Notes to Consolidated Financial Statements
June 30, 2020
1. Organization
Essential Properties Realty Trust, Inc. (the “Company”) is an internally managed real estate company that invests in, owns and manages primarily single-tenant properties that are net leased on a long-term basis to middle-market companies operating service-oriented or experience-based businesses. The Company generally invests in and leases freestanding, single-tenant commercial real estate facilities where a tenant services its customers and conducts activities that are essential to the generation of the tenant’s sales and profits.
The Company was organized on January 12, 2018 as a Maryland corporation. It elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes beginning with the year ended December 31, 2018, and it believes that its current organizational and operational status and intended distributions will allow it to continue to so qualify. Substantially all of the Company’s business is conducted through its operating partnership, Essential Properties, L.P. (the “Operating Partnership”).
On June 25, 2018, the Company completed the initial public offering (“IPO”) of its common stock. The Company’s common stock is listed on the New York Stock Exchange under the ticker symbol “EPRT”. See Note 7—Equity for additional information.
2. Summary of Significant Accounting Policies
Basis of Accounting
The accompanying unaudited consolidated financial statements of the Company were prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). In the opinion of management, all adjustments of a normal recurring nature necessary for a fair presentation of such financial statements have been included. The results of operations for the three and six months ended June 30, 2020 and 2019 are not necessarily indicative of the results for the full year. These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019 that has been filed with the SEC.
Reclassification
Certain amounts previously reported in the consolidated balance sheets have been reclassified to conform with the current period by presenting derivative liabilities separate from accrued liabilities and other payables.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and subsidiaries in which the Company has a controlling financial interest. All intercompany accounts and transactions have been eliminated in consolidation. As of June 30, 2020 and December 31, 2019, the Company, directly or indirectly, held a 99.4% and 99.3% ownership interest in the Operating Partnership and the consolidated financial statements include the financial statements of the Operating Partnership as of these dates. See Note 7—Equity for changes in the ownership interest in the Operating Partnership.
Use of Estimates
The preparation of the consolidated financial statements in conformity with 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 consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Real Estate Investments
Investments in real estate are carried at cost less accumulated depreciation and impairment losses. The cost of investments in real estate reflects their purchase price or development cost. The Company evaluates each
acquisition transaction to determine whether the acquired asset meets the definition of a business. Under Accounting Standards Update (“ASU”) 2017-1, Business Combinations (Topic 805): Clarifying the Definition of a Business, an acquisition does not qualify as a business when there is no substantive process acquired or substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets or the acquisition does not include a substantive process in the form of an acquired workforce or an acquired contract that cannot be replaced without significant cost, effort or delay. Transaction costs related to acquisitions that are asset acquisitions are capitalized as part of the cost basis of the acquired assets, while transaction costs for acquisitions that are deemed to be acquisitions of a business are expensed as incurred. Improvements and replacements are capitalized when they extend the useful life or improve the productive capacity of the asset. Costs of repairs and maintenance are expensed as incurred.
The Company allocates the purchase price of acquired properties accounted for as asset acquisitions to tangible and identifiable intangible assets or liabilities based on their relative fair values. Tangible assets may include land, site improvements and buildings. Intangible assets may include the value of in-place leases and above- and below-market leases and other identifiable intangible assets or liabilities based on lease or property specific characteristics.
The Company incurs various costs in the leasing and development of its properties. Amounts paid to tenants that incentivize them to extend or otherwise amend an existing lease or to sign a new lease agreement are capitalized to lease incentives on the Company’s consolidated balance sheets. Tenant improvements are capitalized to building and improvements within the Company’s consolidated balance sheets. Costs incurred which are directly related to properties under development, which include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs and real estate taxes and insurance, are capitalized during the period of development as construction in progress. After the determination is made to capitalize a cost, it is allocated to the specific component of a project that benefited. Determination of when a development project commences, and capitalization begins, and when a development project has reached substantial completion, and is available for occupancy and capitalization must cease, involves a degree of judgment. The Company does not engage in speculative real estate development. The Company does, however, opportunistically agree to reimburse certain of its tenants for development costs at its properties in exchange for contractually specified rent that generally increases proportionally with its funding.
The fair value of the tangible assets of an acquired property with an in-place operating lease is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to the tangible assets based on the fair value of the tangible assets. The fair value of in-place leases is determined by considering estimates of carrying costs during the expected lease-up periods, current market conditions, as well as costs to execute similar leases based on the specific characteristics of each tenant’s lease. The Company estimates the cost to execute leases with terms similar to the remaining lease terms of the in-place leases, including leasing commissions, legal and other related expenses. Factors the Company considers in this analysis include an estimate of the carrying costs during the expected lease-up periods considering 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 periods, which primarily range from 6 to 12 months. The fair value of above- or below-market leases is recorded based on the net present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between the contractual amount to be paid pursuant to the in-place lease and the Company’s estimate of the fair market lease rate for the corresponding in-place lease, measured over the remaining non-cancelable term of the lease including any below-market fixed rate renewal options for below-market leases.
In making estimates of fair values for purposes of allocating purchase price, the Company uses a number of sources, including real estate valuations prepared by independent valuation firms. The Company also considers information and other factors including market conditions, the industry that the tenant operates in, characteristics of the real estate (e.g., location, size, demographics, value and comparative rental rates), tenant credit profile and the importance of the location of the real estate to the operations of the tenant’s business. Additionally, the Company considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets acquired. The Company uses the information obtained as a result of its pre-acquisition due diligence as part of its consideration of the accounting standard governing asset retirement obligations and, when necessary, will record an asset retirement obligation as part of the purchase price allocation.
Real estate investments that are intended to be sold are designated as “held for sale” on the consolidated balance sheets at the lesser of carrying amount and fair value less estimated selling costs. Real estate investments are no longer depreciated when they are classified as held for sale. If the disposal, or intended disposal, of certain real estate investments represents a strategic shift that has had or will have a major effect on the Company’s operations and financial results, the operations of such real estate investments would be presented as discontinued operations in the consolidated statements of operations and comprehensive income for all applicable periods.
Depreciation and Amortization
Depreciation is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings and 15 years for site improvements. During the three months ended June 30, 2020 and 2019, the Company recorded $11.6 million and $8.5 million, respectively, of depreciation on its real estate investments. During the six months ended June 30, 2020 and 2019, the Company recorded $22.9 million and $16.3 million, respectively, of depreciation on its real estate investments.
Lease incentives are amortized on a straight-line basis as a reduction of rental income over the remaining non-cancellable terms of the respective leases. If a tenant terminates its lease, the unamortized portion of the lease incentive is charged to rental revenue.
Construction in progress is not depreciated until the development has reached substantial completion.
Tenant improvements are depreciated over the non-cancellable term of the related lease or their estimated useful life, whichever is shorter.
Capitalized above-market lease values are amortized on a straight-line basis as a reduction of rental revenue over the remaining non-cancellable terms of the respective leases. Capitalized below-market lease values are accreted on a straight-line basis as an increase to rental revenue over the remaining non-cancellable terms of the respective leases including any below-market fixed rate renewal option periods.
Capitalized above-market ground lease values are accreted as a reduction of property expenses over the remaining terms of the respective leases. Capitalized below-market ground lease values are amortized as an increase to property expenses over the remaining terms of the respective leases and any expected below-market renewal option periods where renewal is considered probable.
The value of in-place leases, exclusive of the value of above-market and below-market lease intangibles, is amortized to depreciation and amortization expense on a straight-line basis over the remaining periods of the respective leases.
If a tenant terminates its lease, the unamortized portion of each intangible, including in-place lease values, is charged to depreciation and amortization expense, while above- and below-market lease adjustments are recorded within rental revenue in the consolidated statements of operations and comprehensive income.
Loans Receivable
The Company holds its loans receivable for long-term investment. Loans receivable are carried at amortized cost, including related unamortized discounts or premiums, if any. The Company recognizes interest income on loans receivable using the effective-interest method applied on a loan-by-loan basis. Direct costs associated with originating loans are offset against any related fees received and the balance, along with any premium or discount, is deferred and amortized as an adjustment to interest income over the term of the related loan receivable using the effective-interest method.
Direct Financing Lease Receivables
Certain of the Company’s real estate investment transactions are accounted for as direct financing leases. The Company records the direct financing lease receivables at their net investment, determined as the aggregate minimum lease payments and the estimated non-guaranteed residual value of the leased property less unearned income. The unearned income is recognized over the term of the related lease so as to produce a constant rate of return on the net investment in the asset. The Company’s investment in direct financing lease receivables is
reduced over the applicable lease term to its non-guaranteed residual value by the portion of rent allocated to the direct financing lease receivables. Subsequent to the adoption of ASC 842, Leases (“ASC 842”), existing direct financing lease receivables will continue to be accounted for in the same manner, unless the underlying contracts are modified.
If and when an investment in direct financing lease receivables is identified for impairment evaluation, the Company will apply the guidance under ASC 326 – Credit Losses (“ASC 326”), ASC 310, Receivables (“ASC 310”) (prior to January 1, 2020 and ASC 840, Leases (“ASC 840”) (prior to January 1, 2019) and ASC 842. Under ASC 310, the lease receivable portion of the net investment in a direct financing lease receivable is evaluated for impairment when it becomes probable that the Company, as the lessor, will be unable to collect all rental payments associated with the Company’s investment in the direct financing lease receivable. Under ASC 326, the impairment model requires an estimate of expected credit losses, measured over the contractual life of an instrument, that considers forecasts of future economic conditions in addition to information about past events and current condition. Under ASC 840 and ASC 842, the Company reviews the estimated non-guaranteed residual value of a property subject to a direct financing lease at least annually. If the review results in a lower estimate than had been previously established, the Company determines whether the decline in estimated non-guaranteed residual value is other than temporary. If a decline is judged to be other than temporary, the accounting for the transaction is revised using the changed estimate and the resulting reduction in the net investment in direct financing lease receivables is recognized by the Company as a loss in the period in which the estimate is changed. As of June 30, 2020 and December 31, 2019, the Company determined that none of its direct financing lease receivables were impaired.
Allowance for Loan Losses
Prior to the adoption of ASC Topic 326, Financial Instruments - Credit Losses (“ASC 326”), the Company periodically evaluated the collectability of its loans receivable, including accrued interest, by analyzing the underlying property level economics and trends, collateral value and quality and other relevant factors in determining the adequacy of its allowance for loan losses. A loan was determined to be impaired when, in management’s judgment based on current information and events, it was probable that the Company would be unable to collect all amounts due according to the contractual terms of the loan agreement. Specific allowances for loan losses were provided for impaired loans on an individual loan basis in the amount by which the carrying value exceeded the estimated fair value of the underlying collateral less disposition costs. As of December 31, 2019, the Company had no allowance for loan losses recorded in its consolidated financial statements.
On January 1, 2020, the Company adopted ASC 326 on a prospective basis. ASC 326 changed how the Company accounts for credit losses for all of the Company’s loans receivable and direct financing lease receivables. ASC 326 replaces the current “incurred loss” model with an “expected loss” model that requires consideration of a broader range of information than used under the incurred losses model. Upon adoption of ASC 326, the Company recorded an initial allowance for loan losses of $0.2 million as of January 1, 2020, netted against loans and direct financing receivables on the Company’s Consolidated balance sheet. Under ASC 326, the Company is required to re-evaluate the expected loss of its loans and direct financing lease receivable portfolio at each balance sheet date. During the three and six months ended June 30, 2020, the Company recorded an allowance for loan losses of approximately $48,000 and $0.7 million, respectively. Changes in the Company’s allowance for loan losses are presented within provision for loan losses in the Company’s consolidated statements of operations.
In connection with the Company’s adoption of ASC 326 on January 1, 2020, the Company implemented a new process including the use of loan loss forecasting models. The Company has used the loan loss forecasting model for estimating expected life-time credit losses, at the individual loan level, for its loan and direct financing lease receivable portfolio. The forecasting model used is the probability weighted expected cash flow method, depending on the type of asset and global assumptions.
The Company used a real estate loss estimate model (“RELEM”) which estimates losses on its loans and direct financing lease receivable portfolio, for purposes of calculating allowances for loan losses. The RELEM allows the Company to refine (on an ongoing basis) the expected loss estimate by incorporating loan specific assumptions as necessary, such as anticipated funding, interest payments, estimated extensions and estimated loan repayment/refinancing at maturity to estimate cash flows over the life of the loan. The model also incorporates assumptions related to underlying collateral values, various loss scenarios, and predicted losses to estimate expected losses. The Company specific loan-level inputs which include loan-to-stabilized-value “LTV” and debt service coverage ratio
metrics, as well as principal balances, property type, location, coupon, origination year, term, subordination, expected repayment dates and future funding’s. The Company categorizes the results by LTV range, which it considers the most significant indicator of credit quality for its loans and direct financing lease receivables. A lower LTV ratio typically indicates a lower credit loss risk.
Real estate lending has several risks that need to be considered. There is the potential for changes in local real estate conditions and subjectivity of real estate valuations. In addition, overall economic conditions may impact the borrowers’ financial condition. Adverse economic conditions such as high unemployment levels, interest rates, tax rates and fuel and energy costs may have an impact on the results of operations and financial conditions of borrowers.
The Company also evaluates each loan and direct financing lease receivable measured at amortized cost for credit deterioration at least quarterly. Credit deterioration occurs when it is deemed probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan or direct financing lease receivables.
The Company's allowance for loan losses is adjusted to reflect the Company's estimation of the current and future economic conditions that impact the performance of the real estate assets securing our loans. These estimations include various macroeconomic factors impacting the likelihood and magnitude of potential credit losses for the Company's loans and direct financing leases during their anticipated term.
Impairment of Long-Lived Assets
If circumstances indicate that the carrying value of a property may not be recoverable, the Company reviews the property for impairment. This review is based on an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. These estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property for properties to be held and used. For properties held for sale, the impairment loss is the adjustment to fair value less estimated cost to dispose of the asset. Impairment assessments have a direct impact on the consolidated statements of operations because recording an impairment loss results in an immediate negative adjustment to the consolidated statements of operations. During the three months ended June 30, 2020 and 2019, the Company recorded $1.5 million and $0.5 million provisions for impairment of real estate, respectively. During the six months ended June 30, 2020 and 2019, the Company recorded $1.9 million and $1.9 million provisions for impairment of real estate, respectively.
Cash and Cash Equivalents
Cash and cash equivalents includes cash in the Company’s bank accounts. The Company considers all cash balances and highly liquid investments with original maturities of three months or less to be cash and cash equivalents. The Company deposits cash with high quality financial institutions. These deposits are guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) up to an insurance limit. As of June 30, 2020 and December 31, 2019, the Company had deposits of $100.8 million and $8.3 million, respectively, of which $100.6 million and $8.1 million, respectively, were in excess of the amount insured by the FDIC. Although the Company bears risk with respect to amounts in excess of those insured by the FDIC, it does not anticipate any losses as a result.
Restricted Cash
Restricted cash primarily consists of cash held with the trustee for the Company’s Master Trust Funding Program (as defined in Note 6—Secured Borrowings). This restricted cash is used to make principal and interest payments on the Company’s secured borrowings, to pay trust expenses and to invest in future real estate investments which will be pledged as collateral under the Master Trust Funding Program. See Note 6—Secured Borrowings for further discussion.
Adjustment to Rental Revenue for Tenant Credit
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. As of January 1, 2019, if the assessment of the collectability of substantially all payments due under a lease changes from probable to not probable, any difference between the rental revenue recognized to date and the lease payments that have been collected is recognized as a current period reduction of rental revenue in the consolidated statements of operations.
During the three months ended June 30, 2020 and 2019, the Company recognized $4.8 million and $0.1 million reductions of rental revenue for tenant credit, respectively. During the six months ended June 30, 2020 and 2019, the Company recognized $5.5 million and $0.1 million reductions of rental revenue for tenant credit, respectively.
Deferred Financing Costs
Financing costs related to establishing the Company’s 2018 Credit Facility and Revolving Credit Facility (as defined below) were deferred and are being amortized as an increase to interest expense in the consolidated statements of operations over the term of the facility and are reported as a component of rent receivables, prepaid expenses and other assets, net on the consolidated balance sheets.
Financing costs related to the issuance of the Company’s secured borrowings under the Master Trust Funding Program, the April 2019 Term Loan and the November 2019 Term Loan (each as defined below) were deferred and are being amortized as an increase to interest expense in the consolidated statements of operations over the term of the related debt instrument and are reported as a reduction of the related debt balance on the consolidated balance sheets.
Derivative Instruments
In the normal course of business, the Company uses derivative financial instruments, which may include interest rate swaps, caps, options, floors and other interest rate derivative contracts, to protect the Company against adverse fluctuations in interest rates by reducing its exposure to variability in cash flows on a portion of the Company’s floating-rate debt. Instruments that meet these hedging criteria are formally designated as hedges at the inception of the derivative contract. 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 variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. 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 also enter into derivative contracts that are intended to economically hedge certain 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 designed and qualifies for hedge accounting treatment. If a derivative is designated and qualifies for cash flow hedge accounting treatment, the change in the estimated fair value of the derivative is recorded in other comprehensive income (loss) in the consolidated statements of comprehensive income to the extent that it is effective. Any ineffective portion of a change in derivative fair value is immediately recorded in earnings. If the Company elects not to apply hedge accounting treatment (or for derivatives that do not qualify as hedges), any change in the fair value of these derivative instruments is recognized immediately in gains (losses) on derivative instruments in the consolidated statements of operations.
Fair Value Measurement
The Company estimates fair value of financial and non-financial assets and liabilities based on the framework established in fair value accounting guidance. Fair value is defined as the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The hierarchy described below prioritizes inputs to the valuation techniques used in measuring the fair value of assets and liabilities. This hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the most observable inputs to be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
Level 1—Quoted prices in active markets for identical assets and liabilities that the Company 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 that reflect the Company’s own 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.
Revenue Recognition
The Company’s rental revenue is primarily rent received from tenants. Rent from tenants is recorded in accordance with the terms of each lease on a straight-line basis over the non-cancellable initial term of the lease from the later of the date of the commencement of the lease and the date of acquisition of the property subject to the lease. Rental revenue recognition begins when the tenant controls the space and continues through the term of the related lease. Because substantially all of the leases provide for rental increases at specified intervals, the Company records a straight-line rent receivable and recognizes revenue on a straight-line basis through the expiration of the non-cancelable term of the lease. The Company takes into account whether the collectability of rents is reasonably assured in determining the amount of straight-line rent to record.
Generally, the Company’s leases provide the tenant with one or more multi-year renewal options, subject to generally the same terms and conditions provided under the initial lease term, including rent increases. If economic incentives make it reasonably certain that an option period to extend the lease will be exercised, the Company will include these options in determining the non-cancelable term of the lease.
The Company defers rental revenue related to lease payments received from tenants in advance of their due dates. These amounts are presented within accrued liabilities, derivatives and other payables on the Company’s consolidated balance sheets.
Certain properties in the Company’s investment portfolio are subject to leases that provide for contingent rent based on a percentage of the tenant’s gross sales. For these leases, the Company recognizes contingent rental revenue when the threshold upon which the contingent lease payment is based is actually reached. During the three months ended June 30, 2020 and 2019, the Company recorded contingent rent of $0.1 million and $0.2 million. During the six months ended June 30, 2020 and 2019, the Company recorded contingent rent of $0.3 million and $0.6 million.
Offering Costs
In connection with the completion of equity offerings, the Company incurs legal, accounting and other offering-related costs. Such costs are deducted from the gross proceeds of each equity offering when the offering is completed. As of June 30, 2020 and December 31, 2019, the Company had capitalized a total of $58.0 million and $49.0 million, respectively, of such costs in the Company’s consolidated balance sheets. These costs are presented as a reduction of additional paid-in capital as of June 30, 2020 and December 31, 2019.
Legal, accounting and other offering-related costs incurred in connection with the Secondary Offering (as defined below) were expensed as incurred and are recorded within general and administrative expense in the Company’s consolidated statements of operations.
Income Taxes
The Company elected and qualified to be taxed as a REIT under sections 856 through 860 of the Internal Revenue Code of 1986, as amended, commencing with its taxable year ended December 31, 2018. REITs are subject to a number of organizational and operational requirements, including a requirement that 90% of ordinary “REIT taxable income” (as determined without regard to the dividends paid deduction or net capital gains) be distributed. As a REIT, the Company will generally not be subject to U.S. federal income tax to the extent that it meets the organizational and operational requirements and its distributions equal or exceed REIT taxable income. For the period subsequent to the effective date of its REIT election, the Company continues to meet the organizational and operational requirements and expects distributions to exceed REIT taxable income. Accordingly, no provision has been made for U.S. federal income taxes. Even though the Company has elected and qualifies for taxation as a REIT, it may be subject to state and local income and franchise taxes, and to federal income and excise tax on its undistributed income. Franchise taxes and federal excise taxes on the Company’s undistributed income, if any, are included in general and administrative expenses on the accompanying consolidated statements of operations. Additionally, taxable income from non-REIT activities managed through the Company's taxable REIT subsidiary is subject to federal, state, and local taxes.
The Company analyzes its tax filing positions in all of the U.S. federal, state and local tax jurisdictions where it is required to file income tax returns, as well as for all open tax years in such jurisdictions. The Company follows a two-step process to evaluate uncertain tax positions. Step one, recognition, occurs when an entity concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Step two, measurement, determines the amount of benefit that is more-likely-than-not to be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when the Company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. The use of a valuation allowance as a substitute for derecognition of tax positions is prohibited.
As of June 30, 2020 and December 31, 2019, the Company did not record any accruals for uncertain tax positions. The Company’s policy is to classify interest expense and penalties relating to taxes in general and administrative expense in the consolidated statements of operations. During the three months ended June 30, 2020 and 2019, the Company recorded de minimis interest or penalties relating to taxes, and there were no interest or penalties with respect to taxes accrued at June 30, 2020 or December 31, 2019. The 2019, 2018, 2017 and 2016 taxable years remain open to examination by federal and/or state taxing jurisdictions to which the Company is subject.
Equity-Based Compensation
In 2020 and 2019, the Company granted shares of restricted common stock and restricted share units (“RSUs”) to its directors, executive officers and other employees that vest over specified time periods, subject to the recipient’s continued service. The Company also granted performance-based RSUs to its executive officers, the final number of which is determined based on objective and subjective performance conditions and which vest over a multi-year period, subject to the recipient’s continued service. The Company accounts for the restricted common stock and RSUs in accordance with ASC 718, Compensation – Stock Compensation, which requires that such compensation be recognized in the financial statements based on its estimated grant-date fair value. The value of such awards is recognized as compensation expense in general and administrative expenses in the accompanying consolidated statements of operations over the applicable service periods.
The Company recognizes compensation expense for equity-based compensation using the straight-line method based on the terms of the individual grant.
Variable Interest Entities
The Financial Accounting Standards Board (“FASB”) provides guidance for determining whether an entity is a variable interest entity (a “VIE”). VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. A VIE is required to be consolidated by its primary beneficiary, which is the party that (i) has the power to control the activities that most significantly impact the VIE’s economic performance and (ii) has the obligation to absorb losses, or the right to receive benefits, of the VIE that could potentially be significant to the VIE.
The Company has concluded that the Operating Partnership is a VIE of which the Company is the primary beneficiary, as the Company has the power to direct the activities that most significantly impact the economic performance of the Operating Partnership. Substantially all of the Company’s assets and liabilities are held by the Operating Partnership. The assets and liabilities of the Operating Partnership are consolidated and reported as assets and liabilities on the Company’s consolidated balance sheets as of June 30, 2020 and December 31, 2019.
As of December 31, 2019, the Company concluded that seven entities to which it had provided mortgage loans were VIEs, because the entities’ equity was not sufficient to finance their activities without additional subordinated financial support. However, the Company was not the primary beneficiary of the entities, because the Company did not have the power to direct the activities that most significantly impact the entities’ economic performance. As of December 31, 2019, the carrying amount of the Company’s loans receivable with these entities was $60.5 million and the Company’s maximum exposure to loss in these entities is limited to the carrying amount of its investment. The Company had no liabilities associated with these VIEs as of December 31, 2019.
As of June 30, 2020, the Company concluded that eight entities to which it had provided mortgage loans were VIEs, because the entities’ equity was not sufficient to finance their activities without additional subordinated financial support. However, the Company was not the primary beneficiary of the entities, because the Company did not have the power to direct the activities that most significantly impact the entities’ economic performance. As of June 30, 2020, the carrying amount of the Company’s loans receivable with these entities was $66.8 million and the Company’s maximum exposure to loss in these entities is limited to the carrying amount of its investment. The Company had no liabilities associated with these VIEs as of June 30, 2020.
Reportable Segments
ASC Topic 280, Segment Reporting, establishes standards for the manner in which enterprises report information about operating segments. Substantially all of the Company’s investments, at acquisition, are comprised of real estate owned that is leased to tenants on a long-term basis, loans and direct financing leases. Therefore, the Company aggregates these investments for reporting purposes and operates in one reportable segment.
Net Income per Share
Net income per share has been computed pursuant to the guidance in the FASB ASC Topic 260, Earnings Per Share. The guidance requires the classification of the Company’s unvested restricted common stock and units, which contain rights to receive non-forfeitable dividends or dividend equivalents, as participating securities requiring the two-class method of computing net income per share. Diluted net income per share of common stock further considers the effect of potentially dilutive shares of common stock outstanding during the period, including the assumed vesting of restricted share units with a market-based or service-based vesting condition, where dilutive. The Operating Partnership Units ("OP Units") held by non-controlling interests represent potentially dilutive securities as the OP Units may be redeemed for cash or, at the Company’s election, exchanged for shares of the Company’s common stock on a one-for-one basis.
The following is a reconciliation of the numerator and denominator used in the computation of basic and diluted net income per share (dollars in thousands):
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Three months ended June 30,
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Six months ended June 30,
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(dollar amounts in thousands)
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2020
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2019
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2020
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2019
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Numerator for basic and diluted earnings per share:
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Net income
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$
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10,444
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$
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10,571
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$
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24,488
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$
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19,294
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Less: net income attributable to non-controlling interests
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(63)
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(2,620)
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(147)
|
|
(5,214)
|
|
Less: net income allocated to unvested restricted common stock and RSUs
|
|
(77)
|
|
|
|
(112)
|
|
(207)
|
|
(267)
|
|
Net income available for common stockholders: basic
|
|
10,304
|
|
|
|
7,839
|
|
24,134
|
|
13,813
|
|
Net income attributable to non-controlling interests
|
|
63
|
|
|
|
2,620
|
|
147
|
|
5,214
|
|
Net income available for common stockholders: diluted
|
|
$
|
10,367
|
|
|
|
$
|
10,459
|
|
$
|
24,281
|
|
$
|
19,027
|
|
|
|
|
|
|
|
|
|
Denominator for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
92,054,919
|
|
|
|
57,825,460
|
|
91,430,110
|
|
51,932,547
|
|
Less: weighted average number of shares of unvested restricted common stock
|
|
(450,522)
|
|
|
|
(721,784)
|
|
(466,710)
|
|
(727,814)
|
|
Weighted average shares outstanding used in basic net income per share
|
|
91,604,397
|
|
|
|
57,103,676
|
|
90,963,400
|
|
51,204,733
|
|
Effects of dilutive securities: (1)
|
|
|
|
|
|
|
|
OP Units
|
|
553,847
|
|
|
|
19,056,552
|
|
553,847
|
|
19,056,552
|
|
Unvested restricted common stock and RSUs
|
|
325,654
|
|
|
|
505,677
|
|
390,851
|
|
425,684
|
|
Weighted average shares outstanding used in diluted net income per share
|
|
92,483,898
|
|
|
|
76,665,905
|
|
91,908,098
|
|
70,686,969
|
|
_____________________________________
(1)For the three and six months ended June 30, 2020, excludes the impact of 73,080 and 69,196 unvested restricted stock units as the effect would have been antidilutive.
Recent Accounting Developments
In February 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) establishing ASC 326, as amended by subsequent ASUs on the topic. ASU 2016-13 is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2019. The Company adopted this guidance on January 1, 2020 and recorded estimates of expected loss on its loans and direct financing lease receivable portfolio beginning on that date, as discussed above.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”), which amends and simplifies existing guidance in order to allow companies to more accurately present the economic effects of risk management activities in the financial statements. The Company adopted ASU 2017-12 while accounting for its interest rate swaps (see Note 5—Derivatives). As the Company did not have other derivatives outstanding at time of adoption, no prior period adjustments were required. Pursuant to the provisions of ASU 2017-12, the Company is no longer required to separately measure and recognize hedge ineffectiveness. Instead, the Company recognizes the entire change in the fair value of cash flow hedges included in the assessment of hedge effectiveness in other comprehensive (loss) income. The amounts recorded in other comprehensive (loss) income will subsequently be reclassified to earnings when the hedged item affects earnings. The adoption of ASU 2017-12 did not have a material impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement: Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which changes the disclosure requirements for fair value measurements by removing, adding and modifying certain disclosures. ASU 2018-13 is effective for annual periods beginning after December 15, 2019, with early adoption permitted. The Company adopted this guidance on January 1, 2020 and the adoption of ASU 2018-13 did not have a material impact on the Company’s related disclosures.
In March 2020, the FASB issued ASU 2020-4, Reference Rate Reform (Topic 848) (“ASU 2020-4”). ASU 2020-4 contains practical expedients for reference rate reform related activities that impact debt, leases, derivatives
and other contracts. The guidance in ASU 2020-4 is optional and may be elected over time as reference rate reform activities occur. During the first quarter of 2020, the Company has elected to apply the hedge accounting expedients related to probability and the assessments of effectiveness for future LIBOR-indexed cash flows to assume that the index upon which future hedged transactions will be based matches the index on the corresponding derivatives. Application of these expedients preserves the presentation of derivatives consistent with past presentation. The Company continues to evaluate the impact of the guidance and may apply other elections as applicable as additional changes in the market occur.
In April 2020, the FASB staff issued a question and answer document (the “Lease Modification Q&A”) focused on the application of lease accounting guidance to lease concessions provided as a result of the COVID-19 pandemic. Under existing lease guidance, the entity would have to determine, on a lease by lease basis, if a lease concession was the result of a new arrangement reached with the tenant, which would be accounted for under the lease modification framework, or if a lease concession was under the enforceable rights and obligations that existed in the original lease, which would be accounted for outside the lease modification framework. The Lease Modification Q&A provides entities with the option to elect to account for lease concessions as though the enforceable rights and obligations existed in the original lease. This election is only available when total cash flows resulting from the modified lease are substantially similar to or less than the cash flows in the original lease. The Company made this election and accounts for rent deferrals by increasing its rent receivables as receivables accrue and continuing to recognize income during the deferral period, resulting in $9.8 million of deferrals being recognized in rental revenues for the three and six months ended June 30, 2020. Lease concessions or amendments other than rent deferrals are evaluated to determine if a substantive change to the consideration in the original lease contract has occurred and should be accounted for as a lease modification. The Company continues to evaluate any amounts recognized for collectability, regardless of whether accounted for as a lease modification or not, and records an adjustment to rental income for tenant credit for amounts that are not probable of collection. For lease concessions granted in conjunction with the COVID-19 pandemic, the Company reviewed all amounts recognized on a tenant-by-tenant basis for collectability.
3. Investments
As of June 30, 2020, the Company had investments in 1,060 properties, including six developments in progress and one undeveloped land parcel. Of these 1,060 properties, 960 represented owned properties (of which 11 were subject to leases accounted for as direct financing leases or loans), 8 represented ground lease interests (of which one building was subject to a lease accounted for as a direct financing lease) and 92 represented properties which secure the Company’s investments in nine mortgage loans receivable. The Company’s gross investment portfolio totaled $2.2 billion as of June 30, 2020 and consisted of gross acquisition cost of real estate investments (including transaction costs) totaling $2.1 billion, and loans and direct financing lease receivables, net, with an aggregate carrying amount of $101.0 million. As of June 30, 2020, 255 of these investments, comprising $364.8 million of net investments, were assets of consolidated special purpose entity subsidiaries and were pledged as collateral under the non-recourse obligations of the Company’s Master Trust Funding Program. (See Note 6—Secured Borrowings.)
As of December 31, 2019, the Company had investments in 1,000 property locations, including eight developments in progress and one undeveloped land parcel. Of these 1,000 property locations, 897 represented owned properties (of which eight were subject to leases accounted for as direct financing leases or loans), 12 represented ground lease interests (of which one building was subject to a lease accounted for as a direct financing lease) and 91 represented properties which secure the Company’s investments in six mortgage loans receivable. The Company’s gross investment portfolio totaled $2.0 billion as of December 31, 2019 and consisted of gross acquisition cost of real estate investments (including transaction costs) totaling $1.9 billion and loans and direct financing lease receivables, net, with an aggregate carrying amount of $92.2 million. As of December 31, 2019, 355 of these investments, comprising $601.3 million of net investments, were assets of consolidated special purpose entity subsidiaries and were pledged as collateral under the non-recourse obligations of these special purpose entities.
Acquisitions in 2020
During the six months ended June 30, 2020, the Company did not have any acquisitions that individually represented more than 5% of the Company’s total investment activity as of June 30, 2020. The following table presents information about the Company’s acquisition activity during the six months ended June 30, 2020:
|
|
|
|
|
|
|
|
|
(Dollar amounts in thousands)
|
|
Total
Investments
|
Ownership type
|
|
Fee Interest
|
Number of properties acquired
|
|
73
|
|
|
|
Allocation of Purchase Price:
|
|
|
Land and improvements
|
|
$
|
63,100
|
|
Building and improvements
|
|
114,469
|
|
Construction in progress (1)
|
|
9,641
|
|
Intangible lease assets
|
|
3,094
|
|
Assets acquired
|
|
190,304
|
|
|
|
|
Intangible lease liabilities
|
|
—
|
|
Liabilities assumed
|
|
—
|
|
Purchase price (including acquisition costs)
|
|
$
|
190,304
|
|
_____________________________________
(1)Represents amounts incurred at and subsequent to acquisition and includes $0.2 million of capitalized interest expense.
Acquisitions in 2019
During the six months ended June 30, 2019, the Company did not complete any acquisitions that individually represented more than 5% of the Company’s total investment activity as of June 30, 2019. The following table presents information about the Company’s acquisition activity during the six months ended June 30, 2019:
|
|
|
|
|
|
|
|
|
(Dollar amounts in thousands)
|
|
Total
Investments
|
Ownership type
|
|
Fee Interest
|
Number of properties acquired
|
|
137
|
|
|
|
Allocation of Purchase Price:
|
|
|
Land and improvements
|
|
$
|
96,418
|
|
Building and improvements
|
|
175,074
|
|
Construction in progress (1)
|
|
5,754
|
|
Intangible lease assets
|
|
10,338
|
|
Assets acquired
|
|
287,584
|
|
|
|
|
Intangible lease liabilities
|
|
(117)
|
|
Liabilities assumed
|
|
(117)
|
|
Purchase price (including acquisition costs)
|
|
$
|
287,467
|
|
_____________________________________
(1)Represents amounts incurred at and subsequent to acquisition and includes $0.1 million of capitalized interest.
Gross Investment Activity
During the six months ended June 30, 2020 and 2019, the Company had the following gross investment activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollar amounts in thousands)
|
|
Number of
Investment
Locations
|
|
Dollar
Amount of
Investments
|
Gross investments, January 1, 2019
|
|
677
|
|
$
|
1,394,549
|
|
Acquisitions of and additions to real estate investments (1)
|
|
137
|
|
290,943
|
|
Sales of investments in real estate
|
|
(18)
|
|
(35,383)
|
|
Relinquishment of properties at end of ground lease term
|
|
(1)
|
|
(241)
|
|
Provisions for impairment of real estate (2)
|
|
|
|
(1,921)
|
|
Investments in loans receivable
|
|
5
|
|
23,566
|
|
Principal collections on direct financing lease receivables
|
|
(11)
|
|
(10,412)
|
|
Other
|
|
|
|
(866)
|
|
Gross investments, June 30, 2019
|
|
|
|
1,660,235
|
|
Less: Accumulated depreciation and amortization (3)
|
|
|
|
(69,010)
|
|
Net investments, June 30, 2019
|
|
789
|
|
$
|
1,591,225
|
|
|
|
|
|
|
Gross investments, January 1, 2020
|
|
1,000
|
|
$
|
2,002,314
|
|
Acquisitions of and additions to real estate investments
|
|
73
|
|
207,774
|
|
Sales of investments in real estate
|
|
(13)
|
|
(21,882)
|
|
Relinquishment of properties at end of ground lease term
|
|
(3)
|
|
(1,931)
|
|
Provisions for impairment of real estate (4)
|
|
|
|
(1,859)
|
|
Investments in loans receivable
|
|
3
|
|
9,656
|
|
Principal collections on loans and direct financing lease receivables
|
|
|
|
(130)
|
|
Other
|
|
|
|
(1,328)
|
|
Gross investments, June 30, 2020
|
|
|
|
2,192,614
|
|
Less: Accumulated depreciation and amortization (3)
|
|
|
|
(113,235)
|
|
Net investments, June 30, 2020
|
|
1,060
|
|
$
|
2,079,379
|
|
_____________________________________
(1)During the six months ended June 30, 2019, the Company acquired nine properties that had secured one of its loans receivable for an aggregate purchase price of $8.2 million. This loan receivable had a carrying value of $5.7 million prior to our acquisition of the mortgaged properties.
(2)During the six months ended June 30, 2019, the Company identified and recorded provisions for impairment at 1 vacant and 5 tenanted properties.
(3)Includes $92.9 million and $53.0 million of accumulated depreciation as of June 30, 2020 and 2019, respectively.
(4)During the six months ended June 30, 2020, the Company identified and recorded provisions for impairment at 4 vacant properties and 1 tenanted property.
Real Estate Investments
The Company’s investment properties are leased to tenants under long-term operating leases that typically include one or more renewal options. See Note 10—Leases for more information about the Company’s leases.
Loans and Direct Financing Lease Receivables
As of June 30, 2020 and December 31, 2019, the Company had ten and seven loans receivable with an aggregate carrying amount of $99.2 million and $89.6 million, respectively. During the three and six months ended June 30, 2020, the borrowers partially repaid $0.1 million in principal on loans receivable. The Company entered into three arrangements accounted for as loans receivable during the six months ended June 30, 2020 with an aggregate carrying value of $8.6 million as of June 30, 2020. The maximum amount of loss due to credit risk is our current principal balance of $99.2 million.
During the six months ended June 30, 2019, the Company entered into three loan receivable arrangements.
The Company’s loans receivable as of June 30, 2020 and December 31, 2019 are summarized as follows (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal Balance Outstanding
|
|
|
Loan Type
|
|
Monthly Payment
|
|
Number of Secured Properties
|
|
Interest Rate
|
|
Maturity Date
|
|
June 30,
2020
|
|
December 31,
2019
|
Mortgage (1)(2)
|
|
Interest only
|
|
2
|
|
8.80%
|
|
2039
|
|
$
|
12,000
|
|
|
$
|
12,000
|
|
Mortgage (2)
|
|
Principal + Interest
|
|
2
|
|
8.10%
|
|
2059
|
|
6,125
|
|
|
5,125
|
|
Mortgage (1)
|
|
Interest only
|
|
2
|
|
8.53%
|
|
2039
|
|
7,300
|
|
|
7,300
|
|
Mortgage (1)
|
|
Interest only
|
|
69
|
|
8.16%
|
|
2034
|
|
28,000
|
|
|
28,000
|
|
Mortgage (1)
|
|
Interest only
|
|
18
|
|
8.05%
|
|
2034
|
|
34,604
|
|
|
34,604
|
|
Mortgage (1)
|
|
Interest only
|
|
1
|
|
8.42%
|
|
2040
|
|
5,300
|
|
|
—
|
|
Leasehold interest (3)
|
|
Principal + Interest
|
|
2
|
|
10.69%
|
|
2039
|
|
1,435
|
|
|
1,435
|
|
Leasehold interest (4)
|
|
Principal + Interest
|
|
1
|
|
2.25%
|
|
2034
|
|
1,137
|
|
|
1,164
|
|
Leasehold interest (4)
|
|
Principal + Interest
|
|
1
|
|
2.41%
|
|
2034
|
|
1,685
|
|
|
—
|
|
Leasehold interest (4)
|
|
Principal + Interest
|
|
1
|
|
4.97%
|
|
2038
|
|
$
|
1,625
|
|
|
—
|
|
Net investment
|
|
|
|
|
|
|
|
|
|
$
|
99,211
|
|
|
$
|
89,628
|
|
_____________________________________
(1)Loan requires monthly payments of interest only with a balloon payment due at maturity.
(2)Loan allows for prepayments in whole or in part without penalty.
(3)This leasehold interest is accounted for as a loan receivable, as the lease for two land parcels contains an option for the lessee to repurchase the leased parcels in 2024 or 2025.
(4)These leasehold interests are accounted for as loans receivable, as the leases for each property contain an option for the relevant lessee to repurchase the leased property in the future.
Scheduled principal payments due under the Company’s loans receivable as of June 30, 2020 were as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Loans Receivable
|
July 1 - December 31, 2020
|
|
$
|
98
|
|
2021
|
|
207
|
|
2022
|
|
220
|
|
2023
|
|
236
|
|
2024
|
|
252
|
|
Thereafter
|
|
98,198
|
|
Total
|
|
$
|
99,211
|
|
As of June 30, 2020 and December 31, 2019, the Company had $2.5 million and $2.6 million, respectively, of net investments accounted for as direct financing lease receivables. The components of the investments accounted for as direct financing lease receivables were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
June 30,
2020
|
|
December 31,
2019
|
Minimum lease payments receivable
|
|
$
|
3,698
|
|
|
$
|
3,866
|
|
Estimated unguaranteed residual value of leased assets
|
|
270
|
|
|
270
|
|
Unearned income from leased assets
|
|
(1,467)
|
|
|
(1,581)
|
|
Net investment
|
|
$
|
2,501
|
|
|
$
|
2,555
|
|
Scheduled future minimum non-cancelable base rental payments due to be received under the direct financing lease receivables as of June 30, 2020 were as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Future Minimum
Base Rental
Payments
|
July 1 - December 31, 2020
|
|
$
|
169
|
|
2021
|
|
340
|
|
2022
|
|
345
|
|
2023
|
|
347
|
|
2024
|
|
289
|
|
Thereafter
|
|
2,208
|
|
Total
|
|
$
|
3,698
|
|
Allowance for Loan Losses
As discussed in Note 2, the Company utilizes the RELEM model which estimates losses on loans and direct financing lease receivables for purposes of calculating an allowance for loan losses. As of June 30, 2020, the Company recorded an allowance for loan losses of $0.7 million. Changes in the Company’s allowance for loan losses are presented within provision for loan losses in the Company’s consolidated statements of operations.
For the six months ended June 30, 2020, the changes to allowance for loan losses were as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Loans and Direct Financing Lease Receivables
|
Balance at December 31, 2019
|
|
$
|
—
|
|
Cumulative-effect adjustment upon adoption of ASC 326
|
|
188
|
|
Current period provision for expected credit losses (1)
|
|
516
|
|
Write-offs charged
|
|
—
|
|
Recoveries
|
|
—
|
|
Balance at June 30, 2020
|
|
$
|
704
|
|
_____________________________________
(1)The increase in expected credit losses is due to the changes in assumptions regarding current macroeconomic factors related to COVID-19.
The significant credit quality indicators for the Company’s loans and direct financing lease receivables measured at amortized cost, were as follows as of June 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized Cost Basis by Origination Year
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
|
2018
|
|
2017
|
|
2016
|
|
Total Amortized Costs Basis
|
Credit Quality Indicator:
|
|
|
|
|
|
|
|
|
|
|
|
|
LTV <60%
|
|
$
|
—
|
|
|
$
|
28,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
832
|
|
|
$
|
28,832
|
|
LTV 60%-70%
|
|
—
|
|
|
34,604
|
|
|
—
|
|
|
—
|
|
|
1,100
|
|
|
35,704
|
|
LTV >70%
|
|
8,611
|
|
|
27,997
|
|
|
—
|
|
|
—
|
|
|
883
|
|
|
37,491
|
|
|
|
$
|
8,611
|
|
|
$
|
90,601
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,815
|
|
|
$
|
102,027
|
|
Real Estate Investments Held for Sale
The Company continually evaluates its portfolio of real estate investments and may elect to dispose of investments considering criteria including, but not limited to, tenant concentration, tenant credit quality, tenant operation type (e.g., industry, sector or concept), unit-level financial performance, local market conditions and lease rates, associated indebtedness and asset location. Real estate investments held for sale are expected to be sold within twelve months.
The following table shows the activity in real estate investments held for sale and intangible lease liabilities held for sale during the six months ended June 30, 2020 and 2019.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollar amounts in thousands)
|
|
Number of Properties
|
|
Real Estate Investments
|
|
Intangible Lease Liabilities
|
|
Net Carrying Value
|
Held for sale balance, December 31, 2018
|
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Transfers to held for sale classification
|
|
2
|
|
|
3,765
|
|
|
—
|
|
|
3,765
|
|
Sales
|
|
—
|
|
|
—
|
|
|
—
|
%
|
|
—
|
|
Transfers to held and used classification
|
|
—
|
|
|
—
|
|
|
—
|
%
|
|
—
|
|
Held for sale balance, June 30, 2019
|
|
2
|
|
|
$
|
3,765
|
|
|
$
|
—
|
|
|
$
|
3,765
|
|
|
|
|
|
|
|
|
|
|
Held for sale balance, December 31, 2019
|
|
1
|
|
|
$
|
1,211
|
|
|
$
|
—
|
|
|
$
|
1,211
|
|
Transfers to held for sale classification
|
|
2
|
|
|
1,792
|
|
|
—
|
|
|
1,792
|
|
Sales
|
|
(1)
|
|
|
$
|
(1,211)
|
|
|
$
|
—
|
|
|
$
|
(1,211)
|
|
Transfers to held and used classification
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Held for sale balance, June 30, 2020
|
|
2
|
|
|
$
|
1,792
|
|
|
$
|
—
|
|
|
$
|
1,792
|
|
Significant Concentrations
The Company did not have any tenants (including for this purpose, all affiliates of such tenants) whose rental revenue for the three and six months ended June 30, 2020 or 2019 represented 10% or more of total rental revenue in the Company’s consolidated statements of operations.
The following table lists the states where the rental revenue from the properties in that state during the periods presented represented 10% or more of total rental revenue in the Company’s consolidated statements of operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
|
Six months ended June 30,
|
|
|
State
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Texas
|
|
12.9%
|
|
12.2%
|
|
12.6%
|
|
12.4%
|
Georgia
|
|
10.5%
|
|
11.3%
|
|
10.7%
|
|
11.2%
|
Intangible Assets and Liabilities
Intangible assets and liabilities consisted of the following as of the dates presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2020
|
|
|
|
|
|
December 31, 2019
|
|
|
|
|
(in thousands)
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net
Carrying
Amount
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net
Carrying
Amount
|
Intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
In-place leases
|
|
$
|
66,533
|
|
|
$
|
16,659
|
|
|
$
|
49,874
|
|
|
$
|
64,828
|
|
|
$
|
14,195
|
|
|
$
|
50,633
|
|
Intangible market lease assets
|
|
12,644
|
|
|
3,944
|
|
|
8,700
|
|
|
14,094
|
|
|
4,228
|
|
|
9,866
|
|
Total intangible assets
|
|
$
|
79,177
|
|
|
$
|
20,603
|
|
|
$
|
58,574
|
|
|
$
|
78,922
|
|
|
$
|
18,423
|
|
|
$
|
60,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible market lease liabilities
|
|
$
|
11,866
|
|
|
$
|
2,737
|
|
|
$
|
9,129
|
|
|
$
|
12,054
|
|
|
$
|
2,490
|
|
|
$
|
9,564
|
|
The remaining weighted average amortization periods for the Company’s intangible assets and liabilities as of June 30, 2020, by category and in total, were as follows:
|
|
|
|
|
|
|
Years Remaining
|
In-place leases
|
10.1
|
Intangible market lease assets
|
15.4
|
Total intangible assets
|
10.8
|
|
|
Intangible market lease liabilities
|
15.4
|
The following table discloses amounts recognized within the consolidated statements of operations related to amortization of in-place leases, amortization and accretion of above- and below-market lease assets and liabilities, net and the amortization and accretion of above- and below-market ground leases for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
|
Six months ended June 30,
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Amortization of in-place leases (1)
|
|
$
|
1,846
|
|
|
$
|
1,551
|
|
|
$
|
3,525
|
|
|
$
|
2,883
|
|
Amortization (accretion) of market lease intangibles, net (2)
|
|
517
|
|
|
200
|
|
|
597
|
|
|
444
|
|
Amortization (accretion) of above- and below-market ground lease intangibles, net (3)
|
|
91
|
|
|
—
|
|
|
213
|
|
|
—
|
|
_____________________________________
(1)Reflected within depreciation and amortization expense.
(2)Reflected within rental revenue.
(3)Reflected within property expenses.
The following table provides the projected amortization of in-place lease assets to depreciation and amortization expense and net amortization of above- and below-market lease intangibles to rental revenue for the next five years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
July 1 - December 31, 2020
|
|
2021
|
|
2022
|
|
2023
|
|
2024
|
In-place lease assets
|
|
$
|
1,661
|
|
|
$
|
3,197
|
|
|
$
|
3,095
|
|
|
$
|
2,987
|
|
|
$
|
2,736
|
|
Adjustment to amortization expense
|
|
$
|
1,661
|
|
|
$
|
3,197
|
|
|
$
|
3,095
|
|
|
$
|
2,987
|
|
|
$
|
2,736
|
|
|
|
|
|
|
|
|
|
|
|
|
Above-market lease assets
|
|
$
|
(402)
|
|
|
$
|
(796)
|
|
|
$
|
(795)
|
|
|
$
|
(764)
|
|
|
$
|
(731)
|
|
Below-market lease liabilities
|
|
264
|
|
|
530
|
|
|
531
|
|
|
485
|
|
|
483
|
|
Net adjustment to rental revenue
|
|
$
|
(138)
|
|
|
$
|
(266)
|
|
|
$
|
(264)
|
|
|
$
|
(279)
|
|
|
$
|
(248)
|
|
4. Credit Facilities
On April 12, 2019, the Company, through the Operating Partnership, entered into a restated credit agreement (the “Amended Credit Agreement”) with a group of lenders, amending and restating the terms of the Company’s previous $300 million revolving credit facility (the “2018 Credit Facility”) to increase the maximum aggregate initial original principal amount of revolving loans available thereunder up to $400.0 million (the “Revolving Credit Facility”) and to permit the incurrence of an additional $200.0 million in term loans thereunder (the “April 2019 Term Loan”).
The Revolving Credit Facility has a term of four years from April 12, 2019, with an extension option of up to one year exercisable by the Operating Partnership, subject to certain conditions, and the April 2019 Term Loan has a term of five years from the effective date of the amended agreement. The loans under each of the Revolving Credit Facility and the April 2019 Term Loan initially bear interest at an annual rate of applicable LIBOR plus the applicable margin (which applicable margin varies between the Revolving Credit Facility and the April 2019 Term Loan). The applicable LIBOR is the rate with a term equivalent to the interest period applicable to the relevant borrowing. The applicable margin initially is a spread set according to a leverage-based pricing grid. At the
Operating Partnership’s election, on and after receipt of an investment grade corporate credit rating from Standard & Poor’s (“S&P”) or Moody’s Investors Services, Inc. (“Moody’s”), the applicable margin will be a spread set according to the Company’s corporate credit ratings provided by S&P and/or Moody’s. The Revolving Credit Facility and the April 2019 Term Loan are freely pre-payable at any time and the Revolving Credit Facility is mandatorily payable if borrowings exceed the borrowing base or the facility limit. The Operating Partnership may re-borrow amounts paid down on the Revolving Credit Facility but not on the April 2019 Term Loan. The Operating Partnership is required to pay revolving credit fees throughout the term of the Revolving Credit Agreement based upon its usage of the Revolving Credit Facility, at a rate which depends on its usage of such facility during the period before the Company receives an investment grade corporate credit rating from S&P or Moody’s, and which rate shall be based on the corporate credit rating from S&P and/or Moody’s after the time, if applicable, the Company receives such a rating. The Operating Partnership was required to pay a ticking fee on the April 2019 Term Loan for the period from April 12, 2019 through May 14, 2019, the date the term loans were drawn. The Amended Credit Agreement has an accordion feature to increase, subject to certain conditions, the maximum availability of credit (either through increased revolving commitments or additional term loans) by up to $200 million.
Additionally, on November 22, 2019, the Company further amended the Amended Credit Agreement to update certain terms to be consistent with those as described under, and to acknowledge, where applicable, the November 2019 Term Loan (as defined below) and to make certain other changes to the Amended Credit Agreement consistent with market practice on future replacement of the LIBOR rate and qualified financial contracts.
The Operating Partnership is the borrower under the Amended Credit Agreement, and the Company and each of its subsidiaries that owns a direct or indirect interest in an eligible real property asset are guarantors under the Amended Credit Agreement.
Under the terms of the Amended Credit Agreement, the Company is subject to various restrictive financial and nonfinancial covenants which, among other things, require the Company to maintain certain leverage ratios, cash flow and debt service coverage ratios, secured borrowing ratios and a minimum level of tangible net worth.
The Amended Credit Agreement restricts the Company’s ability to pay distributions to its stockholders under certain circumstances. However, the Company may make distributions to the extent necessary to maintain its qualification as a REIT under the Internal Revenue Code of 1986, as amended. The Amended Credit Agreement contains certain additional covenants that, subject to exceptions, limit or restrict the Company’s incurrence of indebtedness and liens, disposition of assets, transactions with affiliates, mergers and fundamental changes, modification of organizational documents, changes to fiscal periods, making of investments, negative pledge clauses and lines of business and REIT qualification.
The Company was in compliance with all financial covenants and was not in default of any other provisions under the Amended Credit Facility as of June 30, 2020 and December 31, 2019.
November 2019 Term Loan
On November 26, 2019, the Company, through the Operating Partnership, entered into a new $430 million term loan credit facility (the “November 2019 Term Loan”) with a group of lenders. The November 2019 Term Loan provides for term loans to be drawn up to an aggregate amount of $430 million with a maturity of November 26, 2026. The Company had outstanding borrowings of $430.0 million at June 30, 2020 and $250.0 million at December 31, 2019 under the November 2019 Term Loan.
Borrowings under the November 2019 Term Loan bear interest at an annual rate of applicable LIBOR plus the applicable margin. The applicable LIBOR will be the rate with a term equivalent to the interest period applicable to the relevant borrowing. The applicable margin will initially be a spread set according to a leverage-based pricing grid. At the operating Partnership’s irrevocable election, on and after receipt of an investment grade corporate credit rating from S&P or Moody’s, the applicable margin will be a spread set according to the Company’s corporate credit ratings provided by S&P and/or Moody’s. The November 2019 Term Loan is pre-payable at any time by the Operating Partnership (as borrower), provided, that if the loans under the November 2019 Term Loan are repaid on or before November 26, 2020,they are subject to a two percent prepayment premium, and if repaid thereafter but on or before November 26, 2021, they are subject to a one percent prepayment premium. After November 26, 2021 the loans may be repaid without penalty. The Operating Partnership may not re-borrow amounts paid down on the November 2019 Term Loan. The Operating Partnership was required to pay a ticking fee on any undrawn portion of
the November 2019 Term Loan for the period from November 26, 2019 through March 26, 2020, the date that the November 2019 Term Loan Was fully drawn.The November 2019 Term Loan has an accordion feature to increase, subject to certain conditions, the maximum availability of the facility up to an aggregate of $500 million.
The Operating Partnership is the borrower under the November 2019 Term Loan, and the Company and each of its subsidiaries that owns a direct or indirect interest in an eligible real property asset are guarantors under the facility. Under the terms of the November 2019 Term Loan, the Company is subject to various restrictive financial and nonfinancial covenants which, among other things, require the Company to maintain certain leverage ratios, cash flow and debt service coverage ratios, secured borrowing ratios and a minimum level of tangible net worth.
Additionally, the November 2019 Term Loan restricts the Company’s ability to pay distributions to its stockholders under certain circumstances. However, the Company may make distributions to the extent necessary to maintain its qualification as a REIT under the Internal Revenue Code of 1986, as amended. The facility contains certain covenants that, subject to exceptions, limit or restrict the Company’s incurrence of indebtedness and liens, disposition of assets, transactions with affiliates, mergers and fundamental changes, modification of organizational documents, changes to fiscal periods, making of investments, negative pledge clauses and lines of business and REIT qualification.
The Company was in compliance with all financial covenants and was not in default of any other provisions under the November 2019 Term Loan as of June 30, 2020 and December 31, 2019.
Revolving Credit Facility
The following table presents information about the Revolving Credit Facility and the 2018 Credit Facility in effect for the six months ended June 30, 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
Balance on January 1,
|
|
$
|
46,000
|
|
|
$
|
34,000
|
|
Borrowings
|
|
69,000
|
|
|
119,000
|
|
Repayments
|
|
(115,000)
|
|
|
(86,000)
|
|
Balance on June 30,
|
|
$
|
—
|
|
|
$
|
67,000
|
|
Total deferred financing costs, net, of $3.1 million and $3.5 million related to the Revolving Credit Facility were included within rent receivables, prepaid expenses and other assets, net on the Company’s consolidated balance sheets as of June 30, 2020 and December 31, 2019, respectively. The Company recorded $0.3 million to interest expense during the three months ended June 30, 2020 and 2019 related to amortization of these deferred financing costs. The Company recorded $0.6 million and $0.5 million to interest expense during the six months ended June 30, 2020 and 2019, respectively, related to amortization of these deferred financing costs.
Additionally, the Company recorded $0.5 million and $0.3 million of interest expense on borrowings and unused facility fees during the three months ended June 30, 2020 and 2019, respectively, related to the Revolving Credit Facility and the 2018 Credit Facility. The Company recorded $0.9 million and $1.0 million of interest expense on borrowings and unused facility fees during the six months ended June 30, 2020 and 2019, respectively, related to the Revolving Credit Facility and the 2018 Credit Facility. The weighted average interest rate in effect on the Company’s borrowings under the Revolving Credit Facility as of December 31, 2019 was 3.06%.
As of June 30, 2020 and December 31, 2019, the Company had $400.0 million and $354.0 million of unused borrowing capacity related to the Revolving Credit Facility.
Term Loan Facilities
In May 2019, the Company borrowed the entire $200.0 million available under the April 2019 Term Loan and used the proceeds to repurchase, in part, notes previously issued under its Master Trust Funding Program. The Company borrowed the entire $430.0 million available under the November 2019 Term Loan in separate draws in December 2019 and March 2020 and used the proceeds to voluntarily prepay notes previously issued under its Master Trust Funding Program at par, to repay amounts outstanding under the Revolving Credit Facility and for general working capital purposes. See Note 6—Secured Borrowings for additional information.
Total deferred financing costs, net, of $4.1 million and $4.4 million as of June 30, 2020 and December 31, 2019, related to the Company’s term loan facilities are included as a component of unsecured term loans, net of deferred financing costs on the Company’s consolidated balance sheet as of June 30, 2020. The Company recorded $0.2 million and approximately $41,000 to interest expense during the three months ended June 30, 2020 and 2019 related to the amortization of these fees and direct costs of its term loan facilities. The Company recorded $0.4 million and approximately $41,000 to interest expense during the six months ended June 30, 2020 and 2019 related to the amortization of these fees and direct costs of its term loan facilities.
During the three months ended June 30, 2020, and 2019, the Company recorded $3.1 million of interest expense, including delayed draw ticking fees, related to its term loan facilities. During the six months ended June 30, 2020 and 2019, the Company recorded $6.5 million and $1.0 million of interest expense, respectively, including delayed draw ticking fees, related to its term loan facilities. The variable interest rates in effect on the Company’s borrowings under the April 2019 Term Loan and November 2019 Term Loan as of June 30, 2020 were 1.43% and 1.68%, respectively. The variable interest rates in effect on the Company’s borrowings under the April 2019 Term Loan and November 2019 Term Loan as of December 31, 2019 were 3.00% and 3.22%, The Company fixed the interest rates on its term loan facilities’ variable-rate debt through the use of interest rate swap agreements. See Note 5—Derivative and Hedging Activities for additional information.
5. Derivative and Hedging Activities
The Company does not enter into derivative financial instruments for speculative or trading purposes. 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 uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges 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.
These derivatives are designated and qualify as cash flow hedges and are recorded on a gross basis at fair value. Subsequent to the adoption of ASU 2017-12, assessments of hedge effectiveness are performed quarterly using either a qualitative or quantitative approach. The Company recognizes the entire change in the fair value in accumulated other comprehensive income (loss) and the change in fair value is reflected as unrealized gain/loss on cash flow hedges in the supplemental disclosures of non-cash financing activities in the consolidated statement of cash flows. The amounts recorded in accumulated other comprehensive income (loss) will subsequently be reclassified to interest expense as interest payments are made on the Company’s borrowings under its variable-rate term loan facilities. During the next twelve months, the Company estimates that $9.7 million will be reclassified from other comprehensive income as an increase to interest expense. The Company does not have netting arrangements related to its derivatives.
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. As of June 30, 2020, there were no events of default related to the interest rate swaps.
The following table summarizes the notional amount at inception and fair value of these instruments on the Company's balance sheet as of June 30, 2020 and December 31, 2019 (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives Designated as Hedging Instruments
|
|
Fixed Rate Paid by Company
|
|
Variable Rate Paid by Bank
|
|
Effective Date
|
|
Maturity Date
|
|
Notional Value (1)
|
|
Fair Value of Asset/(Liability) as of June 30, 2020 (2)
|
|
Fair Value of Asset/(Liability) as of December 31,
2019 (2)
|
Interest Rate Swap
|
|
2.06%
|
|
1 month LIBOR
|
|
2019-05-14
|
|
2024-04-12
|
|
$
|
100,000
|
|
|
$
|
(7,177)
|
|
|
$
|
(1,996)
|
|
Interest Rate Swap
|
|
2.06%
|
|
1 month LIBOR
|
|
2019-05-14
|
|
2024-04-12
|
|
50,000
|
|
|
(3,589)
|
|
|
(999)
|
|
Interest Rate Swap
|
|
2.07%
|
|
1 month LIBOR
|
|
2019-05-14
|
|
2024-04-12
|
|
50,000
|
|
|
(3,595)
|
|
|
(1,005)
|
|
Interest Rate Swap (3)
|
|
1.61%
|
|
1 month LIBOR
|
|
2019-12-09
|
|
2026-11-26
|
|
175,000
|
|
|
(14,001)
|
|
|
758
|
|
Interest Rate Swap (3)
|
|
1.61%
|
|
1 month LIBOR
|
|
2019-12-09
|
|
2026-11-26
|
|
50,000
|
|
|
(4,014)
|
|
|
210
|
|
Interest Rate Swap (3)
|
|
1.60%
|
|
1 month LIBOR
|
|
2019-12-09
|
|
2026-11-26
|
|
25,000
|
|
|
(1,982)
|
|
|
127
|
|
Interest Rate Swap (4)
|
|
1.36%
|
|
1 month LIBOR
|
|
2020-07-09
|
|
2026-11-26
|
|
100,000
|
|
|
(6,446)
|
|
|
—
|
|
Interest Rate Swap (4)
|
|
1.36%
|
|
1 month LIBOR
|
|
2020-07-09
|
|
2026-11-26
|
|
80,000
|
|
|
(5,167)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
$
|
630,000
|
|
|
$
|
(45,971)
|
|
|
$
|
(2,905)
|
|
_____________________________________
(1)Notional value indicates the extent of the Company’s involvement in these instruments, but does not represent exposure to credit, interest rate or market risks.
(2)Derivatives in a liability position are included within accrued liabilities, derivatives and other payables in the Company’s consolidated balance sheets totaling to $46.0 million and $4.0 million at June 30, 2020 and December 31, 2019, respectively.
(3)Derivatives in a net asset position are included within rent receivables, prepaid expenses and other assets in the Company’s consolidated balance sheets totaling to $1.1 million at December 31, 2019.
(4)The Company entered into two forward swap contracts during the six months ended June 30, 2020 with an effective date of July 9, 2020 and total notional value of $180.0 million.
The Company has agreements with each of its derivative counterparties that contain a provision where if the Company either defaults or is capable of being declared in default on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.
During the three months ended June 30, 2020 and June 30, 2019, the Company recorded $5.0 million and $3.9 million of accumulated other comprehensive loss. During the six months ended June 30, 2020 and June 30, 2019, the Company recorded $43.1 million and $3.9 million of accumulated other comprehensive loss.
As of June 30, 2020, the fair value of derivatives in a net liability position including accrued interest but excluding any adjustment for nonperformance risk related to these agreements was $47.3 million. As of December 31, 2019, the fair value of derivatives in a net liability position including accrued interest but excluding any adjustment for nonperformance risk related to these agreements was $4.1 million. As of June 30, 2020, there were no derivatives in a net asset position. As of December 31, 2019, the fair value of derivatives in a net asset position including accrued interest but excluding any adjustment for nonperformance risk related to these agreements was $1.0 million.
As of June 30, 2020 and December 31, 2019, the Company had not posted any collateral related to these agreements and was not in breach of any provisions of such 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 $47.7 million and $3.1 million as of June 30, 2020 and December 31, 2019, respectively.
6. Secured Borrowings
In the normal course of business, the Company transfers financial assets in various transactions with Special Purpose Entities (“SPE”) determined to be VIEs, which primarily consist of securitization trusts established for a limited purpose (the “Master Trust Funding Program”). These SPEs are formed for the purpose of securitization transactions in which the Company transfers assets to an SPE, which then issues to investors various forms of debt obligations supported by those assets. In these securitization transactions, the Company typically receives cash from the SPE as proceeds for the transferred assets and retains the rights and obligations to service the transferred assets in accordance with servicing guidelines. All debt obligations issued from the SPEs are non-recourse to the Company.
In accordance with the accounting guidance for asset transfers, the Company considers any ongoing involvement with transferred assets in determining whether the assets can be derecognized from the balance sheets. For transactions that do not meet the requirements for derecognition and remain on the consolidated balance sheets, the transferred assets may not be pledged or exchanged by the Company.
The Company evaluates its interest in certain entities to determine if these entities meet the definition of a VIE and whether the Company is the primary beneficiary and, therefore, should consolidate the entity based on the variable interests it held both at inception and when there was a change in circumstances that required a reconsideration. The Company has determined that the SPEs created in connection with its Master Trust Funding Program should be consolidated as the Company is the primary beneficiary of each of these entities.
In December 2016, the Company issued its first series of notes under the Master Trust Funding Program, consisting of $263.5 million of Class A Notes and $17.3 million of Class B Notes (together, the “Series 2016-1 Notes”). These notes were issued to an affiliate of Eldridge Industries, LLC (“Eldridge”) through underwriting agents. The Series 2016-1 Notes were issued by two SPEs formed to hold assets and issue the secured borrowings associated with the securitization.
In July 2017, the Company issued its second series of notes under the Master Trust Funding Program, consisting of $232.4 million of Class A Notes and $15.7 million of Class B Notes (together, the “Series 2017-1 Notes”). The Series 2017-1 Notes were issued by three SPEs formed to hold assets and issue the secured borrowings associated with the securitization.
Tenant rentals received on assets transferred to SPEs under the Master Trust Funding Program are sent to the trustee and used to pay monthly principal and interest payments.
The Series 2016-1 Notes were scheduled to mature in November 2046, but the terms of the Class A Notes required principal to be paid monthly through November 2021, with a balloon repayment at that time, and the terms of the Class B Notes required no monthly principal payments but required the full principal balance to be paid in November 2021.
The Series 2017-1 Notes mature in June 2047 and have a weighted average interest rate of 4.19% as of June 30, 2020. However, the anticipated repayment date for the Series 2017-1 Notes is June 2024, and if the notes are not repaid in full on or before such anticipated repayment date, additional interest will begin to accrue on the notes
The Series 2017-1 Notes may be voluntarily prepaid, in whole or in part, at any time on or after the date that is 31 months prior to the anticipated repayment date in June 2024 without the payment of a make whole amount. Voluntary prepayments may be made before 31 months prior to the anticipated repayment date.
In May 2019, the Company repurchased a portion of its Class A Series 2016-1 Notes with a face value of $200 million for $201.4 million from an affiliate of Eldridge. On November 12, 2019, the Company cancelled all $200 million of these repurchased Class A Series 2016-1 Notes.
In November 2019, the Company voluntarily prepaid all $70.4 million of the then outstanding Series 2016-1 Notes (consisting of the remaining $53.2 million Class A Series 2016-1 Notes and $17.2 million Class B Series 2016-1 Notes) at par plus accrued interest pursuant to the terms of the agreements related to such securities.
In February 2020, the Company voluntarily prepaid $62.3 million of the Class A Series 2017-1 Notes at par plus accrued interest pursuant to the terms of the agreements related to such securities. The Company was not subject to the payment of a make whole amount in connection with this prepayment. The Company accounted for this prepayment as a debt extinguishment.
As of June 30, 2020 and December 31, 2019, the Company had notes with $175.2 million and $239.1 million, respectively, of combined principal outstanding through its Master Trust Funding Program.
Total deferred financing costs, net, of $2.5 million and $3.8 million related to the Master Trust Funding Program were included within secured borrowings, net of deferred financing costs on the Company’s consolidated balance sheets as of June 30, 2020 and December 31, 2019, respectively. The Company recorded $0.2 million and $0.4 million to interest expense during the three months ended June 30, 2020 and 2019, respectively, related to amortization of these deferred financing costs. The Company recorded $0.3 million and $1.0 million to interest expense during the six months ended June 30, 2020 and 2019, respectively, related to amortization of these deferred financing costs.
In addition, the Company recorded an additional $0.9 million of loss on repayment of secured borrowings related to the amortization of deferred financing costs on the $62.3 million voluntary prepayment of the Class A Series 2017-1 Notes during the six months ended June 30, 2020. During the three and six months ended June 30, 2019, other than scheduled amortizing principal payments, the Company recorded a $4.3 million loss on the repurchase of a portion of the Class A Series 2016-1 Notes, which includes the write-off of unamortized deferred financing charges.
During the three months ended June 30, 2020 and 2019, the Company recorded $1.8 million and $5.5 million, respectively, of interest expense on borrowings under the Master Trust Funding Program. During the six months ended June 30, 2020 and 2019, the Company recorded $3.9 million and $11.3 million, respectively, of interest expense on borrowings under the Master Trust Funding Program. The Company’s secured borrowings issued under the Master Trust Funding Program bear interest at weighted average interest rates of 4.19% and 4.17% as of June 30, 2020 and December 31, 2019, respectively.
The following table summarizes the scheduled principal payments on the Company’s secured borrowings under the Master Trust Funding Program as of June 30, 2020:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Future
Principal
Payments
|
July 1 - December 31, 2020
|
|
$
|
1,967
|
|
2021
|
|
4,083
|
|
2022
|
|
4,292
|
|
2023
|
|
4,512
|
|
2024
|
|
160,305
|
|
Total
|
|
$
|
175,159
|
|
The Company was not in default of any provisions under the Master Trust Funding Program as of June 30, 2020 or December 31, 2019.
7. Equity
Stockholders’ Equity
On March 18, 2019, the Company completed a follow-on offering of 14,030,000 shares of its common stock, including 1,830,000 shares of common stock purchased by the underwriters pursuant to an option to purchase additional shares, at an offering price of $17.50 per share, pursuant to a registration statement on Form S-11 (File Nos. 333-230188 and 333-230252) filed with the SEC under the Securities Act of 1933, as amended (the “Securities Act”). Net proceeds from this follow-on offering, after deducting underwriting discounts and commissions and other expenses, were $234.6 million.
On July 22, 2019, EPRT Holdings, LLC (“EPRT Holdings”) and Security Benefit Life Insurance Company (together, the “Selling Stockholders”), affiliates of Eldridge Industries, LLC (“Eldridge”), completed a secondary public offering (the “Secondary Offering”) of 26,288,316 shares of the Company’s common stock, including 3,428,910 shares of common stock purchased by underwriters pursuant to an option to purchase additional shares. Prior to completion of the Secondary Offering, the Selling Stockholders exchanged 18,502,705 OP Units of the Operating Partnership for a like number of shares of the Company’s common stock. The Company did not receive any proceeds from this transaction.
On January 14, 2020, the Company completed a follow-on offering of 7,935,000 shares its common stock, including 1,035,000 shares of common stock purchased by the underwriters pursuant to an option to purchase additional shares, at an offering price of $25.20 per share. Net proceeds from this follow-on offering, after deducting underwriting discounts and commissions and other expenses, were $191.5 million.
At the Market Program
In June 2020, the Company established a new at the market common equity offering program, pursuant to which it can publicly offer and sell, from time to time, shares of its common stock with an aggregate gross sales price of up to $250 million (the “2020 ATM Program”). In connection with establishing the 2020 ATM Program, the Company terminated its prior at the market program, which it established in August 2019 (the “2019 ATM Program”). Pursuant to the 2019 ATM Program, the Company could publicly offer and sell shares of its common stock with an aggregate gross sales price of up to $200 million and, prior to its termination, the Company issued common stock with an aggregate gross sales price of $184.4 million thereunder. As of June 30, 2020, the Company issued common stock with an aggregate gross sales price of $17.3 million under the 2020 ATM Program and could issue additional common stock with an aggregate gross sales price of up to $232.7 million under the 2020 ATM Program. The 2019 ATM Program has been terminated, and no additional stock can be issued thereunder. As the context requires, the 2020 ATM Program and the 2019 ATM Program are referred to herein as the “ATM Program.”
During the three months ended June 30, 2020, the Company sold 1,027,857 shares of its common stock under the ATM Program, at a weighted average price per share of $16.86, raising $17.3 million in gross proceeds. During the six months ended June 30, 2020, the Company sold 1,281,555 shares of its common stock under the ATM Program, at a weighted average price per share of $18.42, raising $23.6 million in gross proceeds. Net proceeds from selling shares under the ATM Program during the three and six months ended June 30, 2020, after deducting sales agent fees and other expenses associated with establishing and maintaining the ATM Programs, were $16.6 million and $22.7 million.
Dividends on Common Stock
During the six months ended June 30, 2020 and 2019, the Company’s board of directors declared the following quarterly cash dividends on common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date Declared
|
|
Record Date
|
|
Date Paid
|
|
Dividend per Share of Common Stock
|
|
Total Dividend
|
June 11, 2020
|
|
June 30, 2020
|
|
July 15, 2020
|
|
$
|
0.23
|
|
|
$
|
21,419
|
|
March 18, 2020
|
|
March 31, 2020
|
|
April 15, 2020
|
|
0.23
|
|
|
21,168
|
|
June 7, 2019
|
|
June 28, 2019
|
|
July 15, 2019
|
|
0.22
|
|
|
12,725
|
|
March 7, 2019
|
|
March 29, 2019
|
|
April 16, 2019
|
|
0.21
|
|
|
12,143
|
|
8. Non-controlling Interests
Essential Properties OP G.P., LLC, a wholly owned subsidiary of the Company, is the sole general partner of the Operating Partnership, and holds a 1.0% general partner interest in the Operating Partnership. The Company contributes the net proceeds from issuing shares of common stock to the Operating Partnership in exchange for a number of OP Units equal to the number of shares of common stock issued.
Prior to completion of the Secondary Offering, the Selling Stockholders exchanged 18,502,705 OP Units of the Operating Partnership for a like number of shares of the Company’s common stock. Concurrently, EPRT Holdings, one of the Selling Stockholders, distributed the remaining 553,847 OP Units it held to former members of EPRT Holdings (the “Non-controlling OP Unit Holders”). The Selling Stockholders thereafter sold all of the shares of
common stock that they owned through the Secondary Offering and accordingly no longer owned shares of the Company’s common stock or held OP Units following the completion of the Secondary Offering.
As of June 30, 2020, the Company held 93,024,022 OP Units, representing a 99.4% interest in the Operating Partnership. As of the same date, the Non-controlling OP Unit Holders held 553,847 OP Units in the aggregate, representing a 0.6% limited partner interest in the Operating Partnership. The OP Units held by EPRT Holdings and Eldridge prior to the completion of the Secondary Offering and the OP Units held by the Non-controlling OP Unit Holders are presented as non-controlling interests in the Company’s consolidated financial statements.
A holder of OP Units has the right to distributions per unit equal to dividends per share paid on the Company’s common stock and has the right to redeem OP Units for cash or, at the Company’s election, shares of the Company's common stock on a one-for-one basis, provided, however, that such OP Units must have been outstanding for at least one year. During the three and six months ended June 30, 2020, the Company declared total cash dividends of $0.23 and $0.46 per share of common stock, respectively. During the three and six months ended June 30, 2019, the Company declared total cash dividends of $0.21 and $0.43 per share of common stock. Distributions to OP Unit holders were declared and paid concurrently with the Company’s cash dividends to common stockholders.
9. Equity Based Compensation
Equity Incentive Plan
In 2018, the Company adopted an equity incentive plan (the “Equity Incentive Plan”), which provides for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, other stock awards, performance awards and LTIP units. Officers, employees, non-employee directors, consultants, independent contractors and agents who provide services to the Company or to any subsidiary of the Company are eligible to receive such awards. A maximum of 3,550,000 shares may be issued under the Equity Incentive Plan, subject to certain conditions.
Restricted Stock Awards
In January 2019, an aggregate of 46,368 shares of unvested restricted common stock awards (“RSAs”) were issued to the Company’s executive officers, other employees and an external consultant under the Equity Incentive Plan. These RSAs vest over periods ranging from one year to four years from the date of grant, subject to the individual recipient’s continued provision of service to the Company through the applicable vesting dates. In June 2020, an additional 3,658 RSAs were issued to certain members of the Company's board of directors which vested immediately upon grant. The Company estimates the grant date fair value of the unvested RSAs granted under the Equity Incentive Plan using the average market price of the Company’s common stock on the date of grant.
The following table presents information about the Company’s RSAs for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
|
Six months ended June 30,
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Compensation cost recognized in general and administrative expense
|
|
$
|
993
|
|
|
$
|
873
|
|
|
$
|
1,887
|
|
|
$
|
1,745
|
|
Dividends declared on unvested RSAs and charged directly to distributions in excess of cumulative earnings
|
|
55
|
|
|
109
|
|
|
166
|
|
|
264
|
|
Fair value of shares vested during the period
|
|
3,360
|
|
|
3,293
|
|
|
3,512
|
|
|
3,293
|
|
The following table presents information about the Company’s RSAs as of the dates presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
June 30,
2020
|
|
December 31,
2019
|
Total unrecognized compensation cost
|
|
$
|
3,197
|
|
|
$
|
5,026
|
|
Weighted average period over which compensation cost will be recognized (in years)
|
|
1.1
|
|
1.6
|
Restricted Stock Units
In January 2019 and 2020, the Company issued target grants of 119,085 and 84,684 performance-based restricted stock units (“RSUs”), respectively, to the Company’s executive officers under the Equity Incentive Plan. Of these awards, 75% are non-vested RSUs for which vesting percentages and the ultimate number of units vesting will be calculated based on the total shareholder return (“TSR”) of the Company's common stock as compared to the TSR of peer companies identified in the grant agreements. The payout schedule can produce vesting percentages ranging from 0% to 250%. TSR will be calculated based upon the average closing price for the 20-trading day period ending December 31, 2021 (for the 2019 grants) or December 31, 2022 (for the 2020 grants), divided by the average closing price for the 20-trading day period ended January 1, 2019 (for the 2019 grants) or January 1, 2020 (for the 2020 grants). The target number of units is based on achieving a TSR equal to the 50th percentile of the peer group. The Company recorded expense on these TSR RSUs based on achieving the target.
The grant date fair value of the TSR RSUs was measured using a Monte Carlo simulation model based on the following assumptions as of each grant date:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
|
|
|
|
|
2020
|
|
2019
|
Volatility
|
|
20
|
%
|
|
18
|
%
|
Risk free rate
|
|
1.61
|
%
|
|
2.57
|
%
|
The remaining 25% of the performance-based RSUs issued in January 2019 and 2020 vest based on a subjective evaluation by the Compensation Committee of the Company’s board of directors of the individual recipient’s achievement of certain strategic objectives. In May 2020, the Compensation Committee evaluated and subjectively awarded 7,596 of these RSUs to a former executive officer of the Company, which vested immediately. During the three and six months ended June 30, 2020, the Company recorded $0.1 million of compensation expense related to the subjective RSUs awarded to a former executive. As of June 30, 2020, the Compensation Committee had not identified specific performance targets relating to the individual recipients’ achievement of strategic objectives for the remainder of the subjective awards. As such, the remainder of these awards do not have either a service inception or a grant date for GAAP accounting purposes and the Company recorded no compensation cost with respect to this portion of the performance-based RSUs during the three and six months ended June 30, 2020 and 2019.
In June 2019, the Company issued 11,500 RSUs to the Company’s independent directors. These awards vest in full on the earlier of one year from the grant date or the first annual meeting of stockholders that occurs after the grant date, subject to the individual recipient’s continued provision of service to the Company through the applicable vesting date. The Company estimated the grant date fair value of these RSUs using the average market price of the Company’s common stock on the date of grant.
Additionally, in January 2020, the Company issued an aggregate of 71,607 shares of unvested RSUs to the Company’s executive officers and other employees under the Equity Incentive Plan. These awards vest over a period of four years from the date of grant, subject to the individual recipient’s continued provision of service to the Company through the applicable vesting dates.
The following table presents information about the Company’s RSUs for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
|
Six months ended June 30,
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Compensation cost recognized in general and administrative expense
|
|
$
|
840
|
|
|
$
|
155
|
|
|
$
|
1,454
|
|
|
$
|
290
|
|
Dividend equivalents declared and charged directly to distributions in excess of cumulative earnings
|
|
23
|
|
|
2
|
|
|
42
|
|
|
2
|
|
Fair value of units vested during the period
|
|
896
|
|
|
—
|
|
|
896
|
|
|
—
|
|
The following table presents information about the Company’s RSUs as of the dates presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
June 30,
2020
|
|
December 31,
2019
|
Total unrecognized compensation cost
|
|
$
|
5,001
|
|
|
$
|
1,584
|
|
Weighted average period over which compensation cost will be recognized (in years)
|
|
2.8
|
|
2.4
|
The following table presents information about the Company’s RSA and RSU activity during the six months ended June 30, 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Awards
|
|
|
|
Restricted Stock Units
|
|
|
|
|
Shares
|
|
Weighted Average Grant Date Fair Value
|
|
Units
|
|
Weighted Average Grant Date Fair Value
|
Unvested, January 1, 2019
|
|
691,290
|
|
|
$
|
13.68
|
|
|
—
|
|
|
$
|
—
|
|
Granted
|
|
46,368
|
|
|
14.12
|
|
|
100,814
|
|
|
22.80
|
|
Vested
|
|
(240,753)
|
|
|
13.68
|
|
|
—
|
|
|
—
|
|
Forfeited
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Unvested, June 30, 2019
|
|
496,905
|
|
|
$
|
13.72
|
|
|
100,814
|
|
|
$
|
22.80
|
|
|
|
|
|
|
|
|
|
|
Unvested, January 1, 2020
|
|
492,701
|
|
|
$
|
13.72
|
|
|
100,814
|
|
|
$
|
22.80
|
|
Granted
|
|
3,658
|
|
|
15.68
|
|
|
182,681
|
|
|
28.32
|
|
Vested
|
|
(255,761)
|
|
|
13.73
|
|
|
(42,658)
|
|
|
21.00
|
|
Forfeited
|
|
—
|
|
|
—
|
|
|
(5,571)
|
|
|
—
|
|
Unvested, June 30, 2020
|
|
240,598
|
|
|
$
|
13.74
|
|
|
235,266
|
|
|
$
|
27.95
|
|
Unit Based Compensation
Prior to the Company’s IPO in 2018, certain of the Company’s management, board of directors and other external parties held Class B and Class D units in EPRT Holdings which had been granted as equity awards in prior periods. Following the completion of the IPO and related formation transactions, the Class B and Class D unitholders continued to hold vested and unvested interests in EPRT Holdings and, indirectly, the OP Units of the Company’s Operating Partnership held by EPRT Holdings.
On July 22, 2019, in conjunction with the completion of the Secondary Offering, 3,520 previously unvested Class B units and 1,200 previously unvested Class D units in EPRT Holdings automatically vested in accordance with the terms of the grant agreements, which represented all of the remaining outstanding unvested Class B and Class D units. Due to this accelerated vesting, the Company recorded all remaining unrecognized compensation cost on the Class B and Class D units to general and administrative expenses in its consolidated statements of operations at the time of vesting. No Class B or Class D units remained outstanding as of June 30, 2020 and December 31, 2019.
The following table presents information about the Class B and Class D unit activity during the six months ended June 30, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class B Units
|
|
Class D Units
|
|
Total
|
Unvested, January 1, 2019
|
|
5,230
|
|
|
1,800
|
|
|
7,030
|
|
Granted
|
|
—
|
|
|
—
|
|
|
—
|
|
Vested
|
|
(1,710)
|
|
|
(600)
|
|
|
(2,310)
|
|
Forfeited
|
|
—
|
|
|
—
|
|
|
—
|
|
Unvested, June 30, 2019
|
|
3,520
|
|
|
1,200
|
|
|
4,720
|
|
The following table presents information about the Class B and Class D units for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three months ended June 30, 2019
|
|
Six months ended June 30, 2019
|
Compensation cost recognized in general and administrative expense
|
|
$
|
219
|
|
|
$
|
438
|
|
Fair value of units vested during the period
|
|
128
|
|
718
|
10. Leases
As Lessor
The Company’s investment properties are leased to tenants under long-term operating leases that typically include one or more renewal options. The Company’s leases provide for annual base rental payments (generally payable in monthly installments), and generally provide for increases in rent based on fixed contractual terms or as a result of increases in the Consumer Price Index. Substantially all of the leases are triple-net, which means that they provide that the lessees are responsible for the payment of all property operating expenses, including maintenance, insurance, utilities, property taxes and, if applicable, ground rent expense; therefore, the Company is generally not responsible for repairs or other capital expenditures related to the properties while the triple-net leases are in effect and, at the end of the lease term, the lessees are responsible for returning the property to the Company in a substantially similar condition as when they took possession. Some of the Company’s leases provide that in the event the Company wishes to sell the property subject to that lease, it first must offer the lessee the right to purchase the property on the same terms and conditions as any offer which it intends to accept for the sale of the property.
Scheduled future minimum base rental payments due to be received under the remaining non-cancelable term of the operating leases in place as of June 30, 2020 were as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Future Minimum Base Rental Receipts
|
July 1 - December 31, 2020
|
|
$
|
77,296
|
|
2021
|
|
157,464
|
|
2022
|
|
159,630
|
|
2023
|
|
161,776
|
|
2024
|
|
162,556
|
|
Thereafter
|
|
1,864,027
|
|
Total
|
|
$
|
2,582,749
|
|
Since lease renewal periods are exercisable at the option of the lessee, the preceding table presents future minimum base rental payments to be received during the initial non-cancelable lease term only. In addition, the future minimum lease payments exclude contingent rent payments, as applicable, that may be collected from certain tenants based on provisions related to performance thresholds and exclude increases in annual rent based on future changes in the Consumer Price Index, among other items.
The fixed and variable components of lease revenues for the three and six months ended June 30, 2020 and 2019 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
|
Six months ended June 30,
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Fixed lease revenues
|
|
$
|
41,828
|
|
|
$
|
31,968
|
|
|
$
|
82,231
|
|
|
$
|
61,929
|
|
Variable lease revenues (1)
|
|
402
|
|
|
423
|
|
|
768
|
|
|
1,516
|
|
Total lease revenues (2)
|
|
$
|
42,230
|
|
|
$
|
32,391
|
|
|
$
|
82,999
|
|
|
$
|
63,445
|
|
_____________________________________
(1)Includes contingent rent based on a percentage of the tenant’s gross sales and costs paid by the Company for which it is reimbursed by its tenants.
(2)Excludes the amortization and accretion of above- and below-market lease intangible assets and liabilities and lease incentives and the adjustment to rental revenue for tenant credit.
During the three months ended June 30, 2020, the Company entered into deferral agreements with its tenants with respect to $9.8 million of contractual base rent for the period. These rent deferrals were negotiated on a tenant-by-tenant basis, and, in general, allow a tenant to defer all or a portion of its April, May and June rent, with all of the deferred rent to be paid to the Company pursuant to a schedule that generally extends up to 24 months from the original due date of the deferred rent. It is possible that the existing deterioration, or further deterioration, in
the Company's tenants’ ability to operate their businesses, or delays in the supply of products or services to the Company's tenants from vendors that they need to operate their businesses, caused by the COVID-19 pandemic or otherwise, will cause the Company's tenants to be unable or unwilling to meet their contractual obligations to us, including the payment of rent (including deferred rent) or to request further rent deferrals or other concessions. The likelihood of this would increase if the COVID-19 pandemic intensifies or persists for a prolonged period, or if the recession in the United States continues for a prolonged period or if there is an economic slowdown that reduces consumer confidence and economic activity. To the extent the pandemic causes a secular change in consumer behavior that reduces patronage of service-based and/or experience-based businesses, many of the Company's tenants would be adversely affected and their ability to meet their obligations to us could be further impaired. These deferrals reduce the Company's cash flow from operations, reduce its cash available for distribution and adversely affect its ability to make cash distributions to common stockholders. Furthermore, if tenants are unable to pay their deferred rent, the Company will not receive cash in the future in accordance with its expectations.
As Lessee
The Company has a number of ground leases, an office lease and other equipment leases which are classified as operating leases. On January 1, 2019, the Company recorded $4.8 million of right of use (“ROU”) assets and lease liabilities related to these operating leases. The Company’s ROU assets were reduced by $0.1 million of accrued rent expense reclassified from accrued liabilities, derivatives and other payables and $1.2 million of acquired above-market lease liabilities, net, reclassified from intangible lease liabilities, net and increased by $0.1 million of acquired below-market lease assets, net, reclassified from intangible lease assets, net of accumulated depreciation and amortization and $0.2 million of prepaid lease payments. As of June 30, 2020, the Company’s ROU assets and lease liabilities were $4.5 million and $7.1 million, respectively. As of December 31, 2019, the Company’s ROU assets and lease liabilities were $4.8 million and $7.5 million, respectively.
The discount rate applied to measure each ROU asset and lease liability is based on the Company’s incremental borrowing rate ("IBR"). The Company considers the general economic environment and its historical borrowing activity and factors in various financing and asset specific adjustments to ensure the IBR is appropriate to the intended use of the underlying lease. As the Company did not elect to apply hindsight, lease term assumptions determined under ASC 840 were carried forward and applied in calculating the lease liabilities recorded under ASC 842. Certain of the Company’s ground leases offer renewal options which it assesses against relevant economic factors to determine whether it is reasonably certain of exercising or not exercising the option. Lease payments associated with renewal periods that the Company is reasonably certain will be exercised, if any, are included in the measurement of the corresponding lease liability and ROU asset.
The following table sets forth information related to the measurement of the Company’s lease liabilities as of June 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2020
|
|
December 31, 2019
|
Weighted average remaining lease term (in years)
|
|
22.7
|
|
21.9
|
Weighted average discount rate
|
|
7.00%
|
|
7.00%
|
Upon adoption of ASC 842 on January 1, 2019 (see Note 2—Summary of Significant Accounting Policies), ground lease rents are no longer presented on a net basis and instead are reflected on a gross basis in the Company’s consolidated statements of operations for the three and six months ended June 30, 2020 and 2019.
The following table sets forth the details of rent expense for the three and six months ended June 30, 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
|
Six months ended June 30
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Fixed rent expense
|
|
$
|
337
|
|
|
$
|
358
|
|
|
$
|
719
|
|
|
$
|
721
|
|
Variable rent expense
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total rent expense
|
|
$
|
337
|
|
|
$
|
358
|
|
|
$
|
719
|
|
|
$
|
721
|
|
As of June 30, 2020, under ASC 842, future lease payments due from the Company under the ground, office and equipment operating leases where the Company is directly responsible for payment and the future lease
payments due under the ground operating leases where the Company’s tenants are directly responsible for payment over the next five years and thereafter were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Office and
Ground Leases
to be Paid by
the Company
|
|
Ground Leases
to be Paid
Directly by the
Company’s
Tenants
|
|
Total Future
Minimum
Base Rental
Payments
|
July 1 - December 31, 2020
|
|
$
|
330
|
|
|
$
|
323
|
|
|
$
|
653
|
|
2021
|
|
662
|
|
|
650
|
|
|
1,312
|
|
2022
|
|
669
|
|
|
652
|
|
|
1,321
|
|
2023
|
|
656
|
|
|
318
|
|
|
974
|
|
2024
|
|
556
|
|
|
265
|
|
|
821
|
|
Thereafter
|
|
538
|
|
|
12,167
|
|
|
12,705
|
|
Total
|
|
$
|
3,411
|
|
|
$
|
14,375
|
|
|
$
|
17,786
|
|
Present value discount
|
|
|
|
|
|
(10,715)
|
|
Lease liabilities
|
|
|
|
|
|
$
|
7,071
|
|
The Company has adopted the short-term lease policy election and accordingly, the table above excludes future minimum base cash rental payments by the Company or its tenants on leases that have a term of less than 12 months at lease inception. The total of such future obligations is not material.
11. Commitments and Contingencies
As of June 30, 2020, the Company has remaining future commitments, under mortgage notes, reimbursement obligations or similar arrangements, to fund $23.8 million to its tenants for development, construction and renovation costs related to properties leased from the Company.
Litigation and Regulatory Matters
In the ordinary course of business, the Company may become subject to litigation, claims and regulatory matters. There are no material legal or regulatory proceedings pending or known to be contemplated against the Company or its properties.
Environmental Matters
In connection with the ownership of real estate, the Company may be liable for costs and damages related to environmental matters. As of June 30, 2020, the Company had not been notified by any governmental authority of any non-compliance, liability or other claim, and is not aware of any other environmental condition that it believes will have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.
Defined Contribution Retirement Plan
The Company has a defined contribution retirement savings plan qualified under Section 401(a) of the Internal Revenue Code (the “401(k) Plan”). The 401(k) Plan is available to all of the Company’s full-time employees. The Company provides a matching contribution in cash equal to 100% of the first 3% of eligible compensation contributed by participants and 50% of the next 2% of eligible compensation contributed by participants, which vests immediately. During the three months ended June 30, 2020 and 2019, the Company made matching contributions of approximately $19,000 and $17,000, respectively. For both the six months ended June 30, 2020 and 2019, the Company made matching contributions of $0.1 million.
Employment Agreements
The Company has employment agreements with its executive officers. These employment agreements have an initial term of four years, with automatic one year extensions unless notice of non-renewal is provided by either party. These agreements provide for initial annual base salaries and an annual performance bonus. If an executive officer’s employment terminates under certain circumstances, the Company would be liable for any
annual performance bonus awarded for the year prior to termination, to the extent unpaid, continued payments equal to 12 months of base salary, monthly reimbursement for 12 months of COBRA premiums, and under certain situations, a pro rata bonus for the year of termination.
12. Fair Value Measurements
GAAP establishes a hierarchy of valuation techniques based on the observability of inputs used in measuring financial instruments at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs.
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 regularly and, depending on various factors, it is possible that an asset or liability may be classified differently from period to period. However, the Company expects that changes in classifications between levels will be rare.
In addition to the disclosures for assets and liabilities required to be measured at fair value at the balance sheet date, companies are required to disclose the estimated fair values of all financial instruments, even if they are not presented at their fair value on the consolidated balance sheet. The fair values of financial instruments are estimates based upon market conditions and perceived risks as of June 30, 2020 and December 31, 2019. These estimates require management’s judgment and may not be indicative of the future fair values of the assets and liabilities.
Financial assets and liabilities for which the carrying values approximate their fair values include cash and cash equivalents, restricted cash, accounts receivable included within rent receivables, prepaid expenses and other assets, dividends payable and accrued liabilities, derivatives and other payables. Generally, these assets and liabilities are short term in duration and their carrying value approximates fair value on the consolidated balance sheets.
The estimated fair values of the Company’s fixed-rate loans receivable have been derived based on primarily unobservable market inputs such as interest rates and discounted cash flow analyses using estimates of the amount and timing of future cash flows, market rates and credit spreads. These measurements are classified as Level 3 within the fair value hierarchy. The Company believes the carrying value of its fixed-rate loans receivable approximates fair value.
The estimated fair values of the Company’s borrowings under the Revolving Credit Facility, the April 2019 Term Loan and the November 2019 Term Loan have been derived based on primarily unobservable market inputs such as interest rates and discounted cash flow analyses using estimates of the amount and timing of future cash flows, market rates and credit spreads. These measurements are classified as Level 3 within the fair value hierarchy. The Company believes the carrying value of its borrowings under the Revolving Credit Facility, the April 2019 Term Loan and the November 2019 Term Loan as of June 30, 2020 and December 31, 2019 approximate fair value.
The estimated fair values of the Company’s secured borrowings have been derived based on primarily unobservable market inputs such as interest rates and discounted cash flow analyses using estimates of the amount and timing of future cash flows, market rates and credit spreads. These measurements are classified as Level 3 within the fair value hierarchy. As of June 30, 2020, the Company’s secured borrowings had an aggregate carrying value of $175.2 million (excluding net deferred financing costs of $2.5 million and an estimated fair value of $167.6 million. As of December 31, 2019, the Company’s secured borrowings had an aggregate carrying value of $239.1 million (excluding net deferred financing costs of $3.8 million) and an estimated fair value of $247.1 million.
The Company measures its derivative financial instruments at fair value on a recurring basis. The fair values of the Company’s derivative financial instruments were determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of the derivative financial instrument. This analysis reflected the contractual terms of the derivative, including the period to maturity, and used observable market-based inputs, including interest rate market data and implied volatilities in such interest rates. While it was determined that the majority of the inputs used to value the derivatives fall within Level 2 of the fair
value hierarchy under authoritative accounting guidance, the credit valuation adjustments associated with the derivatives also utilized Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default. However, as of June 30, 2020 and December 31, 2019, the significance of the impact of the credit valuation adjustments on the overall valuation of the derivative financial instruments was assessed and it was determined that these adjustments were not significant to the overall valuation of the derivative financial instruments. As a result, it was determined that the derivative financial instruments in their entirety should be classified in Level 2 of the fair value hierarchy. As of June 30, 2020 and December 31, 2019, the Company estimated the fair value of its interest rate swap contracts to be a $46.0 million liability and a $2.9 million net liability, respectively.
The Company measures its real estate investments at fair value on a nonrecurring basis. The fair values of these real estate investments were determined using the following input levels as of the date presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Carrying Value
|
|
|
|
Fair Value Measurements Using Fair Value Hierarchy
|
|
|
|
|
(in thousands)
|
|
|
|
Fair Value
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
June 30, 2020
|
|
|
|
|
|
|
|
|
|
|
Non-financial assets:
|
|
|
|
|
|
|
|
|
|
|
Long-lived assets
|
|
$
|
1,445
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,445
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
|
|
|
|
|
|
|
|
|
Non-financial assets:
|
|
|
|
|
|
|
|
|
|
|
Long-lived assets
|
|
$
|
3,864
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,864
|
|
Long-lived assets: The Company reviews its investments in real estate when events or circumstances change indicating that the carrying amount of an asset may not be recoverable. In the evaluation of an investment in real estate for impairment, many factors are considered, including estimated current and expected operating cash flows from the asset during the projected holding period, costs necessary to extend the life or improve the asset, expected capitalization rates, projected stabilized net operating income, selling costs, and the ability to hold and dispose of the asset in the ordinary course of business.
Quantitative information about Level 3 fair value measurements as of June 30, 2020 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollar amounts in thousands)
|
|
Fair Value
|
|
Valuation Techniques
|
|
Significant Unobservable Inputs
|
|
|
Non-financial assets:
|
|
|
|
|
|
|
|
|
Long-lived assets:
|
|
|
|
|
|
|
|
|
Vacant - Sylacauga, AL
|
|
$
|
187
|
|
|
Sales comparison
approach
|
|
Binding sales contract
|
|
$
|
187
|
|
Vacant - Waterloo, IA
|
|
550
|
|
|
Sales comparison
approach
|
|
Non-binding listing agreement
|
|
550
|
|
Family Dining - Jacksonville, FL
|
|
709
|
|
|
Discounted cash flow approach
|
|
Terminal
Value: 8.0%
Discount
Rate: 8.5%
|
|
709
|
|
13. Related-Party Transactions
During the three and six months ended June 30, 2019, an affiliate of Eldridge provided certain treasury and information technology services to the Company. The Company incurred a de minimis amount of expense for these services during the three and six months ended June 30, 2019, which is included in general and administrative expense in the Company’s consolidated statements of operations. No services were provided to the Company during the three and six months ended June 30, 2020.
In May 2019, the Company repurchased a portion of its Class A Series 2016-1 Notes with a face value of $200 million for $201.4 million from an affiliate of Eldridge. See Note 6—Secured Borrowings for additional information.
14. Subsequent Events
The Company has evaluated all events and transactions that occurred after June 30, 2020 through the filing of this Quarterly Report on Form 10-Q and determined that there have been no events that have occurred that would require adjustment to disclosures in the consolidated financial statements except as disclosed below.
Acquisition and Disposition Activity
Subsequent to June 30, 2020, the Company invested in 6 real estate properties for an aggregate purchase price (including acquisition-related costs) of $23.3 million and invested $2.9 million through new and ongoing construction in progress and reimbursements to tenants for development, construction and renovation costs.
Subsequent to June 30, 2020, the Company sold its investment in 3 real estate properties for an aggregate gross sales price of $2.9 million and incurred $0.1 million of disposition costs related to these transactions.
Appointment of Executive Officer
In July 2020, the Company announced the appointment of Mark E. Patten as an Executive Vice President of the Company and its Chief Financial Officer and Treasurer, effective as of August 10, 2020. In association with his appointment, the Company entered into an employment agreement Mr. Patten with similar terms and conditions as employment agreements the Company has with other executive officers. See Note 11—Commitments and Contingencies for additional information. In recognition of his appointment, Mr. Patten will receive a one-time grant of $1,050,000 of restricted stock units which will vest in equal installments on each of the first, second and third anniversaries of the effective date of his appointment.