ITEM 1.	FINANCIAL STATEMENTS
DIVIDEND CAPITAL DIVERSIFIED PROPERTY FUND INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and footnoted information)
(1)Includes approximately $76.9 million and $82.7 million, after accumulated depreciation and amortization, in consolidated real property variable interest entity investments as of December 31, 2015 and 2014, respectively.
(2)Includes approximately $50.1 million and $59.4 million in consolidated mortgage notes in variable interest entity investments as of December 31, 2015 and 2014, respectively.
(3)Includes 137,275,396 shares of Class E common stock, 1,703,109 shares of Class A common stock, 1,811,277 shares of Class W common stock, and 23,334,275 shares of Class I common stock issued and outstanding as of December 31, 2015, and 163,067,835 shares of Class E common stock, 1,187,215 shares of Class A common stock, 1,116,698 shares of Class W common stock, and 13,027,931 shares of Class I common stock issued and outstanding as of December 31, 2014.
The accompanying notes are an integral part of these consolidated financial statements.
DIVIDEND CAPITAL DIVERSIFIED PROPERTY FUND INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share and footnoted information)
(1)Includes approximately $7.1 million, $6.8 million and $4.7 million paid to our Advisor and its affiliates for reimbursable expenses during the years ended December 31, 2015, 2014, and 2013, respectively.
(2)Includes approximately $125,000 paid to our Advisor for advisory fees associated with the disposition of real properties during the year ended December 31, 2015.
(3)Includes approximately $4.8 million and $419,000 paid to our Advisor for advisory fees associated with the disposition of real properties during the years ended December 31, 2015 and 2014, respectively.
(4)Includes approximately $1.6 million and $2.6 million paid to our Advisor for fees associated with the disposition of real properties during the years ended December 31, 2014 and 2013, respectively.
The accompanying notes are an integral part of these consolidated financial statements.
DIVIDEND CAPITAL DIVERSIFIED PROPERTY FUND INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
DIVIDEND CAPITAL DIVERSIFIED PROPERTY FUND INC.
CONSOLIDATED STATEMENTS OF EQUITY
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
DIVIDEND CAPITAL DIVERSIFIED PROPERTY FUND INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
*Represents the amount of sales proceeds and debt repayments from the disposition of real property or the repayment of borrowings that we did not receive or pay in cash, primarily due to the repayment or assumption of related borrowings by the purchaser or borrower at closing.
The accompanying notes are an integral part of these consolidated financial statements.
DIVIDEND CAPITAL DIVERSIFIED PROPERTY FUND INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
1.ORGANIZATION
Dividend Capital Diversified Property Fund Inc. is a Maryland corporation formed on April 11, 2005 to invest in a diverse portfolio of real property and real estate related investments. As used herein, “the Company,” “we,” “our” and “us” refer to Dividend Capital Diversified Property Fund Inc. and its consolidated subsidiaries and partnerships except where the context otherwise requires.
We believe we have operated in such a manner as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes, and we utilize an Umbrella Partnership Real Estate Investment Trust (“UPREIT”) organizational structure to hold all or substantially all of our assets through our operating partnership, Dividend Capital Total Realty Operating Partnership, L.P. (our “Operating Partnership”). Furthermore, our Operating Partnership wholly owns a taxable REIT subsidiary, DCTRT Leasing Corp. (the “TRS”), through which we have executed certain business transactions that might otherwise have an adverse impact on our status as a REIT if such business transactions were to occur directly or indirectly through our Operating Partnership.
We are the sole general partner of our Operating Partnership. In addition, we have contributed 100% of the proceeds received from our offerings of common stock to our Operating Partnership in exchange for partnership units (“OP Units”) representing our interest as a limited partner of the Operating Partnership.
Dividend Capital Total Advisors LLC (our “Advisor”), a related party, manages our day-to-day activities under the terms and conditions of an advisory agreement (as amended from time to time, the “Advisory Agreement”). Our Advisor and its affiliates receive various forms of compensation, reimbursements and fees for services relating to the investment and management of our real estate assets.
On July 12, 2012, the Securities and Exchange Commission (the “Commission”) declared effective our Registration Statement on Form S-11 (Registration Number 333-175989) (as amended, the “Prior Registration Statement”). The Prior Registration Statement applied to the offer and sale (the “Prior Offering”) of up to $3,000,000,000 of our shares of common stock, of which $2,250,000,000 of shares were expected to be offered to the public in a primary offering and $750,000,000 of shares were expected to be offered to our stockholders pursuant to an amended and restated distribution reinvestment plan (subject to our right to reallocate such amounts). In the Prior Offering, we offered to the public three classes of shares: Class A shares, Class W shares and Class I shares with net asset value (“NAV”) based pricing. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” and Exhibit 99.1 of this Annual Report on Form 10-K for a description of our valuation procedures and valuation components, including important disclosure regarding real property valuations provided by Altus Group U.S., Inc., an independent valuation firm. Our independent registered public accounting firm does not audit our NAV. Selling commissions, dealer manager fees, and distribution fees are allocated to Class A shares, Class W shares, and Class I shares on a class-specific basis and differ for each class, even when the NAV of each class is the same. On September 15, 2015, we terminated the Prior Offering. Through September 15, 2015, the date our Prior Offering terminated, we had raised gross proceeds of approximately $183.0 million from the sale of approximately 25.8 million shares in the Prior Offering, including approximately $3.4 million through our distribution reinvestment plan.
On September 16, 2015, the Commission declared effective our Registration Statement on Form S-11 (Registration Number 333-197767) (the “Follow-On Registration Statement”). The Follow-On Registration Statement applies to the Company’s follow-on “best efforts” offering of up to $1,000,000,000 of the Company’s Class A, Class I and Class W shares of common stock, of which $750,000,000 of shares are expected to be offered to the public in a primary offering and $250,000,000 of shares are expected to be offered to stockholders of the Company pursuant to its distribution reinvestment plan (subject to the Company’s right to reallocate such amounts) (the “Follow-On Offering”). As of December 31, 2015, we had raised gross proceeds of approximately $13.7 million from the sale of approximately 1.8 million shares in the Follow-On Offering.
As of December 31, 2015, we had raised aggregate gross proceeds of approximately $196.7 million from the sale of approximately 27.6 million shares, including approximately $4.6 million raised through our distribution reinvestment plan. As of December 31, 2015, approximately $986.3 million in shares remained available for sale pursuant to the Follow-on Offering, including approximately $248.8 million in shares available for sale through our distribution reinvestment plan.
We are offering to sell any combination of Class A shares, Class W shares and Class I shares with a dollar value up to the maximum offering amount pursuant to the Follow-On Offering. We also sell shares of our unclassified common stock, which we refer to as “Class E” shares, pursuant to our distribution reinvestment plan offering registered on our Registration Statement on Form S-3 (Registration Number 333-162636). In the event of a liquidation event, such assets, or the proceeds therefrom, will be distributed ratably in proportion to the respective NAV for each class until the NAV for each class has been paid. Other than differing allocable fees and liquidation rights, Class E shares, Class A shares, Class W shares, and Class I shares have identical rights and privileges.
2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
Due to our control of our Operating Partnership through our sole general partnership interest and the limited rights of the limited partners, we consolidate our Operating Partnership, and limited partner interests not held by us are reflected as noncontrolling interests in the accompanying consolidated financial statements (herein referred to as “financial statements”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Our financial statements also include the accounts of our consolidated subsidiaries and joint ventures through which we are the primary beneficiary, when such subsidiaries and joint ventures are variable interest entities, or through which we have a controlling interest. In determining whether we have a controlling interest in a joint venture and the requirement to consolidate the accounts of that entity, we consider factors such as ownership interest, board representation, management representation, authority to make decisions, and contractual and substantive participating rights of the partners/members as well as whether the entity is a variable interest entity in which we have the power to direct the activities that most significantly impact the entity’s economic performance and the obligation to absorb losses that could potentially be significant to the entity or the right to receive benefits that could potentially be significant to the entity.
All joint ventures in which we have investments are variable interest entities. All of our investments in joint ventures represent our interests in real estate partnerships, formed for the purpose of acquiring, leasing, managing, holding for investment, selling and otherwise dealing with real property investments. Our involvement with our joint ventures affects our financial position, financial performance and cash flows in ways similar to direct ownership of real property investment. We own a significantly disproportionate majority of the ownership interests of our joint ventures. In each of our joint ventures, our joint venture partner performs the day-to-day management of the real properties owned by the respective joint ventures. However, in each of our joint ventures, we approve the activities that most significantly impact the joint venture’s economic performance. Due to our substantive approval rights and our exposure to the economic returns and losses of each of the joint ventures, we are the primary beneficiary of each of our joint ventures. Based on these considerations, we consolidate all of our investments in joint ventures. See our consolidated balance sheets for disclosure of the amount of real property and mortgage note borrowings that we consolidated through our investments in variable interest entities as of December 31, 2015 and 2014.
Judgments made by us with respect to our level of influence or control of an entity and whether we are the primary beneficiary of a variable interest entity involve consideration of various factors, including the form of our ownership interest, the size of our investment (including loans), our ability to direct the activities of the entity, and our obligation to absorb the losses of, or, our right to receive benefits from the entity. Our ability to correctly assess our influence or control over an entity affects the presentation of these investments in our financial statements and, consequently, our financial position and specific items in our results of operations that are used by our stockholders, lenders and others in their evaluation of us. The maximum risk of loss related to our investment in these consolidated variable interest entities is limited to our recorded investments in such entities. The creditors of the consolidated variable interest entities do not have recourse to our general credit.
Generally, we consolidate real estate partnerships and other entities that are not variable interest entities when we own, directly or indirectly, a majority voting interest in the entity.
Reclassifications
Certain amounts included in the accompanying financial statements for 2014 and 2013 have been reclassified to conform to the 2015 financial statement presentation with no effect on previously reported net income (loss) or equity. We reclassified certain third-party payments related to efforts to acquire real properties that were not ultimately completed (“terminated acquisition costs”) incurred during the years ended December 31, 2014 and 2013 from “general and administrative expenses” into “acquisition-related expenses”, none of which are material.
Balance sheet amounts for properties classified as held for sale have been reclassified as of December 31, 2014. Statements of income amounts for properties classified as discontinued operations have been reclassified for the years ended December 31, 2014 and 2013. After December 31, 2013, a discontinued operation is a component (or group of components) of the entity, the disposal of which would represent a strategic shift that has (or will have) a major effect on the entity’s operations and financial results, when such component (or group of components) have been disposed of or classified as held for sale. Through December 31, 2013, discontinued operations represent properties that we have either disposed of or have classified as held for sale if both the operations and cash flows of the property have been or will be eliminated from our ongoing operations as a result of the disposal transaction and if we will not have any significant continuing involvement in the operations of the property after the disposal transaction. Amounts in our segment and quarterly financial data disclosures in Notes 13 and 16 reflect the reclassification of amounts related to properties classified as discontinued operations as of December 31, 2014.
Investments
Real Property
Costs associated with the acquisition of real property, including acquisition fees paid to our Advisor, are expensed as incurred. In addition, we estimate the fair value of contingent consideration and contingencies related to acquisitions of real property in determining the total cost of the property acquired. Subsequent changes in the fair value of such contingent consideration are recorded either as a gain or loss in our consolidated statements of income. Contingencies are subsequently adjusted through the consolidated statements of income when new information becomes available indicating that settlement of a contingent liability is probable and can be estimated at an amount greater than the acquisition date fair value, or the contingency is resolved, in which case the contingent asset or liability is derecognized.
Costs associated with the development and improvement of our real property assets are capitalized as incurred. Costs incurred in making repairs and maintaining real estate assets are expensed as incurred. During the land development and construction periods, we capitalize interest costs, insurance, real estate taxes and certain general and administrative costs if such costs are incremental and identifiable to a specific activity to get the asset ready for its intended use. The results of operations for acquired real property are included in our accompanying statements of income from their respective acquisition dates.
Upon acquisition, the total cost of a property is allocated to land, building, building and land improvements, tenant improvements and intangible lease assets and liabilities. The purchase price allocation of the total cost to land, building, building improvements, tenant improvements, intangible lease assets and intangible lease liabilities is based on our estimate of the property’s as-if vacant fair value. The as-if vacant fair value is calculated by using all available information such as the replacement cost of such asset, appraisals, property condition reports, market data and other related information. The difference between the fair value and the face value of debt assumed in an acquisition is recorded as an adjustment to the purchase price allocation. The allocation of the total cost of a property to an intangible lease asset includes the value associated with the in-place leases, which may include lost rent, leasing commissions, tenant improvements, legal and other costs.
We record acquired “above-market” and “below-market” leases at their fair value equal to the difference between the contractual amounts to be paid pursuant to each in-place lease and our estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the remaining term of the lease plus the term of any below-market fixed-rate renewal option periods for below-market leases. In addition, we allocate a portion of the purchase price of an acquired property to the estimated value of customer relationships, if any. As of December 31, 2015, we had not recognized any estimated value to customer relationships.
The following table summarizes the amounts that we have incurred in amortization expense for intangible lease assets and adjustments to rental revenue for above-market lease assets and below-market lease liabilities for the years ended December 31, 2015, 2014 and 2013 (amounts in thousands).
We expense any unamortized intangible lease asset or record an adjustment to rental revenue for any unamortized above-market lease asset or below-market lease liability when a tenant terminates a lease before the stated lease expiration date. We recorded an insignificant amount of adjustments related to write-offs of unamortized intangible lease assets and liabilities due to early lease terminations during the years ended December 31, 2015, 2014 and 2013.
Real property assets, including land, building, building and land improvements, tenant improvements, lease commissions, and intangible lease assets and liabilities are stated at historical cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over their estimated useful lives as described in the following table.
Description
Depreciable Life
Land
Not depreciated
Building
40 years
Building and land improvements
5-40 years
Tenant improvements
Lesser of useful life or lease term
Lease commissions
Over lease term
Intangible in-place lease assets
Over lease term
Above-market lease assets
Over lease term
Below-market lease liabilities
Over lease term, including below-market fixed-rate renewal options
The following table presents expected amortization during the next five years and thereafter related to the acquired above-market lease assets, below-market lease liabilities and acquired in-place lease intangibles, for properties owned as of December 31, 2015 (amounts in thousands).
Discontinued Operations and Held for Sale
Beginning with the year ended December 31, 2014, a discontinued operation is defined as a component (or group of components) of the entity, the disposal of which would represent a strategic shift that has (or will have) a major effect on the entity’s operations and financial results, when such a component (or group of components) has been disposed of or classified as held for sale. Through December 31, 2013, we present the results of operations and the respective aggregate net gains (losses) of any property or group of properties that were disposed or classified as held for sale as of the end of each year when the operations and cash flows have been (or will be) eliminated from our ongoing operations and we will not have any significant continuing involvement. Interest expense is included in discontinued operations only if it is directly attributable to these operations or properties. The results of operations of properties that have been classified as discontinued operations are reported as discontinued operations for all periods presented. We classify real property as held for sale when our management commits to a plan to sell the property, the plan has appropriate approvals, the sale of the property is probable, and certain other criteria are met. At such time, the respective assets and liabilities are presented separately on our balance sheets and depreciation is no longer recognized. Assets held for sale are reported at the lower of their carrying amount or their estimated fair value less the costs to sell the assets. We recognize an impairment loss for assets held for sale if the current net book value of the property exceeds its fair value less selling costs. As of December 31, 2014 and 2013, one and 12 of our properties were classified as held for sale, respectively.
Debt Related Investments
Debt related investments are considered to be held for investment, as we have both the intent and ability to hold these investments until maturity. Accordingly, these assets are carried at cost, net of unamortized loan origination costs and fees, discounts, repayments and unfunded commitments unless such loans or investments are deemed to be impaired.
Revenue Recognition
Revenue Recognition - Real Property
We record rental revenue for the full term of each lease on a straight-line basis. Certain properties have leases that offer the tenant a period of time where no rent is due or where rent payments increase during the term of the lease. Accordingly, we record a receivable from tenants for rent that we expect to collect over the remaining lease term rather than currently, which is recorded as straight-line rents receivable. When we acquire a property, the term of existing leases is considered to commence as of the acquisition date for purposes of this calculation. Tenant recovery income includes payments from tenants for real estate taxes, insurance and other property operating expenses and is recognized as rental revenue.
The following table summarizes straight-line rental adjustments and tenant recovery income received from tenants for real estate taxes, insurance and other property operating expenses and recognized as rental revenue for the years ended December 31, 2015, 2014, and 2013 (amounts in thousands):
(1)Tenant recovery income excludes real estate taxes that were paid directly by our tenants that are subject to triple net lease contracts. Such payments totaled approximately $7.0 million, $12.4 million and $12.6 million during the years ended December 31, 2015, 2014, and 2013, respectively.
Impairment
Impairment - Real Property
We review our investments in real property individually on a quarterly basis, and more frequently when such an evaluation is warranted, to determine their appropriate classification, as well as whether there are indicators of impairment. The investments in real property are either classified as held and used or held for sale.
As of December 31, 2015, all of our properties were classified as held and used. The held and used assets are reviewed for indicators of impairment, which may include, among others, vacancy, each tenant’s inability to make rent payments, operating losses or negative operating trends at the property level, notification by a tenant that it will not renew its lease, a decision to dispose of a property, including a change in estimated holding periods, or adverse changes in the fair value of any of our properties. If indicators of impairment exist on a held and used asset, we compare the future estimated undiscounted cash flows from the expected use of the property to its net book value to determine if impairment exists. If the sum of the future estimated undiscounted cash flows is greater than the current net book value, we conclude no impairment exists. If the sum of the future estimated undiscounted cash flows is less than its current net book value, we recognize an impairment loss for the difference between the net book value of the property and its estimated fair value. If a property is classified as held for sale, we recognize an impairment loss if the current net book value of the property exceeds its fair value less selling costs. If our assumptions, projections or estimates regarding a property change in the future, we may have to record an impairment charge to reduce or further reduce the net book value of the property. See Note 3 for a discussion of impairment charges relating to our real properties recorded during the years ended December 31, 2015, 2014, and 2013.
Impairment - Debt Related Investments
We review our debt related investments on a quarterly basis, and more frequently when such an evaluation is warranted, to determine if impairment exists. Accordingly, we do not group our debt related investments into classes by credit quality indicator. A debt related investment is impaired when, based on current information and events (including economic, industry and geographical factors), it is probable that we will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the agreement. When an investment is deemed impaired, the impairment is measured based on the expected future cash flows discounted at the investment’s effective interest rate. As a practical expedient, the Financial Accounting Standards Board (the “FASB”) issued ASC Topic 310, Receivables, which permits a creditor to measure impairment based on the fair value of the collateral of an impaired collateral-dependent debt related investment or to measure impairment based on an observable market price for the impaired debt related investment as an alternative to discounting expected future cash flows. Regardless of the measurement method, a creditor should measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. A debt related investment is also considered impaired if its terms are modified in a troubled debt restructuring (“TDR”). A TDR occurs when we grant a concession to a borrower in financial difficulty by modifying the original terms of the loan. Impairments on TDR loans are generally measured based on the present value of expected future cash flows discounted at the effective interest rate of the original loan. See Note 4 for a discussion of impairment charges relating to our debt related investments recorded during the years ended December 31, 2015, 2014, and 2013.
Derivative Instruments and Hedging Activities
We record all derivative instruments in the accompanying balance sheets at fair value. Accounting for changes in the fair value of a derivative instrument depends on the intended use of the derivative instrument and the designation of the derivative instrument. Derivative instruments used to hedge exposure to changes in the fair value of an asset, liability, or firm commitments attributable to a particular risk, such as interest rate risk, are considered “fair value” hedges. Derivative instruments used to hedge exposure to variability in expected future cash flows, such as future interest payments, or other types of forecasted transactions, are considered “cash flow” hedges. We do not have any fair value hedges.
For derivative instruments designated as cash flow hedges, the changes in the fair value of the derivative instrument that represent changes in expected future cash flows, which are effectively hedged by the derivative instrument, are initially reported as other comprehensive income (loss) in the statement of equity until the derivative instrument is settled. Upon settlement, the effective portion of the hedge is recognized as other comprehensive income (loss) and amortized over the term of the designated cash flow or transaction the derivative instrument was intended to hedge. The change in value of any derivative instrument that is deemed to be ineffective is charged directly to earnings when the determination of hedge ineffectiveness is made. We assess the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For purposes of determining hedge ineffectiveness, management estimates the timing and potential amount of future fixed-rate debt issuances each quarter in order to estimate the cash flows of the designated hedged item or transaction. Management considers the likelihood of the timing and amount of entering into such forecasted transactions when determining the expected future fixed-rate debt issuances. We do not use derivative instruments for trading or speculative purposes. We classify cash paid to settle our forward starting swaps as financing activities in our statements of cash flows.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and highly liquid investments with original maturities of three months or less such as money market mutual funds or certificates of deposits. As of both December 31, 2015 and 2014, we have not realized any losses in such cash accounts or investments and believe that we are not exposed to any significant credit risk.
Restricted Cash
Restricted cash consists primarily of lender and property-related escrow accounts. As of both December 31, 2015 and 2014, we had not realized any losses in such restricted cash accounts or investments related to, and believe that we are not exposed to, any significant credit risk.
Collectability of Receivables
We evaluate the collectability of our rent and other receivables on a regular basis based on factors including, among others, payment history, the financial strength of the tenant or borrower and any guarantors. Specifically with regards to our debt related investments, we evaluate the collectability of our receivables based on factors including, among others, the value of the underlying collateral, the operations and operating trends of the underlying collateral, if any, the asset type and current economic conditions. If our evaluation of these factors indicates we may not recover the full amount of the receivable, we provide a reserve against the portion of the receivable that we estimate may not be recovered. This analysis requires us to determine whether there are factors indicating a receivable may not be fully collectible and to estimate the amount of the receivable that may not be collected. As of December 31, 2015 and 2014, we had rent and other receivables of approximately $34.1 million and $48.3 million included in the caption other assets in our accompanying balance sheets, respectively, related to which we recorded allowances of approximately $628,000 and $261,000 included in the caption other assets, respectively. If our assumptions or estimates regarding the collectability of a receivable change in the future, we may have to record allowances to reduce or further reduce the carrying value of the receivable.
Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss as reported in the accompanying statements of equity primarily consists of the cumulative loss related to our derivatives of $9.1 million, before attribution to noncontrolling interests of $877,000, and cumulative gain related to our real estate securities of approximately $200,000, before attribution of a cumulative loss to noncontrolling interests of $1.2 million.
Basic and Diluted Net Income (Loss) per Common Share
Basic net income (loss) per common share is determined by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share includes the effects of potentially issuable common stock, but only if dilutive, including the presumed exchange of OP Units.
Stock-Based Compensation
Independent Director RSU Awards
On December 5, 2013, our board of directors approved revised compensation for our independent directors. In connection with the revised compensation plan, at each annual meeting of stockholders the independent directors will automatically, upon election, receive an award of restricted stock units (“RSUs”) with respect to Class I shares of our common stock, with the number of RSUs based on the NAV per Class I share as of the end of the day of the annual meeting. RSUs granted under this plan are measured at fair value on the grant date and amortized to compensation expense on a straight-line basis over the service period after which the awards fully vest. Such expense is included in “general and administrative expenses” in our Consolidated Statements of Income. The fair value of these awards is measured at our NAV per share. RSUs awarded to our independent directors vest no later than one year from the date of grant.
Advisor RSU Agreements
We have entered into Restricted Stock Unit Agreements (the “Advisor RSU Agreements”) with our Advisor. The purposes of the Advisor RSU Agreements are to promote an alignment of interests among our stockholders, our Advisor and the personnel of our Advisor and its affiliates, and to promote retention of the personnel of our Advisor and its affiliates. Each restricted stock unit granted pursuant to the Advisor RSU Agreements (the “Company RSU”) will, upon vesting, entitle our Advisor to one Class I share of our common stock. The Advisor is expected to redistribute a significant portion of the Company RSUs and/or shares to senior level employees of our Advisor and its affiliates that provide services to us, although the terms of such redistributions (including the timing, amount and recipients) remain solely in the discretion of our Advisor. The Company RSUs are subject to specified vesting and settlement provisions and, upon settlement in Class I shares of Company common stock, require offsets of advisory fees and expenses otherwise payable from the Company to our Advisor. Each offset amount equals the number of Company RSUs vesting on such date multiplied by the NAV per Class I share publicly disclosed by us as of the end of the grant date. Each offset amount is always calculated based on the grant date NAV per Class I share, even beyond the initial vesting date. At the end of each 12-month period following each vesting date, if the offset amount has not been fully realized by offsets from the cash payments otherwise due and payable to our Advisor under the Advisory Agreement, our Advisor shall promptly pay any shortfall to us.
If our board of directors declares and we pay a cash dividend on Class I shares for any period in which the Company RSUs are outstanding (regardless of whether such Company RSUs are then vested), our Advisor will be entitled to dividend equivalents (“Dividend Equivalents”) with respect to that cash dividend equal to the cash dividends that would have been payable on the same number of Class I shares as the number of Company RSUs subject to the Advisor RSU Agreements had such Class I shares been outstanding during the same portion of such period as the Company RSUs were outstanding. Any such Dividend Equivalents may be paid in cash or Class I shares, at our Advisor’s election. Accordingly, we classify Company RSUs as participating securities because participants receive dividends on unvested shares. We recognize all Company RSUs as outstanding common shares as of the grant date and record unvested dividends as dividends.
Restricted Stock Grants
Effective February 25, 2015 and March 4, 2014, we granted 49,263 and 44,793 restricted shares of Class I common stock, respectively, to certain employees of our Advisor and its affiliates, none of which are our named executive officers. Restricted stock grants are measured at fair value during the service period and recorded to compensation expense over the service period after which the grants fully vest. Such expense is included in “general and administrative expenses” in our Consolidated Statements of Income. The fair value of these awards is measured at our NAV per share as of the date the shares vest. During the years ended December 31, 2015 and 2014, we recorded approximately $188,000 and $125,000 within “general and administrative expenses” in our Consolidated Statements of Income, respectively. Our restricted stock generally vests ratably over a period of three to four years.
Dealer Manager and Distribution Fees
Dividend Capital Securities LLC, which we refer to as our “Dealer Manager,” distributes the shares of our common stock in our public offering on a “best efforts” basis. Our Dealer Manager coordinates our distribution effort and manages our relationships with participating broker-dealers and financial advisors and provides assistance in connection with compliance matters relating to marketing our public offering. Among other fees, we pay our Dealer Manager (i) a dealer manager fee which accrues daily in an amount equal to 1/365th of 0.6% of our NAV per share of Class A and Class W shares outstanding and an amount equal to 1/365th of 0.1% of our NAV per share of Class I shares outstanding on such day on a continuous basis, and (ii) a distribution fee which accrues daily in an amount equal to 1/365th of 0.5% of our NAV per share of Class A shares outstanding on such day on a continuous basis. We cease paying the dealer manager fee and distribution fee with respect to shares sold in the offering on the earlier to occur of the following: (i) a listing of the class of such shares on a national securities exchange, (ii) following the completion of an offering, total underwriting compensation in the offering equaling 10% of the gross proceeds from the primary portion of the respective offering, or (iii) such shares no longer being outstanding.
We account for these dealer manager and distribution fees as a reduction in proceeds received from the sale of common stock. We recognize our obligation to pay such fees on a periodic basis, along with a corresponding reduction against the proceeds raised, as such fees become payable to our dealer manager pursuant to the terms of the dealer manager agreement. We record the net proceeds raised from the sale of common stock as equity as we sells such shares. However, we record the corresponding reduction to capital as dealer manager and distribution fees become contractually due to our Dealer Manager pursuant to the terms of the dealer manager agreement. The payment of dealer manager and distribution fees may extend several years after the sale of the related shares of common stock. See Note 11 for further discussion of dealer manager and distribution fees.
Use of Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions relating to 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 periods. Actual results could differ materially from those estimates. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the periods they are determined to be necessary.
New Accounting Pronouncements
In January 2016, the FASB issued Accounting Standards Update 2016-01, which changes the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The FASB also clarifies the guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The guidance will be effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2017. The guidance should be applied prospectively. Earlier application is permitted regarding the guidance on the presentation of the change in fair value of financial liabilities under the fair value option for financial statements that have not been issued. We do not anticipate the adoption will have a significant impact on our consolidated financial statements.
In September 2015, the FASB issued Accounting Standards Update 2015-16, which simplifies the accounting for adjustments made to provisional amounts recognized in a business combination. The guidance eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, the guidance requires that an acquirer recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. The guidance will be effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2015. The guidance should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. We do not anticipate the adoption will have a significant impact on our consolidated financial statements.
In August 2015 and April 2015, the FASB issued Accounting Standards Update 2015-15 (“ASU 2015-15”) and Accounting Standards Update 2015-03 (“ASU 2015-03”), respectively, which simplify the presentation of debt issuance costs and clarify the guidance for presenting and measuring debt issuance costs related to line-of-credit arrangements. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-15 permits an entity to defer and present debt issuance costs as an asset and subsequently amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The recognition and measurement guidance for debt issuance costs is not affected by the guidance. Both ASU 2015-03 and ASU 2015-15 are effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2015 and will require retrospective application. Early adoption is permitted for financial statements that have not been previously issued. We do not anticipate the adoption will have a significant impact on our consolidated financial statements.
In June 2015, the FASB issued Accounting Standards Update 2015-10 (“ASU 2015-10”), which (i) made technical corrections and improvements to ASC Topic 815, Derivatives and Hedging (“ASC Topic 815”), which became effective upon the issuance of ASU 2015-10, and (ii) made technical corrections and improvements to ASC Topic 820, Fair Value Measurement and Disclosures (“ASC Topic 820”), which is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2015, with early adoption permitted, including adoption in an interim period. We do not anticipate the adoption will have a significant impact on our consolidated financial statements.
In February 2015, the FASB issued Accounting Standards Update 2015-02 (“ASU 2015-02”), Amendments to the Consolidation Analysis, which improves targeted areas of the consolidation guidance and reduces the number of consolidation models. The amendments in ASU 2015-02 are effective for annual and interim periods in fiscal years beginning after December 15, 2015, with early adoption permitted. We are currently evaluating the effect the guidance will have on our consolidated financial statements.
In May 2014, the FASB issued Accounting Standards Update 2014-09 (“ASU 2014-09”), which provides new guidance outlining a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers that supersedes most current revenue recognition guidance. This guidance requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, this guidance expands related disclosure requirements. The new guidance specifically excludes revenue associated with lease contracts. In June 2015, the FASB agreed to defer the effective date of this guidance for a year from the original effective date outlined in ASU 2014-09, and as a result, the guidance will be effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2017 and will require full or modified retrospective application. Early adoption is permitted for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. We do not anticipate the adoption will have a significant impact on our consolidated financial statements.
3.INVESTMENTS IN REAL PROPERTY
Currently, our consolidated investments in real property consist of investments in office, industrial and retail properties. The following tables summarize our consolidated investments in real property as of December 31, 2015 and 2014 (amounts in thousands):
(1)Includes $4.1 million in land, $19.3 million in building and improvements, and $7.0 million in intangible lease assets before accumulated depreciation of $10.2 million, related to an office property classified as held for sale in the accompanying balance sheet as of December 31, 2014.
Acquisitions
The following table summarizes our acquisitions of real properties during the year ended December 31, 2015 (dollar amounts and square footage in thousands):
(1)Our Greater Boston market comprises the greater metro area around Boston, MA. As of December 31, 2015, properties in our Greater Boston market are located in the following states: Massachusetts, Connecticut, New Hampshire, and Rhode Island.
The following table summarizes the allocations of the fair value of the real properties we acquired during the year ended December 31, 2015 to land, building and improvements, intangible lease assets, intangible lease liabilities, and mark-to-market adjustment on assumed debt (dollar amounts in thousands). We have not made any material adjustments related to these allocations.
Pro Forma Financial Information (Unaudited)
The table below includes the following for the years ended December 31, 2015 and 2014: (i) actual selected financial information for the 2015 acquisitions included in our consolidated statements of income; and (ii) pro forma selected financial information reflecting the 2015 acquisitions, as if the date of each acquisition had been January 1, 2014. The pro forma financial information is not intended to represent or be indicative of the Company’s consolidated financial results that would have been reported had the acquisitions been completed at the beginning of the comparable prior period presented and should not be taken as indicative of its future consolidated financial results (dollar amounts in thousands).
(1)For a discussion as to why we view NOI to be an appropriate supplemental performance measure and a reconciliation to GAAP net income, refer to Note 13.
(2)The pro forma total revenues were adjusted to include incremental revenue of approximately $35.4 million and $33.5 million in relation to the 2015 acquisitions for the years ended December 31, 2015 and 2014, respectively.
(3)Acquisition-related expenses of approximately $2.4 million in relation to our 2015 acquisitions were excluded from the pro forma net income for the year ended December 31, 2015 and included in the pro forma net income for the year ended December 31, 2014, as if these expenses had been incurred as of January 1, 2014.
Dispositions
On March 11, 2015, we completed the sale of a portfolio of 12 wholly owned office and industrial properties comprising approximately 2.7 million net rentable square feet (the “Portfolio”) to an unrelated third party, for a gross sales price of approximately $398.6 million. We incurred closing costs and fees of approximately $7.8 million upon the closing of this transaction, including approximately $4.0 million in advisory fees related to the disposition of real property paid to our Advisor. See Note 5 for information regarding financing related to the disposition of the Portfolio.
For the years ended December 31, 2015, 2014, and 2013, our consolidated statements of income include approximately $6.2 million, $33.7 million, and $34.2 million of aggregate revenue attributable to the Portfolio, respectively, and approximately $6.1 million, $33.1 million and $33.4 million of NOI attributable to the Portfolio, respectively.
During 2015, 2014, and 2013 we disposed of the following properties (dollar amounts and square footage in thousands):
(1)The Portfolio includes (i) six office properties comprising 1.1 million net rentable square feet located in the following markets: Los Angeles, CA (three properties, of which one disposed property was a single building from a two-building office property), Northern New Jersey, Miami, FL, and Dallas, TX, and (ii) six industrial properties comprising 1.6 million net rentable square feet located in the following markets: Los Angeles, CA, Dallas, TX, Cleveland, OH, Chicago, IL, Houston, TX, and Denver, CO.
(2)On October 15, 2014, we disposed of a wholly owned industrial property comprising approximately 177,000 net rentable square feet in three buildings located in the Silicon Valley, CA market (“Lundy”). At the time of the disposition, the property had a net investment amount of approximately $13.1 million (after a $2.6 million impairment charge which we recorded during the fourth quarter of 2013). The property was transferred to the lender through a foreclosure sale which extinguished amounts due, including related principal of $13.6 million.
(3)Industrial portfolio included 12 properties located in the following markets: Atlanta, GA, Central Pennsylvania, Cincinnati, OH, Columbus, OH, Dallas, TX, Indianapolis, IN, and Minneapolis/St. Paul, MN.
(4)During the year ended December 31, 2012, we became the 100% owner of the titleholder of a 1.5 million square foot office property in the Dallas, TX market (“Comerica Bank Tower”), as the result of our foreclosure of a non-performing mezzanine loan for which such ownership interest had served as collateral. Comerica Bank Tower was subject to a mortgage note with a principal balance of $179.8 million as of the acquisition date bearing interest at 5.8%, which would have matured in January 2017. On September 10, 2012, we were notified that a receiver (the “Receiver”) had been appointed for the Comerica Bank Tower. As of March 31, 2013, the unpaid principal balance of this mortgage note was $177.4 million. On May 31, 2013, Comerica Bank Tower was sold by the Receiver pursuant to court order to a purchaser unaffiliated with us. Because of the outstanding principal balance of the mortgage note, we did not receive any proceeds from the sale of Comerica Bank Tower.
(5)Industrial portfolio included seven properties located in the following markets: Philadelphia, PA, Sacramento, CA, Central Pennsylvania, Charlotte, NC, Atlanta, GA, and Chicago, IL.
Assets Held for Sale
We did not have any assets or related liabilities classified as held for sale as of December 31, 2015. As of December 31, 2014, we had agreed to dispose of a wholly owned office property comprising approximately 177,000 net rentable square feet in the Dallas, TX market to an unrelated third party. Accordingly, the assets and liabilities related to this property are classified as held for sale in the accompanying balance sheet as of December 31, 2014. We sold the property on January 16, 2015. The following table summarizes the carrying amounts of the major classes of assets and liabilities classified as held for sale as of December 31, 2014 (amounts in thousands):
Discontinued Operations
We present the results of operations and the respective aggregate net gains (losses) of any property or group of properties that were disposed or classified as held for sale as of December 31, 2013, when the operations and cash flows have been (or will be) eliminated from our ongoing operations and we will not have any significant continuing involvement as discontinued operations in our accompanying statements of income. Beginning with the year ended December 31, 2014, as the result of adopting Accounting Standards Update 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, issued by the FASB in April 2014, we present the results of operations and the respective aggregate net gains (losses) of any property or group of properties, the disposal of which would represent a strategic shift that has (or will have) a major effect on our operations and financial results, when such property (or group of properties) have been disposed of or classified as held for sale, as discontinued operations in our accompanying statements of income. Properties sold or classified as held for sale after December 31, 2013 are not classified as discontinued operations unless the sale or classification as held for sale meets the new accounting requirements.
We did not have any discontinued operations for the year ended December 31, 2015. Discontinued operations for the year ended December 31, 2014 include the results of operations and net gain on the disposition of 12 properties classified as held for sale as of December 31, 2013. Discontinued operations for the year ended December 31, 2013 include (i) the results of operations of the 13 properties disposed of during the year ended December 31, 2013, (ii) the results of operations of the 12 properties classified as held for sale as of December 31, 2013 and subsequently disposed of, and (iii) the aggregate net gain on dispositions recorded during the year ended December 31, 2013. The following table summarizes amounts recorded as discontinued operations for the years ended December 31, 2014 and 2013 (amounts in thousands):
Real Property Impairment
During the year ended December 31, 2015, we recorded a $6.5 million impairment charge related to a consolidated office property located in the Chicago, IL market, which we acquired in February 2007 and we hold through a joint venture in which we are not the managing partner. We have an 80% ownership interest in the office property. During the year ended December, 31, 2015, we began to consider possible disposition opportunities for this property. Such disposition opportunities caused us to significantly reduce our estimated holding period for this property. We recorded an impairment charge to reduce the net book value of the property to our estimate of its fair value. In addition, during the year ended December 31, 2015, we recorded approximately $1.6 million of impairment charges related to a wholly owned retail property that we acquired in May 2007 in the Pittsburgh, PA market, which was disposed of in May 2015 (“Mt. Nebo”). Mt. Nebo served as collateral for a cross-collateralized senior mortgage note that is also secured by two other retail properties. Prior to the disposition, the net book value of Mt. Nebo exceeded the contract sales price less the cost to sell by approximately $1.6 million. Accordingly, we recorded an impairment to reduce the net book value of the property to our estimate of its fair value less the cost to sell.
During the year ended December 31, 2014, we recorded a $9.5 million impairment related to Mt. Nebo. During the year ended December 31, 2014, we began to consider possible disposition opportunities for this property. Such disposition opportunities caused us to significantly reduce our estimated holding period for this property. As a result of our review and based on our estimate of future cash flow and fair value of the retail property, we recognized the impairment charge to adjust the carrying value to our estimate of fair value as of December 31, 2014.
During the year ended December 31, 2013, we recorded approximately a $2.6 million impairment charge related to a wholly-owned industrial property that we acquired in September 2006 in the Silicon Valley, CA market, which was disposed of in October 2014. During the year ended December 31, 2013, we determined that this industrial property was unlikely to generate cash flows during our estimated investment period sufficient to recover our net book basis as of December 31, 2013. The primary factor leading to this determination was our determination that the market rental rate we could obtain, and the low demand for industrial space in the particular sub market in which the building was located, did not support our recorded carrying value. As a result of our review and based on our estimate of future cash flow and fair value of the office property, we recognized the impairment charge to adjust the carrying value to our estimate of fair value as of December 31, 2013.
In the calculation of our daily NAV, our real estate assets are carried at fair value using valuation methodologies consistent with ASC Topic 820. As a result, the timing of valuation changes recorded in our NAV will not necessarily be the same as for impairment charges recorded to our consolidated financial statements prepared pursuant to GAAP. Since we determine our NAV daily, impairment charges pursuant to GAAP will likely always be delayed and potentially significantly delayed compared to the change in fair value of our properties included in the calculation of our daily NAV.
Future Minimum Rentals
Future minimum rentals to be received under non-cancelable operating and ground leases in effect as of December 31, 2015, are as follows (amounts in thousands):
The table above does not reflect future rental revenues from the potential renewal or replacement of existing and future leases and excludes property operating expense reimbursements and assumes no early termination of leases.
Concentration of Credit Risk
Concentration of credit risk with respect to our sources of revenue currently exists due to a number of tenants whose rental payments to us make up a relatively high percentage of our rental revenue. Rental revenue from our lease with Charles Schwab & Co., Inc., as master tenant of one of our office properties, represented approximately $25.9 million, or 11.5%, of our total revenue from continuing operations for the year ended December 31, 2015. The following is a summary of amounts related to the top five tenants based on annualized base rent, as of December 31, 2015 (dollar amounts and square feet in thousands):
(1)Annualized base rent represents the annualized monthly base rent of executed leases as of December 31, 2015.
(2)Northrop Grumman exercised a purchase option to acquire the office property that they leased from us on February 18, 2016. As a result, Northrop Grumman is no longer our tenant. Prior to acquiring this property from us, Northrop Grumman’s lease would have expired in 2016. For a more detailed discussion of the purchase option and the related property disposition, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Subsequent Events” of this Annual Report on Form 10-K.
Our properties in Massachusetts, New Jersey, California, and Texas accounted for approximately 18%, 18%, 13%, and 11%, respectively, of our total gross investment in real property portfolio as of December 31, 2015. A deterioration of general economic or other relevant conditions, changes in governmental laws and regulations, acts of nature, demographics or other factors in any of those states or the geographical region in which they are located could result in the loss of a tenant, a decrease in the demand for our properties and a decrease in our revenues from those markets, which in turn may have a disproportionate and material adverse effect on our results of operations and financial condition.
Third Party Purchase Options
“Harborside,” an office property located in Northern New Jersey, was subject to a purchase option held by a third party with an exercise price that we estimated to be approximately $239.4 million and an exercise date in May 2016. On August 5, 2015, we paid the option holder approximately $12.0 million to terminate the option. Such payment is included within capital expenditures in real property in the accompanying consolidated statements of cash flows. As a result, the option is no longer outstanding.
“Colshire,” an office property located in the Washington, DC area, was subject to a purchase option held by the tenant, Northrop Grumman, with an exercise price that we estimated to be approximately $158.4 million and an expiration date in March 2016. The tenant exercised the purchase option during January 2016, triggering a sale of the property to Northrop Grumman in February 2016. See “Item 1A.