Item 1. Business.
Overview
VEREIT is a full-service real estate operating company which owns and manages one of the largest portfolios of single-tenant commercial properties in the U.S. The Company has 4,091 retail, restaurant, office and industrial operating properties with an aggregate of 94.4 million square feet, of which 98.8% was leased as of December 31, 2017, with a weighted-average remaining lease term of 9.5 years. VEREIT’s business model provides equity capital to creditworthy corporations in return for long-term leases on their properties.
Substantially all of our real estate operations are conducted through the Operating Partnership. VEREIT, Inc. is the sole general partner and holder of 97.6% of the common partnership interests in the Operating Partnership (the “OP Units”) as of December 31, 2017 with the remaining 2.4% of the OP Units owned by certain non-affiliated investors and certain former directors, officers and employees of the Former Manager (defined below).
Prior to the fourth quarter of 2017, the Company operated through two business segments, the real estate investment segment and the investment management segment, Cole Capital. On November 13, 2017, the Company entered into a purchase and sale agreement to sell substantially all of the Cole Capital segment. The sale closed on February 1, 2018. Substantially all of the Cole Capital segment is presented as discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented. The Company's continuing operations represent primarily those of the real estate investment segment. See Note 5 -Discontinued Operations, for further information on the sale of Cole Capital.
VEREIT, Inc. was incorporated in the State of Maryland on December 2, 2010 and has elected to be treated as a REIT for U.S. federal income tax purposes. The Operating Partnership was formed in the State of Delaware on January 13, 2011. We operate our business in a manner that permits us to maintain our exemption from registration under the Investment Company Act of 1940, as amended (the “Investment Company Act”). VEREIT, Inc.’s shares of common stock and 6.70% Series F Cumulative Redeemable Preferred Stock (“Series F Preferred Stock”) trade on the New York Stock Exchange (the “NYSE”) under the trading symbols “VER” and “VER PRF,” respectively.
2017 Developments
Real Estate Acquisitions
During the year ended December 31, 2017, the Company acquired controlling financial interests in 88 commercial properties for an aggregate purchase price of $748.8 million.
Real Estate Dispositions
During the year ended December 31, 2017, the Company disposed of 137 properties for an aggregate sales price of $594.9 million, of which the Company’s share was $574.4 million after the profit participation payments related to the disposition of 31 Red Lobster properties and the consolidated joint venture partner’s share of the sales price, resulting in consolidated proceeds of $445.5 million after closing costs and a $66.0 million debt assumption.
Balance Sheet and Liquidity
2017 Bond Offering
On August 11, 2017, the Company closed a senior note offering, consisting of $600.0 million aggregate principal amount of the Operating Partnership’s 3.950% Senior Notes due 2027, (the “2017 Bond Offering”). As discussed in Note 10 - Debt, the Company subsequently used the proceeds from the 2017 Bond Offering to repay borrowings, including swap termination costs and accrued and unpaid interest under its $500.0 million Credit Facility Term Loan. The Company used the remaining proceeds to pay down secured debt.
Share Repurchase Program
On May 12, 2017, the Company’s board of directors authorized the repurchase of up to $200.0 million of the Company’s outstanding Common Stock over the subsequent 12 months, as market conditions warrant. During the year ended December 31, 2017, the Company repurchased 68,759 shares of Common Stock in multiple open market transactions for $0.5 million as part of the Share Repurchase Program.
Debt Reductions
The Company decreased total debt by $293.8 million, from $6.4 billion to $6.1 billion, partially due to the repayment of the Credit Facility Term Loan of $500.0 million and a $579.9 million reduction of secured debt. These reductions of debt were partially offset by the issuance of $600.0 million of unsecured notes and net borrowings on the revolving credit facility of $185.0 million.
Cole Capital Sale
On November 13, 2017, we entered into a purchase and sale agreement (as amended by that certain First Amendment to the Purchase and Sale agreement, dated as of February 1, 2018, the “Cole Capital Purchase and Sale Agreement”) with CCA Acquisition, LLC (the “Cole Purchaser”), an affiliate of CIM Group, LLC. Under the terms of the Cole Capital Purchase and Sale Agreement, the Company agreed to sell to the Cole Purchaser all of the issued and outstanding shares of common stock of Cole Capital Advisors, Inc. (“CCA”), our subsidiary that sponsors and manages non-listed real estate investment trusts, and certain of CCA’s subsidiaries. The sale closed (the “Cole Capital Closing Date”) on February 1, 2018 for total consideration of approximately $120 million paid in cash.
On the Cole Capital Closing Date, we entered into a services agreement (the “Services Agreement”) with Cole Capital, pursuant to which we will continue to provide certain services to Cole Capital and its subsidiaries and to Cole Credit Property Trust IV, Inc. (“CCPT IV”), Cole Real Estate Income Strategy (Daily NAV), Inc. (“INAV”), Cole Office & Industrial REIT (CCIT II), Inc. (“CCIT II”), Cole Office & Industrial REIT (CCIT III), Inc. (“CCIT III”), and Cole Credit Property Trust V, Inc. (“CCPT V” and collectively with CCPT IV, INAV, CCIT II and CCIT III, the “Cole REITs”) including operational real estate support. Under the terms of the Services Agreement, we will be entitled to receive reimbursement for certain of the services provided and fees based on the future revenues of Cole Capital above a specified dollar threshold (the “Net Revenue Payments”), up to an aggregate of $80 million in Net Revenue Payments.
Primary Investment Focus
We own and actively manage a diversified portfolio of single-tenant retail, restaurant, office and industrial real estate assets subject to long-term net leases with creditworthy tenants. Our focus is on single-tenant, net-leased properties that are strategically located and essential to the business operations of the tenant, as well as retail properties that offer necessity and value-oriented products or services. We actively manage the portfolio by considering several metrics including property type, tenant concentration, geography, credit and key economic factors for appropriate balance and diversity. We believe that actively managing our portfolio allows us to attain the best operating results for each asset and the overall portfolio through strategic planning, implementation of these plans and responding proactively to changes and challenges in the marketplace.
Investment Policies
When evaluating prospective investments in or dispositions of real property, our management considers relevant real estate and financial factors, including the location of the property, the leases and other agreements affecting the property and business operations of the tenant, the creditworthiness of major tenants, its income-producing capacity, its physical condition, its prospects for appreciation, its prospects for liquidity, tax considerations and other factors. In this regard, our management will have substantial discretion with respect to the selection of specific investments, subject in certain instances to the approval of the Board of Directors.
As part of our overall portfolio strategy, we seek to lease space and/or acquire properties leased to creditworthy tenants that meet our underwriting and operating guidelines. Prior to entering into any transaction, our corporate credit analysis and underwriting professionals conduct a review of a tenant’s credit quality. In addition, we consistently monitor the credit quality of our portfolio by actively reviewing the creditworthiness of certain tenants, focusing primarily on those tenants representing the greatest concentration of our portfolio. This review primarily includes an analysis of the tenant’s financial statements either quarterly, or as frequently as the lease permits. We also consider tenant credit quality when assessing our portfolio for strategic dispositions. When we assess tenant credit quality, we, among other factors that we may deem relevant: (i) review relevant financial information, including financial ratios, net worth, revenue, cash flows, leverage and liquidity; (ii) evaluate the depth and experience of the tenant’s management team; and (iii) assess the strength/growth of the tenant’s industry. On an on-going basis, we evaluate the need for an allowance for doubtful accounts arising from estimated losses that could result from the tenant’s inability to make required current rent payments and an allowance against accrued rental income for future potential losses that we deem to be unrecoverable over the term of the lease. The factors considered in determining the credit risk of our tenants include, but are not limited to: payment history; credit status and change in status (credit ratings for public companies are used as a primary metric); change in tenant space needs (i.e., expansion/downsize); tenant financial performance; economic conditions in a specific geographic region; and industry specific credit considerations. We are of the opinion that the credit risk of our portfolio is reduced by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants and mitigation options.
Real Estate Investments
As of December 31, 2017, omitting the Excluded Property, the Company owned 4,091 operating properties comprising 94.4 million square feet of retail and commercial space located in 49 states, Puerto Rico and Canada, which includes properties owned through consolidated joint ventures. The rentable space at these properties was 98.8% leased with a weighted-average remaining lease term of 9.5 years. There were no tenants exceeding 10% of our consolidated annualized rental income as of December 31, 2017, 2016 or 2015. As of December 31, 2017, 2016 and 2015, properties located in Texas represented 12.8%, 13.5% and 13.1%, respectively, of our consolidated annualized rental income. As of December 31, 2017, tenants in the casual dining restaurant and manufacturing industries accounted for 13.8% and 10.1%, respectively, of our consolidated annualized rental income. As of December 31, 2016, tenants in the casual dining restaurant and manufacturing industries accounted for 15.6% and 10.1%, respectively, of our consolidated annualized rental income. As of December 31, 2015, tenants in the casual dining restaurant and manufacturing industries accounted for 16.6% and 10.1%, respectively, of our consolidated annualized rental income.
Financing Policies
We rely on leverage to allow us to invest in a greater number of assets and enhance our asset returns. We expect our leverage metrics to improve over time.
We intend to finance future acquisitions with the most advantageous source of capital available to us at the time of the transaction, which may include a combination of public and private offerings of our equity and debt securities, secured and unsecured corporate-level debt, property-level debt and mortgage financing and other public, private or bank debt. In addition, we may acquire properties in exchange for the issuance of common stock or OP Units and we may acquire properties subject to existing mortgage indebtedness.
We also may obtain secured or unsecured debt to acquire properties, and we expect that our financing sources will include the public debt market, banks and institutional investment firms, including asset managers and life insurance companies. Although we intend to maintain a conservative capital structure, our charter does not contain a specific limitation on the amount of debt we may incur and the Board of Directors may implement or change target debt levels at any time without the approval of our stockholders.
We intend to continue to emphasize unsecured corporate-level or OP-level debt in our financing and to seek to reduce the percentage of our assets which are secured by mortgage loans. For information relating to our Credit Facility, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
Competition
We are subject to competition in the acquisition and disposition of properties and in the leasing of our properties. We compete with a number of developers, owners and operators of retail, restaurant, office and industrial real estate, many of which own properties similar to ours in the same markets in which our properties are located. We also may face new competitors and, due to our focus on single-tenant properties located throughout the United States, and because many of our competitors are locally or regionally focused, we do not expect to encounter the same competitors in each region of the United States. Our competitors may be willing to accept lower returns on their investments and may succeed in buying the properties that we have targeted for acquisition. We may also incur costs in connection with unsuccessful acquisitions that we will not be able to recover. Foreign investors may view the U.S. real estate market as being more stable than other international markets and may increase investments in high-quality single-tenant properties, especially in gateway cities.
Regulations
Our investments are subject to various federal, state, local and foreign laws, ordinances and regulations, including, among other things, health, safety and zoning regulations, land use controls, environmental controls relating to air and water quality, noise pollution and indirect environmental impacts such as increased motor vehicle activity. We believe that we have all material permits and approvals necessary under current law to operate our investments.
Our properties are also subject to laws such as the Americans with Disabilities Act of 1990 (“ADA”), which require that all public accommodations must meet federal requirements related to access and use by disabled persons. Some of our properties may currently not be in compliance with the ADA. If one or more of the properties in our portfolio is not in compliance with the ADA or any other regulatory requirements, we may be required to incur additional costs to bring the property into compliance.
Environmental Matters
Under various federal, state and local environmental laws, a current owner of real estate may be required to investigate and clean up contaminated property. Under these laws, courts and government agencies have the authority to impose cleanup
responsibility and liability even if the owner did not know of and was not responsible for the contamination. For example, liability can be imposed upon us based on the activities of our tenants or a prior owner. In addition to the cost of the cleanup, environmental contamination on a property may adversely affect the value of the property and our ability to sell, rent or finance the property, and may adversely impact our investment in that property.
Prior to acquisition of a property, we will obtain Phase I environmental reports, or will rely on recent Phase I environmental reports. These reports will be prepared in accordance with an appropriate level of due diligence based on our standards and generally include a physical site inspection, a review of relevant federal, state and local environmental and health agency database records, one or more interviews with appropriate site-related personnel, review of the property’s chain of title and review of historic aerial photographs and other information on past uses of the property and nearby or adjoining properties. We may also obtain a Phase II investigation which may include limited subsurface investigations and tests for substances of concern where the results of the Phase I environmental reports or other information indicates possible contamination or where our consultants recommend such procedures.
Employees
As of December 31, 2017, we had approximately 330 employees. Following the closing of the Cole Capital sale, approximately 100 of these employees were employed by the Cole Purchaser.
Available Information
We electronically file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports, and proxy statements, with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549, or you may access them through the EDGAR database at the SEC’s website at http://www.sec.gov. In addition, copies of our filings with the SEC may be obtained from the website maintained for us at www.ir.vereit.com. We are providing our website address solely for the information of investors. We do not intend for the information contained on our website to be incorporated into this Annual Report on Form 10-K or other filings with the SEC.
Supplemental U.S. Federal Income Tax Considerations
This summary is for general information purposes only and is not tax advice. This discussion does not address all aspects of taxation that may be relevant to particular holders of our securities in light of their personal investment or tax circumstances.
Recent Legislation
The recently enacted “Tax Cuts and Jobs Act” (the “TCJA”), generally applicable for tax years beginning after December 31, 2017, made significant changes to the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), including a number of provisions of the Internal Revenue Code that affect the taxation of businesses and their owners, including REITs and their stockholders.
Among other changes, the TCJA made the following changes:
•
For tax years beginning after December 31, 2017 and before January 1, 2026, (i) the U.S. federal income tax rates on ordinary income of individuals, trusts and estates have been generally reduced and (ii) non-corporate taxpayers are permitted to take a deduction for certain pass-through business income, including dividends received from REITs that are not designated as capital gain dividends or qualified dividend income, subject to certain limitations.
•
The maximum U.S. federal income tax rate for corporations has been reduced from 35% to 21%, and corporate alternative minimum tax has been eliminated for corporations, which would generally reduce the amount of U.S. federal income tax payable by our taxable REIT subsidiaries (“TRSs”) and by us to the extent we were subject to corporate U.S. federal income tax (for example, if we distributed less than 100% of our taxable income or recognized built-in gains in assets acquired from C corporations). In addition, the maximum withholding rate on distributions by us to non-U.S. stockholders that are treated as attributable to gain from the sale or exchange of a U.S. real property interest is reduced from 35% to 21%.
•
Certain new limitations on the deductibility of interest expense now apply, which limitations may affect the deductibility of interest paid or accrued by us or our TRSs. However, a taxpayer that qualifies as a real estate business may elect to be exempt from such limitations on the deductibility of interest expense.
•
Certain new limitations on net operating losses now apply, which limitations may affect net operating losses generated by us or our TRSs.
•
A U.S. tax-exempt stockholder that is subject to tax on its unrelated business taxable income (“UBTI”) will be required to separately compute its taxable income and loss for each unrelated trade or business activity for purposes of determining its UBTI.
•
New accounting rules generally require us to recognize income items for federal income tax purposes no later than when we take the item into account for financial statement purposes, which may accelerate our recognition of certain income items.
Item 1A.
Item 1A. Risk Factors.
Investors should carefully consider the following factors, together with all the other information included in this Annual Report on Form 10-K, in evaluating the Company and our business. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected, the trading price of the General Partner's securities could decline and its stockholders and/or the Operating Partnership's unitholders may lose all or part of their investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. This “Risk Factors” section contains references to our “capital stock” and to our “stockholders” and “unitholders.” Unless expressly stated otherwise, references to our “capital stock” represent the General Partner’s common stock and any class or series of its preferred stock, references to our “stockholders” represent holders of the General Partner’s common stock and any class or series of its preferred stock and references to our “unitholders” represent holders of the OP units and any class of series of the Operating Partnership’s preferred units.
Risks Related to Our Business
We are primarily dependent on single-tenant leases for our revenue and, accordingly, if we are unable to renew leases, lease vacant space, including vacant space resulting from tenant defaults, or re-lease space as leases expire on favorable terms or at all, our financial condition could be adversely affected.
We focus our investment activities on ownership of freestanding, single-tenant commercial properties that are net leased to a single tenant. Therefore, the financial failure of, or other default by, a significant tenant or multiple tenants could cause a material reduction in our revenues and operating cash flows. In addition, to the extent that we enter into a master lease with a particular tenant, a default specific to a particular property could result in a termination of the entire master lease, resulting in the loss of revenue from all such properties.
We cannot assure you that our leases will be renewed or that we will be able to lease or re-lease the properties on favorable terms, or at all, or that lease terminations will not cause us to sell the properties at a loss. Any of our properties that become vacant could be difficult to re-lease or sell. We have and may continue to experience vacancies either by the continued default of a tenant under its lease or the expiration of one of our leases. We typically must incur all of the costs of ownership for a property that is vacant. Upon or pending the expiration of leases at our properties, we may be required to make rent or other concessions to tenants, or accommodate requests for lower rents, remodeling and other improvements, in order to retain and attract tenants. Certain of our properties may be specifically suited to the particular needs of a tenant (e.g., a retail bank branch or distribution warehouse) and major renovations and expenditures may be required in order for us to re-lease the space for other uses. If the vacancies continue for a long period of time, we may suffer reduced revenues, resulting in less cash available for distribution to our stockholders and unitholders. If we are unable to renew leases, lease vacant space, including vacant space resulting from tenant defaults, or re-lease space as leases expire on favorable terms or at all, our financial condition could be adversely affected.
We are subject to tenant, geographic and industry concentrations that make us more susceptible to adverse events with respect to certain tenants, geographic areas or industries.
As of December 31, 2017, we had derived approximately:
•
$75.4 million, or 6.5%, of our annualized rental income from Red Lobster®, a wholly owned subsidiary of Golden Gate Capital;
•
$343.8 million, or 29.8%, of our annualized rental income from properties located in the following four states: Texas (12.8%), Ohio (5.9%), Florida (5.6%), and Illinois (5.5%); and
•
$612.7 million, or 53.0%, of our annualized rental income from tenants in the following six industries: the casual dining restaurant industry (13.8%), the manufacturing industry (10.1%), the quick service restaurant industry (8.9%), the discount retail industry (8.1%), the pharmacy retail industry (7.1%) and the grocery & supermarket retail industry (5.0%).
Any adverse change in the financial condition of a tenant with whom we may have a significant credit concentration now or in the future, or any downturn of the economy in any state or industry in which we may have a significant credit concentration now or in the future, could result in a material reduction of our cash flows or material losses to us.
Our net leases may require us to pay property-related expenses that are not the obligations of our tenants.
Under the terms of the majority of our net leases, in addition to satisfying their rent obligations, our tenants are responsible for the payment or reimbursement of property expenses such as real estate taxes, insurance and ordinary maintenance and repairs. However, under the provisions of certain existing leases and leases that we may enter into in the future with our tenants, we may be required to pay some or all of the expenses of the property, such as the costs of environmental liabilities, roof and structural repairs, real estate taxes, insurance, certain non-structural repairs and maintenance. If our properties incur significant expenses that must be paid by us under the terms of our leases, our business, financial condition and results of operations may be adversely affected and the amount of cash available to meet expenses and to make distributions to our stockholders and unitholders may be reduced.
Our properties may be subject to impairment charges.
We routinely evaluate our real estate investments for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions and tenant performance. For example, the early termination of, or default under, a lease by a tenant may lead to an impairment charge. Since our investment focus is on properties net leased to a single tenant, the financial failure of, or other default by, a single tenant under its lease(s) may result in a significant impairment loss. If we determine that an impairment has occurred, we would be required to make a downward adjustment to the net carrying value of the property, which could have a material adverse effect on our results of operations in the period in which the impairment charge is recorded. Management has recorded impairment charges related to certain properties in the year ended December 31, 2017, and may record future impairments based on actual results and changes in circumstances. Negative developments in the real estate market may cause management to reevaluate the business and macro-economic assumptions used in its impairment analysis. Changes in management’s assumptions based on actual results may have a material impact on the Company’s financial statements. See “Note 9 - Fair Value Measures” to our consolidated financial statements for a discussion of real estate impairment charges.
Our ownership of certain properties and other facilities are subject to ground leases or other similar agreements which limit our uses of these properties and may restrict our ability to sell or otherwise transfer such properties.
As of December 31, 2017, we held interests in properties and other facilities through leasehold interests in the land on which the buildings are located and we may acquire additional properties in the future that are subject to ground leases or other similar agreements. As of December 31, 2017, the costs associated with these ground leases represented 2.0% of annualized rental revenue. Many of our ground leases and other similar agreements limit our uses of these properties and may restrict our ability to sell or otherwise transfer such properties without the ground landlord’s consent, which may impair their value.
Real estate investments are relatively illiquid and therefore we may not be able to dispose of properties when appropriate or on favorable terms.
Real estate investments are, in general, relatively illiquid and may become even more illiquid during periods of economic downturn. As a result, we may not be able to sell our properties quickly or on favorable terms in response to changes in the economy or other conditions when it otherwise may be prudent to do so. In addition, certain significant expenditures generally do not change in response to economic or other conditions, including debt service obligations, real estate taxes, and operating and maintenance costs. This combination of variable revenue and relatively fixed expenditures may result, under certain market conditions, in reduced earnings. Further, as a result of the 100% prohibited transactions tax applicable to REITs, we intend to hold our properties for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forgo or defer sales of properties that otherwise would be favorable. Therefore, we may be unable to adjust our portfolio promptly in response to economic, market or other conditions, which could adversely affect our business, financial condition, liquidity and results of operations.
Our investments in properties where the underlying tenant has a below investment grade credit rating, as determined by major credit rating agencies, or where the tenant is not rated may have a greater risk of default.
As of December 31, 2017, approximately 60.4% of our tenants were not rated or did not have an investment grade credit rating from a major ratings agency or were not affiliates of companies having an investment grade credit rating. Our investments in properties leased to such tenants may have a greater risk of default and bankruptcy than investments in properties leased exclusively to investment grade tenants. When we invest in properties where the tenant does not have a publicly available credit rating, we will use certain credit-assessment tools as well as rely on our own estimates of the tenant’s credit rating which includes reviewing the tenant’s financial information (e.g., financial ratios, net worth, revenue, cash flows, leverage and liquidity, if applicable). If our ratings estimates are inaccurate, the default or bankruptcy risk for the subject tenant may be greater than anticipated. If our lender or a credit rating agency disagrees with our ratings estimates, we may not be able to obtain our desired level of leverage or
our financing costs may exceed those that we projected. This outcome could have an adverse impact on our returns on that asset and hence our operating results.
We may be unable to sell a property if or when we decide to do so, including as a result of uncertain market conditions, which could adversely impact our ability to make cash distributions to our stockholders and unitholders.
We expect to hold the various real properties in which we invest until such time as we decide that a sale or other disposition is appropriate given our investment business objectives and REIT limitations. We generally intend to hold properties for an extended time, but our management or Board of Directors may exercise their discretion as to whether and when to sell a property to achieve investment objectives. Our ability to dispose of properties on advantageous terms or at all depends on certain factors beyond our control, including competition from other sellers and the availability of attractive financing for potential buyers of our properties. We cannot predict the various market conditions affecting real estate investments which will exist at any particular time in the future. Due to the uncertainty of market conditions which may affect the disposition of our properties, we cannot assure you that we will be able to sell such properties at a profit or at all in the future. Accordingly, the extent to which our stockholders and unitholders will receive cash distributions and realize potential appreciation on our real estate investments will depend upon fluctuating market conditions. Furthermore, we may be required to expend funds to correct defects or to make improvements before a property can be sold.
Dividends paid from sources other than our cash flow from operations could affect our profitability, restrict our ability to generate sufficient cash flow from operations, and dilute stockholders’ and unitholders’ interests in us.
We may not generate sufficient cash flow from operations to pay dividends and we may in the future pay dividends from sources other than from our cash flow from operations, such as borrowings and/or the sale of assets or the proceeds from offerings of securities. We have not established any limit on the amount of borrowings and/or the sale of assets or the proceeds from an offering of securities that may be used to fund dividends, except that, in accordance with our organizational documents and Maryland law, we may not make dividend distributions that would: (1) cause us to be unable to pay our debts as they become due in the usual course of business; (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences; or (3) jeopardize our ability to qualify as a REIT.
Funding dividends from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding dividends with the sale of assets or the proceeds of offerings of securities may affect our ability to generate cash flows. In addition, funding dividends from the sale of additional securities could dilute your interest in us if we sell shares of our common stock or securities that are convertible or exercisable into shares of our common stock to third party investors. As a result, the return you realize on your investment may be reduced. Payment of dividends from these sources could affect our profitability, restrict our ability to generate sufficient cash flow from operations, and dilute stockholders’ and unitholders’ interests in us, any or all of which may adversely affect your overall return.
We could face potential adverse effects from the bankruptcies or insolvencies of tenants or from tenant defaults generally.
The bankruptcy or insolvency of our tenants may adversely affect the income produced by our properties. Under bankruptcy law, a tenant cannot be evicted solely because of its bankruptcy and has the option to assume or reject any unexpired lease. If the tenant rejects the lease, any resulting claim we have for breach of the lease (excluding collateral securing the claim) will be treated as a general unsecured claim. Our claim against the bankrupt tenant for unpaid and future rent will be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease, and it is unlikely that a bankrupt tenant that rejects its lease would pay in full amounts it owes us under the lease. Even if a lease is assumed and brought current, we still run the risk that a tenant could condition lease assumption on a restructuring of certain terms, including rent, that would have an adverse impact on us. Any shortfall resulting from the bankruptcy of one or more of our tenants could adversely affect our cash flows and results of operations and could cause us to reduce the amount of distributions to our stockholders and unitholders.
In addition, the financial failure of, or other default by, one or more of the tenants to whom we have exposure could have an adverse effect on the results of our operations. While we evaluate the creditworthiness of our tenants by reviewing available financial and other pertinent information, there can be no assurance that any tenant will be able to make timely rental payments or avoid defaulting under its lease. If any of our tenants’ businesses experience significant adverse changes, they may fail to make rental payments when due, close a number of stores, exercise early termination rights (to the extent such rights are available to the tenant) or declare bankruptcy. A default by a significant tenant or multiple tenants could cause a material reduction in our revenues and operating cash flows. In addition, if a tenant defaults, we may incur substantial costs in protecting our investment.
If a sale-leaseback transaction is re-characterized in a tenant’s bankruptcy proceeding, our financial condition could be adversely affected.
We have entered and may continue to enter into sale-leaseback transactions. In a sale-leaseback transaction, we purchase a property and then lease it back to the third party from whom we purchased it. In the event of the bankruptcy of a tenant, a transaction structured as a sale-leaseback might possibly be re-characterized as either a financing or a joint venture, either of which outcomes could adversely affect our financial condition, cash flows and the amount available for distribution to our stockholders and unitholders.
If a sale-leaseback is re-characterized as a financing, we would not be considered the owner of the property and, as a result, would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. The tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding balance. If confirmed by the bankruptcy court, we could be bound by the new terms and prevented from foreclosing our lien on the property. If the sale-leaseback is re-characterized as a joint venture, our lessee and we could be treated as co-venturers with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the lessee relating to the property.
We have a history of operating losses and cannot assure you that we will maintain profitability.
Since our inception in 2010, we have experienced net losses (calculated in accordance with U.S. GAAP) and as of December 31, 2017, had an accumulated deficit of $4.78 billion. The extent of our future operating losses and the timing of when we will achieve profitability are uncertain, and together depend on the demand for, and value of, our portfolio of properties. We may never achieve or sustain profitability.
We may be unable to enter into and consummate property acquisitions on advantageous terms or our property acquisitions may not perform as we expect due to competitive conditions and other factors.
We may acquire properties in the future. The acquisition of properties entails various risks, including the risks that our investments may not perform as we expect and that our cost estimates for bringing an acquired property up to market standards may prove inaccurate. Further, we expect to finance any future acquisitions through a combination of borrowings under our unsecured credit facility (the “Credit Facility”), proceeds from equity or debt offerings by the General Partner, the Operating Partnership or their subsidiaries, funds from operations and proceeds from property contributions and dispositions which, if unavailable, could adversely affect our cash flows.
In addition, our ability to acquire properties in the future on satisfactory terms and successfully integrate and operate such properties is subject to the following significant risks:
•
we may be unable to acquire desired properties or the purchase price of a desired property may increase significantly because of competition from other real estate investors, including other real estate operating companies, REITs and investment funds;
•
we may acquire properties that are not accretive to our earnings upon acquisition;
•
we may be unable to obtain the necessary debt or equity financing to consummate an acquisition or, if obtainable, financing may not be on satisfactory terms;
•
we may need to spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;
•
agreements for the acquisition of properties are typically subject to customary conditions to closing, including satisfactory completion of due diligence investigations, and we may spend significant time and money on potential acquisitions that we do not consummate;
•
we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations; and
•
we may acquire properties without any recourse, or with only limited recourse, for liabilities, whether known or unknown, such as cleanup of environmental contamination, remediation of latent defects, claims by tenants, vendors or other persons against the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
Any of the above risks could adversely affect our business, financial condition, liquidity and results of operations.
We have assumed, and may in the future assume, liabilities in connection with our property acquisitions, including unknown liabilities.
We have assumed existing liabilities, some of which may have been unknown or unquantifiable at the time of the transaction. Unknown liabilities might include liabilities for cleanup or remediation of undisclosed environmental conditions, claims of tenants or other persons dealing with prior owners of the properties, tax liabilities, and accrued but unpaid liabilities whether incurred in the ordinary course of business or otherwise. If the magnitude of such unknown liabilities is high, either singly or in the aggregate, it could adversely affect our business, financial condition, liquidity and results of operations.
We face intense competition, which may decrease or prevent increases in the occupancy and rental rates of our properties.
We are subject to competition in the leasing of our properties. We compete with numerous developers, owners and operators of retail, restaurant, industrial and office real estate, many of which have greater financial and other resources than us. Many of our competitors own properties similar to ours in the same markets in which our properties are located. If one of our properties is nearing the end of the lease term or becomes vacant and 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 substantial rent concessions in order to retain tenants when such tenants’ lease expire or attract new tenants. In addition, if our competitors sell assets similar to assets we intend to divest in the same markets and/or at valuations below our valuations for comparable assets, we may be unable to divest our assets at all or at favorable pricing or on favorable terms. As a result of these actions by our competitors, our business, financial condition, liquidity and results of operations may be adversely affected.
The value of our real estate investments is subject to risks associated with our real estate assets and with the real estate industry.
Our real estate investments are subject to various risks, fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may decrease our cash available for distribution to our stockholders and unitholders, as well as the value of our properties. These events include, but are not limited to:
•
adverse changes in international, national or local economic and demographic conditions;
•
vacancies or our inability to lease space on favorable terms, including possible market pressures to offer tenants rent abatements, tenant improvements, early termination rights or tenant-favorable renewal options;
•
adverse changes in financial conditions of buyers, sellers and tenants of properties;
•
inability to collect rent from tenants, or other failures by tenants to perform the obligations under their leases;
•
competition from other real estate investors, including other real estate operating companies, REITs and institutional investment funds;
•
reductions in the level of demand for commercial space generally, and freestanding net leased properties specifically, and changes in the relative popularity of our properties;
•
increases in the supply of freestanding single-tenant properties;
•
fluctuations in interest rates, which could adversely affect our ability, or the ability of buyers and tenants of our properties, to obtain financing on favorable terms or at all;
•
increases in expenses, including, but not limited to, insurance costs, labor costs, energy prices, real estate assessments and other taxes and costs of compliance with laws, regulations and governmental policies, all of which have an adverse impact on the rent a tenant may be willing to pay us in order to lease one or more of our properties;
•
loss of property rights, adverse impacts on our tenants’ business operations and/or increases in tenant vacancies resulting from eminent domain proceedings;
•
civil unrest, acts of God, including earthquakes, floods, hurricanes and other natural disasters, including extreme weather events from possible future climate change, which may result in uninsured losses, and acts of war or terrorism; and
•
changes in, and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning and tax laws, governmental fiscal policies and the Americans with Disabilities Act.
Any or all of these factors could materially adversely affect our results of operations through decreased revenues or increased costs.
Uninsured losses or losses in excess of our insurance coverage could materially adversely affect our financial condition and cash flows, and there can be no assurance as to future costs and the scope of coverage that may be available under insurance policies.
We carry comprehensive liability, fire, extended coverage, and rental loss insurance covering all of the properties in our portfolio under one or more blanket insurance policies with policy specifications, limits and deductibles customarily carried for similar properties. In addition, we carry professional liability and directors’ and officers’ insurance, and cyber liability insurance. We select policy specifications and insured limits that we believe are appropriate and adequate given the relative risk of loss, insurance coverages provided by tenants, the cost of the coverage and industry practice. There can be no assurance, however, that the insured limits on any particular policy will adequately cover an insured loss if one occurs. If any such loss is insured, we may be required to pay a significant deductible on any claim for recovery of such a loss prior to our insurer being obligated to reimburse us for the loss, or the amount of the loss may exceed our coverage for the loss. In addition, we may reduce or discontinue terrorism, earthquake, flood or other insurance on some or all of our properties in the future if the cost of premiums for any of these policies exceeds, in our judgment, the value of the coverage discounted for the risk of loss. Our title insurance policies may not insure for the current aggregate market value of our portfolio, and we do not intend to increase our title insurance coverage as the market value of our portfolio increases.
Further, we do not carry insurance for certain losses, including, but not limited to, losses caused by riots, war or nuclear explosions. Certain types of losses may be either uninsurable or not economically insurable, such as losses due to earthquakes, riots or acts of war. If we experience a loss that is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if these properties were irreparably damaged. In addition, we carry several different lines of insurance, placed with several large insurance carriers. If any one of these large insurance carriers were to become insolvent, we would be forced to replace the existing insurance coverage with another suitable carrier, and any outstanding claims would be at risk for collection. In such an event, we cannot be certain that we would be able to replace the coverage at similar or otherwise favorable terms. As a result of any of the situations described above, our financial condition and cash flows may be materially and adversely affected.
Our participation in joint ventures creates additional risks as compared to direct real estate investments, and the actions of our joint venture partners could adversely affect our operations or performance.
We have in the past participated, and may in the future participate, in transactions structured to purchase assets jointly with unaffiliated third parties (a “joint venture”). There are additional risks involved in joint venture transactions. As a co-investor in a joint venture, we may not be in a position to exercise sole decision-making authority relating to the property, joint venture, or other entity. In addition, there is the potential of the third-party participant in the joint venture becoming bankrupt and the possibility of diverging or inconsistent economic or business interests of us and that participant. These diverging interests could result in, among other things, exposure to liabilities of the joint venture in excess of our proportionate share of these liabilities. The competing rights of each owner in a jointly-owned property could effect a reduction in the value of each owner’s interest in the subject property.
If we are unable to maintain effective disclosure controls and procedures and effective internal control over financial reporting, investor confidence and our stock price could be adversely affected.
Our management is responsible for establishing and maintaining effective disclosure controls and procedures and internal control over financial reporting. There were no changes to our internal control over financial reporting that occurred during the year ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, however, there can be no guarantee as to the effectiveness of our disclosure controls and procedures and we cannot assure you that our internal control over financial reporting will not be subject to material weaknesses in the future. If we fail to maintain the adequacy of our internal controls over financial reporting and our operating internal controls, including any failure to implement required new or improved controls as a result of changes to our business or otherwise, or if we experience difficulties in their implementation, our business, results of operations and financial condition could be adversely affected and we could fail to meet our reporting obligations.
Government investigations relating to the findings of the Audit Committee Investigation may result in significant legal expenses, fines, and/or penalties, including indemnification obligations, and cause our business, financial condition, liquidity and results of operations to suffer.
On November 13, 2014, we received the first of two subpoenas relating to the findings of the Audit Committee Investigation from the staff of the SEC, each of which called for the production of certain documents. On December 19, 2014, we received a subpoena from the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts. The U.S. Attorney’s Office for the Southern District of New York also contacted counsel for the Company and counsel for the Audit Committee. We
are cooperating with these regulators in their investigations. The amount of time needed to resolve these investigations is uncertain, and, although the U.S. Attorney’s Office for the Southern District of New York has indicated that it does not intend to bring criminal charges against the Company arising from its investigation, we cannot predict the outcome of other investigations or whether we will face additional government investigations, inquiries or other actions related to these matters. Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees, among others in connection with the ongoing government investigations and potential future government inquiries, investigations or actions, including advancement of legal fees. These matters could result in actions seeking, among other things, injunctions against us and the payment of significant fines and/or penalties, as well as requiring payment of substantial legal fees and indemnification obligations, and cause our business, financial condition, liquidity and results of operations to suffer. We can provide no assurance as to the outcome of any government investigation.
The Company and certain of our former officers and directors, among others, have been named as defendants in various lawsuits related to the findings of the Audit Committee Investigation which have resulted in significant legal expenses which are expected to continue. Any resolution could require substantial payments by the Company, including indemnification obligations, and may materially impact our business, financial condition, liquidity and results of operations.
Since the October 29, 2014 announcement of the findings of the Audit Committee Investigation and the subsequent restatement of the Company’s financial statements in March 2015, the Company and its former officers and directors (along with others) have been named as defendants in multiple putative securities class action complaints in the United States District Court for the Southern District of New York, which were subsequently consolidated under the caption In re American Realty Capital Properties, Inc. Litigation, 1:15-mc-00040-AKH, multiple individual securities lawsuits and multiple derivative lawsuits. See “Note 15 - Commitments and Contingencies” to our consolidated financial statements for additional details regarding pending litigation matters related to the Audit Committee Investigation.
As a result of the various pending litigations, and subject to certain limitations, we are obligated to advance certain legal expenses to and indemnify our current and former directors, officers and employees, as well as certain outside individuals and entities. These lawsuits have resulted in significant ongoing legal expenses, which are expected to continue. The resolution of these matters, and the timing thereof, are uncertain. Any such resolution, whether through a judgment or a settlement, could require substantial payments by the Company, including potential indemnification obligations, which in large part are not expected to be covered by insurance, and may materially impact the Company’s business, financial condition, liquidity and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial position and results of operations, and they require management to make estimates, judgments, and assumptions about matters that are inherently uncertain.
Our accounting policies and methods are fundamental to how we record and report our financial position and results of operations. We have identified several accounting policies as being critical to the presentation of our financial position and results of operations because they require management to make particularly subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be recorded under different conditions or using different assumptions. Because of the inherent uncertainty of the estimates, judgments, and assumptions associated with these critical accounting policies, we cannot provide any assurance that we will not make subsequent significant adjustments to our consolidated financial statements. If our judgments, assumptions, and allocations prove to be incorrect, or if circumstances change, our business, financial condition, liquidity and results of operations could be adversely affected.
Changes in U.S. accounting standards regarding operating leases may make the leasing of our properties less attractive to our potential tenants, which could reduce overall demand for our leasing services.
Under current authoritative accounting guidance for leases, a lease is classified by a tenant as a capital lease if the significant risks and rewards of ownership are considered to reside with the tenant. Under capital lease accounting for a tenant, both the leased asset and liability are reflected on its balance sheet. If the lease does not meet the criteria for a capital lease, the lease is to be considered an operating lease by the tenant, and the obligation does not appear on the tenant’s balance sheet; rather, the contractual future minimum payment obligations are only disclosed in the footnotes thereto. Thus, entering into an operating lease can appear to enhance a tenant’s balance sheet in comparison to direct ownership. The Financial Accounting Standards Board (the “FASB”) and the International Accounting Standards Board (the “IASB”) conducted a joint project to re-evaluate lease accounting. In February 2016, the FASB issued Accounting Standards Update, (“ASU”) 2016-02, Leases (“ASU 2016-02”) which will require that a lessee recognize assets and liabilities on the balance sheet for all leases with a lease term of more than 12 months, with the result being the recognition of a right of use asset and a lease liability and the disclosure of key information about the entity's leasing arrangements. These and other potential changes to the accounting guidance could affect both our accounting for leases as well as that of our current and potential tenants. These changes may affect how our real estate leasing business is conducted. For example, with the ASU 2016-02 revision, companies may be less willing to enter into leases in general or desire to enter into
leases with shorter terms because the apparent benefits to their balance sheets under current practice could be reduced or eliminated. This impact in turn could make it more difficult for us to enter into leases on terms we find favorable. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company expects the accounting for leases pursuant to which the Company is the lessee to change and is currently evaluating the impact. Leases pursuant to which the Company is the lessee primarily consist of corporate offices and ground leases.
We may not be able to maintain our competitive advantages if we are not able to attract and retain key personnel.
Our success depends to a significant extent on our ability to attract and retain key members of our executive team and staff. Our future success depends in part on the continued service of our senior management team. If there are changes in senior leadership, such changes could be disruptive and could compromise our ability to execute our strategic plan. While we have entered into employment agreements with certain key personnel, there can be no assurance that we will be able to retain the services of individuals whose knowledge and skills are important to our businesses. Our success also depends on our ability to prospectively attract, integrate, train and retain qualified management personnel. Because the competition for qualified personnel is intense, costs related to compensation and retention could increase significantly in the future. If we were to lose a sufficient number of our key employees and were unable to replace them in a reasonable period of time, these losses could damage our business and adversely affect our results of operations.
Competition that traditional retail tenants face from e-commerce retail sales, or the integration of brick and mortar stores with e-commerce retailers, could adversely affect our business.
Our retail tenants face increasing competition from e-commerce retailers. E-commerce sales have accounted for an increasing percentage of retail sales over the past few years and this trend is expected to continue. These trends may have an impact on decisions that retailers make regarding their brick and mortar stores. Changes in shopping trends as a result of the growth in e-commerce may also impact the profitability of retailers that do not adapt to changes in market conditions. The continued growth of e-commerce sales could decrease the need for traditional retail outlets and reduce retailers' space and property requirements. These conditions could adversely impact our results of operations and cash flows if we are unable to meet the needs of our tenants or if our tenants encounter financial difficulties as a result of changing market conditions.
Cybersecurity risks and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information, and/or damage to our business relationships, all of which could negatively impact our financial results.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our tenant and investor relationships. As our reliance on technology has increased, so have the risks posed to our information systems, both internal and those we have outsourced. We have implemented processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations, business relationships or confidential information will not be negatively impacted by such an incident.
We may acquire properties or portfolios of properties through tax deferred contribution transactions, which could result in the dilution of our stockholders and unitholders, and limit our ability to sell or refinance such assets.
We have in the past and may in the future acquire properties or portfolios of properties through tax deferred contribution transactions in exchange for OP Units. Under the limited partnership agreement of the OP, as amended (the “LPA”), after holding the OP Units for a period of one year, unless otherwise consented to by the General Partner, holders of OP Units have a right to redeem the OP Units for the cash value of a corresponding number of shares of the General Partner’s common stock or, at the option of the General Partner, a corresponding number of shares of the General Partner’s common stock. This could result in the dilution of our stockholders and unitholders through the issuance of OP Units that may be exchanged for shares of our common stock. This acquisition structure may also have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties, and may require that we agree to restrictions on our ability to dispose of, or refinance the debt on, the acquired properties in order to protect the contributors’ ability to defer recognition of taxable gain. Similarly, we may be required to incur or maintain debt we would otherwise not incur so we can allocate the debt to the contributors to maintain their tax bases. These restrictions could limit our ability to sell or refinance an asset at a time, or on terms, that would be favorable absent such restrictions.
Risks Related to Financing
We intend to rely on external sources of capital to fund future capital needs, and if we encounter difficulty in obtaining such capital, we may not be able to meet maturing obligations or make any additional investments.
In order to qualify as a REIT under the Internal Revenue Code, we are required, among other things, to distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with U.S. GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. Because of this dividend requirement, we may not be able to fund from cash retained from operations all of our future capital needs, including capital needed to refinance maturing obligations or make investments.
Market volatility and disruption could hinder our ability to obtain new debt financing or refinance our maturing debt on favorable terms or at all or to raise debt and equity capital. Our access to capital will depend upon a number of factors, including:
•
general market conditions;
•
the market’s perception of our future growth potential;
•
the extent of investor interest;
•
analyst reports about us and the REIT industry;
•
the general reputation of REITs and the attractiveness of their equity securities in comparison to other equity securities, including securities issued by other real estate-based companies;
•
our financial performance and that of our tenants;
•
our current debt levels;
•
our current and expected future earnings;
•
our cash flow and cash dividends, including our ability to satisfy the dividend requirements applicable to REITs; and
•
the market price per share of our common stock.
If we are unable to obtain needed capital on satisfactory terms or at all, we may not be able to meet our obligations and commitments as they mature or make any additional investments.
We have substantial amounts of indebtedness outstanding, which may affect our ability to pay dividends, and may expose us to interest rate fluctuation risk and to the risk of default under our debt obligations.
As of December 31, 2017, our aggregate indebtedness was $6.1 billion. We may incur significant additional debt in the future, including borrowings under our Credit Facility, for various purposes including, without limitation, the funding of future acquisitions, capital improvements and leasing commissions in connection with the repositioning of a property and litigation expenses. At December 31, 2017, we had $2.1 billion of undrawn commitments under our Credit Facility. Our substantial outstanding indebtedness, and the limitations imposed on us by our debt agreements, could have significant adverse consequences, including as follows:
•
our cash flow may be insufficient to meet our required principal and interest payments;
•
we may be unable to borrow additional funds as needed or on satisfactory terms to fund future working capital, capital expenditures and other general corporate requirements, which could, among other things, adversely affect our ability to capitalize upon any acquisition opportunities or fund capital improvements and leasing commissions;
•
we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;
•
payments of principal and interest on borrowings may leave us with insufficient cash resources to make the dividend payments necessary to maintain our REIT qualification or may otherwise impose restrictions on our ability to make distributions;
•
we may be forced to dispose of properties, possibly on disadvantageous terms;
•
we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations;
•
certain of the property subsidiaries’ loan documents may include restrictions on such subsidiary’s ability to make dividends to us;
•
we may be unable to hedge floating-rate debt, counterparties may fail to honor their obligations under our hedge agreements, these agreements may not effectively hedge interest rate fluctuation risk, and, upon the expiration of any hedge agreements, we would be exposed to then-existing market rates of interest and future interest rate volatility;
•
we may default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans and exercise their rights under any assignment of rents and leases;
•
we may be vulnerable to general adverse economic and industry conditions; and
•
we may be at a disadvantage compared to our competitors with less indebtedness.
If we default under a loan or indenture (including any default in respect of the financial maintenance and negative covenants contained in the Credit Agreement, or the indenture governing the Senior Notes, we may automatically be in default under any other loan or indenture that has cross-default provisions (including the credit agreement (the “Credit Agreement”)), dated June 30, 2014, as amended, with Wells Fargo Bank National Association, as administrative agent, and other lender parties thereto, governing the Credit Facility), and (x) further borrowings under the Credit Facility will be prohibited, and outstanding indebtedness under the Credit Facility, and our indenture (including the indenture governing the Senior Notes) or such other loans may be accelerated and (y) to the extent any such debt is secured, directly or indirectly, by any properties or assets, the lenders may foreclose on the properties or assets securing such indebtedness.
In addition, increases in interest rates may impede our operating performance and payments of required debt service obligations or amounts due at maturity, or creation of additional reserves under loan agreements or indentures, could adversely affect our financial condition and operating results.
Further, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which could adversely affect our ability to meet the REIT dividend requirements imposed by the Internal Revenue Code.
The indenture governing our Senior Notes and the Credit Agreement contain restrictive covenants that limit our operating flexibility.
The indenture governing our Senior Notes and the Credit Agreement require us to meet customary negative covenants and other financial and operating covenants. The indenture governing our Senior Notes requires us to maintain financial ratios for total leverage, secured debt, debt service coverage and total unencumbered assets. In addition, the Credit Agreement requires us, among other things, to maintain a minimum tangible net worth, a maximum leverage ratio, a minimum fixed charge coverage ratio, a secured leverage ratio, a total unencumbered asset value ratio, a minimum encumbered interest coverage ratio and a minimum encumbered asset value. These covenants restrict our ability to incur secured or unsecured indebtedness and may also restrict our ability to engage in certain business activities.
Our ability to comply with these and other provisions of the indenture governing our Senior Notes and the Credit Agreement may be affected by changes in our operating and financial performance, changes in general business and economic conditions, adverse regulatory developments or other events adversely impacting us. Any failure to comply with these covenants would constitute a default under the indenture governing our Senior Notes and/or the Credit Agreement, as applicable, and would prevent further borrowings under the Credit Agreement and could cause those and other obligations to become due and payable. If any of our indebtedness is accelerated, we may not be able to repay it.
Our organizational documents have no limitation on the amount of indebtedness that we may incur. As a result, we may become more highly leveraged in the future, which could adversely affect our financial condition.
Our business strategy contemplates the use of both secured and unsecured debt to finance long-term growth. While we intend to limit our indebtedness, our organizational documents contain no limitations on the amount of debt that we may incur. Further, our financing decisions and related decisions regarding levels of debt may be determined by our Board of Directors in its discretion without stockholder approval. As a result, we may be able to incur substantial additional debt, including secured debt, in the future, subject to us meeting the financial and operating covenants described above, which could result in us becoming more highly leveraged and adversely affecting our financial condition.
Increases in interest rates would increase our debt service obligations and may adversely affect the refinancing of our existing debt and our ability to incur additional debt, which could adversely affect our financial condition.
Certain of our borrowings bear interest at variable rates, and we may incur additional variable-rate debt in the future. Increases in interest rates would result in higher interest expenses on our existing unhedged variable rate debt, and increase the costs of refinancing existing debt or incurring new debt. Additionally, increases in interest rates may result in a decrease in the value of our real estate and decrease the market price of our capital stock and could accordingly adversely affect our financial condition.
We may not be able to generate sufficient cash flow to meet our debt service obligations.
Our ability to make payments on and to refinance our indebtedness, and to fund our operations, working capital and capital expenditures, depends on our ability to generate cash. To a certain extent, our cash flow is subject to general economic, industry, financial, competitive, operating, legislative, regulatory and other factors, many of which are beyond our control.
We cannot assure you that our business will generate sufficient cash flow from operations or that future sources of cash will be available to us in an amount sufficient to enable us to pay amounts due on our indebtedness or to fund our other liquidity needs.
Additionally, if we incur additional indebtedness in connection with any future acquisitions or development projects or for any other purpose, our debt service obligations could increase. We may need to refinance all or a portion of our indebtedness before maturity. Our ability to refinance our indebtedness or obtain additional financing will depend on, among other things:
•
our financial condition and market conditions at the time;
•
restrictions in the agreements governing our indebtedness;
•
general economic and capital market conditions;
•
the availability of credit from banks or other lenders;
•
investor confidence in us; and
•
our results of operations.
As a result, we may not be able to refinance our indebtedness on commercially reasonable terms, or at all. If we do not generate sufficient cash flow from operations, and additional borrowings or refinancings or proceeds of asset sales or other sources of cash are not available to us, we may not have sufficient cash to enable us to meet all of our obligations. Accordingly, if we cannot service our indebtedness, we may have to take actions such as seeking additional equity, or delaying any strategic acquisitions and alliances or capital expenditures, any of which could have a material adverse effect on our operations.
Adverse changes in our credit ratings could affect our borrowing capacity and borrowing terms.
Our Senior Notes are periodically rated by nationally recognized credit rating agencies. Our current corporate credit and issue-level ratings for our Senior Notes are “BBB-” with a “stable” outlook from Standard & Poor’s Rating Services. Our corporate credit and issue-level ratings for our Senior Notes are “Baa3” with a “stable” outlook assigned by Moody’s Investor Service, Inc. Our corporate credit and issue-level ratings for our Senior Notes are “BBB-“ with a “stable” outlook assigned by Fitch Ratings, Inc. The credit ratings are based on our operating performance, liquidity and leverage ratios, overall financial position, and other factors viewed by the credit rating agencies as relevant to our industry and the economic outlook in general. Our credit ratings can adversely affect the cost and availability of capital, as well as the terms of any financing we obtain. Since we depend in part on debt financing to fund our business, an adverse change in our credit ratings could have a material adverse effect on our financial condition, liquidity, results of operations and the trading price of our Senior Notes.
Risks Related to Equity
The Board of Directors may create and issue a class or series of common or preferred stock without stockholder approval.
Subject to applicable legal and regulatory requirements, the Board of Directors is empowered under our charter to amend our charter from time to time to increase or decrease the aggregate number of shares of our stock or the number of shares of stock of any class or series that we have authority to issue, to designate and issue from time to time one or more classes or series of stock and to classify or reclassify any unissued shares of our common stock or preferred stock without stockholder approval. The Board of Directors may determine the relative preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption of any class or series of stock issued. As a result, we may issue series or classes of stock with voting rights, rights to dividends or other rights, senior to the rights of holders of our outstanding capital stock. The issuance of any such stock could also have the effect of delaying or preventing a change of control transaction that might otherwise be in the best interests of our stockholders. In addition, future sales of shares of our common stock or preferred stock may be dilutive to existing stockholders.
The trading price of our common stock has been and may continue to be subject to wide fluctuations.
The sales price of our common stock on the NYSE has fluctuated in recent quarters. Our stock price may fluctuate in response to a number of events and factors, including as a result of future offerings of our securities, as a result of the events described in this “Risk Factors” section or in our future filings with the SEC, and as a result of changes to our dividend yield relative to yields on other financial instruments (e.g., increases in interest rates resulting in higher yields on other financial instruments may adversely
affect the sales price of our common stock). In addition, the trading volume and price of our common stock may fluctuate and be adversely impacted in response to a number of factors, including:
•
actual or anticipated variations in our operating results, earnings, or liquidity, or those of our competitors;
•
changes in our dividend policy;
•
publication of research reports about us, our competitors, our tenants, or the REIT industry;
•
changes in market valuations of companies similar to us;
•
speculation in the press or investment community;
•
our failure to meet, or changes to, our earnings estimates, or those of any securities analysts;
•
increases in market interest rates;
•
adverse market reaction to the amount of or the maturity of our debt and our ability to refinance such debt and the terms thereof;
•
adverse market reaction to any additional indebtedness we incur or equity or securities we may issue;
•
changes in our credit ratings;
•
changes in our key management;
•
the financial condition, liquidity, results of operations, and prospects of our tenants;
•
litigation and government investigations;
•
failure to maintain our REIT qualification; and
•general market and economic conditions, including the current state of the credit and capital markets.
The issuance of additional equity securities may dilute existing equity holders.
Giving effect to the issuance of common stock in future potential offerings, the receipt of future potential net proceeds and the use of those proceeds, additional equity offerings may have a dilutive effect on our expected earnings per share. Additionally, we are not restricted from issuing additional shares of our common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities in the future. The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market or the perception that such sales could occur.
Future offerings of debt, which would be senior to our common stock upon liquidation, or preferred equity securities that may be senior to our common stock for purposes of dividend distributions or upon liquidation, may adversely affect the market price of our common stock.
In the future, we may issue debt or preferred equity securities. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings, including offerings of convertible preferred stock, may dilute the holdings of our existing stockholders or otherwise reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution. Preferred stock, if issued, could have a preference on liquidating distributions or a preference on distribution payments that could limit our ability to make distributions to holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.
The change of control conversion feature of the Series F Preferred Stock may make it more difficult for a party to take over the Company or discourage a party from taking over the Company.
Upon the occurrence of a change of control (as defined in the Articles Supplementary for the Series F Preferred Stock) the result of which is that our common stock or the common securities of the acquiring or surviving entity are not listed on a national stock exchange, holders of the Series F Preferred Stock will have the right (unless, prior to the change of control conversion date, we have provided or provide notice of our election to redeem the Series F Preferred Stock) to convert some or all of their Series F Preferred Stock into shares of our common stock (or equivalent value of alternative consideration). The change of control conversion feature of the Series F Preferred Stock may have the effect of discouraging a third party from making an acquisition proposal for the Company or of delaying, deferring or preventing certain change of control transactions of the Company under circumstances that stockholders may otherwise believe are in their best interests.
Risks Relating to our Real Estate Investments
Because we own real property, we are subject to extensive environmental regulation, which creates uncertainty regarding future environmental expenditures and liabilities.
Environmental laws regulate, and impose liability for, releases of hazardous or toxic substances into the environment. Under various provisions of these laws, an owner or operator of real estate, such as us, is or may be liable for costs related to soil or groundwater contamination on, in, or migrating to or from its property. In addition, persons who arrange for the disposal or treatment of hazardous or toxic substances may be liable for the costs of cleaning up contamination at the disposal site. Such laws often impose liability regardless of whether the person knew of, or was responsible for, the presence of the hazardous or toxic substances that caused the contamination. The presence of, or contamination resulting from, any of these substances, or the failure to properly remediate them, may adversely affect our ability to sell or lease our property or to borrow using such property as collateral. In addition, persons exposed to hazardous or toxic substances may sue us for personal injury damages. As a result, in connection with our current or former ownership, operation, management and development of real properties, we may be potentially liable for investigation and cleanup costs, penalties, and damages under environmental laws.
Although our properties are generally subjected to preliminary environmental assessments, known as Phase I assessments, by independent environmental consultants that identify certain liabilities, Phase I assessments are limited in scope, and may not include or identify all potential environmental liabilities or risks associated with the property. Further, any environmental liabilities that arose since the date the studies were done would not be identified in the assessments. Unless required by applicable laws or regulations, we may not further investigate, remedy or ameliorate the liabilities disclosed in the Phase I assessments.
We cannot assure you that these or other environmental studies identified all potential environmental liabilities, or that we will not incur material environmental liabilities in the future. If we do incur material environmental liabilities in the future, we may face significant remediation costs, and we may find it difficult to finance or sell any affected properties.
We are subject to risks relating to mortgage, bridge or mezzanine loans.
Investing in mortgage, bridge or mezzanine loans involves risk of defaults on those loans caused by many conditions beyond our control, including local and other economic conditions affecting real estate values and interest rate levels. If there are defaults under these loans, we may not be able to repossess and sell quickly any properties securing such loans. An action to foreclose on a property securing a loan is regulated by state statutes and regulations and is subject to many of the delays and expenses of any lawsuit brought in connection with the foreclosure if the defendant raises defenses or counterclaims. In the event of 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 loan, which could reduce the value of our investment in the defaulted loan.
We are subject to risks relating to real estate-related securities, including commercial mortgage backed securities (“CMBS”).
Real estate-related securities are often unsecured and also may be subordinated to other obligations of the issuer. As a result, investments in real estate-related securities may be subject to risks of (1) limited liquidity in the secondary trading market in the case of unlisted or thinly traded securities, (2) substantial market price volatility resulting from changes in prevailing interest rates in the case of traded equity securities, (3) subordination to the prior claims of banks and other senior lenders to the issuer, (4) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower yielding assets, (5) the possibility that earnings of the issuer or that income from collateral may be insufficient to meet debt service and distribution obligations and (6) the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic slowdown or downturn. These risks may adversely affect the value of outstanding real estate-related securities and the ability of the obliged parties to repay principal and interest or make distribution payments.
CMBS are securities that evidence interests in, or are secured by, a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, these securities are subject to the risks listed above and all of the risks of the underlying mortgage loans. CMBS are issued by investment banks and non-regulated financial institutions, and are not insured or guaranteed by the U.S. government. The value of CMBS may change due to shifts in the market’s perception of issuers and regulatory or tax changes adversely affecting the mortgage securities market as a whole and may be negatively impacted by any dislocation in the mortgage-backed securities market in general.
CMBS are also subject to several risks created through the securitization process. Subordinate CMBS are paid interest only to the extent that there are funds available to make payments. To the extent the collateral pool includes delinquent loans, there is a risk that interest payments on subordinate CMBS will not be fully paid. Subordinate CMBS are also subject to greater credit
risk than those CMBS that are more highly rated. In certain instances, third-party guarantees or other forms of credit support can reduce the credit risk.
Our build-to-suit acquisitions are subject to additional risks related to properties under development.
From time to time, we engage in build-to-suit acquisitions and the acquisition of properties under development. In connection with these businesses, we enter into purchase and sale arrangements with sellers or developers of suitable properties under development or construction. In such cases, we are generally obligated to purchase the property at the completion of construction, provided that the construction conforms to definitive plans, specifications, and costs approved by us in advance, and if other conditions have been met such as there is an effective lease for the property, the tenant has accepted the property and commenced paying rent. We may also engage in development and construction activities involving existing properties, including the expansion of existing facilities (typically at the request of a tenant) or the development or build-out of vacant space at retail properties. We may advance significant amounts in connection with certain development projects.
As a result, we are subject to potential development risks and construction delays and the resultant increased costs and risks, as well as the risk of loss of certain amounts that we have advanced should a development project not be completed. To the extent that we engage in development or construction projects, we may be subject to uncertainties associated with obtaining permits or re-zoning for development, environmental and land use concerns of governmental entities and/or community groups, and the builder’s ability to build in conformity with plans, specifications, budgeted costs and timetables. If a developer or builder fails to perform, we may terminate the purchase, modify the construction contract or resort to legal action to compel performance (or in certain cases, we may elect to take over the project and pursue completion of the project ourselves). A developer’s or builder’s performance may also be affected or delayed by conditions beyond that party’s control. Delays in obtaining permits or completion of construction could also give tenants the right to terminate preconstruction leases.
We may incur additional risks if we make periodic progress payments or other advances to builders before they complete construction. These and other such factors can result in increased project costs or the loss of our investment. Although we rarely engage in construction activities relating to space that is not already leased to one or more tenants, to the extent that we do so, we may be subject to normal lease-up risks relating to newly constructed projects. We also will rely on rental income and expense projections and estimates of the fair market value of property upon completion of construction when agreeing upon a price at the time we acquire the property. If these projections are inaccurate, we may pay too much for a property and our return on our investment could suffer. If we contract with a development company for a newly developed property, there is a risk that money advanced to that development company for the project may not be fully recoverable if the developer fails to successfully complete the project.
Risks Related to the Services Agreement
Our continuing obligation to provide services to Cole Capital under the Services Agreement could have an adverse effect on our business operations.
In connection with the closing of the Cole Capital sale, we entered into the Services Agreement, pursuant to which we will continue to provide certain services, including operational real estate support, through March 31, 2019 (or, if later, the date of the last government filing other than a tax filing made by any of the Cole REITs with respect to its 2018 fiscal year) and will provide consulting and research services through December 31, 2023 as requested by CCA. Under the terms of the Services Agreement, we will be entitled to receive reimbursement for certain of the services provided and fees based on the future revenues of CCA above a specified dollar threshold (the “Net Revenue Payments”), up to an aggregate of $80.0 million in Net Revenue Payments. There is no assurance that we will be successful in managing these services so that they do not have an adverse effect on our business operations and there can be no assurance that we will receive any Net Revenue Payments after February 1, 2018, under the Services Agreement.
We are subject to conflicts of interest relating to the Cole REITs.
During the initial term of the Services Agreement, property acquisition opportunities will be allocated among us and the real estate programs sponsored by CCA pursuant to an asset allocation policy and in accordance with the terms of the Services Agreement. The Cole REITs have characteristics, including targeted investment types, and investment objectives and criteria substantially similar to our own. As a result, we may be seeking to acquire properties and real estate-related investments at the same time as the Cole REITs.
During the initial term of the Services Agreement, in the event that an investment opportunity is identified that may be suitable for more than one of us or the other programs sponsored by CCA and for which more than one of such entities has sufficient uninvested funds, then an allocation committee, which is comprised of employees of the Company and employees of CIM Group,
LLC, CCA or their respective affiliates, will examine the following factors, among others, in determining the entity for which the investment opportunity is most appropriate:
•
the investment objective of each entity;
•
the anticipated operating cash flows of each entity and the cash requirements of each entity;
•
the effect of the acquisition both on diversification of each entity’s investments by type of property, geographic area and tenant concentration;
•
the amount of funds available to each entity and the length of time such funds have been available for investment;
•
the policy of each entity relating to leverage of properties;
•
the income tax effects of the purchase to each entity; and
•
the size of the investment.
If, in the judgment of the allocation committee, the investment opportunity may be equally appropriate for more than one program, then the entity that has had the longest period of time elapse since it was allocated an investment opportunity of a similar size and type (e.g., office, industrial, retail properties or anchored shopping centers) will be allocated such investment opportunity. If a subsequent development, such as a delay in the closing of the acquisition or a delay in the construction of a property, causes any such investment, in the opinion of the allocation committee, to be more appropriate for an entity other than the entity that committed to make the investment, the allocation committee may determine that the Company or a program sponsored by CCA will make the investment.
For programs sponsored by CCA that commenced operations on or after March 5, 2013, the Company retains a right of first refusal for all opportunities to acquire real estate and real estate-related assets or portfolios with a purchase price greater than $100 million. This right of first refusal applies to CCIT II, CCIT III and CCPT V, but does not apply to CCPT IV or INAV.
There can be no assurance that these policies will be adequate to address all of the conflicts that may arise or will address such conflicts in a manner that is favorable to us.
Risks Related to our Organization and Structure
We are a holding company with no direct operations. As a result, we rely on funds received from the Operating Partnership to pay liabilities and dividends, our stockholders’ claims will be structurally subordinated to all liabilities of the Operating Partnership and our stockholders do not have any voting rights with respect to the Operating Partnership’s activities, including the issuance of additional OP Units.
We are a holding company and conduct all of our operations through the Operating Partnership. We do not have, apart from our ownership of the Operating Partnership, any independent operations. As a result, we rely on distributions from the Operating Partnership to pay any dividends we might declare on shares of our common stock. We also rely on distributions from the Operating Partnership to meet our debt service and other obligations, including our obligations to make distributions required to maintain our REIT qualification. The ability of subsidiaries of the Operating Partnership to make distributions to the Operating Partnership, and the ability of the Operating Partnership to make distributions to us in turn, will depend on their operating results and on the terms of any loans that encumber the properties owned by them. Such loans may contain lockbox arrangements, reserve requirements, financial covenants and other provisions that restrict the distribution of funds. In the event of a default under these loans, the defaulting subsidiary would be prohibited from distributing cash. As a result, a default under any of these loans by the borrower subsidiaries could cause us to have insufficient cash to make distributions on our common stock required to maintain our REIT qualification.
In addition, because we are a holding company, stockholders’ claims will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of the Operating Partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, claims of our stockholders will be satisfied only after all of our and the Operating Partnership’s and its subsidiaries’ liabilities and obligations have been paid in full.
As of December 31, 2017, we owned approximately 97.6% of the OP Units in the Operating Partnership. However, the Operating Partnership may issue additional OP Units in the future. Such issuances could reduce our ownership percentage in the Operating Partnership. Because our stockholders would not directly own any such OP Units, they would not have any voting rights with respect to any such issuances or other partnership-level activities of the Operating Partnership.
Our charter and bylaws and Maryland law contain provisions that may delay or prevent a change of control transaction.
Our charter, subject to certain exceptions, limits any person to actual or constructive ownership of no more than 9.8% in value of the aggregate of our outstanding shares of stock and not more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. In addition, our charter provides that we may not consolidate, merge, sell all or substantially all of our assets or engage in a share exchange unless such actions are approved by the affirmative vote of at least two-thirds of the Board of Directors. The ownership limits and the other restrictions on ownership and transfer of our stock and the Board approval requirements contained in our charter may delay or prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Certain provisions in the LPA may delay, defer or prevent unsolicited acquisitions of us.
Certain provisions in the LPA may delay or make more difficult unsolicited acquisitions of us or changes in our control. These provisions could discourage third parties from making such proposals, although some stockholders might consider such proposals, if made, desirable. These provisions include, among others:
•
redemption rights of qualifying parties;
•
the ability of the General Partner in some cases to amend the LPA without the consent of the limited partners;
•
the right of the limited partners to consent to transfers of the general partnership interest of the General Partner and mergers or consolidations of the Company under specified limited circumstances; and
•
restrictions relating to our qualification as a REIT under the Internal Revenue Code.
The LPA also contains other provisions that may have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Tax protection provisions on certain properties could limit our operating flexibility.
We have agreed with ARC Real Estate Partners, LLC, an affiliate of ARC Properties Advisors, LLC (the “Former Manager”), to indemnify it against any adverse tax consequences if we were to sell, convey, transfer or otherwise dispose of all or any portion of the interests in the properties that were acquired by us in our formation transactions, in a taxable transaction. These tax protection provisions apply until September 6, 2021, which is the 10th anniversary of the closing of our initial public offering (“IPO”). Although it may be in our stockholders’ best interest that we sell one or more of these properties, it may be economically disadvantageous for us to do so because of these obligations. We have also agreed to make debt available for ARC Real Estate Partners, LLC to guarantee. We agreed to these provisions at the time of our IPO in order to assist ARC Real Estate Partners, LLC in preserving its tax position after its contribution of its interests in our initial properties. As a result, we may be required to incur and maintain more debt than we would otherwise.
The Company’s fiduciary duties as sole general partner of the Operating Partnership could create conflicts of interest.
The Company has fiduciary duties to the Operating Partnership and the limited partners in the Operating Partnership, the discharge of which may conflict with the interests of its stockholders. The LPA provides that, in the event of a conflict between the duties owed by the Company’s directors to the Company and the duties that the Company owes in its capacity as the sole general partner of the Operating Partnership to the Operating Partnership’s limited partners, the Company’s directors are under no obligation to give priority to the interests of such limited partners. As a holder of OP Units, the Company will have the right to vote on certain amendments to the LPA (which require approval by a majority in interest of the limited partners, including the Company) and individually to approve certain amendments that would adversely affect the rights of the Operating Partnership’s limited partners, as well as the right to vote on mergers and consolidations of the Company in its capacity as sole general partner of the Operating Partnership in certain limited circumstances. These voting rights may be exercised in a manner that conflicts with the interests of the Company’s stockholders. For example, the Company cannot adversely affect the limited partners’ rights to receive distributions, as set forth in the LPA, without their consent, even though modifying such rights might be in the best interest of the Company’s stockholders generally.
The Board of Directors may change significant corporate policies without stockholder approval.
Our investment, financing, borrowing and dividend policies and our policies with respect to other activities, including growth, debt, capitalization and operations, will be determined by the Board of Directors. These policies may be amended or revised at any time and from time to time at the discretion of the Board of Directors without a vote of our stockholders. In addition, the Board of Directors may change our policies with respect to conflicts of interest provided that such changes are consistent with applicable legal requirements. A change in these policies could have an adverse effect on our business, financial condition, liquidity
and results of operations and our ability to satisfy our debt service obligations and to make distributions to our stockholders and unitholders.
Our rights and the rights of our stockholders to take action against our directors and officers are limited under Maryland law.
Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision and limits the liability of our directors and officers to the maximum extent permitted by Maryland law. Maryland law requires us to indemnify our directors and officers for liability actually incurred in connection with any proceeding to which they may be made, or threatened to be made, a party, except to the extent that the act or omission of the director or officer was material to the matter giving rise to the proceeding and was either committed in bad faith or was the result of active and deliberate dishonesty, the director or officer actually received an improper personal benefit in money, property or services, or, in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, our charter obligates us to advance the reasonable defense costs incurred by our directors and officers. Finally, we have entered into agreements with our directors and officers pursuant to which we have agreed to indemnify them to the maximum extent permitted by Maryland law.
U.S. Federal Income and Other Tax Risks
Our failure to remain qualified as a REIT would subject us to U.S. federal income tax and potentially state and local tax, and would adversely affect our operations and the market price of our capital stock.
We elected to be taxed as a REIT commencing with the taxable year ended December 31, 2011 and believe we have operated, and intend to operate, in a manner that has allowed us to qualify as a REIT and will allow us to continue to qualify as a REIT. However, we may terminate our REIT qualification if the Board of Directors determines that not qualifying as a REIT is in our best interests, or the qualification may be terminated inadvertently. Our qualification as a REIT depends upon our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. We structured our activities in a manner designed to satisfy the requirements for qualification as a REIT. However, the REIT qualification requirements are extremely complex and interpretation of the U.S. federal income tax laws governing qualification as a REIT is limited. Accordingly, we cannot be certain that we have been or will be successful in qualifying to be taxed as a REIT. Our ability to satisfy the asset tests depends on our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the annual income and quarterly asset requirements also depends on our ability to successfully manage the composition of our income and assets on an ongoing basis. Accordingly, if certain of our operations were to be recharacterized by the Internal Revenue Service (the “IRS”), such recharacterization would jeopardize our ability to satisfy the requirements for qualification as a REIT. Furthermore, future legislative, judicial or administrative changes to the U.S. federal income tax laws could result in our disqualification as a REIT for past or future periods.
If we fail to qualify as a REIT for any taxable year and we do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT qualification. Losing our REIT qualification would reduce our net earnings because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the dividends paid deduction, and we would no longer be required to make distributions and, accordingly, distributions the Operating Partnership makes to its unitholders could be similarly reduced. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.
Even if we continue to qualify as a REIT, in certain circumstances, we may incur tax liabilities that would reduce our cash available for distribution to our stockholders and unitholders.
Even if we continue to qualify as a REIT, we may be subject to U.S. federal, state and local income taxes. For example, net income from the sale of properties that are considered held for sale and not for investment (a “prohibited transaction” under the Internal Revenue Code) will be subject to a 100% tax. In addition, we may not make sufficient distributions to avoid income and excise taxes on retained income. We also may decide to retain net capital gain we earn from the sale or other disposition of our property or other assets and pay U.S. federal income tax directly on such income. In that event, our stockholders would be treated for federal income tax purposes as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability unless they file U.S. federal income tax returns and thereon seek a refund of such tax. We may, in certain circumstances, be required to pay an excise or penalty tax (which could be significant in amount) in order to utilize one or more relief provisions under the Internal Revenue Code to maintain our qualification as a REIT.
A REIT may own up to 100% of the stock of one or more TRSs. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS of the REIT. A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT. We may use TRSs generally to hold properties for sale in the ordinary course of business or to hold assets or conduct activities that we cannot conduct directly as a REIT. Our TRSs will be subject to applicable U.S. federal, state, local and foreign income tax on their taxable income. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to ensure that the TRS is subject to an appropriate level of corporate taxation. These rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.
Not all taxing jurisdictions recognize the favorable tax treatment afforded to REITs under the Internal Revenue Code. As such, we may be subject to regular corporate net income taxes in certain state, local or foreign taxing jurisdictions. In addition, we, the Operating Partnership, our TRSs, and/or other entities through which we conduct our business may also be subject to state, local or foreign income, franchise, sales, transfer, excise or other taxes. Any taxes that we incur directly or indirectly will reduce our cash available for distribution to our stockholders and unitholders. Additionally, changes in state, local or foreign tax law could reduce the cash flow from certain investments made by us and could make such investments less attractive to potential buyers when we seek to liquidate such investments.
To qualify as a REIT we must meet annual distribution requirements, which may force us to forgo otherwise attractive opportunities or borrow funds during unfavorable market conditions. This could delay or hinder our ability to meet our investment objectives and reduce your overall return.
In order to qualify as a REIT, we must distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with U.S. GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. We will be subject to U.S. federal income tax on our undistributed taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which dividends we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. These requirements could cause us to distribute amounts that otherwise would be spent on investments in real estate assets and it is possible that we might be required to borrow funds, possibly at unfavorable rates, or sell assets to fund these dividends or make taxable stock dividends. Although we intend to make distributions sufficient to meet the annual distribution requirements and to avoid U.S. federal income and excise taxes on our earnings while we qualify as a REIT, it is possible that we might not always be able to do so.
If the Operating Partnership or certain other subsidiaries fail to qualify as a partnership or are not otherwise disregarded for U.S. federal income tax purposes, then we would cease to qualify as a REIT.
We intend to maintain the status of the Operating Partnership as a partnership for U.S. federal income tax purposes. However, if the IRS were to successfully challenge the status of the Operating Partnership as a partnership for such purposes, it would be taxable as a corporation. This would result in our failure to qualify as a REIT and would cause us to be subject to a corporate-level tax on our income. This would substantially reduce our cash available to pay distributions and the yield on your investments. In addition, if one or more of the partnerships or limited liability companies through which the Operating Partnership owns its properties, in whole or in part, loses its characterization as a partnership and is otherwise not disregarded for U.S. federal income tax purposes, then it would be subject to taxation as a corporation, thereby reducing distributions to the Operating Partnership. Such a recharacterization of a subsidiary entity could also threaten our ability to maintain our REIT qualification.
Recent legislation substantially modified the taxation of REITs and their shareholders, and the effects of such legislation and related regulatory action are uncertain.
On December 22, 2017, President Trump signed into law H.R. 1, informally titled the Tax Cuts and Jobs Act (the “TCJA”). The TCJA makes major changes to the Code, including a number of provisions of the Code that affect the taxation of REITs and their stockholders. Among the changes made by the TCJA are permanently reducing the generally applicable corporate tax rate, generally reducing the tax rate applicable to individuals and other non-corporate taxpayers for tax years beginning after December 31, 2017 and before January 1, 2026, eliminating or modifying certain previously allowed deductions (including substantially limiting interest deductibility and, for individuals, the deduction for non-business state and local taxes), and, for taxable years beginning after December 31, 2017 and before January 1, 2026, providing for preferential rates of taxation through a deduction of up to 20% (subject to certain limitations) on most ordinary REIT dividends and certain trade or business income of non-corporate taxpayers. The TCJA also imposes new limitations on the deduction of net operating losses and requires us to recognize income for tax purposes no later than when we take it into account on our financial statements, which may result in us having to make additional taxable distributions to our stockholders in order to comply with REIT distribution requirements or avoid taxes on retained income and gains. The effect of the significant changes made by the TCJA is highly uncertain, and administrative guidance will be required in order to fully evaluate the effect of many provisions. The effect of any technical corrections with respect to the TCJA could have an adverse effect on us or our stockholders. Investors should consult their tax advisors regarding the implications of the TCJA on their investment in our capital stock.
Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.
Currently, the maximum U.S. federal income tax rate applicable to qualified dividend income payable to U.S. stockholders that are individuals, trusts and estates is 20% (not including the net investment income tax). Dividends payable by REITs, however, generally are not eligible for this reduced rate. Although this does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock. Pursuant to the TCJA, non-corporate recipients of dividends from a REIT (other than capital gains dividends and dividends eligible for treatment as qualified dividends) may deduct up to 20% of such REIT dividends for taxable years beginning before January 1, 2026. This deduction mitigates but does not eliminate the difference in effective tax rates between REIT dividends and dividends paid by C corporations.
If we were considered to have actually or constructively paid a “preferential dividend” to certain of our stockholders, our status as a REIT could be adversely affected.
For our taxable years that ended on or before December 31, 2014, and for any year in which we fail to be a “publicly offered” REIT within the meaning of Section 562 of the Code, in order for our distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction, the distributions could not have been “preferential dividends.” We believe we qualify as a publicly offered REIT, but there can be no assurance that we will continue to so qualify. A dividend is not a preferential dividend if the distribution is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences among different classes of stock as set forth in our organizational documents. There is uncertainty as to the IRS’s position regarding whether certain arrangements that REITs have with their stockholders could give rise to the inadvertent payment of a preferential dividend. While we believe that our operations have been structured in such a manner that we will not be treated as inadvertently paying preferential dividends, there is no de minimis or reasonable cause exception with respect to preferential dividends under the Internal Revenue Code. Therefore, if the IRS were to take the position that we inadvertently paid a preferential dividend prior to January 1, 2015 (or any later year in which we are not a publicly offered REIT), we may be deemed either to (a) have distributed less than 100% of our REIT taxable income and be subject to tax on the undistributed portion, or (b) have distributed less than 90% of our REIT taxable income and our status as a REIT could be terminated for the year in which such determination is made and for the four taxable years following the year of termination if we were unable to cure such failure.
Complying with REIT requirements may limit our ability to hedge our liabilities effectively and may cause us to incur tax liabilities.
The REIT provisions of the Internal Revenue Code may limit our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets or to offset certain other positions, if properly identified under applicable Treasury Regulations, does not constitute “gross income” for purposes of the 75% or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions will likely be treated as non-qualifying income for purposes of one or both of the gross income tests. As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit, except for being carried forward against future taxable income of such TRS.
Complying with REIT requirements may force us to forgo or liquidate otherwise attractive investment opportunities.
To qualify as a REIT, we must ensure that we meet the REIT gross income tests annually and that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and certain kinds of mortgage-related securities. The remainder of our investment in securities (other than government securities, qualified real estate assets and stock of a TRS) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities, qualified real estate assets and stock of a TRS) can consist of the securities of any one issuer, no more than 20% of the value of our total assets can be represented by securities of one or more TRSs and no more than 25% of the value of our total assets can be represented by certain debt securities of publicly offered REITs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate assets from our portfolio or not make otherwise attractive investments in order to maintain our qualification as a REIT. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
Re-characterization of sale-leaseback transactions may cause us to lose our REIT status.
We may purchase properties and lease them back to the sellers of such properties. The Internal Revenue Service could challenge our characterization of certain leases in any such sale-leaseback transactions as “true leases,” which allows us to be treated as the owner of the property for U.S. federal income tax purposes. In the event that any sale-leaseback transaction is challenged and re-characterized as a financing transaction or loan for U.S. federal income tax purposes, deductions for depreciation and cost recovery relating to such property would be disallowed. If a sale-leaseback transaction were so re-characterized, we might fail to satisfy the REIT qualification “asset tests” or the “income tests” and, consequently, lose our REIT status effective with the year of re-characterization. Alternatively, such a recharacterization could cause the amount of our REIT taxable income to be recalculated, which might also cause us to fail to meet the distribution requirement for a taxable year and thus lose our REIT status.
We may incur adverse tax consequences if ARCT III, CapLease, ARCT IV, Cole or CCPT failed to qualify as a REIT for U.S. federal income tax purposes.
The tax years subsequent to and including the fiscal year ended December 31, 2013 remain open to examination by the major taxing jurisdictions to which the OP, the General Partner, American Realty Capital Trust III, Inc. (“ARCT III”), CapLease, Inc. (“CapLease”), American Realty Capital Trust IV, Inc., (“ARCT IV”), Cole Real Estate Investments, Inc. (“Cole”) and Cole Credit Property Trust, Inc. (“CCPT”) are subject. If any of ARCT III, CapLease, ARCT IV, Cole or CCPT failed to qualify as a REIT for U.S. federal income tax purposes at any time prior to such entity’s merger with us, we may inherit significant tax liabilities and could fail to qualify as a REIT.
We may be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the market price of our capital stock.
In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of U.S. federal income tax laws applicable to investments similar to an investment in shares of our common stock. Additional changes to the tax laws are likely to continue to occur, and we cannot assure you that any such changes will not adversely affect our taxation and our ability to qualify as a REIT or the taxation of a stockholder. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets. Our stockholders are urged to consult with their tax advisor
with respect to the impact of recent legislation on their investment in our shares and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares.
Although REITs generally receive better tax treatment than entities taxed as regular corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be treated for U.S. federal income tax purposes as a regular corporation. As a result, our charter provides the Board of Directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a regular corporation, without the vote of our stockholders. The Board of Directors has fiduciary duties to us and our stockholders and could only cause such changes in our tax treatment if it determines in good faith that such changes are in the best interest of our stockholders.
Non-U.S. stockholders may be subject to U.S. federal withholding tax and may be subject to U.S. federal income tax upon the disposition of our shares.
Gain recognized by a non-U.S. stockholder upon the sale or exchange of our common stock generally will not be subject to U.S. federal income taxation unless such stock constitutes a “U.S. real property interest” (“USRPI”) under the Foreign Investment in Real Property Tax Act of 1980 (the “FIRPTA”). Our common stock will not constitute a USRPI so long as we are a “domestically-controlled qualified investment entity.” A domestically-controlled qualified investment entity includes a REIT if at all times during a specified testing period, less than 50% in value of such REIT’s stock is held directly or indirectly by non-U.S. stockholders. We believe that we are a domestically-controlled qualified investment entity. However, because our common stock is and will be publicly traded, no assurance can be given that we are or will be a domestically-controlled qualified investment entity.
Even if we do not qualify as a domestically-controlled qualified investment entity at the time a non-U.S. stockholder sells or exchanges our common stock, gain arising from such a sale or exchange would not be subject to U.S. taxation under FIRPTA as a sale of a USRPI if: (a) our common stock is “regularly traded,” as defined by applicable Treasury regulations, on an established securities market, and (b) such non-U.S. stockholder owned, actually and constructively, 10% or less of our common stock at any time during the five-year period ending on the date of the sale. We anticipate that our shares will be “regularly traded” on an established securities market for the foreseeable future, although, no assurance can be given that this will be the case. We encourage you to consult your tax advisor to determine the tax consequences applicable to you if you are a non-U.S. stockholder.
Our property taxes could increase due to property tax rate changes or reassessment, which would impact our cash flows.
Even if we qualify as a REIT for federal income tax purposes, we will be required to pay some state and local taxes on our properties. The real property taxes on our properties may increase as property tax rates change or as our properties are assessed or reassessed by taxing authorities. Therefore, the amount of property taxes we pay in the future may increase substantially. If the property taxes we pay increase and if any such increase is not reimbursable under the terms of our lease, then our cash flows will be impacted, and our ability to pay expected distributions to our stockholders and unitholders could be adversely affected.
The share ownership restrictions of the Internal Revenue Code for REITs and the 9.8% share ownership limit in our charter may inhibit market activity in our shares of stock and restrict our business combination opportunities.
In order to qualify as a REIT, five or fewer individuals, as defined in the Internal Revenue Code, may not own, actually or constructively, more than 50% in value of our issued and outstanding shares of stock at any time during the last half of each taxable year, other than the first year for which a REIT election is made. Attribution rules in the Internal Revenue Code determine if any individual or entity actually or constructively owns our shares of stock under this requirement. Additionally, at least 100 persons must beneficially own our shares of stock during at least 335 days of a taxable year for each taxable year, other than the first year for which a REIT election is made. To help insure that we meet these tests, among other purposes, our charter restricts the acquisition and ownership of our shares of stock.
Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT while we so qualify. Unless exempted by the Board of Directors, for so long as we qualify as a REIT, our charter prohibits, among other limitations on ownership and transfer of shares of our stock, any person from beneficially or constructively owning (applying certain attribution rules under the Internal Revenue Code) more than 9.8% in value of the aggregate of our outstanding shares of stock and more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. The Board of Directors, in its sole discretion and upon receipt of certain representations and undertakings, may exempt a person (prospectively or retrospectively) from the ownership limits. However, the Board of Directors may not, among other limitations, grant an exemption from these ownership restrictions to any proposed transferee whose ownership, direct or indirect, in excess of the 9.8% ownership limit would result in the termination of our qualification as a REIT. These restrictions on transferability and ownership will not apply, however, if the Board of Directors determines that it is no longer in our best interest to continue to qualify as a REIT or that compliance with the restrictions is no longer required in order for us
to continue to so qualify as a REIT. These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
Our principal corporate offices are located at 2325 E. Camelback Road, Suite 1100, Phoenix, Arizona 85016. We have additional office space in New York, New York; Orlando, Florida; Alpharetta, Georgia; Austin, Texas, Washington, D.C.; Los Angeles, California; and Glenview, Illinois. We lease all of these offices, other than our office space in Glenview, Illinois, which was acquired in 2013. We believe these properties we own and lease are suitable for our operations for the foreseeable future.
As of December 31, 2017, omitting the Excluded Property, the Company owned 4,091 operating properties comprising 94.4 million square feet of retail and commercial space located in 49 states, Puerto Rico and Canada, which includes properties owned through consolidated joint ventures. The rentable space at these properties was 98.8% leased with a weighted-average remaining lease term of 9.5 years. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Real Estate Portfolio Metrics for a discussion of the properties we hold for rental operations and Schedule III - Real Estate and Accumulated Depreciation for a detailed listing of such properties.
Item 3.
Item 3. Legal Proceedings.
The information contained under the heading “Litigation” in “Note 14 - Commitments and Contingencies” to our consolidated financial statements is incorporated by reference into this Part I, Item 3. Except as set forth therein, as of the end of the period covered by this Annual Report on Form 10-K, we are not a party to, and none of our properties are subject to, any material pending legal proceedings.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Effective July 31, 2015, we transferred the listing of the General Partner’s common stock and Series F Preferred Stock to the NYSE from NASDAQ Global Select Market. The General Partner’s common stock and Series F Preferred Stock trade under the trading symbols, “VER” and “VER PRF,” respectively.
Stock Price Performance Graph
Set forth below is a line graph comparing the cumulative total stockholder return on the General Partner’s common stock, based on the market price of the common stock and assuming reinvestment of dividends, with the FTSE National Association of Real Estate Investment Trusts All Equity REITs Index (“FTSE NAREIT All Equity REITs”) and the S&P 500 Index (“S&P 500”) for the period commencing December 31, 2012 and ending December 31, 2017. The graph assumes an investment of $100 on December 31, 2012.
The graph above and the accompanying text are not “soliciting material,” are not deemed filed with the SEC and are not to be incorporated by reference in any filing by us under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. In addition, the stock price performance in the graph above is not indicative of future stock price performance.
Stock Price and Distributions
For each quarter indicated, the following table reflects the respective high and low sales prices for the General Partner’s common stock as quoted by the NYSE, as applicable, and the dividend or distribution declared per share of common stock or OP Unit by the General Partner or the Operating Partnership, respectively, in each such period:
_______________________________________________
(1)
The dividend that the General Partner pays on its common stock is equal to the distributions that the Operating Partnership makes on its OP Units pursuant to the terms of the LPA. However, the Operating Partnership did not make distributions in respect of a substantial portion of the outstanding OP Units held by its limited partners beginning on October 15, 2015 and continuing through January 16, 2018 when the dividend on the General Partner’s common stock was paid, as further discussed in “Note 16 - Equity” in our consolidated financial statements.
On February 21, 2018, the Company’s board of directors declared a quarterly cash dividend of $0.1375 per share of common stock (equaling an annualized dividend rate of $0.55 per share) for the first quarter of 2018 to stockholders of record as of March 30, 2018, which will be paid on April 16, 2018. An equivalent distribution by the Operating Partnership is applicable per OP Unit. Our future distributions may vary and will be determined by the General Partner’s Board of Directors based upon the circumstances prevailing at the time, including our financial condition, operating results, estimated taxable income and REIT distribution requirements, and may be adjusted at the discretion of the Board.
As of February 20, 2018, the General Partner had approximately 3,700 registered stockholders of record of its common stock. This figure does not reflect the beneficial ownership of shares held in nominee name. There is no established trading market for the Operating Partnership's OP Units. As of February 20, 2018, there were 29 record holders of the OP Units.
Recent Sales of Unregistered Securities
During the year ended December 31, 2017, the Company did not redeem any Limited Partner OP Units for shares of the General Partner's common stock.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table shows the amount of securities remaining available for future issuance under our equity compensation plans as of December 31, 2017:
_______________________________________________
(1)
The total number of shares of common stock reserved for the issuance of equity incentive awards under our Equity Plan is equal to 10.0% of the total number of issued and outstanding shares of our common stock (on a fully diluted basis assuming the redemption of all OP Units for shares of common stock) at any time. As such, the number of shares available for issuance under the Equity Plan changes automatically with changes in the total number of outstanding shares of common stock, outstanding OP Units, and dilutive securities. See “Note 16 - Equity-based Compensation to our consolidated financial statements for a discussion of the Company’s equity plans.
Repurchases of Equity Securities
We are authorized to repurchase shares of the General Partner’s common stock to satisfy employee withholding tax obligations related to stock-based compensation. During the year ended December 31, 2017, the General Partner and the Operating Partnership repurchased the following shares of common stock and corresponding OP Units that were issued to the General Partner, respectively, in order to satisfy the minimum tax withholding obligation for state and federal payroll taxes on employee stock awards:
_________________________________________
(1)
With respect to these shares/units, the price paid per share/unit is based on the weighted average closing price on the respective vesting date.
Item 6.
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with the accompanying consolidated financial statements and related notes thereto and “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this report entitled “Forward-Looking Statements.” Certain risks may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the section in this report entitled “Risk Factors.”
Overview
VEREIT is a full-service real estate operating company which owns and manages one of the largest portfolios of single-tenant commercial properties in the U.S. The Company has 4,091 retail, restaurant, office and industrial operating properties with an aggregate 94.4 million square feet, of which 98.8% was leased as of December 31, 2017, with a weighted-average remaining lease term of 9.5 years.
Prior to the fourth quarter of 2017, we operated through two business segments, our real estate investment segment and our investment management segment, Cole Capital, which sponsored and managed non-listed real estate investment trusts. On November 13, 2017, we entered into the Cole Capital Purchase and Sale Agreement to sell substantially all of the Cole Capital segment. The sale closed on February 1, 2018. Substantially all of the Cole Capital segment is presented as discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented. See Note 5 -Discontinued Operations, for further information on the sale of Cole Capital.
Effective January 1, 2017, we determined that adjusted funds from operations (“AFFO”), a non-GAAP measure, and our real estate portfolio and economic metrics, should exclude the impact of properties owned by the Company for the month beginning with the date that (i) the properties’ related mortgage loan is in default and (ii) management decides to transfer the properties to the lender in connection with settling the mortgage note obligation, and ending with the disposition date ("Excluded Properties"), to better reflect our ongoing operations. Excluded Properties during the year ended December 31, 2017, were two vacant office properties and five industrial properties, two of which were vacant. Excluded Properties at December 31, 2017, included one vacant industrial property, comprised of 307,275 square feet, which secured a mortgage note payable, with debt outstanding of $16.2 million. The Company did not update data presented for prior periods for this change as it determined the impact on our prior periods was immaterial.
Our Business Environment and Current Outlook
Current conditions in the global capital markets remain volatile as the world’s economic growth has been affected by geopolitical and economic events. In the United States, the overall economic environment continued to improve in 2017. During 2017, the U.S. real gross domestic product increased 2.3%, the unemployment rate decreased 0.6 percentage points to 4.1%, and Core CPI, a measure of inflation which removes food & energy prices and is seasonally adjusted, increased 1.8%, as compared to the same period a year earlier.
Economic trends and government policies affect global and regional commercial real estate markets as well as our operations directly. These include: overall economic activity and employment growth, interest rate levels, the cost and availability of credit and the impact of tax and regulatory policies.
Critical Accounting Policies and Significant Accounting Estimates
Our accounting policies have been established to conform with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires us to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management believes that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different assumptions or estimates that may impact comparability of our results of operations to those of companies in similar businesses. We believe the following critical accounting policies govern the significant judgments and estimates used in the preparation of our financial statements, which should be read in conjunction with the more complete discussion of our accounting policies and procedures included in “Note 2 - Summary of Significant Accounting Policies” to our consolidated financial statements.
Goodwill Impairment
We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable. We adopted ASU 2017-04, Intangibles - Goodwill and Others (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which simplifies the measurement of goodwill impairment by eliminating Step 2 from the goodwill impairment test (comparing the implied fair value of goodwill with the carrying amount of goodwill). The risks and uncertainties involved in applying the principles related to goodwill impairment include, but are not limited to, the following:
•
We estimate the fair value using discounted cash flows and relevant competitor multiples.
•
We monitor factors that may impact the fair value including market comparable company multiples, interest rates and global economic conditions.
•
We use a combined income and market approach in evaluations for potential impairment, which requires management to make key assumptions related to revenue growth rate, cash flow assumptions, discount rate and selection of comparable companies.
See “Note 9 - Fair Value Measures” for discussion regarding our sensitivity analysis performed around these assumptions.
Real Estate Investment Impairment
We invest in real estate assets and subsequently monitor those investments quarterly for impairment, including the review of real estate properties subject to direct financing leases. Additionally, we record depreciation and amortization related to our investments. The risks and uncertainties involved in applying the principles related to real estate investments include, but are not limited to, the following:
•
The estimated useful lives of our depreciable assets affect the amount of depreciation and amortization recognized on our investments.
•
The review of impairment indicators and subsequent determination of the undiscounted future cash flows could require us to reduce the value of assets and recognize an impairment loss.
•
The fair value of held for sale assets is estimated by management. This estimated value could result in a reduction of the carrying value of the asset.
•
Changes in assumptions based on actual results may have a material impact on the Company’s financial results.
Loans Held for Investment Impairment
We evaluate loans held for investment on a quarterly basis. As a first step in the notes receivable impairment process, we must determine, based on current information and events, if it is probable that we will be unable to collect the amounts due in accordance with the loan agreement. The risks and uncertainties involved in applying the principles related to notes receivable include, but are not limited to, the following:
•
Evaluating the financial condition and other current obligations of the borrower involves judgment in assessing their liquidity and financial stability.
Allocation of Purchase Price of Real Estate Assets
In connection with our acquisition of properties, we allocate the purchase price to the tangible and intangible assets and
liabilities acquired based on their respective estimated fair values. Tangible assets consist of land, buildings, fixtures and tenant improvements. Intangible assets consist of above- and below- market lease values and the value of in-place leases. Our purchase price allocations are developed utilizing third-party appraisal reports, industry standards and management experience. The risks and uncertainties involved in applying the principles related to purchase price allocations include, but are not limited to, the following:
•
The value allocated to land as opposed to buildings, fixtures and tenant improvements affects the amount of depreciation expense we record. If more value is attributed to land, depreciation expense is lower than if more value is attributed to buildings, fixtures and tenant improvements;
•
Intangible lease assets and liabilities can be significantly affected by estimates, including market rent, lease term including renewal options at rental rates below estimated market rental rates, carrying costs of the property during a hypothetical expected lease-up period, and current market conditions and costs, including tenant improvement allowances and rent concessions; and
•
We determine whether any financing assumed is above- or below- market based upon comparison to similar financing terms for similar investment properties.
Income Taxes
As a REIT, the General Partner generally is not subject to federal income tax on taxable income that it distributes to its shareholders as long as it distributes at least 90% of its annual taxable income (computed without regard to the deduction for dividends paid and excluding net capital gains), with the exception of its TRS entities. However, the General Partner, including its TRS entities, and the Operating Partnership are still subject to certain state and local income and franchise taxes in the various jurisdictions in which they operate.
We provide for income taxes in accordance with current authoritative accounting and tax guidance. The tax provision or benefit related to significant or unusual items is recognized in the quarter in which those items occur. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the quarter in which the change occurs. The risks and uncertainties involved in applying the principles related to income taxes include, but are not limited to, the following:
•
Our calculations related to income taxes contain uncertainties due to judgment used to calculate tax liabilities in the application of complex tax laws and regulations across the tax jurisdictions where we operate;
•
We file income tax returns in the U.S. federal jurisdiction, the Canadian federal jurisdiction and various state and local jurisdictions, and are subject to routine examinations by the respective tax authorities. We may be challenged upon review by the applicable taxing authorities, and positions we have taken may not be sustained; and
•
The accounting estimates used to compute the provision for or benefit from income taxes may change as new events occur, additional information is obtained or the tax environment changes.
Recently Issued Accounting Pronouncements
Recently issued accounting pronouncements are described in “Note 2 - Summary of Significant Accounting Policies” to our consolidated financial statements.
Operating Highlights and Key Performance Indicators
2017 Activity
•
Acquired controlling financial interests in 88 commercial properties and three land parcels for an aggregate purchase price of $748.8 million, which includes $3.3 million of external acquisition-related expenses that were capitalized and 22 properties acquired in a nonmonetary exchange.
•
Disposed of 137 properties, including six properties relinquished by foreclosure or deed-in-lieu of foreclosure transactions, for an aggregate sales price of $594.9 million, of which our share was $574.4 million, resulting in consolidated proceeds of $445.5 million after a mortgage loan assumption and closing costs, including 15 properties disposed of in connection with a nonmonetary exchange.
•
Total secured debt decreased by $579.9 million, from $2.7 billion to $2.1 billion.
•
Closed 2017 Bond Offering of $600.0 million and repaid all of the outstanding borrowings under our $500.0 million Credit Facility Term Loan.
•
Declared a quarterly dividend of $0.1375 per share of common stock for each quarter of 2017, representing an annualized dividend rate of $0.55 per share.
•
Entered into a purchase and sale agreement to sell substantially all of Cole Capital.
Real Estate Portfolio Metrics
In managing our portfolio, we are committed to diversification by property type, tenant, geography and industry. Below is a summary of our operating property type diversification and our top ten concentrations as of December 31, 2017, based on annualized rental income of $1.2 billion,
Our financial performance is influenced by the timing of acquisitions and dispositions and the operating performance of our real estate properties. The following table shows the property statistics of our operating properties, excluding properties owned through our unconsolidated joint ventures as of December 31, 2017, 2016 and 2015:
____________________________________
(1)
Omits the impact, if any, of the Excluded Properties.
(2)
Economic occupancy rate equals the sum of square feet leased (including space subject to month-to-month agreements) divided by total square feet.
(3)
Investment-grade tenants are those with a credit rating of BBB- or higher by Standard & Poor’s Financial Services LLC or a credit rating of Baa3 or higher by Moody’s Investor Service, Inc. The ratings may reflect those assigned by Standard & Poor’s Financial Services LLC or Moody’s Investor Service, Inc. to the lease guarantor or the parent company, as applicable.
The following table shows the economic metrics of our operating properties, excluding properties owned through our unconsolidated joint ventures, as of December 31, 2017, 2016 and 2015:
____________________________________
(1)
Omits the impact, if any, of the Excluded Properties.
(2)
Based on annualized rental income of our real estate portfolio as of December 31, 2017.
(3)
Through the end of the next five years as of the respective reporting date.
Operating Performance
In addition, management uses the following financial metrics to assess our operating performance (dollar amounts in thousands, except per share amounts). Data presented includes both continuing operations, which primarily represent the Company's real estate operations, and discontinued operations, which represent substantially all of Cole Capital, except as otherwise indicated.
____________________________________
(1)
Represents continuing operations as presented on the statement of operations in accordance with GAAP.
(2)
See “Note 18 - Net Income (Loss) Per Share/Unit” for calculation of net income (loss) per share.
(3)
See the “Non-GAAP Measures” section below for descriptions of our non-GAAP measures and reconciliations to the most comparable U.S. GAAP measure.
Property Financing
Our mortgage notes payable consisted of the following as of December 31, 2017, 2016 and 2015 (dollar amounts in thousands):
_______________________________________________
(1)
Mortgage notes payable have fixed rates or are fixed by way of interest rate swap arrangements. Effective interest rates ranged from 3.1% to 7.2% at December 31, 2017, 2.00% to 7.75% at December 31, 2016, and 3.10% to 10.68% at December 31, 2015.
(2)
Weighted average interest rate is computed using the interest rate in effect until the anticipated repayment date. Should the loan not be repaid at the anticipated repayment date, the applicable interest rate would increase as specified in the respective loan agreement until the extended maturity date.
(3)
Weighted average years remaining to maturity is computed using the anticipated repayment date as specified in each loan agreement, where applicable.
(4)
Omits the Excluded Property and the related outstanding loan amount of $16.2 million and interest rate of 9.48%.
In addition, we have financing which is not secured by interests in real property, which is described under “Liquidity and Capital Resources.”
Future Lease Expirations
The following is a summary of lease expirations for the next 10 years and beyond at the operating properties we owned as of December 31, 2017 (dollar amounts and square feet in thousands):
_______________________________________________
(1)
The Company has certain leases comprised of multiple properties.
Results of Operations
Prior to the fourth quarter of 2017, the Company operated through two business segments, the real estate investment segment and the investment management segment, Cole Capital. On November 13, 2017, the Company entered into a purchase and sale agreement to sell substantially all of the Cole Capital segment. The sale closed on February 1, 2018. Substantially all of the Cole Capital segment is presented as discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented. The Company's continuing operations represent primarily those of the real estate investment segment.
Rental Income
The table below sets forth, for the periods presented, rental income information and the dollar amount change year over year (dollar amounts in thousands):
2017 vs 2016 - The decrease in rental income of $75.8 million during the year ended December 31, 2017 as compared to the year ended December 31, 2016 was primarily due to the disposition of 438 consolidated properties subsequent to January 1, 2016.
2016 vs 2015 - Rental revenue decreased $112.5 million during the year ended December 31, 2016, of which $105.6 million was due to the disposition of 529 consolidated properties subsequent to January 1, 2015. The decrease was also due to an increase in tenant vacancies, particularly Ovation Brands, Inc., which filed for chapter 11 bankruptcy on March 7, 2016 (the “Ovation Bankruptcy”).
Operating Expenses
The table below sets forth, for the periods presented, certain operating expense information and the dollar amount change year over year (dollar amounts in thousands):
Acquisition-Related Expenses
Subsequent to the adoption of ASU 2017-01 as discussed in “Note 2 - Summary of Significant Accounting Policies” to our consolidated financial statements, acquisition-related expenses consist primarily of internal salaries allocated to acquisition-related activities and costs incurred for deals that were not consummated.
2017 vs 2016 - The increase of $2.1 million in acquisition-related expenses for the year ended December 31, 2017, as compared to the same period in 2016 was primarily due to an increase in allocated internal salaries resulting from time spent on acquiring commercial properties during the year ended December 31, 2017. The Company resumed property acquisitions in the fourth quarter of 2016 and acquired 88 properties and three land parcels for an aggregate purchase price of $748.8 million during the year ended December 31, 2017.
2016 vs 2015 - The Company acquired an interest in eight commercial properties for a purchase price of $100.2 million during the year ended December 31, 2016 as compared with the acquisition of 16 properties for an aggregate purchase price of $36.3 million during the year ended December 31, 2015. The decrease in acquisition related expenses of $4.9 million during the year
ended December 31, 2016 was due to a decrease in costs incurred for deals that were not consummated and fewer properties acquired in 2016.
Litigation, Merger and Other Non-routine Costs, Net of Insurance Recoveries
2017 vs 2016 - The increase of $44.1 million during the year ended December 31, 2017 as compared to the same period in 2016 was due to an increase of $25.2 million in legal fees incurred related to the Audit Committee Investigation and related litigation and investigations during the year ended December 31, 2017 as compared to the same period in 2016. Additionally, the Company recognized $21.2 million of insurance recoveries during the year ended December 31, 2016, of which $10.5 million related to litigation resulting from prior mergers and $10.7 million related to the Audit Committee Investigation and related litigation and investigations. No insurance recoveries were recognized during the year ended December 31, 2017 related to the litigation resulting from prior mergers.
2016 vs 2015 - The decrease of $29.7 million during the year ended December 31, 2016 was primarily due to a $20 million decrease in legal fees incurred for litigation arising from the results of the Audit Committee Investigation and related litigation and investigations. Additionally, the Company recognized insurance recoveries of $21.2 million during the year ended December 31, 2016 as compared to $11.4 million in 2015.
Property Operating Expenses and Operating Expense Reimbursements
The table below sets forth, for the periods presented, the property operating expenses, net of operating expense reimbursements, and the dollar amount change year over year (dollar amounts in thousands):
2017 vs 2016 - Property operating expenses such as taxes, insurance, ground rent and maintenance include both reimbursable and non-reimbursable property expenses. Operating expense reimbursement revenue represents reimbursements for such costs that are reimbursable by the tenants per their respective leases. The decrease in net property operating expenses of $8.4 million during the year ended December 31, 2017 as compared to the same period in 2016 was primarily due to the disposition of vacant properties and certain properties subject to double-net or modified gross leases.
2016 vs 2015 - The net increase of $6.7 million during the year ended December 31, 2016 was primarily due to an increase in tenant vacancies, particularly related to Ovation Brands, Inc., which filed for Chapter 11 bankruptcy on March 7, 2016.
General and Administrative Expenses
2017 vs 2016 - The increase of $6.7 million during the year ended December 31, 2017 as compared to the same period in 2016 was primarily due to an increase of $6.8 million of compensation and benefits, including equity based compensation.
2016 vs 2015 - The decrease of $15.2 million during the year ended December 31, 2016 was primarily due to a decrease of $8.2 million in consulting and other professional fees in 2016. Additionally, during the year ended December 31, 2016, accounting fees decreased $2.1 million, primarily due to the work performed during the first quarter of 2015 in connection with the restatements, and legal fees decreased $2.7 million, primarily due to costs incurred in 2015 related to strategic, tax and regulatory matters.
Depreciation and Amortization Expenses
2017 vs 2016 - The decrease of $55.2 million during the year ended December 31, 2017 as compared to the same period in 2016 was primarily due to the disposition of 438 consolidated properties subsequent to January 1, 2016. The Company also recorded $50.5 million and $182.8 million of impairment charges on real estate investments during the years ended December 31, 2017 and 2016, respectively, which reduced the carrying value being depreciated and amortized.
2016 vs 2015 - The decrease of $59.7 million during the year ended December 31, 2016 primarily related to the disposition of 529 consolidated properties subsequent to January 1, 2015. The Company also recorded $182.8 million and $91.8 million of impairment charges on real estate investments during the year ended December 31, 2016 and 2015, respectively, which reduced the carrying value being depreciated and amortized.
Impairments
2017 vs 2016 - The decrease in impairments of $132.3 million during the year ended December 31, 2017 as compared to the same period in 2016 was primarily due to a decrease in the number of properties impaired from 153 during the year ended December 31, 2016 to 69 properties during the year ended December 31, 2017. In addition, the decrease was also due to management identifying certain properties for potential sale as part of its portfolio management strategy to reduce exposure to office properties during the year ended December 31, 2016 as well as the Ovation Bankruptcy during 2016.
2016 vs 2015 - The increase in impairments of $91.1 million during the year ended December 31, 2016 was primarily due to management identifying certain properties for potential sale as part of its portfolio management strategy to reduce exposure to office properties, as well as the Ovation Bankruptcy.
Other (Expense) Income, Income Tax (Provision) Benefit and Loss from Discontinued Operations
The table below sets forth, for the periods presented, certain financial information and the dollar amount change year over year (dollar amounts in thousands):
Interest Expense
2017 vs 2016 - The decrease of $27.6 million during the year ended December 31, 2017 as compared to 2016 was primarily due to the repayment of the Credit Facility Term Loan of $500.0 million and a $579.9 million reduction of secured debt, partially offset by the issuance of $600.0 million of unsecured notes and net borrowings on the revolving credit facility of $185.0 million.
2016 vs 2015 - The decrease of $41.0 million during the year ended December 31, 2016 was primarily a result of a decrease in the total outstanding debt balance from $8.1 billion as of December 31, 2015 to $6.4 billion as of December 31, 2016, largely due to the repayment of all outstanding borrowings under the revolving credit facility, repayment of $0.5 billion of the Credit Facility Term Loan, as well as reducing secured debt with proceeds from the public equity offering and property dispositions.
Gain (Loss) on Extinguishment and Forgiveness of Debt, Net
2017 vs 2016 - The increase of $19.1 million during the year ended December 31, 2017 as compared to the same period in 2016 was primarily a result of three mortgage loans settled by foreclosure or deed-in-lieu of foreclosure for which the Company recognized a gain on forgiveness of debt of $20.5 million, with no comparable gains resulting from foreclosure or deed-in-lieu of foreclosure during the same period in 2016.
2016 vs 2015 - During the year ended December 31, 2016, the Company recorded a loss of $0.8 million in relation to the write-off of deferred financing costs and net premiums consisting of losses relating to the early extinguishment of our 2017 Senior Notes of $13.2 million and the prepayment of a portion of the Credit Facility Term Loan of $4.3 million, as well as the 2016 Term Loan of $2.6 million, as discussed in “Note 10 - Debt” to our consolidated financial statements. These losses were partially offset by a gain on forgiveness of debt of $19.1 million related to a mortgage loan settled by foreclosure. During the year ended December 31, 2015, the Company recorded a gain on forgiveness of debt of $4.8 million related to the foreclosure of one property.
Other Income, Net
2017 vs 2016 - The increase of $1.0 million during the year ended December 31, 2017 as compared to the same period in 2016 was primarily due to post-closing adjustments, of $1.6 million, recorded in accordance with the purchase and sale agreement during the year ended December 31, 2016 related to a multi-tenant asset portfolio sale completed in 2014, offset by a decrease in interest income related to the Company’s investment securities and mortgage notes receivable of $0.6 million.
2016 vs 2015 - The decrease of $4.1 million during the year ended December 31, 2016 as compared to the same period in 2015 was primarily a result of a decrease in disposition fees earned from 1031 real estate programs of $3.8 million.
Reserve for Loan Loss
The reserve for loan loss of $15.3 million for the year ended December 31, 2015 related to an unsecured note from RCS Capital Corporation in connection with the unconsummated sale of Cole Capital. During the three months ended December 31, 2015, the Company assessed the collectability of the note, determined it was unlikely to be repaid and recorded the reserve equal to the carrying value of the note.
Equity in Income and Gain on Disposition of Unconsolidated Entities
2017 vs 2016 - The decrease of $7.0 million during the year ended December 31, 2017 as compared to the same period in 2016 was primarily the result of a gain of $10.2 million recognized on the disposition of one unconsolidated joint venture owning one property in 2016, with no comparable gain in 2017.
2016 vs 2015 - Equity in income (loss) and gain on disposition of unconsolidated entities increased $0.7 million during the year ended December 31, 2016 as compared to 2015. During the year ended December 31, 2016, the Company recorded a gain of $10.2 million related to the disposition of one property, comprising 343 million square feet of office space, owned by an unconsolidated joint venture. During the year ended December 31, 2015, the Company recorded a gain of $6.7 million related to the disposition of its interest in one consolidated joint venture, whose only assets consisted of investments in three unconsolidated joint ventures that owned three properties, comprising 752 million square feet of retail space. During the years ended December 31, 2016 and 2015, the Company recognized $0.9 million and $2.3 million of net income, respectively, from the unconsolidated joint ventures. The Company recorded equity in loss related to its investments in the Cole REITs of $1.3 million during the year ended December 31, 2016, as compared to equity in income of $0.1 million during the year ended December 31, 2015.
Gain (Loss) on Derivative Instruments, Net
2017 vs 2016 - The $4.2 million increase during the year ended December 31, 2017 as compared to the same period in 2016, was primarily a result of the termination of six interest rate swaps in connection with the early repayment of the outstanding borrowings under our Credit Facility Term Loan, as discussed in Note 11 - Derivatives and Hedging Activities to our consolidated financial statements, which resulted in a gain of $1.1 million as compared to a loss of $3.3 million in 2016.
2016 vs 2015 - The decrease during the year ended December 31, 2016, is due to the termination of two interest rate swaps in connection with the early repayment of a portion of the Credit Facility Term Loan, which resulted in a loss of $3.3 million, offset by an increase in the fair value of the Company’s interest rate swaps.
Gain (Loss) on Disposition of Real Estate and Real Estate Assets Held For Sale, Net
2017 vs 2016 - The increase in gain on disposition of real estate and held for sale assets, net of $16.0 million during the year ended December 31, 2017 as compared to the same period in 2016, was due to the Company’s disposition of 131 properties, excluding six properties transferred to the lender in either a deed-in-lieu of foreclosure or foreclosure sale transaction, for an aggregate sales price of $594.9 million which resulted in a gain of $64.7 million during the year ended December 31, 2017, as compared to the disposal of 301 properties for an aggregate sales price of $1.1 billion during the same period in 2016 for a gain of $50.6 million, which included $28.8 million of goodwill allocation related to the sales. During the year ended December 31, 2017, the Company also recognized a loss of $3.1 million related to assets classified as held for sale, as compared to a loss of $5.1 million during the same period in 2016.
2016 vs 2015 - During the year ended December 31, 2016, the change of $117.8 million from a net loss on dispositions of real estate to a net gain was due to the Company’s disposition of 301 properties for an aggregate sales price of $1.1 billion, which resulted in an aggregate gain of $50.6 million, as compared to the disposal of 228 properties for an aggregate sales price of $1.4 billion during the same period in 2015 for a loss of $69.1 million. During the year ended December 31, 2016, the Company also recorded a loss of $5.1 million related to assets classified as held for sale, as compared to a loss of $3.2 million during the same period in 2015.
Provision for Income Taxes
2017 vs 2016 - The consolidated provision for income taxes of $6.9 million for the year ended December 31, 2017 as compared to a provision of $7.1 million for the same period in 2016 reflects an overall decrease in expense attributable to higher state taxes in 2016 and tax on net income from properties held in and sold by a TRS in 2016, which were partially offset by tax on the gain on the sale of certain Canadian properties in 2017.
2016 vs 2015 - The increase of $2.5 million is primarily due to the 2014 accrued state tax expense exceeding actual expenses incurred, resulting in a decrease to the provision for income taxes during the year ended December 31, 2015.
Loss from Discontinued Operations
2017 vs 2016 - During the fourth quarter of 2017, the Company entered into a purchase and sale agreement to sell substantially all of the Cole Capital segment. The decrease in loss from discontinued operations of $104.8 million during the year ended December 31, 2017 was primarily due to decreases in impairment of goodwill of $120.9 million, in general and administrative expenses of $18.8 million and in amortization of intangible assets of $11.7 million, partially offset by the loss recognized on classification as held for sale of $20.0 million and an increase in the provision for income taxes of $24.7 million. Revenues, net of reallowed fees and commissions increased $1.8 million for the year ended December 31, 2017, as compared to the year ended December 31, 2016.
2016 vs 2015 - The decrease in loss from discontinued operations of $60.6 million during the year ended December 31, 2016 was primarily due to a decrease in impairment of intangible assets and goodwill of $92.4 million, offset by a decrease in the benefit from income taxes.
Non-GAAP Measures
Our results are presented in accordance with U.S. GAAP. We also disclose certain non-GAAP measures, as discussed further below. Management uses these non-GAAP financial measures in our internal analysis of results and believes these measures are useful to investors for the reasons explained below. These non-GAAP financial measures should not be considered as substitutes for any measures derived in accordance with U.S. GAAP.
Funds from Operations and Adjusted Funds from Operations
Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”), an industry trade group, has promulgated a supplemental performance measure known as funds from operations (“FFO”), which we believe to be an appropriate supplemental performance measure to reflect the operating performance of a REIT. FFO is not equivalent to our net income or loss as determined under U.S. GAAP.
NAREIT defines FFO as net income or loss computed in accordance with U.S. GAAP, excluding gains or losses from disposition of property, depreciation and amortization of real estate assets and impairment write-downs on depreciable real estate including the pro rata share of adjustments for unconsolidated partnerships and joint ventures. We calculated FFO in accordance with NAREIT’s definition described above.
In addition to FFO, we use adjusted funds from operations (“AFFO”) as a non-GAAP supplemental financial performance measure to evaluate the operating performance of the Company. AFFO, as defined by the Company, excludes from FFO non-routine items such as acquisition-related expenses, litigation, merger and other non-routine costs, net of insurance recoveries, held for sale loss on discontinued operations, gains or losses on sale of investment securities or mortgage notes receivable and legal settlements and insurance recoveries not in the ordinary course of business. We also exclude certain non-cash items such as impairments of goodwill and intangible assets, straight-line rent, net of bad debt expense related to straight-line rent, net direct financing lease adjustments, gains or losses on derivatives, reserves for loan loss, gains or losses on the extinguishment or forgiveness of debt, non-current portion of the tax benefit or expense, equity-based compensation and amortization of intangible assets, deferred financing costs, premiums and discounts on debt and investments, above-market lease assets and below-market lease liabilities. Effective January 1, 2017, we determined to omit the impact of the Excluded Properties and related non-recourse mortgage notes from FFO to calculate AFFO. We did not adjust AFFO during the years prior to January 1, 2017 as the impact was immaterial. Management believes that excluding these costs from FFO provides investors with supplemental performance information that is consistent with the performance models and analysis used by management, and provides investors a view of the performance of our portfolio over time. AFFO allows for a comparison of the performance of our operations with other publicly-traded REITs, as AFFO, or an equivalent measure, is routinely reported by publicly-traded REITs, and we believe often used by analysts and investors for comparison purposes.
For all of these reasons, we believe FFO and AFFO, in addition to net income (loss), as defined by U.S. GAAP, are helpful supplemental performance measures and useful in understanding the various ways in which our management evaluates the performance of the Company over time. However, not all REITs calculate FFO and AFFO the same way, so comparisons with other REITs may not be meaningful. FFO and AFFO should not be considered as alternatives to net income (loss) and are not intended to be used as a liquidity measure indicative of cash flow available to fund our cash needs. Neither the SEC, NAREIT, nor any other regulatory body has evaluated the acceptability of the exclusions used to adjust FFO in order to calculate AFFO and its use as a non-GAAP financial performance measure.
The table below presents FFO and AFFO for the years ended December 31, 2017, 2016 and 2015 (in thousands, except share and per share data) and includes both continuing operations, which primarily represent the Company's real estate operations, and discontinued operations, which represent substantially all of Cole Capital.
____________________________________
(1)
This adjustment represents the non-current portion of the provision for or benefit from income taxes in order to show only the current portion of the provision for or benefit from income taxes as an impact to AFFO. For the three months ended December 31, 2017, this adjustment is net of a current tax benefit due to the acceleration of a bonus compensation-related deduction to take advantage of the Company’s higher effective tax rate in 2017. As the Company already recognized the prior year bonus compensation-related tax deduction during the three months ended March 31, 2017, the acceleration of the 2018 benefit was not included in the computation of AFFO.
(2)
Dilutive securities include unvested restricted shares of common stock and unvested restricted stock units.
(3)
Weighted-average shares for all periods presented exclude the effect of the convertible debt as the Company would expect to settle the debt with cash.
Liquidity and Capital Resources
General
Our principal liquidity needs for the next twelve months and beyond are to:
•
fund normal operating expenses;
•
fund capital expenditures, tenant improvements and leasing costs
•
meet debt service and principal repayment obligations, including balloon payments on maturing debt;
•
pay dividends;
•
pay litigation costs and expenses; and
•
fund property and/or common stock acquisitions.
We expect to be able to satisfy these obligations using one or more of the following sources:
•
cash flow from operations;
•
proceeds from real estate dispositions;
•
utilization of existing line of credit;
•
cash and cash equivalents balance; and
•
issuance of VEREIT debt and equity securities.
2017 Bond Offering
On August 11, 2017, the Company closed a senior note offering, consisting of $600.0 million aggregate principal amount of the Operating Partnership’s 3.950% Senior Notes due 2027. As discussed in Note 10 - Debt, the Company subsequently used a portion of the proceeds from the 2017 Bond Offering to repay borrowings, including swap termination costs and accrued unpaid interest under its $500.0 million Credit Facility Term Loan on August 11, 2017. The Company used the remaining proceeds to pay down secured debt.
Continuous Equity Offering Program
On September 19, 2016, the Company registered a continuous equity offering program (the “Program”) pursuant to which the Company can offer and sell, from time to time through September 19, 2019 in “at-the-market” offerings or certain other transactions, shares of common stock with an aggregate gross sales price of up to $750.0 million, through its sales agents. The Company intends to use the proceeds from any sale of shares for general corporate purposes, which may include funding potential acquisitions and repurchasing or repaying outstanding indebtedness. As of December 31, 2017, no shares of common stock have been issued pursuant to the Program.
Share Repurchase Program
On May 12, 2017, the Company’s board of directors authorized the repurchase of up to $200.0 million of the Company’s outstanding Common Stock over the subsequent 12 months, as market conditions warrant. During the twelve months ended December 31, 2017, the Company repurchased 68,759 shares of common stock in multiple open transactions for $0.5 million.
Disposition Activity
As part of our effort to optimize our real estate portfolio by focusing on holding core assets, during the year ended December 31, 2017, we disposed of 137 properties and six properties transferred to the lender in either a deed-in-lieu foreclosure or foreclosure sale transaction for an aggregate sales price of $594.9 million, of which our share was $574.4 million, resulting in consolidated proceeds of $445.5 million after mortgage loan assumption and closing costs. We expect to continue to explore opportunities to sell additional properties to provide us further financial flexibility and fund property acquisitions.
Credit Facility
Summary and Obligations
We, as guarantor, and the Operating Partnership, as borrower, are parties to the Credit Facility with Wells Fargo Bank, National Association, as administrative agent, and the other lenders party thereto.
As of December 31, 2017, the Credit Facility had an outstanding balance of $185.0 million and allowed for maximum borrowings of $2.3 billion under its revolving credit facility, subject to borrowing availability. The maximum aggregate dollar amount of letters of credit that may be outstanding at any one time under the Credit Facility is $25.0 million. The Operating Partnership used a portion of the proceeds from the 2017 Bond Offering to repay all of the outstanding borrowings, including swap termination costs and accrued and unpaid interest, under its $500.0 million Credit Facility Term Loan on August 11, 2017.
The revolving credit facility generally bears interest at an annual rate of London Inter-Bank Offer Rate (“LIBOR”) plus 1.00% to 1.80% or Base Rate plus 0.00% to 0.80% (based upon our then current credit rating). “Base Rate” is defined as the highest of the prime rate, the federal funds rate plus 0.50% or a floating rate based on one month LIBOR, determined on a daily basis. In addition, the Credit Agreement provides the flexibility for interest rate auctions, pursuant to which, at the Company’s election, the Company may request that lenders make competitive bids to provide revolving loans, which competitive bids may be at pricing levels that differ from the foregoing interest rates.
The Credit Agreement provides for monthly interest payments under the Credit Facility. In the event of default, at the election of a majority of the lenders (or automatically upon a bankruptcy event of default with respect to the OP or the General Partner), the commitments of the lenders under the Credit Facility will mature, and payment of any unpaid amounts in respect of the Credit Facility will be accelerated. The Credit Facility terminates on June 30, 2018, unless extended in accordance with the terms of the Credit Agreement. The Credit Agreement provides for a one-year extension option, exercisable at the Company’s election and subject to certain customary conditions, as well as certain customary “amend and extend” provisions. At any time, upon timely notice by the OP and subject to any breakage fees, the OP may prepay borrowings under the Credit Facility (subject to certain limitations applicable to the prepayment of any loans obtained through an interest rate auction, as described above). The OP incurs a fee equal to 0.15% to 0.25% per annum (based upon the General Partner’s then current credit rating) multiplied by the commitments (whether or not utilized) in respect of the revolving credit facility. In addition, the OP incurs customary administrative agent, letter of credit issuance, letter of credit fronting, extension and other fees.
Credit Facility Covenants
The Credit Facility requires restrictions on corporate guarantees, as well as the maintenance of certain financial covenants. The key financial covenants in the Credit Facility, as defined and calculated per the terms of the Credit Agreement include maintaining the following:
For the purposes of determining unencumbered asset value, the Company is permitted to include restaurant properties representing up to 30% of its unencumbered asset value in such calculation.
The Company believes that it was in compliance with the financial covenants pursuant to the Credit Agreement and is not restricted from accessing any borrowing availability under the Credit Facility as of December 31, 2017.
Corporate Bonds
Summary and Obligations
As of December 31, 2017, the OP had $2.85 billion aggregate principal amount of Senior Notes outstanding. The indenture governing the Senior Notes requires that the Company be in compliance with certain key financial covenants, including maintaining the following:
There were no changes to the financial covenants of our existing Senior Notes during the year ended December 31, 2017. The covenants of our new Senior Notes issued in 2017 are materially the same as our then existing Senior Notes. As of December 31, 2017, the Company believes that it was in compliance with these financial covenants based on the covenant limits and calculations in place at that time.
Convertible Debt
Summary and Obligations
As of December 31, 2017, the Company had $1.0 billion aggregate principal amount of Convertible Notes (as defined in Note 10 - Debt). The OP has issued corresponding identical convertible notes to the General Partner. There were no changes to the terms of the Convertible Notes and the Company believes it was in compliance with the financial covenants pursuant to the indenture governing the Convertible Notes as of December 31, 2017.
Mortgage Notes Payable and Other Debt
Summary and Obligations
As of December 31, 2017, we had non-recourse mortgage indebtedness of $2.1 billion, which was collateralized by 472 properties, reflecting a decrease from December 31, 2016 of $558.9 million derived primarily from our disposition activity during the year ended December 31, 2017. Our mortgage indebtedness bore interest at the weighted-average rate of 4.92% per annum and had a weighted-average maturity of 4.1 years. We may in the future incur additional mortgage debt on the properties we currently own or use long-term non-recourse financing to acquire additional properties.
The payment terms of our loan obligations vary. In general, only interest amounts are payable monthly with all unpaid principal and interest due at maturity. Some of our loan agreements require that we comply with specific reporting and financial covenants mainly related to debt coverage ratios and loan-to-value ratios. Each loan that has these requirements has specific ratio thresholds that must be met.
Restrictions on Loan Covenants
Our mortgage loan obligations generally restrict corporate guarantees and require the maintenance of financial covenants, including maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios), as well as the maintenance of a minimum net worth. The mortgage loan agreements contain no dividend restrictions except in the event of default or when a distribution would drive liquidity below the applicable thresholds. At December 31, 2017, the Company believes that it was in compliance with the financial covenants under the mortgage loan agreements, except for the $16.2 million loan in default as described above and in “Note 10 - Debt” to our consolidated financial statements.
Other Debt
During the fourth quarter of 2017, the Company repaid the remaining outstanding principal balance on the secured term loan from KBC Bank, N.V. (the “KBC Loan”).
Dividends
On November 7, 2017, the Company’s board of directors declared a quarterly cash dividend of $0.1375 per share of common stock (equaling an annualized dividend rate of $0.55 per share) for the fourth quarter of 2017 to stockholders of record as of December 29, 2017, which was paid on January 16, 2018. An equivalent distribution by the Operating Partnership is applicable per OP unit.
Our Series F Preferred Stock, as discussed in “Note 15 - Equity” to our consolidated financial statements, will pay cumulative cash dividends at the rate of 6.70% per annum on their liquidation preference of $25.00 per share (equivalent to $1.675 per share on an annual basis). As of December 31, 2017, there were approximately 42.8 million shares of Series F Preferred Stock (and approximately 42.8 million corresponding Series F Preferred Units that were issued to the General Partner) and 86,874 Limited Partner Series F Preferred Units that were issued and outstanding.
Contractual Obligations
The following is a summary of our contractual obligations as of December 31, 2017 (in thousands):
____________________________________
(1)
For the loan in maturity default, as discussed in Note 10 - Debt , the payment obligations for future periods are based on an estimated extension of maturity to January 1, 2018.
(2)
As of December 31, 2017, we had $78.9 million of variable rate mortgage notes effectively fixed through the use of interest rate swap agreements. We used the effective interest rates fixed under our swap agreements to calculate the debt payment obligations in future periods.
(3)
Interest payments due in future periods on the $14.9 million of variable rate debt and the Credit Facility payment obligations were calculated using a forward LIBOR curve.
Cash Flow Analysis for the year ended December 31, 2017
Operating Activities - During the year ended December 31, 2017, net cash provided by operating activities decreased $4.7 million to $793.3 million from $797.9 million during the same period in 2016. The decrease was primarily due to a decrease in rental receipts related to the disposition of 438 consolidated properties subsequent to January 1, 2016 and an increase in litigation and other non-routine costs paid during the year ended December 31, 2017. This decrease was mostly offset by a decrease in interest payments and insurance recoveries received as compared to the same period in 2016, the receipt of an income tax refund during the year ended December 31, 2017, and an increase in rental receipts related to the acquisition of 96 consolidated properties subsequent to January 1, 2016.
Investing Activities - Net cash used in investing activities for the year ended December 31, 2017 changed $1.2 billion to $274.1 million from cash provided by investing activities of $881.6 million during the same period in 2016. The change was primarily related to an increase in investments in real estate assets of $598.8 million, a decrease in cash proceeds from dispositions of real estate and joint ventures of $555.2 million.
Financing Activities - Net cash used in financing activities of $756.6 million decreased $750.4 million during the year ended December 31, 2017 from $1.5 billion during the same period in 2016. The decrease was primarily due to a decrease in repayments of debt, net of proceeds, of $1.5 billion, which was partially offset by the 2016 common stock offering resulting in net proceeds, after underwriting discounts and offering costs, of $702.8 million and an increase in distributions paid of $28.1 million.
Cash Flow Analysis for the year ended December 31, 2016
Operating Activities - During the year ended December 31, 2016, net cash provided by operating activities decreased $61.7 million to $797.9 million from $859.7 million during the same period in 2015. The decrease was primarily due to a decrease in rental receipts related to the disposition of 529 consolidated properties subsequent to January 1, 2015. This decrease was partially offset by a decrease in interest payments and payments related to the Audit Committee Investigation and related litigation, net of insurance recoveries.
Investing Activities - Net cash provided by investing activities for the year ended December 31, 2016 decreased $59.8 million to $881.6 million from $941.4 million during the same period in 2015. The decrease was primarily related to an increase in investments in real estate assets of $63.9 million, an investment in an unconsolidated joint venture of $25.8 million during 2016 and a decrease in uses and refunds of deposits for real estate assets of $35.4 million. These decreases were partially offset by a decrease in real estate development payments of $40.3 million and the receipt of $50.0 million on the Affiliate Lines of Credit, as compared to $10.0 million in 2015.
Financing Activities - Net cash used in financing activities of $1.5 billion decreased $644.6 million during the year ended December 31, 2016 from $2.2 billion during the same period in 2015. The decrease was primarily due to the 2016 common stock offering resulting in net proceeds, after underwriting discounts and offering costs, of $702.5 million and an increase in proceeds from debt, net of repayments, of $306.3 million, which were partially offset by an increase in distributions paid of $345.0 million
Election as a REIT
The General Partner elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code commencing with the taxable year ended December 31, 2011. As a REIT, except as discussed below, the General Partner generally is not subject to federal income tax on taxable income that it distributes to its stockholders so long as it distributes at least 90% of its annual taxable income (computed without regard to the deduction for dividends paid and excluding net capital gains). REITs are subject to a number of other organizational and operational requirements. Even if the General Partner maintains its qualification for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, federal income taxes on certain income and excise taxes on its undistributed income. We believe we are organized and operating in such a manner as to qualify to be taxed as a REIT for the taxable year ended December 31, 2017.
The Operating Partnership is classified as a partnership for U.S. federal income tax purposes. As a partnership, the Operating Partnership is not a taxable entity for U.S. federal income tax purposes. Instead, each partner in the Operating Partnership is required to take into account its allocable share of the Operating Partnership’s income, gains, losses, deductions and credits for each taxable year. However, the Operating Partnership may be subject to certain state and local taxes on its income and property. Under the LPA, the Operating Partnership is required to conduct business in such a manner as to permit the General partner at all times to qualify as a REIT.
The Company conducted substantially all of its Cole Capital business activities through a TRS. A TRS is a subsidiary of a REIT that is subject to corporate federal, state and local income taxes, as applicable. The Company’s use of a TRS enables it to engage in certain business activities while complying with the REIT qualification requirements and to retain any income generated by these businesses for reinvestment without the requirement to distribute those earnings. The Company conducts all of its business in the United States, Puerto Rico and Canada and, as a result, it files income tax returns in the U.S. federal jurisdiction, the Canadian federal jurisdiction and various state and local jurisdictions. Certain of the Company’s inter-company transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation.
Inflation
We may be adversely impacted by inflation on any leases that do not contain indexed escalation provisions. However, net leases that require the tenant to pay its allocable share of operating expenses, including common area maintenance costs, real estate taxes and insurance, may reduce our exposure to increases in costs and operating expenses resulting from inflation.
Related Party Transactions and Agreements
Through the closing of the Cole Capital sale, we were contractually responsible for managing the Cole REITs’ affairs on a day-to-day basis, identifying and making acquisitions and investments on the Cole REITs’ behalf, and recommending to each of the Cole REIT’s respective board of directors an approach for providing investors with liquidity. In addition, we distributed the shares of common stock for certain of the Cole REITs and advised them regarding offerings, managed relationships with participating broker-dealers and financial advisors, and provided assistance in connection with compliance matters relating to the offerings. We received compensation and reimbursement for services relating to the Cole REITs’ offerings and the investment, management and disposition of their respective assets, as applicable. See “Note 17 - Related Party Transactions and Arrangements” to our consolidated financial statements in this report for a further explanation of the various related party transactions, agreements and fees.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements that have had or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market Risk
The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our market risk arises primarily from interest rate risk relating to variable-rate borrowings. To meet our short and long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes in earnings and cash flows and to manage our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We would not hold or issue these derivative contracts for trading or speculative purposes. We have limited operations in Canada and thus, are not exposed to material foreign currency fluctuations.
Interest Rate Risk
As of December 31, 2017, our debt included fixed-rate debt, including debt that has interest rates that are fixed with the use of derivative instruments, with a fair value and carrying value of $6.1 billion and $5.9 billion, respectively. Changes in market interest rates on our fixed rate debt impact the fair value of the debt, but they have no impact on interest incurred or cash flow. For instance, if interest rates rise 100 basis points and the fixed rate debt balance remains constant, we expect the fair value of our debt to decrease, the same way the price of a bond declines as interest rates rise. The sensitivity analysis related to our fixed-rate debt assumes an immediate 100 basis point move in interest rates from their December 31, 2017 levels, with all other variables held constant. A 100 basis point increase in market interest rates would result in a decrease in the fair value of our fixed rate debt of $224.9 million. A 100 basis point decrease in market interest rates would result in an increase in the fair value of our fixed-rate debt of $279.1 million.
As of December 31, 2017, our debt included variable-rate debt with a fair value and carrying value each of $200.1 million and $199.9 million. The sensitivity analysis related to our variable-rate debt assumes an immediate 100 basis point move in interest rates from their December 31, 2017 levels, with all other variables held constant. A 100 basis point increase or decrease in variable interest rates on our variable-rate notes payable would increase or decrease our interest expense by $2.0 million annually. See “Note 10 - Debt” to our consolidated financial statements.
As of December 31, 2017, our interest rate swaps had a fair value that resulted in assets of $0.6 million. See “Note 11 -Derivatives and Hedging Activities” to our consolidated financial statements for further discussion.
As the information presented above includes only those exposures that existed as of December 31, 2017, it does not consider exposures or positions arising after that date. The information presented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.
These amounts were determined by considering the impact of hypothetical interest rate changes on our borrowing costs and assume no other changes in our capital structure.
Credit Risk
Concentrations of credit risk arise when a number of tenants are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. The Company is subject to tenant, geographic and industry concentrations. Any downturn of the economic conditions in one or more of these tenants, geographies or industries could result in a material reduction of our cash flows or material losses to us.
The factors considered in determining the credit risk of our tenants include, but are not limited to: payment history; credit status and change in status (credit ratings for public companies are used as a primary metric); change in tenant space needs (i.e., expansion/downsize); tenant financial performance; economic conditions in a specific geographic region; and industry specific credit considerations. We believe that the credit risk of our portfolio is reduced by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The information required by Item 8 is hereby incorporated by reference to our consolidated financial statements beginning on page of this document.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
I. Discussion of Controls and Procedures of the General Partner
For purposes of the discussion in this Part I of Item 9A, the “Company” refers to the General Partner.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2017 and determined that the disclosure controls and procedures were effective at a reasonable assurance level as of that date.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2017.
The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report in this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
No change occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d -15(f) of the Exchange Act) during the three months ended December 31, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
II. Discussion of Controls and Procedures of the Operating Partnership
In the information incorporated by reference into this Part II of Item 9A, the term “Company” refers to the Operating Partnership, except as the context otherwise requires.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2017 and determined that the disclosure controls and procedures were effective at a reasonable assurance level as of that date.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2017.
Changes in Internal Control Over Financial Reporting
No change occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d -15(f) of the Exchange Act) during the three months ended December 31, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of VEREIT, Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of VEREIT, Inc. and subsidiaries (the “Company”) as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal controls over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2017, of the Company and our report dated February 21, 2018, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal controls over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exist, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes 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 controls over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE, LLP
Phoenix, Arizona
February 21, 2018
Item 9B.
Item 9B. Other Information.
The following disclosure would have otherwise been filed in a Current Report on Form 8-K under the heading “Item 5.02. Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.”
Amendment to Employment Agreement with Glenn J. Rufrano
Effective February 21, 2018, the Company amended (the “Rufrano Amendment”) the Employment Agreement dated as of March 10, 2015 with Glenn J. Rufrano (the “Rufrano Employment Agreement”), to extend Mr. Rufrano’s term as Chief Executive Officer to April 1, 2021. Pursuant to the Rufrano Amendment, future annual long term incentive awards will not have a minimum guaranteed amount and the vesting of any unvested awards upon termination will be governed by the terms in the applicable award agreement.
The foregoing description of the Rufrano Amendment does not purport to be complete and is qualified in its entirety by reference to such amendment a copy of which is attached to this Annual Report on Form 10-K.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
This information will be contained in our definitive proxy statement for the 2018 Annual Meeting of Stockholders (the “Proxy Statement”), to be filed within 120 days following the end of our fiscal year, and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
Financial Statements
The Financial Statements are included herein at pages through.
Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts is included herein on page.
Schedule III - Real Estate and Accumulated Depreciation is included herein on pages through.
Schedule IV - Mortgage Loans Held for Investment is included herein on page.
Exhibits
The following exhibits are included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (and are numbered in accordance with Item 601 of Regulation S-K):
_____________________________
*
Filed herewith
**
In accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
Item 16. Form 10-K Summary.
Not Applicable
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, each registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized.
VEREIT, INC.
By:
/s/ Michael J. Bartolotta
Michael J. Bartolotta
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
VEREIT OPERATING PARTNERSHIP, L.P.
By: VEREIT, Inc., its sole general partner
By:
/s/ Michael J. Bartolotta
Michael J. Bartolotta
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Dated: February 21, 2018
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Form 10-K has been signed below by the following persons on behalf of each registrant and in the capacities and on the dates indicated.
_________________________________
*
Each person is signing in his or her capacity as an officer and/or director of VEREIT, Inc., which is the sole general partner of VEREIT Operating Partnership, L.P.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of VEREIT, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of VEREIT, Inc. and subsidiaries (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive income (loss), changes in equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 21, 2018, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards required that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risk of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ DELOITTE & TOUCHE LLP
Phoenix, Arizona
February 21, 2018
We have served as the Company’s auditor since 2015.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the partners of VEREIT Operating Partnership, L.P.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of VEREIT Operating Partnership, L.P and subsidiaries (the "Operating Partnership") as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows, for each of the three years in the period ended December 31, 2017, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Operating Partnership as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Operating Partnership's management. Our responsibility is to express an opinion on the Operating Partnership's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Operating Partnership in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Operating Partnership is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Operating Partnership’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ DELOITTE & TOUCHE, LLP
Phoenix, Arizona
February 21, 2018
We have served as the Operating Partnership’s auditor since 2015.
VEREIT, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share data)
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share data)
_______________________________________________
(1)
Represents (income) loss attributable to limited partners and consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
_______________________________________________
(1)
Represents comprehensive (income) loss attributable to limited partners and consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except for share data)
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY - (Continued)
(In thousands, except for share data)
___________________________________
(1)
The Company’s Share Repurchase Program (as defined in Note 15 - Equity), which was authorized by the board of directors on May 12, 2017, allows for the repurchase of up to $200.0 million of the Company’s outstanding shares of Common Stock over the next 12 months.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
VEREIT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for unit data)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per unit data)
_______________________________________________
(1)
Represents (income) loss attributable to consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
_______________________________________________
(1)
Represents (income) loss attributable to consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except for unit data)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
VEREIT OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
The accompanying notes are an integral part of these statements.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017
Note 1 - Organization
VEREIT® is a Maryland corporation, incorporated on December 2, 2010, that qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning in the taxable year ended December 31, 2011. The OP is a Delaware limited partnership of which the General Partner is the sole general partner. VEREIT’s common stock, par value $0.01 per share (“Common Stock”), and its 6.70% Series F Cumulative Redeemable Preferred Stock, par value $0.01 per share (“Series F Preferred Stock”) trade on the New York Stock Exchange (“NYSE”) under the trading symbols, “VER” and “VER PRF,” respectively. As used herein, the terms the “Company,” “we,” “our” and “us” refer to VEREIT, together with its consolidated subsidiaries, including the OP.
VEREIT is a full-service real estate operating company which owns and manages one of the largest portfolios of single-tenant commercial properties in the U.S. VEREIT’s business model provides equity capital to creditworthy corporations in return for long-term leases on their properties. The Company actively manages its portfolio considering a number of metrics including property type, concentration and key economic factors for appropriate balance and diversity.
Substantially all of the Company’s operations are conducted through the OP. VEREIT is the sole general partner and holder of 97.6% of the common equity interests in the OP as of December 31, 2017 with the remaining 2.4% of the common equity interests owned by unaffiliated investors and certain former directors, officers and employees of ARC Properties Advisors, LLC (the “Former Manager”). Under the limited partnership agreement of the OP, as amended (the “LPA”), after holding units of limited partner interests in the OP (“OP Units”) for a period of one year, unless an earlier redemption is otherwise consented to by VEREIT, holders of OP Units have the right to redeem the OP Units for the cash value of a corresponding number of shares of VEREIT’s Common Stock or, at the option of VEREIT, a corresponding number of shares of VEREIT’s Common Stock. The remaining rights of the holders of OP Units are limited, however, and do not include the ability to replace the General Partner or to approve the sale, purchase or refinancing of the OP’s assets.
The actions of the OP and its relationship with the General Partner are governed by the LPA. The General Partner does not have any significant assets other than its investment in the OP. Therefore, the assets and liabilities of the General Partner and the OP are the same. Additionally, pursuant to the LPA, all administrative expenses and expenses associated with the formation, continuity, existence and operation of the General Partner incurred by the General Partner on the OP’s behalf shall be treated as expenses of the OP. Further, when the General Partner issues any equity instrument that has been approved by the General Partner’s board of directors, the LPA requires the OP to issue to the General Partner equity instruments with substantially similar terms, to protect the integrity of the Company’s umbrella partnership REIT structure, pursuant to which each holder of interests in the OP has a proportionate economic interest in the OP reflecting its capital contributions thereto. OP Units issued to the General Partner are referred to as General Partner OP Units. OP Units issued to parties other than the General Partner are referred to as Limited Partner OP Units. The LPA also provides that the OP issue debt with terms and provisions consistent with debt issued by the General Partner. The LPA will be amended to provide for the issuance of any additional class of equivalent equity instruments to the extent the General Partner’s board of directors authorizes the issuance of any new class of equity securities.
Prior to the fourth quarter of 2017, the Company operated through two business segments, the real estate investment segment and the investment management segment, Cole Capital. Substantially all of the Cole Capital segment’s operations were conducted through Cole Capital Advisors, Inc. (“CCA”), an Arizona corporation and a wholly owned subsidiary of the OP. CCA was treated as a taxable REIT subsidiary (“TRS”) under Section 856 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). As discussed further in Note 5 -Discontinued Operations, on November 13, 2017, the OP entered into a purchase and sale agreement (the “Cole Capital Purchase and Sale Agreement”) with CCA Acquisition, LLC (the “Cole Purchaser”), an affiliate of CIM Group, LLC. Under the terms of the Cole Capital Purchase and Sale Agreement, the Company agreed to sell to the Cole Purchaser all of the issued and outstanding shares of common stock of CCA and certain of CCA’s subsidiaries. The sale closed on February 1, 2018. As the Company entered into the Cole Capital Purchase and Sale Agreement during the fourth quarter of 2017, the Company's financial results are reported as a single segment, and the assets, liabilities and related financial results of substantially all of the Cole Capital segment are reflected in the financial statements as discontinued operations.
Note 2 - Summary of Significant Accounting Policies
Basis of Accounting
The consolidated financial statements of the Company presented herein include the accounts of the General Partner and its consolidated subsidiaries, including the OP. All intercompany transactions have been eliminated upon consolidation. The financial statements are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”).
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and its consolidated subsidiaries and consolidated joint venture arrangements. The portions of the consolidated joint venture arrangements not owned by the Company are presented as non-controlling interests in VEREIT’s and the OP’s consolidated balance sheets, statements of operations, statements of comprehensive income (loss) and statements of changes in equity. In addition, as described in Note 1 - Organization, certain third parties have been issued OP Units. Holders of OP Units are considered to be non-controlling interest holders in the OP and their ownership interest in the limited partner’s share is presented as non-controlling interests in VEREIT’s consolidated balance sheets, statements of operations, statements of comprehensive income (loss) and statements of changes in equity. Further, a portion of the earnings and losses of the OP are allocated to non-controlling interest holders based on their respective ownership percentages. Upon conversion of OP Units to Common Stock, any difference between the fair value of shares of Common Stock issued and the carrying value of the OP Units converted is recorded as a component of equity. As of each of December 31, 2017 and December 31, 2016, there were approximately 23.7 million Limited Partner OP Units outstanding.
For legal entities being evaluated for consolidation, the Company must first determine whether the interests that it holds and fees it receives qualify as variable interests in the entity. A variable interest is an investment or other interest that will absorb portions of an entity’s expected losses or receive portions of the entity’s expected residual returns. The Company’s evaluation includes consideration of fees paid to the Company where the Company acts as a decision maker or service provider to the entity being evaluated. If the Company determines that it holds a variable interest in an entity, it evaluates whether that entity is a variable interest entity (“VIE”). VIEs are entities where investors lack sufficient equity at risk for the entity to finance its activities without additional subordinated financial support or where equity investors, as a group, lack one of the following characteristics: (a) the power to direct the activities that most significantly impact the entity’s economic performance, (b) the obligation to absorb the expected losses of the entity, or (c) the right to receive the expected returns of the entity.
The Company then qualitatively assesses whether it is (or is not) the primary beneficiary of a VIE, which is generally defined as the party who has a controlling financial interest in the VIE. Consideration of various factors include, but are not limited to, the Company’s ability to direct the activities that most significantly impact the entity’s economic performance and its obligation to absorb losses from or right to receive benefits of the VIE that could potentially be significant to the VIE. The Company consolidates any VIEs when the Company is determined to be the primary beneficiary of the VIE and the difference between consolidating the VIE and accounting for it using the equity method could be material to the Company’s consolidated financial statements. The Company continually evaluates the need to consolidate these VIEs based on standards set forth in U.S. GAAP.
Reclassification
As described below, the following items previously reported have been reclassified to conform with the current period’s presentation.
Direct financing lease income has been reclassified to rental income for all periods presented.
The assets and liabilities to be transferred pursuant to the Cole Capital Purchase and Sale Agreement and related financial results are reflected in the consolidated balance sheets and consolidated statements of operations as discontinued operations for all periods presented.
In connection with the adoption of Accounting Standards Update (“ASU”) 2016-15 and ASU 2016-18, discussed in “Recent Accounting Pronouncements,” certain reclassifications have been made to prior period balances to conform to current presentation in the consolidated statement of cash flows. Under ASU 2016-15, the Company reclassified a portion of distributions received from equity method investments which were previously reported in cash flows provided by operating activities to cash flows from investing activities in the consolidated statement of cash flows. Under ASU 2016-18, transfers to or from restricted cash which have previously been shown in the Company’s investing activities section of the consolidated statements of cash flows are now required to be shown as part of the total change in cash, cash equivalents and restricted cash in the consolidated statements of cash flows.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management makes significant estimates regarding goodwill and intangible asset impairments, real estate investment impairment, allocation of purchase price of real estate asset acquisitions and income taxes.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Real Estate Investments
The Company records acquired real estate at cost and makes assessments as to the useful lives of depreciable assets. The Company considers the period of future benefit of the asset to determine the appropriate useful lives. Depreciation is computed using a straight-line method over the estimated useful life of 40 years for buildings, five to 15 years for building fixtures and improvements and the remaining lease term for intangible lease assets.
Allocation of Purchase Price of Real Estate Assets
The Company allocates the purchase price of acquired properties to tangible and identifiable intangible assets and liabilities acquired based on their respective fair values. Tangible assets include land, buildings, fixtures and improvements on an as-if vacant basis. The Company utilizes various estimates, processes and information to determine the as-if vacant property value. Identifiable intangible assets and liabilities include amounts allocated to acquired leases for above-market and below-market lease rates and the value of in-place leases. In estimating fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other market data. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, as well as subsequent marketing and leasing activities, in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.
The aggregate value of intangible assets related to in-place leases is primarily the difference between the property valued with existing in-place leases adjusted to market rental rates and the property valued as if vacant. Factors considered by the Company in its analysis of the in-place lease intangibles include an estimate of carrying costs during the expected lease-up period for each property, taking into account current market conditions and costs to execute similar leases. In estimating carrying costs, the Company includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up period, which typically ranges from six to 18 months. The Company also estimates costs to execute similar leases, including leasing commissions, legal and other related expenses. The value of in-place leases is amortized over the initial term of the respective leases. If a tenant terminates its lease, then the unamortized portion of the in-place lease value is charged to expense.
Above-market and below-market in-place lease values for owned properties are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be paid pursuant to the in-place leases and management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease, including any bargain renewal periods. Above-market leases are amortized as a reduction to rental income over the remaining terms of the respective leases. Below-market leases are amortized as an increase to rental income over the remaining terms of the respective leases, including any bargain renewal periods.
The determination of the fair values of the real estate assets and liabilities acquired requires the use of significant assumptions with regard to the current market rental rates, rental growth rates, capitalization and discount rates, interest rates and other variables. The use of alternative estimates may result in a different allocation of the Company’s purchase price, which could materially impact the Company’s results of operations.
In January 2017, the Company elected to early adopt ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”), which clarifies the definition of a business by adding guidance to assist entities in evaluating whether transactions should be accounted for as acquisitions of assets or businesses. During the year ended December 31, 2017, all real estate acquisitions qualified as asset acquisitions, and external acquisition costs related to asset acquisitions were capitalized and allocated to tangible and intangible assets and liabilities as described above. Prior to January 1, 2017, external costs related to property acquisitions were expensed as incurred. Internal costs, such as employee salaries, related to activities necessary to complete, or affect, self-originating asset acquisitions or business combinations are classified as acquisition-related expenses in the accompanying consolidated statements of operations for all periods presented.
Assets Held for Sale
Upon classifying a real estate investment as held for sale, the Company will no longer recognize depreciation expense related to the depreciable assets of the property. Assets held for sale are recorded at the lower of carrying value or estimated fair value, less the estimated cost to dispose of the assets. See Note 4 - Real Estate Investments and Related Intangibles for further discussion regarding properties held for sale.
If circumstances arise that the Company previously considered unlikely and, as a result, the Company decides not to sell a property previously classified as held for sale, the Company will reclassify the property as held and used. The Company measures and records a property that is reclassified as held and used at the lower of (i) its carrying value before the property was classified
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
as held for sale, adjusted for any depreciation expense that would have been recognized had the property been continuously classified as held and used or (ii) the estimated fair value at the date of the subsequent decision not to sell.
Development Activities
Project costs, which include interest expense, associated with the development, construction and lease-up of a real estate project are capitalized as construction in progress. Once the development and construction of the building is substantially completed, the amounts capitalized to construction in progress are transferred to (i) land and (ii) buildings, fixtures and improvements and are depreciated over their respective useful lives.
Discontinued Operations
The Company reports discontinued operations when a component of an entity or group of components that has been disposed of or classified as held for sale and represents a strategic shift that has or will have a major effect on an entity’s operations and financial results. The results of operations for assets meeting the definition of discontinued operations are reflected in the Company’s consolidated statements of operations as discontinued operations for all periods presented. See Note 5 - Discontinued Operations for further discussion regarding discontinued operations.
Investment in Unconsolidated Entities
Unconsolidated Joint Ventures
The Company accounts for its investment in unconsolidated joint venture arrangements (the “Unconsolidated Joint Ventures”) using the equity method of accounting as the Company has the ability to exercise significant influence, but not control, over operating and financial policies of these investments. The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the joint ventures’ earnings and distributions. The Company records its proportionate share of net income (loss) from the Unconsolidated Joint Ventures in equity in income and gain on disposition of unconsolidated entities in the consolidated statements of operations. See Note 4 - Real Estate Investments and Related Intangibles for further discussion on investments in Unconsolidated Joint Ventures.
Cole REITs
As of December 31, 2017 and 2016, the Company owned equity investments in Cole Credit Property Trust IV, Inc. (“CCPT IV”), Cole Real Estate Income Strategy (Daily NAV), Inc. (“INAV”), Cole Office & Industrial REIT (CCIT II), Inc. (“CCIT II”), Cole Office & Industrial REIT (CCIT III), Inc. (“CCIT III”), and Cole Credit Property Trust V, Inc. (“CCPT V” and collectively with CCPT IV, INAV, CCIT II and CCIT III, the “Cole REITs”). The Company accounts for these investments using the equity method of accounting which requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the respective entity’s earnings and distributions. The Company records its proportionate share of net income (loss) from the Cole REITs in equity in income and gain on disposition of unconsolidated entities in the consolidated statements of operations. See Note 17 - Related Party Transactions and Arrangements for further discussion on the Cole REITs.
Leasehold Improvements and Property and Equipment
The Company leases its corporate office facilities under operating leases. Leasehold improvements related to these are recorded at cost less accumulated amortization. Leasehold improvements are amortized over the lesser of the estimated useful life or remaining lease term.
Property and equipment, which typically include computer hardware and software, furniture and fixtures, among other items, are stated at cost less accumulated depreciation. Property and equipment are depreciated on a straight-line method over the estimated useful lives of the assets, which range from three to seven years. The Company reassesses the useful lives of its property and equipment and adjusts the future monthly depreciation expense based on the new useful life, as applicable. If the Company disposes of an asset, the asset and related accumulated depreciation are written off upon disposal.
Goodwill
In the case of a business combination, after identifying all tangible and intangible assets and liabilities, the excess consideration paid over the fair value of the assets and liabilities acquired and assumed, respectively, represents goodwill.
Prior to the adoption of ASU 2017-01, as discussed in “Recent Accounting Pronouncements,” in the event the Company disposed of a property, or classified a property as an asset held for sale, that constituted a business under U.S. GAAP, the Company allocated a portion of the real estate investments reporting unit’s goodwill to that property in determining the gain or loss on the
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
disposal of the property. The amount of goodwill allocated to the business was based on the relative fair value of the business to the fair value of the reporting unit.
Impairments
Real Estate Assets
The Company performs quarterly impairment review procedures, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable. Impairment indicators that the Company considers include, but are not limited to, decrease in net operating income, bankruptcy or other credit concerns of a property’s major tenant or tenants, such as history of late payments, rental concessions and other factors, as well as significant decreases in a property’s revenues due to lease terminations, vacancies, co-tenancy clauses or reduced lease rates. When impairment indicators are identified or if a property is considered to have a more likely than not probability of being disposed of within the next 12 to 24 months, the Company assesses the recoverability of the assets by determining whether the carrying value of the assets will be recovered through the undiscounted future cash flows expected from the use of the assets and their eventual disposition. U.S. GAAP requires us to utilize the Company’s expected holding period of our properties when assessing recoverability. In the event that such expected undiscounted future cash flows do not exceed the carrying value, the Company will adjust the real estate assets to their respective fair values and recognize an impairment loss. Generally, fair value is determined using a discounted cash flow analysis and recent comparable sales transactions. The assumptions and uncertainties utilized in the evaluation of the impairment of real estate assets are discussed in Note 9 - Fair Value Measures. See also Note 4 - Real Estate Investments and Related Intangibles for further discussion regarding real estate investment activity.
Goodwill
The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable. The Company’s annual testing date is during the fourth quarter. In 2017, the Company adopted ASU 2017-04, Intangibles - Goodwill and Others (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which allows the Company to test goodwill for impairment by comparing the carrying value of net assets to their respective fair value. If the fair value is determined to be less than the carrying value, an impairment charge will be recorded for the difference between the fair value and the carrying value. The Company estimates the fair value using discounted cash flows and relevant competitor multiples. The evaluation of goodwill for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. While the Company believes its assumptions are reasonable, there are no guarantees as to actual results. Changes in assumptions based on actual results may have a material impact on the Company’s financial results. The assumptions and uncertainties utilized in the evaluation of the impairment of goodwill are discussed in detail in Note 9 - Fair Value Measures. Goodwill activity is also discussed in Note 3 - Goodwill and goodwill related to discontinued operations is discussed in Note 5 - Discontinued Operations.
Intangible Assets
The Company’s intangible assets primarily consisted of management and advisory contracts that the discontinued operations, Cole Capital, had with certain Cole REITs. There were no impairment indicators identified during the year ended December 31, 2017.
The Company evaluates intangible assets for impairment when an event occurs or circumstances change that indicate the carrying value may not be recoverable. The Company tested intangible assets for impairment by first comparing the carrying value of the asset group to the undiscounted future cash flows expected from the use of the assets and their eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying value, the Company adjusts the intangible assets to their respective fair values and recognized an impairment loss.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Investment in Unconsolidated Entities
The Company is required to determine whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of any of its investment in the unconsolidated entities. If an event or change in circumstance has occurred, the Company is required to evaluate its investment in the unconsolidated entity for potential impairment and determine if the carrying value of its investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until the carrying value is fully recovered. The evaluation of an investment in an unconsolidated entity for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. The use of different judgments and assumptions could result in different conclusions. No impairments of unconsolidated entities were identified during the years ended December 31, 2017, 2016 or 2015.
Leasehold Improvements and Property and Equipment
Leasehold improvements and property and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If this review indicates that the carrying value of the asset is not recoverable, the Company records an impairment loss, measured at fair value by estimated discounted cash flows or market appraisals. The evaluation of leasehold improvements and property and equipment for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. The use of different judgments and assumptions could result in different conclusions. No impairments of leasehold improvements and property and equipment were identified during the years ended December 31, 2017, 2016 or 2015.
Cash and Cash Equivalents
Cash and cash equivalents include cash in bank accounts, as well as investments in highly-liquid money market funds with original maturities of three months or less. The Company deposits cash with several high quality financial institutions. These deposits are guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) up to an insurance limit of $250,000. At times, the Company’s cash and cash equivalents may exceed federally insured levels. Although the Company bears risk on amounts in excess of those insured by the FDIC, it has not experienced and does not anticipate any losses due to the high quality of the institutions where the deposits are held.
Restricted Cash
The Company had $27.7 million and $45.0 million, respectively, in restricted cash as of December 31, 2017 and December 31, 2016. Restricted cash primarily consists of reserves related to lease expirations, as well as maintenance, structural and debt service reserves. In accordance with certain debt agreements, rent from certain of the Company’s tenants is deposited directly into a lockbox account, from which the monthly debt service payments are disbursed to the lender and the excess funds are then disbursed to the Company. Included in restricted cash at December 31, 2017 was $26.4 million in lender reserves and $1.3 million held in restricted lockbox accounts. Included in restricted cash at December 31, 2016 was $40.7 million in lender reserves and $4.3 million held in restricted lockbox accounts.
Investment in Direct Financing Leases
The Company has acquired certain properties that are subject to leases that qualify as direct financing leases in accordance with U.S. GAAP due to the significance of the lease payments from the inception of the leases compared to the fair value of the property or due to bargain purchase options. Investments in direct financing leases represent the fair value of the remaining lease payments on the leases and the estimated fair value of any expected residual property value at the end of the lease term. The fair value of the remaining lease payments is estimated using a discounted cash flow analysis based on interest rates that would represent the Company’s incremental borrowing rate for similar types of debt. The expected residual property value at the end of the lease term is estimated using market data and assessments of the remaining useful lives of the properties at the end of the lease terms, among other factors. Income from direct financing leases is calculated using the effective interest method over the remaining term of the lease.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Mortgage Notes Receivable
The Company classifies its mortgage notes receivable as long-term investments as the Company intends to hold the mortgage notes receivable for the foreseeable future or until maturity. Mortgage notes receivable investments are carried on the Company’s consolidated balance sheets at amortized cost (unpaid principal balance adjusted for unearned discount or premium and mortgage notes receivable origination fees), net of any allowance for mortgage notes receivable losses. Discounts or premiums and mortgage notes receivable origination fees are amortized as a component of interest income using the effective interest method over the life of the respective mortgage notes receivable. From time to time, the Company may determine to sell a mortgage note receivable in which case it must reclassify the asset as held for sale. Mortgage notes receivable held for sale are carried at the lower of cost or estimated fair value. The Company also evaluates its mortgage notes receivable for possible impairment on a quarterly basis, as discussed in Note 7 - Mortgage Notes Receivable
Commercial Mortgage-Backed Securities
The Company classifies all of its commercial mortgage-backed securities (“CMBS”) as available for sale for financial accounting purposes. Under U.S. GAAP, securities classified as available for sale are carried on the consolidated balance sheet at fair value with the net unrealized gains or losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Any premiums or discounts on securities are amortized as a component of interest income using the effective interest method.
The Company estimates fair value on all securities investments quarterly based on a variety of inputs. Under U.S. GAAP, securities where the fair value is less than the Company’s cost are deemed impaired and, therefore, must be measured for other-than-temporary impairment. If an impaired security (i.e., fair value is below cost) is intended to be sold or required to be sold prior to expected recovery of the impairment loss, the full amount of the loss must be recorded in earnings as an other-than-temporary impairment. Otherwise, temporary impairment losses are included in other comprehensive income (loss).
In estimating credit or other-than-temporary impairment losses, management considers a variety of factors, including (1) the financial condition and near-term prospects of the credit, including credit rating of the security and the underlying tenant and an estimate of the likelihood, amount and expected timing of any default, (2) whether the Company expects to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value, (3) the length of time and the extent to which the fair value has been below cost, (4) current market conditions, (5) expected cash flows from the underlying collateral and an estimate of underlying collateral values, and (6) subordination levels within the securitization pool. These estimates are highly subjective and could differ materially from actual results. From the period the Company acquired the CMBS through December 31, 2017, the Company had no other-than-temporary impairment losses. See Note 6 - Investment Securities, at Fair Value for further discussion.
Deferred Financing Costs
Deferred financing costs represent commitment fees, legal fees and other costs associated with obtaining commitments for financing. Pursuant to the Company’s adoption of the FASB ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, the presentation of all deferred financing costs, other than those associated with the revolving credit facility, are presented on the consolidated balance sheets as a direct deduction from the carrying amount of the related debt liability rather than as an asset. These costs are amortized to interest expense over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing costs are written off when the associated debt is refinanced or repaid before maturity. Costs incurred in connection with potential financial transactions that are not completed are expensed in the period in which it is determined the financing will not be completed.
Convertible Debt
The Company has an outstanding aggregate balance of $1.0 billion related to the Convertible Notes (as defined in Note 10 -Debt). The Convertible Notes are convertible into cash or shares of the Company’s Common Stock at the Company’s option. In accordance with U.S GAAP, the Convertible Notes are accounted for as a liability with a separate equity component recorded for the conversion option. A liability was recorded for the Convertible Notes on the respective issuance date at fair value based on a discounted cash flow analysis using current market rates for debt instruments with similar terms. The difference between the initial proceeds from the Convertible Notes and the estimated fair value of the debt instruments resulted in a debt discount, with an offset recorded to additional paid-in capital representing the equity component. The debt discount is being amortized to interest expense over the respective term of the Convertible Notes.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Derivative Instruments
The Company may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with its borrowings. Certain of the techniques used to hedge exposure to interest rate fluctuations may also be used to protect against declines in the market value of assets that result from general trends in debt markets. The principal objective of such agreements is to minimize the risks and/or costs associated with the Company’s operating and financial structure as well as to hedge specific anticipated transactions.
The Company records all derivatives on the consolidated balance sheets at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
The accounting for subsequent changes in the fair value of these derivatives depends on whether each has been designated and qualifies for hedge accounting treatment. If the Company elects not to apply hedge accounting treatment, any changes in the fair value of these derivative instruments is recognized immediately in loss on derivative instruments, net in the consolidated statements of operations and consolidated statements of comprehensive income (loss). If the derivative is designated and qualifies for hedge accounting treatment, the change in the estimated fair value of the derivative is recorded in other comprehensive income (loss) to the extent that it is effective. Any ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings.
Revenue Recognition - Real Estate
The Company’s revenues, which primarily consist of rental income and include rents that each tenant pays in accordance with the terms of each lease reported on a straight-line basis over the initial non-cancelable term of the lease, are recognized when earned and collectability is reasonably assured. When the Company acquires a property, the term of each existing lease is considered to commence as of the acquisition date for the purposes of this calculation. Since many of the leases provide for rental increases at specified intervals, straight-line basis accounting requires the Company to record a receivable, and include in revenues, straight-line rent receivables that the Company will only receive if the tenant makes all rent payments required through the expiration of the initial term of the lease. Straight-line rent receivables are included in rent and tenant receivables and other assets, net, in the consolidated balance sheets. See Note 8 - Rent and Tenant Receivables and Other Assets, Net. Cost recoveries from tenants are included in operating expense reimbursements in the consolidated statements of operations in the period the related costs are incurred. The Company defers the revenue related to lease payments received from tenants in advance of their due dates. As of December 31, 2017 and December 31, 2016, the Company had $56.6 million and $57.6 million, respectively, of deferred rental income, which is included in deferred rent, derivative and other liabilities in the consolidated balance sheets.
The Company continually reviews receivables related to rent and unbilled rent receivables and determines collectability by taking into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of a receivable is uncertain, the Company will record an increase in the allowance for uncollectible accounts in the consolidated balance sheets and in the consolidated statements of operations as a reduction to rental income. As of December 31, 2017 and December 31, 2016, the Company maintained an allowance for uncollectible accounts of $6.9 million and $6.0 million, respectively.
The Company owns certain properties that have associated leases that require the tenant to pay contingent rental income based on a percentage of the tenant’s sales after the achievement of certain sales thresholds, which may be monthly, quarterly or annual targets. As a lessor, the Company defers the recognition of contingent rental income until the specified target that triggers the contingent rental income is achieved, or until such sales upon which percentage rent is based are known.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Revenue Recognition - Cole Capital
Revenue included securities sales commissions, dealer manager fees, distribution and stockholder servicing fees, real estate acquisition fees, financing coordination fees, property management fees, advisory fees, asset management fees and performance fees for services relating to the Cole REITs’ offerings and the investment and management of their respective assets, in accordance with the respective dealer manager and advisory agreements. The Company recorded dealer manager fees, excluding those related to INAV, and securities sales commissions as revenue upon the sale of Cole REIT shares. Dealer manager fees from the sale of INAV shares and distribution and stockholder servicing fees were recorded as revenue when the fees were fixed or determinable. The Company recorded revenue related to acquisition and financing coordination fees upon completion of a transaction and advisory, asset and property management fees as services were performed. The Company was also reimbursed for certain costs incurred in providing these services. Securities sales commissions and dealer manager reimbursements were recorded as revenue as the expenses were incurred, as long as reimbursement was reasonably assured. The Company, in its sole discretion, could reallow all or a portion of its dealer manager fee to such participating broker-dealers as a marketing and due diligence expense reimbursement, based on factors such as the volume of shares issued by such participating broker-dealers and the amount of marketing support provided by such participating broker-dealers. The Company also reallowed 100% of selling commissions earned to participating broker-dealers. Refer to Note 17 - Related Party Transactions and Arrangements for further discussion.
As of December 31, 2017, these revenues are reflected in the Company’s consolidated statements of operations as discontinued operations for all periods presented. See Note 5 - Discontinued Operations for further discussion regarding discontinued operations.
Program Development Costs
The Company paid for organization, registration and offering expenses associated with the sale of common stock of the Cole REITs. The reimbursement of these expenses by the Cole REITs was limited to a certain percentage of the proceeds raised from their offerings, in accordance with their respective advisory agreements and charters. Such expenses paid by the Company on behalf of the Cole REITs in excess of these limits that were expected to be collected were recorded as program development costs. The Company assessed the collectability of the program development costs, considering the offering period and historical and forecasted sales of shares under the Cole REITs’ respective offerings and reserved for any balances considered not collectible. Additional reserves were generally recorded if actual proceeds raised from the offerings and corresponding program development costs incurred differed from management’s assumptions.
As of December 31, 2017, program development costs are included in discontinued operations for all periods presented. See Note 5 - Discontinued Operations for further discussion regarding discontinued operations.
Acquisition-Related Expenses and Litigation, Merger and Other Non-routine Costs, Net of Insurance Recoveries
During the year ended December 31, 2017, all real estate acquisitions qualified as asset acquisitions, and external acquisition costs related to these asset acquisitions were capitalized. Prior to the Company’s adoption of ASU 2017-01 on January 1, 2017, external costs related to real estate acquisitions were expensed as incurred. Internal costs, such as employee salaries, related to activities necessary to complete, or affect, self-originating asset acquisitions or business combinations are classified as acquisition-related expenses in the accompanying consolidated statements of operations. Any costs incurred as a result of a business combination will be classified as acquisition-related expenses or other non-routine transaction related expenses and expensed as incurred.
External acquisition-related costs incurred in relation to prior mergers and litigation resulting therefrom are included in litigation and other non-routine costs, net of insurance recoveries in the consolidated statements of operations. The Company has also incurred legal fees and other costs associated with the Audit Committee Investigation (defined below) and the litigations and investigations resulting therefrom, which are considered non-routine. The Company has directors’ and officers’ insurance and the insurance carriers have paid certain defense costs subject to standard reservation of rights under the respective policies.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Litigation, merger and other non-routine costs, net of insurance recoveries include the following costs (amounts in thousands):
___________________________________
(1)
The negative balance for the years ended December 31, 2017 and 2015 are a result of estimated costs accrued in prior periods that exceeded actual expenses incurred.
(2)
Includes all fees and costs associated with the previously-announced investigation conducted by the audit committee (the “Audit Committee”) of the Company’s board of directors (the “Audit Committee Investigation”) and various litigations and investigations prompted by the results of the Audit Committee Investigation, including fees and costs incurred pursuant to the Company’s advancement obligations, litigation related there to and in connection with related insurance recovery matters.
(3)
Includes legal fees and expenses associated with litigation resulting from prior mergers.
Due from Affiliates
The Company received compensation and reimbursement for services primarily relating to the Cole REITs’ offerings and the investment, management, financing and disposition of their respective assets. Refer to Note 17 - Related Party Transactions and Arrangements for further explanation. The amounts presented in the consolidated balance sheets are receivables that will be settled directly with the respective Cole REITs and were not transferred pursuant the Cole Capital Purchase and Sale Agreement.
Equity-based Compensation
The Company has an equity-based incentive award plan for non-executive directors, officers, other employees and advisors or consultants who provide services to the Company, as applicable, and a non-executive director restricted share plan, which are accounted for under U.S. GAAP for share-based payments. The expense for such awards is recognized over the vesting period or when the requirements for exercise of the award have been met. See Note 16 - Equity-based Compensation for additional information on these plans.
Per Share Data
Income (loss) per basic share of Common Stock is calculated by dividing net income (loss) less dividends on unvested restricted shares of Common Stock and dividends on preferred stock by the weighted-average number of shares of Common Stock issued and outstanding during such period. Diluted income (loss) per share of Common Stock considers the effect of potentially dilutive shares of Common Stock outstanding during the period.
Reportable Segments
Prior to the fourth quarter of the year ended December 31, 2017, the Company operated through two business segments, the real estate investment segment and the investment management segment, Cole Capital. On November 13, 2017, the Company entered into the Cole Capital Purchase and Sale Agreement to sell substantially all of the Cole Capital segment. The sale closed on February 1, 2018. Substantially all of Cole Capital is presented as discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Income Taxes
The General Partner currently qualifies and has elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code. As a REIT, except as discussed below, the General Partner generally is not subject to federal income tax on taxable income that it distributes to its stockholders so long as it distributes at least 90% of its annual taxable income (computed without regard to the deduction for dividends paid and excluding net capital gains). REITs are subject to a number of other organizational and operational requirements. Even if the General Partner maintains its qualification for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, federal income taxes on certain income and excise taxes on its undistributed income.
The OP is classified as a partnership for U.S. federal income tax purposes. As a partnership, the OP is not a taxable entity for U.S. federal income tax purposes. Instead, each partner in the OP is required to take into account its allocable share of the OP’s income, gains, losses, deductions and credits for each taxable year. However, the OP may be subject to certain state and local taxes on its income and property.
As of December 31, 2017, the OP and the General Partner had no material uncertain income tax positions. The tax years subsequent to and including the fiscal year ended December 31, 2013 remain open to examination by the major taxing jurisdictions to which the OP, the General Partner, American Realty Capital Trust III, Inc. (“ARCT III”), CapLease, Inc. (“CapLease”), American Realty Capital Trust IV, Inc., (“ARCT IV”), Cole Real Estate Investments, Inc. (“Cole”) and Cole Credit Property Trust, Inc. are subject.
Under the LPA, the OP is to conduct business in such a manner as to permit the General Partner at all times to qualify as a REIT.
The Company conducted substantially all of its Cole Capital business activities through a TRS. A TRS is a subsidiary of a REIT that is subject to corporate federal, state and local income taxes, as applicable. The Company’s use of a TRS enables it to engage in certain business activities while complying with the REIT qualification requirements and to retain any income generated by these businesses for reinvestment without the requirement to distribute those earnings. The Company conducts all of its business in the United States, Puerto Rico and Canada and, as a result, it files income tax returns in the U.S. federal jurisdiction, the Canadian federal jurisdiction and various state and local jurisdictions. Certain of the Company’s inter-company transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation. The provision for or benefit from income taxes attributable to Cole Capital are included in discontinued operations for all periods presented. See Note 5 - Discontinued Operations for further discussion regarding discontinued operations.
The Company provides for income taxes in accordance with current authoritative accounting and tax guidance. The tax provision or benefit related to significant or unusual items is recognized in the quarter in which those items occur. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the quarter in which the change occurs. The accounting estimates used to compute the provision for or benefit from income taxes may change as new events occur, additional information is obtained or the tax environment changes.
Recent Accounting Pronouncements
In May 2014, the U.S. Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) (Topic 606), which supersedes the revenue recognition requirements in Revenue Recognition, Accounting Standards Codification (“ASC”) (Topic 605) and will require an entity to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For public business entities, the guidance should be applied to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Companies may use either a full retrospective or a modified retrospective approach, which requires applying the new standard to all existing contracts not yet completed as of the effective date and recording a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. The Company plans to use the modified retrospective approach to adopt ASU 2014-09. Once ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which, as discussed below, sets forth principles for the recognition, measurement, presentation and disclosure of leases, goes into effect, ASU 2014-09 may apply to non-lease components in the lease agreements. In January 2018, the FASB proposed amending Topic 842 to allow lessors the option to combine lease and non-lease components when certain criteria are met. The Company has completed its evaluation of the standard’s impact on the Company’s revenue streams and does not expect that the adoption of ASU 2014-09 will have a material impact on its consolidated financial statements.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
In February 2016, the FASB issued ASU 2016-02, which will require that a lessee recognize assets and liabilities on the balance sheet for all leases with a lease term of more than 12 months, with the result being the recognition of a right of use asset and a lease liability and the disclosure of key information about the entity’s leasing arrangements. The lessor accounting model under ASU 2016-02 is similar to current guidance, however it limits the capitalization of initial direct leasing costs, such as internally generated costs. ASU 2016-02 retains a distinction between finance leases (i.e., capital leases under current U.S. GAAP) and operating leases. The classification criteria for distinguishing between finance leases and operating leases will be substantially similar to the classification criteria for distinguishing between capital leases and operating leases under current U.S. GAAP. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. A modified retrospective approach is required for existing leases that have not expired upon adoption and provides for certain practical expedients. The Company’s implementation team has developed an inventory of all leases and is identifying any non-lease components in the lease agreements and is evaluating the impact to the Company, both as lessor and lessee, and its consolidated financial statements. Upon the adoption of ASU 2016-02, the Company will record certain expenses paid directly by a tenant that protect the Company’s interests in its properties, such as real estate taxes, and the related operating expense reimbursement revenue, with no impact on net income. The Company currently does not record such expenses and the related operating expenses reimbursement revenues. The Company expects the accounting for leases pursuant to which the Company is the lessee to change and is currently evaluating the impact. Leases pursuant to which the Company is the lessee primarily consist of corporate offices and ground leases.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (“ASU 2016-13”). ASU 2016-13 is intended to improve financial reporting by requiring more timely recognition of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. ASU 2016-13 requires that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The amendments in ASU 2016-13 require the Company to measure all expected credit losses based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets and eliminates the “incurred loss” methodology under current U.S. GAAP. ASU 2016-13 is effective for fiscal years, and interim periods within, beginning after December 15, 2019. Early adoption is permitted for fiscal years, and interim periods within, beginning after December 15, 2018. The Company is currently evaluating the impact this amendment will have on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which is intended to address diversity in practice related to how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted, and requires retrospective adoption unless it is impracticable to apply, in which case it is to be applied prospectively as of the earliest date practicable. The Company adopted ASU 2016-15 during the fourth quarter of fiscal year 2017 and determined that this standard impacts the Company’s classification of proceeds from the settlement of insurance claims and distributions received from equity method investments. Following the retrospective adoption of this standard, the Company reclassified $2.6 million and $6.5 million of distributions received from equity method investments from cash flows from operating activities to cash flows from investing activities for the years ended December 31, 2016 and 2015, respectively. The Company also reclassified $0.8 million of proceeds from the settlement of property-related insurance claims from cash flows from operating activities to cash flows from investing activities for the year ended December 31, 2015.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”), which provides guidance on the presentation of restricted cash and restricted cash equivalents in the statement of cash flows. In accordance with ASU 2016-18, restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows. The amendments of ASU 2016-18 are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company adopted ASU 2016-18 during the fourth quarter of 2017 and applied the standard retrospectively for all periods presented. Accordingly, for the years ended December 31, 2017, 2016 and 2015, the Company included restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows and removed the change in restricted cash from cash flows from investing activities. This change resulted in a decrease in cash flows from investing activities of $11.1 million during the year ended December 31, 2016 and an increase of $1.5 million in cash flows from investing activities during the year ended December 31, 2015. Upon adoption of ASU 2016-18, the Company also included $3.6 million and $4.4 million, during the years ended December 31, 2016 and 2015, respectively, of restricted cash outflows within the “payments on mortgage notes payable and other debt, including debt extinguishment and swap termination costs’’ line item within cash flows from financing activities in the consolidated statement of cash flows.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
In January 2017, the FASB issued ASU 2017-01, which clarifies the definition of a business by adding guidance to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods, with early adoption permitted, and is required to be applied prospectively to any transactions occurring within the period of adoption. The Company has elected to early adopt ASU 2017-01 effective January 1, 2017. As the Company expects that a majority of its real estate acquisitions will be considered asset acquisitions, external acquisition costs related to these asset acquisitions will be capitalized. Prior to 2017, all acquisition-related costs were expensed as incurred. The adoption of this pronouncement resulted in capitalization of $3.3 million of external acquisitions-related costs during the year ended December 31, 2017. Internal costs, such as employee salaries, related to activities necessary to complete, or affect, self-originating asset acquisitions or business combinations are classified as acquisition-related expenses in the accompanying consolidated statements of operations. Upon adoption of ASU 2017-01, the Company's real estate dispositions qualify as asset dispositions and as such, no portion of the Company’s goodwill was allocated to the cost basis of these assets in determining the gain or loss on disposition of real estate and held for sale assets. Prior to January 1, 2017, when the Company disposed of a property or classified a property as held for sale, it constituted a business per U.S. GAAP and the Company allocated a portion of goodwill to the cost basis of that property in determining the gain or loss on the disposition of real estate and held for sale assets.
In January 2017, the FASB issued ASU 2017-04, which simplifies the measurement of goodwill impairment by eliminating Step 2 from the goodwill impairment test (comparing the implied fair value of goodwill with the carrying amount of goodwill). ASU 2017-04 is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The adoption of this standard is applied prospectively and may result in a different impairment charge as compared to the existing standard. The Company adopted ASU 2017-04 during the fourth quarter of 2017. ASU 2017-04 had no impact on the 2017 annual impairment test. Refer to “Note 3 - Goodwill” for discussion regarding goodwill and “Note 9 - Fair Value Measures” regarding the annual goodwill impairment test.
In February 2017, the FASB issued ASU 2017-05, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets (“ASU 2017-05”), which clarifies the following: 1) nonfinancial assets within the scope of Subtopic 610-20 may include nonfinancial assets transferred within a legal entity to a counterparty; 2) an entity should allocate consideration to each distinct asset by applying the guidance in Topic 606 on allocating the transaction price to performance obligations; and 3) requires entities to derecognize a distinct nonfinancial asset or distinct in substance nonfinancial asset in a partial sale transaction when it (a) does not have (or ceases to have) a controlling financial interest in the legal entity that holds the asset in accordance with Subtopic 810 and (b) transfers control of the asset in accordance with Topic 606. The adoption of this standard will result in higher gains on the sale of partial real estate interests, including contributions of nonfinancial assets to a joint venture or other noncontrolling investee, due to recognizing the full gain when the derecognition criteria are met and recording the retained noncontrolling interest at its fair value. ASU 2017-05 is effective for annual periods, and interim periods therein, beginning after December 15, 2017. The standard is applied prospectively to sales of nonfinancial assets on or after the adoption date. The Company will adopt ASU 2017-09 during the first quarter of fiscal year 2018 and does not expect it will have a material impact on its consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU clarifies which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. This ASU is effective for fiscal years beginning after December 15, 2017 and interim periods therein, with early adoption permitted. The standard is applied prospectively to an award modified on or after the adoption date. The Company will adopt ASU 2017-09 during the first quarter of fiscal year 2018 and does not expect it will have a material impact on its consolidated financial statements.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The targeted amendments in this ASU help simplify certain aspects of hedge accounting and result in a more accurate portrayal of the economics of an entity’s risk management activities in its financial statements. This ASU applies to the Company’s interest rate swaps designated as cash flow hedges. Upon adoption of this ASU, all changes in the fair value of highly effective cash flow hedges will be recorded in accumulated other comprehensive income rather than recognized directly in earnings. Under current U.S. GAAP, the ineffective portion of the change in fair value of cash flow hedges is recognized directly in earnings. This eliminates the requirement to separately measure and disclose ineffectiveness for qualifying cash flow hedges. ASU 2017-12 is effective for public entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The ASU is required to be adopted using a modified retrospective approach with early adoption permitted. The Company will adopt ASU 2017-12 during the first quarter of fiscal year 2018 and does not expect it will have a material impact on its consolidated financial statements.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Note 3 - Goodwill
In connection with prior mergers, the Company recorded goodwill as a result of the merger consideration exceeding the net assets acquired. As of December 31, 2017 and December 31, 2016, the carrying value of goodwill was $1.3 billion. During the year ended December 31, 2017, one property classified as held for sale as of December 31, 2016 was classified as held and used, resulting in an increase to the goodwill allocated to the real estate investment reporting unit of $0.4 million. During the year ended December 31, 2016, the Company allocated $73.2 million of goodwill to dispositions and held for sale assets, which included $2.3 million of goodwill allocated to the cost basis of two properties foreclosed upon as discussed in Note 10 -Debt. The allocated goodwill of $73.2 million was included in gain (loss) on disposition of real estate and real estate assets held for sale, net in the consolidated statement of operations.
The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable. The analysis performed for the annual goodwill tests during the years ended December 31, 2017, 2016 and 2015 resulted in no impairment charges. See Note 9 - Fair Value Measures for a discussion of the Company’s fair value measurements regarding goodwill. Goodwill related to discontinued operations is discussed in Note 5 - Discontinued Operations.
Note 4 - Real Estate Investments and Related Intangibles
Property Acquisitions
During the year ended December 31, 2017, the Company acquired controlling financial interests in 88 commercial properties and three land parcels for an aggregate purchase price of $748.8 million (the “2017 Acquisitions”), which includes $3.3 million of external acquisition-related expenses that were capitalized in accordance with ASU 2017-01 and includes 22 properties acquired in a nonmonetary exchange discussed below. Prior to the adoption of ASU 2017-01, costs related to property acquisitions were expensed as incurred. During the year ended December 31, 2016, the Company acquired a controlling interest in eight commercial properties for an aggregate purchase price of $100.2 million (the “2016 Acquisitions”). During the year ended December 31, 2015, the Company acquired 16 commercial properties and nine land parcels for an aggregate purchase price of $36.3 million (the “2015 Acquisitions”).
The following table presents the allocation of the fair values of the assets acquired and liabilities assumed during the periods presented (in thousands):
____________________________________
(1)
The weighted average amortization period for acquired in-place leases and other intangibles is 15.8 years, 13.8 years and 11.0 years for 2017 Acquisitions, 2016 Acquisitions and 2015 Acquisitions, respectively.
(2)
The weighted average amortization period for acquired above-market leases is 18.0 years and 14.1 years for 2017 Acquisitions and 2015 Acquisitions, respectively. There were no acquired above-market leases during the year ended December 31, 2016.
(3)
The weighted average amortization period for acquired intangible lease liabilities is 13.8 years, 10.0 years and 15.0 years for 2017 Acquisitions, 2016 Acquisitions and 2015 Acquisitions, respectively.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The Company has not included pro forma information for the Company's 2016 Acquisitions or 2015 Acquisitions, which were acquired prior to the adoption of ASU 2017-01 and met the definition of a business combination, as they did not have a material impact on the Company's financial position or results of operations.
Future Lease Payments
The following table presents future minimum base rent payments due to the Company over the next five years and thereafter. These amounts exclude contingent rent payments, as applicable, that may be collected from certain tenants based on provisions related to sales thresholds and increases in annual rent based on exceeding certain economic indexes among other items (in thousands):
____________________________________
(1)
29 properties are subject to direct financing leases and, therefore, revenue is recognized as direct financing lease income on the discounted cash flows of the lease payments. Amounts reflected are the minimum base rental cash payments due to the Company under the lease agreements on these respective properties.
Property Dispositions and Real Estate Assets Held for Sale
During the year ended December 31, 2017, the Company disposed of 137 properties, including one property owned by a consolidated joint venture, six properties transferred to the lender in either a deed-in-lieu of foreclosure or foreclosure sale transaction as discussed in Note 10 - Debt, and 15 properties disposed of in connection with the nonmonetary exchange discussed below, for an aggregate gross sales price of $594.9 million, of which our share was $574.4 million after the profit participation payments related to the disposition of 31 Red Lobster properties and the consolidated joint venture partner’s share of the sales price. The dispositions resulted in proceeds of $445.5 million after a mortgage loan assumption of $66.0 million and closing costs. Additionally, the Company’s tax provision for the year ended December 31, 2017 included $1.7 million of Canadian tax on the gain on sale of certain Canadian properties. The Company recorded a gain of $64.7 million related to the sales which is included in gain (loss) on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
During the year ended December 31, 2016, the Company disposed of 301 properties, for an aggregate gross sales price of $1.08 billion, of which our share was $1.04 billion after the profit participation payment related to the disposition of 70 Red Lobsters. The dispositions resulted in proceeds of $958.4 million after a mortgage loan assumption of $55.0 million and closing costs. The Company recorded a gain of $45.7 million, which included $67.8 million of goodwill allocated to the cost basis of such properties, which is included in gain (loss) on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
During the year ended December 31, 2016, the Company also disposed of one property owned by an unconsolidated joint venture for a gross sales price of $113.5 million, of which our share was $102.1 million based on our ownership interest in the joint venture, resulting in proceeds of $42.3 million after debt repayments of $57.0 million and closing costs. The Company recorded a gain of $10.2 million related to the sale, which is included in equity in income and gain on disposition of unconsolidated entities in the accompanying consolidated statements of operations.
During the year ended December 31, 2015, the Company disposed of 228 properties, including two properties owned by consolidated joint ventures, for an aggregate sales price of $1.4 billion, resulting in consolidated proceeds of $966.1 million after mortgage loan assumptions and closing costs. The Company recorded a loss of $69.1 million related to the sales, which included $96.7 million of goodwill allocated in the cost basis of such properties. The Company’s loss on the sales is included in gain (loss) on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
During the year ended December 31, 2015, the Company also disposed of its interest in one consolidated joint venture, whose only assets consisted of investments in three Unconsolidated Joint Ventures, for an aggregate gross sales price of $77.5 million, of which the Company’s share was $69.8 million based on its ownership interest, resulting in consolidated proceeds of $43.0 million after mortgage loan repayment and closing costs. The mortgage loan obligation of the consolidated joint venture was held by an unconsolidated entity. The Company recorded a gain of $6.7 million related to the sale of the consolidated joint venture, which is included in equity in income and gain on disposition of unconsolidated entities in the accompanying consolidated statements of operations.
As of December 31, 2017, there were 30 properties classified as held for sale with a carrying value of $38.3 million, included in assets related to discontinued operations and real estate assets held for sale, net in the accompanying consolidated balance sheet which are expected to be sold in the next 12 months as part of the Company’s portfolio management strategy. As of December 31, 2016, there were 11 properties classified as held for sale. During the year ended December 31, 2017, the Company recorded a loss of $3.1 million related to held for sale properties. No goodwill was allocated to the cost basis of any additional properties classified as held for sale during the year ended December 31, 2017. During the year ended December 31, 2016, the Company recorded a loss of $0.2 million related to properties classified as held for sale during the respective period, which included $3.2 million of goodwill allocated to the cost basis of such properties. The loss on properties held for sale is included in gain (loss) on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
Intangible Lease Assets and Liabilities
Intangible lease assets and liabilities of the Company consisted of the following as of December 31, 2017 and December 31, 2016 (amounts in thousands, except weighted-average useful life):
The following table provides the projected amortization expense and adjustments to rental income related to the intangible lease assets and liabilities for the next five years as of December 31, 2017 (amounts in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Nonmonetary Exchange
During the year ended December 31, 2017, the Company completed a nonmonetary exchange through the simultaneous acquisition of 22 Bob Evans properties and disposition of 15 Red Lobster properties. Pursuant to Nonmonetary Transactions, ASC (Topic 845), the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset is the fair value of the asset surrendered to obtain the acquired nonmonetary asset, and a gain or loss should be recognized on the exchange. The fair value of the asset received should be used to measure the cost if the fair value of the asset received is more reliable than the fair value of the asset surrendered. The Company estimated the fair value of the Bob Evans and Red Lobster properties using valuation techniques consistent with the income approach and concluded that the fair value was $50.1 million. As the fair value of the assets received exceeded the book value of the assets surrendered, the Company recorded a gain of $7.4 million, which is included in gain (loss) on disposition of real estate and real estate assets held for sale, net in the accompanying consolidated statements of operations.
Impairment of Real Estate Investments
The Company performs quarterly impairment review procedures, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable.
As part of the Company’s quarterly impairment review procedures and considering the factors discussed regarding the Company’s policies on real estate impairment mentioned in Note 2 - Summary of Significant Accounting Policies, real estate assets and an investment in a property subject to a direct financing lease with carrying values totaling $161.9 million were deemed to be impaired and their carrying values were reduced to their estimated fair values of $111.4 million resulting in impairment charges of $50.5 million during the year ended December 31, 2017. The majority of the 2017 impairment charges relate to certain office, restaurant and other properties that, during 2017, management identified for potential sale or determined, based on discussions with the current tenants, will not be re-leased.
During the year ended December 31, 2016, a majority of the impairment charges related to properties identified by management for potential sale as part of its portfolio management strategy to reduce exposure to office properties. Additionally, a tenant of 59 restaurants filed for bankruptcy. As part of the Company’s quarterly impairment review procedures and considering the factors mentioned above, real estate assets with carrying values totaling $668.2 million were deemed to be impaired and their carrying values were reduced to their estimated fair values of $485.4 million, resulting in impairment charges of $182.8 million during the year ended December 31, 2016.
During the year ended December 31, 2015, real estate assets with carrying value totaling $340.1 million were deemed to be impaired and their carrying value was reduced to their estimated fair value of $248.3 million, resulting in impairment charges of $91.8 million.
Consolidated Joint Ventures
The Company had an interest in one joint venture that owned one property as of December 31, 2017 and had total assets of $33.7 million, of which $30.7 million were real estate investments, net of accumulated depreciation and amortization. As of December 31, 2016, the Company had interests in two joint ventures that owned two properties and had total assets of $57.0 million, of which $50.8 million were real estate investments, net of accumulated depreciation and amortization. As of December 31, 2017 and December 31, 2016, one property was secured by a mortgage note payable of $14.9 million and $11.6 million, respectively, which was non-recourse to the Company. The Company has the ability to control operating and financial policies of the consolidated joint ventures. There are restrictions on the use of these assets as the Company would generally be required to obtain the approval of each partner (the “Partner”) in accordance with the joint venture agreement for any major transactions. The Company and each Partner are subject to the provisions of each joint venture agreement, which includes provisions for when additional contributions may be required to fund certain cash shortfalls.
The Partners’ share of the aggregate consolidated joint ventures’ loss was $0.2 million and $14,000 for the years ended December 31, 2017 and 2016, respectively. The Partners’ share of the aggregate consolidated joint ventures’ income was $1.3 million for the year ended December 31, 2015. One joint venture disposed of its property during the year ended December 31, 2017 and the Company disposed of its interest in three consolidated joint ventures during the year ended December 31, 2015, which included one consolidated joint venture, whose only assets were investments in three Unconsolidated Joint Ventures (as defined below).
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Unconsolidated Joint Ventures
The Company’s investment in unconsolidated joint venture arrangements (the “Unconsolidated Joint Ventures”) consisted of interests in two joint ventures that each owned one property as of December 31, 2017 and December 31, 2016. As of December 31, 2017 and December 31, 2016, the Company owned aggregate equity investments of $39.5 million and $41.3 million, respectively, in the Unconsolidated Joint Ventures. The Company accounts for its investments in Unconsolidated Joint Ventures using the equity method of accounting as the Company has the ability to exercise significant influence, but not control, over operating and financial policies of these investments. The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in earnings and distributions from the joint ventures. As of December 31, 2017, the Company’s maximum exposure to risk was $39.5 million, the carrying value of the investments, which is presented in investment in unconsolidated entities in the consolidated balance sheet. The Unconsolidated Joint Ventures had total debt outstanding of $20.4 million as of December 31, 2017, none of which is recourse to the Company, as discussed in Note 10 - Debt. The Company and the respective unconsolidated joint venture partners are subject to the provisions of the applicable joint venture agreement, which includes provisions for when additional contributions may be required to fund certain cash shortfalls.
During the years ended December 31, 2017, 2016 and 2015, the Company recognized $3.3 millions, $0.9 million and $2.3 million of net income, respectively, from the unconsolidated joint ventures.
The following is a summary of the Company’s percentage ownership and carrying amount related to each of the Unconsolidated Joint Ventures as of December 31, 2017 and December 31, 2016 (dollar amounts in thousands):
_______________________________________________
(1)
The Company’s ownership interest in this table reflects its legal ownership interest. Legal ownership may, at times, not equal the Company’s economic interest in the listed properties because of various provisions in certain joint venture agreements regarding distributions of cash flow based on capital account balances, allocations of profits and losses and payments of preferred returns. As a result, the Company’s actual economic interest (as distinct from its legal ownership interest) in certain of the properties could fluctuate from time to time and may not wholly align with its legal ownership interests.
(2)
The total carrying amount of the investments was greater than the underlying equity in net assets by $8.6 million and $6.4 million as of December 31, 2017. and December 31, 2016, respectively. This difference relates to a purchase price allocation of goodwill and a step up in fair value of the investment assets acquired in connection with mergers. The step up in fair value was allocated to the individual investment assets and is being amortized in accordance with the Company’s depreciation policy.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Note 5 - Discontinued Operations
On November 13, 2017, the Company entered into the Cole Capital Purchase and Sale Agreement to sell all of the issued and outstanding shares of common stock of CCA and certain of CCA’s subsidiaries to the Cole Purchaser for approximately $120.0 million paid in cash at closing, subject to customary adjustments to reflect the operation of CCA and such subsidiaries prior to closing. The sale closed on February 1, 2018. At closing, the Company entered into a services agreement (the “Services Agreement”) with the Cole Purchaser pursuant to which the Company will continue to provide certain services to the Cole Purchaser and the Cole REITs, including operational real estate support, over the next year. Under the terms of the Services Agreement, the Company will be entitled to receive reimbursement for certain of the services provided. The Company could also receive additional fees over the next six years if future revenues of Cole Capital exceed a specified dollar threshold (the “Net Revenue Payments”), up to an aggregate of $80.0 million in Net Revenue Payments.
The following is a summary of the assets and liabilities related to discontinued operations and real estate assets held for sale as of December 31, 2017 and December 31, 2016 (in thousands):
___________________________________
(1)
The intangible assets consisted of management and advisory contracts that the Company had with certain Cole REITs. Accumulated amortization was $44.1 million and $29.6 million as of December 31, 2017 and December 31, 2016, respectively.
(2)
Includes program development costs of $3.3 million and $3.2 million as of December 31, 2017 and December 31, 2016, respectively, which were net of reserves of $7.6 million and $31.7 million, respectively.
(3)
The Company performed the annual goodwill test using the $120.0 million cash proceeds provided for under the Cole Capital Purchase and Sale Agreement, plus the estimated fair value of the Net Revenue Payments and determined the carrying amount exceeded the estimated fair value. As such, no goodwill impairment was recorded during the year ended December 31, 2017.
(4)
The Company recognized a loss of $20.0 million on classification of the discontinued operations as held for sale, of which $0.5 million represents estimated costs to sell that were subsequently accrued in accounts payable and accrued expenses as of December 31, 2017. In determining the loss recognized on classification as held for sale, the Company elected to account for the future Net Revenue Payments as a gain contingency. Under this approach, the Company will not recognize any Net Revenue Payments until realized.
(5)
Real estate assets held for sale are not included in assets related to discontinued operations.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following is a summary of the financial information and cash flows for discontinued operations for the years ended December 31, 2017, 2016 and 2015 (in thousands):
Income Taxes
Cole Capital’s business, substantially all of which was conducted through a TRS, recognized a provision of $13.8 million for the year ended December 31, 2017, and a benefit of $10.8 million and $40.9 million for the years ended December 31, 2016 and 2015, respectively.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following table presents the reconciliation of the provision for (benefit from) income taxes with the amount computed by applying the statutory federal income tax rate to loss before income taxes for the years ended December 31, 2017, 2016 and 2015 (in thousands):
The following table presents the components of the provision for (benefit from) income taxes for the years ended December 31, 2017, 2016 and 2015 (in thousands):
The components of the net deferred tax assets (liabilities) as of December 31, 2017 and 2016 which are included in assets or liabilities related to discontinued operations, net in the accompanying consolidated balance sheets, are as follows (in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Note 6 - Investment Securities, at Fair Value
Investment securities are considered available-for-sale and, therefore, increases or decreases in the fair value of these investments are recorded in accumulated other comprehensive income (loss) as a component of equity in the consolidated balance sheets unless the securities are considered to be other-than-temporarily impaired at which time the losses are reclassified to expense.
The following tables detail the unrealized gains and losses on investment securities as of December 31, 2017 and December 31, 2016 (in thousands):
As of each of December 31, 2017 and December 31, 2016, the Company owned eight CMBS with an estimated aggregate fair value of $41.0 million and $47.2 million, respectively. The Company generally receives monthly payments of principal and interest on the CMBS. As of December 31, 2017, the Company earned interest on the CMBS at rates ranging between 5.9% and 9.0%. As of December 31, 2017, the fair value of six CMBS were below their amortized cost. In estimating other-than-temporary impairment losses, management considers a variety of factors, including: (i) whether the Company has the intent to sell the security, (ii) whether the Company expects to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value, and (iii) whether the Company expects to recover the entire amortized cost basis of the security. The Company believes that none of the unrealized losses on investment securities are other-than-temporary as management expects the Company will fully recover the entire amortized cost basis of all securities. As of December 31, 2017, the Company had no other-than-temporary impairment losses.
During the year ended December 31, 2015, the Company recorded a $0.1 million gain on the sale of investment securities, which is included in other income, net in the accompanying consolidated statements of operations. No such gain was recorded for the years ended December 31, 2017 or 2016.
The scheduled maturity of the Company’s CMBS as of December 31, 2017 are as follows (in thousands):
Note 7 - Mortgage Notes Receivable
As of December 31, 2017, the Company owned eight mortgage notes receivable with a weighted-average interest rate of 6.2% and weighted-average years to maturity of 12.6 years. During the year ended December 31, 2017, one mortgage note with a carrying value of $1.5 million at repayment was paid in full prior to the maturity date resulting in a $0.1 million gain, which is included in other income, net in the accompanying consolidated statements of operations. The following table details the mortgage notes receivable as of December 31, 2017 (dollar amounts in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The Company’s mortgage notes receivable are comprised primarily of fully-amortizing or nearly fully-amortizing first mortgage loans. The Company has one mortgage note receivable where the Company does not receive monthly payments of principal and interest but rather the interest is capitalized into the outstanding balance that is due at maturity. The mortgage notes receivable are primarily on commercial real estate, each leased to a single tenant. Therefore, the Company’s monitoring of the credit quality of its mortgage notes receivable is focused primarily on an analysis of the tenant, including review of tenant quality and ratings, trends in the tenant’s industry and general economic conditions and an analysis of measures of collateral coverage, such as an estimate of the loan-to-value ratio (principal amount outstanding divided by the estimated value of the property) and its remaining term until maturity.
The following table summarizes the scheduled aggregate principal payments due to the Company on the mortgage notes receivable subsequent to December 31, 2017 (in thousands):
____________________________________
(1)
Includes additional $3.8 million of interest that will be capitalized into the outstanding balance of the mortgage note receivable subsequent to December 31, 2017.
Unsecured Note Reserve
During the year ended December 31, 2015, the Company assessed the collectability of an unsecured note held with an affiliate of the Former Manager after the December debt service payment was not paid. The Company assessed the liquidity of the borrower, the lien position of the note and the other obligations of the borrower. Based on the analysis, the Company concluded that it was unlikely that the unsecured note will be repaid and recorded a reserve for loan loss equal to the $15.3 million carrying value of the note for the three months ended December 31, 2015. No principal or interest payments have been received relating to the unsecured note during the years ended December 31, 2017 and 2016.
Note 8 - Rent and Tenant Receivables and Other Assets, Net
Rent and tenant receivables and other assets, net consisted of the following as of December 31, 2017 and December 31, 2016 (in thousands):
___________________________________
(1)
Allowance for doubtful accounts included in accounts receivable, net was $6.3 million and $6.0 million as of December 31, 2017 and December 31, 2016, respectively.
(2)
Allowance for doubtful accounts included in straight-line rent receivable, net was $2.0 million as of December 31, 2017. No such allowance was included in the straight-line rent receivable at December 31, 2016.
(3)
Amortization expense for deferred costs related to the revolving credit facility totaled $10.4 million, $10.4 million and $10.7 million for the years ended December 31, 2017, 2016 and 2015, respectively. Accumulated amortization for deferred costs related to the revolving credit facility was $40.3 million and $29.8 million as of December 31, 2017 and December 31, 2016, respectively.
(4)
Amortization expense for leasehold improvements totaled $1.2 million, $2.3 million and $2.2 million for the years ended December 31, 2017, 2016 and
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
2015, respectively, inclusive of write offs of $1.0 million for the year ended December 31, 2016. Accumulated amortization was $4.7 million and $3.5 million as of December 31, 2017 and December 31, 2016, respectively. Depreciation expense for property and equipment totaled $1.8 million, $3.4 million and $2.1 million for the years ended December 31, 2017, 2016 and 2015, respectively, inclusive of write offs of $0.6 million and $1.2 million for the years ended December 31, 2017 and 2016, respectively.
(5)
Net of $1.8 million and $1.6 million of interest receivable reserves as of December 31, 2017 and December 31, 2016.
Note 9 - Fair Value Measures
The Company determines fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. U.S. GAAP guidance defines three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.
Level 3 - Unobservable inputs reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. Changes in the type of inputs may result in a reclassification for certain assets. There were no transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy during the year ended December 31, 2017. The Company expects that changes in classifications between levels will be infrequent.
Items Measured at Fair Value on a Recurring Basis
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis, based on market rates of the Company’s positions and other observable interest rates as discussed in Note 6 - Investment Securities, at Fair Value and Note 11 - Derivatives and Hedging Activities, as of December 31, 2017 and December 31, 2016, aggregated by the level in the fair value hierarchy within which those instruments fall (in thousands):
CMBS - The Company’s CMBS are carried at fair value and are valued using Level 3 inputs. The Company used estimated non-binding quoted market prices from the trading desks of financial institutions that are dealers in such securities for similar CMBS tranches that actively participate in the CMBS market. Broker quotes are only indicative of fair value and may not necessarily represent what the Company would receive in an actual trade for the applicable instrument. Management determines that the prices are representative of fair value through its knowledge and experience in the market. The significant unobservable input used in
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
valuing the CMBS is the discount rate or market yield used to discount the estimated future cash flows expected to be received from the underlying investment, which include both future principal and interest payments. Significant increases or decreases in the discount rate or market yield would result in a decrease or increase in the fair value measurement. The following risks are included in the consideration and selection of discount rates or market yields: risk of default, rating of the investment and comparable company investments.
Derivative Assets and Liabilities - The Company’s derivative financial instruments relate to interest rate swaps, discussed in Note 11 - Derivatives and Hedging Activities. The valuation of derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the counterparties.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of December 31, 2017, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, due to affiliates and accounts payable approximate their carrying value in the accompanying consolidated balance sheets due to their short-term nature and are classified as Level 1 under the fair value hierarchy.
The following are reconciliations of the changes in assets and liabilities with Level 3 inputs in the fair value hierarchy for the years ended December 31, 2017 and 2016 (in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The fair values of the Company’s financial instruments that are not reported at fair value in the consolidated balance sheets are reported below (dollar amounts in thousands):
_______________________________________________
(1)
Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs.
Mortgage notes receivable - The fair value of the Company’s fixed-rate loan portfolio is estimated with a discounted cash flow analysis, utilizing scheduled cash flows and discount rates estimated by management to approximate market interest rates.
Debt - The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of observable market interest rates. Corporate bonds and convertible debt are valued using quoted market prices in active markets with limited trading volume when available.
Items Measured at Fair Value on a Non-Recurring Basis
Certain financial and nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.
Real Estate Investments
As discussed in Note 4 - Real Estate Investments and Related Intangibles, during the year ended December 31, 2017, net real estate assets and an investment in a property subject to a direct financing lease representing 69 properties were deemed to be impaired and their carrying values totaling $161.9 million were reduced to their estimated fair value of $111.4 million, resulting in impairment charges of $50.5 million. During the years ended December 31, 2016 and 2015, net real estate assets related to 153 and 202 properties, respectively, with carrying values totaling $668.2 million and $340.1 million, respectively, were deemed to be impaired and their carrying values were reduced to their estimated fair values of $485.4 million and $248.3 million, respectively, resulting in impairment charges of $182.8 million and $91.8 million, respectively. The Company estimates fair values using Level 3 inputs and using a combined income and market approach, specifically using discounted cash flow analysis and recent comparable sales transactions. The evaluation of real estate assets for potential impairment requires the Company’s management to exercise significant judgment and to make certain key assumptions, including, but not limited to, the following: (1) capitalization rate; (2) discount rates; (3) number of years property will be held; (4) property operating expenses; and (5) re-leasing assumptions including number of months to re-lease, market rental income and required tenant improvements. There are inherent uncertainties in making these estimates such as market conditions and performance and sustainability of the Company’s tenants. For the Company’s impairment tests for the real estate assets during the year ended December 31, 2017, the Company used a range of discount rates from 7.4% to 7.8% with a weighted-average rate of 7.5% and capitalization rates from 6.9% to 10.0% with a weighted-average rate of 8.0%.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following table presents the impairment charges by asset class recorded during the years ended December 31, 2017, 2016 or 2015 (dollar amounts in thousands):
Goodwill
The Company performed its annual test of the goodwill for impairment and determined an estimated fair value of $15.1 billion, $18.3 billion and $19.7 billion at the 2017, 2016, and 2015 measurement dates, respectively, which exceeded the carrying values by 8.1%, 21.0%, and 13.0% respectively. As such, no goodwill impairment was recorded during the years ended December 31, 2017, 2016 or 2015 in income (loss) from continuing operations. If all other assumptions were held constant, increasing the discount rate by 0.5% would decrease the amount that the 2017 fair value exceeds the 2017 carrying value from $1.1 billion to $385.0 million.
The Company estimated the fair value using both the income and market approach in evaluating goodwill for impairment. The assumptions utilized in the income approach include, but are not limited to, revenue growth rates, future cash flows and discount rates. The assumptions utilized in the market approach include, but are not limited to, future cash flows, the selection of comparable companies and measures of operating results and pricing multiples. AFFO multiples for market comparable companies were used to estimate the fair value by applying those multiples to the projected financial information prepared by management. The uncertainties associated with the fair value assumptions for the goodwill are the same as the uncertainties for real estate assets.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Note 10 - Debt
As of December 31, 2017, the Company had $6.1 billion of debt outstanding, including net premiums and net deferred financing costs, with a weighted-average years to maturity of 4.3 years and a weighted-average interest rate of 4.2%. The following table summarizes the carrying value of debt as of December 31, 2017 and December 31, 2016, and the debt activity for the year ended December 31, 2017 (in thousands):
____________________________________
(1)
Includes $16.2 million related to one mortgage note payable in default.
(2)
Net premiums on mortgage notes payable and other debt were recorded upon the assumption of the respective debt instruments in relation to the various mergers and acquisitions. Amortization of these net premiums is recorded as a reduction to interest expense over the remaining term of the respective debt instruments using the effective-interest method.
(3)
Discounts on the corporate bonds and convertible debt were recorded based upon the fair value of the respective debt instruments as of the respective issuance dates. Amortization of these discounts is recorded as an increase to interest expense over the remaining term of the respective debt instruments using the effective-interest method.
(4)
Deferred costs relate to the term portion of the credit facility, which was repaid during the year ended December 31, 2017.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Mortgage Notes Payable
The Company’s mortgage notes payable consisted of the following as of December 31, 2017 (dollar amounts in thousands):
____________________________________
(1)
Gross carrying value is gross real estate assets, including investment in direct financing leases, net of gross real estate liabilities.
(2)
Weighted-average interest rate for variable-rate debt represents the interest rate in effect as of December 31, 2017.
(3)
Includes $78.9 million of variable-rate debt fixed by way of interest rate swap arrangements.
(4)
The table above does not include the loan amount associated with an Unconsolidated Joint Venture of $20.4 million, none of which is recourse to the Company. The loan has a secured fixed rate of 5.20% and a maturity of July 2021.
(5)
Weighted average years remaining to maturity is computed using the anticipated repayment date as specified in each loan agreement, where applicable.
(6)
Weighted average interest rate is computed using the interest rate in effect until the anticipated repayment date. Should the loan not be repaid at the anticipated repayment date, the applicable interest rate shall increase as specified in the respective loan agreement until the extended maturity date.
The Company’s mortgage loan agreements generally restrict corporate guarantees and require the maintenance of financial covenants, including maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios). The mortgage loan agreements contain no dividend restrictions except in the event of default or when a distribution would drive liquidity below the applicable thresholds. At December 31, 2017, except for the loan in default described below, the Company believes it was in compliance with the financial covenants under the mortgage loan agreements and had no restrictions on the payment of dividends.
During the years ended December 31, 2017 and 2016, the Company repaid mortgage notes payable resulting in a gain on extinguishment of debt of $0.3 million in each year, due to the write-off of unamortized premiums, net of deferred financing costs and prepayment penalties, which are included in (loss) gain on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations.
As of December 31, 2017, the Company had $16.2 million related to one outstanding mortgage note payable in default. The Company is engaged with the servicer to determine a method of settlement.
On August 31, 2017, the Company entered into a deed-in-lieu of foreclosure agreement with the lender of a mortgage loan secured by one property, with an outstanding balance of $41.6 million on the date of agreement and conveyed its interest in the property to satisfy the mortgage loan. As a result of the deed-in-lieu of foreclosure transaction, the Company recognized a gain on forgiveness of debt of $6.7 million, which is included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations.
On August 29, 2017, the Company completed the foreclosure sale of one property secured by a mortgage loan and was relieved of all obligations on the non-recourse loan. On the date of the foreclosure sale, the mortgage loan had an outstanding balance of $20.5 million. The Company recognized a gain on forgiveness of debt of $4.8 million, which is included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations as a result of the transaction.
On June 27, 2017, the Company entered into a deed-in-lieu of foreclosure agreement with the lender of a mortgage loan, secured by four properties, with an outstanding balance of $38.3 million and conveyed all interests in the properties to satisfy the mortgage loan. As a result of the deed-in-lieu of foreclosure transaction, the Company recognized a gain on forgiveness of debt of $9.0 million, which is included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations.
On December 30, 2016, the Company received a notice of default from the lender of a non-recourse loan secured by 16 properties, which had an outstanding balance of $11.6 million on the notice date, due to the Company's intentional non-repayment of the loan balance at maturity. During the year ended December 31, 2017, the Company cured the default by fully repaying the outstanding loan balance.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following table summarizes the scheduled aggregate principal repayments due on mortgage notes subsequent to December 31, 2017 (in thousands):
___________________________________
(1)
Includes $16.2 million, excluding accrued interest, related to one mortgage note payable in default.
Other Debt
During the year ended December 31, 2017, the Company repaid the remaining outstanding principal balance of the secured term loan from KBC Bank, N.V. ( the “KBC Loan”).
Corporate Bonds
As of December 31, 2017, the OP had $2.85 billion aggregate principal amount of senior unsecured notes (the “Senior Notes”) outstanding comprised of the following (dollar amounts in thousands):
On August 11, 2017, the Company closed a senior note offering, consisting of $600.0 million aggregate principal amount of the Operating Partnership’s 3.950% Senior Notes due 2027 (the “2027 Senior Notes”) (the offering of the 2027 Senior Notes, the “2017 Bond Offering”).
On June 2, 2016, the Company closed its senior note offering, consisting of (i) $400.0 million aggregate principal amount of 4.125% Senior Notes due June 1, 2021 (the “2021 Senior Notes”) and (ii) $600.0 million aggregate principal amount of 4.875% Senior Notes due June 1, 2026 (the “2026 Senior Notes”) (the offering of the 2021 Senior Notes, collectively with the 2026 Senior Notes.
On July 5, 2016, the Company redeemed $1.3 billion aggregate principal amount of 2.000% senior notes due 2017 (the “2017 Senior Notes”), plus accrued and unpaid interest thereon and the required make-whole premium. Upon consummation of these transactions, the Company had no 2017 Senior Notes outstanding. The Company recorded a loss related to the early extinguishment of $13.2 million which is included in (loss) gain on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations.
The Senior Notes are guaranteed by the General Partner. The OP may redeem all or a part of any series of the Senior Notes at any time, at its option, for the redemption prices set forth in the indenture governing the Senior Notes. If the redemption date is 30 or fewer days prior to the maturity date with respect to the 2019 Senior Notes and the 2021 Senior Notes or is 90 or fewer days prior to the maturity date with respect to the 2024 Senior Notes, the 2026 Senior Notes and the 2027 Senior Notes, the redemption price will equal 100% of the principal amount of the Senior Notes of the applicable series to be redeemed, plus accrued and unpaid interest on the amount being redeemed to, but excluding, the applicable redemption date. The Senior Notes are registered under the Securities Act of 1933, as amended, (the “Securities Act”) and are freely transferable.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The indenture governing our Senior Notes requires us to maintain financial ratios which include maintaining (i) a maximum limitation on incurrence of total debt less than or equal to 65% of Total Assets (as defined in the indenture), (ii) maximum limitation on incurrence of secured debt less than or equal to 40% of Total Assets (as defined in the indenture), (iii) a minimum debt service coverage ratio of at least 1.5x and (iv) a minimum unencumbered asset value of at least 150% of the aggregate principal amount of all of the outstanding Unsecured Debt (as defined in the indenture). The Company believes it was in compliance with the financial covenants pursuant to the indenture governing the Senior Notes as of December 31, 2017.
Convertible Debt
The following table presents the Company’s $597.5 million aggregate principal amount of convertible senior notes due 2018 (the “2018 Convertible Notes”) and $402.5 million aggregate principal amount of convertible senior notes due 2020 (the “2020 Convertible Notes” and, together with the 2018 Convertible Notes, the “Convertible Notes”) with their respective terms (dollar amounts in thousands). The OP has issued corresponding identical convertible notes to the General Partner.
____________________________________
(1)
Excludes the carrying value of the conversion options recorded within additional paid-in capital of $28.6 million and the unamortized discount of $7.8 million as of December 31, 2017. The discount will be amortized over the remaining weighted average term of 1.5 years.
(2)
Conversion rate represents the amount of the General Partner OP Units per $1,000 principal amount of Convertible Notes converted as of December 31, 2017, as adjusted in accordance with the applicable indentures as a result of cash dividend payments.
The 2018 Convertible Notes may be converted into cash, shares of the Company’s common stock or a combination thereof in limited circumstances prior to February 1, 2018 and may be converted into such consideration at any time on or after February 1, 2018. The 2020 Convertible Notes may be converted into cash, shares of the Company’s common stock or a combination thereof, in limited circumstances prior to June 15, 2020, and may be converted into such consideration at any time on or after June 15, 2020. There were no changes to the terms of the Convertible Notes and the Company believes it was in compliance with the financial covenants pursuant to the indenture governing the Convertible Notes as of December 31, 2017.
Credit Facility
The General Partner, as guarantor, and the OP, as borrower, are parties to an unsecured credit facility (the “Credit Facility”) pursuant to a credit agreement, dated as of June 30, 2014, as amended, with Wells Fargo Bank, National Association (“Wells Fargo”), as administrative agent and other lenders party thereto (the “Credit Agreement”).
As of December 31, 2017, the Credit Facility had an outstanding balance of $185.0 million and allowed for maximum borrowings of $2.3 billion under its revolving credit facility, subject to borrowing availability. The maximum aggregate dollar amount of letters of credit that may be outstanding at any one time under the Credit Facility is $25.0 million. The Operating Partnership used a portion of the proceeds from the 2017 Bond Offering discussed above to repay all of the outstanding borrowings, swap termination costs and accrued and unpaid interest, under the Credit Facility’s $0.5 billion term loan facility (the "Credit Facility Term Loan”) on August 11, 2017, resulting in the write-off of unamortized deferred financing costs of $2.0 million, which is included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations.
The revolving credit facility generally bears interest at an annual rate of LIBOR plus 1.00% to 1.80% or Base Rate plus 0.00% to 0.80% (based upon the General Partner’s then current credit rating). “Base Rate” is defined as the highest of the prime rate, the federal funds rate plus 0.50% or a floating rate based on one month LIBOR, determined on a daily basis. The Credit Facility Term Loan generally bears interest at an annual rate of LIBOR plus 1.15% to 2.05%, or Base Rate plus 0.15% to 1.05% (based upon the General Partner’s then current credit rating). In addition, the Credit Agreement provides the flexibility for interest rate auctions, pursuant to which, at the Company’s election, the Company may request that lenders make competitive bids to provide revolving loans, which competitive bids may be at pricing levels that differ from the foregoing interest rates.
The Credit Agreement provides for monthly interest payments under the Credit Facility. In the event of default, at the election of a majority of the lenders (or automatically upon a bankruptcy event of default with respect to the OP or the General Partner), the commitments of the lenders under the Credit Facility will mature, and payment of any unpaid amounts in respect of the Credit Facility will be accelerated. The Credit Facility terminates on June 30, 2018, unless extended in accordance with the terms of the Credit Agreement. The Credit Agreement provides for a one-year extension option, exercisable at the Company’s election and
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
subject to certain customary conditions, as well as certain customary “amend and extend” provisions. At any time, upon timely notice by the OP and subject to any breakage fees, the OP may prepay borrowings under the Credit Facility (subject to certain limitations applicable to the prepayment of any loans obtained through an interest rate auction, as described above). The OP incurs a fee equal to 0.15% to 0.25% per annum (based upon the General Partner’s then current credit rating) multiplied by the commitments (whether or not utilized) in respect of the revolving credit facility. In addition, the OP incurs customary administrative agent, letter of credit issuance, letter of credit fronting, extension and other fees.
The Credit Facility requires restrictions on corporate guarantees, as well as the maintenance of financial covenants, including the maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios) and the maintenance of a minimum net worth. The key financial covenants in the Credit Facility, as defined and calculated per the terms of the Credit Agreement, include maintaining (i) a maximum leverage ratio less than or equal to 60%, (ii) a minimum fixed charge coverage ratio of at least 1.5x, (iii) a secured leverage ratio less than or equal to 45%, (iv) a total unencumbered asset value ratio less than or equal to 60%, (v) a minimum tangible net worth covenant of at least $5.5 billion, (vi) a minimum unencumbered interest coverage ratio of at least 1.75x and (vii) a minimum unencumbered asset value of at least $8.0 billion (up to 30% of which may be comprised of restaurant properties from December 31, 2016 on). The Company believes it was in compliance with the financial covenants pursuant to the Credit Agreement and is not restricted from accessing any borrowing availability under the Credit Facility as of December 31, 2017.
Note 11 - Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
The Company may use derivative financial instruments, including interest rate swaps, caps, options, floors and other interest rate derivative contracts, to hedge all or a portion of the interest rate risk associated with its borrowings. The principal objective of such arrangements is to minimize the risks and/or costs associated with the Company’s operating and financial structure as well as to hedge specific anticipated transactions. The Company does not intend to utilize derivatives for purposes other than interest rate risk management. The use of derivative financial instruments carries certain risks, including the risk that the counterparties to these contractual arrangements are not able to perform under the agreements. To mitigate this risk, the Company only enters into derivative financial instruments with counterparties with high credit ratings and with major financial institutions with which the Company and its affiliates may also have other financial relationships. The Company does not anticipate that any of the counterparties will fail to meet their obligations.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
The effective portion of changes in the fair value of derivatives designated that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the years ended December 31, 2017 and 2016, such derivatives were used to hedge the variable cash flows associated with variable-rate debt. During the year ended December 31, 2017, the Company reclassified previously unrealized losses of $0.2 million from accumulated other comprehensive income into interest expense as a result of the hedged forecasted transactions affecting earnings. The Company also reclassified unrealized losses of $0.8 million from accumulated other comprehensive income into interest expense associated with settled interest rate derivatives.
The ineffective portion of the change in fair value of the derivatives designated that qualify as cash flow hedges is recognized directly in earnings. During the year ended December 31, 2017, the Company recorded a gain of $1.6 million in earnings related to the ineffective portion of the change in fair value of derivatives designated that qualify as cash flow hedges. During the year ended December 31, 2016, the Company recorded a gain of $2.5 million in such earnings. Earnings related to the ineffective portion of the change in fair value of derivatives designated that qualify as cash flow hedges are included in gain (loss) on derivative instruments, net in the accompanying consolidated statements of operations. The ineffectiveness is primarily attributable to the designation of acquired interest rate swaps with a non-zero fair value at inception associated with a prior merger.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
During the year ended December 31, 2017, the Company terminated six of its interest rate swaps in connection with the early repayment of mortgage loans and borrowings under the Credit Facility Term Loan, as discussed in Note 10 - Debt, and accelerated the reclassification of a portion of the amounts in other comprehensive income to earnings as a result of a portion of the hedged forecasted transactions becoming probable not to occur. A gain of $1.1 million was recorded in relation to the acceleration, which is included in gain (loss) on derivative instruments, net in the accompanying consolidated statements of operations.
Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next twelve months, the Company estimates that an additional $0.3 million will be reclassified from other comprehensive income as an increase to interest expense.
During the year ended December 31, 2017, loans associated with thirteen derivative instruments with an aggregate notional value of $662.4 million at the respective settlement date, were repaid in full and one derivative previously designated as a cash flow hedge with a notional value of $27.8 million was de-designated as it was not probable the forecasted hedged transaction would occur. As of December 31, 2017 and December 31, 2016, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk (dollar amounts in thousands):
The table below presents the fair value of the Company’s derivative financial instruments designated as cash flow hedges as well as their classification in the consolidated balance sheets as of December 31, 2017 and December 31, 2016 (in thousands):
Derivatives Not Designated as Hedging Instruments
Derivatives not designated as hedges are not speculative and are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the requirements to be classified as hedging instruments. A gain of $0.3 million for the year ended December 31, 2017 related to the change in the fair value of derivatives not designated as hedging instruments was recorded in gain (loss) on derivative instruments, net in the accompanying consolidated statements of operations. The Company recorded a loss of $0.3 million for the year ended December 31, 2016.
As discussed above, during the year ended December 31, 2017, one derivative previously designated as a cash flow hedge with a notional value of $27.8 million was de-designated as it was not probable the forecasted hedged transaction would occur. As of December 31, 2017 and December 31, 2016, the Company had the following outstanding interest rate derivatives that were not designated as qualifying hedging relationships (dollar amounts in thousands):
The table below presents the fair value of the Company’s derivative financial instruments not designated as a hedge as well as their classification in the consolidated balance sheets as of December 31, 2017 and December 31, 2016 (in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Tabular Disclosure of Offsetting Derivatives
The table below details a gross presentation, the effects of offsetting and a net presentation of the Company’s derivatives as of December 31, 2017 and December 31, 2016 (in thousands). The net amounts of derivative assets or liabilities can be reconciled to the tabular disclosure of fair value.
Credit Risk Related Contingent Features
The Company has agreements with each of its derivative counterparties that contain a provision specifying that if the Company either defaults or is capable of being declared in default on any of its indebtedness, the Company could also be declared in default on its derivative obligations.
As of December 31, 2017, the Company has not posted any collateral related to these agreements and was not in breach of any provisions in these agreements. If the Company had breached any of these provisions, it could have been required to settle its obligations under the agreements at their aggregate termination value of $0.6 million at December 31, 2017.
Note 12 - Supplemental Cash Flow Disclosures
Supplemental cash flow information was as follows for the years ended December 31, 2017, 2016 and 2015 (in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Note 13 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following as of December 31, 2017 and December 31, 2016 (in thousands):
Note 14 - Commitments and Contingencies
Litigation
The Company is involved in various routine legal proceedings and claims incidental to the ordinary course of its business. There are no material legal proceedings pending against the Company, except as follows:
Government Investigations and Litigation Relating to the Audit Committee Investigation
As previously reported, on October 29, 2014, the Company filed a Current Report on Form 8-K (the “October 29 8-K”) reporting the Audit Committee’s conclusion, based on the preliminary findings of its investigation, that certain previously issued consolidated financial statements of the Company, including those included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2014 and June 30, 2014, and related financial information should no longer be relied upon. The Company also reported that the Audit Committee had based its conclusion on the preliminary findings of its investigation into concerns regarding accounting practices and other matters that were first reported to the Audit Committee in early September 2014 and that the Audit Committee believed that an error in the calculation of adjusted funds from operations for the first quarter of 2014 had been identified but intentionally not corrected when the Company reported its financial results for the three and six months ended June 30, 2014. Prior to the filing of the October 29 8-K, the Audit Committee previewed for the SEC the information contained in the filing. Subsequent to that filing, the SEC provided notice that it had commenced a formal investigation and issued subpoenas calling for the production of various documents. In addition, the United States Attorney’s Office for the Southern District of New York contacted counsel for the Audit Committee and counsel for the Company with respect to this matter, and the Secretary of the Commonwealth of Massachusetts issued a subpoena calling for the production of various documents. The Company has been cooperating with these regulators in their investigations.
In connection with these investigations, on September 8, 2016, the United States Attorney’s Office for the Southern District of New York announced the filing of criminal charges against the Company’s former Chief Financial Officer and former Chief Accounting Officer (the “Criminal Action”), as well as the fact that the former Chief Accounting Officer pleaded guilty to the charges filed. Also on September 8, 2016, the SEC announced the filing of a civil complaint against the same two individuals in the United States District Court for the Southern District of New York (the “SEC Civil Action”). On June 30, 2017, following a jury trial, the former Chief Financial Officer was convicted of the charges filed. Both the former Chief Accounting Officer and the former Chief Financial Officer have entered into settlement agreements with the SEC resolving the charges brought against them.
As discussed below, the Company and certain of its former officers and directors have been named as defendants in a number of lawsuits filed following the October 29 8-K, including class actions, derivative actions, and individual actions seeking money damages and other relief under the federal securities laws and state laws in both federal and state courts in New York, Maryland and Arizona.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Between October 30, 2014 and January 20, 2015, the Company and certain of its former officers and directors, among other individuals and entities, were named as defendants in ten securities class action complaints filed in the United States District Court for the Southern District of New York. The court consolidated these actions under the caption In re American Realty Capital Properties, Inc. Litigation, No. 15-MC-00040 (AKH) (the “SDNY Consolidated Securities Class Action”). The plaintiffs filed a second amended class action complaint on December 11, 2015, which asserted claims for violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Certain defendants, including the Company and the OP, filed motions to dismiss the second amended class action complaint (or portions thereof), which were granted in part and denied in part by the court. The Company and the OP answered the second amended class action complaint on July 29, 2016. On September 8, 2016, the court issued an order directing plaintiffs to file a third amended complaint to reflect certain prior rulings by the court. The third amended complaint was filed on September 30, 2016 and the defendants were not required to file new answers. Discovery is ongoing. Plaintiffs in the SDNY Consolidated Securities Class Action filed a motion for class certification and a hearing on the motion was held on August 24, 2017. On August 31, 2017, the court issued orders granting plaintiffs’ motion for class certification and granting summary judgment to defendants with respect to one of plaintiffs’ claims under Section 11 of the Securities Act of 1933. The defendants filed petitions seeking leave to appeal the court’s order granting class certification, which were denied on January 24, 2018. A status conference with the court is scheduled for June 11, 2018.
The Company, certain of its former officers and directors, and the OP, among others, have also been named as defendants in additional individual securities fraud actions filed in the United States District Court for the Southern District of New York: Jet Capital Master Fund, L.P. v. American Realty Capital Properties, Inc., et al., No. 15-cv-307; Twin Securities, Inc. v. American Realty Capital Properties, Inc., et al., No. 15-cv-1291; HG Vora Special Opportunities Master Fund, Ltd v. American Realty Capital Properties, Inc., et al., No. 15-cv-4107; BlackRock ACS US Equity Tracker Fund, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08464; PIMCO Funds: PIMCO Diversified Income Fund, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08466; Clearline Capital Partners LP, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08467; Pentwater Equity Opportunities Master Fund Ltd., et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08510; Archer Capital Master Fund, et al. v. American Realty Capital Properties, Inc. et al, No. 16-cv-05471; Atlas Master Fund et al. v. American Realty Capital Properties, Inc. et al., No. 16-cv-05475; Eton Park Fund, L.P. v. American Realty Capital Properties, Inc., et al., No. 16-cv-09393; Reliance Standard Life Insurance Company, et al, v. American Realty Capital Properties, Inc. et al, No. 17-cv-02796; and Fir Tree Capital Opportunity Master Fund, L.P. et al. v. American Realty Capital Properties, Inc. et al., No. 17-cv-04975 (the “Fir Tree Action”) (collectively, the “Opt-Out Actions”). The Opt-Out Actions assert claims arising out of allegedly false and misleading statements in connection with the purchase or sale of the Company’s securities. Discovery in the Opt-Out Actions is being coordinated with discovery in the SDNY Consolidated Securities Class Action.
On October 27, 2015, the Company and certain of its former officers, among others, were named as defendants in an individual securities fraud action filed in the United States District Court for the District of Arizona, captioned Vanguard Specialized Funds, et al. v. VEREIT, Inc. et al., No. 15-cv-02157 (the “Vanguard Action”). The Vanguard Action asserts claims arising out of allegedly false and misleading statements in connection with the purchase or sale of the Company’s securities. On January 21, 2016, the Company filed a motion to transfer the Vanguard Action to the United States District Court for the Southern District of New York and a motion to dismiss the complaint. On September 29, 2016, the court entered an order denying the Company’s motion to transfer and granting in part and denying in part the Company’s motion to dismiss. The Company filed an answer to the complaint on November 4, 2016. Discovery is ongoing and in large part is being coordinated with discovery in the SDNY Consolidated Securities Action.
The Company was also named as a nominal defendant, and certain of its former officers and directors were named as defendants, in shareholder derivative actions filed in the United States District Court for the Southern District of New York: Witchko v. Schorsch, et al., No. 15-cv-06043 (the “Witchko Action”); and Serafin, et al. v. Schorsch, et al., No. 15-cv-08563 (the “Serafin Action”). The court consolidated the Witchko Action and the Serafin Action (together “the SDNY Derivative Action”) and the plaintiffs designated the complaint filed in the Witchko Action as the operative complaint in the SDNY Derivative Action. The SDNY Derivative Action seeks money damages and other relief on behalf of the Company for alleged breaches of fiduciary duty, among other claims. On February 12, 2016, the Company and other defendants filed a motion to dismiss the SDNY Derivative Action due to plaintiffs’ failure to plead facts demonstrating that the Board’s decision to refuse plaintiffs’ pre-suit demands was wrongful and not a protected business judgment. On June 9, 2016, the court granted in part and denied in part the Company’s and other defendants’ motions to dismiss. Plaintiffs filed an amended complaint on June 30, 2016, and the Company and other defendants filed answers to the amended complaint on July 22, 2016. Discovery in the Witchko Action is being coordinated with discovery in the SDNY Consolidated Securities Class Action.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
On December 3, 2015, the Company was named as a nominal defendant and certain of its former officers and directors were named as defendants in a shareholder derivative action filed in the Circuit Court for Baltimore City in Maryland, Frampton v. Schorsch, et al., No. 24-C-15-006269 (the “Frampton Action”). The Frampton Action seeks money damages and other relief on behalf of the Company for, among other things, alleged breaches of fiduciary duty and contribution and indemnification. By order dated November 4, 2016, the Frampton Action was stayed pending resolution of the SDNY Derivative Action.
On June 10, 2016, the Company was named as a nominal defendant, and certain of its former officers and directors, among others, were named as defendants, in a shareholder derivative action filed in the Supreme Court of the State of New York, Kosky v. Schorsch, et al., No. 653093/2016 (the “Kosky Action”). The Kosky Action seeks money damages and other relief on behalf of the Company for, among other things, alleged breaches of fiduciary duty, negligence, and breach of contract. On October 6, 2016, the parties filed a stipulation staying the Kosky Action until resolution of the SDNY Consolidated Securities Class Action.
On October 6, 2016, the Company was named as a nominal defendant, and certain of its former officers and directors, among others, were named as defendants, in a shareholder derivative action filed in the United States District Court for the District of Maryland, captioned Meloche v. Schorsch, et al., 16-cv-03366 (the “Meloche Action”). An amended complaint was filed on January 17, 2017. The Meloche Action seeks money damages and other relief on behalf of the Company for alleged breaches of fiduciary duty and negligence. By order dated May 16, 2017, the Meloche Action was stayed until resolution of the SDNY Derivative Action.
The Company has not reserved amounts for any of the litigation or investigation matters discussed above either because it has not concluded that a loss is probable in the particular matter or because for some matters, it believes that a loss is probable but that any probable loss or reasonably possible range of loss is not reasonably estimable at this time. The Company is currently unable to reasonably estimate a range of reasonably possible loss because these matters involve significant uncertainties, including the complexity of the facts, the legal theories and the nature of the claims, as well as the methodology for determining damages. The ultimate resolution of these matters, the timing and substance of which is unknown, may materially impact the Company’s business, financial condition, liquidity and results of operations.
Cole Litigation Matter
In December 2013, Realistic Partners filed a putative class action lawsuit against the Company and the then-members of its board of directors in the Supreme Court for the State of New York, captioned Realistic Partners v. American Realty Capital Partners, et al., No. 654468/2013. Cole was later added as a defendant. The plaintiff alleged, among other things, that the board of the Company breached its fiduciary duties in connection with the transactions contemplated under the Cole Merger Agreement (in connection with the merger between a wholly owned subsidiary of Cole and Cole Holdings Corporation) and that Cole aided and abetted those breaches. In January 2014, the parties entered into a memorandum of understanding regarding settlement of all claims asserted on behalf of the alleged class of the Company’s stockholders. The proposed settlement terms required the Company to make certain additional disclosures related to the Cole Merger, which were included in a Current Report on Form 8-K filed by the Company with the SEC on January 17, 2014. The memorandum of understanding also contemplated that the parties would enter into a stipulation of settlement, which would be subject to customary conditions, including confirmatory discovery and court approval following notice to the Company’s stockholders, and provided that the defendants would not object to a payment of up to $625,000 for attorneys’ fees. If the parties enter into a stipulation of settlement, which has not occurred, a hearing will be scheduled at which the court will consider the fairness, reasonableness and adequacy of the settlement. There can be no assurance that the parties will enter into a stipulation of settlement, that the court will approve any proposed settlement, or that any eventual settlement will be under the same terms as those contemplated by the memorandum of understanding.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Contractual Lease Obligations
The following table reflects the minimum base rent payments due from the Company over the next five years and thereafter for certain ground lease obligations, which are substantially reimbursable by our tenants, and office lease obligations (in thousands):
Purchase Commitments
Cole Capital enters into purchase and sale agreements and deposits funds into escrow towards the purchase of real estate assets, most of which are expected to be assigned to one of the Cole REITs at or prior to the closing of the respective acquisition. As of December 31, 2017, Cole Capital was a party to 13 purchase and sale agreements with unaffiliated third-party sellers to purchase a 100% interest in 13 properties, subject to meeting certain criteria, for an aggregate purchase price of $209.0 million, exclusive of closing costs. As of December 31, 2017, Cole Capital had $4.8 million of property escrow deposits held by escrow agents in connection with these future property acquisitions, which may be forfeited if the transactions are not completed under certain circumstances. Cole Capital will be reimbursed by the assigned Cole REIT for amounts escrowed when the property is assigned to the respective Cole REIT.
Environmental Matters
In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. The Company has not been notified by any governmental authority of any non-compliance, liability or other claim, and is not aware of any other environmental condition, in each case, that it believes will have a material adverse effect on the results of operations.
Note 15 - Equity
Common Stock and General Partner OP Units
The General Partner is authorized to issue up to 1.5 billion shares of Common Stock. As of December 31, 2017, the General Partner had approximately 974.2 million shares of Common Stock issued and outstanding.
Additionally, the Operating Partnership had approximately 974.2 million General Partner OP Units issued and outstanding as of December 31, 2017, corresponding to the General Partner’s outstanding shares of Common Stock.
Common Stock Offerings
On August 10, 2016, the Company issued 69.0 million shares of Common Stock in a public offering for net proceeds, after underwriting discounts and offering costs, of $702.5 million, which were used in part to repay the 2016 Term Loan and amounts under the Credit Facility. Concurrently, the Operating Partnership issued the General Partner 69.0 million General Partner OP Units.
Common Stock Continuous Offering Program
On September 19, 2016, the Company registered a continuous equity offering program (the “Program”) pursuant to which the Company can offer and sell, from time to time through September 19, 2019 in “at-the-market” offerings or certain other transactions, shares of Common Stock with an aggregate gross sales price of up to $750.0 million, through its sales agents. As of December 31, 2017, no shares of Common Stock have been issued pursuant to the Program.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Preferred Stock and Preferred OP Units
Series F Preferred Stock
As of December 31, 2017, there were approximately 42.8 million shares of Series F Preferred Stock (and approximately 42.8 million corresponding General Partner Series F Preferred Units) and 86,874 Limited Partner Series F Preferred Units issued and outstanding.
The Series F Preferred Stock pays cumulative cash dividends at the rate of 6.70% per annum on their liquidation preference of $25.00 per share (equivalent to $1.675 per share on an annual basis). The Series F Preferred Stock is not redeemable by the Company before January 3, 2019, the fifth anniversary of the date on which such Series F Preferred Stock was issued (the “Initial Redemption Date”), except under circumstances intended to preserve the General Partner’s status as a REIT for federal and/or state income tax purposes and except upon the occurrence of a change of control. On and after the Initial Redemption Date, the General Partner may, at its option, redeem shares of the Series F Preferred Stock, in whole or from time to time in part, at a redemption price of $25.00 per share plus, subject to exceptions, any accrued and unpaid dividends thereon to the date fixed for redemption. The shares of Series F Preferred Stock have no stated maturity, are not subject to any sinking fund or mandatory redemption and will remain outstanding indefinitely unless the General Partner redeems or otherwise repurchases them or they become convertible and are converted into Common Stock (or, if applicable, alternative consideration). The Series F Preferred Stock trades on the NYSE under the symbol “VER PRF”. The Series F Preferred Units contain the same terms as the Series F Preferred Stock.
For federal income tax purposes, distributions to stockholders are characterized as ordinary dividends, capital gain distributions, or nontaxable distributions. Nontaxable distributions will reduce U.S stockholders’ basis (but not below zero) in their shares. The following table shows the character of the Series F Preferred Stock distributions paid on a percentage basis for the years ended December 31, 2017, 2016 and 2015:
Limited Partner OP Units
As of each December 31, 2017 and December 31, 2016, the Operating Partnership had approximately 23.75 million Limited Partner OP Units outstanding.
As of December 31, 2017, the Company has received redemption requests totaling approximately 13.1 million Limited Partner OP Units from certain affiliates of the Former Manager, which would have been redeemable for a corresponding number of shares of Common Stock. The Company believes it has potential claims against recipients of those OP Units and has engaged in discussions with affiliates of the Former Manager regarding the redemption requests. Pending any resolution, the Company does not currently intend to satisfy any of the redemption requests. In light of the potential claims, since October 15, 2015, the OP has not paid distributions in respect of a substantial portion of the outstanding Limited Partner OP Units when the Common Stock dividends were otherwise paid.
Common Stock Dividends
The Company declared quarterly dividends to stockholders of record each quarter from the third quarter of the year ended December 31, 2015 through the third quarter of the year ended December 31, 2017 of $0.1375 per share of common stock (representing an annualized dividend rate of $0.55 per share). The Company’s board of directors declared a quarterly cash dividend of $0.1375 per share of common stock (equaling an annualized dividend rate of $0.55 per share) for the fourth quarter of 2017 on November 7, 2017 to stockholders of record as of December 31, 2017, which was paid on January 16, 2018. An equivalent distribution by the Operating Partnership is applicable per OP unit.
For federal income tax purposes, distributions to stockholders are characterized as ordinary dividends, capital gain distributions, or nontaxable distributions. Nontaxable distributions will reduce U.S stockholders’ basis (but not below zero) in their shares. The following table shows the character of the common stock distributions paid on a percentage basis for the years ended December 31, 2017, 2016 and 2015:
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Share Repurchase Program
On May 12, 2017, the Company’s board of directors authorized the repurchase of up to $200.0 million of the Company’s outstanding Common Stock over the subsequent 12 months, as market conditions warrant (the “Share Repurchase Program”). Repurchases may be made through open market purchases, privately negotiated transactions, structured or derivative transactions, including accelerated stock repurchase transactions, or other methods of acquiring shares in accordance with applicable securities laws and other legal requirements. The Share Repurchase Program does not obligate the Company to make any repurchases at a specific time or in a specific situation. Repurchases are subject to prevailing market conditions, the trading price of the stock, the Company’s financial performance and other conditions. During the year ended December 31, 2017, the Company repurchased 68,759 shares of Common Stock in multiple open market transactions for $0.5 million as part of the Share Repurchase Program, which are currently deemed to be authorized but unissued shares of Common Stock. Additional shares of Common Stock repurchased by the Company under the Share Repurchase Program, if any, will be returned to the status of authorized but unissued shares of Common Stock.
Common Stock Repurchases to Settle Tax Obligations
Under the General Partner’s Equity Plan (defined below), individuals have the option to have the General Partner repurchase shares vesting from awards made under the Equity Plan in order to satisfy the minimum federal and state tax withholding obligations. During the year ended December 31, 2017, the General Partner repurchased 268,550 shares to satisfy the federal and state tax withholding obligations on behalf of employees.
Note 16 - Equity-based Compensation
Equity Plan
The General Partner has adopted an equity plan (the “Equity Plan”), which provides for the grant of stock options, stock appreciation rights, restricted shares of Common Stock (“Restricted Shares”), restricted stock units (“Restricted Stock Units”), deferred stock units (“Deferred Stock Units”), dividend equivalent rights and other stock-based awards to the General Partner’s and its affiliates’ non-executive directors, officers and other employees and advisors or consultants who provide services to the General Partner or its affiliates. To date, the General Partner has granted fully vested shares of Common Stock, Restricted Shares, Restricted Stock Units and Deferred Stock Units under the Equity Plan. Restricted Shares provide for rights identical to those of Common Stock. Restricted Stock Units do not provide for any rights of a common stockholder prior to the vesting of such Restricted Stock Units. In accordance with U.S. GAAP, Restricted Shares are considered issued and outstanding. As is the case when fully vested shares of Common Stock are issued from the Equity Plan, for each Restricted Share awarded under the Equity Plan, the Operating Partnership issues a General Partner OP Unit to the General Partner with identical terms. Upon vesting of Restricted Stock Units or Deferred Stock Units, the Operating Partnership issues a General Partner OP Unit to the General Partner for each share of Common Stock issued as a result of such vesting.
The General Partner has authorized and reserved a total number of shares equal to 10.0% of the total number of issued and outstanding shares of Common Stock (on a fully diluted basis assuming the redemption of all OP Units for shares of Common Stock) to be issued at any time under the Equity Plan for equity incentive awards. As of December 31, 2017, the General Partner had cumulatively awarded under its Equity Plan approximately 4.0 million Restricted Shares, net of the forfeiture of 3.7 million Restricted Shares through that date, 4.2 million Restricted Stock Units, net of the forfeiture/cancellation of 1.2 million Restricted Stock Units through that date, and 0.3 million Deferred Stock Units, collectively representing approximately 8.5 million shares of Common Stock. Accordingly, as of such date, approximately 91.3 million additional shares were available for future issuance.
During the year ended December 31, 2015, the General Partner awarded 5,634 shares of Common Stock. The fair value of the awards was determined using the closing stock price on the grant date and expensed in full on the grant date. The Company recorded $0.1 million of compensation expense related to the awards for the year ended December 31, 2015. No such shares of Common Stock were awarded during the years ended December 31, 2017 and 2016.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Restricted Shares
The Company has issued Restricted Shares to certain employees and non-executive directors beginning in 2011. In addition, the Company issued Restricted Shares to employees of affiliates of the Former Manager prior to 2015. The fair value of the Restricted Shares granted to employees under the Equity Plan is generally determined using the closing stock price on the grant date and is expensed over the requisite service period on a straight-line basis. The fair value of Restricted Shares granted to non-executive directors and employees of affiliates of the Former Manager under the Equity Plan was measured based upon the fair value of goods or services received or the equity instruments granted, whichever was more reliably determinable, and was expensed in full at the date of grant.
During the years ended December 31, 2017, 2016 and 2015, the Company recorded $2.0 million, $2.7 million and $3.9 million, respectively, of compensation expense related to the Restricted Shares. As of December 31, 2017, there was $0.7 million of unrecognized compensation expense related to the Restricted Shares with a weighted-average remaining term of 1.2 years.
The following table details the activity of the Restricted Shares during the year ended December 31, 2017:
Time-Based Restricted Stock Units
Under the Equity Plan, the Company may award Restricted Stock Units to employees that will vest if the recipient maintains his/her employment over the requisite service period (the “Time-Based Restricted Stock Units”). The fair value of the Time-Based Restricted Stock Units granted to employees under the Equity Plan is generally determined using the closing stock price on the grant date and is expensed over the requisite service period on a straight-line basis, which is generally three years. During the years ended December 31, 2017, 2016 and 2015, the Company recorded $6.3 million, $3.4 million and $1.8 million, respectively, of compensation expense related to the Time-Based Restricted Stock Units. As of December 31, 2017, there was $5.8 million of unrecognized compensation expense related to the Time-Based Restricted Stock Units with a weighted-average remaining term of 1.7 years.
Deferred Stock Units
The Company may award Deferred Stock Units to non-executive directors under the Equity Plan (the “Deferred Stock Units”). Each Deferred Stock Unit represents the right to receive one share of Common Stock. The Deferred Stock Units provide for immediate vesting on the grant date and will be settled with Common Stock either on the earlier of the date on which the respective director separates from the Company, dies or the third anniversary of the grant date, or if granted pursuant to the director’s voluntary election to participate in the director’s deferred compensation program, on the date the director separates from the Company (or upon a change of control or death). The fair value of the Deferred Stock Units is determined using the closing stock price on the grant date and is expensed over the requisite service period or on the grant date for awards with no requisite service period. During the year ended December 31, 2017, the Company recorded approximately $1.0 million of expense related to Deferred Stock Units. During each of the years ended December 31, 2016 or 2015, the Company recorded approximately $0.8 million of expense related to Deferred Stock Units. As of December 31, 2017, there is no unrecognized compensation expense related to the Deferred Stock Units.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following table details the activity of the Time-Based Restricted Stock Units and Deferred Stock Units during the year ended December 31, 2017.
Market-Based Restricted Stock Units
During the year ended December 31, 2015, the General Partner awarded Restricted Stock Units to certain employees under the Equity Plan that were contingent upon the Common Stock reaching a certain market price (the “Market-Based Restricted Stock Units”). The Market-Based Restricted Stock Units were contingent upon the closing price of the Common Stock equaling or exceeding $10 per share for 20 consecutive trading days (the “Market Condition”) and the grantee’s continued employment as of such date on which the Market Condition was met. On July 28, 2016, 610,839 Market-Based Restricted Stock Units vested, of which 199,858 shares were withheld to cover grantees’ tax withholding obligations, resulting in 410,981 shares being issued.
The fair value and derived service period of the Market-Based Restricted Stock Units as of their grant date was determined using a Monte Carlo simulation, which took into account multiple input variables that determine the probability of satisfying the Market Condition. The method required the input of assumptions, including the future dividend yield and expected volatility of the Common Stock. Compensation expense was recognized on a straight-line basis over the derived service period regardless of whether the Market Condition was satisfied, provided that the requisite service condition had been achieved. The Market-Based Restricted Stock Units were fully expensed during the year ended December 31, 2015; however, the Company recorded contra-expense due to the forfeiture of such awards. During the years ended December 31, 2016 and 2015, the Company recorded contra-expense of $0.8 million related to forfeitures and expense of $6.0 million, respectively. There were no such expenses related to the Market-Based Restricted Stock Units for the year ended December 31, 2017. As of December 31, 2017, there was no unrecognized compensation expense related to the Market-Based Restricted Stock Units.
Long-Term Incentive Awards
The General Partner may award long-term incentive-based Restricted Stock Units (the “LTI Target Awards”) to employees under the Equity Plan. Vesting of the LTI Target Awards is based upon the General Partner’s level of achievement of total stockholder return (“TSR”), including both share price appreciation and Common Stock dividends, as measured equally against a market index and against a peer group generally over a three year period.
The fair value and derived service period of the LTI Target Awards as of their grant date is determined using a Monte Carlo simulation which takes into account multiple input variables that determine the probability of satisfying the required TSR, as outlined in the award agreements. This method requires the input of assumptions, including the future dividend yield, the expected volatility of the Common Stock and the expected volatility of the market index constituents and the peer group. Compensation expense is recognized on a straight-line basis over the derived service period regardless of whether the necessary TSR is attained, provided that the requisite service condition has been achieved. During the years ended December 31, 2017, 2016 and 2015, the Company recorded $7.4 million, $4.6 million and $1.9 million respectively, of expense related to the LTI Target Awards. As of December 31, 2017, there was $6.1 million of unrecognized compensation expense related to the LTI Target Awards with a weighted-average remaining term of 1.7 years. During the year ended December 31, 2017, 671,712 LTI Target Awards were canceled as a result of the awards not meeting the vesting criteria as of the measurement date.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following table details the activity of the LTI Target Awards during the year ended December 31, 2017.
Note 17 - Related Party Transactions and Arrangements
Cole Capital
The Company was contractually responsible for managing the Cole REITs’ affairs on a day-to-day basis, identifying and making acquisitions and investments on the Cole REITs’ behalf, and recommending to the respective board of directors of each of the Cole REITs an approach for providing investors with liquidity. In addition, the Company was responsible for raising capital for certain Cole REITs, advised them regarding offerings, managed relationships with participating broker-dealers and financial advisors, and provided assistance in connection with compliance matters relating to the offerings. The Company received compensation and reimbursement for services relating to the Cole REITs’ offerings and the investment, management and disposition of their respective assets, as applicable.
As discussed in Note 5 -Discontinued Operations, the Company entered into the Cole Capital Purchase and Sale Agreement to sell substantially all of Cole Capital. The sale closed on February 1, 2018. The assets and liabilities transferred pursuant to the Cole Capital Purchase and Sale Agreement and related financial results are reflected in the consolidated balance sheets and consolidated statements of operations as discontinued operations for all periods presented. At closing, the Company entered into the Services Agreement with the Cole Purchaser pursuant to which the Company will continue to provide certain services to the Cole Purchaser and the Cole REITs, including operational real estate support, over the next year. Under the terms of the Services Agreement, the Company will be entitled to receive reimbursement for certain of the services provided. The Company could also receive Net Revenue Payments over the next six years if future revenues of Cole Capital exceed a specified dollar threshold, up to an aggregate of $80.0 million in Net Revenue Payments.
Offering-Related Revenue
The Company generally received a selling commission, dealer manager fee and/or a distribution and stockholder servicing fee based on the gross offering proceeds related to the sale of shares of the Cole REITs’ common stock in their primary offerings. The Company reallowed 100% of selling commissions earned to participating broker-dealers. The Company, in its sole discretion, could reallow all or a portion of its dealer manager and distribution and stockholder servicing fee to such participating broker-dealers as a marketing and due diligence expense reimbursement, based on factors such as the volume of shares issued by such participating broker-dealers and the amount of marketing support provided. No selling commissions or dealer manager fees were paid to the Company or other broker-dealers with respect to shares issued under the respective Cole REIT’s distribution reinvestment plan, under which the stockholders may elect to have distributions reinvested in additional shares.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following table shows the offering fee summary information for the Cole REITs conducting offerings as of December 31, 2017:
_______________________________________________
(1)
The Company reallowed 100% of selling commissions to participating broker-dealers during the years ended December 31, 2017, 2016 and 2015.
(2)
The Company could reallow all or a portion of its dealer manager fee and/or distribution and stockholder servicing fee to participating broker-dealers as a marketing and due diligence expense reimbursement.
(3)
The Company received selling commissions, an asset-based dealer manager fee and/or an asset-based distribution and stockholder servicing fee, all based on the net asset value for each class of common stock.
(4)
CCIT II closed its offering during the three months ended September 30, 2016. The program’s fee structure was similar to that of CCPT V.
(5)
The maximum amount of the distribution and stockholder servicing fees with respect to sales of Class T shares was 4.0% of the gross offering proceeds for CCPT V and CCIT III. Distribution and stockholder servicing fees continue to be paid after the offering closes if the 4.0% maximum has not been met.
(6)
Commencing on April 29, 2016, CCPT V began offering Class T shares of common stock in addition to the class of shares of common stock previously offered (now referred to as Class A shares).
(7)
During the three months ended December 31, 2016, the annual distribution and stockholder servicing fee was amended to be 1.0%. Prior to the amendment, the distribution and stockholder servicing fee was 0.8% per annum.
(8)
Fees were accrued daily in the amount of 1/365th of a percentage of the estimated per share NAV and payable monthly in arrears. Distribution and stockholder servicing fees continue to be paid after the offering closes.
Transaction Service Revenue
The Company earned acquisition fees related to the acquisition, development or construction of properties on behalf of certain of the Cole REITs. In addition, the Company was reimbursed for acquisition expenses incurred in the process of acquiring properties up to certain limits per the respective advisory agreement. The Company was not reimbursed for personnel costs in connection with services for which it receives acquisition fees or real estate commissions. In addition, the Company could earn disposition fees related to the sale of one or more properties, including those held indirectly through joint ventures, on behalf of a Cole REIT and other affiliates.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The following table shows the transaction-related fees for the Cole REITs as of December 31, 2017:
_______________________________________________
(1)
Percent was taken on gross purchase price.
(2)
Performance fee was paid only under the following circumstances: (i) if shares are listed on a national securities exchange; (ii) if the respective Cole REIT is sold or the assets are liquidated; or (iii) upon termination of the advisory agreement. In connection with such events, the performance fee will only be earned upon the return to investors of their net capital invested and a 6% annual cumulative, non-compounded return (8% in the case of CCIT II and CCPT IV).
(3)
Financing coordination fee payable for services in connection with the origination, assumption, or refinancing of any debt (other than loans advanced by the Company) to acquire properties or make other permitted investments.
Management Service Revenue
The Company earned advisory and asset and property management fees from certain Cole REITs. The Company was also reimbursed for expenses incurred in providing advisory and asset and property management services, subject to certain limitations. In addition, the Company earned a performance fee relating to INAV for any year in which the total return on stockholders’ capital exceeded 6% per annum on a calendar year basis.
The following table shows the management fees for the Cole REITs as of December 31, 2017:
_______________________________________________
(1) Annualized fee was based on the average monthly invested assets or average assets, as defined in the respective agreements, or net asset value, if available.
(2) The performance fee was limited to 10% of the aggregate total return, for each class, for any individual year.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
The table below reflects the revenue earned from the Cole REITs (including closed programs, as applicable) and joint ventures for the years ended December 31, 2017, 2016 and 2015 (in thousands).
___________________________________
(1)
The Company reallowed 100% of selling commissions to participating broker-dealers during the years ended December 31, 2017, 2016 and 2015.
(2)
During the years ended December 31, 2017, 2016 and 2015, the Company reallowed $2.1 million, $3.2 million and $2.1 million, respectively, of dealer manager fees and/or distribution and stockholder servicing fees to participating broker-dealers as a marketing and due diligence expense reimbursement.
(3)
The Company earned a disposition fee of $4.4 million on behalf of CCIT when CCIT merged with Select Income REIT on January 29, 2015.
(4)
Total related party revenues excludes fees earned from 1031 real estate programs of $1.8 million, $1.4 million and $5.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Investment in the Cole REITs
As of December 31, 2017 and December 31, 2016, the Company owned aggregate equity investments of $3.3 million and $4.7 million, respectively, in the Cole REITs and other affiliated offerings, which are presented in investment in unconsolidated entities in the consolidated balance sheets, as the Company retained certain interests subsequent to the sale of Cole Capital. The Company accounts for these investments using the equity method of accounting which requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the respective Cole REIT’s earnings and distributions. The Company records its proportionate share of net income or loss from the Cole REITs in equity in income and gain on disposition of unconsolidated entities in the consolidated statements of operations. During the years ended December 31, 2017 and 2016, the Company recognized a net loss of $0.5 million and $1.3 million, respectively, from the Cole REITs. During the year ended December 31, 2015, the Company recorded net income of $0.1 million from the Cole REITs.
The table below presents certain information related to the Company’s investments in the Cole REITs as of December 31, 2017 (carrying amount in thousands):
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Due to Affiliates
Due to affiliates was $66,000 and $16,000 as of December 31, 2017 and December 31, 2016, respectively, related to amounts due to the Cole REITs.
Due from Affiliates, Net
As of December 31, 2017 and December 31, 2016, $4.4 million and $5.2 million, respectively, was expected to be collected from affiliates, excluding any outstanding balances from a line of credit with one of the Cole REITs, discussed below, related to services provided by the Company and expenses subject to reimbursement by the Cole REITs in accordance with their respective advisory and property management agreements. These amounts will be settled with the respective Cole REIT and were not transferred pursuant to the Cole Capital Purchase and Sale Agreement.
On September 23, 2016, the Company entered into a $30.0 million revolving line of credit (the “Subordinate Promissory Note”) with Cole Corporate Income Operating Partnership III, LP (“CCI III OP”), the operating partnership of CCIT III (the “Subordinate Promissory Note Agreement”). The Subordinate Promissory Note bears variable interest rates of one-month LIBOR plus the Credit Facility Margin (as defined in the Subordinate Promissory Note Agreement), which ranges from 2.20% to 2.75%, plus 1.75% and matured on September 22, 2017. On March 28, 2017, CCI III OP entered into a modification agreement in order to extend the maturity date of the Subordinate Promissory Note from September 22, 2017 to September 30, 2018. As of December 31, 2017, the Subordinate Promissory Note had an interest rate of 5.6% and $1.6 million and $10.3 million were outstanding as of December 31, 2017 and 2016, respectively. The Subordinate Promissory Note was not transferred pursuant to the Cole Capital Purchase and Sale Agreement.
As of December 31, 2015, the Company had revolving line of credit agreements in place with CCIT II and CCPT V (the “Affiliate Lines of Credit”) that provided for maximum borrowings of $60.0 million to each of CCIT II and CCPT V and bore variable interest rates of one month LIBOR plus 2.20%. As of December 31, 2015, there was $50.0 million outstanding on the Affiliate Lines of Credit. During the year ended December 31, 2016, the Affiliate Lines of Credit matured and no amounts were outstanding as of December 31, 2017 or 2016.
Note 18 - Net Income (Loss) Per Share/Unit
The General Partner’s unvested Restricted Shares contain non-forfeitable rights to dividends and are considered to be participating securities in accordance with U.S. GAAP and, therefore, are included in the computation of earnings per share under the two-class computation method. Under the two-class computation method, net losses are not allocated to participating securities unless the holder of the security has a contractual obligation to share in the losses. The unvested Restricted Shares are not allocated losses as the awards do not have a contractual obligation to share in losses of the General Partner. The two-class computation method is an earnings allocation formula that determines earnings per share for each class of shares of Common Stock and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Net Income (Loss) Per Share
The following is a summary of the basic and diluted net income (loss) per share computation for the General Partner for the years ended December 31, 2017, 2016 and 2015 (dollar amounts in thousands):
For the year ended December 31, 2017, diluted net loss per share attributable to common stockholders excludes approximately 0.3 million unvested Restricted Shares and Restricted Stock Units and approximately 23.7 million OP Units as the effect would have been antidilutive.
For the year ended December 31, 2016, diluted net loss per share attributable to common stockholders excludes approximately 0.9 million unvested Restricted Shares and Restricted Stock Units and approximately 23.8 million OP Units as the effect would have been antidilutive.
For the year ended December 31, 2015, diluted net loss per share attributable to common stockholders excludes approximately 3.3 million of unvested Restricted Shares and Restricted Stock Units and approximately 23.8 million OP Units as the effect would have been antidilutive.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Net Income (Loss) Per Unit
The following is a summary of the basic and diluted net income (loss) per unit attributable to common unitholders, which includes all common general partner unitholders and limited partner unitholders. The computation for the OP for the years ended December 31, 2017, 2016 and 2015 (dollar amounts in thousands):
For the year ended December 31, 2017, diluted net loss per unit attributable to common unitholders excludes approximately 0.3 million unvested Restricted Shares and Restricted Stock Units as the effect would have been antidilutive.
For the year ended December 31, 2016, diluted net loss per unit attributable to common unitholders excludes approximately 0.9 million unvested Restricted Shares and Restricted Stock Units as the effect would have been antidilutive.
For the year ended December 31, 2015, diluted net loss per unit attributable to common unitholders excludes approximately 3.3 million of unvested Restricted Shares and Restricted Stock Units as the effect would have been antidilutive.
Note 19 - Income Taxes
The General Partner currently qualifies and has elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code. As a REIT, the General Partner generally is not subject to federal income tax, with the exception of its TRS entities. However, the General Partner, including its TRS entities, and the Operating Partnership are still subject to certain state and local income and franchise taxes in the various jurisdictions in which they operate. The Company recognized state and local income and franchise tax expense of $6.9 million, $6.0 million and $3.7 million for the years ended December 31, 2017, 2016 and 2015, respectively, which are included in provision for income taxes in the accompanying consolidated statements of operations. In addition, the Company recorded a provision for income taxes of $1.1 million and $0.9 million for the years ended December 31, 2016 and 2015, respectively, related to a TRS entity, which are also included in provision for income taxes in the accompanying consolidated statements of operations. No provision for income taxes related to a TRS entity was recorded for year ended December 31, 2017.
The Company had no unrecognized tax benefits as of or during the years ended December 31, 2017, 2016 or 2015. Any interest and penalties related to unrecognized tax benefits would be recognized in provision for income taxes in the accompanying consolidated statements of operations. The Company files income tax returns in the U.S. federal jurisdiction, Canadian federal jurisdiction and various state and local jurisdictions, and is subject to routine examinations by the respective tax authorities. With few exceptions, the Company is no longer subject to federal or state examinations by tax authorities for years before 2013.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
As of December 31, 2017, the OP and the General Partner had no material uncertain income tax positions. The tax years subsequent to and including the fiscal year ended December 31, 2013 remain open to examination by the major taxing jurisdictions to which the OP, the General Partner, American Realty Capital Trust III, Inc., CapLease, Inc., American Realty Capital Trust IV, Inc., Cole Real Estate Investments, Inc., and Cole Credit Property Trust, Inc. are subject.
Note 20 - Quarterly Results (Unaudited)
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2017 for the General Partner (in thousands, except share and per share amounts):
_______________________________________________
(1)
Represents revenue from continuing operations as presented on the statement of operations in accordance with GAAP. Substantially all of Cole Capital is presented as a discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented.
(2)
The sum of the quarterly net income (loss) per share amounts may not agree to the full year net loss per share amounts. The Company calculates net income (loss) per share based on the weighted-average number of outstanding shares of Common Stock during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
(3)
Represents dilutive net income per share attributable to common stockholders and limited partners.
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2017 for the OP (in thousands, except share and per share amounts):
_______________________________________________
(1)
Represents revenue from continuing operations as presented on the statement of operations in accordance with GAAP. Substantially all of Cole Capital is presented as a discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented.
(2)
The sum of the quarterly net income (loss) per unit amounts may not agree to the full year net loss per unit amounts. The Company calculates net loss per unit based on the weighted-average number of outstanding units during the reporting period. The average number of units fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2016 for the General Partner (in thousands, except share and per share amounts):
_______________________________________________
(1)
Represents revenue from continuing operations as presented on the statement of operations in accordance with GAAP. Substantially all of Cole Capital is presented as a discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented.
(2)
The sum of the quarterly net income (loss) per share amounts may not agree to the full year net loss per share amounts. The Company calculates net loss per share based on the weighted-average number of outstanding shares of Common Stock during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
(3)
Represents dilutive net income per share attributable to common stockholders and limited partners.
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2016 for the OP (in thousands, except share and per share amounts):
_______________________________________________
(1)
Represents revenue from continuing operations as presented on the statement of operations in accordance with GAAP. Substantially all of Cole Capital is presented as a discontinued operations and the Company’s remaining financial results are reported as a single segment for all periods presented.
(2)
The sum of the quarterly net loss per unit amounts may not agree to the full year net loss per unit amounts. The Company calculates net loss per unit based on the weighted-average number of outstanding units during the reporting period. The average number of units fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
VEREIT, INC. and VEREIT OPERATING PARTNERSHIP, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017 - (Continued)
Note 21 - Subsequent Events
The following events occurred subsequent to December 31, 2017:
Cole Sale
The Company closed on the Cole Capital Purchase and Sale Agreement on February 1, 2018. At closing, the Operating Partnership and Cole Capital entered into the Services Agreement, pursuant to which the Company will continue to provide certain services to Cole Capital and its subsidiaries and to the Cole REITs, including operational real estate support. The Company will continue to provide such services through March 31, 2019 (or, if later, the date of the last government filing other than a tax filing made by any of the Cole REITs with respect to its 2018 fiscal year) and will provide consulting and research services through December 31, 2023 as requested by Cole Capital.
Real Estate Investment Activity
From January 1, 2018 through February 20, 2018, the Company disposed of seven properties for an aggregate gross sales price of $57.8 million, of which the Company’s share was $57.4 million and an estimated gain of $8.5 million. In addition, the Company acquired six properties for an aggregate purchase price of $66.3 million, excluding capitalized external acquisition-related expenses.
Common Stock Dividend
On February 21, 2018, the Company’s board of directors declared a quarterly cash dividend of $0.1375 per share of common stock (equaling an annualized dividend rate of $0.55 per share) for the first quarter of 2018 to stockholders of record as of March 30, 2018, which will be paid on April 16, 2018. An equivalent distribution by the Operating Partnership is applicable per OP unit.
Preferred Stock Dividend
On February 21, 2018, the Company’s board of directors declared a monthly cash dividend to holders of the Series F Preferred Stock for April 2018 through June 2018 with respect to the periods included in the table below. The corresponding record and payment dates for each month's Series F Preferred Stock dividend are also shown in the table below. The dividend for the Series F Preferred Stock accrues daily on a 360-day annual basis equal to an annualized dividend rate of $1.675 per share, or $0.1395833 per 30-day month.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
December 31, 2017 (in thousands)
Schedule II - Valuation and Qualifying Accounts
_______________________________________________
(1)
Classified as discontinued operations.
(2)
Deductions related to the return of the Company's interest in two funds not yet in offering ($1.3 million) and the closing of CCPT V's primary offering ($32.0 million).
(3)
Deductions related to the closing of CCIT II’s primary offering.
(4)
Includes $1.0 million classified as discontinued operations.
F- 69
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017 (in thousands)
_______________________________________________
(1)
Initial costs exclude subsequent impairment charges.
(2)
Consists of capital expenditures and real estate development costs, net of condemnations, easements and impairment charges.
(3)
Gross intangible lease assets of $2.04 billion and the associated accumulated amortization of $690.9 million are not reflected in the table above.
(4)
The aggregate cost for Federal income tax purposes of land, buildings, fixtures and improvements as of December 31, 2017 was $15.6 billion.
(5)
Depreciation is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, five to 15 years for building fixtures and improvements.
The following is a reconciliation of the gross real estate activity for the years ended December 31, 2017, 2016 and 2015 (amounts in thousands):
The following is a reconciliation of the accumulated depreciation for the years ended December 31, 2017, 2016 and 2015 (amounts in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
SCHEDULE IV - MORTGAGE LOANS HELD FOR INVESTMENT
December 31, 2017 (in thousands)
Schedule IV - Mortgage Loans Held For Investment
_______________________________________________
(1) Zero coupon rate with balloon payment due at maturity.