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Section 1: 10-Q (10-Q)

sfr-10q_20170331.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One) 

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2017

or

TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to _______________

Commission File Number 001- 36163

 

Colony Starwood Homes

(Exact name of registrant as specified in its charter)

 

 

Maryland

 

80-6260391

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

 

 

8665 East Hartford Drive

Scottsdale, AZ

 

85255

(Address of principal executive offices)

 

(Zip Code)

(480) 362-9760

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes     No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes      No  

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

 

 

  

Accelerated filer

 

 

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a small reporting company)

  

Small reporting company

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes      No  

As of May 4, 2017, there were 113,231,879 of the registrant’s common shares, par value $0.01 per share, outstanding.

 

 

 


COLONY STARWOOD HOMES

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2017

INDEX

 

Part I.

 

Financial Information

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (Unaudited)

 

1

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets

 

1

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations

 

2

 

 

 

 

 

 

 

Condensed Consolidated Statements of Other Comprehensive Income (Loss)

 

3

 

 

 

 

 

 

 

Condensed Consolidated Statements of Equity

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows

 

5

 

 

 

 

 

 

 

Notes to the Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

32

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

45

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

46

 

 

 

 

 

Part II.

 

Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

47

 

 

 

 

 

Item 1A.

 

Risk Factors

 

47

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

47

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

48

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

48

 

 

 

 

 

Item 5.

 

Other Information

 

48

 

 

 

 

 

Item 6.

 

Exhibits

 

48

 

 

 

 

 

Signatures

 

49

 

 

 

 

 

Index to Exhibits

 

50

 

 

 

 


Except where the context suggests otherwise, the terms “we,” “us,” and “our” refer to Colony Starwood Homes (formerly Starwood Waypoint Residential Trust (“SWAY”)), a Maryland real estate investment trust, together with its consolidated subsidiaries, including Colony Starwood Homes Partnership, L.P. (formerly Starwood Waypoint Residential Partnership, L.P.), a Delaware limited partnership through which we conduct substantially all of our business, which we refer to as “our operating partnership”; the term “CAH” refers to Colony American Homes, Inc., our predecessor for accounting purposes; the term “the Manager” refers to SWAY Management LLC, a Delaware limited liability company, our former external manager; and the term “Starwood Capital Group” refers to Starwood Capital Group Global, L.P. (and its predecessors), together with all of its affiliates and subsidiaries, including the Manager prior to its internalization (the “Internalization”), other than us.

 

 

CAUTIONARY STATEMENTS

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains, in addition to historical information, certain forward-looking statements that involve significant risks and uncertainties, which are difficult to predict, and are not guarantees of future performance. Such statements can generally be identified by words such as “anticipates,” “expects,” “intends,” “will,” “could,” “believes,” “estimates,” “continue,” and similar expressions. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are based on certain assumptions and discuss future expectations, describe future plans and strategies, and contain financial and operating projections or state other forward-looking information. Our ability to predict results or the actual effect of future events, actions, plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in, or implied by, the forward-looking statements. Factors that could materially and adversely affect our business, financial condition, liquidity, results of operations and prospects, as well as our ability to make distributions to our shareholders, include, but are not limited to:

 

the risk factors referenced in this Quarterly Report on Form 10-Q are set forth under Item 1A. Risk Factors in our Annual Report on Form 10-K filed on February 28, 2017 and should be read in conjunction with this Quarterly Report on Form 10-Q;

 

unanticipated increases in financing and other costs, including a rise in interest rates;

 

the availability, terms and our ability to effectively deploy short-term and long-term capital;

 

the possibility that unexpected liabilities may arise from the Internalization or our merger with CAH (the “Merger”), including the outcome of any legal proceedings that have been or may be instituted against us, CAH or others following the announcement or the completion of the Internalization or the Merger;

 

changes in our business and growth strategies;

 

our ability to hire and retain highly skilled managerial, investment, financial and operational personnel;

 

volatility in the real estate industry, interest rates and spreads, the debt or equity markets, the economy generally or the rental home market specifically, whether the result of market events or otherwise;

 

events or circumstances that undermine confidence in the financial markets or otherwise have a broad impact on financial markets, such as the sudden instability or collapse of large financial institutions or other significant corporations, terrorist attacks, natural or man-made disasters, or threatened or actual armed conflicts;

 

declines in the value of single-family residential homes, and macroeconomic shifts in demand for, and competition in the supply of, rental homes;

 

the availability of attractive investment opportunities in homes that satisfy our investment objective and business and growth strategies;

 

our ability to convert the properties we acquire into rental homes generating attractive returns and to effectively control the timing and costs relating to the renovation and operation of the properties;

 

our ability to complete our exit from the non-performing loan (“NPL”) (and related real estate owned, or “REO”) business in the anticipated time period on acceptable terms and to re-deploy net cash proceeds therefrom;

 

our ability to lease or re-lease our rental homes to qualified residents on attractive terms or at all;

 

the failure of residents to pay rent when due or otherwise perform their lease obligations;

 

our ability to effectively manage our portfolio of rental homes;

 

the concentration of credit risks to which we are exposed;

i


 

the rates of default or decreased recovery rates on our target assets;

 

the adequacy of our cash reserves and working capital;

 

potential conflicts of interest with Starwood Capital Group, Colony Capital, LLC, Colony NorthStar, Inc. (“Colony NorthStar”) and their affiliates and managed investment activities;

 

the timing of cash flows, if any, from our investments;

 

our expected leverage;

 

financial and operating covenants contained in our credit facilities and securitizations that could restrict our business and investment activities;

 

effects of derivative and hedging transactions;

 

our ability to maintain effective internal controls as required by the Sarbanes-Oxley Act of 2002 and to comply with other public company regulatory requirements;

 

our ability to maintain our exemption from registration as an investment company under the Investment Company Act of 1940, as amended;

 

actions and initiatives of the U.S., state and municipal governments and changes to governments’ policies that impact the economy generally and, more specifically, the housing and rental markets;

 

changes in governmental regulations, tax laws (including changes to laws governing the taxation of real estate investment trusts (“REITs”)) and rates, and similar matters;

 

limitations imposed on our business and our ability to satisfy complex rules in order for us and, if applicable, certain of our subsidiaries to qualify as a REIT for U.S. federal income tax purposes and the ability of certain of our subsidiaries to qualify as taxable REIT subsidiaries (“TRSs”) for U.S. federal income tax purposes, and our ability and the ability of our subsidiaries to operate effectively within the limitations imposed by these rules; and

 

estimates relating to our ability to make distributions to our shareholders in the future.

When considering forward-looking statements, keep in mind the risk factors and other cautionary statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016 and other cautionary statements in this Quarterly Report on Form 10-Q. Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our views as of the date of this Quarterly Report on Form 10-Q. We recommend that readers read this document in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016 and see the discussion on risk factors in Item 1A. Risk Factors, that was filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2017. Our actual results and performance may differ materially from those set forth in, or implied by, our forward-looking statements. Accordingly, we cannot guarantee future results or performance. Furthermore, except as required by law, we are under no duty to, and we do not intend to, update any of our forward-looking statements after the date of this Quarterly Report on Form 10-Q, whether as a result of new information, future events or otherwise.

Merger and Internalization

On September 21, 2015, we and CAH announced the signing of Agreement and Plan of Merger dated as of September 21, 2015, among us and certain of our subsidiaries and CAH and certain of its subsidiaries and certain investors in CAH (“the Merger Agreement”) to combine the two companies in a stock-for-stock transaction.  In connection with the transaction, we internalized the Manager. The Merger and the Internalization were completed on January 5, 2016.

Upon consummation of the Internalization, Starwood Capital Group contributed the outstanding equity interests of the Manager to our operating partnership in exchange for 6,400,000 units in our operating partnership (“OP Units”). The OP Units are redeemable at the election of the holder and we have the option, at our sole discretion, to redeem any such OP Units for cash or exchange such OP Units for common shares, on a one-for-one basis. Subsequent to the Internalization and the Merger, we own all material assets and intellectual property rights of the Manager.

Under the Merger Agreement, CAH shareholders received an aggregate of 64,869,526 of our common shares in exchange for all shares of CAH. Upon completion of the transaction, our existing shareholders and the former owner of the Manager owned approximately 41% of our common shares, while former CAH shareholders owned approximately 59% of our common shares. The terms of the Internalization were negotiated and approved by a special committee of our board of trustees. The share allocation was determined based on each company’s net asset value. Upon the closing of the Internalization and the Merger, we changed our name to Colony Starwood Homes and our common shares are listed and traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “SFR.”  

 

 

ii


 

PART I - FINANCIAL INFORMATION

 

 

Item 1. Financial Statements (Unaudited)

COLONY STARWOOD HOMES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

 

 

As of

 

 

As of

 

 

 

March 31, 2017

 

 

December 31, 2016

 

ASSETS

 

(Unaudited)

 

 

 

 

 

Investments in real estate properties:

 

 

 

 

 

 

 

 

Land and land improvements

 

$

1,595,371

 

 

$

1,584,533

 

Buildings and building improvements

 

 

4,469,092

 

 

 

4,403,871

 

Furniture, fixtures and equipment

 

 

140,333

 

 

 

131,502

 

Total investments in real estate properties

 

 

6,204,796

 

 

 

6,119,906

 

Accumulated depreciation

 

 

(411,968

)

 

 

(370,394

)

Investments in real estate properties, net

 

 

5,792,828

 

 

 

5,749,512

 

Real estate held for sale, net

 

 

23,759

 

 

 

22,201

 

Cash and cash equivalents

 

 

430,926

 

 

 

109,097

 

Restricted cash

 

 

159,131

 

 

 

155,194

 

Investments in unconsolidated joint ventures

 

 

34,114

 

 

 

34,384

 

Asset-backed securitization certificates

 

 

141,103

 

 

 

141,103

 

Assets held for sale (Note 14)

 

 

50,478

 

 

 

76,870

 

Goodwill

 

 

260,230

 

 

 

260,230

 

Other assets, net

 

 

71,304

 

 

 

66,585

 

Total assets

 

$

6,963,873

 

 

$

6,615,176

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

90,617

 

 

$

88,140

 

Resident prepaid rent and security deposits

 

 

60,403

 

 

 

57,823

 

Secured credit facilities

 

 

 

 

 

108,501

 

Mortgage loans, net

 

 

3,327,374

 

 

 

3,333,241

 

Convertible senior notes, net

 

 

516,493

 

 

 

356,983

 

Liabilities related to assets held for sale (Note 14)

 

 

6,005

 

 

 

25,495

 

Other liabilities

 

 

87

 

 

 

 

Total liabilities

 

 

4,000,979

 

 

 

3,970,183

 

Commitments and contingencies (Note 15)

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

 

Preferred shares $.01 par value, 100,000,000 shares authorized, none issued and

   outstanding as of March 31, 2017 and December 31, 2016

 

 

 

 

 

Common shares $.01 par value, 500,000,000 shares authorized, 113,158,594

   and 101,495,759 issued and outstanding as of March 31, 2017 and December 31, 2016

 

 

1,127

 

 

 

1,015

 

Additional paid-in capital

 

 

3,100,597

 

 

 

2,734,034

 

Accumulated deficit

 

 

(357,540

)

 

 

(319,828

)

Accumulated other comprehensive income

 

 

28,681

 

 

 

23,667

 

Total shareholders’ equity

 

 

2,772,865

 

 

 

2,438,888

 

Non-controlling interests

 

 

190,029

 

 

 

206,105

 

Total equity

 

 

2,962,894

 

 

 

2,644,993

 

Total liabilities and equity

 

$

6,963,873

 

 

$

6,615,176

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

1


 

COLONY STARWOOD HOMES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

 

2016

 

REVENUE

 

 

 

 

 

 

 

 

Rental income

 

$

141,095

 

 

$

130,452

 

Other property income

 

 

7,171

 

 

 

4,924

 

Other income

 

 

2,774

 

 

 

2,890

 

Total revenues

 

 

151,040

 

 

 

138,266

 

EXPENSES

 

 

 

 

 

 

 

 

Property operating and maintenance

 

 

18,946

 

 

 

16,738

 

Real estate taxes, insurance and HOA costs

 

 

28,299

 

 

 

27,319

 

Property management

 

 

9,650

 

 

 

10,016

 

Interest expense

 

 

38,999

 

 

 

37,457

 

Depreciation and amortization

 

 

46,185

 

 

 

43,630

 

Impairment of real estate assets

 

 

443

 

 

 

30

 

Share-based compensation

 

 

1,561

 

 

 

387

 

General and administrative

 

 

10,840

 

 

 

16,366

 

Merger and transaction-related

 

 

 

 

 

23,482

 

Total expenses

 

 

154,923

 

 

 

175,425

 

Net gain on sales of real estate

 

 

678

 

 

 

1,384

 

Equity in income from unconsolidated joint ventures

 

 

180

 

 

 

197

 

Loss on extinguishment of debt

 

 

(7,153

)

 

 

 

Other expense, net

 

 

(1,639

)

 

 

(725

)

Loss before income taxes

 

 

(11,817

)

 

 

(36,303

)

Income tax expense

 

 

157

 

 

 

245

 

Net loss from continuing operations

 

 

(11,974

)

 

 

(36,548

)

Loss from discontinued operations, net (Note 14)

 

 

(46

)

 

 

(10,501

)

Net loss

 

 

(12,020

)

 

 

(47,049

)

Net loss attributable to non-controlling interests

 

 

678

 

 

 

2,850

 

Net loss attributable to common shareholders

 

$

(11,342

)

 

$

(44,199

)

 

 

 

 

 

 

 

 

 

Net loss per common share - basic and diluted:

 

 

 

 

 

 

 

 

Net loss from continuing operations attributable to common shareholders

 

$

(0.11

)

 

$

(0.34

)

Net loss from discontinued operations attributable to common shareholders

 

$

 

 

$

(0.09

)

Net loss attributable to common shareholders

 

$

(0.11

)

 

$

(0.43

)

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.22

 

 

$

0.22

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

 

2


 

COLONY STARWOOD HOMES

CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)

(in thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

 

2016

 

Other Comprehensive Loss:

 

 

 

 

 

 

 

 

Net loss

 

$

(12,020

)

 

$

(47,049

)

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

Change in unrealized gains (losses) on cash flow hedges:

 

 

 

 

 

 

 

 

Unrealized gains (losses)

 

 

4,891

 

 

 

(2,351

)

Reclassifications to income

 

 

521

 

 

 

494

 

Other comprehensive income (loss)

 

 

5,412

 

 

 

(1,857

)

Comprehensive loss

 

 

(6,608

)

 

 

(48,906

)

Comprehensive loss attributable to non-controlling interests

 

 

393

 

 

 

2,959

 

Comprehensive loss attributable to common shareholders

 

$

(6,215

)

 

$

(45,947

)

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

 

 

 

3


 

COLONY STARWOOD HOMES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(in thousands, except share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

Other

 

 

Total

 

 

Non-

 

 

 

 

 

 

 

Shares

 

 

Common Shares

 

 

Paid-in

 

 

Accumulated

 

 

Comprehensive

 

 

Shareholders'

 

 

controlling

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Deficit

 

 

Income (Loss)

 

 

Equity

 

 

Interests

 

 

Total Equity

 

Balances at December 31, 2016

 

 

 

 

$

 

 

 

101,495,759

 

 

$

1,015

 

 

$

2,734,034

 

 

$

(319,828

)

 

$

23,667

 

 

$

2,438,888

 

 

$

206,105

 

 

$

2,644,993

 

Capital distributions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(167

)

 

 

(167

)

Dividends declared of $0.22 per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(26,370

)

 

 

 

 

 

(26,370

)

 

 

 

 

 

(26,370

)

Issuance of common shares for settlement

   of RSUs

 

 

 

 

 

 

 

 

118,151

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

1

 

 

 

 

 

 

1

 

Amortization of share-based

   compensation

 

 

 

 

 

 

 

 

3,066

 

 

 

 

 

 

1,566

 

 

 

 

 

 

 

 

 

1,566

 

 

 

 

 

 

1,566

 

Shares withheld for taxes related to

   settlement of RSUs

 

 

 

 

 

 

 

 

(40,738

)

 

 

 

 

 

(1,385

)

 

 

 

 

 

 

 

 

(1,385

)

 

 

 

 

 

(1,385

)

Repurchase of 2017 Convertible Notes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(15,648

)

 

 

 

 

 

 

 

 

(15,648

)

 

 

 

 

 

(15,648

)

Issuance of 2022 Convertible Notes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

17,725

 

 

 

 

 

 

 

 

 

17,725

 

 

 

 

 

 

17,725

 

Issuance of common shares

 

 

 

 

 

 

 

 

11,105,465

 

 

 

111

 

 

 

348,676

 

 

 

 

 

 

 

 

 

348,787

 

 

 

 

 

 

348,787

 

Redemption of OP Units for common

   shares

 

 

 

 

 

 

 

 

476,891

 

 

 

 

 

 

15,629

 

 

 

 

 

 

(113

)

 

 

15,516

 

 

 

(15,516

)

 

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(11,342

)

 

 

 

 

 

(11,342

)

 

 

(678

)

 

 

(12,020

)

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,127

 

 

 

5,127

 

 

 

285

 

 

 

5,412

 

Balances at March 31, 2017

 

 

 

 

$

 

 

 

113,158,594

 

 

$

1,127

 

 

$

3,100,597

 

 

$

(357,540

)

 

$

28,681

 

 

$

2,772,865

 

 

$

190,029

 

 

$

2,962,894

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

 

 

 

4


 

COLONY STARWOOD HOMES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited) 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

 

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net loss

 

$

(12,020

)

 

$

(47,049

)

Adjustments to reconcile net loss to net cash provided by (used in) operating

   activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

46,185

 

 

 

43,630

 

Amortization of debt discounts

 

 

4,534

 

 

 

5,308

 

Amortization of deferred financing costs

 

 

4,622

 

 

 

3,122

 

Amortization of leased vehicle deposits

 

 

41

 

 

 

52

 

Share-based compensation

 

 

1,561

 

 

 

387

 

Equity in income of unconsolidated joint ventures

 

 

(180

)

 

 

(197

)

Distributions from unconsolidated joint ventures

 

 

180

 

 

 

 

Bad debt expense

 

 

2,068

 

 

 

1,075

 

Net gain on sales of real estate

 

 

(1,730

)

 

 

(1,384

)

Gain on loan conversions, net (Note 14)

 

 

(694

)

 

 

(337

)

Gain on NPL sales (Note 14)

 

 

(107

)

 

 

 

Loss on extinguishment of debt

 

 

7,153

 

 

 

 

Unrealized losses from derivative instruments

 

 

1,022

 

 

 

302

 

Impairment of real estate assets

 

 

443

 

 

 

30

 

Net changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Restricted cash

 

 

(6,238

)

 

 

(8,487

)

Other assets

 

 

(1,268

)

 

 

1,062

 

Accounts payable and accrued expenses

 

 

(5,033

)

 

 

(22,551

)

Resident prepaid rent and security deposits

 

 

2,580

 

 

 

368

 

Other liabilities

 

 

 

 

 

(318

)

Net cash provided by (used in) operating activities

 

 

43,119

 

 

 

(24,987

)

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Cash acquired in the Merger and CAH reorganization, net

 

 

 

 

 

57,254

 

Acquisition of real estate properties

 

 

(86,990

)

 

 

(1,790

)

Capital expenditures for real estate properties

 

 

(25,460

)

 

 

(25,058

)

Proceeds from sales of real estate

 

 

51,657

 

 

 

48,403

 

Proceeds from sales of loans and other proceeds on loans (Note 14)

 

 

291

 

 

 

9,334

 

Distributions from unconsolidated joint ventures

 

 

270

 

 

 

460

 

Payment of leasing costs

 

 

(2,153

)

 

 

(2,258

)

Net cash (used in) provided by investing activities

 

 

(62,385

)

 

 

86,345

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

5


 

COLONY STARWOOD HOMES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(in thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

 

2016

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Borrowings on secured credit facilities

 

$

70,233

 

 

$

42,374

 

Payments on secured credit facilities

 

 

(178,734

)

 

 

(2,039

)

Payments on master repurchase facility (Note 14)

 

 

(19,286

)

 

 

(6,894

)

Payments on mortgage loans

 

 

(9,439

)

 

 

(1,759

)

Proceeds from the issuance of convertible senior notes

 

 

345,000

 

 

 

 

Payment of financing costs

 

 

(8,948

)

 

 

89

 

Repurchase of convertible senior notes

 

 

(186,012

)

 

 

 

Proceeds from the issuance of common shares

 

 

360,928

 

 

 

 

Payment of offering costs

 

 

(10,940

)

 

 

(11,871

)

Change in escrow reserves for credit facilities and mortgage loans, net

 

 

2,301

 

 

 

982

 

Repurchases of common shares

 

 

 

 

 

(44,550

)

Contributions from non-controlling interests

 

 

 

 

 

141

 

Distributions to non-controlling interests

 

 

(167

)

 

 

(215

)

Payments of dividends and redemption of preferred shares

 

 

(23,841

)

 

 

(607

)

Net cash provided by (used in) financing activities

 

 

341,095

 

 

 

(24,349

)

Net change in cash and cash equivalents

 

 

321,829

 

 

 

37,009

 

Cash and cash equivalents at beginning of the period

 

 

109,097

 

 

 

162,090

 

Cash and cash equivalents at end of the period

 

$

430,926

 

 

$

199,099

 

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

 

 

 

Cash paid for interest, net of amounts capitalized

 

$

25,423

 

 

$

30,764

 

Cash paid for income taxes

 

$

32

 

 

$

245

 

Income tax refunds

 

$

141

 

 

$

 

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND

   FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Accrued capital expenditures

 

$

3,456

 

 

$

3,509

 

Loan basis converted to real estate properties (Note 14)

 

$

2,429

 

 

$

28,075

 

Accrued dividends to common shareholders

 

$

26,365

 

 

$

23,849

 

Discount on convertible senior notes

 

$

18,015

 

 

$

 

Accrued offering costs

 

$

363

 

 

$

 

Accrued deferred financing costs

 

$

1,843

 

 

$

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

6


 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

Note 1.  Organization and Operations

Except where the context suggests otherwise, the terms “we,” “us,” and “our” refer to Colony Starwood Homes (formerly Starwood Waypoint Residential Trust (“SWAY”)), a Maryland real estate investment trust, together with its consolidated subsidiaries, including Colony Starwood Homes Partnership, L.P. (formerly Starwood Waypoint Residential Partnership, L.P.), a Delaware limited partnership through which we conduct substantially all of our business, which we refer to as “our operating partnership”; the term “CAH” refers to Colony American Homes, Inc., our predecessor for accounting purposes; the term “the Manager” refers to SWAY Management LLC, a Delaware limited liability company, our former external manager; and the term “Starwood Capital Group” refers to Starwood Capital Group Global, L.P. (and its predecessors), together with all of its affiliates and subsidiaries, including the Manager prior to its internalization, other than us.

The Merger

On September 21, 2015, we and CAH announced the signing of the Merger Agreement, to combine the two companies in a stock-for-stock transaction (the “Merger”).  In connection with the transaction, we internalized the Manager. The Merger and the Internalization were completed on January 5, 2016.  

Upon consummation of the Internalization, Starwood Capital Group contributed the outstanding equity interests of the Manager to our operating partnership in exchange for 6,400,000 OP Units. The OP Units are redeemable at the election of the holder and we have the option, at our sole discretion, to redeem any such OP Units for cash or exchange such OP Units for common shares, on a one-for-one basis (see Note 8. Shareholders’ Equity). Subsequent to the Internalization and the Merger, we own all material assets and intellectual property rights of the Manager.

Under the Merger Agreement, CAH shareholders received an aggregate of 64,869,526 of our common shares in exchange for all shares of CAH. Upon completion of the transaction, our existing shareholders and the former owner of the Manager owned approximately 41% of our common shares, while former CAH shareholders owned approximately 59% of our common shares. The share allocation was determined based on each company’s net asset value. The terms of the Internalization were negotiated and approved by a special committee of our board of trustees. Upon the closing of the Internalization and the Merger, we changed our name to Colony Starwood Homes and our common shares are listed and traded on the NYSE under the ticker symbol “SFR.”  

Since both SWAY and CAH had significant pre-combination activities, the Merger was accounted for as a business combination by the combined company in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations.” Based upon consideration of a number of factors, CAH was designated as the accounting acquirer in the Merger (although SWAY was the legal acquirer) which resulted in a reverse acquisition of SWAY for accounting purposes. Consequently, the historical condensed consolidated financial statements included herein as of any date, or for any periods, prior to January 5, 2016, the closing date of the Merger, represent only the pre-Merger condensed consolidated financial position, results of operations, other comprehensive income and cash flows of CAH. SWAY’s assets, liabilities and non-controlling interests were recorded at fair value as of January 5, 2016, and its results of operations are included in our condensed consolidated statements of operations beginning on that date.  The historical financial information included herein as of any date, or for any periods, prior to January 5, 2016 do not reflect the condensed consolidated financial position, results of operations, other comprehensive income or cash flows of the combined companies had the Merger been completed during the historical periods presented.

 

7


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

Overview

We are an internally managed Maryland real estate investment trust and commenced operations in March 2012 primarily to acquire, renovate, lease and manage residential assets in select markets throughout the United States. Our objective is to generate attractive risk-adjusted returns for our shareholders over the long-term through dividends and capital appreciation. Our primary strategy is to acquire single-family rental (“SFR”) homes through a variety of channels, renovate these homes to the extent necessary and lease them to qualified residents. We measure homes by the number of rental units as compared to number of properties, taking into account our limited investments in multi-unit properties. We seek to take advantage of macroeconomic trends in favor of leasing homes by acquiring, owning, renovating and managing homes that we believe will generate substantial current rental revenue, which we expect to grow over time.

Our operating partnership was formed as a Delaware limited partnership in May 2012. Our wholly-owned subsidiary is the sole general partner of our operating partnership, and we conduct substantially all of our business through our operating partnership. We owned 95.0% of the outstanding OP Units as of March 31, 2017.

As a result of the Merger, we have a joint venture with Prime Asset Fund VI, LLC (“Prime”), an entity managed by Prime Finance, an asset manager that specializes in acquisition, resolution and disposition of non-performing loans (“NPLs”). We own a greater than 98.75% interest in the joint venture. We have substantially exited the NPL business and are currently marketing all remaining assets of the joint venture for disposition (see Note 14. Discontinued Operations). Prime earns a one-time fee from us, equal to a percentage of the value (as determined pursuant to the Amended and Restated Limited Partnership Agreement (the “Amended JV Partnership Agreement”) of PrimeStar Fund I, L.P.) of the NPLs and homes we originally designated as rental pool assets upon disposition or resolution of such assets. Prime also earns a fee in connection with the asset management services that Prime provides to the joint venture and additional incentive fees related to the sale of assets in connection our exit from the NPL business.

We intend to operate and to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes. We generally will not be subject to U.S. federal income taxes on our REIT taxable income to the extent that we annually distribute all of our REIT taxable income to shareholders and maintain our qualification as a REIT.

 

 

Note 2.  Basis of Presentation and Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying interim condensed consolidated financial statements are unaudited. These interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and the applicable rules and regulations of the SEC for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The December 31, 2016 condensed consolidated balance sheet was derived from our audited financial statements as of that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. The condensed consolidated financial statements include our accounts and those of our wholly and majority owned subsidiaries. Intercompany amounts have been eliminated.

The accompanying unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to state fairly our financial position as of March 31, 2017, and the results of operations and comprehensive income (loss) for the three months ended March 31, 2017 and 2016 and cash flows for the three months ended March 31, 2017 and 2016. The interim results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017, or for any other future annual or interim period.

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, Quantitative and Qualitative Disclosures About Market Risk, and the consolidated financial statements and notes thereto included in Items 7, 7A and 8, respectively, in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on February 28, 2017.

We consolidate entities in which we retain a controlling financial interest or entities that meet the definition of a variable interest entity (“VIE”) for which we are deemed to be the primary beneficiary. In performing our analysis of whether we are the primary beneficiary, at initial investment and at each quarterly reporting period, we consider whether we individually have the power to direct the activities of the VIE that most significantly affect the entity’s economic performance and also have the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. The determination of whether an entity is a

8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

VIE, and whether we are the primary beneficiary, involves significant judgments, including the determination of which activities most significantly affect the entities’ performance, estimates about the current and future fair values and performance of assets held by the VIE and/or general market conditions.

As described in Note 6. Debt, we entered into multiple mortgage loan arrangements with JP Morgan Chase Bank, N.A. (“JPMorgan”). As part of these arrangements, JPMorgan transferred the loans into trusts that issued and sold pass-through certificates approximating the principal amount of the mortgage loans, and we purchased certain Class F and all related Class G certificates. We have determined that the trusts are VIEs. We have evaluated the purchased Class F and Class G certificates as a variable interest in the trusts and concluded that the Class F and Class G certificates will not absorb a majority of the trusts’ expected losses or receive a majority of the trusts’ expected residual returns. Additionally, we have concluded that the Class F and Class G certificates do not provide us with the ability to direct activities that could impact the trusts’ economic performance. Accordingly, we do not consolidate the trusts and have recorded a mortgage loan liability at March 31, 2017 and December 31, 2016, which is included in mortgage loans, net in the accompanying condensed consolidated balance sheets. Separately, the purchased Class F and Class G certificates have been included and reflected as asset-backed securitization certificates in the accompanying condensed consolidated balance sheets as of March 31, 2017 and December 31, 2016.  

As described in Note 4. Investments in Unconsolidated Joint Ventures, we have a joint venture with the Federal National Mortgage Association (“Fannie Mae”), which is a voting interest entity. Since we do not hold a controlling financial interest in the joint venture but have significant influence over its operating and financial policies, we account for our investment using the equity method. Under the equity method, we initially record our investments at cost and adjust for our proportionate share of net earnings or losses and other comprehensive income or loss, cash contributions made and distributions received, and other adjustments, as appropriate. Distributions of operating profit from the joint venture are reported as part of operating cash flows while distributions related to a capital transaction, such as a refinancing transaction or sale, are reported as investing activities. We perform a periodic evaluation of our investment to determine whether the fair value of the investment is less than the carrying value, and, if so, whether such decrease in value is deemed to be other-than-temporary. There were no impairment losses recognized by us related to our Fannie Mae investment during the three months ended March 31, 2017 and 2016.

Non-controlling interests represent (1) the portion of the equity (net assets) in Prime that is not attributable, directly or indirectly, to us and (2) the interests in our operating partnership held by Starwood Capital Group. Non-controlling interests are presented as a separate component of equity in the condensed consolidated balance sheets. In addition, the accompanying condensed consolidated statements of operations include the allocation of the net income or loss attributable to the non-controlling interest holders.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

The most significant estimates that we make are of the fair value of our properties with regards to impairment. While home values are typically not a highly subjective estimate on a per-unit basis, given the usual availability of comparable property sale and other market data, these fair value estimates significantly affect the condensed consolidated financial statements, including (1) whether certain assets are identified as being potentially impaired and then, if deemed to be impaired, the amount of the resulting impairment charges and (2) the allocation of purchase price to individual assets acquired as part of a pool, which have a significant impact on the amount of gain or loss recognized from a subsequent sale, and the subsequent impairment assessment, of individual assets. As described further below in the description of our significant accounting policies, we determined the fair value of NPLs, at the time of the Merger, by using a discounted cash flow valuation model, which are significantly informed by the fair value of the underlying collateral property, and also applied the estimated effect of a bulk sale of the portfolio. These estimates of fair value are determined using methodologies similar to those described below.

Significant Accounting Policies

Cash and Cash Equivalents

Cash and cash equivalents include cash in banks and short-term investments. Short-term investments are comprised of highly liquid instruments with original maturities of three months or less. We maintain our cash and cash equivalents in multiple financial institutions with high credit quality in order to minimize our credit loss exposure. At times, these balances exceed federally insurable limits.

9


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

Restricted Cash

Restricted cash is primarily comprised of resident security deposits held by us and rental revenues held in accounts controlled by lenders on our debt facilities, as well as cash collateral held by the counterparty to certain of our interest rate swap contracts.

Investments in Real Estate

Effective in the fourth quarter of 2016, we adopted Accounting Standards Update (“ASU”) 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (see Recent Accounting Pronouncements below). Under the revised framework, acquisitions of homes or portfolios of homes are considered asset acquisitions, rather than business combinations, regardless of whether there is a lease in place, because substantially all of the fair value of the acquired assets is concentrated in a single identifiable assets or group of similar identifiable assets. As a result, we account for acquisitions and dispositions of homes as purchases or disposals of assets, rather than businesses.  Prior to the adoption of this standard, we evaluated each purchase transaction to determine whether the acquired assets met the definition of a business within the scope of ASC Topic 805, Business Combinations. We recorded property acquired with an existing lease as a business combination. For property acquisitions accounted for as business combinations, the land, building and improvements and the existing lease were recorded at fair value at the date of acquisition, with acquisition costs expensed as incurred. We accounted for property acquired not subject to an existing lease as an asset acquisition, with the property recorded at the purchase price, including acquisition costs, allocated between land, building and improvements based upon their relative fair values at the date of acquisition. Transaction costs related to acquisitions that were not deemed to be businesses were included in the cost basis of the acquired assets.

We determine fair value in accordance with ASC Topic 820, Fair Value Measurements and Disclosures, primarily based on unobservable data inputs. In making estimates of fair values for purposes of allocating purchase price, we utilize various valuation studies, our own market knowledge, and published market data to estimate fair value of the assets acquired. When applicable, we determine the fair value of acquired in-place leases based on the estimated cost to replace such leases, including foregone rents during an assumed re-lease period, as well as the impact on projected cash flow of acquired leases with rents above or below current market rates.

The nature of our business requires that in certain circumstances properties are acquired subject to existing liens. Liens that are expected to be extinguished in cash are estimated and accrued on the date of acquisition and recorded as a cost of the property.

Expenditures that improve or extend the life of an acquired property, including construction overhead, personnel and other allocated direct costs, along with related holding costs during the renovation period are capitalized and depreciated over their estimated useful life. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred.

We capitalize certain costs incurred in connection with successful property acquisitions and associated stabilization activities, including tangible property improvements and replacements of existing property components. Included in these capitalized costs are certain personnel costs associated with time spent by certain personnel in connection with the planning and execution of all capital additions activities at the property level as well as third-party acquisition agreement fees.  Capitalized indirect costs are allocations of certain department costs, including personnel costs, that directly relate to capital additions activities. We also capitalize property taxes, insurance, interest and homeowners’ association (“HOA”) fees during periods in which property stabilization is in progress. We expense costs that do not relate to capital additions activities, including ordinary repairs, maintenance, resident turnover costs and general and administrative expenses.

We evaluate our long-lived assets for impairment periodically or whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. We evaluate cash flows and determine impairments on a per-unit basis, which is generally a single home but may include a single property with multiple housing units. In making this determination, we review, among other things, current and estimated future rental revenues associated with each home or property, market information for each sub-market (including competition levels, foreclosure levels, leasing trends, lease rates, and the market prices of similar homes currently being offered for sale), and known or probable events indicating that the carrying value may not be recoverable. If an impairment indicator exists, we compare the expected future undiscounted cash flows against the carrying amount of an asset. If the sum of the estimated undiscounted cash flows is less than the carrying amount of the asset, we record an impairment loss for the difference between the estimated fair value and the carrying amount of the asset. Since impairment of homes classified as held for use in our operations is evaluated on the basis of undiscounted cash flows, the carrying values of certain homes may exceed their fair value but no impairment loss is recognized as long as the carrying values are recoverable from future cash flows. However, if homes classified as held for use were subsequently classified as held for sale, they would be required to be measured at fair value less estimated costs to sell, and the resulting impairment losses could be material.

10


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

To determine the estimated fair value, we primarily consider an independent valuation of the property from a third-party automated valuation model (“AVM”) service provider. If an AVM is not available or its confidence index is below a certain threshold, we use local broker-pricing opinions (“BPOs”), if available and current. In order to validate the BPOs received and used in our assessment of fair value of real estate, we perform an internal review to determine if an acceptable valuation approach was used to estimate fair value in compliance with guidance provided by ASC Topic 820. Additionally, we undertake an internal review to assess the relevance and appropriateness of comparable transactions that have been used by the broker in its BPO and any adjustments to comparable transactions made by the broker in reaching its value opinion. In instances where we have both an AVM value and current BPO value for a property, we compare the AVM value to the BPO value and, if they differ beyond a tolerated threshold, which we define as ten percent, an internal evaluation is used as our estimated value. Such values represent the estimated amounts at which the homes could be sold in their current condition, assuming the sale is completed within a period of time typically associated with non-distressed sellers. Estimated values may be less precise, particularly in respect of any necessary repairs, where the interior of homes is not accessible for inspection by the broker performing the valuation.

BPOs are subject to judgments of a particular broker formed by visiting a property, assessing general home values in an area, reviewing comparable listings, and reviewing comparable completed sales. These judgments may vary among brokers and may fluctuate over time based on housing market activities and the influx of additional comparable listings and sales. Our results could be materially and adversely affected if the judgments used by a broker prove to be incorrect or inaccurate.

We evaluate our long-lived assets on a regular basis to ensure that individual properties still meet our investment criteria. If we determine that an individual property no longer meets our investment criteria, we make a decision to dispose of the property. We then market the property for sale and classify it as real estate held for sale in the condensed consolidated financial statements. The properties that are classified as real estate held for sale are reported at the lower of their carrying value or their fair value less estimated costs to sell and are no longer depreciated. For the three months ended March 31, 2017 and 2016, we recorded impairment charges of $0.4 million and $30,000, respectively.

Non-Performing Loans

As a result of the Merger, we acquired a portfolio of NPLs held and administered through our joint venture with Prime. We have decided to exit the NPL business and we are currently marketing all remaining assets of the joint venture for disposition. The disposal of the assets and liabilities of our NPL business represents a strategic shift in operations and is expected to have a major effect on our operations and financial results and therefore the results of operations are presented separately as discontinued operations in all periods in the accompanying condensed consolidated statements of operations. See Note 14. Discontinued Operations for further disclosure.

We determined the fair value for NPLs, at the time of the Merger, by using a discounted cash flow valuation model and also applied the estimated effect of a bulk sale of the portfolio.

When we convert loans into homes (real estate owned or “REO”) through foreclosure or other resolution processes and have obtained title to the property, the property is initially recorded at fair value. The fair value of these assets at the time of loan conversion is estimated using BPOs. Gains are recognized in earnings immediately when the fair value of the acquired property exceeds our recorded investment in the loan. Conversely, any excess of the recorded investment in the loan over the fair value of the property would be immediately recognized as a loss. In situations where property foreclosure is subject to an auction process and a third party submits the winning bid, we recognize the resulting gain or loss. All REOs are classified as assets held for sale and not depreciated. Upon the sale of REOs that were converted from NPLs, we recognize the resulting gain or loss.  

Leasing Costs

We defer direct and indirect costs incurred to lease our properties and amortize them over the term of the lease, usually one year. Amortization of leasing costs is included in depreciation and amortization expense in our condensed consolidated statements of operations.

Purchase Deposits

We make various deposits relating to property acquisitions, including transactions where we have agreed to purchase a home subject to certain conditions being met before closing, such as satisfactory home inspections and title search results. Our purchase deposit balances are recorded in other assets, net in our condensed consolidated balance sheets.

11


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

Derivative Financial Instruments

We are exposed to certain risks arising from both our business operations and economic conditions.  We principally manage our exposures to a wide variety of business and operational risks through the management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments.  Specifically, we enter into derivative financial instruments to manage exposure that may arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments, principally related to our borrowings.

As required by ASC Topic 815, Derivatives and Hedging, we record all derivatives in the condensed 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 we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. 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.  We may enter into derivative contracts that are intended to economically hedge certain of our risks, even though hedge accounting does not apply or we elect not to apply hedge accounting. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income on our condensed consolidated balance sheet and is subsequently reclassified into earnings (interest expense) in the period that the hedged forecasted transaction affects earnings.

Derivatives not designated as hedges are derivatives that do not meet the criteria for hedge accounting under GAAP or for which we have not elected to designate as hedges. We do not use these derivatives for speculative purposes, but instead they are used to manage our exposure to interest rate changes. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in other expense, net in our condensed consolidated statements of operations.

Goodwill

We test goodwill for impairment on an annual basis, or more frequently if circumstances indicate that goodwill carrying values may exceed their fair values. We perform this evaluation at the reporting unit level. As of October 31, 2016 (the date we elected as our annual goodwill impairment test), we were comprised of two operating segments and reporting units, which are represented by (1) our portfolio of SFR homes and (2) our portfolio of NPLs owned in the joint venture by Prime.  However, for financial reporting purposes, we are comprised of one reporting segment, because the Prime joint venture’s revenues, net loss and total assets are each less than 10% of our consolidated totals. Goodwill was allocated only to our SFR business.

As part of our goodwill impairment testing, we first assess a range of qualitative factors including, but not limited to, macroeconomic conditions, industry conditions, the competitive environment, changes in the market for our products and services, regulatory and political developments, and entity-specific factors such as strategies and financial performance when evaluating potential impairment for goodwill.  If, after completing such assessment, it is determined that it is “more likely than not” that the fair value of a reporting unit is less than its carrying value, we proceed to a two-step impairment test, whereby the first step is comparing the fair value of a reporting unit with its carrying amount, including goodwill.  If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered to not be impaired and the second step of the test is not performed.  The second step of the impairment test is performed when the carrying amount of the reporting unit exceeds the fair value, in which case the implied fair value of the reporting unit goodwill is compared with the carrying amount of that goodwill.  If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.

12


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

Based on the results of our 2016 review, we qualitatively concluded that it was not more likely than not that the fair value of our reporting unit was less than its carrying value and therefore determined that goodwill was not impaired.

Convertible Notes

ASC Topic 470-20, Debt with Conversion and Other Options, requires the liability and equity components of convertible debt instruments that may be settled in cash upon conversion, including partial cash settlement, to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. The initial proceeds from the sale of convertible notes are allocated between a liability component and an equity component in a manner that reflects interest expense at the rate of similar nonconvertible debt that could have been issued at such time. The equity component represents the excess initial proceeds received over the fair value of the liability component of the notes as of the date of issuance. We measure the fair value of the debt component of our convertible notes as of the issuance date based on our nonconvertible debt borrowing rate. In connection with the Merger, we adjusted our existing convertible senior notes to estimated fair value based on our nonconvertible debt borrowing rate as of the Merger date. The resulting discount from the outstanding principal balance, and the discount recorded in connection with the 2022 Convertible Notes (see Note 6. Debt), are being amortized using the effective interest rate method over the periods to maturity as noncash interest expense as the notes accrete to their par value.

Transfers of Financial Assets

We may periodically sell our financial assets. In connection with these transactions, we may retain or acquire senior or subordinated interests in the related assets. Gains and losses on such transactions are recognized using the guidance in ASC Topic 860, Transfers and Servicing, which is based on a financial components approach that focuses on control. Under this approach, if a transfer of financial assets meets the criteria for treatment as a sale – legal isolation, ability of transferee to pledge or exchange the transferred assets without constraint, and transferred control – an entity recognizes the financial assets it retains and any liabilities it has incurred, derecognizes the financial assets it has sold, and derecognizes liabilities when extinguished. Transfers that do not qualify for sales treatment are accounted for as secured financing arrangements. We determine the gain or loss on sale of the assets by allocating the carrying value of the sold asset between the sold asset and the interests retained based on their relative fair values, as applicable. The gain or loss on sale is the difference between the cash proceeds from the sale and the amount allocated to the sold asset.

Revenue Recognition

Rental revenue, net of concessions, is recognized on a straight-line basis over the term of the lease. The initial term of our residential leases is generally one year, with renewals upon consent of both parties on an annual or monthly basis.

We periodically evaluate the collectability of our resident and other receivables and record an allowance for doubtful accounts for any estimated probable losses. This allowance is estimated based on payment history and probability of collection. We generally do not require collateral other than resident security deposits. Our allowance for doubtful accounts was $3.1 million and $2.5 million as of March 31, 2017 and December 31, 2016, respectively. Bad debt expense amounts are recorded as property operating and maintenance expenses in the condensed consolidated statements of operations. During the three months ended March 31, 2017 and 2016, we incurred bad debt expense of $2.1 million and $1.1 million, respectively.

We recognize sales of real estate when a sale has closed, title has passed, adequate initial and continuing investment by the buyer is received, possession and other attributes of ownership have been transferred to the buyer, and we are not obligated to perform significant additional activities after closing. All these conditions are typically met at or shortly after closing.

Earnings (Loss) Per Share

We use the two-class method to calculate basic and diluted earnings per common share (“EPS”) as our restricted share units (“RSUs”) are participating securities as defined by GAAP. We calculate basic EPS by dividing net income (loss) attributable to common shareholders for the period by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur from shares issuable in connection with the RSUs, convertible senior notes, and redeemable OP Units, except when doing so would be anti-dilutive.

13


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

Share-Based Compensation

The fair value of our restricted shares and RSUs granted is recorded as expense over the vesting period for the award, with an offsetting increase in shareholders' equity. For grants to employees and trustees, the fair value of RSUs with only a service condition for vesting is determined based upon the share price on the grant date and expense is recognized on a straight-line basis. For RSUs with a performance condition for vesting, such as growth in net operating income, fair value is determined based upon the share price on the grant date and expense is recognized when it is probable the performance goal will be achieved. For RSUs with a market condition for vesting, such as growth in shareholder returns, fair value is estimated using a binomial lattice model and expense is recognized on a straight-line basis.  Performance goals are determined by our board of trustees. For non-employee grants, the fair value is based on the share price when the shares vest, which requires the amount to be adjusted in each subsequent reporting period based on the fair value of the award at the end of the reporting period until the award has vested.

Income Taxes

We have elected to operate as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), and intend to comply with the Code with respect thereto. Accordingly, we will not be subject to federal income tax as long as certain asset, income, dividend distribution, and share ownership tests are met. Many of these requirements are technical and complex, and if we fail to meet these requirements, we may be subject to federal, state, and local income tax and penalties. A REIT's net income from prohibited transactions is subject to a 100% penalty tax. We have taxable REIT subsidiaries (“TRSs”) where certain investments may be made and activities conducted that (1) may have otherwise been subject to the prohibited transactions tax and (2) may not be favorably treated for purposes of complying with the various requirements for REIT qualification. The income, if any, within the TRSs is subject to federal and state income taxes as a domestic C corporation based upon the TRSs' net income. See Note 12. Income Taxes.  We recorded tax expense of approximately $0.2 million and $0.2 million during the three months ended March 31, 2017 and 2016, respectively.

Fair Value Measurement

We estimate the fair value of financial assets and liabilities using the three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The three levels of inputs that may be used to measure fair value, as defined in ASC Topic 820, are as follows:

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Prices are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.

Level 3—Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.

We record certain financial instruments at fair value on a recurring basis when required by GAAP. Certain other real estate assets are measured at fair value on a non-recurring basis. We have not elected the fair value option for any other financial instruments, which are carried at cost with fair value disclosed where reasonably estimable (see Note 10. Fair Value Measurements).

Segment Information

As of March 31, 2017, we are comprised of two operating segments, which are represented by (1) our portfolio of SFR homes and (2) our portfolio of NPLs owned in the joint venture by Prime.  However, for financial reporting purposes, we are comprised of one reportable segment, because the Prime joint venture’s revenues, net loss and total assets are each less than 10% of our consolidated total.

Reclassification of Prior Period Amounts

Certain line items in prior period financial statements have been reclassified to conform to the current period groupings. For the three months ended March 31, 2016, we reclassified $0.3 million of loss on insurance claims from general and administrative expenses to other expense, net, $1.1 million of bad debt expense from property operating and maintenance to rental income, $0.7 million of fees from property operating and maintenance to property management, and $0.6 million of salaries and wages and other services from general and administrative to property management in the condensed consolidated statement of operations. As a result

14


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF MARCH 31, 2017

(Unaudited)

 

of our strategic shift to exit the NPL business in April 2016, the operations of Prime for the three months ended March 31, 2016 are classified in discontinued operations (see Note 14. Discontinued Operations).

Geographic Concentrations

We hold significant concentrations of homes in the following markets in excess of 10% of our total portfolio, based upon aggregate purchase price, and as such are more vulnerable to any adverse macroeconomic developments in such areas:

 

 

 

As of

 

 

As of

 

 

 

March 31,

 

 

December 31,

 

Market

 

2017

 

 

2016

 

Southern California