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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

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

For the quarterly period ended March 31, 2017

Commission File Number: 000-55189

NORTHSTAR REAL ESTATE INCOME II, INC.
(Exact Name of Registrant as Specified in its Charter)
Maryland
90-0916682
(State or Other Jurisdiction of
(IRS Employer
Incorporation or Organization)
Identification No.)
399 Park Avenue, 18th Floor, New York, NY 10022
(Address of Principal Executive Offices, Including Zip Code)

(212) 547-2600
(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 ý   No o

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 ý   No o

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 the 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 o
 
Accelerated filer o
 
Non-accelerated filer ý (Do not check if a smaller reporting company)
 
Smaller reporting company o

Emerging growth company o

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.o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No ý
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:  
The Company has 97,321,260 shares of Class A common stock, $0.01 par value per share, and 17,089,301 shares of Class T common stock, $0.01 par value per share, outstanding as of May 5, 2017.
 



NORTHSTAR REAL ESTATE INCOME II, INC.
FORM 10-Q
TABLE OF CONTENTS



Index
 
Page
 
 
 
 
 
 
 








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FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “seek,” “anticipate,” “estimate,” “believe,” “could,” “project,” “predict,” “continue,” “future” or other similar words or expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Such statements include, but are not limited to, those relating to our ability to make distributions to our stockholders, our reliance on our advisor and our sponsor, the operating performance of our investments, our financing needs, the effects of our current strategies and investment activities and our ability to effectively deploy capital. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain, particularly given the economic environment. 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 the forward-looking statements and you should not unduly rely on these statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from those forward-looking statements. These factors include, but are not limited to:
adverse economic conditions and the impact on the commercial real estate industry;
our ability to deploy capital quickly and successfully and achieve a diversified portfolio consistent with our target asset classes;
our dependence on the resources and personnel of our advisor, our sponsor and their affiliates, including our advisor’s ability to source and close on attractive investment opportunities on our behalf;
the performance of our advisor, our sponsor and their affiliates;
our liquidity and access to capital;
our use of leverage;
our ability to make distributions to our stockholders;
the lack of a public trading market for our shares;
the effect of economic conditions on the valuation of our investments;
the effect of paying distributions to our stockholders from sources other than cash flow provided by operations;
the impact of our sponsor’s recently completed merger with NorthStar Realty Finance Corp. and Colony Capital, Inc. and whether any of the anticipated benefits to our advisor’s and its affiliates’ platform will be realized in full or at all;
our advisor’s and its affiliates’ ability to attract and retain qualified personnel to support our operations and potential changes to key personnel providing management services to us;
our reliance on our advisor and its affiliates and sub-advisors/co-venturers in providing management services to us, the payment of substantial fees to our advisor, the allocation of investments by our advisor and its affiliates among us and the other sponsored or managed companies and strategic vehicles of our sponsor and its affiliates, and various potential conflicts of interest in our relationship with our sponsor;
the impact of market and other conditions influencing the availability of equity versus debt investments and performance of our investments relative to our expectations and the impact on our actual return on invested equity, as well as the cash provided by these investments;
changes in our business or investment strategy;
the impact of economic conditions on borrowers of the debt we originate and acquire and the mortgage loans underlying the commercial mortgage backed securities in which we invest, as well as on the tenants of the real property that we own;
changes in the value of our portfolio;
the impact of fluctuations in interest rates;
our ability to realize current and expected returns over the life of our investments;


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any failure in our advisor’s and its affiliates’ due diligence to identify relevant facts during our underwriting process or otherwise;
illiquidity of debt investments, equity investments or properties in our portfolio;
our ability to finance our assets on terms that are acceptable to us, if at all, including our ability to complete securitization financing transactions;
environmental compliance costs and liabilities;
risks associated with our joint ventures and unconsolidated entities, including our lack of sole decision making authority and the financial condition of our joint venture partners;
increased rates of loss or default and decreased recovery on our investments;
the degree and nature of our competition;
the effectiveness of our risk and portfolio management systems;
the potential failure to maintain effective internal controls, disclosure and procedures;
regulatory requirements with respect to our business generally, as well as the related cost of compliance;
legislative and regulatory changes, including changes to laws governing the taxation of real estate investment trusts, or REITs, and changes to laws affecting non-traded REITs and alternative investments generally;
our ability to maintain our qualification as a REIT for federal income tax purposes and limitations imposed on our business by our status as a REIT;
the loss of our exemption from registration under the Investment Company Act of 1940, as amended;
general volatility in capital markets;
the adequacy of our cash reserves and working capital; and
other risks associated with investing in our targeted investments, including changes in our industry, interest rates, the securities markets, the general economy or the capital markets and real estate markets specifically.
The foregoing list of factors is not exhaustive. All forward-looking statements included in this Quarterly Report on Form 10-Q are based on information available to us on the date hereof and we are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.
Factors that could have a material adverse effect on our operations and future prospects are set forth in our filings with the U.S. Securities and Exchange Commission, or the SEC, included in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and in Part II, Item 1A of this Quarterly Report on Form 10-Q under the heading “Risk Factors.” The risk factors set forth in our filings with the SEC could cause our actual results to differ significantly from those contained in any forward-looking statement contained in this report.



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PART I. Financial Information
Item 1. Financial Statements
NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Per Share Data)
 
March 31, 2017 (Unaudited)
 
December 31, 2016
Assets





Cash and cash equivalents
$
61,083


$
78,081

Restricted cash
75,318


69,699

Real estate debt investments, net
877,159


806,485

Operating real estate, net
396,841

 
399,237

Investments in private equity funds, at fair value
291,733

 
299,681

Real estate securities, available for sale
91,964

 
86,937

Receivables, net
53,017


12,001

Deferred costs and other assets, net
28,941


31,151

Loan collateral receivable, related party
23,728

 
23,728

Total assets(1)
$
1,899,784


$
1,807,000







Liabilities





Mortgage and other notes payable, net
$
379,963

 
$
376,181

Credit facilities
324,711


241,407

Securitization bonds payable, net
190,508

 
191,315

Due to related party
5,814


5,347

Accounts payable and accrued expenses
5,099

 
3,727

Escrow deposits payable
46,747


40,720

Distribution payable
6,718


6,618

Deferred purchase price, net
19,810

 
19,523

Other liabilities
11,342


10,771

Total liabilities(1)
990,712


895,609

Commitments and contingencies





Equity
 


 

NorthStar Real Estate Income II, Inc. Stockholders’ Equity
 


 

Preferred stock, $0.01 par value, 50,000,000 shares authorized, no shares issued and outstanding as of March 31, 2017 and December 31, 2016



Class A common stock, $0.01 par value, 320,000,000 shares authorized, 97,233,597 and 96,892,562 shares issued and outstanding as of March 31, 2017 and December 31, 2016, respectively
972


969

Class T common stock, $0.01 par value, 80,000,000 shares authorized, 17,014,432 and 16,881,086 shares issued and outstanding as of March 31, 2017 and December 31, 2016, respectively
170

 
169

Additional paid-in capital
1,015,822


1,011,599

Retained earnings (accumulated deficit)
(113,553
)

(104,649
)
Accumulated other comprehensive income (loss)
3,593

 
1,164

Total NorthStar Real Estate Income II, Inc. stockholders’ equity
907,004


909,252

Non-controlling interests
2,068


2,139

Total equity
909,072


911,391

Total liabilities and equity
$
1,899,784


$
1,807,000

_________________________________________________________________________
(1)
Represents the consolidated assets and liabilities of NorthStar Real Estate Income Operating Partnership II, LP (the “Operating Partnership”). The Operating Partnership is a consolidated variable interest entity (“VIE”), of which the Company is the sole general partner and owns approximately 99.98%. As of March 31, 2017, the Operating Partnership includes $135.4 million and $94.0 million of assets and liabilities, respectively, of certain VIEs that are consolidated by the Operating Partnership. Refer to Note 2, “Summary of Significant Accounting Policies.”

Refer to accompanying notes to consolidated financial statements.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars and Shares in Thousands, Except Per Share Data)
(Unaudited)

Three Months Ended March 31,
 
2017
 
2016
Net interest income
 
 
 
Interest income
$
17,267

 
$
19,231

Interest expense
4,643

 
4,501

Net interest income
12,624

 
14,730

 
 
 
 
Property and other revenues
 
 
 
Rental and other income
10,660

 
10,413

Total property and other revenues
10,660

 
10,413


 
 
 
Expenses
 
 
 
Asset management and other fees - related party
5,284

 
4,632

Mortgage notes interest expense
3,453

 
3,367

Transaction costs

 
123

Property operating expenses
3,155

 
3,328

General and administrative expenses (refer to Note 8)
3,774

 
2,927

Depreciation and amortization
4,745

 
5,332

Total expenses
20,411

 
19,709

 
 
 
 
Other income (loss)
 
 
 
Unrealized gain (loss) on investments
(66
)
 

Income (loss) before equity in earnings (losses) of unconsolidated ventures and income tax benefit (expense)
2,807

 
5,434

Equity in earnings (losses) of unconsolidated ventures
9,610

 
1,293

Income tax benefit (expense)
(1,917
)
 
(104
)
Net income (loss)
10,500

 
6,623

Net (income) loss attributable to non-controlling interests
(33
)
 
(1
)
Net income (loss) attributable to NorthStar Real Estate Income II, Inc. common stockholders
$
10,467

 
$
6,622

Net income (loss) per share of common stock, basic/diluted
$
0.09

 
$
0.07

Weighted average number of shares of common stock outstanding, basic/diluted
114,128

 
91,209

Distributions declared per share of common stock
$
0.18

 
$
0.18














Refer to accompanying notes to consolidated financial statements.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in Thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2017
 
2016
Net income (loss)
$
10,500

 
$
6,623

Other comprehensive income (loss)
 
 
 
Unrealized gain (loss) on real estate securities, available for sale
2,429

 
2,246

Total other comprehensive income (loss)
2,429

 
2,246

Comprehensive income (loss)
12,929

 
8,869

Comprehensive (income) loss attributable to non-controlling interests
(33
)
 
(1
)
Comprehensive income (loss) attributable to NorthStar Real Estate Income II, Inc. common stockholders
$
12,896

 
$
8,868






































Refer to accompanying notes to consolidated financial statements.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
(Dollars and Shares in Thousands)
 
Common Stock
 
Additional
Paid-in Capital
 
Retained Earnings (Accumulated
Deficit)
 
Accumulated Other Comprehensive Income (Loss)
 
Total Company’s
Stockholders’ Equity
 
Non-controlling
Interests
 
Total
Equity
 
Class A
 
Class T
 
 
 
 
 
 

Shares

Amount

Shares
 
Amount
 
 
 
 
 
 
Balance as of December 31, 2015
84,517

 
$
845

 
1,793

 
$
18

 
$
768,494

 
$
(56,159
)
 
$
(443
)
 
$
712,755

 
$
2,327

 
$
715,082

Net proceeds from issuance of common stock
10,346

 
104

 
14,781

 
148

 
220,316

 

 

 
220,568

 

 
220,568

Issuance and amortization of equity-based compensation
19

 

 

 

 
164

 

 

 
164

 

 
164

Non-controlling interests - distributions

 

 

 

 

 

 

 

 
(272
)
 
(272
)
Other comprehensive income (loss)

 

 

 

 

 

 
1,607

 
1,607

 

 
1,607

Distributions declared

 

 

 

 

 
(70,855
)
 

 
(70,855
)
 

 
(70,855
)
Proceeds from distribution reinvestment plan
3,007

 
30

 
315

 
3

 
32,110

 

 

 
32,143

 

 
32,143

Shares redeemed for cash
(996
)
 
(10
)
 
(8
)
 

 
(9,485
)
 

 

 
(9,495
)
 

 
(9,495
)
Net income (loss)

 

 

 

 

 
22,365

 

 
22,365

 
84

 
22,449

Balance as of December 31, 2016
96,893

 
$
969

 
16,881

 
$
169

 
$
1,011,599

 
$
(104,649
)
 
$
1,164

 
$
909,252

 
$
2,139

 
$
911,391

Accretion of distribution fees on Class T shares

 

 

 

 
(80
)
 

 

 
(80
)
 

 
(80
)
Issuance and amortization of equity-based compensation
8

 

 

 

 
92

 

 

 
92

 

 
92

Non-controlling interests - distributions

 

 

 

 

 

 

 

 
(104
)
 
(104
)
Other comprehensive income (loss)

 

 

 

 

 

 
2,429

 
2,429

 

 
2,429

Distributions declared

 

 

 

 

 
(19,371
)
 

 
(19,371
)
 

 
(19,371
)
Proceeds from distribution reinvestment plan
799

 
8

 
142

 
1

 
8,707

 

 

 
8,716

 

 
8,716

Shares redeemed for cash
(466
)
 
(5
)
 
(9
)
 

 
(4,496
)
 

 

 
(4,501
)
 

 
(4,501
)
Net income (loss)

 

 

 

 

 
10,467

 

 
10,467

 
33

 
10,500

Balance as of March 31, 2017 (unaudited)
97,234


$
972


17,014

 
$
170

 
$
1,015,822


$
(113,553
)
 
$
3,593


$
907,004


$
2,068


$
909,072






















Refer to accompanying notes to consolidated financial statements.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income (loss)
$
10,500

 
$
6,623

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Equity in (earnings) losses of unconsolidated ventures
(9,610
)
 
(1,293
)
Amortization of equity-based compensation
92

 
28

Amortization of deferred financing costs
773

 
364

Amortization of fees / accretion of discount on investments
(881
)
 
(9
)
Amortization of above/below market leases
84

 
122

Depreciation and amortization
4,745

 
5,332

Unrealized (gain) loss on investments
66

 

Distributions of cumulative earnings from PE Investments
9,415

 
1,055

Straight line rental income
(267
)
 
(121
)
Deferred income tax (benefit) expense
806

 
41

Other non-cash adjustments

 
392

Changes in assets and liabilities:
 
 
 
Restricted cash
215

 
(247
)
Receivables, net
661

 
(4,839
)
Deferred costs and other assets, net
(290
)
 
(388
)
Due to related party
(689
)
 
(541
)
Accounts payable and accrued expenses
1,372

 
(541
)
Other liabilities
(75
)
 
303

Net cash provided by (used in) operating activities
16,917

 
6,281

Cash flows from investing activities:
 
 
 
Acquisition of real estate debt investments, net

 
(37,912
)
Origination and funding of real estate debt investments, net
(136,031
)
 
(22,162
)
Repayment on real estate debt investments
24,863

 
250

Improvements to operating real estate
(249
)
 
(2,729
)
Investment in PE Investments
(704
)
 

Acquisition of real estate securities, available for sale
(1,557
)
 
(26,946
)
Distributions in excess of cumulative earnings from PE Investments
9,069

 
3,668

Change in restricted cash
193

 
278

Net cash provided by (used in) investing activities
(104,416
)
 
(85,553
)
Cash flows from financing activities:
 
 
 
Borrowings from credit facilities
104,184

 
24,767

Repayment on credit facilities
(20,880
)
 
(32,832
)
Borrowings from mortgage and other notes
3,601

 
1,758

Repayment on securitization bonds
(1,205
)
 

Net proceeds from issuance of common stock

 
81,305

Net proceeds from issuance of common stock, related party

 
143

Shares redeemed for cash
(4,501
)
 
(645
)
Distributions paid on common stock
(19,271
)
 
(15,219
)
Proceeds from distribution reinvestment plan
8,716

 
7,166

Payment of deferred financing costs
(39
)
 
(111
)
Distributions to non-controlling interests
(104
)
 
(115
)
Net cash provided by (used in) financing activities
70,501

 
66,217

Net increase (decrease) in cash and cash equivalents
(16,998
)
 
(13,055
)
Cash and cash equivalents - beginning of period
78,081

 
179,870

Cash and cash equivalents - end of period
$
61,083

 
$
166,815

 
 
 
 





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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in Thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2017
 
2016
Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Accrued cost of capital
$
80

 
$
610

Subscriptions receivable, gross

 
691

Distribution payable
6,718

 
5,541

Escrow deposits payable
6,027

 
11,243

Accrued disposition fees
410

 
630

Accrued acquisition fees
666

 

Non-cash related to PE Investments
222

 
83

CRE debt investment payoff due from servicer
41,000

 
63,000

Amounts payable relating to improvements of operating real estate

 
237

Reclassification of CRE debt investments to held for sale

 
212,569









































Refer to accompanying notes to consolidated financial statements.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Business and Organization
NorthStar Real Estate Income II, Inc. (the “Company”) was formed to originate, acquire and asset manage a diversified portfolio of commercial real estate (“CRE”) debt, equity and securities investments predominantly in the United States. CRE debt investments include first mortgage loans, subordinate mortgage and mezzanine loans and participations in such loans and preferred equity interests. Real estate equity investments include the Company’s direct ownership in properties, which may be structurally senior to a third-party partner’s equity, as well as indirect interests in real estate through real estate private equity funds (“PE Investments”). CRE securities primarily consist of commercial mortgage-backed securities (“CMBS”) and may include unsecured real estate investment trust (“REIT”) debt, collateralized debt obligation (“CDO”) notes and other securities. The Company may also invest internationally. In addition, the Company owns investments through joint ventures. The Company was formed in December 2012 as a Maryland corporation and commenced operations in September 2013. The Company elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), commencing with the taxable year ended December 31, 2013. The Company conducts its operations so as to continue to qualify as a REIT for U.S. federal income tax purposes.
The Company is externally managed and has no employees. Prior to January 11, 2017, the Company was managed by an affiliate of NorthStar Asset Management Group Inc. (NYSE: NSAM) (“NSAM”). Effective January 10, 2017, NSAM completed its previously announced merger with Colony Capital, Inc. (“Colony”), NorthStar Realty Finance Corp. (“NorthStar Realty”), and Colony NorthStar, Inc. (“Colony NorthStar”), a wholly-owned subsidiary of NSAM, which the Company refers to as the mergers, with Colony NorthStar surviving the mergers and succeeding NSAM as the Company’s sponsor (the “Sponsor”). As a result of the mergers, the Sponsor became an internally-managed equity REIT, with a diversified real estate and investment management platform and publicly-traded on the NYSE under the ticker symbol “CLNS.” In addition, following the mergers, CNI NSII Advisors, LLC (formerly known as NSAM J-NSII Ltd, an affiliate of NSAM), or the Advisor, became a subsidiary of Colony NorthStar. The Advisor manages the Company’s day-to-day operations pursuant to an advisory agreement. The mergers had no material impact on the Company’s operations.
Colony NorthStar manages capital on behalf of its stockholders, as well as institutional and retail investors in private funds, non-traded and traded REITs and registered investment companies.
Substantially all of the Company’s business is conducted through NorthStar Real Estate Income Operating Partnership II, LP (the “Operating Partnership”). The Company is the sole general partner and a limited partner of the Operating Partnership. The other limited partners of the Operating Partnership are NS Real Estate Income Advisor II, LLC (the “Prior Advisor”) and NorthStar OP Holdings II, LLC (the “Special Unit Holder”), each an affiliate of the Sponsor. The Prior Advisor invested $1,000 in the Operating Partnership in exchange for common units and the Special Unit Holder invested $1,000 in the Operating Partnership and was issued a separate class of limited partnership units (the “Special Units”), which are collectively recorded as non-controlling interests on the consolidated balance sheets as of March 31, 2017 and December 31, 2016. As the Company accepted subscriptions for shares in its continuous public offering, which closed in November 2016, it contributed substantially all of the net proceeds to the Operating Partnership as a capital contribution. As of March 31, 2017, the Company’s limited partnership interest in the Operating Partnership was 99.98%.
The Company’s charter authorizes the issuance of up to 400.0 million shares of common stock with a par value of $0.01 per share, of which 320.0 million are designated as Class A shares and 80.0 million are designated as Class T shares, and up to 50.0 million shares of preferred stock with a par value of $0.01 per share. The board of directors of the Company is authorized to amend its charter, without the approval of the stockholders, to increase the aggregate number of authorized shares of capital stock or the number of shares of any class or series that the Company has authority to issue.
On December 18, 2012, as part of its formation, the Company issued 22,223 shares of Class A common stock to NorthStar Realty for $0.2 million. On May 6, 2013, the Company’s registration statement on Form S-11 with the U.S. Securities and Exchange Commission (the “SEC”) was declared effective. Pursuant to such registration statement, the Company offered a maximum of $1.65 billion in any combination of Class A and Class T shares of common stock, excluding the initial shares, in a continuous, public offering, of which up to $1.5 billion in shares were offered pursuant to its primary offering (the “Primary Offering”) to the public and up to $150.0 million in shares were offered pursuant to its distribution reinvestment plan (the “DRP”), which are herein collectively referred to as the Offering.
The Company retained NorthStar Securities, LLC (the “Dealer Manager”), formerly a subsidiary of NSAM that became a subsidiary of the Sponsor upon completion of the mergers, to serve as the dealer manager responsible for marketing the shares offered pursuant to the Primary Offering. On September 18, 2013, the Company commenced operations by satisfying the minimum offering


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

requirement in its Primary Offering as a result of NorthStar Realty purchasing 222,223 Class A shares of common stock for $2.0 million.
The Primary Offering closed effective November 9, 2016. The Company continues to offer and sell shares pursuant to the DRP at the most recently disclosed estimated value per share of each share class, which is currently $9.26. Prior to the closing, $150.0 million of the unsold shares remaining from the Primary Offering were allocated to the DRP, for a total of $300.0 million in shares offered pursuant to the DRP. The Company may amend, suspend or terminate the DRP for any reason, except to eliminate a participant’s ability to withdraw from the DRP, upon ten days written notice.
From inception through May 5, 2017, the Company raised total gross proceeds of $1.2 billion pursuant to the Offering, including gross proceeds of $70.0 million pursuant to the DRP.
2.
Summary of Significant Accounting Policies
Basis of Quarterly Presentation
The accompanying unaudited consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and note disclosures normally included in the consolidated financial statements prepared under U.S. GAAP have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which was filed with the SEC.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, the Operating Partnership and their consolidated subsidiaries. The Company consolidates variable interest entities (“VIEs”), if any, where the Company is the primary beneficiary and voting interest entities which are generally majority owned or otherwise controlled by the Company. All significant intercompany balances are eliminated in consolidation.
Variable Interest Entities
A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. A VIE is defined as an entity 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 from other parties. The determination of whether an entity is a VIE includes both a qualitative and quantitative analysis. The Company bases its qualitative analysis on its review of the design of the entity, its organizational structure including decision-making ability and relevant financial agreements and the quantitative analysis on the forecasted cash flow of the entity. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.
A VIE must be consolidated only by its primary beneficiary, which is defined as the party who, along with its affiliates and agents has both the: (i) power to direct the activities that most significantly impact the VIE’s economic performance; and (ii) obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. The Company determines whether it is the primary beneficiary of a VIE by considering qualitative and quantitative factors, including, but not limited to: which activities most significantly impact the VIE’s economic performance and which party controls such activities; the amount and characteristics of its investment; the obligation or likelihood for the Company or other interests to provide financial support; consideration of the VIE’s purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders and the similarity with and significance to the business activities of the Company and the other interests. The Company reassesses its determination of whether it is the primary beneficiary of a VIE each reporting period. Significant judgments related to these determinations include estimates about the current and future fair value and performance of investments held by these VIEs and general market conditions.
The Company evaluates its investments and financings, including investments in unconsolidated ventures and securitization financing transactions, if any, to determine whether each investment or financing is a VIE. The Company analyzes new investments


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and financings, as well as reconsideration events for existing investments and financings, which vary depending on type of investment or financing.
The most significant consolidated VIEs are the Operating Partnership and certain properties that have non-controlling interests. These entities are VIEs because the non-controlling interests do not have substantive kick-out or participating rights. The Company consolidates these entities because it controls all significant business activities.
The Operating Partnership consolidates certain properties that have non-controlling interests. Included in operating real estate, net on the Company’s consolidated balance sheet as of March 31, 2017 is $118.9 million related to such consolidated VIEs. Included in mortgage and other notes payable, net on the Company’s consolidated balance sheet as of March 31, 2017 is $91.1 million, collateralized by the real estate assets of the related consolidated VIEs.
As of March 31, 2017, the Company identified unconsolidated VIEs related to its CRE debt investments, PE Investments and CRE securities. Assets of each of the VIEs may only be used to settle obligations of the respective VIE. Creditors of each of the VIEs have no recourse to the general credit of the Company.
The following table presents the Company’s classification, carrying value and maximum exposure of unconsolidated VIEs as of March 31, 2017 (dollars in thousands):
 
 
Carrying Value
 
Maximum Exposure to Loss(1)
Real estate debt investments, net
 
$
177,813

 
$
186,378

Investments in private equity funds, at fair value
 
291,733

 
294,924

Real estate securities, available for sale
 
91,964

 
91,964

Total assets of unconsolidated VIEs
 
$
561,510

 
$
573,266

_________________________________________________________________________
(1)
As of March 31, 2017, maximum exposure to loss includes future funding commitments of $8.6 million for real estate debt investments, net, and $3.2 million related to the Company’s proportionate share of an obligation owed through a joint investment for investments in private equity funds, at fair value.
Based on management’s analysis, the Company determined that it is not the primary beneficiary of the VIEs. Accordingly, the VIEs are not consolidated in the Company’s financial statements as of March 31, 2017. The Company did not provide financial support to the unconsolidated VIEs during the three months ended March 31, 2017. As of March 31, 2017, there were no explicit arrangements or implicit variable interests that could require the Company to provide financial support to the unconsolidated VIEs outside of the future funding commitments disclosed above and expected future contributions of $1.0 million related to PE Investments.
Voting Interest Entities
A voting interest entity is an entity in which the total equity investment at risk is sufficient to enable it to finance its activities independently and the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. The usual condition for a controlling financial interest in a voting interest entity is ownership of a majority voting interest. If the Company has a majority voting interest in a voting interest entity, the entity will generally be consolidated. The Company does not consolidate a voting interest entity if there are substantive participating rights by other parties and/or kick-out rights by a single party or a simple majority vote.
The Company performs on-going reassessments of whether entities previously evaluated under the voting interest framework have become VIEs, based on certain events, and therefore subject to the VIE consolidation framework.
Investments in Unconsolidated Ventures
A non-controlling, unconsolidated ownership interest in an entity may be accounted for using the equity method or the cost method, and for either method, the Company may elect the fair value option. The Company will account for an investment in an unconsolidated entity that does not qualify for equity method accounting or for which the fair value option was not elected using the cost method if the Company determines that it does not have significant influence. Under the cost method, equity in earnings is recorded as dividends are received to the extent they are not considered a return of capital, which is recorded as a reduction of cost of the investment.


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Under the equity method, the investment is adjusted each period for capital contributions and distributions and its share of the entity’s net income (loss). Capital contributions, distributions and net income (loss) of such entities are recorded in accordance with the terms of the governing documents. An allocation of net income (loss) may differ from the stated ownership percentage interest in such entity as a result of preferred returns and allocation formulas, if any, as described in such governing documents. Equity method investments are recognized using a cost accumulation model in which the investment is recognized based on the cost to the investor, which includes acquisition fees. The Company records as an expense certain acquisition costs and fees associated with consolidated investments deemed to be business combinations and capitalizes these costs for investments deemed to be acquisitions of an asset, including an equity method investment.
The Company may account for an investment in an unconsolidated entity at fair value by electing the fair value option. The Company elected the fair value option for PE Investments. The Company records the change in fair value for its share of the projected future cash flow of such investments from one period to another in equity in earnings (losses) of unconsolidated ventures in the consolidated statements of operations. Any change in fair value attributed to market related assumptions is considered unrealized gain (loss).
Non-controlling Interests
A non-controlling interest in a consolidated subsidiary is defined as the portion of the equity (net assets) in a subsidiary not attributable, directly or indirectly, to the Company. A non-controlling interest is required to be presented as a separate component of equity on the consolidated balance sheets and presented separately as net income (loss) and comprehensive income (loss) attributable to non-controlling interests. An allocation to a non-controlling interest may differ from the stated ownership percentage interest in such entity as a result of a preferred return and allocation formula, if any, as described in such governing documents.
Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that could affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could materially differ from those estimates and assumptions.
Comprehensive Income (Loss)
The Company reports consolidated comprehensive income (loss) in separate statements following the consolidated statements of operations. Comprehensive income (loss) is defined as the change in equity resulting from net income (loss) and other comprehensive income (loss) (“OCI”). The only component of OCI is unrealized gain (loss) on CRE securities available for sale for which the fair value option was not elected.
Fair Value Option
The fair value option provides an election that allows a company to irrevocably elect to record certain financial assets and liabilities at fair value on an instrument-by-instrument basis at initial recognition. The Company has elected the fair value option for PE Investments. Any change in fair value for assets and liabilities for which the election is made is recognized in earnings.
Cash and Cash Equivalents
The Company considers all highly-liquid investments with an original maturity date of three months or less to be cash equivalents. Cash, including amounts restricted, may at times exceed the Federal Deposit Insurance Corporation deposit insurance limit of $250,000 per institution. The Company mitigates credit risk by placing cash and cash equivalents with major financial institutions. To date, the Company has not experienced any losses on cash and cash equivalents.
Restricted Cash
Restricted cash consists of amounts related to loan origination (escrow deposits) and operating real estate (escrows for taxes, insurance, capital expenditures and payments required under certain lease agreements).
Real Estate Debt Investments
CRE debt investments are generally intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan fees, premium and discount. CRE debt investments that are deemed to be impaired are carried at amortized cost less a loan loss reserve, if deemed appropriate, which approximates fair value. CRE debt investments where the Company does not have the intent


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(Unaudited)

to hold the loan for the foreseeable future or until its expected payoff are classified as held for sale and recorded at the lower of cost or estimated fair value.
The Company may syndicate a portion of the CRE debt investments that it originates or sell the CRE debt investments individually. When a transaction meets the criteria for sale accounting, the Company will no longer recognize the CRE debt investment sold as an asset and will recognize gain or loss based on the difference between the sales price and the carrying value of the CRE debt investment sold. Any related unamortized deferred origination fees, original issue discounts, loan origination costs, discounts or premiums at the time of sale are recognized as an adjustment to the gain or loss on sale, which is included in interest income on the consolidated statement of operations. Any fees received at the time of sale or syndication are recognized as part of interest income.
Operating Real Estate
Operating real estate is carried at historical cost less accumulated depreciation. Ordinary repairs and maintenance are expensed as incurred. Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their useful life. The Company accounts for purchases of operating real estate that qualify as business combinations using the acquisition method, where the purchase price is allocated to tangible assets such as land, building, improvements and other identified intangibles. Costs directly related to an acquisition deemed to be a business combination are expensed and included in transaction costs in the consolidated statements of operations.
Operating real estate is depreciated using the straight-line method over the estimated useful lives of the assets, summarized as follows:
Category:
 
Term:
Building
 
40 years
Building improvements
 
Lesser of the useful life or remaining life of the building
Land improvements
 
10 to 30 years
Tenant improvements
 
Lesser of the useful life or remaining term of the lease
Furniture, fixtures and equipment
 
3 to 10 years
Real Estate Securities
The Company classifies its CRE securities investments as available for sale on the acquisition date, which are carried at fair value. Unrealized gains (losses) are recorded as a component of accumulated OCI in the consolidated statements of equity.
Deferred Costs
Deferred costs primarily include deferred financing costs and deferred lease costs. Deferred financing costs represent commitment fees, legal and other third-party costs associated with obtaining financing. Costs related to revolving credit facilities are recorded in deferred costs and other assets, net and are amortized to interest expense using the straight-line basis over the term of the facility. Costs related to other borrowings are recorded net against the carrying value of such borrowings and are amortized to interest expense using the effective interest method. Unamortized deferred financing costs are expensed to realized gain (loss) when the associated facility is repaid before maturity. Costs incurred in seeking financing transactions, which do not close, are expensed in the period in which it is determined that the financing will not occur. Deferred lease costs consist of fees incurred to initiate and renew operating leases, which are amortized on a straight-line basis over the remaining lease term and are recorded to depreciation and amortization in the consolidated statements of operations.
Identified Intangibles
The Company records acquired identified intangibles, which includes intangible assets (such as the value of the above-market leases, in-place leases, and other intangibles) and intangible liabilities (such as the value of below market leases), based on estimated fair value. The value allocated to the identified intangibles are amortized over the remaining lease term. Above/below-market leases are amortized into rental income, below-market ground leases are amortized into real estate properties-operating expense and in-place leases are amortized into depreciation and amortization expense. Identified intangible assets are recorded in deferred costs and other assets, net, and identified intangible liabilities are recorded in other liabilities on the accompanying consolidated balance sheets.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

Deferred Costs and Other Assets, Net and Other Liabilities
The following table presents a summary of deferred costs and other assets, net and other liabilities as of March 31, 2017 and December 31, 2016 (dollars in thousands):
 
 
March 31, 2017 (Unaudited)
 
December 31, 2016
Deferred costs and other assets, net
 
 
 
 
Intangible assets, net(1)
 
$
20,917

 
$
23,117

Deferred financing costs, net - credit facilities
 
1,756

 
1,911

Deferred commissions and leasing costs
 
4,053

 
3,446

Deposits and pending deal costs
 
61

 
64

Prepaid expenses
 
1,088

 
1,527

Deferred tax asset
 
1,066

 
1,077

Other
 

 
9

Total
 
$
28,941

 
$
31,151

 
 
 
 
 
Other liabilities:
 
 
 
 
Intangible liabilities, net(2)
 
1,647

 
1,799

Tenant security deposits
 
1,442

 
1,439

Tenant prepaid rent
 
1,703

 
1,797

Deferred tax liability(3)
 
6,149

 
5,355

Other
 
401

 
381

Total
 
$
11,342

 
$
10,771

______________________________________________________
(1)
Represents in-place leases and above-market leases, net.
(2)
Represents below-market leases, net.
(3)
Includes $4.3 million of tax related liabilities assumed upon the purchase of PE Investment III, as defined in Note 5, “Investments in Private Equity Funds.”
Acquisition Fees and Expenses
The total of all acquisition fees and expenses for an investment, including acquisition fees to the Advisor, cannot exceed, in the aggregate, 6.0% of the contract purchase price of such investment unless such excess is approved by a majority of the Company’s directors, including independent directors. For the three months ended March 31, 2017, total acquisition fees and expenses did not exceed the allowed limit for any investment. An acquisition fee incurred related to an equity investment will generally be expensed as incurred. An acquisition fee paid to the Advisor related to the acquisition of an equity or debt investment in an unconsolidated joint venture is included in investments in unconsolidated ventures on the consolidated balance sheets. An acquisition fee paid to the Advisor related to the origination or acquisition of debt investments is included in debt investments, net on the consolidated balance sheets and is amortized to interest income over the life of the investment using the effective interest method. The Company records as an expense certain acquisition costs and fees associated with transactions deemed to be business combinations in which it consolidates the asset and capitalizes these costs for transactions deemed to be acquisitions of an asset, including an equity investment.
Revenue Recognition
Real Estate Debt Investments
Interest income is recognized on an accrual basis and any related premium, discount, origination costs and fees are amortized over the life of the investment using the effective interest method. The amortization is reflected as an adjustment to interest income in the consolidated statements of operations. The amortization of a premium or accretion of a discount is discontinued if such loan is reclassified to held for sale.
Operating Real Estate
Rental and other income from operating real estate is derived from the leasing of space to various types of tenants. Rental revenue recognition commences when the tenant takes legal possession of the leased space and the leased space is substantially ready for its intended use. The leases are for fixed terms of varying length and generally provide for annual rentals and expense


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reimbursements to be paid in monthly installments. Rental income from leases is recognized on a straight-line basis over the term of the respective leases. The excess of rent recognized over the amount contractually due pursuant to the underlying leases is included in receivables on the consolidated balance sheets. The Company amortizes any tenant inducements as a reduction of revenue utilizing the straight-line method over the term of the lease. Other income represents revenue from tenant/operator leases which provide for the recovery of all or a portion of the operating expenses and real estate taxes paid by the Company on behalf of the respective property. This revenue is recognized in the same period as the expenses are incurred.
In a situation in which a lease(s) associated with a significant tenant have been, or are expected to be, terminated early, the Company evaluates the remaining useful life of depreciable or amortizable assets in the asset group related to the lease that will be terminated (i.e., tenant improvements, above- and below-market lease intangibles, in-place lease value and deferred leasing costs). Based upon consideration of the facts and circumstances surrounding the termination, the Company may write-off or accelerate the depreciation and amortization associated with the asset group. Such amounts are included within rental and other income for above- and below-market lease intangibles and depreciation and amortization for the remaining lease related asset groups in the consolidated statements of operations.
Real Estate Securities
Interest income is recognized using the effective interest method with any premium or discount amortized or accreted through earnings based on expected cash flow through the expected maturity date of the security. Changes to expected cash flow may result in a change to the yield which is then applied retrospectively for high-credit quality securities that cannot be prepaid or otherwise settled in such a way that the holder would not recover substantially all of the investment or prospectively for all other securities to recognize interest income.
Credit Losses and Impairment on Investments
Real Estate Debt Investments
Loans are considered impaired when, based on current information and events, it is probable that the Company will not be able to collect all principal and interest amounts due according to the contractual terms. The Company assesses the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis or more frequently as necessary. Significant judgment of the Company is required in this analysis. The Company considers the estimated net recoverable value of the loan as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the quality and financial condition of the borrower and the competitive situation of the area where the underlying collateral is located. Because this determination is based on projections of future economic events, which are inherently subjective, the amount ultimately realized may differ materially from the carrying value as of the balance sheet date. If upon completion of the assessment, the estimated fair value of the underlying collateral is less than the net carrying value of the loan, a loan loss reserve is recorded with a corresponding charge to provision for loan losses. The loan loss reserve for each loan is maintained at a level that is determined to be adequate by management to absorb probable losses.
Income recognition is suspended for a loan at the earlier of the date at which payments become 90-days past due or when, in the opinion of the Company, a full recovery of income and principal becomes doubtful. When the ultimate collectability of the principal of an impaired loan is in doubt, all payments are applied to principal under the cost recovery method. When the ultimate collectability of the principal of an impaired loan is not in doubt, contractual interest is recorded as interest income when received, under the cash basis method until an accrual is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Interest accrued and not collected will be reversed against interest income. A loan is written off when it is no longer realizable and/or legally discharged. As of March 31, 2017, the Company did not have any impaired CRE debt investments.
Operating Real Estate
The Company’s real estate portfolio is reviewed on a quarterly basis, or more frequently as necessary, to assess whether there are any indicators that the value of its operating real estate may be impaired or that its carrying value may not be recoverable. A property’s value is considered impaired if the Company’s estimate of the aggregate expected future undiscounted cash flow generated by the property is less than the carrying value. In conducting this review, the Company considers U.S. macroeconomic factors, real estate sector conditions and asset specific and other factors. To the extent an impairment has occurred, the loss is measured as the excess of the carrying value of the property over the estimated fair value and recorded in impairment on operating real estate in the consolidated statements of operations. As of March 31, 2017, the Company did not have any impaired operating real estate.


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(Unaudited)

An allowance for a doubtful account for a tenant receivable is established based on a periodic review of aged receivables resulting from estimated losses due to the inability of tenants to make required rent and other payments contractually due. Additionally, the Company establishes, on a current basis, an allowance for future tenant credit losses on unbilled rent receivable based on an evaluation of the collectability of such amounts.
Real Estate Securities
CRE securities for which the fair value option is elected are not evaluated for other-than-temporary impairment (“OTTI”) as any change in fair value is recorded in the consolidated statements of operations. Realized losses on such securities are reclassified to realized gain (loss) on investments as losses occur.
CRE securities for which the fair value option is not elected are evaluated for OTTI quarterly. Impairment of a security is considered to be other-than-temporary when: (i) the holder has the intent to sell the impaired security; (ii) it is more likely than not the holder will be required to sell the security; or (iii) the holder does not expect to recover the entire amortized cost of the security. When a CRE security has been deemed to be other-than-temporarily impaired due to (i) or (ii), the security is written down to its fair value and an OTTI is recognized in the consolidated statements of operations. In the case of (iii), the security is written down to its fair value and the amount of OTTI is then bifurcated into: (a) the amount related to expected credit losses; and (b) the amount related to fair value adjustments in excess of expected credit losses. The portion of OTTI related to expected credit losses is recognized in the consolidated statements of operations. The remaining OTTI related to the valuation adjustment is recognized as a component of accumulated OCI in the consolidated statements of equity. CRE securities which are not high-credit quality are considered to have an OTTI if the security has an unrealized loss and there has been an adverse change in expected cash flow. The amount of OTTI is then bifurcated as discussed above. As of March 31, 2017, the Company did not have any OTTI recorded on its CRE securities.
Foreign Currency
Assets and liabilities denominated in a foreign currency for which the functional currency is a foreign currency are translated using the currency exchange rate in effect at the end of the period presented and the results of operations for such entities are translated into U.S. dollars using the average currency exchange rate in effect during the period. The resulting foreign currency translation adjustment is recorded as a component of accumulated OCI in the consolidated statements of equity.
Assets and liabilities denominated in a foreign currency for which the functional currency is the U.S. dollar are remeasured using the currency exchange rate in effect at the end of the period presented and the results of operations for such entities are remeasured into U.S. dollars using the average currency exchange rate in effect during the period. The resulting foreign currency remeasurement adjustment is recorded in unrealized gain (loss) on investments and other in the consolidated statements of operations.
As of March 31, 2017 and December 31, 2016, the Company had $5.2 million of deferred purchase price obligations denominated in foreign currency related to its PE Investments.
Equity-Based Compensation
The Company accounts for equity-based compensation awards using the fair value method, which requires an estimate of fair value of the award at the time of grant. All fixed equity-based awards to directors, which have no vesting conditions other than time of service, are amortized to compensation expense over the awards’ vesting period on a straight-line basis. Equity-based compensation is classified within general and administrative expense in the consolidated statements of operations.
Income Taxes
The Company elected to be taxed as a REIT and to comply with the related provisions of the Internal Revenue Code beginning in its taxable year ended December 31, 2013. Accordingly, the Company will generally not be subject to U.S. federal income tax to the extent of its distributions to stockholders as long as certain asset, income and share ownership tests are met. To maintain its qualification as a REIT, the Company must annually distribute at least 90% of its REIT taxable income to its stockholders and meet certain other requirements. The Company believes that all of the criteria to maintain the Company’s REIT qualification have been met for the applicable periods, but there can be no assurance that these criteria will continue to be met in subsequent periods. If the Company were to fail to meet these requirements, it would be subject to U.S. federal income tax and potential interest and penalties, which could have a material adverse impact on its results of operations and amounts available for distributions to its stockholders. The Company’s accounting policy with respect to interest and penalties is to classify these amounts as a component of income tax expense, where applicable.


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The Company may also be subject to certain state, local and franchise taxes. Under certain circumstances, U.S. federal income and excise taxes may be due on its undistributed taxable income.
The Company made joint elections to treat certain subsidiaries as taxable REIT subsidiaries (“TRS”) which may be subject to U.S. federal, state and local income taxes. In general, a TRS of the Company may perform non-customary services for tenants, hold assets that the REIT cannot hold directly and may engage in most real estate or non-real estate-related business.
Certain subsidiaries of the Company are subject to taxation by federal, state and local authorities for the periods presented. Income taxes are accounted for by the asset/liability approach in accordance with U.S. GAAP. Deferred taxes, if any, represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. Such amounts arise from differences between the financial reporting and tax bases of assets and liabilities and are adjusted for changes in tax laws and tax rates in the period which such changes are enacted. A provision for income tax represents the total of income taxes paid or payable for the current period, plus the change in deferred taxes. Current and deferred taxes are recorded on the portion of earnings (losses) recognized by the Company with respect to its interest in TRSs. Deferred income tax assets and liabilities are calculated based on temporary differences between the Company’s U.S. GAAP consolidated financial statements and the federal, state and local tax basis of assets and liabilities as of the consolidated balance sheet date. The Company evaluates the realizability of its deferred tax assets (e.g., net operating loss and capital loss carryforwards) and recognizes a valuation allowance if, based on the available evidence, it is more likely than not that some portion or all of its deferred tax assets will not be realized. When evaluating the realizability of its deferred tax assets, the Company considers estimates of expected future taxable income, existing and projected book/tax differences, tax planning strategies available and the general and industry specific economic outlook. This realizability analysis is inherently subjective, as it requires the Company to forecast its business and general economic environment in future periods. Changes in estimate of deferred tax asset realizability, if any, are included in income tax benefit (expense) in the consolidated statements of operations.
For the three months ended March 31, 2017 and 2016, the Company recorded income tax expense of $1.9 million and $0.1 million, respectively.
Transfers of Financial Assets
Sale accounting for transfers of financial assets requires the transfer of an entire financial asset, a group of financial assets in its entirety or if a component of the financial asset is transferred, that component meets the definition of a participating interest by having characteristics that mirror the original financial asset.
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. If the Company has any continuing involvement, rights or obligations with the transferred financial asset (outside of standard representations and warranties), sale accounting would require that the transfer meets the following sale conditions: (1) the transferred asset has been legally isolated; (2) the transferee has the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred asset; and (3) the Company does not maintain effective control over the transferred asset through an agreement that provides for (a) both an entitlement and an obligation by the Company to repurchase or redeem the asset before its maturity, or (b) the unilateral ability by the Company to reclaim the asset and a more than trivial benefit attributable to that ability, or (c) the transferee requiring the Company to repurchase the asset at a price so favorable to the transferee that it is probable the repurchase will occur.
If sale accounting is met, the transferred financial asset is removed from the balance sheet and a net gain or loss is recognized upon sale, taking into account any retained interests. Transfers of financial assets that do not meet the criteria for sale are accounted for as financing transactions, or secured borrowings.
As a result of the requirements of sale accounting, senior participations in first mortgage loans purchased in connection with a securitization financing transaction are recorded as Loan collateral receivable, related party, on the Company’s consolidated balance sheets. Refer to Note 7, “Borrowings,” for additional information.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting update requiring a company to recognize as revenue the amount of consideration it expects to be entitled to in connection with the transfer of promised goods or services to customers. The accounting standard update will replace most of the existing revenue recognition guidance currently promulgated by U.S. GAAP. In July 2015, the FASB decided to delay the effective date of the new revenue standard by one year. The effective date of the new revenue standard for the Company will be January 1, 2018. Leases are specifically excluded from this guidance


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(Unaudited)

and will be governed by the applicable lease codification; however, this update may have implications in certain variable payment terms included in lease agreements and in sale and leaseback transactions. The Company is currently assessing the potential effect of the adoption on its consolidated financial statements and related disclosures, as applicable.
In January 2016, the FASB issued an accounting update that addressed certain aspects of accounting and disclosure requirements of financial instruments, including the requirement that equity investments with readily determinable fair value be measured at fair value with changes in fair value recognized in results of operations. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company does not have any equity investments with readily determinable fair value recorded as available-for-sale. The Company does not believe that this guidance will have a material impact on its consolidated financial statements and related disclosures.
In February 2016, the FASB issued an accounting update that sets out the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The update requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. Additionally, the new update will require that lessees and lessors capitalize, as initial direct costs, only those costs that are incurred due to the execution of a lease. Under this guidance, allocated payroll costs and other costs that are incurred regardless of whether the lease is obtained will no longer be capitalized as initial direct costs and instead will be expensed as incurred. The new guidance is to be applied using a modified retrospective approach at the beginning of the earliest comparative period in the financial statements and is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently assessing the potential effect the adoption of this guidance will have on its consolidated financial statements and related disclosures.
In March 2016, the FASB issued guidance which eliminates the requirement for an investor to retroactively apply the equity method when its increase in ownership interest (or degree of influence) in an investee triggers equity method accounting. The update requires that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The update should be applied prospectively upon their effective date to increases in the level of ownership interests or degree of influence that results in the adoption of the equity method. The guidance is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. The Company adopted the new guidance prospectively on January 1, 2017 and the adoption of this standard did not have a material impact on its consolidated financial statements and related disclosures.
In March 2016, the FASB issued guidance which amends several aspects of the accounting for equity-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statements of cash flows. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2016. The Company adopted the new guidance prospectively on January 1, 2017 and the adoption of this standard did not have a material impact on its consolidated financial statements and related disclosures.
In June 2016, the FASB issued guidance that changes the impairment model for certain financial instruments by requiring companies to recognize an allowance for expected losses, rather than incurred losses as required currently by the incurred loss approach. The guidance will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases and off-balance-sheet credit exposures (e.g., loan commitments). The new guidance is effective for reporting periods beginning after December 15, 2019 and will be applied as a cumulative adjustment to retained earnings as of the effective date. The Company is currently assessing the potential effect the adoption of this guidance will have on its consolidated financial statements and related disclosures.
In August 2016, the FASB issued guidance that makes eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The new guidance requires adoption on a retrospective basis unless it is impracticable to apply, in which case the company would be required to apply the amendments prospectively as of the earliest date practicable. The Company does not believe that this guidance will have a material impact on its consolidated financial statements and related disclosures.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

In November 2016, the FASB issued guidance which requires entities to show the changes in the total of cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. Entities will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. The guidance is effective for reporting periods beginning after December 15, 2017 and will be applied retrospectively to all periods presented. The Company does not believe that this guidance will have a material impact on its consolidated financial statements and related disclosures.
In January 2017, the FASB issued an accounting update to amend the guidance for determining whether a transaction involves the purchase or disposal of a business or an asset. The amendments clarify that when substantially all of the fair value of the gross assets acquired or disposed of is concentrated in a single identifiable asset or a group of similar identifiable assets, the set and activities is not a business. The guidance is effective for fiscal years, and interim periods within those years, beginning December 15, 2017. The amendments in this update will be applied on a prospective basis. The Company expects that most acquisitions of real estate or in-substance real estate will not meet the revised definition of a business because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e. land, buildings, and related intangible assets). A significant difference between the accounting for an asset acquisition and a business combination is that transaction costs are capitalized for an asset acquisition, rather than expensed for a business combination.
In February 2017, the FASB issued an accounting update which clarifies the scope and application of recently established guidance on recognition of gains and losses from derecognition of non-financial assets, and defines in-substance non-financial assets. In addition, the guidance clarifies the accounting for partial sales of non-financial assets to be more consistent with the accounting for sale of a business. Specifically, in a partial sale to a non-customer, when a non-controlling interest is received or retained, the latter is considered a non-cash consideration and measured at fair value, which would result in full gain or loss recognized upon sale. This guidance has the same effective date as the new revenue guidance, which is January 1, 2018, with early adoption permitted beginning January 1, 2017. Both the revenue guidance and this update must be adopted concurrently. While the transition method is similar to the new revenue guidance, either full retrospective or modified retrospective, the transition approach need not be aligned between both updates. 


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

3.
Real Estate Debt Investments
The following table presents CRE debt investments as of March 31, 2017 (dollars in thousands):
 
 
 
 
 
 
 
 
 
 
Weighted Average
 
Floating Rate as % of Principal Amount
Asset type:
 
Count
 
Principal
Amount(1)
 
Carrying Value(2)
 
Allocation by Investment Type(3)
 
Fixed
Rate
 
Spread
over
LIBOR
(4)
 
Total Unleveraged
Current Yield
 
First mortgage loans(5)
 
22
 
$
723,963

 
$
699,345

 
79.6
%
 

 
5.09
%
 
5.75
%
 
100.0
%
Mezzanine loan
 
1
 
20,528

 
20,600

 
2.3
%
 
14.00
%
 

 
14.00
%
 

Subordinate interests(5)
 
3
 
164,877

 
157,214

 
18.1
%
 
12.44
%
 
12.75
%
 
12.62
%
 
17.4
%
Total/ Weighted average
 
26
 
$
909,368

 
$
877,159

 
100.0
%
 
12.65
%
 
5.33
%
 
7.18
%
 
82.8
%
____________________________________________
(1)
Includes future funding commitments of $25.2 million for first mortgage loans and $8.6 million for subordinate interests.
(2)
Certain CRE debt investments serve as collateral for financing transactions, including carrying value of $454.2 million for Term Loan Facilities, as defined in Note 7, “Borrowings,” and other notes payable as well as $245.2 million for a securitization financing transaction executed in November 2016, Securitization 2016-1, as defined in Note 7. The remainder is unleveraged.
(3)
Based on principal amount.
(4)
Includes a fixed minimum LIBOR rate (“LIBOR floor”), as applicable. As of March 31, 2017, the Company had $545.2 million principal amount of floating-rate loans subject to a LIBOR floor with the weighted average LIBOR floor of 0.37%.
(5)
During the three months ended March 31, 2017, the Company originated four first mortgage loans with an aggregate committed principal balance of $144.6 million, including future funding commitments. During the three months ended March 31, 2017, the Company received repayments on one first mortgage loan and one subordinate interest with aggregate committed principal balances of $41.0 million and $24.9 million, respectively.
The following table presents CRE debt investments as of December 31, 2016 (dollars in thousands):
 
 
 
 
 
 
 
 
 
 
Weighted Average
 
Floating Rate as % of Principal Amount
Asset type:
 
Count
 
Principal
Amount(1)
 
Carrying Value(2)
 
Allocation by Investment Type(3)
 
Fixed
Rate
 
Spread
over
LIBOR
(4)
 
Total Unleveraged
Current Yield
 
First mortgage loans
 
19
 
$
620,389

 
$
604,510

 
74.7
%
 

 
5.26
%
 
5.74
%
 
100.0
%
Mezzanine loan
 
1
 
20,528

 
20,631

 
2.5
%
 
14.00
%
 

 
14.00
%
 

Subordinate interests
 
4
 
189,740

 
181,344

 
22.8
%
 
12.69
%
 
12.75
%
 
12.81
%
 
15.1
%
Total/Weighted average
 
24
 
$
830,657

 
$
806,485

 
100.0
%
 
12.84
%
 
5.53
%
 
7.54
%
 
78.1
%
__________________________________________________________
(1)
Includes future funding commitments of $15.9 million for first mortgage loans and $9.3 million for subordinate interests.
(2)
Certain CRE debt investments serve as collateral for financing transactions, including carrying value of $359.3 million for Term Loan Facilities, as defined in Note 7, “Borrowings,” and other notes payable and $245.2 million for a securitization financing transaction executed in November 2016, Securitization 2016-1, as defined in Note 7. The remainder is unleveraged.
(3)
Based on principal amount.
(4)
Includes a fixed minimum LIBOR floor, as applicable. As of December 31, 2016, the Company had $493.9 million principal amount of floating-rate loans subject to a LIBOR floor with the weighted average LIBOR floor of 0.29%.
The following table presents maturities of CRE debt investments based on principal amount, which includes future funding commitments, as of March 31, 2017 (dollars in thousands):
 
Current
Maturity
 
Maturity
Including
Extensions(1)
April 1 to December 31, 2017
$
206,884

 
$

Years Ending December 31:
 
 
 
2018
274,611

 
20,528

2019
291,637

 
208,117

2020
37,850

 
308,700

2021

 
179,063

Thereafter
98,386

 
192,960

Total
$
909,368

 
$
909,368

____________________________________________________________
(1)
Assumes that all debt with extension options will qualify for extension at such maturity according to the conditions set forth in the governing documents.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

As of March 31, 2017, the weighted average maturity, including extensions, of CRE debt investments was 4.1 years.
Credit Quality Monitoring
CRE debt investments are typically loans secured by direct senior priority liens on real estate properties or by interests in entities that directly own real estate properties, which serve as the primary source of cash for the payment of principal and interest. The Company evaluates its debt investments at least quarterly and differentiates the relative credit quality principally based on: (i) whether the borrower is currently paying contractual debt service in accordance with its contractual terms; and (ii) whether the Company believes the borrower will be able to perform under its contractual terms in the future, as well as the Company’s expectations as to the ultimate recovery of principal at maturity. The Company categorizes a debt investment for which it expects to receive full payment of contractual principal and interest payments as “performing.” The Company will categorize a weaker credit quality debt investment that is currently performing, but for which it believes future collection of all or some portion of principal and interest is in doubt, into a category called “performing with a loan loss reserve.” The Company will categorize a weaker credit quality debt investment that is not performing, which the Company defines as a loan in maturity default and/or past due at least 90 days on its contractual debt service payments, as a non-performing loan (“NPL”). The Company’s definition of an NPL may differ from that of other companies that track NPLs.
As of March 31, 2017, all CRE debt investments were performing in accordance with the contractual terms of their governing documents and were categorized as performing loans. There were no real estate debt investments with contractual payments past due as of March 31, 2017 and December 31, 2016. For the three months ended March 31, 2017, one debt investment contributed more than 10% of interest income.
4.
Operating Real Estate
The following table presents operating real estate, net as of March 31, 2017 and December 31, 2016 (dollars in thousands):
 
 
March 31, 2017 (Unaudited)
 
December 31, 2016
Land and improvements
 
$
93,747

 
$
93,707

Buildings and improvements(1)
 
321,629

 
321,420

Subtotal
 
415,376

 
415,127

Less: Accumulated depreciation
 
(18,535
)
 
(15,890
)
Operating real estate, net
 
$
396,841

 
$
399,237

____________________________________________________________
(1)
Includes tenant improvements as well as furnitures, fixtures, and equipment.

For the three months ended March 31, 2017, the Company had one single property with rental and other income equal to or greater than 10% of total revenue.


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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

5.
Investments in Private Equity Funds
The following is a description of investments in private equity funds that own PE Investments either through unconsolidated ventures or direct investments which are recorded as investments in private equity funds at fair value on the consolidated balance sheets. The Company completed the acquisition of a $45.0 million portfolio of PE Investments in March 2015 (“PE Investment I”), a $27.8 million portfolio of PE Investments in August 2015 (“PE Investment II”), and a $317.6 million portfolio of PE Investments in September 2016 (“PE Investment III”). The Company elected the fair value option for PE Investments, which include both cost method and equity method investments. As a result, the Company records equity in earnings (losses) based on the change in fair value for its share of the projected future cash flow from one period to another. All PE Investments are considered variable interest entities. Refer to Note 2, “Summary of Significant Accounting Policies,” for additional information.
The following table summarizes the Company’s PE Investment acquisitions (dollars in thousands):

PE Investment
 
Initial Closing Date
 
NAV Reference Date(1)
 
Number of Funds(2)
 
Purchase Price
PE Investment I
 
March 20, 2015
 
September 30, 2014
 
6
 
$
45,045

PE Investment II
 
August 4, 2015
 
December 31, 2014
 
3
 
27,788

PE Investment III(3)
 
September 20, 2016
 
March 31, 2016
 
41
 
317,587

Total
 
 
 
 
 
50
 
$
390,420

_______________________________________________________
(1)
Represents the net asset value (“NAV”) date that served as the basis for the purchase price on which the Company agreed to acquire the PE Investment.
(2)
Represents number of underlying fund investments at initial closing date.
(3)
At the time of closing in September 2016, the Company paid $33.9 million to acquire PE Investment III and paid an additional $204.7 million in December 2016. In addition, the Company assumed $44.7 million of deferred purchase price obligations to third parties from the seller, which includes the proportionate share of an obligation owed through a joint investment within PE Investment III, totaling $5.6 million. As of March 31, 2017, $21.0 million in deferred purchase price obligations have been paid and $23.5 million remain outstanding, which includes the Company’s proportionate share of an obligation owed through an unconsolidated joint investment. Refer to Note 8, “Related Party Arrangements,” for additional information.

The following table presents PE Investments as of March 31, 2017 and December 31, 2016 and activity for three months ended March 31, 2017 and 2016 (dollars in thousands):
 
 
Carrying Value(2)
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
PE Investment(1)
 
March 31, 2017 (Unaudited)
 
December 31, 2016
 
Equity in Earnings
 
Distributions
 
Contributions(3)
 
Equity in Earnings
 
Distributions
 
Contributions(3)
PE Investment I
 
$
27,144

 
$
26,949

 
$
952

 
$
757

 
$

 
$
1,055

 
$
4,723

 
$

PE Investment II
 
10,664

 
11,964

 
299

 
1,599

 

 
238

 

 

PE Investment III
 
253,925

 
260,768

 
8,359

 
16,128

 
704

 

 

 

Total
 
$
291,733

 
$
299,681

 
$
9,610

 
$
18,484

 
$
704

 
$
1,293

 
$
4,723

 
$

_________________________________________________________
(1)
The initial closing date for PE Investment I, PE Investment II, and PE Investment III was March 20, 2015, August 4, 2015, and September 20, 2016, respectively.
(2)
Includes a cumulative unrealized loss of $2.2 million and an unrealized gain of $2.5 million for PE Investment I and II, respectively, as of March 31, 2017 and December 31, 2016.
(3)
Includes initial investments, before closing statement adjustments for distributions and contributions, and subsequent contributions, including deferred purchase price fundings.


24

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NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

6.
Real Estate Securities, Available for Sale
CRE securities are comprised of CMBS backed by a pool of CRE loans which are typically well-diversified by type and geography. The following table presents CMBS investments as of March 31, 2017 and December 31, 2016 (dollars in thousands):
 
 
 
 
 
 
 
Cumulative Unrealized
on Investments
 
 
 
Weighted Average
 
 
 
Principal
Amount
(1)
 
Amortized
Cost
 
 
Fair
Value
 
 
 
Unleveraged
Current
Yield
As of Date:
Count
 
Gain
 
(Loss)
 
 
Coupon
 
March 31, 2017 (Unaudited)(1)(2)
14
 
$
130,191

 
$
88,371

 
$
3,681

 
$
(88
)
 
$
91,964

 
3.42
%
 
9.73
%
December 31, 2016(2)
11
 
128,181

 
85,773

 
2,042

 
(878
)
 
86,937

 
3.42
%
 
9.73
%
___________________________________________________
(1)
As of March 31, 2017, certain CRE securities serve as collateral for financing transactions including carrying value of $59.9 million for the CMBS Credit Facilities, as defined in Note 7, “Borrowings.” The remainder is unleveraged.
(2)
Includes a CRE security with an underlying loan that was non-performing at acquisition. The CRE security was purchased for $26.9 million, net of a $21.3 million discount. As of March 31, 2017, the non-accretable amount of total cash flows was $5.7 million.
The Company recorded a net unrealized gain in OCI of $2.4 million and $2.2 million for the three months ended March 31, 2017 and 2016, respectively.
As of March 31, 2017, the Company held two securities with an aggregate carrying value of $7.3 million with a cumulative unrealized loss of $0.1 million, one of which was in an unrealized loss position for a period of greater than 12 months. Based on management’s quarterly evaluation, no OTTI was identified related to these securities. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities prior to recovery of its amortized cost basis, which may be at maturity.


25

Table of Contents
NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

As of March 31, 2017, the weighted average contractual maturity of CRE securities was 30.5 years with an expected maturity of 7.1 years.
7.
Borrowings
The following table presents borrowings as of March 31, 2017 and December 31, 2016 (dollars in thousands):
 
 
 
 
 
 
 
 
 
March 31, 2017 (Unaudited)
 
December 31, 2016
 
Capacity
 
Recourse vs.
Non-Recourse
 
Final
Maturity
 
Contractual
Interest Rate
 
Principal
Amount(1)
 
Carrying
Value(1)
 
Principal
Amount
(1)

Carrying
Value
(1)
Securitization bonds payable, net
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securitization 2016-1
 
 
Non-recourse
(2) 
Sep-31
 
LIBOR + 2.08%
 
$
192,775

 
$
190,508

 
$
193,980

 
$
191,315

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage and other notes payable, net
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Industrial
 
 
Non-recourse
(2) 
Jul-25
 
4.31%
 
250,000

 
249,238

 
250,000

 
249,215

Multi-tenant office
 
 
Non-recourse
(2) 
Aug-20
(3) 
LIBOR + 1.90%
 
91,771

 
91,143

 
88,170

 
87,426

Other notes payable(4)
 
 
Limited Recourse
(4) 
Dec-20
(5) 
LIBOR + 2.65%
 
39,868

 
39,582

 
39,868

 
39,540

Subtotal mortgage and other notes payable, net
 
 
 
 
 
381,639

 
379,963

 
378,038

 
376,181

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Term loan facilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Citibank facility
$
150,000

 
Limited Recourse
(7) 
Oct-19
(6) 
LIBOR + 2.50%
(8) 
54,750

 
54,750

 
54,750

 
54,750

Deutsche Bank facility
200,000

 
Limited Recourse
(9) 
Jul-19
(10) 
LIBOR + 2.42%
(8) 
26,742

 
26,742

 
47,242

 
47,242

Morgan Stanley facility
300,000

 
Limited Recourse
(4) 
(11) 
 
LIBOR + 2.47%
(8) 
200,281

 
200,281

 
101,000

 
101,000

Subtotal term loan facilities
$
650,000

 
 
 
 
 
 
 
281,773

 
281,773

 
202,992

 
202,992

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CMBS credit facilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Citibank facility
 
 
Recourse
 
Various
(12) 
LIBOR + 1.50%
(8) 
9,904

 
9,904

 
9,887

 
9,887

JP Morgan facility
 
 
Recourse
 
Various
(12) 
LIBOR + 1.50%
(8) 
33,034

 
33,034

 
28,528

 
28,528

Subtotal CMBS credit facilities
 
 
 
 
 
 
 
42,938

 
42,938

 
38,415

 
38,415

Subtotal

 
 
 
 
 
 
 
324,711

 
324,711

 
241,407

 
241,407

Total(13)

 
 
 
 
 
 
 
$
899,125

 
$
895,182

 
$
813,425

 
$
808,903

_______________________________________________
(1)
Difference between principal amount and carrying value of securitization bonds payable and mortgage and other notes payable is attributable to deferred financing costs, net.
(2)
Subject to customary non-recourse carveouts.
(3)
The initial maturity of the mortgage payable is August 2018, with a two-year extension available at the Company’s option, which may be subject to the satisfaction of certain customary conditions set forth in the governing documents.
(4)
Recourse solely with respect to 25.0% of the financed amount. Relates to financing obtained for a CRE debt investment.
(5)
The initial maturity of the note payable is December 2018, with two one-year extensions available at the Company’s option, which may be subject to the satisfaction of certain customary conditions set forth in the governing documents.
(6)
The initial maturity of the Citibank Facility is October 2018, with a one-year extension available, which may be subject to the satisfaction of certain customary conditions set forth in the governing documents.
(7)
Recourse solely with respect to 25.0% of the financed amount for assets with a lender debt yield equal to or greater than 10.0% at the time of financing plus 100.0% of the financed amount for assets with a lender debt yield less than 10.0% at the time of financing.
(8)
Represents the weighted average spread as of March 31, 2017. The contractual interest rate depends upon asset type and characteristics and ranges from one-month to three-month LIBOR plus 1.50% to 2.75%.
(9)
Recourse solely with respect to the greater of: (i) 25.0% of the financed amount of stabilized loans plus the financed amount of transitional loans, as further defined in the governing documents; or (ii) the lesser of $25.0 million or the aggregate financed amount of all loans.
(10)
The Company has exercised the second of four, one-year extensions available at the Company’s option, respectively. These extensions may be subject to the satisfaction of certain customary conditions set forth in the governing documents.
(11)
The initial maturity of the Morgan Stanley Facility is June 2019. The Company may, at its option, extend the facility for one-year periods indefinitely, subject to the approval of Morgan Stanley.
(12)
The maturity dates on the CMBS Credit Facilities are dependent upon asset type and will typically range from one to three months.
(13)
Secured by collateral comprised of certain CRE debt, securities, equity investments and loan collateral receivable with a carrying value of $1.2 billion as of March 31, 2017.



26

Table of Contents
NORTHSTAR REAL ESTATE INCOME II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

The following table presents scheduled principal on borrowings, based on final maturity as of March 31, 2017 (dollars in thousands):
 
Total
 
Securitization Bonds Payable
 
Mortgage and Other Notes Payable
 
Credit
Facilities
 
April 1 to December 31, 2017
$
42,938

 
$

 
$

 
$
42,938

(1) 
Years Ending December 31:
 
 
 
 
 
 
 
 
2018

 

 

 

 
2019
81,492

 

 

 
81,492

 
2020
331,920

 

 
131,639

 
200,281

 
2021

 

 

 

 
Thereafter
442,775

 
192,775

 
250,000

 

 
Total
$
899,125

 
$
192,775

 
$
381,639

 
$
324,711

 
_______________________________________________
(1)
Represents CMBS Facilities borrowings, which have maturities typically ranging and renewing on a continuous basis from one to three months.
Securitization Financing Transactions
In November 2016, the Company entered into a $284.2 million securitization financing transaction (“Securitization 2016-1”). The transaction was collateralized by a pool of 10 CRE debt investments with a committed aggregate principal balance of $254.7 million primarily originated by the Company and three senior participations with a committed aggregate principal balance of $29.5 million originated by NorthStar Real Estate Income Trust, Inc. (“NorthStar Income”), a company managed by an affiliate of the Sponsor. A total of $194.0 million of permanent, non-recourse, non-mark-to-market investment-grade securitization bonds were issued, representing an advance rate of 68.3%.

An affiliate of NorthStar Income retained $14.9 million of junior participations in the collateral it contributed. As a result of U.S. GAAP requirements for transfers of financial assets, the senior participations are recorded as Loan collateral receivable, related party, on the Company’s consolidated balance sheets. Refer to Note 2, “Summary of Significant Accounting Policies” for additional information.

Securitization 2016-1 is considered a voting interest entity as the Company has all of the controlling financial interest in the entity and as such, is consolidated by the Company. An affiliate of the Sponsor was appointed special servicer of Securitization 2016-1.
In the event of breaches of certain representations and warranties or a defect in the document of any of the contributed assets to Securitization 2016-1 provided at the time the Company entered into Securitization 2016-1 and contributed the loans that serve as collateral for Securitization 2016-1, the Company may be required to repurchase certain of those loans or replace the affected contributed asset or make a loss of value payment. These obligations do not relate to the credit performance of the loans contributed to Securitization 2016-1, but only to breaches of specific representations and warranties or a defect in the document of any of the contributed assets to Securitization 2016-1. Since inception, the Company has not been required to make any repurchases or replace the affected contributed asset or make a loss of value payment nor has the Company received any notice of assertion of a potential breach of representation and warranty or a defect in the document of any of the contributed assets to Securitization 2016-1. Any payment to repurchase a loan or replace the affected contributed asset or make a loss of value payment would impact the Company’s liquidity. Dependent upon the size of any such payment, the impact to liquidity could be material.
Term Loan Facilities
The Company, through subsidiaries, has entered into credit facility agreements with multiple global financial institutions to provide an aggregate principal amount of up to $650.0 million to finance the origination of first mortgage loans and senior loan participations secured by CRE (“Term Loan Facilities”). The Company agreed to guarantee certain obligations under the Term Loan Facilities, which contain representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary for agreements of this type. The Term Loan Facilities act as revolving loan facilities that can be paid down as assets are repaid or sold and re-drawn upon for new investments. As of March 31, 2017, the Company was in compliance with all of its financial covenants under the Term Loan Facilities.
As of March 31, 2017, the Company had $454.2 million carrying value of CRE debt investments financed with $281.8 million under the Term Loan Facilities.


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(Unaudited)

CMBS Credit Facilities
In October 2015, January 2016, and April 2016, the Company entered into master repurchase agreements (“Merrill Lynch Facility,” “Citibank Facility,” and “JP Morgan Facility,” respectively, and collectively the “CMBS Credit Facilities”) to finance CMBS investments. The CMBS Credit Facilities are on a recourse basis and contain representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary for agreements of this type.
As of March 31, 2017, the Company had $59.9 million carrying value of CRE securities financed with $42.9 million under its CMBS Credit Facilities. As of March 31, 2017, the Company has not utilized the Merrill Lynch Facility.
8.
Related Party Arrangements
Advisor
Subject to certain restrictions and limitations, the Advisor is responsible for managing the Company’s affairs on a day-to-day basis and for identifying, originating, acquiring and asset managing investments on behalf of the Company. The Advisor may delegate certain of its obligations to affiliated entities, which may be organized under the laws of the United States or foreign jurisdictions. References to the Advisor include the Advisor and any such affiliated entities. For such services, to the extent permitted by law and regulations, the Advisor receives fees and reimbursement from the Company. Below is a description and table of the fees and reimbursements incurred to the Advisor.
In June 2016, the advisory agreement was renewed for an additional one-year term commencing on June 30, 2016, with terms identical to those in effect through June 30, 2016.
Fees to Advisor
Asset Management Fee
The Advisor receives a monthly asset management fee equal to one-twelfth of 1.25% of the sum of the amount funded or allocated for CRE investments, including expenses and any financing attributable to such investments, less any principal received on debt and securities investments (or the proportionate share thereof in the case of an investment made through a joint venture).
Incentive Fee
The Advisor is entitled to receive distributions equal to 15.0% of net cash flows of the Company, whether from continuing operations, repayment of loans, disposition of assets or otherwise, but only after stockholders have received, in the aggregate, cumulative distributions equal to their invested capital plus a 7.0% cumulative, non-compounded annual pre-tax return on such invested capital.
Acquisition Fee
The Advisor also receives fees for providing structuring, diligence, underwriting advice and related services in connection with real estate acquisitions equal to 1.0% of the amount funded or allocated by the Company to originate or acquire investments, including acquisition costs and any financing attributable to such investments (or the proportionate share thereof in the case of an investment made through a joint venture). A fee paid to the Advisor in connection with or related to the origination or acquisition of CRE debt investments is included in CRE debt investments, net on the consolidated balance sheets and is amortized to interest income over the life of the investment using the effective interest method. An acquisition fee incurred related to an equity investment will generally be expensed as incurred. A fee paid to the Advisor in connection with an acquisition of an equity or debt investment in an unconsolidated joint venture is included in investments in unconsolidated ventures on the consolidated balance sheets.
Disposition Fee
For substantial assistance in connection with the sale of investments and based on the services provided, as determined by the Company’s independent directors, the Advisor receives a disposition fee up to 1.0% of the contract sales price of each CRE investment sold. The Company does not pay a disposition fee upon the maturity, prepayment, workout, modification or extension of a CRE debt investment unless there is a corresponding fee paid by the borrower, in which case the disposition fee is the lesser of: (i) 1.0% of the principal amount of the CRE debt investment prior to such transaction; or (ii) the amount of the fee paid by the borrower in connection with such transaction. If the Company takes ownership of a property as a result of a workout or foreclosure of a CRE debt investment, the Company will pay a disposition fee upon the sale of such property. A disposition fee from the sale of a CRE investment is generally expensed and included in asset management and other fees - related party in the Company’s consolidated statements of operations. A disposition fee for a CRE debt investment incurred in a transaction other than a sale is


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(Unaudited)

included in CRE debt investments, net on the consolidated balance sheets and is amortized to interest income over the life of the investment using the effective interest method.
Reimbursements to Advisor
Operating Costs
The Advisor is entitled to receive reimbursement for direct and indirect operating costs incurred by the Advisor in connection with administrative services provided to the Company. The Advisor allocates, in good faith, indirect costs to the Company related to the Advisor’s and its affiliates’ employees, occupancy and other general and administrative costs and expenses in accordance with the terms of, and subject to the limitations contained in, the advisory agreement with the Advisor. The indirect costs include the Company’s allocable share of the Advisor’s compensation and benefit costs associated with dedicated or partially dedicated personnel who spend all or a portion of their time managing the Company’s affairs, based upon the percentage of time devoted by such personnel to the Company’s affairs. The indirect costs also include rental and occupancy, technology, office supplies, travel and entertainment and other general and administrative costs and expenses. However, there is no reimbursement for personnel costs related to executive officers (although there may be reimbursement for certain executive officers of the Advisor) and other personnel involved in activities for which the Advisor receives an acquisition fee or a disposition fee. The Advisor allocates these costs to the Company relative to its and its affiliates’ other managed companies in good faith and has reviewed the allocation with the Company’s board of directors, including its independent directors. The Advisor will update the board of directors on a quarterly basis of any material changes to the expense allocation and will provide a detailed review to the board of directors, at least annually, and as otherwise requested by the board of directors. The Company reimburses the Advisor quarterly for operating costs (including the asset management fee) based on a calculation for the four preceding fiscal quarters not to exceed the greater of: (i) 2.0% of its average invested assets; or (ii) 25.0% of its net income determined without reduction for any additions to reserves for depreciation, loan losses or other similar non-cash reserves and excluding any gain from the sale of assets for that period. Notwithstanding the above, the Company may reimburse the Advisor for expenses in excess of this limitation if a majority of the Company’s independent directors determines that such excess expenses are justified based on unusual and non-recurring factors. The Company calculates the expense reimbursement quarterly based upon the trailing twelve-month period.
Organization and Offering Costs
The Advisor is entitled to receive reimbursement for organization and offering costs paid on behalf of the Company in connection with the Offering. The Company is obligated to reimburse the Advisor as applicable, for organization and offering costs to the extent the aggregate of selling commissions, dealer manager fees, distribution fees and other organization and offering costs do not exceed 15.0% of gross proceeds from the Offering. The Advisor does not expect reimbursable organization and offering costs, excluding selling commissions and dealer manager fees, to exceed $15.0 million, or 1.0% of the total proceeds available to be raised from the Primary Offering. The Company shall not reimburse the Advisor for any organization and offering costs that the Company’s independent directors determine are not fair and commercially reasonable to the Company.
Dealer Manager
Selling Commissions, Dealer Manager Fees, and Distribution Fees
As a result of the Primary Offering closing, effective November 9, 2016, the Company no longer pays the Dealer Manager selling commissions and dealer manager fees under a dealer manager agreement.
Pursuant to a dealer manager agreement, the Company pays the Dealer Manager an ongoing distribution fee of up to 1.0% annually of gross proceeds from the sale of Class T shares sold in the Primary Offering, all of which is available to be reallowed to participating broker-dealers. The Dealer Manager will cease receiving distribution fees with respect to each Class T share upon the earliest to occur of the following: (i) a listing of the Company’s shares of common stock on a national securities exchange; (ii) such Class T share is no longer outstanding; (iii) the Dealer Manager’s determination that total underwriting compensation, with respect to all Class A shares and Class T shares would be in excess of 10% of the gross proceeds of the Primary Offering; or (iv) the end of the month in which total underwriting compensation, with respect to the Class T shares held by a stockholder within his or her particular account, would be in excess of 10% of the stockholder’s total gross investment amount at the time of purchase of the primary Class T shares held in such account.
During the three months ended March 31, 2017, the Company recorded a present value adjustment to the estimated liability of distribution fees totaling $0.1 million. As of March 31, 2017, the estimated liability for the present value of the expected future distribution fees payable to the Dealer Manager, which is included in due to related party on the Company’s consolidated balance


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(Unaudited)

sheets, with an offset to additional paid-in capital, was $4.7 million. The Company began issuing Class T shares in October 2015 and during the second quarter of 2016, commenced recording the estimated liability for future distribution fees payable related to all outstanding Class T shares. As of December 31, 2016, the estimated liability was $5.0 million.
No selling commissions, dealer manager fees, or distribution fees are paid for sales pursuant to the DRP or for shares that were sold pursuant to the Company’s distribution support agreement (“Distribution Support Agreement”).
Summary of Fees and Reimbursements
The following table presents the fees and reimbursements incurred and paid to the Advisor and the Dealer Manager for the three months ended March 31, 2017 and the amounts due to related party as of March 31, 2017 and December 31, 2016 (dollars in thousands):

 
 
 
 
Due to Related Party as of
December 31, 2016
 
Three Months Ended
March 31, 2017
 
Due to Related Party as of
March 31, 2017 (Unaudited)
Type of Fee or Reimbursement
 
Financial Statement Location
 
 
Incurred
 
Paid
 
Fees to Advisor Entities
 
 
 
 
 
 
 
 
 
 
Asset management
 
Asset management and other fees-related party
 
$
17

 
$
5,284

 
$
(5,285
)
 
$
16

Acquisition(1)
 
Real estate debt investments, net /
Asset management and other fees-related party
 

 
1,446

 
(780
)
 
666

Disposition(1)
 
Real estate debt investments, net /
Asset management and other fees-related party
 
85

 
709

 
(384
)
 
410

Reimbursements to Advisor Entities
 
 
 
 
 
 
 
 
 

Operating costs(2)
 
General and administrative expenses
 
11

 
2,984

 
(2,943
)
 
52

Offering
 
Cost of capital(3)
 
272

 

 
(272
)
 

Distribution Fees
 
Cost of capital(3)
 
4,962

 
80

 
(372
)
 
4,670

Total
 
 
 
$
5,347

 
$
10,503

 
$
(10,036
)
 
$
5,814

_________________________________________________
(1)
Acquisition/disposition fees incurred to the Advisor related to CRE debt investments are generally offset by origination/exit fees paid to the Company by borrowers if such fees are required from the borrower. Acquisition fees related to equity investments are included in asset management and other fees - related party in the consolidated statements of operations. The Advisor may determine to defer fees or seek reimbursement. From inception through March 31, 2017, the Advisor waived $3.7 million of acquisition fees related to CRE securities and PE Investments.
(2)
As of March 31, 2017, the Advisor has incurred unreimbursed operating costs on behalf of the Company of $15.5 million, that remain eligible to allocate to the Company.
(3)
Cost of capital is included in net proceeds from issuance of common stock in the Company’s consolidated statements of equity.
Investment Activity
In February 2016, the Company purchased a 51.0% interest in a mezzanine loan for $20.5 million at par and CMBS with a face value of $48.2 million at a discount to par of $21.3 million, from NorthStar Realty. The mezzanine loan purchase was in conjunction with a third party purchase of the remaining interest and bears interest at a fixed rate of 14.0%. The loan is secured by a to-be-completed multifamily property located in Queens, NY. The bond was purchased with an unlevered yield of 16.5%. As of purchase date, the weighted average expected maturity of the CMBS was 5.3 years. The purchases were approved by the Company’s board of directors, including all of its independent directors. Subsequent to March 31, 2017, the mezzanine loan was repaid in full.
In September 2016, the Company completed the acquisition of a diversified portfolio of limited partnership or similar equity interests in real estate private equity funds, from NorthStar Realty (“PE Investment III”). At acquisition, PE Investment III was comprised of interests in 41 funds managed by 20 institutional-quality sponsors and had an aggregate reported NAV of approximately $344.3 million as of March 31, 2016 (the “Record Date”). The funds hold interests in assets that are diversified geographically across 24 states and internationally and diversified by investment type, including mixed-use, multifamily, office and hotel properties.
The Company acquired PE Investment III at a price equal to 92.25% of the NAV as of the Record Date with $33.9 million paid at the closing (reflecting $34.3 million of net distributions due to the Company as of the closing date) and $204.7 million paid in December 2016. In addition, the Company assumed approximately $44.7 million of deferred purchase price obligations to third parties from whom NorthStar Realty had originally acquired certain of the fund interests within PE Investment III, which includes the proportionate share of an obligation owed through a joint investment within PE Investment III, totaling $5.6 million. As of


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March 31, 2017, $21.0 million in deferred purchase price obligations have been paid. The Company also agreed to indemnify NorthStar Realty in connection with NorthStar Realty’s continuing guarantee of the payment of such deferred obligations. The transaction was approved by the Company’s board of directors, including all of its independent directors, and supported by an independent third-party valuation of PE Investment III.
In September 2016, the Company originated a $98.4 million subordinate interest in an industrial portfolio (the “Industrial Portfolio”), sponsored and owned by an unaffiliated third party. In connection with the transaction, the third-party sponsor redeemed an interest in an industrial portfolio historically held by NorthStar Realty.
In November 2016, the Company entered into a $284.2 million securitization financing transaction (“Securitization 2016-1”). Securitization 2016-1 was collateralized by a pool of 10 CRE debt investments with a committed aggregate principal balance of $254.7 million primarily originated by the Company and three senior participations with a committed aggregate principal balance of $29.5 million originated by NorthStar Income, a company managed by an affiliate of the Sponsor. An affiliate of the Sponsor was appointed special servicer of Securitization 2016-1.
9.
Equity-Based Compensation
The Company adopted a long-term incentive plan, as amended (the “Plan”), which it may use to attract and retain qualified officers, directors, employees and consultants, as well as an independent directors compensation plan, which is a component of the Plan. Pursuant to the Plan, as of March 31, 2017, the Company’s independent and non-management directors were granted a total of 59,785 Class A shares of restricted common stock for an aggregate $0.6 million, based on the share price on the date of each grant. Unvested shares totaled 20,700 and 21,651 as of March 31, 2017 and December 31, 2016, respectively. The restricted stock granted prior to 2015 generally vests quarterly over four years and the restricted stock granted in and subsequent to 2015 generally vests quarterly over two years. However, the stock will become fully vested on the earlier occurrence of: (i) the termination of the independent or non-management director’s service as a director due to his or her death or disability; or (ii) a change in control of the Company. A maximum of 2,000,000 shares of restricted common stock may be granted, of which 1,940,215 remain available for future grants as of March 31, 2017.
The Company recognized equity-based compensation expense of $91,718 and $27,611 for the three months ended March 31, 2017 and 2016, respectively, related to the issuance of restricted stock to the independent and non-management directors, which was recorded in general and administrative expenses in the consolidated statements of operations.
10.
Stockholders’ Equity
Common Stock from Primary Offering
The Company’s Primary Offering closed effective November 9, 2016. From inception through the close of the Primary Offering, the Company issued 109.2 million shares of common stock, generating gross proceeds of $1.1 billion.
Distribution Reinvestment Plan
The Company adopted a DRP through which common stockholders may elect to reinvest an amount equal to the distributions declared on their shares in additional shares of the Company’s common stock in lieu of receiving cash distributions. As a result of a reallocation of $150.0 million in unsold shares from the Primary Offering to the DRP, the Company may offer up to $300.0 million in shares pursuant to the DRP.
Effective on December 28, 2016, the purchase price for shares in the DRP was $9.26, which is equal to the estimated value per share of the Company’s common stock as of September 30, 2016 (the “Valuation Date”) until such time as the Company establishes a new estimated per share value, at which time the purchase price will adjust to 100% of such estimated value per share. The Company currently expects that the next estimated value per share will be based upon the assets and liabilities as of September 30, 2017.
Previously, following the close of the Primary Offering effective November 9, 2016, the purchase price for shares in the DRP was equal to $9.05, which was equal to the estimated value per share of the Company’s common stock as of September 30, 2015. During the Primary Offering from November 16, 2015 to November 9, 2016, the purchase price for shares for shares in the DRP was $9.79 for Class A shares and $9.25 for Class T shares. Until November 16, 2015, the initial purchase price per share in the DRP was $9.50.


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No selling commissions or dealer manager fees are paid on shares issued pursuant to the DRP. The board of directors of the Company may amend, suspend or terminate the DRP for any reason upon ten-days’ notice to participants, except that the Company may not amend the DRP to eliminate a participant’s ability to withdraw from the DRP.
For the three months ended March 31, 2017, the Company issued 0.9 million shares of common stock totaling $8.7 million of gross offering proceeds pursuant to the DRP. For the year ended December 31, 2016, the Company issued 3.3 million shares of common stock totaling $32.1 million of gross offering proceeds pursuant to the DRP. From inception through March 31, 2017, the Company issued 6.7 million shares of common stock totaling $64.1 million of gross offering proceeds pursuant to the DRP.
Distributions
Distributions to stockholders are declared quarterly by the board of directors of the Company and are paid monthly based on a daily amount of $0.001917808 per share of Class A common stock and $0.001917808 per share of Class T common stock less the distribution fees that are payable with respect to such Class T Shares, which is equivalent to an annualized distribution amount of $0.70 per share of the Company’s common stock, less the distribution fee on Class T Shares. Distributions are generally paid to stockholders on the first business day of the month following the month for which the distribution has accrued.
The following table presents distributions declared for the three months ended March 31, 2017 (dollars in thousands):
 
Distributions(1)
Period
Cash
 
DRP
 
Total
January
$
3,652

 
$
2,999

 
$
6,651

February
3,287

 
2,715

 
6,002

March
3,711

 
3,007

 
6,718

Total
$
10,650

 
$
8,721

 
$
19,371

_________________________________________________
(1)
Represents distributions declared for the period, even though such distributions are actually paid to stockholders the month following such period.
Share Repurchase Program
The Company adopted a share repurchase program that may enable stockholders to sell their shares to the Company in limited circumstances (the “Share Repurchase Program”). The Company may not repurchase shares unless a stockholder has held shares for one year. However, the Company may repurchase shares held less than one year in connection with a stockholder’s death or qualifying disability. The Company is not obligated to repurchase shares under the Share Repurchase Program. The Company may amend, suspend or terminate the Share Repurchase Program at its discretion at any time, subject to certain notice requirements. For the three months ended March 31, 2017, the Company repurchased 0.5 million shares totaling $4.5 million pursuant to the Share Repurchase Program. For the year ended December 31, 2016, the Company repurchased 1.0 million shares totaling $9.5 million pursuant to the Share Repurchase Program. The Company funds repurchase requests received during a quarter with proceeds set aside for that purpose which are not expected to exceed proceeds received from its DRP. As of March 31, 2017, there were no unfulfilled repurchase requests.
11.
Non-controlling Interests
Operating Partnership
Non-controlling interests include the aggregate limited partnership interests in the Operating Partnership held by limited partners, other than the Company. Income (loss) attributable to the non-controlling interests is based on the limited partners’ ownership percentage of the Operating Partnership and was de minimis for the three months ended March 31, 2017 and 2016.
Other
Other non-controlling interests represent third-party equity interests in ventures that are consolidated with the Company’s financial statements. For the three months ended March 31, 2017 and 2016, net income attributable to other non-controlling interests was $33,000 and $1,000, respectively.


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(Unaudited)

12.
Fair Value
Fair Value Measurement
The fair value of financial instruments is categorized based on the priority of the inputs to the valuation technique and categorized into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1.
Quoted prices for identical assets or liabilities in an active market.
Level 2.
Financial assets and liabilities whose values are based on the following:
a)
Quoted prices for similar assets or liabilities in active markets.
b)
Quoted prices for identical or similar assets or liabilities in non-active markets.
c)
Pricing models whose inputs are observable for substantially the full term of the asset or liability.
d)
Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.
Level 3.
Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement.
Determination of Fair Value
The following is a description of the valuation techniques used to measure fair value of assets accounted for at fair value on a recurring basis and the general classification of these instruments pursuant to the fair value hierarchy.
PE Investments
The Company accounts for PE Investments at fair value which is determined based on a valuation model using assumptions for the timing and amount of expected future cash flow for income and realization events for the underlying assets in the funds and discount rate. This fair value measurement is generally based on unobservable inputs and, as such, is classified as Level 3 of the fair value hierarchy. The Company is not using the NAV (practical expedient) of the underlying funds for purposes of determining fair value.
Real Estate Securities
CRE securities are generally valued using a third-party pricing service or broker quotations. These quotations are not adjusted and are based on observable inputs that can be validated, and as such, are classified as Level 2 of the fair value hierarchy. Certain CRE securities may be valued based on a single broker quote or an internal price which may have less observable pricing, and as such, would be classified as Level 3 of the fair value hierarchy. Management determines the prices are representative of fair value through a review of available data, including observable inputs, recent transactions as well as its knowledge of and experience in the market.
Derivative Instruments
Derivative instruments are valued using a third-party pricing service. These quotations are not adjusted and are generally based on valuation models with observable inputs such as interest rates and contractual cash flow, and as such, are classified as Level 2 of the fair value hierarchy. The derivative instruments are recorded within other liabilities on the Company’s consolidated balance sheets.


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Fair Value Hierarchy
Financial assets recorded at fair value on a recurring basis are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table presents financial assets that were accounted for at fair value on a recurring basis as of March 31, 2017 and December 31, 2016 by level within the fair value hierarchy (dollars in thousands):