our hotel portfolio competes for guests primarily with other hotels in the immediate vicinity of our hotels and secondarily with other hotels in the geographic market of our hotels. An increase in the number of competitive hotels in a particular area could have a material adverse effect on the occupancy, average daily rate and revenue per available room of our hotels in that area.
There are numerous housing alternatives that compete with our apartment communities in attracting residents. These include other apartment communities and single-family homes that are available for rent in the markets in which the communities are located. If the demand for our apartment communities is reduced or if competitors develop and/or acquire competing apartment communities, rental rates may drop, which may have a material adverse effect on our financial condition and results of operations. We also face competition from other real estate investment funds, businesses and other entities in the acquisition, development and operation of apartment communities. This competition may result in an increase in costs and prices of apartment communities that we acquire and/or develop.
We may be unable to complete acquisitions that would grow our business and, even if consummated, we may fail to successfully integrate and operate acquired properties.
We plan to acquire additional properties as opportunities arise. Our ability to acquire properties on favorable terms and successfully integrate and operate them is subject to the following significant risks:
• we may be unable to acquire desired properties because of competition from other real estate investors with better access to less expensive capital, including other real estate operating companies, publicly-traded REITs and investment funds;
• we may acquire properties that are not accretive to our results upon acquisition, and we may not successfully manage and lease those properties to meet our expectations;
• competition from other potential acquirers may significantly increase purchase prices;
• acquired properties may be located in new markets where we may face risks associated with a lack of market knowledge or understanding of the local economy, lack of business relationships in the area and unfamiliarity with local governmental and permitting procedures;
• we may be unable to generate sufficient cash from operations or obtain the necessary debt or equity financing to consummate an acquisition on favorable terms or at all;
• we may need to spend more than anticipated amounts to make necessary improvements or renovations to acquired properties;
• we may spend significant time and money on potential acquisitions that we do not consummate;
• we may be unable to quickly and efficiently integrate new acquisitions into our existing operations;
• we may suffer higher than expected vacancy rates and/or lower than expected rental rates; and
• we may acquire properties without any recourse, or with only limited recourse, for liabilities against the former owners of the properties.
If we cannot complete property acquisitions on favorable terms, or operate acquired properties to meet our goals or expectations, our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends could be materially adversely affected.
We may be unable to successfully expand our operations into new markets.
Each of the risks applicable to our ability to acquire and successfully integrate and operate properties in the markets in which our properties are located are also applicable to our ability to acquire and successfully integrate and operate properties in new markets. In addition to these risks, we may not possess the same level of familiarity with the dynamics and market conditions of certain new markets that we may enter, which could adversely affect our ability to expand into those markets. We may be unable to build a significant market share or achieve a desired return on our investments in new markets. If we are unsuccessful in expanding into new markets, it could adversely affect our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends.
Our stockholders will not have any approval rights regarding expansion strategies or specific future investments.
We have expanded and may continue to expand our operations into new real estate-related activities, including, without limitation, (i) originating and/or investing in a variety of loan products, including, but not limited to, mezzanine loans, commercial real estate loans and other types of loans and/or (ii) real estate development activities to create substantially stabilized properties. See "Item 1 - Business-Lending Segment-New Commercial Loans." Stockholders will not have any approval rights with respect to expansion strategies or future investments. Stockholders will therefore be relying on our Advisor with respect to future investments to be made by us. If we are unsuccessful in expanding into new real-estate activities, it could adversely affect our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends.
We may make investments outside of the United States, which would subject us to additional risks that may affect our operations favorably or unfavorably.
We may invest some of our capital outside of the United States. Our investments in foreign countries will be affected favorably or unfavorably by changes in exchange rates due to political and economic factors, including inflation. Because non-U.S. companies are not subject to uniform accounting, auditing and financial reporting standards, practices and requirements comparable with those applicable to U.S. companies, there may be different types of, and lower quality, information available about non-U.S. companies and their assets. This may affect our ability to underwrite and evaluate proposed investments in foreign countries or to obtain appropriate financial reports relating to such investments. In addition, with respect to certain countries, there may be an increased potential for corrupt business practices, or the possibility of expropriation or confiscatory taxation, political or social instability, or diplomatic developments that could affect our investments in those countries. Moreover, individual economies will differ favorably or unfavorably from the U.S. economy in such respects as growth of gross national product, rate of inflation, changes in currency rates and exchange control regulations and capital reinvestment. As a result of the factors described in this paragraph, any investments made outside of the United States may be subject to a higher degree of risk; there can also be no assurance that any such investments will generate returns comparable to investment made in the United States.
We are subject to risks and liabilities unique to joint venture relationships.
We may contemplate acquisitions of properties through joint ventures and sales to institutions of partial ownership of properties that we wholly own. Joint venture investments involve certain risks, including for example:
• disputes with joint venture partners might affect our ability to develop, operate or dispose of a property;
• the refinancing of unconsolidated joint venture debt may require additional equity commitments on our part;
• joint venture partners may control or share certain approval rights over major decisions or might have economic or other business interests or goals that are inconsistent with our business interests or goals that would affect our ability to operate the property;
• we may be forced to fulfill the obligations of a joint venture or of joint venture partners who default on their obligations including those related to debt or interest rate swaps; and
• there may be conflicts of interests because our joint venture partners may have varying interest such as different need for liquidity, different assessments of the market, different tax objectives or ownership of competing interests in properties in our markets.
The occurrence of one or more of the foregoing events could adversely affect our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends.
We may become exposed to risks associated with property development.
We may engage in development and redevelopment activities with respect to certain of our properties. To the extent that we do so, we will be subject to certain risks, including, without limitation:
• the availability and pricing of financing on favorable terms or at all;
• the availability and timely receipt of zoning and other regulatory approvals;
• contractor and subcontractor disputes, strikes, labor disputes or supply disruptions; and
• the cost and timely completion of construction (including risks beyond our control, such as weather or labor conditions, or material shortages).
These risks could result in substantial unanticipated delays or expenses and, under certain circumstances, could prevent completion of development activities once undertaken, any of which could have a material adverse effect on our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends.
Real estate investments are generally illiquid, and we may not be able to sell our properties when we desire.
Our real estate investments are relatively difficult to sell quickly. Return of capital and realization of gains, if any, from an investment generally will occur upon disposition or refinance of the underlying property. We may be unable to realize our investment objectives by sale or other disposition or refinance at attractive prices within any given period of time or may otherwise be unable to complete any exit strategy. In particular, these risks could arise from weakness in or even the lack of an established market for a property, changes in the financial condition or prospects of prospective purchasers, changes in national or international economic conditions, such as the recent economic downturn, and changes in laws, regulations or fiscal policies of jurisdictions in which the property is located. Furthermore, certain properties may be adversely affected by contractual rights, such as rights of first offer.
We may be unable to secure funds for our future long-term liquidity needs, which could adversely impact our business and results of operations.
Our long-term liquidity needs will consist primarily of funds necessary to acquire properties and pay for development or repositioning of properties, non-recurring capital expenditures, and refinancing of indebtedness. We may not have sufficient funds on hand or may not be able to obtain additional financing to cover all of these long-term cash requirements, although it should be noted that we do not currently have any significant property development or repositioning projects planned. The nature of our business, and the requirements imposed by REIT rules that we distribute a substantial majority of our REIT taxable income on an annual basis in the form of dividends, may cause us to have substantial liquidity needs over the long-term. We will seek to satisfy our long-term liquidity needs through cash flows from operations, long-term borrowings, debt and/or equity issuances and/or, to the extent appropriate, property dispositions. These sources of funding may not be available on attractive terms or at all. If we cannot obtain additional funding for our long-term liquidity needs, our investments may generate lower cash flows or decline in value, or both, which may cause us to reduce our dividend or sell assets at a time when we would not otherwise do so.
Potential losses may not be covered by insurance.
Our business operations in California, New York, North Carolina, Texas and the District of Columbia are susceptible to, and could be significantly affected by, adverse weather conditions and natural disasters such as earthquakes, tsunamis, hurricanes, wind, blizzards, floods, landslides, drought and fires. These adverse weather conditions and natural disasters could cause significant damage to the properties in our portfolio, the risk of which is enhanced by the concentration of our properties, by aggregate net operating income and square feet, in California and the District of Columbia. Our insurance may not be adequate to cover business interruption or losses resulting from adverse weather or natural disasters. We do not maintain insurance on our properties for earthquakes, except for those few properties for which such insurance coverage is contractually required. In addition, our insurance policies include customary deductibles and limitations on recovery. As a result, we may be required to incur significant costs in the event of adverse weather conditions and natural disasters. We may discontinue part or all of any insurance coverage on some or all of our properties in the future if the
cost of premiums for any of these policies in our judgment exceeds the value of the coverage discounted for the risk of loss.
Furthermore, we may not carry insurance for certain losses, including, but not limited to, losses caused by war or certain environmental conditions, such as mold or asbestos. In addition, our title insurance policies may not insure for the current aggregate market value of our portfolio, and we do not intend to increase our title insurance coverage if the market value of our portfolio increases. As a result, we may not have sufficient coverage against all losses that we may experience, including from adverse title claims. If we experience a loss that is uninsured or that exceeds policy limits, we could incur significant costs and lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties.
In addition, our properties may not be able to be rebuilt to their existing height or size at their existing location under current land-use laws and policies. In the event that we experience a substantial or comprehensive loss of one of our properties, we may not be able to rebuild such property to its existing specifications and otherwise may have to upgrade such property to meet current code requirements.
Terrorism and other factors affecting demand for our properties could harm our operating results.
The strength and profitability of our business depends on demand for and the value of our properties. Future terrorist attacks in the United States, such as the attacks that occurred in New York and the District of Columbia on September 11, 2001 and in Boston on April 15, 2013, and other acts of terrorism or war may have a negative impact on our operations. Terrorist attacks in the United States and elsewhere may result in declining economic activity, which could harm the demand for and the value of our properties. In addition, the public perception that certain locations are at greater risk for attack, such as major airports, ports, and rail facilities, may decrease the demand for and the value of our properties near these sites. A decrease in demand could make it difficult for us to renew or re-lease our properties at these sites at lease rates equal to or above historical rates. Such terrorist attacks could have an adverse impact on our business even if they are not directed at our properties.
In addition, the terrorist attacks of September 11, 2001 have substantially affected the availability and price of insurance coverage for certain types of damages or occurrences, and our insurance policies for terrorism include large deductibles and co-payments. Although we maintain terrorism insurance coverage on our portfolio, the lack of sufficient insurance for these types of acts could expose us to significant losses and could have a negative impact on our operations.
Because we own real property, we are subject to extensive environmental regulation which creates uncertainty regarding future environmental expenditures and liabilities.
Environmental laws regulate, and impose liability for, releases of hazardous or toxic substances into the environment. Under some of these laws, an owner or operator of real estate may be liable for costs related to soil or groundwater contamination on or migrating to or from its property. In addition, persons who arrange for the disposal or treatment of hazardous or toxic substances may be liable for the costs of cleaning up contamination at the disposal site.
These laws often impose liability regardless of whether the person knew of, or was responsible for, the presence of the hazardous or toxic substances that caused the contamination. The presence of, or contamination resulting from, any of these substances, or the failure to properly remediate them, may adversely affect our ability to sell or rent our property or to borrow using the property as collateral. In addition, persons exposed to hazardous or toxic substances may sue for personal injury damages. For example, some laws impose liability for release of or exposure to asbestos-containing materials. In other cases, some of our properties may have been impacted by contamination from past operations or from off-site sources. As a result, in connection with our current or former ownership, operation,
management and development of real properties, we may be potentially liable for investigation and cleanup costs, penalties and damages under environmental laws.
Although most of our properties have been subjected to preliminary environmental assessments, known as Phase I assessments, by independent environmental consultants that identify certain liabilities, Phase I assessments are limited in scope, and may not include or identify all potential environmental liabilities or risks associated with a property. Unless required by applicable law, we may decide not to further investigate, remedy or ameliorate the liabilities disclosed in the Phase I assessments.
Further, these or other environmental studies may not identify all potential environmental liabilities or accurately assess whether we will incur material environmental liabilities in the future. If we do incur material environmental liabilities in the future, we may face significant remediation costs, and we may find it difficult to sell any affected properties.
Compliance with the ADA and fire, safety and other regulations may require us to make unanticipated expenditures that could significantly reduce the cash available for dividends.
Our properties are subject to regulation under federal laws, such as the ADA, pursuant to which all public accommodations must meet federal requirements related to access and use by disabled persons. Although we believe that our properties substantially comply with present requirements of the ADA, we have not conducted an audit or investigation of all of our properties to determine our compliance. If one or more of our properties or future properties is not in compliance with the ADA, we might be required to take remedial action, which would require us incur additional costs to bring the property into compliance. Noncompliance with the ADA could also result in imposition of fines or an award of damages to private litigants.
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 ultimate amount of the cost of compliance with the ADA or other legislation.
In addition, our properties are subject to various federal, state and local regulatory requirements, such as state and local earthquake, fire and life safety requirements. If we were to fail to comply with these various requirements, we might incur governmental fines or private damage awards. If we incur substantial costs to comply with the ADA or any other regulatory requirements, our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends could be materially adversely affected. Local regulations, including municipal or local ordinances, zoning restrictions and restrictive covenants imposed by community developers may restrict our use of our properties and may require us to obtain approval from local officials or community standards organizations at any time with respect to our properties, including prior to acquiring a property or when undertaking renovations of any of our existing properties.
We face risks associated with security breaches through cyber attacks, cyber intrusions or otherwise, as well as other significant disruptions of our Advisor's and Manager's information technology (IT) networks and related systems.
We face risks associated with security breaches, whether through cyber attacks or cyber intrusions over the Internet, malware, computer viruses, attachments to e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our Advisor's or Manager's IT networks and related systems. The risk of a security breach or disruption, particularly through cyber attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our Advisor's and Manager's IT networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations (including managing our building systems), and, in some cases, may be
critical to the operations of certain of our tenants. There can be no assurance that efforts to maintain the security and integrity of these types of IT networks and related systems will be effective or that attempted security breaches or disruptions would not be successful or damaging. A security breach or other significant disruption involving our Advisor's or Manager's IT networks and related systems could adversely impact our business, financial condition, results of operations, cash flow or ability to satisfy our debt service obligations or to pay dividends.
Changes in accounting standards may adversely impact our financial condition and/or results of operations.
We are subject to the rules and regulations of the U.S. Financial Accounting Standards Board ("FASB") related to generally accepted accounting principles ("GAAP"). Various changes to GAAP are constantly being considered, some of which could materially impact our reported financial condition and/or results of operations. Also, to the extent publicly traded companies in the United States would be required in the future to prepare financial statements in accordance with International Financial Reporting Standards ("IFRS") instead of the current GAAP in the United States, this change in accounting standards could materially impact our reported financial condition and/or results of operations.
Risks Related to Our Lending Business
Commercial mortgage loans expose us to a high degree of risk associated with investing in real estate.
The performance and value of our loans depends upon many factors beyond our control. Commercial real estate has experienced cyclical performance and significant fluctuations in the past that impacts the value of our real estate collateralized loans. The ultimate performance and value of our loans are subject to risks associated with the ownership and operation of the properties which collateralize our loans, including the property owner's ability to operate the property with sufficient cash flow to meet debt service requirements. The performance and value of the properties collateralizing our loans may be adversely affected by:
• changes in national or regional economic conditions;
• changes in real estate market conditions due to changes in national, regional or local economic conditions or property market characteristics;
• competition from other properties;
• changes in interest rates and the condition of the debt and equity capital markets;
• the ongoing need for capital repairs and improvements;
• increases in real estate tax rates and other operating expenses (including utilities);
• adverse changes in governmental rules and fiscal policies; acts of God, including earthquakes, hurricanes and other natural disasters; acts of war or terrorism; or a decrease in the availability of or an increase in the cost of insurance;
• adverse changes in zoning laws;
• the impact of environmental legislation and compliance with environmental laws; and
• other factors that are beyond our control or the control of the commercial property owners.
In the event that any of the properties underlying our loans experience any of the foregoing events or occurrences, the value of, and return on, such loans may be negatively impacted. Moreover, our profitability may be negatively impacted.
There are significant risks in lending to small businesses.
Our loans receivable included in assets held for sale consist primarily of loans to small, privately-owned businesses. There is typically no publicly available information about these businesses; therefore, we must rely on our own due diligence to obtain information in connection with our investment decisions. Our borrowers may not meet net income, cash flow and other coverage tests typically imposed by banks. A borrower's ability to repay its loan may be adversely impacted by numerous factors, including a downturn in its industry or other negative local or macro-economic conditions. Deterioration in a borrower's financial condition and prospects may be accompanied by deterioration in the collateral for the loan. In addition, small businesses typically depend on the management talents and efforts of one person or a small group of people for their success. The loss of services of one or more of these persons could have an adverse impact on the operations of the small business. Small companies are typically more vulnerable to customer preferences, market conditions and economic downturns and often need additional capital to maintain the business, expand or compete. These factors may have an impact on the ultimate recovery of our loans receivable from such businesses. Loans to small businesses, therefore, involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative.
Longer term loans and our real estate owned ("REO") are typically illiquid and their value may decrease.
Our commercial real estate loans and real estate acquired through foreclosure are typically illiquid investments. Therefore, we will be unable to vary our portfolio promptly in response to changing economic, financial and investment conditions. As a result, the fair market value of these investments may decrease in the future and losses may result. The illiquid nature of our loans may adversely affect our ability to dispose of such loans at times when it may be advantageous or necessary for us to liquidate such investments.
We have a concentration of investments which may negatively impact our financial condition and results of operations.
Substantially all of our revenue from the lending segment is generated from loans collateralized by hospitality properties. At December 31, 2014, our loans were 95% concentrated in the hospitality industry. Any factors that negatively impact the hospitality industry, including recessions, severe weather events (such as hurricanes, blizzards, floods, etc.), depressed commercial real estate markets, travel restrictions, bankruptcies or other political or geopolitical events, could have an adverse effect on our financial condition and results of operations.
Establishing loan loss reserves entails significant judgment and may negatively impact our results of operations.
We have a quarterly review process to identify and evaluate potential exposure to loan losses. The determination of whether significant doubt exists and whether a loan loss reserve is necessary requires judgment and consideration of the facts and circumstances existing at the evaluation date. Additionally, further changes to the facts and circumstances of the individual borrowers, the limited service hospitality industry and the economy may require the establishment of additional loan loss reserves and the effect to our results of operations would be adverse. If our judgments underlying the establishment of our loan loss reserves are not correct, our results of operations may be negatively impacted.
Whenever our borrowers experience significant operating difficulties and we are forced to liquidate the collateral underlying the loans, losses may be relatively substantial.
The loans we originate are subject to delinquency, foreclosure and loss, any or all of which could result in losses.
Our legacy commercial real estate loans and loans originated pursuant to the SBA 7(a) loan program are collateralized by income-producing properties (primarily limited service hospitality properties) and typically have personal guaranties. Our commercial real estate mortgage loans are secured by commercial properties, collateralized by properties which may be income producing and typically do not have personal guaranties. In addition, our legacy commercial real estate loans and loans originated pursuant to the SBA 7(a) Program are predominately to operators of limited service hospitality properties. As a result, these operators are subject to risks associated with the hospitality industry, including recessions, severe weather events, depressed commercial real estate markets, travel restrictions, bankruptcies or other political or geopolitical events.
Our real estate loans are subject to risks of delinquency and foreclosure. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expense or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes in national, regional or local economic conditions and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances.
In the event of any loan default, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest on the loan, which could have a material adverse effect on our cash flow from operations. In the event of the bankruptcy of a borrower, the loan to such borrower will be deemed to be collateralized only to the extent of the value of the underlying property at the time of bankruptcy (as determined by the bankruptcy court). If a borrower defaults on one of our commercial real estate loans and the underlying property collateralizing the loan is insufficient to satisfy the outstanding balance of the loan, we will suffer a loss. In addition to losses related to collateral deficiencies, during the foreclosure process we may incur costs related to the protection of our collateral including unpaid real estate taxes, legal fees, franchise fees, insurance and operating shortfalls to the extent the property is being operated by a court-appointed receiver.
Foreclosure and bankruptcy are complex and sometimes lengthy processes that are subject to Federal and state laws and regulations. An action to foreclose on a property is subject to many of the delays and expenses of other lawsuits if the defendant raises defenses or counterclaims. In the event of a default by a mortgagor, these restrictions, among other things, may impede our ability to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due to us on the mortgage loan. Borrowers have the option of seeking Federal bankruptcy protection which could delay the foreclosure process. In conjunction with the bankruptcy process, the terms of the loan agreements may be modified. Typically, delays in the foreclosure process will have a negative impact on our results of operations and/or financial condition due to direct and indirect costs incurred and possible deterioration of the value of the collateral.
We operate in a competitive market for investment opportunities and future competition for our commercial real estate collateralized loans may limit our ability to originate or dispose of our target loans and could also affect the yield of these investments.
We are in competition with a number of entities for the types of commercial real estate collateralized loans that we plan to originate. Those entities include, among others, REITs, specialty finance companies, savings and loan associations, banks and financial institutions. Many of these competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. Several other mortgage REITs have recently raised, or are expected to raise, significant amounts of capital, and may create competition for investment opportunities. Some of these competitors may have a lower cost of funds and access to funding sources that may not be available to us. In addition, many of our competitors may not be subject to the operating constraints associated with REIT qualification or maintenance of exclusions from registration under the Investment Company Act. Furthermore, competition may further limit our ability to generate desired returns. Due to this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations.
We may be subject to lender liability claims.
In recent years, a number of judicial decisions have upheld the right of borrowers to sue lending institutions on the basis of various evolving legal theories, collectively termed "lender liability." Generally, lender liability is founded on the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has assumed a degree of control over the borrower resulting in the creation of a fiduciary duty owed to the borrower or our other creditors or stockholders. We cannot assure prospective investors that such claims will not arise or that we will not be subject to significant liability if a claim of this type did arise.
We may enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.
Subject to maintaining our qualification as a REIT, we may enter into hedging transactions that could require us to fund cash payments in certain circumstances (e.g., the early termination of the hedging instrument caused by an event of default or other early termination event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the hedging instrument). The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. These economic losses will be reflected in our results of operations, and our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time, and the need to fund these obligations could adversely impact our financial condition.
In addition, certain of the hedging instruments that we may enter into could involve risks since they often are not traded on regulated exchanges, guaranteed by an exchange or our clearing house, or regulated by any U.S. or foreign governmental authorities. We cannot assure you that a liquid secondary market will exist for hedging instruments that we may enter into in the future, and we may be required to maintain a position until exercise or expiration, which could result in significant losses.
Furthermore, we intend to record any derivative and hedging transactions we enter into in accordance with GAAP. However, we may choose not to pursue, or fail to qualify for, hedge accounting treatment relating to such derivative instruments. As a result, our operating results may suffer because losses, if any, on these derivative instruments may not be offset by a change in the fair value of the related hedged transaction or item.
Curtailment of our ability to utilize the SBA 7(a) Program by the Federal government could adversely affect our results of operations.
We are dependent upon the Federal government to maintain the SBA 7(a) Program. There can be no assurance that the program will be maintained or that loans will continue to be guaranteed at current levels. In addition, there can be no assurance that First Western will be able to maintain its status as a Preferred Lender or that we can maintain our SBA 7(a) license.
If we cannot continue originating and selling government guaranteed loans at current levels, we could experience a decrease in future servicing spreads and earned premiums. From time-to-time the SBA has reached its internal budgeted limits and ceased to guarantee loans for a stated period of time. In addition, the SBA may change its rules regarding loans or Congress may adopt legislation or fail to approve a budget that would have the effect of discontinuing, reducing availability of funds for, or changing loan programs. Non-governmental programs could replace government programs for some borrowers, but the terms might not be equally acceptable. If these changes occur, the volume of loans to small businesses that now qualify for government guaranteed loans could decline, as could the profitability of these loans.
First Western has been granted national PLP status and originates, sells and services small business loans and is authorized to place SBA guarantees on loans without seeking prior SBA review and approval. Being a national lender, PLP status allows First Western to expedite loans since First Western is not required to present applications to the SBA for concurrent review and approval. The loss of PLP status could adversely impact our marketing efforts and ultimately loan origination volume which could negatively impact our results of operations.
We may not be able to successfully deconsolidate our lending segment, which may result in an adverse effect to our business or the way our company is perceived.
Our Board of Directors approved a plan for the lending business that, when completed, will result in the deconsolidation of the lending segment. We are currently incurring costs and expenses relating to the plan. However, we cannot assure you that we will be able to successfully consummate the deconsolidation of the lending segment as currently contemplated under the plan approved by our Board of Directors or at all. As a result, our failure to deconsolidate the lending segment could have an adverse effect on our business or the way our company is perceived to analysts, investors or others.
Risks Related to Our Organization and Structure
Failure to qualify as a REIT would have significant adverse consequences to us and the value of our stock.
If we fail to qualify as a REIT for federal income tax purposes, we would be taxed as a corporation. We believe that we are organized and qualified as a REIT and intend to operate in a manner that will allow us to continue to qualify as a REIT. However, we cannot assure you that we are qualified as such, or that we will remain qualified as such in the future. This is because qualification as a REIT involves the application of highly technical and complex provisions of the Code as to which there are only limited judicial and administrative interpretations and involves the determination of facts and circumstances not entirely within our control. Future legislation, new regulations, administrative interpretations or court decisions may significantly change the tax laws or the application of the tax laws with respect to qualification as a REIT for federal income tax purposes or the federal income tax consequences of such qualification.
If we fail to qualify as a REIT, we could face serious tax consequences that could substantially reduce our funds available for payment of dividends for each of the years involved because:
• we would not be allowed a deduction for dividends paid to stockholders in computing our taxable income and could be subject to federal income tax at regular corporate rates;
• we also could be subject to the federal alternative minimum tax and possibly increased state and local taxes;
• unless we are entitled to relief under statutory provisions, we could not elect to be subject to be taxed as a REIT for four taxable years following the year during which we are disqualified; and
• all dividends would be subject to tax as ordinary income to the extent of our current and accumulated earnings and profits potentially eligible as "qualified dividends" subject to the applicable income tax rate.
Any such corporate tax liability could be substantial and would reduce our cash available for, among other things, our operations and distributions to stockholders. In addition, if we fail to qualify as a REIT, we would no longer be required to pay dividends. As a result of these factors, our failure to qualify as a REIT could have an adverse effect on our financial conditions, result of operations, cash flows, ability to satisfy our debt service obligations and to pay dividends.
To maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions.
To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our net taxable income each year, excluding net capital gains, and we will be subject to regular corporate income taxes to the extent that we distribute less than 100% of our net taxable income each year. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. In order to maintain our REIT status and avoid the payment of income and excise taxes, we may need to borrow funds to meet the REIT distribution requirements even if the then prevailing market conditions are not favorable for these borrowings. These borrowing needs could result from, among other things, differences in timing between the actual receipt of cash and inclusion of income for federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments. These sources, however, may not be available on favorable terms or at all. Our access to third-party sources of capital depends on a number of factors, including the market's perception of our growth potential, our current debt levels, the market price of our Common Stock, and our current and potential future earnings. We cannot assure you that we will have access to such capital on favorable terms at the desired times, or at all, which may cause us to curtail our investment activities and/or to dispose of assets at inopportune times, and could have an adverse effect on our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends.
Complying with REIT requirements may affect our profitability and may force us to liquidate or forgo otherwise attractive investments.
To qualify as a REIT, we must continually satisfy tests concerning, among other things, the nature and diversification of our assets, the sources of our income and the amounts we distribute to our stockholders. We may be required to liquidate or forgo otherwise attractive investments in order to satisfy the asset and income tests or to qualify under certain statutory relief provisions. We also may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. As a result, having to comply with the distribution requirement could cause us to: (i) sell assets in adverse market conditions; (ii) borrow on unfavorable terms; or (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt. Accordingly, satisfying the REIT requirements could have an adverse effect on our business results, profitability and ability to execute our business plan. Moreover, if we are compelled to liquidate our investments to meet any of these asset, income or distribution tests, or to repay obligations to our lenders, we may be unable to comply with one or more of the requirements
applicable to REITs or may be subject to a 100% tax on any resulting gain if such sales constitute prohibited transactions.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
Income from "qualified dividends" payable to U.S. stockholders that are individuals, trusts and estates are generally subject to tax at preferential rates. Dividends payable by REITs, however, generally are not eligible for the preferential tax rates applicable to qualified dividend income. Although these rules do not adversely affect the taxation of REITs or dividends payable by REITs, to the extent that the preferential rates continue to apply to regular corporate qualified dividends, investors who are individuals, trusts and estates may perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could materially and adversely affect the value of the shares of REITs, including the per share trading price of our securities.
The power of the Board of Directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders.
Our organizational documents permit our Board of Directors to revoke or otherwise terminate our REIT election, without the approval of our stockholders, if the Board of Directors determines that it is not in our best interest to qualify as a REIT. In such a case, we would become subject to U.S. federal, state and local income tax on our net taxable income and we would no longer be required to distribute most of our net taxable income to our stockholders, which have adverse consequences on the total return to our stockholders.
Our ownership of and relationship with our taxable REIT subsidiaries will be limited, and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.
Subject to certain restrictions, a REIT may own up to 100% of the stock of one or more taxable REIT subsidiaries. A taxable REIT subsidiary may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a taxable REIT subsidiary. A corporation of which a taxable REIT subsidiary directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a taxable REIT subsidiary. Overall, no more than 25% of the value of a REIT's assets may consist of stock or securities of one or more taxable REIT subsidiaries. A taxable REIT subsidiary generally will pay income tax at regular corporate rates on any taxable income that it earns. In addition, the taxable REIT subsidiary rules limit the deductibility of interest paid or accrued by a taxable REIT subsidiary to its parent REIT to assure that the taxable REIT subsidiary is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a taxable REIT subsidiary and its parent REIT that are not conducted on an arm's-length basis.
Our taxable REIT subsidiaries are subject to normal corporate income taxes. We continuously monitor the value of our investments in taxable REIT subsidiaries for the purpose of ensuring compliance with the rule that no more than 25% of the value of our assets may consist of taxable REIT subsidiary stock and securities (which is applied at the end of each calendar quarter). The aggregate value of our taxable REIT subsidiary stock and securities is less than 25% of the value of our total assets (including our taxable REIT subsidiary stock and securities) as of December 31, 2014. In addition, we will scrutinize all of our transactions with our taxable REIT subsidiaries for the purpose of ensuring that they are entered into on arm's-length terms in order to avoid incurring the 100% excise tax described above. There are no distribution requirements applicable to the taxable REIT subsidiaries and after-tax earnings may be retained. There can be no assurance, however, that we will be able to comply with the 25% limitation on ownership of taxable REIT subsidiary stock and securities on an
ongoing basis so as to maintain REIT status or to avoid application of the 100% excise tax imposed on certain non-arm's-length transactions.
Certain provisions of Maryland law could inhibit changes in control.
Certain provisions of the Maryland General Corporation Law ("MGCL") may have the effect of inhibiting a third party from making a proposal to acquire us or impeding a change of control under circumstances that otherwise could provide our stockholders with the opportunity to realize a premium over the then-prevailing market price of our Common Stock, including:
• "business combination" provisions that, subject to limitations, prohibit certain business combinations between us and an "interested stockholder" (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter impose special appraisal rights and special stockholder voting requirements on these combinations; and
• "control share" provisions that provide that "control shares" of our company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a "control share acquisition" (defined as the direct or indirect acquisition of ownership or control of "control shares") have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.
We have elected to opt out of these provisions of the MGCL, in the case of the business combination provisions of the MGCL, by resolution of our Board of Directors, and in the case of the control share provisions of the MGCL, pursuant to a provision in our bylaws. However, our Board of Directors may by resolution elect to repeal the foregoing opt-outs from the business combination provisions of the MGCL and we may, by amendment to our bylaws, opt in to the control share provisions of the MGCL in the future.
Our charter, bylaws, the partnership agreement for our operating partnership and Maryland law also contain other provisions that may delay, defer or prevent a transaction or a change of control that might involve a premium price for our Common Stock or otherwise be in the best interest of our stockholders.
We are controlled by an affiliate of CIM Group.
Urban II, an affiliate of CIM Group, beneficially owns shares of our Common Stock that, together with shares held by another affiliate of CIM Group, currently represents approximately 98.2% of the total voting power of the Company. For so long as affiliates of CIM Group continue to own a significant percentage of our stock, CIM Group will be able to significantly influence the composition of our Board of Directors and the approval of actions requiring stockholder approval. Accordingly, CIM Group will have significant influence with respect to our management, business plans and policies, including the appointment and removal of our officers. In particular, CIM Group will be able to cause or prevent a change of control of the Company or a change in the composition of our Board of Directors and could preclude any unsolicited acquisition of the Company. The concentration of ownership could deprive you of an opportunity to receive a premium for your shares of Common Stock as part of a sale of the Company and ultimately might affect the market price of our Common Stock.
We are a "controlled company" within the meaning of the rules of the NASDAQ Stock Market LLC and, as a result, qualify for, and currently rely on, exemptions from certain corporate governance requirements. You do not have the same protections afforded to stockholders of companies that are subject to such requirements.
Affiliates of CIM Group control a majority of the total voting power in the election of our directors. As a result, we are a "controlled company" within the meaning of the rules of the NASDAQ Stock Market LLC. Under these rules, a company of which more than 50% of the voting power in the election of directors is held by an individual, group or another company is a "controlled company" and may elect not to comply with certain corporate governance requirements, including the requirements that (i) a board be comprised of a majority of "independent directors," as defined under the rules of the NASDAQ Stock Market LLC, (ii) a compensation committee be comprised entirely of independent directors and (iii) nomination decisions be made either by independent directors constituting a majority of the independent directors in a vote in which only independent directors participate, or a nomination committee comprised entirely of independent directors.
As of December 31, 2014, we availed ourselves of these exemptions. As a result, our Board of Directors is not comprised of a majority of independent directors, we do not have a compensation committee, and our nomination decisions are made by our entire Board of Directors. Accordingly, investors in our Common Stock do not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NASDAQ Stock Market LLC.
Our future success depends on the Manager and the Advisor, their respective key personnel and their access to the investment professionals of CIM Group. We may not find suitable replacements if such key personnel or investment professionals leave the employment of the Manager, the Advisor or other applicable affiliates of CIM Group or if such key personnel or investment professionals otherwise become unavailable to us.
We rely on the resources of the Manager to manage our day-to-day operations other than the operations of CIM Urban, and CIM Urban relies on the resources of the Advisor to manage its day-to-day operations. We currently do not employ any personnel (other than two executives, who are jointly employed by us and CIM SBA). We rely completely on the Manager to provide management and administration services to us, and CIM Urban relies completely on the Adviser to provide CIM Urban with investment advisory services.
Our executive officers also serve as officers or employees of the Manager and/or the Advisor or other applicable affiliates of CIM Group. The Manager and the Advisor have significant discretion as to the implementation of investment and operating policies and strategies on behalf of us and CIM Urban. Accordingly, we believe that our success depends to a significant extent upon the efforts, experience, diligence, skill and network of business contacts of the officers and key personnel of the Manager, the Advisor and the other applicable affiliates of CIM Group. The departure of any of these officers or key personnel could adversely affect our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends.
We also depend on access to, and the diligence, skill and network of, business contacts of the professionals within CIM Group and the information and deal flow generated by its investment professionals in the course of their investment and portfolio management activities. The departure of any of these individuals, or of a significant number of the investment professionals or principals of CIM Group, could have an adverse effect on our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends. We cannot assure you that we will continue to have access to CIM Group's investment professionals or its information and deal flow.
The Manager and the Advisor and certain of their affiliates manage or otherwise provide services to our business and our subsidiaries' businesses pursuant to the Master Services Agreement and the Investment Management Agreement. Notwithstanding the fact that these agreements provide broad discretion and authority and the payment of fees to the Manager or the Advisor, as applicable, the Master Services Agreement may be assigned by the Manager in certain circumstances without our consent and neither agreement may be terminated by us, except in the case of the Master Services Agreement, in limited circumstances for cause, either or both of which may have a material adverse effect on us.
We and our lending subsidiaries are parties to the Master Services Agreement pursuant to which the Manager has the right to provide or designate third parties to provide various management and administrative services to us and all of our direct and indirect subsidiaries. We are obligated to pay the Manager the Base Service Fee for the provision of Base Services and market rate transaction fees for transactional and other services that the Manager elects to provide to us. Pursuant to the terms of the Master Services Agreement, the Manager has the right to provide any transactional services to us that we would otherwise engage a third party to provide.
Pursuant to the terms of the Master Services Agreement, the Manager may also recommend new business opportunities to us for our approval and will make a recommendation as to whether each such new business should be internally managed or externally managed and if externally managed, the external manager and the terms of the management agreement. If the proposed external manager is to be the Manager, our independent directors must approve the decision to make such new business externally managed and the terms of the applicable management agreement. If such new business is to be internally managed, the Manager will oversee the hiring of personnel and the implementation of internal management as a transactional service.
The Master Services Agreement continues in full force and effect until December 31, 2018, and thereafter will renew automatically each year. We may generally only terminate the Master Services Agreement for the Manager's material breach of the Master Services Agreement, fraud, gross negligence or willful misconduct or if in certain limited circumstances, a change of control of the Manager occurs that our independent directors determine to be materially detrimental to us and our subsidiaries as a whole. We do not have the right to terminate the Master Services Agreement solely for the poor performance of our operations or any investment made by us on the recommendation of the Manager. In addition, CIM Urban does not have the right to terminate the Investment Management Agreement under any circumstances. Moreover, any removal of Urban GP Manager as manager of CIM Urban GP pursuant to the Master Services Agreement or the CIM Urban Partnership Agreement will not affect the rights of the Manager under the Master Services Agreement or the Advisor under the Investment Management Agreement. Accordingly, the Manager will continue to provide the Base Services and receive the Base Service Fee, and the Manager or the applicable service provider will continue to provide the transactional services and receive related transaction fees, under the Master Services Agreement, and the Advisor will continue to receive the management fee under the Investment Management Agreement.
Further, the Master Services Agreement may be assigned by the Manager without our consent in the case of an assignment by the Manager to an affiliate or an entity that is a successor through merger or acquisition of the business of the Manager. In certain circumstances, including the merger or other acquisition of the business of the Manager, the amount of fees being paid pursuant to the agreements or the poor performance by the Manager, we may desire to terminate one or more of the management agreements. As a result of the limited termination rights under these agreements, we may not have the right to terminate such agreement(s), which could have a material adverse effect on us. See "Item 1 Business-Master Services Agreement."
The Manager's and Advisor's fees are payable regardless of our performance, which may reduce their incentive to devote time and resources to our portfolio.
Pursuant to the Master Services Agreement, the Manager is entitled to receive the Base Service Fee, regardless of our performance, and is also entitled to receive fees related to the provision of transactional and other services. The Advisor is entitled to receive an asset management fee based upon the gross asset value of CIM Urban's assets, including any assets acquired by CIM Urban in the future. See "Item 1 Business-Investment Management Agreement." The Manager's and the Advisor's entitlement to substantial non-performance based compensation might reduce their incentive to devote their time and effort to seeking profitable opportunities for our portfolio.
The Advisor's fees are based on the gross asset value of CIM Urban's assets, including any assets acquired by CIM Urban in the future. This fee arrangement may lead the Advisor to recommend riskier investments regardless of their long-term performance in an effort to maximize its compensation.
The Advisor's fees are based on the gross asset value of CIM Urban's assets, including any assets acquired by CIM Urban in the future, which may provide incentive for the Advisor to invest in assets that are riskier investments regardless of their performance. Because these fees are based on gross asset value, the Advisor will benefit when CIM Urban, or we on its behalf, incurs debt or uses leverage. Consequently, the Advisor may recommend investments that are not necessarily in the best interest of our stockholders in order to maximize its compensation.
Each of the Manager and the Advisor undertakes its services to us under very broad mandates; in particular, the Advisor has broad discretion with respect to CIM Urban's investments, and the Board of Directors does not approve each investment and financing decision made by the Advisor, which may result in CIM Urban's making riskier investments than those currently comprising its investment portfolio.
The Manager, under the Master Services Agreement, and the Advisor, under the Investment Management Agreement, have broad discretion and authority over our day-to-day operations and investments. While our directors periodically review the performance of our businesses, they do not review all decisions made by the Manager and the Advisor, including proposed investments or the implementation of other strategic initiatives. In addition, in conducting reviews of our businesses, our directors may rely primarily on information provided to them by the Manager or the Advisor, as the case may be. The Manager and the Advisor may cause us to enter into significant transactions or undertake significant activities that may be difficult or impossible to unwind or exit by the time they are reviewed by our directors. Each of the Manager and the Advisor has great latitude in the implementation of our strategies, including determining the types of assets that are proper investments for us, which could result in investment returns that are substantially below expectations or that result in losses, which could have an adverse effect on our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and to pay dividends. Decisions made and investments entered into by the Advisor may not fully reflect the best interests of our stockholders.
The Advisor may change its investment process, or elect not to follow it, without stockholder consent at any time, which may adversely affect our investments.
The Advisor may change its investment process and philosophy without stockholder consent at any time. In addition, there can be no assurance that the Advisor will follow its investment process in relation to the identification and acquisition or origination of prospective investments. Changes in the Advisor's investment process and/or philosophy may result in inferior, among other things, due diligence and transaction standards, which may adversely affect the performance of our assets and investment portfolio.
The Advisor, the Manager and their respective affiliates may engage in additional management or investment opportunities which compete with us and our subsidiaries, which could result in decisions that are not in the best interests of our stockholders.
The Investment Management Agreement with the Advisor and the Master Services Agreement with the Manager do not prevent the Advisor and the Manager, as applicable, and their respective affiliates from engaging in additional management or investment opportunities, some of which could compete with us and our subsidiaries. The Advisor, the Manager and their respective affiliates may engage in additional management or investment opportunities that have overlapping objectives with ours, and may thus face conflicts in the allocation of investment opportunities to these other investments. Allocation of investment opportunities is at the discretion of the Advisor and/or the Manager and there is no guarantee that this allocation would be made in the best interest of our stockholders.
There may be conflicts of interest in allocating investment opportunities to CIM Urban and other funds, investment vehicles and ventures managed by the Advisor. For example, the Advisor currently serves as the investment manager of CIM VI (Urban REIT), LLC and its parallel funds (collectively, "CIM VI"), a private fund formed to invest in substantially stabilized real estate and real estate-related assets located in urban areas that CIM Group has already qualified for investment. There is a significant overlap in the assets and investment strategies between us and CIM VI, and many of the same investment personnel will provide services to both entities. Further, the Advisor and its affiliates may form funds or sponsor investment vehicles and ventures that have overlapping objectives with CIM Urban and therefore may compete with CIM Urban for investment opportunities. The ability of the Advisor, the Manager and their officers and employees to engage in other business activities, including the management of other investment vehicles sponsored by CIM Group, may reduce the time the Advisor and the Manager spend managing our activities.
Certain of our directors and executive officers may face conflicts of interest related to positions they hold with the Advisor, the Manager, CIM Group and their affiliates, which could result in decisions that are not in the best interest of our stockholders.
Some of our directors and executive officers are also part-owners, officers and/or directors of the Advisor, the Manager, CIM Group and their affiliates. As a result, they may owe fiduciary duties to these various other entities and their equity owners, which fiduciary duties may from time to time conflict with the fiduciary duties they owe to us and our stockholders. Further, these multiple responsibilities may create conflicts of interest for these individuals if they are presented with opportunities that may benefit us and our other affiliates. The individuals may be incentivized to allocate investment opportunities to other entities rather than to us. Their loyalties to other affiliated entities could result in actions or inactions that are detrimental to our business, strategy and investment opportunities.
The business of CIM Urban is managed by Urban GP Manager and we agreed in the Master Services Agreement to appoint an affiliate of CIM Group as the manager of the general partner of CIM Urban; in addition, the general partner of CIM Urban can be removed from that position under certain circumstances as provided in the CIM Urban Partnership Agreement.
Pursuant to the Master Services Agreement, we agreed to appoint an affiliate of CIM Group as the manager of the general partner of CIM Urban. While currently that designated entity, Urban GP Manager, is an affiliate of CIM Group, there can be no assurances that a different entity would not be appointed the manager of the general partner of CIM Urban in the future. Moreover, we may only remove the Urban GP Manager as the manager of CIM Urban GP for "cause" (as defined in the Master Services Agreement). Removal for "cause" also requires the approval of the holders of at least 662/3% of our outstanding shares (excluding for this purpose any shares held by the Manager and any
affiliates of the Manager, except to the extent set forth in the immediately following sentence). Notwithstanding the foregoing, CIM REIT has the right to vote any of our shares that it owns with respect to any vote held to remove the Urban GP Manager as the manager of the CIM Urban GP; provided, however, if any such removal vote is held after the second anniversary of the Master Services Agreement, CIM REIT must obtain voting instructions from certain of its non-affiliated investors with respect to voting the shares beneficially owned by such non-affiliated investors and CIM REIT must vote the number of shares beneficially owned by each such non-affiliated investor as so instructed by such non-affiliated investor. Upon removal, a replacement manager will be appointed by the independent directors. Finally, under the CIM Urban Partnership Agreement, the general partner of CIM Urban may be removed under certain circumstances with the consent of 662/3% of the class A members of CIM REIT.
Subject to the limitations set forth in the governing documents of CIM Urban and the CIM Urban GP, Urban GP Manager is given the power and authority under the Master Services Agreement to manage, to direct the management, business and affairs of and to make all decisions to be made by or on behalf of (1) CIM Urban GP and (2) CIM Urban. Subject to the other terms of the CIM Urban Partnership Agreement, CIM Urban GP has broad discretion over the operations of CIM Urban. Accordingly, while we own indirectly all of the partnership interests in CIM Urban, except as set forth in the Master Services Agreement and the rights specifically reserved to limited partners by the CIM Urban Partnership Agreement and applicable law, we will have no part in the management and control of CIM Urban.
The CIM Urban Partnership Agreement contains provisions that give rights to certain unaffiliated members of CIM REIT to influence the business and operations of CIM Urban; such members may have interests that are adverse to our stockholders and the exercise of such rights may negatively impact the rights of our stockholders, or our business.
The CIM Urban Partnership Agreement requires the consent of a majority in interest of certain members of CIM REIT in order to amend the CIM Urban Partnership Agreement; the Investment Management Agreement can be amended only with the consent of at least 662/3% of the class A members of CIM REIT who are not affiliates of CIM Urban GP. As noted above, in certain situations, upon a two-thirds vote of certain members of CIM REIT, the CIM Urban GP may be removed and replaced. The refusal to permit amendment of the CIM Urban Partnership Agreement or the removal of the general partner by the members of CIM REIT may adversely impact us.
The Manager's and the Advisor's liability is limited under the Master Services Agreement and the Investment Management Agreement, respectively, and we have agreed to indemnify the Manager against certain liabilities and CIM Urban has agreed to indemnify the Advisor against certain liabilities. As a result, we could experience poor performance or losses for which neither the Manager nor the Advisor would be liable.
Pursuant to the Master Services Agreement, the Manager does not assume any responsibility other than to render the services called for thereunder in good faith and will not be responsible for any action of our Board of Directors in following or declining to follow its advice or recommendations. Under the terms of the Master Services Agreement, neither the Manager nor any of its affiliates providing services under the Master Services Agreement will be liable to us, any subsidiary of ours party to the Master Services Agreement, any governing body of any such entity, including any director or officer, or any of our or such subsidiaries' stockholders or partners for acts or omissions pursuant to or in accordance with the Master Services Agreement, except by reason of acts or omissions constituting fraud, willful misconduct, gross negligence or violation of certain laws or any other intentional or criminal wrongdoing or breach of the Master Services Agreement. Moreover, the aggregate liability of any such entities and persons pursuant to the Master Services Agreement is capped at the Base Fee and transaction fees previously paid to the Manager in the two most recent
calendar years. In addition, we have agreed to indemnify our Manager and any of its affiliates providing services under the Master Services Agreement, any affiliates of the Manager and any directors, officers, stockholders, agents, subcontractors, contractors, delegates, members, partners, shareholders, employees and other representatives of each of them from and against all actions, suits, investigations, proceedings or claims except to the extent resulting from such person's fraud, willful misconduct, gross negligence or violation of certain laws or any other intentional or criminal wrongdoing or breach of the Master Services Agreement.
Pursuant to the Investment Management Agreement, the Advisor is not liable to CIM Urban, CIM Urban GP or any manager or director of CIM Urban GP for, among other things, (1) any act or omission performed or omitted by it or for any costs, damages or liabilities arising therefrom, in the absence of fraud, gross negligence, willful misconduct or a breach of the Investment Management Agreement or (2) any losses due to the negligence of any employees, brokers, or other agents of CIM Urban. In addition, CIM Urban has agreed to indemnify the Advisor against any losses, claims, damages or liabilities to which it may become subject in connection with, among other things, (1) any act or omission performed or omitted by it or for any costs, damages or liabilities arising therefrom, in the absence of fraud, gross negligence, willful misconduct or a breach of the Investment Management Agreement or (2) any losses due to the negligence of any employees, brokers, or other agents of CIM Urban.
If we seek to internalize the management functions provided pursuant to the Master Services Agreement and the Investment Management Agreement, there is no assurance that we could reach agreements with the Manager and the Advisor and we could incur substantial costs and lose certain key personnel.
At some point in the future, the board of directors may determine that it is in our best interest to become self-managed by internalizing the functions performed by the Manager and the Advisor and to terminate the Master Services Agreement and the Investment Management Agreement. However, we do not have the unilateral right to terminate the Master Services Agreement and CIM Urban does not have the unilateral right to terminate the Investment Management Agreement, and neither the Manager nor the Advisor would be obligated to enter into an internalization transaction with us. There is no assurance that a mutually acceptable agreement with these entities as to the terms of the internalization could be reached. In addition, the costs that we would incur in any such internalization transaction are uncertain and could be substantial.
Further, if we were to internalize these management functions, certain key employees may not become our employees but may instead remain employees of the Manager and the Advisor or their respective affiliates, especially if the management functions are internalized but the Manager and the Advisor are not acquired by us. An inability to manage an internalization transaction could effectively result in us incurring excess costs and suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. These deficiencies could cause us to incur additional costs, and management's attention could be diverted from most effectively managing our investments, which could result in us incurring unanticipated costs in connection with any internalization transaction.
If we were deemed an investment company under the Investment Company Act, applicable restrictions could make it impractical for us to continue our business as contemplated and could have an adverse effect on our business.
We are not an investment company under the Investment Company Act of 1940, as amended (the "Investment Company Act") and intend to conduct our operations so that we will not be deemed an investment company. However, if we were to be deemed an investment company, restrictions imposed by the Investment Company Act, including limitations on the nature of investments and ability to transact with affiliates, could make it impractical for us to continue our business as contemplated. In addition, the Investment Company Act imposes certain requirements on companies deemed to be
within its regulatory scope, including registration as an investment company, adoption of a specific form of corporate structure and compliance with certain burdensome reporting, record keeping, voting, proxy, disclosure and other rules and regulations. In the event of the characterization of us as an investment company, the failure by us to satisfy such regulatory requirements, whether on a timely basis or at all, would, under certain circumstances, also have a material adverse effect on us.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results.
An effective system of internal control over financial reporting is necessary for us to provide reliable financial reports, prevent fraud and operate successfully as a public company. As part of our ongoing monitoring of internal controls, we may discover material weaknesses or significant deficiencies in our internal controls that we believe require remediation. If we discover such weaknesses, we will make efforts to improve our internal controls in a timely manner. Any system of internal controls, however well designed and operated, is based in part on certain assumptions and can only provide reasonable, not absolute, assurance that the objectives of the system are met. Any failure to maintain effective internal controls, or implement any necessary improvements in a timely manner, could have a materially adverse effect on our business and operating results, or cause us to not meet our reporting obligations, which could affect our ability to remain listed with the NASDAQ Global Market. Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our securities.
Risks Related to Our Common Stock
Future sales of our common shares may cause our market price to drop significantly, even if our business is doing well.
Urban II is entitled to registration rights, subject to certain limitations, with respect to our securities pursuant to the Registration Rights and Lockup Agreement dated March 11, 2014 between us and Urban II (the "Registration Rights and Lockup Agreement"). Urban II is entitled to require us, on up to eight occasions, to register under the Securities Act our common shares it received in connection with the Merger
In accordance with lockup provisions included in the Registration Rights and Lockup Agreement, Urban II is not permitted to engage in public sales of our common shares it received in connection with the Merger until after the 12-month anniversary of the consummation of the Merger without restriction, provided that these restrictions do not apply with respect to public sales of up to 40 million common shares with the prior approval of a majority of the independent Directors. There are no lockup restrictions applicable to private sales or transfer of such shares.
Following the expiration of the lockup restrictions, there may be significant pent-up demand by CIM REIT to sell our common shares that it holds. A large volume of sales of our common shares could decrease the prevailing market price of our common shares and could impair our ability to raise additional capital through the sale of equity securities in the future. Even if a substantial number of sales of our common shares do not occur, the mere perception of the possibility of these sales could depress the market price of our common shares and have a negative effect on our ability to raise capital in the future.
We cannot assure you that we will be able to pay dividends.
Our ability to maintain payment of dividends to our stockholders may be impacted by various factors, including the following:
• we may not have enough capital resources to pay such dividends due to changes in our cash requirements, capital spending plans, cash flow or financial position;
• decisions on whether, when and in which amounts to make any future dividends will remain at all times entirely at the discretion of the Board of Directors, which reserves the right to change our dividend practices at any time and for any reason; and
• we may desire to retain cash to maintain or improve any credit ratings we have or may obtain in the future.
There can be no assurance that the future dividends declared by our Board of Directors will not differ materially from historical dividend levels. Our stockholders have no contractual or other legal right to dividends that have not been declared.
Future issuances of shares of stock could dilute existing stockholders' interests.
We may satisfy our liquidity needs through, among other things, one or more equity issuances. See "Item 1 Business-Financial Strategy" and "Item 7 "Management's Discussion and Analysts of Financial Conditions and Results of Operation"-Liquidity and Capital Resources-Sources and Uses of Funds." Our charter authorizes our Board of Directors to issue additional shares of Common Stock, preferred stock, or other equity securities without stockholder approval. Any such issuance could dilute our existing stockholders' interests.
Market interest rates may have an effect on the value of our Common Stock.
If market interest rates go up, prospective purchasers of shares of our common stock may expect a higher dividend rate on our Common Stock. Higher market interest rates would not, however, result in more funds for us to pay in dividends and, to the contrary, would likely increase our borrowing costs and potentially decrease funds available for dividends. Thus, higher market interest rates could cause the market price of our Common Stock to go down.
Changes in market conditions could adversely affect the market price of our Common Stock.
As with other publicly traded equity securities, the value of our Common Stock depends on various market conditions, which may change from time to time. In addition to the current economic environment and future volatility in the securities and credit markets, the following market conditions may affect the value of our Common Stock:
• the general reputation of REITs and the attractiveness of our equity securities in comparison to other equity securities, including securities issued by other real estate-based companies;
• our financial performance;
• general stock and bond market conditions;
• government action or regulation, including changes in tax law;
• increases in market interest rates, which may lead investors to expect a higher annual yield from our distributions in relation to the price of our shares;
• changes in federal tax laws;
• our ability to re-lease space as leases expire;
• strategic actions by us or our competitors, such as acquisitions or restructurings;
• changes in our credit ratings; and
• any negative change in the level of our dividend or the partial payment thereof in common shares.
The market value of our Common Stock is based primarily upon the market's perception of our growth potential and our current and potential future earnings and cash dividends and our capital structure. Consequently, our Common Stock may trade at prices that are higher or lower than our net asset value per share of Common Stock. If our future earnings or cash dividends are less than expected, the market price of our Common Stock could diminish.
There is a limited trading market for our Common Stock and as a result, our share price is subject to greater volatility and you may not be able to resell your shares at or above the price you pay for them.
Although our common shares are listed for trading on the NASDAQ Global Market, the volume of trading in our common shares has been lower than many other companies listed on the NASDAQ Global Market as approximately 98.2% of our Common Stock are presently owned by Urban II and affiliates of CIM and are therefore not traded. See "-We are controlled by an affiliate of CIM Group." A public trading market with depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Limited trading volume may subject our common shares to greater price volatility and may make it difficult for investors to sell shares at a price that is attractive to them.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of December 31, 2014 our investments consisted of (i) 21 office properties comprising approximately 5.6 million rentable square feet, (ii) five multifamily properties comprising 930 units, (iii) three hotels comprising 1,070 rooms, (iv) three parking garages, two of which have street level retail space, and (v) one development site. Each of our properties is suitable and adequate for its intended use. The following tables contain descriptive information about all of our properties as of December 31, 2014.
Office Portfolio Summary as of December 31, 2014
Office
Other Ancillary Properties within Office Portfolio
Total Office including Other Ancillary
(1)Based on leases signed as of December 31, 2014.
(2)Represents gross monthly base rent, as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursement to base rent.
(3)Represents gross monthly contractual rent under retail (1010 8th Street Parking Garage & Retail) leases commenced as of December 31, 2014), multiplied by twelve. This amount reflects total cash rent before abatements.
(4)901 N Capitol Street is a 39,696 square foot parcel of land located between 899 and 999 N Capitol Street. We are entitled to develop a building with up to 270,172 square feet.
Office Portfolio Detail by Property, Market, and Submarket as of December 31, 2014
(1)Based on leases signed as of December 31, 2014.
(2)Represents gross monthly base rent, as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursement to base rent.
Multifamily Portfolio Summary as of December 31, 2014
(1)Based on number of units occupied as of December 31, 2014.
(2)Represents gross monthly base rent under leases commenced as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before concessions.
Hotel Portfolio Summary as of December 31, 2014
Other Ancillary Properties within Hotel Portfolio
(1)Represents trailing 12-month occupancy and RevPAR as of December 31, 2014. Occupancy represents occupied rooms divided by available rooms, and RevPAR represents room revenue divided by available rooms.
(2)Based on leases signed as of December 31, 2014.
(3)Represents gross monthly contractual rent under parking and retail leases commenced as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursement to base rent.
Office Portfolio-Top 10 Tenants by Annualized Rental Revenue as of December 31, 2014
(1)Represents gross monthly base rent, as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursement to base rent.
Office Portfolio-Diversification by NAICS code as of December 31, 2014
(1)Represents gross monthly base rent, as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursement to base rent.
Office Portfolio-Lease Expiration as of December 31, 2014
(1)Represents gross monthly base rent, as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursement to base rent.
Office Portfolio-Historical Occupancy
(1)Historical occupancies for Office properties are based on leases commenced as of December 31 of each historical year.
(2)4750 Wilshire Blvd was acquired on April 18, 2014.
(3)Lindblade Media Center was acquired on October 21, 2014.
Office Portfolio-Historical Annualized Rents
(1)Annualized Rent Per Occupied Square Foot represents annualized gross rent divided by total occupied square feet as of December 31 of each historical year. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursement to base rent.
(2)4750 Wilshire Blvd was acquired on April 18, 2014.
(3)Lindblade Media Center was acquired on October 21, 2014
Multifamily Portfolio-Historical Occupancy and Annualized Rents
(1)Historical occupancies for Multifamily properties are based on leases commenced as of December 31 of each historical year and were calculated using units and not square feet.
(2)Represents gross monthly base rent, as of December 31. This amount reflects total cash rent before abatements.
Multifamily Properties Overview as of December 31, 2014
(1)Based on number of units occupied as of December 31, 2014.
(2)Represents gross monthly base rent under leases commenced as of December 31, 2014, multiplied by twelve. This amount reflects total cash rent before concessions.
Hotel Portfolio-Ownership, Franchise and Management as of December 31, 2014
Hotel Properties-Historical Occupancy Rates, Average Daily Rates and Revenue per Available Room/Suite as of December 31, 2014
(1)Occupancy percentage represents occupied rooms divided by available rooms.
(2)Represents trailing 12-months occupancy, Average Daily Rate and Revenue per Available Room as of December 31.
(3)CIM Urban was the lender to the LAX Holiday Inn and held the first mortgage secured by the property until a subsidiary of CIM Urban submitted the highest bid at a foreclosure auction that took place on October 8, 2013 and subsequently took possession of the LAX Holiday Inn. The 2013 metrics presented above are for a partial year and represent the values for CIM Urban's period of ownership only.
(4)CIM Urban sold the 160 room hotel located in Los Angeles, California on December 17, 2010. The 2010 metrics presented above are for a partial year and represent the values for CIM Urban's period of ownership only.
(5)Average daily rate represents room revenue divided by occupied rooms.
(6)Revenue per available room represents room revenue divided by available rooms.
Property Indebtedness as of December 31, 2014
(1)Loan is prepayable but is subject to a prepayment fee equal to the interest that would have been due for the month in which the prepayment occurred. If the loan is prepaid prior to April 1, 2015 an additional prepayment fee equal to the greater of (a) one percent (1%) of the amount prepaid or (b) the amount by which the present value of all unpaid principal and interest payments exceeds a specified threshold is due. Loan may also be defeased until June 1, 2015.
(2)Loan may not be prepaid. Loan may be defeased at any time.
(3)Loan is prepayable but is subject to a prepayment fee equal to the difference between (a) the present value of all remaining payments of principal and interest and (b) the amount of principal being prepaid, but in no event shall the prepayment fee be less than one percent (1%).
(4)Loan is prepayable but is subject to a prepayment fee equal to the greater of (a) one percent (1%) of the outstanding principal balance of the note or (b) modified yield maintenance.
(5)Loan is prepayable but if prepaid prior to August 31, 2020 is subject to a prepayment fee equal to the greater of (a) one percent (1%) of the principal being prepaid or (b) yield maintenance.
(6)Loan is prepayable but if prepaid prior to August 31, 2020 is subject to a prepayment fee equal to the greater of (a) one percent (1%) of the principal being prepaid or (b) yield maintenance.
(7)Loan is prepayable but if prepaid prior to August 31, 2020 is subject to a prepayment fee equal to the greater of (a) one percent (1%) of the principal being prepaid or (b) yield maintenance.
(8)Loan is prepayable but is subject to a prepayment fee equal to the greater of (a) one percent (1%) of the principal amount being prepaid multiplied by the quotient of the number of months until maturity divided by the term of the note or (b) the present value of the loan less the amount being prepaid.
(9)Loan is prepayable but is subject to a prepayment fee equal to the greater of (a) one percent (1%) of the principal amount being prepaid multiplied by the quotient of the number of months until maturity divided by the term of the note or (b) the present value of the loan less the principal and accrued interest being prepaid.
Item 3.
Item 3. Legal Proceedings
We are not currently involved in any material pending or threatened legal proceeding nor, to our knowledge, is any material legal proceeding currently threatened against us, other than routine
litigation arising in the ordinary course of business. In the normal course of business we are periodically party to certain legal actions and proceedings involving matters that are generally incidental to our business. While the outcome of these legal actions and proceedings cannot be predicted with certainty, in management's opinion, the resolution of these legal proceedings and actions will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market For Registrant's Common Equity, Related Stockholder Matters And Issuer Purchases Of Equity Securities
Marketplace Designation, Sales Price Information and Holders
Commencing with the Merger on March 11, 2014, our common shares have been traded on the NASDAQ Global Market currently under the symbol "CMCT". The following table sets forth, for the periods indicated, the high and low sales prices as reported on the NASDAQ Global Market and the regular dividends per share declared by us for each such period.
(1)The regular quarterly dividend per share amounts do not include PMC Commercial's pre-Merger dividends or the special dividend paid to PMC Commercial's pre-Merger stockholders; however, these amounts do include the dividends paid on the shares of preferred stock issued to Urban II in the Merger on an as converted basis.
(2)The special dividend to PMC Commercial's pre-Merger stockholders was in the amount of $27.975 per share of common stock (which includes the $27.50 per share of common stock special dividend plus $0.475 pro rata portion of PMC Commercial's regular quarterly cash dividend). Consistent with stock exchange policy for extraordinary dividends, our Common Stock continued to be quoted from the time of the merger without giving effect to the special dividend through the dividend payment date, after which the shares were traded on an ex-dividend basis. As a result of this policy, purchasers of our Common Stock after the record date (the date of the merger) and prior to the "ex" date were entitled to receive a redeemable "due bill" equal in value to the special dividend. For purposes of determining the high and low prices of our Common Stock, we have reduced the quoted market price by the amount of the due bill from the merger date until the ex-dividend date.
(3)The quoted high and low price is for the period from the Acquisition Date of the Merger with PMC Commercial (March 11, 2014) until March 31, 2014. Dividend amounts for the calendar quarters in 2013 and for the first quarter of 2014 through the Acquisition Date (March 11, 2014) represent distributions by CIM Urban in respect of its limited partnership interests. These amounts have been converted to per common share amounts based on the number of our common shares issued to Urban II in the Merger and issued to Urban II upon conversion of the preferred shares issued to Urban II in the Merger.
On March 9, 2015, there were approximately 670 holders of record of our common stock, excluding stockholders whose shares were held by brokerage firms, depositories and other institutional firms in "street name" for their customers. The last reported sales price of our common stock on March 9, 2015 was $17.26.
1.8% of our shares of Common Stock as of March 9, 2015 are held by non-affiliated stockholders.
Our stockholders are entitled to receive dividends when and as declared by the Board of Directors.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information at December 31, 2014 with respect to our common shares, either under options or in respect of restricted stock awards, that may be issued under existing equity compensation plans, all of which have been approved by our stockholders.
Effective January 31, 2015, all 17,050 outstanding options were forfeited in accordance with the plan.
Performance Graph
The information below is not deemed to be "soliciting material" or to be "filed" with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 ("Exchange Act") or to the liabilities of Section 18 of the Exchange Act, and will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent the Company specifically incorporates it by reference into such a filing.
The line graph below compares the percentage change in the cumulative total stockholder return on our Common Stock with the cumulative total return of the S&P 500, the FTSE NAREIT Equity REIT Index and a peer group relating to our prior operations as a mortgage REIT (the "Prior Period Peer Group"). The FTSE NAREIT Equity REIT Index is a free-float adjusted, market capitalization-weighted index of U.S. Equity REITs. The Index includes all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property. During 2014, as a result of the Merger, we transitioned from a mortgage REIT to an equity REIT. Our Prior Period Peer Group consists of all publicly traded investment companies that have the primary focus of mortgage-backed security REITs and specialty finance REITs listed on the NYSE, NYSE MKT and the NASDAQ on which coverage is provided by SNL Financial LC for the period from December 31, 2009 through December 31, 2014. All returns assume an investment of $100 on
December 31, 2009 and the reinvestment of dividends. The stock price performance shown on the graph is not necessarily indicative of future price performance.
Source: SNL Financial LC
Recent Sales of Unregistered Securities and Use of Proceeds
None.
Repurchases of Common Stock
None.
Item 6.
Item 6. Selected Financial Data
The following is a summary of our Selected Financial Data as of and for each of the five years in the period ended December 31, 2014. The following data should be read in conjunction with our consolidated financial statements and the notes thereto and "Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
This Management's Discussion and Analysis of Financial Condition and Results of Operations includes many forward-looking statements. For cautions about relying on such forward-looking statements, please see "Forward-Looking Statements" at the beginning of this Report immediately prior to Item 1. All references to our Common Stock and related per share data have been adjusted in this Report to reflect the reverse stock split.
Executive Summary
The Merger
On July 8, 2013, PMC Commercial, entered into the Merger Agreement with CIM REIT, an affiliate of CIM Group, and subsidiaries of the respective parties. The Merger Agreement provided for the business combination of CIM REIT's wholly owned subsidiary, CIM Urban, and PMC Commercial. Pursuant to the Merger Agreement, Urban II, an affiliate of CIM REIT received 4,400,000 shares of newly-issued PMC Commercial common stock and approximately 65,000,000 shares of newly-issued PMC Commercial preferred stock. Following the Merger and subsequent increase in our authorized number of shares, each share of preferred stock was converted into 1.4 shares of PMC Commercial common stock, resulting in the issuance of 95,440,000 shares of common stock in the aggregate in connection with the Merger, representing approximately 97.8% of PMC Commercial's outstanding shares of common stock.
All shares of PMC Commercial common stock that were outstanding immediately prior to the closing of the Merger continue to remain outstanding following the Acquisition Date. In addition, stockholders of record of PMC Commercial at the close of the business day prior to the Acquisition Date received a special cash dividend of $27.50 per share of PMC Commercial common stock plus that pro-rata portion of PMC Commercial's regular quarterly cash dividend accrued through the Acquisition Date, each of which was paid March 25, 2014.
Furthermore, on April 28, 2014, we filed the Reverse Split Amendment to effectuate a one-for-five reverse stock split of our Common Stock, effective April 29, 2014. Pursuant to the reverse stock split, each five shares of Common Stock issued and outstanding immediately prior to the effective time of the reverse stock split were converted into one share of Common Stock. All per share and outstanding share information included herein from before the Reverse Split Amendment has been presented to reflect the reverse stock split unless otherwise noted.
The Merger was completed on March 11, 2014. Upon completion of the Merger, PMC Commercial became the parent of CIM Urban. PMC Commercial reincorporated from Texas to Maryland on April 28, 2014 and, on the same day, changed its name from "PMC Commercial Trust" to "CIM Commercial Trust Corporation."
The Merger was accounted for as a reverse acquisition under the acquisition method of accounting with CIM Urban considered to be the accounting acquirer based upon the terms of the Merger Agreement. In order to allow CIM Commercial to increase its focus in Class A and creative office properties, our Board of Directors approved a plan for the lending business that, when completed, will result in the deconsolidation of the lending segment. Accordingly, the lending segment is held for sale; the assets and liabilities of our lending segment that are held for sale in accordance with the plan are included in the consolidated balance sheet as of December 31, 2014 as assets and liabilities associated with assets held for sale, the results of its operations are included in the consolidated statements of operations and comprehensive income as income from operations of assets held for sale, and its cash flows are included in the consolidated cash flows for the period from the Acquisition Date through December 31, 2014.
Business Overview
Our principal business is to acquire, own, and operate Class A and creative office properties in vibrant and improving urban communities throughout the United States. These communities are located in areas that include traditional downtown areas and suburban main streets, which have high barriers-to-entry, high population density, improving demographic trends and a propensity for growth. We believe that the critical mass of redevelopment in such areas creates positive externalities, which enhance the value of substantially stabilized assets in the area. We believe that these assets will provide greater returns than similar assets in other markets, as a result of the improving demographics, public commitment, and significant private investment that characterize these areas.
Our real estate business is managed by an affiliate of CIM Group. CIM Group is an integrated, full-service real estate and infrastructure fund manager with multi-disciplinary expertise and in-house research, acquisition, investment, development, finance, leasing, and management capabilities. CIM Group is headquartered in Los Angeles and has offices in Oakland, California; Bethesda, Maryland; Dallas, Texas; and New York, New York.
We seek attractive risk-adjusted returns by exploiting the power of the CIM Group platform. Over time, we seek to expand our real estate holdings in communities targeted by CIM Group for investment, supported by CIM Group's broad real estate investment capabilities, as part of our plan to prudently grow market value and earnings.
Properties
As of December 31, 2014, CIM Urban's investments consisted of (i) 21 office properties comprising of approximately 5.6 million rentable square feet, (ii) five multifamily properties comprising of 930 units, (iii) three hotels comprising of 1,070 rooms, (iv) three parking garages, two of which have street level retail space, and (v) one development site.
Strategy
Our investment strategy is centered around CIM's community qualification process. We believe this strategy provides us with a significant competitive advantage when making urban real estate investments. The qualification process generally takes between six months and five years and is a critical component of CIM's investment evaluation. CIM examines the characteristics of a market to determine whether the district justifies the extensive efforts CIM undertakes in reviewing and making potential investments in its Qualified Communities. Qualified Communities generally fall into one of two categories: (i) transitional urban districts and (ii) well-established, thriving urban areas (typically major central business districts). Qualified Communities are distinct districts which have dedicated resources to become or are currently vibrant communities where people can live, work, shop and be entertained-all within walking distance or close proximity to public transportation. These areas also generally have high barriers to entry, high population density, improving demographic trends and a propensity for growth. In addition to the urbanization of North America in the last 21 years due to the growing preference for an urban lifestyle, today's economic environment has further fueled urban growth due to the need for efficient solutions to meet continued population growth and limited natural resources. CIM believes that a vast majority of the risks associated with making real asset investments are mitigated by accumulating local market knowledge of the community where the investment lies. CIM typically spends significant time and resources qualifying targeted investment communities prior to making any acquisitions. Since 1994, CIM Group has qualified 97 communities and has deployed capital in 48 of these qualified communities. Although we may not invest exclusively in Qualified Communities, it is expected that most of our investments will be identified through this systematic process.
CIM seeks to maximize the value of its investments through active asset management. CIM has extensive in-house research, acquisition, investment, development, financing, leasing and property management capabilities, which leverage its deep understanding of urban communities to position properties for multiple uses and to maximize operating income. As a fully integrated owner and operator, CIM's asset management capabilities are complemented by its in-house property management capabilities. Property managers prepare annual capital and operating budgets and monthly operating reports, monitor results and oversee vendor services, maintenance and capital improvement schedules. In addition, they ensure that revenue objectives are met, lease terms are followed, receivables are collected, preventative maintenance programs are implemented, vendors are evaluated and expenses are controlled. CIM's Asset Management Committee reviews and approves strategic plans for each investment, including financial, leasing, marketing, property positioning and strategic and disposition plans. In addition, the Asset Management Committee reviews and approves the annual business plan for each property, including its capital and operating budget. CIM's organizational structure provides for investment and asset management continuity through multi-disciplinary teams responsible for an asset from the time of the original investment recommendation, through the implementation of the asset's business plan, and any disposition activities.
Lending Segment
We will continue to deploy a portion of our capital to our real estate lending platform through our wholly owned subsidiary (d/b/a PMC Commercial Trust) that originates and services loans under the U.S. SBA 7(a) Guaranteed Loan Program as well as through other lending programs which allow us to achieve attractive risk adjusted returns on its loans.
To take advantage of the expertise of CIM, we have begun to originate commercial real estate loans for properties that are primarily located in CIM Group's Qualified Communities. We are targeting investments between $20 million and $100 million with a focus on developing a diversified pool of loans. These loans are typically short duration (five years or less, inclusive of extension options), floating rate and are expected to be:
• limited and/or non-recourse junior (mezzanine, b-note or 2nd lien) and senior construction loans; or
• limited and/or non-recourse junior (mezzanine, b-note or 2nd lien) and senior acquisition, bridge or repositioning loans.
We intend to participate a portion of these loans with, and/or syndicate a portion of these loans to, one or more institutional investors.
Funds from Operations ("FFO")
We believe that FFO is a widely recognized and appropriate non-GAAP measure of the performance of a REIT and that it is frequently used by security analysts, investors and other interested parties in the evaluation of REITs, many of which present FFO when reporting their results. FFO represents net income (loss), computed in accordance with GAAP, excluding gains (or losses) from sales of real estate, real estate depreciation and amortization (other than amortization of deferred financing costs), and after adjustments for non-controlling interests. We calculate FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts ("NAREIT").
Like any metric, FFO should not be used as the only measure of our performance because it excludes depreciation and amortization and captures neither the changes in the value of our real estate properties that result from use or market conditions nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our operating results. Other REITs may not calculate FFO
in accordance with NAREIT, accordingly, our FFO may not be comparable to those other REITs' FFO. Therefore, FFO should be considered only as a supplement to net income as a measure of our performance and should not be used as a supplement to or substitute measure for cash flow from operating activities computed in accordance with U.S. GAAP. FFO should not be used as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends.
The following table sets forth a reconciliation of net income to FFO:
FFO increased to $93,645,000, or 12.4%, for the year ended December 31, 2014, compared to $83,323,000 for the year ended December 31, 2013. The increase was primarily attributable to income of $12,638,000 from the operations of the lending segment acquired on the Acquisition Date, the recognition of the bargain purchase gain of $4,918,000, a decrease in transaction costs of $3,500,000 and an increase of $4,797,000 in hotel operating income primarily due to the operations of the LAX Holiday Inn, which CIM Urban acquired through foreclosure in October 2013 being reflected as a non-performing mortgage note receivable during part of the year ended December 31, 2013. These increases were partially offset by an increase of $4,337,000 in corporate general and administrative expenses, an increase of $3,455,000 in asset management fees and other fees to related parties, a decrease of $5,126,000 in multifamily net operating income, mainly due to a non-recurring tax abatement we have agreed to refund at our New York property, an increase of $1,144,000 in interest expense from higher debt levels, and a decrease of $1,469,000 in office net operating income, mainly due to increases in real estate taxes at the California properties, a portion of which we expect to be reimbursed by tenants, and an increase in electricity expense at the District of Columbia properties.
FFO decreased to $83,323,000, or 7.2%, for the year ended December 31, 2013, compared to $89,740,000 for the year ended December 31, 2012. The decrease was primarily due to a decrease of $3,346,000 in hotel net operating income due to LAX Holiday Inn being reflected as a non-performing mortgage note receivable during part of the year ended December 31, 2013, and an operating hotel from October 8, 2013 to December 31, 2013, and an increase in transaction costs of $4,431,000, which mainly represents costs related to the Merger and costs associated with the LAX Holiday Inn hotel foreclosure in October 2013, partially offset by an increase of $929,000 in office net operating income, mainly due to increased occupancy at an office property in the District of Columbia.
Rental Rate Trends
Office Rental Rates: The following table sets forth the annualized rent per occupied square foot across our office portfolio as of the specified periods:
(1)Represents gross monthly base rent under leases commenced as of the specified periods, multiplied by twelve. This amount reflects total cash rent before abatements. Total
abatements for the twelve months ended December 31, 2014, 2013 and 2012 were approximately $7,312,000, $14,665,000 and $16,049,000, respectively. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursements to base rent. Annualized rent for certain office properties includes rent attributable to retail.
Over the next four quarters, we expect to see expiring cash rents as set forth in the table below:
(1)All month-to-month tenants are included in the expiring leases in the first quarter listed.
(2)Represents gross monthly base rent, as of December 31, 2014, under leases expiring during the periods above, multiplied by twelve. This amount reflects total cash rent before abatements. Where applicable, annualized rent has been grossed up by adding annualized expense reimbursements to base rent.
Multifamily Rates: The following table sets forth the monthly rent per occupied unit across our multifamily portfolio for the specified periods:
(1)Represents gross monthly base rent under leases as of the specified period, divided by occupied units. This amount reflects total cash rent before concessions.
Occupancy Rates: The following table sets forth the occupancy rates across our office and multifamily real estate portfolios, as of the specified periods:
Hotel Statistics: The following table sets forth the occupancy, average daily rate and RevPAR for the hotel portfolio for the specified periods:
(1)The year ended December 31, 2013 information includes LAX Holiday Inn, of which CIM Urban took possession through foreclosure in October 2013, starting in October 2013.
Secondary Market Loan Sales
Our lending division, which is reflected as held for sale at December 31, 2014, sells loans pursuant to the SBA 7(a) Program. The SBA guaranteed portion of these loans are sold in legal sale transactions to either dealers in government guaranteed loans or institutional investors as the loans are fully funded. These government guaranteed portions of loans may be sold for (1) a cash premium and the minimum 1% SBA required servicing spread, (2) significant future servicing spread and no cash premium or (3) future servicing spread and a cash premium of 10%. We are required to permanently treat certain of the proceeds received from these legally sold portions of loans (those loans sold solely for future servicing spread and those loans sold for a cash premium of 10% and future servicing spread) as secured borrowings (debt) for the life of the loan included in the accompanying consolidated balance sheet as liabilities associated with assets held for sale and 100% of the loan is included in assets held for sale.
Results of Operations
Comparison of the Year Ended December 31, 2014 to the Year Ended December 31,
Overview
Net income increased during the year ended December 31, 2014 primarily due to income of $12,638,000 from the operations of the lending segment acquired on the Acquisition Date, the recognition of the bargain purchase gain of $4,918,000 related to the Merger, a decrease in transaction costs of $3,500,000 and an increase of $4,797,000 in hotel operating income primarily due to the operations of the LAX Holiday Inn, which CIM Urban acquired through foreclosure in October 2013 being reflected as a non-performing mortgage note receivable during part of the year ended December 31, 2013. These increases were partially offset by an increase of $4,337,000 in corporate general and administrative expenses, an increase of $3,455,000 in asset management fees and other fees to related parties, a decrease of $5,126,000 in multifamily net operating income, mainly due to a non-recurring tax abatement we have agreed to refund at our New York property, an increase of $1,144,000 in interest expense from higher debt levels, and a decrease of $1,469,000 in office net operating income, mainly due to increases in real estate taxes at the California properties, a portion of which we expect to be reimbursed by tenants, and an increase in electricity expense at the District of Columbia properties.
CIM Commercial operates in four segments: office, hotel, multifamily and lending. The lending segment is classified as held for sale at December 31, 2014 and included in discontinued operations. Set forth and described below are summary segment results for our three segments for the specified periods.
Summary Segment Results
Revenues
Office Properties Revenue: Revenues include rental revenues from office properties, expense reimbursements and lease termination income. Total office property revenues increased to $179,338,000, or 2.4%, for the year ended December 31, 2014 compared to $175,144,000 for the year ended December 31, 2013, primarily due to revenues related to the office properties acquired in April and October 2014, and revenue increases at certain properties in the San Francisco Bay Area and metro Washington D.C. area, offset by a decrease at the North Carolina office property due to early termination of a large tenant in April 2014.
Hotel Revenue: Total hotel revenue increased to $56,096,000, or 37.9%, for the year ended December 31, 2014 compared to $40,680,000 for the year ended December 31, 2013. The increase is primarily due to the operations of the LAX Holiday Inn, which CIM Urban acquired through foreclosure in October 2013, being reflected as an operating hotel during the year ended December 31, 2014, versus a non-performing mortgage note receivable during part of the year ended December 31, 2013, and an operating hotel from October 8, 2013 to December 31, 2013. Additionally, our hotel properties in Sacramento and Oakland, California experienced RevPAR growth during the year ended December 31, 2014 compared to the year ended December 31, 2013 primarily due to increased rates.
Multifamily Revenue: Total multifamily revenue increased to $20,719,000, or 3.7%, for the year ended December 31, 2014 compared to $19,989,000 for the year ended December 31, 2013. The increase is primarily due to increased rates at our New York property and one of our Dallas properties. We expect multifamily revenue at our New York property to decrease during the year ended December 31, 2015, as our corporate housing tenant is terminating its lease in March 2015 and we expect to re-lease the property as individual units.
Expenses
Office Properties Expenses: Total expenses increased to $74,647,000, or 8.2%, for the year ended December 31, 2014 compared to $68,984,000 for the year ended December 31, 2013. The increase is primarily due to expenses related to the office properties acquired in April and October 2014, an increase in real estate taxes at the California properties, and an increase in electricity expense at the District of Columbia properties.
Hotel Expenses: Total hotel expenses increased to $39,694,000, or 36.5%, for the year ended December 31, 2014 compared to $29,075,000 for the year ended December 31, 2013. The increase is primarily due to the LAX Holiday Inn, which CIM Urban acquired through foreclosure in October 2013, being reflected as an operating hotel during the year ended December 31, 2014, versus a
non-performing mortgage note receivable during part of the year ended December 31, 2013, and an operating hotel from October 8, 2013 to December 31, 2013. Additionally, our hotel property in Sacramento, California had increased variable costs associated with higher occupancy during the year ended December 31, 2014 compared to the year ended December 31, 2013.
Multifamily Expenses: Total multifamily expenses increased to $14,402,000, or 68.5%, for the year ended December 31, 2014 compared to $8,546,000 for the year ended December 31, 2013. The increase is primarily due to an increase in real estate taxes and legal costs in 2014 at our New York property, primarily due to a $4,475,000 expense related to a non-recurring payment we have agreed to make in connection with the refund of tax abatements we received during the period of our ownership in which the property was being leased by a corporate housing operator, which was settled in February 2015.
Interest Expense: Interest expense that has not been allocated to segments of $19,073,000 for the year ended December 31, 2014 represents a $1,144,000 increase from $17,929,000 for the year ended December 31, 2013. Increased interest expense from higher debt levels, incremental credit facility borrowings during the year ended December 31, 2014 and from amortization of deferred loan costs related to the credit facilities terminated and repaid in full in September 2014 was partially offset by lower interest expense from amortizing fixed-rate mortgages as a result of the repayment of approximately $75,909,000 in fixed rate mortgages in September 2013. Outstanding borrowings under our credit facility during the year ended December 31, 2014 were at lower interest rates compared to the interest rates on the fixed rate mortgages that were repaid in September 2013.
General and Administrative: General and administrative expenses that have not been allocated to segments increased to $5,463,000 for the year ended December 31, 2014 compared to $1,126,000 for the year ended December 31, 2013. The increase is primarily due to public company expenses, offset by a one-time gain of $1,166,000 relating to the settlement of a contractual obligation that reduced expenses during the year ended December 31, 2014.
Transaction Costs: Transaction costs totaling $1,563,000 for the year ended December 31, 2014 represent a $3,500,000 decrease from $5,063,000 for the year ended December 31, 2013. The costs incurred during the year ended December 31, 2013 are associated with the Merger, including due diligence costs, reimbursement of PMC Commercial's acquisition-related costs, legal and accounting expenses, as well as costs related to the foreclosure of the LAX Holiday Inn in October 2013. The costs incurred during the year ended December 31, 2014 are mainly associated with the Merger, the acquisition of the two office properties in April and October 2014, and transaction costs related to the lending segment held for sale.
Asset Management Fees and Other Fees to Related Parties: Asset management fees totaled $23,223,000 for the year ended December 31, 2014 compared to $21,767,000 for the year ended December 31, 2013. Management fees are calculated based on a percentage of the gross fair value of CIM Urban's investments, which are appraised in the fourth quarter of each year. The higher fees reflect a net increase in the fair value of the real estate investments based on the December 31, 2013 appraised values, as well as incremental capital expenditures and acquisitions during 2014. In addition, pursuant to the Master Services Agreement entered into on the Acquisition Date, CIM Commercial pays a Base Service Fee equal to $1,000,000 per year (subject to annual escalation by a specified inflation factor beginning on January 1, 2015) to the Manager, a related party. Fees to the Manager totaled $806,000 for the year ended December 31, 2014 compared to $0 for the year ended December 31, 2013. In addition, pursuant to the terms of the Master Services Agreement, the Manager may receive compensation for performing certain services for CIM Commercial and its subsidiaries that are not covered under the Base Service Fee. For the year ended December 31, 2014, we expensed $1,193,000 for such services.
Depreciation and Amortization: Depreciation and amortization expense increased to $69,047,000, or 0.6%, for the year ended December 31, 2014, compared to $68,644,000 for the year ended December 31, 2013. The increase in depreciation and amortization expense compared to the year ended December 31, 2013 is primarily due to depreciation expense associated with additional capital expenditures, depreciation from LAX Holiday Inn, which CIM Urban acquired through foreclosure in October 2013, and the acquisition of the office properties in April and October 2014, offset by decreased amortization of certain in place lease values.
Discontinued Operations
Income from operations of assets held for sale: Represents revenues and expenses from our lending segment, including interest income on loans and other loan related fee income of $18,910,000, offset by expenses of $6,272,000 which include general and administrative expenses, interest expense, and provision for income taxes. The lending operations are reflected beginning on the Acquisition Date through December 31, 2014.
Comparison of the Year Ended December 31, 2013 to the Year Ended December 31,
Overview
Net income decreased during the year ended December 31, 2013 primarily due to a decrease of $3,346,000 in hotel net operating income due to LAX Holiday Inn being reflected as a non-performing mortgage note receivable during part of the year ended December 31, 2013, and an operating hotel from October 8, 2013 to December 31, 2013, an increase in transaction costs of $4,431,000, which mainly represents costs related to the Merger and costs associated with the LAX Holiday Inn hotel foreclosure in October 2013, offset by an increase of $929,000 in office net operating income, mainly due to increased occupancy at an office property in the District of Columbia, and a decrease in depreciation and amortization of $1,299,000 due to certain acquisition-related intangible assets that became fully amortized in 2013.
Set forth and described below are summary segment results for our segments for the specified periods.
Summary Segment Results
Revenues
Office Properties Revenue: Revenues include rental revenues from office properties, expense reimbursements and lease termination income. Total office property revenues increased to $175,144,000, or 1.5%, for the year ended December 31, 2013 compared to $172,583,000 for the year ended December 31, 2012, primarily due to an increase in revenue from an office property in the District of Columbia, which experienced higher occupancy.
Hotel Revenue: Total hotel revenue decreased to $40,680,000, or 1.0%, for the year ended December 31, 2013 compared to $41,086,000 for the year ended December 31, 2012. The decrease is primarily due to lower interest income on a nonperforming note receivable from LAX Holiday Inn during 2013. CIM Urban foreclosed on the hotel in October 2013, and for the period from October 2013 through December 2013, LAX Holiday Inn is reflected as an operating hotel. This decrease was partially offset by increased revenue from our hotel properties in Sacramento and Oakland, California, which experienced occupancy and RevPAR growth during the year ended December 31, 2013 compared to the year ended December 31, 2012.
Multifamily Revenue: Total multifamily revenue increased to $19,989,000, or 6.1%, for the year ended December 31, 2013 compared to $18,844,000 for the year ended December 31, 2012. The increase is primarily due to increased revenue from two of our multifamily properties in Texas, which achieved increased rental rates compared to the 2012 period. Revenue also benefitted from a new retail lease at our multifamily property in New York.
Expenses
Office Properties Expenses: Total expenses increased to $68,984,000, or 2.4%, for the year ended December 31, 2013 compared to $67,352,000 for the year ended December 31, 2012. The increase is primarily due to increased real estate taxes at our District of Columbia properties.
Hotel Expenses: Total hotel expenses increased to $29,075,000, or 11.2%, for the year ended December 31, 2013 compared to $26,135,000 for the year ended December 31, 2012. The increase is primarily due to the LAX Holiday Inn, which CIM Urban acquired through foreclosure in October 2013, being reflected as an operating hotel for the period from October 2013 through December 2013, versus a mortgage note receivable for the year ended December 31, 2012. Additionally, our hotel properties in Sacramento and Oakland, California had increased variable costs associated with higher occupancy during the year ended December 31, 2013 compared to the year ended December 31, 2012.
Multifamily Expenses: Total multifamily expenses increased to $8,546,000, or 10.3%, for the year ended December 31, 2013 compared to $7,751,000 for the year ended December 31, 2012. The increase is primarily due to higher real estate tax expense in the year ended December 31, 2013 compared to the year ended December 31, 2012.
Interest Expense: Interest expense that has not been allocated to segments of $17,929,000 for the year ended December 31, 2013 represents a $927,000 decrease from $18,856,000 for the year ended December 31, 2012. The reduction in interest expense was primarily due to the lower interest rate on our borrowings under our lines of credit outstanding during 2013 versus the interest rates on the fixed rate mortgages of approximately $75,909,000 that were outstanding during the year ended December 31, 2012 that were repaid in September 2013.
General and Administrative: General and administrative expenses that have not been allocated to segments totaled $1,126,000 for the year ended December 31, 2013, consistent with $1,123,000 for the year ended December 31, 2012.
Transaction Costs: Transaction costs totaling $5,063,000 for the year ended December 31, 2013 represent a $4,431,000 increase from $632,000 for the year ended December 31, 2012. The costs incurred during the year ended December 31, 2013 include $1,393,000 of tax, legal, and other costs associated with the foreclosure of the LAX Holiday Inn and $3,670,000 of costs associated with the Merger, which are primarily comprised of due diligence costs, reimbursement of PMC Commercial's acquisition-related costs, legal and accounting expenses. The transaction costs for the year ended December 31, 2012 are associated with the conversion of a loan to equity at one of our District of Columbia office properties.
Asset Management Fees and Other Fees to Related Parties: Asset management fees totaled $21,767,000 for the year ended December 31, 2013 compared to $20,924,000 for the year ended December 31, 2012. Management fees are calculated based on a percentage of the gross fair value of CIM Urban's investments, which are appraised in the fourth quarter of each year. The higher fees reflect a net increase in the fair value of the real estate investments based on the December 31, 2012 appraised values, as well as incremental capital expenditures and acquisitions during the year ended December 31, 2013.
Depreciation and Amortization: Depreciation and amortization expense decreased to $68,644,000, or 1.9%, for the year ended December 31, 2013, compared to $69,943,000 for the year ended December 31, 2012. The decrease in depreciation and amortization expense compared to the year ended December 31, 2012 is primarily due to certain acquisition-related assets that became fully depreciated in 2013, offset by an increase in depreciation associated with additional capital expenditures during the year ended December 31, 2013.
Liquidity and Capital Resources
Sources and Uses of Funds
Credit Facilities
In February 2012, CIM Urban entered into an unsecured revolving line of credit with a bank syndicate, which allowed for maximum borrowings of $100,000,000. Borrowings under the line of credit were limited by certain borrowing base calculations. Outstanding advances under the line of credit bore interest at (i) the base rate, as defined, plus 0.75% to 1.50% or (ii) London InterBank Offered Rate ("LIBOR") plus 1.75% to 2.50%, depending on the maximum consolidated leverage ratio, as defined, until August 2013. In August 2013, the unsecured revolving line was amended, and outstanding advances under the line bore interest at (i) the base rate, as defined, plus 0.25% to 0.85% or (ii) LIBOR plus 1.25% to 1.85%, depending on the maximum consolidated leverage ratio, as defined. The line of credit was also subject to an unused commitment fee of 0.25% or 0.35% depending on the amount of aggregate unused commitments. As of December 31, 2013, $100,000,000 was outstanding under the line of credit. This line of credit was terminated and repaid in full in September 2014.
In August 2013, CIM Urban entered into another unsecured revolving line of credit with a bank syndicate. The line of credit provided an additional $125,000,000 of borrowing capacity that was increased to $150,000,000. CIM Urban amended the line of credit in April 2014 to further increase the maximum aggregate borrowing capacity under the revolving credit facility to $200,000,000. Borrowings under the revolving line were limited by certain borrowing base calculations. Outstanding advances under the line bore interest at (i) the base rate, as defined, plus 0.25% to 0.85% or (ii) LIBOR plus 1.25% to 1.85%, depending on the maximum consolidated leverage ratio, as defined. The line of credit was also subject to an unused commitment fee of 0.25% or 0.35% depending on the amount of aggregate unused commitments. As of December 31, 2013, $64,000,000 was outstanding under the line of credit. This line of credit was terminated and repaid in full in September 2014.
In September 2014, we entered into an $850,000,000 unsecured credit facility with a bank syndicate consisting of a $450,000,000 revolver, a $325,000,000 term loan and a $75,000,000 delayed-draw term loan. The credit facility can be increased to $1,150,000,000, under certain conditions. We are subject to certain financial maintenance covenants and a minimum property ownership condition. Outstanding advances under the revolver bear interest at (i) the base rate, plus 0.20% to 1.00% or (ii) LIBOR plus 1.20% to 2.00%, depending on the maximum consolidated leverage ratio. Outstanding advances under the term loans bear interest at (i) the base rate, plus 0.15% to 0.95% or (ii) LIBOR plus 1.15% to 1.95%, depending on the maximum consolidated leverage ratio. The revolver is also subject to an unused commitment fee of 0.15% or 0.25% depending on the amount of aggregate unused commitments. The delayed draw term loan is also subject to an unused line fee of 0.25%. The credit facility matures in September 2016 and provides for two one-year extension options under certain conditions. As of February 28, 2015 and December 31, 2014, $380,000,000, and $360,000,000, respectively, was outstanding under the credit facility and $470,000,000, and $490,000,000, respectively, was available for future borrowings. Proceeds from the unsecured credit facility were used for acquisitions, general corporate purposes and to repay $323,000,000 outstanding under our unsecured credit facilities.
At December 31, 2014 and 2013, CIM Commercial and CIM Urban, respectively, were in compliance with all of their respective financial covenants.
Our intention is to use the $75,000,000 delayed-draw term loan portion of the unsecured credit facility to pay off mortgages of $72,959,000 as of December 31, 2014, that are maturing during the year ending December 31, 2015.
We have substantial borrowing capacity, and will likely finance our future activities through any of the following methods: (i) offerings of common shares, preferred shares, senior unsecured securities, and other equity and debt securities; (ii) the use and potential expansion of our existing revolving credit lines including the use of the credit line we obtained in September 2014 or the use of a new credit line; (iii) the addition of senior, recourse or non-recourse debt using target acquisitions as well as existing investments as collateral; and/or (iv) the sale of existing investments. We expect to maintain leverage levels that are comparable to those of other commercial property REITs engaged in business strategies similar to our own.
Our long-term liquidity needs will consist primarily of funds necessary to acquire properties and to pay for development or repositioning of properties, non-recurring capital expenditures and refinancing of indebtedness. We may not have sufficient funds on hand or may not be able to obtain additional financing to cover all of these long-term cash requirements. The nature of our business, and the requirements imposed by REIT rules that we distribute a substantial majority of our REIT taxable income on an annual basis in the form of dividends, may cause us to have substantial liquidity needs over the long-term. We will seek to satisfy our long-term liquidity needs through cash flows from operations, long-term borrowings, debt and/or equity issuances and/or, to the extent appropriate, property dispositions. These sources of funding may not be available on attractive terms or at all. If we cannot obtain additional funding for our long-term liquidity needs, our investments may generate lower cash flows or decline in value, or both, which may cause us to reduce our dividend or sell assets at a time when we would not otherwise do so.
Cash Flow Analysis
Comparison of the Year Ended December 31, 2014 to the Year Ended December 31, 2013
As a REIT, our cash flows from operations are typically used to fund our dividends.
Our cash and cash equivalents, inclusive of cash associated with assets held for sale, totaled $27,552,000 and $16,796,000 at December 31, 2014 and 2013, respectively. Our cash flows from
operating activities are primarily dependent upon the occupancy level of our real estate assets, the rental rates achieved through our leases, and the collectability of rent and recoveries from our tenants. Our cash flows from operating activities are also impacted by fluctuations in operating expenses and other general and administrative costs. Net cash provided by operating activities totaled $66,806,000 for the year ended December 31, 2014 compared to $61,827,000 for the year ended December 31, 2013. The increase is mainly due to an increase in segment net operating income of $2,677,000, when adjusted for a $4,475,000 accrual related to a non-recurring payment we have agreed to make in connection with the refund of tax abatements we received during the period of our ownership in which the property was being leased by a corporate housing operator, which was settled in February 2015, as well as lower uses of working capital in 2014 compared to 2013 for deferred leasing costs, other liabilities, and due to related parties.
Our cash flows from investing activities are primarily related to property acquisitions and sales, expenditures for development and redevelopment projects, capital expenditures and, with respect to 2014, the cash flows from the lending segment held for sale. Net cash used in investing activities was $60,301,000 for the year ended December 31, 2014 compared to $22,183,000 for the year ended December 31, 2013, which increased primarily due to use of funds for the acquisition of the office properties acquired in April and October 2014 of $63,436,000, an increase in loans funded, offset by principal collected on loans, and by cash and cash equivalents acquired in the Merger of $3,185,000.
Our cash flows from financing activities are generally impacted by borrowings and capital activities, net of dividends and distributions. Net cash provided by (used in) financing activities increased to $4,251,000 for the year ended December 31, 2014 from ($54,362,000) for the year ended December 31, 2013. We used funds from financing activities during the year ended December 31, 2014 primarily to pay distributions of $144,334,000 in the aggregate ($85,048,000 to partners and stockholders and $59,286,000 for the acquisition of PMC Commercial) compared to partner distributions of $104,035,000 for the year ended December 31, 2013. We had net borrowings, inclusive of borrowings of the lending segment held for sale, of $156,265,000 for the year ended December 31, 2014 compared to $50,302,000 for the year ended December 31, 2013. Additionally, deferred loan costs of $5,774,000 were paid during the year ended December 31, 2014 related to the $850,000,000 credit facility, compared to $395,000 during the year ended December 31, 2013. During the year ended December 31, 2014, we also paid $1,850,000 to redeem class B shares of subsidiary REITs.
Comparison of the Year Ended December 31, 2013 to the Year Ended December 31, 2012
As a REIT, our cash flows from operations are typically used to fund our dividends.
Our cash and cash equivalents totaled $16,796,000 and $31,514,000 at December 31, 2013 and 2012, respectively. Net cash provided by operating activities totaled $61,827,000 for the year ended December 31, 2013 compared to $66,714,000 for the year ended December 31, 2012. The decrease is primarily due to an increase in transaction costs of $4,431,000, which mainly represents costs related to the Merger and costs associated with the LAX Holiday Inn hotel foreclosure in October 2013.
Net cash used in investing activities was $22,183,000 for the year ended December 31, 2013 compared to $29,010,000 for the year ended December 31, 2012. The decrease is mainly due to lower levels of both acquisition and capital expenditure spending in 2013 compared to 2012. Additionally, restricted cash decreased in 2013, due to releases of tax and other impound accounts as a result of the repayment of approximately $75,909,000 in fixed rate mortgages in September 2013.
Net cash used in financing activities increased to $54,362,000 for the year ended December 31, 2013 from $52,427,000 for the year ended December 31, 2012. The 2013 period reflects higher net proceeds from the unsecured line of credit borrowings, which was partially offset by the repayment of mortgage debt. The increase in cash used in financing activities also reflects increased partner
distributions during 2013 of $104,035,000, as compared to $72,987,000 during 2012. The 2013 period includes payment of five distributions versus four payments in the 2012 period.
Summarized Contractual Obligations, Commitments and Contingencies
The following summarizes our contractual obligations at December 31, 2014:
(1)Represents junior subordinated notes and unsecured credit facility.
(2)Principal payments are generally dependent upon cash flows received from the underlying loans. Our estimate of their repayment is based on scheduled principal payments on the underlying loans. Our estimate will differ from actual amounts to the extent we experience prepayments and/or loan liquidations or charge-offs. No payment is due unless payments are received from the borrowers on the underlying loans.
(3)Excludes premiums and discounts. For the mortgages payable, the interest expense is calculated based on the current effective interest rate on the related debt. For our unsecured credit facility, we use the current balance outstanding through maturity date, and is calculated using the variable rates in effect at December 31, 2014.
(4)Represents minimum payments required under executive employment agreements.
(5)Represents future minimum lease payments under our operating leases for office space and under the ground lease for one of the projects.
Off Balance Sheet Arrangements
At December 31, 2014, we did not have any off-balance sheet arrangements.
Critical Accounting Policies and Estimates and Recently Issued Accounting Pronouncements
The discussion and analysis of our historical financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets 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 during the reporting period. While we believe that our estimates are based on reasonable assumptions and judgments at the time they are made, some of our assumptions, estimates and judgments will inevitably prove to be incorrect. As a result, actual results could differ from our estimates, and those differences could be material.
We believe the following critical accounting policies, among others, affect our more significant estimates and assumptions used in preparing our consolidated financial statements. For a discussion of recently issued accounting literature, see Note 3 to the consolidated financial statements included in this Form 10-K.
Investments in Real Estate
We apply the acquisition method to all acquired real estate investments. The purchase consideration of the real estate is recorded at fair value to the acquired tangible assets, consisting primarily of land, site improvements, and building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, other value of in-place leases, and value of tenant relationships and acquired ground leases, based in each case on their fair values. Loan premiums, in the case of above-market rate loans, or loan discounts, in the case of below-market loans, are recorded based on the fair value of any loans assumed in connection with acquiring the real estate.
The fair value of the tangible assets of an acquired property is determined by valuing the property as if it were vacant, and the "as-if-vacant" value is then allocated to land (or acquired ground lease if the land is subject to a ground lease), site improvements, and building and tenant improvements based on management's determination of the relative fair values of these assets. Management determines the as-if-vacant fair value of a property using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses, and estimates of lost rental revenue during the expected lease-up periods based on current market demand. Management also estimates costs to execute similar leases, including leasing commissions, legal, and other related costs.
In allocating the purchase consideration of the identified intangible assets and liabilities of an acquired property, above-market, below-market, and in-place lease values are recorded based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management's estimate of fair market lease rates for the corresponding in-place leases measured over a period equal to the remaining noncancelable term of the lease, and for below-market leases, over a period equal to the initial term plus any below-market fixed-rate renewal periods. Acquired above-market and below-market leases are amortized and recorded to rental and other property income over the initial terms of the prospective leases.
The aggregate value of other acquired intangible assets, consisting of in-place leases and tenant relationships, is measured by the estimated cost of operations during a theoretical lease-up period to replace in-place leases, including lost revenues and any unreimbursed operating expenses, plus an estimate of deferred leasing commissions for in-place leases. The value of in-place leases is amortized to expense over the remaining noncancelable periods of the respective leases. If a lease is terminated prior to its stated expiration, all unamortized amounts relating to that lease are written-off.
For hotels, an intangible value was assigned to expected revenues from advance bookings, which were calculated based on discounted income, and to franchise affiliation, which were calculated based on the difference between the net projected income in the year of acquisition and an estimate of income without the franchise.
Costs related to the acquisition of properties are expensed as incurred. Improvements and replacements are capitalized when they extend the useful life, increase capacity, or improve the efficiency of the asset. Ordinary repairs and maintenance are expensed as incurred.
Investments in real estate are evaluated for impairment on a quarterly basis or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount to the future net cash flows, undiscounted and without interest, expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. The estimated fair value of the asset group identified for step two testing is based on either the income approach with market discount rate, terminal capitalization rate and rental rate assumptions being most critical, or on the sales comparison approach to similar properties. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell.
Estimates regarding the allocation of purchase price and the evaluation of impairment require significant judgment, and some of these estimates involve complex calculations. These assessments have a direct impact on our results of operations as the allocations and evaluations impact the amount and timing of depreciation and amortization expense we reflect in our consolidated financial statements.
Loans Receivable
Our loans receivable included in assets held for sale at December 31, 2014 are carried at their unamortized principal balance less unamortized acquisition discounts and premiums, retained loan discounts and loan loss reserves. For loans originated under the SBA 7(a) Program, we sell the portion of the loan that is guaranteed by the SBA. Upon sale of the SBA guaranteed portion of the loans which are accounted for as sales, the unguaranteed portion of the loan retained by us is valued on a fair value basis and a discount is recorded as a reduction in basis of the retained portion of the loan.
At the Acquisition Date, the carrying value of our loans was adjusted to estimated fair market value and acquisition discounts of $33,907,000 were recorded, which are being accreted to interest income, included in income from operations of assets held for sale, using the effective interest method. As of December 31, 2014, acquisition discounts of $26,495,000 remain that have not yet been accreted to income.
A loan receivable is generally classified as non-accrual (a "Non-Accrual Loan") if (i) it is past due as to payment of principal or interest for a period of 60 days or more, (ii) any portion of the loan is classified as doubtful or is charged off or (iii) the repayment in full of the principal and/or interest is in doubt. Generally, loans are charged-off when management determines that we will be unable to collect any remaining amounts due under the loan agreement, either through liquidation of collateral or other means. Interest income, included in discontinued operations, on a Non-Accrual Loan is recognized on either the cash basis or the cost recovery basis.
On a quarterly basis, and more frequently if indicators exist, we evaluate the collectability of our loans receivable. Our evaluation of collectability involves judgment, estimates, and a review of the ability of the borrower to make principal and interest payments, the underlying collateral and the borrowers' business models and future operations in accordance with Accounting Standards Codification ("ASC") 450-20, Contingencies-Loss Contingencies, and ASC 310-10, Receivables. For the years ended December 31, 2014, 2013 and 2012, no impairments on our loans receivable were recorded. We establish a general loan loss reserve when available information indicates that it is probable a loss has occurred based on the carrying value of the portfolio and the amount of the loss can be reasonably estimated. Significant judgment is required in determining the general loan loss reserve, including estimates of the likelihood of default and the estimated fair value of the collateral. The general loan loss reserve includes those loans, which may have negative characteristics which have not yet become
known to us. In addition to the reserves established on loans not considered impaired that have been evaluated under a specific evaluation, the general loan loss reserve uses a consistent methodology to determine a loss percentage to be applied to loan balances. These loss percentages are based on many factors, primarily cumulative and recent loss history and general economic conditions.
The evaluation of the collectability of our loans receivable is highly subjective and is based in part on factors that could differ materially from actual results in future periods. If these factors change, we may recognize an impairment loss, which could be material.
Accounts Receivable
Accounts receivable are carried net of the allowances for uncollectible amounts. Management's determination of the adequacy of these allowances is based primarily upon evaluation of historical loss experience, individual receivables, current economic conditions, and other relevant factors. The allowances are increased or decreased through the provision for bad debts. If our estimates of collectability differ from the cash received, the timing and amount of our reported revenue could be impacted.
Revenue Recognition
All leases are classified as operating leases and minimum rents are recognized on a straight-line basis over the terms of the leases when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the leased asset. The excess of rents recognized over amounts contractually due pursuant to the underlying leases is recorded as deferred rent. If the lease provides for tenant improvements, we determine whether the tenant improvements, for accounting purposes, are owned by the tenant or us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is considered the owner of the improvements, any tenant improvement allowance that is funded is treated as incentive. Lease incentives paid to tenants are included in other assets and amortized as a reduction to rental revenue on a straight-line basis over the term of the related lease.
Reimbursements from tenants, consisting of amounts due from tenants for common area maintenance, real estate taxes, insurance, and other recoverable costs, are recognized as revenue in the period the expenses are incurred. Tenant reimbursements are recognized and presented on a gross basis when we are the primary obligor with respect to incurring expenses and with respect to having the credit risk.
In addition to minimum rents, certain leases provide for additional rents based upon varying percentages of tenants' sales in excess of annual minimums. Percentage rent is recognized once lessees' specified sales targets have been met.
We derive parking revenues from leases with third party operators. Our parking leases provide for additional rents based upon varying percentages of tenants' sales in excess of annual minimums. Parking percentage rent is recognized once lessee's specific sales targets have been met.
Hotel room sales are recognized upon daily occupancy. Other hotel revenues are recognized as earned upon facility use or food and beverage consumption.
Interest income included in our discontinued operations is comprised of interest earned on loans and our short-term investments and the accretion of net loan origination fees and discounts. Interest income on loans is accrued as earned with the accrual of interest suspended when the related loan becomes a Non-Accrual Loan.
Income Taxes
We have elected to be taxed as a REIT under the provisions of the Code. To the extent we qualify for taxation as a REIT, we generally will not be subject to a federal corporate income tax on our taxable income that is distributed to our stockholders. We may, however, be subject to certain federal excise taxes and state and local taxes on our income and property. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and will not be able to qualify as a REIT for four subsequent taxable years. In order to remain qualified as a REIT under the Code, we must satisfy various requirements in each taxable year, including, among others, limitations on share ownership, asset diversification, sources of income, and the distribution of at least 90% of our taxable income within the specified time in accordance with the Code.
We have wholly-owned taxable REIT subsidiaries ("TRS's") which are subject to federal income taxes. The income generated from the taxable REIT subsidiaries is taxed at normal corporate rates. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
We have established a policy on classification of penalties and interest related to audits of our federal and state income tax returns. If incurred, our policy for recording interest and penalties associated with audits will be to record such items as a component of general and administrative expense or discontinued operations. Penalties, if incurred, will be recorded in general and administrative expense or discontinued operations and interest paid or received will be recorded in interest expense or income, respectively, or discontinued operations in the consolidated statements of operations and comprehensive income.
ASC 740, Income Taxes, provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing our tax returns to determine whether the tax positions are "more likely than not" of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current period. We have reviewed all open tax years and concluded that the application of ASC 740 resulted in no material effect to our consolidated financial position or results of operations.
Discontinued Operations
We classify assets as held for sale when they meet the necessary criteria, which include: (1) management commits to and actively embarks upon a plan to sell the assets, (2) the assets to be sold are available for immediate sale in their present condition, (3) the sale is expected to be completed within one year under terms usual and customary for such sales and (4) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. We believe that we meet these criteria when the plan for sale has been approved by the Board of Directors; there are no known significant contingencies related to the sale and management believes it is probable that the sale will be completed within one year.
Assets held for sale are recorded at the lower of cost or estimated fair value less cost to sell. Revenues and expenses of assets that are held for sale are presented as discontinued operations for all periods presented in the consolidated statements of operations and comprehensive income.
Dividends
Our stockholders are entitled to receive dividends when and as declared by the Board of Directors. In determining our dividend policy, the Board of Directors considers many factors including, but not limited to, expectations for future earnings, REIT taxable income (loss) and maintenance of REIT status, the economic environment and portfolio performance. Consequently, the dividend rate on a quarterly basis does not necessarily correlate directly to any individual factor. There can be no assurance that the future dividends declared by our Board of Directors will not differ materially from historical dividend levels.
During the year ended December 31, 2014, CIM Urban paid a distribution of $16,100,000 prior to the Acquisition Date ($0.1685 per share of Common Stock, as converted).
On March 24, 2014, we declared a common share dividend of $0.05 per share of Common Stock and a preferred dividend of $0.0403 per share of preferred stock ($0.0285 per share of Common Stock, as converted), all of which were paid on March 28, 2014.
On April 28, 2014, we declared a dividend in the aggregate amount of $1,964,000 to the preferred stockholders ($0.0302 per share of preferred stock and $0.0215 per share of Common Stock, as converted) in connection with the conversion of shares of preferred stock to shares of Common Stock, which was paid on June 27, 2014.
On June 12, 2014, we declared a common share dividend of $0.21875 per share of Common Stock which was paid on June 27, 2014.
On September 12, 2014, we declared a common share dividend of $0.21875 per share of Common Stock which was paid on September 29, 2014.
On December 9, 2014, we declared a common share dividend of $0.21875 per share of Common Stock which was paid on December 29, 2014.
On March 6, 2015, we declared a common share dividend of $0.21875 per share of Common Stock, to be paid on March 27, 2015 to stockholders of record on March 20, 2015.
In addition, dividends of $59,286,000 ($27.975 per share of common stock) were paid to the PMC Commercial stockholders in connection with the Merger, which includes the $27.50 per share of common stock special dividend plus the $0.475 pro rata portion of PMC Commercial's regular quarterly cash dividend.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The fair value of our mortgages payable is sensitive to fluctuations in interest rates. Discounted cash flow analysis is generally used to estimate the fair value of our mortgages payable, using rates ranging from 3.92% to 4.12% at December 31, 2014 and 4.85% to 5.00% at December 31, 2013. Mortgages payable with book values of $223,808,000 and $231,105,000 as of December 31, 2014 and 2013, respectively, have a fair value of approximately $231,806,000 and $231,250,000, respectively.
Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevalent market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. We are exposed to market risk in the form of changes in interest rates and the potential impact such changes may have on the cash flows from our floating rate debt or the fair values of our fixed rate debt. At December 31, 2014 and 2013 (excluding premiums and discounts on assumed mortgages and including the debt associated with assets held for sale), $221,847,000 (or 34.3%) and $228,319,000 (or 58.2%) of our debt was fixed rate mortgage loans, and $425,809,000 (or 65.7%) and $164,000,000 (or 41.8%) was floating rate borrowings. Based on the level of floating rate debt outstanding at December 31, 2014 and 2013, a 12.5 basis point change in LIBOR would result in
an annual impact to our earnings of approximately $532,000 and $205,000, respectively. We calculate interest rate sensitivity by multiplying the amount of floating rate debt by the respective change in rate. The sensitivity analysis does not take into consideration possible changes in the balances or fair value of our floating rate debt.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this Item 8 is listed in Part IV, Item 15(a) of this report.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation Of Disclosure Controls And Procedures
As of December 31, 2014, we carried out an evaluation, under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, regarding 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 Exchange Act at the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded, as of that time, that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that it files or submits to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms and include controls and procedures designed to ensure the information required to be disclosed by the Company in such reports is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Management's Report On Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. We reviewed the results of management's assessment with the Audit Committee of the Board of Directors.
Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013). Based on their assessment, management determined that as of December 31, 2014, the Company's internal control over financial reporting was effective based on those criteria.
The effectiveness of the Company's internal control over financial reporting as of December 31, 2014 has been audited by BDO USA, LLP ("BDO"), an independent registered public accounting firm as stated in their report which appears herein.
Report of Independent Registered Accounting Firm
Board of Directors and Stockholders
CIM Commercial Trust Corporation
Dallas, TX
We have audited CIM Commercial Trust Corporation and its subsidiaries' internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). CIM Commercial Trust Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, CIM Commercial Trust Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of CIM Commercial Trust Corporation as of December 31, 2014, and the related consolidated statements of operations, comprehensive income, equity, and cash flows for the year ended December 31, 2014 and our report dated March 16, 2015 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Los Angeles, CA
March 16, 2015
Limitations On The Effectiveness Of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls will prevent all error and fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures. Because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.
Changes In Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2014 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
Information required by this Item regarding the Company's directors and executive officers, and corporate governance, including information with respect to beneficial ownership reporting compliance, will appear in the Proxy Statement we will deliver to our stockholders in connection with our 2015 Annual Meeting of Stockholders. Such information is incorporated herein by reference. Information relating to the registrant's Code of Business Conduct and Ethics that applies to its employees, including its senior financial officers, is included in Part I of this Annual Report on Form 10-K under "Item 1. BUSINESS-Available Information."
Item 11.
Item 11. Executive Compensation
The information required by this Item will appear in the Proxy Statement we will deliver to our stockholders in connection with our 2015 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item regarding security ownership of certain beneficial owners and management will appear in the Proxy Statement we will deliver to our Stockholders in connection with our 2015 Annual Meeting of Stockholders. Such information is incorporated herein by reference. Information relating to securities authorized for issuance under the Company's equity compensation
plans is included in Part II of this Annual Report on Form 10-K under "Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item will appear in the Proxy Statement we will deliver to our stockholders in connection with our 2015 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item will appear in the Proxy Statement we will deliver to our stockholders in connection with our 2015 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)
1. Financial Statements
2. Financial Statement Schedules
The following financial statement schedules for the Registrant are filed as a part of this report:
A. Schedule III-Real Estate and Accumulated Depreciation; and
B. Schedule IV-Mortgage Loans on Real Estate.
Note: Other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.
3. Exhibits
The following documents are included or incorporated by reference in this Annual Report on Form 10-K:
2.1
Agreement and Plan of Merger by and among CIM Urban REIT, LLC, CIM Merger Sub, LLC, PMC Commercial Trust and Southfork Merger Sub, LLC dated July 8, 2013 (incorporated by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated July 8, 2013).
2.2
Agreement and Plan of Merger, dated April 28, 2014, between PMC Commercial Trust and PMC Commercial Merger Sub, Inc. (incorporated by reference to Appendix C to the Registrant's Definitive Proxy Statement on Schedule 14A filed with the SEC on April 14, 2014).
3.1
Articles of Amendment and Restatement of PMC Commercial Merger Sub, Inc. (incorporated by reference to the exhibits to the Registrant's Current Report on Form 8-K filed with the SEC on May 9, 2014).
3.1(a
)
Articles of Amendment (Name Change) (incorporated by reference to the exhibits to the Registrant's Current Report on Form 8-K filed with the SEC on May 2, 2014).
3.1(b
)
Articles of Amendment (Reverse Stock Split) (incorporated by reference to the exhibits to the Registrant's Current Report on Form 8-K filed with the SEC on May 2, 2014).
3.1(c ) Articles of Amendment (Par Value Decrease) (incorporated by reference to the exhibits to the Registrant's Current Report on Form 8-K filed with the SEC on May 2, 2014).
3.2
Bylaws (incorporated by reference to Exhibit 3.2 to the Registrant's Current Report on Form 8-K filed with the SEC on May 2, 2014).
4.1
Purchase Agreement among PMC Commercial Trust, PMC Preferred Capital Trust-A and Taberna Preferred Funding I, Ltd. dated March 15, 2005 (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005).
4.2
Junior Subordinated Indenture between PMC Commercial Trust and JPMorgan Chase Bank, National Association as Trustee dated March 15, 2005 (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005).
4.3
Amended and Restated Trust Agreement among PMC Commercial Trust, JPMorgan Chase Bank, National Association, Chase Bank USA, National Association and The Administrative Trustees Named Herein dated March 15, 2005 (incorporated by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005).
4.4
Preferred Securities Certificate (incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005).
4.5
Floating Rate Junior Subordinated Note due 2035 (incorporated by reference to Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005).
+10.1
2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005).
+*10.2
First Amendment to PMC Commercial Trust 2005 Incentive Plan.
+10.3
Amended and Restated Executive Employment Contract with Jan F. Salit dated August 30, 2013 (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on August 30, 2013).
+10.4
Amended and Restated Executive Employment Contract with Barry N. Berlin dated August 30, 2013 (incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on August 30, 2013).
10.5
Consent to Assignment and Limited Waiver to Agreement and Plan of Merger, dated as of November 20, 2013, by and among PMC Commercial Trust, CIM Urban REIT, LLC, Southfork Merger Sub, LLC, and CIM Merger Sub, LLC, the terms of which were acknowledged and agreed to by a new subsidiary formed by CIM Urban REIT, LLC, Urban Partners II, LLC (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on November 22, 2013).
10.6
Memorandum and Agreement of Settlement dated as of January 28, 2014 by and among Hoak & Co., Hoak Public Equities, L.P., PMC Commercial Trust, Southfork Merger Sub, LLC, CIM Urban REIT, LLC, and the other parties thereto (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on January 30, 2014).
10.7
Rule 10b5-1 Purchase Plan dated January 29, 2014 by and among PMC Commercial Trust, CIM Service Provider, LLC and Merrill Lynch, Pierce, Fenner and Smith Incorporated (incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on January 30, 2014).
10.8
Settlement Agreement dated as of January 28, 2014 by and among PMC Commercial Trust, CIM Urban REIT, LLC, Southfork Merger Sub, LLC, REIT Redux LP, and the other parties thereto (incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K filed with the SEC on January 30, 2014).
10.9
Master Services Agreement dated March 11, 2014 by and among PMC Commercial Trust, certain of its subsidiaries, and CIM Service Provider, LLC (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on March 11, 2014).
10.10
Registration Rights and Lockup Agreement dated March 11, 2014 by and among Urban Partners II, LLC and PMC Commercial Trust (incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on March 11, 2014).
10.11
Service Agreement, dated as of August 7, 2014, by and among CIM Commercial Trust Corporation and CIM Service Provider, LLC, under the Master Services Agreement dated March 11, 2014, by and among PMC Commercial Trust, certain of its subsidiaries, and CIM Service Provider, LLC (incorporated by reference to Exhibit 10.8 to the Registrant's Quarterly Report on Form 10-Q filed with the SEC on August 11, 2014).
10.12
Form of Indemnification Agreement for directors and officers of CIM Commercial Trust Corporation (incorporated by reference to Exhibit 10.9 to the Registrant's Quarterly Report on Form 10-Q filed with the SEC on August 11, 2014).
10.13
Credit Agreement, dated as of September 30, 2014, among CIM Commercial Trust Corporation, each guarantor party thereto, each lender party thereto, Bank of America, N.A., as Administrative Agent, and JPMorgan Chase Bank, N.A. as Syndication Agent (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on October 1, 2014).
10.14
First Amendment to Credit Agreement, dated as of January 14, 2015, among CIM Commercial Trust Corporation, each Lender party thereto and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on January 16, 2015).
*10.15
Staffing and Reimbursement Agreement, dated as of January 1, 2015, by and among CIM SBA Staffing, LLC, PMC Commercial Lending, LLC and CIM Commercial Trust Corporation.
*10.16
Investment Management Agreement, dated as of May 20, 2005, between CIM Urban Partners, L.P. and CIM Urban REIT Management, Inc.
*10.17
Second Amended and Restated Agreement and Limited Partnership of CIM Urban Partners, L.P., dated as of December 22, 2005, by and among CIM Urban Partners GP, Inc. and CIM Urban REIT, LLC.
*21.1
Subsidiaries of the Registrant.
*23.1
Consent of BDO USA, LLP.
*23.2
Consent of Deloitte & Touche LLP
*24.1
Powers of Attorney (included on signature page).
*31.1
Section 302 Officer Certification-Chief Executive Officer
*31.2
Section 302 Officer Certification-Chief Financial Officer
*32.1
Section 906 Officer Certification-Chief Executive Officer
*32.2
Section 906 Officer Certification-Chief Financial Officer
*101
Interactive data files pursuant to Rule 405 of Regulation S-T:
*Filed herewith.
+Management contract or compensatory plan
(b)Exhibits
The exhibits listed in Item 15(a)3 are incorporated by reference or attached hereto.
(c)Excluded Financial Statements Not Applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWERS OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Charles Garner and David Thompson and each of them severally, his or her true and lawful attorney-in-fact with power of substitution and resubstitution to sign in his or her name, place and stead, in any and all capacities, to do any and all things and execute any and all instruments that such attorney may deem necessary or advisable under the Securities Exchange Act of 1934 and any rules, regulations and requirements of the U.S. Securities and Exchange Commission in connection with this Annual Report on Form 10-K and any and all amendments hereto, as fully for all intents and purposes as he or she might or could do in person, and hereby ratifies and confirms all said attorneys-in-fact and agents, each acting alone, and his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms
Board of Directors and Stockholders
CIM Commercial Trust Corporation
Dallas, TX
We have audited the accompanying consolidated balance sheet of CIM Commercial Trust Corporation and its subsidiaries (the "Company") as of December 31, 2014, and the related consolidated statements of operations, comprehensive income, equity, and cash flows for the year ended December 31, 2014. In connection with our audit of the consolidated financial statements, we have also audited the financial statement schedules listed in the accompanying index. These consolidated financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audit.
We conducted our audit 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. 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 presentation of the financial statements and schedules. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CIM Commercial Trust Corporation and its subsidiaries at December 31, 2014, and the results of its operations and its cash flows for the year ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the 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.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), CIM Commercial Trust Corporation's internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 16, 2015 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Los Angeles, CA
March 16, 2015
To the Board of Directors of CIM Commercial Trust Corporation
Dallas, TX
We have audited the accompanying consolidated balance sheet of CIM Urban Partners, LP and its subsidiaries (the "Partnership") as of December 31, 2013, and the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the two years in the period ended December 31, 2013. Our audits also included the 2013 and 2012 financial information included in Schedule III listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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 Partnership 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 Partnership'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.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CIM Urban Partners, LP and its subsidiaries as of December 31, 2013, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the 2013 and 2012 financial information included in Schedule III, 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.
As noted in Note 2 to the consolidated financial statements, on March 11, 2014, the Partnership merged with CIM Commercial Trust Corporation (formerly PMC Commercial Trust). The business combination was accounted for as a reverse merger, with the Partnership as the accounting acquirer.
/s/ DELOITTE & TOUCHE LLP
Los Angeles, California
March 16, 2015
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets as of December 31, 2014 and 2013
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
for the Years Ended December 31, 2014, 2013 and 2012
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Consolidated Statements of Equity
for the Years Ended December 31, 2014, 2013 and 2012
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2014, 2013 and 2012
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012
1. ORGANIZATION AND OPERATIONS
CIM Commercial Trust Corporation ("CIM Commercial" or the "Company") or together with its wholly-owned subsidiaries, (which, together with CIM Commercial may be referred to as "we," "us" or "our") primarily acquires, owns, and operates Class A and creative office properties in vibrant and improving urban communities throughout the United States. These communities are located in areas that include traditional downtown areas and suburban main streets, which have high barriers to entry, high population density, improving demographic trends and a propensity for growth. We also obtain income from the yield and other related fee income earned on our investments from our lending activities, which have principally been to borrowers in the hospitality industry. As discussed in Note 7, the lending segment is held for sale at December 31, 2014. We were originally organized in 1993 as PMC Commercial Trust ("PMC Commercial"), a Texas real estate investment trust.
On July 8, 2013, PMC Commercial entered into a merger agreement (the "Merger Agreement") with CIM Urban REIT, LLC ("CIM REIT") and subsidiaries of the respective parties. CIM REIT was a private commercial REIT and was the owner of CIM Urban Partners, LP ("CIM Urban"). The transaction (the "Merger") was completed on March 11, 2014 (the "Acquisition Date"). The Merger was accounted for as a reverse acquisition under the acquisition method of accounting with CIM Urban considered to be the accounting acquirer based upon the terms of the Merger Agreement. Based on the determination that CIM Urban was the accounting acquirer in the transaction, CIM Urban allocated the purchase price to the fair value of PMC Commercial's assets and liabilities as of the Acquisition Date.
On April 28, 2014, PMC Commercial's charter was amended to increase the authorized shares of common stock of PMC Commercial from 100,000,000 to 1,000,000,000 shares (20,000,000 and 200,000,000 after giving effect to the reverse stock split described below) and PMC Commercial changed its state of incorporation (the "Reincorporation") from Texas to Maryland by means of a merger of PMC Commercial with and into a newly formed, wholly-owned subsidiary Maryland corporation. On April 28, 2014, we changed our name from "PMC Commercial Trust" to "CIM Commercial Trust Corporation." Our common stock ("Common Stock") is currently traded on the NASDAQ Global Market (symbol "CMCT").
On April 28, 2014, we filed Articles of Amendment (the "Reverse Split Amendment") to effectuate a one-for-five reverse stock split of the Common Stock, effective April 29, 2014. Pursuant to the reverse stock split, each five shares of Common Stock issued and outstanding immediately prior to the effective time of the reverse stock split were converted into one (1) share of Common Stock. Fractional shares of Common Stock were not issued as a result of the reverse stock split; instead, holders of pre-split shares of Common Stock who otherwise would have been entitled to receive a fractional share of Common Stock received an amount in cash equal to the product of the fraction of a share multiplied by the closing price of the Common Stock (as adjusted for the one-for-five reverse stock split). In connection with and immediately following the filing of the Reverse Split Amendment, the Company filed Articles of Amendment (the "Par Value Amendment") to decrease the par value of the Common Stock issued and outstanding to $0.001 per share, effective April 29, 2014, subsequent to the effective time of the Reverse Split Amendment. All per share and outstanding share information has been presented to reflect the reverse stock split.
CIM Commercial has qualified and intends to continue to qualify as a Real Estate Investment Trust ("REIT"), as defined in the Internal Revenue Code of 1986, as amended.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
2. MERGER
The Merger Agreement provided for the business combination of CIM REIT's wholly owned subsidiary, CIM Urban and PMC Commercial. Pursuant to the Merger Agreement, an affiliate of CIM REIT received 4,400,000 shares of newly-issued PMC Commercial common stock and approximately 65,000,000 shares of newly-issued PMC Commercial preferred stock. Following the Merger and subsequent increase in our authorized number of shares, each share of preferred stock was converted into 1.4 shares of PMC Commercial common stock, resulting in the issuance of 95,440,000 shares of common stock in the aggregate in connection with the Merger, representing approximately 97.8% of PMC Commercial's outstanding shares of common stock.
All shares of PMC Commercial common stock that were outstanding immediately prior to the closing of the Merger continued to remain outstanding following the Acquisition Date. In addition, stockholders of record of PMC Commercial at the close of the business day prior to the Acquisition Date received a special cash dividend of $27.50 per share of common stock plus that pro-rata portion of PMC Commercial's regular quarterly cash dividend accrued through the Acquisition Date, each of which was paid March 25, 2014.
The Merger was accounted for as a reverse acquisition under the acquisition method of accounting with CIM Urban considered to be the accounting acquirer based upon the terms of the Merger Agreement. Based on the determination that CIM Urban was the accounting acquirer in the transaction, CIM Urban allocated the purchase price to the fair value of PMC Commercial's assets and liabilities as of the Acquisition Date.
Accordingly, the accompanying financial statements include (1) the historical financial information for CIM Urban for all periods presented, (2) the assets and liabilities of PMC Commercial acquired on March 11, 2014 and still owned or held by us in the consolidated balance sheet as of December 31, 2014 and (3) the results of PMC Commercial's operations and cash flows in the consolidated statements of operations and comprehensive income and cash flows for the period from the Acquisition Date through December 31, 2014. The equity of CIM Commercial is the historical equity of CIM Urban retroactively restated to reflect the number of shares of stock issued by PMC Commercial pursuant to the Merger Agreement. In connection with the reverse acquisition, for purposes of presenting equity for CIM Commercial, the historical stockholders of PMC Commercial were deemed to have been issued 2,119,244 shares of Common Stock (2,226,509 shares of Common Stock, less 107,265 shares of treasury stock) on the Acquisition Date.
Consideration Transferred-The fair value of the consideration transferred in the reverse acquisition is determined based on the number of shares of stock the accounting acquirer would have to issue to the stockholders of the accounting acquiree in order to provide the same ratio of ownership in the combined entity following the completion of the Merger, and was determined to be the outstanding stock of PMC Commercial as of the Acquisition Date. The fair value of the consideration transferred was based on the most reliable measure, which was determined to be the market price of PMC Commercial stock as of the Acquisition Date. The computation of the fair value of the
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
2. MERGER (Continued)
consideration transferred, based on the market price of PMC Commercial stock on the Acquisition Date, is as follows:
Purchase Price Allocation-As CIM Urban was the accounting acquirer in the business combination, it has allocated the purchase price to PMC Commercial's individually identifiable assets acquired and liabilities assumed based on their estimated fair values on the Acquisition Date. A bargain purchase gain was recorded as of the Acquisition Date in the amount equal to the excess of the fair value of the identifiable net assets acquired over the total purchase price.
The following table summarizes the allocation of the purchase price:
In order to allow CIM Commercial to increase its focus in Class A and creative office properties, our board of directors (the "Board of Directors") approved a plan for the lending business that, when completed, will result in the deconsolidation of the lending segment. As a result, the lending segment is held for sale at December 31, 2014 (see Note 7).
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
2. MERGER (Continued)
Based on an arrangement with PMC Commercial, certain legal and due diligence expenses related to the Merger incurred by PMC Commercial during a certain period of time were reimbursed by CIM Urban. For the years ended December 31, 2014 and 2013, Merger related costs of $467,000 and $3,670,000, respectively, are included in transaction costs.
Unaudited Pro Forma Financial Information-The following unaudited pro forma consolidated results for the years ended December 31, 2014 and 2013 assume the Merger was completed as of January 1, 2013:
(A)Unaudited pro forma revenues including revenues from the acquired assets included in discontinued operations were $278,398,000 and $256,534,000 for the years ended December 31, 2014 and 2013, respectively.
The unaudited pro forma amounts include the historical operating results of CIM Urban and PMC Commercial prior to the Merger, with adjustments directly attributable to the Merger. The unaudited pro forma results for the year ended December 31, 2014 exclude transaction costs of $3,046,000, a one-time gain of $1,166,000 related to the settlement of a contractual obligation, and the $4,918,000 bargain purchase gain recorded on the Acquisition Date.
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation-The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP").
Principles of Consolidation-The consolidated financial statements include the accounts of CIM Commercial and its subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Investments in Real Estate-Real estate acquisitions are recorded at cost as of the acquisition date. Costs related to the acquisition of properties are expensed as incurred. Investments in real estate are stated at depreciated cost. Depreciation and amortization are recorded on a straight line basis over the estimated useful lives as follows:
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Improvements and replacements are capitalized when they extend the useful life, increase capacity, or improve the efficiency of the asset. Ordinary repairs and maintenance are expensed as incurred.
Investments in real estate are evaluated for impairment on a quarterly basis or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount to the future net cash flows, undiscounted and without interest, expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. The estimated fair value of the asset group identified for step two testing is based on either the income approach with market discount rate, terminal capitalization rate and rental rate assumptions being most critical, or on the sales comparison approach to similar properties. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. No impairment of long-lived assets was recognized during the years ended December 31, 2014, 2013 and 2012.
Cash and Cash Equivalents-Cash and cash equivalents include short-term liquid investments with initial maturities of three months or less.
Restricted Cash-The mortgage loan and hotel management agreements provide for depositing cash into restricted accounts reserved for property taxes, insurance, and capital expenditures.
Loans Receivable-Our loans receivable included in assets held for sale are carried at their unamortized principal balance less unamortized acquisition discounts and premiums, retained loan discounts and loan loss reserves. For loans originated under the Small Business Administration's ("SBA") 7(a) Guaranteed Loan Program ("SBA 7(a) Program") we sell the portion of the loan that is guaranteed by the SBA. Upon sale of the SBA guaranteed portion of the loans which are accounted for as sales, the unguaranteed portion of the loan retained by us is valued on a fair value basis and a discount (the "Retained Loan Discount") is recorded as a reduction in basis of the retained portion of the loan.
At the Acquisition Date, the carrying value of our loans was adjusted to estimated fair market value and acquisition discounts of $33,907,000 were recorded, which are being accreted to interest income, included in income from operations of assets held for sale, using the effective interest method. Acquisition discounts of $26,495,000 remain as of December 31, 2014 which have not yet been accreted to income.
A loan receivable is generally classified as non-accrual (a "Non-Accrual Loan") if (i) it is past due as to payment of principal or interest for a period of 60 days or more, (ii) any portion of the loan is classified as doubtful or is charged-off or (iii) if the repayment in full of the principal and/or interest is in doubt. Generally, loans are charged-off when management determines that we will be unable to collect any remaining amounts due under the loan agreement, either through liquidation of collateral or other means. Interest income, included in discontinued operations, on a Non-Accrual Loan is recognized on either the cash basis or the cost recovery basis.
We recognized interest income and fees related to the LAX Holiday Inn of $316,000 and $3,034,000 for the years ended December 31, 2013 and 2012, respectively. The note paid interest
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
monthly at the London InterBank Offered Rate ("LIBOR") plus 2.35%, with a LIBOR floor of 4.75%. For the year ended December 31, 2012, and for the period from January 1, 2013, to October 8, 2013, the interest rate was 7.10%. The note was acquired at a discount of $6,015,000, which was amortized from the note acquisition through the original maturity date of the note, August 9, 2012. Discount amortization of $810,000 was recorded in interest and other income for the year ended December 31, 2012. On October 8, 2013, we submitted the highest bid at a foreclosure auction and took possession of the LAX hotel. The mortgage note's investment basis was transferred to the property components at their relative fair values upon title transfer (see Note 4). Due to the borrower's default, which made principal exposure likely but not yet certain, from February 2013 to October 2013, we accounted for the note under the nonaccrual method.
On a quarterly basis, and more frequently if indicators exist, we evaluate the collectability of our loans receivable. Our evaluation of collectability involves judgment, estimates, and a review of the ability of the borrower to make principal and interest payments, the underlying collateral and the borrowers' business models and future operations in accordance with Accounting Standards Codification ("ASC") 450-20, Contingencies-Loss Contingencies, and ASC 310-10, Receivables. For the years ended December 31, 2014, 2013 and 2012, no impairments on our loans receivable were recorded. We establish a general loan loss reserve when available information indicates that it is probable a loss has occurred based on the carrying value of the portfolio and the amount of the loss can be reasonably estimated. Significant judgment is required in determining the general loan loss reserve, including estimates of the likelihood of default and the estimated fair value of the collateral. The general loan loss reserve includes those loans, which may have negative characteristics which have not yet become known to us. In addition to the reserves established on loans not considered impaired that have been evaluated under a specific evaluation, the general loan loss reserve uses a consistent methodology to determine a loss percentage to be applied to loan balances. These loss percentages are based on many factors, primarily cumulative and recent loss history and general economic conditions.
Accounts Receivable-Accounts receivable are carried net of the allowances for uncollectible amounts. Management's determination of the adequacy of these allowances is based primarily upon evaluation of historical loss experience, individual receivables, current economic conditions, and other relevant factors. The allowances are increased or decreased through the provision for bad debts. The allowance for uncollectible accounts receivable was $388,000 and $76,000 as of December 31, 2014 and 2013, respectively.
Deferred Rent Receivable and Charges-Deferred rent receivable and charges consist of deferred rent, deferred loan costs and deferred leasing costs. Deferred rent receivable is $53,622,000 and $49,543,000 at December 31, 2014 and 2013, respectively. Deferred loan costs, which represent legal and third-party fees incurred in connection with our borrowing activities, are capitalized and amortized to interest expense on a straight line basis over the life of the related loan, approximating the effective interest method. Deferred loan costs of $7,521,000 and $3,666,000 are presented net of accumulated amortization of $1,741,000 and $1,538,000 at December 31, 2014 and 2013, respectively. Deferred leasing costs, which represent lease commissions and other direct costs associated with the acquisition of tenants, are capitalized and amortized on a straight line basis over the terms of the related leases.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Deferred leasing costs of $55,145,000 and $50,176,000 are presented net of accumulated amortization of $16,917,000 and $14,241,000 at December 31, 2014 and 2013, respectively.
Noncontrolling Interests-Noncontrolling interests represent the interests in various properties owned by third parties. During the year ended December 31, 2014, we paid $1,850,000 to redeem class B shares of subsidiary REITs.
Purchase Accounting for Acquisition of Investments in Real Estate-We apply the acquisition method to all acquired real estate investments. The purchase consideration of the real estate is recorded at fair value to the acquired tangible assets, consisting primarily of land, site improvements, and building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, other value of in-place leases, and value of tenant relationships and acquired ground leases, based in each case on their fair values. Loan premiums, in the case of above-market rate loans, or loan discounts, in the case of below-market loans, are recorded based on the fair value of any loans assumed in connection with acquiring the real estate.
The fair value of the tangible assets of an acquired property is determined by valuing the property as if it were vacant, and the "as-if-vacant" value is then allocated to land (or acquired ground lease if the land is subject to a ground lease), site improvements, and building and tenant improvements based on management's determination of the relative fair values of these assets. Management determines the as-if-vacant fair value of a property using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses, and estimates of lost rental revenue during the expected lease-up periods based on current market demand. Management also estimates costs to execute similar leases, including leasing commissions, legal, and other related costs.
In allocating the purchase consideration of the identified intangible assets and liabilities of an acquired property, above-market, below-market, and in-place lease values are recorded based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management's estimate of fair market lease rates for the corresponding in-place leases measured over a period equal to the remaining noncancelable term of the lease, and for below-market leases, over a period equal to the initial term plus any below-market fixed-rate renewal periods. Acquired above-market and below-market leases are amortized and recorded to rental and other property income over the initial terms of the prospective leases.
The aggregate value of other acquired intangible assets, consisting of in-place leases and tenant relationships, is measured by the estimated cost of operations during a theoretical lease-up period to replace in-place leases, including lost revenues and any unreimbursed operating expenses, plus an estimate of deferred leasing commissions for in-place leases. The value of in-place leases is amortized to expense over the remaining noncancelable periods of the respective leases. If a lease is terminated prior to its stated expiration, all unamortized amounts relating to that lease are written-off.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
For hotels, an intangible value was assigned to expected revenues from advance bookings, which were calculated based on discounted income, and to franchise affiliation, which were calculated based on the difference between the net projected income in the year of acquisition and an estimate of income without the franchise. Advance bookings were $0 and $190,000 at December 31, 2014 and 2013, respectively. Franchise affiliation fees were $955,000 and $1,349,000 at December 31, 2014 and 2013, respectively. Advance bookings are amortized over one to three years, and the franchise affiliation fee is amortized over 10 years. The franchise affiliation fee is fully amortized once the hotel is no longer affiliated with the franchise.
A tax abatement intangible asset was recorded for a property acquired in 2011, based on an approval for a property tax abatement, due to the location of the property. The tax abatement intangible is amortized over eight years. Tax abatement was $2,502,000 and $3,053,000 at December 31, 2014 and 2013, respectively.
Revenue Recognition-All leases are classified as operating leases and minimum rents are recognized on a straight-line basis over the terms of the leases when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the leased asset. The excess of rents recognized over amounts contractually due pursuant to the underlying leases is recorded as deferred rent. If the lease provides for tenant improvements, we determine whether the tenant improvements, for accounting purposes, are owned by the tenant or us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is considered the owner of the improvements, any tenant improvement allowance that is funded is treated as incentive. Lease incentives paid to tenants are included in other assets and amortized as a reduction to rental revenue on a straight-line basis over the term of the related lease. Lease incentives of $8,850,000 and $8,337,000 are presented net of accumulated amortization of $2,072,000 and $1,151,000 at December 31, 2014 and 2013, respectively.
Reimbursements from tenants, consisting of amounts due from tenants for common area maintenance, real estate taxes, insurance, and other recoverable costs, are recognized as revenue in the period the expenses are incurred. Tenant reimbursements are recognized and presented on a gross basis when we are the primary obligor with respect to incurring expenses and with respect to having the credit risk.
In addition to minimum rents, certain leases provide for additional rents based upon varying percentages of tenants' sales in excess of annual minimums. Percentage rent is recognized once lessees' specified sales targets have been met. Included in rental and other property revenues for the years ended December 31, 2014, 2013 and 2012, is $230,000, $99,000 and $162,000, respectively, of percentage rent.
We derive parking revenues from leases with third party operators. Our parking leases provide for additional rents based upon varying percentages of tenants' sales in excess of annual minimums. Parking percentage rent is recognized once lessee's specific sales targets have been met. Included in rental and other property revenues for the years ended December 31, 2014, 2013 and 2012, is $1,562,000, $1,096,000 and $931,000, respectively, of parking percentage rent.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Hotel room sales are recognized upon daily occupancy. Other hotel revenues are recognized as earned upon facility use or food and beverage consumption.
Interest income included in our discontinued operations is comprised of interest earned on loans and our short-term investments and the accretion of net loan origination fees and discounts. Interest income on loans is accrued as earned with the accrual of interest suspended when the related loan becomes a Non-Accrual Loan.
Premiums and Discounts on Debt-Premiums and discounts on debt are accreted or amortized on the effective interest method or on a straight-line basis over the respective term of the loan to interest expense, which approximates the effective interest method.
Stock-Based Compensation Plans-We have options outstanding and issue restricted shares under stock-based compensation plans described more fully in Note 9. We use fair value recognition provisions to account for all awards granted, modified or settled.
Earnings per Share ("EPS")-EPS is computed by dividing net income by the weighted-average number of shares outstanding. Diluted EPS includes the dilutive effect, if any, of stock-based compensation awards.
Distributions to Stockholders-Distributions to stockholders are recorded on the ex-dividend date.
Discontinued Operations-We classify assets as held for sale when they meet the necessary criteria, which include: a) management commits to and actively embarks upon a plan to sell the assets, b) the assets to be sold are available for immediate sale in their present condition, c) the sale is expected to be completed within one year under terms usual and customary for such sales and d) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. We believe that we meet these criteria when the plan for sale has been approved by the Board of Directors, there are no known significant contingencies related to the sale and management believes it is probable that the sale will be completed within one year.
Assets held for sale are recorded at the lower of cost or estimated fair value less cost to sell. Revenues and expenses of assets that are held for sale are presented as discontinued operations for all periods presented in the consolidated statements of operations and comprehensive income.
Income Taxes-We have elected to be taxed as a REIT under the provisions of the Internal Revenue Code of 1986, as amended (the "Code"). To the extent we qualify for taxation as a REIT, we generally will not be subject to a federal corporate income tax on our taxable income that is distributed to our stockholders. We may, however, be subject to certain federal excise taxes and state and local taxes on our income and property. If we fail to qualify as a REIT in any taxable year, we will be subject to Federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and will not be able to qualify as a REIT for four subsequent taxable years. In order to remain qualified as a REIT under the Code, we must satisfy various requirements in each taxable year, including, among others, limitations on share ownership, asset diversification, sources of income, and the distribution of at least 90% of our taxable income within the specified time in accordance with the Code.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
We have wholly-owned taxable REIT subsidiaries ("TRS's") which are subject to federal income taxes. The income generated from the taxable REIT subsidiaries is taxed at normal corporate rates. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
We have established a policy on classification of penalties and interest related to audits of our federal and state income tax returns. If incurred, our policy for recording interest and penalties associated with audits will be to record such items as a component of general and administrative expense or discontinued operations. Penalties, if incurred, will be recorded in general and administrative expense or discontinued operations and interest paid or received will be recorded in interest expense or interest income, respectively, or discontinued operations in the consolidated statements of operations and comprehensive income.
ASC 740, Income Taxes, provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing our tax returns to determine whether the tax positions are "more likely than not" of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current period. We have reviewed all open tax years and concluded that the application of ASC 740 resulted in no material effect to our consolidated financial position or results of operations.
Consolidation Considerations for Our Investments in Real Estate-ASC 810-10, Consolidation, addresses how a business enterprise should evaluate whether it has a controlling interest in an entity through means other than voting rights that would require the entity to be consolidated. We analyze our investments in real estate in accordance with this accounting standard to determine whether they are variable interest entities, and if so, whether we are the primary beneficiary. Our judgment with respect to our level of influence or control over an entity and whether we are the primary beneficiary of a variable interest entity involves consideration of various factors, including the form of our ownership interest, our voting interest, the size of our investment (including loans), and our ability to participate in major policy-making decisions. Our ability to correctly assess our influence or control over an entity affects the presentation of these investments in our consolidated financial statements.
Use of Estimates-The preparation of consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Concentration of Credit Risk-Financial instruments that subject us to credit risk consist primarily of cash and cash equivalents. We have our cash and cash equivalents on deposit with high-quality financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $250,000. Management routinely assesses the financial strength of its tenants and, as a consequence, believes that its accounts receivable credit risk exposure is limited.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Our properties are located throughout the United States. The majority of our revenues are earned from properties located in the Washington, D.C. metro area and California. We are subject to risks incidental to the ownership and operation of commercial real estate. These include, among others, the risks normally associated with changes in the general economic climate in the communities in which we operate, trends in the real estate industry, change in tax laws, interest rate levels, availability of financing, and the potential liability under environmental and other laws.
Fair Value Measurements-The fair value of our financial assets and liabilities are disclosed in Note 12.
We determine the estimated fair value of financial assets and liabilities utilizing a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. The hierarchy for inputs used in measuring fair value is as follows:
Level 1 Inputs-Quoted prices in active markets for identical assets or liabilities
Level 2 Inputs-Observable inputs other than quoted prices in active markets for identical assets and liabilities
Level 3 Inputs-Unobservable inputs
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
We disclose the fair value of our debt. We determine the fair value of mortgage notes payable and junior subordinated notes by performing discounted cash flow analyses using an appropriate market discount rate. We calculate the market discount rate for our mortgage notes payable by obtaining period-end treasury rates for maturities that correspond to the maturities of our debt and then adding an appropriate credit spread. These credit spreads take into account factors such as our credit standing, the maturity of the debt, whether the debt is secured or unsecured, and the loan-to-value ratios of the debt. The carrying value of our secured borrowings-government guaranteed loans approximates fair value as they are based on current market interest rates.
We disclose the fair value of our loans receivable. We determine the fair value of loans receivable subject to credit risk by performing a present value analysis for the anticipated future cash flows taking into consideration the lack of credit risk using an anticipated prepayment rate.
The carrying amounts of our cash and cash equivalents, restricted cash, accounts receivable, unsecured credit facilities, accounts payable, and accrued expenses approximate their fair values due to their short-term maturities at December 31, 2014 and 2013.
Segment Information-Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes. We operate in four business segments: (i) the acquisition, redevelopment, ownership, and management of office real estate; (ii) multifamily real estate; (iii) hotels; and (iv) lending operations, which was added in connection with the Merger and is classified as held for sale at December 31, 2014. The products for our office segment primarily
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
include rental of office space and other tenant services, including tenant reimbursements, parking, and storage space rental. The products for our multifamily segment include rental of apartments and other tenant services. The products of our hotel segment include revenues generated from the operations of hotel properties, rental income generated from a garage located directly across the street from one of the hotels, and an investment in a note receivable secured by a hotel property, for the period from January 1, 2013 to October 8, 2013, and for the year ended December 31, 2012. The income from our lending segment, which includes income from the yield and other related fee income earned on our loans receivable, included in discontinued operations.
Recently Issued Accounting Pronouncements-In April 2014, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360). Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which amends the definition of a discontinued operation and requires entities to provide additional disclosures about disposal transactions that do not meet the discontinued-operations criteria. The revised guidance is effective prospectively to all disposals (or classifications as held for sale) that occur in annual periods (and interim periods therein) beginning on or after December 15, 2014, with early adoption permitted. Entities are prohibited from applying the new ASU to any component, equity method investment, or acquired business that is classified as held for sale before the adoption date. We early adopted this guidance during the second quarter of 2014, and the adoption did not have a material impact on our consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including the guidance on real estate de-recognition for most transactions. For public entities, the ASU is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early application is not permitted. Entities have the option of using either a full retrospective or a modified approach to adopt the guidance in the ASU. The modified approach provides entities relief from having to restate and present comparable prior-year financial statement information; however, entities will still need to evaluate existing contracts as of the date of initial adoption under the ASU to determine whether a cumulative adjustment is necessary. We are currently in the process of evaluating the impact of adoption of the new accounting guidance on our consolidated financial statements.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In August 2014, the FASB issued ASU No. 2014-15 Presentation of Financial Statements-Going Concern (Subtopic 205-40) which requires an entity's management to evaluate whether there are conditions or events, when considered in the aggregate, that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date the financial statements are issued. The ASU is effective for the annual reporting period ending after December 15, 2016, and for annual and interim periods thereafter. Early application is permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.
4. ACQUISITIONS
The fair value of real estate acquired is recorded to (1) the acquired tangible assets, consisting of land; land improvements; building and improvements; furniture, fixtures, and equipment; tenant improvements; and (2) identified intangible assets and liabilities, consisting of the value of above- and below-market leases and the value of in-place leases and tenant relationships, if any, based in each case on their respective fair values. Loan premiums, in the case of above-market rate loans, or loan discounts, in the case of below-market rate loans, are recorded based on the fair value of any loans assumed in connection with acquiring the real estate. Above-market ground leases are recorded based on the respective fair value of the ground leases.
We acquired an office property in 2005 for approximately $120,800,000, paying approximately $41,000,000 in cash and assuming two mortgage loans totaling $79,800,000. The $41,000,000 cash portion of the purchase price was paid by making (a) an approximately $1,000,000 equity investment in the existing property owner and (b) a loan to the existing property owner of approximately $40,000,000, which was converted to equity in 2012. We currently directly own 100% of the property. Prior to the conversion to equity in December 2012, the office property was included in our consolidated financial statements as a variable interest entity.
In October 2013, we foreclosed on the LAX Holiday Inn, a select service hotel, and acquired a 100% fee-simple interest. A subsidiary of CIM Commercial was the first-mortgage lender of the note secured by the hotel. Built in 1973, this hotel has 405 rooms and is located in the LAX submarket of Los Angeles, California.
Acquisitions, funded with proceeds from drawdowns on our unsecured credit facilities during 2014 consisted of the following:
(1)100% fee-simple interest in an office building built in 1984 and renovated in 2014, located in the Mid-Wilshire submarket of Los Angeles, California.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
4. ACQUISITIONS (Continued)
(2)100% fee-simple interest in a portfolio of creative office buildings located in the West Los Angeles submarket of Los Angeles, California. Two of the buildings were built in 1930 and the third was built in 1957. The buildings were renovated in 2010.
The income and expenses related to the first-mortgage on the LAX Holiday Inn acquired by CIM Commercial through foreclosure in October 2013 are included in the consolidated statements of operations and comprehensive income up until the date we took possession of the hotel. The results of the operations of the properties acquired have been included in the consolidated statements of operations and comprehensive income from the date of acquisition. There were no assets acquired or liabilities assumed during the year ended December 31, 2012. The fair value of the assets acquired and liabilities assumed for the above-noted acquisitions during the year ended December 31, 2014, and 2013, respectively, are as follows:
(1)The purchase price of the two acquisitions and the LAX Holiday Inn foreclosure completed during the years ended December 31, 2014 and 2013, respectively, were individually less than 5% and in aggregate less than 10% of our total assets as of December 31, 2014 and 2013, respectively.
(2)In-place leases have a weighted average amortization period of 5.1 years.
(3)Below-market leases have a weighted average amortization period of 5.0 years.
Acquisition related expenses of $491,000 associated with the acquisitions of real estate in 2014 were expensed as incurred during the year ended December 31, 2014. Foreclosure related expenses of $1,393,000 related to the LAX Holiday Inn foreclosure were expensed as incurred during the year ended December 31, 2013. Acquisition related costs of $632,000 associated with the conversion of the office property were expensed as incurred during the year ended December 31, 2012.
Abandoned project costs of $132,000 were expensed as incurred during the year ended December 31, 2014.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
5. INVESTMENTS IN REAL ESTATE
Investments in real estate consist of the following:
For the years ended December 31, 2014, 2013, and 2012 we recorded depreciation expense of $58,635,000, $58,013,000, and $59,149,000, respectively.
6. OTHER INTANGIBLE ASSETS
A schedule of our intangible assets and liabilities and related accumulated amortization and accretion as of December 31, 2014 and 2013, is as follows:
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
6. OTHER INTANGIBLE ASSETS (Continued)
The amortization of the above-market leases which decreased rental and other property income was $602,000, $888,000 and $1,003,000 for the years ended December 31, 2014, 2013 and 2012, respectively. The amortization of the below-market leases included in rental and other property income was $2,631,000, $3,058,000 and $3,814,000 for the years ended December 31, 2014, 2013 and 2012, respectively. The amortization of in-place leases included in depreciation and amortization expense was $2,368,000, $3,368,000 and $5,388,000 for the years ended December 31, 2014, 2013 and 2012, respectively. Included in depreciation and amortization expense is franchise affiliation fee amortization of $394,000 for each of the years ended December 31, 2014, 2013 and 2012, respectively. The amortization of advance bookings included in depreciation and amortization expense was $190,000, $61,000 and $0 for the years ended December 31, 2014, 2013 and 2012, respectively. Tax abatement amortization of $551,000 for each of the years ended December 31, 2014, 2013 and 2012, respectively, and the amortization of below-market ground lease obligation of $140,000 for each of the years ended December 31, 2014, 2013 and 2012, respectively, are included in rental and other property operating expenses.
A schedule of future amortization and accretion of acquisition related intangible assets and liabilities as of December 31, 2014, is as follows:
7. DISCONTINUED OPERATIONS
We have reflected the lending segment, which was acquired in March 2014 as disclosed in Note 2, as held for sale at December 31, 2014, based on a plan approved by the Board to sell the lending business that, when completed, will result in the deconsolidation of the lending segment. In connection with our plan, we have expensed transaction costs of $473,000 as incurred during the year ended December 31, 2014.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
7. DISCONTINUED OPERATIONS (Continued)
The following is a reconciliation of the carrying amounts of assets and liabilities that are classified as held for sale on the consolidated balance sheet as of December 31, 2014:
Loans receivable-net consist of the following:
Commercial mortgage loans-Represents loans to small businesses collateralized by first liens on the real estate of the related business.
SBA 7(a) loans, subject to secured borrowings-Represents the government guaranteed portion of loans which were sold with the proceeds received from the sale reflected as secured borrowings-government guaranteed loans. There is no credit risk associated with these loans since the SBA has guaranteed payment of the principal.
SBA 7(a) loans-Represents the non-government guaranteed retained portion of loans originated under the SBA 7(a) Program and the government guaranteed portion of loans that have not yet been fully funded or sold.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
7. DISCONTINUED OPERATIONS (Continued)
Debt consists of the following:
Secured borrowings-government guaranteed loans-Represents sold SBA 7(a) Program loans which are treated as secured borrowings since the loan sales did not meet the derecognition criteria provided for in ASC 860-30, Transfers and Servicing. To the extent secured borrowings include cash premiums, these premiums are included in secured borrowings and amortized as a reduction to interest expense over the life of the loan using the effective interest method and fully amortized when the loan is repaid in full.
Future principal payments on our debt (face value) at December 31, 2014 are as follows:
(1)Principal payments are generally dependent upon cash flows received from the underlying loans. Our estimate of their repayment is based on scheduled principal payments on the underlying loans. Our estimate will differ from actual amounts to the extent we experience prepayments and/or loan liquidations or charge-offs. No payment is due unless payments are received from the borrowers on the underlying loans.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
7. DISCONTINUED OPERATIONS (Continued)
The following is a reconciliation of the revenue and expenses classified as discontinued operations on the consolidated statement of operations and comprehensive income for the period ended December 31, 2014:
(1)For the period from the Acquisition Date, through December 31, 2014.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
8. DEBT
Information on our debt is as follows:
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
8. DEBT (Continued)
The mortgages payable are secured by deeds of trust on certain of the properties and assignments of rents.
The junior subordinated notes may be redeemed at par at our option.
In February 2012, CIM Urban entered into an unsecured revolving line of credit with a bank syndicate, which allowed for maximum borrowings of $100,000,000. Borrowings under the line of credit were limited by certain borrowing base calculations. Outstanding advances under the line of credit bore interest at (i) the base rate, as defined, plus 0.75% to 1.50% or (ii) LIBOR plus 1.75% to 2.50%, depending on the maximum consolidated leverage ratio, as defined, until August 2013. In August 2013, the unsecured revolving line was amended, and outstanding advances under the line bore interest at (i) the base rate, as defined, plus 0.25% to 0.85% or (ii) LIBOR plus 1.25% to 1.85%, depending on the maximum consolidated leverage ratio, as defined. The line of credit was also subject to an unused commitment fee of 0.25% or 0.35% depending on the amount of aggregate unused commitments. As of December 31, 2013, $100,000,000 was outstanding under the line of credit. This line of credit was terminated and repaid in full in September 2014.
In August 2013, CIM Urban entered into another unsecured revolving line of credit with a bank syndicate. The line of credit provided an additional $125,000,000 of borrowing capacity that was increased to $150,000,000. CIM Urban amended the line of credit in April 2014 to further increase the maximum aggregate borrowing capacity under the revolving credit facility to $200,000,000. Borrowings under the revolving line were limited by certain borrowing base calculations. Outstanding advances under the line bore interest at (i) the base rate, as defined, plus 0.25% to 0.85% or (ii) LIBOR plus 1.25% to 1.85%, depending on the maximum consolidated leverage ratio, as defined. The line of credit was also subject to an unused commitment fee of 0.25% or 0.35% depending on the amount of aggregate unused commitments. As of December 31, 2013, $64,000,000 was outstanding under the line of credit. This line of credit was terminated and repaid in full in September 2014.
In September 2014, CIM Commercial entered into an $850,000,000 unsecured credit facility with a bank syndicate consisting of a $450,000,000 revolver, a $325,000,000 term loan and a $75,000,000 delayed-draw term loan. The credit facility can be increased to $1,150,000,000, under certain conditions. CIM Commercial is subject to certain financial maintenance covenants and a minimum property ownership condition. Outstanding advances under the revolver bear interest at (i) the base rate, plus 0.20% to 1.00% or (ii) LIBOR plus 1.20% to 2.00%, depending on the maximum consolidated leverage ratio. Outstanding advances under the term loans bear interest at (i) the base rate, plus 0.15% to 0.95% or (ii) LIBOR plus 1.15% to 1.95%, depending on the maximum consolidated leverage ratio. The revolver is also subject to an unused commitment fee of 0.15% or 0.25% depending on the amount of aggregate unused commitments. The delayed draw term loan is also subject to an unused line fee of 0.25%. The credit facility matures in September 2016 and provides for two one-year extension options under certain conditions. As of December 31, 2014, $360,000,000 was outstanding under the credit facility and $490,000,000 was available for future borrowings. Proceeds from the unsecured credit facility were used for acquisitions, general corporate purposes and to repay $323,000,000 outstanding under our unsecured credit facilities. At December 31, 2014, the interest rate on our unsecured credit facility ranged from 1.31% to 1.37%.
At December 31, 2014 and 2013, CIM Commercial and CIM Urban, respectively, were in compliance with all of their respective financial covenants.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
8. DEBT (Continued)
At December 31, 2014 and 2013, accrued interest and unused commitment fees payable of $967,000 and $1,017,000, respectively, are included in accounts payable and accrued expenses.
Future principal payments on our debt (face value) at December 31, 2014 are as follows:
(1)Represents the junior subordinated notes, and unsecured credit facility.
9. STOCK-BASED COMPENSATION PLANS
On April 28, 2014, our stockholders approved the First Amendment to the PMC Commercial Trust 2005 Equity Incentive Plan (the "Plan Amendment") to increase the aggregate number of shares of Common Stock thereunder from 100,000 to 300,000 shares and increase the annual limitation on restricted Common Stock grants to all independent directors in the aggregate to 100,000 restricted shares of Common Stock and to each executive officer to no more than 4,000 restricted shares of Common Stock during any fiscal year. The plan terminates in June 2015. At December 31, 2014, we had options outstanding under stock-based compensation plans. The options were repriced as of the Acquisition Date.
Options-Option awards are granted with an exercise price equal to the market price of Common Stock at the date of grant and vest immediately upon grant with five-year contractual terms. A summary of the status of our stock options as of December 31, 2014 and the changes during the year ended are as follows:
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
9. STOCK-BASED COMPENSATION PLANS (Continued)
The market price of our Common Stock at December 31, 2014 is greater than certain of our stock option exercise prices (3,100 shares). The intrinsic value of these stock options outstanding and exercisable at December 31, 2014 was approximately $6,200.
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
The expected term of the options granted represents the period of time that the options are expected to be outstanding and was based on historical data. The risk-free rate was based on the three-year U.S. Treasury rate corresponding to the expected term of the options. We used historical information to determine our expected volatility and forfeiture rate. We recorded compensation expense of $8,000 during the year ended December 31, 2014, respectively, related to this option grant.
The following table summarizes information about stock options outstanding at December 31, 2014:
Effective January 31, 2015, all 17,050 outstanding options were forfeited in accordance with the plan.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
9. STOCK-BASED COMPENSATION PLANS (Continued)
Restricted Shares-A summary of our restricted shares as of December 31, 2014 and the changes during the year ended is as follows:
On March 11, 2014, we granted Common Stock awards of 2,000 restricted shares of Common Stock to each of the independent members of the Board of Directors (6,000 in aggregate) which awards were effective upon the receipt of stockholder approval of the Plan Amendment. The shares of Common Stock vest based on a year of continuous service. Compensation expense related to these restricted shares of Common Stock is being recognized over the vesting period. We recorded compensation expense of $95,000 for the year ended December 31, 2014 related to these restricted shares of Common Stock.
We issued an aggregate of 2,000 restricted shares of Common Stock to two of our executive officers on May 6, 2014. The restricted shares of Common Stock vest based on two years of continuous service with one-third of the shares of Common Stock vesting immediately upon issuance and one-third vesting at the end of each of the next two years. Compensation expense related to these restricted shares of Common Stock is being recognized over the vesting period. We recognized compensation expense of $29,000 for the year ended December 31, 2014 related to these restricted shares of Common Stock.
As of December 31, 2014, there was $48,000 of total unrecognized compensation expense related to shares of Common Stock which will be recognized over the next twelve months. The estimated fair value of restricted shares vested during 2014 was $15,000.
10. EARNINGS PER SHARE ("EPS")
The computations of basic EPS are based on our weighted average shares outstanding. The basic weighted average common shares outstanding was 97,173,000 for the year ended December 31, 2014. For the year ended December 31, 2014, the diluted weighted average common shares outstanding were increased by 3,000 shares to reflect the dilutive effect of stock options. Not included in the computation of diluted EPS were outstanding options to purchase 11,850 shares of Common Stock for the year ended December 31, 2014, because the options' exercise prices were greater than the average market price of the shares.
For purposes of calculating basic EPS for the years ended December 31, 2013 and 2012, approximately 65,000,000 shares of preferred stock issued in connection with the Merger were assumed to have been converted into 91,040,000 shares of Common Stock. As of the Acquisition Date, a subsidiary of CIM REIT had agreed to vote its 97.8% post-Merger ownership of CIM Commercial in
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
10. EARNINGS PER SHARE ("EPS") (Continued)
favor of an increase in the number of authorized CIM Commercial shares of Common Stock to one billion (200,000,000 after giving effect to the reverse stock split), thereby satisfying the condition for the automatic conversion of these shares. The actual conversion of the shares of preferred stock to shares of Common Stock occurred on April 29, 2014.
11. DIVIDENDS DECLARED
During the year ended December 31, 2014, CIM Urban paid a distribution of $16,100,000 prior to the Acquisition Date ($0.1685 per share of Common Stock, as converted).
On March 24, 2014, we declared a common share dividend of $0.05 per share of Common Stock and a preferred dividend of $0.0403 per share of preferred stock ($0.0285 per share of Common Stock, as converted) which were paid on March 28, 2014.
On April 28, 2014, we declared a dividend in the aggregate amount of $1,964,000 to the preferred stockholders ($0.0302 per share of preferred stock and $0.0215 per share of Common Stock, as converted) in connection with the conversion of shares of preferred stock to shares of Common Stock, which was paid on June 27, 2014.
On June 12, 2014, we declared a common share dividend of $0.21875 per share of Common Stock which was paid on June 27, 2014.
On September 12, 2014, we declared a common share dividend of $0.21875 per share of Common Stock which was paid on September 29, 2014.
On December 9, 2014, we declared a common share dividend of $0.21875 per share of Common Stock which was paid on December 29, 2014.
On March 6, 2015, we declared a common share dividend of $0.21875 per share of Common Stock, to be paid on March 27, 2015 to stockholders of record on March 20, 2015.
In addition, dividends of $59,286,000 ($27.975 per share of Common Stock) were paid to the PMC Commercial stockholders in connection with the Merger, which includes the $27.50 per share of Common Stock special dividend plus the $0.475 pro rata portion of PMC Commercial's regular quarterly cash dividend.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of those financial instruments which are not recorded at fair value on a recurring basis on our consolidated balance sheets were as follows:
Management's estimation of the fair value of our financial instruments is based on a Level 3 valuation in the fair value hierarchy established for disclosure of how a company values its financial instruments. In general, quoted market prices from active markets for the identical financial instrument (Level 1 inputs), if available, should be used to value a financial instrument. If quoted prices are not available for the identical financial instrument, then a determination should be made if Level 2 inputs are available. Level 2 inputs include quoted prices for similar financial instruments in active markets for identical or similar financial instruments in markets that are not active (i.e., markets in which there are few transactions for the financial instruments, the prices are not current, price quotations vary substantially, or in which little information is released publicly). There is limited reliable market information for our financial instruments and we utilize other methodologies for valuation purposes since there are no Level 1 or Level 2 determinations available. Accordingly, Level 3 inputs are used to measure fair value.
In general, estimates of fair value may differ from the carrying amounts of the financial assets and liabilities primarily as a result of the effects of discounting future cash flows. Considerable judgment is required to interpret market data and develop estimates of fair value. Accordingly, the estimates presented are made at a point in time and may not be indicative of the amounts we could realize in a current market exchange.
Loans receivable subject to credit risk-Represents the government guaranteed portion of loans which were sold with the proceeds received from the sale reflected as a liability associated with assets held for sale on our consolidated balance sheet. There is no credit risk associated with these loans since the SBA has guaranteed payment of the principal. In order to determine the estimated fair value of these loans, we use a present value technique for the anticipated future cash flows taking into consideration the lack of credit risk using a prepayment rate of 15%.
SBA 7(a) loans receivable, subject to secured borrowings-Represents the government guaranteed portion of loans which were sold with the proceeds received from the sale reflected as secured
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
12. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
borrowings-government guaranteed loans (a liability associated with assets held for sale on our consolidated balance sheet (Note 7)). There is no credit risk associated with these loans since the SBA has guaranteed payment of the principal. In order to determine the estimated fair value of our loans receivable, we use a present value technique for the anticipated future cash flows using certain assumptions including a discount rate based on current market interest rates taking into account the lack of credit risk and prepayment tendencies.
Secured borrowings-government guaranteed loans-The fair value of secured borrowings-government guaranteed loans approximates current market interest rates. Includes the unamortized deferred cash premiums collected on the sale of the government guaranteed portions of the related loans which are included in liabilities associated with assets held for sale.
Junior subordinated notes-The fair value of the junior subordinated notes is estimated based on current interest rates available for debt instruments with similar terms. Discounted cash flow analysis is generally used to estimate the fair value of our junior subordinated notes. The rate used was 3.83% at December 31, 2014.
Unsecured credit facilities-The carrying amount is a reasonable estimation of fair value as the interest rates on the unsecured credit facilities are variable and are at current market interest rates.
Mortgage notes payable-The fair values of mortgage notes are estimated based on current interest rates available for debt instruments with similar terms. The fair value of our mortgages payable is sensitive to fluctuations in interest rates. Discounted cash flow analysis is generally used to estimate the fair value of our mortgages payable, using rates ranging from 3.92% to 4.12% and 4.85% to 5.00% at December 31, 2014 and 2013, respectively.
13. RELATED-PARTY TRANSACTIONS
CIM Urban REIT Management, LP (the "Advisor"), an affiliate of CIM REIT, provides asset management services to CIM Urban. For these services, CIM Urban pays asset management fees to the Advisor on a quarterly basis in arrears. The fee is calculated as a percentage of the daily average gross fair value of our investments, as defined, as follows:
The Advisor earned asset management fees of $23,223,000, $21,767,000 and $20,924,000 for the years ended December 31, 2014, 2013 and 2012, respectively. At December 31, 2014 and 2013, asset management fees of $5,867,000 and $5,426,000, respectively, were due to the Advisor.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
13. RELATED-PARTY TRANSACTIONS (Continued)
CIM Management, Inc. and certain of its affiliates (collectively, the "CIM Management Entities"), all affiliates of CIM REIT, provide property management, leasing, and development services to CIM Urban. The CIM Management Entities earned property management fees, which are included in rental and other property operating expenses, totaling $5,284,000, $4,828,000 and $4,171,000 for the years ended December 31, 2014, 2013 and 2012, respectively. CIM Urban also reimbursed the CIM Management Entities $7,369,000, $5,082,000 and $2,726,000 during the years ended December 31, 2014, 2013 and 2012, respectively, for the cost of on-site personnel incurred on behalf of CIM Urban, which is included in rental and other property operating expenses. The CIM Management Entities earned leasing commissions of $1,904,000, $537,000 and $744,000 for the years ended December 31, 2014, 2013, and 2012, respectively, which were capitalized to deferred charges. In addition, the CIM Management Entities earned development management fees of $566,000, $834,000 and $973,000 for the years ended December 31, 2014, 2013 and 2012, respectively, which were capitalized to investments in real estate.
At December 31, 2014 and 2013, fees payable and expense reimbursements due to the CIM Management Entities of $2,518,000 and $1,445,000, respectively, are included in due to related parties. Also included in due to related parties as of December 31, 2014 and 2013, was $76,000 and $(64,000), respectively, due to (from) the CIM Management Entities and related parties.
On the Acquisition Date, pursuant to the terms of the Merger Agreement, CIM Commercial and its subsidiaries entered into the Master Services Agreement (the "Master Services Agreement") with CIM Service Provider, LLC (the "Manager") pursuant to which the Manager provides or arranges for other service providers to provide management and administration services to CIM Commercial and its subsidiaries following the Merger. Pursuant to the Master Services Agreement, CIM Commercial pays a base service fee (the "Base Service Fee") to the Manager equal to $1,000,000 per year (subject to an annual escalation by a specified inflation factor beginning on January 1, 2015), payable quarterly in arrears. The Base Service Fee began to accrue on the Acquisition Date and was pro-rated based on the number of days during the first quarter in which the Master Services Agreement was in effect. For the year ended December 31, 2014, the Manager earned a Base Service Fee of $806,000. In addition, pursuant to the terms of the Master Services Agreement, the Manager may receive compensation for performing certain services for CIM Commercial and its subsidiaries that are not covered under the Base Service Fee. During the year ended December 31, 2014, such services performed by the Manager included accounting, tax, reporting, internal audit, legal, compliance, risk management, IT, human resources and corporate communications. The Manager's compensation is based on the salaries and benefits of the employees of the Manager and/or its affiliates who performed these services (allocated based on the percentage of time spent on the affairs of CIM Commercial and its subsidiaries). For the year ended December 31, 2014, we expensed $1,193,000 for such services. At December 31, 2014, $725,000 was due to the Manager.
As of January 1, 2015, all of our employees moved to CIM SBA Staffing, LLC, an affiliate of CIM Group ("CIM SBA"), except for two of our executives, who became jointly employed by us and CIM SBA and their employment agreements with us continue in full force and effect. In connection with this, on January 1, 2015, we entered into a Staffing and Reimbursement Agreement with CIM SBA and our subsidiary, PMC Commercial Lending, LLC, which provides that CIM SBA will provide personnel and resources to us and that we will reimburse CIM SBA for the costs and expenses of providing such personnel and resources.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
14. COMMITMENTS AND CONTINGENCIES
Loan Commitments-Commitments to extend credit are agreements to lend to a customer provided the terms established in the contract are met. Our outstanding loan commitments and approvals to fund loans were $22,910,000 at December 31, 2014, the majority of which were for prime-based loans to be originated by our SBA 7(a) subsidiary, the government guaranteed portion of which is intended to be sold. Commitments generally have fixed expiration dates. Since some commitments are expected to expire without being drawn upon, total commitment amounts do not necessarily represent future cash requirements.
General-In connection with the ownership and operation of real estate properties, we have certain obligations for the payment of tenant improvement allowances and lease commissions in connection with new leases and renewals. The Company had a total of $19,721,000 in future obligations under leases to fund tenant improvements and other future construction obligations at December 31, 2014.
Employment Agreements-We have employment agreements with two of our executive officers. Under certain circumstances, as defined within the agreements, the agreements provide for (1) severance compensation or change in control payments to the executive officer in an amount equal to 2.99 times the average of the last three years annual compensation paid to the executive officer and (2) death and disability payments in an amount equal to two times and one time, respectively, the annual salary paid to the executive officer. In addition, to the extent the executive is employed by us on January 1, 2016 and such executive is not entitled to any disability, death or severance payments, the executive would receive restricted share awards as a retention bonus which would vest immediately upon grant. In aggregate, the executive officers would receive 105,000 share awards. We recorded compensation expense of $947,000 during the year ended December 31, 2014 related to these share awards. At December 31, 2014, there was $1,263,000 of total unrecognized compensation expense relating to these awards that will be recognized during 2015.
Litigation-REIT Redux, L.P. et al v. PMC Commercial Trust, et al. On October 9, 2013, a putative class action and derivative lawsuit was filed in the Dallas County Court at Law No. 5 in Dallas County, Texas against and purportedly on behalf of the PMC Commercial Trust shareholders. The plaintiffs alleged, among other things, that the PMC Commercial Trust board breached its fiduciary duties by approving and recommending the merger to the shareholders, failing to maximize value for the shareholders, engaging in bad faith and self-dealing by preferring transactions that further enriched the trust managers at the expense of the shareholders and conspiring to deprive the shareholders of their voting power and prerogatives. The complaint alleged that CIM REIT aided, abetted and induced those breaches of fiduciary duty.
PMC Commercial Trust and CIM REIT entered into various agreements with the plaintiffs to settle their claims, which agreements were effective as of January 28, 2014 and were approved by the court on April 4, 2014 (the "Settlement Agreement"). Under the terms of the Settlement Agreement, the Manager entered into a trading plan (the "Trading Plan") designed to comply with Rule 10b5-1 under the Securities Exchange Act of 1934 to provide for the purchase of up to 550,000 shares of CIM Commercial Common Stock at prices up to $25.00 per share. The Trading Plan commenced on March 12, 2014 and expired on August 10, 2014. Pursuant to the Trading Plan, the Manager acquired approximately 254,000 shares of Common Stock. Additionally, CIM Commercial agreed to be responsible for providing and administering notice of the class action settlement to the members of the
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
14. COMMITMENTS AND CONTINGENCIES (Continued)
settlement class and pay for all reasonable costs incurred in providing such notice. As a result of the settlement, CIM Commercial agreed to payment of attorney's fees and expenses of plaintiffs' counsel of $772,000. In addition, pursuant to the terms of the Settlement Agreement, the Manager purchased 100,000 shares of Common Stock owned by REIT Redux and its other "reporting persons" at a price of $25.00 per share in August 2014.
At December 31, 2014, we recorded a liability of $4,475,000 at one of our multifamily investments. Prior to our acquisition of the property, the former owners of the property enrolled the property in a property tax abatement program under Section 421-a of the New York Real Property Tax Law. At the time we acquired the property, the property was being used for corporate housing. This use continued from the time of acquisition and terminated in March 2015. The New York State Attorney General's office recently determined that the use of the property for corporate housing was inconsistent with the tax abatement program. In cooperation with the New York State Attorney General, we agreed to refund the tax abatements received during the period we owned the property while it was being used for corporate housing. This agreement does not affect the ability of the property to receive tax abatements in the future.
We are not currently involved in any other material pending or threatened legal proceeding nor, to our knowledge, is any material legal proceeding currently threatened against us, other than routine litigation arising in the ordinary course of business. In the normal course of business we are periodically party to certain legal actions and proceedings involving matters that are generally incidental to our business. While the outcome of these legal actions and proceedings cannot be predicted with certainty, in management's opinion, the resolution of these legal proceedings and actions will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
SBA Related-If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant technical deficiencies in the manner in which the loan was originated, funded or serviced under the SBA 7(a) Program, the SBA may seek recovery of the principal loss related to the deficiency from us. With respect to the guaranteed portion of SBA loans that have been sold, the SBA will first honor its guarantee and then seek compensation from us in the event that a loss is deemed to be attributable to technical deficiencies. Based on historical experience, we do not expect that this contingency is probable to be asserted. However, if asserted, it could have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Environmental Matters-In connection with the ownership and operation of real estate properties, we may be potentially liable for costs and damages related to environmental matters, including asbestos-containing materials. We have not been notified by any governmental authority of any noncompliance, liability, or other claim in connection with any of the properties, and we are not aware of any other environmental condition with respect to any of the properties that management believes will have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Rent Expense-The ground lease for a property provides for current annual rent of $437,000, payable quarterly, with increases on June 1, 2015, and every five years thereafter based on the greater of 15% or 50% of the increase in the Consumer Price Index during a five-year adjustment period. In addition, commencing on June 1, 2040 and June 1, 2065, the rent payable during the balance of the lease term shall be increased by an amount equal to 10% of the rent payable during the immediately
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
14. COMMITMENTS AND CONTINGENCIES (Continued)
preceding lease year. The lease term is through May 31, 2089. If the landlord decides to sell the leased property, we have the right of first refusal.
Rent expense under this lease, which includes straight line rent and amortization of acquired below-market ground lease, was $1,752,000 for the years ended December 31, 2014, 2013 and 2012, respectively. We record rent expense on a straight line basis. Straight line rent liability of $11,038,000 and $9,863,000 is included in other liabilities in the accompanying consolidated balance sheets as of December 31, 2014 and 2013, respectively.
We lease office space in Dallas, Texas under a lease which expires in May 2018. We recorded rent expense of $175,000, included in discontinued operations, for the year ended December 31, 2014.
Scheduled future noncancelable minimum lease payments at December 31, 2014 are as follows:
15. FUTURE MINIMUM LEASE RENTALS
Future minimum rental revenues under long-term operating leases at December 31, 2014, excluding tenant reimbursements of certain costs, are summarized as follows:
16. CONCENTRATIONS
Tenant Revenue Concentrations-Rental revenues from the U.S. General Services Administration and other government agencies (collectively, "Governmental Tenants"), which primarily occupy properties located in Washington, D.C., accounted for approximately 24.7%, 27.5% and 28.4% of our rental and other property income for the years ended December 31, 2014, 2013 and 2012, respectively. At December 31, 2014 and 2013, $7,168,000 and $5,596,000, respectively, was due from Governmental Tenants (see Note 15).
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
16. CONCENTRATIONS (Continued)
Geographical Concentrations of Investments in Real Estate-As of December 31, 2014, 2013 and 2012 we owned 21, 19 and 19 office properties, respectively, five multifamily properties, and three hotel properties (inclusive of one note receivable at December 31, 2012), located in four states and Washington, D.C.
Our revenues concentrations from properties for the years ended December 31, 2014, 2013 and 2012, is as follows:
Our real estate investments concentration from properties as of December 31, 2014 and 2013, are as follows:
17. INCOME TAXES
We have elected to be taxed as a REIT under the Code. To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we distribute at least 90% of our taxable income to our stockholders. As a REIT, we generally will not be subject to corporate level Federal income tax on net income that is currently distributed to stockholders.
We have wholly-owned TRS's which are subject to federal and state income taxes. The income generated from the TRS's is taxed at normal corporate rates. No current or deferred income tax provision was included in income from continuing operations.
The provision for income taxes results in effective tax rates that differ from federal and state statutory rates. A reconciliation of the provision for income tax attributable to the TRS's income from
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
17. INCOME TAXES (Continued)
continuing operations computed at federal statutory rates to the income tax provision reported in the financial statements is as follows:
The components of our net deferred tax asset were as follows:
The net operating loss carryforwards at December 31, 2014 were generated by TRS's and are available to offset future taxable income of these TRS's. The net operating loss carryforwards expire from 2027 to 2033. The decrease in the valuation allowance recorded in 2014 was $1,175,000.
The periods subject to examination for our federal and state income returns are 2009 through 2013. As of December 31, 2014, no reserves for uncertain tax positions have been established and we
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
17. INCOME TAXES (Continued)
do not anticipate any material changes in the amount of unrecognized tax benefits recorded to occur within the next 12 months.
18. SEGMENT DISCLOSURE
In accordance with ASC Topic 280, Segment Reporting, our reportable segments consist of three types of commercial real estate properties, namely, office properties, hotel properties (which included an investment in a note receivable secured by a hotel property during the period from January 1, 2013 to October 8, 2013, and for the year ended December 31, 2012) and multifamily properties, as well as a segment for our lending operations, which is held for sale as of December 31, 2014. Management internally evaluates the operating performance and financial results of the segments based on net operating income. We also have certain general and administrative level activities, including public company expenses, legal, accounting, and tax preparation that are not considered separate operating segments and are not allocated to the segments. The reportable segments are accounted for on the same basis of accounting as described in Note 3.
We evaluate the performance of our segments based on net operating income for our real estate segment, defined as: rental and other property income and tenant reimbursements less property and related expenses, and excludes nonproperty income and expenses, interest expense, depreciation and amortization, corporate related general and administrative expenses, and transaction costs.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
18. SEGMENT DISCLOSURE (Continued)
The net operating income of our reportable segments for the years ended December 31, 2014, 2013 and 2012, is as follows:
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
18. SEGMENT DISCLOSURE (Continued)
A reconciliation of segment net operating income to net income for the years ended December 31, 2014, 2013 and 2012, is as follows:
The condensed assets for each of the segments as of December 31, 2014 and 2013, along with capital expenditures and originations for the years ended December 31, 2014, 2013, and 2012 are as follows:
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
18. SEGMENT DISCLOSURE (Continued)
(1)Represents additions and improvements to real estate investments, excluding acquisitions.
CIM COMMERCIAL TRUST CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements as of December 31, 2014 and 2013
and for the Years Ended December 31, 2014, 2013 and 2012 (Continued)
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of quarterly financial information as of and for the years ended December 31, 2014 and 2013.
(1)The prior quarter results have been reclassified to conform to the current quarter presentation. Specifically, results related to properties sold or held for sale have been reclassified into discontinued operations.
Schedule III-Real Estate and Accumulated Depreciation
December 31, 2014
(in thousands)
The aggregate gross cost of property included above for federal income tax purposes approximates $2.1 billion as of December 31, 2014.
The following table reconciles the historical cost of total real estate held for investment from January 1, 2012 to December 31, 2014:
The following table reconciles the accumulated depreciation from January 1, 2012 to December 31, 2014:
Schedule IV-Mortgage Loans on Real Estate
December 31, 2014
(Dollars in thousands, except footnotes)
Conventional Loans-States 2% or greater(1):
(1)There are two loans which are secured by second liens on the properties which are subordinated to our first liens on the properties.
(2)Our loans have both variable and fixed rates of interest. The carrying amount of mortgages with a fixed rate of interest was $25,384,000. Certain loans at variable interest rates have interest rate floors which may be in effect.
(3)For Federal income tax purposes, the cost basis of our mortgage loans on real estate was approximately $131,266,000 (unaudited).
SBA 7(a) Loans-States 2% or greater(1):
(1)Includes approximately $224,000 of loans not secured by real estate. Also includes $242,000 of loans with subordinate lien positions.
(2)Interest rates are variable at spreads over the prime rate unless otherwise noted.
(3)Excludes general reserves of $113,000.
(4)Includes a loan with a face value of $48,000 and a fixed interest rate of 6.00%. Also includes a loan with a face value of $68,000 and a fixed interest rate of 6.00%.
(5)Includes a loan with a face value of $466,000 and a valuation reserve of $26,000. Also includes a loan with a face value of $334,000 and a fixed interest rate of 5.00%.
(6)Represents the government guaranteed portions of our SBA 7(a) loans detailed above. As there is no risk of loss to us related to these portions of the guaranteed loans, the geographic information is not presented as it is not meaningful.
(7)Represents the guaranteed portion of loans which were sold with the proceeds received from the sale reflected as secured borrowings.
(8)For Federal income tax purposes, the cost basis of our loans was approximately $39,445,000 (unaudited).
Schedule IV-Mortgage Loans on Real Estate
December 31, 2014
(Dollars in thousands)
(1)In connection with the Merger, we acquired loans receivable which were recorded at fair value.